STATEMENT OF ADDITIONAL INFORMATION
ICAP FUNDS, INC.
ICAP Discretionary Equity Portfolio
ICAP Equity Portfolio
225 West Wacker Drive, Suite 2400
Chicago, Illinois 60606
1-800-645-2457
This Statement of Additional Information is not a
prospectus and should be read in conjunction with the
Prospectus of ICAP Funds, Inc. (the "Company"), dated
April 30, 1996. Requests for copies of the Prospectus
should be made by writing to the Company at the address
listed above; or by calling 1-800-645-2457.
This Statement of Additional Information is dated April
30, 1996, as supplemented on September 24, 1996.
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ICAP FUNDS, INC.
TABLE OF CONTENTS
Page No.
INVESTMENT RESTRICTIONS . . . . . . . . . . . . . . 4
INVESTMENT POLICIES AND TECHNIQUES . . . . . . . . 5
Illiquid Securities . . . . . . . . . . . . . . 5
Short-Term Fixed Income Securities . . . . . . . 6
Short Sales Against the Box . . . . . . . . . . 7
Warrants . . . . . . . . . . . . . . . . . . . . 8
When-Issued Securities . . . . . . . . . . . . . 8
Unseasoned Companies . . . . . . . . . . . . . . 8
Non-Investment Grade Debt Securities "Junk Bonds" 9
Hedging Strategies . . . . . . . . . . . . . . . 10
General Description of Hedging Strategies . . 10
General Limitations on Futures and Options
Transactions . . . . . . . . . . . . . . . . 10
Asset Coverage for Futures and Options Positions 11
Stock Index Options . . . . . . . . . . . . . 11
Certain Considerations Regarding Options . . . 12
Federal Tax Treatment of Options . . . . . . . 12
Futures Contracts . . . . . . . . . . . . . . 12
Options on Futures . . . . . . . . . . . . . . 14
Federal Tax Treatment of Futures Contracts . . 14
DIRECTORS AND OFFICERS . . . . . . . . . . . . . . 15
PRINCIPAL SHAREHOLDERS . . . . . . . . . . . . . . 17
INVESTMENT ADVISER . . . . . . . . . . . . . . . . 19
PORTFOLIO TRANSACTIONS AND BROKERAGE . . . . . . . 20
CUSTODIAN . . . . . . . . . . . . . . . . . . . . . 21
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT . . . 21
TAXES . . . . . . . . . . . . . . . . . . . . . . . 22
DETERMINATION OF NET ASSET VALUE . . . . . . . . . 22
SHAREHOLDER MEETINGS . . . . . . . . . . . . . . . 22
PERFORMANCE INFORMATION . . . . . . . . . . . . . . 23
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INDEPENDENT ACCOUNTANTS . . . . . . . . . . . . . . 25
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . 25
APPENDIX A - BOND RATINGS . . . . . . . . . . . . A-1
No person has been authorized to give any
information or to make any representations other than
those contained in this Statement of Additional
Information and the Prospectus dated April 30, 1996,
and if given or made, such information or
representations may not be relied upon as having been
authorized by the Company.
This Statement of Additional Information does not
constitute an offer to sell securities.
<PAGE>
INVESTMENT RESTRICTIONS
The investment objective of both the ICAP
Discretionary Equity Portfolio (the "Discretionary
Equity Portfolio") and the ICAP Equity Portfolio (the
"Equity Portfolio") (hereinafter collectively referred
to as the "Portfolios") is to seek a superior total
return with only a moderate degree of risk. This
investment objective is relative to and measured
against the Standard & Poor's 500 ("S&P 500"). The
investment objective and policies of each Portfolio are
described in detail in the Prospectus under the
captions "DISCRETIONARY EQUITY PORTFOLIO" and "EQUITY
PORTFOLIO." The following is a complete list of each
Portfolio's fundamental investment limitations which
cannot be changed without shareholder approval.
Neither Portfolio may:
1. With respect to 75% of its total assets,
purchase securities of any issuer (except
securities issued or guaranteed by the U.S.
government or any agency or instrumentality
thereof) if, as a result, (i) more than 5% of the
Portfolio's total assets would be invested in the
securities of that issuer, or (ii) the Portfolio
would hold more than 10% of the outstanding voting
securities of that issuer.
2. Borrow money, except that the Portfolio
may (i) borrow money from banks for temporary or
emergency purposes (but not for leverage or the
purchase of investments) and (ii) make other
investments or engage in other transactions
permissible under the Investment Company Act of
1940 which may involve a borrowing, provided that
the combination of (i) and (ii) shall not exceed
33 1/3% of the value of the Portfolio's total
assets (including the amount borrowed), less the
Portfolio's liabilities (other than borrowings).
3. Act as an underwriter of another issuer's
securities, except to the extent that the
Portfolio may be deemed to be an underwriter
within the meaning of the Securities Act of 1933
in connection with the purchase and sale of
portfolio securities.
4. Make loans to other persons, except
through (i) the purchase of debt securities
permissible under the Portfolio's investment
policies, (ii) repurchase agreements, or (iii) the
lending of portfolio securities, provided that no
such loan of portfolio securities may be made by
the Portfolio if, as a result, the aggregate of
such loans would exceed 33 1/3% of the value of
the Portfolio's total assets.
5. Purchase or sell physical commodities
unless acquired as a result of ownership of
securities or other instruments (but this shall
not prevent the Portfolio from purchasing or
selling options, futures contracts, or other
derivative instruments, or from investing in
securities or other instruments backed by physical
commodities).
6. Purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prohibit the
Portfolio from purchasing or selling securities or
other instruments backed by real estate or of
issuers engaged in real estate activities).
7. Issue senior securities, except as
permitted under the Investment Company Act of
1940.
8. Purchase the securities of any issuer if,
as a result, more than 25% of the Portfolio's
total assets would be invested in the securities
of issuers whose principal business activities are
in the same industry.
With the exception of the investment restriction
set out in item 2 above, if a percentage restriction is
adhered to at the time of investment, a later increase
in percentage resulting from a change in market value
of the investment or the total assets will not
constitute a violation of that restriction.
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The following investment policies may be
changed by the Board of Directors of the Company (the
"Board of Directors") without shareholder approval.
Neither Portfolio may:
1. Sell securities short, unless the
Portfolio owns or has the right to obtain
securities equivalent in kind and amount to the
securities sold short, and provided that
transactions in options, futures contracts,
options on futures contracts, or other derivative
instruments are not deemed to constitute selling
securities short.
2. Purchase securities on margin, except
that the Portfolio may obtain such short-term
credits as are necessary for the clearance of
transactions; and provided that margin deposits in
connection with futures contracts, options on
futures contracts, or other derivative instruments
shall not constitute purchasing securities on
margin.
3. Pledge, mortgage or hypothecate any
assets owned by the Portfolio except as may be
necessary in connection with permissible
borrowings or investments and then such pledging,
mortgaging, or hypothecating may not exceed 33
1/3% of the Portfolio's total assets at the time
of the borrowing or investment.
4. Purchase the securities of any issuer
(other than securities issued or guaranteed by
domestic or foreign governments or political
subdivisions thereof) if, as a result, more than
5% of its total assets would be invested in the
securities of issuers that, including predecessors
or unconditional guarantors, have a record of less
than three years of continuous operation. This
policy does not apply to securities of pooled
investment vehicles or mortgage or asset-backed
securities.
5. Invest in illiquid securities if, as a
result of such investment, more than 5% of the
Portfolio's net assets would be invested in
illiquid securities.
6. Purchase securities of open-end or
closed-end investment companies except in
compliance with the Investment Company Act of 1940
and applicable state law.
7. Enter into futures contracts or related
options if more than 30% of the Portfolio's net
assets would be represented by futures contracts
or more than 5% of the Portfolio's net assets
would be committed to initial margin deposits and
premiums on futures contracts and related options.
8. Invest in direct interests in oil, gas or
other mineral exploration programs or leases;
however, the Portfolio may invest in the
securities of issuers that engage in these
activities.
9. Purchase securities when borrowings
exceed 5% of its total assets.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the
discussion of the Portfolios' investment objectives,
policies, and techniques that are described in the
Prospectus under the captions "DISCRETIONARY EQUITY
PORTFOLIO," "EQUITY PORTFOLIO," and "INVESTMENT
TECHNIQUES AND RISKS."
Illiquid Securities
The Portfolios may invest in illiquid securities
(i.e., securities that are not readily marketable).
For purposes of this restriction, illiquid securities
include, but are not limited to, restricted securities
(securities the disposition of which is restricted
under the federal securities laws), securities which
may only be resold pursuant
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to Rule 144A under the
Securities Act of 1933, as amended (the "Securities
Act"), and repurchase agreements with maturities in
excess of seven days. However, neither Portfolio will
acquire illiquid securities if, as a result, such
securities would comprise more than 5% of the value of
the Portfolio's net assets. The Board of Directors or
its delegate has the ultimate authority to determine,
to the extent permissible under the federal securities
laws, which securities are liquid or illiquid for
purposes of this 5% limitation. The Board of Directors
has delegated to Institutional Capital Corporation
("ICAP") the day-to-day determination of the liquidity
of any security, although it has retained oversight and
ultimate responsibility for such determinations.
Although no definitive liquidity criteria are used, the
Board of Directors has directed ICAP to look to such
factors as (i) the nature of the market for a security
(including the institutional private resale market),
(ii) the terms of certain securities or other
instruments allowing for the disposition to a third
party or the issuer thereof (e.g., certain repurchase
obligations and demand instruments), (iii) the
availability of market quotations (e.g., for securities
quoted in the PORTAL system), and (iv) other
permissible relevant factors.
Restricted securities may be sold only in
privately negotiated transactions or in a public
offering with respect to which a registration statement
is in effect under the Securities Act. Where
registration is required, a Portfolio may be obligated
to pay all or part of the registration expenses and a
considerable period may elapse between the time of the
decision to sell and the time the Portfolio may be
permitted to sell a security under an effective
registration statement. If, during such a period,
adverse market conditions were to develop, the
Portfolio might obtain a less favorable price than that
which prevailed when it decided to sell. Restricted
securities will be priced at fair value as determined
in good faith by the Board of Directors. If, through
the appreciation of restricted securities or the
depreciation of unrestricted securities, a Portfolio
should be in a position where more than 5% of the value
of its net assets are invested in illiquid securities,
including restricted securities which are not readily
marketable, the affected Portfolio will take such steps
as is deemed advisable, if any, to protect liquidity.
Short-Term Fixed Income Securities
The Discretionary Equity Portfolio may invest up
to 35% of its total assets and, for temporary defensive
purposes up to 100% of its total assets, in cash and
short-term fixed income securities, defined below. The
Equity Portfolio intends to be fully invested at all
times and accordingly will only hold cash or short-term
fixed income securities to meet anticipated redemption
requests, pending investment and to pay expenses which,
in any case, generally will not exceed 5% of its total
assets. The Equity Portfolio may, however, temporarily
exceed this 5% limitation, but only in circumstances
pending investment and only for short periods of time.
Short-term fixed income securities are defined to
include without limitation, the following:
1. U.S. government securities, including
bills, notes and bonds differing as to maturity
and rates of interest, which are either issued or
guaranteed by the U.S. Treasury or by U.S.
government agencies or instrumentalities. U.S.
government agency securities include securities
issued by (a) the Federal Housing Administration,
Farmers Home Administration, Export-Import Bank of
the United States, Small Business Administration,
and the Government National Mortgage Association,
whose securities are supported by the full faith
and credit of the United States; (b) the Federal
Home Loan Banks, Federal Intermediate Credit
Banks, and the Tennessee Valley Authority, whose
securities are supported by the right of the
agency to borrow from the U.S. Treasury; (c) the
Federal National Mortgage Association, whose
securities are supported by the discretionary
authority of the U.S. government to purchase
certain obligations of the agency or
instrumentality; and (d) the Student Loan
Marketing Association, whose securities are
supported only by its credit. While the U.S.
government provides financial support to such U.S.
government-sponsored agencies or
instrumentalities, no assurance can be given that
it always will do so since it is not so obligated
by law. The U.S. government, its agencies, and
instrumentalities do not guarantee the market
value of their securities, and consequently, the
value of such securities may fluctuate.
2. Certificates of Deposit issued against
funds deposited in a bank or savings and loan
association. Such certificates are for a definite
period of time, earn a specified rate of return,
and are normally negotiable. If such certificates
of deposit are non-negotiable, they will be
considered illiquid securities and be subject to
the Portfolios' 5% restriction on investments in
illiquid securities. Pursuant to the certificate
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of deposit, the issuer agrees to pay the amount
deposited plus interest to the bearer of the
certificate on the date specified thereon. Under
current FDIC regulations, the maximum insurance
payable as to any one certificate of deposit is
$100,000; therefore, certificates of deposit
purchased by a Portfolio may not be fully insured.
3. Bankers' acceptances which are short-term
credit instruments used to finance commercial
transactions. Generally, an acceptance is a time
draft drawn on a bank by an exporter or an
importer to obtain a stated amount of funds to pay
for specific merchandise. The draft is then
"accepted" by a bank that, in effect,
unconditionally guarantees to pay the face value
of the instrument on its maturity date. The
acceptance may then be held by the accepting bank
as an asset or it may be sold in the secondary
market at the going rate of interest for a
specific maturity.
4. Repurchase agreements which involve
purchases of debt securities. In such an action,
at the time a Portfolio purchases the security, it
simultaneously agrees to resell and redeliver the
security to the seller, who also simultaneously
agrees to buy back the security at a fixed price
and time. This assures a predetermined yield for
the Portfolio during its holding period since the
resale price is always greater than the purchase
price and reflects an agreed-upon market rate.
Such actions afford an opportunity for the
Portfolio to invest temporarily available cash.
The Portfolios may enter into repurchase
agreements only with respect to obligations of the
U.S. government, its agencies or
instrumentalities; certificates of deposit; or
bankers acceptances in which the Portfolios may
invest. Repurchase agreements may be considered
loans to the seller, collateralized by the
underlying securities. The risk to the Portfolios
is limited to the ability of the seller to pay the
agreed-upon sum on the repurchase date; in the
event of default, the repurchase agreement
provides that the affected Portfolio is entitled
to sell the underlying collateral. If the value
of the collateral declines after the agreement is
entered into, however, and if the seller defaults
under a repurchase agreement when the value of the
underlying collateral is less than the repurchase
price, the Portfolio could incur a loss of both
principal and interest. ICAP monitors the value
of the collateral at the time the action is
entered into and at all times during the term of
the repurchase agreement. ICAP does so in an
effort to determine that the value of the
collateral always equals or exceeds the agreed-
upon repurchase price to be paid to the Portfolio.
If the seller were to be subject to a federal
bankruptcy proceeding, the ability of a Portfolio
to liquidate the collateral could be delayed or
impaired because of certain provisions of the
bankruptcy laws.
5. Bank time deposits, which are monies kept
on deposit with banks or savings and loan
associations for a stated period of time at a
fixed rate of interest. There may be penalties
for the early withdrawal of such time deposits, in
which case the yields of these investments will be
reduced.
6. Commercial paper, which are short-term
unsecured promissory notes, including variable
rate master demand notes issued by corporations to
finance their current operations. Master demand
notes are direct lending arrangements between a
Portfolio and a corporation. There is no
secondary market for the notes. However, they are
redeemable by the Portfolios at any time. ICAP
will consider the financial condition of the
corporation (e.g., earning power, cash flow, and
other liquidity ratios) and will continuously
monitor the corporation's ability to meet all of
its financial obligations, because a Portfolio's
liquidity might be impaired if the corporation
were unable to pay principal and interest on
demand. Investments in commercial paper will be
limited to commercial paper rated in the two
highest categories by a major rating agency or
unrated commercial paper which is, in the opinion
of ICAP, of comparable quality.
Short Sales Against the Box
When ICAP believes that the price of a particular
security held by a Portfolio may decline, it may make
"short sales against the box" to hedge the unrealized
gain on such security. Selling short against the box
involves selling a security which the Portfolio owns
for delivery at a specified date in the future. Each
Portfolio will limit its transactions in short sales
against the box to 5% of its net assets. In addition,
each Portfolio will limit its
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transactions such that
the value of the securities of any issuer in which it
is short will not exceed the lesser of 2% of the value
of the Portfolio's net assets or 2% of the securities
of any class of the issuer. If, for example, a
Portfolio bought 100 shares of ABC at $40 per share in
January and the price appreciates to $50 in March, the
Portfolio might "sell short" the 100 shares at $50 for
delivery the following July. Thereafter, if the price
of the stock declines to $45, it will realize the full
$1,000 gain rather than the $500 gain it would have
received had it sold the stock in the market. On the
other hand, if the price appreciates to $55 per share,
the Portfolio would be required to sell at $50 and thus
receive a $1,000 gain rather than the $1,500 gain it
would have received had it sold the stock in the
market. The Portfolios may also be required to pay a
premium for short sales which would partially offset
any gain.
Warrants
Each Portfolio may invest in warrants if, after
giving effect thereto, not more than 5% of its net
assets will be invested in warrants other than warrants
acquired in units or attached to other securities. Of
such 5%, not more than 2% of its assets at the time of
purchase may be invested in warrants that are not
listed on the New York Stock Exchange or the American
Stock Exchange. Investing in warrants is purely
speculative in that they have no voting rights, pay no
dividends, and have no rights with respect to the
assets of the corporation issuing them. Warrants
basically are options to purchase equity securities at
a specific price for a specific period of time. They
do not represent ownership of the securities but only
the right to buy them. Warrants are issued by the
issuer of the security, which may be purchased on their
exercise. The prices of warrants do not necessarily
parallel the prices of the underlying securities.
When-Issued Securities
The Portfolios may from time to time purchase
securities on a "when-issued" basis. The price of
securities purchased on a when-issued basis is fixed at
the time the commitment to purchase is made, but
delivery and payment for the securities take place at a
later date. Normally, the settlement date occurs
within 45 days of the purchase. During the period
between the purchase and settlement, no payment is made
by the Portfolios to the issuer and no interest is
accrued on debt securities or dividend income is earned
on equity securities. Forward commitments involve a
risk of loss if the value of the security to be
purchased declines prior to the settlement date, which
risk is in addition to the risk of decline in value of
the Portfolios' other assets. While when-issued
securities may be sold prior to the settlement date,
the Portfolios intend to purchase such securities with
the purpose of actually acquiring them. At the time a
Portfolio makes the commitment to purchase a security
on a when-issued basis, it will record the transaction
and reflect the value of the security in determining
its net asset value. The Portfolios do not believe
that net asset value will be adversely affected by
purchases of securities on a when-issued basis.
The Portfolios will maintain cash, U.S. government
securities and high grade liquid debt securities equal
in value to commitments for when-issued securities.
Such segregated securities either will mature or, if
necessary, be sold on or before the settlement date.
When the time comes to pay for when-issued securities,
each Portfolio will meet its obligations from then
available cash flow, sale of the securities held in the
separate account, described above, sale of other
securities or, although it would not normally expect to
do so, from the sale of the when-issued securities
themselves (which may have a market value greater or
less than the Portfolio's payment obligation).
Unseasoned Companies
Neither Portfolio may invest more than 5% of its
net assets in unseasoned companies. While smaller
companies generally have potential for rapid growth,
they often involve higher risks because they lack the
management experience, financial resources, product
diversification, and competitive strengths of larger
corporations. In addition, in many instances, the
securities of smaller companies are traded only over-
the-counter or on regional securities exchanges, and
the frequency and volume of their trading is
substantially less than is typical of larger companies.
Therefore, the securities of smaller companies may be
subject to wider price fluctuations. When making large
sales, the Portfolios may have to sell portfolio
holdings of small companies at discounts from
<PAGE>
quoted
prices or may have to make a series of smaller sales
over an extended period of time due to the trading
volume in smaller company securities.
Non-Investment Grade Debt Securities "Junk Bonds"
The Portfolios may invest up to 5% of their assets
in junk bonds. Junk bonds while generally offering
higher yields than investment grade securities with
similar maturities, involve greater risks, including
the possibility of default or bankruptcy. They are
regarded as predominantly speculative with respect to
the issuer's capacity to pay interest and repay
principal. The special risk considerations in
connection with investments in these securities are
discussed below. Refer to the Appendix of this
Statement of Additional Information for a discussion of
securities ratings.
Effect of Interest Rates and Economic Changes.
The junk bond market is relatively new and its growth
has paralleled a long economic expansion. As a result,
it is not clear how this market may withstand a
prolonged recession or economic downturn. Such an
economic downturn could severely disrupt the market for
and adversely affect the value of such securities.
All interest-bearing securities typically
experience appreciation when interest rates decline and
depreciation when interest rates rise. The market
values of junk bond securities tend to reflect
individual corporate developments to a greater extent
than do higher rated securities, which react primarily
to fluctuations in the general level of interest rates.
Junk bond securities also tend to be more sensitive to
economic conditions than are higher-rated securities.
As a result, they generally involve more credit risks
than securities in the higher-rated categories. During
an economic downturn or a sustained period of rising
interest rates, highly leveraged issuers of junk bond
securities may experience financial stress and may not
have sufficient revenues to meet their payment
obligations. The risk of loss due to default by an
issuer of these securities is significantly greater
than issuers of higher-rated securities because such
securities are generally unsecured and are often
subordinated to other creditors. Further, if the
issuer of a junk bond security defaulted, a Portfolio
might incur additional expenses to seek recovery.
Periods of economic uncertainty and changes would also
generally result in increased volatility in the market
prices of these securities and thus in a Portfolio's
net asset value.
As previously stated, the value of a junk bond
security will generally decrease in a rising interest
rate market, and accordingly so will a Portfolio's net
asset value. If a Portfolio experiences unexpected net
redemptions in such a market, it may be forced to
liquidate a portion of its portfolio securities without
regard to their investment merits. Due to the limited
liquidity of junk bond securities, a Portfolio may be
forced to liquidate these securities at a substantial
discount. Any such liquidation would reduce a
Portfolio's asset base over which expenses could be
allocated and could result in a reduced rate of return
for the Portfolio.
Payment Expectations. Junk bond securities
typically contain redemption, call or prepayment
provisions which permit the issuer of such securities
containing such provisions to redeem the securities at
its discretion. During periods of falling interest
rates, issuers of these securities are likely to redeem
or prepay the securities and refinance them with debt
securities with a lower interest rate. To the extent
an issuer is able to refinance the securities, or
otherwise redeem them, a Portfolio may have to replace
the securities with a lower yielding security, which
could result in a lower return for the Portfolio.
Credit Ratings. Credit ratings issued by credit-
rating agencies evaluate the safety of principal and
interest payments of rated securities. They do not,
however, evaluate the market value risk of junk bond
securities and, therefore may not fully reflect the
true risks of an investment. In addition, credit
rating agencies may or may not make timely changes in a
rating to reflect changes in the economy or in the
condition of the issuer that affect the market value of
the security. Consequently, credit ratings are used
only as a preliminary indicator of investment quality.
Investments in junk bond securities will be more
dependent on ICAP's credit analysis than would be the
case with investments in investment-grade debt
securities. ICAP employs its own credit research and
analysis, which includes a study of existing debt,
capital structure, ability to service debt and to pay
dividends, the issuer's sensitivity to economic
conditions, its operating history and the current trend
of earnings. ICAP continually
<PAGE>
monitors each
Portfolios' investments and carefully evaluates whether
to dispose of or to retain junk bond securities whose
credit ratings or credit quality may have changed.
Liquidity and Valuation. A Portfolio may have
difficulty disposing of certain junk bond securities
because there may be a thin trading market for such
securities. Because not all dealers maintain markets
in all junk bond securities there is no established
retail secondary market for many of these securities.
The Portfolios anticipate that such securities could be
sold only to a limited number of dealers or
institutional investors. To the extent a secondary
trading market does exist, it is generally not as
liquid as the secondary market for higher-rated
securities. The lack of a liquid secondary market may
have an adverse impact on the market price of the
security. The lack of a liquid secondary market for
certain securities may also make it more difficult for
a Portfolio to obtain accurate market quotations for
purposes of valuing the Portfolio. Market quotations
are generally available on many junk bond issues only
from a limited number of dealers and may not
necessarily represent firm bids of such dealers or
prices for actual sales. During periods of thin
trading, the spread between bid and asked prices is
likely to increase significantly. In addition, adverse
publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the values
and liquidity of junk bond securities, especially in a
thinly traded market.
New and Proposed Legislation. Recent legislation
has been adopted, and from time to time, proposals have
been discussed, regarding new legislation designed to
limit the use of certain junk bond securities by
certain issuers. An example of such legislation is a
law which requires federally insured savings and loan
associations to divest their investments in these
securities over time. It is not currently possible to
determine the impact of the recent legislation or the
proposed legislation on the junk bond securities
market. However, it is anticipated that if additional
legislation is enacted or proposed, it could have a
material affect on the value of these securities and
the existence of a secondary trading market for the
securities.
Hedging Strategies
General Description of Hedging Strategies
The Portfolios may engage in hedging activities.
ICAP may cause the Portfolios to utilize a variety of
financial instruments, including options, futures
contracts (sometimes referred to as "futures") and
options on futures contracts to attempt to hedge a
Portfolio's holdings.
Hedging instruments on securities generally are
used to hedge against price movements in one or more
particular securities positions that a Portfolio owns
or intends to acquire. Hedging instruments on stock
indices, in contrast, generally are used to hedge
against price movements in broad equity market sectors
in which a Portfolio has invested or expects to invest.
The use of hedging instruments is subject to applicable
regulations of the Securities and Exchange Commission
(the "SEC"), the several options and futures exchanges
upon which they are traded, the Commodity Futures
Trading Commission (the "CFTC") and various state
regulatory authorities. In addition, a Portfolio's
ability to use hedging instruments will be limited by
tax considerations.
General Limitations on Futures and Options
Transactions
The Company has filed a notice of eligibility for
exclusion from the definition of the term "commodity
pool operator" with the CFTC and the National Futures
Association, which regulate trading in the futures
markets. Pursuant to Section 4.5 of the regulations
under the Commodity Exchange Act (the "CEA"), the
notice of eligibility for the Portfolios includes the
representation that the Portfolios will use futures
contracts and related options solely for bona fide
hedging purposes within the meaning of CFTC
regulations, provided that the Portfolios may hold
other positions in futures contracts and related
options that do not fall within the definition of bona
fide hedging transactions (i.e., for speculative
purposes) if aggregate initial margins and premiums
paid do not exceed 5% of the net asset value of the
respective Portfolios. In addition, neither Portfolio
will enter into futures contracts and options
transactions if more than 30% of its net assets would
be committed to such instruments.
<PAGE>
The foregoing limitations are not fundamental
policies of the Portfolios and may be changed without
shareholder approval as regulatory agencies permit.
Various exchanges and regulatory authorities have
undertaken reviews of options and futures trading in
light of market volatility. Among the possible actions
that have been presented are proposals to adopt new or
more stringent daily price fluctuation limits for
futures and options transactions and proposals to
increase the margin requirements for various types of
futures transactions.
Asset Coverage for Futures and Options Positions
Each Portfolio will comply with the regulatory
requirements of the SEC and the CFTC with respect to
coverage of options and futures positions by registered
investment companies and, if the guidelines so require,
will set aside cash, U.S. government securities, high
grade liquid debt securities and/or other liquid assets
permitted by the SEC and CFTC in a segregated custodial
account in the amount prescribed. Securities held in a
segregated account cannot be sold while the futures or
options position is outstanding, unless replaced with
other permissible assets, and will be marked-to-market
daily.
Stock Index Options
Each Portfolio may (i) purchase stock index
options for any purpose, (ii) sell stock index options
in order to close out existing positions, and/or (iii)
write covered options on stock indexes for hedging
purposes. Stock index options are put options and call
options on various stock indexes. In most respects,
they are identical to listed options on common stocks.
The primary difference between stock options and index
options occurs when index options are exercised. In
the case of stock options, the underlying security,
common stock, is delivered. However, upon the exercise
of an index option, settlement does not occur by
delivery of the securities comprising the index. The
option holder who exercises the index option receives
an amount of cash if the average of the bid and asked
prices of the stock index upon which the option is
based is greater than, in the case of a call, or less
than, in the case of a put, the exercise price of the
option. This amount of cash is equal to the difference
between the average of the bid and asked prices of the
stock index and the exercise price of the option
expressed in dollars times a specified multiple.
A stock index fluctuates with changes in the
market values of the stocks included in the index. For
example, some stock index options are based on a broad
market index, such as the Standard & Poor's 500 or the
Value Line Composite Index or a narrower market index,
such as the Standard & Poor's 100. Indexes may also be
based on an industry or market segment, such as the
AMEX Oil and Gas Index or the Computer and Business
Equipment Index. Options on stock indexes are
currently traded on the following exchanges: the
Chicago Board of Options Exchange, the New York Stock
Exchange, the American Stock Exchange, the Pacific
Stock Exchange, and the Philadelphia Stock Exchange.
A Portfolio's use of stock index options is
subject to certain risks. Successful use by the
Portfolios of options on stock indexes will be subject
to the ability of ICAP to correctly predict movements
in the directions of the stock market. This requires
different skills and techniques than predicting changes
in the prices of individual securities. In addition, a
Portfolio's ability to effectively hedge all or a
portion of the securities in its portfolio, in
anticipation of or during a market decline through
transactions in put options on stock indexes, depends
on the degree to which price movements in the
underlying index correlate with the price movements of
the securities held by a Portfolio. Inasmuch as a
Portfolio's securities will not duplicate the
components of an index, the correlation will not be
perfect. Consequently, each Portfolio will bear the
risk that the prices of its securities being hedged
will not move in the same amount as the prices of its
put options on the stock indexes. It is also possible
that there may be a negative correlation between the
index and a Portfolio's securities which would result
in a loss on both such securities and the options on
stock indexes acquired by the Portfolio.
The hours of trading for options may not conform
to the hours during which the underlying securities are
traded. To the extent that the options markets close
before the markets for the underlying securities,
significant price and rate movements can take place in
the underlying markets that cannot be reflected in the
options markets.
<PAGE>
The purchase of options is a highly
specialized activity which involves investment
techniques and risks different from those associated
with ordinary portfolio securities transactions. The
purchase of stock index options involves the risk that
the premium and transaction costs paid by a Portfolio
in purchasing an option will be lost as a result of
unanticipated movements in prices of the securities
comprising the stock index on which the option is
based.
Certain Considerations Regarding Options
There is no assurance that a liquid secondary
market on an options exchange will exist for any
particular option, or at any particular time, and for
some options no secondary market on an exchange or
elsewhere may exist. If a Portfolio is unable to close
out a call option on securities that it has written
before the option is exercised, the Portfolio may be
required to purchase the optioned securities in order
to satisfy its obligation under the option to deliver
such securities. If a Portfolio is unable to effect a
closing sale transaction with respect to options on
securities that it has purchased, it would have to
exercise the option in order to realize any profit and
would incur transaction costs upon the purchase and
sale of the underlying securities.
The writing and purchasing of options is a highly
specialized activity which involves investment
techniques and risks different from those associated
with ordinary portfolio securities transactions.
Imperfect correlation between the options and
securities markets may detract from the effectiveness
of attempted hedging. Options transactions may result
in significantly higher transaction costs and portfolio
turnover for the Portfolios.
Federal Tax Treatment of Options
Certain option transactions have special tax
results for the Portfolios. Expiration of a call
option written by a Portfolio will result in short-term
capital gain. If the call option is exercised, the
Portfolio will realize a gain or loss from the sale of
the security covering the call option and, in
determining such gain or loss, the option premium will
be included in the proceeds of the sale.
If a Portfolio writes options other than
"qualified covered call options," as defined in Section
1092 of the Internal Revenue Code of 1986, as amended
(the "Code"), or purchases puts, any losses on such
options transactions, to the extent they do not exceed
the unrealized gains on the securities covering the
options, may be subject to deferral until the
securities covering the options have been sold.
In the case of transactions involving "nonequity
options," as defined in Code Section 1256, the
Portfolios will treat any gain or loss arising from the
lapse, closing out or exercise of such positions as 60%
long-term and 40% short-term capital gain or loss as
required by Section 1256 of the Code. In addition,
such positions must be marked-to-market as of the last
business day of the year, and gain or loss must be
recognized for federal income tax purposes in
accordance with the 60%/40% rule discussed above even
though the position has not been terminated. A
"nonequity option" includes an option with respect to
any group of stocks or a stock index if there is in
effect a designation by the CFTC of a contract market
for a contract based on such group of stocks or
indexes. For example, options involving stock indexes
such as the Standard & Poor's 500 and 100 indexes would
be "nonequity options" within the meaning of Code
Section 1256.
Futures Contracts
The Portfolios may enter into futures contracts
(hereinafter referred to as "Futures" or "Futures
Contracts"), including index Futures as a hedge against
movements in the equity markets, in order to establish
more definitely the effective return on securities held
or intended to be acquired by the Portfolios or for
other purposes permissible under the CEA. Each
Portfolio's hedging may include sales of Futures as an
offset against the effect of expected declines in stock
prices and purchases of Futures as an offset against
the effect of expected increases in stock prices. The
Portfolios will not enter into Futures Contracts which
are prohibited under the CEA and will, to the extent
required by regulatory authorities, enter only into
Futures Contracts that are traded on national futures
exchanges and are standardized as to maturity date and
underlying financial instrument. The principal
interest rate
<PAGE>
Futures exchanges in the United States
are the Board of Trade of the City of Chicago and the
Chicago Mercantile Exchange. Futures exchanges and
trading are regulated under the CEA by the CFTC.
An index Futures Contract is an agreement pursuant
to which the parties agree to take or make delivery of
an amount of cash equal to the difference between the
average of the bid and asked prices of the index on the
last trading day of the contract and the price at which
the index Futures Contract was originally written.
Transaction costs are incurred when a Futures Contract
is bought or sold and margin deposits must be
maintained. A Futures Contract may be satisfied by
delivery or purchase, as the case may be, of the
instrument or by payment of the change in the cash
value of the index. More commonly, Futures Contracts
are closed out prior to delivery by entering into an
offsetting transaction in a matching Futures Contract.
Although the value of an index might be a function of
the value of certain specified securities, no physical
delivery of those securities is made. If the
offsetting purchase price is less than the original
sale price, a gain will be realized; if it is more, a
loss will be realized. Conversely, if the offsetting
sale price is more than the original purchase price, a
gain will be realized; if it is less, a loss will be
realized. The transaction costs must also be included
in these calculations. There can be no assurance,
however, that the Portfolios will be able to enter into
an offsetting transaction with respect to a particular
Futures Contract at a particular time. If the
Portfolios are not able to enter into an offsetting
transaction, the Portfolios will continue to be
required to maintain the margin deposits on the Futures
Contract.
Margin is the amount of funds that must be
deposited by each Portfolio with its custodian in a
segregated account in the name of the futures
commission merchant in order to initiate Futures
trading and to maintain the Portfolio's open positions
in Futures Contracts. A margin deposit is intended to
ensure the Portfolio's performance of the Futures
Contract. The margin required for a particular Futures
Contract is set by the exchange on which the Futures
Contract is traded and may be significantly modified
from time to time by the exchange during the term of
the Futures Contract. Futures Contracts are
customarily purchased and sold on margins that may
range upward from less than 5% of the value of the
Futures Contract being traded.
If the price of an open Futures Contract changes
(by increase in the case of a sale or by decrease in
the case of a purchase) so that the loss on the Futures
Contract reaches a point at which the margin on deposit
does not satisfy margin requirements, the broker will
require an increase in the margin. However, if the
value of a position increases because of favorable
price changes in the Futures Contract so that the
margin deposit exceeds the required margin, the broker
will pay the excess to the Portfolio. In computing
daily net asset value, each Portfolio will mark to
market the current value of its open Futures Contracts.
The Portfolios expect to earn interest income on their
margin deposits.
Because of the low margin deposits required,
Futures trading involves an extremely high degree of
leverage. As a result, a relatively small price
movement in a Futures Contract may result in immediate
and substantial loss, as well as gain, to the investor.
For example, if at the time of purchase, 10% of the
value of the Futures Contract is deposited as margin, a
subsequent 10% decrease in the value of the Futures
Contract would result in a total loss of the margin
deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15%
decrease would result in a loss equal to 150% of the
original margin deposit, if the Futures Contract were
closed out. Thus, a purchase or sale of a Futures
Contract may result in losses in excess of the amount
initially invested in the Futures Contract. However, a
Portfolio would presumably have sustained comparable
losses if, instead of the Futures Contract, it had
invested in the underlying financial instrument and
sold it after the decline.
Most United States Futures exchanges limit the
amount of fluctuation permitted in Futures Contract
prices during a single trading day. The daily limit
establishes the maximum amount that the price of a
Futures Contract may vary either up or down from the
previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a
particular type of Futures Contract, no trades may be
made on that day at a price beyond that limit. The
daily limit governs only price movement during a
particular trading day and therefore does not limit
potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures Contract
prices have
<PAGE>
occasionally moved to the daily limit for
several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of
Futures positions and subjecting some Futures traders
to substantial losses.
There can be no assurance that a liquid market
will exist at a time when the Portfolios seek to close
out a Futures position. The Portfolios would continue
to be required to meet margin requirements until the
position is closed, possibly resulting in a decline in
the Portfolios' net asset value. In addition, many of
the contracts discussed above are relatively new
instruments without a significant trading history. As
a result, there can be no assurance that an active
secondary market will develop or continue to exist.
A public market exists in Futures Contracts
covering a number of indexes, including, but not
limited to, the Standard & Poor's 500 Index, the
Standard & Poor's 100 Index, the NASDAQ 100 Index, the
Value Line Composite Index and the New York Stock
Exchange Composite Index.
Options on Futures
The Portfolios may also purchase or write put and
call options on Futures Contracts and enter into
closing transactions with respect to such options to
terminate an existing position. A futures option gives
the holder the right, in return for the premium paid,
to assume a long position (call) or short position
(put) in a Futures Contract at a specified exercise
price prior to the expiration of the option. Upon
exercise of a call option, the holder acquires a long
position in the Futures Contract and the writer is
assigned the opposite short position. In the case of a
put option, the opposite is true. Prior to exercise or
expiration, a futures option may be closed out by an
offsetting purchase or sale of a futures option of the
same series.
The Portfolios may use options on Futures
Contracts in connection with hedging strategies.
Generally, these strategies would be employed under the
same market and market sector conditions in which the
Portfolios use put and call options on securities or
indexes. The purchase of put options on Futures
Contracts is analogous to the purchase of puts on
securities or indexes so as to hedge the Portfolios'
securities holdings against the risk of declining
market prices. The writing of a call option or the
purchasing of a put option on a Futures Contract
constitutes a partial hedge against declining prices of
the securities which are deliverable upon exercise of
the Futures Contract. If the futures price at
expiration of a written call option is below the
exercise price, the Portfolio will retain the full
amount of the option premium which provides a partial
hedge against any decline that may have occurred in the
Portfolio's holdings of securities. If the futures
price when the option is exercised is above the
exercise price, however, the Portfolio will incur a
loss, which may be offset, in whole or in part, by the
increase in the value of the securities held by the
Portfolio that were being hedged. Writing a put option
or purchasing a call option on a Futures Contract
serves as a partial hedge against an increase in the
value of the securities the Portfolio intends to
acquire.
As with investments in Futures Contracts, each
Portfolio is required to deposit and maintain margin
with respect to put and call options on Futures
Contracts written by it. Such margin deposits will
vary depending on the nature of the underlying Futures
Contract (and the related initial margin requirements),
the current market value of the option, and other
futures positions held by the Portfolio. The
Portfolios will set aside in a segregated account at
the Portfolios' custodian liquid assets, such as cash,
U.S. government securities or other high grade liquid
debt obligations equal in value to the amount due on
the underlying obligation. Such segregated assets will
be marked to market daily, and additional assets will
be placed in the segregated account whenever the total
value of the segregated account falls below the amount
due on the underlying obligation.
The risks associated with the use of options on
Futures Contracts include the risk that a Portfolio may
close out its position as a writer of an option only if
a liquid secondary market exists for such options,
which cannot be assured. The Portfolios' successful
use of options on Futures Contracts depends on ICAP's
ability to correctly predict the movement in prices of
Futures Contracts and the underlying instruments, which
may prove to be incorrect. In addition, there may be
imperfect correlation between the instruments being
hedged and the Futures Contract subject to the option.
For additional information, see "Futures Contracts."
<PAGE>
Federal Tax Treatment of Futures Contracts
For federal income tax purposes, each Portfolio is
required to recognize as income for each taxable year
its net unrealized gains and losses on Futures
Contracts as of the end of the year, as well as gains
and losses actually realized during the year. Except
for transactions in Futures Contracts that are
classified as part of a "mixed straddle" under Code
Section 1256, any gain or loss recognized with respect
to a Futures Contract is considered to be 60% long-term
capital gain or loss and 40% short-term capital gain or
loss, without regard to the holding period of the
Futures Contract. In the case of a Futures transaction
not classified as a "mixed straddle," the recognition
of losses may be deferred to a later taxable year.
Sales of Futures Contracts that are intended to
hedge against a change in the value of securities held
by a Portfolio may affect the holding period of such
securities and, consequently, the nature of the gain or
loss on such securities upon disposition.
Each Portfolio intends to operate as a "Regulated
Investment Company" under Subchapter M of the Code, and
therefore will not be liable for federal income taxes
to the extent earnings are timely distributed. In
addition, as a result of being a Regulated Investment
Company, net capital gain that the Portfolios
distribute to shareholders will retain their original
capital gain character in the shareholders' individual
tax returns.
In order for each Portfolio to continue to qualify
for federal income tax treatment as a Regulated
Investment Company, at least 90% of the gross income of
each Portfolio for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income
derived from loans of securities and gains from the
sale of securities, and other income (including gains
on options and futures contracts) derived with respect
to the Portfolio's business of investing in stock or
securities. In addition, gains realized on the sale or
other disposition of securities or Futures Contracts
held for less than three months must be limited to less
than 30% of the Portfolio's annual gross income. It is
anticipated that any net gain realized from the closing
out of Futures Contracts will be considered gain from
the sale of securities and therefore be qualifying
income for purposes of the 90% requirement. For
purposes of applying these tests, any increase in value
on a position that is part of a designated hedge will
be offset by any decrease in value (whether or not
realized) on any other position that is part of such
hedge. It is anticipated that unrealized gains on
Futures Contracts which have been open for less than
three months as of the end of a Portfolio's fiscal year
and which are recognized for tax purposes will not be
considered gains on securities held less than three
months for purposes of the 30% test.
The Portfolios will distribute to shareholders
annually any net capital gains which have been
recognized for federal income tax purposes (including
unrealized gains at the end of the Portfolio's fiscal
year) on Futures transactions. Such distributions will
be combined with distributions of capital gains
realized on the Portfolios' other investments and
shareholders will be advised of the nature of the
payments.
DIRECTORS AND OFFICERS
The directors and officers of the Company,
together with information as to their principal
business occupations during the last five years, and
other information, are shown below. Each director who
is deemed an "interested person," as defined in the
Investment Company Act of 1940 ("Investment Company
Act"), is indicated by an asterisk.
*Robert H. Lyon, President and a Director of the
Company.
Mr. Lyon joined ICAP in 1988 and has been the
President, Chief Investment Officer, and a
Director of ICAP since 1992. Since June 1996, Mr.
Lyon has also served as a member of the Board of
Trustees of the Nuveen Investment Trust, an open-
end management investment company which currently
offers three separate investment portfolios,
including the Nuveen Growth and Income Stock Fund,
<PAGE>
the Nuveen Balanced Stock and Bond Fund and the
Nuveen Balanced Municipal and Stock Fund. For the
seven years prior to joining ICAP, Mr. Lyon was an
Executive Vice President and Director of Research
with Fred Alger Management in New York. Mr. Lyon
graduated from Northwestern University with a B.A.
in economics and received his M.B.A. from the
Wharton School of Finance. Mr. Lyon has served as
President and a Director of the Company since its
inception in December 1994.
*Pamela H. Conroy, Vice President, Treasurer and a
Director of the Company.
Ms. Conroy has been the Senior Vice President of
ICAP since joining the Company in August of 1994.
Her responsibilities include accounting, systems,
communication and product development. Prior to
joining ICAP, Ms. Conroy worked at Northern Trust
where she served as a Vice President and worked in
a variety of capacities in the investments and
securities processing areas over a nine year
period. Ms. Conroy earned a B.A. from the
University of Illinois and an M.M. from the
Kellogg School of Management. Ms. Conroy has
served as Vice President, Treasurer and a Director
of the Company since its inception in December
1994.
*Donald D. Niemann, Vice President, Secretary and a
Director of the Company.
Mr. Niemann was an original co-founder of ICAP and
has served as an Executive Vice President and a
Director of ICAP since March 1993. His
responsibilities at ICAP include stock research,
selection and proxy analysis. Mr. Niemann
received a B.A. in history from Princeton
University and an M.B.A. from Harvard University.
He is a Chartered Financial Analyst (CFA). Mr.
Niemann has served as Vice President and Secretary
of the Company since its inception in December
1994, and as a Director of the Company since July
1995.
*Gary S. Maurer, a Director of the Company.
Mr. Maurer, who joined ICAP in 1972, has served as
Executive Vice President and a Director of ICAP
since March of 1993. His responsibilities include
oversight of quantitative research, as well as
performance measurement and analysis. In
addition, Mr. Maurer is the director of ICAP's
client service effort. Mr. Maurer received a B.A.
in economics from Cornell University and an M.B.A.
from the University of Chicago. Mr. Maurer has
served as a Director of the Company since its
inception in December 1994.
*Barbara A. Chiesa, a Director of the Company.
Ms. Chiesa, who joined ICAP in 1981, currently
serves as Vice President for Trading and is a
Director of ICAP. Previously, Ms. Chiesa served
as an investment officer and trader at Harris
Trust & Savings Bank. Prior to that, Ms. Chiesa
served as an equity trader at First Wisconsin
Trust. She studied accounting at the University
of Wisconsin. Ms. Chiesa has served as a Director
of the Company since its inception in December
1994.
Dr. James A. Gentry, a Director of the Company.
Dr. Gentry, who joined the faculty at the
University of Illinois in 1966, is a Professor of
Finance of the College of Commerce and Business
Administration at the University. Since joining
the University, Dr. Gentry has served as Associate
Dean of the College of Commerce and Business
Administration and has authored numerous articles
and chapters in books. Currently, he teaches
courses in advanced financial management and an
honors course that provides outstanding
undergraduate students with the opportunity to
interact with leading corporate executives. Dr.
Gentry received an A.B. from Indiana State
University, and an M.B.A. and D.B.A. from Indiana
University. Dr. Gentry has served as a Director
of the Company since its inception in December
1994.
<PAGE>
Harold W. Nations, a Director of the Company.
Mr. Nations is a partner with the law firm of
Shefsky, Froelich & Devine Ltd. ("SFD") in
Chicago, Illinois. He has been with SFD since
March, 1991. For the seven years prior thereto,
Mr. Nations was an associate with the firm of
Skadden, Arps, Slate, Meagher, & Flom. Mr.
Nations received a B.A. in chemistry from the
Georgia Institute of Technology and a J.D. from
Nortwestern University Law School. Mr. Nations
has served as a Director of the Company since its
inception in December 1994.
Joseph A. Hays, a Director of the Company.
Mr. Hays has been Vice President/Corporate
Relations for the Tribune Company, a diverse media
company, since April 1983. Mr. Hays received a
B.S. in journalism from Utah State University and
a Bachelor of Law from Indiana University. Mr.
Hays has served as a Director of the Company since
July 1995.
Except for Dr. James A. Gentry, Mr. Harold W.
Nations, and Mr. Joseph A. Hays, the address of all of
the above persons is Institutional Capital Corporation,
225 West Wacker Drive, Suite 2400, Chicago, Illinois
60606. Dr. Gentry's address is the University of
Illinois, 419 Commerce West, 1206 South 6th Street,
Champaign, Illinois 61820-6271. Mr. Nation's address
is 444 North Michigan Avenue, Chicago, Illinois 60611.
Mr. Hays' address is 1110 North Lake Shore Drive,
Apartment 24-South, Chicago, Illinois 60611.
As of April 1, 1996, officers and directors of the
Company beneficially owned 46,191 shares of common
stock or 1.5% of the Discretionary Equity Portfolio's
then outstanding shares and less than 1% of the Equity
Portfolio's then outstanding shares. Directors and
officers of the Company who are also officers,
directors, employees, or shareholders of ICAP do not
receive any remuneration from either of the Portfolios
for serving as directors or officers. All other
directors receive $2,000 worth of shares of common
stock in the Portfolio or Portfolios of their choice
for each board meeting such director attends.
PRINCIPAL SHAREHOLDERS
As of April 1, 1996, the following persons owned
of record or are known by the Company to own of record
or beneficially 5% or more of the outstanding shares of
each Portfolio:
<TABLE>
Name and Address Portfolio No. Shares Percentage
<S> <C> <C> <C>
Marshall & Ilsley Trust Discretionary 302,767 9.93%
Trustee FBO Rite-Hite Corp. Equity
Retirement Savings
1000 N. Water Street
Milwaukee, WI 53202
First Interstate Bank of Discretionary 208,901 6.85%
Califonia Equity
Trustee FBO Chapman
University
P.O. Box 9800
Calabasas, CA 91302
Post & Co. Discretionary 454,115 14.90%
c/o The Bank of New York Equity
P.O. Box 1066
Wall Street Station
New York, NY 10268
<PAGE>
Melrose Wakefield Discretionary 157,868 5.18%
Healthcare Corp. Equity
c/o Mark J. Blass
585 Lebanon Street
Melrose, MA 02176
Union Bank Trust Discretionary Equity 157,141 5.16%
Trustee FBO The Parker
Foundation
c/o Trust Security Service
Mutual Funds
P.O. Box 109
San Diego, CA 92112
Marshall & Ilsley Trust Discretionary 230,948 7.58%
Trustee FBO Oil Gear Co. Equity
1000 N. Water Street
Milwaukee, WI 53202
Bank of America Discretionary 199,244 6.54%
Trustee FBO Presbyterian Equity
Intercommunity Hospital
Defined Benefit Retirement
Plan
P.O. Box 3577
Los Angeles, CA 90051
Wendel & Co. Discretionary 206,712 6.78%
Trustee FBO Presbyterian Equity
Intercommunity Hospital
c/o The Bank of New York
P.O. Box 1066
Wall Street Station
New York, NY 10268
Mitra & Co. Discretionary 176,878 5.80%
1000 N. Water Street Equity
Attn: Mutual Funds
Milwaukee, WI 53202
Northern Trust Company Equity 217,974 8.50%
Cust. FBO McGraw Foundation
P.O. Box 92956
Chicago, IL 60675
Keystone District Council Equity 135,743 5.29%
of Carpenters Pension
Trust
524 South 22nd Street
Harrisburg, PA 17104
Chicago Symphony Orchestra Equity 171,763 6.70%
Pension Trust
c/o Tom Hallett
220 South Michigan Avenue
Chicago, IL 60604
<PAGE>
Wadsworth Atheneum Equity 195,323 7.62%
600 Main Street
Hartford, CT 06103
Wendel & Co. Equity 319,890 12.47%
c/o The Bank of New York
P.O. Box 1066
Wall Street Station
New York, NY 10268
Pennsylvania State Education Equity 413,356 16.12%
Association Pension Plan
400 North 3rd Street, Box 1724
Harrisburg, PA 17105
</TABLE>
As of April 1, 1996, no person owned a controlling
interest in the Company. Shareholders with a
controlling interest could effect the outcome of proxy
voting or the direction of management of the Company.
INVESTMENT ADVISER
Institutional Capital Corporation ("ICAP") is the
investment adviser to the Portfolios. Mr. Lyon
controls ICAP and is the President, Chief Investment
Officer, and a director of ICAP. Ms. Conroy is the
Senior Vice President of ICAP, and both Mr. Maurer and
Mr. Niemann are Executive Vice Presidents and Directors
of ICAP. Ms. Chiesa is a Vice President and Director
or ICAP. Mr. Lyon owns 51% of ICAP. A brief
description of the Portfolios' investment advisory
agreement is set forth in the Prospectus under
"MANAGEMENT."
The Portfolios' advisory agreement is dated
December 30, 1994 (the "Advisory Agreement"). The
Advisory Agreement has an initial term of two years and
thereafter is required to be approved annually by the
Board of Directors of the Company or by vote of a
majority of each of the Portfolio's outstanding voting
securities (as defined in the Investment Company Act).
Each annual renewal must also be approved by the vote
of a majority of the Company's directors who are not
parties to the Advisory Agreement or interested persons
of any such party, cast in person at a meeting called
for the purpose of voting on such approval. The
Advisory Agreement was approved by the vote of a
majority of the Company's directors who are not parties
to the Advisory Agreement or interested persons of any
such party on December 6, 1994 and by the initial
shareholders of each Portfolio on December 14, 1994.
The Advisory Agreement is terminable without penalty,
on 60 days' written notice by the Board of Directors of
the Company, by vote of a majority of each of the
Portfolio's outstanding voting securities, or by ICAP,
and will terminate automatically in the event of its
assignment.
Under the terms of the Advisory Agreement, ICAP
manages the Portfolios' investments, subject to the
supervision of the Company's Board of Directors. ICAP
is responsible for investment decisions and supplies
investment research and portfolio management. At its
expense, ICAP provides office space and all necessary
office facilities, equipment and personnel for
servicing the investments of the Portfolios.
As compensation for its services, each Portfolio
pays to ICAP a monthly advisory fee at the annual rate
of .80% of the average daily net asset value of the
respective Portfolio. See "DETERMINATION OF NET ASSET
VALUE" in the Prospectus. From time to time, ICAP may
voluntarily waive all or a portion of its management
fee for the Portfolios. In fact, ICAP has voluntarily
agreed to waive its management fee and/or reimburse
each Portfolio's operating expenses to the extent
necessary to ensure that neither Portfolio's total
operating expenses exceed .80% of the respective
Portfolio's average daily net assets. During the year
ended December 31, 1995, ICAP received $7,820 and
$36,319 from the Discretionary Equity and Equity
Portfolios, respectively, as
<PAGE>
compensation for its
services under the Advisory Agreement. The amounts
received by ICAP for such services would have been
$141,845 and $190,793 for the Discretionary Equity and
Equity Portfolios, respectively, had ICAP not waived
$134,025 and $154,474, respectively, of its fee during
the year ended December 31, 1995. The organizational
expenses of each Portfolio were advanced by ICAP and
will be reimbursed by the Portfolios over a period of
not more than 60 months. The organizational expenses
were approximately $36,288 for the Discretionary Equity
Portfolio and $36,287 for the Equity Portfolio.
The Advisory Agreement requires ICAP to reimburse
the Portfolios in the event that the expenses and
charges payable by the Portfolios in any fiscal year,
including the advisory fee but excluding taxes,
interest, brokerage commissions, and similar fees,
exceed those set forth in any statutory or regulatory
formula prescribed by any state in which shares of the
Portfolios are registered. Such excess is determined
by valuations made as of the close of each business day
of the year. The most restrictive percentage
limitation currently applicable to the Portfolios will
be 2 1/2% of each Portfolio's average net asset value
up to $30,000,000, 2% on the next $70,000,000 of each
Portfolio's average net asset value and 1 1/2% of each
Portfolio's average net asset value in excess of
$100,000,000. Reimbursement of expenses in excess of
the applicable limitation will be made on a monthly
basis and will be paid to the Portfolios by reduction
of ICAP's fee, subject to later adjustment, month by
month, for the remainder of the Portfolios' fiscal
year. ICAP may from time to time voluntarily absorb
expenses for the Portfolios in addition to the
reimbursement of expenses in excess of applicable
limitations.
PORTFOLIO TRANSACTIONS AND BROKERAGE
ICAP is responsible for decisions to buy and sell
securities for the Portfolios and for the placement of
the Portfolios' securities business, the negotiation of
the commissions to be paid on such transactions and the
allocation of portfolio brokerage and principal
business. It is the policy of ICAP to seek the best
execution at the best security price available with
respect to each transaction, in light of the overall
quality of brokerage and research services provided to
ICAP or the Portfolios. The best price to the
Portfolios means the best net price without regard to
the mix between purchase or sale price and commission,
if any. Purchases may be made from underwriters,
dealers, and, on occasion, the issuers. Commissions
will be paid on the Portfolios' futures and options
transactions, if any. The purchase price of portfolio
securities purchased from an underwriter or dealer may
include underwriting commissions and dealer spreads.
The Portfolios may pay mark-ups on principal
transactions. In selecting broker-dealers and in
negotiating commissions, ICAP considers the firm's
reliability, the quality of its execution services on a
continuing basis and its financial condition.
Brokerage will not be allocated based on the sale of a
Portfolio's shares.
The aggregate amount of brokerage commissions paid
by the Discretionary Equity and Equity Portfolios for
the year ended December 31, 1995 was $44,543 and
$51,101, respectively.
Section 28(e) of the Securities Exchange Act of
1934 ("Section 28(e)") permits an investment adviser,
under certain circumstances, to cause an account to pay
a broker or dealer who supplies brokerage and research
services a commission for effecting a transaction in
excess of the amount of commission another broker or
dealer would have charged for effecting the
transaction. Brokerage and research services include
(a) furnishing advice as to the value of securities,
the advisability of investing, purchasing or selling
securities, and the availability of securities or
purchasers or sellers of securities; (b) furnishing
analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio
strategy, and the performance of accounts; and (c)
effecting securities transactions and performing
functions incidental thereto (such as clearance,
settlement, and custody).
In selecting brokers, ICAP considers investment
and market information and other research, such as
economic, securities and performance measurement
research, provided by such brokers, and the quality and
reliability of brokerage services, including execution
capability, performance, and financial responsibility.
Accordingly, the commissions charged by any such broker
may be greater than the amount another firm might
charge if ICAP determines in good faith that the amount
of such commissions is reasonable in relation to the
value of the research information and brokerage
services provided by such broker to the Portfolios.
ICAP believes
<PAGE>
that the research information received in
this manner provides the Portfolios with benefits by
supplementing the research otherwise available to the
Portfolios. The Advisory Agreement provides that such
higher commissions will not be paid by the Portfolios
unless (a) ICAP determines in good faith that the
amount is reasonable in relation to the services in
terms of the particular transaction or in terms of
ICAP's overall responsibilities with respect to the
accounts as to which it exercises investment
discretion; (b) such payment is made in compliance with
the provisions of Section 28(e), other applicable state
and federal laws, and the Advisory Agreement; and (c)
in the opinion of ICAP, the total commissions paid by
the Portfolios will be reasonable in relation to the
benefits to the Portfolios over the long term. The
investment advisory fees paid by the Portfolios under
the Advisory Agreement are not reduced as a result of
ICAP's receipt of research services.
ICAP places portfolio transactions for other
advisory accounts managed by ICAP. Research services
furnished by firms through which the Portfolios effect
their securities transactions may be used by ICAP in
servicing all of its accounts; not all of such services
may be used by ICAP in connection with the Portfolios.
ICAP believes it is not possible to measure separately
the benefits from research services to each of the
accounts (including the Portfolios) managed by it.
Because the volume and nature of the trading activities
of the accounts are not uniform, the amount of
commissions in excess of those charged by another
broker paid by each account for brokerage and research
services will vary. However, ICAP believes such costs
to the Portfolios will not be disproportionate to the
benefits received by the Portfolios on a continuing
basis. ICAP seeks to allocate portfolio transactions
equitably whenever concurrent decisions are made to
purchase or sell securities by the Portfolios and
another advisory account. In some cases, this
procedure could have an adverse effect on the price or
the amount of securities available to the Portfolios.
In making such allocations between the Portfolio and
other advisory accounts, the main factors considered by
ICAP are the respective investment objectives, the
relative size of portfolio holdings of the same or
comparable securities, the availability of cash for
investment and the size of investment commitments
generally held.
The Discretionary Equity and Equity Portfolios'
portfolio turnover rates for the year ended December
31, 1995 were 102% and 105%, respectively. Each
Portfolio anticipates that its portfolio turnover rate
will not exceed 150%, and is expected to be between
100% and 125%. The annual portfolio turnover rate
indicates changes in each Portfolio's securities
holdings; for instance, a rate of 100% would result if
all the securities in a portfolio (excluding securities
whose maturities at acquisition were one year or less)
at the beginning of an annual period had been replaced
by the end of the period. The turnover rate may vary
from year to year, as well as within a year, and may be
affected by portfolio sales necessary to meet cash
requirements for redemptions of the Portfolios' shares.
CUSTODIAN
As custodian of the Portfolios' assets, United
Missouri Bank, n.a., 928 Grand Avenue, Kansas City,
Missouri 64141, has custody of all securities and cash
of each Portfolio, delivers and receives payment for
securities sold, receives and pays for securities
purchased, collects income from investments and
performs other duties, all as directed by the officers
of the Company.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
Sunstone Financial Group, Inc. ("Sunstone") acts
as transfer agent and dividend-disbursing agent for the
Portfolios. Sunstone is compensated based on an annual
fee per open account of $12.00 (subject to a minimum of
$650 per month from November 1995 through April 1996,
$750 per month from May 1996 through October 1996, and
$14,000 per year beginning November 1996) plus out-of-
pocket expenses such as postage and printing expenses
in connection with shareholder communications.
Sunstone also receives an annual fee per closed account
of $2.50.
<PAGE>
TAXES
Each Portfolio will be treated as a separate
entity for Federal income tax purposes since the Tax
Reform Act of 1986 requires that all portfolios of a
series fund be treated as separate taxpayers. As
indicated under "DIVIDENDS, CAPITAL GAIN DISTRIBUTIONS,
AND TAX STATUS" in the Prospectus, each Portfolio
intends to continue to qualify annually as a "regulated
investment company" under the Code. This qualification
does not involve government supervision of the
Portfolios' management practices or policies.
A dividend or capital gain distribution received
shortly after the purchase of shares reduces the net
asset value of shares by the amount of the dividend or
distribution and, although in effect a return of
capital, will be subject to income taxes. Net gains on
sales of securities when realized and distributed are
taxable as capital gains. If the net asset value of
shares were reduced below a shareholder's cost by
distribution of gains realized on sales of securities,
such distribution would be a return of investment
although taxable as stated above.
DETERMINATION OF NET ASSET VALUE
As set forth in the Prospectus under the same
caption, the net asset value of each of the Portfolios
will be determined as of the close of trading on each
day the New York Stock Exchange is open for trading.
The Portfolios do not determine net asset value on days
the New York Stock Exchange is closed and at other
times described in the Prospectus. The New York Stock
Exchange is closed on New Year's Day, President's Day,
Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day. Additionally, if
any of the aforementioned holidays falls on a Saturday,
the New York Stock Exchange will not be open for
trading on the preceding Friday and when such holiday
falls on a Sunday, the New York Stock Exchange will not
be open for trading on the succeeding Monday, unless
unusual business conditions exist, such as the ending
of a monthly or the yearly accounting period.
SHAREHOLDER MEETINGS
Maryland law permits registered investment
companies, such as the Company, to operate without an
annual meeting of shareholders under specified
circumstances if an annual meeting is not required by
the Investment Company Act. The Company has adopted
the appropriate provisions in its Bylaws and may, at
its discretion, not hold an annual meeting in any year
in which the election of directors is not required to
be acted on by shareholders under the Investment
Company Act.
The Company's Bylaws also contain procedures for
the removal of directors by shareholders of the
Company. At any meeting of shareholders, duly called
and at which a quorum is present, the shareholders may,
by the affirmative vote of the holders of a majority of
the votes entitled to be cast thereon, remove any
director or directors from office and may elect a
successor or successors to fill any resulting vacancies
for the unexpired terms of removed directors.
Upon the written request of the holders of shares
entitled to not less than ten percent (10%) of all the
votes entitled to be cast at such meeting, the
Secretary of the Company shall promptly call a special
meeting of shareholders for the purpose of voting upon
the question of removal of any director. Whenever ten
or more shareholders of record who have been such for
at least six months preceding the date of application,
and who hold in the aggregate either shares having a
net asset value of at least $25,000 or at least one
percent (1%) of the total outstanding shares, whichever
is less, shall apply to the Company's Secretary in
writing, stating that they wish to communicate with
other shareholders with a view to obtaining signatures
to a request for a meeting as described above and
accompanied by a form of communication and request
which they wish to transmit, the Secretary shall within
five business days after such application either: (1)
afford to such applicants access to a list of the names
and addresses of all shareholders as recorded on the
books of the Company; or (2) inform such applicants as
to the
<PAGE>
approximate number of shareholders of record and
the approximate cost of mailing to them the proposed
communication and form of request.
If the Secretary elects to follow the course
specified in clause (2) of the last sentence of the
preceding paragraph, the Secretary, upon the written
request of such applicants, accompanied by a tender of
the material to be mailed and of the reasonable
expenses of mailing, shall, with reasonable promptness,
mail such material to all shareholders of record at
their addresses as recorded on the books unless within
five business days after such tender the Secretary
shall mail to such applicants and file with the SEC,
together with a copy of the material to be mailed, a
written statement signed by at least a majority of the
Board of Directors to the effect that, in their
opinion, either such material contains untrue
statements of fact or omits to state facts necessary to
make the statements contained therein not misleading,
or would be in violation of applicable law, and
specifying the basis of such opinion.
After opportunity for hearing upon the objections
specified in the written statement so filed, the SEC
may, and if demanded by the Board of Directors or by
such applicants shall, enter an order either sustaining
one or more of such objections or refusing to sustain
any of them. If the SEC shall enter an order refusing
to sustain any of such objections, or if, after the
entry of an order sustaining one or more of such
objections, the SEC shall find, after notice and
opportunity for hearing, that all objections so
sustained have been met, and shall enter an order so
declaring, the Secretary shall mail copies of such
material to all shareholders with reasonable promptness
after the entry of such order and the renewal of such
tender.
PERFORMANCE INFORMATION
As described in the "COMPARISON OF INVESTMENT
RESULTS" section of the Portfolios' Prospectus, the
Portfolios' historical performance or return may be
shown in the form of various performance figures. The
Portfolios' performance figures are based upon
historical results and are not necessarily
representative of future performance. Factors
affecting the Portfolios' performance include general
market conditions, operating expenses and investment
management. Any additional fees charged by a dealer or
other financial services firm would reduce the returns
described in this section.
Total Return
The average annual total return of each Portfolio
is computed by finding the average annual compounded
rates of return over the periods that would equate the
initial amount invested to the ending redeemable value,
according to the following formula:
n
P(1+T) = ERV
P = a hypothetical initial payment of
$1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a
hypothetical $1,000 payment made at
the beginning of the stated periods at
the end of the stated periods.
Performance for a specific period is calculated by
first taking an investment (assumed to be $1,000)
("initial investment") in a Portfolio's shares on the
first day of the period and computing the "ending
value" of that investment at the end of the period.
The total return percentage is then determined by
subtracting the initial investment from the ending
value and dividing the remainder by the initial
investment and expressing the result as a percentage.
The calculation assumes that all income and capital
gains dividends paid by a Portfolio have been
reinvested at the net asset value of the Portfolio on
the reinvestment dates during the period. Total return
may also be shown as the increased dollar value of the
hypothetical investment over the period.
<PAGE>
Cumulative total return represents the simple
change in value of an investment over a stated period
and may be quoted as a percentage or as a dollar
amount. Total returns may be broken down into their
components of income and capital (including capital
gains and changes in share price) in order to
illustrate the relationship between these factors and
their contributions to total return.
The total return for the Discretionary Equity
Portfolio and Equity Portfolio for the year ended
December 31, 1995 is 35.21% and 38.85%, respectively.
Volatility
Occasionally statistics may be used to specify a
Portfolio's volatility or risk. Measures of volatility
or risk are generally used to compare a Portfolio's net
asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the
volatility of a fund relative to the total market as
represented by the Standard & Poor's 500 Stock Index.
A beta of more than 1.00 indicates volatility greater
than the market, and a beta of less than 1.00 indicates
volatility less than the market. Another measure of
volatility or risk is standard deviation. Standard
deviation is used to measure variability of net asset
value or total return around an average, over a
specified period of time. The premise is that greater
volatility connotes greater risk undertaken in
achieving performance.
Comparisons
From time to time, in marketing and other
Portfolio literature, the Portfolios' performance may
be compared to the performance of other mutual funds in
general or to the performance of particular types of
mutual funds with similar investment goals, as tracked
by independent organizations. Among these
organizations, Lipper Analytical Services, Inc.
("Lipper"), a widely used independent research firm
which ranks mutual funds by overall performance,
investment objectives, and assets, may be cited.
Lipper performance figures are based on changes in net
asset value, with all income and capital gains
dividends reinvested. Such calculations do not include
the effect of any sales charges imposed by other funds.
The Portfolios will be compared to Lipper's appropriate
fund category, that is, by fund objective and portfolio
holdings.
The Portfolios' performance may also be compared
to the performance of other mutual funds by
Morningstar, Inc., which ranks funds on the basis of
historical risk and total return. Morningstar's
rankings range from five stars (highest) to one star
(lowest) and represent Morningstar's assessment of the
historical risk level and total return of a fund as a
weighted average for 3, 5, and 10 year periods.
Rankings are not absolute or necessarily predictive of
future performance.
Evaluations of Portfolio performance made by
independent sources may also be used in advertisements
concerning the Portfolios, including reprints of or
selections from, editorials or articles about the
Portfolios. Sources for Portfolio performance and
articles about the Portfolios may include publications
such as Money, Forbes, Kiplinger's, Financial World,
Business Week, U.S. News and World Report, the Wall
Street Journal, Barron's and a variety of investment
newsletters.
The Portfolios may compare their performance to a
wide variety of indices and measures of inflation
including the Standard & Poor's Index of 500 Stocks and
the NASDAQ Over-the-Counter Composite Index. There are
differences and similarities between the investments
that the Portfolios may purchase for their respective
portfolios and the investments measured by these
indices.
Investors may want to compare the Portfolios'
performance to that of certificates of deposit offered
by banks and other depository institutions.
Certificates of deposit may offer fixed or variable
interest rates and principal is guaranteed and may be
insured. Withdrawal of the deposits prior to maturity
normally will be subject to a penalty. Rates offered
by banks and other depository institutions are subject
to change at any time specified by the issuing
institution. Investors may also want to compare
performance of the Portfolios to that of money market
funds. Money market fund yields will fluctuate and
shares are not insured, but share values usually remain
stable.
<PAGE>
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin
Avenue, Milwaukee, Wisconsin 53202 have been selected
as the independent accountants for the Portfolios.
FINANCIAL STATEMENTS
The following audited financial statements of each
of the Portfolios for the year ended December 31, 1995
are contained herein:
(a) Schedules of Investments.
(b) Statements of Assets and Liabilities.
(c) Statements of Operations.
(d) Statements of Changes in Net Assets.
(e) Financial Highlights.
(f) Notes to Financial Statements.
(g) Report of Independent Accountants.
<PAGE>
D i s c r e t i o n a r y E q u i t y P o r t f o l i o
S c h e d u l e o f I n v e s t m e n t s
December 31, 1995
_______________________________________________________
Number
of Shares Value
_______________________________________________________
COMMON STOCKS 89.38%
Aerospace 1.70%
6,885 McDonnell Douglas Corp.$ 633,420
Autos & Parts 0.57%
8,875 ITT Industries, Inc. 213,000
Banks & Finance 7.16%
17,585 BankAmerica Corp. 1,138,629
14,680 Citicorp 987,230
15,150 KeyCorp 549,187
=========
2,675,046
Beverages - Soft Drinks 1.73%
11,600 PepsiCo, Inc. 648,150
Chemicals 4.52%
8,615 Dow Chemical Co. 606,281
15,500 Du Pont (E.I.) de Nemours 1,083,063
=========
1,689,344
Communication Equipment 1.27%
8,300 Motorola, Inc. 473,100
Drug & Medical Supplies 10.22%
22,600 Abbott Laboratories 943,550
6,970 American Home Products Corp. 676,090
25,430 Ciba-Geigy AG-ADR 1,121,463
7,930 Hoechst AG-ADR 1,077,608
=========
3,818,711
Electric Equipment 0.52%
7,000 American Standard Companies* 196,000
Electronics 1.72%
12,400 Texas Instruments 641,700
Entertainment 4.85%
11,100 Circus Circus Enterprises, 309,412
Inc.*
9,875 ITT Corp.* 523,375
25,900 Time Warner, Inc. 980,963
=======
1,813,750
See notes to financial statements.
<PAGE>
D i s c r e t i o n a r y E q u i t y P o r t f o l i o
S c h e d u l e o f I n v e s t m e n t s (cont'd.)
December 31, 1995
_______________________________________________________
Number
of Shares Value
_______________________________________________________
Foods 3.40%
9,030 Unilever N.V. $1,270,973
Hospital Management 1.04%
18,700 Tenet Healthcare Corp.* 388,025
Insurance 3.38%
20,260 Allstate Corp. 833,192
8,875 ITT Hartford Group* 429,328
=========
1,262,520
Leisure 1.76%
13,760 Carnival Cruise Lines, Inc. 335,400
10,475 Mattel, Inc. 322,106
=======
657,506
Machinery 1.53%
16,200 Deere & Co. 571,050
Media 2.69%
8,150 Capital Cities/ABC, Inc. 1,005,506
Miscellaneous 3.13%
32,550 Phillips Electronics N.V. 1,167,731
Office Equipment 4.93%
11,225 Compaq Computer Corp.* 538,800
10,000 International Business
Machines Corp. 917,500
14,000 Silicon Graphics, Inc.* 385,000
=========
1,841,300
Oils 7.33%
12,125 Amoco Corp. 871,484
8,810 Atlantic Richfield Co. 975,707
7,950 Mobil Corp. 890,400
========
2,737,591
Other Financial 3.11%
18,485 Travelers Group, Inc. 1,162,244
See notes to financial statements.
<PAGE>
D i s c r e t i o n a r y E q u i t y P o r t f o l i o
S c h e d u l e o f I n v e s t m e n t s (cont'd.)
December 31, 1995
_______________________________________________________
Number
of Shares Value
_______________________________________________________
Paper 4.82%
27,270 International Paper $1,032,851
17,800 Weyerhaeuser Co. 769,850
=========
1,802,701
Pollution Control 3.77%
16,085 Browning Ferris Industries 474,507
31,280 WMX Technologies, Inc. 934,490
=========
1,408,997
Printing & Publishing 0.07%
400 Dun and Bradstreet 25,900
Railroads 6.66%
12,250 Burlington Northern Santa 955,500
Fe Corp.
33,340 Canadian Pacific 604,288
14,050 Union Pacific Corp. 927,300
=========
2,487,088
Retail Stores 1.53%
20,775 Federated Department
Stores, Inc.* 571,313
Specialty Stores 0.36%
4,900 Circuit City Stores, Inc. 135,363
Tobacco 2.87%
11,850 Philip Morris Companies, Inc. 1,072,425
Utilities 2.74%
10,160 AT&T Corp. 657,860
13,300 Tele Danmark A/S-ADR 367,413
=========
1,025,273
Total Common Stocks
(cost $31,120,656) 33,395,727
PREFERRED STOCKS 2.68%
Entertainment 2.68%
51,940 News Corp. Ltd. Preferred ADR 999,845
Total Preferred Stocks
(cost $997,759) 999,845
See notes to financial statements.
<PAGE>
D i s c r e t i o n a r y E q u i t y P o r t f o l i o
S c h e d u l e of I n v e s t m e n t s (c o n t' d.)
_______________________________________________________
Principal
Amount Value
_______________________________________________________
SHORT-TERM INVESTMENTS 9.95%
Commercial Paper 4.00%
$1,500,000 IBM Credit Corp., 5.69%, 1/24/96 $1,494,644
Money Market 5.95%
2,221,822 United Missouri Bank
Money Market Fiduciary 2,221,822
Total Short-term Investments
(cost $3,716,466) 3,716,466
Total Investments 102.01%
(cost $35,834,881) 38,112,038
Liabilities, less Cash
and Other Assets (2.01)% (749,605)
==========
NET ASSETS 100.00% $37,362,433
See notes to financial statements.
*Non-income producing
<PAGE>
E q u i t y P o r t f o l i o
S c h e d u l e o f I n v e s t m e n t s
December 31, 1995
_______________________________________________________
Number
of Shares Value
_______________________________________________________
COMMON STOCKS 94.75%
Aerospace 2.10%
10,695 McDonnell Douglas Corp.$ 983,940
Autos & Parts 0.69%
13,450 ITT Industries, Inc. 322,800
Banks & Finance 8.62%
26,550 BankAmerica Corp. 1,719,113
22,640 Citicorp 1,522,540
21,845 KeyCorp 791,881
=========
4,033,534
Beverages - Soft Drinks 2.07%
17,330 PepsiCo, Inc. 968,314
Chemicals 4.89%
9,550 Dow Chemical Co. 672,081
23,090 Du Pont (E.I.) de Nemours 1,613,414
& Co.
=========
2,285,495
Communication Equipment 1.44%
11,775 Motorola, Inc. 671,175
Drug & Medical Supplies 10.90%
23,800 Abbott Laboratories 993,650
10,920 American Home Products Corp. 1,059,240
32,395 Ciba-Geigy AG-ADR 1,428,620
11,920 Hoechst AG-ADR 1,619,809
=========
5,101,319
Electronics 1.88%
16,970 Texas Instruments 878,197
Entertainment 5.35%
14,930 Circus Circus Enterprises, 416,174
Inc.*
13,450 ITT Corp.* 712,850
36,250 Time Warner, Inc. 1,372,969
=========
2,501,993
Foods 3.37%
11,215 Unilever N.V. 1,578,511
See notes to financial statements.
<PAGE>
E q u i t y P o r t f o l i o
S c h e d u l e o f I n v e s t m e n t s
_______________________________________________________
Number
of Shares Value
_______________________________________________________
Hospital Management 1.25%
28,150 Tenet Healthcare Corp.* $ 584,112
Insurance 4.05%
30,295 Allstate Corp. 1,245,882
13,450 ITT Hartford Group* 650,644
=========
1,896,526
Leisure 2.06%
19,630 Carnival Cruise Lines, Inc. 478,481
15,745 Mattel, Inc. 484,159
=======
962,640
Machinery 1.80%
23,890 Deere & Co. 842,122
Media 3.24%
12,275 Capital Cities/ABC, Inc. 1,514,428
Miscellaneous 3.61%
47,130 Philips Electronics N.V. 1,690,789
Office Equipment 4.63%
14,670 Compaq Computer Corp.* 704,160
14,820 International Business
Machines Corp. 1,359,735
3,700 Silicon Graphics, Inc.* 101,750
=========
2,165,645
Oils 6.61%
11,185 Amoco Corp. 803,922
8,375 Atlantic Richfield Co. 927,531
12,170 Mobil Corp. 1,363,040
=========
3,094,493
Other Financial 3.78%
28,100 Travelers Group, Inc. 1,766,788
Paper 5.14%
35,010 International Paper 1,326,004
24,990 Weyerhaeuser Co. 1,080,818
=========
2,406,822
See notes to financial statements.
<PAGE>
E q u i t y P o r t f o l i o
S c h e d u l e of I v e s t m e n t s (cont'd.)
December 31, 1995
_______________________________________________________
Number
of Shares Value
_______________________________________________________
Pollution Control 4.20%
21,350 Browning Ferris Industries $ 629,825
44,670 WMX Technologies, Inc. 1,334,516
=========
1,964,341
Printing & Publishing 0.08%
600 Dun and Bradstreet 38,850
Railroads 7.03%
14,382 Burlington Northern Santa
Fe Corp. 1,121,796
46,100 Canadian Pacific 835,562
20,190 Union Pacific Corp. 1,332,540
=========
3,289,898
Retail Stores 1.68%
28,510 Federated Department
Stores, Inc.* 784,025
Specialty Stores 0.45%
7,700 Circuit City Stores, Inc. 212,712
Tobacco 2.95%
15,275 Philip Morris Companies, 1,382,388
Inc.
Utilities 0.88%
14,900 Tele Danmark A/S-ADR 411,612
Total Common Stocks
(cost $40,740,181) 44,333,469
PREFERRED STOCKS 3.46%
Entertainment 3.08%
74,880 News Corp. Ltd. Preferred 1,441,440
ADR
Tobacco 0.38%
27,600 RJR Nabisco Holdings Corp.
Series C Pfd. 175,950
Total Preferred Stocks
(cost $1,630,285) 1,617,390
See notes to financial statements.
<PAGE>
E q u i t y P o r t f o l i o
S c h e d u l e of I n v e s t m e n t s (c o n t' d)
______________________________________________________
Principal
Amount Value
_______________________________________________________
SHORT-TERM INVESTMENTS 2.19%
Commercial Paper 0.85%
$400,000 IBM Credit Corp., 5.69%,
1/24/96$ 398,572
Money Market 1.34%
624,726 United Missouri Bank
Money Market Fiduciary 624,726
Total Short-term Investments
(cost $1,023,298) 1,023,298
Total Investments 100.40%
(cost $43,393,764) 46,974,157
Liabilities, less Cash
and Other Assets (0.40)% (186,539)
NET ASSETS 100.00% $46,787,618
See notes to financial statements.
*Non-income producing
<PAGE>
I C A P F u n d s , I n c .
S t a t e m e n t s o f A s s e t s a n d L i a b i l i t i e s
December 31, 1995
_________________________________________________________________
Discretionary
Equity Equity
Portfolio Portfolio
_________________________________________________________________
ASSETS:
Investments, at fair value
(cost $35,834,881 and
$43,393,764, respectively) $38,112,038 $46,974,157
Cash 145,616 ---
Interest and dividends receivable 70,763 75,811
Deferred organization costs 29,033 29,032
Prepaid blue sky fees 13,218 13,217
Other assets 8,417 151
========== =========
Total Assets 38,379,085 47,092,368
LIABILITIES:
Payable for securities purchased 934,053 188,479
Payable to adviser 43,111 43,110
Accrued expenses 29,454 32,560
Accrued investment advisory fee 7,820 36,319
Other liabilities 2,214 4,282
Total Liabilities 1,016,652 304,750
NET ASSETS $37,362,433 $46,787,618
NET ASSETS CONSIST OF:
Capital stock $ 14,696 $ 17,975
Paid-in capital in excess of par 35,082,794 43,203,484
Undistributed net investment income 6,201 51
Distributions in excess of net realized
gain on investments (18,415) (14,285)
Net unrealized appreciation on
investments 2,277,157 3,580,393
Net Assets $37,362,433 $46,787,618
CAPITAL STOCK, $0.01 PAR VALUE
Authorized 100,000,000 100,000,000
Issued and outstanding 1,469,574 1,797,493
NET ASSET VALUE, REDEMPTION PRICE AND
OFFERING PRICE PER SHARE $25.42 $26.03
See notes to financial statements.
<PAGE>
I C A P F u n d s , I n c .
S t a t e m e n t s o f O p e r a t i o n s
For the Year Ended December 31, 1995
______________________________________________________________
Discretionary
Equity Equity
Portfolio Portfolio
______________________________________________________________
INVESTMENT INCOME:
Dividends $344,203(1) $503,950(2)
Interest 100,666 43,185
======== =======
444,869 547,135
EXPENSES:
Investment advisory fees 141,845 190,793
Fund administration and
accounting fees 57,537 71,286
Federal and state registration fees 15,724 19,007
Shareholder servicing 11,494 11,549
Legal fees 11,478 11,478
Custody fees 8,064 10,272
Amortization of organization costs 7,255 7,255
Directors' fees 7,225 7,225
Reports to shareholders 6,569 6,591
Audit fees 6,389 6,389
Other 2,290 3,422
Total expenses before waiver 275,870 345,267
Waiver of expenses by adviser (134,025) (154,474)
Net expenses 141,845 190,793
NET INVESTMENT INCOME 303,024 356,342
REALIZED AND UNREALIZED GAIN:
Net realized gain on investments 1,751,535 2,362,765
Change in unrealized appreciation
on investments 2,277,157 3,580,393
Net gain on investments 4,028,692 5,943,158
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS $4,331,716 $6,299,500
(1) Net of $4,666 in foreign withholding taxes.
(2) Net of $4,846 in foreign withholding taxes.
See notes to financial statements.
<PAGE>
I C A P F u n d s , I n c .
S t a t e m e n t s o f C h a n g e s i n N e t A s s e t s
For the Year Ended December 31, 1995
___________________________________________________________________
Discretionary
Equity Equity
Portfolio Portfolio
___________________________________________________________________
OPERATIONS:
Net investment income $ 303,024 $ 356,342
Net realized gain on investments 1,751,535 2,362,765
Change in unrealized appreciation
on investments 2,277,157 3,580,393
Net increase in net assets
resulting from operations 4,331,716 6,299,500
DISTRIBUTIONS PAID FROM:
Net investment income (300,886) (356,342)
In excess of book net investment income --- (4,012)
Net realized gain on investments (1,751,535) (2,362,765)
In excess of book net realized gain
on investments (18,415) (14,285)
Net decrease in net assets resulting from
distributions paid (2,070,836) (2,737,404)
CAPITAL SHARE TRANSACTIONS:
Shares sold 33,190,611 42,888,716
Shares issued to holders in
reinvestment of distributions 1,982,225 2,429,267
Shares redeemed (170,283) (2,093,461)
Net increase in net assets
resulting from capital share
transactions 35,002,553 43,224,522
TOTAL INCREASE IN NET ASSETS 37,263,433 46,786,618
NET ASSETS:
Beginning of year 99,000 1,000
End of year $37,362,433 $46,787,618
See notes to financial statements.
<PAGE>
I C A P F u n d s , I n c .
F i n a n c i a l H i g h l i g h t s
For the Year Ended December 31, 1995
_______________________________________________________
Discretionary
Equity Equity
Portfolio(1) Portfolio(1)
(For a share outstanding throughout the year)
_______________________________________________________
Net asset value, beginning of year $20.00 $20.00
Income from investment operations:
Net investment income 0.31 0.28
Net realized and unrealized gain
on investments 6.70 7.45
Total income from investment operations 7.01 7.73
Less distributions:
From net investment income (0.31) (0.28)
From net realized gain on investments (1.27) (1.41)
In excess of book net realized gain on
investments (0.01) (0.01)
Total distributions (1.59) (1.70)
Net asset value, end of year $25.42 $26.03
Total return 35.21% 38.85%
Supplemental data and ratios:
Net assets, end of year (in thousands) $37,362 $46,788
Ratio of expenses to average net assets(2) 0.80% 0.80%
Ratio of net investment income to average
net assets(2) 1.71% 1.49%
Portfolio turnover rate 102% 105%
(1) Commencement of operations January 1, 1995.
(2) Net of waivers by ICAP. Without waivers of
expenses, the ratio of expenses to average net
assets would have been 1.56% and 1.44%, and the
ratio of net investment income to average net assets
would have been 0.95% and 0.85% for the
Discretionary Equity and Equity Portfolios,
respectively.
See notes to financial statements.
<PAGE>
N o t e s t o F i n a n c i a l S t a t e m e n t s
D e c e m b e r 3 1, 1 9 9 5
1. Organization
ICAP Funds, Inc. ("ICAP") was incorporated on November
1, 1994 under the laws of the State of Maryland and is
registered as an open-end management investment company
under the Investment Company Act of 1940. Both the
Discretionary Equity and Equity Portfolios (the
"Portfolios") are diversified portfolios of ICAP. The
Discretionary Equity and Equity Portfolios issued and
sold 4,950 and 50 shares of common stock, respectively
("initial shares") at $20 per share to Institutional
Capital Corporation. Institutional Capital Corporation
is the investment adviser (the "Adviser") to the
Portfolios. Both Portfolios commenced operations on
January 1, 1995. The costs incurred in connection with
the organization, initial registration and public
offering of shares of the Portfolios aggregated $36,288
and $36,287 for the Discretionary Equity and Equity
Portfolios, respectively. These costs are being
amortized over the period of benefit, but not to exceed
60 months from each Portfolio's commencement of
operations. The proceeds of any redemption of the
initial shares by the original stockholder or any
transferee will be reduced by a pro rata portion of any
then unamortized organization expenses in the same
proportion as the number of initial shares being
redeemed bears to the number of initial shares
outstanding at the time of such redemption.
2. Significant Accounting Policies
The following is a summary of significant accounting
policies consistently followed by ICAP in the
preparation of its financial statements. These
policies are in conformity with generally accepted
accounting principles.
a) Investment Valuation - Common stocks and other
equity-type securities are valued at the last sales
price on the national securities exchange or Nasdaq on
which such securities are primarily traded; however,
securities traded on a national securities exchange or
Nasdaq for which there were no transactions on a given
day or securities not listed on an exchange or Nasdaq
are valued at the most recent bid prices. Debt
securities are valued by a pricing service that
utilizes electronic data processing techniques to
determine values for normal institutional-sized trading
units of debt securities without regard to the
existence of sale or bid prices when such values are
believed to more accurately reflect the fair value of
such securities; otherwise, actual sale or bid prices
are used. Any securities or other assets for which
market quotations are not readily available are valued
at fair value as determined in good faith by the Board
of Directors. Debt securities having remaining
maturities of 60 days or less when purchased are valued
by the amortized cost method when the Board of
Directors determines that the fair value of such
securities is their amortized cost. Under this method
of valuation, a security is initially valued at its
acquisition cost, and thereafter, amortization of any
discount or premium is recognized daily.
b) Federal Income Taxes - No provision for federal
income taxes has been made since the Portfolios have
complied to date with the provisions of the Internal
Revenue Code available to regulated investment
companies and intend to continue to so comply in future
years.
c) Distributions to Shareholders - Dividends from net
investment income are declared and paid quarterly.
Dividends differ from book net investment income due to
the nondeductible tax treatment of items such as
organization costs. Distributions of net realized
capital gains, if any, will be declared at least
annually. Distributions to shareholders are recorded
on the ex-dividend date. The character of
distributions made during the year from net investment
income or net realized gain may differ from the
characterization for federal income tax purposes due to
differences in the recognition of income, expense and
gain items for financial statement and tax purposes.
Where appropriate, reclassifications between net asset
accounts are made for such differences that are
permanent in nature. Accordingly, at December 31,
1995, reclassifications were recorded from
undistributed net investment income to reduce paid-in
capital by $4,063 for both the Discretionary Equity and
Equity Portfolios.
<PAGE>
d) Short-term Investments - The Portfolios maintain
uninvested cash in a bank overnight investment vehicle
at their custodian. This may present credit risk to
the extent the custodian fails to perform in accordance
with the custody agreement. The creditworthiness of
the custodian is monitored and this investment is
considered to present minimal credit risk by the
Portfolios' Adviser.
e) Other - Investment transactions are accounted for
on the trade date plus one. The Portfolios determine
the gain or loss realized from the investment
transactions by comparing the original cost of the
security lot sold with the net sale proceeds. Dividend
income is recognized on the ex-dividend date and
interest income is recognized on an accrual basis.
3. Capital Share Transactions
Transactions in shares of the Portfolios for the year
ended December 31, 1995 were as follows:
Discretionary
Equity Equity
Portfolio Portfolio
Shares sold 1,392,981 1,783,850
Shares issued to holders in
reinvestment of distributions 78,723 94,610
Shares redeemed (7,080) (81,017)
Net increase 1,464,624 1,797,443
4. Investment Transactions
The aggregate purchases and sales of securities,
excluding short-term investments and U.S. government
obligations, for the Portfolios for the year ended
December 31, 1995 are summarized below:
Discretionary
Equity Equity
Portfolio Portfolio
Purchases $48,007,427 $65,703,268
Sales $17,640,547 $25,695,567
There were no purchases or sales of U.S. government
obligations. At December 31, 1995, gross unrealized
appreciation and depreciation of investments, based on
cost for federal income tax purposes of $35,853,299 and
$43,408,048 for the Discretionary Equity and Equity
Portfolios, respectively, were as follows:
Discretionary
Equity Equity
Portfolio Portfolio
Appreciation $3,066,343 $4,510,729
Depreciation (807,604) (944,620)
Net appreciation on
investments $2,258,739 $3,566,109
<PAGE>
For the year ended December 31, 1995, 100% of dividends
paid from net investment income, excluding short-term
capital gains, qualifies for the dividends received
deduction available to corporate shareholders of both
the Discretionary Equity and Equity Portfolios.
5. Investment Advisory Agreement
The Portfolios have an agreement with the Adviser, with
whom certain officers and directors of ICAP are
affiliated, to furnish investment advisory services to
the Portfolios. Under the terms of this agreement, the
Portfolios will pay the Adviser a monthly fee at the
annual rate of 0.80% of average net assets. Under the
investment advisory agreement, if the aggregate annual
operating expenses (excluding interest, taxes,
brokerage commissions and other costs incurred in
connection with the purchase or sale of portfolio
securities, and extraordinary items) exceed 0.80%, the
Adviser will reimburse the Portfolios for the amount of
such excess.
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of the ICAP
Funds, Inc.
We have audited the accompanying statements of assets
and liabilities of the ICAP Funds, Inc. (the "Funds")
(comprising, respectively the Discretionary Equity and
the Equity Portfolios), including the schedules of
investments in securities, as of December 31, 1995, and
the related statements of operations and changes in net
assets, and financial highlights for the year then
ended. These financial statements and financial
highlights are the responsibility of the Fund's
management. Our responsibility is to express an
opinion on these financial statements and 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
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 as of December 31, 1995 by
correspondence with the custodian and brokers. 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, the financial statements and financial
highlights referred to above present fairly, in all
material respects, the financial position of each of
the respective portfolios constituting ICAP Funds,
Inc., as of December 31, 1995, and the results of their
operations, the changes in their net assets, and the
financial highlights for the year then ended, in
conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P
Milwaukee, Wisconsin
January 19, 1996
<PAGE>
APPENDIX
BOND RATINGS
Standard & Poor's Debt Ratings
A Standard & Poor's corporate or municipal debt
rating is a current assessment of the creditworthiness
of an obligor with respect to a specific obligation.
This assessment may take into consideration obligors
such as guarantors, insurers, or lessees.
The debt rating is not a recommendation to
purchase, sell, or hold a security, as it does not
comment as to market price or suitability for a
particular investor.
The ratings are based on current information
furnished by the issuer or obtained by S&P from other
sources it considers reliable. S&P does not perform an
audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such
information, or based on other circumstances.
The ratings are based, in varying degrees, on the
following considerations:
1. Likelihood of default -- capacity and
willingness of the obligor as to the
timely payment of interest and repayment
of principal in accordance with the terms
of the obligation;
2. Nature of and provisions of the
obligation;
3. Protection afforded by, and relative
position of, the obligation in the event
of bankruptcy, reorganization, or other
arrangement under the laws of bankruptcy
and other laws affecting creditors'
rights.
Investment Grade
AAA Debt rated 'AAA' has the highest rating
assigned by S&P. Capacity to pay interest and repay
principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to
pay interest and repay principal and differs from the
highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay
interest and repay principal although it is somewhat
more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in
higher rated categories.
BBB Debt rated 'BBB' is regarded as having an
adequate capacity to pay interest and repay principal.
Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt
in this category than in higher rated categories.
Speculative grade
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is
regarded as having predominantly speculative
characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least
degree of speculation and 'C' the highest. While such
debt will likely have some quality and protective
characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse
conditions.
<PAGE>
BB Debt rated 'BB' has less near-term
vulnerability to default than other speculative issues.
However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic
conditions which could lead to inadequate capacity to
meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to
senior debt that is assigned an actual or implied 'BBB-
' rating.
B Debt rated 'B' has a greater vulnerability to
default but currently has the capacity to meet interest
payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair
capacity or willingness to pay interest and repay
principal. The 'B' rating category is also used for
debt subordinated to senior debt that is assigned an
actual or implied 'BB' or 'BB-' rating.
CCC Debt rated 'CCC' has a currently identifiable
vulnerability to default, and is dependent upon
favorable business, financial, and economic conditions
to meet timely payment of interest and repayment of
principal. In the event of adverse business,
financial, or economic conditions, it is not likely to
have the capacity to pay interest and repay principal.
The 'CCC' rating category is also used for debt
subordinated to senior debt that is assigned an actual
or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt
subordinated to senior debt that is assigned an actual
or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt
subordinated to senior debt which is assigned an actual
or implied 'CCC-' debt rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition
has been filed, but debt service payments are
continued.
CI The rating 'CI' is reserved for income bonds on
which no interest is being paid.
D Debt rated 'D' is in payment default. The 'D'
rating category is used when interest payments or
principal payments are not made on the date due even if
the applicable grace period has not expired, unless S&P
believes that such payments will be made during such
grade period. The 'D' rating also will be used upon
the filing of a bankruptcy petition if debt service
payments are jeopardized.
Moody's Long-Term Debt Ratings
Aaa - Bonds which are rated Aaa are judged to be
of the best quality. They carry the smallest degree of
investment risk and are generally referred to as "gilt
edged". Interest payments are protected by a large or
by an exceptionally stable margin and principal is
secure. While the various protective elements are
likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong
position of such issues.
Aa - Bonds which are rated Aa are judged to be of
high quality by all standards. Together with the Aaa
group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in
Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other
elements present which make the long-term risk appear
somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable
investment attributes and are to be considered as
upper-medium grade obligations. Factors giving
security to principal and interest are considered
adequate, but elements may be present which suggest a
susceptibility to impairment some time in the future.
Baa - Bonds which are rated Baa are considered as
medium-grade obligations (i.e., they are neither highly
protected nor poorly secured). Interest payments and
principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of
time. Such Bonds lack outstanding investment
characteristics and in fact have speculative
characteristics as well.
<PAGE>
Ba - Bonds which are rated Ba are judged to have
speculative elements; their future cannot be considered
as well-assured. Often the protection of interest and
principal payments may be very moderate, and thereby
not well safeguarded during both good and bad times
over the future. Uncertainty of position characterizes
Bonds in this class.
B - Bonds which are rated B generally lack
characteristics of the desirable investment. Assurance
of interest and principal payments or of maintenance of
other terms of the contract over any long period of
time may be small.
Caa - Bonds which are rated Caa are of poor
standing. Such issues may be in default or there may
be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated Ca represent
obligations which are speculative in a high degree.
Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated
class of bonds, and issues so rated can be regarded as
having extremely poor prospects of ever attaining any
real investment standing.
Fitch Investors Service, Inc. Bond Ratings
Fitch investment grade bond ratings provide a
guide to investors in determining the credit risk
associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to
meet the obligations of a specific debt issue or class
of debt in a timely manner.
The rating takes into consideration special
features of the issue, its relationship to other
obligations of the issuer, the current and prospective
financial condition and operating performance of the
issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit
enhancement that may be provided by insurance policies
or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but
not necessarily identical credit quality since the
rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy,
sell, or hold any security. Ratings do not comment on
the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt
nature or taxability of payments made in respect of any
security.
Fitch ratings are based on information obtained
from issuers, other obligors, underwriters, their
experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or
accuracy of such information. Ratings may be changed,
suspended, or withdrawn as a result of changes in, or
the unavailability of, information or for other
reasons.
AAA Bonds considered to be investment grade and
of the highest credit quality. The obligor
has an exceptionally strong ability to pay
interest and repay principal, which is
unlikely to be affected by reasonably
foreseeable events.
AA Bonds considered to be investment grade and
of very high credit quality. The obligor's
ability to pay interest and repay principal
is very strong, although not quite as strong
as bonds rated 'AAA'. Because bonds rated in
the 'AAA' and 'AA' categories are not
significantly vulnerable to foreseeable
future developments, short-term debt of the
issuers is generally rated 'F-1+'.
<PAGE>
A Bonds considered to be investment grade and
of high credit quality. The obligor's
ability to pay interest and repay principal
is considered to be strong, but may be more
vulnerable to adverse changes in economic
conditions and circumstances than bonds with
higher ratings.
BBB Bonds considered to be investment grade and
of satisfactory credit quality. The
obligor's ability to pay interest and repay
principal is considered to be adequate.
Adverse changes in economic conditions and
circumstances, however, are more likely to
have adverse impact on these bonds and,
therefore, impair timely payment. The
likelihood that the ratings of these bonds
will fall below investment grade is higher
than for bonds with higher ratings.
Fitch speculative grade bond ratings provide a
guide to investors in determining the credit risk
associated with a particular security. The ratings
('BB' to 'C') represent Fitch's assessment of the
likelihood of timely payment of principal and interest
in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating
('DDD' to 'D') is an assessment of the ultimate
recovery value through reorganization or liquidation.
The rating takes into consideration special
features of the issue, its relationship to other
obligations of the issuer, the current and prospective
financial condition and operating performance of the
issuer and any guarantor, as well as the economic and
political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but
not necessarily identical credit quality since the
rating categories cannot fully reflect the differences
in the degrees of credit risk.
BB Bonds are considered speculative. The
obligor's ability to pay interest and repay
principal may be affected over time by
adverse economic changes. However, business
and financial alternatives can be identified
which could assist the obligor in satisfying
its debt service requirements.
B Bonds are considered highly speculative.
While bonds in this class are currently
meeting debt service requirements, the
probability of continued timely payment of
principal and interest reflects the obligor's
limited margin of safety and the need for
reasonable business and economic activity
throughout the life of the issue.
CCC Bonds have certain identifiable
characteristics which, if not remedied, may
lead to default. The ability to meet
obligations requires an advantageous business
and economic environment.
CC Bonds are minimally protected. Default in
payment of interest and/or principal seems
probable over time.
C Bonds are in imminent default in payment of
interest or principal.
DDD,
DD
and D Bonds are in default on interest and/or
principal payments. Such bonds are extremely
speculative and should be valued on the basis
of their ultimate recovery value in
liquidation or reorganization of the obligor.
'DDD' represents the highest potential for
recovery of these bonds, and 'D' represents
the lowest potential for recovery.
Duff & Phelps, Inc. Long-Term Debt Ratings
These ratings represent a summary opinion of the
issuer's long-term fundamental quality. Rating
determination is based on qualitative and quantitative
factors which may vary according to the basic economic
<PAGE>
and financial characteristics of each industry and each
issuer. Important considerations are vulnerability to
economic cycles as well as risks related to such
factors as competition, government action, regulation,
technological obsolescence, demand shifts, cost
structure, and management depth and expertise. The
projected viability of the obligor at the trough of the
cycle is a critical determination.
Each rating also takes into account the legal form
of the security, (e.g., first mortgage bonds,
subordinated debt, preferred stock, etc.). The extent
of rating dispersion among the various classes of
securities is determined by several factors including
relative weightings of the different security classes
in the capital structure, the overall credit strength
of the issuer, and the nature of covenant protection.
The Credit Rating Committee formally reviews all
ratings once per quarter (more frequently, if
necessary). Ratings of 'BBB-' and higher fall within
the definition of investment grade securities, as
defined by bank and insurance supervisory authorities.
Structured finance issues, including real estate,
asset-backed and mortgage-backed financings, use this
same rating scale. Duff & Phelps Credit Rating claims
paying ability ratings of insurance companies use the
same scale with minor modification in the definitions.
Thus, an investor can compare the credit quality of
investment alternatives across industries and
structural types. A "Cash Flow Rating" (as noted for
specific ratings) addresses the likelihood that
aggregate principal and interest will equal or exceed
the rated amount under appropriate stress conditions.
Rating Scale Definition
AAA Highest credit quality. The risk
factors are negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors
are strong. Risk is modest, but may
AA vary slightly from time to time because
of economic conditions.
AA-
A+ Protection factors are average but
adequate. However, risk factors are more
A variable and greater in periods of
economic stress.
A-
BBB+ Below average protection factors but
still considered sufficient for prudent
BBB investment. Considerable variability in
risk during economic cycles.
BBB-
BB+ Below investment grade but deemed likely
to meet obligations when due.
BB Present or prospective financial
protection factors fluctuate according to
BB- industry conditions or company fortunes.
Overall quality may move up or
down frequently within this category.
B+ Below investment grade and possessing
risk that obligations will not be met
B when due. Financial protection factors
will fluctuate widely according to
B- economic cycles, industry conditions
and/or company fortunes. Potential
exists for frequent changes in the
rating within this category or into a higher
or lower rating grade.
<PAGE>
CCC Well below investment grade securities.
Considerable uncertainty exists as to
timely payment of principal, interest or
preferred dividends.
Protection factors are narrow and risk
can be substantial with unfavorable
economic/industry conditions, and/or
with unfavorable company developments.
DD Defaulted debt obligations. Issuer
failed to meet scheduled principal and/or
interest payments.
DP Preferred stock with dividend
arrearages.
SHORT-TERM RATINGS
Standard & Poor's Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a
current assessment of the likelihood of timely payment
of debt considered short-term in the relevant market.
Ratings graded into several categories, ranging
from 'A-1' for the highest quality obligations to 'D'
for the lowest. These categories are as follows:
A-1 This highest category indicates that the
degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+)
designation.
A-2 Capacity for timely payment on issues with
this designation is satisfactory. However, the
relative degree of safety is not as high as for issues
designated 'A-1'.
A-3 Issues carrying this designation have adequate
capacity for timely payment. They are, however, more
vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher
designations.
B Issues rated 'B' are regarded as having only
speculative capacity for timely payment.
C This rating is assigned to short-term debt
obligations with doubtful capacity for payment.
D Debt rated 'D' is in payment default. The 'D'
rating category is used when interest payments or
principal payments are not made on the date due, even
if the applicable grace period has not expired, unless
S&P believes that such payments will be made during
such grace period.
Moody's Commercial Paper Ratings
The term "commercial paper" as used by Moody's
means promissory obligations not having an original
maturity in excess of nine months. Moody's makes no
representation as to whether such commercial paper is
by any other definition "commercial paper" or is exempt
from registration under the Securities Act of 1933, as
amended.
Moody's commercial paper ratings are opinions of
the ability of issuers to repay punctually promissory
obligations not having an original maturity in excess
of nine months. Moody's makes no representation that
such obligations are exempt from registration under the
Securities Act of 1933, nor does it represent that any
specific note is a valid obligation of a rated issuer
or issued in conformity with any applicable law.
Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
<PAGE>
Issuers rated Prime-1 (or related supporting
institutions) have a superior capacity for repayment of
short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following
characteristics: (i) leading market positions in well
established industries, (ii) high rates of return on
funds employed, (iii) conservative capitalization
structures with moderate reliance on debt and ample
asset protection, (iv) broad margins in earnings
coverage of fixed financial charges and high internal
cash generation, and (v) well established access to a
range of financial markets and assured sources of
alternate liquidity.
Issuers rated Prime-2 (or related supporting
institutions) have a strong capacity for repayment of
short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited
above, but to a lesser degree. Earnings trends and
coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still
appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting
institutions) have an acceptable capacity for repayment
of short-term promissory obligations. The effect of
industry characteristics and market composition may be
more pronounced. Variability in earnings and
profitability may result in changes in the level of
debt protection measurements and the requirement for
relatively high financial leverage. Adequate alternate
liquidity is maintained.
Issuers rated Not Prime do not fall within any of
the Prime rating categories.
Fitch Investors Service, Inc. Short-Term Ratings
Fitch's short-term ratings apply to debt
obligations that are payable on demand or have original
maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term
notes, and municipal and investment notes.
The short-term rating places greater emphasis than
a long-term rating on the existence of liquidity
necessary to meet the issuer's obligations in a timely
manner.
F-1+ Exceptionally Strong Credit Quality Issues
assigned this rating are regarded as having
the strongest degree of assurance for timely
payment.
F-1 Very Strong Credit Quality Issues assigned
this rating reflect an assurance of timely
payment only slightly less in degree than
issues rated 'F-1+'.
F-2 Good Credit Quality Issues assigned this
rating have a satisfactory degree of
assurance for timely payment but the margin
of safety is not as great as for issues
assigned 'F-1+' and 'F-1' ratings.
F-3 Fair Credit Quality Issues assigned this
rating have characteristics suggesting that
the degree of assurance for timely payment is
adequate; however, near-term adverse changes
could cause these securities to be rated
below investment grade.
F-S Weak Credit Quality Issues assigned this
rating have characteristics suggesting a
minimal degree of assurance for timely
payment and are vulnerable to near-term
adverse changes in financial and economic
conditions.
D Default Issues assigned this rating are in
actual or imminent payment default.
LOC The symbol LOC indicates that the rating is
based on a letter of credit issued by a commercial
bank.
<PAGE>
Duff & Phelps, Inc. Short-Term Debt Ratings
Duff & Phelps' short-term ratings are consistent
with the rating criteria used by money market
participants. The ratings apply to all obligations
with maturities of under one year, including commercial
paper, the uninsured portion of certificates of
deposit, unsecured bank loans, master notes, bankers
acceptances, irrevocable letters of credit, and current
maturities of long-term debt. Asset-backed commercial
paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined
as not only cash from operations, but also access to
alternative sources of funds including trade credit,
bank lines, and the capital markets. An important
consideration is the level of an obligor's reliance on
short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps Credit
Ratings' short-term ratings is the refinement of the
traditional '1' category. The majority of short-term
debt issuers carry the highest rating, yet quality
differences exist within that tier. As a consequence,
Duff & Phelps Credit Rating has incorporated gradations
of '1+' (one plus) and '1-' (one minus) to assist
investors in recognizing those differences.
These ratings are recognized by the SEC for
broker-dealer requirements, specifically capital
computation guidelines. These ratings meet Department
of Labor ERISA guidelines governing pension and profit
sharing investments. State regulators also recognize
the ratings of Duff & Phelps Credit Rating for
insurance company investment portfolios.
Rating Scale: Definition
High Grade
D-1+ Highest certainty of timely payment.
Short-term liquidity, including internal
operating factors and/or access to
alternative sources of funds, is
outstanding, and safety is just below
risk-free U.S. Treasury short-term
obligations.
D-1 Very high certainty of timely payment.
Liquidity factors are excellent and
supported by good fundamental protection
factors. Risk factors are minor.
D-1- High certainty of timely payment.
Liquidity factors are strong and
supported by good fundamental protection
factors. Risk factors are very small.
Good Grade
D-2 Good certainty of timely payment.
Liquidity factors and company
fundamentals are sound. Although
ongoing funding needs may enlarge total
financing requirements, access to
capital markets is good. Risk factors
are small.
Satisfactory Grade
D-3 Satisfactory liquidity and other
protection factors qualify issue as to
investment grade. Risk factors are
larger and subject to more variation.
Nevertheless, timely payment is
expected.
<PAGE>
Non-investment Grade
D-4 Speculative investment characteristics.
Liquidity is not sufficient to insure
against disruption in debt service.
Operating factors and market access may
be subject to a high degree of
variation.
Default
D-5 Issuer failed to meet scheduled
principal and/or interest payments.
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