<PAGE>
PROSPECTUS
$92,000,000
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUCTION MARKET PREFERRED STOCK ["AMPS-REGISTERED TRADEMARK-"]
3,680 SHARES, SERIES A--LIQUIDATION PREFERENCE $25,000 PER SHARE
------------------------
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is a continuously
offered, non-diversified, closed-end management investment company. The Fund's
investment objective is to provide shareholders of its common stock with as high
a level of current income exempt from Federal income taxes as is consistent with
its investment policies. 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 (SUCH OBLIGATIONS
ARE COMMONLY 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 to the alternative minimum tax. At times, the
Fund may seek to hedge its portfolio through the use of options and futures
transactions. There can be no assurance that the investment objective of the
Fund will be realized.
The Series A AMPS are being offered on a continuing basis by the Fund
through Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"),
which has agreed to use its best efforts to sell the Series A AMPS.
------------------------
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. The Fund's statement of additional information contains
further information about the Fund and is incorporated by reference (legally
considered to be part of this prospectus). You may request a free copy by
writing or calling the Fund at (800) 637-3863.
------------------------
INVESTING IN THE SERIES A AMPS INVOLVES CERTAIN RISKS, WHICH ARE DESCRIBED
IN THE "RISK FACTORS AND SPECIAL CONSIDERATIONS" SECTION BEGINNING ON PAGE 5 OF
THIS PROSPECTUS.
---------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
<S> <C> <C>
Public Offering Price................... $25,000 $92,000,000
Sales Load.............................. None None
Proceeds, before expenses, to Fund...... $25,000 $92,000,000
</TABLE>
The public offering price per share will be increased by the amount of
accumulated dividends, if any, from the date a share is first issued.
This prospectus may be used by Merrill Lynch in connection with offers and
sales related to market-making transactions in the Series A AMPS offered hereby
as well as the Fund's 2,320 outstanding shares of Series A AMPS, with an
aggregate liquidation preference of $58,000,000. Merrill Lynch may act as
principal or agent in such transactions. Such sales will be made at prices
related to prevailing market prices at the time of sale.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
One or more certificates for the Series A AMPS will be delivered to the
nominee of The Depository Trust Company.
- ------------------------
- -Registered Trademark- Registered trademark of Merrill Lynch & Co., Inc.
---------------
MERRILL LYNCH & CO.
---------------
The date of this prospectus is February 19, 1999.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Offering Summary.......................................................... 3
Risk Factors and Special Considerations................................... 5
Financial Highlights...................................................... 7
The Fund.................................................................. 8
Use of Proceeds........................................................... 8
Capitalization............................................................ 8
Investment Objective and Policies......................................... 9
Description of AMPS....................................................... 13
The Auction............................................................... 19
Rating Agency Guidelines.................................................. 28
Investment Advisory and Administrative Arrangements....................... 29
Taxes..................................................................... 30
Description of Capital Stock.............................................. 31
Custodian................................................................. 33
Plan of Distribution...................................................... 33
Transfer Agent, Dividend Disbursing Agent and Registrar................... 34
Legal Opinions............................................................ 34
Independent Auditors...................................................... 34
Year 2000 Issues.......................................................... 34
Table of Contents of Statement of Additional Information.................. 35
Glossary.................................................................. 36
</TABLE>
------------------------
INFORMATION ABOUT THE FUND CAN BE REVIEWED AND COPIED AT THE SEC'S PUBLIC
REFERENCE ROOM IN WASHINGTON, D.C. CALL 1-800-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 DUPLICATING FEE BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC,
WASHINGTON, D.C. 20549-6009.
------------------------
You should rely only on the information contained in this prospectus. We
have not, and the underwriter has not, authorized any other person to provide
you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and Merrill
Lynch is not, making an offer to sell these securities in any jurisdiction where
the offer or sale is not permitted. You should assume that the information
appearing in this prospectus is accurate as of the date on the front cover of
this prospectus only. Our business, financial condition, results of operations
and prospects may have changed since that date.
2
<PAGE>
OFFERING SUMMARY
THIS SUMMARY IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE DETAILED
INFORMATION INCLUDED IN THIS PROSPECTUS AND THE STATEMENT OF ADDITIONAL
INFORMATION.
<TABLE>
<S> <C>
THE OFFERING The Fund is offering an aggregate of 3,680 shares of
Auction Market Preferred Stock, Series A, at a purchase
price of $25,000 per share plus accumulated dividends,
if any, from the date a share is first issued. The
Series A AMPS are being offered on a continuing basis by
the Fund through Merrill Lynch, which has agreed to use
its best efforts to sell the Series A AMPS.
The Series A AMPS are shares of preferred stock of the
Fund that entitle the holders to receive cash dividends
at an annual rate that may vary for the successive
dividend periods. In general, each dividend period for
the Series A AMPS will be seven days. An auction
conducted on the business day next preceding the start
of a dividend period will determine the dividend rate
payable for that period.
The Fund's Articles Supplementary establishing the
Series A AMPS authorize the Fund to issue additional
series of AMPS designated Series B AMPS, Series C AMPS,
Series D AMPS and Series E AMPS, which also are referred
to herein as "AMPS." The Series A AMPS are the only
series currently offered and to be issued and
outstanding. As of the date of this prospectus, 2,320
shares of Series A AMPS representing approximately 33%
of the Fund's capital are issued and outstanding.
Investors and potential investors in shares of AMPS may
participate in auctions for the AMPS through their
broker-dealers.
Generally, investors in AMPS will not receive
certificates representing ownership of their shares.
Ownership of AMPS will be maintained in book entry form
by a securities depository (The Depository Trust
Company), or its nominees, for the account of the
investor's agent member of the securities depository
(generally, the investor's broker-dealer). The
investor's agent member, in turn, will maintain records
of the investor's ownership of AMPS.
DIVIDENDS AND DIVIDEND PERIODS Each dividend period for the Series A AMPS will
generally last seven days; provided, however, that
before any auction, the Fund may decide, subject to
certain limitations and only if it gives notice to
holders, to declare a special dividend period of up to
five years. Dividends on the AMPS are cumulative from
the date a share is first issued. The dividend rate that
will apply to the next dividend period for the Series A
AMPS initially offered by this prospectus will be set
forth in a prospectus supplement. Thereafter, in the
case of dividend periods that are not special dividend
periods, dividends will be payable generally on each
succeeding Thursday in the case of Series A AMPS.
Dividends for the Series A AMPS will be paid through the
securities depository (The Depository Trust Company) on
each Series A dividend payment date.
</TABLE>
3
<PAGE>
<TABLE>
<S> <C>
For each dividend period, the auction agent (IBJ
Whitehall Bank & Trust Company) will hold an auction to
determine the cash dividend rate on the shares of each
series of AMPS.
DETERMINATION OF MAXIMUM
DIVIDEND RATES Generally, the applicable dividend rate for any dividend
period for shares of AMPS will be subject to a maximum
applicable rate. The maximum applicable rate for shares
of AMPS will depend on the credit rating assigned to
such shares and on the length of the dividend period.
There is no minimum applicable dividend rate for any
dividend period.
ASSET MAINTENANCE Under the Fund's Articles Supplementary creating the
AMPS, the Fund must maintain
- asset coverage of the AMPS as required by the rating
agencies rating the AMPS, and
- asset coverage of the AMPS of at least 200% as
required by the Investment Company Act of 1940.
As of the date of this prospectus, asset coverage as
required by the Investment Company Act of 1940 with
respect to the shares of Series A AMPS issued and
outstanding is approximately 300%.
MANDATORY REDEMPTION If the required asset coverage is not maintained or,
when necessary, restored, the Fund must redeem shares of
AMPS at the price of $25,000 per share plus accumulated
but unpaid dividends thereon (whether or not earned or
declared). The Investment Company Act of 1940 may
restrict the Fund's ability to make a mandatory
redemption.
OPTIONAL REDEMPTION The Fund may, at its option, choose to redeem all or a
portion of the shares of AMPS on any dividend payment
date at the price of $25,000 per share, plus accumulated
but unpaid dividends thereon (whether or not earned or
declared) plus any applicable premium.
LIQUIDATION PREFERENCE The liquidation preference (that is, the amount the Fund
must pay to AMPS shareholders when the Fund is
liquidated) of each share of AMPS will be $25,000, plus
an amount equal to accumulated but unpaid dividends
(whether or not earned or declared).
RATINGS The AMPS will be issued with a rating of "aaa" from
Moody's Investor's Services, Inc. and AAA from Standard
& Poor's.
VOTING RIGHTS The Investment Company Act of 1940 requires that the
holders of AMPS and any other preferred stock, voting as
a separate class, have the right to elect at least two
directors at all times and to elect a majority of the
directors at any time when dividends on the AMPS or any
other preferred stock are unpaid for two full years. The
Fund's charter and the Investment Company Act of 1940
require holders of AMPS and any other preferred stock to
vote as a separate class on certain other matters.
</TABLE>
4
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
INTEREST RATE AND CREDIT RISK. The Fund invests in municipal bonds, which
are subject to interest rate and credit risk. Interest rate risk is the risk
that prices of municipal bonds generally increase when interest rates decline
and decrease when interest rates increase. Prices of longer term securities
generally change more in response to interest rate changes than prices of
shorter term securities. Credit risk is the risk that the issuer will be unable
to pay the interest or principal when due. The degree of credit risk depends on
both the financial condition of the issuer and the terms of the obligation.
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 a diversified investment company. Even as a
non-diversified fund, the Fund must still meet the diversification requirements
of applicable Federal 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 than a more widely-diversified fund to any single economic, political or
regulatory occurrence.
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 Standard & Poor's, Moody's Investors Services, Inc. or
Fitch IBCA, Inc. or, if not rated, are considered to be of comparable quality by
the Fund's 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 obligations.
PRIVATE ACTIVITY BONDS. The Fund may invest all or a portion of its assets
in certain tax-exempt securities classified as "private activity bonds." These
bonds may subject certain investors in the Fund to the alternative minimum tax.
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
5
<PAGE>
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.
ANTI-TAKEOVER PROVISIONS. The Fund's Charter includes 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
discourage a third party from seeking to obtain control of the Fund.
INVESTMENT CONSIDERATIONS. Investors in AMPS should consider the following
factors:
- The credit ratings of the AMPS could be reduced while an investor holds
the AMPS.
- Neither broker-dealers nor the Fund are obligated to purchase shares of
AMPS in an auction or otherwise nor is the Fund required to redeem shares
of AMPS in the event of a failed auction.
- If sufficient bids do not exist in an auction, the applicable dividend
rate will be the maximum applicable dividend rate, and in such event,
owners of AMPS wishing to sell will not be able to sell all, and may not
be able to sell any, AMPS in the auction. As a result, investors may not
have liquidity of investment.
SECONDARY MARKET. The broker-dealers intend to maintain a secondary trading
market in the AMPS outside auctions; however, they have no obligation to do so
and there can be no assurance that a secondary market for the AMPS will develop
or, if it does develop, that it will provide holders with a liquid trading
market. The AMPS will not be registered on any stock exchange or on any
automated quotation system. An increase in the level of interest rates likely
will have an adverse effect on the secondary market price of the AMPS, and a
selling shareholder may sell AMPS between auctions at a price per share of less
than $25,000.
6
<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 have been derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
FOR THE
PERIOD
NOVEMBER 3,
FOR THE YEAR ENDED OCTOBER 31, 1995+
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 of common
stock......................................... 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 contingent deferred
sales charge ("CDSC") per share of common stock, if any. The Fund is a
continuously offered closed-end fund, the shares of which are offered at net
asset value. Therefore, no separate market exists.
*** Do not reflect the effect of dividends to preferred stock shareholders.
+ Commencement of operations.
++ The Fund's Preferred Stock initially was issued on March 11, 1996.
# Aggregate total investment return.
7
<PAGE>
THE FUND
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is a continuously
offered, non-diversified, closed-end management investment company. The Fund was
incorporated under the laws of the State of Maryland on July 13, 1994, and has
registered as an investment company under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund's principal office is located at 800 Scudders
Mill Road, Plainsboro, New Jersey 08536, and its telephone number is (609)
282-2800.
The Fund expects to engage in a continuous offering of its common stock at a
price equal to the next determined net asset value per share.
The shares of Auction Market Preferred Stock, Series A (the "Series A AMPS")
are being offered on a continuing basis by the Fund through Merrill Lynch, which
has agreed to use its best efforts to solicit purchasers of the Series A AMPS.
There can be no assurance that the Series A AMPS offered by this prospectus will
be sold. The Fund may reject any order in whole or in part.
USE OF PROCEEDS
Assuming that all shares of Series A AMPS currently registered are sold, it
is estimated that the net proceeds of this offering will be approximately
$91,904,000 after the payment of offering expenses (estimated to be $96,000).
Certain other expenses have been previously paid by the Fund.
The net proceeds of the offering will be invested in long-term obligations
in accordance with the Fund's investment objective and policies during a period
estimated not to exceed three months from the offer and sale of such shares of
AMPS depending on market conditions and the availability of appropriate
securities. Because under normal market conditions, obligations with longer
maturities produce higher yields than shorter-term and medium-term obligations,
the Investment Adviser believes that the spread inherent in the difference
between the short-term and medium-term rates paid by the Fund on the AMPS and
the long-term rates received by the Fund will provide holders of the common
stock with a potentially higher yield. Pending investment in long-term
obligations, it is anticipated that the proceeds will be invested in short-term
tax-exempt securities. See "Investment Objective and Policies" herein and in the
statement of additional information.
CAPITALIZATION
The following table sets forth the Fund's capitalization at October 31,
1998.
<TABLE>
<S> <C>
Stockholders' equity:
Capital Stock (200,000,000 shares authorized)
Preferred Stock, par value $.10 per share (1,920 shares of Series A AMPS
issued and outstanding at $25,000 per share liquidation preference)......... $ 48,000,000
Common Stock, par value $.10 per share (10,523,555 shares issued and
outstanding)................................................................ 1,052,355
Capital in excess of par value attributable to Common Stock..................... 105,809,560
Undistributed realized capital gains on investments--net........................ 2,823,301
Unrealized appreciation on investments--net..................................... 5,653,940
------------
Net assets...................................................................... $163,339,156
------------
------------
</TABLE>
8
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders of its
common stock with as high a level of current income exempt from Federal income
taxes as is consistent with its investment policies. The Fund seeks to achieve
its investment objective by investing primarily in a portfolio of long-term,
investment grade municipal obligations, the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal income taxes. The investment
objective of the Fund is a fundamental policy of the Fund and, therefore, may
not be changed without a vote of a majority of the outstanding voting securities
of the Fund, as defined in the statement of additional information under
"Investment Restrictions." There can be no assurance that the investment
objective of the Fund will be realized. At times the Fund may seek to hedge its
portfolio through the use of futures transactions and options to reduce
volatility in the net asset value of its shares of common stock.
The Fund, at all times, except during interim and temporary periods as
discussed below, will invest at least 80% of its total assets in a portfolio of
obligations issued by or on behalf of states, territories and possessions of the
United States and their political subdivisions, agencies or instrumentalities
paying interest which, in the opinion of bond counsel to the issuer, is exempt
from Federal income taxes ("Municipal Bonds"). The Fund, at all times, except
during temporary periods, will maintain at least 75% of its total assets in
Municipal Bonds that are rated investment grade by a nationally recognized
statistical rating organization or, if unrated, are considered to be of
comparable quality by the Fund's investment adviser, Fund Asset Management, L.P.
(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 dividends that are exempt
from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in Municipal Bonds, to the extent such
investments are permitted by the 1940 Act. Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term Municipal Bonds. Certain Non-Municipal
Tax-Exempt Securities may be characterized as derivative instruments.
Non-Municipal Tax-Exempt Securities will be considered "Municipal Bonds" for
purposes of the Fund's investment objective and policies.
The investment grade Municipal Bonds in which the Fund will primarily invest
are those Municipal Bonds rated at the date of purchase in the four highest
rating categories of Standard & Poor's ("S&P"), Moody's Investor 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 Investors Services, Inc. ("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 fourth highest
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
9
<PAGE>
indicating relative standing within the rating categories set forth above.
Appendix A to the statement of additional information contains a description of
S&P's, Moody's and Fitch's ratings of Municipal Bonds. In assessing the quality
of Municipal Bonds with respect to the foregoing requirements, the Investment
Adviser will take into account the nature of any letters of credit or similar
credit enhancement to which particular Municipal Bonds are entitled and the
creditworthiness of the financial institution that provided such credit
enhancement.
As noted above, the Fund may invest up to 25% of its assets in Municipal
Bonds that are rated below investment grade or, if unrated, are considered to be
of comparable quality by the Investment Adviser. These high yield bonds are
commonly referred to as "junk bonds" and are regarded as predominantly
speculative as to the issuer's ability to make payments of principal and
interest. Consequently, although such bonds can be expected to provide higher
yields and be less subject to interest rate fluctuations, they may be subject to
greater market price fluctuations and risk of loss of principal than lower
yielding, higher rated fixed income securities. Such securities are particularly
vulnerable to adverse changes in the issuer's industry and in general economic
conditions. Issuers of high yield bonds may be highly leveraged and may not have
available to them more traditional methods of financing. The risk of loss due to
default by the issuer is significantly greater for the holders of these bonds
because such securities may be unsecured and may be subordinated to other
creditors of the issuer. In addition, while the high yield bonds in which the
Fund may invest normally will not include securities that, at the time of
investment, are in default or the issuers of which are in bankruptcy, there can
be no assurance that such events will not occur after the Fund purchases a
particular security, in which case the Fund may experience losses and incur
costs.
High yield bonds frequently have call or redemption features that permit an
issuer to repurchase a bond from the Fund, which may decrease the net investment
income to the Fund and dividends to shareholders in the event that the Fund is
required to replace a called security with a lower yielding security. The Fund
may have difficulty disposing of certain high yield bonds because there may be a
thin trading market for such securities. Reduced secondary market liquidity may
have an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. In addition, market quotations are generally
available on many high yield bond issues only from a limited number of dealers
and may not necessarily represent firm bids of such dealers or prices for actual
sales.
Certain Municipal Bonds may be entitled to the benefits of letters of credit
or similar credit enhancements issued by financial institutions. In such
instances, the Board of Directors and the Investment Adviser will take into
account in assessing the quality of such bonds not only the creditworthiness of
the issuer of such bonds but also the creditworthiness of the financial
institutions.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial institution,
typically a commercial bank. The VRDOs in which the Fund will invest are
tax-exempt obligations in the opinion of counsel to the issuer that contain a
floating or variable interest rate adjustment formula and 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.
10
<PAGE>
The average maturity of the Fund's portfolio securities will vary based upon
the Investment Adviser's assessment of economic and market conditions. The net
asset value of the shares of common stock of a closed-end investment company,
such as the Fund, which invests primarily in fixed-income securities, changes as
the general levels of interest rates fluctuate. When interest rates decline, the
value of a fixed-income portfolio can be expected to rise. Conversely, when
interest rates rise, the value of a fixed-income portfolio can be expected to
decline. Prices of longer-term securities generally fluctuate more in response
to interest rate changes than do short-term or medium-term securities. These
changes in net asset value are likely to be greater in the case of a fund having
a leveraged capital structure, such as that used by the Fund.
The Fund intends to invest primarily in long-term Municipal Bonds with a
maturity of more than ten years. Also, the Fund may invest in intermediate-term
Municipal Bonds with a maturity of between three and ten years. The Fund may
invest in short-term, tax-exempt securities, short-term U.S. Government
securities, repurchase agreements or cash. Such short-term securities or cash
will not exceed 20% of its total assets except during interim periods pending
investment of the net proceeds of public offerings of the Fund's securities or
in anticipation of the repurchase or redemption of the Fund's securities and
temporary periods when, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. The Fund does not ordinarily intend to
realize significant interest income not exempt from Federal income tax. For a
more complete description of Municipal Bonds, see "Investment Objectives and
Policies" in the statement of additional information.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by such Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund as a regulated
investment company for purposes of the Code. See "Taxes" herein and in the
Statement of Additional Information. 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.
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below.
BORROWINGS. The Fund is authorized to borrow money in amounts of up to 5%
of the value of its total assets at the time of such borrowings; provided,
however, that the Fund is authorized to borrow moneys in amounts of up to
33 1/3% of the value of its total assets at the time of such borrowings to
finance the repurchase of its own common stock pursuant to tender offers, if
any, or otherwise, to redeem or repurchase AMPS or for temporary, extraordinary
or emergency purposes. Borrowings by the Fund (commonly known, as with the
issuance of preferred stock, as "leveraging") create an opportunity for greater
total return since the Fund will not be required to sell portfolio securities to
purchase tendered shares but, at the same time, increase exposure to capital
risk. In addition, borrowed funds are subject to interest costs that may offset
or exceed the return earned on the borrowed funds. For so long as shares of AMPS
are rated by Moody's or S&P, unless it receives written confirmation from S&P or
Moody's, as the case may be, that such action would not impair the ratings then
assigned to the shares of AMPS by Moody's or S&P, the Fund will not borrow
moneys except for the purpose of clearing portfolio securities transactions
(which borrowings under any circumstances shall be limited to
11
<PAGE>
the lesser of $10 million and an amount equal to 5% of the market value of the
Fund's assets at the time of such borrowings and which borrowings shall be
repaid within 60 days and not be extended or renewed).
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS. The Fund may
purchase or sell Municipal Bonds on a delayed delivery basis or on a when-issued
basis at fixed purchase or sale terms. These transactions arise when securities
are purchased or sold by the Fund with payment and delivery taking place in the
future. The purchase will be recorded on the date the Fund enters into the
commitment, and the value of the obligation will thereafter be reflected in the
calculation of the Fund's net asset value. The value of the obligation on the
delivery date may be more or less than its purchase price. A separate account of
the Fund will be established with its custodian consisting of cash, cash
equivalents or liquid Municipal Bonds having a market value at all times at
least equal to the amount of the forward commitment.
INDEXED AND INVERSE FLOATING OBLIGATIONS. The Fund may invest in Municipal
Bonds 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
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
in repurchase agreements maturing in more than seven days if such investments,
together with all other illiquid investments, would exceed 15% of the Fund's net
assets. In the
12
<PAGE>
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.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts. While the Fund's use of hedging strategies is intended to
reduce the volatility of the net asset value of common stock, the net asset
value of the common stock will fluctuate. There can be no assurance that the
Fund's hedging transactions will be effective. For so long as the AMPS are rated
by Moody's and S&P, the Fund's use of options and financial futures contracts
will be subject to the limitations described under "Rating Agency Guidelines"
herein and in the statement of additional information. Furthermore, the Fund
will only engage in hedging activities from time to time and may not necessarily
be engaging in hedging activities when movements in interest rates occur. The
Fund is under no obligation to enter into hedging transactions and may not do
so.
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains derived from transactions in options and
futures contracts that are distributed to shareholders will be taxable as
ordinary income or, in certain circumstances, as long-term capital gains to
shareholders. See "Taxes--Tax Treatment of Options and Futures Transactions" in
the statement of additional information. In addition, in order to obtain ratings
of the preferred stock from one or more nationally recognized statistical rating
organizations, the Fund may be required to limit its use of hedging techniques
in accordance with the specified guidelines of such rating organizations.
For 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, see "Investment Objective and Policies--Options and Futures
Transactions" in the statement of additional information. 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.
DESCRIPTION OF AMPS
GENERAL
CERTAIN OF THE CAPITALIZED TERMS USED HEREIN ARE DEFINED IN THE GLOSSARY
THAT APPEARS AT THE BACK OF THIS PROSPECTUS.
Under the Articles Supplementary, the Fund is authorized to issue an
aggregate of 40,000 shares of AMPS, designated respectively: 8,000 shares of
Series A AMPS, 8,000 shares of Series B AMPS, 8,000 shares of Series C AMPS,
8,000 shares of Series D AMPS and 8,000 shares of Series E AMPS. The Series A
AMPS offered hereby are the only series currently offered and to be issued and
outstanding.
The AMPS will be shares of preferred stock that entitle their holders to
receive dividends when, as and if declared by the Board of Directors, out of
funds legally available therefor, at a rate per annum that may vary for the
successive Dividend Periods for each such series. Each Dividend Period for the
Series A AMPS will generally be a 7-Day Dividend Period; provided, however, that
prior to any Auction, the Fund may elect, subject to certain limitations
described herein, upon giving notice to holders thereof, a Special Dividend
Period. The Applicable Rate for a particular Dividend Period will be determined
by an Auction conducted on the Business Day before the start of such Dividend
Period. Beneficial Owners and Potential Beneficial Owners of shares of AMPS may
participate in Auctions therefor, although, except in the case of a Special
Dividend Period, Beneficial Owners desiring to continue to hold all of their
shares of AMPS regardless of the Applicable Rate resulting from Auctions
13
<PAGE>
need not participate. For an explanation of Auctions and the method of
determining the Applicable Rate, see "The Auction" herein and in the statement
of additional information.
The following is a brief description of the terms of the shares of AMPS.
This description does not purport to be complete and is subject to and qualified
in its entirety by reference to the Fund's Articles of Incorporation and
Articles Supplementary, including the provisions thereof establishing the AMPS.
The Fund's Articles of Incorporation and the form of Articles Supplementary
establishing the terms of the AMPS have been filed as exhibits to the
Registration Statement of which this prospectus is a part.
DIVIDENDS
GENERAL. The holders of shares of each series of AMPS will be entitled to
receive, when, as and if declared by the Board of Directors of the Fund, out of
funds legally available therefor, cumulative cash dividends on their shares, at
the Applicable Rate determined as set forth herein under "--Determination of
Dividend Rate", payable on the respective dates set forth below. Dividends on
the shares of AMPS so declared and payable shall be paid (i) in preference to
and in priority over any dividends so declared and payable on the Common Stock,
and (ii) to the extent permitted under the Code and to the extent available, out
of net tax-exempt income earned on the Fund's investments. Dividends on shares
of AMPS, to the extent that they are derived from Municipal Bonds, will be
exempt from Federal income taxes, subject to possible application of the
alternative minimum tax. See "Taxes" in the statement of additional information.
Each Dividend Period for the Series A AMPS will generally be seven days (a
"7-Day Dividend Period"). The Fund may create additional series of AMPS in the
future whose Dividend Periods may generally consist of either seven days or 28
days (a "28-Day Dividend Period").
Dividends on the shares of AMPS will accumulate from the date on which the
Fund originally issues the shares of AMPS (the "Date of Original Issue") and
will be payable on the dates described below. Dividends on shares of each series
of AMPS with respect to the Initial Dividend Period shall be payable on the
Initial Dividend Payment Date with respect to each series of AMPS. Following the
Initial Dividend Payment Date for each series of AMPS, dividends on each series
of AMPS will be payable, at the option of the Fund, either (i) with respect to
any 7-Day Dividend Period, any 28-Day Dividend Period and any Short Term
Dividend Period of 35 or fewer days, on the day next succeeding the last day
thereof or (ii) with respect to any Short Term Dividend Period of more than 35
days and with respect to any Long Term Dividend Period, monthly on the first
Business Day of each calendar month during such Short Term Dividend Period or
Long Term Dividend Period and on the day next succeeding the last day thereof
(each such date referred to in clause (i) or (ii) being referred to herein as a
"Normal Dividend Payment Date"), except that if such Normal Dividend Payment
Date is not a Business Day, (i) the Dividend Payment Date shall be the first
Business Day next succeeding such Normal Dividend Payment Date if such Normal
Dividend Payment Date is a Monday, Tuesday, Wednesday or Thursday, or (ii) the
Dividend Payment Date shall be the first Business Day next preceding such Normal
Dividend Payment Date if such Normal Dividend Payment Date is a Friday.
Dividends generally will be payable (in the case of Dividend Periods which are
not Special Dividend Periods) on each succeeding Thursday in the case of Series
A AMPS. Although any particular Dividend Payment Date may not occur on the
originally scheduled date because of the exceptions discussed above, the next
succeeding Dividend Payment Date, subject to such exceptions, will occur on the
next following originally scheduled date. If for any reason a Dividend Payment
Date cannot be fixed as described above, then the Board of Directors or a duly
authorized committee thereof shall fix the Dividend Payment Date. The Initial
Dividend Period, 7-Day Dividend Periods, 28-Day Dividend Periods and Special
Dividend Periods are hereinafter sometimes referred to as "Dividend Periods."
Each dividend payment date determined as provided above is hereinafter referred
to as a "Dividend Payment Date."
14
<PAGE>
Prior to each Dividend Payment Date, the Fund is required to deposit with
the Auction Agent sufficient funds for the payment of declared dividends. The
Fund does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the AMPS, which holder is
expected to be the nominee of the Securities Depository. See "The
Auction--Securities Depository" herein. The Securities Depository will credit
the accounts of the Agent Members of the Existing Holders in accordance with the
Securities Depository's normal procedures which provide for payment in same-day
funds. The Agent Member of an Existing Holder will be responsible for holding or
disbursing such payments on the applicable Dividend Payment Date to such
Existing Holder in accordance with the instructions of such Existing Holder.
Dividends in arrears for any past Dividend Period may be declared and paid at
any time, without reference to any regular Dividend Payment Date, to the nominee
of the Securities Depository. Any dividend payment made on shares of AMPS first
shall be credited against the earliest declared but unpaid dividends accumulated
with respect to such series.
Holders of shares of AMPS will not be entitled to any dividends, whether
payable in cash, property or stock, in excess of full cumulative dividends
except as described under "--Additional Dividends" herein and "--Non-Payment
Period; Late Charge" in the statement of additional information. No interest
will be payable in respect of any dividend payment or payments on the shares of
AMPS which may be in arrears.
The amount of cash dividends per share of any series of AMPS payable (if
declared) on the Initial Dividend Payment Date, each 7-Day Dividend Period, each
28-Day Dividend Period and each Short Term Dividend Period shall be computed by
multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be the number of days in such Dividend Period or part
thereof that such share was outstanding and for which dividends are payable on
such Dividend Payment Date and the denominator of which will be 365, multiplying
the amount so obtained by $25,000, and rounding the amount so obtained to the
nearest cent. During any Long Term Dividend Period, the amount of cash dividends
per share of AMPS payable (if declared) on any Dividend Payment Date shall be
computed by multiplying the Applicable Rate for such Dividend Period by a
fraction, the numerator of which will be such number of days in such part of
such Dividend Period that such share was outstanding and for which dividends are
payable on such Dividend Payment Date and the denominator of which will be 360,
multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent.
NOTIFICATION OF DIVIDEND PERIOD. With respect to each Dividend Period that
is a Special Dividend Period, the Fund, at its sole option and to the extent
permitted by law, by telephonic and written notice (a "Request for Special
Dividend Period") to the Auction Agent and to each Broker-Dealer, may request
that the next succeeding Dividend Period for the shares of AMPS will be a number
of days (other than seven in the case of Series A AMPS), evenly divisible by
seven, and not fewer than seven nor more than 364 in the case of a Short Term
Dividend Period or one whole year or more but not greater than five years in the
case of a Long Term Dividend Period, specified in such notice, provided that the
Fund may not give a Request for Special Dividend Period (and any such request
shall be null and void) unless, for any Auction occurring after the initial
Auction, Sufficient Clearing Bids were made in the last occurring Auction and
unless full cumulative dividends, any amounts due with respect to redemptions,
and any Additional Dividends payable prior to such date have been paid in full.
Such Request for Special Dividend Period, in the case of a Short Term Dividend
Period, shall be given on or prior to the second Business Day but not more than
seven Business Days prior to an Auction Date for the AMPS and, in the case of a
Long Term Dividend Period, shall be given on or prior to the second Business Day
but not more than 28 days prior to an Auction Date for the AMPS. Upon receiving
such Request for Special Dividend Period, the Broker-Dealers jointly shall
determine whether the Fund should issue a Notice of Special Dividend Period for
a series of AMPS as contemplated by such Request for Special Dividend Period and
the Optional Redemption Price of the AMPS during such
15
<PAGE>
Special Dividend Period and the Specific Redemption Provisions and shall give
the Fund and the Auction Agent written notice (a "Response") of such
determination by no later than the second Business Day prior to such Auction
Date. In the event the Response indicates that it is advisable that the Fund
give a notice of a Special Dividend Period for the AMPS, the Fund, by no later
than the second Business Day prior to such Auction Date may give a notice (a
"Notice of Special Dividend Period") to the Auction Agent, the Securities
Depository and each Broker-Dealer. See "Description of
AMPS--Dividends--Notification of Dividend Period" in the statement of additional
information for a detailed description of these procedures.
DETERMINATION OF DIVIDEND RATE. The dividend rate on shares of each series
of AMPS during the period from and including the first Date of Original Issue
for each series of AMPS to but excluding the Initial Dividend Payment Date (the
"Initial Dividend Period") will be a rate per annum determined by the Board of
Directors of the Fund. Commencing on the first Initial Dividend Payment Date for
each series of AMPS, the Applicable Rate on the shares of such series of AMPS
for each Subsequent Dividend Period, which Subsequent Dividend Period shall be a
period commencing on and including a Dividend Payment Date and ending on and
including the calendar day prior to the next Dividend Payment Date (or last
Dividend Payment Date in a Dividend Period if there is more than one Dividend
Payment Date), shall be equal to the rate per annum that results from the
Auction with respect to such Subsequent Dividend Period. The Initial Dividend
Period and Subsequent Dividend Period for each series of AMPS is referred to
herein as a "Dividend Period." Cash dividends shall be calculated as set forth
above under "--Dividends--General."
RESTRICTIONS ON DIVIDENDS AND OTHER PAYMENTS. Under the 1940 Act, the Fund
may not declare dividends or make other distributions on shares of its common
stock or purchase any such shares if, at the time of the declaration,
distribution or purchase, as applicable (and after giving effect thereto), asset
coverage (as defined in the 1940 Act) with respect to the outstanding shares of
AMPS would be less than 200% (or such other percentage as in the future may be
required by law). The Fund estimates that, based on the composition of its
portfolio at October 31, 1998, asset coverage with respect to shares of Series A
AMPS issued and outstanding on that date was approximately 340%. As of the date
of this prospectus, asset coverage with respect to shares of Series A AMPS
issued and outstanding is approximately 300%. Under Federal tax laws, the Fund,
among other things, must distribute at least 90% of its investment company
taxable income each year in order to maintain its qualification for tax
treatment as a regulated investment company. The foregoing limitations on
dividends, distributions and purchases under certain circumstances may impair
the Fund's ability to maintain such qualification. See "Taxes" in the statement
of additional information.
Upon any failure to pay dividends on shares of AMPS for two years or more,
the holders of the shares of AMPS will acquire certain additional voting rights.
See "--Voting Rights" below and in the statement of additional information. Such
rights shall be the exclusive remedy of the holders of shares of AMPS upon any
failure to pay dividends on shares of the Fund.
ADDITIONAL DIVIDENDS. If the Fund retroactively allocates any net capital
gains or other income subject to regular Federal income taxes to shares of AMPS
without having given advance notice thereof to the Auction Agent as described
under "The Auction--Auction Date; Advance Notice of Allocation of Taxable
Income; Inclusion of Taxable Income in Dividends" herein, which may only happen
when such allocation is made as a result of the redemption of all or a portion
of the outstanding shares of AMPS or the liquidation of the Fund (the amount of
such allocation referred to herein as a "Retroactive Taxable Allocation"), the
Fund, within 90 days (and generally within 60 days) after the end of the Fund's
fiscal year for which a Retroactive Taxable Allocation is made, will provide
notice thereof to the Auction Agent and to each holder of shares (initially Cede
as nominee of the Securities Depository) during such fiscal year at such
holder's address as the same appears or last appeared on the stock books of the
Fund. The Fund, within 30 days after such notice is given to the Auction Agent,
will pay
16
<PAGE>
to the Auction Agent (who then will distribute to such holders of shares of
AMPS), out of funds legally available therefor, an amount equal to the aggregate
Additional Dividend (as defined below) with respect to all Retroactive Taxable
Allocations made to such holders during the fiscal year in question. See "Taxes"
in the statement of additional information.
An "Additional Dividend" means payment to a present or former holder of
shares of AMPS of an amount which, when taken together with the aggregate amount
of Retroactive Taxable Allocations made to such holder with respect to the
fiscal year in question, would cause such holder's dividends in dollars (after
Federal income tax consequences) from the aggregate of both the Retroactive
Taxable Allocations and the Additional Dividend to be equal to the dollar amount
of the dividends which would have been received by such holder if the amount of
the aggregate Retroactive Taxable Allocations had been excludable from the gross
income of such holder. Such Additional Dividend shall be calculated (i) without
consideration being given to the time value of money; (ii) assuming that no
holder of shares of AMPS is subject to the Federal alternative minimum tax with
respect to dividends received from the Fund; and (iii) assuming that each
Retroactive Taxable Allocation would be taxable in the hands of each holder of
shares of AMPS at the greater of: (a) the maximum marginal regular Federal
individual income tax rate applicable to ordinary income or capital gains
depending on the taxable character of the distribution (including any surtax);
or (b) the maximum regular Federal corporate income tax rate applicable to
ordinary income or capital gains depending on the taxable character of the
distribution (disregarding in both (a) and (b) the effect of any state or local
taxes and the phase out of, or provision limiting, personal exemptions, itemized
deductions, or the benefit of lower tax brackets). Although the Fund generally
intends to designate any Additional Dividend as an exempt-interest dividend to
the extent permitted by applicable law, it is possible that all or a portion of
any Additional Dividend will be taxable to the recipient thereof. See "Taxes--
Tax Treatment of Additional Dividends" in the statement of additional
information. The Fund will not pay a further Additional Dividend with respect to
any taxable portion of an Additional Dividend.
If the Fund does not give advance notice of the amount of taxable income to
be included in a dividend on shares of AMPS in the related Auction, the Fund may
include such taxable income in a dividend on shares of AMPS if it increases the
dividend by an additional amount calculated as if such income were a Retroactive
Taxable Allocation and the additional amount were an Additional Dividend. See
"The Auction--Auction Date; Advance Notice of Allocation of Taxable Income;
Inclusion of Taxable Income in Dividends" below.
ASSET MAINTENANCE
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Articles Supplementary. These requirements
are summarized below.
1940 ACT AMPS ASSET COVERAGE. The Fund will be required under the Articles
Supplementary to maintain, with respect to shares of AMPS, as of the last
Business Day of each month in which any shares of AMPS are outstanding, asset
coverage of at least 200% with respect to senior securities which are stock,
including the shares of AMPS (or such other asset coverage as in the future may
be specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are stock of a closed-end investment company as a condition of
paying dividends on its common stock) ("1940 Act AMPS Asset Coverage"). If the
Fund fails to maintain 1940 Act AMPS Asset Coverage and such failure is not
cured as of the last Business Day of the following month (the "1940 Act Cure
Date"), the Fund will be required under certain circumstances to redeem certain
of the shares of AMPS. See "-- Redemption" herein and in the statement of
additional information.
17
<PAGE>
As of October 31, 1998, the 1940 Act AMPS Asset Coverage was as follows:
Value of Fund assets less
liabilities not constituting
senior securities $163,339,156 340%
= =
------------------------------ -------
Senior securities 48,000,000
representing indebtedness
plus liquidation value
of the shares of AMPS
As of the date of this prospectus, the 1940 Act AMPS Asset Coverage is 300%.
AMPS BASIC MAINTENANCE AMOUNT. So long as shares of AMPS are outstanding,
the Fund will be required under the Articles Supplementary to maintain as of
each Business Day (a "Valuation Date") S&P Eligible Assets and Moody's Eligible
Assets each having in the aggregate a Discounted Value at least equal to the
AMPS Basic Maintenance Amount. The AMPS Basic Maintenance Amount includes the
sum of (i) the aggregate liquidation value of AMPS then outstanding and (ii)
certain accrued and projected payment obligations of the Fund. See "Description
of AMPS--Asset Maintenance--AMPS Basic Maintenance Amount" in the statement of
additional information. If the Fund fails to meet such requirement as of any
Valuation Date and such failure is not cured on or before the sixth Business Day
after such Valuation Date (the "AMPS Basic Maintenance Cure Date"), the Fund
will be required under certain circumstances to redeem certain of the shares of
AMPS. Upon any failure to maintain the required Discounted Value, the Fund will
use its best efforts to alter the composition of its portfolio to reattain a
Discounted Value at least equal to the AMPS Basic Maintenance Amount on or prior
to the AMPS Basic Maintenance Cure Date. See "--Redemption" herein and in the
statement of additional information.
REDEMPTION
OPTIONAL REDEMPTION. To the extent permitted under the 1940 Act and under
Maryland law, upon giving a Notice of Redemption, as provided in the statement
of additional information, the Fund, at its option, may redeem shares of AMPS of
any series, in whole or in part, out of funds legally available therefor, at the
Optional Redemption Price per share on any Dividend Payment Date; provided that
no share of AMPS may be redeemed at the option of the Fund during (a) the
Initial Dividend Period with respect to a series of shares or (b) a Non-Call
Period to which such share is subject. "Optional Redemption Price" means $25,000
per share of AMPS plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) to the date fixed for redemption plus any
applicable redemption premium, if any, attributable to the designation of a
Premium Call Period. In addition, holders of AMPS may be entitled to receive
Additional Dividends in the event of redemption of such AMPS to the extent
provided herein. See "--Dividends--Additional Dividends" above. The Fund has the
authority to redeem the AMPS for any reason and may redeem all or part of the
outstanding shares of AMPS if it anticipates that the Fund's leveraged capital
structure will result in a lower rate of return to holders of common stock for
any significant period of time than that obtainable if the common stock were
unleveraged.
MANDATORY REDEMPTION. The Fund will be required to redeem, out of funds
legally available therefor, at the Mandatory Redemption Price per share, shares
of AMPS to the extent permitted under the 1940 Act and Maryland law, on a date
fixed by the Board of Directors, if the Fund fails to maintain S&P Eligible
Assets and Moody's Eligible Assets each with an aggregate Discounted Value equal
to or greater than the AMPS Basic Maintenance Amount or to satisfy the 1940 Act
AMPS Asset Coverage and such failure is not cured on or before the AMPS Basic
Maintenance Cure Date or the 1940 Act Cure Date (herein collectively referred to
as a "Cure Date"), as the case may be. "Mandatory
18
<PAGE>
Redemption Price" means $25,000 per share of AMPS plus an amount equal to
accumulated but unpaid dividends (whether or not earned or declared) to the date
fixed for redemption. In addition, holders of AMPS may be entitled to receive
Additional Dividends in the event of redemption of such AMPS to the extent
provided herein. See "--Dividends--Additional Dividends" above.
For a discussion of the allocation procedures to be used if fewer than all
of the outstanding AMPS of any series are to be redeemed and for a discussion of
other redemption procedures, see "--Redemption" in the statement of additional
information.
LIQUIDATION RIGHTS
Upon any liquidation, dissolution or winding up of the Fund, whether
voluntary or involuntary, the holders of shares of all series of AMPS will be
entitled to receive, out of the assets of the Fund available for distribution to
shareholders, before any distribution or payment is made upon any shares of
common stock or any other capital stock of the Fund ranking junior in right of
payment upon liquidation of AMPS, $25,000 per share together with the amount of
any dividends accumulated but unpaid (whether or not earned or declared) thereon
to the date of distribution, and after such payment the holders of AMPS will be
entitled to no other payments except for any Additional Dividends. If such
assets of the Fund shall be insufficient to make the full liquidation payment on
each outstanding series of AMPS and liquidation payments on any other
outstanding class or series of preferred stock of the Fund ranking on a parity
with the AMPS as to payment upon liquidation, then such assets will be
distributed among the holders of each such series of AMPS and the holders of
shares of such other class or series ratably in proportion to the respective
preferential amounts to which they are entitled. After payment of the full
amount of liquidation distribution to which they are entitled, the holders of
AMPS will not be entitled to any further participation in any distribution of
assets by the Fund except for any Additional Dividends. A consolidation, merger
or share exchange of the Fund with or into any other entity or entities or a
sale, whether for cash, shares of stock, securities or properties, of all or
substantially all or any part of the assets of the Fund shall not be deemed or
construed to be a liquidation, dissolution or winding up of the Fund.
VOTING RIGHTS
Except as otherwise indicated in this prospectus and the statement of
additional information and except as otherwise required by applicable law,
holders of shares of AMPS will be entitled to one vote per share on each matter
submitted to a vote of stockholders and will vote together with holders of
shares of common stock as a single class.
The 1940 Act and the Articles Supplementary require that the holders of
preferred stock, including the AMPS, voting as a separate class, have the right
to elect two of the Fund's Directors at all times and to elect a majority of the
Directors at any time that two full years' dividends on the AMPS are unpaid. The
holders of AMPS will vote as a separate class or classes on certain other
matters as required under the Articles Supplementary, the 1940 Act and Maryland
law. In addition, each series of AMPS may vote as a separate series under
certain circumstances. See "--Voting Rights" in the statement of additional
information.
THE AUCTION
GENERAL. Holders of the shares of AMPS will be entitled to receive
cumulative cash dividends on their shares when, as and if declared by the Board
of Directors of the Fund, out of funds legally available therefor, on the
initial dividend payment date with respect to the initial dividend period and,
thereafter, on each dividend payment date with respect to a subsequent dividend
period (generally a period of seven days in the case of Series A AMPS, subject
to certain exceptions set forth under
19
<PAGE>
"--Dividends--General" above) at the rate per annum equal to the applicable rate
for each such dividend period.
The provisions of the Articles Supplementary establishing the terms of the
shares of AMPS offered hereby will provide that the Applicable Rate for each
series of AMPS for each Dividend Period after the Initial Dividend Period
therefor will be equal to the rate per annum that the Auction Agent advises has
resulted on the Business Day preceding the first day of such Dividend Period due
to implementation of the auction procedures set forth in the Articles
Supplementary (the "Auction Procedures") in which persons determine to hold or
offer to purchase or sell shares of AMPS of such series. The Auction Procedures
are attached as Appendix III to the statement of additional information. Each
periodic operation of such procedures with respect to the shares of AMPS is
referred to hereinafter as an "Auction." If, however, the Fund should fail to
pay or duly provide for the full amount of any dividend on shares of AMPS of any
series or the redemption price of shares of AMPS of such series called for
redemption, the Applicable Rate for shares of AMPS will be determined as set
forth under "--Dividends--Non-Payment Period; Late Charge" in the statement of
additional information.
AUCTION AGENT AGREEMENT. The Fund will enter into an agreement (the
"Auction Agent Agreement") with IBJ Whitehall Bank & Trust Company (together
with any successor bank or trust company or other entity entering into a similar
agreement with this Fund, the "Auction Agent"), which provides, among other
things, that the Auction Agent will follow the Auction Procedures for the
purpose of determining the Applicable Rate for the AMPS. The Fund will pay the
Auction Agent compensation for its services under the Auction Agent Agreement.
BROKER-DEALER AGREEMENTS. The Auction Agent has entered into agreements
with Merrill Lynch, Goldman, Sachs & Co., Lehman Special Securities Incorporated
and PaineWebber Incorporated and may enter into similar agreements
(collectively, the "Broker-Dealer Agreements") with one or more of the
broker-dealers (collectively, the "Broker-Dealers") selected by the Fund, which
provide for the participation of such Broker-Dealers in Auctions. Merrill Lynch
is an affiliate of the Investment Adviser in that they share a common parent, ML
& Co.
SECURITIES DEPOSITORY. The Depository Trust Company initially will act as
the Securities Depository for the Agent Members with respect to the shares of
AMPS. One or more registered certificates for all of the shares of AMPS
initially will be registered in the name of Cede, as nominee of the Securities
Depository. The certificate will bear a legend to the effect that such
certificate is issued subject to the provisions restricting transfers of shares
of AMPS contained in the Articles Supplementary. Cede initially will be the
holder of record of all shares of AMPS, and Beneficial Owners will not be
entitled to receive certificates representing their ownership interest in such
shares. The Securities Depository will maintain lists of its participants and
will maintain the positions (ownership interests) of shares of AMPS held by each
Agent Member, whether as the Beneficial Owner thereof for its own account or as
nominee for the Beneficial Owner thereof. Payments made by the Fund to holders
of AMPS will be duly made by making payments to the nominee of the Securities
Depository.
AUCTION PROCEDURES. The following is a brief discussion of the procedures
used in conducting Auctions. Separate auctions will be conducted for each series
of AMPS. This summary is qualified by reference to the Auction Procedures set
forth in Appendix C to the statement of additional information. The Settlement
Procedures to be used with respect to Auctions are set forth in Appendix B to
the statement of additional information.
AUCTION DATE; ADVANCE NOTICE OF ALLOCATION OF TAXABLE INCOME; INCLUSION OF
TAXABLE INCOME IN DIVIDENDS. An Auction to determine the Applicable Rate for
the AMPS offered hereby for each Dividend Period (other than the Initial
Dividend Period therefor) will be held on the first Business Day (as hereinafter
defined) preceding the first day of such Dividend Period, which first day is
also the Dividend Payment Date for the preceding Dividend Period (the date of
each Auction being referred to
20
<PAGE>
herein as an "Auction Date"). "Business Day" means a day on which the New York
Stock Exchange is open for trading and which is not a Saturday, Sunday or other
day on which banks in The City of New York are authorized or obligated by law to
close. Auctions for shares of Series A AMPS for Dividend Periods after the
Initial Dividend Period normally will be held every Wednesday after the
preceding Dividend Payment Date, and each subsequent Dividend Period normally
will begin on the following Thursday (also a Dividend Payment Date). The Auction
Date and the first day of the related Dividend Period (both of which must be
Business Days) need not be consecutive calendar days. For example, in most
cases, if the Wednesday that normally would be an Auction Date is not a Business
Day, then such Auction Date will be the preceding Tuesday and the first day of
the related Dividend Period will continue to be the following Thursday. See
"Description of AMPS--Dividends" herein and in the statement of additional
information for information concerning the circumstances under which a Dividend
Payment Date may fall on a date other than the days specified above, which may
affect the Auction Date.
Except as noted below, whenever the Fund intends to include any net capital
gains or other income subject to regular Federal income taxes in any dividend on
shares of AMPS, the Fund will notify the Auction Agent of the amount to be so
included at least five Business Days prior to the Auction Date on which the
Applicable Rate for such dividend is to be established. Whenever the Auction
Agent receives such notice from the Fund, in turn it will notify each
Broker-Dealer, who, on or prior to such Auction Date, in accordance with its
Broker-Dealer Agreement, will notify its customers who are Beneficial Owners and
Potential Beneficial Owners believed to be interested in submitting an Order in
the Auction to be held on such Auction Date. The Fund also may include such
income in a dividend on shares of AMPS without giving advance notice thereof if
it increases the dividend by an additional amount calculated as if such income
were a Retroactive Taxable Allocation and the additional amount were an
Additional Dividend; provided that the Fund will notify the Auction Agent of the
additional amounts to be included in such dividend at least five Business Days
prior to the applicable Dividend Payment Date. See "Description of
AMPS--Dividends--Additional Dividends" above.
ORDERS BY BENEFICIAL OWNERS, POTENTIAL BENEFICIAL OWNERS, EXISTING HOLDERS
AND POTENTIAL HOLDERS. On or prior to each Auction Date:
(a) each Beneficial Owner may submit to its Broker-Dealer by telephone a:
(i) Hold Order--indicating the number of outstanding shares, if any, of
AMPS that such Beneficial Owner desires to continue to hold without
regard to the Applicable Rate for the next Dividend Period for such
shares;
(ii) Bid--indicating the number of outstanding shares, if any, of AMPS
that such Beneficial Owner desires to continue to hold, provided
that the Applicable Rate for the next Dividend Period for such
shares is not less than the rate per annum then specified by such
Beneficial Owner; and/or
(iii) Sell Order--indicating the number of outstanding shares, if any, of
AMPS that such Beneficial Owner offers to sell without regard to
the Applicable Rate for the next Dividend Period for such shares;
and
(b) Broker-Dealers will contact customers who are Potential Beneficial
Owners of shares of AMPS to determine whether such Potential Beneficial Owners
desire to submit Bids indicating the number of shares of AMPS which they offer
to purchase provided that the Applicable Rate for the next Dividend Period for
such shares is not less than the rates per annum specified in such Bids.
The communication by a Beneficial Owner or Potential Beneficial Owner to a
Broker-Dealer and the communication by a Broker-Dealer, whether or not acting
for its own account, to the Auction Agent of the foregoing information is
hereinafter referred to as an "Order" and collectively as "Orders." A Beneficial
Owner or a Potential Beneficial Owner placing an Order, including a Broker-
21
<PAGE>
Dealer acting in such capacity for its own account, is hereinafter referred to
as a "Bidder" and collectively as "Bidders." Any Order submitted by a Beneficial
Owner or a Potential Beneficial Owner to its Broker-Dealer, or by a
Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to shares of AMPS then held by such Beneficial Owner, as well as Bids
for additional shares of AMPS. For information concerning the priority given to
different types of Orders placed by Beneficial Owners, see "--Submission of
Orders by Broker-Dealers to Auction Agent" below.
The Maximum Applicable Rate for shares of AMPS will be the Applicable
Percentage of the Reference Rate. The Auction Agent will round each applicable
Maximum Applicable Rate to the nearest one-thousandth (0.001) of one percent per
annum, with any such number ending in five ten-thousandths of one percent being
rounded upwards to the nearest one-thousandth (0.001) of one percent. The
Auction Agent will not round the applicable Reference Rate as part of its
calculation of the Maximum Applicable Rate.
The Maximum Applicable Rate for shares of AMPS will depend on the credit
rating or ratings assigned to such shares. The Applicable Percentage will be
determined based on (i) the lower of the credit rating or ratings assigned on
such date to such shares by Moody's and S&P (or if Moody's or S&P or both shall
not make such rating available, the equivalent of either or both of such ratings
by a Substitute Rating Agency or two Substitute Rating Agencies or, in the event
that only one such rating shall be available, such rating) and (ii) whether the
Fund has provided notification to the Auction Agent prior to the Auction
establishing the Applicable Rate for any dividend that net capital gains or
other taxable income will be included in such dividend on shares of AMPS as
follows:
<TABLE>
<CAPTION>
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
CREDIT RATINGS REFERENCE REFERENCE
-------------------------------------------- RATE-- RATE--
MOODY'S S&P NO NOTIFICATION NOTIFICATION
-------------------- -------------------- --------------- ---------------
<S> <C> <C> <C>
"aa3" or higher AA- or higher 110% 150%
"a3" to "a1" A- to A+ 125% 160%
"baa3" to "baa1" BBB- to BBB+ 150% 250%
Below "baa3" Below BBB- 200% 275%
</TABLE>
There is no minimum Applicable Rate in respect of any Dividend Period.
The Fund will take all reasonable action necessary to enable S&P and Moody's
to provide a rating for the AMPS. If either S&P or Moody's shall not make such a
rating available, or neither S&P nor Moody's shall make such a rating available,
Merrill Lynch or its affiliates and successors, after consultation with the
Fund, will select a nationally recognized statistical rating organization (a
"Substitute Rating Agency") or two nationally recognized statistical rating
organizations ("Substitute Rating Agencies") to act as a Substitute Rating
Agency or Substitute Rating Agencies, as the case may be.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "--Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "--Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares."
Neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to comply with the foregoing.
A Broker-Dealer also may hold AMPS in its own account as a Beneficial Owner.
A Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial
Owner or a Potential Beneficial Owner
22
<PAGE>
and therefore participate in an Auction as an Existing Holder or Potential
Holder on behalf of both itself and its customers. Any Order placed with the
Auction Agent by a Broker-Dealer as or on behalf of a Beneficial Owner or a
Potential Beneficial Owner will be treated in the same manner as an Order placed
with a Broker-Dealer by a Beneficial Owner or a Potential Beneficial Owner.
Similarly, any failure by a Broker-Dealer to submit to the Auction Agent an
Order in respect of any AMPS held by it or its customers who are Beneficial
Owners will be treated in the same manner as a Beneficial Owner's failure to
submit to its Broker-Dealer an Order in respect of AMPS held by it, as described
in the next paragraph. Inasmuch as a Broker-Dealer participates in an Auction as
an Existing Holder or a Potential Holder only to represent the interests of a
Beneficial Owner or Potential Beneficial Owner, whether it be its customers or
itself, all discussion herein relating to the consequences of an Auction for
Existing Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented thereby. For information concerning the priority
given to different types of Orders placed by Existing Holders, see "--Submission
of Orders by Broker-Dealers to Auction Agent" below. Each purchase or sale in an
Auction will be settled on the Business Day next succeeding the Auction Date at
a price per share equal to $25,000. See "--Notification of Results; Settlement"
below.
If one or more Orders covering in the aggregate all of the outstanding
shares of AMPS held by a Beneficial Owner are not submitted to the Auction Agent
prior to the Submission Deadline, either because a Broker-Dealer failed to
contact such Beneficial Owner or otherwise, the Auction Agent shall deem a Hold
Order (in the case of an Auction relating to a Dividend Period which is not a
Special Dividend Period) and a Sell Order (in the case of an Auction relating to
a Special Dividend Period) to have been submitted on behalf of such Beneficial
Owner covering the number of outstanding shares of AMPS held by such Beneficial
Owner and not subject to Orders submitted to the Auction Agent.
If all of the outstanding shares of AMPS are subject to Submitted Hold
Orders, the Dividend Period next succeeding the Auction automatically shall be
the same length as the immediately preceding Dividend Period, and the Applicable
Rate for the next Dividend Period for all shares of AMPS will
be 40% of the Reference Rate on the date of the applicable Auction (or 60% of
such rate if the Fund has provided notification to the Auction Agent prior to
the Auction establishing the Applicable Rate for any dividend that net capital
gains or other taxable income will be included in such dividend on shares of
AMPS).
For the purposes of an Auction, shares of AMPS for which the Fund shall have
given notice of redemption and deposited moneys therefor with the Auction Agent
in trust or segregated in an account at the Fund's custodian bank for the
benefit of the Auction Agent, as set forth under "Description of
AMPS--Redemption," will not be considered as outstanding and will not be
included in such Auction. Pursuant to the Articles Supplementary of the Fund,
the Fund will be prohibited from reissuing and its affiliates (other than
Merrill Lynch) will be prohibited from transferring (other than to the Fund) any
shares of AMPS they may acquire. Neither the Fund nor any affiliate of the Fund
(other than Merrill Lynch) may submit an Order in any Auction, except that an
affiliate of the Fund that is a Broker-Dealer may submit an Order.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT. Prior to 1:00
p.m., Eastern time, on each Auction Date, or such other time on the Auction Date
as may be specified by the Auction Agent (the "Submission Deadline"), each
Broker-Dealer will submit to the Auction Agent in writing all Orders obtained by
it for the Auction to be conducted on such Auction Date, designating itself
(unless otherwise permitted by the Fund) as the Existing Holder or Potential
Holder in respect of the shares of AMPS subject to such Orders. Any Order
submitted by a Beneficial Owner or a Potential Beneficial Owner to its
Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline on any Auction Date, shall be irrevocable.
23
<PAGE>
If the rate per annum specified in any Bid contains more than three figures
to the right of the decimal point, the Auction Agent will round such rate per
annum up to the next highest one-thousandth (.001) of 1%.
If one or more Orders of an Existing Holder are submitted to the Auction
Agent and such Orders cover in the aggregate more than the number of outstanding
shares of AMPS held by such Existing Holder, such Orders will be considered
valid in the following order of priority:
(i) any Hold Order will be considered valid up to and including the
number of outstanding shares of AMPS held by such Existing Holder, provided
that if more than one Hold Order is submitted by such Existing Holder and
the number of shares of AMPS subject to such Hold Orders exceeds the number
of outstanding shares of AMPS held by such Existing Holder, the number of
shares of AMPS subject to each of such Hold Orders will be reduced pro rata
so that such Hold Orders, in the aggregate, will cover exactly the number of
outstanding shares of AMPS held by such Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such
Existing Holder, up to and including the excess of the number of outstanding
shares of AMPS held by such Existing Holder over the number of outstanding
shares of AMPS subject to any Hold Order referred to in clause (i) above
(and if more than one Bid submitted by such Existing Holder specifies the
same rate per annum and together they cover more than the remaining number
of shares that can be the subject of valid Bids after application of clause
(i) above and of the foregoing portion of this clause (ii) to any Bid or
Bids specifying a lower rate or rates per annum, the number of shares
subject to each of such Bids will be reduced pro rata so that such Bids, in
the aggregate, cover exactly such remaining number of outstanding shares);
and the number of outstanding shares, if any, subject to Bids not valid
under this clause (ii) shall be treated as the subject of a Bid by a
Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the
excess of the number of outstanding shares of AMPS held by such Existing
Holder over the sum of the number of shares of AMPS subject to Hold Orders
referred to in clause (i) above and the number of shares of AMPS subject to
valid Bids by such Existing Holder referred to in clause (ii) above;
provided that, if more than one Sell Order is submitted by any Existing
Holder and the number of shares of AMPS subject to such Sell Orders is
greater than such excess, the number of shares of AMPS subject to each of
such Sell Orders will be reduced pro rata so that such Sell Orders, in the
aggregate, will cover exactly the number of shares of AMPS equal to such
excess.
If more than one Bid of any Potential Holder is submitted in any Auction,
each Bid submitted in such Auction will be considered a separate Bid with the
rate per annum and number of shares of AMPS specified.
DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND APPLICABLE
RATE. Not earlier than the Submission Deadline for each Auction, the Auction
Agent will assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such "Hold Order", "Bid" or "Sell Order" as submitted or
deemed submitted by a Broker-Dealer hereinafter being referred to as a
"Submitted Hold Order", a "Submitted Bid" or a "Submitted Sell Order", as the
case may be, or as a "Submitted Order") and will determine the excess of the
number of outstanding shares of AMPS over the number of outstanding shares of
AMPS subject to Submitted Hold Orders (such excess being referred to as the
"Available AMPS") and whether Sufficient Clearing Bids have been made in such
Auction. Sufficient Clearing Bids will have been made if the number of
outstanding shares of AMPS that are the subject of Submitted Bids of Potential
Holders with rates per annum not higher than the Maximum Applicable Rate equals
or exceeds the number of outstanding shares that are the subject of Submitted
Sell Orders (including the number of shares subject to Bids of Existing Holders
specifying rates per annum higher than the Maximum Applicable Rate).
24
<PAGE>
If Sufficient Clearing Bids have been made, the Auction Agent will determine
the lowest rate per annum specified in the Submitted Bids (the "Winning Bid
Rate") which would result in the number of shares subject to Submitted Bids
specifying such rate per annum or a lower rate per annum being at
least equal to the Available AMPS. If Sufficient Clearing Bids have been made,
the Winning Bid Rate will be the Applicable Rate for the next Dividend Period
for all shares of AMPS then outstanding.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders), the
Dividend Period next following the Auction automatically will be a 7-Day
Dividend Period in the case of Series A AMPS, and the Applicable Rate for such
Dividend Period will be equal to the Maximum Applicable Rate. If Sufficient
Clearing Bids have not been made, Beneficial Owners that have Submitted Sell
Orders will not be able to sell in the Auction all, and may not be able to sell
any, shares of AMPS subject to such Submitted Sell Orders. See "--Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares"
below. Thus, under some circumstances, Beneficial Owners may not have liquidity
of investment.
ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS AND
ALLOCATION OF SHARES. Based on the determinations described under "Determination
of Sufficient Clearing Bids, Winning Bid Rate and Applicable Rate" and subject
to the discretion of the Auction Agent to round as described below, Submitted
Bids and Submitted Sell Orders will be accepted or rejected in the order of
priority set forth in the Auction Procedures with the result that Existing
Holders and Potential Holders of AMPS will sell, continue to hold and/or
purchase shares of AMPS as set forth below. Existing Holders that submit or are
deemed to have submitted Hold Orders will continue to hold the shares of AMPS
subject to such Hold Orders.
If Sufficient Clearing Bids have been made:
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Winning Bid Rate or a Submitted Sell Order will
sell the outstanding shares of AMPS subject to such Submitted Bid or
Submitted Sell Order;
(b) each Existing Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bid;
(c) each Potential Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will purchase the number of shares
of AMPS subject to such Submitted Bid;
(d) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bids, unless the number
of outstanding shares of AMPS subject to all such Submitted Bids of Existing
Holders is greater than the excess of the Available AMPS over the number of
shares of AMPS accounted for in clauses (b) and (c) above, in which event
each Existing Holder with such a Submitted Bid will sell a number of
outstanding shares of AMPS determined on a pro rata basis based on the
number of outstanding shares of AMPS subject to all such Submitted Bids of
such Existing Holders; and
(e) each Potential Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will purchase any Available AMPS not
accounted for in clause (b), (c) or (d) above on a pro rata basis based on
the shares of AMPS subject to all such Submitted Bids of Potential Holders.
25
<PAGE>
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders):
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will continue
to hold the outstanding shares of AMPS subject to such Submitted Bid;
(b) each Potential Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will purchase
the number of shares of AMPS subject to such Submitted Bid; and
(c) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Maximum Applicable Rate or a Submitted Sell Order
will sell a number of outstanding shares of AMPS determined on a pro rata
basis based on the outstanding shares of AMPS subject to all such Submitted
Bids and Submitted Sell Orders.
If as a result of the Auction Procedures described above any Existing Holder
would be entitled or required to sell, or any Potential Holder would be entitled
or required to purchase, a fraction of a share of AMPS, the Auction Agent, in
such manner as, in its sole discretion, it shall determine, will round up or
down the number of shares of AMPS being sold or purchased on such Auction Date
so that each share sold or purchased by each Existing Holder or Potential Holder
will be a whole share of AMPS. If any Potential Holder would be entitled or
required to purchase less than a whole share of AMPS, the Auction Agent, in such
manner as, in its sole discretion, it shall determine, will allocate shares of
AMPS for purchase among Potential Holders so that only whole shares of AMPS are
purchased by any such Potential Holder, even if such allocation results in one
or more of such Potential Holders not purchasing any shares of AMPS.
NOTIFICATION OF RESULTS; SETTLEMENT. The Auction Agent will advise each
Broker-Dealer who submitted a Bid or Sell Order in an Auction whether such Bid
or Sell Order was accepted or rejected in whole or in part and of the Applicable
Rate for the next Dividend Period for the related shares of AMPS by telephone at
approximately 3:00 p.m., Eastern time, on the Auction Date for such Auction.
Each such Broker-Dealer that submitted an Order for the account of a customer
then will advise such customer whether such Bid or Sell Order was accepted or
rejected, will confirm purchases and sales with each customer purchasing or
selling shares of AMPS as a result of the Auction and will advise each customer
purchasing or selling shares of AMPS to give instructions to its Agent Member of
the Securities Depository to pay the purchase price against delivery of such
shares or to deliver such shares against payment therefor as appropriate. If a
customer selling shares of AMPS as a result of an Auction shall fail to instruct
its Agent Member to deliver such shares, the Broker-Dealer that submitted such
customer's Bid or Sell Order will instruct such Agent Member to deliver such
shares against payment therefor. Each Broker-Dealer that submitted a Hold Order
in an Auction on behalf of a customer also will advise such customer of the
Applicable Rate for the next Dividend Period for the AMPS. The Auction Agent
will record each transfer of shares of AMPS on the record book of Existing
Holders to be maintained by the Auction Agent.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of shares of AMPS as determined in such
Auction. Purchasers will make payment through their Agent Members in same-day
funds to the Securities Depository against delivery through their Agent Members;
the Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to AMPS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for
26
<PAGE>
shares of AMPS are not held by the Securities Depository or its nominee, payment
will be made in same-day funds to the Auction Agent against delivery of such
certificates.
If any Existing Holder selling shares of AMPS in an Auction fails to deliver
such shares, the Broker-Dealer of any person that was to have purchased shares
of AMPS in such Auction may deliver to such person a number of whole shares of
AMPS that is less than the number of shares that otherwise was to be purchased
by such person. In such event, the number of shares of AMPS to be so delivered
will be determined by such Broker-Dealer. Delivery of such lesser number of
shares will constitute good delivery. Each Broker-Dealer Agreement also will
provide that neither the Fund nor the Auction Agent will have responsibility or
liability with respect to the failure of a Potential Beneficial Owner,
Beneficial Owner or their respective Agent Members to deliver shares of AMPS or
to pay for shares of AMPS purchased or sold pursuant to an Auction or otherwise.
BROKER-DEALERS
GENERAL. The Broker-Dealer Agreements provide that a Broker-Dealer may
submit Orders in Auctions for its own account, unless the Fund notifies all
Broker-Dealers that they no longer may do so; provided that Broker-Dealers may
continue to submit Hold Orders and Sell Orders. If a Broker-Dealer submits an
Order for its own account in any Auction of any series of AMPS, it may have
knowledge of Orders placed through it in that Auction and therefore have an
advantage over other Bidders, but such Broker-Dealer would not have knowledge of
Orders submitted by other Broker-Dealers in that Auction.
FEES. The Auction Agent after each Auction will pay a service charge from
funds provided by the Fund to each Broker-Dealer on the basis of the purchase
price of shares of AMPS placed by such Broker-Dealer at such Auction. The
service charge (i) for any 7-Day Dividend Period or 28-Day Dividend Period shall
be payable at the annual rate of 0.25% of the purchase price of the shares of
AMPS placed by such Broker-Dealer in any such Auction and (ii) for any Special
Dividend Period shall be determined by mutual consent of the Fund and any such
Broker-Dealer or Broker-Dealers and shall be based upon a selling concession
that would be applicable to an underwriting of fixed or variable rate preferred
shares with a similar final maturity or variable rate dividend period,
respectively, at the commencement of the Dividend Period with respect to such
Auction (generally expected to be in the 0.25% to 1.00% range). For the purposes
of the preceding sentence, shares of AMPS will be placed by a Broker-Dealer if
such shares were (i) the subject of Hold Orders deemed to have been made by
Beneficial Owners that were acquired by such Beneficial Owners through such
Broker-Dealer or (ii) the subject of the following Orders submitted by such
Broker-Dealer: (A) a Submitted Bid of a Beneficial Owner that resulted in such
Beneficial Owner continuing to hold such shares as a result of the Auction, (B)
a Submitted Bid of a Potential Beneficial Owner that resulted in such Potential
Beneficial Owner purchasing such shares as a result of the Auction or (C) a
Submitted Hold Order.
SECONDARY TRADING MARKET. The Broker-Dealers intend to maintain a secondary
trading market in the AMPS outside of Auctions; however, they have no obligation
to do so and there can be no assurance that a secondary market for the AMPS will
develop or, if it does develop, that it will provide holders with a liquid
trading market (i.e., trading will depend on the presence of willing buyers and
sellers and the trading price is subject to variables to be determined at the
time of the trade by the Broker-Dealers). The AMPS will not be registered on any
stock exchange or on the Nasdaq National Market. An increase in the level of
interest rates likely will have an adverse effect on the secondary market price
of the AMPS, and a selling shareholder may sell AMPS between Auctions at a price
per share of less than $25,000.
27
<PAGE>
RATING AGENCY GUIDELINES
CERTAIN OF THE CAPITALIZED TERMS USED HEREIN ARE DEFINED IN THE GLOSSARY
THAT APPEARS AT THE END OF THIS PROSPECTUS.
The Fund intends that, so long as shares of AMPS are outstanding, the
composition of its portfolio will reflect guidelines established by Moody's and
S&P in connection with the Fund's receipt of a rating for such shares on or
prior to their Date of Original Issue of at least "aaa" from Moody's and AAA
from S&P. Moody's and S&P, nationally recognized statistical rating
organizations, issue ratings for various securities reflecting the perceived
creditworthiness of such securities. The guidelines described here and in the
statement of additional information have been developed by Moody's and S&P in
connection with issuances of asset-backed and similar securities, including debt
obligations and variable rate preferred stock, generally on a case-by-case basis
through discussions with the issuers of these securities. The guidelines are
designed to ensure that assets underlying outstanding debt or preferred stock
will be varied sufficiently and will be of sufficient quality and amount to
justify investment-grade ratings. The guidelines do not have the force of law
but have been adopted by the Fund in order to satisfy current requirements
necessary for Moody's and S&P to issue the above-described ratings for shares of
AMPS, which ratings generally are relied upon by institutional investors in
purchasing such securities. The guidelines provide a set of tests for portfolio
composition and asset coverage that supplement (and in some cases are more
restrictive than) the applicable requirements under the 1940 Act. See
"Description of AMPS--Asset Maintenance" herein and in the statement of
additional information.
The Fund intends to maintain a Discounted Value for its portfolio at least
equal to the AMPS Basic Maintenance Amount. Moody's and S&P each has established
separate guidelines for determining Discounted Value. To the extent any
particular portfolio holding does not satisfy the applicable rating agency's
guidelines, all or a portion of such holding's value will not be included in the
calculation of Discounted Value (as defined by such rating agency). The Moody's
and S&P guidelines do not impose any limitations on the percentage of Fund
assets that may be invested in holdings not eligible for inclusion in the
calculation of the Discounted Value of the Fund's portfolio.
Upon any failure to maintain the required Discounted Value, the Fund will
seek to alter the composition of its portfolio to retain a Discounted Value at
least equal to the AMPS Basic Maintenance Amount on or prior to the AMPS Basic
Maintenance Cure Date, thereby incurring additional transaction costs and
possible losses and/or gains on dispositions of portfolio securities. To the
extent any such failure is not cured in a timely manner, shares of AMPS will be
subject to redemption. See "Description of AMPS--Asset Maintenance" and
"Description of AMPS--Redemption" herein and in the statement of additional
information.
The Fund may, but is not required to, adopt any modifications to these
guidelines that hereafter may be established by Moody's or S&P. Failure to adopt
any such modifications, however, may result in a change in the ratings described
above or a withdrawal of ratings altogether. In addition, any rating agency
providing a rating for the shares of AMPS, at any time, may change or withdraw
any such rating. As set forth in the Articles Supplementary, the Board of
Directors, without shareholder approval, may modify certain definitions or
restrictions which have been adopted by the Fund pursuant to the rating agency
guidelines, provided the Board of Directors has obtained written confirmation
from Moody's and S&P that any such change would not impair the ratings then
assigned by Moody's and S&P to the AMPS.
As recently described by Moody's and S&P, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The ratings on the AMPS are not recommendations to purchase, hold
or sell shares of AMPS, inasmuch as the ratings do not comment as to market
price or suitability for a particular investor, nor do the rating agency
guidelines described above address the likelihood that a holder of shares of
AMPS will be able to sell such shares
28
<PAGE>
in an Auction. The ratings are based on current information furnished to Moody's
and S&P by the Fund and the Investment Adviser and information obtained from
other sources. The ratings may be changed, suspended or withdrawn as a result of
changes in, or the unavailability of, such information. The common stock has not
been rated by a nationally recognized statistical rating organization.
For additional information concerning the Moody's and S&P ratings
guidelines, see "Rating Agency Guidelines" in the statement of additional
information.
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 management services. The Merrill Lynch Asset
Management Group (which includes the Investment Adviser) acts as the investment
adviser to more than 100 registered investment companies. The Investment Adviser
also offers investment advisory services to individuals and institutions. As of
December 1998, the Asset Management Group had a total of approximately $501
billion in investment company and other portfolio assets under management
(approximately $38.3 billion of which were invested 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 Investment Advisory Agreement provides that, subject to the supervision
of the Board of Directors of the Fund, the Investment Adviser is responsible for
the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors. The Fund's portfolio
managers will consider analyses from various sources, make the necessary
investment decisions, and place orders for transactions accordingly. The
Investment Adviser will also be responsible for the performance of certain
management services for the Fund. Robert A. DiMella and John M. Loffredo are the
portfolio managers for the Fund and are primarily responsible for the day-to-day
management.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund pays a monthly fee at an annual rate of 0.50% of
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 of the
Fund connected with investment and economic research, trading and investment
management of the Fund, as well as the compensation of all Directors of the Fund
who are affiliated persons of the Investment Adviser or any of its affiliates.
For the administrative services rendered to the Fund and the facilities
furnished, the Fund pays the Investment Adviser a monthly fee at an annual rate
of 0.25% of the Fund's average daily net assets determined in the same manner as
the fee payable by the Fund under the Investment Advisory Agreement. The
Investment Adviser may pay a portion of the fee received pursuant to the
Administration Agreement to its affiliate, Merrill Lynch, for administrative
services rendered in connection with the shares of AMPS. The combined advisory
and administration fees are greater than the advisory fees
29
<PAGE>
paid by most funds, but are similar in amount to the fees paid by other
continuously offered, closed-end funds.
TAXES
In general, dividends on the AMPS will be exempt from regular Federal income
tax in the hands of holders of such AMPS, subject to the possible application of
the Federal alternative minimum tax. However, the Fund is required to allocate
net capital gains and other taxable income, if any, proportionately between the
common stock and the AMPS in accordance with the current position of the
Internal Revenue Service ("IRS") described under the heading "Taxes" in the
statement of additional information. The Fund may notify the Auction Agent of
the amount of any net capital gains or other anticipated taxable income to be
included in any dividend on the AMPS prior to the Auction establishing the
Applicable Dividend Rate for such dividend. The Auction Agent will in turn
notify holders of the AMPS and prospective purchasers. The amount of taxable
income allocable to the AMPS will depend upon the amount of such income realized
by the Fund and cannot be determined with certainty prior to the end of the
Fund's fiscal year, but is not generally expected to be significant.
Generally, within 60 days after the end of the Fund's taxable year, the Fund
will tell you the amount of exempt-interest dividends and capital gain dividends
you received that year. Capital gain dividends are taxable as long-term capital
gains to you regardless of how long you have held your shares. The tax treatment
of distributions from the Fund is the same whether you choose to receive
distributions in cash or to have them reinvested in shares of the Fund.
If the Fund makes a Retroactive Taxable Allocation, it will pay Additional
Dividends to holders of AMPS who are subject to the Retroactive Taxable
Allocation. See "Description of AMPS--Dividends-- Additional Dividends" above.
The Federal income tax consequences of Additional Dividends under existing law
are uncertain. The Fund intends to treat a holder as receiving a dividend
distribution in the amount of any Additional Dividend only as and when such
Additional Dividend is paid. An Additional Dividend generally will be designated
by the Fund as an exempt-interest dividend except as otherwise required by
applicable law. However, the IRS may assert that all or part of an Additional
Dividend is a taxable dividend either in the taxable year for which the
Retroactive Taxable Allocation is made or in the taxable year in which the
Additional Dividend is paid.
Because the Fund may from time to time invest a substantial portion of its
portfolio in municipal securities bearing income that is taxable under the
Federal alternative minimum tax, the Fund would not ordinarily be a suitable
investment for investors who are subject to the alternative minimum tax.
If at any time when AMPS are outstanding the Fund does not meet the asset
coverage requirements of the 1940 Act, the Fund will be required to suspend
distributions to holders of common stock until the asset coverage is restored.
See "Description of AMPS--Dividends--Restrictions on Dividends and Other
Payments" herein and in the statement of additional information. This may
prevent the Fund from meeting certain distribution requirements for
qualification as a regulated investment company ("RIC"). If the Fund were to
fail to qualify as a RIC, some or all of the distributions would be fully
taxable for Federal income tax purposes. 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 AMPS in order to
maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its shareholders of failing to qualify as a RIC.
See "Description of AMPS--Redemption" herein and in the statement of additional
information. There can be no assurance, however, that any such action would
achieve such objectives.
By law, the Fund must withhold 31% of your distributions and proceeds if you
have not provided a taxpayer identification number or social security number.
For more information regarding the tax treatment of an investment in AMPS, see
"Taxes" in the statement of additional information.
30
<PAGE>
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.
DESCRIPTION OF CAPITAL STOCK
GENERAL
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares were initially classified as common
stock. The Board of Directors is authorized, however, to classify or reclassify
any unissued shares of capital stock by setting or changing in any one or more
respects the designation and number of shares of any such class or series, and
the nature, rates, amounts and times at which and the conditions under which
dividends shall be payable on and the voting, conversion, redemption and
liquidation rights of such class or series and any other preferences, rights,
restrictions, and qualifications applicable thereto. In this regard, the Board
of Directors reclassified 40,000 shares of unissued common stock as AMPS. For a
description of the shares of AMPS, see "Description of AMPS" herein and in the
statement of additional information.
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 BY (EXCLUSIVE OF AMOUNT
AMOUNT FUND FOR ITS HELD BY FUND
TITLE OF CLASS AUTHORIZED OWN ACCOUNT FOR ITS 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
Holders of common stock are entitled to share equally in dividends declared
by the Board of Directors payable to holders of common stock and in the net
assets of the Fund available for distribution to holders of common stock after
payment of the preferential amounts payable to holders of any outstanding
preferred stock. Neither holders of common stock nor holders of preferred stock
have pre-emptive or conversion rights and shares of common stock are not
redeemable. The outstanding shares of common stock are fully paid and
non-assessable.
Holders of common stock are entitled to one vote for each share held and
will vote with the holders of any outstanding shares of AMPS or other preferred
stock on each matter submitted to a vote of holders of common stock, except as
described under "Description of AMPS--Voting Rights" herein and in the statement
of additional information.
Shareholders are entitled to one vote for each share held. The shares of
common stock, AMPS and any other preferred stock do not have cumulative voting
rights, which means that the holders of more than 50% of the shares of common
stock, AMPS and any other preferred stock voting for the election of Directors
can elect all of the Directors standing for election by such holders, and, in
such event, the holders of the remaining shares of common stock, AMPS and any
other preferred stock will not be able to elect any of such Directors.
So long as any shares of AMPS or any other preferred stock are outstanding,
holders of common stock will not be entitled to receive any dividends of or
other distributions from the Fund unless all accumulated dividends on
outstanding shares of AMPS and any other preferred stock have been paid, and
unless asset coverage (as defined in the 1940 Act) with respect to such AMPS and
any other preferred stock would be at least 200% after giving effect to such
distributions. See "Description of
31
<PAGE>
AMPS--Dividends--Restrictions on Dividends and Other Payments" herein and in the
statement of additional information.
The Fund engages in a continuous offering of its common stock. No market
presently exists for the common stock and it is not currently expected that a
secondary market will develop. Since the common stock may not be considered
readily marketable, the Board of Directors of the Fund presently intends, but is
not required, to make tender offers on a quarterly basis to purchase the common
stock from shareholders at the net asset value per share. The repurchase of
common stock pursuant to tender offers may require that the Fund redeem all or a
portion of outstanding shares of preferred stock, including the AMPS. See
"Description of AMPS--Redemption" herein and in the statement of additional
information.
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
PREFERRED STOCK
Under the Fund's Articles Supplementary specifying the powers, preferences
and rights of the AMPS, the Fund is authorized to issue an aggregate of 40,000
shares of AMPS, designated respectively: 8,000 shares of Series A AMPS, 8,000
shares of Series B AMPS, 8,000 shares of Series C AMPS, 8,000 shares of Series D
AMPS and 8,000 shares of Series E AMPS. See "Description of AMPS" herein and in
the statement of additional information. The Series A AMPS are the only series
currently offered and to be issued and outstanding. Under the 1940 Act, the Fund
is permitted to have outstanding more than one series of preferred stock as long
as no single series has priority over another series as to the distribution of
assets of the Fund or the payment of dividends. Neither holders of common stock
nor holders of preferred stock have pre-emptive rights to purchase any shares of
AMPS or any other preferred stock that might be issued. It is anticipated that
the net asset value per share of the AMPS will equal its original purchase price
per share plus accumulated dividends per share.
CERTAIN PROVISIONS OF THE CHARTER
The Fund's Charter includes provisions that could have the effect of
limiting the ability of other entities or persons to acquire control of the Fund
or to change the composition of its Board of Directors and could have the effect
of depriving shareholders of an opportunity to sell their shares at a premium
over prevailing market prices by discouraging a third party from seeking to
obtain control of the Fund. A Director may be removed from office with or
without cause by vote of the holders of at least 66 2/3% of the shares of
capital stock entitled to be voted on the matter. A Director elected by all of
the holders of capital stock may be removed only by action of such holders, and
a director elected by the holders of AMPS and any other preferred stock may be
removed only by action of AMPS and any other preferred stock.
In addition, the Charter 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 all of the votes
entitled to be cast by shareholders of the Fund, voting as a single class,
32
<PAGE>
is required. Such approval, adoption or authorization of the foregoing would
also require the favorable vote of at least a majority of the Fund's shares of
preferred stock then entitled to be voted, including the AMPS, voting as a
separate class.
In addition, conversion of the Fund to an open-end investment company would
require an amendment to the Fund's Charter. The amendment would have to be
declared advisable by the Board of Directors prior to its submission to
shareholders. Such an amendment would require the favorable vote of the holders
of at least 66 2/3% of the Fund's outstanding shares of capital stock (including
the AMPS and any other preferred stock) entitled to be voted on the matter,
voting as a single class (or a majority of such shares if the amendment was
previously approved, adopted or authorized by at least two-thirds of the total
number of Directors fixed in accordance with the by-laws), and, while shares of
preferred stock are outstanding, the affirmative vote of at least a majority of
outstanding shares of preferred stock of the Fund (including the AMPS), voting
as a separate class. Such a vote also would satisfy a separate requirement in
the 1940 Act that the change be approved by the shareholders. Shareholders of an
open-end investment company may require the company to redeem their shares of
common stock at any time (except in certain circumstances as authorized by or
under the 1940 Act) at their net asset value, less such redemption charge, if
any, as might be in effect at the time of a redemption. All redemptions will be
made in cash. If the Fund is converted to an open-end investment company, it
could be required to liquidate portfolio securities to meet requests for
redemption. Conversion to an open-end investment company would also require
redemption of all outstanding shares of preferred stock (including the AMPS) and
would require changes in certain of the Fund's investment policies and
restrictions, such as those relating to the issuance of senior securities and
the borrowing of money.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of shareholders generally.
Reference should be made to the Articles of Incorporation on file with the
Securities and Exchange Commission for the full text of these provisions.
CUSTODIAN
The Fund's securities and cash are held under a custody agreement with The
Bank of New York, 90 Washington Street, New York, New York 10286.
PLAN OF DISTRIBUTION
The AMPS are being offered on a continuing basis by the Fund through Merrill
Lynch, which has agreed to use its best efforts to solicit purchasers of the
AMPS.
The AMPS are being offered at the price of $25,000 per share and Merrill
Lynch will receive no commission or discount in connection with the sale of
AMPS. The Fund reserves the sole right to withdraw, cancel or modify the offer
without notice and may reject orders to purchase AMPS in whole or in part.
Merrill Lynch has the right, in its discretion reasonably exercised, to reject
any proposed purchase of AMPS in whole or in part.
Merrill Lynch will act in Auctions as a Broker-Dealer as set forth under
"The Auction--General Broker-Dealer Agreements" in the statement of additional
information and will be entitled to fees for services as a Broker-Dealer as set
forth under "Description of AMPS-- Broker-Dealers" herein. Merrill Lynch also
may provide information to be used in ascertaining the Reference Rate.
Merrill Lynch is an affiliate of the Investment Adviser and may receive a
portion of the fee paid to the Investment Adviser pursuant to the Administration
Agreement for administrative services rendered in connection with the shares of
AMPS. See "Investment Advisory and Administrative Arrangements" herein and in
the statement of additional information.
33
<PAGE>
The Fund anticipates that Merrill Lynch from time to time may act as a
broker in connection with the execution of the Fund's portfolio transactions.
The Fund and the Investment Adviser have agreed to indemnify Merrill Lynch
against certain liabilities including liabilities under the 1933 Act.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The Transfer Agent, Dividend Disbursing Agent and Registrar for the shares
of AMPS will be IBJ Whitehall Bank & Trust Company. The Transfer Agent, Dividend
Disbursing Agent and Shareholder Servicing Agent for the shares of common stock
is Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, a wholly-owned subsidiary of ML & Co.
LEGAL OPINIONS
Certain legal matters in connection with the AMPS offered hereby will be
passed upon for the Fund and Merrill Lynch by Brown & Wood LLP, One World Trade
Center, New York, New York 10048-0557.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
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"). Like other investment
companies and financial and business organizations, 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.
34
<PAGE>
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<S> <C>
Investment Objective And Policies........................................ 3
Investment Restrictions.................................................. 7
Description of AMPS...................................................... 9
The Auction.............................................................. 18
Rating Agency Guidelines................................................. 18
Directors and Officers................................................... 26
Investment Advisory and Administrative Arrangements...................... 28
Portfolio Transactions................................................... 30
Taxes.................................................................... 31
Net Asset Value.......................................................... 36
Financial Statements..................................................... 36
Additional Information................................................... 36
Appendix A--Ratings of Municipal Bonds................................... A-1
Appendix B--Settlement Procedures........................................ B-1
Appendix C--Auction Procedures........................................... C-1
</TABLE>
35
<PAGE>
GLOSSARY
"'AA' (AA) COMPOSITE COMMERCIAL PAPER RATE", on any Valuation Date, means
(i) the Interest Equivalent of the rate on commercial paper placed on behalf of
issuers whose corporate bonds are rated "AA" by S&P or "Aa" by Moody's or the
equivalent of such rating by another nationally recognized statistical rating
organization, as such rate is made available on a discount basis or otherwise by
the Federal Reserve Bank of New York for the Business Day immediately preceding
such date, or (ii) in the event that the Federal Reserve Bank of New York does
not make available such a rate, then the arithmetic average of the Interest
Equivalent of the rate on commercial paper placed on behalf of such issuers, as
quoted on a discount basis or otherwise by Merrill Lynch, Pierce, Fenner & Smith
Incorporated or its successors that are Commercial Paper Dealers, to the Auction
Agent for the close of business on the Business Day immediately preceding such
date. If one of the Commercial Paper Dealers does not quote a rate required to
determine the "AA" Composite Commercial Paper Rate, the "AA" Composite
Commercial Paper Rate will be determined on the basis of the quotation or
quotations furnished by any Substitute Commercial Paper Dealer or Substitute
Commercial Paper Dealers selected by the Fund to provide such rate or rates not
being supplied by the Commercial Paper Dealer. If the number of Dividend Period
days shall be (i) 7 or more but fewer than 49 days, such rate shall be the
Interest Equivalent of the 30-day rate on such commercial paper; (ii) 49 or more
but fewer than 70 days, such rate shall be the Interest Equivalent of the 60-day
rate on such commercial paper; (iii) 70 or more days but fewer than 85 days,
such rate shall be the arithmetic average of the Interest Equivalent of the
60-day and 90-day rates on such commercial paper; (iv) 85 or more days but fewer
than 99 days, such rate shall be the Interest Equivalent of the 90-day rate on
such commercial paper; (v) 99 or more days but fewer than 120 days, such rate
shall be the arithmetic average of the Interest Equivalent of the 90-day and
120-day rates on such commercial paper; (vi) 120 or more days but fewer than 141
days, such rate shall be the Interest Equivalent of the 120-day rate on such
commercial paper; (vii) 141 or more days but fewer than 162 days, such rate
shall be the arithmetic average of the Interest Equivalent of the 120-day and
180-day rates on such commercial paper; and (viii) 162 or more days but fewer
than 183 days, such rate shall be the Interest Equivalent of the 180-day rate on
such commercial paper.
"ADDITIONAL DIVIDEND" has the meaning set forth on page 17 of this
prospectus.
"AGENT MEMBER" means the member of the Securities Depository that will act
on behalf of a Beneficial Owner of one or more shares of AMPS or on behalf of a
Potential Beneficial Owner.
"AMPS" means the Auction Market preferred stock, Series A, the Auction
Market Preferred Stock, Series B, the Auction Market Preferred Stock, Series C,
the Auction Market Preferred Stock, Series D and the Auction Market Preferred
Stock, Series E, each with a par value of $.10 per share and a liquidation
preference of $25,000 per share plus an amount equal to accumulated but unpaid
dividends thereon (whether or not earned or declared), of the Fund.
"AMPS BASIC MAINTENANCE AMOUNT" has the meaning set forth on page 18 of this
prospectus.
"AMPS BASIC MAINTENANCE CURE DATE" has the meaning set forth on page 18 of
this prospectus.
"AMPS BASIC MAINTENANCE REPORT" has the meaning set forth on page 14 of the
statement of additional information.
"ANTICIPATION NOTES" means the following Municipal Bonds: revenue
anticipation notes, tax anticipation notes, tax and revenue anticipation notes,
grant anticipation notes and bond anticipation notes.
"APPLICABLE PERCENTAGE" has the meaning set forth on page 22 of this
prospectus.
"APPLICABLE RATE" means the rate per annum at which cash dividends are
payable on shares of AMPS for any Dividend Period.
36
<PAGE>
"ARTICLES SUPPLEMENTARY" means the Articles Supplementary of the Fund
specifying the powers, preferences and rights of the shares of AMPS.
"AUCTION" means a periodic operation of the Auction Procedures.
"AUCTION AGENT" means IBJ Whitehall Bank & Trust Company unless and until
another commercial bank, trust company or other financial institution appointed
by a resolution of the Board of Directors of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend disbursing agent and redemption agent for
the AMPS.
"AUCTION AGENT AGREEMENT" means the agreement entered into between the Fund
and the Auction Agent which provides, among other things, that the Auction Agent
will follow the Auction Procedures for the purpose of determining the Applicable
Rate.
"AUCTION DATE" has the meaning set forth on pages 20 to 21 of this
prospectus.
"AUCTION PROCEDURES" means the procedures for conducting Auctions set forth
in Appendix C to the statement of additional information.
"AVAILABLE AMPS" has the meaning set forth on page 24 of this prospectus.
"BENEFICIAL OWNER" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or if applicable, the Auction Agent) as a holder
of shares of AMPS or a Broker-Dealer that holds AMPS for its own account.
"BID" has the meaning set forth on page 21 of this prospectus.
"BIDDER" has the meaning set forth on pages 21 to 22 of this prospectus.
"BOARD OF DIRECTORS" or "BOARD" means the Board of Directors of the Fund.
"BROKER-DEALER" means any broker-dealer, or other entity permitted by law to
perform the functions required of a Broker-Dealer in the Auction Procedures,
that has been selected by the Fund and has entered into a Broker-Dealer
Agreement with the Auction Agent that remains effective.
"BROKER-DEALER AGREEMENT" means an agreement entered into between the
Auction Agent and a Broker-Dealer, including Merrill Lynch, Pierce, Fenner &
Smith Incorporated, pursuant to which such Broker-Dealer agrees to follow the
Auction Procedures.
"BUSINESS DAY" means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in The
City of New York are authorized or obligated by law to close.
"CEDE" means Cede & Co., the nominee of DTC, and in whose name the shares of
AMPS initially will be registered.
"CHARTER" means the Articles of Incorporation, as amended and supplemented
(including the Articles Supplementary), of the Fund.
"CODE" means the Internal Revenue Code of 1986, as amended.
"COMMERCIAL PAPER DEALERS" means Merrill Lynch, Pierce, Fenner & Smith
Incorporated and such other commercial paper dealer or dealers as the Fund from
time to time may appoint or, in lieu thereof, their respective affiliates and
successors.
"COMMON STOCK" means the common stock, par value $.10 per share, of the
Fund.
"DATE OF ORIGINAL ISSUE" means, with respect to each share of AMPS, the date
on which such share first is issued by the Fund.
37
<PAGE>
"DEPOSIT SECURITIES" means cash and Municipal Bonds rated at least A, P1,
VMIG-1 or MIG1 by Moody's or A, A1+ or SP1+ by S&P.
"DISCOUNT FACTOR" means a Moody's Discount Factor or an S&P Discount Factor,
as the case may be.
"DISCOUNTED VALUE" of any asset of the Fund means (i) with respect to an S&P
Eligible Asset, the quotient of the market value thereof divided by the
applicable S&P Discount Factor and (ii) with respect to a Moody's Eligible
Asset, the lower of par and the quotient of the market value thereof divided by
the applicable Moody's Discount Factor.
"DIVIDEND PAYMENT DATE" has the meaning set forth on page 14 of this
prospectus.
"DIVIDEND PERIODS" has the meaning set forth on page 14 of this prospectus.
"DTC" means The Depository Trust Company.
"ELIGIBLE ASSETS" means Moody's Eligible Assets or S&P Eligible Assets, as
the case may be.
"EXISTING HOLDER" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of shares of AMPS
in the records of the Auction Agent.
"FITCH" means Fitch IBCA, Inc. or its successors.
"FORWARD COMMITMENTS" has the meaning set forth on page 25 of the statement
of additional information.
"FUND" means Merrill Lynch Municipal Strategy Fund, Inc., a Maryland
corporation that is the issuer of the AMPS.
"HOLD ORDER" has the meaning set forth on page 21 of this prospectus.
"INITIAL DIVIDEND PAYMENT DATE" means the Initial Dividend Payment Date as
determined by the Board of Directors of the Fund with respect to each series of
AMPS.
"INITIAL DIVIDEND PERIOD" means, with respect to the AMPS, the period from
and including the first Date of Original Issue for each series of AMPS to but
excluding the Initial Dividend Payment Date for each series of AMPS.
"INITIAL MARGIN" means the amount of cash or securities deposited with a
broker as a margin payment at the time of purchase or sale of a financial
futures contract.
"INTEREST EQUIVALENT" means a yield on a 360-day basis of a discount basis
security which is equal to the yield on an equivalent interest-bearing security.
"INVESTMENT ADVISER" means Fund Asset Management, L.P.
"IRS" means the United States Internal Revenue Service.
"LONG TERM DIVIDEND PERIOD" means a dividend period of one whole year or
more but not greater than five years.
"MANDATORY REDEMPTION PRICE" has the meaning set forth on pages 18 to 19 of
this prospectus.
"MARGINAL TAX RATE" means the maximum marginal regular Federal individual
income tax rate applicable to ordinary income or the maximum marginal regular
Federal corporate income tax rate, whichever is greater.
"MAXIMUM APPLICABLE RATE" has the meaning set forth on page 22 of this
prospectus.
"MAXIMUM POTENTIAL ADDITIONAL DIVIDEND LIABILITY" has the meaning set forth
on page 14 of the statement of additional information.
38
<PAGE>
"MOODY'S" means Moody's Investors Service, Inc. or its successors.
"MOODY'S DISCOUNT FACTOR" has the meaning set forth on page 21 of the
statement of additional information.
"MOODY'S ELIGIBLE ASSETS" means assets eligible for inclusion by Moody's in
the calculation of the Discounted Value of the Fund's portfolio as set forth on
page 21 of the statement of additional information.
"MOODY'S EXPOSURE PERIOD" means a period that is the same length or longer
than the number of days used in calculating the cash dividend component of the
AMPS Basic Maintenance Amount and initially shall be the period commencing on
and including a given Valuation Date and ending 48 days thereafter.
"MOODY'S HEDGING TRANSACTIONS" has the meaning set forth on page 23 of the
statement of additional information.
"MOODY'S VOLATILITY FACTOR" means 272% as long as there has been no increase
enacted to the Marginal Tax Rate. If such an increase is enacted but not yet
implemented, the Moody's Volatility Factor shall be as follows:
<TABLE>
<CAPTION>
% CHANGE IN MOODY'S
MARGINAL TAX VOLATILITY
RATE FACTOR
------------------------- ------------
<S> <C>
5% 292%
greater than 5% but less than or equal to 10% 313%
greater than 10% but less than or equal to 15% 338%
greater than 15% but less than or equal to 20% 364%
greater than 20% but less than or equal to 25% 396%
greater than 25% but less than or equal to 30% 432%
greater than 30% but less than or equal to 35% 472%
greater than 35% but less than or equal to 40% 520%
</TABLE>
Notwithstanding the foregoing, the Moody's Volatility Factor may mean such
other potential dividend rate increase factor as Moody's advises the Fund in
writing is applicable.
"MUNICIPAL BONDS" has the meaning set forth on page 9 of this prospectus.
"MUNICIPAL INDEX" has the meaning set forth on page 20 of the statement of
additional information.
"1940 ACT" means the Investment Company Act of 1940, as amended from time to
time.
"1940 ACT AMPS ASSET COVERAGE" has the meaning set forth on page 17 of this
prospectus.
"1940 ACT CURE DATE" has the meaning set forth on page 17 of this
prospectus.
"NON-CALL PERIOD" has the meaning set forth under "Specific Redemption
Provision" below.
"NON-PAYMENT PERIOD" has the meaning set forth on page 12 of the statement
of additional information.
"NON-PAYMENT PERIOD RATE" has the meaning set forth on page 12 of the
statement of additional information.
"NOTICE OF REVOCATION" has the meaning set forth on page 11 of the statement
of additional information.
"NOTICE OF SPECIAL DIVIDEND PERIOD" has the meaning set forth on page 16 of
this prospectus.
39
<PAGE>
"OPTIONAL REDEMPTION PRICE" has the meaning set forth on page 18 of this
prospectus.
"ORDER" has the meaning set forth on page 21 of this prospectus.
"POTENTIAL BENEFICIAL OWNER" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of shares of AMPS but that wishes
to purchase such shares, or that is a Beneficial Owner that wishes to purchase
additional shares of AMPS.
"POTENTIAL HOLDER" means any Broker-Dealer or any such other person as may
be permitted by the Fund, including any Existing Holder, who may be interested
in acquiring shares of AMPS (or, in the case of an Existing Holder, additional
shares of AMPS).
"PREFERRED STOCK" means preferred stock, par value $.10 per share, of the
Fund.
"PREMIUM CALL PERIOD" has the meaning set forth under "Specific Redemption
Provision" below.
"RECEIVABLES FOR MUNICIPAL BONDS SOLD," for purposes of determining S&P
Eligible Assets, has the meaning set forth on page 19 of the statement of
additional information.
"RECEIVABLES FOR MUNICIPAL BONDS SOLD," for purposes of determining Moody's
Eligible Assets, has the meaning set forth on page 22 of the statement of
additional information.
"REFERENCE RATE" means: (i) with respect to a Dividend Period or a Short
Term Dividend Period having 28 or fewer days, the higher of the applicable "A"
Composite Commercial Paper Rate and the Taxable Equivalent of the Short Term
Municipal Bond Rate, (ii) with respect to any Short Term Dividend Period, having
more than 28 but fewer than 183 days, the applicable "AA" Composite Commercial
Paper Rate, (iii) with respect to any Short Term Dividend Period having 183 or
more but fewer than 364 days, the applicable U.S. Treasury Bill Rate and (iv)
with respect to any Long Term Dividend Period, the applicable U.S. Treasury Note
Rate.
"REQUEST FOR SPECIAL DIVIDEND PERIOD" has the meaning set forth on page 15
of this prospectus.
"RESPONSE" has the meaning set forth on pages 15 to 16 of this prospectus.
"RETROACTIVE TAXABLE ALLOCATION" has the meaning set forth on page 16 of
this prospectus.
"S&P" means Standard & Poor's, a division of The McGraw-Hill Companies,
Inc., or its successors.
"S&P DISCOUNT FACTOR" has the meaning set forth on page 18 of the statement
of additional information.
"S&P ELIGIBLE ASSETS" means assets eligible for inclusion by S&P in the
calculation of the Discounted Value of the Fund's portfolio as set forth on page
18 of the statement of additional information.
"S&P EXPOSURE PERIOD" means the maximum period of time following a Valuation
Date, including the Valuation Date and the AMPS Basic Maintenance Cure Date,
that the Fund has under the Articles Supplementary to cure any failure to
maintain, as of such Valuation Date, a Discounted Value for its portfolio at
least equal to the AMPS Basic Maintenance Amount.
"S&P HEDGING TRANSACTIONS" has the meaning set forth on page 20 of the
statement of additional information.
"S&P VOLATILITY FACTOR" means 277% or such other potential dividend rate
increase factor as S&P advises the Fund in writing is applicable.
"SECURITIES DEPOSITORY" means The Depository Trust Company and its
successors and assigns or any successor securities depository selected by the
Fund that agrees to follow the procedures required to be followed by such
securities depository in connection with shares of AMPS.
40
<PAGE>
"SELL ORDER" has the meaning set forth on page 21 of this prospectus.
"7-DAY DIVIDEND PERIOD" means a Dividend Period consisting of seven days.
"SHORT TERM DIVIDEND PERIOD" means a dividend period the number of days in
which are evenly divisible by seven, and not fewer than seven days nor more than
364 days.
"SPECIAL DIVIDEND PERIOD" has the meaning set forth on page 14 of this
prospectus.
"SPECIFIC REDEMPTION PROVISIONS" means, with respect to a Special Dividend
Period, either, or any combination of, (i) a period (a "Non-Call Period")
determined by the Board of Directors of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during which the shares of AMPS subject to
such Dividend Period shall not be subject to redemption at the option of the
Fund and (ii) a period (a "Premium Call Period"), consisting of a number of
whole years and determined by the Board of Directors of the Fund, after
consultation with the Auction Agent and the Broker-Dealers, during each year of
which the shares of AMPS subject to such Dividend Period shall be redeemable at
the Fund's option at a price per share equal to $25,000 plus accumulated but
unpaid dividends plus a premium expressed as a percentage of $25,000, as
determined by the Board of Directors of the Fund after consultation with the
Auction Agent and the Broker-Dealers.
"SUBMISSION DEADLINE" has the meaning set forth on page 23 of this
prospectus.
"SUBMITTED BID" has the meaning set forth on page 24 of this prospectus.
"SUBMITTED HOLD ORDER" has the meaning set forth on page 24 of this
prospectus.
"SUBMITTED ORDER" has the meaning set forth on page 24 of this prospectus.
"SUBMITTED SELL ORDER" has the meaning set forth on page 24 of this
prospectus.
"SUBSEQUENT DIVIDEND PERIOD" means each Dividend Period after the Initial
Dividend Period.
"SUBSTITUTE RATING AGENCY" and "SUBSTITUTE RATING AGENCIES" shall mean a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations, respectively, selected by Merrill
Lynch, Pierce, Fenner & Smith Incorporated, or its respective affiliates and
successors, after consultation with the Fund, to act as a substitute rating
agency or substitute rating agencies, as the case may be, to determine the
credit ratings of the AMPS.
"SUFFICIENT CLEARING BIDS" has the meaning set forth on page 24 of this
prospectus.
"TAXABLE EQUIVALENT OF THE SHORT-TERM MUNICIPAL BOND RATE" on any date means
90% of the quotient of (A) the per annum rate expressed on an interest
equivalent basis equal to the Kenny S&P 30-day High Grade Index (the "Kenny
Index"), or any successor index made available for the Business Day immediately
preceding such date but in any event not later than 8:30 A.M., Eastern time, on
such date by Kenny Information Systems Inc. or any successor thereto, based upon
30-day yield evaluations at par of bonds the interest on which is excludable for
regular Federal income tax purposes under the Code of "high grade" component
issuers selected by Kenny Information Systems Inc. or any such successor from
time to time in its discretion, which component issuers shall include, without
limitation, issuers of general obligation bonds but shall exclude any bonds the
interest on which constitutes an item of tax preference under Section 57(a) (5)
of the Code, or successor provisions, for purposes of the "alternative minimum
tax," divided by (B) 1.00 minus the Marginal Tax Rate (expressed as a decimal);
provided, however, that if the Kenny Index is not made so available by 8:30
A.M., Eastern time, on such date by Kenny Information Systems Inc. or any
successor, the Taxable Equivalent of the Short-Term Municipal Bond Rate shall
mean the quotient of (A) the per annum rate expressed on an interest equivalent
basis equal to the most recent Kenny Index so made available for any preceding
Business Day, divided by (B) 1.00 minus the Marginal Tax Rate (expressed as a
decimal). The Fund may not utilize a successor index to the Kenny Index unless
Moody's and S&P provide the Fund with written
41
<PAGE>
confirmation that the use of such successor index will not adversely affect the
then-current respective Moody's and S&P ratings of the AMPS.
"TREASURY BONDS" has the meaning set forth on page 20 of the statement of
additional information.
"28-DAY DIVIDEND PERIOD" means a Dividend Period consisting of 28 days.
"U.S. TREASURY BILL RATE" on any date means (i) the Interest Equivalent of
the rate on the actively traded Treasury Bill with a maturity most nearly
comparable to the length of the related Dividend Period, as such rate is made
available on a discount basis or otherwise by the Federal Reserve Bank of New
York in its Composite 3:30 P.M. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Bill Rate on such date. "Alternate Treasury Bill Rate" on
any date means the Interest Equivalent of the yield as calculated by reference
to the arithmetic average of the bid price quotations of the actively traded
Treasury Bill with a maturity most nearly comparable to the length of the
related Dividend Period, as determined by bid price quotations as of any time on
the Business Day immediately preceding such date, obtained from at least three
recognized primary U.S. Government securities dealers selected by the Auction
Agent.
"U.S. TREASURY NOTE RATE" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 P.M. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Note Rate on such date. "Alternate Treasury Note Rate" on
any date means the yield as calculated by reference to the arithmetic average of
the bid price quotations of the actively traded, current coupon Treasury Note
with a maturity most nearly comparable to the length of the related Dividend
Period, as determined by the bid price quotations as of any time on the Business
Day immediately preceding such date, obtained from at least three recognized
primary U.S. Government securities dealers selected by the Auction Agent.
"VALUATION DATE" has the meaning set forth on page 18 of this prospectus.
"VARIATION MARGIN" means, in connection with an outstanding financial
futures contract owned or sold by the Fund, the amount of cash or securities
paid to or received from a broker (subsequent to the Initial Margin payment)
from time to time as the price of such financial futures contract fluctuates.
"WINNING BID RATE" has the meaning set forth on page 25 of this prospectus.
42
<PAGE>
- ---------------------------------------------------------
- ---------------------------------------------------------
$92,000,000
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUCTION MARKET PREFERRED STOCK-REGISTERED TRADEMARK-
["AMPS-REGISTERED TRADEMARK-"]
3,680 SHARES, SERIES A
---------------------
PROSPECTUS
---------------------
MERRILL LYNCH & CO.
FEBRUARY 19, 1999
- -REGISTERED TRADEMARK- REGISTERED TRADEMARKS OF MERRILL LYNCH & CO. INC.
- ---------------------------------------------------------
- ---------------------------------------------------------
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
$92,000,000
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
AUCTION MARKET PREFERRED STOCK ["AMPS-REGISTERED TRADEMARK-"]
3,680 SHARES, SERIES A - LIQUIDATION PREFERENCE $25,000 PER SHARE
------------------
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is a continuously
offered, non-diversified, closed-end management investment company that seeks to
provide shareholders of its common stock with as high a level of current income
exempt from Federal income taxes as is consistent with its investment policies.
The Fund seeks to achieve its investment objective by investing primarily in a
portfolio of long-term, investment grade municipal obligations, the interest on
which, in the opinion of bond counsel to the issuer, is exempt from Federal
income taxes. The Fund intends to maintain at least 75% of its total assets in
municipal obligations that are rated investment grade or, if unrated, are
considered by Fund Asset Management, L.P. (the "Investment Adviser") to be of
comparable quality. The Fund may invest up to 25% of its total assets in
municipal obligations that are rated below investment grade (such obligations
are commonly referred to as "junk bonds") or, if unrated, are considered by the
Investment Adviser to be of comparable quality. The Fund may invest in certain
tax-exempt securities that are classified as "private activity bonds" that may
subject certain investors in the Fund to the alternative minimum tax. At times,
the Fund may seek to hedge its portfolio through the use of options and futures
transactions. There can be no assurance that the investment objective of the
Fund will be realized. For more information on the Fund's investment objective
and policies, see "Investment Objective and Policies" herein and in the
prospectus.
------------------------
Certain capitalized terms not otherwise defined in this statement of
additional information have the meaning provided in the Glossary included as
part of the prospectus.
This statement of additional information is not a prospectus, but should be
read in conjunction with the prospectus of the Fund which has been filed with
the Securities and Exchange Commission (the "Commission") and can be obtained,
without charge, by calling (800) 637-3863. The prospectus is incorporated by
reference into this statement of additional information, and this statement of
additional information is incorporated by reference into the prospectus.
- ------------------------
- -Registered Trademark-Registered Trademark of Merrill Lynch & Co., Inc.
---------------
MERRILL LYNCH & CO.
---------------
The date of this statement of additional information is February 19, 1999.
<PAGE>
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<S> <C>
Investment Objective and Policies........................................ 3
Investment Restrictions.................................................. 7
Description of AMPS...................................................... 9
The Auction.............................................................. 18
Rating Agency Guidelines................................................. 18
Directors and Officers................................................... 26
Investment Advisory and Administrative Arrangements...................... 28
Portfolio Transactions................................................... 30
Taxes.................................................................... 31
Net Asset Value.......................................................... 36
Financial Statements..................................................... 36
Additional Information................................................... 36
Appendix A--Ratings of Municipal Bonds................................... A-1
Appendix B--Settlement Procedures........................................ B-1
Appendix C--Auction Procedures........................................... C-1
</TABLE>
2
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders of its
common stock with as high a level of current income exempt from Federal income
taxes as is consistent with its investment policies. The Fund seeks to achieve
its investment objective by investing primarily in a portfolio of long-term,
investment grade municipal obligations, the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal income taxes. The investment
objective of the Fund is a fundamental policy of the Fund and, therefore, may
not be changed without a vote of a majority of the outstanding voting securities
of the Fund, as defined below under "Investment Restrictions." There can be no
assurance that the investment objective of the Fund will be realized. At times
the Fund may seek to hedge its portfolio through the use of futures transactions
and options to reduce volatility in the net asset value of its shares of common
stock.
The Fund, at all times, except during interim and temporary periods, will
invest at least 80% of its total assets in a portfolio of obligations issued by
or on behalf of states, territories and possessions of the United States and
their political subdivisions, agencies or instrumentalities paying interest
which, in the opinion of bond counsel to the issuer, is exempt from Federal
income taxes ("Municipal Bonds"). The Fund, at all times, except during
temporary periods, will maintain at least 75% of its total assets in Municipal
Bonds that are rated investment grade by a nationally recognized statistical
rating organization or, if unrated, are considered to be of comparable quality
by the Fund's investment adviser, Fund Asset Management, L.P. (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 dividends that are exempt
from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in Municipal Bonds, to the extent such
investments are permitted by the 1940 Act. Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term Municipal Bonds. Certain Non-Municipal
Tax-Exempt Securities may be characterized as derivative instruments.
Non-Municipal Tax-Exempt Securities will be considered "Municipal Bonds" for
purposes of the Fund's investment objective and policies.
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 Statement of
Additional Information, 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.
3
<PAGE>
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 a state's industrial base or inability to attract
new industries, economic limits on the ability to tax without eroding the tax
base, state legislative proposals or voter initiatives to limit ad valorem real
property taxes, and the extent to which the entity relies on Federal or state
aid, access to capital markets or other factors beyond a state's or entity's
control. Revenue or special obligation bonds are payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source such
as from the user of the facility being financed. IDBs are in most cases revenue
bonds and generally are not secured by a pledge of the credit or taxing power of
the issuer of such bonds. The payment of the principal and interest on such
industrial development bonds depends solely on the ability of the user of the
facility financed by the bonds to meet its financial obligations and the pledge,
if any, of real and personal property so financed as security for such payment.
Municipal Bonds also may include "moral obligation" bonds, which normally are
issued by special purpose public authorities. If an issuer of moral obligation
bonds is unable to meet its obligations, the repayment of such bonds becomes a
moral commitment but not a legal obligation of the state or municipality in
question.
The Fund may purchase Municipal Bonds classified as "private activity bonds"
(in general, bonds that benefit non-governmental entities). Interest received on
certain tax-exempt securities that are classified as "private activity bonds"
may subject certain investors in the Fund to an alternative minimum tax. See
"Taxes--General." There is no limitation on the percentage of the Fund's assets
that may be invested in Municipal Bonds that may subject certain investors to an
alternative minimum tax. Also included within the general category of Municipal
Bonds are participation certificates issued by government authorities or
entities to finance the acquisition or construction of equipment, land and/or
facilities. The certificates represent participation in a lease, an installment
purchase contract or a conditional sales contract (hereinafter collectively
referred to as "lease obligations") relating to such equipment, land or
facilities. Although lease obligations do not constitute general obligations of
the issuer for which the issuer's unlimited taxing power is pledged, a lease
obligation frequently is backed by the issuer's covenant to budget for,
appropriate and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses, which provide
that the issuer has no obligation to make lease or installment purchase payments
in future years unless money is appropriated for such purpose on a yearly basis.
Although "non-appropriation" lease obligations are secured by the leased
property, disposition of the property in the event of foreclosure might prove
difficult. These securities represent a relatively new type of financing that
has not yet developed the depth of marketability associated with more
conventional securities.
Federal tax legislation has limited the types and volume of bonds qualifying
for a Federal income tax exemption of interest. As a result, this legislation
and legislation that may be enacted in the future may affect the availability of
Municipal Bonds for investment by the Fund.
OPTIONS AND FUTURES TRANSACTIONS
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
4
<PAGE>
security covered by the option from the Fund at the stated exercise price until
the option expires. The Fund writes only covered call options, which means that
so long as the Fund is obligated as the writer of a call option, it will own the
underlying securities subject to the option. The Fund may not write covered call
options on underlying securities in an amount exceeding 15% of the market value
of its total assets.
The Fund will receive a premium from writing a call option, which increases
the Fund's return on the underlying security in the event the option expires
unexercised or is closed out at a profit. By writing a call, the Fund limits its
opportunity to profit from an increase in the market value of the underlying
security above the exercise price of the option for as long as the Fund's
obligation as a writer continues. Covered call options serve as a partial hedge
against a decline in the price of the underlying security. The Fund may engage
in closing transactions in order to terminate outstanding options that it has
written.
PURCHASE OF OPTIONS. The Fund may purchase put options in connection with
its hedging activities. By buying a put the Fund has a right to sell the
underlying security at the exercise price, thus limiting the Fund's risk of loss
through a decline in the market value of the security until the put expires. The
amount of any appreciation in the value of the underlying security will be
partially offset by the amount of the premium paid for the put option and any
related transaction costs. Prior to its expiration, a put option may be sold in
a closing sale transaction; profit or loss from the sale will depend on whether
the amount received is more or less than the premium paid for the put option
plus the related transaction costs. A closing sale transaction cancels out the
Fund's position as the purchaser of an option by means of an offsetting sale of
an identical option prior to the expiration of the option it has purchased. In
certain circumstances, the Fund may purchase call options on securities held in
its portfolio on which it has written call options or on securities that it
intends to purchase. The Fund will not purchase options on securities if, as a
result of such purchase, the aggregate cost of all outstanding options on
securities held by the Fund would exceed 5% of the market value of the Fund's
total assets.
FINANCIAL FUTURES CONTRACTS AND OPTIONS. The Fund is authorized to purchase
and sell financial futures contracts and options thereon solely for the purpose
of hedging its investments in Municipal Bonds against declines in value and to
hedge against increases in the cost of securities it intends to purchase. A
financial futures contract obligates the seller of a contract to deliver and the
purchaser of a contract to take delivery of the type of financial instrument
covered by the contract or, in the case of index-based financial futures
contracts, to make and accept a cash settlement, at a specific future time for a
specified price. A sale of financial futures contracts may provide a hedge
against a decline in the value of portfolio securities because such depreciation
may be offset, in whole or in part, by an increase in the value of the position
in the financial futures contracts. A purchase of financial futures contracts
may provide a hedge against an increase in the cost of securities intended to be
purchased because such appreciation may be offset, in whole or in part, by an
increase in the value of the position in the financial futures contracts.
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker equal to
approximately 5% of the contract amount must be deposited with the broker. This
amount is known as initial margin. Subsequent payments to and from the broker,
called variation margin, are made on a daily basis as the price of the financial
futures contract fluctuates making the long and short positions in the financial
futures contract more or less valuable.
The Fund may purchase and sell financial futures contracts based on The Bond
Buyer Municipal Bond Index, a price-weighted measure of the market value of 40
large recently issued tax-exempt bonds, and purchase and sell put and call
options on such financial futures contracts for the purpose of hedging Municipal
Bonds that the Fund holds or anticipates purchasing against adverse changes in
interest rates. The Fund also may purchase and sell financial futures contracts
on U.S. Government
5
<PAGE>
securities and purchase and sell put and call options on such financial futures
contracts for such hedging purposes. With respect to U.S. Government securities,
currently there are financial futures contracts based on long-term U.S. Treasury
bonds, Treasury notes, GNMA Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Directors, the Fund also may engage in
transactions in other financial futures contracts and options thereon, such as
financial futures contracts or options on other municipal bond indices that may
become available, if the Investment Adviser and the Directors of the Fund should
determine that there is normally a sufficient correlation between the prices of
such financial futures contracts and the Municipal Bonds in which the Fund
invests to make such hedging appropriate.
OVER-THE-COUNTER OPTIONS. The Fund may engage in options and futures
transactions on exchanges and in the over-the-counter markets. In general,
exchange-traded contracts are third-party contracts (i.e., performance of the
parties' obligations is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. Over-the-counter options
transactions ("OTC options") are two-party contracts with price and terms
negotiated by the buyer and seller. See "Restrictions on OTC Options" below for
information as to restrictions on the use of OTC options.
RESTRICTIONS ON OTC OPTIONS. The Fund will engage in OTC options only with
member banks of the Federal Reserve System and primary dealers in U.S.
Government securities or with affiliates of such banks or dealers that have
capital of at least $50 million or whose obligations are guaranteed by an entity
having capital of at least $50 million. OTC options and assets used to cover OTC
options written by the Fund are considered by the staff of the Commission to be
illiquid. The illiquidity of such options or assets may prevent a successful
sale of such options or assets, result in a delay of sale, or reduce the amount
of proceeds that might otherwise be realized.
RISK FACTORS IN OPTIONS AND FUTURES TRANSACTIONS. Utilization of futures
transactions involves the risk of imperfect correlation in movements in the
price of financial futures contracts and movements in the price of the security
that is the subject of the hedge. If the price of the financial futures contract
moves more or less than the price of the security that is the subject of the
hedge, the Fund will experience a gain or loss that will not be completely
offset by movements in the price of such security. There is a risk of imperfect
correlation where the securities underlying financial futures contracts have
different maturities, ratings, geographic compositions or other characteristics
than the security being hedged. In addition, the correlation may be affected by
additions to or deletions from the index that serves as a basis for a financial
futures contract. Finally, in the case of financial futures contracts on U.S.
Government securities and options on such financial futures contracts, the
anticipated correlation of price movements between the U.S. Government
securities underlying the futures or options and Municipal Bonds may be
adversely affected by economic, political, legislative or other developments
that have a disparate impact on the respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission (the "CFTC"),
the futures trading activities described herein will not result in the Fund
being deemed a "commodity pool," as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell financial futures contracts and options thereon (i) for bona
fide hedging purposes, as defined under CFTC regulations, without regard to the
percentage of the Fund's assets committed to margin and option premiums, and
(ii) for non-hedging purposes if, immediately thereafter, the sum of the amount
of initial margin deposits on the Fund's existing futures positions and option
premiums entered into for non-hedging purposes do not exceed 5% of the market
value of the liquidation value of the Fund's portfolio, after taking into
account unrealized profits and unrealized losses on any such transactions.
Margin deposits may consist of cash or securities acceptable to the broker and
the relevant contract market.
6
<PAGE>
When the Fund purchases a financial futures contract, or writes a put option
or purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., commercial paper and daily tender adjustable notes) or
short-term, high-grade, fixed-income securities in a segregated account with the
Fund's custodian so that the amount so segregated plus the amount of initial and
variation margin held in the account of its broker equals the market value of
the financial futures contract, thereby ensuring that the use of such financial
futures contract is unleveraged. It is not anticipated that transactions in
financial futures contracts will have the effect of increasing portfolio
turnover.
Although certain risks are involved in options and futures transactions, the
Investment Adviser believes that, because the Fund will engage in options and
futures transactions only for hedging purposes, the options and futures
portfolio strategies of the Fund will not subject the Fund to certain risks
frequently associated with speculation in options and futures transactions.
The volume of trading in the exchange markets with respect to Municipal Bond
options may be limited, and it is impossible to predict the amount of trading
interest that may exist in such options. In addition, there can be no assurance
that viable exchange markets will continue to be available.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a liquid
secondary market for such options or futures. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures transaction. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with whom the Fund has an open position in an option or financial
futures contract.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a financial futures contract price
during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
moved beyond the daily limit on a number of consecutive trading days.
If it is not possible to close a futures position entered into by the Fund,
the Fund would continue to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such a situation, if the Fund
has insufficient cash, it may have to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so.
The successful use of these transactions also depends on the ability of the
Investment Adviser to forecast correctly the direction and extent of interest
rate movements within a given time frame. To the extent these rates remain
stable during the period in which a financial futures contract is held by the
Fund or move in a direction opposite to that anticipated, the Fund may realize a
loss on the hedging transaction that is not fully or partially offset by an
increase in the value of portfolio securities. As a result, the Fund's total
return for such period may be less than if it had not engaged in the hedging
transaction. Furthermore, the Fund will only engage in hedging transactions from
time to time and may not necessarily be engaging in hedging transactions when
movements in interest rates occur. The Fund is under no obligation to enter into
hedging transactions and may not do so.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and may
not be changed without the approval of the holders of a majority of the Fund's
outstanding shares of common stock and the outstanding shares of AMPS and any
other preferred stock, voting as a single class, and a majority of the
outstanding shares of AMPS and any other preferred stock, voting as a separate
class (which for
7
<PAGE>
this purpose and under the 1940 Act means the lesser of (i) 67% of the shares of
each class of capital stock represented at a meeting at which more than 50% of
the outstanding shares of each class of capital stock are represented or (ii)
more than 50% of the outstanding shares of each class of capital stock). The
Fund may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, real estate limited partnerships,
commodities or commodity contracts; provided that the Fund may invest in
securities directly or indirectly secured by real estate or interests
therein or issued by companies that invest in real estate or interests
therein, and the Fund may purchase and sell financial futures contracts and
options thereon.
3. Issue senior securities or borrow money, except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended
(the "1933 Act"), in selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
Municipal Bonds and other debt securities in accordance with its investment
objective, policies and limitations.
6. Invest more than 25% of its total assets (taken at market value at
the time of each investment) in securities of issuers in a single industry;
provided that, for purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry.
Additional investment restrictions adopted by the Fund, which may be changed
by the Board of Directors without shareholder approval, provide that the Fund
may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be invested
in any one such company, (iii) 10% of the Fund's total assets, taken at
market value, would be invested in such securities, and (iv) the Fund,
together with other investment companies having the same investment adviser
and companies controlled by such companies, owns not more than 10% of the
total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as security
for indebtedness, any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned in investment restriction
(3) above or except as may be necessary in connection with transactions in
financial futures contracts and options thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on margin).
d. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund may
write, purchase and sell options and futures on Municipal Bonds, United
States Government obligations and related indices or otherwise in connection
with bona fide hedging activities and may purchase and sell Call Rights to
require mandatory tender for the purchase of related Municipal Bonds.
8
<PAGE>
For so long as shares of AMPS are rated by Moody's, the Fund will not change
these additional investment restrictions unless it receives written confirmation
from Moody's that engaging in such transactions would not impair the rating then
assigned to the shares of AMPS by Moody's.
If a percentage restriction on the investment or use of assets set forth
above is adhered to at the time a transaction is effected, later changes in
percentages resulting from changing values will not be considered a violation.
The Fund has no intention to file a voluntary application for relief under
Federal bankruptcy law or any similar application under state law for so long as
the Fund is solvent and does not foresee becoming insolvent.
The Investment Adviser and Merrill Lynch share a common parent, Merrill
Lynch & Co., Inc. ("ML & Co."). Because of the affiliation of Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch") with the Investment
Adviser, the Fund is prohibited from engaging in certain transactions involving
Merrill Lynch except pursuant to an exemptive order of the Commission or
otherwise in compliance with the provisions of the 1940 Act and the rules and
regulations thereunder. Included among such restricted transactions will be
purchases from or sales to Merrill Lynch of securities in transactions in which
Merrill Lynch acts as principal. An exemptive order has been obtained that
permits the Fund to effect principal transactions with Merrill Lynch in high
quality, short-term, tax-exempt securities subject to conditions set forth in
such order. The Fund does not presently intend to request an order permitting
other principal transactions with Merrill Lynch.
DESCRIPTION OF AMPS
CERTAIN OF THE CAPITALIZED TERMS USED HEREIN ARE DEFINED IN THE GLOSSARY
THAT APPEARS AT THE BACK OF THE PROSPECTUS.
Under the Articles Supplementary, the Fund is authorized to issue an
aggregate of 40,000 shares of AMPS, designated respectively: 8,000 shares of
Series A AMPS, 8,000 shares of Series B AMPS, 8,000 shares of Series C AMPS,
8,000 shares of Series D AMPS and 8,000 shares of Series E AMPS. The Series A
AMPS offered hereby are the only series currently offered and to be issued and
outstanding.
The AMPS will be shares of Preferred Stock that entitle their holders to
receive dividends when, as and if declared by the Board of Directors, out of
funds legally available therefor, at a rate per annum that may vary for the
successive Dividend Periods for each such series. Each Dividend Period for the
Series A AMPS will generally be a 7-Day Dividend Period; provided, however, that
prior to any Auction, the Fund may elect, subject to certain limitations
described herein, upon giving notice to holders thereof, a Special Dividend
Period. The Applicable Rate for a particular Dividend Period will be determined
by an Auction conducted on the Business Day before the start of such Dividend
Period. Beneficial Owners and Potential Beneficial Owners desiring to continue
to hold of all of their shares of AMPS regardless of the Applicable Rate
resulting from Auctions need not participate. For an explanation of Auctions and
the method of determining the Applicable Rate, see "Appendix C--Auction
Procedures."
Except as otherwise required by law or unless there is no Securities
Depository, all outstanding shares of AMPS will be represented by one or more
certificates registered in the name of the nominee of the Securities Depository
(initially expected to be Cede), and no person acquiring shares of AMPS will be
entitled to receive a certificate representing such shares. See "Appendix
C--Auction Procedures." As a result, the nominee of the Securities Depository is
expected to be the sole holder of record of the shares of AMPS. Accordingly,
each purchaser of AMPS must rely on (i) the procedures of the Securities
Depository and, if such purchaser is not a member of the Securities Depository,
such purchaser's Agent Member, to receive dividends, distributions and notices
and to exercise voting rights
9
<PAGE>
(if and when applicable) and (ii) the records of the Securities Depository and,
if such purchaser is not a member of the Securities Depository, such purchaser's
Agent Member, to evidence its beneficial ownership of shares of AMPS.
When issued and sold, the shares of AMPS will have a liquidation preference
of $25,000 per share plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) and will be fully paid and non-assessable.
See "Description of AMPS--Liquidation Rights" in the prospectus. The shares of
AMPS will not be convertible into shares of common stock or other capital stock
of the Fund, and the holders thereof will have no preemptive rights. The shares
of AMPS will not be subject to any sinking fund but will be subject to
redemption at the option of the Fund at the Optional Redemption Price on any
Dividend Payment Date (except during the Initial Dividend Period and during a
Non-Call Period) and, under certain circumstances, will be subject to mandatory
redemption by the Fund at the Mandatory Redemption Price stated herein. See
"--Redemption."
In addition to serving as the Auction Agent in connection with the Auction
Procedures described below, IBJ Whitehall Bank & Trust Company will be the
transfer agent, registrar, dividend disbursing agent and redemption agent for
the shares of AMPS. The Auction Agent, however, will serve merely as the agent
of the Fund, acting in accordance with the Fund's instructions, and will not be
responsible for any evaluation or verification of any matters certified to it.
Except in an Auction, the Fund will have the right (to the extent permitted
by applicable law) to purchase or otherwise acquire any shares of AMPS so long
as the Fund is current in the payment of dividends on AMPS and on any other
capital stock of the Fund ranking on a parity with the AMPS with respect to the
payment of dividends or upon liquidation.
The following is a brief description of the terms of the shares of AMPS.
This description does not purport to be complete and is subject to and qualified
in its entirety by reference to the Fund's Articles of Incorporation and
Articles Supplementary, including the provisions thereof establishing the AMPS.
The Fund's Articles of Incorporation and the form of Articles Supplementary
establishing the terms of the AMPS have been filed as exhibits to the
Registration Statement of which this statement of additional information is a
part.
DIVIDENDS
The holders of shares of each series of AMPS will be entitled to receive,
when, as and if declared by the Board of Directors of the Fund, out of funds
legally available therefor, cumulative cash dividends on their shares, at the
Applicable Rate determined as set forth below under "Determination of Dividend
Rate", payable on the respective dates set forth below. Dividends on the shares
of AMPS so declared and payable shall be paid (i) in preference to and in
priority over any dividends so declared and payable on the Common Stock, and
(ii) to the extent permitted under the Code and to the extent available, out of
net tax-exempt income earned on the Fund's investments. Dividends on shares of
AMPS, to the extent that they are derived from Municipal Bonds, will be exempt
from Federal income taxes, subject to possible application of the alternative
minimum tax. See "Taxes."
Each Dividend Period for the Series A AMPS will generally be a 7-Day
Dividend Period. The Fund may create additional series of AMPS in the future
whose Dividend Periods may generally be a 7-Day Dividend Period or a 28-Day
Dividend Period.
NOTIFICATION OF DIVIDEND PERIOD. In determining whether the Fund should
issue a Notice of Special Dividend Period for a series of AMPS, the
Broker-Dealers will consider (i) existing short-term and long-term market rates
and indices of such short-term and long-term rates, (ii) existing market supply
and demand for short-term and long-term securities, (iii) existing yield curves
for short-term and long-term securities comparable to the AMPS, (iv) industry
and financial conditions which may affect the AMPS, (v) the investment objective
of the Fund and (vi) the Dividend Periods and dividend rates at
10
<PAGE>
which current and potential beneficial holders of the AMPS would remain or
become beneficial holders. If the Broker-Dealers shall not give the Fund and the
Auction Agent a Response by such second Business Day or if the Response states
that given the factors set forth above it is not advisable that the Fund give a
Notice of Special Dividend Period for the AMPS, the Fund may not give a Notice
of Special Dividend Period in respect of such Request for Special Dividend
Period. In the event the Response indicates that it is advisable that the Fund
give a Notice of Special Dividend Period for the AMPS, the Fund, by no later
than the second Business Day prior to such Auction Date, may give a notice (a
"Notice of Special Dividend Period") to the Auction Agent, the Securities
Depository and each Broker-Dealer, which notice will specify (i) the duration of
the Special Dividend Period, (ii) the Optional Redemption Price as specified in
the related Response and (iii) the Specific Redemption Provisions, if any, as
specified in the related Response. The Fund also shall provide a copy of such
Notice of Special Dividend Period to Moody's and S&P. The Fund shall not give a
Notice of Special Dividend Period, and, if such Notice of Special Dividend
Period shall have been given already, shall give telephonic and written notice
of its revocation (a "Notice of Revocation") to the Auction Agent, each
Broker-Dealer, and the Securities Depository on or prior to the Business Day
prior to the relevant Auction Date if (x) either the 1940 Act AMPS Asset
Coverage is not satisfied or the Fund shall fail to maintain S&P Eligible Assets
and Moody's Eligible Assets each with an aggregate Discounted Value at least
equal to the AMPS Basic Maintenance Amount, in each case on each of the two
Valuation Dates immediately preceding the Business Day prior to the relevant
Auction Date on an actual basis and on a pro forma basis giving effect to the
proposed Special Dividend Period (using as a pro forma dividend rate with
respect to such Special Dividend Period the dividend rate which the
Broker-Dealers shall advise the Fund is an approximately equal rate for
securities similar to the AMPS with an equal dividend period), provided that, in
calculating the aggregate Discounted Value of Moody's Eligible Assets for this
purpose, the Moody's Exposure Period shall be deemed to be one week longer, (y)
sufficient funds for the payment of dividends payable on the immediately
succeeding Dividend Payment Date have not been irrevocably deposited with the
Auction Agent by the close of business on the third Business Day preceding the
related Auction Date or (z) the Broker-Dealers jointly advise the Fund that
after consideration of the factors listed above they have concluded that it is
advisable to give a Notice of Revocation. The Fund also shall provide a copy of
such Notice of Revocation to Moody's and S&P. If the Fund is prohibited from
giving a Notice of Special Dividend Period as a result of the factors enumerated
in clause (x), (y) or (z) above or if the Fund gives a Notice of Revocation with
respect to a Notice of Special Dividend Period, the next succeeding Dividend
Period will be a 7-Day Dividend Period in the case of Series A AMPS. In
addition, in the event Sufficient Clearing Bids are not made in any Auction or
an Auction is not held for any reason, the next succeeding Dividend Period will
be a 7-Day Dividend Period in the case of Series A AMPS, and the Fund may not
again give a Notice of Special Dividend Period (and any such attempted notice
shall be null and void) until Sufficient Clearing Bids have been made in an
Auction with respect to a 7-Day Dividend Period in the case of Series A AMPS.
NON-PAYMENT PERIOD; LATE CHARGE. A Non-Payment Period will commence if the
Fund fails to (i) declare, prior to the close of business on the second Business
Day preceding any Dividend Payment Date, for payment on or (to the extent
permitted as described below) within three Business Days after such Dividend
Payment Date to the persons who held such shares as of 12:00 noon, Eastern time,
on the Business Day preceding such Dividend Payment Date, the full amount of any
dividend on shares of AMPS payable on such Dividend Payment Date or (ii)
deposit, irrevocably in trust, in same-day funds, with the Auction Agent by
12:00 noon, Eastern time, (A) on such Dividend Payment Date the full amount of
any cash dividend on such shares (if declared) payable on such Dividend Payment
Date or (B) on any redemption date for shares of AMPS called for redemption, the
Mandatory Redemption Price per share of such AMPS or, in the case of an optional
redemption, the Optional Redemption Price per share. Such Non-Payment Period
will consist of the period commencing on and including the aforementioned
Dividend Payment Date or redemption date, as the case may be, and ending on and
11
<PAGE>
including the Business Day on which, by 12:00 noon, Eastern time, all unpaid
cash dividends and unpaid redemption prices shall have been so deposited or
otherwise shall have been made available to the applicable holders in same day
funds, provided that a Non-Payment Period for any series of AMPS will not end
unless the Fund shall have given at least five days' but no more than 30 days'
written notice of such deposit or availability to the Auction Agent, the
Securities Depository and all holders of shares of AMPS of such series.
Notwithstanding the foregoing, the failure by the Fund to deposit funds as
provided for by clauses (ii) (A) or (ii) (B) above within three Business Days
after any Dividend Payment Date or redemption date, as the case may be, in each
case to the extent contemplated below, shall not constitute a "Non-Payment
Period."
The Applicable Rate for each Dividend Period for shares of AMPS of any
series, commencing during a Non-Payment Period, will be equal to the Non-Payment
Period Rate; and each Dividend Period commencing after the first day of, and
during, a Non-Payment Period shall be a 7-Day Dividend Period in the case of
Series A AMPS. Any dividend on shares of AMPS due on any Dividend Payment Date
for such shares (if, prior to the close of business on the second Business Day
preceding such Dividend Payment Date, the Fund has declared such dividend
payable on such Dividend Payment Date to the persons who held such shares as of
12:00 noon, Eastern time, on the Business Day preceding such Dividend Payment
Date) or redemption price with respect to such shares not paid to such persons
when due may be paid to such persons in the same form of funds by 12:00 noon,
Eastern time, on any of the first three Business Days after such Dividend
Payment Date or due date, as the case may be, provided that such amount is
accompanied by a late charge calculated for such period of non-payment at the
Non-Payment Period Rate applied to the amount of such non-payment based on the
actual number of days comprising such period divided by 365. In the case of a
willful failure of the Fund to pay a dividend on a Dividend Payment Date or to
redeem any shares of AMPS on the date set for such redemption, the preceding
sentence shall not apply and the Applicable Rate for the Dividend Period
commencing during the Non-Payment Period resulting from such failure shall be
the Non-Payment Period Rate. For the purposes of the foregoing, payment to a
person in same-day funds on any Business Day at any time will be considered
equivalent to payment to that person in New York Clearing House (next-day) funds
at the same time on the preceding Business Day, and any payment made after 12:00
noon, Eastern time, on any Business Day shall be considered to have been made
instead in the same form of funds and to the same person before 12:00 noon,
Eastern time, on the next Business Day.
The Non-Payment Period Rate initially will be 200% of the applicable
Reference Rate (or 275% of such rate if the Fund has provided notification to
the Auction Agent prior to the Auction establishing the Applicable Rate for any
dividend that net capital gains or other taxable income will be included in such
dividend on shares of AMPS), provided that the Board of Directors of the Fund
shall have the authority to adjust, modify, alter or change from time to time
the initial Non-Payment Period Rate if the Board of Directors of the Fund
determines and Moody's and S&P (and any Substitute Rating Agency in lieu of
Moody's or S&P in the event either of such parties shall not rate the AMPS)
advise the Fund in writing that such adjustment, modification, alteration or
change will not adversely affect their then-current ratings on the AMPS.
RESTRICTIONS ON DIVIDENDS AND OTHER PAYMENTS. For so long as any shares of
AMPS are outstanding, the Fund will not declare, pay or set apart for payment
any dividend or other distribution (other than a dividend or distribution paid
in shares of, or options, warrants or rights to subscribe for or purchase,
common stock or other stock, if any, ranking junior to shares of AMPS as to
dividends or upon liquidation) in respect of common stock or any other stock of
the Fund ranking junior to or on a parity with shares of AMPS as to dividends or
upon liquidation, or call for redemption, redeem, purchase or otherwise acquire
for consideration any shares of common stock or any other such junior stock
(except by conversion into or exchange for stock of the Fund ranking junior to
AMPS as to dividends and upon liquidation) or any such parity stock (except by
conversion into or exchange for
12
<PAGE>
stock of the Fund ranking junior to or on a parity with AMPS as to dividends and
upon liquidation), unless (A) immediately after such transaction, the Fund would
have S&P Eligible Assets and Moody's Eligible Assets each with an aggregate
Discounted Value equal to or greater than the AMPS Basic Maintenance Amount, and
the 1940 Act AMPS Asset Coverage (see "-- Asset Maintenance" and "--Redemption"
below) would be satisfied, (B) full cumulative dividends on shares of AMPS due
on or prior to the date of the transaction have been declared and paid or shall
have been declared and sufficient funds for the payment thereof deposited with
the Auction Agent, (C) any Additional Dividend required to be paid on or before
the date of such declaration or payment has been paid and (D) the Fund has
redeemed the full number of shares of AMPS required to be redeemed by any
provision for mandatory redemption contained in the Articles Supplementary.
ASSET MAINTENANCE
1940 ACT AMPS ASSET COVERAGE. The Fund will be required under the Articles
Supplementary to maintain, with respect to shares of AMPS, as of the last
Business Day of each month in which any shares of AMPS are outstanding, asset
coverage of at least 200% with respect to senior securities which are stock,
including the shares of AMPS (or such other asset coverage as in the future may
be specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are stock of a closed-end investment company as a condition of
paying dividends on its common stock) ("1940 Act AMPS Asset Coverage"). If the
Fund fails to maintain 1940 Act AMPS Asset Coverage and such failure is not
cured as of the last Business Day of the following month (the "1940 Act Cure
Date"), the Fund will be required under certain circumstances to redeem certain
of the shares of AMPS. See "--Redemption" below and in the prospectus.
AMPS BASIC MAINTENANCE AMOUNT. So long as shares of AMPS are outstanding,
the Fund will be required under the Articles Supplementary to maintain as of
each Business Day (a "Valuation Date") S&P Eligible Assets and Moody's Eligible
Assets each having in the aggregate a Discounted Value at least equal to the
AMPS Basic Maintenance Amount. If the Fund fails to meet such requirement as of
any Valuation Date and such failure is not cured on or before the sixth Business
Day after such Valuation Date (the "AMPS Basic Maintenance Cure Date"), the Fund
will be required under certain circumstances to redeem certain of the shares of
AMPS. Upon any failure to maintain the required Discounted Value, the Fund will
use its best efforts to alter the composition of its portfolio to reattain a
Discounted Value at least equal to the AMPS Basic Maintenance Amount on or prior
to the AMPS Basic Maintenance Cure Date. See "--Redemption" below and in the
prospectus.
The AMPS Basic Maintenance Amount as of any Valuation Date is defined as the
dollar amount equal to (i) the sum of (A) the product of the number of shares of
AMPS outstanding on such Valuation Date multiplied by the sum of $25,000 and any
applicable redemption premium attributable to the designation of a Premium Call
Period; (B) the aggregate amount of cash dividends (whether or not earned or
declared) that will have accumulated for each share of AMPS outstanding to (but
not including) the end of the current Dividend Period that follows such
Valuation Date in the event the then current Dividend Period will end within 49
calendar days of such Valuation Date or through the 49th day after such
Valuation Date in the event the then current Dividend Period will not end within
49 calendar days of such Valuation Date; (C) in the event the then current
Dividend Period will end within 49 calendar days of such Valuation Date, the
aggregate amount of cash dividends that would accumulate at the Maximum
Applicable Rate applicable to a Dividend Period of 28 or fewer days on any
shares of AMPS outstanding from the end of such Dividend Period through the 49th
day after such Valuation Date, multiplied by the larger of the Moody's
Volatility Factor and the S&P Volatility Factor determined from time to time by
Moody's and S&P, respectively (except that if such Valuation Date occurs during
a Non-Payment Period, the cash dividend for purposes of calculation would
accumulate at the then current Non-Payment Period Rate); (D) the amount of
anticipated Fund expenses for the
13
<PAGE>
90 days subsequent to such Valuation Date; (E) the amount of the Fund's Maximum
Potential Additional Dividend Liability as of such Valuation Date; (F) any
amounts payable for shares of common stock accepted for repurchase at their net
asset value pursuant to tender offers by the Fund; and (G) any current
liabilities as of such Valuation Date to the extent not reflected in any of (i)
(A) through (i) (F) (including, without limitation, and immediately upon
determination, any amounts due and payable by the Fund pursuant to repurchase
agreements, and any amounts payable for Municipal Bonds purchased as of such
Valuation Date) less (ii) either (A) the Discounted Value of any Fund assets, or
(B) the face value of any of the Fund's assets if such assets mature prior to or
on the date of redemption of AMPS or payment of a liability and are either
securities issued or guaranteed by the United States Government or Deposit
Securities, in both cases irrevocably deposited by the Fund for the payment of
the amount needed to redeem shares of AMPS subject to redemption or to satisfy
any of (i) (B) through (i) (G). For purposes of the foregoing, "Maximum
Potential Additional Dividend Liability," as of any Valuation Date, means the
aggregate amount of Additional Dividends that would be due if the Fund were to
make Retroactive Taxable Allocations, with respect to any fiscal year, estimated
based upon dividends paid and the amount of undistributed realized net capital
gains and other taxable income earned by the Fund, as of the end of the calendar
month immediately preceding such Valuation Date and assuming such Additional
Dividends are fully taxable.
The Discount Factors and guidelines for determining the market value of the
Fund's portfolio holdings have been based on criteria established in connection
with rating the AMPS. These factors include, but are not limited to, the
sensitivity of the market value of the relevant asset to changes in interest
rates, the liquidity and depth of the market for the relevant asset, the credit
quality of the relevant asset (for example, the lower the rating of a debt
obligation, the higher the related discount factor) and the frequency with which
the relevant asset is marked to market. In no event shall the Discounted Value
of any asset of the Fund exceed its unpaid principal balance or face amount as
of the date of calculation. The Discount Factor relating to any asset of the
Fund and the AMPS Basic Maintenance Amount, the assets eligible for inclusion in
the calculation of the Discounted Value of the Fund's portfolio and certain
definitions and methods of calculation relating thereto may be changed from time
to time by the Fund, without shareholder approval, but only in the event the
Fund receives written confirmation from S&P, Moody's and any Substitute Rating
Agency that any such changes would not impair the ratings then assigned to the
shares of AMPS by S&P or Moody's or any Substitute Rating Agency.
On or before the third Business Day after a Valuation Date on which the Fund
fails to maintain S&P Eligible Assets and Moody's Eligible Assets each with an
aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount, the Fund is required to deliver to the Auction Agent, Moody's and S&P a
report with respect to the calculation of the AMPS Basic Maintenance Amount and
the value of its portfolio holdings as of the date of such failure (an "AMPS
Basic Maintenance Report"). Additionally, on or before the third Business Day
after the first day of a Special Dividend Period, the Fund will deliver an AMPS
Basic Maintenance Report to S&P and the Auction Agent. The Fund also will
deliver an AMPS Basic Maintenance Report as of the twenty-fifth day of the last
month of each fiscal quarter of the Fund (or, if such day is not a Business Day,
the next succeeding Business Day) on or before the third Business Day after such
day. Within ten Business Days after delivery of such report relating to the
twenty-fifth day of the last month of each fiscal quarter of the Fund (or, if
such day is not a Business Day, the next succeeding Business Day), the Fund will
deliver a letter prepared by the Fund's independent accountants regarding the
accuracy of the calculations made by the Fund in its most recent AMPS Basic
Maintenance Report. Also, on or before 5:00 p.m., Eastern time, on the first
Business Day after shares of common stock are repurchased by the Fund, the Fund
will complete and deliver to S&P and Moody's an AMPS Basic Maintenance Report as
of the close of business on such date that common stock is repurchased. If any
such letter prepared by the Fund's independent accountants shows that an error
was made in the most recent AMPS Basic Maintenance
14
<PAGE>
Report, the calculation or determination made by the Fund's independent
accountants will be conclusive and binding on the Fund.
REDEMPTION
MANDATORY REDEMPTION. The number of shares of AMPS to be redeemed will be
equal to the lesser of (a) the minimum number of shares of AMPS the redemption
of which, if deemed to have occurred immediately prior to the opening of
business on the Cure Date, together with all other shares of the preferred stock
subject to redemption or retirement, would result in the Fund having S&P
Eligible Assets and Moody's Eligible Assets each with an aggregate Discounted
Value equal to or greater than the AMPS Basic Maintenance Amount or satisfaction
of the 1940 Act AMPS Asset Coverage, as the case may be, on such Cure Date
(provided that, if there is no such minimum number of shares the redemption of
which would have such result, all shares of AMPS then outstanding will be
redeemed), and (b) the maximum number of shares of AMPS, together with all other
shares of preferred stock subject to redemption or retirement, that can be
redeemed out of funds expected to be legally available therefor on such
redemption date. In determining the number of shares of AMPS required to be
redeemed in accordance with the foregoing, the Fund shall allocate the number
required to be redeemed that would result in the Fund having S&P Eligible Assets
and Moody's Eligible Assets each with an aggregate Discounted Value equal to or
greater than the AMPS Basic Maintenance Amount or satisfaction of the 1940 Act
AMPS Asset Coverage, as the case may be, pro rata among shares of AMPS and other
preferred stock subject to redemption pursuant to provisions similar to those
set forth below; provided that, shares of AMPS that may not be redeemed at the
option of the Fund due to the designation of a Non-Call Period applicable to
such shares (A) will be subject to mandatory redemption only to the extent that
other shares are not available to satisfy the number of shares required to be
redeemed and (B) will be selected for redemption in an ascending order of
outstanding number of days in the Non-Call Period (with shares with the lowest
number of days to be redeemed first) and by lot in the event of shares having an
equal number of days in such Non-Call Period. The Fund is required to effect
such a mandatory redemption not later than 35 days after such Cure Date, except
that if the Fund does not have funds legally available for the redemption of all
of the required number of shares of AMPS that are subject to mandatory
redemption or the Fund otherwise is unable to effect such redemption on or prior
to 35 days after such Cure Date, the Fund will redeem those shares of AMPS that
it was unable to redeem on the earliest practicable date on which it is able to
effect such redemption.
NOTICE OF REDEMPTION. If shares of AMPS of any series are to be redeemed, a
notice of redemption will be mailed to each record holder of such shares of AMPS
(initially Cede as nominee of the Securities Depository) and to the Auction
Agent not less than 17 nor more than 30 days prior to the date fixed for the
redemption thereof. Each notice of redemption will include a statement setting
forth: (i) the redemption date, (ii) the aggregate number of shares of AMPS of
such series to be redeemed, (iii) the redemption price, (iv) the place or places
where shares of AMPS of such series are to be surrendered for payment of the
redemption price, (v) a statement that dividends on the shares to be redeemed
will cease to accumulate on such redemption date (except that holders may be
entitled to Additional Dividends) and (vi) the provision of the Articles
Supplementary pursuant to which such shares are being redeemed. The notice also
will be published in THE WALL STREET JOURNAL. No defect in the notice of
redemption or in the mailing or publication thereof will affect the validity of
the redemption proceedings, except as required by applicable law.
In the event that less than all of the outstanding shares of any series of
AMPS are to be redeemed, the series and number of shares to be redeemed will be
selected by lot or such other method as the Fund shall deem fair and equitable,
and the results thereof will be communicated to the Auction Agent. The Auction
Agent will give notice to the Securities Depository, whose nominee will be the
record holder of all shares of AMPS, and the Securities Depository will
determine the number of
15
<PAGE>
shares to be redeemed from the account of the Agent Member of each Existing
Holder. Each Agent Member will determine the number of shares to be redeemed
from the account of each Existing Holder for which it acts as agent. An Agent
Member may select for redemption shares from the accounts of some Existing
Holders without selecting for redemption any shares from the accounts of other
Existing Holders. Notwithstanding the foregoing, if neither the Securities
Depository nor its nominee is the record holder of all of the shares, the
particular shares to be redeemed shall be selected by the Fund by lot or by such
other method as the Fund shall deem fair and equitable.
If the Fund gives notice of redemption, and concurrently or thereafter
deposits in trust with the Auction Agent, or segregates in an account at the
Fund's custodian bank for the benefit of the Auction Agent, Deposit Securities
(with a right of substitution) having an aggregate Discounted Value (utilizing
in the case of S&P an S&P Exposure Period of 22 Business Days) equal to the
redemption payment for the shares of AMPS as to which notice of redemption has
been given, with irrevocable instructions and authority to pay the redemption
price to the record holders thereof, then upon the date of such deposit or, if
no such deposit is made, upon such date fixed for redemption (unless the Fund
shall default in making payment of the redemption price), all rights of the
holders of such shares called for redemption will cease and terminate, except
the right of such holders to receive the redemption price thereof and any
Additional Dividends, but without interest, and such shares no longer will be
deemed to be outstanding. The Fund will be entitled to receive, from time to
time, the interest, if any, earned on such Deposit Securities deposited with the
Auction Agent, and the holders of any shares so redeemed will have no claim to
any such interest. Any funds so deposited which are unclaimed at the end of one
year from such redemption date will be repaid, upon demand, to the Fund, after
which the holders of the shares of AMPS so called for redemption may look only
to the Fund for payment thereof.
So long as any shares of AMPS are held of record by the nominee of the
Securities Depository (initially Cede), the redemption price for such shares
will be paid on the redemption date to the nominee of the Securities Depository.
The Securities Depository's normal procedures now provide for it to distribute
the amount of the redemption price to Agent Members who, in turn, are expected
to distribute such funds to the persons for whom they are acting as agent.
Notwithstanding the provisions for redemption described above, no shares of
AMPS shall be subject to optional redemption (i) unless all dividends in arrears
on the outstanding shares of AMPS, and all capital stock of the Fund ranking on
a parity with the AMPS with respect to the payment of dividends or upon
liquidation, have been or are being contemporaneously paid or declared and set
aside for payment and (ii) if redemption thereof would result in the Fund's
failure to maintain Moody's Eligible Assets or S&P Eligible Assets with an
aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount.
VOTING RIGHTS
In connection with the election of the Fund's directors, holders of shares
of AMPS and any other preferred stock, voting as a separate class, shall be
entitled at all times to elect two of the Fund's directors, and the remaining
directors will be elected by holders of shares of common stock and shares of
AMPS and any other preferred stock, voting together as a single class. In
addition, if at any time dividends on outstanding shares of AMPS shall be unpaid
in an amount equal to at least two full years' dividends thereon or if at any
time holders of any shares of preferred stock are entitled, together with the
holders of AMPS, to elect a majority of the directors of the Fund under the 1940
Act, then the number of directors constituting the Board of Directors
automatically shall be increased by the smallest number that, when added to the
two directors elected exclusively by the holders of shares of AMPS and any other
preferred stock as described above, would constitute a majority of the Board of
Directors as so increased by such smallest number, and at a special meeting of
shareholders which will be called and held as soon as practicable, and at all
subsequent meetings at which directors are to be elected, the holders of shares
of AMPS and any other preferred stock, voting as a separate class, will
16
<PAGE>
be entitled to elect the smallest number of additional directors that, together
with the two directors which such holders in any event will be entitled to
elect, constitutes a majority of the total number of directors of the Fund as so
increased. The terms of office of the persons who are directors at the time of
that election will continue. If the Fund thereafter shall pay, or declare and
set apart for payment in full, all dividends payable on all outstanding shares
of AMPS and any other preferred stock for all past Dividend Periods, the
additional voting rights of the holders of shares of AMPS and any other
preferred stock as described above shall cease, and the terms of office of all
of the additional directors elected by the holders of shares of AMPS and any
other preferred stock (but not of the directors with respect to whose election
the holders of common stock were entitled to vote or the two directors the
holders of shares of AMPS and any other preferred stock have the right to elect
in any event) will terminate automatically.
The affirmative vote of a majority of the votes entitled to be cast by
holders of outstanding shares of AMPS and any other preferred stock, voting as a
separate class, will be required to (i) authorize, create or issue (other than
with respect to the issuance of the AMPS authorized by the Articles
Supplementary), or increase the authorized or issued aggregate stated capital
amount of (other than with respect to the issuance of the AMPS authorized by the
Articles Supplementary), any class or series of stock ranking prior to or on
parity with any series of preferred stock with respect to the payment of
dividends or the distribution of assets on liquidation, or increase the
authorized aggregate stated capital amount of AMPS or any other preferred stock
or (ii) amend, alter or repeal the provisions of the Articles of Incorporation,
whether by merger, consolidation or otherwise, so as to adversely affect any of
the contract rights expressly set forth in the Articles of Incorporation of
holders of shares of AMPS or any other preferred stock. To the extent permitted
under the 1940 Act, in the event shares of more than one series of AMPS are
outstanding, the Fund shall not approve any of the actions set forth in clause
(i) or (ii) which adversely affects the contract rights expressly set forth in
the Articles of Incorporation of a holder of shares of a series of AMPS
differently than those of a holder of shares of any other series of AMPS without
the affirmative vote of at least a majority of votes entitled to be cast by
holders of the shares of AMPS of each series adversely affected and outstanding
at such time (each such adversely affected series voting separately as a class).
The Board of Directors, however, without shareholder approval, may amend, alter
or repeal any or all of the various rating agency guidelines described herein in
the event the Fund receives confirmation from the rating agencies that any such
amendment, alteration or repeal would not impair the ratings then assigned to
shares of AMPS. Unless a higher percentage is provided for under "--Certain
Provisions in the Articles of Incorporation" in the prospectus, the affirmative
vote of a majority of the votes entitled to be cast by holders of outstanding
shares of AMPS and any other preferred stock, voting as a separate class, will
be required to approve any plan of reorganization (including bankruptcy
proceedings) adversely affecting such shares or any action requiring a vote of
security holders under Section 13(a) of the 1940 Act including, among other
things, changes in the Fund's investment objective or changes in the investment
restrictions described as fundamental policies under "Investment Objective and
Policies." The class vote of holders of shares of AMPS and any other preferred
stock described above in each case will be in addition to a separate vote of the
requisite percentage of shares of common stock and shares of AMPS and any other
preferred stock, voting together as a single class, necessary to authorize the
action in question.
The foregoing voting provisions will not apply to any series of AMPS if, at
or prior to the time when the act with respect to which such vote otherwise
would be required shall be effected, such shares shall have been (i) redeemed or
(ii) called for redemption and sufficient funds shall have been deposited in
trust to effect such redemption.
17
<PAGE>
THE AUCTION
AUCTION AGENT AGREEMENT
The Auction Agent will act as agent for the Fund pursuant to the Auction
Agent Agreement in connection with Auctions. In the absence of bad faith or
negligence on its part, the Auction Agent will not be liable for any action
taken, suffered or omitted, or for any error of judgment made, by it in the
performance of its duties under the Auction Agent Agreement, and will not be
liable for any error of judgment made in good faith unless the Auction Agent
shall have been negligent in ascertaining the pertinent facts. Pursuant to the
Auction Agent Agreement, the Fund is required to indemnify the Auction Agent for
certain losses and liabilities incurred by the Auction Agent without negligence
or bad faith on its part in connection with the performance of its duties under
such agreement.
The Auction Agent may terminate the Auction Agent Agreement upon notice to
the Fund, which termination may be no earlier than 60 days following delivery of
such notice. If the Auction Agent resigns, the Fund will use its best efforts to
enter into an agreement with a successor Auction Agent containing substantially
the same terms and conditions as the Auction Agent Agreement. The Fund may
terminate the Auction Agent Agreement, provided that prior to such termination
the Fund shall have entered into such an agreement with respect thereto with a
successor Auction Agent.
BROKER-DEALER AGREEMENTS
The Auctions require the participation of one or more broker-dealers. A
Broker-Dealer Agreement may be terminated by the Auction Agent or a
Broker-Dealer on five days' notice to the other party, provided that the
Broker-Dealer Agreement with Merrill Lynch may not be terminated without the
prior written consent of the Fund, which consent may not be unreasonably
withheld.
For the period November 3, 1995 (commencement of operations) to October 31,
1996, and the fiscal years ended October 31, 1997 and 1998, the Fund paid
service fees to Merrill Lynch aggregating $48,107, $100,708 and $120,839,
respectively, as a Broker-Dealer.
AUCTION PROCEDURES
Separate auctions will be conducted for each series of AMPS. The Auction
Procedures are set forth in Appendix C to this statement of additional
information. The Settlement Procedures to be used with respect to Auctions are
set forth in Appendix B to this statement of additional information.
RATING AGENCY GUIDELINES
S&P AAA RATING GUIDELINES
The Discounted Value of the Fund's S&P Eligible Assets is calculated on each
Valuation Date. See "Description of AMPS--Asset Maintenance--AMPS Basic
Maintenance Amount" herein and in the prospectus. S&P Eligible Assets include
cash, Receivables for Municipal Bonds Sold (as defined below) and Municipal
Bonds eligible for consideration under S&P's current guidelines. For purposes of
calculating the Discounted Value of the Fund's portfolio under current S&P
guidelines, the fair market value of Municipal Bonds eligible for consideration
under such guidelines must be discounted by the applicable S&P Discount Factor
set forth in the table below. The Discounted Value of a Municipal Bond eligible
for consideration under S&P guidelines is the fair market value thereof divided
by the S&P Discount Factor. The S&P Discount Factor used to discount a
particular Municipal Bond will be determined by reference to (a) the rating by
S&P, Moody's or Fitch on such Municipal Bond and (b) the S&P Exposure Period.
The S&P Exposure Period is the maximum period of time following a Valuation
Date, including the Valuation Date and the AMPS Basic Maintenance Cure Date,
that the Fund has to cure any failure to maintain, as of such Valuation Date, a
Discounted Value for its portfolio at least equal to the AMPS Basic Maintenance
Amount.
18
<PAGE>
S&P Discount Factors applicable to Municipal Bonds for a range of S&P
Exposure Periods are set forth below:
<TABLE>
<CAPTION>
S&P DISCOUNT FACTORS
RATING CATEGORY
--------------------------------------------------
EXPOSURE PERIOD AAA AA A BB
- ---------------------------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
40 Business Days.......................................... 190% 195% 210% 250%
22 Business Days.......................................... 170 175 190 230
10 Business Days.......................................... 155 160 175 215
7 Business Days........................................... 150 155 170 210
3 Business Days........................................... 130 135 150 190
</TABLE>
Since the S&P Exposure Period currently applicable to the Fund is seven
Business Days, the S&P Discount Factors currently applicable to Municipal Bonds
eligible for consideration under S&P guidelines will be determined by reference
to the factors set forth opposite the exposure period line entitled "7 Business
Days." Notwithstanding the foregoing, (i) the S&P Discount Factor for short-term
Municipal Bonds will be 115%, so long as such Municipal Bonds are rated A1+ or
SP1+ by S&P and mature or have a demand feature exercisable in 30 days or less,
or 120% so long as such Municipal Bonds are rated A-1 or SP-1 by S&P and mature
or have a demand feature exercisable in 30 days or less, or 125% if such
Municipal Bonds are not rated by S&P but are rated VMIG-1, P1 or MIG-1 by
Moody's or F-1+ by Fitch; provided, however, such short-term Municipal Bonds
rated by Moody's or Fitch but not rated by S&P having a demand feature
exercisable in 30 days or less must be backed by a letter of credit, liquidity
facility or guarantee from a bank or other financial institution having a
short-term rating of at least A1+ from S&P; and further provided that such
short-term Municipal Bonds rated by Moody's or Fitch but not rated by S&P may
comprise no more than 50% of short-term Municipal Bonds that qualify as S&P
Eligible Assets, (ii) the S&P Discount Factor for Receivables for Municipal
Bonds Sold that are due more than five Business Days from such Valuation Date
will be the S&P Discount Factor applicable to the Municipal Bonds sold, and
(iii) no S&P Discount Factor will be applied to cash or to Receivables for
Municipal Bonds Sold if such receivables are due within five Business Days of
such Valuation Date. "Receivables for Municipal Bonds Sold", for purposes of
calculating S&P Eligible Assets as of any Valuation Date, means the book value
of receivables for Municipal Bonds sold as of or prior to such Valuation Date.
Also, for purposes of the foregoing, Anticipation Notes rated SP1 or, if not
rated by S&P, rated VMIG-1 by Moody's or F-1+ by Fitch, which do not mature or
have a demand feature exercisable in 30 days and which do not have a long-term
rating, shall be considered to be short-term Municipal Bonds.
The S&P guidelines require certain minimum issue size and geographical
diversification and impose other requirements for purposes of determining S&P
Eligible Assets. In order to be considered S&P Eligible Assets, Municipal Bonds
must:
(i) be interest bearing and pay interest at least semi-annually;
(ii) be payable with respect to principal and interest in U.S. dollars;
(iii) be publicly rated BBB or higher by S&P or, except in the case of
Anticipation Notes that are grant anticipation notes or bond anticipation
notes which must be rated by S&P to be included in S&P Eligible Assets, if
not rated by S&P but rated by Moody's or Fitch, be rated at least A by
Moody's or Fitch (provided that such Moody's-rated or Fitch-rated Municipal
Bonds will be included in S&P Eligible Assets only to the extent the fair
market value of such Municipal Bonds does not exceed 50% of the aggregate
fair market value of the S&P Eligible Assets. For purposes of determining
the S&P Discount Factors applicable to any such Moody's-rated or Fitch-rated
Municipal Bonds, such Municipal Bonds will be deemed to have an S&P rating
which is one full rating category lower than its Moody's rating or Fitch
rating);
19
<PAGE>
(iv) not be subject to a covered call or covered put option written by
the Fund;
(v) except for inverse floating obligations, not be part of a private
placement of Municipal Bonds; and
(vi) except for inverse floating obligations, be part of an issue with
an original issue size of at least $20 million or, if of an issue with an
original issue size below $20 million (but in no event below $10 million),
be issued by an issuer with a total of at least $50 million of securities
outstanding.
Notwithstanding the foregoing:
(i) Municipal Bonds of any one issuer or guarantor (excluding bond
insurers) will be considered S&P Eligible Assets only to the extent the fair
market value of such Municipal Bonds does not exceed 10% of the aggregate
fair market value of the S&P Eligible Assets, provided that 2% is added to
the applicable S&P Discount Factor for every 1% by which the fair market
value of such Municipal Bonds exceeds 5% of the aggregate fair market value
of the S&P Eligible Assets; and
(ii) Municipal Bonds issued by issuers in any one state or territory
will be considered S&P Eligible Assets only to the extent the fair market
value of such Municipal Bonds does not exceed 25% of the aggregate fair
market value of S&P Eligible Assets.
As discussed in the prospectus, the Fund may engage in options or futures
transactions. For so long as any shares of AMPS are rated by S&P, the Fund will
not purchase or sell financial futures contracts, write, purchase or sell
options on financial futures contracts or write put options (except covered put
options) or call options (except covered call options) on portfolio securities
unless it receives written confirmation from S&P that engaging in such
transactions will not impair the ratings then assigned to the shares of AMPS by
S&P, except that the Fund may purchase or sell financial futures contracts based
on the Bond Buyer Municipal Bond Index (the "Municipal Index") or United States
Treasury Bonds or Notes ("Treasury Bonds") and write, purchase or sell put and
call options on such contracts (collectively "S&P Hedging Transactions"),
subject to the following limitations:
(i) the Fund will not engage in any S&P Hedging Transaction based on the
Municipal Index (other than transactions which terminate a financial futures
contract or option held by the Fund by the Fund's taking an opposite
position thereto ("Closing Transactions")), which would cause the Fund at
the time of such transaction to own or have sold the least of (A) more than
1,000 outstanding financial futures contracts based on the Municipal Index,
(B) outstanding financial futures contracts based on the Municipal Index
exceeding in number 25% of the quotient of the fair market value of the
Fund's total assets divided by $100,000 or (C) outstanding financial futures
contracts based on the Municipal Index exceeding in number 10% of the
average number of daily traded financial futures contracts based on the
Municipal Index in the 30 days preceding the time of effecting such
transaction as reported by THE WALL STREET JOURNAL;
(ii) the Fund will not engage in any S&P Hedging Transaction based on
Treasury Bonds (other than Closing Transactions) which would cause the Fund
at the time of such transaction to own or have sold the lesser of (A)
outstanding financial futures contracts based on Treasury Bonds exceeding in
number 50% of the quotient of the fair market value of the Fund's total
assets divided by $100,000 ($200,000 in the case of the two-year United
States Treasury Note) or (B) outstanding financial futures contracts based
on Treasury Bonds exceeding in number 10% of the average number of daily
traded financial futures contracts based on Treasury Bonds in the 30 days
preceding the time of effecting such transaction as reported by THE WALL
STREET JOURNAL;
(iii) the Fund will engage in Closing Transactions to close out any
outstanding financial futures contract which the Fund owns or has sold or
any outstanding option thereon owned by the Fund in the event (A) the Fund
does not have S&P Eligible Assets with an aggregate Discounted
20
<PAGE>
Value equal to or greater than the AMPS Basic Maintenance Amount on two
consecutive Valuation Dates and (B) the Fund is required to pay Variation
Margin on the second such Valuation Date;
(iv) the Fund will engage in a Closing Transaction to close out any
outstanding financial futures contract or option thereon in the month prior
to the delivery month under the terms of such financial futures contract or
option thereon unless the Fund holds the securities deliverable under such
terms; and
(v) when the Fund writes a financial futures contract or an option
thereon, it will either maintain an amount of cash, cash equivalents or high
grade (rated A or better by S&P), fixed-income securities in a segregated
account with the Fund's custodian, so that the amount so segregated plus the
amount of Initial Margin and Variation Margin held in the account of or on
behalf of the Fund's broker with respect to such financial futures contract
or option equals the fair market value of the financial futures contract or
option, or, in the event the Fund writes a financial futures contract or
option thereon which requires delivery of an underlying security, it shall
hold such underlying security in its portfolio.
For purposes of determining whether the Fund has S&P Eligible Assets with a
Discounted Value that equals or exceeds the AMPS Basic Maintenance Amount, the
Discounted Value of cash or securities held for the payment of Initial Margin or
Variation Margin shall be zero and the aggregate Discounted Value of S&P
Eligible Assets shall be reduced by an amount equal to (i) 30% of the aggregate
settlement value, as marked to market, of any outstanding financial futures
contracts based on the Municipal Index which are owned by the Fund plus (ii) 25%
of the aggregate settlement value, as marked to market, of any outstanding
financial futures contracts based on Treasury Bonds which contracts are owned by
the Fund.
MOODY'S "aaa" RATING GUIDELINES
The Discounted Value of the Fund's Moody's Eligible Assets is calculated on
each Valuation Date. See "Description of AMPS--Asset Maintenance--AMPS Basic
Maintenance Amount" herein. Moody's Eligible Assets include cash, Receivables
for Municipal Bonds (as defined below), and Municipal Bonds eligible for
consideration under Moody's guidelines. For purposes of calculating the
Discounted Value of the Fund's portfolio under current Moody's guidelines, the
fair market value of Municipal Bonds eligible for consideration under such
guidelines must be discounted by the applicable Moody's Discount Factor set
forth in the table below. The Discounted Value of a Municipal Bond eligible for
consideration under Moody's guidelines is the lower of par and the quotient of
the fair market value thereof divided by the Moody's Discount Factor. The
Moody's Discount Factor used to discount a particular Municipal Bond will be
determined by reference to (a) the rating by Moody's or S&P on such Municipal
Bond and (b) the Moody's Exposure Period. Moody's Discount Factors for a range
of Moody's Exposure Periods are set forth below:
<TABLE>
<CAPTION>
MOODY'S DISCOUNT FACTORS RATING CATEGORY
-------------------------------------------------------------------------
MOODY'S EXPOSURE PERIOD Aaa(1) Aa(1) A(1) Baa(1) OTHER(2) VMIG-1(3) SP-1+(3)
- ------------------------------------------------------ ------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
7 weeks or less....................................... 151% 159% 168% 202% 229% 136% 148%
8 weeks or less but greater than seven weeks.......... 154 164 173 205 235 137 149
9 weeks or less but greater than eight weeks.......... 158 169 179 209 242 138 150
</TABLE>
- ------------------------
(1) Moody's rating.
(2) Municipal Bonds not rated by Moody's but rated BBB-, BBB or BBB+ by S&P.
21
<PAGE>
(3) Municipal Bonds rated MIG-1, VMIG-1 or P1 or, if not rated by Moody's, rated
SP1+ or A1+ by S&P which do not mature or have a demand feature at par
exercisable within the Moody's Exposure Period and which do not have a
long-term rating. For the purposes of the definition of Moody's Eligible
Assets, these securities will have an assumed rating of A by Moody's.
Since the Moody's Exposure Period currently is 49 days, the Moody's Discount
Factors currently applicable to Municipal Bonds eligible for consideration under
Moody's guidelines will be determined by reference to the factors set forth
opposite the exposure period line entitled "7 weeks or less." Notwithstanding
the foregoing, (i) no Moody's Discount Factor will be applied to short-term
Municipal Bonds so long as such Municipal Bonds are rated at least MIG-1, VMIG-1
or P1 by Moody's and mature or have a demand feature at par exercisable within
the Moody's Exposure Period, and the Moody's Discount Factor for such Municipal
Bonds will be 125% if such Municipal Bonds are not rated by Moody's but are
rated A-1+, SP-1+ or AA by S&P and mature or have a demand feature at par
exercisable within the Moody's Exposure Period, and (ii) no Moody's Discount
Factor will be applied to cash or to Receivables for Municipal Bonds Sold.
"Receivables for Municipal Bonds Sold," for purposes of calculating Moody's
Eligible Assets as of any Valuation Date, means no more than the aggregate of
the following: (i) the book value of receivables for Municipal Bonds sold as of
or prior to such Valuation Date if such receivables are due within five Business
Days of such Valuation Date, and if the trades which generated such receivables
are (A) settled through clearing house firms with respect to which the Fund has
received prior written authorization from Moody's or (B) with counterparties
having a Moody's long-term debt rating of at least Baa3; and (ii) the Moody's
Discounted Value of Municipal Bonds sold as of or prior to such Valuation Date
which generated receivables, if such receivables are due within five Business
Days of such Valuation Date but do not comply with either of conditions (A) or
(B) of the preceding clause (i).
The Moody's guidelines impose certain requirements as to minimum issue size,
issuer diversification and geographical concentration, as well as other
requirements for purposes of determining whether Municipal Bonds constitute
Moody's Eligible Assets, as set forth in the table below:
<TABLE>
<CAPTION>
MINIMUM MAXIMUM MAXIMUM STATE
ISSUE SIZE UNDERLYING OR TERRITORY
RATING ($ MILLIONS) OBLIGOR (%)(1) CONCENTRATION (%)(1)(3)
- ------------------------------------------------------------- --------------- ----------------- -------------------------
<S> <C> <C> <C>
Aaa.......................................................... 10 100 100
Aa........................................................... 10 20 60
A............................................................ 10 10 40
Baa.......................................................... 10 6 20
Other(2)..................................................... 10 4 12
</TABLE>
- ------------------------
(1) The referenced percentages represent maximum cumulative totals for the
related rating category and each lower rating category.
(2) Municipal Bonds not rated by Moody's but rated BBB-, BBB or BBB+ by S&P.
(3) Territorial bonds (other than those issued by Puerto Rico and counted
collectively) are each limited to 10% of Moody's Eligible Assets. For
diversification purposes, Puerto Rico will be treated as a state.
For purposes of the maximum underlying obligor requirement described above,
any such Municipal Bond backed by the guaranty, letter of credit or insurance
issued by a third party will be deemed to be issued by such third party if the
issuance of such third party credit is the sole determinant of the rating on
such Municipal Bond.
Current Moody's guidelines also require that Municipal Bonds constituting
Moody's Eligible Assets pay interest in cash, be publicly rated Baa or higher by
Moody's or, if not rated by Moody's but rated
22
<PAGE>
by S&P, that they be rated at least BBB by S&P, not have suspended ratings by
Moody's and be part of an issue of Municipal Bonds of at least $10,000,000. For
purposes of determining the Moody's Discount Factors applicable to any such
S&P-rated Municipal Bonds, such Municipal Bonds (excluding any short-term
Municipal Bonds) will be deemed to have a Moody's rating which is one full
rating category lower than its S&P rating. When the Fund sells a Municipal Bond
and agrees to repurchase it at a future date, the Discounted Value of such
Municipal Bond will constitute a Moody's Eligible Asset and the amount the Fund
is required to pay upon repurchase of such bond will count as a liability for
purposes of calculating the AMPS Basic Maintenance Amount. When the Fund
purchases a Municipal Bond and agrees to sell it at a future date to another
party, cash receivable by the Fund thereby will constitute a Moody's Eligible
Asset if the long-term debt of such other party is rated at least A2 by Moody's
and such agreement has a term of 30 days or less; otherwise the Discounted Value
of such Municipal Bond will constitute a Moody's Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset if it is (i) held in a margin account, (ii) subject to any
material lien, mortgage, pledge, security interest or security agreement of any
kind, (iii) held for the purchase of a security pursuant to a Forward Commitment
or (iv) irrevocably deposited by the Fund for the payment of dividends or
redemption.
For so long as shares of AMPS are rated by Moody's, in managing the Fund's
portfolio, the Investment Adviser will not alter the composition of the Fund's
portfolio if, in the reasonable belief of the Investment Adviser, the effect of
any such alteration would be to cause the Fund to have Moody's Eligible Assets
with an aggregate Discounted Value, as of the immediately preceding Valuation
Date, less than the AMPS Basic Maintenance Amount as of such Valuation Date;
provided, however, that in the event that, as of the immediately preceding
Valuation Date, the aggregate Discounted Value of Moody's Eligible Assets
exceeded the AMPS Basic Maintenance Amount by five percent or less, the
Investment Adviser will not alter the composition of the Fund's portfolio in a
manner reasonably expected to reduce the aggregate Discounted Value of Moody's
Eligible Assets unless the Fund shall have confirmed that, after giving effect
to such alteration, the aggregate Discounted Value of Moody's Eligible Assets
would exceed the AMPS Basic Maintenance Amount.
For so long as any shares of AMPS are rated by Moody's, the Fund will not
buy or sell financial futures contracts, write, purchase or sell call options on
financial futures contracts or purchase put options on financial futures
contracts or write call options (except covered call options) on portfolio
securities unless it receives written confirmation from Moody's that engaging in
such transactions would not impair the ratings then assigned to the shares of
AMPS by Moody's, except that the Fund may purchase or sell exchange-traded
financial futures contracts based on the Municipal Index or Treasury Bonds and
purchase, write or sell exchange-traded put options on such financial futures
contracts and purchase, write or sell exchange-traded call options on such
financial futures contracts (collectively "Moody's Hedging Transactions"),
subject to the following limitations:
(i) the Fund will not engage in any Moody's Hedging Transaction based on
the Municipal Index (other than Closing Transactions) which would cause the
Fund at the time of such transaction to own or have sold (A) outstanding
financial futures contracts based on the Municipal Index exceeding in number
10% of the average number of daily traded financial futures contracts based
on the Municipal Index in the 30 days preceding the time of effecting such
transaction as reported by THE WALL STREET JOURNAL or (B) outstanding
financial futures contracts based on the Municipal Index having a fair
market value exceeding the fair market value of all Municipal Bonds
constituting Moody's Eligible Assets owned by the Fund (other than Moody's
Eligible Assets already subject to a Moody's Hedging Transaction);
(ii) the Fund will not engage in any Moody's Hedging Transaction based
on Treasury Bonds (other than Closing Transactions) which would cause the
Fund at the time of such transaction to own or have sold (A) outstanding
financial futures contracts based on Treasury Bonds having an
23
<PAGE>
aggregate fair market value exceeding 40% of the aggregate fair market value
of Moody's Eligible Assets owned by the Fund and rated Aa by Moody's (or, if
not rated by Moody's but rated by S&P, rated AAA by S&P) or (B) outstanding
financial futures contracts based on Treasury Bonds having an aggregate fair
market value exceeding 80% of the aggregate fair market value of all
Municipal Bonds constituting Moody's Eligible Assets owned by the Fund
(other than Moody's Eligible Assets already subject to a Moody's Hedging
Transaction) and rated Baa or A by Moody's (or, if not rated by Moody's but
rated by S&P, rated A or AA by S&P) (for purposes of the foregoing clauses
(i) and (ii), the Fund shall be deemed to own the number of financial
futures contracts that underlie any outstanding options written by the
Fund);
(iii) the Fund will engage in Closing Transactions to close out any
outstanding financial futures contract based on the Municipal Index if the
amount of open interest in the Municipal Index as reported by THE WALL
STREET JOURNAL is less than 5,000;
(iv) the Fund will engage in a Closing Transaction to close out any
outstanding financial futures contract by no later than the fifth Business
Day of the month in which such contract expires and will engage in a Closing
Transaction to close out any outstanding option on a financial futures
contract by no later than the first Business Day of the month in which such
option expires;
(v) the Fund will engage in Moody's Hedging Transactions only with
respect to financial futures contracts or options thereon having the next
settlement date or the settlement date immediately thereafter;
(vi) the Fund will not engage in options and futures transactions for
leveraging or speculative purposes and will not write any call options or
sell any financial futures contracts for the purpose of hedging the
anticipated purchase of an asset prior to completion of such purchase; and
(vii) the Fund will not enter into an option or futures transaction
unless, after giving effect thereto, the Fund would continue to have Moody's
Eligible Assets with an aggregate Discounted Value equal to or greater than
the AMPS Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the Discounted Value of Moody's Eligible Assets which the
Fund is obligated to deliver or receive pursuant to an outstanding futures
contract or option shall be as follows: (i) assets subject to call options
written by the Fund which are either exchange-traded and "readily reversible" or
which expire within 49 days after the date as of which such valuation is made
shall be valued at the lesser of (A) Discounted Value and (B) the exercise price
of the call option written by the Fund; (ii) assets subject to call options
written by the Fund not meeting the requirements of clause (i) of this sentence
shall have no value; (iii) assets subject to put options written by the Fund
shall be valued at the lesser of (A) the exercise price and (B) the Discounted
Value of the subject security; (iv) futures contracts shall be valued at the
lesser of (A) settlement price and (B) the Discounted Value of the subject
security, provided that, if a contract matures within 49 days after the date as
of which such valuation is made, where the Fund is the seller the contract may
be valued at the settlement price and where the Fund is the buyer the contract
may be valued at the Discounted Value of the subject securities; and (v) where
delivery may be made to the Fund with any security of a class of securities, the
Fund shall assume that it will take delivery of the security with the lowest
Discounted Value.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the following amounts shall be subtracted from the aggregate
Discounted Value of the Moody's Eligible Assets held by the Fund: (i) 10% of the
exercise price of a written call option; (ii) the exercise price of any written
put option; (iii) where the Fund is the seller under a financial futures
contract, 10% of the settlement price
24
<PAGE>
of the financial futures contract; (iv) where the Fund is the purchaser under a
financial futures contract, the settlement price of assets purchased under such
financial futures contract; (v) the settlement price of the underlying financial
futures contract if the Fund writes put options on a financial futures contract;
and (vi) 105% of the fair market value of the underlying financial futures
contracts if the Fund writes call options on a financial futures contract and
does not own the underlying contract.
For so long as any shares of AMPS are rated by Moody's, the Fund will not
enter into any contract to purchase securities for a fixed price at a future
date beyond customary settlement time (other than such contracts that constitute
Moody's Hedging Transactions), except that the Fund may enter into such
contracts to purchase newly-issued securities on the date such securities are
issued ("Forward Commitments"), subject to the following limitations:
(i) the Fund will maintain in a segregated account with its custodian
cash, cash equivalents or short-term, fixed-income securities rated P-1,
MIG-1 or VMIG-1 by Moody's and maturing prior to the date of the Forward
Commitment with a fair market value that equals or exceeds the amount of the
Fund's obligations under any Forward Commitments to which it is from time to
time a party or long term, fixed income securities with a Discounted Value
that equals or exceeds the amount of the Fund's obligations under any
Forward Commitment to which it is from time to time a party, and
(ii) the Fund will not enter into a Forward Commitment unless, after
giving effect thereto, the Fund would continue to have Moody's Eligible
Assets with an aggregate Discounted Value equal to or greater than the AMPS
Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the Discounted Value of all Forward Commitments to which the
Fund is a party and of all securities deliverable to the Fund pursuant to such
Forward Commitments shall be zero.
------------------------
For so long as shares of AMPS are rated by S&P or Moody's, the Fund, unless
it has received written confirmation from S&P and/or Moody's, as the case may
be, that such action would not impair the ratings then assigned to the AMPS by
S&P and/or Moody's, as the case may be, will not (i) borrow money except for the
purpose of clearing transactions in portfolio securities (which borrowings under
any circumstances shall be limited to the lesser of $10 million and an amount
equal to 5% of the fair market value of the Fund's assets at the time of such
borrowings and which borrowings shall be repaid within 60 days and not be
extended or renewed and shall not cause the aggregate Discounted Value of
Moody's Eligible Assets and S&P Eligible Assets to be less than the AMPS Basic
Maintenance Amount), (ii) engage in short sales of securities, (iii) lend any
securities, (iv) issue any class or series of stock ranking prior to or on a
parity with the AMPS with respect to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up of the Fund,
(v) reissue any AMPS previously purchased or redeemed by the Fund, (vi) merge or
consolidate into or with any other corporation or entity, (vii) change the
Fund's pricing service or (viii) engage in reverse repurchase agreements.
Furthermore, for so long as the shares of AMPS are rated by S&P and Moody's, at
the time the Fund accepts shares of common stock for repurchase in a tender
offer, it shall have Deposit Securities maturing, or the irrevocable sale of
which are due for settlement with a counterparty rated A1 or better in the case
of S&P and P1 or better in the case of Moody's, within three Business Days of
such date of acceptance in an amount at least equal to the shares of common
stock accepted for repurchase in such tender offer; otherwise, the Fund will not
accept such shares for repurchase. Also, for so long as the shares of AMPS are
rated by S&P and Moody's, the Fund will provide, within five Business Days after
the end of each calendar month, a report to S&P and Moody's as to the number and
dollar amount of shares of common stock sold including shares sold pursuant to
reinvestment of
25
<PAGE>
dividends and the number, dollar amount and repurchase price of shares of common
stock repurchased pursuant to a tender offer. Such report also shall provide the
names of any counterparties to which Deposit Securities were sold in conjunction
with the satisfaction of the requirement of having Deposit Securities when the
Fund accepts shares of common stock in a tender offer as set forth above. For so
long as the shares of AMPS are rated by S&P and Moody's, the Fund will provide
notice to S&P and Moody's of the cancellation of any tender offers for its
common stock within three Business Days of such cancellation.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
manager of the Fund, including their ages and their principal occupations during
the last five years is set forth below. Unless otherwise noted, the address of
each Director, executive officer and the portfolio manager is 800 Scudders Mill
Road, Plainsboro, New Jersey 08536.
ARTHUR ZEIKEL (66)--PRESIDENT AND DIRECTOR(1)(2)--Chairman of the Investment
Adviser and its affiliate, Merrill Lynch Asset Management, L.P. ("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 and Director thereof
since 1993; President of Princeton Services 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; Consultant, Urban Institute, Washington, D.C. since 1995.
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; Partner, Small Cities Cable Television from 1986 to 1997.
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 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 (61)--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;
President of Princeton Administrators, L.P. since 1988.
26
<PAGE>
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.
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; Assistant Portfolio Manager of MLAM from 1993 to 1995;
Assistant Portfolio Manager with Prudential Investment Advisers from 1992 to
1993.
DONALD C. BURKE (38)--VICE PRESIDENT AND TREASURER(1)(2)--Senior Vice
President and Treasurer of the Investment Adviser and MLAM since 1999; Senior
Vice President and Treasurer of Princeton Services; Vice President of PFD since
1999; First Vice President of MLAM from 1997 to 1999; Vice President of MLAM
from 1990 to 1997.
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 (13
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" in the prospectus.
COMPENSATION OF DIRECTORS
Pursuant to the terms of the investment advisory agreement between the Fund
and the Investment Adviser (the "Investment Advisory Agreement"), the Investment
Adviser pays all compensation of officers and employees of the Fund as well as
the fees of all Directors of the Fund who are affiliated persons of ML & Co. or
its subsidiaries. The Fund pays each Director not affiliated with the Investment
Adviser (each a "non-affiliated Director") an annual fee of $3,000 plus $300 per
meeting attended, and pays all Director's actual out-of-pocket expenses relating
to attendance at meetings. The Fund also pays members of its Audit and
Nominating Committee (the "Committee"), which consists of all of the
non-affiliated Directors, an annual fee of $900. The Chairman of the Committee
receives an additional annual fee of $1,000. For fiscal year ended October 31,
1998, fees and expenses paid to the non-affiliated Directors that were allocated
to the Fund aggregated $28,715.
27
<PAGE>
The following table sets forth compensation paid by the Fund to the
non-affiliated Directors for the fiscal year ended October 31, 1998, and the
aggregate compensation paid by all investment companies advised by the
Investment Adviser and its affiliate, MLAM ("FAM/MLAM Advised Funds"), to the
non-affiliated Directors for the calendar year ended December 31, 1998.
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT FAM/MLAM
AGGREGATE BENEFITS ACCRUED ADVISED
COMPENSATION AS PART FUNDS PAID TO
NAME OF DIRECTOR FROM FUND OF FUND EXPENSE DIRECTORS
- ----------------------------------------------------------------- ------------- ----------------- --------------
<S> <C> <C> <C>
Ronald W. Forbes(1).............................................. $ 5,400 None $ 192,567
Cynthia A. Montgomery(1)......................................... $ 5,400 None $ 192,567
Charles C. Reilly(1)............................................. $ 6,400 None $ 362,858
Kevin A. Ryan(1)................................................. $ 5,400 None $ 192,567
Richard R. West(1)............................................... $ 5,400 None $ 334,125
</TABLE>
- ------------------------
(1) The Directors serve on the boards of other FAM/MLAM Advised Funds as
follows: Mr. Forbes (37 registered investment companies consisting of 50
portfolios); Ms. Montgomery (37 registered investment companies consisting
of 50 portfolios); Mr. Reilly (56 registered investment companies consisting
of 69 portfolios); Mr. Ryan (37 registered investment companies consisting
of 50 portfolios); and Mr. West (58 registered investment companies
consisting of 83 portfolios).
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS
The Fund has entered into an Investment Advisory Agreement with the
Investment Adviser. The Fund pays the Investment Adviser a monthly fee at an
annual rate of 0.50% 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 the
period November 3, 1995 (commencement of operations) to October 31, 1996, and
for the fiscal years ended October 31, 1997 and 1998, the fee paid by the Fund
to the Investment Adviser pursuant to the Investment Advisory Agreement was
$446,931, $657,929 and $787,978, respectively.
The Fund also has entered into an Administration Agreement with the
Investment Adviser. For the administrative services rendered to the Fund and the
facilities furnished, the Fund pays the Investment Adviser a monthly fee at an
annual rate of 0.25% of the Fund's average daily net assets (determined as set
forth above). For the period November 3, 1995 (commencement of operations) to
October 31, 1996, and for the fiscal years ended October 31, 1997 and 1998, the
fee paid by the Fund to the Investment Adviser pursuant to the Administration
Agreement was $223,466, $328,965 and $393,989, respectively. Such fees were
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 1998, the Investment
Adviser voluntarily waived $419,740, $424,822 and $204,377, respectively, of the
fee 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 the operation of the Fund,
including, among other things, expenses for legal and auditing services, taxes,
listing fees, if any, costs of printing proxies, stock certificates and
shareholder reports, charges of the Custodian and the Transfer Agent, Dividend
Disbursing Agent and Shareholder Servicing Agent, expenses of registering the
shares under Federal and
28
<PAGE>
state securities laws, fees and expenses with respect to the issuance of
preferred shares or any borrowing, Commission fees, fees and expenses of
non-affiliated Directors, accounting and pricing costs, insurance, interest,
brokerage costs, litigation and other extraordinary or non-recurring expenses,
mailing and other expenses properly payable by the Fund. Accounting services are
provided to the Fund by the Investment Adviser, and the Fund reimburses the
Investment Adviser for its costs in connection with such services. For the
period November 3, 1995 (commencement of operations) to October 31, 1996, the
reimbursement for such services was $60,526. For the fiscal years ended October
31, 1997 and 1998, such reimbursement aggregated $61,452 and $65,847,
respectively.
Unless earlier terminated as described below, the Investment Advisory and
Administration Agreements will remain in effect from year to year if approved
annually (a) by the Board of Directors of the Fund or by the shareholders
representing a majority of the outstanding shares of the Fund and (b) by a
majority of the Directors who are not parties to such contracts or interested
persons (as defined in the 1940 Act) of any such party. Such contracts are not
assignable and may be terminated without penalty on 60 days' written notice at
the option of either party thereto or by the vote of the shareholders of the
Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients when one or more clients are selling the same security. If purchases or
sales of securities by the Investment Adviser for the Fund or other funds for
which it acts as investment adviser or for advisory clients arise for
consideration at or about the same time, transactions in such securities will be
made, insofar as feasible, for the respective funds and clients in a manner
deemed equitable to all. To the extent that transactions on behalf of more than
one client of the Investment Adviser or its affiliate during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j1 under the 1940 Act that incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes"). The Codes significantly restrict the
personal investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot" initial
public offering and a prohibition from profiting on short-term trading in
securities. In addition, no employee may purchase or sell any security that at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading "blackout
periods", which prohibit trading by investment personnel of the Fund within
periods of trading by the Fund in the same (or equivalent) security (15 or 30
days depending upon the transaction).
TRANSFER AGENCY SERVICES
Financial Data Services, Inc. (the "Transfer Agent"), acts as the Fund's
transfer agent for the common stock pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement,
29
<PAGE>
the Transfer Agent is responsible for the issuance, transfer and tender of
shares of common stock and the opening and maintenance of shareholder accounts.
Pursuant to the Transfer Agency Agreement, the Transfer Agent receives an annual
fee of up to $14.00 per shareholder account, and is entitled to reimbursement
for certain transaction charges for out-of-pocket expenses incurred by the
Transfer Agent under the Transfer Agency Agreement. Additionally, a $.20 monthly
closed account charge will be assessed on all accounts that close during the
calendar year. Application of this fee will commence the month following the
month the account is closed. At the end of the calendar year, no further fees
will be due. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system, provided the recordkeeping system is
maintained by a subsidiary of ML & Co. For the period November 3, 1995
(commencement of operations) to October 31, 1996, and for the fiscal years ended
October 31, 1997 and 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.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm
involved and the firm's risk in positioning a block of securities. While the
Investment Adviser generally seeks reasonably competitive commission rates, the
Fund does not necessarily pay the lowest commission or spread available. For the
period November 3, 1995 (commencement of operations) to October 31, 1996, the
Fund did not pay any brokerage commissions and for the fiscal years ended
October 31, 1997 and 1998 the Fund paid $1,950 and $1,300, respectively in such
commissions, none of which was paid to Merrill Lynch.
The Fund has no obligation to deal with any broker or dealer in the
execution of transactions in portfolio securities. Subject to obtaining the best
price and execution, securities firms that provide supplemental investment
research to the Investment Adviser, including Merrill Lynch, may receive orders
for transactions by the Fund. Information so received will be in addition to and
not in lieu of the services required to be performed by the Investment Adviser
under the Investment Advisory Agreement, and the expenses of the Investment
Adviser will not necessarily be reduced as a result of the receipt of such
supplemental information.
The securities in which the Fund will invest are traded in the
over-the-counter markets, and the Fund intends to deal directly with the dealers
who make markets in the securities involved, except in those circumstances where
better prices and execution are available elsewhere. Under the 1940 Act, except
as permitted by exemptive order, persons affiliated with the Fund are prohibited
from dealing with the Fund as principal in the purchase and sale of securities.
Since transactions in the over-the-counter market usually involve transactions
with dealers acting as principal for their own account, the Fund will not deal
with affiliated persons, including Merrill Lynch and its affiliates, in
connection with such transactions except that, pursuant to an exemptive order
obtained by the Investment Adviser, the Fund may engage in principal
transactions with Merrill Lynch in high quality, short-term, tax-exempt
securities. See "Investment Restrictions" above. For the period November 3, 1995
(commencement of operations) to October 31, 1996, and for the fiscal years ended
October 31, 1997 and 1998 the Fund engaged in no transactions pursuant to such
order. However, affiliated persons of the Fund may serve as its broker in
over-the-counter transactions conducted on an agency basis.
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
30
<PAGE>
which either comply with rules adopted by the Commission or with interpretations
of the Commission Staff. Rule 10f-3 under the 1940 Act sets forth conditions
under which the Fund may purchase municipal bonds from an underwriting syndicate
of which Merrill Lynch is a member. The rule sets forth requirements relating
to, among other things, the terms of an issue of municipal bonds purchased by
the Fund, the amount of municipal bonds that may be purchased in any one issue
and the assets of the Fund that may be invested in a particular issue.
The Fund may also make loans to tax-exempt borrowers in individually
negotiated transactions with the borrower. Because an active trading market may
not exist for such securities, the prices that the Fund may pay for these
securities or receive on their resale may be lower than that for similar
securities with a more liquid market.
PORTFOLIO TURNOVER
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Investment Adviser. The portfolio turnover rate is calculated
by dividing the lesser of purchases or sales of portfolio securities for the
particular fiscal year by the monthly average of the value of the portfolio
securities owned by the Fund during the particular fiscal year. For purposes of
determining this rate, all securities whose maturities at the time of
acquisition are one year or less are excluded. For the period November 3, 1995
(commencement of operations) to October 31, 1996 and fiscal years ended October
31, 1997 and 1998 the Fund's portfolio turnover rates were 234%, 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.
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 Internal Revenue Service (the "IRS"), in a revenue ruling, held that
certain auction rate preferred stock would be treated as stock for Federal
income tax purposes. The terms of the AMPS are substantially similar, but not
identical, to the auction rate preferred stock discussed in the revenue ruling,
and in the opinion of Brown & Wood LLP, counsel to the Fund, the shares of AMPS
will constitute stock of the Fund and distributions with respect to shares of
AMPS (other than distributions in redemption of shares of AMPS subject to
Section 302(b) of the Code) will constitute dividends to the extent of the
Fund's current and accumulated earnings and profits as calculated for Federal
income tax purposes. Nevertheless, it is possible that the IRS might take a
contrary position, asserting, for example, that the shares of AMPS constitute
debt of the Fund. If this position were upheld, the
31
<PAGE>
discussion of the treatment of distributions below would not apply. Instead,
distributions by the Fund to holders of shares of AMPS would constitute
interest, whether or not they exceeded the earnings and profits of the Fund,
would be included in full in the income of the recipient and would be taxed as
ordinary income. Counsel believes that such a position, if asserted by the IRS,
would be unlikely to prevail.
The Fund intends to qualify to pay "exempt-interest" dividends as defined in
Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations exempt from Federal income tax ("tax-exempt
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund will be qualified
to pay exempt-interest dividends to its shareholders. Exempt-interest dividends
are dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Fund as exempt-interest
dividends in a written notice mailed to the Fund's shareholders within 60 days
after the close of its taxable year. To the extent that the dividends
distributed to the Fund's shareholders are derived from interest income exempt
from tax under Code Section 103(a) and are properly designated as
exempt-interest dividends, they will be excludable from a shareholder's gross
income for Federal income tax purposes. Exempt-interest dividends are included,
however, in determining the portion, if any, of a person's social security and
railroad retirement benefits subject to Federal income taxes. Interest on
indebtedness incurred or continued to purchase or carry Fund shares will not be
deductible by the investor for Federal income tax purposes, to the extent
attributable to exempt-interest dividends. Shareholders are advised to consult
their tax advisers with respect to whether exempt-interest dividends retain the
exclusion under Code Section 103(a) if such shareholder would be treated as a
"substantial user" or "related person" under Code Section 147(a) with respect to
property financed with the proceeds of an issue of "industrial development
bonds" or "private activity bonds," if any, held by the Fund.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal income tax purposes. Distributions, if
any, from an excess of net long-term capital gains over net short-term capital
losses derived from the sale of securities or from certain transactions in
futures or options ("capital gain dividends") are taxable as long-term capital
gains for Federal income tax purposes, regardless of the length of time the
shareholder has owned Fund shares. 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 and 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, will not be
eligible for the dividends received deduction allowed to corporations under the
Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of shares held for six months
or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividends received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax
32
<PAGE>
purposes as being paid by the RIC and received by its shareholders on December
31 of the year in which such dividend was declared.
The IRS has taken the position in a revenue ruling that if a RIC has two 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 and net long-term capital
gains. A class's proportionate share of a particular type of income is
determined according to the percentage of total dividends paid by the RIC during
such year that was paid to such class. Thus, the Fund is required to allocate a
portion of its net capital gains and other taxable income to the shares of AMPS
of each series. The Fund generally will notify the Auction Agent of the amount
of any net capital gains and other taxable income to be included in any dividend
on shares of AMPS prior to the Auction establishing the Applicable Rate for such
dividend. Except for the portion of any dividend that it informs the Auction
Agent will be treated as capital gains or other taxable income, the Fund
anticipates that the dividends paid on the shares of AMPS will constitute
exempt-interest dividends. The amount of net capital gains and ordinary income
allocable to shares of AMPS (the "taxable distribution") will depend upon the
amount of such gains and income realized by the Fund and the total dividends
paid by the Fund on shares of common stock and shares of AMPS during a taxable
year, but the taxable distribution generally is not expected to be significant.
In the opinion of Brown & Wood LLP, counsel to the Fund, under current law
the manner in which the Fund intends to allocate items of tax-exempt income, net
capital gains and other taxable income among shares of common stock and series
of AMPS will be respected for Federal income tax purposes. However, the tax
treatment of Additional Dividends may affect the Fund's calculation of each
class's allocable share of capital gains and other taxable income. See "Tax
Treatment of Additional Dividends." In addition, there is currently no direct
guidance from the IRS or other sources specifically addressing whether the
Fund's method for allocating tax-exempt income, net capital gains and other
taxable income among shares of common stock and series of AMPS will be respected
for Federal income tax purposes, and it is possible that the IRS could disagree
with counsel's opinion and attempt to reallocate the Fund's net capital gains or
other taxable income. In the event of a reallocation, some of the dividends
identified by the Fund as exempt-interest dividends to holders of shares of AMPS
may be recharacterized as additional capital gains or other taxable income. In
the event of such recharacterization, the Fund would not be required to make
payments to such shareholders to offset the tax effect of such reallocation. In
addition, a reallocation may cause the Fund to be liable for income tax and
excise tax on any reallocated taxable income. Brown & Wood LLP has advised the
Fund that, in its opinion, if the IRS were to challenge in court the Fund's
allocations of income and gain, the IRS would be unlikely to prevail. A holder
should be aware, however, that the opinion of Brown & Wood LLP represents only
its best legal judgment and is not binding on the IRS or the courts.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. This alternative minimum tax applies
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds that, although tax-exempt, are used for
purposes other than those generally performed by governmental units and that
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference" which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund intends to
purchase such "private activity bonds" and will report to shareholders within 60
days after 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
33
<PAGE>
earnings, a corporate shareholder may be required to pay an alternative minimum
tax on exempt-interest dividends paid by the Fund.
The Fund may invest in high yield securities, as described herein.
Furthermore, the Fund may also invest in instruments the return on which
includes nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such high yield securities
and/or nontraditional instruments could be recharacterized as taxable ordinary
income.
If at any time when shares of AMPS are outstanding the Fund does not meet
the asset coverage requirements of the 1940 Act, the Fund will be required to
suspend distributions to holders of common stock until the asset coverage is
restored. See "Description of AMPS--Restrictions on Dividends and Other
Payments" herein and in the prospectus. 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 and/or may subject the
Fund to the 4% excise tax discussed above. If the Fund were to fail to qualify
as a RIC, some or all of the distributions would be fully taxable for Federal
income tax purposes. Upon any failure to meet the asset coverage requirements of
the 1940 Act, the Fund, in its sole discretion, may, and under certain
circumstances will be required to, redeem shares of AMPS in order to maintain or
restore the requisite asset coverage and avoid the adverse consequences to the
Fund and its shareholders of failing to qualify as a RIC. See "Description of
AMPS--Redemption" herein and in the prospectus. There can be no assurance,
however, that any such action would achieve such objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund currently contemplates issuing, in
addition to the Series A AMPS, may raise an issue as to whether distributions on
such preferred stock are "preferential" under the Code and therefore not
eligible for the dividends paid deduction. The Fund intends to issue preferred
stock that counsel advises will not result in the payment of a preferential
dividend and may seek a private letter ruling from the IRS to that effect. If
the Fund ultimately relies solely on a legal opinion when it issues such
preferred stock, there is no assurance that the IRS would agree that dividends
on the preferred stock are not preferential. If the IRS successfully disallowed
the dividends paid deduction for dividends on the preferred stock, the Fund
could lose the benefit of the special treatment afforded RICs under the Code. In
this case, dividends paid by the Fund would not be exempt from Federal income
taxes. Additionally, the Fund would be subject to the alternative minimum tax.
Under certain Code provisions, some taxpayers may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisers concerning the applicability of the United States withholding
tax.
34
<PAGE>
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
TAX TREATMENT OF ADDITIONAL DIVIDENDS
If the Fund makes a Retroactive Taxable Allocation, it will pay Additional
Dividends to holders of shares of AMPS who are subject to the Retroactive
Taxable Allocation. See "Description of AMPS-- Dividends--Additional Dividends"
in the prospectus. The Federal income tax consequences of Additional Dividends
under existing law are uncertain. The Fund intends to treat a holder as
receiving a dividend distribution in the amount of any Additional Dividend only
as and when such Additional Dividend is paid. An Additional Dividend generally
will be designated by the Fund as an exempt-interest dividend except as
otherwise required by applicable law. However, the IRS may assert that all or
part of an Additional Dividend is a taxable dividend either in the taxable year
for which the Retroactive Taxable Allocation is made or in the taxable year in
which the Additional Dividend is paid.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities. The Fund may also
purchase and write call and put options on such financial futures contracts. In
general, unless an election is available to the Fund or an exception applies,
such options and financial futures contracts that are "Section 1256 contracts"
will be "marked to market" for Federal income tax purposes at the end of each
taxable year, i.e., each such option or financial futures contract will be
treated as sold for its fair market value on the last day of the taxable year,
and any gain or loss attributable to Section 1256 contracts will be 60%
long-term and 40% short-term capital gain or loss. Application of the
mark-to-market rules to Section 1256 contracts held by the Fund may alter the
timing and character of distributions to shareholders. The mark-to-market rules
outlined above, however, will not apply to certain transactions entered into by
the Fund solely to reduce the risk of changes in price or interest rates with
respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in financial futures
contracts and related options. Under Section 1092, the Fund may be required to
postpone recognition for tax purposes of losses incurred in certain sales of
securities and certain closing transactions in financial futures contracts or
the related options.
STATE AND LOCAL TAXES
The exemption from Federal income tax for exempt-interest dividends does not
necessarily result in an exemption for such dividends under the income or other
tax laws of any state or local taxing authority. Shareholders are advised to
consult their own tax advisers concerning state and local tax matters.
------------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes and with specific
questions as to Federal, foreign, state or local taxes.
35
<PAGE>
NET ASSET VALUE
Net asset value per share of common stock is determined as of 15 minutes
after the close of business on the New York Stock Exchange ("NYSE") (generally,
the NYSE closes at 4:00 p.m. Eastern time) on the last business day in each
week. For purposes of determining the net asset value of a share of common
stock, the value of the securities held by the Fund plus any cash or other
assets (including interest accrued but not yet received) minus all liabilities
(including accrued expenses) and the aggregate liquidation value of the
outstanding shares of preferred stock is divided by the total number of shares
of common stock outstanding at such time. Expenses, including the fees payable
to the Investment Adviser, are accrued daily.
The Municipal Bonds in which the Fund invests are traded primarily in the
over-the-counter markets. In determining net asset value, the Fund uses 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. 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.
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this statement
of additional information by reference to its 1998 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling (800) 456-4587 ext. 789 between 8:00 a.m. and 8:00 p.m. on any business
day.
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the 1940 Act and in
accordance therewith is required to file reports, proxy statements and other
information with the Commission. Any such reports, proxy statements and other
information can be inspected and copied at the public reference facilities of
the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the following regional offices of the Commission:
Regional Office, at Seven World Trade Center, Suite 1300, New York, New York
10048; Pacific Regional Office, at 5670 Wilshire Boulevard, 11th Floor, Los
Angeles, California 90036; and Midwest Regional Office, at Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of such materials can be obtained from the public reference section of
the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. The Commission maintains a Web site at http://www.sec.gov containing
reports, proxy and information statements and other information regarding
registrants, including the Fund, that file electronically with the Commission.
Additional information regarding the Fund and the AMPS is contained in the
Registration Statement on Form N-2, including amendments, exhibits and schedules
thereto, relating to such shares filed by the Fund with the Commission in
Washington, D.C. The prospectus and this statement of additional information do
not contain all of the information set forth in the Registration Statement,
including any amendments, exhibits and schedules thereto. For further
information with respect to the Fund and the
36
<PAGE>
shares offered hereby, reference is made to the Registration Statement.
Statements contained in the prospectus and this statement of additional
information as to the contents of any contract or other document referred to are
not necessarily complete and in each instance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. A copy of the Registration Statement may be inspected without charge
at the Commission's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the Commission upon the payment of certain
fees prescribed by the Commission.
37
<PAGE>
APPENDIX A
RATINGS OF MUNICIPAL BONDS
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,
enjoying strong protection from established cash flows"; MIG-2/VMIG-2 denotes
"high quality" with "ample margins of protection"; MIG-3/VMIG-3 instruments are
of "favorable quality...but...lacking the undeniable strength of the preceding
grades".
A-1
<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 supporting institutions) have a superior
ability for repayment of short-term promissory obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well established industries;
high rates of return on funds employed; conservative capitalization
structures with moderate reliance on debt and ample asset protection; broad
margins in earning coverage of fixed financial charges and high internal
cash generation; and well established access to a range of financial markets
and assured sources of alternate liquidity.
Issuers rated Prime-2 (or 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 effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes to 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, A DIVISION OF THE MCGRAW-HILL COMPANIES, INC.
("STANDARD & POOR'S"), MUNICIPAL DEBT RATINGS
A Standard & Poor's municipal debt 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 program. It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation.
The debt 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 obligors or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor'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 based on circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, and relative position of, the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditors' rights.
A-2
<PAGE>
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to meet its financial commitment on the obligation is extremely
strong.
AA Debt rated "AA" differs from the highest rated issues only in small degree.
The Obligor's capacity to meet its financial commitment on the obligation
is very strong.
A Debt rated "A" is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB Debt rated "BBB" exhibits adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to lead to a
weakened capacity of the obligor to meet its financial commitment on the
obligation.
BB Debt rated "BB," "B," "CCC," "CC" and "C" are regarded as having
B significant speculative characteristics. "BB" indicates the least degree of
CCC speculation and "C" the highest degree of speculation. While such debt will
CC likely have some quality and protective characteristics, these may be
C outweighed by large uncertainties or major risk exposures to adverse
conditions.
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 Standard & Poor's believes
that such payments will be made during such grace period. The "D" rating
also will be used upon the filing of a bankruptcy petition 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 STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's 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 designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
A-3 Issues carrying this designation have an adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
B Issues rated "B" are regarded as having only speculative capacity for timely
payment.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired unless Standard & Poor's
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 Standard &
Poor's by the issuer or obtained by Standard &
A-3
<PAGE>
Poor's 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.
A Standard & Poor's 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 carrying the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable
events.
AA Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA." Because bonds rated in
the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated "F-1+."
A-4
<PAGE>
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 12 months.
</TABLE>
Ratings Outlook: An outlook is used to describe the most likely direction of
any rating change over the intermediate term. It is described as "Positive" or
"Negative." The absence of a designation indicates a stable outlook.
DESCRIPTION OF FITCH'S SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
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 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
A-5
<PAGE>
reflects the obligor's limited margin of safety and the need for reasonable
business and economic activity throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not remedied, may
lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD Bonds are in default on interest and/or principal payments. Such bonds are
DD extremely speculative and should be valued on the basis of their ultimate
D recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on these bonds, and "D"
represents the lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
DESCRIPTION OF FITCH'S SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
"F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as
great as for issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate;
however, near-term adverse changes could cause these securities to be rated
below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are
vulnerable to near-term adverse changes in financial and economic
conditions.
D Default. Issues assigned this rating are in actual or imminent payment
default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit
issued by a commercial bank.
A-6
<PAGE>
APPENDIX B
SETTLEMENT PROCEDURES
The following summary of Settlement Procedures sets forth the procedures
expected to be followed in connection with the settlement of each Auction and
will be incorporated by reference in the Auction Agent Agreement and each
Broker-Dealer Agreement. Nothing contained in this Appendix II constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party. Capitalized terms used herein shall have the respective meanings
specified in the glossary of this prospectus or Appendix III hereto, as the case
may be.
(a) On each Auction Date, the Auction Agent shall notify by telephone or
through the Auction Agent's Processing System the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner of:
the Applicable Rate fixed for the next succeeding Dividend Period;
whether Sufficient Clearing Bids existed for the determination of the
Applicable Rate;
if such Broker-Dealer (a "Seller's Broker-Dealer") submitted a Bid or a
Sell Order on behalf of a Beneficial Owner, the number of shares, if any, of
AMPS to be sold by such Beneficial Owner;
if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a Bid on
behalf of a Potential Beneficial Owner, the number of shares, if any, of
AMPS to be purchased by such Potential Beneficial Owner;
if the aggregate number of shares of AMPS to be sold by all Beneficial
Owners on whose behalf such Broker-Dealer submitted a Bid or a Sell Order
exceeds the aggregate number of shares of AMPS to be purchased by all
Potential Beneficial Owners on whose behalf such Broker-Dealer submitted a
Bid, the name or names of one or more Buyer's Broker-Dealers (and the name
of the Agent Member, if any, of each such Buyer's Broker-Dealer) acting for
one or more purchasers of such excess number of shares of AMPS and the
number of such shares to be purchased from one or more Beneficial Owners on
whose behalf such Broker-Dealer acted by one or more Potential Beneficial
Owners on whose behalf each of such Buyer's Broker-Dealers acted;
if the aggregate number of shares of AMPS to be purchased by all
Potential Beneficial Owners on whose behalf such Broker-Dealer submitted a
Bid exceeds the aggregate number of shares of AMPS to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order, the name or names of one or more Seller's Broker-Dealers (and
the name of the Agent Member, if any, of each such Seller's Broker-Dealer)
acting for one or more sellers of such excess number of shares of AMPS and
the number of such shares to be sold to one or more Potential Beneficial
Owners on whose behalf such Broker-Dealer acted by one or more Beneficial
Owners on whose behalf each of such Seller's Broker-Dealers acted; and
the Auction Date of the next succeeding Auction with respect to the
AMPS.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
in the case of a Broker-Dealer that is a Buyer's Broker-Dealer, instruct
each Potential Beneficial Owner on whose behalf such Broker-Dealer submitted
a Bid that was accepted, in whole or in part, to instruct such Potential
Beneficial Owner's Agent Member to pay to such Broker-Dealer (or its Agent
Member) through the Securities Depository the amount necessary to purchase
the number of shares of AMPS to be purchased pursuant to such Bid against
receipt of such shares
B-1
<PAGE>
and advise such Potential Beneficial Owner of the Applicable Rate for the
next succeeding Dividend Period;
in the case of a Broker-Dealer that is a Seller's Broker-Dealer,
instruct each Beneficial Owner on whose behalf such Broker-Dealer submitted
a Sell Order that was accepted, in whole or in part, or a Bid that was
accepted, in whole or in part, to instruct such Beneficial Owner's Agent
Member to deliver to such Broker-Dealer (or its Agent Member) through the
Securities Depository the number of shares of AMPS to be sold pursuant to
such Order against payment therefor and advise any such Beneficial Owner
that will continue to hold shares of AMPS of the Applicable Rate for the
next succeeding Dividend Period;
advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted a Hold Order of the Applicable Rate for the next succeeding
Dividend Period;
advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
advise each Potential Beneficial Owner on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, of the
Auction Date for the next succeeding Auction.
On the basis of the information provided to it pursuant to (a) above, each
Broker-Dealer that submitted a Bid or a Sell Order on behalf of a Potential
Beneficial Owner or a Beneficial Owner shall, in such manner and at such time or
times as in its sole discretion it may determine, allocate any funds received by
it pursuant to (b)(i) above and any shares of AMPS received by it pursuant to
(b)(ii) above among the Potential Beneficial Owners, if any, on whose behalf
such Broker-Dealer submitted Bids, the Beneficial Owners, if any, on whose
behalf such Broker-Dealer submitted Bids that were accepted or Sell Orders, and
any Broker-Dealer or Broker-Dealers identified to it by the Auction Agent
pursuant to (a)(v) or (a)(vi) above.
(c) On each Auction Date:
(i) each Potential Beneficial Owner and Beneficial Owner shall instruct
its Agent Member as provided in (b)(i) or (ii) above, as the case may be;
each Seller's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through the
Securities Depository to the Agent Member of the Beneficial Owner delivering
shares to such Broker-Dealer pursuant to (b)(ii) above the amount necessary
to purchase such shares against receipt of such shares, and (B) deliver such
shares through the Securities Depository to a Buyer's Broker-Dealer (or its
Agent Member) identified to such Seller's Broker-Dealer pursuant to (a)(v)
above against payment therefor; and
each Buyer's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through the
Securities Depository to a Seller's Broker-Dealer (or its Agent Member)
identified pursuant to (a) (vi) above the amount necessary to purchase the
shares to be purchased pursuant to (b)(i) above against receipt of such
shares, and (B) deliver such shares through the Securities Depository to the
Agent Member of the purchaser thereof against payment therefor.
(d) On the day after the Auction Date:
each Bidder's Agent Member referred to in (d)(i) above shall instruct
the Securities Depository to execute the transactions described in (b)(i) or
(ii) above, and the Securities Depository shall execute such transactions;
each Seller's Broker-Dealer or its Agent Member shall instruct the
Securities Depository to execute the transactions described in (d)(ii)
above, and the Securities Depository shall execute such transactions; and
B-2
<PAGE>
each Buyer's Broker-Dealer or its Agent Member shall instruct the
Securities Depository to execute the transactions described in (d)(iii)
above, and the Securities Depository shall execute such transactions.
(e) If a Beneficial Owner selling shares of AMPS in an Auction fails to
deliver such shares (by authorized book-entry), a Broker-Dealer may deliver to
the Potential Beneficial Owner on behalf of which it submitted a Bid that was
accepted a number of whole shares of AMPS that is less than the number of shares
that otherwise was to be purchased by such Potential Beneficial Owner. In such
event, the number of shares of AMPS to be so delivered shall be determined
solely by such Broker-Dealer. Delivery of such lesser number of shares shall
constitute good delivery. Notwithstanding the foregoing terms of this paragraph
(f), any delivery or non-delivery of shares which shall represent any departure
from the results of an Auction, as determined by the Auction Agent, shall be of
no effect unless and until the Auction Agent shall have been notified of such
delivery or non-delivery in accordance with the provisions of the Auction Agent
Agreement and the Broker-Dealer Agreements.
B-3
<PAGE>
APPENDIX C
AUCTION PROCEDURES
The following procedures will be set forth in provisions of the Articles
Supplementary relating to the AMPS, and will be incorporated by reference in the
Auction Agent Agreement and each Broker-Dealer Agreement. The terms not defined
below are defined in the prospectus and the Glossary in the prospectus. Nothing
contained in this Appendix III constitutes a representation by the Fund that in
each Auction each party referred to herein actually will perform the procedures
described herein to be performed by such party.
PARAGRAPH 10(a) CERTAIN DEFINITIONS.
As used in this Paragraph 10, the following terms shall have the following
meanings, unless the context otherwise requires:
"AMPS" shall mean the shares of AMPS being auctioned pursuant to this
Paragraph 10.
"Auction Date" shall mean the first Business Day preceding the first day
of a Dividend Period.
"Available AMPS" shall have the meaning specified in Paragraph 10(d)(i)
below.
"Bid" shall have the meaning specified in Paragraph 10(b)(i) below.
"Bidder" shall have the meaning specified in Paragraph 10(b)(i) below.
"Hold Order" shall have the meaning specified in Paragraph 10(b)(i)
below.
"Maximum Applicable Rate" for any Dividend Period will be the Applicable
Percentage of the Reference Rate. The Applicable Percentage will be
determined based on (i) the lower of the credit rating or ratings assigned
on such date to such shares by Moody's and S&P (or if Moody's or S&P or both
shall not make such rating available, the equivalent of either or both of
such ratings by a Substitute Rating Agency or two Substitute Rating Agencies
or, in the event that only one such rating shall be available, such rating)
and (ii) whether the Fund has provided modification to the Auction Agent
prior to the Auction establishing the Applicable Rate for any dividend that
net capital gains or other taxable income will be included in such dividend
on shares of AMPS as follows:
<TABLE>
<CAPTION>
APPLICABLE APPLICABLE
PERCENTAGE OF PERCENTAGE OF
CREDIT RATINGS REFERENCE REFERENCE
- ------------------------------------------- RATE- RATE-
MOODY'S S&P NO NOTIFICATION NOTIFICATION
- --------------------- -------------------- --------------- -------------
<S> <C> <C> <C>
"aa3" or higher AA- or higher 110% 150%
"a3" to "a1" A- to A+ 125% 160%
"baa3" to "baa1" BBB- to BBB+ 150% 250%
Below "baa3" Below BBB- 200% 275%
</TABLE>
The Fund shall take all reasonable action necessary to enable S&P and
Moody's to provide a rating for the AMPS. If either S&P or Moody's shall not
make such a rating available, or if neither S&P nor Moody's shall make such a
rating available, Merrill Lynch, Pierce, Fenner & Smith Incorporated or its
affiliates and successors, after consultation with the Fund, shall select a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations to act as a Substitute Rating Agency
or Substitute Rating Agencies, as the case may be.
"Order" shall have the meaning specified in Paragraph 10(b)(i) below.
"Sell Order" shall have the meaning specified in Paragraph 10(b)(i) below.
C-1
<PAGE>
"Submission Deadline" shall mean 1:00 p.m., Eastern time, on any Auction
Date or such other time on any Auction Date as may be specified by the Auction
Agent from time to time as the time by which each Broker-Dealer must submit to
the Auction Agent in writing all Orders obtained by it for the Auction to be
conducted on such Auction Date.
"Submitted Bid" shall have the meaning specified in Paragraph 10(d)(i)
below.
"Submitted Hold Order" shall have the meaning specified in Paragraph
10(d)(i) below.
"Submitted Order" shall have the meaning specified in Paragraph 10(d)(i)
below.
"Submitted Sell Order" shall have the meaning specified in Paragraph
10(d)(i) below.
"Sufficient Clearing Bids" shall have the meaning specified in Paragraph
10(d)(i) below.
"Winning Bid Rate" shall have the meaning specified in Paragraph 10(d)(i)
below.
PARAGRAPH 10(b) ORDERS BY BENEFICIAL OWNERS, POTENTIAL BENEFICIAL OWNERS,
EXISTING HOLDERS AND POTENTIAL HOLDERS.
(i) Unless otherwise permitted by the Fund, Beneficial Owners and Potential
Beneficial Owners may only participate in Auctions through their Broker-Dealers.
Brokers-Dealers will submit the Orders of their respective customers who are
Beneficial Owners and Potential Beneficial Owners to the Auction Agent,
designating themselves as Existing Holders in respect of shares subject to
Orders submitted or deemed submitted to them by Beneficial Owners and as
Potential Holders in respect of shares subject to Orders submitted to them by
Potential Beneficial Owners. A Broker-Dealer may also hold shares of AMPS in its
own account as a Beneficial Owner. A Broker-Dealer may thus submit Orders to the
Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and
therefore participate in an Auction as an Existing Holder or Potential Holder on
behalf of both itself and its customers. On or prior to the Submission Deadline
on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer information as
to:
(1) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner desires to continue to hold
without regard to the Applicable Rate for the next succeeding Dividend
Period;
(2) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner desires to continue to hold,
provided that the Applicable Rate for the next succeeding Dividend Period
shall not be less than the rate per annum specified by such Beneficial
Owner, and/or
(3) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner offers to sell without
regard to the Applicable Rate for the next succeeding Dividend Period;
and
(B) each Broker-Dealer, using a list of Potential Beneficial Owners that
shall be maintained in good faith for the purpose of conducting a
competitive Auction, shall contact Potential Beneficial Owners, including
Persons that are not Beneficial Owners, on such list to determine the number
of outstanding shares, if any, of AMPS which each such Potential Beneficial
Owner offers to purchase, provided that the Applicable Rate for the next
succeeding Dividend Period shall not be less than the rate per annum
specified by such Potential Beneficial Owner.
For the purposes hereof, the communication by a Beneficial Owner or
Potential Beneficial Owner to a Broker-Dealer, or the communication by a
Broker-Dealer acting for its own account to the Auction Agent, of information
referred to in clause (A) or (B) of this Paragraph 10(b)(i) is hereinafter
referred to as an "Order" and each Beneficial Owner and each Potential
Beneficial Owner placing an
C-2
<PAGE>
Order, including a Broker-Dealer acting in such capacity for its own account, is
hereinafter referred to as a "Bidder"; an Order containing the information
referred to in clause (A)(1) of this Paragraph 10(b)(i) is hereinafter referred
to as a "Hold Order"; an Order containing the information referred to in clause
(A)(2) or (B) of this Paragraph 10(b)(i) is hereinafter referred to as a "Bid";
and an Order containing the information referred to in clause (A)(3) of this
Paragraph 10(b)(i) is hereinafter referred to as a "Sell Order." Inasmuch as a
Broker-Dealer participates in an Auction as an Existing Holder or a Potential
Holder only to represent the interests of a Beneficial Owner or Potential
Beneficial Owner, whether it be its customers or itself, all discussion herein
relating to the consequences of an Auction for Existing Holders and Potential
Holders also applies to the underlying beneficial ownership interests
represented thereby.
(ii) (A) A Bid by an Existing Holder shall constitute an irrevocable offer
to sell:
(1) the number of outstanding shares of AMPS specified in such Bid if
the Applicable Rate determined on such Auction Date shall be less than
the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of AMPS to
be determined as set forth in Paragraph 10(e)(i)(D) if the Applicable
Rate determined on such Auction Date shall be equal to the rate per annum
specified therein; or
(3) a lesser number of outstanding shares of AMPS to be determined as
set forth in Paragraph 10(e)(ii)(C) if such specified rate per annum
shall be higher than the Maximum Applicable Rate and Sufficient Clearing
Bids do not exist.
(B) A Sell Order by an Existing Holder shall constitute an irrevocable
offer to sell:
(1) the number of outstanding shares of AMPS specified in such Sell
Order, or
(2) such number or a lesser number of outstanding shares of AMPS to
be determined as set forth in Paragraph 10(e)(ii)(C) if Sufficient
Clearing Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable offer to
purchase:
(1) the number of outstanding shares of AMPS specified in such Bid if
the Applicable Rate determined on such Auction Date shall be higher than
the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of AMPS to
be determined as set forth in Paragraph 10(e)(i)(E) if the Applicable
Rate determined on such Auction Date shall be equal to the rate per annum
specified therein.
PARAGRAPH 10(c) SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT.
(i) Each Broker-Dealer shall submit in writing or through the Auction
Agent's Auction Processing System to the Auction Agent prior to the Submission
Deadline on each Auction Date all Orders obtained by such Broker-Dealer,
designating itself (unless otherwise permitted by the Fund) as an Existing
Holder in respect of shares subject to Orders submitted or deemed submitted to
it by Beneficial Owners and as a Potential Holder in respect of shares subject
to Orders submitted to it by Potential Beneficial Owners, and specifying with
respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the
Broker-Dealer unless otherwise permitted by the Fund);
(B) the aggregate number of outstanding shares of AMPS that are the
subject of such Order;
(C) to the extent that such Bidder is an Existing Holder
C-3
<PAGE>
(1) the number of outstanding shares, if any, of AMPS subject to any
Hold Order placed by such Existing Holder;
(2) the number of outstanding shares, if any, of AMPS subject to any
Bid placed by such Existing Holder and the rate per annum specified in
such Bid; and
(3) the number of outstanding shares, if any, of AMPS subject to any
Sell Order placed by such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate per annum
specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than three
figures to the right of the decimal point, the Auction Agent shall round such
rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the outstanding shares of AMPS
held by an Existing Holder are not submitted to the Auction Agent prior to the
Submission Deadline, the Auction Agent shall deem a Hold Order (in the case of
an Auction relating to a Dividend Period which is not a Special Dividend Period)
and a Sell Order (in the case of an Auction relating to a Special Dividend
Period) to have been submitted on behalf of such Existing Holder covering the
number of outstanding shares of AMPS held by such Existing Holder and not
subject to Orders submitted to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in the
aggregate more than the number of outstanding shares of AMPS held by such
Existing Holder are submitted to the Auction Agent, such Orders shall be
considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder shall be
considered valid up to and including the number of outstanding shares of
AMPS held by such Existing Holder; provided that if more than one Hold Order
is submitted on behalf of such Existing Holder and the number of shares of
AMPS subject to such Hold Orders exceeds the number of outstanding shares of
AMPS held by such Existing Holder, the number of shares of AMPS subject to
each of such Hold Orders shall be reduced pro rata so that such Hold Orders,
in the aggregate, cover exactly the number of outstanding shares of AMPS
held by such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be
considered valid, in the ascending order of their respective rates per annum
if more than one Bid is submitted on behalf of such Existing Holder, up to
and including the excess of the number of outstanding shares of AMPS held by
such Existing Holder over the number of shares of AMPS subject to any Hold
Order referred to in Paragraph 10(c)(iv)(A) above (and if more than one Bid
submitted on behalf of such Existing Holder specifies the same rate per
annum and together they cover more than the remaining number of shares that
can be the subject of valid Bids after application of Paragraph 10(c)(iv)(A)
above and of the foregoing portion of this Paragraph 10(c)(iv)(B) to any Bid
or Bids specifying a lower rate or rates per annum, the number of shares
subject to each of such Bids shall be reduced pro rata so that such Bids, in
the aggregate, cover exactly such remaining number of shares); and the
number of shares, if any, subject to Bids not valid under this Paragraph
10(c)(iv)(B) shall be treated as the subject of a Bid by a Potential Holder;
and
(C) any Sell Order shall be considered valid up to and including the
excess of the number of outstanding shares of AMPS held by such Existing
Holder over the number of shares of AMPS subject to Hold Orders referred to
in Paragraph 10(c)(iv)(A) and Bids referred to in Paragraph 10(c)(iv)(B);
provided that if more than one Sell Order is submitted on behalf of any
Existing Holder and the number of shares of AMPS subject to such Sell Orders
is greater than such excess, the number of shares of AMPS subject to each of
such Sell Orders shall be reduced pro rata so
C-4
<PAGE>
that such Sell Orders, in the aggregate, cover exactly the number of shares
of AMPS equal to such excess.
(v) If more than one Bid is submitted on behalf of any Potential Holder,
each Bid submitted shall be a separate Bid with the rate per annum and number of
shares of AMPS therein specified.
(vi) Any Order submitted by a Beneficial Owner or a Potential Beneficial
Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to
the Submission Deadline on any Auction Date shall be irrevocable.
PARAGRAPH 10(d) DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND
APPLICABLE RATE.
(i) Not earlier than the Submission Deadline on each Auction Date, the
Auction Agent shall assemble all Orders submitted or deemed submitted to it by
the Broker-Dealers (each such Order as submitted or deemed submitted by a
Broker-Dealer being hereinafter referred to individually as a "Submitted Hold
Order," a "Submitted Bid" or a "Submitted Sell Order," as the case may be, or as
a "Submitted Order") and shall determine:
(A) the excess of the total number of outstanding shares of AMPS over
the number of outstanding shares of AMPS that are the subject of Submitted
Hold Orders (such excess being hereinafter referred to as the "Available
AMPS");
(B) from the Submitted Orders whether the number of outstanding shares
of AMPS that are the subject of Submitted Bids by Potential Holders
specifying one or more rates per annum equal to or lower than the Maximum
Applicable Rate exceeds or is equal to the sum of:
(1) the number of outstanding shares of AMPS that are the subject of
Submitted Bids by Existing Holders specifying one or more rates per annum
higher than the Maximum Applicable Rate, and
(2) the number of outstanding shares of AMPS that are subject to
Submitted Sell Orders (if such excess or such equality exists (other than
because the number of outstanding shares of AMPS in clause (1) above and
this clause (2) are each zero because all of the outstanding shares of
AMPS are the subject of Submitted Hold Orders), such Submitted Bids by
Potential Holders hereinafter being referred to collectively as
"Sufficient Clearing Bids"); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum
specified in the Submitted Bids (the "Winning Bid Rate") that if:
(1) each Submitted Bid from Existing Holders specifying the Winning
Bid Rate and all other Submitted Bids from Existing Holders specifying
lower rates per annum were rejected, thus entitling such Existing Holders
to continue to hold the shares of AMPS that are the subject of such
Submitted Bids, and
(2) each Submitted Bid from Potential Holders specifying the Winning
Bid Rate and all other Submitted Bids from Potential Holders specifying
lower rates per annum were accepted, thus entitling the Potential Holders
to purchase the shares of AMPS that are the subject of such Submitted
Bids, would result in the number of shares subject to all Submitted Bids
specifying the Winning Bid Rate or a lower rate per annum being at least
equal to the Available AMPS.
(ii) Promptly after the Auction Agent has made the determinations pursuant
to Paragraph 10(d)(i), the Auction Agent shall advise the Fund of the Maximum
Applicable Rate and, based on such determinations, the Applicable Rate for the
next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable Rate for the
next succeeding Dividend Period shall be equal to the Winning Bid Rate;
C-5
<PAGE>
(B) if Sufficient Clearing Bids do not exist (other than because all of
the outstanding shares of AMPS are the subject of Submitted Hold Orders),
that the Applicable Rate for the next succeeding Dividend Period shall be
equal to the Maximum Applicable Rate; or
(C) if all of the outstanding shares of AMPS are the subject of
Submitted Hold Orders, that the Dividend Period next succeeding the Auction
automatically shall be the same length as the immediately preceding Dividend
Period and the Applicable Rate for the next succeeding Dividend Period shall
be equal to 40% of the Reference Rate (or 60% of such rate if the Fund has
provided notification to the Auction Agent prior to the Auction establishing
the Applicable Rate for any dividend that net capital gains or other taxable
income will be included in such dividend on shares of AMPS) on the date of
the Auction.
PARAGRAPH 10(e) ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL
ORDERS AND ALLOCATION OF SHARES.
Based on the determinations made pursuant to Paragraph 10(d)(i), the
Submitted Bids and Submitted Sell Orders shall be accepted or rejected and the
Auction Agent shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the provisions of
Paragraph 10(e)(iii) and Paragraph 10(e)(iv), Submitted Bids and Submitted Sell
Orders shall be accepted or rejected in the following order of priority and all
other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be accepted and
the Submitted Bid of each of the Existing Holders specifying any rate per
annum that is higher than the Winning Bid Rate shall be accepted, thus
requiring each such Existing Holder to sell the outstanding shares of AMPS
that are the subject of such Submitted Sell Order or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holders specifying any
rate per annum that is lower than the Winning Bid Rate shall be rejected,
thus entitling each such Existing Holder to continue to hold the outstanding
shares of AMPS that are the subject of such Submitted Bid;
(C) the Submitted Bid of each of the Potential Holders specifying any
rate per annum that is lower than the Winning Bid Rate shall be accepted;
(D) the Submitted Bid of each of the Existing Holders specifying a rate
per annum that is equal to the Winning Bid Rate shall be rejected, thus
entitling each such Existing Holder to continue to hold the outstanding
shares of AMPS that are the subject of such Submitted Bid, unless the number
of outstanding shares of AMPS subject to all such Submitted Bids shall be
greater than the number of outstanding shares of AMPS ("Remaining Shares")
equal to the excess of the Available AMPS over the number of outstanding
shares of AMPS subject to Submitted Bids described in Paragraph 10(e)(i)(B)
and Paragraph 10(e)(i)(C), in which event the Submitted Bids of each such
Existing Holder shall be accepted, and each such Existing Holder shall be
required to sell outstanding shares of AMPS, but only in an amount equal to
the difference between (1) the number of outstanding shares of AMPS then
held by such Existing Holder subject to such Submitted Bid and (2) the
number of shares of AMPS obtained by multiplying (x) the number of Remaining
Shares by (y) a fraction the numerator of which shall be the number of
outstanding shares of AMPS held by such Existing Holder subject to such
Submitted Bid and the denominator of which shall be the sum of the numbers
of outstanding shares of AMPS subject to such Submitted Bids made by all
such Existing Holders that specified a rate per annum equal to the Winning
Bid Rate; and
(E) the Submitted Bid of each of the Potential Holders specifying a rate
per annum that is equal to the Winning Bid Rate shall be accepted but only
in an amount equal to the number of outstanding shares of AMPS obtained by
multiplying (x) the difference between the Available
C-6
<PAGE>
AMPS and the number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(i)(B), Paragraph 10(e)(i)(C) and Paragraph
10(e)(i)(D) by (y) a fraction the numerator of which shall be the number of
outstanding shares of AMPS subject to such Submitted Bid and the denominator
of which shall be the sum of the number of outstanding shares of AMPS
subject to such Submitted Bids made by all such Potential Holders that
specified rates per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than because all
of the outstanding shares of AMPS are subject to Submitted Hold Orders), subject
to the provisions of Paragraph 10(e)(iii), Submitted Orders shall be accepted or
rejected as follows in the following order of priority and all other Submitted
Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate per
annum that is equal to or lower than the Maximum Applicable Rate shall be
rejected, thus entitling such Existing Holder to continue to hold the
outstanding shares of AMPS that are the subject of such Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying any rate per
annum that is equal to or lower than the Maximum Applicable Rate shall be
accepted, thus requiring such Potential Holder to purchase the outstanding
shares of AMPS that are the subject of such Submitted Bid; and
(C) the Submitted Bids of each Existing Holder specifying any rate per
annum that is higher than the Maximum Applicable Rate shall be accepted and
the Submitted Sell Orders of each Existing Holder shall be accepted, in both
cases only in an amount equal to the difference between (1) the number of
outstanding shares of AMPS then held by such Existing Holder subject to such
Submitted Bid or Submitted Sell Order and (2) the number of shares of AMPS
obtained by multiplying (x) the difference between the Available AMPS and
the aggregate number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(ii)(A) and Paragraph 10(e)(ii)(B) by (y) a
fraction the numerator of which shall be the number of outstanding shares of
AMPS held by such Existing Holder subject to such Submitted Bid or Submitted
Sell Order and the denominator of which shall be the number of outstanding
shares of AMPS subject to all such Submitted Bids and Submitted Sell Orders.
(iii) If, as a result of the procedures described in Paragraph 10(e)(i) or
Paragraph 10(e)(ii), any Existing Holder would be entitled or required to sell,
or any Potential Holder would be entitled or required to purchase, a fraction of
a share of AMPS on any Auction Date, the Auction Agent shall, in such manner as
in its sole discretion it shall determine, round up or down the number of shares
of AMPS to be purchased or sold by any Existing Holder or Potential Holder on
such Auction Date so that each outstanding share of AMPS purchased or sold by
each Existing Holder or Potential Holder on such Auction Date shall be a whole
share of AMPS.
(iv) If, as a result of the procedures described in Paragraph 10(e)(i), any
Potential Holder would be entitled or required to purchase less than a whole
share of AMPS on any Auction Date, the Auction Agent, in such manner as in its
sole discretion it shall determine, shall allocate shares of AMPS for purchase
among Potential Holders so that only whole shares of AMPS are purchased on such
Auction Date by any Potential Holder, even if such allocation results in one or
more of such Potential Holders not purchasing any shares of AMPS on such Auction
Date.
(v) Based on the results of each Auction, the Auction Agent shall determine,
with respect to each Broker-Dealer that submitted Bids or Sell Orders on behalf
of Existing Holders or Potential Holders, the aggregate number of the
outstanding shares of AMPS to be purchased and the aggregate number of
outstanding shares of AMPS to be sold by such Potential Holders and Existing
Holders and, to the extent that such aggregate number of outstanding shares to
be purchased and such aggregate number of outstanding shares to be sold differ,
the Auction Agent shall determine to which other Broker-
C-7
<PAGE>
Dealer or Broker-Dealers acting for one or more purchasers such Broker-Dealer
shall deliver, or from which other Broker-Dealer or Broker-Dealers acting for
one or more sellers such Broker-Dealer shall receive, as the case may be,
outstanding shares of AMPS.
PARAGRAPH 10(f) MISCELLANEOUS.
The Fund may interpret the provisions of this Paragraph 10 to resolve any
inconsistency or ambiguity, remedy any formal defect or make any other change or
modification that does not substantially adversely affect the rights of
Beneficial Owners of AMPS. A Beneficial Owner or an Existing Holder (A) may
sell, transfer or otherwise dispose of shares of AMPS only pursuant to a Bid or
Sell Order in accordance with the procedures described in this Paragraph 10 or
to or through a Broker-Dealer, provided that in the case of all transfers other
than pursuant to Auctions such Beneficial Owner or Existing Holder, its
Broker-Dealer, if applicable, or its Agent Member advises the Auction Agent of
such transfer and (B) except as otherwise required by law, shall have the
ownership of the shares of AMPS held by it maintained in book entry form by the
Securities Depository in the account of its Agent Member, which in turn will
maintain records of such Beneficial Owner's beneficial ownership. Neither the
Fund nor any Affiliate (other than Merrill Lynch, Pierce, Fenner & Smith
Incorporated) shall submit an Order in any Auction. Any Beneficial Owner that is
an Affiliate (other than Merrill Lynch, Pierce, Fenner & Smith Incorporated)
shall not sell, transfer or otherwise dispose of shares of AMPS to any Person
other than the Fund. All of the outstanding shares of AMPS shall be represented
by one or more certificates registered in the name of the nominee of the
Securities Depository unless otherwise required by law or unless there is no
Securities Depository. If there is no Securities Depository, at the Fund's
option and upon its receipt of such documents as it deems appropriate, any
shares of AMPS may be registered in the Stock Register in the name of the
Beneficial Owner thereof and such Beneficial Owner thereupon will be entitled to
receive certificates therefor and required to deliver certificates therefor upon
transfer or exchange thereof.
C-8
