<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, 1998
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.
(Exact name of registrant as specified in its charter)
ML Principal Protection Trading L.P.
(Rule 140 Co-Registrant)
13-3750642 (Registrant)
Delaware 13-3775509 (Co-Registrant)
-------- --------------------------
(State or 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, New York, NY 10080
-------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 236-5662
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Limited Partnership
Units
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 common equity held by
non-affiliates of the registrant: the registrants are limited partnerships; as
of February 1, 1999, limited partnership units with an aggregate value of
$73,436,589 were outstanding and held by non-affiliates.
Documents Incorporated by Reference
The registrant's "1998 Annual Report and Independent Auditors' Report," the
annual report to security holders for the fiscal year ended December 31, 1998,
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 1998 ON FORM 10-K
Table of Contents
-----------------
<TABLE>
<CAPTION>
PART I PAGE
------
<S> <C> <C>
Item 1. Business...................................................................................... 1
Item 2. Properties.................................................................................... 8
Item 3. Legal Proceedings............................................................................. 8
.
Item 4. Submission of Matters to a Vote of Security Holders........................................... 9
PART II
-------
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......... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................... 22
Item 8. Financial Statements and Supplementary Data................................................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... 28
PART III
--------
Item 10. Directors and Executive Officers of the Registrant............................................ 28
Item 11. Executive Compensation........................................................................ 30
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 30
Item 13. Certain Relationships and Related Transactions................................................ 31
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................... 32
</TABLE>
<PAGE>
PART I
Item 1: Business
--------
(a) General Development of Business:
-------------------------------
ML Principal Protection 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 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 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 and MLAM are each 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. (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. Investors whose subscriptions are accepted at
any time during a calendar quarter are admitted to the Fund as Limited Partners
as of the beginning of the immediately following quarter, acquiring Units at
$100 per Unit. 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, generally, at the beginning of each calendar
quarter, 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.
Only the assets attributable to each Series of Units allocated
to the Trading Partnership are allocated to the Trading Advisors for management.
All outstanding Series of Units currently being issued initially allocate
approximately 85% of their total capital to the Trading Partnership, holding the
rest in reserve at the Partnership level.
As of December 31, 1998, the Partnership's capitalization was
$79,106,838, and the Net Asset value per Series A Unit (the initial Series of
Units), originally $100 as of October 12, 1994, had risen to 134.74 (adding back
$19.00 in Distributions).
Through December 31, 1998, the highest month-end Net Asset
Value of a Series A Unit (the initial Series of Units) was $135.27
(adding back $15.50 in Distributions) (September 30, 1998) and the lowest
$101.04, (October 31, 1994).
1
<PAGE>
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. No distributions are made on any Series of Units
sold after May 1, 1997.
The Fund is a "principal protected" commodity pool. ML&Co.
provides the guarantee described below 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 May 1, 1997 -- 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 sold before May 1, 1997 and five years after issuance for all Series sold
thereafter ). 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 May 1, 1997, 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 Series of
such 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 Segments:
------------------------------------
The Partnership's business constitutes only one segment for
financial reporting purposes, i.e., a speculative "commodity pool." The
Partnership does not engage in sales of goods or services.
(c) Narrative Description of Business:
---------------------------------
General
The Fund trades in the international futures, options on
futures, forwards and options on forward markets, with the objectives of
achieving long-term capital appreciation while controlling performance
volatility. The Fund's assets are allocated and reallocated by MLIP to the
trading management of independent trading advisors applying proprietary
strategies in numerous markets. 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.
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.
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
2
<PAGE>
such Series, is a guarantee only of a return of an investor's initial investment
(plus distributions, if any), not against the loss of the time value of such
investment or 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 partner, 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 are 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, options on futures, forwards and options on forward
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.
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 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. Substantially all of the Fund's
off-exchange trading takes places in the highly liquid, institutionally-based
currency forward markets.
Many of the Partnership's currency trades are executed in the
spot and forward foreign exchange markets (the "FX Markets") where there are no
direct execution costs. Instead, the participants, banks and dealers, including
Merrill Lynch International Bank ("MLIB"), in the FX Markets take a "spread"
between the prices at which they are prepared to buy and sell a particular
currency and such spreads are built into the pricing of the spot or forward
contracts with the Partnership. The General Partner anticipates that some of the
Partnership's foreign currency trades will be executed through MLIB, an
affiliate of the General Partner. MLIB has discontinued the operation of the
foreign exchange service desk, which included seeking multiple quotes from
counterparties unrelated to MLIB for a service fee and trade execution.
In its exchange of futures for physical ("EFP") trading, the
Partnership acquires cash currency positions through banks and dealers,
including Merrill Lynch. The Partnership pays a spread when it exchanges these
positions for futures. This spread reflects, in part, the different settlement
dates of the cash and the futures contracts, as well as prevailing interest
rates, but also includes a pricing spread in favor of the banks and dealers,
which may include a Merrill Lynch entity.
3
<PAGE>
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 as to how the Fund's trading may be
concentrated at any one time or over time.
Custody of Assets. All of the Fund's assets are currently held
-----------------
either in custodial or customer accounts at Merrill Lynch. Fund assets managed
by MLAM are generally held in custodial accounts at a major bank, separate from
all other Merrill Lynch or banking client assets. Assets held in customer
accounts are held at MLPF&S or MLF. These customer accounts are maintained in
the Fund's name, but the assets deposited by the Fund in such accounts are
commingled with those of other MLPF&S and MLF customers.
Available Assets. The Fund earns income, as described below,
----------------
on its "Available Assets," which can be generally described as the cash actually
held by the Fund or invested in Treasury bills or Government Securities.
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 assets managed by MLAM and
the Fund's cash balances 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; (b) short-term Treasury bills purchased by the Fund;
and (c) 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 Fund'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 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. However, cash
management returns cannot be assured, and there may be losses of principal.
The Government Securities acquired by MLAM on behalf of the
Fund are maintained in a custodial account at Merrill Lynch and are specifically
traceable to the Fund. All income earned on such Government Securities inures to
the benefit of the Fund. All fees due to MLAM are paid at no additional cost to
the Fund.
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.
Offset Accounts and Short-Term Treasury Bills
- ---------------------------------------------
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 Fund, 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.
4
<PAGE>
Possible Discontinuation of the Offset Accounts
- -----------------------------------------------
The use of the offset account arrangements for the Fund'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 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.
Offset Account Benefit to Merrill Lynch
- ---------------------------------------
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 (of approximately 0.25% per annum) paid to the offset banks, from
the offset accounts have not exceeded 0.75% per annum of the Fund's average
daily U.S. dollar Available Assets held in the offset accounts. These benefits
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
- ----------------
Fund, the Fund itself does not deposit foreign currencies to margin trading in
non-U.S. dollar denominated futures contracts and options, if any, MLF provides
the necessary margin, permitting the Fund to retain the monies which would
otherwise be required for such margin as part of the Fund's U.S. dollar
Available Assets. The Fund does not earn interest on foreign margin deposits
provided by MLF. The Fund does, however, earn interest on its non-U.S. dollar
Available Assets. Specifically, the Fund is credited by Merrill Lynch with
interest at the prevailing 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. Merrill Lynch charges the Fund Merrill Lynch's cost of
financing realized and unrealized losses on such positions.
The Fund 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 Fund'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 Fund while held in foreign currencies are
subject to exchange-rate risk.
5
<PAGE>
Charges
The following table summarizes the charges incurred by the
Fund during 1998, 1997, and 1996.
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------- ---------------------------- ----------------------------
Charges Dollar % of Average Dollar % of Average Dollar % of Average
Amount Month-End Amount Month-End Amount Month-End
Net Assets Net Assets Net Assets
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Brokerage $6,159,359 6.43% $4,833,598 5.64% $4,775,116 5.77%
Commissions
Administrative Fee 193,861 0.20% 138,103 0.16% 129,057 0.16%
Reimbursement of
Organizational and
Initial Offering Costs - 0.00% 61,989 0.07% 79,700 0.10%
Profit Shares 1,658,306 1.73% 931,522 1.09% 978,264 1.18%
=========================================================================================
Total $8,011,526 8.36% $5,965,212 6.96% $5,962,137 7.21%
=========================================================================================
</TABLE>
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.
The Fund's average month-end Net Assets during 1998, 1997 and
1996 equaled $95,777,172, $85,646,152 and $82,789,767, respectively.
During 1998, 1997 and 1996, the Fund earned $5,434,851,
$4,873,872 and $4,545,186 in interest income, or approximately 5.67%, 5.69% and
5.49% 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).
Effective October 1, 1998, MLIP reduced the Fund's annual
Brokerage Commission from 8.75% to 7.50% of trading assets.
Effective October 1, 1998, the Administrative Fee, while it
continues to be calculated at the rate of 0.25% per annum, is based on the
Fund's month-end total assets (prior to reduction for accrued expenses), not the
Fund's assets allocated to trading.
6
<PAGE>
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 0.625 of 1% (a 7.5% annual rate) of the
Fund's month-end assets committed to trading. The Fund initially commits 85% of
the capital attributable to each Series of Units issued after May 1, 1998.
As of October 1, 1998, the 8.75% per annum Brokerage Commissions were reduced
to 7.50% per annum (0.625 of 1% of the Fund's month-end traded assets).
During 1998, 1997 and 1996, 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 $80, $116 and $116, respectively.
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.
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 total assets. MLIP pays the Fund's
routine administrative costs.
As of October 1, 1998, the 0.25% per annum rate is applied to the Fund's
month-end total assets (prior to reduction for accrued expenses), not the
Fund's assets allocated to trading.
MLIB; Other Bid-ask spreads Bid-ask spreads on forward and related trades.
Counter parties
Government Bid-ask spreads The dealers with which MLAM executes Government Securites trades include
Securities Dealers bid-ask spreads in the prices they quote to the Fund.
</TABLE>
7
<PAGE>
<TABLE>
<S> <C> <C>
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 the net reallocation of
assets away from an Advisor and the 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.
Trading Advisors Consulting Fees 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.
MLF; Extraordinary expenses Actual costs incurred; none paid to date.
Others
</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.
(d) Financial Information about Geographic Areas:
--------------------------------------------
The Trading Partnership trades, on a number of foreign
commodity exchanges. The Partnership does not engage in the sales of goods or
services.
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 (Merrill Lynch World
Headquarters, World Financial Center, South Tower, New York, New York, 10080).
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
8
<PAGE>
actions cannot be predicted 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.
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
---------------------------------------------------------------------
Item 5(a)
- ---------
(a) Market Information:
------------------
There is no established public trading market for the Units,
nor will one develop. Rather, Limited Partners may 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, 1998, there were 4,114 holders of Units,
including the General Partner.
(c) Dividends:
---------
For Series issued on or prior to May 1, 1997, the Partnership
makes annual fixed-rate distributions, payable irrespective of profitability, of
$3.50 per Unit. 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. 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.
9
<PAGE>
As of December 31, 1998, the Partnership had made the following
distributions:
Fixed Rate Discretionary
Series Distribution Date Distribution Distribution
------ ----------------- ------------ -------------
1998 Series A 10/1/98 $ 3.50 $ -
- ---- Series B 1/1/98 3.50 1.50
Series C 4/1/98 3.50 -
Series D 7/1/98 3.50 -
Series E 10/1/98 3.50 -
Series F 1/1/98 3.50 1.25
Series G 4/1/98 3.50 -
Series H 7/1/98 3.50 -
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
- ----
The Fund does not make any distributions on any Series of
Units issued subsequent to May 1, 1997.
(d) Recent Sales of Unregistered Securities;
---------------------------------------
Use of Proceeds from Registered Securities
------------------------------------------
The Fund has units registered with an aggregate price of
$462,114,000. The Fund has sold units with an aggregate price of $162,932,895.
Item 5(b)
- ---------
Not applicable.
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>
Income Statement Data For the Year For the Year For the Year For the Year October 12, 1994
Ended Ended Ended Ended to
December 31, December 31, December 31, December 31, December 31,
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues:
Trading Profits (Loss)
Realized Gain (Loss) $ 8,746,563 $ 5,412,457 $ 9,038,064 $ 4,407,833 $ (363,054)
Change in Unrealized
(Loss) Gain (2,053,193) 1,083,826 (396,221) 1,355,377 1,115,935
-------------------------------------------------------------------------------------
Total Trading Results 6,693,370 6,496,283 8,641,843 5,763,210 752,881
-------------------------------------------------------------------------------------
Interest Income 5,434,851 4,873,872 4,545,186 3,415,670 377,303
-------------------------------------------------------------------------------------
Total Revenues 12,128,221 11,370,155 13,187,029 9,178,880 1,130,184
-------------------------------------------------------------------------------------
Expenses:
Brokerage Commissions 6,159,359 4,833,598 4,775,116 3,216,364 405,653
Administrative Fees/1/ 193,861 138,103 129,057 86,928 10,964
Profit Shares 1,658,306 931,522 978,264 652,366 129,169
-------------------------------------------------------------------------------------
Total Expenses 8,011,526 5,903,223 5,882,437 3,955,658 545,786
-------------------------------------------------------------------------------------
Net Income Before
Minority Interest 4,116,695 5,466,932 7,304,592 5,223,222 584,398
Minority Interest in Income/2/ (27,056) (46,687) (81,228) (36,730) (4,504)
-------------------------------------------------------------------------------------
Net Income $ 4,089,639 $ 5,420,245 $ 7,223,364 $ 5,186,492 $ 579,894
=====================================================================================
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
Balance Sheet Data
December 31, December 31, December 31, December 31, December 31,
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Aggregate Net Asset Value
(Series A-M) $ 79,106,838 $ 101,226,685 $ 78,905,273 $ 74,846,544 $ 32,314,228
-----------------------------------------------------------------------------------------
Net Asset Value per Unit
Series A $115.74/4/ $113.73/5/ $110.71/6/ $106.97/7/ $101.76
Series B $113.99/4/ $114.15/5/ $114.25/6/ $110.36 N/A
Series C $108.92/4/ $108.15/5/ $109.34/6/ $103.35 N/A
Series D $111.45/4/ $109.94/5/ $108.20/6/ $102.34 N/A
Series E $111.14/4/ $109.40/5/ $108.59/6/ $102.72 N/A
Series F $108.95/4/ $109.04/5/ $108.92/6/ N/A N/A
Series G $107.67/4/ $106.52/5/ $107.32 N/A N/A
Series H $107.81/4/ $106.62/5/ $106.47 N/A N/A
Series K $109.61 $104.77 N/A N/A N/A
Series L $106.81 $102.08 N/A N/A N/A
Series M $108.34 $103.70 N/A N/A N/A
Series N $104.43 N/A N/A N/A N/A
Series O $104.77 N/A N/A N/A N/A
Series P $106.92 N/A N/A N/A N/A
Series Q $98.86 N/A 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 Principle ("GAAP") due to the treatment of organizational and initial
offering cost reimbursements.
(4) Net of aggregate distribution of $19.00 per unit on Series A Units,
$17.50 on the Series B Units, $14.50 on the Series C Units, $11.50 on the Series
D Units, $12.50 on the Series E Units, $10.75 on the Series F Units, $10.50 on
the Series G Units and $9.50 on the Series H Units.
(5) 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.
(6) 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.
(7) Net of the distribution of $6.00 per Unit on the Series A Unit.
12
<PAGE>
ML PRINCIPAL PROTECTION L.P.
December 31, 1998
Type of Pool: Multi-Advisor; Selected Advisor/
Publicly-Offered/"Principal Protected"(1)
Inception of Trading: October 12, 1994
Aggregate Subscriptions:$163,402,575
Current Capitalization: $79,106,838
Worst Monthly Drawdown:(2) (3.70)% (2/96)
Worst Peak-to-Valley Drawdown:(3) (3.70)% (2/96)
- -----------------------------------------------------------------------------
Monthly Rates of Return(4)
- -----------------------------------------------------------------------------
Month 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------
January 0.07% 2.06% 2.45% (0.55)% -
- -----------------------------------------------------------------------------
February (0.56) 1.44 (3.70) 2.24 -
- -----------------------------------------------------------------------------
March 0.10 0.05 1.06 4.17 -
- -----------------------------------------------------------------------------
April (1.96) (0.70) 3.10 0.91 -
- -----------------------------------------------------------------------------
May 0.95 (1.43) (1.98) 1.20 -
- -----------------------------------------------------------------------------
June (0.86) 0.70 1.36 (0.21) -
- -----------------------------------------------------------------------------
July (0.67) 3.14 (1.68) (1.30) -
- -----------------------------------------------------------------------------
August 4.83 (2.71) 0.49 0.95 -
- -----------------------------------------------------------------------------
September 3.55 0.86 1.62 (0.32) -
- -----------------------------------------------------------------------------
October 0.06 (0.43) 4.25 0.29 1.04
- -----------------------------------------------------------------------------
November (1.00) 0.80 2.50 0.69 0.32
- -----------------------------------------------------------------------------
December 0.20 2.22 (0.20) 2.12 0.40
- -----------------------------------------------------------------------------
Compound Annual 4.60% 6.01% 9.36% 10.55% 1.76%
Rate of Return (2 2/3 months)
- -----------------------------------------------------------------------------
Rates of Return are presented on a composite, not a
Series-by-Series, basis.
-------------------------
All Units issued on or prior to May 1, 1997 commenced trading
with 60%, and Units issued after May 1, 1997 with 75%, of their assets allocated
to trading. Beginning May 1, 1998, all Units issued after May 1, 1997 have
allocated 85% of their assets to trading.
-------------------------
(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.
13
<PAGE>
- --------------------------------------------------------------------------------
MONTH-END NET ASSET VALUE PER SERIES A UNIT
- --------------------------------------------------------------------------------
Jan. Feb. Mar. Apr. May June
- --------------------------------------------------------------------------------
1994 N/A N/A N/A N/A N/A N/A
- --------------------------------------------------------------------------------
1995 $101.36 $103.63 $107.94 $109.09 $110.40 $110.18
- --------------------------------------------------------------------------------
1996 $109.65/a/ $105.56/a/ $106.69/a/ $110.05/a/ $107.82/a/ $109.33/a/
- --------------------------------------------------------------------------------
1997 $113.00/b/ $114.63/b/ $114.69/b/ $113.89/b/ $112.28/b/ $113.05/b/
- --------------------------------------------------------------------------------
1998 $113.84/c/ $113.25/c/ $113.37/c/ $111.46/c/ $112.48/c/ $111.69/c/
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
July Aug. Sept. Oct. Nov. Dec.
- -------------------------------------------------------------------------------
N/A N/A N/A $101.04 $101.36 $101.76
- -------------------------------------------------------------------------------
$108.94 $109.98 $109.62 $103.91/a/ $104.63/a/ $106.96/a/
- -------------------------------------------------------------------------------
$107.51/a/ $108.04/a/ $109.80/a/ $108.24/b/ $110.93/b/ $110.70/b/
- -------------------------------------------------------------------------------
$116.48/b/ $113.59/b/ $114.53/b/ $110.69/c/ $111.50/c/ $113.73/c/
- -------------------------------------------------------------------------------
$111.09/c/ $116.00/c/ $119.77/c/ $116.40/d/ $115.45/d/ $115.74/d/
- -------------------------------------------------------------------------------
/a/ After reduction for the $6.00 per Series A Unit distribution made as of
October 1, 1995.
/b/ After reduction for the first annual distribution and the $6.00 per Series A
Unit distribution made as of October 1, 1996.
/c/ After reduction for the first and second annual distributions and the $3.50
per Series A Unit distribution made as of October 1, 1997.
/d/ After reduction for the first, second and third annual distribution and the
$3.50 per Series A Unit distribution made on October 1, 1998.
The Net Asset Value per unit varies, until September 30, 1997, from how it would
be calculated for purposes of GAAP, due to the amortization of organizational
and initial offering costs.
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 its capital to the
Advisors. 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 profits and 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.
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.
14
<PAGE>
Results of Operations
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. Because of the speculative nature of its trading, the Fund's past
performance is not necessarily indicative of its future results.
MLIP has made and expects to continue making frequent changes
to both trading asset allocations among Advisors and Advisor combinations as
well as from time to time adjusting the percentage of the Fund's assets
committed to trading. All series of Units trade under the direction of the same
Advisor allocation and combination, as the same may be changed from time to time
by MLIP.
MLIP's decision to terminate or reallocate assets among
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 asset 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
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 Fund.
15
<PAGE>
General
A number of the Advisors are trend-following traders, whose
programs do not attempt to predict price movements. No fundamental economic
supply or demand analyses are used by these Advisors, and no macroeconomic
assessments of the relative strengths of different national economies or
economic sectors. Instead, the programs apply proprietary computer models to
analyzing past market data, and from this data alone attempt to determine
whether market prices are trending. These technical traders base their
strategies on the theory that market prices reflect the collective judgment of
numerous different traders and are, accordingly, the best and most efficient
indication of market movements. However, there are frequent periods during which
fundamental factors external to the market dominate prices.
If a trend-following Advisor's models identify a trend, they
signal positions which follow it. When these models identify the trend as having
ended or reversed, these positions are either closed out or reversed. Due to
their trend-following character, these Advisors' programs do not predict either
the commencement or the end of a price movement. Rather, their objective is to
identify a trend early enough to profit from it and detect its end or reversal
in time to close out the Fund's positions while retaining most of the profits
made from following the trend.
In analyzing the performance of trend-following programs,
economic conditions, political events, weather factors, etc., are not directly
relevant because only market data has any input into trading results.
Furthermore, there is no direct connection between particular market conditions
and price trends. There are so many influences on the markets that the same
general type of economic event may lead to a price trend in some cases but not
in others. The analysis is further complicated by the fact that the programs are
designed to recognize only certain types of trends and to apply only certain
criteria of when a trend has begun. Consequently, even though significant price
trends may occur, if these trends are not comprised of the type of intra-period
price movements which the programs are designed to identify, a trend-following
Advisor may miss the trend altogether.
In the case of the Advisors which implement strategies which
rely more on discretion and market judgment, it is not possible to predict, from
their performance during past market cycles, how they will respond to future
market events.
Performance Summary
This performance summary is an outline description of how the
Fund performed in the past, not necessarily any indication of how it will
perform in the future. In addition, the general causes to which certain price
movements are attributed may or may not in fact have caused such movements, but
simply occurred at or about the same time.
The Advisors, as a group, are unlikely to be profitable in
markets in which such trends do not occur. Static or erratic prices are likely
to result in losses. Similarly, unexpected events (for example, a political
upheaval, natural disaster or governmental intervention) can lead to major
short-term losses as well as gains.
While there can be no assurance that any Advisor will be
profitable, under any given market condition, markets in which substantial and
sustained price movements occur typically offer the best profit potential for
the Fund.
16
<PAGE>
1998
Total Trading
Results
Interest Rates $ 7,116,336
Stock Indices 824,905
Commodities (967,695)
Currencies 2,085,218
Energy (882,409)
Metals (1,482,985)
------------
$ 6,693,370
============
Global interest rate markets provided the Fund with its most
profitable positions for the first quarter, particularly in European bonds where
an extended bond market rally continued despite an environment of robust growth
in the United States, Canada and the United Kingdom, as well as a strong pick-up
in growth in continental Europe. In the second quarter, swings in the U.S.
dollar and developments in Japan affected bond markets, causing the Fund's
interest rate trading to result in losses. This was turned around in the third
quarter, as markets worldwide were turned upside down and the Fund's
non-correlation with general equity and debt markets was strongly exhibited, and
trading was particularly profitable in positions in Eurodollars, German and
Japanese bonds, and U.S. Treasury notes and bonds. Global investors staged a
major flight to quality, resulting in a significant widening of credit spreads
on a global basis. In October, investors pushed the yields on U.S. Treasury
bonds to a 31-year low. The long bond yield fell about 75 basis points in 1998
as the world economy slowed more than expected, inflation continued to fall, the
anticipated small U.S. budget deficit turned into substantial surplus, and the
Fed lowered interest rates.
In currency markets, results early in the year were mixed,
although marginally profitable. During the second quarter, strong gains were
realized in positions in the Japanese yen, which weakened during June to an
eight-year low versus the U.S. dollar. Significant gains from Japanese yen
trading continued into the third quarter, and Japan's problems spread to other
sectors of the global economy, causing commodities prices to decline as demand
from the Asian economies weakened. Japan's deepening recession and credit crunch
continued through the fourth quarter, and the Fund achieved gains from long yen
positions.
Trading results in stock index markets were also mixed in
early 1998, despite a strong first-quarter performance by the U.S. equity market
as several consecutive weekly gains were recorded with most market averages
setting new highs. Second quarter results were profitable as the Asia-Pacific
region's equity markets weakened across the board. In particular, Hong Kong's
Hang Seng index trended downward during most of the second quarter and traded at
a three-year low. As U.S. equity markets declined in July and August, the Fund
profited from short positions in the S&P 500, most notably during August, when
the index dropped 14.5%. Volatility in September made for a difficult trading
environment in the stock index sector, and the Fund incurred modest losses,
although results remained profitable for the quarter and the year overall in
these markets.
In agricultural commodity markets, 1998 began with strong
gains as live cattle and hog prices trended downward throughout the first
quarter. In the second quarter, although the U.S. soybean crop got off to a good
start which contributed to higher yield expectations and a more burdensome
supply outlook, soybean prices traded in a volatile pattern. Sugar futures
maintained mostly a downtrend, as no major buyers emerged to support the market.
Similarly, coffee prices trended downward, as good weather conditions in Central
America and Mexico increased the prospects of more output from these countries.
The third quarter resulted in losses as the U.S. soybean crop increased relative
to the USDA's production estimate as a result of timely rains, which contributed
to lower prices. These losses continued into the fourth quarter as the Fund was
caught on the short side of the soybean complex, as the soybean supply surplus
became more manageable following the November 10th USDA reports, causing prices
to gain upward momentum.
Gold prices began the year drifting sideways, and continued to
weaken following news in the second quarter of a European Central Bank consensus
that ten to fifteen percent of reserves should be made up of gold bullion, which
was at the low end of expectations. Gold was unable to extend third quarter
rallies or to build any significant upside momentum, resulting in a trendless
environment. This was also the case in the fourth quarter, as gold's cost of
17
<PAGE>
production declined. Also, silver markets remained range-bound, while also
experiencing a significant selloff in November, and aluminum traded at its
lowest levels since 1994, with many aluminum smelters operating at a loss.
In energy markets, demand for crude oil in the Middle East was
affected by low oil prices early in the year, and trading resulted in losses.
Initially buoyed on concerns about a U.S.-led military strike against Iraq,
crude oil fell to a nine-year low, as the globally warm winter, the return of
Iraq as a producer and the Asian economic crisis added to OPEC's supply glut
problems. Despite production cuts initiated by OPEC at the end of March, world
oil supplies remained excessive and oil prices stood at relatively low levels
throughout the first half of 1998. Short heating oil positions in the third
quarter proved profitable for the Fund as the market for heating oil prices
dropped to its lowest level in more than a decade. In early December, oil and
natural gas prices dropped sharply, causing continued problems for many emerging
market countries that depend on commodity exports for economic growth and
government financing. These price pressures were mainly due to excessive supply
availability and near-term weather indications that inventories would remain at
more than adequate levels even in the event of a cold Northern Hemisphere
winter. Also, the December U.S. air attack on Iraq failed to cause any damage to
oil pumping and shipping operations, and oil prices fell over 10%.
1997
Total Trading
Results
Interest Rates $ 1,706,686
Stock Indices 232,314
Commodities 679,157
Currencies 3,911,109
Energy (1,278,003)
Metals 1,245,020
------------
$ 6,496,283
============
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.
18
<PAGE>
1996
Total Trading
Results
Interest Rates $ 3,183,955
Stock Indices (746,255)
Commodities 20,119
Currencies 3,301,360
Energy 3,280,677
Metals (398,013)
------------
$ 8,641,843
============
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.
Variables Affecting Performance
- -------------------------------
The principal variables which determine the net performance of
the Fund are gross profitability and interest income. Gross profitability is, in
turn, affected by the percentage of the Fund's assets allocated to trading.
During all periods set forth under "Selected Financial Data,"
the interest rates in many countries were at unusually low levels. The low
interest rates in the United States (although higher than in many other
countries) negatively impacted revenues because interest income is typically a
major component of the Fund's 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 Fund's Brokerage Commissions and Administrative Fees are a
constant percentage of the Fund's assets allocated to trading and total assets,
respectively. The only Fund costs (other than the insignificant currency trading
costs) which are not based on a percentage of the Fund's assets (allocated to
trading or total) are the Profit Shares payable to the 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 the 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 the total profits recognized, as other Advisors have
incurred offsetting losses, reducing overall trading gains but not the Profit
Shares paid to the successful Advisors) -- suggesting the likelihood of
generally trendless, non-consensus markets.
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.
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.
19
<PAGE>
The Different Series of Units
- -----------------------------
All series of Units 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., adjusting trading leverage -must be
done in such a way that all Units have the same percentage of capital allocated
to trading after the adjustment (this restructuring applies only to Units issued
after May 1, 1997). Despite these fundamental similarities among the different
series, because the series begin trading at different times they are likely, as
a result of trading profits and losses, to pay different Profit Shares (although
to the same group of Advisors) and have different Net Asset Values. The series
offered since May 1, 1997 have begun trading at 85%-95% leverage. Series issued
before May 1, 1997 began trading at 60%-75% leverage.
Liquidity; Capital Resources
- ----------------------------
The Fund sells no securities other than the Units. The Fund
borrows only to a limited extent and only on a strictly short-term basis in
order to finance losses on non-U.S. dollar denominated trading positions pending
the conversion of the Fund's dollar deposits. These borrowings are at a
prevailing short-term rate in the relevant currency.
The Fund's assets are held primarily in short-term debt
securities with maturities under one year, and to a lesser extent in short- and
mid-term debt securities with maturities up to five years, as well as in cash.
The Net Asset Value of the Fund's cash and financial instruments is not
materially affected by inflation. Changes in interest rates, which are often
associated with inflation, could cause the value of certain of the Fund's debt
securities to decline, but only to a limited extent. More importantly, changes
in interest rates could cause periods of strong up or down price trends, during
which the Fund's profit potential generally increases. Inflation in commodity
prices could also generate price movements which the strategies might
successfully follow.
The Fund's assets are held in cash and highly liquid U.S.
government securities. Accordingly, except in very unusual circumstances, the
Fund should be able to close out any or all of its open trading positions and
liquidate any or all of its securities holdings quickly and at market prices.
This permits an Advisor to limit losses as well as reduce market exposure on
short notice should its strategies indicate doing so. In addition, because there
is a readily available market value for the Fund's positions and assets, the
Fund's monthly Net Asset Value calculations are precise, and investors need only
wait 10 business days to receive the full redemption proceeds of their Units.
Year 2000 Compliance Initiative
As the millennium approaches, Merrill Lynch has undertaken
initiatives to address the Year 2000 problem (the "Y2K problem"). The Y2K
problem is the result of a widespread programming technique that causes computer
systems to identify a date based on the last two numbers of a year, with the
assumption that the first two numbers of the year are "19". As a result, the
year 2000 would be stored as "00," causing computers to incorrectly interpret
the year as 1900. Left uncorrected, the Y2K problem may cause information
technology systems (e.g., computer databases) and non-information technology
systems (e.g., elevators) to produce incorrect data or cease operating
completely.
Merrill Lynch believes that it has identified and evaluated
its internal Y2K problem and that it is devoting sufficient resources to
renovating technology systems that are not already Year 2000 compliant. The
resource-intensive renovation phase (as further discussed) of Merrill Lynch's
Year 2000 efforts was approximately 95% completed as of January 31, 1999.
Merrill Lynch will focus primarily on completing its renovation and testing and
on integration of the Year 2000 programs of recent acquisitions during the
remainder of 1999. In order to focus attention on the Y2K problem, management
has deferred certain other technology projects: however, this deferral is not
expected to have a material adverse effect on the company's business, results of
operations, or financial condition.
20
<PAGE>
The failure of Merrill Lynch's technology systems relating to
a Y2K problem would likely have a material adverse effect on the company's
business, results of operations, and financial condition. This effect could
include disruption of normal business transactions, such as the settlement,
execution, processing, and recording of trades in securities, commodities,
currencies, and other assets. The Y2K problem could also increase Merrill
Lynch's exposure to risk and its need for liquidity.
In 1995, Merrill Lynch established the Year 2000 Compliance
Initiative, which is an enterprisewide effort to address the risks associated
with the Y2K problem, both internal and external. The Year 2000 Compliance
Initiative's efforts to address the risks associated with the Y2K problem have
been organized into six phases: planning, pre-renovation, renovation, production
testing, certification, and integration testing.
The planning phase involved defining the scope of the Year
2000 Compliance Initiative, including its annual budget and strategy, and
determining the level of expert knowledge available within Merrill Lynch
regarding particular systems or applications. The pre-renovation phase involved
developing a detailed enterprisewide inventory of applications and systems,
identifying the scope of necessary renovations to each application system, and
establishing a conversion schedule. During the renovation phase, source code is
actually converted, date fields are expanded or windowed (windowing is used on
an exception basis only), test data is prepared, and each system or application
is tested using a variety of Year 2000 scenarios. The production testing phase
validates that a renovated system is functionally the same as the existing
production version, that renovation has not introduced defects, and that
expanded or windowed date fields continue to handle current dates properly. The
certification phase validates that a system can run successfully in a Year 2000
environment. The integration testing phase, which will occur throughout 1999,
validates that a system can successfully interface with both internal and
external systems. Finally, as Merrill Lynch continues to implement new systems,
they are also being tested for Year 2000 readiness.
In 1996 and 1997, as part of the planning and pre-renovation
phases, both plans and funding of plans for inventory, preparation, renovation,
and testing of computer systems for the Y2K problem were approved. All plans for
both mission-critical and non-mission-critical systems are tracked and
monitored. The work associated with the Year 2000 Compliance Initiative has been
accomplished by Merrill Lynch employees, with the assistance of consultants
where necessary.
As part of the production testing and certification phases,
Merrill Lynch has performed, and will continue to perform, both internal and
external Year 2000 testing intended to address the risks from the Y2K problem.
As of January 31, 1999, production testing was approximately 93% completed. In
July 1998, Merrill Lynch participated in an industrywide Year 2000 systems test
sponsored by the Securities Industry Association ("SIA"), in which selected
firms tested their computer systems in mock stock trades that simulated dates in
December 1999 and January 2000. Merrill Lynch will participate in further
industrywide testing sponsored by the SIA, currently scheduled for March and
April 1999, which will involve an expanded number of firms, transactions, and
conditions. Merrill Lynch also participated in various other domestic and
international industry tests during 1998.
Merrill Lynch continues to survey and communicate with third
parties whose Year 2000 readiness is important to the company. Information
technology and non-information technology vendors and service providers are
contacted in order to obtain their Year 2000 compliance plans. Based on the
nature of the response and the importance of the product or service involved,
Merrill Lynch determines if additional testing is needed. The results of these
efforts are maintained in a database that is accessible throughout the firm.
Third parties that have been contacted include transactional counterparties,
exchanges, and clearinghouses; a process to access and rate their responses has
been developed. This information as well as other Year 2000 readiness
information on particular countries and their political subdivisions will be
used by Merrill Lynch to manage risk resulting from the Y2K problem. Management
is unable at this point to ascertain whether all significant third parties will
successfully address the Y2K problem. Merrill Lynch will continue to monitor
third parties' Year 2000 readiness to determine if additional or alternative
measures are necessary. In connection with information technology and
non-information technology products and services, contingency plans, which are
developed at the business unit level, may include selection of alternative
vendors or service providers and changing business practices so that a
particular system is not needed. In the case of securities exchanges and
clearinghouses, risk mitigation could include the re-routing of business. In
light of the interdependency of the parties in or serving the financial markets,
however, there can be no assurance that all Y2K problems will be identified and
remediated on a timely basis or that all remediation will be successful. The
failure of exchanges, clearing organizations, vendors, service providers,
counterparties, regulators, or others to resolve their own processing issues
21
<PAGE>
in a timely manner could have a material adverse effect on Merrill Lynch's
business, results of operations, and financial condition.
At year-end 1998, the total estimated expenditures for the
entire Year 2000 Compliance Initiative were approximately $425 million, of which
approximately $125 million was remaining. The majority of these remaining
expenditures are expected to cover testing, risk management, and contingency
planning. There can be no assurance that the costs associated with such
remediation efforts will not exceed those currently anticipated by Merrill
Lynch, or that the costs associated with the remediation efforts or the possible
failure of such remediation efforts would not have a material adverse effect on
Merrill Lynch's business, results of operations, or financial condition.
European Economic and Monetary Union ("EMU") Initiative
-------------------------------------------------------
As of January 1, 1999, the "euro" was adopted as the common
legal currency of participating member states of the EMU. As a consequence of
the introduction of and conversion to the euro, Merrill Lynch was required to
make significant changes to nearly 200 global business systems in order to
reflect the substitution of the euro for the 11 member national currencies and
the European currency unit. The introduction of the euro brings about
fundamental changes in the structure and nature of European financial markets,
including the creation of a unified, more liquid capital market in Europe. As
financial markets in EMU member states converge and local barriers are removed,
competition is expected to increase.
The introduction of the euro affects all Merrill Lynch
facilities that transact, distribute, or provide custody or recordkeeping for
securities or cash denominated in the currency of a participating member state.
Merrill Lynch's systems or procedures that handle such securities or cash were
modified in order to implement the conversion to the euro. The implementation
phase is continuing into the first quarter of 1999 to resolve any
post-conversion issues. The success of Merrill Lynch's euro conversion efforts
was dependent on the euro-compliance of third parties, such as trading
counterparties, financial intermediaries (e.g., securities and commodities
exchanges, depositories, clearing organizations, and commercial banks), and
vendors.
As of the end of the 1998 fiscal year, the total estimated
expenditures associated with the introduction of and conversion to the euro were
approximately $79 million, of which $1 million is remaining to be spent during
the first quarter of 1999 on compliance efforts and project administration.
Management believes that it has identified and evaluated all of the systems and
operational modifications necessary for the conversion to the euro. On January
4, 1999 and since then, Merrill Lynch has conducted normal business operations,
having successfully completed its conversion program. Management does not expect
the introduction of the euro to have a negative effect on its future business,
currency risk, or competitive positioning in the European markets.
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Introduction
Past Results Not Necessarily Indicative of Future Performance
-------------------------------------------------------------
The Fund is a speculative commodity pool. Unlike an operating
company, the risk of market sensitive instruments traded by it is integral, not
incidental, to the Fund's main line of business.
Market movements result in frequent changes in the fair market
value of the Fund's open positions and, consequently, in its earnings and cash
flow. The Fund's market risk is influenced by a wide variety of factors,
including the level and volatility of interest rates, exchange rates, equity
price levels, the market value of financial instruments and contracts, the
diversification effects among the Fund's open positions and the liquidity of the
markets in which it trades.
The Fund, under the direction of the Trading Advisors, rapidly
acquires and liquidates both long and short positions in a wide range of
different markets. Consequently, it is not possible to predict how a possible
future market scenario will affect performance, and the Fund's past performance
is not necessarily indicative of its future results.
22
<PAGE>
Value at Risk is a measure of the maximum amount which the
Fund could reasonably be expected to lose in a given market sector. However, the
inherent uncertainty of the Fund's speculative trading and the recurrence in the
markets traded by the Fund of market movements far exceeding expectations could
result in actual trading or non-trading losses far beyond the indicated Value at
Risk or the Fund's experience to date (i.e., "risk of ruin"). In light of the
foregoing as well as the risks and uncertainties intrinsic to all future
projections, the inclusion of the quantification in this section should not be
considered to constitute any assurance or representation that the Fund's losses
in any market sector will be limited to Value at Risk or by the Fund's attempts
to manage its market risk.
Quantifying the Fund's Trading Value at Risk
- --------------------------------------------
Quantitative Forward-Looking Statements
---------------------------------------
The following quantitative disclosures regarding the Fund's
market risk exposures contain "forward-looking statements" within the meaning of
the safe harbor from civil liability provided for such statements by the Private
Securities Litigation Reform Act of 1995 (set forth in Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934).
All quantitative disclosures in this section are deemed to be forward-looking
statements for purposes of the safe harbor, except for statements of historical
fact.
The Fund's risk exposure in the various market sectors traded
by the Advisors is quantified below in terms of Value at Risk. Due to the Fund's
mark-to-market accounting, any loss in the fair value of the Fund's open
positions is directly reflected in the Fund's earnings (realized or unrealized)
and cash flow (at least in the case of exchange-traded contracts in which
profits and losses on open positions are paid daily through variation margin).
Exchange maintenance margin requirements have been used by the
Fund as the measure of its Value at Risk. Maintenance margin requirements are
set by exchanges to equal or exceed the maximum loss in the fair value of any
given contract incurred in 95% - 99% of the one-day time periods included in the
historical sample (generally approximately one year) researched for purposes of
establishing margin levels. Maintenance margin levels are established by dealers
and exchanges using historical price studies as well as an assessment of current
market volatility and economic fundamentals to provide a probabilistic estimate
of the maximum expected near-term one-day price fluctuation.
In the case of market sensitive instruments which are not
exchange-traded (almost exclusively currencies in the case of the Fund), the
margin requirements for the equivalent futures positions have been used as Value
at Risk. In those rare cases in which a futures-equivalent margin is not
available, dealers' margins have been used.
The fair value of the Fund's futures and forward positions
does not have any optionality component. However, certain of the Advisors trade
commodity options. The Value at Risk associated with options is reflected in the
following table as the margin requirement attributable to the instrument
underlying each option.
100% positive correlation in the different positions held in
each market risk category has been assumed. Consequently, the margin
requirements applicable to the open contracts have been aggregated to determine
each trading category's aggregate Value at Risk. The diversification effects
resulting from the fact that the Fund's positions are rarely, if ever, 100%
positively correlated have not been reflected.
The Fund's Trading Value at Risk in Different Market Sectors
- ------------------------------------------------------------
The following table indicates the trading Value at Risk
associated with the Fund's open positions by market category as of December 31,
1998. As of December 31, 1998, the Fund's total capitalization was approximately
$79,106,838, of which $63,424,815 was allocated to trading.
23
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998
Percentage of
Percentage of Assets Allocated
Market Sector Value at Risk Total Capitalization to Trading
- ------------- ------------- -------------------- ----------
<S> <C> <C> <C>
Interest Rates $ 567,386 0.71% 0.89%
Stock Indices 283,117 0.36 0.45
Commodities 280,302 0.35 0.44
Currencies 1,050,731 1.33 1.65
Energy 226,400 0.29 0.36
Metals 315,100 0.40 0.50
------------ ----------- -----------
TOTAL $ 2,723,036 3.44% 4.29%
============ =========== ===========
</TABLE>
Material Limitations on Value at Risk as an Assessment of Market Risk
- ---------------------------------------------------------------------
The face value of the market sector instruments held by the
Fund is typically many times the applicable maintenance margin requirement
(maintenance margin requirements generally ranging between approximately 1% and
10% of contract face value) as well as many times the capitalization of the
Fund. The magnitude of the Fund's open positions creates a "risk of ruin" not
typically found in most other investment vehicles. Because of the size of its
positions, certain market conditions - unusual, but historically recurring from
time to time - could cause the Fund to incur severe losses over a short period
of time. Even comparatively minor losses could cause MLIP to further deleverage
or terminate the Fund's trading. The foregoing Value at Risk table - as well as
the past performance of the Fund - gives no indication of this "risk of ruin."
Non-Trading Risk
- ----------------
Foreign Currency Balances; Cash on Deposit with MLF
---------------------------------------------------
The Fund has non-trading market risk on its foreign cash
balances not needed for margin. However, these balances (as well as the market
risk they represent) are immaterial.
The Fund also has non-trading market risk on the approximately
20% of its assets which are held in cash at MLF. The value of this cash is not
interest rate sensitive, but there is cash flow risk in that if interest rates
decline so will the cash flow generated on these monies. This cash flow risk is
immaterial.
24
<PAGE>
MLAM's Cash Management
MLAM invests approximately 80% of the Fund's assets in Government
Securities. As of December 31, 1998, the Fund's MLAM account totaled
approximately $61 million.
As of December 31, 1998, the Fund's MLAM account held the following
Government Securities:
<TABLE>
<CAPTION>
Total
Par Value Description Rate Maturity Date Fair Value
---------- ------------ ----- ------------- ----------
Long-Term
---------
<S> <C> <C> <C>
3,000,000 U.S. Treasury Note 5.500% February 29, 2000 $ 3,028,594
1,000,000 U.S. Treasury Note 6.375% May 15, 2000 1,022,344
1,000,000 U.S. Treasury Note 6.000% August 15, 2000 1,020,781
1,000,000 U.S. Treasury Note 5.750% November 15, 2000 1,019,531
1,000,000 U.S. Treasury Note 5.625% November 30, 2000 1,017,967
1,500,000 U.S. Treasury Note 5.625% December 31, 1999 1,514,648
5,000,000 U.S. Treasury Note 5.500% March 31, 2000 5,050,000
5,000,000 U.S. Treasury Note 6.375% May 15, 2000 5,111,719
2,000,000 U.S. Treasury Note 4.500% September 30, 2000 1,995,938
2,000,000 U.S. Treasury Note 5.750% November 15, 2000 2,039,063
2,000,000 U.S. Treasury Note 5.625% November 30, 2000 2,035,938
5,000,000 U.S. Treasury Note 5.375% February 15, 2001 5,078,125
1,000,000 U.S. Treasury Note 5.750% April 30, 2003 1,041,094
1,000,000 U.S. Treasury Note 5.250% August 15, 2003 1,025,625
1,000,000 Federal National Mortgage Association 4.820% December 18, 2000 998,672
2,000,000 Federal National Mortgage Association 5.720% January 9, 2001 2,027,960
4,000,000 Federal National Mortgage Association 4.820% December 18, 2000 3,994,688
3,000,000 Federal National Mortgage Association 5.720% January 9, 2001 3,041,939
3,000,000 Federal National Mortgage Association 5.420% January 23, 2001 3,025,200
---------------
Subtotal $ 45,089,826
----------------
Short-Term
----------
3,000,000 U.S. Treasury Note 5.625% December 31, 1999 $ 3,029,297
3,651,000 Federal Home Loan Mortgage Corporation 5.090% January 8, 1999 3,646,984
4,430,000 Federal Home Loan Mortgage Corporation 5.090% January 8, 1999 4,425,127
4,352,000 Federal Home Loan Mortgage Corporation 5.100% January 11, 1999 4,345,037
----------------
Subtotal $ 15,446,445
----------------
Total Debt $ 60,536,271
================
</TABLE>
25
<PAGE>
Certain unusual market conditions could cause greater interest
rate related losses on the Fund's non-trading instruments in excess of those
suggested by the foregoing quantification, but given the fact that virtually
none of the Fund's Government Securities have any optionality or derivative
multiplier feature, MLIP believes that this would be highly unlikely.
Qualitative Disclosures Regarding Primary Trading Risk Exposures
- ----------------------------------------------------------------
The following qualitative disclosures regarding the Fund's
market risk exposures - except for (i) those disclosures that are statements of
historical fact and (ii) the descriptions of how the Fund manages its primary
market risk exposures - constitute forward-looking statements within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act. The Fund's primary market risk exposures as well as the strategies used and
to be used by MLIP and the Advisors for managing such exposures are subject to
numerous uncertainties, contingencies and risks, any one of which could cause
the actual results of the Fund's risk controls to differ materially from the
objectives of such strategies. Government interventions, defaults and
expropriations, illiquid markets, the emergence of dominant fundamental factors,
political upheavals, changes in historical price relationships, an influx of new
market participants, increased regulation and many other factors could result in
material losses as well as in material changes to the risk exposures and the
risk management strategies of the Fund. There can be no assurance that the
Fund's current market exposure and/or risk management strategies will not change
materially or that any such strategies will be effective in either the short- or
long-term. Investors must be prepared to lose all or substantially all of the
time value of their investment in the Fund.
The following were the primary trading risk exposures of the
Fund as of December 31, 1998, by market sector.
Interest Rates. Interest rate risk is the principal market
--------------
exposure of the Fund. Interest rate movements directly affect the price of
derivative sovereign bond positions held by the Fund and indirectly the value of
its stock index and currency positions. Interest rate movements in one country
as well as relative interest rate movements between countries materially impact
the Fund's profitability. The Fund's primary interest rate exposure is to
interest rate fluctuations in the United States and the other G-7 countries.
However, the Fund also takes positions in the government debt of smaller nations
? e.g., New Zealand and Australia. The General Partner anticipates that G-7
interest rates will remain the primary market exposure of the Fund for the
foreseeable future.
Currencies. The Fund trades in a large number of currencies.
----------
However, the Fund's major exposures have typically been in the dollar/yen,
dollar/mark and dollar/pound positions. The General Partner does not anticipate
that the risk profile of the Fund's currency sector will change significantly in
the future, although it is difficult at this point to predict the effect of the
introduction of the Euro on the Advisors' currency trading strategies. The
currency trading Value at Risk figure includes foreign margin amounts converted
into U.S. dollars with an incremental adjustment to reflect the exchange rate
risk of maintaining Value at Risk in a functional currency other than dollars.
Stock Indices. The Fund's primary equity exposure is to G-7
-------------
equity index price movements. As of December 31, 1998, the Fund's primary
exposures were in the S&P 500, Financial Times (England), Nikkei (Japan) and DAX
(Germany) stock indices. The General Partner anticipates little, if any, trading
in non-G-7 stock indices. The Fund is primarily exposed to the risk of adverse
price trends or static markets in the major U.S., European and Japanese indices.
Metals. The Fund's primary metals market exposure is to
------
fluctuations in the price of gold and silver. Although certain of the Advisors
will, from time to time, trade base metals such as aluminum, copper and tin, the
principal market exposures of the Fund have consistently been in the precious
metals, gold and silver (and, to a much lesser extent, platinum). The Advisors'
gold trading has been increasingly limited due to the long-lasting and mainly
non-volatile decline in the price of gold over the last 10?15 years. However,
silver prices have remained volatile over this period, and the Advisors have,
from time to time, taken substantial positions as they have perceived market
opportunities to develop. The General Partner anticipates that gold and silver
will remain the primary metals market exposure for the Fund.
26
<PAGE>
Commodities. The Fund's primary commodities exposure is to
-----------
agricultural price movements which are often directly affected by severe or
unexpected weather conditions. Soybeans, grains and orange juice accounted for
the substantial bulk of the Fund's commodities exposure as of December 31, 1998.
In the past, the Fund has had material market exposure to live cattle and
hogbellies and may do so again in the future. However, the General Partner
anticipates that the Advisors will maintain an emphasis on soybeans, grains and
orange juice, in which the Fund has historically taken its largest positions.
Energy. The Fund's primary energy market exposure is to gas
------
and oil price movements, often resulting from political developments in the
Middle East. Although the Advisors trade natural gas to a limited extent, oil is
by far the dominant energy market exposure of the Fund. Oil prices are currently
depressed, but they can be volatile and substantial profits and losses have been
and are expected to continue to be experienced in this market.
Qualitative Disclosures Regarding Non-Trading Risk Exposure
- -----------------------------------------------------------
The following were the only non-trading risk exposures of the Fund as
of December 31, 1998.
Foreign Currency Balances. The Fund's primary foreign currency
-------------------------
balances are in Japanese yen, German marks, British pounds and French francs.
The Fund has de minimis exchange rate exposure on these balances.
Securities Positions. The Fund holds only cash or
--------------------
interest-bearing Government Securities. The Fund's market exposure in
instruments held other than for trading is in the interest rate risk exposure of
the Fund's Government Securities portfolio, managed by MLAM pursuant to policies
established by MLIP for which MLAM assumes no responsibility. MLIP manages the
risk of the Fund's MLAM account by imposing limitations both on the overall
duration of the portfolio (two years) and on the maximum duration of any
Government Securities held by MLAM (no later than the Principal Assurance Date
for the most recently issued Series of Units). MLIP has applied essentially the
same risk control policies to the Fund's MLAM account since inception, and the
Fund has never experienced a material loss on this account. In a period of
rapidly rising interest rates (since the Fund's inception in 1994, interest
rates have generally declined until quite recently), the Fund could incur
marked-to-market losses on its MLAM account, but MLIP would attempt to prevent
or control these losses by further reducing the permissible durations of the
Fund's Government Securities in order to reduce the interest rate sensitivity of
these instruments.
Qualitative Disclosures Regarding Means of Managing Risk Exposure
- -----------------------------------------------------------------
Trading Risk
The General Partner has procedures in place intended to
control market risk exposure, although there can be no assurance that they will,
in fact, succeed in doing so. These procedures focus primarily on monitoring the
trading of the Advisors selected from time to time for the Fund, adjusting the
percentage of the Fund's total assets investing in the Trading Partnership with
respect to each series of Units and reviewing outstanding positions for
over-concentrations both on an Advisor-by-Advisor and on an overall Fund
basis. While MLIP does not itself intervene in the markets to hedge or diversify
the Fund's market exposure, MLIP 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.
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 investing in the Trading
Partnership, the General Partner can directly affect the market exposure of the
Fund. 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, subject to
the limitation that all Series of Units issued after May 1997 must be adjusted,
if any such Series is adjusted, so that they all trade at the same degree of
leverage.
At the Advisor level, each Advisor applies its own risk
management policies to its trading. These policies generally limit the total
exposure that may be taken per "risk unit" of assets under management. In
addition, many Advisors follow diversification guidelines (often formulated in
terms of the maximum margin which they will commit to positions in any one
contract or group of related contracts), as well as imposing "stop-loss" points
at which open positions must be closed out. Occasionally, Advisors will limit
the market exposure of their Fund account through
27
<PAGE>
acquiring put or call options which "collar" the risk of open positions.
However, because of the typically high degree of liquidity in the markets traded
by the Fund and the expense of acquiring options, most Advisors rely simply on
stop-loss policies, requiring the liquidation of positions once losses of a
certain magnitude have been incurred.
Certain Advisors treat their risk control policies as strict
rules; others only as general guidelines for controlling risk.
Non-Trading Risk
----------------
The Fund controls the non-trading exchange rate risk of these
balances by regularly converting its foreign currency balances back into dollars
(no less frequently than twice a month, and more frequently if a particular
foreign currency balance becomes unusually high).
The General Partner controls the interest-rate risk of the
Fund's non-trading instruments (Government Securities invested by MLAM for cash
management purposes) by limiting the overall duration of such instruments to no
more than two years and the maximum duration of any Government Securities held
by the Fund to no later than the Principal Assurance Date for the most recently
issued Series of Units. These risk control policies have been successful in the
Fund's operations to date, and MLIP does not anticipate any change in these
policies. However, where the interest rate environment changes materially, MLIP
might shorten the permissible duration of the Fund's Government Securities
portfolio.
The Fund has cash flow interest rate risk on its cash on
deposit with MLF in that declining interest rates would cause the income from
such cash to decline. However, a certain amount of cash or cash equivalents must
be held by the Fund in order to facilitate margin payments and pay expenses and
redemptions. MLIP does not take any steps to limit the cash flow risk on the
approximately 20% of its cash held on deposit at MLF.
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. The General Partner
promoted the Fund and is its controlling person.
Item 9: Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
There were no changes in or disagreements with independent
auditors on accounting and financial disclosure.
PART III
Item 10: Directors and Executive Officers of the Registrant
--------------------------------------------------
10(a) and 10(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 and their
respective business backgrounds are as follows.
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
Jo Ann Di Dario Vice President, Chief Financial Officer and Treasurer-
through April 30, 1999
Michael L. Pungello Vice President, Chief Financial Officer and Treasurer,
effective May 1, 1999
Joseph H. Moglia Director
28
<PAGE>
Allen N. Jones Director
Stephen G. Bodurtha Director
Steven B. Olgin Vice President, Secretary and
Director of Administration
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 has served four consecutive one-year terms
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 currently serves as a member
of the CFTC's Global Markets Advisory Committee.
Jeffrey F. Chandor was born in 1942. Mr. Chandor is Senior
Vice President, 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. Mr. Chandor is
serving a two-year term as a director of the Managed Funds Association.
Jo Ann Di Dario was born in 1946. Ms. Di Dario is, through
April 30, 1999, Vice President, Chief Financial Officer and Treasurer of MLIP.
Before joining MLIP in May 1998, she was self-employed for one year. From
February 1996 to May 1997, she worked as a consultant for Global Asset
Management, an international mutual fund organizer and operator headquartered in
London, where she offered advice on restructuring their back-office operations.
From May 1992 to January 1996, she served as a Vice President of Meridian Bank
Corporation, a regional bank holding company. She was responsible for managing
the treasury operations of Meridian Bank Corporation including its wholly-owned
subsidiary, Meridian Investment Company Inc. From September 1991 to May 1992,
Ms. Di Dario managed the Domestic Treasury Operations of First Fidelity Bank, a
regional bank. From January 1991 to September 1991, Ms. Di Dario was self-
employed. For the previous five years, Ms. Di Dario was Vice President,
Secretary and Controller of Caxton Corporation, a Commodity Pool Operator and
Commodity Trading Advisor. Her background includes seven years of public
accounting experience, and she graduated with high honors from Stockton State
College with a Bachelor of Science degree in Accounting.
Michael L. Pungello was born in 1957. Effective May 1, 1999, Mr.
Pungello will become Vice President, Chief Financial Officer and Treasurer of
MLIP. He was First Vice President and Senior Director of Finance for Merrill
Lynch's Operations, Services and Technology Group from January 1998 to March
1999. Prior to that, Mr. Pungello spent over 18 years with Deloitte & Touche
LLP, and was a partner in their Financial Services practice from June 1990 to
December 1997. He graduated from Fordham University in 1979 with a Bachelor of
Science degree in accounting and received his Master of Business Administration
degree in Finance from New York University in 1987.
Joseph H. Moglia was born in 1949. Mr. Moglia 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 Income Institutional Sales, and Director of the
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 also 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.
29
<PAGE>
Stephen G. Bodurtha was born in 1958. Mr. Bodurtha is a
Director of MLIP. In 1980, Mr. Bodurtha graduated magna cum laude from Wesleyan
University, Middletown, Connecticut with a Bachelor of Arts degree in
Government. 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 the Structured Investments
Group of MLPF&S since 1995.
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.
As of December 31, 1998, the principals of MLIP had no
investment in the Fund, and MLIP's general partner interest in the Fund was
valued at approximately $735,280.
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:
----------------------------------------
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 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.
30
<PAGE>
Item 12: Security Ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners:
-----------------------------------------------
As of December 31, 1998, no person or "group" is known to be
or have been the beneficial owner of more than 5% of the Units.
(b) Security Ownership of Management:
--------------------------------
As of December 31, 1998, the General Partner owned 6,654.61
Units (Unit-equivalent general partnership interests), which was approximately
1% of the total Units outstanding.
(c) Changes in Control:
------------------
None.
Item 13: Certain Relationships and Related Exchange of Futures Transactions
------------------------------------------------------------------
(a) Transactions Between Merrill Lynch and the Fund
-----------------------------------------------
All of the service providers to the Fund, other than the
Advisors, are affiliates of Merrill Lynch. Merrill Lynch negotiated with the
Advisors over the level of its advisory fees and Profit Share. However, none of
the fees paid by the Fund to any Merrill Lynch party were negotiated, and they
are higher than would have been obtained in arm's-length bargaining.
The Fund pays Merrill Lynch substantial Brokerage Commissions
and Administrative Fees as well as bid-ask spreads on forward currency trades.
The Fund also pays MLF interest on short-term loans extended by MLF to cover
losses on foreign currency positions.
Within the Merrill Lynch organization, MLIP is the direct
beneficiary of the revenues received by different Merrill Lynch entities from
the Fund. MLIP controls the management of the Fund and serves as its promoter.
Although MLIP has not sold any assets, directly or indirectly, to the Fund, MLIP
makes substantial profits from the Fund due to the foregoing revenues.
No loans have been, are or will be outstanding between MLIP or
any of its principals nd the Fund.
MLIP pays substantial selling commissions and trailing
commissions to MLPF&S for distributing the Units. MLIP is ultimately paid back
for these expenditures from the revenues it receives from the Fund.
(b) Certain Business Relationships:
------------------------------
MLF, an affiliate of the General Partner, acts as the
principal commodity broker for the Partnership.
In 1998, the Partnership expensed: (i) Brokerage Commissions
of $6,159,359 to the Commodity Broker, which included $1,154,486 in consulting
fees earned the Trading Advisors; and (ii) Administrative Fees of $193,861 to
MLIP. In addition, MLIP and its affiliates may have derived certain economic
benefit from possession of the Fund's assets, as well as from foreign exchange
and 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.
31
<PAGE>
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K
---------------------------------------------------------------
<TABLE>
<S> <C> <C>
(a)1. Financial Statements (found in Exhibit 13.01): Page
---------------------------------------------
Independent Auditors' Report 1
Consolidated Statements of Financial Condition as of December 31, 1998 and 1997 2
For the years ended December 31, 1998, 1997 and 1996:
Consolidated Statements of Income 3
Consolidated Statements of Changes in Partners' Capital 4
Notes to Consolidated Financial Statements 5-14
(a)2. Financial Statement Schedules:
-----------------------------
</TABLE>
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:
<TABLE>
Designation Description
- ------------ -----------
<S> <C>
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, 1998.
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.
</TABLE>
32
<PAGE>
<TABLE>
<S> <C>
Exhibit 10.02: Is incorporated herein by reference from Exhibit 10.02 contained in the Registrant's
- ------------- Registration Statement.
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 1998 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).
</TABLE>
(b) Report on Form 8-K:
------------------
No reports on Form 8-K were filed during the fourth quarter of
1998.
33
<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, 1999 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, 1999
- ----------------------- (Principal Executive Officer)
John R. Frawley, Jr.
/s/Jo Ann Di Dario Vice President, Chief Financial Officer and Treasurer March 25, 1999
- ------------------ (Principal Financial and Accounting Officer)
Jo Ann Di Dario
/s/Jeffrey F. Chandor Senior Vice President, Director of Sales, March 25, 1999
- --------------------- Marketing and Research, and Director
Jeffrey F. Chandor
/s/Allen N. Jones Director March 25, 1999
- -----------------
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> <C>
MERRILL LYNCH INVESTMENT General Partner of Registrant March 25, 1999
PARTNERS INC.
By/s/ John R. Frawley, Jr.
- --------------------------
John R. Frawley, Jr.
</TABLE>
34
<PAGE>
ML PRINCIPAL PROTECTION L.P.
ANNUAL REPORT FOR 1998 ON FORM 10-K
INDEX TO EXHIBITS
-----------------
Exhibit
-------
Exhibit 13.01 1998 Annual Report and Independent Auditors'
Report
35
<PAGE>
EXHIBIT 13.01
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
Consolidated Financial Statements for the Years Ended
December 31, 1998, 1997 and 1996 and
Independent Auditors' Report
[LOGO] MERRILL LYNCH
<PAGE>
To: The Limited Partners of ML Principal Protection L.P.
ML Principal Protection L.P. (the "Fund" or the "Partnership") ended its fifth
fiscal year of trading on December 31, 1998 with an increase in Net Asset Value
("NAV"). During 1998, trading profits were generated in the interest rate,
currency and stock index markets while losses were incurred in agricultural,
metals and energy trading. Please see the accompanying summary financial
information for the NAV of your series of Units.
Global interest rate markets provided the Fund with its most profitable
positions for the first quarter, particularly in European bonds where an
extended bond market rally continued despite an environment of robust growth in
the United States, Canada and the United Kingdom, as well as a strong pick-up in
growth in continental Europe. In the second quarter, swings in the U.S. dollar
and developments in Japan affected bond markets, causing the Fund's interest
rate trading to result in losses. This was turned around in the third quarter,
as markets worldwide were turned upside down and the Fund's non-correlation with
general equity and debt markets was strongly exhibited, and trading was
particularly profitable in positions in Eurodollars, German and Japanese bonds,
and U.S. Treasury notes and bonds. Global investors staged a major flight to
quality, resulting in a significant widening of credit spreads on a global
basis. In October, investors pushed the yields on U.S. Treasury bonds to a 31-
year low. The long bond yield fell about 75 basis points in 1998 as the world
economy slowed more than expected, inflation continued to fall, the anticipated
small U.S. budget deficit turned into substantial surplus, and the Federal
Reserve lowered interest rates.
In currency markets, results early in the year were mixed, although marginally
profitable. During the second quarter, strong gains were realized in positions
in the Japanese yen, which weakened during June to an eight-year low versus the
U.S. dollar. Significant gains from Japanese yen trading continued into the
third quarter, and Japan's problems spread to other sectors of the global
economy, causing commodities prices to decline as demand from the Asian
economies weakened. Japan's deepening recession and credit crunch continued
through the fourth quarter, and the Fund achieved gains from long yen positions.
Trading results in stock index markets were also mixed in early 1998, despite a
strong first-quarter performance by the U.S. equity market as several
consecutive weekly gains were recorded with most market averages setting new
highs. Second quarter results were profitable as the Asia-Pacific region's
equity markets weakened across the board. In particular, Hong Kong's Hang Seng
index trended downward during most of the second quarter and traded at a three-
year low. As U.S. equity markets declined in July and August, the Fund profited
from short positions in the S&P 500, most notably during August, when the index
dropped 14.5%. Volatility in September made for a difficult trading environment
in the stock index sector, and the Fund incurred modest losses, although results
remained profitable for the quarter and the year overall in these markets
In agricultural commodity markets, 1998 began with strong gains as live cattle
and hog prices trended downward throughout the first quarter. In the second
quarter, although the U.S. soybean crop got off to a good start which
contributed to higher yield expectations and a more burdensome supply outlook,
soybean prices traded in a volatile pattern. Sugar futures maintained mostly a
downtrend, as no major buyers emerged to support the market. Similarly, coffee
prices trended
<PAGE>
downward, as good weather conditions in Central America and Mexico increased the
prospects of more output from these countries. The third quarter resulted in
losses as the U.S. soybean crop increased relative to the USDA's production
estimate as a result of timely rains, which contributed to lower prices. These
losses continued into the fourth quarter as the Fund was caught on the short
side of the soybean complex, as the soybean supply surplus became more
manageable following the November 10th USDA reports, causing prices to gain
upward momentum.
Gold prices began the year drifting sideways, and continued to weaken following
news in the second quarter of a European Central Bank consensus that ten to
fifteen percent of reserves should be made up of gold bullion, which was at the
low end of expectations. Gold was unable to extend third quarter rallies or to
build any significant upside momentum, resulting in a trendless environment.
This was also the case in the fourth quarter, as gold's cost of production
declined. Also, silver markets remained range-bound, while also experiencing a
significant selloff in November, and aluminum traded at its lowest levels since
1994, with many aluminum smelters operating at a loss.
In energy markets, demand for crude oil in the Middle East was affected by low
oil prices early in the year, and trading resulted in losses. Initially buoyed
on concerns about a U.S.-led military strike against Iraq, crude oil fell to a
nine-year low, as the globally warm winter, the return of Iraq as a producer and
the Asian economic crisis added to OPEC's supply glut problems. Despite
production cuts initiated by OPEC at the end of March, world oil supplies
remained excessive and oil prices stood at relatively low levels throughout the
first half of 1998. Short heating oil positions in the third quarter proved
profitable for the Fund as the market for heating oil prices dropped to its
lowest level in more than a decade. In early December, oil and natural gas
prices dropped sharply, causing continued problems for many emerging market
countries that depend on commodity exports for economic growth and government
financing. These price pressures were mainly due to excessive supply
availability and near-term weather indications that inventories would remain at
more than adequate levels even in the event of a cold Northern Hemisphere
winter. Also, the December U.S. air attack on Iraq failed to cause any damage
to oil pumping and shipping operations, and oil prices fell over 10%.
Despite a year of unprecedented volatility in key global markets, we were
pleased with the Fund's ability to generate a profit by trading both the long
and short side of a variety of markets, demonstrating its value as an element of
diversification in an investor's portfolio. We look forward to 1999 and the
opportunities it may present.
Sincerely,
John R. Frawley, Jr.
President
Merrill Lynch Investment Partners Inc.
(General Partner)
<PAGE>
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.
(A Delaware Limited Partnership)
------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
----
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996:
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
<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. (the "Partnership") as of December 31, 1998 and
1997, and the related consolidated statements of income and of changes in
partners' capital for each of the three years in the period ended December 31,
1998. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of ML Principal Protection L.P. as of
December 31, 1998 and 1997, and the results of their operations for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
New York, New York
February 4, 1999
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
----------------- ------------------
<S> <C> <C>
ASSETS
Equity in commodity futures trading accounts:
Cash and option premiums $ 20,564,400 $ 6,127,857
Net unrealized profit on open contracts 601,178 2,958,175
Government Securities (Note 1) (Cost : $60,044,483 and $93,663,044) 60,536,271 93,851,028
Cash 43,497 1,423
Accrued interest receivable (Note 2) 685,821 839,464
----------------- ------------------
TOTAL $ 82,431,167 $ 103,777,947
================= ==================
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES:
Brokerage commissions payable (Note 2) $ 402,923 $ 494,349
Profit Shares payable (Note 4) 594,328 591,195
Redemptions payable 1,467,829 636,155
Administrative fees payable (Note 2) 16,960 14,330
----------------- ------------------
Total liabilities 2,482,040 1,736,029
----------------- ------------------
Minority Interest 842,289 815,233
----------------- ------------------
PARTNERS' CAPITAL:
General Partner (6,654.61 Units and 23,141.61 Units) 735,280 2,564,153
Limited Partners (717,784.1628 Units and 989,140.56 Units) 78,371,558 105,628,837
Subscriptions Receivable (0 Units and 69,663.05 Units) - (6,966,305)
----------------- ------------------
Total partners' capital 79,106,838 101,226,685
----------------- ------------------
TOTAL $ 82,431,167 $ 103,777,947
================= ==================
NET ASSET VALUE PER UNIT (Note 5)
</TABLE>
See notes to consolidated financial statements.
-2-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
REVENUES:
Trading profit (loss):
Realized $ 8,746,563 $ 5,412,457 $ 9,038,064
Change in unrealized (2,053,193) 1,083,826 (396,221)
--------------- --------------- ---------------
Total trading results 6,693,370 6,496,283 8,641,843
Interest income (Note 2) 5,434,851 4,873,872 4,545,186
--------------- --------------- ---------------
Total revenues 12,128,221 11,370,155 13,187,029
--------------- --------------- ---------------
EXPENSES:
Brokerage commissions (Note 2) 6,159,359 4,833,598 4,775,116
Profit Shares (Note 4) 1,658,306 931,522 978,264
Administrative fees (Note 2) 193,861 138,103 129,057
--------------- --------------- ---------------
Total expenses 8,011,526 5,903,223 5,882,437
--------------- --------------- ---------------
INCOME BEFORE MINORITY INTEREST 4,116,695 5,466,932 7,304,592
--------------- --------------- ---------------
Minority interest in income (27,056) (46,687) (81,228)
--------------- --------------- ---------------
NET INCOME $ 4,089,639 $ 5,420,245 $ 7,223,364
=============== =============== ===============
NET INCOME PER UNIT:
Weighted average number of General Partner
and Limited Partner Units outstanding (Note 6) 929,254 818,689 754,428
=============== =============== ===============
Net income per weighted average General Partner
and Limited Partner Unit $ 4.40 $ 6.62 $ 9.57
=============== =============== ===============
</TABLE>
See notes to consolidated financial statements.
-3-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Limited General Subscriptions
Units Partners Partner Receivable Total
------------------- ------------------ --------------- ----------------- ------------------
<S> <C> <C> <C> <C> <C>
PARTNERS' CAPITAL,
DECEMBER 31, 1995 714,318.9800 $ 73,080,141 $ 1,766,403 $ - $ 74,846,544
Redemptions (245,127.3600) (25,748,519) - - (25,748,519)
Subscriptions 254,468.3500 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 723,659.9700 76,542,105 2,301,180 - 78,843,285
Redemptions (183,442.9100) (19,816,833) - - (19,816,833)
Subscriptions 472,065.1100 46,994,656 211,855 - 47,206,511
Subscriptions Receivable (69,663.0500) - - (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 942,619.1200 105,628,837 2,564,153 (6,966,305) 101,226,685
Redemptions (426,071.8902) (43,562,357) (1,807,512) - (45,369,869)
Subscriptions 138,228.4930 13,822,849 - - 13,822,849
Subscriptions Receivable 69,663.0500 - - 6,966,305 6,966,305
Distributions - (1,595,262) (33,509) - (1,628,771)
Net income - 4,077,491 12,148 - 4,089,639
------------------- ------------------ --------------- ----------------- ------------------
PARTNERS' CAPITAL,
DECEMBER 31, 1998 724,438.7728 $ 78,371,558 $ 735,280 $ - $ 79,106,838
=================== ================== =============== ================= ==================
</TABLE>
See notes to consolidated financial statements.
-4-
<PAGE>
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML Principal Protection L.P (the "Partnership") was organized as an open-end
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, forwards and options on forward contracts on a wide range of
commodities through ML Principal Protection Trading L.P (the "Trading
Partnership"), of which the Partnership is the sole limited partner, and
investing in Government Securities, as defined. Merrill Lynch Investment
Partners Inc. (the "General Partner", "Trading 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.
Merrill Lynch Futures Inc. ("MLF"), an affiliate of Merrill Lynch, is the
Trading Partnership's commodity broker. Merrill Lynch Asset Management, Inc.
("MLAM"), another affiliate of Merrill Lynch, provides cash management
services to the Partnership investing in Government Securities.
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 intends to maintain a general
partner's interest of at least 1% of the total capital in each series of
units. The General Partner and the Limited Partners share in the profits and
losses of the Partnership and the Trading Partnership in proportion to the
respective interests in the Partnership and the Trading Partnership.
References to the Partnership include references to the Trading Partnership
unless the context otherwise requires.
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 different series of units of limited partnership
interest ("Units") generally as of the beginning of each calendar quarter.
Each series has its own Net Asset Value per Unit. For series issued prior to
May 1, 1997, each series may allocate different percentages of their total
capital to trading. For series issued after May 1, 1997, all such series
must allocate the same percentage of their total capital to trading. All
series, regardless of when issued, 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 trading assets, and
allocates and reallocates the Partnership's trading assets among existing,
replacement and additional Advisors.
-5-
<PAGE>
MLIP determines what percentage of the Partnership's total capital to
allocate to trading by investing in the Trading Partnership 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),
and subject to the requirement that all series issued after May 1, 1997 must
allocate the same percentage of their capital to trading.
Certain of the prior year balances have been reclassified to conform with
the current year's presentation.
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, forwards and options on forward
contracts 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 market value (for those commodity interests for which market
quotations are readily available) or at fair value. The change in unrealized
(loss) profit on open contracts and Government Securities, as defined below,
from one period to the next is reflected in change in unrealized in the
Consolidated Statements of Income.
Foreign Currency Transactions
-----------------------------
The Partnership's functional currency is the U.S. dollar; however, it
transacts business in currencies other than the U.S. dollar. Assets and
liabilities denominated in currencies other than the U.S. dollar are
translated into U.S. dollars at the rates in effect at the dates of the
Statements of Financial Condition. Income and expense items denominated in
currencies other than the U.S. dollar are translated into U.S. dollars at
the rates in effect during the period. Gains and losses resulting from the
translation to U.S. dollars are reported in total trading results currently.
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.
Operating Expenses and Selling Commissions
------------------------------------------
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.
No selling commissions have been or are paid directly by Limited Partners.
All selling commissions are paid by MLIP.
-6-
<PAGE>
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
-----------
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 such Units were issued
are assessed an early redemption charge of 3% of their Net Asset Value as of
the date of redemption. Units redeemed after the twelfth month but on or
before the end of the eighteenth month after such Units were issued are
subject to a redemption charge of 1.5%. Units redeemed after the eighteenth
month but on or before the end of the twenty-fourth month after such Units
were issued are subject to a 1% redemption charge.
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.
Recently Issued Accounting Pronouncements
-----------------------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (the "Statement"). Such Statement is
effective for fiscal years commencing after June 15, 1999. The General
Partner does not believe that the Statement will have a significant effect
on the financial statements of the Partnership.
2. RELATED PARTY TRANSACTIONS
MLAM manages a substantial portion all of the Partnership's available U.S.
dollar assets, pursuant to guidelines established by MLIP for which MLAM
assumes no responsibility, in the Government Securities markets. MLF pays
MLAM annual management fees of .20 of 1% on the first $25 million of certain
assets ("Capital"), including the Partnership's assets 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 is maintained at MLF. On
assets held in U.S. dollars, Merrill Lynch credits the Partnership with
interest at the prevailing 91-day U.S. Treasury bill rate. The Partnership
is credited with interest on any of its net gains actually held by Merrill
Lynch in non-U.S. dollar currencies at a prevailing local rate received by
Merrill Lynch. Merrill Lynch may derive certain economic benefits, in excess
of the interest which Merrill Lynch pays to the Partnership, from possession
of such assets.
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 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.
-7-
<PAGE>
Former investors who do not maintain a Merrill Lynch customer account have
been credited as their response forms are processed. The total amount of the
adjustment was 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 determined that interest was calculated
appropriately since November 1996.
Prior to January 1, 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 invested in the
Trading Partnership. Effective January 1, 1996, this rate was reduced to
.771 of 1% (a 9.25% annual rate), 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 invested in the Trading Partnership (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). Effective October 1, 1998, the
administrative fee calculation base was changed so as to equal .021 of 1% (a
.25% annual rate) of the Partnership's month-end total assets, and each
series' brokerage commission percentage was reduced to .625 of 1% (a 7.50%
annual rate). Assets committed to trading and total assets 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 Trading Partnership during the years ended December 31, 1998,
1997 and 1996, was approximately $80, $116 and $116, 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.
Many of the Partnership's currency trades are executed in the spot and
forward foreign exchange markets (the "FX Markets") where there are no
direct execution costs. Instead, the participants, banks and dealers,
including Merrill Lynch International Bank ("MLIB"), in the FX Markets take
a "spread" between the prices at which they are prepared to buy and sell a
particular currency and such spreads are built into the pricing of the spot
or forward contracts with the Partnership. The General Partner anticipates
that some of the Partnership's foreign currency trades will be executed
through MLIB, an affiliate of the General Partner. MLIB has discontinued the
operation of the foreign exchange service desk, which included seeking
multiple quotes from counterparties unrelated to MLIB for a service fee and
trade execution.
In its exchange of futures for physical ("EFP") trading, the Partnership
acquires cash currency positions through banks and dealers, including
Merrill Lynch. The Partnership pays a spread when it exchanges these
positions for futures. This spread reflects, in part, the different
settlement dates of the cash and the futures contracts, as well as
prevailing interest rates, but also includes a pricing spread in favor of
the banks and dealers, which may include a Merrill Lynch entity.
-8-
<PAGE>
3. ANNUAL DISTRIBUTIONS
The Partnership makes annual fixed-rate distributions, payable
irrespective of profitability, of $3.50 per Unit on Units issued prior to
May 1, 1997. 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 May 1, 1997. As of December 31, 1998, the Partnership had made the
following distributions:
Distribution Fixed-Rate Discretionary
Series Date Distribution Distribution
--------- ----------------------------------------------
1998
-----
Series A 10/1/98 $ 3.50 $ -
Series B 1/1/98 3.50 1.50
Series C 4/1/98 3.50 -
Series D 7/1/98 3.50 -
Series E 10/1/98 3.50 -
Series F 1/1/98 3.50 1.25
Series G 4/1/98 3.50 -
Series H 7/1/98 3.50 -
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 -
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, options on
futures, forwards and option on forward contract trades to be made on
behalf of their respective Trading Partnership accounts, subject 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 and upon the net reallocation of assets away from
an Advisor, including unit redemptions, are paid to the appropriate
Advisors to the extent of the applicable percentage of any New Trading
Profit attributable to such Units.
-9-
<PAGE>
5. NET ASSET VALUE PER UNIT
At December 31, 1998 the Net Asset Values of the different series of Units
were as follows:
Number Net Asset Value
Net Asset Value of Units per Unit
--------------------------------------------------
--------------------------------------------------
Series A Units $ 12,718,104 109,886.0000 $ 115.74
Series B Units 1,498,896 13,150.0000 113.98
Series C Units 2,145,087 19,694.0000 108.92
Series D Units 6,658,019 59,742.0000 111.45
Series E Units 6,063,352 54,556.5800 111.14
Series F Units 3,285,111 30,152.6400 108.95
Series G Units 2,854,082 26,507.1000 107.67
Series H Units 2,185,925 20,275.7250 107.81
Series K Units 7,063,107 64,436.0000 109.61
Series L Units 9,686,313 90,690.0000 106.81
Series M Units 10,476,381 96,696.0600 108.34
Series N Units 5,800,784 55,546.4250 104.43
Series O Units 7,205,406 68,774.2420 104.77
Series P Units 655,841 6,134.0000 106.92
Series Q Units 810,430 8,198.0008 98.86
-------------- ----------------
$ 79,106,838 724,438.7728
============== ================
As of December 31, 1997, the Net Asset Value of the different series of
Units were as follows:
Number Net Asset Value
Net Asset Value of Units per Unit
------------------------------------------------------
------------------------------------------------------
Series A Units $ 17,716,313 155,778.0000 $ 113.73
Series B Units 2,865,130 25,100.0000 114.15
Series C Units 4,061,256 37,551.0000 108.15
Series D Units 10,499,613 95,504.0000 109.94
Series E Units 7,685,677 70,255.8600 109.40
Series F Units 6,136,370 56,275.4800 109.04
Series G Units 5,470,415 51,354.5000 106.52
Series H Units 5,610,794 52,626.2200 106.62
Series K Units 12,127,411 115,752.0000 104.77
Series L Units 14,732,144 144,314.0000 102.08
Series M Units 14,321,562 138,108.0600 103.70
------------------ ----------------
$ 101,226,685 942,619.1200
================== ================
-10-
<PAGE>
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 number of Units outstanding at December 31, 1998, 1997 and 1996
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 the year.
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 in respect of such Units, not
less than $100.
8. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Trading Partnership trades futures, options on futures, forwards and
options on forward contracts on interest rates, stock indices,
commodities, currencies, energy and metals. The Trading Partnership's
total trading results by reporting category for the years ended December
31, 1998, 1997 and 1996 were as follows:
Total Trading Results
--------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
Interest Rates $ 7,116,336 $ 1,706,686 $ 3,183,955
Stock Indices 824,905 232,314 (746,255)
Commodities (967,695) 679,157 20,119
Currencies 2,085,218 3,911,109 3,301,360
Energy (882,409) (1,278,003) 3,280,677
Metals (1,482,985) 1,245,020 (398,013)
--------------- --------------- ---------------
$ 6,693,370 $ 6,496,283 $ 8,641,843
=============== =============== ===============
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 the market values of the
financial instruments or commodities underlying such derivative
instruments frequently result in changes in the Partnership's net
unrealized profit on such derivative instruments as reflected in the
Consolidated Statements of Financial Condition. The Trading 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 such derivative instruments are traded.
The General Partner has procedures in place intended to control market
risk exposure, although there can be no assurance that they will, in fact,
succeed in doing so. These 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 invested in the
Trading Partnership 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
-11-
<PAGE>
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 the Units trade. If MLIP makes a
leverage adjustment to any series issued after May 1, 1997, a
corresponding adjustment is made to the leverage used by all such series.
For series issued prior to May 1, 1997, adjustments to leverage may be
made individually by series. By controlling the percentage of the assets
invested in the Trading Partnership, the General 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 net unrealized profit recorded in the
Consolidated Statements of Financial Condition and the related profit
reflected in trading results in the Consolidated Statements of Income.
The contract/notional values of the Trading Partnership's open derivative
instrument positions as of December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------- ----------------------------------------
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 $ 83,065,616 $ 91,012,676 $ 121,435,283 $ 85,620,621
Stock Indices 3,698,279 1,622,808 1,665,588 8,854,122
Commodities 1,797,931 7,856,776 11,663,786 21,791,599
Currencies 52,385,528 53,181,016 70,272,888 147,312,282
Energy - 2,079,384 1,085,885 9,041,759
Metals 4,190,146 9,506,207 4,412,002 19,039,071
------------------ ------------------ ------------------ -----------------
$ 145,137,500 $ 165,258,867 $ 210,535,432 $ 291,659,454
================== ================== ================== =================
</TABLE>
Substantially all of the Trading Partnership's open derivative instruments
outstanding as of December 31, 1998 expire within one year.
-12-
<PAGE>
The contract/notional values of the Trading Partnership's open exchange-
traded and non-exchange-traded derivative instrument positions as of
December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------- -------------------------------------------
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 $ 102,156,889 $ 116,203,862 $ 142,565,779 $ 183,223,917
Non- Exchange-Traded 42,980,611 49,055,005 67,969,653 108,435,537
------------------ ----------------- ----------------- -----------------
$ 145,137,500 $ 165,258,867 $ 210,535,432 $ 291,659,454
================== ================= ================= =================
</TABLE>
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,
1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------- --------------------------------------------
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 $ 221,031,675 $ 98,633,884 $ 177,189,103 $ 68,697,138
Stock Indices 7,202,373 4,205,480 7,544,449 4,040,832
Commodities 9,417,012 14,567,919 13,113,725 11,481,639
Currencies 119,142,464 136,575,495 70,061,899 113,287,725
Energy 1,961,831 4,354,689 3,621,533 3,415,726
Metals 7,976,980 11,836,785 7,369,251 14,913,348
------------------- ------------------- ------------------- -------------------
$ 366,732,335 $ 270,174,252 $ 278,899,960 $ 215,836,408
=================== =================== =================== ===================
</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 included on the Consolidated Statements of Financial Condition.
-13-
<PAGE>
The gross unrealized profit and the net unrealized profit on the Trading
Partnership's open derivative instrument positions as of December 31, 1998
and 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------- --------------------------------------
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit Profit Profit
----------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Exchange-Traded $ 1,271,311 $ 733,034 $ 3,263,519 $ 2,416,539
Non-Exchange-Traded 911,388 (131,856) 2,119,281 541,636
----------------- --------------- -------------- ---------------
$ 2,182,699 $ 601,178 $ 5,382,800 $ 2,958,175
================= =============== ============== ===============
</TABLE>
The Partnership has credit risk in respect of its counterparties and
brokers, but attempts to control this risk by dealing almost exclusively
with Merrill Lynch entities as counterparties and brokers.
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 (which includes a netting arrangement), 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
On January 4, 1999, distributions were announced for Series B and Series
F. During 1999, both the Series B Unitholders and the Series F Unitholders
received a fixed-rate distribution of $3.50 per unit.
* * * * * * * * * *
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/Jo Ann Di Dario
Jo Ann Di Dario
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
General Partner of
ML Principal Protection L.P.
-14-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 43,497 1,423
<RECEIVABLES> 21,851,399 9,925,496
<SECURITIES-RESALE> 0 0
<SECURITIES-BORROWED> 0 0
<INSTRUMENTS-OWNED> 60,536,271 93,851,028
<PP&E> 0 0
<TOTAL-ASSETS> 82,431,167 103,777,947
<SHORT-TERM> 0 0
<PAYABLES> 3,324,329 2,551,262
<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> 79,106,838 102,041,918
<TOTAL-LIABILITY-AND-EQUITY> 82,431,167 103,777,947
<TRADING-REVENUE> 6,693,370 6,496,283
<INTEREST-DIVIDENDS> 5,434,851 4,873,872
<COMMISSIONS> 6,159,359 4,833,598
<INVESTMENT-BANKING-REVENUES> 0 0
<FEE-REVENUE> 0 0
<INTEREST-EXPENSE> 0 0
<COMPENSATION> 0 0
<INCOME-PRETAX> 4,089,639 5,420,245
<INCOME-PRE-EXTRAORDINARY> 4,089,639 5,420,245
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 929,254 818,689
<EPS-PRIMARY> 4.40 6.62
<EPS-DILUTED> 4.40 6.62
</TABLE>
