Item 1. Report to Shareholders
November 30, 2004
GNMA Fund
Semiannual Report
T. Rowe Price
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The views and opinions in this report were current as of November 30, 2004. They
are not guarantees of performance or investment results and should not be taken
as investment advice. Investment decisions reflect a variety of factors, and the
managers reserve the right to change their views about individual stocks,
sectors, and the markets at any time. As a result, the views expressed should
not be relied upon as a forecast of the fund's future investment intent. The
report is certified under the Sarbanes-Oxley Act of 2002, which requires mutual
funds and other public companies to affirm that, to the best of their knowledge,
the information in their financial reports is fairly and accurately stated in
all material respects.
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REPORTS ON THE WEB
Sign up for our E-mail Program, and you can begin to receive updated fund
reports and prospectuses online rather than through the mail. Log in to your
account at troweprice.com for more information.
T. Rowe Price GNMA Fund
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Fellow Shareholders
Mortgage-backed bonds delivered positive returns over the past six months as
shorter-term interest rates rose and longer-term rates fell from levels attained
in early summer. Mortgage bonds also gained during the 12-month period ended
November 30, 2004, but the lion's share of that return was achieved during the
half year. Our sector of the fixed-income market outpaced comparable Treasuries
since our last report in May.
MARKET ENVIRONMENT
Short- and longer-term interest rates moved counter to each other during the
past six months, with short yields rising and longer yields declining as the
Federal Reserve boosted the fed funds rate target in four stages. The Federal
Reserve's four rate increases from June through November doubled the official
federal funds rate to 2% but left rates at levels that were still quite low by
historical standards; indeed, as recently as four years ago, the federal funds
rate had been above 6%. Factoring in inflation, real short-term rates stood
below 0.5%. The Fed made clear that it would continue to move away from this
highly accommodative stance with further rate increases, although it would do so
at a measured pace.
[GRAPHIC OMITTED]
INTEREST RATE LEVELS
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Current Coupon 10-Year
GNMA Treasury Note
11/30/2003 5.36% 4.33%
5.24 4.25
5.17 4.13
2/04 4.98 3.97
4.90 3.84
5.56 4.51
5/04 5.71 4.65
5.54 4.58
5.43 4.48
8/04 5.10 4.12
5.16 4.12
4.98 4.02
11/30/2004 5.15 4.35
The net effect was a favorable backdrop for longer-term bonds as the 10-year
Treasury yield ended November at roughly the same level as a year ago--and even
lower in the case of the current coupon GNMA. During the period, the U.S. dollar
sank to an all-time low against the euro and gold rose to levels not seen since
the late 1980s. While the Bush administration has proclaimed its preference for
a "strong dollar," it has quietly allowed the dollar to weaken against major
foreign currencies without taking significant steps to reverse the situation.
Recent economic reports reflected solid fundamentals. Low interest rates, ease
of financing, rising incomes, and an improving labor market all acted to bolster
housing demand in recent months. Similarly, strong cash flow, healthy balance
sheets, and rising utilization rates offer ongoing support for business
equipment purchases, with additional stimulus coming from favorable depreciation
allowances set to expire at year-end. Finally, the downward trend in jobless
claims supports the view that slack in the labor market will continue to
diminish. An improving economy normally results in higher interest rates, which
puts downward pressure on bond prices.
The economy grew at a 3.9% annual rate in the third quarter, slightly faster
than the 3.7% initially reported. Higher exports, business investment, and
consumer spending were behind the increase. Chicago purchasing managers reported
that their monthly measure of business activity fell to 65.2% in November from
68.5% the month before as automakers cut back production, but readings above 50%
still reflect an expanding economy.
PERFORMANCE AND STRATEGY REVIEW
In the challenging environment of the past year, your fund provided similar
returns (3.46% and 3.95%) for the 6- and 12-month periods, respectively, ended
November 30, 2004. Fund results surpassed the Lipper peer group average in both
periods but trailed the Citigroup GNMA Index, as can be seen in the Performance
Comparison table. Performance over the six-month period was a result of an
increase in net asset value from $9.54 last May to $9.64 at the end of November
as interest rates fell, plus dividends of $0.23 per share. Over the year,
dividends amounted to $0.43, which overcame a $0.05 drop in the net asset value.
PERFORMANCE COMPARISON
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Periods Ended 11/30/04 6 Months 12 Months
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GNMA Fund 3.46% 3.95%
Citigroup GNMA Index 4.12 4.73
Lipper GNMA Funds Average 3.22 3.39
Please see the fund's quarter-end returns following this letter.
The last six months resulted in excellent returns for the mortgage sector.
Mortgage-backed securities overall returned 4.09% and GNMAs gained 3.91%. GNMAs
typically yield less because they are the only mortgage-backed security backed
by the full faith and credit of the U.S.
government. Excess returns, which are defined as mortgage returns in excess of
those of equal-duration Treasuries, was more than 143 basis points (1.43%) for
the last six months.
Mortgage performance was the result of many factors. Carry, or realized, income
contributed to returns as prepayments were limited. The massive refinancing that
took place in 2003 resulted in a universe of mortgages that has seen the lows in
interest rates and is much less sensitive to dips in mortgage rates. Another
material factor in mortgage performance came from the technical side. Simply
put, demand far outstripped supply. Even with Fannie Mae and Freddie Mac showing
much more muted appetites for mortgages than in past years, banks, money
managers, and hedge funds filled the void and caused mortgage spreads to
tighten. Recently, new buyers--foreign investors--have entered the market.
During the past six months, our strategy was influenced by the Federal Reserve's
anticipated hikes in short-term interest rates and the flattening yield curve
that resulted as the gap between short- and long-term yields narrowed. With
these changes in mind, we kept duration shorter than that of the benchmark index
and at least neutral versus our Lipper peer group. (Duration is a measure of a
bond fund's sensitivity to interest rates; see Glossary for a more detailed
explanation.) Yields have fallen on 10- and 30-year securities while,
simultaneously, short-term rates rose considerably. The result has been a
flattening of the yield curve, as we anticipated, which helped our position.
PORTFOLIO CHARACTERISTICS
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Periods Ended 5/31/04 11/30/04
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Price Per Share $9.54 $9.64
Dividends Per Share
For 6 Months 0.19 0.23
For 12 Months 0.39 0.43
30-Day Dividend Yield* 4.62% 4.53%
30-Day Standardized Yield to Maturity 3.93 3.61
Weighted Average Maturity (years) 5.8 4.7
Weighted Average Effective Duration (years) 4.2 3.0
*Dividends earned for the last 30 days of each period indicated are annualized
and divided by the fund's net asset value at the end of the period.
Note: Yield will vary and is not guaranteed.
As mentioned, fund performance outpaced the average for our Lipper peer group
but lagged the Citigroup GNMA Index because of our shorter duration, and also
because our performance is stated net of fees. We believe we were most able to
add value in security selection. We spend
a great deal of time analyzing trades from a relative value and total return
viewpoint. That analysis paid off as we bought specific coupons that
outperformed the market as a whole.
At the end of November, the portfolio's effective duration had declined to 3.0
years from 4.2 years six months ago. We had 90% of net fund assets invested in
GNMA pass-throughs (one percentage point higher than last May), 5% in
collateralized mortgage obligations (down one percentage point from May), and 5%
in project loan bonds (the same as six months earlier).
SECTOR DIVERSIFICATION
Percent of Percent of
Net Assets Net Assets
5/31/04 11/30/04
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GNMA Pass-Throughs 89% 90%
CMOs 6 5
Project Loans 5 5
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Total 100% 100%
OUTLOOK
Even before it began to increase the federal funds rate, the Federal Reserve had
made it clear that it considered rock-bottom rates to be only temporary. The
Fed's goal is to shift to a more "neutral" posture to achieve its long-term
objective of sustainable economic growth and price stability. It can be argued
what level of short-term interest rates represents neutral, but there is very
little disagreement that this level is higher than the current one. The central
bank is likely to continue moving at a measured pace of quarter-point increases,
possibly at every meeting of the Federal Open Market Committee, which takes
place about eight times per year.
As the Fed implements this policy, the favorable environment for mortgages
should continue. Mortgage-backed securities generally fare best when rates are
steady or the direction of their change is clear. The supply/demand dynamic
could continue to benefit the sector as well. We are cognizant that mortgages
currently are richly priced, but we believe that only a sharp spike in interest
rates or another negative event involving Fannie Mae or Freddie Mac will have a
major impact on the
sector. Even in the latter case, GNMAs provide investors with a yield advantage
over Treasuries, which can help offset any weakness in principal as long as
interest rates rise gradually.
Thank you for investing with T. Rowe Price.
Respectfully submitted,
Connice A. Bavely
Chairman of the fund's Investment Advisory Committee
December 22, 2004
The committee chairman has day-to-day responsibility for managing the portfolio
and works with committee members in developing and executing the fund's
investment program.
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Risks of Investing in Mortgage-Backed Bonds
Mortgage securities are subject to interest rate risk: the decline in bond
prices that usually accompanies a rise in interest rates, potentially reducing
the fund's income level and share price. Historically, GNMAs and other
mortgage-backed bonds have declined less in price when rates were rising because
they carry their own special risks, such as prepayment and extension risk. When
mortgage rates decline, homeowners usually refinance and prepay principal,
causing the average maturity of the portfolio to shorten and reducing the
potential for price gains. Extension risk occurs when rates rise, causing the
portfolio's average maturity to lengthen and increasing its sensitivity to
interest rate risk and possible price declines.
Glossary
Citigroup GNMA Index: An index of 15- and 30-year fixed-rate securities backed
by mortgage pools of the Government National Mortgage Association (GNMA).
Duration: A measure of a bond fund's sensitivity to changes in interest rates.
For example, a fund with a duration of four years would fall about 4% in price
in response to a one-percentage-point rise in interest rates and vice versa.
Lipper averages: The averages of available mutual fund performance returns for
specified time periods in defined categories as tracked by Lipper Inc.
Basis points: One hundred basis points equal one percentage point.
Extension risk: As interest rates rise, the likelihood of prepayment decreases,
and the average life and duration of mortgage securities lengthens. Investors
are unable to capitalize on higher interest rates because their investment is
locked in at a lower rate for a longer period.
Collateralized mortgage obligation (CMO): Collateralized mortgage obligations
are investment-grade bonds that are backed by mortgage pass-throughs whose cash
flows are directed in different ways to different classes. Some classes may have
less risk associated with prepayments, and by default, the other classes will
have more prepayment risk. Those classes with less risk generally yield less
than other mortgage-backed securities.
Average maturity: For a bond fund, this is the weighted average of the stated
maturity dates of the portfolio's securities. In general, the longer the average
maturity, the greater the fund's sensitivity to interest rate changes, which can
mean greater price fluctuation. A shorter average maturity usually means less
interest rate sensitivity and, consequently, a less volatile portfolio.
Real interest rate: The excess of the current interest rate over the current
inflation rate.
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Total return: The annual rate of return on a bond, taking into account interest
income, plus appreciation or depreciation. If a bond is held to maturity, its
total return equals its yield to maturity.
Yield curve: A graphic depiction of the relationship between yields and maturity
dates for a set of similar securities, such as Treasuries or municipal
securities. Securities with longer maturities usually have a higher yield. If
short-term securities offer a higher yield, then the curve is said to be
"inverted." If short- and long-term bonds are offering equivalent yields, then
the curve is said to be "flat."
T. Rowe Price GNMA Fund
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Growth of $10,000
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This chart shows the value of a hypothetical $10,000 investment in the fund over
the past 10 fiscal year periods or since inception (for funds lacking 10-year
records). The result is compared with benchmarks, which may include a
broad-based market index and a peer group average or index. Market indexes do
not include expenses, which are deducted from fund returns as well as mutual
fund averages and indexes.
[GRAPHIC OMITTED]
GNMA FUND
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As of 11/30/04
GNMA Fund $19,785
Lipper GNMA Funds Average $19,220
Lipper GNMA
GNMA Fund Funds Average
11/94 $10,000 $10,000
11/95 11,748 11,616
11/96 12,426 12,320
11/97 13,335 13,203
11/98 14,299 14,169
11/99 14,425 14,327
11/00 15,698 15,533
11/01 17,284 16,997
11/02 18,542 18,141
11/03 19,032 18,571
11/04 19,785 19,220
Average Annual Compound Total Return
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This table shows how the fund and its benchmarks would have performed if their
actual (or cumulative) returns for the periods shown had been earned at a
constant rate.
Periods Ended 11/30/04 1 Year 5 Years 10 Years
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GNMA Fund 3.95% 6.52% 7.06%
Citigroup GNMA Index 4.73 6.90 7.60
Lipper GNMA Funds Average 3.39 6.03 6.74
Returns do not reflect taxes that the shareholder may pay on fund distributions
or the redemption of fund shares. Past performance cannot guarantee future
results.
T. Rowe Price GNMA Fund
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Fund Expense Example
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As a mutual fund shareholder, you may incur two types of costs: (1) transaction
costs such as redemption fees or sales loads and (2) ongoing costs, including
management fees, distribution and service (12b-1) fees, and other fund expenses.
The following example is intended to help you understand your ongoing costs (in
dollars) of investing in the fund and to compare these costs with the ongoing
costs of investing in other mutual funds. The example is based on an investment
of $1,000 invested at the beginning of the most recent six-month period and held
for the entire period.
Actual Expenses
The first line of the following table ("Actual") provides information about
actual account values and actual expenses. You may use the information in this
line, together with your account balance, to estimate the expenses that you paid
over the period. Simply divide your account value by $1,000 (for example, an
$8,600 account value divided by $1,000 = 8.6), then multiply the result by the
number in the first line under the heading "Expenses Paid During Period" to
estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The information on the second line of the table ("Hypothetical") is based on
hypothetical account values and expenses derived from the fund's actual expense
ratio and an assumed 5% per year rate of return before expenses (not the fund's
actual return). You may compare the ongoing costs of investing in the fund with
other funds by contrasting this 5% hypothetical example and the 5% hypothetical
examples that appear in the shareholder reports of the other funds. The
hypothetical account values and expenses may not be used to estimate the actual
ending account balance or expenses you paid for the period.
Note: T. Rowe Price charges an annual small-account maintenance fee of $10,
generally for accounts with less than $2,000 ($500 for UGMA/UTMA). The fee is
waived for any investor whose T. Rowe Price mutual fund accounts total $25,000
or more, accounts employing automatic investing, and IRAs and other retirement
plan accounts that utilize a prototype plan sponsored by T. Rowe Price (although
a separate custodial or administrative fee may apply to such accounts). This fee
is not included in the accompanying table. If you are subject to the fee, keep
it in mind when you are estimating the ongoing expenses of investing in the fund
and when comparing the expenses of this fund with other funds.
You should also be aware that the expenses shown in the table highlight only
your ongoing costs and do not reflect any transaction costs, such as redemption
fees or sales loads. Therefore, the second line of the table is useful in
comparing ongoing costs only and will not help you determine the relative total
costs of owning different funds. To the extent a fund charges transaction costs,
however, the total cost of owning that fund is higher.
T. Rowe Price GNMA Fund
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Beginning Ending Expenses Paid
Account Value Account Value During Period*
6/1/04 11/30/04 6/1/04 to 11/30/04
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Actual $1,000 $1,034.60 $3.42
Hypothetical (assumes 5%
return before expenses) 1,000 1,021.71 3.40
* Expenses are equal to the fund's annualized expense ratio for the six-month
period (0.67%), multiplied by the average account value over the period,
multiplied by the number of days in the most recent fiscal half year (183)
divided by the days in the year (365) to reflect the half-year period.
T. Rowe Price GNMA Fund
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Quarter-End Returns
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Periods Ended 9/30/04 1 Year 5 Years 10 Years
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GNMA Fund 3.34% 6.50% 6.98%
Citigroup GNMA Index 4.32 6.90 7.49
Lipper GNMA Funds Average 2.82 6.02 6.60
Current performance may be lower or higher than the quoted past performance,
which cannot guarantee future results. Share price, principal value, and return
will vary, and you may have a gain or loss when you sell your shares. For the
most recent month-end performance information, please visit our Web site
(troweprice.com) or contact a T. Rowe Price representative at 1-800-225-5132.
This table provides returns through the most recent calendar quarter-end rather
than through the end of the fund's fiscal period. It shows how the fund would
have performed each year if its actual (or cumulative) returns for the periods
shown had been earned at a constant rate. Average annual total return figures
include changes in principal value, reinvested dividends, and capital gain
distributions. Returns do not reflect taxes that the shareholder may pay on fund
distributions or the redemption of fund shares. When assessing performance,
investors should consider both short- and long-term returns.
T. Rowe Price GNMA Fund
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Unaudited
Financial Highlights For a share outstanding throughout each period
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6 Months Year
Ended Ended
11/30/04 5/31/04 5/31/03 5/31/02 5/31/01 5/31/00
NET ASSET VALUE
Beginning of period $ 9.54 $ 9.89 $ 9.61 $ 9.40 $ 8.92 $ 9.33
Investment activities
Net investment income
(loss) 0.20 0.30 0.37 0.52 0.59 0.60
Net realized and
unrealized gain (loss) 0.13 (0.26) 0.30 0.21 0.48 (0.41)
Total from
investment activities 0.33 0.04 0.67 0.73 1.07 0.19
Distributions
Net investment income (0.23) (0.39) (0.39) (0.52) (0.59) (0.60)
NET ASSET VALUE
End of period $ 9.64 $ 9.54 $ 9.89 $ 9.61 $ 9.40 $ 8.92
----------------------------------------------------
Ratios/Supplemental Data
Total return^ 3.46% 0.45% 7.07% 7.95% 12.31% 2.13%
Ratio of total expenses to
average net assets 0.67%+ 0.69% 0.70% 0.69% 0.70% 0.71%
Ratio of net investment
income (loss) to average
net assets 3.99%+ 3.23% 3.68% 5.33% 6.39% 6.61%
Portfolio turnover rate 110.0%+ 302.1% 385.8% 145.2% 71.2% 63.8%
Net assets, end of period
(in millions) $1,344 $1,307 $1,466 $1,223 $1,043 $1,052
^ Total return reflects the rate that an investor would have earned on an
investment in the fund during each period, assuming reinvestment of all
distributions.
+ Annualized
The accompanying notes are an integral part of these financial statements.
T. Rowe Price GNMA Fund
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Unaudited November 30, 2004
Portfolio of Investments (1) $ Par/Shares Value
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(Amounts in 000s)
U.S. GOVERNMENT & AGENCY MORTGAGE-BACKED SECURITIES 98.8%
U.S. Government Obligations 98.8%
Government National Mortgage Assn.
5.00%, 3/15/18 - 10/20/33 217,033 216,951
5.50%, 7/15/14 - 7/15/34 269,414 275,492
6.00%, 11/15/08 - 9/20/34 335,783 348,705
6.50%, 12/15/14 - 10/20/34 105,167 110,978
6.73%, 9/15/30 19,359 21,271
6.75%, 2/15/41 9,809 10,111
7.00%, 3/15/13 - 2/15/34 53,883 57,429
7.50%, 3/15/07 - 9/15/32 27,080 29,148
8.00%, 3/15/14 - 3/15/30 19,302 20,825
8.50%, 12/15/05 - 2/20/23 3,521 3,873
9.00%, 5/15/09 - 9/15/24 1,687 1,885
9.25%, 8/15/16 - 12/15/19 263 295
9.50%, 6/15/09 - 12/15/24 1,017 1,131
9.75%, 8/15/16 - 2/15/21 381 429
10.00%, 2/15/16 - 3/15/26 3,919 4,413
10.25%, 9/20/16 21 24
10.50%, 2/15/13 - 10/15/21 373 422
10.75%, 9/15/17 80 91
11.00%, 2/15/10 - 7/20/20 320 362
11.50%, 6/15/10 - 7/15/20 695 796
12.00%, 10/15/10 - 7/15/15 720 827
12.25%, 3/15/14 - 7/20/15 56 64
12.50%, 4/15/10 - 1/20/16 350 403
12.75%, 12/20/13 - 12/20/14 69 79
13.00%, 1/15/11 - 9/20/15 262 301
13.50%, 5/15/10 - 1/15/15 176 200
CMO
2.212%, 10/16/17 3,728 3,542
2.946%, 3/16/19 7,800 7,538
5.00%, 8/16/28 5,279 5,297
5.064%, 9/16/26 13,200 13,435
5.50%, 2/20 - 10/20/30 32,075 32,647
6.00%, 5/20/29 ++ 11,908 12,013
6.50%, 10/20/27 - 3/20/31 11,525 11,997
IO, 6.50%, 8/20/30 392 8
Principal Only, 3/16/28 1,012 920
TBA
5.00%, 1/1/34 33,000 32,783
5.50%, 1/1/32 62,031 62,935
6.00%, 1/1/33 37,000 38,180
U.S. Department of Veteran Affairs
CMO, VR, 9.61%, 3/15/25 768 825
Total U.S. Government & Agency Mortgage-Backed Securities
(Cost $1,316,872) 1,328,625
Money Market Funds 10.5%
T. Rowe Price Government Reserve Investment Fund
1.94% #+ 141,216 141,216
Total Money Market Funds (Cost $141,216) 141,216
FUTURES CONTRACTS 0.0%
Variation margin receivable (payable) on open futures contracts (2) (53)
Total Futures Contracts (53)
Total Investments in Securities
109.3% of Net Assets (Cost $1,458,088) $1,469,788
----------
(1) Denominated in U.S. dollars unless otherwise noted
# Seven-day yield
++ All or a portion of this security is pledged to cover margin requirements
on futures contracts at November 30, 2004.
+ Affiliated company - See Note 4
CMO Collateralized Mortgage Obligation
IO Interest Only security for which the fund receives interest on notional
principal (par)
TBA To Be Announced security was purchased on a forward commitment basis
VR Variable Rate
T. Rowe Price GNMA Fund
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(2) Open Futures Contracts at November 30, 2004 were as follows:
($ 000s)
Contract Unrealized
Expiration Value Gain (Loss)
---------- ---------- -----------
Short, 630 U.S. Treasury five year
contracts, $500 par of 6.00% GNMA Bonds
pledged as initial margin 3/05 $ (68,562) $ 66
Net payments (receipts) of variation
margin to date (119)
Variation margin receivable (payable)
on open futures contracts $ (53)
-------
The accompanying notes are an integral part of these financial statements.
T. Rowe Price GNMA Fund
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Unaudited November 30, 2004
STATEMENT OF ASSETS AND LIABILITIES
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(In thousands except shares and per share amounts)
Assets
Investments in securities, at value
Affiliated companies (cost $141,216) $ 141,216
Non-affiliated companies (cost $1,316,872) 1,328,572
Total investments in securities 1,469,788
Other assets 11,033
Total assets 1,480,821
Liabilities
Payable for investment securities purchased 134,552
Other liabilities 1,836
Total liabilities 136,388
NET ASSETS $ 1,344,433
---------------
Net Assets Consist of:
Undistributed net investment income (loss) $ (9,490)
Undistributed net realized gain (loss) 6,769
Net unrealized gain (loss) 11,819
Paid-in-capital applicable to 139,458,005 no par
value shares of beneficial interest outstanding;
unlimited number of shares authorized 1,335,335
NET ASSETS $ 1,344,433
---------------
NET ASSET VALUE PER SHARE $ 9.64
---------------
The accompanying notes are an integral part of these financial statements.
T. Rowe Price GNMA Fund
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Unaudited
STATEMENT OF OPERATIONS
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($ 000s)
6 Months
Ended
11/30/04
Investment Income (Loss)
Income
Interest $ 30,182
Dividend 637
Total income 30,819
Expenses
Investment management 3,069
Shareholder servicing 1,074
Custody and accounting 194
Prospectus and shareholder reports 37
Registration 23
Legal and audit 7
Trustees 4
Miscellaneous 6
Total expenses 4,414
Expenses paid indirectly (2)
Net expenses 4,412
Net investment income (loss) 26,407
Realized and Unrealized Gain (Loss)
Net realized gain (loss)
Securities 2,014
Futures (1,685)
Net realized gain (loss) 329
Change in net unrealized gain (loss)
Securities 17,370
Futures 241
Change in net unrealized gain (loss) 17,611
Net realized and unrealized gain (loss) 17,940
INCREASE (DECREASE) IN NET
ASSETS FROM OPERATIONS $ 44,347
---------------
The accompanying notes are an integral part of these financial statements.
T. Rowe Price GNMA Fund
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Unaudited
STATEMENT OF CHANGES IN NET ASSETS
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($ 000s)
6 Months Year
Ended Ended
11/30/04 5/31/04
Increase (Decrease) in Net Assets
Operations
Net investment income (loss) $ 26,407 $ 44,052
Net realized gain (loss) 329 507
Change in net unrealized gain (loss) 17,611 (38,633)
Increase (decrease) in net assets from operations 44,347 5,926
Distributions to shareholders
Net investment income (31,209) (55,362)
Capital share transactions *
Shares sold 87,309 220,259
Distributions reinvested 27,881 49,117
Shares redeemed (90,680) (379,489)
Increase (decrease) in net assets from capital
share transactions 24,510 (110,113)
Net Assets
Increase (decrease) during period 37,648 (159,549)
Beginning of period 1,306,785 1,466,334
End of period $1,344,433 $1,306,785
---------- ----------
(Including undistributed net investment income (loss)
of $(9,490) at 11/30/04 and $(4,688) at 5/31/04)
*Share information
Shares sold 9,035 22,594
Distributions reinvested 2,890 5,061
Shares redeemed (9,414) (39,032)
Increase (decrease) in shares outstanding 2,511 (11,377)
The accompanying notes are an integral part of these financial statements.
T. Rowe Price GNMA Fund
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Unaudited November 30, 2004
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
T. Rowe Price GNMA Fund (the fund) is registered under the Investment Company
Act of 1940 (the 1940 Act) as a diversified, open-end management investment
company. The fund commenced operations on November 26, 1985. The fund seeks high
current income consistent with maximum credit protection and moderate price
fluctuation by investing exclusively in securities backed by the full faith and
credit of the U.S. government and instruments linked to these securities.
The accompanying financial statements were prepared in accordance with
accounting principles generally accepted in the United States of America, which
require the use of estimates made by fund management.
Valuation
The fund values its investments and computes its net asset value per share at
the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day
that the NYSE is open for business. Debt securities are generally traded in the
over-the-counter market. Securities with original maturities of one year or more
are valued at prices furnished by dealers who make markets in such securities or
by an independent pricing service, which considers yield or price of bonds of
comparable quality, coupon, maturity, and type, as well as prices quoted by
dealers who make markets in such securities. Securities with original maturities
of less than one year are stated at fair value, which is determined by using a
matrix system that establishes a value for each security based on bid-side money
market yields.
Investments in mutual funds are valued at the mutual fund's closing net asset
value per share on the day of valuation. Financial futures contracts are valued
at closing settlement prices.
Other investments and those for which the above valuation procedures are
inappropriate or are deemed not to reflect fair value are stated at fair value
as determined in good faith by the T. Rowe Price Valuation Committee,
established by the fund's Board of Trustees.
Credits
The fund earns credits on temporarily uninvested cash balances at the custodian
that reduce the fund's custody charges. Custody expense in the accompanying
financial statements is presented before reduction for credits, which are
reflected as expenses paid indirectly.
Investment Transactions, Investment Income, and Distributions
Income and expenses are recorded on the accrual basis. Premiums and discounts on
debt securities are amortized for financial reporting purposes. Inflation
adjustments to the principal
amount of inflation-indexed bonds are included in interest income. Dividends
received from mutual fund investments are reflected as dividend income; capital
gain distributions are reflected as realized gain/loss. Dividend income and
capital gain distributions are recorded on the ex-dividend date. Investment
transactions are accounted for on the trade date. Realized gains and losses are
reported on the identified cost basis. Payments ("variation margin") made or
received to settle the daily fluctuations in the value of futures contracts are
recorded as unrealized gains or losses until the contracts are closed. Unsettled
variation margin on futures contracts is included in investments in securities,
and unrealized gains and losses on future contracts are included in the change
in net unrealized gain or loss in the accompanying financial statements.
Distributions to shareholders are recorded on the ex-dividend date. Income
distributions are declared on a daily basis and paid monthly. Capital gain
distributions, if any, are declared and paid by the fund, typically on an annual
basis.
Other
In the normal course of business, the fund enters into contracts that provide
general indemnifications. The fund's maximum exposure under these arrangements
is dependent on claims that may be made against the fund in the future and,
therefore, cannot be estimated; however, based on experience, the risk of
material loss from such claims is considered remote.
NOTE 2 - INVESTMENT TRANSACTIONS
Consistent with its investment objective, the fund engages in the following
practices to manage exposure to certain risks or enhance performance. The
investment objective, policies, program, and risk factors of the fund are
described more fully in the fund's prospectus and Statement of Additional
Information.
Futures Contracts
During the six months ended November 30, 2004, the fund was a party to futures
contracts, which provide for the future sale by one party and purchase by
another of a specified amount of a specific financial instrument at an agreed
upon price, date, time, and place. Risks arise from possible illiquidity of the
futures market and from movements in security values and/or interest rates.
Other
Purchases and sales of U.S. government securities aggregated $735,524,000 and
$724,239,000, respectively, for the six months ended November 30, 2004.
NOTE 3 - FEDERAL INCOME TAXES
No provision for federal income taxes is required since the fund intends to
continue to qualify as a regulated investment company under Subchapter M of the
Internal Revenue Code and distribute to shareholders all of its taxable income
and gains. Federal income tax regulations differ from generally accepted
accounting principles; therefore, distributions determined in accordance with
tax regulations may differ in amount or character from net investment income and
realized gains for financial reporting purposes. Financial reporting records are
adjusted for permanent book/tax differences to reflect tax character. Financial
records are not adjusted for temporary differences. The amount and character of
tax-basis distributions and composition of net assets are finalized at fiscal
year-end; accordingly, tax-basis balances have not been determined as of
November 30, 2004.
For tax purposes, the fund has elected to treat net capital losses realized
between November 1 and May 31 of each year as occurring on the first day of the
following tax year; consequently, $3,595,000 of realized losses recognized for
financial reporting purposes in the year ended May 31, 2004 were recognized for
tax purposes on June 1, 2004. Further, the fund intends to retain realized gains
to the extent of available capital loss carryforwards. As of May 31, 2004, the
fund had $8,219,000 of unused capital loss carryforwards that expire in fiscal
2012.
At November 30, 2004, the cost of investments for federal income tax purposes
was $1,458,088,000. Net unrealized gain aggregated $11,819,000 at period-end, of
which $20,017,000 related to appreciated investments and $8,198,000 related to
depreciated investments.
NOTE 4- RELATED PARTY TRANSACTIONS
The fund is managed by T. Rowe Price Associates, Inc. (the manager or Price
Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. The
investment management agreement between the fund and the manager provides for an
annual investment management fee, which is computed daily and paid monthly. The
fee consists of an individual fund fee, equal to 0.15% of the fund's average
daily net assets, and the fund's pro-rata share of a group fee. The group fee is
calculated based on the combined net assets of certain mutual funds sponsored by
Price Associates (the group) applied to a graduated fee schedule, with rates
ranging from 0.48% for the first $1 billion of assets to 0.295% for assets in
excess of $120 billion. The fund's portion of the group fee is determined by the
ratio of its average daily net assets to those of the group. At November 30,
2004, the effective annual group fee rate was 0.31%, and investment management
fee payable totaled $510,000.
In addition, the fund has entered into service agreements with Price Associates
and two wholly owned subsidiaries of Price Associates (collectively, Price).
Price Associates computes the daily share price and maintains the financial
records of the fund. T. Rowe Price Services, Inc., provides shareholder and
administrative services in its capacity as the fund's transfer and dividend
disbursing agent. T. Rowe Price Retirement Plan Services, Inc., provides
subaccounting and recordkeeping services for certain retirement accounts
invested in the fund. For the six months ended November 30, 2004, expenses
incurred pursuant to these service agreements were $52,000 for Price Associates,
$313,000 for T. Rowe Price Services, Inc., and $99,000 for T. Rowe Price
Retirement Plan Services, Inc. At period-end, a total of $98,000 of these
expenses was payable.
The fund is also one of several mutual funds sponsored by Price Associates
(underlying Price funds) in which the T. Rowe Price Spectrum Funds (Spectrum
Funds) may invest. The Spectrum Funds do not invest in the underlying Price
funds for the purpose of exercising management or control. Pursuant to a special
servicing agreement, expenses associated with the operation of the Spectrum
Funds are borne by each underlying Price fund to the extent of estimated savings
to it and in proportion to the average daily value of its shares owned by the
Spectrum Funds. Expenses allocated under this agreement are reflected as
shareholder servicing expense in the accompanying financial statements. For the
six months ended November 30, 2004, the fund was allocated $474,000 of Spectrum
Funds' expenses, of which $300,000 related to services provided by Price and
$78,000 was payable at period-end. At November 30, 2004, approximately 38% of
the outstanding shares of the fund were held by the Spectrum Funds.
The fund may invest in the T. Rowe Price Reserve Investment Fund and the T. Rowe
Price Government Reserve Investment Fund (collectively, the Reserve Funds),
open-end management investment companies managed by Price Associates and
affiliates of the fund. The Reserve Funds are offered as cash management options
to mutual funds, trusts, and other accounts managed by Price Associates and/or
its affiliates, and are not available for direct purchase by members of the
public. The Reserve Funds pay no investment management fees. During the six
months ended November 30, 2004, dividend income from the Reserve Funds totaled
$637,000, and the value of shares of the Reserve Funds held at November 30, 2004
and May 31, 2004 was $141,216,000 and $100,524,000, respectively.
T. Rowe Price GNMA Fund
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Information on Proxy Voting Policies, Procedures, and Records
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A description of the policies and procedures used by T. Rowe Price funds and
portfolios to determine how to vote proxies relating to portfolio securities is
available in each fund's Statement of Additional Information, which you may
request by calling 1-800-225-5132 or by accessing the SEC's Web site,
www.sec.gov. The description of our proxy voting policies and procedures is also
available on our Web site, www.troweprice.com. To access it, click on the words
"Company Info" at the top of our homepage for individual investors. Then, in
the window that appears, click on the "Proxy Voting Policy" navigation button in
the top left corner.
Each fund's most recent annual proxy voting record is available on our Web site
and through the SEC's Web site. To access it through our Web site, follow the
directions above, then click on the words "Proxy Voting Record" at the bottom
of the Proxy Voting Policy page.
How to Obtain Quarterly Portfolio Holdings
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The fund files a complete schedule of portfolio holdings with the Securities and
Exchange Commission for the first and third quarters of each fiscal year on Form
N-Q. The fund's Form N-Q is available electronically on the SEC's Web site
(www.sec.gov); hard copies may be reviewed and copied at the SEC's Public
Reference Room, 450 Fifth St. N.W., Washington, DC 20549. For more information
on the Public Reference Room, call 1-800-SEC-0330.
Item 2. Code of Ethics.
A code of ethics, as defined in Item 2 of Form N-CSR, applicable to its
principal executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions is filed as an
exhibit to the registrant's annual Form N-CSR. No substantive amendments were
approved or waivers were granted to this code of ethics during the registrant's
most recent fiscal half-year.
Item 3. Audit Committee Financial Expert.
Disclosure required in registrant's annual Form N-CSR.
Item 4. Principal Accountant Fees and Services.
Disclosure required in registrant's annual Form N-CSR.
Item 5. Audit Committee of Listed Registrants.
Not applicable.
Item 6. Schedule of Investments.
Not applicable. The complete schedule of investments is included in Item 1 of
this Form N-CSR.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers.
Not applicable.
Item 10. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 11. Controls and Procedures.
(a) The registrant's principal executive officer and principal financial officer
have evaluated the registrant's disclosure controls and procedures within 90
days of this filing and have concluded that the registrant's disclosure controls
and procedures were effective, as of that date, in ensuring that information
required to be disclosed by the registrant in this Form N-CSR was recorded,
processed, summarized, and reported timely.
(b) The registrant's principal executive officer and principal financial officer
are aware of no change in the registrant's internal control over financial
reporting that occurred during the registrant's second fiscal quarter covered by
this report that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting.
Item 12. Exhibits.
(a)(1) The registrant's code of ethics pursuant to Item 2 of Form N-CSR is filed
with the registrant's annual Form N-CSR.
(2) Separate certifications by the registrant's principal executive officer
and principal financial officer, pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 and required by Rule 30a-2(a) under the Investment Company Act of
1940, are attached.
(3) Written solicitation to repurchase securities issued by closed-end
companies: not applicable.
(b) A certification by the registrant's principal executive officer and
principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 and required by Rule 30a-2(b) under the Investment Company Act of 1940,
is attached.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and
the Investment Company Act of 1940, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
T. Rowe Price GNMA Fund
By /s/ James S. Riepe
-----------------------------------
James S. Riepe
Principal Executive Officer
Date January 14, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934 and
the Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By /s/ James S. Riepe
-----------------------------------
James S. Riepe
Principal Executive Officer
Date January 14, 2005
By /s/ Joseph A. Carrier
-----------------------------------
Joseph A. Carrier
Principal Financial Officer
Date January 14, 2005