<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended: December 31, 1997
or
[ ] Transition Report Pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934
Commission file number: 0-25000
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
---------------------------------------------
(Exact name of registrant as specified in its charter)
ML Principal Protection Trading L.P.
(formerly, ML Principal Protection Plus Trading L.P.)
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(Rule 140 Co-Registrant)
13-3750642 (Registrant)
DELAWARE 13-3775509 (Co-Registrant)
- ------------------------------- --------------------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
C/O MERRILL LYNCH INVESTMENT PARTNERS INC.
MERRILL LYNCH WORLD HEADQUARTERS
WORLD FINANCIAL CENTER
SOUTH TOWER, 6TH FLOOR, NEW YORK, NY 10080-6106
------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 236-5662
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT
TO SECTION 12(g) OF THE ACT: Limited Partnership Units
----------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Aggregate market value of the voting and non-voting stock held by non-affiliates
of the registrant: the registrants are limited partnerships; as of February 1,
1998, limited partnership units with an aggregate value of $97,854,937 were
outstanding and held by non-affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's "1997 Annual Report and Independent Auditors' Report," the
annual report to security holders for the fiscal year ended December 31, 1997,
is incorporated by reference into Part II, Item 8, and Part IV hereof and filed
as an Exhibit herewith.
<PAGE>
ML PRINCIPAL PROTECTION L.P.
ANNUAL REPORT FOR 1997 ON FORM 10-K
Table of Contents
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PART I
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<TABLE>
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PAGE
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<S> <C> <C>
Item 1. Business............................................................ 1
Item 2. Properties.......................................................... 9
Item 3. Legal Proceedings................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders................. 9
PART II
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Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................... 9
Item 6. Selected Financial Data........................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 19
Item 8. Financial Statements and Supplementary Data....................... 19
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 19
PART III
--------
Item 10. Directors and Executive Officers of the Registrant............... 20
Item 11. Executive Compensation........................................... 22
Item 12. Security Ownership of Certain Beneficial Owners and Management... 22
Item 13. Certain Relationships and Related Transactions................... 22
PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.... 23
</TABLE>
-i-
<PAGE>
PART I
ITEM 1: BUSINESS
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(a) General Development of Business:
-------------------------------
ML Principal Protection L.P. (formerly, ML Principal Protection Plus
L.P.) (the "Partnership" or the "Fund") was organized under the Delaware Revised
Uniform Limited Partnership Act on January 3, 1994 and began trading operations
on October 12, 1994. The Partnership changed its name to ML Principal
Protection L.P. as of July 1, 1996. The Fund is a multi-strategy, multi-market
managed futures investment employing a range of proprietary strategies
diversified across major markets of the global economy -- financials,
currencies, energy, metals and agriculture. The Fund trades in the
international futures and forward markets under the direction of multiple
independent professional advisors (the "Trading Advisors," or the "Advisors").
The Fund's objectives are achieving, through speculative trading, long-term
capital appreciation while controlling performance volatility.
Merrill Lynch Investment Partners Inc. (the "General Partner" or
"MLIP") acts as the general partner of the Partnership, and selects and
allocates the Fund's assets among the Advisors, each of which trades
independently of the others. MLIP also determines what percentage of the Fund's
assets to allocate to trading and what percentage to hold in reserve. Merrill
Lynch Futures Inc. (the "Commodity Broker" or "MLF") is the Partnership's
commodity broker. Merrill Lynch Asset Management, L.P. ("MLAM") provides cash
management services to the Partnership, pursuant to guidelines established by
MLIP for which MLAM assumes no responsibility, investing Fund assets in
securities issued by the U.S. Government and its agencies ("Government
Securities"). The General Partner is a wholly-owned subsidiary of Merrill Lynch
Group Inc., which in turn is a wholly-owned subsidiary of Merrill Lynch & Co.,
Inc. ("ML&Co."). The Commodity Broker is an indirect wholly-owned subsidiary of
ML&Co. (ML&Co. and its affiliates are herein sometimes referred to as "Merrill
Lynch.")
The Partnership does not trade directly but rather through a
subsidiary limited partnership, ML Principal Protection Trading L.P. (formerly,
ML Principal Protection Plus Trading, L.P.) (the "Trading Partnership"), of
which the General Partner is the general partner and the Partnership the sole
limited partner. See Item 1(c), "Narrative Description of Business -- Two-Tier
Structure of the Fund."
The Fund offers its units of limited partnership interest ("Units")
and receives and processes subscriptions, on a continuous basis, throughout each
calendar quarter at $100 per Unit. Investors whose subscriptions are accepted
at any time during a calender quarter are admitted to the Fund as Limited
Partners as of the beginning of the immediately following quarter. Investors'
customer securities accounts are debited in the amount of their subscriptions on
settlement dates throughout each quarter shortly after their subscriptions are
accepted by MLIP. Subscription proceeds received during a quarter are held in
escrow pending investment in Units as of the beginning of the following quarter.
All interest earned on subscriptions while held in escrow is paid to the
investors on or about the date that Units are issued to them or their
subscription is rejected.
The Units sold at the beginning of each calendar quarter (and also May
1, 1997) are sold in separate series, each of which has its own Net Asset Value.
All series trade pursuant to the same Advisor combination, but because they
begin trading at different times they have different Net Asset Values and may
have different percentages of their capital invested in the Trading Partnership
and allocated to the Trading Advisors for management.
Only the assets attributable to each series of Units and allocated to
the Trading Partnership are allocated to the Trading Advisors for management.
All outstanding series of Units currently being issued initially allocate
approximately 75% of their total capital to the Trading Partnership, holding the
rest in reserve at the Partnership level.
MLIP may from time to time direct certain individual Advisors to
manage their Fund accounts as if they were managing up to 50% more equity than
the actual capital allocated to them. This additional leverage is subject to
the condition that the Fund as a whole will not trade as if it had in excess of
20% more equity than actual capital.
-1-
<PAGE>
When the Fund began trading in October 1994, it had an initial
capitalization of $32,000,000. Through December 31, 1997, a total of an
additional $110,143,741 had been invested in the Units at subsequent quarter-end
closings and also a May 1, 1997 closing (the last sale of the Units occurred as
of October 15, 1997). Through December 31, 1997, Units with an aggregate Net
Asset Value of $49,025,567 have been redeemed (including December 31, 1997
redemptions which were not actually paid out until January 1998), the
Partnership's capitalization was $101,226,685, and the Fund had a total of 3,783
Limited Partners.
Through December 31, 1997, the net gain in the Net Asset Value per
Series A Unit (the initial series of Units) was 13.73%, the highest month-end
Net Asset Value of a Series A Unit was $116.48 (after reducing such Net Asset
Value by distributions of $15.50 per Series A Unit ), as of July 1997 , and the
lowest $101.04, as of October 1994.
The outstanding Series of Units are entitled to fixed-rate annual
distributions (which cannot be reduced prior to the first Principal Assurance
Date, as defined below, for such Series) and may also receive certain
discretionary distributions. MLIP does not presently intend to make any
distributions on any series of Units sold after July 16, 1996.
The Fund is a "principal protected" commodity pool. ML&Co. provides
the guarantee described below ML&Co.'s under 1(c), "Narrative Description of
Business -- ML&Co.'s 'Principal Protection' Undertaking to the Fund" that all
Units of any given series will have a Net Asset Value -- after payment of all
fixed-rate annual as well as discretionary distributions on such Units, in the
case of Units sold on or prior to July 16, 1996 -- of at least their initial
$100 subscription price as of a specified date after their issuance (the
"Principal Assurance Date" for such series, seven years after issuance for all
outstanding Series of Units, anticipated to be generally five years after
issuance for Series sold after July 16, 1996). This guarantee does not prevent
substantial losses, but rather serves only as a form of "stop loss," limiting
the maximum loss which investors who retain their Units until such Units'
Principal Assurance Date can incur. In order to protect ML&Co. from any
liability under its guarantee, MLIP imposes substantial opportunity costs on the
Partnership by deleveraging its trading, retaining a substantial portion of the
Fund's assets in the Partnership rather than investing such assets in the
Trading Partnership for allocation to trading. At such time, if any, as the Net
Asset Value per Unit of a Series declined to 110% or less of the present value
of $100, plus any fixed-rate annual distributions due on such Series, discounted
back from the Principal Assurance Date, MLIP would terminate trading with
respect to such Series altogether in order to ensure that ML&Co. incurred no
financial obligation to the Fund under ML&Co.'s guarantee of the minimum Net
Asset Value per Unit of such Series.
In the case of Units sold after July 16, 1996, the potential
opportunity costs of the Fund's "principal protection" are significantly
increased due to the fact that in the event that MLIP deleverages any particular
series of Units, it must deleverage all series to the same degree. A series
could be deleveraged as a result of losses which accrued subsequent to such
series having recognized profits more than sufficient to offset such losses, but
which were earned before a more recent series was issued and, consequently, were
not available to offset the same losses incurred by such series. Conversely,
losses incurred before a particular series is issued could indirectly cause a
further deleveraging of such series' trading due to the effect of such losses on
the leverage which MLIP believes it is appropriate to use for an earlier-issued
series.
(b) Financial Information about Industry Segments:
---------------------------------------------
The Partnership's business constitutes only one segment for financial
reporting purposes, i.e., a speculative "commodity pool."
(c) Narrative Description of Business:
---------------------------------
GENERAL
The Fund trades in the international futures, options on futures and
forward markets, with the objectives of achieving long-term capital appreciation
while controlling performance volatility.
-2-
<PAGE>
One of the objectives of the Fund is to provide diversification for a
limited portion of the risk segment of the Limited Partners' portfolios.
Commodity pool performance has historically often demonstrated a low degree of
performance correlation with traditional stock and bond holdings. Since it
began trading, the Fund's returns have, in fact, frequently been significantly
non-correlated (not, however, negatively correlated) with the United States
stock and bond markets.
Due to certain concerns expressed by the Securities and Exchange
Commission (the "SEC") regarding whether the different series of Units issued by
the Partnership were significantly similar to each other for the Partnership to
be considered to be engaged in a "continuous offering" of the same class of
security, i.e., the Units (which the Partnership must be in order not to be able
to offer the Units on an ongoing open-end basis), MLIP changed the terms of all
series to be issued after July 16, 1996 to provide that: (i) no distributions
are intended to be made on any such series; (ii) any discretionary trading
leverage adjustments would have to be made so that after any such adjustments
all series were trading at the same degree of leverage (i.e., with the same
percentage of their total capital invested in the Trading Partnership and
allocated to the Advisors for management); and (iii) all series would have the
same five year "Time Horizon" between their respective issuance dates and their
respective Principal Assurance Dates. The series issued on and prior to July 16,
1996 have seven-year Time Horizons, are entitled to fixed rate as well as
discretionary distributions and contemplate MLIP adjusting the leverage of each
series in MLIP's discretion on an individual series-by-series basis.
ML&CO.'S "PRINCIPAL PROTECTION" UNDERTAKING TO THE FUND
ML&Co. has agreed to contribute sufficient capital to the Partnership
so that it will have adequate funds, after adjusting for all liabilities to
third parties, that the Net Asset Value per Unit of each Series will be no less
than $100 as of the Principal Assurance Date for such Series (after the payment
of all distributions, if any, on Units of such Series). This guarantee, which
is effective with respect to any given Series as of the Principal Assurance Date
for such Series, is a guarantee only of a return of an investor's initial
investment (plus distributions, if any), and not on a present value basis, not a
guarantee of profit.
OPERATION OF A SERIES AFTER ITS PRINCIPAL ASSURANCE DATE
MLIP may determine to dissolve a Series as of its Principal Assurance
Date, to extend the ML&Co. guarantee for a certain period of time (resetting the
minimum Net Asset Value per Unit of such Series guaranteed by ML&Co.) or to
continue to operate such Series without a "principal protection" feature.
TWO-TIER STRUCTURE OF THE FUND
The Fund does not trade in the futures and forward markets directly,
but rather through the Trading Partnership, of which the Fund is the sole
limited, and MLIP the sole general partner. The Fund's liability for any
trading losses is limited to the Fund's investment in the Trading Partnership.
USE OF PROCEEDS AND CASH MANAGEMENT INCOME
Subscription Proceeds. MLIP pays from its own funds the selling
---------------------
commissions relating to the sale of the Units. Accordingly, 100% of the
proceeds of Unit sales are received in cash by the Partnership and available for
use in its speculative trading. In such trading, the Partnership's assets are
used as security for and to pay the Partnership's trading losses as well as any
expenses and redemptions. The primary use of the proceeds of the sale of the
Units is to permit the Advisors to trade on a speculative basis in a wide range
of different futures, forwards and options on futures markets on behalf of the
Trading Partnership. While being used for this purpose, the Partnership's
assets are also generally available for cash management and to earn interest, as
more fully described below under "-- Available Assets."
Market Sectors. The Partnership trades in a diversified group of
--------------
markets under the direction of multiple independent Advisors. These Advisors
can, and do, from time to time materially alter the allocation of their overall
trading commitments among different market sectors. Except in the case of
certain trading programs which are purposefully limited in the markets which
they trade, there is essentially no restriction on the commodity interests which
may be traded by any Advisor or the rapidity with which an Advisor may alter its
market sector allocations.
-3-
<PAGE>
The Fund's financial statements contain information relating to the
market sectors traded by the Fund. There can, however, be no assurance as to
which markets may be included in the Fund's portfolio or as to in which market
sectors the Fund's trading may be concentrated at any one time or over time.
Market Types. The Partnership trades on a variety of United States
------------
and foreign futures exchanges. Applicable exchange rules differ significantly
among different countries and exchanges. Substantially all of the Fund's off-
exchange trading takes places in the highly liquid, institutionally-based
currency forward markets. The forward markets are generally unregulated, and in
its forward trading the Fund does not deposit margin with respect to its
positions. The Partnership's forward currency trading is executed exclusively
through the Foreign Exchange Service Desk (the "F/X Desk") operated by MLIP and
certain of its affiliates, with MLF as the "back-to-back" intermediary to the
ultimate counterparties, which include Merrill Lynch International Bank ("MLIB")
with which the Advisors trade on behalf of the Fund.
As in the case of its market sector allocations, the Fund's
commitments to different types of markets -- U.S. and non-U.S., regulated and
unregulated -- differ substantially from time to time as well as over time. The
Fund has no policy restricting its relative commitments to any of these
different types of markets.
The Fund's financial statements contain information relating to the
types of markets traded by the Fund. There can, however, be no assurance as to
in which markets the Fund may trade or the Fund's trading may be concentrated at
any one time or over time.
Custody of Assets. All of the Fund's assets -- other than the assets
-----------------
managed by MLAM and held in a custodial account as described below under "--The
Fund's U.S. Dollar Available Assets Managed by MLAM" -- are currently held in
customer accounts at Merrill Lynch.
Available Assets. The Fund earns interest, as described below, on its
----------------
"Available Assets," which can be generally described as the cash actually held
by the Fund or invested in short-term Treasury bills. Available Assets are held
primarily in U.S. dollars or in U.S. dollar denominated Government Securities,
and to a lesser extent in foreign currencies, and are comprised of the
following: (a) the Fund's cash balances managed by MLAM or held in the offset
accounts (as described below) -- which include "open trade equity" (unrealized
gain and loss on open positions) on United States futures contracts, which is
paid into or out of the Fund's account on a daily basis; and (b) the Fund's cash
balance in foreign currencies derived from its trading in non-U.S. dollar
denominated futures and options contracts, which includes open trade equity on
those exchanges which settle gains and losses on open positions in such
contracts prior to closing out such positions. Available Assets do not include,
and the Fund does not earn interest on, the Fund's gains or losses on its open
forward, commodity option and certain foreign futures positions since such gains
and losses are not collected or paid until such positions are closed out.
The Partnership's Available Assets may be greater than, less than or
equal to the Fund's Net Asset Value (on which the redemption value of the Units
is based) primarily because Net Asset Value reflects all gains and losses on
open positions as well as accrued but unpaid expenses.
The interest income arrangements for the Partnership's U.S. dollar
Available Assets differ from those applicable to its non-U.S. dollar Available
Assets. Interest income, once accrued by the Fund, is subject to the risk of
trading losses.
The Fund's U.S. Dollar Available Assets Managed by MLAM.
-------------------------------------------------------
Approximately 80% of the Fund's U.S. dollar Available Assets are managed
directly by MLAM, pursuant to guidelines established by MLIP for which MLAM
assumes no responsibility, in the Government Securities markets. MLIP's
objective in retaining MLAM to provide cash management services to the Fund is
to enhance the return earned on the Fund's U.S. dollar Available Assets managed
by MLAM to slightly above the 91-day Treasury bill rate, while maintaining
minimal (but by no means eliminating) market risk in the Fund's cash management
operations.
The Government Securities acquired by MLAM on behalf of the Fund are
maintained in a custodial account at a Merrill Lynch affiliate and are
specifically traceable to the Fund. All income earned on such Government
Securities inures to the benefit of the Fund.
-4-
<PAGE>
MLF pays all fees due to MLAM in respect of its management of a
portion of the Fund's U.S. dollar Available Assets, at no additional cost to the
Fund.
MLAM does business as Merrill Lynch Asset Management. MLAM is a
limited partnership. ML&Co. is its limited partner, and Princeton Services,
Inc., a wholly-owned subsidiary of ML&Co., is the general partner.
Interest Earned on the Fund's U.S. Dollar Available Assets Not Managed
----------------------------------------------------------------------
by MLAM. The following description relates to the approximately 20% of the
- -------
Fund's U.S. dollar Available Assets not managed by MLAM.
The Fund's U.S. dollar Available Assets not managed by MLAM are held
in cash in offset accounts and in short-term Treasury bills purchased from
dealers unaffiliated with Merrill Lynch. Offset accounts are non-interest
bearing demand deposit accounts maintained with banks unaffiliated with Merrill
Lynch. An integral feature of the offset arrangements is that the participating
banks specifically acknowledge that the offset accounts are MLF customer
accounts, not subject to any Merrill Lynch liability.
MLF credits the Partnership, as of the end of each month, with
interest at the effective daily 91-day Treasury bill rate on the average daily
U.S. dollar Available Assets held in the offset accounts during such month. The
Fund receives all the interest paid on the short-term Treasury bills in which it
invests.
The use of the offset account arrangements for the Partnership's U.S.
dollar Available Assets not managed by MLAM may be discontinued by Merrill Lynch
whether or not Merrill Lynch otherwise continues to maintain its offset
arrangements. The offset arrangements are dependent on the banks' continued
willingness to make overnight credits available to Merrill Lynch, which, in
turn, is dependent on the credit standing of ML&Co. If Merrill Lynch were to
determine that the offset arrangements had ceased to be practicable (either
because ML&Co. credit lines at participating banks were exhausted or for any
other reason), Merrill Lynch would thereafter attempt to invest all of the
Fund's U.S. dollar Available Assets not managed by MLAM to the maximum
practicable extent in short-term United States Treasury bills. All interest
earned on the U.S. dollar Available Assets so invested would be paid to the
Fund, but MLIP would expect the amount of such interest to be less than that
available to the Fund under the offset account arrangements. The remaining U.S.
dollar Available Assets of the Fund not managed by MLAM would be kept in cash to
meet variation margin payments and pay expenses, but would not earn interest for
the Fund.
The banks at which the offset accounts are maintained make available
to Merrill Lynch interest-free overnight credits, loans or overdrafts in the
amount of the Fund's U.S. dollar Available Assets held in the offset accounts,
charging Merrill Lynch a small fee for this service. The economic benefits
derived by Merrill Lynch -- net of the interest credits paid to the Fund and the
fee paid to the offset banks -- from the offset accounts have not exceeded 3/4
of 1% per annum of the Fund's average daily U.S. dollar Available Assets not
managed by MLAM and held in the offset accounts. These revenues to Merrill
Lynch are in addition to the Brokerage Commissions and Administrative Fees paid
by the Fund to MLF and MLIP, respectively.
Interest Paid by Merrill Lynch on the Fund's Non-U.S. Dollar Available
----------------------------------------------------------------------
Assets. Under the single currency margining system implemented for the
- -------
Partnership, the Partnership itself does not deposit foreign currencies to
margin trading in non-U.S. dollar denominated futures contracts and options. MLF
provides the necessary margin, permitting the Fund to retain the monies which
would otherwise be required for such margin as part of the Partnership's U.S.
dollar Available Assets. The Partnership does not earn interest on foreign
margin deposits provided by MLF. The Partnership does, however, earn interest
on its non-U.S. dollar Available Assets. Specifically, the Fund is credited by
Merrill Lynch with interest at the local short-term rate on realized and
unrealized gains on non-U.S. dollar denominated positions for such gains
actually held in cash by the Fund (MLAM does not manage any of the Fund's non-
U.S. dollar Available Assets.). Merrill Lynch charges the Fund Merrill Lynch's
cost of financing realized and unrealized losses on such positions.
In order to avoid the expense of daily currency conversions, the
Partnership holds foreign currency gains and finances foreign currency losses on
an interim basis until converted into U.S. dollars and either paid into or out
of the Partnership's U.S. dollar Available Assets. Foreign currency gains or
losses on open positions are not converted into U.S. dollars until the positions
are closed. Assets of the Partnership while held in foreign currencies are
subject to exchange rate risk.
-5-
<PAGE>
____________________
The General Partner has determined that there may have been a
miscalculation in the interest credited to the Fund for a period prior to
November 1996. Accordingly, Merrill Lynch has credited the Fund's investors.
For current Merrill Lynch clients, this credit, which includes compounded
interests, appears on the December 1997 account statements. The total amount of
the adjustment is approximately $54,000.
CHARGES
The following table summarizes the charges incurred by the Fund during
1995, 1996 and 1997.
<TABLE>
<CAPTION>
1995 1996 1997
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% OF % OF
% OF AVERAGE AVERAGE AVERAGE
DOLLAR MONTH-END DOLLAR MONTH-END DOLLAR MONTH-END
COST AMOUNT NET ASSETS* AMOUNT NET ASSETS AMOUNT NET ASSETS*
---- ------ ------------ ------ ---------- ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Brokerage
Commissions $3,303,292 5.92% $4,775,116 5.77% $4,833,598 5.64%
Administrative
Fees - - 129,057 0.16 138,103 0.16
Reimbursement of
Organizational
and Initial
Offering Costs 79,700 0.14 79,700 0.10 61,989 0.07
Profit Shares 652,366 1.17 978,264 1.18 931,522 1.09
---------- ---- ---------- ---- ---------- ----
Total $4,035,358 7.23% $5,962,137 7.21% $5,965,212 6.96%
========== ==== ========== ==== ========== ====
</TABLE>
* Only approximately 60% of the Fund's average month-end Net Assets were
allocated to trading during the periods presented. Series of Units issued
subsequent to July 16, 1996 (no such Units have been issued as of the date of
this Report) will commence trading with 75% of their assets allocated to
trading. Consequently, the percentage figures presented would be
correspondingly higher as a percentage of the Fund's average month-end Net
Assets.
____________________
THE FLAT-RATE BROKERAGE COMMISSIONS AND ADMINISTRATIVE FEES WILL IN
THE FUTURE BE HIGHER THAN THOSE IN THE FOREGOING TABLE AS THE UNITS ISSUED AFTER
JULY 16, 1996 WILL TRADE AT 75% RATHER THAN 60% INITIAL LEVERAGE.
____________________
-6-
<PAGE>
The foregoing table does not reflect the bid-ask spreads paid by the
Fund on its forward trading, or the benefits which may be derived by Merrill
Lynch from the deposit of certain of the Fund's U.S. dollar available assets in
offset accounts. See Item 1(c), "Narrative Description of Business -- Use of
Proceeds and Cash Management Income."
The Fund's average month-end Net Assets during 1995, 1996 and 1997
equaled $55,827,125, $82,789,767 and $85,646,152 respectively.
During 1995, 1996 and 1997, the Fund earned $3,415,670, $4,545,186
and $4,873,872 in interest income, or approximately 6.12%, 5.49% and 5.69% of
the Fund's average month-end Net Assets.
Effective January 1, 1997, MLIP reduced the Fund's annual Brokerage
Commissions from 9.25% to 8.75% of trading assets (i.e., assets committed to
trading).
DESCRIPTION OF CURRENT CHARGES
<TABLE>
<CAPTION>
RECIPIENT NATURE OF PAYMENT AMOUNT OF PAYMENT
- --------- ----------------- -----------------
<S> <C> <C>
MLF Brokerage Commissions A flat-rate monthly commission of 0.7291 of 1% (an
8.75% annual rate) of the Fund's month-end assets
committed to trading. The Fund initially commits
8.75% of the capital attributable to each series of Units
issued after July 16, 1996 to trading.
During 1995, 1996 and 1997, the round-turn (each
purchase and sale or sale and purchase of a single
futures contract) equivalent rate of the Fund's flat-rate
Brokerage Commissions was approximately $134,
$116, and $116 respectively. The round-turn rate for
1995 and 1996 reflect Brokerage Commissions at the
rate of 9.25% per annum.
As of January 1, 1997, the 9.25% per annum
Brokerage Commissions were reduced to 8.75% per
annum (0.7291 of 1% of the Fund's month-end assets).
MLF Use of Fund assets Merrill Lynch may derive an economic benefit from
the deposit of certain of the Fund's U.S. dollar
Available Assets not managed by MLAM in offset
accounts; this benefit to date has not exceeded 3/4 of 1%
of such average daily U.S. dollar Available Assets.
MLIP Administrative Fees The Fund pays MLIP a monthly Administrative Fee
equal to 0.020833 of 1% (a 0.25 of 1% annual rate) of
the Fund's month-end assets committed to trading.
MLIP pays the Fund's routine administrative costs.
MLIB Bid-ask spreads Under MLIP's F/X Desk arrangements, MLIB receives
bid-ask spreads on the forward trades it executes with
the Fund.
</TABLE>
-7-
<PAGE>
DESCRIPTION OF CURRENT CHARGES (cont)
<TABLE>
<S> <C> <C>
Other Bid-ask spreads The counterparties other than MLIB with which the
Counterparties F/X Desk deals each also receive bid-ask spreads on
the forward trades executed with the Fund.
MLIP F/X Desk service fees Under the F/X Desk arrangements, MLIP or another
Merrill Lynch entity receives a service fee equal, at
current exchange rates, to approximately $5.00 to
$12.50 on each purchase or sale of each futures
contract-equivalent forward contract executed with
counterparties other than MLIB.
MLIB EFP differentials MLIB or an affiliate receives a differential spread for
exchanging the Fund's spot currency positions (which
are acquired through the F/X Desk, as described
above) for equivalent futures positions.
Government Bid-ask spreads The dealers with which MLAM executes Government
Securities Securites trades include bid-ask spreads in the prices
Dealers they quote to the Fund.
Trading Advisors Profit Shares Prior to January 1, 1997, all Advisors received
quarterly Profit Shares ranging from 15% to 25%
(depending on the Trading Advisor) of any New
Trading Profit. As of January 1, 1997, a number of
Advisors agreed to receive only annual Profit Shares.
Profit Shares are also paid upon redemption of Units.
New Trading Profit is calculated separately in respect
of each Advisor, irrespective of the overall
performance of the Fund. The Fund may pay
substantial Profit Shares during periods when it is
incurring significant overall losses.
MLF; Extraordinary expenses Actual costs incurred; none paid to date, and expected
Others to be negligible.
</TABLE>
------------------------
REGULATION
The General Partner, the Trading Advisors and the Commodity Broker are
each subject to regulation by the Commodity Futures Trading Commission (the
"CFTC") and the National Futures Association. Other than in respect of its
periodic reporting requirements under the Securities Exchange Act of 1934, and
the registration of the Units for continuous public distribution under the
Securities Act of 1933, the Partnership itself is generally not subject to
regulation by the Securities and Exchange Commission. However, MLIP itself is
registered as an "investment adviser" under the Investment Advisers Act of 1940.
(i) through (xii) -- not applicable.
(xiii) The Partnership has no employees.
-8-
<PAGE>
(d) Financial Information about Foreign and Domestic Operations and Export
----------------------------------------------------------------------
Sales:
- -----
The Partnership and the Trading Partnership do not engage in material
operations in foreign countries, nor is a material portion of the Partnership's
revenues derived from customers in foreign countries. The Trading Partnership
does, however, trade, from the United States, on a number of foreign commodity
exchanges.
ITEM 2: PROPERTIES
----------
Neither the Partnership nor the Trading Partnership use any physical
properties in the conduct of its business.
The Partnership's and the Trading Partnership's only place of business is
the place of business of the General Partner (see Item 10 herein). The General
Partner performs all administrative services for the Partnership and the Trading
Partnership from the General Partner's offices.
ITEM 3: LEGAL PROCEEDINGS
-----------------
ML&Co. -- the sole stockholder of Merrill Lynch Group, Inc. (which is
the sole stockholder of MLIP) -- as well as certain of its subsidiaries and
affiliates have been named as defendants in civil actions, arbitration
proceedings and claims arising out of their respective business activities.
Although the ultimate outcome of these actions cannot be ascertained at this
time and the results of legal proceedings cannot be predicted with certainty, it
is the opinion of management that the result of these matters will not be
materially adverse to the business operations of financial condition of MLIP or
the Fund.
MLIP itself has never been the subject of any material litigation.
On June 24, 1997, the CFTC accepted an Offer of Settlement from MLF
and others, in a matter captioned "In the Matter of Mitsubishi Corporation and
Merrill Lynch Futures Inc., et al.," CFTC Docket No. 97-10, pursuant to which
MLF, without admitting or denying the allegations against it, consented to a
finding by the Commission that MLF had violated Section 4c(a)(A) of the
Commodity Exchange Act, relating to wash sales (the CFTC alleged that the
customer entered nearly simultaneous orders without the intent to engage in a
bona fide trading transaction), and CFTC Regulation 1.37(a), relating to
recordkeeping requirements. MLF agreed to cease and desist from violating
Section 4c(a)(A) of the Act and Regulation 1.37(a), and to pay a civil monetary
penalty of $175,000.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
The Partnership has never submitted any matters to a vote of its Limited
Partners.
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
---------------------------------------------------------------------
(a) Market Information:
------------------
There is no established public trading market for the Units, nor will
one develop. Rather, Limited Partners may purchase or redeem Units as of the
end of each month at Net Asset Value, subject to certain early redemption
charges. Units redeemed prior to the Principal Assurance Date are not entitled
to any benefits under the Merrill Lynch & Co., Inc. guarantee.
(b) Holders:
-------
As of December 31, 1997, there were 3,793 holders of Units, including
the General Partner.
-9-
<PAGE>
(c) Dividends:
---------
For series issued on or prior to July 16, 1996, the Partnership makes
annual fixed-rate distributions, payable irrespective of profitability, of
between $2 and $5 per Unit (depending upon the series). The General Partner may
also make discretionary distributions of up to 50% of any Distributable New
Appreciation, as defined, recognized as of each twelve-month anniversary of the
issuance of each series of Units, subject to an annual limit of 4% of the Net
Asset Value per Unit of each series as of the beginning of the preceding twelve-
month period. The first such distribution with respect to the Series A Units
took place on October 1, 1995. At such time Series A Unitholders received a
fixed-rate distribution equal to $3.50 per Unit and a discretionary distribution
equal to $2.50 per Unit (for a total distribution of $6.00 per Unit). Series A
Unitholders received another distribution of $6.00 per Unit on October 1, 1996.
Series A Unitholders received a fixed-rate distribution of $3.50 on October 1,
1997. The first distribution with respect to Series B Units took place on
January 1, 1996. At such distribution, Series B Unitholders also received a
fixed-rate distribution equal to $3.50 per Unit and a discretionary distribution
equal to $2.50 per Unit (for a total distribution of $6.00 per Unit). On
January 1, 1997, Series B received a fixed-rate distribution of $3.50 and a
discretionary distribution of $3.00. The first of such distributions for Series
C, D and E of a fixed rate distribution of $3.50 per Unit took place on April 1,
1996, July 1, 1996 and October 1, 1996, respectively. On April 1, 1997, Series
C received a fixed rate dividend of $3.50 and a discretionary dividend of $4.00.
On July 1, 1997, Series D received a fixed-rate dividend of $3.50 and a
discretionary dividend of $1.00. On October 1, 1997, Series E received a fixed-
rate dividend of $3.50 and a discretionary dividend of $2.00. On January 1,
1997, Series F received a fixed-rate dividend of $3.50 and a discretionary
dividend of $2.50. On April 1, 1997, Series G received a fixed-rate dividend of
$3.50 and a discretionary dividend of $3.50. On July 1, 1997, Series H received
a fixed-rate distribution of $3.50 and a discretionary distribution of $2.50.
Distributions, whether fixed-rate or discretionary, do not reduce the $100
minimum Net Asset Value per Unit assured to investors as of the Principal
Assurance Date for their series of Units.
The Fund does not make any distributions on any series of Units issued
subsequent to July 16, 1996.
(d) Recent Sales of Unregistered Securities;
---------------------------------------
Use of Proceeds from Registered Securities
------------------------------------------
The Fund has 2,250,000 Units of limited partnership interest, with
an aggregate price of $225,000,000. The Fund has sold 1,467,958.85 Units of
limited partnership interest, with an aggregate price of $146,890,977.
-10-
<PAGE>
ITEM 6: SELECTED FINANCIAL DATA
-----------------------
The following selected financial data has been derived from the audited
financial statements of the Partnership:
<TABLE>
<CAPTION>
JANUARY 1, JANUARY 1, OCTOBER 12, 1994
1997 1996 JANUARY 1, 1995 (COMMENCEMENT
TO TO TO OF OPERATIONS) TO
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------ ------------
1997 1996 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA
Revenues:
Trading Profits (Loss)
Realized Gain (Loss) $ 5,412,457 $ 9,038,064 $ 4,407,833 $ (363,054)
Change in Unrealized (Loss) Gain 1,083,826 (396,221) 1,355,377 1,115,935
------------ ----------- ----------- -----------
Total Trading Results 6,496,283 8,641,843 5,763,210 752,881
Interest Income 4,873,872 4,545,186 3,415,670 377,303
------------ ----------- ----------- -----------
Total Revenues 11,370,155 13,187,029 9,178,880 1,130,184
------------ ----------- ----------- -----------
Expenses:
Brokerage Commissions 4,833,598 4,775,116 3,303,292 405,653
Administrative Fees/1/ 138,103 129,057 - 10,964
Profit Shares 931,522 978,264 652,366 129,169
------------ ----------- ----------- -----------
Total Expenses 5,903,223 5,882,437 3,955,658 545,786
------------ ----------- ----------- -----------
Net Income Before Minority Interest 5,466,932 7,304,592 5,223,222 584,398
Minority Interest /2/ (46,687) (81,228) (36,730) (4,504)
------------ ----------- ----------- -----------
Net Income $ 5,420,245 $ 7,223,364 $ 5,186,492 $ 579,894
============ =========== =========== ===========
</TABLE>
-11-
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------ ------------
1997 1996 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
BALANCE SHEET DATA/3/
- ------------------
AGGREGATE NET ASSET VALUE
(Series A-M) $101,226,685 $78,905,273 $74,846,544 $32,314,228
NET ASSET VALUE PER UNIT
Series A $ 113.73/4/ $ 110.70/5/ $ 106.96/6/ $101.76
Series B $ 114.15/4/ $ 114.24/5/ $ 110.36 N/A
Series C $ 108.15/4/ $ 109.33/5/ $ 103.35 N/A
Series D $ 109.94/4/ $ 108.19/5/ $ 102.34 N/A
Series E $ 109.40/4/ $ 108.58/5/ $ 102.72 N/A
Series F $ 109.04/4/ $ 108.92 N/A N/A
Series G $ 106.52/4/ $ 107.32 N/A N/A
Series H $ 106.62/4/ $ 106.47 N/A N/A
Series K $ 104.77/4/ N/A N/A N/A
Series L $ 102.08/4/ N/A N/A N/A
Series M $ 103.70/4/ N/A N/A N/A
</TABLE>
/1/ As of January 1, 1996, a portion of the Brokerage Commissions
were reclassified as Administrative Fees, at no additional cost to the Fund.
Certain amounts in prior periods have been reclassified to conform to the
current period presentation of the Administrative Fees.
/2/ MLIP is general partner of the Trading Partnership. Because
the Fund owns substantially all of the Trading Partnership, Trading Partnership
activities are referred to as Fund activities in this Report. The minority
interest represents MLIP's share, as general partner of the Trading Partnership,
of the Trading Partnership's profit or loss.
/3/ Balance Sheet Data is based on redemption values which differ
immaterially from Net Asset Values as determined under Generally Accepted
Accounting Principals ("GAAP") due to the treatment of organizational and
initial offering cost reimbursements.
/4/ Net of aggregate distributions of $15.50 per Unit on the
Series A Units, $12.50 on the B Units and $11.00 on the Series C, $8.00 on the
Series D Units, $9.00 on the Series E Units, $6.00 on the Series F Units, $7.00
on the Series G Units and $6.00 on the Series H Units.
/5/ Net of aggregate distributions of $12.00 per Unit on the
Series A Units, $6.00 on the B Units and $3.50 on the Series C, D and E Units.
/6/ Net of the distribution of $6.00 per Unit on the Series A Unit.
- --------------------
-12-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
DECEMBER 31, 1997
Type of Pool: Multi-Advisor; Selected Advisor/Publicly-Offered/"Principal
Protected"/(1)/
Inception of Trading: October 12, 1994
Aggregate Subscriptions: 141,979,656
Current Capitalization: $101,226,685
Worst Monthly Drawdown:/(2)/ (3.70)% (2/96)
Worst Peak-to-Valley Drawdown:/(3)/ (3.70)% (2/96)
<TABLE>
<CAPTION>
- ----------------------------------------------------
MONTHLY RATES OF RETURN/(4)/
- ----------------------------------------------------
MONTH 1997 1996 1995 1994
- ----------------------------------------------------
<S> <C> <C> <C> <C>
January 2.06% 2.45% (0.55)% --
- ----------------------------------------------------
February 1.44 (3.70) 2.24 --
- ----------------------------------------------------
March 0.05 1.06 4.17 --
- ----------------------------------------------------
April (0.70) 3.10 0.91 --
- ----------------------------------------------------
May (1.43) (1.98) 1.20 --
- ----------------------------------------------------
June 0.70 1.36 (0.21) --
- ----------------------------------------------------
July 3.14 (1.68) (1.30) --
- ----------------------------------------------------
August (2.71) 0.49 0.95 --
- ----------------------------------------------------
September 0.86 1.62 (0.32) --
- ----------------------------------------------------
October (0.43) 4.25 0.29 1.04
- ----------------------------------------------------
November 0.80 2.50 0.69 0.32
- ----------------------------------------------------
December 2.22 (0.20) 2.12 0.40
- ----------------------------------------------------
Compound 6.01% 9.36% 10.55% 1.76%
Rate of Return (2 2/3%
months)
- ----------------------------------------------------
</TABLE>
Rates of Return are presented on a composite, not a series-by-series, basis.
_________________________
THE UNITS ISSUED AFTER JULY 16, 1996 COMMENCE TRADING WITH 75% OF
THEIR ASSETS ALLOCATED TO TRADING. ALL SERIES OF UNITS ISSUED TO DATE HAVE
TRADED AT ONLY APPROXIMATELY 60% LEVERAGE. INCREASING TRADING LEVERAGE SHOULD
INCREASE MONTHLY RATES OF RETURN (BOTH POSITIVE AND NEGATIVE), DRAWDOWNS, PROFIT
POTENTIAL, RISK AND VOLATILITY.
_________________________
(1) Pursuant to applicable CFTC regulations, a "Multi-Advisor" fund
is defined as one that allocates no more than 25% of its trading assets to any
single manager. The Fund does not currently allocate more than 25% of its
trading assets to any single Advisor but may do so in the future; consequently,
it is referred to as a"Multi-Advisor; Selected Advisor" fund. Certain funds,
including funds sponsored by MLIP, are structured so as to guarantee to
investors that their investment will be worth no less than a specified amount
(typically, the initial purchase price) as of a date certain after the date of
investment. The CFTC refers to such funds as "principal protected." The ML&Co.
Guarantee and MLIP related deleveraging of the Fund's trading provides the
"principal protection" feature of the Fund.
(2) Worst Monthly Drawdown represents the largest negative Monthly
Rate of Return experienced by the Fund; a drawdown is measured on the basis of
month-end Net Asset Value only, and does not reflect intra-month figures.
(3) Worst Peak-to-Valley Drawdown represents the greatest percentage
decline from a month-end cumulative Monthly Rate of Return without such
cumulative Monthly Rate of Return being equaled or exceeded as of a subsequent
month-end. For example, if the Monthly Rate of Return was (1)% in each of
January and February, 1% in March and (2)% in April, the Peak-to-Valley Drawdown
would still be continuing at the end of April in the amount of approximately
(3)%, whereas if the Monthly Rate of Return had been approximately 3% in March,
the Peak-to-Valley Drawdown would have ended as of the end of February at
approximately the (2)% level.
(4) Monthly Rate of Return is the net performance of the Fund during
the month of determination (including interest income and after all expenses
accrued or paid) divided by the total equity of the Fund as of the beginning of
such month. The composite returns of the Fund reflect the results of the Fund
as a whole, not the performance of any single series of Units (however, the
composite returns closely match during the same period the performance of all
series then outstanding). Although the series begin trading at different times
and, accordingly, have materially different cumulative returns, as all series
participate in the same trading account and at approximately the same degree of
leverage, the only significant difference between the performance of different
series during a given month is typically the different amount of Profit Shares
paid. In no month has any series had a rate of return 10% higher or lower than
any other series.
-13-
<PAGE>
<TABLE>
<CAPTION>
MONTH-END NET ASSET VALUE PER SERIES A UNIT
- ------------------------------------------------------------------------------------------------------------------------------------
JAN. FEB. MAR. APR. MAY JUNE JULY AUG. SEPT. OCT. NOV. DEC.
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1994 N/A N/A N/A N/A N/A N/A N/A N/A N/A $ 101.04 $ 101.36 $ 101.76
1995 $ 101.36 $ 103.63 $ 107.94 $ 109.09 $ 110.40 $ 110.18 $ 108.94 $ 109.98 $ 109.62 $ 103.91* $ 104.63* $ 106.96*
- ------------------------------------------------------------------------------------------------------------------------------------
1996 $ 109.65* $ 105.56* $ 106.69* $ 110.05* $ 107.82* $ 109.33* $ 107.51* $ 108.04* $ 109.80* $108.24** $ 110.93** $ 110.70**
- ------------------------------------------------------------------------------------------------------------------------------------
1997 $113.00** $114.63** $114.69** $113.89** $112.28** $113.05** $116.48** $113.59** $114.53** $110.69** $111.50*** $113.73***
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* After reduction for the $6.00 per Series A Unit distribution made as of
October 1, 1995.
** After reduction for the second $6.00 per Series A Unit distribution made as
of October 1, 1996.
*** After reduction for the $3.50 per Series A Unit distribution made as of
October 1, 1997.
-14-
<PAGE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
THE TWO-TIER STRUCTURE OF THE FUND
The Fund does not trade directly through opening managed accounts with the
Advisors, but rather through investing in the Trading Partnership. The Trading
Partnership, in turn, allocates substantially all of its capital to the
Advisors, and the different series of Units share pro rata in the overall
profits and losses of the Trading Partnership based on their respective
investments in it. No series of Units can lose more in its trading than the
amount which such series has invested in the Trading Partnership.
Although different series of Units invest different percentages of their
overall capital in the Trading Partnership, all assets so invested are 100%
allocated to trading. All trading losses are shared pro rata among the
different series based on their respective investments in the Trading
Partnership.
The use of the Trading Partnership by the Fund has no effect on the
leverage at which the different series of Units trade. The Fund trades through
investing in the Trading Partnership rather than directly, solely in order to
eliminate the highly unlikely risk that one series of Units might be subject to
paying trading debts attributable to another. This risk arises because it is
theoretically possible that catastrophic losses could deplete all the assets of
a particular series allocated to the Advisors for management. Any remaining
losses would remain a debt of the Fund to which all other series' capital would
be subject. The Fund/Trading Partnership structure eliminates the risk of such
inter-series liability. The CFTC would not permit the Fund to continue the
offering of the Units unless such inter-series liability were eliminated.
For example, assume that each of Series I and Series II Units had $10
million in capital, and Series I allocated $9.5 million (95% leverage) and
Series II $8.5 million (85% leverage) to the Trading Partnership. If losses
bankrupted the Trading Partnership, each Series' trading account would share pro
rata in such losses. The Series I Units would create a larger deficit balance
because of the higher degree of leverage at which that Series traded. However,
there would be no risk that, for example, a $3 million deficit balance allocable
to Series I trading account would be subject to being repaid from any of the
$1.5 million withheld from trading by the Series II Units (or from any of the
$0.5 million withheld from trading by the Series I Units, for that matter),
because the Fund itself is not liable for the debts of its subsidiary Trading
Partnership. Any deficit balance incurred by a bankrupt Trading Partnership
would become an uncollectible debt due to MLF. MLF accepts such deficit balance
risk each time it accepts a limited liability entity such as the Trading
Partnership as a client.
There is no benefit (or detriment) to investors from the two-tier
Fund/Trading Partnership structure other than permitting the Fund to issue the
series of Units at different times, which series, may, over time, trade with
different percentages of their capital allocated to trading.
OPERATIONAL OVERVIEW; ADVISOR SELECTIONS
The Fund's results of operations depend on MLIP's ability to select
Advisors and the Advisors' ability to trade profitably. MLIP's selection
procedures and trading leveraging analysis, as well as the Advisors' trading
methods, are confidential, so that substantially the only available information
relevant to the Fund's results of operations is its actual performance record to
date.
[Global Futures and Forward Market Chart Appears Here]
MLPF&S Investors
| Custody |
|-------------------Agreement |
Cash Management | Limited Partnership
of Fund and Trading | Units
Partnership Assets held | |
at MLPF&S and MLF | | Sole
| | | General
| |----------- ML Principal Partner
MLAM ------------------------------- Protection L.P. ------------- MLIP
Cash Management | Investment (the "Fund") |
of Fund and Trading | Advisory | |
Partnership Assets held| Contract Sole |
at MLPF&S and MLF | Limited Partner | Sole
| | Customer | | General
| -Agreement--------ML Principal---------| Partner
MLF ---------------------------- Protection Trading L.P.
F/X Desk (the "Trading
Service Agreement Partnership")
| | |
Advisor Advisor Advisor
| | |
Global Futures and Forward Markets
-15-
<PAGE>
However, because of the speculative nature of its trading, the Fund's past
performance is not necessarily indicative of its future results.
MLIP's decision to terminate or reallocate assets among Trading Advisors is
based on a combination of numerous factors. Advisors are, in general, terminated
primarily for unsatisfactory performance, but other factors -- for example, a
change in MLIP's or an Advisor's market outlook, apparent deviation from
announced risk control policies, excessive turnover of positions, changes in
principals, commitment of resources to other business activities, etc. -- may
also have a role in the termination or reallocation decision. The market
judgment and experience of MLIP's principals is an important factor in its
allocation decisions.
MLIP has no timetable or schedule for making Advisor changes or
reallocations, and generally makes a medium- to long-term commitment to all
Advisors selected. There can be no assurance as to the frequency or number of
the Advisor changes that may take place in the future, or as to how long any of
the current Advisors will continue to manage assets for the Partnership.
RESULTS OF OPERATIONS
General. MLIP believes that multi-advisor futures funds should be
-------
regarded as medium- to long-term (i.e., three to five year) investments, but it
is difficult to identify trends in the Fund's operations and virtually
impossible to make any predictions regarding future results based on the results
to date. An investment in the Fund may be less successful over a longer than a
shorter period.
Markets with sustained price trends tend to be more favorable to managed
futures investments than whipsaw, choppy markets, but (i) this is not always the
case, (ii) it is impossible to predict when price trends will occur and (iii)
different Advisors are affected differently by trending markets as well as by
particular types of trends.
MLIP attempts to control credit risk in the Fund's futures, forward and
options trading (the Fund does not trade derivatives other than futures and
forward contracts and options thereon) by trading only through MLF. MLF acts
solely as a broker or counterparty to the Fund's trades; it does not advise with
respect to, or direct, any such trading.
MLIP attempts to control the market risk inherent in the Fund's trading by
MLIP multi-advisor structuring and Trading Advisor selection. MLIP reviews the
positions acquired by the Advisors on a daily basis in an effort to determine
whether the overall positions of the Fund may have become what MLIP analyzes as
being excessively concentrated in a limited number of markets or under the
direction of generally similar strategies -- in which case MLIP may, as of the
next month-end or quarter-end, adjust the Fund's Advisor combination and/or
allocations so as to attempt to reduce the risk of such over-concentration
occurring in the future. MLIP also adjusts the percentage of each series'
capital allocated to trading, with the principal objective of protecting ML&Co.
from any liability under its guarantee of a $100 minimum Net Asset Value per
Unit as of the Principal Assurance Date for each of the respective series of
Units. The market risk to the Fund is limited by the combination of its
"principal protection" feature and its multi-advisor strategy.
Prior to July 16, 1996, all series of Units initially allocated
approximately 60% of their assets to trading. All series of Units sold after
July 16, 1996 initially allocate 75% of their assets to trading. MLIP's
determination as to how much of a series' capital to allocate to trading from
time to time -- again, a determination primarily dictated by MLIP's objective of
ensuring that ML&Co. is never required to make any payments under its guarantee
that the Net Asset Value per Unit of each series will be at least $100 as of
such series' Principal Assurance Date-- has a material impact on the performance
of such series.
In the case of Units issued subsequent to July 16, 1996, MLIP's ability to
adjust the leverage at which these series trade is restricted by the regulatory
requirement that if MLIP adjusts the leverage of any one such series, it must
adjust the leverage of all such series so that all are trading with the same
percentage of their total capital allocated to trading.
MLIP may consider making distributions on the Units offered subsequent to
July 16, 1996 under certain circumstances (for example, if substantial profits
are recognized); however, MLIP does not presently intend to do so. MLIP has,
however, undertaken to make certain distributions on all Units issued on or
prior to July 16, 1996.
The performance of the different series of Units differs somewhat over the
same period, primarily, because as the various series begin trading at different
times, they pay different Profit Shares (although at the same base rates),
during the same periods.
PERFORMANCE SUMMARY
1995
In 1995, prevailing price trends in several key markets enabled the
Advisors to trade profitably for the Fund. Although trading in many of the
traditional commodity markets may have been lackluster, the currency and
financial markets offered exceptional trading conditions. After months
characterized by very difficult trading environments, solid price trends across
many markets (including U.S. Treasury and non-dollar bond markets) began to
emerge during the first quarter of 1995. In the second quarter of 1995, market
volatility once again began to affect trading, as many previously strong price
trends began to weaken and, in some cases, reverse. The U.S. dollar hit new
lows versus the Japanese yen and Deutschemark before rebounding sharply. In
addition, there were strong indications that the U.S. economy was slowing which,
when coupled with a failure of the German Central Bank to lower interest rates,
stalled a rally in the German bond market. During the
-16-
<PAGE>
third quarter there was a correction in U.S. bond prices after several months of
a strong uptrend. Despite exposure to the global interest-rate markets, the
Fund's long positions in U.S. Treasury bonds had a negative impact on
performance. Throughout August and into September, the U.S. dollar rallied
sharply against the Japanese yen and the Deutschemark as a result of the
coordinated intervention by major central banks and widespread recognition of
the growing banking crisis in Japan. Despite continued price volatility during
the final quarter of 1995, the Trading Advisors were able to identify several
trends in key markets. U.S. Treasury bond prices continued their strong move
upward throughout November, due both to weak economic data and optimism on
federal budget talks. As the year ended, the yield on the 30-year Treasury bond
was pushed to its lowest level in more than two years.
1996
1996 began with the East Coast blizzard, continuing difficulties in the
U.S. federal budget talks and an economic slowdown having a negative impact on
many markets. The Fund was profitable in January due to the strong profits in
currency trading as the U.S. dollar reached a 23-month high against the Japanese
yen. In February, however, the Fund incurred its worst monthly loss due to the
sudden reversals in several strong price trends and considerable volatility in
the currency and financial markets. During March, large profits were taken in
the crude oil and gasoline markets as strong demand continued and talks between
the United Nations and Iraq were suspended. This trend continued into the
second quarter, during which strong gains were also recognized in the
agricultural markets as a combination of drought and excessive rain drove wheat
and grain prices to historic highs. In the late summer and early fall months,
the Fund continued to trade profitably as trending prices in a number of key
markets favorably impacted the Fund's performance. In September heating oil hit
a five-year high on soaring prices in Europe, and the Fund was also able to
capitalize on downward trends in the metals markets. Strong trends in the
currency and global bond markets produced significant gains in October and
November, but the year ended with declining performance as December witnessed
the reversal of several strong upward trends and increased volatility in key
markets.
1997
In currency markets, the U.S. dollar rallied and started 1997 on a strong
note, rising to a four-year high versus the Japanese yen and two-and-a-half year
highs versus the Deutsche mark and the Swiss franc. However, the dollar
underwent two significant corrections during the year. The first correction
occurred in the Spring against the Japanese yen, due to the G7 finance
ministers' determination that a further dollar advance would be counter-
productive to their current goals. From August through mid-November, the dollar
corrected against the Eurocurrencies in advance of a well-advertised tightening
by the Bundesbank. By mid-December the dollar had bounced back to new highs
against the yen and was rallying against the mark.
Global interest rate markets began the year on a volatile note, as
investors evaluated economic data for signs of inflation. By the middle of the
year, economic data in key countries was positive indicating lower inflation and
igniting a worldwide rally in the bond markets. Specifically, investor
sentiment was particularly strong in the U.S., where prices on the 30-year
Treasury bond and 10-year Treasury note rose to their highest levels in over two
years. This followed a largely positive economic report delivered by Federal
Reserve Chairman Greenspan in testimony before Congress. Effects of the plunge
in the Hong Kong stock market in late October spread rapidly throughout the
world's financial markets, including global bond markets. After continued
volatility in subsequent months made trading difficult, 1997 interest rate
trading ended on a positive note when U.S. and Japanese bond markets rallied as
a flight to safety from plunging stock markets around the world occurred in
December.
In energy markets, a slump in crude oil prices was characteristic of
its lackluster performance from the beginning of the year. Early in 1997,
volatility returned in the energy markets, reflecting the impact of a winter
significantly warmer than normal. By mid-year, the decline in prices reversed
sharply as Saudi Arabia and Iran, together representing about 45% of OPEC's oil
production, joined forces to pressure oil-producing nations to stay within OPEC
production quotas. In December, financial and economic problems in Asia reduced
demand for oil, and in combination with ample supplies, resulted in crude oil
prices declining once again.
PERFORMANCE OVERVIEW
The principal variables which determine the net performance of the
Partnership are gross profitability and interest income. During all periods set
forth under "Selected Financial Data," the interest rates in many countries were
at unusually low levels. This negatively impacted revenue because interest
income is typically a major component of commodity pool profitability. In
addition, low interest rates are frequently associated with reduced fixed income
market volatility, and in static markets the Fund's profit potential generally
tends to be diminished. On the other hand, during periods of higher interest
rates, the relative attractiveness of a high risk investment such as the Fund
may be reduced as compared to high yielding and much lower risk fixed-income
investments.
The Partnership's Brokerage Commissions and Administrative Fees are a
constant percentage of assets allocated to trading. The only Fund costs (other
than the insignificant F/X Desk service fees, EFP differentials and
organizational and offering cost reimbursement payments as well as bid-ask
spreads on forward contracts) which are not based on a percentage of the Fund's
assets allocated to trading are the Profit Shares payable to the Trading
Advisors on an Advisor-by-Advisor basis. During periods when Profit Shares are
a high percentage of net trading gains, it is likely that there has been
substantial performance non-correlation among Advisors (so that the total Profit
Shares paid to those Advisors which have traded profitably are a high
percentage, or perhaps even in excess, of total profits recognized, as other
Advisors have incurred offsetting losses, reducing overall trading gains but not
the Profit Shares paid to successful Advisors) -- suggesting the likelihood of
generally trendless, non-consensus markets.
-17-
<PAGE>
The events that primarily determine the Partnership's profitability are
those that produce sustained and major price movements. The Advisors are
generally more likely to be able to profit from sustained trends, irrespective
of their direction, than from static markets. During the course of the
Partnership's performance to date, such events have ranged from Federal Reserve
Board reductions in interest rates, the apparent refusal of Iraq to arrive at a
settlement which would permit it to sell oil internationally, the inability of
the U.S. government to agree upon a federal budget, and a combination of drought
and excessive rain negatively impacting U.S. agricultural harvesting as well as
planting. While these events are representative of the type of circumstances
which materially affect the Fund, the specific events which will do so in the
future cannot be predicted or identified.
Unlike many investment fields, there is no meaningful distinction in the
operation of the Fund between realized and unrealized profits. Most of the
contracts traded by the Fund are highly liquid and can be closed out at any
time. Furthermore, the profits on many open positions are effectively realized
on a daily basis through the payment of variation margin.
Except in unusual circumstances, factors -- regulatory approvals, cost of
goods sold, employee relations and the like -- which often materially affect an
operating business have virtually no impact on the Fund.
THE DIFFERENT SERIES OF UNITS
All series of Units issued after July 16, 1996 begin trading with the same
percentage (75%) of their total capital allocated to trading (by investment in
the Trading Partnership). All Series issued prior to such date began trading
with 60% of their total capital allocated to trading. All series trade in a
common trading account and are subject to the same method of calculating their
fees. Furthermore, any discretionary action taken by MLIP -- e.g., making a
distribution or adjusting trading leverage -- must be done in such a way, that
all Units receive the same distributions (if any) as well as having the same
percentage of capital allocated to trading after the adjustment. Despite these
fundamental similarities among the different series, because the series begin
trading at different times they are likely to come, as a result of trading
profits and losses, to have different percentages of their capital allocated to
trading, pay different Profit Shares (although to the same group of Advisors)
and have different Net Asset Values.
LIQUIDITY AND CAPITAL RESOURCES
The amount of capital raised for the Fund should not, except at extremely
high levels of capitalization, have a significant impact on its operations.
The Fund's costs are generally proportional to its asset base and, within broad
ranges of capitalization, the Advisors' trading positions (and the resulting
gains and losses) should increase or decease in approximate proportion to the
size of the Fund account managed by each of them, respectively.
The Partnership raises additional capital only through the continuous
offering of its Units.
Inflation per se is not a significant factor in the Fund's profitability,
although inflationary cycles can give rise to the type of major price movements
that can have a materially favorable or adverse impact on the Fund's
performance.
Changes in the level of prevailing interest rates could have a material
effect on the Fund's trading leverage. Interest rates directly affect the
calculation of the discounted value (discounted back from the relevant Principal
Assurance Date) of the guaranteed $100 minimum Net Asset Value per Unit and,
accordingly, the assets which a given series of Units has available for trading.
In its trading to date, the Fund has from time to time had substantial
unrealized gains and losses on its open positions. These gains or losses are
received or paid on a periodic basis as part of the routine clearing cycle on
exchanges or in the over-the-counter markets (the only over-the-counter market
in which the Fund trades is the inter-bank forward market in currencies). In
highly unusual circumstances, market illiquidity could make it difficult for
certain Advisors to close out open positions, and any such illiquidity could
expose the Fund to significant losses, or cause it to be unable to recognize
unrealized gains. However, in general, there is no meaningful difference
between the Fund's realized and unrealized gains.
THE YEAR 2000 COMPUTER ISSUE
Merrill Lynch's modifications for Year 2000 systems compliance are
proceeding according to plan and are expected to be completed in early 1999.
Based on information currently available, the remaining expenditures are
estimated at $200 million and will cover hardware and software upgrades, systems
consulting, and computer maintenance. These expenditures are not expected to
have a material adverse impact on Merrill Lynch's financial position, results of
operations, or cash flows in future periods. However, the failure of Merrill
Lynch's securities exchanges, clearing organizations, vendors, clients, or
regulators to resolve their own processing issues in a timely manner could
result in a material financial risk. Merrill Lynch is devoting necessary
resources to address all Year 2000 issues in a timely manner.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Not applicable.
-18-
<PAGE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The financial statements required by this Item are included in Exhibit
13.01.
The supplementary financial information ("selected quarterly financial
data" and "information about oil and gas producing activities") specified by
Item 302 of Regulation S-K is not applicable.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
There were no changes in or disagreements with accountants on accounting
and financial disclosure.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
(a,b) Identification of Directors and Executive Officers:
--------------------------------------------------
As a limited partnership, the Partnership itself has no officers or
directors and is managed by the General Partner. Trading decisions are made by
the Trading Advisors on behalf of the Partnership.
The directors and executive officers of MLIP as of February 1, 1998
and their respective business backgrounds are as follows.
<TABLE>
<S> <C>
John R. Frawley, Jr. Chairman, Chief Executive Officer,
President and Director
Jeffrey F. Chandor Senior Vice President, Director of
Sales, Marketing and Research and
Director
Joseph H. Moglia Director
Allen N. Jones Director
Stephen G. Bodurtha Director
Michael A. Karmelin Chief Financial Officer, Vice
President and Treasurer
Steven B. Olgin Vice President, Secretary and Director
of Administration
</TABLE>
John R. Frawley, Jr. was born in 1943. Mr. Frawley is Chairman, Chief
Executive Officer, President and a Director of MLIP and Co-Chairman of MLF. He
joined Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S") in 1966 and
has served in various positions, including Retail and Institutional Sales,
Manager of New York Institutional Sales, Director of Institutional Marketing,
Senior Vice President of Merrill Lynch Capital Markets and Director of
International Institutional Sales. Mr. Frawley holds a Bachelor of Science
degree from Canisius College. Mr. Frawley served on the CFTC's Regulatory
Coordination Advisory Committee from its formation in 1990 through its
dissolution in 1994. Mr. Frawley is currently serving his fourth consecutive
one-year term as Chairman of the Managed Funds Association (formerly, the
Managed Futures Association), a national trade association that represents the
managed futures, hedge funds and fund of funds industry. Mr. Frawley is also a
Director of that organization. Mr. Frawley currently serves on a panel created
by the Chicago Mercantile Exchange and The Board of Trade of the City of Chicago
to study cooperative efforts related to electronic trading, common clearing and
the issues regarding a potential merger.
Jeffrey F. Chandor was born in 1942. Mr. Chandor is Senior Vice
President, the Director of Sales, Marketing and Research and a Director of MLIP.
He joined MLPF&S in 1971 and has served as the Product Manager of International
Institutional Equities, Equity Derivatives and Mortgage-Backed Securities as
well as Managing Director of International Sales in the United States, and
Managing Director of Sales in Europe. Mr. Chandor holds a Bachelor of Arts
degree from Trinity College, Hartford, Connecticut.
Joseph H. Moglia was born in 1949. He is a director of MLIP. In
1971, he graduated from Fordham University with a Bachelor of Arts degree in
Economics. He later received his Master of Science degree from the University
of Delaware. He taught at the high school and college level for sixteen years.
Mr. Moglia joined MLPF&S in 1984, and has served in a number of senior roles,
including Director of New York Fixed Income Institutional Sales, Director of
Global Fixed Institutional Sales, and Director of the
-19-
<PAGE>
Municipal Division. He is currently Senior Vice President and Director of the
Investment Strategy and Product Group in Merrill Lynch Private Client, and
Director of Middle Markets.
Allen N. Jones was born in 1942. Mr. Jones is a Director of MLIP and,
from July 1995 until January 1998, Mr. Jones was Chairman of the Board of
Directors of MLIP. Mr. Jones graduated from the University of Arkansas with a
Bachelor of Science, Business Administration degree in 1964. Since June 1992,
Mr. Jones has held the position of Senior Vice President of MLPF&S. From June
1992 through February 1994, Mr. Jones was the President and Chief Executive
Officer of Merrill Lynch Insurance Group, Inc. ("MLIG") and remains on the Board
of Directors of MLIG and its subsidiary companies. From February 1994 to April
1997, Mr. Jones was the Director of Individual Financial Services of the Merrill
Lynch Private Client Group. In April 1997, Mr. Jones became the Director of
Private Client marketing.
Stephen G. Bodurtha was born in 1958. Mr. Bodurtha is a Director of
MLIP. In 1980, Mr. Bodurtha graduated from Wesleyan University, Middletown,
Connecticut with a Bachelor of Arts degree in Government, magna cum laude. From
1980 to 1983, Mr. Bodurtha worked in the Investment Banking Division of Merrill
Lynch. In 1985, he was awarded his Master of Business Administration degree
from Harvard University, where he also served as Associates Fellow (1985-1986).
From 1986 to 1989, Mr. Bodurtha held the positions of Associate and Vice
President with Kidder, Peabody & Co., Incorporated where he worked in their
Financial Futures & Options Group. Mr. Bodurtha joined MLPF&S in 1989 and has
held the position of First Vice President since 1995. He has been the Director
in charge of MLPF&S's Structured Investments Group since 1995.
Michael A. Karmelin was born in 1947. Mr. Karmelin is Chief Financial
Officer, Vice President and Treasurer of MLIP. Prior to joining MLIP in April
1997, Mr. Karmelin was Chief Financial Officer of Merrill Lynch, Hubbard Inc.
("ML Hubbard"), a sponsor of real estate limited partnerships. Mr. Karmelin
joined ML Hubbard in January 1994 and was a Vice President of ML Hubbard. From
May 1994 to April 1997, he was the Chief Financial Officer of ML Hubbard,
responsible for its accounting, treasury and tax functions. Prior to joining ML
Hubbard, Mr. Karmelin held several senior financial positions with ML&Co and
MLPF&S from December 1985 to December 1993, including Vice President/Senior
Financial Officer Corporate Real Estate and Purchasing, Manager Commitment
Control/Capital Budgeting, and Senior Project Manager/Project Analysis. Prior
to joining ML&Co., Mr. Karmelin was employed at Avco Corporation for 17 years,
where he held a variety of financial positions. Mr. Karmelin holds a B.B.A.
degree in Accounting from Baruch College, C.U.N.Y. and a Master of Business
Administration degree in Corporate Strategy and Finance from New York
University. Mr. Karmelin passed the Certified Public Accounting examination in
1974 and is a member of the Treasury Management Association, the Institute of
Management Accountants and The Strategic Leadership Forum.
Steven B. Olgin was born in 1960. Mr. Olgin is Vice President,
Secretary and the Director of Administration of MLIP. He joined MLIP in July
1994 and became a Vice President in July 1995. From 1986 until July 1994, Mr.
Olgin was an associate of the law firm of Sidley & Austin. In 1982, Mr. Olgin
graduated from The American University with a Bachelor of Science degree in
Business Administration and a Bachelor of Arts degree in Economics. In 1986, he
received his Juris Doctor degree from The John Marshall Law School. Mr. Olgin
is a member of the Managed Funds Association's Government Relations Committee
and has served as an arbitrator for the NFA. Mr. Olgin is also a member of the
Committee on Futures Regulation of the Association of the Bar of the City of New
York.
Messrs. Moglia and Bodurtha became Directors in January 1998.
As of December 31, 1997, the principals of MLIP had no investment in
the Fund and MLIP's general partner interest in the Fund was valued at
approximately $2.6 million.
MLIP acts as general partner to twelve public futures funds whose
units of limited partnership interest are registered under the Securities
Exchange Act of 1934: The Futures Expansion Fund Limited Partnership, The
Growth and Guarantee Fund L.P., ML Futures Investments II L.P., ML Futures
Investments L.P., John W. Henry & Co./Millburn L.P., The S.E.C.T.O.R. Strategy
Fund/SM/ L.P., The SECTOR Strategy Fund/SM/ II L.P., The SECTOR Strategy
Fund/SM/ V L.P., The SECTOR Strategy Fund/SM/ VI L.P., ML Global Horizons L.P.,
ML JWH Strategic Allocation Fund L.P. and the Fund. Because MLIP serves as the
sole general partner of each of these funds, the officers and directors of MLIP
effectively manage them as officers and directors of such funds.
(c) Identification of Certain Significant Employees:
-----------------------------------------------
None.
(d) Family Relationships:
--------------------
None.
(e) Business Experience:
-------------------
See Item 10(a)(b) above.
(f) Involvement in Certain Legal Proceedings:
----------------------------------------
-20-
<PAGE>
None.
(g) Promoters and Control Persons:
-----------------------------
Not applicable.
ITEM 11: EXECUTIVE COMPENSATION
----------------------
The directors and officers of the General Partner are remunerated by the
General Partner in their respective positions. The Partnership does not itself
have any officers, directors or employees. The Partnership pays Brokerage
Commissions to an affiliate of the General Partner and Administrative Fees to
the General Partner. The General Partner or its affiliates may also receive
certain economic benefits from holding certain of the Fund's dollar Available
Assets in offset accounts, as described in Item 1(c) above. The directors and
officers receive no "other compensation" from the Partnership, and the directors
receive no compensation for serving as directors of the General Partner. There
are no compensation plans or arrangements relating to a change in control of
either the Partnership or the General Partner.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN OWNERS AND MANAGEMENT
---------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners:
-----------------------------------------------
As of December 31, 1997, no person or "group" is known to be or have
been the beneficial owner of more than five percent of the Units.
(b) Security Ownership of Management:
--------------------------------
As of December 31, 1997, the General Partner owned 23,141.61 Units
(unit-equivalent general partnership interests), which was less than 3% of the
total Units outstanding.
(c) Changes in Control:
------------------
None.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED EXCHANGE OF FUTURES TRANSACTIONS
------------------------------------------------------------------
(a) Transactions with Management and Others:
---------------------------------------
The General Partner acts as administrative and trading manager of the
Fund. The General Partner provides all normal ongoing administrative functions
of the Partnership, such as accounting, legal and printing services. The
General Partner, which receives the Administrative Fee, pays all expenses
relating to such services.
(b) Certain Business Relationships:
------------------------------
MLF, an affiliate of the General Partner, acts as the principal
commodity broker for the Partnership.
In 1997, the Partnership accrued: (i) Brokerage Commissions of
$4,833,598 to the Commodity Broker, which included $949,508 in consulting fees
accrued by the Commodity Broker to the Trading Advisors; and (ii) Administrative
Fees of $138,103 to MLIP. In addition, MLIP and its affiliates may have derived
certain economic benefit from maintaining a portion of the Fund's assets in
"offset accounts" as described under Item 1(c), "Narrative Description of
Business -- Use of Proceeds and Cash Management -- Income Interest Earned on the
Fund's U.S. Dollar Available Assets not managed by MLAM" and Item 11, "Executive
Compensation" herein, as well as from the Fund's F/X Desk and exchange of
futures for physical ("EFP") trading.
See Item 1(c), "Narrative Description of Business -- Charges" and "--
Description of Current Charges" for a discussion of other business dealings
between MLIP affiliates and the Partnership.
(c) Indebtedness of Management:
--------------------------
The Partnership is prohibited from making any loans, to management or
otherwise.
(d) Transactions with Promoters:
---------------------------
Not applicable.
-21-
<PAGE>
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
---------------------------------------------------------------
(a)1. Financial Statements (found in Exhibit 13.01): Page
----
Independent Auditors' Report 1
Consolidated Statements of Financial Condition as of
December 31, 1997 and 1996 2
For the years ended December 31, 1997, 1996 and 1995:
Consolidated Statements of Operations 3
Consolidated Statements of Changes in Partners' Capital 4
Notes to Financial Statements 5-14
(a)2. Financial Statement Schedules:
-----------------------------
Financial statement schedules not included in this Form 10-K have been
omitted for the reason that they are not required or are not applicable or that
equivalent information has been included in the financial statements or notes
thereto.
(a)3. Exhibits:
--------
The following exhibits are incorporated by reference or are filed
herewith to this Annual Report on Form 10-K:
Designation Description
- ----------- -----------
1.01 Selling Agreement among the Partnership, the General Partner,
Merrill Lynch Futures Inc., the Selling Agent and the Trading
Advisors.
Exhibit 1.01: Is incorporated herein by reference from Exhibit 1.01
- ----------- contained in Amendment No. 1 to the Registration Statement
(File No. 33-73914) filed on July 14, 1994, on Form S-1 under
the Securities Act of 1933 (the "Registrant's Registration
Statement.")
1.01(a) Form of Selling Agreement Amendment among the Partnership, the
General Partner, Merrill Lynch Futures Inc., the Selling Agent
and the Trading Advisors.
Exhibit 1.01(a): Is incorporated herein by reference from Exhibit 1.01(a)
- --------------- contained in the Registrant's report on Form 10-K for the year
ended December 31, 1997.
3.01(i) Amended and Restated Limited Partnership Agreement of the
Partnership.
Exhibit 3.01(i): Is incorporated herein by reference from Exhibit 3.01(ii)
- --------------- contained in the Registrant's Registration Statement (as
Exhibit A).
3.01(ii) Amended and Restated Limited Partnership Agreement of the
Trading Partnership.
Exhibit 3.01(ii): Is incorporated herein by reference from Exhibit 3.01(ii)
- ---------------- contained in Registrant's the Registration Statement.
3.05(ii) Amended and Restated Certificate of Limited Partnership of the
Partnership, dated July 27, 1995.
Exhibit 3.05(ii): Is incorporated herein by reference from Exhibit 3.05(ii)
- ---------------- contained in the Registrant's report on Form 10-Q for the
Quarter Ended June 30, 1995.
10.01(h) Form of Advisory Agreement among the Partnership, the General
Partner, Merrill Lynch Futures Inc. and each Trading Advisor.
Exhibit 10.01(h): Is incorporated herein by reference from Exhibit 10.01(h)
- ---------------- contained in the Registrant's report on Form 10-Q for the
Quarter Ended June 30, 1995.
10.02 Form of Consulting Agreement between Merrill Lynch Futures
Inc. and each trading advisors.
Exhibit 10.02: Is incorporated herein by reference from Exhibit 10.02
- ------------- contained in the Registrant's Registration Statement.
-22-
<PAGE>
10.03 Form of Customer Agreement between the Trading Partnership and
Merrill Lynch Futures Inc.
Exhibit 10.03 Is incorporated herein by reference from Exhibit 10.03
- ------------- contained in the Registrant's Registration Statement (as
Exhibit B).
10.05 Merrill Lynch & Co., Inc. Guarantee.
Exhibit 10.05: Is incorporated herein by reference from Exhibit 10.05
- ------------- contained in the Registrant's Registration Statement (as
Exhibit B).
10.06 Form of Subscription Agreement and Power of Attorney.
Exhibit 10.06: Is incorporated herein by reference from Exhibit 10.06
- ------------- contained in the Registrant's Registration Statement (as
Exhibit D).
10.07(a) Foreign Exchange Desk Service Agreement, dated July 1, 1993
among Merrill Lynch International Bank, Merrill Lynch
Investment Partners Inc., Merrill Lynch Futures Inc. and
various MLIP funds.
Exhibit 10.07(a): Is incorporated herein by reference from Exhibit 10.07
- ---------------- contained in the Registrant's Registration Statement (as
Exhibit D).
10.07(b) Amendment to Foreign Exchange Desk Service Agreement, dated
July 14, 1994, among Merrill Lynch Investment Bank, Merrill
Lynch Investment Partners Inc., Merrill Lynch Futures Inc. and
the Fund.
Exhibit 10.07(b): Is incorporated herein by reference from Exhibit 10.07
- ---------------- contained in the Registrant's Registration Statement.
10.08 Investment Advisory Contract between Merrill Lynch Futures,
the Partnership, the Trading Partnership and MLAM.
Exhibit 10.08: Is incorporated herein by reference from Exhibit 10.08
- ------------- contained in the Registrant's Registration Statement.
10.09(a) Form of Advisory and Consulting Agreement Amendment among the
General Partner, each Advisor, the Partnership and Merrill
Lynch Futures Inc.
Exhibit 10.09(a): Is incorporated herein by reference from Exhibit 10.09(a)
- ---------------- contained in the Registrant's report on Form 10-K for the
year ended December 31, 1996.
10.09(b) Form of Amendment to the Customer Agreement among the
Partnership and MLF.
Exhibit 10.09(b): Is incorporated herein by reference from Exhibit 10.09(b)
- ---------------- contained in the Registrant's report on Form 10-K for the
year ended December 31, 1996.
.
13.01 1997 Annual Report and Independent Auditors' Report.
Exhibit 13.01: Is filed herewith.
- -------------
28.01 Prospectus of the Partnership dated January 25, 1996.
Exhibit 28.01: Is incorporated by reference as filed with the Securities and
- ------------- Exchange Commission pursuant to Rule 424 under the Securities
Act of 1933, Registration Statement (File No. 33-73914) on
Form S-1 (effective January 25, 1996).
(b) Report on Form 8-K:
------------------
No reports on Form 8-K were filed during the fourth quarter of 1997.
-23-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ML PRINCIPAL PROTECTION TRADING L.P.
By: MERRILL LYNCH INVESTMENT PARTNERS INC.
General Partner
By: /s/ John R. Frawley, Jr.
------------------------
John R. Frawley, Jr.
Chairman, Chief Executive Officer,
President and Director
(Principal Executive Officer)
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed on March 25, 1998 by the
following persons on behalf of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/John R. Frawley, Jr. Chairman, Chief Executive Officer, President and Director March 25, 1998
- ------------------------- (Principal Executive Officer)
John R. Frawley, Jr.
/s/Michael A. Karmelin Vice President, Chief Financial Officer and Treasurer March 25, 1998
- ------------------------- (Principal Financial and Accounting Officer)
Michael A. Karmelin
/s/Jeffrey F. Chandor Senior Vice President, Director of Sales, March 25, 1998
- ------------------------- Marketing and Research and Director
Jeffrey F. Chandor
/s/Allen N. Jones Director March 25, 1998
- -------------------------
Allen N. Jones
</TABLE>
(Being the principal executive officer, the principal financial and accounting
officer and a majority of the directors of Merrill Lynch Investment Partners
Inc.)
<TABLE>
<S> <C>
MERRILL LYNCH INVESTMENT General Partner of Registrant March 25, 1998
PARTNERS INC.
</TABLE>
By/s/ John R. Frawley, Jr.
------------------------
John R. Frawley, Jr.
-24-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
ANNUAL REPORT FOR 1997 ON FORM 10-K
INDEX TO EXHIBITS
-----------------
Exhibit
-------
Exhibit 13.01 1997 Annual Report and Independent Auditors' Report
-25-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(Formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
Consolidated Financial Statements for the
Years Ended December 31, 1997, 1996 and 1995
and Independent Auditors' Report
<PAGE>
To: The Limited Partners of ML PRINCIPAL PROTECTION L.P.
ML Principal Protection Plus L.P. (the "Fund" or "Partnership") ended its fourth
fiscal year of trading on December 31, 1997 with an increase in Net Asset Value
("NAV"). During 1997, trading profits were generated in the currency, interest
rate, metals, agriculture and stock index markets while losses were incurred in
energy trading. Please see the accompanying summary financial information for
the NAV of your series of Units.
Trend reversals and extreme market volatility, affected by such factors as the
Asian flu and El Nio, were characteristic of most of 1997. However, the year
proved to be a profitable one overall for the Fund as trends in several key
markets enabled the Trading Advisors to profit despite the significant
obstacles. Although trading results in several sectors may have been
lackluster, the global currency and bond markets offered noteworthy trading
opportunities, which resulted in significant profits in these markets during the
year. Additionally, the currency and interest rate sectors of the Fund's
portfolio represented its largest percentage of market commitments.
In currency markets, the U.S. dollar rallied and started 1997 on a strong note,
rising to a four-year high versus the Japanese yen and two-and-a-half year highs
versus the Deutsche mark and the Swiss franc. However, the dollar underwent two
significant corrections during the year. The first correction occurred in the
Spring against the Japanese yen, due to the G7 finance ministers' determination
that a further dollar advance would be counter-productive to their current
goals. From August through mid-November, the dollar corrected against the
Eurocurrencies in advance of a well-advertised tightening by the Bundesbank. By
mid-December the dollar had bounced back to new highs against the yen and was
rallying against the mark.
Global interest rate markets began the year on a volatile note, as investors
evaluated economic data for signs of inflation. By the middle of the year,
economic data in key countries was positive indicating lower inflation and
igniting a worldwide rally in the bond markets. Specifically, investor
sentiment was particularly strong in the U.S., where prices on the 30-year
Treasury bond and 10-year Treasury note rose to their highest levels in over two
years. This followed a largely positive economic report delivered by Federal
Reserve Chairman Greenspan in testimony before Congress. Effects of the plunge
in the Hong Kong stock market in late October spread rapidly throughout the
world's financial markets, including global bond markets. After continued
volatility in subsequent months made trading difficult, 1997 interest rate
trading ended on a positive note when U.S. and Japanese bond markets rallied as
a flight to safety from plunging stock markets around the world occurred in
December.
In energy markets, a slump in crude oil prices was characteristic of its
lackluster performance from the beginning of the year. Early in 1997,
volatility returned in the energy markets, reflecting the impact of a winter
significantly warmer than normal. By mid-year, the decline in prices reversed
sharply as Saudi Arabia and Iran, together representing about 45% of OPEC's oil
production, joined forces to pressure oil-producing nations to stay within OPEC
production quotas. In December, financial and economic problems in Asia reduced
demand for oil, and in combination with ample supplies, resulted in crude oil
prices declining once again.
Although the overall return for the Fund might have paled in comparison to some
of the popular market indices during 1997, a significant observation is worth
noting. From the time the Dow Jones industrial average hit its high of 8259.31
in August through the end of the year, it declined 4.25% with a continued
increase in volatility. Conversely, the Fund, which has been designed with the
objective of producing returns non-correlated to traditional debt and equity
markets, steadily improved performance during the same time period. We
appreciate your continued investment in the Fund and look forward to 1998 and
the trading opportunities it may bring.
<PAGE>
Sincerely,
John R. Frawley, Jr.
President
MERRILL LYNCH INVESTMENT PARTNERS INC.
(General Partner)
FOR THE EXCLUSIVE USE OF INVESTORS IN ML PRINCIPAL PROTECTION L.P. THIS ANNUAL
REPORT IS NOT AN OFFER TO SELL NOR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES. AN OFFER CAN ONLY BE MADE BY THE PROSPECTUS, AS SUPPLEMENTED, WHICH
CONTAINS IMPORTANT INFORMATION CONCERNING RISK FACTORS, PERFORMANCE AND OTHER
MATERIAL ASPECTS OF THE FUND, TOGETHER WITH SUMMARY FINANCIAL INFORMATION
CURRENT WITHIN 60 DAYS. THE PROSPECTUS MUST BE READ CAREFULLY BEFORE ANY
DECISION WHETHER TO INVEST IS MADE. THIS ANNUAL REPORT MUST NOT BE REPRODUCED
OR DISTRIBUTED IN ANY MANNER. FUTURES TRADING IS SPECULATIVE AND INVOLVES A HIGH
DEGREE OF RISK. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE
RESULTS.
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Page
----
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995:
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Changes in Partners' Capital 4
Notes to Consolidated Financial Statements 5-14
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Partners of
ML Principal Protection L.P.:
We have audited the accompanying consolidated statements of financial condition
of ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.) (a
Delaware limited partnership; the "Partnership") as of December 31, 1997 and
1996, and the related consolidated statements of income and changes in partners'
capital for each of the three years in the period ended December 31, 1997.
These consolidated financial statements are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on these
consolidated financial statements 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 consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of ML Principal Protection L.P. as of
December 31, 1997 and 1996, and the results of their operations for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
February 6, 1998
New York, New York
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------------------ ----------------
<S> <C> <C>
ASSETS
Cash $ 1,423 $ 328
Accrued interest receivable (Note 2) 38,562 23,501
U. S. Government obligations (Note 1) 94,651,930 72,815,648
Equity in commodity futures trading accounts:
Cash and option premiums 6,127,948 7,177,888
Net unrealized profit on open contracts 2,958,084 1,677,317
------------- -------------
TOTAL $ 103,777,947 $ 81,694,682
============= =============
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES:
Redemptions payable $ 636,155 $ 966,906
Brokerage commissions payable (Note 2) 494,349 378,291
Administrative fees payable (Note 2) 14,330 10,224
Profit Shares payable (Note 4) 591,195 658,800
Organizational and initial offering costs payable (Note 1) -- 68,630
------------- -------------
Total liabilities 1,736,029 2,082,851
------------- -------------
Minority Interest 815,233 768,546
------------- -------------
PARTNERS' CAPITAL:
General Partner (23,141.61 Units and 20,873.06 Units) 2,564,153 2,301,180
Limited Partners (989,140.56 Units and 702,786.91 Units) 105,628,837 76,542,105
Subscriptions Receivable (69,663.05 Units and 0 Units) (6,966,305) --
------------- -------------
Total partners' capital 101,226,685 78,843,285
------------- -------------
TOTAL $ 103,777,947 $ 81,694,682
============= =============
</TABLE>
NET ASSET VALUE PER UNIT (Note 5)
See notes to consolidated financial statements.
-2-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- --------------
<S> <C> <C> <C>
REVENUES:
Trading profit (loss):
Realized $ 5,412,457 $ 9,038,064 $ 4,407,833
Change in unrealized 1,083,826 (396,221) 1,355,377
------------ ------------ ------------
Total trading results 6,496,283 8,641,843 5,763,210
Interest income (Note 2) 4,873,872 4,545,186 3,415,670
------------ ------------ ------------
Total revenues 11,370,155 13,187,029 9,178,880
------------ ------------ ------------
EXPENSES:
Profit Shares (Note 4) 931,522 978,264 652,366
Brokerage commissions (Note 2) 4,833,598 4,775,116 3,303,292
Administrative fees (Note 2) 138,103 129,057 --
------------ ------------ ------------
Total expenses 5,903,223 5,882,437 3,955,658
------------ ------------ ------------
INCOME BEFORE MINORITY INTEREST 5,466,932 7,304,592 5,223,222
------------ ------------ ------------
Minority interest in income (46,687) (81,228) (36,730)
------------ ------------ ------------
NET INCOME $ 5,420,245 $ 7,223,364 $ 5,186,492
============ ============ ============
NET INCOME PER UNIT OF PARTNERSHIP INTEREST:
Weighted average number of Units outstanding (Note 6) 818,689 754,428 551,944
============ ============ ============
Net income per weighted average General Partner $ 6.62 $ 9.57 $ 9.40
and Limited Partner Unit ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
-3-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Limited General Subscriptions
Units Partners Partner Receivable Total
--------------- ------------------ --------------- ---------------- --------------
<S> <C> <C> <C> <C> <C>
PARTNERS' CAPITAL,
DECEMBER 31, 1994 317,562.00 $ 31,017,854 $ 1,074,985 $ -- $ 32,092,839
Redemptions (47,810.02) (5,054,249) -- -- (5,054,249)
Subscriptions 444,567.00 43,851,304 605,396 -- 44,456,700
Distributions -- (1,771,806) (63,432) -- (1,835,238)
Net income -- 5,037,038 149,454 -- 5,186,492
---------- ------------- ------------- ------------- -------------
PARTNERS' CAPITAL,
DECEMBER 31, 1995 714,318.98 73,080,141 1,766,403 -- 74,846,544
Redemptions (245,127.36) (25,748,519) -- -- (25,748,519)
Subscriptions 254,468.35 25,102,217 344,618 -- 25,446,835
Distributions -- (2,833,925) (91,014) -- (2,924,939)
Net income -- 6,942,191 281,173 -- 7,223,364
---------- ------------- ------------- ------------- -------------
PARTNERS' CAPITAL,
DECEMBER 31, 1996 723,659.97 76,542,105 2,301,180 -- 78,843,285
Redemptions (183,442.91) (19,816,833) -- -- (19,816,833)
Subscriptions 472,065.11 46,994,656 211,855 -- 47,206,511
Subscriptions Receivable (69,663.05) -- -- (6,966,305) (6,966,305)
Distributions -- (3,362,913) (97,305) -- (3,460,218)
Net income -- 5,271,822 148,423 -- 5,420,245
---------- ------------- ------------- ------------- -------------
PARTNERS' CAPITAL,
DECEMBER 31, 1997 942,619.12 $ 105,628,837 $ 2,564,153 $ (6,966,305) $ 101,226,685
========== ============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
-4-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
- ------------
ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.) (the
"Partnership") was organized as an open-ended fund under the Delaware Revised
Uniform Limited Partnership Act on January 3, 1994 and commenced trading
activities on October 12, 1994. The Partnership engages in both the speculative
trading of futures, options on futures and forward contracts on a wide range of
commodities through ML Principal Protection Trading L.P. (formerly, ML Principal
Protection Plus Trading L.P.) (the "Trading Partnership"), of which the
Partnership is the sole limited partner and investing in U.S. Government
Securities, as defined. Merrill Lynch Investment Partners Inc. (formerly, ML
Futures Investment Partners Inc.) (the "General Partner" or "MLIP"), a wholly-
owned subsidiary of Merrill Lynch Group Inc., which, in turn, is a wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("Merrill Lynch"), is the general
partner of both the Partnership and the Trading Partnership and Merrill Lynch
Futures Inc. ("MLF"), also an affiliate of Merrill Lynch, is the Trading
Partnership's commodity broker. Merrill Lynch Asset Management, L.P. ("MLAM"),
another affiliate of Merrill Lynch, provides cash management services to the
Partnership investing in Government Securities, as defined. Substantially all
of the Partnership's assets are held in accounts maintained at MLF or Merrill
Lynch, Pierce, Fenner & Smith Incorporated, a Merrill Lynch affiliate. The
General Partner has agreed to maintain a general partner's interest of at least
1% of the total capital in each of the Partnership and the Trading Partnership.
The General Partner and the Limited Partners share in the profits and losses of
the Partnership, and the General Partner and the Partnership share in the
profits and losses of the Trading Partnership, in proportion to the respective
interests in the Partnership and the Trading Partnership owned by each.
The consolidated financial statements include the accounts of the Trading
Partnership in which the Partnership is the sole limited partner. All related
transactions and intercompany balances between the Partnership and the Trading
Partnership are eliminated in consolidation.
The ownership by the General Partner in the Trading Partnership represents a
minority interest when the financial results of the Trading Partnership are
consolidated into those of the Partnership. The General Partner's share of the
Trading Partnership's profits and losses is deducted from the Consolidated
Statements of Income, and the General Partner's interest in the Trading
Partnership reduces partners' capital on the Consolidated Statements of
Financial Condition and the Consolidated Statements of Changes in Partners'
Capital.
The Partnership issues units of limited partnership interest ("Units") generally
as of the beginning of each calendar quarter (and also as of May 1, 1997). Each
series has its own Net Asset Value per Unit. Different series may allocate
different percentages of their total capital to trading, but all series trade
under the direction of the same combination of independent advisors (the
"Trading Advisors" or the "Advisors"), chosen from time to time by MLIP to
manage the Trading Partnership's trading.
MLIP selects the Advisors to manage the Partnership's assets, and allocates and
reallocates the Partnership's trading assets among existing, replacement and
additional Advisors.
-5-
<PAGE>
MLIP also determines what percentage of the Partnership's total capital to
allocate to trading from time to time, attempting to balance the desirability of
reducing the opportunity costs of the Partnership's "principal protection"
structure against the necessity of preventing Merrill Lynch from ever being
required to make any payments to the Partnership under the Merrill Lynch
guarantee (see Note 7).
Estimates
- ----------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
- -------------------
Commodity futures, options on futures and forward contract transactions are
recorded on the trade date, and open contracts are reflected in net unrealized
profit on open contracts in the Consolidated Statements of Financial Condition
at the difference between the original contract value and the fair value. The
change in net unrealized profit (loss) on open contracts from one period to the
next is reflected in change in unrealized in the Consolidated Statements of
Income. Fair value is based on quoted market prices on the exchange or market
on which the contract is traded.
U.S. Government Securities
- --------------------------
The Partnership invests a portion of its assets in obligations of the U.S.
Treasury and certain other U.S. government agencies ("Government Securities")
under the direction of MLAM within the parameters established by MLIP for which
MLAM accepts no responsibility. These investments are carried at fair value.
Organizational and Initial Offering Costs, Operating Expenses and Selling
- -------------------------------------------------------------------------
Commissions
-----------
The General Partner advanced all organizational and initial offering costs
relating to the Partnership and the Trading Partnership. The Partnership and
Trading Partnership reimbursed the General Partner for such costs in 36 monthly
installments. For financial reporting purposes, the Partnership deducted the
organizational and initial offering reimbursement costs of $239,100 from
partners' capital at inception. For all other purposes (including determining
Net Asset Values of the Units), the Partnership deducts the organizational and
initial offering cost reimbursements only as actually paid.
The General Partner pays all routine operating costs (including legal,
accounting, printing, postage and similar administrative expenses) of the
Partnership and the Trading Partnership, including the cost of the ongoing
offering of the Units. The General Partner receives administrative fees as well
as a portion of the brokerage commissions paid to MLF by the Partnership as
reimbursement for the foregoing expenses.
No selling commissions have been or are paid by Limited Partners.
Income Taxes
- ------------
No provision for income taxes has been made in the accompanying consolidated
financial statements as each Partner is individually responsible for reporting
income or loss based on such Partner's respective share of the Partnership's
consolidated income and expenses as reported for income tax purposes.
Redemptions
- -----------
-6-
<PAGE>
A Limited Partner may require the Partnership to redeem some or all of such
Partner's Units at Net Asset Value as of the close of business on the last
business day of any month upon ten calendar days' notice. Units redeemed on or
prior to the end of the twelfth full month after purchase are assessed an early
redemption charge of 3% of their Net Asset Value as of the date of redemption.
Dissolution of the Partnership
- ------------------------------
The Partnership will terminate on December 31, 2024, or at an earlier date if
certain conditions occur, as well as under certain other circumstances as set
forth in the Limited Partnership Agreement.
2. RELATED PARTY TRANSACTIONS
MLAM manages substantially all of the Partnership's available U.S. dollar
assets, pursuant to guidelines established by MLIP for which MLAM assumes no
responsibility, in the U.S. Government Securities markets. MLF pays MLAM annual
management fees of .20 of 1% on the first $25 million of Partnership capital
managed by MLAM, .15 of 1% on the next $25 million of capital, .125 of 1% on the
next $50 million, and .10 of 1% on capital in excess of $100 million. Such fees
are paid quarterly in arrears and are calculated on the basis of the average
daily assets managed by MLAM.
A portion of the Partnership's U.S. dollar assets are held at MLF in cash. On
the cash held at MLF, the Partnership receives interest from Merrill Lynch at
the prevailing 91-day U.S. Treasury bill rate. Merrill Lynch may derive certain
economic benefits, in excess of the interest which Merrill Lynch pays to the
Partnership, from possession of such cash.
Merrill Lynch credits the Partnership with interest on the Partnership's non-
U.S. dollar-denominated assets based on local short-term rates. Merrill Lynch
charges the Partnership Merrill Lynch's cost of financing realized and
unrealized losses on the Partnership's non-U.S. dollar-denominated positions.
The General Partner has determined that there may have been a miscalculation in
the interest credited to the Partnership for a period prior to November 1996
(such period may extend prior to that covered by these financial statements).
Accordingly, the General Partner credited current and former investors who
maintained a Merrill Lynch customer account in December 1997 with interest which
was compounded. Former investors who do not maintain a Merrill Lynch customer
account will be credited as their response forms are processed. The total
amount of the adjustment is approximately $54,000. Since this amount was paid
directly to investors by the General Partner, it is not reflected in these
financial statements. The General Partner has determined that interest has been
calculated appropriately since November 1996.
Prior to 1996, the Partnership paid brokerage commissions to MLF in respect of
each series of Units at a flat monthly rate equal to .792 of 1% (a 9.5% annual
rate) of such series' month-end assets allocated to trading. Effective January
1, 1996, this rate was reduced to .771 of 1% (a 9.25% annual rate) of each
series' month-end assets allocated to trading and the Partnership began to pay
MLIP a monthly administrative fee of .021 of 1% (a .25% annual rate) of each
series' month-end assets allocated to trading (this recharacterization had no
economic effect on the Partnership). Effective January 1, 1997, each series'
brokerage commission percentage was reduced to .729 of 1% (an 8.75% annual rate)
of such series' month-end assets allocated to trading. Assets committed to
trading are not reduced for purposes of calculating brokerage commissions and
administrative fees by any accrued brokerage commissions, administrative fees,
Profit Shares or other fees or charges.
The General Partner estimates that the round-turn equivalent commission rate
charged to the Partnership during the years ended December 31, 1997, 1996 and
-7-
<PAGE>
1995, was approximately $116, $116 and $134, respectively, not including, in
calculating round-turn equivalents, forward contracts on a futures-equivalent
basis.
MLF pays the Trading Advisors annual Consulting Fees, ranging up to 4% of the
Partnership's average month-end assets allocated to them for management, after
reduction for a portion of the brokerage commissions accrued with respect to
such assets.
The Partnership trades forward contracts through a foreign exchange service desk
(the "F/X Desk") established by MLIP. The F/X Desk gives the Partnership access
to counterparties in addition to (but also including) Merrill Lynch
International Bank ("MLIB"). MLIP or another Merrill Lynch entity charges a
service fee equal to, at current exchange rates, approximately $5.00 to $12.50
on each purchase or sale (not round-turn) of a futures contract-equivalent face
amount of a given currency traded in the forward markets. No service fees are
charged on trades awarded to MLIB (which receives bid-ask spreads on such
trades).
In its exchange of futures for physical ("EFP") trading with Merrill Lynch, the
Partnership acquires spot or forward (collectively, "cash") currency positions
through the F/X Desk in the same manner and on the same terms as in the case of
the Partnership's other F/X Desk trading. When the Partnership exchanges these
positions for futures, there is a differential between the prices of the two
positions. This differential reflects, in part, the different settlement dates
of the cash and the futures contracts and prevailing interest rates, but also
includes a pricing spread in favor of MLIB or another Merrill Lynch entity. The
Advisors, to date, have made little use of EFPs.
The Partnership's F/X Desk service fee and EFP differential costs have, to date,
totaled no more than .25 of 1% per annum of the Partnership's average month-end
assets.
-8-
<PAGE>
3. ANNUAL DISTRIBUTIONS
The Partnership makes annual fixed-rate distributions, payable irrespective of
profitability, of between $2 and $5 per Unit on Units issued prior to July 16,
1996. The Partnership may also pay discretionary distributions on such Series
of Units of up to 50% of any Distributable New Appreciation, as defined on such
Units. No distributions are payable on Units issued after July 16, 1996. As of
December 31, 1997, the Partnership has made the following distributions:
Series Distribution Fixed-Rate Discretionary
Date Distribution Distribution
--------- -----------------------------------------------
1997
- -----------
Series A 10/1/97 $ 3.50 $ -
Series B 1/1/97 3.50 3.00
Series C 4/1/97 3.50 4.00
Series D 7/1/97 3.50 1.00
Series E 10/1/97 3.50 2.00
Series F 1/1/97 3.50 2.50
Series G 4/1/97 3.50 3.50
Series H 7/1/97 3.50 2.50
1996
- -----------
Series A 10/1/96 $ 3.50 $ 2.50
Series B 1/1/96 3.50 2.50
Series C 4/1/96 3.50 -
Series D 7/1/96 3.50 -
Series E 10/1/96 3.50 -
1995
- -----------
Series A 10/1/95 3.50 2.50
4. AGREEMENTS
The Trading Partnership and the Advisors have each entered into Advisory
Agreements. These Advisory Agreements generally terminate one year after they
are entered into, subject to certain renewal rights exercisable by the
Partnership. The Advisors determine the commodity futures and forward contract
trades to be made on behalf of their respective Partnership accounts, subject to
certain trading policies and to certain rights reserved for the General Partner.
Profit Shares, generally ranging from 15% to 25% of any New Trading Profit, as
defined, recognized by each Advisor individually, irrespective of the overall
performance of any series, either as of the end of each calendar quarter or
year, are paid to the appropriate Advisors. Profit Shares are also paid out in
respect of Units redeemed as of the end of interim months to the extent of the
applicable percentage of any New Trading Profit attributable to such Units.
5. NET ASSET VALUE PER UNIT
For financial reporting purposes, the Partnership deducted the total
organizational and initial offering costs payable to the General Partner at
inception for purposes of determining Net Asset Value. Such deduction was
allocated pro-rata among the outstanding Units of each series based upon the
aggregate Net Asset Value of each series, and then equally among all Units of
the same series. For all other purposes (including computing Net Asset Value
for redemptions) the Partnership deducts the organizational and initial offering
cost reimbursements only as actually paid. The organizational and initial
offering cost reimbursement was
-9-
<PAGE>
completed in October 1997. At December 31, 1997 the Net Asset Values of the
different series of Units for financial reporting purposes and for all other
purposes were:
<TABLE>
<CAPTION>
Net Asset Value Number Net Asset Value
of Units per Unit
----------------------------------------------------------------------------------------
-------------------------------------------------------------------
<S> <C> <C> <C>
Series A Units $ 17,716,313 155,778.00 $ 113.73
Series B Units 2,865,130 25,100.00 114.15
Series C Units 4,061,256 37,551.00 108.15
Series D Units 10,499,613 95,504.00 109.94
Series E Units 7,685,677 70,255.86 109.40
Series F Units 6,136,370 56,275.48 109.04
Series G Units 5,470,415 51,354.50 106.52
Series H Units 5,610,794 52,626.22 106.62
Series K Units 12,127,411 115,752.00 104.77
Series L Units 14,732,144 144,314.00 102.08
Series M Units 14,321,562 138,108.06 103.70
----------------- -----------------
$ 101,226,685 942,619.12
================= =================
</TABLE>
As of December 31, 1996, the Net Asset Value of the different series of Units
for financial reporting purposes and for all other purposes were as follows:
<TABLE>
<CAPTION>
Net Asset Value Net Asset Value per Unit
------------------------------------------ -------------------------------------
All Other Financial Number All Other Financial
Purposes Reporting of Units Purposes Reporting
----------------------------------------------------------- -------------------------------------
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Series A Units $ 21,048,780 $ 21,031,369 190,136.00 $ 110.70 $ 110.61
Series B Units 3,447,686 3,444,936 30,179.00 114.24 114.15
Series C Units 4,996,014 4,992,389 45,696.00 109.33 109.25
Series D Units 12,582,502 12,567,310 116,303.00 108.19 108.06
Series E Units 10,484,159 10,476,812 96,561.50 108.58 108.50
Series F Units 10,179,910 10,173,793 93,465.62 108.92 108.85
Series G Units 6,967,116 6,962,973 64,920.50 107.32 107.25
Series H Units 9,199,107 9,193,703 86,398.35 106.47 106.41
---------------- ----------------- -----------------
Total $ 78,905,274 $ 78,843,285 723,659.97
================ ================= =================
</TABLE>
6. WEIGHTED AVERAGE UNITS
Weighted average number of Units outstanding was computed for purposes of
disclosing consolidated net income per weighted average Unit. The weighted
average Units at December 31, 1997, 1996 and 1995 equals the Units outstanding
as of such date, adjusted proportionately for Units redeemed or issued based on
the respective length of time each was outstanding during such period.
-10-
<PAGE>
7. MERRILL LYNCH & CO., INC. GUARANTEE
Merrill Lynch has guaranteed to the Partnership that it will have sufficient net
assets, as of the Principal Assurance Date for each series of Units, that the
Net Asset Value per Unit of such series as of such Principal Assurance Date will
equal, after reduction for all liabilities to third parties and all
distributions paid to such Units, not less than $100.
8. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Partnership trades futures, options on futures and forward contracts on
interest rates, stock indices, commodities, currencies, energy and metals. The
Partnership's total trading results by reporting category for the years ended
December 31, 1997, 1996 and 1995 were as follows:
Total Trading Results
--------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
Interest Rates $ 1,706,686 $ 3,183,955 $ 3,933,366
Stock Indices 232,314 (746,255) 587,931
Commodities 679,157 20,119 (447,486)
Currencies 3,911,109 3,301,360 2,914,300
Energy (1,278,003) 3,280,677 238,988
Metals 1,245,020 (398,013) (1,463,889)
--------------- --------------- ---------------
$ 6,496,283 $ 8,641,843 $ 5,763,210
=============== =============== ===============
Market Risk
- -----------
Derivative financial instruments involve varying degrees of off-balance sheet
market risk, and changes in the level or volatility of interest rates, foreign
currency exchange rates or market values of the financial instruments or
commodities underlying such derivative instruments frequently result in changes
in the Partnership's unrealized profit on such derivative instruments as
reflected in the Consolidated Statements of Financial Condition. The
Partnership's exposure to market risk is influenced by a number of factors,
including the relationships among the derivative instruments held by the Trading
Partnership as well as the volatility and liquidity in the markets in which the
derivative instruments are traded.
The General Partner has procedures in place intended to control market risk,
although there can be no assurance that they will, in fact, succeed in doing so.
The procedures focus primarily on monitoring the trading of the Advisors
selected from time to time for the Partnership, adjusting the percentage of the
Partnership's total assets allocated to trading with respect to each Series of
Units, calculating the Net Asset Value of the Advisors' respective Partnership
accounts as of the close of business on each day and reviewing outstanding
positions for over-concentrations -- both on an Advisor-by-Advisor and on an
overall Partnership basis. While the General Partner does not itself intervene
in the markets to hedge or diversify the Partnership's market exposure, the
General Partner may urge Advisors to reallocate positions, or itself reallocate
Partnership assets among Advisors (although typically only as of the end of a
month), in an attempt to avoid over-concentrations. However, such interventions
are unusual. Except in cases in which it appears that an Advisor has begun to
deviate from past practice and trading policies or to be trading erratically,
the General Partner's basic risk control procedures consist simply of the
ongoing process of Advisor monitoring and selection, with the market risk
controls being applied by the Advisors themselves.
One important aspect of the General Partner's risk controls is its adjustments
to the leverage at which each Series of Units trades. By controlling the
percentage of each series' assets allocated to trading, the General
-11-
<PAGE>
Partner can directly affect the market exposure of the Partnership. Leverage
control is the principal means by which the General Partner hopes to be able to
ensure that Merrill Lynch is never required to make any payments under its
guarantee that the Net Asset Value per Unit of each series will equal no less
than $100 as of the Principal Assurance Date for such series.
Fair Value
- ----------
The derivative instruments traded by the Trading Partnership are marked to
market daily with the resulting unrealized profit recorded in the Consolidated
Statements of Financial Condition and the related profit (loss) reflected in
trading revenues in the Consolidated Statements of Income.
The contract/notional values of the Trading Partnership's open derivative
instrument positions as of December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------- --------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------ ----------------- ------------------ ------------------
<S> <C> <C> <C> <C>
Interest Rates $ 121,435,283 $ 85,620,621 $ 103,258,306 $ 38,270,540
Stock Indices 1,665,588 8,854,122 4,259,475 2,340,013
Commodities 11,663,786 21,791,599 8,541,433 12,761,047
Currencies 70,272,888 147,312,282 53,592,111 86,479,803
Energy 1,085,885 9,041,759 5,566,768 -
Metals 4,412,002 19,039,071 4,593,702 14,839,516
------------------ ----------------- ------------------ ------------------
$ 210,535,432 $ 291,659,454 $ 179,811,795 $ 154,690,919
================== ================= ================== ==================
</TABLE>
Substantially all of the Trading Partnership's open derivative instruments
outstanding as of December 31, 1997, expire within one year.
The contract/notional values of the Trading Partnership's exchange-traded and
non-exchange-traded derivative instrument positions as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------- --------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------ ----------------- ----------------- ------------------
<S> <C> <C> <C> <C>
Exchange-Traded $ 142,565,779 $ 183,223,917 $ 133,757,339 $ 85,639,298
Non- Exchange-Traded 67,969,653 108,435,537 46,054,456 69,051,621
------------------ ----------------- ----------------- ------------------
$ 210,535,432 $ 291,659,454 $ 179,811,795 $ 154,690,919
================== ================= ================= ==================
</TABLE>
-12-
<PAGE>
The average fair values, based on contract/notional values, of the Trading
Partnership's derivative instrument positions which were open as of the end of
each calendar month during the years ended December 31, 1997 and 1996 were as
follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------- -------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest Rates $ 177,189,103 $ 68,697,138 $ 224,985,973 $ 91,029,835
Stock Indices 7,544,449 4,040,832 10,235,486 2,492,230
Commodities 13,113,725 11,481,639 13,316,970 7,175,841
Currencies 70,061,899 113,287,725 94,601,907 115,671,672
Energy 3,621,533 3,415,726 6,862,906 1,348,945
Metals 7,369,251 14,913,348 13,579,528 19,196,951
------------------ ------------------ ----------------- -----------------
$ 278,899,960 $ 215,836,408 $ 363,582,770 $236,915,474
================== ================== ================= =================
</TABLE>
A portion of the amounts indicated as off-balance sheet risk reflects offsetting
commitments to purchase and to sell the same derivative instrument on the same
date in the future. These commitments are economically offsetting but are not,
as a technical matter, offset in the forward markets until the settlement date.
Credit Risk
- -----------
The risks associated with exchange-traded contracts are typically perceived to
be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases limited
in amount, in some cases not) of the members of the exchange is pledged to
support the financial integrity of the exchange. In over-the-counter
transactions, on the other hand, traders must rely solely on the credit of their
respective individual counterparties. Margins, which may be subject to loss in
the event of a default, are generally required in exchange trading, and
counterparties may require margin in the over-the-counter markets.
The fair value amounts in the above tables represent the extent of the Trading
Partnership's market exposure in the particular class of derivative instrument,
but not the credit risk associated with counterparty nonperformance. The credit
risk associated with these instruments, from counterparty nonperformance, is the
net unrealized profit, if any, included on the Consolidated Statements of
Financial Condition.
The Trading Partnership also has credit risk because the sole counterparty or
broker with respect to most of the Trading Partnership's assets is MLF.
-13-
<PAGE>
The gross unrealized profit and the net unrealized profit on the Trading
Partnership's open derivative instrument positions as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------- ---------------------------------------
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit Profit Profit
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Exchange-Traded $ 3,263,519 $ 2,416,539 $ 2,090,698 $ 1,611,482
Non-Exchange-Traded 2,119,281 541,545 1,172,965 65,835
--------------- --------------- --------------- ---------------
$ 5,382,800 $ 2,958,084 $ 3,263,663 $ 1,677,317
=============== =============== =============== ===============
</TABLE>
The Partnership controls credit risk by dealing almost exclusively with Merrill
Lynch entities as brokers and counterparties.
The Partnership, in its normal course of business, enters into various
contracts, with MLF acting as its commodity broker. Pursuant to the brokerage
arrangement with MLF, to the extent that such trading results in receivables
from and payables to MLF, these receivables and payables are offset and reported
as a net receivable or payable.
9. SUBSEQUENT EVENT
Effective January 1, 1998, distributions were announced for Series B and Series
F. The Series B Unitholders received a fixed-rate distribution of $3.50 per
Series B Unit as well as a discretionary distribution equal to $1.50. The
Series F Unitholders received a fixed-rate distribution of $3.50 per Series F
Unit as well as a discretionary distribution equal to $1.25.
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/ Michael A. Karmelin
-----------------------
Michael A. Karmelin
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
General Partner of
ML Principal Protection L.P.
-14-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<CIK> 0000917259
<NAME> ML PRINCIPAL PROTECTION L.P.
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<CASH> 1,423 328
<RECEIVABLES> 9,124,594 8,878,706
<SECURITIES-RESALE> 0 0
<SECURITIES-BORROWED> 0 0
<INSTRUMENTS-OWNED> 94,651,930 72,815,648
<PP&E> 0 0
<TOTAL-ASSETS> 103,777,947 81,694,682
<SHORT-TERM> 0 0
<PAYABLES> 1,736,029 2,082,851
<REPOS-SOLD> 0 0
<SECURITIES-LOANED> 0 0
<INSTRUMENTS-SOLD> 0 0
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 102,041,918 79,611,831
<TOTAL-LIABILITY-AND-EQUITY> 103,777,947 81,694,682
<TRADING-REVENUE> 6,496,283 8,641,843
<INTEREST-DIVIDENDS> 4,873,872 4,545,186
<COMMISSIONS> 4,833,598 4,775,116
<INVESTMENT-BANKING-REVENUES> 0 0
<FEE-REVENUE> 0 0
<INTEREST-EXPENSE> 0 0
<COMPENSATION> 0 0
<INCOME-PRETAX> 5,420,245 7,223,364
<INCOME-PRE-EXTRAORDINARY> 5,420,245 7,223,364
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 5,420,245 7,223,364
<EPS-PRIMARY> 6.62 9.57
<EPS-DILUTED> 6.62 9.57
</TABLE>
