<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 30, 1998
SECURITIES ACT FILE NO. 333-
INVESTMENT COMPANY ACT FILE NO. 811-07203
POST-EFFECTIVE AMENDMENT TO REGISTRATION STATEMENT AS STATED BELOW
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM N-2
<TABLE>
<S> <C>
/X/ REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
/ / PRE-EFFECTIVE AMENDMENT NO.
/ / POST-EFFECTIVE AMENDMENT NO.
</TABLE>
AND/OR
/X/ REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
/X/ AMENDMENT NO. 12
(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)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 282-2800
------------------------------
ARTHUR ZEIKEL
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(Name and Address of Agent for Service)
------------------------------
COPIES TO:
Patrick D. Sweeney, Esq. Frank P. Bruno, Esq.
Fund Asset Management, L.P. Brown & Wood LLP
P.O. Box 9011 One World Trade Center
Princeton, N.J. 08543-9011 New York, New York 10048-0557
------------------------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after the
effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. /X/
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If the 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>
<CAPTION>
MAXIMUM MAXIMUM AMOUNT OF
TITLE OF SECURITIES AMOUNT BEING OFFERING PRICE AGGREGATE REGISTRATION
BEING REGISTERED REGISTERED(1) PER UNIT(1) OFFERING PRICE(1) FEE(2)
<S> <C> <C> <C> <C>
Common Stock ($.10 par value) 10,000,000 shares $10.89 $108,900,000 $30,274(3)
</TABLE>
(1) Estimated solely for the purposed 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 $22,903 which has
previously been paid to the Commission for registration fees relating to
7,479,217 shares registered pursuant to Securities Act File No. 333-19479
and unissued as of December 23, 1998.
------------------------------
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. 333-19479, 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. 333-19479 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".
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<PAGE>
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
CROSS REFERENCE SHEET
PURSUANT TO RULE 404(c)
<TABLE>
<CAPTION>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
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PART A
1. Outside Front Cover Page............................. Cover Page
2. Inside Front and Outside Back Cover Pages............ Cover Page
3. Fee Table and Synopsis............................... Prospectus Summary; Risk Factors and Special
Considerations; 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................ The Fund; Prospectus Summary; Risk Factors and
Special Considerations; Investment Objective and
Policies; Investment Restrictions
9. Management........................................... Directors and Officers; Investment Advisory and
Administrative Arrangements
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
14. Cover Page........................................... Not Applicable
15. Table of Contents.................................... Not Applicable
16. General Information and History...................... Not Applicable
17. Investment Objective and Policies.................... Prospectus Summary; Investment Objective and
Policies; Investment Restrictions
18. Management........................................... Directors and Officers; Investment Advisory and
Administrative Arrangements
19. Control Persons and Principal Holders of
Securities......................................... Investment Advisory and Administrative Arrangements
20. Investment Advisory and Other Services............... Investment Advisory and Administrative Arrangements;
Custodian; Purchase of Shares; Transfer Agent,
Dividend Disbursing Agent and Shareholder Servicing
Agent; Legal Opinions; Independent Auditors
21. Brokerage Allocation and Other Practices............. Portfolio Transactions
22. Tax Status........................................... Taxes
23. Financial Statements................................. Annual Report dated October 31, 1998*
</TABLE>
- ------------------------
* Incorporated by reference into the Prospectus
PART C
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>
THE INFORMATION CONTAINED IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 30, 1998
PROSPECTUS
FEBRUARY , 1999
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. The Fund's
investment objective 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 Fund
intends to invest at least 75% of its total assets in municipal obligations that
are rated investment grade or, if unrated, are considered by the Fund's
investment adviser to be of comparable quality. THE FUND ALSO MAY INVEST UP TO
25% OF ITS TOTAL ASSETS IN MUNICIPAL OBLIGATIONS THAT ARE RATED BELOW INVESTMENT
GRADE (SOMETIMES REFERRED TO AS "JUNK BONDS") OR, IF UNRATED, ARE CONSIDERED BY
THE FUND'S INVESTMENT ADVISER TO BE OF COMPARABLE QUALITY. The Fund may invest
in certain tax-exempt securities that are classified as "private activity bonds"
that may subject certain investors in the Fund to the alternative minimum tax.
At times, the Fund may seek to hedge its portfolio using options and futures
transactions. There can be no assurance that the investment objective of the
Fund will be realized.
Currently, there is no secondary market for the Fund's common stock. In
order to allow shareholders to sell shares, the Fund generally makes quarterly
tender offers for its shares. In a tender offer, the Fund buys back outstanding
shares of its common stock from shareholders who tender their shares during the
offer period at the Fund's net asset value on the last day of the offer. If the
Fund does not make a tender offer, investors may not be able to sell their
shares.
The Fund intends to offer shares of preferred stock from time to time
representing up to approximately 35% of the Fund's capital including capital
raised by selling the preferred stock. As of the date of this Prospectus, the
Fund has outstanding an aggregate of 2,320 shares of its Auction Market
Preferred Stock-Registered Trademark-, Series A representing approximately %
of the Fund's capital. Investors should carefully consider the special risks
associated with leveraging the Fund's common stock before investing.
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, the Fund's net asset value per
share is $ . Shares may be purchased directly from Merrill Lynch Funds
Distributor, a division of Princeton Funds Distributor, Inc., and from other
selected securities dealers, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated. Merrill Lynch may charge a processing fee (presently $5.35) for
confirming repurchases.
--------------------------
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD KNOW BEFORE INVESTING,
INCLUDING INFORMATION ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST AND KEEP IT
FOR FUTURE REFERENCE.
--------------------------
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<CAPTION>
PER SHARE TOTAL
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<S> <C> <C> <C>
Public Offering Price.................................... $ $
Sales Load............................................... None None
Proceeds, before expenses, to Fund....................... $ $
</TABLE>
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE
SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
--------------------------
FUND ASSET MANAGEMENT, L.P. -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR -- DISTRIBUTOR
- ----------------
- -Registered Trademark- Registered trademark of Merrill Lynch & Co., Inc.
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE DETAILED
INFORMATION INCLUDED IN THIS PROSPECTUS.
<TABLE>
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THE FUND Merrill Lynch Municipal Strategy Fund, Inc. is a
continuously offered, non-diversified, closed-end fund.
THE OFFERING Shares of common stock of the Fund are offered by the
Distributor and other securities dealers, including
Merrill Lynch, Pierce, Fenner & Smith Incorporated. The
Fund offers its common stock at a price equal to the net
asset value per share without a front-end sales charge.
The minimum initial purchase is $1,000 and the minimum
subsequent purchase is $50. The Fund reserves the right
to waive or modify the initial and subsequent minimum
investment requirements at any time. Any order may be
rejected by the Distributor or the Fund.
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 this 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.
INVESTMENT GRADE MUNICIPAL OBLIGATIONS. The Fund
generally will invest substantially all (at least 75%)
of its total assets in municipal obligations that are
rated investment grade by one or more nationally
recognized statistical rating organizations. The Fund
may also buy unrated securities that the investment
adviser considers to be of comparable quality.
HIGH YIELD SECURITIES OR "JUNK" BONDS. The Fund may
invest up to 25% of its total assets in municipal
obligations that are rated below investment grade or, if
unrated, are considered by the Fund's investment adviser
to be of comparable quality. Such lower quality
municipal obligations (sometimes referred to as "junk
bonds") are frequently traded only in markets where the
number of potential purchasers and sellers, if any, is
very limited.
TENDER OFFERS Currently, there is no secondary market for the Fund's
common stock and it is not expected that a secondary
market will develop. To allow shareholders to sell their
shares, the Board of Directors of the Fund intends to
authorize tender offers each calendar quarter to
purchase shares of the Fund's common stock from
shareholders. In a tender offer, the Fund buys
outstanding shares back from shareholders at the Fund's
net asset value on the last day of the offer period.
The Board of Directors is not required to authorize the
making of a tender offer and there can be no assurance
that a tender offer will be made during any particular
quarter. If a tender
</TABLE>
2
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<S> <C>
offer is not made, shareholders may be unable to sell
their shares. In addition, Merrill Lynch charges its
customers a processing fee (presently $5.35) to confirm
a repurchase of shares from such customers pursuant to a
tender offer. Tenders made directly through the
Distributor are not subject to the processing fee.
CONTINGENT DEFERRED SALES CHARGE If shareholders sell shares back to the Fund during a
tender offer and they have held those shares for less
than three years when the tender offer begins, they may
have to pay a contingent deferred sales charge. This
charge varies depending on how long a shareholder has
owned the tendered shares. The amount of the charge is
based on how much the shareholder paid for the tendered
shares or their net asset value, whichever amount is
less.
LEVERAGE ISSUANCE OF PREFERRED STOCK. From time to time, the Fund
may issue preferred stock. The preferred stock may
represent up to 35% of the Fund's capital, including the
capital raised by issuing the preferred stock. As of the
date of this Prospectus, the Fund has outstanding an
aggregate of 2,320 shares of its Series A AMPS,
representing approximately % of its capital. There can
be no assurance, however, that preferred stock
representing any particular percentage of the Fund's
capital will actually be issued. Issuing preferred stock
results in the leveraging of the Fund's common stock.
The Series A AMPS pay dividends that are generally
adjusted every seven days. The Series A AMPS dividend
rate is based upon prevailing interest rates for debt
obligations of comparable maturity. The money raised by
the issuance of the Series A AMPS has been invested in
longer-term obligations in accordance with the Fund's
investment objective.
The Fund may issue additional shares of its Series A
AMPS or other preferred stock in the future. The Fund
expects that other preferred stock issued 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). The dividend
rates on any additional preferred stock issued will be
based upon prevailing interest rates for debt
obligations of comparable maturities. The money raised
by any additional preferred stock issued will be
invested in longer-term obligations in accordance with
the Fund's investment objective.
The expenses of the preferred stock are borne by the
Fund and reduce the net asset value of the common stock.
In addition, at times when the Fund is required to
allocate taxable income to preferred stockholders, the
Series A AMPS may require, and it is expected that the
terms of any other preferred stock may also require, the
Fund to make an additional distribution to the preferred
stockholders (an Additional Distribution). The amount of
this Additional Distribution approximately equals the
tax liability resulting from the allocation and the
additional
</TABLE>
3
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<TABLE>
<S> <C>
distribution. So long as the Fund has preferred stock
outstanding, the Fund will pay fees to the investment
adviser for its services that are higher than if the
Fund did not issue preferred stock because the fees will
be calculated on the basis of the Fund's average daily
net assets, including proceeds from the sale of
preferred stock.
POTENTIAL BENEFITS OF LEVERAGE. Under normal market
conditions, longer term obligations produce higher
yields than short term and medium term obligations. The
Fund's investment adviser believes that the interest
income the Fund receives from its long term investments
will exceed the amount of interest the Fund must pay to
the preferred stockholders. Thus, the Fund's use of
preferred stock should provide common stockholders with
a higher yield than they would receive if the Fund were
not leveraged.
RISKS. The use of leverage creates certain risks for
common stockholders, including higher volatility of both
the net asset value and the market value of the common
stock. Since any decline in the value of the Fund's
investments will affect only the common stockholders, in
a declining market the use of leverage will cause the
Fund's net asset value to decrease more than it would if
the Fund were not leveraged. A decrease in net asset
value will likely also cause a decline in the market
price of the shares of common stock. In addition,
fluctuations in dividend rates paid on, and the amount
of taxable income allocable to, the Series A AMPS and
any other preferred stock will affect the yield to
common stockholders. There can be no assurance that the
Fund will earn a higher return on its investments than
the then current dividend rate (and any Additional
Distribution) it pays on the preferred stock. Under
certain conditions, the benefits of leverage to common
stockholders will be reduced, and the Fund's leveraged
capital structure could result in a lower rate of return
to common stockholders than if the Fund were not
leveraged.
DISTRIBUTIONS. So long as the Series A AMPS and any
other preferred stock is outstanding, common
stockholders will receive all of the Fund's net income
that remains after it pays dividends (and any Additional
Distribution) on the Series A AMPS and any other
preferred stock and generally will be entitled to a pro
rata share of net realized capital gains. If the Fund is
liquidated, preferred stockholders will be entitled to
receive liquidating distributions before any
distribution is made to common stockholders. These
liquidating distributions are expected to equal the
original purchase price per share of the preferred stock
plus any accumulated and unpaid dividends and Additional
Distributions.
REDEMPTION OF PREFERRED STOCK. The Fund may redeem
preferred stock for any reason. For example, the Fund
may redeem all or part of the preferred stock if it
believes that the Fund's leveraged capital structure
will cause common stockholders to
</TABLE>
4
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<TABLE>
<S> <C>
obtain a lower return than they would if the common
stock were unleveraged for any significant amount of
time.
VOTING RIGHTS. Preferred stockholders, voting as a
separate class, are entitled to elect two of the Fund's
Directors. Common and preferred stockholders, voting
together as a single class, are entitled to elect the
remaining Directors. If the Fund fails to pay dividends
to the preferred stockholders for two full years, the
holders of all outstanding shares of preferred stock,
voting as a separate class, would then be entitled to
elect a majority of the Fund's Directors. The preferred
stockholders vote separately on certain other matters as
required under the Fund's Articles of Incorporation, the
Investment Company Act of 1940, as amended, and Maryland
law. Otherwise, holders of preferred stock and common
stock have equal voting rights (one vote per share) and
will vote together as a single class.
RATINGS. The Series A AMPS have been rated "aaa" by
Moody's Investor's Services, Inc. and AAA by Standard &
Poor's. Before it offers any other preferred stock, the
Fund intends to apply to one or more nationally
recognized statistical ratings organizations for ratings
on the preferred stock. The Fund believes that a rating
for the preferred stock will make it easier to market
the stock, which should reduce the dividend rate.
INVESTMENT ADVISER AND Fund Asset Management, L.P., is the Fund's investment
ADMINISTRATOR adviser and provides investment advisory and
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 the Fund's average
daily net assets, including any assets acquired from the
sale of preferred stock. For its administrative
services, the Fund pays the investment adviser a monthly
fee at the annual rate of 0.25% of the Fund's average
daily net assets, including assets acquired from the
sale of preferred stock. While the combined advisory and
administrative fees are higher than those paid by most
funds, they are similar to those paid by other
continuously offered closed-end funds.
DIVIDENDS AND DISTRIBUTIONS Each month the Fund intends to distribute substantially
all of its net investment income remaining after the
payment of dividends (and any Additional Distribution)
on the Series A AMPS and any other preferred stock to
common stockholders. The Fund will distribute net
capital gains, if any, at least annually on a pro rata
basis to common stockholders and preferred stockholders.
When the Fund allocates capital gains or other taxable
income to preferred stockholders under certain
circumstances, the terms of the Series A AMPS may
require, and it is expected that the terms of any other
preferred stock may require, the Fund to make an
Additional Distribution. The Fund may not declare any
cash dividend or other distribution on its common stock
unless the preferred stock has asset coverage of at
least 200%. As of the date of this Prospectus, the
Series A AMPS represent approximately % of the Fund's
capital and the asset coverage with respect to the
Series A AMPS is approximately %. If the
</TABLE>
5
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Fund's ability to make distributions on its common stock
is limited, the Fund may not be able to maintain its
qualification for taxation as a regulated investment
company. This would have adverse tax consequences for
common stockholders.
AUTOMATIC DIVIDEND REINVESTMENT Dividends and capital gains distributions generally are
PLAN used to purchase additional shares of the Fund's common
stock. However, an investor can choose to receive
distributions in cash. Since not all investors can
participate in the automatic dividend reinvestment plan,
you should contact your broker or nominee to confirm
that you are eligible to participate in the plan.
MUTUAL FUND INVESTMENT OPTION Investors who sell their shares pursuant to a tender
offer have the option, subject to certain conditions, to
purchase Class D shares of certain Merrill Lynch funds
with the proceeds from the sale.
</TABLE>
6
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
LIQUIDITY OF SHARES. The Fund is designed primarily for long-term investors
and should not be considered a vehicle for trading purposes. Currently, there is
no secondary market for the Fund's common stock and it is not expected that one
will develop. Moreover, Merrill Lynch and other selected dealers are prohibited
from making a market in the Fund's common stock while the Fund is either
offering or making a tender offer for its common stock.
To allow shareholders to sell their shares, the Board of Directors of the
Fund intends to consider making tender offers once each quarter to repurchase
the Fund's shares at net asset value. However, the Fund's shares are less liquid
than shares of funds traded on a stock exchange, and shareholders who tender
Fund shares held for less than three years may pay a contingent deferred sales
charge. The Fund's Board is not obligated to authorize any tender offer, and
there may be quarters in which no tender offer is made. If the Board does not
authorize a tender offer, shareholders may be unable to sell their shares.
Closed-end funds that trade in a secondary market are subject to the risk that
the market price of the shares may be lower than the net asset value, commonly
referred to as "trading at a discount." As long as there is no secondary market
for the Fund's shares, the Fund is not subject to this risk.
NON-DIVERSIFICATION. The Fund is registered as a "non-diversified"
investment company. This means that the Fund may invest a greater percentage of
its assets in a single issuer than can a diversified investment company. Even as
a non-diversified fund, the Fund must still meet the diversification
requirements of applicable Federal income tax laws. Since the Fund may invest a
relatively high percentage of its assets in a limited number of issuers, the
Fund may be more exposed to any single economic, political or regulatory
occurrence than a more widely-diversified fund.
INVESTMENT GRADE BONDS. The Fund generally invests at least 75% of its
total assets in municipal obligations that are rated in the investment grade
rating categories by S&P, Moody's or Fitch IBCA, Inc. 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.
HIGH YIELD SECURITIES OR "JUNK BONDS." The Fund may invest up to 25% of its
total assets in debt securities commonly known as junk bonds. Junk bonds are
debt securities that are rated below investment grade by the major rating
agencies or are unrated securities that the Fund's Investment Adviser believes
are of comparable quality. Although junk bonds generally pay higher rates of
interest than investment grade bonds, they are high risk investments that may
cause income and principal losses for the Fund. Junk bonds generally are less
liquid and experience more price volatility than higher rated bonds. The issuers
of junk bonds may have a larger amount of outstanding debt relative to their
assets than issuers of investment grade bonds. In the event of an issuer's
bankruptcy, claims of other creditors may have priority over the claims of junk
bond holders, leaving few or no assets available to repay junk bond holders.
Junk bonds may be subject to greater call and redemption risk than higher rated
debt securities.
High yield securities also tend to be more sensitive to economic conditions
than investment grade securities. A general economic downturn or a sustained
period of rising interest rates likely will have a greater impact on the
financial condition of a high yield bond issuer.
Negative publicity and investor perceptions also may reduce the value and
liquidity of high yield securities. When the market value of high yield
securities goes down the Fund's net asset value is also likely to go down. In
addition, the Fund may incur additional expenses if it is forced to seek
recovery upon a default of a portfolio holding or if it participates in the
restructuring of the obligation.
PRIVATE ACTIVITY BONDS. The Fund may invest in certain tax-exempt
securities classified as "private activity bonds." These bonds subject certain
investors in the Fund to the alternative minimum tax.
LEVERAGE. The Fund has 2,320 shares of Series A AMPS outstanding and may
offer other shares of preferred stock. As of the date of this Prospectus, the
Series A AMPS represent approximately % of the
7
<PAGE>
Fund's capital including capital raised by issuing the Series A AMPS. Leverage
creates certain risks for common stockholders, including higher volatility of
both the net asset value and the market value of the common stock. Leverage also
creates the risk that the investment return on shares of the Fund's common stock
will be reduced to the extent the dividends paid on preferred stock and other
expenses of the preferred stock exceed the income earned by the Fund on its
investments. If the Fund is liquidated, preferred stockholders will be entitled
to receive liquidating distributions before any distribution is made to common
stockholders.
INDEXED AND INVERSE FLOATING RATE SECURITIES. The Fund may invest in
securities whose potential returns are directly related to changes in an
underlying index or interest rate, known as indexed securities. The return on
indexed securities will rise when the underlying index or interest rate rises
and fall when the index or interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes in an interest rate
(inverse floaters). In general, income on inverse floaters will decrease when
short term interest rates increase and increase when short term interest rates
decrease. Investments in inverse floaters may subject the Fund to the risks of
reduced or eliminated interest payments and losses of principal. In addition,
certain indexed securities and inverse floaters may increase or decrease in
value at a greater rate than the underlying interest rate, which effectively
leverages the Fund's investment. As a result, the market value of such
securities will generally be more volatile than that of fixed rate, tax exempt
securities. Both indexed securities and inverse floaters are derivative
securities and can be considered speculative.
OPTIONS AND FUTURES TRANSACTIONS. The Fund may seek to hedge its portfolio
against changes in interest rates using options and financial futures contracts.
The Fund's hedging transactions are designed to reduce volatility, but come at
some cost. For example, the Fund may try to limit its risk of loss from a
decline in price of a portfolio security by purchasing a put option. However,
the Fund must pay for the option, and the price of the security may not in fact
drop. In large part, the success of the Fund's hedging activities depends on its
ability to forecast movements in securities prices and interest rates. The Fund
does not, however, intend to enter into options and futures transactions for
speculative purposes. The Fund is not required to hedge its portfolio and may
not do so.
RATING AGENCY GUIDELINES. The Fund is subject to certain investment
restrictions imposed by guidelines of the two nationally recognized statistical
rating organizations that have issued ratings for the Series A AMPS. Any other
preferred stock issued may subject the Fund to similar investment restrictions.
These guidelines may impose asset coverage or portfolio composition requirements
that are more stringent than those imposed by the 1940 Act. The Fund does not
expect these requirements or guidelines to prevent the investment adviser from
managing the Fund's portfolio in accordance with the Fund's investment objective
and policies.
ANTITAKEOVER PROVISIONS. The Fund's Articles of Incorporation include
provisions that could limit the ability of other entities or persons to acquire
control of the Fund or to change the composition of its Board of Directors. Such
provisions could limit the ability of shareholders to sell their shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund.
8
<PAGE>
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)
Investment Advisory Fee(b)(e)..................................... 0.72%
Shareholder Servicing Fee(c)...................................... 0.12%
Interest Payments on Borrowed Funds............................... None
Other Expenses(d)(e).............................................. 0.95%
----------------------
Total Annual Expenses........................................... 1.79%
----------------------
----------------------
</TABLE>
- ------------------------
(a) See "Contingent Deferred Sales Charge"--page .
(b) See "Risks and Special Considerations of Leverage"--page and "Investment
Advisory and Administrative Arrangements"--page .
(c) See "Investment Advisory and Administrative Arrangements--Transfer Agency
Services"--page .
(d) Includes administrative fees, which are payable to the Investment Adviser by
the Fund at the rate of 0.25% of net assets attributable to common shares.
See "Investment Advisory and Administrative Arrangements"--page .
(e) As of the date of this Prospectus, the Fund has utilized leverage by issuing
Series A AMPS in an amount representing approximately % of the Fund's
capital. See "Risks and Special Considerations of Leverage"--page and
"Investment Advisory and Administrative Arrangements"--page .
<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 1.79%, (2) a 5% annual return throughout the
periods and (3) tender at the end of the period............................. $ 48* $ 66* $ 97 $ 211
An investor would pay the following expenses on a $1,000 investment assuming
no tender at the end of the period.......................................... $ 18 $ 56 $ 97 $ 211
</TABLE>
- ------------------------
* Reflects the contingent deferred sales charge.
The Fee Table is intended to assist investors in understanding the costs and
expenses that a shareholder in the Fund will bear directly or indirectly. The
expenses set forth under "Other Expenses" are based on estimated amounts through
the end of the Fund's current fiscal year. The example set forth above assumes
reinvestment of all dividends and distributions and uses a 5% annual rate of
return as mandated by Securities and Exchange Commission regulations. THE
EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR
ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR ANNUAL RATES OF RETURN MAY BE
MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch") may charge its customers a
processing fee (presently $5.35) for confirming purchases and repurchases.
Purchases and repurchases made directly through the Distributor are not subject
to the processing fee.
9
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the fiscal year ended
October 31, 1998 and the independent auditors' report thereon appear in the
annual report of the Fund for the fiscal year ended October 31, 1998, which is
incorporated by reference herein. Further information about the performance of
the Fund is contained in the annual report, which may be obtained, without
charge, by writing the Fund at the address on the inside back cover of this
Prospectus or by calling (609) 282-2800.
The following per share data and ratios are derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
FOR THE
PERIOD
FOR THE YEAR NOVEMBER 3,
ENDED 1995+
OCTOBER 31, TO
INCREASE (DECREASE) IN NET ASSET ------------------------ OCTOBER 31,
VALUE PER SHARE OF COMMON STOCK: 1998 1997 1996
- ----------------------------------------------------------------------- ----------- ----------- -------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................................. $ 10.87 $ 10.17 $ 10.00
----------- ----------- -------------
Investment income--net............................................... .73 .75 .68
Realized and unrealized gain on investments--net..................... .35 .70 .21
Total from investment operations....................................... 1.08 1.45 .89
----------- ----------- -------------
Less dividends and distributions to Common Stock shareholders:
Investment income--net............................................... (.60) (.59) (.59)
Realized gain on investments--net.................................... (.19) -- --
----------- ----------- -------------
Total dividends and distributions to Common Stock shareholders......... (.79) (.59) (.59)
----------- ----------- -------------
Effect of Preferred Stock activity:++
Dividends and distributions to Preferred Stock shareholders:
Investment income--net............................................... (.13) (.16) (.09)
Realized gain on investments--net.................................... (.07) -- --
Capital charge resulting from issuance of Preferred Stock............ -- -- (.04)
----------- ----------- -------------
Total effect of Preferred Stock activity............................... (.20) (.16) (.13)
----------- ----------- -------------
Net asset value, end of period......................................... $ 10.96 $ 10.87 $ 10.17
----------- ----------- -------------
----------- ----------- -------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................................... 8.28% 13.08% 7.81%#
----------- ----------- -------------
----------- ----------- -------------
RATIOS TO AVERAGE NET ASSETS:***
Expenses, net of reimbursement......................................... 1.12% .96% .53%*
----------- ----------- -------------
----------- ----------- -------------
Expenses............................................................... 1.25% 1.28% 1.26%*
----------- ----------- -------------
----------- ----------- -------------
Investment income--net................................................. 4.61% 5.01% 5.40%*
----------- ----------- -------------
----------- ----------- -------------
SUPPLEMENTAL DATA:
Net assets, net of Preferred Stock, end of period (in thousands)....... $ 115,339 $ 101,463 $ 83,573
----------- ----------- -------------
----------- ----------- -------------
Preferred Stock outstanding, end of period (in thousands).............. $ 48,000 $ 48,000 $ 38,000
----------- ----------- -------------
----------- ----------- -------------
Portfolio turnover..................................................... 141.53% 144.34% 234.41%
----------- ----------- -------------
----------- ----------- -------------
LEVERAGE:
Asset coverage per $1,000 of Preferred Stock........................... $ 3,403 $ 3,114 $ 3,199
----------- ----------- -------------
----------- ----------- -------------
DIVIDENDS PER SHARE ON PREFERRED STOCK OUTSTANDING:
Investment income--net................................................. $ 533 $ 897 $ 564
----------- ----------- -------------
----------- ----------- -------------
</TABLE>
- ------------------------------
* Annualized.
** Total investment returns exclude the effects of the CDSC per share of common
stock, if any. The Fund is a continuously offered closed-end fund, the
shares of which are offered at net asset value. Therefore, no separate
market exists.
*** Do not reflect the effect of dividends to Preferred Stock shareholders.
+ Commencement of operations.
++ The Fund's Preferred Stock initially was issued on March 11, 1996.
# Aggregate total investment return.
10
<PAGE>
THE FUND
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is a continuously
offered, non-diversified, closed-end management investment company. The Fund was
incorporated under the laws of the State of Maryland on July 13, 1994, and has
registered as an investment company under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund's principal office is located at 800 Scudders
Mill Road, Plainsboro, New Jersey 08536, and its telephone number is (609)
282-2800.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of current income exempt from Federal income taxes as is consistent with
its investment policies and prudent investment management. The Fund seeks to
achieve its investment objective by investing primarily in a portfolio of
long-term, investment grade municipal obligations, the interest on which, in the
opinion of bond counsel to the issuer, is exempt from Federal income taxes. The
investment objective of the Fund is a fundamental policy of the Fund and may not
be changed without the approval of a majority of the outstanding voting
securities of the Fund, as defined below under "Investment Restrictions." There
can be no assurance that the investment objective of the Fund will be realized.
At times, the Fund may seek to hedge its portfolio through the use of futures
transactions and options to reduce volatility in the net asset value of its
shares of common stock.
The Fund at all times, except during interim and temporary periods as
discussed below, will invest at least 80% of its total assets in a portfolio of
obligations issued by or on behalf of states, territories and possessions of the
United States and their political subdivisions, agencies or instrumentalities
that pay 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 defensive periods, will maintain substantially all (at least
75%) of its total assets in Municipal Bonds that are rated investment grade by a
nationally recognized statistical rating organization or, if unrated, are
considered to be of comparable quality by the Investment Adviser. Additionally,
the Fund may invest up to 25% of its total assets in Municipal Bonds that are
rated below investment grade by a nationally recognized statistical rating
organization or, are unrated, but considered by the Investment Adviser to be of
comparable quality. The Fund has established no minimum percentage of assets
that must be invested in such lower quality Municipal Bonds. Such lower quality
Municipal Bonds are frequently traded only in markets where the number of
potential purchasers and sellers, if any, is very limited. The Fund may invest
in certain tax-exempt securities classified as "private activity bonds' (in
general, bonds that benefit non-governmental entities) that may subject certain
investors in the Fund to an alternative minimum tax. The Fund will not invest
more than 25% of its total assets (taken at market value) in Municipal Bonds
whose issuers are located in the same state.
The Fund also may invest in securities not issued by or on behalf of a state
or territory or by an agency or instrumentality thereof, if the Fund
nevertheless believes such securities pay interest or distributions that are
exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in Municipal Bonds, to the extent such
investments are permitted by the 1940 Act. Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term Municipal Bonds. Certain Non-Municipal
Tax-Exempt Securities may be characterized as derivative instruments.
Non-Municipal Tax-Exempt Securities will be considered "Municipal Bonds" for
purposes of the Fund's investment objective and policies.
Investment in shares of the Fund's common stock offers several potential
benefits. The Fund offers investors the opportunity to receive income exempt
from Federal income taxes by investing in a professionally managed portfolio
comprised primarily of investment grade Municipal Bonds. The Fund also relieves
the investor of the burdensome administrative details involved in managing a
portfolio of Municipal
11
<PAGE>
Bonds. Additionally, the Investment Adviser will seek to enhance the yield on
the common stock by leveraging the Fund's capital structure through the issuance
of preferred stock. These benefits are at least partially offset by the expenses
involved in operating an investment company. Such expenses primarily consist of
the investment advisory and administrative fees and operational costs.
Additionally, the use of leverage involves certain expenses and special risk
considerations. See "Risks and Special Considerations of Leverage."
The investment grade Municipal Bonds in which the Fund will invest are those
Municipal Bonds rated at the date of purchase in the four highest rating
categories of Standard & Poor's ("S&P"), Moody's Investors Services, Inc.
("Moody's") or Fitch IBCA, Inc. ("Fitch") or, if unrated, considered to be of
comparable quality by the Investment Adviser. In the case of long-term debt, the
investment grade rating categories are AAA through BBB for S&P, Aaa through Baa
for Moody's and AAA through BBB for Fitch. In the case of short-term notes, the
investment grade rating categories are SP-1+ through SP-3 for S&P, MIG-1 through
MIG-3 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 lowest investment grade rating category (BBB, SP-3 and
A-3 for S&P; Baa, MIG-3 and Prime-3 for Moody's; and BBB, F-3 and F-3 for
Fitch), while considered "investment grade," have certain speculative
characteristics. There may be sub-categories or gradations indicating relative
standing within the rating categories set forth above. See Appendix I to this
Prospectus for a description of S&P's, Moody's and Fitch's ratings of Municipal
Bonds. In assessing the quality of Municipal Bonds with respect to the foregoing
requirements, the Investment Adviser will take into account the nature of any
letters of credit or similar credit enhancements to which particular Municipal
Bonds are entitled and the creditworthiness of the financial institution that
provided the credit enhancement.
As noted above, the Fund may invest up to 25% of its assets in Municipal
Bonds that are rated below investment grade or, if unrated, are considered to be
of comparable quality by the Investment Adviser. These high yield bonds are
commonly referred to as "junk bonds" and are regarded as predominantly
speculative as to the issuer's ability to make payments of principal and
interest. Consequently, although such bonds can be expected to provide higher
yields and be less subject to interest rate fluctuations, they may be subject to
greater market price fluctuations and risk of loss of principal than lower
yielding, higher rated fixed income securities. Such securities are particularly
vulnerable to adverse changes in the issuer's industry and in general economic
conditions. Issuers of high yield bonds may be highly leveraged and may not have
available to them more traditional methods of financing. The risk of loss due to
default by the issuer is significantly greater for the holders of these bonds
because such securities may be unsecured and may be subordinated to other
creditors of the issuer. In addition, while the high yield bonds in which the
Fund may invest normally will not include securities that, at the time of
investment, are in default or the issuers of which are in bankruptcy, there can
be no assurance that such events will not occur after the Fund purchases a
particular security, in which case the Fund may experience losses and incur
costs.
High yield bonds frequently have call or redemption features that permit an
issuer to repurchase such bonds from the Fund, which may decrease the net
investment income to the Fund and dividends to shareholders in the event that
the Fund is required to replace a called security with a lower yielding
security. The Fund may have difficulty disposing of certain high yield bonds
because there may be a thin trading market for such securities. Reduced
secondary market liquidity may have an adverse impact on market price and the
Fund's ability to dispose of particular issues when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. In addition, market
quotations are generally available on many high yield bond issues only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales.
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
12
<PAGE>
Adviser will take into account in assessing the quality of such bonds not only
the creditworthiness of the issuer of such bonds but also the creditworthiness
of the financial institutions.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial institution,
typically a commercial bank. The VRDOs in which the Fund will invest are tax-
exempt obligations in the opinion of counsel to the issuer that contain a
floating or variable interest rate adjustment formula and an unconditional right
of demand on the part of the holder thereof to receive payment of the unpaid
principal balance plus accrued interest on a short notice period not to exceed
seven days. Participating VRDOs provide the Fund with a specified undivided
interest (up to 100%) in the underlying obligation and the right to demand
payment of the unpaid principal balance plus accrued interest on the
Participating VRDOs from the financial institution on a specified number of
days' notice, not to exceed seven days. There is, however, the possibility that
because of default or insolvency, the demand feature of VRDOs or Participating
VRDOs may not be honored. The Fund has been advised by its counsel that the Fund
should be entitled to treat the income received on Participating VRDOs as
interest from tax-exempt obligations.
The average maturity of the Fund's portfolio securities will vary based upon
the Investment Adviser's assessment of economic and market conditions. The net
asset value of the shares of common stock of a closed-end investment company,
such as the Fund, which invests primarily in fixed-income securities, changes as
the general levels of interest rates fluctuate. When interest rates decline, the
value of a fixed-income portfolio can be expected to rise. Conversely, when
interest rates rise, the value of a fixed-income portfolio can be expected to
decline. Prices of longer-term securities generally fluctuate more in response
to interest rate changes than do short-term or medium-term securities. These
changes in net asset value are likely to be greater in the case of a fund having
a leveraged capital structure, such as that used by the Fund. See "Risks and
Special Considerations of Leverage."
The Fund intends to invest primarily in long-term Municipal Bonds with a
maturity of more than ten years. Also, the Fund may invest in intermediate-term
Municipal Bonds with a maturity of between three years and ten years. The Fund
may invest in short-term, tax-exempt securities, short-term U.S. Government
securities, repurchase agreements or cash. Such short-term securities or cash
will not exceed 20% of its total assets except during interim periods pending
investment of the net proceeds of public offerings of the Fund's securities or
in anticipation of the repurchase or redemption of the Fund's securities and
temporary periods when, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. The Fund does not ordinarily intend to
realize significant interest income not exempt from Federal income tax.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by such Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund as a "regulated
investment company" for purposes of the Federal tax laws. See "Taxes." To
qualify, among other requirements, the Fund will limit its investments so that,
at the close of each quarter of the taxable year, (i) not more than 25% of the
market value of the Fund's total assets will be invested in the securities
(other than U.S. Government securities) of a single issuer, and (ii) with
respect to 50% of the market value of its total assets, not more than 5% of the
market value of its total assets will be invested in the securities (other than
U.S. Government securities) of a single issuer. A fund that elects to be
classified as "diversified" under the 1940 Act must satisfy the foregoing 5%
requirement with respect to 75% of its total assets. To the extent that the Fund
assumes large positions in the securities of a small number of issuers, the
Fund's yield may fluctuate to a greater extent than that of a diversified
company as a result of changes in the financial condition or in the market's
assessment of the issuers.
13
<PAGE>
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include primarily debt obligations issued to obtain funds
for various public purposes, including construction and equipping of a wide
range of public facilities, refunding of outstanding obligations and obtaining
funds for general operating expenses and loans to other public institutions and
facilities. In addition, certain types of industrial development bonds are
issued by or on behalf of public authorities to finance various privately
operated facilities, including certain local facilities for water supply, gas,
electricity, sewage or solid waste disposal. For purposes of this Prospectus,
such obligations are Municipal Bonds if the interest paid thereon is exempt from
Federal income tax, even though such bonds may be industrial development bonds
("IDBs") or "private activity bonds" as discussed below. Also, for purposes of
this Prospectus, Non-Municipal Tax-Exempt Securities as discussed above will be
considered Municipal Bonds.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" or "special obligation" bonds, which latter
category includes IDBs and, for bonds issued after August 15, 1986, private
activity bonds. General obligation bonds are secured by the issuer's pledge of
faith, credit and taxing power for the payment of principal and interest. The
taxing power of any governmental entity may be limited, however, by provisions
of state constitutions or laws, and an entity's credit will depend on many
factors, including potential erosion of the tax base due to population declines,
natural disasters, declines in the state's industrial base or inability to
attract new industries, economic limits on the ability to tax without eroding
the tax base, state legislative proposals or voter initiatives to limit ad
valorem real property taxes, and the extent to which the entity relies on
Federal or state aid, access to capital markets or other factors beyond the
state's or entity's control. Revenue or special obligation bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise tax or other specific
revenue source such as from the user of the facility being financed. IDBs are in
most cases revenue bonds and generally are not secured by a pledge of the credit
or taxing power of the issuer of such bonds. The payment of the principal and
interest on such industrial development bonds depends solely on the ability of
the user of the facility financed by the bonds to meet its financial obligations
and the pledge, if any, of real and personal property so financed as security
for such payment. Municipal Bonds also may include "moral obligation" bonds,
which normally are issued by special purpose public authorities. If an issuer of
moral obligation bonds is unable to meet its obligations, the repayment of such
bonds becomes a moral commitment but not a legal obligation of the state or
municipality in question.
The Fund may purchase Municipal Bonds classified as "private activity bonds"
(in general, bonds that benefit non-governmental entities). Interest received on
certain tax-exempt securities that are classified as "private activity bonds"
may subject certain investors in the Fund to the alternative minimum tax. There
is no limitation on the percentage of the Fund's assets that may be invested in
private activity bonds. See "Taxes."
Federal tax legislation has limited the types and volume of bonds qualifying
for a Federal income tax exemption of interest. As a result, this legislation
and legislation that may be enacted in the future may affect the availability of
Municipal Bonds for investment by the Fund.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively referred to
as "lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation frequently is
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses, which provide that the issuer has no 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
14
<PAGE>
securities represent a relatively new type of financing that has not yet
developed the depth of marketability associated with more conventional
securities.
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
BORROWINGS. The Fund is authorized to borrow money in amounts of up to 5%
of the value of its total assets at the time of such borrowings; provided,
however, that the Fund is authorized to borrow moneys in amounts of up to
33 1/3% of the value of its total assets at the time of such borrowings to
finance the repurchase of its own common stock pursuant to tender offers, if
any, or otherwise, to redeem or repurchase shares of preferred stock or for
temporary, extraordinary or emergency purposes. Borrowings by the Fund (commonly
known, as with the issuance of preferred stock, as "leveraging") create an
opportunity for greater total return since the Fund will not be required to sell
portfolio securities to purchase tendered shares but, at the same time, increase
exposure to capital risk. In addition, borrowed funds are subject to interest
costs that may offset or exceed the return earned on the borrowed funds.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS. The Fund may
purchase or sell Municipal Bonds on a delayed delivery basis or on a when-issued
basis at fixed purchase or sale terms. These transactions arise when securities
are purchased or sold by the Fund with payment and delivery taking place in the
future. The purchase will be recorded on the date the Fund enters into the
commitment, and the value of the obligation will thereafter be reflected in the
calculation of the Fund's net asset value. The value of the obligation on the
delivery date may be more or less than its purchase price. A separate account of
the Fund will be established with its custodian consisting of cash, cash
equivalents or liquid Municipal Bonds having a market value at all times at
least equal to the amount of the forward commitment.
INDEXED AND INVERSE FLOATING OBLIGATIONS. The Fund may invest in Municipal
Bonds yielding a return 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, income from inverse floating rate bonds
will decrease when short-term interest rates increase, and will increase when
short-term interest rates decrease. Such securities have the effect of providing
a degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate that
is a multiple (typically two) of the rate at which fixed-rate, long-term, tax-
exempt securities increase or decrease in response to such changes. As a result,
the market values of such securities generally will be more volatile than the
market values of fixed-rate tax-exempt securities. To seek to limit the
volatility of these securities, the Fund may purchase inverse floating
obligations with shorter-term maturities or which contain limitations on the
extent to which the interest rate may vary. The Investment Adviser believes that
indexed and inverse floating obligations represent a flexible portfolio
management instrument for the Fund that allows the Investment Adviser to vary
the degree of investment leverage relatively efficiently under different market
conditions.
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
15
<PAGE>
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to holding a
Municipal Bond as a non-callable security.
REPURCHASE AGREEMENTS. The Fund may invest in Municipal Bonds and U.S.
Government securities pursuant to repurchase agreements. Repurchase agreements
may be entered into only with a member bank of the Federal Reserve System or a
primary dealer in U.S. Government securities. Under such agreements, the bank or
primary dealer agrees, upon entering into the contract, to repurchase the
security at a mutually agreed upon time and price, thereby determining the yield
during the term of the agreement. This results in a fixed rate of return
insulated from market fluctuations during such period. The Fund may not invest
more than 15% of its total assets in repurchase agreements maturing in more than
seven days. In the event of default by the seller under a repurchase agreement,
the Fund may suffer time delays and incur costs or possible losses in connection
with the disposal of the collateral.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities 'sold." Therefore,
amounts earned under such agreements will not be considered tax-exempt interest.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of common
stock, the net asset value of the common stock will fluctuate. There can be no
assurance that the Fund's hedging transactions will be effective. In addition,
because of the anticipated leveraged nature of the common stock, hedging
transactions will result in a larger impact on the net asset value of the common
stock than would be the case if the common stock were not leveraged.
Furthermore, the Fund may only engage in hedging activities from time to time
and may not necessarily be engaging in hedging activities when movements in
interest rates occur. The Fund is under no obligation to use hedging
transactions and may not do so.
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains from transactions in options and futures
contracts that are distributed to shareholders are 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 receives a premium from writing a call option that 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
16
<PAGE>
above the exercise price of the option for as long as the Fund's obligation as a
writer continues. Covered call options serve as a partial hedge against a
decline in the price of the underlying security. The Fund may engage in closing
transactions in order to terminate outstanding options that it has written.
PURCHASE OF OPTIONS. The Fund may purchase put options in connection with
its hedging activities. By buying a put the Fund has a right to sell the
underlying security at the exercise price, thus limiting the Fund's risk of loss
through a decline in the market value of the security until the put expires. The
amount of any appreciation in the value of the underlying security will be
partially offset by the amount of the premium paid for the put option and any
related transaction costs. Prior to its expiration, a put option may be sold in
a closing sale transaction; profit or loss from the sale will depend on whether
the amount received is more or less than the premium paid for the put option
plus the related transaction costs. A closing sale transaction cancels out the
Fund's position as the purchaser of an option by means of an offsetting sale of
an identical option prior to the expiration of the option it has purchased. In
certain circumstances, the Fund may purchase call options on securities held in
its portfolio on which it has written call options or on securities that it
intends to purchase. The Fund will not purchase options on securities if, as a
result of such purchase, the aggregate cost of all outstanding options on
securities held by the Fund would exceed 5% of the market value of the Fund's
total assets.
FINANCIAL FUTURES CONTRACTS AND OPTIONS. The Fund is authorized to purchase
and sell financial futures contracts and options thereon solely for the purposes
of hedging its investments in Municipal Bonds against declines in value and
hedging against increases in the cost of securities it intends to purchase. A
financial futures contract obligates the seller of a contract to deliver and the
purchaser of a contract to take delivery of the type of financial instrument
covered by the contract or, in the case of index-based financial futures
contracts, to make and accept a cash settlement, at a specific future time for a
specified price. A sale of financial futures contracts may provide a hedge
against a decline in the value of portfolio securities because such depreciation
may be offset, in whole or in part, by an increase in the value of the position
in the financial futures contracts. A purchase of financial futures contracts
may provide a hedge against an increase in the cost of securities intended to be
purchased because such appreciation may be offset, in whole or in part, by an
increase in the value of the position in the financial futures contracts.
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker equal to
approximately 5% of the contract amount must be deposited with the broker. This
amount is known as initial margin. Subsequent payments to and from the broker,
called variation margin, are made on a daily basis as the price of the financial
futures contract fluctuates making the long and short positions in the financial
futures contract more or less valuable.
The Fund may purchase and sell financial futures contracts based on The Bond
Buyer Municipal Bond Index, a price-weighted measure of the market value of 40
large recently issued tax-exempt bonds, and purchase and sell put and call
options on such financial futures contracts for the purpose of hedging Municipal
Bonds that the Fund holds or anticipates purchasing against adverse changes in
interest rates. The Fund also may purchase and sell financial futures contracts
on U.S. Government securities and purchase and sell put and call options on such
financial futures contracts for such hedging purposes. With respect to U.S.
Government securities, currently there are financial futures contracts based on
long-term U.S. Treasury bonds, Treasury notes, GNMA Certificates and three-month
U.S. Treasury bills.
Subject to policies adopted by the Board of Directors, the Fund also may
engage in transactions in other financial futures contracts transactions and
options thereon, such as financial futures contracts or options on other
municipal bond indices that may become available, if the Investment Adviser and
the Directors of the Fund should determine that there is normally a sufficient
correlation between the prices of such financial futures contracts and the
Municipal Bonds in which the Fund invests to make such hedging appropriate.
17
<PAGE>
OVER-THE-COUNTER OPTIONS. The Fund may engage in options and futures
transactions on exchanges and in the over-the-counter markets. In general,
exchange-traded contracts are third-party contracts (i.e., performance of the
parties' obligations is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. Over-the-counter options ("OTC
options") transactions are two-party contracts with price and terms negotiated
by the buyer and seller. See "Restrictions on OTC Options" below for information
as to restrictions on the use of OTC options.
RESTRICTIONS ON OTC OPTIONS. The Fund will engage in OTC options only with
member banks of the Federal Reserve System and primary dealers in U.S.
Government securities or with affiliates of such banks or dealers that have
capital of at least $50 million or whose obligations are guaranteed by an entity
having capital of at least $50 million or any other bank or dealer having
capital of at least $150 million or whose obligations are guaranteed by an
entity having capital of at least $150 million. OTC options and assets used to
cover OTC options written by the Fund are considered by the staff of the
Commission to be illiquid. The illiquidity of such options or assets may prevent
a successful sale of such options or assets, result in a delay of sale, or
reduce the amount of proceeds that might otherwise be realized.
RISK FACTORS IN OPTIONS AND FUTURES TRANSACTIONS. Utilization of futures
transactions involves the risk of imperfect correlation in movements in the
price of financial futures contracts and movements in the price of the security
that is the subject of the hedge. If the price of the financial futures contract
moves more or less than the price of the security that is the subject of the
hedge, the Fund will experience a gain or loss that will not be completely
offset by movements in the price of such security. There is a risk of imperfect
correlation where the securities underlying financial futures contracts have
different maturities, ratings, geographic compositions or other characteristics
than the security being hedged. In addition, the correlation may be affected by
additions to or deletions from the index that serves as a basis for a financial
futures contract. Finally, in the case of futures contracts on U.S. Government
securities and options on such futures contracts, the anticipated correlation of
price movements between the U.S. Government securities underlying the futures or
options and Municipal Bonds may be adversely affected by economic, political,
legislative or other developments that have a disparate impact on the respective
markets for such securities.
Under regulations of the Commodity Futures Trading Commission (the "CFTC"),
the futures trading activities described herein will not result in the Fund
being deemed a "commodity pool," as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell financial futures contracts and options thereon (i) for bona
fide hedging purposes, as defined under CFTC regulations, without regard to the
percentage of the Fund's assets committed to margin and option premiums, and
(ii) for non-hedging purposes if, immediately thereafter, the sum of the amount
of initial margin deposits on the Fund's existing futures positions and option
premiums entered into for non-hedging purposes do not exceed 5% of the market
value of the liquidation value of the Fund's portfolio, after taking into
account unrealized profits and unrealized losses on any such transactions.
Margin deposits may consist of cash or securities acceptable to the broker and
the relevant contract market.
When the Fund purchases a financial futures contract, or writes a put option
or purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., commercial paper and daily tender adjustable notes) or
short-term, high-grade, fixed-income securities in a segregated account with the
Fund's custodian so that the amount so segregated plus the amount of initial and
variation margin held in the account of its broker equals the market value of
the financial futures contract, thereby ensuring that the use of such financial
futures contract is unleveraged. It is not anticipated that transactions in
futures contracts will have the effect of increasing portfolio turnover.
Although certain risks are involved in options and futures transactions, the
Investment Adviser believes that, because the Fund engages in options and
futures transactions only for hedging purposes, the options and futures
portfolio strategies of the Fund do not subject the Fund to certain risks
frequently associated with speculation in options and futures transactions.
18
<PAGE>
The volume of trading in the exchange markets with respect to Municipal Bond
options may be limited, and it is impossible to predict the amount of trading
interest that may exist in such options. In addition, there can be no assurance
that viable exchange markets will continue to be available.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a liquid
secondary market for such options or futures. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures transaction. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with whom the Fund has an open position in an option or financial
futures contract.
The liquidity of a secondary market in a financial futures contract may be
adversely affected by "daily price fluctuation limits" established by commodity
exchanges which limit the amount of fluctuation in a financial futures contract
price during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
moved beyond the daily limit on a number of consecutive trading days.
If it is not possible to close a financial futures position entered into by
the Fund, the Fund would continue to be required to make daily cash payments of
variation margin in the event of adverse price movements. In such a situation,
if the Fund has insufficient cash, it may have to sell portfolio securities to
meet daily variation margin requirements at a time when it may be
disadvantageous to do so.
The successful use of these transactions also depends on the ability of the
Investment Adviser to forecast correctly the direction and extent of interest
rate movements within a given time frame. To the extent these rates remain
stable during the period in which a futures contract is held by the Fund or move
in a direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction that is not fully or partially offset by an 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
From time to time, the Fund may issue preferred stock representing up to
approximately 35% of the Fund's capital, including capital raised through the
sale of the preferred stock. As of the date of this Prospectus, the Fund has
2,320 shares of its Series A AMPS outstanding, representing approximately %
of its capital. There can be no assurance, however, that preferred stock
representing any particular percentage of the Fund's capital will actually be
issued. Issuing preferred stock leverages the Fund's common stock. The Series A
AMPS pay dividends that are generally adjusted 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 from the sale of the Series A
AMPS were invested in longer-term obligations in accordance with the Fund's
investment objective, as will be the proceeds of the issuance of any additional
shares of preferred stock. The Fund may issue additional shares of its Series A
AMPS or other preferred stock in the future. Other preferred stock will pay
dividends that will be adjusted over either relatively short-term periods
(generally seven to 28 days) or medium-term periods (up to five years) and the
dividend rates thereon will be based upon prevailing interest rates for debt
obligations of comparable maturities. Issuance and ongoing expenses of the
preferred stock will be borne by the Fund and will reduce the net asset value of
the common stock. Additionally, under certain circumstances, when the Fund is
required to allocate taxable income to holders of preferred stock, it is
anticipated that the terms of the preferred stock will require the Fund to make
an additional distribution to such holders in an amount approximately equal to
the tax liability resulting from such allocation and such additional
distribution (such amount, an "Additional Distribution"). Because under normal
market conditions,
19
<PAGE>
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.
The use 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 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 used leverage by issuing Series
A AMPS that pay dividends at a rate that generally will be adjusted every seven
days in an amount representing approximately % of the Fund's capital at an
annual dividend rate of % payable on such preferred stock based on market
rates as of
20
<PAGE>
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
%.
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 % 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)........................ ()% ()% % % %
Corresponding common stock Return................................. ()% ()% ()% % %
</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.
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 2,320 shares of Series A AMPS
representing approximately % of the Fund's capital, and the asset coverage
with respect to the Series A AMPS is approximately %. 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, the fiscal year ended October
31, 1997 and the fiscal year ended October 31, 1998, Merrill Lynch was paid
$48,107, $100,708 and $120,839, respectively, in service fees by the Fund.
21
<PAGE>
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and may
not be changed without the approval of the holders of a majority of the Fund's
outstanding shares of common stock (which for this purpose and under the 1940
Act means the lesser of (i) 67% of the shares represented at a meeting at which
more than 50% of the outstanding shares of common stock are represented or (ii)
more than 50% of the outstanding shares) and of the outstanding shares of
preferred stock, voting together as a class, and the approval of a majority of
the outstanding shares of preferred stock, voting separately by class. The Fund
may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, real estate limited partnerships,
commodities or commodity contracts; provided that the Fund may invest in
securities directly or indirectly secured by real estate or interests
therein or issued by companies that invest in real estate or interests
therein, and the Fund may purchase and sell financial futures contracts and
options thereon. Issue senior securities or borrow money, except as
permitted by Section 18 of the 1940 Act.
3. 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.
4. 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.
5. Invest more than 25% of its total assets (taken at market value at
the time of each investment) in securities of issuers in a single industry;
provided that, for purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry.
Additional investment restrictions adopted by the Fund, which may be changed
by the Board of Directors, without shareholder approval, provide that the Fund
may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be invested
in any one such company, (iii) 10% of the Fund's total assets, taken at
market value, would be invested in such securities, and (iv) the Fund,
together with other investment companies having the same investment adviser
and companies controlled by such companies, owns not more than 10% of the
total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as security
for indebtedness, any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned in investment restriction
(3) above or except as may be necessary in connection with transactions in
financial futures contracts and options thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on margin).
d. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund may
write, purchase and sell options and futures on Municipal Bonds, United
States Government obligations and related indices or otherwise in connection
with
22
<PAGE>
bona fide hedging activities and may purchase and sell Call Rights to
require mandatory tender for the purchase of related Municipal Bonds.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentages resulting from changing values will not be
considered a violation.
The Investment Adviser of the Fund and Merrill Lynch share a common parent,
Merrill Lynch & Co., Inc. ("ML & Co"). Because of the affiliation of Merrill
Lynch with the Investment Adviser, the Fund is prohibited from engaging in
certain transactions involving Merrill Lynch except pursuant to an exemptive
order of the Securities and Exchange Commission or otherwise in compliance with
the provisions of the 1940 Act and the rules and regulations thereunder.
Included among such restricted transactions will be purchases from or sales to
Merrill Lynch of securities in transactions in which Merrill Lynch acts as
principal. An exemptive order has been obtained that permits the Fund to effect
principal transactions with Merrill Lynch in high quality, short-term,
tax-exempt securities subject to conditions set forth in such order. The Fund
does not presently intend to request an order permitting other principal
transactions with Merrill Lynch.
PURCHASE OF SHARES
The Distributor, an affiliate of both the Investment Adviser and Merrill
Lynch, acts as the distributor of shares of common stock of the Fund. The Fund
is engaged in a continuous offering of its shares of common stock on a best
efforts basis through the Distributor and other selected securities dealers that
have entered into 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 the Transfer
Agent. The minimum initial purchase is $1,000 and the minimum subsequent
purchase is $50. The Fund reserves the right to waive or modify the initial and
subsequent minimum investment requirements at any time. In connection with an
exemption the Fund has obtained from the Commission relating to its tender
offers, the Fund will not offer its shares during the five business days
preceding the termination of a tender offer.
To permit the Fund to invest the net proceeds from the sale of its shares of
common stock in an orderly manner, the Fund may, from time to time, suspend the
sale of its shares of common stock, except for sales to existing holders of
common stock and dividend reinvestments.
Due to the administrative complexities associated with the continuous
offering, administrative errors may result in the Distributor or an affiliate
inadvertently acquiring nominal numbers (in no event in excess of 5% of the
shares of common stock) of shares of common stock that it may wish to resell.
Such shares of common stock will not be subject to any investment restriction
and may be resold pursuant to this Prospectus.
The Fund offers its shares of common stock at a public offering price equal
to the next determined net asset value per share without a front-end sales
charge (although in certain cases a CDSC may apply as described herein). The
applicable offering price for purchase orders is based on the net asset value of
the Fund next determined after receipt of the purchase order by the Distributor.
As to purchase orders received by securities dealers prior to the close of
business on the New York Stock Exchange ("NYSE") (generally, the NYSE closes at
4:00 p.m., Eastern time), which includes orders received after the close of
business on the previous day, the applicable offering price is based on the net
asset value determined as of 15 minutes after the close of business on the NYSE
on that day provided the Distributor in turn receives the order from the
securities dealer prior to 30 minutes after the close of business on the NYSE on
that day. If the purchase orders are not received by the Distributor prior to 30
minutes after the close of business on the NYSE, such orders are 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
23
<PAGE>
otherwise and may thereafter resume such offering from time to time. Neither the
Distributor nor the dealers are permitted to withhold placing orders to benefit
themselves by a price change. The Distributor is required to advise the Fund
promptly of all purchase orders and cause payments for shares of common stock to
be delivered promptly to the Fund. Merrill Lynch charges its customers a
processing fee (presently $5.35) to confirm a purchase of shares by such
customers. Purchases made directly through the Transfer Agent 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. In addition, the Distributor compensates
Merrill Lynch and other selected dealers at an annual rate equal to 0.25% of the
value of Fund shares sold by Merrill Lynch and such dealers that remain
outstanding after one year from the date of their original purchase. The
payments made by the Distributor will be made from its own assets and will not
be an expense borne by the Fund, although the Distributor may recover some of
these payments by imposing a contingent deferred sales charge (as described
below) against shareholders who tender shares owned less than three years. See
"Contingent Deferred Sales Charge." Total compensation paid to Merrill Lynch,
other selected dealers and the Distributor, including the compensation paid at
the time of purchase, the 0.25% annual payments mentioned above and the CDSC, if
any, will not exceed the applicable limit (presently 8%), as determined from
time to time by the National Association of Securities Dealers, Inc. For the
period November 3, 1995 (commencement of operations) to October 31, 1996 the
Distributor paid approximately $1,059,723 to Merrill Lynch in connection with
the sale of shares of common stock of the Fund. For the fiscal years ended
October 31, 1997 and October 31, 1998, the Distributor paid approximately
$1,510,306 and $ , respectively, to Merrill Lynch in connection with such
sales.
Upon the transfer of shares out of a Merrill Lynch brokerage account, an
investment account in the transferring shareholder's name will be opened
automatically, without charge, at the Fund's Transfer Agent. 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 takes certain actions that provide liquidity to
shareholders. The Fund may from time to time make offers to purchase its shares
of common stock from all beneficial holders of the Fund's common stock at a
price per share equal to the net asset value per share of the common stock
determined at the close of business on the day an offer terminates. Commencing
with the second quarter of the Fund's operations, the Board of Directors has
considered making 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 undertake the making of any 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.
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 that equals or
approximates net asset value.
24
<PAGE>
Although the Board of Directors believes that the tender offers generally
are 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. Tender
offers are therefore likely to increase the Fund's expense ratio (assuming such
acquisition is not offset by the issuance of additional shares of common stock).
Furthermore, if the Fund borrows to finance the making of tender offers,
interest on such borrowing will reduce the Fund's net investment income.
It is the Board's announced policy, which may be changed by the Board, not
to purchase shares pursuant to a tender offer if (1) such purchases would impair
the Fund's status as a regulated investment company under the Federal tax laws
(which would make the Fund a taxable entity, causing the Fund's income to be
taxed at the corporate level in addition to the taxation of shareholders who
receive dividends from the Fund); (2) the Fund would not be able to liquidate
portfolio securities in a manner that is orderly and consistent with the Fund's
investment objective and policies in order to purchase common stock tendered
pursuant to the tender offer; or (3) there is, in the Board's judgment, any (a)
legal action or proceeding instituted or threatened challenging the tender offer
or otherwise materially adversely affecting the Fund, (b) declaration of banking
moratorium by Federal or state authorities or any suspension of payment by banks
in the United States or New York State, that is material to the Fund, (c)
limitation imposed by Federal or state authorities on the extension of credit by
lending institutions, (d) commencement of war, armed hostilities or other
international or national calamity directly or indirectly involving the United
States that is material to the Fund, or (e) other event or condition that would
have a material adverse effect on the Fund or its shareholders if shares of
common stock tendered pursuant to the tender offer were purchased. Thus, there
can be no assurance that the Board will proceed with any tender offer. The Board
of Directors may modify these conditions in light of circumstances existing at
the time. If the Board of Directors determines to purchase the Fund's shares of
common stock pursuant to a tender offer, such purchases could reduce
significantly 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.
In the event that circumstances arise under which the Fund does not conduct
the tender offers regularly, the Board of Directors will consider alternate
means of providing liquidity for holders of common stock. Such action would
include evaluating any secondary market that then exists for the common stock
and determining whether it provides 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 plans to consider alternate
means of providing liquidity. Among the alternatives that the Board of Directors
may consider is listing the Fund's common stock on a major domestic stock
exchange or on the Nasdaq National Market. The Board of Directors also may
consider causing the Fund to repurchase its shares from time to time in
open-market or private transactions when it can do so on terms that represent a
favorable investment opportunity. In any event, the Board of Directors plans to
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.
Consummating a tender offer may require the Fund to liquidate portfolio
securities and realize gains or losses at a time when the Investment Adviser
would otherwise consider it disadvantageous to do so.
25
<PAGE>
Each tender offer is 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 contain information
prescribed by such laws and the rules and regulations promulgated thereunder.
The repurchase of tendered shares by the Fund is a taxable event. See "Taxes."
The Fund pays all costs and expenses associated with making of any tender offer.
A CDSC is imposed on most shares accepted for tender that have been held for
less than three years. See "Contingent Deferred Sales Charge." In addition,
Merrill Lynch charges its customers a processing fee (presently $5.35) to
confirm a repurchase of shares from such customers pursuant to a tender offer.
Tenders made directly through the Transfer Agent are not subject to the
processing fee.
Shareholders 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") in a tender offer by the Fund in Class D shares of certain Merrill
Lynch-sponsored open-end funds ("Eligible Class D Shares") at their net asset
value, without the imposition of an initial sales charge, if the conditions set
forth below are satisfied. First, net proceeds from the sale of the Original
Shares in the tender offer must be immediately reinvested in Eligible Class D
Shares. Second, the investment option is available only with respect to the
proceeds of shares of the Fund's common stock as to which no CDSC is applicable.
Shareholders who already own Class A shares of the fund in which they wish to
invest proceeds from the sale of the Original Shares, in the same account into
which they will purchase the additional shares, may purchase Class A rather than
Class D shares so long as all of the other requirements of this paragraph are
met. Class D shares are subject to an ongoing account maintenance fee at an
annual rate of up to 0.25% of the average daily net asset value of the
applicable fund. Before taking advantage of this investment option, shareholders
should obtain a currently effective prospectus of the fund in which they intend
to invest and should consult their Merrill Lynch Financial Consultant.
Shareholders who utilize this investment option will be treated as if they first
received cash for their tendered shares and then used the proceeds to purchase
the other shares and consequently will realize a taxable gain or loss in the
same manner as if they received cash for their tendered shares. See
"Taxes--Offer to Purchase Shares."
CONTINGENT DEFERRED SALES CHARGE
A CDSC to recover distribution expenses incurred by the Distributor is
charged against the shareholder's investment account and paid to the Distributor
in connection with most shares of common stock held for less than three years
that are repurchased pursuant to a tender offer. The CDSC is 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 acquired by reinvesting 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 varies depending on the length of time the common stock has been owned
since purchase (separate purchases shall not be aggregated for these purposes),
as set forth in the following table:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
YEAR OF REPURCHASE SALES CHARGE
- -------------------------------------------------------------------------- -----------------------
<S> <C>
First..................................................................... 3.0%
Second.................................................................... 2.0%
Third..................................................................... 1.0%
Fourth and following...................................................... 0.0%
</TABLE>
In determining whether a CDSC is applicable to a tender of shares of common
stock, the calculation is determined in the manner that results in the lowest
possible amount being charged. It is assumed that the shareholder first tenders
shares of common stock held for over three years and shares of common stock
26
<PAGE>
acquired by reinvesting dividends or distributions, followed by shares of common
stock held longest during the three-year period. The CDSC will not be applied to
dollar amounts representing an increase in the net asset value since the time of
purchase. The Fund waives CDSC's on Fund shares tendered following the death of
all beneficial owners of such shares, provided the shares are tendered within
one year of death (a death certificate and other applicable documents may be
required). At the time of tender, the record or succeeding beneficial owner must
notify the transfer agent either directly or indirectly through the Distributor
that the CDSC should be waived. Upon confirmation of the owner's entitlement,
the waiver will be granted; otherwise, the waiver will be lost.
EXAMPLE:
Assume an investor purchased 1,000 shares of common stock (at a cost of
$10,000). Two years after purchase, the net asset value per share is $12.00 and,
during the two year period, the investor has acquired 100 additional shares of
common stock by reinvesting dividends. If the investor first tenders 500 shares
at this time (proceeds of $6,000), 100 shares will not be subject to the CDSC
because they were acquired by reinvesting dividends. With respect to the
remaining 400 shares tendered, the CDSC is applied only to the original cost of
$10 per share (and not to the increase in net asset value of $2.00 per share).
Therefore, $4,000 of the $6,000 redemption proceeds will be charged at a rate of
2.0% (the applicable rate in the second year after purchase).
For the period November 3, 1995 (commencement of operations) to October 31,
1996, the amount paid to the Distributor in CDSCs aggregated $38,710. For the
fiscal years ended October 31, 1997 and October 31, 1998, such amount paid to
the Distributor aggregated $85,662 and $146,028, respectively.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and portfolio managers
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 portfolio manager is P.O. Box 9011,
Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL (66)--PRESIDENT AND DIRECTOR(1)(2)-- Chairman of the
Investment Adviser and MLAM (which terms, as used herein, include their
corporate predecessors) since 1997; President of the Investment Adviser and MLAM
from 1977 to 1997; Chairman of Princeton Services, Inc. ("Princeton Services)
since 1997, Director since 1993 and President from 1993 to 1997; Executive Vice
President of ML & Co. since 1990.
RONALD W. FORBES (58)--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 (46)--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 (67)--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.
KEVIN A. RYAN (66)--DIRECTOR(2)--127 Commonwealth Avenue, Chestnut Hill,
Massachusetts 02167. Founder and current Director of The Boston University
Center for the Advancement of Ethics and
27
<PAGE>
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 (60)--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., Vornado Realty Trust, Inc., Vornado Operating
Company and Alexander's Inc.
TERRY K. GLENN (58)--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 Princeton
Funds Distributor, Inc. ("PFD") since 1986 and Director thereof since 1991.
VINCENT R. GIORDANO (54)--SENIOR VICE PRESIDENT(1)(2)--Senior Vice President
of the Investment Adviser and MLAM since 1984; Senior Vice President of
Princeton Services since 1993; Vice President of MLAM from 1980 to 1984.
DONALD C. BURKE (38)--VICE PRESIDENT(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997 and Director of Taxation of
MLAM since 1990.
KENNETH A. JACOB (47)--VICE PRESIDENT(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997.
JOHN M. LOFFREDO, CFA (35)--VICE PRESIDENT AND PORTFOLIO
MANAGER(1)(2)--First Vice President of MLAM since 1997; Vice President of MLAM
from 1991 to 1997.
ROBERT A. DIMELLA, CFA (32)--VICE PRESIDENT AND PORTFOLIO
MANAGER(1)(2)--Vice President of MLAM since 1997; Assistant Vice President of
MLAM from 1995 to 1997; employee of MLAM since 1993; Assistant Portfolio Manager
with Prudential Investment Advisors from 1992 to 1993; Research Associate with
Prudential Investment Corporation from 1989 to 1992.
GERALD M. RICHARD (49)--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 PFD since 1981 and
Treasurer since 1984.
PATRICK D. SWEENEY (44)--SECRETARY(1)(2)--First Vice President of MLAM since
1997; Vice President of MLAM from 1990 to 1997.
- ------------------------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee, officer or member of the
advisory board of one or more investment companies for which the Investment
Adviser or MLAM acts as investment adviser.
At December 1, 1998, the officers and Directors of the Fund as a group (14
persons) owned an aggregate of less than 1% of the outstanding shares of the
common stock and the Series A AMPS, respectively, and less than 1% of the
outstanding shares of common stock of ML & Co.
In connection with the election of the Fund's Directors, holders of shares
of Series A AMPS and other preferred stock, voting as a separate class, are
entitled to elect two of the Fund's Directors, and the remaining Directors will
be elected by all holders of capital stock, voting as a single class. Messrs.
Forbes and Reilly have been designated as the Directors to be elected by holders
of the preferred stock. See "Description of Capital Stock."
COMPENSATION OF DIRECTORS
Pursuant to an Investment Advisory Agreement with the Fund, the Investment
Adviser pays all compensation of officers and employees of the Fund as well as
the fees of all Directors who are affiliated persons of ML & Co. or its
subsidiaries. The Fund pays each Director not affiliated with the Investment
Adviser a fee of $3,000 per year plus $300 per meeting attended and pays all
Director's actual out-of-
28
<PAGE>
pocket expenses relating to attendance at meetings. The Fund also pays members
of the Board's Audit and Nominating Committee (the "Committee"), which consists
of all of the non-affiliated Directors an annual fee of $900. The Chairman of
the Committee receives an additional annual fee of $1,000. For the fiscal year
ended October 31, 1998, fees and expenses paid to the non-affiliated Directors
that were allocated to the Fund aggregated $28,715.
The following table sets forth the compensation earned by the non-affiliated
Directors from the Fund for the fiscal year ended October 31, 1998, and the
aggregate compensation paid to non-affiliated Directors from all registered
investment companies advised by the Investment Adviser and its affiliate, MLAM
("FAM/MLAM Advised Funds"), for the calendar year ended December 31, 1998.
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PENSION OR RETIREMENT FROM FUND AND
BENEFITS ACCRUED AS FAM/MLAM ADVISED
COMPENSATION PART FUNDS PAID TO
NAME OF DIRECTOR FROM FUND OF FUND EXPENSE DIRECTORS(1)
- ----------------------------------------------------- ------------- ---------------------- -------------------
<S> <C> <C> <C>
Ronald W. Forbes..................................... $ 5,400 None $
Cynthia A. Montgomery................................ $ 5,400 None $
Charles C. Reilly.................................... $ 6,400 None $
Kevin A. Ryan........................................ $ 5,400 None $
Richard R. West...................................... $ 5,400 None $
</TABLE>
- ------------------------
(1) The Directors serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Forbes (35 registered investment companies consisting of 48 portfolios);
Ms. Montgomery (35 registered investment companies consisting of 48
portfolios); Mr. Reilly (54 registered investment companies consisting of
67 portfolios); Mr. Ryan (35 registered investment companies consisting of
48 portfolios); and Mr. West (54 registered investment companies consisting
of 67 portfolios).
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS
The Investment Adviser, which is owned and controlled by ML & Co., a
financial services holding company and the parent of Merrill Lynch, provides the
Fund with investment advisory and administrative services. The Asset Management
Group of ML & Co. (which includes the Investment Adviser) acts as the investment
adviser to more than 100 registered investment companies and offers portfolio
management services to individuals and institutions. As of 1998, the
Asset Management Group had a total of approximately $ billion in investment
company and other portfolio assets under management (including $ billion in
municipal securities). This amount includes assets managed for certain
affiliates of the Investment Adviser. The Investment Adviser is a limited
partnership the partners of which are ML & Co. and Princeton Services. The
principal business address of the Investment Adviser is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536.
The Fund's Investment Advisory Agreement with the Investment Adviser
provides that, subject to the supervision of the Board of Directors of the Fund,
the Investment Adviser is responsible for the actual management of the Fund's
portfolio. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Investment Adviser, subject to review by the
Board of Directors. The Fund's portfolio managers will consider analyses from
various sources, make the necessary investment decisions, and place orders for
transactions accordingly. The Investment Adviser will also be responsible for
the performance of certain management services for the Fund. Robert A. DiMella
and John M. Loffredo are the portfolio managers for the Fund and are primarily
responsible for the Fund's day-to-day management.
29
<PAGE>
For investment advisory services, the Fund pays the Investment Adviser 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 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,
performing investment and economic research, trading and investment management
for the Fund, as well as the compensation of all Directors of the Fund who are
affiliated persons of ML & Co. or its subsidiaries.
For administrative services, the Fund pays the Investment Adviser a monthly
fee at an annual rate of 0.25 of 1% of the Fund's average daily net assets
determined in the same manner as the fee payable by the Fund under the
Investment Advisory Agreement. The Investment Adviser may pay a portion of the
fee received pursuant to the Administration Agreement to its affiliate, Merrill
Lynch, for administrative services rendered in connection with any preferred
stock of the Fund. The combined advisory and administration fees are greater
than the advisory fees paid by most funds, but are similar in amount to the fees
paid by other continuously offered, closed-end funds.
For the period November 3, 1995 (commencement of operations) to October 31,
1996, and for the fiscal years ended October 31, 1997 and October 31, 1998, the
fees paid by the Fund to the Investment Adviser pursuant to the Investment
Advisory Agreement were $446,931, $657,929, and $787,978, respectively, and the
fees paid by the Fund pursuant to the Administration Agreement were $223,466,
$328,965, and $393,989, respectively (such fees based on average daily net
assets of approximately $89.9 million, $82.9 million and $110.0 million,
respectively). For the period November 3, 1995 (commencement of operations) to
October 31, 1996, and for the fiscal years ended October 31, 1997 and October
31, 1998, the Investment Adviser voluntarily waived $419,740, $424,822, and
$204,377, respectively, of the fees paid by the Fund pursuant to the Investment
Advisory Agreement and voluntarily reimbursed the Fund additional expenses of
$231,006, $0, and $0, respectively.
The Fund pays all other expenses incurred in its operations, including,
among other things, legal and auditing expenses, taxes, costs of printing
proxies, stock certificates and shareholder reports, charges of the Fund's
custodian and transfer agent, expenses of registering the shares under Federal
and state securities laws, fees and expenses with respect to the issuance of
preferred shares or any borrowing, Securities and Exchange Commission fees, fees
and expenses of non-affiliated Directors, accounting and pricing costs,
insurance, interest, brokerage costs, litigation and other extraordinary or
non-recurring expenses, mailing and other expenses properly payable by the Fund.
Accounting services are provided to the Fund by the Investment Adviser, and the
Fund reimburses the Investment Adviser for its costs in connection with such
services. For the period November 3, 1995 (commencement of operations) to
October 31, 1996, the reimbursement for such services was $60,526. For the
fiscal years ended October 31, 1997 and October 31, 1998, such reimbursement
aggregated $61,452 and $65,847, respectively.
Unless earlier terminated as described below, the Investment Advisory and
Administration Agreements remain in effect from year to year if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contracts or interested persons (as defined in the 1940 Act)
of any such party. Such contracts are not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party thereto
or by the vote of the shareholders of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of
30
<PAGE>
different objectives or other factors, a particular security may be bought for
an advisory client when other 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. Transactions effected by the Investment Adviser (or its
affiliate) on behalf of more than one of its clients during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, causing an adverse effect on price.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the 1940 Act that incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes'). The Codes significantly restrict the
personal investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot" initial
public offering and a prohibition from profiting on short-term trading in
securities. In addition, no employee may purchase or sell any security that at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading "blackout
periods', which prohibit trading by investment personnel of the Fund within
periods of trading by the Fund in the same (or equivalent) security (15 or 30
days depending upon the transaction).
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm
involved and the firm's risk in positioning a block of securities. While the
Investment Adviser generally seeks reasonably competitive commission rates, the
Fund does not necessarily pay the lowest commission or spread available. For the
period November 3, 1995 (commencement of operations) to October 31, 1996 and for
the fiscal years ended October 31, 1997 and October 31, 1998, 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 providing the best
price and execution, securities firms that provide investment research to the
Investment Adviser, including Merrill Lynch, may receive orders for transactions
by the Fund. Research information provided to the Investment Adviser by
securities firms is supplemental. It does not replace or reduce the level of
services performed by the Investment Adviser and the expenses of the Investment
Adviser will not be reduced because it receives supplemental research
information.
The Fund invests in securities traded in the over-the-counter markets, and
the Fund intends to deal directly with 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, including Merrill Lynch, are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities. Since transactions in the over-the-counter market usually involve
transactions with dealers acting as principals for their own accounts, the Fund
does not deal with
31
<PAGE>
Merrill Lynch and its affiliates in connection with such transactions except
that, pursuant to exemptive orders obtained by the Investment Adviser, the Fund
may engage in principal transactions with Merrill Lynch in high quality,
short-term securities. See "Investment Restrictions." For the period November 3,
1995 (commencement of operations) to October 31, 1996 and for the fiscal years
ended October 31, 1997 and October 31, 1998, the Fund engaged in no transactions
pursuant to such order. However, affiliated persons of the Fund, including
Merrill Lynch, may serve as its broker in certain over-the-counter transactions
conducted on an agency basis.
The Fund may not purchase securities, including Municipal Bonds, during the
existence of any underwriting syndicate of which Merrill Lynch is a member or in
a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Directors of the Fund which either comply
with rules adopted by the Commission or with interpretations of the Commission
Staff. Rule 10f-3 under the 1940 Act sets forth conditions under which the Fund
may purchase municipal bonds from an underwriting syndicate of which Merrill
Lynch is a member. The rule sets forth requirements relating to, among other
things, the terms of an issue of municipal bonds purchased by the Fund, the
amount of municipal bonds that may be purchased in any one issue and the assets
of the Fund that may be invested in a particular issue.
The Fund may also make loans to tax-exempt borrowers in individually
negotiated transactions with the borrower. Because an active trading market may
not exist for such securities, the prices that the Fund may pay for these
securities or receive on their resale may be lower than that for similar
securities with a more liquid market.
PORTFOLIO TURNOVER
The Fund may dispose of securities without regard to the length of time they
have been held when such action, for defensive or other reasons, appears
advisable to its Investment Adviser. The portfolio turnover rate is calculated
by dividing the lesser of purchases or sales of portfolio securities for the
particular fiscal year by the monthly average value of the portfolio securities
owned by the Fund during the year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded. A high portfolio turnover rate has certain tax consequences and
results in greater transaction costs, which are borne directly by the Fund. For
the fiscal years ended October 31, 1997 and October 31, 1998 the Fund's
portfolio turnover rates were 144% and 142%, respectively. Portfolio turnover
rates tend to be high for funds in their first few years of operations. The Fund
purchases temporary holdings until more, appropriate, long-term investments are
acquired. This strategy continues until the Fund "matures" into a portfolio of
core holdings enabling it to meet its investment objectives.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute substantially all of its net investment
income. Dividends from such net investment income are paid monthly. As long as
any preferred stock is outstanding, monthly distributions to holders of common
stock normally will consist of substantially all net investment income remaining
after the payment of dividends (and any Additional Distribution) on the Series A
AMPS and any other preferred stock. All net realized capital gains, if any, will
be distributed at least annually to holders of common stock and pro rata to
holders of common stock and preferred stock. While any shares of preferred stock
are outstanding, the Fund may not declare any cash dividend or other
distribution on its common stock, unless at the time of such declaration (1) all
accumulated preferred stock dividends, including any Additional Distribution,
have been paid, and (2) the net asset value of the Fund's portfolio (determined
after deducting the amount of such dividend or other distribution) is at least
200% of the liquidation value of the outstanding preferred stock (expected to
equal the original purchase price of the outstanding shares of preferred stock
plus any accumulated and unpaid dividends thereon and any accumulated but unpaid
Additional Distribution). As of the date of this Prospectus, Series A AMPS
represent approximately % of the Fund's capital and the asset coverage with
respect to the Series A AMPS is approximately %. If
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<PAGE>
the Fund's ability to make distributions on its common stock is limited, such
limitation could under certain circumstances impair the ability of the Fund to
maintain its qualification for taxation as a regulated investment company, which
could have adverse tax consequences for holders of common stock. See "Taxes."
All net realized capital gains, if any, will be distributed to the Fund's
shareholders at least annually. See "Automatic Dividend Reinvestment Plan" for
information concerning the manner in which dividends and distributions to
holders of common stock may be automatically reinvested in shares of common
stock of the Fund. Dividends and distributions are taxable to shareholders as
discussed below whether they are reinvested in shares of the Fund or received in
cash. The Fund is not responsible for any failure of delivery to the
shareholder's address of record and no interest will accrue on amounts
represented by uncashed distribution or redemption checks.
TAXES
GENERAL
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue Code
of 1986, as amended (the "Code"). As long as it so qualifies, in any taxable
year in which it distributes at least 90% of its taxable net income and 90% of
its tax-exempt net income (see below), the Fund (but not its shareholders) will
not be subject to Federal income tax to the extent that it distributes its net
investment income and net realized capital gains. The Fund intends to distribute
substantially all of such income.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year-end, plus certain undistributed
amounts from previous years. The required distributions, however, are based only
on the taxable income of a RIC. The excise tax, therefore, generally will not
apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Fund intends to qualify to pay "exempt-interest" dividends as defined in
Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations exempt from Federal income tax ("tax-exempt
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund will be qualified
to pay exempt-interest dividends to its shareholders. Exempt-interest dividends
are dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Fund as exempt-interest
dividends in a written notice mailed to the Fund's shareholders within 60 days
after the close of its taxable year. To the extent that the dividends
distributed to the Fund's shareholders are derived from interest income exempt
from tax under Code Section 103(a) and are properly designated as
exempt-interest dividends, they will be excludable from a shareholder's gross
income for Federal income tax purposes. Exempt-interest dividends are included,
however, in determining the portion, if any, of a person's social security and
railroad retirement benefits subject to Federal income taxes. Interest on
indebtedness incurred or continued to purchase or carry Fund shares will not be
deductible by the investor for Federal income tax purposes, to the extent
attributable to exempt-interest dividends. Shareholders are advised to consult
their tax advisers with respect to whether exempt-interest dividends retain the
exclusion under Code Section 103(a) if such shareholder would be treated as a
"substantial user" or "related person" under Code Section 147(a) with respect to
property financed with the proceeds of an issue of "industrial development
bonds" or "private activity bonds," if any, held by the Fund.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal income tax purposes. Distributions, if
any,
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<PAGE>
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. Certain categories of capital gains are taxable at
different rates. Generally not later than 60 days after the close of its taxable
year, the Fund will provide its shareholders with a written notice designating
the amounts of any exempt-interest dividends, ordinary income dividends or
capital gain dividends, as well as any amount of capital gain dividends in the
different categories of capital gain referred to above. Distributions by the
Fund, whether from exempt-interest income, ordinary income or capital gains, are
not eligible for the dividends received deduction allowed to corporations under
the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of shares held for six months
or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividends received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the RIC and
received by its shareholders on December 31 of the year in which such dividend
was declared.
The Internal Revenue Service ("IRS") has taken the position in a revenue
ruling that if a RIC has two or more 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 total dividends paid by the RIC during such year that was paid to such class.
Consequently, the Fund intends to designate distributions made to the common
stock, the Series A AMPS and any other preferred stock issued by the Fund, as
consisting of particular types of income in accordance with the classes'
proportionate shares of such income. Thus, the Fund will designate dividends
paid as exempt-interest dividends in a manner that allocates such dividends
between the holders of common stock and Series A AMPS in proportion to the total
dividends paid to each class during the taxable year, or otherwise as required
by applicable law. Capital gain dividends will similarly be allocated among the
classes in proportion to the total dividends paid to each class during the
taxable year, or otherwise as required by applicable law. When capital gain or
other taxable income is allocated to holders of Series A AMPS pursuant to the
allocation rules described above, the terms of the Series A AMPS require the
Fund to make an additional distribution to or otherwise compensate such holders
for the tax liability resulting from such allocation.
In the opinion of Brown & Wood LLP, counsel to the Fund, under current law
the manner in which the Fund allocates items of tax-exempt income, net capital
gains, and other taxable income, if any, between shares of common stock and
shares of Series A AMPS will be respected for Federal income tax purposes.
However, there currently is no direct guidance from the IRS or other sources
specifically addressing whether the Fund's method for allocating tax-exempt
income, net capital gains, and other taxable income between shares of common
stock and shares of Series A AMPS will be respected for Federal income tax
purposes, and it is possible that the IRS could disagree with counsel's opinion
and attempt to reallocate the Fund's net capital gains or other taxable income.
A reallocation may cause the Fund to be liable for income tax and excise tax on
any reallocated taxable income. Brown & Wood LLP has advised the Fund that, in
its opinion, if the IRS were to challenge in court the Fund's allocations of
income and gain, the IRS would be unlikely to prevail. The opinion of Brown &
Wood LLP, however, represents only its best legal judgment and is not binding on
the IRS or the courts.
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<PAGE>
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. This alternative minimum tax applies
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds that, although tax-exempt, are used for
purposes other than those generally performed by governmental units and that
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference" which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund intends to
purchase such "private activity bonds" and will report to shareholders within 60
days after its calendar year-end the portion of its dividends declared during
the year which constitutes an item of tax preference for alternative minimum tax
purposes. The Code further provides that corporations are subject to an
alternative minimum tax based, in part, on certain differences between taxable
income as adjusted for other tax preferences and the corporation's "adjusted
current earnings," which more closely reflect a corporation's economic income.
Because an exempt-interest dividend paid by the Fund will be included in
adjusted current earnings, a corporate shareholder may be required to pay an
alternative minimum tax on exempt-interest dividends paid by the Fund.
The Fund may invest in high yield securities, as described herein.
Furthermore, the Fund may also invest in instruments the return on which
includes nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such high yield securities
and/or nontraditional instruments could be recharacterized as taxable ordinary
income.
If at any time when Series A AMPS or other shares of preferred stock are
outstanding the Fund does not meet the asset coverage requirements of the 1940
Act, the Fund will be required to suspend distributions to holders of common
stock until the asset coverage is restored. See "Dividends and Distributions."
This may prevent the Fund from distributing at least 90% of its net investment
income and may, therefore, jeopardize the Fund's qualification for taxation as a
RIC. Upon any failure to meet the asset coverage requirements of the 1940 Act,
the Fund, in its sole discretion, may, and under certain circumstances will be
required to, redeem shares of preferred stock in order to maintain or restore
the requisite asset coverage and avoid the adverse consequences to the Fund and
its shareholders of failing to qualify as a RIC. There can be no assurance,
however, that any such action would achieve such objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund currently contemplates issuing in
addition to the Series A AMPS may raise an issue as to whether distributions on
such preferred stock are "preferential" under the Code and therefore not
eligible for the dividends paid deduction. The Fund intends to issue preferred
stock that counsel advises will not result in the payment of a preferential
dividend and may seek a private letter ruling from the Internal Revenue Service
to that effect. If the Fund ultimately relies solely on a legal opinion when it
issues such preferred stock, there is no assurance that the Internal Revenue
Service would agree that dividends on the preferred stock are not preferential.
If the Internal Revenue Service successfully disallowed the dividends paid
deduction for dividends on the preferred stock, the Fund could be disqualified
as a RIC. In this case, dividends paid by the Fund would not be exempt from
Federal income taxes. Additionally, the Fund would be subject to the alternative
minimum tax.
The value of common shares acquired pursuant to the Fund's dividend
reinvestment plan will generally be excluded from gross income to the extent
that the cash amount reinvested would be excluded from gross income. If, when
the Fund's shares are trading at a premium over net asset value, the Fund issues
shares pursuant to the dividend reinvestment plan that 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
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<PAGE>
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, as well as plan participants, 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 are those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
TENDER OFFERS
Under current law, a holder of common stock, who, pursuant to any tender
offer, tenders all of its shares and who, after such tender offer, is not
considered to own any shares under attribution rules contained in the Code will
realize a taxable gain or loss depending upon such shareholder's basis in the
shares. Such gain or loss will be treated as capital gain or loss if the shares
are held as capital assets and will be long-term if the shares have been held
for more than one year. Different tax consequences may apply to tendering and
non-tendering holders of common stock in connection with a tender offer, and
these consequences will be disclosed in the related offering documents. For
example, if a tendering holder of common stock tenders less than all shares
owned by or attributed to such shareholder, and if the distribution to such
shareholder does not otherwise qualify as a sale or exchange, the proceeds
received will be treated as a taxable dividend, or, if the Fund has insufficient
earnings and profits, a return of capital or capital gain, depending on the
shareholder's basis in the tendered shares. Also, there is a remote risk that
non-tendering holders of common stock may be considered to have received a
deemed distribution that may be a taxable dividend in whole or in part. Holders
of common stock may wish to consult their tax advisers prior to tendering.
Likewise, if holders of common stock whose shares are acquired by the Fund in
the open market sell less than all shares owned by or attributed to them, a risk
exists that these shareholders will be subject to taxable dividend treatment,
and a remote risk exists that the remaining shareholders may be considered to
have received a deemed distribution.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is available
to the Fund or an exception applies, such options and financial futures
contracts that are "Section 1256 contracts" will be "marked to market" for
Federal income tax purposes at the end of each taxable year, i.e., each such
option or financial futures contract will be treated as sold for its fair market
value on the last day of the taxable year, and any gain or loss attributable to
Section 1256 contracts will be 60% long-term and
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<PAGE>
40% short-term capital gain or loss. Application of the mark-to-market rules to
Section 1256 contracts held by the Fund may alter the timing and character of
distributions to shareholders. The mark-to-market rules outlined above, however,
will not apply to certain transactions entered into by the Fund solely to reduce
the risk of changes in price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in financial futures
contracts and related options. Under Section 1092, the Fund may be required to
postpone recognition for tax purposes of losses incurred in certain sales of
securities and certain closing transactions in financial futures contracts or
the related options.
STATE AND LOCAL TAXES
The exemption from Federal income tax for exempt-interest dividends does not
necessarily result in an exemption for such dividends under the income or other
tax laws of any state or local taxing authority. Shareholders are advised to
consult their own tax advisers concerning state and local tax matters.
------------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes and with specific
questions as to Federal, foreign, state, or local taxes.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
All dividends and capital gains distributions on the common stock of the
Fund are reinvested automatically in full and fractional shares of common stock
of the Fund at the net asset value per share next determined on the payable date
of such dividend or distribution. A shareholder may at any time, by written
notification to Merrill Lynch if the shareholder's account is maintained with
Merrill Lynch or by written notification or by telephone (1-800-MER-FUND) to the
transfer agent, if the shareholder's account is maintained with the transfer
agent, elect to have subsequent dividends or both dividends and capital gains
distributions paid in cash, rather than reinvested, in which event payment will
be mailed on or about the payment date (provided that, in the event that a
payment on an account maintained at the transfer agent would amount to $10 or
less, a shareholder will not receive such payment in cash and such payment will
be automatically reinvested in additional shares). Cash payments can also be
directly deposited to the shareholder's bank account. No CDSC will be imposed on
redemptions of shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. The Fund is not responsible for any
failure of delivery to the shareholder's address of record and no interest will
accrue on amounts represented by uncashed distribution or redemption checks.
The automatic reinvestment of dividends does not relieve participants of any
Federal income tax that may be payable (or required to be withheld) on such
dividends or distributions. See "Taxes."
NET ASSET VALUE
The net asset value per share of common stock is determined once daily as of
15 minutes after the close of business on the NYSE (generally, the NYSE closes
at 4:00 p.m., Eastern time), on each business day during which the NYSE is open
for trading. The NYSE is not open on New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. For purposes of determining the net asset
value of a share of common stock, the value of the securities held by the Fund
plus any cash or other assets (including interest accrued but not yet received)
minus all liabilities (including accrued expenses) and the aggregate liquidation
value of the
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<PAGE>
outstanding shares of preferred stock is divided by the total number of shares
of common stock outstanding at such time. Expenses, including the fees payable
to the Investment Adviser, are accrued daily.
The municipal bonds in which the Fund invests are traded primarily in the
over-the-counter markets. In determining net asset value, the Fund utilizes the
valuations of portfolio securities furnished by a pricing service approved by
the Board of Directors. The pricing service typically values portfolio
securities at the bid price or the yield equivalent when quotations are readily
available. Market illiquidity may make it difficult for the Fund to obtain
accurate quotations for its holdings of high-yield Municipal Bonds. Municipal
Bonds for which quotations are not readily available are valued at fair market
value on a consistent basis as determined by the pricing service using a matrix
system to determine valuations. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
supervision of the Board of Directors. The Board of Directors has determined in
good faith that the use of a pricing service is a fair method of determining the
valuation of portfolio securities. Obligations with remaining maturities of 60
days or less are valued at amortized cost, unless this method no longer produces
fair valuations. Positions in futures contracts are valued at closing prices for
such contracts established by the exchange on which they are traded, or if
market quotations are not readily available, are valued at fair value on a
consistent basis using methods determined in good faith by the Board of
Directors.
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares were initially classified as common
stock. The Board of Directors is authorized, however, to classify or reclassify
any unissued shares of capital stock by setting or changing in any one or more
respects the designation and number of shares of any such class or series, and
the nature, rates, amounts and times at which and the conditions under which
dividends shall be payable on and the voting, conversion, redemption and
liquidation rights of such class or series and any other preferences, rights,
restrictions, and qualifications applicable thereto. In this regard, the Board
of Directors reclassified 40,000 shares of unissued common stock as Auction
Market Preferred Stock, par value $0.10 per share, liquidation preference
$25,000 per share ("AMPS").
The following table shows the amount of (i) capital stock authorized, (ii)
capital stock held by the Fund for its own account and (iii) capital stock
outstanding for each class of authorized securities of the Fund as of October
31, 1998.
<TABLE>
<CAPTION>
AMOUNT OUTSTANDING
AS OF OCTOBER 31, 1998
AMOUNT HELD (EXCLUSIVE OF AMOUNT
BY HELD
AMOUNT FUND FOR ITS BY FUND FOR ITS
TITLE OF CLASS AUTHORIZED OWN ACCOUNT OWN ACCOUNT)
- ----------------------------------------------------------- ------------- ----------------- -----------------------
<S> <C> <C> <C>
Common Stock............................................... 199,960,000 -0- 10,523,555
Auction Market Preferred Stock............................. 40,000 -0- 1,920
</TABLE>
COMMON STOCK
Shares of common stock, when issued and fully outstanding, are fully paid
and non-assessable. Shareholders 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. Shareholders 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
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<PAGE>
respect to preferred stock would be at least 200% after giving effect to such
distributions. See "Preferred Stock" below.
The Fund sends unaudited reports at least semi-annually and audited annual
financial statements to all of its shareholders.
PREFERRED STOCK
The Fund's shares of preferred stock may be issued in one or more series,
with rights as determined by the Board of Directors, by action of the Board of
Directors without the approval of the holders of common stock. Under the Fund's
Articles Supplementary specifying the powers, preferences and rights of the
AMPS, the Fund is authorized to issue an aggregate of 40,000 shares of AMPS,
designated respectively: 8,000 shares of Series A AMPS, 8,000 shares of Series B
AMPS, 8,000 shares of Series C AMPS, 8,000 shares of Series D AMPS and 8,000
shares of Series E AMPS. 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.
As of the date of this Prospectus, the Fund has issued 2,320 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.
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<PAGE>
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 that issue ratings on the preferred stock. The
Charter prohibits the sale or transfer of preferred stock to any affiliate of
the Fund or the Investment Adviser, except for an affiliate that may be acting
as a broker-dealer in connection with the preferred stock.
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A Director may be removed from office
with or without cause by vote of the holders of at least 66 2/3% of the shares
of capital stock entitled to be voted on the matter. A director elected by all
of the holders of capital stock may be removed only by action of such holders,
and a director elected by the holders of preferred stock may be removed only by
action of such holders.
In addition, the Articles of Incorporation require the favorable vote of the
holders of at least 66 2/3% of the Fund's shares of capital stock, then entitled
to be voted, voting as a single class, to approve, adopt or authorize the
following:
- a merger or consolidation or statutory share exchange of the Fund with
other corporations,
- 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
- a liquidation or dissolution of the Fund,
unless such action has been approved, adopted or authorized by the affirmative
vote of two-thirds of the total number of Directors fixed in accordance with the
by-laws, in which case the affirmative vote of a majority of the Fund's shares
of capital stock is required. The approval, adoption or authorization of the
40
<PAGE>
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 Article of Incorporation on file with the
Securities and Exchange Commission for the full text of these provisions.
PERFORMANCE DATA
From time to time, the Fund may include its yield, tax equivalent yield
and/or total return on its common stock for various specified time periods in
advertisements or information furnished to present or prospective shareholders.
The yield of the Fund refers to the income generated by an investment in the
Fund over a stated period. Yield is calculated by annualizing the distribution
over a stated period and dividing the product by the average per share net
value. For the fiscal year ended October 31, 1998, the Fund earned $0.596 per
share income dividends, representing a net annualized yield of 5.46%, based on a
month-end per share net asset value of common stock of $10.96. Tax equivalent
yield quotations will be computed by dividing (a) the part of the Fund's yield
that is tax-exempt by (b) one minus a stated tax rate and (c) adding the result
to that part, if any, of the Fund's yield that is not tax-exempt. The
tax-equivalent yield for the fiscal year ended October 31, 1998 (based on a
Federal income tax rate of 28%) was 7.58%. See Appendix II to this Prospectus
for more information regarding tax equivalent yields.
The Fund also may quote annual total return and aggregate total return
performance data. Total return quotations for the specified periods will be
computed by finding the rate of return (based on net investment income and any
capital gains or losses on portfolio investments over such periods) that would
equate the initial amount invested to the value of such investment at the end of
the period. For the fiscal year ended October 31, 1998, the annual total return
of the Fund was 8.28%, based on the change in per share net asset value of
common stock from $10.87 to $10.96, and assuming reinvestment of $0.733 per
share income dividends and $0.047 per share capital gains distributions.
The calculation of yield, tax-equivalent yield and total return does not
reflect the imposition of any CDSC or the amount of any shareholder's tax
liability.
41
<PAGE>
Yield, tax-equivalent yield and total return figures are based on the Fund's
historical performance and are not intended to indicate future performance. The
Fund's yield is expected to fluctuate, and its total return varies 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, FORTUNE
MAGAZINE or other industry publications. When comparing its performance to a
market index, the Fund may refer to various statistical measures derived from
the historic performance of the Fund and the index, such as standard deviation
and beta. As with other performance data, performance comparisons should not be
considered indicative of the Fund's relative performance for any future period.
Yield comparisons should not be considered indicative of the Fund's yield and
tax-equivalent yield or relative performance for any future period. In addition,
from time to time the Fund may include its risk-adjusted performance ratings
assigned by Morningstar Publications, Inc. in advertising or supplemental sales
literature.
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 for the shares of common stock of the Fund is Financial
Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484, a subsidiary of ML & Co.
Pursuant to a Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement with the Fund (the "Transfer Agency Agreement"), the
Transfer Agent is responsible for the issuance, transfer and tender of shares of
common stock and the opening and maintenance of shareholder accounts. Pursuant
to the Transfer Agency Agreement, the Transfer Agent receives an annual fee of
up to $14.00 per shareholder account, and is entitled to reimbursement for
certain transaction charges and out-of-pocket expenses incurred by it under the
Agreement. Additionally, a $.20 monthly closed account charge is assessed on all
accounts that close during the calendar year. Application of this fee commences
the month following the month the account is closed and terminates at the end of
the calendar year. For purposes of the Transfer Agency Agreement, the term
"account" includes a shareholder account maintained directly by the Transfer
Agent and any other account representing the beneficial interest of a person in
the relevant share class on a recordkeeping system, provided the recordkeeping
system is maintained by a subsidiary of ML & Co. For the period November 3, 1995
(commencement of operations) to October 31, 1996 and for the fiscal years ended
October 31, 1997 and October 31, 1998, the total fees paid by the Fund to the
transfer agent were $71,704, $113,071, and $134,859, respectively, pursuant to
the Transfer Agency Agreement.
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:
Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
42
<PAGE>
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 Financial Data Services, Inc. at 800-637-3863.
LEGAL OPINIONS
Certain legal matters in connection with the common stock offered hereby
will be passed on for the Fund by Brown & Wood LLP, One World Trade Center, New
York, New York 10048-0557.
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Prospectus
by reference to its 1998 annual report to shareholders. You may request a copy
of the annual report at no charge by calling 1-800-456-4587 ext. 789 between
8:00 a.m. and 8:00 p.m. on any business day.
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.
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the year
1900 (commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Investment Adviser or other Fund
service providers do not properly address this problem before January 1, 2000.
The Investment Adviser expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Investment Adviser that they
also expect to resolve the Year 2000 Problem, and the Investment Adviser will
continue to monitor the situation as the Year 2000 approaches. However, if the
problem has not been fully addressed, the Fund could be negatively affected. The
Year 2000 Problem could also have a negative impact on the issuers of securities
in which the Fund invests, and this could hurt the Fund's investment returns.
43
<PAGE>
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.
NOTE: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
SHORT-TERM NOTES: The three ratings of Moody's for short-term notes are
MIG-1/VMIG-1, MIG-2/VMIG-2 and MIG-3/VMIG-3; MIG-1/VMIG-1 denotes "best
quality...strong protection by established cash flows"; MIG-2/VMIG-2 denotes
"high quality" with "ample margins of protection"; MIG-3/VMIG-3 notes are of
"favorable quality...but...lacking the undeniable strength of the preceding
grades."
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<PAGE>
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a
superior ability for repayment of short-term promissory obligations. Prime-1
repayment ability will often be evidenced by the following characteristics:
leading market positions in well established industries; high rates of
return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in
earnings coverage of fixed financial charges and high internal cash
generation; and well-established access to a range of financial markets and
assured sources of alternate liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
ability for repayment of short-term promissory obligations. This will
normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, may be more
subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level
of debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF STANDARD & POOR'S ("S&P") MUNICIPAL DEBT RATINGS
An S&P issue credit rating is a current opinion of the creditworthiness of
an obligor with respect to a specific financial obligation, a specific class of
financial obligations, or a specific financial program. It takes into
consideration the creditworthiness of guarantors, insurers or other forms of
credit enhancement on the obligation.
The issue credit rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor. The ratings are based on current
information furnished by the issuer or obtained by S&P's from other sources
S&P's considers reliable. S&P's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment-capacity and willingness of the obligor to
meet its financial commitment on an obligation in accordance with the terms
of obligation:
II. Nature of and provisions of the obligation; and
III. Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditors' rights.
AAA Debt rated "AAA" has the highest rating assigned by S&P. The obligor's
capacity to meet its financial commitment on obligation is extremely
strong.
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<PAGE>
AA Debt rated "AA" differs from the highest rated obligations only in small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A Debt rated "A" is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB Debt rated "BBB" exhibits adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to lead to a
weakened capacity of the obligor to meet its financial commitment to the
obligation.
BB Debt rated "BB," "B," "CCC," "CC" and "C" is regarded as having significant
speculative characteristics.
B "BB" indicates the least degree of speculation and "C" the highest degree
of speculation. While such bonds
CCC will likely have some quality and protective characteristics, these may be
outweighed by large
CC uncertainties or major exposures to adverse conditions.
C
D Debt rated "D" is in payment default. The "D" rating category is used when
payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The "D" rating also will be
used upon the filing of a bankruptcy petition or the taking of similar
action if payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF S&P'S COMMERCIAL PAPER RATINGS
An S&P Commercial Paper Rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into several categories, ranging from "A-1" for the
highest-quality obligations to "D" for the lowest. These categories are as
follows:
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. BIssues
rated "B" are regarded as having only speculative capacity for timely
payment.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that
such payments will be made during such grace period.
A Commercial Paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to S&P by the
issuer or obtained by S&P from other sources it considers reliable. The ratings
may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information.
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<PAGE>
DESCRIPTION OF S&P'S SHORT-TERM ISSUED CREDIT RATING
An S&P note rating reflects the liquidity factors and market access risks
unique to notes. Notes due in three years or less will likely receive a note
rating. Notes maturing beyond three years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment.
--Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus "+"
designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of
the notes.
SP-3 Speculative capacity to pay principal and interest.
DESCRIPTION OF FITCH IBCA, INC.'S ("FITCH") INVESTMENT GRADE BOND RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guarantees unless otherwise indicated. Bonds
that have the same rating are of similar but not necessarily identical credit
quality since the rating categories do not fully reflect small differences in
the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
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+."
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A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit quality.
The obligor's ability to pay interest and repay principal is considered to
be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds, and
therefore impair timely payment. The likelihood that the ratings of these
bonds will fall below investment grade is higher than for bonds with higher
ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
<TABLE>
<S> <C>
NR: Indicates that Fitch does not rate the specific issue.
Conditional: A conditional rating is premised on the successful completion of a project or
the occurrence of a specific event.
Suspended: A rating is suspended when Fitch deems the amount of information available from
the issuer to be inadequate for rating purposes.
Withdrawn: A rating will be withdrawn when an issue matures or is called or refinanced
and, at Fitch's discretion, when an issuer fails to furnish proper and timely
information.
FitchAlert: Ratings are placed on FitchAlert to notify investors of an occurrence that is
likely to result in a rating change and the likely direction of such change.
These are designated as "Positive" indicating a potential upgrade, "Negative"
for potential downgrade, or "Evolving" where ratings may be raised or lowered.
FitchAlert is relatively short-term, and should be resolved within three to 12
months.
</TABLE>
DESCRIPTION OF FITCH'S SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
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.
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<PAGE>
CCC Bonds have certain identifiable characteristics which, if not remedied, may
lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD Bonds are in default on interest and/or principal payments. Such bonds are
extremely speculative and
DD should be valued on the basis of their ultimate recovery value in
liquidation or reorganization of the
D obligor. "DDD" represents the highest potential for recovery on these
bonds, and "D" represents the lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
DESCRIPTION OF FITCH'S INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
"F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as
great as for issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate;
however, near-term adverse changes could cause these securities to be rated
below investment grade.
F-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.
49
<PAGE>
APPENDIX II
TAXABLE EQUIVALENT YIELDS FOR 1999
<TABLE>
<CAPTION>
TAXABLE INCOME*
- ------------------------------------------ 1999 A TAX-EXEMPT YIELD OF
SINGLE JOINT FEDERAL ----------------------------------------------------------------
RETURN RETURN TAX BRACKET 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
- -------------------- -------------------- ----------- --------- --------- --------- --------- --------- ---------
IS EQUAL TO A TAXABLE YIELD OF
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 25,751-$ 62,450 $ 43,051-$104,050 28.00% 6.94% 7.64% 8.33% 9.03% 9.72% 10.42%
$ 62,451-$130,250 $104,051-$158,550 31.00% 7.25% 7.97% 8.70% 9.42% 10.14% 10.87%
$130,251-$283,150 $158,551-$283,150 36.00% 7.81% 8.59% 9.38% 10.16% 10.94% 11.72%
Over $283,150 Over $283,150 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.
50
<PAGE>
[CHART]
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
51
<PAGE>
INFORMATION ABOUT THE FUND CAN BE REVIEWED AND COPIED AT THE SEC'S PUBLIC
REFERENCE ROOM IN WASHINGTON, D.C. CALL 1-888-SEC-0330 FOR INFORMATION ON THE
OPERATION OF THE PUBLIC REFERENCE ROOM. THIS INFORMATION IS ALSO AVAILABLE ON
THE SEC'S INTERNET SITE AT HTTP://WWW.SEC.GOV AND COPIES MAY BE OBTAINED UPON
PAYMENT OF A DUPLICATION FEE BY WRITING THE PUBLIC REFERENCE ROOM OF THE SEC,
WASHINGTON, D.C. 20549-6009.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE
IS AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT.
--------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary................................ 2
Risk Factors and Special Considerations........... 7
Fee Table......................................... 9
Financial Highlights.............................. 10
The Fund.......................................... 11
Investment Objective and Policies................. 11
Risks and Special Considerations of Leverage...... 19
Investment Restrictions........................... 22
Purchase of Shares................................ 23
Tender Offers..................................... 24
Contingent Deferred Sales Charge.................. 26
Directors and Officers............................ 27
Investment Advisory and Administrative
Arrangements..................................... 29
Portfolio Transactions............................ 31
Dividends and Distributions....................... 32
Taxes............................................. 33
Automatic Dividend Reinvestment Plan.............. 37
Net Asset Value................................... 37
Description of Capital Stock...................... 38
Performance Data.................................. 41
Custodian......................................... 42
Transfer Agent, Dividend Disbursing Agent and
Shareholder Servicing Agent...................... 42
Legal Opinions.................................... 42
Financial Statements.............................. 43
Independent Auditors.............................. 43
Year 2000 Issues.................................. 43
Appendix I--Ratings of Municipal Bonds and
Commercial Paper................................. 44
Appendix II--Taxable Equivalent Yields for 1999... 50
</TABLE>
CODE # 18302-0299
[LOGO]
MERRILL LYNCH
MUNICIPAL STRATEGY
FUND, INC.
[LOGO]
PROSPECTUS
February ,1999
Distributor
Merrill Lynch
Funds Distributor,
a division of
Princeton Funds
Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE>
PART C OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) FINANCIAL STATEMENTS
PART A:
Financial Highlights for each of the years in the two-year period ended
October 31, 1998 and for the period November 3, 1995 (commencement of
operations) to October 31, 1996.
PART B:
Schedule of Investments as of October 31, 1998.*
Statement of Assets, Liabilities and Capital as of October 31, 1998.*
Statement of Operations for the year ended October 31, 1998.*
Statements of Changes in Net Assets for each of the years in the
two-year period ended October 31, 1998.*
Financial Highlights for each of the years in the two-year period ended
October 31, 1998 and for the period November 3, 1995 (commencement of
operations) to October 31, 1996.*
- ------------------------
* Included in the Registrant's 1998 Annual Report to Shareholders filed with
the Securities and Exchange Commission for the year ended October 31, 1998
pursuant to Rule 30b2-1 under the Investment Company Act of 1940, as amended
(the "1940 Act").
(2) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ---------------------------------------------------------------------------------------------------------
<C> <C> <S>
(a)(1) -- Articles of Incorporation of the Registrant.(a)
(2) -- Articles of Amendment to the Articles of Incorporation of the Registrant (name change).(a)
(3) -- Form of Articles Supplementary creating shares of Auction Market Preferred Stock ("AMPS-Registered
Trademark-") 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") (now known as Princeton Funds Distributor, Inc.) (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)
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ---------------------------------------------------------------------------------------------------------
<C> <C> <S>
(i) -- Not applicable.
(j) -- Form of Custody Agreement between the Registrant and The Bank of New York.(a)
(k)(1) -- Form of Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency Agreement between
Registrant and Merrill Lynch Financial Data Services, Inc. ("MLFDS") (now known as Financial Data
Services, Inc.).(a)
(2) -- Form of License Agreement relating to the use of the "Merrill Lynch" name.(a)
(3) -- Form of Auction Agent Agreement between the Registrant and IBJ Schroder Bank & Trust Company.(b)
(4) -- Form of Broker-Dealer Agreement.(b)
(5) -- Form of Letter of Representations.(b)
(l) -- Opinion of Brown & Wood LLP, counsel to the Registrant.
(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...................................................... $ 30,274
Printing (other than stock certificates).......................... 11,500
Legal fees and expenses........................................... 10,000
Accounting fees and expenses...................................... 2,000
NASD fees......................................................... 11,390
Miscellaneous..................................................... 836
---------
Total......................................................... $ 66,000
---------
---------
</TABLE>
C-2
<PAGE>
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 AS
TITLE OF CLASS OF OCTOBER 31, 1998
- ------------------------------------------------------------------------ --------------------
<S> <C>
Shares of Common Stock, par value $0.10 per share....................... 2,474
Shares of AMPS, par value $0.10 per share, liquidation preference
$25,000 per share..................................................... 1,920
</TABLE>
- ------------------------
Note: The number of holders shown above includes holders of record plus
beneficial owners, whose shares are held of record by Merrill Lynch.
ITEM 29. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, previously filed as
Exhibit (a)(1) to the Registrant's Common Stock Registration Statement, Article
VI of the Registrant's By-Laws, previously filed as Exhibit (b) to the
Registrant's Common Stock Registration Statement, and the Investment Advisory
Agreement, a form of which was filed as Exhibit (g)(1) to the Registrant's
Common Stock Registration Statement, provide for indemnification.
Insofar as indemnification for liabilities arising under the 1933 Act may be
provided to directors, officers and controlling persons of the Registrant,
pursuant to the foregoing provisions or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the 1933 Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of Expenses incurred
or paid by a director, officer or controlling person of the Registrant in
connection with any successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the 1933 Act and will be governed by the
final adjudication of such issue.
Reference is made to Section 9 of each of the Common Stock and AMPS
Distribution Agreements, forms of which were previously filed as Exhibits (h)(1)
and (h) to the Registrant's Common Stock Registration Statement and AMPS
Registration Statement, respectively, for provisions relating to the
indemnification of the underwriter and distributor, respectively.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
Fund Asset Management, L.P. (the "Investment Adviser" or "FAM"), an
affiliate of the Investment Adviser, acts as the investment adviser for the
following open-end registered investment companies: CBA Money Fund, CMA
Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series
Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund Accumulation
Program, Inc., Financial Institutions Series Trust, Merrill Lynch Basic Value
Fund, Inc., Merrill Lynch California Municipal Series Trust, Merrill Lynch
Corporate Bond Fund, Inc., Merrill Lynch Corporate High Yield 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 Puerto Rico Tax Exempt Fund, Inc., Merrill Lynch
Special Value Fund, Inc., Merrill Lynch World Income Fund, Inc. and The
Municipal Fund Accumulation
C-3
<PAGE>
Program, Inc.; and for the following closed-end registered investment companies:
Apex Municipal Fund Inc., Corporate High Yield Fund, Inc., Corporate High Yield
Fund II, Inc., Corporate High Yield Fund III, Inc., Debt Strategies Fund, Inc.,
Debt Strategies Fund II, Inc., Debt Strategies Fund III, Inc., Income
Opportunities Fund 1999, Inc., Income Opportunities Fund 2000, Inc., Merrill
Lynch Municipal Strategy Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund,
Inc., MuniInsured Fund, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings California Insured Fund II, Inc., MuniHoldings California Insured
Fund III, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured
Fund II, MuniHoldings Florida Insured Fund III, MuniHoldings Fund, Inc.,
MuniHoldings Fund II, Inc., MuniHoldings Insured Fund, Inc., MuniHoldings New
Jersey Insured Fund, Inc., MuniHoldings New Jersey Insured Fund II, Inc.,
MuniHoldings New York Fund, Inc., MuniHoldings New York Insured Fund, Inc.,
MuniHoldings New York Insured Fund II, Inc., MuniVest Florida Fund, MuniVest
Michigan Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest
Pennsylvania Insured Fund, MuniYield Arizona Fund, Inc., MuniYield California
Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc., MuniYield California
Insured Fund, Inc., MuniYield California Insured Fund II, Inc., MuniYield
Florida Fund, MuniYield Florida Insured Fund, MuniYield Fund, Inc., MuniYield
Insured Fund, Inc., MuniYield Michigan Fund, Inc., MuniYield Michigan Insured
Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New Jersey Insured Fund,
Inc., MuniYield New York Insured Fund, Inc., MuniYield New York Insured Fund II,
Inc., MuniYield Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield
Quality Fund II, Senior High Income Portfolio, Inc. and WorldWide DollarVest
Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM") acts as the investment adviser
for the following open-end registered investment companies: Merrill Lynch
Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas Income Fund, Inc.,
Merrill Lynch Asset Builder Program, Inc., Merrill Lynch Asset Growth Fund,
Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch Capital Fund, Inc.,
Merrill Lynch Convertible Fund, Inc., Merrill Lynch Developing Capital Markets
Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill Lynch Euro Fund, Merrill
Lynch Fundamental Growth Fund, Inc., Merrill Lynch Global Allocation Fund, Inc.,
Merrill Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch
Global Growth Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill Lynch
Global Resources Trust, Inc., Merrill Lynch Global Small Cap Fund, Inc., Merrill
Lynch Global Technology Fund, Inc., Merrill Lynch Global Utility Fund, Inc.,
Merrill Lynch Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch
Healthcare Fund, Inc., Merrill Lynch Intermediate Government Bond Fund, Merrill
Lynch International Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill
Lynch Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series Trust,
Merrill Lynch Pacific Fund, Inc., Merrill Lynch Real Estate 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.A. Government Reserves, Merrill Lynch U.S. Treasury Money Fund,
Merrill Lynch Utility Income Fund, Inc., Merrill Lynch Variable Series Fund,
Inc. and Hotchkis and Wiley Funds (advised by Hotchkis and Wiley, a division of
MLAM) and for the following closed-end registered investment companies: Merrill
Lynch High Income Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating
Rate Fund, Inc. MLAM also acts as sub-adviser to Merrill Lynch World Strategy
Portfolio and Merrill Lynch Basic Value Equity Portfolio, two investment
portfolios of EQ Advisors Trust.
The address of each of these registered investment companies is P.O. Box
9011, Princeton, New Jersey 08543-9011. The address of Merrill Lynch Funds for
Institutions Series and Merrill Lynch Intermediate Government Bond Fund is One
Financial Center, 23rd Floor, Boston, Massachusetts 02110-2665. The address of
the Investment Adviser, FAM, Princeton Services, Inc. ("Princeton Services") and
Princeton Administrators, L.P. is also P.O. Box 9011, Princeton, New Jersey
08543-9011. The address of Princeton Funds Distributor, Inc. ("PFD") and of
Merrill Lynch Funds Distributor ("MLFD") is P.O. Box 9081, Princeton, New Jersey
08543-9081. The address of Merrill Lynch and Merrill Lynch & Co., Inc. ("ML &
Co.") is North Tower, World Financial Center, 250 Vesey Street, New York, New
York 10281-1201. The address of Financial Data Services, Inc. ("FDS") is 4800
Deer Lake Drive East, Jacksonville, Florida 32246-6484.
C-4
<PAGE>
Set forth below is a list of each executive officer and director of the
Investment Adviser indicating each business, profession, vocation or employment
of a substantial nature in which each such person has been engaged for the past
two years for his, her or its own account or in the capacity of director,
officer, employee, partner or trustee. In addition, Mr. Zeikel is President, Mr.
Glenn is Executive Vice President and Mr. Richard is Treasurer of all or
substantially all of the investment companies in the first two paragraphs of
this Item 30. Messrs. Zeikel, Glenn and Richard also hold the same position with
all or substantially all of the investment companies advised by FAM as they do
with those advised by the Investment Adviser. Messrs. Giordano, Harvey, Kirstein
and Monagle are officers or directors/trustees of one or more of such companies.
<TABLE>
<CAPTION>
POSITION WITH OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME INVESTMENT ADVISER VOCATION OR EMPLOYMENT
- ----------------------------------- ---------------------------- -----------------------------------------------
<S> <C> <C>
ML & Co............................ Limited Partner Financial Services Holding Company; Limited
Partner of MLAM
Princeton Services................. General Partner General Partner of MLAM
Arthur Zeikel...................... Chairman Chairman of MLAM; President of MLAM and FAM
(from 1977 to 1997); Chairman and Director of
Princeton Services; President of Princeton
Services (from 1993 to 1997); Executive Vice
President of ML & Co.
Jeffrey M. Peek.................... President President of MLAM since 1997; President and
Director of Princeton Services; Executive
Vice President of ML & Co.; Managing Director
and Co-Head of the Investment Banking
Division of Merrill Lynch (in 1997); Senior
Vice President and Director of the Global
Securities and Economics Division of Merrill
Lynch (from 1995 to 1997).
Mark A. DeSario.................... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Terry K. Glenn..................... Executive Vice President Executive Vice President of MLAM; Executive
Vice President and Director of Princeton
Services; President and Director of Princeton
Funds Distributor; President of Princeton
Administrators, L.P.
Linda L. Federici.................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Vincent R. Giordano................ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Elizabeth A. Griffin............... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Norman R. Harvey................... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Michael J. Hennewinkel............. Senior Vice President, Senior Vice President, General Counsel and
General Counsel and Secretary of MLAM; Senior Vice President of
Secretary Princeton Services
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME INVESTMENT ADVISER VOCATION OR EMPLOYMENT
- ----------------------------------- ---------------------------- -----------------------------------------------
<S> <C> <C>
Philip L. Kirstein................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President, Director and Secretary of
Princeton Services
Ronald M. Kloss.................... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Debra W. Landsman-Yaros............ Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services; Vice
President of Princeton Funds Distributor
Stephen M. M. Miller............... Senior Vice President Executive Vice President of Princeton
Administrators L.P.; Senior Vice President of
Princeton Services
Joseph T. Monagle, Jr.............. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Richard L. Reller.................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services and Director
of Princeton Funds Distributor
Gerald M. Richard.................. Senior Vice President and Senior Vice President and Treasurer of MLAM;
Treasurer Senior Vice President and Treasurer of
Princeton Services; Vice President and
Treasurer of Princeton Funds Distributor
Gregory D. Upah.................... Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
Ronald L. Welburn.................. Senior Vice President Senior Vice President of MLAM; Senior Vice
President of Princeton Services
</TABLE>
Merrill Lynch Asset Management U.K. Limited ("MLAM U.K.") acts as
sub-adviser for the following registered investment companies: The Corporate
Fund Accumulation Program, Inc., Corporate High Yield Fund, Inc., Corporate High
Yield Fund II, Inc., Corporate High Yield Fund III, Inc., Income Opportunities
Fund 1999, Inc., Income Opportunities Fund 2000, 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
Basic Value Fund, Inc., Merrill Lynch Capital Fund, Inc., Merrill Lynch Consults
International Portfolio, Merrill Lynch Convertible Fund, Inc., Merrill Lynch
Corporate Bond Fund, Inc., Merrill Lynch Developing Capital Markets, Inc.,
Merrill Lynch Dragon Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc.,
Merrill Lynch EuroFund, Merrill Lynch Fundamental Growth Fund, Inc., Merrill
Lynch Fund for Tomorrow, Inc., Merrill Lynch Global Allocation Fund, Inc.,
Merrill Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch
Global Growth Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill Lynch
Global Resources Trust, Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch
Global Utility Fund, Inc., Merrill Lynch Global Value Fund, Inc., Merrill Lynch
Growth Fund, Merrill Lynch Healthcare Fund, Inc., Merrill Lynch International
Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill Lynch Middle
East/Africa Fund, Inc., Merrill Lynch Pacific Fund, Inc., Merrill Lynch Phoenix
Fund, Inc., Merrill Lynch Real Estate Fund, Inc., Merrill Lynch Series Fund,
Inc., Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch Special
Value Fund, Inc., Merrill Lynch Strategic Dividend Fund, Merrill Lynch
Technology Fund, Inc., Merrill Lynch Utility Income Fund, Inc., Merrill Lynch
Variable Series Funds, Inc., Merrill Lynch World Income Fund, Inc., The
Municipal Fund Accumulation Program, Inc. and Worldwide DollarVest Fund, Inc.
The
C-6
<PAGE>
address of each of these registered investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011. The address of MLAM U.K. is Milton Gate, 1
Moor Lane, London EC2Y 9HA, England.
Set forth below is a list of each executive officer and director of MLAM
U.K. indicating each business, profession, vocation or employment of a
substantial nature in which each such person has been engaged since January 1,
1996, for his or her own account or in the capacity of director, officer,
partner or trustee. In addition, Messrs. Zeikel, Albert and Richard are officers
of one or more of the registered investment companies listed in the first two
paragraphs of this Item 28.
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION WITH MLAM U.K. PROFESSION, VOCATION OR EMPLOYMENT
- ---------------------------- -------------------------------- -------------------------------------------------
<S> <C> <C>
Arthur Zeikel............... Director and Chairman Chairman of the Manager and FAM; President of the
Manager and FAM from 1977 to 1997; Chairman and
Director of Princeton Services; President of
Princeton Services from 1973 to 1997; Executive
Vice President of ML & Co.
Alan J. Albert.............. Senior Managing Director Vice President of the Manager
Nicholas C.D. Hall.......... Director Director of Merrill Lynch Europe PLC.; General
Counsel of Merrill Lynch International Private
Banking Group
Gerald M. Richard........... Senior Vice President Senior Vice President and Treasurer of the
Manager and FAM; Senior Vice President and
Treasurer of Princeton Services; Vice President
and Treasurer of Princeton Funds Distributor
Carol Ann Langham........... Company Secretary None
Debra Anne Searle........... Assistant Company Secretary None
</TABLE>
ITEM 31. LOCATION OF ACCOUNT AND RECORDS.
All accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act of 1940, as amended, and the rules
thereunder will be maintained at the offices of the registrant (800 Scudders
Mill Road, Plainsboro, New Jersey 08536), its investment adviser (800 Scudders
Mill Road, Plainsboro, New Jersey 08536), and its 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
C-7
<PAGE>
(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-8
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the Township of Plainsboro and State of New Jersey, on the 30th
of December, 1998.
<TABLE>
<S> <C> <C>
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
(Registrant)
By: /s/ ARTHUR ZEIKEL
-----------------------------------------
(Arthur Zeikel, President)
</TABLE>
Each person whose signature appears below 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>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ ARTHUR ZEIKEL President and Director
- ------------------------------ (Principal Executive December 30, 1998
(ARTHUR ZEIKEL) Officer)
/s/ GERALD M. RICHARD Treasurer (Principal
- ------------------------------ Financial and Accounting December 30, 1998
(GERALD M. RICHARD) Officer)
/s/ RONALD W. FORBES
- ------------------------------ Director December 30, 1998
(RONALD W. FORBES)
/s/ CYNTHIA A. MONTGOMERY
- ------------------------------ Director December 30, 1998
(CYNTHIA MONTGOMERY)
/s/ CHARLES C. REILLY
- ------------------------------ Director December 30, 1998
(CHARLES C. REILLY)
/s/ KEVIN A. RYAN
- ------------------------------ Director December 30, 1998
(KEVIN A. RYAN)
/s/ RICHARD R. WEST
- ------------------------------ Director December 30, 1998
(RICHARD R. WEST)
</TABLE>
C-9
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ---------------------------------------------
<C> <C> <S> <C>
(l) -- Opinion of Brown & Wood LLP, counsel to the
Registrant
(n) -- Consent of Deloitte & Touche LLP, independent
auditors for the Registrant
(r) -- Financial Data Schedule
</TABLE>
<PAGE>
Exhibit (l)
Brown & Wood LLP
One World Trade Center
New York, N.Y. 10048-0557
Telephone: (212) 839-5300
Facsimile: (212) 839-5599
December 30, 1998
Merrill Lynch Municipal Strategy Fund, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Ladies and Gentlemen:
This opinion is being furnished in connection with the registration by
Merrill Lynch Municipal Strategy Fund, Inc., a Maryland corporation (the
"Fund"), of shares of common stock, par value $0.10 per share (the "Shares"),
under the Securities Act of 1933, as amended (the "Securities Act"), pursuant to
the Fund's registration statement on Form N-2, as amended (the "Registration
Statement"), under the Securities Act, in the amount set forth under "Amount
Being Registered" on the facing page of the Registration Statement.
As counsel for the Fund, we are familiar with the proceedings taken by it in
connection with the authorization, issuance and sale of the Shares. In addition,
we have examined and are familiar with the Articles of Incorporation of the
Fund, as amended, 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 Shares, upon
issuance and sale in the manner referred to in the Registration Statement, 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>
Exhibit (n)
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Municipal Strategy Fund, Inc:
We consent to the incorporation by reference in this Registration Statement on
Form N-2 of our report dated December 10, 1998 appearing in the annual report to
Shareholders of Merrill Lynch Municipal Strategy Fund, Inc. for the year ended
October 31, 1998, and to the reference to us under the caption "Financial
Highlights" in the Prospectus, which is a part of such Registration Statement.
Deloitte & Touche LLP
Princeton, New Jersey
December 28, 1998
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<PAGE>
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