<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 14, 1997
SECURITIES ACT FILE NO. 33-64311
INVESTMENT COMPANY ACT FILE NO. 811-7203
POST-EFFECTIVE AMENDMENT TO REGISTRATION STATEMENT AS STATED BELOW
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] PRE-EFFECTIVE AMENDMENT NO.
[X] POST-EFFECTIVE AMENDMENT NO. 1
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] AMENDMENT NO. 7
(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
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(609) 282-2800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
ARTHUR ZEIKEL
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
COPIES TO:
<TABLE>
<S> <C>
MARK B. GOLDFUS, ESQ. FRANK P. BRUNO, ESQ.
FUND ASSET MANAGEMENT, L.P. BROWN & WOOD LLP
P.O. BOX 9011 ONE WORLD TRADE CENTER
PRINCETON, N.J. 08543-9011 NEW YORK, NEW YORK 10048-0557
</TABLE>
------------------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after
the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If 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. [ ]
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<PAGE> 2
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
CROSS REFERENCE SHEET
PURSUANT TO RULE 404(C)
<TABLE>
<CAPTION>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
- ------------------------------------------------- --------------------------------------------
<C> <S> <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; Experts
21. Brokerage Allocation and Other Practices.... Portfolio Transactions
22. Tax Status.................................. Taxes
23. Financial Statements........................ Financial Statements
PART C--OTHER INFORMATION
</TABLE>
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> 3
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 JANUARY 14, 1997
PROSPECTUS
$62,000,000
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUCTION MARKET PREFERRED STOCK ["AMPS(R)"]
2,480 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 seeking 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 which 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 WHICH 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 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.
(Continued on next page.)
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C> <C> <C>
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PRICE TO SALES PROCEEDS TO
PUBLIC(1) LOAD(2)(3) FUND(1)(4)
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Per Share........................ $25,000 None $25,000
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Total............................ $62,000,000 None $62,000,000
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</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 $186,000 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.
- ---------------
(R)Registered trademark of Merrill Lynch & Co., Inc.
------------------------
MERRILL LYNCH & CO.
------------------------
The date of this Prospectus is February , 1997.
<PAGE> 4
(Continued from previous page)
As of the date of this Prospectus, the Fund has outstanding an aggregate of
1,520 shares of its Auction Market Preferred Stock(R), Series A ("the Series A
AMPS(R)" or "AMPS(C)"), which represents approximately 31% 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 which 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 only may 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> 5
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.
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 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 Fund intends to maintain at least 75%
of its total assets in municipal obligations which 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 which 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. 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. 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 130 other registered management
investment companies. The Investment Adviser also offers
portfolio management and portfolio analysis services to
individuals and institutions. As of December 31, 1996,
the Investment Adviser and MLAM had a total of
approximately $ billion in investment company and
other portfolio assets under management (approximately
$ billion of which were invested in municipal
securities), including accounts of certain affiliates of
the Investment Adviser. See "Investment Advisory and
Administrative Arrangements".
THE OFFERING The Fund is offering an aggregate of 2,480 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".
3
<PAGE> 6
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, 1,520
shares of Series A AMPS representing approximately 31%
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
PERIODS Each Dividend Period for the Series A AMPS will
generally consist of seven days (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. 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
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
which 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 deposi-
4
<PAGE> 7
tory) 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
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.
5
<PAGE> 8
ADVANCE NOTICE OF
ALLOCATION OF TAXABLE
INCOME; INCLUSION OF
TAXABLE INCOME IN
DIVIDENDS Dividends paid by the Fund, to the extent paid from
tax-exempt income earned on municipal obligations, will
be exempt from Federal income taxes, subject to the
possible application of the alternative minimum tax.
However, the Fund is required 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
APPLICABLE RATES Except during a Non-Payment Period, the Applicable Rate
for any Dividend Period for 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, (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
6
<PAGE> 9
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:
<TABLE>
<CAPTION>
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
CREDIT RATINGS REFERENCE RATE REFERENCE
------------------------------------- --NO RATE
MOODY'S S&P 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 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 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,
7
<PAGE> 10
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
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
8
<PAGE> 11
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, thus,
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.
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,
1996, 1940 Act AMPS Asset Coverage with respect to the
shares of Series A AMPS issued and outstanding on that
date was approximately 320%. 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 326%.
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".
9
<PAGE> 12
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 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 Charter".
10
<PAGE> 13
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 Investors Service, 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 which are rated below investment grade or, if not
rated, considered by the Investment Adviser to be of comparable quality. These
securities are regarded as predominantly speculative and investments therein
entail certain risks. See "Investment Objective and Policies". The Fund may
invest in certain tax-exempt securities classified as "private activity bonds"
that may subject certain investors in the Fund to the alternative minimum tax.
See "Taxes--General".
The following table sets forth the average monthly dollar-weighted market
value by S&P rating category of the obligations held by the Fund during the
fiscal year ended October 31, 1996:
<TABLE>
<S> <C>
Rated Obligations......................................... 85.1%
AAA: 31.5%; AA: 11.2%; A: 16.3%; BBB: 20.1%; and BB: 6.0%
Unrated Obligations*...................................... 14.9%
</TABLE>
- ---------------
* Obligations which 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 2.4% are of comparable quality to obligations rated AAA, 4.1%
are of comparable quality to obligations rated AA, 2.6% are of comparable
quality to obligations rated BBB, 4.9% are of comparable quality to
obligations rated BB, and 0.9% are of comparable quality to obligations rated
B. 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 which 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"). The Fund has express limitations on the
percentage of its assets that may be committed to certain of such investments.
Other of such investments have no express quantitative limitations, although
they 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 which have a similar effect on the return to Common Stock
investors as the leveraging of the Fund's portfolio; however, certain derivative
investments will not be taken into account as senior securities (as defined in
the 1940 Act) 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
11
<PAGE> 14
contracts and movements in the price of the security which is the subject of the
hedge and the inability to close futures transactions under certain conditions.
Options transactions involve the potential loss of the opportunity to profit
from any price increase in the underlying security above the option exercise
price or the potential loss of the premium paid for the option. Because of the
anticipated leveraged nature of the Common Stock, hedging transactions will
result in a larger impact on the net asset value of the Common Stock than would
be the case if the Common Stock were not leveraged. OTC options and assets used
to cover OTC options written by the Fund are considered by the staff of the
Securities and Exchange Commission to be illiquid. The illiquidity of such
options or assets may prevent a successful sale of such options or assets,
result in a delay of sale, or reduce the amount of proceeds that might be
otherwise realized. See "Investment Objective and Policies--Options and Futures
Transactions". The Fund intends to apply for ratings of the Preferred Stock from
one or more nationally recognized statistical rating organizations. In order to
obtain these ratings, the Fund may be required to limit its use of hedging
techniques in accordance with the specified guidelines of such rating
organizations.
The Fund's Charter 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. See "Description of Capital Stock--Certain
Provisions of the Charter".
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.
12
<PAGE> 15
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with the annual audit 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 the
independent auditors' report thereon are set forth herein under "Financial
Statements".
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
FOR THE PERIOD
NOVEMBER 3, 1995+ TO
OCTOBER 31, 1996
--------------------
<S> <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.................. $ 10.00
-------
Investment Income -- net........................................................ .68
Realized and unrealized gain on investments -- net.............................. .21
-------
Total from investment operations................................................ .89
-------
Less dividends to Common Stock shareholders:
Investment income -- net...................................................... (.59)
-------
Effect of Preferred Stock activity:++
Dividends to Preferred Stock shareholders:
Investment income -- net.................................................... (.09)
Capital charge resulting from issuance of Preferred Stock..................... (.04)
-------
Total effect of Preferred Stock activity........................................ (.13)
-------
Net asset value per share of Common Stock, end of period........................ $ 10.17
=======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share of Common Stock.............................. 7.81%#
=======
RATIOS TO AVERAGE NET ASSETS:***
Expenses, net of reimbursement.................................................. .53%*
=======
Expenses........................................................................ 1.26%*
=======
Investment income -- net........................................................ 5.40%*
=======
SUPPLEMENTAL DATA:
Net assets, net of Preferred Stock, end of period (in thousands)................ $ 83,573
=======
Preferred Stock outstanding, end of period (in thousands)....................... $ 38,000
=======
Portfolio turnover.............................................................. 234.41%
=======
LEVERAGE:
Asset coverage per $1,000....................................................... $ 3,199
=======
DIVIDEND PER SHARE ON PREFERRED STOCK OUTSTANDING:
Investment Income -- net........................................................ $ 564
=======
</TABLE>
- ---------------
* Annualized
** Total investment returns exclude the effects of the CDSC per share of Common
Stock, if any. The Fund is a continuously offered closed-end fund, the
shares of which are offered at net asset value. Therefore, no separate
market exists for such shares.
*** 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.
13
<PAGE> 16
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 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 $62,000,000.
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, 1996.
<TABLE>
<S> <C>
Shareholders' equity:
Capital Stock (200,000,000 shares authorized)
Preferred Stock, par value $.10 per share (1,520 shares of Series A AMPS
issued and outstanding at $25,000 per share liquidation preference)...... $ 38,000,000
Common Stock, par value $.10 per share (8,218,896 shares issued and
outstanding)............................................................. 821,890
Capital in excess of par value attributable to Common Stock................... 81,271,986
Undistributed investment income--net.......................................... 4,568
Accumulated realized capital losses on investments--net....................... (460,513)
Unrealized appreciation on investments--net................................... 1,934,946
------------
Net assets.................................................................... $121,572,877
===========
</TABLE>
14
<PAGE> 17
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 that may not be changed without a vote of a majority of the Fund's
outstanding voting securities, 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 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 which are rated below investment grade by a
nationally recognized statistical rating organization or, if unrated, are
considered to be of comparable quality by the Investment Adviser. 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 to be 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 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, are 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 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 which
provided such credit enhancement.
15
<PAGE> 18
As noted above, the Fund may invest up to 25% of its assets in Municipal
Bonds which 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, 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 which, 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 which contain a
floating or variable interest rate adjustment formula and an unconditional right
of demand on the part of the holder thereof to receive payment of the unpaid
principal balance plus accrued interest on a short notice period not to exceed
seven days. Participating VRDOs provide the Fund with a specified undivided
interest (up to 100%) in the underlying obligation and the right to demand
payment of the unpaid principal balance plus accrued interest on the
Participating VRDOs from the financial institution on a specified number of
days' notice, not to exceed seven days. There is, however, the possibility that
because of default or insolvency, the demand feature of VRDOs or Participating
VRDOs may not be honored. The Fund has been advised by its counsel that the Fund
should be entitled to treat the income received on Participating VRDOs as
interest from tax-exempt obligations.
The average maturity of the Fund's portfolio securities will vary based
upon the Investment Adviser's assessment of economic and market conditions. The
net asset value of the shares of common stock of a closed-end investment
company, such as the Fund, which invests primarily in fixed-income securities,
changes as the general levels of interest rates fluctuate. When interest rates
decline, the value of a fixed-income portfolio can be expected to rise.
Conversely, when interest rates rise, the value of a fixed-income portfolio can
be expected to decline. Prices of longer-term securities generally fluctuate
more in response to interest rate changes than do short-term or medium-term
securities. These changes in net asset value are likely to be greater in the
case of a fund having a leveraged capital structure, as proposed for 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
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<PAGE> 19
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 for the special tax
treatment afforded regulated investment companies under 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 which 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 debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refinancing of outstanding obligations and obtaining of 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" 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. 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. Industrial development bonds are in most cases revenue bonds and do
not generally constitute the pledge of the credit or taxing power of the issuer
of such bonds. The repayment of the principal and payment of the 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 may also include "moral obligation" bonds which are
normally 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 which are classified as "private
activity bonds" may subject certain investors in the Fund to an alternative
minimum tax. There is no limitation on the percentage of the Fund's assets that
may be invested in Municipal Bonds which may subject certain investors to an
alternative minimum tax. See "Taxes--General". Also included within the general
category of Municipal Bonds are participation certificates issued by government
authorities or entities to
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<PAGE> 20
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 the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which 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 or
otherwise, to redeem or repurchase AMPS or for temporary, extraordinary or
emergency purposes. Borrowings by the Fund (commonly known as "leveraging")
create an opportunity for greater total return since the Fund will not be
required to sell portfolio securities to purchase tendered shares but, at the
same time, increase exposure to capital risk. In addition, borrowed funds are
subject to interest costs that may offset or exceed the return earned on the
borrowed funds. 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 day 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 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
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<PAGE> 21
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 which 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.
Repurchase Agreements. The Fund may invest in 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 or an affiliate thereof. Under such agreements, the seller 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. 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 disposition of the
underlying securities.
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".
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<PAGE> 22
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 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.
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<PAGE> 23
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>
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
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<PAGE> 24
(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 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;
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<PAGE> 25
(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;
(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
23
<PAGE> 26
the foregoing, (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>
MINIMUM MAXIMUM STATE
ISSUE SIZE MAXIMUM OR TERRITORY
($ 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 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.
24
<PAGE> 27
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 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
25
<PAGE> 28
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 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
26
<PAGE> 29
(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 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 and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of Common
Stock, the net asset value of the Common Stock will fluctuate. There can be no
assurance that the Fund's hedging transactions will be effective. 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
only engage in hedging activities from time to time and may not necessarily be
engaging in hedging activities when movements in interest rates occur.
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains 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
27
<PAGE> 30
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
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 which 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 certain financial futures contracts and options thereon solely
for the purpose of hedging its investments in Municipal Bonds against declines
in value and hedging against increases in the cost of securities it intends to
purchase. A financial futures contract obligates the seller of a contract to
deliver and the purchaser of a contract to take delivery of the type of
financial instrument covered by the contract or, in the case of index-based
financial futures contracts, to make and accept a cash settlement, at a specific
future time for a specified price. A sale of financial futures contracts may
provide a hedge against a decline in the value of portfolio securities because
such depreciation may be offset, in whole or in part, by an increase in the
value of the position in the financial futures contracts. A purchase of
financial futures contracts may provide a hedge against an increase in the cost
of securities intended to be purchased because such appreciation may be offset,
in whole or in part, by an increase in the value of the position in the
financial futures contracts.
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker equal to
approximately 5% of the contract amount must be deposited with the broker. This
amount is known as initial margin. Subsequent payments to and from the broker,
called variation margin, are made on a daily basis as the price of the financial
futures contract fluctuates making the long and short positions in the financial
futures contract more or less valuable.
28
<PAGE> 31
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 tax-exempt issues, and purchase and sell put and call options on such
financial futures contracts for the purpose of hedging Municipal Bonds which 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, U.S. Treasury notes, GNMA Certificates and
three-month U.S. Treasury bills.
Subject to policies adopted by the Board of Directors, the Fund also may
engage in transactions in other financial futures contracts and options, such as
financial futures contracts and options on other municipal bond indices which
may become available, if the Investment Adviser should determine that there is
normally 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 ("OTC options").
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. OTC option
transactions are two-party contracts with prices 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 transactions in OTC
options only with member banks of the Federal Reserve System and primary dealers
in U.S. Government securities or with affiliates of such banks or dealers which
have capital of at least $50 million or whose obligations are guaranteed by an
entity having capital of at least $50 million or any other bank or dealer having
capital of at least $150 million or whose obligations are guaranteed by an
entity having capital of at least $150 million. OTC options and assets used to
cover OTC options written by the Fund are considered by the staff of the
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 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
which 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 which 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 which 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
which 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, 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
29
<PAGE> 32
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.
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
Fund may be restricted in engaging in options and futures transactions due to
the requirement that less than 30% of its gross income in each taxable year be
derived from the sale or other disposition of securities held for less than
three months. See "Taxes--Tax Treatment of 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.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a liquid
secondary market for such options or futures. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures transaction. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with which the Fund has an open position in an option or financial
futures contract.
The liquidity of a secondary market in a financial futures contract may be
adversely affected by "daily price fluctuation limits" established by commodity
exchanges which limit the amount of fluctuation in a financial futures contract
price during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
reached or exceeded the daily limit on a number of consecutive trading days.
If it is not possible to close a financial futures position entered into by
the Fund, the Fund would continue to be required to make daily cash payments of
variation margin in the event of adverse price movements. In such a situation,
if the Fund has insufficient cash, it may have to sell portfolio securities to
meet daily variation margin requirements at a time when it may be
disadvantageous to do so.
The successful use of these transactions also depends on the ability of the
Investment Adviser to forecast correctly the direction and extent of interest
rate movements within a given time frame. To the extent these rates remain
stable during the period in which a 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 which 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.
30
<PAGE> 33
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".
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 Schroeder 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 Charter and Articles Supplementary,
including the provisions thereof establishing the AMPS. The Fund's Charter and
the form of
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<PAGE> 34
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 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.
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<PAGE> 35
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 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> 36
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
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<PAGE> 37
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" 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 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.
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<PAGE> 38
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 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
36
<PAGE> 39
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 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.
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<PAGE> 40
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 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
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<PAGE> 41
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 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
39
<PAGE> 42
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, Merrill Lynch was paid service fees by the Fund aggregating $48,107 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".
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".
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<PAGE> 43
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, 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
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<PAGE> 44
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 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,
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<PAGE> 45
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 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
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<PAGE> 46
of its portfolio at October 31, 1996, asset coverage with respect to shares of
Series A AMPS issued and outstanding on that date was approximately 320%. As of
the date of this Prospectus, asset coverage with respect to shares of Series A
AMPS issued and outstanding is approximately 326%. 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".
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
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<PAGE> 47
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 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, 1996, 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 $121,572,877
= = 320%
- ---------------------------- -------------
Senior securities $38,003,592
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 326%.
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 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".
45
<PAGE> 48
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.
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
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<PAGE> 49
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 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 which 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
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<PAGE> 50
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 which 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 which 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 which
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.
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
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<PAGE> 51
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.
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
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<PAGE> 52
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 Charter, whether by merger,
consolidation or otherwise, so as to adversely affect any of the contract rights
expressly set forth in the Charter 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 Charter 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 of AMPS. Unless a higher percentage is provided
for under "--Certain Provisions in the Charter", 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.
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<PAGE> 53
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, provide that the Fund may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Fund except
as may be necessary in connection with borrowings mentioned in investment
restriction (3) above or except as may be necessary in connection with
transactions in financial futures contracts and options thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on
margin).
d. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund may
write, purchase and sell options and futures on Municipal Bonds, U.S.
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 are owned and controlled by ML &
Co. Because of the affiliation of Merrill Lynch with the Fund, the Fund is
prohibited from engaging in certain transactions involving Merrill Lynch except
pursuant to an exemptive order 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 it acts as principal. An exemptive order has
been obtained which 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 may consider in the future
requesting an order permitting other principal transactions with Merrill Lynch,
but there can be no assurance that such application will be made and, if made,
that such order would be granted.
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<PAGE> 54
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 are set forth below. Unless otherwise noted, the
address of each Director and executive officer is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536.
ARTHUR ZEIKEL (64)--President and Director(1)(2)--President of the
Investment Adviser (which term, as used herein, includes its corporate
predecessors) since 1977; President of MLAM (which term, as used herein,
includes its corporate predecessors) since 1977; President and Director of
Princeton Services, Inc. ("Princeton Services") since 1993; Executive Vice
President of ML & Co. since 1990; Director of Merrill Lynch Funds Distributor,
Inc. ("MLFD") since 1977.
RONALD W. FORBES (56)--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 (44)--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 (65)--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 CableVision since 1986.
KEVIN A. RYAN (64)--Director(2)--127 Commonwealth Avenue, Chestnut Hill,
Massachusetts 02167. Founder, current Director and Professor 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 (58)--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), Smith-Corona Corporation (manufacturer of typewriters and word
processors) and Alexander's Inc. (real estate company).
TERRY K. GLENN (56)--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 MLFD since
1986 and Director thereof since 1991; President of Princeton Administrators,
L.P. since 1988.
VINCENT R. GIORDANO (52)--Senior Vice President(1)(2)--Portfolio Manager of
the Investment Adviser and MLAM since 1977 and Senior Vice President of the
Investment Adviser and MLAM since 1984; Vice President of MLAM from 1980 to
1984; Senior Vice President of Princeton Services since 1993.
KENNETH A. JACOB--(45)--Vice President(1)(2)--Vice President of the
Investment Adviser and MLAM since 1984.
ROBERT A. DIMELLA, CFA (30)--Portfolio Manager(1)(2)--Assistant Vice
President of MLAM since 1995; Assistant Portfolio Manager of MLAM from 1993 to
1995; Assistant Portfolio Manager with Prudential Investment Advisors from 1992
to 1993; Research Associate with Prudential Investment Corporation from 1989 to
1992.
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<PAGE> 55
DONALD C. BURKE (36)--Vice President(1)(2)--Vice President and Director of
Taxation of MLAM since 1990; employee of Deloitte & Touche LLP from 1982 to
1990.
GERALD M. RICHARD (47)--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; Treasurer since 1984 and employee of MLFD since 1978.
MARK B. GOLDFUS (49)--Secretary(1)(2)--Vice President of the Investment
Adviser and MLAM since 1985.
- ------------
(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.
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
The Fund pays each Director not affiliated with the Investment Adviser an
annual fee of $2,000 per year plus $400 per meeting attended, together with such
Director's actual out-of-pocket expenses relating to attendance at meetings. The
Fund also compensates members of its Audit Committee, which consists of all of
the Directors not affiliated with the Investment Adviser at a rate of $1,000 per
year. The Chairman of the Audit Committee receives an additional fee of $1,000
per year. An additional fee of $400 was paid to each Director in connection with
an organizational meeting held on August 31, 1995. For the period November 3,
1995 (commencement of operations) to October 31, 1996, fees and expenses paid to
the nonaffiliated Directors of the Fund aggregated $24,645.
The following table sets forth compensation paid by the Fund to the
non-interested Directors for the period November 3, 1995 (commencement of
operations) to October 31, 1996, and for the calendar year ended December 31,
1995 the aggregate compensation paid by all investment companies advised by the
Investment Adviser and its affiliate, MLAM ("FAM/MLAM Advised Funds"), to the
non-interested Directors.
<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
- ---------------------------------------------- ------------ ------------------- ----------------
<S> <C> <C> <C>
Ronald W. Forbes(1)........................... $5,000 None $147,100
Cynthia A. Montgomery(1)...................... $5,000 None $147,100
Charles C. Reilly(1).......................... $5,000 None $269,600
Kevin A. Ryan(1).............................. $5,000 None $147,100
Richard R. West(1)............................ $6,000 None $294,600
</TABLE>
- ------------
(1) The Directors serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Forbes (23 registered investment companies consisting of 36 portfolios); Ms.
Montgomery (23 registered investment companies consisting of 36 portfolios);
Mr. Reilly (41 registered investment companies consisting of 54 portfolios);
Mr. Ryan (23 registered investment companies consisting of 36 portfolios);
and Mr. West (41 registered investment companies consisting of 54
portfolios).
53
<PAGE> 56
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS
The Investment Adviser is an affiliate of MLAM, which is owned and
controlled by ML & Co., a financial services holding company. The Investment
Adviser provides the Fund with investment advisory and management services. The
Investment Adviser or MLAM acts as the investment adviser for over 130 other
registered investment companies. The Investment Adviser also offers portfolio
management and portfolio analysis services to individuals and institutions. As
of December 31, 1996, the Investment Adviser and MLAM had a total of
approximately $ billion in investment company and other portfolio assets
under management (approximately $ billion of which were invested in
municipal securities), including accounts of certain affiliates of the
Investment Adviser. The principal business address of the Investment Adviser is
800 Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement with the Investment Adviser (the
"Investment Advisory Agreement") provides that, subject to the direction 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 Investment Adviser provides the portfolio management for the Fund. Such
portfolio management will consider analyses from various sources (including
brokerage firms with which the Fund does business), make the necessary
investment decisions, and place orders for transactions accordingly. The
Investment Adviser will also be responsible for the performance of certain
administrative and management services for the Fund. Robert A. DiMella, CFA, is
the portfolio manager for the Fund and is primarily responsible for the day-
to-day management of the Fund's portfolio. He has served as an Assistant Vice
President of MLAM since 1995 and a portfolio manager of the Investment Adviser
and MLAM since 1993.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay 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. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of printing proxies, listing fees,
if any, stock certificates and shareholder reports, charges of the Custodian and
the Transfer Agent, Dividend Disbursing Agent and Shareholder Servicing Agent,
charges of any auction agent and broker-dealers in connection with Preferred
Stock of the Fund, expenses of registering shares of Common Stock and Preferred
Stock under Federal and state securities laws, fees and expenses with respect to
any issuance of Preferred Stock or any borrowing, Securities and Exchange
Commission fees, fees and expenses of unaffiliated 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
aggregated $60,526.
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<PAGE> 57
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, the fee paid by the Fund to the Investment Adviser pursuant to the
Investment Advisory Agreement was $446,931 and the fee paid by the Fund pursuant
to the Administration Agreement was $223,466 (based on average daily net assets
of approximately $89.9 million). For this period, the Investment Adviser
voluntarily waived $419,740 of the fee paid by the Fund pursuant to the
Investment Advisory Agreement and voluntarily reimbursed the Fund additional
expenses of $231,006.
Unless earlier terminated as described below, the Investment Advisory and
Administration Agreements will continue in effect for a period of two years from
the date of execution and will remain in effect from year to year thereafter 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 affiliate 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 which 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 U.S. 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 which 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"), which
is a wholly-owned subsidiary of ML & Co., acts as the Fund's transfer agent for
the Common Stock pursuant to a transfer agency, dividend
55
<PAGE> 58
disbursing agency and shareholder servicing agency agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and tender of shares of Common
Stock and the opening and maintenance of shareholder accounts. Pursuant to the
Transfer Agency Agreement, the Fund pays the Transfer Agent an annual fee of
$14.00 per shareholder account, and the Transfer Agent is entitled to certain
nominal miscellaneous charges and reimbursement for out-of-pocket expenses
incurred by it under the Transfer Agency Agreement. For the period November 3,
1995 (commencement of operations) to October 31, 1996, the Fund's payments to
the Transfer Agent pursuant to the Transfer Agency Agreement, including
reimbursement for out-of-pocket expenses, aggregated $71,704. As of December 31,
1996, the Fund had shareholder accounts. At this level of accounts, the
annual fee payable to the Transfer Agent would aggregate approximately $ ,
plus out-of-pocket expenses.
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.
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 which provided 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 primarily 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, the Fund engaged in no
transactions pursuant to such order. An affiliated person of the Fund may serve
as its broker in over-the-counter transactions conducted on an agency basis.
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 the Investment Adviser. The Fund will, however, monitor its trading
so as to comply with certain requirements for qualification as a RIC under the
Code. 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
56
<PAGE> 59
less are excluded. For the period November 3, 1995 (commencement of operations)
to October 31, 1996 the Fund's portfolio turnover rate was 234.41%.
TAXES
GENERAL
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. If 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, 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 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 shall 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 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 shares of a RIC paying
exempt-interest dividends, such as the Fund, is not deductible for Federal
income tax purposes to the extent attributable to exempt-interest dividends.
Each shareholder is advised to consult a tax adviser 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.
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<PAGE> 60
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. 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 Fund shares held for six
months or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividends received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
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. 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, counsel to the Fund, under current law the
manner in which the Fund intends to allocate items of tax-exempt income, net
capital gains, and other taxable income, if any, 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, 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 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
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<PAGE> 61
would be unlikely to prevail. A holder should be aware, however, that the
opinion of Brown & Wood 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. The alternative minimum tax will apply
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference" which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund intends to
purchase such "private activity bonds" and will report to shareholders within 60
days after its taxable year-end the portion of its dividends declared during the
year which constitutes an item of tax preference for alternative minimum tax
purposes. The Code further provides that corporations are subject to an
alternative minimum tax based, in part, on certain differences between taxable
income as adjusted for other tax preferences and the corporation's "adjusted
current earnings", which more closely reflect a corporation's economic income.
Because an exempt-interest dividend paid by the Fund will be included in
adjusted current earnings, a corporate shareholder may be required to pay an
alternative minimum tax on exempt-interest dividends paid by the Fund.
The Fund may invest in high yield securities, as described in the
Prospectus. 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 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 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 on the
Common Stock 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.
59
<PAGE> 62
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.
The Code provides that every shareholder 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.
ENVIRONMENTAL TAX
The Code previously imposed a deductible tax (the "Environmental Tax") on a
corporation's modified alternative minimum taxable income (computed without
regard to the alternative minimum tax net operating loss deduction and the
deduction for the Environmental Tax) at a rate of $12 per $10,000 (0.12%) of
alternative minimum taxable income in excess of $2,000,000. The Environmental
Tax has expired, but may be reinstated in the future. The Environmental Tax was
imposed even if the corporation was not required to pay an alternative minimum
tax because the corporation's regular income tax liability exceeded its minimum
tax liability. The Code provides, however, that a RIC, such as the Fund, would
not be subject to the Environmental Tax. However, exempt-interest dividends paid
by the Fund that create alternative minimum taxable income for corporate
shareholders (as described above) could subject corporate shareholders of the
Fund to the Environmental Tax.
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 financial futures
contracts and interest rate financial 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 these 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.
60
<PAGE> 63
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other disposition
of securities held for less than three months. Accordingly, the Fund may be
restricted in effecting closing transactions within three months after entering
into an option or financial futures contract.
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 specific
questions as to Federal, foreign, state or local taxes.
NET ASSET VALUE
Net asset value per share of Common Stock is determined 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 day during which the NYSE is open
for trading. 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 the preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends, qualifications or terms or conditions of redemption. 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".
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<PAGE> 64
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 December
31, 1996.
<TABLE>
<CAPTION>
AMOUNT
OUTSTANDING
AMOUNT HELD (EXCLUSIVE OF
BY FUND AMOUNT HELD
AMOUNT FOR ITS OWN BY FUND FOR ITS
TITLE OF CLASS AUTHORIZED ACCOUNT OWN ACCOUNT)
- ------------------------------------------------------ ----------- ----------- ---------------
<S> <C> <C> <C>
Common Stock.......................................... 199,960,000 -0- 8,401,936
Auction Market Preferred Stock........................ 40,000 -0- 1,520
</TABLE>
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
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<PAGE> 65
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.
CERTAIN PROVISIONS OF THE CHARTER
The Fund's Charter 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 but only by vote of the holders of at least 66 2/3% of the votes
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 Charter 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 any other corporation,
(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 at least 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 Charter. 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 Charter on file with the Securities and Exchange
Commission for the full text of these provisions.
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<PAGE> 66
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> 67
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, 1996, the related statements of operations and changes in
net assets, and the financial highlights for 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 audit.
We conducted our audit 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 as of October 31, 1996 by
correspondence with the custodian and broker. 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 audit provides 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, 1996, the results of its
operations, the changes in its net assets and the financial highlights for the
period November 3, 1995 to October 31, 1996 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
December 9, 1996
65
<PAGE> 68
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C> <C>
Alabama--2.4% NR* Aaa $ 2,815 Alabama HFA, S/F Home Mortgage Revenue Bonds, Series A-1,
6.60% due 4/01/2019 $ 2,941
Arizona--0.5% A1+ P1 600 Coconino County, Arizona, Pollution Control Corporation
Revenue Bonds (Arizona Public Service--Navajo Project),
VRDN, AMT, Series A, 3.65% due 10/01/2029 (h) 600
Arkansas--1.0% AAA NR* 1,180 Arkansas State Development Finance Authority, S/F Mortgage
Revenue Bonds (Mortgage Backed Securities Program), AMT,
Series D, 6.80% due 1/01/2022 (f)(g) 1,236
California--5.2% BBB- Baa 5,000 Foothill, California, Eastern Transportation Corridor Agency,
Toll Road Revenue Bonds, Senior Lien, Series A, 6.50% due
1/01/2015 (i) 1,600
AAA Aaa 1,750 Los Angeles, California, Wastewater System Revenue Refunding
Bonds, Series D, 5.20% due 11/01/2021 (b) 1,623
AAA Aaa 3,000 San Diego, California, IDR (San Diego Gas and Electric Co.),
Series A, 6.10% due 9/01/2018 (a) 3,092
Colorado--5.3% NR* Aa 2,000 Colorado HFA, S/F Program, AMT, Series D-1, 7.375% due 6/01/2026 2,185
AAA Aaa 3,840 El Paso County, Colorado, Falcon School District No. 49,
UT, 6.50% due 12/01/2015 (a) 4,258
Connecticut--4.0% AA Aa 3,825 Connecticut State, HFA, Housing Mortgage Finance Program
Revenue Bonds, Sub-Series B-1, 6.125% due 5/15/2018 3,892
BBB- NR* 1,000 Connecticut State Health and Educational Facilities Authority
Revenue Bonds (University of New Haven), Series D, 6.70% due
7/01/2026 1,005
Florida--3.6% AA Aa 1,000 Florida HFA, Refunding (Homeowner Mortgage), Series 1B, 5.95%
due 7/01/2014 1,012
NR* Baa1 1,000 Jacksonville, Florida, Health Facilities Authority, IDR
(National Benevolent--Cypress Village), Series A, 6.25% due
12/01/2026 996
BBB+ Baa2 1,000 Nassau County, Florida, PCR, Refunding (ITT Rayonier Inc.
Project), 6.25% due 6/01/2010 1,016
NR* Baa 750 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida
Education and Research Foundation Project), Series A, 6.85%
due 9/01/2013 802
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
Georgia--0.9% AAA Aaa 1,000 Municipal Electric Authority of Georgia (Project One), Sub-Series
A, 6.50% due 1/01/2026 (c) 1,090
Illinois--8.8% NR* NR* 2,000 Beardstown, Illinois, IDR (Jefferson Smurfit Corp. Project),
8% due 10/01/2016 2,121
AAA Aaa 3,630 Illinois Development Finance Authority, PCR, Refunding
(Commerce Edison Company Project), Series D, 6.75% due
3/01/2015 (c) 3,971
AA- Aa3 3,285 Illinois Development Finance Authority Revenue Bonds
(Presbyterian Home Lake), Series B, 6.30% due 9/01/2022 3,367
NR* Baa1 1,250 Illinois Health Facilities Authority Revenue Bonds (Holy Cross
Hospital Project), 6.70% due 3/01/2014 1,284
Indiana--4.3% BBB Baa2 4,900 Indianapolis, Indiana, Airport Authority, Special Facilities
Revenue Bonds (Federal Express Corporation Project), AMT, 7.10%
due 1/15/2017 5,240
Maryland--0.9% A- NR* 1,000 Maryland State Energy Financing Administration, Solid Waste
Disposal Revenue Bonds (Wheelabrator Water Projects), AMT, 6.30%
due 12/01/2010 1,039
</TABLE>
66
<PAGE> 69
<TABLE>
<S> <C> <C> <C> <C>
Massachusetts-- A+ Aa 1,000 Massachusetts State, HFA, S/F Housing Revenue Bonds, Series 41,
5.1% 6.35% due 6/01/2017 1,035
A- NR* 5,000 Massachusetts State Health and Educational Facilities Authority,
Revenue Refunding Bonds (Melrose Wakefield Hospital), Series B,
6.25% due 7/01/2012 5,106
Michigan--6.3% Michigan State Hospital Finance Authority Revenue Bonds:
AAA Aaa 3,100 INFLOS (Sisters of Mercy), 8.717% due 2/15/2022 (d)(e) 3,314
A A 500 Refunding (Detroit Medical Center Obligated Group), Series A,
6.50% due 8/15/2018 522
AAA Aaa 3,600 Western Townships, Michigan, Utilities Authority, Sewer Disposal
System, Crossover Refunding, 6.50% due 1/01/2019 (d) 3,829
Minnesota--0.8% AA+ Aa 1,000 Minnesota State, HFA, S/F Mortgage, Series D, 6% due 1/01/2016 1,012
New Mexico--2.4% BB+ Ba1 2,900 Farmington, New Mexico, PCR, Refunding (Public Service
Company--San Juan Project), Series A, 6.40% due 8/15/2023 2,906
New York--11.7% AAA Aaa 2,000 Metropolitan Transportation Authority, New York, Commuter
Facilities Revenue Bonds, Series A, 6.10% due 7/01/2026 (b) 2,074
BBB+ Baa1 2,500 New York City, New York, GO, Refunding, UT, Series C, 5.875%
due 2/01/2016 2,417
BBB+ Baa1 2,500 New York City, New York, GO, UT, Series F, 5.75% due 2/01/2019 2,365
BB+ Baa2 3,525 New York City, New York, IDA, Special Facility Revenue Bonds
(American Airlines Inc. Project), AMT, 6.90% due 8/01/2024 3,747
A Aa 3,400 New York State Environmental Facilities Corporation, PCR (State
Water Revolving Fund), Series E, 6.50% due 6/15/2014 3,646
North Carolina-- AA Aa 1,500 North Carolina HFA, S/F, Series II, 6.20% due 3/01/2016 1,547
1.3%
Ohio--3.6% 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 1,779
NR* Aa 1,000 Franklin County, Ohio, Hospital Revenue Refunding and
Improvement Bonds (Childrens Hospital Project), Series A,
5.875% due 11/01/2025 995
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) 1,559
Oklahoma--1.4% BBB Baa 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional
Facility Revenue Bonds, 6.60% due 7/01/2010 1,689
Oregon--1.7% NR* Aa 1,630 Oregon State Housing and Community Services Department, S/F
Mortgage Program Revenue Bonds, AMT, Series E, 7.10% due
7/01/2014 1,709
AAA Aaa 1,000 Portland, Oregon, Arena Gas Tax Revenue Bonds, 6.25% due
6/01/2017 (d)(i) 291
</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
HDA Housing Development Authority
HFA Housing Finance Agency
IDA Industrial Development Authority
IDB Industrial Development Board
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
IRS Inverse Rate Securities
M/F Multi-Family
PCR Pollution Control Revenue Bonds
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
67
<PAGE> 70
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C> <C>
Pennsylvania--7.1% AAA Aaa $ 2,950 Keystone Oaks, Pennsylvania, School District, IRS, UT,
Series D, 7.754% due 9/01/2016 (c)(e) $ 2,966
Pennsylvania Economic Development Financing Authority,
Resource Recovery Revenue Bonds:
BBB- NR* 2,500 (Colver Project), AMT, Series D, 7.15% due 12/01/2018 2,619
NR* NR* 2,000 (Northampton Generating), Series A, 6.50% due 1/01/2013 1,961
NR* NR* 1,000 Philadelphia, Pennsylvania, Authority for IDR, Refunding
(Commercial Development--Philadelphia Airport), AMT, 7.75%
due 12/01/2017 1,070
South Carolina-- AAA Aaa 2,000 Fairfield County, South Carolina, PCR (South Carolina Gas and
3.1% Electric Co.), 6.50% due 9/01/2014 (a) 2,188
A- A1 1,500 Richland County, South Carolina, Solid Waste Disposal
Facilities Revenue Bonds (Union Camp Corporation Project),
AMT, Series A, 6.75% due 5/01/2022 1,589
Tennessee--0.5% AA- Aa3 620 Humphreys County, Tennessee, IDB, Solid Waste Disposal Revenue
Bonds (E.I. DuPont de Nemours & Co. Project), AMT, 6.70% due
5/01/2024 664
Texas--10.2% A- A 5,760 Harris County, Texas, Health Facilities Development Corporation,
Hospital Revenue Bonds (Memorial Hospital Systems Project),
Series A, 6.625% due 6/01/2024 6,036
AAA Aaa 1,000 Harris County, Texas, Refunding (Toll Road), Senior Lien, 5.375%
due 8/15/2020 (b) 958
AAA Aaa 2,600 Red River Authority, Texas, PCR, Refunding (West Texas Utilities
Co.--Public Service Co. of Oklahoma--Central Power and Light
Co.), 6% due 6/01/2020 (a) 2,674
AAA Aaa 2,500 Texas State Municipal Power Agency, Revenue Refunding Bonds,
Series A, 6.75% due 9/01/2012 (c) 2,772
Utah--0.2% NR* P1 200 Salt Lake County, Utah, PCR, Refunding (Service Station
Holdings Project), VRDN, 3.60% due 2/01/2008 (h) 200
Virginia--3.1% NR* NR* 1,700 Richmond, Virginia, IDA, Museum Facilities Revenue Refunding
Bonds (Virginia Historical Society Project), 6.25% due 9/01/2016 1,681
AA+ Aa1 2,000 Virginia State, HDA, M/F Housing, Series B, 5.95% due 5/01/2016 2,019
Wyoming--1.7% BBB Baa2 2,000 Sweetwater County, Wyoming, Solid Waste Disposal Revenue
Bonds (FMC Corporation Project), AMT, Series A, 7% due 6/01/2024 2,119
Puerto Rico--1.9% BBB+ Baa1 2,500 Puerto Rico Electric Power Authority Revenue Bonds, 5.25% due
7/01/2021 2,290
Total Investments (Cost--$118,383)--99.0% 120,318
Other Assets Less Liabilities--1.0% 1,255
--------
Net Assets--100.0% $121,573
========
<FN>
(a)MBIA Insured.
(b)FGIC Insured.
(c)AMBAC Insured.
(d)FSA Insured.
(e)The interest rate is subject to change periodically and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at October 31, 1996.
(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, 1996.
(i)Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
</TABLE>
68
<PAGE> 71
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of October 31, 1996
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$118,382,975) (Note 1a) $120,317,921
Cash 93,817
Receivables:
Interest $ 2,138,178
Capital shares sold 192,616 2,330,794
------------
Deferred organization expenses (Note 1e) 249,048
Prepaid expenses and other assets (Note 1e) 71,191
------------
Total assets 123,062,771
------------
Liabilities: Payables:
Securities purchased 989,690
Dividends to shareholders (Note 1f) 190,131
Administration fees (Note 2) 25,354
Investment advisory fees (Note 2) 15,213 1,220,388
------------
Accrued expenses and other liabilities 269,506
------------
Total liabilities 1,489,894
------------
Net Assets: Net assets $121,572,877
============
Capital: Capital Stock (200,000,000 shares authorized) (Note 4):
Preferred Stock, par value $.10 per share (1,520 shares of
AMPS* issued and outstanding at $25,000
per share liquidation preference) $ 38,000,000
Common Stock, par value $.10 per share (8,218,896 shares
issued and outstanding) $ 821,890
Paid-in capital in excess of par 81,271,986
Undistributed investment income--net 4,568
Accumulated realized capital losses on investments--net (Note 5) (460,513)
Unrealized appreciation on investments--net 1,934,946
------------
Total--Equivalent to $10.17 net asset value per share of Common Stock 83,572,877
------------
Total capital $121,572,877
============
<FN>
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
69
<PAGE> 72
<TABLE>
STATEMENTS OF OPERATIONS
<CAPTION>
For the Period November 3, 1995++ to October 31, 1996
<S> <C> <C> <C>
Investment Interest and amortization of premium and discount earned $ 5,319,253
Income (Note 1d):
Expenses: Investment advisory fees (Note 2) $ 446,931
Administrative fees (Note 2) 223,466
Registration fees 87,541
Transfer agent fees 71,704
Amortization of organization expenses (Note 1e) 61,964
Accounting services (Note 2) 60,526
Commission fees 48,107
Professional fees 41,000
Listing fees 34,941
Directors' fees and expenses 24,645
Custodian fees 11,606
Printing and shareholder reports 10,467
Pricing fees 5,974
------------
Total expenses before reimbursement 1,128,872
Reimbursement of expenses (Note 2) (650,746)
------------
Total expenses after reimbursement 478,126
------------
Investment income--net 4,841,127
------------
Realized & Realized loss on investments--net (460,513)
Unrealized Gain Unrealized appreciation on investments--net 1,934,946
(Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 6,315,560
(Notes 1b, 1d & 3): ============
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
70
<PAGE> 73
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Period
Nov. 3, 1995++
Increase (Decrease) in Net Assets: to Oct. 31, 1996
<S> <C> <C>
Operations: Investment income--net $ 4,841,127
Realized loss on investments--net (460,513)
Unrealized appreciation on investments--net 1,934,946
------------
Net increase in net assets resulting from operations 6,315,560
------------
Dividends to Investment income--net:
Shareholders Common Stock (4,173,956)
(Note 1f): Preferred Stock (662,603)
------------
Net decrease in net assets resulting from dividends to shareholders (4,836,559)
------------
Capital Stock Proceeds from issuance of Preferred Stock 38,000,000
Transactions Net increase in net assets derived from Common Stock transactions 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 119,993,876
------------
Net Assets: Total increase in net assets 121,472,877
Beginning of period 100,000
------------
End of period* $121,572,877
============
<FN>
*Undistributed investment income--net $ 4,568
============
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
71
<PAGE> 74
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. For the Period
Nov. 3, 1995++ to
Increase (Decrease) in Net Asset Value: Oct. 31, 1996
<S> <C> <C>
Per Share Net asset value, beginning of period $ 10.00
Performance: ------------
Investment income--net .68
Realized and unrealized gain on investments--net .21
------------
Total from investment operations .89
------------
Less dividends to Common Stock shareholders:
Investment income--net (.59)
------------
Effect of Preferred Stock activity:++++
Dividends to Preferred Stock shareholders:
Investment income--net (.09)
Capital charge resulting from issuance of Preferred Stock (.04)
------------
Total effect of Preferred Stock activity (.13)
------------
Net asset value, end of period $ 10.17
============
Total Investment Based on net asset value per share 7.81%+++
Return:** ============
Ratios to Average Expenses, net of reimbursement .53%*
Net Assets:*** ============
Expenses 1.26%*
============
Investment income--net 5.40%*
============
Supplemental Net assets, net of Preferred Stock, end of period (in thousands) $ 83,573
Data: ============
Preferred Stock outstanding, end of period (in thousands) $ 38,000
============
Portfolio turnover 234.41%
============
Leverage: Asset coverage per $1,000 $ 3,199
============
Dividends Investment income--net $ 564
Per Share on ============
Preferred Stock
Outstanding:
<FN>
*Annualized.
**Total investment returns exclude the effects of the early
withdrawal charge, if any. The Fund is a continuously offered,
closed-end fund, the shares of which are offered at net asset value.
Therefore, no separate market exists for such shares.
***Do not reflect the effect of dividends to Preferred Stock
shareholders.
++Commencement of Operations.
++++The Fund's Preferred Stock was issued on March 11, 1996.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
72
<PAGE> 75
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 municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Options, which
are traded on exchanges, are valued at their last sale price as of
the close of such exchanges or, lacking any sales, at the last
available bid price. Short-term investments with remaining
maturities of sixty days or less are valued at amortized cost, which
approximates market value. Securities and assets for which market
quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of
Directors of the Fund, including valuations furnished by a pricing
service retained by the Fund, which may utilize a matrix system for
valuations. The procedures of the pricing service and its valuations
are reviewed by the officers of the Fund under the general
supervision of the Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
interest rate futures contracts and options on such futures
contracts for the purpose of hedging the market risk on existing
securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial
margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from
or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are
known as variation margin and are recorded by the Fund as unrealized
gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of
the contract at the time it was opened and the value at the time it
was closed.
* Options--The Fund is authorized to write covered call options and
purchase put options. When the Fund writes an option, an amount
equal to the premium received by the Fund is reflected as an asset
and an equivalent liability. The amount of the liability is
subsequently marked to market to reflect the current market value of
the option written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization and offering expenses--Deferred
organization expenses are amortized on a straight-line basis over a
five-year period beginning with the commencement of operations.
Direct expenses relating to the public offering of the Preferred
73
<PAGE> 76
NOTES TO FINANCIAL STATEMENTS (concluded)
Stock were charged to capital at the time of issuance. Prepaid
registration fees are charged to expense as the related shares are
issued.
(f) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates.
2. Investment Advisory Agreement and Transactions
with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of 0.50% of
the Fund's average daily net assets.
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
perfomance of administrative services (other than investment advice
and related portfolio activities) necessary for the operation of the
Fund. For the period November 3, 1995 to October 31, 1996, FAM
earned fees of $446,931, of which $419,740 was voluntarily waived.
FAM also voluntarily reimbursed the Fund additional expenses of
$231,006.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, Merrill Lynch, Pierce, Fenner & Smith Inc.
("MLPF&S"), MLFDS, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the period November 3, 1995 to October 31, 1996 were
$300,970,894 and $205,009,562, respectively.
Net realized and unrealized gains (losses) as of October 31, 1996
were as follows:
Realized Unrealized
Gains (Losses) Gains
Long-term investments $ (1,101,657) $ 1,934,946
Financial futures contracts 641,144 --
------------ ------------
Total $ (460,513) $ 1,934,946
=========== ===========
As of October 31, 1996, net unrealized appreciation for Federal
income tax purposes aggregated $1,914,325, of which $2,024,224
related to appreciated securities and $109,899 related to
depreciated securities. The aggregate cost of investments at October
31, 1996 for Federal income tax purposes was $118,403,596.
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
74
<PAGE> 77
shares of capital stock without approval of the holders of Common Stock.
Transactions in Common Stock were as follows:
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 redeemed (199,672) (1,980,112)
----------- -----------
Net increase 8,208,896 $82,293,876
=========== ===========
[FN]
++Prior to November 3, 1995 (commencement of operations), the Fund
issued 10,000 shares to FAM for $100,000.
Preferred Stock
Auction Market Preferred Stock ("AMPS") are shares of Preferred
Stock of the Fund that entitle their holders to receive cash
dividends at an annual rate that may vary for the successive
dividend periods. The yield in effect at October 31, 1996 was 3.45%.
In connection with the offering of AMPS, the Board of Directors
reclassified 1,520 shares of unissued capital stock as AMPS. As of
October 31, 1996, there were 1,520 AMPS shares authorized, issued
and outstanding with a liquidation preference of $25,000 per share.
The Fund pays commissions to certain broker dealers at the end of
each auction at an annual rate ranging from 0.25% to 0.375%,
calculated on the proceeds of each auction. For the period November
3, 1995 to October 31, 1996, MLPF&S, an affiliate of FAM, earned
$48,107 as commissions.
5. Capital Loss Carryforward:
At October 31, 1996, the Fund had a net capital loss carryforward of
approximately $355,000, all of which expires in 2004. This amount
will be available to offset like amounts of any future taxable gain.
75
<PAGE> 78
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 44 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 46 of
this Prospectus.
"AMPS Basic Maintenance Cure Date " has the meaning set forth on page 45 of
this Prospectus.
"AMPS Basic Maintenance Report " has the meaning set forth on page 46 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 34 to 35 of
this Prospectus.
"Applicable Rate " means the rate per annum at which cash dividends are
payable on shares of AMPS for any Dividend Period.
"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.
76
<PAGE> 79
"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 33 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.
"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
77
<PAGE> 80
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 40 of this
Prospectus.
"Dividend Periods " has the meaning set forth on page 40 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 26 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.
"Mandatory Redemption Price " has the meaning set forth on page 47 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 page 46 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 23 of this
Prospectus.
"Moody's Eligible Assets " has the meaning set forth on page 23 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 25 of
this Prospectus.
78
<PAGE> 81
"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 or equal to) 5% 292%
(greater than) 5% but (less or equal to) 10% 313%
(greater than) 10% but (less or equal to) 15% 338%
(greater than) 15% but (less or equal to) 20% 364%
(greater than) 20% but (less or equal to) 25% 396%
(greater than) 25% but (less or equal to) 30% 432%
(greater than) 30% but (less or equal to) 35% 472%
(greater than) 35% but (less 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 15 of this Prospectus.
"Municipal Index " has the meaning set forth on page 22 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 45 of
this Prospectus.
"1940 Act Cure Date " has the meaning set forth on page 45 of this
Prospectus.
"Non-Call Period " has the meaning set forth under "Specific Redemption
Provisions" below.
"Non-Payment Period " has the meaning set forth on page 43 of this
Prospectus.
"Non-Payment Period Rate " has the meaning set forth on page 43 of this
Prospectus.
"Notice of Revocation " has the meaning set forth on page 42 of this
Prospectus.
"Notice of Special Dividend Period " has the meaning set forth on page 42
of this Prospectus.
"Optional Redemption Price " has the meaning set forth on page 47 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
Provisions" below.
"Receivables for Municipal Bonds Sold, " for purposes of determining S&P
Eligible Assets, has the meaning set forth on page 21 of this Prospectus.
"Receivables for Municipal Bonds Sold, " for purposes of determining
Moody's Eligible Assets, has the meaning set forth on page 24 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 "AA"
Composite Commercial Paper Rate and the Taxable
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<PAGE> 82
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 41
of this Prospectus.
"Response " has the meaning set forth on page 41 of this Prospectus.
"Retroactive Taxable Allocation " has the meaning set forth on page 44 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 21 of this
Prospectus.
"S&P Eligible Assets " has the meaning set forth on page 20 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 22 of this
Prospectus.
"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.
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<PAGE> 83
"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 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 22 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 45 of this Prospectus.
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"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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APPENDIX A
RATINGS OF MUNICIPAL BONDS AND COMMERCIAL PAPER
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ("MOODY'S") MUNICIPAL BOND
RATINGS
Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge". Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa--Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present, but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa--Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca--Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C--Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Con. (. . .)--Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
Short-term Notes and Variable Rate Demand Obligations: The four ratings of
Moody's for short-term notes and VRDOs are MIG-1/VMIG-1, MIG-2/VMIG-2,
MIG-3/VMIG-3, and MIG-4/VMIG-4; MIG-1/VMIG-1 denotes "best quality, enjoying
strong protection from established cash flows"; MIG-2/VMIG-2 denotes "high
quality" with "ample margins of protection"; MIG-3/VMIG-3 instruments
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are of "favorable quality . . . but lacking the undeniable strength of the
preceding grades"; MIG-4/VMIG-4 instruments are of "adequate quality, carrying
specific risk but having protection . . . and not distinctly or predominantly
speculative".
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
PRIME-1 Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term promissory obligations.
Prime-1 repayment ability will often be evidenced by the following
characteristics: leading market positions in well established industries;
high rates of return on funds employed; conservative capitalization
structure with moderate reliance on debt and ample asset protection; broad
margins in earnings coverage of fixed financial charges and high internal
cash generation; and with well-established access to a range of financial
markets and assured sources of alternate liquidity.
PRIME-2 Issuers rated Prime-2 (or supporting institutions) have a
strong ability for repayment of senior 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.
PRIME-3 Issuers rated Prime-3 (or supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effects 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.
NOT PRIME Issuers rated Not Prime do not fall within any of the Prime
rating categories.
If an issuer represents to Moody's that its Commercial Paper obligations
are supported by the credit of another entity or entities, then the name or
names of such supporting entity or entities are listed within the parentheses
beneath the name of the issuer, or there is a footnote referring the reader to
another page for the name or names of the supporting entity or entities. In
assigning ratings to such issuers, Moody's evaluates the financial strength of
the affiliated corporations, commercial banks, insurance companies, foreign
governments or other entities, but only as one factor in the total rating
assessment. Moody's makes no representations and gives no opinion on the legal
validity or enforceability of any support arrangement. You are cautioned to
review with your counsel any questions regarding particular support
arrangements.
DESCRIPTION OF STANDARD & POOR'S RATINGS SERVICES ("S&P") MUNICIPAL DEBT RATINGS
An S&P municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers, or
lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources S&P 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 for other
circumstances.
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The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default-capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, 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.
AAA Debt rated "AAA" has the highest rating assigned by S&P's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small
degree.
A Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in
higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher-rated categories.
BB, B, CCC, CC, C Debt rated "BB", "B", "CCC", "CC" and "C" is
regarded, on balance, as predominately speculative with respect to capacity
to pay interest and repay principal in accordance with the terms of the
obligation. "BB" indicates the lowest degree of speculation and "C" the
highest degree of speculation. While such debt will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
C1 The rating "C1" is reserved for income bonds on which no interest
is being paid.
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's
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 if debt
service payments are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF S&P'S COMMERCIAL PAPER RATINGS
An S&P's commercial paper rating is a current assessment of the likelihood
of timely payment of debt considered short-term in the relevant market.
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:
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 (+) designation.
A-2--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1".
A-3--Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher
designations.
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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's
believes that such payments will be made during such grace period.
A commercial paper rating is not a recommendation to purchase, sell or hold
a security inasmuch as it does not comment as to market price or suitability for
a particular investor. The ratings are based on current information furnished to
S&P's by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not conduct 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.
A S&P's municipal note rating reflects the liquidity concerns and market
access risks unique to such 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>
<C> <S>
SP-1 A very strong, or strong, capacity to pay principal and interest. Issues
that possess overwhelming safety characteristics will be given a "+"
designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
</TABLE>
DESCRIPTION OF FITCH INVESTORS SERVICE, INC.'S ("FITCH") INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guarantees unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
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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.
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.
Credit Trend Indicator: Credit trend indicators show whether credit fundamentals
are improving, stable, declining, or uncertain, as follows:
<TABLE>
<S> <C>
Improving (up arrow)
Stable (left and right arrow)
Declining (down arrow)
Uncertain (up and down arrow)
</TABLE>
Credit trend indicators are not predictions that any rating change will occur,
and have a longer-term time frame than issues placed on FitchAlert.
NR indicates that Fitch does not rate the specific issue.
CONDITIONAL: A conditional rating is premised on the successful completion
of a project or the occurrence of a specific event.
SUSPENDED: A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
WITHDRAWN: A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to furnish proper
and timely information.
FITCHALERT: Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the likely direction
of such change. These are designated as "Positive" indicating a potential
upgrade, "Negative" for potential downgrade, or "Evolving" where ratings may be
raised or lowered. FitchAlert is relatively short-term, and should be resolved
within three to 12 months.
RATINGS OUTLOOK: An outlook is used to describe the most likely direction
of any rating change over the intermediate term. It is described as "Positive"
or "Negative". The absence of a designation indicates a stable outlook.
DESCRIPTION OF FITCH'S SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely
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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.
It should be noted that issues 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.
BB--Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B--Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC--Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
CC--Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C--Bonds are in imminent default in payment of interest or principal.
DDD, DD, and D--Bonds are in default on interest and/or principal payments.
Such bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on these bonds, and "D" represents
the lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD," "DD," or "D" categories.
DESCRIPTION OF FITCH'S SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short-term ratings are as follows:
<TABLE>
<C> <S>
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.
</TABLE>
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<TABLE>
<C> <S>
F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate;
however, near-term adverse changes could cause these securities to be rated
below investment grade.
F-4 Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are vulnerable
to near-term adverse changes in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent payment
default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit
issued by a commercial bank.
</TABLE>
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<PAGE> 92
APPENDIX B
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 B 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 C 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 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;
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<PAGE> 93
(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;
(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.
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<PAGE> 94
(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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<PAGE> 95
APPENDIX C
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 C 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.
(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
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<PAGE> 96
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.
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
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<PAGE> 97
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 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
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<PAGE> 98
(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 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.
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<PAGE> 99
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
(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.
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PARAGRAPH 10(E) ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL
ORDERS 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 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;
98
<PAGE> 101
(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.
(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
99
<PAGE> 102
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.
100
<PAGE> 103
[THIS PAGE INTENTIONALLY LEFT BLANK]
101
<PAGE> 104
[THIS PAGE INTENTIONALLY LEFT BLANK]
102
<PAGE> 105
- ------------------------------------------------------
- ------------------------------------------------------
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....................... 11
Financial Highlights................... 13
The Fund............................... 14
Use of Proceeds........................ 14
Capitalization......................... 14
Investment Objective and Policies...... 15
Description of AMPS.................... 31
Investment Restrictions................ 50
Directors and Officers................. 52
Investment Advisory and Administrative
Arrangements......................... 54
Portfolio Transactions................. 56
Taxes.................................. 57
Net Asset Value........................ 61
Description of Capital Stock........... 61
Custodian.............................. 64
Plan of Distribution................... 64
Transfer Agent, Dividend Disbursing
Agent and Registrar.................. 64
Legal Opinions......................... 64
Independent Auditors................... 64
Independent Auditors' Report........... 65
Financial Statements................... 66
Glossary............................... 76
Appendix A--Ratings of Municipal Bonds
and Commercial Paper................. 83
Appendix B--Settlement Procedures...... 90
Appendix C--Auction Procedures......... 93
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
$62,000,000
MERRILL LYNCH MUNICIPAL
STRATEGY FUND, INC.
AUCTION MARKET PREFERRED STOCK
["AMPS"(R)]
2,480 SHARES, SERIES A
------------------------
PROSPECTUS
------------------------
MERRILL LYNCH & CO.
FEBRUARY , 1997
(R)Registered trademark of Merrill Lynch & Co., Inc.
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 106
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents fair
and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission File due to ASCII-incompatibility and cross-
references this material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------------- -----------------------------
Compass plates, circular graph Back cover of Prospectus.
paper and Merrill Lynch Logo
including stylized market bull.
<PAGE> 107
PART C.
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) FINANCIAL STATEMENTS
Financial Highlights for the period November 3, 1995 (commencement of
operations) to October 31, 1996.
Schedule of Investments as of October 31, 1996.
Statement of Assets, Liabilities and Capital as of October 31, 1996.
Statement of Operations for the period November 3, 1995 (commencement of
operations) to October 31, 1996.
Statement of Changes in Net Assets for the period November 3, 1995
(commencement of operations) to October 31, 1996.
(2) EXHIBITS:
<TABLE>
<C> <C> <S>
(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") of the Registrant. (b)
(b) -- By-Laws of the Registrant. (a)
(c) -- Not applicable.
(d)(1) -- Portions of the Articles of Incorporation, By-Laws and the
Articles Supplementary 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 Adviser. (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 the Registrant and Merrill
Lynch Financial Data Services, Inc. ("MLFDS"). (a)
(2) -- Form of Auction Agent Agreement between the Registrant and IBJ
Schroder Bank & Trust Company. (b)
</TABLE>
C-1
<PAGE> 108
<TABLE>
<S> <C> <C>
(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 DECEMBER 31, 1996
- ------------------------------------------------------------------------- ---------------------
<S> <C>
Common Stock, $.10 par value.............................................
Preferred Stock, $.10 par value..........................................
</TABLE>
- ------------------
Note: The number of holders shown above includes holders of record plus
beneficial owners whose shares are held of record by Merrill Lynch.
C-2
<PAGE> 109
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"), acts as investment
adviser for the following open-end 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 investment companies: Apex
Municipal Fund, Inc., Corporate High Yield Fund, Inc., Corporate High Yield Fund
II, Inc., Income Opportunities Fund 1999, Inc., Income Opportunities Fund 2000,
Inc., Merrill Lynch Municipal Strategy Fund, Inc., MuniAssets Fund, Inc.,
MuniEnhanced Fund, Inc., MuniInsured Fund, Inc., MuniVest California Insured
Fund, Inc., MuniVest Florida Fund, MuniVest Fund, Inc., MuniVest Fund II, Inc.,
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 Insured Fund II, 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, Inc., MuniYield New York Insured Fund III,
Inc., MuniYield Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield
Quality Fund II, Inc., Senior High Income Portfolio, Inc., Taurus MuniCalifornia
Holdings, Inc., Taurus MuniNew York Holdings, Inc. and Worldwide DollarVest
Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the
Investment Adviser, acts as the investment adviser for the following open-end
investment companies: Merrill Lynch Adjustable Rate Securities Fund, Inc.,
Merrill Lynch Americas Income Fund, Inc., Merrill Lynch Asset Builder Program,
C-3
<PAGE> 110
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 Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill
Lynch Fundamental Growth Fund, Inc., Merrill Lynch Fund For Tomorrow, Inc.,
Merrill Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch
Global Allocation Fund, Inc., Merrill Lynch Global Convertible 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 Institutional Intermediate 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 for the following
closed-end investment companies: Convertible Holdings, Inc., Merrill Lynch High
Income Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating Rate Fund,
Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch Funds
for Institutions Series and Merrill Lynch Institutional Intermediate Fund is One
Financial Center, 15th 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 North Tower, World Financial Center, 250 Vesey Street, New York, New
York 10281-1213. The address of 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 or her or its own account or in the capacity of
director, officer, employee, partner or trustee. In addition, Mr. Zeikel is
President, Mr. Richard is Treasurer and Mr. Glenn is Executive Vice President of
all or substantially all of the investment companies described in the preceding
paragraph and also hold the same positions 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, Hewitt 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,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- -------------------------- ----------------------------------------
<S> <C> <C>
ML & Co.................. Limited Partner Financial Services Holding Company;
Limited Partner of FAM
Princeton Services....... General Partner General Partner of MLAM
Arthur Zeikel............ President President and Director of MLAM;
President and Director of Princeton
Services; Director of MLFD; 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 MLFDS; President of
Princeton Administrators, L.P.;
Director of MLFDS
</TABLE>
C-4
<PAGE> 111
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- -------------------------- ----------------------------------------
<S> <C> <C>
Vincent R. Giordano...... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Elizabeth 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
N. John Hewitt........... 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
General Counsel and and Secretary of MLAM; Senior Vice
Secretary President, General Counsel, Director
and Secretary of Princeton Services;
Director of MLFD
Ronald M. Kloss.......... Senior Vice President and Senior Vice President and Controller of
Controller MLAM; Senior Vice President and
Controller of Princeton Services
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, Pierce,
Fenner & Smith Incorporated from 1989
to 1995
Richard L. Reller........ Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Gerald M. Richard........ Senior Vice President and Senior Vice President and Treasurer of
Treasurer MLAM; Senior Vice President and
Treasurer of Princeton Services; Vice
President and Treasurer of MLFD
Ronald L. Welburn........ Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Anthony Wiseman.......... 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 and the rules promulgated
thereunder are maintained at the offices of the Registrant
C-5
<PAGE> 112
(800 Scudders Mill Road, Plainsboro, New Jersey 08536), the Investment Adviser
(800 Scudders Mill Road, Plainsboro, New Jersey 08536), and the Registrant's
custodian and transfer agent.
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
ITEM 33. UNDERTAKINGS.
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> 113
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 14th day of January, 1997.
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
(Registrant)
By: /s/ TERRY K. GLENN
------------------------------------------
(Terry K. Glenn, Executive Vice 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>
SIGNATURES TITLE DATE
- ------------------------------------- ------------------------------------- ------------------
<S> <C> <C>
ARTHUR ZEIKEL* President and Director (Principal
- ------------------------------------- Executive Officer)
(Arthur Zeikel)
GERALD M. RICHARD* Treasurer (Principal Financial and
- ------------------------------------- Accounting Officer)
(Gerald M. Richard)
RONALD W. FORBES* Director
- -------------------------------------
(Ronald W. Forbes)
CYNTHIA A. MONTGOMERY* Director
- -------------------------------------
(Cynthia A. Montgomery)
CHARLES C. REILLY* Director
- -------------------------------------
(Charles C. Reilly)
KEVIN A. RYAN* Director
- -------------------------------------
(Kevin A. Ryan)
RICHARD R. WEST* Director
- -------------------------------------
(Richard R. West)
*By: /s/ TERRY K. GLENN January 14, 1997
- -------------------------------------
(Terry K. Glenn,
Attorney-in-Fact)
</TABLE>
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<PAGE> 114
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBITS DESCRIPTION
-------- ----------------------------------------------------------
<C> <C> <S> <C>
(n) -- Consent of Deloitte & Touche LLP, independent auditors for
the Registrant............................................
(r) -- Financial Data Schedule...................................
</TABLE>
<PAGE> 1
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Municipal Strategy Fund, Inc.
We consent to the use in Post-Effective Amendment No. 1 to Registration
Statement No. 33-64311 of our report dated December 9, 1996 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
January 14, 1997
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000927121
<NAME> MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> OCT-31-1996
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