MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND OF MLMSMST, 497, 1995-02-15

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND OF MLMSMST
497, 1995-02-15

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<PAGE>

PROSPECTUS
- ----------
FEBRUARY 10, 1995
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. 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 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.

----------------

Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select PricingSM System" on page 3.

Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9011, Princeton, New Jersey 08543-9011 [(609)
282-2800], or from securities dealers which have entered into dealer agreements
with the Distributor, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000 and the
minimum subsequent purchase 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".

----------------

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 CON-
TRARY 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 February 10, 1995 (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>

FEE TABLE

A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:

<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- ---------- ------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION
EXPENSES:
Maximum Sales Charge
Imposed on Purchases
(as a percentage of
offering price)....... 4.00%(c) None None 4.00%(c)
Sales Charge Imposed
on Dividend
Reinvestments......... None None None None
Deferred Sales Charge
(as a percentage of
original purchase
price or redemption
proceeds, whichever
is lower)............. None(d) 4.0% during the first 1.0% for one year None(d)
year, decreasing 1.0%
annually thereafter to 0.0%
after the fourth year
Exchange Fee........... None None None None
ANNUAL FUND OPERATING
EXPENSES (AS A
PERCENTAGE OF AVERAGE
NET ASSETS)(e):
Management Fees(f)..... 0.55% 0.55% 0.55% 0.55%
12b-1 Fees(g):
Account Maintenance
Fees................ None 0.25% 0.25% 0.10%
Distribution Fees.... None 0.25% 0.35% None
(Class B shares convert to
Class D shares automatically
after approximately ten years
and cease being subject
to distribution fees)
Other Expenses:
Custodial Fees...... 0.06% 0.06% 0.06% 0.06%
Shareholder
Servicing Costs(h). 0.08% 0.09% 0.09% 0.08%
Miscellaneous....... 1.80% 1.80% 1.80% 1.80%
---- ---- ---- ----
Total Other Ex-
penses............ 1.94% 1.95% 1.95% 1.94%
---- ---- ---- ----
Total Fund Operating
Expenses............ 2.49% 3.00% 3.10% 2.59%
==== ==== ==== ====
</TABLE>
- --------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain investment programs. See "Purchase of
Shares--Initial Sales Charge Alternatives--Class A and Class D Shares"--
page 21.
(b) Class B shares convert to Class D shares automatically approximately 10
years after initial purchase. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares"--page 23.
(c) Reduced for purchases of $25,000 and over. Class A or Class D purchases of
$1,000,000 or more may not be subject to an initial sales charge. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class
D Shares"--page 21.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that purchases of $1,000,000 or more which may not
be subject to an initial sales charge may instead be subject to a CDSC if
redeemed within the first year after purchase.
(e) Information under "Other Expenses" for each class of shares is estimated
for the fiscal year ending July 31, 1995.
(f) See "Management of the Trust--Management and Advisory Arrangements"--page
18.
(g) See "Purchase of Shares--Distribution Plans"--page 26.
(h) See "Management of the Trust--Transfer Agency Services"--page 19.

2
<PAGE>

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 fol-
lowing expenses on a $1,000 in-
vestment including the maximum
$40 initial sales charge (Class
A and Class D shares only) and
assuming (1) the Total Fund Op-
erating Expenses for each class
set forth above; (2) a 5% an-
nual return throughout the pe-
riods and (3) redemption at the
end of the period:
Class A........................ $64 $114 $167 $311
Class B........................ $70 $113 $158 $332
Class C........................ $41 $ 96 $163 $341
Class D........................ $65 $117 $172 $321
An investor would pay the fol-
lowing expenses on the same
$1,000 investment assuming no
redemption at the end of the
period:
Class A........................ $64 $114 $167 $311
Class B........................ $30 $ 93 $158 $332
Class C........................ $31 $ 96 $163 $341
Class D........................ $65 $117 $172 $321
</TABLE>

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 ("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 and Class C
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. ("NASD"). 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".

MERRILL LYNCH SELECT PRICING(SM) SYSTEM

The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
60 mutual funds advised by Merrill Lynch Asset Management, L.P. ("MLAM") or an
affiliate of MLAM, Fund Asset Management, L.P. ("FAM" or the "Manager"). Funds
advised by MLAM or FAM are referred to herein as "MLAM-advised mutual funds".

Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The deferred sales charges and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on the

3
<PAGE>

Class D shares, are imposed directly against those classes and not against all
assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of
shares will be calculated in the same manner at the same time and will differ
only to the extent that account maintenance and distribution fees and any
incremental transfer agency costs relating to a particular class are borne
exclusively by that class. Each class has different exchange privileges. See
"Shareholder Services--Exchange Privilege".

Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The distribution-
related revenues paid with respect to a class will not be used to finance the
distribution expenditures of another class. Sales personnel may receive
different compensation for selling different classes of shares.

The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select PricingSM System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select PricingSM System that the investor
believes is most beneficial under his particular circumstances. More detailed
information as to each class of shares is set forth under "Purchase of
Shares".

<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(/1/) FEE FEE CONVERSION FEATURE
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- -------------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to D shares
at a rate of 4.0% during the automatically after
first year, decreasing 1.0% approximately ten years(/4/)
annually to 0.0%
- -------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.35% No
- -------------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 0.10% No No
charge(/3/)
</TABLE>

- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. Contingent deferred sales charges ("CDSCs") are
imposed if the redemption occurs within the applicable CDSC time period.
The charge will be assessed on an amount equal to the lesser of the
proceeds of redemption or the cost of the shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to a CDSC if redeemed within one year.
See "Class A" and "Class D" below.
(4) The conversion period for dividend reinvestment shares is modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-
advised mutual fund, the conversion period applicable to the Class B
shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked on to the holding period for the shares
acquired.

Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class A shares.
Investors that currently own Class A shares in a shareholder account
are entitled to purchase additional Class A shares in that account.
In addition, Class A shares will be offered to Merrill Lynch & Co.,
Inc.

4
<PAGE>

("ML & Co.") and its subsidiaries (the term "subsidiaries" when used
herein with respect to ML & Co., includes MLAM, the Manager and certain
other entities directly or indirectly wholly-owned and controlled by ML
& Co.), and their directors and employees, and to members of the Boards
of MLAM-advised mutual funds. The maximum initial sales charge is
4.00%, which is reduced for purchases of $25,000 and over. Purchases of
$1,000,000 or more may not be subject to an initial sales charge but if
the initial sales charge is waived such purchases may be subject to a
CDSC of 1% if the shares are redeemed within one year after purchase.
Sales charges also are reduced under a right of accumulation which
takes into account the investors' holdings of all classes of all MLAM-
advised mutual funds. See "Purchase of Shares--Initial Sales Charge
Alternatives--Class A and Class D Shares".

Class B: Class B shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.25% of the Fund's average net
assets attributable to Class B shares, and a CDSC if they are
redeemed within four years of purchase. Approximately ten years after
issuance, Class B shares will convert automatically into Class D
shares of the Fund, which are subject to a lower account maintenance
fee of 0.10% and no distribution fee; Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made convert
into Class D shares automatically after approximately eight years. If
Class B shares of the Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to
the Class B shares acquired in the exchange will apply, as will the
Class D account maintenance fee of the acquired fund upon the
conversion, and the holding period for the shares exchanged will be
tacked on to the holding period for the shares acquired. Automatic
conversion of Class B shares into Class D shares will occur at least
once a month on the basis of the relative net asset values of the
shares of the two classes on the conversion date, without the
imposition of any sales load, fee or other charge. Conversion of
Class B shares to Class D shares will not be deemed a purchase or
sale of the shares for Federal income tax purposes. Shares purchased
through reinvestment of dividends on Class B shares also will convert
automatically to Class D shares. The conversion period for dividend
reinvestment shares is modified as described under "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Conversion of Class B Shares to Class D Shares".

Class C: Class C shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.35% of the Fund's average net
assets attributable to Class C shares. Class C shares are also
subject to a CDSC if they are redeemed within one year of purchase.
Although Class C shares are subject to a 1.0% CDSC for only one year
(as compared to four years for Class B), Class C shares have no
conversion feature and, accordingly, an investor that purchases Class
C shares will be subject to distribution fees that will be imposed on
Class C shares for an indefinite period subject to annual approval by
the Trust's Board of Trustees and regulatory limitations.

Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.10% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC
when they are redeemed. Purchases of $1,000,000 or more may not be
subject to an initial sales charge, but if the initial sales charge
is waived such purchases will be subject to a CDSC of 1.0% if the
shares are redeemed within one year after purchase. The schedule of
initial sales charges and reductions for Class D shares is the same
as the schedule for Class A shares. Class D shares also will be
issued upon conversion of Class B shares as described above under
"Class B". See "Purchase of Shares--Initial Sales Charge
Alternatives--Class A and Class D Shares".

5
<PAGE>

The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
PricingSM System that the investor believes is most beneficial under his
particular circumstances.

Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative
particularly attractive because similar sales charge reductions are not
available with respect to the deferred sales charges imposed in connection with
purchases of Class B or Class C shares. Investors not qualifying for reduced
initial sales charges who expect to maintain their investment for an extended
period of time also may elect to purchase Class A or Class D shares, because
over time the accumulated ongoing account maintenance and distribution fees on
Class B or Class C shares may exceed the initial sales charge and, in the case
of Class D shares, the account maintenance fee. Although some investors that
previously purchased Class A shares may no longer be eligible to purchase Class
A shares of other MLAM-advised mutual funds, those previously purchased Class A
shares, together with Class B, Class C and Class D shares holdings, will count
toward a right of accumulation which may qualify the investor for reduced
initial sales charges on new initial sales charge purchases. In addition, the
ongoing Class B and Class C account maintenance and distribution fees will
cause Class B and Class C shares to have higher expense ratios, pay lower
dividends and have lower total returns than the initial sales charge shares.
The ongoing Class D account maintenance fees will cause Class D shares to have
a higher expense ratio, pay lower dividends and have a lower total return than
Class A shares.

Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are subject to ongoing account
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially may be offset to the extent any
return is realized on the additional funds initially invested in Class B or
Class C shares. In addition, Class B shares will be converted into Class D
shares of the Fund after a conversion period of approximately ten years, and
thereafter investors will be subject to lower ongoing fees.

Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend
to hold their shares for an extended period of time. Investors in Class B
shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all their assets invested initially
and they are uncertain as to the length of time they intend to hold their
assets in MLAM-advised mutual funds. Although Class C shareholders are subject
to a shorter CDSC period at a lower rate, they are subject to higher
distribution fees and forego the Class B conversion feature, making their
investment subject to account maintenance and distribution fees for an
indefinite period of time. In addition, while both Class B and Class C
distribution fees are subject to the limitations on asset-based sales charges
imposed by the NASD, the Class B distribution fees are further limited under a
voluntary waiver of asset-based sales charges. See "Purchase of Shares--
Limitations on the Payment of Deferred Sales Charges".

6
<PAGE>

FINANCIAL HIGHLIGHTS
(UNAUDITED)

The financial information in the table below is unaudited. Financial
statements for the period September 30, 1994 (commencement of operations) to
December 31, 1994, are included in the Statement of Additional Information.

The following per share data and ratios have been derived from information
provided in the financial statements.

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
---------------------- ---------------------- -------------------- --------------------
FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD
SEPTEMBER 30, 1994+ TO SEPTEMBER 30, 1994+ TO OCTOBER 21, 1994+ TO OCTOBER 21, 1994+ TO
DECEMBER 31, 1994 DECEMBER 31, 1994 DECEMBER 31, 1994 DECEMBER 31, 1994
---------------------- ---------------------- -------------------- --------------------
<S> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net Asset Value,
beginning of period.... $10.00 $10.00 $ 9.92 $9.92
------ ------ ------ -----
Investment income--net.. 0.16 0.14 0.10 0.12
Realized and unrealized
loss on investments--
net.................... (0.29) (0.29) (0.20) (0.21)
------ ------ ------ -----
Total from investment
operations............. (0.13) (0.15) (0.10) (0.09)
------ ------ ------ -----
LESS DIVIDENDS:
Investment income--net.. (0.16) (0.14) (0.10) (0.12)
------ ------ ------ -----
Total Dividends......... (0.16) (0.14) (0.10) (0.12)
------ ------ ------ -----
Net asset value, end of
period................. $ 9.71 $ 9.71 $ 9.72 $9.71
====== ====== ====== =====
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. (1.31)%++ (1.44)%++ (0.97)%++ (0.88)%++
====== ====== ====== =====
RATIOS TO AVERAGE NET
ASSETS:
Expenses, excluding
distribution fees and
net of reimbursement... 0.00%* 0.00%* 0.00%* 0.00%*
====== ====== ====== =====
Expenses, net of
reimbursement.......... 0.00%* 0.50%* 0.60%* 0.10%*
====== ====== ====== =====
Expenses................ 2.49%* 3.00%* 3.14%* 2.58%*
====== ====== ====== =====
Investment income--net.. 6.23%* 5.75%* 5.87%* 6.46%*
====== ====== ====== =====
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $1,949 $6,111 $ 31 $ 74
====== ====== ====== =====
Portfolio turnover...... 28.83% 28.83% 28.83% 28.83%
====== ====== ====== =====
</TABLE>
- --------
+ Commencement of operations.
++ Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.

7
<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
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. 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 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 Ratings Group ("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, 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

8
<PAGE>

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 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.

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.

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<PAGE>

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.

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 not be 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 certain classes of 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.

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<PAGE>

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. 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 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 if such investments, together with investments
in other

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<PAGE>

unseasoned issuers, would exceed 5% of the Fund's total assets. 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.

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.
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. Interest and principal payable on the Municipal
Bonds may also be based on relative changes among particular indices. 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,
which may include reduced or eliminated interest payments and losses of
invested principal. 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 flexible portfolio management
instruments for the Fund which allow the Fund to seek potential investment
rewards, hedge other portfolio positions or 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 total assets (however, in
accordance with the provisions of certain state laws, the Fund currently will
not invest in excess of 10% of its total assets in illiquid securities).

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<PAGE>

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 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% (10% to the extent required by certain state
laws) of the Fund's total 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

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<PAGE>

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% (10% to the extent required by certain state laws) of the
Fund's total 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 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.

14
<PAGE>

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 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.

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<PAGE>

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.

Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.

REPURCHASE AGREEMENTS

As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S.
Government securities or an affiliate thereof. Under such agreements, the
seller agrees, upon entering into the contract, to repurchase the security from
the Fund 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. The Fund may not invest
in repurchase agreements maturing in more than seven days if such investments,
together with the Fund's other illiquid investments, would exceed 15% (10% to
the extent required by certain state laws) of the Fund's total assets. In the
event of default by the seller under a repurchase agreement; the Fund may
suffer time delays and incur costs or possible losses in connection with the
disposition of the underlying securities.

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

16
<PAGE>

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.

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 Trust 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 Code. See "Distributions and Taxes--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.

MANAGEMENT OF THE TRUST

TRUSTEES

The Trustees of the Trust consist of five individuals, four 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.

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<PAGE>

The Trustees are:

Arthur Zeikel*--President and Chief Investment Officer of the Manager and
MLAM; President and Director of Princeton Services, Inc.; Executive Vice
President of ML & Co. and Executive Vice President of Merrill Lynch;
Director of the Distributor.

Herbert I. London--John M. Olin Professor of Humanities, New York
University.

Robert R. Martin--Director, WTC Industries, 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

The Manager, which is an affiliate of MLAM and is owned and controlled by ML
& Co., a financial services holding company, 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 100 other registered investment companies. MLAM
also provides investment advisory services to individuals and institutional
accounts. As of December 31, 1994, the Manager and MLAM had a total of
approximately $163.8 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 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 Trust to pay certain expenses incurred
in the Fund's operations, including, among other things, the management fee,
legal and audit fees, unaffiliated Trustees'

18
<PAGE>

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 voluntarily waive all or a portion of its management fee and may
voluntarily waive all or a portion of the Fund's expenses.

CODE OF ETHICS

The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.

The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Manager include a ban on acquiring any securities in a "hot" initial public
offering and a prohibition from profiting on short-term trading in securities.
In addition, no employee may purchase or sell any security which at the time is
being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Manager. Furthermore, the Codes provide for trading "blackout periods" which
prohibit trading by investment personnel of the Fund within periods of trading
by the Fund in the same (or equivalent) security (15 or 30 days depending upon
the transaction).

TRANSFER AGENCY SERVICES

Financial Data Services, Inc. (the "Transfer Agent"), which is a wholly-owned
subsidiary of ML & Co., 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 $11.00 per Class A or Class D shareholder account and $14.00 per
Class B or Class C 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

Merrill Lynch Funds Distributor, Inc. (the "Distributor"), an affiliate of
the Manager, MLAM and Merrill Lynch, acts as the Distributor of the shares of
the Fund. Shares of the Fund are offered continuously for sale by the
Distributor and other eligible securities dealers (including Merrill Lynch).
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 is
$1,000, and the minimum subsequent purchase is $50.

The Fund is offering its shares in four classes at a public offering price
equal to the next determined net asset value per share plus sales charges
imposed either at the time of purchase or on a deferred basis depending

19
<PAGE>

upon the class of shares selected by the investor under the Merrill Lynch
Select Pricing SM System, 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 the close of business
on the New York Stock Exchange (generally, 4:00 P.M., New York time), which
includes orders received after the close of business on the previous day, the
applicable offering price will be based on the net asset value as of 15
minutes after the close of business on the New York Stock Exchange on the day
the orders are placed with the Distributor, provided the orders are received
by the Distributor prior to 30 minutes after the close of business on the New
York Stock Exchange on that day. If the purchase orders are not received by
the Distributor prior to 30 minutes after the close of business on the New
York Stock Exchange, such orders shall be deemed received on the next business
day. The Trust or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Distributor or the Trust.
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.

On September 30, 1994, the Fund completed the subscription offering of its
shares by issuing 208,447 Class A shares for net proceeds to the Fund of
$2,084,470 and 548,667 Class B shares for net proceeds to the Fund of
$5,486,670. In connection with such subscription offering, the Distributor
received $68,249, all of which was paid to Merrill Lynch as selected dealer.
Class C and Class D shares were not publicly offered until October 21, 1994.

The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the
investment thereafter being subject to a contingent deferred sales charge and
ongoing distribution fees. A discussion of the factors that investors should
consider in determining the method of purchasing shares under the Merrill
Lynch Select PricingSM System is set forth under "Merrill Lynch Select
PricingSM System" on page 3.

Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The deferred sales charges and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on Class D shares, will be imposed directly against those classes and
not against all assets of the Fund and, accordingly, such charges will not
affect the net asset value of any other class or have any impact on investors
choosing another sales charge option. Dividends paid by the Fund for each
class of shares will be calculated in the

20
<PAGE>

same manner at the same time and will differ only to the extent that account
maintenance and distribution fees and any incremental transfer agency costs
relating to a particular class are borne exclusively by that class. Class B,
Class C and Class D shares each have exclusive voting rights with respect to
the Rule 12b-1 distribution plan adopted with respect to such class pursuant
to which account maintenance and/or distribution fees are paid. See
"Distribution Plans" below. Each class has different exchange privileges. See
"Shareholder Services--Exchange Privilege".

Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in
that the sales charges applicable to each class provide for the financing of
the distribution of the shares of the Fund. The distribution-related revenues
paid with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised
that only Class A and Class D shares may be available for purchase through
securities dealers, other than Merrill Lynch, which are eligible to sell
shares.

The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select PricingSM System.

<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(/1/) FEE FEE CONVERSION FEATURE
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- ----------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to D shares
at a rate of 4.0% during the automatically after
first year, decreasing 1.0% approximately
annually to 0.0% ten years(/4/)
- ----------------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.35% No
- ----------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 0.10% No No
charge(/3/)
</TABLE>

- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs may be imposed if the redemption occurs
within the applicable CDSC time period. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of
the shares being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to a CDSC if redeemed within one year.
(4) The conversion period for dividend reinvestment shares is modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-
advised mutual fund, the conversion period applicable to the Class B
shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares
acquired.

INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES

Investors choosing the initial sales charge alternatives who are eligible to
purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.

21
<PAGE>

The public offering price of Class A and Class D 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
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED THE 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**......... 0.00 0.00 0.00
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more made on or after October 21, 1994 (the date Class D
shares were initially offered to the public). If the sales charge is
waived, such purchases will be subject to a CDSC of 1.0% if the shares are
redeemed within one year after purchase. Class A purchases made prior to
October 21, 1994 may be subject to a CDSC if the shares are redeemed within
one year of purchase at the following annual rates: 0.75% on purchases of
$1,000,000 to $2,500,000; 0.40% on purchases of $2,500,001 to $3,500,000;
0.25% on purchases of $3,500,001 to $5,000,000; and 0.20% on purchases of
more than $5,000,000 in lieu of paying an initial sales charge. The charge
will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed.

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 and
Class D 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.

Eligible Class A Investors. Class A shares are offered to a limited group of
investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares in a
shareholder account are entitled to purchase additional Class A shares in that
account. Class A shares are available at net asset value to corporate warranty
insurance reserve fund programs provided that the program has $3 million or
more initially invested in MLAM-advised mutual funds. Also eligible to
purchase Class A shares at net asset value are participants in certain
investment programs including TMA SM Managed Trusts to which Merrill Lynch
Trust Company provides discretionary trustee services and certain purchases
made in connection with the Merrill Lynch Mutual Fund Adviser program. In
addition, Class A shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees and to members of the Boards of
MLAM-advised investment companies, including the Fund. Certain persons who
acquire shares of MLAM-advised closed-end funds who wish to reinvest the net
proceeds from a sale of their closed-end fund shares of common stock in shares
of the Fund also may purchase Class A shares of the Fund if certain conditions
set forth in the Statement of Additional Information are met. For example,
Class A shares of the Fund and certain other MLAM-advised mutual funds are
offered at net asset value to shareholders of Merrill Lynch Senior Floating
Rate Fund, Inc. who wish to reinvest the net proceeds from a sale of certain
of their shares of common stock of Merrill Lynch Senior Floating Rate Fund,
Inc. in shares of such funds.

22
<PAGE>

Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges
also may be reduced under a Right of Accumulation and a Letter of Intention.

Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors".

Class D shares are offered at net asset value without sales charge to an
investor who has a business relationship with a Merrill Lynch financial
consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.

Additional information concerning these reduced initial sales charges is set
forth in the Statement of Additional Information.

DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES

Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.

The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four year CDSC,
while Class C shares are subject only to a one year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B and Class C
shares are subject to distribution fees of 0.25% and 0.35%, respectively, of
net assets as discussed below under "Distribution Plans". The proceeds from the
account maintenance fees are used to compensate Merrill Lynch for providing
continuing account maintenance activities.

Class B and Class C shares are 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 and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.

Proceeds from the CDSC and the distribution fee 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 and Class C
shares, such as the payment of compensation to financial consultants for
selling Class B and Class C shares from the dealers' own funds. The combination
of the CDSC and the ongoing distribution fee facilitates the ability of the
Fund to sell the Class B and Class C shares without a sales charge being
deducted at the time of purchase. Approximately ten years after issuance, Class
B shares will convert automatically into Class D shares of the Fund, which are
subject to a lower account maintenance fee and no distribution fee; Class B
shares of certain

23
<PAGE>

other MLAM-advised mutual funds into which exchanges may be made convert into
Class D shares automatically after approximately eight years. If Class B shares
of the Fund are exchanged for Class B shares of another MLAM-advised mutual
fund, the conversion period applicable to the Class B shares acquired in the
exchange will apply, and the holding period for the shares exchanged will be
tacked onto the holding period for the shares acquired.

Imposition of the CDSC and the distribution fee on Class B and Class C shares
is limited by the NASD asset-based sales charge rule. See "Limitations on the
Payment of Deferred Sales Charges" below. The proceeds from the ongoing account
maintenance fee are used to compensate Merrill Lynch for providing continuing
account maintenance activities. 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 CDSC schedule relating to the Class B shares acquired as a
result of the exchange.

Contingent Deferred Sales Charges--Class B Shares. 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 proceeds of
redemption or the cost of the shares being redeemed. 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
DOLLAR AMOUNT
YEAR SINCE 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 held for over four years 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 a 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 or her first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to a CDSC because of

24
<PAGE>

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 rate in the third
year after purchase).

The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Internal Revenue Code of 1986, as amended) of a
shareholder. Additional information concerning the waiver of the Class B CDSC
is set forth in the Statement of Additional Information.

Contingent Deferred Sales Charges--Class C Shares. Class C shares which are
redeemed within one year of purchase may be subject to a 1.0% CDSC charged as a
percentage of the dollar amount subject thereto. The charge will be assessed on
an amount equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed. Accordingly, no Class C CDSC will be imposed on
increases in net asset value above the initial purchase price. In addition, no
Class C CDSC will be assessed on shares derived from reinvestment of dividends
or capital gains distributions.

In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one-year period. The charge will not be applicable 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 a redemption.

Conversion of Class B Shares to Class D Shares. After approximately ten years
(the "Conversion Period"), Class B shares will be converted automatically into
Class D shares of the Fund. Class D shares are subject to an ongoing account
maintenance fee of 0.10% of net assets but are not subject to the distribution
fee that is borne by Class B shares. Automatic conversion of Class B shares
into Class D shares will occur at least once each month (on the "Conversion
Date") on the basis of the relative net asset values of the shares of the two
classes on the Conversion Date, without the imposition of any sales load, fee
or other charge. Conversion of Class B shares to Class D shares will not be
deemed a purchase or sale of the shares for Federal income tax purposes.

In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.

Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.

25
<PAGE>

In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa, the
Conversion Period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked onto
the holding period for the shares acquired.

DISTRIBUTION PLANS

The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the 1940 Act (each a "Distribution
Plan") with respect to the account maintenance and/or distribution fees paid by
the Fund to the Distributor with respect to such classes. The Class B and Class
C Distribution Plans provide for the payment of account maintenance fees and
distribution fees, and the Class D Distribution Plan provides for the payment
of account maintenance fees.

The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.

The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rate of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable
to the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C
shares through dealers without the assessment of an initial sales charge and at
the same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.

The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred, and, accordingly, distribution-related revenues from the
Distribution Plans 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 Class B and Class C Distribution
Plans. 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

26
<PAGE>

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.

LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES.

The maximum sales charge rule in the Rules of Fair Practice of the NASD
imposes a limitation on certain asset-based sales charges such as the
distribution fee and the CDSC borne by the Class B and Class C shares, but not
the account maintenance fee. The maximum sales charge rule is applied
separately to each class. 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 and Class C shares,
computed separately (defined to exclude shares issued pursuant to dividend
reinvestments and exchanges) plus (2) interest on the unpaid balance for the
respective class, computed separately, 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). In connection with the Class B
shares, 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") in connection with the Class B shares 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 with respect to
Class B shares 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.

The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Trustees of the Trust will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Trustees will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not
be used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those
Class B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to Class
D Shares".

REDEMPTION OF SHARES

The Trust is required to redeem for cash all 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, there will be no
charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their

27
<PAGE>

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.

REDEMPTION

A shareholder wishing to redeem shares may do so without charge 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 will not exceed 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 such request is
received by the Trust from such dealer not later than 30 minutes after the
close of business on the New York Stock Exchange (generally, 4:00 P.M., New
York time), on the same day. Dealers have the responsibility of submitting such
repurchase requests to the Trust not later than 30 minutes after the close of
business on the New York Stock Exchange, in order to obtain that day's closing
price.

The foregoing repurchase arrangements are for the convenience of shareholders
and do not involve a charge by the Trust (other than any applicable CDSC).
Securities firms which do not have selected dealer agreements with the
Distributor, however, may impose a transaction 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

28
<PAGE>

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 AND CLASS D SHARES

Shareholders who have redeemed their Class A or Class D shares have a one-
time privilege to reinstate their accounts by purchasing Class A or Class D
shares, as the case may be, 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 or Class D shareholder only the first time such
shareholder makes a redemption.

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, copies of the various plans described below 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.

Investment Account. Each shareholder whose account is maintained at the
Transfer Agent has an Investment Account and will receive statements, at least
quarterly, from the Transfer Agent. These statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gain distributions. The
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 ordinary 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 at the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the Class A or Class D shares are to be
transferred will not take delivery of shares of the Fund, a shareholder either
must redeem the Class A or Class D shares (paying any applicable CDSC) 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 or Class D shares. Shareholders interested in
transferring their Class B or Class C 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 at the Transfer Agent.

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<PAGE>

Exchange Privilege. Shareholders of each class of shares of the Fund have an
exchange privilege with certain other MLAM-advised mutual funds. 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.

Under the Merrill Lynch Select Pricing SM System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-
advised mutual fund if the shareholder holds any Class A shares of the second
fund in his account in which the exchange is made at the time of the exchange
or is otherwise eligible to purchase Class A shares of the second fund. If the
Class A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, and the shareholder does not hold Class A shares of
the second fund in his account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the
shareholder will receive Class D shares of the second fund as a result of the
exchange. Class D shares also may be exchanged for Class A shares of a second
MLAM-advised mutual fund at any time as long as, at the time of the exchange,
the shareholder holds Class A shares of the second fund in the account in
which the exchange is made or is otherwise eligible to purchase Class A shares
of the second fund.

Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously
paid on the Class A or Class D shares being exchanged and the sales charge
payable at the time of the exchange on the shares being acquired.

Class B, Class C and Class D shares are exchangeable with shares of the same
class of other MLAM-advised mutual funds.

Shares of the Fund which are subject to a CDSC are exchangeable on the basis
of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares
of the Fund is "tacked" to the holding period of the newly acquired shares of
the other fund.

Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares
are held in a money market fund, however, will not count toward satisfaction
of the holding period requirement for reduction of any CDSC imposed on such
shares, if any, and, with respect to Class B shares, toward satisfaction of
the Conversion Period.

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. 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 MLAM-advised mutual fund from
which the exchange has been made.

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.

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<PAGE>

The Fund's exchange privilege is modified with respect to purchases of Class
A and Class D shares under the Merrill Lynch Mutual Fund Adviser ("MFA")
program. First, the initial allocation of assets is made under the MFA program.
Then, any subsequent exchange under the MFA program of Class A or Class D
shares of a MLAM-advised mutual fund for Class A or Class D 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 MLAM-
advised mutual fund and the sales charge payable on the shares of the Fund
being acquired in the exchange under the MFA 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. Cash payments can also be directly deposited to the shareholder's bank
account. No CDSC will be imposed upon redemption of shares issued as a result
of the automatic reinvestment of dividends or capital gains distributions.

Systematic Withdrawal. A Class A or Class D 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. Alternatively, a Class A or
Class D shareholder whose shares are held within a CMA(R) or CBA(R) account may
elect to have shares redeemed on a monthly, bimonthly, quarterly, semiannual or
annual basis through the CMA(R)/CBA(R) Systematic Redemption Program, subject
to certain conditions.

Automatic Investment Plans. Regular additions of Class A, Class B, Class C
and Class D 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) or CBA(R) accounts may arrange to have periodic investments
made in the Fund in their CMA(R) or CBA(R) account or in certain related
accounts in amounts of $100 or more through the CMA(R)/CBA(R) Automated
Investment Program.

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

31
<PAGE>

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 prior to
the determination of the net asset value which is calculated 15 minutes after
the close of business on the New York Stock Exchange (generally, 4:00 P.M., New
York time) 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 the 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 each class of shares will be
reduced as a result of any account maintenance, distribution and transfer
agency fees applicable to that class.

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 will continue 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

32
<PAGE>

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, Class B,
Class C and Class D 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
also will be exempt from 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. 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. Distributions by the
Fund, whether from exempt-interest income, ordinary income or capital gains
will not be eligible for the dividends received deduction allowed to
corporations under the Code. 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 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.

33
<PAGE>

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.

No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.

If a shareholder exercises an 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 any sales charge paid to the Fund
on the exchanged shares reduces any sales charge such shareholder would have
owed upon purchase of the new shares in the absence of the exchange privilege.
Instead, such sales charge will be treated as an amount paid for the new
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 on capital gain
dividends and 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

34
<PAGE>

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.

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 advisors 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, 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 separately for Class
A, Class B, Class C and Class D shares 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 any CDSC that would be applicable to a
complete redemption of the investment at the end of the specified period such
as in the case of Class B and Class C shares and the maximum sales charge in
the case of Class A and Class D shares. Dividends paid by the Fund with respect
to all 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 fees and distribution charges and any
incremental transfer agency costs relating to each class of shares will be
borne exclusively by that class. The Fund will include performance data for all
classes of 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

35
<PAGE>

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 waiver of the CDSC in the case of
Class B shares or reduced sales charges in the case of Class A and Class D
shares, 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.

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. The yield for the 30-day period ended
December 31, 1994 was 6.39% for Class A shares, 6.14% for Class B shares, 6.02%
for Class C shares and 6.28% for Class D shares and the tax-equivalent yield
for the same period (based on a Federal income tax rate of 28%) was 8.88% for
Class A shares, 8.53% for Class B shares, 8.36% for Class C shares and 8.72%
for Class D shares. The yield without voluntary reimbursement for the 30-day
period would have been 4.01% for Class A shares, 3.66% for Class B shares,
3.54% for Class C shares and 3.90% for Class D shares with a tax-equivalent
yield of 5.57% for Class A shares, 5.08% for Class B shares, 4.92% for Class C
shares and 5.42% for Class D shares.

Total return, yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance. The
Fund's total return, yield and tax-equivalent 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 indicative of the Fund's relative
performance for any future period.

ADDITIONAL INFORMATION

DETERMINATION OF NET ASSET VALUE

The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily 15 minutes after the close of business on the New York
Stock Exchange (generally, 4:00 P.M., New York time),

36
<PAGE>

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 per share net asset value of the Class A shares generally will be higher
than the per share net asset value of shares of the other classes, reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares and
the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class D
shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares. It is expected, however, that the per share net asset value of the
classes will tend to converge (although not necessarily meet) immediately after
the payment of dividends or distributions which will differ by approximately
the amount of the expense accrual differentials 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 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, and in certain
cases 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, Class B, Class C
and Class D shares. Class A, Class B, Class C and Class D shares represent
interests in the same assets of the Fund and are identical in all respects
except that Class B, Class C and Class D shares bear certain expenses related
to the account maintenance associated with such shares, and Class B and Class C
shares bear certain expenses related to the distribution of such shares. Each
class has exclusive voting rights with respect to matters relating to account
maintenance and distribution expenditures as applicable. See "Purchase of
Shares". The Trust has received an order (the "Order") from the Commission
permitting the issuance and sale of multiple classes of common stock. The
Trustees of the Trust may classify and reclassify the shares of any Series into
additional classes at a future date.

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. 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

37
<PAGE>

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, the Class B, Class C and Class D shares bear certain
additional expenses. 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: TAMFO
P.O. Box 45289
Jacksonville, FL 32232-5289

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.

38
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART 1)
- -------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares

of Merrill Lynch Arkansas Municipal Bond Fund and establish an Investment
Account as described in the Prospectus. In the event that I am not eligible to
purchase Class A shares, I understand that Class D shares will be purchased.

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). 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: (Please list all funds. Use a separate sheet of
paper if necessary.)
1. .................................. 4. ..................................
2. .................................. 5. ..................................
3. .................................. 6. ..................................
Name...........................................................................
First Name Initial Last Name
Name of Co-Owner (if any)......................................................
First Name Initial Last Name
Address.......................................... Date........................
.................................................
(Zip Code)
Occupation........................... Name and Address of Employer ........
.....................................
.....................................
..................................... .....................................
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. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS

Ordinary Income Dividends Long-Term Capital Gains
++ ++ ++ ++
+ Select [_] Reinvest + + Select [_] Reinvest +
+ One: [_] Cash + + One: [_] Cash +
++ ++ ++ ++

If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU:
[_] Check or [_] Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by
direct deposit to my bank account and, if necessary, debit entries and
adjustments for any credit entries made to my account in accordance with the
terms I have selected on the Merrill Lynch Arkansas Municipal Bond Fund
Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE) [_] checking [_] savings

Name on your account ..........................................................

Bank Name .................... Bank Number ........... Account Number .......

Bank Address ..................................................................

I agree that this authorization will remain in effect until I provide written
notification to Financial Data Services, Inc. amending or terminating this
service.

Signature of Depositor ........................................................

Signature of Depositor ............................... Date...................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED
CHECK MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD
ACCOMPANY THIS APPLICATION.
- -------------------------------------------------------------------------------

39
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART 1) --
(CONTINUED)
- -------------------------------------------------------------------------------

3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER

++++++++++++++++++++++++++++++++++
+ +
++++++++++++++++++++++++++++++++++

Social Security Number or Taxpayer Identification Number

Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2)
that I am not subject to backup withholding (as discussed in the Prospectus
under "Distributions and Taxes--Taxes") 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. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS
CERTIFICATION TO OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.

Signature of Owner................... Signature of Co-Owner (if any).......
- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)

..................., 19......
Date of Initial Purchase

Dear Sir/Madam:

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 Merrill Lynch Funds
Distributor, Inc. acts as 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 Merrill Lynch Arkansas Municipal
Bond 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 of Co-Owner
(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.............................

Account Number....................... Account Number.......................
- -------------------------------------------------------------------------------

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
authorization form and agree to
notify the Distributor of any
+ + purchases made under a Letter of
++ ++ Intention or Systematic Withdrawal
Plan. We guarantee the Shareholder's
This form, when completed, should signature.
be mailed to:
.....................................
Merrill Lynch Arkansas Dealer Name and Address
Municipal Bond Fund
c/o Financial Data Services, By ..................................
Inc. Authorized Signature of Dealer
Transfer Agency Mutual Fund
Operations [_][_][_] [_][_][_][_] ...............
P.O. Box 45289 Branch-Code F/C No. F/C Last Name
Jacksonville, FL 32232-5289
[_][_][_] [_][_][_][_][_]
Dealer's Customer Account No.

40
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART 2)
- -------------------------------------------------------------------------------

NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR
AUTOMATIC INVESTMENT PLANS ONLY.
- -------------------------------------------------------------------------------

1. ACCOUNT REGISTRATION

++++++++++++++++++++++++++++++++++
Name of Owner...................... + +
++++++++++++++++++++++++++++++++++
Name of Co-Owner (if any).......... Social Security Number or
Taxpayer Identification
Number

Address............................ Account Number ....................
(if existing account)
...............................
- -------------------------------------------------------------------------------

2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)

MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of [_] Class A or [_] Class D shares in Merrill Lynch Arkansas
Municipal Bond Fund at cost or current offering price. Withdrawals to be made
either (check one) [_] Monthly on the 24th day of each month, or [_] Quarterly
on the 24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on or as soon as possible thereafter.
---------
(month)

SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): [_] $
or [_] % of the current value of [_] Class A or [_] Class D shares in the
account.

SPECIFY WITHDRAWAL METHOD: [_] check or [_] direct deposit to bank account
(check one and complete part (a) or (b) below):

DRAW CHECKS PAYABLE (CHECK ONE)

(a)I hereby authorize payment by check
[_] as indicated in Item 1.
[_] to the order of..........................................................

Mail to (check one)
[_] the address indicated in Item 1.
[_] Name (Please Print)......................................................

Address .......................................................................

..........................................................................

Signature of Owner................................ Date..................

Signature of Co-Owner (if any)............................................

(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO FINANCIAL DATA SERVICES, INC. AMENDING OR TERMINATING
THIS SERVICE.

Specify type of account (check one): [_] checking [_] savings

Name on your account...........................................................

Bank Name......................................................................

Bank Number........................ Account Number............................

Bank Address...................................................................

...............................................................................

Signature of Depositor................................. Date..................

Signature of Depositor.........................................................
(If joint account, both must sign)

NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID"
OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.

41
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART 2) --
(CONTINUED)
- -------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN

I hereby request that Financial Data Services, Inc. draw an automated
clearing house ("ACH") debit on my checking account as described below each
month to purchase: (choose one)

[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares

of Merrill Lynch Arkansas Municipal Bond Fund subject to the terms set forth
below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.

AUTHORIZATION TO HONOR ACH DEBITS
FINANCIAL DATA SERVICES, INC. DRAWN BY FINANCIAL DATA SERVICES,
INC.
You are hereby authorized to draw an
ACH debit each month on my bank To...............................Bank
account for investment in Merrill (Investor's Bank)
Lynch Arkansas Municipal Bond Fund
as indicated below: Bank Address........................

Amount of each ACH debit $........
City...... State...... Zip Code.....

Account Number ................... As a convenience to me, I hereby
request and authorize you to pay and
Please date and invest ACH debits on charge to my account ACH debits
the 20th of each month beginning drawn on my account by and payable
to Financial Data Services, Inc. I
......(month) or as soon thereafter as agree that your rights in respect to
possible. each such debit shall be the same as
if it were a check drawn on you and
I agree that you are drawing these signed personally by me. This
ACH debits voluntarily at my request authority is to remain in effect
and that you shall not be liable for until revoked personally by me in
any loss arising from any delay in writing. Until you receive such
preparing or failure to prepare any notice, you shall be fully protected
such debit. If I change banks or in honoring any such debit. I
desire to terminate or suspend this further agree that if any such debit
program, I agree to notify you be dishonored, whether with or
promptly in writing. I hereby without cause and whether
authorize you to take any action to intentionally or inadvertently, you
correct erroneous ACH debits of my shall be under no liability.
bank account or purchases of fund
shares including liquidating shares ............ .....................
of the Fund and credit my bank Date Signature of
account. I further agree that if a Depositor
check or debit is not honored upon
presentation, Financial Data ............ .....................
Services, Inc. is authorized to Bank Signature of Depositor
discontinue immediately the Automatic Account (If joint account,
Investment Plan and to liquidate Number both must sign)
sufficient shares held in my account
to offset the purchase made with the
dishonored debit.

............ .....................
Date Signature of
Depositor

......................
Signature of Depositor
(If joint account,
both must sign)

NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.

42
<PAGE>

MANAGER

Fund Asset Management

Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey

Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011

DISTRIBUTOR

Merrill Lynch Funds Distributor, Inc.

Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey

Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011

CUSTODIAN

State Street Bank and Trust Company
P.O. Box 351
Boston, Massachusetts 02101

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 LLP
117 Campus Drive
Princeton, New Jersey 08540-6400

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 REPRESEN-
TATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION WITH THE
OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMA-
TION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY
THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.

-------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table.................................................................. 2
Merrill Lynch Select PricingSM System...................................... 3
Financial Highlights....................................................... 7
Investment Objective and Policies.......................................... 8
Potential Benefits........................................................ 10
Special and Risk Considerations Relating to Arkansas Municipal Bonds...... 10
Description of Municipal Bonds............................................ 11
When-Issued Securities and Delayed Delivery Transactions.................. 13
Call Rights............................................................... 13
Financial Futures Transactions and Options................................ 14
Repurchase Agreements..................................................... 16
Investment Restrictions................................................... 16
Management of the Trust.................................................... 17
Trustees.................................................................. 17
Management and Advisory Arrangements...................................... 18
Code of Ethics............................................................ 19
Transfer Agency Services.................................................. 19
Purchase of Shares......................................................... 19
Initial Sales Charge Alternatives--Class A and Class D Shares............. 21
Deferred Sales Charge Alternatives--Class B and Class C Shares............ 23
Distribution Plans........................................................ 26
Limitations on the Payment of Deferred Sales Charges...................... 27
Redemption of Shares....................................................... 27
Redemption................................................................ 28
Repurchase................................................................ 28
Reinstatement Privilege--Class A and Class D Shares....................... 29
Shareholder Services....................................................... 29
Portfolio Transactions..................................................... 31
Distributions and Taxes.................................................... 32
Distributions............................................................. 32
Taxes..................................................................... 32
Performance Data........................................................... 35
Additional Information..................................................... 36
Determination of Net Asset Value.......................................... 36
Organization of the Trust................................................. 37
Shareholder Reports....................................................... 38
Shareholder Inquiries..................................................... 38
Authorization Form......................................................... 39
</TABLE>

Code #18321-0295

LOGO Merrill Lynch

Merrill Lynch
Arkansas Municipal
Bond Fund

Merrill Lynch Multi-State
Municipal Series Trust

[ART]

Prospectus

February 10, 1995

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
P.O. 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 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.

----------------

Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.

----------------

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 February
10, 1995 (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 February 10, 1995
<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 Ratings Group ("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

2
<PAGE>

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 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, which may include reduced or eliminated interest payments and
losses of invested principal. 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 flexible portfolio management
instruments for the Fund which allow the Fund to seek potential investment
rewards, hedge other portfolio positions or 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% (10% to the extent required by certain state
laws) of the Fund's total assets.

3
<PAGE>

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 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% (10% to the extent required by certain state laws) of the
Fund's total 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

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<PAGE>

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 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.

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<PAGE>

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 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% (10% to the extent required by certain state laws) of the
Fund's total 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,

6
<PAGE>

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 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.

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<PAGE>

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-
1/VMIG-1 through MIG-4/VMIG-4 by Moody's or F-1 through F-3 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

The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the
Federal Reserve System or a primary dealer in U.S. Government securities or an
affiliate thereof. Under such agreements, seller 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 repurchase agreements, the prices at which the trades are conducted do not
reflect accrued interest on the underlying obligations. 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 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. 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. In the event of a default under such a
repurchase agreement, 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
maturing in more than seven days if such investments, together with all other
illiquid investments, would exceed 15% (10% to the extent required by certain
state laws) of the Fund's total assets.

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<PAGE>

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.

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

9
<PAGE>

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. 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

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<PAGE>

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.

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.

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<PAGE>

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.

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

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<PAGE>

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 were approved for trading in 1986.
Trading in such futures contracts may tend to 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.

INVESTMENT RESTRICTIONS

The Fund has adopted a number of fundamental and non-fundamental restrictions
and policies relating to the investment of its assets and its activities. The
fundamental policies set forth below 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.

13
<PAGE>

2. Make investments for the purpose of exercising control or management.

3. Purchase or sell real estate, except that, to the extent permitted by
applicable law, 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 (the "Securities Act"), 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 Commodity Exchange Act.

Under the non-fundamental investment restrictions, 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. The Fund currently does not intend
to engage in short sales, except short sales "against the box".

14
<PAGE>

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 Trust has otherwise
determined to be liquid pursuant to applicable law. Notwithstanding the 15%
limitation herein, to the extent the laws of any state in which the Fund's
shares are registered or qualified for sale require a lower limitation, the
Fund will observe such limitation. As of the date hereof, therefore, the
Fund will not invest more than 10% of its total assets in securities which
are subject to this investment restriction (c).

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 trustees of the Trust, 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.

i. Notwithstanding fundamental investment restriction (6) above, borrow
amounts in excess of 20% of its total assets, taken at market value
(including the amount borrowed), and then only from banks as a temporary
measure for extraordinary or emergency purposes. In addition, the Fund will
not purchase securities while borrowings are outstanding.

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.

15
<PAGE>

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, their ages 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
P.O. Box 9011, Princeton, New Jersey 08543-9011.

Arthur Zeikel (62)--President and Trustee (1)(2)--President and Chief
Investment Officer of the Manager (which term, as used herein, includes the
Manager's corporate predecessors) since 1977; President of Merrill Lynch Asset
Management, L.P. ("MLAM", which term, as used herein, includes MLAM's corporate
predecessors) 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. ("ML & Co.") since
1990; 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").

Herbert I. London (55)--Trustee (2)--113-115 University Place, New York, New
York 10003. John M. Olin Professor of Humanities, New York University since
1993; Professor, New York University 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
Naval Institute since 1980; Director, Damon Corporation since 1991; Overseer,
Center for Naval Analyses from 1983 to 1993.

Robert R. Martin (67)--Trustee (2)--513 Grand Hill, St. Paul, Minnesota
55102. Director, WTC Industries, Inc. since 1995 and Chairman thereof from 1994
to 1995; 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 (65)--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.

16
<PAGE>

Andre F. Perold (42)--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 Limited since 1991 and Teknekron Software Systems since
1994.

Terry K. Glenn (54)--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 (50)--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 (43)--Vice President and Portfolio Manager (1)(2)--Vice
President of the Manager and MLAM since 1984.

Donald C. Burke (34)--Vice President (1)(2)--Vice President and Director of
Taxation of MLAM since 1990; Employee of Deloitte & Touche LLP from 1982 to
1990.

Gerald M. Richard (45)--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 (36)--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.

At January 1, 1995, the Trustees and officers of the Trust as a group (11
persons) owned an aggregate of less than 1% of the outstanding shares of
Common Stock of ML & Co. and owned an aggregate of less than 1% of the
outstanding shares of the Fund.

COMPENSATION OF TRUSTEES

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 and Nominating Committee, which consists of
all the non-affiliated Trustees, an annual fee of $2,000 plus $500 per
committee meeting attended. The Trust reimburses each unaffiliated Trustee for
his out-of-pocket expenses relating to attendance at Board and Committee
meetings. In addition, the Chairman of the Committee receives an annual fee
for serving as Chairman of the Committee. The fees and expenses of the
Trustees are allocated to the respective series of the Trust on the basis of
asset size.

17
<PAGE>

The following table sets forth for the period October 1, 1994 to September
30, 1995, an estimate of the compensation to be paid by the Fund to the non-
affiliated Trustees and the aggregate compensation to be paid by all investment
companies advised by FAM and its affiliate, MLAM ("FAM/MLAM Advised Funds") to
the non-affiliated Trustees.

<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT FROM FUND AND
BENEFITS FAM/MLAM
AGGREGATE ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF FUND PAID TO
NAME OF TRUSTEE FROM FUND(1) EXPENSE TRUSTEES(1)(2)
- --------------- ------------ ------------ --------------
<S> <C> <C> <C>
Herbert I. London...................... $70 None $162,000
Robert R. Martin....................... $70 None $162,000
Joseph L. May.......................... $70 None $162,000
Andre F. Perold........................ $70 None $162,000
</TABLE>
- --------
(1) Estimated for the period October 1, 1994 to September 30, 1995 assuming
that the Board of Trustees of the Trust and the Audit Committee each hold
four meetings during the year which are attended by all of the Trustees and
that the fees are allocated among the series of the Trust on the basis of
the relative net asset value of each series.
(2) In addition to the Trust, the Trustees serve on the boards of other
FAM/MLAM Advised Funds as follows: Mr. London (23 boards); Mr. Martin (23
boards); Mr. May (23 boards); and Mr. Perold (23 boards).

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.

18
<PAGE>

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 ML &
Co. or any of its affiliates. 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 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 will be financed by the Fund pursuant to the Distribution
Plans in compliance with Rule 12b-1 under the 1940 Act. See "Purchase of
Shares--Distribution Plans".

The Manager is a limited partnership, the partners of which are ML & Co. 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.

The Fund issues four classes of shares under the Merrill Lynch Select
Pricing SM System: shares of Class A and Class D are sold to investors
choosing the initial sales charge alternatives, and shares of Class B and
Class C are sold to investors choosing the deferred sales charge alternatives.
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has

19
<PAGE>

the same rights, except that Class B, Class C and Class D shares bear the
expenses of the ongoing account maintenance fees, and Class B and Class C
shares bear the expenses of the ongoing distribution fees and the additional
incremental transfer agency costs resulting from the deferred sales charge
arrangements. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect
to such class pursuant to which account maintenance and/or distribution fees
are paid. Each class has different exchange privileges. See "Shareholder
Services--Exchange Privilege".

The Merrill Lynch Select Pricing SM System is used by more than 50 mutual
funds advised by MLAM or its affiliate, the Manager. Funds advised by MLAM or
the Manager are referred to herein as "MLAM-advised mutual funds".

The Fund has entered into four separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the
offering of each class of 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.

INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES

The term "purchase", as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
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.

Closed-End Fund Investment Option. Class A shares of the Fund and other
MLAM-advised mutual funds ("Eligible Class A Shares") are offered at net asset
value to shareholders of certain closed-end funds advised by the Manager or
MLAM who purchased such closed-end fund shares prior to October 21, 1994, the
date the Merrill Lynch Select Pricing SM System commenced operations, and wish
to reinvest the net proceeds of a sale of their closed-end fund shares of
common stock in Eligible Class A or Class D shares, if the conditions set
forth below are satisfied. Alternatively, closed-end fund shareholders who
purchased such shares on or after October 21, 1994 and wish to reinvest the
net proceeds from a sale of their closed-end fund shares are offered Class A
shares (if eligible to buy Class A shares) or Class D shares of the Fund and
other MLAM-advised mutual funds ("Eligible Class D Shares"), if the following
conditions are met. First, the sale

20
<PAGE>

of the closed-end fund shares must be made through Merrill Lynch, and the net
proceeds therefrom must be immediately reinvested in Eligible Class A or Class
D Shares. Second, the closed-end fund shares must either have 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. ("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.

REDUCED INITIAL SALES CHARGES

Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares 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 all classes of
shares of the Fund and of other MLAM-advised mutual funds. 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. Shares held in the name of a nominee
or custodian under pension, profit-sharing or other employee benefit plans may
not be combined with other shares to qualify for the right of accumulation.

Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds made within a 13-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, recordkeeping services. The Letter of Intention is not a
binding obligation to purchase any amount of Class A or Class D 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 and Class D shares of the Fund and of other MLAM-advised mutual funds
presently held, at cost or maximum offering price (whichever is higher), on 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

21
<PAGE>

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 or Class D shares purchased at the reduced rate
and the sales charge applicable to the shares actually purchased through the
Letter. Class A or Class D shares equal to at least five percent of the
intended amount will be held in escrow during the 13-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 a purchase during the term of such Letter
would otherwise be subject to a further reduced sales charge based on the
right of accumulation, the purchaser will be entitled on that purchase and
subsequent purchases to that further reduced percentage sales charge, 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
a MLAM-advised money market fund into the Fund that creates a sales charge
will count toward completing a new or existing Letter of Intention from the
Fund.

TMA SM Managed Trusts. Class A shares are offered to TMA SM Managed Trusts
to which Merrill Lynch Trust Company provides discretionary trustee service at
net asset value.

Purchase Privilege of Certain Persons. Trustees of the Trust, members of the
Boards of other MLAM-advised investment companies, ML & Co. and its
subsidiaries (the term "subsidiaries", when used herein with respect to ML &
Co., includes MLAM, the Manager and certain other entities directly or
indirectly wholly-owned and controlled by ML & Co.), and their directors and
employees, 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.

Class D shares of the Fund are 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 advise Merrill Lynch that
it will purchase Class D shares of the Fund with proceeds from a redemption of
a mutual fund that was sponsored by the financial consultant's previous firm
and was subject to a sales charge either at the time of purchase or on a
deferred basis; and second, the investor also must establish that such
redemption had been made within 60 days prior to the investment in the Fund,
and the proceeds from the redemption had been maintained in the interim in
cash or a money market fund.

Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by
a non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: First, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares
of such other fund were subject to sales charge either at the time of purchase
or on a deferred basis; and, second, such purchase of Class D shares must be
made within 90 days after such notice.

Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Merrill Lynch
financial consultant and who has invested in a mutual fund for

22
<PAGE>

which Merrill Lynch has not served as a selected dealer if the following
conditions are satisfied: First, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from the redemption of
shares of such other mutual fund and that such shares have been outstanding for
a period of no less than six months; and second, such purchase of Class D
shares must be made within 60 days after the redemption and the proceeds from
the redemption must be maintained in the interim in cash or a money market
fund.

Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D 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. The issuance of Class D
shares for consideration other than cash is limited to bona fide
reorganizations, statutory mergers or other acquisitions of portfolio
securities which (i) meet the investment objectives and policies of the Fund;
(ii) are acquired for investment and not for resale (subject to the
understanding that the disposition of the Fund's portfolio securities shall at
all times remain within its control); and (iii) are liquid securities, the
value of which is readily ascertainable, which are not restricted as to
transfer either by law or liquidity of market (except that the Fund may acquire
through such transactions restricted or illiquid securities to the extent the
Fund does not exceed the applicable limits on acquisition of such securities
set forth under "Investment Objective and Policies" herein).

Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be
needed in obtaining such investments.

DISTRIBUTION PLANS

Reference is made to "Purchase of Shares--Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a "Distribution Plan") with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.

Payments of the account maintenance fees and/or distribution fees are subject
to the provisions of Rule 12b-1 under the 1940 Act. Among other things, each
Distribution Plan provides that the Distributor shall provide and the Trustees
shall review quarterly reports of the disbursement of the account maintenance
and/or distribution fees paid to the Distributor. In their consideration of
each 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 related class of shareholders. Each 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 each Distribution Plan in accordance with Rule 12b-1, the Independent
Trustees concluded that there is reasonable likelihood that each Distribution
Plan will benefit the Fund and its related class of shareholders. Each
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 related class of voting securities of the Fund. A
Distribution Plan cannot be amended to

23
<PAGE>

increase materially the amount to be spent by the Fund without the approval of
the related class of 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 such Distribution
Plan, cast in person at a meeting called for that purpose. Rule 12b-1 further
requires that the Trust preserve copies of each Distribution Plan and any
report made pursuant to such plan for a period of not less than six years from
the date of such Distribution Plan or such report, the first two years in an
easily accessible place.

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 distribution fee and the
contingent deferred sales charge ("CDSC") borne by the Class B and Class C
shares but not the account maintenance fee. The maximum sales charge rule is
applied separately to each class. 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 and Class C
shares, computed separately (defined to exclude shares issued pursuant to
dividend reinvestments and exchanges), plus (2) interest on the unpaid balance
for the respective class, computed separately, 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). In connection with the Class B
shares, 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") in connection with the Class B shares 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 with respect to
Class B shares, 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 payment in excess of the amount payable under the NASD formula
will not be made.

24
<PAGE>

The following table sets forth comparative information as of December 31,
1994, with respect to the Class B and Class C shares of the Fund indicating
the maximum allowable payments that can be made under the NASD maximum sales
charge rule and with respect to Class B shares, the Distributor's voluntary
maximum for the period September 30, 1994 (commencement of operations) to
December 31, 1994.

<TABLE>
<CAPTION>
DATA CALCULATED AS OF DECEMBER 31, 1994
---------------------------------------------------------------------------------
(IN THOUSANDS)
ALLOWABLE ALLOWABLE AMOUNTS ANNUAL
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE DISTRIBUTION
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID FEE AT CURRENT
CLASS B SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE NET ASSET LEVEL(4)
- ------- -------- --------- ---------- ------- -------------- --------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule
as Adopted.... $6,326 $395 $9 $404 $5 $400 $15
Under Distribu-
tor's
Voluntary
Waiver........ $6,326 $395 $32 $427 $5 $422 $15
<CAPTION>
(NOT IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS C
- -------
Under NASD Rule
as Adopted.... $29,755 $1,860 $8 $1,868 $6 $1,861 $109
</TABLE>
- --------
(1) Purchase price of all eligible Class B shares sold since September 30,
1994 (commencement of operations) other than shares acquired through
dividend reinvestment and the exchange privilege; purchase price of all
eligible Class C shares sold since October 21, 1994 (commencement of
operations) other than shares acquired through dividend reinvestment and
the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0% as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum or the NASD
maximum.

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.

DEFERRED SALES CHARGES--CLASS B SHARES

As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charges Alternatives--Class B and Class C Shares", while Class B shares
redeemed within four years of purchase are subject to a 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 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.

25
<PAGE>

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 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 and
trustees of the Trust, the Manager or any subsidiary thereof each owning
beneficially more than one-half of one per cent of the securities of an issuer
together own beneficially more than five percent 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 NASD 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

26
<PAGE>

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.)

Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which
they manage unless the member (i) has obtained prior express authorization from
the account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules
the Commission has prescribed with respect to the requirements of clauses (i)
and (ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund.

DETERMINATION OF NET ASSET VALUE

The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily, Monday through Friday, as of 15 minutes after the close
of business on the New York Stock Exchange (generally, 4:00 P.M., New York
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 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 per share net asset value of Class B, Class
C and Class D shares generally will be lower than the per share net asset value
of Class A shares, reflecting the higher daily expense accruals of the account
maintenance, distribution and higher transfer agency fees applicable with
respect to Class B and Class C shares and the daily expense accruals of the
account maintenance fees applicable with respect to Class D shares; moreover,
the per share net asset value of Class B and Class C shares generally will be
lower than the per share net asset value of Class D shares, reflecting the
daily expense accruals of the distribution fees and higher transfer agency fees
applicable with respect to Class B and Class C shares of the Fund. It is
expected, however, that the per share net asset value of the four classes will
tend to converge (although not necessarily meet) immediately after the payment
of dividends, which will differ by approximately the amount of the expense
accrual differentials 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,

27
<PAGE>

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 and copies of the various plans described below 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 statements, at least quarterly, from the
Transfer Agent showing any reinvestment of dividends and capital gains
distributions activity in the account since the previous statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than reinvestment of dividends and capital gains
distributions. Shareholders considering transferring their Class A or Class D
shares from Merrill Lynch to another brokerage firm or financial institution
should be aware that, if the firm to which the Class A or Class D shares are to
be transferred will not take delivery of shares of the Fund, a shareholder
either must redeem the Class A or Class D 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 or
Class D shares. Shareholders interested in transferring their Class B or Class
C 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 at the Transfer Agent. 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 PLANS

A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if he or she is an eligible Class A investor as
described in the Prospectus) or Class B, Class C or Class D 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 Fund's Automatic Investment Plan whereby the Fund is authorized
through pre-authorized checks or automated clearing house debits 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

28
<PAGE>

such shareholder. The Fund's Automatic Investment Plan is not available to
shareholders whose shares are held in brokerage accounts with Merrill Lynch.
Alternatively, investors who maintain CMA (R) or CBA (R) accounts may arrange
to have periodic investments made in the Fund in their CMA (R) or CBA (R)
account or in certain related accounts in amounts of $100 or more through the
CMA (R)/CBA (R) Automated 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 or direct deposited on or about the payment date. Cash payments can also
be directly deposited to the shareholder's bank account.

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 AND CLASS D SHARES

A Class A or Class D 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 or Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more, and monthly withdrawals are
available for shareholders with Class A or Class D shares with such a value of
$10,000 or more.

At the time of each withdrawal payment, sufficient Class A or Class D shares
are redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The shareholder may specify
either a dollar amount or a percentage of the value of his Class A or Class D
shares. Redemptions will be made at net asset value as determined 15 minutes
after the close of business on the New York Stock Exchange (generally, 4:00
P.M., New York 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 or Class D 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 or
Class D shares in the Investment Account are reinvested automatically in the
Fund's Class A or Class D shares, respectively. 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 or Class D shares concurrent
with withdrawals are ordinarily disadvantageous to the shareholder

29
<PAGE>

because of sales charges and tax liabilities. The Trust will not knowingly
accept purchase orders for Class A or Class D 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.

Alternatively, a Class A or Class D shareholder whose shares are held within
a CMA (R) or CBA (R) Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA (R)/CBA (R)
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 redemptions 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
CMA (R)/CBA (R) Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the CMA (R)/CBA (R)
Automated Investment Program. For more information on the CMA (R)/CBA (R)
Systematic Redemption Program, eligible shareholders should contact their
Financial Consultant.

EXCHANGE PRIVILEGE

Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds listed below. Under the Merrill
Lynch Select Pricing System, Class A shareholders may exchange Class A shares
of the Fund for Class A shares of a second MLAM-advised mutual fund if the
shareholder holds any Class A shares of the second fund in his account in which
the exchange is made at the time of the exchange or is otherwise eligible to
purchase Class A shares of the second fund. If the Class A shareholder wants to
exchange Class A shares for shares of a second MLAM-advised mutual fund, and
the shareholder does not hold Class A shares of the second fund in his account
at the time of the exchange and is not otherwise eligible to acquire Class A
shares of the second fund, the shareholder will receive Class D shares of the
second fund as a result of the exchange. Class D shares also may be exchanged
for Class A shares of a second MLAM-advised mutual fund at any time as long as,
at the time of exchange, the shareholder holds Class A shares of the second
fund in the account in which the exchange is made or is otherwise eligible to
purchase Class A shares of the second fund. Class B, Class C and Class D shares
are exchangeable with shares of the same class of other MLAM-advised mutual
funds. For purposes of computing the CDSC that may be payable upon a
disposition of the shares acquired in the exchange, the holding period for the
previously owned shares of the Fund is "tacked" to the holding period of the
newly acquired shares of the other fund as more fully described below. Class A,
Class B, Class C and Class D shares are also exchangeable for shares of certain
MLAM-advised money market funds specifically designated below as available for
exchange by holders of Class A, Class B, Class C and Class D shares. 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 15 days. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.

30
<PAGE>

Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of other MLAM-advised mutual
funds ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, plus an amount equal to the
difference, if any, between the sales charge previously paid on the outstanding
Class A or Class D shares and the sales charge payable at the time of the
exchange on the new Class A or Class D shares. With respect to outstanding
Class A or Class D 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 or Class D shares in the initial purchase and
any subsequent exchange. Class A or Class D shares issued pursuant to dividend
reinvestment are sold on a no-load basis in each of the funds offering Class A
or Class D shares. For purposes of the exchange privilege, Class A and Class D
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 or
Class D shares on which the dividend was paid. Based on this formula, Class A
and Class D shares generally may be exchanged into the Class A or Class D
shares of the other funds or into shares of the Class A or Class D money market
funds without a sales charge.

In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B and Class C shares") offers to exchange its Class B or
Class C shares for Class B or Class C shares, respectively ("new Class B or
Class C shares") of another MLAM-advised mutual fund on the basis of relative
net asset value per Class B or Class C 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 or
Class C shares, the holding period for the outstanding Class B or Class C
shares is "tacked" to the holding period of the new Class B or Class C 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% CDSC 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 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 or Class C shares are held in a Class B or Class C money market
fund will not count towards satisfaction of the holding period requirement for
purposes of reducing the CDSC or, with respect to the Class B shares, towards
satisfaction of the conversion period. However, shares of a money market fund
which were acquired as a result of an exchange for Class B or Class C shares of
the Fund may, in turn, be exchanged back into Class B or Class C shares,
respectively, of any fund offering such shares, in which event the holding
period for Class B or Class C 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

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("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 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 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 continued to hold for an additional two and a half years,
any subsequent redemption will not incur a CDSC.

Set forth below is a description of the investment objectives of the other
funds into which exchanges can be made:

Funds Issuing Class A, Class B, Class C and Class D 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 of fund
shares resulting from movements in
interest rates through investment
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 as
high a level of income exempt from
Federal and Arizona income taxes as is
consistent with prudent investment
management.

Merrill Lynch Asset Growth Fund,
Inc. ............................... High total investment return,
consistent with prudent risk, from
investment in United States and
foreign equity, debt and money market
securities the combination of which
will be varied both with respect to
types of securities and markets in
response to changing market and
economic trends.

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<PAGE>

Merrill Lynch Asset Income Fund,
Inc. ............................... A high level of current income through
investment primarily in United States
fixed income securities.

Merrill Lynch Balanced Fund for
Investment and Retirement, Inc. .... As high a level of total investment
return as is consistent with
relatively low level of risk through
investment 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 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.

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 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 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 to provide as
high a level of income exempt from
Federal and Colorado income taxes as
is consistent with prudent investment
management.

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<PAGE>

Merrill Lynch Connecticut Municipal
Bond Fund........................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide 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.

Merrill Lynch EuroFund............... Capital appreciation primarily through
investment in equity securities of
corporations domiciled in Europe.

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 to provide 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 to provide 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.

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<PAGE>

Merrill Lynch Fund For Tomorrow,
Inc................................. Long-term growth through investment in
a portfolio 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 investment return,
consistent with prudent risk, through
a fully managed investment policy
utilizing 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 government and corporate
bonds denominated in various
currencies and multinational currency
units.

Merrill Lynch Global Convertible
Fund, Inc........................... High total return from investment
primarily in an internationally
diversified portfolio of convertible
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, Inc.
(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 resource
assets.
Merrill Lynch Global SmallCap Fund,
Inc................................. Long-term growth of capital by
investing primarily in equity
securities of companies with
relatively small market
capitalizations located in various
foreign countries and in the United
States.

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<PAGE>

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
engaged in the ownership or operation
of facilities 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.
Merrill Lynch Maryland Municipal
Bond Fund........................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide 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 to provide as high a
level of income exempt from Federal
and Massachusetts income taxes as is
consistent with prudent investment
management through investment in a
portfolio primarily of intermediate-
term investment grade Massachusetts
Municipal Bonds.

Merrill Lynch Massachusetts
Municipal Bond Fund................. A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and Massachusetts income taxes
as is consistent with prudent
investment management.

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<PAGE>

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 to provide as high a
level of income exempt 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
Municipal Bonds.

Merrill Lynch Michigan Municipal
Bond Fund........................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide 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 Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and Minnesota personal 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 Municipal Series Trust, a series
fund, whose objective is to provide as
high a level as possible of income
exempt from Federal income taxes by
investing in investment grade
obligations with a dollar weighted
average maturity of five to twelve
years.

Merrill Lynch New Jersey 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 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 Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and New Jersey income taxes as
is consistent with prudent investment
management.

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<PAGE>

Merrill Lynch New Mexico Municipal
Bond Fund........................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide 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 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,
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 investment grade New
York Municipal Bonds.

Merrill Lynch New York Municipal
Bond Fund........................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal, New York State and New York
City income taxes as is consistent
with prudent investment management.

Merrill Lynch North Carolina
Municipal Bond Fund................. A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and North Carolina income
taxes as is consistent with prudent
investment management.

Merrill Lynch Ohio Municipal
BondFund............................ A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and Ohio income taxes as is
consistent with prudent investment
management.

Merrill Lynch Oregon Municipal Bond
Fund................................ A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide 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 securities of corporations
domiciled in Far Eastern and Western
Pacific countries, including Japan,
Australia, Hong Kong and Singapore.

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<PAGE>

Merrill Lynch Pennsylvania 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 Pennsylvania personal income taxes
as is consistent with prudent
investment management through
investment in a portfolio of
intermediate-term investment grade
Pennsylvania Municipal Bonds.

Merrill Lynch Pennsylvania Municipal
Bond Fund........................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and Pennsylvania personal
income taxes as is consistent with
prudent investment management.

Merrill Lynch Phoenix Fund, Inc. .... Long-term growth of capital by
investing in equity 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 current or
prospective condition of such issuer.

Merrill Lynch Short-Term Global
Income Fund, Inc. .................. As high a level of current income as is
consistent with prudent investment
management from a global portfolio of
high quality debt securities
denominated in various currencies and
multinational currency units and
having remaining maturities 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
investment value and emerging growth
companies regardless of size.

Merrill Lynch Strategic Dividend
Fund................................ Long-term total return from investment
in dividend-paying common stocks which
yield more than Standard & Poor's 500
Composite Stock Price Index.

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 technology.

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<PAGE>

Merrill Lynch Texas Municipal Bond
Fund................................ A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal income taxes as is consistent
with prudent investment management by
investing primarily in a portfolio of
long-term, investment grade
obligations issued by the State of
Texas, its political subdivisions,
agencies and instrumentalities.

Merrill Lynch Utility Income Fund,
Inc................................. High current income through investment
in equity and debt securities issued
by companies which are primarily
engaged in the ownership or operation
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 Share Money Market Funds:

Merrill Lynch Ready Assets Trust..... Preservation of capital, liquidity and
the highest 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 Retirement Series Trust, a
series fund, whose objectives 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 liquidity available from investing
in direct obligations 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 diversified portfolio
of short-term marketable securities
which are direct obligations of the
U.S. Treasury.

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<PAGE>

Class B, Class C and Class D Share Money Market Funds:

Merrill Lynch Government Fund........ A portfolio of Merrill Lynch Funds For
Institutions Series, a series fund,
whose objective is to provide current
income consistent with liquidity and
security of principal from investment
in securities issued or guaranteed by
the U.S. Government, its agencies and
instrumentalities and in repurchase
agreements secured by such
obligations.

Merrill Lynch Institutional Fund..... A portfolio of Merrill Lynch Funds For
Institutions 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
Institutions Series, a series fund,
whose objective is to provide current
income exempt from Federal income
taxes, preservation of capital and
liquidity available from investing in
a diversified portfolio of short-term,
high quality municipal bonds.

Merrill Lynch Treasury Fund.......... A portfolio of Merrill Lynch Funds For
Institutions Series, a series fund,
whose objective is to provide current
income consistent with liquidity and
security of principal from investment
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 at any time and thereafter may
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.

DISTRIBUTIONS AND TAXES

The Trust intends to continue 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

41
<PAGE>

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.

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 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, Class B, Class C and
Class D 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) among the Class A,
Class B, Class C and Class D shareholders according to a method (which it
believes is consistent with the Commission's exemptive order permitting the
issuance and sale of multiple classes of shares) that is based on the gross
income allocable to Class A, Class B, Class C and Class D 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 Fund shares is not
deductible 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

42
<PAGE>

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 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 among Class A, Class B, Class C and Class D 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. 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. Distributions by the
Fund, whether from exempt-interest income, ordinary income or capital gains
will not be eligible for the dividends received deduction allowed to
corporations under the Code. 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. 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.

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

43
<PAGE>

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.

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 on capital gain
dividends and 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.

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<PAGE>

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 taxable income 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 write, 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 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 financial futures contracts and related
options. Under Section 1092, the Fund may be required to postpone recognition
for tax purposes of losses incurred in certain closing transactions in
financial futures contracts or the related options.

One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income 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.

45
<PAGE>

Shareholders are urged to consult their own tax advisors 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.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. 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, yield and tax-equivalent yield are determined
separately for Class A, Class B, Class C and Class D 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 and Class D 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 and Class C 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 (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.

46
<PAGE>

Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for
the period indicated.

<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES* CLASS D SHARES*
--------------------------- --------------------------- --------------------------- ---------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT
$1,000 THE END OF THE $1,000 THE END OF THE $1,000 THE END OF THE $1,000 THE END OF THE
INVESTMENT PERIOD INVESTMENT PERIOD INVESTMENT PERIOD INVESTMENT PERIOD
------------ -------------- ------------ -------------- ------------ -------------- ------------ --------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
September 30,
1994
(inception) to
December 31,
1994........... (19.28%) $947.40 (19.51%) $946.80 (9.63%) $980.50 (22.54%) $951.50
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
September 30,
1994
(inception) to
December 31,
1994........... (1.31%) $986.90 (1.44%) $985.60 (0.97%) $990.30 (0.88%) $991.20
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
September 30,
1994
(inception) to
December 31,
1994........... (5.26%) $947.40 (5.32%) $946.80 (1.95%) $980.50 (4.85%) $951.50
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended on
December, 31
1994........... 6.39% 6.14% 6.02% 6.28%
<CAPTION>
TAX-EQUIVALENT YIELD**
<S> <C> <C> <C> <C>
30 days ended on
December 31,
1994........... 8.88% 8.53% 8.36% 8.72%
</TABLE>
- --------
* Information as to Class C and Class D shares is presented only for the
period October 21, 1994 to December 31, 1994. Prior to October 21, 1994, no
Class C or Class D shares were publicly issued.
** Based on a Federal income tax rate of 28%.

In order to reflect the reduced sales charges in the case of Class A or Class
D 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

47
<PAGE>

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, Class B, Class C and Class D shares.
Class A, Class B, Class C and Class D shares represent interests in the same
assets of the Fund and are identical in all respects except that the Class B,
Class C and Class D shares bear certain expenses related to the account
maintenance and/or distribution of such shares and have exclusive voting rights
with respect to matters relating to such account maintenance and/or
distribution expenditures. 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. The Board of Trustees may classify and reclassify the shares of any
Series into additional classes at a future date.

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, Class C and Class D shares have exclusive
voting rights with respect to matters relating to the account maintenance
and/or distribution expenses being borne solely by such class. 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
account maintenance and/or distribution of the Class B, Class C and Class D
shares are 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

48
<PAGE>

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.

COMPUTATION OF OFFERING PRICE PER SHARE

An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund based on the value of the Fund's net
assets and number of shares outstanding on December 31, 1994 is calculated as
set forth below.

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
---------- ---------- ------- -------
<S> <C> <C> <C> <C>
Net Assets............................... $1,948,912 $6,110,764 $31,126 $73,995
---------- ---------- ------- -------
Number of Shares Outstanding............. 200,629 629,067 3,203 7,618
========== ========== ======= =======
Net Asset Value Per Share (net assets
divided by number of shares
outstanding)............................ $ 9.71 $ 9.71 $ 9.72 $ 9.71
Sales Charge (for Class A and Class D
shares: 4.00% of offering price (4.17%
of net asset value per share))*......... .40 ** ** .40
---------- ---------- ------- -------
Offering Price........................... $ 10.11 $ 9.71 $ 9.72 $ 10.11
========== ========== ======= =======
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC on redemption of shares. See "Purchase of Shares--
Deferred Sales Charge Alternatives--Class B and Class C Shares" in the
Prospectus.

INDEPENDENT AUDITORS

Deloitte & Touche LLP, 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. The independent auditors are responsible for auditing the annual
financial statements of the Fund.

CUSTODIAN

State Street Bank and Trust Company, P.O. Box 351, Boston, Massachusetts
02101, 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.

49
<PAGE>

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 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.

To the knowledge of the Trust, no person or entity owned beneficially 5% or
more of the Fund's shares on February 1, 1995.

50
<PAGE>

APPENDIX I

ECONOMIC AND FINANCIAL CONDITIONS IN ARKANSAS

The following information is a brief summary of factors affecting the economy
of the state and does not purport to be a complete description of such factors.
The summary is based primarily upon one or more publicly available offering
statements relating to debt offerings of state issuers, however, it has not
been updated nor will it be updated during the year. The Trust has not
independently verified this information.

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 1993 was $15,994, or 77% 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 1994
equalled or was below the national average in each month. In 1994 Arkansas
ranked 22nd in total employment growth and 7th in manufacturing job growth
representing a 4.8% annual rate of growth in manufacturing jobs.

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),

51
<PAGE>

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.

As of June 30, 1994, the State's outstanding General Obligation Bonds from
the three authorized programs totalled $149,261,000. 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, 1994, $1,947,866,000 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, 1994, aggregated
approximately $31,965,000.

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
$1,239,544,000 principal amount of bonds outstanding as of June 30, 1994.

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.

52
<PAGE>

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.

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.

53
<PAGE>

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.

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 ("CAFR") 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. The
CAFR conforms with generally accepted accounting principles ("GAAP") for
governments.

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.

54
<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.

55
<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 RATINGS GROUP ("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.

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.

56
<PAGE>

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, Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on
CCC, balance, as predominately speculative with respect to
CC, C 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.

57
<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.

58
<PAGE>

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.

--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 issuer 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 Standard & Poor'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.

59
<PAGE>

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.

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 (designated with up arrow)
Stable (designated with left arrrow) (designated with right arrow)
Declining (designated with down arrow)
Uncertain (designated with up and down arrow)

Credit trend indicators are not predictions that any rating change will occur,
and have a longer-term time frame than issues placed on FitchAlert.

60
<PAGE>

NR indicates that Fitch does not rate the specific issue.

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.

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.

61
<PAGE>

C Bonds are in imminent default in payment of interest or
principal.

DDD, DD 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.

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.

62
<PAGE>

INDEPENDENT AUDITORS' REPORT

The Board of Trustees and Shareholder of
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 LLP
Princeton, New Jersey
August 1, 1994

63
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST

STATEMENT OF ASSETS AND LIABILITIES

JULY 28, 1994

<TABLE>
<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.

64
<PAGE>

The following financial statements for the Fund for the period September 30,
1994 (commencement of operations) to December 31, 1994 are unaudited.

These unaudited interim financial statements reflect all adjustments which
are, in the opinion of management, necessary to a fair statement of the results
for the interim period presented. All such adjustments are of a normal
recurring nature.

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

SCHEDULE OF INVESTMENTS (UNAUDITED)

DECEMBER 31, 1994
(IN THOUSANDS)

<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
RATINGS RATINGS AMOUNT ISSUE (NOTE 1A)
------- ------- ------ ----- ---------
<C> <C> <C> <S> <C>
Arkansas--81.3%
AAA NR* $1,500 Arkansas State Development Finance
Authority, S/F Mortgage Revenue Bonds,
Series A, AMT, 7.30% due 3/01/2013(b) .... $1,546
AA Aa 350 Arkansas State Refunding (Waste Disposal &
Pollution),
Series B, 6.25% due 7/01/2020 ............ 337
NR* A 350 Arkansas State Student Loan Authority
Revenue Bonds, Sub-series B, AMT, 7.25%
due 6/01/2009............................. 350
AA- A1 350 Blytheville, Arkansas, Solid Waste
Recycling & Sewer Treatment Revenue Bonds
(Nucor Corp. Project),
AMT, 6.375% due 1/01/2023................. 326
A- A3 1,000 Camden, Arkansas, Environmental Improvement
Revenue Bonds (International Paper Co.
Project), Series A, AMT, 7.625% due
11/01/2018 ............................... 1,033
NR* P1 400 Crosset, Arkansas, PCR (Georgia-Pacific
Corp. Project),
VRDN, 5.45% due 10/01/2007(a)............. 400
AAA Aaa 350 Fort Smith, Arkansas, Water, Sewer and
Construction Revenue Refunding Bonds, 6%
due 10/01/2012(c)......................... 336
NR* NR* 350 Hot Springs, Arkansas, Water Revenue
Refunding Bonds,
5.60% due 9/01/2008(d).................... 326
BBB Baa2 200 Jefferson County, Arkansas, PCR, Refunding
(Arkansas Power & Light Co. Project),
6.30% due 6/01/2018 ...................... 188
AAA Aaa 375 Little Rock, Arkansas, Municipal Airport
Revenue Refunding Bonds, 6% due
11/01/2014(c)............................. 361
AAA Aaa 400 North Little Rock, Arkansas, Electric
Revenue Refunding Bonds, Series A, 6.50%
due 7/01/2015(c).......................... 400
BBB Baa2 300 Pope County, Arkansas, PCR, Refunding
(Arkansas Power & Light Co. Project),
6.30% due 12/01/2016...................... 283
A- NR* 500 Pulaski County, Arkansas, Hospital Revenue
Bonds (Arkansas Children's Hospital
Project), Series A, 6.20% due 3/01/2022... 457
AAA Aaa 350 Pulaski County, Arkansas, Split School
District, Revenue Refunding Bonds, 5.25%
due 2/01/2019(e).......................... 291
</TABLE>

65
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

SCHEDULE OF INVESTMENTS (UNAUDITED) (CONCLUDED)

DECEMBER 31, 1994
(IN THOUSANDS)

<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
RATINGS RATINGS AMOUNT ISSUE (NOTE 1a)
------- ------- ------ ----- ---------
<C> <C> <C> <S> <C>
Puerto Rico--16.2%
A Baa1 $325 Puerto Rico Commonwealth GO,
UT, 6.50% due 7/01/2023....... $ 314
A Baa1 320 Puerto Rico, Commonwealth,
Highway & Transportation
Authority, Highway Revenue
Bonds, Series T, 6.625% due
7/01/2018..................... 314
BBB- NR* 425 Puerto Rico, Industrial,
Tourist, Educational, Medical
& Environmental Control
Facilities Financing
Authority, Higher Education
Revenue Bonds (PolyTechnic
University of Puerto Rico
Project), Series A, 5.50% due
8/01/2024..................... 334
A+ A 400 Puerto Rico Telephone Authority
Revenue Refunding Bonds,
Series L, 5.75% due 1/01/2011. 365
------
Total Investments (Cost--$8,062)--97.5%................ 7,961
Other Assets Less Liabilities--2.5%.................... 204
------
Net Assets--100.0%..................................... $8,165
======
</TABLE>
- --------
(a) The interest rate is subject to change periodically based upon the
prevailing market rate. The interest rate shown is the rate in effect at
December 31, 1994.
(b) GNMA Collateralized
(c) MBIA Insured
(d) Bank Qualified
(e) FSA Insured
* Not Rated

See Notes to Financial Statements.

Portfolio Abbreviations
To simplify the listings of Merrill Lynch Arkansas Municipal Bond Fund's
portfolio holdings in the Schedule of Investments, we have abbreviated the
names of many of the securities according to the list below.

AMT Alternative Minimum Tax (subject to)
GO General Obligation Bonds
PCR Pollution Control Revenue Bonds
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes

66
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

FINANCIAL INFORMATION

DECEMBER 31, 1994

STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED) AS OF DECEMBER 31, 1994
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost $8,061,941) (Note
1a).................................................... $7,960,439
Cash.................................................... 27,582
Receivables:
Interest.............................................. $182,093
Beneficial interest sold.............................. 82,001
Investment adviser (Note 2)........................... 40,194 304,288
--------
Deferred organization expenses (Note 1e)................ 49,600
----------
Total assets............................................ 8,341,909
----------
LIABILITIES:
Payables:
Dividends to shareholders (Note 1f)................... 58,925
Beneficial interest redeemed.......................... 46,958
Distributor (Note 2).................................. 2,724 108,607
--------
Accrued expenses and other liabilities.................. 68,505
----------
Total liabilities....................................... 177,112
----------
NET ASSETS:
Net assets.............................................. $8,164,797
==========
NET ASSETS CONSIST OF:
Class A Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized.................. $ 20,063
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized.................. 62,907
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized.................. 320
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized.................. 762
Paid-in capital in excess of par........................ 8,312,338
Accumulated realized capital losses on investments--net. (130,091)
Unrealized depreciation on investments--net............. (101,502)
----------
Net assets.............................................. $8,164,797
==========
NET ASSET VALUE:
Class A--Based on net assets of $1,948,912 and 200,629
shares of beneficial interest outstanding.............. $ 9.71
==========
Class B--Based on net assets of $6,110,764 and 629,067
shares of beneficial interest outstanding.............. $ 9.71
==========
Class C--Based on net assets of $31,126 and 3,203 shares
of beneficial interest outstanding..................... $ 9.72
==========
Class D--Based on net assets of $73,995 and 7,618 shares
of beneficial interest outstanding..................... $ 9.71
==========
</TABLE>

See Notes to Financial Statements.

67
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

FINANCIAL INFORMATION

DECEMBER 31, 1994

STATEMENT OF OPERATIONS (UNAUDITED)
FOR THE PERIOD SEPTEMBER 30, 1994+ TO DECEMBER 31, 1994

<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1D):
Interest and amortization of premium and discount
earned................................................ $ 128,950
EXPENSES:
Printing and shareholder reports....................... $ 15,406
Investment advisory fees (Note 2)...................... 11,357
Accounting services (Note 2)........................... 9,249
Distribution fees--Class B (Note 2).................... 7,629
Professional fees...................................... 4,494
Registration fees (Note 1e)............................ 3,778
Amortization of organization expenses (Note 1)......... 2,564
Transfer agent fees--Class B (Note 2).................. 1,536
Custodian fees......................................... 1,298
Pricing fees........................................... 896
Transfer agent fees--Class A (Note 2).................. 447
Trustees' fees and expenses............................ 125
Account maintenance fees--Class D (Note 2)............. 14
Transfer agent fees--Class D (Note 2).................. 12
Distribution fees--Class C (Note 2).................... 11
Transfer agent fees--Class C (Note 2).................. 3
Other.................................................. 386
--------
Total expenses before reimbursement.................... 59,205
Reimbursement of expenses (Note 2)..................... (51,551)
--------
Total expenses after reimbursement..................... 7,654
---------
Investment income--net................................. 121,296
---------
REALIZED AND UNREALIZED LOSS ON INVESTMENTS--NET (NOTES
1D AND 3):
Realized loss on investments--net...................... (130,091)
Unrealized depreciation on investments--net............ (101,502)
---------
Net Decrease in Assets Resulting from Operations....... $(110,297)
=========
</TABLE>
- --------
+ Commencement of Operations.

See Notes to Financial Statements.

68
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

FINANCIAL INFORMATION

DECEMBER 31, 1994

STATEMENT OF CHANGES IN NET ASSETS (UNAUDITED)
FOR THE PERIOD SEPTEMBER 30, 1994+ TO DECEMBER 31, 1994

<TABLE>
<S> <C>
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS:
Investment income--net........................................... $ 121,296
Realized loss on investments--net................................ (130,091)
Unrealized depreciation on investments--net...................... (101,502)
----------
Net decrease in net assets resulting from operations............. (110,297)
----------
DIVIDENDS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A........................................................ (32,592)
Class B........................................................ (87,672)
Class C........................................................ (109)
Class D........................................................ (923)
----------
Net decrease in net assets resulting from dividends to sharehold-
ers............................................................. (121,296)
----------
BENEFICIAL INTEREST TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share transac-
tions........................................................... 8,296,390
----------
NET ASSETS:
Total increase in net assets..................................... 8,064,797
Beginning of period.............................................. 100,000
----------
End of period.................................................... $8,164,797
==========
</TABLE>
- --------
+ Commencement of Operations.

See Notes to Financial Statements.

69
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

FINANCIAL INFORMATION

DECEMBER 31, 1994

FINANCIAL HIGHLIGHTS (UNAUDITED)

The following per share data and ratios have been derived from information
provided in the financial statements.

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
------------------- ------------------- ----------------- -----------------
FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD FOR THE PERIOD
SEPTEMBER 30, 1994+ SEPTEMBER 30, 1994+ OCTOBER 21, 1994+ OCTOBER 21, 1994+
TO DECEMBER 31, TO DECEMBER 31, TO DECEMBER 31, TO DECEMBER 31,
1994 1994 1994 1994
------------------- ------------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period... $10.00 $10.00 $9.92 $9.92
------ ------ ----- -----
Investment income--
net................... .16 .14 .10 .12
Realized and
unrealized loss on
investments--net...... (.29) (.29) (.20) (.21)
------ ------ ----- -----
Total from investment
operations............ (.13) (.15) (.10) (.09)
------ ------ ----- -----
Less dividends:
Investment income--
net................. (.16) (.14) (.10) (.12)
------ ------ ----- -----
Total dividends........ (.16) (.14) (.10) (.12)
------ ------ ----- -----
Net asset value, end
of period............. $9.71 $ 9.71 $9.72 $9.71
====== ====== ===== =====
TOTAL INVESTMENT
RETURN:**
Based on net asset
value per share....... (1.31)%++ (1.44)%++ (0.97)%++ (0.88)%++
====== ====== ===== =====
RATIOS TO AVERAGE NET
ASSETS:
Expenses, excluding
distribution fees
and net of
reimbursement......... .00%* .00%* .00%* .00%*
====== ====== ===== =====
Expenses, net of
reimbursement......... .00%* .50%* .60%* .10%*
====== ====== ===== =====
Expenses............... 2.49%* 3.00%* 3.14%* 2.58%*
====== ====== ===== =====
Investment income--
net................... 6.23%* 5.75%* 5.87%* 6.46%*
====== ====== ===== =====
SUPPLEMENTAL DATA:
Net assets, end of
period (in
thousands)............ $1,949 $6,111 $ 31 $ 74
====== ====== ===== =====
Portfolio turnover..... 28.83% 28.83% 28.83% 28.83%
====== ====== ===== =====
</TABLE>
- --------
* Annualized.
** Total investment returns exclude the effect of sales loads.
+ Commencement of Operations.
++ Aggregate total investment return.

See Notes to Financial Statements.

70
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

AS OF DECEMBER 31, 1994

1. SIGNIFICANT ACCOUNTING POLICIES:

Merrill Lynch Arkansas Municipal Bond Fund (the "Fund") is part of the
Merrill Lynch Multi-State Municipal Series Trust (the "Trust"). The Fund is
registered under the Investment Company Act of 1940 as a non-diversified,
open-end investment management company. Prior to commencement of operations on
September 30, 1994 the Fund had no operations other than those relating to
organizational matters and the issue of 10,000 shares of beneficial interest
of the Fund to Fund Asset Management, L.P. ("FAM") for $100,000. The Fund
offers four classes of shares under the Merrill Lynch Select Pricing SM
System. Shares of Class A and Class D are sold with a front-end sales charge.
Shares of Class B and Class C may be subject to a contingent deferred sales
charge. All classes of shares have identical voting, dividend, liquidation and
other rights and the same terms and conditions, except that Class B, Class C
and Class D shares bear certain expenses related to the distribution of such
shares. Each class has exclusive voting rights with respect to matters
relating to the account maintenance of such shares and Class B and Class C
also bear certain expenses relating to the distribution of such shares. Each
class has exclusive voting rights with respect to matters relating to its
account maintenance and distribution expenditures. The following is a summary
of significant accounting policies followed by the Fund.

(a) Valuation of investments--Municipal bonds and other portfolio securities
are traded primarily in the over-the-counter municipal bond and money markets
and are valued at the last available bid price or yield equivalents as
obtained by the Fund's pricing service from one or more dealers that make
markets in such securities. Financial futures contracts and options thereon,
which are traded on exchanges are valued at their settlement price as of the
close of such exchanges. Short-term investments with a remaining maturity of
sixty 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 Board of Trustees of the Trust.

(b) Financial futures contracts--The Fund may purchase or sell interest rate
futures contracts and options on such futures contracts for the purpose of
hedging the market risk on existing portfolio holdings or the intended
purchase of securities. Futures contracts are contracts for delayed delivery
of securities at a specific future date and at a specific price or yield. Upon
entering into a contract, the Fund deposits and maintains as collateral such
initial margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from or pay to
the broker an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin and are
recorded by the Fund as unrealized gains or losses. When the contract is
closed, the Fund records a realized gain or loss equal to the difference
between the value of the contract at the time it was opened and the value at
the time it was closed.

(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.

71
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)--(Continued)

AS OF DECEMBER 31, 1994

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income is recognized on the accrual basis. Discounts and market
premiums are amortized into interest income. Realized gains and losses on
security transactions are determined on the identified cost basis.

(e) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
five-year period. Prepaid registration fees are charged to expense as the
related shares are issued.

(f) Dividends and distributions--Dividends from net investment income are
declared daily and paid monthly. Distributions of capital gains are recorded on
the ex-dividend dates.

(g) Non-income producing investments--Written and purchased options are non-
income producing investments.

2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:

The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is a limited partner.

FAM is responsible for the management of the Fund's portfolio and provides
the necessary personnel, facilities, equipment and certain other services
necessary to the operations of the Fund. For such services, the Fund pays a
monthly fee based upon the average daily value of the Fund's net assets at the
following annual rates: 0.55% of the Fund's average daily net assets not
exceeding $500 million; 0.525% of average daily net assets in excess of $500
million but not exceeding $1 billion; and 0.50% of average daily net assets in
excess of $1 billion. For the period September 30, 1994 to December 31, 1994,
FAM earned fees of $11,357, all of which were waived. FAM also reimbursed the
Fund for additional expenses of $40,194.

Pursuant to the distribution plans (the "Distribution Plans") adopted by the
Fund in accordance with Rule 12b-1 under the Investment Company Act of 1940,
the Fund pays Merrill Lynch Funds Distributor, Inc. ("MLFD" or the
"Distributor") ongoing account maintenance and distribution fees. The fees are
accrued daily and paid monthly, at annual rates based upon the average daily
net assets of the shares as follows:

<TABLE>
<CAPTION>
ACCOUNT DISTRIBUTION
MAINTENANCE FEE FEE
--------------- ------------
<S> <C> <C>
Class B............................................ 0.25% 0.25%
Class C............................................ 0.25% 0.35%
Class D............................................ 0.10% --
</TABLE>

Pursuant to a sub-agreement with the Distributor, Merrill Lynch, Pierce,
Fenner, and Smith Inc. ("MLPF&S"), a subsidiary of ML & Co., also provides
account maintenance and distribution services to the

72
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)--(Continued)

AS OF DECEMBER 31, 1994

Fund. The ongoing account maintenance fee compensates the Distributor and
MLPF&S for providing account maintenance services to Class B, Class C and Class
D shareholders. The ongoing distribution fee compensates the Distributor and
MLPF&S for providing shareholder and distribution-related services to Class B
and Class C shareholders.

For the period September 30, 1994 to December 31, 1994, MLFD earned
underwriting discounts and MLPF&S earned dealer concessions on sales of the
Fund's Class A and Class D shares as follows:

<TABLE>
<CAPTION>
MLFD MLPF&S
---- -------
<S> <C> <C>
Class A............................................................ $570 $68,853
Class D............................................................ 2 37
</TABLE>

MLPF&S received contingent deferred sales charges of $775 relating to
transactions in Class B shares of beneficial interest.

2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES (CONTINUED):

Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.
is the Fund's transfer agent.

Accounting services are provided to the Fund by FAM at cost.

Certain officers and/or trustees of the Fund are officers and/or directors of
FAM, PSI, MLFD, FDS, MLPF&S, and/or ML & Co.

3. INVESTMENTS:

Purchases and sales of investments, excluding short-term securities, for the
period September 30, 1994 to December 31, 1994, were $9,720,622 and $1,957,758,
respectively.

Net realized and unrealized losses as of December 31, 1994 were as follows:
<TABLE>
<CAPTION>
REALIZED UNREALIZED
LOSSES LOSSES
--------- ----------
<S> <C> <C>
Long-term investments............................... $(100,501) $(101,502)
Financial futures contracts......................... (29,590) --
--------- ---------
Total............................................. $(130,091) $(101,502)
========= =========
</TABLE>

As of December 31, 1994, net unrealized depreciation for Federal income tax
purposes aggregated $101,502, of which $53,573 related to appreciated
securities and $155,075 related to depreciated securities. The aggregate cost
of investments at December 31, 1994 for Federal income tax purposes was
$8,061,941.

4. BENEFICIAL INTEREST TRANSACTIONS:

Net increase in net assets derived from beneficial interest transactions was
$8,296,390 for the period ended December 31, 1994.

73
<PAGE>

MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND

NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)--(Continued)

AS OF DECEMBER 31, 1994

Transactions in shares of beneficial interest for each class were as follows:

<TABLE>
<CAPTION>
CLASS A SHARES FOR THE PERIOD
SEPTEMBER 30, 1994+ DOLLAR
TO DECEMBER 31, 1994 SHARES AMOUNT
- ----------------------------- ------- ----------
<S> <C> <C>
Shares sold................................................ 210,530 $2,105,263
Shares issued in reinvestment of dividends................. 65 612
------- ----------
Total issued............................................... 210,595 2,105,875
Shares redeemed............................................ (14,966) (147,891)
------- ----------
Net increase............................................... 195,629 $1,957,984
======= ==========
<CAPTION>
CLASS B SHARES FOR THE PERIOD
SEPTEMBER 30, 1994+ DOLLAR
TO DECEMBER 31, 1994 SHARES AMOUNT
- ----------------------------- ------- ----------
<S> <C> <C>
Shares sold................................................ 661,319 $6,592,201
Shares issued in reinvestment of dividends................. 266 2,605
------- ----------
Total issued............................................... 661,585 6,594,806
Shares redeemed............................................ (37,518) (363,591)
------- ----------
Net increase............................................... 624,067 $6,231,215
======= ==========
<CAPTION>
CLASS C SHARES FOR THE PERIOD
OCTOBER 21, 1994+ DOLLAR
TO DECEMBER 31, 1994 SHARES AMOUNT
- ----------------------------- ------- ----------
<S> <C> <C>
Shares sold................................................ 3,202 $ 30,845
Shares issued in reinvestment of dividends................. 1 4
------- ----------
Total issued............................................... 3,203 30,849
Shares redeemed............................................ -- --
------- ----------
Net increase............................................... 3,203 $ 30,849
======= ==========
<CAPTION>
CLASS D SHARES FOR THE PERIOD
SEPTEMBER 30, 1994+ DOLLAR
TO DECEMBER 31, 1994 SHARES AMOUNT
- ----------------------------- ------- ----------
<S> <C> <C>
Shares sold................................................ 12,457 $ 122,129
Shares issued in reinvestment of dividends................. 1 4
------- ----------
Total issued............................................... 12,458 122,133
Shares redeemed............................................ (4,840) (45,791)
------- ----------
Net increase............................................... 7,618 $ 76,342
======= ==========
</TABLE>

+ Prior to September 30, 1994 (commencement of operations), the Fund issued
5,000 shares to FAMI for $50,000.

74
<PAGE>

[This Page Intentionally Left Blank]

75
<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..................................... 7
Repurchase Agreements.................................................... 8
Financial Futures Transactions and Options............................... 9
Investment Restrictions................................................... 13
Management of the Trust................................................... 16
Trustees and Officers.................................................... 16
Compensation of Trustees................................................. 17
Management and Advisory Arrangements..................................... 18
Purchase of Shares........................................................ 19
Initial Sales Charge Alternatives--
Class A and Class D Shares.............................................. 20
Reduced Initial Sales Charges............................................ 21
Distribution Plans....................................................... 23
Limitations on the Payment of Deferred Sales Charges..................... 24
Redemption of Shares...................................................... 25
Deferred Sales Charges--
Class B Shares.......................................................... 25
Portfolio Transactions.................................................... 26
Determination of Net Asset Value.......................................... 27
Shareholder Services...................................................... 28
Investment Account....................................................... 28
Automatic Investment Plans............................................... 28
Automatic Reinvestment of Dividends and Capital Gains Distributions...... 29
Systematic Withdrawal Plans--
Class A and Class D Shares.............................................. 29
Exchange Privilege....................................................... 30
Distributions and Taxes................................................... 41
Environmental Tax........................................................ 45
Tax Treatment of Options and Futures Transactions........................ 45
Performance Data.......................................................... 46
General Information....................................................... 47
Description of Shares.................................................... 47
Computation of Offering Price Per Share.................................. 49
Independent Auditors..................................................... 49
Custodian................................................................ 49
Transfer Agent........................................................... 50
Legal Counsel............................................................ 50
Reports to Shareholders.................................................. 50
Additional Information................................................... 50
Appendix I--Economic and Financial Conditions In Arkansas................. 51
Appendix II--Ratings of Municipal Bonds................................... 55
Independent Auditors' Report.............................................. 63
Statement of Assets and Liabilities....................................... 64
Financial Statements (unaudited).......................................... 65
</TABLE>

Code #18320-0295

LOGO Merrill Lynch

Merrill Lynch
Arkansas Municipal
Bond Fund

Merrill Lynch Multi-State
Municipal Series Trust

[ART]

Statement of
Additional
Information

February 10, 1995

Distributor:
Merrill Lynch
Funds Distributor, Inc.

<PAGE>

APPENDIX FOR GRAPHIC AND IMAGE MATERIAL

Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission file due to ASCII-incompatibility and cross-
references this material to the location of each occurrence in the text.

DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull