<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 30, 1997
SECURITIES ACT FILE NO. 333-19479
INVESTMENT COMPANY ACT FILE NO. 811-07203
POST-EFFECTIVE AMENDMENT TO REGISTRATION STATEMENT AS STATED BELOW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X] PRE-EFFECTIVE AMENDMENT NO. 1
[ ] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] AMENDMENT NO. 8
(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 statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
<TABLE>
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
MAXIMUM
MAXIMUM AGGREGATE AMOUNT OF
TITLE OF SECURITIES AMOUNT BEING OFFERING PRICE OFFERING REGISTRATION
BEING REGISTERED REGISTERED PER UNIT PRICE(1) FEE(2)
- -------------------------------------------------------------------------------------------------
Common Stock ($.10 par value) 10,000,000 shares $10.11 $100,773,871.6 $30,537.54(3)
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
</TABLE>
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457 under the Securities Act of 1933.
(2) Transmitted prior to the filing date to the designated lockbox at Mellon
Bank in Pittsburgh, PA.
(3) The amount of the registration fee does not include $4,627.38 which has
previously been paid to the Commission for registration fees relating to
1,341,940 shares registered pursuant to Securities Act File No. 33-54655 and
unissued as of January 28, 1997, nor does it include $100.00 which has
previously been paid to the Commission for registration fees relating to
32,258 shares registered pursuant to Securities Act File No. 333-19479 and
unissued as of January 28, 1997.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY
DETERMINE.
PURSUANT TO RULE 429 UNDER THE SECURITIES ACT, THE PROSPECTUS IN THIS
REGISTRATION STATEMENT IS A COMBINED PROSPECTUS AND RELATES TO REGISTRATION
STATEMENT NO. 33-54655, AS AMENDED, PREVIOUSLY FILED BY THE REGISTRANT ON FORM
N-2. THIS REGISTRATION STATEMENT ALSO CONSTITUTES POST-EFFECTIVE AMENDMENT NO. 2
TO REGISTRATION STATEMENT NO. 33-54655, AND SUCH POST-EFFECTIVE AMENDMENT SHALL
HEREAFTER BECOME EFFECTIVE CONCURRENTLY WITH THE EFFECTIVENESS OF THIS
REGISTRATION STATEMENT AND IN ACCORDANCE WITH SECTION 8(C) OF THE SECURITIES
ACT. THE REGISTRATION STATEMENT AND THE REGISTRATION STATEMENT AMENDED HEREBY
ARE COLLECTIVELY REFERRED TO HEREUNDER AS THE "REGISTRATION STATEMENT".
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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
- ---------------------- ---------------------
<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
3. Fee Table and Synopsis...................... Prospectus Summary; Fee Table
4. Financial Highlights........................ Financial Highlights
5. Plan of Distribution........................ Prospectus Summary; Purchase of Shares
6. Selling Shareholders........................ Not Applicable
7. Use of Proceeds............................. Investment Objective and Policies
8. General Description of the Registrant....... Prospectus Summary; The Fund; Investment
Objective and Policies Risk and Special
Considerations of Leverage; Investment
Restrictions
9. Management.................................. Investment Advisory and Administrative
Arrangements; Directors and Officers
10. Capital Stock, Long-Term Debt, and Other
Securities................................ Description of Capital Stock
11. Defaults and Arrears on Senior Securities... Not Applicable
12. Legal Proceedings........................... Not Applicable
13. Table of Contents of the Statement of
Additional Information.................... Not Applicable
PART B--INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION
14. Cover Page.................................. Not Applicable
15. Table of Contents........................... Not Applicable
16. General Information and History............. Not Applicable
17. Investment Objective and Policies........... Prospectus Summary; Investment Objective and
Policies; Investment Restrictions
18. Management.................................. Directors and Officers; Investment Advisory
and Administrative Arrangements
19. Control Persons and Principal Holders of
Securities................................ Investment Advisory and Administrative
Arrangements
20. Investment Advisory and Other Services...... Investment Advisory and Administrative
Arrangements; Custodian; Purchase of
Shares; Transfer Agent, Dividend
Disbursing Agent and Shareholder Servicing
Agent; 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 STATE.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JANUARY 30, 1997
PROSPECTUS
FEBRUARY 3, 1997
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
COMMON STOCK
------------------------
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is a continuously
offered, non-diversified, closed-end management investment company seeking to
provide shareholders with as high a level of current income exempt from Federal
income taxes as is consistent with its investment policies and prudent
investment management. The Fund seeks to achieve its investment objective by
investing primarily in a portfolio of long-term, investment grade municipal
obligations the interest on which, in the opinion of bond counsel to the issuer,
is exempt from Federal income taxes. The Fund intends to maintain at least 75%
of its total assets in municipal obligations 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.
No market presently exists for the Fund's Common Stock and it is not
currently expected that a secondary market will develop. The Fund intends to
offer shares of preferred stock from time to time representing up to
approximately 35% of the Fund's capital. There can be no assurance, however,
that preferred stock representing such percentage of the Fund's capital will
actually be issued. INVESTORS SHOULD NOTE THE SPECIAL RISKS ASSOCIATED WITH THE
LEVERAGING OF THE COMMON STOCK. SEE "RISKS AND SPECIAL CONSIDERATIONS OF
LEVERAGE" AND "DESCRIPTION OF CAPITAL STOCK." (Continued on next page)
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
========================================================================================================
PRICE TO SALES PROCEEDS TO
PUBLIC(1) LOAD(2) FUND(3)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share............................... $ None(2) $
- ---------------------------------------------------------------------------------------------------------
Total(3)............................... $ None(2) $
=========================================================================================================
</TABLE>
(1) The Common Stock is offered on a best efforts basis at a price equal to net
asset value, which from November 3, 1995 (commencement of operations) to the
date of this Prospectus, has ranged from $9.58 to $10.37 per share.
(2) Because Merrill Lynch Funds Distributor, Inc. will pay all offering expenses
(other than registration fees) and sales commissions to selected dealers
(primarily Merrill Lynch, Pierce, Fenner & Smith Incorporated) from its own
assets, all of the proceeds of the offering will be available to the Fund
for investment in portfolio securities. See "Purchase of Shares." Purchases
of shares of the Fund are not subject to any front-end sales charge, but are
subject to a contingent deferred sales charge of up to 3.0% of the original
purchase amount as described herein.
(3) These amounts (a) do not take into account (i) organizational expenses of
the Fund of approximately $249,048, which are being amortized over a
five-year period and charged as expenses against the income of the Fund or
(ii) prepaid registration fees, in the amount of approximately $130,000,
which will be charged to income as the related shares are issued, and (b)
assume all shares currently registered are sold pursuant to a continuous
offering.
------------------------
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE> 4
(Continued from previous page)
Shares of Common Stock of the Fund are offered on a best efforts basis at a
price equal to the next determined net asset value per share without a front-end
sales charge. As of the date of this Prospectus, net asset value per share is
$ . Shares may be purchased directly from Merrill Lynch Funds
Distributor, Inc. (the "Distributor"), P.O. Box 9081, Princeton, New Jersey
08543-9081, (609), 282-2800, or from securities dealers which have entered into
dealer agreements with the Distributor, including Merrill Lynch, Pierce, Fenner
& Smith Incorporated ("Merrill Lynch"). Merrill Lynch may charge its customers a
processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases directly through the Distributor, (609) 282-2800, are not subject to
the processing fee. The minimum initial purchase is $1,000 and the minimum
subsequent purchase is $50. See "Purchase of Shares."
Since the Fund's Common Stock may not be considered readily marketable, the
Board of Directors of the Fund presently intends, but is not required, to make
tender offers on a quarterly basis to purchase all or a portion of the Common
Stock of the Fund from shareholders at the net asset value per share. In the
event that tender offers are not made, however, shareholders may find that their
shares of Common Stock are not marketable. See "Tender Offers." Shares of Common
Stock purchased by the Fund pursuant to tender offers which have been held for
less than three years will be subject to a CDSC which will not exceed 3.0% of
the original purchase amount for such Common Stock, which will be paid to the
Distributor. See "Contingent Deferred Sales Charge."
As of the date of this Prospectus, the Fund has outstanding an aggregate of
1,520 shares of its Auction Market Preferred Stock(R), Series A (the "Series A
AMPS(R)"), which represent approximately 31% of the Fund's capital. The Fund
intends to issue preferred stock from time to time representing up to
approximately 35% of the Fund's capital. There can be no assurance, however,
that preferred stock representing any particular percentage of the Fund's
capital will actually be issued. The issuance of preferred stock results in a
leveraging of the Common Stock. The Series A AMPS pay dividends that are
adjusted generally every seven days and the dividend rate on the Series A AMPS
is based upon prevailing interest rates for debt obligations of comparable
maturity. The proceeds of the Series A AMPS issuance have been invested in
longer-term obligations in accordance with the Fund's investment objective, as
will the proceeds of the issuance of any other preferred stock. The Fund may
issue additional shares of its Series A AMPS or other preferred stock in the
future. Other preferred stock will pay dividends that will be adjusted over
either relatively short-term periods (generally seven to 28 days) or medium-term
periods (up to five years) and the dividend rates thereon will be based upon
prevailing interest rates for debt obligations of comparable maturities. Because
under normal market conditions, obligations with longer maturities produce
higher yields than short-term and medium-term obligations, the Investment
Adviser believes that the spread inherent in the difference between the
short-term and medium-term rates paid by the Fund and the longer-term rates
received by the Fund will provide holders of Common Stock with a potentially
higher yield.
The Fund is designed primarily for long-term investors and should not be
considered a vehicle for trading purposes. The address of the Fund is 800
Scudders Mill Road, Plainsboro, New Jersey 08536, and its telephone number is
(609) 282-2800. This Prospectus sets forth concisely information about the Fund
that a prospective investor ought to know before purchasing shares. Investors
are advised to read this Prospectus carefully and retain it for future
reference.
- ------------------
(R)Registered trademark of Merrill Lynch & Co., Inc.
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.
THE FUND Merrill Lynch Municipal Strategy Fund, Inc. (the
"Fund") is a continuously offered, non-diversified,
closed-end management investment company. See "The
Fund."
THE OFFERING Shares of Common Stock of the Fund may be offered by
Merrill Lynch Funds Distributor, Inc. (the
"Distributor"), and other securities dealers which have
entered into selected dealer agreements with the
Distributor, including Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch").
The Fund offers its Common Stock at a price equal to
the next determined net asset value per share without a
front-end sales charge (although in certain cases a
CDSC may apply as described herein). The minimum
initial is $1,000 and the minimum subsequent purchase
is $50. The Fund reserves the right to waive or modify
the initial and subsequent minimum investment
requirements at any time. See "Purchase of Shares."
INVESTMENT OBJECTIVE
AND POLICIES The investment objective of the Fund is to provide
shareholders with as high a level of current income
exempt from Federal income taxes as is consistent with
its investment policies and prudent investment
management. The Fund will seek to achieve its
investment objective by investing primarily in a
portfolio of long-term investment grade municipal
obligations the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal
income taxes. The Fund intends to maintain at least 75%
of its total assets in municipal obligations 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."
TENDER OFFERS No market presently exists for the Fund's Common Stock
and it is not currently anticipated that a secondary
market will develop. In view of this, the Board of
Directors of the Fund intends to make tender offers on
a quarterly basis to purchase Common Stock of the Fund
from shareholders at a price per share equal to the net
asset value per share of the Common Stock determined at
the close of business on the day an offer terminates.
3
<PAGE> 6
Although the Board of Directors currently intends to
make quarterly tender offers for the Common Stock, it
is under no obligation to do so and no assurance can be
given that in any particular quarter a tender offer
will be made. If a tender offer is not made,
shareholders may be unable to sell their shares. Shares
of Common Stock which have been held for less than
three years and which are purchased by the Fund
pursuant to tender offers will be subject to a CDSC.
See "Contingent Deferred Sales Charge." In addition,
Merrill Lynch may charge its customers a processing fee
(presently, $4.85) to confirm a repurchase of shares
from such customers pursuant to a Tender Offer. Tenders
made directly through the Distributor, (609) 282-2800,
are not subject to the processing fee.
LEVERAGE 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)"), which represent approximately 31% of the
Fund's capital. The Fund intends to issue preferred
stock from time to time representing up to
approximately 35% of the Fund's capital. There can be
no assurance, however, that preferred stock
representing any particular percentage of the Fund's
capital will actually be issued. The issuance of
preferred stock results in a leveraging of the Common
Stock. The Series A AMPS pay dividends that are
adjusted generally every seven days and the dividend
rate on the Series A AMPS is based upon prevailing
interest rates for debt obligations of comparable
maturity. The proceeds of the Series A AMPS issuance
have been invested in longer-term obligations in
accordance with the Fund's investment objective, as
will the proceeds of the issuance of any other
preferred stock. The Fund may issue additional shares
of its Series A AMPS or other preferred stock in the
future. Other preferred stock will pay dividends that
will be adjusted over either relatively short-term
periods (generally seven to 28 days) or medium-term
periods (up to five years) and the dividend rates
thereon will be based upon prevailing interest rates
for debt obligations of comparable maturities. Issuance
and ongoing expenses of the preferred stock will be
borne by the Fund and will reduce the net asset value
of the Common Stock. Additionally, under certain
circumstances when the Fund is required to allocate
taxable income to holders of preferred stock, the
Series A AMPS require, and it is anticipated that the
terms of any other preferred stock will require, the
Fund to make an additional distribution to such holders
in an amount approximately equal to the tax liability
resulting from such allocation and such additional
distribution (such amount, an "Additional
Distribution").
The use of leverage by the Fund creates an opportunity
for increased net income, but, at the same time,
creates special risks. Because under normal market
conditions obligations with longer maturities produce
4
<PAGE> 7
higher yields than short-term and medium-term
obligations, the Investment Adviser believes that the
spread inherent in the difference between the
short-term and medium-term rates (and any Additional
Distribution) paid by the Fund and the longer-term
rates received by the Fund will provide holders of
Common Stock with a potentially higher yield. Investors
should note, however, that leverage creates certain
risks for holders of Common Stock, including higher
volatility of both the net asset value and market value
of the Common Stock. Since any decline in the value of
the Fund's investments will be borne entirely by
holders of Common Stock, the effect of leverage in a
declining market would result in a greater decrease in
net asset value than if the Fund were not leveraged,
which would likely be reflected in a decline in the
market price for shares of Common Stock. Additionally,
fluctuations in the dividend rates on, and the amount
of taxable income allocable to, the preferred stock
will affect the yield to holders of Common Stock. See
"Risks and Special Considerations of Leverage." Holders
of the Common Stock will receive all net income of the
Fund remaining after payment of dividends (and any
Additional Distribution) on the Series A AMPS and any
other preferred stock to be issued by the Fund and will
generally be entitled to a pro rata share of net
realized capital gains. Upon any liquidation of the
Fund, the holders of shares of preferred stock will be
entitled to receive liquidating distributions (expected
to equal the original purchase price per share of
preferred stock plus any accumulated and unpaid
dividends thereon and any accumulated and unpaid
Additional Distribution) before any distribution is
made to holders of Common Stock. See "Description of
Capital Stock--Preferred Stock."
Holders of preferred stock, voting as a separate class,
will be entitled to elect two of the Fund's Directors,
and holders of common and preferred stock, voting
together as a single class, will be entitled to elect
the remaining Directors. If at any time dividends on
the Fund's preferred stock were to be in arrears in an
amount equal to two full years of dividend payments,
the holders of all outstanding shares of preferred
stock, voting as a separate class, would be entitled to
elect a majority of the Fund's Directors. The holders
of preferred stock will also vote separately on certain
other matters as required under the Fund's Articles of
Incorporation and the Investment Company Act of 1940,
as amended (the "1940 Act"), and Maryland law but
otherwise will have equal voting rights with holders of
Common Stock (one vote per share) and will vote
together with holders of Common Stock as a single
class. See "Description of Capital Stock--Preferred
Stock--Voting Rights."
There can be no assurance that the Fund will be able to
realize a higher net return on its investment portfolio
than the then current dividend rate
5
<PAGE> 8
(and any Additional Distribution) on the preferred
stock. Changes in certain factors could cause the
relationship between the short-term and medium-term
dividend rates (and any Additional Distribution) paid
by the Fund on the preferred stock and the long-term
rates received by the Fund on its investment portfolio
to change so that such short-term and medium-term rates
(and any Additional Distribution) may substantially
increase relative to rates on the long-term obligations
in which the Fund may be invested. Under such
conditions, the Fund's leveraged capital structure
would result in a greater decline in the net asset
value of the Common Stock and a greater decrease in the
current yield paid to holders of Common Stock than if
the Fund were not leveraged. The Fund will have the
authority to redeem the preferred stock for any reason
and may redeem all or part of the preferred stock if it
anticipates that the Fund's leveraged capital structure
will result in a lower rate of return to holders of the
Common Stock than that obtainable if the Common Stock
were unleveraged for any significant amount of time or
in order to maintain asset coverage required by the
1940 Act and any nationally recognized statistical
rating organization rating the preferred stock. The
leveraging of the Common Stock would be eliminated
during any period that preferred stock is not
outstanding.
The Series A AMPS have been rated "aaa" by Moody's
Investors Service, Inc. ("Moody's") and AAA by Standard
& Poor's Ratings Services ("S&P"). Prior to the time it
offers additional preferred stock, the Fund intends to
apply for ratings on such preferred stock from one or
more nationally recognized statistical rating
organizations. The Fund believes that obtaining a
rating for such preferred stock will enhance the
marketability of the preferred stock and thereby reduce
the dividend rate on the preferred stock from that
which the Fund would be required to pay if the
preferred stock were not rated. Ratings on preferred
stock issued by the Fund should not be confused with
ratings on obligations held by the Fund.
INVESTMENT ADVISER Fund Asset Management, L.P. is the Fund's investment
adviser (the "Investment Adviser") and is responsible
for the management of the Fund's investment portfolio
and for providing administrative services to the Fund.
For its advisory services, the Fund pays the Investment
Adviser a monthly fee at the annual rate of 0.50 of 1%
of the Fund's average daily net assets. 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 Manage-
6
<PAGE> 9
ment, 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 $234.1 billion in investment company and
other portfolio assets under management (approximately
$30.7 billion of which were invested in municipal
securities), including accounts of certain affiliates
of the Investment Adviser. See "Investment Advisory and
Administrative Arrangements."
DIVIDENDS
AND DISTRIBUTIONS The Fund intends to pay dividends monthly and to
distribute substantially all of its net investment
income to holders of Common Stock. As long as any
preferred stock is outstanding, monthly distributions
to holders of Common Stock will consist of
substantially all net investment income remaining after
the payment of dividends (and any Additional
Distribution) on the Series A AMPS and any other
preferred stock to be issued by the Fund. Net capital
gains, if any, will be distributed at least annually to
holders of Common Stock and on a pro rata basis to
holders of Common Stock and preferred stock. When
capital gains or other taxable income is allocated to
holders of preferred stock under certain circumstances,
the terms of the Series A AMPS require, and it is
anticipated that the terms of any other preferred stock
will require, the Fund to make an Additional
Distribution. The Fund is not permitted to declare any
cash dividend or other distribution on its Common Stock
unless asset coverage (as defined in the 1940 Act) with
respect to the Fund's preferred stock is at least 200%.
As of the date of this Prospectus, the Series A AMPS
represent approximately 31% of the Fund's capital and
the asset coverage with respect to the Series A AMPS is
approximately 326%. If the Fund's ability to make
distributions on its Common Stock is limited, this
could under certain circumstances impair the ability of
the Fund to maintain its qualification for taxation as
a regulated investment company, which would have
adverse tax consequences for holders of Common Stock.
See "Taxes."
AUTOMATIC DIVIDEND
REINVESTMENT PLAN All dividends and capital gains distributions will be
automatically reinvested in additional shares of Common
Stock of the Fund unless a shareholder elects to
receive cash. Shareholders whose shares are held in the
name of a broker or nominee should contact such broker
or nominee to confirm that they may participate in the
Fund's dividend reinvestment plan. See "Automatic
Dividend Reinvestment Plan."
7
<PAGE> 10
RISK FACTORS AND SPECIAL CONSIDERATIONS
The Fund expects that there will be no secondary market for its Common
Stock. Moreover, Merrill Lynch and other selected dealers are prohibited under
applicable law from making a market in the Fund's Common Stock while the Fund is
making either a public offering of or a tender offer to purchase its Common
Stock. To the extent a secondary market does develop, however, investors should
be aware that the shares of closed-end funds frequently trade in the secondary
market at a discount. Should there be a secondary market for the Fund's shares
of Common Stock, the market price of the shares may vary from net asset value.
Because of the lack of a secondary market and the CDSC, the Fund is
designed primarily for long-term investors and should not be considered a
vehicle for trading purposes.
The net asset value of the Fund's shares of Common Stock will fluctuate
with interest rate changes as well as with price changes of the Fund's portfolio
securities, and these fluctuations are likely to be greater in the case of a
fund having a leveraged capital structure, such as the Fund. See "Risks and
Special Considerations of Leverage."
The Fund has registered as a "non-diversified" investment company so that
it will be able to invest more than 5% of its assets in the obligations of any
single issuer, subject to the diversification requirements of Subchapter M of
the Internal Revenue Code of 1986, as amended (the "Code"), applicable to the
Fund. Since the Fund may invest a relatively high percentage of its assets in
the obligations of a limited number of issuers, the Fund may be more susceptible
than a more widely-diversified fund to any single economic, political or
regulatory occurrence.
The Fund intends to invest at least 75% of its total assets in municipal
obligations that are rated in the investment grade rating categories by S&P,
Moody's or Fitch 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 (such
obligations are commonly referred to as "junk bonds") or, if not rated,
considered by the Investment Adviser to be of comparable quality. These
securities are regarded as predominantly speculative and investments therein
entail certain risks. See "Investment Objective and Policies." The Fund may
invest in certain tax-exempt securities classified as "private activity bonds"
that may subject certain investors in the Fund to the alternative minimum tax.
See "Taxes--General."
The following table sets forth the 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....................................... 95.5%
AAA: 37.0%; AA: 12.1%; A: 15.3%; BBB: 28.8%; and BB:
2.3%
Unrated Obligations*.................................... 4.5%
</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, 3.2% are of comparable quality to obligations rated BB, and
1.3% 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.
8
<PAGE> 11
The Fund will be subject to certain restrictions on investments imposed by
guidelines of one or more nationally recognized statistical rating organizations
which may issue ratings for the preferred stock. These guidelines may impose
asset coverage or portfolio composition requirements that are more stringent
than those imposed by the 1940 Act. It is not anticipated that these covenants
or guidelines will impede the Investment Adviser from managing the Fund's
portfolio in accordance with the Fund's investment objective and policies.
In order to seek to hedge various portfolio positions or to enhance its
return, the Fund may invest in certain instruments 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 leverage transactions discussed under "Risks and Special
Considerations of Leverage;" however, certain derivative investments will not be
taken into account for purposes of calculating the percentage of leverage of the
Fund's portfolio. For a further discussion of the risks associated with
derivative investments, see "Investment Objective and Policies," "Investment
Objective and Policies--Other Investment Policies--Indexed and Inverse Floating
Obligations," "--Call Rights" and "Investment Objective and Policies--Options
and Futures Transactions."
Subject to its investment restrictions, the Fund is authorized to engage in
options and futures transactions on exchanges and in the over-the-counter
markets ("OTC options") for hedging purposes with certain specified entities
meeting the criteria of the Fund. These transactions involve certain risk
considerations. These risks include the risk of imperfect correlation in
movements in the price of futures contracts and movements in the price of the
security which is the subject of the hedge and the inability to close futures
transactions under certain conditions. Options transactions involve the
potential loss of the opportunity to profit from any price increase in the
underlying security above the option exercise price or the potential loss of the
premium paid for the option. Because of the anticipated leveraged nature of the
Common Stock, hedging transactions will result in a larger impact on the net
asset value of the Common Stock than would be the case if the Common Stock were
not leveraged. OTC options and assets used to cover OTC options written by the
Fund are considered by the staff of the Securities and Exchange Commission to be
illiquid. The illiquidity of such options or assets may prevent a successful
sale of such options or assets, result in a delay of sale, or reduce the amount
of proceeds that might be otherwise realized. See "Investment Objective and
Policies--Options and Futures Transactions." The Fund intends to apply for
ratings of the preferred stock from one or more nationally recognized
statistical rating organizations. In order to obtain these ratings, the Fund may
be required to limit its use of hedging techniques in accordance with the
specified guidelines of such rating organizations.
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. See "Description of Capital
Stock--Certain Provisions of the Articles of Incorporation."
9
<PAGE> 12
FEE TABLE
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load (as a percentage of offering price).......... None
Dividend Reinvestment Plan Fees................................. None
Contingent Deferred Sales Charge (as a percentage of original
purchase price or net asset value at the time of
repurchase)(a)................................................ 3.0% during the first year,
decreasing 1.0% annually
thereafter to 0.0% after the
third year
ANNUAL EXPENSES (as a percentage of average net assets attributable
to shares of Common Stock)
Investment Advisory Fee(b)...................................... 0.63%
Shareholder Servicing Fee(c).................................... 0.10%
Interest Payments on Borrowed Funds............................. None
Other Expenses(d)............................................... 0.86%
-----
1.59%
Total Annual Expenses(e)............................................ =====
</TABLE>
- ---------------
(a) See "Contingent Deferred Sales Charge"--page 30.
(b) For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay monthly fees at the annual rate of
0.50 of 1% of the Fund's average daily net assets (i.e., the average daily
value of the total assets of the Fund, including proceeds from the issuance
of shares of preferred stock, minus the sum of accrued liabilities of the
Fund and accumulated dividends on the shares of preferred stock). As of the
date of this Prospectus, the Fund has utilized leverage by issuing Series A
AMPS in an amount representing approximately 31% of the Fund's capital. See
"Risks and Special Considerations of Leverage"--page 21 and "Investment
Advisory and Administrative Arrangements"--page 33.
(c) See "Investment Advisory and Administrative Arrangements--Transfer Agency
Services"--page 35.
(d) Includes monthly fees payable to the Investment Adviser under the
Administration Agreement at the annual rate of 0.25 of 1% of the Fund's
average daily net assets, as defined in note (b) above. See "Investment
Advisory and Administrative Arrangements"--page 33.
(e) For the fiscal year ended October 31, 1996, the Investment Adviser
voluntarily waived $419,740 of the advisory fees due from the Fund and
voluntarily reimbursed the Fund for a portion of other expenses. Total
Annual Expenses in the fee table have been restated to assume the absence of
any such waiver or reimbursement because the Investment Adviser may
discontinue or reduce such waiver of fees and/or assumption of expenses at
any time without notice. For the fiscal year ended October 31, 1996, the
Investment Adviser waived advisory fees and reimbursed expenses totaling
0.92% after which the Fund's total expense ratio was 0.67%.
<TABLE>
<CAPTION>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000 investment
assuming, (1) total annual expenses of 1.59%, (2) a 5% annual return
throughout the periods and (3) tender at the end of the period.......... $ 46* $60* $87 $189
An investor would pay the following expenses on a $1,000 investment
assuming no tender at the end of the period............................. $ 16 $50 $87 $189
</TABLE>
- ---------------
* Reflects the Contingent Deferred Sales Charge.
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under "Other Expenses" are based on estimated
amounts through the end of the Fund's first fiscal year on an annualized basis.
The example set forth above assumes reinvestment of all dividends and
distributions and utilizes a 5% annual rate of return as mandated by the
Securities and Exchange Commission regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND
ACTUAL EXPENSES OR ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED
FOR PURPOSES OF THE EXAMPLE. Merrill Lynch may charge its customers a processing
fee (presently $4.85) for confirming purchases and repurchases. Purchases and
repurchases directly through the Distributor, (609) 282-2800, are not subject to
the processing fee. See "Purchase of Shares" and "Tender Offers."
10
<PAGE> 13
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 of Preferred Stock.................................... $ 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.
11
<PAGE> 14
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 1940 Act. The Fund's principal office is located at 800
Scudders Mill Road, Plainsboro, New Jersey 08536, and its telephone number is
(609) 282-2800.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of current income exempt from Federal income taxes as is consistent
with its investment policies and prudent investment management. The Fund seeks
to achieve its investment objective by investing primarily in a portfolio of
long-term, investment grade municipal obligations, the interest on which, in the
opinion of bond counsel to the issuer, is exempt from Federal income taxes. The
investment objective of the Fund is a fundamental policy 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 pay interest or distributions which are
exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in Municipal Bonds, to the extent such
investments are permitted by the 1940 Act. Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term Municipal Bonds. Certain Non-Municipal
Tax-Exempt Securities may be characterized as derivative instruments.
Non-Municipal Tax-Exempt Securities will be considered "Municipal Bonds" for
purposes of the Fund's investment objective and policies.
12
<PAGE> 15
Investment in shares of Common Stock of the Fund offers several benefits.
The Fund offers investors the opportunity to receive income exempt from Federal
income taxes by investing in a professionally managed portfolio comprised
primarily of investment grade Municipal Bonds. The Fund also relieves the
investor of the burdensome administrative details involved in managing a
portfolio of Municipal Bonds. Additionally, the Investment Adviser will seek to
enhance the yield on the Common Stock by leveraging the Fund's capital structure
through the issuance of preferred stock. The benefits are at least partially
offset by the expenses involved in operating an investment company. Such
expenses primarily consist of the advisory fee, administrative fee and
operational costs. Additionally, the use of leverage involves certain expenses
and special risk considerations. See "Risks and Special Considerations of
Leverage."
The investment grade Municipal Bonds in which the Fund will invest are
those Municipal Bonds rated at the date of purchase in the four highest rating
categories of S&P, Moody's or Fitch or, if unrated, 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 I to this Prospectus for a
description of S&P's, Moody's and Fitch's ratings of Municipal Bonds. In
assessing the quality of Municipal Bonds with respect to the foregoing
requirements, the Investment Adviser will take into account the nature of any
letters of credit or similar credit enhancements to which particular Municipal
Bonds are entitled and the creditworthiness of the financial institution which
provided such credit enhancement.
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 bonds from the Fund, which may decrease the net
investment income to the Fund and dividends to shareholders in the event that
the Fund is required to replace a called security with a lower yielding
security. The Fund may have difficulty disposing of certain high yield bonds
because there may be a thin trading market
13
<PAGE> 16
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 years and ten years. The Fund
may invest in short-term, tax-exempt securities, short-term U.S. Government
securities, repurchase agreements or cash. Such short-term securities or cash
will not exceed 20% of its total assets except during interim periods pending
investment of the net proceeds of public offerings of the Fund's securities or
in anticipation of the repurchase or redemption of the Fund's securities and
temporary periods when, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. The Fund does not ordinarily intend to
realize significant interest income not exempt from Federal income tax.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by such Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund for the special tax
treatment
14
<PAGE> 17
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. IDBs 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 finance the acquisition or construction of equipment,
land and/or facilities. The certificates represent participations in a lease, an
installment purchase contract or a conditional sales contract (hereinafter
15
<PAGE> 18
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 shares of preferred stock 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.
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
16
<PAGE> 19
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.
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 ("financial futures contracts") and options thereon. While the
Fund's use of hedging strategies is intended to reduce the volatility of the net
asset value of Common Stock, the net asset value of the Common Stock will
fluctuate. There can be no assurance that the Fund's hedging transactions will
be effective. In addition, because of the anticipated leveraged nature of the
Common Stock, hedging transactions will result in a larger impact on the net
asset value of the Common Stock than would be the case if the Common Stock were
not leveraged. Furthermore, the Fund will only engage in hedging activities from
time to time and may not necessarily be engaging in hedging activities when
movements in interest rates occur.
17
<PAGE> 20
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains from transactions in options and futures
contracts distributed to shareholders will be taxable as ordinary income or, in
certain circumstances, as long-term capital gains to shareholders. See
"Taxes--Tax Treatment of Options and Futures Transactions." In addition, in
order to obtain ratings of the preferred stock from one or more nationally
recognized statistical rating organizations, the Fund may be required to limit
its use of hedging techniques in accordance with the specified guidelines of
such organizations.
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 purposes of hedging its investments in Municipal Bonds against declines
in value and hedging against increases in the cost of securities it intends to
purchase. A financial futures contract obligates the seller of a contract to
deliver and the purchaser of a contract to take delivery of the type of
financial instrument covered by the contract or, in the case of index-based
financial futures contracts, to make and accept a cash settlement, at a specific
future time for a specified price. A sale of
18
<PAGE> 21
financial futures contracts may provide a hedge against a decline in the value
of portfolio securities because such depreciation may be offset, in whole or in
part, by an increase in the value of the position in the financial futures
contracts. A purchase of financial futures contracts may provide a hedge against
an increase in the cost of securities intended to be purchased because such
appreciation may be offset, in whole or in part, by an increase in the value of
the position in the financial futures contracts.
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker equal to
approximately 5% of the contract amount must be deposited with the broker. This
amount is known as initial margin. Subsequent payments to and from the broker,
called variation margin, are made on a daily basis as the price of the financial
futures contract fluctuates making the long and short positions in the financial
futures contract more or less valuable.
The Fund may purchase and sell financial futures contracts based on The
Bond Buyer Municipal Bond Index, a price-weighted measure of the market value of
40 large 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
19
<PAGE> 22
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
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
20
<PAGE> 23
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.
RISKS AND SPECIAL CONSIDERATIONS OF LEVERAGE
EFFECTS OF LEVERAGE
As of the date of this Prospectus, the Fund has outstanding an aggregate of
1,520 shares of its Series A AMPS, which represent approximately 31% of the
Fund's capital. The Fund intends to issue preferred stock from time to time
representing up to approximately 35% of the Fund's capital. There can be no
assurance, however, that preferred stock representing any particular percentage
of the Fund's capital will actually be issued. The issuance of preferred stock
results in a leveraging of the Common Stock. The Series A AMPS pay dividends
that are adjusted generally every seven days and the dividend rate of the Series
A AMPS is based upon prevailing interest rates for debt obligations of
comparable maturity. The proceeds of the Series A AMPS issuance have been
invested in longer-term obligations in accordance with the Fund's investment
objective, as will the proceeds of the issuance of any other preferred stock.
The Fund may issue additional shares of its Series A AMPS or other preferred
stock in the future. Other preferred stock will pay dividends that will be
adjusted over either relatively short-term periods (generally seven to 28 days)
or medium-term periods (up to five years) and the dividend rates thereon will be
based upon prevailing interest rates for debt obligations of comparable
maturities. Issuance and ongoing expenses of the preferred stock will be borne
by the Fund and will reduce the net asset value of the Common Stock.
Additionally, under certain circumstances, when the Fund is required to allocate
taxable income to holders of preferred stock, it is anticipated that the terms
of the preferred stock will require the Fund to make an additional distribution
to such holders in an amount approximately equal to the tax liability resulting
from such allocation and such additional distribution
21
<PAGE> 24
(such amount, an "Additional Distribution"). Because under normal market
conditions, obligations with longer maturities produce higher yields than
short-term and medium-term obligations, the Investment Adviser believes that the
spread inherent in the difference between the short-term and medium-term rates
(and any Additional Distributions) paid by the Fund as dividends on the
preferred stock and the longer-term rates received by the Fund will provide
holders of Common Stock with a potentially higher yield.
Utilization of leverage, however, involves certain risks to the holders of
Common Stock. For example, issuance of the preferred stock may result in higher
volatility of the net asset value of the Common Stock and potentially more
volatility in the market value of the Common Stock. In addition, fluctuations in
the short-term and medium-term dividend rates on, and the amount of taxable
income allocable to, the preferred stock will affect the yield to holders of
Common Stock. So long as the Fund, taking into account the costs associated with
the preferred stock and the Fund's operating expenses, is able to realize a
higher net return on its investment portfolio than the then current dividend
rate (and any Additional Distribution) of the preferred stock, the effect of
leverage will be to cause holders of Common Stock to realize a higher current
rate of return than if the Fund were not leveraged. Similarly, since a pro rata
portion of the Fund's net realized capital gains on its investment assets are
generally payable to holders of Common Stock, if net capital gains are realized
by the Fund, the effect of leverage will be to increase the amount of such gains
distributed to holders of Common Stock. However, short-term, medium-term and
long-term interest rates change from time to time as does their relationship to
each other (i.e., the slope of the yield curve) depending upon such factors as
supply and demand forces, monetary and tax policies and investor expectations.
Changes in such factors could cause the relationship between short-term,
medium-term and long-term rates to change (i.e., to flatten or to invert the
slope of the yield curve) so that short-term and medium-term rates may
substantially increase relative to the long-term obligations in which the Fund
may be invested. To the extent that the current dividend rate (and any
Additional Distribution) on the preferred stock approaches the net return on the
Fund's investment portfolio, the benefit of leverage to holders of Common Stock
will be reduced, and if the current dividend rate (and any Additional
Distribution) on the preferred stock were to exceed the net return on the Fund's
portfolio, the Fund's leveraged capital structure would result in a lower
current yield to holders of Common Stock than if the Fund were not leveraged.
Similarly, since both the costs associated with the issuance of preferred stock
and any decline in the value of the Fund's investments (including investments
purchased with the proceeds from any preferred stock offering) will be borne
entirely by holders of Common Stock, the effect of leverage in a declining
market would result in a greater decrease in net asset value to holders of
Common Stock than if the Fund were not leveraged.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the Common Stock. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under the Code. See "Taxes." The Fund intends, however, to
take all measures necessary to continue to make Common Stock dividend payments.
If the Fund's current investment income were not sufficient to meet dividend
requirements on either the Common Stock or the preferred stock, it could be
necessary for the Fund to liquidate certain of its investments. In addition, the
Fund will have the authority to redeem the preferred stock for any reason and
may redeem all or part of the preferred stock if (i) it anticipates that the
Fund's leveraged capital structure will result in a lower rate of return for any
significant amount of time to holders of the Common Stock than that obtainable
if the Common Stock were unleveraged, (ii) the asset coverage for the preferred
stock declines below 200%, either as a result of a decline in the value of the
Fund's portfolio investments or as a result of the repurchase of Common Stock in
tender offers, or (iii) in order to maintain the asset coverage guidelines
established by nationally recognized rating agencies
22
<PAGE> 25
rating the preferred stock. Redemption of the preferred stock or insufficient
investment income to make dividend payments may reduce the net asset value of
the Common Stock and require the Fund to liquidate a portion of its investments
at a time when it may be disadvantageous, in the absence of such extraordinary
circumstances, to do so.
As of the date of this Prospectus, the Fund has utilized leverage by the
issuance of Series A AMPS that pay dividends at a rate that generally will be
adjusted every seven days in an amount representing approximately 31% of the
Fund's capital at an annual dividend rate of 3.45% payable on such preferred
stock based on market rates as of the date of this Prospectus. The annual return
that the Fund's portfolio must experience (net of expenses) in order to cover
such dividend payments would be 0.82%.
The following table is designed to illustrate the effect on the return to a
holder of the Fund's Common Stock of the leverage obtained by the issuance of
Series A AMPS representing approximately 31% of the Fund's capital, assuming
hypothetical annual returns on the Fund's portfolio of minus 10% to plus 10%. As
the table shows, leverage generally increases the return to stockholders when
portfolio return is positive and decreases the return when the portfolio return
is negative. The figures appearing in the table are hypothetical and actual
returns may be greater or less than those appearing in the table.
<TABLE>
<S> <C> <C> <C> <C> <C>
Assumed Portfolio Return
(net of expenses).................. (10)% (5)% 0% 5% 10%
Corresponding Common Stock Return.... (14)% (7)% (1)% 5% 12%
</TABLE>
The leveraging of the Common Stock would be eliminated during any period
that preferred stock is not outstanding and the risks and special considerations
related to leverage described in this Prospectus would not apply.
PORTFOLIO MANAGEMENT AND OTHER CONSIDERATIONS
In the event of an increase in short-term or medium-term rates or other
change in market conditions to the point where the Fund's leverage could
adversely affect holders of Common Stock as noted above, or in anticipation of
such changes, the Fund may attempt to shorten the average maturity of its
investment portfolio, which would tend to offset the negative impact of leverage
on holders of Common Stock. The Fund also may attempt to reduce the degree to
which it is leveraged by redeeming preferred stock pursuant to the provisions of
the Fund's Articles Supplementary establishing the rights and preferences of the
preferred stock or otherwise purchasing shares of preferred stock. Purchases and
redemptions of preferred stock, whether through redemptions, on the open market
or in negotiated transactions, are subject to limitations under the 1940 Act. If
market conditions subsequently change, the Fund may sell previously unissued
shares of preferred stock or shares of preferred stock that the Fund previously
issued but later repurchased or redeemed.
The Series A AMPS have been rated "aaa" by Moody's and AAA by S&P. Prior to
the time it offers additional preferred stock, the Fund intends to apply for
ratings on such preferred stock from one or more nationally recognized
statistical rating organizations. In order to obtain these ratings, the Fund may
be required to maintain portfolio holdings meeting specified guidelines of such
organizations. These guidelines may impose asset coverage requirements that are
more stringent than those imposed by the 1940 Act. It is not anticipated that
these guidelines will impede the Investment Adviser from managing the Fund's
portfolio in accordance with the Fund's investment objective and policies.
Ratings on preferred stock issued by the Fund should not be confused with
ratings on obligations held by the Fund.
23
<PAGE> 26
Under the 1940 Act, the Fund is not permitted to issue shares of preferred
stock unless immediately after such issuance the net asset value of the Fund's
portfolio is at least 200% of the liquidation value of the outstanding preferred
stock (expected to equal the original purchase price of the outstanding shares
of preferred stock plus any accumulated and unpaid dividends thereon and any
accumulated and unpaid Additional Distribution). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on its Common Stock
unless, at the time of such declaration, the net asset value of the Fund's
portfolio (determined after deducting the amount of such dividend or
distribution) is at least 200% of such liquidation value. As of the date of this
Prospectus, the Fund's capital structure includes 1,520 shares of Series A AMPS
representing approximately 31% of the Fund's capital, and the asset coverage
with respect to the Series A AMPS is approximately 326%. To the extent possible,
the Fund intends to purchase or redeem shares of preferred stock from time to
time to maintain coverage of preferred stock of at least 200%.
The Fund pays service fees to certain broker-dealers at the end of each
auction in connection with the Series A AMPS. For the period November 3, 1995
(commencement of operations) to October 31, 1996, Merrill Lynch earned $48,107
in such service fees.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and,
prior to issuance of the preferred stock, may not be changed without the
approval of the holders of a majority of the Fund's outstanding shares of Common
Stock (which for this purpose and under the 1940 Act means the lesser of (i) 67%
of the shares of Common Stock represented at a meeting at which more than 50% of
the outstanding shares of Common Stock are represented or (ii) more than 50% of
the outstanding shares). Subsequent to the issuance of the preferred stock, the
following investment restrictions may not be changed without the approval of a
majority of the outstanding shares of Common Stock and of the outstanding shares
of preferred stock, voting together as a class, and the approval of a majority
of the outstanding shares of preferred stock, voting separately by class. The
Fund may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, real estate limited partnerships,
commodities or commodity contracts; provided that the Fund may invest in
securities directly or indirectly secured by real estate or interests
therein or issued by companies that invest in real estate or interests
therein, and the Fund may purchase and sell financial futures contracts and
options thereon.
3. Issue senior securities or borrow money, except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended
(the "1933 Act"), in selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
Municipal Bonds and other debt securities in accordance with its investment
objective, policies and limitations.
6. Invest more than 25% of its total assets (taken at market value at
the time of each investment) in securities of issuers in a single industry;
provided that, for purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry.
24
<PAGE> 27
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.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentages resulting from changing values will not be
considered a violation.
The Investment Adviser of the Fund and Merrill Lynch 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.
PURCHASE OF SHARES
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), an affiliate of
the Investment Adviser, MLAM and Merrill Lynch, acts as the distributor of
shares of Common Stock of the Fund. The Fund is engaged in a continuous offering
of its shares of Common Stock through the Distributor and other securities
25
<PAGE> 28
dealers which have entered into selected dealer agreements with the Distributor,
including Merrill Lynch. Shares of the Fund may be purchased from the
Distributor or selected dealers, including Merrill Lynch, or by mailing a
purchase order directly to Merrill Lynch Financial Data Services, Inc. (the
"Transfer Agent"). The minimum initial purchase is $1,000 and the minimum
subsequent purchase is $50. In connection with an exemption the Fund has
obtained from the Securities and Exchange Commission (the "SEC") relating to its
tender offers, the Fund will not offer its shares during the five business days
preceding the termination of a tender offer. See "Tender Offers."
To permit the Fund to invest the net proceeds from the sale of its shares
of Common Stock in an orderly manner, the Fund may delay the commencement of the
continuous offering of its shares of Common Stock or, from time to time, suspend
the sale of its shares of Common Stock, except for sales to existing holders of
Common Stock and dividend reinvestments.
Due to the administrative complexities associated with the continuous
offering, administrative errors may result in the Distributor or an affiliate
inadvertently acquiring nominal numbers (in no event in excess of 5% of the
shares of Common Stock) of shares of Common Stock which it may wish to resell.
Such shares of Common Stock will not be subject to any investment restriction
and may be resold pursuant to this Prospectus.
The Fund offers its shares of Common Stock at a public offering price equal
to the next determined net asset value per share without a front-end sales
charge (although in certain cases a CDSC may apply as described herein). The
applicable offering price for purchase orders is based on the net asset value of
the Fund next determined after receipt of the purchase order by the Distributor.
As to purchase orders received by securities dealers prior to the close of
business on the New York Stock Exchange (the "NYSE") (generally, 4:00 P.M., New
York time), which includes orders received after the determination of net asset
value on the previous day, the applicable offering price will be based on the
net asset value determined as of 15 minutes after the close of business on the
NYSE on the day the order is placed with the Distributor, provided the order is
received by the Distributor prior to 30 minutes after the close of business on
the NYSE on that day. If the purchase orders are not received by the Distributor
prior to 30 minutes after the close of business on the NYSE, such orders shall
be deemed received on the next business day. Any order may be rejected by the
Distributor or the Fund. The Fund or the Distributor may suspend the continuous
offering of the Fund's shares to the general public at any time in response to
conditions in the securities markets or otherwise and may thereafter resume such
offering from time to time. Neither the Distributor nor the dealers are
permitted to withhold placing orders to benefit themselves by a price change.
The Distributor is required to advise the Fund promptly of all purchase orders
and cause payments for shares of Common Stock to be delivered promptly to the
Fund. Merrill Lynch charges its customers a processing fee (presently $4.85) to
confirm a purchase of shares by such customers. Purchases directly through the
Distributor are not subject to the processing fee.
The Distributor compensates Merrill Lynch and other selected dealers at a
rate of 3.0% of amounts purchased. If the shares remain outstanding after one
year from the date of their original purchase, the Distributor will compensate
Merrill Lynch and such dealers at an annual rate equal to 0.25% of the value of
Fund shares sold by Merrill Lynch and such dealers and remaining outstanding.
These amounts do not represent an expense to the Fund and its shareholders since
the payments made by the Distributor will be made from its own assets, which may
include amounts received by the Distributor as CDSCs. See "Contingent Deferred
Sales Charge." The compensation paid to selected dealers and the Distributor,
including the compensation paid at the time of purchase, the 0.25% annual
payments mentioned above and the
26
<PAGE> 29
CDSC, if any, will not in the aggregate exceed the applicable limit (presently
8%), as determined from time to time by the National Association of Securities
Dealers, Inc. For the period November 3, 1995 (commencement of operations) to
October 31, 1996 the Distributor paid approximately $1,059,723 to Merrill Lynch
in connection with the sale of shares of Common Stock of the Fund.
Upon the transfer of shares out of a Merrill Lynch brokerage account, an
investment account in the transferring shareholder's name will be opened
automatically, without charge, at the Fund's transfer agent, dividend disbursing
agent and shareholder servicing agent. Shareholders should be aware that it will
not be possible to transfer their shares from Merrill Lynch to another brokerage
firm or financial institution. Shareholders interested in transferring their
brokerage accounts from Merrill Lynch and who do not wish to have an account
maintained for such shares at the Transfer Agent must tender the shares for
repurchase by the Fund as described under "Tender Offers" so that the cash
proceeds can be transferred to the account at the new firm.
TENDER OFFERS
In recognition of the possibility that a secondary market for the Fund's
shares will not exist, the Fund may take actions which will provide liquidity to
shareholders. The Fund may from time to time make an offer to purchase its
shares of Common Stock from all beneficial holders of the Fund's Common Stock at
a price per share equal to the net asset value per share of the Common Stock
determined at the close of business on the day an offer terminates ("Tender
Offer"). Commencing with the second quarter of the Fund's operations, the Board
of Directors has considered the making of Tender Offers on a quarterly basis,
and the Board of Directors intends to continue this practice. There can be no
assurance, however, that the Board of Directors will decide to undertake the
making of a Tender Offer. Subject to the Fund's investment restriction with
respect to borrowings, the Fund may borrow money to finance the repurchase of
shares pursuant to any Tender Offers. See "Investment Objective and
Policies--Other Investment Policies--Borrowings" and "Investment Restrictions."
The Fund expects that ordinarily there will be no secondary market for the
Fund's Common Stock and that periodic tenders will be the only source of
liquidity for Fund shareholders. Nevertheless, if a secondary market develops
for the Common Stock of the Fund, the market price of the shares may vary from
net asset value from time to time. Such variance may be affected by, among other
factors, relative demand and supply of shares and the performance of the Fund,
especially as it affects the yield on and net asset value of the Common Stock of
the Fund. A Tender Offer for shares of Common Stock of the Fund at net asset
value is expected to reduce any spread between net asset value and market price
that may otherwise develop. However, there can be no assurance that such action
would result in the Fund's Common Stock trading at a price which equals or
approximates net asset value.
Although the Board of Directors believes that the Tender Offers generally
would be beneficial to the Fund's holders of Common Stock, the acquisition of
shares of Common Stock by the Fund will decrease the total assets of the Fund
and therefore have the likely effect of increasing the Fund's expense ratio
(assuming such acquisition is not offset by the issuance of additional shares of
Common Stock). Furthermore, if the Fund borrows to finance the making of Tender
Offers, interest on such borrowing will reduce the Fund's net investment income.
27
<PAGE> 30
It is the Board's announced policy, which may be changed by the Board, not
to purchase shares pursuant to a Tender Offer if (1) such purchases would impair
the Fund's status as a regulated investment company under the Code (which would
make the Fund a taxable entity, causing the Fund's income to be taxed at the
corporate level in addition to the taxation of shareholders who receive
dividends from the Fund); (2) the Fund would not be able to liquidate portfolio
securities in a manner which is orderly and consistent with the Fund's
investment objective and policies in order to purchase Common Stock tendered
pursuant to the Tender Offer; or (3) there is, in the Board's judgment, any (a)
legal action or proceeding instituted or threatened challenging the Tender Offer
or otherwise materially adversely affecting the Fund, (b) declaration of banking
moratorium by Federal or state authorities or any suspension of payment by banks
in the United States or New York State, which is material to the Fund, (c)
limitation imposed by Federal or state authorities on the extension of credit by
lending institutions, (d) commencement of war, armed hostilities or other
international or national calamity directly or indirectly involving the United
States which is material to the Fund, or (e) other event or condition which
would have a material adverse effect on the Fund or its shareholders if shares
of Common Stock tendered pursuant to the Tender Offer were purchased. Thus,
there can be no assurance that the Board will proceed with any Tender Offer. The
Board of Directors may modify these conditions in light of circumstances
existing at the time. If the Board of Directors determines to purchase the
Fund's shares of Common Stock pursuant to a Tender Offer, such purchases could
significantly reduce the asset coverage of any borrowing or outstanding senior
securities, including any preferred stock. The Fund may not purchase shares of
Common Stock to the extent such purchases would result in the asset coverage
with respect to such borrowing or senior securities, including any preferred
stock, being reduced below the asset coverage requirement set forth in the 1940
Act or, with respect to preferred stock, the asset coverage requirements of any
nationally recognized statistical rating organization rating the preferred
stock. Accordingly, in order to purchase all shares of Common Stock tendered,
the Fund may have to repay all or part of any then outstanding borrowing or
redeem all or part of any then outstanding senior securities, including any
preferred stock, to maintain the required asset coverage. See "Risks and Special
Considerations of Leverage-- Portfolio Management and Other Considerations." In
addition, the amount of shares of Common Stock for which the Fund makes any
particular Tender Offer may be limited for the reasons set forth above or in
respect of other concerns related to liquidity of the Fund's portfolio.
The Fund has obtained an exemption from the Securities and Exchange
Commission relating to Tender Offers which includes representations by the Fund
that no secondary market for shares of the Fund's Common Stock is expected to
develop. The exemption is conditioned on the absence of a secondary market, and
neither the Fund nor Merrill Lynch nor any other broker-dealer is allowed to
conduct any offers or sales of the Fund's Common Stock in the continuous
offering during the last five business days of any Tender Offer. In the event
that circumstances arise under which the Fund does not conduct the Tender Offers
regularly, the Board of Directors would consider alternative means of providing
liquidity for holders of Common Stock. Such action would include an evaluation
of any secondary market that then existed and a determination of whether such
market provided liquidity for holders of Common Stock. If the Board of Directors
determines that such market, if any, fails to provide liquidity for the holders
of Common Stock, the Board expects that it will consider all then available
alternatives to provide such liquidity. Among the alternatives which the Board
of Directors may consider is the listing of the Fund's Common Stock on a major
domestic stock exchange or on the Nasdaq National Market system in order to
provide such liquidity. The Board of Directors also may consider causing the
Fund to repurchase its shares from time to time in open-market or private
transactions when it can do so on terms that represent a favorable investment
opportunity. In any event, the Board of
28
<PAGE> 31
Directors expects it will cause the Fund to take whatever action it deems
necessary or appropriate to provide liquidity for the holders of Common Stock in
light of the facts and circumstances existing at such time.
To consummate a Tender Offer in order to repurchase its shares of Common
Stock, the Fund may be required to liquidate portfolio securities and realize
gains or losses at a time when the Investment Adviser would otherwise consider
it disadvantageous to do so. In such event gains may be realized on securities
held for less than three months. However, in order to qualify as a regulated
investment company under the Code, the Fund must limit such gains and,
accordingly, the amount of gain that the Fund could realize in the ordinary
course of its portfolio management from sales of other securities held for less
than three months would be reduced. This may adversely affect the Fund's yield.
See "Taxes."
Each Tender Offer will be made and shareholders notified in accordance with
the requirements of the Securities Exchange Act of 1934 and the 1940 Act, either
by publication or mailing or both. The offering documents will contain such
information as is prescribed by such laws and the rules and regulations
promulgated thereunder. The repurchase of tendered shares by the Fund is a
taxable event for the tendering shareholder. See "Taxes--Offers to Purchase
Shares." The Fund will pay all costs and expenses associated with the making of
any Tender Offer. A CDSC will be imposed on most shares accepted for tender
which have been held for less than three years. See "Contingent Deferred Sales
Charge." In addition, Merrill Lynch charges its customers a processing fee
(presently $4.85) to confirm a repurchase of shares from such customers pursuant
to a Tender Offer. Tenders made directly through the Distributor, (609)
282-2800, are not subject to the processing fee.
Shareholders of the Fund have an investment option consisting of the right
to reinvest the net proceeds from a sale of shares of the Fund's Common Stock
(the "Original Shares") pursuant to a tender offer by the Fund in Class D
initial sales charge shares of certain Merrill Lynch-sponsored open-end
investment companies ("Eligible Class D Shares") at their net asset value,
without the imposition of the initial sales charge, if the conditions set forth
below are satisfied. First, net proceeds from the sale of the Original Shares in
the tender offer must be immediately reinvested in Eligible Class D Shares.
Second, the investment option is available only with respect to the proceeds of
shares of the Fund's Common Stock as to which a CDSC is no longer applicable
because of the length of time that the shareholder has held the shares.
Shareholders who already own Class A shares of the investment company in the
account in which they are purchasing shares of such investment company may
purchase Class A shares rather than Class D shares so long as all of the other
requirements of this paragraph are met. Before taking advantage of this
investment option, shareholders of the Fund should obtain a currently effective
prospectus of the mutual fund which they intend to purchase. To exercise this
investment option, shareholders should consult their Merrill Lynch financial
consultant. Shareholders who utilize this investment option will realize a
taxable gain or loss in connection with the repurchase of shares in a Tender
Offer in the same manner as if they received cash for their tendered shares. See
"Taxes--Offers to Purchase Shares."
29
<PAGE> 32
CONTINGENT DEFERRED SALES CHARGE
A CDSC to recover distribution expenses incurred by the Distributor will be
imposed against the shareholder's investment account and paid to the Distributor
in connection with most shares of Common Stock held for less than three years
which are accepted by the Fund for repurchase pursuant to a Tender Offer in the
manner described below. The CDSC will be imposed on those shares of Common Stock
accepted for tender based on an amount equal to the lesser of the then current
net asset value of the shares of Common Stock or the cost of the shares of
Common Stock being tendered. Accordingly, the CDSC is not imposed on increases
in the net asset value above the initial purchase price. In addition, the CDSC
is not imposed on shares derived from reinvestments of dividends or capital
gains distributions. In determining whether a CDSC is payable, it is assumed
that the acceptance of an offer to repurchase pursuant to a Tender Offer would
be made from the earliest purchase of shares of Common Stock. The CDSC imposed
will vary depending on the length of time the Common Stock has been owned since
purchase (separate purchases shall not be aggregated for these purposes), as set
forth in the following table:
<TABLE>
<CAPTION>
CONTINGENT
DEFERRED
SALES
YEAR OF REPURCHASE AFTER PURCHASE CHARGE
--------------------------------- --------
<S> <C>
First........................................... 3.0%
Second.......................................... 2.0%
Third........................................... 1.0%
Fourth and following............................ 0%
</TABLE>
In determining whether a CDSC is applicable to a tender of shares of Common
Stock, the calculation will be determined in the manner that results in the
lowest possible amount being charged. Therefore, it will be assumed that the
tender is first of shares of Common Stock held for over three years and shares
of Common Stock acquired pursuant to reinvestment of dividends or distributions
and then of shares of Common Stock held longest during the three-year period.
The CDSC will not be applied to dollar amounts representing an increase in the
net asset value since the time of purchase.
EXAMPLE:
Assume an investor purchased 1,000 shares of Common Stock (at a cost of
$10,000) and in the second year after purchase, the net asset value per share is
$12.00 and, during such time, the investor has acquired 100 additional shares of
Common Stock upon dividend reinvestment. If at such time the investor makes his
or her first redemption of 500 shares of Common Stock (proceeds of $6,000), 100
shares will not be subject to the CDSC because of dividend reinvestment. With
respect to the remaining 400 shares of Common Stock, the CDSC is applied only to
the original cost of $10 per share and not to the increase in net asset value of
$2.00 per share. Therefore, $4,000 of the $6,000 redemption proceeds will be
charged at a rate of 2.0% (the applicable rate in the second year after
purchase).
For the period November 3, 1995 (commencement of operations) to October 31,
1996, the amount paid to the Distributor in CDSCs aggregated $38,710.
30
<PAGE> 33
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
manager of the Fund, including their ages and their principal occupations for at
least the last five years is set forth below. Unless otherwise noted, the
address of each Director, executive officer and the portfolio manager is 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 the Distributor 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 the
Distributor 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.
31
<PAGE> 34
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.
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 the
Distributor since 1981, Treasurer since 1984 and employee of the Distributor
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
annually. 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 non-interested Directors of the Fund aggregated
$24,645.
32
<PAGE> 35
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).
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS
The Investment Adviser is an affiliate of MLAM and is owned and controlled
by ML & Co., a financial services holding company. The Investment Adviser will
provide 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 $234.1 billion in investment company and other portfolio assets
under management (approximately $30.7 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 Fund's
day-to-day management. He has served as an Assistant Vice President of MLAM
since 1995 and a portfolio manager of the Investment Adviser and MLAM since
1993.
33
<PAGE> 36
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.
For the administrative services rendered to the Fund and the facilities
furnished, the Fund pays the Investment Adviser a monthly fee at an annual rate
of 0.25 of 1% of the Fund's average daily net assets determined in the same
manner as the fee payable by the Fund under the Investment Advisory Agreement.
The Investment Adviser may pay a portion of the fee received pursuant to the
Administration Agreement to its affiliate, Merrill Lynch, for administrative
services rendered in connection with any preferred stock of the Fund. The
combined advisory and administration fees are greater than the advisory fees
paid by most funds, but are similar in amount to the fees paid by other
continuously offered, closed-end funds.
For the period November 3, 1995 (commencement of operations) to October 31,
1996, 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 to the
Investment Adviser pursuant to the Administration Agreement was $223,446 (each
fee paid 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 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
34
<PAGE> 37
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 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 2,185 shareholder accounts. At this level of accounts, the annual fee
payable to the Transfer Agent would aggregate approximately $31,000, plus
out-of-pocket expenses.
35
<PAGE> 38
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 principals 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
36
<PAGE> 39
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%.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute all of its net investment income. Dividends
from such net investment income will be declared and paid monthly to holders of
Common Stock. As long as any preferred stock is outstanding, monthly
distributions to holders of Common Stock normally will consist of substantially
all net investment income remaining after the payment of dividends (and any
Additional Distribution) on the Series A AMPS and any other preferred stock. All
net realized long-term or short-term capital gains, if any, will be distributed
at least annually to holders of Common Stock and pro rata to holders of Common
Stock and preferred stock. While any shares of preferred stock are outstanding,
the Fund may not declare any cash dividend or other distribution on its Common
Stock, unless at the time of such declaration (1) all accumulated preferred
stock dividends, including any Additional Distribution, have been paid, and (2)
the net asset value of the Fund's portfolio (determined after deducting the
amount of such dividend or other distribution) is at least 200% of the
liquidation value of the outstanding preferred stock (expected to equal the
original purchase price of the outstanding shares of preferred stock plus any
accumulated and unpaid dividends thereon and any accumulated but unpaid
Additional Distribution). As of the date of this Prospectus, Series A AMPS
represent approximately 31% of the Fund's capital and the asset coverage with
respect to the Series A AMPS is approximately 326%. If the Fund's ability to
make distributions on its Common Stock is limited, such limitation could under
certain circumstances impair the ability of the Fund to maintain its
qualification for taxation as a regulated investment company, which could have
adverse tax consequences for holders of Common Stock. See "Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of Common Stock may be
automatically reinvested in shares of Common Stock of the Fund. Dividends may be
taxable to shareholders under certain circumstances as discussed below, whether
they are reinvested in shares of the Fund or received in cash.
TAXES
GENERAL
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. 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.
37
<PAGE> 40
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 income tax purposes. Exempt-interest dividends are included,
however, in determining the portion, if any, of a person's Social Security and
railroad retirement benefits subject to Federal income taxes. Interest on
indebtedness incurred or continued to purchase or carry Fund shares 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.
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
will be 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 Internal Revenue Service has taken the position in a revenue ruling
that if a RIC has two classes of shares, it may designate distributions made to
each class in any year as consisting of no more than such class's proportionate
share of particular types of income, including exempt-interest income and net
long-term capital gains. A class's proportionate share of a particular type of
income is determined according to the percentage of
38
<PAGE> 41
total dividends paid by the RIC during such year that was paid to such class.
Consequently, when both Common Stock and preferred stock are outstanding, the
Fund intends to designate distributions made to the classes as consisting of
particular types of income in accordance with the classes' proportionate shares
of such income. Thus, the Fund will designate dividends paid as exempt-interest
dividends in a manner that allocates such dividends between the holders of
Common Stock and preferred stock in proportion to the total dividends paid to
each class during the taxable year, or otherwise as required by applicable law.
Capital gain dividends will similarly be allocated between the two classes in
proportion to the total dividends paid to each class during the taxable year, or
otherwise as required by applicable law. When capital gain or other taxable
income is allocated to holders of preferred stock pursuant to the allocation
rules described above, the terms of the preferred stock may require the Fund to
make an additional distribution to or otherwise compensate such holders for the
tax liability resulting from such allocation.
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 reflects 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 preferred stock are outstanding the Fund does
not meet the asset coverage requirements of the 1940 Act, the Fund will be
required to suspend distributions to holders of Common Stock until the asset
coverage is restored. See "Dividends and Distributions." This may prevent the
Fund from distributing at least 90% of its net investment income and may,
therefore, jeopardize the 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 preferred stock in order to maintain
or restore the requisite asset coverage and avoid the adverse consequences to
the Fund and its shareholders of failing to qualify as a RIC. There can be no
assurance, however, that any such action would achieve such objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund currently contemplates issuing may
raise an issue
39
<PAGE> 42
as to whether distributions on such preferred stock are "preferential" under the
Code and therefore not eligible for the dividends paid deduction. The Fund
intends to issue preferred stock that counsel advises will not result in the
payment of a preferential dividend and may seek a private letter ruling from the
Internal Revenue Service to that effect. If the Fund ultimately relies solely on
a legal opinion when it issues such preferred stock, there is no assurance that
the Internal Revenue Service would agree that dividends on the preferred stock
are not preferential. If the Internal Revenue Service successfully disallowed
the dividends paid deduction for dividends on the preferred stock, the Fund
could be disqualified as a RIC. In this case, dividends on the Common Stock
would not be exempt from Federal income taxes. Additionally, the Fund would be
subject to the alternative minimum tax.
The value of shares acquired pursuant to the Fund's dividend reinvestment
plan will generally be excluded from gross income to the extent that the cash
amount reinvested would be excluded from gross income. If, when the Fund's
shares are trading at a premium over net asset value, the Fund issues shares
pursuant to the dividend reinvestment plan which have a greater fair market
value than the amount of cash reinvested, it is possible that all or a portion
of such discount (which may not exceed 5% of the fair market value of the Fund's
shares) could be viewed as a taxable distribution. If the discount is viewed as
a taxable distribution, it is also possible that the taxable character of this
discount would be allocable to all the shareholders, including shareholders who
do not participate in the dividend reinvestment plan. Thus, shareholders who do
not participate in the dividend reinvestment plan might be required to report as
ordinary income a portion of their distributions equal to their allocable share
of the discount.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisers concerning the applicability of the United States withholding
tax.
Under certain Code provisions, some taxpayers may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every 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
40
<PAGE> 43
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 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.
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.
OFFERS TO PURCHASE SHARES
Under current law, a holder of Common Stock, who, pursuant to any Tender
Offer, tenders all shares of Common Stock owned by such shareholder and who,
after such Tender Offer, is not considered to own any shares under attribution
rules contained in the Code will realize a taxable gain or loss depending upon
such shareholder's basis in the shares. Such gain or loss will be treated as
capital gain or loss if the shares are held as capital assets in the
shareholder's hands and will be long-term or short-term depending upon the
shareholder's holding period for the shares. Different tax consequences may
apply to tendering and non-tendering holders of Common Stock in connection with
a Tender Offer, and these consequences will be disclosed in the related offering
documents. For example, if a tendering holder of Common Stock tenders less than
all shares owned by or attributed to such shareholder, and if the distribution
to such shareholder does not otherwise qualify as an exchange, the proceeds
received will be treated as a taxable dividend, return of capital or capital
gain depending on the Fund's earnings and profits and the shareholder's basis in
the tendered shares. Also, there is a remote risk that non-tendering holders of
Common Stock may be considered to have received a deemed distribution which may
be a taxable dividend in whole or in part. Holders of Common Stock may wish to
consult their tax advisers prior to tendering. If holders of Common Stock whose
shares are acquired by the Fund in the open market sell less than all shares
owned by or attributed to them, there is a risk that these
41
<PAGE> 44
shareholders will be subject to taxable dividend treatment, as well as a remote
risk that the remaining shareholders may be considered to have received a deemed
distribution.
STATE AND LOCAL TAXES
The exemption from Federal income tax for exempt-interest dividends does
not necessarily result in an exemption for such dividends under the income or
other tax laws of any state or local taxing authority. Shareholders are advised
to consult their own tax advisers concerning state and local tax matters.
------------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and
Treasury Regulations presently in effect. For the complete provisions, reference
should be made to the pertinent Code sections and the Treasury Regulations
promulgated thereunder. The Code and the Treasury Regulations are subject to
change by legislative or administrative action either prospectively or
retroactively.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
All dividends and capital gains distributions on the Common Stock of the
Fund are reinvested automatically in full and fractional shares of Common Stock
of the Fund at the net asset value per share next determined on the payable date
of such dividend or distribution. A shareholder may at any time, by request to
his Merrill Lynch financial consultant or by written notification or by
telephone (1-800-MER-FUND) to the Transfer Agent, elect to have subsequent
dividends or capital gains distributions, or both, paid in cash, rather than
reinvested, in which event payment will be mailed on or about the payment date.
Cash payments can also be directly deposited to the shareholder's bank account.
No CDSC will be imposed upon redemption of shares issued as a result of the
automatic reinvestment of dividends or capital gains distributions.
The automatic reinvestment of dividends will not relieve participants of
any Federal income tax that may be payable (or required to be withheld) on such
dividends or distributions. See "Taxes."
NET ASSET VALUE
Net asset value per share of Common Stock is determined as of 15 minutes
after the close of business on 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 preferred stock
is divided by the total number of shares of Common Stock outstanding at such
time. Expenses, including the fees payable to the Investment Adviser, are
accrued daily.
The Municipal Bonds and other portfolio securities 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.
42
<PAGE> 45
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 financial 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
Auction Market Preferred Stock, par value $0.10 per share, liquidation
preference $25,000 per share ("AMPS").
The following table shows the amount of (i) capital stock authorized, (ii)
capital stock held by the Fund for its own account and (iii) capital stock
outstanding for each class of authorized securities of the Fund as of 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
Shares of Common Stock, when issued and outstanding, will be fully paid and
non-assessable. Holders of Common Stock are entitled to share pro rata in the
net assets of the Fund available for distribution to holders of Common Stock
upon liquidation of the Fund. Holders of Common Stock are entitled to one vote
for each share held.
So long as any shares of the Fund's preferred stock are outstanding,
holders of Common Stock will not be entitled to receive any net income of or
other distributions from the Fund unless all accumulated dividends on preferred
stock have been paid and unless asset coverage (as defined in the 1940 Act) with
respect to preferred stock would be at least 200% after giving effect to such
distributions. See "Preferred Stock" below.
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its shareholders.
43
<PAGE> 46
PREFERRED STOCK
The Fund's shares of preferred stock may be issued in one or more series,
with rights as determined by the Board of Directors, by action of the Board of
Directors without the approval of the holders of Common Stock. Under the Funds's
Articles Supplementary specifying the powers, preferences and rights of the
AMPS, the Fund is authorized to issue an aggregate of 40,000 shares of AMPS,
designated respectively: 8,000 shares of Series A AMPS, 8,000 shares of Series B
AMPS, 8,000 shares of Series C AMPS, 8,000 shares of Series D AMPS and 8,000
shares of Series E AMPS. The Series A AMPS are the only series currently offered
and to be issued and outstanding. Under the 1940 Act, the Fund is permitted to
have outstanding more than one series of preferred stock so long as no single
series has a priority over another series as to the distributions of assets of
the Fund or the payment of dividends. Holders of Common Stock have no preemptive
right to purchase any shares of preferred stock that might be issued. It is
anticipated that the net asset value per share of the preferred stock will equal
its original purchase price per share plus accumulated dividends per share.
The Fund has issued 1,520 shares of Series A AMPS and may offer additional
shares of AMPS and other preferred stock (representing up to approximately 35%
of the Fund's capital), subject to market conditions and to the Board's
continuing to believe that leveraging the Fund's capital structure through the
issuance of preferred stock is likely to achieve the benefits to the holders of
Common Stock described in the Prospectus. The terms of such preferred stock,
including its dividend rate, voting rights, liquidation preference and
redemption provisions will be determined by the Board of Directors (subject to
applicable law and the Fund's Articles of Incorporation). The redetermination of
the dividend rate will be made at relatively short intervals (generally seven or
28 days), or a medium-term dividend rate, in which case periodic redetermination
of the dividend rate will be made at intervals of up to five years. In either
case, such redetermination of the dividend rate will be made through an auction
or remarketing procedure. Additionally, under certain circumstances, when the
Fund is required to allocate taxable income to holders of the preferred stock,
it is anticipated that the terms of the preferred stock will require the Fund to
make an Additional Distribution (as defined in "Risks and Special Considerations
of Leverage--Effects of Leverage") to such holders. The Board also has indicated
that it is likely that the liquidation preference, voting rights and redemption
provisions of the preferred stock will be as stated below. The Fund's Articles
of Incorporation, as amended, together with any Articles Supplementary, are
referred to below as the "Charter."
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of shares of
preferred stock will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus an
amount equal to accumulated and unpaid dividends whether or not earned or
declared and any accumulated and unpaid Additional Distribution) before any
distribution of assets is made to holders of Common Stock. After payment of the
full amount of the liquidating distribution to which they are entitled, the
preferred stockholders will not be entitled to any further participation in any
distribution of assets by the Fund. A consolidation or merger of the Fund with
or into any other corporation or corporations or a sale of all or substantially
all of the assets of the Fund will not be deemed to be a liquidation,
dissolution or winding up of the Fund.
Voting Rights. Except as otherwise indicated in this Prospectus and except
as otherwise required by applicable law, holders of shares of preferred stock
will have equal voting rights with holders of shares of Common Stock (one vote
per share) and will vote together with holders of Common Stock as a single
class.
44
<PAGE> 47
In connection with the election of the Fund's directors, holders of shares
of Series A AMPS and other preferred stock, voting as a separate class, are
entitled to elect two of the Fund's directors, and the remaining directors will
be elected by all holders of capital stock, voting as a single class. So long as
any preferred stock is outstanding, the Fund will have not less than five
directors. If at any time dividends on shares of the Fund's preferred stock
shall be unpaid in an amount equal to two full years' dividends thereon, the
holders of all outstanding shares of preferred stock, voting as a separate
class, will be entitled to elect a majority of the Fund's directors until all
dividends in default have been paid or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding shares
of the preferred stock, voting as a separate class, will be required to (i)
authorize, create or issue (other than the preferred stock authorized by the
Articles Supplementary creating such preferred stock), or increase the
authorized or issued aggregate stated capital amount of (other than the
preferred stock authorized by the Articles Supplementary creating such preferred
stock), any class or series of stock ranking prior to or on a parity with any
series of preferred stock with respect to payment of dividends or the
distribution of assets on liquidation, or increase the authorized amount of
preferred stock or (ii) amend, alter or repeal the provisions of the Charter,
whether by merger, consolidation or otherwise, so as to adversely affect any of
the contract rights expressly set forth in the Charter of holders of preferred
stock.
Redemption Provisions. Shares of preferred stock generally will be
redeemable at the option of the Fund at a price equal to their liquidation
preference plus accumulated but unpaid dividends to the date of redemption plus,
under certain circumstances, a redemption premium. Shares of preferred stock
will also be subject to mandatory redemption at a price equal to their
liquidation preference plus accumulated but unpaid dividends to the date of
redemption upon the occurrence of certain specified events, such as the failure
of the Fund to maintain asset coverage requirements for the preferred stock
specified by the rating agencies which issue ratings on the preferred stock. The
Charter prohibits the sale or transfer of preferred stock to any affiliate of
the Fund or the Investment Adviser, except for an affiliate that may be acting
as a broker-dealer in connection with the preferred stock.
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A director may be removed from office
with or without cause 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 preferred stock may be removed only by action
of such holders.
In addition, the Articles of Incorporation require the favorable vote of
the holders of at least 66 2/3% of the Fund's shares of capital stock, then
entitled to be voted, voting as a single class, to approve, adopt or authorize
the following:
(i) a merger or consolidation or statutory share exchange of the Fund
with any other corporation,
45
<PAGE> 48
(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 the Fund's
shares of capital stock is required. The approval, adoption or authorization of
the foregoing would also require the favorable vote of at least a majority of
the Fund's shares of preferred stock then entitled to be voted, voting as a
separate class.
In addition, conversion of the Fund to an open-end investment company would
require an amendment to the Fund's Articles of Incorporation. The amendment
would have to be declared advisable by the Board of Directors prior to its
submission to shareholders. Such an amendment would require the favorable vote
of the holders of at least 66 2/3% of the Fund's outstanding shares of capital
stock (including the preferred stock) entitled to be voted on the matter, voting
as a single class (or a majority of such shares if the amendment was previously
approved, adopted or authorized by at least two-thirds of the total number of
Directors fixed in accordance with the by-laws), and, while shares of preferred
stock are outstanding, the affirmative vote of at least a majority of
outstanding shares of preferred stock of the Fund, voting as a separate class.
Such a vote also would satisfy a separate requirement in the 1940 Act that the
change be approved by the shareholders. Shareholders of an open-end investment
company may require the company to redeem their shares of common stock at any
time (except in certain circumstances as authorized by or under the 1940 Act) at
their net asset value, less such redemption charge, if any, as might be in
effect at the time of a redemption. All redemptions will be made in cash. If the
Fund is converted to an open-end investment company, it could be required to
liquidate portfolio securities to meet requests for redemption. Conversion to an
open-end investment company would also require redemption of all outstanding
shares of preferred stock and would require changes in certain of the Fund's
investment policies and restrictions, such as those relating to the issuance of
senior securities and the borrowing of money.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of shareholders generally.
Reference should be made to the Charter on file with the SEC for the full text
of these provisions.
PERFORMANCE DATA
From time to time, the Fund may include its yield and/or total return on
its Common Stock for various specified time periods in advertisements or
information furnished to present or prospective shareholders. The yield of the
Fund refers to the income generated by an investment in the Fund over a stated
period. Yield is calculated by annualizing the distribution over a stated period
and dividing the product by the average per share net value. For the period
November 3, 1995 (commencement of operations) to October 31, 1996, the Fund
earned income dividends of $0.585 per share, representing a net annualized yield
of 5.80%, based on a net asset value of $10.17 per share of Common Stock on
October 31, 1996.
The Fund also may quote annual total return and aggregate total return
performance data. Total return quotations for the specified periods will be
computed by finding the rate of return (based on net investment
46
<PAGE> 49
income and any capital gains or losses on portfolio investments over such
periods) that would equate the initial amount invested to the value of such
investment at the end of the period. For the period November 3, 1995
(commencement of operations) to October 31, 1996, the annual total return of the
Fund was 7.81%, based on the change in net asset value per share of Common Stock
from $10.00 to $10.17, and assuming reinvestment of income dividends of $0.562
per share of Common Stock.
The calculation of yield and total return does not reflect the imposition
of any CDSC or the amount of any shareholder's tax liability.
Yield and total return figures are based on the Fund's historical
performance and are not intended to indicate further performance. The Fund's
yield is expected to fluctuate, and its total return will vary depending on
market conditions, the Municipal Bonds and other securities comprising the
Fund's portfolio, the Fund's operating expenses and the amount of net realized
and unrealized capital gains or losses during the period.
On occasion, the Fund may compare its yield and tax-equivalent yield to
yield data published by Lipper Analytical Services, Inc. or performance data
published by Morningstar Publications, Inc., Money Magazine, U.S. News & World
Report, Business Week, CDA Investment Technology, Inc., Forbes Magazine and
Fortune Magazine. Yield comparisons should not be considered indicative of the
Fund's yield and tax-equivalent yield or relative performance for any future
period.
CUSTODIAN
The Fund's securities and cash are held under a custody agreement with The
Bank of New York, 90 Washington Street, New York, New York 10286.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT
AND SHAREHOLDER SERVICING AGENT
The transfer agent, dividend disbursing agent and shareholder servicing
agent for the shares of Common Stock of the Fund is Merrill Lynch Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484, a
wholly owned subsidiary of ML & Co.
Shareholder Reports. Only one copy of each shareholder report and certain
shareholder communications will be mailed to each identified shareholder
regardless of the number of accounts such shareholder has. If a shareholder
wishes to receive separate copies of each report and communication for each of
the shareholder's related accounts the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch and/or mutual fund account numbers. If
you have any questions regarding this, please call your Merrill Lynch financial
consultant or Merrill Lynch Financial Data Services, Inc. at 800-637-3863.
47
<PAGE> 50
LEGAL OPINIONS
Certain legal matters in connection with the Common Stock offered hereby
will be passed on for the Fund by Brown & Wood LLP, One World Trade Center, New
York, New York 10048-0557.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, have
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to ratification by shareholders of the Fund. The
independent auditors are responsible for auditing the financial statements of
the Fund.
48
<PAGE> 51
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
49
<PAGE> 52
<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>
50
<PAGE> 53
<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
51
<PAGE> 54
<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>
52
<PAGE> 55
<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>
53
<PAGE> 56
<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>
54
<PAGE> 57
<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>
55
<PAGE> 58
<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>
56
<PAGE> 59
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
57
<PAGE> 60
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
58
<PAGE> 61
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.
59
<PAGE> 62
[This page is intentionally left blank.]
60
<PAGE> 63
APPENDIX I
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
61
<PAGE> 64
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 are of
"favorable quality . . . but lacking the undeniable strength of the preceding
grades"; MIG-4/VMIG-4 notes 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 many of the following
characteristics: leading market positions in well established industries;
high rates of return on funds employed; conservative capitalization
structure with moderate reliance on debt and ample asset protection; broad
margins in earnings coverage of fixed financial charges and high internal
cash generation; and well-established access to a range of financial
markets and assured sources of alternate liquidity.
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
62
<PAGE> 65
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's 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's from other sources S&P's considers reliable. S&P's does not
perform an audit in connection with any rating and may, on occasion, rely on
unaudited financial information. The ratings may be changed, suspended or
withdrawn as a result of changes in, or unavailability of, such information, or
for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of 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.
63
<PAGE> 66
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 plus sign (+)
designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
A-3 Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
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's from other sources it considers
reliable. S&P's does not conduct an audit in connection with any rating and may,
on occasion, relay 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.
An 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).
64
<PAGE> 67
Source of payment (the more dependent the issue is on the market for
its refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
<TABLE>
<S> <C>
SP-1 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.
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.
65
<PAGE> 68
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 X
Stable UW
Declining Z
X
Uncertain Z
</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 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.
66
<PAGE> 69
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>
<S> <C>
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded
as having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance
of timely payment only slightly less in degree than issues rated "F-1+."
</TABLE>
67
<PAGE> 70
<TABLE>
<S> <C>
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree
of assurance for timely payment, but the margin of safety is not as great as
for issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate;
however, near-term adverse changes could cause these securities to be rated
below investment grade.
F-4 Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are vulnerable
to near-term adverse changes in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent payment
default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit
issued by a commercial bank.
</TABLE>
68
<PAGE> 71
APPENDIX II
TAXABLE EQUIVALENT YIELDS FOR 1997
<TABLE>
<CAPTION>
TAXABLE INCOME* A TAX-EXEMPT YIELD OF
- ------------------------ -------------------------------------------------------------------------------
1997
FEDERAL
SINGLE JOINT TAX
RETURN RETURN BRACKET 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
- ---------- ---------- --------- --------- --------- --------- --------- --------- ---------
IS EQUAL TO A TAXABLE YIELD OF
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$24,651- $41,201- 28.00% 6.94% 7.64% 8.33% 9.03% 9.72% 10.42%
$59,750 $99,600
$59,751- $99,601- 31.00% 7.25% 7.97% 8.70% 9.42% 10.14% 10.87%
$124,650 $151,750
$124,651- $151,751- 36.00% 7.81% 8.59% 9.38% 10.16% 10.94% 11.72%
$271,050 $271,050
Over Over
$271,050 $271,050 39.60% 8.28% 9.11% 9.93% 10.76% 11.59% 12.42%
</TABLE>
- ------------------
* An investor's marginal tax rates may exceed the rates shown in the above table
due to the reduction, or possible elimination, of the personal exemption
deduction for high-income taxpayers and an overall limit on itemized
deductions. Income also may be subject to certain state and local taxes. For
investors who pay alternative minimum tax, tax-exempt yields may be equivalent
to lower taxable yields than those shown above. The tax rates shown above do
not apply to corporate taxpayers. The tax characteristics of the Fund are
described more fully elsewhere in this Prospectus. Consult your tax adviser
for further details. This chart is for illustrative purposes only and cannot
be taken as an indication of anticipated Fund performance.
69
<PAGE> 72
[This page is intentionally left blank.]
70
<PAGE> 73
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUTHORIZATION FORM
- --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase .... shares of Merrill Lynch
Municipal Strategy Fund, Inc. and establish an Investment Account as described
in the Prospectus.
Basis for establishing an Investment Account:
I enclose a check for $.... payable to Merrill Lynch Financial Data
Services, Inc., as an initial investment (minimum $1,000). (Subsequent
investments $50 or more.) I understand that this purchase will be executed at
the applicable offering price next to be determined after this Application is
received by you.
Until you are notified by me in writing, the following options with respect
to dividends and distributions are elected:
<TABLE>
<S> <C> <C>
---------------------------------------- ----------------------------------------
Distribution Elect [ ] reinvest dividends Elect [ ] reinvest capital gains
Options One [ ] pay dividends in cash One [ ] pay capital gains in cash
---------------------------------------- ----------------------------------------
</TABLE>
IF NO ELECTION IS MADE, DIVIDENDS AND CAPITAL GAINS WILL BE REINVESTED
AUTOMATICALLY AT NET ASSET VALUE WITHOUT A SALES CHARGE.
<TABLE>
<S> <C>
(PLEASE PRINT)
Name.........................................................
First Name Initial Last Name
__ __ __ __ __ __ __ __ __
Name of Co-Owner (if any).................................... Social Security No.
First Name Initial Last Name or Taxpayer Identification No.
Address......................................................
............................................................. ........................, 19.....
(Zip Code) Date
</TABLE>
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security No. or Taxpayer Identification No. and (2) that I am
not subject to backup withholding (as discussed in the Prospectus under "Taxes")
either because I have not been notified that I am subject thereto as a result of
a failure to report all interest or dividends, or the Internal Revenue Service
("IRS") has notified me that I am no longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDERREPORTING, AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH-SPONSORED INVESTMENT COMPANIES.
SIGNATURE OF OWNER ................. SIGNATURE OF CO-OWNER (IF ANY).............
In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.
- --------------------------------------------------------------------------------
2. FOR DEALER ONLY
Branch Office, Address, Stamp
_____ _____
| |
| |
| |
|_____ _____|
This form when completed should be mailed to:
Merrill Lynch Municipal Strategy Fund, Inc.
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289.
We guarantee the Shareholder's Signature.
......................................................
Dealer Name and Address
By ...................................................
Authorized Signature of Dealer
__ __ __ __ __ __ __ _____________
Branch-Code F/C No. F/C Last Name
__ __ __ __ __ __ __ __
Dealer's Customer A/C No.
71
<PAGE> 74
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.................... 8
Fee Table........................... 10
Financial Highlights................ 11
The Fund............................ 12
Investment Objective and Policies... 12
Risks and Special Considerations of
Leverage.......................... 21
Investment Restrictions............. 24
Purchase of Shares.................. 25
Tender Offers....................... 27
Contingent Deferred Sales Charge.... 30
Directors and Officers.............. 31
Investment Advisory and
Administrative Arrangements....... 33
Portfolio Transactions.............. 36
Dividends and Distributions......... 37
Taxes............................... 37
Automatic Dividend Reinvestment
Plan.............................. 42
Net Asset Value..................... 42
Description of Capital Stock........ 43
Performance Data.................... 46
Custodian........................... 47
Transfer Agent, Dividend Disbursing
Agent and Shareholder Servicing
Agent............................. 47
Legal Opinions...................... 48
Independent Auditors................ 48
Independent Auditors' Report........ 49
Financial Statements................ 50
Appendix I--Ratings of Municipal
Bonds and Commercial Paper........ 61
Appendix II--Taxable Equivalent
Yields for 1997................... 69
Authorization Form.................. 71
</TABLE>
Code #18302-0297
[LOGO]
MERRILL LYNCH
MUNICIPAL STRATEGY
FUND, INC.
PROSPECTUS MLYNCH COMPASS
February 3, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE> 75
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 plate, circular Back cover of Prospectus.
graph paper and Merrill Lynch
logo including stylized market
bull.
<PAGE> 76
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>
<S> <C> <C>
(a)(1) -- Articles of Incorporation of the Registrant. (a)
(2) -- Articles of Amendment to the Articles of Incorporation of the Registrant
(name change). (a)
(3) -- Form of Articles Supplementary creating shares of Auction Market Preferred
Stock ("AMPS") of the Registrant. (b)
(b) -- By-Laws of the Registrant. (a)
(c) -- Not applicable.
(d)(1) -- Portions of the Articles of Incorporation and By-Laws of the Registrant
defining the rights of holders of shares of the Registrant. (c)
(2) -- Form of specimen certificate for shares of Common Stock of the Registrant.
(a)
(3) -- Form of specimen certificate for shares of AMPS of the Registrant. (b)
(e) -- Not applicable.
(f) -- Not applicable.
(g)(1) -- Form of Investment Advisory Agreement between the Registrant and Fund
Asset Management, L.P. (a)
(2) -- Form of Administration Agreement between the Registrant and Fund Asset
Management, L.P. (a)
(h)(1) -- Form of Distribution Agreement relating to the Common Stock between the
Registrant and Merrill Lynch Funds Distributor, Inc. ("MLFD") (the "Common
Stock Distribution Agreement"). (a)
(2) -- Form of Selected Dealer Agreement relating to the Common Stock. (a)
(3) -- Form of Distribution Agreement relating to the AMPS between the Registrant
and Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch")
(the "AMPS Distribution Agreement"). (b)
(i) -- Not applicable.
(j) -- Form of Custody Agreement between the Registrant and The Bank of New York.
(a)
(k)(1) -- Form of Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between the Registrant and Merrill Lynch
Financial Data Services, Inc. ("MLFDS"). (a)
(2) -- Form of License Agreement relating to the use of the "Merrill Lynch" name.
(a)
(3) -- Form of Auction Agent Agreement between the Registrant and IBJ Schroeder
Bank & Trust Company. (b)
(4) -- Form of Broker-Dealer Agreement. (b)
(5) -- Form of Letter of Representations. (b)
(l) -- Opinion of Brown & Wood LLP, counsel to the Registrant.
</TABLE>
C-1
<PAGE> 77
<TABLE>
<S> <C> <C>
(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) Previously filed as an Exhibit to the Registrant's registration statement on
Form N-2, File No. 33-54655 (the "Common Stock Registration Statement")
filed under the Securities Act of 1933, as amended (the "1933 Act").
(b) Incorporated by reference to the Registrant's registration statement on Form
N-2, File No. 33-64311 (the "AMPS Registration Statement").
(c) Reference is made to Article V, Article VI (sections 2,3,4,5 and 6), Article
VII, Article VIII, Article X, Article XI, Article XII and Article XIII of
the Registrant's Articles of Incorporation, previously filed as Exhibit
(a)(1) to the Common Stock Registration Statement; and to Article II,
Article III (sections 1, 2, 3, 5 and 17), Article VI, Article VII, Article
XII, Article XIII and Article XIV of the Registrant's By-Laws, previously
filed as Exhibit (b) to the Common Stock Registration Statement. Reference
is also made to the Form of Articles Supplementary previously filed as
Exhibit (a)(3) to the AMPS Registration Statement.
ITEM 25. MARKETING ARRANGEMENTS.
Previously provided as Exhibit (h) to the Registrant's Common Stock
Registration Statement.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this Registration Statement.
<TABLE>
<S> <C>
Registration...................................................... $ 100
Printing (other than stock certificates).......................... 50,000
Fees and expenses of qualifications under state securities laws... 70,000
Legal fees and expenses........................................... 10,000
NASD fees......................................................... 533
--------
Total........................................................ $130,633
========
</TABLE>
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The information in the Prospectus under the captions "Investment Advisory
and Administrative Arrangements" and "Description of Capital Stock -- Common
Stock" and in Note 1 to the Statement of Assets, Liabilities and Capital is
incorporated herein by reference.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES.
<TABLE>
<CAPTION>
NUMBER OF HOLDERS
TITLE OF CLASS DECEMBER 31, 1996
-------------- -----------------
<S> <C>
Shares of Common Stock, par value $0.10 per share................... 2,185
Shares of AMPS, par value $0.10 per share, liquidation
preference $25,000 per share...................................... 1
</TABLE>
- ---------------
Note: The number of holders shown above includes holders of record plus
beneficial owners, whose shares are held of record by Merrill Lynch.
ITEM 29. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, previously filed as
Exhibit (a)(1) to the Registrant's Common Stock Registration Statement, Article
VI of the Registrant's By-Laws, previously filed as Exhibit (b) to the
Registrant's
C-2
<PAGE> 78
Common Stock Registration Statement, and the Investment Advisory Agreement, a
form of which was filed as Exhibit (g)(1) to the Registrant's Common Stock
Registration Statement, provide for indemnification.
Insofar as indemnification for liabilities arising under the 1933 Act may
be provided to directors, officers and controlling persons of the Registrant,
pursuant to the foregoing provisions or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the 1933 Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in
connection with any successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the 1933 Act and will be governed by the
final adjudication of such issue.
Reference is made to Section 9 of each of the Common Stock and AMPS
Distribution Agreements, forms of which were previously filed as Exhibits (h)(1)
and (h) to the Registrant's Common Stock Registration Statement and AMPS
Registration Statement, respectively, for provisions relating to the
indemnification of the underwriter and distributor, respectively.
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
Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc.,
Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund, Inc.,
Merrill Lynch World Income Fund, Inc., and The Municipal Fund Accumulation
Program, Inc.; and for the following closed-end 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., 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,
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
C-3
<PAGE> 79
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, MLFD, Princeton Services, Inc. ("Princeton
Services") and Princeton Administrators, L.P. also is P.O. Box 9011, Princeton,
New Jersey 08543-9011. The address of Merrill Lynch and Merrill Lynch & Co.,
Inc. ("ML & Co.") is 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, Kirstein and Monagle are
directors or officers of one or more of such companies.
Officers and Partners of FAM are set forth below as follows:
<TABLE>
<CAPTION>
POSITION(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 MLFDS; Executive
Vice President of ML & Co.
Terry K. Glenn........... Executive Vice President Executive Vice President of MLAM;
Executive Vice President and Director
of Princeton Services; President and
Director of MLFDS; President of
Princeton Administrators, L.P.
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
</TABLE>
C-4
<PAGE> 80
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- -------------------------- ----------------------------------------
<S> <C> <C>
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>
C-5
<PAGE> 81
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 (the "1940 Act") and the
rules promulgated thereunder are maintained at the offices of the Registrant
(800 Scudders Mill Road, Plainsboro, New Jersey 08536), the Investment Adviser
(800 Scudders Mill Road, Plainsboro, New Jersey 08536), and the Registrant's
custodian and transfer agent.
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
ITEM 33. UNDERTAKINGS.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
1933 Act;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the Registration Statement; and
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the Registration Statement
or any material change to such information in the Registration
Statement.
(2) That, for the purpose of determining any liability under the 1933
Act, each such post-effective amendment shall be deemed to be a new
Registration Statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
C-6
<PAGE> 82
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the Township of Plainsboro and State of New Jersey, on the 30th
of January, 1997.
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
(Registrant)
By: /s/ ARTHUR ZEIKEL
---------------------------------------
(Arthur Zeikel, President and Director)
Each person whose signature appears hereby authorizes Arthur Zeikel, Terry
K. Glenn or Gerald M. Richard, or any of them, as attorney-in-fact, to sign on
his or her behalf, individually and in each capacity stated below, any
amendments to this Registration Statement (including post-effective amendments)
and to file the same, with all exhibits thereto, with the Securities and
Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<S> <C> <C>
/s/ ARTHUR ZEIKEL President and Director January 30, 1997
- ------------------------------------------ (Principal Executive Officer)
(Arthur Zeikel)
GERALD M. RICHARD Treasurer (Principal Financial
- ------------------------------------------ and Accounting Officer)
(Gerald M. Richard)
RONALD W. FORBES Director
- ------------------------------------------
(Ronald W. Forbes)
CYNTHIA A. MONTGOMERY Director
- ------------------------------------------
(Cynthia A. Montgomery)
CHARLES C. REILLY Director
- ------------------------------------------
(Charles C. Reilly)
KEVIN A. RYAN Director
- ------------------------------------------
(Kevin A. Ryan)
RICHARD R. WEST Director
- ------------------------------------------
(Richard R. West)
*By: /s/ ARTHUR ZEIKEL January 30, 1997
- ------------------------------------------
(Arthur Zeikel, Attorney-in-Fact)
</TABLE>
C-7
<PAGE> 83
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- --------
<S> <C> <C>
(l) -- Opinion of Brown & Wood LLP, counsel for the Registrant.
(n) -- Consent of Deloitte & Touche LLP, independent auditors for the Registrant.
(r) -- Financial Data Schedule.
</TABLE>
<PAGE> 1
BROWN & WOOD LLP
ONE WORLD TRADE CENTER
NEW YORK, N.Y. 10048-0557
TELEPHONE: 212-839-5300
FACSIMILE: 212-839-5599
January 30, 1997
Merrill Lynch Municipal Strategy
Fund, Inc.
P.O. Box 9011
Princeton, New Jersey 08543-9011
Ladies and Gentlemen:
We have acted as counsel for Merrill Lynch Municipal Strategy Fund,
Inc., a Maryland corporation (the "Fund"), in connection with the registration
of 9,967,742 shares of common stock, par value $0.10 per share (the "Common
Stock"), under the Securities Act of 1933, as amended, pursuant to a
pre-effective amendment to the registration statement on Form N-2 to be filed
with the Securities and Exchange Commission on the date hereof (the
"Amendment").
As counsel for the Fund, we are familiar with the proceedings taken by
the Fund in connection with the authorization, issuance and sale of the Common
Stock. In addition, we have examined and are familiar with the Articles of
Incorporation of the Fund, as amended, including the Articles Supplementary,
the By-Laws of the Fund and such other documents as we have deemed relevant to
the matters referred to in this opinion.
Based upon the foregoing, we are of the opinion that the Common Stock,
upon issuance and sale in the manner referred to in the Amendment for
consideration
<PAGE> 2
not less than the par value thereof, will be legally issued, fully paid and
non-assessable shares of common stock of the Fund.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus
constituting a part thereof.
Very truly yours,
/s/ BROWN & WOOD LLP
<PAGE> 1
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Municipal Strategy Fund, Inc.:
We consent to the use in Pre-Effective Amendment No. 1 to Registration
Statement No. 333-19479 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.
/s/ Deloitte & Touche LLP
- ------------------------------------
Deloitte & Touche LLP
Princeton, New Jersey
January 30, 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
<PERIOD-START> NOV-03-1995
<PERIOD-END> OCT-31-1996
<INVESTMENTS-AT-COST> 118382975
<INVESTMENTS-AT-VALUE> 120317921
<RECEIVABLES> 2330794
<ASSETS-OTHER> 414056
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 123062771
<PAYABLE-FOR-SECURITIES> 989690
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 500204
<TOTAL-LIABILITIES> 1489894
<SENIOR-EQUITY> 38000000
<PAID-IN-CAPITAL-COMMON> 82093876
<SHARES-COMMON-STOCK> 8218896
<SHARES-COMMON-PRIOR> 10000
<ACCUMULATED-NII-CURRENT> 4568
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (460513)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 1934946
<NET-ASSETS> 121572877
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 5319253
<OTHER-INCOME> 0
<EXPENSES-NET> (478126)
<NET-INVESTMENT-INCOME> 4841127
<REALIZED-GAINS-CURRENT> (460513)
<APPREC-INCREASE-CURRENT> 1934946
<NET-CHANGE-FROM-OPS> 6315560
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (4836559)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 8321280
<NUMBER-OF-SHARES-REDEEMED> (199672)
<SHARES-REINVESTED> 87288
<NET-CHANGE-IN-ASSETS> 121472877
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 446931
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1128872
<AVERAGE-NET-ASSETS> 89877312
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> .68
<PER-SHARE-GAIN-APPREC> .21
<PER-SHARE-DIVIDEND> (.59)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.17
<EXPENSE-RATIO> 1.26
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
