MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Semi-Annual Report
April 30, 1997
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.
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.
<PAGE>
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 of 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
For the six-month period ended April 30, 1997, the Common Stock of
Merrill Lynch Municipal Strategy Fund, Inc. earned $0.294 per share
income dividends. This represents a net annualized yield of 5.85%,
based on a month-end per share net asset value of $10.15. Over the
same period, the total investment return on the Fund's Common Stock
was +2.71%, based on a change in per share net asset value from
$10.17 to $10.15, and assuming reinvestment of $0.297 per share
income dividends.
The average yield of the Fund's Auction Market Preferred Stock for
the six-month period ended April 30, 1997 was 3.55%.
<PAGE>
The Municipal Market
Environment
Long-term tax-exempt revenue bonds traded in a relatively narrow
range throughout much of the six months ended April 30, 1997. By mid-
January 1997, municipal bond yields had risen to over 6% as
investors reacted negatively to reports of progressively stronger
domestic economic growth. However, a continued lack of any material
inflationary pressures allowed bond yields to decline to their prior
levels by late February. Bond yields rose again as investors became
increasingly concerned that the US domestic economic strength seen
thus far in 1997 would continue and that the increase in short-term
interest rates administered by the Federal Reserve Board (FRB) in
late March would be the first in a series of such moves designed to
slow the US economy before any dormant inflationary pressures were
awakened. Long-term tax-exempt bond yields rose approximately 15
basis points (0.15%) to almost 6.15% by mid-April. Similarly, long-
term US Treasury bond yields rose over 35 basis points over the same
period to 7.16%. However, in late April economic indicators were
released showing that despite considerable economic growth, any
inflationary pressures, particularly those associated with wage
increases, were well-contained and of no immediate concern. Fixed-
income bond prices staged a significant rally during the last week
of April with long-term US Treasury bond yields falling nearly 20
basis points to end the month at 6.95%. Municipal bond yields, as
measured by the Bond Buyer Revenue Bond Index, declined nearly 15
basis points to stand at 6.01% by April 30, 1997.
As in recent quarters, the relative stability of long-term tax-
exempt bond yields was supported by low levels of new municipal bond
issuance. Over the past six months, approximately $90 billion in
long-term tax-exempt bonds was underwritten, a decline of more than
6% versus the corresponding period a year earlier. During the three-
month period ended April 30, 1997, $41 billion in new long-term
municipal bonds was issued, also a 6% decline in issuance as
compared to the three months ended April 30, 1996. Overall investor
demand has remained strong, particularly from property and casualty
insurance companies and individual retail investors. In recent
years, investor demand has increased whenever tax-exempt bond yields
have approached or exceeded the 6% level as they have in the past
few months.
Additionally, in recent months much of the new bond issuance was
dominated by a number of larger issues. These included $710 million
in New York City water bonds, $600 million in state of California
bonds, $1 billion in New York City general obligation bonds, $435
million in Dade County, Florida water and sewer revenue bonds, $450
million in Puerto Rico Electric Authority issues, and $930 million
in Port Authority of New York and New Jersey issues. These bonds
have typically been issued in states with relatively high state
income taxes and consequently generally were underwritten at yields
that were relatively unattractive to residents in other states. This
has exacerbated the general decline in overall issuance in recent
years, making the decrease in supply even more dramatic for general
market investors.
<PAGE>
The present economic situation remains nearly ideal. The domestic
economy continues to grow steadily with little, if any, sign of a
resurgence in inflation. Recent economic growth generated
considerable unexpected tax revenues for the Federal government.
Forecasts for the 1997 Federal fiscal deficit were reduced to under
$100 billion, a level not seen since the early 1980s. Such a reduced
Federal deficit enhances the prospect for a balanced Federal budget.
All of these factors support a scenario of steady, or even falling,
interest rates in the coming years. Present annual estimates of
future municipal bond issuance remain centered around $175 billion,
indicating that the current relative scarcity of tax-exempt bonds
should continue for at least the remainder of the year. Should
interest rates begin to decline later this year, either as the
result of a balanced Federal budget or continued benign inflation,
investors are unlikely to be able to purchase long-term municipal
bonds at their currently attractive levels.
Portfolio Strategy
During the past six months, we maintained a neutral-to-slightly
constructive investment strategy that concentrated on providing an
attractive level of tax-exempt income while seeking to preserve the
Fund's net asset value. The everchanging perception on the state of
the economy, and the need for possible further monetary policy
tightening by the FRB caused large swings in interest rates over
this time period.
We have strived to take advantage of market fluctuations to seek to
enhance the Fund's total return. We purchased interest rate-
sensitive bonds in the middle of January when tax-exempt interest
rates increased to attractive levels. However, we subsequently sold
these issues after the bond market rally in early February. Looking
forward, we expect the FRB to continue raising short-term interest
rates, which is expected to place negative pressure on long-term tax-
exempt interest rates. We anticipate maintaining a neutral portfolio
strategy until there are signs that the economy is slowing to below
trend growth, thereby reducing the threat of rising inflation.
The yield on the Fund's Auction Market Preferred Stock has been
trading within a narrow range between 3.50%--3.75%. Over the past
few weeks, the interest rate on the Preferred Stock has been greater
than 4% in response to pressures from seasonal corporate and
individual tax payments. This interest rate has started to decline,
and is expected to return to normal levels shortly. Leverage
continues to benefit Common Stock shareholders by significantly
augmenting their yield. However, should the spread between short-
term and long-term tax-exempt interest rates narrow, the benefits of
leverage will decline 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.)
<PAGE>
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
(Vincent R. Giordano)
Vincent R. Giordano
Senior Vice President
(Robert A. DiMella)
Robert A. DiMella
Portfolio Manager
June 5, 1997
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)
GO General Obligation Bonds
HFA Housing Finance Agency
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
IRS Inverse Rate Securities
PCR Pollution Control Revenue Bonds
RITR Residual Interest Trust Receipts
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
<PAGE>
<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--2.3% NR* Aaa $ 2,815 Alabama HFA, S/F Home Mortgage Revenue Bonds, Series A-1,
6.60% due 4/01/2019 $ 2,968
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) 1,228
California--2.9% BBB- Baa 5,000 Foothill, California, Eastern Transportation Corridor Agency,
Toll Road Revenue Bonds, Senior Lien, Series A, 6.50%**
due 1/01/2015 1,645
AAA Aaa 2,000 San Diego, California, IDR, RITR, 7.435% due 9/01/2019 (e) 2,088
Colorado--10.6% NR* Aa2 2,000 Colorado HFA, S/F Program, AMT, Series D-1, 7.375% due 6/01/2026 2,188
NR* NR* 1,500 Denver, Colorado, Urban Renewal Authority, Tax Increment
Revenue Bonds (Downtown Denver), AMT, Series A, 7.75% due 9/01/2016 1,505
AAA Aaa 8,840 El Paso County, Colorado, Falcon School District No. 49, UT,
6.50% due 12/01/2015 (a) 9,711
Connecticut--0.8% 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 1,023
Florida--5.1% AAA Aaa 3,750 Dade County, Florida, Water and Sewer Systems Revenue Bonds,
5.25% due 10/01/2021 (b) 3,519
NR* Baa1 1,000 Jacksonville, Florida, Health Facilities Authority, IDR
(National Benevolent--Cypress Village), Series A, 6.25% due
12/01/2026 1,003
BBB+ Baa2 1,000 Nassau County, Florida, PCR, Refunding (ITT Rayonier Inc.
Project), 6.25% due 6/01/2010 1,017
NR* Baa 750 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida
Education and Research Foundation Project), Series A, 6.85%
due 9/01/2013 803
A1+ VMIG1++ 100 Saint Lucie County, Florida, PCR, Refunding (Florida Power &
Light Company Project), VRDN, 4.45% due 1/01/2026 (h) 100
Georgia--2.5% AA Aa 2,000 Atlanta, Georgia, GO, UT, Series A, 6.125% due 12/01/2023 2,049
AAA Aaa 1,000 Municipal Electric Authority of Georgia (Project One),
Sub-Series A, 6.50% due 1/01/2026 (c) 1,063
Illinois--8.5% NR* NR* 2,000 Beardstown, Illinois, IDR (Jefferson Smurfit Corp. Project),
8% due 10/01/2016 2,185
AAA Aaa 3,630 Illinois Development Finance Authority, PCR, Refunding
(Commerce Edison Company Project), Series D, 6.75% due 3/01/2015 (c) 3,953
AA- Aa3 3,285 Illinois Development Finance Authority Revenue Bonds
(Presbyterian Home Lake), Series B, 6.30% due 9/01/2022 3,379
NR* Baa1 1,250 Illinois Health Facilities Authority Revenue Bonds (Holy Cross
Hospital Project), 6.70% due 3/01/2014 1,288
<PAGE>
Indiana--1.2% AAA Aaa 1,500 Tippecanoe County, Indiana, School Building Corp. (First
Mortgage), 6% due 7/15/2013 (a) 1,531
Kentucky--2.5% NR* NR* 3,150 Perry County, Kentucky, Solid Waste Disposal Revenue Bonds
(TJ International Project), AMT, 6.55% due 4/15/2027 3,150
Louisiana--3.1% BB NR* 4,000 Port New Orleans, Louisiana, IDR, Refunding (Continental
Grain Co. Project), 6.50% due 1/01/2017 3,986
Maryland--0.8% A- NR* 1,000 Maryland State Energy Financing Administration, Solid Waste
Disposal Revenue Bonds (Wheelabrator Water Projects), AMT,
6.30% due 12/01/2010 1,035
Massachusetts-- A- NR* 5,000 Massachusetts State Health and Educational Facilities
4.0% Authority, Revenue Refunding Bonds (Melrose Wakefield Hospital),
Series B, 6.25% due 7/01/2012 5,106
Michigan--3.0% Michigan State Hospital Finance Authority Revenue Bonds:
AAA Aaa 3,100 INFLOS (Sisters of Mercy), 8.514% due 2/15/2022 (d)(e) 3,232
A A2 500 Refunding (Detroit Medical Center Obligated Group), Series A,
6.50% due 8/15/2018 523
Nevada--1.2% NR* NR* 1,530 Reno-Sparks Convention and Visitors Authority, Nevada,
Limited Obligation Revenue Refunding Bonds, 6.40% due 11/01/2003 1,501
New Jersey--2.1% BBB Baa2 2,500 New Jersey Health Care Facilities Financing Authority, Revenue
Refunding Bonds (Englewood Hospital & Medical Center), 6.75%
due 7/01/2024 2,629
New Mexico--3.9% Farmington, New Mexico, PCR, Refunding (Public Service
Company--San Juan Project):
BB+ Ba1 3,000 Series A, 6.30% due 12/01/2016 2,969
BB+ Ba1 2,000 Series D, 6.375% due 4/01/2022 1,983
New York--14.6% BBB+ Baa1 7,085 New York City, New York, GO, UT, Series F, 5.75% due 2/01/2019 6,722
BBB Baa1 2,475 New York State Dormitory Authority Revenue Bonds (Consolidated
City University System--Second General), Series A, 5.75% due
7/01/2018 2,421
BBB+ Baa1 6,300 New York State Dormitory Authority Revenue Bonds (State
University Educational Facilities), 5.50% due 5/15/2026 5,829
A Aa 3,400 New York State Environmental Facilities Corporation, PCR (State
Water Revolving Fund), Series E, 6.50% due 6/15/2014 3,597
North Carolina-- AA Aa3 1,500 North Carolina Medical Care Commission, Health Care Facilities
1.1% Revenue Bonds (Carolina Medicorp. Project), 5.25% due 5/01/2026 1,369
Ohio--3.7% 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 1,782
NR* NR* 1,400 Ohio State Higher Educational Facilities Commission Revenue
Bonds (University of Findlay Project), 6.125% due 9/01/2016 1,358
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) 1,546
<PAGE>
Oklahoma--1.3% BBB Baa 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional
Facility Revenue Bonds, 6.60% due 7/01/2010 1,676
</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>
Oregon--1.3% NR* Aa2 $ 1,630 Oregon State Housing and Community Services Department,
S/F Mortgage Program Revenue Bonds, AMT, Series E, 7.10%
due 7/01/2014 $ 1,707
Pennsylvania--9.6% AAA Aaa 2,950 Keystone Oaks, Pennsylvania, School District, IRS, UT,
Series D, 7.623% due 9/01/2016 (c)(e) 2,862
Pennsylvania Economic Development Financing Authority, Resource
Recovery Revenue Bonds, AMT:
BBB- NR* 1,000 (Colver Project), Series D, 7.125% due 12/01/2015 1,050
BBB- NR* 2,500 (Colver Project), Series D, 7.15% due 12/01/2018 2,617
NR* NR* 2,000 (Northampton Generating), Series A, 6.50% due 1/01/2013 1,968
NR* NR* 1,000 Philadelphia, Pennsylvania, Authority for IDR, Refunding
(Commercial Development--Days Inn), Series B, 6.50% due 10/01/2027 981
AAA Aaa 3,000 Philadelphia, Pennsylvania, GO, UT, 5% due 5/15/2025 (a) 2,681
South Carolina-- AAA Aaa 2,000 Fairfield County, South Carolina, PCR (South Carolina Gas and
1.7% Electric Co.), 6.50% due 9/01/2014 (a) 2,151
Tennessee--1.3% NR* NR* 1,610 Hardeman County, Tennessee, Correctional Facilities Revenue Bonds
(Correctional Facilities Corp.), 7.75% due 8/01/2017 1,639
Texas--5.5% A- A2 3,250 Harris County, Texas, Health Facilities Development Corporation,
Hospital Revenue Bonds (Memorial Hospital Systems Project),
Series A, 6.625% due 6/01/2004 (i) 3,593
B+ Ba2 2,500 Houston, Texas, Airport System Revenue Bonds, Special Facilities
(Continental Airline Terminal Improvement), AMT, Series B, 6.125%
due 7/15/2017 2,416
A- Baa1 1,000 Lower Colorado River Authority, Texas, PCR (Samsung Austin
Semiconductor), AMT, 6.375% due 4/01/2027 1,006
Wyoming--3.2% BBB Baa2 3,785 Sweetwater County, Wyoming, Solid Waste Disposal Revenue Bonds
(FMC Corporation Project), AMT, Series A, 7% due 6/01/2024 3,998
Total Investments (Cost--$124,094)--98.8% 125,329
Other Assets Less Liabilities--1.2% 1,485
--------
Net Assets--100.0% $126,814
========
<PAGE>
<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, 1997.
(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 April 30, 1997.
(i)Prerefunded.
*Not Rated.
**Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
++Highest short-term rating by Moody's Investors Service, Inc.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
As of April 30, 1997
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$124,094,167) (Note 1a) $125,328,931
Cash 74,972
Receivables:
Securities sold $ 6,278,890
Interest 2,307,582
Capital shares sold 197,684 8,784,156
------------
Deferred organization expenses (Note 1e) 249,048
Prepaid expenses and other assets 71,191
------------
Total assets 134,508,298
------------
Liabilities: Payables:
Securities purchased 7,190,547
Dividends to shareholders (Note 1f) 211,206
Administration fees (Note 2) 25,676
Investment advisory fees (Note 2) 15,406 7,442,835
------------
Accrued expenses and other liabilities 251,750
------------
Total liabilities 7,694,585
------------
<PAGE>
Net Assets: Net assets $126,813,713
============
Capital: Capital Stock (200,000,000 shares authorized) (Note 4):
Preferred Stock, par value $.10 per share (2,480 shares of
AMPS* issued and 1,520 shares outstanding at $25,000 per
share liquidation preference) $ 38,000,000
Common Stock, par value $.10 per share (8,746,455 shares
issued and outstanding) $ 874,646
Paid-in capital in excess of par 86,589,280
Undistributed realized capital gains on investments--net 115,023
Unrealized appreciation on investments--net 1,234,764
------------
Total--Equivalent to $10.15 net asset value per share of
Common Stock 88,813,713
------------
Total capital $126,813,713
============
<FN>
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF OPERATIONS
For the Six Months Ended April 30, 1997
<S> <S> <C> <C>
Investment Interest and amortization of premium and discount earned $ 3,750,429
Income (Note 1d):
Expenses: Investment advisory fees (Note 2) $ 308,528
Administrative fees (Note 2) 154,264
Transfer agent fees 50,220
Registration fees 47,862
Commission fees 43,877
Printing and shareholder reports 41,933
Listing fees 33,279
Professional fees 28,777
Amortization of organization expenses (Note 1e) 28,276
Accounting services (Note 2) 22,393
Directors' fees and expenses 11,193
Custodian fees 7,386
Pricing fees 3,946
Other 26,137
------------
Total expenses before reimbursement 808,071
Reimbursement of expenses (Note 2) (215,969)
------------
Total expenses after reimbursement 592,102
------------
Investment income--net 3,158,327
------------
<PAGE>
Realized & Realized gain on investments--net 575,536
Unrealized Gain Change in unrealized appreciation on investments--net (700,182)
(Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 3,033,681
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the For the Period
Six Months November 3,
Ended 1995++ to
April 30, October 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <S> <C> <C>
Operations: Investment income--net $ 3,158,327 $ 4,841,127
Realized gain (loss) on investments--net 575,536 (460,513)
Change in unrealized appreciation on investments--net (700,182) 1,934,946
------------ ------------
Net increase in net assets resulting from operations 3,033,681 6,315,560
------------ ------------
Dividends to Investment income--net:
Shareholders Common Stock (2,493,624) (4,173,956)
(Note 1f): Preferred Stock (669,271) (662,603)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders (3,162,895) (4,836,559)
------------ ------------
Capital Stock Proceeds from issuance of Preferred Stock -- 38,000,000
Transactions Net increase in net assets derived from Common Stock transactions 5,370,050 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 5,370,050 119,993,876
------------ ------------
Net Assets: Total increase in net assets 5,240,836 121,472,877
Beginning of period 121,572,877 100,000
------------ ------------
End of period* $126,813,713 $121,572,877
============ ============
<FN>
*Undistributed investment income--net $ -- $ 4,568
============ ============
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
For the For the Period
The following per share data and ratios have been derived Six Months November 3,
from information provided in the financial statements. Ended 1995++ to
April 30, October 31,
Increase (Decrease) in Net Asset Value: 1997 1996
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 10.17 $ 10.00
Operating ------------ ------------
Performance: Investment income--net .37 .68
Realized and unrealized gain (loss) on investments--net (.02) .21
------------ ------------
Total from investment operations .35 .89
------------ ------------
Less dividends to Common Stock shareholders:
Investment income--net (.29) (.59)
------------ ------------
Effect of Preferred Stock activity:++++
Dividends to Preferred Stock shareholders:
Investment income--net (.08) (.09)
Capital charge resulting from issuance of Preferred Stock -- (.04)
------------ ------------
Total effect of Preferred Stock activity (.08) (.13)
------------ ------------
Net asset value, end of period $ 10.15 $ 10.17
============ ============
Total Investment Based on net asset value per share 2.71%+++ 7.81%+++
Return:** ============ ============
Ratios to Average Expenses, net of reimbursement .96%* .53%*
Net Assets:*** ============ ============
Expenses 1.31%* 1.26%*
============ ============
Investment income--net 5.12%* 5.40%*
============ ============
Supplemental Net assets, net of Preferred Stock, end of period (in thousands) $ 88,814 $ 83,573
Data: ============ ============
Preferred Stock outstanding, end of period (in thousands) $ 38,000 $ 38,000
============ ============
Portfolio turnover 79.72% 234.41%
============ ============
Leverage: Asset coverage per $1,000 $ 3,337 $ 3,199
============ ============
<PAGE>
Dividends Investment income--net $ 440 $ 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.
***Do not reflect the effect of dividends to Preferred Stock
shareholders.
++Commencement of Operations.
++++The Fund's Preferred Stock was initially 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. 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 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.
<PAGE>
(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.
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).
NOTES TO FINANCIAL STATEMENTS (concluded)
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.
<PAGE>
(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. Direct expenses relating to the public offering of
the Common and Preferred Stock were charged to capital at the time
of issuance. 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.
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. For the six months ended April
30, 1997, FAM earned fees of $308,528 of which $215,969 was
voluntarily waived.
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.
For the six months ended April 30, 1997, Merrill Lynch Funds
Distributor, Inc. ("MLFD") earned early withdrawal charges of
$73,661 relating to the tender of the Fund's shares.
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, MLFDS, MLFD, and/or ML & Co.
<PAGE>
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the six months ended April 30, 1997 were $103,846,214 and
$97,383,641, respectively.
Net realized and unrealized gains as of April 30, 1997 were as
follows:
Realized Unrealized
Gains Gains
Long-term investments $ 575,536 $ 1,234,764
---------- -----------
Total $ 575,536 $ 1,234,764
========== ===========
As of April 30, 1997, net unrealized appreciation for Federal income
tax purposes aggregated $1,234,764, of which $1,792,236 related to
appreciated securities and $557,472 related to depreciated
securities. The aggregate cost of investments at April 30, 1997, for
Federal income tax purposes was $124,094,167.
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 Six
Months Ended Dollar
April 30, 1997 Shares Amount
Shares sold 668,561 $ 6,837,829
Shares issued to shareholders in
reinvestment of dividends 60,954 623,084
----------- -----------
Total issued 729,515 7,460,913
Shares tendered (201,956) (2,090,863)
----------- -----------
Net increase 527,559 $ 5,370,050
=========== ===========
For the Period Ended
November 3, 1995++ to Dollar
October 31, 1996 Shares Amount
<PAGE>
Shares sold 8,331,280 $83,406,334
Shares issued to shareholders in
reinvestment of dividends 87,288 867,654
----------- -----------
Total issued 8,418,568 84,273,988
Shares tendered (199,672) (1,980,112)
----------- -----------
Net increase 8,218,896 $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 April 30, 1997 was 3.87%.
In connection with the offering of AMPS, the Board of Directors
reclassified 40,000 shares of unissued capital stock as AMPS. As of
April 30, 1997, there were 2,480 AMPS shares issued and 1,520 shares
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 1.00%,
calculated on the proceeds of each auction. For the six months ended
April 30, 1997, Merrill Lynch, Pierce, Fenner & Smith Inc., an
affiliate of FAM, earned $46,345 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
<PAGE>
Custodian
The Bank of New York
90 Washington Street
New York, NY 10286
Transfer Agent
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
