<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 30, 1997
SECURITIES ACT FILE NO. 33-64311
INVESTMENT COMPANY ACT FILE NO. 811-7203
POST-EFFECTIVE AMENDMENT TO REGISTRATION STATEMENT AS STATED BELOW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO.
POST-EFFECTIVE AMENDMENT NO. 3
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 11
(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
800 Scudders Mill Road
Plainsboro, New Jersey 08536
(Zip Code)
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:
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
------------------------
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 this Form is a post-effective amendment filed pursuant to Rule 462(b)
under the Securities Act, check the following box and list the Securities Act
registration 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. / /
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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<PAGE>
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
CROSS REFERENCE SHEET
PURSUANT TO RULE 404(C)
<TABLE>
<CAPTION>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
------------------------------------------------------ ------------------------------------------------------
<S> <C> <C>
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;
Plan of Distribution
3. Fee Table and Synopsis................................ Not Applicable
4. Financial Highlights.................................. Financial Highlights
5. Plan of Distribution.................................. Plan of Distribution
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; Investment Restrictions
9. Management............................................ Investment Advisory and Administrative Arrangements;
Directors and Officers
10. Capital Stock, Long-Term Debt and Other Securities.... Description of AMPS; 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; Plan of Distribution; Transfer Agent,
Dividend Disbursing Agent and Registrar; 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>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 30, 1997
PROSPECTUS
FEBRUARY __, 1998
$ _____________________________
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUCTION MARKET PREFERRED STOCK ['AMPS(REGISTERED)']
_________ SHARES, SERIES A--LIQUIDATION PREFERENCE $25,000 PER SHARE
------------------------
Merrill Lynch Municipal Strategy Fund, Inc. (the 'Fund') is a continuously
offered, non-diversified, closed-end management investment company that seeks to
provide shareholders of its Common Stock 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. The address of the
Fund is 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its telephone
number is (609) 282-2800. Investors are advised to read this Prospectus
carefully and retain it for future reference. The Securities and Exchange
Commission maintains a website (http://www.sec.gov) that contains material
incorporated by reference herein and other information regarding the Fund.
(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.
[CAPTION]
<TABLE>
PRICE TO SALES PROCEEDS TO
PUBLIC(1) LOAD(2)(3) FUND(1)(4)
---------- ---------- -----------
<S> <C> <C> <C>
Per Share....................... $25,000 None $25,000
Total........................... $ None $
</TABLE>
(1) Plus accumulated dividends, if any, from the Date of Original Issue.
(2) The Fund and the Investment Adviser have agreed to indemnify Merrill Lynch,
Pierce, Fenner & Smith Incorporated ('Merrill Lynch') against certain
liabilities under the Securities Act of 1933, as amended. See 'Plan of
Distribution.'
(3) Merrill Lynch will act as a Broker-Dealer in Auctions and will be entitled
to a service fee (usually at the annual rate of 0.25% of the purchase price
for AMPS placed in an Auction) as a Broker-Dealer. See 'Description of
AMPS--Broker-Dealers.'
(4) Offering expenses of $______ have been previously paid by the Fund.
------------------------
The AMPS are being offered on a continuing basis by the Fund through Merrill
Lynch, which has agreed to use its best efforts to solicit purchasers of the
AMPS. There can be no assurance that the AMPS offered by this Prospectus will be
sold. The Fund may reject any order in whole or in part. See 'Plan of
Distribution.' One or more certificates for the AMPS will be delivered to the
nominee of The Depository Trust Company.
- ------------------
(Registered) Registered trademark of Merrill Lynch & Co., Inc.
------------------------
MERRILL LYNCH & CO.
------------------------
<PAGE>
(Continued from previous page)
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)' or 'AMPS(Copyright)'), which represents approximately
33% of the Fund's capital. The Fund intends to issue AMPS from time to time
representing up to approximately 35% of the Fund's capital.
Dividends on the shares of Series A AMPS of the Fund offered hereby will be
cumulative from the Date of Original Issue. The Applicable Rate on the shares of
AMPS for each Dividend Period will be determined pursuant to periodic auctions
conducted in accordance with the procedures described in Appendix C hereto (an
'Auction'). Except as otherwise provided herein, each Dividend Period for the
shares of Series A AMPS will be a 7-Day Dividend Period; provided, however, that
prior to any Auction, the Fund may elect, subject to certain limitations
described herein, upon giving notice to holders thereof, a Special Dividend
Period. See 'Description of AMPS--Dividends.'
The Applicable Rate on the shares of AMPS for each Dividend Period will be
reset on the basis of Bids, Hold Orders and Sell Orders placed by Existing
Holders and Potential Holders in the Auction conducted on the Business Day next
preceding the commencement of such Dividend Period. The Applicable Rate that
results from an Auction for any Dividend Period will not be greater than the
Maximum Applicable Rate. See 'Description of AMPS--The Auction-- Orders by
Beneficial Owners, Potential Beneficial Owners, Existing Holders and Potential
Holders.' For Series A AMPS sold by the Fund pursuant to this Prospectus, the
Applicable Rate will be set forth in a Prospectus Supplement.
The Fund currently is required to allocate net capital gains and other
taxable income, if any, proportionately between shares of Common Stock and
shares of AMPS. The Fund will give notice of the amount of any taxable income to
be included in a dividend on shares of AMPS in the related Auction, as described
herein, or include such income in a dividend on shares of AMPS without giving
advance notice thereof if it increases the dividend by an additional amount to
offset substantially the tax effect thereof. The amount of taxable income
allocable to shares of AMPS will depend upon the amount of such income realized
by the Fund and other factors but generally is not expected to be significant.
See 'Taxes.'
Each prospective purchaser should review carefully the detailed information
regarding the Auction Procedures that appears in this Prospectus, including the
Appendices, and should note that (i) an Order constitutes an irrevocable
commitment to hold, purchase or sell AMPS based upon the results of the related
Auction, (ii) the Auctions will be conducted through telephone communications,
(iii) settlement for purchases and sales will be on the Business Day following
the Auction and (iv) ownership of AMPS will be maintained in book-entry form by
or through the Securities Depository. Under certain circumstances, holders of
AMPS may be unable to sell their shares of AMPS in an Auction and thus may lack
liquidity of investment. Shares of AMPS may only be transferred pursuant to a
Bid or a Sell Order placed in an Auction through a Broker-Dealer to the Auction
Agent or in the secondary market, if any.
The shares of AMPS are redeemable, in whole or in part, at the option of the
Fund, on any Dividend Payment Date (except during a Non-Call period) at the
Optional Redemption Price per share and will be subject to mandatory redemption
on dates fixed by the Board of Directors, under certain circumstances, at the
Mandatory Redemption Price per share.
If the Fund fails to pay on any Dividend Payment Date (or within the
applicable grace period) the full amount of any dividend or the redemption price
of shares of AMPS called for redemption, the Applicable Rate will not be based
on the results of an Auction but instead will be equal to the Non-Payment Period
Rate until such failure to pay is cured. See 'Description of
AMPS--Dividends--Non-Payment Period; Late Charge.'
The Broker-Dealers intend to maintain a secondary trading market in the AMPS
outside of Auctions; however, they have no obligation to do so, and there can be
no assurance that a secondary market for the AMPS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The AMPS will not be registered on any stock exchange or
on the National Association of Securities Dealers Automated Quotation system. An
increase in the level of interest rates, particularly during any Long Term
Dividend Period, likely will have an adverse effect on the secondary market
price of the AMPS, and a selling shareholder may sell AMPS between Auctions at a
price per share of less than $25,000.
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the more
detailed information included elsewhere in this Prospectus. Certain of the
capitalized terms used herein are defined in the Glossary that appears at the
end of this Prospectus.
<TABLE>
<S> <C>
THE FUND Merrill Lynch Municipal Strategy Fund, Inc. (the 'Fund') is a continuously offered,
non-diversified, closed-end management investment company. See 'The Fund.'
INVESTMENT OBJECTIVE AND The investment objective of the Fund is to provide shareholders of its Common Stock
POLICIES 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 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.'
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 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.'
</TABLE>
3
<PAGE>
<TABLE>
<S> <C>
THE OFFERING The Fund is offering an aggregate of [______] shares of Series A AMPS, at a purchase
price of $25,000 per share plus accumulated dividends, if any, from the Date of
Original Issue. The shares of AMPS are being offered on a continuing basis by the
Fund through Merrill Lynch, who has agreed to use its best efforts to solicit
purchasers of the AMPS. See 'Plan of Distribution.'
The AMPS will be shares of preferred stock of the Fund that entitle their holders
to receive cash dividends at a rate per annum that may vary for the successive
Dividend Periods. In general as described below, each Dividend Period will be seven
days in length. The Applicable Rate for a particular Dividend Period will be
determined by an Auction conducted on the Business Day next preceding the start of
such Dividend Period.
The Fund's Articles Supplementary establishing the Series A AMPS authorize the Fund
to issue additional series of AMPS designated Series B AMPS, Series C AMPS, Series D
AMPS and Series E AMPS, which also are referred to herein as 'AMPS.' The Series A
AMPS are the only series currently offered and to be issued and outstanding. As of
the date of this Prospectus, 1,920 shares of Series A AMPS representing
approximately 33% of the Fund's capital are issued and outstanding.
Through their Broker-Dealers, Beneficial Owners and Potential Beneficial Owners of
shares of AMPS of each series may participate in Auctions therefor, although,
except in the case of a Special Dividend Period, Beneficial Owners desiring to
continue to hold all of their shares of AMPS regardless of the Applicable Rate
resulting from Auctions need not participate. For an explanation of Auctions and
the method of determining the Applicable Rate, see 'Description of AMPS--The
Auction.'
Except as described herein, investors in AMPS will not receive certificates
representing ownership of their shares. Ownership of AMPS will be maintained in
book entry form by the Securities Depository or its nominee for the account of the
investor's Agent Member. The investor's Agent Member, in turn, will maintain
records of such investor's beneficial ownership of AMPS. Accordingly, references
herein to an investor's investment in or purchase, sale or ownership of AMPS are to
purchases, sales or ownership of those shares by Beneficial Owners.
DIVIDENDS AND DIVIDEND Each Dividend Period for the Series A AMPS will generally consist of seven days (a
PERIODS '7-Day Dividend Period'); provided, however, that prior to any Auction, the Fund
may elect, subject to certain limitations described herein, upon giving notice to
holders thereof, a Special Dividend Period. A Special Dividend Period is a Dividend
Period consisting of a specified number of days (other than seven in the case of
Series A AMPS), evenly divisible by seven and not fewer than seven nor more than
364 (a 'Short Term Dividend Period') or a Dividend Period consisting of a specified
period of one whole year or more but not greater than five years (a 'Long Term
Dividend Period'). Dividends on the AMPS offered hereby are cumulative from the
Date of Original Issue and are payable when, as and if declared by the Board of
Directors of the Fund, out of funds legally
</TABLE>
4
<PAGE>
<TABLE>
<S> <C>
available therefor. For Series A AMPS sold by the Fund pursuant to this Prospectus,
the Applicable Rate for the next Dividend Period will be set forth in a Prospectus
Supplement. Thereafter, in the case of Dividend Periods that are not Special
Dividend Periods, dividends will be payable generally on each succeeding Thursday
in the case of Series A AMPS, subject to certain exceptions.
Dividends for the Series A AMPS will be paid through the Securities Depository (The
Depository Trust Company or a successor securities depository) on each Dividend
Payment Date for such series. The Securities Depository's normal procedures provide
for it to distribute dividends in same-day funds to Agent Members, who are in turn
expected to distribute such dividends to the person for whom they are acting as
agent in accordance with the instructions of such person. See 'Description of
AMPS--Dividends.'
For each Dividend Period, the cash dividend rate on the shares of each series of
AMPS will be the Applicable Rate for such series that the Auction Agent (IBJ
Schroder Bank & Trust Company or any successor) advises the Fund has resulted from
an Auction relating to such series. See 'Description of AMPS-- Dividends.' For
Series A AMPS sold by the Fund pursuant to this Prospectus, the Applicable Rate
will be set forth in a Prospectus Supplement.
The Articles Supplementary provide that until the Fund gives a Request for Special
Dividend Period and the related Notice of Special Dividend Period with respect to a
series of AMPS, only 7-Day Dividend Periods will be applicable to the Series A
AMPS. While the Fund does not currently intend to give a Request for Special
Dividend Period with respect to the AMPS, it may so elect in the future subject to,
and on, the conditions discussed under 'Description of the
AMPS--Dividends--Notification of Dividend Period.'
A Special Dividend Period will not be effective for a series of the AMPS unless
Sufficient Clearing Bids exist at the Auction in respect of such Special Dividend
Period. If Sufficient Clearing Bids do not exist at such Auction for a series of
the AMPS, the Dividend Period commencing on the Business Day succeeding such
Auction will be a 7-Day Dividend Period in the case of Series A AMPS, and the
holders of the AMPS of such series outstanding prior to such Auction will be
required to continue to hold such shares for such Dividend Period. In addition, the
Fund may not give a Notice of Special Dividend Period with respect to a series of
AMPS, or if the Fund has given a Notice of Special Dividend Period for a series of
AMPS, the Fund will be required to give a Notice of Revocation in respect thereof
if (i) either the 1940 Act AMPS Asset Coverage is not satisfied or the Fund fails
to maintain S&P Eligible Assets and Moody's Eligible Assets each with an aggregate
Discounted Value at least equal to the AMPS Basic Maintenance Amount, in each case
on each of the two Valuation Dates immediately preceding the Business Day prior to
the related Auction Date for the AMPS, (ii) sufficient funds for the payment of
dividends payable on the immediately succeeding Dividend Payment Date have not been
irrevocably deposited with the Auction Agent by the close of business on the third
Business Day preceding the related Auction Date, or (iii) the Broker-Dealers have
given the
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
Fund notice that it is not advisable to hold an Auction in respect of a Special
Dividend Period. In such event, the next succeeding Dividend Period will be a 7-Day
Dividend Period in the case of Series A AMPS.
ADVANCE NOTICE OF ALLOCATION Dividends paid by the Fund, to the extent paid from tax-exempt income earned on
OF TAXABLE INCOME; municipal obligations, will be exempt from Federal income taxes, subject to the
INCLUSION OF TAXABLE possible application of the alternative minimum tax. However, the Fund is required
INCOME IN DIVIDENDS to allocate net capital gains and other income subject to regular Federal income
taxes, if any, proportionately between shares of Common Stock and shares of AMPS in
accordance with the current position of the IRS described herein. The Fund will
notify the Auction Agent of the amount of any net capital gains or other taxable
income to be included in any dividend on shares of AMPS prior to the Auction
establishing the Applicable Rate for such dividend. The Auction Agent in turn will
notify each Broker-Dealer whenever it receives any such notice from the Fund, and
each Broker-Dealer will notify its Beneficial Owners and Potential Beneficial
Owners, as provided in its Broker-Dealer Agreement. In limited circumstances, the
Fund also may include such income in a dividend on shares of AMPS without giving
advance notice thereof if it increases the dividend by an additional amount to
offset the tax effect thereof. The amount of taxable income allocable to shares of
AMPS will depend upon the amount of such income realized by the Fund and other
factors, but generally is not expected to be significant. See 'Taxes' and
'Description of AMPS--The Auction-- Auction Date; Advance Notice of Allocation of
Taxable Income; Inclusion of Taxable Income in Dividends.'
ADDITIONAL DIVIDENDS If the Fund retroactively allocates any net capital gains or other income subject
to regular Federal income taxes to shares of AMPS without having given advance
notice thereof as described above, which may only happen when such allocation is
made as a result of the redemption of all or a portion of the outstanding shares of
AMPS or the liquidation of the Fund, the Fund will make certain payments to holders
of shares of AMPS to which such allocation was made to offset substantially the tax
effect thereof. In no other instances will the Fund be required to make payments to
holders of shares of AMPS to offset the tax effect of any reallocation of net
capital gains or other taxable income. See 'Description of
AMPS--Dividends--Additional Dividends' and 'Taxes.'
DETERMINATION OF MAXIMUM Except during a Non-Payment Period, the Applicable Rate for any Dividend Period for
APPLICABLE RATES shares of AMPS of each series will not be more than the Maximum Applicable Rate
applicable to such shares. The Maximum Applicable Rate for shares of AMPS will
depend on the credit rating assigned to such shares and on the duration of the
Dividend Period. The Maximum Applicable Rate will be the Applicable Percentage of
the Reference Rate. The Reference Rate is (i) with respect to any Dividend Period
or any Short Term Dividend Period having 28 or fewer days, the higher of the
applicable 'AA' Composite Commercial Paper Rate and the Taxable Equivalent of the
Short-Term Municipal Bond Rate, (ii) with respect to any Short Term Dividend Period
having more than 28 but fewer than 183 days, the applicable 'AA' Composite
Commercial Paper Rate,
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
(iii) with respect to any Short Term Dividend Period having 183 or more but fewer
than 364 days, the applicable U.S. Treasury Bill Rate and (iv) with respect to any
Long Term Dividend Period, the applicable U.S. Treasury Note Rate. The Applicable
Percentage will be determined based on (i) the lower of the credit rating or
ratings assigned on such date to the AMPS by Moody's Investors Service, Inc.
('Moody's') and Standard & Poor's Ratings Services ('S&P') (or, if Moody's or S&P
or both shall not make such rating available, the equivalent of either or both of
such ratings by a Substitute Rating Agency or two Substitute Rating Agencies or, in
the event that only one such rating shall be available, such rating) and (ii)
whether the Fund has provided notification to the Auction Agent prior to the
Auction establishing the Applicable Rate for any dividend that net capital gains or
other taxable income will be included in such dividend on shares of AMPS as
follows:
<CAPTION>
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
CREDIT RATINGS REFERENCE REFERENCE
------------------------------------- RATE--NO RATE--
MOODY'S S&P NOTIFICATION NOTIFICATION
----------------- ---------------- --------------- -------------
<S> <C> <C> <C> <C>
'aa3' or higher AA- or higher 110% 150%
'a3' to 'a1' A- to A+ 125% 160%
'baa3' to 'baa1' BBB- to BBB+ 150% 250%
Below 'baa3' Below BBB- 200% 275%
</TABLE>
<TABLE>
<S> <C>
There is no minimum Applicable Rate in respect of any Dividend Period.
The Applicable Rate for any Dividend Period commencing during any Non-Payment
Period, and the rate used to calculate the late charge described under 'Description
of AMPS--Dividends--Non-Payment Period; Late Charge', initially will be 200% of the
Reference Rate (or 275% of such rate if the Fund has provided notification to the
Auction Agent prior to the Auction establishing the Applicable Rate for any
dividend that net capital gains or other taxable income will be included in such
dividend on shares of AMPS).
AUCTION PROCEDURES Separate Auctions will be conducted for each series of AMPS. As used in the
following description of the Auction Procedures, unless the context otherwise
requires, 'AMPS' means the series of AMPS subject to the related Auction, and
'Beneficial Owners', 'Potential Beneficial Owners', 'Existing Holders' and
'Potential Holders' means Beneficial Owners of such series, Potential Beneficial
Owners of such series, Existing Holders of such series and Potential Holders of
such series, respectively. Unless otherwise permitted by the Fund, Beneficial
Owners and Potential Beneficial Owners of AMPS may only participate in Auctions
through their Broker-Dealers. Broker-Dealers will submit the Orders of their
respective customers who are Beneficial Owners and Potential Beneficial Owners to
the Auction Agent, designating themselves as Existing Holders in
</TABLE>
7
<PAGE>
<TABLE>
<S> <C>
respect of shares subject to Orders submitted or deemed submitted to them by
Beneficial Owners and as Potential Holders in respect of shares subject to Orders
submitted to them by Potential Beneficial Owners. On or prior to each Auction Date
for the AMPS (the Business Day next preceding the first day of each Dividend
Period), each Beneficial Owner may submit Orders to its Broker-Dealer as follows:
-- Hold Order--indicating its desire to hold shares of AMPS without regard to the
Applicable Rate for the next Dividend Period for such shares.
-- Bid--indicating its desire to hold shares of AMPS, provided that the Applicable
Rate for the next Dividend Period for such shares is not less than the rate per
annum specified in such Bid.
-- Sell Order--indicating its desire to sell shares of AMPS without regard to the
Applicable Rate for the next Dividend Period for such shares.
A Beneficial Owner may submit different types of Orders to its Broker-Dealer with
respect to shares of AMPS then held by such Beneficial Owner, provided that the
total number of shares of AMPS covered by such Orders does not exceed the number of
shares of AMPS held by such Beneficial Owner. If, however, a Beneficial Owner
offers through its Broker-Dealer to purchase additional shares of AMPS in such
Auction, such Beneficial Owner, for purposes of such offer to purchase additional
shares, will be treated as a Potential Beneficial Owner as described below. Bids by
Beneficial Owners through their Broker-Dealers with rates per annum higher than the
Maximum Applicable Rate will be treated as Sell Orders. A Hold Order (in the case
of an Auction relating to a Dividend Period which is not a Special Dividend Period)
and a Sell Order (in the case of an Auction relating to a Special Dividend Period)
shall be deemed to have been submitted on behalf of a Beneficial Owner if an Order
with respect to shares of AMPS then held by such Beneficial Owner is not submitted
on behalf of such Beneficial Owner for any reason, including the failure of a
Broker-Dealer to submit such Beneficial Owner's Order to the Auction Agent.
Potential Beneficial Owners of shares of AMPS may submit Bids through their
Broker-Dealers in which they offer to purchase shares of AMPS, provided that the
Applicable Rate for the next Dividend Period for such shares is not less than the
rate per annum specified in such Bid. A Bid by a Potential Beneficial Owner with a
rate per annum higher than the Maximum Applicable Rate will not be considered.
Neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's
failure to comply with any of the foregoing.
A Broker-Dealer also may hold AMPS for its own account as a Beneficial Owner. A
Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial Owner or
a Potential Beneficial Owner and therefore participate in an Auction as an Existing
Holder or Potential Holder on behalf of both itself and its customers. An Order
placed with the Auction Agent by a Broker-Dealer as an Existing
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
Holder or a Potential Holder as or on behalf of a Beneficial Owner or a Potential
Beneficial Owner, as the case may be, will be treated in the same manner as an
Order placed with a Broker-Dealer by a Beneficial Owner or a Potential Beneficial
Owner. Similarly, any failure by a Broker-Dealer to submit to the Auction Agent an
Order in respect of any AMPS held by it or its customers who are Beneficial Owners
will be treated in the same manner as a Beneficial Owner's failure to submit to its
Broker-Dealer an Order in respect of AMPS held by it, as described above. Inasmuch
as a Broker-Dealer participates in an Auction as an Existing Holder or a Potential
Holder only to represent the interests of a Beneficial Owner or Potential
Beneficial Owner, whether it be its customers or itself, all discussion herein
relating to the consequences of an Auction for Existing Holders and Potential
Holders also applies to the underlying beneficial ownership interests represented
thereby.
If Sufficient Clearing Bids exist in an Auction (that is, in general, the number of
shares of AMPS subject to Bids by Potential Holders with rates equal to or lower
than the Maximum Applicable Rate is at least equal to the number of shares of AMPS
subject to Sell Orders by Existing Holders), the Applicable Rate will be the lowest
rate per annum specified in the Submitted Bids which, taking into account such rate
per annum and all lower rates per annum bid by Existing Holders and Potential
Holders, would result in Existing Holders and Potential Holders owning all of the
shares of AMPS available for purchase in the Auction. If Sufficient Clearing Bids
do not exist, the Dividend Period next following the Auction automatically will be
a 7-Day Dividend Period in the case of Series A AMPS, and the Applicable Rate will
be the Maximum Applicable Rate, and in such event, Existing Holders that have
submitted Sell Orders will not be able to sell in the Auction all, and may not be
able to sell any, shares of AMPS subject to such Sell Orders. Thus, under certain
circumstances, Existing Holders and the Beneficial Owners they represent may not
have liquidity of investment. If all Existing Holders submit (or are deemed to have
submitted) Hold Orders in an Auction, the Dividend Period next following the
Auction automatically shall be the same length as the immediately preceding
Dividend Period, and the Applicable Rate will be 40% of the Reference Rate (as
defined under 'Determination of Maximum Applicable Rates' above) in effect on the
date of the Auction (or 60% of such rate if the Fund has provided notification to
the Auction Agent prior to the Auction establishing the Applicable Rate for any
dividend that net capital gains or other taxable income will be included in such
dividend on shares of AMPS).
The Auction Procedures include a pro rata allocation of shares for purchase and
sale, which may result in an Existing Holder selling or holding, or a Potential
Holder purchasing, a number of shares of AMPS that is less than the number of
shares of AMPS specified in its Order. To the extent the allocation has this
result, a Broker-Dealer will be required to make appropriate pro rata allocations
among its customers and itself.
</TABLE>
9
<PAGE>
<TABLE>
<S> <C>
A Sell Order by an Existing Holder will constitute an irrevocable offer to sell the
shares of AMPS subject thereto, and a Bid placed by an Existing Holder also will
constitute an irrevocable offer to sell the shares of AMPS subject thereto if the
rate per annum specified in the Bid is higher than the Applicable Rate determined
in the Auction, in each case at a price per share equal to $25,000. A Bid placed by
a Potential Holder will constitute an irrevocable offer to purchase the shares of
AMPS subject thereto if the rate per annum specified in such Bid is less than or
equal to the Applicable Rate determined in the Auction. Settlement of purchases and
sales will be made on the next Business Day (also a Dividend Payment Date) after
the Auction Date through the Securities Depository. Purchasers will make payment
through their Agent Members in same-day funds to the Securities Depository against
delivery by book-entry to their Agent Members. The Securities Depository will make
payment to the sellers' Agent Members in accordance with the Securities
Depository's normal procedures, which now provide for payment in same-day funds.
See 'Description of AMPS--The Auction.'
ASSET MAINTENANCE Under the Articles Supplementary, the Fund must maintain (i) S&P Eligible Assets
and Moody's Eligible Assets each having in the aggregate a Discounted Value at
least equal to the AMPS Basic Maintenance Amount and (ii) 1940 Act AMPS Asset
Coverage of at least 200%. See 'Description of AMPS--Asset Maintenance.'
Based on the composition of its portfolio at October 31, 1997, 1940 Act AMPS Asset
Coverage with respect to the shares of Series A AMPS issued and outstanding on that
date was approximately 311%. As of the date of this Prospectus, 1940 AMPS Asset
Coverage with respect to the shares of Series A AMPS issued and outstanding is
approximately 307%.
The Discount Factors and guidelines for calculating the Discounted Value of the
Fund's portfolio for purposes of determining whether the AMPS Basic Maintenance
Amount has been satisfied have been established by Moody's and S&P in connection
with the Fund's receipt of ratings on the shares of AMPS on their Date of Original
Issue of 'aaa' from Moody's and AAA from S&P. See 'Investment Objective and
Policies--Rating Agency Guidelines.'
MANDATORY REDEMPTION If the AMPS Basic Maintenance Amount or the 1940 Act AMPS Asset Coverage is not
maintained or restored as specified herein, shares of AMPS will be subject to
mandatory redemption, out of funds legally available therefor, at the Mandatory
Redemption Price of $25,000 per share plus an amount equal to dividends thereon
(whether or not earned or declared) accumulated but unpaid to the date fixed for
redemption. In addition, holders of AMPS may be entitled to receive Additional
Dividends in the event of redemption of such AMPS to the extent provided herein.
See 'Description of AMPS--Dividends--Additional Dividends.' Any such redemption
will be limited to the minimum number of shares of AMPS necessary to restore the
AMPS Basic Maintenance Amount or the 1940 Act AMPS Asset Coverage, as the case may
be. The Fund's ability to make such a mandatory redemption may be restricted by the
provisions of the
</TABLE>
10
<PAGE>
<TABLE>
<S> <C>
Investment Company Act of 1940, as amended (the '1940 Act'). See 'Description of
AMPS--Redemption--Mandatory Redemption.'
OPTIONAL REDEMPTION The shares of AMPS of each series are redeemable at the option of the Fund, as a
whole or in part, on any Dividend Payment Date (except during the Initial Dividend
Period or a Non-Call Period) at the Optional Redemption Price of $25,000 per share,
plus an amount equal to dividends thereon (whether or not earned or declared)
accumulated but unpaid to the date fixed for redemption plus the premium, if any,
resulting from the designation of a Premium Call Period. See 'Description of
AMPS--Redemption--Optional Redemption.' In addition, holders of shares of AMPS may
be entitled to receive Additional Dividends in the event of redemption of such
shares of AMPS to the extent provided herein. See 'Description of
AMPS--Dividends--Additional Dividends.'
LIQUIDATION PREFERENCE The liquidation preference of each share of AMPS will be $25,000, plus an amount
equal to accumulated but unpaid dividends (whether or not earned or declared). See
'Description of AMPS--Liquidation Rights.' In addition, holders of AMPS may be
entitled to receive Additional Dividends in the event of the liquidation of the
Fund as provided herein. See 'Description of AMPS-- Dividends--Additional
Dividends.'
RATINGS It is a condition to their issuance that the AMPS be issued with a rating of 'aaa'
from Moody's and AAA from S&P. See 'Investment Objective and Policies-- Rating
Agency Guidelines.'
VOTING RIGHTS The 1940 Act requires that the holders of AMPS and any other Preferred Stock,
voting as a separate class, have the right to elect at least two directors at all
times and to elect a majority of the directors at any time when two years'
dividends on the AMPS or any other Preferred Stock are unpaid. The holders of AMPS
and any other Preferred Stock will vote as a separate class on certain other
matters as required under the Fund's Charter and the 1940 Act. See 'Description of
AMPS--Voting Rights' and 'Description of Capital Stock--Certain Provisions of the
Articles of Incorporation.'
</TABLE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
The Fund has registered as a 'non-diversified' investment company so that
it will be able to invest more than 5% of its total 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 or, if not rated, are
considered by the Investment Adviser to be of comparable quality. These
securities are regarded as predominantly speculative and
11
<PAGE>
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.
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 that 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
12
<PAGE>
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 holders of Common Stock 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.'
For so long as any shares of AMPS are rated by Moody's, the Fund will not
buy or sell financial futures contracts, write, purchase or sell call options on
financial futures contracts or purchase put options on financial futures
contracts or write call options (except covered call options) on portfolio
securities unless it receives written confirmation from Moody's that engaging in
such transactions would not impair the ratings then assigned to the shares of
AMPS by Moody's, except that the Fund may engage in Moody's Hedging Transactions
subject to the limitations described herein. For so long as any shares of AMPS
are rated by S&P, the Fund will not purchase or sell financial futures
contracts, write, purchase or sell options on financial futures contracts or
write put options (except covered put options) or call options (except covered
call options) on portfolio securities unless it receives written confirmation
from S&P that engaging in such transactions will not impair the ratings then
assigned to the shares of AMPS by S&P, except that the Fund may engage in S&P
Hedging Transactions subject to the limitations described herein. See
'Investment Objective and Policies--Rating Agency Guidelines' and '--Options and
Futures Transactions.'
There are a number of specific factors investors in AMPS should consider.
-- The credit ratings of the AMPS could be reduced while an investor holds
the AMPS.
-- Neither Broker-Dealers nor the Fund are obligated to purchase shares of
AMPS in an Auction or otherwise nor is the Fund required to redeem
shares of AMPS in the event of a failed Auction.
-- If in an Auction for the AMPS Sufficient Clearing Bids do not exist the
Applicable Rate will be the Maximum Applicable Rate, and in such event,
Beneficial Owners that have submitted Sell Orders will not be able to
sell in the Auction all, and may not be able to sell any, shares of AMPS
subject to such Sell Orders. Thus, under certain circumstances,
Beneficial Owners may not have liquidity of investment.
The Broker-Dealers intend to maintain a secondary trading market in the
AMPS outside of Auctions; however, they have no obligation to do so and there
can be no assurance that a secondary market for the AMPS will develop or, if it
does develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The AMPS will not be registered on any stock exchange or
on the National Association of Securities Dealers Automated Quotation System. An
increase in the level of interest rates likely will have an adverse effect on
the secondary market price of the AMPS, and a selling shareholder may sell AMPS
between Auctions at a price per share of less than $25,000.
13
<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 period
November 3, 1995 (commencement of operations) to October 31, 1996 and for 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 YEAR FOR THE PERIOD
ENDED OCTOBER 31, NOVEMBER 3, 1995+ TO
1997 OCTOBER 31, 1996
----------------- --------------------
<S> <C> <C>
Increase (Decrease) in Net Asset Value per share of Common Stock:
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.............................................. $ 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 contingent deferred
sales charge ('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.
14
<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.
The Fund expects to engage in a continuous offering of its Common Stock at
a price equal to the next determined net asset value per share.
USE OF PROCEEDS
Assuming that all shares of Series A AMPS currently registered are sold, it
is estimated that the net proceeds of this offering will be $ .
Offering expenses of $186,000 have been previously paid by the Fund.
The net proceeds of the offering will be invested in long-term obligations
in accordance with the Fund's investment objective and policies during a period
estimated not to exceed three months from the offer and sale of such shares of
AMPS depending on market conditions and the availability of appropriate
securities. Because under normal market conditions, obligations with longer
maturities produce higher yields than shorter-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 on the AMPS and
the long-term rates received by the Fund will provide holders of the Common
Stock with a potentially higher yield. Pending investment in long-term
obligations, it is anticipated that the proceeds will be invested in short-term
tax-exempt securities. See 'Investment Objective and Policies.'
CAPITALIZATION
The following table sets forth the capitalization of the Fund as of October
31, 1997.
<TABLE>
<S> <C>
Shareholders' equity:
Capital Stock (200,000,000 shares authorized)
Preferred Stock, par value $.10 per share (2,480 shares of Series A AMPS issued and 1,920
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
Capital in excess of par value attributable to Common Stock....................................... 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
------------
Net assets........................................................................................ $149,462,819
------------
------------
</TABLE>
15
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders of its
Common Stock 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 dividends 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.
The investment grade Municipal Bonds in which the Fund will primarily
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 A to this
Prospectus for a description of
16
<PAGE>
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 enhancement 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 bond 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.
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.
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<PAGE>
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 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, 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,
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<PAGE>
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 a 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 a 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 participation 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 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 AMPS 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
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<PAGE>
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. For so long as shares of AMPS are rated by Moody's or S&P,
unless it receives written confirmation from S&P or Moody's, as the case may be,
that such action would not impair the ratings then assigned to the shares of
AMPS by Moody's or S&P, the Fund will not borrow moneys except for the purpose
of clearing portfolio securities transactions (which borrowings under any
circumstances shall be limited to the lesser of $10 million and an amount equal
to 5% of the market value of the Fund's assets at the time of such borrowings
and which borrowings shall be repaid within 60 days and not be extended or
renewed).
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 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.
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<PAGE>
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.
RATING AGENCY GUIDELINES
Certain of the capitalized terms used herein are defined in the Glossary
that appears at the end of this Prospectus.
The Fund intends that, so long as shares of AMPS are outstanding, the
composition of its portfolio will reflect guidelines established by Moody's and
S&P in connection with the Fund's receipt of a rating for such shares on or
prior to their Date of Original Issue of at least 'aaa' from Moody's and AAA
from S&P. Moody's and S&P, nationally recognized statistical rating
organizations, issue ratings for various securities reflecting the perceived
creditworthiness of such securities. The guidelines described below have been
developed by Moody's and S&P in connection with issuances of asset-backed and
similar securities, including debt obligations and variable rate preferred
stock, generally on a case-by-case basis through discussions with the issuers of
these securities. The guidelines are designed to ensure that assets underlying
outstanding debt or preferred stock will be varied sufficiently and will be of
sufficient quality and amount to justify investment-grade ratings. The
guidelines do not have the force of law but have been adopted by the Fund in
order to satisfy current requirements necessary for Moody's and S&P to issue the
above-described ratings for shares of AMPS, which ratings generally are relied
upon by institutional investors in purchasing such securities. The guidelines
provide a set of tests for portfolio composition and asset coverage that
supplement (and in some cases are more restrictive than) the applicable
requirements under the 1940 Act. See 'Description of AMPS--Asset Maintenance.'
The Fund intends to maintain a Discounted Value for its portfolio at least
equal to the AMPS Basic Maintenance Amount. Moody's and S&P each has established
separate guidelines for determining Discounted Value. To the extent any
particular portfolio holding does not satisfy the applicable rating agency's
guidelines, all or a portion of such holding's value will not be included in the
calculation of Discounted Value (as defined by such rating agency). The Moody's
and S&P guidelines do not impose any limitations on the percentage of Fund
assets that may be invested in holdings not eligible for inclusion in the
calculation of the Discounted Value of the Fund's portfolio.
Upon any failure to maintain the required Discounted Value, the Fund will
seek to alter the composition of its portfolio to reattain a Discounted Value at
least equal to the AMPS Basic Maintenance Amount on or prior to the AMPS Basic
Maintenance Cure Date, thereby incurring additional transaction costs and
possible losses and/or gains on dispositions of portfolio securities. To the
extent any such failure is not cured in a timely manner, shares of AMPS will be
subject to redemption. See 'Description of AMPS--Asset Maintenance' and
'Description of AMPS--Redemption.' The AMPS Basic Maintenance Amount includes
the sum of (i) the
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aggregate liquidation value of AMPS then outstanding and (ii) certain accrued
and projected payment obligations of the Fund. See 'Description of AMPS--Asset
Maintenance.'
The Fund may, but is not required to, adopt any modifications to these
guidelines that hereafter may be established by Moody's or S&P. Failure to adopt
any such modifications, however, may result in a change in the ratings described
above or a withdrawal of ratings altogether. In addition, any rating agency
providing a rating for the shares of AMPS, at any time, may change or withdraw
any such rating. As set forth in the Articles Supplementary, the Board of
Directors, without shareholder approval, may modify certain definitions or
restrictions which have been adopted by the Fund pursuant to the rating agency
guidelines, provided the Board of Directors has obtained written confirmation
from Moody's and S&P that any such change would not impair the ratings then
assigned by Moody's and S&P to the AMPS.
As recently described by Moody's and S&P, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The ratings on the AMPS are not recommendations to purchase, hold
or sell shares of AMPS, inasmuch as the ratings do not comment as to market
price or suitability for a particular investor, nor do the rating agency
guidelines described above address the likelihood that a holder of shares of
AMPS will be able to sell such shares in an Auction. The ratings are based on
current information furnished to Moody's and S&P by the Fund and the Investment
Adviser and information obtained from other sources. The ratings may be changed,
suspended or withdrawn as a result of changes in, or the unavailability of, such
information. The Common Stock has not been rated by a nationally recognized
statistical rating organization.
S&P AAA Rating Guidelines. The Discounted Value of the Fund's S&P Eligible
Assets is calculated on each Valuation Date. See 'Description of AMPS--Asset
Maintenance--AMPS Basic Maintenance Amount'. S&P Eligible Assets include cash,
Receivables for Municipal Bonds Sold (as defined below) and Municipal Bonds
eligible for consideration under S&P's current guidelines. For purposes of
calculating the Discounted Value of the Fund's portfolio under current S&P
guidelines, the fair market value of Municipal Bonds eligible for consideration
under such guidelines must be discounted by the applicable S&P Discount Factor
set forth in the table below. The Discounted Value of a Municipal Bond eligible
for consideration under S&P guidelines is the fair market value thereof divided
by the S&P Discount Factor. The S&P Discount Factor used to discount a
particular Municipal Bond will be determined by reference to (a) the rating by
S&P or Moody's on such Municipal Bond and (b) the S&P Exposure Period. The S&P
Exposure Period is the maximum period of time following a Valuation Date,
including the Valuation Date and the AMPS Basic Maintenance Cure Date, that the
Fund has to cure any failure to maintain, as of such Valuation Date, a
Discounted Value for its portfolio at least equal to the AMPS Basic Maintenance
Amount.
S&P Discount Factors applicable to Municipal Bonds for a range of S&P
Exposure Periods are set forth below:
<TABLE>
<CAPTION>
S&P DISCOUNT FACTORS
RATING CATEGORY
------------------------
EXPOSURE PERIOD AAA AA A BB
- --------------------------------------------------------------------------- --- --- --- ---
<S> <C> <C> <C> <C>
40 Business Days........................................................... 190% 195% 210% 250%
22 Business Days........................................................... 170 175 190 230
10 Business Days........................................................... 155 160 175 215
7 Business Days........................................................... 150 155 170 210
3 Business Days........................................................... 130 135 150 190
</TABLE>
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Since the S&P Exposure Period currently applicable to the Fund is seven
Business Days, the S&P Discount Factors currently applicable to Municipal Bonds
eligible for consideration under S&P guidelines will be determined by reference
to the factors set forth opposite the exposure period line entitled '7 Business
Days.' Notwithstanding the foregoing, (i) the S&P Discount Factor for short-term
Municipal Bonds will be 115%, so long as such Municipal Bonds are rated A-1+ or
SP-1+ by S&P and mature or have a demand feature exercisable in 30 days or less,
or 125% if such Municipal Bonds are not rated by S&P but are rated VMIG-1, P-1
or MIG-1 by Moody's; provided, however, such short-term Municipal Bonds rated by
Moody's but not rated by S&P having a demand feature exercisable in 30 days or
less must be backed by a letter of credit, liquidity facility or guarantee from
a bank or other financial institution having a short-term rating of at least
A-1+ from S&P; and further provided that such short-term Municipal Bonds rated
by Moody's but not rated by S&P may comprise no more than 50% of short-term
Municipal Bonds that qualify as S&P Eligible Assets and (ii) no S&P Discount
Factor will be applied to cash or to Receivables for Municipal Bonds Sold.
'Receivables for Municipal Bonds Sold', for purposes of calculating S&P Eligible
Assets as of any Valuation Date, means the book value of receivables for
Municipal Bonds sold as of or prior to such Valuation Date if such receivables
are due within five Business Days of such Valuation Date. The Fund may adopt S&P
Discount Factors for Municipal Bonds other than Municipal Bonds provided that
S&P advises the Fund in writing that such action will not adversely affect its
then current rating on the AMPS. Also, for purposes of the foregoing,
Anticipation Notes rated SP-1+ or, if not rated by S&P, rated VMIG-1 by Moody's,
which do not mature or have a demand feature exercisable in 30 days and which do
not have a long-term rating, shall be considered to be short-term Municipal
Bonds.
The S&P guidelines require certain minimum issue size and geographical
diversification and impose other requirements for purposes of determining S&P
Eligible Assets. In order to be considered S&P Eligible Assets, Municipal Bonds
must:
(i) Be interest bearing and pay interest at least semi-annually;
(ii) Be payable with respect to principal and interest in U.S.
dollars;
(iii) Be publicly rated BBB or higher by S&P or, except in the case of
Anticipation Notes that are grant anticipation notes or bond anticipation
notes which must be rated by S&P to be included in S&P Eligible Assets, if
not rated by S&P but rated by Moody's, be rated at least A by Moody's
(provided that such Moody's-rated Municipal Bonds will be included in S&P
Eligible Assets only to the extent the fair market value of such Municipal
Bonds does not exceed 50% of the aggregate fair market value of the S&P
Eligible Assets. For purposes of determining the S&P Discount Factors
applicable to any such Moody's-rated Municipal Bonds, such Municipal Bonds
will be deemed to have an S&P rating which is one full rating category
lower than its Moody's rating);
(iv) Not be subject to a covered call or covered put option written by
the Fund;
(v) Not be part of a private placement of Municipal Bonds; and
(vi) Be part of an issue with an original issue size of at least $20
million or, if of an issue with an original issue size below $20 million
(but in no event below $10 million), be issued by an issuer with a total of
at least $50 million of securities outstanding.
Notwithstanding the foregoing:
(i) Municipal Bonds of any one issuer or guarantor (excluding bond
insurers) will be considered S&P Eligible Assets only to the extent the
fair market value of such Bonds does not exceed 10% of the aggregate fair
market value of the S&P Eligible Assets, provided that 2% is added to the
applicable S&P Discount
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<PAGE>
Factor for every 1% by which the fair market value of such Municipal Bonds
exceeds 5% of the aggregate fair market value of the S&P Eligible Assets;
(ii) Municipal Bonds guaranteed or insured by any one bond insurer
will be considered S&P Eligible Assets only to the extent the fair market
value of such Municipal Bonds does not exceed 25% of the aggregate fair
market value of the S&P Eligible Assets; and
(iii) Municipal Bonds issued by issuers in any one state or territory
will be considered S&P Eligible Assets only to the extent the fair market
value of such Municipal Bonds does not exceed 20% of the aggregate fair
market value of S&P Eligible Assets.
The Fund may include Municipal Bonds as S&P Eligible Assets pursuant to
guidelines and restrictions to be established by S&P, provided that S&P advises
the Fund in writing that such action will not adversely affect its then current
rating on the AMPS.
As discussed above, the Fund may engage in options or futures transactions.
For so long as any shares of AMPS are rated by S&P, the Fund will not purchase
or sell financial futures contracts, write, purchase or sell options on
financial futures contracts or write put options (except covered put options) or
call options (except covered call options) on portfolio securities unless it
receives written confirmation from S&P that engaging in such transactions will
not impair the ratings then assigned to the shares of AMPS by S&P, except that
the Fund may purchase or sell financial futures contracts based on the Bond
Buyer Municipal Bond Index (the 'Municipal Index') or United States Treasury
Bonds or Notes ('Treasury Bonds') and write, purchase or sell put and call
options on such contracts (collectively 'S&P Hedging Transactions'), subject to
the following limitations:
(i) the Fund will not engage in any S&P Hedging Transaction based on
the Municipal Index (other than transactions which terminate a financial
futures contract or option held by the Fund by the Fund's taking an
opposite position thereto ('Closing Transactions')), which would cause the
Fund at the time of such transaction to own or have sold the least of (A)
more than 1,000 outstanding financial futures contracts based on the
Municipal Index, (B) outstanding financial futures contracts based on the
Municipal Index exceeding in number 25% of the quotient of the fair market
value of the Fund's total assets divided by $100,000 or (C) outstanding
financial futures contracts based on the Municipal Index exceeding in
number 10% of the average number of daily traded financial futures
contracts based on the Municipal Index in the 30 days preceding the time of
effecting such transaction as reported by The Wall Street Journal;
(ii) the Fund will not engage in any S&P Hedging Transaction based on
Treasury Bonds (other than Closing Transactions) which would cause the Fund
at the time of such transaction to own or have sold the lesser of (A)
outstanding financial futures contracts based on Treasury Bonds and on the
Municipal Index exceeding in number 25% of the quotient of the fair market
value of the Fund's total assets divided by $100,000 or (B) outstanding
financial futures contracts based on Treasury Bonds exceeding in number 10%
of the average number of daily traded financial futures contracts based on
Treasury Bonds in the 30 days preceding the time of effecting such
transaction as reported by The Wall Street Journal;
(iii) the Fund will engage in Closing Transactions to close out any
outstanding financial futures contract which the Fund owns or has sold or
any outstanding option thereon owned by the Fund in the event (A) the Fund
does not have S&P Eligible Assets with an aggregate Discounted Value equal
to or greater than the AMPS Basic Maintenance Amount on two consecutive
Valuation Dates and (B) the Fund is required to pay Variation Margin on the
second such Valuation Date;
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<PAGE>
(iv) the Fund will engage in a Closing Transaction to close out any
outstanding financial futures contract or option thereon in the month prior
to the delivery month under the terms of such financial futures contract or
option thereon unless the Fund holds the securities deliverable under such
terms; and
(v) when the Fund writes a financial futures contract or an option
thereon, it will either maintain an amount of cash, cash equivalents or
short-term, fixed-income securities in a segregated account with the Fund's
custodian, so that the amount so segregated plus the amount of Initial
Margin and Variation Margin held in the account of or on behalf of the
Fund's broker with respect to such financial futures contract or option
equals the fair market value of the financial futures contract or option,
or, in the event the Fund writes a financial futures contract or option
thereon which requires delivery of an underlying security, it shall hold
such underlying security in its portfolio.
For purposes of determining whether the Fund has S&P Eligible Assets with a
Discounted Value that equals or exceeds the AMPS Basic Maintenance Amount, the
Discounted Value of cash or securities held for the payment of Initial Margin or
Variation Margin shall be zero and the aggregate Discounted Value of S&P
Eligible Assets shall be reduced by an amount equal to (i) 30% of the aggregate
settlement value, as marked to market, of any outstanding financial futures
contracts based on the Municipal Index which are owned by the Fund plus (ii) 25%
of the aggregate settlement value, as marked to market, of any outstanding
financial futures contracts based on Treasury Bonds which contracts are owned by
the Fund.
Moody's 'aaa' Rating Guidelines. The Discounted Value of the Fund's
Moody's Eligible Assets is calculated on each Valuation Date. See 'Description
of AMPS--Asset Maintenance--AMPS Basic Maintenance Amount.' Moody's Eligible
Assets include cash, Receivables for Municipal Bonds (as defined below), and
Municipal Bonds eligible for consideration under Moody's guidelines. For
purposes of calculating the Discounted Value of the Fund's portfolio under
current Moody's guidelines, the fair market value of Municipal Bonds eligible
for consideration under such guidelines must be discounted by the applicable
Moody's Discount Factor set forth in the table below. The Discounted Value of a
Municipal Bond eligible for consideration under Moody's guidelines is the lower
of par and the quotient of the fair market value thereof divided by the Moody's
Discount Factor. The Moody's Discount Factor used to discount a particular
Municipal Bond will be determined by reference to (a) the rating by Moody's or
S&P on such Municipal Bond and (b) the Moody's Exposure Period. Moody's Discount
Factors for a range of Moody's Exposure Periods are set forth below:
<TABLE>
<CAPTION>
MOODY'S DISCOUNT FACTORS RATING CATEGORY
----------------------------------------------------------------
MOODY'S EXPOSURE PERIOD AAA(1) AA(1) A(1) BAA(1) OTHER(2) VMIG-1(3) SP-1+(3)
- ------------------------------------------------------- ------ ----- ---- ------ -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
7 weeks or less........................................ 151% 159% 168 % 202% 229% 136% 148%
8 weeks or less but greater than seven weeks........... 154 164 173 205 235 137 149
9 weeks or less but greater than eight weeks........... 158 169 179 209 242 138 150
</TABLE>
- ------------------
(1) Moody's rating.
(2) Municipal Bonds not rated by Moody's but rated BBB-, BBB or BBB+ by S&P.
(3) Municipal Bonds rated MIG-1, VMIG-1 or P-1 or, if not rated by Moody's,
rated SP-1+ or A-1+ by S&P which do not mature or have a demand feature at
par exercisable within the Moody's Exposure Period and which do not have a
long-term rating. For the purposes of the definition of Moody's Eligible
Assets, these securities will have an assumed rating of A by Moody's.
Since the Moody's Exposure Period currently is 49 days, the Moody's
Discount Factors currently applicable to Municipal Bonds eligible for
consideration under Moody's guidelines will be determined by reference to the
factors set forth opposite the exposure period line entitled '7 weeks or less.'
Notwithstanding the foregoing,
25
<PAGE>
(i) no Moody's Discount Factor will be applied to short-term Municipal Bonds so
long as such Municipal Bonds are rated at least MIG-1, VMIG-1 or P-1 by Moody's
and mature or have a demand feature at par exercisable within the Moody's
Exposure Period, and the Moody's Discount Factor for such Municipal Bonds will
be 125% if such Municipal Bonds are not rated by Moody's but are rated A-1+,
SP-1+ or AA by S&P and mature or have a demand feature at par exercisable within
the Moody's Exposure Period, and (ii) no Moody's Discount Factor will be applied
to cash or to Receivables for Municipal Bonds Sold. 'Receivables for Municipal
Bonds Sold', for purposes of calculating Moody's Eligible Assets as of any
Valuation Date, means no more than the aggregate of the following: (i) the book
value of receivables for Municipal Bonds sold as of or prior to such Valuation
Date if such receivables are due within five Business Days of such Valuation
Date, and if the trades which generated such receivables are (A) settled through
clearing house firms with respect to which the Fund has received prior written
authorization from Moody's or (B) with counterparties having a Moody's long-term
debt rating of at least Baa3; and (ii) the Moody's Discounted Value of Municipal
Bonds sold as of or prior to such Valuation Date which generated receivables, if
such receivables are due within five Business Days of such Valuation Date but do
not comply with either of conditions (A) or (B) of the preceding clause (i).
The Moody's guidelines impose certain requirements as to minimum issue
size, issuer diversification and geographical concentration, as well as other
requirements for purposes of determining whether Municipal Bonds constitute
Moody's Eligible Assets, as set forth in the table below:
<TABLE>
<CAPTION>
MAXIMUM STATE
MINIMUM ISSUE MAXIMUM OR TERRITORY
SIZE ($ UNDERLYING CONCENTRATION
RATING MILLIONS) OBLIGOR (%)(1) (%)(1)(3)
- ----------------------------------------------------------- ------------- -------------- -------------
<S> <C> <C> <C>
Aaa........................................................ 10 100 100
Aa......................................................... 10 20 60
A.......................................................... 10 10 40
Baa........................................................ 10 6 20
Other (2).................................................. 10 4 12
</TABLE>
- ------------------
(1) The referenced percentages represent maximum cumulative totals for the
related rating category and each lower rating category.
(2) Municipal Bonds not rated by Moody's but rated BBB-, BBB or BBB+ by S&P.
(3) Territorial bonds (other than those issued by Puerto Rico and counted
collectively) are each limited to 10% of Moody's Eligible Assets. For
diversification purposes, Puerto Rico will be treated as a state.
For purposes of the maximum underlying obligor requirement described above,
any such Municipal Bond backed by the guaranty, letter of credit or insurance
issued by a third party will be deemed to be issued by such third party if the
issuance of such third party credit is the sole determinant of the rating on
such Municipal Bond.
Current Moody's guidelines also require that Municipal Bonds constituting
Moody's Eligible Assets pay interest in cash, be publicly rated Baa or higher by
Moody's or, if not rated by Moody's but rated by S&P, that they be rated at
least BBB- by S&P, not have suspended ratings by Moody's and be part of an issue
of Municipal Bonds of at least $10,000,000. For purposes of determining the
Moody's Discount Factors applicable to any such S&P-rated Municipal Bonds, such
Municipal Bonds (excluding any short-term Municipal Bonds) will be deemed to
have a Moody's rating which is one full rating category lower than its S&P
rating. When the Fund sells a Municipal Bond and agrees to repurchase it at a
future date, the Discounted Value of such Municipal Bond will constitute a
Moody's Eligible Asset and the amount the Fund is required to pay upon
repurchase of such bond
26
<PAGE>
will count as a liability for purposes of calculating the AMPS Basic Maintenance
Amount. When the Fund purchases a Municipal Bond and agrees to sell it at a
future date to another party, cash receivable by the Fund thereby will
constitute a Moody's Eligible Asset if the long-term debt of such other party is
rated at least A2 by Moody's and such agreement has a term of 30 days or less;
otherwise the Discounted Value of such Municipal Bond will constitute a Moody's
Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset if it is (i) held in a margin account, (ii) subject to any
material lien, mortgage, pledge, security interest or security agreement of any
kind, (iii) held for the purchase of a security pursuant to a Forward Commitment
or (iv) irrevocably deposited by the Fund for the payment of dividends or
redemption.
For so long as shares of AMPS are rated by Moody's, in managing the Fund's
portfolio, the Investment Adviser will not alter the composition of the Fund's
portfolio if, in the reasonable belief of the Investment Adviser, the effect of
any such alteration would be to cause the Fund to have Moody's Eligible Assets
with an aggregate Discounted Value, as of the immediately preceding Valuation
Date, less than the AMPS Basic Maintenance Amount as of such Valuation Date;
provided, however, that in the event that, as of the immediately preceding
Valuation Date, the aggregate Discounted Value of Moody's Eligible Assets
exceeded the AMPS Basic Maintenance Amount by five percent or less, the
Investment Adviser will not alter the composition of the Fund's portfolio in a
manner reasonably expected to reduce the aggregate Discounted Value of Moody's
Eligible Assets unless the Fund shall have confirmed that, after giving effect
to such alteration, the aggregate Discounted Value of Moody's Eligible Assets
would exceed the AMPS Basic Maintenance Amount.
For so long as any shares of AMPS are rated by Moody's, the Fund will not
buy or sell financial futures contracts, write, purchase or sell call options on
financial futures contracts or purchase put options on financial futures
contracts or write call options (except covered call options) on portfolio
securities unless it receives written confirmation from Moody's that engaging in
such transactions would not impair the ratings then assigned to the shares of
AMPS by Moody's, except that the Fund may purchase or sell exchange-traded
financial futures contracts based on the Municipal Index or Treasury Bonds and
purchase, write or sell exchange-traded put options on such financial futures
contracts and purchase, write or sell exchange-traded call options on such
financial futures contracts (collectively 'Moody's Hedging Transactions'),
subject to the following limitations:
(i) the Fund will not engage in any Moody's Hedging Transaction based
on the Municipal Index (other than Closing Transactions) which would cause
the Fund at the time of such transaction to own or have sold (A)
outstanding financial futures contracts based on the Municipal Index
exceeding in number 10% of the average number of daily traded financial
futures contracts based on the Municipal Index in the 30 days preceding the
time of effecting such transaction as reported by The Wall Street Journal
or (B) outstanding financial futures contracts based on the Municipal Index
having a fair market value exceeding the fair market value of all Municipal
Bonds constituting Moody's Eligible Assets owned by the Fund (other than
Moody's Eligible Assets already subject to a Moody's Hedging Transaction);
(ii) the Fund will not engage in any Moody's Hedging Transaction based
on Treasury Bonds (other than Closing Transactions) which would cause the
Fund at the time of such transaction to own or have sold (A) outstanding
financial futures contracts based on Treasury Bonds having an aggregate
fair market value exceeding 40% of the aggregate fair market value of
Moody's Eligible Assets owned by the Fund and rated Aa by Moody's (or, if
not rated by Moody's but rated by S&P, rated AAA by S&P) or (B) outstanding
financial futures contracts based on Treasury Bonds having an aggregate
fair market value exceeding 80% of the aggregate fair market value of all
Municipal Bonds constituting Moody's Eligible Assets owned by the Fund
(other than Moody's Eligible Assets already subject to a Moody's Hedging
Transaction) and rated
27
<PAGE>
Baa or A by Moody's (or, if not rated by Moody's but rated by S&P, rated A
or AA by S&P) (for purposes of the foregoing clauses (i) and (ii), the Fund
shall be deemed to own the number of financial futures contracts that
underlie any outstanding options written by the Fund);
(iii) the Fund will engage in Closing Transactions to close out any
outstanding financial futures contract based on the Municipal Index if the
amount of open interest in the Municipal Index as reported by The Wall
Street Journal is less than 5,000;
(iv) the Fund will engage in a Closing Transaction to close out any
outstanding financial futures contract by no later than the fifth Business
Day of the month in which such contract expires and will engage in a
Closing Transaction to close out any outstanding option on a financial
futures contract by no later than the first Business Day of the month in
which such option expires;
(v) the Fund will engage in Moody's Hedging Transactions only with
respect to financial futures contracts or options thereon having the next
settlement date or the settlement date immediately thereafter;
(vi) the Fund will not engage in options and futures transactions for
leveraging or speculative purposes and will not write any call options or
sell any financial futures contracts for the purpose of hedging the
anticipated purchase of an asset prior to completion of such purchase; and
(vii) the Fund will not enter into an option or futures transaction
unless, after giving effect thereto, the Fund would continue to have
Moody's Eligible Assets with an aggregate Discounted Value equal to or
greater than the AMPS Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the Discounted Value of Moody's Eligible Assets which the
Fund is obligated to deliver or receive pursuant to an outstanding futures
contract or option shall be as follows: (i) assets subject to call options
written by the Fund which are either exchange-traded and 'readily reversible' or
which expire within 49 days after the date as of which such valuation is made
shall be valued at the lesser of (A) Discounted Value and (B) the exercise price
of the call option written by the Fund; (ii) assets subject to call options
written by the Fund not meeting the requirements of clause (i) of this sentence
shall have no value; (iii) assets subject to put options written by the Fund
shall be valued at the lesser of (A) the exercise price and (B) the Discounted
Value of the subject security; (iv) futures contracts shall be valued at the
lesser of (A) settlement price and (B) the Discounted Value of the subject
security, provided that, if a contract matures within 49 days after the date as
of which such valuation is made, where the Fund is the seller the contract may
be valued at the settlement price and where the Fund is the buyer the contract
may be valued at the Discounted Value of the subject securities; and (v) where
delivery may be made to the Fund with any security of a class of securities, the
Fund shall assume that it will take delivery of the security with the lowest
Discounted Value.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the following amounts shall be subtracted from the aggregate
Discounted Value of the Moody's Eligible Assets held by the Fund: (i) 10% of the
exercise price of a written call option; (ii) the exercise price of any written
put option; (iii) where the Fund is the seller under a financial futures
contract, 10% of the settlement price of the financial futures contract; (iv)
where the Fund is the purchaser under a financial futures contract, the
settlement price of assets purchased under such financial futures contract; (v)
the settlement price of the underlying financial futures contract if the Fund
writes put options on a financial futures contract; and (vi) 105% of the fair
market value of the underlying financial
28
<PAGE>
futures contracts if the Fund writes call options on a financial futures
contract and does not own the underlying contract.
For so long as any shares of AMPS are rated by Moody's, the Fund will not
enter into any contract to purchase securities for a fixed price at a future
date beyond customary settlement time (other than such contracts that constitute
Moody's Hedging Transactions), except that the Fund may enter into such
contracts to purchase newly-issued securities on the date such securities are
issued ('Forward Commitments'), subject to the following limitations:
(i) the Fund will maintain in a segregated account with its custodian
cash, cash equivalents or short-term, fixed-income securities rated P-1,
MIG-1 or VMIG-1 by Moody's and maturing prior to the date of the Forward
Commitment with a fair market value that equals or exceeds the amount of
the Fund's obligations under any Forward Commitments to which it is from
time to time a party or long-term, fixed income securities with a
Discounted Value that equals or exceeds the amount of the Fund's
obligations under any Forward Commitment to which it is from time to time a
party, and
(ii) the Fund will not enter into a Forward Commitment unless, after
giving effect thereto, the Fund would continue to have Moody's Eligible
Assets with an aggregate Discounted Value equal to or greater than the AMPS
Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the Discounted Value of all Forward Commitments to which the
Fund is a party and of all securities deliverable to the Fund pursuant to such
Forward Commitments shall be zero.
------------------------
For so long as shares of AMPS are rated by S&P or Moody's, the Fund, unless
it has received written confirmation from S&P and/or Moody's, as the case may
be, that such action would not impair the ratings then assigned to the AMPS by
S&P and/or Moody's, as the case may be, will not (i) borrow money except for the
purpose of clearing transactions in portfolio securities (which borrowings under
any circumstances shall be limited to the lesser of $10 million and an amount
equal to 5% of the fair market value of the Fund's assets at the time of such
borrowings and which borrowings shall be repaid within 60 days and not be
extended or renewed and shall not cause the aggregate Discounted Value of
Moody's Eligible Assets and S&P Eligible Assets to be less than the AMPS Basic
Maintenance Amount), (ii) engage in short sales of securities, (iii) lend any
securities, (iv) issue any class or series of stock ranking prior to or on a
parity with the AMPS with respect to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up of the Fund,
(v) reissue any AMPS previously purchased or redeemed by the Fund, (vi) merge or
consolidate into or with any other corporation or entity, (vii) change the
Fund's pricing service or (viii) engage in reverse repurchase agreements.
Furthermore, for so long as the shares of AMPS are rated by S&P and Moody's, at
the time the Fund accepts shares of Common Stock for repurchase in a tender
offer, it shall have Deposit Securities maturing, or the irrevocable sale of
which are due for settlement with a counterparty rated A-1 or better in the case
of S&P and P-1 or better in the case of Moody's, within three Business Days of
such date of acceptance in an amount at least equal to the shares of Common
Stock accepted for repurchase in such tender offer; otherwise, the Fund will not
accept such shares for repurchase. Also, for so long as the shares of AMPS are
rated by S&P and Moody's, the Fund will provide, within five Business Days after
the end of each calendar month, a report to S&P and Moody's as to the number and
dollar amount of shares of Common Stock sold including shares sold pursuant to
reinvestment of dividends and the number, dollar amount and repurchase price of
shares of Common Stock repurchased pursuant to a tender offer. Such report also
shall provide the names of any counterparties to which
29
<PAGE>
Deposit Securities were sold in conjunction with the satisfaction of the
requirement of having Deposit Securities when the Fund accepts shares of Common
Stock in a tender offer as set forth above. For so long as the shares of AMPS
are rated by S&P and Moody's, the Fund will provide notice to S&P and Moody's of
the cancellation of any tender offers for its Common Stock within three Business
Days of such cancellation.
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. 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. For so long as the AMPS are rated
by Moody's and S&P, the Fund's use of options and financial futures contracts
will be subject to the limitations described under 'Investment Objective and
Policies--Rating Agency Guidelines.' Furthermore, the Fund will 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 derived from transactions in options and
futures contracts which are 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 rating organizations.
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
30
<PAGE>
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
purpose of hedging its investments in Municipal Bonds against declines in value
and to hedge 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 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 Directors, the Fund also may engage in
transactions in other financial futures contracts 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
transactions ('OTC options') 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
31
<PAGE>
dealers that have capital of at least $50 million or whose obligations are
guaranteed by an entity having capital of at least $50 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 financial futures contracts on U.S.
Government securities and options on such financial 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 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
financial 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
32
<PAGE>
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 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 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 financial 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
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.
DESCRIPTION OF AMPS
Certain of the capitalized terms used herein are defined in the Glossary
that appears at the back of this Prospectus.
Under the Articles Supplementary, 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 offered hereby are the only series currently offered and to be issued and
outstanding.
The AMPS will be shares of Preferred Stock that entitle their holders to
receive dividends when, as and if declared by the Board of Directors, out of
funds legally available therefor, at a rate per annum that may vary for the
successive Dividend Periods for each such series. Each Dividend Period for the
Series A AMPS will generally be a 7-Day Dividend Period; provided, however, that
prior to any Auction, the Fund may elect, subject to certain limitations
described herein, upon giving notice to holders thereof, a Special Dividend
Period. The Applicable Rate for a particular Dividend Period will be determined
by an Auction conducted on the Business Day before the start of such Dividend
Period. Beneficial Owners and Potential Beneficial Owners of shares of AMPS may
participate in Auctions therefor, although, except in the case of a Special
Dividend Period, Beneficial Owners desiring to continue to hold all of their
shares of AMPS regardless of the Applicable Rate resulting from Auctions need
not participate. For an explanation of Auctions and the method of determining
the Applicable Rate, see '--The Auction.'
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<PAGE>
Except as otherwise required by law or unless there is no Securities
Depository, all outstanding shares of AMPS will be represented by one or more
certificates registered in the name of the nominee of the Securities Depository
(initially expected to be Cede), and no person acquiring shares of AMPS will be
entitled to receive a certificate representing such shares. See Appendix C
(Auction Procedures). As a result, the nominee of the Securities Depository is
expected to be the sole holder of record of the shares of AMPS. Accordingly,
each purchaser of AMPS must rely on (i) the procedures of the Securities
Depository and, if such purchaser is not a member of the Securities Depository,
such purchaser's Agent Member, to receive dividends, distributions and notices
and to exercise voting rights (if and when applicable) and (ii) the records of
the Securities Depository and, if such purchaser is not a member of the
Securities Depository, such purchaser's Agent Member, to evidence its beneficial
ownership of shares of AMPS.
When issued and sold, the shares of AMPS will have a liquidation preference
of $25,000 per share plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) and will be fully paid and non-assessable.
See '--Liquidation Rights.' The shares of AMPS will not be convertible into
shares of Common Stock or other capital stock of the Fund, and the holders
thereof will have no preemptive rights. The shares of AMPS will not be subject
to any sinking fund but will be subject to redemption at the option of the Fund
at the Optional Redemption Price on any Dividend Payment Date (except during the
Initial Dividend Period and during a Non-Call Period) and, under certain
circumstances, will be subject to mandatory redemption by the Fund at the
Mandatory Redemption Price stated herein. See '--Redemption.'
In addition to serving as the Auction Agent in connection with the Auction
Procedures described below, IBJ Schroder Bank & Trust Company will be the
transfer agent, registrar, dividend disbursing agent and redemption agent for
the shares of AMPS. The Auction Agent, however, will serve merely as the agent
of the Fund, acting in accordance with the Fund's instructions, and will not be
responsible for any evaluation or verification of any matters certified to it.
Except in an Auction, the Fund will have the right (to the extent permitted
by applicable law) to purchase or otherwise acquire any shares of AMPS so long
as the Fund is current in the payment of dividends on AMPS and on any other
capital stock of the Fund ranking on a parity with the AMPS with respect to the
payment of dividends or upon liquidation.
The following is a brief description of the terms of the shares of AMPS.
This description does not purport to be complete and is subject to and qualified
in its entirety by reference to the Fund's Articles of Incorporation and
Articles Supplementary, including the provisions thereof establishing the AMPS.
The Fund's Articles of Incorporation and the form of Articles Supplementary
establishing the terms of the AMPS have been filed as exhibits to the
Registration Statement of which this Prospectus is a part.
THE AUCTION
General. Holders of the shares of AMPS of each series will be entitled to
receive cumulative cash dividends on their shares when, as and if declared by
the Board of Directors of the Fund, out of funds legally available therefor, on
the Initial Dividend Payment Date with respect to the Initial Dividend Period
and, thereafter, on each Dividend Payment Date with respect to a Subsequent
Dividend Period (generally a period of seven days in the case of Series A AMPS,
subject to certain exceptions set forth under '--Dividends-- General') at the
rate per annum equal to the Applicable Rate for each such Dividend Period.
The provisions of the Articles Supplementary establishing the terms of the
shares of AMPS offered hereby will provide that the Applicable Rate for each
series of AMPS for each Dividend Period after the Initial Dividend Period
therefor will be equal to the rate per annum that the Auction Agent advises has
resulted on the Business
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<PAGE>
Day preceding the first day of such Dividend Period due to implementation of the
auction procedures set forth in the Articles Supplementary (the 'Auction
Procedures') in which persons determine to hold or offer to purchase or sell
shares of AMPS of such series. The Auction Procedures are attached as Appendix C
to this Prospectus. Each periodic operation of such procedures with respect to
the shares of AMPS is referred to hereinafter as an 'Auction'. If, however, the
Fund should fail to pay or duly provide for the full amount of any dividend on
shares of AMPS of any series or the redemption price of shares of AMPS of such
series called for redemption, the Applicable Rate for shares of AMPS will be
determined as set forth under '--Dividends--Determination of Dividend Rate.'
Auction Agent Agreement. The Fund will enter into an agreement (the
'Auction Agent Agreement') with IBJ Schroder Bank & Trust Company (together with
any successor bank or trust company or other entity entering into a similar
agreement with this Fund, the 'Auction Agent'), which provides, among other
things, that the Auction Agent will follow the Auction Procedures for the
purpose of determining the Applicable Rate for the AMPS. The Fund will pay the
Auction Agent compensation for its services under the Auction Agent Agreement.
The Auction Agent will act as agent for the Fund in connection with
Auctions. In the absence of bad faith or negligence on its part, the Auction
Agent will not be liable for any action taken, suffered or omitted, or for any
error of judgment made, by it in the performance of its duties under the Auction
Agent Agreement, and will not be liable for any error of judgment made in good
faith unless the Auction Agent shall have been negligent in ascertaining the
pertinent facts. Pursuant to the Auction Agent Agreement, the Fund is required
to indemnify the Auction Agent for certain losses and liabilities incurred by
the Auction Agent without negligence or bad faith on its part in connection with
the performance of its duties under such agreement.
The Auction Agent may terminate the Auction Agent Agreement upon notice to
the Fund, which termination may be no earlier than 60 days following delivery of
such notice. If the Auction Agent resigns, the Fund will use its best efforts to
enter into an agreement with a successor Auction Agent containing substantially
the same terms and conditions as the Auction Agent Agreement. The Fund may
terminate the Auction Agent Agreement, provided that prior to such termination
the Fund shall have entered into such an agreement with respect thereto with a
successor Auction Agent.
Broker-Dealer Agreements. The Auctions require the participation of one or
more broker-dealers. The Auction Agent will enter into agreements with Merrill
Lynch, Goldman, Sachs & Co., Lehman Special Securities Incorporated and
PaineWebber Incorporated and may enter into similar agreements (collectively,
the 'Broker-Dealer Agreements') with one or more of the broker-dealers
(collectively, the 'Broker-Dealers') selected by the Fund, which provide for the
participation of such Broker-Dealers in Auctions. Merrill Lynch is an affiliate
of the Investment Adviser in that they share a common parent, ML & Co. A
Broker-Dealer Agreement may be terminated by the Auction Agent or a
Broker-Dealer on five days' notice to the other party, provided that the
Broker-Dealer Agreement with Merrill Lynch may not be terminated without the
prior written consent of the Fund, which consent may not be unreasonably
withheld.
Securities Depository. The Depository Trust Company initially will act as
the Securities Depository for the Agent Members with respect to the shares of
AMPS of each series. One or more registered certificates for all of the shares
of AMPS initially will be registered in the name of Cede, as nominee of the
Securities Depository. The certificate will bear a legend to the effect that
such certificate is issued subject to the provisions restricting transfers of
shares of AMPS contained in the Articles Supplementary. Cede initially will be
the holder of record of all shares of AMPS, and Beneficial Owners will not be
entitled to receive certificates representing their ownership interest in such
shares. See Appendix C (Auction Procedures). The Securities Depository will
maintain lists of its participants and will maintain the positions (ownership
interests) of shares of AMPS held by
35
<PAGE>
each Agent Member, whether as the Beneficial Owner thereof for its own account
or as nominee for the Beneficial Owner thereof. Payments made by the Fund to
holders of AMPS will be duly made by making payments to the nominee of the
Securities Depository.
Auction Procedures. The following is a brief summary of the procedures to
be used in conducting Auctions. Separate auctions will be conducted for each
series of AMPS. Accordingly, as used in the following brief summary, unless the
context otherwise requires, 'AMPS' means the series of AMPS subject to the
related Auction and 'Beneficial Owners,' 'Potential Beneficial Owners,'
'Existing Holders' and 'Potential Holders' mean Beneficial Owners, Potential
Beneficial Owners, Existing Holders and Potential Holders of such series,
respectively. This summary is qualified by reference to the Auction procedures
set forth in Appendix C hereto. The Settlement Procedures to be used with
respect to Auctions are set forth in Appendix B hereto.
Auction Date; Advance Notice of Allocation of Taxable Income; Inclusion of
Taxable Income in Dividends. An Auction to determine the Applicable Rate for
each series of AMPS offered hereby for each Dividend Period (other than the
Initial Dividend Period therefor) will be held on the first Business Day (as
hereinafter defined) preceding the first day of such Dividend Period, which
first day is also the Dividend Payment Date for the preceding Dividend Period
(the date of each Auction being referred to herein as an 'Auction Date').
'Business Day' means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in The
City of New York are authorized or obligated by law to close. Auctions for
shares of Series A AMPS for Dividend Periods after the Initial Dividend Period
normally will be held every Wednesday after the preceding Dividend Payment Date,
and each subsequent Dividend Period normally will begin on the following
Thursday (also a Dividend Payment Date). The Auction Date and the first day of
the related Dividend Period (both of which must be Business Days) need not be
consecutive calendar days. For example, in most cases, if the Wednesday that
normally would be an Auction Date is not a Business Day, then such Auction Date
will be the preceding Tuesday and the first day of the related Dividend Period
will continue to be the following Thursday. See '--Dividends' for information
concerning the circumstances under which a Dividend Payment Date may fall on a
date other than the days specified above, which may affect the Auction Date.
Except as noted below, whenever the Fund intends to include any net capital
gains or other income subject to regular Federal income taxes in any dividend on
shares of AMPS, the Fund will notify the Auction Agent of the amount to be so
included at least five Business Days prior to the Auction Date on which the
Applicable Rate for such dividend is to be established. Whenever the Auction
Agent receives such notice from the Fund, in turn it will notify each
Broker-Dealer, who, on or prior to such Auction Date, in accordance with its
Broker-Dealer Agreement, will notify its customers who are Beneficial Owners and
Potential Beneficial Owners believed to be interested in submitting an Order in
the Auction to be held on such Auction Date. The Fund also may include such
income in a dividend on shares of AMPS without giving advance notice thereof if
it increases the dividend by an additional amount calculated as if such income
were a Retroactive Taxable Allocation and the additional amount were an
Additional Dividend; provided that the Fund will notify the Auction Agent of the
additional amounts to be included in such dividend at least five Business Days
prior to the applicable Dividend Payment Date. See '--Dividends--Additional
Dividends.'
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<PAGE>
Orders by Beneficial Owners, Potential Beneficial Owners, Existing Holders
and Potential Holders. On or prior to each Auction Date:
(a) each Beneficial Owner may submit to its Broker-Dealer by
telephone a:
(i) Hold Order--indicating the number of outstanding shares, if
any, of AMPS that such Beneficial Owner desires to continue to hold
without regard to the Applicable Rate for the next Dividend Period
for such shares;
(ii) Bid--indicating the number of outstanding shares, if any,
of AMPS that such Beneficial Owner desires to continue to hold,
provided that the Applicable Rate for the next Dividend Period for
such shares is not less than the rate per annum then specified by
such Beneficial Owner; and/or
(iii) Sell Order--indicating the number of outstanding shares,
if any, of AMPS that such Beneficial Owner offers to sell without
regard to the Applicable Rate for the next Dividend Period for such
shares; and
(b) Broker-Dealers will contact customers who are Potential Beneficial
Owners of shares of AMPS to determine whether such Potential Beneficial
Owners desire to submit Bids indicating the number of shares of AMPS which
they offer to purchase provided that the Applicable Rate for the next
Dividend Period for such shares is not less than the rates per annum
specified in such Bids.
The communication by a Beneficial Owner or Potential Beneficial Owner to a
Broker-Dealer and the communication by a Broker-Dealer, whether or not acting
for its own account, to the Auction Agent of the foregoing information is
hereinafter referred to as an 'Order' and collectively as 'Orders.' A Beneficial
Owner or a Potential Beneficial Owner placing an Order, including a
Broker-Dealer acting in such capacity for its own account, is hereinafter
referred to as a 'Bidder' and collectively as 'Bidders.' Any Order submitted by
a Beneficial Owner or a Potential Beneficial Owner to its Broker-Dealer, or by a
Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to shares of AMPS then held by such Beneficial Owner, as well as Bids
for additional shares of AMPS. For information concerning the priority given to
different types of Orders placed by Beneficial Owners, see 'Submission of Orders
by Broker-Dealers to Auction Agent' below.
The Maximum Applicable Rate for shares of AMPS will be the Applicable
Percentage of the Reference Rate. The Auction Agent will round each applicable
Maximum Applicable Rate to the nearest one-thousandth (0.001) of one percent per
annum, with any such number ending in five ten-thousandths of one percent being
rounded upwards to the nearest one-thousandth (0.001) of one percent. The
Auction Agent will not round the applicable Reference Rate as part of its
calculation of the Maximum Applicable Rate.
The Maximum Applicable Rate for shares of AMPS will depend on the credit
rating or ratings assigned to such shares. The Applicable Percentage will be
determined based on (i) the lower of the credit rating or ratings assigned on
such date to such shares by Moody's and S&P (or if Moody's or S&P or both shall
not make such rating available, the equivalent of either or both of such ratings
by a Substitute Rating Agency or two Substitute Rating Agencies or, in the event
that only one such rating shall be available, such rating) and (ii) whether the
Fund has provided notification to the Auction Agent prior to the Auction
establishing the Applicable Rate for any
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<PAGE>
dividend that net capital gains or other taxable income will be included in such
dividend on shares of AMPS as follows:
<TABLE>
<CAPTION>
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
CREDIT RATINGS REFERENCE REFERENCE
- -------------------------------------- RATE-- RATE--
MOODY'S S&P NO NOTIFICATION NOTIFICATION
- ------------------ ---------------- --------------- -------------
<S> <C> <C> <C>
'aa3' or higher AA- or higher 110% 150%
'a3' to 'a1' A- to A+ 125% 160%
'baa3' to 'baa1' BBB- to BBB+ 150% 250%
Below 'baa3' Below BBB- 200% 275%
</TABLE>
There is no minimum Applicable Rate in respect of any Dividend Period.
The Fund will take all reasonable action necessary to enable S&P and
Moody's to provide a rating for the AMPS. If either S&P or Moody's shall not
make such a rating available, or neither S&P nor Moody's shall make such a
rating available, Merrill Lynch or its affiliates and successors, after
consultation with the Fund, will select a nationally recognized statistical
rating organization (a 'Substitute Rating Agency') or two nationally recognized
statistical rating organizations ('Substitute Rating Agencies') to act as a
Substitute Rating Agency or Substitute Rating Agencies, as the case may be.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See 'Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate' and 'Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares.'
Neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to comply with the foregoing.
A Broker-Dealer also may hold AMPS in its own account as a Beneficial
Owner. A Broker-Dealer thus may submit Orders to the Auction Agent as a
Beneficial Owner or a Potential Beneficial Owner and therefore participate in an
Auction as an Existing Holder or Potential Holder on behalf of both itself and
its customers. Any Order placed with the Auction Agent by a Broker-Dealer as or
on behalf of a Beneficial Owner or a Potential Beneficial Owner will be treated
in the same manner as an Order placed with a Broker-Dealer by a Beneficial Owner
or a Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to
submit to the Auction Agent an Order in respect of any AMPS held by it or its
customers who are Beneficial Owners will be treated in the same manner as a
Beneficial Owner's failure to submit to its Broker-Dealer an Order in respect of
AMPS held by it, as described in the next paragraph. Inasmuch as a Broker-Dealer
participates in an Auction as an Existing Holder or a Potential Holder only to
represent the interests of a Beneficial Owner or Potential Beneficial Owner,
whether it be its customers or itself, all discussion herein relating to the
consequences of an Auction for Existing Holders and Potential Holders also
applies to the underlying beneficial ownership interests represented thereby.
For information concerning the priority given to different types of Orders
placed by Existing Holders, see 'Submission of Orders by Broker-Dealers to
Auction Agent.' Each purchase or sale in an Auction will be settled on the
Business Day next succeeding the Auction Date at a price per share equal to
$25,000. See 'Notification of Results; Settlement.'
If one or more Orders covering in the aggregate all of the outstanding
shares of AMPS held by a Beneficial Owner are not submitted to the Auction Agent
prior to the Submission Deadline, either because a Broker-Dealer
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<PAGE>
failed to contact such Beneficial Owner or otherwise, the Auction Agent shall
deem a Hold Order (in the case of an Auction relating to a Dividend Period which
is not a Special Dividend Period) and a Sell Order (in the case of an Auction
relating to a Special Dividend Period) to have been submitted on behalf of such
Beneficial Owner covering the number of outstanding shares of AMPS held by such
Beneficial Owner and not subject to Orders submitted to the Auction Agent.
If all of the outstanding shares of AMPS are subject to Submitted Hold
Orders, the Dividend Period next succeeding the Auction automatically shall be
the same length as the immediately preceding Dividend Period, and the Applicable
Rate for the next Dividend Period for all shares of AMPS will be 40% of the
Reference Rate on the date of the applicable Auction (or 60% of such rate if the
Fund has provided notification to the Auction Agent prior to the Auction
establishing the Applicable Rate for any dividend that net capital gains or
other taxable income will be included in such dividend on shares of AMPS).
For the purposes of an Auction, shares of AMPS for which the Fund shall
have given notice of redemption and deposited moneys therefor with the Auction
Agent in trust or segregated in an account at the Fund's custodian bank for the
benefit of the Auction Agent, as set forth under 'Description of
AMPS--Redemption,' will not be considered as outstanding and will not be
included in such Auction. Pursuant to the Articles Supplementary of the Fund,
the Fund will be prohibited from reissuing and its affiliates (other than
Merrill Lynch) will be prohibited from transferring (other than to the Fund) any
shares of AMPS they may acquire. Neither the Fund nor any affiliate of the Fund
(other than Merrill Lynch) may submit an Order in any Auction, except that an
affiliate of the Fund that is a Broker-Dealer may submit an Order.
Submission of Orders by Broker-Dealers to Auction Agent. Prior to 1:00
p.m., New York City time, on each Auction Date, or such other time on the
Auction Date as may be specified by the Auction Agent (the 'Submission
Deadline'), each Broker-Dealer will submit to the Auction Agent in writing all
Orders obtained by it for the Auction to be conducted on such Auction Date,
designating itself (unless otherwise permitted by the Fund) as the Existing
Holder or Potential Holder in respect of the shares of AMPS subject to such
Orders. Any Order submitted by a Beneficial Owner or a Potential Beneficial
Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to
the Submission Deadline on any Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three figures
to the right of the decimal point, the Auction Agent will round such rate per
annum up to the next highest one-thousandth (.001) of 1%.
If one or more Orders of an Existing Holder are submitted to the Auction
Agent and such Orders cover in the aggregate more than the number of outstanding
shares of AMPS held by such Existing Holder, such Orders will be considered
valid in the following order of priority:
(i) any Hold Order will be considered valid up to and including the
number of outstanding shares of AMPS held by such Existing Holder, provided
that if more than one Hold Order is submitted by such Existing Holder and
the number of shares of AMPS subject to such Hold Orders exceeds the number
of outstanding shares of AMPS held by such Existing Holder, the number of
shares of AMPS subject to each of such Hold Orders will be reduced pro rata
so that such Hold Orders, in the aggregate, will cover exactly the number
of outstanding shares of AMPS held by such Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of
their respective rates per annum if more than one Bid is submitted by such
Existing Holder, up to and including the excess of the number of
outstanding shares of AMPS held by such Existing Holder over the number of
outstanding shares of AMPS subject to any Hold Order referred to in clause
(i) above (and if more than one Bid submitted by such Existing Holder
specifies the same rate per annum and together they cover more than the
remaining number
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<PAGE>
of shares that can be the subject of valid Bids after application of clause
(i) above and of the foregoing portion of this clause (ii) to any Bid or
Bids specifying a lower rate or rates per annum, the number of shares
subject to each of such Bids will be reduced pro rata so that such Bids, in
the aggregate, cover exactly such remaining number of outstanding shares);
and the number of outstanding shares, if any, subject to Bids not valid
under this clause (ii) shall be treated as the subject of a Bid by a
Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the
excess of the number of outstanding shares of AMPS held by such Existing
Holder over the sum of the number of shares of AMPS subject to Hold Orders
referred to in clause (i) above and the number of shares of AMPS subject to
valid Bids by such Existing Holder referred to in clause (ii) above;
provided that, if more than one Sell Order is submitted by any Existing
Holder and the number of shares of AMPS subject to such Sell Orders is
greater than such excess, the number of shares of AMPS subject to each of
such Sell Orders will be reduced pro rata so that such Sell Orders, in the
aggregate, will cover exactly the number of shares of AMPS equal to such
excess.
If more than one Bid of any Potential Holder is submitted in any Auction,
each Bid submitted in such Auction will be considered a separate Bid with the
rate per annum and number of shares of AMPS specified.
Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable
Rate. Not earlier than the Submission Deadline for each Auction, the Auction
Agent will assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such 'Hold Order', 'Bid' or 'Sell Order' as submitted or
deemed submitted by a Broker-Dealer hereinafter being referred to as a
'Submitted Hold Order', a 'Submitted Bid' or a 'Submitted Sell Order', as the
case may be, or as a 'Submitted Order') and will determine the excess of the
number of outstanding shares of AMPS over the number of outstanding shares of
AMPS subject to Submitted Hold Orders (such excess being referred to as the
'Available AMPS') and whether Sufficient Clearing Bids have been made in such
Auction. Sufficient Clearing Bids will have been made if the number of
outstanding shares of AMPS that are the subject of Submitted Bids of Potential
Holders with rates per annum not higher than the Maximum Applicable Rate equals
or exceeds the number of outstanding shares that are the subject of Submitted
Sell Orders (including the number of shares subject to Bids of Existing Holders
specifying rates per annum higher than the Maximum Applicable Rate).
If Sufficient Clearing Bids have been made, the Auction Agent will
determine the lowest rate per annum specified in the Submitted Bids (the
'Winning Bid Rate') which would result in the number of shares subject to
Submitted Bids specifying such rate per annum or a lower rate per annum being at
least equal to the Available AMPS. If Sufficient Clearing Bids have been made,
the Winning Bid Rate will be the Applicable Rate for the next Dividend Period
for all shares of AMPS then outstanding.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders), the
Dividend Period next following the Auction automatically will be a 7-Day
Dividend Period in the case of Series A AMPS, and the Applicable Rate for such
Dividend Period will be equal to the Maximum Applicable Rate. If Sufficient
Clearing Bids have not been made, Beneficial Owners that have Submitted Sell
Orders will not be able to sell in the Auction all, and may not be able to sell
any, shares of AMPS subject to such Submitted Sell Orders. See 'Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares.'
Thus, under some circumstances, Beneficial Owners may not have liquidity of
investment.
Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares. Based on the determinations described under 'Determination
of Sufficient Clearing Bids, Winning Bid Rate and Applicable Rate' and subject
to the discretion of the Auction Agent to round as described below, Submitted
Bids
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<PAGE>
and Submitted Sell Orders will be accepted or rejected in the order of priority
set forth in the Auction Procedures with the result that Existing Holders and
Potential Holders of AMPS will sell, continue to hold and/or purchase shares of
AMPS as set forth below. Existing Holders that submit or are deemed to have
submitted Hold Orders will continue to hold the shares of AMPS subject to such
Hold Orders.
If Sufficient Clearing Bids have been made:
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Winning Bid Rate or a Submitted Sell Order will
sell the outstanding shares of AMPS subject to such Submitted Bid or
Submitted Sell Order;
(b) each Existing Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bid;
(c) each Potential Holder that placed a Submitted Bid specifying a
rate per annum lower than the Winning Bid Rate will purchase the number of
shares of AMPS subject to such Submitted Bid;
(d) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bids, unless the
number of outstanding shares of AMPS subject to all such Submitted Bids of
Existing Holders is greater than the excess of the Available AMPS over the
number of shares of AMPS accounted for in clauses (b) and (c) above, in
which event each Existing Holder with such a Submitted Bid will sell a
number of outstanding shares of AMPS determined on a pro rata basis based
on the number of outstanding shares of AMPS subject to all such Submitted
Bids of such Existing Holders; and
(e) each Potential Holder that placed a Submitted Bid specifying a
rate per annum equal to the Winning Bid Rate will purchase any Available
AMPS not accounted for in clause (b), (c) or (d) above on a pro rata basis
based on the shares of AMPS subject to all such Submitted Bids of Potential
Holders.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders):
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will continue
to hold the outstanding shares of AMPS subject to such Submitted Bid;
(b) each Potential Holder that placed a Submitted Bid specifying a
rate per annum equal to or lower than the Maximum Applicable Rate will
purchase the number of shares of AMPS subject to such Submitted Bid; and
(c) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Maximum Applicable Rate or a Submitted Sell Order
will sell a number of outstanding shares of AMPS determined on a pro rata
basis based on the outstanding shares of AMPS subject to all such Submitted
Bids and Submitted Sell Orders.
If as a result of the Auction Procedures described above any Existing
Holder would be entitled or required to sell, or any Potential Holder would be
entitled or required to purchase, a fraction of a share of AMPS, the Auction
Agent, in such manner as, in its sole discretion, it shall determine, will round
up or down the number of shares of AMPS being sold or purchased on such Auction
Date so that each share sold or purchased by each Existing Holder or Potential
Holder will be a whole share of AMPS. If any Potential Holder would be entitled
or required to purchase less than a whole share of AMPS, the Auction Agent, in
such manner as, in its sole
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discretion, it shall determine, will allocate shares of AMPS for purchase among
Potential Holders so that only whole shares of AMPS are purchased by any such
Potential Holder, even if such allocation results in one or more of such
Potential Holders not purchasing any shares of AMPS.
Notification of Results; Settlement. The Auction Agent will advise each
Broker-Dealer who submitted a Bid or Sell Order in an Auction whether such Bid
or Sell Order was accepted or rejected in whole or in part and of the Applicable
Rate for the next Dividend Period for the related shares of AMPS by telephone at
approximately 3:00 p.m., New York City time, on the Auction Date for such
Auction. Each such Broker-Dealer that submitted an Order for the account of a
customer then will advise such customer whether such Bid or Sell Order was
accepted or rejected, will confirm purchases and sales with each customer
purchasing or selling shares of AMPS as a result of the Auction and will advise
each customer purchasing or selling shares of AMPS to give instructions to its
Agent Member of the Securities Depository to pay the purchase price against
delivery of such shares or to deliver such shares against payment therefor as
appropriate. If a customer selling shares of AMPS as a result of an Auction
shall fail to instruct its Agent Member to deliver such shares, the
Broker-Dealer that submitted such customer's Bid or Sell Order will instruct
such Agent Member to deliver such shares against payment therefor. Each
Broker-Dealer that submitted a Hold Order in an Auction on behalf of a customer
also will advise such customer of the Applicable Rate for the next Dividend
Period for the AMPS. The Auction Agent will record each transfer of shares of
AMPS on the record book of Existing Holders to be maintained by the Auction
Agent.
In accordance with the Securities Depository's normal procedures, on the
day after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of shares of AMPS as determined in such
Auction. Purchasers will make payment through their Agent Members in same-day
funds to the Securities Depository against delivery through their Agent Members;
the Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to AMPS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for shares of AMPS are not held by the
Securities Depository or its nominee, payment will be made in same-day funds to
the Auction Agent against delivery of such certificates.
If any Existing Holder selling shares of AMPS in an Auction fails to
deliver such shares, the Broker-Dealer of any person that was to have purchased
shares of AMPS in such Auction may deliver to such person a number of whole
shares of AMPS that is less than the number of shares that otherwise was to be
purchased by such person. In such event, the number of shares of AMPS to be so
delivered will be determined by such Broker-Dealer. Delivery of such lesser
number of shares will constitute good delivery. Each Broker-Dealer Agreement
also will provide that neither the Fund nor the Auction Agent will have
responsibility or liability with respect to the failure of a Potential
Beneficial Owner, Beneficial Owner or their respective Agent Members to deliver
shares of AMPS or to pay for shares of AMPS purchased or sold pursuant to an
Auction or otherwise.
BROKER-DEALERS
The Auction Agent after each Auction will pay a service charge from funds
provided by the Fund to each Broker-Dealer on the basis of the purchase price of
shares of AMPS placed by such Broker-Dealer at such Auction. The service charge
(i) for any 7-Day Dividend Period or 28-Day Dividend Period shall be payable at
the annual rate of 0.25% of the purchase price of the shares of AMPS placed by
such Broker-Dealer in any such Auction and (ii) for any Special Dividend Period
shall be determined by mutual consent of the Fund and any such Broker-Dealer or
Broker-Dealers and shall be based upon a selling concession that would be
applicable to an
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underwriting of fixed or variable rate preferred shares with a similar final
maturity or variable rate dividend period, respectively, at the commencement of
the Dividend Period with respect to such Auction (generally expected to be in
the 0.25% to 1.00% range). For the purposes of the preceding sentence, shares of
AMPS will be placed by a Broker-Dealer if such shares were (i) the subject of
Hold Orders deemed to have been made by Beneficial Owners that were acquired by
such Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a Submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold such
shares as a result of the Auction, (B) a Submitted Bid of a Potential Beneficial
Owner that resulted in such Potential Beneficial Owner purchasing such shares as
a result of the Auction or (C) a Submitted Hold Order.
The Broker-Dealer Agreements provide that a Broker-Dealer may submit Orders
in Auctions for its own account, unless the Fund notifies all Broker-Dealers
that they no longer may do so; provided that Broker-Dealers may continue to
submit Hold Orders and Sell Orders. If a Broker-Dealer submits an Order for its
own account in any Auction of any series of AMPS, it may have knowledge of
Orders placed through it in that Auction and therefore have an advantage over
other Bidders, but such Broker-Dealer would not have knowledge of Orders
submitted by other Broker-Dealers in that Auction.
The Broker-Dealers intend to maintain a secondary trading market in the
AMPS outside of Auctions; however, they have no obligation to do so and there
can be no assurance that a secondary market for the AMPS will develop or, if it
does develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The AMPS will not be registered on any stock exchange or
on the National Association of Securities Dealers Automated Quotation system. An
increase in the level of interest rates likely will have an adverse effect on
the secondary market price of the AMPS, and a selling shareholder may sell AMPS
between Auctions at a price per share of less than $25,000.
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 service
fees by the Fund aggregating $48,107 and $100,708, respectively, as a
Broker-Dealer.
DIVIDENDS
General. The holders of shares of each series of AMPS will be entitled to
receive, when, as and if declared by the Board of Directors of the Fund, out of
funds legally available therefor, cumulative cash dividends on their shares, at
the Applicable Rate determined as set forth below under 'Determination of
Dividend Rate', payable on the respective dates set forth below. Dividends on
the shares of AMPS so declared and payable shall be paid (i) in preference to
and in priority over any dividends so declared and payable on the Common Stock,
and (ii) to the extent permitted under the Code and to the extent available, out
of net tax-exempt income earned on the Fund's investments. Dividends on shares
of AMPS, to the extent that they are derived from Municipal Bonds, will be
exempt from Federal income taxes, subject to possible application of the
alternative minimum tax. See 'Taxes.'
Each Dividend Period for the Series A AMPS will generally be a 7-Day
Dividend Period. The Fund may create additional series of AMPS in the future
whose Dividend Periods may generally consist of either seven days or 28 days (a
'28-Day Dividend Period').
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Dividends on the shares of AMPS will accumulate from the date on which the
Fund originally issues the shares of AMPS (the 'Date of Original Issue') and
will be payable on the dates described below. Dividends on shares of each series
of AMPS with respect to the Initial Dividend Period shall be payable on the
Initial Dividend Payment Date with respect to each series of AMPS. Following the
Initial Dividend Payment Date for each series of AMPS, dividends on each series
of AMPS will be payable, at the option of the Fund, either (i) with respect to
any 7-Day Dividend Period, any 28-Day Dividend Period and any Short Term
Dividend Period of 35 or fewer days, on the day next succeeding the last day
thereof or (ii) with respect to any Short Term Dividend Period of more than 35
days and with respect to any Long Term Dividend Period, monthly on the first
Business Day of each calendar month during such Short Term Dividend Period or
Long Term Dividend Period and on the day next succeeding the last day thereof
(each such date referred to in clause (i) or (ii) being referred to herein as a
'Normal Dividend Payment Date'), except that if such Normal Dividend Payment
Date is not a Business Day, (i) the Dividend Payment Date shall be the first
Business Day next succeeding such Normal Dividend Payment Date if such Normal
Dividend Payment Date is a Monday, Tuesday, Wednesday or Thursday, or (ii) the
Dividend Payment Date shall be the first Business Day next preceding such Normal
Dividend Payment Date if such Normal Dividend Payment Date is a Friday.
Dividends generally will be payable (in the case of Dividend Periods which are
not Special Dividend Periods) on each succeeding Thursday in the case of Series
A AMPS. Although any particular Dividend Payment Date may not occur on the
originally scheduled date because of the exceptions discussed above, the next
succeeding Dividend Payment Date, subject to such exceptions, will occur on the
next following originally scheduled date. If for any reason a Dividend Payment
Date cannot be fixed as described above, then the Board of Directors or a duly
authorized committee thereof shall fix the Dividend Payment Date. The Initial
Dividend Period, 7-Day Dividend Periods, 28-Day Dividend Periods and Special
Dividend Periods are hereinafter sometimes referred to as 'Dividend Periods'.
Each dividend payment date determined as provided above is hereinafter referred
to as a 'Dividend Payment Date.'
Prior to each Dividend Payment Date, the Fund is required to deposit with
the Auction Agent sufficient funds for the payment of declared dividends. The
Fund does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the AMPS, which holder
is expected to be the nominee of the Securities Depository. See '--The
Auction--Securities Depository.' The Securities Depository will credit the
accounts of the Agent Members of the Existing Holders in accordance with the
Securities Depository's normal procedures which provide for payment in same-day
funds. The Agent Member of an Existing Holder will be responsible for holding or
disbursing such payments on the applicable Dividend Payment Date to such
Existing Holder in accordance with the instructions of such Existing Holder.
Dividends in arrears for any past Dividend Period may be declared and paid at
any time, without reference to any regular Dividend Payment Date, to the nominee
of the Securities Depository. Any dividend payment made on shares of AMPS first
shall be credited against the earliest declared but unpaid dividends accumulated
with respect to such series.
Holders of shares of AMPS will not be entitled to any dividends, whether
payable in cash, property or stock, in excess of full cumulative dividends
except as described under 'Additional Dividends' and 'Non-Payment Period; Late
Charge' below. No interest will be payable in respect of any dividend payment or
payments on the shares of AMPS which may be in arrears.
The amount of cash dividends per share of any series of AMPS payable (if
declared) on the Initial Dividend Payment Date, each 7-Day Dividend Period, each
28-Day Dividend Period and each Short Term Dividend Period shall be computed by
multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be the number of days in such Dividend Period or part
thereof that such share was outstanding and for which dividends are payable on
such Dividend Payment Date and the denominator of which will be 365,
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multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent. During any Long Term Dividend Period, the amount
of cash dividends per share of AMPS payable (if declared) on any Dividend
Payment Date shall be computed by multiplying the Applicable Rate for such
Dividend Period by a fraction, the numerator of which will be such number of
days in such part of such Dividend Period that such share was outstanding and
for which dividends are payable on such Dividend Payment Date and the
denominator of which will be 360, multiplying the amount so obtained by $25,000,
and rounding the amount so obtained to the nearest cent.
Notification of Dividend Period. With respect to each Dividend Period that
is a Special Dividend Period, the Fund, at its sole option and to the extent
permitted by law, by telephonic and written notice (a 'Request for Special
Dividend Period') to the Auction Agent and to each Broker-Dealer, may request
that the next succeeding Dividend Period for the shares of AMPS will be a number
of days (other than seven in the case of Series A AMPS), evenly divisible by
seven, and not fewer than seven nor more than 364 in the case of a Short Term
Dividend Period or one whole year or more but not greater than five years in the
case of a Long Term Dividend Period, specified in such notice, provided that the
Fund may not give a Request for Special Dividend Period (and any such request
shall be null and void) unless, for any Auction occurring after the initial
Auction, Sufficient Clearing Bids were made in the last occurring Auction and
unless full cumulative dividends, any amounts due with respect to redemptions,
and any Additional Dividends payable prior to such date have been paid in full.
Such Request for Special Dividend Period, in the case of a Short Term Dividend
Period, shall be given on or prior to the second Business Day but not more than
seven Business Days prior to an Auction Date for the AMPS and, in the case of a
Long Term Dividend Period, shall be given on or prior to the second Business Day
but not more than 28 days prior to an Auction Date for the AMPS. Upon receiving
such Request for Special Dividend Period, the Broker-Dealers jointly shall
determine whether given the factors set forth below it is advisable that the
Fund issue a Notice of Special Dividend Period for a series of AMPS as
contemplated by such Request for Special Dividend Period and the Optional
Redemption Price of the AMPS during such Special Dividend Period and the
Specific Redemption Provisions and shall give the Fund and the Auction Agent
written notice (a 'Response') of such determination by no later than the second
Business Day prior to such Auction Date. In making such determination the
Broker-Dealers will consider (i) existing short-term and long-term market rates
and indices of such short-term and long-term rates, (ii) existing market supply
and demand for short-term and long-term securities, (iii) existing yield curves
for short-term and long-term securities comparable to the AMPS, (iv) industry
and financial conditions which may affect the AMPS, (v) the investment objective
of the Fund and (vi) the Dividend Periods and dividend rates at which current
and potential beneficial holders of the AMPS would remain or become beneficial
holders. If the Broker-Dealers shall not give the Fund and the Auction Agent a
Response by such second Business Day or if the Response states that given the
factors set forth above it is not advisable that the Fund give a Notice of
Special Dividend Period for the AMPS, the Fund may not give a Notice of Special
Dividend Period in respect of such Request for Special Dividend Period. In the
event the Response indicates that it is advisable that the Fund give a Notice of
Special Dividend Period for the AMPS, the Fund, by no later than the second
Business Day prior to such Auction Date, may give a notice (a 'Notice of Special
Dividend Period') to the Auction Agent, the Securities Depository and each
Broker-Dealer, which notice will specify (i) the duration of the Special
Dividend Period, (ii) the Optional Redemption Price as specified in the related
Response and (iii) the Specific Redemption Provisions, if any, as specified in
the related Response. The Fund also shall provide a copy of such Notice of
Special Dividend Period to Moody's and S&P. The Fund shall not give a Notice of
Special Dividend Period, and, if such Notice of Special Dividend Period shall
have been given already, shall give telephonic and written notice of its
revocation (a 'Notice of Revocation') to the Auction Agent, each Broker-Dealer,
and the Securities Depository on or prior to the Business Day prior to the
relevant Auction Date if (x) either the 1940 Act AMPS Asset Coverage is not
satisfied or the Fund shall fail to
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maintain S&P Eligible Assets and Moody's Eligible Assets each with an aggregate
Discounted Value at least equal to the AMPS Basic Maintenance Amount, in each
case on each of the two Valuation Dates immediately preceding the Business Day
prior to the relevant Auction Date on an actual basis and on a pro forma basis
giving effect to the proposed Special Dividend Period (using as a pro forma
dividend rate with respect to such Special Dividend Period the dividend rate
which the Broker-Dealers shall advise the Fund is an approximately equal rate
for securities similar to the AMPS with an equal dividend period), provided
that, in calculating the aggregate Discounted Value of Moody's Eligible Assets
for this purpose, the Moody's Exposure Period shall be deemed to be one week
longer, (y) sufficient funds for the payment of dividends payable on the
immediately succeeding Dividend Payment Date have not been irrevocably deposited
with the Auction Agent by the close of business on the third Business Day
preceding the related Auction Date or (z) the Broker-Dealers jointly advise the
Fund that after consideration of the factors listed above they have concluded
that it is advisable to give a Notice of Revocation. The Fund also shall provide
a copy of such Notice of Revocation to Moody's and S&P. If the Fund is
prohibited from giving a Notice of Special Dividend Period as a result of the
factors enumerated in clause (x), (y) or (z) above or if the Fund gives a Notice
of Revocation with respect to a Notice of Special Dividend Period, the next
succeeding Dividend Period will be a 7-Day Dividend Period in the case of Series
A AMPS. In addition, in the event Sufficient Clearing Bids are not made in any
Auction or an Auction is not held for any reason, the next succeeding Dividend
Period will be a 7-Day Dividend Period in the case of Series A AMPS, and the
Fund may not again give a Notice of Special Dividend Period (and any such
attempted notice shall be null and void) until Sufficient Clearing Bids have
been made in an Auction with respect to a 7-Day Dividend Period in the case of
Series A AMPS.
Determination of Dividend Rate. The dividend rate on shares of each series
of AMPS during the period from and including the first Date of Original Issue
for each series of AMPS to but excluding the Initial Dividend Payment Date (the
'Initial Dividend Period') will be a rate per annum determined by the Board of
Directors of the Fund. Commencing on the first Initial Dividend Payment Date for
each series of AMPS, the Applicable Rate on the shares of such series of AMPS
for each Subsequent Dividend Period, which Subsequent Dividend Period shall be a
period commencing on and including a Dividend Payment Date and ending on and
including the calendar day prior to the next Dividend Payment Date (or last
Dividend Payment Date in a Dividend Period if there is more than one Dividend
Payment Date), shall be equal to the rate per annum that results from the
Auction with respect to such Subsequent Dividend Period. The Initial Dividend
Period and Subsequent Dividend Period for each series of AMPS
is referred to herein as a 'Dividend Period.' Cash dividends shall
be calculated as set forth above under 'Dividends--General.'
Non-Payment Period; Late Charge. A Non-Payment Period will commence if the
Fund fails to (i) declare, prior to the close of business on the second Business
Day preceding any Dividend Payment Date, for payment on or (to the extent
permitted as described below) within three Business Days after such Dividend
Payment Date to the persons who held such shares as of 12:00 noon, New York City
time, on the Business Day preceding such Dividend Payment Date, the full amount
of any dividend on shares of AMPS payable on such Dividend Payment Date or (ii)
deposit, irrevocably in trust, in same-day funds, with the Auction Agent by
12:00 noon, New York City time, (A) on such Dividend Payment Date the full
amount of any cash dividend on such shares (if declared) payable on such
Dividend Payment Date or (B) on any redemption date for shares of AMPS called
for redemption, the Mandatory Redemption Price per share of such AMPS or, in the
case of an optional redemption, the Optional Redemption Price per share. Such
Non-Payment Period will consist of the period commencing on and including the
aforementioned Dividend Payment Date or redemption date, as the case may be, and
ending on and including the Business Day on which, by 12:00 noon, New York City
time, all unpaid cash dividends and unpaid redemption prices shall have been so
deposited or otherwise shall have been made available to the applicable holders
in same day funds, provided that a Non-Payment Period for any series of AMPS
will not end
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unless the Fund shall have given at least five days' but no more than 30 days'
written notice of such deposit or availability to the Auction Agent, the
Securities Depository and all holders of shares of AMPS of such series.
Notwithstanding the foregoing, the failure by the Fund to deposit funds as
provided for by clauses (ii) (A) or (ii) (B) above within three Business Days
after any Dividend Payment Date or redemption date, as the case may be, in each
case to the extent contemplated below, shall not constitute a 'Non-Payment
Period.' The Applicable Rate for each Dividend Period for shares of AMPS of any
series, commencing during a Non-Payment Period, will be equal to the Non-Payment
Period Rate; and each Dividend Period commencing after the first day of, and
during, a Non-Payment Period shall be a 7-Day Dividend Period in the case of
Series A AMPS. Any dividend on shares of AMPS due on any Dividend Payment Date
for such shares (if, prior to the close of business on the second Business Day
preceding such Dividend Payment Date, the Fund has declared such dividend
payable on such Dividend Payment Date to the persons who held such shares as of
12:00 noon, New York City time, on the Business Day preceding such Dividend
Payment Date) or redemption price with respect to such shares not paid to such
persons when due may be paid to such persons in the same form of funds by 12:00
noon, New York City time, on any of the first three Business Days after such
Dividend Payment Date or due date, as the case may be, provided that such amount
is accompanied by a late charge calculated for such period of non-payment at the
Non-Payment Period Rate applied to the amount of such non-payment based on the
actual number of days comprising such period divided by 365. In the case of a
willful failure of the Fund to pay a dividend on a Dividend Payment Date or to
redeem any shares of AMPS on the date set for such redemption, the preceding
sentence shall not apply and the Applicable Rate for the Dividend Period
commencing during the Non-Payment Period resulting from such failure shall be
the Non-Payment Period Rate. For the purposes of the foregoing, payment to a
person in same-day funds on any Business Day at any time will be considered
equivalent to payment to that person in New York Clearing House (next-day) funds
at the same time on the preceding Business Day, and any payment made after 12:00
noon, New York City time, on any Business Day shall be considered to have been
made instead in the same form of funds and to the same person before 12:00 noon,
New York City time, on the next Business Day. The Non-Payment Period Rate
initially will be 200% of the applicable Reference Rate (or 275% of such rate if
the Fund has provided notification to the Auction Agent prior to the Auction
establishing the Applicable Rate for any dividend that net capital gains or
other taxable income will be included in such dividend on shares of AMPS),
provided that the Board of Directors of the Fund shall have the authority to
adjust, modify, alter or change from time to time the initial Non-Payment Period
Rate if the Board of Directors of the Fund determines and Moody's and S&P (and
any Substitute Rating Agency in lieu of Moody's or S&P in the event either of
such parties shall not rate the AMPS) advise the Fund in writing that such
adjustment, modification, alteration or change will not adversely affect their
then-current ratings on the AMPS.
Restrictions on Dividends and Other Payments. Under the 1940 Act, the Fund
may not declare dividends or make other distributions on shares of Common Stock
or purchase any such shares if, at the time of the declaration, distribution or
purchase, as applicable (and after giving effect thereto), asset coverage (as
defined in the 1940 Act) with respect to the outstanding shares of AMPS would be
less than 200% (or such other percentage as in the future may be required by
law). The Fund estimates that, based on the composition of its portfolio at
October 31, 1997, asset coverage with respect to shares of Series A AMPS issued
and outstanding on that date was approximately 311%. As of the date of this
Prospectus, asset coverage with respect to shares of Series A AMPS issued and
outstanding is approximately 307%. Under the Code, the Fund, among other things,
must distribute at least 90% of its investment company taxable income each year
in order to maintain its qualification for tax treatment as a regulated
investment company. The foregoing limitations on dividends, distributions and
purchases under certain circumstances may impair the Fund's ability to maintain
such qualification. See 'Taxes.'
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Upon any failure to pay dividends on shares of AMPS for two years or more,
the holders of the shares of AMPS will acquire certain additional voting rights.
See 'Voting Rights' below. Such rights shall be the exclusive remedy of the
holders of shares of AMPS upon any failure to pay dividends on shares of the
Fund.
For so long as any shares of AMPS are outstanding, the Fund will not
declare, pay or set apart for payment any dividend or other distribution (other
than a dividend or distribution paid in shares of, or options, warrants or
rights to subscribe for or purchase, Common Stock or other stock, if any,
ranking junior to shares of AMPS as to dividends or upon liquidation) in respect
of Common Stock or any other stock of the Fund ranking junior to or on a parity
with shares of AMPS as to dividends or upon liquidation, or call for redemption,
redeem, purchase or otherwise acquire for consideration any shares of Common
Stock or any other such junior stock (except by conversion into or exchange for
stock of the Fund ranking junior to AMPS as to dividends and upon liquidation)
or any such parity stock (except by conversion into or exchange for stock of the
Fund ranking junior to or on a parity with AMPS as to dividends and upon
liquidation), unless (A) immediately after such transaction, the Fund would have
S&P Eligible Assets and Moody's Eligible Assets each with an aggregate
Discounted Value equal to or greater than the AMPS Basic Maintenance Amount, and
the 1940 Act AMPS Asset Coverage (see 'Asset Maintenance' and 'Redemption'
below) would be satisfied, (B) full cumulative dividends on shares of AMPS due
on or prior to the date of the transaction have been declared and paid or shall
have been declared and sufficient funds for the payment thereof deposited with
the Auction Agent, (C) any Additional Dividend required to be paid on or before
the date of such declaration or payment has been paid and (D) the Fund has
redeemed the full number of shares of AMPS required to be redeemed by any
provision for mandatory redemption contained in the Articles Supplementary.
Additional Dividends. If the Fund retroactively allocates any net capital
gains or other income subject to regular Federal income taxes to shares of AMPS
without having given advance notice thereof to the Auction Agent as described
above under 'The Auction--Auction Date; Advance Notice of Allocation of Taxable
Income; Inclusion of Taxable Income in Dividends', which may only happen when
such allocation is made as a result of the redemption of all or a portion of the
outstanding shares of AMPS or the liquidation of the Fund (the amount of such
allocation referred to herein as a 'Retroactive Taxable Allocation'), the Fund,
within 90 days (and generally within 60 days) after the end of the Fund's fiscal
year for which a Retroactive Taxable Allocation is made, will provide notice
thereof to the Auction Agent and to each holder of shares (initially Cede as
nominee of the Securities Depository) during such fiscal year at such holder's
address as the same appears or last appeared on the stock books of the Fund. The
Fund, within 30 days after such notice is given to the Auction Agent, will pay
to the Auction Agent (who then will distribute to such holders of shares of
AMPS), out of funds legally available therefor, an amount equal to the aggregate
Additional Dividend (as defined below) with respect to all Retroactive Taxable
Allocations made to such holders during the fiscal year in question. See
'Taxes.'
An 'Additional Dividend' means payment to a present or former holder of
shares of AMPS of an amount which, when taken together with the aggregate amount
of Retroactive Taxable Allocations made to such holder with respect to the
fiscal year in question, would cause such holder's dividends in dollars (after
Federal income tax consequences) from the aggregate of both the Retroactive
Taxable Allocations and the Additional Dividend to be equal to the dollar amount
of the dividends which would have been received by such holder if the amount of
the aggregate Retroactive Taxable Allocations had been excludable from the gross
income of such holder. Such Additional Dividend shall be calculated (i) without
consideration being given to the time value of money; (ii) assuming that no
holder of shares of AMPS is subject to the Federal alternative minimum tax with
respect to dividends received from the Fund; and (iii) assuming that each
Retroactive Taxable Allocation would be taxable in the hands of each holder of
shares of AMPS at the greater of: (a) the maximum marginal regular Federal
individual income tax rate applicable
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<PAGE>
to ordinary income or capital gains depending on the taxable character of the
distribution (including any surtax); or (b) the maximum regular Federal
corporate income tax rate applicable to ordinary income or capital gains
depending on the taxable character of the distribution (disregarding in both (a)
and (b) the effect of any state or local taxes and the phase out of, or
provision limiting, personal exemptions, itemized deductions, or the benefit of
lower tax brackets). Although the Fund generally intends to designate any
Additional Dividend as an exempt-interest dividend to the extent permitted by
applicable law, it is possible that all or a portion of any Additional Dividend
will be taxable to the recipient thereof. See 'Taxes--Tax Treatment of
Additional Dividends.' The Fund will not pay a further Additional Dividend with
respect to any taxable portion of an Additional Dividend.
If the Fund does not give advance notice of the amount of taxable income to
be included in a dividend on shares of AMPS in the related Auction, as described
above under 'The Auction--Auction Date; Advance Notice of Allocation of Taxable
Income; Inclusion of Taxable Income in Dividends,' the Fund may include such
taxable income in a dividend on shares of AMPS if it increases the dividend by
an additional amount calculated as if such income were a Retroactive Taxable
Allocation and the additional amount were an Additional Dividend.
ASSET MAINTENANCE
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Articles Supplementary. These requirements
are summarized below.
1940 Act AMPS Asset Coverage. The Fund will be required under the Articles
Supplementary to maintain, with respect to shares of AMPS, as of the last
Business Day of each month in which any shares of AMPS are outstanding, asset
coverage of at least 200% with respect to senior securities which are stock,
including the shares of AMPS (or such other asset coverage as in the future may
be specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are stock of a closed-end investment company as a condition of
paying dividends on its common stock) ('1940 Act AMPS Asset Coverage'). If the
Fund fails to maintain 1940 Act AMPS Asset Coverage and such failure is not
cured as of the last Business Day of the following month (the '1940 Act Cure
Date'), the Fund will be required under certain circumstances to redeem certain
of the shares of AMPS. See 'Redemption' below.
As of October 31, 1997, the 1940 Act AMPS Asset Coverage was as follows:
<TABLE>
<S> <C> <C> <C> <C>
Value of Fund assets less
liabilities not constituting
senior securities $149,462,819
- ---------------------------- = ------------ = 311%
Senior securities $ 48,009,600
representing indebtedness
plus liquidation value
of the shares of AMPS
</TABLE>
As of the date of this Prospectus, the 1940 Act AMPS Asset Coverage is
approximately 307%.
AMPS Basic Maintenance Amount. So long as shares of AMPS are outstanding,
the Fund will be required under the Articles Supplementary to maintain as of
each Business Day (a 'Valuation Date') S&P Eligible Assets and Moody's Eligible
Assets each having in the aggregate a Discounted Value at least equal to the
AMPS Basic Maintenance Amount. If the Fund fails to meet such requirement as of
any Valuation Date and such failure is not cured on or before the sixth Business
Day after such Valuation Date (the 'AMPS Basic Maintenance Cure Date'), the Fund
will be required under certain circumstances to redeem certain of the shares of
AMPS. Upon any failure to maintain the required Discounted Value, the Fund will
use its best efforts to alter the composition
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<PAGE>
of its portfolio to reattain a Discounted Value at least equal to the AMPS Basic
Maintenance Amount on or prior to the AMPS Basic Maintenance Cure Date. See
'Redemption'.
The AMPS Basic Maintenance Amount as of any Valuation Date is defined as
the dollar amount equal to (i) the sum of (A) the product of the number of
shares of AMPS outstanding on such Valuation Date multiplied by the sum of
$25,000 and any applicable redemption premium attributable to the designation of
a Premium Call Period; (B) the aggregate amount of cash dividends (whether or
not earned or declared) that will have accumulated for each share of AMPS
outstanding to (but not including) the end of the current Dividend Period that
follows such Valuation Date in the event the then current Dividend Period will
end within 49 calendar days of such Valuation Date or through the 49th day after
such Valuation Date in the event the then current Dividend Period will not end
within 49 calendar days of such Valuation Date; (C) in the event the then
current Dividend Period will end within 49 calendar days of such Valuation Date,
the aggregate amount of cash dividends that would accumulate at the Maximum
Applicable Rate applicable to a Dividend Period of 28 or fewer days on any
shares of AMPS outstanding from the end of such Dividend Period through the 49th
day after such Valuation Date, multiplied by the larger of the Moody's
Volatility Factor and the S&P Volatility Factor determined from time to time by
Moody's and S&P, respectively (except that if such Valuation Date occurs during
a Non-Payment Period, the cash dividend for purposes of calculation would
accumulate at the then current Non-Payment Period Rate); (D) the amount of
anticipated Fund expenses for the 90 days subsequent to such Valuation Date; (E)
the amount of the Fund's Maximum Potential Additional Dividend Liability as of
such Valuation Date; (F) any amounts payable for shares of Common Stock accepted
for repurchase at their net asset value pursuant to tender offers by the Fund;
and (G) any current liabilities as of such Valuation Date to the extent not
reflected in any of (i) (A) through (i) (F) (including, without limitation, and
immediately upon determination, any amounts due and payable by the Fund pursuant
to repurchase agreements, and any amounts payable for Municipal Bonds purchased
as of such Valuation Date) less (ii) either (A) the Discounted Value of any Fund
assets, or (B) the face value of any of the Fund's assets if such assets mature
prior to or on the date of redemption of AMPS or payment of a liability and are
either securities issued or guaranteed by the United States Government or
Deposit Securities, in both cases irrevocably deposited by the Fund for the
payment of the amount needed to redeem shares of AMPS subject to redemption or
to satisfy any of (i) (B) through (i) (G). For purposes of the foregoing,
'Maximum Potential Additional Dividend Liability,' as of any Valuation Date,
means the aggregate amount of Additional Dividends that would be due if the Fund
were to make Retroactive Taxable Allocations, with respect to any fiscal year,
estimated based upon dividends paid and the amount of undistributed realized net
capital gains and other taxable income earned by the Fund, as of the end of the
calendar month immediately preceding such Valuation Date and assuming such
Additional Dividends are fully taxable.
The Discount Factors and guidelines for determining the market value of the
Fund's portfolio holdings have been based on criteria established in connection
with rating the AMPS. These factors include, but are not limited to, the
sensitivity of the market value of the relevant asset to changes in interest
rates, the liquidity and depth of the market for the relevant asset, the credit
quality of the relevant asset (for example, the lower the rating of a debt
obligation, the higher the related discount factor) and the frequency with which
the relevant asset is marked to market. In no event shall the Discounted Value
of any asset of the Fund exceed its unpaid principal balance or face amount as
of the date of calculation. The Discount Factor relating to any asset of the
Fund and the AMPS Basic Maintenance Amount, the assets eligible for inclusion in
the calculation of the Discounted Value of the Fund's portfolio and certain
definitions and methods of calculation relating thereto may be changed from time
to time by the Fund, without shareholder approval, but only in the event the
Fund receives written confirmation from S&P, Moody's and any Substitute Rating
Agency that any such changes would not impair the ratings then assigned to the
shares of AMPS by S&P or Moody's or any Substitute Rating Agency.
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<PAGE>
On or before the third Business Day after a Valuation Date on which the
Fund fails to maintain S&P Eligible Assets and Moody's Eligible Assets each with
an aggregate Discounted Value equal to or greater than the AMPS Basic
Maintenance Amount, the Fund is required to deliver to the Auction Agent,
Moody's and S&P a report with respect to the calculation of the AMPS Basic
Maintenance Amount and the value of its portfolio holdings as of the date of
such failure (an 'AMPS Basic Maintenance Report'). Additionally, on or before
the third Business Day after the first day of a Special Dividend Period, the
Fund will deliver an AMPS Basic Maintenance Report to S&P and the Auction Agent.
The Fund also will deliver an AMPS Basic Maintenance Report as of the
twenty-fifth day of the last month of each fiscal quarter of the Fund (or, if
such day is not a Business Day, the next succeeding Business Day) on or before
the third Business Day after such day. Within ten Business Days after delivery
of such report relating to the twenty-fifth day of the last month of each fiscal
quarter of the Fund (or, if such day is not a Business Day, the next succeeding
Business Day), the Fund will deliver a letter prepared by the Fund's independent
accountants regarding the accuracy of the calculations made by the Fund in its
most recent AMPS Basic Maintenance Report. Also, on or before 5:00 p.m., New
York City time, on the first Business Day after shares of Common Stock are
repurchased by the Fund, the Fund will complete and deliver to S&P and Moody's
an AMPS Basic Maintenance Report as of the close of business on such date that
Common Stock is repurchased. If any such letter prepared by the Fund's
independent accountants shows that an error was made in the most recent AMPS
Basic Maintenance Report, the calculation or determination made by the Fund's
independent accountants will be conclusive and binding on the Fund.
REDEMPTION
Optional Redemption. To the extent permitted under the 1940 Act and under
Maryland law, upon giving a Notice of Redemption, as provided below, the Fund,
at its option, may redeem shares of AMPS of any series, in whole or in part, out
of funds legally available therefor, at the Optional Redemption Price per share
on any Dividend Payment Date; provided that no share of AMPS may be redeemed at
the option of the Fund during (a) the Initial Dividend Period with respect to a
series of shares or (b) a Non-Call Period to which such share is subject.
'Optional Redemption Price' means $25,000 per share of AMPS plus an amount equal
to accumulated but unpaid dividends (whether or not earned or declared) to the
date fixed for redemption plus any applicable redemption premium, if any,
attributable to the designation of a Premium Call Period. In addition, holders
of AMPS may be entitled to receive Additional Dividends in the event of
redemption of such AMPS to the extent provided herein. See
'--Dividends--Additional Dividends.' The Fund has the authority to redeem the
AMPS for any reason and may redeem all or part of the outstanding shares of AMPS
if it anticipates that the Fund's leveraged capital structure will result in a
lower rate of return to holders of Common Stock for any significant period of
time than that obtainable if the Common Stock were unleveraged.
Mandatory Redemption. The Fund will be required to redeem, out of funds
legally available therefor, at the Mandatory Redemption Price per share, shares
of AMPS to the extent permitted under the 1940 Act and Maryland law, on a date
fixed by the Board of Directors, if the Fund fails to maintain S&P Eligible
Assets and Moody's Eligible Assets each with an aggregate Discounted Value equal
to or greater than the AMPS Basic Maintenance Amount or to satisfy the 1940 Act
AMPS Asset Coverage and such failure is not cured on or before the AMPS Basic
Maintenance Cure Date or the 1940 Act Cure Date (herein collectively referred to
as a 'Cure Date'), as the case may be. 'Mandatory Redemption Price' means
$25,000 per share of AMPS plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption.
In addition, holders of AMPS may be entitled to receive Additional Dividends in
the event of redemption of such AMPS to the extent provided herein. See
'--Dividends--Additional Dividends.' The number of shares of AMPS to be redeemed
will be equal to the lesser of (a) the minimum number of shares of AMPS the
redemption of which, if deemed to have occurred immediately prior to the opening
of business on the Cure Date, together
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<PAGE>
with all other shares of the Preferred Stock subject to redemption or
retirement, would result in the Fund having S&P Eligible Assets and Moody's
Eligible Assets each with an aggregate Discounted Value equal to or greater than
the AMPS Basic Maintenance Amount or satisfaction of the 1940 Act AMPS Asset
Coverage, as the case may be, on such Cure Date (provided that, if there is no
such minimum number of shares the redemption of which would have such result,
all shares of AMPS then outstanding will be redeemed), and (b) the maximum
number of shares of AMPS, together with all other shares of Preferred Stock
subject to redemption or retirement, that can be redeemed out of funds expected
to be legally available therefor on such redemption date. In determining the
number of shares of AMPS required to be redeemed in accordance with the
foregoing, the Fund shall allocate the number required to be redeemed that would
result in the Fund having S&P Eligible Assets and Moody's Eligible Assets each
with an aggregate Discounted Value equal to or greater than the AMPS Basic
Maintenance Amount or satisfaction of the 1940 Act AMPS Asset Coverage, as the
case may be, pro rata among shares of AMPS and other Preferred Stock subject to
redemption pursuant to provisions similar to those set forth below; provided
that, shares of AMPS that may not be redeemed at the option of the Fund due to
the designation of a Non-Call Period applicable to such shares (A) will be
subject to mandatory redemption only to the extent that other shares are not
available to satisfy the number of shares required to be redeemed and (B) will
be selected for redemption in an ascending order of outstanding number of days
in the Non-Call Period (with shares with the lowest number of days to be
redeemed first) and by lot in the event of shares having an equal number of days
in such Non-Call Period. The Fund is required to effect such a mandatory
redemption not later than 35 days after such Cure Date, except that if the Fund
does not have funds legally available for the redemption of all of the required
number of shares of AMPS that are subject to mandatory redemption or the Fund
otherwise is unable to effect such redemption on or prior to 35 days after such
Cure Date, the Fund will redeem those shares of AMPS that it was unable to
redeem on the earliest practicable date on which it is able to effect such
redemption.
General. If shares of AMPS of any series are to be redeemed, a notice of
redemption will be mailed to each record holder of such shares of AMPS
(initially Cede as nominee of the Securities Depository) and to the Auction
Agent not less than 17 nor more than 30 days prior to the date fixed for the
redemption thereof. Each notice of redemption will include a statement setting
forth: (i) the redemption date, (ii) the aggregate number of shares of AMPS of
such series to be redeemed, (iii) the redemption price, (iv) the place or places
where shares of AMPS of such series are to be surrendered for payment of the
redemption price, (v) a statement that dividends on the shares to be redeemed
will cease to accumulate on such redemption date (except that holders may be
entitled to Additional Dividends) and (vi) the provision of the Articles
Supplementary pursuant to which such shares are being redeemed. The notice also
will be published in The Wall Street Journal. No defect in the notice of
redemption or in the mailing or publication thereof will affect the validity of
the redemption proceedings, except as required by applicable law.
In the event that less than all of the outstanding shares of any series of
AMPS are to be redeemed, the series and number of shares to be redeemed will be
selected by lot or such other method as the Fund shall deem fair and equitable,
and the results thereof will be communicated to the Auction Agent. The Auction
Agent will give notice to the Securities Depository, whose nominee will be the
record holder of all shares of AMPS, and the Securities Depository will
determine the number of shares to be redeemed from the account of the Agent
Member of each Existing Holder. Each Agent Member will determine the number of
shares to be redeemed from the account of each Existing Holder for which it acts
as agent. An Agent Member may select for redemption shares from the accounts of
some Existing Holders without selecting for redemption any shares from the
accounts of other Existing Holders. Notwithstanding the foregoing, if neither
the Securities Depository nor its nominee is the record holder of all of the
shares, the particular shares to be redeemed shall be selected by the Fund by
lot or by such other method as the Fund shall deem fair and equitable.
52
<PAGE>
If the Fund gives notice of redemption, and concurrently or thereafter
deposits in trust with the Auction Agent, or segregates in an account at the
Fund's custodian bank for the benefit of the Auction Agent, Deposit Securities
(with a right of substitution) having an aggregate Discounted Value (utilizing
in the case of S&P an S&P Exposure Period of 22 Business Days) equal to the
redemption payment for the shares of AMPS as to which notice of redemption has
been given, with irrevocable instructions and authority to pay the redemption
price to the record holders thereof, then upon the date of such deposit or, if
no such deposit is made, upon such date fixed for redemption (unless the Fund
shall default in making payment of the redemption price), all rights of the
holders of such shares called for redemption will cease and terminate, except
the right of such holders to receive the redemption price thereof and any
Additional Dividends, but without interest, and such shares no longer will be
deemed to be outstanding. The Fund will be entitled to receive, from time to
time, the interest, if any, earned on such Deposit Securities deposited with the
Auction Agent, and the holders of any shares so redeemed will have no claim to
any such interest. Any funds so deposited which are unclaimed at the end of one
year from such redemption date will be repaid, upon demand, to the Fund, after
which the holders of the shares of AMPS so called for redemption may look only
to the Fund for payment thereof.
So long as any shares of AMPS are held of record by the nominee of the
Securities Depository (initially Cede), the redemption price for such shares
will be paid on the redemption date to the nominee of the Securities Depository.
The Securities Depository's normal procedures now provide for it to distribute
the amount of the redemption price to Agent Members who, in turn, are expected
to distribute such funds to the persons for whom they are acting as agent.
Notwithstanding the provisions for redemption described above, no shares of
AMPS shall be subject to optional redemption (i) unless all dividends in arrears
on the outstanding shares of AMPS, and all capital stock of the Fund ranking on
a parity with the AMPS with respect to the payment of dividends or upon
liquidation, have been or are being contemporaneously paid or declared and set
aside for payment and (ii) if redemption thereof would result in the Fund's
failure to maintain Moody's Eligible Assets or S&P Eligible Assets with an
aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount.
LIQUIDATION RIGHTS
Upon any liquidation, dissolution or winding up of the Fund, whether
voluntary or involuntary, the holders of shares of all series of AMPS will be
entitled to receive, out of the assets of the Fund available for distribution to
shareholders, before any distribution or payment is made upon any shares of
Common Stock or any other capital stock of the Fund ranking junior in right of
payment upon liquidation of AMPS, $25,000 per share together with the amount of
any dividends accumulated but unpaid (whether or not earned or declared) thereon
to the date of distribution, and after such payment the holders of AMPS will be
entitled to no other payments except for any Additional Dividends. If such
assets of the Fund shall be insufficient to make the full liquidation payment on
each outstanding series of AMPS and liquidation payments on any other
outstanding class or series of Preferred Stock of the Fund ranking on a parity
with the AMPS as to payment upon liquidation, then such assets will be
distributed among the holders of each such series of AMPS and the holders of
shares of such other class or series ratably in proportion to the respective
preferential amounts to which they are entitled. After payment of the full
amount of liquidation distribution to which they are entitled, the holders of
AMPS will not be entitled to any further participation in any distribution of
assets by the Fund except for any Additional Dividends. A consolidation, merger
or share exchange of the Fund with or into any other entity or entities or a
sale, whether for cash, shares of stock, securities or properties, of all or
substantially all or any part of the assets of the Fund shall not be deemed or
construed to be a liquidation, dissolution or winding up of the Fund.
53
<PAGE>
VOTING RIGHTS
Except as otherwise indicated in this Prospectus and except as otherwise
required by applicable law, holders of shares of AMPS will be entitled to one
vote per share on each matter submitted to a vote of stockholders and will vote
together with holders of shares of Common Stock as a single class.
In connection with the election of the Fund's directors, holders of shares
of AMPS and any other Preferred Stock, voting as a separate class, shall be
entitled at all times to elect two of the Fund's directors, and the remaining
directors will be elected by holders of shares of Common Stock and shares of
AMPS and any other Preferred Stock, voting together as a single class. In
addition, if at any time dividends on outstanding shares of AMPS shall be unpaid
in an amount equal to at least two full years' dividends thereon or if at any
time holders of any shares of Preferred Stock are entitled, together with the
holders of AMPS, to elect a majority of the directors of the Fund under the 1940
Act, then the number of directors constituting the Board of Directors
automatically shall be increased by the smallest number that, when added to the
two directors elected exclusively by the holders of shares of AMPS and any other
Preferred Stock as described above, would constitute a majority of the Board of
Directors as so increased by such smallest number, and at a special meeting of
shareholders which will be called and held as soon as practicable, and at all
subsequent meetings at which directors are to be elected, the holders of shares
of AMPS and any other Preferred Stock, voting as a separate class, will be
entitled to elect the smallest number of additional directors that, together
with the two directors which such holders in any event will be entitled to
elect, constitutes a majority of the total number of directors of the Fund as so
increased. The terms of office of the persons who are directors at the time of
that election will continue. If the Fund thereafter shall pay, or declare and
set apart for payment in full, all dividends payable on all outstanding shares
of AMPS and any other Preferred Stock for all past Dividend Periods, the
additional voting rights of the holders of shares of AMPS and any other
Preferred Stock as described above shall cease, and the terms of office of all
of the additional directors elected by the holders of shares of AMPS and any
other Preferred Stock (but not of the directors with respect to whose election
the holders of Common Stock were entitled to vote or the two directors the
holders of shares of AMPS and any other Preferred Stock have the right to elect
in any event) will terminate automatically.
The affirmative vote of a majority of the votes entitled to be cast by
holders of outstanding shares of AMPS and any other Preferred Stock, voting as a
separate class, will be required to (i) authorize, create or issue (other than
with respect to the issuance of the AMPS authorized by the Articles
Supplementary), or increase the authorized or issued aggregate stated capital
amount of (other than with respect to the issuance of the AMPS authorized by the
Articles Supplementary), any class or series of stock ranking prior to or on
parity with any series of Preferred Stock with respect to the payment of
dividends or the distribution of assets on liquidation, or increase the
authorized aggregate stated capital amount of AMPS or any other Preferred Stock
or (ii) amend, alter or repeal the provisions of the Articles of Incorporation,
whether by merger, consolidation or otherwise, so as to adversely affect any of
the contract rights expressly set forth in the Articles of Incorporation of
holders of shares of AMPS or any other Preferred Stock. To the extent permitted
under the 1940 Act, in the event shares of more than one series of AMPS are
outstanding, the Fund shall not approve any of the actions set forth in clause
(i) or (ii) which adversely affects the contract rights expressly set forth in
the Articles of Incorporation of a holder of shares of a series of AMPS
differently than those of a holder of shares of any other series of AMPS without
the affirmative vote of at least a majority of votes entitled to be cast by
holders of the shares of AMPS of each series adversely affected and outstanding
at such time (each such adversely affected series voting separately as a class).
The Board of Directors, however, without shareholder approval, may amend, alter
or repeal any or all of the various rating agency guidelines described herein in
the event the Fund receives confirmation from the rating agencies that any such
amendment, alteration or repeal would not impair the ratings then assigned to
shares
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<PAGE>
of AMPS. Unless a higher percentage is provided for under '--Certain
Provisions in the Articles of Incorporation', the affirmative vote of a majority
of the votes entitled to be cast by holders of outstanding shares of AMPS and
any other Preferred Stock, voting as a separate class, will be required to
approve any plan of reorganization (including bankruptcy proceedings) adversely
affecting such shares or any action requiring a vote of security holders under
Section 13(a) of the 1940 Act including, among other things, changes in the
Fund's investment objective or changes in the investment restrictions described
as fundamental policies under 'Investment Objective and Policies.' The class
vote of holders of shares of AMPS and any other Preferred Stock described above
in each case will be in addition to a separate vote of the requisite percentage
of shares of Common Stock and shares of AMPS and any other Preferred Stock,
voting together as a single class, necessary to authorize the action in
question.
The foregoing voting provisions will not apply to any series of AMPS if, at
or prior to the time when the act with respect to which such vote otherwise
would be required shall be effected, such shares shall have been (i) redeemed or
(ii) called for redemption and sufficient funds shall have been deposited in
trust to effect such redemption.
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 and the outstanding shares of AMPS and any
other Preferred Stock, voting as a single class, and a majority of the
outstanding shares of AMPS and any other Preferred Stock, voting as a separate
class (which for this purpose and under the 1940 Act means the lesser of (i) 67%
of the shares of each class of capital stock represented at a meeting at which
more than 50% of the outstanding shares of each class of capital stock are
represented or (ii) more than 50% of the outstanding shares of each class of
capital stock). 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
55
<PAGE>
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
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.
For so long as shares of AMPS are rated by Moody's, the Fund will not
change these additional investment restrictions unless it receives written
confirmation from Moody's that engaging in such transactions would not impair
the rating then assigned to the shares of AMPS by Moody's.
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 Fund has no intention to file a voluntary application for relief under
Federal bankruptcy law or any similar application under state law for so long as
the Fund is solvent and does not foresee becoming insolvent.
The Investment Adviser 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.
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 and executive officer 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 of 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.
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<PAGE>
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 Merrill
Lynch Funds Distributor, Inc. ('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.
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 MLFD since
1981 and Treasurer since 1984.
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<PAGE>
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 the investment advisory agreement between the Fund
and the Investment Adviser (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 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 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 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
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>
TOTAL
COMPENSATION
PENSION OR FROM FUND AND
AGGREGATE RETIREMENT BENEFITS FAM/MLAM ADVISED
COMPENSATION ACCRUED AS PART OF FUNDS PAID TO
NAME OF DIRECTOR FROM FUND 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).
58
<PAGE>
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
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 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 the shares of AMPS. 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 fee paid by the Fund
to the Investment Adviser pursuant to the Investment Advisory Agreement was
$446,931 and $657,929, respectively and the fee paid by the Fund pursuant to the
Administration Agreement was $223,466 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 the for the fiscal year ended October 31,
1997, the Investment Adviser voluntarily waived $419,740 and $424,822,
respectively, of the fee paid by the Fund
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<PAGE>
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 the shareholders
representing 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.
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
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<PAGE>
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 for
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, the
Fund did not pay any brokerage commissions and for the fiscal year ended October
31, 1997 the Fund paid $1,950 in such commissions.
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 principal for their own account, 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.
61
<PAGE>
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 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.
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 Internal Revenue Service (the 'IRS'), in a revenue ruling, held that
certain auction rate preferred stock would be treated as stock for Federal
income tax purposes. The terms of the AMPS are substantially similar, but not
identical, to the auction rate preferred stock discussed in the revenue ruling,
and in the opinion of Brown & Wood LLP, counsel to the Fund, the shares of AMPS
will constitute stock of the Fund and distributions with respect to shares of
AMPS (other than distributions in redemption of shares of AMPS subject to
Section 302(b) of the Code) will constitute dividends to the extent of the
Fund's current and accumulated
62
<PAGE>
earnings and profits as calculated for Federal income tax purposes.
Nevertheless, it is possible that the IRS might take a contrary position,
asserting, for example, that the shares of AMPS constitute debt of the Fund. If
this position were upheld, the discussion of the treatment of distributions
below would not apply. Instead, distributions by the Fund to holders of shares
of AMPS would constitute interest, whether or not they exceeded the earnings and
profits of the Fund, would be included in full in the income of the recipient
and would be taxed as ordinary income. Counsel believes that such a position, if
asserted by the IRS, would be unlikely to prevail.
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 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
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<PAGE>
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 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 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. Thus, the Fund is required to allocate a portion of its net
capital gains and other taxable income to the shares of AMPS of each series. The
Fund generally will notify the Auction Agent of the amount of any net capital
gains and other taxable income to be included in any dividend on shares of AMPS
prior to the Auction establishing the Applicable Rate for such dividend. Except
for the portion of any dividend that it informs the Auction Agent will be
treated as capital gains or other taxable income, the Fund anticipates that the
dividends paid on the shares of AMPS will constitute exempt-interest dividends.
The amount of net capital gains and ordinary income allocable to shares of AMPS
(the 'taxable distribution') will depend upon the amount of such gains and
income realized by the Fund and the total dividends paid by the Fund on shares
of Common Stock and shares of AMPS during a taxable year, but the taxable
distribution generally is not expected to be significant.
In the opinion of Brown & Wood LLP, counsel to the Fund, under current law
the manner in which the Fund intends to allocate items of tax-exempt income, net
capital gains (including additional categories of capital gains) and other
taxable income between shares of Common Stock and shares of AMPS will be
respected for Federal income tax purposes. However, the tax treatment of
Additional Dividends may affect the Fund's calculation of each class's allocable
share of capital gains and other taxable income. See 'Tax Treatment of
Additional Dividends.' In addition, there is currently no direct guidance from
the IRS or other sources specifically addressing whether the Fund's method for
allocating tax-exempt income, net capital gains (including additional categories
of capital gains) and other taxable income between shares of Common Stock and
shares of 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. In the event of
a reallocation, some of the dividends identified by the Fund as exempt-interest
dividends to holders of shares of AMPS may be recharacterized as additional
capital gains or other taxable income. In the event of such recharacterization,
the Fund would not be required to make payments to such shareholders to offset
the tax effect of such reallocation. In addition, 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 IRS
would be unlikely to prevail. A holder should be aware, however, that the
opinion of Brown & Wood LLP 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
64
<PAGE>
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 shares of AMPS 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 'Description of AMPS--Restrictions on Dividends and Other
Payments'. This may prevent the Fund from distributing at least 90% of its net
investment income, and may, therefore, jeopardize the 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 AMPS 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. See 'Description of
AMPS--Redemption'. 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 IRS 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 IRS would agree that dividends
on the Preferred Stock are not preferential. If the IRS successfully disallowed
the dividends paid deduction for dividends on the Preferred Stock, the Fund
could lose the benefit of the special treatment afforded RICs under the Code. 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.
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.
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.
65
<PAGE>
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.
TAX TREATMENT OF ADDITIONAL DIVIDENDS
If the Fund makes a Retroactive Taxable Allocation, it will pay Additional
Dividends to holders of shares of AMPS who are subject to the Retroactive
Taxable Allocation. See 'Description of AMPS--Dividends-- Additional Dividends'.
The Federal income tax consequences of Additional Dividends under existing law
are uncertain. The Fund intends to treat a holder as receiving a dividend
distribution in the amount of any Additional Dividend only as and when such
Additional Dividend is paid. An Additional Dividend generally will be designated
by the Fund as an exempt-interest dividend except as otherwise required by
applicable law. However, the IRS may assert that all or part of an Additional
Dividend is a taxable dividend either in the taxable year for which the
Retroactive Taxable Allocation is made or in the taxable year in which the
Additional Dividend is paid.
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. 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.
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 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.
66
<PAGE>
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 New York Stock Exchange (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 AMPS 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.
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 AMPS. For a
description of the shares of AMPS, see 'Description of 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
(EXCLUSIVE OF
AMOUNT HELD AMOUNT HELD
BY FUND BY FUND
AMOUNT FOR ITS OWN FOR ITS OWN
TITLE OF CLASS AUTHORIZED ACCOUNT ACCOUNT)
- ------------------------------------------------------------------ ----------- ----------- -----------------
<S> <C> <C> <C>
Common Stock...................................................... 199,960,000 -0- 9,333,017
Auction Market Preferred Stock.................................... 40,000 -0- 1,920
</TABLE>
67
<PAGE>
COMMON STOCK
Holders of Common Stock are entitled to share equally in dividends declared
by the Board of Directors payable to holders of Common Stock and in the net
assets of the Fund available for distribution to holders of Common Stock after
payment of the preferential amounts payable to holders of any outstanding
Preferred Stock. Neither holders of Common Stock nor holders of Preferred Stock
have pre-emptive or conversion rights and shares of Common Stock are not
redeemable. The outstanding shares of Common Stock are fully paid and non-
assessable.
Holders of Common Stock are entitled to one vote for each share held and
will vote with the holders of any outstanding shares of AMPS or other Preferred
Stock on each matter submitted to a vote of holders of Common Stock, except as
described under 'Description of AMPS--Voting Rights.'
Shareholders are entitled to one vote for each share held. The shares of
Common Stock, AMPS and any other Preferred Stock do not have cumulative voting
rights, which means that the holders of more than 50% of the shares of Common
Stock, AMPS and any other Preferred Stock voting for the election of Directors
can elect all of the Directors standing for election by such holders, and, in
such event, the holders of the remaining shares of Common Stock, AMPS and any
other Preferred Stock will not be able to elect any of such Directors.
So long as any shares of AMPS or any other Preferred Stock are outstanding,
holders of Common Stock will not be entitled to receive any dividends of or
other distributions from the Fund unless all accumulated dividends on
outstanding shares of AMPS and any other Preferred Stock have been paid, and
unless asset coverage (as defined in the 1940 Act) with respect to such AMPS and
any other Preferred Stock would be at least 200% after giving effect to such
distributions. See 'Description of AMPS--Restrictions on Dividends and Other
Payments.'
The Fund engages in a continuous offering of its Common Stock. No market
presently exists for the Common Stock and it is not currently expected that a
secondary market will develop. Since the 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 the Common
Stock from shareholders at the net asset value per share. The repurchase of
Common Stock pursuant to tender offers may require that the Fund redeem all or a
portion of outstanding shares of Preferred Stock, including the AMPS. See
'Description of AMPS--Redemption.'
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
PREFERRED STOCK
Under the Fund'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. See 'Description of 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 as long as no single series has priority over another
series as to the distribution of assets of the Fund or the payment of dividends.
Neither holders of Common Stock nor holders of Preferred Stock have pre-emptive
rights to purchase any shares of AMPS or any other Preferred Stock that might be
issued. It is anticipated that the net asset value per share of the AMPS will
equal its original purchase price per share plus accumulated dividends per
share.
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<PAGE>
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation includes 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 AMPS and any other Preferred
Stock may be removed only by action of AMPS and any other Preferred Stock.
In addition, the Articles of Incorporation requires 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 all of the votes
entitled to be cast by shareholders of the Fund, voting as a single class, is
required. Such 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, including the AMPS, 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 AMPS and any other 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 (including
the AMPS), 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 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 (including
the AMPS) 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 Articles of Incorporation on file with the
Commission for the full text of these provisions.
69
<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.
PLAN OF DISTRIBUTION
The AMPS are being offered on a continuing basis by the Fund through
Merrill Lynch, which has agreed to use its best efforts to solicit purchasers of
the AMPS.
The AMPS are being offered at the price of $25,000 per share and Merrill
Lynch will receive no commission or discount in connection with the sale of
AMPS. The Fund reserves the sole right to withdraw, cancel or modify the offer
without notice and may reject orders to purchase AMPS in whole or in part.
Merrill Lynch has the right, in its discretion reasonably exercised, to reject
any proposed purchase of AMPS in whole or in part.
Merrill Lynch will act in Auctions as a Broker-Dealer as set forth under
'Description of AMPS--The Auction--Broker-Dealer Agreements' and will be
entitled to fees for services as a Broker-Dealer as set forth under 'Description
of AMPS--Broker-Dealers.' Merrill Lynch also may provide information to be used
in ascertaining the Reference Rate.
Merrill Lynch is an affiliate of the Investment Adviser and may receive a
portion of the fee paid to the Investment Adviser pursuant to the Administration
Agreement for administrative services rendered in connection with the shares of
AMPS. See 'Investment Advisory and Administrative Arrangements.'
The Fund anticipates that Merrill Lynch from time to time may act as a
broker in connection with the execution of the Fund's portfolio transactions.
The Fund and the Investment Adviser have agreed to indemnify Merrill Lynch
against certain liabilities including liabilities under the 1933 Act.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The Transfer Agent, Dividend Disbursing Agent and Registrar for the shares
of AMPS will be IBJ Schroder Bank & Trust Company. The Transfer Agent, Dividend
Disbursing Agent and Shareholder Servicing Agent for the shares of Common Stock
is Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, a wholly-owned subsidiary of ML & Co.
LEGAL OPINIONS
Certain legal matters in connection with the AMPS offered hereby will be
passed upon for the Fund and Merrill Lynch 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.
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<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
71
<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>
72
<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
73
<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>
74
<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
============
</TABLE>
(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.
See Notes to Financial Statements.
75
<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
=============
</TABLE>
* Auction Market Preferred Stock.
See Notes to Financial Statements.
76
<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): ============
</TABLE>
See Notes to Financial Statements.
77
<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
============ ============
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
78
<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:
</TABLE>
* 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.
79
<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.
80
<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.
81
<PAGE>
GLOSSARY
'AA' (AA) Composite Commercial Paper Rate', on any Valuation Date, means
(i) the Interest Equivalent of the rate on commercial paper placed on behalf of
issuers whose corporate bonds are rated 'AA' by S&P or 'Aa' by Moody's or the
equivalent of such rating by another nationally recognized statistical rating
organization, as such rate is made available on a discount basis or otherwise by
the Federal Reserve Bank of New York for the Business Day immediately preceding
such date, or (ii) in the event that the Federal Reserve Bank of New York does
not make available such a rate, then the arithmetic average of the Interest
Equivalent of the rate on commercial paper placed on behalf of such issuers, as
quoted on a discount basis or otherwise by Merrill Lynch, Pierce, Fenner & Smith
Incorporated or its successors that are Commercial Paper Dealers, to the Auction
Agent for the close of business on the Business Day immediately preceding such
date. If one of the Commercial Paper Dealers does not quote a rate required to
determine the 'AA' Composite Commercial Paper Rate, the 'AA' Composite
Commercial Paper Rate will be determined on the basis of the quotation or
quotations furnished by any Substitute Commercial Paper Dealer or Substitute
Commercial Paper Dealers selected by the Fund to provide such rate or rates not
being supplied by the Commercial Paper Dealer. If the number of Dividend Period
days shall be (i) 7 or more but fewer than 49 days, such rate shall be the
Interest Equivalent of the 30-day rate on such commercial paper; (ii) 49 or more
but fewer than 70 days, such rate shall be the Interest Equivalent of the 60-day
rate on such commercial paper; (iii) 70 or more days but fewer than 85 days,
such rate shall be the arithmetic average of the Interest Equivalent of the
60-day and 90-day rates on such commercial paper; (iv) 85 or more days but fewer
than 99 days, such rate shall be the Interest Equivalent of the 90-day rate on
such commercial paper; (v) 99 or more days but fewer than 120 days, such rate
shall be the arithmetic average of the Interest Equivalent of the 90-day and
120-day rates on such commercial paper; (vi) 120 or more days but fewer than 141
days, such rate shall be the Interest Equivalent of the 120-day rate on such
commercial paper; (vii) 141 or more days but fewer than 162 days, such rate
shall be the arithmetic average of the Interest Equivalent of the 120-day and
180-day rates on such commercial paper; and (viii) 162 or more days but fewer
than 183 days, such rate shall be the Interest Equivalent of the 180-day rate on
such commercial paper.
'Additional Dividend' has the meaning set forth on page 49 of this
Prospectus.
'Agent Member' means the member of the Securities Depository that will act
on behalf of a Beneficial Owner of one or more shares of AMPS or on behalf of a
Potential Beneficial Owner.
'AMPS' means the Auction Market Preferred Stock, Series A, the Auction
Market Preferred Stock, Series B, the Auction Market Preferred Stock, Series C,
the Auction Market Preferred Stock, Series D and the Auction Market Preferred
Stock, Series E, each with a par value of $.10 per share and a liquidation
preference of $25,000 per share plus an amount equal to accumulated but unpaid
dividends thereon (whether or not earned or declared), of the Fund.
'AMPS Basic Maintenance Amount' has the meaning set forth on page 51 of
this Prospectus.
'AMPS Basic Maintenance Cure Date' has the meaning set forth on page 50 of
this Prospectus.
'AMPS Basic Maintenance Report' has the meaning set forth on page 51 of
this Prospectus.
'Anticipation Notes' means the following Municipal Bonds: revenue
anticipation notes, tax anticipation notes, tax and revenue anticipation notes,
grant anticipation notes and bond anticipation notes.
'Applicable Percentage' has the meaning set forth on pages 38 to 39 of this
Prospectus.
'Applicable Rate' means the rate per annum at which cash dividends are
payable on shares of AMPS for any Dividend Period.
82
<PAGE>
'Articles Supplementary' means the Articles Supplementary of the Fund
specifying the powers, preferences and rights of the shares of AMPS.
'Auction' means a periodic operation of the Auction Procedures.
'Auction Agent' means IBJ Schroder Bank & Trust Company unless and until
another commercial bank, trust company or other financial institution appointed
by a resolution of the Board of Directors of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend disbursing agent and redemption agent for
the AMPS.
'Auction Agent Agreement' means the agreement entered into between the Fund
and the Auction Agent which provides, among other things, that the Auction Agent
will follow the Auction Procedures for the purpose of determining the Applicable
Rate.
'Auction Date' has the meaning set forth on page 37 of this Prospectus.
'Auction Procedures' means the procedures for conducting Auctions set forth
in Appendix C to this Prospectus.
'Available AMPS' has the meaning specified in Paragraph 10(d)(i) of the
Auction Procedures.
'Beneficial Owner' means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or if applicable, the Auction Agent) as a holder
of shares of AMPS or a Broker-Dealer that holds AMPS for its own account.
'Bid' has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
'Bidder' has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
'Board of Directors' or 'Board' means the Board of Directors of the Fund.
'Broker-Dealer' means any broker-dealer, or other entity permitted by law
to perform the functions required of a Broker-Dealer in the Auction Procedures,
that has been selected by the Fund and has entered into a Broker-Dealer
Agreement with the Auction Agent that remains effective.
'Broker-Dealer Agreement' means an agreement entered into between the
Auction Agent and a Broker-Dealer, including Merrill Lynch, Pierce, Fenner &
Smith Incorporated, pursuant to which such Broker-Dealer agrees to follow the
Auction Procedures.
'Business Day' means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in The
City of New York are authorized or obligated by law to close.
'Cede' means Cede & Co., the nominee of DTC, and in whose name the shares
of AMPS initially will be registered.
'Charter' means the Articles of Incorporation, as amended and supplemented
(including the Articles Supplementary), of the Fund.
'Code' means the Internal Revenue Code of 1986, as amended.
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<PAGE>
'Commercial Paper Dealers' means Merrill Lynch, Pierce, Fenner & Smith
Incorporated and such other commercial paper dealer or dealers as the Fund from
time to time may appoint or, in lieu thereof, their respective affiliates and
successors.
'Common Stock' means the Common Stock, par value $.10 per share, of the
Fund.
'Date of Original Issue' means, with respect to each share of AMPS, the
date on which such share first is issued by the Fund.
'Deposit Securities' means cash and Municipal Bonds rated at least A, P-1,
VMIG-1 or MIG-1 by Moody's or A, A-1+ or SP-1+ by S&P.
'Discount Factor' means a Moody's Discount Factor or an S&P Discount
Factor, as the case may be.
'Discounted Value' of any asset of the Fund means (i) with respect to an
S&P Eligible Asset, the quotient of the market value thereof divided by the
applicable S&P Discount Factor and (ii) with respect to a Moody's Eligible
Asset, the lower of par and the quotient of the market value thereof divided by
the applicable Moody's Discount Factor.
'Dividend Payment Date' has the meaning set forth on page 45 of this
Prospectus.
'Dividend Periods' has the meaning set forth on page 45 of this Prospectus.
'DTC' means The Depository Trust Company.
'Eligible Assets' means Moody's Eligible Assets or S&P Eligible Assets, as
the case may be.
'Existing Holder' means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of shares of AMPS
in the records of the Auction Agent.
'Forward Commitments' has the meaning set forth on page 30 of this
Prospectus.
'Fund' means Merrill Lynch Municipal Strategy Fund, Inc., a Maryland
corporation that is the issuer of the AMPS.
'Hold Order' has the meaning specified in Subsection 10(b)(i) of the
Auction Procedures.
'Initial Dividend Payment Date' means the Initial Dividend Payment Date as
determined by the Board of Directors of the Fund with respect to each series of
AMPS.
'Initial Dividend Period' means, with respect to the AMPS, the period from
and including the first Date of Original Issue for each series of AMPS to but
excluding the Initial Dividend Payment Date for each series of AMPS.
'Initial Margin' means the amount of cash or securities deposited with a
broker as a margin payment at the time of purchase or sale of a financial
futures contract.
'Interest Equivalent' means a yield on a 360-day basis of a discount basis
security which is equal to the yield on an equivalent interest-bearing security.
'Investment Adviser' means Fund Asset Management, L.P.
'IRS' means the United States Internal Revenue Service.
'Long Term Dividend Period' has the meaning set forth on page 4 of this
Prospectus.
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<PAGE>
'Mandatory Redemption Price' has the meaning set forth on page 53 of this
Prospectus.
'Marginal Tax Rate' means the maximum marginal regular Federal individual
income tax rate applicable to ordinary income or the maximum marginal regular
Federal corporate income tax rate, whichever is greater.
'Maximum Applicable Rate' has the meaning specified under 'Description of
AMPS--The Auction-- Orders by Beneficial Owners, Potential Beneficial Owners,
Existing Holders and Potential Holders' in the Prospectus.
'Maximum Potential Additional Dividend Liability' has the meaning set forth
on pages 51 to 52 of this Prospectus.
'Moody's' means Moody's Investors Service, Inc. or its successors.
'Moody's Discount Factor' has the meaning set forth on page 26 of this
Prospectus.
'Moody's Eligible Assets' has the meaning set forth on page 26 of this
Prospectus.
'Moody's Exposure Period' means a period that is the same length or longer
than the number of days used in calculating the cash dividend component of the
AMPS Basic Maintenance Amount and initially shall be the period commencing on
and including a given Valuation Date and ending 48 days thereafter.
'Moody's Hedging Transactions' has the meaning set forth on page 28 of this
Prospectus.
'Moody's Volatility Factor' means 272% as long as there has been no
increase enacted to the Marginal Tax Rate. If such an increase is enacted but
not yet implemented, the Moody's Volatility Factor shall be as follows:
<TABLE>
<CAPTION>
% CHANGE IN
MARGINAL TAX MOODY'S
RATE VOLATILITY FACTOR
- ------------- -----------------
<S> <C>
Less than or equal to 5% 292%
Greater than 5% but less than or equal to 10% 313%
Greater than 10% but less than or equal to 15% 338%
Greater than 15% but less than or equal to 20% 364%
Greater than 20% but less than or equal to 25% 396%
Greater than 25% but less than or equal to 30% 432%
Greater than 30% but less than or equal to 35% 472%
Greater than 35% but less than or equal to 40% 520%
</TABLE>
Notwithstanding the foregoing, the Moody's Volatility Factor may mean such
other potential dividend rate increase factor as Moody's advises the Fund in
writing is applicable.
'Municipal Bonds' has the meaning set forth on page 19 of this Prospectus.
'Municipal Index' has the meaning set forth on page 25 of this Prospectus.
'1940 Act' means the Investment Company Act of 1940, as amended from time
to time.
'1940 Act AMPS Asset Coverage' has the meaning set forth on page 50 of this
Prospectus.
'1940 Act Cure Date' has the meaning set forth on page 50 of this
Prospectus.
'Non-Call Period' has the meaning set forth under 'Specific Redemption
Provision' below.
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<PAGE>
'Non-Payment Period' has the meaning set forth on page 48 of this
Prospectus.
'Non-Payment Period Rate' has the meaning set forth on page 48 of this
Prospectus.
'Notice of Revocation' has the meaning set forth on page 47 of this
Prospectus.
'Notice of Special Dividend Period' has the meaning set forth on page 46 of
this Prospectus.
'Optional Redemption Price' has the meaning set forth on page 52 of this
Prospectus.
'Order' has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
'Potential Beneficial Owner' means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of shares of AMPS but that wishes
to purchase such shares, or that is a Beneficial Owner that wishes to purchase
additional shares of AMPS.
'Potential Holder' means any Broker-Dealer or any such other person as may
be permitted by the Fund, including any Existing Holder, who may be interested
in acquiring shares of AMPS (or, in the case of an Existing Holder, additional
shares of AMPS).
'Preferred Stock' means Preferred Stock, par value $.10 per share, of the
Fund.
'Premium Call Period' has the meaning set forth under 'Specific Redemption
Provision' below.
'Receivables for Municipal Bonds Sold,' for purposes of determining S&P
Eligible Assets, has the meaning set forth on page 24 of this Prospectus.
'Receivables for Municipal Bonds Sold,' for purposes of determining Moody's
Eligible Assets, has the meaning set forth on page 27 of this Prospectus.
'Reference Rate' means: (i) with respect to a Dividend Period or a Short
Term Dividend Period having 28 or fewer days, the higher of the applicable 'A'
Composite Commercial Paper Rate and the Taxable Equivalent of the Short Term
Municipal Bond Rate, (ii) with respect to any Short Term Dividend Period, having
more than 28 but fewer than 183 days, the applicable 'AA' Composite Commercial
Paper Rate, (iii) with respect to any Short Term Dividend Period having 183 or
more but fewer than 364 days, the applicable U.S. Treasury Bill Rate and (iv)
with respect to any Long Term Dividend Period, the applicable U.S. Treasury Note
Rate.
'Request for Special Dividend Period' has the meaning set forth on page 46
of this Prospectus.
'Response' has the meaning set forth on page 46 of this Prospectus.
'Retroactive Taxable Allocation' has the meaning set forth on page 49 of
this Prospectus.
'S&P' means Standard & Poor's Ratings Services or its successors.
'S&P Discount Factor' has the meaning set forth on page 23 of this
Prospectus.
'S&P Eligible Assets' has the meaning set forth on page 23 of this
Prospectus.
'S&P Exposure Period' means the maximum period of time following a
Valuation Date, including the Valuation Date and the AMPS Basic Maintenance Cure
Date, that the Fund has under the Articles Supplementary to cure any failure to
maintain, as of such Valuation Date, a Discounted Value for its portfolio at
least equal to the AMPS Basic Maintenance Amount.
'S&P Hedging Transactions' has the meaning set forth on page 25 of this
Prospectus.
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<PAGE>
'S&P Volatility Factor' means 277% or such other potential dividend rate
increase factor as S&P advises the Fund in writing is applicable.
'Securities Depository' means The Depository Trust Company and its
successors and assigns or any successor securities depository selected by the
Fund that agrees to follow the procedures required to be followed by such
securities depository in connection with shares of AMPS.
'Sell Order' has the meaning specified in Subsection 10(b)(i) of the
Auction Procedures.
'7-Day Dividend Period' means a Dividend Period consisting of seven days.
'Short Term Dividend Period' has the meaning set forth on page 4 of this
Prospectus.
'Special Dividend Period' has the meaning set forth on page 4 of this
Prospectus.
'Specific Redemption Provisions' means, with respect to a Special Dividend
Period, either, or any combination of, (i) a period (a 'Non-Call Period')
determined by the Board of Directors of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during which the shares of AMPS subject to
such Dividend Period shall not be subject to redemption at the option of the
Fund and (ii) a period (a 'Premium Call Period'), consisting of a number of
whole years and determined by the Board of Directors of the Fund, after
consultation with the Auction Agent and the Broker-Dealers, during each year of
which the shares of AMPS subject to such Dividend Period shall be redeemable at
the Fund's option at a price per share equal to $25,000 plus accumulated but
unpaid dividends plus a premium expressed as a percentage of $25,000, as
determined by the Board of Directors of the Fund after consultation with the
Auction Agent and the Broker-Dealers.
'Submission Deadline' has the meaning specified in Subsection 10(a)(x) of
the Auction Procedures.
'Submitted Bid' has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
'Submitted Hold Order' has the meaning specified in Subsection 10(d)(i) of
the Auction Procedures.
'Submitted Order' has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
'Submitted Sell Order' has the meaning specified in Subsection 10(d)(i) of
the Auction Procedures.
'Subsequent Dividend Period' means each Dividend Period after the Initial
Dividend Period.
'Substitute Rating Agency' and 'Substitute Rating Agencies' shall mean a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations, respectively, selected by Merrill
Lynch, Pierce, Fenner & Smith Incorporated, or its respective affiliates and
successors, after consultation with the Fund, to act as a substitute rating
agency or substitute rating agencies, as the case may be, to determine the
credit ratings of the AMPS.
'Sufficient Clearing Bids' has the meaning specified in Subsection 10(d)(i)
of the Auction Procedures.
'Taxable Equivalent of the Short-Term Municipal Bond Rate' on any date
means 90% of the quotient of (A) the per annum rate expressed on an interest
equivalent basis equal to the Kenny S&P 30-day High Grade Index (the 'Kenny
Index'), or any successor index made available for the Business Day immediately
preceding such date but in any event not later than 8:30 A.M., New York City
time, on such date by Kenny Information Systems Inc. or any successor thereto,
based upon 30-day yield evaluations at par of bonds the interest on which is
excludable for regular Federal income tax purposes under the Code of 'high
grade' component issuers selected by Kenny Information Systems Inc. or any such
successor from time to time in its discretion, which component issuers shall
include, without limitation, issuers of general obligation bonds but shall
exclude any
87
<PAGE>
bonds the interest on which constitutes an item of tax preference under Section
57(a) (5) of the Code, or successor provisions, for purposes of the 'alternative
minimum tax,' divided by (B) 1.00 minus the Marginal Tax Rate (expressed as a
decimal); provided, however, that if the Kenny Index is not made so available by
8:30 A.M., New York City time, on such date by Kenny Information Systems Inc. or
any successor, the Taxable Equivalent of the Short-Term Municipal Bond Rate
shall mean the quotient of (A) the per annum rate expressed on an interest
equivalent basis equal to the most recent Kenny Index so made available for any
preceding Business Day, divided by (B) 1.00 minus the Marginal Tax Rate
(expressed as a decimal). The Fund may not utilize a successor index to the
Kenny Index unless Moody's and S&P provide the Fund with written confirmation
that the use of such successor index will not adversely affect the then-current
respective Moody's and S&P ratings of the AMPS.
'Treasury Bonds' has the meaning set forth on page 25 of this Prospectus.
'28-Day Dividend Period' means a Dividend Period consisting of 28 days.
'U.S. Treasury Bill Rate' on any date means (i) the Interest Equivalent of
the rate on the actively traded Treasury Bill with a maturity most nearly
comparable to the length of the related Dividend Period, as such rate is made
available on a discount basis or otherwise by the Federal Reserve Bank of New
York in its Composite 3:30 P.M. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Bill Rate on such date. 'Alternate Treasury Bill Rate' on
any date means the Interest Equivalent of the yield as calculated by reference
to the arithmetic average of the bid price quotations of the actively traded
Treasury Bill with a maturity most nearly comparable to the length of the
related Dividend Period, as determined by bid price quotations as of any time on
the Business Day immediately preceding such date, obtained from at least three
recognized primary U.S. Government securities dealers selected by the Auction
Agent.
'U.S. Treasury Note Rate' on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 P.M. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Note Rate on such date. 'Alternate Treasury Note Rate' on
any date means the yield as calculated by reference to the arithmetic average of
the bid price quotations of the actively traded, current coupon Treasury Note
with a maturity most nearly comparable to the length of the related Dividend
Period, as determined by the bid price quotations as of any time on the Business
Day immediately preceding such date, obtained from at least three recognized
primary U.S. Government securities dealers selected by the Auction Agent.
'Valuation Date' has the meaning set forth on page 51 of this Prospectus.
'Variation Margin' means, in connection with an outstanding financial
futures contract owned or sold by the Fund, the amount of cash or securities
paid to or received from a broker (subsequent to the Initial Margin payment)
from time to time as the price of such financial futures contract fluctuates.
'Winning Bid Rate' has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
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<PAGE>
APPENDIX I
RATINGS OF MUNICIPAL BONDS AND COMMERCIAL PAPER
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ('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 payment 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 categories which Moody's
believes possess the strongest credit attributes within those categories are
designated by the symbols Aa1, A1, Baa1, Ba1 and B1.
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<PAGE>
Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes 'best
quality . . . strong protection by established cash flows'; MIG 2/VMIG2 denotes
'high quality' with ample margins of protection; MIG 3/VMIG3 notes are of
'favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades'; MIG 4/VMIG4 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 ability of
rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of short-term promissory obligations. Prime-1
repayment ability will often be evidenced by many of 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 earning 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.
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The ratings are based on current information furnished by the obligors or
obtained by S&P from other sources it considers reliable. S&P 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 based on 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 the obligation;
II. Nature of and provisions of the obligation; and
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 the 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 on 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
CCC bonds 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 a 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.
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<PAGE>
DESCRIPTION OF S&P 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 an 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.
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 and 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 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>
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<PAGE>
DESCRIPTION OF FITCH IBCA, INC. ('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 ratings
represent 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 of 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 guaranties unless otherwise indicated.
Bonds carrying 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.
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 any 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.
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<PAGE>
<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 12
months.
RATINGS An outlook is used to describe the most likely direction of any rating charge over the
OUTLOOK intermediate term. It is described as a 'Positive' or 'Negative.' The absence of a designation
indicates a stable outlook.
</TABLE>
DESCRIPTION OF FITCH 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.
</TABLE>
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<TABLE>
<S> <C>
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 INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally 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.
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-S 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>
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APPENDIX II
SETTLEMENT PROCEDURES
The following summary of Settlement Procedures sets forth the procedures
expected to be followed in connection with the settlement of each Auction and
will be incorporated by reference in the Auction Agent Agreement and each
Broker-Dealer Agreement. Nothing contained in this Appendix II constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party. Capitalized terms used herein shall have the respective meanings
specified in the glossary of this Prospectus or Appendix III hereto, as the case
may be.
(a) On each Auction Date, the Auction Agent shall notify by telephone or
through the Auction Agent's Processing System the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner of:
(i) the Applicable Rate fixed for the next succeeding Dividend Period;
(ii) whether Sufficient Clearing Bids existed for the determination of
the Applicable Rate;
(iii) if such Broker-Dealer (a 'Seller's Broker-Dealer') submitted a
Bid or a Sell Order on behalf of a Beneficial Owner, the number of shares,
if any, of AMPS to be sold by such Beneficial Owner;
(iv) if such Broker-Dealer (a 'Buyer's Broker-Dealer') submitted a Bid
on behalf of a Potential Beneficial Owner, the number of shares, if any, of
AMPS to be purchased by such Potential Beneficial Owner;
(v) if the aggregate number of shares of AMPS to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order exceeds the aggregate number of shares of AMPS to be purchased
by all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid, the name or names of one or more Buyer's Broker-Dealers
(and the name of the Agent Member, if any, of each such Buyer's
Broker-Dealer) acting for one or more purchasers of such excess number of
shares of AMPS and the number of such shares to be purchased from one or
more Beneficial Owners on whose behalf such Broker-Dealer acted by one or
more Potential Beneficial Owners on whose behalf each of such Buyer's
Broker-Dealers acted;
(vi) if the aggregate number of shares of AMPS to be purchased by all
Potential Beneficial Owners on whose behalf such Broker-Dealer submitted a
Bid exceeds the aggregate number of shares of AMPS to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order, the name or names of one or more Seller's Broker-Dealers (and
the name of the Agent Member, if any, of each such Seller's Broker-Dealer)
acting for one or more sellers of such excess number of shares of AMPS and
the number of such shares to be sold to one or more Potential Beneficial
Owners on whose behalf such Broker-Dealer acted by one or more Beneficial
Owners on whose behalf each of such Seller's Broker-Dealers acted; and
(vii) the Auction Date of the next succeeding Auction with respect to
the AMPS.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
(i) in the case of a Broker-Dealer that is a Buyer's Broker-Dealer,
instruct each Potential Beneficial Owner on whose behalf such Broker-Dealer
submitted a Bid that was accepted, in whole or in part, to instruct such
Potential Beneficial Owner's Agent Member to pay to such Broker-Dealer (or
its Agent
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Member) through the Securities Depository the amount necessary to purchase
the number of shares of AMPS to be purchased pursuant to such Bid against
receipt of such shares and advise such Potential Beneficial Owner of the
Applicable Rate for the next succeeding Dividend Period;
(ii) in the case of a Broker-Dealer that is a Seller's Broker-Dealer,
instruct each Beneficial Owner on whose behalf such Broker-Dealer submitted
a Sell Order that was accepted, in whole or in part, or a Bid that was
accepted, in whole or in part, to instruct such Beneficial Owner's Agent
Member to deliver to such Broker-Dealer (or its Agent Member) through the
Securities Depository the number of shares of AMPS to be sold pursuant to
such Order against payment therefor and advise any such Beneficial Owner
that will continue to hold shares of AMPS of the Applicable Rate for the
next succeeding Dividend Period;
(iii) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted a Hold Order of the Applicable Rate for the next succeeding
Dividend Period;
(iv) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
(v) advise each Potential Beneficial Owner on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, of
the Auction Date for the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to (a) above,
each Broker-Dealer that submitted a Bid or a Sell Order on behalf of a Potential
Beneficial Owner or a Beneficial Owner shall, in such manner and at such time or
times as in its sole discretion it may determine, allocate any funds received by
it pursuant to (b)(i) above and any shares of AMPS received by it pursuant to
(b)(ii) above among the Potential Beneficial Owners, if any, on whose behalf
such Broker-Dealer submitted Bids, the Beneficial Owners, if any, on whose
behalf such Broker-Dealer submitted Bids that were accepted or Sell Orders, and
any Broker-Dealer or Broker-Dealers identified to it by the Auction Agent
pursuant to (a)(v) or (a)(vi) above.
(d) On each Auction Date:
(i) each Potential Beneficial Owner and Beneficial Owner shall
instruct its Agent Member as provided in (b)(i) or (ii) above, as the case
may be;
(ii) each Seller's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to the Agent Member of the Beneficial Owner
delivering shares to such Broker-Dealer pursuant to (b)(ii) above the
amount necessary to purchase such shares against receipt of such shares,
and (B) deliver such shares through the Securities Depository to a Buyer's
Broker-Dealer (or its Agent Member) identified to such Seller's
Broker-Dealer pursuant to (a)(v) above against payment therefor; and
(iii) each Buyer's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to a Seller's Broker-Dealer (or its Agent Member)
identified pursuant to (a) (vi) above the amount necessary to purchase the
shares to be purchased pursuant to (b)(i) above against receipt of such
shares, and (B) deliver such shares through the Securities Depository to
the Agent Member of the purchaser thereof against payment therefor.
(e) On the day after the Auction Date:
(i) each Bidder's Agent Member referred to in (d)(i) above shall
instruct the Securities Depository to execute the transactions described in
(b)(i) or (ii) above, and the Securities Depository shall execute such
transactions;
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(ii) each Seller's Broker-Dealer or its Agent Member shall instruct
the Securities Depository to execute the transactions described in (d)(ii)
above, and the Securities Depository shall execute such transactions; and
(iii) each Buyer's Broker-Dealer or its Agent Member shall instruct
the Securities Depository to execute the transactions described in (d)(iii)
above, and the Securities Depository shall execute such transactions.
(f) If a Beneficial Owner selling shares of AMPS in an Auction fails to
deliver such shares (by authorized book-entry), a Broker-Dealer may deliver to
the Potential Beneficial Owner on behalf of which it submitted a Bid that was
accepted a number of whole shares of AMPS that is less than the number of shares
that otherwise was to be purchased by such Potential Beneficial Owner. In such
event, the number of shares of AMPS to be so delivered shall be determined
solely by such Broker-Dealer. Delivery of such lesser number of shares shall
constitute good delivery. Notwithstanding the foregoing terms of this paragraph
(f), any delivery or non-delivery of shares which shall represent any departure
from the results of an Auction, as determined by the Auction Agent, shall be of
no effect unless and until the Auction Agent shall have been notified of such
delivery or non-delivery in accordance with the provisions of the Auction Agent
Agreement and the Broker-Dealer Agreements.
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APPENDIX III
AUCTION PROCEDURES
The following procedures will be set forth in provisions of the Articles
Supplementary relating to the AMPS, and will be incorporated by reference in the
Auction Agent Agreement and each Broker-Dealer Agreement. The terms not defined
below are defined in the forepart of this Prospectus. Nothing contained in this
Appendix III constitutes a representation by the Fund that in each Auction each
party referred to herein actually will perform the procedures described herein
to be performed by such party.
Paragraph 10(a) Certain Definitions.
As used in this Paragraph 10, the following terms shall have the following
meanings, unless the context otherwise requires:
(i) 'AMPS' shall mean the shares of AMPS being auctioned pursuant to
this Paragraph 10.
(ii) 'Auction Date' shall mean the first Business Day preceding the
first day of a Dividend Period.
(iii) 'Available AMPS' shall have the meaning specified in Paragraph
10(d)(i) below.
(iv) 'Bid' shall have the meaning specified in Paragraph 10(b)(i)
below.
(v) 'Bidder' shall have the meaning specified in Paragraph 10(b)(i)
below.
(vi) 'Hold Order' shall have the meaning specified in Paragraph
10(b)(i) below.
(vii) 'Maximum Applicable Rate' for any Dividend Period will be the
Applicable Percentage of the Reference Rate. The Applicable Percentage will
be determined based on (i) the lower of the credit rating or ratings
assigned on such date to such shares by Moody's and S&P (or if Moody's or
S&P or both shall not make such rating available, the equivalent of either
or both of such ratings by a Substitute Rating Agency or two Substitute
Rating Agencies or, in the event that only one such rating shall be
available, such rating) and (ii) whether the Fund has provided modification
to the Auction Agent prior to the Auction establishing the Applicable Rate
for any dividend that net capital gains or other taxable income will be
included in such dividend on shares of AMPS as follows:
<TABLE>
<CAPTION>
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
CREDIT RATINGS REFERENCE REFERENCE
- ------------------------------------------ RATE-- RATE--
MOODY'S S&P NO NOTIFICATION NOTIFICATION
- ------------------- ------------------- --------------- ---------------
<S> <C> <C> <C>
'aa3' or higher AA- or Higher 110% 150%
'a3' or 'a1' A- to A+ 125% 160%
'baa3' to 'baa1' BBB- to BBB+ 150% 250%
Below 'baa3' Below BBB- 200% 275%
</TABLE>
The Fund shall take all reasonable action necessary to enable S&P and
Moody's to provide a rating for the AMPS. If either S&P or Moody's shall not
make such a rating available, or if neither S&P nor Moody's shall make such a
rating available, Merrill Lynch, Pierce, Fenner & Smith Incorporated or its
affiliates and successors, after consultation with the Fund, shall select a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations to act as a Substitute Rating Agency
or Substitute Rating Agencies, as the case may be.
(viii) 'Order' shall have the meaning specified in Paragraph 10(b)(i)
below.
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(ix) 'Sell Order' shall have the meaning specified in Paragraph
10(b)(i) below.
(x) 'Submission Deadline' shall mean 1:00 p.m., New York City time, on
any Auction Date or such other time on any Auction Date as may be specified
by the Auction Agent from time to time as the time by which each
Broker-Dealer must submit to the Auction Agent in writing all Orders
obtained by it for the Auction to be conducted on such Auction Date.
(xi) 'Submitted Bid' shall have the meaning specified in Paragraph
10(d)(i) below.
(xii) 'Submitted Hold Order' shall have the meaning specified in
Paragraph 10(d)(i) below.
(xiii) 'Submitted Order' shall have the meaning specified in Paragraph
10(d)(i) below.
(xiv) 'Submitted Sell Order' shall have the meaning specified in
Paragraph 10(d)(i) below.
(xv) 'Sufficient Clearing Bids' shall have the meaning specified in
Paragraph 10(d)(i) below.
(xvi) 'Winning Bid Rate' shall have the meaning specified in Paragraph
10(d)(i) below.
Paragraph 10(b) Orders by Beneficial Owners, Potential Beneficial Owners,
Existing Holders and Potential Holders.
(i) Unless otherwise permitted by the Fund, Beneficial Owners and Potential
Beneficial Owners may only participate in Auctions through their Broker-Dealers.
Brokers-Dealers will submit the Orders of their respective customers who are
Beneficial Owners and Potential Beneficial Owners to the Auction Agent,
designating themselves as Existing Holders in respect of shares subject to
Orders submitted or deemed submitted to them by Beneficial Owners and as
Potential Holders in respect of shares subject to Orders submitted to them by
Potential Beneficial Owners. A Broker-Dealer may also hold shares of AMPS in its
own account as a Beneficial Owner. A Broker-Dealer may thus submit Orders to the
Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and
therefore participate in an Auction as an Existing Holder or Potential Holder on
behalf of both itself and its customers. On or prior to the Submission Deadline
on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer information
as to:
(1) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner desires to continue to hold
without regard to the Applicable Rate for the next succeeding Dividend
Period;
(2) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner desires to continue to
hold, provided that the Applicable Rate for the next succeeding Dividend
Period shall not be less than the rate per annum specified by such
Beneficial Owner, and/or
(3) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner offers to sell without
regard to the Applicable Rate for the next succeeding Dividend Period;
and
(B) each Broker-Dealer, using a list of Potential Beneficial Owners
that shall be maintained in good faith for the purpose of conducting a
competitive Auction, shall contact Potential Beneficial Owners, including
Persons that are not Beneficial Owners, on such list to determine the
number of outstanding shares, if any, of AMPS which each such Potential
Beneficial Owner offers to purchase, provided that the Applicable Rate for
the next succeeding Dividend Period shall not be less than the rate per
annum specified by such Potential Beneficial Owner.
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For the purposes hereof, the communication by a Beneficial Owner or
Potential Beneficial Owner to a Broker-Dealer, or the communication by a
Broker-Dealer acting for its own account to the Auction Agent, of information
referred to in clause (A) or (B) of this Paragraph 10(b)(i) is hereinafter
referred to as an 'Order' and each Beneficial Owner and each Potential
Beneficial Owner placing an Order, including a Broker-Dealer acting in such
capacity for its own account, is hereinafter referred to as a 'Bidder'; an Order
containing the information referred to in clause (A)(1) of this Paragraph
10(b)(i) is hereinafter referred to as a 'Hold Order'; an Order containing the
information referred to in clause (A)(2) or (B) of this Paragraph 10(b)(i) is
hereinafter referred to as a 'Bid'; and an Order containing the information
referred to in clause (A)(3) of this Paragraph 10(b)(i) is hereinafter referred
to as a 'Sell Order.' Inasmuch as a Broker-Dealer participates in an Auction as
an Existing Holder or a Potential Holder only to represent the interests of a
Beneficial Owner or Potential Beneficial Owner, whether it be its customers or
itself, all discussion herein relating to the consequences of an Auction for
Existing Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented thereby.
(ii)(A) A Bid by an Existing Holder shall constitute an irrevocable offer
to sell:
(1) the number of outstanding shares of AMPS specified in such Bid if
the Applicable Rate determined on such Auction Date shall be less than the
rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(i)(D) if the Applicable Rate
determined on such Auction Date shall be equal to the rate per annum
specified therein; or
(3) a lesser number of outstanding shares of AMPS to be determined as
set forth in Paragraph 10(e)(ii)(C) if such specified rate per annum shall
be higher than the Maximum Applicable Rate and Sufficient Clearing Bids do
not exist.
(B) A Sell Order by an Existing Holder shall constitute an irrevocable
offer to sell:
(1) the number of outstanding shares of AMPS specified in such Sell
Order, or
(2) such number or a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(ii)(C) if Sufficient Clearing
Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable offer to
purchase:
(1) the number of outstanding shares of AMPS specified in such Bid if
the Applicable Rate determined on such Auction Date shall be higher than
the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(i)(E) if the Applicable Rate
determined on such Auction Date shall be equal to the rate per annum
specified therein.
Paragraph 10(c) Submission of Orders by Broker-Dealers to Auction Agent.
(i) Each Broker-Dealer shall submit in writing or through the Auction
Agent's Auction Processing System to the Auction Agent prior to the Submission
Deadline on each Auction Date all Orders obtained by such Broker-Dealer,
designating itself (unless otherwise permitted by the Fund) as an Existing
Holder in respect of shares subject to Orders submitted or deemed submitted to
it by Beneficial Owners and as a Potential Holder in respect
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of shares subject to Orders submitted to it by Potential Beneficial Owners, and
specifying with respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the
Broker-Dealer unless otherwise permitted by the Fund);
(B) the aggregate number of outstanding shares of AMPS that are the
subject of such Order;
(C) to the extent that such Bidder is an Existing Holder
(1) the number of outstanding shares, if any, of AMPS subject to
any Hold Order placed by such Existing Holder;
(2) the number of outstanding shares, if any, of AMPS subject to
any Bid placed by such Existing Holder and the rate per annum specified
in such Bid; and
(3) the number of outstanding shares, if any, of AMPS subject to
any Sell Order placed by such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate per
annum specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than three
figures to the right of the decimal point, the Auction Agent shall round such
rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the outstanding shares of AMPS
held by an Existing Holder are not submitted to the Auction Agent prior to the
Submission Deadline, the Auction Agent shall deem a Hold Order (in the case of
an Auction relating to a Dividend Period which is not a Special Dividend Period)
and a Sell Order (in the case of an Auction relating to a Special Dividend
Period) to have been submitted on behalf of such Existing Holder covering the
number of outstanding shares of AMPS held by such Existing Holder and not
subject to Orders submitted to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in the
aggregate more than the number of outstanding shares of AMPS held by such
Existing Holder are submitted to the Auction Agent, such Orders shall be
considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder shall
be considered valid up to and including the number of outstanding shares of
AMPS held by such Existing Holder; provided that if more than one Hold
Order is submitted on behalf of such Existing Holder and the number of
shares of AMPS subject to such Hold Orders exceeds the number of
outstanding shares of AMPS held by such Existing Holder, the number of
shares of AMPS subject to each of such Hold Orders shall be reduced pro
rata so that such Hold Orders, in the aggregate, cover exactly the number
of outstanding shares of AMPS held by such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be
considered valid, in the ascending order of their respective rates per
annum if more than one Bid is submitted on behalf of such Existing Holder,
up to and including the excess of the number of outstanding shares of AMPS
held by such Existing Holder over the number of shares of AMPS subject to
any Hold Order referred to in Paragraph 10(c)(iv)(A) above (and if more
than one Bid submitted on behalf of such Existing Holder specifies the same
rate per annum and together they cover more than the remaining number of
shares that can be the subject of valid Bids after application of Paragraph
10(c)(iv)(A) above and of the foregoing portion of this Paragraph
10(c)(iv)(B) to any Bid or Bids specifying a lower rate or rates per annum,
the number of shares subject to
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each of such Bids shall be reduced pro rata so that such Bids, in the
aggregate, cover exactly such remaining number of shares); and the number
of shares, if any, subject to Bids not valid under this Paragraph
10(c)(iv)(B) shall be treated as the subject of a Bid by a Potential
Holder; and
(C) any Sell Order shall be considered valid up to and including the
excess of the number of outstanding shares of AMPS held by such Existing
Holder over the number of shares of AMPS subject to Hold Orders referred to
in Paragraph 10(c)(iv)(A) and Bids referred to in Paragraph 10(c)(iv)(B);
provided that if more than one Sell Order is submitted on behalf of any
Existing Holder and the number of shares of AMPS subject to such Sell
Orders is greater than such excess, the number of shares of AMPS subject to
each of such Sell Orders shall be reduced pro rata so that such Sell
Orders, in the aggregate, cover exactly the number of shares of AMPS equal
to such excess.
(v) If more than one Bid is submitted on behalf of any Potential Holder,
each Bid submitted shall be a separate Bid with the rate per annum and number of
shares of AMPS therein specified.
(vi) Any Order submitted by a Beneficial Owner or a Potential Beneficial
Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to
the Submission Deadline on any Auction Date shall be irrevocable.
Paragraph 10(d) Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate.
(i) Not earlier than the Submission Deadline on each Auction Date, the
Auction Agent shall assemble all Orders submitted or deemed submitted to it by
the Broker-Dealers (each such Order as submitted or deemed submitted by a
Broker-Dealer being hereinafter referred to individually as a 'Submitted Hold
Order,' a 'Submitted Bid' or a 'Submitted Sell Order,' as the case may be, or as
a 'Submitted Order') and shall determine:
(A) the excess of the total number of outstanding shares of AMPS over
the number of outstanding shares of AMPS that are the subject of Submitted
Hold Orders (such excess being hereinafter referred to as the 'Available
AMPS');
(B) from the Submitted Orders whether the number of outstanding shares
of AMPS that are the subject of Submitted Bids by Potential Holders
specifying one or more rates per annum equal to or lower than the Maximum
Applicable Rate exceeds or is equal to the sum of:
(1) the number of outstanding shares of AMPS that are the subject
of Submitted Bids by Existing Holders specifying one or more rates per
annum higher than the Maximum Applicable Rate, and
(2) the number of outstanding shares of AMPS that are subject to
Submitted Sell Orders (if such excess or such equality exists (other
than because the number of outstanding shares of AMPS in clause (1)
above and this clause (2) are each zero because all of the outstanding
shares of AMPS are the subject of Submitted Hold Orders), such Submitted
Bids by Potential Holders hereinafter being referred to collectively as
'Sufficient Clearing Bids'); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum
specified in the Submitted Bids (the 'Winning Bid Rate') that if:
(1) each Submitted Bid from Existing Holders specifying the Winning
Bid Rate and all other submitted Bids from Existing Holders specifying
lower rates per annum were rejected, thus entitling such Existing
Holders to continue to hold the shares of AMPS that are the subject of
such Submitted Bids, and
103
<PAGE>
(2) each Submitted Bid from Potential Holders specifying the
Winning Bid Rate and all other Submitted Bids from Potential Holders
specifying lower rates per annum were accepted, thus entitling the
Potential Holders to purchase the shares of AMPS that are the subject of
such Submitted Bids, would result in the number of shares subject to all
Submitted Bids specifying the Winning Bid Rate or a lower rate per annum
being at least equal to the Available AMPS.
(ii) Promptly after the Auction Agent has made the determinations pursuant
to Paragraph 10(d)(i), the Auction Agent shall advise the Fund of the Maximum
Applicable Rate and, based on such determinations, the Applicable Rate for the
next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable Rate for
the next succeeding Dividend Period shall be equal to the Winning Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than because all
of the outstanding shares of AMPS are the subject of Submitted Hold
Orders), that the Applicable Rate for the next succeeding Dividend Period
shall be equal to the Maximum Applicable Rate; or
(C) if all of the outstanding shares of AMPS are the subject of
Submitted Hold Orders, that the Dividend Period next succeeding the Auction
automatically shall be the same length as the immediately preceding
Dividend Period and the Applicable Rate for the next succeeding Dividend
Period shall be equal to 40% of the Reference Rate (or 60% of such rate if
the Fund has provided notification to the Auction Agent prior to the
Auction establishing the Applicable Rate for any dividend that net capital
gains or other taxable income will be included in such dividend on shares
of AMPS) on the date of the Auction.
Paragraph 10(e) Acceptance and Rejection of Submitted Bids and Submitted
SellOrders and Allocation of Shares.
Based on the determinations made pursuant to Paragraph 10(d)(i), the
Submitted Bids and Submitted Sell Orders shall be accepted or rejected and the
Auction Agent shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the provisions
of Paragraph 10(e)(iii) and Paragraph 10(e)(iv), Submitted Bids and Submitted
Sell Orders shall be accepted or rejected in the following order of priority and
all other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be accepted
and the Submitted Bid of each of the Existing Holders specifying any rate
per annum that is higher than the Winning Bid Rate shall be accepted, thus
requiring each such Existing Holder to sell the outstanding shares of AMPS
that are the subject of such Submitted Sell Order or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holders specifying any
rate per annum that is lower than the Winning Bid Rate shall be rejected,
thus entitling each such Existing Holder to continue to hold the
outstanding shares of AMPS that are the subject of such Submitted Bid;
(C) the Submitted Bid of each of the Potential Holders specifying any
rate per annum that is lower than the Winning Bid Rate shall be accepted;
(D) the Submitted Bid of each of the Existing Holders specifying a
rate per annum that is equal to the Winning Bid Rate shall be rejected,
thus entitling each such Existing Holder to continue to hold the
outstanding shares of AMPS that are the subject of such Submitted Bid,
unless the number of outstanding shares of AMPS subject to all such
Submitted Bids shall be greater than the number of outstanding shares of
AMPS ('Remaining Shares') equal to the excess of the Available AMPS over
the number of outstanding
104
<PAGE>
shares of AMPS subject to Submitted Bids described in Paragraph 10(e)(i)(B)
and Paragraph 10(e)(i)(C), in which event the Submitted Bids of each such
Existing Holder shall be accepted, and each such Existing Holder shall be
required to sell outstanding shares of AMPS, but only in an amount equal to
the difference between (1) the number of outstanding shares of AMPS then
held by such Existing Holder subject to such Submitted Bid and (2) the
number of shares of AMPS obtained by multiplying (x) the number of
Remaining Shares by (y) a fraction the numerator of which shall be the
number of outstanding shares of AMPS held by such Existing Holder subject
to such Submitted Bid and the denominator of which shall be the sum of the
numbers of outstanding shares of AMPS subject to such Submitted Bids made
by all such Existing Holders that specified a rate per annum equal to the
Winning Bid Rate; and
(E) the Submitted Bid of each of the Potential Holders specifying a
rate per annum that is equal to the Winning Bid Rate shall be accepted but
only in an amount equal to the number of outstanding shares of AMPS
obtained by multiplying (x) the difference between the Available AMPS and
the number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(i)(B), Paragraph 10(e)(i)(C) and Paragraph
10(e)(i)(D) by (y) a fraction the numerator of which shall be the number of
outstanding shares of AMPS subject to such Submitted Bid and the
denominator of which shall be the sum of the number of outstanding shares
of AMPS subject to such Submitted Bids made by all such Potential Holders
that specified rates per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than because all
of the outstanding shares of AMPS are subject to Submitted Hold Orders), subject
to the provisions of Paragraph 10(e)(iii), Submitted Orders shall be accepted or
rejected as follows in the following order of priority and all other Submitted
Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate per
annum that is equal to or lower than the Maximum Applicable Rate shall be
rejected, thus entitling such Existing Holder to continue to hold the
outstanding shares of AMPS that are the subject of such Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying any rate per
annum that is equal to or lower than the Maximum Applicable Rate shall be
accepted, thus requiring such Potential Holder to purchase the outstanding
shares of AMPS that are the subject of such Submitted Bid; and
(C) the Submitted Bids of each Existing Holder specifying any rate per
annum that is higher than the Maximum Applicable Rate shall be accepted and
the Submitted Sell Orders of each Existing Holder shall be accepted, in
both cases only in an amount equal to the difference between (1) the number
of outstanding shares of AMPS then held by such Existing Holder subject to
such Submitted Bid or Submitted Sell Order and (2) the number of shares of
AMPS obtained by multiplying (x) the difference between the Available AMPS
and the aggregate number of outstanding shares of AMPS subject to Submitted
Bids described in Paragraph 10(e)(ii)(A) and Paragraph 10(e)(ii)(B) by (y)
a fraction the numerator of which shall be the number of outstanding shares
of AMPS held by such Existing Holder subject to such Submitted Bid or
Submitted Sell Order and the denominator of which shall be the number of
outstanding shares of AMPS subject to all such Submitted Bids and Submitted
Sell Orders.
(iii) If, as a result of the procedures described in Paragraph 10(e)(i) or
Paragraph 10(e)(ii), any Existing Holder would be entitled or required to sell,
or any Potential Holder would be entitled or required to purchase, a fraction of
a share of AMPS on any Auction Date, the Auction Agent shall, in such manner as
in its sole discretion it shall determine, round up or down the number of shares
of AMPS to be purchased or sold by any Existing Holder or Potential Holder on
such Auction Date so that each outstanding share of AMPS purchased or sold by
each Existing Holder or Potential Holder on such Auction Date shall be a whole
share of AMPS.
105
<PAGE>
(iv) If, as a result of the procedures described in Paragraph 10(e)(i), any
Potential Holder would be entitled or required to purchase less than a whole
share of AMPS on any Auction Date, the Auction Agent, in such manner as in its
sole discretion it shall determine, shall allocate shares of AMPS for purchase
among Potential Holders so that only whole shares of AMPS are purchased on such
Auction Date by any Potential Holder, even if such allocation results in one or
more of such Potential Holders not purchasing any shares of AMPS on such Auction
Date.
(v) Based on the results of each Auction, the Auction Agent shall
determine, with respect to each Broker-Dealer that submitted Bids or Sell Orders
on behalf of Existing Holders or Potential Holders, the aggregate number of the
outstanding shares of AMPS to be purchased and the aggregate number of
outstanding shares of AMPS to be sold by such Potential Holders and Existing
Holders and, to the extent that such aggregate number of outstanding shares to
be purchased and such aggregate number of outstanding shares to be sold differ,
the Auction Agent shall determine to which other Broker-Dealer or Broker-Dealers
acting for one or more purchasers such Broker-Dealer shall deliver, or from
which other Broker-Dealer or Broker-Dealers acting for one or more sellers such
Broker-Dealer shall receive, as the case may be, outstanding shares of AMPS.
Paragraph 10(f) Miscellaneous.
The Fund may interpret the provisions of this Paragraph 10 to resolve any
inconsistency or ambiguity, remedy any formal defect or make any other change or
modification that does not substantially adversely affect the rights of
Beneficial Owners of AMPS. A Beneficial Owner or an Existing Holder (A) may
sell, transfer or otherwise dispose of shares of AMPS only pursuant to a Bid or
Sell Order in accordance with the procedures described in this Paragraph 10 or
to or through a Broker-Dealer, provided that in the case of all transfers other
than pursuant to Auctions such Beneficial Owner or Existing Holder, its
Broker-Dealer, if applicable, or its Agent Member advises the Auction Agent of
such transfer and (B) except as otherwise required by law, shall have the
ownership of the shares of AMPS held by it maintained in book entry form by the
Securities Depository in the account of its Agent Member, which in turn will
maintain records of such Beneficial Owner's beneficial ownership. Neither the
Fund nor any Affiliate (other than Merrill Lynch, Pierce, Fenner & Smith
Incorporated) shall submit an Order in any Auction. Any Beneficial Owner that is
an Affiliate (other than Merrill Lynch, Pierce, Fenner & Smith Incorporated)
shall not sell, transfer or otherwise dispose of shares of AMPS to any Person
other than the Fund. All of the outstanding shares of AMPS shall be represented
by one or more certificates registered in the name of the nominee of the
Securities Depository unless otherwise required by law or unless there is no
Securities Depository. If there is no Securities Depository, at the Fund's
option and upon its receipt of such documents as it deems appropriate, any
shares of AMPS may be registered in the Stock Register in the name of the
Beneficial Owner thereof and such Beneficial Owner thereupon will be entitled to
receive certificates therefor and required to deliver certificates thereof or
upon transfer or exchange thereof.
106
<PAGE>
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<PAGE>
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<PAGE>
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<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............................. 3
Risk Factors and Special Considerations........ 12
Financial Highlights........................... 15
The Fund....................................... 16
Use of Proceeds................................ 16
Capitalization................................. 16
Investment Objective and Policies.............. 17
Description of AMPS............................ 34
Investment Restrictions........................ 57
Directors and Officers......................... 58
Investment Advisory and Administrative
Arrangements................................. 61
Portfolio Transactions......................... 63
Taxes.......................................... 64
Net Asset Value................................ 69
Description of Capital Stock................... 69
Custodian...................................... 72
Plan of Distribution........................... 72
Transfer Agent, Dividend Disbursing Agent and
Registrar.................................... 72
Legal Opinions................................. 72
Independent Auditors........................... 72
Independent Auditors' Report................... 73
Financial Statements........................... 74
Glossary....................................... 84
Appendix I--Ratings of Municipal Bonds and
Commercial Paper............................. 91
Appendix II--Settlement Procedures............. 98
Appendix III--Auction Procedures............... 101
</TABLE>
$
MERRILL LYNCH
MUNICIPAL STRATEGY FUND, INC.
AUCTION MARKET
PREFERRED STOCK ['AMPS(REGISTERED)']
________ SHARES, SERIES A
-------------------------
PROSPECTUS
-------------------------
MERRILL LYNCH & CO.
FEBRUARY , 1998
(Registered)Registered trademark of Merrill Lynch & Co., Inc.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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 fiscal year ended October 31, 1997 and for
the period November 3, 1995 (commencement of operations) to October 31, 1996.
Statements of Changes in Net Assets for the fiscal 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
------
<S> <C> <C> <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 the AMPS of the Registrant. (b)
(e) -- Not applicable.
(f) -- Not applicable.
(g)(1) -- Form of Investment Advisory Agreement between the Registrant and the Investment Advisor. (a)
(2) -- Form of Administration Agreement between the Registrant and the Administrator. (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) -- Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency Agreement between
Registrant and Merrill Lynch Financial Data Services, Inc. ('MLFDS'). (a)
</TABLE>
C-1
<PAGE>
<TABLE>
<S> <C> <C> <C>
(2) -- Form of Auction Agent Agreement between the Registrant and IBJ Schroder Bank & Trust Company. (b)
(3) -- Form of Broker-Dealer Agreement. (b)
(4) -- Form of Letter of Representations. (b)
(5) -- Form of License Agreement relating to the use of the 'Merrill Lynch' name. (a)
(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>
- ------------------
(a) Incorporated by reference to the Registrant's registration statement on Form
N-2, File No. 33-54655 (the 'Common Stock Registration Statement').
(b) Previously filed as an Exhibit to the Registrant's registration statement on
Form N-2, File No. 33-64311 (the 'AMPS Registration Statement') filed under
the Securities Act of 1933, as amended (the '1933 Act').
(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)
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 AMPS Registration
Statement.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Previously provided in connection with Pre-Effective Amendment No. 1 to the
Registrant's AMPS Registration Statement.
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 RECORD HOLDERS
TITLE OF CLASS AT OCTOBER 31, 1997
- ------------------------------------------------------------------------------ ------------------------
<S> <C>
Common Stock, $.10 par value.................................................. 2,270
Preferred Stock, $.10 par value............................................... 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.
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<PAGE>
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, filed as Exhibit
(a)(1) to the Registrant's Common Stock Registration Statement, Article VI of
the Registrant's By-Laws, filed as Exhibit (b) to the Registrant's Common Stock
Registration Statement, and the Investment Advisory Agreement, 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.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF THE INVESTMENT ADVISER.
Fund Asset Management, L.P. (the 'Investment Adviser'), an affiliate of
MLAM, 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 Limited Maturity 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 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, MuniYield Pennsylvania Fund, MuniYield
Quality Fund, Inc., MuniYield Quality Fund II, Inc., Senior High Income
Portfolio, Inc., Taurus MuniCalifornia Holdings, Inc., Taurus MuniNewYork
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
C-3
<PAGE>
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 Bond Fund for Investment and
Retirement, 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); and 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, Princeton Services, Inc. ('Princeton Services')
and Princeton Administrators, L.P. also is P.O. Box 9011, Princeton, New Jersey
08543-9011. The address of MLFD is P.O. Box 9081, Princeton, New Jersey
08543-9081. 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, 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 the Investment Adviser are set forth below as
follows:
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME INVESTMENT ADVISER 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) and President
December 10, 1997); (prior to December 10, 1997) of MLAM; President
President (prior to and Director of Princeton Services; Director of
December 10, 1997) MLFDS; Executive Vice President of ML & Co.
Jeffrey M. Peek.................. President (since President (since December 10, 1997) of MLAM;
December 10, 1997) President and Director (since December 10, 1997)
of MLFDS; Executive Vice President of ML & Co.
Terry K. Glenn................... Executive Vice President Executive Vice President of MLAM; 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 President Senior Vice President of MLAM; Senior Vice
President of Princeton Services.
Vincent R. Giordano.............. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
</TABLE>
C-4
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME INVESTMENT ADVISER VOCATION OR EMPLOYMENT
- --------------------------------- ------------------------- --------------------------------------------------
<S> <C> <C>
Elizabeth A. Griffin............. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Norman R. Harvey................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Michael J. Hennewinkel........... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Philip L. Kirstein............... Senior Vice President, Senior Vice President, General Counsel and
General Counsel and Secretary of MLAM; Senior Vice President,
Secretary General Counsel, Director and Secretary of
Princeton Services
Ronald M. Kloss.................. Senior Vice President and Senior Vice President and Controller of MLAM;
Controller Senior Vice President and Controller of
Princeton Services
Debra Landsman-Yaros............. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services; Vice President
of MLFD
Stephen M.M. Miller.............. Senior Vice President Executive Vice President of Princeton
Administrators L.P.; Senior Vice President of
Princeton Services
Joseph T. Monagle................ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Michael L. Quinn................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services; Managing
Director and First Vice President of Merrill
Lynch from 1989 to 1995
Richard L. Reller................ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services; and Director of
MLFD
Gerald M. Richard................ Senior Vice President and Senior Vice President and Treasurer of MLAM;
Treasurer Senior Vice President and Treasurer of Princeton
Services; Vice President and Treasurer of MLFD
Gregory D. Upah.................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Ronald L. Welburn................ Senior Vice President Senior Vice President of MLAM; 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.
C-5
<PAGE>
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
ITEM 33. UNDERTAKINGS.
Registrant 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-6
<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 29 day 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
Post-Effective Amendment to the Registration Statement has been signed below by
the following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- ------------------
<C> <S> <C>
/s/ ARTHUR ZEIKEL* President and Director (Principal Executive
- ------------------------------------------ Officer)
(Arthur Zeikel)
/s/ GERALD M. RICHARD* Treasurer (Principal Financial and
- ------------------------------------------ Accounting Officer)
(Gerald M. Richard)
/s/ RONALD W. FORBES* Director
- ------------------------------------------
(Ronald W. Forbes)
/s/ CYNTHIA A. MONTGOMERY* Director
- ------------------------------------------
(Cynthia A. Montgomery)
/s/ CHARLES C. REILLY* Director
- ------------------------------------------
(Charles C. Reilly)
/s/ KEVIN A. RYAN* Director
- ------------------------------------------
(Kevin A. Ryan)
/s/ RICHARD R. WEST* Director
- ------------------------------------------
(Richard R. West)
*By: /s/ ARTHUR ZEIKEL December 29, 1997
- ------------------------------------------
(Arthur Zeikel,
Attorney-in-Fact)
</TABLE>
C-7
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -------------------------------------------------------------------------
<S> <C> <C>
27 -- Financial Data Schedule
99(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. 3 to Registration
Statement No. 33-64311 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
