<PAGE> 1
REGISTRATION NO. 2-28174
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 / X /
Pre-Effective Amendment No. _____ / /
Post-Effective Amendment No. 48 / X /
-----
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 / X /
Capstone Fixed Income Series, Inc.
- ------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
5847 San Felipe, Suite 4100, Houston, Texas 77057
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (713) 260-9000
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Allan S. Mostoff, Esq., Dechert Price & Rhoads
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1500 K Street, N.W., Suite 500, Washington, DC 20005
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(Name and Address of Agent for Service)
It is proposed that this filing will become effective (check appropriate
box)
/ X / immediately upon filing pursuant to paragraph (b).
/ / on ________________ pursuant to paragraph (b).
/ / 60 days after filing pursuant to paragraph (a).
/ / on (date) pursuant to paragraph (a) of rule 485.
The Registrant has filed with the Securities and Exchange Commission a
declaration pursuant to Rule 24f-2 under the Investment Company Act of
1940, and:
/ X / filed the notice required by that Rule on February 27, 1995;
or
/ / intends to file the notice required by that Rule on or
about________________; or
/ / during the most recent fiscal year did not sell any securities
pursuant to Rule 24f-2 under the Investment Company Act of
1940, and, pursuant to Rule 24f-2(b)(2), need not file the
Notice.
Total Pages ______ Exhibit Index Page ______
<PAGE> 2
CAPSTONE FIXED INCOME SERIES
CAPSTONE GOVERNMENT INCOME FUND
CAPSTONE INTERMEDIATE GOVERNMENT FUND
CROSS REFERENCE SHEET
BETWEEN
ITEMS OF FORM N-1A AND PROSPECTUS
(PART A TO REGISTRATION STATEMENT NO. 2-28174)
Item
Number Form N-1A Heading Caption in Prospectus
- ------ ----------------- ---------------------
1. Cover Page Prospectus Cover Page
2. Synopsis Prospectus Summary; Fund Expenses
3. Condensed Financial Information Financial Highlights
4. General Description of Investment Objective and
Registrant Policies; Investment Practices;
Investment Risks; Investment
Restrictions; Management of the Fund;
General Information
5. Management of the Fund Management of the Fund
6. Capital Stock and Other General Information;
Securities Distributions and Taxes
7. Purchase of Securities Being Determination of Net Asset Value;
Offered Purchasing Shares
8. Redemption or Repurchase Redemption and Repurchase of
Shares Shares
9. Pending Legal Proceedings Inapplicable
<PAGE> 3
CAPSTONE GOVERNMENT INCOME FUND
A SERIES OF CAPSTONE FIXED INCOME SERIES, INC.
5847 San Felipe, Suite 4100
Houston, TX 77057
1-800-262-6631
MARCH 25, 1996
PROSPECTUS
Capstone Government Income Fund (the "Fund") is the initial of two
series of Capstone Fixed Income Series, Inc. (the "Corporation"), an open-
end diversified management investment company. The investment objective of
the Fund is to earn a high level of total return, consistent with safety of
principal. The Fund seeks to achieve its investment objective by investing
in debt obligations that have remaining maturities of three years or less
and that are issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. The Fund may also, in pursuit of its investment
objective, engage in the purchasing and selling of options on U.S.
Government securities in seeking to hedge against changes in interest rates
and to enhance the Fund's yield. This Prospectus sets forth certain
information about the Fund that a prospective investor should know before
investing. Investors should read and retain this Prospectus for future
reference.
A STATEMENT OF ADDITIONAL INFORMATION about the Fund dated March 25,
1996, has been filed with the Securities and Exchange Commission and
contains further information about the Fund. A copy of the Statement of
Additional Information may be obtained without charge by calling or writing
the Fund at the telephone number or address listed above. The Statement of
Additional Information is incorporated herein by reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE> 4
CAPSTONE GOVERNMENT INCOME FUND
INVESTMENT ADVISER: ADMINISTRATOR:
Capstone Asset Management Company Capstone Asset Management Company
5847 San Felipe, Suite 4100 5847 San Felipe, Suite 4100
Houston, Texas 77057 Houston, Texas 77057
DISTRIBUTOR: SHAREHOLDER SERVICING AGENT:
Capstone Asset Planning Company Fund/Plan Services, Inc.
5847 San Felipe, Suite 4100 2 W. Elm Street
Houston, Texas 77057 P.O. Box 874
1-800-262-6631 Conshohocken, Pennsylvania 19428
TABLE OF CONTENTS
PAGE
----
Prospectus Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Fund Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Financial Highlights. . . . . . . . . . . . . . . . . . . . . . . . . . 7
Investment Objective and Policies . . . . . . . . . . . . . . . . . . . 8
Investment Practices. . . . . . . . . . . . . . . . . . . . . . . . . . 9
Investment Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Investment Restrictions . . . . . . . . . . . . . . . . . . . . . . . . 12
Performance Information . . . . . . . . . . . . . . . . . . . . . . . . 12
Management of the Fund . . . . . . . . . . . . . . . . . . . . . . . . 13
Purchasing Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Distributions and Taxes . . . . . . . . . . . . . . . . . . . . . . . . 18
Redemption and Repurchase of Shares . . . . . . . . . . . . . . . . . . 20
Determination of Net Asset Value. . . . . . . . . . . . . . . . . . . . 22
Stockholder Services . . . . . . . . . . . . . . . . . . . . . . . . . 22
General Information . . . . . . . . . . . . . . . . . . . . . . . . . . 24
No dealer, salesman, or any other person has been authorized to give
any information or to make any representations, other than those contained
in this Prospectus, in connection with the offer contained in this
Prospectus and, if given or made, such other information or representations
must not be relied upon as having been authorized by the Fund or its
Distributor. This Prospectus does not constitute an offer by the Fund or
by the Distributor to sell or a solicitation of an offer to buy any of the
securities offered hereby in any jurisdiction to any person to whom it is
unlawful for the Fund or the Distributor to make such offer or solicitation
in such jurisdiction.
<PAGE> 5
CAPSTONE GOVERNMENT INCOME FUND
PROSPECTUS SUMMARY
Type of Company . . . The Fund is a series of Capstone Fixed Income
Series, Inc., an open-end diversified management
investment company organized as a Maryland series
company. (see page 24)
Investment Objective. The Fund's investment objective is to earn a high
level of total return, consistent with safety of
principal. The Fund seeks to achieve its objective
by investing in short- and intermediate-term
securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities. (see
page 8)
Investment Policies . The Fund will invest in debt obligations that have
remaining maturities of three years or less and that
are issued by the U.S. Treasury and other U.S.
agencies and instrumentalities. The Fund may also
buy and sell covered options on U.S. Government
securities. (see page 8)
Risk Factors . . . . The securities in which the Fund may invest are
subject to market, credit and interest rate risks.
Additionally, the Fund could be adversely affected
by its options transactions if forecasts of the
Adviser are incorrect. (see page 12)
Investment Adviser . Capstone Asset Management Company (the "Adviser") is
the Fund's investment adviser pursuant to an
agreement dated May 11, 1992. The Adviser provides
investment advice and places orders to purchase and
sell securities for the Fund. The Adviser is
responsible chiefly for the overall design and
structure of the Fund's investment portfolio, the
investment philosophy, strategy and maturity
structure. It is paid a monthly fee equal to an
annual rate of 0.40% of the Fund's average daily net
assets. (see page 13)
Administrator . . . . Capstone Asset Management Company (the
"Administrator") is the Fund's Administrator. The
Administrator provides advisory and/or
administrative services to the other mutual funds in
the Capstone Group, and is Adviser of the Fund. For
its services, the Administrator is paid a monthly
fee equal to an annual rate of 0.10% of the Fund's
average daily net assets. (see page 15)
Dividends and
Distributions . . . . The Fund pays dividends from net investment income
at least annually and distributes capital gains at
least annually. (see page 18)
Distributor and
Offering Price. . . . Shares of the Fund are continuously offered for sale
through the Fund's Distributor, Capstone Asset
Planning Company, without a
<PAGE> 6
sales load, at the net asset value next determined
after receipt of the order. The Fund bears certain
expenses pursuant to a written Rule 12b-1 distribution
plan. (see page 17)
Minimum Purchase. . . The minimum purchase required for initial investment
is $200, except for continuous investment plans, and
there is no minimum for subsequent investments.
Certain waivers are available. (see page 17)
Redemption . . . . . Shares of the Fund can be redeemed at net asset
value, without charge. (see page 20)
<PAGE> 7
FUND EXPENSES
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load Imposed on Purchases 0%
(as a percentage of offering price)
Maximum Sales Load Imposed on Reinvested
Dividends 0%
(as a percentage of offering price)
Deferred Sales Load (as a percentage of 0%
original purchase price or redemption
proceeds, as applicable)
Redemption Fees (as a percentage of 0%
amount redeemed, if applicable)
Exchange Fee 0%
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management and Administration Fees 0.37%
12b-1 Fees* 0.19%
Other Expenses 0.21%
Total Fund Operating Expenses 0.77%
EXAMPLE
1 year 3 years 5 years 10 years
------ ------- ------- --------
You would pay the following expenses
on a $1,000 investment, assuming (1)
5% annual return and (2) redemption
at the end of each time period: $8 $25 $43 $95
____________
* Under rules of the National Association of Securities Dealers, Inc. (the
"NASD"), a 12b-1 fee may be treated as a sales charge for certain
purposes under those rules. Because the 12b-1 fee is an annual fee charged
against the assets of a Fund, long-term stockholders may pay more in total
sales charges than the economic equivalent of the maximum front-end sales
charge permitted by rules of the NASD (see "Distributor").
The purpose of the foregoing table is to assist investors in
understanding the various costs and expenses that an investor in the Fund
will bear directly or indirectly. See "Purchasing Shares" and "Redemption
and Repurchase of Shares" below for more complete descriptions of those
expenses. The information under the heading "Annual Fund Operating
Expenses" is based on expenses actually incurred by the Fund during its
last fiscal year ended November 30, 1995. The management and
administration fee information contained in the table is based on the
maximum asset-based fees. There
<PAGE> 8
were no deductions for expense reimbursements or waivers by the Fund's
Adviser or Administrator during the last fiscal year. See "Management of
the Fund" for more complete descriptions of the fees paid to the Adviser
and the Administrator.
THE EXAMPLE WHICH IMMEDIATELY FOLLOWS THE TABLE USES THE "TOTAL FUND
OPERATING EXPENSES" FIGURE ABOVE AND ASSUMES IT WILL REMAIN CONSTANT OVER
THE ILLUSTRATED PERIOD. THE EXAMPLE SHOULD NOT BE CONSIDERED A
REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL FUND EXPENSES MAY BE
GREATER OR LESSER THAN THOSE SHOWN IN THE EXAMPLE OR IN THE TABLE.
<PAGE> 9
FINANCIAL HIGHLIGHTS
The following table sets forth the per share operating performance
data for a share of capital stock outstanding, total return, ratios to
average net assets and other supplemental data for each year indicated.
This information has been derived from information provided in the Fund's
financial statements which have been audited by Tait, Weller & Baker for
the years ended November 30, 1995 and December 31, 1994 and 1993 and the
year ended September 30, 1990, and by Ernst & Young LLP, independent
auditors, for the year ended December 31, 1992, the period from October 1,
1991 to December 31, 1991 and the year ended September 30, 1991. The
Fund's Annual Report contains additional performance information and is
available free of charge upon request by calling the Fund at 1-800-262-
6631.
<TABLE>
<CAPTION>
PERIOD
FROM
ELEVEN OCT. 1,
MONTHS YEAR ENDED 1991 TO
ENDED DECEMBER 31, DEC. 31, YEAR ENDED SEPTEMBER 30,
NOV. 30, ----------------------- ------- ----------------------------------------
1995(3) 1994 1993 1992 1991(1) 1991(2) 1990 1989 1988 1987
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE DATA
Net asset value at beginning
of period . . . . . . . . . $4.73 $4.80 $4.74 $4.67 $4.73 $4.67 $5.09 $5.22 $ 5.20 $5.26
----- ----- ----- ----- ----- ----- ----- ----- ------ -----
Income from investment
operations:
Net investment income . . . .24 .18 .17 .23 .06 .25 .44 .45 .44 .48
Net realized and
unrealized gain (loss). . . .01 (.12) (.01) (.06) .06 (.08) (.40) (.11) .09 (.07)
----- ----- ----- ----- ----- ----- ----- ----- ------ -----
Total from investment
operations. . . . . . . . . .25 .06 .16 .17 .12 .17 .04 .34 .53 .41
----- ----- ----- ----- ----- ----- ----- ----- ------ -----
Less distributions from net
investment income . . . . . .00 (.13) (.10) (.10) (.18) (.11) (.46) (.47) (.51) (.47)
----- ----- ----- ----- ----- ----- ----- ----- ------ -----
Net asset value at end of
period. . . . . . . . . . . $4.98 $4.73 $4.80 $4.74 $4.67 $4.73 $4.67 $5.09 $ 5.22 $5.20
===== ===== ===== ===== ===== ===== ===== ===== ====== =====
Total Return. . . . . . . . . 5.29% 1.13% 3.32% 3.55% 2.49% 3.63% .73% 6.73% 10.73% 7.93%
===== ===== ===== ===== ===== ===== ===== ===== ===== =====
RATIOS/SUPPLEMENTAL DATA
Ratio of operating expenses
to average net assets . . . .77%(4) .87% .93% .92% .31% 1.45% 1.40% 1.24% 1.29% 1.29%
Ratio of interest expenses
to average net assets . . . .00% .00% .00% .04% .10% .22% .00% .00% .00% .00%
----- ---- ---- ---- ---- ---- ---- ---- ---- ----
Ratio of total expenses to
average net assets. . . . . .77%(4) .87% .93% .96% .41% 1.67% 1.40% 1.24% 1.29% 1.29%
===== ===== ===== ===== ==== ==== ===== ==== ==== =====
Ratio of net investment
income to average net assets 5.56%(4) 4.20% 3.64% 4.69% 1.34% 5.29% 9.06% 8.75% 8.51% 8.90%
Portfolio turnover . . . . . 309.66% 285.13% 596.36% 633.41% 129.05% 753.62% 82.00% 69.89% 100.48% 102.11%
Net assets at end of period
(in thousands) . . . . . . 67,997 8,705 33,795 29,847 30,565 36,720 17,648 20,214 24,575 22,497
</TABLE>
______________
(1) Selected per share data and ratios including total return have not
been annualized.
(2) Effective January 1991, the investment objective and investment
adviser were changed.
(3) Based on average shares outstanding determined daily.
(4) Annualized.
<PAGE> 10
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to earn a high level of total
return, consistent with safety of principal. Total return would include
net realized and unrealized capital gains and net investment income. The
Fund seeks to achieve its objective by investing in debt obligations that
have remaining maturities of three years or less and that are issued or
guaranteed by the U.S. Government, its agencies or instrumentalities and by
engaging in certain income enhancement strategies. The Fund's investment
objective is a fundamental policy and may not be changed without the
authorization of the holders of a majority of the Fund's outstanding voting
securities. There can be no assurance that the Fund's investment objective
will be achieved.
By holding primarily U.S. Government securities, the Fund will seek to
earn current income comparable to the stated coupons of the securities held
in the portfolio. In addition, by entering into the specific yield
enhancement strategies detailed below, including covered put and call
option writing and use of option premium income to purchase options, the
Fund will attempt to hedge the price risk of the portfolio securities and
to enhance the current income of the portfolio beyond the stated coupons
attached to the portfolio securities. Fund monies that are not invested in
U.S. Government securities or employed in hedging or income enhancement
strategies will be invested in repurchase agreements backed by U.S.
Government securities.
Under no circumstances will the Fund purchase debt obligations that
have more than three years remaining to maturity, nor will the Adviser
transact business that will cause the Fund's weighted-average maturity to
be in excess of two years on the last business day of each calendar year.
Accordingly, the Adviser expects that the Fund's daily net asset value will
be limited in changes to those not exceeding the price sensitivity of two-
to-three year U.S. Treasury notes.
The Fund intends to reinvest all interest income earned by the Fund's
portfolio in securities that mature before the end of the calendar year.
The purpose of this procedure is to protect all interest income for
possible distribution to stockholders. Interest income is, therefore, not
intended for use in financing hedging or yield enhancement strategies. In
this way the Fund hopes to protect its portfolio's principal value from
erosion due to net options trading losses.
Prior to a Special Meeting of Stockholders held January 8, 1991, the
Fund's name was Investors Income Fund, Inc. and its investment objective
was to seek a high level of current income along with preservation of
capital through investments in U.S. Government and corporate bonds, money
market instruments and other income-producing securities.
The portfolio turnover rate for the fiscal years ended November 30,
1995 and December 31, 1994 and 1993 was 310%, 285% and 596%, respectively.
It is anticipated that the Fund will incur a high portfolio turnover rate
in connection with the use of covered option writing strategies; high
portfolio turnover can be expected to increase the Fund's transaction
costs. Additionally, to the extent portfolio turnover results in
realization of net short-term capital gains, stockholders will be taxed on
such gains at ordinary income tax rates (except stockholders investing
through retirement plans that are not taxed currently on accumulations).
<PAGE> 11
INVESTMENT PRACTICES
The significant investments and investment strategies employed by the
Fund, including related risks, are described below. For more information
concerning the Fund's investment practices, see the Fund's Statement of
Additional Information.
U.S. GOVERNMENT SECURITIES. The Fund may invest in securities issued
by the U.S. Treasury, including bills, notes and bonds with three years or
less remaining until maturity. Those instruments are direct obligations of
the U.S. Government and, as such, are backed by the "full faith and credit"
of the United States. They differ primarily in the dates of their
issuance, stated coupons, call provisions and maturity dates.
U.S. GOVERNMENT AGENCIES SECURITIES. The Fund may invest up to 50% of
its portfolio in instruments issued by agencies or instrumentalities of the
U.S. Government. Some agencies, including the Department of Housing and
Urban Development, the Government National Mortgage Association, the
Farmer's Home Administration, and the Small Business Administration, issue
securities backed by the "full faith and credit" of the United States.
U.S. Government agencies and instrumentalities that issue securities not
backed by the "full faith and credit" of the U.S. Government in which the
Fund may invest are limited to the Federal Farm Credit System, the Federal
Land Banks, the Federal Intermediate Credit Banks, the Banks for
Cooperatives, the Federal Home Loan Banks, the Federal National Mortgage
Association and the Federal Home Loan Mortgage Corporation. In the case of
issues not backed by the U.S. Government, the investor must look
principally to the agency issuing the obligation for ultimate repayment of
principal and interest.
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements
(a purchase of, and simultaneous commitment to resell, a security at an
agreed upon price on an agreed upon date) only with member banks of the
Federal Reserve System, recognized primary dealers of Government
securities, and member firms of the New York Stock Exchange. When
participating in repurchase agreements, the Fund buys securities from a
vendor, e.g., a bank or brokerage firm, with the agreement that the vendor
will repurchase the securities at a higher price or agreed rate of interest
at a later date. The securities underlying a repurchase agreement will be
marked-to-market every business day so that the value of the collateral is
at least equal to the value of the loan, including the accrued interest
thereon. Such transactions afford an opportunity for the Fund to earn a
return on available cash at minimal market risk, although the Fund may be
subject to various delays and risks of loss if the vendor is unable to meet
its obligation to repurchase or to maintain collateral in accordance with
the agreement. In evaluating whether to enter into repurchase agreements,
the Adviser will carefully consider the creditworthiness of the vendor. If
the member bank or member firm that is the party to the repurchase
agreement petitions for bankruptcy or otherwise becomes subject to the U.S.
Bankruptcy Code, the law regarding the rights of the Fund is unsettled.
REVERSE REPURCHASE AGREEMENTS. A reverse repurchase agreement
involves the sale of a U.S. Treasury obligation by the Fund and its
agreement to repurchase the instrument at a specific time and price. The
Fund will maintain a segregated account, which will be marked-to-market
daily, consisting of cash, cash equivalents and U.S. Government securities
at least equal to its obligations under reverse repurchase agreements,
including any accrued interest. The Fund will not invest proceeds from
these transactions beyond the expiration of the reverse repurchase
agreement. The Fund may not enter into these transactions with more than
33% of its portfolio, and will only enter into such agreements with
<PAGE> 12
dealers approved by the Fund for repurchase agreements.
COVERED OPTIONS STRATEGIES. The Fund may write (or sell) put and call
options on the U.S. Government securities that the Fund is authorized to
buy or already holds in its portfolio. These option contracts may be
listed for trading on a national securities exchange or traded over-the-
counter. The Fund may also purchase put and call options on U.S.
Government securities. The Fund will not write covered calls on more than
50% of its portfolio, and the Fund will not write covered calls with strike
prices lower than the underlying securities' cost basis on more than 25% of
its total portfolio.
A call option gives the purchaser the right to buy, and the writer the
obligation to sell, the underlying security at the agreed upon exercise (or
"strike") price during the option period. A put option gives the
purchaser the right to sell, and the writer the obligation to buy, the
underlying security at the strike price during the option period.
Purchasers of options pay an amount, known as a premium, to the option
writer in exchange for the right under the option contract.
The Fund may sell "covered" put and call options as a means of hedging
the price risk of securities in the Fund's portfolio. The sale of a call
option against a security held by the portfolio constitutes a "covered
call." The sale of a put option against an amount of cash equal to the
put's potential liability constitutes a "covered put." When the Fund sells
an option, if the underlying securities do not increase (in the case of a
call option) or decrease (in the case of a put option) to a price level
that would make the exercise of the option profitable to the holder of the
option, the option will generally expire without being exercised and the
Fund will realize as profit the premium paid for such option. When a call
option of which the Fund is the writer is exercised, the option holder
purchases the underlying security at the strike price and the Fund does not
participate in any increase in the price of such securities above the
strike price. When a put option of which the Fund is the writer is
exercised, the Fund will be required to purchase the underlying securities
at the strike price, which may be in excess of the market value of such
securities. Sales of covered puts will not total more than 10% of the
Fund's total assets however, the Fund may sell covered puts on up to 20% of
the Fund's total assets if the strike price of the put is lower than the
underlying security's current market value.
Over-the-counter options ("OTC options") differ from exchange-traded
options in several respects. They are transacted directly with dealers and
not with a clearing corporation, and there is a risk of non-performance by
the dealer. OTC options are available for a greater variety of securities
and for a wider range of expiration dates and exercise prices than exchange
traded options. Because OTC options are not traded on an exchange, pricing
is normally done by reference to information from a market maker. This
information is carefully monitored by the Adviser and verified in
appropriate cases. An OTC option transaction will be entered into by the
Fund only with a securities dealer meeting criteria established by the
Fund.
The Fund may, in order to avoid the exercise of an option sold by it,
cancel its obligation under the option by entering into a closing purchase
transaction, if available, unless it is determined to be in the Fund's
interest to sell (in the case of a call option) or to purchase (in the case
of a put option) the underlying securities. A closing purchase transaction
consists of the Fund purchasing an option having the same terms as the
option sold by the Fund and has the effect of cancelling the Fund's
position as a seller. The premium which the Fund will pay in executing a
closing purchase transaction may be higher than the premium received when
the option was sold, depending in large part upon the relative price of the
underlying security at the time of each transaction. To the extent options
sold by the Fund are
<PAGE> 13
exercised and the Fund either delivers portfolio securities to the holder of
a call option or liquidates securities in its portfolio as a source of funds
to purchase securities put to the Fund, the Fund's portfolio turnover rate
may increase, resulting in a possible increase in short-term capital gains
and a possible decrease in long-term capital gains.
Put and call option purchases by the Fund are not limited in par
amount, nor in underlying security. However, the Fund may not exercise
options that call for purchases or sales of securities not authorized by
the Fund's investment policies. Put and call purchases are limited,
however, in dollar amount by the net premiums received by the Fund from
options sales and not yet distributed to stockholders as dividends.
Moreover, the Fund may not invest more than 5% of its total assets in
option purchases.
RISKS OF WRITING OPTIONS. By writing a call option, the Fund loses
the potential for gain on the underlying security above the exercise price
while the option is outstanding; by writing a put option a Fund might
become obligated to purchase the underlying security at an exercise price
that exceeds the then current market price.
WHEN-ISSUED AND FORWARD DELIVERY SECURITIES. Securities may be
purchased on a "when-issued" or on a "forward delivery" basis, which means
that the obligations will be delivered at a future date beyond customary
settlement time. The commitment to purchase a security for which payment
will be made on a future date may be deemed a separate security. Although
the Fund is not limited in the amount of securities for which it may have
commitments to purchase on such basis, it is expected that in normal
circumstances, the Fund will commit no more than 25% of its assets to such
purchases. The Fund does not pay for securities until received or start
earning interest on them until it is notified of the settlement date. In
order to invest its assets immediately, while awaiting delivery of
securities purchased on such basis, the Fund will normally invest in short-
term securities that may bear interest at a lower rate than longer-term
securities.
These transactions are subject to market fluctuations; the value of
the securities at delivery may be more or less than their purchase price,
and yields available in the market may be higher than yields on the
securities obtained pursuant to such transactions. Because the Fund relies
on the buyer or seller, as the case may be, to consummate the transactions,
failure by the other party to complete the transaction may result in the
Fund missing the opportunity of obtaining a price or yield considered to be
advantageous. The Fund will make commitments to purchase securities on
such basis only with the intention of actually acquiring these securities,
but the Fund may sell such securities prior to the settlement date if such
sale is considered to be advisable. To the extent the Fund engages in
"when-issued" and "forward delivery" transactions, it will do so for the
purpose of acquiring securities for the Fund's portfolio consistent with
the Fund's investment objectives and policies and not for the purpose of
investment leverage.
The SEC generally requires that when investment companies, such as the
Fund, effect transactions of the foregoing nature, such funds must either
segregate cash or readily marketable high-grade debt securities with its
Custodian in the amount of its obligations under the foregoing
transactions, or cover such obligations by maintaining positions in
portfolio securities or options that would serve to satisfy or offset the
risk of such obligations. When effecting transactions of the foregoing
nature, the Fund will comply with such segregation or cover requirements.
<PAGE> 14
INVESTMENT RISKS
The Fund is designed as a means of investing in short-term U.S.
Government securities, and not as a trading vehicle. To the extent that
the Fund invests in fixed rate obligations, the net asset value of the Fund
may rise and fall with general interest rate changes. During periods of
falling interest rates, the values of such securities generally rise.
Conversely, during periods of rising interest rates, the values of such
securities generally decline.
The Fund will attempt to achieve its objective of earning a high level
of total return by establishing the shortest possible maturity allowed by
market conditions consistent with its investment objective, but the Fund
can make no predictions as to what this maturity will be inside the stated
restriction of three year maximum maturity. Changes in the value of
portfolio securities do not affect the investment income from these
securities, however, or the ability of the Fund to reinvest these earnings
as they become available prior to distributions.
Although the Fund's option writing activities cause portfolio turnover
to be high (see "Investment Objective and Policies"), it is not an
objective of the Fund to attempt to profit from interest rate changes by
entering speculative positions or by excessively trading the portfolio.
Obligations held by the Fund may, however, be subject to call prior to
their maturity. Call provisions tend to be exercised when interest rates
have fallen, forcing reinvestment of the proceeds at lower interest rates.
INVESTMENT RESTRICTIONS
The Fund has certain investment restrictions some of which, as well as
the Fund's investment objective, are fundamental and, accordingly, may not
be changed without the approval of the holders of a majority of the Fund's
shares, which means the lesser of (i) more than 50% of the outstanding
shares of the Fund, or (ii) 67% or more the outstanding shares of the Fund
present at a meeting in which holders of more than 50% of its outstanding
shares are represented in person or by proxy. The Fund's fundamental and
non-fundamental investment restrictions are fully described in the
Statement of Additional Information. Among other things, the Fund's
fundamental investment restrictions provide that the Fund may not borrow
money, except that the Fund may enter into reverse repurchase agreements,
and, as a temporary measure for extraordinary or emergency purposes, it may
borrow from banks in an amount not to exceed 1/3 of the value its net
assets, including the amount borrowed. The Fund will not purchase
additional securities while its borrowings exceed 5% of its total assets.
PERFORMANCE INFORMATION
The Fund may from time to time include figures indicating the Fund's
yield, total return or average annual total return in advertisements or
reports to stockholders or prospective investors. Quotations of the Fund's
yield will be based on all investment income per share earned during a
particular 30-day period (including dividends and interest), less expenses
accrued during the period ("net investment income"), and will be computed
by dividing net investment income by the maximum offering price per share
on the last day of the period. Average annual total return and total
return figures represent the increase (or decrease) in the value of an
investment in the Fund over a specified period. Both calculations assume
that all income dividends and capital gain distributions during the period
are
<PAGE> 15
reinvested at net asset value in additional Fund shares. Quotations of
the average annual total return reflect the deduction of a proportional
share of Fund expenses on an annual basis. The results, which are
annualized, represent an average annual compounded rate of return on a
hypothetical investment in the Fund over a period of 1, 5 and 10 years
ending on the most recent calendar quarter (but not for a period greater
than the life of the Fund). Quotations of total return, which are not
annualized, represent historical earnings and asset value fluctuations.
Performance information for the Fund may be compared, in reports and
promotional literature, to: (i) the Merrill Lynch One to Three-Year
Treasury Index and the Shearson Lehman Intermediate Government/Corporate
Bond Index; (ii) certain performance figures prepared for broad groups of
mutual funds with investment goals similar to the Fund by organizations
such as Lipper Analytical and the Donoghue Organization; (iii) the Consumer
Price Index, a statistical measure of change, over time, in the price of
goods and services in major expenditure groups (such as food, housing,
apparel, transportation, medical care, entertainment and other goods and
services) typically purchased by urban consumers; (iv) other mutual funds
with similar goals; and (v) certificates of deposit. Instruments included
in the Shearson and Merrill indexes, which are unmanaged, may not
necessarily be typical of the type of investments made by the Fund. Other
material differences between the Fund and these indexes may include (i) the
managed character of the Fund's portfolio (i.e., the Fund may purchase and
sell investment securities based on their performance while securities
comprising the particular index may remain as part of the index without
regard to their performance), and (ii) the index would not generally
reflect deductions for administrative expenses and costs. Further, broad-
based economic indexes measure developments of general matters which may or
may not be relevant to the Fund's performance during particular periods.
For example, the purchasing power of consumers' dollars is measured by
comparing the costs of goods and services today with the costs of the same
goods and services at an earlier date.
There are three material differences between an investment in the Fund
and ownership of a certificate of deposit ("CD"). First, an investment in
the Fund is subject to a greater degree of risk and fluctuation of value
than a CD, which guarantees a specific rate of return. Second, if interest
rates rise in the future, the capital value of bonds purchased at the
present time will fall, which will affect the Fund's performance if such
securities are held in its portfolio. Third, the underlying assets of a CD
are federally insured on amounts up to $100,000.
Performance information for the Fund reflects only the performance of
a hypothetical investment in the Fund during the particular time period on
which the calculations are based. Performance information should be
considered in light of the Fund's investment objectives and policies, the
types and quality of the Fund's portfolio investments, market conditions
during the particular time period and operating expenses. Such information
should not be considered as a representation of the Fund's future
performance. For a description of the methods used to determine the Fund's
yield, total return and average annual total return, see the Statement of
Additional Information.
MANAGEMENT OF THE FUND
The Fund is a series of an open-end diversified management investment
company, commonly called a mutual fund. See "General Information".
Through the purchase of shares of the Fund, investors with goals similar to
the investment objective of the Fund can participate in the investment
performance of the portfolio of investments held by the Fund. The
management and affairs of the Fund are supervised
<PAGE> 16
by its Board of Directors.
INVESTMENT ADVISER
Capstone Asset Management Company serves as the investment adviser
(the "Adviser") to the Fund pursuant to an investment advisory agreement
("Advisory Agreement") dated May 11, 1992 between the Adviser and the Fund.
The Adviser, located at 5847 San Felipe, Suite 4100, Houston, Texas 77057
was incorporated in 1982 and is a wholly-owned subsidiary of Capstone
Financial Services, Inc. The Adviser serves as investment adviser and/or
administrator to five other mutual funds: Capstone Growth Fund, Inc.,
Capstone Intermediate Government Fund, Capstone Nikko Japan Fund, Capstone
New Zealand Fund, and Medical Research Investment Fund, Inc. (collectively,
the "Capstone Funds"), and to pension and profit sharing accounts,
corporations and individuals. Assets under management are approximately
$1.3 billion.
The Fund is managed primarily by Howard S. Potter, Managing Director
of Capstone Asset Management Company. Mr. Potter began his Wall Street
career trading financial futures as a local floor trader. In 1981 he
joined Donaldson, Lufkin & Jenrette, Inc. as Assistant Vice President of
Marketing, where, in addition to other responsibilities, he published two
weekly newsletters on financial futures and debt options. He moved to
Oppenheimer & Company in 1984 to spearhead their Risk Management Group, and
from there joined James Money Management in 1988 as Chief Investment
Officer for all yield enhancement products and portfolio manager of several
mutual funds. In 1991, Mr. Potter formed New Castle Advisers, Inc.
("NCA"). As the president of this registered investment advisory firm, Mr.
Potter served as the portfolio manager of several mutual funds, and since
1992 he has served as portfolio manager of the Fund. Mr. Potter received a
B.A. degree from the University of Wisconsin and a M.A. degree from
Northwestern University.
Since 1992, NCA has served as the Fund's subadviser, and Mr. Potter as
the Fund's portfolio manager. On January 1, 1996, Capstone Financial
Services, Inc., the parent of the Adviser, acquired a majority interest in
NCA, and NCA simultaneously resigned as subadviser to the Fund. Mr. Potter
continues to act as the Fund's portfolio manager through his position as
Managing Director of the Adviser. The Fund therefore no longer has a
separate subadviser. This change has had no effect on advisory fees paid
by the Fund, since fees to NCA were previously paid by the Adviser out of
its fees from the Fund. The Adviser now retains the entire fee.
Pursuant to the terms of the Advisory Agreement, the Adviser has
agreed to (1) provide a program of continuous investment management for the
Fund in accordance with the Fund's investment objectives, policies and
limitations, (2) make investment decisions for the Fund and (3) place
orders to purchase and sell securities for the Fund, subject to the
supervision of the Board of Directors. In accordance with the Fund's
policy of allocating portfolio brokerage described in the Statement of
Additional Information, the Adviser is permitted to consider sales of Fund
shares as a factor in selecting broker-dealers to execute portfolio
transactions, subject to best execution. For these services the Fund pays
the Adviser a fee computed daily and payable monthly at the annual rate of
0.40% of the first $250 million of the Fund's average daily net assets and
0.36% of such assets over $250 million. For the fiscal year ended November
30, 1995 the Fund paid advisory fees to the Adviser equal to 0.37% of the
Fund's average daily net assets out of which the Adviser paid fees of
$453,142 to NCA, which was the Fund's subadviser during that year.
<PAGE> 17
The Advisory Agreement provides that the Adviser shall not be liable
for any error of judgment or of law, or for any loss suffered by the Fund
in connection with the matters to which the agreements relate except a loss
resulting from willful misfeasance, bad faith or gross negligence on the
part of the Adviser in the performance of their obligations and duties, or
by reason of their reckless disregard of their obligations and duties under
the Advisory Agreement.
The Advisory Agreement will remain in effect from year to year
provided its renewal is specifically approved at least annually by the
Board of Directors or by vote of a majority of the Fund's outstanding
voting securities (as defined in the 1940 Act) and, in either case, by a
majority of the directors who are not parties to the Advisory Agreement or
interested persons of any such party. The Advisory Agreement will
terminate automatically in the event of its assignment and may be
terminated without penalty by vote of a majority of the Fund's outstanding
voting securities or by either party on not more than 60 days' written
notice.
ADMINISTRATOR
Pursuant to a separate Administration Agreement, the Adviser also
provides administrative services for the Fund, supervises the Fund's daily
business affairs, coordinates the activities of persons providing services
to the Fund and furnishes office space and equipment to the Fund. Such
services are subject to general review by the Board of Directors. For
these administrative services, the Fund pays a fee, computed daily and
payable monthly, at an annual rate of 0.10% of the Fund's average net
assets.
DISTRIBUTOR
Pursuant to a Distribution Agreement with the Fund dated May 7, 1995,
Capstone Asset Planning Company (the "Distributor"), is the principal
underwriter of the Fund and, acting as exclusive agent, sells shares of the
Fund to the public on a continuous basis.
The Fund has adopted a Service and Distribution Plan (the "Plan")
pursuant to which it uses its assets to finance certain activities relating
to the distribution of its shares to investors and provision of certain
stockholder services. The Plan permits payments to be made by the Fund to
the Distributor to reimburse it for particular expenditures incurred by it
in connection with the distribution of the Fund's shares to investors and
provision of certain stockholder services including but not limited to the
payment of compensation, including incentive compensation, to securities
dealers (which may include the Distributor itself) and certain banks,
investment advisers and pension consultants (collectively, the "Service
Organizations") to obtain various distribution related and/or
administrative services for the Fund. These services include, among other
things, processing new stockholder account applications, preparing and
transmitting to the Fund's Transfer Agent computer processable tapes of all
transactions by customers and serving as the primary source of information
to customers in answering questions concerning the Fund and their
transactions with the Fund. The Distributor is also authorized to engage
in advertising, the preparation and distribution of sales literature and
other promotional activities on behalf of the Fund. In addition, the Plan
authorizes payment by the Fund of the cost of preparing, printing and
distributing Fund Prospectuses and Statements of Additional Information to
prospective investors and of implementing and operating the Plan.
Under the Plan, payments made to the Distributor may not exceed an
amount computed at an annual rate of 0.20% of the average net assets of the
Fund. The Distributor is permitted to collect fees
<PAGE> 18
under the Plan on a monthly basis. Any expenditures incurred in excess of
the limitation described above during a given month may be carried forward
up to twelve months for reimbursement, subject always to the 0.20% limit,
and no interest or carrying charges will be payable by the Fund on amounts
carried forward. Payments under the Plan are further limited by rules of the
National Association of Securities Dealers. The Plan may be terminated by
the Fund at any time and the Fund will not be liable for amounts not
reimbursed as of the termination date. During the fiscal year ended
November 30, 1995, the effective rate of servicing fees paid to service
organizations other than Capstone Asset Planning Company was .18% of the
Fund's average net assets.
The Plan was approved by a majority of the Fund's stockholders on
January 8, 1991, and may be continued thereafter from year to year,
provided that such continuance is approved at least annually by a vote of a
majority of the Board of Directors, including a majority of the directors
who have no direct or indirect financial interest in the operation of the
Plan or any of its agreements ("Plan Directors"). The Plan was last
approved by unanimous vote of a majority of the Board of Directors,
including a majority of the Plan Directors, on May 7, 1995.
The Glass-Steagall Act and other applicable laws currently prohibit
banks from engaging in the business of underwriting, selling or
distributing securities. Accordingly, unless such laws are changed, if the
Fund engages banks as Service Organizations, the banks would perform only
administrative and shareholder servicing functions. If a bank were
prohibited from acting as a Service Organization, alternative means for
continuing the servicing of such shareholders would be sought.
EXPENSES
The Fund pays all expenses incurred in the operation of the Fund other
than those assumed by the Adviser under the Advisory Agreement or
Administration Agreement, respectively. Expenses payable by the Fund
include: fees and expenses of directors who are not "interested persons"
(as defined in the 1940 Act); fees of the Adviser; Board of Directors
meeting-related expenses of the directors and officers; mailing expenses of
all Fund officers and directors; expenses for legal and auditing services;
data processing and pricing services; costs of printing and mailing
proxies, stock certificates and stockholder reports; administration fees;
charges of the custodian, transfer agent, registrar or dividend disbursing
agent; expenses pursuant to the Service and Distribution Plan; Securities
and Exchange Commission fees; membership fees in trade associations;
fidelity bond coverage for the Fund's officers; directors' and officers'
errors and omissions insurance coverage; interest; brokerage costs; taxes;
expenses of qualifying the Fund's shares for sale in various states;
litigation; and other extraordinary or non-recurring expenses and other
expenses properly payable by the Fund.
The Fund's expenses are accrued daily and are deducted from its total
income before dividends are paid. Under the Advisory and Administration
Agreements, if the Fund's ordinary expenses for any fiscal year (including
advisory and administrative fees, but excluding interest, local, state and
Federal taxes and extraordinary expenses) exceed the expense limitations of
any state having jurisdiction over the Fund, then the annual advisory and
administration fees will be reduced ratably (but not below zero) until the
Fund can operate within the expense limitation discussed above. The Fund's
total operating expenses as a percentage of its average net assets during
the fiscal year ended November 30, 1995 were 0.77%.
<PAGE> 19
PURCHASING SHARES
Capstone Asset Planning Company (the "Distributor"), located at 5847
San Felipe, Houston, Texas 77057, is the principal underwriter of the Fund
and, acting as exclusive agent, sells shares of the Fund to the public on a
continuous basis. Edward L. Jaroski is a director of the Corporation, the
Adviser and the Distributor. Some officers of the Fund are also officers
of the Adviser, Distributor and their parent company, Capstone Financial
Services, Inc.
Shares of the Fund are sold in a continuous offering and may be
purchased on any business day through authorized investment dealers or
directly from the Fund's Distributor. Except for the Fund itself, only the
Distributor and investment dealers which have a sales agreement with the
Distributor are authorized to sell shares of the Fund. For further
information, reference is made to the caption "Distributor" in the Fund's
Statement of Additional Information.
The initial purchase must be at least $200, except for continuous
investment plans which have no minimum, and there is no minimum for
subsequent investments. Shares of the Fund are sold at net asset value,
without a sales charge, and will be credited to a stockholder's account at
the net asset value next computed after an order is received by the
Distributor. Whenever a transaction takes place in the stockholder's
account, a statement will be mailed reflecting the status of the account.
Share certificates are not issued unless requested by the stockholder in
writing to the Fund's Transfer Agent. The Fund's management reserves the
right to reject any purchase order if, in its opinion, it is in the Fund's
best interest to do so.
Payment for all orders to purchase Fund shares must be received by the
Fund's Transfer Agent within three business days after the order was
placed.
INVESTING THROUGH AUTHORIZED DEALERS
If any authorized dealer receives an order, the dealer may contact the
Distributor directly. Orders received by dealers by the close of trading
on the New York Stock Exchange on a business day that are transmitted to
the Distributor by 4:00 p.m. Central time on that day will be effected at
the net asset value per share determined as of the close of trading on the
New York Stock Exchange that day. Otherwise, the orders will be effected
at the next determined net asset value. It is the dealer's responsibility
to transmit orders so that they will be received by the Distributor before
4:00 p.m. Central time.
After each investment, the stockholder and the authorized investment
dealer receive confirmation statements of the number of shares purchased
and owned.
PURCHASES THROUGH THE DISTRIBUTOR
An account may be opened by mailing a check or other negotiable bank
draft (payable to Capstone Government Income Fund) together with the
completed Investment Application Form to the Fund's Transfer Agent:
Capstone Government Income Fund, c/o Fund/Plan Services, Inc., 2 W. Elm
Street, P.O. Box 874, Conshohocken, Pennsylvania 19428. All such
investments are effected at the net asset value of Fund shares next
computed following receipt of payment by the Transfer Agent. Confirmations
of the opening of an account and of all subsequent transactions in the
account are
<PAGE> 20
forwarded by the Transfer Agent to the stockholder's address of record.
TELEPHONE PURCHASE AUTHORIZATION (INVESTING BY PHONE)
Stockholders who have completed the Telephone Purchase Authorization
section of the Investment Application Form may purchase additional shares
by telephoning the Fund's Transfer Agent at (800) 845-2340. The minimum
telephone purchase is $1,000 and the maximum is the greater of $1,000 or
five times the net asset value of shares (for which certificates have not
been issued) held by the stockholder on the day preceding such telephone
purchase for which payment has been received. The telephone purchase will
be effected at the net asset value next computed after receipt of the call
by the Fund's Transfer Agent. Payment for the telephone purchase must be
received by the Transfer Agent within three business days after the order
is placed. If payment is not received within three business days after the
order is placed, the stockholder will be liable for all losses incurred as
a result of the purchase.
INVESTING BY WIRE
Investors having an account with a commercial bank that is a member of
the Federal Reserve System may purchase shares of the Fund by requesting
their bank to transmit funds by wire to: United Missouri Bank KC NA, ABA
10-10-00695, For; Fund/Plan Services, Inc. Account 98-7037-0719; Further
Credit Capstone Government Income Fund. The investor's name and account
number must be specified in the wire.
Initial Purchases - Before making an initial investment by wire, an
investor must first telephone (800) 845-2340 to be assigned an account
number. The investor's name, account number, taxpayer identification or
social security number, and address must be specified in the wire. In
addition, the investment application which accompanies this Prospectus
should be promptly forwarded to Capstone Government Income Fund, c/o
Fund/Plan Services, Inc., 2 W. Elm Street, P.O. Box 874, Conshohocken,
Pennsylvania 19428.
Subsequent Purchases - Additional investments may be made at any time
through the wire procedures described above, which must include the
investor's name and account number. The investor's bank may impose a fee
for investments by wire.
DISTRIBUTIONS AND TAXES
PAYMENT OPTIONS
Distributions (whether treated for tax purposes as ordinary income or
long-term capital gains) to stockholders of the Fund are paid in additional
shares of the Fund, with no sales charge, based on the Fund's net asset
value as of the close of business on the record date for such
distributions. However, a stockholder may elect on the application form
which accompanies this Prospectus to receive distributions as follows:
Option 1. To receive income dividends in cash and capital gain
distributions in additional Fund shares, or
<PAGE> 21
Option 2. To receive all income dividends and capital gain
distributions in cash.
The Fund pays any dividends from investment company taxable income
annually in December, and intends to make any distributions representing
net capital gain annually in December. The Fund will advise each
stockholder annually of the amounts of dividends from investment company
taxable income and of net capital gain distributions reinvested or paid in
cash to the stockholder during the calendar year.
If you select Option 1 or Option 2 and the U.S. Postal Service cannot
deliver your checks, or if your checks remain uncashed for six months, your
distribution checks will be reinvested in your account at the then current
net asset value and your election will be converted to the purchase of
additional shares.
TAXES
The Fund intends to qualify and elect to be treated as a regulated
investment company under the Federal tax law. In any taxable year in which
the Fund so qualifies and distributes at least 90% of its investment
company taxable income (which includes, among other items, interest and the
excess of realized net short-term capital gain over realized net long-term
capital loss), the Fund generally will be relieved of Federal income tax on
its investment company taxable income and net capital gains (the excess of
realized net long-term capital gains over realized net short-term capital
losses) distributed to stockholders. Amounts not distributed on a timely
basis in accordance with a calendar year distribution requirement are also
subject to a nondeductible 4% excise tax. To prevent application of the
excise tax, the Fund intends to make its distributions in accordance with
the calendar year distribution requirement. A distribution will be treated
as paid on December 31 of the calendar year if it is declared by the Fund
in October, November or December of that year to stockholders of record on
a date in such a month and paid by the Fund during January of the following
calendar year. Such distributions will be taxable to stockholders in the
calendar year in which the distributions are declared, rather than the
calendar year in which the distributions are received.
Distributions from investment company taxable income are taxable to
stockholders as ordinary income. Distributions of the net capital gain
designated by the Fund as capital gain dividends are taxable as long-term
capital gains regardless of the length of time a stockholder may have held
shares of the Fund. The tax treatment of distributions treated as ordinary
income or capital gain will be the same whether the stockholder invests the
distributions in additional shares or elects to receive them in cash. Some
of the Fund's distributions may constitute a return of capital.
Stockholders will be notified each year of the amounts and nature of
dividends and distributions paid to them by the Fund, including the amounts
(if any) for that year which have been designated as capital gain
dividends.
Special tax rules may apply to the Fund's transactions involving
options. These rules, among other things: (i) may affect whether capital
gains and losses from such transactions are considered to be short-term or
long-term; (ii) may have the effect of converting capital gains and losses
into ordinary income and losses; (iii) may have the effect of deferring
losses and/or accelerating the recognition of gains or losses; and (iv) for
purposes of qualifying as a regulated investment company, may limit the
extent to which the Fund will be able to engage in such transactions.
<PAGE> 22
Upon the sale, redemption, or other disposition of shares of the Fund,
a stockholder generally will realize a taxable gain or loss, depending upon
his basis in the shares. Such gain or loss will be treated as capital gain
or loss if the shares are capital assets in the stockholder's hands and
will be long-term or short-term, depending on the stockholder's holding
period for the shares. Any loss realized on a sale or exchange will be
disallowed to the extent the shares disposed of are replaced (including
shares acquired pursuant to the reinvestment plan) within a period of 61
days beginning 30 days before and ending 30 days after the shares are
disposed of. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Any loss realized by a
stockholder on a disposition of Fund shares held by the stockholder for six
months or less will be treated as a long-term capital loss to the extent of
any capital gain dividends received by the stockholder with respect to such
shares.
The Fund may be required to withhold Federal income tax at the rate of
31% of all taxable distributions (including gross proceeds from the
redemption of Fund shares) payable to stockholders who fail to provide the
Fund with their correct taxpayer identification number or to make required
certifications, or where the Fund or the stockholder has been notified by
the Internal Revenue Service that the stockholder is subject to backup
withholding. Corporate stockholders and certain other stockholders
specified in the Code generally are exempt from such backup withholding.
Backup withholding is not an additional tax. Any amounts withheld may be
credited against the stockholder's Federal income tax liability.
Distributions also may be subject to additional state, local and
foreign taxes, depending on each stockholder's particular situation. In
addition, foreign stockholders may be subject to Federal income tax rules
that differ significantly from those described above. Stockholders are
advised to consult their tax advisers with respect to the particular tax
consequences to them of an investment in the Fund.
REDEMPTION AND REPURCHASE OF SHARES
Shares of the Fund, in any amount, may be redeemed at any time,
without charge, at the net asset value next determined after a request is
received by the Fund. See "Determination of Net Asset Value." In
addition, the Distributor is authorized as agent for the Fund to offer to
repurchase at the net asset value next determined after the request is
received by the Distributor, shares which are presented by telephone or
telegraph to the Distributor by authorized investment dealers. Broker-
dealers may charge for their services in connection with the repurchase,
but the Distributor and its affiliates will not charge any fee for such
repurchase.
Requests for redemption may be made by calling the Fund at 1-800-845-
2340, by telegraph or other wire communication, or by letter upon
completion of the Expedited Redemption portion set forth in the application
form. Payment of redemption proceeds may be delayed if the shares to be
redeemed were purchased by check and such check has not cleared (which may
take up to 15 days from the purchase date). Generally, stockholders may
require the Fund to redeem their shares by sending a written request,
signed by the record owner(s), to Capstone Government Income Fund, c/o
Fund/Plan Services, Inc., 2 W. Elm Street, P.O. Box 874, Conshohocken,
Pennsylvania 19428. In addition, certain expedited redemption methods
described below are available. If stock certificates have been issued for
shares being redeemed, such certificates must accompany the written request
with the stockholder's signature guaranteed by an "eligible guarantor
institution", as defined in Rule 17Ad-15 under the Securities Exchange Act
of 1934, which participates in a signature guarantee program. Eligible
guarantor
<PAGE> 23
institutions include banks, brokers, dealers, credit unions, national
securities exchanges, registered securities associations, clearing
agencies and savings associations. A broker-dealer guaranteeing signatures
must be a member of a clearing corporation or maintain net capital of at
least $100,000. Credit unions must be authorized to issue signature
guarantees. No signature guarantees for shares for which no certificates
have been issued are required when an application is on file at the
Transfer Agent and payment is to be made to the stockholder of record at
the stockholder's address of record. However, if the proceeds of the
redemption are to be paid to someone other than the registered holder, or
to other than the stockholder's address of record, or the shares are to be
transferred, the owner's signature must be guaranteed by a commercial bank
or by a securities firm having membership on a recognized national
securities exchange.
The Fund reserves the right to pay any portion of redemption requests
in excess of $1 million in readily marketable securities from the Fund's
portfolio. In this case, the stockholders generally will incur brokerage
charges on the sale of the securities.
Normally the Fund will make payment for all shares redeemed within two
(2) business days, but in no event will payment be made more than three (3)
business days after receipt of a redemption request and/or certificate in
proper order. However, payment may be postponed or the right of redemption
suspended for more than three (3) business days under unusual
circumstances, such as when trading is not taking place on the New York
Stock Exchange. Proceeds of redeemed shares will be transmitted by Federal
Funds wire to the shareholder's bank account designated on the application
form (which must be at a commercial bank which is a member of the Federal
Reserve System) or by check.
The value of shares on repurchase or redemption may be more or less
than the investor's cost depending upon the market value of the Fund's
portfolio securities at the time of redemption. No redemption fee is
charged for the redemption of shares.
EXPEDITED TELEPHONE REDEMPTION
A stockholder redeeming at least $1,000 of shares (for which
certificates have not been issued), and who has authorized expedited
redemption on the application form filed with the Fund's Transfer Agent
may, at the time of such redemption, request that funds be mailed or wired
to the commercial bank or registered broker-dealer he has previously
designated on the application by telephoning the Transfer Agent at 1-800-
845-2340. Proceeds for redemptions requested by 2:45 p.m. Central time
will be sent on the next business day. In order to allow the Adviser to
manage the Fund more effectively, stockholders are strongly urged to
initiate redemptions as early in the day as possible and to notify the
Transfer Agent in advance of redemptions in excess of $5 million. If a
stockholder seeks to use an expedited method of redemption of shares
recently purchased by check, the Fund may withhold the redemption proceeds
until it is reasonably assured of the collection of the check representing
the purchase, which may take up to 15 days from the purchase date. The
Fund, Distributor and Transfer Agent reserve the right at any time to
suspend or terminate the expedited redemption procedure or to impose a fee
for this service. At the present time there is no fee charged for this
service. During periods of unusual economic or market changes,
stockholders may experience difficulties or delays in effecting telephone
redemptions.
When exchange or redemption requests are made by telephone, the Fund
has procedures in place designed to give reasonable assurance that such
telephone instructions are genuine, including recording telephone calls and
sending written confirmation of transactions. The Fund will not be liable
for losses
<PAGE> 24
due to unauthorized or fraudulent telephone transactions unless it does not
follow such procedures, in which case it may be liable for such losses.
DETERMINATION OF NET ASSET VALUE
The Fund's net asset value is computed daily, Monday through Friday,
as of 4:15 p.m. Eastern Time, except that the net asset value will not be
computed on the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day and the days that the Federal Reserve wire system is closed.
The Fund also will determine its net asset value on any day in which there
is sufficient trading in its portfolio securities that the net asset value
might be affected materially, but only if on any such day the Fund is
required to sell or redeem shares. The Fund's net asset value per share is
computed by dividing the value of the securities held by the Fund plus any
cash or other assets (including any accrued interest and dividends
receivable but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares outstanding at such time, adjusted
to the nearest whole cent. The net asset value so computed will be used
for all purchase orders and redemption requests received between such
computation and the preceding computation.
All portfolio securities for which over-the-counter market quotations
are readily available are valued at the mean between the bid and asked
prices. OTC options are valued using the Black-Scholes Model, which
utilizes the option's characteristics when bought or sold and the market
price of the underlying security to determine a daily price for each OTC
option's position. The only pricing variable changed daily is the price of
the underlying security. Short-term instruments having a maturity date of
more than 60 days are valued on a "mark-to-market" basis, that is, at
prices based on market quotations for securities of similar type, yield,
quality and maturity, until 60 days prior to maturity and thereafter at
amortized value. Short-term instruments having a maturity date of 60 days
or less at the time of purchase are valued at amortized cost value unless
the Board of Directors determines this does not represent fair market
value. When market quotations are not readily available, portfolio
securities are valued at their fair value as determined in good faith under
procedures established by and under the general supervision of the Board of
Directors (valuation of securities for which market quotations are not
readily available may be based upon current market prices of securities
which are comparable in coupon, rating and maturity or an appropriate
matrix utilizing similar factors).
STOCKHOLDER SERVICES
Capstone Government Income Fund provides its stockholders with a
number of services and conveniences designed to assist investors in the
management of their investments. These stockholder services include the
following:
TAX-DEFERRED RETIREMENT PLANS
Shares may be purchased by virtually all types of tax-deferred
retirement plans. The Distributor or its affiliates make available plan
forms and/or custody agreements for the following:
o Individual Retirement Accounts (for individuals and their non-
employed spouses who
<PAGE> 25
wish to make limited tax deductible contributions to a
tax-deferred account for retirement); and
o Simplified Employee Pension Plans.
Dividends and distributions will be automatically reinvested without a
sales charge. For further details, including fees charged, tax
consequences and redemption information, see the specific plan documents
which can be obtained from the Fund.
Investors should consult with their tax adviser before establishing
any of the tax-deferred retirement plans described above.
EXCHANGE PRIVILEGE
Shares of the Fund which have been outstanding 15 days or more may be
exchanged for shares of other Capstone Funds at a price based on their
respective net asset values with no sales or administrative charge. Any
exchange must meet applicable minimum investment and other requirements for
the Capstone Fund (or class of such Fund) into which the exchange is
requested. A Fund stockholder requesting such an exchange will be sent a
current prospectus for the fund into which the exchange is requested.
Shares held less than 15 days cannot be exchanged. In such instances, the
shares will be redeemed at the next computed net asset value.
Purchases, redemptions, and exchanges should be made for investment
purposes only. A pattern of frequent exchanges, purchases and sales may be
deemed abusive by the Adviser and, at the discretion of the Adviser, can be
limited by the Fund's refusal to accept further purchase and/or exchange
orders from the investor. Although the Adviser will consider all factors
it deems relevant in determining whether a pattern of frequent purchases,
redemptions and/or exchanges by a particular investor is abusive and not in
the best interests of the Fund or its other stockholders, as a general
policy investors should be aware that engaging in more than one exchange or
purchase-sale transaction during any thirty-day period with respect to a
particular fund may be deemed abusive and therefore subject to the above
restrictions.
An exchange of shares is treated for Federal income tax purposes as a
sale of shares given in exchange and the stockholder may, therefore,
realize a taxable gain or loss. The exchange privilege may be exercised
only in those states where shares of the fund for which shares held are
being exchanged may be legally sold, and the privilege may be amended or
terminated upon 60 days' notice to stockholders.
The stockholder may exercise the following exchange privilege options:
Exchange by Mail - Stockholders may mail a written notice
requesting an exchange to the Fund's Transfer Agent.
Exchange by Telephone - Stockholders must authorize telephone
exchange on the application form filed with the Fund's Transfer
Agent to exchange shares by telephone. Telephone exchanges may
be made from 9:30 a.m. to 4:00 p.m. Eastern time, Monday through
Friday, except holidays. If certificates have been issued to the
investor, this procedure may be utilized only if he delivers his
certificates, duly endorsed for transfer, to the Transfer Agent
prior to giving telephone instructions. During periods of
unusual
<PAGE> 26
economic or market changes, stockholders may experience
difficulties or delays in effecting telephone exchanges.
When exchange or redemption requests are made by telephone, the Fund
has procedures in place designed to give reasonable assurance that such
telephone instructions are genuine, including recording telephone calls and
sending written confirmation of transactions. The Fund will not be liable
for losses due to unauthorized or fraudulent telephone transactions unless
it does not follow such procedures, in which case it may be liable for such
losses.
PRE-AUTHORIZED PAYMENT
A stockholder may arrange to make regular monthly investments of $25
or more automatically from his checking account by authorizing the Fund's
Transfer Agent to withdraw the payment from his checking account. Pre-
Authorized Payment Forms can be obtained by contacting the Transfer Agent.
SYSTEMATIC WITHDRAWAL PLAN
Investors may open a withdrawal plan providing for withdrawals of $50
or more monthly, quarterly, semi-annually or annually if they have a
minimum balance of $5,000 in shares of the Fund. The minimum periodic
amount which may be withdrawn pursuant to this plan is $50.
These payments do not represent a yield or return on investment and
may constitute return of initial capital. In addition, such payments may
deplete or eliminate the investment. Stockholders cannot be assured that
they will receive payment for any specific period because payments will
terminate when all shares have been redeemed. The number of such payments
will depend primarily upon the amount and frequency of payments and the
yield on the remaining shares. Under this plan, any distributions must be
reinvested in additional shares at net asset value.
The Systematic Withdrawal Plan is voluntary, flexible, and under the
stockholder's control and direction at all times, and does not limit or
alter the stockholder's right to redeem shares. Such plan may be
terminated in writing at any time by either the stockholder or the Fund.
The cost of operating the Systematic Withdrawal Plan is borne by the Fund.
It would not be advisable for investors to make purchases of shares
involving any sales charge while participating in the Systematic Withdrawal
Plan.
GENERAL INFORMATION
The Fund is the initial series of Capstone Fixed Income Series, Inc.
(the "Corporation"), an open-end diversified management investment company,
as defined in the Investment Company Act of 1940, as amended. It was
originally incorporated in Delaware in 1968 and was reorganized as the
initial series of the Corporation, which was established under Maryland law
on May 11, 1992. There is one other series of shares outstanding, Capstone
Intermediate Government Fund, and the Corporation may create additional
series in the future. The Corporation has an authorized capitalization of
two hundred million shares of $.001 par value common stock. Each existing
and future series will be treated as a separate mutual fund with its own
investment objective and policies. All shares have equal voting and
liquidation rights and have one vote per share. Voting rights are
noncumulative, which means that holders of more than 50% of the shares
voting for the election of directors may elect 100% of the directors if
they choose
<PAGE> 27
to do so, and in such event the holders of the remaining less than 50% of
the shares voting for the directors will not be able to elect any directors.
All shares have equal dividend rights, are fully paid, nonassessable and
freely transferable and have no conversion, pre-emptive or subscription
rights. Fractional shares have the same rights, pro rata, as full shares.
On all matters submitted to stockholder vote, all shares of the
Corporation then issued and outstanding, irrespective of series, will be
voted in the aggregate and not by individual series, except (1) when
required by the Investment Company Act of 1940, shares will be voted by
individual series, and (ii) when a matter is determined by the directors to
affect less than all of the Corporation's series, then only holders of
shares of the affected series will be entitled to vote on such a matter.
The Fund's securities are held by The Fifth Third Bank, Cincinnati,
Ohio, under a Custodian Agreement with the Fund. Fund/Plan Services, Inc.
acts as both Transfer Agent and dividend paying agent for the Fund.
Inquiries by stockholders of the Fund should be addressed to the Fund
at its address stated on the cover page of this Prospectus.
ANNUAL MEETINGS
Neither the Corporation nor the Fund is required to hold an annual
meeting of its stockholders; however, stockholders have the right to
require the Secretary of the Corporation to call a stockholders' meeting
upon the written request of stockholders entitled to vote not less than ten
percent of all votes entitled to be cast at such meeting, provided that (1)
such request shall state the purposes of such meeting and the matters
proposed to be acted on, and (2) the stockholders requesting such meeting
shall have paid to the Fund the reasonably estimated cost of preparing and
mailing the notice thereof, which the Secretary shall determine and specify
to such stockholders. No meeting shall be called upon the request of
stockholders to consider any matter which is substantially the same as a
matter voted upon at any special meeting of the stockholders held during
the preceding twelve months, unless requested by the holders of a majority
of all shares entitled to be voted at such meeting.
<PAGE> 28
CAPSTONE INTERMEDIATE GOVERNMENT FUND
A SERIES OF CAPSTONE FIXED INCOME SERIES, INC.
5847 San Felipe, Suite 4100
Houston, TX 77057
1-800-262-6631
MARCH 25, 1996
PROSPECTUS
Capstone Intermediate Government Fund (the "Fund") is a newly
organized series of Capstone Fixed Income Series, Inc. (the "Corporation"),
an open-end diversified management investment company. The investment
objectives of the Fund are to earn a high level of total return and to
moderate share price volatility. The Fund seeks to achieve its objective
of seeking high total return by investing in debt obligations that have
remaining maturities of seven years or less. Its investments will be
primarily in securities that are issued or guaranteed by the U.S.
Government, its agencies or instrumentalities. It may also invest in
securities of highly rated U. S. corporations and banks. In pursuing its
objectives to moderate share price volatility and to increase total return,
the Fund may purchase and sell futures contracts and options on U.S.
Government securities. This Prospectus sets forth certain information
about the Fund that a prospective investor should know before investing.
Investors should read and retain this Prospectus for future reference.
A STATEMENT OF ADDITIONAL INFORMATION about the Fund dated March 25,
1996 has been filed with the Securities and Exchange Commission and
contains further information about the Fund. A copy of the Statement of
Additional Information may be obtained without charge by calling or writing
the Fund at the telephone number or address listed above. The Statement of
Additional Information is incorporated herein by reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE> 29
CAPSTONE INTERMEDIATE GOVERNMENT FUND
INVESTMENT ADVISER: SHAREHOLDER SERVICING AGENT:
Capstone Asset Management Company Fund/Plan Services, Inc.
5847 San Felipe, Suite 4100 2 W. Elm Street
Suite 4100 P.O. Box 874
Houston, Texas 77057 Conshohocken, Pennsylvania 19428
DISTRIBUTOR:
Capstone Asset Planning Company
5847 San Felipe, Suite 4100
Houston, Texas 77057
TABLE OF CONTENTS
PAGE
----
Prospectus Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Fund Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Investment Objective and Policies . . . . . . . . . . . . . . . . . . . 5
Investment Practices. . . . . . . . . . . . . . . . . . . . . . . . . . 6
Investment Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Investment Restrictions . . . . . . . . . . . . . . . . . . . . . . . . 10
Performance Information . . . . . . . . . . . . . . . . . . . . . . . . 10
Management of the Fund . . . . . . . . . . . . . . . . . . . . . . . . 11
Purchasing Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Distributions and Taxes . . . . . . . . . . . . . . . . . . . . . . . . 16
Redemption and Repurchase of Shares . . . . . . . . . . . . . . . . . . 17
Determination of Net Asset Value. . . . . . . . . . . . . . . . . . . . 19
Stockholder Services . . . . . . . . . . . . . . . . . . . . . . . . . 20
General Information . . . . . . . . . . . . . . . . . . . . . . . . . . 22
No dealer, salesman, or any other person has been authorized to give
any information or to make any representations, other than those contained
in this Prospectus, in connection with the offer contained in this
Prospectus and, if given or made, such other information or representations
must not be relied upon as having been authorized by the Fund or its
Distributor. This Prospectus does not constitute an offer by the Fund or
by the Distributor to sell or a solicitation of an offer to buy any of the
securities offered hereby in any jurisdiction to any person to whom it is
unlawful for the Fund or the Distributor to make such offer or solicitation
in such jurisdiction.
<PAGE> 30
CAPSTONE INTERMEDIATE GOVERNMENT FUND
PROSPECTUS SUMMARY
Type of Company . . . . The Fund is a newly organized series of Capstone
Fixed Income Series, Inc., an open-end diversified
management investment company organized as a
Maryland series company. (see page 22)
Investment Objective. . The Fund's investment objectives are to earn a
high level of total return and to moderate share
price volatility. (see page 5)
Investment Policies . . The Fund will invest in debt obligations that have
remaining maturities of seven years or less.
Under normal market conditions, at least 65% of
its assets will be invested in securities issued
or guaranteed by the U.S. Government, its agencies
or instrumentalities. The Fund may also invest in
securities issued by high grade debt issued by
corporations and banks and may buy and sell
futures contracts and options on U.S. Treasury
securities and covered options on U.S. Government
securities. (see page 5)
Risk Factors . . . . . The securities in which the Fund may invest are
subject to market, credit and interest rate risks.
Additionally, the Fund could be adversely affected
by its futures contracts and options transactions
if forecasts of the Adviser are incorrect. (see
page 9)
Investment Adviser . . Capstone Asset Management Company (the "Adviser")
is the Fund's investment adviser and is paid a
monthly fee equal to an annual rate of 0.45% of
the Fund's average daily net assets. The Adviser
provides advisory and/or administrative services
to the other mutual funds in the Capstone Group.
(see page 11)
Dividends and
Distributions . . . . . The Fund pays dividends from net investment income
at least annually and distributes capital gains at
least annually. (see page 15)
Distributor and Offering
Price . . . . . . . . . Shares of the Fund are continuously offered for
sale through the Fund's Distributor, Capstone
Asset Planning Company, without a sales load, at
the net asset value next determined after receipt
of the order. The Fund bears certain expenses
pursuant to a written Rule 12b-1 distribution
plan. (see page 14)
Minimum Purchase. . . . The minimum purchase required for initial
investment is $200, except for continuous
investment plans, and there is no minimum for
subsequent investments. Certain waivers are
available. (see page 14)
Redemption . . . . . . Shares of the Fund can be redeemed at net asset
value, without charge. (see page 17)
<PAGE> 31
FUND EXPENSES
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load Imposed on Purchases (as a percentage of offering
price) 0%
Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of
offering price) 0%
Deferred Sales Load (as a percentage of original purchase price or
redemption proceeds, as applicable) 0%
Redemption Fees (as a percentage of amount redeemed, if applicable) 0%
Exchange Fee 0%
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management Fee .45%
12b-1 Fees* .25%
Estimated Other Expenses .13%
Total Fund Operating Expenses .83%
EXAMPLE
1 year 3 years
------ -------
You would pay the following expenses on a $1,000
investment, assuming (1) 5% annual return and (2)
redemption at the end of each time period: $8 $26
____________
* Under rules of the National Association of Securities Dealers, Inc. (the
"NASD"), a 12b-1 fee may be treated as a sales charge for certain
purposes under those rules. Because the 12b-1 fee is an annual fee charged
against the assets of a Fund, long-term stockholders may pay more in total
sales charges than the economic equivalent of the maximum front-end sales
charge permitted by rules of the NASD (see "Distributor").
The purpose of the foregoing table is to assist investors in
understanding the various costs and expenses that an investor in the Fund
will bear directly or indirectly. The information under the heading
"Annual Fund Operating Expenses" is based on projected expenses the Fund
will incur during its first year of operation and assumes the average net
assets of the Fund to be $100 million. The management and administration
fee information contained in the table is based on the maximum asset-based
fees. See "Management of the Fund" for more complete descriptions of the
fees paid to the Adviser.
THE EXAMPLE WHICH IMMEDIATELY FOLLOWS THE TABLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR
<PAGE> 32
PERFORMANCE. ACTUAL FUND EXPENSES MAY BE GREATER OR LESSER THAN THOSE SHOWN
IN THE EXAMPLE OR IN THE TABLE.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objectives are to earn a high level of total
return and to moderate share price volatility. The Fund's total return
would include net realized and unrealized capital gains and net investment
income. The Fund seeks to achieve its objectives by investing in debt
obligations that have remaining maturities of seven years or less.
Additionally, under normal market conditions, at least 65% of its total
assets will be invested in securities that are issued or guaranteed by the
U.S. Government, its agencies or instrumentalities. The Fund may also
invest in securities of U. S. corporations and banks rated A or better by
Moody's Investor Services, Inc. ("Moody's"), or Standard & Poors
Corporation ("S&P" ) and may engage in certain income enhancement and
hedging strategies. The Fund's investment objectives are fundamental
policies and may not be changed without the authorization of the holders of
a majority of the Fund's outstanding voting securities. There can be no
assurance that the Fund's investment objectives will be achieved.
By holding primarily U.S. Government and highly rated corporate and
bank securities, the Fund will seek to earn current income comparable to
the stated coupons of the securities held in the portfolio. In addition,
by entering into the specific yield enhancement and hedging strategies
detailed below, including the purchase and sale of futures contracts and
covered put and call options writing, the Fund will attempt to hedge the
price risk of the portfolio securities and to enhance the current income of
the portfolio beyond the stated coupons attached to the portfolio
securities. Fund monies that are not invested in U.S. Government,
corporate or bank securities or employed in hedging or income enhancement
strategies will be invested in repurchase agreements backed by U.S.
Government securities.
Under no circumstances will the Fund purchase debt obligations that
have more than seven years remaining to maturity, nor will the Adviser
transact business that will create a weighted-average maturity of the Fund
to be in excess of four years. Accordingly, the Adviser expects that the
Fund's daily net asset value will be limited in changes to those not
exceeding the price sensitivity of five-year U.S. Treasury notes.
The Fund intends to reinvest all interest income earned by the Fund's
portfolio in securities that mature before the end of the calendar year.
The purpose of this procedure is to protect all interest income for
possible distribution to stockholders. Interest income is, therefore, not
intended for use in financing hedging or yield enhancement strategies.
It is anticipated that the Fund will incur a high portfolio turnover
rate in connection with the use of covered option writing strategies; high
portfolio turnover can be expected to increase the Fund's transaction
costs. Additionally, to the extent portfolio turnover results in
realization of net short-term capital gains, stockholders will be taxed on
such gains at ordinary income tax rates (except stockholders investing
through retirement plans that are not taxed currently on accumulations).
<PAGE> 33
INVESTMENT PRACTICES
The significant investments and investment strategies employed by the
Fund, including related risks, are described below. For more information
concerning the Fund's investment practices, see the Fund's Statement of
Additional Information.
U.S. GOVERNMENT SECURITIES. The Fund may invest in securities issued
by the U.S. Treasury, including bills, notes and bonds with SEVEN years or
less remaining until maturity. Those instruments are direct obligations of
the U.S. Government and, as such, are backed by the "full faith and credit"
of the United States. They differ primarily in the dates of their
issuance, stated coupons, call provisions and maturity dates.
U.S. GOVERNMENT AGENCIES SECURITIES. The Fund may invest up to 50% of
its portfolio in instruments issued by agencies or instrumentalities of the
U.S. Government. Some agencies, including the Department of Housing and
Urban Development, the Government National Mortgage Association, the
Farmer's Home Administration, and the Small Business Administration, issue
securities backed by the "full faith and credit" of the United States.
U.S. Government agencies and instrumentalities that issue securities not
backed by the "full faith and credit" of the U.S. Government in which the
Fund may invest are limited to the Federal Farm Credit System, the Federal
Land Banks, the Federal Intermediate Credit Banks, the Banks for
Cooperatives, the Federal Home Loan Banks, the Federal National Mortgage
Association and the Federal Home Loan Mortgage Corporation. In the case of
issues not backed by the U.S. Government, the investor must look
principally to the agency issuing the obligation for ultimate repayment of
principal and interest.
U. S. CORPORATE SECURITIES. The Fund may invest up to 35% of its
portfolio in debt instruments issued by U.S. corporations and banks rated A
or better by Moodys or S&P. In the event that such securities held by the
Fund are downgraded below these ratings, the Fund may retain the
securities, provided that it will dispose of such downgraded securities to
the extent they would exceed 5% of the Fund's assets. The Fund may not at
any time hold securities of one corporate or bank issuer in excess of 5% of
its portfolio. This investment restriction does not apply to securities
issued by the U. S. Treasury or Government agencies. Corporate and bank
issues purchased by the Fund may include fixed coupon, callable, asset-
backed, and floating-rate securities, but does not include convertible
securities.
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements
(a purchase of, and simultaneous commitment to resell, a security at an
agreed upon price on an agreed upon date) only with member banks of the
Federal Reserve System, recognized primary dealers of Government
securities, and member firms of the New York Stock Exchange. When
participating in repurchase agreements, the Fund buys securities from a
vendor, e.g., a bank or brokerage firm, with the agreement that the vendor
will repurchase the securities at a higher price or agreed rate of interest
at a later date. The securities underlying a repurchase agreement will be
marked-to-market every business day so that the value of the collateral is
at least equal to the value of the loan, including the accrued interest
thereon. Such transactions afford an opportunity for the Fund to earn a
return on available cash at minimal market risk, although the Fund may be
subject to various delays and risks of loss if the vendor is unable to meet
its obligation to repurchase or to maintain collateral in accordance with
the agreement. In evaluating whether to enter into repurchase agreements,
the Adviser will carefully consider the creditworthiness of the vendor.
If the member bank or member firm that is the party to the repurchase
agreement petitions for bankruptcy or otherwise becomes subject to the U.S.
Bankruptcy Code, the law regarding the rights
<PAGE> 34
of the Fund is unsettled.
REVERSE REPURCHASE AGREEMENTS. A reverse repurchase agreement
involves the sale of a U.S. Treasury obligation by the Fund and its
agreement to repurchase the instrument at a specific time and price. The
Fund will maintain a segregated account, which will be marked-to-market
daily, consisting of cash, cash equivalents and U.S. Government securities
at least equal to its obligations under reverse repurchase agreements,
including any accrued interest. The Fund will not invest proceeds from
these transactions beyond the expiration of the reverse repurchase
agreement. The Fund may not enter into these transactions with more than
33% of its portfolio, and will only enter into such agreements with dealers
approved by the Fund for repurchase agreements.
COVERED OPTIONS STRATEGIES. The Fund may write (or sell) put and call
options on the U.S. Government securities that the Fund is authorized to
buy or already holds in its portfolio. These option contracts may be
listed for trading on a national securities exchange or traded over-the-
counter. The Fund may also purchase put and call options on U.S.
Government securities. The Fund will not write covered calls on more than
75% of its portfolio.
A call option gives the purchaser the right to buy, and the writer the
obligation to sell, the underlying security at the agreed upon exercise (or
"strike") price during the option period. A put option gives the
purchaser the right to sell, and the writer the obligation to buy, the
underlying security at the strike price during the option period.
Purchasers of options pay an amount, known as a premium, to the option
writer in exchange for the right under the option contract.
The Fund may sell "covered" put and call options as a means of hedging
the price risk of securities in the Fund's portfolio. The sale of a call
option against a security held by the portfolio constitutes a "covered
call." The sale of a put option against an amount of cash equal to the
put's potential liability constitutes a "covered put." When the Fund sells
an option, if the underlying securities do not increase (in the case of a
call option) or decrease (in the case of a put option) to a price level
that would make the exercise of the option profitable to the holder of the
option, the option will generally expire without being exercised and the
Fund will realize as profit the premium paid for such option. When a call
option of which the Fund is the writer is exercised, the option holder
purchases the underlying security at the strike price and the Fund does not
participate in any increase in the price of such securities above the
strike price. When a put option of which the Fund is the writer is
exercised, the Fund will be required to purchase the underlying securities
at the strike price, which may be in excess of the market value of such
securities. Sales of covered puts will not total more than 50% of the
Fund's total assets.
Over-the-counter options ("OTC options") differ from exchange-traded
options in several respects. They are transacted directly with dealers and
not with a clearing corporation, and there is a risk of non-performance by
the dealer. OTC options are available for a greater variety of securities
and for a wider range of expiration dates and exercise prices than exchange
traded options. Because OTC options are not traded on an exchange, pricing
is normally done by reference to information from a market maker. This
information is carefully monitored by the Adviser and verified in
appropriate cases. An OTC option transaction will be entered into by the
Fund only with a securities dealer meeting criteria established by the
Fund.
The Fund may, in order to avoid the exercise of an option sold by it,
cancel its obligation under
<PAGE> 35
the option by entering into a closing purchase transaction, if available,
unless it is determined to be in the Fund's interest to sell (in the case
of a call option) or to purchase (in the case of a put option) the
underlying securities. A closing purchase transaction consists of the Fund
purchasing an option having the same terms as the option sold by the Fund
and has the effect of cancelling the Fund's position as a seller. The
premium which the Fund will pay in executing a closing purchase transaction
may be higher than the premium received when the option was sold, depending
in large part upon the relative price of the underlying security at the time
of each transaction. To the extent options sold by the Fund are exercised
and the Fund either delivers portfolio securities to the holder of a call
option or liquidates securities in its portfolio as a source of funds to
purchase securities put to the Fund, the Fund's portfolio turnover rate may
increase, resulting in a possible increase in short-term capital gains and a
possible decrease in long-term capital gains.
Put and call option purchases by the Fund are not limited in par
amount, nor in underlying security. However, the Fund may not exercise
options that call for purchases or sales of securities not authorized by
the Fund's investment policies. However, the Fund may not invest more than
5% of its total assets in option purchases.
RISKS OF WRITING OPTIONS. By writing a call option, the Fund loses
the potential for gain on the underlying security above the exercise price
while the option is outstanding; by writing a put option a Fund might
become obligated to purchase the underlying security at an exercise price
that exceeds the then current market price.
WHEN-ISSUED AND FORWARD DELIVERY SECURITIES. Securities may be
purchased on a "when-issued" or on a "forward delivery" basis, which means
that the obligations will be delivered at a future date beyond customary
settlement time. The commitment to purchase a security for which payment
will be made on a future date may be deemed a separate security. Although
the Fund is not limited in the amount of securities for which it may have
commitments to purchase on such basis, it is expected that in normal
circumstances, the Fund will commit no more than 35% of its assets to such
purchases. The Fund does not pay for securities until received or start
earning interest on them until it is notified of the settlement date. In
order to invest its assets immediately, while awaiting delivery of
securities purchased on such basis, the Fund will normally invest in short-
term securities that may bear interest at a lower rate than longer-term
securities.
These transactions are subject to market fluctuations; the value of
the securities at delivery may be more or less than their purchase price,
and yields available in the market may be higher than yields on the
securities obtained pursuant to such transactions. Because the Fund relies
on the buyer or seller, as the case may be, to consummate the transactions,
failure by the other party to complete the transaction may result in the
Fund missing the opportunity of obtaining a price or yield considered to be
advantageous. The Fund will make commitments to purchase securities on
such basis only with the intention of actually acquiring these securities,
but the Fund may sell such securities prior to the settlement date if such
sale is considered to be advisable. To the extent the Fund engages in
"when-issued" and "forward delivery" transactions, it will do so for the
purpose of acquiring securities for the Fund's portfolio consistent with
the Fund's investment objectives and policies and not for the purpose of
investment leverage.
The SEC generally requires that when investment companies, such as the
Fund, effect transactions of the foregoing nature, such funds must either
segregate cash or readily marketable high-
<PAGE> 36
grade debt securities with its Custodian in the amount of its obligations
under the foregoing transactions, or cover such obligations by maintaining
positions in portfolio securities or options that would serve to satisfy or
offset the risk of such obligations. When effecting transactions of the
foregoing nature, the Fund will comply with such segregation or cover
requirements.
Interest Rate Futures Contracts and Options on Interest Rate Futures
Contracts. The Fund may invest in interest rate futures contracts and
options on interest rate futures contracts as a substitute for a comparable
market position and to hedge against adverse movements in interest rates.
To the extent that these instruments are utilized, the Fund will be subject
to the investment risks of having purchased or sold the securities
underlying the contracts. The Fund may purchase call options on interest
rate futures contracts to hedge against declines in interest rates and may
purchase puts on interest rate futures contracts to hedge its portfolio
securities against the risk of rising interest rates.
The Fund may also sell options on interest rate futures contracts as
part of closing purchase transactions to terminate its options positions.
No assurance can be given that such closing transactions can be effected or
that there will be a correlation between price movements in the options on
interest rate futures and price movements in the Fund's portfolio
securities which are the subject of the hedge. Also, the Fund's purchase
of such options will be based upon predictions as to anticipated interest
rate changes, which may prove to be inaccurate.
INVESTMENT RISKS
The Fund is designed as a means of investing in intermediate-term U.S.
Government, corporate and bank securities, and not as a trading vehicle.
To the extent that the Fund invests in fixed rate obligations, the net
asset value of the Fund may rise and fall with general interest rate
changes. During periods of falling interest rates, the values of such
securities generally rise. Conversely, during periods of rising interest
rates, the values of such securities generally decline.
The Fund will attempt to achieve its objective of earning a high level
of total return by establishing the shortest possible maturity allowed by
market conditions consistent with its investment objective, but the Fund
can make no predictions as to what this maturity will be inside the stated
restriction of seven year maximum, and four-year weighted-average
maturities. Changes in the value of portfolio securities do not affect the
investment income from these securities, however, or the ability of the
Fund to reinvest these earnings as they become available prior to
distributions.
The Fund attempts to moderate share price fluctuations through its
transactions in options and futures. These transactions require the Fund
to segregate assets to cover its obligations under the contracts and also
result in brokerage costs. Further, these transactions may not have their
intended effect if the Adviser's expectations as to market conditions are
incorrect, in which case losses to the Fund may be greater than if these
techniques had not been used. Moreover, if the Fund wishes to close out a
futures or option transaction, there is no assurance that an appropriate
closing transaction will be available.
Although the Fund's option writing activities cause portfolio turnover
to be high (see "Investment Objective and Policies"), it is not an
objective of the Fund to attempt to profit from interest rate changes by
entering speculative positions or by excessively trading the portfolio.
Obligations held
<PAGE> 37
by the Fund may, however, be subject to call prior to their maturity. Call
provisions tend to be exercised when interest rates have fallen, forcing
reinvestment of the proceeds at lower interest rates.
INVESTMENT RESTRICTIONS
The Fund has certain investment restrictions some of which, as well as
the Fund's investment objective, are fundamental and, accordingly, may not
be changed without the approval of the holders of a majority of the Fund's
shares, which means the lesser of (i) more than 50% of the outstanding
shares of the Fund, or (ii) 67% or more of the outstanding shares of the
Fund present at a meeting in which holders of more than 50% of its
outstanding shares are represented in person or by proxy. The Fund's
fundamental and non-fundamental investment restrictions are fully described
in the Statement of Additional Information. Among other things, the Fund's
fundamental investment restrictions provide that the Fund may not borrow
money, except that the Fund may enter into reverse repurchase agreements,
and, as a temporary measure for extraordinary or emergency purposes, it may
borrow from banks in an amount not to exceed 1/3 of the value its net
assets, including the amount borrowed. The Fund will not purchase
securities while its borrowings exceed 5% of its total assets.
PERFORMANCE INFORMATION
The Fund may from time to time include figures indicating the Fund's
yield, total return or average annual total return in advertisements or
reports to stockholders or prospective investors. Quotations of the Fund's
yield will be based on all investment income per share earned during a
particular 30-day period (including dividends and interest), less expenses
accrued during the period ("net investment income"), and will be computed
by dividing net investment income by the maximum offering price per share
on the last day of the period. Average annual total return and total
return figures represent the increase (or decrease) in the value of an
investment in the Fund over a specified period. Both calculations assume
that all income dividends and capital gain distributions during the period
are reinvested at net asset value in additional Fund shares. Quotations of
the average annual total return reflect the deduction of a proportional
share of Fund expenses on an annual basis. The results, which are
annualized, represent an average annual compounded rate of return on a
hypothetical investment in the Fund over a period of 1, 5 and 10 years
ending on the most recent calendar quarter (but not for a period greater
than the life of the Fund). Quotations of total return, which are not
annualized, represent historical earnings and asset value fluctuations.
Performance information for the Fund may be compared, in reports and
promotional literature, to: (i) the Merrill Lynch Treasury Indices and the
Lehman Intermediate Government/Corporate Bond Index; (ii) certain
performance figures prepared for broad groups of mutual funds with
investment goals similar to the Fund by organizations such as Lipper
Analytical Organization; (iii) the Consumer Price Index, a statistical
measure of change, over time, in the price of goods and services in major
expenditure groups (such as food, housing, apparel, transportation, medical
care, entertainment and other goods and services) typically purchased by
urban consumers; (iv) other mutual funds with similar goals; and (v)
certificates of deposit. Instruments included in the Shearson and Merrill
indexes, which are unmanaged, may not necessarily be typical of the type of
investments made by the Fund. Other material differences between the Fund
and these indexes may include (i) the managed character of the Fund's
portfolio (i.e., the Fund may purchase and sell investment securities based
on their performance while securities
<PAGE> 38
comprising the particular index may remain as part of the index without
regard to their performance), and (ii) the index would not generally reflect
deductions for administrative expenses and costs. Further, broad-based
economic indexes measure developments of general matters which may or may
not be relevant to the Fund's performance during particular periods. For
example, the purchasing power of consumers' dollars is measured by comparing
the costs of goods and services today with the costs of the same goods and
services at an earlier date.
There are three material differences between an investment in the Fund
and ownership of a certificate of deposit ("CD"). First, an investment in
the Fund is subject to a greater degree of risk and fluctuation of value
than a CD, which guarantees a specific rate of return. Second, if interest
rates rise in the future, the capital value of bonds purchased at the
present time will fall, which will affect the Fund's performance if such
securities are held in its portfolio. Third, the underlying assets of a CD
are federally insured on amounts up to $100,000.
Performance information for the Fund reflects only the performance of
a hypothetical investment in the Fund during the particular time period on
which the calculations are based. Performance information should be
considered in light of the Fund's investment objectives and policies, the
types and quality of the Fund's portfolio investments, market conditions
during the particular time period and operating expenses. Such information
should not be considered as a representation of the Fund's future
performance. For a description of the methods used to determine the Fund's
yield, total return and average annual total return, see the Statement of
Additional Information.
MANAGEMENT OF THE FUND
The Fund is a series of an open-end diversified management investment
company, commonly called a mutual fund. See "General Information".
Through the purchase of shares of the Fund, investors with goals similar to
the investment objective of the Fund can participate in the investment
performance of the portfolio of investments held by the Fund. The
management and affairs of the Fund are supervised by its Board of
Directors.
INVESTMENT ADVISER
Capstone Asset Management Company ("CAMCO") serves as the investment
adviser (the "Adviser") to the Fund pursuant to an investment advisory
agreement ("Advisory Agreement") dated March 25, 1996 between the Adviser
and the Fund. CAMCO, located at 5847 San Felipe, Suite 4100, Houston,
Texas 77057 was incorporated in 1982 and is a wholly-owned subsidiary of
Capstone Financial Services, Inc. CAMCO serves as investment adviser
and/or administrator to five other mutual funds: Capstone Growth Fund,
Inc., Capstone Government Income Fund, Capstone Nikko Japan Fund, Capstone
New Zealand Fund, and Medical Research Investment Fund, Inc. (collectively,
the "Capstone Funds"), and to pension and profit sharing accounts,
corporations and individuals. Assets under management are approximately
$1.3 billion.
The Fund is managed primarily by Howard S. Potter, Managing Director
of Capstone Asset Management Company. Mr. Potter began his Wall Street
career trading financial futures as a local floor trader. In 1981 he
joined Donaldson, Lufkin & Jenrette, Inc. as Assistant Vice President of
Marketing, where, in addition to other responsibilities, he published two
weekly newsletters on financial futures and
<PAGE> 39
debt options. He moved to Oppenheimer & Company in 1984 to spearhead their
Risk Management Group, and from there joined James Money Management in 1988
as Chief Investment Officer for all yield enhancement projects and portfolio
manager of several mutual funds. In 1991, Mr. Potter formed New Castle
Advisers, Inc. As the president of this registered investment advisory firm,
Mr. Potter served as the portfolio manager of several mutual funds, and since
1992 he has served as portfolio manager of Capstone Government Income Fund.
Capstone Financial Services, Inc., the parent of the Fund's adviser, acquired
a majority interest in New Castle Advisers, Inc. in January 1996. Mr. Potter
received a B.A. degree from the University of Wisconsin and a M.A. degree
from Northwestern University.
Pursuant to the terms of the Advisory Agreement, the Adviser has
agreed to (1) provide a program of continuous investment management for the
Fund in accordance with the Fund's investment objectives, policies and
limitations, (2) make investment decisions for the Fund, (3) place orders
to purchase and sell securities for the Fund, subject to the supervision of
the Board of Directors and (4) provide administrative services for the
Fund. In accordance with the Fund's policy of allocating portfolio
brokerage described in the Statement of Additional Information, the Adviser
is permitted to consider sales of Fund shares as a factor in selecting
broker-dealers to execute portfolio transactions, subject to best
execution. For these services the Fund pays CAMCO a fee computed daily and
payable monthly at the annual rate of 0.45% of the first $450 million of
the Fund's average daily net assets and 0.36% of such assets over $450
million.
The Advisory Agreement provides that the Adviser shall not be liable
for any error of judgment or of law, or for any loss suffered by the Fund
in connection with the matters to which the agreement relates except a loss
resulting from willful misfeasance, bad faith or gross negligence on the
part of the Adviser in the performance of its obligations and duties, or by
reason of its reckless disregard of its obligations and duties under the
Advisory Agreement.
The Advisory Agreement will remain in effect until March 25, 1998,
and will continue in effect thereafter only if such continuance is
specifically approved at least annually by the Board of Directors or by
vote of a majority of the Fund's outstanding voting securities (as defined
in the 1940 Act) and, in either case, by a majority of the directors who
are not parties to the Advisory Agreement, or interested persons of such
party. The Advisory Agreement will terminate automatically in the event
of its assignment and may be terminated without penalty by vote of a
majority of the Fund's outstanding voting securities or by either party on
not more than 60 days' written notice.
The Adviser reserves the right at its own discretion to waive all or
part of its advisory fees at any time. If such action is elected by the
Adviser, it will be done so under the appropriate rules and regulations as
they relate to such matters and appropriately disclosed in all performance
and marketing literature.
DISTRIBUTOR
Pursuant to a Distribution Agreement with the Fund dated March 25,
1996, Capstone Asset Planning Company (the "Distributor"), is the principal
underwriter of the Fund and, acting as exclusive agent, sells shares of the
Fund to the public on a continuous basis.
The Fund has adopted a Service and Distribution Plan (the "Plan")
pursuant to which it uses its assets to finance certain activities relating
to the distribution of its shares to investors and provision of
<PAGE> 40
certain stockholder services. The Plan permits payments to be made by the
Fund to the Distributor to reimburse it for particular expenditures incurred
by it in connection with the distribution of the Fund's shares to investors
and provision of certain stockholder services including but not limited to the
payment of compensation, including incentive compensation, to securities
dealers (which may include the Distributor itself) and certain banks,
investment advisers and pension consultants (collectively, the "Service
Organizations") to obtain various distribution related and/or
administrative services for the Fund. These services include, among other
things, processing new stockholder account applications, preparing and
transmitting to the Fund's Transfer Agent computer processable tapes of all
transactions by customers and serving as the primary source of information
to customers in answering questions concerning the Fund and their
transactions with the Fund. The Distributor is also authorized to engage
in advertising, the preparation and distribution of sales literature and
other promotional activities on behalf of the Fund. In addition, the Plan
authorizes payment by the Fund of the cost of preparing, printing and
distributing Fund Prospectuses and Statements of Additional Information to
prospective investors and of implementing and operating the Plan.
Under the Plan, payments made to the Distributor may not exceed an
amount computed at an annual rate of 0.25% of the average net assets of the
Fund. The Distributor is permitted to collect fees under the Plan on a
monthly basis. Any expenditures incurred in excess of the limitation
described above during a given month may be carried forward up to twelve
months for reimbursement, subject always to the 0.25% limit, and no
interest or carrying charges will be payable by the Fund on amounts carried
forward. Payments under the Plan are further limited by rules of the
National Association of Securities Dealers. The Plan may be terminated by
the Fund at any time and the Fund will not be liable for amounts not
reimbursed as of the termination date.
The Plan was approved by a majority of the Fund's directors, including
a majority of the directors who have no direct or indirect financial
interest in the operation of the Plan or any of its agreements ("Plan
Directors") on November 13, 1995. The Plan may be continued from year to
year, provided that such continuance is approved at least annually by a
vote of a majority of the Board of Directors, including a majority of the
Plan Directors.
The Glass-Steagall Act and other applicable laws currently prohibit
banks from engaging in the business of underwriting, selling or
distributing securities. Accordingly, unless such laws are changed, if the
Fund engages banks as Service Organizations, the banks would perform only
administrative and shareholder servicing functions. If a bank were
prohibited from acting as a Service Organization, alternative means for
continuing the servicing of such shareholders would be sought.
EXPENSES
The Fund pays all expenses incurred in the operation of the Fund other
than those assumed by the Adviser under the Advisory Agreement. Expenses
payable by the Fund include: fees and expenses of directors who are not
"interested persons" (as defined in the 1940 Act); fees of the Adviser;
Board of Directors meeting-related expenses of the directors and officers;
mailing expenses of all Fund officers and directors; expenses for legal and
auditing services; data processing and pricing services; costs of printing
and mailing proxies, stock certificates and stockholder reports; fees of
the Administrator; charges of the custodian, transfer agent, registrar or
dividend disbursing agent; expenses pursuant to the Service and
Distribution Plan; Securities and Exchange Commission fees; membership fees
in trade associations; fidelity bond coverage for the Fund's officers;
directors' and officers' errors and omissions
<PAGE> 41
insurance coverage; interest; brokerage costs; taxes; expenses of qualifying
the Fund's shares for sale in various states; litigation; and other
extraordinary or non-recurring expenses and other expenses properly payable
by the Fund.
The Fund's expenses are accrued daily and are deducted from its total
income before dividends are paid. Under the Advisory Agreement, if the
Fund's ordinary expenses for any fiscal year (including advisory fees, but
excluding interest, local, state and Federal taxes and extraordinary
expenses) exceed the expense limitations of any state having jurisdiction
over the Fund, then the annual advisory fees will be reduced ratably (but
not below zero) by the Adviser until the Fund can operate within the
expense limitation discussed above.
PURCHASING SHARES
Capstone Asset Planning Company (the "Distributor"), located at 5847
San Felipe, Suite 4100, Houston, Texas 77057, is the principal underwriter
of the Fund and, acting as exclusive agent, sells shares of the Fund to the
public on a continuous basis. Edward L. Jaroski is a director of the
Corporation, the Adviser and the Distributor. Some officers of the
Corporation are also officers of the Adviser, Distributor and their parent
company, Capstone Financial Services, Inc.
Shares of the Fund are sold in a continuous offering and may be
purchased on any business day through authorized investment dealers or
directly from the Fund's Distributor. Except for the Fund itself, only the
Distributor and investment dealers which have a sales agreement with the
Distributor are authorized to sell shares of the Fund. For further
information, reference is made to the caption "Distributor" in the Fund's
Statement of Additional Information.
The initial purchase must be at least $200, except for continuous
investment plans which have no minimum, and there is no minimum for
subsequent investments. The minimum purchase requirement is waived for
employees of CAMCO and their immediate family members. "Immediate family
member" is defined as a spouse, parent, child or sibling. Shares of the
Fund are sold at net asset value, without a sales charge, and will be
credited to a stockholder's account at the net asset value next computed
after an order is received by the Distributor. Whenever a transaction
takes place in the stockholder's account, a statement will be mailed
reflecting the status of the account. Share certificates are not issued
unless requested by the stockholder in writing to the Fund's Transfer
Agent. The Fund's management reserves the right to reject any purchase
order if, in its opinion, it is in the Fund's best interest to do so.
Payment for all orders to purchase Fund shares must be received by the
Fund's Transfer Agent within three business days after the order was
placed.
INVESTING THROUGH AUTHORIZED DEALERS
If any authorized dealer receives an order, the dealer may contact the
Distributor directly. Orders received by dealers by the close of trading
on the New York Stock Exchange on a business day that are transmitted to
the Distributor by 4:00 p.m. Central time on that day will be effected at
the net asset value per share determined as of the close of trading on the
New York Stock Exchange that day. Otherwise, the orders will be effected
at the next determined net asset value. It is the dealer's responsibility
to transmit orders so that they will be received by the Distributor before
4:00 p.m. Central
<PAGE> 42
time.
After each investment, the stockholder and the authorized investment
dealer receive confirmation statements of the number of shares purchased
and owned.
PURCHASES THROUGH THE DISTRIBUTOR
An account may be opened by mailing a check or other negotiable bank
draft (payable to Capstone Intermediate Government Fund) together with the
completed Investment Application Form included with this Prospectus to the
Fund's Transfer Agent: Capstone Intermediate Government Fund, c/o
Fund/Plan Services, Inc., 2 W. Elm Street, P.O. Box 874, Conshohocken,
Pennsylvania 19428. All such investments are effected at the net asset
value of Fund shares next computed following receipt of payment by the
Transfer Agent. Confirmations of the opening of an account and of all
subsequent transactions in the account are forwarded by the Transfer Agent
to the stockholder's address of record.
TELEPHONE PURCHASE AUTHORIZATION (INVESTING BY PHONE)
Stockholders who have completed the Telephone Purchase Authorization
section of the Investment Application Form may purchase additional shares
by telephoning the Fund's Transfer Agent at (800) 845-2340. The minimum
telephone purchase is $1,000 and the maximum is the greater of $1,000 or
five times the net asset value of shares (for which certificates have not
been issued) held by the stockholder on the day preceding such telephone
purchase for which payment has been received. The telephone purchase will
be effected at the net asset value next computed after receipt of the call
by the Fund's Transfer Agent. Payment for the telephone purchase must be
received by the Transfer Agent within three business days after the order
is placed. If payment is not received within three business days after the
order is placed, the stockholder will be liable for all losses incurred as
a result of the purchase.
INVESTING BY WIRE
Investors having an account with a commercial bank that is a member of
the Federal Reserve System may purchase shares of the Fund by requesting
their bank to transmit funds by wire to: United Missouri Bank KC NA, ABA
10-10-00695, For; Fund/Plan Services, Inc. Account 98-7037-0719; Further
Credit Capstone Intermediate Government Fund. The investor's name and
account number must be specified in the wire.
Initial Purchases - Before making an initial investment by wire, an
investor must first telephone (800) 845-2340 to be assigned an account
number. The investor's name, account number, taxpayer identification or
social security number, and address must be specified in the wire. In
addition, the investment application which accompanies this Prospectus
should be promptly forwarded to Capstone Intermediate Government Fund, c/o
Fund/Plan Services, Inc., 2 W. Elm Street, P.O. Box 874, Conshohocken,
Pennsylvania 19428.
Subsequent Purchases - Additional investments may be made at any time
through the wire procedures described above, which must include the
investor's name and account number. The investor's bank may impose a fee
for investments by wire.
<PAGE> 43
DISTRIBUTIONS AND TAXES
PAYMENT OPTIONS
Distributions (whether treated for tax purposes as ordinary income or
long-term capital gains) to stockholders of the Fund are paid in additional
shares of the Fund, with no sales charge, based on the Fund's net asset
value as of the close of business on the record date for such
distributions. However, a stockholder may elect on the application form
which accompanies this Prospectus to receive distributions as follows:
Option 1. To receive income dividends in cash and capital gain
distributions in additional Fund shares, or
Option 2. To receive all income dividends and capital gain
distributions in cash.
The Fund pays any dividends from investment company taxable income
annually in December, and intends to make any distributions representing
net capital gain annually in December. The Fund will advise each
stockholder annually of the amounts of dividends from investment company
taxable income and of net capital gain distributions reinvested or paid in
cash to the stockholder during the calendar year.
If you select Option 1 or Option 2 and the U.S. Postal Service cannot
deliver your checks, or if your checks remain uncashed for six months, your
distribution checks will be reinvested in your account at the then current
net asset value and your election will be converted to the purchase of
additional shares.
TAXES
The Fund intends to qualify and elect to be treated as a regulated
investment company under the Federal tax law. In any taxable year in which
the Fund so qualifies and distributes at least 90% of its investment
company taxable income (which includes, among other items, interest and the
excess of realized net short-term capital gain over realized net long-term
capital loss), the Fund generally will be relieved of Federal income tax on
its investment company taxable income and net capital gains (the excess of
realized net long-term capital gains over realized net short-term capital
losses) distributed to stockholders. Amounts not distributed on a timely
basis in accordance with a calendar year distribution requirement are also
subject to a nondeductible 4% excise tax. To prevent application of the
excise tax, the Fund intends to make its distributions in accordance with
the calendar year distribution requirement. A distribution will be treated
as paid on December 31 of the calendar year if it is declared by the Fund
in October, November or December of that year to stockholders of record on
a date in such a month and paid by the Fund during January of the following
calendar year. Such distributions will be taxable to stockholders in the
calendar year in which the distributions are declared, rather than the
calendar year in which the distributions are received.
Distributions from investment company taxable income are taxable to
stockholders as ordinary income. Distributions of the net capital gain
designated by the Fund as capital gain dividends are taxable as long-term
capital gains regardless of the length of time a stockholder may have held
shares of the Fund. The tax treatment of distributions treated as ordinary
income or capital gain will be the same whether the stockholder invests the
distributions in additional shares or elects to receive them in cash.
<PAGE> 44
Some of the Fund's distributions may constitute a return of capital.
Stockholders will be notified each year of the amounts and nature of
dividends and distributions paid to them by the Fund, including the amounts
(if any) for that year which have been designated as capital gain
dividends.
Special tax rules may apply to the Fund's transactions involving
options. These rules, among other things: (i) may affect whether capital
gains and losses from such transactions are considered to be short-term or
long-term; (ii) may have the effect of converting capital gains and losses
into ordinary income and losses; (iii) may have the effect of deferring
losses and/or accelerating the recognition of gains or losses; and (iv) for
purposes of qualifying as a regulated investment company, may limit the
extent to which the Fund will be able to engage in such transactions.
Upon the sale, redemption, or other disposition of shares of the Fund,
a stockholder generally will realize a taxable gain or loss, depending upon
his basis in the shares. Such gain or loss will be treated as capital gain
or loss if the shares are capital assets in the stockholder's hands and
will be long-term or short-term, depending on the stockholder's holding
period for the shares. Any loss realized on a sale or exchange will be
disallowed to the extent the shares disposed of are replaced (including
shares acquired pursuant to the reinvestment plan) within a period of 61
days beginning 30 days before and ending 30 days after the shares are
disposed of. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Any loss realized by a
stockholder on a disposition of Fund shares held by the stockholder for six
months or less will be treated as a long-term capital loss to the extent of
any capital gain dividends received by the stockholder with respect to such
shares.
The Fund may be required to withhold Federal income tax at the rate of
31% of all taxable distributions (including gross proceeds from the
redemption of Fund shares) payable to stockholders who fail to provide the
Fund with their correct taxpayer identification number or to make required
certifications, or where the Fund or the stockholder has been notified by
the Internal Revenue Service that the stockholder is subject to backup
withholding. Corporate stockholders and certain other stockholders
specified in the Code generally are exempt from such backup withholding.
Backup withholding is not an additional tax. Any amounts withheld may be
credited against the stockholder's Federal income tax liability.
Distributions also may be subject to additional state, local and
foreign taxes, depending on each stockholder's particular situation. In
addition, foreign stockholders may be subject to Federal income tax rules
that differ significantly from those described above. Stockholders are
advised to consult their tax advisers with respect to the particular tax
consequences to them of an investment in the Fund.
REDEMPTION AND REPURCHASE OF SHARES
Shares of the Fund, in any amount, may be redeemed at any time,
without charge, at the net asset value next determined after a request is
received by the Fund. See "Determination of Net Asset Value." In
addition, the Distributor is authorized as agent for the Fund to offer to
repurchase at the net asset value next determined after the request is
received by the Distributor, shares which are presented by telephone or
telegraph to the Distributor by authorized investment dealers. Broker-
dealers may charge for their services in connection with the repurchase,
but the Distributor and its affiliates will not charge any fee
<PAGE> 45
for such repurchase.
Requests for redemption may be made by calling the Fund at 800-845-
2340, by telegraph or other wire communication, or by letter upon
completion of the Expedited Redemption portion set forth in the application
form included in this Prospectus. Payment of redemption proceeds may be
delayed if the shares to be redeemed were purchased by check and such check
has not cleared (which may take up to 15 days from the purchase date).
Generally, stockholders may require the Fund to redeem their shares by
sending a written request, signed by the record owner(s), to Capstone
Intermediate Government Fund, c/o Fund/Plan Services, Inc., 2 W. Elm
Street, P.O. Box 874, Conshohocken, Pennsylvania 19428. In addition,
certain expedited redemption methods described below are available. If
stock certificates have been issued for shares being redeemed, such
certificates must accompany the written request with the stockholder's
signature guaranteed by an "eligible guarantor institution", as defined in
Rule 17Ad-15 under the Securities Exchange Act of 1934, which participates
in a signature guarantee program. Eligible guarantor institutions include
banks, brokers, dealers, credit unions, national securities exchanges,
registered securities associations, clearing agencies and savings
associations. A broker-dealer guaranteeing signatures must be a member of
a clearing corporation or maintain net capital of at least $100,000.
Credit unions must be authorized to issue signature guarantees. No
signature guarantees for shares for which no certificates have been issued
are required when an application is on file at the Transfer Agent and
payment is to be made to the stockholder of record at the stockholder's
address of record. However, if the proceeds of the redemption are to be
paid to someone other than the registered holder, or to other than the
stockholder's address of record, or the shares are to be transferred, the
owner's signature must be guaranteed by a commercial bank or by a
securities firm having membership on a recognized national securities
exchange.
The Fund reserves the right to pay any portion of redemption requests
in excess of $1 million in readily marketable securities from the Fund's
portfolio. In this case, the stockholders may incur brokerage charges on
the sale of the securities.
Normally the Fund will make payment for all shares redeemed within two
(2) business days, but in no event will payment be made more than three (3)
business days after receipt of a redemption request and/or certificate in
proper order. However, payment may be postponed or the right of redemption
suspended for more than three (3) business days under unusual
circumstances, such as when trading is not taking place on the New York
Stock Exchange. Proceeds of redeemed shares will be transmitted by Federal
Funds wire to the shareholder's bank account designated on the application
form (which must be at a commercial bank which is a member of the Federal
Reserve System) or by check.
The value of shares on repurchase or redemption may be more or less
than the investor's cost depending upon the market value of the Fund's
portfolio securities at the time of redemption. No redemption fee is
charged for the redemption of shares.
EXPEDITED TELEPHONE REDEMPTION
A stockholder redeeming at least $1,000 of shares (for which
certificates have not been issued), and who has authorized expedited
redemption on the application form filed with the Fund's Transfer Agent
may, at the time of such redemption, request that funds be mailed or wired
to the commercial bank or registered broker-dealer he has previously
designated on the application by telephoning the Transfer Agent at 800-845-
2340. Proceeds for redemptions requested by 2:45 p.m. Central time will be
sent on
<PAGE> 46
the next business day. In order to allow the Adviser to manage the Fund more
effectively, stockholders are strongly urged to initiate redemptions as early
in the day as possible and to notify the Transfer Agent in advance of
redemptions in excess of $5 million. If a stockholder seeks to use an
expedited method of redemption of shares recently purchased by check, the
Fund may withhold the redemption proceeds until it is reasonably assured of
the collection of the check representing the purchase, which may take up to
15 days from the purchase date. The Fund, Distributor and Transfer Agent
reserve the right at any time to suspend or terminate the expedited
redemption procedure or to impose a fee for this service. At the present
time there is no fee charged for this service. During periods of unusual
economic or market changes, stockholders may experience difficulties or
delays in effecting telephone redemptions.
When exchange or redemption requests are made by telephone, the Fund
has procedures in place designed to give reasonable assurance that such
telephone instructions are genuine, including recording telephone calls and
sending written confirmation of transactions. The Fund will not be liable
for losses due to unauthorized or fraudulent telephone transactions unless
it does not follow such procedures, in which case it may be liable for such
losses.
DETERMINATION OF NET ASSET VALUE
The Fund's net asset value is computed daily, Monday through Friday,
as of 4:15 p.m. Eastern Time, except that the net asset value will not be
computed on the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day and the days that the Federal Reserve wire system is closed.
The Fund also will determine its net asset value on any day in which there
is sufficient trading in its portfolio securities that the net asset value
might be affected materially, but only if on any such day the Fund is
required to sell or redeem shares. The Fund's net asset value per share is
computed by dividing the value of the securities held by the Fund plus any
cash or other assets (including any accrued interest and dividends
receivable but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares outstanding at such time, adjusted
to the nearest whole cent. The net asset value so computed will be used
for all purchase orders and redemption requests received between such
computation and the preceding computation.
The value of the Fund's portfolio securities and other assets is based
on market values determined by procedures established by the Corporation's
Board of Directors. Securities listed on a national exchange or designated
as national market system securities are valued at the last sale price or,
if there has been no sale that day, at the last bid price. All portfolio
securities for which over-the-counter market quotations are readily
available are valued at the mean between the bid and asked prices. OTC
options are valued using the Black-Scholes Model, which utilizes the
option's characteristics when bought or sold and the market price of the
underlying security to determine a daily price for each OTC option's
position. The only pricing variable changed daily is the price of the
underlying security. Short-term instruments having a maturity date of more
than 60 days are valued on a "mark-to-market" basis, that is, at prices
based on market quotations for securities of similar type, yield, quality
and maturity, until 60 days prior to maturity and thereafter at amortized
value. Short-term instruments having a maturity date of 60 days or less at
the time of purchase are valued at amortized cost value unless the Board of
Directors determines this does not represent fair market value. When
market quotations are not readily available, portfolio securities are
valued at their fair value as determined in good faith under procedures
established by and under the general supervision of the Board of Directors
(valuation of
<PAGE> 47
securities for which market quotations are not readily available may be
based upon current market prices of securities which are comparable in
coupon, rating and maturity or an appropriate matrix utilizing similar
factors).
STOCKHOLDER SERVICES
Capstone Intermediate Government Fund provides its stockholders with
a number of services and conveniences designed to assist investors in the
management of their investments. These stockholder services include the
following:
TAX-DEFERRED RETIREMENT PLANS
Shares may be purchased by virtually all types of tax-deferred
retirement plans. The Distributor or its affiliates make available plan
forms and/or custody agreements for the following:
o Individual Retirement Accounts (for individuals and their non-
employed spouses who wish to make limited tax deductible
contributions to a tax-deferred account for retirement); and
o Simplified Employee Pension Plans.
Dividends and distributions will be automatically reinvested without a
sales charge. For further details, including fees charged, tax
consequences and redemption information, see the specific plan documents
which can be obtained from the Fund.
Investors should consult with their tax adviser before establishing
any of the tax-deferred retirement plans described above.
EXCHANGE PRIVILEGE
Shares of the Fund which have been outstanding 15 days or more may be
exchanged for shares of other Capstone Funds with no administrative charge.
The exchange of shares held 15 days or more will be effected at net asset
values plus an amount equal to the difference, if any, between the sales
charges previously paid or deemed applicable with respect of the shares
being exchanged, and the sales charge payable on shares of the Capstone
Fund for which those shares are being exchanged, determined in accordance
with applicable legal requirements. A Fund stockholder requesting such an
exchange will be sent a current prospectus for the fund into which the
exchange is requested. Shares held less than 15 days cannot be exchanged.
In such instances, the shares will be redeemed at the next computed net
asset value and the entire sales commission paid on the purchase will be
refunded to the investor.
Purchases, redemptions, and exchanges should be made for investment
purposes only. A pattern of frequent exchanges, purchases and sales may be
deemed abusive by the Adviser and, at the discretion of the Adviser, can be
limited by the Fund's refusal to accept further purchase and/or exchange
orders from the investor. Although the Adviser will consider all factors
it deems relevant in determining whether a pattern of frequent purchases,
redemptions and/or exchanges by a particular investor is abusive and not in
the best interests of the Fund or its other stockholders, as a general
policy investors should be
<PAGE> 48
aware that engaging in more than one exchange or purchase-sale transaction
during any thirty-day period with respect to a particular fund may be deemed
abusive and therefore subject to the above restrictions.
An exchange of shares is treated for Federal income tax purposes as a
sale of shares given in exchange and the stockholder may, therefore,
realize a taxable gain or loss. The exchange privilege may be exercised
only in those states where shares of the fund for which shares held are
being exchanged may be legally sold, and the privilege may be amended or
terminated upon 60 days' notice to stockholders.
The stockholder may exercise the following exchange privilege options:
Exchange by Mail - Stockholders may mail a written notice
requesting an exchange to the Fund's Transfer Agent.
Exchange by Telephone - Stockholders must authorize telephone
exchange on the application form filed with the Fund's Transfer
Agent to exchange shares by telephone. Telephone exchanges may
be made from 9:30 a.m. to 4:00 p.m. Eastern time, Monday through
Friday, except holidays. If certificates have been issued to the
investor, this procedure may be utilized only if he delivers his
certificates, duly endorsed for transfer, to the Transfer Agent
prior to giving telephone instructions. During periods of
unusual economic or market changes, stockholders may experience
difficulties or delays in effecting telephone exchanges.
When exchange or redemption requests are made by telephone, the Fund
has procedures in place designed to give reasonable assurance that such
telephone instructions are genuine, including recording telephone calls and
sending written confirmation of transactions. The Fund will not be liable
for losses due to unauthorized or fraudulent telephone transactions unless
it does not follow such procedures, in which case it may be liable for such
losses.
PRE-AUTHORIZED PAYMENT
A stockholder may arrange to make regular monthly investments of $25
or more automatically from his checking account by authorizing the Fund's
Transfer Agent to withdraw the payment from his checking account. Pre-
Authorized Payment Forms can be obtained by contacting the Transfer Agent.
SYSTEMATIC WITHDRAWAL PLAN
Investors may open a withdrawal plan providing for withdrawals of $50
or more monthly, quarterly, semi-annually or annually if they have a
minimum balance of $5,000 in shares of the Fund. The minimum periodic
amount which may be withdrawn pursuant to this plan is $50.
These payments do not represent a yield or return on investment and
may constitute return of initial capital. In addition, such payments may
deplete or eliminate the investment. Stockholders cannot be assured that
they will receive payment for any specific period because payments will
terminate when all shares have been redeemed. The number of such payments
will depend primarily upon the amount and frequency of payments and the
yield on the remaining shares. Under this plan, any distributions must be
reinvested in additional shares at net asset value.
<PAGE> 49
The Systematic Withdrawal Plan is voluntary, flexible, and under the
stockholder's control and direction at all times, and does not limit or
alter the stockholder's right to redeem shares. Such plan may be
terminated in writing at any time by either the stockholder or the Fund.
The cost of operating the Systematic Withdrawal Plan is borne by the Fund.
It would not be advisable for investors to make purchases of shares
involving any sales charge while participating in the Systematic Withdrawal
Plan.
GENERAL INFORMATION
The Fund is a series of Capstone Fixed Income Series, Inc. (the
"Corporation"), an open-end diversified management investment company, as
defined in the Investment Company Act of 1940, as amended. The
Corporation, which was established under Maryland law on May 11, 1992, has
an authorized capitalization of two hundred million shares of $.001 par
value common stock. There is one other series of shares outstanding,
Capstone Government Income Fund. All shares have equal voting and
liquidation rights and have one vote per share. Voting rights are
noncumulative, which means that holders of more than 50% of the shares
voting for the election of directors may elect 100% of the directors if
they choose to do so, and in such event the holders of the remaining less
than 50% of the shares voting for the directors will not be able to elect
any directors. All shares have equal dividend rights, are fully paid,
nonassessable and freely transferable and have no conversion, pre-emptive
or subscription rights. Fractional shares have the same rights, pro rata,
as full shares.
On all matters submitted to stockholder vote, all shares of the
Corporation then issued and outstanding, irrespective of series, will be
voted in the aggregate and not by individual series, except (i) when
required by the Investment Company Act of 1940, shares will be voted by
individual series, and (ii) when a matter is determined by the directors to
affect less than all of the Corporation's series, then only holders of
shares of the affected series will be entitled to vote on such a matter.
The Fund's securities are held by The Fifth Third Bank, Cincinnati,
Ohio, under a Custodian Agreement with the Fund. Fund/Plan Services, Inc.
acts as both Transfer Agent and dividend paying agent for the Fund.
Inquiries by stockholders of the Fund should be addressed to the Fund
at its address stated on the cover page of this Prospectus.
ANNUAL MEETINGS
Neither the Corporation nor the Fund is required to hold an annual
meeting of its stockholders; however, stockholders have the right to
require the Secretary of the Corporation to call a stockholders' meeting
upon the written request of stockholders entitled to vote not less than ten
percent of all votes entitled to be cast at such meeting, provided that (1)
such request shall state the purposes of such meeting and the matters
proposed to be acted on, and (2) the stockholders requesting such meeting
shall have paid to the Fund the reasonably estimated cost of preparing and
mailing the notice thereof, which the Secretary shall determine and specify
to such stockholders. No meeting shall be called upon the request of
stockholders to consider any matter which is substantially the same as a
matter voted upon at any special meeting of the stockholders held during
the preceding twelve months, unless requested by the holders of a majority
of all shares entitled to be voted at such meeting.
<PAGE> 50
CAPSTONE FIXED INCOME SERIES, INC.
CAPSTONE GOVERNMENT INCOME FUND
CAPSTONE INTERMEDIATE GOVERNMENT FUND
CROSS REFERENCE SHEET
BETWEEN
ITEMS OF FORM N-1A AND THE
STATEMENT OF ADDITIONAL INFORMATION
(PART B TO REGISTRATION STATEMENT NO. 2-28174)
Item Caption in Statement of
Number Form N-1A Heading Additional Information
- ----- ----------------- -----------------------
10. Cover Page Cover Page
11. Table of Contents Table of Contents
12. General Information and History General Information
13. Investment Objectives and Investment Restrictions; Risk
Policies Factors
14. Management of the Fund Directors and Executive Officers
15. Control Persons and Principal Control Persons and Principal
Holders of Securities Holders of Securities
16. Investment Advisory and Other Investment Advisory Agreement;
Services Administration Agreement; Other
Information
17. Brokerage Allocation Portfolio Transactions and
Brokerage
18. Capital Stock and Other Inapplicable
Securities
19. Purchase, Redemption and Pricing Determination of Net Asset
of Securities Being Offered Value; How to Buy and Redeem
Shares
20. Tax Status Taxes
21. Underwriter Distributor
22. Calculation of Performance Data Performance Information
23. Financial Statements Financial Statements
<PAGE> 51
CAPSTONE GOVERNMENT INCOME FUND
A SERIES OF CAPSTONE FIXED INCOME SERIES, INC.
STATEMENT OF ADDITIONAL INFORMATION
March 25, 1996
This Statement of Additional Information is not a Prospectus but
contains information in addition to and more detailed than that set forth
in the Prospectus and should be read in conjunction with the Prospectus.
The Statement of Additional Information and the related Prospectus are both
dated March 25, 1996. A Prospectus may be obtained without charge by
contacting Capstone Asset Planning Company, by phone at (800) 262-6631 or
by writing to it at 5847 San Felipe, Houston, Texas 77057.
TABLE OF CONTENTS
Page
----
General Information . . . . . . . . . . . . . . . . . . . . . 2
Investment Restrictions . . . . . . . . . . . . . . . . . . . 2
Risk Factors. . . . . . . . . . . . . . . . . . . . . . . . . 4
Options . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Performance Information . . . . . . . . . . . . . . . . . . . 7
Directors and Executive Officers. . . . . . . . . . . . . . . 8
Investment Advisory Agreement . . . . . . . . . . . . . . . . 11
Administration Agreement. . . . . . . . . . . . . . . . . . . 12
Distributor . . . . . . . . . . . . . . . . . . . . . . . . . 13
Portfolio Transactions and Brokerage. . . . . . . . . . . . . 15
Determination of Net Asset Value. . . . . . . . . . . . . . . 16
How to Buy and Redeem Shares. . . . . . . . . . . . . . . . . 16
Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Control Persons and Principal Holders of Securities . . . . . 20
Other Information . . . . . . . . . . . . . . . . . . . . . . 21
Financial Statements. . . . . . . . . . . . . . . . . . . . . 22
<PAGE> 52
GENERAL INFORMATION
Capstone Government Income Fund ("the Fund") was originally
incorporated in Delaware in 1968 and commenced business shortly thereafter
as an open-end diversified management company under the Investment Company
Act of 1940. In February 1991 the Fund's name was changed to Capstone
Government Income Fund, Inc. from Investors Income Fund, Inc. On February
18, 1992 stockholders approved a plan of reorganization pursuant to which
the Fund became, on May 11, 1992, the initial series of a new Maryland
series company, Capstone Fixed Income Series, Inc. (the "Corporation"), and
the Fund's name was changed to Capstone Government Income Fund (see
"General Information" in the Prospectus). The Corporation has one other
series, Capstone Intermediate Government Fund, and may create additional
series in the future. Each existing and future series will be treated as a
separate mutual fund with its own investment objective and policies.
The Fund is a member of a group of investment companies (the "Capstone
Group") sponsored by Capstone Asset Management Company which provides
advisory and administrative services to the Fund.
INVESTMENT RESTRICTIONS
A. FUNDAMENTAL
The Fund may not:
1. With respect to 75% of its assets, purchase more than 10% of the
voting securities of any one issuer or invest more than 5% of the
value of its total assets in the securities of any one issuer,
except the U.S. Government, its agencies or instrumentalities
(see additional non-fundamental restriction 1., below);
2. borrow money, except that the Fund may enter into reverse
repurchase agreements, and, as a temporary measure for
extraordinary or emergency purposes, it may borrow from banks in
an amount not to exceed 1/3 of the value of its net assets,
including the amount borrowed;
3. issue any senior securities, except as appropriate to evidence
indebtedness which it is permitted to incur;
4. act as underwriter, except to the extent that it might be deemed
to be an underwriter for the purposes of the Securities Act of
1933, as amended, with respect to securities which it sells to
the public if registration under such Act, as amended, is
required in connection with such sale;
5. purchase any securities which would cause 25% or more of the
market value of its total assets at the time of such purchase to
be invested in the securities of one or more issuers having their
principal business activities in the same industry, provided that
there is no limit with respect to investments in securities
issued or guaranteed by the U.S. Government, its agencies and
instrumentalities, or in repurchase or reverse repurchase
agreements backed by such securities;
<PAGE> 53
6. purchase or sell real estate except for its own use in connection
with its business;
7. purchase or sell commodities or commodity contracts, except that
the Fund may invest in futures contracts and related options;
8. make loans to other persons except (a) through the use of
repurchase agreements and (b) by the purchase of debt securities
in accordance with its investment policies; and
9. invest in securities or other instruments that are not authorized
for investment by a Federal savings association without
limitation as to a percentage of its assets and that are not
authorized for investment by national banks without limitation as
to a percentage of its capital and surplus, and none of the above
Fundamental Investment Restrictions shall be construed to permit
any such investment(s).
The Fund will make no purchases of securities so long as it has
outstanding borrowings, except for reverse repurchase agreements.
Additionally, the Fund has agreed with the staff of the Securities and
Exchange Commission that it will not include any reverse repurchase
agreements, including those backed by securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities, within the
exception from the 25% limit in restriction Number 5, above. Finally, the
Fund has no present intention to lend its portfolio securities or to engage
in transactions in futures contracts or related options, and will not
engage in such transactions until appropriate disclosure concerning these
practices, including their risks, is included in the Fund's Prospectus and
Statement of Additional Information.
B. NON-FUNDAMENTAL
The following restrictions are not fundamental and may be changed by
the Fund without stockholder approval, but only in compliance with
applicable law, regulation or regulatory policy and in compliance with the
Fundamental Investment Restrictions listed above, including but not limited
to, Number 9.
The Fund may not:
1. as to the portion of its assets not subject to Fundamental
Restriction 1., above, purchase more than 10% of the voting
securities of any one issuer or invest more than 5% of the value
of its total assets in the securities of any one issuer, except
the U.S. Government, its agencies or instrumentalities (the Fund
does not generally intend to invest in voting securities of any
issuer);
2. acquire or retain securities of any investment company, except as
part of a plan of merger, reorganization or consolidation;
3. pledge, mortgage or hypothecate its assets in excess, together
with permitted borrowings, of 1/3 of its net assets;
4. invest more than 10% of its total assets in securities that are
not readily marketable, the disposition of which is restricted
under Federal securities laws, or in repurchase agreements not
terminable within 7 days, provided that over-the-counter options
with
<PAGE> 54
securities dealers meeting criteria established by the
Fund's Board of Directors that give the Fund an absolute right to
repurchase (a) according to a "repurchase formula" or (b) at a
price determined from independent sources by the Adviser will not
be considered securities that are not readily marketable;
5. purchase or retain securities of any issuer if the officers or
directors of the Fund and the Adviser who own beneficially more
than 1/2 of 1% of the securities of such issuer together own
beneficially more than 5% of such securities;
6. sell securities short or purchase securities on margin, except
for such short-term credits as are necessary for the clearance of
transactions and in connection with entering into futures
contracts and related options to the extent permitted by the
Fund's investment policies;
7. write put and call options except to the extent permitted by the
Fund's investment policies;
8. invest in oil, gas or other mineral exploration or development
programs (although the Fund is not prohibited from investing in
issuers that own or invest in such interests); and
9. under normal circumstances, invest less than 65% of its assets in
obligations that are issued or guaranteed as to principal or
interest by the U.S. Government, its agencies, authorities or
instrumentalities or in repurchase agreements fully
collateralized by such obligations.
The portfolio securities of the Fund may be turned over whenever
necessary or appropriate in the opinion of the Fund's management to seek
the achievement of the basic objective of the Fund. It is anticipated that
the Fund will incur a high portfolio turnover rate in connection with the
use of covered option writing strategies.
RISK FACTORS
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements
with U.S. Government securities dealers recognized by the Federal Reserve
Board, with member banks of the Federal Reserve System or with such other
brokers or dealers that meet the credit guidelines of the Fund's Board of
Directors. In a repurchase agreement, the Fund buys a security from a
seller that has agreed to repurchase the same security at a mutually agreed
upon date and price. The Fund's resale price will be in excess of the
purchase price, reflecting an agreed upon interest rate. This interest
rate is effective for the period of time the Fund is invested in the
agreement and is not related to the coupon rate on the underlying security.
Repurchase agreements may also be viewed as fully collateralized loans of
money by the Fund to the seller. The period of these repurchase agreements
will usually be short, from overnight to one week, and at no time will the
Fund invest in repurchase agreements for more than one year. The Fund will
always receive as collateral securities whose market value including
accrued interest is, and during the entire term of the agreement remains,
at least equal to 100% of the dollar amount invested by the Fund in each
agreement, and the Fund will make payment for such securities only upon
physical delivery or upon evidence of book entry transfer to the account of
the custodian. If the seller
<PAGE> 55
defaults, the Fund might incur a loss if the value of the collateral
securing the repurchase agreement declines and might incur disposition
costs in connection with liquidating the collateral. In addition, if
bankruptcy proceedings are commenced with respect to the seller of a
security which is the subject of a repurchase agreement, realization upon
the collateral by the Fund may be delayed or limited. In an attempt to
minimize these risks, the Adviser will consider and monitor the
creditworthiness of parties to repurchase agreements.
OPTIONS
PURPOSE. The principal reason for writing options is to hedge, to a
limited extent, adverse price changes of the portfolio due to general
interest rate changes. In addition, options are written to obtain, through
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. Such current return could be expected to
fluctuate because premiums earned from an options writing program and
dividend or interest income yields on portfolio securities vary as economic
and market conditions change. Actively writing options on portfolio
securities is likely to result in a substantially higher portfolio turnover
rate than that of most other investment companies. Additionally, if the
Adviser is incorrect in its forecast, the result to the Fund from these
hedging practices may be worse than if no hedging transactions were entered
into.
WRITING OPTIONS. The purchaser of a call option pays a premium to the
writer (i.e., the seller) for the right to buy the underlying security from
the writer at a specified price during a certain period. The Fund would
write call options only on a covered basis, which means that at all times
during the option period, the Fund would own or have the right to acquire
securities of the type that it would be obligated to deliver if any
outstanding options were exercised.
The purchaser of a put option pays a premium to the writer (i.e., the
seller) for the right to sell the underlying security to the writer at a
specified price during a certain period. The Fund would write put options
only on a "covered" basis, which means that at all times during the option
period, the Fund would maintain in a segregated account with its Custodian
cash, cash equivalents or U.S. Government securities in an amount of not
less than the exercise price of the option, or would hold a put on the same
underlying security at an equal or greater exercise price.
CLOSING PURCHASE TRANSACTIONS AND OFFSETTING TRANSACTIONS. In order
to terminate its position as a writer of a call or put option, the Fund
could enter into a "closing purchase transaction," which is the purchase of
a call (put) on the same underlying security and having the same exercise
price and expiration date as the call (put) previously written by the Fund.
The Fund would realize a gain (loss) if the premium plus commission paid in
the closing purchase transaction is less (greater) than the premium it
received on the sale of the option. The Fund would also realize a gain if
an option it has written lapses unexercised.
The Fund could write options that are listed on an exchange as well as
options which are privately negotiated in over-the-counter transactions. A
Fund could close out its position as a writer of an option only if a liquid
secondary market exists for options of that series, but there is no
assurance that such a market will exist, particularly in the case of over-
the-counter options, since they can be closed out only with the other party
to the transaction. Alternatively, the Fund could purchase an offsetting
option, which would not close out its position as a writer, but would
<PAGE> 56
provide an asset of equal value to its obligation under the option written.
If the Fund is not able to enter into a closing purchase transaction or to
purchase an offsetting option with respect to an option it has written, it
will be required to maintain the securities subject to the call or the
collateral underlying the put until a closing purchase transaction can be
entered into (or the option is exercised or expires), even though it might
not be advantageous to do so.
PURCHASING CALL AND PUT OPTIONS. The Fund could purchase call options
to protect (i.e., hedge) against anticipated increases in the prices of
securities it wishes to acquire. Alternatively, call options could be
purchased for capital appreciation. Since the premium paid for call
options is typically a small fraction of the price of the underlying
security, a given amount of funds will purchase call options covering a
much larger quantity of such security than could be purchased directly. By
purchasing call options, the Fund could benefit from any significant
increase in the price of the underlying security to a greater extent than
had it invested the same amount in the security directly. However, because
of the very high volatility of option premiums, the Fund would bear a
significant risk of losing the entire premium if the price of the
underlying security did not rise sufficiently, or if it did not do so
before the option expired.
Conversely, put options could be purchased to protect (i.e., hedge)
against anticipated declines in the market of either specific portfolio
securities or of the Fund's assets generally. Alternatively, put options
could be purchased for capital appreciation in anticipation of a price
decline in the underlying security and a corresponding increase in the
value of the put option. The purchase of put options for capital
appreciation involves the same significant risk of loss as described above
for call options.
In any case, the purchase of options for capital appreciation would
increase the Fund's volatility by increasing the impact of changes in the
market prices of the underlying securities on the Fund's net asset value.
OVER-THE-COUNTER OPTIONS. The Fund may invest up to ten percent of
its net assets (determined at the time of investment) in illiquid
securities, including securities that are not readily marketable and
repurchase agreements which have a maturity of longer than seven days. An
over-the-counter option transaction will be entered into by the Fund only
with a securities dealer meeting criteria established by the Fund's Board
of Directors that gives the Fund an absolute right to repurchase the option
on demand by the Fund at a price (a) based on an agreed formula or (b)
determined from independent sources and agreed to by the Adviser. Such an
OTC option will not be subject to the Fund's 10% limit on investments in
illiquid securities.
REVERSE REPURCHASE AGREEMENTS. A reverse repurchase agreement
involves the sale of a U.S. Treasury obligation by the Fund and its
agreement to repurchase the instrument at a specific time and price. The
Fund will maintain a segregated account, which will be marked-to-market
daily consisting of cash, cash equivalents and U.S. Government securities
at least equal to its obligations under reverse repurchase agreements,
including any accrued interest. The Fund will not invest proceeds from
these transactions beyond the expiration of the reverse repurchase
agreement. The Fund may not enter into these transactions with more than
33% of its portfolio, and will only transact these agreements with dealers
approved by the Fund for repurchase agreements.
<PAGE> 57
PERFORMANCE INFORMATION
The Fund may from time to time include figures indicating its yield,
total return or average annual total return in advertisements or reports to
stockholders or prospective investors. Quotations of the Fund's yield will
be based on all investment income per share earned during a particular 30-
day period (including dividends and interest), less expenses accrued during
the period ("net investment income"), and are computed by dividing net
investment income per share earned during the period by the maximum
offering price per share on the last day of the period, according to the
following formula:
YIELD = 2[(a-b + 1)6-1]
cd
where a = dividends and interest earned during the period,
b = expenses accrued for the period (net of reimbursements or
waivers),
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends, and
d = the maximum offering price per share on the last day of the
period.
For the 30-day period ended November 30, 1995 the Fund's yield was
5.169%.
Average annual total return and total return figures represent the
increase (or decrease) in the value of an investment in the Fund over a
specified period. Both calculations assume that all income dividends and
capital gains distributions during the period are reinvested at net asset
value in additional Fund shares. Quotations of the average annual total
return reflect a proportional share of Fund expenses on an annual basis.
The results, which are annualized, represent an average annual compounded
rate of return on a hypothetical investment in the Fund over a period of 1,
5 and 10 years ending on the most recent calendar quarter (but not for a
period greater than the life of the Fund), calculated pursuant to the
following formula:
P (1 + T)n= ERV
where P = a hypothetical initial payment of $1,000,
T = the average annual total return,
n = the number of years, and
ERV = the ending redeemable value of a hypothetical $1,000
payment made at the beginning of the period.
For the 1, 5 and 10 year periods ended November 30, 1995 the Fund's
average annual total return was 5.177%, 4.165% and 5.926%, respectively.
Quotations of total return, which are not annualized, represent
historical earnings and asset value fluctuations. Total return is based on
past performance and is not a guarantee of future results. For the 1, 5
and 10 year periods ended November 30, 1995 the Fund's total return was
5.177%, 22.633% and 77.833%, respectively.
Performance information for the Fund may be compared, in reports and
promotional literature, to: (i) certain unmanaged indexes such as the
Merrill Lynch One to Three-Year Treasury Index and the Shearson Lehman
Intermediate Government/Corporate Bond Index; (ii) certain performance
figures
<PAGE> 58
prepared for broad groups of mutual funds with investment goals similar
to the Fund by organizations such as Lipper Analytical and the Donoghue
Organization; (iii) the Consumer Price Index (the "CPI"), a statistical
measure of change, over time, in the price of goods and services in major
expenditure groups (such as food, housing, apparel, transportation,
medical care, entertainment and other goods and services) typically
purchased by urban consumers; (iv) other mutual funds with similar goals;
and (v) certificates of deposit. Instruments included in unmanaged
indexes, such as the Shearson and Merrill indexes, may not necessarily be
typical of the type of investments made by the Fund. Other material
differences between the Fund and such indexes may include (i) the managed
character of the Fund's portfolio (i.e. the Fund may purchase and sell
investment securities based on their performance while securities
comprising the particular index may remain as part of the index without
regard to their performance), and (ii) the index would not generally
reflect deductions for administrative expenses and costs. Further, broad-
based economic indexes measure developments of general matters which may or
may not be relevant to the Fund's performance during particular periods.
For example, the purchasing power of consumers' dollars by comparing the
costs of goods and services today with the costs of the same goods and
services at an earlier date.
There are three material differences between an investment in the Fund
and ownership of a certificate of deposit ("CD"). First, an investment in
the Fund is subject to a greater degree of risk and fluctuation of value
than a CD, which guarantees a specific rate of return. Second, if interest
rates rise in the future, the capital value of bonds purchased at the
present time will fall, which will affect the Fund's performance if such
securities are held in its portfolio. Third, the underlying assets of a CD
are federally insured on amounts up to $100,000.
Performance information for the Fund reflects only the performance of
a hypothetical investment in the Fund during the particular time period on
which the calculations are based. Performance information should be
considered in light of the Fund's investment objectives and policies, the
types and quality of the Fund's portfolio investments, market conditions
during the particular time period and operating expenses. Such information
should not be considered as a representation of the Fund's future
performance.
DIRECTORS AND EXECUTIVE OFFICERS
The names and addresses of the directors and principal officers of the
Corporation are set forth below, together with their positions and their
principal occupations during the last five years and, in the case of the
directors, their positions with certain other organizations and companies.
*EDWARD L. JAROSKI, Chairman of the Board, President and Director.
5847 San Felipe, Suite 4100, Houston, Texas 77057. President
(since 1992) and Director (since 1987) of the Capstone Asset
Management Company; President and Director of Capstone Asset
Planning Company and Capstone Financial Services, Inc. (since
1987); Director/Trustee and Officer of other Capstone Funds.
______________
* Director who is an interested person as defined in the Investment
Company Act of 1940 because of his relationship to the Adviser and
Distributor.
<PAGE> 59
JAMES F. LEARY, Director. c/o Search Capital Group, Inc., 700 N.
Pearl Street, Suite 400, L.B. 401, Dallas, Texas 75201-2809.
President of Sunwestern Management, Inc., (since June 1982) and
President of SIF Management (since January 1992), venture capital
limited partnership concerns; General Partner of Sunwestern
Advisors, L.P., Sunwestern Associates, Sunwestern Associates II,
Sunwestern Partners, L.P. and Sunwestern Ventures, Ltd. (venture
capital limited partnership entities affiliated with Sunwestern
Management, Inc. and SIF Management, Inc.). Director of: other
Capstone Funds; Anthem Financial, Inc. (financial services);
Associated Materials, Inc. (tire cord, siding and industrial cable
manufacturer); The Flagship Group, Inc. (vertical market
microcomputer software); Marketing Mercadeo International (public
relations and marketing consultants); MaxServ, Inc. (appliance
repair database systems); MESBIC Ventures, Inc. (minority
enterprise small business investment company); OpenConnect Systems,
Inc. (computer networking hardware and software); PhaseOut of
America, Inc. (smoking cessation products); and Search Capital
Group, Inc. (financial services).
JOHN R. PARKER, Director. P.O. Box 42, Woodbury, Vermont 05681.
Consultant and private investor (since 1990); Director of Nova
Natural Resources (oil, gas, minerals); Director of other Capstone
Funds; formerly Senior Vice President of McRae Capital Management,
Inc. (1991-1995); and registered representative of Rickel &
Associates (1988-1991).
PHILIP C. SMITH, Director. 87 Lord's Highway, Weston, Connecticut
06880. Private investor; Director of other Capstone Funds and the
Lexington Mutual Funds.
BERNARD J. VAUGHAN, Director. 113 Bryn Mawr Avenue, Bala Cynwyd,
Pennsylvania 19004. Director of other Capstone Funds; formerly
Vice President of Fidelity Bank (1979-1993).
DAN E. WATSON, Executive Vice President. 5847 San Felipe, Suite 4100,
Houston, Texas 77057. Chairman of the Board (since 1992) and
Director of Capstone Asset Management Company (since 1987);
Chairman of the Board and Director of Capstone Asset Planning
Company and Capstone Financial Services, Inc. (since 1987); Officer
of other Capstone Funds.
HOWARD S. POTTER, Executive Vice President. 1 Barker Avenue, White
Plains, New York 10601. Managing Director of Capstone Financial
Services, Inc., Capstone Asset Management Company and Capstone
Asset Planning Company (since 1996); formerly President of New
Castle Advisers, Inc. (1991-1995); Senior Vice President of James
Money Management, Inc. (1988-1991).
JOHN M. METZINGER, Vice President. 5847 San Felipe, Suite 4100,
Houston, Texas 77057. Assistant Vice President (1992-1993) and
Vice President (since 1993) of Capstone Financial Services, Inc.
and Capstone Asset Management Company; Investment Analyst (1990-
1991) and Assistant Portfolio Manager (1991-1992) with Capstone
Financial Services, Inc.; Officer of other Capstone Funds.
IRIS R. CLAY, Secretary. 5847 San Felipe, Suite 4100, Houston, Texas
77057. Secretary (since February 1996); Assistant Vice President
(1994-1996) and Assistant Secretary (1990-1994)
<PAGE> 60
of Capstone Financial Services, Inc., Capstone Asset Management
Company and Capstone Planning Company; Officer of other Capstone Funds.
NORMA R. YBARBO, Assistant Secretary. 5847 San Felipe, Suite 4100,
Houston, Texas 77057. Assistant Compliance Officer (since 1994),
Compliance Analyst (1993-1994) and Compliance Assistant (1987-1993)
of Capstone Financial Services, Inc.; Officer of other Capstone
Funds.
LINDA G. GIUFFRE, Treasurer. 5847 San Felipe, Suite 410, Houston,
Texas 77057. Vice President and Treasurer (since February 1996) of
Capstone Financial Services, Inc., Capstone Asset Management
Company and Capstone Asset Planning Company; Treasurer and
Secretary (1994-1996) of Capstone Financial Services, Inc.,
Capstone Asset Management Company and Capstone Asset Planning
Company; Treasurer (1987-1994) of Capstone Financial Services,
Inc.; Officer of other Capstone Funds.
The Fund has an Audit Committee and a Nominating Committee that
consist of the Corporation's disinterested directors. Mr. Leary serves as
Chairman of the Audit Committee and Mr. Smith is Chairman of the Nominating
Committee.
The directors and officers of the Corporation as a group own less than
one percent of the outstanding shares of the Fund. The directors of the
Corporation (other than Mr. Jaroski) also received compensation for serving
as directors of other investment companies sponsored by the Adviser as
identified in the foregoing table.
Each director not affiliated with the Adviser is entitled to $250 for
each Board meeting attended, and is paid a $500 annual retainer by the
Fund. The directors and officers of the Corporation are also reimbursed
for expenses incurred in attending meetings of the Board of Directors. For
the fiscal year ended November 30, 1995, the Fund paid or accrued for the
account of the directors and officers, as a group for services in all
capacities, a total of $3,265.
The following table represents the fees paid during the 1995 calendar
year to the directors of the Fund and the total compensation each director
received during that period from the Capstone Fund complex.
<PAGE> 61
COMPENSATION TABLE
<TABLE>
<CAPTION>
Total
Compensation
From
Aggregate Pension or Registrant
Compensation Retirement Estimated Annual and Fund
From Benefits Accrued Benefits Upon Complex Paid
Name of Person, Position Registrant* As Part of Fund Retirement to Directors
- ------------------------ ------------ ---------------- ---------------- ------------
<S> <C> <C> <C> <C>
James F. Leary, Director $1,125 $0 $0 $4,000(1)
John R. Parker, Director 1,000 0 0 3,750(1)
Philip C. Smith, Director 1,000 0 0 6,750(1)(2)(3)
Bernard J. Vaughan, Director 1,125 0 0 6,250(1)(2)
____________
* Directors do not receive any deferred compensation.
(1) Director of Capstone Fixed Income Series, Inc. and Capstone Growth Fund, Inc.
(2) Trustee of Capstone International Series Trust.
(3) Director of Medical Research Investment Fund, Inc.
</TABLE>
INVESTMENT ADVISORY AGREEMENT
Capstone Asset Management Company serves as the investment adviser
(the "Adviser") to the Fund pursuant to an investment advisory agreement
("Advisory Agreement") dated May 11, 1992 between the Adviser and the Fund.
The Advisory Agreement was approved by stockholders on February 18, 1992.
The Adviser, located at 5847 San Felipe, Suite 4100, Houston, Texas 77057
is a wholly-owned subsidiary of Capstone Financial Services, Inc.
Subadvisory services were provided to the Fund from February 1992 to
January 1996 by New Castle Advisers, Inc. ("NCA"), pursuant to a
Subadvisory Agreement.
In January 1996, Capstone Financial Services, Inc., the parent of the
Adviser, acquired a majority interest in NCA and NCA resigned as subadviser
to the Fund. All advisory services to the Fund are now provided by the
Adviser. Howard Potter, formerly president of NCA and now managing
director of Capstone Asset Management Company, continues to provide
portfolio management services to the Fund.
Pursuant to the terms of the Advisory Agreement, the Adviser has
agreed to (1) provide a program of continuous investment management for the
Fund in accordance with the Fund's investment objectives, policies and
limitations, (2) make investment decisions for the Fund, and (3) place
orders to purchase and sell securities for the Fund, subject to the
supervision of the Board of Directors. For these services the Fund pays
the Adviser a fee computed daily and payable monthly at the annual rate of
0.40% of the Fund's average daily net assets up to $250 million and 0.36%
of such assets in excess of $250 million. Advisory fees paid to the
Adviser during the fiscal year ended November 30, 1995 totaled $604,189.
<PAGE> 62
The Adviser received advisory fees from the Fund totaling $357,033
during the fiscal year ended December 31, 1994, of which $267,775 was paid
to NCA. During the fiscal year ended December 31, 1993, the Adviser
received advisory fees from the Fund totaling $303,978, of which $227,984
was paid to NCA.
The annual fees of the Adviser and the Administrator (see
"Administration Agreement") will be reduced to the extent that the Fund's
ordinary expenses for any fiscal year (including advisory or administrative
fees, but excluding brokerage commissions, interest, local, state and
Federal taxes and extraordinary expenses) exceed the expense limitations of
any state having jurisdiction over the Fund. In such event, the annual
advisory and administration fees of the Adviser and the Administrator will
be reduced pro rata (but not below zero) to the extent necessary to comply
with such expense limitations. Each will bear its pro rata share of any
such fee reduction or reimbursement based on the percentage that such
firm's fee bears to the total fees paid or due to them by or on behalf of
the Fund under the Advisory Agreement and the Administration Agreement
(described below). At the date of this Statement of Additional
Information, the strictest expense limitation applicable to the Fund is
2.5% of the first $30 million of the Fund's average net assets, 2.0% of the
next $70 million of average net assets, and 1.5% of the remaining average
net assets for any fiscal year.
DURATION AND TERMINATION
Unless terminated earlier as described below, the current Advisory
Agreement between the Fund and the Adviser will remain in effect from year
to year provided its renewal is specifically approved at least annually by
the Board of Directors or by vote of a majority of the Fund's outstanding
voting securities (as defined in the 1940 Act) and, in either case, by a
majority of the directors who are not parties to the Advisory Agreement or
interested persons of any such party. The Advisory Agreement will
terminate automatically in the event of its assignment and may be
terminated without penalty by vote of a majority of the Fund's outstanding
voting securities or by either party on not more than 60 days' written
notice.
ADMINISTRATION AGREEMENT
Under an agreement ("Administration Agreement") dated May 11, 1992
between the Fund and Capstone Asset Management Company (the
"Administrator"), the Administrator supervises all aspects of the Fund's
operations other than the management of its investments. The Administrator
is the Fund's Adviser and an affiliate of Capstone Asset Planning Company,
the principal underwriter of the Fund.
The Administrator administers the affairs of the Fund subject to the
direction of the Corporation's Board of Directors and officers. In this
connection, the Administrator (i) assists in supervising all aspects of the
Fund's operations, including the coordination of all matters relating to
the functions of the Adviser, custodian, transfer agent, other stockholder
service agents, accountants, attorneys and other parties performing
services or operational functions for the Fund, (ii) provides the Fund, at
the Administrator's expense, with the services of persons competent to
perform such administrative and clerical functions as are necessary in
order to provide effective administration of the Fund, including duties in
connection with stockholder relations, reports, redemption requests and
account adjustments and the maintenance of certain books and records of the
Fund, (iii) coordinates the preparation of registration statements,
prospectuses, reports, proxy solicitation materials and
<PAGE> 63
amendments thereto, (iv) provides the Fund with office space and facilities
necessary to perform the Administrator's obligations under the Administration
Agreement, and (v) pays all compensation of officers of the Corporation and
the fees of all directors of the Corporation who are affiliated persons of the
Administrator, the Administrator's parent, CFS, and other subsidiaries.
The Administration Agreement provides that the Administrator receives
a fee from the Fund for its services as Administrator. The Fund may also
be required to reimburse the Administrator for its costs in calculating the
Fund's daily net asset value and providing related accounting and books and
records maintenance services. Pursuant to the Administration Agreement,
the Administrator receives for its services a fee calculated daily and
payable monthly, equal to an annual rate of 0.10% of the Fund's average net
assets.
The Fund pays all expenses incurred in the operation of the Fund other
than those assumed by the Adviser and Administrator under the Advisory
Agreement or Administration Agreement, respectively. Expenses payable by
the Fund include: fees and expenses of directors who are not "interested
persons" (as defined in the 1940 Act); fees of the Adviser; Board of
Directors meeting-related expenses of the directors and officers; mailing
expenses of all Fund officers and directors; expenses for legal and
auditing services; data processing and pricing services; costs of printing
and mailing proxies, stock certificates and stockholder reports; fees of
the Administrator; charges of the custodian, transfer agent, registrar or
dividend disbursing agent; expenses pursuant to the Service and
Distribution Plan; Securities and Exchange Commission fees; membership fees
in trade associations; fidelity bond coverage for the Fund's officers;
directors' and officers' errors and omissions insurance coverage; interest;
brokerage costs; taxes; expenses of qualifying the Fund's shares for sale
in various states; litigation; and other extraordinary or non-recurring
expenses and other expenses properly payable by the Fund.
DISTRIBUTOR
Capstone Asset Planning Company (the "Distributor") acts as the
principal underwriter of the Fund's shares pursuant to a written agreement
with the Fund dated May 11, 1992 (the "Distribution Agreement"). The
Distributor has the exclusive right (except for distributions of shares
directly by the Fund) to distribute Fund shares in a continuous offering
through affiliated and unaffiliated dealers. The Distributor's obligation
is a "best efforts" arrangement under which the Distributor is required to
take and pay for only such Fund shares as may be sold to the public. The
Distributor is not obligated to sell any stated number of shares. Except
to the extent otherwise permitted by the Service and Distribution Plan (see
below), the Distributor bears the cost of printing (but not typesetting)
prospectuses used in connection with this offering and the cost and expense
of supplemental sales literature, promotion and advertising. Prior to
December 1990 sales of Fund shares were subject to a sales charge. The
sales charge was paid to the Distributor, who re-allowed a portion of the
sales charge to broker-dealers who had entered into an agreement with the
Distributor to offer for sale the Fund's shares.
The Distribution Agreement will remain in effect until May 7, 1995
(unless earlier terminated as discussed below), and is renewable from year
to year thereafter if approved (a) by the Corporation's Board of Directors
or by a vote of a majority of the Fund's outstanding voting securities and
(b) by the affirmative vote of a majority of directors who are not parties
to the Distribution Agreement or interested persons of any party thereto,
by votes cast in person at a meeting called for such purpose. The
Distribution Agreement provides that it will terminate if assigned (as
defined in the 1940 Act), and that it
<PAGE> 64
may be terminated without penalty byeither party on 60 days' written notice.
On January 8, 1991, the Fund adopted a Service and Distribution Plan
(the "Plan") pursuant to Rule 12b-1 of the Investment Company Act of 1940
which permits the Fund to absorb certain expenses in connection with the
distribution of its shares and provision of certain services to
stockholders. See "Management of the Fund - Distributor" in the Fund's
Prospectus. As required by Rule 12b-1, the Fund's Plan and related
agreements were approved by a vote of the Fund's Board of Directors, and by
a vote of the directors who are not "interested persons" of the Fund as
defined under the 1940 Act and have no direct or indirect interest in the
operation of the Plan or any agreements related to the Plan (the "Plan
Directors"), and by the Fund's stockholders at a Special Meeting of
Stockholders held December 20, 1990. In compliance with the Rule, the
directors requested and evaluated information they thought necessary to
make an informed determination of whether the Plan and related agreements
should be implemented, and concluded, in the exercise of reasonable
business judgment and in light of their fiduciary duties, that there is a
reasonable likelihood that the Plan and related agreements will benefit the
Fund and its stockholders.
As required by Rule 12b-1, the directors review quarterly reports
prepared by the Distributor on the amounts expended and the purposes for
the expenditures.
The Plan and related agreements may be terminated at any time by a
vote of the Plan Directors. As required by Rule 12b-1, selection and
nomination of disinterested directors for the Corporation is committed to
the discretion of the directors who are not "interested persons" as defined
under the 1940 Act, who comprise the Corporation's Nominating Committee.
The Plan and related agreements may be terminated by a vote of the
stockholders. Any change in the Plan that would materially increase the
distribution expenses of the Fund requires stockholder approval, but
otherwise, the Plan may be amended by the directors, including a majority
of the Plan Directors.
The Plan will continue in effect for successive one year periods
provided that such continuance is specifically approved by a majority of
the directors, including a majority of the Plan Directors. The Plan was
last approved by a majority of directors, including a majority of the Plan
Directors on May 7, 1995.
The Distributor is reimbursed by the Fund for stockholder servicing,
printing and advertising expenses incurred in connection with the Plan. The
amounts paid to the Distributor and reallowed by the Distributor to other
Service Organizations were as follows:
FISCAL YEAR TOTAL 12B-1 AMOUNT RETAINED AMOUNT PAID TO OTHER
ENDED FEES PAID BY CAPCO SERVICE ORGANIZATIONS
11/95 $305,403 $15,643 $289,760
12/94 177,501 33,902 143,599
12/93 151,989 39,683 112,306
<PAGE> 65
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the policies established by the Corporation's Board of
Directors, the Adviser is responsible for decisions to buy and sell
securities for the Fund and for the placement of its portfolio business and
the negotiation of the commissions paid on such transactions. It is the
policy of the Adviser to seek (except as noted below) the best security
price available with respect to each transaction. In selecting dealers and
in negotiating commissions, the Adviser considers the firm's reliability,
the quality of its execution services on a continuing basis and its
financial condition. When more than one firm are believed to meet these
criteria, preference may be given to firms which also provide research
services to the Fund or the Adviser. From time to time, the Adviser
effects securities transactions through Capstone Asset Planning Company,
TradeStar Investments, Inc. and Williams McKay Jordan & Mills, Inc.,
broker-dealer affiliates of the Adviser.
The portfolio of the Fund is composed primarily of cash, short-term
and intermediate-term debt securities and when purchases and sales of
securities for the portfolio are made, a "spread" or "mark-up" (dealer's
profit) is generally included in the price of the securities. The Fund's
portfolio transactions are generally effected without the payment of
brokerage commissions; during the last three fiscal years, the Fund paid no
brokerage commissions on portfolio transactions.
The Fund has no obligation to deal with any broker or group of brokers
in executing transactions in portfolio securities. As discussed above,
most of the Fund's transactions are executed on a principal basis without
the payment of a commission. On trades involving a commission, the Adviser
generally seeks reasonably competitive commission rates for transactions
they place on behalf of the Fund, although the Fund does not necessarily
pay the lowest commission available. For non-principal transactions the
Adviser is authorized to cause the Fund to pay a broker that provides
brokerage and research services a commission in excess of the amount
another broker might have charged for effecting a securities transaction.
Such higher commission may be paid if the Adviser determines in good faith
that the amount paid is reasonable in relation to the services received in
terms of the particular transaction or the Adviser's overall
responsibilities to the Fund and other clients of the Adviser. Such
research services must provide lawful and appropriate assistance to the
Adviser in the performance of its investment decision-making
responsibilities and may include: (a) furnishing advice as to the value of
securities, the advisability of investing in, purchasing or selling
securities, and the availability of securities or the purchasers or sellers
of securities; and (b) furnishing analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy,
and the performance of accounts. Such information may be received orally
or in writing and will be in addition to and not in lieu of the services
required to be performed by the Adviser under the Advisory Agreement. The
expenses of the Adviser will not necessarily be reduced as a result of the
receipt of such supplemental information. This information may be useful
to the Adviser in providing services to clients other than the Fund, and
not all such information is used by the Adviser in connection with the
Fund. Conversely, such information provided to the Adviser by brokers and
dealers through whom other clients of the Adviser effect securities
transactions may be useful to the Adviser in providing services to the
Fund.
Some of the securities in which the Fund invests may be traded in the
OTC markets, and the Fund intends to deal directly with the dealers who
make markets in the securities involved, except in those circumstances
where better prices and execution are available elsewhere.
Although investment decisions for the Fund are made independently from
those of the other
<PAGE> 66
accounts managed by the Adviser, investments of the kind made by the Fund
may also be made by those other accounts. Opportunities to purchase or sell
securities will be allocated in the discretion of the Adviser by such means
as will, in their judgment, result in fair and equal treatment in connection
with the other accounts managed by them. Such means may include allocating
opportunities ratably, rotationally or at random among the Fund and other
accounts, on the basis of accounts having the least favorable performance or
any combination of the foregoing. The Adviser may aggregate orders for
purchases and sales of securities of the same issuer on the same day among
the Fund and other accounts and the price paid to or received by the Fund
and those accounts will be the average obtained in those orders. In some
cases, the foregoing aggregation and allocation procedures may affect
adversely the price paid or received by the Fund or the size of the position
purchased or sold by the Fund.
DETERMINATION OF NET ASSET VALUE
The Fund's net asset value is computed daily, Monday through Friday,
as of 4:15 p.m. Eastern Time, except that the net asset value will not be
computed on the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day and the days that the Federal Reserve wire system is closed.
The Fund also will determine its net asset value on any day in which there
is sufficient trading in its portfolio securities that the net asset value
might be affected materially, but only if on any such day the Fund is
required to sell or redeem shares. The Fund's net asset value per share is
computed by dividing the value of the securities held by the Fund plus any
cash or other assets (including any accrued interest and dividends
receivable but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares outstanding at such time, adjusted
to the nearest whole cent. The net asset value so computed will be used
for all purchase orders and redemption requests received between such
computation and the preceding computation.
All portfolio securities for which over-the-counter ("OTC") market
quotations are readily available are valued at the mean between the bid and
asked prices. OTC options are valued using the Black-Scholes Model, which
utilizes the option's characteristics when bought or sold and the market
price of the underlying security to determine a daily price for each OTC
option's position. The only pricing variable changed daily is the price of
the underlying security. Short-term instruments having a maturity date of
more than 60 days are valued on a "mark-to-market" basis, that is, at
prices based on market quotations for securities of similar type, yield,
quality and maturity, until 60 days prior to maturity and thereafter at
amortized value. Short-term instruments having a maturity date of 60 days
or less at the time of purchase are valued at amortized cost value unless
the Board of Directors determines this does not represent fair market
value. When market quotations are not readily available, portfolio
securities are valued at their fair value as determined in good faith under
procedures established by and under the general supervision of the Board of
Directors (valuation of securities for which market quotations are not
readily available may be based upon current market prices of securities
which are comparable in coupon, rating and maturity or an appropriate
matrix utilizing similar factors).
HOW TO BUY AND REDEEM SHARES
Shares of the Fund are sold in a continuous offering and may be
purchased on any business day through authorized dealers, including
Capstone Asset Planning Company. Certain broker-dealers assist
<PAGE> 67
their clients in the purchase of shares from the Distributor and may charge
a fee for this service in addition to the Fund's net asset value.
Shares will be credited to a stockholder's account at the public
offering price next computed after an order is received by the Distributor.
Initial purchases must be at least $200, and there is no minimum for
subsequent investments. No stock certificates representing shares
purchased will be issued except upon written request to the Fund's Transfer
Agent. The Fund's management reserves the right to reject any purchase
order if, in its opinion, it is in the Fund's best interest to do so. See
"Purchasing Shares" in the Prospectus.
Generally, a stockholder may require the Fund to redeem his shares by
sending a written request, signed by the record owner(s), to Capstone
Government Income Fund, c/o Fund/Plan Services, Inc., P.O. Box 874, 2 W.
Elm Street, Conshohocken, Pennsylvania 19428. In addition, certain
expedited redemption methods are available. See "Redemption and Repurchase
of Shares" in the Prospectus.
TAXES
The following summary describes some of the more significant Federal
income tax consequences applicable to investors in the Fund based on
existing Federal tax law. New tax laws may be enacted which might affect
the tax consequences of an investment in the Fund. The following
discussion is necessarily general, and prospective investors are urged to
consult their own tax advisers with respect to the particular tax
consequences to the investor of an investment in the Fund.
The Fund intends to qualify and elect to be treated as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1986,
as amended (the "Code"). Qualification and election to be taxed as a
regulated investment company involves no supervision of management or
investment policies or practices by any government agency. To qualify as a
regulated investment company the Fund must, with respect to each taxable
year, distribute to stockholders at least 90% of its investment company
taxable income (which includes, among other items, interest and the excess
of net short-term capital gains over net long-term capital losses) and meet
certain diversification of assets, source of income, and other requirements
of the Code.
As a regulated investment company, the Fund generally is not subject
to Federal income tax on its investment company taxable income and net
capital gain (net long-term capital gains in excess of net short-term
capital losses), if any, that it distributes to stockholders. The Fund
intends to distribute to its stockholders, at least annually, substantially
all of its investment company taxable income and net capital gain. Amounts
not distributed on a timely basis in accordance with a calendar year
distribution requirement are subject to a nondeductible 4% excise tax. To
prevent imposition of the tax, the Fund must distribute during each
calendar year (1) at least 98% of its ordinary income (not taking into
account any capital gains or losses) for the calendar year, (2) at least
98% of its capital gains in excess of its capital losses for the twelve-
month period ending on October 31 of the calendar year (reduced by certain
ordinary losses, as prescribed by the Code), and (3) all ordinary income
and capital gains for previous years that were not distributed during such
years. A distribution will be treated as paid on December 31 of the
calendar year if it is declared by the Fund in October, November or
December of that year to stockholders on a record date in such a month and
paid by the Fund during January of the following calendar year. Such
distributions will be taxable to stockholders in the calendar year the
distributions are
<PAGE> 68
declared, rather than the calendar year in which the distributions are
received. To prevent application of the excise tax, the Fund intends to
make its distributions in accordance with the calendar year distribution
requirement.
If the Fund retains its net capital gains, although it has no plans to
do so, the Fund may elect to treat such amounts as having been distributed
to its stockholders. As a result, the stockholders would be subject to tax
on undistributed capital gain, would be able to claim their proportionate
share of the Federal income taxes paid by the Fund on such gains as a
credit against their own Federal income tax liabilities, and would be
entitled to an increase in their basis in their Fund shares.
DISTRIBUTIONS. Dividends paid out of the Fund's investment company
taxable income will be taxable to a stockholder as ordinary income.
Distributions of net capital gains, if any, designated by the Fund as
capital gain dividends, are taxable as long-term capital gains, regardless
of how long the stockholder has held the Fund's shares, and are not
eligible for the dividends received deduction.
Dividends received by corporate stockholders may qualify for the
dividends received deduction to the extent the Fund designates its
dividends as derived from dividends from domestic corporations. The amount
designated by the Fund as so qualifying cannot exceed the aggregate amount
of dividends received by the Fund from domestic corporations for the
taxable year. Since the Fund's income may not consist exclusively of
dividends eligible for the corporate dividends received deduction, its
distributions of investment company taxable income likewise may not be
eligible, in whole or in part, for that deduction. The alternative minimum
tax applicable to corporations may reduce the benefits of the dividends
received deduction. The dividends received deduction may be further
reduced if the shares of the Fund are debt-financed or are deemed to have
been held less than 46 days.
All distributions are taxable to the stockholder whether reinvested in
additional shares or received in cash. Stockholders receiving
distributions in the form of additional shares will have a cost basis for
Federal income tax purposes in each share received equal to the net asset
value of a share of the Fund on the reinvestment date. Stockholders will
be notified annually as to the Federal tax status of distributions paid to
them by the Fund.
Distributions by the Fund reduce the net asset value of the Fund
shares. Should a distribution reduce the net asset value below a
stockholder's cost basis, such distribution nevertheless would be taxable
to the stockholder as ordinary income or capital gain as described above,
even though, from an investment standpoint, it may constitute a partial
return of capital. In particular, investors should be careful to consider
the tax implications of buying shares just prior to a distribution by the
Fund. The price of shares purchased at that time includes the amount of
the forthcoming distribution, but the distribution will generally be
taxable to them.
HEDGING AND OTHER TRANSACTIONS. Certain options are "section 1256
contracts." Any gains or losses on section 1256 contracts generally are
considered 60% long-term and 40% short-term capital gains or losses
("60/40"). Also, section 1256 contracts held by the Fund at the end of
each taxable year (and at other times prescribed pursuant to the Code) are
"marked-to-market" with the result that unrealized gains or losses are
treated as though they were realized and the resulting gain or loss is
generally treated as 60/40 gain or loss.
Generally, the hedging transactions undertaken by the Fund may result
in "straddles" for Federal
<PAGE> 69
income tax purposes. The straddle rules may affect the character of gains
(or losses) realized by the Fund. In addition, losses realized by the Fund
on positions that are part of a straddle may be deferred under the straddle
rules, rather than being taken into account in calculating the taxable
income for the taxable year in which such losses are realized. Because only
a few regulations implementing the straddle rules have been promulgated, the
tax consequences to the Fund of hedging transactions are not entirely clear.
The hedging transactions may increase the amount of short-term capital gain
realized by the Fund which is taxed as ordinary income when distributed to
stockholders.
The Fund may make one or more of the elections available under the
Code which are applicable to straddles. If the Fund makes any of the
elections, the amount, character and timing of the recognition of gains or
losses from the affected straddle positions will be determined under rules
that vary according to the election(s) made. The rules applicable under
certain of the elections may operate to accelerate the recognition of gains
or losses from the affected straddle positions.
Because application of the straddle rules may affect the character of
gains or losses, defer losses and/or accelerate the recognition of gains or
losses from the affected straddle positions, the amount which must be
distributed to stockholders, and which will be taxed to stockholders as
ordinary income or long-term capital gain, may be increased or decreased
substantially as compared to a fund that did not engage in such hedging
transactions.
Because the tax consequences of straddle transactions to the Fund are
not entirely clear, it may ultimately be determined that the Fund's tax
accounting procedures failed to conform to the straddle rules.
Consequently, the Fund may have inadvertently failed to satisfy one or more
of the requirements for qualification as a regulated investment company.
If the Fund has failed to satisfy the requirement that it distribute at
least 90% of its net investment company taxable income, the Fund may be
able to preserve its regulated investment company status by making a
"deficiency dividend" distribution. In addition, the Fund would have to
pay interest and a penalty on the amount of the deficiency dividend
distribution. If the Fund fails to satisfy one of the other requirements
for qualification as a regulated investment company, the Fund would be
taxed as an ordinary corporation, and its distributions, including net
capital gain distributions, would be taxable to stockholders as ordinary
dividends. Moreover, upon any requalification as a regulated investment
company, the Fund might be subject to a corporate-level tax on certain
gains.
Certain requirements that must be met under the Code in order for the
Fund to qualify as a regulated investment company may limit the extent to
which the Fund will be able to engage in transactions in options.
Certain of the debt securities acquired by the Fund may be treated as
debt securities that were originally issued at a discount. Original issue
discount can generally be defined as the difference between the price at
which a security was issued and its stated redemption price at maturity.
Although no cash income is actually received by the Fund, original issue
discount on a taxable debt security earned in a given year generally is
treated for Federal income tax purposes as interest and, therefore, such
income would be subject to the distribution requirements of the Code.
Some of the debt securities may be purchased by the Fund at a discount
which exceeds the original issue discount on such debt securities, if any.
This additional discount represents market discount for Federal income tax
purposes. The gain realized on the disposition of any debt security
<PAGE> 70
acquired after April 30, 1993 or any taxable debt security acquired prior
to May 1, 1993 having market discount will be treated as ordinary income
to the extent it does not exceed the accrued market discount on such debt
security. Generally, market discount accrues on a daily basis for each day
the debt security is held by the Fund at a constant rate over the time
remaining to the debt security maturity or, at the election of the Fund, at
a constant yield to maturity which takes into account the semi-annual
compounding of interest.
DISPOSITION OF SHARES. Upon disposition (by redemption, repurchase,
sale or exchange) of Fund shares, a stockholder will realize a taxable gain
or loss depending upon his basis in his shares. Such gain or loss will be
treated as capital gain or loss if the shares are capital assets in the
stockholder's hands. Such gain or loss generally will be long-term or
short-term depending upon the stockholder's holding period for the shares.
However, a loss realized by a stockholder on the disposition of Fund shares
with respect to which capital gain dividends have been paid will, to the
extent of such capital gain dividends, be treated as long-term capital loss
if such shares have been held by the stockholder for six months or less.
Further, a loss realized on a disposition will be disallowed to the extent
the shares disposed of are replaced (whether by reinvestment of
distributions or otherwise) within a period of 61 days beginning 30 days
before and ending 30 days after the shares are disposed of. In such a
case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss. Exchanges of Fund shares for shares of other funds
generally would be treated as taxable sales of the shares exchanged by the
stockholder.
BACKUP WITHHOLDING. The Fund may be required to withhold Federal
income tax at the rate of 31% of all taxable distributions from the Fund
and of gross proceeds from the redemption of shares payable to stockholders
who fail to provide the Fund with their correct taxpayer identification
number or to make required certifications, or who have been notified by the
Internal Revenue Service that they are subject to backup withholding.
Corporate stockholders and certain other stockholders specified in the Code
generally are exempt from backup withholding. Backup withholding is not an
additional tax. Any amounts withheld may be credited against the
stockholder's U.S. Federal income tax liability.
OTHER TAXES. Distributions also may be subject to additional state,
local and foreign taxes depending on each stockholder's particular
situation. Foreign stockholders may be subject to U.S. tax rules that
differ significantly from those described above, including the likelihood
that distributions to them would be subject to withholding of U.S. tax at a
rate of 30% (or at a lower rate under a tax treaty). Stockholders are
advised to consult their own tax advisers with respect to the particular
tax consequences to them of an investment in the Fund.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
The following table sets forth information concerning each person who,
to the knowledge of the Board of Directors, owned more than five percent of
the Fund's common stock as of March 15, 1996:
<PAGE> 71
REGISTRATION PERCENT OWNED
------------ -------------
Cheshire County Savings Bank 28.23%
P.O. Box 746
Keene, NH 03431
New Milford Savings Bank 14.11
P.O. Box 600
New Milford, CT 06776
Curtiss Wright Corporation 9.88
1200 Wall Street West
Lyndhurst, NJ 07071
Orange Savings Bank 5.64
Attn: Daniel J. Laplante
c/o CFX Corporation
102 Main Street
Keene, NH 03431
Robertson Banking Company 5.62
P.O. Box 490
Demopolis, AL 36732
To the knowledge of the Board of Directors, each person named has sole
voting investment power with respect to the shares owned.
OTHER INFORMATION
CUSTODY OF ASSETS. All securities owned by the Fund and all cash,
including proceeds from the sale of shares of the Fund and of securities in
the Fund's investment portfolio, are held by The Fifth Third Bank, 38
Fountain Square, Cincinnati, Ohio 45263, as Custodian.
STOCKHOLDER REPORTS. Semi-annual statements are furnished to
stockholders, and annually such statements are audited by the Fund's
independent accountants.
INDEPENDENT ACCOUNTANTS. Tait, Weller & Baker, Two Penn Center Plaza,
Suite 700, Philadelphia, Pennsylvania 19102-1707, the independent
accountants for the Fund, performs annual audits of the Fund's financial
statements.
LEGAL COUNSEL. Dechert Price & Rhoads, 1500 K Street, N.W., Suite
500, Washington, DC 20005, is legal counsel to the Fund.
<PAGE> 72
ERNST & YOUNG LLP One Houston Center Phone: 713 750 5000
Suite 2400 Fax: 713 750 1501
1221 McKinney Street
Houston, Texas 77010-2007
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Directors
Capstone Government Income Fund
a series of Capstone Fixed Income Series, Inc.
We have audited the statement of assets and liabilities of Capstone
Government Income Fund (the "Fund"), a series of Capstone Fixed Income
Series, Inc., including the schedule of investments, as of December 31,
1992, and the related statement of operations for the year then ended, the
statement of changes in net assets for the year then ended and the period
from October 1, 1991 to December 31, 1991 (not presented separately
herein), and the financial highlights for the year then ended, the period
from October 1, 1991 to December 31, 1991 and the year ended September 30,
1991. These financial statements and financial highlights and are the
responsibility of the Fund's management. Our responsibility is to express
an opinion on these financial statements and financial highlights based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards required that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of December 31, 1992, by correspondence with custodian
and brokers. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Capstone Government Income Fund at December 31, 1992, the results of its
operations for the year then ended, the changes in its net assets for the
year then ended and the period from October 1, 1991 to December 31, 1991,
and the financial highlights for the year then ended, the period from
October 1, 1991 to December 31, 1991, and the year ended September 30,
1991, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Houston, Texas
February 9, 1993
<PAGE> 73
CAPSTONE GOVERNMENT INCOME FUND
- ------------------------------------------------------------------------------
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
of Capstone Fixed Income Series, Inc.
We have audited the accompanying statement of assets and liabilities of
Capstone Government Income Fund (the "Fund"), a series of Capstone Fixed
Income Series, Inc., including the portfolio of investments, as of November
30, 1995 and the related statement of operations for the eleven months then
ended, the statement of changes in net assets for the eleven months then
ended, and for the year ended December 31, 1994, and the financial highlights
for the eleven months then ended, each of the two years in the period ended
December 31, 1994 and the year ended September 30, 1990. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits. The financial
highlights for the year ended December 31, 1992, the period from October 1,
1991 to December 31, 1991 and the year ended September 30, 1991 were audited
by other auditors whose report dated February 9, 1993 expressed an
unqualified opinion thereon.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free from material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosure in
the financial statements. Our procedures included confirmation of securities
owned as of November 30, 1995 by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights
referred to above present fairly, in all material respects, the financial
position of Capstone Government Income Fund at November 30, 1995, the results
of its operations for the eleven months then ended, the changes in its net
assets for the eleven months then ended and the year ended December 31, 1994
and the financial highlights for the eleven months then ended, each of the
two years in the period ended December 31, 1994 and the year ended September
30, 1990, in conformity with generally accepted accounting principles.
Tait, Weller & Baker
Philadelphia, Pennsylvania
December 15, 1995
<PAGE> 74
PORTFOLIO OF INVESTMENTS NOVEMBER 30, 1995
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal Value Percentage of
Amount (See Note 1-A) Net Assets
BONDS --------- -------------- -------------
-----
<S> <C> <C> <C>
U.S. Government $10,000,000 U.S. Treasury Note, 7.250%,11/30/96. . . . . . . . . . $10,171,850 14.95%
88.25% 10,000,000 U.S. Treasury Note, 6.750%, 05/31/97 . . . . . . . . . 10,189,050 14.98
10,000,000 U.S. Treasury Note, 5.625%, 10/31/97 . . . . . . . . . 10,046,850 14.78
19,550,000 FHLB Note, 6.050%, 03/21/97, callable 12/21/95. . . . 19,588,709 28.81
10,000,000 FHLB Note, 6.160%, 10/17/97, callable 01/17/96. . . . 10,014,050 14.73
----------- -----
Total U.S. Government (Cost $59,922,806). . . . . . . . . . . . . $60,010,509 88.25%
SHORT-TERM
OBLIGATIONS
-----------
Repurchase Agreements 7,695,000 Merrill Lynch, 5.85%, 12/01/95 (dated 11/30/95)
Collateralized by $7,480,000 U.S. Treasury
Note 8.500%, 04/15/97
(Repurchase Proceeds $7,696,250). . . . . . . . . . . . 7,695,000 11.32
----------- -----
Total Short-Term Obligations
(Cost $7,695,000) . . . . . . . . . . . . . . . . . . . 7,695,000 11.32
----------- -----
Total Investments in Securities
(Cost $ 67,617,806)(a). . . . . . . . . . . . . . . . . 67,705,509 99.57%
----------- -----
OPTIONS
-------
Liability for Written Call Options
on U.S. Treasury Notes (b)
(0.03)% Expiration Month/Strike Price
-----------------------------
$10,000,000 par value, 5.625%,
due 10/31/97 December 1995/100.375. . . . . . . . . . . . . . (17,188) (0.03)
----------- -----
Total Written - Call Options
(Premium Received $12,500) . . . . . . . . . . . (17,188) (0.03)
----------- -----
Other Assets less Liabilities. . . . . . . . . . 308,876 0.46
----------- -----
Net Assets, equivalent to $4.98 per
share for 13,645,953 shares of $.001 par value
shares outstanding. . . . . . . . . . . . . . . . $67,997,197 100.00%
=========== ======
(a) At November 30, 1995, unrealized appreciation of securities based on Federal income tax cost is as follows:
Unrealized appreciation . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87,703
-----------
Net unrealized appreciation. . . . . . . . . . . . . . . . . . . . 87,703
===========
(b) As of November 30, 1995, portfolio securities valued at $10,046,850 were held in connection with covered call options written.
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
<PAGE> 75
STATEMENT OF ASSETS AND LIABILITIES - NOVEMBER 30, 1995
- -------------------------------------------------------------------------------
<TABLE>
ASSETS:
<S> <C>
Investments in securities at market (identified cost $67,617,806) (Notes 1-
A and 1C). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $67,705,509
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,421
Receivables:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . .$ 358,254
Written option premium. . . . . . . . . . . . . . . . . . . . 12,500
Capital stock . . . . . . . . . . . . . . . . . . . . . . . . 1,145
--------- 371,899
-----------
Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,080,829
-----------
LIABILITIES:
Covered call option: written, at value (premium received $12,500) (Notes
1A, 1B and 4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,188
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,417
Payable for capital stock . . . . . . . . . . . . . . . . . . . . . . . . . 27
-----------
Total Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 83,632
-----------
NET ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $67,997,197
===========
NET ASSET VALUE AND OFFERING PRICE PER SHARE:
($67,997,197/13,645,953 shares outstanding of $.001 par value,
200,000,000 shares authorized) . . . . . . . . . . . . . . . . . . . . . . . $ 4.98
===========
SOURCE OF NET ASSETS:
Paid in capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $66,433,185
Undistributed net investment income. . . . . . . . . . . . . . . . . . . . . 8,391,049
Accumulated net realized loss on investments . . . . . . . . . . . . . . . . (6,910,052)
Net unrealized appreciation of securities and written options. . . . . . . . 83,015
-----------
$67,997,197
===========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
</TABLE>
<PAGE> 76
STATEMENT OF OPERATIONS FOR THE ELEVEN MONTHS ENDED NOVEMBER 30, 1995
- -------------------------------------------------------------------------------
<TABLE>
INVESTMENT INCOME:
<S> <C>
Interest Income. . . . . . . . . . . . . . . . . . . . . . . . . $9,555,447
----------
Expenses:
Advisory fees (Note 2). . . . . . . . . . . . . . . . . . . 604,189
Distribution fees (Note 2). . . . . . . . . . . . . . . . . 305,403
Administration services (Note 2). . . . . . . . . . . . . . 151,047
Transfer agent fees . . . . . . . . . . . . . . . . . . . . 26,608
Professional fees . . . . . . . . . . . . . . . . . . . . . 30,854
Custodian fees. . . . . . . . . . . . . . . . . . . . . . . 10,241
Filing and registration fees. . . . . . . . . . . . . . . . 13,454
Directors' fees and expenses. . . . . . . . . . . . . . . . 3,265
Reports and notices to stockholders . . . . . . . . . . . . 3,039
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . 16,298
----------
Total expenses. . . . . . . . . . . . . . . . . . . . . . . 1,164,398
----------
Net Investment Income. . . . . . . . . . . . . . . . . 8,391,049
----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain from security transactions . . . . . . . . . . 312,608
Net realized gain from written options . . . . . . . . . . . . . 211,562
Unrealized appreciation of investments:
Beginning of period. . . . . . . . . . . . . . . . . $ 635
End of period. . . . . . . . . . . . . . . . . . . . 83,015
-------
Net change in unrealized appreciation of investments. . 82,380
----------
Net realized and unrealized gain on investments . . . . 606,550
----------
Net increase in net assets resulting from operations. . $8,997,599
==========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
<PAGE> 77
STATEMENT OF CHANGES IN NET ASSETS
- ------------------------------------------------------------------------------
<TABLE>
ELEVEN MONTHS ENDED YEAR ENDED
NOVEMBER 30, 1995 DECEMBER 31, 1994
------------------- -----------------
<S> <C> <C>
OPERATIONS:
Net investment income. . . . . . . . . . . . $ 8,391,049 $ 3,748,921
Net realized gain (loss) on investments. . . 524,170 (2,470,055)
Net change in unrealized appreciation of
investments. . . . . . . . . . . . . . . . 82,380 111,566
----------- ------------
Net increase in net assets resulting from
operations . . . . . . . . . . . . . . . . 8,997,599 1,390,432
EQUALIZATION:
Undistributed investment income included in
prices of shares sold and redeemed (Note 1-H) --- (3,436,857)
DISTRIBUTIONS TO SHAREHOLDERS:
Distributions from investment income . . . . --- (219,989)
CAPITAL SHARE TRANSACTIONS:
Increase (decrease) in net assets resulting from capital share
transactions (Note 3). . . . . . . . . . . 50,294,521 (22,824,241)
---------- -----------
Total increase (decrease) in net assets 59,292,120 (25,090,655)
NET ASSETS:
Beginning of period. . . . . . . . . . . . . 8,705,077 33,795,732
---------- -----------
End of period (including undistributed net
investment income of $8,391,049 and $0,
respectively). . . . . . . . . . . . . . . $67,997,197 $ 8,705,077
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - NOVEMBER 30, 1995
- ------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Capstone Government Income Fund (the "Fund") referred to as the "Fund" is
the initial series of Capstone Fixed Income Series, Inc. (the "Corporation"),
which is registered under the Investment Company Act of 1940, as amended (the
"Act"), as a diversified, open-end management investment company. The Fund
was originally incorporated in Delaware in 1968 and was reorganized as the
initial series of the Corporation, which was established under Maryland Law
on May 11, 1992.
On January 8, 1991, shareholders approved various changes in the
fundamental investment policies of the Fund. The current investment
objective of the Fund is to earn a high level of total return, consistent
with safety of principal. The Fund seeks to achieve this objective by
investing in debt obligations that have remaining maturities of three years
or less and that are issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, and by engaging in certain income enhancement
strategies. Prior to the change, the Fund's investment objective was to
secure a high level of current income on its investments along with the
preservation of the Fund's capital. To achieve this objective, the Fund
invested in U.S. Government securities and corporate obligations,
convertibles, preferred and common stocks, and money market investments. The
Fund changed its fiscal and tax year end from September 30 to December 31,
commencing with December 31, 1991. The Fund has changed its fiscal year end
to November 30, commencing with November 30, 1995, but continues to maintain
a December 31 tax year end.
<PAGE> 78
The following is a summary of significant accounting policies followed by
the Fund in the preparation of its financial statements.
(A) VALUATION OF INVESTMENTS - Debt securities (other than short-term
obligations) including listed issues are valued at the mean between the bid
and asked prices on the basis of valuations furnished by a pricing service.
Over-the-counter options, which include both written and purchased options,
are valued using the Black-Scholes Model, which utilizes the option's
characteristics when bought or sold and the market price of the underlying
security to determine a daily price for each OTC option's position. The only
pricing variable changed daily is the price of the underlying security. When
market quotations are not readily available, portfolio securities are valued
at their fair value as determined in good faith under procedures established
by and under the general supervision of the Board of Directors (valuation of
securities for which market quotations are not readily available may be based
upon current market prices of securities which are comparable in coupon,
rating and maturity or an appropriate matrix utilizing similar factors).
Short-term investments are valued at amortized cost which approximates value.
(B) CALL AND PUT OPTIONS - When the Fund writes a call or put option, an
amount equal to the premium received is reflected as a liability. The
amount of the liability is subsequently "marked to market" to reflect the
current market value of the option written. If an option which the Fund has
written either expires on its stipulated expiration date, or if the Fund
enters into a closing purchase transaction, the Fund realizes a gain (or loss
if the cost of the closing transaction exceeds the premium received when the
option is sold), and the liability related to such option is extinguished.
If a call option which the Fund has written is exercised, the Fund realizes a
gain or loss from the sale of the underlying security and the proceeds from
such a sale are increased by the premium originally received. If a put
option which the Fund has written is exercised, the amount of the premium
originally received reduces the cost of the security which the Fund purchases
upon exercise of the option.
The premium paid by the Fund for the purchase of a call or put option is
recorded as an investment and subsequently "marked to market" to reflect the
current market value of the option purchased. If an option which the Fund has
purchased expires on the stipulated expiration date, the Fund realizes a loss
in the amount of the cost of the option. If the Fund enters into a closing
transaction, it realizes a gain (loss) if the proceeds from the sale are
greater (less) than the cost of the option purchased. If the Fund exercises
a put option, it realizes a gain or loss from the sale of the underlying
security and the proceeds from such sale will be decreased by the premium
originally paid. If the Fund exercises a call option, the cost of the
security purchased upon exercise is increased by the premium originally paid.
These option contracts may be listed for trading on a national securities
exchange or traded over-the-counter. Over-the-counter options are transacted
directly with dealers and not with a clearing corporation, and there is a
risk of non-performance by the dealer. The Fund, as writer of a call option,
loses the potential for gain on the underlying security above the exercise
price while the option is outstanding. By writing a put option, the Fund
might become obligated to purchase the underlying security at an exercise
price that exceeds the then current market price.
(C) REPURCHASE AGREEMENTS - The Fund may enter into repurchase agreements
with U.S. Government securities dealers recognized by the Federal Reserve
Board, with member banks of the Federal Reserve System or with such other
brokers or dealers that meet the credit guidelines of the Corporation's Board
of Directors. In a repurchase agreement, the Fund buys a security from a
seller that has agreed to repurchase the same security at a mutually agreed
upon date and price. The Fund's resale price will be in excess of the
purchase price, reflecting an agreed upon interest rate. This interest rate
is effective for the period of time the Fund is invested in the agreement and
is not related to the coupon rate on the underlying security. Repurchase
agreements may also be viewed as fully collateralized loans of money by the
Fund to the seller. The period of these repurchase agreements will usually
be short, from overnight to one week, and at no time will the Fund invest in
repurchase agreements for more than one year. The Fund will always receive
as collateral securities whose market value including accrued interest is,
and during the entire term of the agreement remains, at least equal to 100%
of the dollar amount invested by the Fund in each agreement, and the Fund
will make payment for such securities only upon physical delivery or upon
evidence of book entry transfer to the account of the custodian. If the
seller defaults, the Fund might incur a loss if the value of the collateral
securing the repurchase agreement declines and might incur disposition costs
in connection with liquidating the collateral. In addition, if bankruptcy
proceedings are commenced with respect to the seller of a
security which is the subject of a repurchase agreement, realization of the
collateral by the Fund may be delayed or limited. In an attempt to minimize
these risks, New Castle Advisers, Inc., the Subadviser, will consider and
monitor the creditworthiness of parties to repurchase agreements.
(D) REVERSE REPURCHASE AGREEMENTS - A reverse repurchase agreement involves
the sale of an investment obligation by the Fund and its agreement to
repurchase the instrument at a specific time and price. The Fund will
maintain a segregated account, which will be marked to market daily,
consisting of cash, cash equivalents and U.S. Government securities at least
equal to its obligations under reverse repurchase agreements, including any
accrued interest. The Fund will not invest proceeds from these transactions
beyond the expiration of the reverse repurchase agreement. The Fund may not
enter into these transactions with more than 33% of its portfolio, and will
only enter into such agreements with dealers approved by the Board of
Directors of the Corporation for repurchase agreements.
<PAGE> 79
(E) SECURITY TRANSACTIONS AND INVESTMENT INCOME - Security transactions are
accounted for on the trade date (the date the securities are purchased or
sold). Interest income on investments is accrued daily. Premiums on
securities purchased are amortized over the life of the respective securities
and discounts are recharacterized to income upon sale or maturity of the
respective security. Realized gains and losses from security transactions
are determined on the basis of identified cost.
(F) FEDERAL INCOME TAXES - No provision is considered necessary for Federal
income taxes since it is the policy of the Fund to distribute all of its
taxable income, including any net realized gains on sales of investments, and
to qualify as a "regulated investment company" under the applicable section
of the Internal Revenue Code. The Fund has approximately $5,865,000 of
capital losses for Federal income tax purposes available to offset future
taxable capital gains, if any, of which $508,400 expires in December 1996,
$702,100 expires in December 1998, $1,207,900 expires in December 1999,
$2,210,100 expires in December 2002 and $1,236,500 expires n December 2003.
(G) SHARE TRANSACTIONS AND DISTRIBUTIONS TO SHAREHOLDERS - Fund shares are
sold in continuous public offering at the net asset value. Transactions in
Fund shares are recorded on the trade date. The Fund redeems its shares at
the net asset value. Dividends and other distributions are recorded by the
Fund on the ex-dividend date and may be reinvested at net asset value.
Income distributions and capital gain distributions, if any, are determined
in accordance with income tax regulations which may differ from generally
accepted accounting principles. The Fund also utilizes earnings and profits
distributed to shareholders on redemption of shares as part of the dividend
paid deduction for income tax purposes. The Fund files its tax return on a
December 31 basis; all permanent timing differences will be adjusted at that
time.
(H) EQUALIZATION - Prior to January 1, 1995, the Fund followed the accounting
practice known as book equalization by which a portion, on a per-share basis,
of the proceeds from sales and costs of redemptions of capital shares
equivalent to the amount of distributable investment income on the date of
the transaction was credited or charged to undistributed income. As a
result, undistributed investment income per share was unaffected by sales or
redemptions of capital shares. In November 1994 the Board of Directors voted
to discontinue the use of book equalization.
NOTE 2 - INVESTMENT ADVISORY AND ADMINISTRATOR'S FEES AND OTHER TRANSACTIONS
WITH AFFILIATES
Capstone Asset Management Company ("CAMCO"), serves as the Investment
Adviser to the Fund pursuant to an Investment Advisory Agreement dated May
11, 1992 between CAMCO and the Fund. New Castle Advisers, Inc. ("NCA")
serves as Subadviser to the Fund pursuant to a Subadvisory Agreement between
CAMCO and NCA dated May 11, 1992.
CAMCO is responsible chiefly for the overall design and structure of the
Fund's investment portfolio, as well as for establishing the Fund's
investment philosophy, strategy and maturity structure. CAMCO is also
responsible for performance and yield curve analysis. NCA is responsible
chiefly for the market timing of purchases and sales, and for all yield
enhancement strategies and creditworthiness analysis. For these services the
Fund pays CAMCO a fee computed daily and paid monthly at the annual rate of
0.40% of the first $250 million of the Fund's average daily net assets and
0.36% of such assets over $250 million. Out of these fees, CAMCO pays NCA a
fee computed daily and payable monthly at the annual rate of 0.30% of the
first $250 million and 0.27% of the Fund's average daily net assets over $250
million.
CAMCO also provides administrative services to the Fund pursuant to an
Administrative Agreement. For these services, CAMCO is paid a monthly fee
equal to an annual rate of 0.10% of the Fund's average daily net assets.
Investment advisory and administrative fees paid to CAMCO for the eleven
months ended November 30, 1995 were $755,236, of which CAMCO retained
$302,094.
Pursuant to the Investment Advisory and Subadvisory Agreements and the
Administrative Agreement, CAMCO and NCA have agreed to reduce their fees on a
pro rata basis (but not below zero) to the extent that the Fund's ordinary
expenses for any fiscal year (including advisory or administrative fees, but
excluding brokerage commissions, interest, local, state and Federal taxes and
extraordinary expenses) exceed the expense limitation of any state having
jurisdiction over the Fund.
Pursuant to a Distribution Agreement with the Fund dated May 11, 1992,
Capstone Asset Planning Company ("CAPCO"), is the principal underwriter of
the Fund and, acting as exclusive agent, sells shares of the Fund to the
public on a continuous basis.
The Fund has adopted a Service and Distribution Plan (the "Plan") pursuant
to Rule 12b-1 under the Act in which it uses its assets to finance certain
activities relating to the distribution of its shares to investors and
provision of certain stockholder services. The Plan
<PAGE> 80
permits payments to be made by the Fund to the Distributor to reimburse it for
particular expenditures incurred by it in connection with the distribution of
the Fund's shares to investors and provision of certain stockholder services
including, but not limited to, the payment of compensation, including incentive
compensation, to securities dealers (which may include CAPCO itself) and
certain banks, investment advisers and pension consultants (collectively, the
"Service Organizations") to obtain various distribution-related and/or
administrative services for the Fund. CAPCO is also authorized to engage in
advertising, the preparation and distribution of sales literature and other
promotional activities on behalf of the Fund. In addition, the Plan
authorizes payment by the Fund of the cost of preparing, printing and
distributing Fund Prospectuses and Statements of Additional Information to
prospective investors and of implementing and operating the Plan.
Under the Plan, payments made to CAPCO may not exceed an amount computed at
an annual rate of 0.20% of the average net assets of the Fund. CAPCO is
permitted to collect fees under the Plan on a monthly basis. Any
expenditures incurred in excess of the limitation described above during a
given month may be carried forward up to twelve months for reimbursement,
subject always to the 0.20% limit, and no interest or carrying charges will
be payable by the Fund on amounts carried forward. The Plan may be
terminated by the Fund at any time and the Fund will not be liable for
amounts not reimbursed as of the termination date. During the eleven months
ended November 30, 1995, the Fund paid $305,403 in distribution expenses. Of
this amount $124,889 was paid to Service Organizations other than CAPCO.
CAMCO is an affiliate of CAPCO and both are wholly-owned subsidiaries of
Capstone Financial Services, Inc. ("CFS"). Certain officers and directors of
the Fund, are also officers and directors of CAMCO, CAPCO, and CFS.
NOTE 3 - CAPITAL STOCK
Transactions in capital stock were as follows:
<TABLE>
<CAPTION>
ELEVEN MONTHS ENDED YEAR ENDED
NOVEMBER 30, 1995 DECEMBER 31, 1994
--------------------------- ----------------------------
Shares Value Shares Value
------ ----- ------ -----
<S> <C> <C> <C> <C>
Shares sold. . . . . . . . . . . . . . . . . 122,401,739 $ 587,808,899 39,255,843 $ 186,318,073
Shares issued in Asset Transfer (Note 5) . . -- -- 974,433 4,677,279
Shares issued to shareholders in
reinvestment of distributions. . . . . . . -- -- 42,251 199,845
----------- ------------- ---------- -------------
122,401,739 587,808,899 40,272,527 191,195,197
Shares reacquired. . . . . . . . . . . . . . (110,595,379) (537,514,378) (45,478,766) (214,019,438)
----------- ------------- ---------- -------------
Net increase (decrease). . . . . . . . . . . 11,806,360 $ 50,294,521 (5,206,239) $ (22,824,241)
=========== ============= ========== =============
</TABLE>
NOTE 4 - PURCHASES AND SALES OF SECURITIES
For the eleven months ended November 30, 1995, the cost of purchases and
proceeds from sales of securities other than short-term obligations
aggregated $378,395,081 and $226,661,549, respectively.
Written options transactions during the period are summarized as follows:
<TABLE>
<CAPTION>
CALL/PUT OPTIONS WRITTEN FACE AMOUNT
PREMIUMS RECEIVED OF CONTRACTS
------------------------ ------------
<S> <C> <C>
Options outstanding at December 31, 1994. . . $ 0 $ 0
Options written. . . . . . . . . . . . . . . . (547,969) 207,000,000
Options closed . . . . . . . . . . . . . . . . 303,438 (106,000,000)
Options exercised. . . . . . . . . . . . . . . 68,750 (25,000,000)
Options expired. . . . . . . . . . . . . . . . 163,281 (66,000,000)
-------- -------------
Options outstanding at November 30, 1995 . . . (12,500) $ 10,000,000
-------- =============
Unrealized depreciation at November 30, 1995 . $ (4,788)
--------
Market value of written options at November
30, 1995. . . . . . . . . . . . . . . . . . $(17,288)
========
</TABLE>
<PAGE> 81
NOTE 5 -ACQUISITION OF INVESTORS CASH RESERVE FUND, INC.
On June 6, 1994, Capstone Government Income Fund (the "Fund") purchased
all of the assets of Investors Cash Reserve Fund, Inc. ("ICRF"), in exchange
for shares of the Fund of equivalent value and the assumption by the Fund of
certain identified liabilities of ICRF. The transaction was pursuant to a
Purchase Agreement and Plan of Complete Liquidation approved by stockholders
of ICRF on May 31, 1994. The acquisition was accomplished by a tax-free
exchange of 974,433 shares of the Fund (valued at $4,677,279) for the
4,677,279 shares of ICRF on June 6, 1994. The exchange had no effect on the
net asset value per share of the Fund. ICRF's net assets at that date were
$4,677,279, consisting of capital stock of $46,772, and paid in surplus of
$4,630,507. The aggregate net assets of the Fund and ICRF immediately before
the acquisition were $110,929,732, and $4,677,279, respectively.
<PAGE> 82
CAPSTONE INTERMEDIATE GOVERNMENT FUND
A SERIES OF CAPSTONE FIXED INCOME SERIES, INC.
STATEMENT OF ADDITIONAL INFORMATION
March 25, 1996
This Statement of Additional Information is not a Prospectus but
contains information in addition to and more detailed than that set forth
in the Prospectus and should be read in conjunction with the Prospectus.
The Statement of Additional Information and the related Prospectus are both
dated March 25, 1996. A Prospectus may be obtained without charge by
contacting Capstone Asset Planning Company, by phone at (800) 262-6631 or
by writing to it at 5847 San Felipe, Houston, Texas 77057.
TABLE OF CONTENTS
Page
----
General Information . . . . . . . . . . . . . . . . . . . . . 2
Investment Restrictions . . . . . . . . . . . . . . . . . . . 2
Investment Policies and Risk Factors. . . . . . . . . . . . . 4
Performance Information . . . . . . . . . . . . . . . . . . . 8
Directors and Executive Officers. . . . . . . . . . . . . . . 10
Investment Advisory Agreement . . . . . . . . . . . . . . . . 12
Distributor . . . . . . . . . . . . . . . . . . . . . . . . . 14
Portfolio Transactions and Brokerage. . . . . . . . . . . . . 15
Determination of Net Asset Value. . . . . . . . . . . . . . . 16
How to Buy and Redeem Shares. . . . . . . . . . . . . . . . . 17
Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Control Persons and Principal Holders of Securities . . . . . 21
Other Information . . . . . . . . . . . . . . . . . . . . . . 21
<PAGE> 83
GENERAL INFORMATION
Capstone Intermediate Government Fund (the "Fund") is a newly
organized series of Capstone Fixed Income Series, Inc. (the "Corporation").
The Corporation was originally incorporated in Delaware in 1968 and
commenced business shortly thereafter as an open-end diversified management
company under the Investment Company Act of 1940. On May 11, 1992, it was
reorganized as a Maryland series company (see "General Information" in the
Prospectus).
The Fund is a member of a group of mutual funds (the "Capstone Group")
sponsored by Capstone Asset Management Company which provides advisory
services to the Fund.
INVESTMENT RESTRICTIONS
A. FUNDAMENTAL
The Fund may not:
1. With respect to 75% of its assets, purchase more than 10% of the
voting securities of any one issuer or invest more than 5% of the
value of its total assets in the securities of any one issuer,
except the U.S. Government, its agencies or instrumentalities
(see additional non-fundamental restriction 1., below);
2. borrow money, except that the Fund may enter into reverse
repurchase agreements, and, as a temporary measure for
extraordinary or emergency purposes, it may borrow from banks in
an amount not to exceed 1/3 of the value of its net assets,
including the amount borrowed;
3. issue any senior securities, except as appropriate to evidence
indebtedness which it is permitted to incur;
4. act as underwriter, except to the extent that it might be deemed
to be an underwriter for the purposes of the Securities Act of
1933, as amended, with respect to securities which it sells to
the public if registration under such Act, as amended, is
required in connection with such sale;
5. purchase any securities which would cause 25% or more of the
market value of its total assets at the time of such purchase to
be invested in the securities of one or more issuers having their
principal business activities in the same industry, provided that
there is no limit with respect to investments in securities
issued or guaranteed by the U.S. Government, its agencies and
instrumentalities, or in repurchase or reverse repurchase
agreements backed by such securities;
6. purchase or sell real estate except for its own use in connection
with its business;
7. purchase or sell commodities or commodity contracts, except that
the Fund may invest in futures contracts and related options;
<PAGE> 84
8. make loans to other persons except (a) through the use of
repurchase agreements and (b) by the purchase of debt securities
in accordance with its investment policies; and
9. invest in securities or other instruments that are not authorized
for investment by a Federal savings association without
limitation as to a percentage of its assets and that are not
authorized for investment by national banks without limitation as
to a percentage of its capital and surplus, and none of the above
Fundamental Investment Restrictions shall be construed to permit
any such investment(s).
The Fund will make no purchases of securities so long as it has
outstanding borrowings, except for reverse repurchase agreements.
Additionally, the Fund has agreed with the staff of the Securities and
Exchange Commission that it will not include any reverse repurchase
agreements, including those backed by securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities, within the
exception from the 25% limit in restriction Number 5, above. Finally, the
Fund has no present intention to lend its portfolio securities, and will
not engage in such transactions until appropriate disclosure concerning
this practice, including its risks, is included in the Fund's Prospectus
and Statement of Additional Information.
B. NON-FUNDAMENTAL
The following restrictions are not fundamental and may be changed by
the Fund without stockholder approval, but only in compliance with
applicable law, regulation or regulatory policy and in compliance with the
Fundamental Investment Restrictions listed above, including but not limited
to, Number 9.
The Fund may not:
1. as to the portion of its assets not subject to Fundamental
Restriction 1., above, purchase more than 10% of the voting
securities of any one issuer or invest more than 5% of the value
of its total assets in the securities of any one issuer, except
the U.S. Government, its agencies or instrumentalities (the Fund
does not generally intend to invest in voting securities of any
issuer);
2. acquire or retain securities of any investment company, except as
part of a plan of merger, reorganization or consolidation;
3. pledge, mortgage or hypothecate its assets in excess, together
with permitted borrowings, of 1/3 of its net assets;
4. invest more than 10% of its total net assets in securities that
are not readily marketable, the disposition of which is
restricted under Federal securities laws, or in repurchase
agreements not terminable within 7 days, provided that over-the-
counter options with securities dealers meeting criteria
established by the Fund's Board of Directors that give the Fund
an absolute right to repurchase (a) according to a "repurchase
formula" or (b) at a price determined from independent sources by
the Adviser will not be considered securities that are not
readily marketable;
<PAGE> 85
5. purchase or retain securities of any issuer if the officers or
directors of the Fund, the Adviser who own beneficially more than
1/2 of 1% of the securities of such issuer together own
beneficially more than 5% of such securities;
6. sell securities short or purchase securities on margin, except
for such short-term credits as are necessary for the clearance of
transactions and in connection with entering into futures
contracts and related options to the extent permitted by the
Fund's investment policies;
7. write put and call options except to the extent permitted by the
Fund's investment policies;
8. invest in oil, gas or other mineral exploration or development
programs (although the Fund is not prohibited from investing in
issuers that own or invest in such interests); and
9. under normal circumstances, invest less than 65% of its total
assets in obligations that are issued or guaranteed as to
principal or interest by the U.S. Government, its agencies,
authorities or instrumentalities or in repurchase agreements
fully collateralized by such obligations.
The portfolio securities of the Fund may be turned over whenever
necessary or appropriate in the opinion of the Fund's management to seek
the achievement of the basic objective of the Fund. It is anticipated that
the Fund will incur a high portfolio turnover rate in connection with the
use of covered option writing strategies.
INVESTMENT POLICIES AND RISK FACTORS
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with U.S. Government
securities dealers recognized by the Federal Reserve Board, with member
banks of the Federal Reserve System or with such other brokers or dealers
that meet the credit guidelines of the Fund's Board of Directors. In a
repurchase agreement, the Fund buys a security from a seller that has
agreed to repurchase the same security at a mutually agreed upon date and
price. The Fund's resale price will be in excess of the purchase price,
reflecting an agreed upon interest rate. This interest rate is effective
for the period of time the Fund is invested in the agreement and is not
related to the coupon rate on the underlying security. Repurchase
agreements may also be viewed as fully collateralized loans of money by the
Fund to the seller. The period of these repurchase agreements will usually
be short, from overnight to one week, and at no time will the Fund invest
in repurchase agreements for more than one year. The Fund will always
receive as collateral securities whose market value including accrued
interest is, and during the entire term of the agreement remains, at least
equal to 100% of the dollar amount invested by the Fund in each agreement,
and the Fund will make payment for such securities only upon physical
delivery or upon evidence of book entry transfer to the account of the
custodian. If the seller defaults, the Fund might incur a loss if the
value of the collateral securing the repurchase agreement declines and
might incur disposition costs in connection with liquidating the
collateral. In addition, if bankruptcy proceedings are commenced with
respect to the seller of a security which is the subject of a repurchase
<PAGE> 86
agreement, realization upon the collateral by the Fund may be delayed or
limited. In an attempt to minimize these risks, the Adviser will consider
and monitor the creditworthiness of parties to repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
A reverse repurchase agreement involves the sale of a U.S. Treasury
obligation by the Fund and its agreement to repurchase the instrument at a
specific time and price. The Fund will maintain a segregated account,
which will be marked-to-market daily consisting of cash, cash equivalents
and U.S. Government securities at least equal to its obligations under
reverse repurchase agreements, including any accrued interest. The Fund
will not invest proceeds from these transactions beyond the expiration of
the reverse repurchase agreement. The Fund may not enter into these
transactions with more than 33% of its portfolio, and will only transact
these agreements with dealers approved by the Fund for repurchase
agreements.
OPTIONS
Purpose. The principal reason for writing options is to hedge, to a
limited extent, adverse price changes of the portfolio due to general
interest rate changes. In addition, options are written to obtain, through
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. Such current return could be expected to
fluctuate because premiums earned from an options writing program and
dividend or interest income yields on portfolio securities vary as economic
and market conditions change. Actively writing options on portfolio
securities is likely to result in a substantially higher portfolio turnover
rate than that of most other investment companies. Additionally, if the
Adviser is incorrect in its forecast, the result to the Fund from these
hedging practices may be worse than if no hedging transactions were entered
into.
WRITING OPTIONS. The purchaser of a call option pays a premium to the
writer (i.e., the seller) for the right to buy the underlying security from
the writer at a specified price during a certain period. The Fund would
write call options only on a covered basis, which means that at all times
during the option period, the Fund would own or have the right to acquire
securities of the type that it would be obligated to deliver if any
outstanding options were exercised.
The purchaser of a put option pays a premium to the writer (i.e., the
seller) for the right to sell the underlying security to the writer at a
specified price during a certain period. The Fund would write put options
only on a "covered" basis, which means that at all times during the option
period, the Fund would maintain in a segregated account with its Custodian
cash, cash equivalents or U.S. Government securities in an amount of not
less than the exercise price of the option, or would hold a put on the same
underlying security at an equal or greater exercise price.
CLOSING PURCHASE TRANSACTIONS AND OFFSETTING TRANSACTIONS. In order
to terminate its position as a writer of a call or put option, the Fund
could enter into a "closing purchase transaction," which is the purchase of
a call (put) on the same underlying security and having the same exercise
price and expiration date as the call (put) previously written by the Fund.
The Fund would realize a gain (loss) if the premium plus commission paid in
the closing purchase transaction is less (greater) than the premium it
received on the sale of the option. The Fund would also realize a gain if
an option it has written lapses unexercised.
<PAGE> 87
The Fund could write options that are listed on an exchange as well as
options which are privately negotiated in over-the-counter transactions. A
Fund could close out its position as a writer of an option only if a liquid
secondary market exists for options of that series, but there is no
assurance that such a market will exist, particularly in the case of over-
the-counter options, since they can be closed out only with the other party
to the transaction. Alternatively, the Fund could purchase an offsetting
option, which would not close out its position as a writer, but would
provide an asset of equal value to its obligation under the option written.
If the Fund is not able to enter into a closing purchase transaction or to
purchase an offsetting option with respect to an option it has written, it
will be required to maintain the securities subject to the call or the
collateral underlying the put until a closing purchase transaction can be
entered into (or the option is exercised or expires), even though it might
not be advantageous to do so.
PURCHASING CALL AND PUT OPTIONS. The Fund could purchase call options
to protect (i.e., hedge) against anticipated increases in the prices of
securities it wishes to acquire. Alternatively, call options could be
purchased for capital appreciation. Since the premium paid for call
options is typically a small fraction of the price of the underlying
security, a given amount of funds will purchase call options covering a
much larger quantity of such security than could be purchased directly. By
purchasing call options, the Fund could benefit from any significant
increase in the price of the underlying security to a greater extent than
had it invested the same amount in the security directly. However, because
of the very high volatility of option premiums, the Fund would bear a
significant risk of losing the entire premium if the price of the
underlying security did not rise sufficiently, or if it did not do so
before the option expired.
Conversely, put options could be purchased to protect (i.e., hedge)
against anticipated declines in the market of either specific portfolio
securities or of the Fund's assets generally. Alternatively, put options
could be purchased for capital appreciation in anticipation of a price
decline in the underlying security and a corresponding increase in the
value of the put option. The purchase of put options for capital
appreciation involves the same significant risk of loss as described above
for call options.
In any case, the purchase of options for capital appreciation would
increase the Fund's volatility by increasing the impact of changes in the
market prices of the underlying securities on the Fund's net asset value.
OVER-THE-COUNTER OPTIONS. The Fund may invest up to ten percent of
its net assets (determined at the time of investment) in illiquid
securities, including securities that are not readily marketable and
repurchase agreements which have a maturity of longer than seven days. An
OTC option transaction will be entered into by the Fund only with a
securities dealer meeting criteria established by the Fund's Board of
Directors that gives the Fund an absolute right to repurchase the option on
demand by the Fund at a price (a) based on an agreed formula or (b)
determined from independent sources and agreed to by the Adviser. Such an
OTC option will not be subject to the Fund's 10% limit on investments in
illiquid securities.
FUTURES AND RELATED OPTIONS
Interest Rate Futures Contracts. The Fund may purchase and sell
interest rate futures contracts ("futures contracts") as a hedge against
changes in interest rates. A futures contract is an agreement between two
parties to buy and sell a security for a set price on a future date.
Futures contracts are traded on designated "contracts markets" which,
through their clearing corporations,
<PAGE> 88
guarantee performance of the contracts. Currently, there are futures
contracts based on securities such as long-term U.S. Treasury bonds, U.S.
Treasury notes, GNMA Certificates and three-month U.S. Treasury bills. For
municipal securities, there is the Bond Buyer Municipal Bond Index.
Generally, if market interest rates increase, the value of outstanding
debt securities declines (and vice versa). Entering into a futures
contract for the sale of securities has an effect similar to the actual
sale of securities, although sale of the futures contract might be
accomplished more easily and quickly. For example, if the Fund holds long-
term U.S. Government securities and the Adviser anticipates a rise in long-
term interest rates, the Fund could, in lieu of disposing of its portfolio
securities, enter into futures contracts for the sale of similar long-term
securities. If rates increased and the value of the Fund's portfolio
securities declined, the value of the Fund's futures contracts would
increase, thereby protecting the Fund by preventing net asset value from
declining as much as it otherwise would have. Similarly, entering into
futures contracts for the purchase of securities has an effect similar to
actual purchase of the underlying securities, but permits the continued
holding of securities other than the underlying securities. For example,
if the Adviser expects long-term interest rates to decline, the Fund might
enter into futures contracts for the purchase of long-term securities, so
that it could gain rapid market exposure that may offset anticipated
increases in the cost of securities it intends to purchase, while
continuing to hold higher-yielding short-term securities or waiting for the
long-term market to stabilize.
OPTIONS ON FUTURES CONTRACTS. The Fund may purchase and write put and
call options on futures contracts that are traded on a U.S. exchange or
board of trade and enter into related closing transactions to attempt to
gain additional protection against the effects of interest rate, currency
or equity market fluctuations. There can be no assurance that such closing
transactions will be available at all times. In return for the premium
paid, such an option gives the purchaser the right to assume a position in
a futures contract at any time during the option period for a specified
exercise price.
The Fund may purchase put options on futures contracts in lieu of, and
for the same purpose as, the sale of a futures contract. It also may
purchase such put options in order to hedge a long position in the
underlying futures contract.
The purchase of call options on futures contracts is intended to serve
the same purpose as the actual purchase of the futures contracts. The Fund
may purchase call options on futures contracts in anticipation of a market
advance when it is not fully invested.
The Fund may write a call option on a futures contract in order to
hedge against a decline in the prices of the index or securities underlying
the futures contracts. If the price of the futures contract at expiration
is below the exercise price, the Fund would retrain the option premium,
which would offset, in part, any decline in the value of its portfolio
securities.
The writing of a put option on a futures contract is similar to the
purchase of the futures contracts, except that, if market price declines,
the Fund would pay more than the market price for the underlying securities
or index units. The net cost to that Fund would be reduced, however, by
the premium received on the sale of the put, less any transaction costs.
RISKS OF FUTURES AND OPTIONS INVESTMENTS. The Fund will incur
brokerage fees in connection with its futures and options transactions, and
it will be required to segregate funds for the benefit of
<PAGE> 89
brokers as margin to guarantee performance of its futures and options
contracts. In addition, while such contracts will be entered into to reduce
certain risks, trading in these contracts entails certain other risks. Thus,
while the Fund may benefit from the use of futures contracts and related
options, unanticipated changes in interest rates may result in a poorer
overall performance for the Fund than if it had not entered into any such
contracts. Additionally, the skills required to invest successfully in
futures and options may differ from skills required for managing other
assets in the Fund's portfolio. Further, although the Adviser may engage
in transactions with respect to index-based futures contracts if the
Adviser believes a correlation exists between price movements in the index
and in the Fund's portfolio securities, such a correlation is not likely to
be perfect because the Fund's portfolio is not likely to duplicate the
index, making the futures contract an imperfect hedge.
LIMITATIONS ON FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS.
The Fund will use financial futures contracts and related options only for
"bona fide hedging" purposes, as such term is defined in applicable
regulations of the CFTC, or, with respect to positions in financial futures
and related options that do not qualify as "bona fide hedging" positions,
will enter such non-hedging positions only to the extent that aggregate
initial margin deposits plus premiums paid by it for open futures option
positions, less the amount by which any such positions are "in-the-money",
would not exceed 5% of the Fund's total assets.
PERFORMANCE INFORMATION
The Fund may from time to time include figures indicating its yield,
total return or average annual total return in advertisements or reports to
stockholders or prospective investors. Quotations of the Fund's yield will
be based on all investment income per share earned during a particular 30-
day period (including dividends and interest), less expenses accrued during
the period ("net investment income"), and are computed by dividing net
investment income per share earned during the period by the maximum
offering price per share on the last day of the period, according to the
following formula:
YIELD = 2[(a-b + 1)6-1]
cd
where a = dividends and interest earned during the period,
b = expenses accrued for the period (net of reimbursements or
waivers),
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends, and
d = the maximum offering price per share on the last day of the
period.
Average annual total return and total return figures represent the
increase (or decrease) in the value of an investment in the Fund over a
specified period. Both calculations assume that all income dividends and
capital gains distributions during the period are reinvested at net asset
value in additional Fund shares. Quotations of the average annual total
return reflect a proportional share of Fund expenses on an annual basis.
The results, which are annualized, represent an average annual compounded
rate of return on a hypothetical investment in the Fund over a period of 1,
5 and 10 years ending on the most recent calendar quarter (but not for a
period greater than the life of the Fund), calculated pursuant to the
following formula:
<PAGE> 90
P (1 + T)n= ERV
where P = a hypothetical initial payment of $1,000,
T = the average annual total return,
n = the number of years, and
ERV = the ending redeemable value of a hypothetical $1,000
payment made at the beginning of the period.
Quotations of total return, which are not annualized, represent
historical earnings and asset value fluctuations. Total return is based on
past performance and is not a guarantee of future results.
Performance information for the Fund may be compared, in reports and
promotional literature, to: (i) certain unmanaged indexes such as the
Merrill Lynch Treasury Indices and the Shearson Lehman Intermediate
Government/Corporate Bond Index; (ii) certain performance figures prepared
for broad groups of mutual funds with investment goals similar to the Fund
by organizations such as Lipper Analytical and the Donoghue Organization;
(iii) the Consumer Price Index (the "CPI"), a statistical measure of
change, over time, in the price of goods and services in major expenditure
groups (such as food, housing, apparel, transportation, medical care,
entertainment and other goods and services) typically purchased by urban
consumers; (iv) other mutual funds with similar goals; and (v) certificates
of deposit. Instruments included in unmanaged indexes, such as the
Shearson and Merrill indexes, may not necessarily be typical of the type of
investments made by the Fund. Other material differences between the Fund
and such indexes may include (i) the managed character of the Fund's
portfolio (i.e. the Fund may purchase and sell investment securities based
on their performance while securities comprising the particular index may
remain as part of the index without regard to their performance), and (ii)
the index would not generally reflect deductions for administrative
expenses and costs. Further, broad-based economic indexes measure
developments of general matters which may or may not be relevant to the
Fund's performance during particular periods. For example, the purchasing
power of consumers' dollars by comparing the costs of goods and services
today with the costs of the same goods and services at an earlier date.
There are three material differences between an investment in the Fund
and ownership of a certificate of deposit ("CD"). First, an investment in
the Fund is subject to a greater degree of risk and fluctuation of value
than a CD, which guarantees a specific rate of return. Second, if interest
rates rise in the future, the capital value of bonds purchased at the
present time will fall, which will affect the Fund's performance if such
securities are held in its portfolio. Third, the underlying assets of a CD
are federally insured on amounts up to $100,000.
Performance information for the Fund reflects only the performance of
a hypothetical investment in the Fund during the particular time period on
which the calculations are based. Performance information should be
considered in light of the Fund's investment objectives and policies, the
types and quality of the Fund's portfolio investments, market conditions
during the particular time period and operating expenses. Such information
should not be considered as a representation of the Fund's future
performance.
<PAGE> 91
DIRECTORS AND EXECUTIVE OFFICERS
The names and addresses of the directors and principal officers of the
Corporation are set forth below, together with their positions and their
principal occupations during the last five years and, in the case of the
directors, their positions with certain other organizations and companies.
*EDWARD L. JAROSKI, Chairman of the Board, President and Director.
5847 San Felipe, Suite 4100, Houston, Texas 77057. President
(since 1992) and Director (since 1987) of the Capstone Asset
Management Company; President and Director of Capstone Asset
Planning Company and Capstone Financial Services, Inc. (since
1987); Director/Trustee and Officer of other Capstone Funds.
JAMES F. LEARY, Director. c/o Search Capital Group, Inc., 700 N.
Pearl Street, Suite 400, L.B. 401, Dallas, TX 75201-2809.
President of Sunwestern Management, Inc., (since June 1982) and
President of SIF Management (since January 1992), venture capital
limited partnership concerns; General Partner of Sunwestern
Advisors, L.P., Sunwestern Associates, Sunwestern Associates II,
Sunwestern Partners, L.P. and Sunwestern Ventures, Ltd. (venture
capital limited partnership entities affiliated with Sunwestern
Management, Inc. and SIF Management, Inc.). Director of: other
Capstone Funds; Anthem Financial, Inc. (financial services);
Associated Materials, Inc. (tire cord, siding and industrial cable
manufacturer); The Flagship Group, Inc. (vertical market
microcomputer software); Marketing Mercadeo International (public
relations and marketing consultants); MaxServ, Inc. (appliance
repair database systems); MESBIC Ventures, Inc. (minority
enterprise small business investment company); OpenConnect Systems,
Inc. (computer networking hardware and software); PhaseOut of
America, Inc. (smoking cessation products); and Search Capital
Group, Inc. (financial services).
JOHN R. PARKER, Director. P.O. Box 42, Woodbury, Vermont 05681.
Consultant and private investor (since 1990); Director of Nova
Natural Resources (oil, gas, minerals); Director of other Capstone
Funds; formerly Senior Vice President of McRae Capital Management,
Inc. (1991-1995); and registered representative of Rickel &
Associates (1988-1991).
PHILIP C. SMITH, Director. 87 Lord's Highway, Weston, Connecticut
06880. Private investor; Director of other Capstone Funds and the
Lexington Mutual Funds.
BERNARD J. VAUGHAN, Director. 113 Bryn Mawr Avenue, Bala Cynwyd,
Pennsylvania 19004. Director of other Capstone Funds; formerly
Vice President of Fidelity Bank (1979-1993).
DAN E. WATSON, Executive Vice President. 5847 San Felipe, Suite 4100,
Houston, Texas 77057. Chairman of the Board (since 1992) and
Director of Capstone Asset Management Company (since 1987);
Chairman of the Board and Director of Capstone Asset Planning
______________
* Director who is an interested person as defined in the Investment
Company Act of 1940 because of his relationship to the Adviser and
Distributor.
<PAGE> 92
Company and Capstone Financial Services, Inc. (since 1987); Officer
of other Capstone Funds.
HOWARD S. POTTER, Executive Vice President. 1 Barker Avenue, White
Plains, New York 10601. Managing Director of Capstone Financial
Services, Inc., Capstone Asset Management Company and Capstone
Asset Planning Company (since 1996); formerly President of New
Castle Advisers, Inc. (1991-1995); Senior Vice President of James
Money Management, Inc. (1988-1991).
JOHN M. METZINGER, Vice President. 5847 San Felipe, Suite 4100,
Houston, Texas 77057. Assistant Vice President (1992-1993) and
Vice President (since 1993) of Capstone Financial Services, Inc.
and Capstone Asset Management Company; Investment Analyst (1990-
1991) and Assistant Portfolio Manager (1991-1992) with Capstone
Financial Services, Inc.; Officer of other Capstone Funds.
IRIS R. CLAY, Secretary. 5847 San Felipe, Suite 4100, Houston, Texas
77057. Secretary (since February 1996); Assistant Vice President
(1994-1996) and Assistant Secretary (1990-1994) of Capstone
Financial Services, Inc., Capstone Asset Management Company and
Capstone Planning Company; Officer of other Capstone Funds.
NORMA R. YBARBO, Assistant Secretary. 5847 San Felipe, Suite 4100,
Houston, Texas 77057. Assistant Compliance Officer (since 1994),
Compliance Analyst (1993-1994) and Compliance Assistant (1987-1993)
of Capstone Financial Services, Inc.; Officer of other Capstone
Funds.
LINDA G. GIUFFRE, Treasurer. 5847 San Felipe, Suite 410, Houston,
Texas 77057. Vice President and Treasurer (since February 1996) of
Capstone Financial Services, Inc., Capstone Asset Management
Company and Capstone Asset Planning Company; Treasurer and
Secretary (1994-1996) of Capstone Financial Services, Inc.,
Capstone Asset Management Company and Capstone Asset Planning
Company; Treasurer (1987-1994) of Capstone Financial Services,
Inc.; Officer of other Capstone Funds.
The Corporation has an Audit Committee and a Nominating Committee that
consist of the Corporation's disinterested directors. Mr. Leary serves as
Chairman of the Audit Committee and Mr. Smith is Chairman of the Nominating
Committee.
The directors and officers of the Corporation as a group own less than
one percent of the outstanding shares of the Fund. The directors of the
Corporation (other than Mr. Jaroski) also received compensation for serving
as directors of other investment companies sponsored by the Adviser as
identified in the foregoing table.
Each director not affiliated with the Adviser is entitled to $250 for
each Board meeting attended, and is paid a $1,000 annual retainer by the
Corporation. The directors and officers of the Corporation are also
reimbursed for expenses incurred in attending meetings of the Board of
Directors.
The following table represents the fees paid during the 1995 calendar
year to the directors of the Fund and the total compensation each director
received during that period from the Capstone Fund
<PAGE> 93
complex.
COMPENSATION TABLE
<TABLE>
<CAPTION>
Total
Compensation
From
Aggregate Pension or Registrant
Compensation Retirement Estimated Annual and Fund
Name of Person, From Benefits Accrued Benefits Upon Complex Paid
Position Registrant* As Part of Fund Retirement to Directors
- --------------- ------------ ---------------- --------------- ------------
<S> <C> <C> <C> <C>
James F. Leary, Director $1,000 $0 $0 $5,000(1)
John R. Parker, Director 1,000 0 0 5,000(1)
Philip C. Smith, Director 1,000 0 0 8,000(1)(2)(3)
Bernard J. Vaughan, Director 1,000 0 0 7,000(1)(2)
____________
* Directors do not receive any deferred compensation.
(1) Director of Capstone Fixed Income Series, Inc. and Capstone Growth Fund, Inc.
(2) Trustee of Capstone International Series Trust.
(3) Director of Medical Research Investment Fund, Inc.
</TABLE>
INVESTMENT ADVISORY AGREEMENT
Capstone Asset Management Company ("the Adviser") serves as the
investment adviser to the Fund pursuant to an investment advisory agreement
("Advisory Agreement") dated March 25, 1996 between the Adviser and the
Fund. The Advisory Agreement was approved by the Fund's initial
stockholder on February 5, 1996. The Adviser, located at 5847 San Felipe,
Suite 4100, Houston, Texas 77057 is a wholly-owned subsidiary of Capstone
Financial Services, Inc.
Pursuant to the terms of the Advisory Agreement and subject to the
supervision of the Board of Directors, the Adviser has agreed to (1)
provide a program of continuous investment management for the Fund in
accordance with the Fund's investment objectives, policies and limitations,
(2) make investment decisions for the Fund, (3) place orders to purchase
and sell securities for the Fund, and (4) provide administrative services
for the Fund. In this connection, the Adviser (i) assists in supervising
all aspects of the Fund's operations, including the coordination of all
matters relating to the functions of the Adviser, custodian, transfer
agent, other stockholder service agents, accountants, attorneys and other
parties performing services or operational functions for the Fund, (ii)
provides the Fund, at the Adviser's expense, with the services of persons
competent to perform such administrative and clerical functions as are
necessary in order to provide effective administration of the Fund,
including duties in connection with stockholder relations, reports,
redemption requests and account adjustments and the maintenance of
<PAGE> 94
certain books and records of the Fund, (iii) coordinates the preparation of
registration statements, prospectuses, reports, proxy solicitation
materials and amendments thereto, (iv) provides the Fund with office space
and facilities necessary to perform the Adviser's obligations under the
Advisory Agreement, and (v) pays all compensation of officers of the
Corporation and the fees of all directors of the Corporation who are
affiliated persons of the Adviser, the Adviser's parent, and other
subsidiaries. For these services the Fund pays the Adviser a fee computed
daily and payable monthly at the annual rate of 0.45% of the Fund's average
daily net assets up to $450 million and 0.36% of such assets in excess of
$450 million.
The annual fees of the Adviser will be reduced to the extent that the
Fund's ordinary expenses for any fiscal year (including advisory fees, but
excluding brokerage commissions, interest, local, state and Federal taxes
and extraordinary expenses) exceed the expense limitations of any state
having jurisdiction over the Fund. In such event, the annual advisory fees
of the Adviser will be reduced pro rata (but not below zero) to the extent
necessary to comply with such expense limitations. At the date of this
Statement of Additional Information, the strictest expense limitation
applicable to the Fund is 2.5% of the first $30 million of the Fund's
average net assets, 2.0% of the next $70 million of average net assets, and
1.5% of the remaining average net assets for any fiscal year.
The Fund pays all expenses incurred in the operation of the Fund other
than those assumed by the Adviser under the Advisory Agreement. Expenses
payable by the Fund include: fees and expenses of directors who are not
"interested persons" (as defined in the 1940 Act); fees of the Adviser;
Board of Directors meeting-related expenses of the directors and officers;
mailing expenses of all officers and directors; expenses for legal and
auditing services; data processing and pricing services; costs of printing
and mailing proxies, stock certificates and stockholder reports; fees of
the Adviser; charges of the custodian, transfer agent, registrar or
dividend disbursing agent; expenses pursuant to the Service and
Distribution Plan (see "Distributor"); Securities and Exchange Commission
fees; membership fees in trade associations; fidelity bond coverage for the
Fund's officers; directors' and officers' errors and omissions insurance
coverage; interest; brokerage costs; taxes; expenses of qualifying the
Fund's shares for sale in various states; litigation; and other
extraordinary or non-recurring expenses and other expenses properly payable
by the Fund.
The following individuals are affiliated persons of both the
Corporation and the Adviser as defined in the 1940 Act: Dan E. Watson,
Edward L. Jaroski, Howard S. Potter, John M. Metzinger, Iris R. Clay, Linda
G. Giuffre and Norma Ybarbo.
DURATION AND TERMINATION
Unless terminated earlier as described below, the Advisory Agreement
will, by its terms, remain in effect until March 25, 1998, and will
continue in effect thereafter only if such continuance is specifically
approved at least annually by the Board of Directors or by vote of a
majority of the Fund's outstanding voting securities (as defined in the
1940 Act) and, in either case, by a majority of the directors who are not
parties to the Advisory Agreement or interested persons of any such party.
The Advisory Agreement will terminate automatically in the event of its
assignment and may be terminated without penalty by vote of a majority of
the Fund's outstanding voting securities or by either party on not more
than 60 days' written notice.
<PAGE> 95
DISTRIBUTOR
Capstone Asset Planning Company (the "Distributor") acts as the
principal underwriter of the Fund's shares pursuant to a written agreement
with the Fund dated March 26, 1996 (the "Distribution Agreement"). The
Distributor has the exclusive right (except for distributions of shares
directly by the Fund) to distribute Fund shares in a continuous offering
through affiliated and unaffiliated dealers. The Distributor's obligation
is a "best efforts" arrangement under which the Distributor is required to
take and pay for only such Fund shares as may be sold to the public. The
Distributor is not obligated to sell any stated number of shares. Except
to the extent otherwise permitted by the Service and Distribution Plan (see
below), the Distributor bears the cost of printing (but not typesetting)
prospectuses used in connection with this offering and the cost and expense
of supplemental sales literature, promotion and advertising.
The Distribution Agreement will remain in effect until March 25, 1998
(unless earlier terminated as discussed below), and is renewable from year
to year thereafter if approved (a) by the Corporation's Board of Directors
or by a vote of a majority of the Fund's outstanding voting securities and
(b) by the affirmative vote of a majority of directors who are not parties
to the Distribution Agreement or interested persons of any party thereto,
by votes cast in person at a meeting called for such purpose. The
Distribution Agreement provides that it will terminate if assigned (as
defined in the 1940 Act), and that it may be terminated without penalty by
either party on 60 days' written notice.
The Fund has adopted a Service and Distribution Plan (the "Plan")
pursuant to Rule 12b-1 of the Investment Company Act of 1940 which permits
the Fund to absorb certain expenses in connection with the distribution of
its shares and provision of certain services to stockholders. See
"Management of the Fund - Distributor" in the Fund's Prospectus. As
required by Rule 12b-1, the Fund's Plan and related agreements were
approved by a vote of the Fund's Board of Directors, and by a vote of the
directors who are not "interested persons" of the Fund as defined under the
1940 Act and have no direct or indirect interest in the operation of the
Plan or any agreements related to the Plan (the "Plan Directors"), and by
the Fund's initial stockholder on February 5, 1996. In compliance with the
Rule, the directors requested and evaluated information they thought
necessary to make an informed determination of whether the Plan and related
agreements should be implemented, and concluded, in the exercise of
reasonable business judgment and in light of their fiduciary duties, that
there is a reasonable likelihood that the Plan and related agreements will
benefit the Fund and its stockholders.
As required by Rule 12b-1, the directors review quarterly reports
prepared by the Distributor on the amounts expended and the purposes for
the expenditures.
The Plan and related agreements may be terminated at any time by a
vote of the Plan Directors. As required by Rule 12b-1, selection and
nomination of disinterested directors for the Corporation is committed to
the discretion of the directors who are not "interested persons" as defined
under the 1940 Act, who comprise the Corporation's Nominating Committee.
The Plan and related agreements may be terminated by a vote of the
stockholders. Any change in the Plan that would materially increase the
distribution expenses of the Fund requires stockholder approval, but
otherwise, the Plan may be amended by the directors, including a majority
of the Plan Directors.
<PAGE> 96
The Plan will continue in effect for successive one year periods
provided that such continuance is specifically approved by a majority of
the directors, including a majority of the Plan Directors.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the policies established by the Corporation's Board of
Directors, the Adviser is responsible for decisions to buy and sell
securities for the Fund and for the placement of its portfolio business and
the negotiation of the commissions paid on such transactions. It is the
policy of the Adviser to seek (except as noted below) the best security
price available with respect to each transaction. In selecting dealers and
in negotiating commissions, the Adviser considers the firm's reliability,
the quality of its execution services on a continuing basis and its
financial condition. When more than one firm are believed to meet these
criteria, preference may be given to firms which also provide research
services to the Fund or the Adviser. From time to time, the Adviser
effects securities transactions through Capstone Asset Planning Company,
TradeStar Investments, Inc. and Williams McKay Jordan & Mills, Inc.,
broker-dealer affiliates of the Adviser.
The portfolio of the Fund is composed primarily of cash, short-term
and intermediate-term debt securities and when purchases and sales of
securities for the portfolio are made, a "spread" or "mark-up" (dealer's
profit) is generally included in the price of the securities. The Fund's
portfolio transactions are generally effected without the payment of
brokerage commissions.
The Fund has no obligation to deal with any broker or group of brokers
in executing transactions in portfolio securities. As discussed above,
most of the Fund's transactions are executed on a principal basis without
the payment of a commission. On trades involving a commission, the Adviser
generally seeks reasonably competitive commission rates for transactions it
places on behalf of the Fund, although the Fund does not necessarily pay
the lowest commission available. For non-principal transactions the
Adviser is authorized to cause the Fund to pay a broker that provides
brokerage and research services a commission in excess of the amount
another broker might have charged for effecting a securities transaction.
Such higher commission may be paid if the Adviser determines in good faith
that the amount paid is reasonable in relation to the services received in
terms of the particular transaction or the Adviser's overall
responsibilities to the Fund and other clients of the Adviser. Such
research services must provide lawful and appropriate assistance to the
Adviser in the performance of its investment decision-making
responsibilities and may include: (a) furnishing advice as to the value of
securities, the advisability of investing in, purchasing or selling
securities, and the availability of securities or the purchasers or sellers
of securities; and (b) furnishing analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy,
and the performance of accounts. Such information may be received orally
or in writing and will be in addition to and not in lieu of the services
required to be performed by the Adviser under the Advisory Agreement . The
expenses of the Adviser will not necessarily be reduced as a result of the
receipt of such supplemental information. This information may be useful
to the Adviser in providing services to clients other than the Fund, and
not all such information is used by the Adviser in connection with the
Fund. Conversely, such information provided to the Adviser by brokers and
dealers through whom other clients of the Adviser effect securities
transactions may be useful to the Adviser in providing services to the
Fund.
Some of the securities in which the Fund invests may be traded in the
OTC markets, and the Fund intends to deal directly with the dealers who
make markets in the securities involved, except in
<PAGE> 97
those circumstances where better prices and execution are available elsewhere.
Although investment decisions for the Fund are made independently from
those of the other accounts managed by the Adviser, investments of the kind
made by the Fund may also be made by those other accounts. Opportunities
to purchase or sell securities will be allocated in the discretion of the
Adviser by such means as will, in their judgment, result in fair and equal
treatment in connection with the other accounts managed by them. Such
means may include allocating opportunities ratably, rotationally or at
random among the Fund and other accounts, on the basis of accounts having
the least favorable performance or any combination of the foregoing. The
Adviser may aggregate orders for purchases and sales of securities of the
same issuer on the same day among the Fund and other accounts and the price
paid to or received by the Fund and those accounts will be the average
obtained in those orders. In some cases, the foregoing aggregation and
allocation procedures may affect adversely the price paid or received by
the Fund or the size of the position purchased or sold by the Fund.
DETERMINATION OF NET ASSET VALUE
The Fund's net asset value is computed daily, Monday through Friday,
as of 4:15 p.m. Eastern Time, except that the net asset value will not be
computed on the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day and the days that the Federal Reserve wire system is closed.
The Fund also will determine its net asset value on any day in which there
is sufficient trading in its portfolio securities that the net asset value
might be affected materially, but only if on any such day the Fund is
required to sell or redeem shares. The Fund's net asset value per share is
computed by dividing the value of the securities held by the Fund plus any
cash or other assets (including any accrued interest and dividends
receivable but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares outstanding at such time, adjusted
to the nearest whole cent. The net asset value so computed will be used
for all purchase orders and redemption requests received between such
computation and the preceding computation.
The value of the Fund's portfolio securities and other assets is based
on market values determined by procedures established by the Corporation's
Board of Directors. Securities listed on a national exchange or designated
as national market system securities are valued at the last sale price or,
if there has been no sale that day, at the last bid price. All portfolio
securities for which over-the-counter ("OTC") market quotations are readily
available are valued at the mean between the bid and asked prices. OTC
options are valued using the Black-Scholes Model, which utilizes the
option's characteristics when bought or sold and the market price of the
underlying security to determine a daily price for each OTC option's
position. The only pricing variable changed daily is the price of the
underlying security. Short-term instruments having a maturity date of more
than 60 days are valued on a "mark-to-market" basis, that is, at prices
based on market quotations for securities of similar type, yield, quality
and maturity, until 60 days prior to maturity and thereafter at amortized
value. Short-term instruments having a maturity date of 60 days or less at
the time of purchase are valued at amortized cost value unless the Board of
Directors determines this does not represent fair market value. When
market quotations are not readily available, portfolio securities are
valued at their fair value as determined in good faith under procedures
established by and under the general supervision of the Board of Directors
(valuation of securities for which market quotations are not readily
available may be based upon current market prices of securities which are
comparable in coupon, rating and maturity or an appropriate matrix
utilizing
<PAGE> 98
similar factors).
HOW TO BUY AND REDEEM SHARES
Shares of the Fund are sold in a continuous offering and may be
purchased on any business day through authorized dealers, including
Capstone Asset Planning Company. Certain broker-dealers assist their
clients in the purchase of shares from the Distributor and may charge a fee
for this service in addition to the Fund's net asset value.
Shares will be credited to a stockholder's account at the public
offering price next computed after an order is received by the Distributor.
Initial purchases must be at least $10,000, and there is no minimum for
subsequent investments. No stock certificates representing shares
purchased will be issued except upon written request to the Fund's Transfer
Agent. The Fund's management reserves the right to reject any purchase
order if, in its opinion, it is in the Fund's best interest to do so. See
"Purchasing Shares" in the Prospectus.
Generally, a stockholder may require the Fund to redeem his shares by
sending a written request, signed by the record owner(s), to Capstone
Intermediate Government Fund, c/o Fund/Plan Services, Inc., P.O. Box 874, 2
W. Elm Street, Conshohocken, Pennsylvania 19428. In addition, certain
expedited redemption methods are available. See "Redemption and Repurchase
of Shares" in the Prospectus.
TAXES
The following summary describes some of the more significant Federal
income tax consequences applicable to investors in the Fund based on
existing Federal tax law. New tax laws may be enacted which might affect
the tax consequences of an investment in the Fund. The following
discussion is necessarily general, and prospective investors are urged to
consult their own tax advisers with respect to the particular tax
consequences to the investor of an investment in the Fund.
The Fund intends to qualify and elect to be treated as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1986,
as amended (the "Code"). Qualification and election to be taxed as a
regulated investment company involves no supervision of management or
investment policies or practices by any government agency. To qualify as a
regulated investment company the Fund must, with respect to each taxable
year, distribute to stockholders at least 90% of its investment company
taxable income (which includes, among other items, interest and the excess
of net short-term capital gains over net long-term capital losses) and meet
certain diversification of assets, source of income, and other requirements
of the Code.
As a regulated investment company, the Fund generally is not subject
to Federal income tax on its investment company taxable income and net
capital gain (net long-term capital gains in excess of net short-term
capital losses), if any, that it distributes to stockholders. The Fund
intends to distribute to its stockholders, at least annually, substantially
all of its investment company taxable income and net capital gain. Amounts
not distributed on a timely basis in accordance with a calendar year
distribution requirement are subject to a nondeductible 4% excise tax. To
prevent imposition of the tax, the Fund must distribute during each
calendar year (1) at least 98% of its ordinary income (not taking into
account
<PAGE> 99
any capital gains or losses) for the calendar year, (2) at least 98% of its
capital gains in excess of its capital losses for the twelve-month period
ending on October 31 of the calendar year (reduced by certain ordinary
losses, as prescribed by the Code), and (3) all ordinary income and capital
gains for previous years that were not distributed during such years. A
distribution will be treated as paid on December 31 of the calendar year if
it is declared by the Fund in October, November or December of that year to
stockholders on a record date in such a month and paid by the Fund during
January of the following calendar year. Such distributions will be taxable
to stockholders in the calendar year the distributions are declared, rather
than the calendar year in which the distributions are received. To prevent
application of the excise tax, the Fund intends to make its distributions
in accordance with the calendar year distribution requirement.
If the Fund retains its net capital gains, although it has no plans to
do so, the Fund may elect to treat such amounts as having been distributed
to its stockholders. As a result, the stockholders would be subject to tax
on undistributed capital gain, would be able to claim their proportionate
share of the Federal income taxes paid by the Fund on such gains as a
credit against their own Federal income tax liabilities, and would be
entitled to an increase in their basis in their Fund shares.
DISTRIBUTIONS. Dividends paid out of the Fund's investment company
taxable income will be taxable to a stockholder as ordinary income.
Distributions of net capital gains, if any, designated by the Fund as
capital gain dividends, are taxable as long-term capital gains, regardless
of how long the stockholder has held the Fund's shares, and are not
eligible for the dividends received deduction.
Dividends received by corporate stockholders may qualify for the
dividends received deduction to the extent the Fund designates its
dividends as derived from dividends from domestic corporations. The amount
designated by the Fund as so qualifying cannot exceed the aggregate amount
of dividends received by the Fund from domestic corporations for the
taxable year. Since the Fund's income may not consist exclusively of
dividends eligible for the corporate dividends received deduction, its
distributions of investment company taxable income likewise may not be
eligible, in whole or in part, for that deduction. The alternative minimum
tax applicable to corporations may reduce the benefits of the dividends
received deduction. The dividends received deduction may be further
reduced if the shares of the Fund are debt-financed or are deemed to have
been held less than 46 days.
All distributions are taxable to the stockholder whether reinvested in
additional shares or received in cash. Stockholders receiving
distributions in the form of additional shares will have a cost basis for
Federal income tax purposes in each share received equal to the net asset
value of a share of the Fund on the reinvestment date. Stockholders will
be notified annually as to the Federal tax status of distributions paid to
them by the Fund.
Distributions by the Fund reduce the net asset value of the Fund
shares. Should a distribution reduce the net asset value below a
stockholder's cost basis, such distribution nevertheless would be taxable
to the stockholder as ordinary income or capital gain as described above,
even though, from an investment standpoint, it may constitute a partial
return of capital. In particular, investors should be careful to consider
the tax implications of buying shares just prior to a distribution by the
Fund. The price of shares purchased at that time includes the amount of
the forthcoming distribution, but the distribution will generally be
taxable to them.
HEDGING AND OTHER TRANSACTIONS. Certain options are "section 1256
contracts." Any gains
<PAGE> 100
or losses on section 1256 contracts generally are considered 60% long-term
and 40% short-term capital gains or losses ("60/40"). Also, section 1256
contracts held by the Fund at the end of each taxable year (and at other
times prescribed pursuant to the Code) are "marked-to-market" with the
result that unrealized gains or losses are treated as though they were
realized and the resulting gain or loss is generally treated as 60/40 gain
or loss.
Generally, the hedging transactions undertaken by the Fund may result
in "straddles" for Federal income tax purposes. The straddle rules may
affect the character of gains (or losses) realized by the Fund. In
addition, losses realized by the Fund on positions that are part of a
straddle may be deferred under the straddle rules, rather than being taken
into account in calculating the taxable income for the taxable year in
which such losses are realized. Because only a few regulations
implementing the straddle rules have been promulgated, the tax consequences
to the Fund of hedging transactions are not entirely clear. The hedging
transactions may increase the amount of short-term capital gain realized by
the Fund which is taxed as ordinary income when distributed to
stockholders.
The Fund may make one or more of the elections available under the
Code which are applicable to straddles. If the Fund makes any of the
elections, the amount, character and timing of the recognition of gains or
losses from the affected straddle positions will be determined under rules
that vary according to the election(s) made. The rules applicable under
certain of the elections may operate to accelerate the recognition of gains
or losses from the affected straddle positions.
Because application of the straddle rules may affect the character of
gains or losses, defer losses and/or accelerate the recognition of gains or
losses from the affected straddle positions, the amount which must be
distributed to stockholders, and which will be taxed to stockholders as
ordinary income or long-term capital gain, may be increased or decreased
substantially as compared to a fund that did not engage in such hedging
transactions.
Because the tax consequences of straddle transactions to the Fund are
not entirely clear, it may ultimately be determined that the Fund's tax
accounting procedures failed to conform to the straddle rules.
Consequently, the Fund may have inadvertently failed to satisfy one or more
of the requirements for qualification as a regulated investment company.
If the Fund has failed to satisfy the requirement that it distribute at
least 90% of its net investment company taxable income, the Fund may be
able to preserve its regulated investment company status by making a
"deficiency dividend" distribution. In addition, the Fund would have to
pay interest and a penalty on the amount of the deficiency dividend
distribution. If the Fund fails to satisfy one of the other requirements
for qualification as a regulated investment company, the Fund would be
taxed as an ordinary corporation, and its distributions, including net
capital gain distributions, would be taxable to stockholders as ordinary
dividends. Moreover, upon any requalification as a regulated investment
company, the Fund might be subject to a corporate-level tax on certain
gains.
Certain requirements that must be met under the Code in order for the
Fund to qualify as a regulated investment company may limit the extent to
which the Fund will be able to engage in transactions in options.
Certain of the debt securities acquired by the Fund may be treated as
debt securities that were originally issued at a discount. Original issue
discount can generally be defined as the difference between the price at
which a security was issued and its stated redemption price at maturity.
Although
<PAGE> 101
no cash income is actually received by the Fund, original issue discount
on a taxable debt security earned in a given year generally is treated
for Federal income tax purposes as interest and, therefore, such income
would be subject to the distribution requirements of the Code.
Some of the debt securities may be purchased by the Fund at a discount
which exceeds the original issue discount on such debt securities, if any.
This additional discount represents market discount for Federal income tax
purposes. The gain realized on the disposition of any debt security
acquired after April 30, 1993 or any taxable debt security acquired prior
to May 1, 1993 having market discount will be treated as ordinary income
to the extent it does not exceed the accrued market discount on such debt
security. Generally, market discount accrues on a daily basis for each day
the debt security is held by the Fund at a constant rate over the time
remaining to the debt security maturity or, at the election of the Fund, at
a constant yield to maturity which takes into account the semi-annual
compounding of interest.
DISPOSITION OF SHARES. Upon disposition (by redemption, repurchase,
sale or exchange) of Fund shares, a stockholder will realize a taxable gain
or loss depending upon his basis in his shares. Such gain or loss will be
treated as capital gain or loss if the shares are capital assets in the
stockholder's hands. Such gain or loss generally will be long-term or
short-term depending upon the stockholder's holding period for the shares.
However, a loss realized by a stockholder on the disposition of Fund shares
with respect to which capital gain dividends have been paid will, to the
extent of such capital gain dividends, be treated as long-term capital loss
if such shares have been held by the stockholder for six months or less.
Further, a loss realized on a disposition will be disallowed to the extent
the shares disposed of are replaced (whether by reinvestment of
distributions or otherwise) within a period of 61 days beginning 30 days
before and ending 30 days after the shares are disposed of. In such a
case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss. Exchanges of Fund shares for shares of other funds
generally would be treated as taxable sales of the shares exchanged by the
stockholder.
BACKUP WITHHOLDING. The Fund may be required to withhold Federal
income tax at the rate of 31% of all taxable distributions from the Fund
and of gross proceeds from the redemption of shares payable to stockholders
who fail to provide the Fund with their correct taxpayer identification
number or to make required certifications, or who have been notified by the
Internal Revenue Service that they are subject to backup withholding.
Corporate stockholders and certain other stockholders specified in the Code
generally are exempt from backup withholding. Backup withholding is not an
additional tax. Any amounts withheld may be credited against the
stockholder's U.S. Federal income tax liability.
OTHER TAXES. Distributions also may be subject to additional state,
local and foreign taxes depending on each stockholder's particular
situation. Foreign stockholders may be subject to U.S. tax rules that
differ significantly from those described above, including the likelihood
that distributions to them would be subject to withholding of U.S. tax at a
rate of 30% (or at a lower rate under a tax treaty). Stockholders are
advised to consult their own tax advisers with respect to the particular
tax consequences to them of an investment in the Fund.
<PAGE> 102
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
To the knowledge of the Board of Directors, no person owns more than
five percent of the Fund's common stock.
OTHER INFORMATION
CUSTODY OF ASSETS. All securities owned by the Fund and all cash,
including proceeds from the sale of shares of the Fund and of securities in
the Fund's investment portfolio, are held by The Fifth Third Bank, 38
Fountain Square, Cincinnati, Ohio 45263, as Custodian.
STOCKHOLDER REPORTS. Semi-annual statements are furnished to
stockholders, and annually such statements are audited by the Fund's
independent accountants.
INDEPENDENT ACCOUNTANTS. Tait, Weller & Baker, Two Penn Center Plaza,
Suite 700, Philadelphia, Pennsylvania 19102-1707, the independent
accountants for the Fund, performs annual audits of the Fund's financial
statements.
LEGAL COUNSEL. Dechert Price & Rhoads, 1500 K Street, N.W., Suite
500, Washington, DC 20005, is legal counsel to the Fund.
<PAGE> 103
CAPSTONE FIXED INCOME SERIES, INC.
CAPSTONE GOVERNMENT INCOME FUND
CAPSTONE INTERMEDIATE GOVERNMENT FUND
OTHER INFORMATION
(PART C TO REGISTRATION STATEMENT NO. 2-28174)
Item 24. Financial Statements and Exhibits
---------------------------------
Exhibits not incorporated by reference to a prior filing are
designated by an asterisk; all exhibits not so designated are incorporated
hereby by reference to a prior filing as indicated.
(a) Financial Statements:
Condensed Financial Information (Part A)
Statement of Assets and Liabilities, including the
schedule of investments, as of December 31, 1994 (Part B)
Statement of Operations for the year ended December 31,
1994 (Part B)
Statement of Changes in Net Assets for the years ended
December 31, 1994 and 1993 (Part B)
Notes to Financial Statements (Part B)
(b) Exhibits:
A. Exhibits filed pursuant to Form N-1A
1(a) Copy of Certificate of Incorporation dated
December 6, 1967; Exhibit 1 to Registration No.
2-28174.
1(b) Copy of Certificate of Amendment of Certificate
of Incorporation dated May 14, 1968; Exhibit 1A
to Amendment No. 1 to Registration No. 2-28174.
1(c) Copy of Certificate of Amendment of Certificate
of Incorporation dated July 23, 1979; Exhibit 1
to Amendment No. 6 to Registration No. 2-28174.
1(d) Copy of Certificate of Amendment of Certificate
of Incorporation dated December 19, 1980;
Exhibit 2(ii) to Post-Effective Amendment No.
22 to Registration No. 2-28174.
1(e) Copy of Certificate of Amendment of Certificate
of Incorporation dated July 25, 1977; Exhibit
1(e) to Post-Effective Amendment No. 29 to
Registration No. 2-28174.
1(f) Copy of Certificate of Amendment of Certificate
of Incorporation dated April 30, 1986; Exhibit
1(f) to Post-Effective Amendment No. 29 to
Registration No. 2-28174.
<PAGE> 104
1(g) Copy of Certificate of Amendment of Certificate
of Incorporation dated January 12, 1990;
Exhibit 1(g) to Post-Effective Amendment No. 33
to Registration No. 2-28174.
1(h) Copy of Certificate of Amendment of Certificate
of Incorporation of Investors Income Fund, Inc.
dated January 8, 1991; Exhibit 1(h) to Post-
Effective Amendment No. 36 to Registration No.
2-28174.
1(i) Copy of Certificate of Amendment of Certificate
of Incorporation of Investors Income Fund, Inc.
dated February 15, 1991; Exhibit 1(i) to Post-
Effective Amendment No. 36 to Registration No.
2-28174.
1(j) Copy of Agreement and Articles of Merger of
Capstone Fixed Income Series, Inc. dated May
11, 1992; Exhibit 1(j) to Post-Effective
Amendment No. 41 to Registration No. 2-28174.
1(k) Copy of Articles of Incorporation of Capstone
Fixed Income Series, Inc. dated May 11, 1992;
Exhibit 1(k) to Post-Effective Amendment No. 41
to Registration No. 2-28174.
2(a) Copy of By-Laws of Southwestern Investors
Income Fund, Inc., as amended; Exhibit 2 to
Post-Effective Amendment No. 25 to Registration
No. 2-28174.
2(b) Copy of Amendment to By-Laws of Investors
Income Fund, Inc., as amended; Exhibit 2(b) to
Post-Effective Amendment No. 33 to Registration
No. 2-28174.
2(c) Copy of By-Laws of Capstone Fixed Income
Series, Inc.; Exhibit 2(c) to Post-Effective
Amendment No. 41 to Registration No. 2-28174.
3 None
4 Specimen Common Stock Certificate
5(a) Copy of Investment Advisory Agreement between
Southwestern Investors Income Fund, Inc. and
Tenneco Asset Management Company dated as of
July 26, 1982; Exhibit 5 to Post-Effective
Amendment No. 25 to Registration No. 2-28174.
5(b) Copy of Amendment to Investment Advisory
Agreement between Southwestern Investors Income
Fund, Inc. and Tenneco Asset Management Company
dated as of February 21, 1984; Exhibit 5(b) to
Post-Effective Amendment No. 27 to Registration
No. 2-28174.
<PAGE> 105
5(c) Copy of Investment Advisory Agreement between
Investors Income Fund, Inc. and Capstone Asset
Management Company dated as of September 1,
1987; Exhibit 5(c) to Post-Effective Amendment
No. 30 to Registration No. 2-28174.
5(d) Copy of Consulting Agreement between Howard S.
Potter and Capstone Asset Management Company
dated as of November 1, 1991; Exhibit 5(d) to
Post-Effective Amendment No. 39 to Registration
No. 2-28174.
5(e) Copy of Interim Subadvisory Agreement between
New Castle Advisers, Inc. and Capstone Asset
Management Company dated November 21, 1991;
Exhibit 5(e) to Post-Effective Amendment No. 39
to Registration No. 2-28174.
5(f) Copy of Investment Advisory Agreement between
Capstone Government Income Fund and Capstone
Asset Management Company dated February 19,
1992; Exhibit 5(f) to Post-Effective Amendment
No. 39 to Registration No. 2-28174.
5(g) Copy of Subadvisory Agreement between New
Castle Advisers, Inc. and Capstone Asset
Management Company dated February 19, 1992;
Exhibit 5(g) to Post-Effective Amendment No. 39
to Registration No. 2-28174.
5(h) Copy of Investment Advisory Agreement between
Capstone Fixed Income Series, Inc. and Capstone
Asset Management Company dated May 11, 1992;
Exhibit 5(h) to Post-Effective Amendment No. 41
to Registration No. 2-28174.
5(i) Copy of Subadvisory Agreement between New
Castle Advisers, Inc. and Capstone Asset
Management Company dated May 11, 1992; Exhibit
5(i) to Post-Effective Amendment No. 41 to
Registration No. 2-28174.
5(j) Proposed form of Investment Advisory Agreement
between Capstone Fixed Income Series, Inc., on
behalf of Bond USA Fund, and Greenwich Asset
Management, Incorporated; Exhibit 5(j) to Post-
Effective Amendment No. 42 to Registration No.
2-28174.
5(k) Proposed form of Subadvisory Agreement between
Capstone Asset Management Company and Greenwich
Asset Management, Incorporated; Exhibit 5(k) to
Post-Effective Amendment No. 42 to Registration
No. 2-28174.
5(l) Proposed form of Investment Advisory Agreement
between Capstone Fixed Income Series, Inc., on
behalf of Capstone Intermediate Government
Fund, and Capstone Asset
<PAGE> 106
Management Company; Exhibit 5(l) to Post-
Effective Amendment No. 47 to Registration No.
2-28174.
6(a) Copy of General Distribution Agreement between
Southwestern Investors Income Fund, Inc. and
Tenneco Asset Planning Company dated October 1,
1984; Exhibit 6 to Post-Effective Amendment No.
28 to Registration No. 2-28174.
6(b) Copy of General Distribution Agreement between
Investors Income Fund, Inc. and Capstone Asset
Planning Company dated September 1, 1987;
Exhibit 6(b) to Post-Effective Amendment No. 30
to Registration No. 2-28174.
6(c) Copy of General Distribution Agreement between
Capstone Government Income Fund and Capstone
Asset Planning Company dated March 1, 1992;
Exhibit 6(c) to Post-Effective Amendment No. 39
to Registration No. 2-28174.
6(d) Copy of General Distribution Agreement between
Capstone Fixed Income Series, Inc., on behalf
of Capstone Government Income Fund, and
Capstone Asset Planning Company dated May 11,
1992; Exhibit 6(d) to Post-Effective Amendment
No. 41 to Registration No. 2-28174.
6(e) Copy of Selling Group Agreement; Exhibit 6(e)
to Post-Effective Amendment No. 39 to
Registration No. 2-28174.
6(f) Proposed form of General Distribution Agreement
between Capstone Fixed Income Series, Inc., on
behalf of Bond USA Fund, and Capstone Asset
Planning Company; Exhibit 6(f) to Post-
Effective Amendment No. 42 to Registration No.
2-28174.
7 None
8(a) Copy of Custodian Agreement between
Southwestern Investors Income Fund, Inc. and
First Pennsylvania Bank N.A., dated July 1,
1985; Exhibit 8 to Post-Effective Amendment No.
28 to Registration No. 2-28174.
8(b) Proposed form of Custodian Agreement between
Capstone Fixed Income Series, Inc., on behalf
of Bond USA Fund, and The Nottingham Company,
Inc.; Exhibit 8(b) to Post-Effective Amendment
No. 42 to Registration No. 2-28174.
8(c) Copy of Custody Agreement between Capstone
Fixed Income Series, Inc. and The Fifth Third
Bank dated December 13, 1994.
9(a)(1) Copy of Administration Agreement between
Southwestern Investors Income Fund, Inc. and
First Pennsylvania Bank, N.A.
<PAGE> 107
dated as of May 19, 1982.
9(a)(2) Copy of Amendment of the Administration
Agreement among Southwestern Investors Income
Fund, Inc., First Pennsylvania Bank, N.A. and
Fund/Plan Services, Inc. dated as of December
23, 1985.
9(a)(3) Copy of Administration Agreement between
Investors Income Fund, Inc. and Capstone
Financial Services, Inc. dated as of October 1,
1987; Exhibit 9(c) to Post-Effective Amendment
No. 30 to Registration No. 2-28174.
9(a)(4) Proposed form of Administration Agreement
between Capstone Fixed Income Series, Inc., on
behalf of Bond USA Fund, and
Capstone Asset Management Company; Exhibit
9(a)(4) to Post-Effective Amendment No. 42 to
Registration No. 2-28174.
9(b)(1) Copy of Amendment of the Administration
Agreement among Southwestern Investors Income
Fund, Inc., First Pennsylvania Bank, N.A. and
Fund/Plan Services, Inc. dated as of December
23, 1985.
9(c) Copy of Administration Agreement between
Investors Income Fund, Inc. and Capstone
Financial Services, Inc. dated as of October 1,
1987; Exhibit 9(c) to Post-Effective Amendment
No. 30 to Registration No. 2-28174.
10 Opinion of Dechert Price & Rhoads
*11(a)(1) Consent of Ernst & Young LLP, Independent
Auditors.
*11(a)(2) Consent of Tait, Weller & Baker, Independent
Certified Public Accountants.
*11(b) Powers of Attorney of Messrs. James F. Leary,
John R. Parker, Philip C. Smith and Bernard J.
Vaughan.
12 None
13 None
14(a)(1) Southwestern Life Insurance Company Defined
Benefit Pension Plan and Trust; Exhibit
14(a)(1) to Pre-Effective Amendment No. 1 to
Registration No. 2-99810.
______________
* Filed herewith
<PAGE> 108
14(a)(2) Adoption Agreement for Southwestern Life
Insurance Company Standardized Integrated
Defined Benefit Pension Plan and Trust
(with Pairing Provisions); Exhibit 14(a)(2) to
Pre-Effective Amendment No. 1 to Registration
No. 2-99810.
14(a)(3) Adoption Agreement for Southwestern Life
Insurance Company Standardized Non-Integrated
Defined Benefit Pension Plan and Trust (with
Pairing Provisions); Exhibit 14(a)(3) to Pre-
Effective Amendment No. 1 to Registration No.
2-99810.
14(a)(4) Adoption Agreement for Southwestern Life
Insurance Company Non-Standardized Integrated
Defined Benefit Pension Plan and Trust; Exhibit
14(a)(4) to Pre-Effective Amendment No. 1 to
Registration No. 2-99810.
14(a)(5) Adoption Agreement for Southwestern Life
Insurance Company Non-Standardized Non-
Integrated Defined Benefit Pension Plan
and Trust; Exhibit 14(a)(5) to Pre-Effective
Amendment No. 1 to Registration No. 2-99810.
14(b)(1) Southwestern Life Insurance Company Combination
Profit Sharing-Money Purchase Plan and Trust;
Exhibit 14(b)(1) to Pre-Effective Amendment No.
1 to Registration No. 2-99810.
14(b)(2) Adoption Agreement for Southwestern Life
Insurance Company Standardized Money Purchase
Plan and Trust (with Pairing Provisions);
Exhibit 14(b)(2) to Pre-Effective Amendment No.
1 to Registration No. 2-99810.
14(b)(3) Adoption Agreement for Southwestern Life
Insurance Company Standardized Profit Sharing
Plan and Trust (with Pairing Provisions);
Exhibit 14(b)(3) to Pre-Effective Amendment No.
1 to Registration No. 2-99810.
14(b)(4) Adoption Agreement for Southwestern Life
Insurance Company Non-Standardized Money
Purchase Plan and Trust; Exhibit 14(b)(4) to
Pre-Effective Amendment No. 1 to Registration
No. 2-99810.
14(b)(5) Adoption Agreement for Southwestern Life
Insurance Company Non-Standardized Profit
Sharing Plan and Trust; Exhibit 14(b)(5) to
Pre-Effective Amendment No. 1 to Registration
No. 2-99810.
14(c) Form 5305, Simplified Employee Pension-
Individual Retirement Accounts Contribution
Agreement; Exhibit 14(c) to Pre-Effective
Amendment No. 1 to Registration No. 2-99810.
14(d) Form 5305-A, Individual Retirement Custodial
Account; Exhibit
<PAGE> 109
14(d) to Pre-Effective Amendment No. 1 to
Registration No. 2-99810.
14(e)(1) Southwestern Life Insurance Company Tax
Deferred Annuity Program Custodial Agreement;
Exhibit 14(e)(1) to Pre-Effective Amendment No.
1 to Registration No. 2-99810.
14(e)(2) Amendment to Application for Investment Plans
under a 403(b)(7) Plan; Exhibit 14(e)(2) to
Pre-Effective Amendment No. 1 to Registration
No. 2-99810.
15(a) Copy of Service and Distribution Plan; Exhibit
15(a) to Post-Effective Amendment No. 39 to
Registration No. 2-28174.
15(b) Copy of Service Agreement; Exhibit 15(b) to
Post-Effective Amendment No. 39 to Registration
No. 2-28174.
15(c) Proposed form of Service and Distribution Plan
between Capstone Fixed Income Series, Inc., on
behalf of Bond USA Fund, and Capstone Asset
Planning Company; Exhibit 15(c) to Post-
Effective Amendment No. 42 to Registration No.
2-28174.
15(d) Proposed form of Service and Distribution Plan
between Capstone Fixed Income Series, Inc., on
behalf of Capstone Intermediate Government
Fund, and Capstone Asset Planning Company;
Exhibit 15(d) to Post-Effective Amendment No.
47 to Registration No. 2-28174.
*16 Schedule for Computation of Performance
Quotations.
B. Exhibits filed pursuant to Rule 483 of Regulation C under
the Securities Act of 1933, as amended.
Item 25. Persons Controlled by or under Common Control with Registrant
-------------------------------------------------------------
Registrant does not control and is not under common control with
any person.
Item 26. Number of Holders of Securities
-------------------------------
Number of Record Holders
Title of Class Title of Series As of March 18, 1996
-------------- --------------- ------------------------
Common Stock, CGIF 1,025
par value $.001
______________
* Filed herewith
<PAGE> 110
Common Stock, CIGF 0
par value $.001
Item 27. Indemnification
---------------
The Articles of Incorporation of the Registrant include the
following:
ARTICLE VII
"Article 7.4 Indemnification. The Corporation,
including its successors and assigns, shall indemnify its
directors and officers and make advance payment of related
expenses to the fullest extent permitted, and in accordance with
the procedures required, by the General Laws of the State of
Maryland and the Investment Company Act of 1940. The By-Laws may
provide that the Corporation shall indemnify its employees and/or
agents in any manner and within such limits as permitted by
applicable law. Such indemnification shall be in addition to any
other right or claim to which any director, officer, employee or
agent may otherwise be entitled. The Corporation may purchase
and maintain insurance on behalf of any person who is or was a
director, officer, employee or agent of the Corporation or is or
was serving at the request of the Corporation as a director,
officer, partner, trustee, employee or agent of another foreign
or domestic corporation, partnership, joint venture, trust or
other enterprise or employee benefit plan, against any liability
(including, with respect to employee benefit plans, excise taxes)
asserted against and incurred by such person in any such capacity
or arising out of such person's position, whether or not the
Corporation would have had the power to indemnify against such
liability. The rights provided to any person by this Article 7.4
shall be enforceable against the Corporation by such person who
shall be presumed to have relied upon such rights in serving or
continuing to serve in the capacities indicated herein. No
amendment of these Articles of Incorporation shall impair the
rights of any person arising at any time with respect to events
occurring prior to such amendment."
The By-Laws of the Registrant include the following:
ARTICLE VI
INDEMNIFICATION
The Corporation shall indemnify (a) its Directors and
officers, whether serving the Corporation or at its request any
other entity, to the full extent required or permitted by (i)
Maryland law now or hereafter in force, including the advance of
expenses under the procedures and to the full extent permitted by
law, and (ii) the Investment Company Act of 1940, as amended, and
(b) other employees and agents to such extent as shall be
authorized by the Board of Directors and be permitted by law. The
foregoing rights of indemnification shall not be exclusive of any
other rights to which those seeking indemnification may be
entitled. The Board of Directors may take such action as is
necessary to carry out these indemnification provisions and is
expressly empowered to adopt, approve and amend from time to time
such resolutions or contracts implementing such provisions or such
further
<PAGE> 111
indemnification arrangements as may be permitted by law."
Insofar as indemnification for liability arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that in
the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer
or controlling person of the Registrant in the successful defense
of any action, suit or proceeding) is asserted by such director,
officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in
the Act and will be governed by the final adjudication of such
issue.
To the extent that the Articles of Incorporation, By-Laws or any
other instrument pursuant to which the Registrant is organized or
administered indemnify any director or officer of the Registrant,
or that any contract or agreement indemnifies any person who
undertakes to act as investment adviser or principal underwriter to
the Registrant, any such provision protecting or purporting to
protect such persons against any liability to the Registrant or its
security holders to which he would otherwise by subject by reason
of willful misfeasance, bad faith, or gross negligence, in the
performance of this duties, or by reason of his reckless disregard
of this duties pursuant to the conduct of his office or obligations
pursuant to such contract or agreement, will be interpreted and
enforced in a manner consistent with the provisions of Sections
17(h) and (i) of the Investment Company Act of 1940, as amended,
and Release No. IC-11330 issued thereunder.
Item 28. Business and Other Connections of Investment Adviser
----------------------------------------------------
The investment adviser of the Registrant is also the investment
adviser and/or administrator of four other investment companies: Capstone
Growth Fund, Inc., Capstone Nikko Japan Fund, Capstone New Zealand Fund and
Medical Research Investment Fund, Inc. Such adviser also manages private
accounts and is an adviser for a portion of the Tenneco Inc. Pension Plan.
For further information, see "Directors and Officers" in Part B hereof.
Item 29. Principal Underwriters
----------------------
(a) The principal underwriter of the Registrant, Capstone Asset
Planning Company, also acts as principal underwriter for Capstone Growth
Fund, Inc., Capstone Nikko Japan Fund, Capstone New Zealand Fund and
Medical Research Investment Fund, Inc.
<PAGE> 112
(b)
<TABLE>
<CAPTION>
Name and Principal Positions and Offices Positions and Offices
Business Address* with Underwriter with Registrant
- ------------------ --------------------- ---------------------
<S> <C> <C>
Dan E. Watson Chairman of the Board Executive Vice President
and Director
Edward L. Jaroski President and Director President and Chairman of the Board
Howard S. Potter Managing Director Executive Vice President
John M. Metzinger -- Vice President
Leticia N. Jaroski Vice President --
Janet K. Roberts Assistant Vice President --
Iris R. Clay Corporate Secretary Corporate Secretary
Norma R. Ybarbo -- Assistant Secretary
Linda G. Giuffre Vice President and Treasurer
Treasurer
</TABLE>
______________
* 5847 San Felipe, Suite 4100, Houston, Texas 77057
Item 30. Location of Accounts and Records
--------------------------------
Capstone Asset Management Company, the investment adviser to
the Registrant, 5847 San Felipe, Suite 4100, Houston, Texas 77057, The
Fifth Third Bank, the custodian of the Registrant, 38 Fountain Square,
Cincinnati, Ohio 45263, and Fund/Plan Services, Inc., the transfer agent of
the Registrant, 2 W. Elm Street, P.O. Box 874, Conshohocken, Pennsylvania
19428, maintain physical possession of each account, book or other document
required to be maintained by Section 31(a) of Investment Company Act of
1940 and the rules promulgated thereunder.
Item 31. Management Services
-------------------
Not applicable.
Item 32. Undertakings
------------
*32(a) Copy of Undertaking on behalf of Capstone Government
Income Fund.
*32(b) Copy of Undertaking on behalf of Capstone
Intermediate Government Fund.
<PAGE> 113
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all
of the requirements for effectiveness of this Registration Statement or
Amendment pursuant to Rule 485(b) under the Securities Act of 1933 and has
duly caused this Registration Statement or Amendment to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of
Houston, and State of Texas on the 25th day of March, 1996.
CAPSTONE FIXED INCOME SERIES, INC.
Registrant
By: /s/EDWARD L. JAROSKI
--------------------------------
Edward L. Jaroski, President
Pursuant to the requirements of the Securities Act of 1933, this
Amendment to Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/sEDWARD L. JAROSKI President (Principal March 25, 1996
- ------------------------ Executive Officer)
Edward L. Jaroski
/s/LINDA G. GIUFFRE Treasurer (Principal March 25, 1996
- ------------------------ Financial & Accounting
Linda G. Giuffre Officer)
JAMES F. LEARY* Director March 25, 1996
- ------------------------
James F. Leary
JOHN R. PARKER* Director March 25, 1996
- ------------------------
John R. Parker
PHILIP C. SMITH* Director March 25, 1996
- ------------------------
Philip C. Smith
BERNARD J. VAUGHAN* Director March 25, 1996
- ------------------------
Bernard J. Vaughan
* By: /s/EDWARD L. JAROSKI
-----------------------------
Edward L. Jaroski, Attorney-In-Fact
<PAGE> 114
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibits
- ------- -----------------------
11(a)(l) Consent of Ernst & Young LLP, Independent Auditors
11(a)(2) Consent of Tait, Weller & Baker, Independent Certified
Public Accountants
11(b) Powers of Attorney of Messrs. James F. Leary, John R.
Parker, Philip C. Smith and Bernard J. Vaughan
16 Schedule for Computation of Performance Quotations
32(a) Copy of Undertaking on behalf of Capstone Government
Income Fund
32(b) Copy of Undertaking on behalf of Capstone Intermediate
Government Fund
<PAGE> 1
EXHIBIT 11.A.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference made to our firm under the caption "Financial
Highlights" and to the use of our report dated February 9, 1993 on the
financial highlights of Capstone Government Income Fund for the year ended
December 31, 1992, the period from October 1, 1991 to December 31, 1991 and
the year ended September 30, 1991 in Post-Effective Amendment No. 48 to the
Registration Statement (Form N-1A No. 2-28174) of Capstone Fixed Income
Series, Inc.
/s/ERNST & YOUNG LLP
Ernst & Young LLP
March 25, 1996
<PAGE> 1
EXHIBIT 11.A.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the reference to our firm in the Registration Statement (Form
N-1A) and related Statement of Additional Information of Capstone
Government Income Fund, a series of Capstone Fixed Income Series, Inc., and
to the inclusion of our report dated December 15, 1995.
/s/TAIT, WELLER & BAKER
TAIT, WELLER & BAKER
Philadelphia, Pennsylvania
March 22, 1996
<PAGE> 1
EXHIBIT 11.B
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below appoints Edward L. Jaroski as his true and lawful attorney-
in-fact, with full power of substitution and resubstitution, for him and in
his name, place and stead, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this Registration
Statement, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact full power and authority to
do and perform each and every act and thing requisite and necessary to be
done in connection therewith, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorney-in-fact, or his substitute or substitutes, may lawfully do or
cause to be done by virtue hereof.
/s/JAMES F. LEARY Director March 25, 1996
- ----------------------------
James F. Leary
/s/JOHN R. PARKER Director March 25, 1996
- ----------------------------
John R. Parker
/s/PHILIP C. SMITH Director March 25, 1996
- ----------------------------
Philip C. Smith
/s/BERNARD J. VAUGHAN Director March 25, 1996
- ----------------------------
Bernard J. Vaughan
<PAGE> 1
EXHIBIT 16
CAPSTONE GOVERNMENT INCOME FUND
SCHEDULE FOR COMPUTATION OF YIELD
Yield = 2[(a - b) + 1)6 - 1]
cd
a = dividends and interest earned during the period,
b = expenses accrued for the period (net of reimbursements),
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends, and
d = the maximum offering price per share on the last day of the
period.
*****************************
Yield = 2[(338,137.38 - 42,800.49) + 1)6 - 1]
------------------------
(13,914,465.873)(4.98)
= 5.169% (for 1 month period ending November 30, 1995)
<PAGE> 2
CAPSTONE GOVERNMENT INCOME FUND
SCHEDULE OF COMPUTATION FOR AVERAGE ANNUAL TOTAL RETURN
P (1 + T)n = ERV
P = a hypothetical initial payment of $1,000,
T = the average annual total return,
n = the number of years,
ERV = the ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
period.
*****************************
The Fund's average annualized total return for the one year period ending
November 30, 1995 is 5.177%.
$1,000 (1 + .05177)1 = ERV
$1,051.77 = ERV
An initial payment of $1,000 invested on 12/01/94 will result in 205.761
shares. Income distribution of $0.125 resulted in 5.438 additional shares
rendering a total of 211.199 shares. On 11/30/95 the net asset value of
Capstone Government Income Fund was $4.98 per share, thereby creating a
total market value of $1,051.77 and yielding an average annual total return
of 5.177%.
*****************************
The Fund's average annualized total return for the five year period from
December 1, 1990 to November 30, 1995 is 4.165%.
$1,000 (1 + .04165)5 = ERV
$1,226.33 = ERV
An initial payment of $1,000 on 12/01/90 will result in 220.264 shares.
Income distributions of $0.532 resulted in 25.987 additional shares,
rendering a total of 246.251 shares. At 11/30/95 the net asset value of
Capstone Government Income Fund was $4.98 per share, thereby creating a
total market value of $1,226.33 and yielding an average annual total return
of 4.165%.
*****************************
The Fund's average annualized total return for the ten year period from
December 1, 1985 to November 30, 1995 is 5.926%.
$1,000 (1 + .05926)10 = ERV
$1,778.33 = ERV
An initial payment of $1,000 on 12/01/85 will result in 202.840 shares.
Income distributions of $2.862 resulted in 154.254 additional shares,
rendering a total of 357.094 shares. At 11/30/95 the net asset value of
Capstone Government Income Fund was $4.98 per share, thereby creating a
total market value of $1,778.33 and yielding an average return of 5.926%.
<PAGE> 3
CAPSTONE GOVERNMENT INCOME FUND
SCHEDULE OF COMPUTATION FOR TOTAL RETURN
P (1 + T) = ERV
P = a hypothetical initial payment of $1,000,
T = the total return,
ERV = the ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
period.
*****************************
The Fund's total return for the one year period ending November 30, 1995 is
5.177%.
$1,000(1 + .05177) = ERV
$1,051.77 = ERV
An initial payment of $1,000 invested on 12/01/94 will result in 205.761
shares. Income distributions of $0.125 resulted in 5.438 additional shares
rendering a total of 211.199 shares. On 11/30/95 the net asset value of
Capstone Government Income Fund was $4.98 per share, thereby creating a
total market value of $1,051.77 and yielding a total return of 5.177%.
*****************************
The Fund's total return for the five year period from December 1, 1990 to
November 30, 1995 is 22.633%.
$1,000(1 + .22633) = ERV
$1,226.33 = ERV
An initial payment of $1,000 on 12/01/90 will result in 220.264 shares.
Income distributions of $0.532 resulted in 25.987 additional shares,
rendering a total of 246.251 shares. At 11/30/95 the net asset value of
Capstone Government Income Fund was $4.98 per share, thereby creating a
total market value of $1,226.33 and yielding a total return of 22.633%.
*****************************
The Fund's total return for the ten year period from December 1, 1985 to
November 30, 1995 is 77.833%.
$1,000 (1 + .77833) = ERV
$1,778.33 = ERV
An initial payment of $1,000 on 12/01/85 will result in 202.840 shares.
Income distributions of $2.862 resulted in 154.254 additional shares,
rendering a total of 357.094 shares. At 11/30/95 the net asset value of
Capstone Government Income Fund was $4.98 per share, thereby creating a
total market value of $1,778.33 and yielding a total return of 77.833%.
<PAGE> 1
EXHIBIT 32A
UNDERTAKING
I, Iris R. Clay, on behalf of Capstone Government Income Fund (the
"Fund"), do hereby undertake to the Securities and Exchange Commission to
furnish the Fund's Annual Report to investors free of charge as requested
in comments received from the Securities and Exchange Commission.
CAPSTONE GOVERNMENT INCOME FUND
Dated: March 25, 1996 /s/IRIS R. CLAY
-----------------------------
Iris R. Clay, Secretary
<PAGE> 1
EXHIBIT 32B
UNDERTAKING
I,Iris R. Clay, on behalf of Capstone Intermediate Government Fund (the
"Fund"), do hereby undertake to the Securities and Exchange Commission to
file the Fund's unaudited financial statements within four to six months as
requested in comments received from the Securities and Exchange Commission.
CAPSTONE INTERMEDIATE GOVERNMENT FUND
Dated: March 25, 1996 /s/IRIS R. CLAY
----------------------------
Iris R. Clay, Secretary
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
The Annual Report for Capstone Government Income Fund for the period ended
November 30, 1995.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> NOV-30-1995
<PERIOD-START> NOV-01-1994
<PERIOD-END> NOV-30-1995
<INVESTMENTS-AT-COST> 67,617,806
<INVESTMENTS-AT-VALUE> 67,705,509
<RECEIVABLES> 371,899
<ASSETS-OTHER> 3,421
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 68,080,829
<PAYABLE-FOR-SECURITIES> 27
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 83,605
<TOTAL-LIABILITIES> 83,632
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 66,433,185
<SHARES-COMMON-STOCK> 13,645,953
<SHARES-COMMON-PRIOR> 1,839,593
<ACCUMULATED-NII-CURRENT> 8,391,049
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (6,910,052)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 83,015
<NET-ASSETS> 67,997,197
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 9,555,447
<OTHER-INCOME> 0
<EXPENSES-NET> 1,164,398
<NET-INVESTMENT-INCOME> 8,391,049
<REALIZED-GAINS-CURRENT> 524,170
<APPREC-INCREASE-CURRENT> 82,380
<NET-CHANGE-FROM-OPS> 8,997,599
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 122,401,739
<NUMBER-OF-SHARES-REDEEMED> 110,595,379
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 11,806,360
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 7,434,223
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 604,189
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,164,398
<AVERAGE-NET-ASSETS> 165,066,472
<PER-SHARE-NAV-BEGIN> 4.73
<PER-SHARE-NII> 0.24
<PER-SHARE-GAIN-APPREC> 0.01
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 4.98
<EXPENSE-RATIO> 0.77
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
