MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Semi-Annual Report
April 30, 1996
<PAGE>
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.
Merrill Lynch Municipal
Strategy Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
The Benefits and
Risks of
Leveraging
<PAGE>
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.
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 pick-up 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.
<PAGE>
DEAR SHAREHOLDER
We are pleased to provide you with this first semi-annual report for
Merrill Lynch Municipal Strategy Fund, Inc. In this and future
shareholder reports, we will highlight the Fund's performance,
describe recent investment activities, and examine market
developments that helped shape our investment strategy during the
period under review. The Fund seeks to provide shareholders with as
high a level of current income exempt from Federal income taxes by
investing primarily in a portfolio of long-term, investment-grade
municipal obligations.
Since inception (November 3, 1995) through April 30, 1996, the
Common Stock of Merrill Lynch Municipal Strategy Fund, Inc. earned
$0.290 per share income dividends. This represents a net annualized
yield of 6.05%, based on a month-end per share net asset value of
$9.76. Over the same period, the total investment return on the
Fund's Common Stock was +0.44%, based on a change in per share net
asset value from $10.00 to $9.76, and assuming reinvestment of
$0.269 per share income dividends.
Since inception (November 3, 1995) through April 30, 1996, the
Fund's Auction Market Preferred Stock had an average yield of 3.62%.
The Environment
Investor perceptions regarding the US economy changed over the
course of the six-month period ended April 30, 1996. As 1995 drew to
a close and 1996 began, it appeared that the US economy was losing
momentum. Lackluster retail sales, increases in initial unemployment
claims (along with weak job and income growth), and evidence of
slowing in the manufacturing sector all suggested that the rate of
economic growth was decelerating, with some forecasters even
suggesting the possibility of an imminent recession.
However, the consensus outlook for the rate of future economic
growth changed dramatically with the report of stronger-than-
expected employment data for February and March. As a result,
investors began to anticipate renewed economic growth. Long-term
interest rates rose, and the Federal Reserve Board left monetary
policy on hold. Adding to investor concerns was the report that the
Knight Ridder-Commodity Research Bureau Index was near an eight-year
high, largely because of an increase in agricultural prices and an
upward spike in the price of crude oil.
Investors are likely to continue to focus on the probable direction
of economic activity and Federal Reserve Board monetary policy in
the weeks ahead. At this time, inflationary pressures do not seem to
be building and the capital spending, housing and consumption
sectors are still relatively weak, which suggest that the economy is
not on the verge of overheating. Nevertheless, it is likely that
further indications of stronger economic activity in the weeks ahead
may add to investor concerns that accelerating economic activity
could lead to higher inflation and interest rates.
<PAGE>
The Municipal Market
During the six months ended April 30, 1996, tax-exempt bond yields
rose as investors became increasingly concerned that recent economic
growth would reignite inflationary pressures. Through early February
1996, municipal bond yields continued their earlier declines
supported by continued moderate economic growth and favorable
inflationary expectations. As measured by the Bond Buyer Revenue
Bond Index, yields on uninsured, A-rated municipal revenue bonds
declined an additional 30 basis points (0.30%) to 5.70% by early
February. As signs of emerging economic growth became more numerous,
particularly with the release of the strong March employment
figures, inflation fears increased and bond yields rose in response
for the remainder of the six-month period ended April 30, 1996. At
April 30, 1996, long-term municipal bond yields were approximately
6.30%, an increase of approximately 30 basis points over the last
six months. The rise in US Treasury bond yields was more
substantial. Over the last six months, yields on US Treasury
securities rose approximately 60 basis points to 6.90%. During the
April period, the municipal bond market reversed the trend seen
throughout much of 1995 and significantly outperformed the US
Treasury bond market.
The municipal bond market's recent outperformance was largely the
result of two principal factors. First, and perhaps more important,
much of the earlier concern regarding proposed changes in Federal
income tax codes and their effect on the tax treatment of tax-exempt
bond income has dissipated. As the negative revenue impact of the
various proposals, such as the flat tax, became apparent, the
likelihood of immediate reform quickly diminished. When the Kemp
Commission dealing with Federal income tax reform released its
findings early in 1996, the obvious need for reform was highlighted.
However, no specific recommendations of a flat tax, value-added tax
or any other reform were made. Consequently, fears of losing the
favored tax treatment of municipal bond income declined even
further. As a percentage of Treasury bond yields, tax-exempt bond
yield ratios quickly declined from 95% to approximately 90%. This
allowed the municipal bond market to maintain much of the gains made
since early 1995.
<PAGE>
The second major factor leading to the municipal bond market's
recent improvement was the return of a more favorable technical
environment. Over the past six months, approximately $90 billion in
municipal securities were underwritten, an increase of approximately
45% versus the comparable period a year earlier. However, much of
this increase was biased by recent underwritings dedicated toward
refinancing. Like individual homeowners, municipal issuers sought to
refinance their existing higher-couponed debt as tax-exempt bond
yields declined from their highs in 1995. In recent months such
refinancings were estimated to represent at least 50% of total
issuance. However, the recent rise in tax-exempt interest rates
slowed the pace of such refinancings. Over the last three months
approximately $40 billion in long-term tax-exempt securities were
underwritten, an increase of 35% compared to the same period a year
ago. At current interest rate levels large amounts of refundings are
unlikely and the rate of new bond issuance should continue to
decline.
Additionally, investors continue to receive significant amounts of
assets derived from coupon income, bond maturities, and proceeds
from early redemptions. In recent months investors received over $30
billion in such assets. These cash flows helped maintain individual
retail investor demand in recent months. Additionally, major
institutional investors, such as certain insurance companies whose
underwriting profits were cyclically high, demonstrated significant
ongoing interest in the tax-exempt bond market, particularly on
higher-quality securities. Individual and institutional investor
demand was strong enough during the six-month period ended April 30,
1996 to absorb the relative increase in bond issuance.
Looking ahead, we believe the municipal bond market is likely to
continue to outperform the US Treasury market. Investor demand
should remain adequate to absorb new bond issuance. It is also
unlikely that the rapid pace of issuance seen thus far in 1996 will
be maintained. The recent rise in yields made further bond
refinancings economically unfeasible. Since these refinancings were
the driving force of recent bond issuance, as the amount of these
refundings decline, overall issuance should decline. This should
allow the current demand/supply balance to be easily maintained in
upcoming months.
Additionally, as a percentage of US Treasury bond yields, long-term
municipal bond yields remain historically attractive. It is likely
that recent interest rate increases will have a negative impact on
economic growth, perhaps as early as late summer 1996. With long-
term mortgage rates above 8%, the domestic housing sector has
already indicated signs of slower growth. If other interest rate
sectors of the economy, such as the automobile industry, begin to
show similar adverse effects, taxable interest rates would be poised
to resume their decline. With long-term tax-exempt revenue bonds
yielding approximately 90% of their taxable counterparts, municipal
bond yields are poised to decline further.
<PAGE>
Portfolio Strategy
Our initial focus at the time of the Fund's inception was to seek to
enhance tax-exempt income while structuring the Fund to benefit from
a continued bond market rally. We started the period with an
optimistic interest rate outlook based on the prospect of slow
economic growth and low inflation. This strategy proved successful
as the bond market rallied into January 1996. Unfortunately, our
strategy remained constructive during February and early March when
interest rates began to rise. We reversed course and became
extremely defensive, protecting the Fund from the significant back
up in interest rates that brought the 30-year US Treasury bond to
6.90% by the end of March. At this time we began buying, believing
that the market had oversold, only to have the market continue its
decline.
Currently, we are cautiously optimistic on the interest rate
outlook. There is a considerable amount of negative news priced into
the market, and any positive surprises in economic data could rally
the market substantially. We will maintain the Fund's neutral
position until such signs develop.
The Fund began auctioning its Auction Market Preferred Stock in mid-
March at an initial rate of 3.45%. While the interest rate on the
Fund's Preferred Stock increased because of calendar pressures, the
Fund's Common Stock shareholders continued to pick up an attractive
yield. We anticipate that the interest rate on Preferred Stock may
decline to the 3.50% range in the upcoming months from its current
interest rate of 3.80%. 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 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
(Vincent R. Giordano)
Vincent R. Giordano
Senior Vice President
<PAGE>
(Robert A. DiMella)
Robert A. DiMella
Portfolio Manager
June 7, 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.
ACES SM Adjustable Convertible Extendable Securities
AMT Alternative Minimum Tax (subject to)
DATES Daily Adjustable Tax-Exempt Securities
GO General Obligation Bonds
HFA Housing Finance Agency
IDB Industrial Development Board
INFLOS Inverse Floating Rate Municipal Bonds
IRS Inverse Rate Securities
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--8.5% NR* Aaa $ 2,815 Alabama, HFA, S/F Home Mortgage Revenue Bonds, Series A-1,
6.60% due 4/01/2019 $ 2,895
BBB Baa1 5,490 Courtland, Alabama, IDB, Solid Waste Disposal Revenue Bonds
(Champion International Corporation Project), Series A, AMT,
6.50% due 9/01/2025 5,400
<PAGE>
Alaska--1.0% AAA Aaa 1,000 Alaska State Housing Finance Corporation, Refunding Bonds,
Series A, 5.875% due 12/01/2024 (a)(g)(h) 963
Arizona--0.5% Maricopa County, Arizona, Pollution Control Corp., PCR,
Refunding (Arizona Public Service Co.), VRDN (j):
A1+ P1 300 Series C, 4.15% due 5/01/2029 300
A1+ P1 200 Series E, 4.10% due 5/01/2029 200
Arkansas--2.0% BBB- Baa3 2,000 Pope County, Arkansas, PCR, Refunding (Arkansas Power and
Light Company Project), 6.30% due 11/01/2020 1,998
California AAA Aaa 3,730 Cathedral City, California, Public Financing Authority, Revenue
- --3.6% Refunding Bonds (Tax Allocation--Redevelopment Projects),
Series A, 5.50% due 8/01/2017 (a) 3,520
Colorado--5.4% NR* Aa 2,000 Colorado, HFA, S/F Program, AMT, Series D-1, 7.375% due 6/01/2026 2,159
AAA Aaa 3,215 Denver, Colorado, City and County Airport Revenue Bonds,
AMT, Series B, 5.625% due 11/15/2008 (a) 3,177
Florida--10.4% Dade County, Florida, Refunding (Seaport), UT (a):
AAA Aaa 4,050 5.125% due 10/01/2016 3,702
AAA Aaa 4,240 5.125% due 10/01/2021 3,820
BBB Baa2 1,000 Nassau County, Florida, PCR, Refunding (ITT Rayonier Inc.
Project), 6.25% due 6/01/2010 998
NR* Baa 750 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida
Education and Research Foundation Project), Series A,
6.85% due 9/01/2013 769
A1 VMIG1++ 900 Pinellas County, Florida, Health Facilities Authority,
Revenue Refunding Bonds (Pooled Hospital Loan Program),
DATES, 4% due 12/01/2015 (j) 900
Georgia--1.1% AAA Aaa 1,000 Municipal Electric Authority, Georgia (Project One),
Sub-Series A, 6.50% due 1/01/2026 (c) 1,047
</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>
Illinois--1.3% NR* Baa1 $ 1,250 Illinois Health Facilities Authority Revenue Bonds (Holy
Cross Hospital Project), 6.70% due 3/01/2014 $ 1,241
<PAGE>
Indiana--2.3% NR* Aaa 2,000 Indianapolis, Indiana, Local Public Improvement Bond Bank
Revenue Bonds, Series C, 6.70% due 1/01/2002 (i) 2,219
Massachusetts AAA Aaa 3,000 Massachusetts State Water Resource Authority, General
- --3.1% Revenue Bonds, Series A, 6% due 8/01/2024 (a) 3,000
Michigan--9.8% AAA Aaa 2,000 Detroit, Michigan, Sewer Disposal Revenue Bonds, INFLOS,
7.44% due 7/01/2023 (b)(e) 1,792
A1+ VMIG1++ 500 Grand Rapids, Michigan, Water Supply System, Revenue
Refunding Bonds, VRDN, 4.10% due 1/01/2020 (b)(j) 500
Michigan State Hospital Finance Authority Revenue Bonds:
AAA Aaa 3,100 INFLOS (Sisters of Mercy), 8.686% due 2/15/2022 (d)(e) 3,170
A A 500 Refunding (Detroit Medical Center Obligation Group),
Series A, 6.50% due 8/15/2018 505
AAA Aaa 3,600 Western Townships, Michigan, Utilities Authority, Sewer
Disposal System, Crossover Revenue Refunding Bonds, 6.50%
due 1/01/2019 (d) 3,701
Missouri--0.6% A1+ VMIG1++ 600 Missouri State Health and Educational Facilities
Authority, Revenue Refunding Bonds (Washington University),
VRDN, Series B, 4.10% due 9/01/2030 (j) 600
Nevada--1.9% AAA Aaa 2,000 Reno, Nevada, Hospital Revenue Refunding Bonds (Saint Mary's
Regional Medical Center), Series A, 5.625% due 5/15/2023 (a) 1,860
New Mexico-- BB Ba2 2,000 Farmington, New Mexico, PCR, Refunding (Public Service
2.0% Company--San Juan Project), Series A, 6.40% due 8/15/2023 1,920
New York--22.7% BBB+ Baa1 4,965 New York City, New York, GO, UT, Series D, 6% due 2/15/2016 4,685
BBB- Baa1 6,000 New York State Dormitory Authority Revenue Bonds (Upstate
Community Colleges), Series A, 6.20% due 7/01/2015 5,920
AAA Aaa 3,950 New York State Energy Research and Development Authority,
Facilities Revenue Refunding Bonds (Consolidated Edison
Company of New York), Series A, 6.10% due 8/15/2020 (a) 3,997
AAA Aaa 2,500 New York State Energy Research and Development Authority,
Gas Facilities Revenue Refunding Bonds (Brooklyn Union Gas
Company), Series A, 5.50% due 1/01/2021 (a) 2,361
A Aa 3,400 New York State Environmental Facilities Corporation, PCR
(State Water Revolving Fund), Series E, 6.50% due 6/15/2014 3,581
BBB Baa1 2,000 New York State Urban Development Corporation Revenue Bonds,
Correctional Capital Facilities, Series 6, 5.375% due 1/01/2015 1,790
<PAGE>
North A A2 3,750 Martin County, North Carolina, Industrial Facilities and
Carolina--4.9% Pollution Control Financing Authority Revenue Bonds (Solid
Waste Disposal--Weyerhaeuser Company), AMT, 6.80% due 5/01/2024 3,961
NR* VMIG1++ 700 North Carolina Medical Care Commission, Hospital Revenue
Bonds (Pooled Financing Project), ACES, Series B, 4% due
10/01/2013 (j) 700
A1+ NR* 200 Raleigh-Durham, North Carolina, Airport Authority, Special
Facility Revenue Refunding Bonds (American Airlines), VRDN,
Series B, 4.10% due 11/01/2015 (j) 200
Pennsylvania AAA Aaa 1,950 Keystone Oaks, Pennsylvania, School District, IRS, UT,
- --4.9% Series D, 7.805% due 9/01/2016 (c)(e) 1,821
NR* NR* 2,000 Pennsylvania Economic Development Financing Authority,
Resource Recovery Senior Revenue Bonds (Northampton
Generating), Series A, 6.50% due 1/01/2013 1,921
NR* NR* 1,000 Philadelphia, Pennsylvania, Authority for Industrial
Development, Revenue Refunding Bonds (Commercial
Development--Philadelphia Airport), AMT, 7.75% due 12/01/2017 1,039
Rhode Rhode Island Depositors Economic Protection Corporation,
Island--4.3% Special Obligation Revenue Refunding Bonds, Series A:
A- Baa1 830 5.75% due 8/01/2021 784
A- Baa1 1,170 5.75% due 8/01/2021 (k) 1,148
AA+ Aa 2,250 Rhode Island Housing and Mortgage Finance Corporation
(Home Ownership Opportunity), Series 5, AMT, 6.40% due
4/01/2024 2,254
South AAA Aaa 2,000 Fairfield County, South Carolina, PCR (South Carolina
Carolina--3.7% Gas and Electric Co.), 6.50% due 9/01/2014 (a) 2,113
A- A1 1,500 Richland County, South Carolina, Solid Waste Disposal
Facilities Revenue Bonds (Union Camp Corporation Project),
Series A, AMT, 6.75% due 5/01/2022 1,558
Texas--3.0% BBB Baa2 2,980 West Side Calhoun County, Texas, Navigation District,
Solid Waste Disposal Revenue Bonds (Union Carbide Chemicals
Project), AMT, 6.40% due 5/01/2023 2,921
Utah--0.5% AAA Aaa 500 Utah State HFA, S/F Mortgage Revenue Bonds, Series F-2,
AMT, 7% due 7/01/2027 (f) 518
<PAGE>
West NR* A1 1,500 West Virginia State Hospital Finance Authority, Hospital
Virginia--1.5% Revenue Bonds (Charleston Area Medical Center Inc.),
Series A, 6.50% due 9/01/2023 1,511
Wyoming--2.1% BBB Baa2 2,000 Sweetwater County, Wyoming, Solid Waste Disposal Revenue
Bonds (FMC Corporation Project), Series A, AMT, 7% due
6/01/2024 2,074
Total Investments (Cost--$100,748)--101.1% 99,213
Liabilities in Excess of Other Assets--(1.1%) (1,104)
-------
Net Assets--100.0% $98,109
=======
<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 April 30, 1996.
(f)FHA Insured.
(g)FNMA Collateralized.
(h)GNMA Collateralized.
(i)Prerefunded.
(j)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate in
effect at April 30, 1996.
(k)Escrowed to Maturity.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of April 30, 1996
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$100,747,757)(Note 1a) $ 99,213,245
Cash 23,287
Receivables:
Interest $ 1,864,962
Capital shares sold 193,484
Investment adviser (Note 2) 82,100 2,140,546
------------
Deferred organization expenses (Note 1e) 185,038
------------
Total assets 101,562,116
------------
Liabilities: Payables:
Securities purchased 2,992,382
Dividends to shareholders (Note 1f) 171,479
Administration fees (Note 2) 14,769 3,178,630
------------
Accrued expenses and other liabilities 274,767
------------
Total liabilities 3,453,397
------------
Net Assets: Net assets $ 98,108,719
============
Capital: Capital Stock (200,000,000 shares authorized)(Note 4):
Preferred Stock, par value $.10 per share (1,000 shares
of AMPS* issued and outstanding at $25,000 per share
liquidation preference) $ 25,000,000
Common Stock, par value $.10 per share (7,489,188 shares
issued and outstanding) $ 748,919
Paid-in capital in excess of par 74,125,499
Accumulated investment loss--net (11,471)
Accumulated realized capital losses on investments--net (219,716)
Unrealized depreciation on investments--net (1,534,512)
------------
Total--Equivalent to $9.76 net asset value per share of
Common Stock 73,108,719
------------
Total capital $ 98,108,719
============
<FN>
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Period Ended November 3, 1995++ to April 30, 1996
<S> <S> <C> <C>
Investment Interest and amortization of premium and discount earned $ 2,064,997
Income (Note 1d):
Expenses: Investment advisory fees (Note 2) $ 175,673
Administrative fees (Note 2) 87,837
Registration fees 41,497
Amortization of organization expenses (Note 1e) 26,784
Professional fees 25,378
Printing and shareholder reports 20,860
Listing fees 19,231
Accounting services (Note 2) 18,427
Commission fees 17,408
Transfer agent fees 16,207
Directors' fees and expenses 10,599
Custodian fees 3,740
Pricing fees 2,846
Other 6,437
------------
Total expenses before reimbursement 472,924
Reimbursement of expenses (Note 2) (389,662)
------------
Total expenses after reimbursement 83,262
------------
Investment income--net 1,981,735
------------
Realized & Realized loss on investments--net (219,716)
Unrealized Unrealized depreciation on investments--net (1,534,512)
Loss on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 227,507
- --Net (Notes 1b, ============
1d & 3):
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
STATEMENT OF CHANGES IN NET ASSETS
<CAPTION>
For the
Period Ended
Nov. 3, 1995++ to
Increase (Decrease) in Net Assets: April 30, 1996
<S> <S> <C>
Operations: Investment income--net $ 1,981,735
Realized loss on investments--net (219,716)
Unrealized depreciation on investments--net (1,534,512)
------------
Net increase in net assets resulting from operations 227,507
------------
Dividends to Investment income--net:
Shareholders Common Stock (1,866,786)
(Note 1f): Preferred Stock (126,420)
------------
Net decrease in net assets resulting from dividends to shareholders (1,993,206)
------------
Capital Stock Proceeds from issuance of Preferred Stock 25,000,000
Transactions Net increase in net assets derived from Common Stock transactions 75,074,418
(Notes 1e & 4): Offering costs resulting from the issuance of Preferred Stock (300,000)
------------
Net increase in net assets derived from capital stock transactions 99,774,418
------------
Net Assets: Total increase in net assets 98,008,719
Beginning of period 100,000
------------
End of period $ 98,108,719
============
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived For the
from information provided in the financial statements. Period Ended
Nov. 3, 1995++ to
Increase (Decrease) in Net Asset Value: April 30, 1996
<S> <S> <C>
Per Share Net asset value, beginning of period $ 10.00
Operating ------------
Performance: Investment income--net .31
Realized and unrealized loss on investments--net (.20)
------------
Total from investment operations .11
------------
Less dividends to Common Stock shareholders:
Investment income--net (.29)
------------
Effect of Preferred Stock activity:++++
Dividends to Preferred Stock shareholders:
Investment income--net (.02)
Capital charge resulting from issuance of Preferred Stock (.04)
------------
Total effect of Preferred Stock activity (.06)
------------
Net asset value, end of period $ 9.76
============
Total Investment Based on net asset value per share .44%+++
Return:** ============
Ratios to Expenses, net of reimbursement .24%*
Average ============
Net Assets:*** Expenses 1.34%*
============
Investment income--net 5.62%*
============
Supplemental Net assets, net of Preferred Stock, end of period (in thousands) $ 73,109
Data: ============
Preferred Stock outstanding, end of period (in thousands) $ 25,000
============
Portfolio turnover 127.06%
============
Leverage: Asset coverage per $1,000 $ 3,924
============
Dividends Investment income--net $ 126
Per Share on ============
Preferred Stock
Outstanding:
<FN>
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, may result
in substantially different returns. Total investment returns exclude
the effects of sales loads.
***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>
<PAGE>
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. These unaudited 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. The following is
a summary of significant accounting policies followed by the Fund.
(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 valua-tions 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.
<PAGE>
* 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.
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 Common and
Preferred Stock were charged to capital at the time of issuance.
<PAGE>
(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.
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
performance of administrative services (other than investment advice
and related portfolio activities) necessary for the operation of the
Fund. The Investment Advisory Agreement obligates FAM to reimburse
the Fund to the extent the Fund's expenses (excluding interest,
taxes, distribution fees, brokerage fees and commissions, and
extraordinary items) exceed 2.5% of the Fund's first $30 million of
average net assets, 2.0% of the next $70 million of average daily
net assets, and 1.5% of the average net assets in excess thereof.
FAM's obligation to reimburse the Fund is limited to the amount of
the investment advisory fee. No fee payment will be made to FAM
during any fiscal year which will cause such expenses to exceed the
most restrictive expense limitation applicable at the time of such
payment. For the period November 3, 1995 to April 30, 1996, FAM
earned fees of $175,673, all of which was voluntarily waived. FAM
also voluntarily reimbursed the Fund additional expenses of
$213,989.
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.
<PAGE>
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the period ended November 3, 1995 to April 30, 1996 were
$159,797,404 and $78,704,587, respectively.
Net realized and unrealized gains (losses) as of April 30, 1996 were
as follows:
Realized
Gains Unrealized
(Losses) Losses
Long-term investments $ (920,109) $(1,534,512)
Financial futures contracts 700,393 --
----------- -----------
Total $ (219,716) $(1,534,512)
=========== ===========
As of April 30, 1996, net unrealized depreciation for Federal income
tax purposes aggregated $1,534,514, of which $229,734 related to
appreciated securities and $1,764,248 related to depreciated
securities. The aggregate cost of investments at April 30, 1996 for
Federal income tax purposes was $100,747,757.
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.
Transactions in common stock were as follows:
For the Period Ended
November 3, 1995++ to Dollar
April 30, 1996 Shares Amount
Shares sold 7,448,638 $74,769,151
Shares issued to shareholders in
reinvestment of dividends 30,550 305,267
----------- -----------
Net increase 7,479,188 $75,074,418
=========== ===========
[FN]
++Prior to November 3, 1995 (commencement of operations), the Fund
issued 10,000 shares to FAM for $100,000.
<PAGE>
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 April 30, 1996 was 3.85%.
In connection with the offering of AMPS, the Board of Directors
reclassified 1,000 shares of unissued capital stock as AMPS. As of
April 30, 1996, there were 1,000 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 April 30, 1996, MLPF&S, an affiliate of FAM, earned
$7,320 as commissions.
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
<PAGE>
Transfer Agent
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
(800) 637-38631
