MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Quarterly Report
July 31, 1997
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
Patrick D. Sweeney, Secretary
Custodian
The Bank of New York
90 Washington Street
New York, NY 10286
Transfer Agents
Common Stock:
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
<PAGE>
Preferred Stock:
IBJ Schroder Bank & Trust Company
One State Street
New York, NY 10004
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
Printed on post-consumer recycled paper
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.
DEAR SHAREHOLDER
For the three months ended July 31, 1997, the Common Stock of
Merrill Lynch Municipal Strategy Fund, Inc. earned $0.147 per share
income dividends. This represents a net annualized yield of 5.36%,
based on a month-end per share net asset value of $10.90. Over the
same period, the total investment return on the Fund's Common Stock
was +8.88%, based on a change in per share net asset value from
$10.15 to $10.90, and assuming reinvestment of $0.145 per share
income dividends.
<PAGE>
For the three-month period ended July 31, 1997, the Fund's Auction
Market Preferred Stock had an average yield of 3.71%.
The Municipal Market
Environment
During the three months ended July 31, 1997, a number of very
favorable factors combined to push both tax-exempt and taxable bond
yields to recent historic lows. A slowing domestic economy, a
continued benign, if not improving, inflationary environment, a
declining Federal budget deficit with resultant reduced Treasury
borrowing needs, and a successful Congressional budget accord all
resulted in significant declines in fixed-income yields. By the end
of July, 30-year US Treasury bond yields declined 65 basis points
(0.65%) to 6.30%, their lowest level in over a year. Similarly, as
measured by the Bond Buyer Revenue Bond Index, long-term municipal
revenue bond yields fell over 50 basis points to end the July 31,
1997 quarter at 5.49%, their lowest level since early 1994.
The decline in tax-exempt bond yields in recent months was even more
impressive given that the municipal market lost much of the
technical support it enjoyed for over a year. In previous quarters,
new tax-exempt bond issuance was declining, or at least stable.
However, over the last three months, many municipal bond issuers
viewed the recent decline in bond yields as an opportunity to both
issue new debt as well as replace older, higher-couponed issues with
lower-yielding issues. Consequently, during the July 31, 1997
quarter, new tax-exempt bond issuance totaled over $54 billion, an
increase of over 15% compared to July 31, 1996 quarter levels.
The decline in municipal bond yields also resulted in some reduction
in retail investor demand. In earlier episodes of rapidly declining
interest rates, individual investor demand initially fell until
investors become more acclimated to the current levels. If interest
rates stabilize, we expect investor demand to return to earlier
levels. In addition, this past June and July, municipal bond
investors received over $50 billion in assets from coupon income
payments, bond maturities, and the proceeds from early bond
redemptions. Despite the continued allure of the US equity market,
most of these assets are expected to be reallocated to the municipal
bond market as investors adjust to the new investment environment.
<PAGE>
Looking forward, given the extent of the recent bond market rally,
some retrenchment or at least a period of consolidation is likely.
However, the positive backdrop of modest economic growth and low
inflation suggests that any such adjustment is not likely to be
excessive. Despite recent increases in new bond issuance, supply for
all of 1997 is not expected to be materially different than earlier
estimates of approximately $175 billion. It is likely that the
recent increase in issuance was largely borrowed from issuance
originally scheduled for later this year. Additionally, any
significant increase in tax-exempt bond yields will prevent any
further bond refinancings reducing future supply. Unless the current
positive economic fundamentals undergo immediate and meaningful
deterioration, any increase in municipal bond yields is likely to be
viewed as an opportunity to purchase more attractively priced tax-
exempt securities.
Portfolio Strategy
During the three months ended July 31, 1997, Merrill Lynch Municipal
Strategy Fund, Inc. maintained a defensive-to-neutral posture as we
concentrated on seeking to enhance tax-exempt income while
preserving net asset value. With economic growth at nearly 6.0%
during the first quarter of 1997, and the labor market at full
employment, we viewed the upside to the bond market as limited.
Surprisingly, the economy and interest rates behaved the exact
opposite of our forecast. Declining consumer demand brought the
economy to a standstill, inflation continued to remain benign, and
positive news on the Federal budget deficit pushed interest rates to
recent historic lows. Fortunately, the holdings of the Fund
outperformed the general market. Yield spreads on larger-coupon,
higher-yielding bonds which historically widen during declining
interest rate environments actually narrowed significantly.
Looking forward, we anticipate that the Federal Reserve Board will
resume raising short-term interest rates at least one more time,
which should place negative pressure on long-term tax-exempt rates.
The Fund will maintain its defensive-to-neutral posture until there
are signs the economy is slowing to below-trend growth, reducing the
threat of rising inflation.
The yield on the Fund's Auction Market Preferred Stock traded
between 3.55%--4.15%. Calendar pressures from corporate and
individual tax payments kept the yield at the higher end of this
range but it steadily declined over the past quarter. Leverage
continues to benefit the Common Stock shareholders by significantly
augmenting their yield. However, should the spread between short-
term and long-term 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
August 20, 1997
PORTFOLIO COMPOSITION
For the Quarter Ended July 31, 1997
Top Ten States*
New York 15.77%
Colorado 10.28
Illinois 7.49
Pennsylvania 7.46
Georgia 5.46
Texas 4.64
Massachusetts 3.92
New Mexico 3.87
Florida 3.78
Ohio 3.64
-------
Total Top Ten 66.31
Total Others 33.69
-------
Total Portfolio 100.00%
=======
<PAGE>
Net assets as of July 31, 1997 were $137,259,633.
Quality Ratings*
(Based on Nationally Recognized Rating Services)
A pie chart depicting the quality ratings of the Fund's Investments.
AAA/Aaa 41%
AA/Aa 15%
A/A 10%
BBB/Baa 16%
AA/Ba 8%
NR++ 10%
[FN]
*Based on total market value of the portfolio as of July 31, 1997.
++Not Rated.
