<PAGE>
PROSPECTUS
- ----------
AUGUST 12, 1994
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch Arkansas Municipal Bond Fund (the "Fund") is a mutual fund
seeking to provide shareholders with as high a level of income exempt from
Federal and Arkansas income taxes as is consistent with prudent investment
management. The Fund invests primarily in a non-diversified portfolio of long-
term, investment grade obligations, the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal and Arkansas income taxes.
The Fund may invest in certain tax-exempt securities classified as "private
activity bonds" that may subject certain investors in the Fund to an
alternative minimum tax. At times, the Fund may seek to hedge its portfolio
through the use of futures transactions and options. There can be no assurance
that the investment objective of the Fund will be realized.
The Fund offers two classes of shares which may be purchased during the
subscription offering at $10.00 per share and during the continuous offering at
a price equal to the next determined net asset value per share, plus in both
cases a sales charge which, at the election of the purchaser, may be imposed
(i) at the time of purchase (the "Class A shares"), or (ii) on a deferred basis
(the "Class B shares"). The deferred charges to which the Class B shares are
subject shall consist of a contingent deferred sales charge which may be
imposed on redemptions made within four years of purchase and an ongoing
account maintenance fee and distribution fee. These alternatives permit an
investor to choose the method of purchasing shares that is most beneficial
given the amount of the purchase, the length of time the investor expects to
hold the shares and other circumstances. Investors should understand that the
purpose and function of the deferred sales charges with respect to the Class B
shares are the same as those of the initial sales charge with respect to the
Class A shares. Investors also should understand that over time the deferred
charges related to Class B shares may exceed the initial sales charge with
respect to Class A shares. See "Alternative Sales Arrangements" on page 4.
Each Class A share and Class B share represents identical interests in the
investment portfolio of the Fund and has the same rights, except that Class B
shares bear the expenses of the account maintenance fee and distribution fee
and certain other costs resulting from the deferred sales charge arrangement,
which will cause Class B shares to have a higher expense ratio and to pay lower
dividends than those related to Class A shares, and that Class B shares have
exclusive voting rights with respect to the account maintenance fee and the
distribution fee. The two classes also have different exchange privileges.
(continued on following page)
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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.
----------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated August 12, 1994 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission and
is available, without charge, by calling or by writing Merrill Lynch Multi-
State Municipal Series Trust (the "Trust") at the above telephone number or
address. The Statement of Additional Information is hereby incorporated by
reference into this Prospectus. The Fund is a separate series of the Trust, an
open-end management investment company organized as a Massachusetts business
trust.
----------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
(continued from prior page)
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), Box 9011,
Princeton, New Jersey 08543-9011 [(609) 282-2800], and other securities dealers
which have entered into selected dealer agreements with the Distributor,
including Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"),
will solicit subscriptions for shares of the Fund during a period expected to
end on September 23, 1994, unless extended. On the fifth business day after the
conclusion of this subscription period, the subscriptions will be payable, the
shares will be issued and the Fund will commence operations. The public
offering price of the shares during the subscription offering will be $10.00
per share in the case of Class B shares and $10.00 per share plus a sales
charge of 4.00%, subject to reductions on purchases in single transactions of
$25,000 or more, in the case of Class A shares. After the completion of the
initial subscription offering, the Fund will engage in a continuous offering of
its shares at a price equal to the next determined net asset value per share in
the case of Class B shares and the next determined net asset value per share,
plus a sales charge subject to reductions as noted above, in the case of Class
A shares. Shareholders may redeem their shares at any time at the next
determined net asset value. The Class B shares may be subject to a contingent
deferred sales charge if redeemed within four years of purchase and are subject
to ongoing account maintenance and distribution fees. The minimum initial
purchase during the subscription and continuous offerings is $1,000 and the
minimum subsequent purchase in the continuous offering is $50. Merrill Lynch
may charge its customers a processing fee (presently $4.85) for confirming
purchases and repurchases. Purchases and redemptions directly through the
Fund's Transfer Agent are not subject to the processing fee. See "Purchase of
Shares" and "Redemption of Shares".
2
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to Class A shares and Class B shares follows:
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
INITIAL SALES DEFERRED SALES
CHARGE CHARGE
ALTERNATIVE ALTERNATIVE
---------------- --------------
<S> <C> <C> <C> <C>
Shareholder Transaction Expenses:
Maximum Sales Charge Imposed on
Purchases (as a percentage of
offering price)................. 4.00%(a) None
Sales Charge Imposed on Dividend
Reinvestments .................. None None
Deferred Sales Charge (as a per-
centage of original purchase None 4.0%
price or redemption proceeds,
whichever is lower) ............ during the first year,
decreasing 1.0%
annually to 0.0% after
the fourth year(b)
Exchange Fee .................... None None
Annual Fund Operating Expenses (as
a percentage of average net as-
sets):
Management Fees(c) .............. 0.55% 0.55%
Rule 12b-1 Fees ................. None 0.50%(d)
Other Expenses
Custodial Fees................. 0.04% 0.04%
Shareholder Servicing Costs(e). 0.08% 0.08%
Miscellaneous.................. 1.04% 1.04%
------- ----
Total Other Expenses......... 1.16% 1.16%
---- ----
Total Fund Operating Expenses..... 1.71% 2.21%
==== ====
</TABLE>
- --------
(a) Reduced for purchases of $25,000 and over, decreasing to 0.50% for
purchases of $1,000,000 and over. Certain purchasers of Class A shares
investing $1,000,000 or more may in lieu of a front-end sales load, be
assessed a deferred sales charge on redemptions within the first year of
such investment. See "Purchase of Shares--Initial Sales Charge
Alternative--Class A Shares"--page 21.
(b) See "Purchase of Shares--Deferred Sales Charge Alternative--Class B
Shares"--page 22.
(c) See "Management of the Trust--Management and Advisory Arrangements"--page
16.
(d) See "Purchase of Shares--Deferred Sales Charge Alternative--Class B
Shares--Distribution Plan"--page 23.
(e) See "Management of the Trust--Transfer Agency Services"--page 17.
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
-------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses
on a $1,000 investment including, for Class A
shares, the maximum $40 front-end sales
charge and assuming (1) an operating expense
ratio of 1.71% for Class A shares and 2.21%
for Class B shares, (2) a 5% annual return
throughout the periods and (3) redemption at
the end of the period:
Class A .................................... $56.69 $91.72 $129.10 $233.86
Class B .................................... $62.41 $89.12 $118.47 $254.42
An investor would pay the following expenses
on the same $1,000 investment assuming no re-
demption at the end of the period:
Class A .................................... $56.69 $91.72 $129.10 $233.86
Class B .................................... $22.41 $69.12 $118.47 $254.42
</TABLE>
3
<PAGE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under "Other Expenses" are based on
estimated amounts through the end of the Fund's first fiscal year on an
annualized basis. The Example set forth above assumes reinvestment of all
dividends and distributions and utilizes a 5% annual rate of return as mandated
by Securities and Exchange Commission (the "Commission") regulations. THE
EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR
ANNUAL RATE OF RETURN, AND ACTUAL EXPENSES OR ANNUAL RATE OF RETURN MAY BE MORE
OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. Class B shareholders
who hold their shares for an extended period of time may pay more in Rule 12b-1
distribution fees than the economic equivalent of the maximum front-end sales
charges permitted under the Rules of Fair Practice of the National Association
of Securities Dealers, Inc. Merrill Lynch may charge its customers a processing
fee (presently $4.85) for confirming purchases and repurchases. Purchases and
redemptions directly through the Fund's Transfer Agent are not subject to the
processing fee. See "Purchase of Shares" and "Redemption of Shares".
ALTERNATIVE SALES ARRANGEMENTS
Shares of the Fund may be purchased during the subscription offering at
$10.00 per share and during the continuous offering at a price equal to the
next determined net asset value per share, plus in both cases a sales charge
which, at the election of the purchaser, may be imposed either (i) at the time
of the purchase (the "initial sales charge alternative"), or (ii) on a deferred
basis (the "deferred sales charge alternative").
Class A Shares. An investor who elects the initial sales charge alternative
acquires Class A shares. Although Class A shares incur a sales charge when they
are purchased, they enjoy the benefit of not being subject to the ongoing
account maintenance and distribution fees to which Class B shares are subject
or any sales charge when they are redeemed. Certain purchasers of Class A
shares qualify for reduced initial sales charges. See "Purchase of Shares".
Class B Shares. An investor who elects the deferred sales charge alternative
acquires Class B shares. Class B shares do not incur a sales charge when they
are purchased, but they are subject to ongoing account maintenance and
distribution fees and a sales charge if they are redeemed within four years of
purchase. Class B shares enjoy the benefit of permitting all of the investor's
dollars to work from the time the investment is made. The ongoing account
maintenance and distribution fees paid by Class B shares will cause such shares
to have a higher expense ratio and to pay lower dividends than those related to
Class A shares. Payment of the distribution fee is subject to certain limits as
set forth under "Purchase of Shares--Deferred Sales Charge Alternative--Class B
Shares".
As an illustration, investors who qualify for significantly reduced sales
charges might elect the initial sales charge alternative because similar sales
charge reductions are not available for purchases under the deferred sales
charge alternative. Moreover, shares acquired under the initial sales charge
alternative would not be subject to ongoing account maintenance and
distribution fees. However, because initial sales charges are deducted at the
time of purchase, such investors would not have all their funds invested
initially. Investors not qualifying for reduced initial sales charges who
expect to maintain their investment for an extended period of time also might
elect the initial sales charge alternative because over time the accumulated
continuing account maintenance and distribution fees may exceed the initial
sales charge. Again, however, such investors must weigh this consideration
against the fact that not all of their funds will be invested initially.
4
<PAGE>
Furthermore, the ongoing account maintenance and distribution fees will be
offset to the extent any return is realized on the additional funds initially
invested under the deferred alternative. However, there can be no assurance as
to the return, if any, which will be realized on such additional funds. Certain
other investors might determine it to be more advantageous to have all of their
funds invested initially, although remaining subject to continued account
maintenance and distribution fees and, for a four-year period of time, a
contingent deferred sales charge.
The distribution expenses incurred by the Distributor and dealers (primarily
Merrill Lynch) in connection with the sale of the shares will be paid, in the
case of the Class A shares, from the proceeds of the initial sales charge. In
the case of the Class B shares, such distribution expenses will be paid from
the proceeds of the ongoing distribution fee and, if applicable, the contingent
deferred sales charge incurred upon redemption within four years of purchase.
Sales personnel may receive different compensation for selling Class A or Class
B shares. Investors should understand that the purpose and function of the
deferred sales charges with respect to the Class B shares are the same as those
of the initial sales charge with respect to the Class A shares.
Dividends paid by the Fund with respect to Class A and Class B shares, to the
extent any dividends are paid, will be calculated in the same manner at the
same time on the same day and will be in the same amount, except that account
maintenance and distribution fees and any incremental transfer agency costs
relating to Class B shares will be borne exclusively by that class. See
"Additional Information--Determination of Net Asset Value". Class A and Class B
shareholders of the Fund have an exchange privilege for Class A and Class B
shares, respectively, of certain other mutual funds sponsored by Merrill Lynch.
Class A and Class B shareholders of the Fund also may exchange their shares for
shares of certain money market funds sponsored by Merrill Lynch. See
"Shareholder Services--Exchange Privilege".
The Trustees of the Trust have determined that currently no conflict of
interest exists between the Class A and Class B shares. On an ongoing basis,
the Trustees of the Trust, pursuant to their fiduciary duties under the
Investment Company Act of 1940 and state laws, will seek to assure that no such
conflict arises.
The alternative sales arrangements permit an investor to choose the
method of purchasing shares that is most beneficial given the amount of the
purchase, the length of time the investor expects to hold the shares and
other circumstances. Investors should determine whether under their
particular circumstances it is more advantageous to incur an initial sales
charge and not be subject to ongoing charges, or to have the entire initial
purchase price invested in the Fund with the investment thereafter being
subject to ongoing account maintenance and distribution fees. To assist
investors in making this determination, the Fee Table on page 3 sets forth
the charges applicable to each class of shares and a discussion of relevant
factors in making such determination is set forth under "Purchase of
Shares--Alternative Sales Arrangements" on page 20.
5
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and Arkansas income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective while providing investors with the opportunity to invest in a non-
diversified portfolio of securities consisting primarily of long-term
obligations issued by or on behalf of the State of Arkansas, its political
subdivisions, agencies and instrumentalities and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the Virgin Islands
and Guam, which pay interest exempt, in the opinion of bond counsel to the
issuer, from Federal and Arkansas income taxes. Obligations exempt from Federal
income taxes are referred to herein as "Municipal Bonds" and obligations exempt
from both Federal and Arkansas income taxes are referred to as "Arkansas
Municipal Bonds". Unless otherwise indicated, references to Municipal Bonds
shall be deemed to include Arkansas Municipal Bonds. The Fund at all times,
except during temporary defensive periods, will maintain at least 65% of its
total assets invested in Arkansas Municipal Bonds. The investment objective of
the Fund as set forth in the first sentence of this paragraph is a fundamental
policy and may not be changed without shareholder approval. At times, the Fund
may seek to hedge its portfolio through the use of futures transactions to
reduce volatility in the net asset value of Fund shares.
Municipal Bonds may include several types of bonds. The risks and special
considerations involved in investments in Municipal Bonds vary with the types
of instruments being acquired. Investments in Non- Municipal Tax-Exempt
Securities, as defined herein, may present similar risks, depending on the
particular product. See "Description of Municipal Bonds". The interest on
Municipal Bonds may bear a fixed rate or be payable at a variable or floating
rate. At least 80% of the Municipal Bonds purchased by the Fund primarily will
be what are commonly referred to as "investment grade" securities, which are
obligations rated at the time of purchase within the four highest quality
ratings as determined by either Moody's Investors Service, Inc. ("Moody's")
(currently Aaa, Aa, A and Baa), Standard & Poor's Corporation ("Standard &
Poor's") (currently AAA, AA, A and BBB) or Fitch Investors Service, Inc.
("Fitch") (currently AAA, AA, A and BBB). If Municipal Bonds are unrated, such
securities will possess creditworthiness comparable, in the opinion of the
manager of the Fund, Fund Asset Management, L.P. (the "Manager"), to
obligations in which the Fund may invest. Municipal Bonds rated in the fourth
highest rating category, while considered "investment grade", have certain
speculative characteristics and are more likely to be downgraded to non-
investment grade than obligations rated in one of the top three rating
categories. See Appendix II--"Ratings of Municipal Bonds"--in the Statement of
Additional Information for more information regarding ratings of debt
securities. An issue of rated Municipal Bonds may cease to be rated or its
rating may be reduced below "investment grade" subsequent to its purchase by
the Fund. If an obligation is downgraded below investment grade, the Manager
will consider factors such as price, credit risk, market conditions, financial
condition of the issuer and interest rates to determine whether to continue to
hold the obligation in the Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that are
rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch, or which
in the Manager's judgment, possess similar credit characteristics. Such
securities, sometimes referred to as "high-yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and
repay principal in accordance with the terms of the security and generally
involve a greater volatility of price than securities in higher rating
categories. The market prices of high-yielding, lower-rated securities may
fluctuate more than higher-rated securities and may decline significantly in
periods of general economic difficulty, which may follow periods of rising
interest rates. In purchasing such securities, the Fund will rely on the
Manager's judgment, analysis
6
<PAGE>
and experience in evaluating the creditworthiness of the issuer of such
securities. The Manager will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of its management and regulatory
matters. See "Investment Objective and Policies" in the Statement of Additional
Information for a more detailed discussion of the pertinent risk factors
involved in investing in "high yield" or "junk" bonds and Appendix II--"Ratings
of Municipal Bonds"--in the Statement of Additional Information for additional
information regarding ratings of debt securities. The Fund does not intend to
purchase debt securities that are in default or which the Manager believes will
be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of credit
or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing the
quality of such bonds not only the creditworthiness of the issuer of such bonds
but also the creditworthiness of the financial institution. Certain instruments
in which the Fund may invest may be characterized as derivative instruments.
See "Description of Municipal Bonds" and "Financial Futures Transactions and
Options".
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial
institution. The VRDOs in which the Fund will invest are tax-exempt obligations
which contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest on a short notice
period not to exceed seven days. Participating VRDOs provide the Fund with a
specified undivided interest (up to 100%) of the underlying obligation and the
right to demand payment of the unpaid principal balance plus accrued interest
on the Participating VRDOs from the financial institution on a specified number
of days' notice, not to exceed seven days. There is, however, the possibility
that because of a default or insolvency, the demand feature of VRDOs or
Participating VRDOs may not be honored. The Fund has been advised by its
counsel that the Fund should be entitled to treat the income received on
Participating VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of the
unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed illiquid securities. A VRDO with a demand notice
period exceeding seven days will therefore be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for
such determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Arkansas income taxes. However, to the extent that suitable
Arkansas Municipal Bonds are not available for investment by the Fund, the Fund
may purchase Municipal Bonds issued by other states, their agencies and
instrumentalities, the interest income on which is exempt, in the opinion of
bond counsel, from Federal, but not Arkansas, taxation. The Fund also may
invest in securities not issued by or on behalf of a state or territory or by
an agency or instrumentality thereof, if the Fund nevertheless believes such
securities to be exempt from Federal income taxation ("Non-Municipal Tax-Exempt
Securities"). Non-Municipal Tax-Exempt Securities may include securities issued
by other investment companies that invest in municipal bonds, to the extent
such investments are permitted by the Investment Company Act of 1940, as
amended (the "1940 Act"). Other Non-Municipal Tax-Exempt Securities could
include trust certificates or other derivative instruments evidencing interests
in one or more Municipal Bonds.
7
<PAGE>
Under normal circumstances, except when acceptable securities are unavailable
as determined by the Manager, the Fund will invest at least 65% of its total
assets in Arkansas Municipal Bonds. For temporary
defensive periods or to provide liquidity, the Fund has the authority to invest
as much as 35% of its total assets in tax-exempt or taxable money market
obligations with a maturity of one year or less (such short-term obligations
being referred to herein as "Temporary Investments"), except that taxable
Temporary Investments shall not exceed 20% of the Fund's net assets. The
Temporary Investments, VRDOs and Participating VRDOs in which the Fund may
invest also will be in the following rating categories at the time of purchase:
MIG-1/VMIG-1 through MIG-4/VMIG-4 for notes and VRDOs and Prime-1 through
Prime-3 for commercial paper (as determined by Moody's), SP-1 and SP-2 for
notes and A-1 through A-3 for VRDOs and commercial paper (as determined by
Standard & Poor's), or F-1 through F-3 for notes, VRDOs and commercial paper
(as determined by Fitch) or, if unrated, of comparable quality in the opinion
of the Manager. The Fund at all times will have at least 80% of its net assets
invested in securities the interest on which is exempt from Federal taxation.
However, interest received on certain otherwise tax-exempt securities which are
classified as "private activity bonds" (in general, bonds that benefit non-
governmental entities), may be subject to a Federal alternative minimum tax.
The percentage of the Fund's net assets invested in "private activity bonds"
will vary during the year. See "Distributions and Taxes". In addition, the Fund
reserves the right to invest temporarily a greater portion of its assets in
Temporary Investments for defensive purposes, when, in the judgment of the
Manager, market conditions warrant. The investment objective of the Fund is a
fundamental policy of the Fund which may be not changed without a vote of a
majority of the outstanding shares of the Fund. The Fund's hedging strategies,
which are described in more detail under "Financial Futures Transactions and
Options", are not fundamental policies and may be modified by the Trustees of
the Trust without the approval of the Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and Arkansas
income taxes by investing in a professionally managed portfolio consisting
primarily of long-term Arkansas Municipal Bonds. The Fund also provides
liquidity because of its redemption features and relieves the investor of the
burdensome administrative details involved in managing a portfolio of tax-
exempt securities. The benefits of investing in the Fund are at least partially
offset by the expenses involved in operating an investment company. Such
expenses primarily consist of the management fee and operational costs, and in
the case of Class B shares, account maintenance and distribution fees.
SPECIAL AND RISK CONSIDERATIONS RELATING TO ARKANSAS MUNICIPAL BONDS
The Fund ordinarily will invest at least 65% of its total assets in Arkansas
Municipal Bonds, and therefore it is more susceptible to factors adversely
affecting issuers of Arkansas Municipal Bonds than is a tax-exempt mutual fund
that is not concentrated in issuers of Arkansas Municipal Bonds to this degree.
Many different economic and social conditions may affect the financial
condition of Arkansas and its political subdivisions in the future. Although
the general economy of the State is presently improving, future events which
could negatively impact the State include: the effects of inflation, decreases
in tax collections due to recessionary trends such as increased unemployment,
slowdowns in business activity generally and the cyclical nature of some
manufacturing sectors. Standard & Poor's lowered its rating of the Arkansas
Development Finance Authority's Guaranty Revenue Bond program from A+ to A- on
June 24, 1994.
8
<PAGE>
The rating change reflects a substantial drop in interest earnings on state
treasury fund balances since the program was originally rated in 1987. Treasury
earnings are a backup source of bond repayment in the event that the Guaranty
Revenue Fund is ever exhausted. The Manager does not believe that the current
economic conditions in Arkansas will have a significant adverse effect on the
Fund's ability to invest in high quality Arkansas Municipal Bonds. See Appendix
I, "Economic and Financial Conditions in Arkansas," in the Statement of
Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (including water, sewer, gas, electricity, solid waste, health care,
transportation, education and housing facilities), refunding of outstanding
obligations and obtaining funds for general operating expenses and loans to
other public institutions and facilities. In addition, certain types of bonds
are issued by or on behalf of public authorities to finance various privately
operated facilities, including certain facilities for the local furnishing of
electric energy or gas, sewage facilities, solid waste disposal facilities and
other specialized facilities. For purposes of this Prospectus, such obligations
are referred to as Municipal Bonds if the interest paid thereon is exempt from
Federal income tax, and, as Arkansas Municipal Bonds if the interest thereon is
exempt from Federal and Arkansas income taxes, even though such bonds may be
"private activity bonds" as discussed below.
The two principal classifications of Municipal Bonds are "general obligation"
bonds and "revenue" bonds which latter category includes industrial development
bonds ("IDBs") and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest. The
taxing power of any governmental entity may be limited, however, by provisions
of state constitutions or laws, and an entity's creditworthiness will depend on
many factors, including potential erosion of the tax base due to population
declines, natural disasters, declines in the state's industrial base or
inability to attract new industries, economic limits on the ability to tax
without eroding the tax base, state legislative proposals or voter initiatives
to limit ad valorem real property taxes and the extent to which the entity
relies on Federal or state aid, access to capital markets or other factors
beyond the state or entity's control. Accordingly, the capacity of the issuer
of a general obligation bond as to the timely payment of interest and the
repayment of principal when due is affected by the issuer's maintenance of its
tax base.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as payments from the
user of the facility being financed; accordingly, the timely payment of
interest and the repayment of principal in accordance with the terms of the
revenue or special obligation bond is a function of the economic viability of
such facility or such revenue source. The Fund will not invest more than 10% of
its total assets (taken at market value at the time of each investment) in
industrial revenue bonds where the entity supplying the revenues from which the
issuer is paid, including predecessors, has a record of less than three years
of continuous business operations. Investments involving entities with less
than three years of continuous business operations may pose somewhat greater
risks due to the lack of a substantial operating history for such entities. The
Manager believes, however, that the potential benefits of such investments
outweigh the potential risks, particularly given the Fund's limitations on such
investments.
9
<PAGE>
The Fund may purchase IDBs and private activity bonds. IDBs and private
activity bonds are tax-exempt securities issued by states, municipalities or
public authorities to provide funds, usually through a loan or lease
arrangement, to a private entity for the purpose of financing construction or
improvement of a facility to be used by the entity. Such bonds are secured
primarily by revenues derived from loan repayments or lease payments due from
the entity which may or may not be guaranteed by a parent company or otherwise
secured. Neither IDBs nor private activity bonds are secured by a pledge of the
taxing power of the issuer of such bonds. Therefore, an investor should be
aware that repayment of such bonds depends on the revenues of a private entity
and be aware of the risks that such an investment may entail. Continued ability
of an entity to generate sufficient revenues for the payment of principal and
interest on such bonds will be affected by many factors including the size of
the entity, capital structure, demand for its products or services,
competition, general economic conditions, governmental regulation and the
entity's dependence on revenues for the operation of the particular facility
being financed. The Fund may also invest in so-called "moral obligation" bonds.
If an issuer of such bonds is unable to meet its obligations, repayment of such
bonds becomes a moral commitment, but not a legal obligation, of the issuer.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called "inverse floating obligations" or
"residual interest bonds" on which the interest rates typically decline as
market rates increase and increase as market rates decline. To the extent the
Fund invests in these types of Municipal Bonds, the Fund's return on such
Municipal Bonds will be subject to risk with respect to the value of the
particular index. Such securities have the effect of providing a degree of
investment leverage, since they may increase or decrease in value in response
to changes, as an illustration, in market interest rates at a rate which is a
multiple (typically two) of the rate at which fixed-rate long-term tax-exempt
securities increase or decrease in response to such changes. As a result, the
market values of such securities will generally be more volatile than the
market values of fixed-rate tax-exempt securities. To seek to limit the
volatility of these securities, the Fund may purchase inverse floating
obligations with shorter term maturities or which contain limitations on the
extent to which the interest rate may vary. The Manager believes that indexed
and inverse floating obligations represent a flexible portfolio management
instrument for the Fund which allows the Manager to vary the degree of
investment leverage relatively efficiently under different market conditions.
Certain investments in such obligations may be illiquid. The Fund may not
invest in such illiquid obligations if such investments, together with other
illiquid investments, would exceed 15% of the Fund's net assets.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called
"lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation frequently
is backed by the issuer's covenant to budget for, appropriate and make the
payments due under the lease obligation. However, certain lease obligations
contain "non-appropriation" clauses which provide that the issuer has no
obligation to make lease or installment purchase payments in future years
unless money is appropriated for such purpose on a yearly basis. Although "non-
appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
These securities represent a type of financing that has not yet
10
<PAGE>
developed the depth of marketability associated with more conventional
securities. Certain investments in lease obligations may be illiquid. The Fund
may not invest in illiquid lease obligations if such investments, together with
other illiquid investments, would exceed 15% of the Fund's net assets. The Fund
may, however, invest without regard to such limitation in lease obligations
which the Manager, pursuant to guidelines which have been adopted by the Board
of Trustees and subject to the supervision of the Board, determines to be
liquid. The Manager will deem lease obligations liquid if they are publicly
offered and have received an investment grade rating of Baa or better by
Moody's, or BBB or better by Standard & Poor's or Fitch. Unrated lease
obligations, or those rated below investment grade, will be considered liquid
if the obligations come to the market through an underwritten public offering
and at least two dealers are willing to give competitive bids. In reference to
the latter, the Manager must, among other things, also review the
creditworthiness of the municipality obligated to make payment under the lease
obligation and make certain specified determinations based on such factors as
the existence of a rating or credit enhancement such as insurance, the
frequency of trades or quotes for the obligation and the willingness of dealers
to make a market in the obligation.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which may be enacted in the future may affect
the availability of Municipal Bonds for investment by the Fund.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis or
a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment and the value of the obligation will thereafter be
reflected in the calculation of the Fund's net asset value. The value of the
obligation on the delivery date may be more or less than its purchase price. A
separate account of the Fund will be established with its custodian consisting
of cash, cash equivalents or high grade, liquid Municipal Bonds having a market
value at all times at least equal to the amount of the forward commitment.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity of
the related Municipal Bond will expire without value. The economic effect to
holding both the Call Right and the related Municipal Bond is identical to
holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% of the Fund's net assets.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
The Fund is authorized to purchase and sell certain exchange traded financial
futures contracts ("financial futures contracts") solely for the purpose of
hedging its investments in Municipal Bonds against declines in value and to
hedge against increases in the cost of securities it intends to purchase.
However, any
11
<PAGE>
transactions involving financial futures or options (including puts and calls
associated therewith) will be in accordance with the Fund's investment policies
and limitations. A financial futures contract obligates the seller of a
contract to deliver and the purchaser of a contract to take delivery of the
type of financial instrument covered by the contract, or in the case of index-
based futures contracts to make and accept a cash settlement, at a specific
future time for a specified price. A sale of financial futures contracts may
provide a hedge against a decline in the value of portfolio securities because
such depreciation may be offset, in whole or in part, by an increase in the
value of the position in the financial futures contracts. A purchase of
financial futures contracts may provide a hedge against an increase in the cost
of securities intended to be purchased, because such appreciation may be
offset, in whole or in part, by an increase in the value of the position in the
futures contracts. Distributions, if any, of net long-term capital gains from
certain transactions in futures or options are taxable at long-term capital
gains rates for Federal income tax purposes, regardless of the length of time
the shareholder has owned Fund shares. See "Distributions and Taxes--Taxes".
The Fund deals in financial futures contracts traded on the Chicago Board of
Trade based on The Bond Buyer Municipal Bond Index, a price-weighted measure of
the market value of 40 large, recently issued tax-exempt bonds. There can be no
assurance, however, that a liquid secondary market will exist to terminate any
particular financial futures contract at any specific time. If it is not
possible to close a financial futures position entered into by the Fund, the
Fund would continue to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such a situation, if the
Fund has insufficient cash, it may have to sell portfolio securities to meet
daily variation margin requirements at a time when it may be disadvantageous to
do so. The inability to close financial futures positions also could have an
adverse impact on the Fund's ability to hedge effectively. There is also the
risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a financial futures contract.
The Fund may purchase and sell financial futures contracts on U.S. Government
securities and write and purchase put and call options on such futures
contracts as a hedge against adverse changes in interest rates as described
more fully in the Statement of Additional Information. With respect to U.S.
Government securities, currently there are financial futures contracts based on
long-term U.S. Treasury bonds, Treasury notes, Government National Mortgage
Association ("GNMA") Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions and options thereon, such as
financial futures contracts or options on other municipal bond indexes which
may become available if the Manager of the Fund and the Trustees of the Trust
should determine that there is normally a sufficient correlation between the
prices of such futures contracts and the Municipal Bonds in which the Fund
invests to make such hedging appropriate.
Utilization of futures transactions and options thereon involves the risk of
imperfect correlation in movements in the price of futures contracts and
movements in the price of the security which is the subject of the hedge. If
the price of the futures contract moves more or less than the price of the
security that is the subject of the hedge, the Fund will experience a gain or
loss which will not be completely offset by movements in the price of such
security. There is a risk of imperfect correlation where the securities
underlying futures contracts have different maturities, ratings or geographic
mixes than the security being hedged. In addition, the correlation may be
affected by additions to or deletions from the index which serves as a basis
for a financial futures contract. Finally, in the case of futures contracts on
U.S. Government securities and options
12
<PAGE>
on such futures contracts, the anticipated correlation of price movements
between the U.S. Government securities underlying the futures or options and
Municipal Bonds may be adversely affected by economic, political, legislative
or other developments which have a disparate impact on the respective markets
for such securities.
Under regulations of the Commodity Futures Trading Commission, the futures
trading activities described herein will not result in the Fund being deemed to
be a "commodity pool," as defined under such regulations, provided that the
Fund adheres to certain restrictions. In particular, the Fund may purchase and
sell futures contracts and options thereon (i) for bona fide hedging purposes,
and (ii) for non-hedging purposes, if the aggregate initial margins and
premiums required to establish positions in such contracts and options does not
exceed 5% of the liquidation value of the Fund's portfolio assets after taking
into account unrealized profits and unrealized losses on any such contracts and
options. (However, as stated above, the Fund intends to engage in options and
futures transactions only for hedging purposes.) Margin deposits may consist of
cash or securities acceptable to the broker and the relevant contract market.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender adjustable
notes) or short-term, high-grade, fixed-income securities in a segregated
account with the Fund's custodian, so that the amount so segregated plus the
amount of initial and variation margin held in the account of its broker equals
the market value of the futures contracts, thereby ensuring that the use of
such futures contract is unleveraged. It is not anticipated that transactions
in futures contracts will have the effect of increasing portfolio turnover.
Although certain risks are involved in options and futures transactions, the
Manager believes that, because the Fund will engage in futures transactions
only for hedging purposes, the futures portfolio strategies of the Fund will
not subject the Fund to certain risks frequently associated with speculation in
futures transactions. The Fund must meet certain Federal income tax
requirements under the Internal Revenue Code of 1986, as amended (the "Code"),
in order to qualify for the special tax treatment afforded regulated investment
companies, including a requirement that less than 30% of its gross income be
derived from the sale or other disposition of securities held for less than
three months. Additionally, the Fund is required to meet certain
diversification requirements under the Code.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past moved beyond the
daily limit on a number of consecutive trading days.
The successful use of transactions in futures also depends on the ability of
the Manager to forecast correctly the direction and extent of interest rate
movements within a given time frame. To the extent these rates remain stable
during the period in which a futures contract is held by the Fund or moves in a
direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction which is not fully or partially offset by an increase in
the value of portfolio securities. As a result, the Fund's total return for
such period may be less than if it had not engaged in the hedging transaction.
Furthermore, the Fund will only engage in hedging transactions from time to
time and may not necessarily be engaging in hedging transactions when movements
in interest rates occur.
13
<PAGE>
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
REPURCHASE AGREEMENTS AND PURCHASE AND SALE CONTRACTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements or purchase and sale contracts. Repurchase agreements and
purchase and sale contracts may be entered into only with a member bank of the
Federal Reserve System or primary dealer in U.S. Government securities. Under
such agreements, the bank or primary dealer agrees, upon entering into the
contract, to repurchase the security at a mutually agreed upon time and price,
thereby determining the yield during the term of the agreement. This results in
a fixed rate of return insulated from market fluctuations during such period.
In the case of repurchase agreements, the prices at which the trades are
conducted do not reflect accrued interest on the underlying obligations;
whereas, in the case of purchase and sale contracts, the prices take into
account accrued interest. Such agreements usually cover short periods, such as
under one week. Repurchase agreements may be construed to be collateralized
loans by the purchaser to the seller secured by the securities transferred to
the purchaser. In the case of a repurchase agreement, the Fund will require the
seller to provide additional collateral if the market value of the securities
falls below the repurchase price at any time during the term of the repurchase
agreement; the Fund does not have the right to seek additional collateral in
the case of purchase and sale contracts. In the event of default by the seller
under the repurchase agreement construed to be a collateralized loan, the
underlying securities are not owned by the Fund but only constitute collateral
for the seller's obligation to pay the repurchase price. Therefore, the Fund
may suffer time delays and incur costs or possible losses in connection with
the disposition of the collateral. A purchase and sale contract differs from a
repurchase agreement in that the contract arrangements stipulate that the
securities are owned by the Fund. In the event of a default under such a
repurchase agreement or under a purchase and sale contract, instead of the
contractual fixed rate of return, the rate of return to the Fund shall be
dependent upon intervening fluctuations of the market value of such security
and the accrued interest on the security. In such event, the Fund would have
rights against the seller for breach of contract with respect to any losses
arising from market fluctuations following the failure of the seller to
perform. The Fund may not invest in repurchase agreements or purchase and sale
contracts maturing in more than seven days if such investments, together with
all other illiquid investments, would exceed 15% of the Fund's net assets.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that are
described in the Statement of Additional Information. Investment restrictions
and policies which are fundamental policies may not be changed without the
approval of the holders of a majority of the Fund's outstanding voting
securities, as defined in the 1940 Act. Among its fundamental policies, the
Fund may not: (i) invest more than 25% of its assets, taken at market value, in
the securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities) [For purposes of this
restriction, states, municipalities and their political subdivisions are not
considered to be part of any industry]; and (ii) borrow money, except that (a)
the Fund may borrow from banks (as defined in the 1940 Act) in amounts up to 33
1/3% of its total assets (including the amount borrowed), (b) the Fund may
borrow up to an additional 5% of its total assets for temporary purposes, (c)
the Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (d) the Fund may
purchase securities on margin to the extent permitted by applicable law. The
Fund may not pledge its assets other than to secure such borrowings or, to the
extent permitted by the Fund's investment policies as set forth in the
Prospectus and Statement of
14
<PAGE>
Additional Information, as they may be amended from time to time, in connection
with hedging transactions, short sales, when-issued and forward commitment
transactions and similar investment strategies.
Among its non-fundamental policies, the Fund may not (i) purchase securities
of other investment companies, except to the extent such purchases are
permitted by applicable law; (ii) invest in securities which cannot be readily
resold because of legal or contractual restrictions or which cannot otherwise
be marketed, redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its total assets would be invested in such
securities [This restriction shall not apply to securities which mature within
seven days or securities which the Board of Trustees of the Fund has otherwise
determined to be liquid pursuant to applicable law]; and (iii) invest in
securities of companies having a record, together with predecessors, of less
than three years of continuous operation, if more than 5% of the Fund's total
assets would be invested in such securities. This restriction shall not apply
to mortgaged-backed securities, asset-backed securities or obligations issued
or guaranteed by the U.S. Government, its agencies or instrumentalities.
The Fund is classified as non-diversified within the meaning of the 1940 Act,
which means that the Fund is not limited by the 1940 Act in the proportion of
its assets that it may invest in obligations of a single issuer. However, the
Fund's investments will be limited so as to qualify as a "regulated investment
company" for purposes of the Internal Revenue Code. See "Taxes". To qualify,
among other requirements, the Trust will limit the Fund's investments so that,
at the close of each quarter of the taxable year, (i) not more than 25% of the
market value of the Fund's total assets will be invested in the securities of a
single issuer, and (ii) with respect to 50% of the market value of its total
assets, not more than 5% of the market value of its total assets will be
invested in the securities of a single issuer and the Fund will not own more
than 10% of the outstanding voting securities of a single issuer. For purposes
of this restriction, the Fund will regard each state and each political
subdivision, agency or instrumentality of such state and each multi-state
agency of which such state is a member and each public authority which issues
securities on behalf of a private entity as a separate issuer, except that if
the security is backed only by the assets and revenues of a non-government
entity then the entity with the ultimate responsibility for the payment of
interest and principal may be regarded as the sole issuer. These tax-related
limitations may be changed by the Trustees of the Trust to the extent necessary
to comply with changes to the Federal tax requirements. A fund which elects to
be classified as "diversified" under the 1940 Act must satisfy the foregoing 5%
and 10% requirements with respect to 75% of its total assets. To the extent
that the Fund assumes large positions in the obligations of a small number of
issuers, the Fund's total return may fluctuate to a greater extent than that of
a diversified company as a result of changes in the financial condition or in
the market's assessment of the issuers.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
15
<PAGE>
MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
Arthur Zeikel*--President and Chief Investment Officer of Fund Asset
Management, L.P. and Merrill Lynch Asset Management, L.P. ("MLAM");
President and Director of Princeton Services, Inc.; Executive Vice
President of Merrill Lynch & Co., Inc. since 1990; Executive Vice
President of Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") since 1990 and a Senior Vice President thereof from
1985 to 1990; Director of Merrill Lynch Funds Distributor, Inc.
Kenneth S. Axelson--Former Executive Vice President and Director, J.C.
Penney Company, Inc.
Herbert I. London--John M. Olin Professor of Humanities, New York
University.
Robert R. Martin--Chairman, WTC Industries, Inc. and former Chairman
and Chief Executive Officer, Kinnard Investments, Inc.
Joseph L. May--Attorney in private practice.
Andre F. Perold--Professor, Harvard Business School.
- --------
*Interested person, as defined in the 1940 Act, of the Trust.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Fund Asset Management, L.P. (the "Manager"), which is an affiliate of MLAM
and is owned and controlled by Merrill Lynch & Co., Inc., acts as the manager
for the Fund and provides the Fund with management services. The Manager or
MLAM acts as the investment adviser for over 90 other registered investment
companies. MLAM also offers portfolio management and portfolio analysis
services to individuals and institutions. As of June 29, 1994, the Manager and
MLAM had a total of approximately $161.4 billion in investment company and
other portfolio assets under management, including accounts of certain
affiliates of the Manager.
Subject to the direction of the Trustees, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager. The Manager performs certain of
the other administrative services and provides all the office space,
facilities, equipment and necessary personnel for management of the Fund.
Vincent R. Giordano and Kenneth A. Jacob are the Portfolio Managers for the
Fund. Vincent R. Giordano has been a Portfolio Manager of the Manager and MLAM
since 1977 and a Senior Vice President of the Manager and MLAM since 1984.
Kenneth A. Jacob has been a Vice President of the Manager and MLAM since 1984.
Pursuant to the management agreement between the Manager and the Trust on
behalf of the Fund (the "Management Agreement"), the Manager is entitled to
receive from the Fund a monthly fee based upon the average daily net assets of
the Fund at the following annual rates: 0.55% of the average daily net assets
not
16
<PAGE>
exceeding $500 million; 0.525% of the average daily net assets exceeding $500
million but not exceeding $1.0 billion; and 0.50% of the average daily net
assets exceeding $1.0 billion.
The Management Agreement obligates the Fund to pay certain expenses incurred
in the Fund's operations, including, among other things, the management fee,
legal and audit fees, unaffiliated Trustees' fees and expenses, registration
fees, custodian and transfer agency fees, accounting and pricing costs, and
certain of the costs of printing proxies, shareholder reports, prospectuses and
statements of additional information. Accounting services are provided to the
Fund by the Manager, and the Fund reimburses the Manager for its costs in
connection with such services. The Manager may waive all or a portion of its
management fee and may voluntarily assume all or a portion of the Fund's
expenses.
TRANSFER AGENCY SERVICES
Financial Data Services, Inc. (the "Transfer Agent"), which is a wholly-owned
subsidiary of Merrill Lynch & Co., Inc., acts as the Trust's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of
shareholder accounts. Pursuant to the Transfer Agency Agreement, the Fund
pays the Transfer Agent an annual fee of $10.00 per Class A shareholder account
and $12.00 per Class B shareholder account, and the Transfer Agent is entitled
to reimbursement from the Fund for out-of-pocket expenses incurred by the
Transfer Agent under the Transfer Agency Agreement.
PURCHASE OF SHARES
SUBSCRIPTION OFFERING
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), a subsidiary of
MLAM and an affiliate of Merrill Lynch, acts as the distributor of Class A and
Class B shares of the Fund.
The Distributor, Merrill Lynch and other securities dealers which have
entered into selected dealer agreements with the Distributor will solicit
subscriptions for shares of the Fund during a period expected to end on
September 23, 1994. The subscription period may be extended for up to an
additional 30 days upon agreement between the Trust on behalf of the Fund and
the Distributor. On the fifth business day after the conclusion of the
subscription period, the subscriptions will be payable, the Class A and Class B
shares will be issued and the Fund will commence operations. The subscription
offering may be terminated by the Trust or the Distributor at any time, in
which event no Class A and Class B shares will be issued (and, therefore, the
Fund will not commence operations and no amounts will be payable by
subscribers, and no sales charges will be assessed) or a limited number of
shares will be issued.
17
<PAGE>
The public offering price of the Class A shares during the subscription
offering is set forth in the table below:
<TABLE>
<CAPTION>
SUBSCRIPTION PERIOD
-------------------------------------------
SECURITIES DEALERS'
SALES CHARGE CONCESSION
------------------ ------------------------
PERCENTAGE* PERCENTAGE*
PUBLIC OF PUBLIC OF PUBLIC
OFFERING DOLLAR OFFERING DOLLAR OFFERING
PRICE AMOUNT PRICE AMOUNT PRICE
-------- ------ ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Less than $25,000......... $10.417 $.417 4.00% $.417 4.00%
$25,000 but less than
$50,000.................. 10.390 .390 3.75 .390 3.75
$50,000 but less than
$100,000................. 10.336 .336 3.25 .336 3.25
$100,000 but less than
$250,000................. 10.256 .256 2.50 .256 2.50
$250,000 but less than
$1,000,000............... 10.152 .152 1.50 .152 1.50
$1,000,000 and over....... 10.050 .050 0.50 .050 0.50
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
Initial sales charges may be waived for shareholders purchasing $1 million or
more in a single transaction (other than a tax qualified retirement plan under
Section 401 of the Code, a deferred compensation plan under Section 403(b) and
Section 457 of the Code, or employer sponsored non-qualified After-Tax Savings
and Investment programs maintained on the Merrill Lynch Group Employee Services
system), or a purchase by a TMASM Managed Trust, of Class A shares of the Fund.
In addition, purchases of Class A shares of the Fund made in connection with a
single investment of $1 million or more under the Merrill Lynch Mutual Fund
Adviser Program will not be subject to an initial sales charge. Purchases
described in this paragraph will be subject instead to a contingent deferred
sales charge ("CDSC") if the shares are redeemed within one year after purchase
at the following rates:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE OF
AMOUNT OF PURCHASE DOLLAR AMOUNT SUBJECT TO CHARGE
------------------ -------------------------------
<S> <C>
$1 million up to $2.5 million............. 0.75%
Over $2.5 million up to $3.5 million...... 0.40%
Over $3.5 million up to $5 million........ 0.25%
Over $5 million........................... 0.20%
</TABLE>
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A shares
of the Fund will receive a concession equal to most of the sales charge, they
may be deemed to be underwriters under the Securities Act of 1933, as amended.
The proceeds per share to the Fund from the sale of all Class A shares sold
during the subscription period will be $10.00.
The public offering price of the Class B shares during the subscription
offering will be $10.00 per share. However, the Class B shares may be subject
to a contingent deferred sales charge described below under "Deferred Sales
Charge Alternative--Class B Shares--CDSC" if redeemed within four years of
purchase and are subject to ongoing account maintenance and distribution fees
as described below.
The minimum initial purchase for both Class A and Class B shares during the
subscription period is $1,000.
18
<PAGE>
CONTINUOUS OFFERING
Commencing immediately after completion of the subscription offering, Class A
and Class B shares of the Fund will be offered continuously for sale by the
Distributor and other eligible securities dealers (including Merrill Lynch).
During the continuous offering, shares of the Fund may be purchased from
securities dealers or by mailing a purchase order directly to the Transfer
Agent. The minimum initial purchase during the continuous offering is $1,000.
The minimum subsequent purchase is $50.
The Fund will offer its shares during the continuous offering at a public
offering price equal to the next determined net asset value per share plus
sales charges which, at the option of the purchaser, may be imposed either at
the time of purchase (the "initial sales charge alternative") or on a deferred
basis (the "deferred sales charge alternative"), as described below. The
applicable offering price for purchase orders is based upon the net asset value
of the Fund next determined after receipt of the purchase orders by the
Distributor. As to purchase orders received by securities dealers prior to 4:15
P.M., New York time, which includes orders received after the determination of
net asset value on the previous day, the applicable offering price will be
based on the net asset value determined as of 4:15 P.M. on the day the order is
placed with the Distributor, provided the order is received by the Distributor
prior to 4:30 P.M., New York time, on that day. If the purchase orders are not
received by the Distributor prior to 4:30 P.M., New York time, such orders
shall be deemed received on the next business day. Any order may be rejected by
the Distributor or the Trust. The Trust or the Distributor may suspend the
continuous offering of the Fund's shares at any time in response to conditions
in the securities markets or otherwise and may thereafter resume such offering
from time to time. Neither the Distributor nor the dealers are permitted to
withhold placing orders to benefit themselves by a price change. Merrill Lynch
may charge its customers a processing fee (presently $4.85) to confirm a sale
of shares to such customers. Purchases directly through the Fund's Transfer
Agent are not subject to the processing fee.
----------------
The Fund presently issues two classes of shares: Class A shares are sold to
investors choosing the initial sales charge alternative, and Class B shares are
sold to investors choosing the deferred sales charge alternative. Each class of
shares represents an interest in the same portfolio of investments of the Fund,
has thesame rights and is identical to the other class in all respects, except
that Class B shares bear the expenses of the deferred sales arrangements, any
expenses (including incremental transfer agency costs) resulting from such
sales arrangements and the expenses paid by the account maintenance fee and
have exclusive voting rights with respect to the Rule 12b-1 distribution plan
pursuant to which the account maintenance and distribution fees are paid. The
two classes also have different exchange privileges. See "Shareholder
Services-- Exchange Privilege". The net income attributable to Class B shares
and the dividends payable on Class B shares will be reduced by the amount of
the account maintenance and distribution fees and incremental transfer agency
costs relating to Class B shares; accordingly, the net asset value of the Class
B shares will be reduced by such amount to the extent the Fund has
undistributed net income. Sales personnel may receive different compensation
for selling Class A or Class B shares. Investors are advised that only Class A
shares may be available for purchase through securities dealers, other than
Merrill Lynch, that are eligible to sell shares.
The boards of directors or trustees of each of the mutual funds advised by
the Manager or MLAM and presently offering two classes of shares, including the
Fund, approved in August, 1994 a new distribution system for shares of the
funds, which will be named the Merrill Lynch Select PricingSM System. Under the
19
<PAGE>
Select PricingSM System, eligible investors would be permitted to choose from
different sales charge alternatives offered through four classes of shares. It
is currently anticipated that, subject to the approvals of the shareholders of
the other funds, the Select PricingSM System will be implemented for all of
such mutual funds, including the Fund. The Select PricingSM System has been
approved by the sole shareholder of the Fund.
ALTERNATIVE SALES ARRANGEMENTS
The alternative sales arrangements of the Fund permit investors to choose the
method of purchasing shares that is most beneficial given the amount of their
purchase, the length of time the investor expects to hold his shares and other
relevant circumstances. INVESTORS SHOULD DETERMINE WHETHER UNDER THEIR
PARTICULAR CIRCUMSTANCES IT IS MORE ADVANTAGEOUS TO INCUR AN INITIAL SALES
CHARGE AND NOT BE SUBJECT TO ONGOING CHARGES, AS DISCUSSED BELOW, OR TO HAVE
THE ENTIRE INITIAL PURCHASE PRICE INVESTED IN THE FUND WITH THE INVESTMENT
THEREAFTER BEING SUBJECT TO ONGOING CHARGES.
As an illustration, investors who qualify for significantly reduced sales
charges, as described below, might elect the initial sales charge alternative
because similar sales charge reductions are not available for purchases under
the deferred sales charge alternative. Moreover, shares acquired under the
initial sales charge alternative would not be subject to ongoing account
maintenance and distribution fees as described below. However, because initial
sales charges are deducted at the time of purchase, such investors would not
have all their funds invested initially.
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also might elect the
initial sales charge alternative because over time the accumulated continuing
account maintenance and distribution fees may exceed the initial sales charge.
Again, however, such investors must weigh this consideration against the fact
that not all their funds will be invested initially. Furthermore, the ongoing
account maintenance and distribution fees will be offset to the extent that any
return is realized on the additional funds initially invested under the
deferred alternative. Another factor that may be applicable under certain
circumstances is that the payment of the Class B distribution fee and CDSC is
subject to certain limits as set forth below under "Deferred Sales Charge
Alternative--Class B Shares".
Certain other investors might determine it to be more advantageous to have
all their funds invested initially, although remaining subject to continued
account maintenance and distribution fees and, for a four-year period of time,
a CDSC as described below. For example, an investor subject to the 4.0% initial
sales charge will have to hold his investment at least 8 years for the 0.25%
account maintenance fee and 0.25% distribution fee to exceed the initial sales
charge of Class A shares. This example does not take into account the time
value of money which further reduces the impact of the ongoing account
maintenance and distribution fees on the investment, fluctuations in the net
asset value, the effect of the return on the investment over this period of
time or the effect of any limits that may be imposed upon the payment of the
distribution fee and the CDSC.
20
<PAGE>
INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
The public offering price of Class A shares for purchasers choosing the
initial sales charge alternative is the next determined net asset value plus
varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE DISCOUNT TO
AS PERCENTAGE AS PERCENTAGE* SELECTED DEALERS
OF OFFERING OF THE NET AS PERCENTAGE OF THE
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED OFFERING PRICE
------------------ ------------- --------------- --------------------
<S> <C> <C> <C>
Less than $25,000....... 4.00% 4.17% 3.75%
$25,000 but less than
$50,000................ 3.75 3.90 3.50
$50,000 but less than
$100,000............... 3.25 3.36 3.00
$100,000 but less than
$250,000............... 2.50 2.56 2.25
$250,000 but less than
$1,000,000............. 1.50 1.52 1.25
$1,000,000 and over..... 0.50 0.50 0.40
</TABLE>
--------
* Rounded to the nearest one-hundredth percent.
Initial sales charges may be waived for shareholders purchasing $1 million or
more in a single transaction (other than a tax qualified retirement plan under
Section 401 of the Code, a deferred compensation plan under Section 403(b) and
Section 457 of the Code, or employer sponsored non-qualified After-Tax Savings
and Investment programs maintained on the Merrill Lynch Group Employee Services
system), or a purchase by a TMASM Managed Trust, of Class A shares of the Fund.
In addition, purchases of Class A shares of the Fund made in connection with a
single investment of $1 million or more under the Merrill Lynch Mutual Fund
Adviser Program will not be subject to an initial sales charge. Purchases
described in this paragraph will be subject instead to a CDSC if the shares are
redeemed within one year after purchase at the following rates:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE OF
AMOUNT OF PURCHASE DOLLAR AMOUNT SUBJECT TO CHARGE
------------------ -------------------------------
<S> <C>
$1 million up to $2.5 million............. 0.75%
Over $2.5 million up to $3.5 million...... 0.40%
Over $3.5 million up to $5 million........ 0.25%
Over $5 million........................... 0.20%
</TABLE>
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A shares
of the Fund will receive a concession equal to most of the sales charge, they
may be deemed to be underwriters under the Securities Act of 1933, as amended.
Reduced Initial Sales Charges. Sales charges are reduced under a Right of
Accumulation and a Letter of Intention. Class A shares of the Fund are offered
at net asset value to Trustees of the Trust, to directors or trustees of
certain other Merrill Lynch-sponsored investment companies, to an investor who
has a business relationship with a financial consultant who joined Merrill
Lynch from another investment firm within six months prior to the date of
purchase if certain conditions set forth in the Statement of Additional
Information are met, to directors of Merrill Lynch & Co., Inc. and to employees
of Merrill Lynch & Co., Inc. and its subsidiaries. Also, Class A shares may be
offered at net asset value in connection with the acquisition of assets of
other investment companies. No initial sales charges are imposed upon Class A
shares issued as a result of the automatic reinvestment of dividends or capital
gains distributions. Class A shares are offered to TMASM
21
<PAGE>
Managed Trusts to which Merrill Lynch Trust Company provides discretionary
trustee services at net asset value plus a reduced sales charge. Class A
shares of the Fund are offered at net asset value to certain employer
sponsored non-qualified After Tax Savings and Investment programs, provided
such plans meet the required minimum number of eligible employees or required
amount of assets advised by the Fund's investment adviser or any of its
affiliates. Class A shares of the Fund also are offered at net asset value to
shareholders of certain closed-end funds advised by the Manager or MLAM who
wish to reinvest the net proceeds from a sale of their closed-end fund shares
of common stock in shares of the Fund, provided certain conditions are met.
Thus, for example, Class A shares of the Fund are offered at net asset value
to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. (formerly
known as Merrill Lynch Prime Fund, Inc.) ("Senior Floating Rate Fund") who
wish to reinvest the net proceeds from a sale of certain of their shares of
common stock of Senior Floating Rate Fund in shares of the Fund. In order to
exercise this investment option, Senior Floating Rate Fund shareholders must
sell their Senior Floating Rate Fund shares to the Senior Floating Rate Fund
in connection with a tender offer conducted by the Senior Floating Rate Fund
and reinvest the proceeds immediately in the Fund. This investment option is
available only with respect to the proceeds of Senior Floating Rate Fund
shares as to which no Early Withdrawal Charge (as defined in the Senior
Floating Rate Fund prospectus) is applicable. Purchase orders from Senior
Floating Rate Fund shareholders wishing to exercise this investment option
will be accepted only on the day that the related Senior Floating Rate Fund
tender offer terminates and will be effected at the net asset value of the
Fund at such day. Class A shares of the Fund may be purchased at net asset
value, without a sales charge, by programs associated with professional
athletic players' associations which have invested in the aggregate more than
$10 million in Merrill Lynch-sponsored investment companies. Additional
information concerning these reduced initial sales charges is set forth in the
Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVE--CLASS B SHARES
Investors choosing the deferred sales charge alternative purchase Class B
shares at net asset value per share without the imposition of a sales charge
at the time of purchase. The Class B shares are being sold without an initial
sales charge so that the Fund will receive the full amount of the investor's
purchase payment. Merrill Lynch compensates its financial consultants for
selling Class B shares at the time of purchase from its own funds. The
proceeds of the CDSC and the ongoing distribution fee discussed below are used
to defray Merrill Lynch's distribution expenses, including compensating its
financial consultants. The proceeds from the ongoing account maintenance fee
are used to compensate Merrill Lynch for providing continuing account
maintenance activities.
Proceeds from the CDSCs are paid to the Distributor and are used in whole or
in part by the Distributor to defray the expenses of dealers (including
Merrill Lynch) related to providing distribution-related services to the Fund
in connection with the sale of the Class B shares, such as the payment of
compensation to financial consultants for selling Class B shares, from the
dealer's own funds. Payments by the Fund to the Distributor of the
distribution fee under the distribution plan described below also may be used
in whole or in part by the Distributor for this purpose. The combination of
the CDSC and the ongoing distribution fee facilitates the ability of the Fund
to sell the Class B shares without a sales charge being deducted at the time
of purchase. Class B shareholders of the Fund exercising the exchange
privilege described under "Shareholder Services--Exchange Privilege" will
continue to be subject to the Fund's CDSC schedule, if such schedule is higher
than the deferred sales charge schedule relating to the Class B shares
acquired as a result of the exchange.
CDSC. Class B shares which are redeemed within four years of purchase may be
subject to a CDSC at the rates set forth below charged as a percentage of the
dollar amount subject thereto. The charge will be assessed on an amount equal
to the lesser of the current market value or the cost of the shares being
redeemed.
22
<PAGE>
Accordingly, no CDSC will be imposed on increases in net asset value above the
initial purchase price. In addition, no CDSC will be assessed on shares derived
from reinvestment of dividends or capital gains distributions.
The following table sets forth the rates of the CDSC:
<TABLE>
<CAPTION>
CDSC AS A
PERCENTAGE OF
YEAR SINCE DOLLAR AMOUNT
PURCHASE SUBJECT TO
PAYMENT MADE CHARGE
------------ -------------
<S> <C>
0-1........................................................ 4.0%
1-2........................................................ 3.0%
2-3........................................................ 2.0%
3-4........................................................ 1.0%
4 and thereafter........................................... None
</TABLE>
In determining whether a CDSC is applicable to a redemption, the calculation
will be determined in the manner that results in the lowest possible applicable
rate being charged. Therefore, it will be assumed that the redemption is first
of shares until such time as the CDSC is no longer applicable or shares
acquired pursuant to reinvestment of dividends or distributions and then of
shares held longest during the four-year period. The charge will not be applied
to dollar amounts representing an increase in the net asset value since the
time of purchase. A transfer of shares from a shareholder's account to another
account will be assumed to be made in the same order as redemption.
To provide an example, assume an investor purchased 100 Class B shares at $10
per share (at a cost of $1,000) and in the third year after purchase, the net
asset value per share is $12 and, during such time, the investor has acquired
10 additional shares upon dividend reinvestment. If at such time the investor
makes his first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to charge because of dividend reinvestment. With respect to the
remaining 40 shares, the CDSC is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 2.0% (the
applicable rates in the third year after purchase). The CDSC is waived on
redemptions of shares following the death or disability (as defined in the
Code) of a shareholder.
Distribution Plan. Pursuant to a distribution plan adopted by the Fund under
Rule 12b-1 under the 1940 Act (the "Distribution Plan"), the Fund pays the
Distributor an ongoing account maintenance fee and distribution fee relating to
Class B shares, which are accrued daily and paid monthly, at the annual rates
of 0.25% and 0.25%, respectively, of the average daily net assets of the Class
B shares of the Fund. Pursuant to a sub-agreement with the Distributor, Merrill
Lynch also provides account maintenance and distribution services to the Fund.
The ongoing account maintenance fee compensates the Distributor and Merrill
Lynch for providing account maintenance services to Class B shareholders.The
ongoing distribution fee compensates the Distributor and Merrill Lynch for
providing distribution services and bearing certain distribution-related
expenses of the Fund, including payments to financial consultants for selling
Class B shares of the Fund.
The Distribution Plan is designed to permit an investor to purchase Class B
shares through dealers without the assessment of a front-end sales charge and
at the same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B shares. In this regard, the purpose and
function of the ongoing distribution fee under the Distribution Plan and the
CDSC are the same as those of the initial sales charge with respect to the
Class A shares of the Fund in that the deferred sales charges provide for the
financing of the distribution of the Fund's Class B shares.
23
<PAGE>
The payments under the Distribution Plan are based on a percentage of
average daily net assets of Class B shares regardless of the amount of
expenses incurred, and, accordingly, distribution-related revenues may be more
or less than distribution-related expenses. Information with respect to the
distribution-related revenues and expenses is presented to the Trustees for
their consideration in connection with their deliberations as to the
continuance of the Distribution Plan. This information is presented annually
as of December 31 of each year on a "fully allocated accrual" basis and
quarterly on a "direct expense and revenue/cash" basis. On the fully allocated
accrual basis, revenues consist of the account maintenance fees, distribution
fees, the CDSCs and certain other related revenues, and expenses consist of
financial consultant compensation, branch office and regional operation center
selling and transaction processing expenses, advertising, sales promotion and
market expenses, corporate overhead and interest expense. On the direct
expense and revenue/cash basis, revenues consist of the account maintenance
fees, distribution fees and CDSCs, and the expenses consist of financial
consultant compensation.
The Fund has no obligation with respect to distribution-related expenses
incurred by the Distributor and Merrill Lynch in connection with the Class B
shares, and there is no assurance that the Trustees of the Trust will approve
the continuance of the Distribution Plan from year to year. However, the
Distributor intends to seek annual continuation of the Distribution Plan. In
their review of the Distribution Plan, the Trustees will not be asked to take
into consideration expenses incurred in connection with the distribution of
Class A shares or of shares of other funds for which the Distributor acts as
distributor. The account maintenance fee, the distribution fee and the CDSC in
the case of Class B shares will not be used to subsidize the sale of Class A
shares.
Limitations on the Payment of Deferred Sales Charges. The maximum sales
charge rule in the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. ("NASD") imposes a limitation on certain asset-based
sales charges such as the Fund's distribution fee and the CDSC, but not the
account maintenance fee. As applicable to the Fund, the maximum sales charge
rule limits the aggregate of distribution fee payments and CDSCs payable by
the Fund to (1) 6.25% of eligible gross sales of Class B shares (defined to
exclude shares issued pursuant to dividend reinvestments and exchanges) plus
(2) interest on the unpaid balance at the prime rate plus 1% (the unpaid
balance being the maximum amount payable minus amounts received from the
payment of the distribution fee and the CDSC). The Distributor has voluntarily
agreed to waive interest charges on the unpaid balance in excess of 0.50% of
eligible gross sales. Consequently, the maximum amount payable to the
Distributor (referred to as the "voluntary maximum") is 6.75% of eligible
gross sales. The Distributor retains the right to stop waiving the interest
charges at any time. To the extent payments would exceed the voluntary
maximum, the Fund will not make further payments of the distribution fee and
any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances,
payments in excess of the amount payable under the NASD formula will not be
made.
REDEMPTION OF SHARES
The Trust is required to redeem for cash all full and fractional shares of
the Fund upon receipt of a written request in proper form. The redemption
price is the net asset value per share next determined after the initial
receipt of proper notice of redemption. Except for any CDSC which may be
applicable to Class B shares, there will be no charge for redemption if the
redemption request is sent directly to the Transfer Agent. Shareholders
liquidating their holdings will receive upon redemption all dividends
reinvested through the date of redemption. The value of shares at the time of
redemption may be more or less than the shareholder's cost, depending on the
market value of the securities held by the Fund at such time.
24
<PAGE>
REDEMPTION
A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Transfer Agent, Financial Data Services, Inc., Transfer Agency
Mutual Fund Operations, P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to
Financial Data Services, Inc., Transfer Agency Mutual Fund Operations, 4800
Deer Lake Drive East, Jacksonville, Florida 32246-6484. Proper notice of
redemption in the case of shares deposited with the Transfer Agent may be
accomplished by a written letter requesting redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may
be accomplished by a written letter as noted above accompanied by certificates
for the shares to be redeemed. Redemption requests should not be sent to the
Trust. The notice in either event requires the signature(s) of all persons in
whose name(s) the shares are registered, signed exactly as such name(s)
appear(s) on the Transfer Agent's register. The signature(s) on the redemption
request must be guaranteed by an "eligible guarantor institution" as such term
is defined in Rule 17Ad-15 under the Securities Exchange Act of 1934, as
amended, the existence and validity of which may be verified by the Transfer
Agent through the use of industry publications. Notarized signatures are not
sufficient. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority. For shareholders redeeming directly with the Transfer Agent,
payments will be mailed within seven days of receipt of a proper notice of
redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal funds or certified
check drawn on a United States bank). The Trust may delay or cause to be
delayed the mailing of a redemption check until such time as it has assured
itself that good payment has been collected for the purchase of such Fund
shares, which may take up to 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that
the request for repurchase is received by the dealer prior to the close of
business on the New York Stock Exchange on the day received and is received by
the Fund from such dealer not later than 4:30 P.M., New York time, on the same
day.
Dealers have the responsibility of submitting such repurchase requests to
the Trust not later than 4:30 P.M., New York time, in order to obtain that
day's closing price. The repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Trust (other than the
applicable CDSC in the case of Class B shares); securities firms which do not
have selected dealer agreements with the Distributor, however, may impose a
charge on the shareholder for transmitting the notice of repurchase to the
Trust. Merrill Lynch may charge its customers a processing fee (presently
$4.85) to confirm a repurchase of shares of such customers. Redemptions
directly through the Fund's Transfer Agent are not subject to the processing
fee. The Trust reserves the right to reject any order for repurchase, which
right of rejection might adversely affect shareholders seeking redemption
through the repurchase procedure. However, a shareholder whose order for
repurchase is rejected by the Trust may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS A SHARES
Shareholders who have redeemed their Class A shares have a one-time
privilege to reinstate their accounts by purchasing Class A shares of the Fund
at net asset value without a sales charge up to the dollar amount redeemed.
The reinstatement privilege may be exercised by sending a notice of exercise
along with a check for the amount to be reinstated to the Transfer Agent
within 30 days after the date the request for redemption was accepted by the
Transfer Agent or the Distributor. The reinstatement will be made at the net
asset value per share next determined after the notice of reinstatement is
received and cannot exceed the amount of the redemption proceeds. The
reinstatement is a one-time privilege and may be exercised by the Class A
shareholder only the first time such shareholder makes a redemption.
25
<PAGE>
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
designed to facilitate investment in shares of the Fund. Full details as to
each of such services and instructions as to how to participate in the various
services or plans, or to change options with respect thereto can be obtained
from the Trust by calling the telephone number on the cover page hereof or from
the Distributor or Merrill Lynch. Included in such services are the following:
Investment Account. Each shareholder whose account (an "Investment Account")
is maintained at the Transfer Agent has an Investment Account and will receive
quarterly statements from the Transfer Agent. These quarterly statements will
serve as transaction confirmations for automatic investment purchases and the
reinvestment of income dividends and long-term capital gain distributions. The
quarterly statements will also show any other activity in the account since the
preceding statement. Shareholders will receive separate transaction
confirmations for each purchase or sale transaction other than automatic
investment purchases and the reinvestment of income dividends and long-term
capital gain distributions. A shareholder may make additions to his Investment
Account at any time by mailing a check directly to the Transfer Agent.
Shareholders may also maintain their accounts through Merrill Lynch. Upon the
transfer of shares out of a Merrill Lynch brokerage account, an Investment
Account in the transferring shareholder's name will be opened automatically,
without charge, at the Transfer Agent. Shareholders considering transferring
their Class A shares from Merrill Lynch to another brokerage firm or financial
institution should be aware that, if the firm to which the Class A shares are
to be transferred will not take delivery of shares of the Fund, a shareholder
either must redeem the Class A shares so that the cash proceeds can be
transferred to the account at the new firm or such shareholder must continue to
maintain an Investment Account at the Transfer Agent for those Class A shares.
Shareholders interested in transferring their Class B shares from Merrill Lynch
and who do not wish to have an Investment Account maintained for such shares at
the Transfer Agent may request their new brokerage firm to maintain such shares
in an account registered in the name of the brokerage firm for the benefit of
the shareholder. If the new brokerage firm is willing to accommodate the
shareholder in this manner, the shareholder must request that he be issued
certificates for his shares and then must turn the certificates over to the new
firm for re-registration as described in the preceding sentence.
Exchange Privilege. Shareholders of the Fund each have an exchange privilege
with certain other mutual funds sponsored by Merrill Lynch. There is currently
no limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated at any time in
accordance with the rules of the Commission. Class A shareholders of the Fund
may exchange their shares ("outstanding Class A shares") for Class A shares of
another fund ("new Class A shares") on the basis of relative net asset value
per Class A share, plus an amount equal to the difference, if any, between the
sales charge previously paid on the outstanding Class A shares and the sales
charge payable at the time of the exchange on the new Class A shares. However,
the Fund's exchange privilege is modified with respect to purchases of Class A
shares under the Merrill Lynch Mutual Fund Adviser program. First, the initial
allocation of assets is made under the program. Then, any subsequent exchange
under the program of Class A shares of a fund for Class A shares of the Fund
will be made solely on the basis of the relative net asset values of the shares
being exchanged. Therefore, there will not be a charge for any difference
between the sales charge previously paid on the shares of the other fund and
the sales charge payable on the shares of the Fund being acquired in the
exchange under this program. The exchange privilege is available only to U.S.
shareholders in states where the exchange legally may be made. The exchange
privilege also may be modified if the Merrill Lynch Select Pricing SM System is
adopted. See "Purchase of Shares--Continuous Offering."
Class B shareholders of the Fund may exchange their shares ("outstanding
Class B shares") for Class B shares of another fund ("new Class B shares") on
the basis of relative net asset value per share, without the
26
<PAGE>
payment of any CDSC that might otherwise be due upon the redemption of the
outstanding Class B shares. Class B shareholders of the Fund exercising the
exchange privilege will continue to be subject to the Fund's CDSC schedule if
such schedule is higher than the deferred sales charge schedule relating to the
new Class B shares. In addition, Class B shares of the Fund acquired through
use of the exchange privilege will be subject to the Fund's CDSC schedule if
such schedule is higher than the deferred sales charge schedule relating to the
Class B shares of the fund from which the exchange has been made. For purposes
of computing the CDSC that may be payable upon a disposition of the new Class B
shares, the holding period for the outstanding Class B shares is "tacked" to
the holding period of the new Class B shares. Class A and Class B shareholders
of the Fund may also exchange their shares for shares of certain money market
funds, but in the case of an exchange from Class B shares the period of time
that shares are held in a money market fund will not count toward satisfaction
of the holding period requirement for purposes of reducing the CDSC. Exercise
of the exchange privilege is treated as a sale for Federal income tax purposes.
For further information, see "Shareholder Services -- Exchange Privilege" in
the Statement of Additional Information.
The Fund's exchange privilege is modified with respect to purchases of Class
A shares under the Merrill Lynch Mutual Fund Adviser program. First, the
initial allocation of assets is made under the program. Then, any subsequent
exchange under the program of Class A shares of a fund for Class A shares of
the Fund will be made solely on the basis of the relative net asset values of
the shares being exchanged. Therefore, there will not be a charge for any
difference between the sales charge previously paid on the shares of the other
fund and the sales charge payable on the shares of the Fund being acquired in
the exchange under this program.
Automatic Reinvestment of Dividends and Capital Gains Distributions. All
dividends and capital gains distributions are reinvested automatically in full
and fractional shares of the Fund, without a sales charge, at the net asset
value per share at the close of business on the monthly payment date for such
dividends and distributions. A shareholder may at any time, by written
notification or by telephone (1-800-MER-FUND) to the Transfer Agent, elect to
have subsequent dividends or both dividends and capital gains distributions
paid in cash, rather than reinvested, in which event payment will be mailed
monthly. No deferred sales charge will be imposed upon redemption of shares
issued as a result of the automatic reinvestment of dividends or capital gains
distributions.
Systematic Withdrawal and Automatic Investment Plans. A Class A shareholder
may elect to receive systematic withdrawal payments from his Investment Account
in the form of payment by check or through automatic payment by direct deposit
to his bank account on either a monthly or quarterly basis. A Class A
shareholder whose shares are held within a CMA(R), CBA(R) or Retirement Account
may elect to have shares redeemed on a monthly, bimonthly, quarterly,
semiannual or annual basis through the Systematic Redemption Program, subject
to certain conditions. Regular additions of both Class A and Class B shares may
be made to an investor's Investment Account by prearranged charges of $50 or
more to his regular bank account. The Fund's Automatic Investment Program is
not available to shareholders whose shares are held in a brokerage account with
Merrill Lynch. Alternatively, investors who maintain CMA(R) accounts may
arrange to have periodic investments made in the Fund in their CMA(R) account
or in certain related accounts in amounts of $100 or more through the CMA(R)
Automatic Investment Program.
27
<PAGE>
PORTFOLIO TRANSACTIONS
The Trust has no obligation to deal with any dealer or group of dealers in
the execution of transactions in portfolio securities of the Fund. Municipal
Bonds and other securities in which the Fund invests are traded primarily in
the over-the-counter market. Where possible, the Trust deals directly with the
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Trust to obtain the best net results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread), the size, type and difficulty of the
transactions involved, the firm's general execution and operations facilities,
and the firm's risk in positioning the securities involved and the provision of
supplemental investment research by the firm. While reasonably competitive
spreads or commissions are sought, the Fund will not necessarily be paying the
lowest spread or commission available. The sale of shares of the Fund may be
taken into consideration as a factor in the selection of brokers or dealers to
execute portfolio transactions for the Fund. The portfolio securities of the
Fund generally are traded on a net basis and normally do not involve either
brokerage commissions or transfer taxes. The cost of portfolio securities
transactions of the Fund primarily consists of dealer or underwriter spreads.
Under the 1940 Act, persons affiliated with the Trust, including Merrill Lynch,
are prohibited from dealing with the Trust as a principal in the purchase and
sale of securities unless such trading is permitted by an exemptive order
issued by the Commission. The Trust has obtained an exemptive order permitting
it to engage in certain principal transactions with Merrill Lynch involving
high quality short-term municipal bonds subject to certain conditions. In
addition, the Trust may not purchase securities, including Municipal Bonds, for
the Fund during the existence of any underwriting syndicate of which Merrill
Lynch is a member except pursuant to procedures approved by the Trustees of the
Trust which comply with rules adopted by the Commission. Affiliated persons of
the Trust may serve as its broker in over-the-counter transactions conducted
for the Fund on an agency basis only.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily
following the normal close of trading on the New York Stock Exchange (currently
4:00 P.M.) prior to the determination of the net asset value on that day. The
net investment income of the Fund for dividend purposes consists of interest
earned on portfolio securities, less expenses, in each case computed since the
most recent determination of the net asset value. Expenses of the Fund,
including the management fees and Class B account maintenance and distribution
fees, are accrued daily. Dividends of net investment income are declared daily
and reinvested monthly in the form of additional full and fractional shares of
the Fund at net asset value as of the close of business on the "payment date"
unless the shareholder elects to receive such dividends in cash. Shares will
accrue dividends as long as they are issued and outstanding. Shares are issued
and outstanding from the settlement date of a purchase order to the day prior
to settlement date of a redemption order.
All net realized long- or short-term capital gains, if any, are declared and
distributed to the Fund's shareholders at least annually. Capital gains
distributions will be reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on Class B shares will be lower
than per share dividends and distributions on Class A shares as a result of the
distribution and transfer agency fees applicable with respect to the Class B
shares. See "Additional Information--Determination of Net Asset Value".
28
<PAGE>
See "Shareholder Services" for information as to how to elect either dividend
reinvestment or cash payments. Portions of dividends and distributions which
are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to elect and to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The Trust
intends to cause the Fund to distribute substantially all of such income.
Arkansas has incorporated the special Federal tax provisions affecting
regulated investment companies into state income tax law. Consequently, for
Arkansas income tax purposes, the Fund will be treated as a RIC to the extent
it qualifies as such under the Code.
To the extent that the dividends distributed to the Fund's Class A and Class
B shareholders (together, the "shareholders") are derived from interest income
exempt from Federal income tax under Code Section 103(a) and are properly
designated as "exempt-interest dividends" by the Trust, they will be excludable
from a shareholder's gross income for Federal income tax purposes. Exempt-
interest dividends are included, however, in determining the portion, if any,
of a person's social security benefits and railroad retirement benefits subject
to Federal income taxes. The portion of such exempt-interest dividends paid
from interest received by the Fund from Arkansas Municipal Bonds will not be
subject to Arkansas income taxes. Shareholders subject to income taxation by
states other than Arkansas will realize a lower after-tax rate of return than
Arkansas shareholders since the dividends distributed by the Fund generally
will not be exempt, to any significant degree, from income taxation by such
other states. The Trust will inform shareholders annually as to the portion of
the Fund's distributions which constitutes exempt-interest dividends and the
portion which is exempt from Arkansas income tax. Interest on indebtedness
incurred or continued to purchase or carry Fund shares is not deductible for
Federal or Arkansas income tax purposes to the extent attributable to exempt-
interest dividends. Persons who may be "substantial users" (or "related
persons" of substantial users) of facilities financed by industrial development
bonds or private activity bonds held by the Fund should consult their tax
advisers before purchasing Fund shares.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal income tax purposes. Such distributions
are not eligible for the dividends received deduction for corporations.
Distributions, if any, of net long-term capital gains from the sale of
securities or from certain transactions in futures or options ("capital gain
dividends") are taxable as long-term capital gains for Federal income tax
purposes, regardless of the length of time the shareholder has owned Fund
shares. Under the Revenue Reconciliation Act of 1993, all or a portion of the
Fund's gain from the sale or redemption of tax-exempt obligations purchased at
a market discount will be treated as ordinary income rather than capital gain.
This rule may increase the amount of ordinary income dividends received by
shareholders. Distributions in excess of the Fund's earnings and profits will
first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Any loss upon the
sale or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. In addition, such loss will be disallowed to the extent of any
exempt-interest dividends received by the shareholder. If the Fund pays a
29
<PAGE>
dividend in January which was declared in the previous October, November or
December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
In 1991, Arkansas enacted legislation adopting certain sections of the Code
and related regulations in effect on January 1, 1991, which apply to the
computation of capital gains and losses. For individuals, net capital gains are
taxed at a maximum of 6% (as compared with the maximum rate of 7% for ordinary
income). Special capital gains treatment is not available in Arkansas for
corporate taxpayers.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. This alternative minimum tax applies
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds," and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain
differences between taxable income as adjusted for other tax preferences and
the corporation's "adjusted current earnings," which more closely reflect a
corporation's economic income. Because an exempt-interest dividend paid by the
Fund will be included in adjusted current earnings, a corporate shareholder may
be required to pay alternative minimum tax on exempt-interest dividends paid by
the Fund.
The Revenue Reconciliation Act of 1993 has added new marginal tax brackets of
36% and 39.6% for individuals and has created a graduated structure of 26% and
28% for the alternative minimum tax applicable to individual taxpayers. These
rate increases may affect an individual investor's after-tax return from an
investment in the Fund as compared with such investor's return from taxable
investments.
If a Class A shareholder exercises the exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent the sales charge
paid to the Fund reduces any sales charge such shareholder would have owed upon
purchase of the new Class A shares in the absence of the exchange privilege.
Instead, such sales charge will be treated as an amount paid for the new Class
A shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and capital gain dividends
and on redemption payments ("backup withholding"). Generally, shareholders
subject to backup withholding will be those for whom no certified taxpayer
identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
30
<PAGE>
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Arkansas tax laws presently in
effect. For the complete provisions, reference should be made to the pertinent
Code sections, the Treasury regulations promulgated thereunder and the
applicable Arkansas income tax laws. The Code and the Treasury regulations, as
well as the Arkansas tax laws, are subject to change by legislative, judicial
or administrative action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes (other than those
imposed by Arkansas) and with specific questions as to Federal, foreign, state
or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
yield and tax equivalent yield for various specified time periods in
advertisements or information furnished to present or prospective shareholders.
Average annual total return, yield and tax equivalent yield are computed in
accordance with formulas specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A shares and the contingent deferred sales charge that would be
applicable to a complete redemption of the investment at the end of the
specified period in the case of Class B shares. Dividends paid by the Fund with
respect to Class A and Class B shares, to the extent any dividends are paid,
will be calculated in the same manner at the same time on the same day and will
be in the same amount, except that account maintenance and distribution charges
and any incremental transfer agency costs relating to Class B shares will be
borne exclusively by that Class. The Fund will include performance data for
both Class A and Class B shares of the Fund in any advertisement or information
including performance data of the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the impact on the performance data calculations
of including or excluding the maximum applicable sales charges, actual annual
or annualized total return data generally will be lower than average annual
total return data since the average annual rates of return reflect compounding,
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time. In advertisements distributed to investors whose
purchases are subject to reduced sales charges in the case of Class A shares or
waiver of the CDSC in the case of Class B shares (such as investors in certain
retirement plans), the performance data may take into account the reduced, and
not the maximum, sales charge or may not take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or waiver of the CDSC, a lower amount of expenses is deducted. See
"Purchase of Shares". The Fund's total return may be expressed either as a
percentage or as a dollar amount in order to illustrate such total return on a
hypothetical $1,000 investment in the Fund at the beginning of each specified
period.
31
<PAGE>
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average daily number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per
share on the last day of the period. Tax equivalent yield quotations will be
computed by dividing (a) the part of the Fund's yield that is tax-exempt by (b)
one minus a stated tax rate and (c) adding the result to that part, if any, of
the Fund's yield that is not tax-exempt.
Total return and yield figures are based on the Fund's historical performance
and are not intended to indicate future performance. The Fund's total return
and yield will vary depending on market conditions, the securities comprising
the Fund's portfolio, the Fund's operating expenses and the amount of realized
and unrealized net capital gain or losses during the period. The value of an
investment in the Fund will fluctuate and an investor's shares, when redeemed,
may be worth more or less than their original cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
("Morningstar") and CDA Investment Technology, Inc., or to data contained in
publications such as Money Magazine, U.S. News & World Report, Business Week,
Forbes Magazine and Fortune Magazine. From time to time, the Fund may include
the Fund's Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered representative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the Fund is determined by the Manager once daily as of
4:15 P.M., New York time, on each day during which the New York Stock Exchange
is open for trading. The net asset value per share is computed by dividing the
sum of the value of the securities held by the Fund plus any cash or other
assets minus all liabilities by the total number of shares outstanding at such
time, rounded to the nearest cent. Expenses, including the fees payable to the
Manager and the Distributor, are accrued daily.
The net asset value per share of the Class A shares and the net asset value
per share of the Class B shares are expected to be equivalent. Under certain
circumstances, however, the per share net asset value of the Class B shares may
be lower than the per share net asset value of the Class A shares reflecting
the higher daily expense accruals of the deferred charges (and incremental
transfer agency costs) applicable with respect to the Class B shares. Even
under those circumstances, the per share net asset value of the two classes
eventually will tend to converge immediately after the payment of dividends,
which will differ by approximately the amount of the expense accrual
differential between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on August 2, 1985
under the laws of Massachusetts. On October 1, 1987, the Trust changed its name
from "Merrill Lynch Multi-State Tax-Exempt Series Trust" to "Merrill Lynch
Multi-State Municipal Bond Series Trust" and on December 22, 1987 the Trust
changed its name to "Merrill Lynch Multi-State Municipal Series Trust". The
Trust is an open-end management investment company comprised of separate series
("Series"), each of which is a
32
<PAGE>
separate portfolio offering shares to selected groups of purchasers. Each of
the Series is to be managed independently in order to provide to shareholders
who are residents of the state to which such Series relates as high a level of
income exempt from Federal, state and local income taxes as is consistent with
prudent investment management. The Trustees are authorized to create an
unlimited number of Series and, with respect to each Series, to issue an
unlimited number of full and fractional shares of beneficial interest of $.10
par value of different classes. Shareholder approval is not required for the
authorization of additional Series or classes of a Series of the Trust. At the
date of this Prospectus, the shares of the Fund are divided into Class A shares
and Class B shares. Both Class A and Class B shares represent an interest in
the same assets of the Fund and have identical voting, dividend, liquidation
and other rights and the same terms and conditions except that expenses related
to the account maintenance and distribution of the Class B shares are borne
solely by such class and Class B shares have exclusive voting rights with
respect to matters relating to such distribution expenditures. See "Purchase of
Shares". The Trust has received an order (the "Order") from the Commission
permitting the issuance and sale of multiple classes of shares. The Order
permits the Trust to issue additional classes of shares of any Series if the
Board of Trustees deems such issuance to be in the best interest of the Trust.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. All shares of the Trust have equal voting rights, except that
only shares of the respective Series are entitled to vote on matters concerning
only that Series and, as noted above, only Class B shares of a Series will have
exclusive voting rights with respect to matters relating to the account
maintenance and distribution expenses being borne solely by such class. There
normally will be no meeting of shareholders for the purpose of electing
Trustees unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders, at which time the Trustees
then in office will call a shareholders' meeting for the election of Trustees.
Shareholders may, in accordance with the terms of the Declaration of Trust,
cause a meeting of shareholders to be held for the purpose of voting on the
removal of Trustees. Also, the Trust will be required to call a special meeting
of shareholders of a Series in accordance with the requirements of the 1940 Act
to seek approval of new management and advisory arrangements, of a material
increase in distribution fees or of a change in the fundamental policies,
objectives or restrictions of a Series. Except as set forth above, the Trustees
shall continue to hold office and appoint successor Trustees. Each issued and
outstanding share is entitled to participate equally in dividends and
distributions declared by the respective Series and in net assets of such
Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities except that, as noted above, expenses related to the
distribution of the Class B shares of a Series will be borne solely by such
class. The obligations and liabilities of a particular Series are restricted to
the assets of that Series and do not extend to the assets of the Trust
generally. The shares of each Series, when issued, will be fully-paid and non-
assessable by the Trust.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts, the shareholder should notify in writing:
Financial Data Services, Inc.
Attn: Document Evaluation Unit
P.O. Box 45290
Jacksonville, FL 32232-5290
33
<PAGE>
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
matter please call your Merrill Lynch financial consultant or Financial Data
Services, Inc. at 800-637-3863.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
The Declaration of Trust establishing the Trust, dated August 2, 1985, a copy
of which together with all amendments thereto (the "Declaration"), is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability, nor shall resort be had to such
person's private property for the satisfaction of any obligation or claim of
the Trust, but the "Trust Property" only shall be liable.
34
<PAGE>
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND--AUTHORIZATION FORM
- -------------------------------------------------------------------------------
NOTE: THIS FORM MAY NOT BE USED FOR PURCHASES THROUGH THE MERRILL LYNCH
BLUEPRINTSM PROGRAM. YOU MAY REQUEST A MERRILL LYNCH BLUEPRINTSM PROGRAM
APPLICATION BY CALLING (800) 637-2434.
- -------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase . . . . . . . Class A shares or
. . . . . . . Class B shares (choose one) of Merrill Lynch Arkansas Municipal
Bond Fund and establish an Investment Account as described in the Prospectus.
Basis for establishing an Investment Account:
A. I enclose a check for $ . . . . . . . payable to Financial Data
Services, Inc., as an initial investment (minimum $1,000) (subsequent
investment $50 or more). I understand that this purchase will be executed
at the applicable offering price next to be determined after this
Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the right of accumulation as outlined in the Statement of
Additional Information:
1. ....................................... 4. ...............................
2. ....................................... 5. ...............................
3. ....................................... 6. ...............................
(Please list all Funds. Use a separate sheet of paper if necessary.)
Until you are notified by me in writing, the following options with
respect to dividends and distributions are elected:
Distribution Elect [_] reinvest dividends Elect [_] reinvest capital gains
Options One [_] pay dividends in cash One [_] pay capital gains in cash
If no election is made, dividends and capital gains will be reinvested
automatically at net asset value without a sales charge.
----------------
(Please Print)
Name .............................................
First Name Initial Last Name
Name of Co-Owner (if any).............................. Social Security
First Name Initial Last Name No. or Taxpayer
Identification
No.
Address ..........................................
.................................................. ................, 19. .
(Zip Code) Date
Occupation .............. Name and Address..................................
of Employer.......................................
..................................................
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security No. or Taxpayer Identification No. and (2) that I
am not subject to backup withholding (as discussed under "Distribution and
Taxes--Taxes" in the Prospectus) either because I have not been notified that
I am subject thereto as a result of a failure to report all interest or
dividends, or the Internal Revenue Service ("IRS") has notified me that I am
no longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING,
AND IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS
BEEN TERMINATED.
SIGNATURE OF OWNER .............. SIGNATURE OF CO-OWNER (IF ANY) ........
In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.
- -------------------------------------------------------------------------------
2. LETTER OF INTENTION--CLASS A SHARES ONLY (SEE TERMS AND CONDITIONS IN THE
STATEMENT OF ADDITIONAL INFORMATION)
..............., 19...
Gentlemen: Date of initial
purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Arkansas Municipal Bond Fund or any other investment company with an
initial sales charge or deferred sales charge for which the Merrill Lynch
Funds Distributor, Inc. acts as a distributor over the next 13-month period
which will equal or exceed:
[_] $25,000 [_] $50,000 [_] $100,000 [_] $250,000 [_] $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Fund prospectus.
I agree to the terms and conditions of the Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Arkansas Municipal Bond Fund held as security.
By .................................. .....................................
Signature of Owner Signature (If registered in joint
names, both must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name ............................ (2) Name ............................
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35
<PAGE>
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND--AUTHORIZATION FORM
- --------------------------------------------------------------------------------
3.SYSTEMATIC WITHDRAWAL PLAN--CLASS A SHARES ONLY (SEE TERMS AND CONDITIONS IN
THE STATEMENT OF ADDITIONAL INFORMATION)
Minimum Requirements: $10,000 for monthly disbursements, $5,000 for
quarterly, of shares in Merrill Lynch Arkansas Municipal Bond Fund at cost or
current offering price.
Withdrawals to be made either (check
one) [_] Monthly [_] Quarterly. Quarterly withdrawals
are made on the 24th day of March, June, September
and December.
Begin systematic withdrawal on . . . . . . . . . , 19. .
[date]
Specify withdrawal amount (check one): [_] $ . . . . . . . or [_] . . . . .% of
the current value of Class A shares in the account
Specify withdrawal method: [_] check or [_] direct deposit to bank account
(CHECK ONE AND COMPLETE PART (A) OR (B) BELOW):
(a) I HEREBY AUTHORIZE PAYMENT (a) I HEREBY AUTHORIZE PAYMENT
BY CHECK BY DIRECT DEPOSIT TO BANK
ACCOUNT and (if necessary) debit
entries and adjustments for any
credit entries made in error to
my account
Draw checks payable
(check one) Specify type of account (check
[_] as indicated in item 1. one): [_] checking [_] savings
[_] to the order of ............ I agree that this authorization
will remain in effect until I
provide written notification to
Financial Data Services, Inc.
amending or terminating this
service.
Name on your Account ............
Mail to (check one) Bank .....................................
[_] the address indicated in Bank # ................ Account # ........
item 1.
[_] Name (Please Print) ........ Bank Address ....................
Signature of Depositor .. Date ...........
Address .........................
Signature of Depositor (if joint
Signature of Owner............... account) ........................
NOTE: IF AUTOMATIC DIRECT
DEPOSIT IS ELECTED, YOUR BLANK,
UNSIGNED CHECK MARKED "VOID" OR
A DEPOSIT SLIP FROM YOUR SAVINGS
ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
Signature of Co-Owner (if any)...
- --------------------------------------------------------------------------------
4. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Financial Data Services, Inc. draw a check or an
automated clearing house ("ACH") debit on my checking account as described
below each month to purchase . . . . . Class A shares or . . . . . Class B
shares of Merrill Lynch Arkansas Municipal Bond Fund subject to the terms set
forth below.
FINANCIAL DATA SERVICES, INC. AUTHORIZATION TO HONOR CHECKS OR ACH
DEBITS
You are hereby authorized to DRAWN BY FINANCIAL DATA SERVICES, INC.
draw a check or an ACH debit To ...................................Bank
each month on my bank account (Investor's Bank)
for investment in Merrill Lynch Bank Address .............................
Arkansas Municipal Bond Fund as City .......... State ..... Zip Code......
indicated below:
Amount of each check or ACH
debit $ .....................
As a convenience to me, I hereby request
Account No. ................. and authorize you to pay and charge to my
Please date and invest account checks or ACH debits drawn on my
checks or draw ACH debits on account by and payable to Financial Data
the 20th of each month Services, Inc. I agree that your rights
beginning ................... in respect to each such check or debit
shall be the same as if it were a check
(Month) drawn on you and signed personally by me.
or as soon thereafter as This authority is to remain in effect un-
possible. til revoked personally by me in writing.
Until you receive such notice, you shall
I agree that you are preparing be fully protected in honoring any such
these checks or drawing these check or debit. I further agree that if
debits voluntarily at my request any such check or debit be dishonored,
and that you shall not be liable whether with or without cause and whether
for any loss arising from any intentionally or inadvertently, you shall
delay in preparing or failure to be under no liability.
prepare any such check or debit. ......... ...............................
If I change banks or desire to Date Signature of Depositor
terminate or suspend this pro- ......... ...............................
gram, I agree to notify you Bank Signature of Depositor
promptly in writing. Account (If joint account, both must
I further agree that if a check Number sign)
or debit is not honored upon NOTE: IF AUTOMATIC INVESTMENT PLAN IS
presentation, Financial Data ELECTED, YOUR BLANK, UNSIGNED CHECK
Services, Inc. is authorized to MARKED "VOID" SHOULD ACCOMPANY THIS
discontinue immediately the APPLICATION.
Automatic Investment Plan and to
liquidate sufficient shares held
in my account to offset the
purchase made with the returned
check or dishonored debit.
...... ......................
Date Signature of
Depositor
......................
Signature of
Depositor
(If joint account,
both must sign)
- --------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp We hereby authorize Merrill Lynch Funds
Distributor, Inc. to act as our agent in
connection with transactions under this au-
thorization form and agree to notify the
Distributor of any purchases made under a
Letter of Intention or Systematic With-
drawal Plan. We guarantee the Shareholder's
Signature.
This form when completed should
be mailed to:
............................................
Merrill Lynch Arkansas Dealer Name and Address
Municipal Bond Fund c/o By .........................................
Financial Data Services, Inc. Authorized Signature of Dealer
Transfer Agency Mutual Fund
Operations P.O. Box
45289Jacksonville, FL 32232-
5289
............................................
Branch- F/C No. F/C Last Name
Code
............................................
Dealer's Customer
A/C No.
36
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK.]
37
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK.]
38
<PAGE>
MANAGER
Fund Asset Management, L.P.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
Box 9011
Princeton, New Jersey 08543-9011
CUSTODIAN
National Westminster Bank NJ
100 Wall Street
20th Floor
New York, New York 10005
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
Transfer Agency Mutual Fund Operations
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche
117 Campus Drive
Princeton, New Jersey 08540
COUNSEL
Brown & Wood
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION WITH
THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER IN-
FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTI-
TUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table................................................................. 3
Alternative Sales Arrangements............................................ 4
Investment Objective and Policies......................................... 6
Potential Benefits....................................................... 8
Special and Risk Considerations Relating to Arkansas Municipal Bonds..... 8
Description of Municipal Bonds........................................... 9
When-Issued Securities and Delayed Delivery Transactions................. 11
Call Rights.............................................................. 11
Financial Futures Transactions and Options............................... 11
Repurchase Agreements and Purchase and Sale Contracts.................... 14
Investment Restrictions.................................................. 14
Management of the Trust................................................... 16
Trustees................................................................. 16
Management and Advisory Arrangements..................................... 16
Transfer Agency Services................................................. 17
Purchase of Shares........................................................ 17
Subscription Offering.................................................... 17
Continuous Offering...................................................... 19
Alternative Sales Arrangements........................................... 20
Initial Sales Charge Alternative--Class A Shares......................... 21
Deferred Sales Charge Alternative--Class B Shares........................ 22
Redemption of Shares...................................................... 24
Redemption............................................................... 24
Repurchase............................................................... 25
Reinstatement Privilege -- Class A Shares................................ 25
Shareholder Services...................................................... 26
Portfolio Transactions.................................................... 28
Distributions and Taxes................................................... 28
Distributions............................................................ 28
Taxes.................................................................... 29
Performance Data.......................................................... 31
Additional Information.................................................... 32
Determination of Net Asset Value......................................... 32
Organization of the Trust................................................ 32
Shareholder Reports...................................................... 33
Shareholder Inquiries.................................................... 34
Authorization Form........................................................ 35
</TABLE>
Code # 18321-0894
LOGO
Merrill Lynch
MERRILL LYNCH ARKANSAS
MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE
MUNICIPAL SERIES TRUST
[ART]
Prospectus
August 12, 1994
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
- -----------------------------------
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
BOX 9011, PRINCETON, NEW JERSEY 08543-9011--PHONE NO. (609) 282-2800
----------------
Merrill Lynch Arkansas Municipal Bond Fund (the "Fund") is a series of
Merrill Lynch Multi-State Municipal Series Trust (the "Trust"), an open-end
management investment company organized as a Massachusetts business trust. The
investment objective of the Fund is to provide shareholders with as high a
level of income exempt from Federal and Arkansas income taxes as is consistent
with prudent investment management. The Fund invests primarily in a non-
diversified portfolio of long-term investment grade obligations the interest on
which is exempt from Federal and Arkansas income taxes in the opinion of bond
counsel to the issuer ("Arkansas Municipal Bonds"). There can be no assurance
that the investment objective of the Fund will be realized.
The Fund offers two classes of shares which may be purchased during the
subscription offering at $10.00 per share and during the continuous offering at
a price equal to the next determined net asset value per share, plus in both
cases a sales charge which, at the election of the purchaser, may be imposed
(i) at the time of purchase (the "Class A shares"), or (ii) on a deferred basis
(the "Class B shares"). These alternatives permit an investor to choose the
method of purchasing shares that is most beneficial given the amount of the
purchase, the length of time the investor expects to hold the shares and other
circumstances. Investors should understand that the purpose and function of the
deferred sales charge with respect to the Class B shares are the same as the
purpose and function of the initial sales charge with respect to the Class A
shares. Each Class A share and Class B share represents an identical interest
in the investment portfolio of the Fund and has the same rights, except that
Class B shares bear the expenses of the account maintenance and distribution
fees and certain other costs resulting from the deferred sales charge
arrangement and have exclusive voting rights with respect to the account
maintenance and distribution fees. The two classes also have different exchange
privileges.
----------------
The Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the prospectus of the Fund, dated August 12,
1994 (the "Prospectus"), which has been filed with the Securities and Exchange
Commission and can be obtained, without charge, by calling or by writing the
Fund at the above telephone number or address. This Statement of Additional
Information has been incorporated by reference into the Prospectus. Capitalized
terms used but not defined herein have the same meanings as in the Prospectus.
----------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
The date of this Statement of Additional Information is August 12, 1994
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and Arkansas personal income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective by investing primarily in a portfolio of long-term obligations issued
by or on behalf of the State of Arkansas, its political subdivisions, agencies
and instrumentalities and obligations of other qualifying issuers, such as
issuers located in Puerto Rico, the Virgin Islands and Guam, which pay interest
exempt, in the opinion of bond counsel to the issuer, from Federal and Arkansas
income taxes. Obligations exempt from Federal income taxes are referred to
herein as "Municipal Bonds" and obligations exempt from both Federal and
Arkansas income taxes are referred to as "Arkansas Municipal Bonds". Unless
otherwise indicated, references to Municipal Bonds shall be deemed to include
Arkansas Municipal Bonds. The Fund anticipates that at all times, except during
temporary defensive periods, it will maintain at least 65% of its total assets
invested in Arkansas Municipal Bonds. At times, the Fund will seek to hedge its
portfolio through the use of futures transactions to reduce volatility in the
net asset value of Fund shares. Reference is made to "Investment Objective and
Policies" in the Prospectus for a discussion of the investment objective and
policies of the Fund.
Municipal Bonds may include general obligation bonds of the State and its
political subdivisions, revenue bonds of utility systems, highways, bridges,
port and airport facilities, colleges, hospitals, housing facilities, etc., and
industrial development bonds or private activity bonds. The interest on such
obligations may bear a fixed rate or be payable at a variable or floating rate.
The Municipal Bonds purchased by the Fund will be primarily what are commonly
referred to as "investment grade" securities, which are obligations rated at
the time of purchase within the four highest quality ratings as determined by
either Moody's Investors Service, Inc. ("Moody's") (currently Aaa, Aa, A and
Baa), Standard & Poor's Corporation ("Standard & Poor's") (currently AAA, AA, A
and BBB) or Fitch Investors Service, Inc. ("Fitch") (currently AAA, AA, A and
BBB). If unrated, such securities will possess creditworthiness comparable, in
the opinion of the manager of the Fund, Fund Asset Management, L.P. (the
"Manager"), to other obligations in which the Fund may invest.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Arkansas income taxes. However, to the extent that suitable
Arkansas Municipal Bonds are not available for investment by the Fund, the Fund
may purchase Municipal Bonds issued by other states, their agencies and
instrumentalities, the interest income on which is exempt, in the opinion of
bond counsel, from Federal but not Arkansas taxation. The Fund also may invest
in securities not issued by or on behalf of a state or territory or by an
agency or instrumentality thereof, if the Fund nevertheless believes such
securities to be exempt from Federal income taxation ("Non-Municipal Tax-Exempt
Securities"). Non-Municipal Tax-Exempt Securities may include securities issued
by other investment companies that invest in municipal bonds, to the extent
permitted by applicable law. Other Non-Municipal Tax-Exempt Securities also
could include trust certificates or other instruments evidencing interests in
one or more long-term municipal securities.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund, under normal circumstances, will invest at least 65% of its
total assets in Arkansas Municipal Bonds. For temporary periods or to provide
liquidity, the Fund has the authority to invest as much as 35% of its total
assets in tax-exempt or taxable money market obligations with a maturity of one
year or less (such short-term obligations being referred to herein as
"Temporary Investments"), except that taxable Temporary Investments shall not
exceed 20% of the Fund's net assets. The Fund at all times will have at least
80% of its net assets invested in securities exempt from Federal income
taxation. However, interest received on
2
<PAGE>
certain otherwise tax-exempt securities which are classified as "private
activity bonds" (in general bonds that benefit non-governmental entities) may
be subject to an alternative minimum tax. The Fund may purchase such private
activity bonds. See "Distributions and Taxes". In addition, the Fund reserves
the right to invest temporarily a greater portion of its assets in Temporary
Investments for defensive purposes, when, in the judgment of the Manager,
market conditions warrant. The investment objective of the Fund set forth in
this paragraph is a fundamental policy of the Fund which may not be changed
without a vote of a majority of the outstanding shares of the Fund. The Fund's
hedging strategies are not fundamental policies and may be modified by the
Trustees of the Trust without the approval of the Fund's shareholders.
Municipal Bonds may at times be purchased or sold on a delayed delivery basis
or a when-issued basis. These transactions arise when securities are purchased
or sold by the Fund with payment and delivery taking place in the future, often
a month or more after the purchase. The payment obligation and the interest
rate are each fixed at the time the buyer enters into the commitment. The Fund
will make only commitments to purchase such securities with the intention of
actually acquiring the securities, but the Fund may sell these securities prior
to the settlement date if it is deemed advisable. Purchasing Municipal Bonds on
a when-issued basis involves the risk that the yields available in the market
when the delivery takes place actually may be higher than those obtained in the
transaction itself; if yields so increase, the value of the when-issued
obligations generally will decrease. The Fund will maintain a separate account
at its custodian bank consisting of cash, cash equivalents or high-grade,
liquid Municipal Bonds or Temporary Investments (valued on a daily basis) equal
at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called "inverse floating obligations" or
"residual interest bonds" on which the interest rates typically decline as
market rates increase and increase as market rates decline. For example, to the
extent the Fund invests in these types of Municipal Bonds, the Fund's return on
such Municipal Bonds will be subject to risk with respect to the value of the
particular index. Such securities have the effect of providing a degree of
investment leverage, since they may increase or decrease in value in response
to changes, as an illustration, in market interest rates at a rate which is a
multiple (typically two) of the rate at which fixed-rate long-term tax exempt
securities increase or decrease in response to such changes. As a result, the
market values of such securities will generally be more volatile than the
market values of fixed-rate tax exempt securities. To seek to limit the
volatility of these securities, the Fund may purchase inverse floating
obligations with shorter term maturities or which contain limitations on the
extent to which the interest rate may vary. The Manager believes that indexed
and inverse floating obligations represent a flexible portfolio management
instrument for the Fund which allows the Manager to vary the degree of
investment leverage relatively efficiently under different market conditions.
Certain investments in such obligations may be illiquid. The Fund may not
invest in such illiquid obligations if such investments, together with other
illiquid investments, would exceed 15% of the Fund's net assets.
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity of
the related Municipal Bond will expire without value. The economic effect of
holding both the Call Right and the related Municipal Bond is identical to
holding a
3
<PAGE>
Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% of the Fund's net assets.
The Fund may invest up to 20% of its total assets in Municipal Bonds which
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics ("high
yield securities"). See Appendix II--"Ratings of Municipal Bonds"--for
additional information regarding ratings of debt securities. The Manager
considers the ratings assigned by Standard & Poor's, Moody's or Fitch as one of
several factors in its independent credit analysis of issuers.
High yield securities are considered by Standard & Poor's, Moody's and Fitch
to have varying degrees of speculative characteristics. Consequently, although
high yield securities can be expected to provide higher yields, such securities
may be subject to greater market price fluctuations and risk of loss of
principal than lower yielding, higher rated debt securities. Investments in
high yield securities will be made only when, in the judgment of the Manager,
such securities provide attractive total return potential relative to the risk
of such securities, as compared to higher quality debt securities. The Fund
generally will not invest in debt securities in the lowest rating categories
(those rated CC or lower by Standard & Poor's or Fitch or Ca or lower by
Moody's) unless the Manager believes that the financial condition of the issuer
or the protection afforded the particular securities is stronger than would
otherwise be indicated by such low ratings. The Fund does not intend to
purchase debt securities that are in default or which the Manager believes will
be in default.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers or obligors generally
are greater than is the case with higher rated securities. For example, during
an economic downturn or a sustained period of rising interest rates, issuers of
high yield securities may be more likely to experience financial stress,
especially if such issuers are highly leveraged. During periods of economic
recession, such issuers may not have sufficient revenues to meet their interest
payment obligations. The issuer's ability to service its debt obligations also
may be adversely affected by specific issuer developments, or the issuer's
inability to meet specific projected business forecasts, or the unavailability
of additional financing. The risk of loss due to default by the issuer is
significantly greater for the holders of high yield securities because such
securities may be unsecured and may be subordinated to other creditors of the
issuer.
High yield securities frequently have call or redemption features that would
permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends
to shareholders.
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. Because not all
dealers maintain markets in all high yield securities, there is no established
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent that a secondary trading market for high
yield securities does exist, it generally is not as liquid as the secondary
market for higher rated securities. Reduced secondary market liquidity may have
an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. Reduced secondary market liquidity for certain
securities also may make it more difficult for the Fund to obtain
4
<PAGE>
accurate market quotations for purposes of valuing the Fund's portfolio.
Market quotations generally are available on many high yield securities only
from a limited number of dealers and may not necessarily represent firm bids
of such dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve
special risks because the securities so acquired are new issues. In such
instances the Fund may be a substantial purchaser of the issue and therefore
have the opportunity to participate in structuring the terms of the offering.
Although this may enable the Fund to seek to protect itself against certain of
such risks, the considerations discussed herein would nevertheless remain
applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely
affecting the market value of high yield securities are likely to affect
adversely the Fund's net asset value. In addition, the Fund may incur
additional expenses to the extent that it is required to seek recovery upon a
default on a portfolio holding or participate in the restructuring of the
obligation.
DESCRIPTION OF MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion
concerning futures and options transactions is set forth under "Investment
Objective and Policies" in the Prospectus. Information with respect to ratings
assigned to tax-exempt obligations which the Fund may purchase is set forth in
Appendix II to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding of outstanding obligations and obtaining funds for general operating
expenses and loans to other public institutions and facilities. In addition,
certain types of bonds are issued by or on behalf of public authorities to
finance various privately owned or operated facilities, including certain
facilities for local furnishing of electric energy or gas, sewage facilities,
solid waste disposal facilities and other specialized facilities. Such
obligations are included within the term Municipal Bonds if the interest paid
thereon is, in the opinion of bond counsel, excluded from gross income for
Federal income tax purposes and, in the case of Arkansas Municipal Bonds,
exempt from Arkansas income taxes. Other types of industrial development bonds
or private activity bonds, the proceeds of which are used for the
construction, equipment or improvement of privately operated industrial or
commercial facilities, may constitute Municipal Bonds, although the current
Federal tax laws place substantial limitations on the size of such issues.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds which latter category includes
industrial development bonds and, for bonds issued after August 15, 1986,
private activity bonds. General obligation bonds are secured by the issuer's
pledge of faith, credit and taxing power for the payment of principal and
interest. Revenue bonds are payable only from the revenues derived from a
particular facility or class of facilities or, in some cases, from the
proceeds of a special or limited tax or other specific revenue source such as
payments from the user of the facility being financed. Industrial development
bonds ("IDBs") and, in the case of bonds issued after April 15, 1986, private
activity bonds, are in most cases revenue bonds and generally do not
constitute the pledge of the credit or taxing power of the issuer of such
bonds. Generally, the payment of the principal of and interest on such IDBs
and private activity
5
<PAGE>
bonds depends solely on the ability of the user of the facility financed by the
bonds to meet its financial obligations and the pledge, if any, of real and
personal property so financed as security for such payment, unless a line of
credit, bond insurance or other security is furnished. The Fund also may invest
in "moral obligation" bonds, which are normally issued by special purpose
public authorities. Under a moral obligation bond, if the issuer thereof is
unable to meet its obligations, the repayment of the bond becomes a moral
commitment, but not a legal obligation, of the state or municipality in
question.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called
"lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation is
frequently backed by the issuer's covenant to budget for, appropriate and make
the payments due under the lease obligation. Certain investments in lease
obligations may be illiquid. The Fund may not invest in illiquid lease
obligations if such investments, together with all other illiquid investments,
would exceed 15% of the Fund's net assets. The Fund may, however, invest
without regard to such limitation in lease obligations which the Manager,
pursuant to the guidelines which have been adopted by the Board of Trustees and
subject to the supervision of the Board of Trustees, determines to be liquid.
The Manager will deem lease obligations liquid if they are publicly offered and
have received an investment grade rating of Baa or better by Moody's, or BBB or
better by Standard & Poor's or Fitch. Unrated lease obligations, or those rated
below investment grade, will be considered liquid if the obligations come to
the market through an underwritten public offering and at least two dealers are
willing to give competitive bids. In reference to the latter, the Manager must,
among other things, also review the creditworthiness of the municipality
obligated to make payment under the lease obligation and make certain specified
determinations based on such factors as the existence of a rating or credit
enhancement such as insurance, the frequency of trades or quotes for the
obligation and the willingness of dealers to make a market in the obligation.
Yields on Municipal Bonds are dependent on a variety of factors, including
the general condition of the money market and of the municipal bond market, the
size of a particular offering, the financial condition of the issuer, the
general conditions of the Municipal Bond market, the maturity of the
obligation, and the rating of the issue. The ability of the Fund to achieve its
investment objective also is dependent on the continuing ability of the issuers
of the bonds in which the Fund invests to meet their obligations for the
payment of interest and principal when due. There are variations in the risks
involved in holding Municipal Bonds, both within a particular classification
and between classifications, depending on numerous factors. Furthermore, the
rights of owners of Municipal Bonds and the obligations of the issuer of such
Municipal Bonds may be subject to applicable bankruptcy, insolvency and similar
laws and court decisions affecting the rights of creditors generally.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject to
the limitations set forth under "Investment Objective and Policies". The tax-
exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with remaining maturity of less than one
year, variable rate demand notes and participations therein. Municipal notes
include tax anticipation notes, bond anticipation notes and grant anticipation
notes. Anticipation notes are sold as interim financing in anticipation of tax
collection, bond sales, government grants or revenue receipts. Municipal
commercial paper refers to
6
<PAGE>
short-term unsecured promissory notes generally issued to finance short-term
credit needs. The taxable money market securities in which the Fund may invest
as Temporary Investments consist of U.S. Government securities, U.S. Government
agency securities, domestic bank or savings institution certificates of deposit
and bankers' acceptances, short-term corporate debt securities such as
commercial paper, and repurchase agreements. These Temporary Investments must
have a stated maturity not in excess of one year from the date of purchase.
Variable rate demand obligations ("VRDOs") are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable
at intervals (ranging from daily to up to one year) to some prevailing market
rate for similar investments, such adjustment formula being calculated to
maintain the market value of the VRDO at approximately the par value of the
VRDOs on the adjustment date. The adjustments typically are set at a rate
determined by the remarketing agent or based upon the prime rate of a bank or
some other appropriate interest rate adjustment index. The Fund may invest in
all types of tax-exempt instruments currently outstanding or to be issued in
the future which satisfy the short-term maturity and quality standards of the
Fund.
The Fund also may invest in VRDOs in the form of participation interests
("Participating VRDOs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In addition, a
Participating VRDO is backed by an irrevocable letter of credit or guaranty of
the financial institution. The Fund would have an undivided interest in the
underlying obligation and thus participate on the same basis as the financial
institution in such obligation except that the financial institution typically
retains fees out of the interest paid on the obligation for servicing the
obligation, providing the letter of credit and issuing the repurchase
commitment. The Fund has been advised by its counsel that the Fund should be
entitled to treat the income received on Participating VRDOs as interest from
tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of the
unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
period exceeding seven days therefore will be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and will be ultimately responsible
for such determination.
The Trust has established the following standards with respect to money
market securities and VRDOs in which the Fund invests. Commercial paper
investments at the time of purchase must be rated "A-1" through "A-3" by
Standard & Poor's, "Prime-1" through "Prime-3" by Moody's or "F-1" through "F-
3" by Fitch or, if not rated, issued by companies having an outstanding debt
issue rated at least "A" by Standard & Poor's, Fitch or Moody's. Investments in
corporate bonds and debentures (which must have maturities at the date of
purchase of one year or less) must be rated at the time of purchase at least
"A" by Standard & Poor's, Moody's or Fitch. Notes and VRDOs at the time of
purchase must be rated SP-1/A-1 through SP-2/A-3 by Standard & Poor's, MIG-
l/VMIG-1 through MIG-4/VMIG-4 by Moody's or F-1 through F-3
7
<PAGE>
by Fitch. Temporary Investments, if not rated, must be of comparable quality to
securities rated in the above rating categories in the opinion of the Manager.
The Fund may not invest in any security issued by a commercial bank or a
savings institution unless the bank or institution is organized and operating
in the United States, has total assets of at least one billion dollars and is a
member of the Federal Deposit Insurance Corporation ("FDIC"), except that up to
10% of total assets may be invested in certificates of deposit of small
institutions if such certificates are insured fully by the FDIC.
REPURCHASE AGREEMENTS AND PURCHASE AND SALE CONTRACTS
The Fund may invest in securities pursuant to repurchase agreements or
purchase and sale contracts. Repurchase agreements and purchase and sale
contracts may be entered into only with a member bank of the Federal Reserve
System or primary dealer in U.S. Government securities. Under such agreements,
the bank or primary dealer agrees, upon entering into the contract, to
repurchase the security at a mutually agreed upon time and price, thereby
determining the yield during the term of the agreement. This results in a fixed
rate of return insulated from market fluctuations during such period. In the
case of repurchase agreements, the prices at which the trades are conducted do
not reflect accrued interest on the underlying obligations; whereas, in the
case of purchase and sale contracts, the prices take into account accrued
interest. Such agreements usually cover short periods, such as under one week.
Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
In the case of a repurchase agreement, the Fund will require the seller to
provide additional collateral if the market value of the securities falls below
the repurchase price at any time during the term of the repurchase agreement;
the Fund does not have the right to seek additional collateral in the case of
purchase and sale contracts. In the event of default by the seller under a
repurchase agreement construed to be a collateralized loan, the underlying
securities are not owned by the Fund but only constitute collateral for the
seller's obligation to pay the repurchase price. Therefore, the Fund may suffer
time delays and incur costs or possible losses in connection with the
disposition of the collateral. A purchase and sale contract differs from a
repurchase agreement in that the contract arrangements stipulate that the
securities are owned by the Fund. In the event of a default under such a
repurchase agreement or under a purchase and sale contract, instead of the
contractual fixed rate of return, the rate of return to the Fund will depend on
intervening fluctuations of the market value of such security and the accrued
interest on the security. In such event, the Fund would have rights against the
seller for breach of contract with respect to any losses arising from market
fluctuations following the failure of the seller to perform. The Fund may not
invest in repurchase agreements or purchase and sale contracts maturing in more
than seven days if such investments, together with all other illiquid
investments, would exceed 15% of the Fund's net assets. While the substance of
purchase and sale contracts is similar to repurchase agreements, because of the
different treatment with respect to accrued interest and additional collateral,
management believes that purchase and sale contracts are not repurchase
agreements as such term is understood in the banking and brokerage community.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold". Therefore,
amounts earned under such agreements will not be considered tax-exempt
interest. The treatment of purchase and sale contracts is less certain.
However, it is likely that income from such arrangements also will not be
considered tax-exempt interest.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
"Investment Objective and Policies" in the Prospectus. Set forth below is
additional information concerning these transactions.
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As described in the Prospectus, the Fund may purchase and sell exchange
traded financial futures contracts ("financial futures contracts") to hedge its
portfolio of Municipal Bonds against declines in the value of such securities
and to hedge against increases in the cost of securities the Fund intends to
purchase. However, any transactions involving financial futures or options (or
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. See "Investment Objective and Policies--
Investment Restrictions" in the Prospectus. To hedge its portfolio, the Fund
may take an investment position in a futures contract which will move in the
opposite direction from the portfolio position being hedged. While the Fund's
use of hedging strategies is intended to moderate capital changes in portfolio
holdings and thereby reduce the volatility of the net asset value of Fund
shares, the Fund anticipates that its net asset value will fluctuate. Set forth
below is information concerning futures transactions.
Description of Futures Contracts. A futures contract is an agreement between
two parties to buy and sell a security, or in the case of an index-based
futures contract, to make and accept a cash settlement for a set price on a
future date. A majority of transactions in futures contracts, however, do not
result in the actual delivery of the underlying instrument or cash settlement,
but are settled through liquidation, i.e., by entering into an offsetting
transaction. Futures contracts have been designed by boards of trade which have
been designated "contracts markets" by the Commodity Futures Trading Commission
("CFTC").
The purchase or sale of a futures contract differs from the purchase or sale
of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the
purchaser and seller under the futures contract. Subsequent payments to and
from the broker, called "variation margin", are required to be made on a daily
basis as the price of the futures contract fluctuates making the long and short
positions in the futures contract more or less valuable, a process known as
"mark to the market". At any time prior to the settlement date of the futures
contract, the position may be closed out by taking an opposite position which
will operate to terminate the position in the futures contract. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the broker, and the purchaser realizes a loss or
gain. In addition, a nominal commission is paid on each completed sale
transaction.
The Fund may deal in financial futures contracts based on a long-term
municipal bond index developed by the Chicago Board of Trade ("CBT") and The
Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue and general obligations bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more. Twice
a month new issues satisfying the eligibility requirements are added to, and an
equal number of old issues are deleted from, the Municipal Bond Index. The
value of the Municipal Bond Index is computed daily according to a formula
based on the price of each bond in the Municipal Bond Index, as evaluated by
six dealer-to-dealer brokers.
The Municipal Bond Index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the
exchange membership which also is responsible for handling daily accounting of
deposits or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S.
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Treasury bonds, Treasury notes, Government National Mortgage Association
("GNMA") Certificates and three-month U.S. Treasury bills. The Fund may
purchase and write call and put options on futures contracts on U.S. Government
securities in connection with its hedging strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other futures contracts transactions such as futures contracts on other
municipal bond indices which may become available if the Manager and the
Trustees should determine that there is normally a sufficient correlation
between the prices of such futures contracts and the Municipal Bonds in which
the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as
a result of the shortening of maturities. The sale of futures contracts
provides an alternative means of hedging against declines in the value of its
investments in Municipal Bonds. As such values decline, the value of the Fund's
positions in the futures contracts will tend to increase, thus offsetting all
or a portion of the depreciation in the market value of the Fund's Municipal
Bond investments which are being hedged. While the Fund will incur commission
expenses in selling and closing out futures positions, commissions on futures
transactions are lower than transaction costs incurred in the purchase and sale
of Municipal Bonds. In addition, the ability of the Fund to trade in the
standardized contracts available in the futures markets may offer a more
effective defensive position than a program to reduce the average maturity of
the portfolio securities due to the unique and varied credit and technical
characteristics of the municipal debt instruments available to the Fund.
Employing futures as a hedge also may permit the Fund to assume a defensive
posture without reducing the yield on its investments beyond any amounts
required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such Municipal
Bonds, resulting from an increase in interest rates or otherwise, that may
occur before such purchases can be effected. Subject to the degree of
correlation between the Municipal Bonds and the futures contracts, subsequent
increases in the cost of Municipal Bonds should be reflected in the value of
the futures held by the Fund. As such purchases are made, an equivalent amount
of futures contracts will be closed out. Due to changing market conditions and
interest rate forecasts, however, a futures position may be terminated without
a corresponding purchase of portfolio securities.
Call Options on Futures Contracts. The Fund also may purchase and sell
exchange traded call and put options on financial futures contracts on U.S.
Government securities. The purchase of a call option on a futures contract is
analogous to the purchase of a call option on an individual security. Depending
on the pricing of the option compared to either the futures contract on which
it is based, or on the price of the underlying debt securities, it may or may
not be less risky than ownership of the futures contract or underlying debt
securities. Like the purchase of a futures contract, the Fund will purchase a
call option on a futures contract to hedge against a market advance when the
Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in
the Fund's portfolio holdings.
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<PAGE>
Put Options on Futures Contracts. The purchase of options on a futures
contract is analogous to the purchase of protective put options on portfolio
securities. The Fund will purchase put options on futures contracts to hedge
the Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial hedge
against increasing prices of the securities which are deliverable upon exercise
of the futures contract. If the futures price at expiration is higher than the
exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any increase in the price of Municipal
Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit initial
and variation margin pursuant to requirements similar to those applicable to
futures contracts. Premiums received from the writing of an option will be
included in initial margin. The writing of an option on a futures contract
involves risks similar to those relating to futures contracts.
----------------
The Trust has received an order from the Securities and Exchange Commission
(the "Commission") exempting it from the provisions of Section 17(f) and
Section 18(f) of the Investment Company Act of 1940, as amended (the "1940
Act"), in connection with its strategy of investing in futures contracts.
Section 17(f) relates to the custody of securities and other assets of an
investment company and may be deemed to prohibit certain arrangements between
the Trust and commodities brokers with respect to initial and variation margin.
Section 18(f) of the 1940 Act prohibits an open-end investment company such as
the Trust from issuing a "senior security" other than a borrowing from a bank.
The staff of the Commission has in the past indicated that a futures contract
may be a "senior security" under the 1940 Act.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes.) Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases futures contracts or a call option with respect
thereto or writes a put option on a futures contract, an amount of cash, cash
equivalents or short-term, high-grade, fixed income securities will be
deposited in a segregated account with the Fund's custodian so that the amount
so segregated, plus the amount of initial and variation margin held in the
account of its broker, equals the market value of the futures contract, thereby
ensuring that the use of such futures is unleveraged.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not offset completely by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
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<PAGE>
The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures contract may vary from the Municipal Bonds held by
the Fund. As a result, the Fund's ability to hedge effectively all or a portion
of the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of the Municipal Bonds held by the Fund. The correlation may be
affected by disparities in the average maturity, ratings, geographical mix or
structure of the Fund's investments as compared to those comprising the
Municipal Bond Index, and general economic or political factors. In addition,
the correlation between movements in the value of the Municipal Bond Index may
be subject to change over time as additions to and deletions from the Municipal
Bond Index alter its structure. The correlation between futures contracts on
U.S. Government securities and the Municipal Bonds held by the Fund may be
adversely affected by similar factors and the risk of imperfect correlation
between movements in the prices of such futures contracts and the prices of the
Municipal Bonds held by the Fund may be greater.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability
to close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The Fund will
enter into a futures position only if, in the judgment of the Manager, there
appears to be an actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the hedging transaction which is
not fully or partially offset by an increase in the value of portfolio
securities. As a result, the Fund's total return for such period may be less
than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however,
any losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option on
a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be reflected fully in the value of the
option purchased.
Municipal Bond Index futures contracts have only recently been approved for
trading and therefore have little trading history. It is possible that trading
in such futures contracts will be less liquid than that in other futures
contracts. The trading of futures contracts also is subject to certain market
risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
12
<PAGE>
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions and policies relating to the
investment of its assets and its activities, which are fundamental policies and
may not be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities (which for this purpose and under the 1940
Act means the lesser of (i) 67% of the Fund's shares at a meeting at which more
than 50% of the outstanding shares of the Fund are represented or (ii) more
than 50% of the Fund's outstanding shares). The Fund may not:
1. Invest more than 25% of its assets taken at market value at the time of
each investment, in the securities of issuers in any particular industry
(excluding the U.S. Government and its agencies and instrumentalities). For
purposes of this restriction, states, municipalities and their political
subdivisions are not considered to be part of any industry.
2. Make investments for the purpose of exercising control or management.
3. Purchase or sell real estate, except that the Fund may invest in
securities directly or indirectly secured by real estate or interests therein
or issued by companies which invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, short-term commercial paper, certificates of deposit, bankers'
acceptances and repurchase agreements shall not be deemed to be the making of a
loan, and except further that the Fund may lend its portfolio securities,
provided that the lending of portfolio securities may be made only in
accordance with applicable law and guidelines set forth in the Fund's
Prospectus and Statement of Additional Information, as they may be amended from
time to time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (a) the Fund may borrow from banks (as defined
in the 1940 Act) in amounts up to 33 1/3% of its total assets (including the
amount borrowed), (b) the Fund may borrow up to an additional 5% of its total
assets for temporary purposes, (c) the Fund may obtain such short-term credit
as may be necessary for the clearance of purchases and sales of portfolio
securities and (d) the Fund may purchase securities on margin to the extent
permitted by applicable law. The Fund may not pledge its assets other than to
secure such borrowings or, to the extent permitted by the Fund's investment
policies as set forth in the Prospectus and Statement of Additional
Information, as they may be amended from time to time, in connection with
hedging transactions, short sales, when-issued and forward commitment
transactions and similar investment strategies.
7. Underwrite securities of other issuers, except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933, as
amended, in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to the
extent the Fund may do so in accordance with applicable law and the Fund's
Prospectus and Statement of Additional Information, as they may be amended from
time to time, and without registering as a commodity pool operator under the
Commodities Exchange Act.
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<PAGE>
Additional non-fundamental investment restrictions adopted by the Fund, which
may be changed by the Trustees, provide that the Fund may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently allows the Fund to purchase the securities of other investment
companies only if immediately thereafter not more than (i) 3% of the total
outstanding voting stock of such company is owned by the Fund, (ii) 5% of
the Fund's total assets, taken at market value, would be invested in any
one such company, (iii) 10% of the Fund's total assets, taken at market
value, would be invested in such securities, and (iv) the Fund, together
with other investment companies having the same investment adviser and
companies controlled by such companies, owns not more than 10% of the total
outstanding stock of any one closed-end investment company.
b. Make short sales of securities or maintain a short position except to
the extent permitted by applicable law.
c. Invest in securities which cannot be readily resold because of legal
or contractual restriction or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Trustees of the Fund has otherwise determined
to be liquid pursuant to applicable law.
d. Invest in warrants if, at the time of acquisition, its investments in
warrants, valued at the lower of cost or market value, would exceed 5% of
the Fund's net assets; included within such limitation, but not to exceed
2% of the Fund's net assets, are warrants which are not listed on the New
York Stock Exchange or American Stock Exchange or a major foreign exchange.
For purposes of this restriction, warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of the Fund's total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities, asset-
backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
f. Purchase or retain the securities of any issuer, if those individual
officers and directors of the Fund, the Manager or any subsidiary thereof
each owning more than one-half of 1% of the securities of such issuer own
in the aggregate more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.
14
<PAGE>
In addition, to comply with Federal income tax requirements for qualification
as a "regulated investment company", the Fund's investments will be limited in
a manner such that, at the close of each quarter of each fiscal year, (a) no
more than 25% of the Fund's total assets are invested in the securities of a
single issuer, and (b) with regard to at least 50% of the Fund's total assets,
no more than 5% of its total assets are invested in the securities of a single
issuer. For purposes of this restriction, the Fund will regard each state and
each political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a non-
governmental entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal income tax requirements.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
for brokerage transactions permitted under the 1940 Act involving only usual
and customary commissions or transactions pursuant to an exemptive order under
the 1940 Act. Included among such restricted transactions will be purchases
from or sales to Merrill Lynch of securities in transactions in which it acts
as principal. See "Portfolio Transactions". An exemptive order has been
obtained which permits the Trust to effect principal transactions with Merrill
Lynch in high quality, short-term, tax-exempt securities subject to conditions
set forth in such order.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
The Trustees and executive officers of the Trust and their principal
occupations for at least the last five years are set forth below. Unless
otherwise noted, the address of each Trustee and executive officer is Box 9011,
Princeton, New Jersey 08543-9011.
Arthur Zeikel--President and Trustee(1)(2)--President and Chief Investment
Officer of the Manager (which term, as used herein, includes the Manager's
corporate predecessor) since 1977; President of Merrill Lynch Asset Management,
L.P. (doing business as Merrill Lynch Asset Management and referred to herein,
together with its corporate predecessor, as "MLAM") since 1977 and Chief
Investment Officer thereof since 1976; President and Director of Princeton
Services, Inc. ("Princeton Services") since 1993; Executive Vice President of
Merrill Lynch & Co., Inc. since 1991; Executive Vice President of Merrill Lynch
since 1990 and a Senior Vice President thereof from 1985 to 1990; Director of
Merrill Lynch Funds Distributor, Inc. ("MLFD" or the "Distributor").
Kenneth S. Axelson--Trustee(2)--75 Jameson Point Road, Rockland, Maine 04841.
Executive Vice President and Director, J.C. Penney Company, Inc. until 1982;
Director, UNUM Corporation, Protection Mutual Insurance Company, Zurn
Industries, Inc. and, formerly, of Central Maine Power Company (until 1992),
Key Trust Company of Maine (until 1992) and Grumman Corporation (until 1994);
Trustee, The Chicago Dock and Canal Trust.
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<PAGE>
Herbert I. London--Trustee(2)--New York University--Gallatin Division, 113-
115 University Place, New York, New York 10003. John M. Olin Professor of
Humanities, New York University since 1993 and Professor thereof since 1973;
Dean, Gallatin Division of New York University from 1978 to 1993 and Director
from 1975 to 1976; Distinguished Fellow, Herman Kahn Chair, Hudson Institute
from 1984 to 1985; Trustee, Hudson Institute since 1980; Director, Damon
Corporation since 1991; Overseer, Center for Naval Analyses.
Robert R. Martin--Trustee(2)--513 Grand Hill, St. Paul, Minnesota 55102.
Chairman, WTC Industries, Inc. since 1994; Chairman and Chief Executive
Officer, Kinnard Investments, Inc. from 1990 to 1993; Executive Vice President,
Dain Bosworth from 1974 to 1989; Director, Carnegie Capital Management from
1977 to 1985 and Chairman thereof in 1979; Director, Securities Industry
Association from 1981 to 1982 and Public Securities Association from 1979 to
1980; Trustee, Northland College since 1992.
Joseph L. May--Trustee(2)--424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983;
Vice President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The May
Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
Andre F. Perold--Trustee(2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and
Associate Professor from 1983 to 1989; Trustee, The Common Fund, since 1989;
Director, Quantec Investment Technology (a private United Kingdom company).
Terry K. Glenn--Executive Vice President(1)(2)--Executive Vice President of
the Manager and MLAM since 1983; Executive Vice President and Director of
Princeton Services since 1993; President of MLFD since 1986 and Director
thereof since 1991.
Vincent R. Giordano--Vice President and Portfolio Manager(1)(2)--Portfolio
Manager of the Manager and MLAM since 1977 and Senior Vice President of the
Manager and MLAM since 1984; Vice President of MLAM from 1980 to 1984; Senior
Vice President of Princeton Services since 1993.
Kenneth A. Jacob--Vice President and Portfolio Manager(1)(2)--Vice President
of the Manager and MLAM since 1984.
Donald C. Burke--Vice President(1)(2)--Vice President and Director of
Taxation of MLAM since 1990; Employee of Deloitte & Touche from 1982 to 1990.
Gerald M. Richard--Treasurer(1)(2)--Senior Vice President and Treasurer of
the Manager and MLAM since 1984; Senior Vice President and Treasurer of
Princeton Services since 1993; Treasurer of MLFD since 1984 and Vice President
since 1981.
Jerry Weiss--Secretary(1)(2)--Vice President of MLAM since 1990; Attorney in
private practice from 1982 to 1990.
- --------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
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At June 30, 1994, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 1/4 of 1% of the outstanding shares of
Common Stock of Merrill Lynch & Co., Inc. and owned an aggregate of less than
1% of the outstanding shares of the Fund.
The Trust pays each Trustee not affiliated with the Manager a fee of $10,000
per year plus $1,000 per meeting attended, together with such Trustee's actual
out-of-pocket expenses relating to attendance at meetings. The Trust also
compensates members of its Audit Committee, which consists of all the non-
affiliated Trustees.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Trust--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If the Manager or its affiliates purchase or sell
securities for the Fund or other funds for which they act as manager or for
their advisory clients and such sales or purchases arise for consideration at
or about the same time, transactions in such securities will be made, insofar
as feasible, for the respective funds and clients in a manner deemed equitable
to all. To the extent that transactions on behalf of more than one client of
the Manager or its affiliates during the same period may increase the demand
for securities being purchased or the supply of securities being sold, there
may be an adverse effect on price.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the "Management Agreement"), the Manager receives for its
services to the Fund monthly compensation based upon the average daily net
assets of the Fund at the following annual rates: 0.55% of the average daily
net assets not exceeding $500 million; 0.525% of the average daily net assets
exceeding $500 million but not exceeding $1.0 billion; and 0.50% of the average
daily net assets exceeding $1.0 billion.
The Management Agreement obligates the Manager to provide investment advisory
services and to pay all compensation of and furnish office space for officers
and employees of the Trust connected with investment and economic research,
trading and investment management of the Trust, as well as the compensation of
all Trustees of the Trust who are affiliated persons of the Manager or any of
its subsidiaries. The Fund pays all other expenses incurred in its operation
and, if other Series shall be added ("Series"), a portion of the Trust's
general administrative expenses will be allocated on the basis of the asset
size of the respective Series. Expenses that will be borne directly by the
Series include, among other things, redemption expenses, expenses of portfolio
transactions, expenses of registering the shares under Federal and state
securities laws, pricing costs (including the daily calculation of net asset
value), expenses of printing shareholder reports, prospectuses and statements
of additional information (except to the extent paid by the Distributor as
described below), fees for legal and auditing services, Commission fees,
interest, certain taxes, and other
expenses attributable to a particular Series. Expenses which will be allocated
on the basis of asset size of the respective Series include fees and expenses
of unaffiliated Trustees, state franchise taxes, costs of printing proxies and
other expenses related to shareholder meetings, and other expenses properly
payable by the Trust. The organizational expenses of the Trust were paid by the
Trust, and as additional Series are added to the
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Trust, the organizational expenses are allocated among the Series (including
the Fund) in a manner deemed equitable by the Trustees. Depending upon the
nature of a lawsuit, litigation costs may be assessed to the specific Series to
which the lawsuit relates or allocated on the basis of the asset size of the
respective Series. The Trustees have determined that this is an appropriate
method of allocation of expenses. Accounting services are provided to the Fund
by the Manager and the Fund reimburses the Manager for its costs in connection
with such services. As required by the Fund's distribution agreements, the
Distributor will pay the promotional expenses of the Fund incurred in
connection with the offering of shares of the Fund. Certain expenses in
connection with account maintenance and the distribution of Class B shares will
be financed by the Fund pursuant to the Distribution Plan in compliance with
Rule 12b-1 under the 1940 Act. See "Purchase of Shares--Deferred Sales Charge
Alternative--Class B Shares--Distribution Plan".
The Manager is a limited partnership, the partners of which are Merrill Lynch
& Co., Inc., Fund Asset Management, Inc. and Princeton Services, Inc.
Duration and Termination. Unless earlier terminated as described below, the
Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties to
such contract or interested persons (as defined in the 1940 Act) of any such
party. Such contracts are not assignable and may be terminated without penalty
on 60 days' written notice at the option of either party thereto or by vote of
the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
ALTERNATIVE SALES ARRANGEMENTS
The Fund issues two classes of shares: Class A shares are sold to investors
choosing the initial sales charge alternative and Class B shares are sold to
investors choosing the deferred sales charge alternative. The two classes of
shares each represents an interest in the same portfolio of investments of the
Fund, has the same rights and is identical in all respects, except that Class B
shares bear the expenses of the deferred sales arrangements and any expenses
(including incremental transfer agency costs) resulting from such sales
arrangements and the expenses paid by the account maintenance fee. The two
classes also have different exchange privileges. See "Shareholder Services--
Exchange Privilege".
The Fund has entered into separate distribution agreements with the
Distributor in connection with the subscription and continuous offering of
Class A and Class B shares of the Fund (the "Distribution Agreements"). The
Distribution Agreements obligate the Distributor to pay certain expenses in
connection with the offering of the Class A and Class B shares of the Fund.
After the prospectuses, statements of additional information and periodic
reports have been prepared, set in type and mailed to shareholders, the
Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to
dealers and prospective investors. The Distributor also pays for other
supplementary sales literature and advertising costs. The Distribution
Agreements are subject to the same renewal requirements and termination
provisions as the Management Agreement described above.
The boards of directors or trustees of each of the mutual funds advised by
the Manager or MLAM and presently offering two classes of shares, including the
Fund, approved in August, 1994 a new distribution
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system for shares of the funds, which will be named the Merrill Lynch Select
Pricing SM System. Under the Select Pricing SM System, eligible investors
would be permitted to choose from different sales charge alternatives offered
through four classes of shares. It is currently anticipated that, subject to
the approvals of the shareholders of the other funds, the Select Pricing SM
System will be implemented for all of such mutual funds, including the Fund.
The Select Pricing SM System has been approved by the sole shareholder of the
Fund.
INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
The term "purchase", as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A shares of
the Fund, refers to a single purchase by an individual, or to concurrent
purchases, which in the aggregate are at least equal to the prescribed
amounts, by an individual, his spouse and their children under the age of 21
years purchasing shares for his or their own account and to single purchases
by a trustee or other fiduciary purchasing shares for a single trust estate or
single fiduciary account although more than one beneficiary is involved. The
term "purchase" also includes purchases by any "company", as that term is
defined in the 1940 Act, but does not include purchases by any such company
which has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it
shall not include purchases by any group of individuals whose sole
organizational nexus is that the participants therein are credit cardholders
of a company, policyholders of an insurance company, customers of either a
bank or broker-dealer or clients of an investment adviser.
REDUCED INITIAL SALES CHARGES--CLASS A SHARES
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase Class
A shares of the Fund at the offering price applicable to the total of (a) the
dollar amount then being purchased plus (b) an amount equal to the then
current net asset value or cost, whichever is higher, of the purchaser's
combined holdings of the Class A shares and Class B shares of the Fund and of
any other investment company with an initial sales charge or a deferred sales
charge for which the Distributor acts as the distributor. For any such right
of accumulation to be made available, the Distributor must be provided at the
time of purchase, by the purchaser or the purchaser's securities dealer, with
sufficient information to permit confirmation of qualification. Acceptance of
the purchase order is subject to such confirmation. The right of accumulation
may be amended or terminated at any time.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A shares of the Fund or any other
investment company with an initial sales charge or a deferred sales charge for
which the Distributor acts as the distributor made within a thirteen-month
period starting with the first purchase pursuant to a Letter of Intention in
the form provided in the Prospectus. The Letter of Intention is available only
to investors whose accounts are maintained at the Fund's Transfer Agent. The
Letter of Intention is not available to employee benefit plans for which
Merrill Lynch provides plan participant, record-keeping services. The Letter
of Intention is not a binding obligation to purchase any amount of Class A
shares; however, its execution will result in the purchaser paying a lower
sales charge at the appropriate quantity purchase level. A purchase not
originally made pursuant to a Letter of Intention may be included under a
subsequent Letter of Intention executed within 90 days of such purchase if the
Distributor is informed in writing of this intent within such 90-day period.
The value of Class A shares of the Fund and of other investment companies with
an initial sales charge or a deferred sales charge for which the Distributor
acts as the distributor presently held, at cost or maximum offering price
(whichever is higher), on
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the date of the first purchase under the Letter of Intention, may be included
as a credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied
only to new purchases. If the total amount of shares does not equal the amount
stated in the Letter of Intention (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the expiration of such Letter, the
difference between the sales charge on the Class A shares purchased at the
reduced rate and the sales charge applicable to the shares actually purchased
through the Letter. Class A shares equal to at least five percent of the
intended amount will be held in escrow during the thirteen-month period (while
remaining registered in the name of the purchaser) for this purpose. The first
purchase under the Letter of Intention must be at least five percent of the
dollar amount of such Letter. If during the term of such Letter, a purchase
brings the total amount invested to an amount equal to or in excess of the
amount indicated in the Letter, the purchaser will be entitled on that purchase
and subsequent purchases to the reduced percentage sales charge which would be
applicable to a single purchase equal to the total dollar value of the Class A
shares then being purchased under such Letter, but there will be no retroactive
reduction of the sales charges on any previous purchase. The value of any
shares redeemed or otherwise disposed of by the purchaser prior to termination
or completion of the Letter of Intention will be deducted from the total
purchases made under such Letter. An exchange from Merrill Lynch Ready Assets
Trust, Merrill Lynch Retirement Reserves Money Fund, Merrill Lynch U.S.
Treasury Money Fund or Merrill Lynch U.S.A. Government Reserves into the Fund
that creates a sales charge will count toward completing a new or existing
Letter of Intention from the Fund.
Employer Sponsored Non-Qualified After-Tax Savings and Investment Programs.
Class A shares are offered at net asset value to employer sponsored non-
qualified After-Tax Savings and Investment programs maintained on the Merrill
Lynch Group Employee Services system, provided the program or certain other
plans or programs sponsored by the employer has $5 million or more in existing
plan assets initially invested in portfolios, mutual funds or trusts advised by
the Fund's investment adviser or an affiliate. Class A shares are also offered
at net asset value to After-Tax Savings and Investment programs, provided the
program has accumulated $5 million or more in existing assets invested in
mutual funds advised by the Fund's investment adviser or an affiliated adviser
charging a front-end sales charge or contingent deferred sales charge. In this
case as well, assets or certain other plans sponsored by the same sponsor or an
affiliated sponsor may be aggregated. The Class A share reduced load
breakpoints also apply to these aggregated assets. After-Tax Savings and
Investment programs are also offered Class A shares at net asset value,
provided such plan initially has 1,000 or more employees eligible to
participate in the plan. Employees eligible to participate in such plans of the
same sponsoring employer or its affiliates may be aggregated. The minimum
initial and subsequent purchase requirements are waived in connection with all
the above-referenced plans.
Purchase Privilege of Certain Persons. Trustees of the Trust and directors or
trustees of other Merrill Lynch-sponsored investment companies, directors of
Merrill Lynch & Co., Inc., employees of Merrill Lynch & Co., Inc. and its
subsidiaries and any trust, pension, profit-sharing or other benefit plan for
such persons, may purchase Class A shares of the Fund at net asset value. Under
such programs, the Fund realizes economies of scale and reduction of sales
related expenses by virtue of familiarity with the Fund.
Class A shares of the Fund will be offered at net asset value, without sales
charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied. First, the investor must purchase Class A shares of
the Fund with proceeds from a redemption of shares of a mutual fund that was
sponsored by the financial consultant's previous firm and imposed a sales
charge either at the time of purchase or on a deferred basis. Second, such
redemption must have been made within 60 days
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prior to the investment in the Fund, and the proceeds from the redemption must
have been maintained in the interim in cash or a money market fund.
Closed-End Fund Option. Class A shares of the Fund and certain other mutual
funds advised by the Manager or MLAM (the "Eligible Class A shares") are
offered at net asset value to shareholders of certain closed-end funds advised
by the Manager or MLAM who wish to reinvest the net proceeds of a sale of their
closed-end fund shares of common stock in Eligible Class A shares, if the
conditions set forth below are satisfied. First, the sale of closed-end fund
shares must be made through Merrill Lynch, and the net proceeds therefrom must
be immediately reinvested in Eligible Class A shares. Second, the closed-end
fund shares must have either been acquired in the initial public offering or be
shares representing dividends from shares of common stock acquired in such
offering. Third, the closed-end fund shares must have been continuously
maintained in a Merrill Lynch securities account. Fourth, there must be a
minimum purchase of $250 to be eligible for the investment option. Class A
shares of the Fund are offered at net asset value to shareholders of Merrill
Lynch Senior Floating Rate Fund, Inc. (formerly Merrill Lynch Prime Fund, Inc.)
("Senior Floating Rate Fund") who wish to reinvest the net proceeds from a sale
of certain of their shares of common stock of Senior Floating Rate Fund in
shares of the Fund. In order to exercise this investment option, Senior
Floating Rate Fund shareholders must sell their Senior Floating Rate shares to
the Senior Floating Rate Fund in connection with a tender offer conducted by
the Senior Floating Rate Fund and reinvest the proceeds immediately in the
Fund. This investment option is available only with respect to the proceeds of
Senior Floating Rate Fund shares as to which no Early Withdrawal Charge (as
defined in the Senior Floating Rate Fund prospectus) is applicable. Purchase
orders from Senior Floating Rate Fund shareholders wishing to exercise this
investment option will be accepted only on the day that the related Senior
Floating Rate Fund tender offer terminates and will be effected at the net
asset value of the Fund at such day.
Acquisition of Certain Investment Companies. The public offering price of
Class A shares may be reduced to the net asset value per Class A share in
connection with the acquisition of the assets of or merger or consolidation
with a personal holding company or a public or private investment company. The
value of the assets or company acquired in a tax-free transaction may be
adjusted in appropriate cases to reduce possible adverse tax consequences to
the Fund which might result from an acquisition of assets having net unrealized
appreciation which is disproportionately higher at the time of acquisition than
the realized or unrealized appreciation of the Fund.
DEFERRED SALES CHARGE ALTERNATIVE--CLASS B SHARES
Distribution Plan. Reference is made to "Purchase of Shares--Distribution
Plan" in the Prospectus for certain information with respect to the
Distribution Plan of the Fund.
The payment of the distribution fee is subject to the provisions of Rule 12b-
1 under the 1940 Act. Among other things, the Distribution Plan provides that
the Distributor shall provide and the Trustees shall review quarterly reports
of the disbursement of the distribution fees paid to the Distributor. In their
consideration of the Distribution Plan, the Trustees must consider all factors
they deem relevant, including information as to the benefits of the
Distribution Plan to the Fund and its Class B shareholders. The Distribution
Plan further provides that, so long as the Distribution Plan remains in effect,
the selection and nomination of Trustees who are not "interested persons" of
the Trust, as defined in the 1940 Act (the "Independent Trustees"), shall be
committed to the discretion of the Independent Trustees then in office. In
approving the Distribution Plan in accordance with Rule 12b-1, the Independent
Trustees concluded that there is reasonable likelihood that the Distribution
Plan will benefit the Fund and its Class B shareholders. The Distribution Plan
can be terminated at any time, without penalty, by the vote of a majority of
the Independent Trustees or by the vote of the holders of a majority of the
outstanding Class B voting securities of the Fund. The
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Distribution Plan cannot be amended to increase materially the amount to be
spent by the Fund without approval by Class B shareholders and all material
amendments are required to be approved by the vote of Trustees, including a
majority of the Independent Trustees who have no direct or indirect financial
interest in the Distribution Plan, cast in person at a meeting called for that
purpose. Rule 12b-1 further requires that the Trust preserve copies of the
Distribution Plan and any report made pursuant to such plan for a period of not
less than six years from the date of the Distribution Plan or such report, the
first two years in an easily accessible place.
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the New
York Stock Exchange is restricted as determined by the Commission or such
Exchange is closed (other than customary weekend and holiday closings), for any
period during which an emergency exists, as defined by the Commission, as a
result of which disposal of portfolio securities or determination of the net
asset value of the Fund is not reasonably practicable, and for such other
periods as the Commission may by order permit for the protection of
shareholders of the Fund.
CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
As discussed in the Prospectus under "Purchase of Shares--Alternative Sales
Arrangements--Deferred Sales Charge Alternative--Class B Shares", while Class B
shares redeemed within four years of purchase are subject to a contingent
deferred sales charge ("CDSC") under most circumstances, the charge is waived
on redemptions of Class B shares following the death or disability of a Class B
shareholder. Redemptions for which the waiver applies are any partial or
complete redemption following the death or disability (as defined in the
Internal Revenue Code of 1986, as amended (the "Code")) of a Class B
shareholder (including one who owns the Class B shares as joint tenant with his
or her spouse), provided the redemption is requested within one year of the
death or initial determination of disability. The CDSC is also waived for any
Class B shares which are purchased by a Merrill Lynch rollover IRA, that was
funded by a rollover from a terminated 401(k) plan managed by the MLAM Private
Portfolio Group, and held in such account at the time of redemption.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies" and "Portfolio
Transactions" in the Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as a principal in the purchase and sale of securities
unless such trading is permitted by an exemptive order issued by the
Commission. Since over-the-counter transactions are usually principal
transactions, affiliated persons of the Trust, including Merrill Lynch, may not
serve as dealer in connection with transactions with the Fund. The Trust has
obtained an exemptive order permitting it to engage in certain principal
transactions with Merrill Lynch involving high quality short-term municipal
bonds subject to certain conditions. Affiliated persons of the Trust may serve
as broker for the Fund in over-the-counter transactions conducted on an agency
basis. Certain court decisions have raised questions as to the extent to which
investment companies
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should seek exemptions under the 1940 Act in order to seek to recapture
underwriting and dealer spreads from affiliated entities. The Trustees have
considered all factors deemed relevant, and have made a determination not to
seek such recapture at this time. The Trustees will reconsider this matter from
time to time.
As a non-fundamental restriction, the Trust will prohibit the purchase or
retention by the Fund of the securities of any issuer if the officers,
directors or trustees of the Trust or the Manager owning beneficially more than
one-half of one per cent of the securities of an issuer together own
beneficially more than five per cent of the securities of that issuer. In
addition, under the 1940 Act, the Fund may not purchase securities during the
existence of any underwriting syndicate of which Merrill Lynch is a member
except pursuant to an exemptive order or rules adopted by the Commission. Rule
10f-3 under the 1940 Act sets forth conditions under which the Fund may
purchase municipal bonds in such transactions. The rule sets forth requirements
relating to, among other things, the terms of an issue of municipal bonds
purchased by the Fund, the amount of municipal bonds which may be purchased in
any one issue and the assets of the Fund which may be invested in a particular
issue.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who
provide supplemental investment research (such as information concerning tax-
exempt securities, economic data and market forecasts) to the Manager may
receive orders for transactions by the Fund. Information so received will be in
addition to and not in lieu of the services required to be performed by the
Manager under its Management Agreement and the expenses of the Manager will not
necessarily be reduced as a result of the receipt of such supplemental
information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Rules of Fair Practice of the National Association of Securities Dealers,
Inc., and policies established by the Trustees of the Trust, the Manager may
consider sales of shares of the Fund as a factor in the selection of brokers or
dealers to execute portfolio transactions for the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. While it is not possible to predict turnover rates
with any certainty, at present it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances after the Fund's portfolio
is invested in accordance with its investment objective, will be less than
100%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by
the monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded.)
DETERMINATION OF NET ASSET VALUE
The net asset value of the Fund is determined by the Manager once daily,
Monday through Friday, as of 4:15 P.M., New York City time, on each day during
which the New York Stock Exchange is open for trading. The New York Stock
Exchange is not open on New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Net asset
value per share is computed by dividing the sum of the value of the securities
held by the Fund plus any cash or other assets
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minus all liabilities by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Manager and Distributor, are accrued daily. The net asset value per share of
the Class A shares and the net asset value per share of the Class B shares are
expected to be equivalent. Under certain circumstances, however, the per share
net asset value of the Class B shares may be lower than the per share net asset
value of the Class A shares reflecting the higher daily expense accruals of the
account maintenance and distribution fees (and incremental transfer agency
costs) applicable with respect to the Class B shares. Even under those
circumstances, the per share net asset value of the two classes will tend to
converge immediately after the payment of dividends, which will differ by
approximately the amount of the expense accrual differential between the
classes.
The Municipal Bonds, and other portfolio securities in which the Fund invests
are traded primarily in over-the-counter municipal bond and money markets and
are valued at the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers that make
markets in the securities. One bond is the "yield equivalent" of another bond
when, taking into account market price, maturity, coupon rate, credit rating
and ultimate return of principal, both bonds will theoretically produce an
equivalent return to the bondholder. Financial futures contracts and options
thereon, which are traded on exchanges, are valued at their settlement prices
as of the close of such exchanges. Short-term investments with a remaining
maturity of 60 days or less are valued on an amortized cost basis, which
approximates market value. Securities and assets for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Trustees of the Trust, including valuations
furnished by a pricing service retained by the Trust, which may utilize a
matrix system for valuations. The procedures of the pricing service and its
valuations are reviewed by the officers of the Trust under the general
supervision of the Trustees.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services described below which are
designed to facilitate investment in shares of the Fund. Full details as to
each of such services can be obtained from the Trust, the Distributor or
Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive quarterly statements from the Transfer
Agent. These quarterly statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of income dividends and
long-term capital gain distributions. The quarterly statements will also show
any other activity in the account since the preceding statement. Shareholders
will receive separate transaction confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
income dividends and long-term capital gain distributions. Shareholders
considering transferring their Class A shares from Merrill Lynch to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class A shares are to be transferred will not take delivery of shares
of the Fund, a shareholder either must redeem the Class A shares so that the
cash proceeds can be transferred to the account at the new firm or such
shareholder must continue to maintain an Investment Account at the Transfer
Agent for those Class A shares. Shareholders interested in transferring their
Class B shares from Merrill Lynch and who do not wish to have an Investment
Account maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the
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<PAGE>
benefit of the shareholder. If the new brokerage firm is willing to accommodate
the shareholder in this manner, the shareholder must request that he be issued
certificates for his shares, and then must turn the certificates over to the
new firm for re-registration as described in the preceding sentence. A
shareholder may make additions to his Investment Account at any time by mailing
a check directly to the Transfer Agent.
Share certificates are issued only for full shares and only upon the specific
request of the shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
AUTOMATIC INVESTMENT PLAN
A shareholder may make additions to an Investment Account at any time by
purchasing Class A or Class B shares at the applicable public offering price
either through the shareholder's securities dealer, or by mail directly to the
Transfer Agent, acting as agent for such securities dealers. Voluntary
accumulation also can be made through a service known as the Automatic
Investment Plan whereby the Fund is authorized through pre-authorized checks of
$50 or more to charge the regular bank account of the shareholder on a regular
basis to provide systematic additions to the Investment Account of such
shareholder. The Fund's Automatic Investment Program is not available to
shareholders whose shares are held in brokerage account with Merrill Lynch.
Alternatively, investors who maintain CMA(R) accounts may arrange to have
periodic investments made in the Fund in their CMA(R) account or in certain
related accounts in amounts of $100 or more through the CMA(R) Automatic
Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
reinvested automatically in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of
business on the monthly payment date for such dividends and distributions.
Shareholders may elect in writing to receive either their income dividends or
capital gains distributions, or both, in cash, in which event payment will be
mailed on or about the payment date.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, such instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A SHARES
A Class A shareholder may elect to make systematic withdrawals from an
Investment Account on either a monthly or quarterly basis as provided below.
Quarterly withdrawals are available for shareholders who have acquired Class A
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals for shareholders with Class A shares
with such a value of $10,000 or more.
At the time of each withdrawal payment, sufficient Class A shares are
redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The shareholder
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may specify either a dollar amount or a percentage of the value of his Class A
shares. Redemptions will be made at net asset value as determined at the normal
close of business on the New York Stock Exchange (currently 4:00 P.M., New York
City time) on the 24th day of each month or the 24th day of the last month of
each quarter, whichever is applicable. If the Exchange is not open for business
on such date, the Class A shares will be redeemed at the close of business on
the following business day. The check for the withdrawal payment will be
mailed, or the direct deposit for the withdrawal payment will be made, on the
next business day following redemption. When a shareholder is making systematic
withdrawals, dividends and distributions on all Class A shares in the
Investment Account are reinvested automatically in the Fund's Class A shares. A
shareholder's Systematic Withdrawal Plan may be terminated at any time, without
charge or penalty, by the shareholder, the Trust, the Transfer Agent or the
Distributor. Withdrawal payments should not be considered as dividends, yield
or income. Each withdrawal is a taxable event. If periodic withdrawals
continuously exceed reinvested dividends, the shareholder's original investment
may be reduced correspondingly. Purchases of additional Class A shares
concurrent with withdrawals are ordinarily disadvantageous to the shareholder
because of sales charges and tax liabilities. The Trust will not knowingly
accept purchase orders for Class A shares of the Fund from investors who
maintain a Systematic Withdrawal Plan unless such purchase is equal to at least
one year's scheduled withdrawals or $1,200, whichever is greater. Periodic
investments may not be made into an Investment Account in which the shareholder
has elected to make systematic withdrawals.
A Class A shareholder whose shares are held within a CMA(R), CBA(R) or
Retirement Account may elect to have shares redeemed on a monthly, bimonthly,
quarterly, semiannual or annual basis through the Systematic Redemption
Program. The minimum fixed dollar amount redeemable is $25. The proceeds of
systematic redemptions will be posted to the shareholder's account five
business days after the date the shares are redeemed. Monthly systematic
redemptions will be made at net asset value on the first Monday of each month,
bimonthly systematic redemption will be made at net asset value on the first
Monday of every other month, and quarterly, semiannual or annual redemptions
are made at net asset value on the first Monday of months selected at the
shareholder's option. If the first Monday of the month is a holiday, the
redemption will be processed at net asset value on the next business day. The
Systematic Redemption Program is not available if Company shares are being
purchased within the account pursuant to the Automatic Investment Program. For
more information on the Systematic Redemption Program, eligible shareholders
should contact their Financial Consultant.
EXCHANGE PRIVILEGE
Class A and Class B shareholders of the Fund may exchange their Class A or
Class B shares of the Fund for shares of the same class of the funds that issue
Class A and Class B shares listed below. In addition, Class A shareholders of
the Fund may exchange their Class A shares of the Fund for shares of the "Class
A money market funds," and Class B shareholders of the Fund may exchange their
Class B shares for shares of the "Class B money market funds," on the basis
described below. Shares with a net asset value of at least $100 are required to
qualify for the exchange privilege and any shares utilized in an exchange must
have been held by the shareholder for at least 15 days. Certain funds into
which exchanges may be made may impose a redemption fee (not in excess of 2.00%
of the amount redeemed) on shares purchased through the exchange privilege when
such shares are subsequently redeemed, including redemption through subsequent
exchanges. Such redemption fee would be in addition to any CDSC otherwise
applicable to a redemption of Class B shares. It is contemplated that the
exchange privilege may be applicable to other new mutual funds whose shares may
be distributed by the Distributor.
26
<PAGE>
Under the exchange privilege, each of the funds with Class A shares
outstanding offers to exchange its Class A shares ("new Class A shares") for
Class A shares ("outstanding Class A shares") of any of the other funds, on the
basis of relative net asset value per Class A share, plus an amount equal to
the difference, if any, between the sales charge previously paid on the
outstanding Class A shares and the sales charge payable at the time of the
exchange on the new Class A shares. With respect to outstanding Class A shares
as to which previous exchanges have taken place, the "sales charge previously
paid" shall include the aggregate of the sales charges paid with respect to
such Class A shares in the initial purchase and any subsequent exchange. Class
A shares issued pursuant to dividend reinvestment are sold on a no-load basis
in each of the funds offering Class A shares. For purposes of the exchange
privilege, Class A shares acquired through dividend reinvestment shall be
deemed to have been sold with a sales charge equal to the sales charge
previously paid on the Class A shares on which the dividend was paid. Based on
this formula, Class A shares generally may be exchanged into the Class A shares
of the other funds or into shares of a money market fund advised by the Manager
or its affiliates with a reduced or without a sales charge.
In addition, each of the funds with Class B shares outstanding offers to
exchange its Class B shares ("new
Class B shares") for Class B shares ("outstanding Class B shares") of any of
the other funds on the basis of relative net asset value per Class B share,
without the payment of any CDSC that might otherwise be due on redemption of
the outstanding shares. Class B shareholders of the Fund exercising the
exchange privilege will continue to be subject to the Fund's CDSC schedule if
such schedule is higher than the CDSC schedule relating to the new Class B
shares acquired through use of the exchange privilege. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the fund from which the exchange has
been made. For purposes of computing the sales charge that may be payable on a
disposition of the new Class B shares, the holding period for the outstanding
Class B shares is "tacked" to the holding period of the new Class B shares. For
example, an investor may exchange Class B shares of the Fund for those of
Merrill Lynch Special Value Fund, Inc. ("Special Value Fund") after having held
the Fund's Class B shares for two and a half years. The 2% sales load that
generally would apply to a redemption would not apply to the exchange. Three
years later the investor may decide to redeem the Class B shares of Special
Value Fund and receive cash. There will be no CDSC due on this redemption,
since by "tacking" the two and a half year holding period of the Fund's Class B
shares to the three-year holding period for the Special Value Fund Class B
shares, the investor will be deemed to have held the new Class B shares for
more than five years.
Shareholders also may exchange Class A shares and Class B shares of the Fund
into shares of a money market fund advised by the Manager or its affiliates,
but the period of time that Class B shares are held in a money market fund will
not count towards satisfaction of the holding period requirement for purposes
of reducing the CDSC. However, shares of a money market fund which were
acquired as a result of an exchange for Class B shares of the Fund may, in
turn, be exchanged back into Class B shares of any fund offering such shares,
in which event the holding period for Class B shares of the fund will be
aggregated with previous holding periods for purposes of reducing the CDSC.
Thus, for example, an investor may exchange Class B shares of the Fund for
shares of Merrill Lynch Institutional Fund after having held the Class B shares
for two and a half years and three years later decide to redeem the shares of
Merrill Lynch Institutional Fund for cash. At the time of this redemption, the
2% CDSC that would have been due had the Class B shares of the Fund been
redeemed for cash rather than exchanged for shares of Merrill Lynch
Institutional Fund will be payable. If, instead of such redemption the
shareholder exchanged such shares for Class B shares of a fund which the
shareholder continues to hold for an additional two and a half years, any
subsequent redemption will not incur a CDSC.
27
<PAGE>
Set forth below is a description of the investment objectives of the other
funds into which exchanges can be made:
Funds issuing Class A and Class B Shares
Merrill Lynch Adjustable
Rate Securities Fund,
Inc. ..................... High current income consistent with a policy of
limiting the degree of fluctuation in net asset
value by investing primarily in a portfolio of
adjustable rate securities, consisting
principally of mortgage-backed and asset-backed
securities.
Merrill Lynch Americas
Income Fund, Inc. ........
A high level of current income, consistent with
prudent investment risk, by investing primarily
in debt securities denominated in a currency of
a country located in the Western Hemisphere
(i.e., North and South America and the
surrounding waters).
Merrill Lynch Arizona
Limited Maturity
Municipal Bond Fund ......
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is to provide as high a level of
income exempt from Federal and Arizona income
taxes as is consistent with prudent investment
management through investment in a portfolio
primarily of intermediate-term investment grade
Arizona Municipal Bonds.
Merrill Lynch Arizona
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide investors with as high a
level of income exempt from Federal and Arizona
income taxes as is consistent with prudent
investment management.
Merrill Lynch Balanced
Fund for Investment and
Retirement ...............
As high a level of total investment return as is
consistent with reasonable risk by investing in
common stock and other types of securities,
including fixed income securities and
convertible securities.
Merrill Lynch Basic Value
Fund, Inc. ...............
Capital appreciation and, secondarily, income
through investment in securities, primarily
equities, that are undervalued and therefore
represent basic investment value.
Merrill Lynch California
Insured Municipal Bond
Fund......................
A portfolio of Merrill Lynch California Municipal
Series Trust, a series fund, whose objective is
to provide shareholders with as high a level of
income exempt from Federal and California income
taxes as is consistent with prudent investment
management through investment in a portfolio
primarily of insured California Municipal Bonds.
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<PAGE>
Merrill Lynch California
Limited Maturity
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is to provide shareholders with
as high a level of income exempt from Federal
and California income taxes as is consistent
with prudent investment management through
investment in a portfolio primarily of
intermediate-term investment grade California
Municipal Bonds.
Merrill Lynch California
Municipal Bond Fund ......
A portfolio of Merrill Lynch California Municipal
Series Trust, a series fund, whose objective is
to provide investors with as high a level of
income exempt from Federal and California income
taxes as is consistent with prudent investment
management.
Merrill Lynch Capital
Fund, Inc. ...............
The highest total investment return consistent
with prudent risk through a fully managed
investment policy utilizing equity, debt and
convertible securities.
Merrill Lynch Colorado
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is as high a level of income exempt
from Federal and Colorado income taxes as is
consistent with prudent investment management.
Merrill Lynch Connecticut
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is as high a level of income exempt
from Federal and Connecticut income taxes as is
consistent with prudent investment management.
Merrill Lynch Corporate
Bond Fund, Inc. ..........
Current income from three separate diversified
portfolios of fixed income securities.
Merrill Lynch Developing
Capital Markets Fund,
Inc. .....................
Long-term appreciation through investment in
securities, principally equities, of issuers in
countries having smaller capital markets.
Merrill Lynch Dragon Fund,
Inc. .....................
Capital appreciation primarily through investment
in equity and debt securities of issuers
domiciled in developing countries located in
Asia and the Pacific Basin, other than Japan,
Australia and New Zealand.
Merrill Lynch EuroFund.....
Capital appreciation primarily through investment
in equity securities of corporations domiciled
in Europe.
29
<PAGE>
Merrill Lynch Federal
Securities Trust .........
High current return through investments in U.S.
Government and Government agency securities,
including GNMA mortgage-backed certificates and
other mortgage-backed Government securities.
Merrill Lynch Florida
Limited Maturity
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is as high a level of income
exempt from Federal income taxes as is
consistent with prudent investment management
while seeking to offer shareholders the
opportunity to own securities exempt from
Florida intangible personal property taxes
through investment in a portfolio primarily of
intermediate-term investment grade Florida
Municipal Bonds.
Merrill Lynch Florida
Municipal Bond Fund ......
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is as high a level of income exempt
from Federal income taxes as is consistent with
prudent investment management while seeking to
offer shareholders the opportunity to own
securities exempt from Florida intangible
personal property taxes.
Merrill Lynch Fund For
Tomorrow, Inc.............
Long-term growth through investment in a portfo-
lio of good quality securities, primarily common
stock, potentially positioned to benefit from
demographic and cultural changes as they affect
consumer markets.
Merrill Lynch Fundamental
Growth Fund, Inc. ........
Long-term growth through investment in a
diversified portfolio of equity securities
placing particular emphasis on companies that
have exhibited above-average growth rates in
earnings.
Merrill Lynch Global
Allocation Fund, Inc......
High total return, consistent with prudent risk,
through a fully managed investment policy util-
izing United States and foreign equity, debt and
money market securities, the combination of
which will be varied from time to time both with
respect to the types of securities and markets
in response to changing market and economic
trends.
Merrill Lynch Global Bond
Fund for Investment and
Retirement................
High total investment return from investment in a
global portfolio of debt instruments denominated
in various currencies and multi-national cur-
rency units.
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<PAGE>
Merrill Lynch Global
Convertible Fund, Inc.....
High total return from investment primarily in an
internationally diversified portfolio of con-
vertible debt securities, convertible preferred
stock and "synthetic" convertible securities
consisting of a combination of debt securities
or preferred stock and warrants or options.
Merrill Lynch Global
Holdings (residents of
Arizona must meet
investor suitability
standards) ...............
The highest total investment return consistent
with prudent risk through worldwide investment
in an internationally diversified portfolio of
securities.
Merrill Lynch Global
Resources Trust...........
Long-term growth and protection of capital from
investment in securities of domestic and foreign
companies that possess substantial natural re-
source assets.
Merrill Lynch Global
Utility Fund, Inc.........
Capital appreciation and current income through
investment of at least 65% of its total assets
in equity and debt securities issued by domestic
and foreign companies which are primarily en-
gaged in the ownership or operation of facili-
ties used to generate, transmit or distribute
electricity, telecommunications, gas or water.
Merrill Lynch Growth Fund
for Investment and
Retirement................
Growth of capital and, secondarily, income from
investment in a diversified portfolio of equity
securities placing principal emphasis on those
securities which management of the fund believes
to be undervalued.
Merrill Lynch Healthcare
Fund, Inc. (residents of
Wisconsin must meet
investor suitability
standards)................
Capital appreciation through worldwide investment
in equity securities of companies that derive or
are expected to derive a substantial portion of
their sales from products and services in
healthcare.
Merrill Lynch
International Equity
Fund...................... Capital appreciation and, secondarily, income by
investing in a diversified portfolio of equity
securities of issuers located in countries other
than the United States.
Merrill Lynch Latin
America Fund, Inc. .......
Capital appreciation by investing primarily in
Latin American equity and debt securities.
31
<PAGE>
Merrill Lynch Maryland
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and Maryland income taxes as is consistent with
prudent investment management.
Merrill Lynch
Massachusetts Limited
Maturity Municipal Bond
Fund......................
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is as high a level of income ex-
empt from Federal and Massachusetts income taxes
as is consistent with prudent investment manage-
ment through investment in a portfolio primarily
of intermediate-term investment grade Massachu-
setts Municipal Bonds.
Merrill Lynch
Massachusetts Municipal
Bond Fund................. A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and Massachusetts income taxes as is consistent
with prudent investment management.
Merrill Lynch Michigan
Limited Maturity
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is as high a level of income ex-
empt from Federal and Michigan income taxes as
is consistent with prudent investment management
through investment in a portfolio primarily of
intermediate-term investment grade Michigan Mu-
nicipal Bonds.
Merrill Lynch Michigan
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is as high a level of income exempt
from Federal and Michigan income taxes as is
consistent with prudent investment management.
Merrill Lynch Minnesota
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and Minnesota income taxes as is consistent with
prudent investment management.
Merrill Lynch Municipal
Bond Fund, Inc............
Tax-exempt income from three separate diversified
portfolios of municipal bonds.
Merrill Lynch Municipal
Intermediate Term Fund....
Currently the only portfolio of Merrill Lynch Mu-
nicipal Series Trust, a series fund, whose ob-
jective is to provide as high a level as possi-
ble of income exempt from Federal income taxes
by investing in investment grade obligations
with a dollar weighted average maturity of five
to twelve years.
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<PAGE>
Merrill Lynch New Jersey
Limited Maturity Munici-
pal Bond Fund.............
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is as high a level of income ex-
empt from Federal and New Jersey income taxes as
is consistent with prudent investment management
through a portfolio primarily of intermediate-
term investment grade New Jersey Municipal
Bonds.
Merrill Lynch New Jersey
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and New Jersey income taxes as is consistent
with prudent investment management.
Merrill Lynch New Mexico
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and New Mexico income taxes as is consistent
with prudent investment management.
Merrill Lynch New York
Limited Maturity Munici-
pal Bond Fund.............
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is as high a level of income ex-
empt from Federal, New York State and New York
City income taxes as is consistent with prudent
investment management through investment in a
portfolio primarily of intermediate-term invest-
ment grade New York Municipal Bonds.
Merrill Lynch New York Mu-
nicipal Bond Fund.........
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Feder-
al, New York State and New York City income
taxes as is consistent with prudent investment
management.
Merrill Lynch North Caro-
lina Municipal Bond Fund..
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and North Carolina income taxes as is consistent
with prudent investment management.
Merrill Lynch Ohio Munici-
pal Bond Fund.............
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and Ohio income taxes as is consistent with pru-
dent investment management.
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<PAGE>
Merrill Lynch Oregon Mu-
nicipal Bond Fund.........
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and Oregon income taxes as is consistent with
prudent investment management.
Merrill Lynch Pacific
Fund, Inc.................
Capital appreciation by investing in equity secu-
rities of corporations domiciled in Far Eastern
and Western Pacific countries, including Japan,
Australia, Hong Kong and Singapore.
Merrill Lynch Pennsylvania
Limited Maturity Munici-
pal Bond Fund.............
A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund,
whose objective is to provide as high a level of
income exempt from Federal and Pennsylvania in-
come taxes as is consistent with prudent invest-
ment management through investment in a portfo-
lio of intermediate-term investment grade Penn-
sylvania Municipal Bonds.
Merrill Lynch Pennsylvania
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
and Pennsylvania income taxes as is consistent
with prudent investment management.
Merrill Lynch Phoenix
Fund, Inc.................
Long-term growth of capital by investing in eq-
uity and fixed income securities, including tax-
exempt securities, of issuers in weak financial
condition or experiencing poor operating results
believed to be undervalued relative to the cur-
rent or prospective condition of such issuer.
Merrill Lynch Short-Term
Global Income Fund, Inc...
As high a level of current income as is consis-
tent with prudent investment management from a
global portfolio of high quality debt securities
denominated in various currencies and multina-
tional currency units and having remaining matu-
rities not exceeding three years.
Merrill Lynch Special
Value Fund, Inc...........
Long-term growth of capital from investments in
securities, primarily equities, of relatively
small companies believed to have special invest-
ment value and emerging growth companies regard-
less of size.
Merrill Lynch Strategic
Dividend Fund.............
Long-term total return from investment in divi-
dend paying common stocks which yield more than
Standard & Poor's 500 Composite Stock Price In-
dex.
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<PAGE>
Merrill Lynch Technology
Fund, Inc.................
Capital appreciation through worldwide investment
in equity securities of companies that derive or
are expected to derive a substantial portion of
their sales from products and services in tech-
nology.
Merrill Lynch Texas
Municipal Bond Fund.......
A portfolio of Merrill Lynch Multi-State Munici-
pal Series Trust, a series fund, whose objective
is as high a level of income exempt from Federal
income taxes as is consistent with prudent in-
vestment management by investing primarily in a
portfolio of long-term, investment grade obliga-
tions issued by the State of Texas, its politi-
cal subdivisions, agencies and instrumentali-
ties.
Merrill Lynch Utility In-
come Fund, Inc............
High current income through investment in equity
and debt securities issued by companies which
are primarily engaged in the ownership or opera-
tion of facilities used to generate, transmit or
distribute electricity, telecommunications, gas
or water.
Merrill Lynch World Income
Fund, Inc. ...............
High current income by investing in a global
portfolio of fixed income securities denominated
in various currencies, including multinational
currencies.
Class A Money Market Funds
Merrill Lynch Ready Assets
Trust.....................
Preservation of capital, liquidity and the high-
est possible current income consistent with the
foregoing objectives from the short-term money
market securities in which the Trust invests.
Merrill Lynch Retirement
Reserves Money Fund
(available only if the
exchange occurs within
certain retirement
plans)....................
Currently the only portfolio of Merrill Lynch Re-
tirement Series Trust, a series fund, whose ob-
jectives are current income, preservation of
capital and liquidity available from investing
in a diversified portfolio of short-term money
market securities.
Merrill Lynch U.S.A.
Government Reserves.......
Preservation of capital, current income and li-
quidity available from investing in direct obli-
gations of the U.S. Government and repurchase
agreements relating to such securities.
Merrill Lynch U.S.
Treasury Money Fund.......
Preservation of capital, liquidity and current
income through investment exclusively in a di-
versified portfolio of short-term marketable se-
curities which are direct obligations of the
U.S. Treasury.
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<PAGE>
Class B Money Market Funds
Merrill Lynch Government
Fund......................
A portfolio of Merrill Lynch Funds For Institu-
tions Series, a series fund, whose objective is
to provide current income consistent with li-
quidity and security of principal from invest-
ment in securities issued or guaranteed by the
U.S. Government, its agencies and instrumentali-
ties and in repurchase agreements secured by
such obligations.
Merrill Lynch
Institutional Fund........
A portfolio of Merrill Lynch Funds For Institu-
tions Series, a series fund, whose objective is
to provide maximum current income consistent
with liquidity and the maintenance of a high
quality portfolio of money market securities.
Merrill Lynch
Institutional Tax-Exempt
Fund......................
A portfolio of Merrill Lynch Funds for Institu-
tions Series, a series fund, whose objective is
to provide current income exempt from Federal
income taxes, preservation of capital and li-
quidity available from investing in a diversi-
fied portfolio of short-term, high quality mu-
nicipal bonds.
Merrill Lynch Treasury A portfolio of Merrill Lynch Funds For Institu-
Fund...................... tions Series, a series fund, whose objective is
to provide current income consistent with li-
quidity and security of principal from invest-
ment in direct obligations of the U.S. Treasury
and up to 10% of its total assets in repurchase
agreements secured by such obligations.
Before effecting an exchange, shareholders of the Fund should obtain a
currently effective prospectus of the fund into which the exchange is to be
made.
To exercise the exchange privilege, shareholders should contact their
Merrill Lynch financial consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other funds described above
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated at any time in accordance with the
rules of the Commission. The Fund reserves the right to limit the number of
times an investor may exercise the exchange privilege. Certain funds may
suspend the continuous offering of their shares to the general public at any
time and may thereafter resume such offering from time to time. The exchange
privilege is available only to U.S. shareholders in states where the exchange
legally may be made. In addition, the exchange privilege also may be modified
if the Merrill Lynch Select Pricing SM System is adopted. See "Purchase of
Shares--Alternative Sales Arrangements."
DISTRIBUTIONS AND TAXES
The Trust intends to elect and to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income
and 90% of its tax-exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The
Trust intends to cause the Fund to distribute substantially all of such
income.
36
<PAGE>
As discussed in the Fund's Prospectus, the Trust has established other
series in addition to the Fund (together with the Fund, the "Series"). Each
Series of the Trust is treated as a separate corporation for Federal income
tax purposes. Each Series, therefore, is considered to be a separate entity in
determining its treatment under the rules for RICs described in the
Prospectus. Losses in one Series do not offset gains in another Series, and
the requirements (other than certain organizational requirements) for
qualifying for RIC status are determined at the Series level rather than at
the Trust level.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. The required distributions, however, are based
only on the taxable income of a RIC. The excise tax, therefore, generally will
not apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends. The Trust anticipates that it will make sufficient
timely distributions of taxable income of the Fund to avoid imposition of the
excise tax on the Fund.
Arkansas has incorporated the special Federal tax provisions affecting
regulated investment companies into state income tax law. Consequently, for
Arkansas income tax purposes, the Fund will be treated as a RIC to the extent
it qualifies as such under the Code.
The Trust intends to qualify the Fund to pay "exempt-interest dividends" as
defined in Section 852(b)(5) of the Code. Under such section if, at the close
of each quarter of the Fund's taxable year, at least 50% of the value of the
Fund's total assets consists of obligations exempt from Federal income tax
("tax-exempt obligations") under Section 103(a) of the Code (relating
generally to obligations of a state or local governmental unit), the Fund
shall be qualified to pay exempt-interest dividends to its Class A and Class B
shareholders (together, the "shareholders"). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as exempt-
interest dividends in a written notice mailed to the Fund's shareholders
within 60 days after the close of the Fund's taxable year. For this purpose,
the Fund will allocate interest from tax-exempt obligations (as well as
ordinary income, capital gains and tax preference items, discussed below)
between the Class A and Class B shareholders according to a method (which it
believes is consistent with the Commission's exemptive order permitting the
issuance and sale of two classes of shares) that is based on the gross income
allocable to Class A and Class B shareholders during the taxable year, or such
other method as the Internal Revenue Service may prescribe. To the extent that
the dividends distributed to the Fund's shareholders are derived from interest
income exempt from Federal income tax under Code Section 103(a) and are
properly designated as exempt-interest dividends, they will be excludable from
a shareholder's gross income for Federal income tax purposes. Exempt-interest
dividends are included, however, in determining the portion, if any, of a
person's social security benefits and railroad retirement benefits subject to
Federal income taxes. Interest on indebtedness incurred or continued to
purchase or carry shares of a RIC paying exempt-interest dividends, such as
the Fund, will not be deductible by the investor for Federal or Arkansas
income tax purposes to the extent attributable to exempt-interest dividends.
Shareholders are advised to consult their tax advisers with respect to whether
exempt-interest dividends retain the exclusion under Code Section 103(a) if a
shareholder would be treated as a "substantial user" or "related person" under
Code Section 147(a) with respect to property financed with the proceeds of an
issue of "industrial development bonds" or "private activity bonds," if any,
held by the Fund.
The portion of the Fund's exempt-interest dividends paid from interest
received by the Fund from Arkansas Municipal Bonds will also be exempt from
Arkansas income tax. Shareholders subject to income taxation in states other
than Arkansas will realize a lower after-tax rate of return than Arkansas
shareholders since the dividends distributed by the Fund generally will not be
exempt, to any significant degree, from income taxation by such other states.
The Trust will inform shareholders annually regarding the portion of
37
<PAGE>
the Fund's distributions which constitutes exempt-interest dividends and the
portion which is exempt from Arkansas income taxes. The Trust will allocate
exempt-interest dividends between Class A and Class B shareholders for
Arkansas income tax purposes based on a method similar to that described above
for Federal income tax purposes.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal income tax purposes. Such distributions
are not eligible for the dividends received deduction for corporations.
Distributions, if any, of net long-term capital gains from the sale of
securities or from certain transactions in futures or options ("capital gain
dividends") are taxable as long-term capital gains for Federal income tax
purposes, regardless of the length of time the shareholder has owned Fund
shares. Under the Revenue Reconciliation Act of 1993, all or a portion of the
Fund's gain from the sale or redemption of tax-exempt obligations purchased at
a market discount will be treated as ordinary income rather than capital gain.
This rule may increase the amount of ordinary income dividends received by
shareholders. Distributions in excess of the Fund's earnings and profits will
first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Any loss upon the
sale or exchange of Fund shares held for six months or less, however, will be
treated as long-term capital loss to the extent of capital gain dividends
received by the shareholder. In addition, such loss will be disallowed to the
extent of any exempt-interest dividends received by the shareholder. If the
Fund pays a dividend in January which was declared in the previous October,
November or December to shareholders of record on a specific date in one of
such months, then such dividend will be treated for tax purposes as being paid
by the Fund and received by its shareholders on December 31 of the year in
which such dividend was declared.
In 1991, Arkansas enacted legislation adopting certain sections of the Code
and related regulations in effect on January 1, 1991, which apply to the
computation of capital gains and losses. For individuals, net capital gains
are taxed at a maximum of 6% (as compared with the maximum rate of 7% for
ordinary income). Special capital gains treatment is not available in Arkansas
for corporate taxpayers.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item
of "tax preference," which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will
purchase such "private activity bonds," and the Trust will report to
shareholders within 60 days after the Fund's taxable year-end the portion of
the Fund's dividends declared during the year which constitutes an item of tax
preference for alternative minimum tax purposes. The Code further provides
that corporations are subject to an alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax
preferences and the corporation's "adjusted current earnings," which more
closely reflect a corporation's economic income. Because an exempt-interest
dividend paid by the Fund will be included in adjusted current earnings, a
corporate shareholder may be required to pay alternative minimum tax on
exempt-interest dividends paid by the Fund.
The Revenue Reconciliation Act of 1993 has added new marginal tax brackets
of 36% and 39.6% for individuals and has created a graduated structure of 26%
and 28% for the alternative minimum tax applicable to individual taxpayers.
These rate increases may affect an individual investor's after-tax return from
an investment in the Fund as compared with such investor's return from taxable
investments.
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<PAGE>
If a Class A shareholder exercises the exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent the sales charge
paid to the Fund reduces any sales charge such shareholder would have owed upon
purchase of the new Class A shares in the absence of the exchange privilege.
Instead, such sales charge will be treated as an amount paid for the new Class
A shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
Ordinary income dividends paid by the Fund to shareholders who are
nonresident aliens or foreign entities will be subject to a 30% United States
withholding tax under existing provisions of the Code applicable to foreign
individuals and entities unless a reduced rate of withholding or a withholding
exemption is provided under applicable treaty law. Nonresident shareholders are
urged to consult their own tax advisers concerning the applicability of the
United States withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividends and capital gain
dividends and on redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code imposes a deductible tax (the "Environmental Tax") on a
corporation's modified alternative minimum taxable income (computed without
regard to the alternative tax net operating loss deduction and the deduction
for the Environmental Tax) at a rate of $12 per $10,000 (0.12%) of alternative
minimum taxable income in excess of $2,000,000. The Environmental Tax is
imposed for taxable years beginning after December 31, 1986 and before January
1, 1996. The Environmental Tax is imposed even if the corporation is not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeds its minimum tax liability. The Code provides,
however, that a RIC, such as the Fund, is not subject to the Environmental Tax.
However, exempt-interest dividends paid by the Fund that create alternative
minimum tax preferences for corporate shareholders under the Code (as described
above) may subject corporate shareholders of the Fund to the Environmental Tax.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is
available to the Fund or an exception applies, such options and financial
futures contracts that are "Section 1256 contracts" will be "marked to market"
for Federal income tax purposes at the end of each taxable year, i.e., each
such option or financial futures contract will be treated as sold for its fair
market value on the last day of the taxable
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<PAGE>
year, and any gain or loss attributable to Section 1256 contracts will be 60%
long-term and 40% short-term capital gain or loss. Application of these rules
to Section 1256 contracts held by the Fund may alter the timing and character
of distributions to shareholders.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's transactions in options and financial futures contracts.
Under Section 1092, the Fund may be required to postpone recognition for tax
purposes of losses incurred in certain closing transactions in options and
financial futures contracts.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income must be derived from gains from the sale or other
disposition of securities held for less than three months. Accordingly, the
Fund may be restricted in effecting closing transactions within three months
after entering into an option or financial futures contract.
----------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Arkansas tax laws presently in
effect. For the complete provisions, reference should be made to the pertinent
Code sections, the Treasury regulations promulgated thereunder and the
applicable Arkansas tax laws. The Code and the Treasury regulations, as well as
the Arkansas tax laws, are subject to change by legislative or administrative
action either prospectively or retroactively.
Shareholders are urged to consult their own tax advisers regarding the
availability of any exemptions from state or local taxes (other than those
imposed by Arkansas) and with specific questions as to Federal, state, local or
foreign taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
Total return and yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return and yield are determined separately for Class A and
Class B shares in accordance with formulas specified by the Commission.
Average annual total return quotations for the specified periods are computed
by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A shares and the CDSC that would be applicable to a complete redemption
of the investment at the end of the specified period in the case of the Class B
shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that
40
<PAGE>
(1) as required by the periods of the quotations, actual annual, annualized or
aggregate data, rather than average annual data, may be quoted and (2) the
maximum applicable sales charges will not be included with respect to annual or
annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of
return reflect compounding over a longer period of time.
In order to reflect the reduced sales charges in the case of Class A shares
or the waiver of the CDSC in the case of Class B shares applicable to certain
investors, as described under "Purchase of Shares" and "Redemption of Shares",
respectively, the total return data quoted by the Fund in advertisements
directed to such investors may take into account the reduced, and not the
maximum, sales charge or may take into account the CDSC and therefore may
reflect greater total return since, due to the reduced sales charge or the
waiver of sales charges, a lower amount of expenses is deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate Series each of which will consist of a separate portfolio which will
issue separate shares. The Trust is presently comprised of the Fund, Merrill
Lynch Arizona Municipal Bond Fund, Merrill Lynch Colorado Municipal Bond Fund,
Merrill Lynch Connecticut Municipal Bond Fund, Merrill Lynch Florida Municipal
Bond Fund, Merrill Lynch Maryland Municipal Bond Fund, Merrill Lynch
Massachusetts Municipal Bond Fund, Merrill Lynch Michigan Municipal Bond Fund,
Merrill Lynch Minnesota Municipal Bond Fund, Merrill Lynch New Jersey Municipal
Bond Fund, Merrill Lynch New Mexico Municipal Bond Fund, Merrill Lynch New York
Municipal Bond Fund, Merrill Lynch North Carolina Municipal Bond Fund, Merrill
Lynch Ohio Municipal Bond Fund, Merrill Lynch Oregon Municipal Bond Fund,
Merrill Lynch Pennsylvania Municipal Bond Fund and Merrill Lynch Texas
Municipal Bond Fund. The Trustees are authorized to create an unlimited number
of Series and, with respect to each Series, to issue an unlimited number of
full and fractional shares of beneficial interest, par value $.10 per share, of
different classes and to divide or combine the shares into a greater or lesser
number of shares without thereby changing the proportionate beneficial
interests in the Series. Shareholder approval is not necessary for the
authorization of additional Series or classes of a Series of the Trust. At the
date of this Statement of Additional Information, the shares of the Fund are
divided into Class A shares and Class B shares. Both Class A and Class B shares
represent an interest in the same assets of the Fund and have identical voting,
dividend, liquidation and other rights and the same terms and conditions except
that expenses related to the distribution fee of the Class B shares are borne
solely by such Class B shares and the Class B shares have exclusive voting
rights with respect to matters relating to such distribution expenditures. See
"Purchase of Shares". The Trust has received an order ("the Order") from the
Commission permitting the issuance and sale of multiple classes of shares. The
Order permits the Trust to issue additional classes of shares of any Series if
the Board of Trustees deems such issuance to be in the best interest of the
Trust.
All shares of the Trust have equal voting rights, except that only shares of
the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B shares will have exclusive voting rights
with respect to matters relating to the distribution expenses being borne
solely by such class.
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Each issued and outstanding share is entitled to one vote and to participate
equally in dividends and distributions declared by the Fund and in the net
assets of such Series upon liquidation or dissolution remaining after
satisfaction of outstanding liabilities, except that, as noted above, expenses
related to the distribution of the Class B shares will be borne solely by such
class. There normally will be no meeting of shareholders for the purposes of
electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may, in accordance with the terms of the Declaration of
Trust, cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders in accordance with the requirements of the 1940 Act to
seek approval of new management and advisory arrangements, of a material
increase in distribution fees or of a change in the fundamental policies,
objectives or restrictions of a Series.
The obligations and liabilities of a particular Series are restricted to the
assets of that Series and do not extend to the assets of the Trust generally.
The shares of each Series, when issued, will be fully paid and nonassessable,
have no preference, preemptive, conversion, exchange or similar rights, and are
freely transferable. Holders of shares of any Series are entitled to redeem
their shares as set forth elsewhere herein and in the Prospectus. Shares do not
have cumulative voting rights and the holders of more than 50% of the shares of
the Trust voting for the election of Trustees can elect all of the Trustees if
they choose to do so and in such event the holders of the remaining shares
would not be able to elect any Trustees. No amendments may be made to the
Declaration of Trust without the affirmative vote of a majority of the
outstanding shares of the Trust.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares of the Fund for $100,000. Such shares were acquired for investment and
can only be disposed of by redemption. The organizational expenses of the Fund
(estimated at approximately $49,600) will be paid by the Fund and amortized
over a period not exceeding five years. The proceeds realized by the Manager
(or any subsequent holder) upon the redemption of any of the shares initially
purchased by it will be reduced by the proportionate amount of unamortized
organizational expenses which the number of shares redeemed bears to the number
of shares initially purchased. Such organizational expenses include certain of
the initial organizational expenses of the Trust which have been allocated to
the Fund by the Trustees. If additional Series are added to the Trust, the
organizational expenses will be allocated among the Series in a manner deemed
equitable by the Trustees.
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<PAGE>
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A and
Class B shares of the Fund based on the projected value of the Fund's estimated
net assets and projected number of shares outstanding on the date its shares
are first offered for sale to public investors is as follows:
TABLE*
<TABLE>
<CAPTION>
CLASS A CLASS B
---------- ----------
<S> <C> <C>
Net Assets............................................ $50,000.00 $50,000.00
Number of Shares Outstanding.......................... 5,000 5,000
========== ==========
Net Asset Value Per Share (net assets divided by num-
ber of shares outstanding)........................... $ 10.00 $ 10.00
Sales Charge (for Class A shares: 4.00% of offering
price (4.17% of net asset value per share))*......... $ .42 $ **
---------- ----------
Offering Price........................................ $ 10.42 $ 10.00
========== ==========
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B shares are not subject to an initial sales charge but may be
subject to a contingent deferred sales charge on redemption of shares
within four years of purchase. See "Purchase of Shares--Deferred Sales
Charge Alternative--Class B Shares" herein and in the Prospectus.
INDEPENDENT AUDITORS
Deloitte & Touche, 117 Campus Drive, Princeton, New Jersey 08540, has been
selected as the independent auditors of the Fund. The selection of independent
auditors is subject to ratification by the shareholders of the Fund. In
addition, the employment of such auditors may be terminated without any penalty
by vote of a majority of the outstanding shares of the Trust at a meeting
called for the purpose of terminating such employment. The independent auditors
are responsible for auditing the annual financial statements of the Fund.
CUSTODIAN
National Westminster Bank NJ, 100 Wall Street, 20th Floor, New York, New York
10005, acts as the custodian of the Fund's assets. The custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
delivery of securities and collecting interest on the Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, acts as the Trust's transfer agent. The Transfer Agent is
responsible for the issuance, transfer and redemption of shares and the
opening, maintenance and servicing of shareholder accounts. See "Management of
the Trust--Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on July 31 of each year. The Trust sends to
shareholders of the Fund at least semi-annually reports showing the Fund's
portfolio and other information. An annual report, containing
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<PAGE>
financial statements audited by independent auditors, is sent to shareholders
each year. After the end of each year shareholders will receive Federal income
tax information regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act of 1933 and the
Investment Company Act of 1940, to which reference is hereby made.
The Declaration of Trust establishing the Trust dated August 2, 1985, a copy
of which, together with all amendments thereto (the "Declaration") is on file
in the office of the Secretary of The Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability; nor shall resort be had to any
such person's private property for the satisfaction of any obligation or claim
of the Trust but the "Trust Property" only shall be liable.
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<PAGE>
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN ARKANSAS
ECONOMIC INFORMATION
During the past two decades, Arkansas' (the "State" or "Arkansas") economic
base has shifted from agriculture to light manufacturing. The State is now
moving toward a heavier manufacturing base involving more sophisticated
processes and products such as electrical machinery, transportation equipment,
fabricated metals, and electronics. Resource-related industries dominate and
the largest employers are the food products, lumber and paper goods industries.
The agricultural sector, though much diminished in importance, remains a
significant contributor to state income. Chief products are broilers, rice and
soybeans. The diversification of economic interests has lessened the State's
cyclical sensitivity to the impact of any single sector.
Despite significant economic changes, Arkansas remains among the poorest of
the States. Arkansas' personal income per capita in 1992 was $15,439, or 78% of
the national average. While low, Arkansas' figure reflects strong gains and
relative improvement in recent decades. Population losses in the 1940's and
1950's resulted from farm mechanization and the migration of farm laborers.
More recent gains are attributed to employment provided by manufacturing growth
and the State's attraction to retirees. The State's unemployment rate in 1993
equalled or was below the national average in each month.
GENERAL AND REVENUE OBLIGATIONS
The Constitution of the State of Arkansas does not limit the amount of
general obligation bonds which may be issued by the State; however, no such
bonds may be issued unless approved by the voters of the State at a general
election or a special election held for that purpose.
There is no constitutional limitation on the aggregate principal amount of
revenue bonds that may be issued by the State and its agencies. All revenue
bonds and notes are secured only by specific revenue streams and neither the
general revenues of the State nor its full faith and credit are pledged to
repayment.
On November 2, 1982, the voters of the State approved the issuance of general
obligation bonds pursuant to the Arkansas Water Resources Development Act of
1981 (Act 496 of 1981), which authorized the issuance of general obligation
bonds, with the approval of the Governor, in a total principal amount not to
exceed $100,000,000. Act 496 of 1981 further provides that no more than
$15,000,000 of bonds may be issued during any fiscal biennium unless the
General Assembly shall, by law, have authorized a greater principal amount
thereof to be issued during any fiscal biennium.
On November 8, 1988, the voters of the State approved the issuance of general
obligation bonds pursuant to the Arkansas Waste Disposal and Pollution
Abatement Facilities Financing Act of 1987 (Act 686 of 1987), which authorized
the issuance of General Obligation Bonds, with the approval of the Governor, in
a total principal amount not to exceed $250,000,000. Act 686 of 1987 provides
that no more than $50,000,000 of bonds may be issued during any fiscal biennium
unless the General Assembly shall, by law, have authorized a greater principal
amount to be issued.
On November 6, 1990, the voters of the State approved the issuance of College
Savings General Obligation Bonds pursuant to the Arkansas College Savings Bond
Act of 1989. The Bonds are issued in series not to exceed $300,000,000 in the
aggregate and not to exceed $100,000,000 in any fiscal biennium.
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<PAGE>
As of June 30, 1993, the State's outstanding General Obligation Bonds from
the three authorized programs totalled $148,035,000. The State has no other
outstanding general obligation debt. There is no legislation pending calling
for the issuance of any further general obligation of the State. From 1972
through 1984, the State had no general obligation debt outstanding.
In addition to the State's General Obligation Bonds, the State had
outstanding at June 30, 1993, $1,785,779,000 in revenue bonds and notes issued
by various state agencies, authorities and institutions of higher education.
LEASE OBLIGATION
Numerous state agencies presently lease equipment and/or occupy leased office
space. These lease commitments are cancelable, without penalty, upon the
failure of the State to appropriate sufficient funds at each biennial
legislative session. Capital lease obligations at June 30, 1993, aggregated
approximately $24,948,000.
ARKANSAS DEVELOPMENT FINANCE AUTHORITY
The Arkansas Development Finance Authority ("Authority") is the largest
issuer of tax exempt debt in the State. The Authority was created by the
Arkansas General Assembly in 1985 as a multipurpose finance authority. After
its creation, it assumed the functions, powers and duties of the Arkansas
Housing Development Agency and that agency was abolished. In addition to
providing financing for residential housing, the Authority is permitted to
issue revenue bonds for the purpose of financing agricultural business
enterprise, capital improvements for State agencies and local governments,
educational facilities, health care facilities, industrial enterprises and
short-term advance funding of local government obligations. The Authority had
$1,397,708,000 principal amount of bonds outstanding as of June 30, 1993.
BONDS ISSUED BY POLITICAL SUBDIVISIONS AND OTHER CONSTITUTIONAL AUTHORITIES
Cities, counties, public facilities boards, improvement districts, utilities
commissions, water districts and other constitutional authorities are
authorized to issue general obligation and revenue bonds. The majority of these
bonds are special revenue obligations which are unrated absent credit
enhancement.
FINANCIAL ORGANIZATIONS AND MANAGEMENT
The following State organizations share responsibility for statewide
financial management: the General Assembly, the Office of Budget and the Office
of Accounting of the Department of Finance and Administration, the Governor,
the Treasurer and the Division of Legislative Audit. The State is prohibited by
its Constitution from deficit spending. Accordingly, spending is limited to
actual revenues received by the State.
The General Assembly has responsibility for legislating the level of State
services and appropriating the funds for operations of State agencies. The
Office of Budget prepares the Executive Budget with the advice and consent of
the Governor. The Office of Budget also monitors the level and type of State
expenditures. The Accounting Division has the responsibility for maintaining
fund and appropriation control and, through the Pre-Audit Section and in
conjunction with the Auditor of State, has responsibility for the disbursement
process. The Treasurer has responsibilities for disbursement, bank
reconciliation, and investment of State funds (with the advice of the State
Board of Finance). The Division of Legislative Audit has responsibility for
performing financial post-audits of State agencies.
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<PAGE>
BUDGET OF STATE AGENCIES
State agencies submit biennial budget requests to the Office of Budget of the
Department of Finance and Administration. The Office of Budget prepares the
Executive Budget and an estimate of general revenues. The Executive Budget
contains the budget amount recommended by the Governor.
The General Assembly appropriates money after consideration of both the
Executive Budget and the revenue estimate. The appropriation process begins in
the joint House-Senate Budget Committee and then proceeds through both houses
of the General Assembly. Legislative appropriations are subject to the
Governor's approval or veto, including the authority of line-item veto.
The General Assembly also must enact legislation pursuant to the Revenue
Stabilization Act to provide for an allotment process of funding appropriations
in order to comply with state law prohibiting deficit spending. The Governor
may restrict spending to a level below the level of appropriations.
REVENUE STABILIZATION ACT
Act 750 of 1973, codified at Arkansas Code Annotated (S)(S) 19-5-101 et seq.,
establishes the State's revenue stabilization law (the "Stabilization Act").
The Stabilization Act and related legislation govern the administration and
distribution of State revenues.
Pursuant to the Stabilization Act, all general and special revenues are
deposited into the General Revenue Allotment Account and the Special Revenue
Allotment Account according to the type of revenue being deposited. From the
General Revenue Fund, 3% of all general revenues are distributed to the
Constitutional Officers Fund and the Central Services Fund to provide support
for the State's elected officials (legislators, constitutional officers,
judges), their staffs, and the Department of Finance and Administration. The
balance is then distributed to separate funds proportionately as established by
the Stabilization Act. From the Special Revenue Fund, 3% of special revenues
collected by the Department of Finance and Administration and 1-1 1/2% of all
special revenues collected by other agencies are first distributed to provide
support for the State's elected officials, their staffs and the Department of
Finance and Administration. The balance is then distributed to the funds for
which the special revenues were collected as provided by law.
Special revenues, which are primarily user taxes, are generally earmarked for
the program or agency providing the related service.
General revenues are transferred into funds established and maintained by the
Treasurer for major programs and agencies of the State in accordance with
funding priorities established by the General Assembly.
Pursuant to the Stabilization Act, the General Assembly establishes three
levels of priority for general revenue spending, levels "A," "B," and "C."
Successive levels of appropriations are funded only in the event sufficient
revenues have been generated to fully fund any prior level. Accordingly,
appropriations made to programs and agencies are only maximum authorizations to
spend. Actual expenditures are limited to the lesser of (i) special revenues
earmarked for a program or agencies' fund maintained by the Treasurer or (ii)
the maximum appropriation by the General Assembly.
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<PAGE>
Since State revenues are not collected throughout the year in a pattern
consistent with program and agency expenditures, the Budget Stabilization Trust
Fund, which receives one-half of the interest earnings from State fund
investments, has been established and is utilized to assure proper cash flow
during any period. Other interest earnings are pledged to special revenue
obligations or used to supplement the State's capital construction program.
AUDITING PROCEDURES
The accounts of the State are subject to post-audit by the Division of
Legislative Audit. Audits are performed as a series of audits which include
agencies and funds. Copies of audit reports are made available for each fiscal
year and may be obtained from the Division of Legislative Audit, State Capitol
Mall, Little Rock, Arkansas 72201.
REVENUE STRUCTURE OF THE STATE
The Department of Finance and Administration prepares a Comprehensive Annual
Financial Report after the close of each fiscal year. The Report is not
independently audited and is compiled by the Department of Finance and
Administration from information provided by the various State agencies. The
State maintains its accounting records for budgeted governmental operations on
a cash basis. A separate accounting system is maintained to convert the cash
basis accounting to the modified accrual or accrual basis, as applicable; and
the Comprehensive Annual Financial Report is based on the modified
accrual/accrual system of accounting. The State is in the process of a multi-
year conversion to GAAP accounting, and financial reporting is becoming more
comprehensive.
BOND RATINGS
Currently, Arkansas' general obligation bonds are rated Aa by Moody's and A+
by Standard & Poor's. The Arkansas Development Finance Authority's $65,000,000
principal amount of Guaranty Revenue Bonds are rated A- with a stable outlook
by Standard & Poor's. The rating of the Guaranty Revenue Bonds was lowered to
A- from A+ on June 24, 1994. The rating change reflects a substantial drop in
treasury earnings on state fund balances since the program was originally rated
in 1987. Treasury earnings are a backup source of bond repayment in the event
that the Guaranty Revenue Fund (currently $14 million) is ever exhausted.
Standard & Poor's found, however, that the loan program financed by the
Guaranty Bond Program exhibited strict lending criteria, good portfolio
performance, strong program loan oversight and rapid debt amortization by 2009.
The City of Little Rock's General Obligation Bonds are currently rated Aa by
Moody's and AA+ by Standard & Poor's. In the absence of credit enhancement from
bond insurance, letter of credit or other credit facilities, the bonds of state
agencies, colleges and universities, other local political subdivisions and
other boards and commissions are generally unrated.
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<PAGE>
APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ("MOODY'S") MUNICIPAL BOND
RATINGS
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payment and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
Ba Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
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<PAGE>
Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG 2/VMIG2 denotes
"high quality" with ample margins of protection; MIG 3/VMIG3 notes are of
"favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality . . .
[p]rotection commonly regarded as required of an investment security is
present . . . there is specific risk."
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings: Aaa--judged
to be the best quality, carry the smallest degree of investment risk; Aa--
judged to be of high quality by all standards; A--possess many favorable
investment attributes and are to be considered as upper medium grade
obligations.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed
financial charges and high internal cash generation; and well established
access to a range of financial markets and assured sources of alternate
liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations. The effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF STANDARD & POOR'S CORPORATION'S ("STANDARD & POOR'S") MUNICIPAL
DEBT RATINGS
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers,
or lessees.
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The debt rating is not a recommendation to purchase, sell or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default--capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in
accordance with the terms of the obligation;
II. Nature of and provisions of the obligations;
III. Protection afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization or other arrangement
under the laws of bankruptcy and other laws affecting creditors'
rights.
AAA Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is
extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the higher-rated issues only
in small degree.
A Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than debt in higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in this
category than for debt in higher rated categories.
BB, B, CCC, CC, C Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on
balance, as predominately speculative with respect to capacity
to pay interest and repay principal in accordance with the
terms of the obligations. "BB" indicates the lowest degree of
speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties
or major exposures to adverse conditions.
CI The rating "CI" is reserved for income bonds on which no
interest is being paid.
D Debt rated "D" is in payment default. The "D" rating category
is used when interest payments or principal payments are not
made on the date due even if the applicable grace period has
not expired, unless Standard & Poor's believes that such
payments will be made during such grace period. The "D" rating
also will be used upon the filing of a bankruptcy petition if
debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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<PAGE>
DESCRIPTION OF STANDARD & POOR'S CORPORATE BOND RATINGS
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to specific obligation. Debt rated
"AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay
interest and repay principal is extremely strong. Debt rated "AA" has a very
strong capacity to pay interest and to repay principal and differs from the
highest rated issues only in small degree. Debt rated "A" has a strong capacity
to pay interest and repay principal although it is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
debt of a higher rated category. Debt rated "BBB" is regarded as having an
adequate capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher rated
categories.
The ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into four categories, ranging from "A" for
the highest quality obligations to "D" for the lowest. Ratings are applicable
to both taxable and tax-exempt commercial paper. Issues assigned the highest
rating are regarded as having the greatest capacity for timely payment. Issues
in this category are further refined with the designation 1, 2 and 3 to
indicate the relative degree of safety. The three designations in the "A"
category are as follows:
A-1
This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined
to possess extremely strong safety characteristics are denoted with a
plus sign (+) designation.
A-2
Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for
issues designated "A-1".
A-3
Issues carrying this designation have a satisfactory capacity for
timely payment. They are, however, somewhat more vulnerable to the
adverse effects of changes in circumstances than obligations carrying
the higher designations.
B
Issues rated "B" are regarded as having only speculative capacity for
timely payment.
C
This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D
Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date
due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
A Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive
a note rating. Notes maturing beyond 3 years will most likely receive a long-
term debt rating. The following criteria will be used in making that
assessment.
52
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--Amortization schedule (the larger the final maturity relative to other
maturities, the more likely it will be treated as a note).
--Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
SP-1 A very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will
be given a "+" designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
Standard & Poor's may continue to rate note issues with a maturity greater
than three years in accordance with the same rating scale currently employed
for municipal bond ratings.
Unrated: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuers belongs to a group of securities that are not
rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not
published in Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date information to permit a judgment to be formed;
if a bond is called for redemption; or for other reasons.
DESCRIPTION OF FITCH INVESTORS SERVICE, INC.'S ("FITCH") INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
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<PAGE>
Fitch ratings are based on information obtained from issuers, other obligors,
underwriters, their experts, and other sources Fitch believes to be reliable.
Fitch does not audit or verify the truth or accuracy of such information.
Ratings may be changed, suspended, or withdrawn as a result of changes in, or
the unavailability of, information or for any other reasons.
AAA Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong
ability to pay interest and repay principal, which is unlikely
to be affected by reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and
repay principal is very strong, although not quite as strong
as bonds rated "AAA". Because bonds rated in the "AAA" and
"AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these
issuers is generally rated "F-1+".
A Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay
principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and
repay principal is considered to be adequate. Adverse changes
in economic conditions and circumstances, however, are more
likely to have adverse impact on these bonds, and therefore,
impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than
for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
Credit Trend Indicator: Credit trend indicators show whether credit
fundamentals are improving, stable, declining, or uncertain, as follows:
Improving (Arrow Up)
Stable (Arrow left) (Arrow Right)
Declining (Arrow Down)
Uncertain (Arrow Up)
(Arrow Down)
Credit trend indicators are not predictions that any rating change will occur,
and have a longer-term time frame than issues placed on FitchAlert.
indicates that Fitch does not rate the specific issue.
NR
CONDITIONAL A conditional rating is premised on the successful completion
of a project or the occurrence of a specific event.
SUSPENDED
A rating is suspended when Fitch deems the amount of
information available from the issuer to be inadequate for
rating purposes.
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WITHDRAWN A rating will be withdrawn when an issue matures or is called
or refinanced and, at Fitch's discretion, when an issuer
fails to furnish proper and timely information.
FITCHALERT Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and
the likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be
raised or lowered. FitchAlert is relatively short-term, and
should be resolved within 12 months.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
alternatives can be identified which could assist the obligor
in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and
the need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal.
DDD, DD and D Bonds are in default on interest and/or principal payments.
Such bonds are extremely speculative and should be valued on
the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. "DDD" represents the highest
potential for recovery on these bonds, and "D" represents the
lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD", "DD", or "D" categories.
55
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DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of
assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in
degree than issues rated "F-1+".
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as for issues assigned "F-1+"
and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for
timely payment is adequate, however, near-term adverse changes
could cause these securities to be rated below investment
grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes
in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a
letter of credit issued by a commercial bank.
INS The symbol "INS" indicates that the rating is based on an
insurance policy or financial guaranty issued by an insurance
company.
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INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholder,
Merrill Lynch Arkansas Municipal Bond Fund of
Merrill Lynch Multi-State Municipal Series Trust:
We have audited the accompanying statement of assets and liabilities of Merrill
Lynch Arkansas Municipal Bond Fund of Merrill Lynch Multi-State Municipal
Series Trust as of July 28, 1994. This financial statement is the
responsibility of the Fund's management. Our responsibility is to express an
opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such statement of assets and liabilities presents fairly, in
all material respects, the financial position of Merrill Lynch Arkansas
Municipal Bond Fund of Merrill Lynch Multi-State Municipal Series Trust as of
July 28, 1994, in conformity with generally accepted accounting principles.
Deloitte & Touche
Princeton, New Jersey
August 1, 1994
57
<PAGE>
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
STATEMENT OF ASSETS AND LIABILITIES
JULY 28, 1994
<TABLE>
<CAPTION>
<S> <C>
Assets:
Cash in bank..................................................... $100,000
Prepaid registration fees (Note 3)............................... 19,700
Deferred organization expenses (Note 4).......................... 49,600
--------
Total Assets....................................................... 169,300
Liabilities-Accrued expenses....................................... 69,300
--------
Net Assets (equivalent to $10.00 per share on 5,000 Class A Shares
of beneficial interest (par value $0.10) and 5,000 of Class B
Shares of beneficial interest (par value $0.10) outstanding with an
unlimited number of shares authorized) (Note 1).................... $100,000
========
</TABLE>
- --------
Notes to Statement of Assets and Liabilities:
(1) Merrill Lynch Multi-State Municipal Series Trust (the "Trust") was
organized as a Massachusetts business trust on August 2, 1985. To date,
Merrill Lynch Arkansas Municipal Bond Fund (the "Fund") has not had any
transactions other than those relating to organizational matters and the
sale of 5,000 Class A shares and 5,000 Class B shares of beneficial
interest of the Fund to Fund Asset Management, L.P. (the "Manager"). The
Trust is registered under the Investment Company Act of 1940 as an open-end
management investment company.
(2) The Trust has entered into a Management Agreement with the Manager and
separate Class A and Class B Distribution Agreements and a Distribution
Plan with Merrill Lynch Funds Distributor, Inc. (the "Distributor") on
behalf of the Fund. (See "Management of the Trust--Management and Advisory
Arrangements" in the Prospectus and Statement of Additional Information.)
Certain officers and/or Trustees of the Trust are officers and/or directors
of the Manager and the Distributor.
(3)Prepaid registration fees are charged to income as the related shares are
issued.
(4) Deferred organization expenses will be amortized over a period from the
date the Fund commences operations not exceeding five years. In the event
that the Manager (or any subsequent holder) redeems any of its original
shares prior to the end of the five-year period, the proceeds of the
redemption payable in respect of such shares shall be reduced by the pro
rata share (based on the proportionate share of the original shares
redeemed to the total number of original shares outstanding at the time of
redemption) of the unamortized deferred organization expenses as of the
date of such redemption. In the event that the Fund is liquidated prior to
the end of the five-year period, the Manager (or any subsequent holder)
shall bear the unamortized deferred organization expenses.
58
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59
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................... 2
Description of Municipal Bonds and Temporary
Investments.............................................................. 5
Description of Municipal Bonds........................................... 5
Description of Temporary Investments..................................... 6
Repurchase Agreements and Purchase and Sale Contracts.................... 8
Financial Futures Transactions and Options............................... 8
Investment Restrictions................................................... 13
Management of the Trust................................................... 15
Trustees and Officers.................................................... 15
Management and Advisory Arrangements..................................... 17
Purchase of Shares........................................................ 18
Alternative Sales Arrangements........................................... 18
Initial Sales Charge Alternative--Class A Shares......................... 19
Reduced Initial Sales Charges--Class A Shares............................ 19
Deferred Sales Charge Alternative--Class B Shares........................ 21
Redemption of Shares...................................................... 22
Contingent Deferred Sales Charge--Class B Shares......................... 22
Portfolio Transactions.................................................... 22
Determination of Net Asset Value.......................................... 23
Shareholder Services...................................................... 24
Investment Account....................................................... 24
Automatic Investment Plan................................................ 25
Automatic Reinvestment of Dividends and Capital Gains Distributions...... 25
Systematic Withdrawal Plans--Class A Shares.............................. 25
Exchange Privilege....................................................... 26
Distributions and Taxes................................................... 36
Environmental Tax........................................................ 39
Tax Treatment of Options and Futures Transactions........................ 39
Performance Data.......................................................... 40
General Information....................................................... 41
Description of Shares.................................................... 41
Computation of Offering Price Per Share.................................. 43
Independent Auditors..................................................... 43
Custodian................................................................ 43
Transfer Agent........................................................... 43
Legal Counsel............................................................ 43
Reports to Shareholders.................................................. 43
Additional Information................................................... 44
Appendix I--Economic and Financial Conditions In Arkansas................. 45
Appendix II--Ratings of Municipal Bonds................................... 49
Independent Auditors' Report.............................................. 57
Statement of Assets and Liabilities....................................... 58
</TABLE>
Code # 18320-0894
LOGO
Merrill Lynch
MERRILL LYNCH ARKANSAS
MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE
MUNICIPAL SERIES TRUST
(ART)
Statement of
Additional Information
August 12, 1994
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
GRAPHICS APPENDIX LIST
PAGE WHERE
GRAPHIC
APPEARS DESCRIPTION OF GRAPHIC OR CROSS REFERENCE
- --------------------------------------------------------------------------------
PRO BC Two Compass faces.
- --------------------------------------------------------------------------------
SAI BC Two Compass faces.
- --------------------------------------------------------------------------------
<PAGE>
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND OF
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
SUPPLEMENT DATED AUGUST 12, 1994 TO
PROSPECTUS DATED AUGUST 12, 1994
FOR USE IN THE STATE OF MISSOURI
The Fund is authorized to invest up to 20% of its total assets in lower rated
Municipal Bonds, commonly known as "junk bonds." Investments of this type are
subject to greater risk of loss of principal and interest than are higher rated
bonds. For additional information about lower rated Municipal Bonds, see page 6
of the Prospectus.
Code #18321-MO
