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STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price Variable Annuity
Statement of Additional Information for the Fund
The date of this Statement of Additional Information is May 1, 2000.
T. ROWE PRICE FIXED INCOME SERIES, INC. (the "Corporation")
T. Rowe Price Limited-Term Bond Portfolio (the "fund")
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Mailing Address: T. Rowe Price Variable Annuity Service Center P.O. Box
750440 Topeka, Kansas 66675-0440 1-800-469-6587
Shares of the fund are designed to be offered to insurance company separate
accounts established for the purpose of funding variable annuity contracts.
They may also be offered to insurance company separate accounts established
for the purpose of funding variable life contracts. Variable annuity and
variable life contract holders or participants are not the shareholders of
the fund. Rather, the separate account is the shareholder. The variable
annuity and variable life contracts are described in separate prospectuses
issued by the insurance companies. The fund assumes no responsibility for any
insurance company prospectuses or variable annuity or variable life
contracts.
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the appropriate fund's prospectus dated May 1, 2000,
which may be obtained by contacting the T. Rowe Price Variable Annuity
Service Center.
The fund's financial statements for the year ended December 31, 1999, and the
report of independent accountants are included in the fund's Annual Report
and incorporated by reference into this Statement of Additional Information.
TRP609 (5/00)
K15-146
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TABLE OF CONTENTS
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Capital Stock 45 Legal Counsel 46
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Code of Ethics 37 Management of the Fund 33
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Custodian 37 Net Asset Value Per Share 42
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Distributor for the 37 Portfolio Management Practices 18
Fund
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Dividends and 42 Portfolio Transactions 38
Distributions
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Federal Registration 46 Pricing of Securities 41
of Shares
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Independent 46 Principal Holders of Securities 35
Accountants
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Investment Management 36 Ratings of Commercial Paper 47
Services
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Investment Objectives 2 Ratings of Corporate Debt Securities 47
and Policies
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Investment Performance 44 Risk Factors 2
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Investment Program 8 Tax Status 42
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Investment 31 Yield Information 43
Restrictions
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INVESTMENT OBJECTIVES AND POLICIES
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The following information supplements the discussion of the fund's investment
objectives and policies discussed in the fund's prospectus.
The fund will not make a material change in its investment objectives without
obtaining shareholder approval. Unless otherwise specified, the investment
programs and restrictions of the fund are not fundamental policies. The
fund's operating policies are subject to change by its Board of Directors
without shareholder approval. However, shareholders will be notified of a
material change in an operating policy. The fund's fundamental policies may
not be changed without the approval of at least a majority of the outstanding
shares of the fund or, if it is less, 67% of the shares represented at a
meeting of shareholders at which the holders of 50% or more of the shares are
represented. References to the following are as indicated:
Investment Company Act of 1940 ("1940 Act")
Securities and Exchange Commission ("SEC")
T. Rowe Price Associates, Inc. ("T. Rowe Price")
Moody's Investors Service, Inc. ("Moody's")
Standard & Poor's Corporation ("S&P")
Internal Revenue Code of 1986 ("Code")
Rowe Price-Fleming International, Inc. ("Price-Fleming")
RISK FACTORS
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Reference is also made to the sections entitled "Types of Securities" and
"Portfolio Management Practices" for discussions of the risks associated with
the investments and practices described therein as they apply to the fund.
Because of its investment policy, the fund may or may not be suitable or
appropriate for all investors. The fund is not a money market fund and is not
an appropriate investment for those whose primary objective is
<PAGE>
principal stability. There is risk in all investment. The fund is designed
for the investor who seeks to participate in a diversified portfolio of
short- and intermediate-term investment grade bonds and other debt securities
(up to 10% of which may be below investment grade) which provide a higher
rate of income than a money market fund and less risk of capital fluctuation
than a portfolio of long-term debt securities. The value of the portfolio
securities of the fund will fluctuate based upon market conditions. Although
the fund seeks to reduce risk by investing in a diversified portfolio, such
diversification does not eliminate all risk. There can, of course, be no
assurance that the fund will achieve these results.
Debt Obligations
Yields on short-, intermediate-, and long-term debt securities are dependent
on a variety of factors, including the general conditions of the money and
bond markets, the size of a particular offering, the maturity of the
obligation, and the credit quality and rating of the issue. Debt securities
with longer maturities tend to have higher yields and are generally subject
to potentially greater capital appreciation and depreciation than obligations
with shorter maturities and lower yields. The market prices of debt
securities usually vary, depending upon available yields. An increase in
interest rates will generally reduce the value of portfolio debt securities,
and a decline in interest rates will generally increase the value of
portfolio debt securities. The ability of the fund to achieve its investment
objective is also dependent on the continuing ability of the issuers of the
debt securities in which the fund invests to meet their obligations for the
payment of interest and principal when due. Although the fund seeks to reduce
risk by portfolio diversification, credit analysis, and attention to trends
in the economy, industries, and financial markets, such efforts will not
eliminate all risk. There can, of course, be no assurance that the fund will
achieve its investment objective.
After purchase by the fund, a debt security may cease to be rated or its
rating may be reduced below the minimum required for purchase by the fund.
Neither event will require a sale of such security by the fund. However, T.
Rowe Price will consider such events in its determination of whether the fund
should continue to hold the security. To the extent that the ratings given by
Moody's or S&P may change as a result of changes in such organizations or
their rating systems, the fund will attempt to use comparable ratings as
standards for investments in accordance with the investment policies
contained in the prospectus. When purchasing unrated securities, T. Rowe
Price, under the supervision of the fund's Board of Directors, determines
whether the unrated security is of a quality comparable to that which the
fund is allowed to purchase.
Securities backed by the full faith and credit of the United States (for
example, GNMA and U.S. Treasury securities) are generally considered to be
among the most, if not the most, creditworthy investments available. While
the U.S. government has honored its credit obligations continuously for the
last 200 years, political events in 1995 and 1996, at times, called into
question whether the United States would default on its obligations. Such an
event would be unprecedented and there is no way to predict its results on
the securities markets or the fund. However, it is very likely default by the
U.S. would result in losses to the fund.
Mortgage Securities
Mortgage-backed securities differ from conventional bonds in that principal
is paid back over the life of the security rather than at maturity. As a
result, the holder of a mortgage-backed security (i.e., the fund) receives
monthly scheduled payments of principal and interest, and may receive
unscheduled principal payments representing prepayments on the underlying
mortgages. The incidence of unscheduled principal prepayments is also likely
to increase in mortgage pools owned by the fund when prevailing mortgage loan
rates fall below the mortgage rates of the securities underlying the
individual pool. The effect of such prepayments in a falling rate environment
is to (1) cause the fund to reinvest principal payments at the then lower
prevailing interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security. Conversely, the fund may
realize a gain on prepayments of mortgage pools trading at a discount. Such
prepayments will provide an early return of principal which may then be
reinvested at the then higher prevailing interest rate.
The market value of adjustable rate mortgage securities ("ARMs"), like other
U.S. government securities, will generally vary inversely with changes in
market interest rates, declining when interest rates rise and rising when
interest rates decline. Because of their periodic adjustment feature, ARMs
should be more sensitive to short-term interest rates than long-term rates.
They should also display less volatility than long-term
<PAGE>
mortgage-backed securities. Thus, while having less risk of a decline during
periods of rapidly rising rates, ARMs may also have less potential for
capital appreciation than other investments of comparable maturities.
Interest rate caps on mortgages underlying ARM securities may prevent income
on the ARM from increasing to prevailing interest rate levels and cause the
securities to decline in value. In addition, to the extent ARMs are purchased
at a premium, mortgage foreclosures and unscheduled principal prepayments may
result in some loss of the holders' principal investment to the extent of the
premium paid. On the other hand, if ARMs are purchased at a discount, both a
scheduled payment of principal and an unscheduled prepayment of principal
will increase current and total returns and will accelerate the recognition
of income which when distributed to shareholders will be taxable as ordinary
income.
Risk Factors of Foreign Investing There are special risks in foreign
investing. Certain of these risks are inherent in any mutual fund while
others relate more to the countries in which the fund will invest. Many of
the risks are more pronounced for investments in developing or emerging
market countries, such as many of the countries of Asia, Latin America,
Eastern Europe, Russia, Africa, and the Middle East. Although there is no
universally accepted definition, a developing country is generally considered
to be a country which is in the initial stages of its industrialization cycle
with a per capita gross national product of less than $8,000.
. Political and Economic Factors Individual foreign economies of certain
countries differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency, and balance of payments position.
The internal politics of certain foreign countries are not as stable as in
the United States. For example, in 1991, the existing government in Thailand
was overthrown in a military coup. In 1994-1995, the Mexican peso plunged in
value setting off a severe crisis in the Mexican economy. Asia is still
coming to terms with its own crisis and recessionary conditions sparked off
by widespread currency weakness in late 1997. In 1998, there was substantial
turmoil in markets throughout the world. In 1999, the democratically elected
government of Pakistan was over thrown by a military coup. The Russian
government also defaulted on all its domestic debt. In addition, significant
external political risks currently affect some foreign countries. Both Taiwan
and China still claim sovereignty of one another and there is a demilitarized
border and hostile relations between North and South Korea.
Governments in certain foreign countries continue to participate to a
significant degree, through ownership interest or regulation, in their
respective economies. Action by these governments could have a significant
effect on market prices of securities and payment of dividends. The economies
of many foreign countries are heavily dependent upon international trade and
are accordingly affected by protective trade barriers and economic conditions
of their trading partners. The enactment by these trading partners of
protectionist trade legislation could have a significant adverse effect upon
the securities markets of such countries.
. Currency Fluctuations The fund invests in securities denominated in various
currencies. Accordingly, a change in the value of any such currency against
the U.S. dollar will result in a corresponding change in the U.S. dollar
value of the fund's assets denominated in that currency. Such changes will
also affect the fund's income. Generally, when a given currency appreciates
against the dollar (the dollar weakens) the value of the fund's securities
denominated in that currency will rise. When a given currency depreciates
against the dollar (the dollar strengthens) the value of the fund's
securities denominated in that currency would be expected to decline.
. Investment and Repatriation Restrictions Foreign investment in the
securities markets of certain foreign countries is restricted or controlled
in varying degrees. These restrictions limit at times and preclude investment
in certain of such countries and increase the cost and expenses of the fund.
Investments by foreign investors are subject to a variety of restrictions in
many developing countries. These restrictions may take the form of prior
governmental approval, limits on the amount or type of securities held by
foreigners, and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at any time by
these or other countries in which the funds invest. In addition, the
repatriation of both investment income and capital from several foreign
countries is restricted and controlled under certain regulations, including
in some cases the need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year. In 1998, the
government of Malaysia imposed currency
<PAGE>
controls which effectively made it impossible for foreign investors to
convert Malaysian ringgits to foreign currencies.
. Market Characteristics It is contemplated that most foreign securities will
be purchased in over-the-counter markets or on securities exchanges located
in the countries in which the respective principal offices of the issuers of
the various securities are located, if that is the best available market.
Investments in certain markets may be made through American Depository
Receipts ("ADRs") and Global Depository Receipts ("GDRs") traded in the
United States or on foreign exchanges. Foreign securities markets are
generally not as developed or efficient as, and more volatile than, those in
the United States. While growing in volume, they usually have substantially
less volume than U.S. markets and the fund's portfolio securities may be less
liquid and subject to more rapid and erratic price movements than securities
of comparable U.S. companies. Securities may trade at price/earnings
multiples higher than comparable United States securities and such levels may
not be sustainable. Commissions on foreign securities are generally higher
than commissions on United States exchanges, and while there is an increasing
number of overseas securities markets that have adopted a system of
negotiated rates, a number are still subject to an established schedule of
minimum commission rates. There is generally less government supervision and
regulation of foreign securities exchanges, brokers, and listed companies
than in the United States. Moreover, settlement practices for transactions in
foreign markets may differ from those in United States markets. Such
differences include delays beyond periods customary in the United States and
practices, such as delivery of securities prior to receipt of payment, which
increase the likelihood of a "failed settlement." Failed settlements can
result in losses to the fund.
. Investment Funds The fund may invest in investment funds which have been
authorized by the governments of certain countries specifically to permit
foreign investment in securities of companies listed and traded on the stock
exchanges in these respective countries. The fund's investment in these funds
is subject to the provisions of the 1940 Act. If the fund invests in such
investment funds, the fund's shareholders will bear not only their
proportionate share of the expenses of the fund (including operating expenses
and the fees of the investment manager), but also will bear indirectly
similar expenses of the underlying investment funds. In addition, the
securities of these investment funds may trade at a premium over their net
asset value.
. Information and Supervision There is generally less publicly available
information about foreign companies comparable to reports and ratings that
are published about companies in the United States. Foreign companies are
also generally not subject to uniform accounting, auditing and financial
reporting standards, practices, and requirements comparable to those
applicable to United States companies. It also is often more difficult to
keep currently informed of corporate actions which affect the prices of
portfolio securities.
. Taxes The dividends and interest payable on certain of the fund's foreign
portfolio securities may be subject to foreign withholding taxes, thus
reducing the net amount of income available for distribution to the fund's
shareholders.
. Other With respect to certain foreign countries, especially developing and
emerging ones, there is the possibility of adverse changes in investment or
exchange control regulations, expropriation or confiscatory taxation,
limitations on the removal of funds or other assets of the funds, political
or social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
. Eastern Europe and Russia Changes occurring in Eastern Europe and Russia
today could have long-term potential consequences. As restrictions fall, this
could result in rising standards of living, lower manufacturing costs,
growing consumer spending, and substantial economic growth. However,
investment in most countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too recent to
establish a definite trend away from centrally planned economies and
state-owned industries. The collapse of the ruble from its crawling peg
exchange rate against the U.S. dollar has set back the path of reform for
several years. In many of the countries of Eastern Europe and Russia, there
is no stock exchange or formal market for securities. Such countries may also
have government exchange controls, currencies with no recognizable market
value relative to the established currencies of western market economies,
little or no experience in trading in securities, no financial reporting
standards, a lack of a banking and securities infrastructure to handle such
trading, and a legal tradition which does not recognize rights in private
property. In addition, these countries may have national policies which
restrict investments in companies deemed
<PAGE>
sensitive to the country's national interest. Further, the governments in
such countries may require governmental or quasi-governmental authorities to
act as custodian of the fund's assets invested in such countries, and these
authorities may not qualify as a foreign custodian under the 1940 Act and
exemptive relief from such Act may be required. All of these considerations
are among the factors which could cause significant risks and uncertainties
to investment in Eastern Europe and Russia. The fund will only invest in a
company located in, or a government of, Eastern Europe and Russia, if it
believes the potential return justifies the risk.
. Latin America
Inflation Most Latin American countries have experienced, at one time or
another, severe and persistent levels of inflation, including, in some cases,
hyperinflation. This has, in turn, led to high interest rates, extreme
measures by governments to keep inflation in check, and a generally
debilitating effect on economic growth. Although inflation in many countries
has lessened, there is no guarantee it will remain at lower levels.
Political Instability The political history of certain Latin American
countries has been characterized by political uncertainty, intervention by
the military in civilian and economic spheres, and political corruption. Such
developments, if they were to reoccur, could reverse favorable trends toward
market and economic reform, privatization, and removal of trade barriers, and
result in significant disruption in securities markets.
Foreign Currency Certain Latin American countries may experience sudden and
large adjustments in their currency which, in turn, can have a disruptive and
negative effect on foreign investors. For example, in late 1994 the value of
the Mexican peso lost more than one-third of its value relative to the
dollar. In 1999, the Brazalian real lost 30% of its value against the U.S.
dollar. Certain Latin American countries may impose restrictions on the free
conversion of their currency into foreign currencies, including the U.S.
dollar. There is no significant foreign exchange market for many currencies
and it would, as a result, be difficult for the fund to engage in foreign
currency transactions designed to protect the value of the fund's interests
in securities denominated in such currencies.
Sovereign Debt A number of Latin American countries are among the largest
debtors of developing countries. There have been moratoria on, and
reschedulings of, repayment with respect to these debts. Such events can
restrict the flexibility of these debtor nations in the international markets
and result in the imposition of onerous conditions on their economies.
. Asia (ex-Japan)
Political Instability The political history of certain Asian countries has
been characterized by political uncertainty, intervention by the military in
civilian and economic spheres, and political corruption. Such developments,
if they continue to occur, could reverse favorable trends toward market and
economic reform, privatization, and removal of trade barriers and result in
significant disruption in securities markets.
Foreign Currency Certain Asian countries may have managed currencies which
are maintained at artificial levels to the U.S. dollar rather than at levels
determined by the market. This type of system can lead to sudden and large
adjustments in the currency which, in turn, can have a disruptive and
negative effect on foreign investors. For example, in 1997 the Thai baht lost
46.75% of its value against the U.S. dollar. Certain Asian countries also may
restrict the free conversion of their currency into foreign currencies,
including the U.S. dollar. There is no significant foreign exchange market
for certain currencies and it would, as a result, be difficult for the fund
to engage in foreign currency transactions designed to protect the value of
the fund's interests in securities denominated in such currencies.
Debt A number of Asian companies are highly dependent on foreign loans for
their operation. In 1997, several Asian countries were forced to negotiate
loans from the International Monetary Fund ("IMF") and others that impose
strict repayment term schedules and require significant economic and
financial restructuring.
. Japan
The fund's concentration of its investments in Japan means the fund will be
more dependent on the investment considerations discussed above and may be
more volatile than a fund which is broadly diversified
<PAGE>
geographically. To the extent any of the other funds also invest in Japan,
such investments will be subject to these same factors. Additional factors
relating to Japan include the following:
Japan has experienced earthquakes and tidal waves of varying degrees of
severity, and the risks of such phenomena, and damage resulting therefrom,
continue to exist. Japan also has one of the world's highest population
densities. A significant percentage of the total population of Japan is
concentrated in the metropolitan areas of Tokyo, Osaka and Nagoya.
Economy The Japanese economy languished for much of the last decade. Lack of
effective governmental action in the areas of tax reform to reduce high tax
rates, banking regulation to address enormous amounts of bad debt, and
economic reforms to attempt to stimulate spending are among the factors cited
as possible causes of Japan's economic problems. The yen has had a history of
unpredictable and volatile movements against the dollar; a weakening yen
hurts U.S. investors holding yen denominated securities. Finally, the
Japanese stock market has experienced wild swings in value and has often been
considered significantly overvalued.
Energy Japan has historically depended on oil for most of its energy
requirements. Almost all of its oil is imported, the majority from the Middle
East. In the past, oil prices have had a major impact on the domestic
economy, but more recently Japan has worked to reduce its dependence on oil
by encouraging energy conservation and use of alternative fuels. In addition,
a restructuring of industry, with emphasis shifting from basic industries to
processing and assembly type industries, has contributed to the reduction of
oil consumption. However, there is no guarantee this favorable trend will
continue.
Foreign Trade Overseas trade is important to Japan's economy. Japan has few
natural resources and must export to pay for its imports of these basic
requirements. Because of the concentration of Japanese exports in highly
visible products such as automobiles, machine tools and semiconductors and
the large trade surpluses ensuing therefrom, Japan has had difficult
relations with its trading partners, particularly the U.S. It is possible
that trade sanctions or other protectionist measures could impact Japan
adversely in both the short- and long-term.
Special Risks of Investing in Junk Bonds The following special considerations
are additional risk factors associated with the fund's investments in
lower-rated debt securities.
. Youth and Growth of the Lower-Rated Debt Securities Market The market for
lower-rated debt securities is relatively new and its growth has paralleled a
long economic expansion. Past experience may not, therefore, provide an
accurate indication of future performance of this market, particularly during
periods of economic recession. An economic downturn or increase in interest
rates is likely to have a greater negative effect on this market, the value
of lower-rated debt securities in the fund's portfolio, the fund's net asset
value and the ability of the bonds' issuers to repay principal and interest,
meet projected business goals and obtain additional financing than on
higher-rated securities. These circumstances also may result in a higher
incidence of defaults than with respect to higher-rated securities. An
investment in this fund is more speculative than investment in shares of a
fund which invests only in higher-rated debt securities.
. Sensitivity to Interest Rate and Economic Changes Prices of lower-rated debt
securities may be more sensitive to adverse economic changes or corporate
developments than higher-rated investments. Debt securities with longer
maturities, which may have higher yields, may increase or decrease in value
more than debt securities with shorter maturities. Market prices of
lower-rated debt securities structured as zero coupon or pay-in-kind
securities are affected to a greater extent by interest rate changes and may
be more volatile than securities which pay interest periodically and in cash.
Where it deems it appropriate and in the best interests of fund shareholders,
the fund may incur additional expenses to seek recovery on a debt security on
which the issuer has defaulted and to pursue litigation to protect the
interests of security holders of its portfolio companies.
. Liquidity and Valuation Because the market for lower-rated securities may be
thinner and less active than for higher-rated securities, there may be market
price volatility for these securities and limited liquidity in the resale
market. Nonrated securities are usually not as attractive to as many buyers
as rated securities are, a factor which may make nonrated securities less
marketable. These factors may have the effect of limiting the availability of
the securities for purchase by the fund and may also limit the ability of the
fund to sell such
<PAGE>
securities at their fair value either to meet redemption requests or in
response to changes in the economy or the financial markets.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-rated
debt securities, especially in a thinly traded market. To the extent the fund
owns or may acquire illiquid or restricted lower-rated securities, these
securities may involve special registration responsibilities, liabilities and
costs, and liquidity and valuation difficulties. Changes in values of debt
securities which the fund owns will affect its net asset value per share. If
market quotations are not readily available for the fund's lower-rated or
nonrated securities, these securities will be valued by a method that the
fund's Board of Directors believes accurately reflects fair value. Judgment
plays a greater role in valuing lower-rated debt securities than with respect
to securities for which more external sources of quotations and last sale
information are available.
. Taxation Special tax considerations are associated with investing in
lower-rated debt securities structured as zero coupon or pay-in-kind
securities. The fund accrues income on these securities prior to the receipt
of cash payments. The fund must distribute substantially all of its income to
its shareholders to qualify for pass-through treatment under the tax laws and
may, therefore, have to dispose of its portfolio securities to satisfy
distribution requirements.
INVESTMENT PROGRAM
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Types of Securities
Set forth below is additional information about certain of the investments
described in the fund's prospectus.
Debt Securities
Fixed income securities in which the fund may invest include, but are not
limited to, those described below.
. U.S. Government Obligations Bills, notes, bonds, and other debt securities
issued by the U.S. Treasury. These are direct obligations of the U.S.
government and differ mainly in the length of their maturities.
. U.S. Government Agency Securities Issued or guaranteed by U.S.
government-sponsored enterprises and federal agencies. These include
securities issued by the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Bank, Federal Land Banks,
Farmers Home Administration, Banks for Cooperatives, Federal Intermediate
Credit Banks, Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these securities are
supported by the full faith and credit of the U.S. Treasury; the remainder
are supported only by the credit of the instrumentality, which may or may not
include the right of the issuer to borrow from the Treasury.
. Bank Obligations Certificates of deposit, bankers' acceptances, and other
short-term debt obligations. Certificates of deposit are short-term
obligations of commercial banks. A bankers' acceptance is a time draft drawn
on a commercial bank by a borrower, usually in connection with international
commercial transactions. Certificates of deposit may have fixed or variable
rates. The fund may invest in U.S. banks, foreign branches of U.S. banks,
U.S. branches of foreign banks, and foreign branches of foreign banks.
. Corporate Debt Securities Outstanding nonconvertible corporate debt
securities (e.g., bonds and debentures) which have one year or less remaining
to maturity. Corporate notes may have fixed, variable, or floating rates.
. Commercial Paper and Commercial Notes Short-term promissory notes issued by
corporations primarily to finance short-term credit needs. Certain notes may
have floating or variable rates and may contain options, exercisable by
either the buyer or the seller, that extend or shorten the maturity of the
note.
. Foreign Government Securities Issued or guaranteed by a foreign government,
province, instrumentality, political subdivision, or similar unit thereof.
<PAGE>
. Savings and Loan Obligations Negotiable certificates of deposit and other
short-term debt obligations of savings and loan associations.
. Supranational Agencies Securities of certain supranational entities, such as
the International Development Bank.
Mortgage-Related Securities
Mortgage-related securities in which the fund may invest include, but are not
limited to, those described below.
. Mortgage-Backed Securities Mortgage-backed securities are securities
representing an interest in a pool of mortgages. The mortgages may be of a
variety of types, including adjustable rate, conventional 30-year fixed rate,
graduated payment, and 15-year. Principal and interest payments made on the
mortgages in the underlying mortgage pool are passed through to the fund.
This is in contrast to traditional bonds where principal is normally paid
back at maturity in a lump sum. Unscheduled prepayments of principal shorten
the securities' weighted average life and may lower their total return. (When
a mortgage in the underlying mortgage pool is prepaid, an unscheduled
principal prepayment is passed through to the fund. This principal is
returned to the fund at par. As a result, if a mortgage security were trading
at a premium, its total return would be lowered by prepayments, and if a
mortgage security were trading at a discount, its total return would be
increased by prepayments.) The value of these securities also may change
because of changes in the market's perception of the creditworthiness of the
federal agency that issued them. In addition, the mortgage securities market
in general may be adversely affected by changes in governmental regulation or
tax policies.
. U.S. Government Agency Mortgage-Backed Securities These are obligations
issued or guaranteed by the United States government or one of its agencies
or instrumentalities, such as the Government National Mortgage Association
("Ginnie Mae" or "GNMA"), the Federal National Mortgage Association ("Fannie
Mae" or "FNMA") the Federal Home Loan Mortgage Corporation ("Freddie Mac" or
"FHLMC"), and the Federal Agricultural Mortgage Corporation ("Farmer Mac" or
"FAMC"). FNMA, FHLMC, and FAMC obligations are not backed by the full faith
and credit of the U.S. government as GNMA certificates are, but they are
supported by the instrumentality's right to borrow from the United States
Treasury. U.S. Government Agency Mortgage-Backed Certificates provide for the
pass-through to investors of their pro-rata share of monthly payments
(including any prepayments) made by the individual borrowers on the pooled
mortgage loans, net of any fees paid to the guarantor of such securities and
the servicer of the underlying mortgage loans. Each of GNMA, FNMA, FHLMC, and
FAMC guarantees timely distributions of interest to certificate holders. GNMA
and FNMA guarantee timely distributions of scheduled principal. FHLMC has in
the past guaranteed only the ultimate collection of principal of the
underlying mortgage loan; however, FHLMC now issues mortgage-backed
securities (FHLMC Gold PCS) which also guarantee timely payment of monthly
principal reductions.
. Ginnie Mae Certificates Ginnie Mae is a wholly owned corporate
instrumentality of the United States within the Department of Housing and
Urban Development. The National Housing Act of 1934, as amended (the "Housing
Act"), authorizes Ginnie Mae to guarantee the timely payment of the principal
of and interest on certificates that are based on and backed by a pool of
mortgage loans insured by the Federal Housing Administration under the
Housing Act, or Title V of the Housing Act of 1949 ("FHA Loans"), or
guaranteed by the Department of Veterans Affairs under the Servicemen's
Readjustment Act of 1944, as amended ("VA Loans"), or by pools of other
eligible mortgage loans. The Housing Act provides that the full faith and
credit of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In order to meet
its obligations under such guaranty, Ginnie Mae is authorized to borrow from
the United States Treasury with no limitations as to amount.
. Fannie Mae Certificates Fannie Mae is a federally chartered and privately
owned corporation organized and existing under the Federal National Mortgage
Association Charter Act of 1938. FNMA Certificates represent a pro-rata
interest in a group of mortgage loans purchased by Fannie Mae. FNMA
guarantees the timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith and credit
of the U.S. government.
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. Freddie Mac Certificates Freddie Mac is a corporate instrumentality of the
United States created pursuant to the Emergency Home Finance Act of 1970, as
amended ("FHLMC Act"). Freddie Mac Certificates represent a pro-rata interest
in a group of mortgage loans ("Freddie Mac Certificates") purchased by
Freddie Mac. Freddie Mac guarantees timely payment of interest and principal
on certain securities it issues and timely payment of interest and eventual
payment of principal on other securities it issues. The obligations of
Freddie Mac are obligations solely of Freddie Mac and are not backed by the
full faith and credit of the U.S. government.
. Farmer Mac Certificates Farmer Mac is a federally chartered instrumentality
of the United States established by Title VIII of the Farm Credit Act of
1971, as amended ("Charter Act"). Farmer Mac was chartered primarily to
attract new capital for financing of agricultural real estate by making a
secondary market in certain qualified agricultural real estate loans. Farmer
Mac provides guarantees of timely payment of principal and interest on
securities representing interests in, or obligations backed by, pools of
mortgages secured by first liens on agricultural real estate ("Farmer Mac
Certificates"). Similar to Fannie Mae and Freddie Mac, Farmer Mac
Certificates are not supported by the full faith and credit of the U.S.
government; rather, Farmer Mac may borrow from the U.S. Treasury to meet its
guaranty obligations.
As discussed above, prepayments on the underlying mortgages and their effect
upon the rate of return of a mortgage-backed security, is the principal
investment risk for a purchaser of such securities, like the fund. Over time,
any pool of mortgages will experience prepayments due to a variety of
factors, including (1) sales of the underlying homes (including
foreclosures), (2) refinancings of the underlying mortgages, and (3)
increased amortization by the mortgagee. These factors, in turn, depend upon
general economic factors, such as level of interest rates and economic
growth. Thus, investors normally expect prepayment rates to increase during
periods of strong economic growth or declining interest rates, and to
decrease in recessions and rising interest rate environments. Accordingly,
the life of the mortgage-backed security is likely to be substantially
shorter than the stated maturity of the mortgages in the underlying pool.
Because of such variation in prepayment rates, it is not possible to predict
the life of a particular mortgage-backed security, but FHA statistics
indicate that 25- to 30-year single family dwelling mortgages have an average
life of approximately 12 years. The majority of Ginnie Mae Certificates are
backed by mortgages of this type, and, accordingly, the generally accepted
practice treats Ginnie Mae Certificates as 30-year securities which prepay in
full in the 12th year. FNMA and Freddie Mac Certificates may have differing
prepayment characteristics.
Fixed rate mortgage-backed securities bear a stated "coupon rate" which
represents the effective mortgage rate at the time of issuance, less certain
fees to GNMA, FNMA and FHLMC for providing the guarantee, and the issuer for
assembling the pool and for passing through monthly payments of interest and
principal.
Payments to holders of mortgage-backed securities consist of the monthly
distributions of interest and principal less the applicable fees. The actual
yield to be earned by a holder of mortgage-backed securities is calculated by
dividing interest payments by the purchase price paid for the mortgage-backed
securities (which may be at a premium or a discount from the face value of
the certificate).
Monthly distributions of interest, as contrasted to semiannual distributions
which are common for other fixed interest investments, have the effect of
compounding and thereby raising the effective annual yield earned on
mortgage-backed securities. Because of the variation in the life of the pools
of mortgages which back various mortgage-backed securities, and because it is
impossible to anticipate the rate of interest at which future principal
payments may be reinvested, the actual yield earned from a portfolio of
mortgage-backed securities will differ significantly from the yield estimated
by using an assumption of a certain life for each mortgage-backed security
included in such a portfolio as described above.
. U.S. Government Agency Multiclass Pass-Through Securities Unlike CMOs, U.S.
Government Agency Multiclass Pass-Through Securities, which include FNMA
Guaranteed REMIC Pass-Through Certificates and FHLMC Multi-Class Mortgage
Participation Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references herein to CMOs
include multiclass pass-through securities.
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. Multi-Class Residential Mortgage Securities Such securities represent
interests in pools of mortgage loans to residential home buyers made by
commercial banks, savings and loan associations or other financial
institutions. Unlike GNMA, FNMA and FHLMC securities, the payment of
principal and interest on Multi-Class Residential Mortgage Securities is not
guaranteed by the U.S. government or any of its agencies. Accordingly, yields
on Multi-Class Residential Mortgage Securities have been historically higher
than the yields on U.S. government mortgage securities. However, the risk of
loss due to default on such instruments is higher since they are not
guaranteed by the U.S. government or its agencies. Additionally, pools of
such securities may be divided into senior or subordinated segments. Although
subordinated mortgage securities may have a higher yield than senior mortgage
securities, the risk of loss of principal is greater because losses on the
underlying mortgage loans must be borne by persons holding subordinated
securities before those holding senior mortgage securities.
. Privately Issued Mortgage-Backed Certificates These are pass-through
certificates issued by non-governmental issuers. Pools of conventional
residential or commercial mortgage loans created by such issuers generally
offer a higher rate of interest than government and government-related pools
because there are no direct or indirect government guarantees of payment.
Timely payment of interest and principal of these pools is, however,
generally supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance. The insurance and
guarantees are issued by government entities, private insurance or the
mortgage poolers. Such insurance and guarantees and the creditworthiness of
the issuers thereof will be considered in determining whether a
mortgage-related security meets the fund's quality standards. The fund may
buy mortgage-related securities without insurance or guarantees if through an
examination of the loan experience and practices of the poolers, the
investment manager determines that the securities meet the fund's quality
standards.
. Stripped Mortgage-Backed Securities These instruments are a type of
potentially high-risk derivative. They represent interests in a pool of
mortgages, the cash flow of which has been separated into its interest and
principal components. "IOs" (interest only securities) receive the interest
portion of the cash flow while "POs" (principal only securities) receive the
principal portion. IOs and POs are usually structured as tranches of a CMO.
Stripped Mortgage-Backed Securities may be issued by U.S. government agencies
or by private issuers similar to those described above with respect to CMOs
and privately issued mortgage-backed certificates. As interest rates rise and
fall, the value of IOs tends to move in the same direction as interest rates.
The value of the other mortgage-backed securities described herein, like
other debt instruments, will tend to move in the opposite direction compared
to interest rates. Under the Code, POs may generate taxable income from the
current accrual of original issue discount, without a corresponding
distribution of cash to the fund.
The cash flows and yields on IO and PO classes are extremely sensitive to the
rate of principal payments (including prepayments) on the related underlying
mortgage assets. In the case of IOs, prepayments affect the amount, but not
the timing, of cash flows provided to the investor. In contrast, prepayments
on the mortgage pool affect the timing, but not the amount, of cash flows
received by investors in POs. For example, a rapid or slow rate of principal
payments may have a material adverse effect on the prices of IOs or POs,
respectively. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, an investor may fail to fully recoup
its initial investment in an IO class of a stripped mortgage-backed security,
even if the IO class is rated AAA or Aaa or is derived from a full faith and
credit obligation. Conversely, if the underlying mortgage assets experience
slower than anticipated prepayments of principal, the price on a PO class
will be affected more severely than would be the case with a traditional
mortgage-backed security.
The staff of the SEC has advised the fund that it believes the fund should
treat IOs and POs, other than government-issued IOs or POs backed by fixed
rate mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid securities,
to 15% of the fund's net assets. Under the staff's position, the
determination of whether a particular government-issued IO or PO backed by
fixed rate mortgages is liquid may be made on a case by case basis under
guidelines and standards established by the fund's Board of Directors. The
fund's Board of Directors has delegated to T. Rowe Price the authority to
determine the liquidity of these investments based on the following
guidelines: the type of issuer; type of collateral, including age and
prepayment characteristics; rate of interest on coupon relative to current
market
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rates and the effect of the rate on the potential for prepayments; complexity
of the issue's structure, including the number of tranches; size of the issue
and the number of dealers who make a market in the IO or PO.
. Collateralized Mortgage Obligations (CMOs) CMOs are bonds that are
collateralized by whole loan mortgages or mortgage pass-through securities.
The bonds issued in a CMO deal are divided into groups, and each group of
bonds is referred to as a "tranche." Under the traditional CMO structure, the
cash flows generated by the mortgages or mortgage pass-through securities in
the collateral pool are used to first pay interest and then pay principal to
the CMO bondholders. The bonds issued under such CMO structure are retired
sequentially as opposed to the pro-rata return of principal found in
traditional pass-through obligations. Subject to the various provisions of
individual CMO issues, the cash flow generated by the underlying collateral
(to the extent it exceeds the amount required to pay the stated interest) is
used to retire the bonds. Under the CMO structure, the repayment of principal
among the different tranches is prioritized in accordance with the terms of
the particular CMO issuance. The "fastest-pay" tranche of bonds, as specified
in the prospectus for the issuance, would initially receive all principal
payments. When that tranche of bonds is retired, the next tranche, or
tranches, in the sequence, as specified in the prospectus, receive all of the
principal payments until they are retired. The sequential retirement of bond
groups continues until the last tranche, or group of bonds, is retired.
Accordingly, the CMO structure allows the issuer to use cash flows of long
maturity, monthly-pay collateral to formulate securities with short,
intermediate and long final maturities and expected average lives.
In recent years, new types of CMO tranches have evolved. These include
floating rate CMOs, planned amortization classes, accrual bonds and CMO
residuals. These newer structures affect the amount and timing of principal
and interest received by each tranche from the underlying collateral. Under
certain of these new structures, given classes of CMOs have priority over
others with respect to the receipt of prepayments on the mortgages.
Therefore, depending on the type of CMOs in which the fund invests, the
investment may be subject to a greater or lesser risk of prepayment than
other types of mortgage-related securities.
The primary risk of any mortgage security is the uncertainty of the timing of
cash flows. For CMOs, the primary risk results from the rate of prepayments
on the underlying mortgages serving as collateral and from the structure of
the deal (priority of the individual tranches). An increase or decrease in
prepayment rates (resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs. The prices of
certain CMOs, depending on their structure and the rate of prepayments, can
be volatile. Some CMOs may also not be as liquid as other securities.
. Adjustable Rate Mortgage Securities ARMs, like fixed rate mortgages, have a
specified maturity date, and the principal amount of the mortgage is repaid
over the life of the mortgage. Unlike fixed rate mortgages, the interest rate
on ARMs is adjusted at regular intervals based on a specified, published
interest rate "index" such as a Treasury rate index. The new rate is
determined by adding a specific interest amount, the "margin," to the
interest rate of the index. Investment in ARM securities allows the fund to
participate in changing interest rate levels through regular adjustments in
the coupons of the underlying mortgages, resulting in more variable current
income and lower price volatility than longer-term fixed rate mortgage
securities. ARM securities are a less effective means of locking in long-term
rates than fixed rate mortgages since the income from adjustable rate
mortgages will increase during periods of rising interest rates and decline
during periods of falling rates.
. Characteristics of Adjustable Rate Mortgage Securities The interest rates
paid on the mortgages underlying ARM securities are reset at regular
intervals by adding an interest rate margin to a specified interest rate
index. There are three main categories of indices: those based on U.S.
Treasury securities such as the constant maturity treasury rate ("CMT");
those derived from a calculated measure such as a cost of funds index
("COFI") or a moving average of mortgage rates; and those based on certain
actively traded or prominent short-term rates such as the London Interbank
Offered Rate ("LIBOR"). Some indices, such as the one-year constant maturity
Treasury rate, closely mirror changes in interest rate levels. Others, such
as COFI, tend to lag behind changes in market rate levels but reset monthly,
thus tending to be somewhat less volatile. Such a delay in adjusting to
changes in interest rates may cause securities owned by the fund to increase
or decrease in value, particularly during periods between interest adjustment
dates.
Caps and Floors ARMs will frequently have caps and floors which limit the
maximum amount by which the interest rate to the residential borrower may
move up or down, respectively, each adjustment period and over
<PAGE>
the life of the loan. Interest rate caps on ARM securities may cause them to
decrease in value in an increasing interest rate environment. Such caps may
also prevent their income from increasing to levels commensurate with
prevailing interest rates. Conversely, interest rate floors on ARM securities
may cause their income to remain higher than prevailing interest rate levels
and result in an increase in the value of such securities. However, this
increase may be tempered by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up to 30 years.
However due to the adjustable rate feature of ARM securities, their prices
are considered to have volatility characteristics which approximate the
average period of time until the next adjustment of the interest rate. As a
result, the principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed rate
mortgage securities. Prepayments however, will increase their principal
volatility. See also the discussion of Mortgage-Backed Securities.
. Other Mortgage-Related Securities The fund expects that governmental,
government-related or private entities may create mortgage loan pools
offering pass-through investments in addition to those described above. The
mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or interest
payments may vary or whose terms to maturity may differ from customary
long-term fixed rate mortgages. As new types of mortgage-related securities
are developed and offered to investors, the investment manager will,
consistent with the fund's objective, policies and quality standards,
consider making investments in such new types of securities.
Asset-Backed Securities
The credit quality of most asset-backed securities depends primarily on the
credit quality of the assets underlying such securities, how well the entity
issuing the security is insulated from the credit risk of the originator or
any other affiliated entities and the amount and quality of any credit
support provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of principal payments
received on the underlying assets, which in turn may be affected by a variety
of economic and other factors. As a result, the yield on any asset-backed
security is difficult to predict with precision and actual yield to maturity
may be more or less than the anticipated yield to maturity. Asset-backed
securities may be classified as pass-through certificates or collateralized
obligations.
Pass-through certificates are asset-backed securities which represent an
undivided fractional ownership interest in an underlying pool of assets.
Pass-through certificates usually provide for payments of principal and
interest received to be passed through to their holders, usually after
deduction for certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest in the
underlying assets, the holders thereof bear directly the risk of any defaults
by the obligors on the underlying assets not covered by any credit support.
See "Types of Credit Support."
Asset-backed securities issued in the form of debt instruments, also known as
collateralized obligations, are generally issued as the debt of a special
purpose entity organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card or
automobile receivables. The assets collateralizing such asset-backed
securities are pledged to a trustee or custodian for the benefit of the
holders thereof. Such issuers generally hold no assets other than those
underlying the asset-backed securities and any credit support provided. As a
result, although payments on such asset-backed securities are obligations of
the issuers, in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing entities are
unlikely to have sufficient assets to satisfy their obligations on the
related asset-backed securities.
. Methods of Allocating Cash Flows While many asset-backed securities are
issued with only one class of security, many asset-backed securities are
issued in more than one class, each with different payment terms. Multiple
class asset-backed securities are issued for two main reasons. First,
multiple classes may be used as a method of providing credit support. This is
accomplished typically through creation of one or more classes whose right to
payments on the asset-backed security is made subordinate to the right to
such payments of the remaining class or classes. See "Types of Credit
Support." Second, multiple classes may permit the issuance of
<PAGE>
securities with payment terms, interest rates or other characteristics
differing both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed securities
entitling the holder to disproportionate interests with respect to the
allocation of interest and principal of the assets backing the security), and
securities with class or classes having characteristics which mimic the
characteristics of non-asset-backed securities, such as floating interest
rates (i.e., interest rates which adjust as a specified benchmark changes) or
scheduled amortization of principal.
Asset-backed securities in which the payment streams on the underlying assets
are allocated in a manner different than those described above may be issued
in the future. The fund may invest in such asset-backed securities if such
investment is otherwise consistent with its investment objectives and
policies and with the investment restrictions of the fund.
. Types of Credit Support Asset-backed securities are often backed by a pool
of assets representing the obligations of a number of different parties. To
lessen the effect of failures by obligors on underlying assets to make
payments, such securities may contain elements of credit support. Such credit
support falls into two classes: liquidity protection and protection against
ultimate default by an obligor on the underlying assets. Liquidity protection
refers to the provision of advances, generally by the entity administering
the pool of assets, to ensure that scheduled payments on the underlying pool
are made in a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the assets in
the pool. Such protection may be provided through guarantees, insurance
policies or letters of credit obtained from third parties "external credit
enhancement," through various means of structuring the transaction "internal
credit enhancement," or through a combination of such approaches. Examples of
asset-backed securities with credit support arising out of the structure of
the transaction include "senior-subordinated securities" (multiple class
asset-backed securities with certain classes subordinate to other classes as
to the payment of principal thereon, with the result that defaults on the
underlying assets are borne first by the holders of the subordinated class)
and asset-backed securities that have "reserve funds" (where cash or
investments, sometimes funded from a portion of the initial payments on the
underlying assets, are held in reserve against future losses) or that have
been "over collateralized" (where the scheduled payments on, or the principal
amount of, the underlying assets substantially exceeds that required to make
payment of the asset-backed securities and pay any servicing or other fees).
The degree of credit support provided on each issue is based generally on
historical information respecting the level of credit risk associated with
such payments. Depending upon the type of assets securitized, historical
information on credit risk and prepayment rates may be limited or even
unavailable. Delinquency or loss in excess of that anticipated could
adversely affect the return on an investment in an asset-backed security.
. Automobile Receivable Securities The fund may invest in asset-backed
securities which are backed by receivables from motor vehicle installment
sales contracts or installment loans secured by motor vehicles ("Automobile
Receivable Securities"). Since installment sales contracts for motor vehicles
or installment loans related thereto ("Automobile Contracts") typically have
shorter durations and lower incidences of prepayment, Automobile Receivable
Securities generally will exhibit a shorter average life and are less
susceptible to prepayment risk.
Most entities that issue Automobile Receivable Securities create an
enforceable interest in their respective Automobile Contracts only by filing
a financing statement and by having the servicer of the Automobile Contracts,
which is usually the originator of the Automobile Contracts, take custody
thereof. In such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in violation of
its obligation not to do so, there is a risk that such party could acquire an
interest in the Automobile Contracts superior to that of the holders of
Automobile Receivable Securities. Also, although most Automobile Contracts
grant a security interest in the motor vehicle being financed, in most states
the security interest in a motor vehicle must be noted on the certificate of
title to create an enforceable security interest against competing claims of
other parties. Due to the large number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually is not
amended to reflect the assignment of the seller's security interest for the
benefit of the holders of the Automobile Receivable Securities. Therefore,
there is the possibility that recoveries on repossessed collateral may not,
in some cases, be available to support payments
<PAGE>
on the securities. In addition, various state and federal securities laws
give the motor vehicle owner the right to assert against the holder of the
owner's Automobile Contract certain defenses such owner would have against
the seller of the motor vehicle. The assertion of such defenses could reduce
payments on the Automobile Receivable Securities.
. Credit Card Receivable Securities The fund may invest in asset-backed
securities backed by receivables from revolving credit card agreements
("Credit Card Receivable Securities"). Credit balances on revolving credit
card agreements ("Accounts") are generally paid down more rapidly than are
Automobile Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order to lengthen
the maturity of Credit Card Receivable Securities, most such securities
provide for a fixed period during which only interest payments on the
underlying Accounts are passed through to the security holder and principal
payments received on such Accounts are used to fund the transfer to the pool
of assets supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial fixed period
usually may be shortened upon the occurrence of specified events which signal
a potential deterioration in the quality of the assets backing the security,
such as the imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable Securities thus
depends upon the continued generation of additional principal amounts in the
underlying account during the initial period and the non-occurrence of
specified events. An acceleration in cardholders' payment rates or any other
event which shortens the period during which additional credit card charges
on an Account may be transferred to the pool of assets supporting the related
Credit Card Receivable Security could shorten the weighted average life and
yield of the Credit Card Receivable Security.
Credit cardholders are entitled to the protection of a number of state and
federal consumer credit laws, many of which give such holder the right to set
off certain amounts against balances owed on the credit card, thereby
reducing amounts paid on Accounts. In addition, unlike most other
asset-backed securities, Accounts are unsecured obligations of the
cardholder.
Other Assets Asset-backed securities backed by assets other than those
described above, including, but not limited to, small business loans and
accounts receivable, equipment leases, commercial real estate loans, boat
loans, and manufacturing housing loans. The fund may invest in such
securities in the future if such investment is otherwise consistent with its
investment objective and policies.
Hybrid Instruments
Hybrid Instruments (a type of potentially high-risk derivative) have been
developed and combine the elements of futures contracts or options with those
of debt, preferred equity, or a depository instrument (hereinafter "Hybrid
Instruments"). Generally, a Hybrid Instrument will be a debt security,
preferred stock, depository share, trust certificate, certificate of deposit,
or other evidence of indebtedness on which a portion of or all interest
payments, and/or the principal or stated amount payable at maturity,
redemption, or retirement, is determined by reference to prices, changes in
prices, or differences between prices, of securities, currencies,
intangibles, goods, articles, or commodities (collectively "Underlying
Assets") or by another objective index, economic factor, or other measure,
such as interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid Instruments may
take a variety of forms, including, but not limited to, debt instruments with
interest or principal payments or redemption terms determined by reference to
the value of a currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference to the
value of a currency, or convertible securities with the conversion terms
related to a particular commodity.
Hybrid Instruments can be an efficient means of creating exposure to a
particular market, or segment of a market, with the objective of enhancing
total return. For example, a fund may wish to take advantage of expected
declines in interest rates in several European countries, but avoid the
transaction costs associated with buying and currency-hedging the foreign
bond positions. One solution would be to purchase a U.S. dollar-denominated
Hybrid Instrument whose redemption price is linked to the average three-year
interest rate in a designated group of countries. The redemption price
formula would provide for payoffs of greater than par if the average interest
rate was lower than a specified level, and payoffs of less than par if rates
were above the specified level. Furthermore, the fund could limit the
downside risk of the security by establishing a
<PAGE>
minimum redemption price so that the principal paid at maturity could not be
below a predetermined minimum level if interest rates were to rise
significantly. The purpose of this arrangement, known as a structured
security with an embedded put option, would be to give the fund the desired
European bond exposure while avoiding currency risk, limiting downside market
risk, and lowering transactions costs. Of course, there is no guarantee that
the strategy will be successful, and the fund could lose money if, for
example, interest rates do not move as anticipated or credit problems develop
with the issuer of the Hybrid Instrument.
The risks of investing in Hybrid Instruments reflect a combination of the
risks of investing in securities, options, futures, and currencies. Thus, an
investment in a Hybrid Instrument may entail significant risks that are not
associated with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars, or bears
interest either at a fixed rate or a floating rate determined by reference to
a common, nationally published benchmark. The risks of a particular Hybrid
Instrument will, of course, depend upon the terms of the instrument, but may
include, without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the instrument is
linked. Such risks generally depend upon factors which are unrelated to the
operations or credit quality of the issuer of the Hybrid Instrument and which
may not be readily foreseen by the purchaser, such as economic and political
events, the supply and demand for the Underlying Assets, and interest rate
movements. In recent years, various Benchmarks and prices for Underlying
Assets have been highly volatile, and such volatility may be expected in the
future. Reference is also made to the discussion of futures, options, and
forward contracts herein for a discussion of the risks associated with such
investments.
Hybrid Instruments are potentially more volatile and carry greater market
risks than traditional debt instruments. Depending on the structure of the
particular Hybrid Instrument, changes in a Benchmark may be magnified by the
terms of the Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices of the
Hybrid Instrument and the Benchmark or Underlying Asset may not move in the
same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred dividends at below
market (or even relatively nominal) rates. Alternatively, Hybrid Instruments
may bear interest at above market rates but bear an increased risk of
principal loss (or gain). The latter scenario may result if "leverage" is
used to structure the Hybrid Instrument. Leverage risk occurs when the Hybrid
Instrument is structured so that a given change in a Benchmark or Underlying
Asset is multiplied to produce a greater value change in the Hybrid
Instrument, thereby magnifying the risk of loss as well as the potential for
gain.
Hybrid Instruments may also carry liquidity risk since the instruments are
often "customized" to meet the portfolio needs of a particular investor, and
therefore, the number of investors that are willing and able to buy such
instruments in the secondary market may be smaller than that for more
traditional debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market without the
guarantee of a central clearing organization or in a transaction between the
fund and the issuer of the Hybrid Instrument, the creditworthiness of the
counterparty or issuer of the Hybrid Instrument would be an additional risk
factor which the fund would have to consider and monitor. Hybrid Instruments
also may not be subject to regulation of the Commodities Futures Trading
Commission ("CFTC"), which generally regulates the trading of commodity
futures by U.S. persons, the SEC, which regulates the offer and sale of
securities by and to U.S. persons, or any other governmental regulatory
authority.
The various risks discussed above, particularly the market risk of such
instruments, may in turn cause significant fluctuations in the net asset
value of the fund. Accordingly, the fund will limit its investments in Hybrid
Instruments to 10% of total assets. However, because of their volatility, it
is possible that the fund's investment in Hybrid Instruments will account for
more than 10% of the fund's return (positive or negative).
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest rates that are
reset periodically by predetermined formulas or indexes in order to minimize
movements in the principal value of the investment. Such securities may have
long-term maturities, but may be treated as a short-term investment under
certain conditions.
<PAGE>
Generally, as interest rates decrease or increase, the potential for capital
appreciation or depreciation on these securities is less than for fixed-rate
obligations. These securities may take the following forms:
. Variable Rate Securities A variable rate instrument is one whose terms
provide for the adjustment of its interest rate on set dates and which, upon
each adjustment until the final maturity of the instrument or the period
remaining until the principal amount can be recovered through demand, can
reasonably be expected to have a market value which approximates its
amortized cost. A variable rate instrument, the principal amount of which is
scheduled to be paid in 397 calendar days or less, is deemed to have a
maturity equal to the earlier of the period remaining until the next
readjustment of the interest rate or the period remaining until the principal
amount can be recovered through demand. A variable rate instrument the
principal amount of which is scheduled to be paid in more than 397 calendar
days and which is subject to a demand feature which entitles the purchaser to
receive the principal amount of the underlying security or securities, either
(i) at any time upon notice of no more than 30 days, or (ii) at specified
intervals not exceeding 397 calendar days and upon no more than 30 days'
notice ("Demand Feature"), is deemed to have a maturity equal to the longer
of the period remaining until the next readjustment of the interest rate or
the period remaining until the principal amount can be recovered through
demand. A government security that is a variable rate security where the
variable rate is readjusted no less frequently than every 762 calendar days
is deemed to have a maturity equal to the period remaining until the next
readjustment of the interest rate.
. Floating Rate Securities A floating rate security provides for the
adjustment of its interest rates whenever a specified interest rate changes
and which, at any time until the final maturity of the instrument or the
period remaining until the principal amount can be recovered through demand,
can reasonably be expected to have a market value that approximates its
amortized cost. A floating rate security, the principal amount of which must
unconditionally be paid in 397 calendar days or less is deemed to have a
maturity of one day. A floating rate security, the principal amount of which
is scheduled to be paid in more than 397 calendar days, that is subject to a
Demand Feature is deemed to have a maturity equal to the period remaining
until the principal amount can be recovered through demand. A government
security that is a floating rate security is deemed to have a remaining
maturity of one day.
. Put Option Bonds Long-term obligations with maturities longer than one year
may provide purchasers an optional or mandatory tender of the security at par
value at predetermined intervals, often ranging from one month to several
years (e.g., a 30-year bond with a five-year tender period). These
instruments are deemed to have a maturity equal to the period remaining to
the put date.
When-Issued Securities and Forward Commitment Contracts
The price of such securities, which may be expressed in yield terms, is fixed
at the time the commitment to purchase is made, but delivery and payment take
place at a later date. Normally, the settlement date occurs within 90 days of
the purchase for When-Issueds, but may be substantially longer for Forwards.
During the period between purchase and settlement, no payment is made by the
fund to the issuer and no interest accrues to the fund. The purchase of these
securities will result in a loss if their value declines prior to the
settlement date. This could occur, for example, if interest rates increase
prior to settlement. The longer the period between purchase and settlement,
the greater the risks are. At the time the fund makes the commitment to
purchase these securities, it will record the transaction and reflect the
value of the security in determining its net asset value. The fund will cover
these securities by maintaining cash, liquid, high-grade debt securities, or
other suitable cover as permitted by the SEC with its custodian bank equal in
value to commitments for them during the time between the purchase and the
settlement. Therefore, the longer this period, the longer the period during
which alternative investment options are not available to the fund (to the
extent of the securities used for cover). Such securities either will mature
or, if necessary, be sold on or before the settlement date.
To the extent the fund remains fully or almost fully invested (in securities
with a remaining maturity of more than one year) at the same time it
purchases these securities, there will be greater fluctuations in the fund's
net asset value than if the fund did not purchase them.
<PAGE>
Illiquid or Restricted Securities
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act of 1933 (the "1933 Act"). Where registration
is required, the fund may be obligated to pay all or part of the registration
expenses, and a considerable period may elapse between the time of the
decision to sell and the time the fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the fund might obtain a less favorable
price than prevailed when it decided to sell. Restricted securities will be
priced at fair value as determined in accordance with procedures prescribed
by the fund's Board of Directors. If, through the appreciation of illiquid
securities or the depreciation of liquid securities, the fund should be in a
position where more than 15% of the value of its net assets is invested in
illiquid assets, including restricted securities, the fund will take
appropriate steps to protect liquidity.
Notwithstanding the above, the fund may purchase securities which, while
privately placed, are eligible for purchase and sale under Rule 144A under
the 1933 Act. This rule permits certain qualified institutional buyers, such
as the fund, to trade in privately placed securities even though such
securities are not registered under the 1933 Act. T. Rowe Price, under the
supervision of the fund's Board of Directors, will consider whether
securities purchased under Rule 144A are illiquid and thus subject to the
fund's restriction of investing no more than 15% of its net assets in
illiquid securities. A determination of whether a Rule 144A security is
liquid or not is a question of fact. In making this determination, T. Rowe
Price will consider the trading markets for the specific security taking into
account the unregistered nature of a Rule 144A security. In addition, T. Rowe
Price could consider the following: (1) frequency of trades and quotes; (2)
number of dealers and potential purchases; (3) dealer undertakings to make a
market; and (4) the nature of the security and of marketplace trades (e.g.,
the time needed to dispose of the security, the method of soliciting offers,
and the mechanics of transfer). The liquidity of Rule 144A securities would
be monitored and, if as a result of changed conditions it is determined that
a Rule 144A security is no longer liquid, the fund's holdings of illiquid
securities would be reviewed to determine what, if any, steps are required to
assure that the fund does not invest more than 15% of its net assets in
illiquid securities. Investing in Rule 144A securities could have the effect
of increasing the amount of the fund's assets invested in illiquid securities
if qualified institutional buyers are unwilling to purchase such securities.
There are, of course, other types of securities that are, or may become
available, which are similar to the foregoing and the fund may invest in
these securities.
PORTFOLIO MANAGEMENT PRACTICES
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Lending of Portfolio Securities
Securities loans are made to broker-dealers, institutional investors, or
other persons, pursuant to agreements requiring that the loans be
continuously secured by collateral at least equal at all times to the value
of the securities lent, marked to market on a daily basis. The collateral
received will consist of cash, U.S. government securities, letters of credit,
or such other collateral as may be permitted under its investment program.
While the securities are being lent, the fund will continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities,
as well as interest on the investment of the collateral or a fee from the
borrower. The fund has a right to call each loan and obtain the securities,
within such period of time which coincides with the normal settlement period
for purchases and sales of such securities in the respective markets. The
fund will not have the right to vote on securities while they are being lent,
but it will call a loan in anticipation of any important vote. The risks in
lending portfolio securities, as with other extensions of secured credit,
consist of possible delay in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral
should the borrower fail financially. Loans will only be made to firms deemed
by T. Rowe Price to be of good standing and will not be made unless, in the
judgment of T. Rowe Price, the consideration to be earned from such loans
would justify the risk.
<PAGE>
Interfund Borrowing and Lending
The fund is a party to an exemptive order received from the SEC on December
8, 1998, amended on November 23, 1999, that permits it to borrow money from
and/or lend money to other funds in the T. Rowe Price complex ("Price
Funds"). All loans are set at an interest rate between the rate charged on
overnight repurchase agreements and short-term bank loans. All loans are
subject to numerous conditions designed to ensure fair and equitable
treatment of all participating funds. The program is subject to the oversight
and periodic review of the Boards of Directors of the Price Funds.
Repurchase Agreements
The fund may enter into a repurchase agreement through which an investor
(such as the fund) purchases a security (known as the "underlying security")
from a well-established securities dealer or a bank that is a member of the
Federal Reserve System. Any such dealer or bank will be on T. Rowe Price's
approved list and have a credit rating with respect to its short-term debt of
at least A1 by S&P, P1 by Moody's, or the equivalent rating by T. Rowe Price.
At that time, the bank or securities dealer agrees to repurchase the
underlying security at the same price, plus specified interest. Repurchase
agreements are generally for a short period of time, often less than a week.
Repurchase agreements which do not provide for payment within seven days will
be treated as illiquid securities. The fund will only enter into repurchase
agreements where (1) the underlying securities are of the type (excluding
maturity limitations) which the fund's investment guidelines would allow it
to purchase directly, (2) the market value of the underlying security,
including interest accrued, will be at all times equal to or exceed the value
of the repurchase agreement, and (3) payment for the underlying security is
made only upon physical delivery or evidence of book-entry transfer to the
account of the custodian or a bank acting as agent. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the fund
could experience both delays in liquidating the underlying security and
losses, including: (a) possible decline in the value of the underlying
security during the period while the fund seeks to enforce its rights
thereto; (b) possible subnormal levels of income and lack of access to income
during this period; and (c) expenses of enforcing its rights.
Reverse Repurchase Agreements
Although the fund has no current intention of engaging in reverse repurchase
agreements, the fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a fund is the seller
of, rather than the investor in, securities, and agrees to repurchase them at
an agreed upon time and price. Use of a reverse repurchase agreement may be
preferable to a regular sale and later repurchase of the securities because
it avoids certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the fund, subject to
Investment Restriction (1). (See "Investment Restrictions.")
Money Market Reserves
It is expected that the fund will invest its cash reserves primarily in one
or more money market funds established for the exclusive use of the T. Rowe
Price family of mutual funds and other clients of T. Rowe Price and
Price-Fleming. Currently, two such money market funds are in
operation-Reserve Investment Fund ("RIF") and Government Reserve Investment
Fund ("GRF"), each a series of the Reserve Investment Funds, Inc. Additional
series may be created in the future. These funds were created and operate
under an Exemptive Order issued by the SEC (Investment Company Act Release
No. IC-22770, July 29, 1997).
Both funds must comply with the requirements of Rule 2a-7 under the 1940 Act
governing money market funds. The RIF invests at least 95% of its total
assets in prime money market instruments receiving the highest credit rating.
The GRF invests primarily in a portfolio of U.S. government-backed
securities, primarily U.S. Treasuries, and repurchase agreements thereon.
The RIF and GRF provide a very efficient means of managing the cash reserves
of the fund. While neither RIF or GRF pay an advisory fee to the Investment
Manager, they will incur other expenses. However, the RIF and GRF are
expected by T. Rowe Price to operate at very low expense ratios. The fund
will only invest in RIF or GRF to the extent it is consistent with its
objective and program.
<PAGE>
Neither fund is insured or guaranteed by the U.S. government, and there is no
assurance they will maintain a stable net asset value of $1.00 per share.
Options
Options are a type of potentially high-risk derivative.
Writing Covered Call Options
The fund may write (sell) American or European style "covered" call options
and purchase options to close out options previously written by the fund. In
writing covered call options, the fund expects to generate additional premium
income which should serve to enhance the fund's total return and reduce the
effect of any price decline of the security or currency involved in the
option. Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's opinion, are not expected to have any
major price increases or moves in the near future but which, over the long
term, are deemed to be attractive investments for the fund.
A call option gives the holder (buyer) the "right to purchase", and the
writer (seller) has the "obligation to sell", a security or currency at a
specified price (the exercise price) at expiration of the option (European
style) or at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option continues,
he may be assigned an exercise notice by the broker-dealer through whom such
option was sold, requiring him to deliver the underlying security or currency
against payment of the exercise price. This obligation terminates upon the
expiration of the call option, or such earlier time at which the writer
effects a closing purchase transaction by repurchasing an option identical to
that previously sold. To secure his obligation to deliver the underlying
security or currency in the case of a call option, a writer is required to
deposit in escrow the underlying security or currency or other assets in
accordance with the rules of a clearing corporation.
The fund generally will write only covered call options. This means that the
fund will either own the security or currency subject to the option or an
option to purchase the same underlying security or currency, having an
exercise price equal to or less than the exercise price of the "covered"
option. From time to time, the fund will write a call option that is not
covered as indicated above but where the fund will establish and maintain
with its custodian for the term of the option, an account consisting of cash,
U.S. government securities, other liquid high-grade debt obligations, or
other suitable cover as permitted by the SEC having a value equal to the
fluctuating market value of the optioned securities or currencies. While such
an option would be "covered" with sufficient collateral to satisfy SEC
prohibitions on issuing senior securities, this type of strategy would expose
the fund to the risks of writing uncovered options.
Portfolio securities or currencies on which call options may be written will
be purchased solely on the basis of investment considerations consistent with
the fund's investment objective. The writing of covered call options is a
conservative investment technique believed to involve relatively little risk
(in contrast to the writing of naked or uncovered options, which the fund
generally will not do), but capable of enhancing the fund's total return.
When writing a covered call option, a fund, in return for the premium, gives
up the opportunity for profit from a price increase in the underlying
security or currency above the exercise price, but conversely retains the
risk of loss should the price of the security or currency decline. Unlike one
who owns securities or currencies not subject to an option, the fund has no
control over when it may be required to sell the underlying securities or
currencies, since it may be assigned an exercise notice at any time prior to
the expiration of its obligation as a writer. If a call option which the fund
has written expires, the fund will realize a gain in the amount of the
premium; however, such gain may be offset by a decline in the market value of
the underlying security or currency during the option period. If the call
option is exercised, the fund will realize a gain or loss from the sale of
the underlying security or currency. The fund does not consider a security or
currency covered by a call to be "pledged" as that term is used in the fund's
policy which limits the pledging or mortgaging of its assets. If the fund
writes an uncovered option as described above, it will bear the risk of
having to purchase the security subject to the option at a price higher than
the exercise price of the option. As the price of a security could appreciate
substantially, the fund's loss could be significant.
<PAGE>
The premium received is the market value of an option. The premium the fund
will receive from writing a call option will reflect, among other things, the
current market price of the underlying security or currency, the relationship
of the exercise price to such market price, the historical price volatility
of the underlying security or currency, and the length of the option period.
Once the decision to write a call option has been made, T. Rowe Price, in
determining whether a particular call option should be written on a
particular security or currency, will consider the reasonableness of the
anticipated premium and the likelihood that a liquid secondary market will
exist for those options. The premium received by the fund for writing covered
call options will be recorded as a liability of the fund. This liability will
be adjusted daily to the option's current market value, which will be the
latest sale price at the time at which the net asset value per share of the
fund is computed (close of the New York Stock Exchange), or, in the absence
of such sale, the latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in a closing
transaction, or delivery of the underlying security or currency upon the
exercise of the option.
Closing transactions will be effected in order to realize a profit on an
outstanding call option, to prevent an underlying security or currency from
being called, or to permit the sale of the underlying security or currency.
Furthermore, effecting a closing transaction will permit the fund to write
another call option on the underlying security or currency with either a
different exercise price or expiration date or both. If the fund desires to
sell a particular security or currency from its portfolio on which it has
written a call option, or purchased a put option, it will seek to effect a
closing transaction prior to, or concurrently with, the sale of the security
or currency. There is, of course, no assurance that the fund will be able to
effect such closing transactions at favorable prices. If the fund cannot
enter into such a transaction, it may be required to hold a security or
currency that it might otherwise have sold. When the fund writes a covered
call option, it runs the risk of not being able to participate in the
appreciation of the underlying securities or currencies above the exercise
price, as well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in higher
transaction costs. The fund will pay transaction costs in connection with the
writing of options to close out previously written options. Such transaction
costs are normally higher than those applicable to purchases and sales of
portfolio securities.
Call options written by the fund will normally have expiration dates of less
than nine months from the date written. The exercise price of the options may
be below, equal to, or above the current market values of the underlying
securities or currencies at the time the options are written. From time to
time, the fund may purchase an underlying security or currency for delivery
in accordance with an exercise notice of a call option assigned to it, rather
than delivering such security or currency from its portfolio. In such cases,
additional costs may be incurred.
The fund will realize a profit or loss from a closing purchase transaction if
the cost of the transaction is less or more than the premium received from
the writing of the option. Because increases in the market price of a call
option will generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a call option
is likely to be offset in whole or in part by appreciation of the underlying
security or currency owned by the fund.
The fund will not write a covered call option if, as a result, the aggregate
market value of all portfolio securities or currencies covering written call
or put options exceeds 25% of the market value of the fund's net assets. In
calculating the 25% limit, the fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and puts on
identical securities or currencies with identical maturity dates.
Writing Covered Put Options
The fund may write American or European style covered put options and
purchase options to close out options previously written by the fund. A put
option gives the purchaser of the option the right to sell, and the writer
(seller) has the obligation to buy, the underlying security or currency at
the exercise price during the option period (American style) or at the
expiration of the option (European style). So long as the obligation of the
writer continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to make payment to the
exercise price against delivery of the underlying security or currency. The
operation of put options in other respects, including their related risks and
rewards, is substantially identical to that of call options.
<PAGE>
The fund would write put options only on a covered basis, which means that
the fund would maintain in a segregated account cash, U.S. government
securities, other liquid high-grade debt obligations, or other suitable cover
as determined by the SEC, in an amount not less than the exercise price or
the fund will own an option to sell the underlying security or currency
subject to the option having an exercise price equal to or greater than the
exercise price of the "covered" option at all times while the put option is
outstanding. (The rules of a clearing corporation currently require that such
assets be deposited in escrow to secure payment of the exercise price.)
The fund would generally write covered put options in circumstances where T.
Rowe Price wishes to purchase the underlying security or currency for the
fund's portfolio at a price lower than the current market price of the
security or currency. In such event the fund would write a put option at an
exercise price which, reduced by the premium received on the option, reflects
the lower price it is willing to pay. Since the fund would also receive
interest on debt securities or currencies maintained to cover the exercise
price of the option, this technique could be used to enhance current return
during periods of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency would decline
below the exercise price less the premiums received. Such a decline could be
substantial and result in a significant loss to the fund. In addition, the
fund, because it does not own the specific securities or currencies which it
may be required to purchase in exercise of the put, cannot benefit from
appreciation, if any, with respect to such specific securities or currencies.
The fund will not write a covered put option if, as a result, the aggregate
market value of all portfolio securities or currencies covering put or call
options exceeds 25% of the market value of the fund's net assets. In
calculating the 25% limit, the fund will offset, against the value of assets
covering written puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
Purchasing Put Options
The fund may purchase American or European style put options. As the holder
of a put option, the fund has the right to sell the underlying security or
currency at the exercise price at any time during the option period (American
style) or at the expiration of the option (European style). The fund may
enter into closing sale transactions with respect to such options, exercise
them or permit them to expire. The fund may purchase put options for
defensive purposes in order to protect against an anticipated decline in the
value of its securities or currencies. An example of such use of put options
is provided next.
The fund may purchase a put option on an underlying security or currency (a
"protective put") owned by the fund as a defensive technique in order to
protect against an anticipated decline in the value of the security or
currency. Such hedge protection is provided only during the life of the put
option when the fund, as the holder of the put option, is able to sell the
underlying security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's exchange
value. For example, a put option may be purchased in order to protect
unrealized appreciation of a security or currency where T. Rowe Price deems
it desirable to continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any transaction costs
would reduce any capital gain otherwise available for distribution when the
security or currency is eventually sold.
The fund may also purchase put options at a time when the fund does not own
the underlying security or currency. By purchasing put options on a security
or currency it does not own, the fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the underlying
security or currency remains equal to or greater than the exercise price
during the life of the put option, the fund will lose its entire investment
in the put option. In order for the purchase of a put option to be
profitable, the market price of the underlying security or currency must
decline sufficiently below the exercise price to cover the premium and
transaction costs, unless the put option is sold in a closing sale
transaction.
The fund will not commit more than 5% of its assets to premiums when
purchasing put and call options. The premium paid by the fund when purchasing
a put option will be recorded as an asset of the fund. This asset will be
adjusted daily to the option's current market value, which will be the latest
sale price at the time at
<PAGE>
which the net asset value per share of the fund is computed (close of New
York Stock Exchange), or, in the absence of such sale, the latest bid price.
This asset will be terminated upon expiration of the option, the selling
(writing) of an identical option in a closing transaction, or the delivery of
the underlying security or currency upon the exercise of the option.
Purchasing Call Options
The fund may purchase American or European style call options. As the holder
of a call option, the fund has the right to purchase the underlying security
or currency at the exercise price at any time during the option period
(American style) or at the expiration of the option (European style). The
fund may enter into closing sale transactions with respect to such options,
exercise them or permit them to expire. The fund may purchase call options
for the purpose of increasing its current return or avoiding tax consequences
which could reduce its current return. The fund may also purchase call
options in order to acquire the underlying securities or currencies. Examples
of such uses of call options are provided next.
Call options may be purchased by the fund for the purpose of acquiring the
underlying securities or currencies for its portfolio. Utilized in this
fashion, the purchase of call options enables the fund to acquire the
securities or currencies at the exercise price of the call option plus the
premium paid. At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities or
currencies directly. This technique may also be useful to the fund in
purchasing a large block of securities or currencies that would be more
difficult to acquire by direct market purchases. So long as it holds such a
call option rather than the underlying security or currency itself, the fund
is partially protected from any unexpected decline in the market price of the
underlying security or currency and in such event could allow the call option
to expire, incurring a loss only to the extent of the premium paid for the
option.
The fund will not commit more than 5% of its assets to premiums when
purchasing call and put options. The fund may also purchase call options on
underlying securities or currencies it owns in order to protect unrealized
gains on call options previously written by it. A call option would be
purchased for this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call options may
also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The fund may engage in transactions involving dealer options. Certain risks
are specific to dealer options. While the fund would look to a clearing
corporation to exercise exchange-traded options, if the fund were to purchase
a dealer option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the dealer to do
so would result in the loss of the premium paid by the fund as well as loss
of the expected benefit of the transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options have none. Consequently, the fund will generally be able to
realize the value of a dealer option it has purchased only by exercising it
or reselling it to the dealer who issued it. Similarly, when the fund writes
a dealer option, it generally will be able to close out the option prior to
its expiration only by entering into a closing purchase transaction with the
dealer to which the fund originally wrote the option. While the fund will
seek to enter into dealer options only with dealers who will agree to and
which are expected to be capable of entering into closing transactions with
the fund, there can be no assurance that the fund will be able to liquidate a
dealer option at a favorable price at any time prior to expiration. Until the
fund, as a covered dealer call option writer, is able to effect a closing
purchase transaction, it will not be able to liquidate securities (or other
assets) or currencies used as cover until the option expires or is exercised.
In the event of insolvency of the contra party, the fund may be unable to
liquidate a dealer option. With respect to options written by the fund, the
inability to enter into a closing transaction may result in material losses
to the fund. For example, since the fund must maintain a secured position
with respect to any call option on a security it writes, the fund may not
sell the assets which it has segregated to secure the position while it is
obligated under the option. This requirement may impair a fund's ability to
sell portfolio securities or currencies at a time when such sale might be
advantageous.
<PAGE>
The Staff of the SEC has taken the position that purchased dealer options and
the assets used to secure the written dealer options are illiquid securities.
The fund may treat the cover used for written Over-the-Counter ("OTC")
options as liquid if the dealer agrees that the fund may repurchase the OTC
option it has written for a maximum price to be calculated by a predetermined
formula. In such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds the
intrinsic value of the option.
Interest Rate Transactions
The fund may enter into various interest rate transactions such as interest
rate swaps and the purchase or sale of interest rate caps and floors, to
preserve a return or spread on a particular investment or portion of its
portfolio, to create synthetic securities, or to structure transactions
designed for other non-speculative purposes.
Interest rate swaps involve the exchange by the fund with third parties of
its respective commitments to pay or receive interest, e.g., an exchange of
floating rate payments for fixed rate payments. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds
a predetermined interest rate, to receive payments of interest on a
contractually-based principal amount from the party selling the interest rate
cap. The purchase of an interest rate floor entitles the purchaser, to the
extent that a specified index falls below a predetermined interest rate, to
receive payments of interest on a contractually-based principal amount from
the party selling the interest rate floor. In circumstances in which T. Rowe
Price anticipates that interest rates will decline, the fund might, for
example, enter into an interest rate swap as the floating rate payor. In the
case where the fund purchase such an interest rate swap, if the floating rate
payments fell below the level of the fixed rate payment set in the swap
agreement, the fund's counterparties would pay the fund's amounts equal to
interest computed at the difference between the fixed and floating rates over
the national principal amount. Such payments would offset or partially offset
the decrease in the payments the fund would receive in respect of floating
rate assets being hedged. In the case of purchasing an interest rate floor,
if interest rates declined below the floor rate, the fund would receive
payments from the counterparties which would wholly or partially offset the
decrease in the payments they would receive in respect of the financial
instruments being hedged.
The fund will usually enter into interest rate swaps on a net basis, i.e.,
the two payment streams are netted out, with the fund receiving or paying, as
the case may be, only the net amount of the two payments. The net amount of
the excess, if any, of the fund's obligations over its entitlements with
respect to each interest rate swap will be accrued on a daily basis and an
amount of cash or high-quality liquid securities having an aggregate net
asset value at least equal to the accrued excess will be maintained in an
account by the fund's custodian. If the fund enters into an interest rate
swap on other than a net basis, the fund would maintain an account in the
full amount accrued on a daily basis of the fund's obligations with respect
to the swap. To the extent the fund sells (i.e., writes) caps and floors, it
will maintain in an account cash or high-quality liquid debt securities
having an aggregate net asset value at least equal to the full amount,
accrued on a daily basis, of the fund's obligations with respect to any caps
or floors. The fund will not enter into any interest rate swap, cap or floor
transaction unless the unsecured senior debt or the claims paying ability of
the counterparty thereto is rated at least A by S&P. T. Rowe Price will
monitor the creditworthiness of counterparties on an ongoing basis. If there
is a default by the other parties to such a transaction, the fund will have
contractual remedies pursuant to the agreements related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. T. Rowe Price has determined that,
as a result, the swap market has become relatively liquid. The fund may enter
into interest rate swaps only with respect to positions held in its
portfolio. Interest rate swaps do not involve the delivery of securities or
other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest
payments that the fund is contractually obligated to make. If the other
parties to interest rate swaps default, the fund's risk of loss consists of
the net amount of interest payments that the fund is contractually entitled
to receive. Since interest rate swaps are individually
<PAGE>
negotiated, the fund expects to achieve an acceptable degree of correlation
between its right to receive interest on loan interests and its right and
obligation to receive and pay interest pursuant to interest rate swaps.
The aggregate purchase price of caps and floor held by the fund may not
exceed 10% of the fund's total assets. The fund may sell (i.e., write) caps
and floors without limitation, subject to the account coverage requirement
described above.
Futures Contracts
Futures contracts are a type of potentially high-risk derivative.
Transactions in Futures
The fund may enter into futures contracts including stock index, interest
rate, and currency futures ("futures" or "futures contracts").
Interest rate or currency futures contracts may be used as a hedge against
changes in prevailing levels of interest rates or currency exchange rates in
order to establish more definitely the effective return on securities or
currencies held or intended to be acquired by the fund. In this regard, the
fund could sell interest rate or currency futures as an offset against the
effect of expected increases in interest rates or currency exchange rates and
purchase such futures as an offset against the effect of expected declines in
interest rates or currency exchange rates.
The fund will enter into futures contracts which are traded on national or
foreign futures exchanges, and are standardized as to maturity date and
underlying financial instrument. Futures exchanges and trading in the United
States are regulated under the Commodity Exchange Act by the CFTC. Although
techniques other than the sale and purchase of futures contracts could be
used for the above-referenced purposes, futures contracts offer an effective
and relatively low cost means of implementing the fund's objectives in these
areas.
Regulatory Limitations
If the fund purchases or sells futures contracts or related options which do
not qualify as bona fide hedging under applicable CFTC rules, the aggregate
initial margin deposits and premium required to establish those positions
cannot exceed 5% of the liquidation value of the fund after taking into
account unrealized profits and unrealized losses on any such contracts it has
entered into; provided, however, that in the case of an option that is
in-the-money at the time of purchase, the in-the-money amount may be excluded
in calculating the 5% limitation. For purposes of this policy, options on
futures contracts and foreign currency options traded on a commodities
exchange will be considered "related options." This policy may be modified by
the Board of Directors without a shareholder vote and does not limit the
percentage of the fund's assets at risk to 5%.
In instances involving the purchase of futures contracts or the writing of
call or put options thereon by the fund, an amount of cash, liquid assets, or
other suitable cover as permitted by the SEC, equal to the market value of
the futures contracts and options thereon (less any related margin deposits),
will be identified by the fund to cover the position, or alternative cover
(such as owning an offsetting position) will be employed. Assets used as
cover or held in an identified account cannot be sold while the position in
the corresponding option or future is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion of a fund's
assets to cover or identified accounts could impede portfolio management or
the fund's ability to meet redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different (including less
stringent) or additional restrictions, the fund would comply with such new
restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party and purchase by
another party of a specified amount of a specific financial instrument (e.g.,
units of a stock index) for a specified price, date, time, and place
designated at the time the contract is made. Brokerage fees are incurred when
a futures contract is bought or sold and margin deposits must be maintained.
Entering into a contract to buy is commonly referred
<PAGE>
to as buying or purchasing a contract or holding a long position. Entering
into a contract to sell is commonly referred to as selling a contract or
holding a short position.
Unlike when the fund purchases or sells a security, no price would be paid or
received by the fund upon the purchase or sale of a futures contract. Upon
entering into a futures contract, and to maintain the fund's open positions
in futures contracts, the fund would be required to deposit with its
custodian in a segregated account in the name of the futures broker an amount
of cash, or liquid assets known as "initial margin." The margin required for
a particular futures contract is set by the exchange on which the contract is
traded, and may be significantly modified from time to time by the exchange
during the term of the contract. Futures contracts are customarily purchased
and sold on margins that may range upward from less than 5% of the value of
the contract being traded.
If the price of an open futures contract changes (by increase in the case of
a sale or by decrease in the case of a purchase) so that the loss on the
futures contract reaches a point at which the margin on deposit does not
satisfy margin requirements, the broker will require an increase in the
margin. However, if the value of a position increases because of favorable
price changes in the futures contract so that the margin deposit exceeds the
required margin, the broker will pay the excess to the fund.
These subsequent payments, called "variation margin," to and from the futures
broker, are made on a daily basis as the price of the underlying assets
fluctuate, making the long and short positions in the futures contract more
or less valuable, a process known as "marking to market."
Although certain futures contracts, by their terms, require actual future
delivery of and payment for the underlying instruments, in practice most
futures contracts are usually closed out before the delivery date. Closing
out an open futures contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for the same
aggregate amount of the identical securities and the same delivery date. If
the offsetting purchase price is less than the original sale price, the fund
realizes a gain; if it is more, the fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the fund
realizes a gain; if it is less, the fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
fund is not able to enter into an offsetting transaction, the fund will
continue to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the underlying instrument
is not delivered, the contractual obligations arising from the sale of one
contract of September Treasury bills on an exchange may be fulfilled at any
time before delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one contract of
September Treasury bills on the same exchange. In such instance, the
difference between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for transaction
costs, represents the profit or loss to the fund.
Special Risks of Transactions in Futures Contracts
. Volatility and Leverage The prices of futures contracts are volatile and are
influenced, among other things, by actual and anticipated changes in the
market and interest rates, which in turn are affected by fiscal and monetary
policies and national and international political and economic events.
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of
a trading session. Once the daily limit has been reached in a particular type
of futures contract, no trades may be made on that day at a price beyond that
limit. The daily limit governs only price movement during a particular
trading day and therefore does not limit potential losses, because the limit
may prevent the liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several consecutive trading
days with little or no trading, thereby preventing prompt liquidation of
futures positions and subjecting some futures traders to substantial losses.
<PAGE>
Margin deposits required on futures trading are low. As a result, a
relatively small price movement in a futures contract may result in immediate
and substantial loss, as well as gain, to the investor. For example, if at
the time of purchase, 10% of the value of the futures contract is deposited
as margin, a subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any deduction for
the transaction costs, if the account were then closed out. A 15% decrease
would result in a loss equal to 150% of the original margin deposit, if the
contract were closed out. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
. Liquidity The fund may elect to close some or all of its futures positions
at any time prior to their expiration. The fund would do so to reduce
exposure represented by long futures positions or short futures positions.
The fund may close its positions by taking opposite positions which would
operate to terminate the fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional cash would
be required to be paid by or released to the fund, and the fund would realize
a loss or a gain.
Futures contracts may be closed out only on the exchange or board of trade
where the contracts were initially traded. Although the fund intends to
purchase or sell futures contracts only on exchanges or boards of trade where
there appears to be an active market, there is no assurance that a liquid
market on an exchange or board of trade will exist for any particular
contract at any particular time. In such event, it might not be possible to
close a futures contract, and in the event of adverse price movements, the
fund would continue to be required to make daily cash payments of variation
margin. However, in the event futures contracts have been used to hedge the
underlying instruments, the fund would continue to hold the underlying
instruments subject to the hedge until the futures contracts could be
terminated. In such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses on the
futures contract. However, as described next, there is no guarantee that the
price of the underlying instruments will, in fact, correlate with the price
movements in the futures contract and thus provide an offset to losses on a
futures contract.
. Hedging Risk A decision of whether, when, and how to hedge involves skill
and judgment, and even a well-conceived hedge may be unsuccessful to some
degree because of unexpected market behavior, market or interest rate trends.
There are several risks in connection with the use by the fund of futures
contracts as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures contracts and
movements in the prices of the underlying instruments which are the subject
of the hedge. T. Rowe Price will, however, attempt to reduce this risk by
entering into futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the fund's underlying
instruments sought to be hedged.
Successful use of futures contracts by the fund for hedging purposes is also
subject to T. Rowe Price's ability to correctly predict movements in the
direction of the market. It is possible that, when the fund has sold futures
to hedge its portfolio against a decline in the market, the index, indices,
or instruments underlying futures might advance and the value of the
underlying instruments held in the fund's portfolio might decline. If this
were to occur, the fund would lose money on the futures and also would
experience a decline in value in its underlying instruments. However, while
this might occur to a certain degree, T. Rowe Price believes that over time
the value of the fund's portfolio will tend to move in the same direction as
the market indices used to hedge the portfolio. It is also possible that, if
the fund were to hedge against the possibility of a decline in the market
(adversely affecting the underlying instruments held in its portfolio) and
prices instead increased, the fund would lose part or all of the benefit of
increased value of those underlying instruments that it has hedged, because
it would have offsetting losses in its futures positions. In addition, in
such situations, if the fund had insufficient cash, it might have to sell
underlying instruments to meet daily variation margin requirements. Such
sales of underlying instruments might be, but would not necessarily be, at
increased prices (which would reflect the rising market). The fund might have
to sell underlying instruments at a time when it would be disadvantageous to
do so.
In addition to the possibility that there might be an imperfect correlation,
or no correlation at all, between price movements in the futures contracts
and the portion of the portfolio being hedged, the price movements of futures
contracts might not correlate perfectly with price movements in the
underlying instruments due to
<PAGE>
certain market distortions. First, all participants in the futures market are
subject to margin deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close futures
contracts through offsetting transactions, which could distort the normal
relationship between the underlying instruments and futures markets. Second,
the margin requirements in the futures market are less onerous than margin
requirements in the securities markets and, as a result, the futures market
might attract more speculators than the securities markets do. Increased
participation by speculators in the futures market might also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market and also because of imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures contracts,
even a correct forecast of general market trends by T. Rowe Price might not
result in a successful hedging transaction over a very short time period.
Options on Futures Contracts
The fund may purchase and sell options on the same types of futures in which
it may invest.
Options (another type of potentially high-risk derivative) on futures are
similar to options on underlying instruments except that options on futures
give the purchaser the right, in return for the premium paid, to assume a
position in a futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase or sell the
futures contract, at a specified exercise price at any time during the period
of the option. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by the delivery of the accumulated balance in the writer's
futures margin account which represents the amount by which the market price
of the futures contract, at exercise, exceeds (in the case of a call) or is
less than (in the case of a put) the exercise price of the option on the
futures contract. Purchasers of options who fail to exercise their options
prior to the exercise date suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put options on stock
index futures, the fund may write or purchase call and put options on
financial indices. Such options would be used in a manner similar to the use
of options on futures contracts. From time to time, a single order to
purchase or sell futures contracts (or options thereon) may be made on behalf
of the fund and other T. Rowe Price funds. Such aggregated orders would be
allocated among the funds and the other T. Rowe Price funds in a fair and
nondiscriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks in Transactions on Futures
Contracts" are substantially the same as the risks of using options on
futures. If the fund were to write an option on a futures contract, it would
be required to deposit and maintain initial and variation margin in the same
manner as a regular futures contract. In addition, where the fund seeks to
close out an option position by writing or buying an offsetting option
covering the same index, underlying instrument or contract and having the
same exercise price and expiration date, its ability to establish and close
out positions on such options will be subject to the maintenance of a liquid
secondary market. Reasons for the absence of a liquid secondary market on an
exchange include the following: (1) there may be insufficient trading
interest in certain options; (2) restrictions may be imposed by an exchange
on opening transactions or closing transactions or both; (3) trading halts,
suspensions, or other restrictions may be imposed with respect to particular
classes or series of options, or underlying instruments; (4) unusual or
unforeseen circumstances may interrupt normal operations on an exchange; (5)
the facilities of an exchange or a clearing corporation may not at all times
be adequate to handle current trading volume; or (6) one or more exchanges
could, for economic or other reasons, decide or be compelled at some future
date to discontinue the trading of options (or a particular class or series
of options), in which event the secondary market on that exchange (or in the
class or series of options) would cease to exist, although outstanding
options on the exchange that had been issued by a clearing corporation as a
result of trades on that exchange would continue to be exercisable in
accordance with their terms. There is no assurance that higher than
anticipated trading activity or other unforeseen events might not, at times,
render certain of the facilities of any of the clearing corporations
inadequate, and thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of customers'
orders.
<PAGE>
Additional Futures and Options Contracts
Although the fund has no current intention of engaging in futures or options
transactions other than those described above, it reserves the right to do
so. Such futures and options trading might involve risks which differ from
those involved in the futures and options described above.
Foreign Futures and Options
Participation in foreign futures and foreign options transactions involves
the execution and clearing of trades on or subject to the rules of a foreign
board of trade. Neither the National Futures Association nor any domestic
exchange regulates activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the power to compel
enforcement of the rules of a foreign board of trade or any applicable
foreign law. This is true even if the exchange is formally linked to a
domestic market so that a position taken on the market may be liquidated by a
transaction on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or foreign
options transaction occurs. For these reasons, when the fund trades foreign
futures or foreign options contracts, it may not be afforded certain of the
protective measures provided by the Commodity Exchange Act, the CFTC's
regulations and the rules of the National Futures Association and any
domestic exchange, including the right to use reparations proceedings before
the CFTC and arbitration proceedings provided by the National Futures
Association or any domestic futures exchange. In particular, funds received
from the fund for foreign futures or foreign options transactions may not be
provided the same protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any foreign
futures or foreign options contract and, therefore, the potential profit and
loss thereon may be affected by any variance in the foreign exchange rate
between the time the fund's order is placed and the time it is liquidated,
offset or exercised.
Foreign Currency Transactions
A forward foreign currency exchange contract involves an obligation to
purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. These contracts are principally traded
in the interbank market conducted directly between currency traders (usually
large, commercial banks) and their customers. A forward contract generally
has no deposit requirement, and no commissions are charged at any stage for
trades.
The fund may enter into forward contracts for a variety of purposes in
connection with the management of the foreign securities portion of its
portfolio. The fund's use of such contracts would include, but not be limited
to, the following:
First, when the fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, it may desire to "lock in" the
U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of dollars, of the amount of foreign
currency involved in the underlying security transactions, the fund will be
able to protect itself against a possible loss resulting from an adverse
change in the relationship between the U.S. dollar and the subject foreign
currency during the period between the date the security is purchased or sold
and the date on which payment is made or received.
Second, when T. Rowe Price believes that one currency may experience a
substantial movement against another currency, including the U.S. dollar, it
may enter into a forward contract to sell or buy the amount of the former
foreign currency, approximating the value of some or all of the fund's
portfolio securities denominated in such foreign currency. Alternatively,
where appropriate, the fund may hedge all or part of its foreign currency
exposure through the use of a basket of currencies or a proxy currency where
such currency or currencies act as an effective proxy for other currencies.
In such a case, the fund may enter into a forward contract where the amount
of the foreign currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging technique may be
more efficient and economical than entering into separate forward contracts
for each currency held in the fund. The precise matching of the forward
contract amounts and the value of the securities involved will not generally
be possible since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of those
securities between the date the forward contract is entered into and the date
it matures. The projection of short-term currency market movement is
extremely difficult, and the successful execution of a
<PAGE>
short-term hedging strategy is highly uncertain. Under normal circumstances,
consideration of the prospect for currency parties will be incorporated into
the longer term investment decisions made with regard to overall
diversification strategies. However, T. Rowe Price believes that it is
important to have the flexibility to enter into such forward contracts when
it determines that the best interests of the fund will be served.
Third, the fund may use forward contracts when the fund wishes to hedge out
of the dollar into a foreign currency in order to create a synthetic bond or
money market instrument-the security would be issued in U.S. dollars but the
dollar component would be transformed into a foreign currency through a
forward contract.
The fund may enter into forward contacts for any other purpose consistent
with the fund's investment objective and program. However, the fund will not
enter into a forward contract, or maintain exposure to any such contract(s),
if the amount of foreign currency required to be delivered thereunder would
exceed the fund's holdings of liquid, high-grade debt securities, currency
available for cover of the forward contract(s), or other suitable cover as
permitted by the SEC. In determining the amount to be delivered under a
contract, the fund may net offsetting positions.
At the maturity of a forward contract, the fund may sell the portfolio
security and make delivery of the foreign currency, or it may retain the
security and either extend the maturity of the forward contract (by "rolling"
that contract forward) or may initiate a new forward contract.
If the fund retains the portfolio security and engages in an offsetting
transaction, the fund will incur a gain or a loss (as described below) to the
extent that there has been movement in forward contract prices. If the fund
engages in an offsetting transaction, it may subsequently enter into a new
forward contract to sell the foreign currency. Should forward prices decline
during the period between the fund's entering into a forward contract for the
sale of a foreign currency and the date it enters into an offsetting contract
for the purchase of the foreign currency, the fund will realize a gain to the
extent the price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices increase, the
fund will suffer a loss to the extent of the price of the currency it has
agreed to purchase exceeds the price of the currency it has agreed to sell.
The fund's dealing in forward foreign currency exchange contracts will
generally be limited to the transactions described above. However, the fund
reserves the right to enter into forward foreign currency contracts for
different purposes and under different circumstances. Of course, the fund is
not required to enter into forward contracts with regard to its foreign
currency-denominated securities and will not do so unless deemed appropriate
by T. Rowe Price. It also should be realized that this method of hedging
against a decline in the value of a currency does not eliminate fluctuations
in the underlying prices of the securities. It simply establishes a rate of
exchange at a future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the hedged
currency, at the same time, they tend to limit any potential gain which might
result from an increase in the value of that currency.
Although the fund values its assets daily in terms of U.S. dollars, it does
not intend to convert its holdings of foreign currencies into U.S. dollars on
a daily basis. It will do so from time to time, and there are costs
associated with currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on the difference
(the "spread") between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to
the fund at one rate, while offering a lesser rate of exchange should the
fund desire to resell that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts, and Forward Foreign
Exchange Contracts
The fund may enter into certain options, futures, and forward foreign
exchange contracts, including options and futures on currencies, which will
be treated as Section 1256 contracts or straddles.
Transactions that are considered Section 1256 contracts will be considered to
have been closed at the end of the fund's fiscal year and any gains or losses
will be recognized for tax purposes at that time. Such gains or losses from
the normal closing or settlement of such transactions will be characterized
as 60% long-term capital gain (taxable at a maximum rate of 20%) or loss and
40% short-term capital gain or loss regardless of the holding period of the
instrument (ordinary income or loss for foreign exchange contracts). The fund
will
<PAGE>
be required to distribute net gains on such transactions to shareholders even
though it may not have closed the transaction and received cash to pay such
distributions.
Options, futures, and forward foreign exchange contracts, including options
and futures on currencies, which offset a foreign dollar-denominated bond or
currency position may be considered straddles for tax purposes, in which case
a loss on any position in a straddle will be subject to deferral to the
extent of unrealized gain in an offsetting position. The holding period of
the securities or currencies comprising the straddle will be deemed not to
begin until the straddle is terminated. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an equity
security will not include the period of time the option is outstanding.
Losses on written covered calls and purchased puts on securities, excluding
certain "qualified covered call" options on equity securities, may be
long-term capital losses, if the security covering the option was held for
more than 12 months prior to the writing of the option.
In order for the fund to continue to qualify for federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income, i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or currencies. Tax regulations could be issued limiting the extent
that net gain realized from option, futures, or foreign forward exchange
contracts on currencies is qualifying income for purposes of the 90%
requirement.
As a result of the "Taxpayer Relief Act of 1997," entering into certain
options, futures contracts, or forward contracts may result in the
"constructive sale" of offsetting stocks or debt securities of the fund.
INVESTMENT RESTRICTIONS
-------------------------------------------------------------------------------
Fundamental policies may not be changed without the approval of the lesser of
(1) 67% of the fund's shares present at a meeting of shareholders if the
holders of more than 50% of the outstanding shares are present in person or
by proxy or (2) more than 50% of a fund's outstanding shares. Other
restrictions in the form of operating policies are subject to change by the
fund's Board of Directors without shareholder approval. Any investment
restriction which involves a maximum percentage of securities or assets shall
not be considered to be violated unless an excess over the percentage occurs
immediately after, and is caused by, an acquisition of securities or assets
of, or borrowings by, the fund. Calculation of the fund's total assets for
compliance with any of the following fundamental or operating policies or any
other investment restrictions set forth in the fund's prospectus or Statement
of Additional Information will not include cash collateral held in connection
with securities lending activities.
Fundamental Policies
As a matter of fundamental policy, the fund may not:
(1) Borrowing Borrow money except that the fund may (i) borrow for
non-leveraging, temporary, or emergency purposes; and (ii) engage in
reverse repurchase agreements and make other investments or engage in
other transactions, which may involve a borrowing, in a manner consistent
with the fund's investment objective and program, provided that the
combination of (i) and (ii) shall not exceed 33/1//\\/3/\\% of the value
of the fund's total assets (including the amount borrowed) less
liabilities (other than borrowings) or such other percentage permitted by
law. Any borrowings which come to exceed this amount will be reduced in
accordance with applicable law. The fund may borrow from banks, other
Price Funds, or other persons to the extent permitted by applicable law;
(2) Commodities Purchase or sell physical commodities; except that it may
enter into futures contracts and options thereon;
(3) Industry Concentration Purchase the securities of any issuer if, as a
result, more than 25% of the value of the fund's total assets would be
invested in the securities of issuers having their principal business
activities in the same industry;
<PAGE>
(4) Loans Make loans, although the fund may (i) lend portfolio securities and
participate in an interfund lending program with other Price Funds
provided that no such loan may be made if, as a result, the aggregate of
such loans would exceed 33/1//\\/3/\\% of the value of the fund's total
assets; (ii) purchase money market securities and enter into repurchase
agreements; and (iii) acquire publicly distributed or privately placed
debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer Purchase a security
if, as a result, with respect to 75% of the value of its total assets,
more than 5% of the value of the fund's total assets would be invested in
the securities of a single issuer, except securities issued or guaranteed
by the U.S. government or any of its agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer Purchase a security
if, as a result, with respect to 75% of the value of the fund's total
assets, more than 10% of the outstanding voting securities of any issuer
would be held by the fund (other than obligations issued or guaranteed by
the U.S. government, its agencies or instrumentalities);
(7) Real Estate Purchase or sell real estate, including limited partnership
interests therein, unless acquired as a result of ownership of securities
or other instruments (but this shall not prevent the fund from investing
in securities or other instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities Issue senior securities except in compliance with the
1940 Act; or
(9) Underwriting Underwrite securities issued by other persons, except to the
extent that the fund may be deemed to be an underwriter within the
meaning of the 1933 Act in connection with the purchase and sale of its
portfolio securities in the ordinary course of pursuing its investment
program.
NOTES
The following Notes should be read in connection with the above-described
fundamental policies. The Notes are not fundamental policies.
With respect to investment restriction (2), the fund does not consider
currency contracts or hybrid investments to be commodities.
For purposes of investment restriction (3), U.S., state, or local
governments, or related agencies or instrumentalities, are not considered
an industry. Industries are determined by reference to the
classifications of industries set forth in the fund's semiannual and
annual reports. It is the position of the Staff of the SEC that foreign
governments are industries for purposes of this restriction.
For purposes of investment restriction (4), the fund will consider the
acquisition of a debt security to include the execution of a note or
other evidence of an extension of credit with a term of more than nine
months.
For purposes of investment restriction (5), the fund will consider a
repurchase agreement fully collateralized with U.S. government securities
to be U.S. government securities.
Operating Policies
As a matter of operating policy, the fund may not:
(1) Borrowing Purchase additional securities when money borrowed exceeds 5%
of its total assets;
The fund will limit borrowing for any variable annuity separate account
to (a) 10% of net asset value when borrowing for any general purpose, and
(b) 25% of net asset value when borrowing as a temporary measure to
facilitate redemptions.
Net asset value of a portfolio is the market value of all investments or
assets owned less outstanding liabilities of the portfolio at the time
that any new or additional borrowing is undertaken.
<PAGE>
(2) Control of Portfolio Companies Invest in companies for the purpose of
exercising management or control;
(3) Equity Securities Purchase any common stocks or other equity securities;
(4) Futures Contracts Purchase a futures contract or an option thereon, if,
with respect to positions in futures or options on futures which do not
represent bona fide hedging, the aggregate initial margin and premiums on
such options would exceed 5% of the fund's net asset value;
(5) Illiquid Securities Purchase illiquid securities if, as a result, more
than 15% of its net assets would be invested in such securities;
(6) Investment Companies Purchase securities of open-end or closed-end
investment companies except (i) in compliance with the 1940 Act; or (ii)
securities of the Reserve Investment or Government Reserve Investment
Funds;
(7) Margin Purchase securities on margin, except (i) for use of short-term
credit necessary for clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection with futures contracts or
other permissible investments;
(8) Mortgaging Mortgage, pledge, hypothecate or, in any manner, transfer any
security owned by the fund as security for indebtedness except as may be
necessary in connection with permissible borrowings or investments and
then such mortgaging, pledging, or hypothecating may not exceed
33/1//\\/3/\\% of the fund's total assets at the time of borrowing or
investment;
(9) Oil and Gas Programs Purchase participations or other direct interests
in, or enter into leases with respect to oil, gas, or other mineral
exploration or development programs if, as a result thereof, more than 5%
of the value of the total assets of the fund would be invested in such
programs;
(10) Options, etc. Invest in puts, calls, straddles, spreads, or any
combination thereof, except to the extent permitted by the prospectus and
Statement of Additional Information;
(11) Short Sales Effect short sales of securities; or
(12) Warrants Invest in warrants if, as a result thereof, more than 10% of
the value of the net assets of the fund would be invested in warrants.
Notwithstanding anything in the above fundamental and operating restrictions
to the contrary, the fund may invest all of its assets in a single investment
company or a series thereof in connection with a "master-feeder" arrangement.
Such an investment would be made where the fund (a "Feeder"), and one or more
other funds with the same investment objective and program as the fund,
sought to accomplish its investment objective and program by investing all of
its assets in the shares of another investment company (the "Master"). The
Master would, in turn, have the same investment objective and program as the
fund. The fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make investments in
portfolio companies on behalf of a number of Feeder funds.
MANAGEMENT OF THE FUND
-------------------------------------------------------------------------------
The officers and directors of the fund are listed below. Unless otherwise
noted, the address of each is 100 East Pratt Street, Baltimore, Maryland
21202. Except as indicated, each has been an employee of T. Rowe Price for
more than five years. In the list below, the fund's directors who are
considered "interested persons" of T. Rowe Price as defined under Section
2(a)(19) of the 1940 Act are noted with an asterisk (*). These directors are
referred to as inside directors by virtue of their officership, directorship,
and/or employment with T. Rowe Price.
<PAGE>
Independent Directors/(a)/
CALVIN W. BURNETT, PH.D., 3/16/32, President, Coppin State College; formerly:
Director, Maryland Chamber of Commerce and Provident Bank of Maryland;
formerly: President, Baltimore Area Council Boy Scouts of America; Vice
President and Board of Directors, The Walters Art Gallery; Address: 2500 West
North Avenue, Baltimore, Maryland 21216
ANTHONY W. DEERING, 1/28/45, Director, Chairman of the Board, President, and
Chief Executive Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Address: 10275 Little Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, 8/22/34, President, F. Pierce Linaweaver & Associates,
Inc.; Consulting Environmental & Civil Engineers; formerly (1987-1991)
Executive Vice President, EA Engineering, Science, and Technology, Inc., and
President, EA Engineering, Inc., Baltimore, Maryland; Address: Green Spring
Station, 2360 West Joppa Road, Suite 224, Lutherville, Maryland 21093
JOHN G. SCHREIBER, 10/21/46, Owner/President, Schreiber Investments, Inc., a
real estate investment company; Director, AMLI Residential Properties Trust
and Urban Shopping Centers, Inc.; Partner, Blackstone Real Estate Partners,
L.P.; Director and formerly Executive Vice President, JMB Realty Corporation,
a national real estate investment manager and developer; Address: Centaur
Capital Partners, One Westminster Place, Lake Forest, IL 60045
(a) Unless otherwise indicated, the Independent Directors have been at their
respective companies for at least five years.
Inside Directors/Officers
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board-Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and Vice President-Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board
and Director, T. Rowe Price Investment Services, Inc., T. Rowe Price
Services, Inc., and T. Rowe Price Retirement Plan Services, Inc.; Chairman of
the Board, Director, President, and Trust Officer, T. Rowe Price Trust
Company; Director, Price-Fleming and General Re Corporation
M. DAVID TESTA, 4/22/44, Director-Chairman of the Board and Director,
Price-Fleming; Vice Chairman of the Board, Chief Investment Officer,
Director, and Managing Director, T. Rowe Price; Vice President and Director,
T. Rowe Price Trust Company; Chartered Financial Analyst
EDWARD A. WIESE, 4/12/59, President-Vice President, T. Rowe Price and T. Rowe
Price Trust Company; Chartered Financial Analyst
PATRICE BERCHTENBREITER ELY, 1/13/53, Vice President-Vice President, T. Rowe
Price
STEVEN G. BROOKS, 8/5/54, Vice President-Vice President, T. Rowe Price;
Chartered Financial Analyst
ROBERT P. CAMPBELL, 1/31/56, Vice President-Vice President, T. Rowe Price and
T. Rowe Price Trust Company
PATRICK S. CASSIDY, 8/27/64, Vice President-Vice President, T. Rowe Price;
Chartered Financial Analyst
CHARLES B. HILL, 9/22/61, Vice President-Vice President, T. Rowe Price
HENRY H. HOPKINS, 12/23/42, Vice President-Vice President, Price-Fleming and
T. Rowe Price Retirement Plan Services, Inc.; Director and Managing Director,
T. Rowe Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc. and T. Rowe Price Trust Company
JAMES M. MCDONALD, 9/29/49, Vice President-Vice President, T. Rowe Price
CHERYL A. MICKEL, 1/11/67, Vice President-Vice President, T. Rowe Price
ROBERT M. RUBINO, 8/2/53, Vice President-Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, 9/19/59, Vice President-Vice President, T. Rowe Price
<PAGE>
VIRGINIA A. STIRLING, 9/5/51, Vice President-Vice President, T. Rowe Price
MARK J. VASELKIV, 7/22/58, Vice President-Managing Director and Vice
President, T. Rowe Price
PATRICIA B. LIPPERT, 1/12/53, Secretary-Assistant Vice President, T. Rowe
Price and T. Rowe Price Investment Services, Inc.
JOSEPH A. CARRIER, 12/30/60, Treasurer-Vice President, T. Rowe Price and T.
Rowe Price Investment Services, Inc.
DAVID S. MIDDLETON, 1/18/56, Controller-Vice President, T. Rowe Price and T.
Rowe Price Trust Company
BRIAN E. BURNS, 10/6/60, Assistant Vice President-Assistant Vice President,
T. Rowe Price
JOAN R. POTEE, 11/23/47, Assistant Vice President-Vice President, T. Rowe
Price
INGRID I. VORDEMBERGE, 9/27/35, Assistant Vice President-Employee, T. Rowe
Price
Compensation Table
The fund does not pay pension or retirement benefits to its independent
officers or directors. Also, any director of the fund who is an officer or
employee of T. Rowe Price or Price-Fleming does not receive any remuneration
from the fund.
<TABLE>
<CAPTION>
Name of Person, Aggregate Compensation from Total Compensation from Fund and
Position Fund(a) Fund Complex Paid to Directors(b)
- -------------------------------------- ------------------------------------------- ---------------------------------
- ------------------------------------------------------------------------------------------------------------------------
<C> <S> <S>
Calvin W. Burnett, PH.D., Director 0 $65,000
Anthony W. Deering, Director $1,267 80,000
F. Pierce Linaweaver, Director 0 67,000
John G. Schreiber, Director 0 67,000
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Amounts in this column are based on accrued compensation for calendar
year 1999.
(b) Amounts in this column are based on compensation received from January
1, 1999 to December 31, 1999. The T. Rowe Price complex included 88 funds
as of December 31, 1999.
The fund's Executive Committee, consisting of the fund's interested
directors, has been authorized by its respective Board of Directors to
exercise all powers of the Board to manage the funds in the intervals between
meetings of the Board, except the powers prohibited by statute from being
delegated.
PRINCIPAL HOLDERS OF SECURITIES
-------------------------------------------------------------------------------
As of the date of the prospectus, the officers and directors of the fund, as
a group, owned less than 1% of the outstanding shares of the fund.
As of April 1, 2000, the following shareholders beneficially owned more than
5% of the outstanding shares of the fund:
Security Benefit Life Insurance Company, FBO T. Rowe Price No-Load Variable
Annuity, Attn.: Mark Young, 700 SW Harrison St., Topeka, KS 66636-0002;
United of Omaha-Series V, Attn.: John Martin, Corporate General Ledger,
Mutual of Omaha Plaza, Omaha, NE 68175; I L Annuity & Insurance Company,
Visionary Choice, Attn.: Susan Russell, 2960 N. Meridian St., Box 7149,
Indianapolis, IN 46207. Sentry Life Insurance Company, 1800 N. Point Dr.,
Stevens Point, WI 54481.
<PAGE>
INVESTMENT MANAGEMENT SERVICES
-------------------------------------------------------------------------------
Services
Under the Management Agreement, T. Rowe Price provides the fund with
discretionary investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of the fund in accordance with
the fund's investment objectives, program, and restrictions as provided in
its prospectus and this Statement of Additional Information. T. Rowe Price is
also responsible for effecting all security transactions on behalf of the
fund, including the negotiation of commissions and the allocation of
principal business and portfolio brokerage. In addition to these services, T.
Rowe Price provides the fund with certain corporate administrative services,
including: maintaining the fund's corporate existence and corporate records;
registering and qualifying fund shares under federal laws; monitoring the
financial, accounting, and administrative functions of the fund; maintaining
liaison with the agents employed by the fund such as the fund's custodian and
transfer agent; assisting the fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as officers,
directors, and committee members of the fund without cost to the fund.
The Management Agreement also provides that T. Rowe Price, its directors,
officers, employees, and certain other persons performing specific functions
for the fund will only be liable to the fund for losses resulting from
willful misfeasance, bad faith, gross negligence, or reckless disregard of
duty.
Management Fee
The fund pays T. Rowe Price an annual all-inclusive fee (the "Fee") of 0.70%.
The Fee is paid monthly to the T. Rowe Price on the first business day of the
next succeeding calendar month and is the sum of the daily Fee accruals for
each month. The daily Fee accrual for any particular day is calculated by
multiplying the fraction of one (1) over the number of calendar days in the
year by the appropriate Fee rate and multiplying this product by the net
assets of the fund for that day as determined in accordance with the fund's
prospectus as of the close of business from the previous business day on
which the fund was open for business.
The Management Agreement between the fund and T. Rowe Price provides that T.
Rowe Price will pay all expenses of the fund's operations, except interest,
taxes, brokerage commissions, and other charges incident to the purchase,
sale, or lending of the fund's portfolio securities, directors' fee and
expenses (including counsel fees and expenses), and such nonrecurring or
extraordinary expenses that may arise, including the costs of actions, suits,
or proceedings to which the fund is a party and the expenses the fund may
incur as a result of its obligation to provide indemnification to its
officers, directors, and agents. However, the Board of Directors of the fund
reserves the right to impose additional fees against shareholder accounts to
defray expenses which would otherwise be paid by T. Rowe Price under the
Management Agreement. The Board does not anticipate levying such charges;
such a fee, if charged, may be retained by the fund or paid to T. Rowe Price.
Under the Management Agreement, the fund paid T. Rowe Price the following
amounts for the years indicated:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C>
$
$355,000 $89,000 -0-
</TABLE>
In 1999, the fund's investment manager made payments of $52,900.93 to various
insurance companies for services.
From time to time, T. Rowe Price may pay eligible insurance companies for
services they provide to the fund for contract holders.
<PAGE>
DISTRIBUTOR FOR THE FUND
-------------------------------------------------------------------------------
Investment Services, a Maryland corporation formed in 1980 as a wholly owned
subsidiary of T. Rowe Price, serves as the fund's distributor. Investment
Services is registered as a broker-dealer under the Securities Exchange Act
of 1934 and is a member of the National Association of Securities Dealers,
Inc. The offering of the fund's shares is continuous.
Investment Services is located at the same address as the fund and T. Rowe
Price-100 East Pratt Street, Baltimore, Maryland 21202.
Investment Services serves as distributor to the fund pursuant to an
Underwriting Agreement ("Underwriting Agreement"), which provides that the
fund will pay all fees and expenses in connection with: necessary state
filings; preparing, setting in type, printing, and mailing its prospectuses
and reports to shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services will pay all
fees and expenses in connection with: printing and distributing prospectuses
and reports for use in offering and selling fund shares; preparing, setting
in type, printing, and mailing all sales literature and advertising;
Investment Services' federal and state registrations as a broker-dealer; and
offering and selling shares, except for those fees and expenses specifically
assumed by the fund. Investment Services' expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the fund in connection with the sale
of its shares in the various states in which Investment Services is qualified
as a broker-dealer. Under the Underwriting Agreement, Investment Services
accepts orders for fund shares at net asset value. No sales charges are paid
by investors or the fund.
CUSTODIAN
-------------------------------------------------------------------------------
State Street Bank and Trust Company is the custodian for the fund's U.S.
securities and cash, but it does not participate in the fund's investment
decisions. Portfolio securities purchased in the U.S. are maintained in the
custody of the Bank and may be entered into the Federal Reserve Book Entry
System, or the security depository system of the Depository Trust
Corporation. State Street Bank's main office is at 225 Franklin Street,
Boston, Massachusetts 02110.
The fund has entered into a Custodian Agreement with The Chase Manhattan
Bank, N.A., London, pursuant to which portfolio securities which are
purchased outside the United States are maintained in the custody of various
foreign branches of The Chase Manhattan Bank and such other custodians,
including foreign banks and foreign securities depositories as are approved
in accordance with regulations under the 1940 Act. The address for The Chase
Manhattan Bank, N.A., London is Woolgate House, Coleman Street, London, EC2P
2HD, England.
CODE OF ETHICS
-------------------------------------------------------------------------------
The fund's investment adviser (T. Rowe Price) has a written Code of Ethics
which requires all Access Persons to obtain prior clearance before engaging
in personal securities transactions. In addition, all employees must report
their personal securities transactions within 10 days of their execution.
Access Persons will not be permitted to effect transactions in a security: if
there are pending client orders in the security; the security has been
purchased or sold by a client within seven calendar days; the security is
being considered for purchase for a client; or the security is subject to
internal trading restrictions. In addition, Access Persons are prohibited
from profiting from short-term trading (e.g., purchases and sales involving
the same security within 60 days). Any person becoming an Access Person must
file a statement of personal securities holdings within 10 days of this date.
All Access Persons are required to file an annual statement with respect to
their personal securities
<PAGE>
holdings. Any material violation of the Code of Ethics is reported to the
Board of the fund. The Board also reviews the administration of the Code of
Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
-------------------------------------------------------------------------------
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio securities on
behalf of the fund are made by T. Rowe Price. T. Rowe Price is also
responsible for implementing these decisions, including the negotiation of
commissions and the allocation of portfolio brokerage and principal business.
The fund's purchases and sales of fixed income portfolio securities are
normally done on a principal basis and do not involve the payment of a
commission although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage commissions
would not normally apply to the fund. However, it is included because T. Rowe
Price does manage a significant number of common stock portfolios which do
engage in agency transactions and pay commissions and because some research
and services resulting from the payment of such commissions may benefit the
fund.
How Brokers and Dealers Are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the issuer or a primary
market-maker acting as principal for the securities on a net basis, with no
brokerage commission being paid by the client although the price usually
includes an undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the bid and asked
prices. Securities may also be purchased from underwriters at prices which
include underwriting fees.
With respect to equity and fixed income securities, T. Rowe Price may effect
principal transactions on behalf of the fund with a broker or dealer who
furnishes brokerage and/or research services, designate any such broker or
dealer to receive selling concessions, discounts, or other allowances, or
otherwise deal with any such broker or dealer in connection with the
acquisition of securities in underwritings. T. Rowe Price may receive
research services in connection with brokerage transactions, including
designations in fixed price offerings.
Equity Securities
In purchasing and selling equity securities, it is T. Rowe Price's policy to
obtain quality execution at the most favorable prices through responsible
brokers and dealers and at competitive commission rates where such rates are
negotiable. However, under certain conditions, the fund may pay higher
brokerage commissions in return for brokerage and research services. As a
general practice, over-the-counter orders are executed with market-makers. In
selecting among market-makers, T. Rowe Price generally seeks to select those
it believes to be actively and effectively trading the security being
purchased or sold. In selecting broker-dealers to execute the fund's
portfolio transactions, consideration is given to such factors as the price
of the security, the rate of the commission, the size and difficulty of the
order, the reliability, integrity, financial condition, general execution and
operational capabilities of competing brokers and dealers, their expertise in
particular markets and brokerage and research services provided by them. It
is not the policy of T. Rowe Price to seek the lowest available commission
rate where it is believed that a broker or dealer charging a higher
commission rate would offer greater reliability or provide better price or
execution.
How Evaluations Are Made of the Overall Reasonableness of Brokerage Commissions
Paid
On a continuing basis, T. Rowe Price seeks to determine what levels of
commission rates are reasonable in the marketplace for transactions executed
on behalf of the fund. In evaluating the reasonableness of commission rates,
T. Rowe Price considers: (a) historical commission rates; (b) rates which
other institutional investors are paying, based on available public
information; (c) rates quoted by brokers and dealers; (d) the size of a
particular transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular transaction in
terms of both execution and settlement; (f) the level and type of
<PAGE>
business done with a particular firm over a period of time; and (g) the
extent to which the broker or dealer has capital at risk in the transaction.
Descriptions of Research Services Received From Brokers and Dealers
T. Rowe Price receives a wide range of research services from brokers and
dealers. These services include information on the economy, industries,
groups of securities, individual companies, statistical information,
accounting and tax law interpretations, political developments, legal
developments affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement analysis,
performance analysis, and analysis of corporate responsibility issues. These
services provide both domestic and international perspective. Research
services are received primarily in the form of written reports, computer
generated services, telephone contacts, and personal meetings with security
analysts. In addition, such services may be provided in the form of meetings
arranged with corporate and industry spokespersons, economists, academicians,
and government representatives. In some cases, research services are
generated by third parties but are provided to T. Rowe Price by or through
broker-dealers.
Research services received from brokers and dealers are supplemental to T.
Rowe Price's own research effort and, when utilized, are subject to internal
analysis before being incorporated by T. Rowe Price into its investment
process. As a practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information presently
provided by brokers and dealers. T. Rowe Price pays cash for certain research
services received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash. While receipt
of research services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could be materially
increased if it attempted to generate such additional information through its
own staff. To the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses which it might
otherwise bear.
T. Rowe Price has a policy of not allocating brokerage business in return for
products or services other than brokerage or research services. In accordance
with the provisions of Section 28(e) of the Securities Exchange Act of 1934,
T. Rowe Price may from time to time receive services and products which serve
both research and non-research functions. In such event, T. Rowe Price makes
a good faith determination of the anticipated research and non-research use
of the product or service and allocates brokerage only with respect to the
research component.
Commissions to Brokers Who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and execution
services also furnish research services to T. Rowe Price. With regard to the
payment of brokerage commissions, T. Rowe Price has adopted a brokerage
allocation policy embodying the concepts of Section 28(e) of the Securities
Exchange Act of 1934, which permits an investment adviser to cause an account
to pay commission rates in excess of those another broker or dealer would
have charged for effecting the same transaction, if the adviser determines in
good faith that the commission paid is reasonable in relation to the value of
the brokerage and research services provided. The determination may be viewed
in terms of either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over which it
exercises investment discretion. Accordingly, while T. Rowe Price cannot
readily determine the extent to which commission rates or net prices charged
by broker-dealers reflect the value of their research services, T. Rowe Price
would expect to assess the reasonableness of commissions in light of the
total brokerage and research services provided by each particular broker. T.
Rowe Price may receive research, as defined in Section 28(e), in connection
with selling concessions and designations in fixed price offerings in which
the funds participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific amount of business
to any broker or dealer over any specific time period. Historically, the
majority of brokerage placement has been determined by the needs of a
specific transaction such as market-making, availability of a buyer or seller
of a particular security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for that portion
of its discretionary client brokerage business where special needs do not
exist, or where the
<PAGE>
business may be allocated among several brokers or dealers which are able to
meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the brokerage and
research services provided by brokers or dealers, and attempts to allocate a
portion of its brokerage business in response to these assessments. Research
analysts, counselors, various investment committees, and the Trading
Department each seek to evaluate the brokerage and research services they
receive from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition, brokers or dealers
sometimes suggest a level of business they would like to receive in return
for the various brokerage and research services they provide. Actual
brokerage received by any firm may be less than the suggested allocations but
can, and often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above. In no case
is a broker or dealer excluded from receiving business from T. Rowe Price
because it has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently applied to all
its fully discretionary accounts, which represent a substantial majority of
all assets under management. Research services furnished by brokers or
dealers through which T. Rowe Price effects securities transactions may be
used in servicing all accounts (including non-fund accounts) managed by T.
Rowe Price. Conversely, research services received from brokers or dealers
which execute transactions for the fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the fund.
From time to time, orders for clients may be placed through a computerized
transaction network.
The fund does not allocate business to any broker-dealer on the basis of its
sales of the fund's shares. However, this does not mean that broker-dealers
who purchase fund shares for their clients will not receive business from the
fund.
Some of T. Rowe Price's other clients have investment objectives and programs
similar to those of the fund. T. Rowe Price may occasionally make
recommendations to other clients which result in their purchasing or selling
securities simultaneously with the fund. As a result, the demand for
securities being purchased or the supply of securities being sold may
increase, and this could have an adverse effect on the price of those
securities. It is T. Rowe Price's policy not to favor one client over another
in making recommendations or in placing orders. T. Rowe Price frequently
follows the practice of grouping orders of various clients for execution
which generally results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of transactions at
various prices on a given day, each participating client's proportionate
share of such order reflects the average price paid or received with respect
to the total order. T. Rowe Price has established a general investment policy
that it will ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price funds) if, as a result
of such purchases, 10% or more of the outstanding common stock of such
company would be held by its clients in the aggregate.
At the present time, T. Rowe Price does not recapture commissions or
underwriting discounts or selling group concessions in connection with
taxable securities acquired in underwritten offerings. T. Rowe Price does,
however, attempt to negotiate elimination of all or a portion of the selling
group concession or underwriting discount when purchasing tax-exempt
municipal securities on behalf of its clients in underwritten offerings.
Trade Allocation Policies
T. Rowe Price has developed written trade allocation guidelines for its
Equity, Municipal, and Taxable Fixed Income Trading Desks. Generally, when
the amount of securities available in a public offering or the secondary
market is insufficient to satisfy the volume or price requirements for the
participating client portfolios, the guidelines require a pro-rata allocation
based upon the amounts initially requested by each portfolio manager. In
allocating trades made on combined basis, the Trading Desks seek to achieve
the same net unit price of the securities for each participating client.
Because a pro-rata allocation may not always adequately accommodate all facts
and circumstances, the guidelines provide for exceptions to allocate trades
<PAGE>
on an adjusted, pro-rata basis. Examples of where adjustments may be made
include: (i) reallocations to recognize the efforts of a portfolio manager in
negotiating a transaction or a private placement; (ii) reallocations to
eliminate deminimis positions; (iii) priority for accounts with specialized
investment policies and objectives; and (iv) reallocations in light of a
participating portfolio's characteristics (e.g., industry or issuer
concentration, duration, and credit exposure).
Transactions With Related Brokers and Dealers
As provided in the Investment Management Agreement between the fund and T.
Rowe Price, T. Rowe Price is responsible not only for making decisions with
respect to the purchase and sale of the fund's portfolio securities, but also
for implementing these decisions, including the negotiation of commissions
and the allocation of portfolio brokerage and principal business. It is
expected that, from time to time, T. Rowe Price may place orders for the
fund's portfolio transactions with broker-dealer affiliates of Robert Fleming
Holdings Limited ("RF"), an affiliate of Price-Fleming. RF, through Copthall
Overseas Limited, a wholly owned subsidiary, owns 25% of the common stock of
Price-Fleming. Fifty percent of the common stock of Price-Fleming is owned by
TRP Finance, Inc., a wholly owned subsidiary of T. Rowe Price, and the
remaining 25% is owned by Jardine Fleming International Holdings Limited, a
wholly owned subsidiary of Jardine Fleming Group Limited ("JF"). JF is owned
by RF.
The Board of Directors of the fund has authorized T. Rowe Price to utilize
certain affiliates of RF and JF in the capacity of broker in connection with
the execution of the fund's portfolio transactions. Other affiliates of RF
and JF also may be used. Although it does not believe that the fund's use of
these brokers would be subject to Section 17(e) of the 1940 Act, the Board of
Directors of the fund has agreed that the procedures set forth in Rule 17e-1
under that Act will be followed when using such brokers.
Other
For the fiscal years ended December 31, 1999, 1998, and 1997, the fund
engaged in portfolio transactions involving broker-dealers totaling, $20,000,
$10,000, and $6,000, respectively. The entire amounts represented principal
transactions as to which the fund had no knowledge of the profits or losses
realized by the respective broker-dealers for the fiscal years ended December
31, 1999, 1998, and 1997, respectively. The percentage of total portfolio
transactions, placed with firms which provided research, statistical or other
services to T. Rowe Price in connection with the management of the fund, or
in some cases, to the fund for the fiscal years ended December 31, 1999,
1998, and 1997, were approximately 45.5%, 84.7%, and 0%, respectively.
The portfolio turnover rates for the fiscal years ending December 31, 1999,
1998, and 1997, were 36.2%, 50.9%, and 48.7%, respectively.
PRICING OF SECURITIES
-------------------------------------------------------------------------------
Debt securities are generally traded in the over-the-counter market.
Investments in domestic securities with remaining maturities of one year or
more and foreign securities are stated at fair value using a bid-side
valuation as furnished by dealers who make markets in such securities or by
an independent pricing service, which considers yield or price of bonds of
comparable quality, coupon, maturity, and type, as well as prices quoted by
dealers who make markets in such securities. Domestic securities with
remaining maturities less than one year are stated at fair value which is
determined by using a matrix system that establishes a value for each
security based on bid-side money market yields.There are a number of pricing
services available, and the Board of Directors, on the basis of an ongoing
evaluation of these services, may use or may discontinue the use of any
pricing service in whole or part.
For the purposes of determining the fund's net asset value per share, the
U.S. dollar value of all assets and liabilities initially expressed in
foreign currencies is determined by using the mean of the bid and offer
prices of such currencies against U.S. dollars quoted by a major bank.
<PAGE>
Assets and liabilities for which the above valuation procedures are
inappropriate or are deemed not to reflect fair value, are stated at fair
value as determined in good faith by or under the supervision of the officers
of the fund, as authorized by the Board of Directors.
Investments in mutual funds are valued at the closing net asset value per
share of the mutual fund on the day of valuation. In the absence of a last
sale price, purchased and written options are valued at the mean of the
latest bid and asked prices, respectively.
NET ASSET VALUE PER SHARE
-------------------------------------------------------------------------------
The purchase and redemption price of the fund's shares is equal to the fund's
net asset value per share or share price. The fund determines its net asset
value per share by subtracting its liabilities (including accrued expenses
and dividends payable) from its total assets (the market value of the
securities the fund holds plus cash and other assets, including income
accrued but not yet received) and dividing the result by the total number of
shares outstanding. The net asset value per share of the fund is normally
calculated as of the close of trading on the New York Stock Exchange ("NYSE")
every day the NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Dr. Martin Luther King, Jr. Holiday, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of net asset value (and the offering, sale redemption and
repurchase of shares) for the fund may be suspended at times (a) during which
the NYSE is closed, other than customary weekend and holiday closings, (b)
during which trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable for the fund
fairly to determine the value of its net assets, or (d) during which a
governmental body having jurisdiction over the fund may by order permit such
a suspension for the protection of the fund's shareholders; provided that
applicable rules and regulations of the SEC (or any succeeding governmental
authority) shall govern as to whether the conditions prescribed in (b), (c),
or (d) exist.
DIVIDENDS AND DISTRIBUTIONS
-------------------------------------------------------------------------------
Unless the separate account elects otherwise, the fund's annual capital gain
distribution will be reinvested on the reinvestment date using the NAV per
share of that date. The reinvestment date normally precedes the payment date
by one day, although the exact timing is subject to change and can be as
great as 10 days.
TAX STATUS
-------------------------------------------------------------------------------
The fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code and also intends to diversify its assets in
accordance with regulations under Code Section 817(h).
In 1987, the Treasury Department indicated that it may issue regulations
addressing the circumstances in which a policyholder's control of the
investments of the insurance company separate account would result in the
policyholder being treated as the owner of such assets. Although there is no
present indication that such regulations will be issued, their adoption could
alter the tax treatment of the policyholder, separate account or insurance
company.
For tax purposes, the fund must declare dividends by December 31 of each year
equal to at least 98% of ordinary income (as of December 31) and capital
gains (as of October 31) in order to avoid a federal excise tax and
distribute within 12 months 100% of ordinary income and capital gains as of
December 31 to avoid a federal income tax. In certain circumstances, the fund
may not be required to comply with the excise tax
<PAGE>
distribution requirements. It does not make any difference whether dividends
and capital gain distributions are paid in cash or in additional shares.
At the time a shareholder acquires fund shares, the fund's net asset value
may reflect undistributed income, capital gains or net unrealized
appreciation of securities held by the fund which may be subsequently
distributed as either dividends or capital gain distributions.
If, in any taxable year, the fund should not qualify as a regulated
investment company under the Code: (i) the fund would be taxed at normal
corporate rates on the entire amount of its taxable income, if any, without
deduction for dividends or other distributions to shareholders; and (ii) the
fund's distributions to the extent made out of the fund's current or
accumulated earnings and profits would be treated as ordinary dividends by
shareholders (regardless of whether they would otherwise have been considered
capital gain dividends), and (iii) the separate accounts investing in the
fund may fail to satisfy the requirements of Code Section 817(h) which in
turn could adversely affect the tax status of life insurance and annuity
contracts with premiums invested in the affected separate accounts.
To the extent the fund invests in foreign securities, the following would
apply:
Passive Foreign Investment Companies
The fund may purchase the securities of certain foreign investment funds or
trusts called passive foreign investment companies. Such trusts have been the
only or primary way to invest in certain countries. In addition to bearing
their proportionate share of the trust's expenses (management fees and
operating expenses), shareholders will also indirectly bear similar expenses
of such trusts. Capital gains on the sale of such holdings are considered
ordinary income regardless of how long the fund held its investment. In
addition, the fund may be subject to corporate income tax and an interest
charge on certain dividends and capital gains earned from these investments,
regardless of whether such income and gains are distributed to shareholders.
To avoid such tax and interest, the fund intends to treat these securities as
sold on the last day of its fiscal year and recognize any gains for tax
purposes at that time; deductions for losses are allowable only to the extent
of any gains resulting from these deemed sales for prior taxable years. Such
gains and losses will be treated as ordinary income. The fund will be
required to distribute any resulting income even though it has not sold the
security and received cash to pay such distributions.
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of gain or loss on
the sale of debt securities attributable to foreign exchange rate
fluctuations, are taxable as ordinary income. If the net effect of these
transactions is a gain, the ordinary income dividend paid by the fund will be
increased. If the result is a loss, the income dividend paid by the fund will
be decreased, or to the extent such dividend has already been paid, it may be
classified as a return of capital. Adjustments to reflect these gains and
losses will be made at the end of the fund's taxable year.
YIELD INFORMATION
-------------------------------------------------------------------------------
An income factor is calculated for each security in the portfolio based upon
the security's market value at the beginning of the period and yield as
determined in conformity with regulations of the SEC. The income factors are
then totaled for all securities in the portfolio. Next, expenses of the fund
for the period, net of expected reimbursements, are deducted from the income
to arrive at net income, which is then converted to a per share amount by
dividing net income by the average number of shares outstanding during the
period. The net income per share is divided by the net asset value on the
last day of the period to produce a monthly yield which is then annualized.
If applicable, a taxable-equivalent yield is calculated by dividing this
yield by one minus the effective federal, state, and/or city or local income
tax rates. Quoted yield factors are for comparison
<PAGE>
purposes only, and are not intended to indicate future performance or
forecast the dividend per share of the fund.
The yield of the fund calculated under the above-described method for the
month ended December 31, 1999, was 6.37%.
INVESTMENT PERFORMANCE
-------------------------------------------------------------------------------
Total Return Performance
The fund's calculation of total return performance includes the reinvestment
of all capital gain distributions and income dividends for the period or
periods indicated, without regard to tax consequences to a shareholder in the
fund. Total return is calculated as the percentage change between the
beginning value of a static account in the fund and the ending value of that
account measured by the then current net asset value, including all shares
acquired through reinvestment of income and capital gain dividends. The
results shown are historical and should not be considered indicative of the
future performance of the fund. Each average annual compound rate of return
is derived from the cumulative performance of the fund over the time period
specified. The annual compound rate of return for the fund over any other
period of time will vary from the average.
<TABLE>
<CAPTION>
Performance of Limited-Term Bond Portfolio
1 Yr. 5 Yrs. 10 Yrs. % Since Inception
----- ------ ------- ------- ---------
Ended Ended Ended Inception Date
- --------------------------- ----- ----- ----- --------- ----
12/31/99 12/31/99 12/31/99 12/31/99
-------- -------- -------- --------
----------------------------------------------------
<S> <C> <C> <C> <C> <S>
Cumulative Performance
Percentage Change 0.84% 31.00% -- 34.44% 05/13/94
Average Annual Compound 0.84 5.55 -- 5.39 05/13/94
Rates of Return
- -------------------------------------------------------------------------------
</TABLE>
Outside Sources of Information
From time to time, in reports and promotional literature: (1) the fund's
total return performance, ranking, or any other measure of the fund's
performance may be compared to any one or combination of the following: (a) a
broad-based index; (b) other groups of mutual funds, including T. Rowe Price
funds, tracked by independent research firms ranking entities, or financial
publications; (c) indices of securities comparable to those in which the fund
invests; (2) the Consumer Price Index (or any other measure for inflation,
government statistics, such as GNP may be used to illustrate investment
attributes of the fund or the general economic, business, investment, or
financial environment in which the fund operates; (3) various financial,
economic, and market statistics developed by brokers, dealers, and other
persons may be used to illustrate aspects of the fund's performance; (4) the
effect of tax-deferred compounding on the fund's investment returns, or on
returns in general in both qualified and nonqualified retirement plans or any
other tax advantage product, may be illustrated by graphs, charts, etc.; and
(5) the sectors or industries in which the fund invests may be compared to
relevant indices or surveys in order to evaluate the fund's historical
performance or current or potential value with respect to the particular
industry or sector.
Other Publications
From time to time, in newsletters and other publications issued by Investment
Services, T. Rowe Price mutual fund portfolio managers may discuss economic,
financial, and political developments in the U.S. and abroad and how these
conditions have affected or may affect securities prices or the fund;
individual securities within the fund's portfolio; and their philosophy
regarding the selection of individual stocks, including why specific stocks
have been added, removed, or excluded from the fund's portfolio.
<PAGE>
Other Features and Benefits
The fund is a member of the T. Rowe Price family of funds and may help
investors achieve various long-term investment goals, which include, but are
not limited to, investing money for retirement, saving for a down payment on
a home, or paying college costs. To explain how the fund could be used to
assist investors in planning for these goals and to illustrate basic
principles of investing, various worksheets and guides prepared by T. Rowe
Price and/or Investment Services may be made available.
No-Load Versus Load and 12b-1 Funds
Many mutual funds charge sales fees to investors or use fund assets to
finance distribution activities. These fees are in addition to the normal
advisory fees and expenses charged by all mutual funds. There are several
types of fees charged which vary in magnitude and which may often be used in
combination. A sales charge (or "load") can be charged at the time the fund
is purchased (front-end load) or at the time of redemption (back-end load).
Front-end loads are charged on the total amount invested. Back-end loads or
"redemption fees" are charged either on the amount originally invested or on
the amount redeemed. 12b-1 plans allow for the payment of marketing and sales
expenses from fund assets. These expenses are usually computed daily as a
fixed percentage of assets.
The fund is a no-load fund which imposes no sales charges or 12b-1 fees.
No-load funds are generally sold directly to the public without the use of
commissioned sales representatives. This means that 100% of your purchase is
invested for you.
Redemptions in Kind
The fund has filed a notice of election under Rule 18f-1 of the 1940 Act.
This permits the fund to effect redemptions in kind as set forth in its
prospectus.
In the unlikely event a shareholder were to receive an in kind redemption of
portfolio securities of the fund, it would be the responsibility of the
shareholder to dispose of the securities. The shareholder would be at risk
that the value of the securities would decline prior to their sale, that it
would be difficult to sell the securities and that brokerage fees could be
incurred.
Issuance of Fund Shares for Securities
Transactions involving issuance of fund shares for securities or assets other
than cash will be limited to (1) bona fide reorganizations; (2) statutory
mergers; or (3) other acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the fund; (b) are acquired for
investment and not for resale except in accordance with applicable law; (c)
have a value that is readily ascertainable via listing on or trading in a
recognized United States or international exchange or market; and (d) are not
illiquid.
CAPITAL STOCK
-------------------------------------------------------------------------------
The Charter of the Corporation authorizes its Board of Directors to classify
and reclassify any and all shares which are then unissued, including unissued
shares of capital stock into any number of classes or series, each class or
series consisting of such number of shares and having such designations, such
powers, preferences, rights, qualifications, limitations, and restrictions,
as shall be determined by the Board subject to the 1940 Act and other
applicable law. Currently, the Corporation consists of two series: the T.
Rowe Price Limited-Term Bond Portfolio established in 1994, and T. Rowe Price
Prime Reserve Portfolio established in 1996. (The other fund is described in
a separate Statement of Additional Information.) The shares of any such
additional classes or series might therefore differ from the shares of the
present class and series of capital stock and from each other as to
preferences, conversions or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or terms or conditions of
redemption, subject to applicable law, and might thus be superior or inferior
to the capital stock or to other classes or series in various
characteristics. The Corporation's Board of Directors may increase or
decrease the aggregate number of shares of stock or the number of shares of
stock of any class or series that the fund has authorized to issue without
shareholder approval.
<PAGE>
The various insurance companies own the outstanding shares of the fund in
their separate accounts. These separate accounts are registered as investment
companies under the 1940 Act or are excluded from registration. Each
insurance company, as the Shareholder, is entitled to one vote for each full
share held (and fractional votes for fractional shares held). Under the
current laws, the insurance companies must vote the shares held in registered
separate accounts in accordance with voting instructions received from
variable contract holders or participants. Fund shares for which contract
holders or participants are entitled to give voting instructions, but as to
which no voting instructions are received, and shares owned by the insurance
companies or affiliated companies in the separate accounts, will be voted in
proportion to the shares for which voting instructions have been received.
There will normally be no meeting of shareholders for the purpose of electing
directors unless and until such time as less than a majority of the directors
holding office have been elected by shareholders, at which time the directors
then in office will call a shareholders' meeting for the election of
directors. Except as set forth above, the directors shall continue to hold
office and may appoint successor directors. Voting rights are not cumulative,
so that the holders of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors of the fund,
in which event the holders of the remaining shares will be unable to elect
any person as a director. As set forth in the By-Laws of the Corporation, a
special meeting of shareholders of the Corporation shall be called by the
Secretary of the Corporation on the written request of shareholders entitled
to cast at least 10% of all the votes of the Corporation entitled to be cast
at such meeting. Shareholders requesting such a meeting must pay to the
Corporation the reasonably estimated costs of preparing and mailing the
notice of the meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating to the
other shareholders of the Corporation to the extent required by Section 16(c)
of the 1940 Act.
FEDERAL REGISTRATION OF SHARES
-------------------------------------------------------------------------------
The fund's shares are registered for sale under the 1933 Act. Registration of
the fund's shares is not required under any state law, but the fund is
required to make certain filings with and pay fees to the states in order to
sell its shares in the states.
LEGAL COUNSEL
-------------------------------------------------------------------------------
Swidler Berlin Shereff Friedman, LLP, whose address is The Chrysler Building,
405 Lexington Avenue, New York, New York 10174, is legal counsel to the fund.
INDEPENDENT ACCOUNTANTS
-------------------------------------------------------------------------------
PricewaterhouseCoopers LLP, 250 West Pratt Street, 21st Floor, Baltimore,
Maryland 21201, are the independent accountants to the funds.
The financial statements of the fund for the year ended December 31, 1999,
and the report of independent accountants are included in the fund's Annual
Report for the year ended December 31, 1999. A copy of the Annual Report
accompanies this Statement of Additional Information. The following financial
statements and the report of independent accountants appearing in the Annual
Report for the year ended December 31, 1999, are incorporated into this
Statement of Additional Information by reference:
<PAGE>
<TABLE>
<CAPTION>
ANNUAL REPORT REFERENCES:
LIMITED-TERM
BOND PORTFOLIO
--------------
<S> <C>
Financial Highlights 5
Statement of Net Assets, December 31, 1999 6-9
Statement of Operations, year ended December 31, 1999 10
Statement of Changes in Net Assets, years ended
December 31, 1999 and December 31, 1998 11
Notes to Financial Statements, December 31, 1999 12-13
Report of Independent Accountants 14
</TABLE>
RATINGS OF COMMERCIAL PAPER
-------------------------------------------------------------------------------
Moody's Investors Service, Inc. The rating of Prime-1 is the highest
commercial paper rating assigned by Moody's. Among the factors considered by
Moody's in assigning rating are the following: valuation of the management of
the issuer; economic evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in certain areas;
evaluation of the issuer's products in relation to competition and customer
acceptance; liquidity; amount and quality of long-term debt; trend of
earnings over a period of 10 years; financial strength of the parent company
and the relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a result of
public interest questions and preparations to meet such obligations. These
factors are all considered in determining whether the commercial paper is
rated P1, P2, or P3.
Standard & Poor's Corporation Commercial paper rated A (highest quality) by
S&P has the following characteristics: liquidity ratios are adequate to meet
cash requirements; long-term senior debt is rated "A" or better, although in
some cases "BBB" credits may be allowed. The issuer has access to at least
two additional channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a strong position
within the industry. The reliability and quality of management are
unquestioned. The relative strength or weakness of the above factors
determines whether the issuer's commercial paper is rated A1, A2, or A3.
Fitch IBCA, Inc. Fitch 1-Highest grade Commercial paper assigned this rating
is regarded as having the strongest degree of assurance for timely payment.
Fitch 2-Very good grade Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest issues.
RATINGS OF CORPORATE DEBT SECURITIES
-------------------------------------------------------------------------------
Moody's Investors Service, Inc.
Aaa-Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edge."
Aa-Bonds rated Aa are judged to be of high quality by all standards. Together
with the Aaa group they comprise what are generally know as high-grade bonds.
A-Bonds rated A possess many favorable investment attributes and are to be
considered as upper medium-grade obligations.
Baa-Bonds rated Baa are considered as medium-grade obligations, i.e., they
are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
<PAGE>
elements may be lacking or may be characteristically unreliable over any
great length of time. Such bonds lack outstanding investment characteristics
and in fact have speculative characteristics as well.
Ba-Bonds rated Ba are judged to have speculative elements: their futures
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterize bonds in this class.
B-Bonds rated B generally lack the characteristics of a desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa-Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or
interest.
Ca-Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.
C-Bonds rated C represent the lowest-rated, and have extremely poor prospects
of attaining investment standing.
Standard & Poor's Corporation
AAA-This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA-Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong.
A-Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category.
BB, B, CCC, CC, C-Bonds rated BB, B, CCC, CC, and C are regarded on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal. BB indicates the lowest degree of speculation
and C the highest degree of speculation. While such bonds will likely have
some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
D-In default.
Fitch IBCA, Inc.
AAA-High grade, broadly marketable, suitable for investment by trustees and
fiduciary institutions, and liable to slight market fluctuation other than
through changes in the money rate. The prime feature of a "AAA" bond is the
showing of earnings several times or many times interest requirements for
such stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features may enter, such
as wide margin of protection through collateral, security or direct lien on
specific property. Sinking funds or voluntary reduction of debt by call or
purchase or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA-Of safety virtually beyond question and readily salable. Their merits are
not greatly unlike those of "AAA" class but a bond so rated may be junior
though of strong lien, or the margin of safety is less strikingly broad. The
issue may be the obligation of a small company, strongly secured, but
influenced as to rating by the lesser financial power of the enterprise and
more local type of market.
<PAGE>
A-Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB-Bonds rated BBB are considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions ad
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the ratings
of these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB, B, CCC, CC, and C are regarded on balance as predominantly speculative
with respect to the issuer's capacity to repay interest and repay principal
in accordance with the terms of the obligation for bond issues not in
default. BB indicates the lowest degree of speculation and C the highest
degree of speculation. The rating takes into consideration special features
of the issue, its relationship to other obligations of the issuer, and the
current and prospective financial condition and operating performance of the
issuer.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price Variable Annuity
Statement of Additional Information for the Fund
The date of this Statement of Additional Information is May 1, 2000.
T. ROWE PRICE FIXED INCOME SERIES, INC. (the "Corporation")
T. Rowe Price Prime Reserve Portfolio (the "fund")
-------------------------------------------------------------------------------
Mailing Address: T. Rowe Price Variable Annuity Service Center P.O. Box
750440 Topeka, Kansas 66675-0440 1-800-469-6587
Shares of the fund are designed to be offered to insurance company separate
accounts established for the purpose of funding variable annuity contracts.
They may also be offered to insurance company separate accounts established
for the purpose of funding variable life contracts. Variable annuity and
variable life contract holders or participants are not the shareholders of
the fund. Rather, the separate account is the shareholder. The variable
annuity and variable life contracts are described in separate prospectuses
issued by the insurance companies. The fund assumes no responsibility for any
insurance company prospectuses or variable annuity or variable life
contracts.
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the appropriate fund's prospectus dated May 1, 2000,
which may be obtained by contacting the T. Rowe Price Variable Annuity
Service Center.
The fund's financial statements for the year ended December 31, 1999, and the
report of independent accountants are included in the fund's Annual Report
and incorporated by reference into this Statement of Additional Information.
TRP609 (5/00)
K15-144
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
-----------------
Page Page
---- ----
<S> <C> <C> <C> <C>
Capital Stock 2 Legal Counsel 23
2
- ----------------------------------- ---------------------------------------
Code of Ethics Management of
15 the 11
Fund
- ----------------------------------- ---------------------------------------
Custodian 15 Net Asset Value Per Share 19
- ----------------------------------- ---------------------------------------
Distributor for the Fund 14 Portfolio Management Practices 8
- ----------------------------------- ---------------------------------------
Dividends and Distributions 20 Portfolio Transactions 15
- ----------------------------------- ---------------------------------------
Federal Registration of 23 Pricing of Securities 18
Shares
- ----------------------------------- ---------------------------------------
Independent Accountants 2 Principal Holders of Securities 13
3
- ----------------------------------- ---------------------------------------
Investment Management 13 Ratings of Commercial Paper 24
Services
- ----------------------------------- ---------------------------------------
Investment Objectives and 2 Risk Factors 2
Policies
- ----------------------------------- ---------------------------------------
Investment Performance 21 Tax Status 20
- ----------------------------------- ---------------------------------------
Investment Program 3 Yield Information 21
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Investment Restrictions 9
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</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
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The following information supplements the discussion of the fund's investment
objectives and policies discussed in the fund's prospectus.
The fund will not make a material change in its investment objectives without
obtaining shareholder approval. Unless otherwise specified, the investment
programs and restrictions of the fund are not fundamental policies. The
fund's operating policies are subject to change by its Board of Directors
without shareholder approval. However, shareholders will be notified of a
material change in an operating policy. The fund's fundamental policies may
not be changed without the approval of at least a majority of the outstanding
shares of the fund or, if it is less, 67% of the shares represented at a
meeting of shareholders at which the holders of 50% or more of the shares are
represented. References to the following are as indicated:
Investment Company Act of 1940 ("1940 Act")
Securities and Exchange Commission ("SEC")
T. Rowe Price Associates, Inc. ("T. Rowe Price")
Moody's Investors Service, Inc. ("Moody's")
Standard & Poor's Corporation ("S&P")
Internal Revenue Code of 1986 ("Code")
Rowe Price-Fleming International, Inc. ("Price-Fleming")
RISK FACTORS
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Reference is also made to the sections entitled "Types of Securities" and
"Portfolio Management Practices" for discussions of the risks associated with
the investments and practices described therein as they apply to the fund.
<PAGE>
Debt Obligations
Yields on short-, intermediate-, and long-term debt securities are dependent
on a variety of factors, including the general conditions of the money and
bond markets, the size of a particular offering, the maturity of the
obligation, and the credit quality and rating of the issue. Debt securities
with longer maturities tend to have higher yields and are generally subject
to potentially greater capital appreciation and depreciation than obligations
with shorter maturities and lower yields. The market prices of debt
securities usually vary, depending upon available yields. An increase in
interest rates will generally reduce the value of portfolio debt securities,
and a decline in interest rates will generally increase the value of
portfolio debt securities. The ability of the fund to achieve its investment
objective is also dependent on the continuing ability of the issuers of the
debt securities in which the fund invests to meet their obligations for the
payment of interest and principal when due. Although the fund seeks to reduce
risk by portfolio diversification, credit analysis, and attention to trends
in the economy, industries, and financial markets, such efforts will not
eliminate all risk. There can, of course, be no assurance that the fund will
achieve its investment objective.
After purchase by a fund, a security may cease to be rated or its rating may
be reduced below the minimum required for purchase by the fund. The fund will
follow the procedures set forth in Rule 2a-7 under the 1940 Act in its
determination of whether the fund should continue to hold the security. To
the extent that the ratings given by Moody's or S&P may change as a result of
changes in such organizations or their rating systems, the fund will attempt
to use comparable ratings as standards for investments in accordance with the
investment policies contained in the prospectus. When purchasing unrated
securities, T. Rowe Price, under the supervision of the fund's Board of
Directors, determines whether the unrated security is of a quality comparable
to that which the fund is allowed to purchase.
Securities backed by the full faith and credit of the United States (for
example, GNMA and U.S. Treasury securities) are generally considered to be
among the most, if not the most, creditworthy investments available. While
the U.S. government has honored its credit obligations continuously for the
last 200 years, political events in 1995 and 1996, at times, called into
question whether the United States would default on its obligations. Such an
event would be unprecedented and there is no way to predict its results on
the securities markets or the fund. However, it is very likely default by the
U.S. would result in losses to the fund.
There can be no assurance that the fund will achieve its investment objective
or be able to maintain its net asset value per share at $1.00. The price of
the fund is not guaranteed or insured by the U.S. government and its yield is
not fixed. An increase in interest rates could reduce the value of the fund's
portfolio investments, and a decline in interest rates could increase the
value.
INVESTMENT PROGRAM
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Types of Securities
Set forth below is additional information about certain of the investments
described in the fund's prospectus.
Debt Securities
Fixed income securities in which the fund may invest include, but are not
limited to, those described below.
. U.S. Government Obligations Bills, notes, bonds, and other debt securities
issued by the U.S. Treasury. These are direct obligations of the U.S.
government and differ mainly in the length of their maturities.
. U.S. Government Agency Securities Issued or guaranteed by U.S.
government-sponsored enterprises and federal agencies. These include
securities issued by the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Bank, Federal Land Banks,
Farmers Home Administration, Banks for Cooperatives, Federal Intermediate
Credit Banks, Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these securities are
supported by the full faith and credit of the U.S. Treasury; the remainder
are supported only by the credit of the instrumentality, which may or may not
include the right of the issuer to borrow from the Treasury.
<PAGE>
. Bank Obligations Certificates of deposit, bankers' acceptances, and other
short-term debt obligations. Certificates of deposit are short-term
obligations of commercial banks. A bankers' acceptance is a time draft drawn
on a commercial bank by a borrower, usually in connection with international
commercial transactions. Certificates of deposit may have fixed or variable
rates. The fund may invest in U.S. banks, foreign branches of U.S. banks,
U.S. branches of foreign banks, and foreign branches of foreign banks.
. Corporate Debt Securities Outstanding nonconvertible corporate debt
securities (e.g., bonds and debentures) which have one year or less remaining
to maturity. Corporate notes may have fixed, variable, or floating rates.
. Commercial Paper and Commercial Notes Short-term promissory notes issued by
corporations primarily to finance short-term credit needs. Certain notes may
have floating or variable rates and may contain options, exercisable by
either the buyer or the seller, that extend or shorten the maturity of the
note.
. Foreign Government Securities Issued or guaranteed by a foreign government,
province, instrumentality, political subdivision, or similar unit thereof.
. Savings and Loan Obligations Negotiable certificates of deposit and other
short-term debt obligations of savings and loan associations.
. Supranational Agencies Securities of certain supranational entities, such as
the International Development Bank.
Asset-Backed Securities
The credit quality of most asset-backed securities depends primarily on the
credit quality of the assets underlying such securities, how well the entity
issuing the security is insulated from the credit risk of the originator or
any other affiliated entities and the amount and quality of any credit
support provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of principal payments
received on the underlying assets, which in turn may be affected by a variety
of economic and other factors. As a result, the yield on any asset-backed
security is difficult to predict with precision and actual yield to maturity
may be more or less than the anticipated yield to maturity. Asset-backed
securities may be classified as pass-through certificates or collateralized
obligations.
Pass-through certificates are asset-backed securities which represent an
undivided fractional ownership interest in an underlying pool of assets.
Pass-through certificates usually provide for payments of principal and
interest received to be passed through to their holders, usually after
deduction for certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest in the
underlying assets, the holders thereof bear directly the risk of any defaults
by the obligors on the underlying assets not covered by any credit support.
See "Types of Credit Support."
Asset-backed securities issued in the form of debt instruments, also known as
collateralized obligations, are generally issued as the debt of a special
purpose entity organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card or
automobile receivables. The assets collateralizing such asset-backed
securities are pledged to a trustee or custodian for the benefit of the
holders thereof. Such issuers generally hold no assets other than those
underlying the asset-backed securities and any credit support provided. As a
result, although payments on such asset-backed securities are obligations of
the issuers, in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing entities are
unlikely to have sufficient assets to satisfy their obligations on the
related asset-backed securities.
. Methods of Allocating Cash Flows While many asset-backed securities are
issued with only one class of security, many asset-backed securities are
issued in more than one class, each with different payment terms. Multiple
class asset-backed securities are issued for two main reasons. First,
multiple classes may be used as a method of providing credit support. This is
accomplished typically through creation of one or more classes whose right to
payments on the asset-backed security is made subordinate to the right to
such payments of the remaining class or classes. See "Types of Credit
Support." Second, multiple classes may permit the issuance of
<PAGE>
securities with payment terms, interest rates or other characteristics
differing both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed securities
entitling the holder to disproportionate interests with respect to the
allocation of interest and principal of the assets backing the security), and
securities with class or classes having characteristics which mimic the
characteristics of non-asset-backed securities, such as floating interest
rates (i.e., interest rates which adjust as a specified benchmark changes) or
scheduled amortization of principal.
Asset-backed securities in which the payment streams on the underlying assets
are allocated in a manner different than those described above may be issued
in the future. The fund may invest in such asset-backed securities if such
investment is otherwise consistent with its investment objectives and
policies and with the investment restrictions of the fund.
. Types of Credit Support Asset-backed securities are often backed by a pool
of assets representing the obligations of a number of different parties. To
lessen the effect of failures by obligors on underlying assets to make
payments, such securities may contain elements of credit support. Such credit
support falls into two classes: liquidity protection and protection against
ultimate default by an obligor on the underlying assets. Liquidity protection
refers to the provision of advances, generally by the entity administering
the pool of assets, to ensure that scheduled payments on the underlying pool
are made in a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the assets in
the pool. Such protection may be provided through guarantees, insurance
policies or letters of credit obtained from third parties "external credit
enhancement," through various means of structuring the transaction "internal
credit enhancement," or through a combination of such approaches. Examples of
asset-backed securities with credit support arising out of the structure of
the transaction include "senior-subordinated securities" (multiple class
asset-backed securities with certain classes subordinate to other classes as
to the payment of principal thereon, with the result that defaults on the
underlying assets are borne first by the holders of the subordinated class)
and asset-backed securities that have "reserve funds" (where cash or
investments, sometimes funded from a portion of the initial payments on the
underlying assets, are held in reserve against future losses) or that have
been "over collateralized" (where the scheduled payments on, or the principal
amount of, the underlying assets substantially exceeds that required to make
payment of the asset-backed securities and pay any servicing or other fees).
The degree of credit support provided on each issue is based generally on
historical information respecting the level of credit risk associated with
such payments. Depending upon the type of assets securitized, historical
information on credit risk and prepayment rates may be limited or even
unavailable. Delinquency or loss in excess of that anticipated could
adversely affect the return on an investment in an asset-backed security.
. Automobile Receivable Securities The fund may invest in asset-backed
securities which are backed by receivables from motor vehicle installment
sales contracts or installment loans secured by motor vehicles ("Automobile
Receivable Securities"). Since installment sales contracts for motor vehicles
or installment loans related thereto ("Automobile Contracts") typically have
shorter durations and lower incidences of prepayment, Automobile Receivable
Securities generally will exhibit a shorter average life and are less
susceptible to prepayment risk.
Most entities that issue Automobile Receivable Securities create an
enforceable interest in their respective Automobile Contracts only by filing
a financing statement and by having the servicer of the Automobile Contracts,
which is usually the originator of the Automobile Contracts, take custody
thereof. In such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in violation of
its obligation not to do so, there is a risk that such party could acquire an
interest in the Automobile Contracts superior to that of the holders of
Automobile Receivable Securities. Also, although most Automobile Contracts
grant a security interest in the motor vehicle being financed, in most states
the security interest in a motor vehicle must be noted on the certificate of
title to create an enforceable security interest against competing claims of
other parties. Due to the large number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually is not
amended to reflect the assignment of the seller's security interest for the
benefit of the holders of the Automobile Receivable Securities. Therefore,
there is the possibility that recoveries on repossessed collateral may not,
in some cases, be available to support payments
<PAGE>
on the securities. In addition, various state and federal securities laws
give the motor vehicle owner the right to assert against the holder of the
owner's Automobile Contract certain defenses such owner would have against
the seller of the motor vehicle. The assertion of such defenses could reduce
payments on the Automobile Receivable Securities.
. Credit Card Receivable Securities The fund may invest in asset-backed
securities backed by receivables from revolving credit card agreements
("Credit Card Receivable Securities"). Credit balances on revolving credit
card agreements ("Accounts") are generally paid down more rapidly than are
Automobile Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order to lengthen
the maturity of Credit Card Receivable Securities, most such securities
provide for a fixed period during which only interest payments on the
underlying Accounts are passed through to the security holder and principal
payments received on such Accounts are used to fund the transfer to the pool
of assets supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial fixed period
usually may be shortened upon the occurrence of specified events which signal
a potential deterioration in the quality of the assets backing the security,
such as the imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable Securities thus
depends upon the continued generation of additional principal amounts in the
underlying account during the initial period and the non-occurrence of
specified events. An acceleration in cardholders' payment rates or any other
event which shortens the period during which additional credit card charges
on an Account may be transferred to the pool of assets supporting the related
Credit Card Receivable Security could shorten the weighted average life and
yield of the Credit Card Receivable Security.
Credit cardholders are entitled to the protection of a number of state and
federal consumer credit laws, many of which give such holder the right to set
off certain amounts against balances owed on the credit card, thereby
reducing amounts paid on Accounts. In addition, unlike most other
asset-backed securities, Accounts are unsecured obligations of the
cardholder.
Other Assets Asset-backed securities backed by assets other than those
described above, including, but not limited to, small business loans and
accounts receivable, equipment leases, commercial real estate loans, boat
loans, and manufacturing housing loans. The fund may invest in such
securities in the future if such investment is otherwise consistent with its
investment objective and policies.
There are, of course, other types of securities that are, or may become
available, which are similar to the foregoing and the fund may invest in
these securities.
When-Issued Securities and Forward Commitment Contracts
The price of such securities, which may be expressed in yield terms, is fixed
at the time the commitment to purchase is made, but delivery and payment take
place at a later date. Normally, the settlement date occurs within 90 days of
the purchase for When-Issueds, but may be substantially longer for Forwards.
During the period between purchase and settlement, no payment is made by the
fund to the issuer and no interest accrues to the fund. The purchase of these
securities will result in a loss if their value declines prior to the
settlement date. This could occur, for example, if interest rates increase
prior to settlement. The longer the period between purchase and settlement,
the greater the risks are. At the time the fund makes the commitment to
purchase these securities, it will record the transaction and reflect the
value of the security in determining its net asset value. The fund will cover
these securities by maintaining cash, liquid, high-grade debt securities, or
other suitable cover as permitted by the SEC with its custodian bank equal in
value to commitments for them during the time between the purchase and the
settlement. Therefore, the longer this period, the longer the period during
which alternative investment options are not available to the fund (to the
extent of the securities used for cover). Such securities either will mature
or, if necessary, be sold on or before the settlement date.
To the extent the fund remains fully or almost fully invested (in securities
with a remaining maturity of more than one year) at the same time it
purchases these securities, there will be greater fluctuations in the fund's
net asset value than if the fund did not purchase them.
<PAGE>
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest rates that are
reset periodically by predetermined formulas or indexes in order to minimize
movements in the principal value of the investment. Such securities may have
long-term maturities, but may be treated as a short-term investment under
certain conditions. Generally, as interest rates decrease or increase, the
potential for capital appreciation or depreciation on these securities is
less than for fixed-rate obligations. These securities may take the following
forms:
. Variable Rate Securities A variable rate instrument is one whose terms
provide for the adjustment of its interest rate on set dates and which, upon
each adjustment until the final maturity of the instrument or the period
remaining until the principal amount can be recovered through demand, can
reasonably be expected to have a market value which approximates its
amortized cost. A variable rate instrument, the principal amount of which is
scheduled to be paid in 397 calendar days or less, is deemed to have a
maturity equal to the earlier of the period remaining until the next
readjustment of the interest rate or the period remaining until the principal
amount can be recovered through demand. A variable rate instrument the
principal amount of which is scheduled to be paid in more than 397 calendar
days and which is subject to a demand feature which entitles the purchaser to
receive the principal amount of the underlying security or securities, either
(i) at any time upon notice of no more than 30 days, or (ii) at specified
intervals not exceeding 397 calendar days and upon no more than 30 days'
notice ("Demand Feature"), is deemed to have a maturity equal to the longer
of the period remaining until the next readjustment of the interest rate or
the period remaining until the principal amount can be recovered through
demand. A government security that is a variable rate security where the
variable rate is readjusted no less frequently than every 762 calendar days
is deemed to have a maturity equal to the period remaining until the next
readjustment of the interest rate.
. Floating Rate Securities A floating rate security provides for the
adjustment of its interest rates whenever a specified interest rate changes
and which, at any time until the final maturity of the instrument or the
period remaining until the principal amount can be recovered through demand,
can reasonably be expected to have a market value that approximates its
amortized cost. A floating rate security, the principal amount of which must
unconditionally be paid in 397 calendar days or less is deemed to have a
maturity of one day. A floating rate security, the principal amount of which
is scheduled to be paid in more than 397 calendar days, that is subject to a
Demand Feature is deemed to have a maturity equal to the period remaining
until the principal amount can be recovered through demand. A government
security that is a floating rate security is deemed to have a remaining
maturity of one day.
. Put Option Bonds Long-term obligations with maturities longer than one year
may provide purchasers an optional or mandatory tender of the security at par
value at predetermined intervals, often ranging from one month to several
years (e.g., a 30-year bond with a five-year tender period). These
instruments are deemed to have a maturity equal to the period remaining to
the put date.
Illiquid or Restricted Securities
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act of 1933 (the "1933 Act"). Where registration
is required, the fund may be obligated to pay all or part of the registration
expenses, and a considerable period may elapse between the time of the
decision to sell and the time the fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the fund might obtain a less favorable
price than prevailed when it decided to sell. Restricted securities will be
priced at fair value as determined in accordance with procedures prescribed
by the fund's Board of Directors. If, through the appreciation of illiquid
securities or the depreciation of liquid securities, the fund should be in a
position where more than 10% of the value of its net assets is invested in
illiquid assets, including restricted securities, the fund will take
appropriate steps to protect liquidity.
Notwithstanding the above, the fund may purchase securities which, while
privately placed, are eligible for purchase and sale under Rule 144A under
the 1933 Act. This rule permits certain qualified institutional buyers, such
as the fund, to trade in privately placed securities even though such
securities are not registered under the 1933 Act. T. Rowe Price, under the
supervision of the fund's Board of Directors, will consider whether
securities purchased under Rule 144A are illiquid and thus subject to the
fund's restriction of
<PAGE>
investing no more than 10% of its net assets in illiquid securities. A
determination of whether a Rule 144A security is liquid or not is a question
of fact. In making this determination, T. Rowe Price will consider the
trading markets for the specific security taking into account the
unregistered nature of a Rule 144A security. In addition, T. Rowe Price could
consider the following: (1) frequency of trades and quotes; (2) number of
dealers and potential purchases; (3) dealer undertakings to make a market;
and (4) the nature of the security and of marketplace trades (e.g., the time
needed to dispose of the security, the method of soliciting offers, and the
mechanics of transfer). The liquidity of Rule 144A securities would be
monitored and, if as a result of changed conditions it is determined that a
Rule 144A security is no longer liquid, the fund's holdings of illiquid
securities would be reviewed to determine what, if any, steps are required to
assure that the fund does not invest more than 10% of its net assets in
illiquid securities. Investing in Rule 144A securities could have the effect
of increasing the amount of the fund's assets invested in illiquid securities
if qualified institutional buyers are unwilling to purchase such securities.
PORTFOLIO MANAGEMENT PRACTICES
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Lending of Portfolio Securities
Securities loans are made to broker-dealers, institutional investors, or
other persons, pursuant to agreements requiring that the loans be
continuously secured by collateral at least equal at all times to the value
of the securities lent, marked to market on a daily basis. The collateral
received will consist of cash, U.S. government securities, letters of credit,
or such other collateral as may be permitted under its investment program.
While the securities are being lent, the fund will continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities,
as well as interest on the investment of the collateral or a fee from the
borrower. The fund has a right to call each loan and obtain the securities,
within such period of time which coincides with the normal settlement period
for purchases and sales of such securities in the respective markets. The
fund will not have the right to vote on securities while they are being lent,
but it will call a loan in anticipation of any important vote. The risks in
lending portfolio securities, as with other extensions of secured credit,
consist of possible delay in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral
should the borrower fail financially. Loans will only be made to firms deemed
by T. Rowe Price to be of good standing and will not be made unless, in the
judgment of T. Rowe Price, the consideration to be earned from such loans
would justify the risk.
Interfund Borrowing and Lending
The fund is a party to an exemptive order received from the SEC on December
8, 1998, amended on November 23, 1999, that permits it to borrow money from
and/or lend money to other funds in the T. Rowe Price complex ("Price
Funds"). All loans are set at an interest rate between the rate charged on
overnight repurchase agreements and short-term bank loans. All loans are
subject to numerous conditions designed to ensure fair and equitable
treatment of all participating funds. The program is subject to the oversight
and periodic review of the Boards of Directors of the Price Funds.
Repurchase Agreements
The fund may enter into a repurchase agreement through which an investor
(such as the fund) purchases a security (known as the "underlying security")
from a well-established securities dealer or a bank that is a member of the
Federal Reserve System. Any such dealer or bank will be on T. Rowe Price's
approved list. At that time, the bank or securities dealer agrees to
repurchase the underlying security at the same price, plus specified
interest. Repurchase agreements are generally for a short period of time,
often less than a week. Repurchase agreements which do not provide for
payment within seven days will be treated as illiquid securities. The fund
will only enter into repurchase agreements where (i) the underlying
securities are either U.S. government securities or securities that, at the
time the repurchase agreement is entered into, are rated in the highest
rating category by the requisite number of NRSROs (as required by Rule 2a-7
under the 1940 Act) and otherwise are of the type (excluding maturity
limitations) which the fund's investment guidelines would allow it to
purchase directly; (ii) the market value of the underlying security,
including interest accrued, will
<PAGE>
be equal to or exceed the value of the repurchase agreement; and (iii)
payment for the underlying security is made only upon physical delivery or
evidence of book-entry transfer to the account of the custodian or a bank
acting as agent. In the event of a bankruptcy or other default of a seller of
a repurchase agreement, the fund could experience both delays in liquidating
the underlying security and losses, including: (a) possible decline in the
value of the underlying security during the period while the fund seeks to
enforce its rights thereto; (b) possible subnormal levels of income and lack
of access to income during this period; and (c) expenses of enforcing its
rights.
Reverse Repurchase Agreements
Although the fund has no current intention of engaging in reverse repurchase
agreements, the fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a fund is the seller
of, rather than the investor in, securities, and agrees to repurchase them at
an agreed upon time and price. Use of a reverse repurchase agreement may be
preferable to a regular sale and later repurchase of the securities because
it avoids certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the fund, subject to
Investment Restriction (1). (See "Investment Restrictions.")
INVESTMENT RESTRICTIONS
-------------------------------------------------------------------------------
Fundamental policies may not be changed without the approval of the lesser of
(1) 67% of the fund's shares present at a meeting of shareholders if the
holders of more than 50% of the outstanding shares are present in person or
by proxy or (2) more than 50% of a fund's outstanding shares. Other
restrictions in the form of operating policies are subject to change by the
fund's Board of Directors without shareholder approval. Any investment
restriction which involves a maximum percentage of securities or assets shall
not be considered to be violated unless an excess over the percentage occurs
immediately after, and is caused by, an acquisition of securities or assets
of, or borrowings by, the fund. Calculation of the fund's total assets for
compliance with any of the following fundamental or operating policies or any
other investment restrictions set forth in the fund's prospectus or Statement
of Additional Information will not include cash collateral held in connection
with securities lending activities.
Fundamental Policies
As a matter of fundamental policy, the fund may not:
(1) Borrowing Borrow money except that the fund may (i) borrow for
non-leveraging, temporary, or emergency purposes; and (ii) engage in
reverse repurchase agreements and make other investments or engage in
other transactions, which may involve a borrowing, in a manner consistent
with the fund's investment objective and program, provided that the
combination of (i) and (ii) shall not exceed 33/1//\\/3/\\% of the value
of the fund's total assets (including the amount borrowed) less
liabilities (other than borrowings) or such other percentage permitted by
law. Any borrowings which come to exceed this amount will be reduced in
accordance with applicable law. The fund may borrow from banks, other
Price Funds, or other persons to the extent permitted by applicable law;
(2) Commodities Purchase or sell physical commodities;
(3) Industry Concentration Purchase the securities of any issuer if, as a
result, more than 25% of the value of the fund's total assets would be
invested in the securities of issuers having their principal business
activities in the same industry; provided, however, that this limitation
does not apply to securities of the banking industry including, but not
limited to, certificates of deposit and bankers' acceptances;
(4) Loans Make loans, although the fund may (i) lend portfolio securities and
participate in an interfund lending program with other Price Funds
provided that no such loan may be made if, as a result, the aggregate of
such loans would exceed 33/1//\\/3/\\% of the value of the fund's total
assets; (ii) purchase money
<PAGE>
market securities and enter into repurchase agreements; and (iii) acquire
publicly distributed or privately placed debt securities and purchase
debt;
(5) Percent Limit on Assets Invested in Any One Issuer Purchase a security
if, as a result, with respect to 75% of the value of its total assets,
more than 5% of the value of the fund's total assets would be invested in
the securities of a single issuer, except securities issued or guaranteed
by the U.S. government or any of its agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer Purchase a security
if, as a result, with respect to 75% of the value of the fund's total
assets, more than 10% of the outstanding voting securities of any issuer
would be held by the fund (other than obligations issued or guaranteed by
the U.S. government, its agencies or instrumentalities);
(7) Real Estate Purchase or sell real estate, including limited partnership
interests therein, unless acquired as a result of ownership of securities
or other instruments (but this shall not prevent the fund from investing
in securities or other instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities Issue senior securities except in compliance with the
1940 Act; or
(9) Underwriting Underwrite securities issued by other persons, except to the
extent that the fund may be deemed to be an underwriter within the
meaning of the 1933 Act in connection with the purchase and sale of its
portfolio securities in the ordinary course of pursuing its investment
program.
NOTES
The following Notes should be read in connection with the above-described
fundamental policies. The Notes are not fundamental policies.
With respect to investment restriction (1), the fund has no current
intention of engaging in any borrowing transactions.
With respect to investment restriction (2), the fund does not consider
currency contracts or hybrid investments to be commodities.
For purposes of investment restriction (3), U.S., state, or local
governments, or related agencies or instrumentalities, are not considered
an industry. Industries are determined by reference to the
classifications of industries set forth in the fund's semiannual and
annual reports. It is the position of the Staff of the SEC that foreign
governments are industries for purposes of this restriction.
For purposes of investment restriction (4), the fund will consider the
acquisition of a debt security to include the execution of a note or
other evidence of an extension of credit with a term of more than nine
months.
For purposes of investment restriction (5), the fund will consider a
repurchase agreement fully collateralized with U.S. government securities
to be U.S. government securities.
Operating Policies
As a matter of operating policy, the fund may not:
(1) Borrowing Purchase additional securities when money borrowed exceeds 5%
of its total assets;
The fund will limit borrowing for any variable annuity separate account
to (a) 10% of net asset value when borrowing for any general purpose, and
(b) 25% of net asset value when borrowing as a temporary measure to
facilitate redemptions.
Net asset value of a portfolio is the market value of all investments or
assets owned less outstanding liabilities of the portfolio at the time
that any new or additional borrowing is undertaken.
(2) Control of Portfolio Companies Invest in companies for the purpose of
exercising management or control;
<PAGE>
(3) Equity Securities Purchase any common stocks or other equity securities,
except as set forth in its prospectus and operating policy on investment
companies;
(4) Illiquid Securities Purchase illiquid securities if, as a result, more
than 10% of its net assets would be invested in such securities;
(5) Investment Companies Purchase securities of open-end or closed-end
investment companies except (i) in compliance with the 1940 Act; or (ii)
securities of the Reserve Investment or Government Reserve Investment
Funds;
(6) Margin Purchase securities on margin, except (i) for use of short-term
credit necessary for clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection with futures contracts or
other permissible investments;
(7) Mortgaging Mortgage, pledge, hypothecate or, in any manner, transfer any
security owned by the fund as security for indebtedness except as may be
necessary in connection with permissible borrowings or investments and
then such mortgaging, pledging, or hypothecating may not exceed
33/1//\\/3/\\% of the fund's total assets at the time of borrowing or
investment;
(8) Oil and Gas Programs Purchase participations or other direct interests
in, or enter into leases with respect to oil, gas, or other mineral
exploration or development programs if, as a result thereof, more than 5%
of the value of the total assets of the fund would be invested in such
programs;
(9) Options, etc. Invest in puts, calls, straddles, spreads, or any
combination thereof, except to the extent permitted by the prospectus and
Statement of Additional Information;
(10) Short Sales Effect short sales of securities; or
(11) Warrants Invest in warrants if, as a result thereof, more than 10% of
the value of the net assets of the fund would be invested in warrants.
Notwithstanding anything in the above fundamental and operating restrictions
to the contrary, the fund may invest all of its assets in a single investment
company or a series thereof in connection with a "master-feeder" arrangement.
Such an investment would be made where the fund (a "Feeder"), and one or more
other funds with the same investment objective and program as the fund,
sought to accomplish its investment objective and program by investing all of
its assets in the shares of another investment company (the "Master"). The
Master would, in turn, have the same investment objective and program as the
fund. The fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make investments in
portfolio companies on behalf of a number of Feeder funds.
MANAGEMENT OF THE FUND
-------------------------------------------------------------------------------
The officers and directors of the fund are listed below. Unless otherwise
noted, the address of each is 100 East Pratt Street, Baltimore, Maryland
21202. Except as indicated, each has been an employee of T. Rowe Price for
more than five years. In the list below, the fund's directors who are
considered "interested persons" of T. Rowe Price as defined under Section
2(a)(19) of the 1940 Act are noted with an asterisk (*). These directors are
referred to as inside directors by virtue of their officership, directorship,
and/or employment with T. Rowe Price.
Independent Directors/(a)/
CALVIN W. BURNETT, PH.D., 3/16/32, President, Coppin State College; formerly:
Director, Maryland Chamber of Commerce and Provident Bank of Maryland;
formerly: President, Baltimore Area Council Boy Scouts of America; Vice
President and Board of Directors, The Walters Art Gallery; Address: 2500 West
North Avenue, Baltimore, Maryland 21216
<PAGE>
ANTHONY W. DEERING, 1/28/45, Director, Chairman of the Board, President, and
Chief Executive Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Address: 10275 Little Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, 8/22/34, President, F. Pierce Linaweaver & Associates,
Inc.; Consulting Environmental & Civil Engineers; formerly (1987-1991)
Executive Vice President, EA Engineering, Science, and Technology, Inc., and
President, EA Engineering, Inc., Baltimore, Maryland; Address: Green Spring
Station, 2360 West Joppa Road, Suite 224, Lutherville, Maryland 21093
JOHN G. SCHREIBER, 10/21/46, Owner/President, Schreiber Investments, Inc., a
real estate investment company; Director, AMLI Residential Properties Trust
and Urban Shopping Centers, Inc.; Partner, Blackstone Real Estate Partners,
L.P.; Director and formerly Executive Vice President, JMB Realty Corporation,
a national real estate investment manager and developer; Address: Centaur
Capital Partners, One Westminster Place, Lake Forest, IL 60045
(a) Unless otherwise indicated, the Independent Directors have been at their
respective companies for at least five years.
Inside Directors/Officers
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board-Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and Vice President-Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board
and Director, T. Rowe Price Investment Services, Inc., T. Rowe Price
Services, Inc., and T. Rowe Price Retirement Plan Services, Inc.; Chairman of
the Board, Director, President, and Trust Officer, T. Rowe Price Trust
Company; Director, Price-Fleming and General Re Corporation
M. DAVID TESTA, 4/22/44, Director-Chairman of the Board and Director,
Price-Fleming; Vice Chairman of the Board, Chief Investment Officer,
Director, and Managing Director, T. Rowe Price; Vice President and Director,
T. Rowe Price Trust Company; Chartered Financial Analyst
EDWARD A. WIESE, 4/12/59, President-Vice President, T. Rowe Price and T. Rowe
Price Trust Company; Chartered Financial Analyst
PATRICE BERCHTENBREITER ELY, 1/13/53, Vice President-Vice President, T. Rowe
Price
STEVEN G. BROOKS, 8/5/54, Vice President-Vice President, T. Rowe Price;
Chartered Financial Analyst
ROBERT P. CAMPBELL, 1/31/56, Vice President-Vice President, T. Rowe Price and
T. Rowe Price Trust Company
PATRICK S. CASSIDY, 8/27/64, Vice President-Vice President, T. Rowe Price;
Chartered Financial Analyst
CHARLES B. HILL, 9/22/61, Vice President-Vice President, T. Rowe Price
HENRY H. HOPKINS, 12/23/42, Vice President-Vice President, Price-Fleming and
T. Rowe Price Retirement Plan Services, Inc.; Director and Managing Director,
T. Rowe Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc. and T. Rowe Price Trust Company
JAMES M. MCDONALD, 9/29/49, Vice President-Vice President, T. Rowe Price
CHERYL A. MICKEL, 1/11/67, Vice President-Vice President, T. Rowe Price
ROBERT M. RUBINO, 8/2/53, Vice President-Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, 9/19/59, Vice President-Vice President, T. Rowe Price
VIRGINIA A. STIRLING, 9/5/51, Vice President-Vice President, T. Rowe Price
MARK J. VASELKIV, 7/22/58, Vice President-Managing Director and Vice
President, T. Rowe Price
PATRICIA B. LIPPERT, 1/12/53, Secretary-Assistant Vice President, T. Rowe
Price and T. Rowe Price Investment Services, Inc.
<PAGE>
JOSEPH A. CARRIER, 12/30/60, Treasurer-Vice President, T. Rowe Price and T.
Rowe Price Investment Services, Inc.
DAVID S. MIDDLETON, 1/18/56, Controller-Vice President, T. Rowe Price and T.
Rowe Price Trust Company
BRIAN E. BURNS, 10/6/60, Assistant Vice President-Assistant Vice President,
T. Rowe Price
JOAN R. POTEE, 11/23/47, Assistant Vice President-Vice President, T. Rowe
Price
INGRID I. VORDEMBERGE, 9/27/35, Assistant Vice President-Employee, T. Rowe
Price
Compensation Table
The fund does not pay pension or retirement benefits to its independent
officers or directors. Also, any director of the fund who is an officer or
employee of T. Rowe Price or Price-Fleming does not receive any remuneration
from the fund.
<TABLE>
<CAPTION>
Name of Person, Aggregate Compensation from Total Compensation from Fund and
Position Fund(a) Fund Complex Paid to Directors(b)
- -------------------------------------- ------------------------------------------- ---------------------------------
- ------------------------------------------------------------------------------------------------------------------------
<C> <S> <S>
Calvin W. Burnett, PH.D., Director $1,286 $65,000
Anthony W. Deering, Director 1,294 80,000
F. Pierce Linaweaver, Director 1,286 67,000
John G. Schreiber, Director 1,286 67,000
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Amounts in this column are based on accrued compensation for calendar
year 1999.
(b) Amounts in this column are based on compensation received from January
1, 1999 to December 31, 1999. The T. Rowe Price complex included 88 funds
as of December 31, 1999.
The fund's Executive Committee, consisting of the fund's interested
directors, has been authorized by its respective Board of Directors to
exercise all powers of the Board to manage the funds in the intervals between
meetings of the Board, except the powers prohibited by statute from being
delegated.
PRINCIPAL HOLDERS OF SECURITIES
-------------------------------------------------------------------------------
As of the date of the prospectus, the officers and directors of the fund, as
a group, owned less than 1% of the outstanding shares of the fund.
As of April 1, 2000, the following shareholders beneficially owned more than
5% of the outstanding shares of the fund:
Security Benefit Life Insurance Company, FBO, T. Rowe Price No-Load Variable
Annuity, Attn.: Mark Young, 700 SW Harrison St., Topeka, KS 66636-0002; First
Security Benefit Life & Annuity Company of New York, FBO, T. Rowe Price
No-Load Variable Annuity, Attn.: Mark Young, 700 SW Harrison St., Topeka, KS
66636-0002.
INVESTMENT MANAGEMENT SERVICES
-------------------------------------------------------------------------------
Services
Under the Management Agreement, T. Rowe Price provides the fund with
discretionary investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of the fund in accordance with
the fund's investment objectives, program, and restrictions as provided in
its prospectus and this Statement of Additional Information. T. Rowe Price is
also responsible for effecting all security
<PAGE>
transactions on behalf of the fund, including the negotiation of commissions
and the allocation of principal business and portfolio brokerage. In addition
to these services, T. Rowe Price provides the fund with certain corporate
administrative services, including: maintaining the fund's corporate
existence and corporate records; registering and qualifying fund shares under
federal laws; monitoring the financial, accounting, and administrative
functions of the fund; maintaining liaison with the agents employed by the
fund such as the fund's custodian and transfer agent; assisting the fund in
the coordination of such agents' activities; and permitting T. Rowe Price's
employees to serve as officers, directors, and committee members of the fund
without cost to the fund.
The Management Agreement also provides that T. Rowe Price, its directors,
officers, employees, and certain other persons performing specific functions
for the fund will only be liable to the fund for losses resulting from
willful misfeasance, bad faith, gross negligence, or reckless disregard of
duty.
Management Fee
The fund pays T. Rowe Price an annual all-inclusive fee (the "Fee") of 0.55%.
The Fee is paid monthly to the T. Rowe Price on the first business day of the
next succeeding calendar month and is the sum of the daily Fee accruals for
each month. The daily Fee accrual for any particular day is calculated by
multiplying the fraction of one (1) over the number of calendar days in the
year by the appropriate Fee rate and multiplying this product by the net
assets of the fund for that day as determined in accordance with the fund's
prospectus as of the close of business from the previous business day on
which the fund was open for business.
The Management Agreement between the fund and T. Rowe Price provides that T.
Rowe Price will pay all expenses of the fund's operations, except interest,
taxes, brokerage commissions, and other charges incident to the purchase,
sale, or lending of the fund's portfolio securities, directors' fee and
expenses (including counsel fees and expenses), and such nonrecurring or
extraordinary expenses that may arise, including the costs of actions, suits,
or proceedings to which the fund is a party and the expenses the fund may
incur as a result of its obligation to provide indemnification to its
officers, directors, and agents. However, the Board of Directors of the fund
reserves the right to impose additional fees against shareholder accounts to
defray expenses which would otherwise be paid by T. Rowe Price under the
Management Agreement. The Board does not anticipate levying such charges;
such a fee, if charged, may be retained by the fund or paid to T. Rowe Price.
Under the Management Agreement, the fund did not levy additional fees for the
following years: 1999, 1998, and 1997.
DISTRIBUTOR FOR THE FUND
-------------------------------------------------------------------------------
Investment Services, a Maryland corporation formed in 1980 as a wholly owned
subsidiary of T. Rowe Price, serves as the fund's distributor. Investment
Services is registered as a broker-dealer under the Securities Exchange Act
of 1934 and is a member of the National Association of Securities Dealers,
Inc. The offering of the fund's shares is continuous.
Investment Services is located at the same address as the fund and T. Rowe
Price-100 East Pratt Street, Baltimore, Maryland 21202.
Investment Services serves as distributor to the fund pursuant to an
Underwriting Agreement ("Underwriting Agreement"), which provides that the
fund will pay all fees and expenses in connection with: necessary state
filings; preparing, setting in type, printing, and mailing its prospectuses
and reports to shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services will pay all
fees and expenses in connection with: printing and distributing prospectuses
and reports for use in offering and selling fund shares; preparing, setting
in type, printing, and mailing all sales literature and advertising;
Investment Services' federal and state registrations as a broker-dealer; and
offering and selling shares, except for those fees and expenses specifically
assumed by the fund. Investment Services' expenses are paid by T. Rowe Price.
<PAGE>
Investment Services acts as the agent of the fund in connection with the sale
of its shares in the various states in which Investment Services is qualified
as a broker-dealer. Under the Underwriting Agreement, Investment Services
accepts orders for fund shares at net asset value. No sales charges are paid
by investors or the fund.
CUSTODIAN
-------------------------------------------------------------------------------
State Street Bank and Trust Company is the custodian for the fund's U.S.
securities and cash, but it does not participate in the fund's investment
decisions. Portfolio securities purchased in the U.S. are maintained in the
custody of the Bank and may be entered into the Federal Reserve Book Entry
System, or the security depository system of the Depository Trust
Corporation. State Street Bank's main office is at 225 Franklin Street,
Boston, Massachusetts 02110.
CODE OF ETHICS
-------------------------------------------------------------------------------
The fund's investment adviser (T. Rowe Price) has a written Code of Ethics
which requires all Access Persons to obtain prior clearance before engaging
in personal securities transactions. In addition, all employees must report
their personal securities transactions within 10 days of their execution.
Access Persons will not be permitted to effect transactions in a security: if
there are pending client orders in the security; the security has been
purchased or sold by a client within seven calendar days; the security is
being considered for purchase for a client; or the security is subject to
internal trading restrictions. In addition, Access Persons are prohibited
from profiting from short-term trading (e.g., purchases and sales involving
the same security within 60 days). Any person becoming an Access Person must
file a statement of personal securities holdings within 10 days of this date.
All Access Persons are required to file an annual statement with respect to
their personal securities holdings. Any material violation of the Code of
Ethics is reported to the Board of the fund. The Board also reviews the
administration of the Code of Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
-------------------------------------------------------------------------------
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio securities on
behalf of the fund are made by T. Rowe Price. T. Rowe Price is also
responsible for implementing these decisions, including the negotiation of
commissions and the allocation of portfolio brokerage and principal business.
The fund's purchases and sales of fixed income portfolio securities are
normally done on a principal basis and do not involve the payment of a
commission although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage commissions
would not normally apply to the fund. However, it is included because T. Rowe
Price does manage a significant number of common stock portfolios which do
engage in agency transactions and pay commissions and because some research
and services resulting from the payment of such commissions may benefit the
fund.
How Brokers and Dealers Are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the issuer or a primary
market-maker acting as principal for the securities on a net basis, with no
brokerage commission being paid by the client although the price usually
includes an undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the bid and asked
prices. Securities may also be purchased from underwriters at prices which
include underwriting fees.
With respect to equity and fixed income securities, T. Rowe Price may effect
principal transactions on behalf of the fund with a broker or dealer who
furnishes brokerage and/or research services, designate any such
<PAGE>
broker or dealer to receive selling concessions, discounts, or other
allowances, or otherwise deal with any such broker or dealer in connection
with the acquisition of securities in underwritings. T. Rowe Price may
receive research services in connection with brokerage transactions,
including designations in fixed price offerings.
Equity Securities
In purchasing and selling equity securities, it is T. Rowe Price's policy to
obtain quality execution at the most favorable prices through responsible
brokers and dealers and at competitive commission rates where such rates are
negotiable. However, under certain conditions, the fund may pay higher
brokerage commissions in return for brokerage and research services. As a
general practice, over-the-counter orders are executed with market-makers. In
selecting among market-makers, T. Rowe Price generally seeks to select those
it believes to be actively and effectively trading the security being
purchased or sold. In selecting broker-dealers to execute the fund's
portfolio transactions, consideration is given to such factors as the price
of the security, the rate of the commission, the size and difficulty of the
order, the reliability, integrity, financial condition, general execution and
operational capabilities of competing brokers and dealers, their expertise in
particular markets and brokerage and research services provided by them. It
is not the policy of T. Rowe Price to seek the lowest available commission
rate where it is believed that a broker or dealer charging a higher
commission rate would offer greater reliability or provide better price or
execution.
How Evaluations Are Made of the Overall Reasonableness of Brokerage Commissions
Paid
On a continuing basis, T. Rowe Price seeks to determine what levels of
commission rates are reasonable in the marketplace for transactions executed
on behalf of the fund. In evaluating the reasonableness of commission rates,
T. Rowe Price considers: (a) historical commission rates; (b) rates which
other institutional investors are paying, based on available public
information; (c) rates quoted by brokers and dealers; (d) the size of a
particular transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular transaction in
terms of both execution and settlement; (f) the level and type of business
done with a particular firm over a period of time; and (g) the extent to
which the broker or dealer has capital at risk in the transaction.
Descriptions of Research Services Received From Brokers and Dealers
T. Rowe Price receives a wide range of research services from brokers and
dealers. These services include information on the economy, industries,
groups of securities, individual companies, statistical information,
accounting and tax law interpretations, political developments, legal
developments affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement analysis,
performance analysis, and analysis of corporate responsibility issues. These
services provide both domestic and international perspective. Research
services are received primarily in the form of written reports, computer
generated services, telephone contacts, and personal meetings with security
analysts. In addition, such services may be provided in the form of meetings
arranged with corporate and industry spokespersons, economists, academicians,
and government representatives. In some cases, research services are
generated by third parties but are provided to T. Rowe Price by or through
broker-dealers.
Research services received from brokers and dealers are supplemental to T.
Rowe Price's own research effort and, when utilized, are subject to internal
analysis before being incorporated by T. Rowe Price into its investment
process. As a practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information presently
provided by brokers and dealers. T. Rowe Price pays cash for certain research
services received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash. While receipt
of research services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could be materially
increased if it attempted to generate such additional information through its
own staff. To the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses which it might
otherwise bear.
T. Rowe Price has a policy of not allocating brokerage business in return for
products or services other than brokerage or research services. In accordance
with the provisions of Section 28(e) of the Securities Exchange Act of 1934,
T. Rowe Price may from time to time receive services and products which serve
both research
<PAGE>
and non-research functions. In such event, T. Rowe Price makes a good faith
determination of the anticipated research and non-research use of the product
or service and allocates brokerage only with respect to the research
component.
Commissions to Brokers Who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and execution
services also furnish research services to T. Rowe Price. With regard to the
payment of brokerage commissions, T. Rowe Price has adopted a brokerage
allocation policy embodying the concepts of Section 28(e) of the Securities
Exchange Act of 1934, which permits an investment adviser to cause an account
to pay commission rates in excess of those another broker or dealer would
have charged for effecting the same transaction, if the adviser determines in
good faith that the commission paid is reasonable in relation to the value of
the brokerage and research services provided. The determination may be viewed
in terms of either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over which it
exercises investment discretion. Accordingly, while T. Rowe Price cannot
readily determine the extent to which commission rates or net prices charged
by broker-dealers reflect the value of their research services, T. Rowe Price
would expect to assess the reasonableness of commissions in light of the
total brokerage and research services provided by each particular broker. T.
Rowe Price may receive research, as defined in Section 28(e), in connection
with selling concessions and designations in fixed price offerings in which
the funds participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific amount of business
to any broker or dealer over any specific time period. Historically, the
majority of brokerage placement has been determined by the needs of a
specific transaction such as market-making, availability of a buyer or seller
of a particular security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for that portion
of its discretionary client brokerage business where special needs do not
exist, or where the business may be allocated among several brokers or
dealers which are able to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the brokerage and
research services provided by brokers or dealers, and attempts to allocate a
portion of its brokerage business in response to these assessments. Research
analysts, counselors, various investment committees, and the Trading
Department each seek to evaluate the brokerage and research services they
receive from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition, brokers or dealers
sometimes suggest a level of business they would like to receive in return
for the various brokerage and research services they provide. Actual
brokerage received by any firm may be less than the suggested allocations but
can, and often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above. In no case
is a broker or dealer excluded from receiving business from T. Rowe Price
because it has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently applied to all
its fully discretionary accounts, which represent a substantial majority of
all assets under management. Research services furnished by brokers or
dealers through which T. Rowe Price effects securities transactions may be
used in servicing all accounts (including non-fund accounts) managed by T.
Rowe Price. Conversely, research services received from brokers or dealers
which execute transactions for the fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the fund.
From time to time, orders for clients may be placed through a computerized
transaction network.
The fund does not allocate business to any broker-dealer on the basis of its
sales of the fund's shares. However, this does not mean that broker-dealers
who purchase fund shares for their clients will not receive business from the
fund.
Some of T. Rowe Price's other clients have investment objectives and programs
similar to those of the fund. T. Rowe Price may occasionally make
recommendations to other clients which result in their purchasing or
<PAGE>
selling securities simultaneously with the fund. As a result, the demand for
securities being purchased or the supply of securities being sold may
increase, and this could have an adverse effect on the price of those
securities. It is T. Rowe Price's policy not to favor one client over another
in making recommendations or in placing orders. T. Rowe Price frequently
follows the practice of grouping orders of various clients for execution
which generally results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of transactions at
various prices on a given day, each participating client's proportionate
share of such order reflects the average price paid or received with respect
to the total order. T. Rowe Price has established a general investment policy
that it will ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price funds) if, as a result
of such purchases, 10% or more of the outstanding common stock of such
company would be held by its clients in the aggregate.
At the present time, T. Rowe Price does not recapture commissions or
underwriting discounts or selling group concessions in connection with
taxable securities acquired in underwritten offerings. T. Rowe Price does,
however, attempt to negotiate elimination of all or a portion of the selling
group concession or underwriting discount when purchasing tax-exempt
municipal securities on behalf of its clients in underwritten offerings.
Trade Allocation Policies
T. Rowe Price has developed written trade allocation guidelines for its
Equity, Municipal, and Taxable Fixed Income Trading Desks. Generally, when
the amount of securities available in a public offering or the secondary
market is insufficient to satisfy the volume or price requirements for the
participating client portfolios, the guidelines require a pro-rata allocation
based upon the amounts initially requested by each portfolio manager. In
allocating trades made on combined basis, the Trading Desks seek to achieve
the same net unit price of the securities for each participating client.
Because a pro-rata allocation may not always adequately accommodate all facts
and circumstances, the guidelines provide for exceptions to allocate trades
on an adjusted, pro-rata basis. Examples of where adjustments may be made
include: (i) reallocations to recognize the efforts of a portfolio manager in
negotiating a transaction or a private placement; (ii) reallocations to
eliminate deminimis positions; (iii) priority for accounts with specialized
investment policies and objectives; and (iv) reallocations in light of a
participating portfolio's characteristics (e.g., industry or issuer
concentration, duration, and credit exposure).
Other
The fund did not pay any brokerage commissions for the fiscal years ending
December 31, 1999 and 1998, respectively.
PRICING OF SECURITIES
-------------------------------------------------------------------------------
Securities are valued at amortized cost.
Assets and liabilities for which the above valuation procedures are
inappropriate or are deemed not to reflect fair value, are stated at fair
value as determined in good faith by or under the supervision of the officers
of the fund, as authorized by the Board of Directors.
Maintenance of Money Fund's Net Asset Value Per Share at $1.00
It is the policy of the fund to attempt to maintain a net asset value of
$1.00 per share by using the amortized cost method of valuation permitted by
Rule 2a-7 under the 1940 Act. Under this method, securities are valued by
reference to the fund's acquisition cost as adjusted for amortization of
premium or accumulation of discount rather than by reference to their market
value. Under Rule 2a-7:
(a) The Board of Directors must establish written procedures reasonably
designed, taking into account current market conditions and the fund's
investment objectives, to stabilize the fund's net asset value per share,
as computed for the purpose of distribution, redemption and repurchase,
at a single value;
<PAGE>
(b) The fund must (i) maintain a dollar-weighted average portfolio maturity
appropriate to its objective of maintaining a stable price per share,
(ii) not purchase any instrument with a remaining maturity greater than
397 days, and (iii) maintain a dollar-weighted average portfolio maturity
of 90 days or less;
(c) The fund must limit its purchase of portfolio instruments, including
repurchase agreements, to those U.S. dollar-denominated instruments which
the fund's Board of Directors determines present minimal credit risks,
and which are eligible securities as defined by Rule 2a-7; and
(d) The Board of Directors must determine that (i) it is in the best interest
of the fund and its shareholders to maintain a stable net asset value per
share under the amortized cost method; and (ii) the fund will continue to
use the amortized cost method only so long as the Board of Directors
believes that it fairly reflects the market based net asset value per
share.
Although the fund believes that it will be able to maintain its net asset
value at $1.00 per share under most conditions, there can be no absolute
assurance that it will be able to do so on a continuous basis. If the fund's
net asset value per share declined, or was expected to decline, below $1.00
(rounded to the nearest one cent), the Board of Directors of the fund might
temporarily reduce or suspend dividend payments in an effort to maintain the
net asset value at $1.00 per share. As a result of such reduction or
suspension of dividends, an investor would receive less income during a given
period than if such a reduction or suspension had not taken place. Such
action could result in an investor receiving no dividend for the period
during which he holds his shares and in his receiving, upon redemption, a
price per share lower than that which he paid. On the other hand, if the
fund's net asset value per share were to increase, or were anticipated to
increase above $1.00 (rounded to the nearest one cent), the Board of
Directors of the fund might supplement dividends in an effort to maintain the
net asset value at $1.00 per share.
Prime Money Market Securities Defined
Prime money market securities are those which are described as First Tier
Securities under Rule 2a-7 of the 1940 Act. These include any security with a
remaining maturity of 397 days or less that is rated (or that has been issued
by an issuer that is rated with respect to a class of short-term debt
obligations, or any security within that class that is comparable in priority
and security with the security) by any two nationally recognized statistical
rating organizations (NRSROs) (or if only one NRSRO has issued a rating, that
NRSRO) in the highest rating category for short-term debt obligations (within
which there may be sub-categories). First Tier Securities also include
unrated securities comparable in quality to rated securities, as determined
by T. Rowe Price under the supervision of the fund's Board of Directors.
NET ASSET VALUE PER SHARE
-------------------------------------------------------------------------------
The purchase and redemption price of the fund's shares is equal to the fund's
net asset value per share or share price. The fund determines its net asset
value per share by subtracting its liabilities (including accrued expenses
and dividends payable) from its total assets (the market value of the
securities the fund holds plus cash and other assets, including income
accrued but not yet received) and dividing the result by the total number of
shares outstanding. The net asset value per share of the fund is normally
calculated as of the close of trading on the New York Stock Exchange ("NYSE")
every day the NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Dr. Martin Luther King, Jr. Holiday, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of net asset value (and the offering, sale redemption and
repurchase of shares) for the fund may be suspended at times (a) during which
the NYSE is closed, other than customary weekend and holiday closings, (b)
during which trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable for the fund
fairly to determine the value of its net assets, or (d) during which a
governmental body having jurisdiction over the fund may by order permit such
a suspension for the protection of the fund's
<PAGE>
shareholders; provided that applicable rules and regulations of the SEC (or
any succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c), or (d) exist.
DIVIDENDS AND DISTRIBUTIONS
-------------------------------------------------------------------------------
Unless the separate account elects otherwise, the fund's annual capital gain
distribution will be reinvested on the reinvestment date using the NAV per
share of that date. The reinvestment date normally precedes the payment date
by one day, although the exact timing is subject to change and can be as
great as 10 days.
TAX STATUS
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The fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code and also intends to diversify its assets in
accordance with regulations under Code Section 817(h).
In 1987, the Treasury Department indicated that it may issue regulations
addressing the circumstances in which a policyholder's control of the
investments of the insurance company separate account would result in the
policyholder being treated as the owner of such assets. Although there is no
present indication that such regulations will be issued, their adoption could
alter the tax treatment of the policyholder, separate account or insurance
company.
For tax purposes, the fund must declare dividends by December 31 of each year
equal to at least 98% of ordinary income (as of December 31) and capital
gains (as of October 31) in order to avoid a federal excise tax and
distribute within 12 months 100% of ordinary income and capital gains as of
December 31 to avoid a federal income tax. In certain circumstances, the fund
may not be required to comply with the excise tax distribution requirements.
It does not make any difference whether dividends and capital gain
distributions are paid in cash or in additional shares.
At the time a shareholder acquires fund shares, the fund's net asset value
may reflect undistributed income, capital gains or net unrealized
appreciation of securities held by the fund which may be subsequently
distributed as either dividends or capital gain distributions.
If, in any taxable year, the fund should not qualify as a regulated
investment company under the Code: (i) the fund would be taxed at normal
corporate rates on the entire amount of its taxable income, if any, without
deduction for dividends or other distributions to shareholders; and (ii) the
fund's distributions to the extent made out of the fund's current or
accumulated earnings and profits would be treated as ordinary dividends by
shareholders (regardless of whether they would otherwise have been considered
capital gain dividends), and (iii) the separate accounts investing in the
fund may fail to satisfy the requirements of Code Section 817(h) which in
turn could adversely affect the tax status of life insurance and annuity
contracts with premiums invested in the affected separate accounts.
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be subject to U.S. tax.
For shareholders who are not engaged in a business in the U.S., this tax
would be imposed at the rate of 30% upon the gross amount of the dividends in
the absence of a Tax Treaty providing for a reduced rate or exemption from
U.S. taxation. Distributions of net long-term capital gains realized by the
fund are not subject to tax unless the foreign shareholder is a nonresident
alien individual who was physically present in the U.S. during the tax year
for more than 182 days.
<PAGE>
YIELD INFORMATION
-------------------------------------------------------------------------------
The fund's current and historical yield for a period is calculated by
dividing the net change in value of an account (including all dividends
accrued and dividends reinvested in additional shares) by the account value
at the beginning of the period to obtain the base period return. This base
period return is divided by the number of days in the period, then multiplied
by 365 to arrive at the annualized yield for that period. The fund's
annualized compound yield for such period is compounded by dividing the base
period return by the number of days in the period, and compounding that
figure over 365 days.
The fund's seven-day yield for the period ending December 31, 1999 was 5.66%,
and the fund's compound yield for the same period was 5.82%
INVESTMENT PERFORMANCE
-------------------------------------------------------------------------------
Total Return Performance
The fund's calculation of total return performance includes the reinvestment
of all capital gain distributions and income dividends for the period or
periods indicated, without regard to tax consequences to a shareholder in the
fund. Total return is calculated as the percentage change between the
beginning value of a static account in the fund and the ending value of that
account measured by the then current net asset value, including all shares
acquired through reinvestment of income and capital gain dividends. The
results shown are historical and should not be considered indicative of the
future performance of the fund. Each average annual compound rate of return
is derived from the cumulative performance of the fund over the time period
specified. The annual compound rate of return for the fund over any other
period of time will vary from the average.
<TABLE>
<CAPTION>
Performance of Prime Reserve Portfolio
1 Yr. 5 Yrs. 10 Yrs. % Since Inception
----- ------ ------- ------- ---------
Ended Ended Ended Inception Date
- --------------------------- ----- ----- ----- --------- ----
12/31/99 12/31/99 12/31/99 12/31/99
-------- -------- -------- --------
----------------------------------------------------
<S> <C> <C> <C> <C> <S>
Cumulative Performance
Percentage Change 4.89% -- -- 16.32% 12/31/96
Average Annual Compound 4.89 -- -- 5.17 12/31/96
Rates of Return
- -------------------------------------------------------------------------------
</TABLE>
Lipper Average source: Lipper Analytical Services, Inc.-Variable Annuity
Underlying Fund Universe
Outside Sources of Information
From time to time, in reports and promotional literature: (1) the fund's
total return performance, ranking, or any other measure of the fund's
performance may be compared to any one or combination of the following: (a) a
broad-based index; (b) other groups of mutual funds, including T. Rowe Price
funds, tracked by independent research firms ranking entities, or financial
publications; (c) indices of securities comparable to those in which the fund
invests; (2) the Consumer Price Index (or any other measure for inflation,
government statistics, such as GNP may be used to illustrate investment
attributes of the fund or the general economic, business, investment, or
financial environment in which the fund operates; (3) various financial,
economic, and market statistics developed by brokers, dealers, and other
persons may be used to illustrate aspects of the fund's performance; (4) the
effect of tax-deferred compounding on the fund's investment returns, or on
returns in general in both qualified and nonqualified retirement plans or any
other tax advantage product, may be illustrated by graphs, charts, etc.; and
(5) the sectors or industries in which the fund invests may be compared to
relevant indices or surveys in order to evaluate the fund's historical
performance or current or potential value with respect to the particular
industry or sector.
<PAGE>
Other Publications
From time to time, in newsletters and other publications issued by Investment
Services, T. Rowe Price mutual fund portfolio managers may discuss economic,
financial, and political developments in the U.S. and abroad and how these
conditions have affected or may affect securities prices or the fund;
individual securities within the fund's portfolio; and their philosophy
regarding the selection of individual stocks, including why specific stocks
have been added, removed, or excluded from the fund's portfolio.
Other Features and Benefits
The fund is a member of the T. Rowe Price family of funds and may help
investors achieve various long-term investment goals, which include, but are
not limited to, investing money for retirement, saving for a down payment on
a home, or paying college costs. To explain how the fund could be used to
assist investors in planning for these goals and to illustrate basic
principles of investing, various worksheets and guides prepared by T. Rowe
Price and/or Investment Services may be made available.
No-Load Versus Load and 12b-1 Funds
Many mutual funds charge sales fees to investors or use fund assets to
finance distribution activities. These fees are in addition to the normal
advisory fees and expenses charged by all mutual funds. There are several
types of fees charged which vary in magnitude and which may often be used in
combination. A sales charge (or "load") can be charged at the time the fund
is purchased (front-end load) or at the time of redemption (back-end load).
Front-end loads are charged on the total amount invested. Back-end loads or
"redemption fees" are charged either on the amount originally invested or on
the amount redeemed. 12b-1 plans allow for the payment of marketing and sales
expenses from fund assets. These expenses are usually computed daily as a
fixed percentage of assets.
The fund is a no-load fund which imposes no sales charges or 12b-1 fees.
No-load funds are generally sold directly to the public without the use of
commissioned sales representatives. This means that 100% of your purchase is
invested for you.
Issuance of Fund Shares for Securities
Transactions involving issuance of fund shares for securities or assets other
than cash will be limited to (1) bona fide reorganizations; (2) statutory
mergers; or (3) other acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the fund; (b) are acquired for
investment and not for resale except in accordance with applicable law; (c)
have a value that is readily ascertainable via listing on or trading in a
recognized United States or international exchange or market; and (d) are not
illiquid.
CAPITAL STOCK
-------------------------------------------------------------------------------
The Charter of the Corporation authorizes its Board of Directors to classify
and reclassify any and all shares which are then unissued, including unissued
shares of capital stock into any number of classes or series, each class or
series consisting of such number of shares and having such designations, such
powers, preferences, rights, qualifications, limitations, and restrictions,
as shall be determined by the Board subject to the 1940 Act and other
applicable law. Currently, the Corporation consists of two series: the T.
Rowe Price Limited-Term Bond Portfolio established in 1994, and T. Rowe Price
Prime Reserve Portfolio established in 1996. (The other fund is described in
a separate Statement of Additional Information.) The shares of any such
additional classes or series might therefore differ from the shares of the
present class and series of capital stock and from each other as to
preferences, conversions or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or terms or conditions of
redemption, subject to applicable law, and might thus be superior or inferior
to the capital stock or to other classes or series in various
characteristics. The Corporation's Board of Directors may increase or
decrease the aggregate number of shares of stock or the number of shares of
stock of any class or series that the Fund has authorized to issue without
shareholder approval.
<PAGE>
The various insurance companies own the outstanding shares of the fund in
their separate accounts. These separate accounts are registered as investment
companies under the 1940 Act or are excluded from registration. Each
insurance company, as the Shareholder, is entitled to one vote for each full
share held (and fractional votes for fractional shares held). Under the
current laws, the insurance companies must vote the shares held in registered
separate accounts in accordance with voting instructions received from
variable contract holders or participants. Fund shares for which contract
holders or participants are entitled to give voting instructions, but as to
which no voting instructions are received, and shares owned by the insurance
companies or affiliated companies in the separate accounts, will be voted in
proportion to the shares for which voting instructions have been received.
There will normally be no meeting of shareholders for the purpose of electing
directors unless and until such time as less than a majority of the directors
holding office have been elected by shareholders, at which time the directors
then in office will call a shareholders' meeting for the election of
directors. Except as set forth above, the directors shall continue to hold
office and may appoint successor directors. Voting rights are not cumulative,
so that the holders of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors of the fund,
in which event the holders of the remaining shares will be unable to elect
any person as a director. As set forth in the By-Laws of the Corporation, a
special meeting of shareholders of the Corporation shall be called by the
Secretary of the Corporation on the written request of shareholders entitled
to cast at least 10% of all the votes of the Corporation entitled to be cast
at such meeting. Shareholders requesting such a meeting must pay to the
Corporation the reasonably estimated costs of preparing and mailing the
notice of the meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating to the
other shareholders of the Corporation to the extent required by Section 16(c)
of the 1940 Act.
FEDERAL REGISTRATION OF SHARES
-------------------------------------------------------------------------------
The fund's shares are registered for sale under the 1933 Act. Registration of
the fund's shares is not required under any state law, but the fund is
required to make certain filings with and pay fees to the states in order to
sell its shares in the states.
LEGAL COUNSEL
-------------------------------------------------------------------------------
Swidler Berlin Shereff Friedman, LLP, whose address is The Chrysler Building,
405 Lexington Avenue, New York, New York 10174, is legal counsel to the fund.
INDEPENDENT ACCOUNTANTS
-------------------------------------------------------------------------------
PricewaterhouseCoopers LLP, 250 West Pratt Street, 21st Floor, Baltimore,
Maryland 21201, are the independent accountants to the funds.
The financial statements of the fund for the year ended December 31, 1999,
and the report of independent accountants are included in the fund's Annual
Report for the year ended December 31, 1999. A copy of the Annual Report
accompanies this Statement of Additional Information. The following financial
statements and the report of independent accountants appearing in the Annual
Report for the year ended December 31, 1999, are incorporated into this
Statement of Additional Information by reference:
<PAGE>
<TABLE>
<CAPTION>
ANNUAL REPORT REFERENCES:
PRIME RESERVE
PORTFOLIO
---------
<S> <C>
Financial Highlights 4
Statement of Net Assets, December 31, 1999 5-7
Statement of Operations, year ended December 31, 1999 8
Statement of Changes in Net Assets, years ended
December 31, 1999 9
Notes to Financial Statements, December 31, 1999 10
Report of Independent Accountants 11
</TABLE>
RATINGS OF COMMERCIAL PAPER
-------------------------------------------------------------------------------
Moody's Investors Service, Inc. The rating of Prime-1 is the highest
commercial paper rating assigned by Moody's. Among the factors considered by
Moody's in assigning rating are the following: valuation of the management of
the issuer; economic evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in certain areas;
evaluation of the issuer's products in relation to competition and customer
acceptance; liquidity; amount and quality of long-term debt; trend of
earnings over a period of 10 years; financial strength of the parent company
and the relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a result of
public interest questions and preparations to meet such obligations. These
factors are all considered in determining whether the commercial paper is
rated P1, P2, or P3.
Standard & Poor's Corporation Commercial paper rated A (highest quality) by
S&P has the following characteristics: liquidity ratios are adequate to meet
cash requirements; long-term senior debt is rated "A" or better, although in
some cases "BBB" credits may be allowed. The issuer has access to at least
two additional channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a strong position
within the industry. The reliability and quality of management are
unquestioned. The relative strength or weakness of the above factors
determines whether the issuer's commercial paper is rated A1, A2, or A3.
Fitch IBCA, Inc. Fitch 1-Highest grade Commercial paper assigned this rating
is regarded as having the strongest degree of assurance for timely payment.
Fitch 2-Very good grade Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest issues.