UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSRS
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-04077
Name of Fund: Merrill Lynch U.S. Government Fund
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, 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: 08/31/06
Date of reporting period: 09/01/05 - 02/28/06
Item 1 - Report to Stockholders
Semi-Annual Report
February 28, 2006
Merrill Lynch
U.S. Government Fund
(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 1-800-637-3863; (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
Financial markets began 2006 with a return to volatility following a fairly
uninspiring 2005. For the six- and 12-month periods ended February 28, 2006,
most major market indexes landed in positive territory:
Total Returns as of February 28, 2006 6-month 12-month
U.S. equities (Standard & Poor's 500 Index) + 5.93% + 8.40%
Small cap U.S. equities (Russell 2000 Index) +10.24 +16.59
International equities (MSCI Europe, Australasia, Far East Index) +15.14 +17.41
Fixed income (Lehman Brothers Aggregate Bond Index) - 0.11 + 2.74
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) + 0.99 + 3.87
High yield bonds (Credit Suisse High Yield Index) + 1.89 + 3.27
The Federal Reserve Board (the Fed) increased interest rates 200 basis points
(2.00%) over the past 12 months, bringing the target federal funds rate to
4.5%. Notably, Ben Bernanke replaced Alan Greenspan as Fed chairman in
January, a month after the central bank removed the critical word "measured"
from the description of its rate-hiking program. Still, most observers expect
at least one more interest rate hike before the Fed pauses in its tightening
campaign.
U.S. economic growth, which came in at 4.1% in the third quarter of 2005, fell
to 1.6% in the fourth quarter. Growth is expected to reaccelerate in the first
quarter of 2006, although the economy is likely to feel some pressure in the
quarters ahead as the consumer sector seems to be softening. Capital spending
by businesses, however, appears relatively strong. Overall corporate health,
including strong company balance sheets, helped prompt robust dividend-
distribution, share-buyback and merger-and-acquisition activity in 2005, a
trend that has continued in 2006. This, as well as reasonably good company
earnings and low core inflation, has been supportive of U.S. stocks despite
the headwinds of rising interest rates and high energy prices. Many
international equity markets have fared even better, thanks in part to
higher economic growth rates and low inflation.
In the U.S. bond market, short-term interest rates continued to move higher
as longer-term interest rates advanced more moderately. After flattening
dramatically in 2005, the Treasury curve recently has been toying with bouts
of inversion, whereby short-term yields have surpassed long-term yields. At
period-end, the six-month Treasury bill offered the highest yield on the
curve at 4.74%.
Amid the uncertainty inherent in the financial markets, we encourage you
to review your goals periodically with your financial advisor and to make
portfolio changes, as needed. For timely "food for thought" for
investors, we also invite you to visit Shareholder magazine at
www.mlim.ml.com/shareholdermagazine. As always, we thank you for
trusting Merrill Lynch Investment Managers with your investment assets,
and we look forward to continuing to serve your investment needs.
Sincerely,
(Robert C. Doll, Jr.)
Robert C. Doll, Jr.
President and Trustee
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
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
CFA Institute and the New York Society of Security Analysts.
Table of Contents Page
A Letter From the President 2
A Discussion With Your Fund's Portfolio Managers 4
Announcement to Shareholders 6
Performance Data 6
Disclosure of Expenses 8
Schedule of Investments 9
Portfolio Information 13
Financial Statements 14
Financial Highlights 18
Notes to Financial Statements 23
Disclosure of Investment Advisory Agreement 29
Officers and Trustees 31
CFA (R) and Chartered Financial Analyst (R) are trademarks owned by the CFA
Institute.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
A Discussion With Your Fund's Portfolio Managers
The Fund increased its distribution yield during the period and provided total
returns similar to the Lipper Intermediate U.S. Government Fund's average in a
challenging fixed income investment environment.
How did the Fund perform during the period in light of the existing market
conditions?
For the six-month period ended February 28, 2006, Merrill Lynch U.S.
Government Fund's Class A, Class B, Class C, Class I and Class R Shares had
total returns of -.36%, -.62%, -.55%, -.14% and -.39%, 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 benchmark Citigroup
Government/ Mortgage Index returned +.12%. Fund returns were generally
competitive with those of its comparable Lipper category of Intermediate U.S.
Government Funds, which provided an average return of -.24% for the six-month
period. (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 five years - 10
years.)
The Fund's primary objective is to seek current income for shareholders. As
such, we are pleased with the Fund's ability to increase its monthly
distribution yield to just over 4%, an increase of roughly 40 basis points
(.40%) since our last report to shareholders. This yield is competitive with
similar intermediate U.S. government funds.
During the past six months, the Federal Reserve Board (the Fed) advanced its
monetary tightening campaign with quarter-point rate hikes in September,
November and December 2005 and January 2006. This brought the target federal
funds rate to 4.5% at period-end. At the same time, rates rose all along the
curve, with the two-year Treasury yield increasing 85 basis points to 4.69%
over the six-month period, and the 10-year Treasury yield increasing 53 basis
points to 4.55%. The yield curve, which had flattened considerably since the
Fed began increasing interest rates in 2004, had inverted by period-end. That
is, short-term issues were providing higher yields than long-term issues,
marking the first yield curve inversion in about five years.
Given the rise in interest rates, our relatively short duration profile
benefited performance, as the portfolio was less susceptible to the negative
price impact of rising interest rates.
We did not have any significant biases in terms of the shape of the yield
curve. We maintained an underweight in the 10-year sector, offset somewhat by
exposure in the 30-year area. Ultimately, the flattening and then inversion of
the yield curve hurt the mortgage dollar roll market, which had been a place
to generate incremental returns in the Fund. This limited our ability to
enhance returns to some extent. Also detracting from performance somewhat in
the final two months of the period was a slight underweight to residential
mortgages, which performed extremely well in the new year following a volatile
period of under-performance in mid-to-late 2005.
While underexposed to U.S. Treasury and agency issues, we had more substantial
positions in the agency commercial mortgage market. Spreads remained fairly
tight in these markets throughout the period, meaning there was limited
opportunity for capital appreciation. Still, these structured securities
provide more yield than Treasury issues and agency debentures while also
offering much better prepayment protection than residential mortgage-backed
securities (MBS). This allowed us to add some yield in the prevailing market
environment.
What changes were made to the portfolio during the period?
In an effort to pick up yield in a flat yield curve environment, we reduced
our exposure to straight agency collateral and residential MBS and invested in
structured agency product and collateralized mortgage obligations (CMOs). CMOs
are pools of mortgages that are structured to provide a certain cash flow
based on the prepayment speeds of the underlying mortgages. Essentially, the
residential mortgage and CMO markets move in similar directions; however, as
residential mortgages became expensive toward the end of the period,
structured products lagged. This presented us with an opportunity to
participate in the mortgage market at more attractive levels. The CMO market
offered capital appreciation potential and better prepayment and extension
protection.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Similarly, we found compelling opportunities in hybrid adjustable rate
mortgages (ARMs), which also became available at relatively inexpensive
levels. We expect hybrid ARMs to become richer as supply decreases and demand
for the product remains steady. Hybrid ARMs had been the refinancing tool of
choice for homeowners in previous years as the yield curve was extremely
steep. Going forward, we expect mortgage creation to favor fixed rate due to
the flattening of the yield curve, and rates on hybrid ARMs and 30-year fixed
rate mortgages becoming increasingly similar causing a decrease in the supply
of hybrid ARMS and, ultimately, tightening spreads. Like CMOs, the hybrid ARMs
also offer better protection from prepayment and extension risk than the
residential fixed rate mortgage market.
Other portfolio activity included the addition of agency commercial mortgages
in December. These Fannie Mae issues serve as an alternative to owning
straight Treasury or agency securities, once again reflecting our efforts to
add structure to the portfolio and generate incremental yield above that
offered by the Treasury and agency asset classes. In February, heavy supply
brought opportunities to add some non-agency, AAA-rated commercial MBS to the
portfolio. This was more of a tactical trade, as we intend to sell and take
profits in the future when commercial MBS spreads tighten.
Throughout the period, we used Treasury futures and interest rate swaps as a
vehicle to hedge interest rate risk. Interest rate swaps also allow us to
hedge some of the high-quality spread risk that exists in some of the
aforementioned products. Overall, we continued to de-emphasize total return
trades in favor of transactions that we believed could positively affect the
current yield of the portfolio.
How would you characterize the Fund's position at the close of the period?
With the economy expected to gain momentum in the first quarter of 2006, we
expect the Fed to raise interest rates at its March meeting and perhaps once
more by mid-year. At period-end, we had an underweight position in residential
mortgages of approximately 5% relative to the benchmark. In addition, we
positioned the Fund with hybrid ARMs and well-structured agency CMOs as a
surrogate for residential mortgages. Both of these security types offer
exposure to the mortgage market but with more protection in the event that
interest rates do continue to rise. We also ended the period with nearly a 10%
position in AAA-rated MBS, as we tactically established positions in this
sector as opportunities presented themselves over the past six months.
In terms of duration, we remain slightly short relative to our benchmark in
anticipation of healthy economic growth and continued Fed tightening. The
majority of our short duration is expressed through an underweight position in
the 10-year part of the yield curve. Overall, our focus continues to be on
preserving the yield of the Fund, while also enhancing the overall structure
of the portfolio and providing protection against rising interest rates.
Frank Viola
Vice President and Co-Portfolio Manager
Thomas Musmanno
Vice President and Co-Portfolio Manager
Laura Powers
Vice President and Co-Portfolio Manager
March 14, 2006
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Announcement to Shareholders
On February 15, 2006, BlackRock, Inc. ("BlackRock") and Merrill Lynch & Co.,
Inc. ("Merrill Lynch") entered into an agreement to contribute Merrill Lynch's
investment management business, Merrill Lynch Investment Managers, L.P. and
certain affiliates (including Fund Asset Management, L.P. and Merrill Lynch
Investment Managers International Limited), to BlackRock to create a new
independent company that will be one of the world's largest asset management
firms with nearly $1 trillion in assets under management (based on combined
assets under management as of December 31, 2005). The transaction is expected
to close in the third quarter of 2006, at which time the new company will
operate under the BlackRock name. If approved by the Fund's Board of Trustees
and Fund shareholders, the combined company that results from the transaction
is expected to become the investment adviser of the Fund.
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.
* Effective December 28, 2005, Class I Shares are no longer subject to any
front-end sales charge. Class I Shares bear no ongoing distribution or account
maintenance fees and are available only to eligible investors. Had the sales
charge been included, the Fund's Class I Shares' performance would have been
lower.
* 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.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Performance Data (concluded)
Recent Performance Results
6-Month 12-Month 10-Year Standardized
As of February 28, 2006 Total Return Total Return Total Return 30-Day Yield
ML U.S. Government Fund Class A Shares* -0.36% +2.00% +68.40% 4.02%
ML U.S. Government Fund Class B Shares* -0.62 +1.47 +59.92 3.67
ML U.S. Government Fund Class C Shares* -0.55 +1.42 +59.12 3.61
ML U.S. Government Fund Class I Shares* -0.14 +2.26 +72.82 4.44
ML U.S. Government Fund Class R Shares* -0.39 +1.75 +65.13 3.94
Citigroup Government/Mortgage Index** +0.12 +3.08 +82.11 --
* 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.
Average Annual Total Return
Return Without Return With
Sales Charge Sales Charge**
Class A Shares*
One Year Ended 2/28/06 +2.00% -2.08%
Five Years Ended 2/28/06 +4.20 +3.36
Ten Years Ended 2/28/06 +5.35 +4.92
* Maximum sales charge is 4%.
** Assuming maximum sales charge.
Return Return
Without CDSC With CDSC**
Class B Shares*
One Year Ended 2/28/06 +1.47% -2.45%
Five Years Ended 2/28/06 +3.67 +3.32
Ten Years Ended 2/28/06 +4.81 +4.81
* Maximum contingent deferred sales charge is 4% and is reduced
to 0% after six years.
** Assuming payment of applicable contingent deferred sales
charge.
Return Return
Without CDSC With CDSC**
Class C Shares*
One Year Ended 2/28/06 +1.42% +0.43%
Five Years Ended 2/28/06 +3.61 +3.61
Ten Years Ended 2/28/06 +4.75 +4.75
* Maximum contingent deferred sales charge is 1% and is reduced
to 0% after one year.
** Assuming payment of applicable contingent deferred sales
charge.
Class I Shares Return
One Year Ended 2/28/06 +2.26%
Five Years Ended 2/28/06 +4.46
Ten Years Ended 2/28/06 +5.62
Class R Shares Return
One Year Ended 2/28/06 +1.75%
Five Years Ended 2/28/06 +4.03
Ten Years Ended 2/28/06 +5.14
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
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 12b-1 fees, and other Fund expenses. The following example (which is
based on a hypothetical investment of $1,000 invested on September 1, 2005 and
held through February 28, 2006) 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 September 1, 2005
September 1, February 28, to February 28,
2005 2006 2006
Actual
Class A $1,000 $ 996.40 $5.20
Class B $1,000 $ 993.80 $7.71
Class C $1,000 $ 994.50 $8.06
Class I $1,000 $ 998.60 $4.01
Class R $1,000 $ 996.10 $6.58
Hypothetical (5% annual return before expenses)**
Class A $1,000 $1,019.59 $5.26
Class B $1,000 $1,017.06 $7.80
Class C $1,000 $1,016.72 $8.15
Class I $1,000 $1,020.78 $4.06
Class R $1,000 $1,018.20 $6.66
* For each class of the Fund, expenses are equal to the annualized expense ratio for the class
(1.05% for Class A, 1.56% for Class B, 1.63% for Class C, .81% for Class I and 1.33% for Class R),
multiplied by the average account value over the period, multiplied by 181/365 (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 FEBRUARY 28, 2006
Schedule of Investments
Face Interest Maturity
Issue Amount Rate Date(s) Value
U.S. Government & Agency Obligations--19.9%
Fannie Mae $ 3,000,000 6.25 % 5/15/2029 $ 3,536,211
39,200,000 6.625 9/15/2009 41,321,935
Federal Farm Credit Bank 15,500,000 4.55 6/08/2020 14,685,770
Freddie Mac 25,000,000 4.375 9/17/2010 24,484,950
U.S. Treasury Bonds 10,000,000 4.50 2/15/2036 9,994,530
11,000,000 6.875 8/15/2025 14,036,176
42,200,000 7.125 2/15/2023 54,011,063
15,000,000 7.625 2/15/2025 20,466,795
17,502,000 8.125 8/15/2019 23,421,229
U.S. Treasury Notes 6,500,000 3.375 2/28/2007 6,414,181
4,015,000 3.50 2/15/2010 3,849,538
50,000,000 4.125 8/15/2008 49,427,750
42,500,000 4.50 11/15/2010 42,277,555
Total U.S. Government & Agency Obligations (Cost--$312,844,373)--19.9% 307,927,683
U.S. Government Agency Mortgage-Backed Obligations*--67.6%
Fannie Mae Guaranteed Pass-Through Certificates 37,191,640 0.686 (1)(3) 2/25/2013 627,449
5,143,980 4.28 2/01/2010 4,970,245
3,445,475 4.62 11/01/2014 3,315,068
33,430,443 4.655 2/01/2015 32,211,596
9,723,673 4.68 2/01/2015 9,384,235
8,695,625 4.70 3/01/2015 8,401,358
6,384,829 4.72 3/01/2014 6,167,832
26,826,834 4.85 (1) 9/01/2035 26,471,987
53,248,504 4.86 1/01/2015 - 2/01/2015 51,984,636
34,378,349 4.90 1/01/2014 33,689,499
25,914,802 4.94 12/01/2012 - 3/01/2015 25,545,036
32,218,238 4.954 (1) 9/01/2035 31,612,609
958,270 5.00 11/01/2019 946,424
713,016 5.00 8/01/2035 692,873
8,842,248 5.01 1/01/2015 8,656,079
39,220,000 5.10 2/01/2013 39,126,674
8,877,724 5.25 1/01/2016 8,930,709
19,987,062 5.275 11/01/2015 20,041,549
40,432,175 5.315 11/01/2015 40,656,561
10,778,912 5.34 1/01/2021 10,814,340
30,581,346 5.355 11/01/2015 30,835,517
25,106,404 5.50 3/01/2032 - 2/01/2035 24,718,720
2,802,545 6.50 12/01/2008 - 2/01/2014 2,877,203
18,418,038 6.50 3/01/2033 - 1/01/2036 18,865,225
238,828 7.00 (3) 7/1/2026 51,072
1,462,704 7.16 1/25/2022 1,478,053
5,694,649 7.50 7/01/2016 - 12/01/2032 5,965,755
20,718 8.00 9/01/2024 - 9/01/2027 22,131
1,117,001 8.50 8/01/2012 - 7/15/2023 1,209,058
338,918 11.00 2/01/2011 - 8/01/2020 371,149
264,514 13.00 9/01/2013 - 3/01/2015 292,984
Freddie Mac Mortgage Participation Certificates 31,996,807 4.50 9/01/2020 - 2/01/2021 30,987,978
33,193,547 5.00 1/01/2019 - 9/01/2019 32,789,691
58,840,924 5.00 7/01/2035 - 2/01/2036 57,032,184
15,543,982 5.009 (1) 10/01/2035 15,301,108
25,403,481 5.50 3/01/2016 - 1/01/2021 25,507,458
31,420,875 5.50 1/01/2035 - 3/01/2035 31,160,318
26,082,371 6.00 10/01/2009 - 10/01/2020 26,512,826
108,272,483 6.00 5/01/2029 - 10/01/2035 109,402,556
2,366,004 6.50 8/01/2029 2,430,812
1,238,041 7.00 4/01/2032 1,280,072
1,004,117 7.50 5/01/2009 - 10/01/2011 1,046,314
15,199,785 7.50 8/01/2017 - 12/01/2032 15,918,760
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Schedule of Investments (continued)
Face Interest Maturity
Issue Amount Rate Date(s) Value
U.S. Government Agency Mortgage-Backed Obligations* (concluded)
Freddie Mac Mortgage Participation Certificates $ 1,001,346 8.00 % 1/01/2008 - 7/01/2012 $ 1,045,685
(concluded) 1,606,958 8.00 10/01/2027 - 8/01/2032 1,717,080
329,598 8.50 1/01/2025 - 7/01/2025 356,686
296 10.00 7/01/2019 322
203,707 11.00 8/01/2010 - 9/01/2020 223,356
164,773 11.50 7/01/2013 - 6/01/2020 178,287
140,207 12.00 6/01/2013 - 6/01/2020 153,379
223,796 12.50 12/01/2015 - 7/01/2019 243,382
304,631 13.00 9/01/2010 - 2/01/2016 334,604
3,346 628.00 (1)(3) 2/15/2022 40,150
Ginnie Mae MBS Certificates 136,443,200 0.778 (1)(3) 1/16/2045 7,355,141
133,909,000 0.797 (1)(3) 1/16/2046 7,950,847
135,640,955 0.912 (3) 11/16/2045 7,990,100
34,758,434 1.012 (1)(3) 6/16/2045 2,334,241
57,796,147 1.033 (1)(3) 1/16/2044 2,765,636
164,023,298 1.065 (1)(3) 9/16/2044 8,303,679
44,473,243 5.00 12/15/2034 - 1/15/2035 43,805,685
9,630,900 5.10 10/15/2007 - 12/01/2015 9,464,003
12,527,200 5.11 8/01/2045 - 1/15/2047 12,203,485
20,266,268 5.50 7/15/2006 - 11/30/2045 20,513,126
12,931,460 5.60 1/15/2009 13,226,214
7,846,700 5.70 3/01/2015 - 8/15/2046 8,012,878
49,061,300 5.80 4/15/2046 50,656,980
2,096,162 6.00 5/15/2024 - 11/15/2031 2,140,854
34,553,684 6.09 10/15/2008 36,401,867
3,972,479 7.00 4/15/2023 - 4/15/2032 4,151,268
4,510,980 7.50 2/15/2025 - 12/15/2031 4,746,703
25,804 10.50 1/15/2016 - 4/15/2021 28,759
55 11.00 1/15/2016 60
Total U.S. Government Agency Mortgage-Backed Obligations (Cost--$1,061,600,798)--67.6% 1,046,648,160
U.S. Government Agency Mortgage-Backed Obligations*--Collateralized Mortgage Obligations--21.6%
Fannie Mae Guaranteed Pass-Through Certificates 14,320,753 4.721 (1) 4/25/2035 14,322,958
23,346,209 4.881 (1) 12/25/2017 - 6/25/2028 23,406,467
18,031,939 4.981 (1) 10/25/2031 18,154,792
5,466,674 5.00 8/25/2022 5,395,776
75,610,713 5.50 11/25/2022 - 11/25/2031 75,313,981
1,210,076 7.25 3/25/2026 1,260,207
Freddie Mac Mortgage Participation Certificates 4,463,480 2.37 12/15/2009 4,317,807
15,000,000 4.50 10/15/2031 14,083,476
25,606,595 4.92 (1) 7/15/2028 25,675,528
411,534 4.975 (1) 2/15/2022 411,714
19,121,000 5.50 6/15/2030 18,984,306
Ginnie Mae MBS Certificates 39,068,412 3.225 9/16/2021 37,455,449
7,573,039 3.878 12/16/2019 7,373,079
4,661,939 4.25 (1) 4/16/2045 3,763,667
8,400,000 4.522 (1) 2/16/2028 8,042,514
5,237,520 4.65 (1) 1/16/2045 4,624,119
20,000,000 4.658 12/16/2030 19,290,444
5,609,091 4.723 (1) 8/16/2045 5,059,137
7,000,000 4.793 (1) 11/16/2037 6,641,250
10,000,000 4.816 (1) 10/16/2029 9,771,508
8,873,790 4.959 (1) 3/16/2046 8,121,679
2,896,326 5.175 (1) 12/16/2044 2,827,082
20,000,000 5.494 (1) 8/16/2027 20,185,706
Total U.S. Government Agency Mortgage-Backed Obligations--Collateralized Mortgage Obligations
(Cost--$338,023,089)--21.6% 334,482,646
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Schedule of Investments (continued)
Face
Amount Issue Value
Non-U.S. Government Agency Mortgage-Backed Obligations*--Collateralized Mortgage Obligations--12.8%
$ 11,250,000 Ameriquest Mortgage Securities, Inc. Series 2004-IA1 Class M1, 5.381%
due 9/25/2034 (1) $ 11,299,728
20,000,000 Bear Stearns Commercial Mortgage Securities Series 2005-PW10 Class A4, 5.405%
due 12/11/2040 (1) 20,160,330
37,750,000 CS First Boston Mortgage Securities Corp. Series 2005-C6 Class A4, 5.23%
due 12/15/2040 (1) 37,524,156
2,606,580 Centex Home Equity Series 2004-B Class AV1, 4.781% due 3/25/2034 (1) 2,607,768
6,886,735 Countrywide Home Equity Loan Trust Series 2004-K Class 2A, 4.87% due 2/15/2034 (1) 6,899,406
20,000,000 GS Mortgage Securities Corp. II Series 2005-GG4 Class A2, 4.475% due 7/10/2039 19,425,738
13,128,000 JPMorgan Chase Commercial Mortgage Securities Corp. Series 2005-LDP2 Class A2,
4.575% due 7/15/2042 12,786,920
30,000,000 JP Morgan Chase Commercial Mortgage Security Series 2005-LDP5 Class A4, 5.179%
due 12/15/2044 (1) 29,929,854
21,558,246 JP Morgan Mortgage Trust Series 2005-A2 Class 4A1, 5.218% due 4/25/2035 (1) 21,192,767
8,000,000 Residential Asset Mortgage Products, Inc. Series 2004-RS9 Class AII2, 4.921%
due 5/25/2034 (1) 8,025,903
3,164,947 Securitized Asset Backed Receivables LLC Trust Series 2004-OP1 Class A2, 4.831%
due 2/25/2034 (1) 3,164,830
9,338,801 Washington Mutual Series 2004-AR12 Class A3, 4.823% due 10/25/2044 (1) 9,378,155
15,938,565 Wells Fargo Home Equity Trust Series 2004-2 Class A32, 4.921% due 2/25/2032 (1) 15,979,908
Total Non-U.S. Government Agency Mortgage-Backed Obligations--Collateralized Mortgage Obligations
(Cost--$199,598,092)--12.8% 198,375,463
Number of
Contracts++ Options Purchased
Put Options Purchased 100 Pay a fixed rate of 5.95% and receive a floating rate based on 3-month LIBOR,
expiring April 2007, Broker JPMorgan Chase Bank (2) 556,700
Total Options Purchased (Premiums Paid--$950,500)--0.0% 556,700
Total Investments (Cost--$1,913,016,852)--121.9% 1,887,990,652
Options Written
Call Options Written 12.5 Pay a fixed rate of 5.06% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker UBS Warburg (2) (23,750)
12.5 Pay a fixed rate of 5.08% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker JPMorgan Chase Bank (2) (55,087)
12.5 Pay a fixed rate of 5.08% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker Lehman Brothers Special Finance (2) (71,150)
12.5 Pay a fixed rate of 5.10% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker Lehman Brothers Special Finance (2) (53,500)
Put Options Written 12.5 Pay a fixed rate of 5.06% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker UBS Warburg (2) (35,000)
12.5 Pay a fixed rate of 5.08% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker JPMorgan Chase Bank (2) (55,088)
12.5 Pay a fixed rate of 5.08% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker Lehman Brothers Special Finance (2) (63,175)
12.5 Pay a fixed rate of 5.10% and receive a floating rate based on 3-month LIBOR,
expiring March 2006, Broker Lehman Brothers Special Finance (2) (25,900)
77.5 Receive a fixed rate of 6.07% and pay a floating rate based on 3-month LIBOR,
expiring April 2007, Broker JPMorgan Chase Bank (2) (540,872)
Total Options Written (Premiums Received--$1,554,250)--0.0% (923,522)
Total Investments, Net of Options Written
(Cost--$1,911,462,602**)--121.9% 1,887,067,130
Liabilities in Excess of Other Assets--(21.9%) (338,847,990)
----------------
Net Assets--100.0% $ 1,548,219,140
================
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
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 February 28, 2006, as computed for
federal income tax purposes, were as follows:
Aggregate cost $ 1,911,531,782
==================
Gross unrealized appreciation $ 5,246,431
Gross unrealized depreciation (29,711,083)
------------------
Net unrealized depreciation $ (24,464,652)
==================
(1) Floating rate note.
(2) This European style option, 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.
o 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:
Net Interest
Issue Activity Income
Merrill Lynch Liquidity Series, LLC
Money Market Series $(26,372,500) $ 61,920
o Swaps outstanding as of February 28, 2006 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 US Agency Index and
pay a floating rate based on
1-month LIBOR minus 0.05%
Broker, Lehman Brothers
Special Finance
Expires April 2006 $ 25,000,000 --
Receive (pay) a variable return
based on the change in the since
inception return of the Lehman
Brothers U.S. Treasury Index and
pay a floating rate based on
1-month LIBOR minus 0.12%
Broker, Lehman Brothers
Special Finance
Expires May 2006 $ 50,000,000 --
Swaps outstanding as of February 28, 2006 were as follows (continued):
Unrealized
Notional Appreciation
Amount (Depreciation)
Pay a fixed rate of 4.94% and
receive a floating rate based on
3-month LIBOR
Broker, Lehman Brothers
Special Finance
Expires December 2012 $ 18,500,000 $ 143,675
Pay a fixed rate of 4.933% and
receive a floating rate based on
3-month LIBOR
Broker, JPMorgan Chase Bank
Expires January 2013 $ 40,000,000 329,884
Pay a fixed rate of 4.934% and
receive a floating rate based on
3-month LIBOR
Broker, Lehman Brothers
Special Finance
Expires June 2013 $ 35,000,000 300,193
Pay a fixed rate of 4.8875% and
receive a floating rate based on
3-month LIBOR
Broker, JPMorgan Chase Bank
Expires December 2014 $ 93,000,000 1,219,328
Pay a fixed rate of 4.760% and
receive a floating rate based on
3-month LIBOR
Broker, Credit Suisse First Boston
Expires June 2015 $ 30,000,000 688,132
Pay a fixed rate of 4.72% and
receive a floating rate based on
3-month LIBOR
Broker, Citibank N.A.
Expires September 2015 $ 6,500,000 173,359
Pay a fixed rate of 5.078% and
receive a floating rate based on
3-month LIBOR
Broker, Lehman Brothers
Special Finance
Expires December 2015 $ 19,000,000 (18,594)
Pay a fixed rate of 4.9575% and
receive a floating rate based on
a 3-month LIBOR
Broker, JPMorgan Chase Bank
Expires December 2015 $ 28,500,000 259,301
Pay a fixed rate of 4.995% and
receive a floating rate based on
3-month LIBOR
Broker, UBS Warburg
Expires December 2015 $ 36,000,000 223,104
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Schedule of Investments (concluded)
Swaps outstanding as of February 28, 2006 (concluded):
Unrealized
Notional Appreciation
Amount (Depreciation)
Pay a fixed rate of 5.008% and
receive a floating rate based on
3-month LIBOR
Broker, Lehman Brothers
Special Finance
Expires February 2016 $ 12,400,000 $ 66,881
Pay a fixed rate of 5.1025% and
receive a floating rate based on
3-month LIBOR
Broker, Lehman Brothers
Special Finance
Expires March 2016 $ 65,500,000 (119,668)
Receive a fixed rate of 5.065% and
pay a floating rate based on a
3-month LIBOR
Broker, Lehman Brothers
Special Finance
Expires March 2016 $ 1,012,000 (13,135)
Unrealized
Notional Appreciation
Amount (Depreciation)
Pay a fixed rate of 5.151% and
receive a floating rate based on
3-month LIBOR
Broker, JPMorgan Chase Bank
Expires March 2016 $ 54,000,000 $ (301,320)
Receive a fixed rate of 4.95% and
pay a floating rate based on
3-month LIBOR
Broker, JPMorgan Chase Bank
Expires April 2017 $ 15,140,000 (138,622)
Pay a fixed rate of 5.11% and
receive a floating rate based on
3-month LIBOR
Broker, JPMorgan Chase Bank
Expires April 2037 $ 8,210,000 (38,012)
-----------
Total $ 2,774,506
===========
See Notes to Financial Statements.
Portfolio Information as of February 28, 2006
Percent of
Total
Asset Mix Investments
U.S. Government Agency Mortgage-Backed
Obligations 55.5%
U.S. Government & Agency Obligations--
Collateralized Mortgage Obligations 17.7
U.S. Government & Agency Obligations 16.3
Non-U.S. Government Agency Mortgage-
Backed Securities--Collateralized
Mortgage Obligations 10.5
Other* --**
* Includes portfolio holdings in options.
** Amount is less than (.01%).
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Statement of Assets and Liabilities
As of February 28, 2006
Assets
Investments, at value (identified cost--$1,912,066,352) $ 1,887,433,952
Options purchased, at value (premiums paid--$950,500) 556,700
Cash 14,026,562
Unrealized appreciation on swaps--net 3,403,857
Receivables:
Securities sold $ 123,719,846
Interest 8,179,695
Swaps 2,669,935
Beneficial interest sold 2,171,773
Variation margin 132,000
Options written 130,625
Principal paydowns 19,637 137,023,511
---------------
Prepaid expenses and other assets 181,715
---------------
Total assets 2,042,626,297
---------------
Liabilities
Reverse repurchase agreement 389,408,409
Options written, at value (premiums received--$1,554,250) 923,522
Unrealized depreciation on swaps--net 629,351
Payables:
Securities purchased 90,867,662
Beneficial interest redeemed 5,238,643
Swaps 3,459,742
Dividends to shareholders 1,586,559
Other affiliates 977,071
Investment adviser 462,858
Distributor 445,322
Interest on loans 335,663
Closed options written 24,260 103,397,780
---------------
Other liabilities 48,095
---------------
Total liabilities 494,407,157
---------------
Net Assets
Net assets $ 1,548,219,140
===============
Net Assets Consist of
Class A Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized $ 6,834,573
Class B Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 2,783,566
Class C Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 2,273,964
Class I Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 3,288,622
Class R Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 265,131
Paid-in capital in excess of par 1,562,057,914
Undistributed investment income--net $ 1,335,856
Accumulated realized losses--net (8,999,520)
Unrealized depreciation--net (21,620,966)
---------------
Total accumulated losses--net (29,284,630)
---------------
Net Assets $ 1,548,219,140
===============
Net Asset Value
Class A--Based on net assets of $685,054,103 and 68,345,726 shares of beneficial
interest outstanding $ 10.02
===============
Class B--Based on net assets of $279,023,352 and 27,835,662 shares of beneficial
interest outstanding $ 10.02
===============
Class C--Based on net assets of $227,912,872 and 22,739,640 shares of beneficial
interest outstanding $ 10.02
===============
Class I--Based on net assets of $329,690,005 and 32,886,223 shares of beneficial
interest outstanding $ 10.03
===============
Class R--Based on net assets of $26,538,808 and 2,651,312 shares of beneficial
interest outstanding $ 10.01
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Statement of Operations
For the Six Months Ended February 28, 2006
Investment Income
Interest $ 43,989,973
Securities lending--net 61,920
---------------
Total income 44,051,893
---------------
Expenses
Investment advisory fees $ 3,773,755
Interest expense 3,707,813
Account maintenance and distribution fees--Class B 1,132,341
Account maintenance and distribution fees--Class C 936,868
Account maintenance fees--Class A 892,776
Transfer agent fees--Class A 870,557
Transfer agent fees--Class I 405,661
Transfer agent fees--Class B 396,016
Transfer agent fees--Class C 319,155
Accounting services 245,176
Custodian fees 99,020
Short sale expense 91,875
Account maintenance and distribution fees--Class R 57,644
Professional fees 52,195
Registration fees 45,502
Printing and shareholder reports 43,038
Pricing fees 33,335
Transfer agent fees--Class R 30,053
Trustees' fees and expenses 28,199
Other 26,279
---------------
Total expenses 13,187,258
---------------
Investment income--net 30,864,635
---------------
Realized & Unrealized Gain (Loss)--Net
Realized gain (loss) on:
Investments--net (8,549,062)
Futures contracts and swaps--net (1,344,552)
Options written--net (132,635)
Short sales--net (194,312) (10,220,561)
---------------
Change in unrealized appreciation/depreciation on:
Investments--net (37,216,847)
Swaps--net 8,645,621
Options written--net 1,158,253 (27,412,973)
--------------- ---------------
Total realized and unrealized loss--net (37,633,534)
---------------
Net Decrease in Net Assets Resulting from Operations $ (6,768,899)
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Statements of Changes in Net Assets
For the Six For the
Months Ended Year Ended
February 28, August 31,
Increase (Decrease) in Net Assets: 2006 2005
Operations
Investment income--net $ 30,864,635 $ 53,245,250
Realized gain (loss)--net (10,220,561) 25,606,893
Change in unrealized appreciation/depreciation--net (27,412,973) (25,136,802)
--------------- ---------------
Net increase (decrease) in net assets resulting from operations (6,768,899) 53,715,341
--------------- ---------------
Dividends & Distributions to Shareholders
Investment income--net:
Class A (14,223,257) (27,412,537)
Class B (5,221,223) (11,609,588)
Class C (3,990,878) (8,117,957)
Class I (6,938,359) (13,783,700)
Class R (433,180) (467,783)
Realized gain--net:
Class A (897,119) --
Class B (370,126) --
Class C (288,609) --
Class I (413,656) --
Class R (30,543) --
--------------- ---------------
Net decrease in net assets resulting from dividends and distributions to shareholders (32,806,950) (61,391,565)
--------------- ---------------
Beneficial Interest Transactions
Net decrease in net assets derived from beneficial interest transactions (116,655,046) (184,361,007)
--------------- ---------------
Net Assets
Total decrease in net assets (156,230,895) (192,037,231)
Beginning of period 1,704,450,035 1,896,487,266
--------------- ---------------
End of period* $ 1,548,219,140 $ 1,704,450,035
=============== ===============
* Undistributed investment income--net $ 1,335,856 $ 1,278,118
=============== ===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Statement of Cash Flows
For the Six Months Ended February 28, 2006
Cash Used for Operating Activities
Net decrease in net assets resulting from operations $ (6,768,899)
Adjustments to reconcile net decrease in net assets resulting from operations to net
cash used for operating activities:
Increase in receivables (3,306,729)
Increase in other assets (20,176)
Increase in other liabilities 3,106,183
Realized and unrealized loss--net 37,633,534
Amortization of premium and discount 1,601,477
Proceeds from sales and paydowns of long-term securities 676,485,465
Other investment related transactions 196,645
Purchases of long-term securities (994,435,136)
Proceeds from sales of short-term investments 59,100,000
Premiums received from options written 5,298,313
Premiums paid on closing options written (5,112,253)
---------------
Cash used for operating activities (226,221,576)
---------------
Cash Provided by Financing Activities
Proceeds from issuance of Common Stock 154,178,902
Cash payments on Common Stock (284,948,886)
Cash receipts from borrowings 389,408,409
Dividends paid to shareholders (18,432,762)
---------------
Cash provided by financing activities 240,205,663
---------------
Cash
Net increase in cash 13,984,087
Cash at beginning of period 42,475
---------------
Cash at end of period 14,026,562
===============
Cash Flow Information
Cash paid for interest $ 3,372,150
===============
Noncash Financing Activities
Capital shares issued in reinvestment of dividends and distributions paid to shareholders $ 13,958,391
===============
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Financial Highlights
Class A
For the Six
Months Ended
The following per share data and ratios have been derived February 28, For the Year Ended August 31,
from information provided in the financial statements. 2006 2005 2004 2003 2002
Per Share Operating Performance
Net asset value, beginning of period $ 10.27 $ 10.31 $ 10.13 $ 10.25 $ 9.95
------------ ---------- ---------- ---------- ----------
Investment income--net .20++ .32++ .27++ .32 .43
Realized and unrealized gain (loss)--net (.24) .01 .19 (.12) .30
------------ ---------- ---------- ---------- ----------
Total from investment operations (.04) .33 .46 .20 .73
------------ ---------- ---------- ---------- ----------
Less dividends and distributions from:
Investment income--net (.20) (.37) (.28) (.32) (.43)
Realized gain--net (.01) -- -- -- --
------------ ---------- ---------- ---------- ----------
Total dividends and distributions (.21) (.37) (.28) (.32) (.43)
------------ ---------- ---------- ---------- ----------
Net asset value, end of period $ 10.02 $ 10.27 $ 10.31 $ 10.13 $ 10.25
============ ========== ========== ========== ==========
Total Investment Return**
Based on net asset value per share (.36%)+++ 3.22% 4.63% 1.93% 7.54%
============ ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses, excluding interest expense 1.05%* 1.01% .98% .95% .97%
============ ========== ========== ========== ==========
Expenses 1.51%* 1.01% .98% .95% .97%
============ ========== ========== ========== ==========
Investment income--net 3.99%* 3.11% 2.65% 3.09% 4.30%
============ ========== ========== ========== ==========
Supplemental Data
Net assets, end of period (in thousands) $ 685,054 $ 769,309 $ 798,279 $ 855,543 $ 819,410
============ ========== ========== ========== ==========
Portfolio turnover 41.98% 336.73% 508.54% 428.59% 426.77%
============ ========== ========== ========== ==========
* Annualized.
** Total investment returns exclude the effects of sales charges.
++ Based on average shares outstanding.
+++ Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Financial Highlights (continued)
Class B
For the Six
Months Ended
The following per share data and ratios have been derived February 28, For the Year Ended August 31,
from information provided in the financial statements. 2006 2005 2004 2003 2002
Per Share Operating Performance
Net asset value, beginning of period $ 10.27 $ 10.31 $ 10.13 $ 10.26 $ 9.95
------------ ---------- ---------- ---------- ----------
Investment income--net .17++ .26++ .22++ .26 .38
Realized and unrealized gain (loss)--net (.24) .01 .19 (.13) .31
------------ ---------- ---------- ---------- ----------
Total from investment operations (.07) .27 .41 .13 .69
------------ ---------- ---------- ---------- ----------
Less dividends and distributions from:
Investment income--net (.17) (.31) (.23) (.26) (.38)
Realized gain--net (.01) -- -- -- --
------------ ---------- ---------- ---------- ----------
Total dividends and distributions (.18) (.31) (.23) (.26) (.38)
------------ ---------- ---------- ---------- ----------
Net asset value, end of period $ 10.02 $ 10.27 $ 10.31 $ 10.13 $ 10.26
============ ========== ========== ========== ==========
Total Investment Return**
Based on net asset value per share (.62%)+++ 2.68% 4.09% 1.40% 6.99%
============ ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses, excluding interest expense 1.56%* 1.53% 1.50% 1.47% 1.49%
============ ========== ========== ========== ==========
Expenses 2.02%* 1.53% 1.50% 1.47% 1.49%
============ ========== ========== ========== ==========
Investment income--net 3.47%* 2.55% 2.14% 2.58% 3.76%
============ ========== ========== ========== ==========
Supplemental Data
Net assets, end of period (in thousands) $ 279,023 $ 332,744 $ 438,679 $ 591,435 $ 613,282
============ ========== ========== ========== ==========
Portfolio turnover 41.98% 336.73% 508.54% 428.59% 426.77%
============ ========== ========== ========== ==========
* Annualized.
** Total investment returns exclude the effects of sales charges.
++ Based on average shares outstanding.
+++ Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Financial Highlights (continued)
Class C
For the Six
Months Ended
The following per share data and ratios have been derived February 28, For the Year Ended August 31,
from information provided in the financial statements. 2006 2005 2004 2003 2002
Per Share Operating Performance
Net asset value, beginning of period $ 10.26 $ 10.31 $ 10.13 $ 10.25 $ 9.95
------------ ---------- ---------- ---------- ----------
Investment income--net .17+++ .26+++ .21+++ .26 .37
Realized and unrealized gain (loss)--net (.23) --++ .19 (.12) .30
------------ ---------- ---------- ---------- ----------
Total from investment operations (.06) .26 .40 .14 .67
------------ ---------- ---------- ---------- ----------
Less dividends and distributions from:
Investment income--net (.17) (.31) (.22) (.26) (.37)
Realized gain--net (.01) -- -- -- --
------------ ---------- ---------- ---------- ----------
Total dividends and distributions (.18) (.31) (.22) (.26) (.37)
------------ ---------- ---------- ---------- ----------
Net asset value, end of period $ 10.02 $ 10.26 $ 10.31 $ 10.13 $ 10.25
============ ========== ========== ========== ==========
Total Investment Return**
Based on net asset value per share (.55%)+++++ 2.53% 4.03% 1.35% 6.94%
============ ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses, excluding interest expense 1.63%* 1.59% 1.55% 1.52% 1.54%
============ ========== ========== ========== ==========
Expenses 2.09%* 1.59% 1.55% 1.52% 1.54%
============ ========== ========== ========== ==========
Investment income--net 3.42%* 2.51% 2.09% 2.52% 3.40%
============ ========== ========== ========== ==========
Supplemental Data
Net assets, end of period (in thousands) $ 227,913 $ 247,884 $ 301,532 $ 414,539 $ 384,119
============ ========== ========== ========== ==========
Portfolio turnover 41.98% 336.73% 508.54% 428.59% 426.77%
============ ========== ========== ========== ==========
* Annualized.
** Total investment returns exclude the effects of sales charges.
++ Amount is less than $.01 per share.
+++ Based on average shares outstanding.
+++++ Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Financial Highlights (continued)
Class I
For the Six
Months Ended
The following per share data and ratios have been derived February 28, For the Year Ended August 31,
from information provided in the financial statements. 2006 2005 2004 2003 2002
Per Share Operating Performance
Net asset value, beginning of period $ 10.27 $ 10.31 $ 10.13 $ 10.26 $ 9.95
------------ ---------- ---------- ---------- ----------
Investment income--net .21+++ .35+++ .29+++ .34 .46
Realized and unrealized gain (loss)--net (.23) --++ .20 (.13) .31
------------ ---------- ---------- ---------- ----------
Total from investment operations (.02) .35 .49 .21 .77
------------ ---------- ---------- ---------- ----------
Less dividends and distributions from:
Investment income--net (.21) (.39) (.31) (.34) (.46)
Realized gain--net (.01) -- -- -- --
------------ ---------- ---------- ---------- ----------
Total dividends and distributions (.22) (.39) (.31) (.34) (.46)
------------ ---------- ---------- ---------- ----------
Net asset value, end of period $ 10.03 $ 10.27 $ 10.31 $ 10.13 $ 10.26
============ ========== ========== ========== ==========
Total Investment Return**
Based on net asset value per share (.14%)+++++ 3.47% 4.89% 2.08% 7.91%
============ ========== ========== ========== ==========
Ratios to Average Net Assets
Expenses, excluding interest expense .81%* .76% .73% .70% .72%
============ ========== ========== ========== ==========
Expenses 1.27%* .76% .73% .70% .72%
============ ========== ========== ========== ==========
Investment income--net 4.25%* 3.38% 2.89% 3.34% 4.53%
============ ========== ========== ========== ==========
Supplemental Data
Net assets, end of period (in thousands) $ 329,690 $ 334,660 $ 349,958 $ 328,408 $ 296,305
============ ========== ========== ========== ==========
Portfolio turnover 41.98% 336.73% 508.54% 428.59% 426.77%
============ ========== ========== ========== ==========
* Annualized.
** Total investment returns exclude the effects of sales charges. Effective December 28, 2005,
Class I Shares are no longer subject to any front-end sales charge.
++ Amount is less than $.01 per share.
+++ Based on average shares outstanding.
+++++ Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Financial Highlights (concluded)
Class R
For the Period
For the Six January 3,
Months Ended For the Year Ended 2003++ to
The following per share data and ratios have been derived February 28, August 31, August 31,
from information provided in the financial statements. 2006 2005 2004 2003
Per Share Operating Performance
Net asset value, beginning of period $ 10.25 $ 10.29 $ 10.12 $ 10.31
----------- ---------- ---------- ----------
Investment income--net .19+++ .31+++ .23+++ .24
Realized and unrealized gain (loss)--net (.23) (.01) .20 (.19)
----------- ---------- ---------- ----------
Total from investment operations (.04) .30 .43 .05
----------- ---------- ---------- ----------
Less dividends and distributions from:
Investment income--net (.19) (.34) (.26) (.24)
Realized gain--net (.01) -- -- --
----------- ---------- ---------- ----------
Total from dividends and distributions (.20) (.34) (.26) (.24)
----------- ---------- ---------- ----------
Net asset value, end of period $ 10.01 $ 10.25 $ 10.29 $ 10.12
=========== ========== ========== ==========
Total Investment Return
Based on net asset value per share (.39%)+++++ 2.96% 4.34% .44%+++++
=========== ========== ========== ==========
Ratios to Average Net Assets
Expenses, excluding interest expense 1.33%* 1.27% 1.21% 1.23%*
=========== ========== ========== ==========
Expenses 1.81%* 1.27% 1.21% 1.23%*
=========== ========== ========== ==========
Investment income--net 3.76%* 2.97% 2.25% 2.81%*
=========== ========== ========== ==========
Supplemental Data
Net assets, end of period (in thousands) $ 26,539 $ 19,854 $ 8,040 $ 77
=========== ========== ========== ==========
Portfolio turnover 41.98% 336.73% 508.54% 428.59%
=========== ========== ========== ==========
* Annualized.
++ Commencement of operations.
+++ Based on average shares outstanding.
+++++ Aggregate total investment return.
See Notes to Financial Statements.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Notes to Financial Statements
1. Significant Accounting Policies:
Merrill Lynch U.S. Government Fund (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company. The Fund's financial statements are prepared in
conformity with U.S. generally accepted accounting principles which may
require the use of management accruals and estimates. Actual results may
differ from these estimates. These unaudited financial statements reflect all
adjustments, which are, in the opinion of management, necessary to present a
fair statement of the results for the interim period. All such adjustments are
of a normal, recurring nature. The Fund offers multiple classes of shares.
Effective December 28, 2005, Class I Shares are no longer subject to any front-
end sales charge. Class A Shares 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 I Shares are sold only to certain eligible investors. 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.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Notes to Financial Statements (continued)
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.
(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) Reverse repurchase agreements--The Fund may enter into reverse repurchase
agreements. Under reverse repurchase agreements, the Fund sells securities to
the counterparty and agrees to repurchase them at a mutually agreed upon date
and price, and may exchange their respective commitments to pay or receive
interest. If the counterparty defaults on its obligation, the Fund's ability
to receive interest will be delayed or limited. Furthermore, if the Fund does
not have sufficient client income to pay its obligation under the reverse
repurchase agreement, the Fund would be in default and the counterparty would
be able to terminate the repurchase agreement. At the time a portfolio enters
into a reverse repurchase agreement, it will establish a segregated account
with the custodian containing cash, or cash equivalents of liquid high grade
debt securities having a value at least equal to the repurchase price.
(d) 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.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Notes to Financial Statements (continued)
* 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.
* Short sales--When a Fund engages in a short sale, an amount equal to the
proceeds 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 market value of the short sale. The Fund maintains a segregated
account of securities as collateral for the short sales. The Fund is exposed
to market risk based on the amount, if any, that the market value of the stock
exceeds the market value of the securities in the segregated account. The Fund
is required to repay the counterparty any dividends or interest received on
the security sold short.
(e) 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.
(f) 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.
(g) Prepaid registration fees--Prepaid registration fees are charged to
expense as the related shares are issued.
(h) 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.
(i) 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.
(j) 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.
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.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Notes to Financial Statements (continued)
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 operationsof 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%
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 six months ended February 28, 2006, 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 $ 2,066 $ 16,624
Class I $ 2,193 $ 27,102
For the six months ended February 28, 2006, MLPF&S received contingent
deferred sales charges of $132,615 and $3,223 relating to transactions in
Class B and Class C Shares, respectively. Furthermore, MLPF&S received
contingent deferred sales charges of $839 relating to transactions subject to
front-end sales charge waivers in Class I 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 six months ended February 28, 2006,
MLIM, LLC received $26,329 in securities lending agent fees.
For the six months ended February 28, 2006, the Fund reimbursed MLIM $17,850
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.
In February 2006, ML & Co. and BlackRock, Inc. entered into an agreement to
merge ML & Co.'s investment management business, including FAM, with the
investment management business of BlackRock, Inc. The transaction is expected
to close in the third quarter of 2006.
3. Investments:
Purchases (including pay-ups) and sales (including paydowns) of investments,
excluding short-term securities, for the six months ended February 28, 2006
were $1,034,983,205 and $764,431,642, respectively.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Notes to Financial Statements (continued)
Transactions in call and put options written for the six months ended
February 28, 2006 were as follows:
Call Options Number of Premiums
Written Contracts* Received
Outstanding call options written,
beginning of period 164 $ 527,750
Options written 325 2,222,969
Options expired (25) (52,500)
Options closed (414) (2,396,344)
--------------- ---------------
Outstanding call options written,
end of period 50 $ 301,875
=============== ===============
* One contract represents a notional amount of $1,000,000.
Put Options Number of Premiums
Written Contracts* Received
Outstanding put options written,
beginning of period 164.0 $ 734,075
Options written 402.5 3,205,969
Options expired (25.0) (85,000)
Options closed (414.0) (2,602,669)
--------------- ---------------
Outstanding put options written,
end of period 127.5 $ 1,252,375
=============== ===============
* 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
$116,655,046 and $184,361,007 for the six months ended February 28, 2006 and
the year ended August 31, 2005, respectively.
Transactions in shares of beneficial interest for each class were as follows:
Class A Shares for the
Six Months Ended Dollar
February 28, 2006 Shares Amount
Shares sold 4,942,979 $ 49,837,702
Automatic conversion of shares 976,556 9,833,742
Shares issued to shareholders in
reinvestment of dividends and
distributions 582,522 5,873,477
--------------- ---------------
Total issued 6,502,057 65,544,921
Shares redeemed (13,096,286) (132,086,270)
--------------- ---------------
Net decrease (6,594,229) $ (66,541,349)
=============== ===============
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 11,168,892
--------------- ---------------
Total issued 16,381,853 168,191,850
Shares redeemed (18,900,986) (194,005,388)
--------------- ---------------
Net decrease (2,519,133) $ (25,813,538)
=============== ===============
Class B Shares for the
Six Months Ended Dollar
February 28, 2006 Shares Amount
Shares sold 1,681,079 $ 16,949,300
Shares issued to shareholders in
reinvestment of dividends and
distributions 412,561 4,159,387
--------------- ---------------
Total issued 2,093,640 21,108,687
--------------- ---------------
Shares redeemed (5,693,064) (57,370,936)
Automatic conversion of shares (976,447) (9,833,742)
--------------- ---------------
Total redeemed (6,669,511) (67,204,678)
--------------- ---------------
Net decrease (4,575,871) $ (46,095,991)
=============== ===============
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 C Shares for the
Six Months Ended Dollar
February 28, 2006 Shares Amount
Shares sold 2,273,759 $ 22,916,475
Shares issued to shareholders in
reinvestment of dividends and
distributions 326,728 3,293,170
--------------- ---------------
Total issued 2,600,487 26,209,645
Shares redeemed (4,009,455) (40,387,220)
--------------- ---------------
Net decrease (1,408,968) $ (14,177,575)
=============== ===============
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Notes to Financial Statements (concluded)
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 I Shares for the
Six Months Ended Dollar
February 28, 2006 Shares Amount
Shares sold 5,169,114 $ 52,106,119
Shares issued to shareholders in
reinvestment of dividends and
distributions 19,496 196,476
--------------- ---------------
Total issued 5,188,610 52,302,595
Shares redeemed (4,896,932) (49,330,087)
--------------- ---------------
Net increase 291,678 $ 2,972,508
=============== ===============
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 R Shares for the
Six Months Ended Dollar
February 28, 2006 Shares Amount
Shares sold 1,238,926 $ 12,461,711
Shares issued to shareholders in
reinvestment of dividends and
distributions 43,315 435,881
--------------- ---------------
Total issued 1,282,241 12,897,592
Shares redeemed (567,574) (5,710,231)
--------------- ---------------
Net increase 714,667 $ 7,187,361
=============== ===============
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
=============== ===============
5. Reverse Repurchase Agreement:
For the six months ended February 28, 2006, the Fund's average amount
outstanding was approximately $176,790,000 and daily weighted average interest
rate was 3.10%.
6. 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. 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 six months ended February 28, 2006. On November 23, 2005,
the credit agreement was renewed for one year under substantially the same
terms.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Disclosure of Investment Advisory Agreement
Activities of and Composition of the Board of Trustees
All but one member of the Board of Trustees is an independent director whose
only affiliation with Fund Asset Management, L.P. (the "Manager") or other
Merrill Lynch affiliates is as a director of the Fund and certain other funds
advised by the Manager or its affiliates. The Co-chairmen of the Board are
also independent trustees. New director nominees are chosen as nominees by a
Nominating Committee comprised of independent trustees. All independent
trustees also are members of the Board's Audit Committee and the independent
trustees meet in executive session at each in-person Board meeting. The Board
and the Audit Committee meet in person for at least two days each quarter and
conduct other in-person and telephone meetings throughout the year, some of
which are formal board meetings, and some of which are informational meetings.
The independent counsel to the independent trustees attends all in-person
Board and Audit Committee meetings and other meetings at the independent
trustees' request.
Management Agreement--Matters Considered by the Board
Every year, the Board considers approval of the Fund's management agreement
(the "Management Agreement"). The Board assesses the nature, scope and quality
of the services provided to the Fund by the personnel of the Manager and their
affiliates, including administrative services, shareholder services, oversight
of fund accounting, marketing services and assistance in meeting legal and
regulatory requirements. The Board also receives and assesses information
regarding the services provided to the Fund by certain unaffiliated service
providers.
At various times throughout the year, the Board also considers a range of
information in connection with its oversight of the services provided by the
Manager and its affiliates. Among the matters considered are: (a) fees (in
addition to management fees) paid to the Manager and its affiliates by the
Fund, such as transfer agency fees and fees for marketing and distribution;
(b) Fund operating expenses paid to third parties; (c) the resources devoted
to and compliance reports relating to the Fund's investment objective,
policies and restrictions, and its compliance with its Code of Ethics and the
Manager's compliance policies and procedures; and (d) the nature, cost and
character of non-investment management services provided by the Manager and
its affiliates.
The Board believes that the Manager is one of the most experienced global
asset management firms and considers the overall services provided by the
Manager to be of high quality. The Board also believes that the Manager is
financially sound and well managed and notes that the Manager is affiliated
with one of America's largest financial firms. The Board works closely with
the Manager in overseeing the Manager's efforts to achieve good performance.
As part of this effort, the Board discusses portfolio manager effectiveness
and, when performance is not satisfactory, discusses with the Manager taking
steps such as changing investment personnel.
Annual Consideration of Approval by the Board of Trustees
In the period prior to the Board meeting to consider renewal of the Investment
Advisory Agreement, the Board requests and receives materials specifically
relating to the Fund's Investment Advisory Agreement. These materials include
(a) information compiled by Lipper Inc. ("Lipper") on the fees and expenses
and the investment performance of the Fund as compared to a comparable group
of funds as classified by Lipper; (b) sales and redemption data for the Fund;
(c) a discussion by the Fund's portfolio management team of investment
strategies used by the Fund during its most recent fiscal year; and (d)
information on the profitability to the Manager and its affiliates of the
Management Agreement and other relationships with the Fund. The Board also
considers other matters it deems important to the approval process such as
payments made to the Manager or its affiliates relating to the distribution of
Fund shares, services related to the valuation and pricing of Fund portfolio
holdings, the Fund's portfolio turnover statistics, and direct and indirect
benefits to the Manager and its affiliates from their relationship with the
Fund.
Certain Specific Renewal Data
In connection with the most recent renewal of the Fund's Investment Advisory
Agreement in February, 2006, the independent trustees' and Board's review
included the following:
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Disclosure of Investment Advisory Agreement (concluded)
Services Provided by the Manager--The Board reviewed the nature, extent and
quality of services provided by the Manager, focusing on investment advisory
services and the resulting performance of the Fund. The Board uses data
provided by Lipper and by the Manager in its review of advisory services. The
Board compared Fund performance - both including and excluding the effects of
the Fund's fees and expenses - to the performance of a comparable group of
mutual funds, and the performance of a relevant index or combination of
indexes. While the Board reviews performance data at least quarterly,
consistent with the Manager's investment goals, the Board attaches more
importance to performance over relatively long periods of time, typically
three to five years. The Board concluded that the comparative data indicated
that performance was satisfactory. The Board concluded that the nature and
quality of these services supported the continuation of the Management
Agreement with the Fund.
The Manager's Personnel and Investment Process--The Board reviews at least
annually the Fund's investment objectives and strategies. The Board discusses
with senior management of the Manager responsible for investment operations
and the senior management of the Manager's taxable fixed-income investing
group the strategies being used to achieve the stated objectives. Among other
things, the Board considers the size, education and experience of the
Manager's investment staff, its use of technology, and the Manager's approach
to training and retaining portfolio managers and other research, advisory and
management personnel. The Board also reviews the Manager's compensation
policies and practices with respect to the Fund's portfolio managers. The
Board also considered the experience of the Fund's portfolio managers and
noted that each member of the Fund's management team has more than eight
years' experience in analyzing and investing in fixed income securities.
Moreover, the Manager and its investment staff have extensive experience in
analyzing and managing the types of investments used by the Fund. The Board
concluded that the Fund benefits from that expertise.
Management Fees and Other Expenses--The Board reviews the Fund's contractual
management fee rate and actual management fee rate as a percentage of total
assets at common asset levels - the actual rate includes advisory and
administrative service fees and the effects of any fee waivers - compared to
the other funds considered comparable by Lipper. The Board also compares the
Fund's total expenses to those of other comparable funds. The Board considered
the services provided to and the fees charged by the Manager to other types of
clients with similar investment mandates and noted that the fees charged to a
retail offshore fund exceeded those being charged to the Fund. The Board
determined that the Fund's contractual and actual management fee rates, as
well as total expenses, were competitive with those of comparable funds. The
Board concluded that the Fund's management fee rate and overall expense ratio
are reasonable when compared to those of other comparable funds.
Profitability--The Board considers the cost of the services provided to the
Fund by the Manager, and the Manager's and its affiliates' profits relating to
the management and distribution of the Fund and the MLIM/FAM-advised funds. As
part of its analysis, the Board reviewed the Manager's methodology in
allocating its costs to the management of the Fund and concluded that there
was a reasonable basis for the allocation. The Board concluded that that the
profits of the Manager and its affiliates are acceptable in relation to the
nature and quality of services provided and given the level of fees and
expenses overall.
Economies of Scale--The Board considered the extent to which economies of
scale might be realized as the assets of the Fund increase and whether there
should be changes in the management fee rate or structure in order to enable
the Fund to participate in these economies of scale. The Board noted that the
Fund's management fee rate includes a breakpoint schedule that reduces the
Fund's management fee rate as the Fund's assets increase. The Board determined
that the management fee structure was reasonable and that no changes were
currently necessary.
Conclusion
After the independent trustees deliberated in executive session, the entire
Board, including all of the independent trustees, approved the renewal of the
existing Investment Advisory Agreement, concluding that the advisory fee
(including fee waivers) was reasonable in relation to the services provided
and that a contract renewal was in the best interests of the shareholders.
MERRILL LYNCH U.S. GOVERNMENT FUND FEBRUARY 28, 2006
Officers and Trustees
Robert C. Doll, Jr., President and Trustee
James H. Bodurtha, Trustee
Kenneth A. Froot, Trustee
Joe Grills, Trustee
Herbert I. London, Trustee
Roberta Cooper Ramo, Trustee
Robert S. Salomon, Jr., Trustee
Donald C. Burke, Vice President and Treasurer
Thomas Musmanno, Vice President
Laura Powers, Vice President
Frank Viola, Vice President
Jeffrey Hiller, Chief Compliance Officer
Alice A. Pellegrino, Secretary
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
Effective January 1, 2006, Stephen B. Swensrud retired as Trustee of Merrill
Lynch U.S. Government Fund. The Fund's Board of Trustees wishes Mr. Swensrud
well in his retirement.
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 FEBRUARY 28, 2006
Item 2 - Code of Ethics - Not Applicable to this semi-annual report
Item 3 - Audit Committee Financial Expert - Not Applicable to this semi-
annual report
Item 4 - Principal Accountant Fees and Services - Not Applicable to this
semi-annual report
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 last 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 - Not Applicable to this semi-annual report
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
By: /s/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Merrill Lynch U.S. Government Fund
Date: April 20, 2006
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
Date: April 20, 2006
By: /s/ Donald C. Burke
---------------------------
Donald C. Burke,
Chief Financial Officer of
Merrill Lynch U.S. Government Fund
Date: April 20, 2006