UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT
COMPANIES
Investment Company Act file number 811-4077
Name of Fund: Merrill Lynch U.S. Government Mortgage Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Terry K. Glenn, President,
Merrill Lynch U.S. Government Mortgage Fund, Inc., 800 Scudders Mill
Road, Plainsboro, NJ, 08536. Mailing address: P.O. Box 9011,
Princeton, NJ, 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 08/31/03
Date of reporting period: 09/01/02 - 08/31/03
Item 1 - Attach shareholder report
(BULL LOGO)
Merrill Lynch Investment Managers
www.mlim.ml.com
Merrill Lynch
U.S. Government
Mortgage Fund
Annual Report
August 31, 2003
This report is not authorized for use as an offer of sale or a
solicitation of an offer to buy shares of the Fund unless
accompanied or preceded by the Fund's current prospectus. Past
performance results shown in this report should not be considered a
representation of future performance. Investment return and
principal value of shares will fluctuate so that shares, when
redeemed, may be worth more or less than their original cost.
Statements and other information herein are as dated and are subject
to change.
A description of the policies and procedures that the Fund uses to
determine how to vote proxies relating to portfolio securities is
available (1) without charge, upon request, by calling toll-free
1-800-MER-FUND (1-800-637-3863); (2) on www.mutualfunds.ml.com; and
(3) on the Securities and Exchange Commission's website at
http://www.sec.gov.
Merrill Lynch U.S. Government Mortgage Fund
Box 9011
Princeton, NJ
08543-9011
A Letter From the President
Dear Shareholder
Now more than half behind us, 2003 has been a meaningful year in
many respects. After one of the most significant equity market
downturns in many investors' memories, this year finally brought
hopeful signs for a sustainable economic recovery. With that bit of
good news, fixed income investments, which had become the asset
class of choice during the long equity market decline, were left to
perform on a new playing field.
The Federal Reserve Board continued its accommodative monetary
policy into June 2003, when it brought the Federal Funds rate down
to 1%, its lowest level since 1958. With this move, long-term
interest rates continued to be volatile, as investors began to
anticipate the impact of future Federal Reserve Board moves and
economic revitalization. As of August 31, 2003, the 10-year Treasury
bond was yielding 4.47%. This compared to a yield of 3.69% six
months earlier and 4.14% one year ago.
Against this backdrop, our portfolio managers continued to work
diligently to deliver on our commitment to provide superior
performance within reasonable expectations for risk and return. With
that said, remember also that the advice and guidance of a skilled
financial advisor often can mean the difference between fruitful and
fruitless investing. A financial professional can help you choose
those investments that will best serve you as you plan for your
financial future.
Finally, I am proud to premiere a new look to our shareholder
communications. Our portfolio manager commentaries have been trimmed
and organized in such a way that you can get the information you
need at a glance, in plain language. Today's markets are confusing
enough. We want to help you put it all in perspective. The report's
new size also allows us certain mailing efficiencies.
We thank you for trusting Merrill Lynch Investment Managers with
your investment assets, and we look forward to serving you in the
months and years ahead.
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President and Trustee
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
We are pleased to present to you the management team of
Merrill Lynch U.S. Government Mortgage Fund
Senior Portfolio Manager Frank Viola joined Merrill Lynch Investment
Managers in 1997 and heads the Merrill Lynch U.S. Government
Mortgage Fund team. Mr. Viola received a bachelor's degree from The
Pennsylvania State University and is a CFA R charterholder. He is
also an associate of the Society of Actuaries and a member of the
American Academy of Actuaries. In addition to Mr. Viola, the
investment team includes Co-Portfolio Manager Teresa Giacino,
Jeffrey Hewson, Ted Magnani and Tom Musmanno. Ms. Giacino earned a
bachelor's degree from Rider University. Mr. Hewson received a
bachelor's degree and an MBA from Rutgers University. Mr. Magnani
has a bachelor's degree from Rutgers University. Mr. Musmanno
received a bachelor's degree from Siena College and an MBA from St.
John's University. He is a CFA charterholder and a member of the
Association for Investment Management and Research and the New York
Society of Security Analysts. The team has a combined 81 years of
investment experience.
Frank Viola
Senior Portfolio Manager
Table of Contents
A Letter From the President 2
A Discussion With Your Fund's Portfolio Managers 4
Performance Data 6
Schedule of Investments 10
Financial Information 14
Financial Highlights 17
Notes to Financial Statements 22
Independent Auditors' Report 28
Officers and Trustees 29
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
A Discussion With Your Fund's Portfolio Managers
The year was marked by extreme volatility in long-term interest
rates, and we ended the period overweight in mortgage-backed
securities and with a conservative duration in line with that of the
Fund's benchmark.
Discuss the economic conditions that existed during the period.
Economic news was mixed during the period. Late in 2002 and into
2003, U.S. economic activity slowed as the conflict in Iraq brought
consumer and business spending to a standstill. Gross domestic
product (GDP) for the first quarter of 2003 grew at only 1.4%, the
same rate of growth as the disappointing fourth quarter of 2002. On
the positive side, low mortgage rates supported the strength in the
housing market and mortgage refinancing provided consumers with some
financial flexibility.
As the geopolitical concerns subsided, economic growth began to show
improvement, with 3.3% growth registered in the second quarter of
2003. By the end of August 2003, it was evident that the U.S.
economy was growing still faster. Even if further defense spending
increases do not match up to second-quarter levels, we believe
consumer spending and business investment expenditure should
continue to drive the economy to above 4% growth in the second half
of 2003.
Despite the generally favorable growth trend, weak labor markets and
a more recent decline in mortgage-refinancing activity shed doubt
over the sustainability of the economic expansion. Nevertheless, we
believe the longer-term prospects for the economy seem bright.
Throughout the period, the Federal Reserve Board maintained its
accommodative monetary policy, most recently dropping the Federal
Funds rate to 1% at its June meeting. We expect short-term interest
rates to remain at this level for some time as the Federal Reserve
Board maintains its focus on achieving sustainable economic growth.
How did the Fund perform during the fiscal year in light of the
existing market conditions?
For the 12 months ended August 31, 2003, the Fund's Class A, Class
B, Class C and Class I Shares had total returns of +1.93%, +1.40%,
+1.35% and +2.08%, respectively. This compared to the +2.49% return
of the Fund's unmanaged benchmark, the Citigroup Mortgage Index, for
the same period. (Fund results shown do not reflect sales charges
and would be lower if sales charges were included. Complete
performance information can be found on pages 6 - 9 of this report
to shareholders.)
The slightly longer average duration of the portfolio's mortgage-
backed securities (MBS) contributed to the relative underperformance
during the period. The Fund's overall exposure to the mortgage
market rose as we purchased MBS forward by financing existing
positions. That is, we agreed to purchase MBS for a predetermined
price at a future time rather than sell some of our holdings to fund
these purchases. We sought to reduce the risk associated with this
strategy by short-selling U.S. Treasury futures. This was based on
our belief that MBS returns would exceed those of Treasury issues.
In fact, Fund performance did benefit from an extended rally in
mortgage securities during much of the year. However, this strategy
detracted from performance in July 2003, when MBS dramatically
underperformed Treasury notes. The MBS market recouped some of its
losses in August when it outperformed Treasury issues by 28 basis
points (.28%).
The past year was characterized by considerable interest rate
volatility. The yield on the ten-year Treasury note, a benchmark for
MBS, reached its historical low in June. At the same time, however,
we saw historically high levels of mortgage-refinancing activity. As
a result, the prepayments of higher-rate mortgages prevented MBS
prices from rising significantly, and MBS returns were eroded.
Additionally, the record-high values and refinancing activity
shortened the duration of MBS. At one point during the 12-month
period, the duration of the Citigroup Mortgage Index was under one
year.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Late in the period, as long-term interest rates increased
dramatically and the yield on the ten-year Treasury note rose nearly
150 basis points from its June low, the risk in the MBS market
shifted from prepayment risk to duration-extension risk. When
interest rates rise considerably, refinancing opportunity
diminishes, thereby extending the duration of MBS. At its peak
during the 12-month period, the duration of the Citigroup Mortgage
Index was 4.7 years.
What changes were made to the portfolio during the period?
We increased the Fund's exposure to MBS, as this sector provided a
significant yield advantage over U.S. Treasury issues with
comparable durations. We purchased these securities forward by
financing existing positions. We were able to finance much of the
portfolio's collateral position at rates that were lower than the
effective yields of the securities. The steep Treasury yield curve
and the demand for collateralized mortgage obligation issues helped
to sustain the strong demand for MBS collateral.
Also during the period, we reduced the Fund's exposure to U.S.
Treasury securities and agency debt. In addition, as swap spreads
(the difference in yields between fixed- and variable-rate
securities that are traded among borrowers and lenders) reached
historical lows, we reduced the Fund's position in multi-family
mortgage pools, as their valuations reached rich levels.
How would you characterize the Fund's position at the close of the
period?
At the end of August, the Fund remained overweight in MBS and was
positioned with a near-benchmark duration. While we believe some
interest rate volatility will continue in the near future, we also
believe that, barring a major geopolitical event, the ten-year
Treasury note will trade within a 4.10% - 4.75% yield range. In our
opinion, the yield spread between MBS and Treasury issues should
tighten as this new range is established and interest rate
volatility stabilizes. This should allow MBS to outperform its
Treasury counterparts on a duration-adjusted basis.
Frank Viola
Vice President and Portfolio Manager
Teresa L. Giacino
Vice President and Portfolio Manager
September 9, 2003
Effective April 14, 2003, the share class names for the Merrill
Lynch family of mutual funds were changed to be consistent with the
standard share classes of most other mutual fund families. As of
that date, all Class A Shares were redesignated Class I Shares. At
the same time, Class D Shares were redesignated Class A Shares.
There are no changes to the Class B or Class C share class labels.
Trading symbols have not changed nor have current eligibility rules
or pricing structures. This redesignation of share classes does not
impact your investment.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Performance Data
About Fund Performance
Effective April 14, 2003, Class A Shares were redesignated Class I
Shares and Class D Shares were redesignated Class A Shares.
Investors are able to purchase shares of the Fund through multiple
pricing alternatives:
* Class A Shares incur a maximum initial sales charge of 4% and an
account maintenance fee of 0.25% (but no distribution fee).
* Effective December 1, 2002, Class B Shares are subject to a
maximum contingent deferred sales charge of 4%, declining to 0%
after six years. All Class B Shares purchased prior to December 1,
2002 will maintain the four-year schedule. In addition, Class B
Shares are subject to a distribution fee of 0.50% and an account
maintenance fee of 0.25%. These shares automatically convert to
Class A Shares after approximately ten years. (There is no initial
sales charge for automatic share conversions.)
* Class C Shares are subject to a distribution fee of 0.55% and an
account maintenance fee of 0.25%. In addition, Class C Shares are
subject to a 1% contingent deferred sales charge if redeemed within
one year of purchase.
* Class I Shares incur a maximum initial sales charge (front-end
load) of 4% and bear no ongoing distribution or account maintenance
fees. Class I Shares are available only to eligible investors, as
detailed in the Fund's prospectus.
* Class R Shares do not incur a maximum sales charge (front-end
load) or deferred sales charge. These shares are subject to a
distribution fee of 0.25% and an account maintenance fee of 0.25%.
Class R Shares are available only to certain retirement plans.
None of the past results shown should be considered a representation
of future performance. Performance results do not reflect the
deduction of taxes that a shareholder would pay on fund
distributions or the redemption of fund shares. Figures shown in
each of the following tables assume reinvestment of all dividends
and capital gains distributions at net asset value on the payable
date. Investment return and principal value of shares will fluctuate
so that shares, when redeemed, may be worth more or less than their
original cost. Dividends paid to each class of shares will vary
because of the different levels of account maintenance, distribution
and transfer agency fees applicable to each class, which are
deducted from the income available to be paid to shareholders.
Recent Performance Results
Ten-Year/
6-Month 12-Month Since Inception Standardized
As of August 31, 2003 Total Return Total Return Total Return 30-Day Yield
ML U.S. Government Mortgage Fund Class A Shares* -0.94% +1.93% +74.09% 0.88%
ML U.S. Government Mortgage Fund Class B Shares* -1.19 +1.40 +65.32 0.40
ML U.S. Government Mortgage Fund Class C Shares* -1.22 +1.35 +71.92 0.35
ML U.S. Government Mortgage Fund Class I Shares* -0.81 +2.08 +84.78 1.12
ML U.S. Government Mortgage Fund Class R Shares* -0.81 -- + 0.44 0.67
Citigroup Mortgage Index** -0.56 +2.49 +91.91/+93.67/+0.57 --
*Investment results shown do not reflect sales charges; results
shown would be lower if a sales charge was included. Total
investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital
gains distributions at net asset value on the payable date. The
Fund's ten-year/inception periods are ten years for Class A & Class
B Shares, from 10/21/94 for Class C & Class I Shares, and from
1/03/03 for Class R Shares.
**This unmanaged Index reflects the performance of a capital market
weighting of the outstanding agency-issued mortgage-backed
securities. Ten year/since inception total returns are for ten
years, from 10/31/94 and from 1/03/03, respectively.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Performance Data (continued)
TOTAL RETURN BASED ON A $10,000 INVESTMENT
A line graph illustrating the growth of a $10,000 investment in
ML U.S. Government Mortgage Fund++ Class A and Class B Shares*
compared to a similar investment in Citigroup Mortgage Index++++.
Values illustrated are as follows:
ML U.S. Government Mortgage Fund++
Class A Shares*
Date Value
August 1993 $ 9,600.00
August 1994 $ 9,402.00
August 1995 $10,293.00
August 1996 $10,729.00
August 1997 $11,727.00
August 1998 $12,648.00
August 1999 $12,772.00
August 2000 $13,676.00
August 2001 $15,240.00
August 2002 $16,394.00
August 2003 $16,712.00
ML U.S. Government Mortgage Fund++
Class B Shares*
Date Value
August 1993 $10,000.00
August 1994 $ 9,745.00
August 1995 $10,591.00
August 1996 $11,005.00
August 1997 $11,965.00
August 1998 $12,839.00
August 1999 $12,898.00
August 2000 $13,740.00
August 2001 $15,232.00
August 2002 $16,301.00
August 2003 $16,532.00
Citigroup Mortgage Index++++
Date Value
August 1993 $10,000.00
August 1994 $10,046.00
August 1995 $11,147.00
August 1996 $11,708.00
August 1997 $12,924.00
August 1998 $14,031.00
August 1999 $14,297.00
August 2000 $15,458.00
August 2001 $17,293.00
August 2002 $18,725.00
August 2003 $19,191.00
*Assuming maximum sales charge, transaction costs and other
operating expenses, including advisory fees.
++The Fund invests primarily in U.S. government and U.S. government
agency securities, including GNMA mortgage-backed certificates and
other mortgage-backed government securities. U.S. government agency
securities include debt securities issued or guaranteed or to
principal and interest by U.S. government agencies, U.S. government
sponsored enterprises and U.S. government instrumentalities that are
not direct obligations of the United States.
++++This unmanaged Index reflects the performance of a capital
market weighting of the outstanding agency-issued mortgage-backed
securities.
Past performance is not predictive of future performance.
Average Annual Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
One Year Ended 8/31/03 +1.93% -2.15%
Five Years Ended 8/31/03 +5.73 +4.87
Ten Years Ended 8/31/03 +5.70 +5.27
*Maximum sales charge is 4%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
One Year Ended 8/31/03 +1.40% -2.55%
Five Years Ended 8/31/03 +5.19 +4.86
Ten Years 8/31/03 +5.16 +5.16
*Maximum contingent deferred sales charge is 4% and is reduced to 0%
after six years.
**Assuming payment of applicable contingent deferred sales charge.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Performance Data (continued)
TOTAL RETURN BASED ON A $10,000 INVESTMENT
A line graph illustrating the growth of a $10,000 investment in
ML U.S. Government Mortgage Fund++ Class C and Class I Shares*
compared to a similar investment in Citigroup Mortgage Index++++.
Values illustrated are as follows:
ML U.S. Government Mortgage Fund++
Class C Shares*
Date Value
10/21/1994** $10,000.00
August 1995 $11,057.00
August 1996 $11,483.00
August 1997 $12,479.00
August 1998 $13,384.00
August 1999 $13,439.00
August 2000 $14,309.00
August 2001 $15,856.00
August 2002 $16,960.00
August 2003 $17,192.00
ML U.S. Government Mortgage Fund++
Class I Shares*
Date Value
10/21/1994** $ 9,600.00
August 1995 $10,709.00
August 1996 $11,192.00
August 1997 $12,275.00
August 1998 $13,272.00
August 1999 $13,436.00
August 2000 $14,408.00
August 2001 $16,095.00
August 2002 $17,374.00
August 2003 $17,739.00
Citigroup Mortgage Index++++
Date Value
10/21/1994** $10,000.00
August 1995 $11,249.00
August 1996 $11,816.00
August 1997 $13,042.00
August 1998 $14,159.00
August 1999 $14,428.00
August 2000 $15,600.00
August 2001 $17,451.00
August 2002 $18,896.00
August 2003 $19,367.00
*Assuming maximum sales charge, transaction costs and other
operating expenses, including advisory fees.
**Commencement of operations.
++The Fund invests primarily in U.S. government and government
agency securities, including GNMA mortgage-backed certificates and
other mortgage-backed government securities. U.S. government agency
securities include debt securities issued or guaranteed or to
principal and interest by U.S. government agencies, U.S. government
sponsored enterprises and U.S. government instrumentalities that are
not direct obligations of the United States.
++++This unmanaged Index reflects the performance of a capital
market weighting of the outstanding agency-issued mortgage-backed
securities. The starting date for the Index is from 10/31/94.
Past performance is not predictive of future performance.
Average Annual Total Return
% Return % Return
Without CDSC With CDSC**
Class C Shares*
One Year Ended 8/31/03 +1.35% +0.36%
Five Years Ended 8/31/03 +5.14 +5.14
Inception (10/21/94)
through 8/31/03 +6.31 +6.31
*Maximum contingent deferred sales charge is 1% and is reduced to 0%
after one year.
**Assuming payment of applicable contingent deferred sales charge.
% Return Without % Return With
Sales Charge Sales Charge**
Class I Shares*
One Year Ended 8/31/03 +2.08% -2.00%
Five Years Ended 8/31/03 +5.97 +5.11
Inception (10/21/94)
through 8/31/03 +7.18 +6.68
*Maximum sales charge is 4%.
**Assuming maximum sales charge.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Performance Data (concluded)
TOTAL RETURN BASED ON A $10,000 INVESTMENT
A line graph illustrating the growth of a $10,000 investment in
ML U.S. Government Mortgage Fund++ Class R Shares* compared to a
similar investment in Citigroup Mortgage Index++++. Values
illustrated are as follows:
ML U.S. Government Mortgage Fund++
Class R Shares*
Date Value
1/03/2003** $10,000.00
August 2003 $10,044.00
Citigroup Mortgage Index++++
Date Value
1/03/2003** $10,000.00
August 2003 $10,057.00
*Assuming maximum sales charge, transaction costs and other
operating expenses, including advisory fees.
**Commencement of operations.
++The Fund invests primarily in U.S. government and government
agency securities, including GNMA mortgage-backed certificates and
other mortgage-backed government securities. U.S. government agency
securities include debt securities issued or guaranteed or to
principal and interest by U.S. government agencies, U.S. government
sponsored enterprises and U.S. government instrumentalities that are
not direct obligations of the United States.
++++This unmanaged Index reflects the performance of a capital
market weighting of the outstanding agency-issued mortgage-backed
securities.
Past performance is not predictive of future performance.
Aggregate Total Return
% Return Without
Sales Charge
Class R Shares
Inception (1/03/03) through 8/31/03 +0.44%
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Schedule of Investments
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
Non-U.S. Government Agency Mortgage-Backed Obligations*--1.2%
Countrywide Home Loans, Inc. 02-18-A10 $ 7,225,548 5.50 % 11/25/2032 $ 7,282,789
02-32-1A1 6,819,017 6.00 11/25/2032 6,910,626
Deutsche Mortgage Securities, Inc. 03-01-1A1 12,315,932 4.50 4/25/2033 12,429,322
Total Non-U.S. Government Agency Obligations (Cost--$26,665,354) 26,622,737
U.S. Government Agency Obligations--1.6%
Fannie Mae 10,000,000 4.25 7/15/2007 10,318,440
Freddie Mac Participation Certificates 25,000,000 5.75 4/29/2009 25,636,250
Total U.S. Government Agency Obligations (Cost--$35,962,493) 35,954,690
U.S. Government Agency Mortgage-Backed Obligations*--104.9%
Fannie Mae 25,000,000 4.50 TBA(11) 24,554,700
18,460,810 5.00 TBA(11) 18,524,278
39,518,137 6.50 12/01/2008 - 2/01/2014 41,620,764
104,467,651 6.50 4/01/2026 - 12/01/2032 108,161,346
4,562,229 7.00 11/01/2013 - 11/01/2014 4,850,851
31,370 7.00 8/01/2029 33,092
24,655,008 7.50 7/01/2016 - 12/01/2032 26,218,210
135,840 8.00 9/01/2024 - 9/01/2027 146,798
145,449 8.50 5/01/2010 - 8/01/2012 158,972
3,395,100 8.50(3) 7/15/2023 3,699,715
2,445,855 9.50 3/01/2020 2,614,008
826,155 11.00 10/01/2011 - 8/01/2020 924,460
386,281 13.00 8/01/2013 - 3/01/2015 445,821
Fannie Mae #0385872 5,392,605 4.28(7) 2/01/2010 5,321,292
Mortgage-Backed Securities-- #0629304 971,016 5.50(9) 3/01/2032 967,608
Multi-Family++ #0160465 31,836,907 6.16(8) 8/01/2013 34,434,722
#0073943 1,292,454 7.18(4) 2/01/2019 1,374,605
#0375052 4,471,219 7.50(9) 3/01/2027 4,867,294
#0160024 697,398 7.625(10) 11/01/2003 699,432
Fannie Mae 94-M1-IO 12,336,371 0.87(1) 10/25/2003 15,420
Mortgage-Backed Securities-- 98-M1-IO2 82,399,940 1.0664(1) 2/25/2013 3,077,786
REMICs**--Multi-Family++ 02-M2-N 173,087,334 1.6793(1) 8/25/2012 17,350,967
97-M8-A2 19,135,000 7.16 1/25/2022 20,956,694
96-M3-A2 5,004,474 7.41 3/25/2021 5,100,858
Fannie Mae REMICS** 03-41-YF 25,000,000 1.41 6/25/2028 25,160,310
03-23-AB 17,639,408 4.00 3/25/2017 17,365,512
94-56-TB 2,268,633 6.50(1) 7/25/2022 28,664
Trust 273 802,750 7.00(1) 7/01/2026 136,987
96-W1-AL 3,704,079 7.25 3/25/2026 3,846,795
Freddie Mac 406 10.00 7/01/2019 451
Participation Certificates 2,401,968 10.50 1/01/2010 - 9/01/2020 2,678,877
481,588 11.00 8/01/2010 - 9/01/2020 539,713
607,511 11.50 12/01/2011 - 6/01/2020 685,586
344,036 12.00 5/01/2010 - 6/01/2020 389,358
474,217 12.50 11/01/2014 - 7/01/2019 535,337
898,785 13.00 11/01/2009 - 2/01/2016 1,028,051
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Schedule of Investments (continued)
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
U.S. Government Agency Mortgage-Backed Obligations (concluded)
Freddie Mac $ 8,000,795 4.50 % 6/01/2018 - 9/01/2018 $ 7,860,378
Participation Certificates-- 55,000,000 4.50 8/01/2033 - 9/15/2033 51,210,891
Gold Program 123,254,606 5.00 5/01/2018 - 9/15/2018 123,678,354
167,000,098 5.00 5/01/2033 - 9/15/2033 161,429,534
68,975,756 5.50 3/01/2013 - 12/01/2017 70,461,938
521,000,000 5.50 8/01/2033 - 9/15/2033 518,594,692
79,185,766 6.00 4/01/2009 - 10/01/2017 81,910,952
279,539,847 6.00 3/01/2029 - 9/15/2033 284,048,654
202,449,603 6.50 10/01/2028 - 10/15/2033 209,437,266
10,867,258 7.00 8/01/2011 - 6/01/2016 11,515,883
121,667,636 7.00 7/01/2028 - 7/01/2032 128,157,196
2,858,366 7.50 5/01/2009 - 10/01/2011 3,044,139
67,645,540 7.50 8/01/2017 - 12/01/2032 72,051,755
3,280,130 8.00 1/01/2008 - 7/01/2012 3,530,939
9,198,169 8.00 10/01/2027 - 8/01/2032 9,845,017
770,071 8.50 1/01/2025 - 7/01/2025 835,338
462,761 10.50 10/01/2020 - 12/01/2020 520,102
Freddie Mac REMICS** Trust 134 201,006 9.00(1) 4/01/2022 9,680
Trust 1220 1,106,072 10.00 2/15/2022 1,111,130
Government National Mortgage Association 696,033 5.50 3/15/2029 - 4/15/2029 697,970
5,557,493 6.00 5/15/2024 - 11/15/2031 5,679,382
57,966,599 6.50 10/15/2023 - 3/15/2032 60,337,048
59,747,410 7.00 4/15/2023 - 4/15/2032 63,186,766
19,970,846 7.50 2/15/2025 - 12/15/2031 21,276,110
9,964,191 8.00 1/15/2024 - 8/15/2026 10,761,929
6,541,932 10.00 12/15/2015 - 12/15/2021 7,309,913
31,743 10.50 1/15/2016 - 4/15/2021 35,672
69 11.00 1/15/2016 79
964 11.50 8/15/2013 1,095
Government National Mortgage 2002-81B 10,000,000 5.042 1/16/2029 9,755,366
Association REMICS**
Total U.S. Government Agency Mortgage-Backed Obligations (Cost--$2,302,648,107) 2,296,810,502
Short-Term Securities--35.5%
U.S. Government Agency Fannie Mae 575,000,000 1.01 9/15/2003 (d) 574,786,854
Obligations*** 160,000,000 1.03 9/18/2003 159,926,756
---------------
734,713,610
Beneficial Interest/
Shares Held
Merrill Lynch Liquidity Series, LLC Money
Market Series (a)(b) $ 5,082,000 5,082,000
Merrill Lynch Premier Institutional
Fund (a)(b) 3,388,000 3,388,000
---------------
8,470,000
Face
Amount Issue
Repurchase Agreements $34,500,000 Morgan Stanley & Co., Inc. purchased on 8/29/2003 to
yield 1% to 9/02/2003, repurchase price $34,503,833
collateralized by FGCI and FNMA, 4.417% to 7.00% due
10/01/2013 to 5/01/2033 34,500,000
Total Short-Term Securites (Cost--$777,683,610) 777,683,610
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Schedule of Investments (continued)
Number of Contracts/ Strike Notification
Notional Amount Issue Price Date Value
Options Purchased--0.1%
Call Options 4,740 Government National Mortgage Association,
Purchased 30-Year, 5.75% Adjustable Rate Mortgage,
Broker Lehman Brothers (5)(6) 100 9/20/2011(5) $ 3,792
$33,600,000 Swaption, expiring 8/27/2013, Broker,
Lehman Brothers (2) 1,471,210
---------------
1,475,002
Put Options $33,600,000 Swaption, expiring 8/27/2013, Broker,
Purchased Lehman Brothers (2) 1,644,586
Total Options Purchased (Cost--$3,024,000) 3,119,588
Total Investments (Cost--$3,145,983,564)--143.3% 3,140,191,127
Options Written--(0.2%)
Call Options $12,500,000 Swaption, expiring 9/08/2003, Broker,
Written Morgan Stanley (2) (7,900)
$50,000,000 Swaption, expiring 8/30/2005, Broker,
Lehman Brothers (2) (2,818,250)
---------------
(2,826,150)
Put Options 4,740 Government National Mortgage Association,
Written 30-Year, 5.75% Adjustable Rate Mortgage,
Broker, Lehman Brothers (5)(6) 100 9/20/2011(5) (4,740)
$12,500,000 Swaption, expiring 9/08/2003, Broker,
Morgan Stanley (2) (27,138)
$50,000,000 Swaption, expiring 8/30/2005, Broker,
Lehman Brothers (2) (2,563,800)
---------------
(2,595,678)
Total Options Written (Premiums Received--$5,487,400) (5,421,828)
Total Investments, Net of Options Written (Cost--$3,140,496,164)--143.1% 3,134,769,299
Variation Margin on Financial Futures Contracts (c)--0.1% 610,313
Liabilities in Excess of Other Assets (e)--(43.2%) (945,377,533)
---------------
Net Assets--100.0% $ 2,190,002,079
===============
(1)Represents the interest only portion of a mortgage-backed
obligation.
(2)This European style swaption, which can be exercised only to the
expiration date, represents a standby commitment whereby the Fund is
obligated to enter into a predetermined interest rate swap contract
upon exercise of the swaption.
(3)Federal Housing Administration/Veterans' Administration Mortgages
packaged by the Federal National Mortgage Association.
(4)Represents a balloon mortgage that amortizes on a 22-year
schedule and has a 22-year original maturity.
(5)Represents European style options which can be exercised only on
the notification date. These options, when combined, represent a
standby purchase commitment whereby the Fund is obligated to
purchase the outstanding principal amount of specific Government
National Mortgage Association, 30-year, 5.75% Adjustable Rate
Mortgage pools as of September 20, 2011. For this commitment, the
Fund receives a net .12% per annum based on the nominal value
covered by the options.
(6)Adjustable Rate Security. The interest rate resets annually at
the one-year Constant Maturing Treasury rate plus 1.5%, subject to a
1% annual adjustment cap and an 11% life cap.
(7)Represents balloon mortgages that amortize on a 30-year schedule
and has a 7-year original maturity.
(8)Represents a mortgage that amortizes on a 15-year schedule and
has a 15-year original maturity.
(9)Represents a balloon mortgage that amortizes on a 30-year
schedule and has a 30-year original maturity.
(10)Represents a mortgage that amortizes on a 10-year schedule and
has a 10-year original maturity.
(11)Represents a "to-be-announced" (TBA) transaction. The Fund has
committed to purchasing securities for which all specific
information is not available at this time.
++Underlying multi-family loans have prepayment protection by means
of lockout periods and/or yield maintenance premiums.
*Mortgage-Backed Obligations are subject to principal paydowns as a
result of prepayments or refinancings of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity.
**Real Estate Mortgage Investment Conduits (REMIC).
***U.S. Government Agency Obligations are traded on a discount
basis; the interest rate shown reflects the discount rate paid at
the time of purchase by the Fund.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Schedule of Investments (concluded)
(a)Investments in companies considered to be an affiliate of the
Fund (such companies are defined as "Affiliated Companies" in
Section 2(a)(3) of the Investment Company Act of 1940) are as
follows:
Dividend/
Net Interest
Affiliate Activity Income
Merrill Lynch Liquidity Series, LLC
Money Market Series $5,082,000 $9,396
Merrill Lynch Premier Institutional Fund 3,388,000 $7,384
(b)Security was purchased with the cash proceeds from securities
loans.
(c)Financial futures contracts sold as of August 31, 2003 were as
follows:
Number of Expiration Face Unrealized
Contracts Issue Date Value Gains
3,140 U.S. Treasury September
5-Year Notes 2003 $358,795,745 $8,734,807
900 U.S. Treasury September
10-Year Notes 2003 100,836,469 458,344
----------
Total Unrealized Gains--Net $9,193,151
==========
(d)All or a portion of security held as collateral in connection
with open financial futures contracts.
(e)Swaps entered into as of August 31, 2003 were as follows:
Notional Unrealized
Amount Appreciation
Receive a price return equal to
JP Morgan U.S. Agency Mortgage
Index Total Return and pay floating
rate based on 1-month USD LIBOR,
minus .25%
Broker, JP Morgan Chase Bank
Expires January 2004 $ 30,000,000 --
Receive a price return equal to
JP Morgan U.S. Agency Mortgage
Index Total Return and pay floating
rate based on 1-month USD LIBOR,
minus .30%
Broker, JP Morgan Chase Bank
Expires April 2004 $ 50,000,000 --
Receive a price return equal to
JP Morgan U.S. Agency Mortgage
Index Total Return and pay floating
rate based on 1-month USD LIBOR,
minus .30%
Broker, JP Morgan Chase Bank
Expires November 2003 $ 72,000,000 --
Receive a price return equal to
JP Morgan U.S. Agency Mortgage
Index Total Return and pay floating
rate based on 1-month USD LIBOR,
minus .25%
Broker, JP Morgan Chase Bank
Expires January 2004 $ 50,000,000 --
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Statement of Assets and Liabilities
As of August 31, 2003
Assets
Investments, at value (including securities loaned of $8,254,720)
(identified cost--$3,142,959,564) $ 3,137,071,539
Options purchased, at value (cost--$3,024,000) 3,119,588
Cash 21,654
Receivables:
Securities sold $ 19,533,118
Interest 10,116,587
Beneficial interest sold 2,221,361
Swap settlements 1,638,826
Variation margin 610,313
Principal paydowns 407,628 34,527,833
---------------
Prepaid registration fees and other assets 312,410
---------------
Total assets 3,175,053,024
---------------
Liabilities
Collateral on securities loaned, at value 8,470,000
Options purchased, at value (premiums received--$5,487,400) 5,421,828
Payables:
Securities purchased 961,193,932
Beneficial interest redeemed 4,645,415
Dividends to shareholders 2,174,625
Distributor 880,399
Investment adviser 802,366
Other affiliates 686,221 970,382,958
---------------
Accrued expenses and other liabilities 776,159
---------------
Total liabilities 985,050,945
---------------
Net Assets
Net assets $ 2,190,002,079
===============
Net Assets Consist of
Class A Shares of beneficial interest, $.10 par value, unlimited number
of shares authorized $ 8,445,911
Class B Shares of beneficial interest, $.10 par value, unlimited number
of shares authorized 5,838,398
Class C Shares of beneficial interest, $.10 par value, unlimited number
of shares authorized 4,092,593
Class I Shares of beneficial interest, $.10 par value, unlimited number
of shares authorized 3,240,968
Class R Shares of beneficial interest, $.10 par value, unlimited number
of shares authorized 760
Paid-in capital in excess of par 2,204,348,584
Accumulated distributions in excess of investment income--net $ (1,170,818)
Accumulated realized capital losses on investments--net (38,260,602)
Unrealized appreciation on investments--net 3,466,285
---------------
Total accumulated losses--net (35,965,135)
---------------
Net assets $ 2,190,002,079
===============
Net Asset Value
Class A--Based on net assets of $855,543,136 and 84,459,108 shares of
beneficial interest outstanding $ 10.13
===============
Class B--Based on net assets of $591,434,966 and 58,383,975 shares of
beneficial interest outstanding $ 10.13
===============
Class C--Based on net assets of $414,538,693 and 40,925,926 shares of
beneficial interest outstanding $ 10.13
===============
Class I--Based on net assets of $328,408,352 and 32,409,681 shares of
beneficial interest outstanding $ 10.13
===============
Class R--Based on net assets of $76,932 and 7,601 shares of beneficial
interest outstanding $ 10.12
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Statement of Operations
For the Year Ended August 31, 2003
Investment Income
Interest $ 93,477,288
Securities lending--net 16,780
---------------
Total income 93,494,068
---------------
Expenses
Investment advisory fees $ 10,501,962
Account maintenance and distribution fees--Class B 4,898,928
Account maintenance and distribution fees--Class C 3,616,519
Account maintenance fees--Class A 2,170,935
Transfer agent fees--Class A 1,557,878
Transfer agent fees--Class B 1,288,255
Transfer agent fees--Class C 901,288
Transfer agent fees--Class I 610,601
Accounting services 582,191
Custodian fees 258,557
Professional fees 161,347
Registration fees 125,041
Printing and shareholder reports 112,447
Trustees' fees and expenses 93,336
Pricing fees 71,527
Account maintenance and distribution fees--Class R 37
Transfer agent fees--Class R 15
Other 87,890
---------------
Total expenses 27,038,754
---------------
Investment income--net 66,455,314
---------------
Realized & Unrealized Gain (Loss) on Investments--Net
Realized gain on investments--net 8,431,538
Change in unrealized appreciation on investments--net (36,750,188)
---------------
Total realized and unrealized loss on investments--net (28,318,650)
---------------
Net Increase in Net Assets Resulting from Operations $ 38,136,664
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Statements of Changes in Net Assets
For the Year Ended
August 31,
Increase (Decrease) in Net Assets: 2003 2002
Operations
Investment income--net $ 66,455,314 $ 70,870,370
Realized gain on investments--net 8,431,538 44,845,955
Change in unrealized appreciation on investments--net (36,750,188) 10,796,050
--------------- ---------------
Net increase in net assets resulting from operations 38,136,664 126,512,375
--------------- ---------------
Dividends to Shareholders
Investment income--net:
Class A (26,838,903) (33,007,938)
Class B (16,821,329) (20,225,769)
Class C (11,397,197) (6,030,923)
Class I (11,356,412) (11,605,740)
Class R (205) --
--------------- ---------------
Net decrease in net assets resulting from dividends to shareholders (66,414,046) (70,870,370)
--------------- ---------------
Beneficial Interest Transactions
Net increase in net assets derived from beneficial interest transactions 105,163,018 570,270,612
--------------- ---------------
Net Assets
Total increase in net assets 76,885,636 625,912,617
Beginning of year 2,113,116,443 1,487,203,826
--------------- ---------------
End of year* $ 2,190,002,079 $ 2,113,116,443
=============== ===============
*Accumulated distributions in excess of investment income--net $ (1,170,818) --
=============== ===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Financial Highlights
The following per share data and ratios have been derived Class A++
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2003 2002 2001 2000 1999
Per Share Operating Performance
Net asset value, beginning of year $ 10.25 $ 9.95 $ 9.44 $ 9.36 $ 9.79
---------- ---------- ---------- ---------- ----------
Investment income--net .32 .43 .55 .56 .53
Realized and unrealized gain (loss) on
investments--net (.12) .30 .51 .08 (.43)
---------- ---------- ---------- ---------- ----------
Total from investment operations .20 .73 1.06 .64 .10
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.32) (.43) (.55) (.56) (.53)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.13 $ 10.25 $ 9.95 $ 9.44 $ 9.36
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 1.93% 7.54% 11.49% 7.08% .98%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses .95% .97% 1.00% 1.00% .95%
========== ========== ========== ========== ==========
Investment income--net 3.09% 4.30% 5.59% 5.99% 5.47%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 855,543 $ 819,410 $ 729,136 $ 720,311 $ 795,813
========== ========== ========== ========== ==========
Portfolio turnover 428.59% 426.77% 199.30% 37.28% 58.16%
========== ========== ========== ========== ==========
*Total investment returns exclude the effects of sales charges.
++"Effective April 14, 2003, Class D Shares were redesignated Class
A Shares."
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Financial Highlights (continued)
The following per share data and ratios have been derived Class B
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2003 2002 2001 2000 1999
Per Share Operating Performance
Net asset value, beginning of year $ 10.26 $ 9.95 $ 9.44 $ 9.36 $ 9.79
---------- ---------- ---------- ---------- ----------
Investment income--net .26 .38 .50 .51 .48
Realized and unrealized gain (loss)
on investments--net (.13) .31 .51 .08 (.43)
---------- ---------- ---------- ---------- ----------
Total from investment operations .13 .69 1.01 .59 .05
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.26) (.38) (.50) (.51) (.48)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.13 $ 10.26 $ 9.95 $ 9.44 $ 9.36
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 1.40% 6.99% 10.91% 6.53% .46%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses 1.47% 1.49% 1.52% 1.52% 1.46%
========== ========== ========== ========== ==========
Investment income--net 2.58% 3.76% 5.07% 5.47% 4.95%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 591,435 $ 613,282 $ 466,432 $ 405,846 $ 571,969
========== ========== ========== ========== ==========
Portfolio turnover 428.59% 426.77% 199.30% 37.28% 58.16%
========== ========== ========== ========== ==========
*Total investment returns exclude the effects of sales charges.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Financial Highlights (continued)
The following per share data and ratios have been derived Class C
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2003 2002 2001 2000 1999
Per Share Operating Performance
Net asset value, beginning of year $ 10.25 $ 9.95 $ 9.44 $ 9.36 $ 9.79
---------- ---------- ---------- ---------- ----------
Investment income--net .26 .37 .49 .51 .48
Realized and unrealized gain (loss)
on investments--net (.12) .30 .51 .08 (.43)
---------- ---------- ---------- ---------- ----------
Total from investment operations .14 .67 1.00 .59 .05
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.26) (.37) (.49) (.51) (.48)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.13 $ 10.25 $ 9.95 $ 9.44 $ 9.36
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 1.35% 6.94% 10.86% 6.47% .41%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses 1.52% 1.54% 1.57% 1.57% 1.51%
========== ========== ========== ========== ==========
Investment income--net 2.52% 3.40% 5.00% 5.43% 4.90%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 414,539 $ 384,119 $ 56,706 $ 30,593 $ 46,614
========== ========== ========== ========== ==========
Portfolio turnover 428.59% 426.77% 199.30% 37.28% 58.16%
========== ========== ========== ========== ==========
*Total investment returns exclude the effects of sales charges.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Financial Highlights (continued)
The following per share data and ratios have been derived Class I++
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2003 2002 2001 2000 1999
Per Share Operating Performance
Net asset value, beginning of year $ 10.26 $ 9.95 $ 9.44 $ 9.37 $ 9.80
---------- ---------- ---------- ---------- ----------
Investment income--net .34 .46 .57 .58 .55
Realized and unrealized gain (loss)
on investments--net (.13) .31 .51 .07 (.43)
---------- ---------- ---------- ---------- ----------
Total from investment operations .21 .77 1.08 .65 .12
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.34) (.46) (.57) (.58) (.55)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.13 $ 10.26 $ 9.95 $ 9.44 $ 9.37
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 2.08% 7.91% 11.77% 7.23% 1.24%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses .70% .72% .75% .75% .70%
========== ========== ========== ========== ==========
Investment income--net 3.34% 4.53% 5.84% 6.23% 5.71%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 328,408 $ 296,305 $ 234,930 $ 192,119 $ 212,131
========== ========== ========== ========== ==========
Portfolio turnover 428.59% 426.77% 199.30% 37.28% 58.16%
========== ========== ========== ========== ==========
*Total investment returns exclude the effects of sales charges.
++"Effective April 14, 2003, Class A Shares were redesignated Class
I Shares."
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Financial Highlights (concluded)
Class R
The following per share data and ratios have been derived For the Period
from information provided in the financial statements. January 3, 2003++
to August 31,
Increase (Decrease) in Net Asset Value: 2003
Per Share Operating Performance
Net asset value, beginning of period $ 10.31
----------
Investment income--net .24
Realized and unrealized loss on investments--net (.19)
----------
Total from investment operations .05
----------
Less dividends from investment income--net (.24)
----------
Net asset value, end of period $ 10.12
==========
Total Investment Return**
Based on net asset value per share .44%+++
==========
Ratios to Average Net Assets
Expenses 1.23%*
==========
Investment income--net 2.81%*
==========
Supplemental Data
Net assets, end of period (in thousands) $ 77
==========
Portfolio turnover 428.59%
==========
*Annualized.
**Total investment returns exclude the effects of sales charges.
++Commencement of operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Notes to Financial Statements
1. Significant Accounting Policies:
Merrill Lynch U.S. Government Mortgage Fund (the "Fund") is
registered under the Investment Company Act of 1940, as amended, as
a diversified, open-end management investment company. The Fund's
financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America, which
may require the use of management accruals and estimates. The Fund
offers multiple classes of shares. Effective April 14, 2003, Class A
Shares were redesignated Class I Shares and Class D Shares were
redesignated Class A Shares. The Fund's financial statements and
financial highlights contained within this report reflect the new
share class redesignation. Shares of Class A and Class I are sold
with a front-end sales charge. Shares of Class B and Class C may be
subject to a contingent deferred sales charge. Class R Shares are
sold only to certain retirement plans. All classes of shares have
identical voting, dividend, liquidation and other rights and the
same terms and conditions, except that Class A, Class B, Class C and
Class R Shares bear certain expenses related to the account
maintenance of such shares, and Class B, Class C and Class R Shares
also bear certain expenses related to the distribution of such
shares. Each class has exclusive voting rights with respect to
matters relating to its account maintenance and distribution
expenditures. Income, expenses (other than expenses attributable to
a specific class) and realized and unrealized gains and losses on
investments are allocated daily to each class based on its relative
net assets. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of investments--Securities that are held by the Fund
that are traded on stock exchanges or the Nasdaq National Market are
valued at the last sale price or official close price on the
exchange on which such securities are traded, as of the close of
business on the day the securities are being valued or, lacking any
sales, at the last available bid price for long positions, and at
the last available ask price for short positions. In cases where
securities are traded on more than one exchange, the securities are
valued on the exchange designated as the primary market by or under
the authority of the Board of Trustees of the Fund. Long positions
in securities traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid
price or yield equivalent obtained from one or more dealers or
pricing services approved by the Board of Trustees of the Fund.
Short positions in securities traded in the OTC market are valued at
the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according
to the broadest and most representative market. When the Fund writes
an option, the amount of the premium received is recorded on the
books of the Fund as an asset and an equivalent liability. The
amount of the liability is subsequently valued to reflect the
current market value of the option written, based on the last sale
price in the case of exchange-traded options or, in the case of
options traded in the OTC market, the last ask price. Options
purchased by the Fund are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in
the OTC market, the last bid price. The value of swaps, including
interest rate swaps, caps and floors, will be determined by
obtaining dealer quotations. Other investments, including futures
contracts and related options, are stated at market value.
Obligations with remaining maturities of 60 days or less are valued
at amortized cost unless the Investment Adviser believes that this
method no longer produces fair valuations. Repurchase agreements
will be valued at cost plus accrued interest. The Fund employs
certain pricing services to provide securities prices for the Fund.
Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by
or under the direction of the Trustees of the Fund, including
valuations furnished by the pricing services retained by the Fund,
which may use a matrix system for valuations. The procedures of a
pricing service and its valuations are reviewed by the officers of
the Fund under the general supervision of the Trustees. Such
valuations and procedures will be reviewed periodically by the
Trustees.
Generally, trading in foreign securities, as well as U.S. Government
securities and money market instruments, is substantially completed
each day at various times prior to the close of business on the New
York Stock Exchange ("NYSE"). The values of such securities used in
computing the net asset value of the Fund's shares are determined as
of such times. Foreign currency exchange rates also are generally
determined prior to the close of business on the NYSE. Occasionally,
events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and
the close of business on the NYSE that may not be reflected in the
computation of the Fund's net asset value. If events (for example, a
company announcement, market volatility or a natural disaster) occur
during such periods that are expected to materially affect the value
of such securities, those securities may be valued at their fair
value as determined in good faith by the Board of Trustees or by the
Investment Adviser using a pricing service and/or procedures
approved by the Board of Trustees.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Notes to Financial Statements (continued)
(b) Repurchase agreements--The Fund invests in U.S. government
securities pursuant to repurchase agreements. Under such agreements,
the counterparty agrees to repurchase the security at a mutually
agreed upon time and price. The Fund takes possession of the
underlying securities, marks to market such securities and, if
necessary, receives additional securities daily to ensure that the
contract is fully collateralized. If the counterparty defaults and
the fair value of the collateral declines, liquidation of the
collateral by the Fund may be delayed or limited.
(c) Derivative financial instruments--The Fund may engage in various
portfolio investment strategies both to increase the return of the
Fund and to hedge, or protect, its exposure to interest rate
movement and movements in the securities markets. Losses may arise
due to changes in the value of the contract or if the counterparty
does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
financial futures contracts and options on such futures contracts.
Futures contracts are contracts for delayed delivery of securities
at a specific future date and at a specific price or yield. Upon
entering into a contract, the Fund deposits and maintains as
collateral such initial margin as required by the exchange on which
the transaction is effected. Pursuant to the contract, the Fund
agrees to receive from or pay to the broker an amount of cash equal
to the daily fluctuation in value of the contract. Such receipts or
payments are known as variation margin and are recorded by the Fund
as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss equal to the difference between the
value of the contract at the time it was opened and the value at the
time it was closed.
* Options--The Fund may write and purchase call and put options.
When the Fund writes an option, an amount equal to the premium
received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked to
market to reflect the current market value of the option written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premiums paid or received).
Written and purchased options are non-income producing investments.
* Swaps--The Fund may enter into swap agreements, which are over-the-
counter contracts in which the Fund and a counterparty agree to make
periodic net payments on a specified notional amount. The net
payments can be made for a set period of time or may be triggered by
a pre-determined credit event. The net periodic payments may be
based on a fixed or variable interest rate; the change in market
value of a specific security, basket of securities, or index; or the
return generated by a security.
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Realized gains and losses on security
transactions are determined on the identified cost basis. Dividend
income is recorded on the ex-dividend dates. Interest income and
extended delivery fees are recognized on the accrual basis. The Fund
amortizes all premiums and discounts on debt securities.
(f) Prepaid registration fees--Prepaid registration fees are charged
to expense as the related shares are issued.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Notes to Financial Statements (continued)
(g) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates.
(h) Securities lending--The Fund may lend securities to financial
institutions that provide cash or securities issued or guaranteed by
the U.S. government as collateral, which will be maintained at all
times in an amount equal to at least 100% of the current market
value of the loaned securities. The market value of the loaned
securities is determined at the close of business of the Fund and
any additional required collateral is delivered to the Fund on the
next business day. Where the Fund receives securities as collateral
for the loaned securities, it collects a fee from the borrower. The
Fund typically receives the income on the loaned securities but does
not receive the income on the collateral. Where the Fund receives
cash collateral, it may invest such collateral and retain the amount
earned on such investment, net of any amount rebated to the
borrower. Loans of securities are terminable at any time and the
borrower, after notice, is required to return borrowed securities
within five business days. The Fund may pay reasonable finder's,
lending agent, administrative and custodial fees in connection with
its loans. In the event that the borrower defaults on its obligation
to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access
to the collateral. The Fund also could suffer a loss where the value
of the collateral falls below the market value of the borrowed
securities, in the event of borrower default or in the event of
losses on investments made with cash collateral.
(i) Mortgage dollar rolls--The Fund may sell mortgage-backed
securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar (same type, coupon and
maturity) securities on a specific future date.
(j) Reclassification--Accounting principles generally accepted in
the United States of America require that certain components of net
assets be adjusted to reflect permanent differences between
financial and tax reporting. Accordingly, the current year's
permanent book/tax differences of $10,577 has been reclassified
between paid-in capital in excess of par and accumulated
distributions in excess of investment income, $109,238,934 between
paid-in capital in excess of par and accumulated net realized
capital losses and $1,222,663 has been reclassified between
accumulated distributions in excess of investment income and
accumulated net realized capital losses. These reclassifications
have no effect on net assets or net asset values per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect, wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner. The Fund has also entered into a Distribution
Agreement and Distribution Plans with FAM Distributors, Inc. ("FAMD"
or the "Distributor"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily
value of the Fund's net assets at the following rate:
Portion of Average Daily Value of Net Assets: Rate
Not exceeding $500 million .500%
In excess of $500 million but not
exceeding $1 billion .475%
In excess of $1 billion but not
exceeding $1.5 billion .450%
In excess of $1.5 billion but not
exceeding $2 billion .425%
In excess of $2 billion but not
exceeding $2.5 billion .400%
In excess of $2.5 billion but not
exceeding $3.5 billion .375%
In excess of $3.5 billion but not
exceeding $5 billion .350%
In excess of $5 billion but not
exceeding $6.5 billion .325%
Exceeding $6.5 billion .300%
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Notes to Financial Statements (continued)
Pursuant to the Distribution Plans adopted by the Fund in accordance
with Rule 12b-1 under the Investment Company Act of 1940, the Fund
pays the Distributor ongoing account maintenance and distribution
fees. The fees are accrued daily and paid monthly at annual rates
based upon the average daily net assets of the shares as follows:
Account
Maintenance Distribution
Fee Fee
Class A .25% --
Class B .25% .50%
Class C .25% .55%
Class R .25% .25%
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of
ML & Co., also provides account maintenance and distribution
services to the Fund. The ongoing account maintenance fee
compensates the Distributor and MLPF&S for providing account
maintenance services to Class A, Class B, Class C and Class R
shareholders. The ongoing distribution fee compensates the
Distributor and MLPF&S for providing shareholder and distribution-
related services to Class B, Class C and Class R shareholders.
For the year ended August 31, 2003, FAMD earned underwriting
discounts and direct commissions and MLPF&S earned dealer
concessions on sales of the Fund's Class A and Class I Shares as
follows:
FAMD MLPF&S
Class A $15,626 $150,199
Class I $ 74 $ 867
For the year ended August 31, 2003, MLPF&S received contingent
deferred sales charges of $1,531,054 and $412,116 relating to
transactions in Class B and Class C Shares, respectively.
Furthermore, MLPF&S received contingent deferred sales charges of
$500 relating to transactions subject to front-end sales charge
waivers in Class A Shares.
The Fund has received an exemptive order from the Securities and
Exchange Commission permitting it to lend portfolio securities to
MLPF&S or its affiliates. Pursuant to that order, the Fund also has
retained Merrill Lynch Investment Managers, LLC ("MLIM, LLC"), an
affiliate of FAM, as the securities lending agent for a fee based on
a share of the returns on investment of cash collateral. MLIM, LLC
may, on behalf of the Fund, invest cash collateral received by the
Fund for such loans, among other things, in a private investment
company managed by MLIM, LLC or in registered money market funds
advised by FAM or its affiliates. For the year ended August 31,
2003, MLIM, LLC received $7,122 in securities lending agent fees.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of
ML & Co., is the Fund's transfer agent.
For the year ended August 31, 2003, the Fund reimbursed FAM $51,449
for certain accounting services.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, FAMD, FDS, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 2003 were $10,242,166,759 and
$9,904,308,429, respectively.
Net realized gains (losses) for the year ended August 31, 2003 and
net unrealized gains (losses) as of August 31, 2003 were as follows:
Realized Unrealized
Gains (Losses) Gains (Losses)
Long-term investments $ 15,041,421 $ (5,888,025)
Short-term investments 5,055 --
Options purchased 218,400 95,587
Options written 281,250 65,572
Swaps (1,222,663) --
Financial futures contracts (5,891,925) 9,193,151
--------------- ---------------
Total $ 8,431,538 $ 3,466,285
=============== ===============
As of August 31, 2003, net unrealized depreciation for Federal
income tax purposes aggregated $5,985,647, of which $19,278,719
related to appreciated securities and $25,264,366 related to
depreciated securities. The aggregate cost of investments, including
options, at August 31, 2003 for Federal income tax purposes was
$3,140,754,945.
Transactions in options written for the year ended August 31, 2003
were as follows:
Call Options Number of Contracts/ Premiums
Written Notional Amount Received
Outstanding call options
written, beginning of year -- --
Options sold 62,500,000 $ 2,723,075
--------------- ---------------
Outstanding call options
written, end of year 62,500,000 $ 2,723,075
=============== ===============
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Notes to Financial Statements (continued)
Put Options Number of Contracts/ Premiums
Written Notional Amount Received
Outstanding put options
written, beginning of year 8,334 --
Options sold 92,500,000 $ 3,045,575
Options expired (30,003,594) (281,250)
--------------- ---------------
Outstanding put options
written, end of year 62,504,740 $ 2,764,325
=============== ===============
4. Shares of Beneficial Interest:
Net increase in net assets derived from beneficial interest
transactions was $105,163,018 and $570,270,612 for the years ended
August 31, 2003 and August 31, 2002, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 2003++ Shares Amount
Shares sold 24,830,194 $ 255,763,407
Automatic conversion of shares 3,615,714 37,226,405
Shares resulting from reorganization 596,152 6,095,331
Shares issued to shareholders in
reinvestment of dividends 1,060,137 10,900,865
--------------- ---------------
Total issued 30,102,197 309,986,008
Shares redeemed (25,547,897) (262,751,395)
--------------- ---------------
Net increase 4,554,300 $ 47,234,613
=============== ===============
++"Effective April 14, 2003, Class D Shares were redesignated Class
A Shares."
Class A Shares for the Year Dollar
Ended August 31, 2002++ Shares Amount
Shares sold 20,212,614 $ 202,939,375
Automatic conversion of shares 4,242,478 42,579,446
Shares issued to shareholders
in reinvestment of dividends 1,401,211 14,032,640
--------------- ---------------
Total issued 25,856,303 259,551,461
Shares redeemed (19,239,653) (193,244,943)
--------------- ---------------
Net increase 6,616,650 $ 66,306,518
=============== ===============
++"Effective April 14, 2003, Class D Shares were redesignated Class
A Shares."
Class B Shares for the Year Dollar
Ended August 31, 2003 Shares Amount
Shares sold 18,176,359 $ 187,220,780
Shares resulting from reorganization 4,826,184 49,346,327
Shares issued to shareholders in
reinvestment of dividends 1,158,460 11,913,503
--------------- ---------------
Total issued 24,161,003 248,480,610
Automatic conversion of shares (3,615,196) (37,226,405)
Shares redeemed (21,964,595) (225,788,918)
--------------- ---------------
Net decrease (1,418,788) $ (14,534,713)
=============== ===============
Class B Shares for the Year Dollar
Ended August 31, 2002 Shares Amount
Shares sold 31,093,475 $ 312,870,794
Shares issued to shareholders
in reinvestment of dividends 1,334,120 13,361,729
--------------- ---------------
Total issued 32,427,595 326,232,523
Automatic conversion of shares (4,242,478) (42,579,446)
Shares redeemed (15,266,335) (153,149,838)
--------------- ---------------
Net increase 12,918,782 $ 130,503,239
=============== ===============
Class C Shares for the Year Dollar
Ended August 31, 2003 Shares Amount
Shares sold 13,348,468 $ 137,411,546
Shares resulting from reorganization 2,032,979 20,784,497
Shares issued to shareholders in
reinvestment of dividends 784,713 8,069,165
--------------- ---------------
Total issued 16,166,160 166,265,208
Shares redeemed (12,700,515) (130,461,166)
--------------- ---------------
Net increase 3,465,645 $ 35,804,042
=============== ===============
Class C Shares for the Year Dollar
Ended August 31, 2002 Shares Amount
Shares sold 36,241,942 $ 365,105,905
Shares issued to shareholders in
reinvestment of dividends 396,331 3,980,543
--------------- ---------------
Total issued 36,638,273 369,086,448
Shares redeemed (4,878,224) (49,036,615)
--------------- ---------------
Net increase 31,760,049 $ 320,049,833
=============== ===============
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Notes to Financial Statements (concluded)
Class I Shares for the Year Dollar
Ended August 31, 2003++ Shares Amount
Shares sold 17,831,397 $ 183,727,174
Shares resulting from reorganization 519,193 5,310,013
Shares issued to shareholders in
reinvestment of dividends 73,598 757,179
--------------- ---------------
Total issued 18,424,188 189,794,366
Shares redeemed (14,900,196) (153,212,760)
--------------- ---------------
Net increase 3,523,992 $ 36,581,606
=============== ===============
++"Effective April 14, 2003, Class A Shares were redesignated Class
I Shares."
Class I Shares for the Year Dollar
Ended August 31, 2002++ Shares Amount
Shares sold 17,379,563 $ 174,841,269
Shares issued to shareholders in
reinvestment of dividends 112,848 1,130,075
--------------- ---------------
Total issued 17,492,411 175,971,344
Shares redeemed (12,214,134) (122,560,322)
--------------- ---------------
Net increase 5,278,277 $ 53,411,022
=============== ===============
++"Effective April 14, 2003, Class A Shares were redesignated Class
I Shares."
Class R Shares for the
Period January 3, 2003++ Dollar
to August 31, 2003 Shares Amount
Shares sold 7,588 $ 77,337
Shares issued to shareholders in
reinvestment of dividends 13 133
--------------- ---------------
Net increase 7,601 $ 77,470
=============== ===============
++Commencement of operations.
5. Short-Term Borrowings:
The Fund, along with certain other funds managed by FAM and its
affiliates, is a party to a $500,000,000 credit agreement with Bank
One, N.A. and certain other lenders. The Fund may borrow under the
credit agreement to fund shareholder redemptions and for other
lawful purposes other than for leverage. The Fund may borrow up to
the maximum amount allowable under the Fund's current prospectus and
statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of
..09% per annum based on the Fund's pro rata share of the unused
portion of the credit agreement. Amounts borrowed under the credit
agreement bear interest at a rate equal to, at each fund's election,
the Federal Funds rate plus .50% or a base rate as determined by
Bank One, N.A. On November 29, 2002, the credit agreement was
renewed for one year under the same terms, except that the
commitment was reduced from $1,000,000,000 to $500,000,000. The Fund
did not borrow under the credit agreement during the year ended
August 31, 2003.
6. Distributions to Shareholders:
The tax character of distributions paid during the fiscal years
ended August 31, 2003 and August 31, 2002 was as follows:
8/31/2003 8/31/2002
Distributions paid from:
Ordinary income $ 66,414,046 $ 70,870,370
--------------- ---------------
Total taxable distributions $ 66,414,046 $ 70,870,370
=============== ===============
As of August 31, 2003, the components of accumulated losses on a tax
basis were as follows:
Undistributed ordinary income--net $ --
Undistributed long-term capital gains--net --
---------------
Total undistributed earnings--net --
Capital loss carryforward (25,195,353)*
Unrealized losses--net (10,769,782)**
---------------
Total accumulated losses--net $ (35,965,135)
===============
*On August 31, 2003, the Fund had a net capital loss carryforward of
$25,195,353, of which $16,732,658 expires in 2004, $4,697,041
expires in 2008 and $3,765,654 expires in 2009. This amount will be
available to offset like amounts of any future taxable gains.
**The difference between book-basis and tax-basis net unrealized
losses is attributable primarily to the tax deferral of losses on
wash sales, the tax deferral of losses on straddles and the
realization for tax purposes of unrealized gains (losses) on certain
futures contracts.
7. Acquisition of Mercury U.S. Government Securities Fund:
On October 21, 2002, the Fund acquired all of the net assets of
Mercury U.S. Government Securities Fund pursuant to a plan of
reorganization. The acquisition was accomplished by a tax-free
exchange of 7,632,157 shares of common stock of Mercury U.S.
Government Securities Fund for 7,974,508 shares of common stock of
the Fund. Mercury U.S. Government Securities Fund's net assets on
that date of $81,536,168, including $2,022,330 of net unrealized
appreciation and $331,332 of accumulated net realized capital
losses, were combined with those of the Fund. The aggregate net
assets immediately after the acquisition amounted to $2,283,359,445.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Independent Auditors' Report
To the Shareholders and Board of Trustees
of Merrill Lynch U.S. Government Mortgage Fund:
We have audited the accompanying statement of assets and
liabilities, including the schedule of investments, of Merrill Lynch
U.S. Government Mortgage Fund as of August 31, 2003, and the related
statement of operations for the year then ended, the statements of
changes in net assets for each of the two years in the period then
ended, and the financial highlights for each of the respective
periods 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 auditing standards
generally accepted in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and 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 August 31, 2003, by
correspondence with the custodian and brokers; where replies were
not received from brokers, we performed other auditing procedures.
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 Merrill Lynch U.S. Government Mortgage Fund as
of August 31, 2003, the results of its operations for the year then
ended, the changes in its net assets for each of the two years in
the period then ended, and its financial highlights for each of the
respective periods then ended, in conformity with accounting
principles generally accepted in the United States of America.
Deloitte & Touche LLP
Princeton, New Jersey
October 24, 2003
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Officers and Trustees (unaudited)
Number of
Portfolios in Other Public
Position(s) Length Fund Complex Directorships
Held Of Time Overseen by Held by
Name, Address & Age with Fund Served Principal Occupation(s) During Past 5 Years Trustee Trustee
Interested Trustee
Terry K. Glenn* President 1999 to President and Chairman of Merrill Lynch 122 Funds None
P.O. Box 9011 and present Investment Managers, L.P. ("MLIM")/Fund 163 Portfolios
Princeton, Trustee and Asset Management, L.P. ("FAM")--Advised
NJ 08543-9011 1984 to Funds since 1999; Chairman (Americas Region)
Age: 62 present of MLIM from 2000 to 2002; Executive Vice
President of MLIM and FAM (which terms as
used herein include their corporate
predecessors) from 1983 to 2002; President
of FAM Distributors, Inc. ("FAMD") from
1986 to 2002 and Director thereof from
1991 to 2002; Executive Vice President
and Director of Princeton Services, Inc.
("Princeton Services") from 1993 to 2002;
President of Princeton Administrators, L.P.
from 1989 to 2002; Director of Financial
Data Services, Inc. since 1985.
*Mr. Glenn is a director, trustee or member of an advisory board of
certain other investment companies for which MLIM or FAM acts as
investment adviser. Mr. Glenn is an "interested person," as
described in the Investment Company Act, of the Fund based on his
former positions with MLIM, FAM, FAMD, Princeton Services and
Princeton Administrators, L.P. The Trustee's term is unlimited.
Trustees serve until their resignation, removal or death, or until
December 31 of the year in which they turn 72. As Fund President,
Mr. Glenn serves at the pleasure of the Board of Trustees.
Independent Trustees*
James H. Bodurtha Trustee 2002 to Director, The China Business Group, Inc. 40 Funds None
P.O. Box 9095 present since 1996, and Executive Vice President 59 Portfolios
Princeton, thereof from 1996 to 2003; Chairman,
NJ 08543-9095 Berkshire Holding Corporation since 1980;
Age: 59 Partner, Squire, Sanders & Dempsey from
1980 to 1993.
Joe Grills Trustee 1994 to Member of the Committee of Investment of 40 Funds Kimco Realty
P.O. Box 9095 present Employee Benefit Assets of the Association 59 Portfolios Corporation
Princeton, of Financial Professionals ("CIEBA") since
NJ 08543-9095 1986 and its Chairman from 1991 to 1992;
Age: 68 Member of the Investment Advisory Committees
of the State of New York Common Retirement
Fund since 1989; Member of the Investment
Advisory Committee of the Howard Hughes
Medical Institute from 1997 to 2000;
Director, Duke Management Company since
1992 and Vice Chairman thereof since 1998;
Director LaSalle Street Fund from 1995 to
2001; Director, Kimco Realty Corporation
since 1997; Member of the Investment
Advisory Committee of the Virginia
Retirement System since 1998 and Vice
Chairman thereof since 2002; Director,
Montpelier Foundation since 1998 and Vice
Chairman thereof since 2000; Member of
the Investment Committee of the Woodberry
Forest School since 2000; Member of the
Investment Committee of the National Trust
for Historic Preservation since 2000.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Officers and Trustees (unaudited)(continued)
Number of
Portfolios in Other Public
Position(s) Length Fund Complex Directorships
Held Of Time Overseen by Held by
Name, Address & Age with Fund Served Principal Occupation(s) During Past 5 Years Trustee Trustee
Independent Trustees* (concluded)
Herbert I. London Trustee 2002 to John M. Olin Professor of Humanities, New 40 Funds None
P.O. Box 9095 present York University since 1993 and Professor 59 Portfolios
Princeton, thereof since 1980; President of Hudson
NJ 08543-9095 Institute since 1997 and Trustee thereof
Age: 64 since 1980.
Andre F. Perold Trustee 2002 to George Gund Professor of Finance and 40 Funds None
P.O. Box 9095 present Banking, Harvard Business School since 59 Portfolios
Princeton, 2000 and a member of the faculty since
NJ 08543-9095 1979; Director and Chairman of the
Age: 51 Board, UNX, Inc. since 2003; Director,
Sanlam Limited and Sanlam Life since
2001; Director, Genbel Securities
and Gensec Bank since 1999; Director,
Stockback.com from 2002 to 2002; Trustee
of Commonfund from 1989 to 2001; Director,
Bulldogresearch.com from 2000 to 2001;
Director, Sanlam Investment Management
from 1999 to 2001; Director, Quantec
Limited from 1991 to 1999.
Roberta Cooper Ramo Trustee 2002 to Shareholder, Modrall, Sperling, Roehl, 40 Funds None
P.O. Box 9095 present Harris & Sisk, P.A. since 1993; Director 59 Portfolios
Princeton, of Cooper's, Inc. since 1999 and
NJ 08543-9095 Chairman of the Board since 2000;
Age: 61 Director of ECMC, Inc. since 2001.
Robert S. Salomon, Jr. Trustee 1996 to Principal of STI Management since 1994; 40 Funds None
P.O. Box 9095 present Regular columnist with Forbes Magazine 59 Portfolios
Princeton, from 1992 to 2001; Trustee of Commonfund
NJ 08543-9095 from 1980 to 2001; Director of Rye Country
Age: 66 Day School since 2001.
Stephen B. Swensrud Trustee 1984 to Chairman, Fernwood Advisors (investment 41 Funds None
P.O. Box 9095 present adviser) since 1996; Principal of Fernwood 60 Portfolios
Princeton, Associates (financial consultant) since
NJ 08543-9095 1975; Chairman of RPP Corporation since
Age: 70 1978; Director, International Mobile
Communications, Inc. since 1998.
*The Trustee's term is unlimited. Trustees serve until their
resignation, removal or death, or until December 31 of the year in
which they turn 72.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Officers and Trustees (unaudited)(concluded)
Position(s) Length
Held Of Time
Name, Address & Age with Fund Served* Principal Occupation(s) During Past 5 Years
Fund Officers
Donald C. Burke Vice 1993 to First Vice President of MLIM and FAM since 1997 and Treasurer thereof
P.O. Box 9011 President present since 1999; Senior Vice President and Treasurer of Princeton Services
Princeton, and and since 1999; Vice President of FAMD since 1999; Director of MLIM Taxation
NJ 08543-9011 Treasurer 1999 to since 1990.
Age: 43 present
Frank Viola Vice 2002 to Managing Director of MLIM since 2002; Director (Global Fixed Income) of
P.O. Box 9011 President present MLIM from 2000 to 2002; Vice President of MLIM from 1996 to 2000.
Princeton,
NJ 08543-9011
Age: 38
Teresa L. Giacino Vice 2002 to Vice President (Global Fixed Income) of MLIM since 1992.
P.O. Box 9011 President present
Princeton,
NJ 08543-9011
Age: 41
Bradley J. Lucido Secretary 2001 to Director of MLIM since 2002; Vice President (Legal Advisory) of MLIM from
P.O. Box 9011 present 1999 to 2002 and Attorney thereof since 1995.
Princeton,
NJ 08543-9011
Age: 37
*Officers of the Fund serve at the pleasure of the Board of
Trustees.
Further information about the Fund's Officers and Directors is
available in the Fund's Statement of Additional Information, which
can be obtained without charge by calling 1-800-MER-FUND.
Custodian
The Bank of New York
100 Church Street
New York, NY 10286
Transfer Agent
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
800-637-3863
Electronic Delivery
The Fund is now offering electronic delivery of communications
to its shareholders. In order to receive this service, you must
register your account and provide us with e-mail information.
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MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND, AUGUST 31, 2003
Item 2 - Did registrant adopt a code of ethics, as of the end of the
period covered by this report, that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by
the registrant or a third party? If not, why not? Briefly describe
any amendments or waivers that occurred during the period. State
here if code of ethics/amendments/waivers are on website and give
website address-. State here if fund will send code of ethics to
shareholders without charge upon request--
The registrant has adopted a code of ethics, as of the end of the
period covered by this report, that applies to the registrant's
principal executive officer, principal financial officer and
principal accounting officer, or persons performing similar
functions. A copy of the code of ethics is available without charge
upon request by calling toll-free 1-800-MER-FUND (1-800-637-3863).
Item 3 - Did the registrant's board of directors determine that the
registrant either: (i) has at least one audit committee financial
expert serving on its audit committee; or (ii) does not have an
audit committee financial expert serving on its audit committee? If
yes, disclose name of financial expert and whether he/she is
"independent," (fund may, but is not required, to disclose
name/independence of more than one financial expert) If no, explain
why not. -
The registrant's board of directors has determined that (i) the
registrant has the following audit committee financial experts
serving on its audit committee and (ii) each audit committee
financial expert is independent: (1) Joe Grills, (2) Andre Perold,
(3) Robert S. Salomon, Jr., and (4) Stephen B. Swensrud.
Item 4 - Disclose annually only (not answered until December 15,
2003)
(a) Audit Fees - Disclose aggregate fees billed for each of the last
two fiscal years for professional services rendered by the principal
accountant for the audit of the registrant's annual financial
statements or services that are normally provided by the accountant
in connection with statutory and regulatory filings or engagements
for those fiscal years. N/A.
(b) Audit-Related Fees - Disclose aggregate fees billed in each of
the last two fiscal years for assurance and related services by the
principal accountant that are reasonably related to the performance
of the audit of the registrant's financial statements and are not
reported under paragraph (a) of this Item. Registrants shall
describe the nature of the services comprising the fees disclosed
under this category. N/A.
(c) Tax Fees - Disclose aggregate fees billed in each of the last
two fiscal years for professional services rendered by the principal
accountant for tax compliance, tax advice, and tax planning.
Registrants shall describe the nature of the services comprising the
fees disclosed under this category. N/A.
(d) All Other Fees - Disclose aggregate fees billed in each of the
last two fiscal years for products and services provided by the
principal accountant, other than the services reported in paragraphs
(a) through (c) of this Item. Registrants shall describe the nature
of the services comprising the fees disclosed under this category.
N/A.
(e)(1) Disclose the audit committee's pre-approval policies and
procedures described in paragraph (c)(7) of Rule 2-01 of Regulation
S-X. N/A.
(e)(2) Disclose the percentage of services described in each of
paragraphs (b) through (d) of this Item that were approved by the
audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of
Regulation S-X. N/A.
(f) If greater than 50%, disclose the percentage of hours expended
on the principal accountant's engagement to audit the registrant's
financial statements for the most recent fiscal year that were
attributed to work performed by persons other than the principal
accountant's full-time, permanent employees. N/A.
(g) Disclose the aggregate non-audit fees billed by the registrant's
accountant for services rendered to the registrant, and rendered to
the registrant's investment adviser (not including any sub-adviser
whose role is primarily portfolio management and is subcontracted
with or overseen by another investment adviser), and any entity
controlling, controlled by, or under common control with the adviser
that provides ongoing services to the registrant for each of the
last two fiscal years of the registrant. N/A.
(h) Disclose whether the registrant's audit committee has considered
whether the provision of non-audit services that were rendered to
the registrant's investment adviser (not including any subadviser
whose role is primarily portfolio management and is subcontracted
with or overseen by another investment adviser), and any entity
controlling, controlled by, or under common control with the
investment adviser that provides ongoing services to the registrant
that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal
accountant's independence. N/A.
Item 5 - If the registrant is a listed issuer as defined in Rule 10A-
3 under the Exchange Act, state whether or not the registrant has a
separately-designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. If the
registrant has such a committee, however designated, identify each
committee member. If the entire board of directors is acting as the
registrant's audit committee in Section 3(a)(58)(B) of the Exchange
Act, so state.
If applicable, provide the disclosure required by Rule 10A-3(d)
under the Exchange Act regarding an exemption from the listing
standards for audit committees. N/A
(Listed issuers must be in compliance with the new listing rules by
the earlier of their first annual shareholders meeting after January
2004, or October 31, 2004 (annual requirement))
Item 6 - Reserved
Item 7 - For closed-end funds that contain voting securities in
their portfolio, describe the policies and procedures that it uses
to determine how to vote proxies relating to those portfolio
securities. N/A
Item 8--Reserved
Item 9(a) - The registrant's certifying officers have reasonably
designed such disclosure controls and procedures to ensure material
information relating to the registrant is made known to us by others
particularly during the period in which this report is being
prepared. The registrant's certifying officers have determined that
the registrant's disclosure controls and procedures are effective
based on our evaluation of these controls and procedures as of a
date within 90 days prior to the filing date of this report.
Item 9(b)--There were no significant changes in the registrant's
internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Item 10 - Exhibits
10(a) - Attach code of ethics or amendments/waivers, unless code of
ethics or amendments/waivers is on website or offered to
shareholders upon request without charge. N/A.
10(b) - Attach certifications pursuant to Section 302 of the
Sarbanes-Oxley Act. Attached hereto.
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.
Merrill Lynch U.S. Government Mortgage Fund, Inc.
By: _/s/ Terry K. Glenn_______
Terry K. Glenn,
President of
Merrill Lynch U.S. Government Mortgage Fund, Inc.
Date: October 24, 2003
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/ Terry K. Glenn________
Terry K. Glenn,
President of
Merrill Lynch U.S. Government Mortgage Fund, Inc.
Date: October 24, 2003
By: _/s/ Donald C. Burke________
Donald C. Burke,
Chief Financial Officer of
Merrill Lynch U.S. Government Mortgage Fund, Inc.
Date: October 24, 2003
Attached hereto as a furnished exhibit are the certifications
pursuant to Section 906 of the Sarbanes-Oxley Act.