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Invest With Confidence
To help you achieve your financial goals, T. Rowe Price offers a wide range of
stock, bond, and money market investments, as well as convenient services and
timely, informative reports.
PROSPECTUS
PERSONAL STRATEGY FUNDS
T. ROWE PRICE
PERSONAL STRATEGY FUNDS, INC.
JULY 29, 1994
A FAMILY OF FUNDS DIVERSIFIED ACROSS STOCKS, BONDS, AND MONEY MARKET
SECURITIES TO OFFER THREE LEVELS OF POTENTIAL RISK AND REWARD.
Facts at a Glance
Investment Goals Each of the three funds seeks the highest total return over
time consistent with its particular investment strategy and level of potential
risk. There is no assurance the funds will achieve their objectives.
Strategies and Risk/Reward Potential
Each fund will invest in a diversified portfolio of stocks, bonds, and money
market securities. The investment mix will be shifted gradually within
specified ranges for each fund according to the manager's outlook for the
economy and the financial markets.
Generally, the higher the fund's stock component, the greater the potential
return and risk of price decline.
Income Fund. To moderate price fluctuations, approximately 50% to 70% of
assets invested in bonds and money market securities with the balance in
stocks. Risk/Reward Potential: Lower risk and return Prospectus than the other
two funds.
Balanced Fund. For both appreciation and income, approximately 50% to 70% of
assets invested in stocks with the remainder in bonds and money market
securities. Risk/Reward Potential: Higher risk and return than the Income Fund
but less than the Growth Fund.
Growth Fund. For greater appreciation, approximately 70% to 90% of assets
invested in stocks, with the balance in bonds and money market securities.
Risk/Reward Potential: Highest expected risk and return of the three funds.
Investor Profile Individuals who seek to match their investment goals, time
horizon and risk tolerance with a single investment that diversifies across
several asset categories. Appropriate for both regular and tax-deferred
accounts, such as IRAs.
Fees and Charges 100% no-load. No fees or charges to buy or sell shares or to
reinvest dividends; no 12b-1 marketing fees; free telephone exchange.
Investment Manager Founded in 1937 by the late Thomas Rowe Price, Jr.,
T. Rowe Price Associates, Inc. ("T. Rowe Price") and its affiliates were
managing over $53 billion for approximately three million individual and
institutional investor accounts as of March 31, 1994.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EX-CHANGE COMMISSION, OR ANY STATE SECURITIES COMMISSION,
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
T. ROWE PRICE
PERSONAL STRATEGY FUNDS, INC.
JULY 29, 1994
PROSPECTUS
CONTENTS
_____________________________________________________________________________
1 ABOUT THE PERSONAL STRATEGY FUNDS
_____________________________________________________________________________
TRANSACTION AND FUND EXPENSES 2
_____________________________________________________________________________
FUND AND MARKET CHARACTERISTICS 4
_____________________________________________________________________________
2 ABOUT YOUR ACCOUNT
_____________________________________________________________________________
PRICING SHARES;
RECEIVING SALE PROCEEDS 9
_____________________________________________________________________________
DISTRIBUTIONS AND TAXES 10
_____________________________________________________________________________
TRANSACTION PROCEDURES AND
SPECIAL REQUIREMENTS 12
_____________________________________________________________________________
3 MORE ABOUT THE FUNDS
_____________________________________________________________________________
ORGANIZATION AND MANAGEMENT 14
_____________________________________________________________________________
UNDERSTANDING FUND PERFORMANCE 16
_____________________________________________________________________________
INVESTMENT POLICIES AND PRACTICES 16
_____________________________________________________________________________
4 INVESTING WITH T. ROWE PRICE
_____________________________________________________________________________
MEETING REQUIREMENTS
FOR NEW ACCOUNTS 24
_____________________________________________________________________________
OPENING A NEW ACCOUNT 24
_____________________________________________________________________________
PURCHASING ADDITIONAL SHARES 25
_____________________________________________________________________________
EXCHANGING AND REDEEMING 25
_____________________________________________________________________________
SHAREHOLDER SERVICES 26
_____________________________________________________________________________
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD KNOW BEFORE INVESTING. PLEASE
KEEP IT FOR FUTURE REFERENCE. A STATEMENT OF ADDITIONAL INFORMATION ABOUT THE
FUNDS, DATED JULY 29, 1994, HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION AND IS INCORPORATED BY REFERENCE IN THIS PROSPECTUS. TO OBTAIN A
FREE COPY, CALL 1-800-638-5660.
1 About the Personal Strategy Funds
1 ABOUT THE PERSONAL STRATEGY FUNDS
Transaction and Fund Expenses
These tables should help you understand the kinds of expenses you will bear
directly or indirectly as a fund shareholder. The first part of the table,
"Shareholder Transaction Expenses" shows that you pay no sales charges. All
the money you invest in a fund goes to work for you, subject to the fees
explained below.
_____________________________________________________________________________
LIKE ALL T. ROWE PRICE FUNDS, THE PERSONAL STRATEGY FUNDS ARE 100% NO LOAD.
Shareholder Transaction Expenses
Income Balanced Growth
_____________________________________________________________________________
Sales charge "load" on purchases None None None
_____________________________________________________________________________
Sales charge "load" on
reinvested dividends None None None
_____________________________________________________________________________
Redemption fees None None None
_____________________________________________________________________________
Exchange fees None None None
_____________________________________________________________________________
Percentage of Fiscal 1995
Average Net Assets Annual Fund Expenses
Income Balanced Growth
_____________________________________________________________________________
Management fee (after reduction) 0.16%* 0.40%* 0.31%*
_____________________________________________________________________________
Total other (Shareholder servicing,
custodial, auditing, etc.) 0.79% 0.65% 0.79%
_____________________________________________________________________________
Marketing fees (12b-1) None None None
_____________________________________________________________________________
Total fund expenses (after reduction) 0.95%* 1.05%* 1.10%*
_____________________________________________________________________________
Note: The funds charge a $5.00 fee for wire redemptions under $5,000, subject
to change without notice.
*To limit each fund's expenses during its initial period of operations, T.
Rowe Price has agreed to waive its fees and bear any expenses through May 31,
1996, to the extent such fees or expenses would cause the Income, Balanced
or Growth Funds' ratio of expenses to average net assets to exceed 0.95%,
1.05% and 1.10%, respectively. Fees waived or expenses paid or assumed under
this agreement are subject to reimbursement to T. Rowe Price by each fund
whenever the fund's expense ratio is below the previously stated ratio;
however, no reimbursement will be made after May 31, 1998, or if it would
result in the expense ratio exceeding the ratio as previously stated. Without
this expense limitation, it is estimated each fund's management fee and total
expense ratio for the first period of operation would be 0.49%, 0.59% and
0.64% and 1.28%, 1.24% and 1.43% for the Income, Balanced and Growth Funds,
respectively. Organizational expenses will be charged to the funds over a
period not to exceed 60 months.
_____________________________________________________________________________
Table 1
The second half of the table, "Annual Fund Expenses," provides an estimate of
how much it will cost to operate each fund for a year, based on projected 1995
fiscal year expenses (and any expense limitations described above). These are
costs you pay indirectly, because they are deducted from the fund's total
assets before the daily share price is calculated and before dividends and
other distributions are made. In other words, you will not see these expenses
on your account statement.
The main types of expenses, which all mutual funds may charge against fund
assets, are:
o A management fee: the percent of fund assets paid to the fund's
investment manager. Each fund's fee is comprised of a group fee,
discussed later, and an individual fund fee, as follows: Income 0.15%,
Balanced 0.25%, and Growth 0.30%.
o "Other" administrative expenses: primarily the servicing of shareholder
accounts, such as providing statements, reports, disbursing dividends,
as well as custodial services. For the period ending May 31, 1995, the
funds are expected to pay the fees shown in Table 2 to T. Rowe Price
Services, Inc. for transfer and dividend disbursing functions and
shareholder services; T. Rowe Price Retirement Plan Services, Inc. for
recordkeeping services for certain retirement plans; and T. Rowe Price
for fund accounting services.
Service Fees Paid
Transfer Subaccounting Accounting
Agent Services
_____________________________________________________________________________
Income $100,000 $25,000 $55,000
_____________________________________________________________________________
Balanced $300,000 $50,000 $55,000
_____________________________________________________________________________
Growth $250,000 $37,500 $55,000
_____________________________________________________________________________
Table 2
o Marketing or distribution fees: an annual charge ("12b-1") to existing
shareholders to defray the cost of selling shares to new shareholders.
T. Rowe Price funds do not levy 12b-1 fees.
For further details on fund expenses, please see "The Funds'
Organization and Management."
o Hypothetical example: Assume you invest $1,000, the fund returns 5%
annually, expense ratios remain as previously listed, and you close your
account at the end of the time periods shown. Your expenses would be:
_____________________________________________________________________________
THE TABLE AT RIGHT IS JUST AN EXAMPLE; ACTUAL EXPENSES CAN BE HIGHER OR LOWER
THAN THOSE SHOWN.
Fund 1 Year 3 Years
_____________________________________________________________________________
Income $10 $30
_____________________________________________________________________________
Balanced $11 $33
_____________________________________________________________________________
Growth $11 $35
_____________________________________________________________________________
Table 3
Fund and Market Characteristics
_____________________________________________________________________________
GENERALLY, THE GREATER THE PORTION OF TOTAL RETURN DERIVED FROM STOCKS, THE
HIGHER THE FUND'S POTENTIAL RETURN OVER TIME AND THE GREATER THE RISK OF PRICE
DECLINES.
This section takes a closer look at each fund's investment program as well as
some fundamentals of stock, bond, and money market investing.
What are the objectives of each portfolio?
o Income Fund: The objective is to seek the highest total return over time
consistent with a primary emphasis on income and a secondary emphasis on
capital appreciation. The fund pursues this objective by investing in a
diversified portfolio typically consisting of approximately 40% stocks,
40% bonds, and 20% money market securities. Under normal conditions,
allocations can vary by 10% above or below these ranges based on the
fund manager's outlook for the economy and the financial markets.
o Balanced Fund: The objective is to seek the highest total return over
time consistent with an emphasis on both capital appreciation and
income. The fund pursues this objective by investing in a diversified
portfolio typically consisting of approximately 60% stocks, 30% bonds,
and 10% money market securities. Under normal conditions, allocations
can vary by 10% above or below these ranges based on the fund manager's
outlook for the economy and the financial markets.
o Growth Fund: The objective is to seek the highest total return over time
consistent with a primary emphasis on capital appreciation; income is
expected to play a secondary role. The fund pursues this objective by
investing in a diversified portfolio typically consisting of
approximately 80% stocks and 20% bonds and money market securities.
Under normal conditions, allocations can vary by 10% above or below
these ranges, based on the fund manager's outlook for the economy and
the financial markets.
_____________________________________________________________________________
UNDER UNUSUAL MARKET CONDITIONS, FOR TEMPORARY DEFENSIVE PURPOSES, EACH OF THE
FUNDS MAY INVEST IN MONEY MARKET SECURITIES WITHOUT LIMITATION.
APPENDIX A
(Three pie charts appear here as an illustration of the funds' investment
programs and risk profiles.)
_____________________________________________________________________________
THE FUND MANAGER REGULARLY REVIEWS THE ASSET ALLOCATION AND MAY MAKE GRADUAL
CHANGES, WITHIN THE DEFINED RANGES, BASED ON THE OUTLOOK FOR THE ECONOMY,
INTEREST RATES, AND THE FINANCIAL MARKETS. THE FUNDS WILL NOT ATTEMPT TO TIME
SHORT-TERM MARKET MOVES.
What are the advantages of having three Personal Strategy funds instead of
just one?
To accommodate a wider range of investor preferences and time horizons than
would be possible with a single fund, these funds offer three different
combinations of the appreciation potential of common stocks, the greater
income of bonds and the stability of money market securities. These allocation
mixes represent three distinct levels of potential returns and investment
risk.
Generally, the potential for higher investment returns over time is
accompanied by higher investment risk-the risk of declines in the value of
your principal. Investors respond differently to this risk/reward trade-off;
some are comfortable with higher risk levels, while others are not. An
investor's time horizon should play a major role in the choice of investments.
A fundamental investment principle is that those with, for example, a 15-year
investment horizon can pursue a more aggressive investment program than those
with a 5-year horizon. Also, investors who seek a more aggressive approach at
a particular stage of their lives may prefer a more balanced or conservative
approach at another stage as their circumstances, investment horizon, or
investment objectives change.
What are the advantages of diversifying across stocks, bonds, and money market
securities?
Diversification is the investment equivalent of not putting all your eggs in
one basket. While there is no guarantee, a fund's overall volatility could be
reduced by spreading investments across several types of assets. Since prices
of stocks and bonds may respond differently to changes in economic conditions
and interest rate levels, a rise in bond prices, for example, could help
offset a fall in stock prices. Money market securities have a stabilizing
influence, since their price fluctuations are very small. In addition, the
steady income provided by bonds and money market securities contributes
positively to a portfolio's total return, cushioning the impact of any price
declines or enhancing price increases.
Diversification among asset classes is intended to reduce the risk associated
with investing in a single asset category; however, there is no guarantee the
strategy will always result in lower overall volatility for any of the funds.
_____________________________________________________________________________
FOR A MORE DETAILED DISCUSSION OF THE FUNDS' INVESTMENTS AND THEIR RISK
FACTORS, PLEASE SEE "INVEST-MENT POLICIES AND PRACTICES."
What are the general characteristics and risk factors of these major asset
classes?
o Stocks represent ownership in a corporation. Common stock prices
fluctuate with changes in a company's current earnings and future
prospects and with overall stock market conditions. Stocks of many
well-established corporations offer the potential for appreciation and
rising dividends. While smaller companies usually reinvest earnings in
their own growth and, therefore, pay minimal or no dividends, they offer
the possibility of even greater appreciation if their businesses prosper
and grow.
Historically, stocks have provided higher returns over time than bonds
or money market securities and, therefore, offer a way to invest for
long-term growth of capital. In addition, stock investments have
provided the greatest protection against the erosion of purchasing power
caused by inflation.
Share prices of even the best managed, most profitable corporations are
subject to market risk, which means their stock prices can decline. In
addition, swings in investor psychology and/or significant trading by
large institutional investors can result in price fluctuations. For this
reason, equity investors should have a long-term investment horizon and
be willing to wait out bear markets.
o Bonds are debt securities, meaning the issuer has a contractual
obligation to pay interest at a fixed rate on specified dates and to
repay principal (the bond's face value) upon maturity. Bonds have two
main sources of risk. Credit risk refers to the possibility that a
bond's price may fall due to a credit downgrade or "default," i.e., the
issuer failing to make an interest or principal payment. Interest rate
risk refers to a bond's price movement in response to changes in
interest rates. When rates rise, bond prices fall, and vice versa.
Generally, the longer a bond's maturity, the greater its potential price
fluctuation.
The funds expect to invest primarily in bonds with investment-grade
credit ratings. However, the funds may also make investments in more
volatile below-investment-grade (or "junk") bonds, including bonds with
the lowest rating. Investment-grade securities include a range of
securities from the highest rated (AAA) to medium quality (BBB).
Securities in the BBB category may be more susceptible to price declines
arising from adverse economic conditions or changing circumstances. The
securities at the lower end of the BBB category have certain speculative
characteristics. Prices of junk bonds are usually more affected by
adverse economic conditions or a deterioration in the issuer's financial
circumstances than by overall changes in interest rates. To compensate
investors for higher credit risk exposure, such bonds usually provide
higher income. Please see "High Yield/High Risk Investing" for further
information on these investments.
o Money market securities are debt obligations issued primarily by the
U.S. Government, Government agencies, and corporations. The high credit
ratings, short maturities, and high liquidity of the funds' money market
securities should minimize their credit and market risk. Their low risk
is usually accompanied by low potential returns relative to other
investments.
_____________________________________________________________________________
FOR A DISCUSSION OF THE EFFECT OF CURRENCY EXCHANGE RATE FLUCTUATIONS AND
OTHER SPECIAL RISKS OF FOREIGN INVESTING, PLEASE SEE "INVESTMENT POLICIES AND
PRACTICES."
Why include foreign securities?
The funds may invest a portion of their assets in foreign securities. Foreign
stocks and bonds offer advantages to a portfolio but also represent additional
risk. The potential advantages are extra diversification and enhanced returns.
Since foreign stock and bond markets may move somewhat independently from
their U.S. counterparts, such investments could reduce a portfolio's
short-term price fluctuations while offering a way to participate in markets
that may generate attractive returns. Of course, if U.S. and foreign markets
move in the same direction, the positive or negative effect on a fund's share
price could be magnified. In addition, a significant decline in foreign
securities' prices could reduce the funds' returns.
How does the portfolio manager try to reduce risk and increase returns?
Consistent with each fund's objective, the managers of the Personal Strategy
Funds may employ the following risk management tools:
o broad diversification, as discussed previously, to reduce the impact of
a single holding or asset class on the fund's share price;
o gradual allocation changes among and within asset classes (stocks,
bonds, etc.) to take advantage of market opportunities and changing
economic conditions;
o thorough research of stocks, bonds, and other securities by our analysts
to find the most favorable investment opportunities.
How can I decide which fund is most appropriate for me?
Review your own financial objectives, investment time horizon, and risk
tolerance. Use the table below, which summarizes the funds' main
characteristics, to help choose a fund (or funds) for your particular needs.
o The Income Fund is designed for more conservative investors who value
the reduced volatility provided by substantial investments in
income-producing securities but also seek some capital growth. The fund
will invest at least 65% of its total assets in income-producing bonds
and dividend-paying common stocks.
o The Balanced Fund is intended for those seeking a middle-of-the-road
approach that emphasizes stocks for their higher capital appreciation
potential but retains a significant income component to temper
volatility. The fund will invest at least 25% of its total assets in
senior fixed income securities.
o The Growth Fund, with the greatest exposure to stocks, is designed for
more aggressive investors who can withstand the market's inevitable
setbacks to seek its potential long-term rewards. The fund will invest
at least 65% of its total assets in common stocks of companies whose
earnings or dividends are expected to increase.
To review some investing ground rules or to gain a more accurate picture
of your own investment objectives, we suggest you use the Investment
Guide you may have received with this prospectus, or call 1-800-638-5660
to request the Guide.
_____________________________________________________________________________
THE FUND OR FUNDS YOU SELECT SHOULD REFLECT YOUR INDIVIDUAL INVESTMENT GOALS,
BUT SHOULD NOT BE RELIED UPON FOR SHORT-TERM FINANCIAL NEEDS OR REPRESENT YOUR
COMPLETE INVESTMENT PROGRAM.
Differences among funds
Asset Allocation
Fund Benchmarks Ranges Relative Risk/Reward
_____________________________________________________________________________
Income 40% stocks 30 - 50% Lowest
40 bonds 30 - 50
20 money markets 10 - 30
_____________________________________________________________________________
Balanced 60% stocks 50 - 70% Moderate
30 bonds 20 - 40
10 money markets 0 - 20
_____________________________________________________________________________
Growth 80% stocks 70 - 90% Highest
20 bonds 10 - 30
_____________________________________________________________________________
Table 4
Is there other information I need to review before making a decision?
Yes. Although the funds will invest primarily in common stocks, bonds, and
money market securities, they can also make other investments which have
additional and different risks. Be sure to review "Investment Policies and
Practices" in Section 3, which reviews the following topics: Types of
Securities in which the funds may invest including preferred stocks,
convertible securities and warrants, foreign securities, asset-backed
securities, mortgage-backed securities, hybrid instruments, zero coupon and
pay-in-kind bonds and private placements; and Types of Management
Practices-cash position, borrowing money and transferring assets, futures and
options, interest rate swaps, managing foreign currency risk, lending of
portfolio securities, when-issued securities and forward commitment contracts,
portfolio transactions, high-yield/high-risk investing and credit quality
considerations.
2 About Your Account
2 ABOUT YOUR ACCOUNT
_____________________________________________________________________________
THE VARIOUS WAYS YOU CAN BUY, SELL, AND EXCHANGE SHARES ARE EXPLAINED AT THE
END OF THIS PROSPECTUS AND ON THE NEW ACCOUNT FORM.
Pricing Shares and Receiving Sale Proceeds
Here are some procedures you should know when investing in a fund.
How and when shares are priced
The share price (also called "net asset value" or NAV per share) for each fund
is calculated at 4 p.m. ET each day the New York Stock Exchange is open for
business. To calculate the NAV, a fund's assets are priced and totaled,
liabilities are subtracted, and the balance, called net assets, is divided by
the number of shares outstanding.
_____________________________________________________________________________
WHEN FILLING OUT THE NEW ACCOUNT FORM, YOU MAY WISH TO GIVE YOURSELF THE
WIDEST RANGE OF OPTIONS FOR RECEIVING PROCEEDS FROM A SALE.
How your purchase, sale, or exchange price is determined.
If we receive your request in correct form before 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions are priced may be changed in case of an
emergency or if the New York Stock Exchange closes at a time other than 4 p.m.
ET.
How you can receive the proceeds from a sale
_____________________________________________________________________________
IF FOR SOME REASON WE CANNOT ACCEPT YOUR REQUEST TO SELL SHARES, WE WILL
CONTACT YOU.
If your request is received by 4 p.m. ET in correct form, proceeds are usually
sent on the next business day. Proceeds can be sent to you by mail, or to your
bank account by ACH transfer or bank wire. Proceeds sent by bank wire should
be credited to your bank account the next business day, and proceeds sent by
ACH transfer should be credited the second day after the sale. ACH (Automated
Clearing House) is an automated method of initiating payments from and
receiving payments in your financial institution account. ACH is a payment
system supported by over 20,000 banks, savings banks, and credit unions, which
electronically exchange the transactions primarily through the Federal Reserve
Banks.
Exception: Under certain circumstances and when deemed to be in the fund's
best interests, your proceeds may not be sent for up to five business days
after receiving your sale or ex-change request. If you were exchanging into a
bond or money fund, your new investment would not begin to earn dividends
until the sixth business day.
Useful Information on Distributions and Taxes
_____________________________________________________________________________
THE FUNDS DISTRIBUTE ALL NET INVESTMENT INCOME AND REALIZED CAPITAL GAINS TO
SHAREHOLDERS.
Dividends and other distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding; that
is, you receive interest and capital gain distributions on a rising number of
shares.
Dividends not reinvested are paid by check or transmitted to your bank account
via ACH. If the Post Office cannot deliver your check, or if your check
remains uncashed for six months, a fund reserves the right to reinvest your
distribution check in your account at the then current NAV and to reinvest all
subsequent distributions in shares of the fund.
Income dividends
o The Balanced and Income Funds declare and pay dividends (if any)
quarterly.
o The Growth Fund declares and pays dividends (if any) annually.
o All or part of a fund's dividends will be eligible for the 70% deduction
for dividends received by corporations.
Capital gains
o A capital gain or loss is the difference between the purchase and sale
price of a security.
o If the fund has net capital gains for the year (after subtracting any
capital losses), they are usually declared and paid in December to
shareholders of record on a specified date that month.
_____________________________________________________________________________
THE FUNDS SEND TIMELY INFORMATION FOR YOUR TAX FILING NEEDS.
Tax information
You need to be aware of the possible tax consequences when:
o the fund makes a distribution to your account, or
o you sell fund shares, including an exchange from one fund to another.
Taxes on fund redemptions. When you sell shares in any fund, you may realize a
gain or loss. An exchange from one fund to another is still a sale for tax
purposes.
In January, the funds will send you and the IRS Form 1099-B, indicating the
date and amount of each sale you made in the fund during the prior year. We
will also tell you the average cost of the shares you sold during the year.
Average cost information is not reported to the IRS, and you do not have to
use it. You may calculate the cost basis using other methods acceptable to the
IRS, such as "specific identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction (except for systematic purchases and redemptions)
you make and a year-end statement detailing all your transactions in each fund
account during the year.
_____________________________________________________________________________
DISTRIBUTIONS ARE TAXABLE WHETHER REINVESTED IN ADDITIONAL SHARES OR RECEIVED
IN CASH.
Taxes on fund distributions. The following summary does not apply to
retirement accounts, such as IRAs, which are tax-deferred until you withdraw
money from them.
In January, the funds will send you and the IRS Form 1099-DIV indicating the
tax status of any dividend and capital gain distribution made to you. All
distributions made by these funds are taxable to you for the year in which
they were paid. The only exception is that distributions declared during the
last three months of the year and paid in January are taxed as though they
were paid by December 31. Dividends and distributions are taxable to you
regardless of whether they are taken in cash or reinvested. The funds will
send you any additional information you need to determine your taxes on fund
distributions, such as the portion of your dividend, if any, that may be
exempt from state income taxes.
Short-term capital gains are taxable as ordinary income and long-term gains
are taxable at the applicable long-term gain rate. The gain is long or short
term depending on how long the fund held the securities, not how long you held
shares in the fund. If you realize a loss on the sale or exchange of fund
shares held six months or less, your short-term loss recognized is
reclassified to long-term to the extent of any capital gain distribution
received.
Distributions resulting from the sale of certain foreign currencies and debt
securities, to the extent of foreign exchange gains, are taxed as ordinary
income. If the fund pays nonrefundable taxes to foreign governments during
the year, the taxes will reduce the fund's dividends.
Tax effect of buying shares before a capital gain or quarterly dividend
distribution. If you buy shares shortly before or on the "record date"-the
date that establishes you as the person to receive the upcoming
distribution-you will receive in the form of a taxable distribution a portion
of the money you just invested. Therefore, you may wish to find out a fund's
record date(s) before investing. Of course, the fund's share price may reflect
undistributed capital gains or income and unrealized appreciation at any time.
Transaction Procedures and Special Requirements
_____________________________________________________________________________
FOLLOWING THESE PROCEDURES HELPS ASSURE TIMELY AND ACCURATE TRANSACTIONS.
Purchase Conditions
Nonpayment. If your payment is not received or you pay with a check or ACH
transfer that does not clear, your purchase will be cancelled. You will be
responsible for any losses or expenses incurred by the fund or transfer agent,
and the fund can redeem shares you own in this or another identically
registered T. Rowe Price fund as reimbursement. The fund and its agents have
the right to reject or cancel any purchase, exchange, or redemption due to
nonpayment.
U.S. dollars. All purchases must be paid for in U.S. dollars; checks must be
drawn on U.S. banks.
Sale (Redemption) Conditions
10-day hold. If you sell shares that you just purchased and paid for by check
or ACH transfer, the fund will process your redemption but will generally
delay sending you the proceeds for up to 10 calendar days to allow the check
or transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following
receipt unless the check or ACH transfer has not cleared. (The 10-day hold
does not apply to purchases paid for by: bank wire; cashier's, certified, or
treasurer's checks; or automatic purchases through your paycheck.)
Telephone transactions. Telephone exchange and redemption are established
automatically when you sign the New Account Form unless you check the box
which states that you do not want these services. The fund uses reasonable
procedures (including shareholder identity verification) to confirm that
instructions given by telephone are genuine. If these procedures are not
followed, it is the opinion of certain regulatory agencies that a fund may be
liable for any losses that may result from acting on the instructions given.
All conversations are recorded, and a confirmation is sent within five
business days after the telephone transaction.
Redemptions over $250,000. Large sales can adversely affect a portfolio
manager's ability to implement a fund's investment strategy by causing the
premature sale of securities that would otherwise be held. If in any 90-day
period, you redeem (sell) more than $250,000, or your sale amounts to more
than 1% of the fund's net assets, the fund has the right to delay sending your
proceeds for up to five business days after receiving your request, or to pay
the difference between the redemption amount and the lesser of the two
previously mentioned figures with securities from the fund.
Excessive Trading
_____________________________________________________________________________
T. ROWE PRICE MAY BAR EXCESSIVE TRADERS FROM PURCHASING SHARES.
Frequent trades involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses. We define "excessive trading" as exceeding
one purchase and sale involving the same fund within any 120-day period.
For example, you are in fund A. You can move substantial assets from A to fund
B, and, within the next 120 days, sell your shares in fund B to return to fund
A or move to fund C.
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: 1)
trades solely between money market funds, 2) redemptions that are not part of
exchanges, and 3) systematic purchases or redemptions (see "Shareholder
Services").
Keeping Your Account Open
Due to the relatively high cost of maintaining small accounts, we ask you to
maintain an account balance of at least $1,000. If your balance is below
$1,000 for three months or longer, the fund has the right to close your
account after giving you 60 days in which to increase your balance.
_____________________________________________________________________________
A SIGNATURE GUARANTEE IS DESIGNED TO PROTECT YOU AND THE FUND FROM FRAUD BY
VERIFYING YOUR SIGNATURE.
Signature Guarantees
You may need to have your signature guaranteed in certain situations, such as:
o Written requests 1) to redeem over $50,000 or 2) to wire redemption
proceeds.
o Remitting redemption proceeds to any person, address, or bank account
not on record.
o Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration from yours.
o Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker/dealers and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
3 More About the Funds
3 MORE ABOUT THE FUNDS
The Funds' Organization and Management
_____________________________________________________________________________
SHAREHOLDERS BENEFIT FROM T. ROWE PRICE'S 57 YEARS OF INVEST-MENT MANAGEMENT
EXPERIENCE.
How are the funds organized?
The T. Rowe Price Personal Strategy Funds, Inc., incorporated in Maryland in
1994, is a diversified, open-end investment company or mutual fund. Mutual
funds pool money received from shareholders and invest it to try to achieve
specific objectives.
What is meant by "shares"?
As with all mutual funds, investors purchase "shares" when they invest in a
fund. These shares are part of a fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
o receive a proportional interest in a fund's income and capital gain
distributions;
o cast one vote per share on certain fund matters, including the election
of fund directors, changes in fundamental policies, or approval of
changes in a fund's management contract.
Does each fund have an annual shareholder meeting?
The funds are not required to hold annual meetings and do not intend to do so
except when certain matters, such as a change in a fund's fundamental
policies, are to be decided. In addition, shareholders representing at least
10% of all eligible votes may call a special meeting if they wish for the
purpose of voting on the removal of any fund director(s). If a meeting is held
and you cannot attend, you can vote by proxy. Before the meeting, the fund
will send you proxy materials that explain the issues to be decided and
include a voting card for you to mail back.
_____________________________________________________________________________
ALL DECISIONS REGARDING THE PURCHASE AND SALE OF FUND INVESTMENTS ARE MADE BY
T. ROWE PRICE ASSOCIATES- SPECIFICALLY BY THE FUNDS' PORTFOLIO MANAGERS.
Who runs the funds?
General Oversight. The funds are governed by a Board of Directors that meets
regularly to review the fund's investments, performance, expenses, and other
business affairs. The Board elects the funds' officers.
Portfolio Management. The funds' investments are guided by two committees. An
Asset Allocation Committee meets regularly to determine the asset allocation
of the three funds among stocks, bonds, and money market securities. Committee
members include Peter Van Dyke, Chairman, Stephen W. Boesel, Edmund M. Notzon,
William T. Reynolds, James S. Riepe, Charles P. Smith, and M. David Testa.
Day-to-day responsibility for managing the funds' investments lies with an
Investment Advisory Committee which includes Messrs. Boesel, John D.
Gillespie, Notzon, Testa and Van Dyke.
The Asset Allocation Committee has been acting in this role for T. Rowe Price
since 1990 and its members bring a wide range of investment experience to this
task. Members of the Invest-ment Advisory Committee responsible for making
day-to-day portfolio decisions for the funds are each experienced investment
managers. Mr. Van Dyke has been managing investments since joining T. Rowe
Price in 1985. Mr. Boesel has been managing investments since joining T. Rowe
Price in 1973. Mr. Gillespie joined T. Rowe Price in 1986 and has been
managing investments since 1989. Mr. Notzon joined T. Rowe Price in 1989 and
has been managing investments since 1991. Mr. Testa has been managing
investments since joining T. Rowe Price in 1972.
Marketing. T. Rowe Price Investment Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, distributes (sells) shares of these and all other T. Rowe
Price funds.
Shareholder Services. T. Rowe Price Services, Inc., another wholly-owned
subsidiary, acts as the funds' transfer and dividend disbursing agent and
provides shareholder and administrative services. Services for certain types
of retirement plans are provided by T. Rowe Price Retirement Plan Services,
Inc., also a wholly-owned subsidiary. The address for each is 100 East Pratt
St., Baltimore, MD 21202.
How are fund expenses determined?
The management agreement spells out the expenses to be paid by each fund. In
addition to the management fee, each fund pays for the following: shareholder
service expenses; custodial, accounting, legal, and audit fees; costs of
preparing and printing prospectuses and reports sent to shareholders;
registration fees and expenses; proxy and annual meeting expenses (if any);
and director/trustee fees and expenses.
The Management Fee.
This fee has two parts-an "individual fund fee" (discussed on page 3) which
reflects the fund's particular investment management costs, and a "group fee."
The group fee, which is designed to reflect the benefits of the shared
resources of the T. Rowe Price investment management complex, is calculated
monthly based on the net combined assets of all T. Rowe Price funds (except
Equity Index and both Spectrum Funds and any institutional or private label
mutual funds). The group fee schedule (shown below) is graduated, declining as
the asset total rises, so shareholders benefit from the overall growth in
mutual fund assets.
0.480% First $1 billion 0.370% Next $1 billion 0.330% Next $10 billion
0.450% Next $1 billion 0.360% Next $2 billion 0.320% Next $10 billion
0.420% Next $1 billion 0.350% Next $2 billion 0.310% Thereafter
0.390% Next $1 billion 0.340% Next $5 billion
Each fund's portion of the group fee is determined by the ratio of its daily
net assets to the daily net assets of all the Price funds described above.
Based on combined Price funds' assets of approximately $35.5 billion at June
30, 1994, the Group Fee was 0.34%.
Understanding Performance Information
_____________________________________________________________________________
TOTAL RETURN IS THE MOST WIDELY USED PERFORMANCE MEASURE. DETAILED PERFORMANCE
INFORMATION IS INCLUDED IN THE FUNDS' ANNUAL REPORTS AND QUARTERLY SHAREHOLDER
REPORTS.
This section should help you understand the terms used to describe the funds'
performance. You will come across them in shareholder reports you receive from
us four times a year, in our newsletters, "Insights" reports, in T. Rowe Price
advertisements, and in the media.
Total Return
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share price
and assumes that all dividends and capital gains (if any) paid during the
period were reinvested in additional shares. Including reinvested
distributions means that total return numbers include the effect of
compounding, i.e., you receive income and capital gain distributions on a
rising number of shares.
Advertisements for the fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and the end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative
return, it tells you what constant year-by-year return would have produced the
actual, cumulative return. By smoothing out all the variations in annual
performance, it gives you an idea of the investment's annual contribution to
your portfolio provided you held it for the entire period in question.
Investment Policies and Practices
_____________________________________________________________________________
FUND MANAGERS HAVE CONSIDERABLE LEEWAY IN CHOOSING INVESTMENT STRATEGIES AND
SELECTING SECURITIES THEY BELIEVE WILL HELP THE FUNDS ACHIEVE THEIR
OBJECTIVES.
This section takes a detailed look at some of the securities the funds may
hold in their portfolios and the various kinds of investment practices that
may be used in day-to-day portfolio management. The funds' investment programs
are subject to further restrictions and risks described in the Statement of
Additional Information. The funds adhere to applicable investment restrictions
at the time they make an investment. A later change in circumstances will not
require the sale of an investment if it was proper at the time it was made.
Shareholder approval is required to substantively change a fund's objective
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating policies"
which can be changed without shareholder approval. How-ever, significant
changes are discussed with shareholders in fund reports.
Types of Portfolio Securities
In seeking to meet their investment objectives, the funds may invest in any
type of security or instrument (including derivatives) whose investment
characteristics are consistent with the fund's investment program. These and
some of the other investment techniques the funds may use are described in the
following pages.
Fundamental policy: A fund will not purchase a security if, as a result, with
respect to 75% of the fund's total assets, more than 5% of its total assets
would be invested in securities of the issuer or more than 10% of the voting
securities of the issuer would be held by the fund.
Bonds. A bond is an interest-bearing security-an IOU-issued by companies or
governmental units. The issuer has a contractual obligation to pay interest at
a stated rate on specific dates and to repay principal (the bond's face value)
on a specified date. An issuer may have the right to redeem or "call" a bond
before maturity, and the investor may have to reinvest the proceeds at lower
market rates.
A bond's annual interest income, set by its coupon rate, is usually fixed for
the life of the bond. Its yield (income as a percent of current price) will
fluctuate to reflect changes in interest rate levels. A bond's price usually
rises when interest rates fall, and vice versa, so its yield stays current.
Bonds may be unsecured (backed by the issuer's general creditworthiness only)
or secured (also backed by specified collateral).
Certain bonds have interest rates that are adjusted periodically which tend to
minimize fluctuations of their principal value. The maturity of those
securities may be shortened under certain specified conditions.
Bonds may be designated as senior, junior, or subordinated obligations. Senior
obligations generally have the first claim on a corporation's earnings and
assets and, in the event of liquidation, are paid before junior or other debt.
Common and Preferred Stocks. Stocks represent shares of ownership in a
company. Generally, preferred stock has a specified dividend and ranks after
bonds and before common stocks in its claim on income for dividend payments
and on assets should the company be liquidated. After other claims are
satisfied, common stockholders participate in company profits on a pro rata
basis; profits may be paid out in dividends or reinvested in the company to
help it grow. Increases and decreases in earnings are usually reflected in a
company's stock price, so common stocks generally have the greatest
appreciation and depreciation potential of all corporate securities. While
most preferred stocks pay a dividend, the funds may purchase preferred stock
where the issuer has omitted, or is in danger of omitting, payment of its
dividend. Such investments would be made primarily for their capital
appreciation potential.
Convertible Securities and Warrants. The funds may invest in debt or preferred
equity securities convertible into or exchangeable for equity securities.
Traditionally, convertible securities have paid dividends or interest at rates
higher than common stocks but lower than non-convertible securities. They
generally participate in the appreciation or depreciation of the underlying
stock into which they are convertible, but to a lesser degree. In recent
years, convertibles have been developed which combine higher or lower current
income with options and other features. Warrants are options to buy a stated
number of shares of common stock at a specified price any time during the life
of the warrants (generally, two or more years).
Foreign Securities. The funds may invest in foreign securities. These include
non-dollar de-nominated securities traded outside of the U.S. and dollar
denominated securities traded in the U.S. (such as ADRs). Such investments
increase a portfolio's diversification and may enhance return, but they also
involve some special risks such as exposure to potentially adverse local
political and economic developments; nationalization and exchange controls;
potentially lower liquidity and higher volatility; possible problems arising
from accounting, disclosure, settlement, and regulatory practices that differ
from U.S. standards; and the chance that fluctuations in foreign exchange
rates will decrease the investment's value (favorable changes can increase its
value).
Operating policy: Each fund may invest up to 35% of its total assets in
foreign securities.
Asset-backed Securities. An underlying pool of assets, such as credit card or
automobile trade receivables or corporate loans or bonds, backs these bonds
and provides the interest and principal payments to investors. Credit quality
depends primarily on the quality of the underlying assets and the level of
credit support, if any, provided by the issuer. The underlying assets (i.e.,
loans) are subject to prepayments which can shorten the securities' weighted
average life and may lower their return. The value of these securities also
may change because of actual or perceived changes in the creditworthiness of
the originator, servicing agent, or of the financial institution providing the
credit support. There is no limit on the portion of the funds' fixed income
investments in these securities.
Mortgage-backed Securities. The funds may invest in a variety of
mortgage-backed securities. Mortgage lenders pool individual home mortgages
with similar characteristics to back a certificate or bond, which is sold to
investors such as the funds. Interest and principal payments generated by the
underlying mortgages are passed through to the investors. The "big three"
issuers are Government National Mortgage Association (GNMA), the Federal
National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage
Corporation (Freddie Mac). GNMA certificates are backed by the full faith and
credit of the U.S. Govern-ment, while others, such as Fannie Mae and Freddie
Mac certificates, are only supported by the ability to borrow from the U.S.
Treasury or supported only by the credit of the agency. Private mortgage
bankers and other institutions also issue mortgage-backed securities.
Mortgage securities are subject to scheduled and unscheduled principal
payments as homeowners pay down or prepay their mortgages. As these payments
are received, they must be reinvested when interest rates may be higher or
lower than on the original mortgage security. Therefore, mortgage securities
are not an effective means of locking in long-term interest rates. In
addition, when interest rates fall, the pace of mortgage prepayments picks up.
These refinanced mortgages are paid off at face value (par), causing a loss
for any investor who may have purchased the security at a price above par. In
such an environment, this risk limits the potential price appreciation of
these securities and can negatively affect a fund's net asset value. When
rates rise, however, mortgage-backed securities have historically experienced
smaller price declines than comparable quality bonds. There is no limit on the
portion of the funds' fixed income investments in these securities.
Additional mortgage-backed securities in which the funds may invest include:
o Collateralized Mortgage Obligations (CMOs). CMOs are debt securities
that are fully collateralized by a portfolio of mortgages or
mortgage-backed securities. All interest and principal payments from the
underlying mortgages are passed through to the CMOs in such a way as to
create more definite maturities than is the case with the underlying
mortgages. CMOs may pay fixed or variable rates of interest, and certain
CMOs have priority over others with respect to the receipt of
prepayments.
o Stripped Mortgage Securities. Stripped mortgage securities (a type of
derivative) are created by separating the interest and principal
payments generated by a pool of mortgage-backed securities or a CMO to
create additional classes of securities. Generally, one class receives
only interest payments (IOs) and one principal payments (POs). Unlike
GNMA securities and POs, the value of IOs tends to move in the same
direction as interest rates. The funds could use IOs as a hedge against
falling prepaying rates (interest rates are rising) and/or a bear market
environment. POs can be used as a hedge against rising prepayment rates
(interest rates are falling) and/or a bull market environment. IOs and
POs are acutely sensitive to interest rate changes and to the rate of
principal prepayments. A rapid or unexpected increase in prepayments can
severely depress the price of IOs, while a rapid or unexpected decrease
in prepayments could have the same effect on POs. These securities are
very volatile in price and may have lower liquidity than most other
mortgage-backed securities. Certain non-stripped CMOs may also exhibit
these qualities, especially those which pay variable rates of interest
which adjust inversely with and more rapidly than short-term interest
rates. There is no guarantee a fund's investment in CMOs, IOs or POs
will be successful, and a fund's total return could be adversely
affected as a result.
Operating policy: Each fund may invest up to 10% of its total assets in
stripped mortgage securities.
Hybrid Instruments. These instruments (a type of derivative) can combine
the characteristics of securities, futures and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively
or negatively) to the price of some commodity, currency or securities
index or another interest rate (each a "benchmark"). Hybrids can be used
as an efficient means of pursuing a variety of investment goals,
including currency hedging, duration management and increased total
return. Hybrids may not bear interest or pay dividends. The value of a
hybrid or its interest rate may be a multiple of a benchmark and, as a
result, may be leveraged and move (up or down) more steeply and rapidly
than the benchmark. These benchmarks may be sensitive to economic and
political events, such as commodity shortages and currency devaluations,
which cannot be readily foreseen by the purchaser of a hybrid. Under
certain conditions, the redemption value of a hybrid could be zero.
Hybrids can have volatile prices and limited liquidity. Thus, an
investment in a hybrid may entail significant market risks that are not
associated with a similar investment in a traditional, U.S.
dollar-denominated bond that has a fixed principal amount and pays a
fixed rate or floating rate of interest. The purchase of hybrids exposes
the funds to the credit risk of the issuer of the hybrid. These risks
may cause significant fluctuations in the net asset value of the funds.
There is no assurance that a fund's investment in hybrids will be
successful.
Operating policy: Each fund may invest up to 10% of its total assets in hybrid
instruments.
Investment Funds. The funds may invest in other investment funds or companies,
primarily where such investments would be the only practical means of
investing in certain foreign countries. Such investments would result in the
funds paying additional or duplicative fees and expenses. The risks of such
investment would reflect the risks of investing in the types
of securities in which the investment funds or companies invest.
Operating policy: Each fund may invest up to 10% of its assets in other
investment funds and companies.
Zero Coupon Bonds and Pay-in-Kind Bonds. A zero coupon bond does not make cash
interest payments during the life of the bond. Instead, it is sold at a deep
discount to face value, and the interest consists of the gradual appreciation
in price as the bond approaches maturity. "Zeros" can be an attractive
financing method for issuers with near-term cash-flow problems. Pay-in-kind
(PIK) bonds pay interest in cash or additional securities, at the issuer's
option, for a specified period. Like zeros, they may help a corporation
economize on cash. PIK prices reflect the market value of the underlying debt
plus any accrued interest. Zeros and PIKS can be higher- or lower-quality
debt, and both are more volatile than coupon bonds.
Each fund is required to distribute to shareholders income imputed to any zero
or PIK investments. Such distributions could reduce a fund's reserve position.
Each fund may invest up to 10% of its total assets in zero coupon and
pay-in-kind bonds.
Private Placements (Restricted Securities). These securities are sold directly
to a small number of investors, usually institutions. Unlike public offerings,
such securities are not registered with the SEC. Although certain of these
securities may be readily sold, for example under Rule 144A, others may be
illiquid and their sale may involve substantial delays and additional costs.
Operating policy: Each fund will not invest more than 15% of its net assets in
illiquid securities and no more than 5% of its total assets in certain
restricted securities.
Types of Management Practices
Cash Position. Each fund will hold a certain portion of their assets in money
market securities, including repurchase agreements, in the two highest rating
categories, maturing in one year or less. For temporary, defensive purposes, a
fund may invest without limitation in such securities. This reserve position
provides flexibility in meeting redemptions, expenses, and the timing of new
investments, and serves as a short-term defense during periods of unusual
market volatility.
Borrowing Money and Transferring Assets. The funds can borrow money from banks
as a temporary measure for emergency purposes, to facilitate redemption
requests, or for other purposes consistent with the fund's investment
objectives and program. Such borrowings may be collateralized with fund
assets, subject to restrictions.
Fundamental policy: Borrowings may not exceed 331_3% of a fund's total assets.
Operating policies: Each fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 331_3% of a fund's total
assets. A fund may not purchase additional securities when borrowings exceed
5% of total assets.
Futures and Options. Futures (a type of derivative) are often used to manage
risk because they enable the investor to buy or sell an asset in the future at
an agreed upon price. Options (another type of derivative) give the investor
the right, but not the obligation, to buy or sell an asset at a predetermined
price in the future. The funds may buy and sell futures contracts (and options
on such contracts) for a number of reasons including: to manage their exposure
to changes in interest rates, stock and bond prices, and foreign currencies;
as an efficient means of adjusting their overall exposure to certain markets;
and to adjust the portfolio's duration. The funds may purchase, sell, or write
call and put options on securities, financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile; using them could lower the fund's total return
and the potential loss from the use of futures can exceed the fund's initial
investment in such contracts.
Operating policies: Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of a fund's net
asset value. Options on securities: The total market value of securities
against which a fund has written call or put options may not exceed 25% of its
total assets. A fund will not commit more than 5% of its total assets to
premiums when purchasing call or put options.
Interest Rate Transactions. The funds may enter into various interest rate
transactions (a type of derivative investment) such as interest rate swaps and
the purchase or sale of interest rate caps, collars 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
purposes.
Operating policy: Each fund will not invest more than 10% of its total assets
in interest rate transactions.
Managing Foreign Currency Risk. Investors in foreign securities may "hedge"
their exposure to potentially unfavorable currency changes by purchasing a
contract to exchange one currency for another on some future date at a
specified exchange rate. In certain circumstances, a "proxy currency" may be
substituted for the currency in which the investment is denominated, a
strategy known as "proxy hedging." Although foreign currency transactions will
be used primarily to protect a fund's foreign securities from adverse currency
movements relative to the dollar, they involve the risk that anticipated
currency movements will not occur and a fund's total return could be reduced.
Lending of Portfolio Securities. Like other mutual funds, the funds may lend
securities to broker-dealers, other institutions, or other persons to earn
additional income. The principal risk is the potential insolvency of the
broker-dealer or other borrower. In this event, the funds could experience
delays in recovering their securities and possibly capital losses.
Fundamental policy: The value of loaned securities may not exceed 331_3% of a
fund's total assets.
When-Issued Securities and Forward Commitment Contracts. The funds may
purchase securities on a when-issued or delayed delivery basis or may purchase
or sell securities on a forward commitment basis. There is no limit on the
portion of the funds' fixed income investments in these securities. The price
of these securities is fixed at the time of the commitment to buy, but
delivery and payment can take place a month or more later. During the interim
period, the market value of the securities can fluctuate, and no interest
accrues to the purchaser. At the time of delivery, the value of the securities
may be more or less than the purchase or sale price. To the extent each 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.
Portfolio Transactions. The funds will not generally trade in securities
(either common stocks or bonds) for short-term profits, but, when
circumstances warrant, securities may be purchased and sold without regard to
the length of time held. The portfolio turnover rate for each of the Balanced,
Growth and Income Funds is not expected to exceed 40%.
High Yield/High Risk Investing. The total return and yield of lower quality
(high yield/high risk) bonds, commonly referred to as "junk bonds," can be
expected to fluctuate more than the total return and yield of higher quality
bonds. Junk bonds are regarded as predominantly speculative with respect to
the issuer's continuing ability to meet principal and interest payments.
Successful investment in low and lower-medium quality bonds involves greater
investment risk and is highly dependent on T. Rowe Price's credit analysis. A
real or perceived economic downturn or higher interest rates could cause a
decline in high yield bond prices, because such events could lessen the
ability of issuers to make principal and interest payments. These bonds are
often thinly-traded and can be more difficult to sell and value accurately
than high-quality bonds. Because objective pricing data may be less available,
judgment may play a greater role in the valuation process. In addition, the
entire junk bond market can experience sudden and sharp price swings due to a
variety of factors, including changes in economic forecasts, stock market
activity, large or sustained sales by major investors, a high-profile default,
or just a change in the market's psychology. This type of volatility is
usually associated more with stocks than bonds, but junk bond investors should
be prepared for it.
Operating policy: The Balanced, Growth and Income Funds may each invest up to
20%, 15% and 25%, respectively, of their total assets in below investment
grade or junk bonds.
Credit Quality Considerations. The credit quality of most bond issues is
evaluated by rating agencies such as Moody's and Standard & Poor's. Credit
quality refers to the issuer's ability to meet all required interest and
principal payments. The highest ratings are assigned to issuers perceived to
be the best credit risks. T. Rowe Price research analysts also evaluate all
portfolio holdings of the funds, including those rated by outside agencies.
The lower the rating on a bond, the higher the yield, other things being
equal.
Table 5 shows the rating scale used by the major rating agencies. T. Rowe
Price considers publicly available ratings, but emphasizes its own credit
analysis when selecting investments.
Ratings of Corporate Debt Securities
Moody's Standard Fitch Investors Definition
Investors & Poor's Service, Inc.
Service, Inc. Corporation
_____________________________________________________________________________
Long-Term Aaa AAA AAA Highest quality
__________________________________________________________________
Aa AA AA High quality
__________________________________________________________________
A A A Upper medium grade
__________________________________________________________________
Baa BBB BBB Medium grade
__________________________________________________________________
Ba BB BB Low grade
__________________________________________________________________
B B B Speculative
__________________________________________________________________
Caa, Ca CCC, CC CCC, CC Sub-marginal
__________________________________________________________________
Ca C C Income bond, no
interest paid
__________________________________________________________________
C D DDD, DD, D Probably in
default
__________________________________________________________________
Moody's S&P Fitch
_____________________________________________________________________________
Commercial P-1 Superior quality A-1+ Extremely quality F-1+ Exceptionally
Paper strong quality
A-1 Strong quality F-1 Very strong
quality
__________________________________________________________________
P-2 Strong quality A-2 Satisfactory qualityF-2 Good credit
quality
__________________________________________________________________
P-3 Acceptable quality A-3 Adequate quality F-3 Fair credit
quality
__________________________________________________________________
B Speculative quality F-S Weak credit
quality
_____________________________________________________________________________
Table 5
4 Investing with T. Rowe Price
4 INVESTING WITH T. ROWE PRICE
Meeting Requirements for New Accounts
_____________________________________________________________________________
ALWAYS VERIFY YOUR TRANSACTIONS BY CAREFULLY REVIEWING THE CONFIRMATION WE
SEND YOU. PLEASE REPORT ANY DISCREPANCIES TO SHAREHOLDER SERVICES.
Tax Identification Number
We must have your correct social security or corporate tax identification
number and a signed New Account Form or W-9 Form. Otherwise, federal law
requires the funds to withhold a percentage (currently 31%) of your dividends,
capital gain distributions, and redemptions, and may subject you to an IRS
fine. You will also be prohibited from opening another account by exchange. If
this information is not received within 60 days after your account is
established, your account may be redeemed, priced at the NAV on the date of
redemption.
Unless you request otherwise, one shareholder report will be mailed to
multiple account owners with the same tax identification number and same zip
code and to shareholders who have requested that their account be combined
with someone else's for financial reporting.
Opening a New Account: $2,500 minimum initial investment; $1,000 for
retirement or gifts or transfers to minors (UGMA/UTMA) accounts
_____________________________________________________________________________
REGULAR MAIL
T. ROWE PRICE
ACCOUNT SERVICES
P.O. BOX 17300
BALTIMORE, MD
21298-9353
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name
and account type would have to be identical.)
By Mail
Please make your check payable to T. Rowe Price funds (otherwise it may be
returned) and send it together with the New Account Form to the address at
left.
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MAILGRAM, EXPRESS,
REGISTERED, OR CERTIFIED MAIL
T. ROWE PRICE
ACCOUNT SERVICES
10090 RED RUN BLVD.
OWINGS MILLS, MD 21117
By Wire
o Call Investor Services for an account number and use the wire address
below.
o Complete a New Account Form and mail it to one of the appropriate
addresses listed at left.
Note: Retirement plans cannot be opened by wire.
o Give the following wire address to your bank: Morgan Guaranty Trust Co.
of New York, ABA# 021000238, T. Rowe Price [fund name], AC-00153938.
Provide fund name, account name(s), and account number.
By Exchange
Call Shareholder Services. The new account will have the same
registration as the account from which you are exchanging. Services for
the new account may be carried over by telephone request if
preauthorized on the existing account. (See explanation of "Excessive
Trading" under "Transaction Procedures.")
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DROP-OFF LOCATIONS:
101 EAST LOMBARD ST.
BALTIMORE, MD
T. ROWE PRICE
FINANCIAL CENTER
10090 RED RUN BLVD.
OWINGS MILLS, MD
FARRAGUT SQUARE
900 17TH ST., N.W.
WASHINGTON, D.C.
In Person
Drop off your New Account Form at any of the locations listed at left and
obtain a receipt.
Note: The fund and its agents reserve the right to waive or lower investment
minimums; to accept initial purchases by telephone or mailgram; cancel or
rescind any purchase or exchange upon notice to the shareholder within five
business days of the trade or if the written confirmation has not been
received by the shareholder, whichever is sooner (for example, if an account
has been restricted due to excessive trading or fraud); to otherwise modify
the conditions of purchase or any services at any time; or to act on any
instructions believed to be genuine.
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ARCO TOWER
31ST FLOOR
515 SOUTH FLOWER ST.
LOS ANGELES, CA
Purchasing Additional Shares: $100 minimum purchase;
$50 minimum for retirement plans and Automatic Asset Builder; $5,000 minimum
for telephone purchases
By ACH Transfer
Use Tele*Access (registered trademark), PC*Access (registered trademark) or
call Investor Services if you have established electronic transfers using the
ACH network.
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REGULAR MAIL
T. ROWE PRICE FUNDS
ACCOUNT SERVICES
P.O. BOX 89000
BALTIMORE, MD
21289-1500
By Wire
Call Shareholder Services or use the wire address in "Opening a New Account."
By Mail
o Provide your account number and the fund name on your check.
o Mail the check to us at the address shown at left either with a
reinvestment slip or a note indicating the fund and account number in
which you wish to purchase shares.
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form ($50 minimum).
By Phone
Call Shareholder Services to lock in that day's closing price; payment is due
within five days ($5,000 minimum).
Exchanging and Redeeming Shares
By Phone
Call Shareholder Services. If you find our phones busy during unusually
volatile markets, please consider placing your order by Tele*Access or
PC*Access (if you have previously authorized telephone services), or by
express mail or mailgram. For exchange policies, please see "Transaction
Procedures and Special Requirements-Excessive Trading."
Redemption proceeds can be mailed to your account address, sent by ACH
transfer, or wired to your bank. For charges, see "Electronic Transfers-By
Wire" on the next page.
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MAILGRAM, EXPRESS,
REGISTERED, OR
CERTIFIED MAIL
(SEE PAGE 22.)
By Mail
Provide account name(s) and numbers, fund name(s), and exchange or redemption
amount. For exchanges, mail to the appropriate address below or at left,
indicate the fund you are exchanging from and the fund(s) you are exchanging
into. T. Rowe Price requires the signatures of all owners exactly as
registered, and possibly a signature guarantee (see "Transaction Procedures
and Special Requirements-Signature Guarantees").
Regular Mail
For Non-Retirement and IRA Accounts: For Employer-Sponsored Retirement
Accounts:
T. Rowe Price Account Services T. Rowe Price Trust Company
P.O. Box 89000 P.O. Box 89000
Baltimore, MD 21289-0220 Baltimore, MD 21289-0300
Note: Redemptions from retirement accounts, including IRAs, must be in
writing. Please call Shareholder Services to obtain an IRA Distribution
Request Form. For employer-sponsored retirement accounts, call Investor
Services or your plan administrator for instructions.
Shareholder Services
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INVESTOR SERVICES
1-800-638-5660
1-410-547-2308
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically and others you must authorize on the New Account Form.
By signing up for services on the New Account Form rather than later, you
avoid having to complete a separate form and obtain a signature guarantee.
This section reviews some of the principal services currently offered. Our
Services Guide contains detailed descriptions of these and other services.
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IF YOU ARE A NEW T. ROWE PRICE INVESTOR, YOU WILL RECEIVE A SERVICES GUIDE
WITH OUR WELCOME KIT.
Retirement Plans
We offer a wide range of plans for individuals and institutions, including
large and small businesses: IRAs, SEP-IRAs, Keoghs (profit sharing, money
purchase pension), 401(k), and 403(b)(7). For information on IRAs, call
Investor Services. For information on all other retirement plans, please call
our Trust Company at 1-800-492-7670.
Exchange Service
You can move money from one account to an existing identically registered
account, or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund
are limited to investors living in states where the funds are registered.)
Some of the T. Rowe Price funds may impose a redemption fee of .50% to 2%,
payable to such funds, on shares held for less than one year, or in some
funds, six months.
Note: Shares purchased by telephone may not be exchanged to another fund until
payment is received.
Automated Services
Tele*Access. 24-hour service via toll-free number provides information such as
yields, prices, dividends, account balances, and your latest transaction as
well as the ability to request prospectuses and account forms and initiate
purchase, redemption and exchange orders in your accounts (see "Electronic
Transfers" below).
PC*Access. 24-hour service via dial-up modem provides the same information as
Tele*Access, but on a personal computer. Please call Investor Services for an
information guide.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our four investor center locations.
Electronic Transfers
By ACH. With no charges to pay, you can initiate a purchase or redemption for
as little as $100 or as much as $100,000 between your bank account and fund
account using the ACH network. Enter instructions via Tele*Access, PC*Access
or call Shareholder Services.
By Wire. Electronic transfers can also be conducted via bank wire. There is
currently a $5.00 fee for wire redemptions under $5,000, and your bank may
charge for wire transfers regardless of size.
Automatic Investing ($50 minimum)
You can invest automatically in several different ways, including:
o Automatic Asset Builder. You instruct us to move $50 or more once a
month or less often from your bank account, or you can instruct your
employer to send all or a portion of your paycheck to the fund or funds
you designate.
o Automatic Exchange. Enables you to set up systematic investments from
one fund account into another, such as from a money fund into a stock
fund.
Discount Brokerage
You can trade stocks, bonds, options, precious metals and other securities at
a substantial savings over regular commission rates. Call Investor Services
for information.
Note: If you buy or sell T. Rowe Price Funds through anyone other than T. Rowe
Price, such as broker-dealers or banks, you may be charged transaction or
service fees by those institutions. No such fees are charged by T. Rowe Price
Investment Services or the fund for transactions conducted directly with the
fund.
Personal Strategy Trust Benchmark mixes
Each of three pie charts shows the asset allocations among stocks, bonds, and
money markets for each of the Personal Strategy Funds (Income, Balanced, and
Conservative Growth).
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DESCRIPTION OF SIGNIFICANT DIFFERENCES BETWEEN EDGAR FILING AND PRINTED COPY
Information appearing in all capital letters before a paragraph in the Edgar
filing will appear, in the printed copy, as call-outs in the left margin.
<PAGE>
PAGE 1
STATEMENT OF ADDITIONAL INFORMATION
T. ROWE PRICE ADJUSTABLE RATE U.S. GOVERNMENT FUND, INC.
T. ROWE PRICE GNMA FUND
T. ROWE PRICE HIGH YIELD FUND, INC.
T. ROWE PRICE NEW INCOME FUND, INC.
T. ROWE PRICE PERSONAL STRATEGY FUNDS, INC.
T. ROWE PRICE PRIME RESERVE FUND, INC.
T. ROWE PRICE SHORT-TERM BOND FUND, INC.
T. ROWE PRICE U.S. TREASURY FUNDS, INC.
U.S. Treasury Intermediate Fund
U.S. Treasury Long-Term Fund
U.S. Treasury Money Fund
(collectively the "Funds" and individually the "Fund")
This Statement of Additional Information is not a prospectus but should
be read in conjunction with the appropriate Fund's prospectus dated July 29,
1994, which may be obtained from T. Rowe Price Investment Services, Inc., 100
East Pratt Street, Baltimore, Maryland 21202.
If you would like a prospectus for a Fund of which you are not a
shareholder, please call 1-800-638-5660. A prospectus with more complete
information, including management fees and expenses will be sent to you.
Please read it carefully.
The date of this Statement of Additional Information is July 29, 1994.
<PAGE>
PAGE 2
TABLE OF CONTENTS
Page Page
Asset-Backed Securities. . . . . . .16 Lending of Portfolio
Capital Stock. . . . . . . . . . . .83 Securities. . . . . . . . . . . . 26
Code of Ethics . . . . . . . . . . .61 Management of Fund . . . . . . . . 50
Custodian. . . . . . . . . . . . . .61 Mortgage-Related
Description of the Fund. . . . . . .84 Securities . . . . . . . . . . . .9
Distributor for Fund . . . . . . . .60 Net Asset Value Per Share. . . . . 71
Dividends and Distributions. . . . .71 Options. . . . . . . . . . . . . . 29
Federal and State Portfolio Transactions
62
Registration of Shares. . . . . . .85 Pricing of Securities. . . . . . . 68
Foreign Currency . Principal Holders of
Transactions. . . . . . . . . . . .42 Securities . . . . . . . . . . . 56
Foreign Futures and Options. . . . .40 Ratings of Commerical Paper. . . . 87
Futures Contracts. . . . . . . . . .34 Ratings of Corporate
Hybrid Instruments . . . . . . . . .22 Debt Securities. . . . . . . . . 88
Independent Accountants. . . . . . .86 Repurchase Agreements. . . . . . . 27
Illiquid or Restricted . . . . Risk Factors
3
Securities. . . . . . . . . . . . .25 Tax Status . . . . . . . . . . . . 71
Investment Management Services . . .56 Taxation of Foreign
Investment Objectives and Policies . 2 Shareholders . . . . . . . . . . 72
Investment Performance . . . . . . .74 Warrants . . . . . . . . . . . . . 22
Investment Program . . . . . . . . . 8 When-Issued Securities and Forward
Investment Restrictions. . . . . . .44 Commitment Contracts . . . . . . 24
Legal Counsel. . . . . . . . . . . .85 Yield Information. . . . . . . . . 73
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of each Fund's
investment objectives and policies discussed in each Fund's prospectus. The
Funds will not make a material change in their investment objectives without
obtaining shareholder approval. Unless otherwise specified, the investment
programs and restrictions of the Funds are not fundamental policies. Each
Fund's operating policies are subject to change by each Board of
Directors/Trustees without shareholder approval. However, shareholders will
be notified of a material change in an operating policy. Each 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.
Throughout this Statement of Additional Information, "the Fund" is
intended to refer to each Fund listed on the cover page, unless otherwise
indicated.<PAGE>
PAGE 3
RISK FACTORS
All Funds
Debt Obligations
Yields on short, intermediate, and long-term 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.
For the Prime Reserve and U.S. Treasury Money Funds, the procedures set forth
in Rule 2a-7, under the Investment Company Act of 1940, may require the prompt
sale of any such security. For the other Funds, neither event will require a
sale of such security by the Fund. However, T. Rowe Price will consider such
event 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
qualify comparable to that which the Fund is allowed to purchase.
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.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
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 principal
stability. 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
its investment objective.
<PAGE>
PAGE 4
Prime Reserve and U.S. Treasury Money Funds
There can be no assurance that the Funds will achieve their investment
objectives or be able to maintain their 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.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Mortgage 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 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 mortgage 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.
High Yield, New Income, Personal Strategy, and Short-Term Bond Funds
Risk Factors of Foreign Investing
There are special risks in foreign investing. Certain of these risks
are inherent in any mutual fund investing in foreign securities while others
relate more to the countries in which the Funds will invest. Many of the
risks are more pronounced for investments in developing or emerging countries,
such as many of the countries of Southeast Asia, Latin America, Eastern Europe
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.
PAGE 5
Political and Economic Factors. Individual foreign economies of certain
countries may 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 1992, there were two
military coup attempts in Venezuela and in 1992 the President of Brazil was
impeached. 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 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 Funds will invest 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 Funds' assets denominated in that currency. Such
changes will also affect the Funds' 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
Funds' securities denominated in that currency would be expected to decline.
Investment and Repatriation of Restrictions. Foreign investment in the
securities markets of certain foreign countries is restricted or controlled in
varying degrees. These restrictions may limit at times and preclude
investment in certain of such countries and may increase the cost and expenses
of the Funds. 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.
Market Characteristics. Foreign stock and bond markets are generally
not as developed or efficient as, and may be more volatile than, those in the
United States. While growing in volume, they usually have substantially less
volume than U.S. markets and the Funds' portfolio securities may be less
liquid and subject to more rapid and erratic price movements than securities
of comparable U.S. companies. Equity securities may trade at price/earnings
multiples higher than comparable United States securities and such levels may
not be sustainable. Fixed commissions on foreign stock exchanges are
generally higher than negotiated commissions on United States exchanges,
although the Funds will endeavor to achieve the most favorable net results on
their portfolio transactions. There is generally less government supervision
and regulation of foreign
PAGE 6
stock 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 may 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 a Fund.
Investment Funds. The Funds 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 Funds' investment in these funds
is subject to the provisions of the 1940 Act. If the Funds invest in such
investment funds, the Funds' shareholders will bear not only their
proportionate share of the expenses of the Funds (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 may be 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 Funds'
foreign portfolio securities may be subject to foreign withholding taxes, thus
reducing the net amount of income available for distribution to the Funds'
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 the 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. 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 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 a Fund's assets
invested in such countries and these authorities may not qualify as a foreign
custodian under the Investment Company Act of 1940 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
PAGE 7
investment in Eastern Europe and Russia. Each 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. To the extent any
securities issued by companies in Eastern Europe and Russia are considered
illiquid, each Fund will be required to include such securities within its 15%
restriction on investing in illiquid securities.
High Yield and Personal Strategy Funds
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 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
PAGE 8
securities than with respect to securities for which more external sources of
quotations and last sale information are available.
Congressional Action. New and proposed laws may have an impact on the
market for lower rated debt securities. For example, as a result of the
Financial Institution's Reform, Recovery, and Enforcement Act of 1989, savings
and loan associations were required to dispose of their high yield bonds no
later than July 1, 1994. Qualified affiliates of savings and loan
associations, however, may purchase and retain these securities, and savings
and loan associations may divest these securities by sale to their qualified
affiliates. T. Rowe Price is unable at this time to predict what effect, if
any, the legislation may have on the market for lower rated debt securities.
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.
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.
INVESTMENT PROGRAM
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.
All Funds
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; and 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 9
The GNMA, U.S. Treasury Money, Intermediate, and Long-Term Funds may
only invest in these securities if they are supported by the full faith and
credit of the U.S. government.
All Funds, except GNMA, U.S. Treasury Money, Intermediate and Long-Term Funds
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). Corporate notes may have fixed,
variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by corporations
primarily to finance short-term credit needs. Certain notes may have floating
or variable rates.
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.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Mortgage-Related Securities
Mortgage-related securities in which the Fund may invest include, but
are not limited to, those described below. The GNMA, U.S. Treasury
Intermediate and U.S. Treasury Long-Term Funds may only invest in these
securities to the extent they are backed by the full faith and credit of the
U.S. Government.
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.
PAGE 10
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.
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 (the "FHLMC Act"). Freddie Mac Certificates represent a pro-rata
interest in a group of mortgage loans (a "Freddie Mac Certificate group")
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 is 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.
PAGE 11
Farmer Mac Certificates. The Federal Agricultural Mortgage Corporation
("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's Certificates are not supported by the full faith
and credit of the U.S. Government; rather, Farmer Mac may borrow up 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 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 semi-annual
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.
PAGE 12
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.
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 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.
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 a 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.
PAGE 13
CMO structures may also include floating rate CMOs, planned amortization
classes, accrual bonds and CMO residuals. These structures affect the amount
and timing of principal and interest received by each tranche from the
underlying collateral. Under certain of these 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. 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.
Stripped Mortgage-Backed Securities. Stripped Mortgage-Backed
securities 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 Internal Revenue Code of 1986, as amended (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. 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 recoup fully 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 Securities and Exchange Commission 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 and PO backed by fixed rate mortgages may be made on a
case by case basis under guidelines and standards established by the Fund's
Board of Directors/Trustees. The Fund's Board of Directors/Trustees has
delegated to T. Rowe
PAGE 14
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 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. The Fund will treat non-government-issued IOs and POs not backed by
fixed or adjustable rate mortgages as illiquid unless and until the Securities
and Exchange Commission modifies its position.
Adjustable Rate Mortgages. Adjustable rate mortgage (ARM) securities
are collateralized by adjustable rate, rather than fixed rate, mortgages.
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. The ARM securities in which the
Fund expects to invest will generally adjust their interest rates at regular
intervals of one year or less. 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 -Interest Rate
Indices. The interest rates paid on adjustable rate securities are readjusted
periodically to an increment over some predetermined interest rate index.
Such readjustments occur at intervals ranging from one to 60 months. There
are three main categories of indexes: (1) those based on U.S. Treasury
securities (2) those derived from a calculated measure such as a cost of funds
index ("COFI") or a moving average of mortgage rates and (3) those based on
actively traded or prominently posted short-term, interest rates. Commonly
utilized indexes include the one-year, three-year and five-year constant
maturity Treasury rates, the three-month Treasury bill rate, the 180-day
Treasury bill rate, rates on longer-term Treasury securities, the 11th
District Federal Home Loan Bank Cost of Funds, the National Median Cost of
Funds, the one-month, three-month, six-month or one-year London Interbank
Offered Rate (LIBOR), the prime rate of a specific bank, or commercial paper
rates. Some indexes, such as the one-year constant maturity Treasury rate,
closely mirror changes in market interest rate levels. Others, such as the
11th District Home Loan Bank Cost of Funds index, tend to lag behind changes
in market rate levels. The market value of the Fund's assets and of the net
asset value of the Fund's shares will be affected by the length of the
adjustment period, the degree of volatility in the applicable indexes and the
maximum increase or decrease of the interest rate adjustment on any one
adjustment date, in any one year and over the life of the securities. These
maximum increases and decreases are typically referred to as "caps" and
"floors", respectively.
A number of factors affect the performance of the Cost of Funds Index
and may cause the Cost of Funds Index to move in a manner different from
indices based upon specific interest rates, such as the One Year Treasury
Index. Additionally, there can be no assurance that the Cost of Funds Index
will necessarily move in the same direction or at the same rate as prevailing
interest rates. Furthermore, any movement in the Cost of Funds Index as
compared to other indices based
PAGE 15
upon specific interest rates may be affected by changes instituted by the FHLB
of San Francisco in the method used to calculate the Cost of Funds Index. To
the extent that the Cost of Funds Index may reflect interest changes on a more
delayed basis than other indices, in a period of rising interest rates, any
increase may produce a higher yield later than would be produced by such other
indices, and in a period of declining interest rates, the Cost of Funds Index
may remain higher than other market interest rates which may result in a
higher level of principal prepayments on mortgage loans which adjust in
accordance with the Cost of Funds Index than mortgage loans which adjust in
accordance with other indices.
LIBOR, the London interbank offered rate, is the interest rate that the
most creditworthy international banks dealing in U.S. dollar-denominated
deposits and loans charge each other for large dollar-denominated loans.
LIBOR is also usually the base rate for large dollar-denominated loans in the
international market. LIBOR is generally quoted for loans having rate
adjustments at one, three, six or 12 month intervals.
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 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 on page 9.
Several characteristics of ARMs may make them more susceptible to prepayments
than other Mortgage-Backed Securities. An adjustable rate mortgage has
greater incentives to refinance with a fixed rate mortgage during favorable
interest rate environments, in order to avoid interest rate risk. Also, homes
financed with adjustable rate mortgages may be sold more frequently because of
the prevalence of first-time home buyers in the adjustable rate mortgage
market. Also, delinquency and foreclosure rates are higher in this market
since many buyers use adjustable rate mortgages to purchase homes that they
could not otherwise finance on a fixed rate basis. Significant increases in
the index rates for the adjustable rate mortgages may also result in increased
delinquency and default rates, which in turn, may affect prepayment rates on
the ARMs.
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.
PAGE 16
All Funds (except GNMA, U.S. Treasury Intermediate, Long-Term, and Money
Funds)
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 or pay-through 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 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.
PAGE 17
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 internal credit enhancement 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
PAGE 18
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 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 accounts 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 manufactured 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 reserves the right
to invest in these securities.
High Yield Fund
Collateralized Bond or Loan Obligations
CBOs are bonds collateralized by corporate bonds and CLOs are bonds
collateralized by bank loans. CBOs and CLOs are structured into tranches, and
payments are allocated such that each tranche has a predictable cash flow
stream and average life. CBOs are fairly recent entrants
PAGE 19
to the fixed income market. Most issues to date have been collateralized by
high yield bonds or loans, with heavy credit enhancement.
Loan Participations and Assignments
Loan participations and assignments (collectively "participations") will
typically be participating interests in loans made by a syndicate of banks,
represented by an agent bank which has negotiated and structured the loan, to
corporate borrowers to finance internal growth, mergers, acquisitions, stock
repurchases, leveraged buy-outs and other corporate activities. Such loans
may also have been made to governmental borrowers, especially governments of
developing countries (LDC debt). LDC debt will involve the risk that the
governmental entity responsible for the repayment of the debt may be unable or
unwilling to do so when due. The loans underlying such participations may be
secured or unsecured, and the Fund may invest in loans collateralized by
mortgages on real property or which have no collateral. The loan
participations themselves may extend for the entire term of the loan or may
extend only for short "strips" that correspond to a quarterly or monthly
floating rate interest period on the underlying loan. Thus, a term or
revolving credit that extends for several years may be subdivided into shorter
periods.
The loan participations in which the Fund will invest will also vary in
legal structure. Occasionally, lenders assign to another institution both the
lender's rights and obligations under a credit agreement. Since this type of
assignment relieves the original lender of its obligations, it is call a
novation. More typically, a lender assigns only its right to receive payments
of principal and interest under a promissory note, credit agreement or similar
document. A true assignment shifts to the assignee the direct debtor-creditor
relationship with the underlying borrower. Alternatively, a lender may assign
only part of its rights to receive payments pursuant to the underlying
instrument or loan agreement. Such partial assignments, which are more
accurately characterized as "participating interests," do not shift the
debtor-creditor relationship to the assignee, who must rely on the original
lending institution to collect sums due and to otherwise enforce its rights
against the agent bank which administers the loan or against the underlying
borrower.
Pursuant to an SEC no-action letter, and because the Fund is allowed to
purchase debt and debt securities, including debt securities at private
placement, the Fund will treat loan participations as securities and not
subject to its fundamental investment restriction prohibiting the Fund from
making loans.
There may not be a recognizable, liquid public market for loan
participations. To the extent this is the case, the Fund would consider the
loan participation as illiquid and subject to the Fund's restriction on
investing no more than 15% of its net assets in illiquid securities.
Where required by applicable SEC positions, the Fund will treat both the
corporate borrower and the bank selling the participation interest as an
issuer for purposes of its fundamental investment restriction on
diversification.
Various service fees received by the Fund from loan participations, may
be treated as non-interest income depending on the nature of the fee
(commitment, takedown, commission, service or loan origination). To the
extent the service fees are not interest income, they will not qualify as
income under Section 851(b) of the Internal Revenue Code. Thus the sum of
such fees plus any other non-qualifying income earned by the Fund cannot
exceed 10% of total income.
PAGE 20
Trade Claims
Trade claims are non-securitized rights of payment arising from
obligations other than borrowed funds. Trade claims typically arise when, in
the ordinary course of business, vendors and suppliers extend credit to a
company by offering payment terms. Generally, when a company files for
bankruptcy protection payments on these trade claims cease and the claims are
subject to compromise along with the other debts of the company. Trade claims
typically are bought and sold at a discount reflecting the degree of
uncertainty with respect to the timing and extent of recovery. In addition to
the risks otherwise associated with low-quality obligations, trade claims have
other risks, including the possibility that the amount of the claim may be
disputed by the obligor.
Over the last few years a market for the trade claims of bankrupt
companies has developed. Many vendors are either unwilling or lack the
resources to hold their claim through the extended bankruptcy process with an
uncertain outcome and timing. Some vendors are also aggressive in
establishing reserves against these receivables, so that the sale of the claim
at a discount may not result in the recognition of a loss.
Trade claims can represent an attractive investment opportunity because
these claims typically are priced at a discount to comparable public
securities. This discount is a reflection of both a less liquid market, a
smaller universe of potential buyers and the risks peculiar to trade claim
investing. It is not unusual for trade claims to be priced at a discount to
public securities that have an equal or lower priority claim.
As noted above, investing in trade claims does carry some unique risks
which include:
o Establishing the Amount of the Claim. Frequently, the supplier's
estimate of its receivable will differ from the customer's estimate
of its payable. Resolution of these differences can result in a
reduction in the amount of the claim. This risk can be reduced by
only purchasing scheduled claims (claims already listed as
liabilities by the debtor) and seeking representations from the
seller.
o Defenses to Claims. The debtor has a variety of defenses that can
be asserted under the bankruptcy code against any claim. Trade
claims are subject to these defenses, the most common of which for
trade claims relates to preference payments. (Preference payments
are all payments made by the debtor during the 90 days prior to the
filing. These payments are presumed to have benefited the receiving
creditor at the expense of the other creditors. The receiving
creditor may be required to return the payment unless it can show
the payments were received in the ordinary course of business.)
While none of these defenses can result in any additional liability
of the purchaser of the trade claim, they can reduce or wipe out the
entire purchased claim. This risk can be reduced by seeking
representations and indemnification from the seller.
o Documentation/Indemnification. Each trade claim purchased requires
documentation that must be negotiated between the buyer and seller.
This documentation is extremely important since it can protect the
purchaser from losses such as those described above. Legal expenses
in negotiating a purchase agreement can be fairly high.
Additionally, it is important to note that the value of an
indemnification depends on the sellers credit.
PAGE 21
o Volatile Pricing Due to Illiquid Market. There are only a handful
of brokers for trade claims and the quoted price of these claims can
be volatile. Generally, it is
expected that Trade Claims would be considered illiquid investments.
o No Current Yield/Ultimate Recovery. Trade claims are almost never
entitled to earn interest. As a result, the return on such an
investment is very sensitive to the length of the bankruptcy, which
is uncertain. Although not unique to trade claims, it is worth
noting that the ultimate recovery on the claim is uncertain and
there is no way to calculate a conventional yield to maturity on
this investment. Additionally, the exit for this investment is a
plan of reorganization which may include the distribution of new
securities. These securities may be as illiquid as the original
trade claim investment.
o Tax Issue. Although the issue is not free from doubt, it is likely
that Trade Claims would be treated as non-securities investments.
As a result, any gains would be considered "non-qualifying" under
the Internal Revenue Code. The Fund may have up to 10% of its gross
income (including capital gains) derived from non-qualifying
sources.
High Yield and Personal Strategy Funds
Zero Coupon and Pay-in-Kind Bonds
A zero coupon security has no cash coupon payments. Instead, the issuer
sells the security at a substantial discount from its maturity value. The
interest received by the investor from holding this security to maturity is
the difference between the maturity value and the purchase price. The
advantage to the investor is that reinvestment risk of the income received
during the life of the bond is eliminated. However, zero-coupon bonds like
other bonds retain interest rate and credit risk and usually display more
price volatility than those securities that pay a cash coupon.
Pay-in-Kind (PIK) Instruments are securities that pay interest in either
cash or additional securities, at the issuer's option, for a specified period.
PIK's, like zero coupon bonds, are designed to give an issuer flexibility in
managing cash flow. PIK bonds can be either senior or subordinated debt and
trade flat (i.e., without accrued interest). The price of PIK bonds is
expected to reflect the market value of the underlying debt plus an amount
representing accrued interest since the last payment. PIK's are usually less
volatile than zero coupon bonds, but more volatile than cash pay securities.
For federal income tax purposes, these types of bonds will require the
recognition of gross income each year even though no cash may be paid to the
Fund until the maturity or call date of the bond. The Fund will nonetheless
be required to distribute substantially all of this gross income each year to
comply with the Internal Revenue Code, and such distributions could reduce the
amount of cash available for investment by the Fund.
High Yield, New Income, and Personal Strategy Funds
Warrants
The Fund may acquire warrants. Warrants are pure speculation in that
they have no voting rights, pay no dividends and have no rights with respect
to the assets of the corporation issuing
PAGE 22
them. Warrants basically are options to purchase equity securities at a
specific price valid for a specific period of time. They do not represent
ownership of the securities, but only the right to buy them. Warrants differ
from call options in that warrants are issued by the issuer of the security
which may be purchased on their exercise, whereas call options may be written
or issued by anyone. The prices of warrants do not necessarily move parallel
to the prices of the underlying securities.
Adjustable Rate, High Yield, New Income, Personal Strategy, and Short-Term
Bond Funds
Hybrid Instruments
Hybrid Instruments 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
transactions 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 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.
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
PAGE 23
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
counter party 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 net 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).
All Funds
When-Issued Securities and Forward Commitment Contracts
The Fund may purchase securities on a "when-issued" or delayed delivery
basis ("When-Issueds") and may purchase securities on a forward commitment
basis ("Forwards"). Any or all of the Fund's investments in debt securities
may be in the form of When-Issueds and Forwards. The
PAGE 24
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 and/or liquid, high-grade debt securities
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.
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest rates that are
reset periodically by pre-determined 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. Variable rate instruments are those whose
terms provide for the adjustment of their interest rates on set dates and
which, upon such adjustment, can reasonably be expected to have a market value
that approximates its par value. A variable rate instrument, the principal
amount of which is scheduled to be paid in 397 days or less, is deemed to have
a maturity equal to the period remaining until the next readjustment of the
interest rate. A variable rate instrument which is subject to a demand
feature entitles the purchaser to receive the principal amount of the
underlying security or securities, either (i) upon notice of no more than 30
days or (ii) at specified intervals not exceeding 397 days and upon no more
than 30 days' notice, 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.
Floating Rate Securities. Floating rate instruments are those whose
terms provide for the adjustment of their interest rates whenever a specified
interest rate changes and which, at any time, can reasonably be expected to
have a market value that approximates its par value. The maturity of a
floating rate instrument is deemed to be the period remaining until the date
(noted on the face of the instrument) on which the principal amount must be
paid, or in the case of an instrument called for redemption, the date on which
the redemption payment must be made. Floating rate instruments with demand
features are deemed to have a maturity equal to the period remaining until the
principal amount can be recovered through demand.
PAGE 25
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.
Adjustable Rate, High Yield, New Income, Personal Strategy, Prime Reserve, and
Short-Term Bond Funds
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% (10% for Prime Reserve and U.S. Treasury
Money Funds) 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% (10% for Prime Reserve and U.S. Treasury Money
Funds) 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 (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%
(10% for Prime Reserve and U.S. Treasury Money Funds) 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.
New Income and Short-Term Bond Funds
Industry Concentration
PAGE 26
When the market for corporate debt securities is dominated by issues in
the gas utility, gas transmission utility, electric utility, telephone
utility, or petroleum industry, the Fund will as a matter of fundamental
policy concentrate more than 25%, but not more than 50%, of its assets, in any
one such industry, if the Fund has cash for such investment (i.e., will not
sell portfolio securities to raise cash) and, if in T. Rowe Price's judgment,
the return available and the marketability, quality, and availability of the
debt securities of such industry justifies such concentration in light of the
Fund's investment objective. Domination would exist with respect to any one
such industry, when, in the preceding 30-day period, more than 25% of all
new-issue corporate debt offerings (within the four highest grades of Moody's
or S&P and with maturities of 10 years or less) of $25,000,000 or more
consisted of issues in such industry. Although the Fund will normally
purchase corporate debt securities in the secondary market as opposed to new
offerings, T. Rowe Price believes that the new issue-based dominance standard,
as defined above, is appropriate because it is easily determined and
represents an accurate correlation to the secondary market. Investors should
understand that concentration in any industry may result in increased risk.
Investments in any of these industries may be affected by environmental
conditions, energy conservation programs, fuel shortages, difficulty in
obtaining adequate return on capital in financing operations and large
construction programs, and the ability of the capital markets to absorb debt
issues. In addition, it is possible that the public service commissions which
have jurisdiction over these industries may not grant future increases in
rates sufficient to offset increases in operating expenses. These industries
also face numerous legislative and regulatory uncertainties at both federal
and state government levels. Management believes that any risk to the Fund
which might result from concentration in any industry will be minimized by the
Fund's practice of diversifying its investments in other respects. The Fund's
policy with respect to industry concentration is a fundamental policy. (For
investment restriction on industry concentration, see Investment Restriction
(4) on pages 45 and 46.)
PORTFOLIO MANAGEMENT PRACTICES
Lending of Portfolio Securities
Securities loans are made to broker-dealers or 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 on
five business days' notice or, in connection with securities trading on
foreign markets, within such longer period of time which coincides with the
normal settlement period for purchases and sales of such securities in such
foreign markets. The Fund will not have the right to vote 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.
Other Lending/Borrowing
PAGE 27
Subject to approval by the Securities and Exchange Commission and certain
state regulatory agencies, the Fund may make loans to, or borrow funds from,
other mutual funds sponsored or advised by T. Rowe Price or Rowe Price-Fleming
International, Inc. (collectively, "Price Funds"). The Fund has no current
intention of engaging in these practices at this time.
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) (A) Prime Reserve and U.S. Treasury Money
Funds--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, (B) Adjustable Rate, GNMA, High Yield, New
Income, Short-Term Bond, Personal Strategy, and U.S. Treasury Intermediate and
Long-Term Funds--the underlying securities 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 be at all times 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.
<PAGE>
PAGE 28
Reverse Repurchase Agreements
Although the Fund has no current intention, in the foreseeable future,
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," page 45.)
High Yield Fund
Short Sales
The Fund may make short sales for hedging purposes to protect the Fund
against companies whose credit is deteriorating. Short sales are transactions
in which the Fund sells a security it does not own in anticipation of a
decline in the market value of that security. The Fund's short sales would be
limited to situations where the Fund owns a debt security of a company and
would sell short the common or preferred stock or another debt security at a
different level of the capital structure of the same company. No securities
will be sold short if, after the effect is given to any such short sale, the
total market value of all securities sold short would exceed 2% of the value
of the Fund's net assets.
To complete a short sale transaction, the Fund must borrow the security
to make delivery to the buyer. The Fund then is obligated to replace the
security borrowed by purchasing it at the market price at the time of
replacement. The price at such time may be more or less than the price at
which the security was sold by the Fund. Until the security is replaced, the
Fund is required to pay to the lender amounts equal to any dividends or
interest which accrue during the period of the loan. To borrow the security,
the Fund also may be required to pay a premium, which would increase the cost
of the security sold. The proceeds of the short sale will be retained by the
broker, to the extent necessary to meet margin requirements, until the short
position is closed out.
Until the Fund replaces a borrowed security in connection with a short
sale, the Fund will: (a) maintain daily a segregated account, containing cash
or U.S. government securities, at such a level that (i) the amount deposited
in the account plus the amount deposited with the broker as collateral will
equal the current value of the security sold short and (ii) the amount
deposited in the segregated account plus the amount deposited with the broker
as collateral will not be less than the market value of the security at the
time its was sold short; or (b) otherwise cover its short position.
The Fund will incur a loss as a result of the short sale if the price of
the security sold short increases between the date of the short sale and the
date on which the Fund replaces the borrowed security. The Fund will realize
a gain if the security sold short declines in price between those dates. This
result is the opposite of what one would expect from a cash purchase of a long
position in a security. The amount of any gain will be decreased, and the
amount of any loss increased, by the amount of any premium, dividends or
interest the Fund may be required to pay in connection with a short sale. Any
gain or loss on the security sold short would be separate from a gain or loss
on the Fund security being hedged by the short sale.
PAGE 29
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Options
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 a
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" 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 will write only covered call options. This means that the Fund
will 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, or will
establish and maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other liquid high-
grade debt obligations having a value equal to the fluctuating market value of
the optioned securities or currencies.
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 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.
PAGE 30
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.
In order to comply with the requirements of several states, the Fund
will not write a covered call option if, as a result, the aggregate market
value of all portfolio securities or currencies covering call or put options
exceeds 25% of the market value of the Fund's net assets. Should these state
PAGE 31
laws change or should the Fund obtain a waiver of its application, the Fund
reserves the right to increase this percentage. 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 of 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.
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 or other liquid high-grade debt obligations 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.
In order to comply with the requirements of several states, 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. Should these state
laws change or should the Fund obtain a waiver of its application, the Fund
reserves the right to increase this percentage. 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.
<PAGE>
PAGE 32
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 below.
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.
To the extent required by the laws of certain states, the Fund may not
be permitted to commit more than 5% of its assets to premiums when purchasing
put and call options. Should these state laws change or should the Fund
obtain a waiver of its application, the Fund may commit more than 5% of its
assets to premiums when purchasing call and put 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 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
PAGE 33
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 below.
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.
To the extent required by the laws of certain states, the Fund may not
be permitted to commit more than 5% of its assets to premiums when purchasing
call and put options. Should these state laws change or should the Fund
obtain a waiver of its application, the Fund may 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
PAGE 34
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.
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 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. Accordingly, the Fund will treat dealer options as subject to the
Fund's limitation on illiquid securities. If the SEC changes its position on
the liquidity of dealer options, the Fund will change its treatment of such
instrument accordingly.
High Yield Fund
Spread Option Transactions
The Fund may purchase from and sell to securities dealers covered spread
options. Such covered spread options are not presently exchange listed or
traded. The purchase of a spread option gives the Fund the right to put, or
sell, a security that it owns at a fixed dollar spread or fixed yield spread
in relationship to another security that the Fund does not own, but which is
used as a benchmark. The risk to the Fund in purchasing covered spread
options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used
to protect the Fund against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of the spread
option. The security covering the spread option will be maintained in a
segregated account by the Fund's custodian. The Fund does not consider a
security covered by a spread option to be "pledged" as that term is used in
the Fund's policy limiting the pledging or mortgaging of its assets. The Fund
may also buy and sell uncovered spread options. Such options would be used
for the same purposes and be subject to similar risks as covered spread
options. However, in an uncovered spread option, the Fund would not own
either of the securities involved in the spread.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Futures Contracts
Transactions in Futures
The Fund may enter into futures contracts, including stock index,
interest rate and currency futures ("futures or futures contracts").
Stock index futures contracts may be used to provide a hedge for a
portion of the Fund's portfolio, as a cash management tool, or as an efficient
way for T. Rowe Price to implement either an increase or decrease in portfolio
market exposure in response to changing market conditions. The Fund may
purchase or sell futures contracts with respect to any stock index.
Nevertheless, to hedge the Fund's portfolio successfully, the Fund must sell
futures contacts with respect to indices
PAGE 35
or subindices whose movements will have a significant correlation with
movements in the prices of the Fund's portfolio securities.
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. Futures
are traded in London, at the London International Financial Futures Exchange,
in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock Exchange. 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
The Fund will engage in futures contracts and options thereon only for
bona fide hedging, yield enhancement, and risk management purposes, in each
case in accordance with rules and regulations of the CFTC and applicable state
law.
The Fund may not purchase or sell futures contracts or related options
if, with respect to positions which do not qualify as bona fide hedging under
applicable CFTC rules, the sum of the amounts of initial margin deposits and
premiums paid on those positions would exceed 5% of the net asset 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/Trustees without a shareholder vote and
does not limit the percentage of the Fund's assets at risk to 5%.
In accordance with the rules of the State of California, the Fund may
have to apply the above 5% test without excluding the value of initial margin
and premiums paid for bona fide hedging positions.
The Fund's use of futures contracts will not result in leverage.
Therefore, to the extent necessary, in instances involving the purchase of
futures contracts or the writing of call or put options thereon by the Fund,
an amount of cash, U.S. government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts and options
thereon (less any related margin deposits), will be identified in an account
with the Fund's custodian 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
PAGE 36
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 debt security) 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 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, U.S. government securities, suitable money market instruments, or
liquid, high-grade debt securities, 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 the market." The Fund
expects to earn interest income on its margin deposits.
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
PAGE 37
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.
A futures contract on the Standard & Poor's 500 Stock Index, composed of
500 selected common stocks, most of which are listed on the New York Stock
Exchange, provides an example of how futures contracts operate. The S&P 500
Index assigns relative weightings to the common stocks included in the Index,
and the Index fluctuates with changes in the market values of those common
stocks. In the case of futures contracts on the S&P 500 Index, the contracts
are to buy or sell 500 units. Thus, if the value of the S&P 500 Index were
$150, one contract would be worth $75,000 (500 units x $150). The contract
specifies that no delivery of the actual stocks making up the index will take
place. Instead, settlement in cash occurs. Over the life of the contract,
the gain or loss realized by the Fund will equal the difference between the
purchase (or sale) price of the contract and the price at which the contract
is terminated. For example, if the Fund enters into the example contract
above and the S&P 500 Index is at $154 on the termination date, the Fund will
gain $2,000 (500 units x gain of $4). If, however, the S&P 500 Index is at
$148 on that future date, the Fund will lose $1,000 (500 units x loss of $2).
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.
Because of the low margin deposits required, futures trading involves an
extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss,
as well as gain, to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin, a 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
PAGE 38
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.
However, the Fund would presumably have sustained comparable losses if,
instead of the futures contract, it had invested in the underlying financial
instrument and sold it after the decline. Furthermore, in the case of a
futures contract purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the Fund earmarks
to the futures contract money market instruments equal in value to the current
value of the underlying instrument less the margin deposit.
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 below, 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.
PAGE 39
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 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 the 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 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
interest rate 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
PAGE 40
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 non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on Futures
Contracts" are substantially the same as the risks of using options on
futures. 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: (i)
there may be insufficient trading interest in certain options; (ii)
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options, or
underlying instruments; (iv) unusual or unforeseen circumstances may interrupt
normal operations on an exchange; (v) the facilities of an exchange or a
clearing corporation may not at all times be adequate to handle current
trading volume; or (vi) 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.
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
Commission and arbitration proceedings
PAGE 41
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.
U.S. Treasury Intermediate and Long-Term Funds
Limitations on Futures and Options for
Intermediate and Long-Term Funds
The Funds will not purchase a futures contract or 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
positions would exceed 5% of the Fund's net asset value. In addition, neither
of the Funds will enter into a futures transaction if it would be obligated to
purchase or deliver under outstanding open futures contracts amounts which
would exceed 15% of the Fund's total assets.
A Fund will not write a covered call option if, as a result, the
aggregate market value of all portfolio securities covering call options or
subject to delivery under put options exceeds 15% of the market value of the
Fund's total assets.
A Fund will not write a covered put option if, as a result, the
aggregate market value of all portfolio securities subject to such put options
or covering call options exceeds 15% of the market value of the Fund's total
assets.
In order to comply with the laws of certain states, a Fund will not
invest more than 5% of its total assets in premiums on put options. Should
these state laws change or should a Fund obtain a waiver of their
applications, the Fund may invest up to 15% of its total assets in premiums on
put options.
In order to comply with the laws of certain states, a Fund will not
invest more than 5% of its total assets in premiums on call options. Should
these state laws change or should a Fund obtain a waiver of their
applications, the Fund may invest up to 15% of its total assets in premiums on
call options.
In order to comply with the laws of certain states, a Fund will not
purchase puts, calls, straddles, spreads and any combination thereof if by
reason thereof the value of its aggregate investment in such classes of
securities will exceed 5% of its total assets. Should these state laws change
or should a Fund obtain a waiver of their application, the Fund may invest a
higher percentage of its total assets in puts, calls, straddles, or spreads.
The total amount of a Fund's total assets invested in futures and
options under any combination of the limitations described above will not
exceed 15% of the Fund's total assets.
<PAGE>
High Yield, New Income, and Short-Term Bond Funds
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 short-term hedging
strategy is highly uncertain. Under normal circumstances, consideration of
the prospect for currency parities 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
PAGE 43
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 and currency available for cover of the
forward contract(s). 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 investors
should be aware of the costs of 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 option, futures, and forward foreign
exchange contracts, including options and futures on currencies, which will be
treated as Section 1256 contracts or straddles.
Transactions which 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 or loss and 40% short-term capital
PAGE 44
gain or loss regardless of the holding period of the instrument. The Fund
will 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. For securities offsetting a purchased
put, this adjustment of the holding period may increase the gain from sales of
securities held less than three months. 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 loss, if the security covering the option was held for
more than twelve 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. Pending tax regulations could limit 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. In
addition, gains realized on the sale or other disposition of securities,
including option, futures or foreign forward exchange contracts on securities
or securities indexes and, in some cases, currencies, held for less than three
months, must be limited to less than 30% of the Fund's annual gross income.
In order to avoid realizing excessive gains on securities or currencies held
less than three months, the Fund may be required to defer the closing out of
option, futures or foreign forward exchange contracts) beyond the time when it
would otherwise be advantageous to do so. It is anticipated that unrealized
gains on Section 1256 option, futures and foreign forward exchange contracts,
which have been open for less than three months as of the end of the Fund's
fiscal year and which are recognized for tax purposes, will not be considered
gains on securities or currencies held less than three months for purposes of
the 30% test.
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 the Fund's outstanding shares. Other
restrictions in the form of operating policies are subject to change by the
Fund's Board of Directors/Trustees 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.
Fundamental Policies
PAGE 45
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 the Fund (other than the Prime Reserve and Treasury
Money Funds) may enter into futures contracts and options
thereon;
(3) (a) Industry Concentration (All Funds, except High Yield,
New Income, Prime Reserve and Short-Term Bond Funds).
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;
(b) Industry Concentration (High Yield Fund). 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 the
Fund will normally invest more than 25% of its total assets
in the securities of the banking industry including, but not
limited to, bank certificates of deposit and bankers'
acceptances, when the Fund's position in issues maturing in
one year or less equals 35% or more of the Fund's total
assets;
(c) Industry Concentration (New Income Fund). 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 the
Fund will invest more than 25% of its total assets, but not
more than 50%, in any one of the gas utility, gas
transmission utility, electric utility, telephone utility,
and petroleum industries under certain circumstances, and
further provided that this limitation does not apply to
securities of the banking industry including, but not
limited to, certificates of deposit and bankers'
acceptances;
PAGE 46
(d) Industry Concentration (Prime Reserve Fund). 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; and
(e) Industry Concentration (Short-Term Bond Fund). 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 the
Fund will normally invest more than 25% of its total assets
in the securities of the banking industry including, but not
limited to, bank certificates of deposit and bankers'
acceptances when the Fund's position in issues maturing in
one year or less equals 35% or more of the Fund's total
assets; provided, further, that the Fund will invest more
than 25% of its total assets, but not more than 50%, in any
one of the gas utility, gas transmission utility, electric
utility, telephone utility, and petroleum industries under
certain circumstances;
(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 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 Investment Company Act of 1940; or
PAGE 47
(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 Securities Act
of 1933 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 restrictions (1) and (4) the Fund
will not borrow from or lend to any other T. Rowe Price Fund
unless each Fund applies for and receives an exemptive order
from the SEC or the SEC issues rules permitting such
transactions. The Fund has no current intention of engaging
in any such activity and there is no assurance the SEC would
grant any order requested by the Fund or promulgate any
rules allowing the transactions.
With respect to investment restriction (1), the Prime
Reserve and U.S. Treasury Money Funds have no current
intention of engaging in any borrowing transactions.
With respect to investment restriction (2), the Fund does
not consider currency contracts or hybrid instruments 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 Semi-annual and Annual Reports.
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. The Fund will not purchase additional securities
when money borrowed exceeds 5% of its total assets;
(2) Control of Portfolio Companies. Invest in companies for the
purpose of exercising management or control;
PAGE 48
(3) (a) Equity Securities (All Funds, except High Yield, New
Income, and Personal Strategy Funds). Purchase any common
stocks or other equity securities, or securities convertible
into equity securities except as set forth in its operating
policy on investment companies;
(b) Equity Securities (High Yield Fund). Invest more than
20% of the Fund's total assets in equity securities
(including up to 5% in warrants);
(c) Equity Securities (New Income Fund). Invest more than
25% of its total assets in equity securities; and
(d) Equity Securities (Personal Strategy Funds). Purchase
any common stocks or other equity securities, except as set
forth in its prospectus and operating policy on investment
companies;
(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 positions
would exceed 5% of the Fund's net asset value;
(5) (a) Illiquid Securities (All Funds, except Personal Strategy
Funds). Purchase illiquid securities if, as a result, more
than 15% (10% for the Prime Reserve and U.S. Treasury Money
Funds) of its net assets would be invested in such
securities; and
(b) Illiquid Securities (Personal Strategy Funds). Purchase
illiquid securities and securities of unseasoned issuers if,
as a result, more than 15% of a Fund's net assets would be
invested in such securities, provided that the Fund will not
invest more than 5% of its total assets in restricted
securities and not more than 5% in securities of unseasoned
issuers. Securities eligible for resale under Rule 144A of
the Securities Act of 1933 are not included in the 5%
limitation but are subject to the 15% limitation;
(6) Investment Companies. Purchase securities of open-end or
closed-end investment companies except in compliance with
the Investment Company Act of 1940 and applicable state law,
and in the case of the Prime Reserve and U.S. Treasury Money
Funds, only securities of other money market funds.
Duplicate fees may result from such purchases;
(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;
PAGE 49
(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 or enter into leases with respect to, oil,
gas, or other mineral exploration or development 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) Ownership of Portfolio Securities by Officers and Directors.
Purchase or retain the securities of any issuer if, to the
knowledge of the Fund's management, those officers and
directors of the Fund, and of its investment manager, who
each own beneficially more than .5% of the outstanding
securities of such issuer, together own beneficially more
than 5% of such securities;
(12) (a) Short Sales (All Funds, except High Yield Fund). Effect
short sales of securities;
(b) Short Sales (High Yield Fund). Effect short sales of
securities, other than as set forth in its prospectus and
Statement of Additional Information;
(13) Unseasoned Issuers. Purchase a security (other than
obligations issued or guaranteed by the U.S., any foreign,
state or local government, their agencies or
instrumentalities) if, as a result, more than 5% of the
value of the Fund's total assets would be invested in the
securities issuers which at the time of purchase had been in
operation for less than three years (for this purpose, the
period of operation of any issuer shall include the period
of operation of any predecessor or unconditional guarantor
of such issuer). This restriction does not apply to
securities of pooled investment vehicles or mortgage or
asset-backed securities; or
(14) Warrants. Invest in warrants if, as a result thereof, more
than 2% of the value of the total assets of the Fund would
be invested in warrants which are not listed on the New York
Stock Exchange, the American Stock Exchange, or a recognized
foreign exchange, or more than 5% of the value of the total
assets of the Fund would be invested in warrants whether or
not so listed. For purposes of these percentage
limitations, the warrants will be valued at the lower of
cost or market and warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.
Personal Strategy Funds
PAGE 50
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 FUND
The officers and directors/trustees 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/trustees who are considered "interested persons" of T. Rowe Price as
defined under Section 2(a)(19) of the Investment Company Act of 1940 are noted
with an asterisk (*). These directors/trustees are referred to as inside
directors by virtue of their officership, directorship, and/or employment with
T. Rowe Price.
All Funds, except Personal Strategy Funds
Independent Directors/Trustees
ROBERT P. BLACK, Retired; formerly President, Federal Reserve Bank of
Richmond; Address: 10 Dahlgren Road, Richmond, Virginia 23233
CALVIN W. BURNETT, PH.D., President, Coppin State College; Director, Maryland
Chamber of Commerce and Provident Bank of Maryland; President, Baltimore Area
Council Boy Scouts of America; Vice President, Board of Directors, The Walters
Art Gallery; Address: 2500 West North Avenue, Baltimore, Maryland 21216
ANTHONY W. DEERING, Director, President and Chief Operating Officer, The Rouse
Company, real estate developers, Columbia, Maryland; Advisory Director,
Kleinwort, Benson (North America) Corporation, a registered broker-dealer;
Address: 10275 Little Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver & Associates, Inc.;
formerly (1987-1991) Executive Vice President, EA Engineering, Science, and
Technology, Inc., and (1987-1990) President, EA Engineering, Inc., Baltimore,
Maryland; Address:
The Legg Mason Tower, 111 South Calvert Street, Suite 2700, Baltimore,
Maryland 21202
JOHN G. SCHREIBER, President, Schreiber Investments, Inc., a real estate
investment company; Director, AMCI Residential Properties Trust; Partner,
Blackstone Real Estate Partners, L.P.; Director and formerly (1/80-12/90)
Executive Vice President, JMB Realty Corporation, a national real estate
investment manager and developer; Address: 1115 East Illinois Road, Lake
Forest, Illinois 60045
ANNE MARIE WHITTEMORE, Partner, law firm of McGuire, Woods, Battle & Boothe,
Richmond, Virginia; formerly, Chairman (1991-1993) and Director (1989-1993),
Federal Reserve Bank of Richmond; Director, Owens & Minor, Inc., USF&G
Corporation, Old Dominion University, and James River Corporation; Member,
Richmond Bar Association and American Bar
PAGE 51
Association; Address: One James Center, 901 East Cary Street, Richmond,
Virginia 23219-4030
Personal Strategy Funds
LEO C. BAILEY, Retired; Address: 3396 South Placita Fabula, Green Valley,
Arizona 85614
DONALD W. DICK, JR., Principal, Overseas Partners, Inc., a financial
investment firm; Director, Waverly Press, Inc., Baltimore, Maryland; Address:
375 Park Avenue, Suite 2201, New York, New York 10152
DAVID K. FAGIN, Chairman, Chief Executive Officer and Director, Golden Star
Resources, Ltd.; formerly (1986-7/91) President, Chief Operating Officer and
Director, Homestake Mining Company; Address: One Norwest Center, 1700 Lincoln
Street, Suite 1950, Denver, Colorado 80203
ADDISON LANIER, Financial management; President and Director, Thomas Emery's
Sons, Inc., and Emery Group, Inc.; Director, Scinet Development and Holdings,
Inc.; Address: 441 Vine Street, #2310, Cincinnati, Ohio 45202-2913
JOHN K. MAJOR, Chairman of the Board and President, KCMA Incorporated, Tulsa,
Oklahoma; Address: 126 E. 26 Place, Tulsa, Oklahoma 74114-2422
HANNE M. MERRIMAN, Retail business consultant; formerly, President and Chief
Operating Officer, Nan Duskin, Inc., a women's specialty store, Director and
Chairman Federal Reserve Bank of Richmond, and President and Chief Executive
Officer, Honeybee, Inc., a division of Spiegel, Inc; Director, Ann Taylor
Stores Corporation, Central Illinois Public Service Company, CIPSCO
Incorporated, The Rouse Company, State Farm Mutual Automobile Insurance
Company and USAir Group, Inc., Member, National Women's Forum; Trustee,
American-Scandinavian Foundation; Address: One James Center, 901 East Cary
Street, Richmond, Virginia 23219-4030
HUBERT D. VOS, President, Stonington Capital Corporation, a private investment
company; Address: 1231 State Street, Suite 210, Santa Barbara, CA 93190-0409
PAUL M. WYTHES, Founding General Partner, Sutter Hill Ventures, a venture
capital limited partnership providing equity capital to young high technology
companies throughout the United States; Director, Teltone Corporation,
Interventional Technologies Inc., and Stuart Medical, Inc.; Address: 755 Page
Mill Road, Suite A200, Palo Alto, California 94304
Officers
HENRY H. HOPKINS, Vice President--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; Vice President, Rowe Price-
Fleming International, Inc. and T. Rowe Price Retirement Plan Services, Inc.
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
ROGER L. FIERY, III, Assistant Vice President--Vice President, Rowe Price-
Fleming International, Inc.
EDWARD T. SCHNEIDER, Assistant Vice President--Assistant Vice President, T.
Rowe Price and T. Rowe Price Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T. Rowe Price
<PAGE>
PAGE 52
Adjustable Rate Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price Retirement
Plan Services, Inc., Chartered Investment Counselor
*PETER VAN DYKE, President and Director--Managing Director, T. Rowe Price;
Vice President of Rowe Price-Fleming International, Inc. and T. Rowe Price
Trust Company
*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman of the Board, T. Rowe Price Services, Inc., and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
HEATHER R. LANDON, Executive Vice President--Vice President, T. Rowe Price and
T. Rowe Price Trust Company
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price and Rowe Price-
Fleming International, Inc.
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company; formerly, (1972-1989) charter member of the U.S. Senior
Executive Services and Director, Analysis and Evaluation Division in the
Office of Water Regulations and Standards of the U.S. Environmental Protection
Agency
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe Price; Vice
President, Rowe Price-Fleming International, Inc.
GWENDOLYN G. WAGNER, Vice President--Assistant Vice President, T. Rowe Price
DONNA M. ENNIS-DAVIS, Assistant Vice President--Employee, T. Rowe Price
GNMA Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director and
Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price Retirement
Plan Services, Inc.; Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Trustee--Managing Director, T. Rowe Price;
Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc.; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
PETER VAN DYKE, President--Managing Director, T. Rowe Price; Vice President,
Rowe Price-Fleming International, Inc. and T. Rowe Price Trust Company
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price and Rowe
Price-Fleming International, Inc.; formerly (4/80-5/90) Vice President and
Director, Private Finance, New York Life Insurance Company, New York, New York
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price and Rowe Price-
Fleming International, Inc.
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company; formerly (1972-1989) charter member of the U.S. Senior
Executive Service and Director,
PAGE 53
Analysis and Evaluation Division in the Office of Water Regulations and
Standards of the U.S. Environmental Protection Agency
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe Price; Vice
President, Rowe Price-Fleming International, Inc.
High Yield Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust Company and T.
Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor
*RICHARD S. SWINGLE, President and Director--Managing Director, T. Rowe Price
*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
CATHERINE B. BRAY, Vice President--Vice President, T. Rowe Price
ANDREW M. BROOKS, Vice President--Vice President, T. Rowe Price
MICHAEL J. CONELIUS, Vice President--Assistant Vice President, T. Rowe Price
HUBERT M. STILES, JR., Vice President--Vice President, T. Rowe Price
JAY W. VAN ERT, Vice President--Vice President, T. Rowe Price
MARK J. VASELKIV, Vice President--Vice President, T. Rowe Price
THEA N. WILLIAMS, Vice President--Vice President, T. Rowe Price
JAMES M. McDONALD, Assistant Vice President--Vice President, T. Rowe Price
New Income Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price Retirement
Plan Services, Inc., Chartered Investment Counselor
*CARTER O. HOFFMAN, Vice President and Director--Managing Director, T. Rowe
Price; Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
*CHARLES P. SMITH, President and Director--Managing Director, T. Rowe Price;
Vice President, Rowe Price-Fleming International, Inc.
SHAWN P. BURKE, Vice President--Vice President, T. Rowe Price; formerly (1985-
1990) Assistant Vice President/Corporate Finance, Standard & Poor's
Corporation; (1990-1993) Vice President/Senior Credit Officer, Merrill Lynch &
Co., New York, New York
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price and Rowe
Price Fleming International, Inc.; formerly (4/80-5/90) Vice President and
Director, Private Finance, New York Life Insurance Company, New York, New York
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
PAGE 54
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company; formerly (1972-1989) charter member of the U.S. Senior
Executive Service and Director, Analysis and Evaluation Division in the Office
of Water Regulations and Standards of the U.S. Environmental Protection Agency
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe Price; formerly
(1/89-12/93) senior bond trader, Scudder, Stevens & Clark, Boston,
Massachusetts
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price; Vice
President, Rowe Price-Fleming International, Inc. and T. Rowe Price Trust
Company
Prime Reserve Fund
*GEORGE J. COLLINS, Vice President and Director--President, Managing Director,
and Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price Retirement
Plan Services, Inc., Chartered Investment Counselor
*CARTER O. HOFFMAN, Chairman of the Board--Managing Director, T. Rowe Price;
Chartered Investment Counselor
EDWARD A. WIESE, President--Vice President, T. Rowe Price, Rowe Price-Fleming
International, Inc. and T. Rowe Price Trust Company
ROBERT P. CAMPBELL, Executive Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International Inc.; formerly (4/80-5/90) Vice President
and Director, Private Finance, New York Life Insurance Company, New York, New
York
JAMES M. MCDONALD, Executive Vice President--Vice President, T. Rowe Price
PATRICE L. BERCHTENBREITER, Vice President--Vice President, T. Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial Economist of T.
Rowe Price
MICHAEL J. CONELIUS, Vice President--Assistant Vice President, T. Rowe Price
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe Price;
Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
Short-Term Bond Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price Retirement
Plan Services, Inc., Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
VEENA A. KUTLER, President--Vice President, T. Rowe Price and Rowe Price-
Fleming International, Inc.
PAGE 55
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price and Rowe
Price-Fleming International, Inc.; formerly (4/80-5/90) Vice President and
Director, Private Finance, New York Life Insurance Company, New York, New York
CHRISTY M. DIPIETRO, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe Price; Vice
President, Rowe Price-Fleming International, Inc.
EDWARD A. WIESE, Vice President--Vice President, T. Rowe Price, Rowe Price-
Fleming International, Inc. and T. Rowe Price Trust Company
U.S. Treasury Intermediate, Long-Term and Money Funds
*GEORGE J. COLLINS, President and Director--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price Retirement
Plan Services, Inc., Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company, Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
*CHARLES P. SMITH, Executive Vice President and Director--Managing Director,
T. Rowe Price; Vice President, Rowe Price-Fleming International, Inc.
*PETER VAN DYKE, Executive Vice President and Director--Managing Director, T.
Rowe Price; Vice President, Rowe Price-Fleming International, Inc. and T. Rowe
Price Trust Company
EDWARD A. WIESE, Executive Vice President--Vice President, T. Rowe Price, Rowe
Price-Fleming International, Inc. and T. Rowe Price Trust Company
PAUL W. BOLTZ, Vice President--Vice President and Financial Economist of T.
Rowe Price
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price and Rowe
Price-Fleming International Inc.; formerly (4/80-5/90) Vice President and
Director, Private Finance, New York Life Insurance Company, New York, New York
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price and Rowe Price-
Fleming International, Inc.
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe Price; formerly
(1/89-12/93) senior bond trader, Scudder, Stevens & Clark, Boston,
Massachusetts
Personal Strategy Fund
M. DAVID TESTA, Chairman of the Board--Managing Director, T. Rowe Price;
Chairman of the Board, Rowe Price-Fleming International, Inc.; Director and
Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst
PETER VAN DYKE, President--Managing Director, T. Rowe Price; Vice President of
Rowe Price-Fleming International, Inc., T. Rowe Price Trust Company and T.
Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor
STEPHEN W. BOESEL, Executive Vice President--Vice President, T. Rowe Price
PAGE 56
JOHN D. GILLESPIE, Executive Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Executive Vice President--Vice President, T. Rowe Price and
T. Rowe Price Trust Company; formerly (1972-1989) charter member of the U.S.
Senior Executive Service and Director, Analysis and Evaluation Division in the
Office of Water Regulations and Standards of the U.S. Environmental Protection
Agency
JOHN H. LAPORTE, Vice President--Managing Director, T. Rowe Price; Chartered
Financial Analyst
JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe Price;
Chairman of the Board, T. Rowe Price Services, Inc. and T. Rowe Price
Retirement Plan Services, Inc.; President and Director, T. Rowe Price
Investment Services, Inc; President and Trust Officer, T. Rowe Price Trust
Company, Director, Rowe Price-Fleming International, Inc. and Rhone-Poulenc
Rorer, Inc.
WILLIAM T. REYNOLDS, Vice President--Managing Director, T. Rowe Price
BRIAN C. ROGERS, Vice President--Managing Director, T. Rowe Price
Each Fund's Executive Committee, consisting of the Fund's interested
directors/trustees, has been authorized by its respective Board of
Directors/Trustees to exercise all powers of the Board to manage the Fund 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 February 28, 1994, Yachtcrew & Co., FBO Spectrum Income Account,
State Street Bank and Trust Co., 1776 Heritage Drive-4W, North Quincy, MA
02171-2010 beneficially owned more than 5% of the outstanding shares of the
GNMA, High Yield, New Income and Short-Term Bonds Funds, and T. Rowe Price
Trust Co. Inc., Attn: Installation Team for Conversion Assets, New England
Electric Plan, 25 Research Drive, Westborough, MA 01582 beneficially owned
more than 5% of then outstanding shares of the U.S. Treasury Money Fund.
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 and state 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
PAGE 57
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 a fee ("Fee") which consists of two
components: a Group Management Fee ("Group Fee") and an Individual Fund Fee
("Fund Fee"). The Fee is paid monthly to T. Rowe Price on the first business
day of the next succeeding calendar month and is calculated as described
below.
The monthly Group Fee ("Monthly Group Fee") is the sum of the daily
Group Fee accruals ("Daily Group Fee Accruals") for each month. The Daily
Group Fee Accrual for any particular day is computed by multiplying the Price
Funds' group fee accrual as determined below ("Daily Price Funds' Group Fee
Accrual") by the ratio of the Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily Price Funds'
Group 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
annualized Daily Price Funds' Group Fee Accrual for that day as determined in
accordance with the following schedule:
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Thereafter
For the purpose of calculating the Group Fee, the Price Funds include all
the mutual funds distributed by T. Rowe Price Investment Services, Inc.,
(excluding T. Rowe Price Spectrum Fund, Inc. and any institutional or private
label mutual funds). For the purpose of calculating the Daily Price Funds'
Group Fee Accrual for any particular day, the net assets of each Price Fund
are determined in accordance with the Fund's prospectus as of the close of
business on the previous business day on which the Fund was open for business.
PAGE 58
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the daily Fund
Fee accruals ("Daily Fund Fee Accruals") for each month. The Daily Fund Fee
Accrual for any particular day is computed by multiplying the fraction of one
(1) over the number of calendar days in the year by the individual Fund 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 on the previous business day on which the Fund was open for business.
The individual fund fees for each Fund are listed in the chart below:
Individual Fund Fees
Adjustable Rate Fund 0.10%
GNMA Fund 0.15%
High Yield Fund 0.30%
New Income Fund 0.15%
Prime Reserve Fund 0.05%
Short-Term Bond Fund 0.10%
U.S. Treasury Intermediate Fund 0.05%
U.S. Treasury Long-Term Fund 0.05%
U.S. Treasury Money Fund 0.00%
Personal Strategy Growth Fund 0.30%
Personal Strategy Balanced Fund 0.25%
Personal Strategy Income Fund 0.15%
The following chart sets forth the total management fees, if any, paid to
T. Rowe Price by each Fund, for the fiscal years ended February 28, 1994,
February 28, 1993, and February 29, 1992:
Fund 1994 1993 1992
Adjustable Rate $ 526,000 $ 627,000 *
GNMA4,626,000 4,102,000 $ 3,069,000
High Yield 10,554,000 8,014,000 5,701,000
New Income 7,750,000 7,113,000 6,348,000
Prime Reserve 13,617,000 15,620,000 18,486,000
Short-Term Bond 2,873,000 2,136,000 1,398,000
U.S. Treasury Intermediate 755,000 571,000 309,000
U.S. Treasury Long-Term 180,000 125,000 4,000
U.S. Treasury Money 2,084,000 165,000 2,140,000
* Due to the Fund's expense limitation in effect at that time, no
management fee was paid by the Fund to T. Rowe Price.
Limitation on Fund Expenses
The Management Agreement between the Fund and T. Rowe Price provides that
the Fund will bear all expenses of its operations not specifically assumed by
T. Rowe Price. However, in compliance with certain state regulations, T. Rowe
Price will reimburse the Fund for certain expenses which in any year exceed
the limits prescribed by any state in which the Fund's shares are qualified
for sale. Presently, the most restrictive expense ratio limitation imposed by
any state is 2.5% of the first $30 million of the Fund's average daily net
assets, 2% of the next $70 million of
PAGE 59
the Fund's assets, and 1.5% of net assets in excess of $100 million.
Reimbursement by the Fund to T. Rowe Price of any expenses paid or assumed
under a state expense limitation may not be made more than two years after the
end of the fiscal year in which the expenses were paid or assumed.
The following chart sets forth expense ratio limitations and the periods
for which they are effective. For each, T. Rowe Price has agreed to bear any
Fund expenses which would cause the Fund's ratio of expenses to average net
assets to exceed the indicated percentage limitations. The expenses borne by
T. Rowe Price are subject to reimbursement by the Fund through the indicated
reimbursement date, provided no reimbursement will be made if it would result
in the Fund's expense ratio exceeding its applicable limitation.
Expense
Limitation Ratio Reimbursement
Fund Period Limitation Date
Adjustable Rate+ January 1, 1994- 0.70% May 31, 1998
May 31, 1996
U.S. Treasury March 1, 1993- 0.80% February 28, 1997
Intermediate++ February 28, 1995
U.S. Treasury March 1, 1993- 0.80% February 28, 1997
Long-Term++ February 28, 1995
Personal Strategy July 1, 1994- 0.95% May 31, 1998
Income Fund May 31, 1996
Personal Strategy July 1, 1994- 1.05% May 31, 1998
Balanced Fund May 31, 1996
Personal Strategy July 1, 1994- 1.10% May 31, 1998
Growth Fund May 31, 1996
+ The Adjustable Rate Fund previously operated under a 0.40% limitation
that expired December 31, 1993. The reimbursement period for this
limitation extends through June 30, 1995.
++ The U.S. Treasury Intermediate and U.S. Treasury Long-Term Funds'
operated under a 0.80% limitation that expired February 29, 1993. The
reimbursement period for this limitation extends through February 28,
1995.
Each of the above-referenced Fund's Management Agreement also provides that
one or more additional expense limitation periods (of the same or different
time periods) may be implemented after the expiration of the current expense
limitation, and that with respect to any such additional limitation period,
the Fund may reimburse T. Rowe Price, provided the reimbursement does not
result in the Fund's aggregate expenses exceeding the additional expense
limitation.
Pursuant to the Adjustable Rate Fund's current expense limitation,
$938,000 of management fees were not accrued by the Fund for the year ended
February 28, 1994.
Pursuant to the U.S. Treasury Intermediate Fund's current expense
limitation, $77,000 of unaccrued 1993 fees for the Fund, representing the
entire unaccrued balance, were reimbursed to T. Rowe Price during the year
ended February 28, 1994.
PAGE 60
Pursuant to the U.S. Treasury Long-Term Fund's current expense
limitation, $61,000 of management fees were not accrued by the Fund for the
year ended February 28, 1994. Additionally, $303,000 of unaccrued fees from
the prior period for the Fund was subject to reimbursement through February
28, 1995.
GNMA, High Yield, New Income, Prime Reserve and Short-Term Bond Funds
T. Rowe Price Spectrum Fund, Inc.
The Fund is a party to a Special Servicing Agreement ("Agreement")
between and among T. Rowe Price Spectrum Fund, Inc. ("Spectrum Fund"), T. Rowe
Price, T. Rowe Price Services, Inc. and various other T. Rowe Price funds
which, along with the Fund, are funds in which Spectrum Fund invests
(collectively all such funds "Underlying Price Funds").
The Agreement provides that, if the Board of Directors/Trustees of any
Underlying Price Fund determines that such Underlying Fund's share of the
aggregate expenses of Spectrum Fund is less than the estimated savings to the
Underlying Price Fund from the operation of Spectrum Fund, the Underlying
Price Fund will bear those expenses in proportion to the average daily value
of its shares owned by Spectrum Fund, provided further that no Underlying
Price Fund will bear such expenses in excess of the estimated savings to it.
Such savings are expected to result primarily from the elimination of numerous
separate shareholder accounts which are or would have been invested directly
in the Underlying Price Funds and the resulting reduction in shareholder
servicing costs. Although such cost savings are not certain, the estimated
savings to the Underlying Price Funds generated by the operation of Spectrum
Fund are expected to be sufficient to offset most, if not all, of the expenses
incurred by Spectrum Fund.
All Funds
DISTRIBUTOR FOR FUND
T. Rowe Price Investment Services, Inc. ("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: registering and
qualifying its shares under the various state "blue sky" laws; 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
PAGE 61
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 Fund 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 all states in which the shares are qualified and 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
domestic 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. The Fund (other than the GNMA, Prime Reserve and U.S.
Treasury Intermediate, Long-Term and Money Funds) 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 by the Fund's Board of Directors/Trustees in
accordance with regulations under the Investment Company Act of 1940. The
Bank's main office is at 225 Franklin Street, Boston, Massachusetts 02110.
The address for The Chase Manhattan Bank, N.A., London is Woolgate House,
Coleman Street, London, EC2P 2HD, England.
CODE OF ETHICS
The Funds' investment adviser (T. Rowe Price) has a written Code of
Ethics which requires all employees to obtain prior clearance before engaging
in any personal securities transactions. In addition, all employees must
report their personal securities transactions within ten days of their
execution. Employees 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; a change has occurred in T. Rowe
Price's rating of the security within five days; or the security is subject to
internal trading restrictions. 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.
<PAGE>
PAGE 62
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 (except to the extent it purchases equity
securities (High Yield, New Income, and Personal Strategy Funds only)).
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
Equity Securities
In purchasing and selling the Fund's portfolio securities, it is T. Rowe
Price's policy to obtain quality execution at the most favorable prices
through responsible brokers and dealers and, in the case of agency
transactions, at competitive commission rates. 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, 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.
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.
PAGE 63
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, both before and
since rates have been fully negotiable; (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.
Description 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.
<PAGE>
PAGE 64
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
PAGE 65
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.
To the extent possible, T. Rowe Price intends to recapture solicitation
fees paid in connection with tender offers through T. Rowe Price Investment
Services, Inc., the Fund's distributor. 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.
Adjustable Rate, High Yield, New Income, Personal Strategy, and Short-Term
Bond Funds
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 T. Rowe Price may place orders for the Fund's portfolio transactions with
broker-dealers through the same trading desk T. Rowe Price uses for portfolio
transactions in domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities are located.
These brokers and dealers may include certain affiliates of Robert Fleming
Holdings Limited ("Robert Fleming Holdings") and Jardine Fleming Group Limited
("JFG"), persons indirectly related to T. Rowe Price. Robert Fleming
Holdings, through Copthall Overseas Limited, a wholly-owned subsidiary, owns
25% of the common stock of Rowe Price-Fleming International, Inc. ("RPFI"), an
investment adviser registered under the Investment
PAGE 66
Advisers Act of 1940. Fifty percent of the common stock of RPFI is owned by
TRP Finance, Inc., a wholly-owned subsidiary of T. Rowe Price, and the
remaining 25% is owned by Jardine Fleming Holdings Limited, a subsidiary of
JFG. JFG is 50% owned by Robert Fleming Holdings and 50% owned by Jardine
Matheson Holdings Limited. Orders for the Fund's portfolio transactions
placed with affiliates of Robert Fleming Holdings and JFG will result in
commissions being received by such affiliates.
The Board of Directors/Trustees of the Fund has authorized T. Rowe Price
to utilize certain affiliates of Robert Fleming and JFG in the capacity of
broker in connection with the execution of the Fund's portfolio transactions.
These affiliates include, but are not limited to, Jardine Fleming Securities
Limited ("JFS"), a wholly-owned subsidiary of JFG, Robert Fleming & Co.
Limited ("RF&Co."), Jardine Fleming Australia Securities Limited, and Robert
Fleming, Inc. (a New York brokerage firm). Other affiliates of Robert Fleming
Holding and JFG 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
Investment Company Act of 1940, the Board of Directors/Trustees 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
The Funds engaged in portfolio transactions involving broker-dealers in
the following amounts for the fiscal years ended February 28, 1994, February
28, 1993 and February 29, 1992:
Fund 1994 1993 1992
______ ____ ____ ____
Adjustable Rate $ 793,565,000 $ 1,876,498,000 $ 427,475,000
GNMA 2,306,951,000 1,528,454,000 1,438,762,000
High Yield 18,554,222,000 16,168,606,000 6,702,967,000
New Income 20,265,475,000 15,193,999,000 6,648,064,000
Prime Reserve 29,024,172,000 36,478,989,000 29,975,769,000
Short-Term Bond 4,266,837,000 5,805,958,000 5,534,535,000
U.S. Treasury 81,970,000 91,923,000 218,317,000
Intermediate
U.S. Treasury 142,513,000 192,941,000 192,774,000
Long-Term
U.S. Treasury Money 3,449,951,000 2,804,196,000 23,290,378,000
The entire amount for each of these years represented principal
transactions as to which the Adjustable Rate, GNMA, Prime Reserve, U.S.
Treasury Intermediate, Long-Term and Money Funds have no knowledge of the
profits or losses realized by the respective broker-dealers for the fiscal
years ended February 28, 1994, February 28, 1993 and February 29, 1992. With
respect to the High Yield, New Income and Short-Term Bond Funds, the following
amounts consisted of principal transactions as to which the Funds have no
knowledge of the profits or losses realized by the
<PAGE>
PAGE 67
respective broker-dealers for the fiscal years ended February 28, 1994,
February 28, 1993 and February 29, 1992:
Fund 1994 1993 1992
______ ____ ____ ____
High Yield $17,956,306,000 $15,737,460,000 $6,682,140,000
New Income 20,206,382,000 15,189,019,000 6,518,595,000
Short-Term Bond 0 0 5,034,535,000
The following amounts involved trades with brokers acting as agents or
underwriters for the fiscal years ended February 28, 1994, February 28, 1993,
and February 29, 1992:
Fund 1994 1993 1992
______ ____ ____ ____
High Yield $597,916,000 $431,147,000 $ 20,827,000
New Income 59,093,000 4,980,000 129,469,000
Short-Term Bond 0 0 5,000,000
The amounts shown below involved trades with brokers acting as agents or
underwriters, in which such brokers received total commissions, including
discounts received in connection with underwritings for the fiscal years ended
February 28, 1994, February 28, 1993 and February 29, 1992:
Fund 1994 1993 1992
______ ____ ____ ____
High Yield $16,730,000 $3,661,000 $1,201,000
New Income 169,000 20,000 402,000
Short-Term Bond 0 0 15,000
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 Funds, or in some cases, to the Funds
for the fiscal years ended February 28, 1994, February 28, 1993 and February
29, 1992, are shown below:
Fund 1994 1993 1992
______ ____ ____ ____
Adjustable Rate 100% 94% 100%
GNMA 91% 91% 99%
High Yield 70% 70% 59%
New Income 61% 61% 87%
Prime Reserve 87% 81% 76%
Short-Term Bond 61% 84% 79%
U.S. Treasury 85% 98% 100%
Intermediate
U.S. Treasury Long-Term 98% 99% 100%
U.S. Treasury Money 66% 75% 60%
PAGE 68
The portfolio turnover rates for the following Funds for the fiscal
years ended February 28, 1994, February 28, 1993 and February 29, 1992 are as
follows:
Fund 1994 1993 1992
______ ____ ____ ____
Adjustable Rate 70.4% 110.8% 98.4%
GNMA 92.5% 94.2% 66.0%
High Yield 107.0% 104.4% 58.9%
New Income 58.3% 85.8% 49.7%
Short-Term Bond 90.8% 68.4% 380.7%
U.S. Treasury 20.2% 22.8% 91.4%
Intermediate
U.S. Treasury Long-Term 59.4% 165.4% 162.4%
Prime Reserve Fund
The Fund, in pursuing its objectives, may engage in short-term trading to
take advantage of market variations. The Fund will seek to protect principal,
improve liquidity of its securities, or enhance yield by purchasing and
selling securities based upon existing or anticipated market discrepancies.
U.S. Treasury Money Fund
The Fund, in pursuing its objectives, may engage in short-term trading to
take advantage of market variations. The Fund will seek to protect principal,
improve liquidity of its securities, or enhance yield by purchasing and
selling securities based upon existing or anticipated market discrepancies.
PRICING OF SECURITIES
Adjustable Rate, GNMA, High Yield, New Income, Short-Term Bond, U.S. Treasury
Intermediate and Long-Term Funds
Fixed income 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 ongoing evaluation of these services, may use or
may discontinue the use of any pricing service in whole or in part.
PAGE 69
High Yield, New Income, and Personal Strategy Funds
Equity securities listed or regularly traded on a securities exchange
(including NASDAQ) are valued at the last quoted sales price on the day the
valuations are made. A security which is listed or traded on more than one
exchange is valued at the quotation on the exchange determined to be the
primary market for such security. Other equity securities and those listed
securities that are not traded on a particular day are valued at a price
within the limits of the latest bid and asked prices deemed by the Board of
Directors/Trustees, or by persons delegated by the Board, best to reflect fair
value.
Debt securities are generally traded in the over-the-counter market and
are valued at a price deemed best to reflect fair value as quoted by dealers
who make markets in these securities or by an independent pricing service.
Short-term debt securities are valued at their cost in local currency which,
when combined with accrued interest, approximates fair value.
Prime Reserve and U.S. Treasury Money Funds
Securities with more than 60 days remaining to maturity are stated at
fair value which is determined by using a matrix system that establishes a
value for each security based on money market yields. Securities originally
purchased with remaining maturities of 60 days or less are valued at amortized
cost. In addition, securities purchased with maturities in excess of 60 days,
but which currently have maturities of 60 days or less, are valued at their
amortized cost for the 60 days prior to maturity--such amortization being
based on the fair value of the securities on the 61st day prior to maturity.
All Funds
For the purposes of determining the Fund's net asset value per share, all
assets and liabilities initially expressed in foreign currencies are converted
into U.S. dollars at the mean of the bid and offer prices of such currencies
against U.S. dollars quoted by any major bank.
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 officers of
the Funds, as authorized by the Board of Directors.
Prime Reserve and U.S. Treasury Money Funds
Maintenance of Net Asset Value Per Share
It is the policy of the Fund to attempt to maintain a net asset value of
$1.00 per share by rounding to the nearest one cent. This method of valuation
is commonly referred to as "penny rounding" and is permitted by Rule 2a-7
under the Investment Company Act of 1940. Under Rule 2a-7:
(a) the Board of Directors of the Fund must undertake to assure, to the
extent reasonably practical taking into account current market conditions
affecting the Fund's investment objectives, that the Fund's net asset
value will not deviate from $1.00 per share;
PAGE 70
Prime Reserve Fund
(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 (or in the case of U.S. government securities greater than
762 days), and (iii) maintain a dollar-weighted average portfolio
maturity of 90 days or less;
U.S. Treasury Money Fund
(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 762 days, and (iii) maintain a dollar-weighted average portfolio
maturity of 90 days or less;
Prime Reserve and U.S. Treasury Money Funds
(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 price per
share under the penny rounding method; and (ii) the Fund will continue to
use the penny rounding 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 Reserve Fund
Prime Money Market Securities Defined. Prime money market securities are
those which are described as First Tier Securities under Rule 2a-7 of the
Investment Company Act of 1940. 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
PAGE 71
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.
All Funds
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 the Fund's 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 net asset value of the Prime Reserve and
U.S. Treasury Money Funds is also calculated as of 12:00 noon (Eastern time)
every day the NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Washington's Birthday, 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 Securities and Exchange Commission (or
any succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c), or (d) exist.
DIVIDENDS AND DISTRIBUTIONS
Unless you elect otherwise, the Fund's annual capital gain distribution,
if any, will be reinvested on the reinvestment date using the NAV per share of
that date. The reinvestment date normally precedes the payment date by about
10 days although the exact timing is subject to change.
TAX STATUS
The Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Internal Revenue Code of 1986, as amended ("Code").
Dividends and distributions paid by the Fund are not eligible for the
dividends-received deduction for corporate shareholders. For tax purposes, it
does not make any difference whether dividends and capital gain distributions
are paid in cash or in additional shares. The Fund must declare dividends
equal to at least 98% of ordinary income (as of December 31) and capital gains
PAGE 72
(as of October 31) in order to avoid a federal excise tax and distribute 100%
of ordinary income and capital gains as of its tax year-end to avoid federal
income tax.
At the time of your purchase, the Fund's net asset value may reflect
undistributed capital gains or net unrealized appreciation of securities held
by the Fund. A subsequent distribution to you of such amounts, although
constituting a return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is permitted to carry
forward its net realized capital losses, if any, for eight years and realize
net capital gains up to the amount of such losses without being required to
pay taxes on, or distribute such gains. On May 31, 1994, the books of each
Fund (other than the Personal Strategy Fund) indicated that each Fund's
aggregate net assets included undistributed net income, net realized capital
gains, and unrealized appreciation which are listed below.
Net Realized Unrealized
Undistributed Capital Appreciation/
Fund Net Income Gains/(Losses) (Depreciation)
Adjustable Rate $(1,938,550) $(953,447) $(3,465,529)
GNMA 8,763 (15,464,402) (26,398,092)
High Yield 3,988,627 (5,944,499) (119,580,285)
New Income 21,962 1,014,811 (65,070,648)
Prime Reserve 2,105,954 1,900 203,760
Short-Term Bond 121,010 (4,542,864) (15,924,117)
U.S. Treasury Intermediate (108,298) 55,985 (6,124,061)
U.S. Treasury Long-Term (38,345) (577,048) (2,954,108)
U.S. Treasury Money 81,339 2,371 174,801
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 taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been considered
capital gain dividends).
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.
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 dividend paid by the Fund will be increased; if
the
PAGE 73
result is a loss, the income dividend paid by the Fund will be decreased.
Adjustments to reflect these gains and losses will be made at the end of the
Fund's taxable year.
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure calculated in
the following manner:
Adjustable Rate and GNMA Funds
In conformity with regulations of the Securities and Exchange Commission,
an income factor is calculated for each security in the portfolio based upon
the security's coupon rate. The income factors are then adjusted for any
gains or losses which have resulted from prepayments of principal during the
period. The income factors are then totalled 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. Quoted yield factors are for
comparison purposes only, and are not intended to indicate future performance
or forecast the dividend per share of the Fund.
The yields of the Adjustable Rate and GNMA Funds calculated under the
above-described method for the month ended May 31, 1994 were 4.10% and 5.40%,
respectively.
High Yield, New Income, Short-Term Bond, U.S. Treasury Intermediate and U.S.
Treasury Long-Term Funds
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 Securities and Exchange
Commission. The income factors are then totalled 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. Quoted yield factors are for
comparison purposes only, and are not intended to indicate future performance
or forecast the dividend per share of the Fund.
The yields of the High Yield, New Income, Short-Term Bond, Intermediate
and Long-Term Funds calculated under the above-described method for the month
ended May 31, 1994, were 8.87%, 6.12%, 5.55%, 5.75% and 6.47%, respectively.
Prime Reserve and U.S. Treasury Money Funds
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.
PAGE 74
The seven-day yields ending May 31, 1994 for the Prime Reserve and U.S.
Treasury Money Funds were 3.33% and 3.18%, respectively, and the Funds'
compound yield for the same period were 3.38% and 3.23%, respectively.
All Funds
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 gains
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.
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
2/28/94 2/28/94 2/28/94 2/28/94
Adjustable Rate U.S. Government Fund
T. Rowe Price Adjustable Rate
U.S. Government Fund, Inc. 3.11% 9.30%
(9/30/91)
Lipper Average of Adjustable
Rate Mortgage Funds 3.17 10.27
Merrill Lynch 1-3 Year
Govt. Index 3.48 16.22
Salomon Brothers 1-Year
Treasury Index 2.61 11.17
Salomon Brothers 2-Year
Treasury Index 3.46 16.51
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PAGE 75
GNMA Fund
T. Rowe Price GNMA Fund 3.71 61.78% 96.72
(11/26/85)
Salomon Brothers 30-Year
GNMA Index 4.67 69.52 124.78
Lehman Brothers GNMA Bond Index 4.49 68.70 123.75
Lipper GNMA Funds Average 3.78 60.10 100.59
High Yield Fund
High Yield Fund 16.59 58.38 176.57
(12/31/84)
Merrill Lynch High Yield Index 14.16 84.90 225.33
Merrill Lynch Medium Quality Long
Corporate Index 8.89 85.02 223.61
Lipper's Average of High Current
Yield Funds 16.66 71.26 174.45
New Income Fund
New Income Fund 5.36 61.39 162.15% 514.54
(8/31/73)
Salomon Bros. Broad Investment
Grade Index 5.58 69.34 202.62 N/A
Salomon Bros. High Grade Corporate
Bond Index 6.73 81.35 264.06 605.12
Lehman Bros. Govt./Corp.
Bond Index 5.71 69.42 198.31 574.11
Lipper Corporate Bond Fund's
-A Rated Average 5.64 64.93 188.36 523.68
Short-Term Bond Fund
T. Rowe Price Short-Term Bond Fund 4.36 47.78 122.71
(3/2/84)
T. Rowe Price Prime Reserve Fund2.60 30.24 88.03
Donoghue Average of all Taxable
Money Funds 2.70 30.32 86.25
Lehman Bros. 1-3 Year Govt./Corp.
Bond Index 3.62 50.11 139.27
Lipper Short Investment Grade
Debt Funds Average 3.95 49.71 136.46
<PAGE>
PAGE 76
U.S. Treasury Intermediate Fund
Intermediate Fund 3.80 47.81
(9/29/89)
Lehman Brothers Intermediate
Treasury Index 4.23 48.86
U.S. Treasury Long-Term Fund
Long-Term Fund 5.89 52.29
(9/29/89)
Lehman Brothers Government/Corporate
Bond Index 5.71 54.53
Lehman Brothers Long Treasury Index 8.32 64.05
Merrill Lynch 10-15 Year
Treasury Index 6.54 61.96
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
2/28/94 2/28/94 2/28/94 2/28/94
Adjustable Rate U.S. Government Fund
T. Rowe Price Adjustable Rate
U.S. Government Fund, Inc. 3.11% 3.75%
(9/30/91)
Lipper Average of Adjustable
Rate Mortgage Funds 3.17 4.13
Merrill Lynch 1-3 Year
Govt. Index 3.48 6.42
Salomon Brothers 1-Year
Treasury Index 2.61 4.48
Salomon Brothers 2-Year
Treasury Index 3.46 6.53
GNMA Fund
T. Rowe Price GNMA Fund 3.71 10.10% 8.54
(11/26/85)
Salomon Brothers 30-Year
GNMA Index 4.67 11.13 10.31
Lehman Brothers GNMA Bond
Index 4.49 11.03 10.25
Lipper GNMA Funds Average 3.78 9.87 8.80
<PAGE>
PAGE 77
High Yield Fund
High Yield Fund 16.59 9.63 11.74
(12/31/84)
Merrill Lynch High Yield Index 14.16 13.08 13.74
Merrill Lynch Medium Quality Long
Corporate Index 8.89 13.09 13.67
Lipper's Average of High Current
Yield Funds 16.66 11.28 11.55
New Income Fund
New Income Fund 5.36 10.05 10.12% 9.26
(8/31/73)
Salomon Bros. Broad Investment
Grade Index 5.58 11.11 11.71 N/A
Salomon Bros. High Grade Corporate
Bond Index 6.73 12.64 13.79 9.99
Lehman Bros. Govt./Corp.
Bond Index 5.71 11.12 11.55 9.75
Lipper Corporate Bond Fund's
-A Rated Average 10.52 11.17 9.34
Short-Term Bond Fund
T. Rowe Price Short-Term Bond Fund 4.36 8.12 8.34
(3/2/84)
T. Rowe Price Prime Reserve Fund2.60 5.42 6.52
Donoghue Average of all Taxable
Money Funds 2.70 5.44 6.42
Lehman Bros. 1-3 Year Govt./Corp.
Bond Index 3.62 8.46 9.12
Lipper Short Investment Grade
Debt Funds Average 3.95 8.40 8.99
U.S. Treasury Intermediate Fund
Intermediate Fund 3.80 9.25
(9/29/89)
Lehman Brothers Intermediate
Treasury Index 4.23 9.43
<PAGE>
PAGE 78
U.S. Treasury Long-Term Fund
Long-Term Fund 5.89 9.99
(9/29/89)
Lehman Brothers Government/Corporate
Bond Index 5.71 10.36
Lehman Brothers Long Treasury Index 8.32 11.86
Merrill Lynch 10-15 Year
Treasury Index 6.54 11.54
Outside Sources of Information
From time to time, in reports and promotional literature, one or more of
the T. Rowe Price funds, including this Fund, may compare its performance to
Overnight Government Repurchase Agreements, Treasury bills, notes, and bonds,
certificates of deposit, and six-month money market certificates. Performance
may also be compared to (1) indices of broad groups of managed or unmanaged
securities considered to be representative of or similar to Fund portfolio
holdings; (2) other mutual funds; or (3) other measures of performance set
forth in publications such as:
Advertising News Service, Inc., "Bank Rate Monitor+ - The Weekly Financial
Rate Reporter" is a weekly publication which lists the yields on various
money market instruments offered to the public by 100 leading banks and
thrift institutions in the U.S., including loan rates offered by these
banks. Bank certificates of deposit differ from mutual funds in several
ways: the interest rate established by the sponsoring bank is fixed for the
term of a CD; there are penalties for early withdrawal from CDs; and the
principal on a CD is insured.
Donoghue Organization, Inc., "Donoghue's Money Fund Report" is a weekly
publication which tracks net assets, yield, maturity and portfolio holdings
on approximately 380 money market mutual funds offered in the U.S. These
funds are broken down into various categories such as U.S. Treasury,
Domestic Prime and Euros, Domestic Prime and Euros and Yankees, and
Aggressive.
First Boston High Yield Index. It shows statistics on the Composite Index
and analytical data on new issues in the marketplace and low-grade issuers.
Lipper Analytical Services, Inc., "Lipper-Fixed Income Fund Performance
Analysis" is a monthly publication which tracks net assets, total return,
principal return and yield on approximately 950 fixed income mutual funds
offered in the United States.
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable Bond Indices" is a
monthly publication which lists principal, coupon and total return on over
100 different taxable bond indices tracked by Merrill Lynch, together with
the par weighted characteristics of each Index. The index used as a
benchmark for the High Yield Fund is the High Yield Index. The two indices
used as benchmarks for the Short-Term Bond Fund are the 91-Day Treasury
Bill Index and the 1-2.99 Year Treasury Note Index.
Morningstar, Inc., is a widely used independent research firm which rates
mutual funds by overall performance, investment objectives and assets.
PAGE 79
Salomon Brothers Inc., "Analytical Record of Yields and Yield Spreads" is a
publication which tracks historical yields and yield spreads on short-term
market rates, public obligations of the U.S. Treasury and agencies of the
U.S. government, public corporate debt obligations, municipal debt
obligations and preferred stocks.
Salomon Brothers Inc., "Bond Market Round-up" is a weekly publication which
tracks the yields and yield spreads on a large, but select, group of money
market instruments, public corporate debt obligations, and public
obligations of the U.S. Treasury and agencies of the U.S. Government.
Salomon Brothers Inc., "High Yield Composite Index" is an index which
provides performance and statistics for the high yield market place.
Salomon Brothers Inc., "Market Performance" is a monthly publication which
tracks principal return, total return and yield on the Salomon Brothers
Broad investment - Grade Bond Index and the components of the Index.
Shearson Lehman Brothers, Inc., "The Bond Market Report" is a monthly
publication which tracks principal, coupon and total return on the Shearson
Lehman Govt./Corp. Index and Shearson Lehman Aggregate Bond Index, as well
as all the components of these Indices.
Telerate Systems, Inc., is a market data distribution network which tracks
a broad range of financial markets including, the daily rates on money
market instruments, public corporate debt obligations and public
obligations of the U.S. Treasury and agencies of the U.S. Government.
Wall Street Journal, is a national daily financial news publication which
lists the yields and current market values on money market instruments,
public corporate debt obligations, public obligations of the U.S. Treasury
and agencies of the U.S. government as well as common stocks, preferred
stocks, convertible preferred stocks, options and commodities; in addition
to indices prepared by the research departments of such financial
organizations as Shearson Lehman/American Express Inc., and Merrill Lynch,
Pierce, Fenner and Smith, Inc., including information provided by the
Federal Reserve Board.
Performance rankings and ratings reported periodically in national
financial publications such as MONEY, FORBES, BUSINESS WEEK, BARRON'S, etc.
will also be used.
All Funds, except Prime Reserve and Personal Strategy Funds
Benefits of Investing in High-Quality Bond Funds
o Higher Income
Bonds have generally provided a higher income than money market
securities because yield usually increased with longer maturities. For
instance, the yield on the 30-year Treasury bond usually exceeds the
yield on the 1-year Treasury bill or 5-year Treasury note. However,
securities with longer maturities fluctuate more in price than those with
shorter maturities. Therefore, the investor must weigh the advantages of
higher yields against the possibility of greater fluctuation in the
principal value of your investment.
PAGE 80
o Income Compounding
Investing in bond mutual funds allows investors to benefit from easy and
convenient compounding, because you can automatically reinvest monthly
dividends in additional fund shares. Each month investors earn interest
on a larger number of shares. Also, reinvesting dividends removes the
temptation to spend the income.
o Broad Diversification
Each share of a mutual fund represents an interest in a large pool of
securities, so even a small investment is broadly diversified by
maturity. Since most bonds trade efficiently only in very large
blocks,mutual funds provide a degree of diversification that may be
difficult for individual investors to achieve on their own.
o Lower Portfolio Volatility
Investing a portion of one's assets in longer term, high-quality bonds
can help smooth out the fluctuations in your overall investment results,
because bond prices do not necessarily move with stock prices. Also,
bonds usually have higher income yields than stocks, thus increasing the
total income component of your portfolio. This strategy should also add
stability to overall results, as income is always a positive component of
total return.
o Liquidity
A bond fund can supplement a money market fund or bank account as a
source of capital for unexpected contingencies. T. Rowe Price fixed-
income funds offer you easy access to money through free checkwriting and
convenient redemption or exchange features. Of course, the value of a
bond fund's shares redeemed through checkwriting may be worth more or
less than their value at the time of their original purchase.
o Suitability
High-quality bond funds are most suitable for the following objectives:
obtaining a higher current income with minimal credit risk; compounding
of income over time; or diversifying overall investments to reduce
volatility.
All Funds
IRAs
An IRA is a long-term investment whose objective is to accumulate
personal savings for retirement. Due to the long-term nature of the
investment, even slight differences in performance will result in
significantly different assets at retirement. Mutual funds, with their
diversity of choice, can be used for IRA investments. Generally, individuals
may need to adjust their underlying IRA investments as their time to
retirement and tolerance for risk changes.
<PAGE>
PAGE 81
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, such as 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 Associates, Inc. and/or T.
Rowe Price Investment Services, Inc. may be made available. These currently
include: the Asset Mix Worksheet which is designed to show shareholders how to
reduce their investment risk by developing a diversified investment plan; the
College Planning Guide which discusses various aspects of financial planning
to meet college expenses and assists parents in projecting the costs of a
college education for their children; the Retirement Planning Kit (also
available in a PC version) includes a detailed workbook to determine how much
money you may need for retirement and suggests how you might invest to achieve
your objectives; and the Retirees Financial Guide which includes a detailed
workbook to determine how much money you can afford to spend and still
preserve your purchasing power and suggests how you might invest to reach your
goal. From time to time, other worksheets and guides may be made available as
well. Of course, an investment in the Fund cannot guarantee that such goals
will be met. Personal Strategy Planner simplifies investment decision making
by helping investors define personal financial goals, establish length of time
the investor intends to invest, determine risk "comfort zone" and select
diversified investment mix.
To assist investors in understanding the different returns and risk
characteristics of various investments, the aforementioned guides will include
presentation of historical returns of various investments using published
indices. An example of this is shown below.
Historical Returns for Different Investments
Annualized returns for periods ended 12/31/93
50 years 20 years 10 years 5 years
Small-Company Stocks 15.3% 18.8% 10.0% 13.3%
Large-Company Stocks 12.3 12.8 14.9 14.5
Foreign Stocks N/A 14.4 17.9 2.3
Long-Term Corporate Bonds 5.6 10.2 14.0 13.0
Intermediate-Term U.S.
Gov't. Bonds 5.7 9.8 11.4 11.3
Treasury Bills 4.6 7.5 6.4 5.6
U.S. Inflation 4.3 5.9 3.7 3.9
Sources: Ibbotson Associates, Morgan Stanley. Foreign stocks reflect
performance of The Morgan Stanley Capital International EAFE Index, which
includes some 1,000 companies representing the
PAGE 82
stock markets of Europe, Australia, New Zealand, and the Far East. This chart
is for illustrative purposes only and should not be considered as performance
for, or the annualized return of, any T. Rowe Price Fund. Past performance
does not guarantee future results.
Also included will be various portfolios demonstrating how these
historical indices would have performed in various combinations over a
specified time period in terms of return. An example of this is shown below.
Performance of Retirement Portfolios*
Asset Mix Average Annualized Value
Returns 20 Years of
Ended 12/31/93 $10,000
Investment
After Period
_____________________ ______________________ ____________
Nominal Real Best Worst
Portfolio Growth Income Safety Return Return** Year Year
I. Low
Risk 40% 40% 20% 11.3% 5.4% 24.9% -9.3% $ 79,775
II. Moderate
Risk 60% 30% 10% 12.1% 6.2% 29.1% -15.6% $ 90,248
III. High
Risk 80% 20% 0% 12.9% 7.0% 33.4% -21.9% $100,031
Source: T. Rowe Price Associates; data supplied by Lehman Brothers, Wilshire
Associates, and Ibbotson Associates.
* Based on actual performance for the 20 years ended 1993 of stocks (85%
Wilshire 5000 and 15% Europe, Australia, Far East [EAFE] Index), bonds
(Lehman Brothers Aggregate Bond Index from 1976-93 and Lehman Brothers
Government/Corporate Bond Index from 1974-75), and 30-day Treasury bills
from January 1974 through December 1993. Past performance does not
guarantee future results. Figures include changes in principal value and
reinvested dividends and assume the same asset mix is maintained each
year. This exhibit is for illustrative purposes only and is not
representative of the performance of any T. Rowe Price fund.
** Based on inflation rate of 5.9% for the 20-year period ended 12/31/93.
Insights
From time to time, Insights, a T. Rowe Price publication of reports on
specific investment topics and strategies, may be included in the Fund's
fulfillment kit. Such reports may include information concerning:
calculating taxable gains and losses on mutual fund transactions, coping
PAGE 83
with stock market volatility, benefiting from dollar cost averaging,
understanding international markets, investing in high-yield "junk" bonds,
growth stock investing, conservative stock investing, value investing,
investing in small companies, tax-free investing, fixed income investing,
investing in mortgage-backed securities, as well as other topics and
strategies.
Other Publications
From time to time, in newsletters and other publications issued by T.
Rowe Price Investment Services, Inc., reference may be made to economic,
financial and political developments in the U.S. and abroad and their effect
on securities prices. Such discussions may take the form of commentary on
these developments by T. Rowe Price mutual fund portfolio managers and their
views and analysis on how such developments could affect investments in mutual
funds.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in kind
redemption of portfolio securities of the Fund, brokerage fees could be
incurred by the shareholder in a subsequent sale of such securities.
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.
All Funds, except GNMA Fund
CAPITAL STOCK
The Fund's Charter authorizes the 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 Investment Company Act and
other applicable law. 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 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.
Except to the extent that the Fund's Board of Directors might provide by
resolution that holders of shares of a particular class are entitled to vote
as a class on specified matters presented for a vote of the holders of all
shares entitled to vote on such matters, there would be no right of
PAGE 84
class vote unless and to the extent that such a right might be construed to
exist under Maryland law. The Charter contains no provision entitling the
holders of the present class of capital stock to a vote as a class on any
matter. Accordingly, the preferences, rights, and other characteristics
attaching to any class of shares, including the present class of capital
stock, might be altered or eliminated, or the class might be combined with
another class or classes, by action approved by the vote of the holders of a
majority of all the shares of all classes entitled to be voted on the
proposal, without any additional right to vote as a class by the holders of
the capital stock or of another affected class or classes.
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of directors (to the extent hereinafter provided) and on other
matters submitted to the vote of shareholders. There will normally be no
meetings 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 Fund, a special meeting of
shareholders of the Fund shall be called by the Secretary of the Fund on the
written request of shareholders entitled to cast at least 10% of all the votes
of the Fund entitled to be cast at such meeting. Shareholders requesting such
a meeting must pay to the Fund the reasonably estimated costs of preparing and
mailing the notice of the meeting. The Fund, however, will otherwise assist
the shareholders seeking to hold the special meeting in communicating to the
other shareholders of the Fund to the extent required by Section 16(c) of the
Investment Company Act of 1940.
GNMA Fund
DESCRIPTION OF THE FUND
For tax and business reasons, the Fund was organized in 1985 as a
Massachusetts Business Trust and is registered with the Securities and
Exchange Commission under the Investment Company Act of 1940 as a diversified,
open-end investment company, commonly known as a "mutual fund."
The Declaration of Trust permits the Board of Trustees to issue an
unlimited number of full and fractional shares of a single class. The
Declaration of Trust also provides that the Board of Trustees may issue
additional series or classes of shares. Each share represents an equal
proportionate beneficial interest in the Fund. In the event of the
liquidation of the Fund, each share is entitled to a pro rata share of the net
assets of the Fund.
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of trustees (to the extent hereinafter provided) and on other
matters submitted to the vote of shareholders. There will normally be no
meetings of shareholders for the purpose of electing trustees unless and until
such time as less than a majority of the trustees holding office have been
elected by shareholders, at which time the trustees then in office will call a
shareholders' meeting for the election of trustees. Pursuant to Section 16(c)
of the Investment Company Act of 1940, holders of record of not less
PAGE 85
than two-thirds of the outstanding shares of the Fund may remove a trustee by
a vote cast in person or by proxy at a meeting called for that purpose.
Except as set forth above, the trustees shall continue to hold office and may
appoint successor trustees. Voting rights are not cumulative, so that the
holders of more than 50% of the shares voting in the election of trustees can,
if they choose to do so, elect all the trustees of the Trust, in which event
the holders of the remaining shares will be unable to elect any person as a
trustee. No amendments may be made to the Declaration of Trust without the
affirmative vote of a majority of the outstanding shares of the Trust.
Shares have no preemptive or conversion rights; the right of redemption
and the privilege of exchange are described in the prospectus. Shares are
fully paid and nonassessable, except as set forth below. The Trust may be
terminated (i) upon the sale of its assets to another diversified, open-end
management investment company, if approved by the vote of the holders of two-
thirds of the outstanding shares of the Trust, or (ii) upon liquidation and
distribution of the assets of the Trust, if approved by the vote of the
holders of a majority of the outstanding shares of the Trust. If not so
terminated, the Trust will continue indefinitely.
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Fund.
However, the Declaration of Trust disclaims shareholder liability for acts or
obligations of the Fund and requires that notice of such disclaimer be given
in each agreement, obligation or instrument entered into or executed by the
Fund or a Trustee. The Declaration of Trust provides for indemnification from
Fund property for all losses and expenses of any shareholder held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself would be unable to meet its
obligations, a possibility which T. Rowe Price believes is remote. Upon
payment of any liability incurred by the Fund, the shareholders of the Fund
paying such liability will be entitled to reimbursement from the general
assets of the Fund. The Trustees intend to conduct the operations of the Fund
in such a way so as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of such Fund.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the Securities Act of
1933, and the Fund or its shares are registered under the laws of all states
which require registration, as well as the District of Columbia and Puerto
Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman, whose address is 919 Third
Avenue, New York, New York 10022, is legal counsel to the Fund.<PAGE>
PAGE 86
INDEPENDENT ACCOUNTANTS
GNMA, High Yield, New Income, Prime Reserve, Short-Term Bond and Money Funds
Price Waterhouse, 7 St. Paul Street, Suite 1700, Baltimore, Maryland
21202, are independent accountants to the Fund.
Adjustable Rate, Intermediate, Long-Term, and Personal Strategy Funds
Coopers & Lybrand, 217 East Redwood Street, Baltimore, Maryland 21202,
are independent accountants to the Fund.
Financial Statements
The Statement of Assets and Liabilities of the Personal Strategy Funds
as of July 25, 1994, included in the Statement of Additional Information has
been so included in reliance on the report of Coopers & Lybrand, given on the
authority of said firm as experts in auditing and accounting.
The financial statements of the Fund for the year ended February 28,
1994, and the report of independent accountants are included in the Fund's
Annual Report for the period February 28, 1994. 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 February 28, 1994 are incorporated into this
Statement of Additional Information by reference:
NEW PRIME SHORT-
GNMA INCOME RESERVE TERM BOND
____ ______ _______ _________
Report of Independent
Accountants 12 15 11 17
Statement of Net Assets,
February 28, 1994 6-7 6-10 5-8 6-11
Statement of Operations, year
ended February 28, 1994 8 11 8 12
Statement of Changes in Net
Assets, years ended
February 28, 1994 and
February 28, 1993 9 12 9 13
Notes to Financial Statements
February 28, 1994 9-11 12-14 9-10 14-15
Financial Highlights 11 14 11 16
<PAGE>
PAGE 87
U.S. TREASURY U.S. TREASURY U.S. TREASURY
MONEY INTERMEDIATE LONG-TERM
_____________ ____________ _____________
Report of Independent
Accountants 18 19 19
Statement of Net Assets,
February 28, 1994 7-9 8-9 10-11
Statement of Operations, year
ended February 28, 1994 11 11 11
Statement of Changes in Net
Assets, years ended
February 28, 1994 and
February 28, 1993 12 12 12
Notes to Financial Statements
February 28, 1994 13-14 13-14 13-14
Financial Highlights 15 16 17
ADJUSTABLE RATE HIGH YIELD
_______________ __________
Report of Independent
Accountants 13 19
Portfolio of Investments,
February 28, 1994 5-7 6-13
Statement of Assets and
Liabilities, February 28, 1994 7 14
Statement of Operations, year
ended February 28, 1994 8 15
Statement of Changes in Net
Assets, years ended
February 28, 1994 and
February 28, 1993 9 16
Notes to Financial Statements
February 28, 1994 10-11 16-18
Financial Highlights 12 18
RATINGS OF COMMERCIAL PAPER
Adjustable Rate, High Yield, Prime Reserve and Short-Term Bond Funds
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 ratings 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
PAGE 88
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.
Prime Reserve Fund
Fitch Investors Service, 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
Adjustable Rate, High Yield, New Income, Personal Strategy, and Short-Term
Bond Funds
Moody's Investors Services, Inc. (Moody's)
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 known 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
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
PAGE 89
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.
Standard & Poor's Corporation (S&P)
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, C, CCC, CC-Bonds rated BB, B, CCC, and CC 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 CC 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.
Fitch Investors Service, Inc.
AAA-High grade, broadly marketable, suitable for investment by trustees
and fiduciary institutions, and liable to but 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 a 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>
PAGE 90
T. ROWE PRICE PERSONAL STRATEGY FUNDS, INC.
STATEMENT OF ASSETS AND LIABILITIES
JULY 25, 1994
Balanced Growth Income
Fund Fund Fund
________ ______ ______
Assets
Receivable for Fund shares sold $30,000 $30,000 $40,000
Deferred organizational expenses 42,507 42,507 42,507
_______ _______ _______
Total assets 72,507 72,507 82,507
Liabilities
Amount due Manager 39,407 39,407 39,407
Accrued expenses 3,100 3,100 3,100
_______ _______ _______
Total liabilities 42,507 42,507 42,507
_______ _______ _______
Net Assets - offering and redemption
price of $10.00 per share; 1,000,000,000
shares of $0.0001 par value capital
stock authorized, 3,000 shares
outstanding $30,000 $30,000
======= =======
Net Assets - offering and redemption
price of $10.00 per share; 1,000,000,000
shares of $0.0001 par value capital
stock authorized, 4,000 shares
outstanding $40,000
=======
NOTE TO STATEMENT OF ASSETS AND LIABILITIES
T. Rowe Price Personal Strategy Fund, Inc. (the "Corporation") was
organized on May 21, 1994, as a Maryland corporation and is registered under
the Investment Company Act of 1940. The Corporation is a series fund, of
which the T. Rowe Price Personal Strategy Balanced Fund, T. Rowe Price
Personal Strategy Growth Fund and the T. Rowe Price Personal Strategy Income
Fund (the "Funds"), diversified, open-end management investment companies are
the only funds currently established. The Corporation has had no operations
other than those matters related to organization and registration as an
investment company, the registration of shares for sale under the Securities
Act of 1933, and the sale of 3,000 shares of the T. Rowe Price Personal
Strategy Balanced Fund at $10.00 per share, the sale of 3,000 shares of the T.
Rowe Price Personal Strategy Growth Fund at $10.00 per share, the sale of
4,000 shares of the T. Rowe Price Personal Strategy Income Fund at $10.00 per
share on July 25, 1994 to T. Rowe Price Associates, Inc. Each Fund's
receivable for fund shares sold was funded by T. Rowe Price Associates, Inc.
on July 26, 1994. The Funds have entered into an investment management
agreement with T. Rowe Price Associates, Inc. (the Manager) which is described
in the Statement of Additional Information under the heading "Investment
Management Services."
<PAGE>
PAGE 91
Organizational expenses of $42,507 for each fund have been accrued at July
25, 1994, and will be amortized on a straight-line basis over a period not to
exceed sixty months. The Manager has agreed to advance certain organizational
expenses incurred by the Funds and will be reimbursed for such expenses
approximately six months after the commencement of the Fund's operations.
The Manager has agreed that in the event any of its initial shares are
redeemed during the 60-month amortization period of the deferred
organizational expenses, proceeds from a redemption of the shares representing
the initial capital will be reduced by a pro rata portion of any unamortized
organizational expenses.
<PAGE>
PAGE 92
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
T. Rowe Price Personal Strategy Funds, Inc.:
We have audited the accompanying statement of assets and liabilities of the
T. Rowe Price Personal Strategy Funds, Inc. (the "Funds"), comprised of the T.
Rowe Price Personal Strategy Balanced Fund, T. Rowe Price Personal Strategy
Growth Fund, and T. Rowe Price Personal Strategy Income Fund, as of July 25,
1994. This financial statement is the responsibility of the Funds'
management. Our responsibility is to express an opinion of this financial
statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of the T.
Rowe Price Personal Strategy Funds, Inc. as of July 25, 1994, in conformity
with generally accepted accounting principles.
COOPERS & LYBRAND
Baltimore, Maryland
July 26, 1994
<PAGE>
