<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 31, 1997
SECURITIES ACT FILE NO. 333-19479
INVESTMENT COMPANY ACT FILE NO. 811-07203
POST-EFFECTIVE AMENDMENT TO REGISTRATION STATEMENT AS STATED BELOW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-2
/X/ REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
/ / PRE-EFFECTIVE AMENDMENT NO.
/X/ POST-EFFECTIVE AMENDMENT NO. 1
AND/OR
/X/ REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
/X/ AMENDMENT NO. 10
(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
<TABLE>
<S> <C>
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 282-2800
ARTHUR ZEIKEL
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
COPIES TO:
<TABLE>
<S> <C>
PATRICK D. SWEENEY, ESQ. FRANK P. BRUNO, ESQ.
FUND ASSET MANAGEMENT, L.P. BROWN & WOOD LLP
P.O. BOX 9011 ONE WORLD TRADE CENTER
PRINCETON, N.J. 08543-9011 NEW YORK, NEW YORK 10048-0557
</TABLE>
------------------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after
the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the 'Securities Act'), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. /X/
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. / /
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
CROSS REFERENCE SHEET
PURSUANT TO RULE 404(C)
<TABLE>
<S> <C>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
PART A--INFORMATION REQUIRED IN A PROSPECTUS
1. Outside Front Cover Page........................... Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages.......... Inside Front and Outside Back Cover Pages
3. Fee Table and Synopsis............................. Prospectus Summary; Fee Table
4. Financial Highlights............................... Financial Highlights
5. Plan of Distribution............................... Prospectus Summary; Purchase of Shares
6. Selling Shareholders............................... Not Applicable
7. Use of Proceeds.................................... Investment Objective and Policies
8. General Description of the Registrant.............. Prospectus Summary; The Fund; Investment Objective
and Policies; Risk and Special Considerations of
Leverage; Investment Restrictions
9. Management......................................... Investment Advisory and Administrative
Arrangements; Directors and Officers
10. Capital Stock, Long-Term Debt, and Other
Securities....................................... Description of Capital Stock
11. Defaults and Arrears on Senior Securities.......... Not Applicable
12. Legal Proceedings.................................. Not Applicable
13. Table of Contents of the Statement of Additional
Information...................................... Not Applicable
PART B--INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION
14. Cover Page......................................... Not Applicable
15. Table of Contents.................................. Not Applicable
16. General Information and History.................... Not Applicable
17. Investment Objective and Policies.................. Prospectus Summary; Investment Objective and
Policies; Investment Restrictions
18. Management......................................... Directors and Officers; Investment Advisory and
Administrative Arrangements
19. Control Persons and Principal Holders of
Securities....................................... Investment Advisory and Administrative Arrangements
20. Investment Advisory and Other Services............. Investment Advisory and Administrative
Arrangements; Custodian; Purchase of Shares;
Transfer Agent, Dividend Disbursing Agent and
Shareholder Servicing Agent; Legal Opinions;
Independent Auditors
21. Brokerage Allocation and Other Practices........... Portfolio Transactions
22. Tax Status......................................... Taxes
23. Financial Statements............................... Financial Statements
</TABLE>
PART C--OTHER INFORMATION
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 31, 1997
PROSPECTUS
FEBRUARY , 1998
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
COMMON STOCK
------------------------
Merrill Lynch Municipal Strategy Fund, Inc. (the 'Fund') is a continuously
offered, non-diversified, closed-end management investment company that seeks to
provide shareholders with as high a level of current income exempt from Federal
income taxes as is consistent with its investment policies and prudent
investment management. The Fund seeks to achieve its investment objective by
investing primarily in a portfolio of long-term, investment grade municipal
obligations the interest on which, in the opinion of bond counsel to the issuer,
is exempt from Federal income taxes. The Fund intends to maintain at least 75%
of its total assets in municipal obligations that are rated investment grade or,
if unrated, are considered by Fund Asset Management, L.P. (the 'Investment
Adviser') to be of comparable quality. THE FUND MAY INVEST UP TO 25% OF ITS
TOTAL ASSETS IN MUNICIPAL OBLIGATIONS THAT ARE RATED BELOW INVESTMENT GRADE
(SUCH OBLIGATIONS ARE COMMONLY REFERRED TO AS 'JUNK BONDS') OR, IF UNRATED, ARE
CONSIDERED BY THE INVESTMENT ADVISER TO BE OF COMPARABLE QUALITY. The Fund may
invest in certain tax-exempt securities that are classified as 'private activity
bonds' that may subject certain investors in the Fund to an alternative minimum
tax. At times, the Fund may seek to hedge its portfolio through the use of
options and futures transactions. There can be no assurance that the investment
objective of the Fund will be realized.
(Continued on next page)
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO SALES PROCEEDS TO
PUBLIC(1) LOAD(2) FUND(3)
<S> <C> <C> <C>
Per Share....................... $ None(2) $
Total(3)........................ $ None(2) $
</TABLE>
(1) The Common Stock is offered on a best efforts basis at a price equal to net
asset value, which from November 3, 1995 (commencement of operations) to the
date of this Prospectus, has ranged from $ to $ per share.
(2) Because Merrill Lynch Funds Distributor, Inc. will pay all offering expenses
(other than registration fees) and sales commissions to selected dealers
(primarily Merrill Lynch, Pierce, Fenner & Smith Incorporated) from its own
assets, all of the proceeds of the offering will be available to the Fund
for investment in portfolio securities. See 'Purchase of Shares.' Purchases
of shares of the Fund are not subject to any front-end sales charge, but are
subject to a contingent deferred sales charge ('CDSC') of up to 3.0% of the
original purchase amount as described herein.
(3) These amounts (a) do not take into account (i) organizational expenses of
the Fund of approximately $186,914, which are being amortized over a
five-year period and charged as expenses against the income of the Fund or
(ii) prepaid registration fees, in the amount of approximately $55,170,
which will be charged to income as the related shares are issued, and (b)
assume all shares currently registered are sold pursuant to a continuous
offering.
------------------------
FUND ASSET MANAGEMENT, L.P.--INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
(Continued from previous page)
No market presently exists for the Fund's Common Stock and it is not
currently expected that a secondary market will develop. The Fund intends to
offer shares of preferred stock from time to time representing up to
approximately 35% of the Fund's capital. There can be no assurance, however,
that preferred stock representing such percentage of the Fund's capital will
actually be issued. INVESTORS SHOULD NOTE THE SPECIAL RISKS ASSOCIATED WITH THE
LEVERAGING OF THE COMMON STOCK. SEE 'RISKS AND SPECIAL CONSIDERATIONS OF
LEVERAGE' AND 'DESCRIPTION OF CAPITAL STOCK.'
Shares of Common Stock of the Fund are offered on a best efforts basis at a
price equal to the next determined net asset value per share without a front-end
sales charge. As of the date of this Prospectus, net asset value per share is
$ . Shares may be purchased directly from Merrill Lynch Funds Distributor,
Inc. ('MLFD' or the 'Distributor'), P.O. Box 9081, Princeton, New Jersey
08543-9081, (609) 282-2800, or from securities dealers that have entered into
dealer agreements with the Distributor, including Merrill Lynch, Pierce, Fenner
& Smith Incorporated ('Merrill Lynch'). Merrill Lynch may charge its customers a
processing fee (presently $5.35) for confirming purchases and repurchases.
Purchases made directly through the Distributor are not subject to the
processing fee. The minimum initial purchase is $1,000 and the minimum
subsequent purchase is $50. See 'Purchase of Shares.'
Since the Fund's Common Stock may not be considered readily marketable, the
Board of Directors of the Fund presently intends, but is not required, to make
tender offers on a quarterly basis to purchase all or a portion of the Common
Stock of the Fund from shareholders at the net asset value per share on the date
the tender offer ends. In the event that tender offers are not made, however,
shareholders may find that their shares of Common Stock are not marketable. See
'Tender Offers.' Shares of Common Stock purchased by the Fund pursuant to tender
offers that have been held for less than three years will be subject to a CDSC
which will not exceed 3.0% of the original purchase amount for such Common
Stock, which will be paid to the Distributor. See 'Contingent Deferred Sales
Charge.'
As of the date of this Prospectus, the Fund has outstanding an aggregate of
1,920 shares of its Auction Market Preferred Stock(Registered), Series A (the
'Series A AMPS(Registered)'), which represent approximately 33% of the Fund's
capital. The Fund intends to issue preferred stock from time to time
representing up to approximately 35% of the Fund's capital. There can be no
assurance, however, that preferred stock representing any particular percentage
of the Fund's capital will actually be issued. The issuance of preferred stock
results in a leveraging of the Common Stock. The Series A AMPS pay dividends
that are adjusted generally every seven days and the dividend rate on the Series
A AMPS is based upon prevailing interest rates for debt obligations of
comparable maturity. The proceeds of the Series A AMPS issuance have been
invested in longer-term obligations in accordance with the Fund's investment
objective, as will the proceeds of the issuance of any other preferred stock.
The Fund may issue additional shares of its Series A AMPS or other preferred
stock in the future. Other preferred stock will pay dividends that will be
adjusted over either relatively short-term periods (generally seven to 28 days)
or medium-term periods (up to five years) and the dividend rates thereon will be
based upon prevailing interest rates for debt obligations of comparable
maturities. Because under normal market conditions, obligations with longer
maturities produce higher yields than short-term and medium-term obligations,
the Investment Adviser believes that the spread inherent in the difference
between the short-term and medium-term rates paid by the Fund and the
longer-term rates received by the Fund will provide holders of Common Stock with
a potentially higher yield.
The Fund is designed primarily for long-term investors and should not be
considered a vehicle for trading purposes. The address of the Fund is 800
Scudders Mill Road, Plainsboro, New Jersey 08536, and its telephone number is
(609) 282-2800. This Prospectus sets forth concisely information about the Fund
that a prospective investor ought to know before purchasing shares. Investors
are advised to read this Prospectus carefully and retain it for future
reference. The Securities and Exchange Commission maintains a web site
(http://www.sec.gov) that contains material incorporated by reference herein and
other information regarding the Fund.
- ------------------
(Registered)Registered trademark of Merrill Lynch & Co., Inc.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the more
detailed information included elsewhere in this Prospectus.
THE FUND
Merrill Lynch Municipal Strategy Fund, Inc. (the 'Fund') is a continuously
offered, non-diversified, closed-end management investment company. See 'The
Fund.'
THE OFFERING
Shares of Common Stock of the Fund may be offered by Merrill Lynch Funds
Distributor, Inc. (the 'Distributor'), and other securities dealers that have
entered into selected dealer agreements with the Distributor, including Merrill
Lynch, Pierce, Fenner & Smith Incorporated ('Merrill Lynch').
The Fund offers its Common Stock at a price equal to the next determined
net asset value per share without a front-end sales charge (although in certain
cases a contingent deferred sales charge ('CDSC') may apply as described
herein). The minimum initial purchase is $1,000 and the minimum subsequent
purchase is $50. The Fund reserves the right to waive or modify the initial and
subsequent minimum investment requirements at any time. See 'Purchase of
Shares.'
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of current income exempt from Federal income taxes as is consistent
with its investment policies and prudent investment management. The Fund will
seek to achieve its investment objective by investing primarily in a portfolio
of long-term investment grade municipal obligations the interest on which, in
the opinion of bond counsel to the issuer, is exempt from Federal income taxes.
The Fund intends to maintain at least 75% of its total assets in municipal
obligations that are rated investment grade or, if unrated, are considered by
the Investment Adviser to be of comparable quality. The Fund may invest up to
25% of its total assets in municipal obligations that are rated below investment
grade or, if unrated, are considered by the Investment Adviser to be of
comparable quality. Such lower quality municipal obligations (also commonly
referred to as 'junk bonds') are frequently traded only in markets where the
number of potential purchasers and sellers, if any, is very limited. See
'Investment Objective and Policies.'
TENDER OFFERS
No market presently exists for the Fund's Common Stock and it is not
currently anticipated that a secondary market will develop. In view of this, the
Board of Directors of the Fund intends to authorize tender offers on a quarterly
basis to purchase Common Stock of the Fund from shareholders at a price per
share equal to the net asset value per share of the Common Stock determined at
the close of business on the day an offer terminates.
The Board of Directors is under no obligation to authorize the making of a
tender offer and no assurance can be given that in any particular quarter a
tender offer will be made. If a tender offer is not made, shareholders may
2
<PAGE>
be unable to sell their shares. Shares of Common Stock that have been held for
less than three years and that are purchased by the Fund pursuant to tender
offers will be subject to a CDSC. See 'Contingent Deferred Sales Charge.' In
addition, Merrill Lynch charges its customers a processing fee (presently $5.35)
to confirm a repurchase of shares from such customers pursuant to a Tender
Offer. Tenders made directly through the Distributor are not subject to the
processing fee.
LEVERAGE
As of the date of this Prospectus, the Fund has outstanding an aggregate of
1,920 shares of its Series A AMPS, which represent approximately 33% of the
Fund's capital. The Fund intends to issue preferred stock from time to time
representing up to approximately 35% of the Fund's capital. There can be no
assurance, however, that preferred stock representing any particular percentage
of the Fund's capital will actually be issued. The issuance of preferred stock
results in a leveraging of the Common Stock. The Series A AMPS pay dividends
that are generally adjusted every seven days and the dividend rate on the Series
A AMPS is based upon prevailing interest rates for debt obligations of
comparable maturity. The proceeds of the Series A AMPS issuance have been
invested in longer-term obligations in accordance with the Fund's investment
objective, as will the proceeds of the issuance of any other preferred stock.
The Fund may issue additional shares of its Series A AMPS or other preferred
stock in the future. Other preferred stock will pay dividends that will be
adjusted over either relatively short-term periods (generally seven to 28 days)
or medium-term periods (up to five years) and the dividend rates thereon will be
based upon prevailing interest rates for debt obligations of comparable
maturities. Issuance and ongoing expenses of the preferred stock will be borne
by the Fund and will reduce the net asset value of the Common Stock.
Additionally, under certain circumstances when the Fund is required to allocate
taxable income to holders of preferred stock, the Series A AMPS require, and it
is anticipated that the terms of any other preferred stock will require, the
Fund to make an additional distribution to such holders in an amount
approximately equal to the tax liability resulting from such allocation and such
additional distribution (such amount, an 'Additional Distribution').
The use of leverage by the Fund creates an opportunity for increased net
income, but, at the same time, creates special risks. Because under normal
market conditions obligations with longer maturities produce higher yields than
short-term and medium-term obligations, the Investment Adviser believes that the
spread inherent in the difference between the short-term and medium-term rates
(and any Additional Distribution) paid by the Fund and the longer-term rates
received by the Fund will provide holders of Common Stock with a potentially
higher yield. Investors should note, however, that leverage creates certain
risks for holders of Common Stock, including higher volatility of both the net
asset value and market value of the Common Stock. Since any decline in the value
of the Fund's investments will be borne entirely by holders of Common Stock, the
effect of leverage in a declining market would result in a greater decrease in
net asset value than if the Fund were not leveraged, which would likely be
reflected in a decline in the market price for shares of Common Stock.
Additionally, fluctuations in the dividend rates on, and the amount of taxable
income allocable to, the preferred stock will affect the yield to holders of
Common Stock. See 'Risks and Special Considerations of Leverage.' Holders of the
Common Stock will receive all net income of the Fund remaining after payment of
dividends (and any Additional Distribution) on the Series A AMPS and any other
preferred stock to be issued by the Fund and will generally be entitled to a pro
rata share of net realized capital gains. Upon any liquidation of the Fund, the
holders of shares of preferred stock will be entitled to receive liquidating
distributions (expected to equal the original purchase price per share of
preferred stock plus any accumulated and unpaid dividends thereon and any
accumulated and unpaid Additional Distribution) before any distribution is made
to holders of Common Stock. See 'Description of Capital Stock--Preferred Stock.'
3
<PAGE>
Holders of preferred stock, voting as a separate class, will be entitled to
elect two of the Fund's Directors, and holders of common and preferred stock,
voting together as a single class, will be entitled to elect the remaining
Directors. If at any time dividends on the Fund's preferred stock were to be in
arrears in an amount equal to two full years of dividend payments, the holders
of all outstanding shares of preferred stock, voting as a separate class, would
be entitled to elect a majority of the Fund's Directors. The holders of
preferred stock will also vote separately on certain other matters as required
under the Fund's Articles of Incorporation and the Investment Company Act of
1940, as amended (the '1940 Act'), and Maryland law but otherwise will have
equal voting rights with holders of Common Stock (one vote per share) and will
vote together with holders of Common Stock as a single class. See 'Description
of Capital Stock--Preferred Stock--Voting Rights.'
There can be no assurance that the Fund will be able to realize a higher
net return on its investment portfolio than the then current dividend rate (and
any Additional Distribution) on the preferred stock. Changes in certain factors
could cause the relationship between the short-term and medium-term dividend
rates (and any Additional Distribution) paid by the Fund on the preferred stock
and the long-term rates received by the Fund on its investment portfolio to
change so that such short-term and medium-term rates (and any Additional
Distribution) may substantially increase relative to rates on the long-term
obligations in which the Fund may be invested. Under such conditions, the Fund's
leveraged capital structure would result in a greater decline in the net asset
value of the Common Stock and a greater decrease in the current yield paid to
holders of Common Stock than if the Fund were not leveraged. The Fund will have
the authority to redeem the preferred stock for any reason and may redeem all or
part of the preferred stock if it anticipates that the Fund's leveraged capital
structure will result in a lower rate of return to holders of the Common Stock
than that obtainable if the Common Stock were unleveraged for any significant
amount of time or in order to maintain asset coverage required by the 1940 Act
and any nationally recognized statistical rating organization rating the
preferred stock. The leveraging of the Common Stock would be eliminated during
any period that preferred stock is not outstanding.
The Series A AMPS have been rated 'aaa' by Moody's Investors Service, Inc.
('Moody's') and AAA by Standard & Poor's Ratings Services ('S&P'). Prior to the
time it offers additional preferred stock, the Fund intends to apply for ratings
on such preferred stock from one or more nationally recognized statistical
rating organizations. The Fund believes that obtaining a rating for such
preferred stock will enhance the marketability of the preferred stock and
thereby reduce the dividend rate on the preferred stock from that which the Fund
would be required to pay if the preferred stock were not rated. Ratings on
preferred stock issued by the Fund should not be confused with ratings on
obligations held by the Fund.
INVESTMENT ADVISER
Fund Asset Management, L.P. is the Fund's investment adviser (the
'Investment Adviser') and is responsible for the management of the Fund's
investment portfolio and for providing administrative services to the Fund. For
its advisory services, the Fund pays the Investment Adviser a monthly fee at the
annual rate of 0.50 of 1% of the Fund's average daily net assets, including
proceeds from the sale of preferred stock. For administrative services, the Fund
pays the Investment Adviser a monthly fee at the annual rate of 0.25 of 1% of
the Fund's average daily net assets, including proceeds from the sale of
preferred stock. While the aggregate of the advisory and administrative fees is
higher than that paid by many other investment companies, it is similar to that
paid by other continuously offered closed-end funds. The Investment Adviser is
an affiliate of Merrill Lynch Asset Management, L.P. ('MLAM'), which is owned
and controlled by Merrill Lynch & Co., Inc. ('ML & Co.'). The Investment Adviser
or MLAM acts as the investment adviser to more than 140 other registered
management investment companies. The Investment Adviser also offers portfolio
management and portfolio
4
<PAGE>
analysis services to individuals and institutions. As of November 30, 1997, the
Investment Adviser and MLAM had a total of approximately $273.9 billion in
investment company and other portfolio assets under management (approximately
$34.1 billion of which were invested in municipal securities), including
accounts of certain affiliates of the Investment Adviser. See 'Investment
Advisory and Administrative Arrangements.'
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to pay dividends monthly and to distribute substantially
all of its net investment income to holders of Common Stock. As long as any
preferred stock is outstanding, monthly distributions to holders of Common Stock
will consist of substantially all net investment income remaining after the
payment of dividends (and any Additional Distribution) on the Series A AMPS and
any other preferred stock to be issued by the Fund. Net capital gains, if any,
will be distributed at least annually to holders of Common Stock and on a pro
rata basis to holders of Common Stock and preferred stock. When capital gains or
other taxable income is allocated to holders of preferred stock under certain
circumstances, the terms of the Series A AMPS require, and it is anticipated
that the terms of any other preferred stock will require, the Fund to make an
Additional Distribution. The Fund is not permitted to declare any cash dividend
or other distribution on its Common Stock unless asset coverage (as defined in
the 1940 Act) with respect to the Fund's preferred stock is at least 200%. As of
the date of this Prospectus, the Series A AMPS represent approximately 33% of
the Fund's capital and the asset coverage with respect to the Series A AMPS is
approximately 307%. If the Fund's ability to make distributions on its Common
Stock is limited, this could under certain circumstances impair the ability of
the Fund to maintain its qualification for taxation as a regulated investment
company, which would have adverse tax consequences for holders of Common Stock.
See 'Taxes.'
AUTOMATIC DIVIDEND REINVESTMENT PLAN
All dividends and capital gains distributions will be automatically
reinvested in additional shares of Common Stock of the Fund unless a shareholder
elects to receive cash. Shareholders whose shares are held in the name of a
broker or nominee should contact such broker or nominee to confirm that they may
participate in the Fund's dividend reinvestment plan. See 'Automatic Dividend
Reinvestment Plan.'
RISK FACTORS AND SPECIAL CONSIDERATIONS
The Fund expects that there will be no secondary market for its Common
Stock. Moreover, Merrill Lynch and other selected dealers are prohibited under
applicable law from making a market in the Fund's Common Stock while the Fund is
making either a public offering of or a tender offer to purchase its Common
Stock. To the extent a secondary market does develop, however, investors should
be aware that the shares of closed-end funds frequently trade in the secondary
market at a discount. Should there be a secondary market for the Fund's shares
of Common Stock, the market price of the shares may vary from net asset value.
5
<PAGE>
Because of the lack of a secondary market and the CDSC, the Fund is
designed primarily for long-term investors and should not be considered a
vehicle for trading purposes.
The net asset value of the Fund's shares of Common Stock will fluctuate
with interest rate changes as well as with price changes of the Fund's portfolio
securities, and these fluctuations are likely to be greater in the case of a
fund having a leveraged capital structure, such as the Fund. See 'Risks and
Special Considerations of Leverage.'
The Fund has registered as a 'non-diversified' investment company so that
it will be able to invest more than 5% of its assets in the obligations of any
single issuer, subject to the diversification requirements of Subchapter M of
the Internal Revenue Code of 1986, as amended (the 'Code'), applicable to the
Fund. Since the Fund may invest a relatively high percentage of its assets in
the obligations of a limited number of issuers, the Fund may be more susceptible
than a more widely-diversified fund to any single economic, political or
regulatory occurrence.
The Fund intends to invest at least 75% of its total assets in municipal
obligations that are rated in the investment grade rating categories by S&P,
Moody's or Fitch IBCA, Inc. ('Fitch') or, if not rated, are considered to be of
comparable quality by the Investment Adviser. Obligations rated in the lowest
investment-grade category have certain speculative characteristics.
Additionally, the Fund may invest up to 25% of its total assets in municipal
obligations that are rated below investment grade (such obligations are commonly
referred to as 'junk bonds') or, if not rated, considered by the Investment
Adviser to be of comparable quality. These securities are regarded as
predominantly speculative and investments therein entail certain risks. See
'Investment Objective and Policies.' The Fund may invest in certain tax-exempt
securities classified as 'private activity bonds' that may subject certain
investors in the Fund to the alternative minimum tax. See 'Taxes--General.'
The following table sets forth the market value, by S&P rating category, of
all the obligations held by the Fund at October 31, 1997:
<TABLE>
<S> <C>
Rated Obligations........................................................................ 80.20%
AAA: 39.4%; AA: 9.8%; A: 7.8%; BBB: 8.8%; BB: 7.0%;
B: 1.3% and A1+: 6.1%
Unrated Obligations*..................................................................... 19.8%
</TABLE>
- ------------------
* Obligations that are not rated by S&P. Such obligations may be rated by
nationally recognized statistical rating organizations other than S&P, or may
not be rated by any of such organizations. With respect to the percentage of
the Fund's assets invested in such securities, the Fund's Investment Adviser
believes that, 2.0% are of comparable quality to obligations rated AAA, 2.6%
are of comparable quality to obligations rated AA, 6.6% are of comparable
quality to obligations rated BBB, and 8.6% are of comparable quality to
obligations rated BB. This determination is based on the Investment Adviser's
own internal evaluation and does not necessarily reflect how such securities
would be rated by S&P if it were to rate the securities.
6
<PAGE>
The Fund will be subject to certain restrictions on investments imposed by
guidelines of one or more nationally recognized statistical rating organizations
that may issue ratings for the preferred stock. These guidelines may impose
asset coverage or portfolio composition requirements that are more stringent
than those imposed by the 1940 Act. It is not anticipated that these covenants
or guidelines will impede the Investment Adviser from managing the Fund's
portfolio in accordance with the Fund's investment objective and policies.
In order to seek to hedge various portfolio positions or to enhance its
return, the Fund may invest in certain instruments that may be characterized as
derivatives. These investments include various types of options transactions and
futures and options thereon. Such investments also may consist of non-municipal
tax-exempt securities and securities the potential investment return on which is
based on the change in particular measurements of value or interest rates
('indexed securities'), including securities the potential investment return on
which is inversely related to a change in particular measurements of value or
interest rates ('inverse securities'). Certain of such investments may be made
solely for hedging purposes, not for speculation, and may in some cases require
limitations as to the type of permissible counter-party to the transaction.
Investments in indexed securities, including inverse securities, subject the
Fund to the risks associated with changes in the particular indices, which may
include reduced or eliminated interest payments and losses of invested
principal. Derivative instruments may have certain characteristics that have a
similar effect on the return to Common Stock investors as the leverage
transactions discussed under 'Risks and Special Considerations of Leverage;'
however, certain derivative investments will not be taken into account for
purposes of calculating the percentage of leverage of the Fund's portfolio. For
a further discussion of the risks associated with derivative investments, see
'Investment Objective and Policies,' 'Investment Objective and Policies--Other
Investment Policies-- Indexed and Inverse Floating Obligations,' '--Call Rights'
and 'Investment Objective and Policies--Options and Futures Transactions.'
Subject to its investment restrictions, the Fund is authorized to engage in
options and futures transactions on exchanges and in the over-the-counter
markets ('OTC options') for hedging purposes with certain specified entities
meeting the criteria of the Fund. These transactions involve certain risk
considerations. These risks include the risk of imperfect correlation in
movements in the price of futures contracts and movements in the price of the
security which is the subject of the hedge and the inability to close futures
transactions under certain conditions. Options transactions involve the
potential loss of the opportunity to profit from any price increase in the
underlying security above the option exercise price or the potential loss of the
premium paid for the option. Because of the anticipated leveraged nature of the
Common Stock, hedging transactions will result in a larger impact on the net
asset value of the Common Stock than would be the case if the Common Stock were
not leveraged. OTC options and assets used to cover OTC options written by the
Fund are considered by the staff of the Securities and Exchange Commission to be
illiquid. The illiquidity of such options or assets may prevent a successful
sale of such options or assets, result in a delay of sale, or reduce the amount
of proceeds that might be otherwise realized. See 'Investment Objective and
Policies--Options and Futures Transactions.' The Fund intends to apply for
ratings of the preferred stock from one or more nationally recognized
statistical rating organizations. In order to obtain these ratings, the Fund may
be required to limit its use of hedging techniques in accordance with the
specified guidelines of such rating organizations.
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. See 'Description of Capital
Stock--Certain Provisions of the Articles of Incorporation.'
7
<PAGE>
FEE TABLE
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum Sales Load (as a percentage of offering price).................................... None
Dividend Reinvestment Plan Fees........................................................... None
Contingent Deferred Sales Charge (as a percentage of original purchase price or net asset
value at the time of repurchase)(a)..................................................... 3.0% during the first
year, decreasing 1.0%
annually thereafter to
0.0% after the third
year
<CAPTION>
ANNUAL EXPENSES (AS A PERCENTAGE OF AVERAGE NET ASSETS
ATTRIBUTABLE TO SHARES OF COMMON STOCK)
<S> <C>
Investment Advisory Fee(b)............................................................................. 0.72%
Shareholder Servicing Fee(c)........................................................................... 0.12%
Interest Payments on Borrowed Funds.................................................................... None
Other Expenses(d)...................................................................................... 1.01%
-----
Total Annual Expenses(e)............................................................................... 1.85%
-----
-----
</TABLE>
- ------------------------
(a) See 'Contingent Deferred Sales Charge'--page 30.
(b) For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay monthly fees at the annual rate of
0.50 of 1% of the Fund's average daily net assets (i.e., the average daily
value of the total assets of the Fund, including proceeds from the issuance
of shares of preferred stock, minus the sum of accrued liabilities of the
Fund and accumulated dividends on the shares of preferred stock). As of the
date of this Prospectus, the Fund has utilized leverage by issuing Series A
AMPS in an amount representing approximately 33% of the Fund's capital. See
'Risks and Special Considerations of Leverage'--page 21 and 'Investment
Advisory and Administrative Arrangements'--page 33.
(c) See 'Investment Advisory and Administrative Arrangements--Transfer Agency
Services'--page 35.
(d) Includes monthly fees payable to the Investment Adviser under the
Administration Agreement at the annual rate of 0.25 of 1% of the Fund's
average daily net assets, as defined in note (b) above. See 'Investment
Advisory and Administrative Arrangements'--page 33.
(e) For the fiscal year ended October 31, 1997, the Investment Adviser
voluntarily waived $424,822 of the advisory fees due from the Fund. Total
Annual Expenses in the fee table have been restated to assume the absence of
any such waiver because the Investment Adviser may discontinue or reduce
such waiver of fees at any time without notice. For the fiscal year ended
October 31, 1997, the Investment Adviser waived advisory fees totaling 0.32%
after which the Fund's total expense ratio was 0.96%.
<TABLE>
<CAPTION>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000 investment assuming,
(1) total annual expenses of 1.85%, (2) a 5% annual return throughout the
periods and (3) tender at the end of the period............................ $ 49* $68* $ 100 $217
An investor would pay the following expenses on a $1,000 investment assuming
no tender at the end of the period......................................... $ 19 $58 $ 100 $217
</TABLE>
- ------------------------
* Reflects the Contingent Deferred Sales Charge.
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Expenses set forth under 'Other Expenses' are based on estimated
amounts through the end of the Fund's current fiscal year. The example set forth
above assumes reinvestment of all dividends and distributions and utilizes a 5%
annual rate of return as mandated by the Securities and Exchange Commission
regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR ANNUAL RATES
OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE.
Merrill Lynch may charge its customers a processing fee (presently $5.35) for
confirming purchases and repurchases. Purchases and repurchases made directly
through the Distributor are not subject to the processing fee. See 'Purchase of
Shares' and 'Tender Offers.'
8
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with the annual audits of the financial statements of the Fund by
Deloitte & Touche LLP, independent auditors. Financial statements for the fiscal
year ended October 31, 1997 and the independent auditors' report thereon are set
forth herein under 'Financial Statements.'
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR NOVEMBER 3, 1995+
Increase (Decrease) in Net Asset Value ENDED TO
per share of Common Stock: OCTOBER 31, 1997 OCTOBER 31, 1996
- ----------------------------------------------------------------------------- ---------------- -----------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value per share of Common Stock, beginning of period............... $ 10.17 $ 10.00
-------- --------
Investment Income--net..................................................... .75 .68
Realized and unrealized gain on investments--net........................... .70 .21
-------- --------
Total from investment operations............................................. 1.45 .89
-------- --------
Less dividends to Common Stock shareholders:
Investment income--net..................................................... (.59) (.59)
-------- --------
Effect of Preferred Stock activity:++
Dividends to Preferred Stock shareholders:
Investment income--net................................................... (.16) (.09)
Capital charge resulting from issuance of Preferred Stock.................. -- (.04)
-------- --------
Total effect of Preferred Stock activity..................................... (.16) (.13)
-------- --------
Net asset value per share of Common Stock, end of period..................... $ 10.87 $ 10.17
-------- --------
-------- --------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share of Common Stock......................... 13.08% 7.81%#
-------- --------
-------- --------
RATIOS TO AVERAGE NET ASSETS:***
Expenses, net of reimbursement............................................... .96% .53%*
-------- --------
-------- --------
Expenses..................................................................... 1.28% 1.26%*
-------- --------
-------- --------
Investment income--net....................................................... 5.01% 5.40%*
-------- --------
-------- --------
SUPPLEMENTAL DATA:
Net assets, net of Preferred Stock, end of period (in thousands)............. $101,463 $ 83,573
-------- --------
-------- --------
Preferred Stock outstanding, end of period (in thousands).................... $ 48,000 $ 38,000
-------- --------
-------- --------
Portfolio turnover........................................................... 144.34% 234.41%
-------- --------
-------- --------
LEVERAGE:
Asset coverage per $1,000 of Preferred Stock................................. $ 3,114 $ 3,199
-------- --------
-------- --------
DIVIDENDS PER SHARE ON PREFERRED STOCK OUTSTANDING:
Investment Income--net....................................................... $ 897 $ 564
-------- --------
-------- --------
</TABLE>
- ------------------
* Annualized.
** Total investment returns exclude the effects of the CDSC per share of Common
Stock, 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 initially was issued on March 11, 1996.
# Aggregate total investment return.
9
<PAGE>
THE FUND
Merrill Lynch Municipal Strategy Fund, Inc. (the 'Fund') is a continuously
offered, non-diversified, closed-end management investment company. The Fund was
incorporated under the laws of the State of Maryland on July 13, 1994, and has
registered as an investment company under the Investment Company Act of 1940, as
amended (the '1940 Act'). The Fund's principal office is located at 800 Scudders
Mill Road, Plainsboro, New Jersey 08536, and its telephone number is (609)
282-2800.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of current income exempt from Federal income taxes as is consistent
with its investment policies and prudent investment management. The Fund seeks
to achieve its investment objective by investing primarily in a portfolio of
long-term, investment grade municipal obligations, the interest on which, in the
opinion of bond counsel to the issuer, is exempt from Federal income taxes. The
investment objective of the Fund is a fundamental policy of the Fund and,
therefore, may not be changed without a vote of a majority of the outstanding
voting securities of the Fund, as defined below under 'Investment Restrictions.'
There can be no assurance that the investment objective of the Fund will be
realized. At times, the Fund may seek to hedge its portfolio through the use of
futures transactions and options to reduce volatility in the net asset value of
its shares of Common Stock.
The Fund, at all times, except during interim and temporary periods as
discussed below, will invest at least 80% of its total assets in a portfolio of
obligations issued by or on behalf of states, territories and possessions of the
United States and their political subdivisions, agencies or instrumentalities
paying interest which, in the opinion of bond counsel to the issuer, is exempt
from Federal income taxes ('Municipal Bonds'). The Fund, at all times, except
during temporary periods, will maintain at least 75% of its total assets in
Municipal Bonds that are rated investment grade by a nationally recognized
statistical rating organization or, if unrated, are considered to be of
comparable quality by the Investment Adviser. Additionally, the Fund may invest
up to 25% of its total assets in Municipal Bonds that are rated below investment
grade by a nationally recognized statistical rating organization or, are
unrated, but considered by the Investment Adviser to be of comparable quality.
Such lower quality Municipal Bonds are frequently traded only in markets where
the number of potential purchasers and sellers, if any, is very limited. The
Fund may invest in certain tax-exempt securities classified as 'private activity
bonds' (in general, bonds that benefit non-governmental entities) that may
subject certain investors in the Fund to an alternative minimum tax. The Fund
will not invest more than 25% of its total assets (taken at market value) in
Municipal Bonds whose issuers are located in the same state.
The Fund also may invest in securities not issued by or on behalf of a
state or territory or by an agency or instrumentality thereof, if the Fund
nevertheless believes such securities pay interest or distributions that are
exempt from Federal income taxation ('Non-Municipal Tax-Exempt Securities').
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in Municipal Bonds, to the extent such
investments are permitted by the 1940 Act. Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term Municipal Bonds. Certain Non-Municipal
Tax-Exempt Securities may be characterized as derivative instruments.
Non-Municipal Tax-Exempt Securities will be considered 'Municipal Bonds' for
purposes of the Fund's investment objective and policies.
Investment in shares of Common Stock of the Fund offers several potential
benefits. The Fund offers investors the opportunity to receive income exempt
from Federal income taxes by investing in a professionally managed portfolio
comprised primarily of investment grade Municipal Bonds. The Fund also relieves
the
10
<PAGE>
investor of the burdensome administrative details involved in managing a
portfolio of Municipal Bonds. Additionally, the Investment Adviser will seek to
enhance the yield on the Common Stock by leveraging the Fund's capital structure
through the issuance of preferred stock. These benefits are at least partially
offset by the expenses involved in operating an investment company. Such
expenses primarily consist of the advisory and administrative fees and
operational costs. Additionally, the use of leverage involves certain expenses
and special risk considerations. See 'Risks and Special Considerations of
Leverage.'
The investment grade Municipal Bonds in which the Fund will invest are
those Municipal Bonds rated at the date of purchase in the four highest rating
categories of S&P, Moody's or Fitch or, if unrated, considered to be of
comparable quality by the Investment Adviser. In the case of long-term debt, the
investment grade rating categories are AAA through BBB for S&P, Aaa through Baa
for Moody's and AAA through BBB for Fitch. In the case of short-term notes, the
investment grade rating categories are SP-1+ through SP-3 for S&P, MIG-1 through
MIG-4 for Moody's and F-1+ through F-3 for Fitch. In the case of tax-exempt
commercial paper, the investment grade rating categories are A-1+ through A-3
for S&P, Prime-1 through Prime-3 for Moody's and F-1+ through F-3 for Fitch.
Obligations ranked in the fourth highest rating category (BBB, SP-3 and A-3 for
S&P; Baa, MIG-4 and Prime-3 for Moody's; and BBB, F-3 and F-3 for Fitch), while
considered 'investment grade,' have certain speculative characteristics. There
may be sub-categories or gradations indicating relative standing within the
rating categories set forth above. See Appendix I to this Prospectus for a
description of S&P's, Moody's and Fitch's ratings of Municipal Bonds. In
assessing the quality of Municipal Bonds with respect to the foregoing
requirements, the Investment Adviser will take into account the nature of any
letters of credit or similar credit enhancements to which particular Municipal
Bonds are entitled and the creditworthiness of the financial institution that
provided such credit enhancement.
As noted above, the Fund may invest up to 25% of its assets in Municipal
Bonds that are rated below investment grade or, if unrated, are considered to be
of comparable quality by the Investment Adviser. These high yield bonds are
commonly referred to as 'junk bonds' and are regarded as predominantly
speculative as to the issuer's ability to make payments of principal and
interest. Consequently, although such bonds can be expected to provide higher
yields and be less subject to interest rate fluctuations, they may be subject
to greater market price fluctuations and risk of loss of principal than lower
yielding, higher rated fixed income securities. Such securities are particularly
vulnerable to adverse changes in the issuer's industry and in general economic
conditions. Issuers of high yield bonds may be highly leveraged and may not have
available to them more traditional methods of financing. The risk of loss due to
default by the issuer is significantly greater for the holders of these bonds
because such securities may be unsecured and may be subordinated to other
creditors of the issuer. In addition, while the high yield bonds in which the
Fund may invest normally will not include securities that, at the time of
investment, are in default or the issuers of which are in bankruptcy, there can
be no assurance that such events will not occur after the Fund purchases a
particular security, in which case the Fund may experience losses and incur
costs.
High yield bonds frequently have call or redemption features that permit an
issuer to repurchase such bonds from the Fund, which may decrease the net
investment income to the Fund and dividends to shareholders in the event that
the Fund is required to replace a called security with a lower yielding
security. The Fund may have difficulty disposing of certain high yield bonds
because there may be a thin trading market for such securities. Reduced
secondary market liquidity may have an adverse impact on market price and the
Fund's ability to dispose of particular issues when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. In addition, market
quotations are generally available on many high yield bond issues only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales.
11
<PAGE>
Certain Municipal Bonds may be entitled to the benefits of letters of
credit or similar credit enhancements issued by financial institutions. In such
instances, the Board of Directors and the Investment Adviser will take into
account in assessing the quality of such bonds not only the creditworthiness of
the issuer of such bonds but also the creditworthiness of the financial
institutions.
The Fund's investments may also include variable rate demand obligations
('VRDOs') and VRDOs in the form of participation interests ('Participating
VRDOs') in variable rate tax-exempt obligations held by a financial institution,
typically a commercial bank. The VRDOs in which the Fund will invest are
tax-exempt obligations in the opinion of counsel to the issuer that contain a
floating or variable interest rate adjustment formula and an unconditional right
of demand on the part of the holder thereof to receive payment of the unpaid
principal balance plus accrued interest on a short notice period not to exceed
seven days. Participating VRDOs provide the Fund with a specified undivided
interest (up to 100%) in the underlying obligation and the right to demand
payment of the unpaid principal balance plus accrued interest on the
Participating VRDOs from the financial institution on a specified number of
days' notice, not to exceed seven days. There is, however, the possibility that
because of default or insolvency, the demand feature of VRDOs or Participating
VRDOs may not be honored. The Fund has been advised by its counsel that the Fund
should be entitled to treat the income received on Participating VRDOs as
interest from tax-exempt obligations.
The average maturity of the Fund's portfolio securities will vary based
upon the Investment Adviser's assessment of economic and market conditions. The
net asset value of the shares of common stock of a closed-end investment
company, such as the Fund, which invests primarily in fixed-income securities,
changes as the general levels of interest rates fluctuate. When interest rates
decline, the value of a fixed-income portfolio can be expected to rise.
Conversely, when interest rates rise, the value of a fixed-income portfolio can
be expected to decline. Prices of longer-term securities generally fluctuate
more in response to interest rate changes than do short-term or medium-term
securities. These changes in net asset value are likely to be greater in the
case of a fund having a leveraged capital structure, such as that used by the
Fund. See 'Risks and Special Considerations of Leverage.'
The Fund intends to invest primarily in long-term Municipal Bonds with a
maturity of more than ten years. Also, the Fund may invest in intermediate-term
Municipal Bonds with a maturity of between three years and ten years. The Fund
may invest in short-term, tax-exempt securities, short-term U.S. Government
securities, repurchase agreements or cash. Such short-term securities or cash
will not exceed 20% of its total assets except during interim periods pending
investment of the net proceeds of public offerings of the Fund's securities or
in anticipation of the repurchase or redemption of the Fund's securities and
temporary periods when, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. The Fund does not ordinarily intend to
realize significant interest income not exempt from Federal income tax.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by such Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund as a 'regulated
investment company' for purposes of the Code. See 'Taxes.' To qualify, among
other requirements, the Fund will limit its investments so that, at the close of
each quarter of the taxable year, (i) not more than 25% of the market value of
the Fund's total assets will be invested in the securities (other than U.S.
Government securities) of a single issuer, and (ii) with respect to 50% of the
market value of its total assets, not more than 5% of the market value of its
total assets will be invested in the securities (other than U.S. Government
securities) of a single issuer. A fund that elects to be classified as
'diversified' under the 1940 Act must satisfy the foregoing 5% requirement with
respect to 75% of its total assets. To the extent that the Fund assumes large
positions in the securities of a small number of issuers,
12
<PAGE>
the Fund's yield may fluctuate to a greater extent than that of a diversified
company as a result of changes in the financial condition or in the market's
assessment of the issuers.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include primarily debt obligations issued to obtain funds
for various public purposes, including construction and equipping of a wide
range of public facilities, refunding of outstanding obligations and obtaining
funds for general operating expenses and loans to other public institutions and
facilities. In addition, certain types of industrial development bonds are
issued by or on behalf of public authorities to finance various privately
operated facilities, including certain local facilities for water supply, gas,
electricity, sewage or solid waste disposal. For purposes of this Prospectus,
such obligations are Municipal Bonds if the interest paid thereon is exempt from
Federal income tax, even though such bonds may be industrial development bonds
('IDBs') or 'private activity bonds' as discussed below. Also, for purposes of
this Prospectus, Non-Municipal Tax-Exempt Securities as discussed above will be
considered Municipal Bonds.
The two principal classifications of Municipal Bonds are 'general
obligation' bonds and 'revenue' or 'special obligation' bonds, which latter
category includes IDBs and, for bonds issued after August 15, 1986, private
activity bonds. General obligation bonds are secured by the issuer's pledge of
faith, credit and taxing power for the payment of principal and interest. The
taxing power of any governmental entity may be limited, however, by provisions
of state constitutions or laws, and an entity's credit will depend on many
factors, including potential erosion of the tax base due to population declines,
natural disasters, declines in the state's industrial base or inability to
attract new industries, economic limits on the ability to tax without eroding
the tax base, state legislative proposals or voter initiatives to limit ad
valorem real property taxes, and the extent to which the entity relies on
Federal or state aid, access to capital markets or other factors beyond the
state's or entity's control. Revenue or special obligation bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise tax or other specific
revenue source such as from the user of the facility being financed. IDBs are in
most cases revenue bonds and generally are not secured by a pledge of the credit
or taxing power of the issuer of such bonds. The payment of the principal and
interest on such industrial development bonds depends solely on the ability of
the user of the facility financed by the bonds to meet its financial obligations
and the pledge, if any, of real and personal property so financed as security
for such payment. Municipal Bonds also may include 'moral obligation' bonds,
which normally are issued by special purpose public authorities. If an issuer of
moral obligation bonds is unable to meet its obligations, the repayment of such
bonds becomes a moral commitment but not a legal obligation of the state or
municipality in question.
The Fund may purchase Municipal Bonds classified as 'private activity
bonds' (in general, bonds that benefit non-governmental entities). Interest
received on certain tax-exempt securities that are classified as 'private
activity bonds' may subject certain investors in the Fund to an alternative
minimum tax. See 'Taxes-- General.' There is no limitation on the percentage of
the Fund's assets that may be invested in Municipal Bonds that may subject
certain investors to an alternative minimum tax. Also included within the
general category of Municipal Bonds are participation certificates issued by
government authorities or entities to finance the acquisition or construction of
equipment, land and/or facilities. The certificates represent participations in
a lease, an installment purchase contract or a conditional sales contract
(hereinafter collectively referred to as 'lease obligations') relating to such
equipment, land or facilities. Although lease obligations do not constitute
general obligations of the issuer for which the issuer's unlimited taxing power
is pledged, a lease obligation frequently is backed by the issuer's covenant to
budget for, appropriate and make the payments due under the lease obligation.
However, certain lease obligations contain 'non-appropriation' clauses, which
provide that the issuer has no
13
<PAGE>
obligation to make lease or installment purchase payments in future years unless
money is appropriated for such purpose on a yearly basis. Although
'non-appropriation' lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that has not yet
developed the depth of marketability associated with more conventional
securities.
Federal tax legislation has limited the types and volume of bonds
qualifying for a Federal income tax exemption of interest. As a result, this
legislation and legislation that may be enacted in the future may affect the
availability of Municipal Bonds for investment by the Fund.
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
Borrowings. The Fund is authorized to borrow money in amounts of up to 5%
of the value of its total assets at the time of such borrowings; provided,
however, that the Fund is authorized to borrow moneys in amounts of up to
33 1/3% of the value of its total assets at the time of such borrowings to
finance the repurchase of its own Common Stock pursuant to tender offers, if
any, or otherwise, to redeem or repurchase shares of preferred stock or for
temporary, extraordinary or emergency purposes. Borrowings by the Fund (commonly
known, as with the issuance of preferred stock, as 'leveraging') create an
opportunity for greater total return since the Fund will not be required to sell
portfolio securities to purchase tendered shares but, at the same time, increase
exposure to capital risk. In addition, borrowed funds are subject to interest
costs that may offset or exceed the return earned on the borrowed funds.
When-Issued Securities and Delayed Delivery Transactions. The Fund may
purchase or sell Municipal Bonds on a delayed delivery basis or on a when-issued
basis at fixed purchase or sale terms. These transactions arise when securities
are purchased or sold by the Fund with payment and delivery taking place in the
future. The purchase will be recorded on the date the Fund enters into the
commitment, and the value of the obligation will thereafter be reflected in the
calculation of the Fund's net asset value. The value of the obligation on the
delivery date may be more or less than its purchase price. A separate account of
the Fund will be established with its custodian consisting of cash, cash
equivalents or liquid Municipal Bonds having a market value at all times at
least equal to the amount of the forward commitment.
Indexed and Inverse Floating Obligations. The Fund may invest in Municipal
Bonds the return on which is based on a particular index of value or interest
rates. For example, the Fund may invest in Municipal Bonds that pay interest
based on an index of Municipal Bond interest rates. The principal amount payable
upon maturity of certain Municipal Bonds also may be based on the value of an
index. To the extent the Fund invests in these types of Municipal Bonds, the
Fund's return on such Municipal Bonds will be subject to risk with respect to
the value of the particular index. Also, the Fund may invest in so-called
'inverse floating obligations' or 'residual interest bonds' on which the
interest rates typically vary inversely with a short-term floating rate (which
may be reset periodically by a dutch auction, a remarketing agent, or by
reference to a short-term tax-exempt interest rate index). The Fund may purchase
in the secondary market synthetically-created inverse floating rate bonds
evidenced by custodial or trust receipts. Generally, interest rates on inverse
floating rate bonds will decrease when short-term rates increase, and will
increase when short-term rates decrease. Such securities have the effect of
providing a degree of investment leverage, since they may increase or decrease
in value in response to changes, as an illustration, in market interest rates at
a rate that is a multiple (typically two) of the rate at which fixed-rate,
long-term, tax-exempt securities increase or decrease in response to such
changes. As a result, the market values of such securities generally will be
more volatile than the market values of fixed-rate tax-exempt
14
<PAGE>
securities. To seek to limit the volatility of these securities, the Fund may
purchase inverse floating obligations with shorter-term maturities or which
contain limitations on the extent to which the interest rate may vary. The
Investment Adviser believes that indexed and inverse floating obligations
represent a flexible portfolio management instrument for the Fund which allows
the Investment Adviser to vary the degree of investment leverage relatively
efficiently under different market conditions. The Fund will not invest more
than 10% of its total assets in inverse floating obligations and residual
interest bonds.
Call Rights. The Fund may purchase a Municipal Bond issuer's right to call
all or a portion of such Municipal Bond for mandatory tender for purchase (a
'Call Right'). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to holding a
Municipal Bond as a non-callable security.
Repurchase Agreements. The Fund may invest in Municipal Bonds and U.S.
Government securities pursuant to repurchase agreements. Repurchase agreements
may be entered into only with a member bank of the Federal Reserve System or a
primary dealer in U.S. Government securities. Under such agreements, the bank or
primary dealer agrees, upon entering into the contract, to repurchase the
security at a mutually agreed upon time and price, thereby determining the yield
during the term of the agreement. This results in a fixed rate of return
insulated from market fluctuations during such period. The Fund may not invest
in repurchase agreements maturing in more than seven days if such investments,
together with all other illiquid investments, would exceed 15% of the Fund's net
assets. In the event of default by the seller under a repurchase agreement, the
Fund may suffer time delays and incur costs or possible losses in connection
with the disposal of the collateral.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities 'sold.' Therefore,
amounts earned under such agreements will not be considered tax-exempt interest.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of Common
Stock, the net asset value of the Common Stock will fluctuate. There can be no
assurance that the Fund's hedging transactions will be effective. In addition,
because of the anticipated leveraged nature of the Common Stock, hedging
transactions will result in a larger impact on the net asset value of the Common
Stock than would be the case if the Common Stock were not leveraged.
Furthermore, the Fund will only engage in hedging activities from time to time
and may not necessarily be engaging in hedging activities when movements in
interest rates occur.
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains from transactions in options and futures
contracts distributed to shareholders will be taxable as ordinary income or, in
certain circumstances, as long-term capital gains to shareholders. See
'Taxes--Tax Treatment of Options and Futures Transactions.' In addition, in
order to obtain ratings of the preferred stock from one or more nationally
recognized statistical rating organizations, the Fund may be required to limit
its use of hedging techniques in accordance with the specified guidelines of
such organizations.
15
<PAGE>
The following is a description of the options and futures transactions in
which the Fund may engage, limitations on the use of such transactions and risks
associated therewith. The investment policies with respect to the hedging
transactions of the Fund are not fundamental policies and may be modified by the
Board of Directors of the Fund without the approval of the Fund's shareholders.
Writing Covered Call Options. The Fund may write (i.e., sell) covered call
options with respect to Municipal Bonds it owns, thereby giving the holder of
the option the right to buy the underlying security covered by the option from
the Fund at the stated exercise price until the option expires. The Fund writes
only covered call options, which means that so long as the Fund is obligated as
the writer of a call option, it will own the underlying securities subject to
the option. The Fund may not write covered call options on underlying securities
in an amount exceeding 15% of the market value of its total assets.
The Fund will receive a premium from writing a call option, which increases
the Fund's return on the underlying security in the event the option expires
unexercised or is closed out at a profit. By writing a call, the Fund limits its
opportunity to profit from an increase in the market value of the underlying
security above the exercise price of the option for as long as the Fund's
obligation as a writer continues. Covered call options serve as a partial hedge
against a decline in the price of the underlying security. The Fund may engage
in closing transactions in order to terminate outstanding options that it has
written.
Purchase of Options. The Fund may purchase put options in connection with
its hedging activities. By buying a put the Fund has a right to sell the
underlying security at the exercise price, thus limiting the Fund's risk of loss
through a decline in the market value of the security until the put expires. The
amount of any appreciation in the value of the underlying security will be
partially offset by the amount of the premium paid for the put option and any
related transaction costs. Prior to its expiration, a put option may be sold in
a closing sale transaction; profit or loss from the sale will depend on whether
the amount received is more or less than the premium paid for the put option
plus the related transaction costs. A closing sale transaction cancels out the
Fund's position as the purchaser of an option by means of an offsetting sale of
an identical option prior to the expiration of the option it has purchased. In
certain circumstances, the Fund may purchase call options on securities held in
its portfolio on which it has written call options or on securities that it
intends to purchase. The Fund will not purchase options on securities if, as a
result of such purchase, the aggregate cost of all outstanding options on
securities held by the Fund would exceed 5% of the market value of the Fund's
total assets.
Financial Futures Contracts and Options. The Fund is authorized to
purchase and sell financial futures contracts and options thereon solely for the
purposes of hedging its investments in Municipal Bonds against declines in value
and hedging against increases in the cost of securities it intends to purchase.
A financial futures contract obligates the seller of a contract to deliver and
the purchaser of a contract to take delivery of the type of financial instrument
covered by the contract or, in the case of index-based financial futures
contracts, to make and accept a cash settlement, at a specific future time for a
specified price. A sale of financial futures contracts may provide a hedge
against a decline in the value of portfolio securities because such depreciation
may be offset, in whole or in part, by an increase in the value of the position
in the financial futures contracts. A purchase of financial futures contracts
may provide a hedge against an increase in the cost of securities intended to be
purchased because such appreciation may be offset, in whole or in part, by an
increase in the value of the position in the financial futures contracts.
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker equal to
approximately 5% of the contract amount must be deposited with the broker. This
amount is known as initial margin. Subsequent payments to and from the broker,
called variation margin, are made on a daily basis as the
16
<PAGE>
price of the financial futures contract fluctuates making the long and short
positions in the financial futures contract more or less valuable.
The Fund may purchase and sell financial futures contracts based on The
Bond Buyer Municipal Bond Index, a price-weighted measure of the market value of
40 large recently issued tax-exempt bonds, and purchase and sell put and call
options on such financial futures contracts for the purpose of hedging Municipal
Bonds that the Fund holds or anticipates purchasing against adverse changes in
interest rates. The Fund also may purchase and sell financial futures contracts
on U.S. Government securities and purchase and sell put and call options on such
financial futures contracts for such hedging purposes. With respect to U.S.
Government securities, currently there are financial futures contracts based on
long-term U.S. Treasury bonds, Treasury notes, GNMA Certificates and three-month
U.S. Treasury bills.
Subject to policies adopted by the Board of Directors, the Fund also may
engage in transactions in other financial futures contracts transactions and
options thereon, such as financial futures contracts or options on other
municipal bond indices that may become available, if the Investment Adviser and
the Directors of the Fund should determine that there is normally a sufficient
correlation between the prices of such financial futures contracts and the
Municipal Bonds in which the Fund invests to make such hedging appropriate.
Over-The-Counter Options. The Fund may engage in options and futures
transactions on exchanges and in the over-the-counter markets. In general,
exchange-traded contracts are third-party contracts (i.e., performance of the
parties' obligations is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. Over-the-counter options ('OTC
options') transactions are two-party contracts with price and terms negotiated
by the buyer and seller. See 'Restrictions on OTC Options' below for information
as to restrictions on the use of OTC options.
Restrictions on OTC Options. The Fund will engage in OTC options only with
member banks of the Federal Reserve System and primary dealers in U.S.
Government securities or with affiliates of such banks or dealers that have
capital of at least $50 million or whose obligations are guaranteed by an entity
having capital of at least $50 million or any other bank or dealer having
capital of at least $150 million or whose obligations are guaranteed by an
entity having capital of at least $150 million. OTC options and assets used to
cover OTC options written by the Fund are considered by the staff of the
Commission to be illiquid. The illiquidity of such options or assets may prevent
a successful sale of such options or assets, result in a delay of sale, or
reduce the amount of proceeds that might otherwise be realized.
Risk Factors in Options and Futures Transactions. Utilization of futures
transactions involves the risk of imperfect correlation in movements in the
price of financial futures contracts and movements in the price of the security
that is the subject of the hedge. If the price of the financial futures contract
moves more or less than the price of the security that is the subject of the
hedge, the Fund will experience a gain or loss that will not be completely
offset by movements in the price of such security. There is a risk of imperfect
correlation where the securities underlying financial futures contracts have
different maturities, ratings, geographic compositions or other characteristics
than the security being hedged. In addition, the correlation may be affected by
additions to or deletions from the index that serves as a basis for a financial
futures contract. Finally, in the case of futures contracts on U.S. Government
securities and options on such futures contracts, the anticipated correlation of
price movements between the U.S. Government securities underlying the futures or
options and Municipal Bonds may be adversely affected by economic, political,
legislative or other developments that have a disparate impact on the respective
markets for such securities.
Under regulations of the Commodity Futures Trading Commission (the 'CFTC'),
the futures trading activities described herein will not result in the Fund
being deemed a 'commodity pool,' as defined under such
17
<PAGE>
regulations, provided that the Fund adheres to certain restrictions. In
particular, the Fund may purchase and sell financial futures contracts and
options thereon (i) for bona fide hedging purposes, as defined under CFTC
regulations, without regard to the percentage of the Fund's assets committed to
margin and option premiums, and (ii) for non-hedging purposes if, immediately
thereafter, the sum of the amount of initial margin deposits on the Fund's
existing futures positions and option premiums entered into for non-hedging
purposes do not exceed 5% of the market value of the liquidation value of the
Fund's portfolio, after taking into account unrealized profits and unrealized
losses on any such transactions. Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases a financial futures contract, or writes a put
option or purchases a call option thereon, it will maintain an amount of cash,
cash equivalents (e.g., commercial paper and daily tender adjustable notes) or
short-term, high-grade, fixed-income securities in a segregated account with the
Fund's custodian so that the amount so segregated plus the amount of initial and
variation margin held in the account of its broker equals the market value of
the financial futures contract, thereby ensuring that the use of such financial
futures contract is unleveraged. It is not anticipated that transactions in
futures contracts will have the effect of increasing portfolio turnover.
Although certain risks are involved in options and futures transactions,
the Investment Adviser believes that, because the Fund will engage in options
and futures transactions only for hedging purposes, the options and futures
portfolio strategies of the Fund will not subject the Fund to certain risks
frequently associated with speculation in options and futures transactions.
The volume of trading in the exchange markets with respect to Municipal
Bond options may be limited, and it is impossible to predict the amount of
trading interest that may exist in such options. In addition, there can be no
assurance that viable exchange markets will continue to be available.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a liquid
secondary market for such options or futures. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures transaction. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with whom the Fund has an open position in an option or financial
futures contract.
The liquidity of a secondary market in a financial futures contract may be
adversely affected by 'daily price fluctuation limits' established by commodity
exchanges which limit the amount of fluctuation in a financial futures contract
price during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
moved beyond the daily limit on a number of consecutive trading days.
If it is not possible to close a financial futures position entered into by
the Fund, the Fund would continue to be required to make daily cash payments of
variation margin in the event of adverse price movements. In such a situation,
if the Fund has insufficient cash, it may have to sell portfolio securities to
meet daily variation margin requirements at a time when it may be
disadvantageous to do so.
The successful use of these transactions also depends on the ability of the
Investment Adviser to forecast correctly the direction and extent of interest
rate movements within a given time frame. To the extent these rates remain
stable during the period in which a futures contract is held by the Fund or move
in a direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction that is not fully or partially offset by an
18
<PAGE>
increase in the value of portfolio securities. As a result, the Fund's total
return for such period may be less than if it had not engaged in the hedging
transaction. Furthermore, the Fund will only engage in hedging transactions from
time to time and may not necessarily be engaging in hedging transactions when
movements in interest rates occur.
RISKS AND SPECIAL CONSIDERATIONS OF LEVERAGE
EFFECTS OF LEVERAGE
As of the date of this Prospectus, the Fund has outstanding an aggregate of
1,920 shares of its Series A AMPS, which represent approximately 33% of the
Fund's capital. The Fund intends to issue preferred stock from time to time
representing up to approximately 35% of the Fund's capital. There can be no
assurance, however, that preferred stock representing any particular percentage
of the Fund's capital will actually be issued. The issuance of preferred stock
results in a leveraging of the Common Stock. The Series A AMPS pay dividends
that are adjusted generally every seven days and the dividend rate of the Series
A AMPS is based upon prevailing interest rates for debt obligations of
comparable maturity. The proceeds of the Series A AMPS issuance have been
invested in longer-term obligations in accordance with the Fund's investment
objective, as will the proceeds of the issuance of any other preferred stock.
The Fund may issue additional shares of its Series A AMPS or other preferred
stock in the future. Other preferred stock will pay dividends that will be
adjusted over either relatively short-term periods (generally seven to 28 days)
or medium-term periods (up to five years) and the dividend rates thereon will be
based upon prevailing interest rates for debt obligations of comparable
maturities. Issuance and ongoing expenses of the preferred stock will be borne
by the Fund and will reduce the net asset value of the Common Stock.
Additionally, under certain circumstances, when the Fund is required to allocate
taxable income to holders of preferred stock, it is anticipated that the terms
of the preferred stock will require the Fund to make an additional distribution
to such holders in an amount approximately equal to the tax liability resulting
from such allocation and such additional distribution (such amount, an
'Additional Distribution'). Because under normal market conditions, obligations
with longer maturities produce higher yields than short-term and medium-term
obligations, the Investment Adviser believes that the spread inherent in the
difference between the short-term and medium-term rates (and any Additional
Distributions) paid by the Fund as dividends on the preferred stock and the
longer-term rates received by the Fund will provide holders of Common Stock with
a potentially higher yield.
Utilization of leverage, however, involves certain risks to the holders of
Common Stock. For example, issuance of the preferred stock may result in higher
volatility of the net asset value of the Common Stock and potentially more
volatility in the market value of the Common Stock. In addition, fluctuations in
the short-term and medium-term dividend rates on, and the amount of taxable
income allocable to, the preferred stock will affect the yield to holders of
Common Stock. So long as the Fund, taking into account the costs associated with
the preferred stock and the Fund's operating expenses, is able to realize a
higher net return on its investment portfolio than the then current dividend
rate (and any Additional Distribution) of the preferred stock, the effect of
leverage will be to cause holders of Common Stock to realize a higher current
rate of return than if the Fund were not leveraged. Similarly, since a pro rata
portion of the Fund's net realized capital gains on its investment assets are
generally payable to holders of Common Stock, if net capital gains are realized
by the Fund, the effect of leverage will be to increase the amount of such gains
distributed to holders of Common Stock. However, short-term, medium-term and
long-term interest rates change from time to time as does their relationship to
each other (i.e., the slope of the yield curve) depending upon such factors as
supply and demand forces, monetary and tax policies and investor expectations.
Changes in such factors could cause the relationship between short-term,
19
<PAGE>
medium-term and long-term rates to change (i.e., to flatten or to invert the
slope of the yield curve) so that short-term and medium-term rates may
substantially increase relative to the long-term obligations in which the Fund
may be invested. To the extent that the current dividend rate (and any
Additional Distribution) on the preferred stock approaches the net return on the
Fund's investment portfolio, the benefit of leverage to holders of Common Stock
will be reduced, and if the current dividend rate (and any Additional
Distribution) on the preferred stock were to exceed the net return on the Fund's
portfolio, the Fund's leveraged capital structure would result in a lower
current yield to holders of Common Stock than if the Fund were not leveraged.
Similarly, since both the costs associated with the issuance of preferred stock
and any decline in the value of the Fund's investments (including investments
purchased with the proceeds from any preferred stock offering) will be borne
entirely by holders of Common Stock, the effect of leverage in a declining
market would result in a greater decrease in net asset value to holders of
Common Stock than if the Fund were not leveraged.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the Common Stock. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under the Code. See 'Taxes.' The Fund intends, however, to
take all measures necessary to continue to make Common Stock dividend payments.
If the Fund's current investment income were not sufficient to meet dividend
requirements on either the Common Stock or the preferred stock, it could be
necessary for the Fund to liquidate certain of its investments. In addition, the
Fund will have the authority to redeem the preferred stock for any reason and
may redeem all or part of the preferred stock if (i) it anticipates that the
Fund's leveraged capital structure will result in a lower rate of return for any
significant amount of time to holders of the Common Stock than that obtainable
if the Common Stock were unleveraged, (ii) the asset coverage for the preferred
stock declines below 200%, either as a result of a decline in the value of the
Fund's portfolio investments or as a result of the repurchase of Common Stock in
tender offers, or (iii) in order to maintain the asset coverage guidelines
established by nationally recognized rating agencies rating the preferred stock.
Redemption of the preferred stock or insufficient investment income to make
dividend payments may reduce the net asset value of the Common Stock and require
the Fund to liquidate a portion of its investments at a time when it may be
disadvantageous, in the absence of such extraordinary circumstances, to do so.
As of the date of this Prospectus, the Fund has utilized leverage by the
issuance of Series A AMPS that pay dividends at a rate that generally will be
adjusted every seven days in an amount representing approximately 33% of the
Fund's capital at an annual dividend rate of 3.52% payable on such preferred
stock based on market rates as of the date of this Prospectus. The annual return
that the Fund's portfolio must experience (net of expenses) in order to cover
such dividend payments would be 0.87%.
The following table is designed to illustrate the effect on the return to a
holder of the Fund's Common Stock of the leverage obtained by the issuance of
Series A AMPS representing approximately 33% of the Fund's capital, assuming
hypothetical annual returns on the Fund's portfolio of minus 10% to plus 10%. As
the table shows, leverage generally increases the return to stockholders when
portfolio return is positive and decreases the return when the portfolio return
is negative. The figures appearing in the table are hypothetical and actual
returns may be greater or less than those appearing in the table.
<TABLE>
<S> <C> <C> <C> <C> <C>
Assumed Portfolio Return (net of expenses)........................... (10 )% (5)% 0% 5% 10%
Corresponding Common Stock Return.................................... (14 )% (8)% (1)% 5% 12%
</TABLE>
The leveraging of the Common Stock would be eliminated during any period
that preferred stock is not outstanding and the risks and special considerations
related to leverage described in this Prospectus would not apply.
20
<PAGE>
PORTFOLIO MANAGEMENT AND OTHER CONSIDERATIONS
In the event of an increase in short-term or medium-term rates or other
change in market conditions to the point where the Fund's leverage could
adversely affect holders of Common Stock as noted above, or in anticipation of
such changes, the Fund may attempt to shorten the average maturity of its
investment portfolio, which would tend to offset the negative impact of leverage
on holders of Common Stock. The Fund also may attempt to reduce the degree to
which it is leveraged by redeeming preferred stock pursuant to the provisions of
the Fund's Articles Supplementary establishing the rights and preferences of the
preferred stock or otherwise purchasing shares of preferred stock. Purchases and
redemptions of preferred stock, whether through redemptions, on the open market
or in negotiated transactions, are subject to limitations under the 1940 Act. If
market conditions subsequently change, the Fund may sell previously unissued
shares of preferred stock or shares of preferred stock that the Fund previously
issued but later repurchased or redeemed.
The Series A AMPS have been rated 'aaa' by Moody's and AAA by S&P. Prior to
the time it offers additional preferred stock, the Fund intends to apply for
ratings on such preferred stock from one or more nationally recognized
statistical rating organizations. In order to obtain these ratings, the Fund may
be required to maintain portfolio holdings meeting specified guidelines of such
organizations. These guidelines may impose asset coverage requirements that are
more stringent than those imposed by the 1940 Act. It is not anticipated that
these guidelines will impede the Investment Adviser from managing the Fund's
portfolio in accordance with the Fund's investment objective and policies.
Ratings on preferred stock issued by the Fund should not be confused with
ratings on obligations held by the Fund.
Under the 1940 Act, the Fund is not permitted to issue shares of preferred
stock unless immediately after such issuance the net asset value of the Fund's
portfolio is at least 200% of the liquidation value of the outstanding preferred
stock (expected to equal the original purchase price of the outstanding shares
of preferred stock plus any accumulated and unpaid dividends thereon and any
accumulated and unpaid Additional Distribution). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on its Common Stock
unless, at the time of such declaration, the net asset value of the Fund's
portfolio (determined after deducting the amount of such dividend or
distribution) is at least 200% of such liquidation value. As of the date of this
Prospectus, the Fund's capital structure includes 1,920 shares of Series A AMPS
representing approximately 33% of the Fund's capital, and the asset coverage
with respect to the Series A AMPS is approximately 307%. To the extent possible,
the Fund intends to purchase or redeem shares of preferred stock from time to
time to maintain coverage of preferred stock of at least 200%.
The Fund pays service fees to certain broker-dealers at the end of each
auction in connection with the Series A AMPS. For the period November 3, 1995
(commencement of operations) to October 31, 1996, and the fiscal year ended
October 31, 1997, Merrill Lynch was paid $48,107 and $100,708, respectively, in
service fees by the Fund.
21
<PAGE>
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and may
not be changed without the approval of the holders of a majority of the Fund's
outstanding shares of Common Stock (which for this purpose and under the 1940
Act means the lesser of (i) 67% of the shares represented at a meeting at which
more than 50% of the outstanding shares of Common Stock are represented or (ii)
more than 50% of the outstanding shares) and of the outstanding shares of
preferred stock, voting together as a class, and the approval of a majority of
the outstanding shares of preferred stock, voting separately by class. The Fund
may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, real estate limited partnerships,
commodities or commodity contracts; provided that the Fund may
invest in securities directly or indirectly secured by real estate
or interests therein or issued by companies that invest in real
estate or interests therein, and the Fund may purchase and sell
financial futures contracts and options thereon.
3. Issue senior securities or borrow money, except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as
amended (the '1933 Act'), in selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
Municipal Bonds and other debt securities in accordance with its
investment objective, policies and limitations.
6. Invest more than 25% of its total assets (taken at market value at
the time of each investment) in securities of issuers in a single
industry; provided that, for purposes of this restriction, states,
municipalities and their political subdivisions are not considered
to be part of any industry.)
Additional investment restrictions adopted by the Fund, which may be
changed by the Board of Directors, without shareholder approval, provide that
the Fund may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Fund except
as may be necessary in connection with borrowings mentioned in investment
restriction (3) above or except as may be necessary in connection with
transactions in financial futures contracts and options thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on
margin).
d. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund may
write, purchase and sell options and futures on Municipal Bonds, United
22
<PAGE>
States Government obligations and related indices or otherwise in
connection with bona fide hedging activities and may purchase and sell Call
Rights to require mandatory tender for the purchase of related Municipal
Bonds.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentages resulting from changing values will not be
considered a violation.
The Investment Adviser of the Fund and Merrill Lynch share a common parent,
Merrill Lynch & Co., Inc. ('ML & Co'). Because of the affiliation of Merrill
Lynch with the Investment Adviser, the Fund is prohibited from engaging in
certain transactions involving Merrill Lynch except pursuant to an exemptive
order of the Commission or otherwise in compliance with the provisions of the
1940 Act and the rules and regulations thereunder. Included among such
restricted transactions will be purchases from or sales to Merrill Lynch of
securities in transactions in which Merrill Lynch acts as principal. An
exemptive order has been obtained that permits the Fund to effect principal
transactions with Merrill Lynch in high quality, short-term, tax-exempt
securities subject to conditions set forth in such order. The Fund does not
presently intend to request an order permitting other principal transactions
with Merrill Lynch.
PURCHASE OF SHARES
The Distributor, an affiliate of both the Investment Adviser and Merrill
Lynch, acts as the distributor of shares of Common Stock of the Fund. The Fund
is engaged in a continuous offering of its shares of Common Stock through the
Distributor and other securities dealers that have entered into selected dealer
agreements with the Distributor, including Merrill Lynch. Shares of the Fund may
be purchased from the Distributor or selected dealers, including Merrill Lynch,
or by mailing a purchase order directly to Merrill Lynch Financial Data
Services, Inc. (the 'Transfer Agent'). The minimum initial purchase is $1,000
and the minimum subsequent purchase is $50. In connection with an exemption the
Fund has obtained from the Commission relating to its tender offers, the Fund
will not offer its shares during the five business days preceding the
termination of a tender offer. See 'Tender Offers'.
To permit the Fund to invest the net proceeds from the sale of its shares
of Common Stock in an orderly manner, the Fund may, from time to time, suspend
the sale of its shares of Common Stock, except for sales to existing holders of
Common Stock and dividend reinvestments.
Due to the administrative complexities associated with the continuous
offering, administrative errors may result in the Distributor or an affiliate
inadvertently acquiring nominal numbers (in no event in excess of 5% of the
shares of Common Stock) of shares of Common Stock that it may wish to resell.
Such shares of Common Stock will not be subject to any investment restriction
and may be resold pursuant to this Prospectus.
The Fund offers its shares of Common Stock at a public offering price equal
to the next determined net asset value per share without a front-end sales
charge (although in certain cases a CDSC may apply as described herein). The
applicable offering price for purchase orders is based on the net asset value of
the Fund next determined after receipt of the purchase order by the Distributor.
As to purchase orders received by securities dealers prior to the close of
business on the New York Stock Exchange (the 'NYSE') (close of business, 4:00
p.m., New York time), which includes orders received after the close of business
on the previous day, the applicable offering price will be based on the net
asset value determined as of 15 minutes after the close of business on the NYSE
on that day provided the Distributor in turn receives the order from the
securities dealer prior to 30 minutes after the close of business on the NYSE on
that day. If the purchase orders are not received by
23
<PAGE>
the Distributor prior to 30 minutes after the close of business on the NYSE,
such orders shall be deemed received on the next business day. Any order may be
rejected by the Distributor or the Fund. The Fund or the Distributor may suspend
the continuous offering of the Fund's shares to the general public at any time
in response to conditions in the securities markets or otherwise and may
thereafter resume such offering from time to time. Neither the Distributor nor
the dealers are permitted to withhold placing orders to benefit themselves by a
price change. The Distributor is required to advise the Fund promptly of all
purchase orders and cause payments for shares of Common Stock to be delivered
promptly to the Fund. Merrill Lynch charges its customers a processing fee
(presently $5.35) to confirm a purchase of shares by such customers. Purchases
made directly through the Distributor are not subject to the processing fee.
The Distributor compensates Merrill Lynch and other selected dealers at a
rate of 3.0% of amounts purchased. If the shares remain outstanding after one
year from the date of their original purchase, the Distributor will compensate
Merrill Lynch and such dealers at an annual rate equal to 0.25% of the value of
Fund shares sold by Merrill Lynch and such dealers and remaining outstanding.
These amounts do not represent an expense to the Fund and its shareholders since
the payments made by the Distributor will be made from its own assets, which may
include amounts received by the Distributor as CDSCs. See 'Contingent Deferred
Sales Charge.' The compensation paid to selected dealers and the Distributor,
including the compensation paid at the time of purchase, the 0.25% annual
payments mentioned above and the CDSC, if any, will not in the aggregate exceed
the applicable limit (presently 8%), as determined from time to time by the
National Association of Securities Dealers, Inc. For the period November 3, 1995
(commencement of operations) to October 31, 1996 the Distributor paid
approximately $1,059,723 to Merrill Lynch in connection with the sale of shares
of Common Stock of the Fund. For the fiscal year ended October 31, 1997, the
Distributor paid approximately $1,510,306 to Merrill Lynch in connection with
such sales.
Upon the transfer of shares out of a Merrill Lynch brokerage account, an
investment account in the transferring shareholder's name will be opened
automatically, without charge, at the Fund's transfer agent, dividend disbursing
agent and shareholder servicing agent. Shareholders should be aware that it will
not be possible to transfer their shares from Merrill Lynch to another brokerage
firm or financial institution. Shareholders interested in transferring their
brokerage accounts from Merrill Lynch and who do not wish to have an account
maintained for such shares at the Transfer Agent must tender the shares for
repurchase by the Fund as described under 'Tender Offers' so that the cash
proceeds can be transferred to the account at the new firm.
TENDER OFFERS
In recognition of the possibility that a secondary market for the Fund's
shares will not exist, the Fund may take actions that will provide liquidity to
shareholders. The Fund may from time to time make offers to purchase its shares
of Common Stock from all beneficial holders of the Fund's Common Stock at a
price per share equal to the net asset value per share of the Common Stock
determined at the close of business on the day an offer terminates ('Tender
Offer'). Commencing with the second quarter of the Fund's operations, the Board
of Directors has considered the making of Tender Offers on a quarterly basis,
and the Board of Directors intends to continue this practice. There can be no
assurance, however, that the Board of Directors will decide to undertake the
making of a Tender Offer. Subject to the Fund's investment restriction with
respect to borrowings, the Fund may borrow money to finance the repurchase of
shares pursuant to any Tender Offers. See 'Investment Objective and
Policies--Other Investment Policies--Borrowings' and 'Investment Restrictions.'
The Fund expects that ordinarily there will be no secondary market for the
Fund's Common Stock and that periodic tenders will be the only source of
liquidity for Fund shareholders. Nevertheless, if a secondary market
24
<PAGE>
develops for the Common Stock of the Fund, the market price of the shares may
vary from net asset value from time to time. Such variance may be affected by,
among other factors, relative demand and supply of shares and the performance of
the Fund, especially as it affects the yield on and net asset value of the
Common Stock of the Fund. A Tender Offer for shares of Common Stock of the Fund
at net asset value is expected to reduce any spread between net asset value and
market price that may otherwise develop. However, there can be no assurance that
such action would result in the Fund's Common Stock trading at a price that
equals or approximates net asset value.
Although the Board of Directors believes that the Tender Offers generally
would be beneficial to the Fund's holders of Common Stock, the acquisition of
shares of Common Stock by the Fund will decrease the total assets of the Fund
and therefore have the likely effect of increasing the Fund's expense ratio
(assuming such acquisition is not offset by the issuance of additional shares of
Common Stock). Furthermore, if the Fund borrows to finance the making of Tender
Offers, interest on such borrowing will reduce the Fund's net investment income.
It is the Board's announced policy, which may be changed by the Board, not
to purchase shares pursuant to a Tender Offer if (1) such purchases would impair
the Fund's status as a regulated investment company under the Code (which would
make the Fund a taxable entity, causing the Fund's income to be taxed at the
corporate level in addition to the taxation of shareholders who receive
dividends from the Fund); (2) the Fund would not be able to liquidate portfolio
securities in a manner that is orderly and consistent with the Fund's investment
objective and policies in order to purchase Common Stock tendered pursuant to
the Tender Offer; or (3) there is, in the Board's judgment, any (a) legal action
or proceeding instituted or threatened challenging the Tender Offer or otherwise
materially adversely affecting the Fund, (b) declaration of banking moratorium
by Federal or state authorities or any suspension of payment by banks in the
United States or New York State, that is material to the Fund, (c) limitation
imposed by Federal or state authorities on the extension of credit by lending
institutions, (d) commencement of war, armed hostilities or other international
or national calamity directly or indirectly involving the United States that is
material to the Fund, or (e) other event or condition that would have a material
adverse effect on the Fund or its shareholders if shares of Common Stock
tendered pursuant to the Tender Offer were purchased. Thus, there can be no
assurance that the Board will proceed with any Tender Offer. The Board of
Directors may modify these conditions in light of circumstances existing at the
time. If the Board of Directors determines to purchase the Fund's shares of
Common Stock pursuant to a Tender Offer, such purchases could significantly
reduce the asset coverage of any borrowing or outstanding senior securities,
including any preferred stock. The Fund may not purchase shares of Common Stock
to the extent such purchases would result in the asset coverage with respect to
such borrowing or senior securities, including any preferred stock, being
reduced below the asset coverage requirement set forth in the 1940 Act or, with
respect to preferred stock, the asset coverage requirements of any nationally
recognized statistical rating organization rating the preferred stock.
Accordingly, in order to purchase all shares of Common Stock tendered, the Fund
may have to repay all or part of any then outstanding borrowing or redeem all or
part of any then outstanding senior securities, including any preferred stock,
to maintain the required asset coverage. See 'Risks and Special Considerations
of Leverage--Portfolio Management and Other Considerations.' In addition, the
amount of shares of Common Stock for which the Fund makes any particular Tender
Offer may be limited for the reasons set forth above or in respect of other
concerns related to liquidity of the Fund's portfolio.
The Fund has been granted an exemption from the Commission relating to
Tender Offers that is based on representations by the Fund that no secondary
market for shares of the Fund's Common Stock is expected to develop. The
exemption is conditioned on the absence of a secondary market, and neither the
Fund nor Merrill Lynch nor any other broker-dealer is allowed to conduct any
offers or sales of the Fund's Common Stock in the continuous offering during the
last five business days of any Tender Offer. In the event that circumstances
arise
25
<PAGE>
under which the Fund does not conduct the Tender Offers regularly, the Board of
Directors would consider alternate means of providing liquidity for holders of
Common Stock. Such action would include an evaluation of any secondary market
that then existed and a determination of whether such market provided liquidity
for holders of Common Stock. If the Board of Directors determines that such
market, if any, fails to provide liquidity for the holders of Common Stock, the
Board expects that it will consider all then available alternatives to provide
such liquidity. Among the alternatives that the Board of Directors may consider
is the listing of the Fund's Common Stock on a major domestic stock exchange or
on the Nasdaq National Market System in order to provide such liquidity. The
Board of Directors also may consider causing the Fund to repurchase its shares
from time to time in open-market or private transactions when it can do so on
terms that represent a favorable investment opportunity. In any event, the Board
of Directors expects it will cause the Fund to take whatever action it deems
necessary or appropriate to provide liquidity for the holders of Common Stock in
light of the facts and circumstances existing at such time.
To consummate a Tender Offer in order to repurchase its shares of Common
Stock, the Fund may be required to liquidate portfolio securities, and realize
gains or losses, at a time when the Investment Adviser would otherwise consider
it disadvantageous to do so.
Each Tender Offer will be made and shareholders notified in accordance with
the requirements of the Securities Exchange Act of 1934 and the 1940 Act, either
by publication or mailing or both. The offering documents will contain such
information as is prescribed by such laws and the rules and regulations
promulgated thereunder. The repurchase of tendered shares by the Fund is a
taxable event. See 'Taxes--Offers to Purchase Shares.' The Fund will pay all
costs and expenses associated with the making of any Tender Offer. A CDSC will
be imposed on most shares accepted for tender that have been held for less than
three years. See 'Contingent Deferred Sales Charge.' In addition, Merrill Lynch
charges its customers a processing fee (presently $5.35) to confirm a repurchase
of shares from such customers pursuant to a Tender Offer. Tenders made directly
through the Distributor, are not subject to the processing fee.
Shareholders of the Fund have an investment option consisting of the right
to reinvest the net proceeds from a sale of shares of the Fund's Common Stock
(the 'Original Shares') pursuant to a tender offer by the Fund in Class D
initial sales charge shares of certain Merrill Lynch-sponsored open-end
investment companies ('Eligible Class D Shares') at their net asset value,
without the imposition of the initial sales charge, if the conditions set forth
below are satisfied. First, net proceeds from the sale of the Original Shares in
the tender offer must be immediately reinvested in Eligible Class D Shares.
Second, the investment option is available only with respect to the proceeds of
shares of the Fund's Common Stock as to which no CDSC is applicable.
Shareholders who already own Class A shares of the investment company in the
account in which they are purchasing shares of such investment company may
purchase Class A shares rather than Class D shares so long as all of the other
requirements of this paragraph are met. Class D shares are subject to an ongoing
account maintenance fee at an annual rate of up to 0.25% of the average daily
net asset value of the applicable investment company. Before taking advantage of
this investment option, shareholders of the Fund should obtain a currently
effective prospectus of the mutual fund that they intend to purchase. To
exercise this investment option, shareholders should consult their Merrill Lynch
Financial Consultant. Shareholders who utilize this investment option will be
treated as if they first received cash for their tendered shares and then used
the proceeds to purchase the other shares and consequently will realize a
taxable gain or loss in the same manner as if they received cash for their
tendered shares. See 'Taxes--Offer to Purchase Shares.'
26
<PAGE>
CONTINGENT DEFERRED SALES CHARGE
A CDSC to recover distribution expenses incurred by the Distributor will be
charged against the shareholder's investment account and paid to the Distributor
in connection with most shares of Common Stock held for less than three years
that are accepted by the Fund for repurchase pursuant to a Tender Offer in the
manner described below. The CDSC will be imposed on those shares of Common Stock
accepted for tender based on an amount equal to the lesser of the then current
net asset value of the shares of Common Stock or the cost of the shares of
Common Stock being tendered. Accordingly, the CDSC is not imposed on increases
in the net asset value above the initial purchase price. In addition, the CDSC
is not imposed on shares derived from reinvestments of dividends or capital
gains distributions. In determining whether a CDSC is payable, it is assumed
that the acceptance of an offer to repurchase pursuant to a Tender Offer would
be made from the earliest purchase of shares of Common Stock. The CDSC imposed
will vary depending on the length of time the Common Stock has been owned since
purchase (separate purchases shall not be aggregated for these purposes), as set
forth in the following table:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
YEAR OF REPURCHASE AFTER PURCHASE SALES CHARGE
- ------------------------------------------------------ -------------------
<S> <C>
First................................................. 3.0%
Second................................................ 2.0%
Third................................................. 1.0%
Fourth and following.................................. 0%
</TABLE>
In determining whether a CDSC is applicable to a tender of shares of Common
Stock, the calculation will be determined in the manner that results in the
lowest possible amount being charged. Therefore, it will be assumed that the
tender is first of shares of Common Stock held for over three years and shares
of Common Stock acquired pursuant to reinvestment of dividends or distributions
and then of shares of Common Stock held longest during the three-year period.
The CDSC will not be applied to dollar amounts representing an increase in the
net asset value since the time of purchase. The CDSC will be waived on Fund
shares tendered following the death of all beneficial owners of such shares,
provided the shares are tendered within one year of death (a death certificate
and other applicable documents may be required). At the time of acceptance of
the tender offer, the record or succeeding beneficial owner must notify the
Transfer Agent either directly or indirectly through the Distributor that the
CDSC should be waived. Upon confirmation of the owner's entitlement, the waiver
will be granted; otherwise, the waiver will be lost.
EXAMPLE:
Assume an investor purchased 1,000 shares of Common Stock (at a cost of
$10,000) and in the second year after purchase, the net asset value per share is
$12.00 and, during such time, the investor has acquired 100 additional shares of
Common Stock upon dividend reinvestment. If at such time the investor makes his
or her first redemption of 500 shares of Common Stock (proceeds of $6,000), 100
shares will not be subject to the CDSC because of dividend reinvestment. With
respect to the remaining 400 shares of Common Stock, the CDSC is applied only to
the original cost of $10 per share and not to the increase in net asset value of
$2.00 per share. Therefore, $4,000 of the $6,000 redemption proceeds will be
charged at a rate of 2.0% (the applicable rate in the second year after
purchase).
For the period November 3, 1995 (commencement of operations) to October 31,
1996, the amount paid to the Distributor in CDSCs aggregated $38,710. For the
fiscal year ended October 31, 1997, such amount paid to the Distributor
aggregated $85,662.
27
<PAGE>
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
manager of the Fund, including their ages and their principal occupations for at
least the last five years is set forth below. Unless otherwise noted, the
address of each Director, executive officer and the portfolio manager is P.O.
Box 9011, Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL(65)--President and Director(1)(2)--Chairman of the Investment
Adviser (which term, as used herein, includes its corporate predecessors) and
MLAM (which term, as used herein, includes its corporate predecessors) since
1997; President of the Investment Adviser from 1977 to 1997; President of MLAM
from 1977 to 1997; President and Director of Princeton Services, Inc.
('Princeton Services') from 1993 to 1997; Executive Vice President of ML & Co.
since 1990.
RONALD W. FORBES (57)--Director(2)--1400 Washington Avenue, Albany, New
York 12222. Professor of Finance, School of Business, State University of New
York at Albany, since 1989.
CYNTHIA A. MONTGOMERY (45)--Director(2)--Harvard Business School, Soldiers
Field Road, Boston, Massachusetts 02163. Professor, Harvard Business School
since 1989; Associate Professor, J.L. Kellogg Graduate School of Management,
Northwestern University from 1985 to 1989; Assistant Professor, Graduate School
of Business Administration, The University of Michigan from 1979 to 1985;
Director, UNUM Corporation since 1990 and Director of Newell Co. since 1995.
CHARLES C. REILLY (66)--Director(2)--9 Hampton Harbor Road, Hampton Bays,
New York 11946. Self-employed financial consultant since 1990; President and
Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior Vice
President of Arnhold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business from 1990 to 1991;
Adjunct Professor, Wharton School, The University of Pennsylvania from 1989 to
1990; Partner, Small Cities Cable Television since 1986.
KEVIN A. RYAN (65)--Director(2)--127 Commonwealth Avenue, Chestnut Hill,
Massachusetts 02167. Founder and current Director of The Boston University
Center for the Advancement of Ethics and Character; Professor of Education at
Boston University since 1982; formerly taught on the faculties of The University
of Chicago, Stanford University and Ohio State University.
RICHARD R. WEST (59)--Director(2)--Box 604, Genoa, Nevada 89411. Professor
of Finance since 1984, and Dean from 1984 to 1993, and currently Dean Emeritus
of New York University, Leonard N. Stern School of Business Administration;
Director of Bowne & Co., Inc. (financial printers), Vornado, Inc. (real estate
holding company) and Alexander's Inc. (real estate company) .
TERRY K. GLENN (57)--Executive Vice President(1)(2)--Executive Vice
President of the Investment Adviser and MLAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of the MLFD
since 1986 and Director thereof since 1991; President of Princeton
Administrators, L.P., since 1988.
VINCENT R. GIORDANO (53)--Senior Vice President(1)(2)--Senior Vice
President of the Investment Adviser and MLAM since 1984; Senior Vice President
of Princeton Services since 1993; Vice President of MLAM from 1980 to 1984.
DONALD C. BURKE (37)--Vice President(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997 and Director of Taxation of
MLAM since 1990.
KENNETH A. JACOB (46)--Vice President(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997.
28
<PAGE>
JOHN M. LOFFREDO, CFA (34)--Vice President and Portfolio
Manager(1)(2)--First Vice President of MLAM since 1997; Vice President of MLAM
from 1991 to 1997.
ROBERT A. DIMELLA, CFA (31)--Vice President and Portfolio
Manager(1)(2)--Vice President of MLAM since 1997; Assistant Vice President of
MLAM from 1995 to 1997; employee of MLAM since 1993; Assistant Portfolio Manager
with Prudential Investment Advisors from 1992 to 1993; Research Associate with
Prudential Investment Corporation from 1989 to 1992.
GERALD M. RICHARD (48)--Treasurer(1)(2)--Senior Vice President and
Treasurer of the Investment Adviser and MLAM since 1984; Senior Vice President
and Treasurer of Princeton Services since 1993; Vice President of the
Distributor since 1981 and Treasurer since 1984.
PATRICK D. SWEENEY (43)--Secretary(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997.
- ------------------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee, officer or member of the
advisory board of one or more investment companies for which the Investment
Adviser or MLAM acts as investment adviser.
At November 30, 1997, the officers and Directors of the Fund as a group (14
persons) owned an aggregate of less than 1% of the outstanding shares of the
Common Stock and the Series A AMPS, respectively, and less than 1% of the
outstanding shares of Common Stock of ML & Co.
In connection with the election of the Fund's Directors, holders of shares
of Series A AMPS and other preferred stock, voting as a separate class, are
entitled to elect two of the Fund's Directors, and the remaining Directors will
be elected by all holders of capital stock, voting as a single class. Messrs.
Forbes and Reilly have been designated as the Directors to be elected by holders
of the preferred stock. See 'Description of Capital Stock.'
COMPENSATION OF DIRECTORS
Pursuant to the terms of its investment advisory agreement with the Fund
(the 'Investment Advisory Agreement'), the Investment Adviser pays all
compensation of officers and employees of the Fund as well as the fees of all
Directors of the Fund who are affiliated persons of ML&Co. or its subsidiaries.
The Fund pays each Director not affiliated with the Investment Adviser (each a
'non-affiliated Director') an annual fee of $3,000 per year plus $400 per
meeting attended and pays all Director's actual out-of-pocket expenses relating
to attendance at meetings. The Fund also pays members of its Audit and
Nominating Committee (the 'Committee'), which consists of all of the
non-affiliated Directors an annual fee of $900. The Chairman of the Committee
receives an additional annual fee of $1,000. For the fiscal year ended October
31, 1997, fees and expenses paid to the non-affiliated Directors that were
allocated to the Fund aggregated $24,576.
The following table sets forth the compensation paid by the Fund to the
non-affiliated Directors for the fiscal year ended October 31, 1997, and the
aggregate compensation paid by all investment companies advised by the
29
<PAGE>
Investment Adviser and its affiliate, MLAM ('FAM/MLAM Advised Funds'), to the
non-affiliated Directors for the calendar year ended December 31, 1996.
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
FROM FUND AND
PENSION OR RETIREMENT MLAM/FAM ADVISED
COMPENSATION BENEFITS ACCRUED AS PART FUNDS PAID TO
NAME OF DIRECTOR FROM FUND OF FUND EXPENSE DIRECTORS(1)
- ---------------------------------------------------- ------------ ------------------------ ----------------
<S> <C> <C> <C>
Ronald W. Forbes.................................... $4,600 None $142,500
Cynthia A. Montgomery............................... $4,600 None $142,500
Charles C. Reilly................................... $5,600 None $293,833
Kevin A. Ryan....................................... $4,600 None $142,500
Richard R. West..................................... $4,600 None $269,833
</TABLE>
- ------------------
(1) The Directors serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Forbes (29 registered investment companies consisting of 42 portfolios); Ms.
Montgomery (29 registered investment companies consisting of 42 portfolios);
Mr. Reilly (47 registered investment companies consisting of 60 portfolios);
Mr. Ryan (29 registered investment companies consisting of 42 portfolios);
and Mr. West (48 registered investment companies consisting of 70
portfolios).
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS
The Investment Adviser, an affiliate of MLAM, which is owned and controlled
by ML & Co., a financial services holding company and the parent of Merrill
Lynch, provides the Fund with investment advisory and administrative services.
The Investment Adviser or MLAM acts as the investment adviser for over 140 other
registered investment companies. The Investment Adviser also offers portfolio
management and portfolio analysis services to individuals and institutions. As
of November 30, 1997, the Investment Adviser and MLAM had a total of
approximately $273.9 billion in investment company and other assets under
management (including $34.1 billion in municipal securities), including
accounts of certain affiliates of the Investment Adviser. The Investment Adviser
is a limited partnership the partners of which are ML & Co. and Princeton
Services. The principal business address of the Investment Adviser is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement provides that, subject to the supervision
of the Board of Directors of the Fund, the Investment Adviser is responsible for
the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors. The Fund's portfolio
managers will consider analyses from various sources, make the necessary
investment decisions, and place orders for transactions accordingly. The
Investment Adviser will also be responsible for the performance of certain
management services for the Fund. Robert A. DiMella, CFA, and John M. Loffredo
are the portfolio managers for the Fund and are primarily responsible for the
Fund's day-to-day management.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund pays a monthly fee at an annual rate of 0.50 of 1%
of the Fund's average daily net assets (i.e., the average daily value of the
total assets of the Fund, including proceeds from the issuance of shares of
preferred stock, minus the sum of accrued liabilities of the Fund and
accumulated dividends on the shares of preferred stock). For purposes of this
calculation, average daily net assets are determined at the end of each month on
the basis of the average net assets of the Fund for each day during the month.
Under the terms of an administration agreement with the Fund (the
'Administration Agreement'), the Investment Adviser also performs or arranges
for the performance of the administrative services (i.e., services other than
investment advice and related portfolio activities) necessary for the operation
of the Fund, including paying all compensation of and furnishing office space
for officers and employees of the Fund connected with
30
<PAGE>
investment and economic research, trading and investment management of the Fund,
as well as the compensation of all Directors of the Fund who are affiliated
persons of the Investment Adviser or any of its affiliates.
For the administrative services rendered to the Fund and the facilities
furnished, the Fund pays the Investment Adviser a monthly fee at an annual rate
of 0.25 of 1% of the Fund's average daily net assets determined in the same
manner as the fee payable by the Fund under the Investment Advisory Agreement.
The Investment Adviser may pay a portion of the fee received pursuant to the
Administration Agreement to its affiliate, Merrill Lynch, for administrative
services rendered in connection with any preferred stock of the Fund. The
combined advisory and administration fees are greater than the advisory fees
paid by most funds, but are similar in amount to the fees paid by other
continuously offered, closed-end funds.
For the period November 3, 1995 (commencement of operations) to October 31,
1996, and for the fiscal year ended October 31, 1997, the fees paid by the Fund
to the Investment Adviser pursuant to the Investment Advisory Agreement were
$446,931 and $657,929, respectively, and the fees paid by the Fund pursuant to
the Administration Agreement were $223,446 and $328,965, respectively (such fees
based on average daily net assets of approximately $89.9 million and $82.9
million, respectively). For the period November 3, 1995 (commencement of
operations) to October 31, 1996, and for the fiscal year ended October 31, 1997,
the Investment Adviser voluntarily waived $419,740 and $424,822, respectively of
the fees paid by the Fund pursuant to the Investment Advisory Agreement and
voluntarily reimbursed the Fund additional expenses of $231,006 and $0,
respectively.
The Fund pays all other expenses incurred in the operation of the Fund,
including, among other things, expenses for legal and auditing services, taxes,
listing fees, if any, costs of printing proxies, stock certificates and
shareholder reports, charges of the Custodian and the Transfer Agent, Dividend
Disbursing Agent and Shareholder Servicing Agent, expenses of registering the
shares under Federal and state securities laws, fees and expenses with respect
to the issuance of preferred shares or any borrowing, Commission fees, fees and
expenses of non-affiliated Directors, accounting and pricing costs, insurance,
interest, brokerage costs, litigation and other extraordinary or non-recurring
expenses, mailing and other expenses properly payable by the Fund. Accounting
services are provided to the Fund by the Investment Adviser, and the Fund
reimburses the Investment Adviser for its costs in connection with such
services. For the period November 3, 1995 (commencement of operations) to
October 31, 1996, the reimbursement for such services was $60,526. For the
fiscal year ended October 31, 1997, such reimbursement aggregated $61,452.
Unless earlier terminated as described below, the Investment Advisory and
Administration Agreements will remain in effect from year to year if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contracts or interested persons (as defined in the 1940 Act)
of any such party. Such contracts are not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party thereto
or by the vote of the shareholders of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients when one or more clients are selling the same security. If purchases or
sales of securities by the Investment Adviser for the Fund or other funds for
which it acts as investment adviser or for advisory clients arise for
consideration at or about the same time, transactions in such securities will be
made, insofar as feasible, for the respective funds and clients in a manner
deemed equitable to all. To the extent that transactions on behalf of more than
one client of the Investment Adviser or its affiliate during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price.
31
<PAGE>
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the 1940 Act that incorporates the Code of Ethics of the
Investment Adviser (together, the 'Codes'). The Codes significantly restrict the
personal investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a 'hot' initial
public offering and a prohibition from profiting on short-term trading in
securities. In addition, no employee may purchase or sell any security that at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading 'blackout
periods', which prohibit trading by investment personnel of the Fund within
periods of trading by the Fund in the same (or equivalent) security (15 or 30
days depending upon the transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the 'Transfer Agent') acts as
the Fund's transfer agent for the Common Stock pursuant to a Transfer Agency,
Dividend Disbursing Agency and Shareholder Servicing Agency Agreement (the
'Transfer Agency Agreement'). Pursuant to the Transfer Agency Agreement, the
Transfer Agent is responsible for the issuance, transfer and tender of shares of
Common Stock and the opening and maintenance of shareholder accounts. Pursuant
to the Transfer Agency Agreement, the Transfer Agent receives an annual fee of
up to $14.00 per shareholder account and is entitled to reimbursement for
certain transaction charges and out-of-pocket expenses incurred by the Transfer
Agent under the Transfer Agency Agreement. Additionally, a $.20 monthly closed
account charge will be assessed on all accounts that close during the calendar
year. Application of this fee will commence the month following the month the
account is closed. At the end of the calendar year, no further fees will be due.
For purposes of the Transfer Agency Agreement, the term 'account' includes a
shareholder account maintained directly by the Transfer Agent and any other
account representing the beneficial interest of a person in the relevant share
class on a recordkeeping system, provided the recordkeeping system is maintained
by a subsidiary of ML & Co. For the period November 3, 1995 (commencement of
operations) to October 31, 1996 and for the fiscal year ended October 31, 1997,
the total fees paid by the Fund to the Transfer Agent were $71,704 and $113,071,
respectively, pursuant to the Transfer Agency Agreement.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm
involved and the firm's risk in positioning a block of securities. While the
Investment Adviser generally seeks reasonably competitive commission rates, the
Fund does not necessarily pay the lowest commission or spread available. For the
period November 3, 1995 (commencement of operations) to October 31, 1996 and for
the fiscal year ended October 31, 1997, the Fund did not pay any brokerage
commissions.
32
<PAGE>
The Fund has no obligation to deal with any broker or dealer in the
execution of transactions in portfolio securities. Subject to obtaining the best
price and execution, securities firms that provide supplemental investment
research to the Investment Adviser, including Merrill Lynch, may receive orders
for transactions by the Fund. Information so received will be in addition to and
not in lieu of the services required to be performed by the Investment Adviser
under the Investment Advisory Agreement, and the expenses of the Investment
Adviser will not necessarily be reduced as a result of the receipt of such
supplemental information.
The securities in which the Fund will invest are traded in the
over-the-counter markets, and the Fund intends to deal directly with the dealers
who make markets in the securities involved, except in those circumstances where
better prices and execution are available elsewhere. Under the 1940 Act, except
as permitted by exemptive order, persons affiliated with the Fund are prohibited
from dealing with the Fund as principal in the purchase and sale of securities.
Since transactions in the over-the-counter market usually involve transactions
with dealers acting as principals for their own accounts, the Fund will not deal
with affiliated persons, including Merrill Lynch and its affiliates, in
connection with such transactions except that, pursuant to an exemptive order
obtained by the Investment Adviser, the Fund may engage in principal
transactions with Merrill Lynch in high quality, short-term, tax-exempt
securities. See 'Investment Restrictions.' For the period November 3, 1995
(commencement of operations) to October 31, 1996 and for the fiscal year ended
October 31, 1997, the Fund engaged in no transactions pursuant to such order.
However, affiliated persons of the Fund may serve as its broker in over-the-
counter transactions conducted on an agency basis.
The Fund may not purchase securities, including Municipal Bonds, during the
existence of any underwriting syndicate of which Merrill Lynch is a member or in
a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Directors of the Fund which either comply
with rules adopted by the Commission or with interpretations of the Commission
Staff. Rule 10f-3 under the 1940 Act sets forth conditions under which the Fund
may purchase municipal bonds from an underwriting syndicate of which Merrill
Lynch is a member. The rule sets forth requirements relating to, among other
things, the terms of an issue of municipal bonds purchased by the Fund, the
amount of municipal bonds that may be purchased in any one issue and the assets
of the Fund that may be invested in a particular issue.
The Fund may also make loans to tax-exempt borrowers in individually
negotiated transactions with the borrower. Because an active trading market may
not exist for such securities, the prices that the Fund may pay for these
securities or receive on their resale may be lower than that for similar
securities with a more liquid market.
PORTFOLIO TURNOVER
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Investment Adviser. The portfolio turnover rate is calculated
by dividing the lesser of purchases or sales of portfolio securities for the
particular fiscal year by the monthly average of the value of the portfolio
securities owned by the Fund during the particular fiscal year. For purposes of
determining this rate, all securities whose maturities at the time of
acquisition are one year or less are excluded. For the period November 3, 1995
(commencement of operations) to October 31, 1996 and for the fiscal year ended
October 31, 1997 the Fund's portfolio turnover rates were 234.41% and 144.34%,
respectively. Portfolio turnover rates tend to be high for funds in their first
few years of operations. The Fund purchases temporary holdings until more,
appropriate, long-term investments are acquired. This strategy continues until
the Fund "matures" into a portfolio of core holdings enabling it to meet its
investment objectives.
33
<PAGE>
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute substantially all of its net investment
income. Dividends from such net investment income are paid monthly. As long as
any preferred stock is outstanding, monthly distributions to holders of Common
Stock normally will consist of substantially all net investment income remaining
after the payment of dividends (and any Additional Distribution) on the Series A
AMPS and any other preferred stock. All net realized capital gains, if any, will
be distributed at least annually to holders of Common Stock and pro rata to
holders of Common Stock and preferred stock. While any shares of preferred stock
are outstanding, the Fund may not declare any cash dividend or other
distribution on its Common Stock, unless at the time of such declaration (1) all
accumulated preferred stock dividends, including any Additional Distribution,
have been paid, and (2) the net asset value of the Fund's portfolio (determined
after deducting the amount of such dividend or other distribution) is at least
200% of the liquidation value of the outstanding preferred stock (expected to
equal the original purchase price of the outstanding shares of preferred stock
plus any accumulated and unpaid dividends thereon and any accumulated but unpaid
Additional Distribution). As of the date of this Prospectus, Series A AMPS
represent approximately 33% of the Fund's capital and the asset coverage with
respect to the Series A AMPS is approximately 307%. If the Fund's ability to
make distributions on its Common Stock is limited, such limitation could under
certain circumstances impair the ability of the Fund to maintain its
qualification for taxation as a regulated investment company, which could have
adverse tax consequences for holders of Common Stock. See 'Taxes.'
All net realized capital gains, if any, will be distributed to the Fund's
Shareholders at least annually. See 'Automatic Dividend Reinvestment Plan' for
information concerning the manner in which dividends and distributions to
holders of Common Stock may be automatically reinvested in shares of Common
Stock of the Fund. Dividends and distributions are taxable to shareholders as
discussed below whether they are reinvested in shares of the Fund or received in
cash.
TAXES
GENERAL
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ('RICs') under the Code. As long as it
so qualifies, in any taxable year in which it distributes at least 90% of its
taxable net income and 90% of its tax-exempt net income (see below), the Fund
(but not its shareholders) will not be subject to Federal income tax to the
extent that it distributes its net investment income and net realized capital
gains. The Fund intends to distribute substantially all of such income.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year-end, plus certain undistributed
amounts from previous years. The required distributions, however, are based only
on the taxable income of a RIC. The excise tax, therefore, generally will not
apply to the tax-exempt income of a RIC, such as the Fund, that pays exempt-
interest dividends.
The Fund intends to qualify to pay 'exempt-interest' dividends as defined
in Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations exempt from Federal income tax ('tax-exempt
obligations') under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund will be qualified
to pay exempt-interest dividends to its shareholders. Exempt-interest dividends
are dividends or any
34
<PAGE>
part thereof paid by the Fund which are attributable to interest on tax-exempt
obligations and designated by the Fund as exempt-interest dividends in a written
notice mailed to the Fund's shareholders within 60 days after the close of its
taxable year. To the extent that the dividends distributed to the Fund's
shareholders are derived from interest income exempt from tax under Code Section
103(a) and are properly designated as exempt-interest dividends, they will be
excludable from a shareholder's gross income for Federal income tax purposes.
Exempt-interest dividends are included, however, in determining the portion, if
any, of a person's social security and railroad retirement benefits subject to
Federal income taxes. Interest on indebtedness incurred or continued to purchase
or carry Fund shares will not be deductible by the investor for Federal income
tax purposes, to the extent attributable to exempt-interest dividends.
Shareholders are advised to consult their tax advisers with respect to whether
exempt-interest dividends retain the exclusion under Code Section 103(a) if such
shareholder would be treated as a 'substantial user' or 'related person' under
Code Section 147(a) with respect to property financed with the proceeds of an
issue of 'industrial development bonds' or 'private activity bonds,' if any,
held by the Fund.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short-term capital gains over
net long-term capital losses ('ordinary income dividends'), such distributions
are considered ordinary income for Federal income tax purposes. Distributions,
if any, from an excess of net long-term capital gains over net short-term
capital losses derived from the sale of securities or from certain transactions
in futures or options ('capital gain dividends') are taxable as long-term
capital gains for Federal income tax purposes, regardless of the length of time
the shareholder has owned Fund shares. Recent legislation creates additional
categories of capital gains taxable at different rates. Generally not later than
60 days after the close of its taxable year, the Fund will provide its
shareholders with a written notice designating the amounts of any
exempt-interest dividends, ordinary income dividends or capital gain dividends,
as well as the amount of capital gain dividends in the different categories of
capital gain referred to above. Distributions by the Fund, whether from
exempt-interest income, ordinary income or capital gains, will not be eligible
for the dividends received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of shares held for six months
or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividends received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the RIC and
received by its shareholders on December 31 of the year in which such dividend
was declared.
The Internal Revenue Service ('IRS') has taken the position in a revenue
ruling that if a RIC has two classes of shares, it may designate distributions
made to each class in any year as consisting of no more than such class's
proportionate share of particular types of income, including exempt-interest
income and net long-term capital gains, including the different categories of
capital gains discussed above. A class's proportionate share of a particular
type of income is determined according to the percentage of total dividends paid
by the RIC during such year that was paid to such class. Consequently, the Fund
intends to designate distributions made to the Common Stock, the Series A AMPS
and any other preferred stock issued by the Fund, as consisting of particular
35
<PAGE>
types of income in accordance with the classes' proportionate shares of such
income. Thus, the Fund will designate dividends paid as exempt-interest
dividends in a manner that allocates such dividends between the holders of
Common Stock and Series A AMPS in proportion to the total dividends paid to each
class during the taxable year, or otherwise as required by applicable law.
Capital gain dividends will similarly be allocated between the two classes in
proportion to the total dividends paid to each class during the taxable year, or
otherwise as required by applicable law. When capital gain or other taxable
income is allocated to holders of Series A AMPS pursuant to the allocation rules
described above, the terms of the Series A AMPS require the Fund to make an
additional distribution to or otherwise compensate such holders for the tax
liability resulting from such allocation.
In the opinion of Brown & Wood, LLP, counsel to the Fund, under current law
the manner in which the Fund allocates items of tax-exempt income, net capital
gains, and other taxable income, if any, between shares of Common Stock and
shares of Series A AMPS will be respected for Federal income tax purposes.
However, there currently is no direct guidance from the IRS or other sources
specifically addressing whether the Fund's method for allocating tax-exempt
income, net capital gains, and other taxable income between shares of Common
Stock and shares of Series A AMPS will be respected for Federal income tax
purposes, and it is possible that the IRS could disagree with counsel's opinion
and attempt to reallocate the Fund's net capital gains or other taxable income.
A reallocation may cause the Fund to be liable for income tax and excise tax on
any reallocated taxable income. Brown & Wood, LLP has advised the Fund that, in
its opinion, if the IRS were to challenge in court the Fund's allocations of
income and gain, the Fund would be unlikely to prevail. The opinion of Brown &
Wood, LLP, however, represents only its best legal judgment and is not binding
on the IRS or the courts.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. This alternative minimum tax applies
to interest received on 'private activity bonds' issued after August 7, 1986.
Private activity bonds are bonds that, although tax-exempt, are used for
purposes other than those generally performed by governmental units and that
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
'tax preference' which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund intends to
purchase such 'private activity bonds' and will report to shareholders within 60
days after its taxable year-end the portion of its dividends declared during the
year which constitutes an item of tax preference for alternative minimum tax
purposes. The Code further provides that corporations are subject to an
alternative minimum tax based, in part, on certain differences between taxable
income as adjusted for other tax preferences and the corporation's 'adjusted
current earnings', which more closely reflect a corporation's economic income.
Because an exempt-interest dividend paid by the Fund will be included in
adjusted current earnings, a corporate shareholder may be required to pay an
alternative minimum tax on exempt-interest dividends paid by the Fund.
The Fund may invest in high yield securities, as described herein.
Furthermore, the Fund may also invest in instruments the return on which
includes nontraditional features such as indexed principal or interest payments
('nontraditional instruments'). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such high yield securities
and/or nontraditional instruments could be recharacterized as taxable ordinary
income.
If at any time when Series A AMPS or other shares of preferred stock are
outstanding the Fund does not meet the asset coverage requirements of the 1940
Act, the Fund will be required to suspend distributions to holders of Common
Stock until the asset coverage is restored. See 'Dividends and Distributions.'
This may prevent the Fund from distributing at least 90% of its net investment
income and may, therefore, jeopardize the
36
<PAGE>
Fund's qualification for taxation as a RIC. Upon any failure to meet the asset
coverage requirements of the 1940 Act, the Fund, in its sole discretion, may,
and under certain circumstances will be required to, redeem shares of preferred
stock in order to maintain or restore the requisite asset coverage and avoid the
adverse consequences to the Fund and its shareholders of failing to qualify as a
RIC. There can be no assurance, however, that any such action would achieve such
objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund currently contemplates issuing in
addition to the Series A AMPS may raise an issue as to whether distributions on
such preferred stock are 'preferential' under the Code and therefore not
eligible for the dividends paid deduction. The Fund intends to issue preferred
stock that counsel advises will not result in the payment of a preferential
dividend and may seek a private letter ruling from the Internal Revenue Service
to that effect. If the Fund ultimately relies solely on a legal opinion when it
issues such preferred stock, there is no assurance that the Internal Revenue
Service would agree that dividends on the preferred stock are not preferential.
If the Internal Revenue Service successfully disallowed the dividends paid
deduction for dividends on the preferred stock, the Fund could be disqualified
as a RIC. In this case, dividends paid by the Fund would not be exempt from
Federal income taxes. Additionally, the Fund would be subject to the alternative
minimum tax.
The value of common shares acquired pursuant to the Fund's dividend
reinvestment plan will generally be excluded from gross income to the extent
that the cash amount reinvested would be excluded from gross income. If, when
the Fund's shares are trading at a premium over net asset value, the Fund issues
shares pursuant to the dividend reinvestment plan which have a greater fair
market value than the amount of cash reinvested, it is possible that all or a
portion of such discount (which may not exceed 5% of the fair market value of
the Fund's shares) could be viewed as a taxable distribution. If the discount is
viewed as a taxable distribution, it is also possible that the taxable character
of this discount would be allocable to all the shareholders, including
shareholders who do not participate in the dividend reinvestment plan. Thus,
shareholders who do not participate in the dividend reinvestment plan might be
required to report as ordinary income a portion of their distributions equal to
their allocable share of the discount.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisers concerning the applicability of the United States withholding
tax.
Under certain Code provisions, some taxpayers may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ('backup withholding'). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
37
<PAGE>
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ('financial
futures contracts'). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is available
to the Fund or an exception applies, such options and financial futures
contracts that are 'Section 1256 contracts' will be 'marked to market' for
Federal income tax purposes at the end of each taxable year, i.e., each such
option or financial futures contract will be treated as sold for its fair market
value on the last day of the taxable year, and any gain or loss attributable to
Section 1256 contracts will be 60% long-term and 40% short-term capital gain or
loss. Application of the mark-to-market rules to Section 1256 contracts held by
the Fund may alter the timing and character of distributions to shareholders.
The mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain 'straddles,' may affect the
taxation of the Fund's sales of securities and transactions in financial futures
contracts and related options. Under Section 1092, the Fund may be required to
postpone recognition for tax purposes of losses incurred in certain sales of
securities and certain closing transactions in financial futures contracts or
the related options.
OFFERS TO PURCHASE SHARES
Under current law, a holder of Common Stock, who, pursuant to any Tender
Offer, tenders all shares of Common Stock owned by such shareholder and who,
after such Tender Offer, is not considered to own any shares under attribution
rules contained in the Code will realize a taxable gain or loss depending upon
such shareholder's basis in the shares. Such gain or loss will be treated as
capital gain or loss if the shares are held as capital assets, and the
applicable category of capital gain and related tax rate will depend on the
shareholder's holding period for the shares. Different tax consequences may
apply to tendering and non-tendering holders of Common Stock in connection with
a Tender Offer, and these consequences will be disclosed in the related offering
documents. For example, if a tendering holder of Common Stock tenders less than
all shares owned by or attributed to such shareholder, and if the distribution
to such shareholder does not otherwise qualify as a sale or exchange, the
proceeds received will be treated as a taxable dividend, or, if the Fund has
insufficient earnings and profits, a return of capital or capital gain,
depending on the shareholder's basis in the tendered shares. Also, there is a
remote risk that
non-tendering holders of Common Stock may be considered to have received a
deemed distribution that may be a taxable dividend in whole or in part. Holders
of Common Stock may wish to consult their tax advisers prior to tendering.
Likewise, if holders of Common Stock whose shares are acquired by the Fund in
the open market sell less than all shares owned by or attributed to them, a risk
exists that these shareholders will be subject to taxable dividend treatment,
and a remote risk exists that the remaining shareholders may be considered to
have received a deemed distribution.
STATE AND LOCAL TAXES
The exemption from Federal income tax for exempt-interest dividends does
not necessarily result in an exemption for such dividends under the income or
other tax laws of any state or local taxing authority. Shareholders are advised
to consult their own tax advisers concerning state and local tax matters.
------------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code
38
<PAGE>
sections and the Treasury regulations promulgated thereunder. The Code and the
Treasury regulations are subject to change by legislative, judicial or
administrative action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes and with specific
questions as to Federal, foreign, state, or local taxes.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
All dividends and capital gains distributions on the Common Stock of the
Fund are reinvested automatically in full and fractional shares of Common Stock
of the Fund at the net asset value per share next determined on the payable date
of such dividend or distribution. A shareholder may at any time, by written
notification to Merrill Lynch if the shareholder's account is maintained with
Merrill Lynch or by written notification or by telephone (1-800-MER-FUND) to the
Transfer Agent, if the shareholder's account is maintained with the Transfer
Agent, elect to have subsequent dividends or both dividends and capital gains
distributions paid in cash, rather than reinvested, in which event payment will
be mailed on or about the payment date. The Fund is not responsible for any
failure of delivery to the shareholder's address of record and no interest will
accrue on amounts represented by uncashed distribution or redemption checks.
Cash payments can also be directly deposited to the shareholder's bank account.
No CDSC will be imposed on redemptions of shares issued as a result of the
automatic reinvestment of dividends or capital gains distributions.
The automatic reinvestment of dividends will not relieve participants of
any Federal income tax that may be payable (or required to be withheld) on such
dividends or distributions. See 'Taxes.'
NET ASSET VALUE
The net asset value per share of Common Stock is determined once daily as
of 15 minutes after the close of business on the NYSE (generally, 4:00 p.m., New
York time), on each business day during which the NYSE is open for trading. The
NYSE is not open on New Year's Day, Martin Luther King, Jr. Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day. For purposes of determining the net asset value of a share of
Common Stock, the value of the securities held by the Fund plus any cash or
other assets (including interest accrued but not yet received) minus all
liabilities (including accrued expenses) and the aggregate liquidation value of
the outstanding shares of preferred stock is divided by the total number of
shares of Common Stock outstanding at such time. Expenses, including the fees
payable to the Investment Adviser, are accrued daily.
The Municipal Bonds in which the Fund invests are traded primarily in the
over-the-counter markets. In determining net asset value, the Fund utilizes the
valuations of portfolio securities furnished by a pricing service approved by
the Board of Directors. The pricing service typically values portfolio
securities at the bid price or the yield equivalent when quotations are readily
available. Municipal Bonds for which quotations are not readily available are
valued at fair market value on a consistent basis as determined by the pricing
service using a matrix system to determine 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. The Board of Directors
has determined in good faith that the use of a pricing service is a fair method
of determining the valuation of portfolio securities. Obligations with remaining
maturities of 60 days or less are valued at amortized cost, unless this method
no longer produces fair valuations. Positions in futures contracts are valued at
closing prices for such contracts established by the exchange on which they are
traded, or if market quotations are not readily available, are valued at fair
value on a consistent basis using methods determined in good faith by the Board
of Directors.
39
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares were initially classified as Common
Stock. The Board of Directors is authorized, however, to classify or reclassify
any unissued shares of capital stock by setting or changing in any one or more
respects the designation and number of shares of any such class or series, and
the nature, rates, amounts and times at which and the conditions under which
dividends shall be payable on and the voting, conversion, redemption and
liquidation rights of such class or series and any other preferences, rights,
restrictions, and qualifications applicable thereto. In this regard, the Board
of Directors reclassified 40,000 shares of unissued Common Stock as Auction
Market Preferred Stock, par value $0.10 per share, liquidation preference
$25,000 per share ('AMPS').
The following table shows the amount of (i) capital stock authorized, (ii)
capital stock held by the Fund for its own account and (iii) capital stock
outstanding for each class of authorized securities of the Fund as of October
31, 1997.
<TABLE>
<CAPTION>
AMOUNT OUTSTANDING
AS OF OCTOBER 31, 1997
AMOUNT HELD (EXCLUSIVE OF AMOUNT HELD
AMOUNT BY FUND FOR ITS BY FUND FOR ITS
TITLE OF CLASS AUTHORIZED OWN ACCOUNT OWN ACCOUNT)
- ----------------------------------------------------------- ----------- ----------- --------------------------
<S> <C> <C> <C>
Common Stock............................................... 199,960,000 0 9,333,017
Auction Market Preferred Stock............................. 40,000 0 1,920
</TABLE>
COMMON STOCK
Shares of Common Stock, when issued and outstanding, will be fully paid and
non-assessable. Holders of Common Stock are entitled to share pro rata in the
net assets of the Fund available for distribution to holders of Common Stock
upon liquidation of the Fund. Holders of Common Stock are entitled to one vote
for each share held.
So long as any shares of the Fund's preferred stock are outstanding,
holders of Common Stock will not be entitled to receive any net income of or
other distributions from the Fund unless all accumulated dividends on preferred
stock have been paid and unless asset coverage (as defined in the 1940 Act) with
respect to preferred stock would be at least 200% after giving effect to such
distributions. See 'Preferred Stock' below.
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its shareholders.
PREFERRED STOCK
The Fund's shares of preferred stock may be issued in one or more series,
with rights as determined by the Board of Directors, by action of the Board of
Directors without the approval of the holders of Common Stock. Under the Funds's
Articles Supplementary specifying the powers, preferences and rights of the
AMPS, the Fund is authorized to issue an aggregate of 40,000 shares of AMPS,
designated respectively: 8,000 shares of Series A AMPS, 8,000 shares of Series B
AMPS, 8,000 shares of Series C AMPS, 8,000 shares of Series D AMPS and 8,000
shares of Series E AMPS. The Series A AMPS are the only series currently offered
and to be issued and outstanding. Under the 1940 Act, the Fund is permitted to
have outstanding more than one series of preferred stock so long as no single
series has a priority over another series as to the distributions of assets of
the Fund or the payment of dividends. Holders of Common Stock have no preemptive
right to purchase any shares of
40
<PAGE>
preferred stock that might be issued. It is anticipated that the net asset value
per share of the preferred stock will equal its original purchase price per
share plus accumulated dividends per share.
The Fund has issued 1,920 shares of Series A AMPS and may offer additional
shares of AMPS and other preferred stock (representing up to approximately 35%
of the Fund's capital), subject to market conditions and to the Board's
continuing to believe that leveraging the Fund's capital structure through the
issuance of preferred stock is likely to achieve the benefits to the holders of
Common Stock described in the Prospectus. The terms of such preferred stock,
including its dividend rate, voting rights, liquidation preference and
redemption provisions will be determined by the Board of Directors (subject to
applicable law and the Fund's Articles of Incorporation). The redetermination of
the dividend rate will be made at relatively short intervals (generally seven or
28 days), or a medium-term dividend rate, in which case periodic redetermination
of the dividend rate will be made at intervals of up to five years. In either
case, such redetermination of the dividend rate will be made through an auction
or remarketing procedure. Additionally, under certain circumstances, when the
Fund is required to allocate taxable income to holders of the preferred stock,
it is anticipated that the terms of the preferred stock will require the Fund to
make an Additional Distribution (as defined in 'Risks and Special Considerations
of Leverage--Effects of Leverage') to such holders. The Board also has indicated
that it is likely that the liquidation preference, voting rights and redemption
provisions of the preferred stock will be as stated below. The Fund's Articles
of Incorporation, as amended, together with any Articles Supplementary, are
referred to below as the 'Charter.'
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of shares of
preferred stock will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus an
amount equal to accumulated and unpaid dividends whether or not earned or
declared and any accumulated and unpaid Additional Distribution) before any
distribution of assets is made to holders of Common Stock. After payment of the
full amount of the liquidating distribution to which they are entitled, the
preferred stockholders will not be entitled to any further participation in any
distribution of assets by the Fund. A consolidation or merger of the Fund with
or into any other corporation or corporations or a sale of all or substantially
all of the assets of the Fund will not be deemed to be a liquidation,
dissolution or winding up of the Fund.
Voting Rights. Except as otherwise indicated in this Prospectus and except
as otherwise required by applicable law, holders of shares of preferred stock
will have equal voting rights with holders of shares of Common Stock (one vote
per share) and will vote together with holders of Common Stock as a single
class.
In connection with the election of the Fund's directors, holders of shares
of Series A AMPS and other preferred stock, voting as a separate class, are
entitled to elect two of the Fund's directors, and the remaining directors will
be elected by all holders of capital stock, voting as a single class. So long as
any preferred stock is outstanding, the Fund will have not less than five
directors. If at any time dividends on shares of the Fund's preferred stock
shall be unpaid in an amount equal to two full years' dividends thereon, the
holders of all outstanding shares of preferred stock, voting as a separate
class, will be entitled to elect a majority of the Fund's directors until all
dividends in default have been paid or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding shares
of the preferred stock, voting as a separate class, will be required to (i)
authorize, create or issue (other than the preferred stock authorized by the
Articles Supplementary creating such preferred stock), or increase the
authorized or issued aggregate stated capital amount of (other than the
preferred stock authorized by the Articles Supplementary creating such preferred
stock), any class or series of stock ranking prior to or on a parity with any
series of preferred stock with respect to payment of dividends or the
distribution of assets on liquidation, or increase the authorized amount of
preferred stock or (ii) amend, alter or repeal the provisions of the Charter,
whether by merger, consolidation or
41
<PAGE>
otherwise, so as to adversely affect any of the contract rights expressly set
forth in the Charter of holders of preferred stock.
Redemption Provisions. Shares of preferred stock generally will be
redeemable at the option of the Fund at a price equal to their liquidation
preference plus accumulated but unpaid dividends to the date of redemption plus,
under certain circumstances, a redemption premium. Shares of preferred stock
will also be subject to mandatory redemption at a price equal to their
liquidation preference plus accumulated but unpaid dividends to the date of
redemption upon the occurrence of certain specified events, such as the failure
of the Fund to maintain asset coverage requirements for the preferred stock
specified by the rating agencies that issue ratings on the preferred stock. The
Charter prohibits the sale or transfer of preferred stock to any affiliate of
the Fund or the Investment Adviser, except for an affiliate that may be acting
as a broker-dealer in connection with the preferred stock.
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A Director may be removed from office
with or without cause by vote of the holders of at least 66 2/3% of the shares
of capital stock entitled to be voted on the matter. A director elected by all
of the holders of capital stock may be removed only by action of such holders,
and a director elected by the holders of preferred stock may be removed only by
action of such holders.
In addition, the Articles of Incorporation require the favorable vote of
the holders of at least 66 2/3% of the Fund's shares of capital stock, then
entitled to be voted, voting as a single class, to approve, adopt or authorize
the following:
(i) a merger or consolidation or statutory share exchange of the Fund
with other corporations,
(ii) a sale of all or substantially all of the Fund's assets (other
than in the regular course of the Fund's investment activities), or
(iii) a liquidation or dissolution of the Fund,
unless such action has been approved, adopted or authorized by the affirmative
vote of two-thirds of the total number of Directors fixed in accordance with the
by-laws, in which case the affirmative vote of a majority of the Fund's shares
of capital stock is required. The approval, adoption or authorization of the
foregoing would also require the favorable vote of at least a majority of the
Fund's shares of preferred stock then entitled to be voted, voting as a separate
class.
In addition, conversion of the Fund to an open-end investment company would
require an amendment to the Fund's Articles of Incorporation. The amendment
would have to be declared advisable by the Board of Directors prior to its
submission to shareholders. Such an amendment would require the favorable vote
of the holders of at least 66 2/3% of the Fund's outstanding shares of capital
stock (including the preferred stock) entitled to be voted on the matter, voting
as a single class (or a majority of such shares if the amendment was previously
approved, adopted or authorized by at least two-thirds of the total number of
Directors fixed in accordance with the by-laws), and, while shares of preferred
stock are outstanding, the affirmative vote of at least a majority of
outstanding shares of preferred stock of the Fund, voting as a separate class.
Such a vote also would satisfy a separate requirement in the 1940 Act that the
change be approved by the shareholders. Shareholders of an open-end investment
company may require the company to redeem their shares of common stock at any
time (except in certain circumstances as authorized by or under the 1940 Act) at
their net asset value, less such redemption
42
<PAGE>
charge, if any, as might be in effect at the time of a redemption. All
redemptions will be made in cash. If the Fund is converted to an open-end
investment company, it could be required to liquidate portfolio securities to
meet requests for redemption. Conversion to an open-end investment company would
also require redemption of all outstanding shares of preferred stock and would
require changes in certain of the Fund's investment policies and restrictions,
such as those relating to the issuance of senior securities and the borrowing of
money.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of shareholders generally.
Reference should be made to the Article of Incorporation on file with the
Commission for the full text of these provisions.
PERFORMANCE DATA
From time to time, the Fund may include its yield, tax equivalent yield
and/or total return on its Common Stock for various specified time periods in
advertisements or information furnished to present or prospective shareholders.
The yield of the Fund refers to the income generated by an investment in
the Fund over a stated period. Yield is calculated by annualizing the
distribution over a stated period and dividing the product by the average per
share net value. For the fiscal year ended October 31, 1997, the Fund earned
$0.590 per share income dividends, representing a net annualized yield of 5.40%,
based on a month-end per share net asset value of Common Stock of $10.87. Tax
equivalent yield quotations will be computed by dividing (a) the part of the
Fund's yield that is tax-exempt by (b) one minus a stated tax rate and (c)
adding the result to that part, if any, of the Fund's yield that is not
tax-exempt. The tax-equivalent yield for the fiscal year ended October 31, 1997
(based on a Federal income tax rate of 28%) was 7.50%. See Appendix II to this
Prospectus for more information regarding tax equivalent yields.
The Fund also may quote annual total return and aggregate total return
performance data. Total return quotations for the specified periods will be
computed by finding the rate of return (based on net investment income and any
capital gains or losses on portfolio investments over such periods) that would
equate the initial amount invested to the value of such investment at the end of
the period. For the fiscal year ended October 31, 1997, the annual total return
of the Fund was 13.08%, based on the change in per share net asset value of
Common Stock from $10.17 to $10.87, and assuming reinvestment of $0.598 per
share income dividends of Common Stock.
The calculation of yield, tax-equivalent yield and total return does not
reflect the imposition of any CDSC or the amount of any shareholder's tax
liability.
Yield, tax-equivalent yield and total return figures are based on the
Fund's historical performance and are not intended to indicate future
performance. The Fund's yield is expected to fluctuate, and its total return
will vary depending on market conditions, the Municipal Bonds and other
securities comprising the Fund's portfolio, the Fund's operating expenses and
the amount of net realized and unrealized capital gains or losses during the
period.
On occasion, the Fund may compare its yield and tax-equivalent yield to
yield data published by Lipper Analytical Services, Inc. or performance data
published by Morningstar Publications, Inc., Money Magazine, U.S. News & World
Report, Business Week, CDA Investment Technology, Inc., Forbes Magazine and
Fortune Magazine. Yield comparisons should not be considered indicative of the
Fund's yield and tax-equivalent yield or relative performance for any future
period.
43
<PAGE>
CUSTODIAN
The Fund's securities and cash are held under a custody agreement with The
Bank of New York, 90 Washington Street, New York, New York 10286.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT
AND SHAREHOLDER SERVICING AGENT
The Transfer Agent, Dividend Disbursing Agent and Shareholder Servicing
Agent for the shares of Common Stock of the Fund is Merrill Lynch Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484, a
wholly owned subsidiary of ML & Co.
Shareholder Reports. Only one copy of each shareholder report and certain
shareholder communications will be mailed to each identified shareholder
regardless of the number of accounts such shareholder has. If a shareholder
wishes to receive separate copies of each report and communication for each of
the shareholder's related accounts the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
The written notification should include the shareholder's name, address,
tax identification number and Merrill Lynch and/or mutual fund account numbers.
If you have any questions regarding this, please call your Merrill Lynch
Financial Consultant or Merrill Lynch Financial Data Services, Inc. at
800-637-3863.
LEGAL OPINIONS
Certain legal matters in connection with the Common Stock offered hereby
will be passed on for the Fund by Brown & Wood LLP, One World Trade Center, New
York, New York 10048-0557.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, have
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to ratification by shareholders of the Fund. The
independent auditors are responsible for auditing the financial statements of
the Fund.
44
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Municipal Strategy Fund, Inc.:
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, 1997, the related statements of operations for the year
then ended and changes in net assets, and the financial highlights for the year
then ended and 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
audits.
We conducted our audits 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 at October
31, 1997 by correspondence with the custodian and brokers. 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 audits provide 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, 1997, the results of its
operations, the changes in its net assets and the financial highlights for the
respective stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
December 10, 1997
45
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C> <C>
Alabama -- 2.0% NR* Aaa $2,815 Alabama HFA, S/F Home Mortgage Revenue Bonds, Series A-1, 6.60% due 4/01/2019 $3,013
Arizona -- 4.1% A1+ P1 2,200 Maricopa County, Arizona, PCR, Refunding (Arizona Public Service Co.),
VRDN, Series C, 4% due 5/01/2029 (h) 2,200
B B2 2,000 Pima County, Arizona, IDA, Industrial Revenue Bonds (Tucson Power Co. Project),
Series B, 6% due 9/01/2029 2,019
NR* NR* 1,875 Show Low, Arizona, Improvement District No. 5, 6.375% due 1/01/2015 1,877
Arkansas -- 0.8% 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) 1,268
California -- AAA Aaa 2,000 San Diego, California, IDR, RITR, 8.185% due 9/01/2019 (e) 2,270
1.5%
Colorado -- 9.3% NR* Aa2 2,000 Colorado HFA, S/F Program, AMT, Series D-1, 7.375% due 6/01/2026 2,230
NR* NR* 1,500 Denver, Colorado, Urban Renewal Authority, Tax Increment Revenue Bonds
(Downtown Denver), AMT, Series A, 7.75% due 9/01/2016 1,652
AAA Aaa 8,840 El Paso County, Colorado, Falcon School District No. 49, UT, 6.50% due
12/01/2015 (a) 10,058
Connecticut -- BBB- NR* 1,000 Connecticut State Health and Educational Facilities Authority Revenue Bonds
0.7% (University of New Haven), Series D, 6.70% due 7/01/2026 1,070
Florida -- 6.8% AAA Aaa 1,000 Dade County, Florida, Aviation Revenue Bonds (Miami International Airport),
Series C, 5.125% due 10/01/2027 (d) 969
AA- VMIG1+ 500 Dade County, Florida, IDA, Exempt Facilities Revenue Refunding Bonds
(Florida Power and Light Co.), VRDN, 3.65% due 6/01/2021 (h) 500
A1 NR* 200 Escambia County, Florida, PCR, Refunding (Gulf Power Co. Project),
VRDN, 3.75% due 7/01/2022 (h) 200
NR* Baa1 1,000 Jacksonville, Florida, Health Facilities Authority, IDR (National
Benevolent -- Cypress Village), Series A, 6.25% due 12/01/2026 1,057
BBB+ Baa2 1,000 Nassau County, Florida, PCR, Refunding (ITT Rayonier Inc. Project),
6.25% due 6/01/2010 1,052
NR* Baa 2,260 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida Education and
Research Foundation Project), Series A, 6.85% due 9/01/2013 2,508
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
BBB- NR* 3,140 Santa Rosa Bay, Florida, Bridge Authority, 6.25% due 7/01/2028 3,287
Georgia -- 5.8% AA Aa3 2,000 Atlanta, Georgia, GO, UT, Series A, 6.125% due 12/01/2023 2,161
A1 VMIG1+ 2,500 Burke County, Georgia, Development Authority, PCR (Georgia Power
Company -- Vogtle Project), VRDN, 2nd Series, 3.65% due 4/01/2025 (h) 2,500
AA+ Aa2 3,875 Georgia State Housing & Finance Authority, S/F Mortgage Revenue Bonds,
Sub-Series A-1, 6.125% due 12/01/2015 4,086
Illinois -- 5.2% NR* NR* 980 Beardstown, Illinois, IDR (Jefferson Smurfit Corp. Project), 8% due 10/01/2016 1,114
AAA Aaa 1,630 Illinois Development Finance Authority, PCR, Refunding (Commerce Edison
Company Project), Series D, 6.75% due 3/01/2015 (c) 1,823
AA- Aa3 3,285 Illinois Development Finance Authority Revenue Bonds (Presbyterian Home Lake),
Series B, 6.30% due 9/01/2022 3,528
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C> <C>
NR* Baa1 1,250 Illinois Health Facilities Authority Revenue Bonds (Holy Cross Hospital Project),
6.70% due 3/01/2014 1,331
Indiana -- 2.1% NR* NR* 1,500 Indiana Health Facilities Financing Authority Revenue Bonds (Hartsfield
Village Project), Series A, 6.375% due 8/15/2027 1,509
AAA Aaa 1,500 Tippecanoe County, Indiana, School Building Corp. (First Mortgage), 6% due
7/15/2013 (a) 1,583
Louisiana -- 2.8% BB NR* 4,000 Port New Orleans, Louisiana, IDR, Refunding (Continental Grain Co. Project),
6.50% due 1/01/2017 4,232
Maryland -- 2.2% NR* NR* 2,000 Maryland State Energy Financing Administration, Limited Obligation Revenue Bonds
(Cogeneration -- AES Warrior Run), AMT, 7.40% due 9/01/2019 2,195
A- NR* 1,000 Maryland State Energy Financing Administration, Solid Waste Disposal Revenue
Bonds (Wheelabrator Water Projects), AMT, 6.30% due 12/01/2010 1,084
Massachusetts -- A- NR* 5,000 Massachusetts State Health and Educational Facilities Authority, Revenue
3.5% Refunding Bonds (Melrose Wakefield Hospital), Series B, 6.25% due 7/01/2012 5,266
Michigan -- 2.7% Michigan State Hospital Finance Authority Revenue Bonds:
AAA Aaa 3,100 INFLOS (Sisters of Mercy), 8.767% due 2/15/2022 (d)(e) 3,522
A A2 500 Refunding (Detroit Medical Center Obligated Group), Series A, 6.50% due 8/15/2018 539
Missouri -- 1.6% AAA NR* 2,175 Missouri State Housing Development Commission Mortgage Revenue Bonds,
Series C-1, 6.55% due 9/01/2028 (f)(g) 2,376
Montana -- 2.1% AA Aa2 3,000 Montana State Board of Housing, S/F Mortgage Refunding Bonds, Series A-1,
5.95% due 12/01/2027 3,094
Nevada -- 1.1% NR* NR* 1,530 Reno-Sparks Convention and Vistors Authority, Nevada, Limited Obligation
Revenue Refunding Bonds, 6.40% due 11/01/2003 1,616
New Jersey -- AAA Aaa 3,985 New Jersey Environmental Infrastructure Trust (Wastewater Treatment),
8.5% 5% due 9/01/2017 3,906
New Jersey Health Care Facilities Financing Authority, Revenue Refunding Bonds:
BBB Baa2 2,500 (Englewood Hospital & Medical Center), 6.75% due 7/01/2024 2,719
AAA Aaa 4,950 (Kennedy), Series A, 5.125% due 7/01/2027 (a) 4,785
BBB Baa2 1,200 (Saint Elizabeth Hospital Obligation Group), 6% due 7/01/2014 1,239
</TABLE>
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
HFA Housing Finance Agency
IDA Industrial Development Authority
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
IRS Inverse Rate Securities
RITR Residual Interest Trust Receipts
PCR Pollution Control Revenue Bonds
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
47
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C> <C>
New Mexico -- A1+ P1 600 Farmington, New Mexico, PCR, Refunding (Arizona Public Service Co.),
5.6% VRDN, Series B, 3.70% due 9/01/2024 (h) 600
Farmington, New Mexico, PCR, Refunding (Public Service Company --
San Juan Project):
BB+ Ba1 3,000 Series A, 6.30% due 12/01/2016 3,172
BB+ Ba1 2,000 Series D, 6.375% due 4/01/2022 2,124
AAA NR* 2,500 New Mexico Mortgage Finance Authority, S/F Mortgage Revenue Bonds, AMT,
Series E-2, 5.75% due 7/01/2029 (f)(g) 2,508
New York -- 6.9% AAA Aaa 6,000 New York City, New York, Municipal Water Finance Authority, Water and Sewer
System Revenue Bonds, Series B, 5.875% due 6/15/2026 (d) 6,239
BBB+ Baa1 1,000 New York City, New York, Refunding, GO, UT, Series F, 6% due 8/01/2013 1,043
BBB+ Baa1 1,000 New York State Thruway Authority, Service Contract Revenue Bonds (Local
Highway and Bridge), 5.75% due 4/01/2016 1,028
NR* A3 2,000 United Nations Development Corporation of New York, Revenue Refunding Bonds,
Series C, 5.50% due 7/01/2017 2,001
North Carolina -- A+ A1 1,100 North Carolina Medical Care Commission, Hospital Revenue Bonds
2.2% (Rex Hospital Project), 6.25% due 6/01/2017 1,175
AA Aa2 1,970 North Carolina S/F, HFA, Series II, 6.20% due 3/01/2016 2,082
Ohio -- 3.3% 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 1,858
NR* NR* 1,400 Ohio State Higher Educational Facility Commission Revenue Bonds
(University of Findlay Project), 6.125% due 9/01/2016 1,446
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) 1,606
Oklahoma -- 1.2% AAA Baa 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional Facility Revenue
Bonds, 6.60% due 7/01/2010 (j) 1,843
Oregon -- 2.5% AAA Aaa 2,000 Multnomah County, Oregon, Educational Facilities Revenue Refunding
Bonds (University of Portland Project), 5% due 4/01/2018 (c) 1,930
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 1,736
Pennsylvania -- AAA Aaa 2,000 Hampton Township, Pennsylvania, School District, UT, 5% due 9/01/2027 (b) 1,908
4.8% AAA Aaa 2,950 Keystone Oaks, Pennsylvania, School District, IRS, UT, Series D,
7.521% due 9/01/2016 (c)(e) 3,145
NR* NR* 2,000 Pennsylvania Economic Development Financing Authority, Resource
Recovery Revenue Bonds (Northampton Generating), AMT, Series A,
6.50% due 1/01/2013 2,073
South Carolina -- AAA Aaa 2,000 Fairfield County, South Carolina, PCR (South Carolina Gas and Electric Co.),
1.5% 6.50% due 9/01/2014 (a) 2,200
Tennessee -- NR* NR* 1,610 Hardeman County, Tennessee, Correctional Facilities Revenue Bonds
1.2% (Correctional Facilities Corp.), 7.75% due 8/01/2017 1,792
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C> <C>
Texas -- 12.6% Harris County, Texas, Health Facilities Development Corporation, Hospital
Revenue Bonds:
A- A2 3,250 (Memorial Hospital Systems Project), Series A, 6.625% due 6/01/2004 (i) 3,686
A1+ NR* 2,000 (Methodist Hospital), VRDN, 4% due 12/01/2025 (h) 2,000
A1+ NR* 2,700 Refunding (Methodist Hospital), VRDN, 3.70% due 12/01/2026 (h) 2,700
BB Ba2 1,000 Houston, Texas, Airport System Revenue Bonds, Special Facilities
(Continental Airline Terminal Improvement), AMT, Series B, 6.125% due 7/15/2027 1,030
AAA Aaa 6,500 Tarrant County, Texas, Health Facilities Development Corp., Health System
Revenue Bonds (Texas Health Resources), Series A, 5% due 2/15/2026 (a) 6,116
AAA Aaa 3,250 Texas State Department, Housing and Community Affairs, S/F Mortgage Revenue
Teams, Series A, Class 3, AMT, 5.80% due 9/01/2029 (a) 3,275
Utah -- 0.7% NR* NR* 1,000 Tooele County, Utah, PCR, Refunding (Laidlaw Environmental),
AMT, Series A, 7.55% due 7/01/2027 1,095
Virginia AAA NR* 1,160 Newport News, Virginia, Redevelopment and Housing Authority, Revenue
0.8% Refunding Bonds, Series A, 5.85% due 12/20/2030 (g) 1,192
------------
Total Investments (Cost -- $152,688) -- 106.1% 158,641
Liabilities in Excess of Other Assets -- (6.1%) (9,178)
------------
Net Assets -- 100.0% $149,463
============
(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, 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
October 31, 1997.
(i) Prerefunded.
(j) Insured by Connie Lee.
* Not Rated.
+ Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte and Touche LLP.
</TABLE>
See Notes to Financial Statements.
49
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
As of October 31, 1997
<S> <C> <C> <C>
Assets: Investments, at value (identified cost -- $152,688,471) (Note 1a) $158,641,205
Cash 361,988
Receivables:
Securities sold $7,357,733
Interest 2,358,403
Capital shares sold 49,996 9,766,132
-------------
Deferred organization expenses (Note 1e) 186,914
Prepaid expenses and other assets (Note 1e) 56,491
-------------
Total assets 169,012,730
-------------
Liabilities: Payables:
Securities purchased 19,193,580
Dividends to shareholders (Note 1f) 144,015
Investment advisory fees (Note 2) 40,142
Administration fees (Note 2) 33,452 19,411,189
-------------
Accrued expenses and other liabilities 138,722
-------------
Total liabilities 19,549,911
-------------
Net Assets: Net assets $149,462,819
=============
Capital: Capital Stock (200,000,000 shares authorized) (Note 4):
Preferred Stock, par value $.10 per share (2,480 shares of AMPS* issued and
1,920 shares outstanding at $25,000 per share liquidation preference) $48,000,000
Common Stock, par value $.10 per share (9,333,017 shares issued and
outstanding) $933,302
Paid-in capital in excess of par 92,775,533
Undistributed investment income -- net 19,200
Undistributed realized capital gains on investments -- net 1,782,050
Unrealized appreciation on investments -- net 5,952,734
-------------
Total -- Equivalent to $10.87 net asset value per share of Common Stock 101,462,819
-------------
Total capital $149,462,819
=============
* Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS
For the Year Ended October 31, 1997
<S> <C> <C> <C>
Investment Interest and amortization of premium and discount earned $7,862,361
Income (Note 1d):
Expenses: Investment advisory fees (Note 2) $657,929
Administrative fees (Note 2) 328,965
Transfer agent fees 113,071
Commission fees 100,805
Registration fees 90,198
Printing and shareholder reports 73,334
Professional fees 63,810
Amortization of organization expenses (Note 1e) 62,134
Accounting services (Note 2) 61,452
Listing fees 48,341
Directors' fees and expenses 24,596
Custodian fees 14,655
Pricing fees 8,513
Other 41,080
------------
Total expenses before reimbursement 1,688,883
Reimbursement of expenses (Note 2) (424,822)
------------
Total expenses after reimbursement 1,264,061
------------
Investment income -- net 6,598,300
------------
Realized & Realized gain on investments -- net 2,242,563
Unrealized Change in unrealized appreciation on investments -- net 4,017,788
Gain on ------------
Investments -- Net Net Increase in Net Assets Resulting from Operations $12,858,651
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
STATEMENTS OF CHANGES IN NET ASSETS
For the For the Period
Year Ended Nov. 3, 1995+
Increase (Decrease) in Net Assets: Oct. 31, 1997 To Oct. 31, 1996
<S> <C> <C> <C>
Operations: Investment income -- net $6,598,300 $4,841,127
Realized gain (loss) on investments -- net 2,242,563 (460,513)
Change in unrealized appreciation on investments -- net 4,017,788 1,934,946
------------ ------------
Net increase in net assets resulting from operations 12,858,651 6,315,560
------------ ------------
Dividends to Investment income -- net:
Shareholders Common Stock (5,164,727) (4,173,956)
(Note 1f): Preferred Stock (1,418,941) (662,603)
------------ ------------
Net decrease in net assets resulting from dividends to shareholders (6,583,668) (4,836,559)
------------ ------------
Capital Stock Proceeds from issuance of Preferred Stock 10,000,000 38,000,000
Transactions Net increase in net assets derived from Common Stock transactions 11,614,959 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 21,614,959 119,993,876
------------ ------------
Net Assets: Total increase in net assets 27,889,942 121,472,877
Beginning of period 121,572,877 100,000
------------ ------------
End of period* $149,462,819 $121,572,877
------------ ------------
* Undistributed investment income -- net $19,200 $4,568
============ ============
+ Commencement of operations.
See Notes to Financial Statements.
</TABLE>
52
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
The Following Per Share Data and Ratios Have Been Derived
from Information Provided in the Financial Statements. For the For the Period
Year Ended Nov. 3, 1995+
Increase (Decrease) in Net Asset Value: Oct. 31, 1997 To Oct. 31, 1996
<S> <C> <C> <C>
Per Share Net asset value, beginning of period $10.17 $10.00
Operating -------- --------
Performance: Investment income -- net .75 .68
Realized and unrealized gain on investments -- net .70 .21
-------- --------
Total from investment operations 1.45 .89
-------- --------
Less dividends to Common Stock shareholders:
Investment income -- net (.59) (.59)
-------- --------
Effect of Preferred Stock activity:++
Dividends to Preferred Stock shareholders:
Investment income -- net (.16) (.09)
Capital charge resulting from issuance of Preferred Stock -- (.04)
-------- --------
Total effect of Preferred Stock activity (.16) (.13)
-------- --------
Net asset value, end of period $10.87 $10.17
======== ========
Total Investment Based on net asset value per share 13.08% 7.81%++++
Return:** ======== ========
Ratios to Expenses, net of reimbursement .96% .53%*
Average Net ======== ========
Assets:*** Expenses 1.28% 1.26%*
======== ========
Investment income -- net 5.01% 5.40%*
======== ========
Supplemental Net assets, net of Preferred Stock, end of period (in thousands) $101,463 $83,573
Data: ======== ========
Preferred Stock outstanding, end of period (in thousands) $48,000 $38,000
======== ========
Portfolio turnover 144.34% 234.41%
======== ========
Leverage: Asset coverage per $1,000 $3,114 $3,199
======== ========
Dividends Per Share Investment income -- net $897 $564
on Preferred Stock ======== ========
Outstanding:
* Annualized.
** Total investment returns exclude the effects of the contingent deferred sales charge, if any.
The Fund is a continously 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>
53
<PAGE>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1997
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.
(a) Valuation of investments -- Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the over-the-
counter 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.
[bullet] 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.
[bullet] 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.
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.
54
<PAGE>
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 year ended October 31, 1997, FAM earned fees of
$657,929, of which $424,822 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 porfolio
activities) necessary for the operation of the Fund.
A contingent deferred sales charge will be imposed on most shares
accepted for tender which have been held for less than three years. For
the year ended October 31, 1997, Merrill Lynch Funds Distributors, Inc.
("MLFD") earned contingent deferred sales charges of $85,662 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.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for
the year ended October 31, 1997 were $207,179,298 and $185,239,565,
respectively.
Net realized and unrealized gains (losses) as of October 31, 1997 were as
follows:
Realized Unrealized
Gains (Losses) Gains
Long-term investments $2,544,513 $5,952,734
Financial futures contracts (301,950) --
------------ -----------
Total $2,242,563 $5,952,734
============ ===========
As of October 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $5,935,894, of which $5,937,994 related to appreciated
securities and $2,100 related to depreciated securities. The aggregate
cost of investments at October 31, 1997, for Federal income tax purposes
was $152,705,311.
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 Year Ended Dollar
October 31, 1997 Shares Amount
Shares sold 1,457,495 $15,202,668
Shares issued to shareholders
in reinvestment of dividends 128,620 1,344,046
------------ ------------
Total issued 1,586,115 16,546,714
Shares tendered (471,994) (4,931,755)
------------ ------------
Net increase 1,114,121 $11,614,959
============ ============
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 tendered (199,672) (1,980,112)
------------ ------------
Net increase 8,208,896 $82,293,876
============ =============
+ 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, 1997 was 3.65%.
In connection with the offering of AMPS, the Board of Directors
reclassified 40,000 shares of unissued capital stock as AMPS. For the year
ended October 31, 1997 and the period ended November 3, 1995 to October
31, 1996, 400 shares and 1,520 shares of Preferred Stock were sold,
respectively. As of October 31, 1997, there were 2,480 AMPS issued and
1,920 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 year ended October 31, 1997, Merrill
Lynch, Pierce, Fenner & Smith Inc., an affiliate of FAM, earned $100,708
as commissions.
55
<PAGE>
APPENDIX I
RATINGS OF MUNICIPAL BONDS AND COMMERCIAL PAPER
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ('MOODY'S') MUNICIPAL BOND
RATINGS
<TABLE>
<S> <C>
Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of
investment risk and are generally referred to as 'gilt edge.' Interest payments are protected by a
large or by an exceptionally stable margin and principal is secure. While the various protective
elements are likely to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa
group they comprise what are generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and are to be considered as
upper medium grade obligations. Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a susceptibility to impairment sometime in the
future.
Baa Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly
protected nor poorly secured. Interest payments and principal security appear adequate for the
present, but certain protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment characteristics and in fact
have speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered
as well assured. Often the protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of
interest and principal payments or of maintenance of other terms of the contract over any long
period of time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be
present elements of danger with respect to principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues
are often in default or have other marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
</TABLE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
Short-term Notes: The four ratings of Moody's for short-term notes are
MIG-1/VMIG-1, MIG-2/VMIG-2, MIG-3/VMIG-3, and MIG-4/VMIG-4; MIG-1/VMIG-1 denotes
'best quality . . . strong protection by established cash flows'; MIG-2/VMIG-2
denotes 'high quality' with 'ample margins of protection';
56
<PAGE>
MIG-3/VMIG-3 notes are of 'favorable quality . . . but . . . lacking the
undeniable strength of the preceding grades'; MIG-4/VMIG-4 notes are of
'adequate quality . . . [p]rotection commonly regarded as required of an
investment security is present . . . there is specific risk.'
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a
superior ability for repayment of short-term promissory obligations.
Prime-1 repayment ability will often be evidenced by the following
characteristics: leading market positions in well established industries;
high rates of return on funds employed; conservative capitalization
structure with moderate reliance on debt and ample asset protection; broad
margins in earnings coverage of fixed financial charges and high internal
cash generation; and well-established access to a range of financial
markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a
strong ability for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, may
be more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the
level of debt protection measurements and may require relatively high
financial leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF STANDARD & POOR'S RATINGS SERVICES ('S&P') MUNICIPAL DEBT RATINGS
An S&P issue credit rating is a current opinion of the creditworthiness of
an obligor with respect to a specific financial obligation, a specific class of
financial obligations, or a specific financial program. It takes into
consideration the creditworthiness of guarantors, insurers or other forms of
credit enhancement on the obligation.
The issue credit rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P's from other sources S&P's considers reliable. S&P's does not
perform an audit in connection with any rating and may, on occasion, rely on
unaudited financial information. The ratings may be changed, suspended or
withdrawn as a result of changes in, or unavailability of, such information, or
for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment-capacity and willingness of the obligor to
meet its financial commitment on an obligation in accordance with
the terms of obligation:
II. Nature of and provisions of the obligation; and
57
<PAGE>
III. Protection afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization or other arrangement
under the laws of bankruptcy and other laws affecting creditors'
rights.
<TABLE>
<S> <C>
AAA Debt rated 'AAA' has the highest rating assigned by S&P. The obligor's capacity to meet its financial
commitment on obligation is extremely strong.
AA Debt rated 'AA' differs from the highest rated obligations only in small degree. The obligor's capacity to
meet its financial commitment on the obligation is very strong.
A Debt rated 'A' is somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than debt in higher-rated categories. However, the obligor's capacity to meet its
financial commitment on the obligation is still strong.
BBB Debt rated 'BBB' exhibits adequate protection parameters. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial
commitment to the obligation.
BB Debt rated 'BB,' 'B,' 'CCC,' 'CC' and 'C' is regarded as having significant speculative characteristics.
B 'BB' indicates the least degree of speculation and 'C' the highest degree of speculation. While such bonds
CCC will likely have some quality and protective characteristics, these may be outweighed by large
CC uncertainties or major exposures to adverse conditions.
C
D Debt rated 'D' is in payment default. The 'D' rating category is used when payments on an obligation are
not made on the date due even if the applicable grace period has not expired, unless S&P believes that
such payments will be made during such grace period. The 'D' rating also will be used upon the filing of a
bankruptcy petition or the taking of similar action if payments on an obligation are jeopardized.
</TABLE>
Plus (+) or Minus (-): The ratings from 'AA' to 'CCC' may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF S&P'S COMMERCIAL PAPER RATINGS
An S&P Commercial Paper Rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into several categories, ranging from 'A-1' for the
highest-quality obligations to 'D' for the lowest. These categories are as
follows:
<TABLE>
<S> <C>
A-1 This highest category indicates that the degree of safety regarding timely payment is strong. Those issues
determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of
safety is not as high as for issues designated 'A-1.'
A-3 Issues carrying this designation have adequate capacity for timely payment. They are, however, more
vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher
designations.
B Issues rated 'B' are regarded as having only speculative capacity for timely payment.
C This rating is assigned to short-term debt obligations with a doubtful capacity for payment.
</TABLE>
58
<PAGE>
<TABLE>
<S> <C>
D Debt rated 'D' is in payment default. The 'D' rating category is used when interest payments or principal
payments are not made on the date due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
</TABLE>
A Commercial Paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to S&P by the
issuer or obtained by S&P from other sources it considers reliable. The ratings
may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information.
DESCRIPTION OF S&P'S SHORT-TERM ISSUED CREDIT RATING
An S&P note rating reflects the liquidity factors and market access risks
unique to notes. Notes due in three years or less will likely receive a note
rating. Notes maturing beyond three years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment.
--Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
<TABLE>
<S> <C>
SP-1 Strong capacity to pay principal and interest. An issue determined to possess a very strong capacity to pay
debt service is given a plus '+' designation.
SP-2 Satisfactory capacity to pay principal and interest, with some vulnerability to adverse financial and
economic changes over the term of the notes.
SP-3 Speculative capacity to pay principal and interest.
</TABLE>
DESCRIPTION OF FITCH IBCA, INC.'S ('FITCH') INVESTMENT GRADE BOND RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guarantees unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
59
<PAGE>
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
<TABLE>
<S> <C>
AAA Bonds considered to be investment grade and of the highest credit quality. The obligor has an
exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit quality. The obligor's ability to pay
interest and repay principal is very strong, although not quite as strong as bonds rated 'AAA.' Because
bonds rated in the 'AAA' and 'AA' categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated 'F-1+.'
A Bonds considered to be investment grade and of high credit quality. The obligor's ability to pay interest
and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay
interest and repay principal is considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these bonds, and therefore impair timely
payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than
for bonds with higher ratings.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the 'AAA' category.
<TABLE>
<S> <C>
NR: Indicates that Fitch does not rate the specific issue.
Conditional: A conditional rating is premised on the successful completion of a project or the occurrence of
a specific event.
Suspended: A rating is suspended when Fitch deems the amount of information available from the issuer to
be inadequate for rating purposes.
Withdrawn: A rating will be withdrawn when an issue matures or is called or refinanced and, at Fitch's
discretion, when an issuer fails to furnish proper and timely information.
FitchAlert: Ratings are placed on FitchAlert to notify investors of an occurrence that is likely to result
in a rating change and the likely direction of such change. These are designated as 'Positive'
indicating a potential upgrade, 'Negative' for potential downgrade, or 'Evolving' where ratings
may be raised or lowered. FitchAlert is relatively short-term, and should be resolved within
three to 12 months.
</TABLE>
60
<PAGE>
DESCRIPTION OF FITCH'S SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
('BB' to 'C') represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ('DDD' to 'D') is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since rating categories cannot fully reflect the
differences in degrees of credit risk.
<TABLE>
<S> <C>
BB Bonds are considered speculative. The obligor's ability to pay interest and repay principal may be
affected over time by adverse economic changes. However, business and financial alternatives can be
identified which could assist the obligor in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this class are currently meeting debt service
requirements, the probability of continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic activity throughout the life of
the issue.
CCC Bonds have certain identifiable characteristics which, if not remedied, may lead to default. The ability
to meet obligations requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD Bonds are in default on interest and/or principal payments. Such bonds are extremely speculative and
DD should be valued on the basis of their ultimate recovery value in liquidation or reorganization of the
D obligor. 'DDD' represents the highest potential for recovery on these bonds, and 'D' represents the lowest
potential for recovery.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the 'DDD,' 'DD,' or 'D' categories.
DESCRIPTION OF FITCH'S INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short-term ratings are as follows:
<TABLE>
<S> <C>
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as having the strongest
degree of assurance for timely payment.
</TABLE>
61
<PAGE>
<TABLE>
<S> <C>
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely payment only
slightly less in degree than issues rated 'F-1+.'
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of assurance for timely
payment, but the margin of safety is not as great as for issues assigned 'F-1+' and 'F-1' ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics suggesting that the degree of
assurance for timely payment is adequate; however, near-term adverse changes could cause these securities
to be rated below investment grade.
F-4 Weak Credit Quality. Issues assigned this rating have characteristics suggesting a minimal degree of
assurance for timely payment and are vulnerable to near-term adverse changes in financial and economic
conditions.
D Default. Issues assigned this rating are in actual or imminent payment default.
LOC The symbol 'LOC' indicates that the rating is based on a letter of credit issued by a commercial bank.
</TABLE>
62
<PAGE>
APPENDIX II
TAXABLE EQUIVALENT YIELDS FOR 1998
<TABLE>
<CAPTION>
TAXABLE INCOME*
- ---------------------------------------- A TAX-EXEMPT YIELD OF
SINGLE JOINT 1998 FEDERAL ----------------------------------------------------------
RETURN RETURN TAX BRACKET 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
- ------------------ ------------------ ------------ ----- ----- ----- ------ ------ ------
IS EQUAL TO A TAXABLE YIELD OF
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 25,351-$ 61,400 $ 42,351-$102,300 28.00% 6.94% 7.64% 8.33% 9.03% 9.72% 10.42%
$ 61,401-$128,100 $102,301-$155,950 31.00% 7.25% 7.97% 8.70% 9.42% 10.14% 10.87%
$128,101-$278,450 $155,951-$278,450 36.00% 7.81% 8.59% 9.38% 10.16% 10.94% 11.72%
Over $278,450 Over $278,450 39.60% 8.28% 9.11% 9.93% 10.76% 11.59% 12.42%
</TABLE>
- ------------------
* An investor's marginal tax rates may exceed the rates shown in the above table
due to the reduction, or possible elimination, of the personal exemption
deduction for high-income taxpayers and an overall limit on itemized
deductions. Income also may be subject to certain state and local taxes. For
investors who pay alternative minimum tax, tax-exempt yields may be equivalent
to lower taxable yields than those shown above. The tax rates shown above do
not apply to corporate taxpayers. The tax characteristics of the Fund are
described more fully elsewhere in this Prospectus. Consult your tax adviser
for further details. This chart is for illustrative purposes only and cannot
be taken as an indication of anticipated Fund performance.
63
<PAGE>
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUTHORIZATION FORM
- --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase....shares of Merrill Lynch Municipal
Strategy Fund, Inc. and establish an Investment Account as described in the
Prospectus.
Basis for establishing an Investment Account:
I enclose a check for $... payable to Merrill Lynch Financial Data Services,
Inc., as an initial investment (minimum $1,000). (Subsequent investments $50 or
more.) I understand that this purchase will be executed at the applicable
offering price next to be determined after this Application is received by you.
<TABLE>
<S> <C>
/ / / / / / / / / /
(PLEASE PRINT) Social Security No.
or Taxpayer Identification No.
Name ...............................................
First Name Initial Last
Name of Co-Owner (if ................................
First Name Initial Last
Address .............................................
................... ..........................................................
(Zip Code) Date
</TABLE>
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security No. or Taxpayer Identification No. and (2) that I am
not subject to backup withholding (as discussed in the Prospectus under 'Taxes')
either because I have not been notified that I am subject thereto as a result of
a failure to report all interest or dividends, or the Internal Revenue Service
('IRS') has notified me that I am no longer subject thereto. INSTRUCTION: You
must strike out the language in (2) above if you have been notified that you are
subject to backup withholding due to underreporting, and if you have not
received a notice from the IRS that backup withholding has been terminated. The
undersigned authorizes the furnishing of this certification to other Merrill
Lynch-sponsored investment companies.
<TABLE>
<S> <C>
SIGNATURE OF OWNER ........................................ SIGNATURE OF CO-OWNER (IF ANY) .............................
</TABLE>
In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTION
Until you are notified by me, the following options with respect to
dividends and distributions are elected.
<TABLE>
<S> <C>
Ordinary Income Dividends Long-Term Capital Gains
SELECT / / Reinvest SELECT / / Reinvest
ONE: / / Cash ONE: / / Cash
</TABLE>
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU:
/ / Check or / / Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch Municipal Strategy Fund, Inc. Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE): / / checking / / savings
Name on your Account ...........................................................
Bank Name ......................................................................
<TABLE>
<S> <C>
Bank Number ................................................ Account Number .............................................
</TABLE>
Bank Address ...................................................................
I agree that this authorization will remain in effect until I provide written
notification to Merrill Lynch Financial Data Services, Inc. amending or
terminating this service.
Signature of Depositor .........................................................
<TABLE>
<S> <C>
Signature of Depositor ..................................... Date .......................................................
</TABLE>
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED 'VOID' OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
64
<PAGE>
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUTHORIZATION FORM--(CONTINUED)
- --------------------------------------------------------------------------------
3. FOR DEALER ONLY
Branch, Office Address, Stamp
This form, when completed, should be mailed to:
Merrill Lynch Municipal Strategy Fund, Inc.
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
We guarantee the Shareholder's Signature.
...............................................................................
Dealer Name and Address
By..............................................................................
Authorized Signature of Dealer
/ / / / / / / / / .......................................
Branch Code F/C No. F/C Last Name
/ / / / / / / / / /
Dealer's Customer F/C No.
65
<PAGE>
------------------------------------------------------
------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OF ANY SECURITIES OTHER THAN THE
REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY STATE
OR JURISDICTION OF THE UNITED STATES OR ANY COUNTRY WHERE SUCH OFFER WOULD BE
UNLAWFUL.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary............................. 2
Risk Factors and Special Considerations........ 6
Fee Table...................................... 8
Financial Highlights........................... 9
The Fund....................................... 10
Investment Objective and Policies.............. 10
Risks and Special Considerations of Leverage... 19
Investment Restrictions........................ 22
Purchase of Shares............................. 23
Tender Offers.................................. 24
Contingent Deferred Sales Charge............... 27
Directors and Officers......................... 28
Investment Advisory and Administrative
Arrangements................................. 30
Portfolio Transactions......................... 32
Dividends and Distributions.................... 33
Taxes.......................................... 34
Automatic Dividend Reinvestment Plan........... 39
Net Asset Value................................ 39
Description of Capital Stock................... 40
Performance Data............................... 43
Custodian...................................... 44
Transfer Agent, Dividend Disbursing Agent and
Shareholder Servicing Agent.................. 44
Legal Opinions................................. 44
Independent Auditors........................... 44
Independent Auditors' Report................... 45
Financial Statements........................... 46
Appendix I--Ratings of Municipal Bonds and
Commercial Paper............................. 57
Appendix II--Taxable Equivalent Yields for
1998......................................... 64
Authorization Form............................. 65
</TABLE>
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
MERRILL LYNCH
MUNICIPAL STRATEGY
FUND, INC.
-------------------------
PROSPECTUS
-------------------------
MERRILL LYNCH & CO.
FEBRUARY , 1998
Code #18302-0298
------------------------------------------------------
------------------------------------------------------
<PAGE>
PART C OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) FINANCIAL STATEMENTS
PART A:
Financial Highlights for the fiscal year ended October 31, 1997
and for the period November 3, 1995 (commencement of operations) to
October 31, 1996.
PART B:
Schedule of Investments as of October 31, 1997.
Statement of Assets, Liabilities and Capital as of October 31,
1997.
Statement of Operations for the year ended October 31, 1997.
Statements of Changes in Net Assets for the year ended October
31, 1997 and for the period November 3, 1995 (commencement of
operations) to October 31, 1996.
Financial Highlights for the fiscal year ended October 31, 1997
and for the period November 3, 1995 (commencement of operations) to
October 31, 1996.
(2) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C>
(a) (1) -- Articles of Incorporation of the Registrant.(a)
(2) -- Articles of Amendment to the Articles of Incorporation of the Registrant (name change).(a)
(3) -- Form of Articles Supplementary creating shares of Auction Market Preferred Stock ('AMPS(Registered)') of
the Registrant.(b)
(b)
-- By-Laws of the Registrant.(a)
(c)
-- Not applicable.
(d) (1) -- Portions of the Articles of Incorporation and By-Laws of the Registrant defining the rights of holders
of shares of the Registrant.(c)
(2) -- Form of specimen certificate for shares of Common Stock of the Registrant. (a)
(3) -- Form of specimen certificate for shares of AMPS of the Registrant.(b)
(e)
-- Not applicable.
(f)
-- Not applicable.
(g) (1) -- Form of Investment Advisory Agreement between the Registrant and Fund Asset Management, L.P.(a)
(2) -- Form of Administration Agreement between the Registrant and Fund Asset Management, L.P.(a)
(h) (1) -- Form of Distribution Agreement relating to the Common Stock between the Registrant and Merrill Lynch
Funds Distributor, Inc. ('MLFD') (the 'Common Stock Distribution Agreement').(a)
(2) -- Form of Selected Dealer Agreement relating to the Common Stock.(a)
(3) -- Form of Distribution Agreement relating to the AMPS between the Registrant and Merrill Lynch, Pierce,
Fenner & Smith Incorporated ('Merrill Lynch') (the 'AMPS Distribution Agreement').(b)
(i)
-- Not applicable.
(j)
-- Form of Custody Agreement between the Registrant and The Bank of New York. (a)
(k) (1) -- Form of Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency Agreement between
Registrant and Merrill Lynch Financial Data Services, Inc. ('MLFDS').(a)
(2) -- Form of License Agreement relating to the use of the 'Merrill Lynch' name. (a)
(3) -- Form of Auction Agent Agreement between the Registrant and IBJ Schroder Bank & Trust Company.(b)
(4) -- Form of Broker-Dealer Agreement.(b)
(5) -- Form of Letter of Representations.(b)
(l)
-- Not applicable.
(m)
-- Not applicable.
(n)
-- Consent of Deloitte & Touche LLP, independent auditors for the Registrant.
(o)
-- Not applicable.
(p)
-- Certificate of Fund Asset Management, L.P.(a)
(q)
-- Not applicable.
(r)
-- Financial Data Schedule.
</TABLE>
C-1
<PAGE>
- ------------------
(a) Previously filed as an Exhibit to the Registrant's registration statement on
Form N-2, File No. 33-54655 (the 'Common Stock Registration Statement')
filed under the Securities Act of 1933, as amended (the '1933 Act').
(b) Incorporated by reference to the Registrant's registration statement on Form
N-2, File No. 33-64311 (the 'AMPS Registration Statement').
(c) Reference is made to Article V, Article VI (sections 2,3,4,5 and 6), Article
VII, Article VIII, Article X, Article XI, Article XII and Article XIII of
the Registrant's Articles of Incorporation, previously filed as Exhibit
(a)(1) to the Common Stock Registration Statement; and to Article II,
Article III (sections 1, 2, 3, 5 and 17), Article VI, Article VII, Article
XII, Article XIII and Article XIV of the Registrant's By-Laws, previously
filed as Exhibit (b) to the Common Stock Registration Statement. Reference
is also made to the Form of Articles Supplementary previously filed as
Exhibit (a)(3) to the AMPS Registration Statement.
ITEM 25. MARKETING ARRANGEMENTS.
Previously provided as Exhibit (h) to the Registrant's Common Stock
Registration Statement.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Previously provided in connection with the Registrant's Registration
Statement, File No. 333-19479.
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The information in the Prospectus under the captions 'Investment Advisory
and Administrative Arrangements' and 'Description of Capital Stock--Common
Stock' and in Note 1 to the Statement of Assets, Liabilities and Capital is
incorporated herein by reference.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES.
<TABLE>
<CAPTION>
NUMBER OF HOLDERS
TITLE OF CLASS AS OF OCTOBER 31, 1997
- ----------------------------------------------------------------------------- ----------------------
<S> <C>
Shares of Common Stock, par value $0.10 per share............................ 2,270
Shares of AMPS, par value $0.10 per share, liquidation preference $25,000 per
share...................................................................... 1,920
</TABLE>
- ------------------
Note: The number of holders shown above includes holders of record plus
beneficial owners, whose shares are held of record by Merrill Lynch.
ITEM 29. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, previously filed as
Exhibit (a)(1) to the Registrant's Common Stock Registration Statement, Article
VI of the Registrant's By-Laws, previously filed as Exhibit (b) to the
Registrant's Common Stock Registration Statement, and the Investment Advisory
Agreement, a form of which was filed as Exhibit (g)(1) to the Registrant's
Common Stock Registration Statement, provide for indemnification.
Insofar as indemnification for liabilities arising under the 1933 Act may
be provided to directors, officers and controlling persons of the Registrant,
pursuant to the foregoing provisions or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the 1933 Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in
connection with any successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the 1933 Act and will be governed by the
final adjudication of such issue.
Reference is made to Section 9 of each of the Common Stock and AMPS
Distribution Agreements, forms of which were previously filed as Exhibits (h)(1)
and (h) to the Registrant's Common Stock Registration Statement and AMPS
Registration Statement, respectively, for provisions relating to the
indemnification of the underwriter and distributor, respectively.
C-2
<PAGE>
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF THE INVESTMENT ADVISER.
Fund Asset Management, L.P. (the 'Investment Adviser'), acts as investment
adviser for the following open-end registered investment companies: CBA Money
Fund, CMA Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal
Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund
Accumulation Program, Inc., Financial Institutions Series Trust, Merrill Lynch
Basic Value Fund, Inc., Merrill Lynch California Municipal Series Trust, Merrill
Lynch Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc.,
Merrill Lynch Federal Securities Trust, Merrill Lynch Funds for Institutions
Series, Merrill Lynch Multi-State Limited Maturity Municipal Series Trust,
Merrill Lynch Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond
Fund, Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund,
Inc., Merrill Lynch World Income Fund, Inc., and The Municipal Fund Accumulation
Program, Inc.; and for the following closed-end registered investment companies:
Apex Municipal Fund, Inc., Corporate High Yield Fund, Inc., Corporate High Yield
Fund II, Inc., Debt Strategies Fund, Inc., Income Opportunities Fund 1999, Inc.,
Income Opportunities Fund 2000, Inc., Merrill Lynch Municipal Strategy Fund,
Inc., MuniAssets Fund, Inc., MuniEnhanced Fund, Inc., MuniHoldings Fund, Inc.,
MuniHoldings California Insured Fund, Inc., MuniHoldings Florida Insured Fund,
MuniHoldings New York Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund,
Inc., MuniVest Fund II, Inc., MuniVest Florida Fund, MuniVest Michigan Insured
Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest New York Insured Fund,
Inc., MuniVest Pennsylvania Insured Fund, MuniYield Arizona Fund, Inc.,
MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc.,
MuniYield New Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc.,
MuniYield New York Insured Fund II, Inc., MuniYield Pennsylvania Fund, MuniYield
Quality Fund, Inc., MuniYield Quality Fund II, Inc., Senior High Income
Portfolio, Inc., Taurus MuniCalifornia Holdings, Inc., Taurus MuniNew York
Holdings, Inc. and Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ('MLAM'), an affiliate of the
Investment Adviser, acts as the investment adviser for the following open-end
registered investment companies: Merrill Lynch Adjustable Rate Securities Fund,
Inc., Merrill Lynch Americas Income Fund, Inc., Merrill Lynch Asset Builder
Program, Inc., Merrill Lynch Asset Growth Fund, Inc., Merrill Lynch Asset Income
Fund, Inc., Merrill Lynch Capital Fund, Inc., Merrill Lynch Developing Capital
Markets Fund, Inc., Merrill Lynch Convertible Fund, Inc. Merrill Lynch Dragon
Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fundamental Growth Fund, Inc.,
Merrill Lynch Fund for Tomorrow, Inc., Merrill Lynch Global Allocation Fund,
Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill Lynch Global Growth
Fund, Inc., Merrill Lynch Global Holdings, Merrill Lynch Global Resources Trust,
Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch Global Utility Fund,
Inc., Merrill Lynch Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill
Lynch Healthcare Fund, Inc., Merrill Lynch Intermediate Government Bond Fund,
Merrill Lynch International Equity Fund, Merrill Lynch Latin America Fund, Inc.,
Merrill Lynch Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series
Trust, Merrill Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets Trust,
Merrill Lynch Retirement Series Trust, Merrill Lynch Series Fund, Inc., Merrill
Lynch Short-Term Global Income Fund, Inc., Merrill Lynch Strategic Dividend
Fund, Merrill Lynch Technology Fund, Inc., Merrill Lynch U.S. Treasury Money
Fund, Merrill Lynch U.S.A. Government Reserves, Merrill Lynch Utility Income
Fund, Inc. and Merrill Lynch Variable Series Funds, Inc., and Hotchkis and Wiley
Funds (advised by Hotchkis and Wiley, a division of MLAM); for the following
closed-end registered investment companies: Merrill Lynch High Income Municipal
Bond Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc. MLAM also acts
as sub-adviser to Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic
Value Equity Portfolio, two investment portfolios of EQ Advisory Trust.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011. The address of Merrill Lynch Funds for
Institutions Series and Merrill Lynch Intermediate Government Bond Fund is One
Financial Center, 23rd Floor, Boston, Massachusetts 02111-2646. The address of
the Investment Adviser, MLAM, MLFD, Princeton Services, Inc. ('Princeton
Services') and Princeton Administrators, L.P. also is P.O. Box 9011, Princeton,
New Jersey 08543-9011. The address of Merrill Lynch and Merrill Lynch & Co.,
Inc. ('ML & Co.') is World Financial Center, North Tower, 250 Vesey Street, New
York, New York 10281-1213. The address of Merrill Lynch Financial Data Services,
Inc. ('MLFDS') is 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner of the
Investment Adviser indicating each business, profession, vocation or employment
of a substantial nature in which each such person or entity has been engaged for
the past two years for his, her or its own account or in the capacity of
director, officer, employee,
C-3
<PAGE>
partner or trustee. In addition, Mr. Zeikel is President, Mr. Glenn is Executive
Vice President and Mr. Richard is Treasurer of all or substantially all of the
investment companies described in the first two paragraphs of this Item 30.
Messrs. Zeikel, Glenn and Richard also hold the same position with all or
substantially all of the investment companies advised by MLAM as they do with
those advised by the Investment Adviser. Messrs. Giordano, Harvey, Kirstein and
Monagle are directors or officers of one or more of such companies.
Officers and Partners of FAM are set forth below as follows:
<TABLE>
<CAPTION>
POSITION WITH
INVESTMENT OTHER SUBSTANTIAL BUSINESS,
NAME ADVISER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- --------------- -----------------------------------
<S> <C> <C>
ML & Co.................. Limited Partner Financial Services Holding Company;
Limited Partner of FAM
Princeton Services....... General Partner General Partner of MLAM
Arthur Zeikel............ Chairman (since Chairman (since December 10, 1997)
December 10, and President (prior to December
1997); 10, 1997) of MLAM; President and
President Director of Princeton Services;
(prior to Director of MLFDS; Executive Vice
December 10, President of ML & Co.
1997)
Jeffrey M. Peek.......... President President (since December 10, 1997)
(since of MLAM; President and Director
December (since December 10, 1997) of
10, 1997 MLFDS; Executive Vice President
of ML & Co.
Terry K. Glenn........... Executive Vice Executive Vice President of MLAM;
President Executive Vice President and
Director of Princeton Services;
President and Director of MLFD;
Director of MLFDS; President of
Princeton Administrators, L.P.
Linda L. Federici........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Vincent R. Giordano...... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Elizabeth A. Griffin..... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Norman R. Harvey......... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Michael J. Hennewinkel... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Philip L. Kirstein....... Senior Vice Senior Vice President, General
President, Counsel and Secretary of MLAM;
General Senior Vice President, General
Counsel Counsel Director and Secretary of
and Secretary Princeton Services
Ronald M. Kloss.......... Senior Vice Senior Vice President and
President and Controller of MLAM; Senior Vice
Controller President and Controller of
Princeton Services
Debra Landsman-Yaros..... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services; Vice President of MLFD.
Stephen M.M. Miller...... Senior Vice Executive Vice President of
President Princeton Administrators L.P.;
Senior Vice President of
Princeton Services
Joseph T. Monagle........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Michael L. Quinn......... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services; Managing Director and
First Vice President of Merrill
Lynch from 1989 to 1995.
</TABLE>
C-4
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH
INVESTMENT OTHER SUBSTANTIAL BUSINESS,
NAME ADVISER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- --------------- -----------------------------------
<S> <C> <C>
Richard L. Reller........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services and Director of MLFD
Gerald M. Richard........ Senior Vice Senior Vice President and Treasurer
President and of MLAM; Senior Vice President and
Treasurer Treasurer of Princeton Services;
Vice President and Treasurer of
MLFD
Gregory D. Upah.......... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Ronald L. Welburn........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
</TABLE>
ITEM 31. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended and the Rules
thereunder will be maintained at the offices of the Registrant (800 Scudders
Mill Road, Plainsboro, New Jersey 08536), the Investment Adviser (800 Scudders
Mill Road, Plainsboro, New Jersey 08536), and the Registrant's custodian and
transfer agent.
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
ITEM 33. UNDERTAKINGS.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
1933 Act;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the Registration Statement; and
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the Registration Statement
or any material change to such information in the Registration
Statement.
(2) That, for the purpose of determining any liability under the 1933
Act, each such post-effective amendment shall be deemed to be a new
Registration Statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
C-5
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND THE
INVESTMENT COMPANY ACT OF 1940, THE REGISTRANT HAS DULY CAUSED THIS POST
EFFECTIVE AMENDMENT TO THE REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY
THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE TOWNSHIP OF PLAINSBORO AND
STATE OF NEW JERSEY, ON THE 30TH OF DECEMBER, 1997.
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
(Registrant)
By: /s/ ARTHUR ZEIKEL
----------------------------------
(ARTHUR ZEIKEL, PRESIDENT)
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- ------------------
<S> <C> <C>
/S/ ARTHUR ZEIKEL President and Director (Principal
- ------------------------------------------ Executive Officer)
(ARTHUR ZEIKEL)
GERALD M. RICHARD* Treasurer (Principal Financial and
- ------------------------------------------ Accounting Officer)
(GERALD M. RICHARD)
RONALD W. FORBES* Director
- ------------------------------------------
(RONALD W. FORBES)
CYNTHIA A. MONTGOMERY* Director
- ------------------------------------------
(CYNTHIA A. MONTGOMERY)
CHARLES C. REILLY* Director
- ------------------------------------------
(CHARLES C. REILLY)
KEVIN A. RYAN* Director
- ------------------------------------------
(KEVIN A. RYAN)
RICHARD R. WEST* Director
- ------------------------------------------
(RICHARD R. WEST)
*By: /s/ARTHUR ZEIKEL December 30, 1997
- ------------------------------------------
(ARTHUR ZEIKEL, ATTORNEY-IN-FACT)
</TABLE>
C-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------------------------------------
<S> <C> <C>
27 -- Financial Data Schedule.
99.2(n) -- Consent of Deloitte & Touche LLP, independent auditors for the Registrant.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000927121
<NAME> MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1997
<PERIOD-START> NOV-01-1996
<PERIOD-END> OCT-31-1997
<INVESTMENTS-AT-COST> 152688471
<INVESTMENTS-AT-VALUE> 158641205
<RECEIVABLES> 9766132
<ASSETS-OTHER> 605393
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 169012730
<PAYABLE-FOR-SECURITIES> 19193580
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 356331
<TOTAL-LIABILITIES> 19549911
<SENIOR-EQUITY> 48000000
<PAID-IN-CAPITAL-COMMON> 93708835
<SHARES-COMMON-STOCK> 9333017
<SHARES-COMMON-PRIOR> 8218896
<ACCUMULATED-NII-CURRENT> 19200
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 1782050
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 5952734
<NET-ASSETS> 149462819
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 7862361
<OTHER-INCOME> 0
<EXPENSES-NET> (1264061)
<NET-INVESTMENT-INCOME> 6598300
<REALIZED-GAINS-CURRENT> 2242563
<APPREC-INCREASE-CURRENT> 4017788
<NET-CHANGE-FROM-OPS> 12858651
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (6583668)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1457495
<NUMBER-OF-SHARES-REDEEMED> (471994)
<SHARES-REINVESTED> 128620
<NET-CHANGE-IN-ASSETS> 27889942
<ACCUMULATED-NII-PRIOR> 4568
<ACCUMULATED-GAINS-PRIOR> (460513)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 657929
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1688883
<AVERAGE-NET-ASSETS> 130868685
<PER-SHARE-NAV-BEGIN> 10.17
<PER-SHARE-NII> .75
<PER-SHARE-GAIN-APPREC> .70
<PER-SHARE-DIVIDEND> (.59)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.87
<EXPENSE-RATIO> 1.28
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' CONSENT
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.:
We consent to the use in Post-Effective Amendment No. 1 to Registration
Statement No. 333-19479 of our report dated December 10, 1997 and to the
reference to us under the caption 'Financial Highlights' appearing in the
Prospectus, which is a part of such Registration Statement.
Deloitte & Touche LLP
Princeton, New Jersey
December 30, 1997
