MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Semi-Annual Report
April 30, 1998
This report, including the financial information herein, is
transmitted to the shareholders of Merrill Lynch Municipal Strategy
Fund, Inc. for their information. It is not a prospectus, circular
or representation intended for use in the purchase of shares of the
Fund or any securities mentioned in the report. Past performance
results shown in this report should not be considered a
representation of future performance. The Fund has leveraged its
Common Stock by issuing Preferred Stock to provide the Common Stock
shareholders with a potentially higher rate of return. Leverage
creates risks for Common Stock shareholders, including the
likelihood of greater volatility of net asset value and market price
of shares of the Common Stock, and the risk that fluctuations in the
short-term dividend rates of the Preferred Stock may affect the
yield to Common Stock shareholders. Statements and other information
herein are as dated and are subject to change.
Merrill Lynch Municipal
Strategy Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
The Benefits and
Risks of
Leveraging
Merrill Lynch Municipal Strategy Fund, Inc. utilizes leveraging to
seek to enhance the yield and net asset value of its Common Stock.
However, these objectives cannot be achieved in all interest rate
environments. To leverage, the Fund issues Preferred Stock, which
pays dividends at prevailing short-term interest rates, and invests
the proceeds in long-term municipal bonds. The interest earned on
these investments is paid to Common Stock shareholders in the form
of dividends, and the value of these portfolio holdings is reflected
in the per share net asset value of the Fund's Common Stock.
However, in order to benefit Common Stock shareholders, the yield
curve must be positively sloped; that is, short-term interest rates
must be lower than long-term interest rates. At the same time, a
period of generally declining interest rates will benefit Common
Stock shareholders. If either of these conditions change, then the
risks of leveraging will begin to outweigh the benefits.
To illustrate these concepts, assume a fund's Common Stock
capitalization of $100 million and the issuance of Preferred Stock
for an additional $50 million, creating a total value of $150
million available for investment in long-term municipal bonds. If
prevailing short-term interest rates are approximately 3% and long-
term interest rates are approximately 6%, the yield curve has a
strongly positive slope. The fund pays dividends on the $50 million
of Preferred Stock based on the lower short-term interest rates. At
the same time, the fund's total portfolio of $150 million earns the
income based on long-term interest rates. Of course, increases in
short-term interest rates would reduce (and even eliminate) the
dividends on the Common Stock.
In this case, the dividends paid to Preferred Stock shareholders are
significantly lower than the income earned on the fund's long-term
investments, and therefore the Common Stock shareholders are the
beneficiaries of the incremental yield. However, if short-term
interest rates rise, narrowing the differential between short-term
and long-term interest rates, the incremental yield pickup on the
Common Stock will be reduced or eliminated completely. At the same
time, the market value of the fund's Common Stock may, as a result,
decline. Furthermore, if long-term interest rates rise, the Common
Stock's net asset value will reflect the full decline in the price
of the portfolio's investments, since the value of the fund's
Preferred Stock does not fluctuate. In addition to the decline in
net asset value, the market value of the fund's Common Stock may
also decline.
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
DEAR SHAREHOLDER
For the six months ended April 30, 1998, the Common Stock of Merrill
Lynch Municipal Strategy Fund, Inc. earned $0.308 per share income
dividends. This represents a net annualized yield of 5.84%, based on
a month-end net asset value of $10.74 per share. Over the same
period, the total investment return on the Fund's Common Stock was
+3.35%, based on a change in per share net asset value from $10.87
to $10.74, and assuming reinvestment of $0.444 per share income
dividends and $0.047 per share capital gains distributions.
For the three months ended April 30, 1998, the Fund's total
investment return was -1.34%, based on a change in per share net
asset value from $11.02 to $10.74, and assuming reinvestment of
$0.130 per share income dividends.
For the three months ended April 30, 1998, the Fund's Auction Market
Preferred Stock had an average yield of 3.64%.
The Municipal Market Environment
During the three months ended April 30, 1998, bond yields generally
moved higher. While low inflation has supported lower interest
rates, much of the decline in bond yields in late 1997 and early
1998 were driven more by the turmoil in Asian financial markets than
by domestic economic fundamentals. Weak economic conditions in Asia
were expected to negatively impact US growth through reduced export
demand. Additionally, inflation in the United States was also
expected to decline in response to lower prices on goods imported
from Asian manufacturers. However, in recent months, many investors
have become increasingly concerned that most of the downturn in
Asia, especially in Japan, has already occurred and any future
deterioration will not be severe enough to constrain US economic
growth and inflationary pressures. These concerns served to push
interest rates higher in the latter part of the period, causing
fixed-income yields to retrace much of their earlier gains. At April
30, 1998, the 30-year US Treasury bond yield was 5.95%, rising 14
basis points (0.14%) during the last three months. Long-term
municipal revenue bond yields declined less than 20 basis points to
end April at 5.52%.
Thus far in 1998, the municipal bond market has experienced
unexpectedly strong supply pressures. These supply pressures have
prevented tax-exempt bond yields from declining as much as US
Treasury bond yields. Over the last six months, more than $135
billion in new tax-exempt bonds were underwritten, an increase of
more than 40% compared to the same period a year ago. During the
last three months, municipalities issued over $72 billion in new
securities, an increase of more than 60% compared to the same three-
month period in 1997. Additionally, corporate issuers have also
viewed current interest rate levels as an opportunity to issue
significant amounts of taxable securities. Thus far in 1998, over
$100 billion in investment-grade corporate bonds have been
underwritten, an increase of more than 60% relative to the
comparable period a year ago. This sizeable corporate bond issuance
has tended to support generally higher fixed-income yields and
reduce the demand for tax-exempt bonds.
However, the recent pace of new municipal bond issuance is unlikely
to be maintained. Continued increases in bond issuance will require
lower and lower tax-exempt bond yields to generate the economic
savings necessary for additional municipal bond refinancings.
Preliminary estimates for 1998 total municipal bond issuance are
presently in the $200 billion--$225 billion range. These estimates
suggest that recent supply pressures are likely to abate later in
the year. Municipal bond investors received approximately $30
billion earlier this year in coupon payments, bond maturities and
proceeds from early redemptions. The demand generated by these
assets has helped offset the increase in supply seen thus far this
year. Furthermore, looking ahead, June and July have also tended to
be periods of strong investor demand as seasonal factors are likely
to generate strong income flows similar to those seen earlier this
year.
It is also possible that at least some of the recent economic
strength seen in the United States will be reversed in the coming
months. A particularly mild winter has been partially responsible
for a strong housing sector, as well as other construction
industries. This recent strong trend may not be sustained and may
lead to weaker construction growth later this year. Additionally,
strong economic growth in 1997 and the increased use of electronic
tax filing have resulted in larger and earlier Federal and state
income tax refunds to many individuals. These refunds appear to have
supported strong consumer spending in recent months, but may be
borrowing against weaker spending later this year. In addition, the
continued impact of the Asian financial crisis on the US domestic
economy's future growth remains unclear. Barring a dramatic and
unexpected resurgence of domestic inflation, we do not believe that
the Federal Reserve Board will be willing to raise interest rates
until the full impact of the Asian situation can be established.
All these factors suggest that over the near term, tax-exempt as
well as taxable bond yields are unlikely to rise by any appreciable
amount. Recent supply pressures have caused municipal bond yield
ratios to rise relative to US Treasury bond yields. At April 30,
1998, long-term tax-exempt bond yields were at attractive yield
ratios relative to comparable US Treasury securities (over 90%), and
well in excess of their expected range of 85%--88%. Any further
pressure on the municipal market may well represent a very
attractive investment opportunity.
Portfolio Strategy
During the six months ended April 30, 1998, we shifted from our
defensive position to a more constructive investment outlook. We
expected economic growth to slow along with a continued reduction in
inflation as a result of the declines in Asian equity markets. As of
April 30, 1998, only one of these expectations had been met.
Inflation has continued to fall but economic growth has not slowed.
Looking forward to the balance of 1998, we expect to maintain a
constructive outlook. We believe the continued instability of the
Asian equity markets will have a negative impact on the US economy,
allowing inflation and interest rates to decline further.
For the three months ended April 30, 1998, the yield on the Fund's
Auction Market Preferred Stock traded between 3.25%--3.90%. The
yield has been at the higher end of the range recently as a result
of temporary tax season pressure but is expected to return to the
3.50% level in the next few weeks. Leverage continues to benefit the
Fund's Common Stock shareholders by significantly augmenting their
yield. However, should the spread between short-term and long-term
tax-exempt rates narrow, the benefits of leverage will decline and,
as a result, reduce the yield to the Fund's Common Stock. (For a
complete explanation of the benefits and risks of leveraging, see
page 1 of this report to shareholders.)
In Conclusion
We appreciate your ongoing interest in Merrill Lynch Municipal
Strategy Fund, Inc., and we look forward to serving your investment
needs in the months and years to come.
Sincerely,
(Arthur Zeikel)
Arthur Zeikel
President
(Vincent R. Giordano)
Vincent R. Giordano
Senior Vice President
(Robert A. DiMella)
Robert A. DiMella
Vice President and
Portfolio Manager
(John M. Loffredo)
John M. Loffredo
Vice President and
Portfolio Manager
June 4, 1998
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
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)
CP Commercial Paper
DATES Daily Adjustable Tax-Exempt Securities
GO General Obligation Bonds
HDA Housing Development Authority
HFA Housing Finance Agency
IDA Industrial Development Authority
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
IRS Inverse Rate Securities
PCR Pollution Control Revenue Bonds
RITR Residual Interest Trust Receipts
S/F Single-Family
UT Unlimited Tax
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <S> <S> <C> <S> <C>
Alabama--1.8% NR* Aaa $ 2,815 Alabama HFA, S/F Home Mortgage Revenue Bonds, Series A-1,
6.60% due 4/01/2019 $ 3,009
Alaska--0.9% A1+ P1 1,400 Valdez, Alaska, Marine Terminal Revenue Refunding Bonds (Exxon
Pipeline Company Project), CP, Series B, 4.10% due 12/01/2033 1,400
Arizona--6.0% B B2 2,000 Apache County, Arizona, IDA, PCR, Refunding (Tucson Electric
Power Co. Project), Series A, 5.85% due 3/01/2028 2,001
BBB- NR* 1,500 Coconino County, Arizona, PCR, Refunding (Nevada Power Co.
Project), Series E, 5.35% due 10/01/2022 1,431
BB+ Ba1 1,500 Maricopa County, Arizona, Pollution Control Corp., PCR, Refunding
(Public Service Co.), Series A, 5.75% due 11/01/2022 1,525
NR* B1 1,600 Phoenix, Arizona, IDA, Airport Facilities Revenue Refunding
Bonds (America West Airlines Inc.), AMT, 6.30% due 4/01/2023 1,606
B B2 2,000 Pima County, Arizona, IDA, Industrial Revenue Bonds (Tucson
Electric Power Co. Project), Series B, 6% due 9/01/2029 2,044
NR* NR* 1,000 Show Low, Arizona, Improvement District No. 5, 6.375% due
1/01/2015 1,036
Arkansas--2.3% AAA NR* 1,160 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) 1,246
AAA Aaa 2,500 North Little Rock, Arkansas, Electric Revenue Refunding Bonds,
5.15% due 1/01/2015 (c) 2,480
California--4.2% AAA Aaa 5,130 Anaheim, California, Public Financing Authority, Lease
Revenue Bonds (Public Improvements Project), Sub-Series C,
5.48%** due 9/01/2018 (d) 1,722
A+ A1 2,725 California State Veterans, AMT, Series BH, 5.60% due 12/01/2032 2,742
AAA Aaa 2,000 San Diego, California, IDR, RITR, 7.785% due 9/01/2019 (e) 2,290
Colorado--8.6% NR* Aa2 2,000 Colorado HFA, S/F Program, AMT, Series D-1, 7.375% due 6/01/2026 2,235
NR* NR* 1,500 Denver, Colorado, Urban Renewal Authority, Tax Increment
Revenue Bonds (Downtown Denver), AMT, Series A, 7.75% due
9/01/2016 1,659
AAA Aaa 8,840 El Paso County, Colorado, School District No. 49 (Falcon), UT,
6.50% due 12/01/2015 (a) 9,917
Connecticut A+ NR* 2,000 Connecticut State Development Authority, Water Facility
- --2.0% Revenue Bonds (Bridgeport Hydraulic Co. Project), AMT, 6.15%
due 4/01/2035 2,143
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 1,083
Florida--10.2% AAA Aaa 3,000 Florida State Turnpike Authority, Turnpike Revenue Bonds,
Series A, 4.50% due 7/01/2027 (b) 2,617
NR* Baa1 1,000 Jacksonville, Florida, Health Facilities Authority, IDR
(National Benevolent--Cypress Village), Series A, 6.25% due
12/01/2026 1,061
Miami Dade County, Florida, Special Obligations Bonds (a):
AAA Aaa 5,445 Refunding, Series A, 5.05%** due 10/01/2014 2,277
AAA Aaa 5,000 Refunding, Series A, 5.272%** due 10/01/2020 1,478
AAA Aaa 5,550 Series B, 5.553%** due 10/01/2028 1,043
AAA Aaa 16,110 Series C, 5.455%** due 10/01/2028 3,009
BBB+ Baa2 1,000 Nassau County, Florida, PCR, Refunding (ITT Rayonier Inc.
Project), 6.25% due 6/01/2010 1,048
NR* NR* 1,250 North Springs Improvement District, Florida, Special Assessment
Revenue Bonds (Heron Bay Project), 7% due 5/01/2019 1,298
NR* Ba2 2,260 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida
Education and Research Foundation Project), Series A, 6.85%
due 9/01/2013 2,428
Georgia--2.1% AA+ Aa2 3,250 Georgia State Housing & Finance Authority, S/F Mortgage
Revenue Bonds, Series A, Sub-Series A-1, 6.125% due 12/01/2015 3,429
Illinois--4.9% NR* NR* 980 Beardstown, Illinois, IDR (Jefferson Smurfit Corp. Project), 8%
due 10/01/2016 1,130
AA- Aa3 3,285 Illinois Development Finance Authority Revenue Bonds (Presbyterian
Home Lake), Series B, 6.30% due 9/01/2022 3,581
AA Aa3 1,700 Illinois HDA, Revenue Bonds (Homeowner Mortgage), AMT, Series
D, Sub-Series D-2, 5.65% due 8/01/2028 1,711
NR* Baa1 1,250 Illinois Health Facilities Authority Revenue Bonds (Holy Cross
Hospital Project), 6.70% due 3/01/2014 1,361
Louisiana--2.7% BB NR* 4,000 Port New Orleans, Louisiana, IDR, Refunding (Continental
Grain Co. Project), 6.50% due 1/01/2017 4,299
Maryland--2.1% NR* NR* 3,000 Maryland State Energy Financing Administration, Limited Obligation
Revenue Bonds (Cogeneration--AES Warrior Run), AMT, 7.40% due
9/01/2019 3,308
Massachusetts AAA Aaa 3,615 Massachusetts State HFA, RITR, Series 29, 6.42% due
- --5.7% 12/01/2028 (a)(e) 3,601
A- NR* 5,000 Massachusetts State Health and Educational Facilities Authority,
Revenue Refunding Bonds (Melrose Wakefield Hospital), Series B,
6.25% due 7/01/2004 (i) 5,483
Michigan--2.6% Michigan State Hospital Finance Authority Revenue Bonds:
AAA Aaa 3,100 INFLOS (Sisters of Mercy), 8.716% due 2/15/2022 (d)(e) 3,549
A A2 500 Refunding (Detroit Medical Center Obligated Group), Series A,
6.50% due 8/15/2018 541
Minnesota--1.1% AA Aa2 1,680 Minnesota State HFA, S/F Mortgage, AMT, Series D, 5.85% due
7/01/2019 1,738
Mississippi--0.9% NR* NR* 1,400 Mississippi Development Bank, Special Obligation Refunding
Bonds (Diamond Lakes Utilities), Series A, 6.25% due 12/01/2017 1,424
Missouri--1.5% AAA NR* 2,175 Missouri State Housing Development Commission Mortgage
Revenue Bonds, Series C-1, 6.55% due 9/01/2028 (f)(g) 2,378
Montana--2.0% AA Aa2 3,000 Montana State Board of Housing, S/F Mortgage Refunding Bonds,
Series A-1, 5.95% due 12/01/2027 3,121
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <S> <S> <C> <S> <C>
Nevada--1.0% NR* NR* $ 1,530 Reno Sparks Convention and Vistors Authority, Nevada, Limited
Obligation Revenue Refunding Bonds, 6.40% due 11/01/2003 $ 1,618
New Jersey--2.5% New Jersey Health Care Facilities Financing Authority, Revenue
Refunding Bonds:
BBB Baa2 2,500 (Englewood Hospital & Medical Center), 6.75% due 7/01/2024 2,741
BBB Baa2 1,200 (Saint Elizabeth Hospital Obligation Group), 6% due 7/01/2014 1,256
New Mexico--4.3% Farmington, New Mexico, PCR, Refunding (Public Service Company
--San Juan Project):
BB+ Ba1 3,000 Series A, 6.30% due 12/01/2016 3,189
BB+ Ba1 1,000 Series D, 6.375% due 4/01/2022 1,071
AAA NR* 2,500 New Mexico Mortgage Finance Authority, S/F Mortgage Revenue
Bonds, AMT, Series E-2, 5.75% due 7/01/2029 2,560
New York--9.0% AAA Aaa 3,000 New York City, New York, Municipal Water Finance Authority, Water
and Sewer System Revenue Bonds, Series 11, RITR, 7.27% due
6/15/2026 (d)(e) 3,270
BBB+ A3 1,000 New York City, New York, Refunding, GO, UT, Series F, 6% due
8/01/2013 1,058
AA Aa3 3,000 New York City, New York, Transitional Finance Authority
Revenue Bonds (Secured Future Tax), Series C, 4.75% due
5/01/2023 2,746
BBB+ Baa1 2,500 New York State Dormitory Authority Revenue Bonds (Department
of Health), 5.50% due 7/01/2025 2,482
A1+ NR* 2,800 New York State Energy, Research and Development Authority,
PCR (Niagara Mohawk Power Corporation Project), DATES,
Series A, 4.05% due 7/01/2015 (h) 2,800
NR* A3 2,000 United Nations Development Corporation of New York, Revenue
Refunding Bonds, Series C, 5.50% due 7/01/2017 2,002
North AA Aa2 1,940 North Carolina S/F, HFA, Series II, 6.20% due 3/01/2016 2,057
Carolina--1.3%
Ohio--8.3% BB- Ba2 4,120 Cleveland, Ohio, Airport Special Revenue Bonds (Continental
Airlines Inc. Project), AMT, 5.375% due 9/15/2027 3,916
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 1,875
NR* NR* 1,500 Franklin County, Ohio, Health Care Facilities Revenue Refunding
Bonds (Ohio Presbyterian Services), 5.50% due 7/01/2021 1,463
AAA Aaa 3,000 Ohio HFA, Mortgage Revenue Bonds, RITR, AMT, Series 15, 6.12%
due 9/01/2019 (d)(e)(g) 2,944
NR* NR* 1,400 Ohio State Higher Educational Facility Commission Revenue
Bonds (University of Findlay Project), 6.125% due 9/01/2016 1,451
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) 1,615
Oklahoma--1.2% AAA Baa 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional
Facility Revenue Bonds, 6.60% due 7/01/2006 (j) 1,903
Oregon--1.1% NR* Aa2 1,630 Oregon State Housing and Community Services Department, S/F
Mortgage Program Revenue Bonds, AMT, Series E, 7.10% due
7/01/2014 1,734
Pennsylvania AAA Aaa 2,950 Keystone Oaks, Pennsylvania, School District, IRS, UT,
- --2.1% Series D, 7.724% due 9/04/2002 (c)(e)(i) 3,378
South Carolina AAA Aaa 1,000 Fairfield County, South Carolina, PCR (South Carolina Gas
- --0.7% and Electric Co.), 6.50% due 9/01/2014 (a) 1,091
Tennessee--1.1% NR* NR* 1,610 Hardeman County, Tennessee, Correctional Facilities Revenue
Bonds (Correctional Facilities Corp.), 7.75% due 8/01/2017 1,801
Texas--2.9% NR* A3 3,250 Harris County, Texas, Health Facilities Development
Corporation, Hospital Revenue Bonds (Memorial Hospital Systems
Project), Series A, 6.625% due 6/01/2004 (i) 3,652
BB Ba2 1,000 Houston, Texas, Airport System Revenue Bonds, Special
Facilities (Continental Airline Terminal Improvement), AMT,
Series B, 6.125% due 7/15/2027 1,042
Utah--0.7% NR* NR* 1,000 Toole County, Utah, PCR, Refunding (Laidlaw Environmental),
AMT, Series A, 7.55% due 7/01/2027 1,101
Virginia--1.2% AAA NR* 1,910 Newport News, Virginia, Redevelopment and Housing Authority,
Revenue Refunding Bonds, Series A, 5.85% due 12/20/2030 (g) 1,972
Total Investments (Cost--$153,592)--99.0% 158,270
Other Assets Less Liabilities--1.0% 1,593
--------
Net Assets--100.0% $159,863
========
<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 April 30, 1998.
(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 April 30, 1998.
(i)Prerefunded.
(j)Connie Lee Insured.
*Not Rated.
**Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
See Notes to Financial Statements.
</TABLE>
Quality
Profile
The quality ratings of securities in the Fund as of April 30, 1998
were as follows:
Percent of
S&P Rating/Moody's Rating Net Assets
AAA/Aaa 37.1%
AA/Aa 14.0
A/A 11.0
BBB/Baa 9.0
BB/Ba 10.9
B/B 3.6
NR (Not Rated) 10.8
Other++ 2.6
[FN]
++Temporary investments in short-term municipal securities.
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of April 30, 1998
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$153,591,755) (Note 1a) $158,270,253
Cash 86,837
Receivables:
Securities sold $ 4,774,612
Interest 2,339,092
Capital shares sold 79,483 7,193,187
------------
Deferred organization expenses (Note 1e) 186,914
Prepaid registration fees and other assets (Note 1e) 56,491
------------
Total assets 165,793,682
------------
Liabilities: Payables:
Securities purchased 5,432,850
Dividends to shareholders (Note 1f) 206,465
Investment advisory fees (Note 2) 52,593
Administration fees (Note 2) 32,870 5,724,778
------------
Accrued expenses and other liabilities 205,694
------------
Total liabilities 5,930,472
------------
Net Assets: Net assets $159,863,210
============
Capital: Capital Stock (200,000,000 shares authorized) (Note 4):
Preferred Stock, par value $.10 per share (2,480 shares of
AMPS* issued and 1,920 shares outstanding
at $25,000 per share liquidation preference) $ 48,000,000
Common Stock, par value $.10 per share (10,416,787 shares
issued and outstanding) $ 1,041,679
Paid-in capital in excess of par 104,621,261
Undistributed investment income--net 5,089
Undistributed realized capital gains on investments--net 1,516,683
Unrealized appreciation on investments--net 4,678,498
------------
Total--Equivalent to $10.74 net asset value per share
of Common Stock 111,863,210
------------
Total capital $159,863,210
============
<FN>
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Six Months Ended April 30, 1998
<S> <S> <C> <C>
Investment Interest and amortization of premium and discount earned $ 4,346,120
Income (Note 1d):
Expenses: Investment advisory fees (Note 2) $ 377,532
Administrative fees (Note 2) 188,766
Registration fees (Note 1e) 64,810
Transfer agent fees 63,481
Commission fees 58,504
Printing and shareholder reports 49,528
Professional fees 37,632
Accounting services (Note 2) 34,581
Amortization of organization expenses (Note 1e) 29,844
Directors' fees and expenses 14,032
Listing fees 12,699
Custodian fees 7,055
Pricing fees 5,518
Other 8,537
------------
Total expenses before reimbursement 952,519
Reimbursement of expenses (Note 2) (122,288)
------------
Total expenses after reimbursement 830,231
------------
Investment income--net 3,515,889
------------
Realized & Realized gain on investments--net 1,920,286
Unrealized Gain Change in unrealized appreciation on investments--net (1,274,236)
(Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 4,161,939
(Notes 1b, ============
1d & 3):
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the For the
Six Months Year
Ended Ended
April 30, October 31,
Increase (Decrease) in Net Assets: 1998 1997
<S> <S> <C> <C>
Operations: Investment income--net $ 3,515,889 $ 6,598,300
Realized gain on investments--net 1,920,286 2,242,563
Change in unrealized appreciation on investments--net (1,274,236) 4,017,788
------------ ------------
Net increase in net assets resulting from operations 4,161,939 12,858,651
------------ ------------
Dividends and Investment income--net:
Distributions to Common Stock (2,961,354) (5,164,727)
Shareholders Preferred Stock (568,646) (1,418,941)
(Note 1f): Realized gain on investments--net:
Common Stock (1,715,637) --
Preferred Stock (470,016) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders (5,715,653) (6,583,668)
------------ ------------
Capital Stock Proceeds from issuance of Preferred Stock -- 10,000,000
Transactions Net proceeds from issuance of Common Stock 11,954,105 11,614,959
(Note 4):
Net increase in net assets derived from capital stock
transactions 11,954,105 21,614,959
------------ ------------
Net Assets: Total increase in net assets 10,400,391 27,889,942
Beginning of period 149,462,819 121,572,877
------------ ------------
End of period* $159,863,210 $149,462,819
============ ============
<FN>
*Undistributed investment income--net $ 5,089 $ 19,200
============ ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have For the For the For the Period
been derived from information provided in the Six Months Year November 3,
financial statements. Ended Ended 1995++ to
April 30, October 31, October 31,
Increase (Decrease) in Net Asset Value: 1998 1997 1996
<S> <S> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.87 $ 10.17 $ 10.00
Operating ------------ ------------ ------------
Performance: Investment income--net .37 .75 .68
Realized and unrealized gain on
investments--net .11 .70 .21
------------ ------------ ------------
Total from investment operations .48 1.45 .89
------------ ------------ ------------
Less dividends and distributions to Common Stock
shareholders:
Investment income--net (.31) (.59) (.59)
Realized gain on investments--net (.19) -- --
------------ ------------ ------------
Total dividends and distributions to Common Stock
shareholders (.50) (.59) (.59)
------------ ------------ ------------
Effect of Preferred Stock activity:++++
Dividends and distributions to Preferred Stock
shareholders:
Investment income--net (.06) (.16) (.09)
Realized gain on investments--net (.05) -- --
Capital charge resulting from issuance of
Preferred Stock -- -- (.04)
------------ ------------ ------------
Total effect of Preferred Stock activity (.11) (.16) (.13)
------------ ------------ ------------
Net asset value, end of period $ 10.74 $ 10.87 $ 10.17
============ ============ ============
Total Investment Based on net asset value per share 3.35%+++ 13.08% 7.81%+++
Return:** ============ ============ ============
Ratios to Average Expenses, net of reimbursement 1.10%* .96% .53%*
Net Assets:*** ============ ============ ============
Expenses 1.26%* 1.28% 1.26%*
============ ============ ============
Investment income--net 4.66%* 5.01% 5.40%*
============ ============ ============
Supplemental Net assets, net of Preferred Stock, end
Data: of period (in thousands) $ 111,863 $ 101,463 $ 83,573
============ ============ ============
Preferred Stock outstanding, end of period
(in thousands) $ 48,000 $ 48,000 $ 38,000
============ ============ ============
Portfolio turnover 74.87% 144.34% 234.41%
============ ============ ============
Leverage: Asset coverage per $1,000 $ 3,330 $ 3,114 $ 3,199
============ ============ ============
Dividends Investment income--net $ 296 $ 897 $ 564
Per Share on ============ ============ ============
Preferred Stock
Outstanding:
<FN>
*Annualized.
**Total investment returns exclude the effects of the contingent
deferred sales 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.
***Do not reflect the effect of dividends to Preferred Stock
shareholders.
++Commencement of operations.
++++The Fund's Preferred Stock was initially issued on March 11,
1996.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
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. These unaudited financial statements reflect all
adjustments which are, in the opinion of management, necessary to a
fair statement of the results for the interim period presented. All
such adjustments are of a normal recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter markets and are valued at the last available bid
price in the over-the-counter market or on the basis of yield
equivalents as obtained from one or more dealers that make markets
in the securities. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their settlement prices
as of the close of such exchanges. Options, which are traded on
exchanges, are valued at their last sale price as of the close of
such exchanges or, lacking any sales, at the last available bid
price. Short-term investments with remaining maturities of sixty
days or less are valued at amortized cost, which approximates market
value. Securities and assets for which market quotations are not
readily available are valued at fair value as determined in good
faith by or under the direction of the Board of Directors of the
Fund, including valuations furnished by a pricing service retained
by the Fund, which may utilize a matrix system for valuations. The
procedures of the pricing service and its valuations are reviewed by
the officers of the Fund under the general supervision of the Board
of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
financial 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 expenses and prepaid registration fees--
Deferred organization expenses are amortized on a straight-line
basis over a five-year period. 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, including proceeds from the
issuance of Preferred Stock. For the six months ended April 30,
1998, FAM earned fees of $377,532, of which $122,288 was voluntarily
waived.
The Fund also has entered into an Administrative Services Agreement
with FAM whereby FAM will receive a fee equal to an annual rate of
0.25% of the Fund's average daily net assets, in return for the
performance of administrative services (other than investment advice
and related portfolio activities) necessary for the operation of the
Fund. For the six months ended April 30, 1998, Merrill Lynch Funds
Distributors, Inc. ("MLFD") earned early withdrawal charges of
$79,753 relating to the tender of the Fund's shares.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the six months ended April 30, 1998 were $118,868,065 and
$112,863,005, respectively.
Net realized gains for the six months ended April 30, 1998 and net
unrealized gains as of April 30, 1998 were as follows:
Realized Unrealized
Gains Gains
Long-term investments $ 1,920,286 $ 4,678,498
----------- -----------
Total $ 1,920,286 $ 4,678,498
=========== ===========
As of April 30, 1998, net unrealized appreciation for Federal income
tax purposes aggregated $4,678,498, of which $5,689,138 related to
appreciated securities and $1,010,640 related to depreciated
securities. The aggregate cost of investments at April 30, 1998, for
Federal income tax purposes was $153,591,755.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock,
including Preferred Stock, par value $.10 per share, all of which
were initially classified as Common Stock. The Board of Directors is
authorized, however, to reclassify any unissued shares of capital
stock without approval of the holders of Common Stock.
Merrill Lynch Municipal Strategy Fund, Inc., April 30, 1998
NOTES TO FINANCIAL STATEMENTS (concluded)
Transactions in Common Stock were as follows:
For the Six Months Dollar
Ended April 30, 1998 Shares Amount
Shares sold 1,749,715 $19,223,144
Shares issued to shareholders in
reinvestment of dividends and
distributions 117,415 1,284,072
----------- -----------
Total issued 1,867,130 20,507,216
Shares redeemed (783,360) (8,553,111)
----------- -----------
Net increase 1,083,770 $11,954,105
=========== ===========
For the Year Ended Dollar
October 31, 1997 Shares Amount
Shares sold 1,457,495 $15,202,668
Shares issued to shareholders in
reinvestment of dividends 128,620 1,344,046
----------- -----------
Total issued 1,586,115 16,546,714
Shares tendered (471,994) (4,931,755)
----------- -----------
Net increase 1,114,121 $11,614,959
=========== ===========
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 April 30, 1998 was 3.874%.
In connection with the offering of AMPS, the Board of Directors
reclassified 40,000 shares of unissued capital stock as AMPS. AMPS
shares outstanding during the six months ended April 30, 1998
remained constant and during the year ended October 31, 1997
increased by 400 as a result of shares sold. As of April 30, 1998,
there were 2,480 AMPS shares issued and 1,920 shares outstanding
with a liquidation preference of $25,000 per share.
The Fund pays commissions to certain broker-dealers at the end of
each auction at an annual rate ranging from 0.25% to 1.00%,
calculated on the proceeds of each auction. For the six months ended
April 30, 1998, Merrill Lynch, Pierce, Fenner & Smith Inc., an
affiliate of FAM, earned $60,864 as commissions.
OFFICERS AND DIRECTORS
Arthur Zeikel, President and Director
Ronald W. Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Terry K. Glenn, Executive Vice President
Vincent R. Giordano, Senior Vice President
Donald C. Burke, Vice President
Robert A. DiMella, Vice President
Kenneth A. Jacob, Vice President
John M. Loffredo, Vice President
Gerald M. Richard, Treasurer
Patrick D. Sweeney, Secretary
Custodian
The Bank of New York
90 Washington Street
New York, NY 10286
Transfer Agent
Common Stock:
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
Preferred Stock:
IBJ Schroder Bank & Trust Company
One State Street
New York, NY 10004
