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 811-04077
Name of Fund: Merrill Lynch U.S. Government Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief Executive
Officer, Merrill Lynch U.S. Government 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: 08/31/05
Date of reporting period: 09/01/04 - 08/31/05
Item 1 - Report to Stockholders
Merrill Lynch
U.S. Government Fund
Annual Report
August 31, 2005
(BULL LOGO) Merrill Lynch Investment Managers
www.mlim.ml.com
Mercury Advisors
A Division of Merrill Lynch Investment Managers
www.mercury.ml.com
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) at www.mutualfunds.ml.com; and (3) on the Securities and Exchange
Commission's Web site at http://www.sec.gov. Information about how the
Fund voted proxies relating to securities held in the Fund's portfolio
during the most recent 12-month period ended June 30 is available (1) at
www.mutualfunds.ml.com and (2) on the Securities and Exchange Commission's
Web site at http://www.sec.gov.
Merrill Lynch U.S. Government Fund
Box 9011
Princeton, NJ
08543-9011
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A Letter From the President
Dear Shareholder
Amid what we've coined a "muddle through" year for the financial markets, the
major market benchmarks managed to post positive results for the current
reporting period:
Total Returns as of August 31, 2005 6-month 12-month
U.S. equities (Standard & Poor's 500 Index) +2.33% +12.56%
Small-cap U.S. equities (Russell 2000 Index) +5.75% +23.10%
International equities (MSCI Europe Australasia Far East Index) +1.98% +23.58%
Fixed income (Lehman Brothers Aggregate Bond Index) +2.85% + 4.15%
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) +2.85% + 5.31%
High yield bonds (Credit Suisse First Boston High Yield Index) +1.35% + 8.98%
Since June 2004, the Federal Reserve Board (the Fed) has tirelessly advanced
its interest rate-hiking program, bringing the federal funds rate to 3.5% by
August 31 (and to 3.75% on September 20). Economists and investors have
struggled to project the Fed's future moves, vacillating from expectations for
an impending end to monetary tightening to fears that the central bank may
increase interest rates more than is necessary to moderate economic growth and
keep inflation in check. Most recently, the devastation of Hurricane Katrina
added a new element of ambiguity in terms of its impact on the economy and Fed
sentiment. Many now believe the Fed will suspend its interest rate-hiking
campaign at some point this year.
Equity market returns over the past several months have reflected a degree of
investor uncertainty. After a strong finish to 2004, the S&P 500 Index posted
gains in four of the first eight months of 2005. Up to this point, strong
corporate earnings reports and low long-term bond yields have worked in favor
of equities. Factors that pose the greatest risks to stocks include record-
high oil prices, continued interest rate hikes and the possibility for
disappointing earnings for the remainder of the year.
Fixed income markets have fared relatively well in the face of monetary
tightening. As the short end of the yield curve moved in concert with Fed
interest rate hikes, long-term bond yields remained low, perpetuating the
yield curve flattening trend. Because bond prices move in the opposite
direction of yields, the result has been that longer-term bonds have
outperformed short-term bonds. At period end, the spread between two-year and
10-year Treasury yields was just 18 basis points (.18%).
Financial markets are likely to face continued crosscurrents for the remainder
of 2005, particularly as the economy digests the impact of Hurricane Katrina.
Nevertheless, opportunities do exist and we encourage you to work with your
financial advisor to diversify your portfolio among a variety of asset types.
This can help to diffuse risk while also tapping into the potential benefits
of a broader range of investment alternatives. As always, we thank you for
trusting Merrill Lynch Investment Managers with your investment assets.
Sincerely,
(Robert C. Doll, Jr.)
Robert C. Doll, Jr.
President and Trustee
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
We are pleased to present to you the management team of
Merrill Lynch U.S. Government Fund
Laura Powers, Frank Viola and Thomas Musmanno are portfolio managers of
Merrill Lynch U.S. Government Fund. Ms. Powers, who joined Merrill Lynch
Investment Managers (MLIM) in 1988, received a bachelor's degree from Winona
State University and is a Certified Public Accountant. Mr. Viola, who joined
MLIM in 1997, earned a bachelor's degree from The Pennsylvania State
University and is a CFA (R) charterholder, an associate of the Society of
Actuaries and a member of the American Academy of Actuaries. Mr. Musmanno, who
joined MLIM in 1993, 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.
Table of Contents
A Letter From the President 2
A Discussion With Your Fund's Portfolio Managers 4
Performance Data 6
Disclosure of Expenses 8
Schedule of Investments 9
Portfolio Information 13
Financial Statements 14
Financial Highlights 17
Notes to Financial Statements 22
Report of Independent Registered Public Accounting Firm 28
Important Tax Information 28
Officers and Trustees 29
CFA (R) and Chartered Financial Analyst (R) are trademarks owned by the
Association for Investment Management and Research.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
A Discussion With Your Fund's Portfolio Managers
The Fund provided returns in line with those of its peers in the Lipper
Intermediate U.S. Government Funds category and was able to increase its
distribution yield during the fiscal year.
How did the Fund perform during the fiscal year in light of the existing
market conditions?
For the 12-month period ended August 31, 2005, Merrill Lynch U.S. Government
Fund's Class A, Class B, Class C, Class I and Class R Shares had total returns
of +3.22%, +2.68%, +2.53%, +3.47% and +2.96%, respectively. (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 and 7 of
this report to shareholders.) For the same period, the Citigroup Mortgage
Index returned +4.05%, and the Fund's new benchmark, the Citigroup
Government/Mortgage Index, returned +4.04%. Effective June 30, 2005, the Fund
changed its benchmark to coincide with a name change and the elimination of a
non-fundamental investment restriction that required the portfolio to invest
at least 80% of its assets in mortgage-related government securities.* The
Fund now invests at least 80% of its net assets in U.S. government and U.S.
government agency securities while maintaining its investment objective of
seeking high current return. The new benchmark provides a better
representation of the Fund's composition and, therefore, a more suitable
measure of performance.
The Fund's comparable Lipper category is now the Intermediate U.S. Government
Funds category, which provided an average return of +2.71% for the 12-month
period ended August 31, 2005. (Funds in this Lipper category invest at least
65% of their assets in securities issued or guaranteed by the U.S. government,
its agencies, or its instrumentalities, with dollar-weighted average
maturities of three to 10 years.)
The yield curve continued to flatten during the year, with the spread between
the two-year and the 10-year Treasury narrowing from 172 basis points (1.72%)
at August 31, 2004 to just 18 basis points at August 31, 2005. Against this
backdrop, our yield curve position, which was based on the expectation for a
flattening trend, benefited performance. Specifically, we overweighted longer-
dated bonds (10-year and 30-year maturities) and underweighted shorter-
maturity issues in the two-year to three-year range. In an environment where
the Federal Reserve Board (the Fed) was increasing short-term interest rates
and inflation expectations were fairly muted, we believed that the difference
between the two-year and 10-year Treasury yields would gradually move closer
to zero. This occurred as the short-term interest rate followed the federal
funds rate higher and longer-term yields held stable or declined. As bond
prices move opposite of yields, longer-dated securities outperformed shorter-
maturity issues, increasing return.
The Fund's allocation to prepayment-protected mortgage securities also was
additive to performance. At period-end, approximately 30% of the Fund's net
assets was invested in Ginnie Mae (Government National Mortgage Association)
project loans and construction loans as well as Fannie Mae (Federal National
Mortgage Association) DUS (delegated underwriting and servicing). Residential
mortgages experienced accelerated prepayments as homeowners sought to take
advantage of the low long-term interest rates and refinance their debt. The
structured mortgage products, however, offer built-in prepayment protection in
the form of prepayment penalties, to which the Fund is generally entitled when
there is a prepayment. These securities provide less yield than mortgage pass-
through securities, but more yield than Treasury issues and agency debentures
while also offering much better prepayment protection.
Hindering performance versus the benchmarks was the Fund's short duration
position. We reduced the Fund's duration based on our belief that economic
growth would be strong, particularly throughout the first half of 2005,
prompting interest rates to rise (and bond prices to fall). However, it
appeared that economic growth, while positive, was somewhat disappointing to
market participants, causing longer-term interest rates to hold firm or
decline. Historically, in a monetary tightening environment, the Treasury
curve has tended to flatten, with short-term interest rates rising more than
longer-term rates. While our yield curve bias protected the Fund against some
of this, our overall short duration position detracted from performance. In
this particular cycle, however, longer rates actually declined as the Fed
raised the short-term interest rate target. This defied our expectations - and
those of the Fed.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
What changes were made to the portfolio during the period?
The Fund's new benchmark, the Citigroup Government/Mortgage Index, comprises
50% residential mortgages, 35% Treasury issues and 15% agency debentures. The
Fund's former benchmark comprised 100% mortgages, and the portfolio was
required to invest at least 80% in government mortgage products. Thus, the
biggest change during the period was the reduction of the portfolio's
residential mortgage position from 100% of net assets to about 50%. At the
same time, we increased exposure to structured products, which offered the
prepayment protection described earlier and served as a surrogate for the
positively convex agency debt and Treasury bonds represented in the Index.
Residential mortgages tend to do well in stable interest rate environments.
Having reduced our residential mortgage position, but still expecting less
volatility in interest rates, we sold options as an alternate way to express
our view that rates would stay relatively range-bound.
We maintained the Fund's yield curve flattening bias throughout most of the
year, removing it in the final month of the period. We began the shift toward
neutral in mid-August when yield spreads (between two- and 10-year Treasury
issues) hit our target level of approximately 20 basis points. After Hurricane
Katrina devastated the Gulf Coast on August 29, we felt inflationary pressures
could increase, thereby slowing economic growth in 2006 and prompting yields
to rise; therefore, we removed the remainder of the curve flattening bias.
Throughout the fiscal year, we continued to deemphasize total return trades in
favor of transactions that we believed could positively affect the current
yield of the portfolio. As a result, we were successfully able to increase the
Fund's distribution yield - the monthly income paid to shareholders - from
approximately 1% to 3.75% by period-end.
How would you characterize the Fund's position at the close of the period?
At period-end, our strategy centered on two primary themes, which we intend to
pursue in the months ahead. First, we intend to maintain a duration posture
modestly shorter than that of our benchmark. While we believe economic growth
will be slightly below trend levels, we expect that longer-term interest rates
will rise in response to what we would still consider positive economic
activity. Second, we intend to seek a competitive yield for our shareholders.
There is clearly some uncertainty regarding the absolute level and shape of
the Treasury yield curve. Thus, we will continue to invest heavily in
structured product as a proxy for agency debt and Treasury securities in an
effort to both add structure to the portfolio and generate incremental yield
above that offered by the Treasury and agency asset classes.
We believe the Fed is approaching the end of its measured monetary tightening
campaign. Consensus expectations are that the Fed will raise interest rates
twice more in 2005, which gives us enough reason to maintain a short duration.
However, because we are nearing the end of the cycle, we believe a more
neutral bias on the yield curve is appropriate rather than trying to exploit
any further flattening. Having said that, we will continue to monitor economic
data and Fed language for signs of interest rate direction, particularly in
the aftermath of Hurricane Katrina, and we stand ready to adjust our approach
as needed.
Frank Viola
Vice President and Co-Portfolio Manager
Thomas Musmanno
Vice President and Co-Portfolio Manager
Laura Powers
Vice President and Co-Portfolio Manager
September 13, 2005
* Effective June 30, 2005, Merrill Lynch U.S. Government Mortgage Fund (the
"Fund") changed its name to Merrill Lynch U.S. Government Fund. As a result
of this name change, the Fund revised its non-fundamental investment
restriction of investing at least 80% of its assets in U.S. government
securities representing an ownership interest in mortgage pools, or U.S.
government and U.S. government agency securities of issuers whose primary
purpose is to facilitate the making of residential or commercial mortgages,
to eliminate the reference to mortgage securities. As a non-fundamental
investment restriction, the Fund will now invest, under normal
circumstances, at least 80% of its assets in U.S. government and U.S.
government agency securities. In addition, the Fund will target an average
remaining maturity of between three and 10 years (for mortgage-backed
securities, maturity will be considered to be the average remaining life
based on certain prepayment assumptions). These changes do not affect any
investor's holding in the Fund or the Fund's investment objective to seek
high current return through investments in U.S. government securities and
U.S. government agency securities, including Government National Mortgage
Association mortgage-backed certificates and other mortgage-backed
government securities.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Performance Data
About Fund Performance
Investors are able to purchase shares of the Fund through multiple pricing
alternatives:
* Class A Shares incur a maximum initial sales charge (front-end load) of 4%
and an account maintenance fee of 0.25% per year (but no distribution fee).
* 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% per year and an account
maintenance fee of 0.25% per year. 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% per year and an
account maintenance fee of 0.25% per year. 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%
per year and an account maintenance fee of 0.25% per year. Class R Shares are
available only to certain retirement plans. Prior to inception, Class R Share
performance results are those of Class I Shares (which have no distribution or
account maintenance fees) restated for Class R Share fees.
None of the past results shown should be considered a representation of future
performance. Current performance may be lower or higher than the performance
data quoted. Refer to www.mlim.ml.com to obtain performance data current to
the most recent month-end. 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 gain distributions, if any, 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
6-Month 12-Month 10-Year Standardized
As of August 31, 2005 Total Return Total Return Total Return 30-Day Yield
ML U.S. Government Fund Class A Shares* +2.37% +3.22% +75.34% 3.34%
ML U.S. Government Fund Class B Shares* +2.11 +2.68 +66.82 2.96
ML U.S. Government Fund Class C Shares* +1.98 +2.53 +65.84 2.90
ML U.S. Government Fund Class I Shares* +2.40 +3.47 +79.77 3.57
ML U.S. Government Fund Class R Shares* +2.15 +2.96 +71.78 3.23
Citigroup Government/Mortgage Index** +2.96 +4.04 +89.50 --
Citigroup Mortgage Index*** +2.50 +4.05 +90.01 --
* Investment results shown do not reflect sales charges; results shown would be lower if a sales charge
was included. Cumulative 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.
** This unmanaged Index is a subset of the Citigroup U.S. Broad Investment Grade (USBIG) Index, tracking
the performance of the U.S. Treasury/government-sponsored component (fixed rate issues with a maturity
of one year or longer) and the mortgage component (15- and 30-year mortgages) of the USBIG.
*** This unmanaged Index reflects the performance of a capital market weighting of the outstanding agency-issued
mortgage-backed securities.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
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 Fund++ Class A, Class B, Class C, Class I and Class R Shares*
compared to a similar investment in Citigroup Government/Mortgage Index++++
and Citigroup Mortgage Index++++++. Values illustrated are as follows:
ML U.S. Government Fund++
Class A Shares*
Date Value
August 1995 $ 9,600.00
August 1996 $10,007.00
August 1997 $10,987.00
August 1998 $11,796.00
August 1999 $11,912.00
August 2000 $12,755.00
August 2001 $14,214.00
August 2002 $15,290.00
August 2003 $15,585.00
August 2004 $16,308.00
August 2005 $16,832.00
ML U.S. Government Fund++
Class B Shares*
Date Value
August 1995 $10,000.00
August 1996 $10,390.00
August 1997 $11,297.00
August 1998 $12,122.00
August 1999 $12,178.00
August 2000 $12,973.00
August 2001 $14,382.00
August 2002 $15,391.00
August 2003 $15,607.00
August 2004 $16,247.00
August 2005 $16,682.00
ML U.S. Government Fund++
Class C Shares*
Date Value
August 1995 $10,000.00
August 1996 $10,385.00
August 1997 $11,287.00
August 1998 $12,104.00
August 1999 $12,154.00
August 2000 $12,941.00
August 2001 $14,340.00
August 2002 $15,339.00
August 2003 $15,547.00
August 2004 $16,175.00
August 2005 $16,584.00
ML U.S. Government Fund++
Class I Shares*
Date Value
August 1995 $ 9,600.00
August 1996 $10,032.00
August 1997 $11,004.00
August 1998 $11,897.00
August 1999 $12,045.00
August 2000 $12,916.00
August 2001 $14,428.00
August 2002 $15,574.00
August 2003 $15,900.00
August 2004 $16,678.00
August 2005 $17,258.00
ML U.S. Government Fund++
Class R Shares*
Date Value
August 1995 $10,000.00
August 1996 $10,399.00
August 1997 $11,349.00
August 1998 $12,209.00
August 1999 $12,299.00
August 2000 $13,123.00
August 2001 $14,588.00
August 2002 $15,668.00
August 2003 $15,989.00
August 2004 $16,684.00
August 2005 $17,178.00
Citigroup Government/Mortgage Index++++
Date Value
August 1995 $10,000.00
August 1996 $10,418.00
August 1997 $11,431.00
August 1998 $12,674.00
August 1999 $12,776.00
August 2000 $13,786.00
August 2001 $15,404.00
August 2002 $16,769.00
August 2003 $17,233.00
August 2004 $18,214.00
August 2005 $18,950.00
Citigroup Mortgage Index++++++
Date Value
August 1995 $10,000.00
August 1996 $10,504.00
August 1997 $11,594.00
August 1998 $12,587.00
August 1999 $12,827.00
August 2000 $13,868.00
August 2001 $15,514.00
August 2002 $16,799.00
August 2003 $17,217.00
August 2004 $18,262.00
August 2005 $19,001.00
* Assuming maximum sales charge, transaction costs and other operating
expenses, including advisory fees.
++ The Fund invests at least 80% of its assets in U.S. government and U.S.
government agency securities, including GNMA mortgage-backed
certificates and other mortgage-backed government securities.
++++ This unmanaged Index is a subset of the Citigroup U.S. Broad Investment
Grade (USBIG) Index, tracking the performance of the U.S. Treasury/
government-sponsored component (fixed rate issues with a maturity of
one year or longer) and the mortgage component (15-year and 30-year
mortgages) of the USBIG.
++++++ 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 results.
Average Annual Total Return
Return Without Return With
Sales Charge Sales Charge**
Class A Shares*
One Year Ended 8/31/05 +3.22% -0.91%
Five Years Ended 8/31/05 +5.70 +4.84
Ten Years Ended 8/31/05 +5.78 +5.35
Return Return
Without CDSC With CDSC++++++
Class B Shares++
One Year Ended 8/31/05 +2.68% -1.30%
Five Years Ended 8/31/05 +5.16 +4.83
Ten Years Ended 8/31/05 +5.25 +5.25
Return Return
Without CDSC With CDSC++++++
Class C Shares++++
One Year Ended 8/31/05 +2.53% +1.53%
Five Years Ended 8/31/05 +5.09 +5.09
Ten Years Ended 8/31/05 +5.19 +5.19
Return Without Return With
Sales Charge Sales Charge**
Class I Shares*
One Year Ended 8/31/05 +3.47% -0.66%
Five Years Ended 8/31/05 +5.97 +5.11
Ten Years Ended 8/31/05 +6.04 +5.61
Class R Shares Return
One Year Ended 8/31/05 +2.96%
Five Years Ended 8/31/05 +5.53
Ten Years Ended 8/31/05 +5.56
* Maximum sales charge is 4%.
** Assuming maximum sales charge.
++ Maximum contingent deferred sales charge is 4% and is reduced to 0%
after six years.
++++ Maximum contingent deferred sales charge is 1% and is reduced to 0%
after one year.
++++++ Assuming payment of applicable contingent deferred sales charge.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Disclosure of Expenses
Shareholders of this Fund may incur the following charges: (a) expenses
related to transactions, including sales charges, redemption fees and exchange
fees; and (b) operating expenses including advisory fees, distribution fees
including 12(b)-1 fees, and other Fund expenses. The following example (which
is based on a hypothetical investment of $1,000 invested on March 31, 2005 and
held through August 31, 2005) is intended to assist shareholders both in
calculating expenses based on an investment in the Fund and in comparing these
expenses with similar costs of investing in other mutual funds.
The first table below provides information about actual account values and
actual expenses. In order to estimate the expenses a shareholder paid during
the period covered by this report, shareholders can divide their account value
by $1,000 and then multiply the result by the number in the first line under
the heading entitled "Expenses Paid During the Period."
The second table below provides information about hypothetical account values
and hypothetical expenses based on the Fund's actual expense ratio and an
assumed rate of return of 5% per year before expenses. In order to assist
shareholders in comparing the ongoing expenses of investing in this Fund and
other funds, compare the 5% hypothetical example with the 5% hypothetical
examples that appear in other funds' shareholder reports.
The expenses shown in the table are intended to highlight shareholders ongoing
costs only and do not reflect any transactional expenses, such as sales
charges, redemption fees or exchange fees. Therefore, the second table is
useful in comparing ongoing expenses only, and will not help shareholders
determine the relative total expenses of owning different funds. If these
transactional expenses were included, shareholder expenses would have been
higher.
Expenses Paid
Beginning Ending During the Period*
Account Value Account Value March 31, 2005
March 31, August 31, to August 31,
2005 2005 2005
Actual
Class A $1,000 $1,023.70 $5.25
Class B $1,000 $1,021.10 $7.90
Class C $1,000 $1,019.80 $8.15
Class I $1,000 $1,024.00 $3.98
Class R $1,000 $1,021.50 $6.52
Hypothetical (5% annual return before expenses)**
Class A $1,000 $1,020.01 $5.24
Class B $1,000 $1,017.39 $7.88
Class C $1,000 $1,017.14 $8.13
Class I $1,000 $1,021.27 $3.97
Class R $1,000 $1,018.75 $6.51
* For each class of the Fund, expenses are equal to the annualized expense ratio for the class (1.03% for
Class A, 1.55% for Class B, 1.60% for Class C, .78% for Class I and 1.28% for Class R), multiplied by the
average account value over the period, multiplied by 184/365 (to reflect the one-half year period shown).
** Hypothetical 5% annual return before expenses is calculated by pro-rating the number of days in the most
recent fiscal half-year divided by 365.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Schedule of Investments
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
U.S. Government & Agency Obligations--13.6%
Fannie Mae $ 8,000,000 6.25 % 5/15/2029 $ 9,826,208
51,200,000 6.625 9/15/2009 55,923,763
Federal Farm Credit Bank 15,500,000 4.55 6/08/2020 15,357,183
Freddie Mac 25,000,000 4.375 9/17/2010 25,228,175
U.S. Treasury Bonds 10,400,000 5.375 2/15/2031 (c) 12,193,189
42,200,000 7.125 2/15/2023 56,674,938
15,000,000 7.625 2/15/2025 21,479,880
10,000,000 8.125 8/15/2019 14,070,700
U.S. Treasury Notes 6,500,000 3.375 2/28/2007 6,457,347
14,250,000 4.125 5/15/2015 (c) 14,341,841
Total U.S. Government & Agency Obligations (Cost--$226,602,407)--13.6% 231,553,224
U.S. Government Agency Mortgage-Backed Obligations*--56.6%
Fannie Mae Guaranteed Pass-Through Certificates 44,131,199 0.686 (1)(3) 2/25/2013 964,073
5,195,492 4.28 2/01/2010 5,159,946
23,657,903 4.50 9/01/2034 22,973,865
3,469,155 4.62 11/01/2014 3,490,102
33,661,056 4.655 2/01/2015 33,946,727
9,788,560 4.68 2/01/2015 9,888,506
8,752,962 4.70 3/01/2015 8,854,195
6,434,126 4.72 3/01/2014 6,484,613
53,501,539 4.86 1/01/2015 - 2/01/2015 53,967,306
28,725,000 4.861 9/01/2035 28,859,648
7,961,612 4.94 3/01/2015 8,194,240
1,324,990 5.00 5/01/2018 - 3/01/2020 1,346,315
18,721,998 5.00 8/01/2035 18,602,920
8,919,928 5.01 1/01/2015 9,149,492
86,429,565 5.50 3/01/2032 - 2/01/2035 87,366,912
3,321,628 6.50 12/01/2008 - 2/01/2014 3,445,453
1,450,709 6.50 3/01/2033 1,502,417
277,611 7.00 (3) 7/01/2026 51,874
1,638,772 7.16 1/25/2022 1,679,134
7,299,286 7.50 7/01/2016 - 12/01/2032 7,744,088
24,732 8.00 9/01/2024 - 9/01/2027 26,517
1,355,994 8.50 8/01/2012 - 7/15/2023 1,484,757
388,814 11.00 2/01/2011 - 8/01/2020 431,537
289,142 13.00 9/01/2013 - 3/01/2015 325,788
Freddie Mac Mortgage Participation Certificates 129,422,259 5.00 1/01/2019 - 4/01/2020 130,474,389
37,882,753 5.00 7/01/2035 37,629,969
11,783,622 5.50 3/01/2016 - 8/01/2019 12,044,837
108,598,094 5.50 1/01/2035 - 3/01/2035 109,835,363
6,851,976 6.00 3/01/2016 - 6/01/2017 7,069,913
49,959,098 6.00 1/01/2032 - 9/01/2034 51,173,280
2,761,501 6.50 8/01/2029 2,865,830
1,819,390 7.00 4/01/2032 1,903,712
1,234,795 7.50 5/01/2009 - 10/01/2011 1,302,165
19,100,810 7.50 8/01/2017 - 12/01/2032 20,291,170
1,283,214 8.00 1/01/2008 - 7/01/2012 1,358,231
2,197,471 8.00 10/01/2027 - 8/01/2032 2,351,492
356,323 8.50 1/01/2025 - 7/01/2025 388,813
314 10.00 7/01/2019 348
1,485,639 10.50 1/01/2010 - 12/01/2020 1,664,925
233,329 11.00 8/01/2010 - 9/01/2020 260,140
189,445 11.50 12/01/2011 - 6/01/2020 208,125
147,571 12.00 6/01/2013 - 6/01/2020 164,307
257,391 12.50 12/01/2015 - 7/01/2019 283,464
437,384 13.00 9/01/2010 - 2/01/2016 488,044
3,959 751.00 (1)(3) 2/15/2022 57,408
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Schedule of Investments (continued)
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
U.S. Government Agency Mortgage-Backed Obligations* (concluded)
Ginnie Mae MBS Certificates $ 137,230,380 0.778% (1)(3) 1/16/2045 $ 7,713,720
34,965,964 1.012 (1)(3) 6/16/2045 2,476,290
59,654,104 1.033 (1)(3) 1/16/2044 3,045,342
167,644,987 1.065 (1)(3) 9/16/2044 9,134,975
47,807,269 5.00 12/15/2034 - 1/15/2035 48,001,916
9,630,900 5.10 10/15/2007 - 12/01/2015 9,867,627
12,527,200 5.11 8/01/2045 - 1/15/2047 12,743,695
20,302,314 5.50 7/15/2006 - 11/30/2045 21,483,796
12,931,460 5.60 1/15/2009 13,794,634
7,846,700 5.70 3/01/2015 - 8/15/2046 8,363,649
49,061,300 5.80 4/15/2046 52,708,027
2,528,362 6.00 5/15/2024 - 11/15/2031 2,610,118
34,553,684 6.09 10/15/2008 37,897,444
20,693,480 6.50 10/15/2023 - 3/15/2032 21,606,276
4,982,535 7.00 4/15/2023 - 4/15/2032 5,243,369
5,714,414 7.50 2/15/2025 - 12/15/2031 6,090,616
2,849,348 10.00 2/15/2016 - 12/15/2021 3,210,163
26,274 10.50 1/15/2016 - 4/15/2021 29,911
59 11.00 1/15/2016 65
Total U.S. Government Agency Mortgage-Backed Obligations (Cost--$957,753,409)--56.6% 963,777,983
U.S. Government Agency Mortgage-Backed Obligations*--Collateralized Mortgage Obligations--18.2%
Fannie Mae Guaranteed Pass-Through Certificates 19,561,143 3.781 (1) 4/25/2035 19,570,098
6,968,291 3.941 (1) 12/25/2017 6,921,720
19,365,734 3.941 (1) 6/25/2028 19,394,955
21,556,290 4.041 (1) 10/25/2031 21,670,846
5,952,029 5.50 11/25/2022 6,014,414
1,397,752 7.25 3/25/2026 1,469,870
Freddie Mac Mortgage Participation Certificates 6,505,774 2.37 12/15/2009 6,367,154
28,024,793 3.921 (1) 7/15/2028 27,973,015
486,974 10.00 (1) 2/15/2022 486,985
Ginnie Mae MBS Certificates 40,000,000 3.225 9/16/2021 38,810,848
9,709,157 3.878 12/16/2019 9,569,380
4,564,090 4.25 (1) 4/16/2045 4,047,266
39,180,573 4.368 11/16/2030 38,735,611
8,400,000 4.522 (1) 2/16/2028 8,325,752
5,117,382 4.65 (1) 1/16/2045 4,742,790
20,000,000 4.658 12/16/2030 19,976,120
5,500,000 4.723 10/03/2022 5,326,191
10,000,000 4.816 (1) 10/16/2029 10,118,750
8,000,000 4.917 (1) 2/16/2032 8,095,878
8,656,912 4.959 (1) 3/16/2046 8,675,849
10,000,000 5.042 1/16/2029 10,227,402
2,822,501 5.175 (1) 12/16/2044 2,986,825
10,000,000 5.252 (1) 1/16/2034 10,375,538
20,000,000 5.499 (1) 8/16/2027 20,944,310
Total U.S. Government Agency Mortgage-Backed Obligations--Collateralized Mortgage Obligations
(Cost--$309,687,234)--18.2% 310,827,567
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Schedule of Investments (continued)
Face
Amount Issue Value
Non-U.S. Government Agency Mortgage-Backed Securities*--Collateralized Mortgage Obligations--11.4%
$ 11,250,000 Ameriquest Mortgage Securities, Inc. Series 2004-IA1 Class M1, 4.441%
due 9/25/2034 (1) $ 11,314,440
47,823,000 Bear Stearns Adjustable Rate Mortgage Trust Series 2004-4 Class A4, 3.515%
due 6/25/2034 (1) 46,660,820
5,527,926 Centex Home Equity Series 2004-B Class AV1, 3.841% due 3/25/2034 (1) 5,530,594
11,142,232 Countrywide Home Equity Loan Trust Series 2004-K Class 2A, 3.871% due 2/15/2034 (1) 11,162,125
20,000,000 GS Mortgage Securities Corp. II Series 2005-GG4 Class A2, 4.475% due 7/10/2039 19,997,353
13,128,000 JPMorgan Chase Commercial Mortgage Securities Corp. Series 2005-LDP2 Class A2,
4.575% due 7/15/2042 13,162,699
19,000,000 Mastr Asset Backed Securities Trust Series 2004-HE1 Class A3, 4.001% due 9/25/2034 (1) 19,026,129
17,095,000 New Century Home Equity Loan Trust Series 2004-3 Class A5, 3.991% due 11/25/2034 (1) 17,137,737
8,000,000 Residential Asset Mortgage Products, Inc. Series 2004-RS9 Class AII2, 3.981%
due 5/25/2034 (1) 8,038,060
7,719,077 Securitized Asset Backed Receivables LLC Trust Series 2004-OP1 Class A2, 3.891%
due 2/25/2034 (1) 7,718,774
15,252,548 Washington Mutual Series 2004-AR12 Class A3, 3.76% due 10/25/2044 (1) 15,373,394
19,000,000 Wells Fargo Home Equity Trust Series 2004-2 Class A32, 3.981% due 2/25/2032 (1) 19,061,535
Total Non-U.S. Government Agency Mortgage-Backed Securities--Collateralized Mortgage Obligations
(Cost--$194,108,737)--11.4% 194,183,660
Short-Term Securities--5.0%
Repurchase 59,100,000 Credit Suisse First Boston Corp., purchased on 8/31/2005 to yield 3.59% to 9/01/2005,
Agreement repurchase price $59,105,894, collateralized by FNMA, 4.756% to 5.113% due 2/01/2025
to 5/01/2035 59,100,000
Beneficial
Interest
$ 26,372,500 Merrill Lynch Liquidity Series, LLC Money Market Series (a)(b) 26,372,500
Total Short-Term Securities (Cost--$85,472,500)--5.0% 85,472,500
Total Investments (Cost--$1,773,624,287)--104.8% 1,785,814,934
Number of
Contracts++ Options Written
Call Options 89 1-Year Swaption, expiring January 2006 at 4.25% Broker UBS Warburg (2) (186,900)
Written 12.5 10-Year Swaption, expiring September 2005 at 4.67% Broker JPMorgan Chase (2) (232,050)
12.5 10-Year Swaption, expiring September 2005 at 4.72% Broker Lehman Brothers (2) (272,950)
12.5 10-Year Swaption, expiring September 2005 at 4.785% Broker JPMorgan Chase (2) (335,363)
12.5 10-Year Swaption, expiring September 2005 at 4.88% Broker Lehman Brothers Special
Finance (2) (430,987)
25 3-Month Swaption, expiring November 2005 at 4.205% Broker Credit Suisse First
Boston (2) (115,250)
Put Options 89 1-Year Swaption, expiring January 2006 at 4.25% Broker UBS Warburg (2) (160,200)
Written 12.5 10-Year Swaption, expiring September 2005 at 4.67% Broker JPMorgan Chase (2) (19,237)
12.5 10-Year Swaption, expiring September 2005 at 4.72% Broker Lehman Brothers (2) (125)
12.5 10-Year Swaption, expiring September 2005 at 4.785% Broker JPMorgan Chase (2) (4,900)
12.5 10-Year Swaption, expiring September 2005 at 4.88% Broker Lehman Brothers Special
Finance (2) (13)
25 3-Month Swaption, expiring November 2005 at 5.105% Broker Credit Suisse First Boston (2) (31,375)
Total Options Written (Premiums Received--$1,261,825)--(0.1%) (1,789,350)
Total Investments, Net of Options Written--(Cost--$1,772,362,462**)--104.7% 1,784,025,584
Liabilities in Excess of Other Assets--(4.7%) (79,575,549)
---------------
Net Assets--100.0% $ 1,704,450,035
===============
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Schedule of Investments (continued)
++ One contract represents a notional amount of $1,000,000.
* Mortgage-Backed Securities are subject to principal paydowns as a result of
prepayments or refinancing of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity.
** The cost and unrealized appreciation (depreciation) of investments, net of
options written, as of August 31, 2005, as computed for federal income
tax purposes, were as follows:
Aggregate cost $ 1,772,431,642
=================
Gross unrealized appreciation $ 18,096,572
Gross unrealized depreciation (6,502,630)
-----------------
Net unrealized appreciation $ 11,593,942
=================
(1) Floating rate note.
(2) This European style swaption, which can be exercised only on the expiration
date, represents a standby commitment whereby the writer of the option is
obligated to enter into a predetermined interest rate swap contract upon
exercise of swaption.
(3) Represents the interest only portion of a mortgage-backed obligation.
(a) Investments in companies considered to be an affiliate of the Fund, for
purposes of Section 2(a)(3) of the Investment Company Act of 1940, were
as follows:
Interest/
Net Dividend
Affiliate Activity Income
Merrill Lynch Liquidity Series, LLC
Money Market Series $ 26,372,500 $ 85,413
Merrill Lynch Premier Institutional
Fund (10,600,000) $ 27,161
(b) Security was purchased with the cash proceeds from securities loans.
(c) Security, or a portion of security, is on loan.
Swaps outstanding as of August 31, 2005 were as follows:
Unrealized
Notional Appreciation
Amount (Depreciation)
Receive (pay) a variable return
based on the change in the since
inception return of the Lehman
Brothers MBS Fixed Rate Index
and pay a floating rate based on
1-month USD LIBOR minus 0.10%
Broker, Lehman Brothers
Special Finance
Expires September 2005 $100,000,000 --
Receive (pay) a variable return
based on the change in the since
inception return of the Lehman
Brothers MBS Fixed Rate Index
and pay a floating rate based on
1-month USD LIBOR minus 0.12%
Broker, UBS Warburg
Expires November 2005 $ 50,000,000 --
Swaps outstanding as of August 31, 2005 (continued):
Unrealized
Notional Appreciation
Amount (Depreciation)
Receive (pay) a variable return
based on the change in the since
inception return of the Lehman
Brothers MBS Fixed Rate Index
and pay a floating rate based on
1-month USD LIBOR minus 0.03%
Broker, Lehman Brothers
Special Finance
Expires December 2005 $100,000,000 --
Pay a fixed rate of 3.4775% and
receive a floating rate based on
3-month USD LIBOR
Broker, Lehman Brothers
Special Finance
Expires September 2008 $ 40,000,000 $ 848,924
Pay a fixed rate of 4.635% and
receive a floating rate based on
3-month USD LIBOR
Broker, JPMorgan Chase Bank
Expires April 2010 $ 10,000,000 (152,045)
Pay a fixed rate of 4.53% and
receive a floating rate based on
3-month USD LIBOR
Broker, HSBC Bank USA
Expires August 2010 $ 10,000,000 (109,026)
Pay a fixed rate of 4.76% and
receive a floating rate based on
3-month USD LIBOR
Broker, Credit Suisse First Boston
International
Expires June 2015 $ 40,000,000 (1,023,358)
Pay a fixed rate of 4.811% and
receive a floating rate based on
3-month USD LIBOR
Broker, Lehman Brothers
Special Finance
Expires September 2015 $ 8,500,000 (241,026)
Pay a fixed rate of 5.145% and
receive a floating rate based on
3-month USD LIBOR
Broker, Lehman Brothers
Special Finance
Expires September 2015 $45,000,000 (2,480,310)
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Schedule of Investments (concluded)
Swaps outstanding as of August 31, 2005 (concluded):
Unrealized
Notional Appreciation
Amount (Depreciation)
Pay a fixed rate of 4.794% and
receive a floating rate based on
3-month USD LIBOR
Broker, Lehman Brothers
Special Finance
Expires September 2015 $12,000,000 $ (323,928)
Pay a fixed rate of 5.014% and
receive a floating rate based on
3-month USD LIBOR
Broker, JPMorgan Chase Bank
Expires September 2015 $ 7,000,000 (340,487)
Pay a fixed rate of 4.739% and
receive a floating rate based on
3-month USD LIBOR
Broker, JPMorgan Chase Bank
Expires September 2015 $12,000,000 (271,044)
Unrealized
Notional Appreciation
Amount (Depreciation)
Pay a fixed rate of 5.2265% and
receive a floating rate based on
3-month USD LIBOR
Broker, JPMorgan Chase Bank
Expires September 2015 $35,000,000 $(2,157,680)
Pay a fixed rate of 4.72% and
receive a floating rate based on
3-month USD LIBOR
Broker, Citibank N.A.
Expires September 2015 $ 6,500,000 (141,245)
Receive a fixed rate of 4.88% and
pay a floating rate based on
3-month USD LIBOR
Broker, Lehman Brothers
Special Finance
Expires September 2015 $43,800,000 520,110
------------
Total $(5,871,115)
============
See Notes to Financial Statements.
Portfolio Information as of August 31, 2005
Percent of
Asset Mix Total Investments
U.S. Government Agency Mortgage-Backed
Obligations 54.0%
U.S. Government Agency Mortgage-Backed
Obligations--Collateralized Mortgage
Obligations 17.4
U.S. Government & Agency Obligations 13.0
Non-U.S. Government Agency Mortgage-Backed
Securities--Collateralized Mortgage
Obligations 10.9
Other* 4.7
* Includes portfolio holdings in short-term investments and options.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Statement of Assets and Liabilities
As of August 31, 2005
Assets
Investments in unaffiliated securities, at value (including securities loaned
of $25,814,360) (identified cost--$1,747,251,787) $ 1,759,442,434
Investment in affiliated securities, at value (identified cost--$26,372,500) 26,372,500
Cash 42,475
Receivables:
Securities sold $ 35,339,532
Interest 7,667,865
Beneficial interest sold 2,079,368
Principal paydowns 746,788
Securities lending 7,036 45,840,589
---------------
Prepaid expenses and other assets 161,539
---------------
Total assets 1,831,859,537
---------------
Liabilities
Collateral on securities loaned, at value 26,372,500
Options written, at value (premiums received--$1,261,825) 1,789,350
Unrealized depreciation on swaps--net 5,871,115
Payables:
Securities purchased 84,280,422
Beneficial interest redeemed 5,302,785
Dividends to shareholders 1,170,762
Other affiliates 651,726
Distributor 552,336
Investment adviser 523,539
Swaps 319,854 92,801,424
---------------
Accrued expenses and other liabilities 575,113
---------------
Total liabilities 127,409,502
---------------
Net Assets
Net assets $ 1,704,450,035
===============
Net Assets Consist of
Class A Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized $ 7,493,996
Class B Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 3,241,153
Class C Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 2,414,861
Class I Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 3,259,455
Class R Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 193,665
Paid-in capital in excess of par 1,677,555,686
Undistributed investment income--net $ 1,278,118
Undistributed realized capital gains--net 3,221,094
Unrealized appreciation--net 5,792,007
---------------
Total accumulated earnings--net 10,291,219
---------------
Net Assets $ 1,704,450,035
===============
Net Asset Value
Class A--Based on net assets of $769,308,521 and 74,939,955 shares of beneficial
interest outstanding $ 10.27
===============
Class B--Based on net assets of $332,743,783 and 32,411,533 shares of beneficial
interest outstanding $ 10.27
===============
Class C--Based on net assets of $247,884,080 and 24,148,608 shares of beneficial
interest outstanding $ 10.26
===============
Class I--Based on net assets of $334,660,003 and 32,594,545 shares of beneficial
interest outstanding $ 10.27
===============
Class R--Based on net assets of $19,853,648 and 1,936,645 shares of beneficial
interest outstanding $ 10.25
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Statement of Operations
For the Year Ended August 31, 2005
Investment Income
Interest $ 74,077,111
Securities lending--net 112,574
---------------
Total income 74,189,685
---------------
Expenses
Investment advisory fees $ 8,415,026
Account maintenance and distribution fees--Class B 2,876,960
Account maintenance and distribution fees--Class C 2,183,795
Account maintenance fees--Class A 1,926,502
Transfer agent fees--Class A 1,694,288
Transfer agent fees--Class B 918,313
Transfer agent fees--Class I 797,364
Transfer agent fees--Class C 668,694
Accounting services 507,716
Custodian fees 195,412
Printing and shareholder reports 109,451
Professional fees 92,399
Registration fees 90,825
Pricing fees 86,878
Account maintenance and distribution fees--Class R 69,281
Trustees' fees and expenses 55,819
Transfer agent fees--Class R 30,761
Other 224,951
---------------
Total expenses 20,944,435
---------------
Investment income--net 53,245,250
---------------
Realized & Unrealized Gain (Loss)--Net
Realized gain (loss) on:
Investments--net 23,981,712
Futures contracts and swaps--net (791,510)
Options written--net 2,416,691 25,606,893
---------------
Change in unrealized appreciation/depreciation on:
Investments--net (19,323,623)
Futures contracts and swaps--net (5,285,654)
Options written--net (527,525) (25,136,802)
--------------- ---------------
Total realized and unrealized gain--net 470,091
---------------
Net Increase in Net Assets Resulting from Operations $ 53,715,341
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Statements of Changes in Net Assets
For the Year Ended
August 31,
Increase (Decrease) in Net Assets: 2005 2004
Operations
Investment income--net $ 53,245,250 $ 50,565,902
Realized gain--net 25,606,893 10,222,989
Change in unrealized appreciation/depreciation--net (25,136,802) 27,462,524
--------------- ---------------
Net increase in net assets resulting from operations 53,715,341 88,251,415
--------------- ---------------
Dividends to Shareholders
Investment income--net:
Class A (27,412,537) (23,500,858)
Class B (11,609,588) (11,684,031)
Class C (8,117,957) (7,884,557)
Class I (13,783,700) (10,070,313)
Class R (467,783) (83,884)
--------------- ---------------
Net decrease in net assets resulting from dividends to shareholders (61,391,565) (53,223,643)
--------------- ---------------
Beneficial Interest Transactions
Net decrease in net assets derived from beneficial interest transactions (184,361,007) (328,542,585)
--------------- ---------------
Net Assets
Total decrease in net assets (192,037,231) (293,514,813)
Beginning of year 1,896,487,266 2,190,002,079
--------------- ---------------
End of year* $ 1,704,450,035 $ 1,896,487,266
=============== ===============
* Undistributed investment income--net $ 1,278,118 $ 7,020,261
=============== ===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Financial Highlights
Class A
The following per share data and ratios have been derived For the Year Ended August 31,
from information provided in the financial statements. 2005 2004 2003 2002 2001
Per Share Operating Performance
Net asset value, beginning of year $ 10.31 $ 10.13 $ 10.25 $ 9.95 $ 9.44
---------- ---------- ---------- ---------- ----------
Investment income--net .32++ .27++ .32 .43 .55
Realized and unrealized gain (loss)--net .01 .19 (.12) .30 .51
---------- ---------- ---------- ---------- ----------
Total from investment operations .33 .46 .20 .73 1.06
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.37) (.28) (.32) (.43) (.55)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.27 $ 10.31 $ 10.13 $ 10.25 $ 9.95
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 3.22% 4.63% 1.93% 7.54% 11.49%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses 1.01% .98% .95% .97% 1.00%
========== ========== ========== ========== ==========
Investment income--net 3.11% 2.65% 3.09% 4.30% 5.59%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 769,309 $ 798,279 $ 855,543 $ 819,410 $ 729,136
========== ========== ========== ========== ==========
Portfolio turnover 336.73% 508.54% 428.59% 426.77% 199.30%
========== ========== ========== ========== ==========
* Total investment returns exclude the effects of sales charges.
++ Based on average shares outstanding.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Financial Highlights (continued)
Class B
The following per share data and ratios have been derived For the Year Ended August 31,
from information provided in the financial statements. 2005 2004 2003 2002 2001
Per Share Operating Performance
Net asset value, beginning of year $ 10.31 $ 10.13 $ 10.26 $ 9.95 $ 9.44
---------- ---------- ---------- ---------- ----------
Investment income--net .26++ .22++ .26 .38 .50
Realized and unrealized gain (loss)--net .01 .19 (.13) .31 .51
---------- ---------- ---------- ---------- ----------
Total from investment operations .27 .41 .13 .69 1.01
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.31) (.23) (.26) (.38) (.50)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.27 $ 10.31 $ 10.13 $ 10.26 $ 9.95
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 2.68% 4.09% 1.40% 6.99% 10.91%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses 1.53% 1.50% 1.47% 1.49% 1.52%
========== ========== ========== ========== ==========
Investment income--net 2.55% 2.14% 2.58% 3.76% 5.07%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 332,744 $ 438,679 $ 591,435 $ 613,282 $ 466,432
========== ========== ========== ========== ==========
Portfolio turnover 336.73% 508.54% 428.59% 426.77% 199.30%
========== ========== ========== ========== ==========
* Total investment returns exclude the effects of sales charges.
++ Based on average shares outstanding.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Financial Highlights (continued)
Class C
The following per share data and ratios have been derived For the Year Ended August 31,
from information provided in the financial statements. 2005 2004 2003 2002 2001
Per Share Operating Performance
Net asset value, beginning of year $ 10.31 $ 10.13 $ 10.25 $ 9.95 $ 9.44
---------- ---------- ---------- ---------- ----------
Investment income--net .26++ .21++ .26 .37 .49
Realized and unrealized gain (loss)--net --++++ .19 (.12) .30 .51
---------- ---------- ---------- ---------- ----------
Total from investment operations .26 .40 .14 .67 1.00
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.31) (.22) (.26) (.37) (.49)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.26 $ 10.31 $ 10.13 $ 10.25 $ 9.95
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 2.53% 4.03% 1.35% 6.94% 10.86%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses 1.59% 1.55% 1.52% 1.54% 1.57%
========== ========== ========== ========== ==========
Investment income--net 2.51% 2.09% 2.52% 3.40% 5.00%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 247,884 $ 301,532 $ 414,539 $ 384,119 $ 56,706
========== ========== ========== ========== ==========
Portfolio turnover 336.73% 508.54% 428.59% 426.77% 199.30%
========== ========== ========== ========== ==========
* Total investment returns exclude the effects of sales charges.
++ Based on average shares outstanding.
++++ Amount is less than $0.01 per share.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Financial Highlights (continued)
Class I
The following per share data and ratios have been derived For the Year Ended August 31,
from information provided in the financial statements. 2005 2004 2003 2002 2001
Per Share Operating Performance
Net asset value, beginning of year $ 10.31 $ 10.13 $ 10.26 $ 9.95 $ 9.44
---------- ---------- ---------- ---------- ----------
Investment income--net .35++ .29++ .34 .46 .57
Realized and unrealized gain (loss)--net --++++ .20 (.13) .31 .51
---------- ---------- ---------- ---------- ----------
Total from investment operations .35 .49 .21 .77 1.08
---------- ---------- ---------- ---------- ----------
Less dividends from investment income--net (.39) (.31) (.34) (.46) (.57)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 10.27 $ 10.31 $ 10.13 $ 10.26 $ 9.95
========== ========== ========== ========== ==========
Total Investment Return*
Based on net asset value per share 3.47% 4.89% 2.08% 7.91% 11.77%
========== ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses .76% .73% .70% .72% .75%
========== ========== ========== ========== ==========
Investment income--net 3.38% 2.89% 3.34% 4.53% 5.84%
========== ========== ========== ========== ==========
Supplemental Data
Net assets, end of year (in thousands) $ 334,660 $ 349,958 $ 328,408 $ 296,305 $ 234,930
========== ========== ========== ========== ==========
Portfolio turnover 336.73% 508.54% 428.59% 426.77% 199.30%
========== ========== ========== ========== ==========
* Total investment returns exclude the effects of sales charges.
++ Based on average shares outstanding.
++++ Amount is less than $0.01 per share.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Financial Highlights (concluded)
Class R
For the Period
January 3,
For the Year Ended 2003++ to
The following per share data and ratios have been derived August 31, August 31,
from information provided in the financial statements. 2005 2004 2003
Per Share Operating Performance
Net asset value, beginning of period $ 10.29 $ 10.12 $ 10.31
----------- ----------- -----------
Investment income--net .31++++ .23++++ .24
Realized and unrealized gain (loss)--net (.01) .20 (.19)
----------- ----------- -----------
Total from investment operations .30 .43 .05
----------- ----------- -----------
Less dividends from investment income--net (.34) (.26) (.24)
----------- ----------- -----------
Net asset value, end of period $ 10.25 $ 10.29 $ 10.12
=========== =========== ===========
Total Investment Return**
Based on net asset value per share 2.96% 4.34% .44%+++
=========== =========== ===========
Ratios to Average Net Assets
Expenses 1.27% 1.21% 1.23%*
=========== =========== ===========
Investment income--net 2.97% 2.25% 2.81%*
=========== =========== ===========
Supplemental Data
Net assets, end of period (in thousands) $ 19,854 $ 8,040 $ 77
=========== =========== ===========
Portfolio turnover 336.73% 508.54% 428.59%
=========== =========== ===========
* Annualized.
** Total investment returns exclude the effects of sales charges.
++ Commencement of operations.
++++ Based on average shares outstanding.
+++ Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Notes to Financial Statements
1. Significant Accounting Policies:
Merrill Lynch U.S. Government Fund (the "Fund")(formerly Merrill Lynch U.S.
Government Mortgage 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 U.S. generally
accepted accounting principles which may require the use of management
accruals and estimates. Actual results may differ from these estimates. The
Fund offers multiple classes of shares. 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 (except that Class B
shareholders may vote upon material changes to the Class A distribution plan).
Income, expenses (other than expenses attributable to a specific class) and
realized and unrealized gains and losses 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--Debt securities are traded primarily in the over-
the-counter ("OTC") markets and are valued at the last available bid price in
the OTC market or on the basis of values obtained by a pricing service.
Pricing services use valuation matrixes that incorporate both dealer-supplied
valuations and valuation models. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
direction of the Board of Trustees. Such valuations and procedures will be
reviewed periodically by the Board of Trustees of the Fund. Financial futures
contracts and options thereon, which are traded on exchanges, are valued at
their closing prices as of the close of such exchanges. Options written or
purchased are valued at the last sale price in the case of exchange-traded
options. In the case of options traded in the OTC market, valuation is the
last asked price (options written) or the last bid price (options purchased).
Swap agreements are valued based upon quoted fair valuations received daily by
the Fund from a pricing service or counterparty. Short-term investments with a
remaining maturity of 60 days or less are valued at amortized cost which
approximates market value, under which method the investment is valued at cost
and any premium or discount is amortized on a straight line basis to maturity.
Repurchase agreements are valued at cost plus accrued interest. Investments in
open-end investment companies are valued at their net asset value each
business day. Securities and other assets for which market quotations are not
readily available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Fund.
Equity securities that are held by the Fund, which are traded on stock
exchanges or the Nasdaq National Market are valued at the last sale price or
official close price on the exchange, 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 asked price for short
positions. In cases where equity 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 traded in the OTC market, Nasdaq Small Cap or Bulletin Board are
valued at the last available bid price obtained from one or more dealers or
pricing services approved by the Board of Trustees of the Fund. Short
positions traded in the OTC market are valued at the last available asked
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.
Generally, trading in foreign securities, 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 Fund's Board of Trustees or by the Investment Adviser using a pricing
service and/or procedures approved by the Fund's Board of Trustees.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Notes to Financial Statements (continued)
(b) Repurchase agreements--The Fund may invest 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 movements 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 predetermined credit event. The
net periodic payments may be based on a fixed or variable interest rate; the
change in market value of a specified security, basket of securities, or
index; or the return generated by a security. These periodic payments received
or made by the Fund are recorded in the accompanying Statement of Operations
as realized gains or losses, respectively. Gains or losses are realized upon
termination of the swap agreements. Swaps are marked-to-market daily and
changes in the value are recorded as unrealized appreciation (depreciation).
Risks include changes in the returns of the underlying instruments, failure of
the counterparties to perform under contracts' terms and the possible lack of
liquidity with respect to the swap agreements.
(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 FUND AUGUST 31, 2005
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 contract to repurchase
substantially similar (same type, coupon and maturity) securities on a
specific future date.
(j) Reclassification--U.S. generally accepted accounting prinicples require
that certain components of net assets be adjusted to reflect permanent
differences between financial and tax reporting. Accordingly, during the
current year, $2,404,172 has been reclassified between undistributed net
realized capital gains and undistributed net investment income as a result of
permanent differences attributable to swap agreements. This reclassification
has 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 rates:
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%
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%
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Notes to Financial Statements (continued)
Pursuant to a sub-agreement with the Distributor, Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), an affiliate of FAM, 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, 2005, 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 $ 2,628 $ 27,255
Class I $ 4 $ 63
For the year ended August 31, 2005, MLPF&S received contingent deferred sales
charges of $500,249 and $5,562 relating to transactions in Class B and Class C
Shares, respectively. Furthermore, MLPF&S received contingent deferred sales
charges of $1,513 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, 2005, MLIM,
LLC received $46,296 in securities lending agent fees.
For the year ended August 31, 2005, the Fund reimbursed MLIM $40,937 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Fund's transfer agent.
Certain officers and/or trustees of the Fund are officers and/or directors of
FAM, PSI, FAMD, FDS, ML & Co., and/or MLIM, LLC.
3. Investments:
Purchases (including pay-ups) and sales (including paydowns) of investments,
excluding short-term securities, for the year ended August 31, 2005 were
$5,674,995,334 and $5,950,413,865, respectively.
Transactions in call and put options written for the year ended August 31,
2005 were as follows:
Call Options Number of Premiums
Written Contracts* Received
Outstanding call options written,
beginning of year -- --
Options written 2,701 $ 2,689,063
Options expired (2,400) (1,078,500)
Options closed (137) (1,082,813)
-------------- ---------------
Outstanding call options written,
end of year 164 $ 527,750
============== ===============
* One contract represents a notional amount of $1,000,000.
Put Options Number of Premiums
Written Contracts* Received
Outstanding put options written,
beginning of year -- --
Options sold 851 $ 3,589,220
Options expired (500) (76,875)
Options closed (187) (2,778,270)
-------------- ---------------
Outstanding put options written,
end of year 164 $ 734,075
=============== ===============
* One contract represents a notional amount of $1,000,000.
4. Shares of Beneficial Interest:
Net decrease in net assets derived from beneficial interest transactions was
$184,361,007 and $328,542,585 for the years ended August 31, 2005 and August
31, 2004, respectively.
Transactions in shares of beneficial interest for each class were as follows:
Class A Shares for the Year Dollar
Ended August 31, 2005 Shares Amount
Shares sold 13,755,263 $ 141,240,518
Automatic conversion of shares 1,537,836 15,782,440
Shares issued to shareholders
in reinvestment of dividends 1,088,754 11,168,893
-------------- ---------------
Total issued 16,381,853 168,191,851
Shares redeemed (18,900,986) (194,005,389)
-------------- ---------------
Net decrease (2,519,133) $ (25,813,538)
============== ===============
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Notes to Financial Statements (continued)
Class A Shares for the Year Dollar
Ended August 31, 2004 Shares Amount
Shares sold 15,955,583 $ 163,141,791
Automatic conversion of shares 2,043,991 20,880,726
Shares issued to shareholders
in reinvestment of dividends 1,004,421 10,285,233
-------------- ---------------
Total issued 19,003,995 194,307,750
Shares redeemed (26,004,015) (265,728,253)
-------------- ---------------
Net decrease (7,000,020) $ (71,420,503)
============== ===============
Class B Shares for the Year Dollar
Ended August 31, 2005 Shares Amount
Shares sold 3,965,033 $ 40,697,638
Shares issued to shareholders
in reinvestment of dividends 832,873 8,544,862
-------------- ---------------
Total issued 4,797,906 49,242,500
-------------- ---------------
Shares redeemed (13,411,984) (137,655,114)
Automatic conversion of shares (1,537,822) (15,782,440)
-------------- ---------------
Total redeemed (14,949,806) (153,437,554)
-------------- ---------------
Net decrease (10,151,900) $ (104,195,054)
============== ===============
Class B Shares for the Year Dollar
Ended August 31, 2004 Shares Amount
Shares sold 5,582,565 $ 57,115,360
Shares issued to shareholders
in reinvestment of dividends 844,324 8,648,702
-------------- ---------------
Total issued 6,426,889 65,764,062
-------------- ---------------
Automatic conversion of shares (2,043,898) (20,880,726)
Shares redeemed (20,203,533) (206,479,766)
-------------- ---------------
Total redeemed (22,247,431) (227,360,492)
-------------- ---------------
Net decrease (15,820,542) $ (161,596,430)
============== ===============
Class C Shares for the Year Dollar
Ended August 31, 2005 Shares Amount
Shares sold 4,015,656 $ 41,183,291
Shares issued to shareholders
in reinvestment of dividends 592,719 6,079,698
-------------- ---------------
Total issued 4,608,375 47,262,989
Shares redeemed (9,720,117) (99,718,766)
-------------- ---------------
Net decrease (5,111,742) $ (52,455,777)
============== ===============
Class C Shares for the Year Dollar
Ended August 31, 2004 Shares Amount
Shares sold 3,281,754 $ 33,583,925
Shares issued to shareholders
in reinvestment of dividends 566,068 5,796,384
-------------- ---------------
Total issued 3,847,822 39,380,309
Shares redeemed (15,513,398) (158,579,358)
-------------- ---------------
Net decrease (11,665,576) $ (119,199,049)
============== ===============
Class I Shares for the Year Dollar
Ended August 31, 2005 Shares Amount
Shares sold 14,818,949 $ 152,032,859
Shares issued to shareholders
in reinvestment of dividends 41,103 421,526
-------------- ---------------
Total issued 14,860,052 152,454,385
Shares redeemed (16,211,687) (166,192,288)
-------------- ---------------
Net decrease (1,351,635) $ (13,737,903)
============== ===============
Class I Shares for the Year Dollar
Ended August 31, 2004 Shares Amount
Shares sold 11,818,884 $ 120,972,566
Shares issued to shareholders
in reinvestment of dividends 41,314 423,214
-------------- ---------------
Total issued 11,860,198 121,395,780
Shares redeemed (10,323,699) (105,644,634)
-------------- ---------------
Net increase 1,536,499 $ 15,751,146
============== ===============
Class R Shares for the Year Dollar
Ended August 31, 2005 Shares Amount
Shares sold 1,626,211 $ 16,665,960
Shares issued to shareholders
in reinvestment of dividends 43,218 442,418
-------------- ---------------
Total issued 1,669,429 17,108,378
Shares redeemed (514,000) (5,267,113)
-------------- ---------------
Net increase 1,155,429 $ 11,841,265
============== ===============
Class R Shares for the Year Dollar
Ended August 31, 2004 Shares Amount
Shares sold 949,466 $ 9,714,926
Shares issued to shareholders
in reinvestment of dividends 7,660 78,178
-------------- ---------------
Total issued 957,126 9,793,104
Shares redeemed (183,511) (1,870,853)
-------------- ---------------
Net increase 773,615 $ 7,922,251
============== ===============
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Notes to Financial Statements (concluded)
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 a group of lenders, which
expires November 2005. 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 .07% 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 defined in the credit agreement. The Fund did not
borrow under the credit agreement during the year ended August 31, 2005.
6. Distributions to Shareholders:
The tax character of distributions paid during the fiscal years ended August
31, 2005 and August 31, 2004 was as follows:
8/31/2005 8/31/2004
Distributions paid from:
Ordinary income $ 61,391,565 $ 53,223,643
-------------- ---------------
Total taxable distributions $ 61,391,565 $ 53,223,643
============== ===============
As of August 31, 2005, the components of accumulated earnings on a tax basis
were as follows:
Undistributed ordinary income--net $ 4,583,224
Undistributed long-term capital gains--net --
---------------
Total undistributed earnings--net 4,583,224
Capital loss carryforward --
Unrealized gains--net 5,707,995*
---------------
Total accumulated earnings--net $ 10,291,219
===============
*The difference between book-basis and tax-basis net unrealized
gains is attributable primarily to the tax deferral of losses on wash
sales and the tax deferral of losses on straddles.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Trustees
of Merrill Lynch U.S. Government Fund:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Merrill Lynch U.S. Government Fund
(formerly Merrill Lynch U.S. Government Mortgage Fund) as of August 31, 2005,
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 five years in the
period 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 the standards of the Public Company
Accounting Oversight Board (United States). 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. The Fund is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Fund's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. Our
procedures included confirmation of securities owned as of August 31, 2005, by
correspondence with the custodian and brokers; where replies were not received
from brokers, we performed other auditing procedures. 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 Fund as of August 31, 2005, 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 five years in the period then ended, in conformity with U.S. generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
October 25, 2005
Important Tax Information (unaudited)
Of the ordinary income distributions paid monthly by Merrill Lynch U.S.
Government Fund during the taxable year ended August 31, 2005, 4.20% was
attributable to federal obligations.
The law varies in each state as to whether and what percentage of dividend
income attributable to federal obligations is exempt from state income tax. We
recommend that you consult your tax adviser to determine if any portion of the
dividends you received is exempt from state income taxes.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Officers and Trustees
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name, Address & Age Fund Served Principal Occupation(s) During Past 5 Years Trustee Trustee
Interested Trustee
Robert C. Doll, Jr.* President 2005 to President of the MLIM/FAM-advised funds since 130 Funds None
P.O. Box 9011 and present 2005; President of MLIM and FAM since 2001; 175 Portfolios
Princeton, Trustee Co-Head (Americas Region) thereof from 2000
NJ 08543-9011 to 2001 and Senior Vice President from 1999
Age: 51 to 2001; President and Director of Princeton
Services, Inc. ("Princeton Services") since
2001; President of Princeton Administrators,
L.P. ("Princeton Administrators") since 2001;
Chief Investment Officer of Oppenheimer Funds,
Inc. in 1999 and Executive Vice President
thereof from 1991 to 1999.
* Mr. Doll 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. Doll
is an "interested person," as defined in the Investment Company Act, of the Fund
based on his current positions with MLIM, FAM, Princeton Services and Princeton
Administrators. Trustees serve until their resignation, removal or death, or
until December 31 of the year in which they turn 72. As Fund President,
Mr. Doll serves at the pleasure of the Board of Trustees.
Independent Trustees*
James H. Bodurtha** Trustee 2002 to Director, The China Business Group, Inc. 39 Funds None
P.O. Box 9095 present since 1996 and Executive Vice President 59 Portfolios
Princeton, thereof from 1996 to 2003; Chairman of the
NJ 08543-9095 Board, Berkshire Holding Corporation since
Age: 61 1980; Partner, Squire, Sanders & Dempsey
from 1980 to 1993.
Kenneth A. Froot Trustee 2005 to Professor, Harvard University since 1992; 39 Funds None
P.O. Box 9095 present Professor, Massachusetts Institute of 59 Portfolios
Princeton, Technology from 1986 to 1992.
NJ 08543-9095
Age: 48
Joe Grills** Trustee 1994 to Member of the Committee of Investment of 39 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; Member of CIEBA's Executive Committee
Age: 70 since 1988 and its Chairman from 1991 to 1992;
Assistant Treasurer of International Business
Machines Corporation ("IBM") and Chief
Investment Officer of IBM Retirement Funds
from 1986 to 1993; Member of the Investment
Advisory Committee 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 University Management
Company from 1992 to 2004, Vice Chairman
thereof from 1998 to 2004, and Director Emeritus
thereof since 2004; 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, Vice Chairman thereof from
2002 to 2005, and Chairman thereof since 2005;
Director, Montpelier Foundation since 1998 and
its Vice Chairman 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 FUND AUGUST 31, 2005
Officers and Trustees (continued)
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name, Address & Age 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 39 Funds None
P.O. Box 9095 present York University since 1993 and Professor 59 Portfolios
Princeton, thereof since 1980; President, Hudson
NJ 08543-9095 Institute since 1997 and Trustee thereof since
Age: 66 1980; Dean, Gallatin Division of New York
University from 1976 to 1993; Distinguished
Fellow, Herman Kahn Chair, Hudson Institute
from 1984 to 1985; Director, Damon Corp. from
1991 to 1995; Overseer, Center for Naval
Analyses from 1983 to 1993.
Roberta Cooper Ramo Trustee 2002 to Shareholder, Modrall, Sperling, Roehl, 39 Funds None
P.O. Box 9095 present Harris & Sisk, P.A. since 1993; President, 59 Portfolios
Princeton, American Bar Association from 1995 to 1996
NJ 08543-9095 and Member of the Board of Governors thereof
Age: 63 from 1994 to 1997; Shareholder, Poole, Kelly
& Ramo, Attorneys at Law, P.C. from 1977 to
1993; Director of ECMC Group (service provider
to students, schools and lenders) since 2001;
Director, United New Mexico Bank (now Wells
Fargo) from 1983 to 1988; Director, First
National Bank of New Mexico (now Wells Fargo)
from 1975 to 1976; Vice President, American
Law Institute since 2004.
Robert S. Salomon, Jr. Trustee 1996 to Principal of STI Management (investment 39 Funds None
P.O. Box 9095 present adviser) since 1994; Chairman and CEO of 59 Portfolios
Princeton, Salomon Brothers Asset Management Inc. from
NJ 08543-9095 1992 to 1995; Chairman of Salomon Brothers
Age: 68 Equity Mutual Funds from 1992 to 1995; regular
columnist with Forbes Magazine from 1992 to
2002; Director of Stock Research and U.S. Equity
Strategist at Salomon Brothers Inc. from 1975 to
1991; Trustee, Commonfund from 1980 to 2001.
Stephen B. Swensrud Trustee 1984 to Chairman of Fernwood Advisors, Inc. 40 Funds None
P.O. Box 9095 present (investment adviser) since 1996; Principal, 60 Portfolios
Princeton, Fernwood Associates (financial consultants)
NJ 08543-9095 since 1975; Chairman of R.P.P. Corporation
Age: 72 (manufacturing company) since 1978; Director
of International Mobile Communications, Inc.
(telecommunications) since 1998.
* Trustees serve until their resignation, removal or death, or until December 31
of the year in which they turn 72.
** Co-Chairman of the Board and of the Audit Committee.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Officers and Trustees (concluded)
Position(s) Length of
Held with Time
Name, Address & Age 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 since 1999;
P.O. Box 9011 President present Senior Vice President and Treasurer of Princeton Services since 1999 and Director
Princeton, and and since 2004; Vice President of FAM Distributors, Inc. ("FAMD") since 1999; Vice
NJ 08543-9011 Treasurer 1999 to President of MLIM and FAM from 1990 to 1997; Director of Taxation of MLIMfrom
Age: 45 present 1990 to 2001; Vice President, Treasurer and Secretary of the IQ Funds since 2004.
Thomas F. Musmanno Vice 2005 to Director of MLIM since 2004; Vice President of MLIM from 1996 to 2004;
P.O. Box 9011 President present Derivatives and Structured Products Specialist with MLIM from 2000 to 2002;
Princeton, Portfolio Manager with MLIM since 1996.
NJ 08543-9011
Age: 36
Laura Powers Vice 2005 to Director of MLIM since 1998; Vice President of MLIM from 1993 to 1997; Portfolio
P.O. Box 9011 President present Manager with MLIM since 1992.
Princeton,
NJ 08543-9011
Age: 42
Frank Viola Vice 1992 to Managing Director of MLIM since 2002; Head of the Global Fixed Income Structured
P.O. Box 9011 President present Asset Team since 2002; Director (Global Fixed Income) of MLIM from 2000 to 2001
Princeton, and Vice President from 1997 to 2000.
NJ 08543-9011
Age: 40
Jeffrey Hiller Chief 2004 to Chief Compliance Officer of the MLIM/FAM-advised funds and First Vice President
P.O. Box 9011 Compliance present and Chief Compliance Officer of MLIM (Americas Region) since 2004; Chief
Princeton, Officer Compliance Officer of the IQ Funds since 2004; Global Director of Compliance at
NJ 08543-9011 Morgan Stanley Investment Management from 2002 to 2004; Managing Director and
Age: 54 Global Director of Compliance at Citigroup Asset Management from 2000 to 2002;
Chief Compliance Officer at Soros Fund Management in 2000; Chief Compliance
Officer at Prudential Financial from 1995 to 2000; Senior Counsel in the
Commission's Division of Enforcement in Washington, D.C. from 1990 to 1995.
Alice A. Pellegrino Secretary 2004 to Director (Legal Advisory) of MLIM since 2002; Vice President of MLIM from 1999 to
P.O. Box 9011 present 2002; Attorney associated with MLIM since 1997; Secretary of MLIM, FAM, FAMD
Princeton, and Princeton Services since 2004.
NJ 08543-9011
Age: 45
* Officers of the Fund serve at the pleasure of the Board of Trustees.
Further information about the Fund's Officers and Trustees 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
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
Electronic Delivery
The Fund offers 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. To sign up for this service, simply access this Web
site at http://www.icsdelivery.com/live and follow the instructions. When you
visit this site, you will obtain a personal identification number (PIN). You
will need this PIN should you wish to update your e-mail address, choose to
discontinue this service and/or make any other changes to the service. This
service is not available for certain retirement accounts at this time.
MERRILL LYNCH U.S. GOVERNMENT FUND AUGUST 31, 2005
Item 2 - Code of Ethics - 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 - Audit Committee Financial Expert - 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 F. Perold (resigned as of October 1, 2004), (3)
Robert S. Salomon, Jr., and (4) Stephen B. Swensrud.
Item 4 - Principal Accountant Fees and Services
(a) Audit Fees - Fiscal Year Ending August 31, 2005 - $48,000
Fiscal Year Ending August 31, 2004 - $45,000
(b) Audit-Related Fees -Fiscal Year Ending August 31, 2005 - $0
Fiscal Year Ending August 31, 2004 - $0
(c) Tax Fees - Fiscal Year Ending August 31, 2005 - $7,300
Fiscal Year Ending August 31, 2004 - $7,800
The nature of the services include tax compliance, tax advice and
tax planning.
(d) All Other Fees - Fiscal Year Ending August 31, 2005 - $0
Fiscal Year Ending August 31, 2004 - $0
(e)(1) The registrant's audit committee (the "Committee") has
adopted policies and procedures with regard to the pre-approval of
services. Audit, audit-related and tax compliance services provided
to the registrant on an annual basis require specific pre-approval
by the Committee. The Committee also must approve other non-audit
services provided to the registrant and those non-audit services
provided to the registrant's affiliated service providers that
relate directly to the operations and the financial reporting of the
registrant. Certain of these non-audit services that the Committee
believes are a) consistent with the SEC's auditor independence rules
and b) routine and recurring services that will not impair the
independence of the independent accountants may be approved by the
Committee without consideration on a specific case-by-case basis
("general pre-approval"). However, such services will only be
deemed pre-approved provided that any individual project does not
exceed $5,000 attributable to the registrant or $50,000 for all of
the registrants the Committee oversees. Any proposed services
exceeding the pre-approved cost levels will require specific pre-
approval by the Committee, as will any other services not subject to
general pre-approval (e.g., unanticipated but permissible services).
The Committee is informed of each service approved subject to
general pre-approval at the next regularly scheduled in-person board
meeting.
(e)(2) 0%
(f) Not Applicable
(g) Fiscal Year Ending August 31, 2005 - $7,377,027
Fiscal Year Ending August 31, 2004 - $14,913,836
(h) The registrant's audit committee has considered and determined
that the provision of non-audit services that were rendered to the
registrant's 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.
Regulation S-X Rule 2-01(c)(7)(ii) - $1,227,000, 0%
Item 5 - Audit Committee of Listed Registrants - Not Applicable
Item 6 - Schedule of Investments - Not Applicable
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
11(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.
11(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act
(17 CFR 270.30a-3(d)) that occurred during the second fiscal half-
year of the period 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 attached hereto
12(a)(1) - Code of Ethics - See Item 2
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(b) - Certifications - 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 Fund, Inc.
By: /s/ Robert C. Doll, Jr.
-------------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Merrill Lynch U.S. Government Fund, Inc.
Date: October 19, 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/ Robert C. Doll, Jr.
-------------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Merrill Lynch U.S. Government Fund, Inc.
Date: October 19, 2005
By: /s/ Donald C. Burke
-------------------------------
Donald C. Burke,
Chief Financial Officer of
Merrill Lynch U.S. Government Fund, Inc.
Date: October 19, 2005