MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Annual Report
October 31, 1996
This report, including the financial information herein, is
transmitted to the shareholders of Merrill Lynch Municipal Strategy
Fund, Inc. for their information. It is not a prospectus, circular
or representation intended for use in the purchase of shares of the
Fund or any securities mentioned in the report. Past performance
results shown in this report should not be considered a
representation of future performance. The Fund has leveraged its
Common Stock by issuing Preferred Stock to provide the Common Stock
shareholders with a potentially higher rate of return. Leverage
creates risks for Common Stock shareholders, including the
likelihood of greater volatility of net asset value and market price
shares of the Common Stock, and the risk that fluctuations in the
short-term dividend rates of the Preferred Stock may affect the
yield to Common Stock shareholders. Statements and other information
herein are as dated and are subject to change.
<PAGE>
Merrill Lynch Municipal
Strategy Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
The Benefits and
Risks of
Leveraging
Merrill Lynch Municipal Strategy Fund, Inc. utilizes leveraging to
seek to enhance the yield and net asset value of its Common Stock.
However, these objectives cannot be achieved in all interest rate
environments. To leverage, the Fund issues Preferred Stock, which
pays dividends at prevailing short-term interest rates, and invests
the proceeds in long-term municipal bonds. The interest earned on
these investments is paid to Common Stock shareholders in the form
of dividends, and the value of these portfolio holdings is reflected
in the per share net asset value of the Fund's Common Stock.
However, in order to benefit Common Stock shareholders, the yield
curve must be positively sloped; that is, short-term interest rates
must be lower than long-term interest rates. At the same time, a
period of generally declining interest rates will benefit Common
Stock shareholders. If either of these conditions change, then the
risks of leveraging will begin to outweigh the benefits.
<PAGE>
To illustrate these concepts, assume a fund's Common Stock
capitalization of $100 million and the issuance of Preferred Stock
for an additional $50 million, creating a total value of $150
million available for investment in long-term municipal bonds. If
prevailing short-term interest rates are approximately 3% and long-
term interest rates are approximately 6%, the yield curve has a
strongly positive slope. The fund pays dividends on the $50 million
of Preferred Stock based on the lower short-term interest rates. At
the same time, the fund's total portfolio of $150 million earns the
income based on long-term interest rates. Of course, increases in
short-term interest rates would reduce (and even eliminate) the
dividends on the Common Stock.
In this case, the dividends paid to Preferred Stock shareholders are
significantly lower than the income earned on the fund's long-term
investments, and therefore the Common Stock shareholders are the
beneficiaries of the incremental yield. However, if short-term
interest rates rise, narrowing the differential between short-term
and long-term interest rates, the incremental yield pickup on the
Common Stock will be reduced or eliminated completely. At the same
time, the market value on the fund's Common Stock may, as a result,
decline. Furthermore, if long-term interest rates rise, the Common
Stock's net asset value will reflect the full decline in the price
of the portfolio's investments, since the value of the fund's
Preferred Stock does not fluctuate. In addition to the decline in
net asset value, the market value of the fund's Common Stock may
also decline.
DEAR SHAREHOLDER
Since inception (November 3, 1995) through October 31, 1996, the
Common Stock of Merrill Lynch Municipal Strategy Fund, Inc. earned
$0.585 per share income dividends. This represents a net annualized
yield of 5.80%, based on a month-end per share net asset value of
$10.17. Over the same period, the total investment return on the
Fund's Common Stock was +7.81%, based on a change in per share net
asset value from $10.00 to $10.17, and assuming reinvestment of
$0.562 per share income dividends.
For the six-month period ended October 31, 1996, the total
investment return on the Fund's Common Stock was +7.34%, based on a
change in per share net asset value from $9.76 to $10.17, and
assuming reinvestment of $0.293 per share income dividends.
For the six-month period ended October 31, 1996, the Fund's Auction
Market Preferred Stock had an average yield of 3.44%.
<PAGE>
For the six months ended October 31, 1996, the Fund was on average
25% leveraged.
The Municipal Market
Environment
The tax-exempt bond market continued to improve over the three
months ended October 31, 1996. As measured by the Bond Buyer Index,
yields on uninsured, long-term municipal revenue bonds declined an
additional 16 basis points (0.16%) to end the October 31, 1996
quarter at 5.94%. Current tax-exempt bond yields are at their lowest
levels in the last six months. The economic environment remained
little changed in recent months. Economic growth continued to be
moderate, with some recent signs of reduced growth. Inflation
remained well-contained, reducing recent fears of an imminent
interest rate increase by the Federal Reserve Board. This reduction
in investor concerns regarding increases in short-term interest
rates helped support significant declines in US Treasury bond
yields. During the past three months, the yield on the 30-year
Treasury bond fell 33 basis points to end the October 31, 1996
quarter at 6.64%.
Much of the tax-exempt bond market's strong technical position--one
of the primary reasons for the improvement in municipal bond yields
seen thus far in 1996--has remained intact. Just over $40 billion in
long-term tax-exempt bonds was issued during the October quarter, an
increase of less than 3% compared to the October 31, 1995 quarter.
The municipal bond market's recent underperformance relative to
Treasury issues was the result of a number of other factors. Among
other things, as tax-exempt bond yields declined to relatively low
levels, in the past some investors temporarily have lost interest in
the municipal bond market. As interest rates continue to decline, as
they did in 1994, investors quickly adjust to the new levels.
In addition, the Presidential and Congressional elections
resurrected some investor concerns regarding continued Federal
deficit reduction and potential legislative restrictions upon the
municipal bond market. This situation is similar to that at the
beginning of 1996 when tax-exempt bond yields were negatively
impacted by fears that legislation reducing the tax advantages of
municipal bonds would be introduced to aid further deficit
reductions. Fears that the Democratic party could regain control of
both houses of Congress, as well as maintain the White House, caused
some investors to wait until after the elections before allocating
investment funds to the municipal bond market.
Currently, the future direction of interest rates remains unclear.
The Federal Reserve Board's decision to hold interest rates steady
in late September temporarily relieved mounting fears of rising
interest rates for the remainder of 1996. Should economic growth
slow further in the upcoming quarter, as expected by the Federal
Reserve Board, and inflation remain well-contained, interest rates
are poised to decline further. Under such a scenario, municipal bond
yields are also likely to decline. Given current levels of expected
future supply, the municipal bond market could perform very well as
both retail and institutional investors chase an increasingly scarce
commodity.
<PAGE>
Portfolio Strategy
Merrill Lynch Municipal Strategy Fund, Inc. commenced operations on
November 3, 1995 with a constructive outlook on interest rates. Our
main focus was investing proceeds to seek to enhance tax-exempt
income with above-average quality bonds. We invested all of the
proceeds of the Fund's initial offering within the first two weeks
after inception and achieved an attractive yield. We remained
constructive on the interest rate outlook fully participating in the
bond market rally through January 1996. Unfortunately, our portfolio
strategy remained constructive when investors reacted negatively
following the release of the February payroll data. Since then, we
have successfully utilized the trading range that continues to
confine the bond market. Looking ahead, we expect yields to continue
to fluctuate within a relatively narrow range. The bond market has
priced in a weakening economy with no signs of a Federal Reserve
Board tightening. Should this perception change, interest rates
would likely increase substantially. Our investment strategy will
remain slightly defensive, concentrating on bonds less sensitive to
interest rate volatility in an effort to enhance tax-exempt income
while seeking to protect its net assets.
We initiated the auctioning of the Fund's Preferred Stock in mid-
March and have increased the amount twice as new subscriptions came
into the Fund. Since March the interest rate on the Preferred Stock
averaged between 3.35% and 3.85%, continuing to benefit Common Stock
shareholders. However, should the spread between short-term and long-
term interest rates narrow, the benefits of leverage will diminish
and the yield on the Fund's Common Stock will be reduced. (For a
complete explanation of the benefits and risks of leveraging, see
page 1 of this report to shareholders.)
In Conclusion
We appreciate your ongoing interest in Merrill Lynch Municipal
Strategy Fund, Inc., and we look forward to serving your investment
needs in the months and years to come.
Sincerely,
(Arthur Zeikel)
Arthur Zeikel
President
<PAGE>
(Vincent R. Giordano)
Vincent R. Giordano
Senior Vice President
(Robert A. DiMella)
Robert A. DiMella
Portfolio Manager
December 4, 1996
Portfolio Abbreviations
To simplify the listings of Merrill Lynch Municipal Strategy Fund,
Inc.'s portfolio holdings in the Schedule of Investments, we have
abbreviated the names of many of the securities according to the
list below and at right.
AMT Alternative Minimum Tax (subject to)
DATES Daily Adjustable Tax-Exempt Securities
GO General Obligation Bonds
HDA Housing Development Authority
HFA Housing Finance Agency
IDA Industrial Development Authority
IDB Industrial Development Board
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
IRS Inverse Rate Securities
M/F Multi-Family
PCR Pollution Control Revenue Bonds
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <S> <S> <C> <S> <C>
Alabama--2.4% NR* Aaa $ 2,815 Alabama HFA, S/F Home Mortgage Revenue Bonds, Series A-1,
6.60% due 4/01/2019 $ 2,941
<PAGE>
Arizona--0.5% A1+ P1 600 Coconino County, Arizona, Pollution Control Corporation
Revenue Bonds (Arizona Public Service--Navajo Project),
VRDN, AMT, Series A, 3.65% due 10/01/2029 (h) 600
Arkansas--1.0% AAA NR* 1,180 Arkansas State Development Finance Authority, S/F Mortgage
Revenue Bonds (Mortgage Backed Securities Program), AMT,
Series D, 6.80% due 1/01/2022 (f)(g) 1,236
California--5.2% BBB- Baa 5,000 Foothill, California, Eastern Transportation Corridor Agency,
Toll Road Revenue Bonds, Senior Lien, Series A, 6.50% due
1/01/2015 (i) 1,600
AAA Aaa 1,750 Los Angeles, California, Wastewater System Revenue Refunding
Bonds, Series D, 5.20% due 11/01/2021 (b) 1,623
AAA Aaa 3,000 San Diego, California, IDR (San Diego Gas and Electric Co.),
Series A, 6.10% due 9/01/2018 (a) 3,092
Colorado--5.3% NR* Aa 2,000 Colorado HFA, S/F Program, AMT, Series D-1, 7.375% due 6/01/2026 2,185
AAA Aaa 3,840 El Paso County, Colorado, Falcon School District No. 49,
UT, 6.50% due 12/01/2015 (a) 4,258
Connecticut--4.0% AA Aa 3,825 Connecticut State, HFA, Housing Mortgage Finance Program
Revenue Bonds, Sub-Series B-1, 6.125% due 5/15/2018 3,892
BBB- NR* 1,000 Connecticut State Health and Educational Facilities Authority
Revenue Bonds (University of New Haven), Series D, 6.70% due
7/01/2026 1,005
Florida--3.6% AA Aa 1,000 Florida HFA, Refunding (Homeowner Mortgage), Series 1B, 5.95%
due 7/01/2014 1,012
NR* Baa1 1,000 Jacksonville, Florida, Health Facilities Authority, IDR
(National Benevolent--Cypress Village), Series A, 6.25% due
12/01/2026 996
BBB+ Baa2 1,000 Nassau County, Florida, PCR, Refunding (ITT Rayonier Inc.
Project), 6.25% due 6/01/2010 1,016
NR* Baa 750 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida
Education and Research Foundation Project), Series A, 6.85%
due 9/01/2013 802
A1 VMIG1++ 600 Pinellas County, Florida, Health Facilities Authority, Revenue
Refunding Bonds (Pooled Hospital Loan Program), DATES, 3.65%
due 12/01/2015 (h) 600
Georgia--0.9% AAA Aaa 1,000 Municipal Electric Authority of Georgia (Project One), Sub-Series
A, 6.50% due 1/01/2026 (c) 1,090
Illinois--8.8% NR* NR* 2,000 Beardstown, Illinois, IDR (Jefferson Smurfit Corp. Project),
8% due 10/01/2016 2,121
AAA Aaa 3,630 Illinois Development Finance Authority, PCR, Refunding
(Commerce Edison Company Project), Series D, 6.75% due
3/01/2015 (c) 3,971
AA- Aa3 3,285 Illinois Development Finance Authority Revenue Bonds
(Presbyterian Home Lake), Series B, 6.30% due 9/01/2022 3,367
NR* Baa1 1,250 Illinois Health Facilities Authority Revenue Bonds (Holy Cross
Hospital Project), 6.70% due 3/01/2014 1,284
<PAGE>
Indiana--4.3% BBB Baa2 4,900 Indianapolis, Indiana, Airport Authority, Special Facilities
Revenue Bonds (Federal Express Corporation Project), AMT, 7.10%
due 1/15/2017 5,240
Maryland--0.9% A- NR* 1,000 Maryland State Energy Financing Administration, Solid Waste
Disposal Revenue Bonds (Wheelabrator Water Projects), AMT, 6.30%
due 12/01/2010 1,039
Massachusetts-- A+ Aa 1,000 Massachusetts State, HFA, S/F Housing Revenue Bonds, Series 41,
6.35% due 6/01/2017 1,035
5.1% A- NR* 5,000 Massachusetts State Health and Educational Facilities Authority,
Revenue Refunding Bonds (Melrose Wakefield Hospital), Series B,
6.25% due 7/01/2012 5,106
Michigan--6.3% Michigan State Hospital Finance Authority Revenue Bonds:
AAA Aaa 3,100 INFLOS (Sisters of Mercy), 8.717% due 2/15/2022 (d)(e) 3,314
A A 500 Refunding (Detroit Medical Center Obligated Group), Series A,
6.50% due 8/15/2018 522
AAA Aaa 3,600 Western Townships, Michigan, Utilities Authority, Sewer Disposal
System, Crossover Refunding, 6.50% due 1/01/2019 (d) 3,829
Minnesota--0.8% AA+ Aa 1,000 Minnesota State, HFA, S/F Mortgage, Series D, 6% due 1/01/2016 1,012
New Mexico--2.4% BB+ Ba1 2,900 Farmington, New Mexico, PCR, Refunding (Public Service
Company--San Juan Project), Series A, 6.40% due 8/15/2023 2,906
New York--11.7% AAA Aaa 2,000 Metropolitan Transportation Authority, New York, Commuter
Facilities Revenue Bonds, Series A, 6.10% due 7/01/2026 (b) 2,074
BBB+ Baa1 2,500 New York City, New York, GO, Refunding, UT, Series C, 5.875%
due 2/01/2016 2,417
BBB+ Baa1 2,500 New York City, New York, GO, UT, Series F, 5.75% due 2/01/2019 2,365
BB+ Baa2 3,525 New York City, New York, IDA, Special Facility Revenue Bonds
(American Airlines Inc. Project), AMT, 6.90% due 8/01/2024 3,747
A Aa 3,400 New York State Environmental Facilities Corporation, PCR (State
Water Revolving Fund), Series E, 6.50% due 6/15/2014 3,646
North Carolina-- AA Aa 1,500 North Carolina HFA, S/F, Series II, 6.20% due 3/01/2016 1,547
1.3%
Ohio--3.6% BBB- NR* 1,750 Dayton, Ohio, Special Facilities Revenue Refunding Bonds (Emery
Air Freight Corp.--Emery Worldwide Air Inc.), Series F, 6.05%
due 10/01/2009 1,779
NR* Aa 1,000 Franklin County, Ohio, Hospital Revenue Refunding and
Improvement Bonds (Childrens Hospital Project), Series A,
5.875% due 11/01/2025 995
AAA Aaa 1,500 Ohio State, Water Development Authority, Pollution Control
Facilities Revenue Refunding Bonds (Pennsylvania Power Co.
Project), 6.15% due 8/01/2023 (c) 1,559
Oklahoma--1.4% BBB Baa 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional
Facility Revenue Bonds, 6.60% due 7/01/2010 1,689
<PAGE>
Oregon--1.7% NR* Aa 1,630 Oregon State Housing and Community Services Department, S/F
Mortgage Program Revenue Bonds, AMT, Series E, 7.10% due
7/01/2014 1,709
AAA Aaa 1,000 Portland, Oregon, Arena Gas Tax Revenue Bonds, 6.25% due
6/01/2017 (d)(i) 291
</TABLE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <S> <S> <C> <S> <C>
Pennsylvania--7.1% AAA Aaa $ 2,950 Keystone Oaks, Pennsylvania, School District, IRS, UT,
Series D, 7.754% due 9/01/2016 (c)(e) $ 2,966
Pennsylvania Economic Development Financing Authority,
Resource Recovery Revenue Bonds:
BBB- NR* 2,500 (Colver Project), AMT, Series D, 7.15% due 12/01/2018 2,619
NR* NR* 2,000 (Northampton Generating), Series A, 6.50% due 1/01/2013 1,961
NR* NR* 1,000 Philadelphia, Pennsylvania, Authority for IDR, Refunding
(Commercial Development--Philadelphia Airport), AMT, 7.75%
due 12/01/2017 1,070
South Carolina-- AAA Aaa 2,000 Fairfield County, South Carolina, PCR (South Carolina Gas and
3.1% Electric Co.), 6.50% due 9/01/2014 (a) 2,188
A- A1 1,500 Richland County, South Carolina, Solid Waste Disposal
Facilities Revenue Bonds (Union Camp Corporation Project),
AMT, Series A, 6.75% due 5/01/2022 1,589
Tennessee--0.5% AA- Aa3 620 Humphreys County, Tennessee, IDB, Solid Waste Disposal Revenue
Bonds (E.I. DuPont de Nemours & Co. Project), AMT, 6.70% due
5/01/2024 664
Texas--10.2% A- A 5,760 Harris County, Texas, Health Facilities Development Corporation,
Hospital Revenue Bonds (Memorial Hospital Systems Project),
Series A, 6.625% due 6/01/2024 6,036
AAA Aaa 1,000 Harris County, Texas, Refunding (Toll Road), Senior Lien, 5.375%
due 8/15/2020 (b) 958
AAA Aaa 2,600 Red River Authority, Texas, PCR, Refunding (West Texas Utilities
Co.--Public Service Co. of Oklahoma--Central Power and Light
Co.), 6% due 6/01/2020 (a) 2,674
AAA Aaa 2,500 Texas State Municipal Power Agency, Revenue Refunding Bonds,
Series A, 6.75% due 9/01/2012 (c) 2,772
Utah--0.2% NR* P1 200 Salt Lake County, Utah, PCR, Refunding (Service Station
Holdings Project), VRDN, 3.60% due 2/01/2008 (h) 200
Virginia--3.1% NR* NR* 1,700 Richmond, Virginia, IDA, Museum Facilities Revenue Refunding
Bonds (Virginia Historical Society Project), 6.25% due 9/01/2016 1,681
AA+ Aa1 2,000 Virginia State, HDA, M/F Housing, Series B, 5.95% due 5/01/2016 2,019
<PAGE>
Wyoming--1.7% BBB Baa2 2,000 Sweetwater County, Wyoming, Solid Waste Disposal Revenue
Bonds (FMC Corporation Project), AMT, Series A, 7% due 6/01/2024 2,119
Puerto Rico--1.9% BBB+ Baa1 2,500 Puerto Rico Electric Power Authority Revenue Bonds, 5.25% due
7/01/2021 2,290
Total Investments (Cost--$118,383)--99.0% 120,318
Other Assets Less Liabilities--1.0% 1,255
--------
Net Assets--100.0% $121,573
========
<FN>
(a)MBIA Insured.
(b)FGIC Insured.
(c)AMBAC Insured.
(d)FSA Insured.
(e)The interest rate is subject to change periodically and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at October 31, 1996.
(f)FNMA Collateralized.
(g)GNMA Collateralized.
(h)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate in
effect at October 31, 1996.
(i)Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of October 31, 1996
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$118,382,975) (Note 1a) $120,317,921
Cash 93,817
Receivables:
Interest $ 2,138,178
Capital shares sold 192,616 2,330,794
------------
Deferred organization expenses (Note 1e) 249,048
Prepaid expenses and other assets (Note 1e) 71,191
------------
Total assets 123,062,771
------------
<PAGE>
Liabilities: Payables:
Securities purchased 989,690
Dividends to shareholders (Note 1f) 190,131
Administration fees (Note 2) 25,354
Investment advisory fees (Note 2) 15,213 1,220,388
------------
Accrued expenses and other liabilities 269,506
------------
Total liabilities 1,489,894
------------
Net Assets: Net assets $121,572,877
============
Capital: Capital Stock (200,000,000 shares authorized) (Note 4):
Preferred Stock, par value $.10 per share (1,520 shares of
AMPS* issued and outstanding at $25,000
per share liquidation preference) $ 38,000,000
Common Stock, par value $.10 per share (8,218,896 shares
issued and outstanding) $ 821,890
Paid-in capital in excess of par 81,271,986
Undistributed investment income--net 4,568
Accumulated realized capital losses on investments--net (Note 5) (460,513)
Unrealized appreciation on investments--net 1,934,946
------------
Total--Equivalent to $10.17 net asset value per share of Common Stock 83,572,877
------------
Total capital $121,572,877
============
<FN>
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENTS OF OPERATIONS
<CAPTION>
For the Period November 3, 1995++ to October 31, 1996
<S> <S> <C> <C>
Investment Interest and amortization of premium and discount earned $ 5,319,253
Income (Note 1d):
<PAGE>
Expenses: Investment advisory fees (Note 2) $ 446,931
Administrative fees (Note 2) 223,466
Registration fees 87,541
Transfer agent fees 71,704
Amortization of organization expenses (Note 1e) 61,964
Accounting services (Note 2) 60,526
Commission fees 48,107
Professional fees 41,000
Listing fees 34,941
Directors' fees and expenses 24,645
Custodian fees 11,606
Printing and shareholder reports 10,467
Pricing fees 5,974
------------
Total expenses before reimbursement 1,128,872
Reimbursement of expenses (Note 2) (650,746)
------------
Total expenses after reimbursement 478,126
------------
Investment income--net 4,841,127
------------
Realized & Realized loss on investments--net (460,513)
Unrealized Gain Unrealized appreciation on investments--net 1,934,946
(Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 6,315,560
(Notes 1b, 1d & 3): ============
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Period
Nov. 3, 1995++
Increase (Decrease) in Net Assets: to Oct. 31, 1996
<S> <S> <C>
Operations: Investment income--net $ 4,841,127
Realized loss on investments--net (460,513)
Unrealized appreciation on investments--net 1,934,946
------------
Net increase in net assets resulting from operations 6,315,560
------------
Dividends to Investment income--net:
Shareholders Common Stock (4,173,956)
(Note 1f): Preferred Stock (662,603)
------------
Net decrease in net assets resulting from dividends to shareholders (4,836,559)
------------
<PAGE>
Capital Stock Proceeds from issuance of Preferred Stock 38,000,000
Transactions Net increase in net assets derived from Common Stock transactions 82,293,876
(Notes 1e & 4): Offering costs resulting from the issuance of Preferred Stock (300,000)
------------
Net increase in net assets derived from capital stock transactions 119,993,876
------------
Net Assets: Total increase in net assets 121,472,877
Beginning of period 100,000
------------
End of period* $121,572,877
============
<FN>
*Undistributed investment income--net $ 4,568
============
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. For the Period
Nov. 3, 1995++ to
Increase (Decrease) in Net Asset Value: Oct. 31, 1996
<S> <S> <C>
Per Share Net asset value, beginning of period $ 10.00
Performance: ------------
Investment income--net .68
Realized and unrealized gain on investments--net .21
------------
Total from investment operations .89
------------
Less dividends to Common Stock shareholders:
Investment income--net (.59)
------------
Effect of Preferred Stock activity:++++
Dividends to Preferred Stock shareholders:
Investment income--net (.09)
Capital charge resulting from issuance of Preferred Stock (.04)
------------
Total effect of Preferred Stock activity (.13)
------------
Net asset value, end of period $ 10.17
============
Total Investment Based on net asset value per share 7.81%+++
Return:** ============
<PAGE>
Ratios to Average Expenses, net of reimbursement .53%*
Net Assets:*** ============
Expenses 1.26%*
============
Investment income--net 5.40%*
============
Supplemental Net assets, net of Preferred Stock, end of period (in thousands) $ 83,573
Data: ============
Preferred Stock outstanding, end of period (in thousands) $ 38,000
============
Portfolio turnover 234.41%
============
Leverage: Asset coverage per $1,000 $ 3,199
============
Dividends Investment income--net $ 564
Per Share on ============
Preferred Stock
Outstanding:
<FN>
*Annualized.
**Total investment returns exclude the effects of the early
withdrawal charge, if any. The Fund is a continuously offered,
closed-end fund, the shares of which are offered at net asset value.
Therefore, no separate market exists for such shares.
***Do not reflect the effect of dividends to Preferred Stock
shareholders.
++Commencement of Operations.
++++The Fund's Preferred Stock was issued on March 11, 1996.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is
registered under the Investment Company Act of 1940 as a
continuously offered, non-diversified, closed-end management
investment company. The following is a summary of significant
accounting policies followed by the Fund.
<PAGE>
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
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. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Options, which
are traded on exchanges, are valued at their last sale price as of
the close of such exchanges or, lacking any sales, at the last
available bid price. Short-term investments with remaining
maturities of sixty days or less are valued at amortized cost, 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
Directors of the Fund, including valuations furnished by a pricing
service retained by the Fund, which may utilize a matrix system for
valuations. The procedures of the pricing service and its valuations
are reviewed by the officers of the Fund under the general
supervision of the Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* 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
securities 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.
* Options--The Fund is authorized to write covered call options and
purchase put options. When the Fund writes an option, an amount
equal to the premium received by the Fund is reflected as an asset
and an equivalent liability. The amount of the liability is
subsequently marked to market to reflect the current market value of
the option written.
<PAGE>
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
(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.
(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 and offering expenses--Deferred
organization expenses are amortized on a straight-line basis over a
five-year period beginning with the commencement of operations.
Direct expenses relating to the public offering of the Preferred
Stock were charged to capital at the time of issuance. Prepaid
registration fees are charged to expense as the related shares are
issued.
NOTES TO FINANCIAL STATEMENTS (concluded)
(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.
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 the
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 at an annual rate of 0.50% of
the Fund's average daily net assets.
<PAGE>
The Fund also has entered into an Administrative Services Agreement
with FAM whereby FAM will receive a fee equal to an annual rate of
0.25% of the Fund's average daily net assets, in return for the
perfomance of administrative services (other than investment advice
and related portfolio activities) necessary for the operation of the
Fund. For the period November 3, 1995 to October 31, 1996, FAM
earned fees of $446,931, of which $419,740 was voluntarily waived.
FAM also voluntarily reimbursed the Fund additional expenses of
$231,006.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), 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 directors of the Fund are officers and/or
directors of FAM, PSI, Merrill Lynch, Pierce, Fenner & Smith Inc.
("MLPF&S"), MLFDS, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the period November 3, 1995 to October 31, 1996 were
$300,970,894 and $205,009,562, respectively.
Net realized and unrealized gains (losses) as of October 31, 1996
were as follows:
Realized Unrealized
Gains (Losses) Gains
Long-term investments $ (1,101,657) $ 1,934,946
Financial futures contracts 641,144 --
------------ ------------
Total $ (460,513) $ 1,934,946
=========== ===========
As of October 31, 1996, net unrealized appreciation for Federal
income tax purposes aggregated $1,914,325, of which $2,024,224
related to appreciated securities and $109,899 related to
depreciated securities. The aggregate cost of investments at October
31, 1996 for Federal income tax purposes was $118,403,596.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock,
including Preferred Stock, par value $.10 per share, all of which
were initially classified as Common Stock. The Board of Directors is
authorized, however, to reclassify any unissued shares of capital
stock without approval of the holders of Common Stock.
<PAGE>
Transactions in Common Stock were as follows:
For the Period
November 3, 1995++ to Dollar
October 31, 1996 Shares Amount
Shares sold 8,321,280 $83,406,334
Shares issued to shareholders in
reinvestment of dividends 87,288 867,654
----------- -----------
Total issued 8,408,568 84,273,988
Shares redeemed (199,672) (1,980,112)
----------- -----------
Net increase 8,208,896 $82,293,876
=========== ===========
[FN]
++Prior to November 3, 1995 (commencement of operations), the Fund
issued 10,000 shares to FAM for $100,000.
Preferred Stock
Auction Market Preferred Stock ("AMPS") are shares of Preferred
Stock of the Fund that entitle their holders to receive cash
dividends at an annual rate that may vary for the successive
dividend periods. The yield in effect at October 31, 1996 was 3.45%.
In connection with the offering of AMPS, the Board of Directors
reclassified 1,520 shares of unissued capital stock as AMPS. As of
October 31, 1996, there were 1,520 AMPS shares authorized, issued
and outstanding with a liquidation preference of $25,000 per share.
The Fund pays commissions to certain broker dealers at the end of
each auction at an annual rate ranging from 0.25% to 0.375%,
calculated on the proceeds of each auction. For the period November
3, 1995 to October 31, 1996, MLPF&S, an affiliate of FAM, earned
$48,107 as commissions.
5. Capital Loss Carryforward:
At October 31, 1996, the Fund had a net capital loss carryforward of
approximately $355,000, all of which expires in 2004. This amount
will be available to offset like amounts of any future taxable gain.
<AUDIT-REPORT>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Municipal Strategy Fund, Inc.:
<PAGE>
We have audited the accompanying statement of assets, liabilities
and capital, including the schedule of investments, of Merrill Lynch
Municipal Strategy Fund, Inc. as of October 31, 1996, the related
statements of operations and changes in net assets, and the
financial highlights for the period November 3, 1995 (commencement
of operations) to October 31, 1996. These financial statements and
the financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these
financial statements and the financial highlights 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
statements and the financial highlights are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.
Our procedures included confirmation of securities owned as of
October 31, 1996 by correspondence with the custodian and broker. 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 financial statements and financial highlights
present fairly, in all material respects, the financial position of
Merrill Lynch Municipal Strategy Fund, Inc. as of October 31, 1996,
the results of its operations, the changes in its net assets and the
financial highlights for the period November 3, 1995 to October 31,
1996 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
December 9, 1996
</AUDIT-REPORT>
IMPORTANT TAX INFORMATION (unaudited)
All of the net investment income distributions paid by Merrill Lynch
Municipal Strategy Fund, Inc. during its taxable year ended October
31, 1996 qualify as tax-exempt interest dividends for Federal income
tax purposes. Additionally, there were no capital gains distributed
by the Fund during the year.
Please retain this information for your records.
<PAGE>
OFFICERS AND DIRECTORS
Arthur Zeikel, President and Director
Ronald W. Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Terry K. Glenn, Executive Vice President
Vincent R. Giordano, Senior Vice President
Donald C. Burke, Vice President
Kenneth A. Jacob, Vice President
Gerald M. Richard, Treasurer
Mark B. Goldfus, Secretary
Custodian
The Bank of New York
90 Washington Street
New York, New York 10286
Transfer Agent
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
(800) 637-38631
