MERRILL LYNCH
MUNICIPAL
STRATEGY
FUND, INC.
FUND LOGO
Annual Report
October 31, 2000
Merrill Lynch Municipal Strategy Fund, Inc. seeks to provide
shareholders with as high a level of current income exempt from
Federal income taxes as is consistent with its investment policies
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.
This report, including the financial information herein, is
transmitted to shareholders of Merrill Lynch Municipal Strategy
Fund, Inc. for their information. It is not a prospectus. Past
performance results shown in this report should not be considered a
representation of future performance. The Fund has leveraged its
Common Stock by issuing Preferred Stock to provide the Common Stock
shareholders with a potentially higher rate of return. Leverage
creates risks for Common Stock shareholders, including the
likelihood of greater volatility of net asset value and market price
of shares of the Common Stock, and the risk that fluctuations in the
short-term dividend rates of the Preferred Stock may affect the
yield to Common Stock shareholders. Statements and other information
herein are as dated and are subject to change.
Merrill Lynch Municipal
Strategy Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
MERRILL LYNCH MUNICIPAL STRATEGY FUND, INC.
The Benefits and
Risks of
Leveraging
Merrill Lynch Municipal Strategy Fund, Inc. utilizes leveraging to
seek to enhance the yield and net asset value of its Common Stock.
However, these objectives cannot be achieved in all interest rate
environments. To leverage, the Fund issues Preferred Stock, which
pays dividends at prevailing short-term interest rates, and invests
the proceeds in long-term municipal bonds. The interest earned on
these investments is paid to Common Stock shareholders in the form
of dividends, and the value of these portfolio holdings is reflected
in the per share net asset value of the Fund's Common Stock.
However, in order to benefit Common Stock shareholders, the yield
curve must be positively sloped; that is, short-term interest rates
must be lower than long-term interest rates. At the same time, a
period of generally declining interest rates will benefit Common
Stock shareholders. If either of these conditions change, then the
risks of leveraging will begin to outweigh the benefits.
To illustrate these concepts, assume a fund's Common Stock
capitalization of $100 million and the issuance of Preferred Stock
for an additional $50 million, creating a total value of $150
million available for investment in long-term municipal bonds. If
prevailing short-term interest rates are approximately 3% and long-
term interest rates are approximately 6%, the yield curve has a
strongly positive slope. The fund pays dividends on the $50 million
of Preferred Stock based on the lower short-term interest rates. At
the same time, the fund's total portfolio of $150 million earns the
income based on long-term interest rates. Of course, increases in
short-term interest rates would reduce (and even eliminate) the
dividends on the Common Stock.
In this case, the dividends paid to Preferred Stock share-holders
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, income on inverse floaters will decrease when short-term
interest rates increase and increase when short-term interest rates
decrease. Invest-ments 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. In order to manage
the Fund's leverage, the Fund may from time to time repurchase
shares of the Fund's auction market preferred stock in the open
market.
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 2000
DEAR SHAREHOLDER
For the year ended October 31, 2000, the Common Stock of Merrill
Lynch Municipal Strategy Fund, Inc. earned $0.488 per share income
dividends. This represents a net annualized yield of 5.57%, based on
a month-end asset value of $8.75. Over the same period, the total
investment return on the Fund's Common Stock was +4.09%, based on a
change in per share net asset value from $8.89 to $8.75, and
assuming reinvestment of $0.489 per share income dividends.
For the six months ended October 31, 2000, the total investment
return on the Fund's Common Stock was +3.83%, based on a change in
per share net asset value from $8.65 to $8.75, and assuming
reinvestment of $0.223 per share income dividends.
For the six-month period ended October 31, 2000, the Fund's Auction
Market Preferred Stock had an average yield of 4.25%.
The Municipal Market Environment
During the six months ended October 31, 2000, long-term US Treasury
bond yields generally drifted lower. A number of economic
indicators, particularly employment, new home sales and consumer
spending, have suggested that US economic growth, while still
strong, has moderated from 1999's robust levels. Preliminary
estimates for third-quarter 2000 US gross domestic product growth
were recently released at 2.7%, well below the first-quarter 2000
rate of 4.8% and the second-quarter 2000 rate of 5.6%. This decline
in economic growth suggests to some analysts that the Federal
Reserve Board has finished raising interest rates for its current
interest rate cycle. The Federal Reserve Board increased short-term
interest rates at its May meeting and has since kept monetary policy
steady at its subsequent meetings. Given the potential for stable
short-term interest rates in the coming months, investor emphasis
focused on the continuing US Treasury debt reduction program and
forecasts of sizeable Federal budgetary surpluses going forward.
Many investors have concluded that there will be a significant
future shortage of longer-dated maturity US Treasury securities. By
late August, US Treasury bond yields declined 30 basis points
(0.30%) to 5.66%, their lowest level in more than a year.
However, for the remainder of the period, bond yields were unable to
maintain their earlier gains. Rising oil prices were the major focus
behind the decline in bond prices, as many investors feared that
higher oil prices would result in increased inflationary pressures.
Additionally, US corporations issued large amounts of taxable debt
in order to take advantage of the current low interest rate
environment. During the last three months, US corporations issued
more than $100 billion in investment-grade securities, offering
yields in the 7.25% - 9% range. Many investors found these taxable
issues an attractive and more plentiful alternative to US Treasury
bonds. As the demand for US Treasury issues weakened, US bond yields
rose. Although US Treasury bond yields rose to 5.78% by the end of
October 2000, overall they declined almost 20 basis points during
the last six months.
The six-month period ended October 31, 2000 was one of the few
periods in recent years in which the tax-exempt bond market
outperformed its taxable counterpart, the US Treasury bond market.
While municipal bond yields followed the similar seesaw pattern of
Treasury bond yields, tax-exempt bond price volatility was
significantly reduced. Municipal bond yields traded in a relatively
narrow range during much of October 2000. Overall investor demand
for municipal bonds remained strong, allowing tax-exempt bond
yields, as measured by the Bond Buyer Revenue Bond Index, to decline
30 basis points to end the period at 5.75%.
In the past three months, new long-term municipal bond issuance has
continued to decline, albeit at a slower rate than earlier this
year. During this period, more than $53 billion in new long-term
municipal bonds was issued, a decline of 3% compared to the same
three-month period in 1999. During the last six months, more than
$105 billion in tax-exempt bonds was underwritten, a decline of 8%
compared to the same six-month period in 1999. Just under $200
billion in new municipal securities was marketed during the past
year, a decline of more than 16% compared to the same 12-month
period in 1999.
The demand for municipal bonds came from a number of non-traditional
and conventional sources. Derivative/arbitrage programs and
insurance companies remained the dominant institutional buyers,
while individual retail purchases also remained strong. Traditional,
open-end tax-exempt mutual funds have continued to see significant
disintermediation. It was recently reported that thus far during the
2000 calendar year, long-term municipal bond mutual funds
experienced net cash outflows of more than $15 billion. Fortunately,
the combination of reduced new bond issuance and ongoing demand from
non-traditional sources has been able to more than offset the
decline in demand from tax-exempt mutual funds. This favorable
balance has fostered a significant decline in municipal bond yields
in recent months.
Currently, there is no reason to expect that the positive technical
position of the municipal bond market will significantly
deteriorate. The steeply positive yield curve and the relatively
high credit quality that the tax-exempt bond market offers should
continue to attract different classes of institutional buyers.
Strong state and local governmental financial conditions also
suggest that issuance should remain manageable into next year.
However, the results of the presidential election may affect the tax-
exempt bond market. Various tax and spending programs proposed by
both candidates have obvious implications for state and local
governments as well as corporate and individual taxpayers. Political
history has shown that the enactment of campaign promises, both
Republican and Democratic, has very often been a long, laborious
process. This suggests that over the next few months US economic
factors will most likely have a greater effect on bond yields than
political considerations.
Portfolio Strategy
During the six-month period ending October 31, 2000, we managed the
Fund with the intent of sustaining an appealing level of tax-exempt
income. At the end of May, we believed that the municipal market was
approaching a high in yields. In our opinion, investors had fully
discounted any further increases in short-term interest rates and
that any other increases would serve to slow economic growth and
keep inflation manageable.
The months leading to October brought extreme volatility to the
municipal market. Tax-exempt yields dropped about 40 basis points
from the end of May to the end of October, although the average
yield change from month to month was about 13 basis points. This
volatility occurred because most investors could not decide if the
Federal Reserve Board was ahead or behind the curve in taming
inflation.
We structured the investment-grade portion of the Fund to take
advantage of any drop in yields. However, the high-yield portion of
the Fund negatively affected Fund performance as the spreads between
high-grade municipal bonds and lower-quality bonds widened out
significantly.
In July, we began selling high-yield positions that outperformed the
market and were still trading at tight spreads, along with credits
that would not respond well to an economic "hard landing." This
strategy helped cushion the Fund slightly from another round of
widening that affected high-yield bonds from the end of July to the
end of October.
Going forward, we will seek to take advantage of any backup in
interest rates to invest the Fund's cash in investment-grade
positions. This positioning would allow us the opportunity to take
advantage of lower interest rates in the future, as a result of the
impending economic slowdown and a potential easing in the Federal
Funds rate.
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 5, 2000
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 2000
<TABLE>
PROXY RESULTS
<CAPTION>
During the six-month period ended October 31, 2000, Merrill Lynch
Municipal Strategy Fund, Inc.'s Common Stock shareholders voted on
the following proposals. The proposals were approved at a
shareholders' meeting on July 25, 2000. The description
of each proposal and number of shares voted are as follows:
Shares Voted
For
<S> <S> <C>
1. To elect the Fund's Directors: Terry K. Glenn 10,504,553
Cynthia A. Montgomery 10,504,553
Kevin A. Ryan 10,504,553
Roscoe S. Suddarth 10,524,553
Richard R. West 10,521,091
Arthur Zeikel 10,524,553
Edward D. Zinbarg 10,424,553
<CAPTION>
Shares Voted Shares Voted Shares Voted
For Against Abstain
<S> <C> <C> <C>
2. To ratify the selection of Deloitte & Touche LLP as the Fund's
independent auditors for the current fiscal year. 13,316,244 41,709 262,628
3. To convert the Fund to "master/feeder" structure 9,804,148 262,856 553,677
<CAPTION>
During the six-month period ended October 31, 2000, Merrill Lynch
Municipal Strategy Fund, Inc.'s Preferred Stock shareholders voted
on the following proposals. The proposals were approved at a
shareholders' meeting on July 25, 2000. The description of each
proposal and number of shares voted are as follows:
Shares Voted
For
<S> <S> <C>
1. To elect the Fund's Board of Directors: Terry K. Glenn 2,247
Ronald W. Forbes 2,247
Cynthia A. Montgomery 2,247
Charles C. Reilly 2,247
Kevin A. Ryan 2,247
Roscoe S. Suddarth 2,247
Richard R. West 2,247
Arthur Zeikel 2,247
Edward D. Zinbarg 2,247
<CAPTION>
Shares Voted Shares Voted Shares Voted
For Against Abstain
<S> <C> <C> <C>
2. To ratify the selection of Deloitte & Touche LLP as the Fund's
independent auditors for the current fiscal year. 2,246 -- 1
3. To convert the Fund to "master/feeder" structure 2,232 5 10
</TABLE>
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face
STATE Ratings Ratings Amount Issue Value
<S> <S> <S> <C> <S> <C>
Arizona--2.5% Phoenix, Arizona, IDA, Airport Facility Revenue Refunding
Bonds (America West Airlines Inc. Project), AMT:
NR* B1 $ 2,000 6.25% due 6/01/2019 $ 1,788
NR* B1 1,600 6.30% due 4/01/2023 1,425
California--8.2% AAA Aaa 8,000 California State University and Colleges, Student Union
Revenue Bonds (Chico), Series B, 4.375% due 11/01/2028 (a) 6,642
AAA Aaa 1,560 Centinela Valley, California, Union High School
District, GO, Series A, 5.875% due 8/01/2024 (a) 1,629
Los Angeles County, California, Schools Regionalized
Business Services, COP, Pooled Financing, Series A (c):
AAA Aaa 1,430 5.90%** due 8/01/2019 505
AAA Aaa 2,510 6%** due 8/01/2029 490
NR* Aa3 1,250 Sacramento County, California, Sanitation District
Financing Authority, Revenue Refunding Bonds, Trust Receipts,
Class R, Series A, 7.829% due 12/01/2019 (e) 1,368
Colorado--6.1% NR* Aaa 4,430 Broomfield, Colorado, Open Space Park and Recreational
Facilities, COP, 5.75% due 12/01/2014 (c) 4,655
AA Aa2 1,500 Colorado HFA, Revenue Refunding Bonds (S/F Program),
AMT, Series D-2, 6.90% due 4/01/2029 1,653
NR* NR* 1,500 Denver, Colorado, Urban Renewal Authority, Tax Increment
Revenue Bonds (Pavilions), AMT, 7.75% due 9/01/2016 1,595
Connecticut--2.5% NR* NR* 750 Connecticut State Development Authority, IDR
(AFCO Cargo BDL-LLC Project), AMT, 7.35% due 4/01/2010 761
NR* Aaa 2,175 Connecticut State Special Tax Obligation Revenue Bonds,
RIB, Series 372, 7.59% due 12/01/2017 (b)(e) 2,446
Florida--1.8% A1+ VMIG1++ 200 Martin County, Florida, PCR, Refunding (Florida Power &
Light Company Project), VRDN, 4.65% due 7/15/2022 (g) 200
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 2,098
</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
PCR Pollution Control Revenue Bonds
RIB Residual Interest Bonds
RITR Residual Interest Trust Receipts
S/F Single-Family
VRDN Variable Rate Demand Notes
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face
STATE Ratings Ratings Amount Issue Value
<S> <S> <S> <C> <S> <C>
Georgia--2.5% AAA Aa2 $ 3,250 Georgia State, HFA, S/F Mortgage Revenue
Refunding Bonds, Series A, Sub-Series A-1, 6.125%
due 12/01/2015 (h) $ 3,298
Illinois--4.1% NR* NR* 910 Beardstown, Illinois, IDR (Jefferson Smurfit Corp.
Project), 8% due 10/01/2016 949
AAA Aaa 3,285 Illinois Development Finance Authority Revenue Bonds
(Presbyterian Home Lake Project), Series B, 6.30%
due 9/01/2022 (d) 3,421
NR* Ba3 1,250 Illinois Health Facilities Authority Revenue Bonds
(Holy Cross Hospital Project), 6.70% due 3/01/2014 1,064
Indiana--2.2% BBB Baa1 3,000 Indiana State Development Finance Authority,
Environmental Revenue Refunding and Improvement Bonds
(USX Corporation Project), 6.15% due 7/15/2022 2,862
Louisiana--2.9% BB- NR* 4,000 Port New Orleans, Louisiana, IDR, Refunding
(Continental Grain Company Project), 6.50%
due 1/01/2017 3,770
Maryland--2.3% NR* NR* 3,000 Maryland State Energy Financing Administration,
Limited Obligation Revenue Bonds (Cogeneration-AES
Warrior Run), AMT, 7.40% due 9/01/2019 3,039
Massachusetts AAA Aa1 1,600 Massachusetts Bay, Massachusetts, Transportation
--6.4% Authority, Revenue Refunding Bonds (Special Assessment),
Series A, 5.25% due 7/01/2030 1,517
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 2,087
AAA Aaa 5,000 Massachusetts State Turnpike Authority, Metropolitan
Highway System, Revenue Refunding Bonds, Senior-Series A,
5.125% due 1/01/2023 (a) 4,694
Mississippi--2.2% BBB- Ba1 3,150 Mississippi Business Finance Corporation, Mississippi,
PCR, Refunding (System Energy Resources Inc. Project),
5.875% due 4/01/2022 2,890
New Jersey--0.3% BBB- Baa3 500 New Jersey Health Care Facilities Financing Authority,
Revenue Refunding Bonds (St. Elizabeth Hospital
Obligation Group), 6% due 7/01/2014 459
New York--19.4% NR* Aaa 3,000 New York City, New York, City Municipal Water Finance
Authority, Water and Sewer System Revenue Bonds, RITR,
Series 11, 7.07% due 6/15/2026 (d)(e) 3,090
AAA Aaa 2,320 New York City, New York, City Municipal Water Finance
Authority, Water and Sewer System Revenue Refunding Bonds,
Series A, 5.125% due 6/15/2022 (c) 2,180
AA+ Aa2 4,300 New York City, New York, City Transitional Finance
Authority Revenue Bonds, Series A, 5.125% due 8/15/2021 4,056
New York City, New York, GO, Refunding, Series G:
AAA Aaa 2,090 5.75% due 2/01/2014 (a) 2,171
AAA Aaa 2,000 5.75% due 2/01/2014 (b) 2,078
AAA NR* 3,300 New York State Dormitory Authority, Revenue Refunding
Bonds (City University--Third Generation Resources),
Series 2, 5% due 7/01/2028 (d) 3,003
New York State Thruway Authority, Highway and Bridge
Trust Fund Revenue Bonds, Series A (d):
AAA Aaa 2,850 6% due 4/01/2015 3,055
AAA Aaa 2,625 6% due 4/01/2016 2,800
AAA Aaa 2,850 Port Authority of New York and New Jersey, Special
Obligation Revenue Bonds (JFK International Air Terminal
Project), AMT, Series 6, 5.75% due 12/01/2025 (a) 2,878
North Carolina AA Aa2 1,795 North Carolina, HFA, S/F Revenue Bonds, Series II,
--1.4% 6.20% due 3/01/2016 (h) 1,828
Ohio--1.5% NR* Baa3 3,000 Franklin County, Ohio, Hospital Revenue Bonds
(Doctors of Ohio Health Corp.), Series A,
5.60% due 12/01/2028 1,962
Oklahoma--2.7% AAA NR* 1,650 Holdenville, Oklahoma, Industrial Authority, Correctional
Facility Revenue Bonds, 6.60% due 7/01/2006 (f)(i) 1,817
A1+ VMIG1++ 1,700 Oklahoma State Industries Authority, Revenue Refunding
Bonds (Integris Baptist), VRDN, Series B, 4.60% due
8/15/2029 (a)(g) 1,700
Pennsylvania AAA Aaa 4,200 Delaware River Port Authority of Pennsylvania and
--6.5% New Jersey Revenue Bonds, 5.75% due 1/01/2015 (d) 4,391
Pennsylvania Economic Development Financing Authority,
Exempt Facilities Revenue Bonds (National Gypsum
Company), AMT:
NR* NR* 1,750 Series A, 6.25% due 11/01/2027 1,463
NR* NR* 2,000 Series B, 6.125% due 11/01/2027 1,644
NR* NR* 1,000 Philadelphia, Pennsylvania, Authority for IDR, Refunding,
Commercial Development (Doubletree), Series A, 6.50%
due 10/01/2027 964
South Carolina AAA Aaa 1,000 Fairfield County, South Carolina, PCR (South Carolina
--0.8% Electric and Gas), 6.50% due 9/01/2014 (a) 1,056
Tennessee--1.3% NR* NR* 1,610 Hardeman County, Tennessee, Correctional Facilities
Corporation Revenue Bonds, 7.75% due 8/01/2017 1,646
Texas--3.8% AAA Aaa 3,000 Grapevine-Colleyville, Texas, Independent School
District, GO, Refunding, 5% due 8/15/2029 2,689
Harris County, Texas, Health Facilities Development
Corporation, Hospital Revenue Refunding Bonds
(Methodist Hospital), VRDN (g):
A1+ NR* 100 4.60% due 12/01/2025 100
A1+ NR* 100 4.60% due 12/01/2026 100
BBB- Baa3 2,000 Lower Colorado River Authority, Texas, PCR (Samsung
Austin Semiconductor), AMT, 6.95% due 4/01/2030 2,038
Utah--0.0% NR* NR* 1,000 Tooele County, Utah, PCR, Refunding (Laidlaw Environmental),
AMT, Series A, 7.55% due 7/01/2027 (j) 38
Virginia--6.2% AAA Aaa 5,000 Fairfax County, Virginia, EDA, Resource Recovery Revenue
Refunding Bonds, AMT, Series A, 6.10% due 2/01/2011 (c) 5,447
NR* NR* 1,750 Peninsula Ports Authority, Virginia, Revenue Refunding
Bonds (Port Facility-Zeigler Coal), 6.90% due 5/02/2022 (j) 420
Pocahontas Parkway Association, Virginia, Toll Road
Revenue Bonds:
NR* Ba1 6,200 First Tier, Sub-Series C, 6.25%** due 8/15/2031 607
BBB- Baa3 11,960 Senior Series B, 5.95%** due 8/15/2029 1,543
Washington--1.0% AAA Aaa 1,500 Grant County, Washington, Public Utility District
No. 002, Electric Revenue Bonds, Series G, 4.75%
due 1/01/2017 (a) 1,368
Wisconsin--2.9% NR* Aaa 3,675 Milwaukee County, Wisconsin, Airport Revenue Bonds,
AMT, Series A, 6% due 12/01/2019 (b) 3,784
</TABLE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face
STATE Ratings Ratings Amount Issue Value
<S> <S> <S> <C> <S> <C>
Wyoming--2.5% NR* P1 $ 700 Uinta County, Wyoming, PCR, Refunding (Chevron USA Inc.
Project), VRDN, 4.55% due 8/15/2020 (g) $ 700
AA NR* 2,500 Wyoming Student Loan Corporation, Student Loan
Revenue Refunding Bonds, Series A, 6.20% due 6/01/2024 2,607
Puerto Rico NR* Aaa 2,500 Puerto Rico Commonwealth, Highway and Transportation
--4.6% Authority, Transportation Revenue Bonds, Trust Receipts,
Class R, Series B, 7.57% due 7/01/2035 (a)(e) 2,702
AAA Aaa 2,000 Puerto Rico Electric Power Authority, Power Revenue
Refunding Bonds, Series EE, 4.75% due 7/01/2024 (a) 1,809
AAA Aaa 1,530 Puerto Rico Public Buildings Authority Revenue Bonds
(Government Facilities), Series B, 5% due 7/01/2027 (c) 1,438
Total Investments (Cost--$132,774)--98.6% 128,477
Other Assets Less Liabilities--1.4% 1,817
--------
Net Assets--100.0% $130,294
========
(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, 2000.
(f)Connie Lee Insured.
(g)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, 2000.
(h)FHA Insured.
(i)Prerefunded.
(j)Non-income producing security.
*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 & Touche LLP.
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of October 31, 2000
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$132,774,079) $128,477,014
Cash 119,565
Receivables:
Interest $ 2,001,369
Capital shares sold 126,212 2,127,581
------------
Deferred organization expenses 341
Prepaid registration fees and other assets 37,442
------------
Total assets 130,761,943
------------
Liabilities: Payables:
Dividends to shareholders 163,418
Investment advisory fees 46,730
Administration fees 29,206 239,354
------------
Accrued expenses and other liabilities 228,591
------------
Total liabilities 467,945
------------
Net Assets: Net assets $130,293,998
============
Capital: Capital Stock (200,000,000 shares authorized):
Preferred Stock, par value $.10 per share (2,480 shares of
AMPS* issued and 1,796 shares outstanding at $25,000 per
share liquidation preference) $ 44,900,000
Common Stock, par value $.10 per share (9,755,788 shares
issued and outstanding) $ 975,579
Paid-in capital in excess of par 101,119,137
Undistributed investment income--net 642
Accumulated realized capital losses on investments--net (8,998,265)
Accumulated distributions in excess of realized capital
gains on investments--net (3,406,030)
Unrealized depreciation on investments--net (4,297,065)
------------
Total--Equivalent to $8.75 net asset value per
share of Common Stock 85,393,998
------------
Total capital $130,293,998
============
*Auction Market Preferred Stock.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 2000
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended October 31, 2000
<S> <S> <C> <C>
Investment Interest and amortization of premium and discount earned $ 9,185,175
Income:
Expenses: Investment advisory fees $ 746,301
Administrative fees 373,150
Commission fees 147,134
Professional fees 131,037
Transfer agent fees 120,507
Printing and shareholder reports 91,453
Accounting services 86,990
Amortization of organization expenses 62,304
Directors' fees and expenses 31,324
Custodian fees 13,403
Registration fees 13,001
Pricing fees 8,091
Other 45,816
------------
Total expenses before reimbursement 1,870,511
Reimbursement of expenses (149,260)
------------
Total expenses after reimbursement 1,721,251
------------
Investment income--net 7,463,924
------------
Realized & Realized loss on investments--net (7,857,686)
Unrealized Change in unrealized depreciation on investments--net 6,239,229
Gain (Loss) on ------------
Investments--Net: Net Increase in Net Assets Resulting from Operations $ 5,845,467
============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
For the Year
Ended October 31,
Increase (Decrease) in Net Assets: 2000 1999
<S> <S> <C> <C>
Operations: Investment income--net $ 7,463,924 $ 7,955,477
Realized loss on investments--net (7,857,686) (3,963,881)
Change in unrealized appreciation/depreciation
on investments--net 6,239,229 (16,190,234)
------------ ------------
Net increase (decrease) in net assets resulting
from operations 5,845,467 (12,198,638)
------------ ------------
Dividends & Investment income--net:
Distributions to Common Stock (5,136,655) (6,440,369)
Shareholders: Preferred Stock (2,346,958) (1,494,777)
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 (7,483,613) (11,341,176)
------------ ------------
Capital Stock Net increase (decrease) in Preferred Stock transactions (13,100,000) 10,000,000
Transactions: Net increase (decrease) in Common Stock transactions (15,141,666) 10,374,468
------------ ------------
Net increase (decrease)in net assets derived from
capital stock transactions (28,241,666) 20,374,468
------------ ------------
Net Assets: Total decrease in net assets (29,879,812) (3,165,346)
Beginning of year 160,173,810 163,339,156
------------ ------------
End of year* $130,293,998 $160,173,810
============ ============
*Undistributed investment income--net $ 642 $ 20,331
============ ============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 2000
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
For the
Period
The following per share data and ratios have been derived Nov. 3,
from information provided in the financial statements. 1995++ to
For the Year Ended October 31, Oct. 31,
Increase (Decrease) in Net Asset Value: 2000 1999 1998 1997 1996
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 8.89 $ 10.96 $ 10.87 $ 10.17 $ 10.00
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .72 .71 .73 .75 .68
Realized and unrealized gain (loss)
on investments--net (.14) (1.75) .35 .70 .21
-------- -------- -------- -------- --------
Total from investment operations .58 (1.04) 1.08 1.45 .89
-------- -------- -------- -------- --------
Less dividends and distributions to
Common Stock shareholders:
Investment income--net (.49) (.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 (.49) (.85) (.79) (.59) (.59)
-------- -------- -------- -------- --------
Effect of Preferred Stock activity:++++
Dividends and distributions to
Preferred Stock shareholders:
Investment income--net (.23) (.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 (.23) (.18) (.20) (.16) (.13)
-------- -------- -------- -------- --------
Net asset value, end of period $ 8.75 $ 8.89 $ 10.96 $ 10.87 $ 10.17
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 4.09% (11.94%) 8.28% 13.08% 7.81%+++
Return:** ======== ======== ======== ======== ========
Ratios Based on Total expenses, net of reimbursement*** 1.88% 1.75% 1.61% 1.37% .68%*
Average Net ======== ======== ======== ======== ========
Assets of Total expenses*** 2.04% 1.90% 1.80% 1.83% 1.60%*
Common Stock: ======== ======== ======== ======== ========
Total investment income--net*** 8.14% 6.98% 6.65% 7.14% 6.86%*
======== ======== ======== ======== ========
Amount of dividends to Preferred
Stock shareholders 2.56% 1.31% 1.21% 1.53% .94%*
======== ======== ======== ======== ========
Investment income--net, to
Common Stock shareholders 5.58% 5.67% 5.44% 5.61% 5.92%*
======== ======== ======== ======== ========
Ratios Based on Total expenses, net of reimbursement 1.15% 1.17% 1.12% .96% .53%*
Total Average ======== ======== ======== ======== ========
Net Total expenses 1.25% 1.27% 1.25% 1.28% 1.26%*
Assets:***++++++ ======== ======== ======== ======== ========
Total investment income--net 4.99% 4.66% 4.61% 5.01% 5.40%*
======== ======== ======== ======== ========
Ratios Based on Dividends to Preferred Stock Shareholders 4.05% 2.63% 2.75% 3.58% 3.49%*
Average Net ======== ======== ======== ======== ========
Assets of
Preferred Stock:
Supplemental Net assets, net of Preferred Stock,
Data: end of period (in thousands) $ 85,394 $102,174 $115,339 $101,463 $ 83,573
======== ======== ======== ======== ========
Preferred Stock outstanding,
end of period (in thousands) $ 44,900 $ 58,000 $ 48,000 $ 48,000 $ 38,000
======== ======== ======== ======== ========
Portfolio turnover 115.52% 158.57% 141.53% 144.34% 234.41%
======== ======== ======== ======== ========
Leverage: Asset coverage per $1,000 $ 2,902 $ 2,762 $ 3,403 $ 3,114 $ 3,199
======== ======== ======== ======== ========
Dividends Per Investment income--net $ 1,015 $ 644 $ 533 $ 897 $ 564
Share On ======== ======== ======== ======== ========
Preferred Stock
Outstanding:
*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. The Fund's Investment Adviser
voluntarily waived a portion of its management fee. Without such
waiver, the Fund's performance would have been lower.
***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, 2000
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
conformity with accounting principles generally accepted in the
United States of America, 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 investment strategies to increase or decrease the level of
risk to which the Fund is exposed more quickly and efficiently than
transactions in other types of instruments. 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. 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, 2000,
FAM earned fees of $746,301, of which $149,260 was 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 portfolio activities) necessary for the operation of the
Fund.
For the year ended October 31, 2000, FAM Distributors Inc. ("FAMD"),
which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.,
earned early withdrawal charges of $115,842 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.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, FDS, FAMD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended October 31, 2000 were $159,580,282 and
$181,935,000, respectively.
Net realized losses for the year ended October 31, 2000 and net
unrealized losses as of October 31, 2000, were as follows:
Realized Unrealized
Losses Losses
Long-term investments $ (7,857,686) $ (4,297,065)
------------ -------------
Total $ (7,857,686) $ (4,297,065)
============ =============
As of October 31, 2000, net unrealized depreciation for Federal
income tax purposes aggregated $4,311,900, of which $2,270,143
related to appreciated securities and $6,582,043 related to
depreciated securities. The aggregate cost of investments at October
31, 2000 for Federal income tax purposes was $132,788,914.
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.
Transactions in Common Stock were as follows:
For the Year Ended Dollar
October 31, 2000 Shares Amount
Shares sold 630,905 $ 5,502,348
Shares issued to shareholders
in reinvestment of dividends 179,287 1,561,399
------------ -------------
Total issued 810,192 7,063,747
Shares tendered (2,553,660) (22,205,413)
------------ -------------
Net decrease (1,743,468) $ (15,141,666)
============ =============
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
============ =============
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
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, 2000 was 3.50%.
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, 2000 decreased
by 524 as a result of shares retired and during the year ended
October 31, 1999 increased by 400 as a result of shares sold.
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, 2000, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, an affiliate of FAM, earned $127,823 as commissions.
5. Capital Loss Carryforward:
At October 31, 2000, the Fund had a net capital loss carry-forward
of approximately $12,294,000, of which $4,320,000 expires in 2007
and $7,974,000 expires in 2008. This amount will be available to
offset like amounts of any future taxable gains.
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, 2000, 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 four-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 auditing standards
generally accepted in the United States of America. 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, 2000 by
correspondence with the custodian. 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, 2000,
the results of its operations, the changes in its net assets, and
the financial highlights for the respective stated periods in
conformity with accounting principles generally accepted in the
United States of America.
Deloitte & Touche LLP
Princeton, New Jersey
December 5, 2000
IMPORTANT TAX INFORMATION (unaudited)
All of the net investment income distributions paid by Merrill Lynch
Municipal Strategy Fund, Inc. during its taxable year ended October
31, 2000 qualify as tax-exempt interest dividends for Federal income
tax purposes. Additionally, there were no capital gains
distributions paid by the Fund during the year.
Please retain this information for your records.
QUALITY PROFILE (unaudited)
The quality ratings of securities in the Fund as of October 31, 2000
were as follows:
Percent of
S&P Rating/Moody's Rating Net Assets
AAA/Aaa 59.1%
AA/Aa 8.8
A/A 1.6
BBB/Baa 9.0
BB/Ba 4.2
B/B 4.1
NR(Not Rated) 9.6
Other++ 2.2
++Temporary investments in short-term municipal securities.
Merrill Lynch Municipal Strategy Fund, Inc., October 31, 2000
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
Roscoe S. Suddarth, Director
Richard R. West, Director
Arthur Zeikel, Director
Edward D. Zinbarg, 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
Jodi M. Pinedo, 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
