MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Annual Report
October 31, 1999
Officers and Directors
Terry K. Glenn, President and Director
Ronald W. Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Arthur Zeikel, Director
Vincent R. Giordano, Senior Vice President
Robert A. DiMella, Vice President
Kenneth A. Jacob, Vice President
John M. Loffredo, Vice President
Donald C. Burke, Vice President and
Treasurer
William E. Zitelli, Secretary
Custodian
The Bank of New York
90 Washington Street
New York, NY 10286
Transfer Agent
Common Stock:
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
Preferred Stock:
The Bank of New York
100 Church Street
New York, NY 10286
This report, including the financial information herein, is
transmitted to the shareholders of Merrill Lynch Municipal Strategy
Fund, Inc. for their information. It is not a prospectus, circular
or representation intended for use in the purchase of shares of the
Fund or any securities mentioned in the report. Past performance
results shown in this report should not be considered a
representation of future performance. The Fund has leveraged its
Common Stock by issuing Preferred Stock to provide the Common Stock
shareholders with a potentially higher rate of return. Leverage
creates risks for Common Stock shareholders, including the
likelihood of greater volatility of net asset value and market price
of shares of the Common Stock, and the risk that fluctuations in the
short-term dividend rates of the Preferred Stock may affect the
yield to Common Stock shareholders. Statements and other information
herein are as dated and are subject to change.
Merrill Lynch Municipal
Strategy Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
The Benefits and
Risks of
Leveraging
Merrill Lynch Municipal Strategy Fund, Inc. utilizes lever-aging to
seek to enhance the yield and net asset value of its Common Stock.
However, these objectives cannot be achieved in all interest rate
environments. To leverage, the Fund issues Preferred Stock, which
pays dividends at prevailing short-term interest rates, and invests
the proceeds in long-term municipal bonds. The interest earned on
these investments is paid to Common Stock shareholders in the form
of dividends, and the value of these portfolio holdings is reflected
in the per share net asset value of the Fund's Common Stock.
However, in order to benefit Common Stock shareholders, the yield
curve must be positively sloped; that is, short-term interest rates
must be lower than long-term interest rates. At the same time, a
period of generally declining interest rates will benefit Common
Stock shareholders. If either of these conditions change, then the
risks of leveraging will begin to outweigh the benefits.
To illustrate these concepts, assume a fund's Common Stock
capitalization of $100 million and the issuance of Preferred Stock
for an additional $50 million, creating a total value of $150
million available for investment in long-term municipal bonds. If
prevailing short-term interest rates are approximately 3% and long-
term interest rates are approximately 6%, the yield curve has a
strongly positive slope. The fund pays dividends on the $50 million
of Preferred Stock based on the lower short-term interest rates. At
the same time, the fund's total portfolio of $150 million earns the
income based on long-term interest rates. Of course, increases in
short-term interest rates would reduce (and even eliminate) the
dividends on the Common Stock.
In this case, the dividends paid to Preferred Stock shareholders
are significantly lower than the income earned on the fund's long-
term investments, and therefore the Common Stock shareholders are
the beneficiaries of the incremental yield. However, if short-term
interest rates rise, narrowing the differential between short-term
and long-term interest rates, the incremental yield pickup on the
Common Stock will be reduced or eliminated completely. At the same
time, the market value of the fund's Common Stock may, as a result,
decline. Furthermore, if long-term interest rates rise, the Common
Stock's net asset value will reflect the full decline in the price
of the portfolio's investments, since the value of the fund's
Preferred Stock does not fluctuate. In addition to the decline in
net asset value, the market value of the fund's Common Stock may
also decline.
As a part of its investment strategy, the Fund may invest in certain
securities whose potential income return is inversely related to
changes in a floating interest rate ("inverse floaters"). In
general, interest rates on inverse floaters will decrease when short-
term interest rates increase and increase when short-term interest
rates decrease. Investments in inverse floaters may be
characterized as derivative securities and may subject the Fund to
the risks of reduced or eliminated interest payments and losses of
invested principal. In addition, inverse floaters have the effect of
providing investment leverage and, as a result, the market value of
such securities will generally be more volatile than that of fixed-
rate, tax-exempt securities. To the extent the Fund invests in
inverse floaters, the market value of the Fund's portfolio and the
net asset value of the Fund's shares may also be more volatile than
if the Fund did not invest in these securities.
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
DEAR SHAREHOLDER
For the year ended October 31, 1999, the Common Stock of Merrill
Lynch Municipal Strategy Fund, Inc. earned $0.569 per share income
dividends, which included earned and unpaid dividends of $0.041.
This represents a net annualized yield of 6.40%, based on a month-
end net asset value of $8.89. Over the same period, the total
investment return on the Fund's Common Stock was -11.94%, based on a
change in per share net asset value from $10.96 to $8.89, and
assuming reinvestment of $0.760 per share ordinary income dividends
and $0.096 per share capital gains distributions.
For the six months ended October 31, 1999, the total investment
return on the Fund's Common Stock was -13.42%, based on a change in
per share net asset value from $10.56 to $8.89, and assuming
reinvestment of $0.270 per share income dividends.
For the six-month period ended October 31, 1999, the Fund's Auction
Market Preferred Stock had an average yield of 3.24%.
The Municipal Market Environment
The combination of steady strong domestic economic growth,
improvement in foreign economies (most notably in Japan) and
increasing investor concerns regarding potential increases in US
inflation put upward pressure on bond yields throughout the three-
month period ended October 31, 1999. Continued strong US employment
growth was among the reasons the Federal Reserve Board cited for
raising short-term interest rates in late August. US Treasury bond
yields reacted by climbing above 6.375% by late October. However, at
October month-end, economic indicators were released suggesting
that, despite strong economic and employment growth in the third
quarter, inflationary pressures have remained extremely well
contained. This resulted in a significant rally in the US Treasury
bond market, pushing US Treasury bond yields downward to end the
three-month period at approximately 6.15%. During the period, yields
on 30-year US Treasury bonds increased over 10 basis points (0.10%).
Long-term tax-exempt bond yields also rose during the three months
ended October 31, 1999. Investor concerns of additional moves by the
Federal Reserve Board to moderate US economic growth and, more
importantly, the loss of the strong technical support that the tax-
exempt market enjoyed in early 1999 helped push municipal bond
yields significantly higher for the remainder of the period. The
yields on long-term tax-exempt revenue bonds rose over 50 basis
points to 6.18% by October 31, 1999, as measured by the Bond Buyer
Revenue Bond Index.
In recent months, the significant decline in new tax-exempt bond
issuance has remained a positive factor within the municipal bond
market, as it had been for much of the past year. During the last
six months, more than $110 billion in long-term municipal bonds was
issued, a decline of nearly 20% compared to the same period a year
ago. During the past three months, $55 billion in municipal bonds
was underwritten, representing a decline of nearly 10% compared to
the corresponding period in 1998. Additionally, in June and July,
investors received more than $40 billion in coupon income and
proceeds from bond maturities and early bond redemptions. These
proceeds have generated considerable retail investor interest, which
has helped absorb the recent diminished supply.
Although tax-exempt bond yields are at their highest level in over
two years and have attracted significant retail investor interest,
institutional demand has declined sharply. Long-term municipal
mutual funds have seen consistent outflows in recent months as the
yields of individual securities have risen faster than those of
larger, more diverse mutual funds. In addition, the demand from
property/casualty insurance companies has weakened as a result of
the losses, and anticipated losses, incurred as a result of the
series of damaging storms across much of the eastern United States.
Additionally, many institutional investors who were attracted to the
municipal bond market in recent years by historically attractive tax-
exempt bond yield ratios of over 90% have found other asset classes
even more attractive. Even with a reduced supply position, tax-
exempt issuers have been forced to repeatedly raise municipal bond
yields in the attempt to attract adequate demand.
The recent relative underperformance of the municipal bond market
has resulted in an opportunity for long-term investors to purchase
tax-exempt issues whose yields are nearly identical with taxable US
Treasury securities. At October 31, 1999, long-term uninsured
municipal revenue bond yields were 100% of comparable US Treasury
securities. In recent months, many taxable asset classes, such as
corporate bonds, mortgage-backed securities and US agency debt, have
all accelerated debt issuance. This acceleration was initiated
largely to avoid issuing securities at year-end and to minimize any
associated Year 2000 (Y2K) problems that may develop. However, this
increased issuance has also resulted in higher yield levels in the
various asset classes as lower bond prices became necessary to
attract sufficient investor demand. Going forward, it is believed
that the pace of non-US government debt issuance is likely to slow
significantly. As the supply of this debt declines, we would expect
many institutional investors to return to the municipal bond market
and the attractive yield ratios available.
Looking ahead, it appears to us that long-term tax-exempt bond
yields will remain under pressure, trading in a broad range centered
near current levels. Investors are likely to remain concerned about
future action by the Federal Reserve Board in November. Y2K
considerations may prohibit any further Federal Reserve Board moves
through the end of the year and the beginning of 2000. Any
improvement in bond prices will probably be contingent upon
weakening in both US employment growth and consumer spending. The
100 basis point rise in US Treasury bond yields seen thus far this
year may negatively impact US economic growth. The US housing market
will be among the first sectors likely to be affected, as some
declines have already been evidenced in response to higher mortgage
rates. We believe that it is also unrealistic to expect double-digit
returns in US equity markets to continue indefinitely. Much of the
US consumer's wealth is tied to recent stock market appreciation.
Any slowing in these incredible growth rates is likely to reduce
consumer spending. We believe that these factors suggest that the
worst of the recent increase in bond yields has passed and stable,
if not slightly improving, bond prices may be expected.
Portfolio Strategy
For the past three months, and for most of this year, we
underestimated the underlying strength of both the US and global
economies. We had believed that, in the absence of any material
inflationary pressures and given the enhanced productivity of US
companies, any increases in US economic strength would not result in
meaningful increases in interest rates. However, while inflationary
pressures did not surface as increases in productivity kept US labor
costs low, concerns of future inflation pushed long-term bond yields
much higher faster then we had expected. Economies around the world
rebounded from last fall's financial market turmoil with surprising
strength. Improvements in these foreign economies also allowed the
Federal Reserve Board to raise short-term interest rates, pushing
long-term interest rates higher as well.
We opted to maintain a fully invested position with emphasis on
seeking to enhance tax-exempt income. Overall portfolio composition
was largely current coupon, longer-dated issues for incremental
yield. To some extent, this was a reflection of our belief that tax-
exempt yields would remain in a narrow range with little need for
price appreciation. This strategy resulted in an attractive tax-
exempt yield for our shareholders. However, this was accompanied by
an increased net asset value volatility.
At October 31, 1999, Merrill Lynch Municipal Strategy Fund, Inc. was
positioned positively. We believe that we are approaching the highs
in yields. Recent interest rate increases as well as the anticipated
tightening in mid-November largely restored investor confidence that
the Federal Reserve Board would not allow inflation to rise
significantly. Some decline in economic growth, particularly in the
housing and retail sales sectors, can already be seen in response to
interest rate increases in recent months. Additionally, history
suggests that whenever tax-exempt bond yields rise close to or above
US Treasury bond yields for an extended period of time, municipal
bond portfolios tend to generate better total returns in the
following six months--twelve months.
During the October quarter, short-term tax-exempt interest rates
provided a significant yield benefit to the Fund's Common Stock
shareholders. Although the Federal Reserve Board increased short-
term taxable interest rates twice during the period and again on
November 16, 1999, interest rates on the Fund's Preferred Stock
remained near historical averages for much of the past three months.
However, should the spread between short-term and long-term interest
rates narrow, the benefits of the leverage will decline and, as a
result, reduce the yield on the Fund's Common Stock. (For a complete
explanation of the benefits and risks of leverage, see page 1 of
this report to shareholders.)
In Conclusion
We appreciate your ongoing interest in Merrill Lynch Municipal
Strategy Fund, Inc., and we look forward to serving your investment
needs in the months and years to come.
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President and Director
(Vincent R. Giordano)
Vincent R. Giordano
Senior Vice President
(Robert A. DiMella)
Robert A. DiMella
Vice President and Portfolio Manager
(John M. Loffredo)
John M. Loffredo
Vice President and Portfolio Manager
December 7, 1999
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <S> <S> <C> <S> <C>
Alaska--1.4% Valdez, Alaska, Marine Terminal Revenue Refunding Bonds
(Exxon Pipeline Company Project), VRDN (i):
A1+ VMIG1++ $ 200 Series A, 3.50% due 12/01/2033 $ 200
A1+ VMIG1++ 2,000 Series C, 3.50% due 12/01/2033 2,000
Arizona--5.7% B B2 2,000 Apache County, Arizona, IDA, PCR, Refunding (Tuscon
Electric Power Company Project), Series A, 5.85% due 3/01/2028 1,747
BBB- Baa3 1,500 Maricopa County, Arizona, Pollution Control Corporation,
PCR, Refunding (Public Service Company of New Mexico),
Series A, 5.75% due 11/01/2022 1,333
Phoenix, Arizona, IDA, Airport Facility Revenue Refunding
Bonds (America West Airlines Inc. Project), AMT:
NR* B1 2,000 6.25% due 6/01/2019 1,843
NR* B1 1,600 6.30% due 4/01/2023 1,475
B B2 2,000 Pima County, Arizona, IDA, Industrial Revenue Refunding
Bonds (Tucson Electric Power Company Project), Series B,
6% due 9/01/2029 1,790
NR* NR* 1,000 Show Low, Arizona, Improvement District No. 5, Special
Assessment Bonds, 6.375% due 1/01/2015 985
California NR* A2 2,500 California Health Facilities Finance Authority Revenue
- --9.1% Bonds (Cedars-Sinai Medical Center), Series A, 6.25% due 12/01/2034 2,464
AAA NR* 5,250 California Health Facilities Finance Authority, Revenue
Refunding Bonds, RIB, Series 90, 7.145% due 8/15/2028 (a)(e) 4,234
AA- Aa3 2,725 California State, GO, Refunding (Veterans Bonds), AMT,
Series BH, 5.60% due 12/01/2032 2,503
AAA Aaa 5,000 California State Public Works Board, Lease Revenue Refunding
Bonds (Department of Corrections--State Prisons), Series A,
5% due 12/01/2019 (c) 4,496
Los Angeles County, California, Schools Regionalized
Business Services, COP, Pooled Financing, Series A (c):
AAA Aaa 1,430 5.90%** due 8/01/2019 422
AAA Aaa 2,510 6%** due 8/01/2029 394
Colorado NR* NR* 1,500 Denver, Colorado, Urban Renewal Authority, Tax Increment
- --1.0% Revenue Bonds (Pavilions), AMT, 7.75% due 9/01/2016 1,640
Connecticut BB- Ba1 5,000 Connecticut State Development Authority, PCR, Refunding
- --5.0% (Connecticut Light & Power Company), Series A, 5.85%
due 9/01/2028 4,569
NR* Baa3 4,000 Mashantucket Western Pequot Tribe, Connecticut, Special
Revenue Refunding Bonds, Sub-Series A, 5.50% due 9/01/2028 3,524
District of A1+ VMIG1++ 1,000 District of Columbia, GO (General Fund Recovery),
Columbia-- VRDN, Series B-2, 3.55% due 6/01/2003 (i) 1,000
0.6%
Florida--8.1% AAA Aaa 3,145 Florida State Board of Education, Capital Outlay, GO
(Public Education), Series B, 4.50% due 6/01/2028 (a) 2,464
A- Baa1 4,000 Highlands County, Florida, Health Facilities Authority
Revenue Bonds (Adventist Hospital Health System), 5.25%
due 11/15/2020 3,379
NR* Aaa 2,500 Orange County, Florida, School Board COP, RIB, Series 130,
6.67% due 8/01/2023 (a)(e) 2,028
NR* B1 2,260 Palm Bay, Florida, Lease Revenue Refunding Bonds (Florida
Education and Research Foundation Project), Series A,
6.85% due 9/01/2013 2,125
A1+ VMIG1++ 3,000 Saint Lucie County, Florida, PCR, Refunding (Florida Power
and Light Company Project), VRDN, 3.50% due 1/01/2026 (i) 3,000
Georgia AAA Aa2 3,250 Georgia State HFA, S/F Mortgage Revenue Refunding Bonds,
- --2.1% Series A, Sub-Series A-1, 6.125% due 12/01/2015 (j) 3,301
Illinois NR* NR* 935 Beardstown, Illinois, IDR (Jefferson Smurfit Corp. Project),
- --3.5% 8% due 10/01/2016 1,018
AAA Aa3 3,285 Illinois Development Finance Authority Revenue Bonds
(Presbyterian Home Lake Project), Series B, 6.30%
due 9/01/2022 (d) 3,342
NR* Baa1 1,250 Illinois Health Facilities Authority Revenue Bonds
(Holy Cross Hospital Project), 6.70% due 3/01/2014 1,274
Louisiana CC NR* 4,000 Port New Orleans, Louisiana, IDR, Refunding (Continental Grain
- --2.4% Company Project), 6.50% due 1/01/2017 3,800
Maryland NR* NR* 3,000 Maryland State Energy Financing Administration, Limited
- --1.9% Obligation Revenue Bonds (Cogeneration-AES Warrior Run),
AMT, 7.40% due 9/01/2019 3,131
Massachusetts AA NR* 1,650 Massachusetts State Development Finance Agency,
- --4.0% Revenue Refunding Bonds (The May Institute Inc. Issue),
6% due 9/01/2019 1,600
NR* Aaa 3,615 Massachusetts State, HFA, Revenue Refunding Bonds, RITR,
Series 29, 6.82% due 12/01/2028 (a)(e) 2,799
A NR* 2,000 Massachusetts State Health and Educational Facilities
Authority Revenue Bonds (Schepens Eye Research Project),
Series A, 6.50% due 7/01/2028 2,043
Michigan AAA Aaa 3,100 Michigan State Hospital Finance Authority, Revenue
- --2.0% Refunding Bonds, INFLOS, 8.666% due 2/15/2022 (d)(e) 3,177
Mississippi BBB- Ba1 3,000 Mississippi Business Finance Corporation, Mississippi,
- --2.4% PCR, Refunding (System Energy Resources Inc. Project),
5.875% due 4/01/2022 2,644
NR* NR* 1,300 Mississippi Development Bank, Special Obligation Revenue
Refunding Bonds (Diamond Lakes Utilities), Series A,
6.25% due 12/01/2017 1,260
Nevada--1.0% NR* NR* 1,530 Reno-Sparks Convention and Visitors Authority, Nevada, Limited
Obligation Revenue Refunding Bonds, 6.40% due 11/01/2003 1,568
New Jersey BB Ba2 4,000 New Jersey EDA, Special Facility Revenue Bonds (Continental Airlines
- --4.6% Inc. Project), AMT, 6.25% due 9/15/2029 3,725
New Jersey Health Care Facilities Financing Authority,
Revenue Refunding Bonds:
BBB- Baa2 2,500 (Englewood Hospital and Medical Center), 6.75% due 7/01/2024 2,513
BBB Baa2 1,200 (Saint Elizabeth Hospital Obligation Group), 6% due 7/01/2014 1,124
</TABLE>
Portfolio Abbreviations
To simplify the listings of Merrill Lynch Municipal Strategy Fund,
Inc.'s portfolio holdings in the Schedule of Investments, we have
abbreviated the names of many of the securities according to the
list below and at right.
AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
EDA Economic Development Authority
GO General Obligation Bonds
HFA Housing Finance Agency
IDA Industrial Development Authority
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
PCR Pollution Control Revenue Bonds
RIB Residual Interest Bonds
RITR Residual Interest Trust Receipts
S/F Single-Family
VRDN Variable Rate Demand Notes
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
STATE Ratings Ratings Amount Issue (Note 1a)
<S> <S> <S> <C> <S> <C>
New Mexico A1+ P1 $ 600 Farmington, New Mexico, PCR, Refunding (Arizona Public
- --2.8% Service Company), VRDN, Series A, 3.55% due 5/01/2024 (i) $ 600
Farmington, New Mexico, PCR, Refunding
(Public Service Company-San Juan Project):
BBB- Baa3 3,000 Series A, 6.30% due 12/01/2016 2,877
BBB Baa3 1,000 Series D, 6.375% due 4/01/2022 956
New York A1+ VMIG1++ 3,000 Long Island Power Authority, New York, Electric System
- --13.7% Revenue Bonds, VRDN, Sub-Series 5, 3.50% due 5/01/2033 (i) 3,000
NR* Aaa 3,000 New York City, New York, City Municipal Water Finance
Authority, Water and Sewer System Revenue Bonds, RITR,
Series 11, 7.77% due 6/15/2026 (d)(e) 2,885
A1+ VMIG1++ 1,000 New York City, New York, City Municipal Water Finance
Authority, Water and Sewer System Revenue Refunding Bonds,
VRDN, Series G, 3.50% due 6/15/2024 (b)(i) 1,000
AAA Aaa 7,000 New York State Dormitory Authority Revenue Bonds (State University
Educational Facilities), Series B, 4.75% due 5/15/2028 (a) 5,697
AAA Aaa 10,000 Port Authority of New York and New Jersey, Consolidated
Revenue Bonds, 116th Series, 4.25% due 10/01/2026 (b) 7,547
A+ Aa3 2,000 Triborough Bridge and Tunnel Authority, New York, General
Purpose Revenue Bonds, Series B, 5.20% due 1/01/2027 1,753
North AA Aa2 1,830 North Carolina HFA, S/F Revenue Bonds, Series II, 6.20%
Carolina due 3/01/2016 (j) 1,866
- --1.2%
Ohio--8.3% BBB NR* 4,875 Dayton, Ohio, Special Facilities Revenue Refunding Bonds
(Emery Air Freight), Series A, 5.625% due 2/01/2018 4,351
NR* Baa3 3,000 Franklin County, Ohio, Hospital Revenue Bonds (Doctors of
Ohio Health Corp.), Series A, 5.60% due 12/01/2028 2,518
BBB- Baa2 3,000 Ohio State Environmental Improvement Revenue Refunding Bonds
(USX Corporation Project), 5.625% due 5/01/2029 2,625
NR* NR* 3,000 Ohio State, HFA, Mortgage Revenue Refunding Bonds, RITR, AMT,
Series 15, 6.57% due 9/01/2019 (d)(e)(g) 2,410
NR* NR* 1,400 Ohio State Higher Educational Facility, Commission Revenue
Bonds (University of Findlay Project), 6.125% due 9/01/2016 1,370
Oklahoma AAA NR* 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional
- --1.1% Facility Revenue Bonds, 6.60% due 7/01/2006 (f)(h) 1,812
Pennsylvania NR* NR* 1,750 Pennsylvania Economic Development Financing Authority,
- --1.6% Exempt Facilities Revenue Bonds (National Gypsum Company), AMT,
Series A, 6.25% due 11/01/2027 1,661
NR* NR* 1,000 Philadelphia, Pennsylvania, Authority for IDR, Refunding,
Commercial Development (Doubletree), Series A, 6.50% due 10/01/2027 993
South AAA Aaa 1,000 Fairfield County, South Carolina, PCR (South Carolina
Carolina Electric and Gas), 6.50% due 9/01/2014 (a) 1,062
- --0.7%
Tennessee NR* NR* 1,610 Hardeman County, Tennessee, Correctional Facilities
- --1.1% Corporation Revenue Bonds, 7.75% due 8/01/2017 1,693
Texas--2.7% AAA Aaa 5,000 Bexar, Texas, Metropolitan Water District, Waterworks System
Revenue Refunding Bonds, 5% due 5/01/2022 (a) 4,326
Utah--0.6% NR* NR* 1,000 Tooele County, Utah, PCR, Refunding (Laidlaw Environmental),
AMT, Series A, 7.55% due 7/01/2027 1,048
Virginia NR* NR* 1,500 Dulles Town Center Community Development Authority, Virginia,
- --3.3% Special Assessment Tax (Dulles Town Center Project), 6.25%
due 3/01/2026 1,417
NR* NR* 1,750 Peninsula Ports Authority, Virginia, Revenue Refunding Bonds
(Port Facility--Zeigler Coal), 6.90% due 5/02/2022 1,692
Pocahontas Parkway Association, Virginia, Toll Road Revenue Bonds:
NR* Ba1 6,200 First Tier, Sub-Series C, 6.25%** due 8/15/2031 631
BBB- Baa3 11,600 Senior Series B, 5.91%** due 8/15/2029 1,502
Wyoming AA NR* 5,000 Wyoming Student Loan Corporation, Student Loan Revenue Refunding
- --3.1% Bonds, Series A, 6.20% due 6/01/2024 4,956
Puerto Rico AAA Aaa 10,000 Puerto Rico Commonwealth, GO, Refunding, Public
- --5.1% Improvement, 4.50% due 7/01/2023 (c) 8,116
Total Investments (Cost--$170,834)--100.1% 160,298
Liabilities in Excess of Other Assets--(0.1%) (124)
--------
Net Assets--100.0% $160,174
========
<FN>
(a)MBIA Insured.
(b)FGIC Insured.
(c)AMBAC Insured.
(d)FSA Insured.
(e)The interest rate is subject to change periodically and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at October 31, 1999.
(f)Connie Lee Insured.
(g)GNMA Collateralized.
(h)Prerefunded.
(i)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate in
effect at October 31, 1999.
(j)FHA Insured.
*Not Rated.
**Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte and Touche LLP.
See Notes to Financial Statements.
</TABLE>
Quality
Profile
The quality ratings of securities in the Fund as of October 31, 1999
were as follows:
Percent of
S&P Rating/Moody's Rating Net Assets
AAA/Aaa 36.3%
AA/Aa 7.9
A/A 4.9
BBB/Baa 17.0
BB/Ba 5.6
B/B 5.6
CC/Ca 2.4
NR (Not Rated) 13.7
Other++ 6.7
[FN]
++Temporary investments in short-term municipal securities.
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of October 31, 1999
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$170,834,341) (Note 1a) $160,298,047
Cash 60,198
Receivables:
Interest $ 2,609,620
Securities sold 100,000 2,709,620
------------
Deferred organization expenses (Note 1e) 62,645
Prepaid registration fees and other assets (Note 1e) 11,189
------------
Total assets 163,141,699
------------
Liabilities: Payables:
Securities purchased 2,444,998
Dividends to shareholders (Note 1f) 166,138
Investment advisory fees (Note 2) 62,109
Administration fees (Note 2) 38,818 2,712,063
------------
Accrued expenses and other liabilities 255,826
------------
Total liabilities 2,967,889
------------
Net Assets: Net assets $160,173,810
============
Capital: Capital Stock (200,000,000 shares authorized) (Note 4):
Preferred Stock, par value $.10 per share (2,480 shares of
AMPS* issued and 2,320 shares outstanding at $25,000 per share
liquidation preference) $ 58,000,000
Common Stock, par value $.10 per share (11,499,256 shares
issued and outstanding) $ 1,149,926
Paid-in capital in excess of par 116,086,456
Undistributed investment income--net 20,331
Accumulated realized capital losses on investments--net (Note 5) (1,140,579)
Accumulated distributions in excess of realized capital
gains on investments--net (Note 1f) (3,406,030)
Unrealized depreciation on investments--net (10,536,294)
------------
Total--Equivalent to $8.89 net asset value per
share of Common Stock 102,173,810
------------
Total capital $160,173,810
============
<FN>
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended October 31, 1999
<S> <S> <C> <C>
Investment Interest and amortization of premium and discount earned $ 9,953,782
Income (Note 1d):
Expenses: Investment advisory fees (Note 2) $ 852,812
Administrative fees (Note 2) 426,406
Professional fees 149,980
Commission fees (Note 4) 144,234
Printing and shareholder reports 130,135
Transfer agent fees 122,750
Registration fees 72,684
Listing fees 63,461
Amortization of organization expenses (Note 1e) 62,134
Accounting services (Note 2) 55,031
Directors' fees and expenses 26,790
Custodian fees 19,923
Pricing fees 10,064
Other 32,463
------------
Total expenses before reimbursement 2,168,867
Reimbursement of expenses (Note 2) (170,562)
------------
Total expenses after reimbursement 1,998,305
------------
Investment income--net 7,955,477
------------
Realized & Realized loss on investments--net (3,963,881)
Unrealized Loss on Change in unrealized appreciation/depreciation on investments--net (16,190,234)
Investments--Net ------------
(Notes 1b, 1d & 3):
Net Decrease in Net Assets Resulting from Operations $(12,198,638)
============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Year Ended
October 31,
Increase (Decrease) in Net Assets: 1999 1998
<S> <S> <C> <C>
Operations: Investment income--net $ 7,955,477 $ 7,264,212
Realized gain (loss) on investments--net (3,963,881) 3,377,592
Change in unrealized appreciation/depreciation on
investments--net (16,190,234) (298,794)
------------ ------------
Net increase (decrease) in net assets resulting
from operations (12,198,638) 10,343,010
------------ ------------
Dividends & Investment income--net:
Distributions to Common Stock (6,440,369) (5,962,701)
Shareholders Preferred Stock (1,494,777) (1,320,711)
(Note 1f): Realized gain on investments--net:
Common Stock -- (1,715,643)
Preferred Stock -- (620,698)
In excess of realized gain on investments--net:
Common Stock (2,910,041) --
Preferred Stock (495,989) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders (11,341,176) (9,619,753)
------------ ------------
Capital Stock Proceeds from issuance of Preferred Stock 10,000,000 --
Transactions Net proceeds from issuance of Common Stock 10,374,468 13,153,080
(Note 4): ------------ ------------
Net increase in net assets derived from capital stock
transactions 20,374,468 13,153,080
------------ ------------
Net Assets: Total increase (decrease) in net assets (3,165,346) 13,876,337
Beginning of year 163,339,156 149,462,819
------------ ------------
End of year* $160,173,810 $163,339,156
============ ============
<FN>
*Undistributed investment income--net $ 20,331 $ --
============ ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
For the
The following per share data and ratios Period
have been derived from information provided November 3,
in the financial statements. For the Year Ended 1995++ to
October 31, October 31,
Increase (Decrease) in Net Asset Value: 1999 1998 1997 1996
<S> <S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.96 $ 10.87 $ 10.17 $ 10.00
Operating ------------ ------------ ------------ ------------
Performance: Investment income--net .71 .73 .75 .68
Realized and unrealized gain
(loss) on investments--net (1.75) .35 .70 .21
------------ ------------ ------------ ------------
Total from investment operations (1.04) 1.08 1.45 .89
------------ ------------ ------------ ------------
Less dividends and distributions to
Common Stock shareholders:
Investment income--net (.58) (.60) (.59) (.59)
Realized gain on investments--net -- (.19) -- --
In excess of realized gain on
investments--net (.27) -- -- --
------------ ------------ ------------ ------------
Total dividends and distributions to
Common Stock shareholders (.85) (.79) (.59) (.59)
------------ ------------ ------------ ------------
Effect of Preferred Stock activity:++++
Dividends and distributions to
Preferred Stock shareholders:
Investment income--net (.13) (.13) (.16) (.09)
Realized gain on investments--net -- (.07) -- --
In excess of realized gain on
investments--net (.05) -- -- --
Capital charge resulting from
issuance of Preferred Stock -- -- -- (.04)
------------ ------------ ------------ ------------
Total effect of Preferred Stock
activity (.18) (.20) (.16) (.13)
------------ ------------ ------------ ------------
Net asset value, end of period $ 8.89 $ 10.96 $ 10.87 $ 10.17
============ ============ ============ ============
Total Investment Based on net asset value per share (11.94%) 8.28% 13.08% 7.81%+++
Return:** ============ ============ ============ ============
Ratios Based on Total expenses, net of reimbursement*** 1.75% 1.61% 1.37% .68%*
Average Net ============ ============ ============ ============
Assets of Total expenses*** 1.90% 1.80% 1.83% 1.60%*
Common Stock: ============ ============ ============ ============
Total investment income--net*** 6.98% 6.65% 7.14% 6.86%*
============ ============ ============ ============
Amount of dividends to Preferred Stock
shareholders 1.31% 1.21% 1.53% .94%*
============ ============ ============ ============
Investment income--net, to Common Stock
shareholders 5.67% 5.44% 5.61% 5.92%*
============ ============ ============ ============
Ratios Based Total expenses, net of reimbursement 1.17% 1.12% .96% .53%*
on Total ============ ============ ============ ============
Average Net Total expenses 1.27% 1.25% 1.28% 1.26%*
Assets:++++++*** ============ ============ ============ ============
Total investment income--net 4.66% 4.61% 5.01% 5.40%*
============ ============ ============ ============
Ratios Based on Dividends to Preferred Stock
Average Net shareholders 2.63% 2.75% 3.58% 3.49%*
Assets of ============ ============ ============ ============
Preferred Stock:
Supplemental Net assets, net of Preferred Stock,
Data: end of period (in thousands) $ 102,174 $ 115,339 $ 101,463 $ 83,573
============ ============ ============ ============
Preferred Stock outstanding, end of
period (in thousands) $ 58,000 $ 48,000 $ 48,000 $ 38,000
============ ============ ============ ============
Portfolio turnover 158.57% 141.53% 144.34% 234.41%
============ ============ ============ ============
Leverage: Asset coverage per $1,000 $ 2,762 $ 3,403 $ 3,114 $ 3,199
============ ============ ============ ============
Dividends Per Investment income--net $ 644 $ 533 $ 897 $ 564
Share On ============ ============ ============ ============
Preferred Stock
Outstanding:
<FN>
*Annualized.
**Total investment returns exclude the effects of the contingent
deferred sales charge, if any. The Fund is a continuously offered,
closed-end fund, the shares of which are offered at net asset value.
Therefore, no separate market exists.
***Do not reflect the effect of dividends to Preferred Stock
shareholders.
++Commencement of operations.
++++The Fund's Preferred Stock was initially issued on March 11, 1996.
++++++Includes Common and Preferred Stock average net assets.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Municipal Strategy Fund, Inc. (the "Fund") is
registered under the Investment Company Act of 1940 as a
continuously offered, non-diversified, closed-end management
investment company. The Fund's financial statements are prepared in
accordance with generally accepted accounting principles, which may
require the use of management accruals and estimates. The following
is a summary of significant accounting policies followed by the
Fund.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter markets and are valued at the last available bid
price in the over-the-counter market or on the basis of yield
equivalents as obtained from one or more dealers that make markets
in the securities. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their settlement prices
as of the close of such exchanges. Options written or purchased are
valued at the last sale price in the case of exchange-traded
options. In the case of options traded in the over-counter-market,
valuation is the last asked price (options written) or the last bid
price (options purchased). Short-term investments with remaining
maturities of sixty days or less are valued at amortized cost, which
approximates market value. Securities and assets for which market
quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of
Directors of the Fund, including valuations furnished by a pricing
service retained by the Fund, which may utilize a matrix system for
valuations. The procedures of the pricing service and its valuations
are reviewed by the officers of the Fund under the general
supervision of the Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
financial futures contracts and options on such futures contracts
for the purpose of hedging the market risk on existing securities or
the intended purchase of securities. Futures contracts are contracts
for delayed delivery of securities at a specific future date and at
a specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
* Options--The Fund is authorized to write covered call options and
purchase put options. When the Fund writes an option, an amount
equal to the premium received by the Fund is reflected as an asset
and an equivalent liability. The amount of the liability is
subsequently marked to market to reflect the current market value of
the option written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization and prepaid registration fees--Deferred
organization expenses are amortized on a straight-line basis over a
period not exceeding five years. In accordance with Statement of
Position 98-5, any unamortized organization expenses will be
expensed on the first day of the next fiscal year beginning after
December 15, 1998. This charge will not have any material impact on
the operations of the Fund. Prepaid registration fees are charged to
expense as the related shares are issued.
(f) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates. Distributions in excess
of realized capital gains are due primarily to differing tax
treatments for futures transactions.
2. Investment Advisory Agreement and Transactions
with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of .50% of
the Fund's average daily net assets, including proceeds from the
issuance of Preferred Stock. For the year ended October 31, 1999,
FAM earned fees of $852,812, of which $170,562 was voluntarily
waived.
The Fund also has entered into an Administrative Services Agreement
with FAM whereby FAM will receive a fee equal to an annual rate of
.25% of the Fund's average daily net assets, in return for the
performance of administrative services (other than investment advice
and related porfolio activities) necessary for the operation of the
Fund.
For the year ended October 31, 1999, Merrill Lynch Funds
Distributors ("MLFD"), a division of Princeton Funds Distributor,
Inc. ("PFD"), earned early withdrawal charges of $60,852 relating to
the tender of the Fund's shares.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of
ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, FDS, PFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for year ended October 31, 1999, were $271,626,840 and $265,285,999,
respectively.
Net realized gains (losses) for year ended October 31, 1999 and net
unrealized losses as of October 31, 1999, were as follows:
Realized Unrealized
Gains (Losses) Losses
Long-term investments $ (4,526,700) $(10,536,294)
Financial futures contracts 562,819 --
------------ ------------
Total $ (3,963,881) $(10,536,294)
============ ============
As of October 31, 1999, net unrealized depreciation for Federal
income tax purposes aggregated $10,551,530, of which $709,686
related to appreciated securities and $11,261,216 related to
depreciated securities. The aggregate cost of investments at October
31, 1999 for Federal income tax purposes was $170,849,577.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock,
including Preferred Stock, par value $.10 per share, all of which
were initially classified as Common Stock. The Board of Directors is
authorized, however, to reclassify any unissued shares of capital
stock without approval of the holders of Common Stock.
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 1999
NOTES TO FINANCIAL STATEMENTS (concluded)
Transactions in Common Stock were as follows:
For the Year Ended Dollar
October 31, 1999 Shares Amount
Shares sold 2,518,676 $26,054,342
Shares issued to shareholders in
reinvestment of dividends and
distributions 295,128 3,036,851
------------ -----------
Total issued 2,813,804 29,091,193
Shares tendered (1,838,103) (18,716,725)
------------ -----------
Net increase 975,701 $10,374,468
============ ===========
For the Year Ended Dollar
October 31, 1998 Shares Amount
Shares sold 2,294,432 $25,204,676
Shares issued to shareholders in
reinvestment of dividends and
distributions 200,364 2,192,687
------------ -----------
Total issued 2,494,796 27,397,363
Shares tendered (1,304,258) (14,244,283)
------------ -----------
Net increase 1,190,538 $13,153,080
============ ===========
Preferred Stock
Auction Market Preferred Stock ("AMPS") are shares of Preferred
Stock of the Fund, with a par value of $.10 per share and a
liquidation preference of $25,000 per share, that entitle their
holders to receive cash dividends at an annual rate that may vary
for the successive dividend periods. The yield in effect at October
31, 1999 was 3.29%.
In connection with the offering of AMPS, the Board of Directors
reclassified 40,000 shares of unissued capital stock as AMPS. AMPS
shares outstanding during the year ended October 31, 1999 increased
by 400 as a result of shares sold and during the year ended October
31, 1998 remained constant.
The Fund pays commissions to certain broker dealers at the end of
each auction at an annual rate ranging from .25% to 1.00%,
calculated on the proceeds of each auction. For the year ended
October 31, 1999, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, an affiliate of FAM, earned $133,923 as commissions.
5. Capital Loss Carryforward:
At October 31, 1999, the Fund had a net capital loss carry-forward
of approximately $4,320,000, all of which expires in 2007. This
amount will be available to offset like amounts of any future
taxable gains.
<AUDIT-REPORT>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Municipal Strategy Fund, Inc.:
We have audited the accompanying statement of assets, liabilities
and capital, including the schedule of investments, of Merrill Lynch
Municipal Strategy Fund, Inc. as of October 31, 1999, the related
statements of operations for the year then ended and changes in net
assets for each of the years in the two-year period then ended, and
the financial highlights for each of the years in the three-year
period then ended and the period November 3, 1995 (commencement of
operations) to October 31, 1996. These financial statements and the
financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements and the financial highlights are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.
Our procedures included confirmation of securities owned at October
31, 1999 by correspondence with the custodian and broker. An audit
also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights
present fairly, in all material respects, the financial position of
Merrill Lynch Municipal Strategy Fund, Inc. as of October 31, 1999,
the results of its operations, the changes in its net assets, and
the financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
December 10, 1999
</AUDIT-REPORT>
<TABLE>
IMPORTANT TAX INFORMATION (UNAUDITED)
<CAPTION>
All of the net investment income distributions paid by Merrill Lynch
Municipal Strategy Fund, Inc. during its taxable year ended October
31, 1999 qualify as tax-exempt interest dividends for Federal income
tax purposes. Additionally, the following table summarizes the
taxable capital gains distributions paid by the Fund during the
year:
Payable Short-Term Long-Term
Date Capital Gains Capital Gains*
<S> <C> <C> <C>
Common Stock Shareholders 12/31/98 $.176813 $.095782
Preferred Stock Shareholders 11/05/98 $13.87 $ 9.97
11/12/98 $16.59 $ 7.38
11/19/98 $17.93 $ 8.05
11/27/98 $19.21 $ 8.71
12/03/98 $14.57 $ 6.69
12/10/98 $16.41 $ 7.62
12/17/98 $12.65 $ 5.95
12/24/98 $18.44 $ 8.83
12/31/98 $20.41 $10.17
1/07/99 $11.80 $ 7.09
<FN>
*All of the distributions are subject to the 20% tax rate.
Please retain this information for your records.
</TABLE>
