Exhibit 17(a)
FILING PURSUANT TO RULE 485(b)
As filed with the Securities and Exchange Commission on December 19, 2001
Securities Act File No. 2-92366
Investment Company Act File No. 811-4077
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT [X]
OF 1933 Pre-Effective Amendment No. [ ]
Post-Effective Amendment No. 19 [X]
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 20 [X]
(Check appropriate box or boxes)
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Merrill Lynch U.S. Government Mortgage Fund
(Exact Name of Registrant as Specified in Charter)
800 Scudders Mill Road, Plainsboro, New Jersey 08536
(Address of Principal Executive Offices)
Registrant's Telephone Number, including Area Code: (609) 282-2800
Terry K. Glenn
Merrill Lynch U.S. Government Mortgage Fund
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address: P.O. Box 9011, Princeton, New Jersey 08543-9011
(Name and Address of Agent for Service)
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Copies to:
Counsel for the Fund: Philip L. Kirstein, Esq.
SIDLEY AUSTIN BROWN & WOOD LLP FUND ASSET MANAGEMENT, L.P.
875 Third Avenue P.O. Box 9011
New York, New York 10022-6225 Princeton, New Jersey 08543-9011
Attention: Thomas R. Smith, Jr., Esq.
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It is proposed that this filing will become effective (check appropriate box):
x immediately upon filing pursuant to paragraph (b)
o on (date) pursuant to paragraph (b)
o 60 days after filing pursuant to paragraph (a)(1)
o on (date) pursuant to paragraph (a)(1)
o 75 days after filing pursuant to paragraph (a)(2)
o on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
o this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
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Title of Securities Being Registered: Common Stock, par value $.10 per share.
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Merrill Lynch U.S. Government Mortgage Fund
December 19, 2001
This Prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep it
for future reference.
The Securities and Exchange Commission has not approved or disapproved these
securities or passed upon the adequacy of this Prospectus. Any representation
to the contrary is a criminal offense.
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Table of Contents
PAGE
KEY FACTS
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Merrill Lynch U.S. Government Mortgage Fund at a Glance 3
Risk/Return Bar Chart 5
Fees and Expenses 6
DETAILS ABOUT THE FUND
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How the Fund Invests 8
Investment Risks 9
YOUR ACCOUNT
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Merrill Lynch Select Pricing SM System 15
How to Buy, Sell, Transfer and Exchange Shares 21
Participation in Fee-Based Programs 25
MANAGEMENT OF THE FUND
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Fund Asset Management 28
Financial Highlights 29
FOR MORE INFORMATION
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Shareholder Reports Back Cover
Statement of Additional Information Back Cover
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
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In an effort to help you better understand the many concepts involved in making
an investment decision, we have defined highlighted terms in this prospectus in
the sidebar.
U.S. Government Securities -- debt securities issued or guaranteed as to
principal and interest by the U.S. Government that are supported by the full
faith and credit of the United States.
U.S. Government Agency Securities -- debt securities issued or guaranteed as to
principal and interest by U.S. Government agencies, U.S. Government-sponsored
enterprises and U.S. Government instrumentalities that are not direct
obligations of the United States.
Government-sponsored enterprises -- private corporations sponsored by the
Federal government that have the legal status of government agencies, such as
the Federal Home Loan Mortgage Corporation ("Freddie Mac"), or Federal National
Mortgage Association ("Fannie Mae").
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND AT A GLANCE
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What is the Fund's investment objective?
The Fund's investment objective is to seek high current return through
investments in U.S. Government securities and U.S. Government Agency
securities, including Government National Mortgage Association ("Ginnie Mae")
mortgage backed certificates and other mortgage backed government securities.
What are the Fund's main investment strategies?
The Fund seeks to achieve its investment objective by selecting securities of
any maturity issued or guaranteed by the U.S. Government, by various agencies
of the U.S. Government and by various instrumentalities that have been
established or sponsored by the U.S. Government. Some of these securities,
including U.S. Treasury bills, notes and bonds and securities of Ginnie Mae and
the Federal Housing Administration (FHA), are issued or guaranteed by the U.S.
Government and are supported by the full faith and credit of the U.S. Other
securities are issued or guaranteed by Federal agencies or Government-sponsored
enterprises and are not direct obligations of the United States, but involve
sponsorship or guarantees by government agencies or enterprises.
The Fund will normally invest at least 80% of its total assets in Ginnie Mae
mortgage backed certificates, other U.S. Government securities representing
ownership interest in mortgage pools, or U.S. Government and Agency securities
of issuers whose primary purpose is to facilitate the making of residential or
commercial mortgages.
The Fund may seek to enhance its return through the use of derivatives, such as
options, futures, interest rate swaps and credit default swaps, and to hedge
its portfolio through the use of derivative transactions. The hedging
strategies are intended to reduce volatility in the net asset value of Fund
shares.
In selecting portfolio securities, the Fund's manager will consider the
relative yield of different types of U.S. Government and Agency securities and
its assessment of future interest rate patterns.
What are the main risks of investing in the Fund?
As with any mutual fund, the value of the Fund's investments -- and therefore
the value of Fund shares may fluctuate. These changes may occur because
interest rates are rising or falling. At other times, there are specific
factors that may affect the value of a particular investment. If the value of
the Fund's investments goes down, you may lose money.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
3
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Hedge -- an investment technique involving the purchase or short sale of an
asset in the expectation that any gain will offset losses experienced on other
holdings, or vice versa.
Yield -- the income generated by an investment in the Fund.
Credit Risk -- the risk that the issuer will be unable to pay principal or
interest when due.
Prepayment Risk -- the risk that certain obligations will be paid off by the
obligor more quickly than anticipated and the proceeds may be invested in
securities with lower yields.
Extension Risk -- the risk that certain obligations will be paid off more
slowly by the obligor than anticipated and the value of these securities will
fall.
Liquidity -- the ease with which a security can be traded. Securities that are
less liquid have fewer potential buyers and, as a consequence, greater
volatility.
Leverage -- the risk associated with certain types of investments that
relatively small market movements may result in large changes in the value of
an investment.
Although U.S. Government and Agency securities often involve minimal credit
risk, changes in the value of the Fund's securities may occur in response to
interest rate movements -- generally, when interest rates go up, the value of
the securities goes down. In general, U.S. Government and Agency securities
with longer maturities will be subject to greater volatility resulting from
interest rate fluctuations than securities with shorter maturities. Further,
mortgage backed securities may involve special risks, including prepayment risk
and extension risk, and may be more volatile than other fixed income securities
of similar maturities.
Although the Fund may invest in derivatives to seek to enhance its return and
to hedge against risks in its portfolio, it is not bound to do so and the Fund
cannot guarantee the success of any hedging strategies it does use. Derivatives
may be volatile and subject to liquidity, leverage, credit and other types of
risks.
Who should invest?
The Fund may be an appropriate investment for you if you:
o Are investing with long term goals, such as retirement or funding a
child's education.
o Want a professionally managed portfolio
o Are willing to accept the risk that the value of your investment may
decline as a result of interest rate movements in order to seek high
current return.
o Are looking for an investment that provides income with minimal credit
risk.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
4
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RISK/RETURN BAR CHART
The bar chart and table shown below provide an indication of the risks of
investing in the Fund. The bar chart shows changes in the Fund's performance
for Class D shares for each of the past ten calendar years. Sales charges are
not reflected in the bar chart. If these amounts were reflected, returns would
be less than those shown. The table compares the average annual total returns
for each class of the Fund's shares for the periods shown with those of the
Salomon Brothers Mortgage Index. How the Fund performed in the past is not
necessarily an indication of how the Fund will perform in the future.
During the ten-year period shown in the bar chart, the highest return for a
quarter was 5.04% (quarter ended September 30, 1991) and the lowest return for
a quarter was -2.74% (quarter ended March 31,1994). The Fund's year-to-date
return as of September 30, 2001 was 7.73%.
Average Annual Total Returns Past Past Past Ten Years/
(as of December 31, 2000) One Year Five Years Since Inception
- --------------------------------------------------- 6.52% 5.46% 6.93%+
Merrill Lynch U.S. Government Mortgage Fund*A
Salomon Brothers Mortgage Index** 11.25% 6.89% 8.32%++
Merrill Lynch U.S. Government Mortgage Fund*B 6.12% 5.54% 5.52%#
Salomon Brothers Mortgage Index** 11.25% 6.89% 7.05%##
Merrill Lynch U.S. Government Mortgage Fund*C 9.06% 5.49% 6.77%+
Salomon Brothers Mortgage Index** 11.25% 6.89% 8.32%++
Merrill Lynch U.S. Government Mortgage Fund*D 6.26% 5.22% 6.34%
Salomon Brothers Mortgage Index** 11.25% 6.89% 7.88%
*Includes sales charge.
**This unmanaged Index reflects the performance of a capital market weighting
of the outstanding agency-issued mortgage backed securities. Past
performance is not predictive of future performance.
+Inception date is October 21, 1994.
++Since October 31, 1994.
#Inception date is December 23, 1991.
##Since December 31, 1991.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
5
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UNDERSTANDING EXPENSES
Fund investors pay various fees and expenses, either directly or indirectly.
Listed below are some of the main types of expenses, which the Fund may charge:
Expenses paid directly by the shareholder:
Shareholder Fees -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
Expenses paid indirectly by the shareholder:
Annual Fund Operating Expenses -- expenses that cover the costs of operating
the Fund.
Management Fee -- a fee paid to the Manager for managing the Fund.
Distribution Fees -- fees used to support the Fund's marketing and distribution
efforts, such as compensating Financial Advisors and other financial
intermediaries, advertising and promotion.
Service (Account Maintenance) Fees -- fees used to compensate securities
dealers and other financial intermediaries for account maintenance activities.
FEES AND EXPENSES
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not
everyone is eligible to buy every class. After determining which classes you
are eligible to buy, decide which class best suits your needs. Your Merrill
Lynch Financial Consultant can help you with this decision.
This table shows the different fees and expenses that you may pay if you buy
and hold the different classes of shares of the Fund. Future expenses may be
greater or less than those indicated below.
Shareholder Fees (fees paid directly from your investment)(a): Class A Class B (b)Class C Class D
Maximum Sales Charge (Load) imposed on purchases (as a percentage of offering price) 4.00%(c) None None 4.00%(c)
Maximum Deferred Sales Charge (Load) (as a percentage of original purchase price or None(d) 4.0%(c) 1.0%(c) None(d)
redemption proceeds, whichever is lower)
Maximum Sales Charge (Load) imposed on Dividend Reinvestments None None None None
Redemption Fee None None None None
Exchange Fee None None None None
Annual Fund Operating Expenses (expenses that are deducted from Fund assets):
Management Fee(e) 0.48% 0.48% 0.48% 0.48%
Distribution and/or Service (12b-1) Fees(f) None 0.75% 0.80% 0.25%
Other Expenses (including transfer agency fees)(g) 0.27% 0.29% 0.29% 0.27%
Total Annual Fund Operating Expenses 0.75% 1.52% 1.57% 1.00%
(a) In addition, Merrill Lynch may charge clients a processing fee (currently
$5.35) when a client buys or sells shares. See "Your Account -- How to
Buy, Sell, Transfer and Exchange Shares."
(b) Class B shares automatically convert to Class D shares about ten years
after you buy them and will no longer be subject to distribution fees.
(c) Some investors may qualify for reductions in the sales charge (load).
(d) You may pay a deferred sales charge if you purchase $1 million or more and
you redeem within one year.
(e) The Fund pays the Manager a fee at the annual rate of 0.50% of the average
daily net assets of the Fund not exceeding $500 million; 0.475% of the
average daily net assets of the Fund in excess of $500 million but not
exceeding $1 billion; 0.45% of the average daily net assets of the Fund in
excess of $1 billion but not exceeding $1.5 billion; 0.425% of the average
daily net assets of the Fund in excess of $1.5 billion but not exceeding
$2 billion; 0.40% of the average daily net assets of the Fund in excess of
$2 billion but not exceeding $2.5 billion; 0.375% of the average daily net
assets of the Fund in excess of $2.5 billion but not exceeding $3.5
billion; 0.35% of the average daily net assets of the Fund in excess of
$3.5 billion but not exceeding $5 billion; 0.325% of the average daily net
assets of the Fund in excess of $5 billion but not exceeding $6.5 billion;
and 0.30% of the average daily net assets of the Fund in excess of $6.5
billion. For the fiscal year ended August 31, 2001, the Manager received a
fee equal to 0.48% of the Fund's average daily net assets.
(footnotes continued on next page)
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
6
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(footnotes continued from previous page)
(f) The Fund calls the "Service Fee" an "Account Maintenance Fee." Account
Maintenance Fee is the term used elsewhere in this Prospectus and in all
other Fund materials. If you hold Class B or Class C shares over time, it
may cost you more in distribution (12b-1) fees than the maximum sales
charge that you would have paid if you had bought one of the other
classes.
(g) Financial Data Services, Inc., an affiliate of the Manager, provides
transfer agency services to the Fund. The Fund pays a fee for these
services. The Manager or its affiliates also provide certain accounting
services to the Fund and the Fund reimburses the Manager or its affiliates
for such services.
Examples:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate
you will receive a 5% annual rate of return. Your annual return may be more or
less than the 5% used in this example. Although your actual costs may be higher
or lower, based on these assumptions your costs would be:
EXPENSES IF YOU DID REDEEM YOUR SHARES:
1 Year 3 Years 5 Years 10 Years
Class A $ 474 $ 630 $ 800 $ 1,293
Class B $ 555 $ 680 $ 829 $ 1,813
Class C $ 260 $ 496 $ 855 $ 1,867
Class D $ 498 $ 706 $ 930 $ 1,576
EXPENSES IF YOU DID NOT REDEEM YOUR SHARES:
1 Year 3 Years 5 Years 10 Years
Class A $ 474 $ 630 $ 800 $ 1,293
Class B $ 155 $ 480 $ 829 $ 1,813
Class C $ 160 $ 496 $ 855 $ 1,867
Class D $ 498 $ 706 $ 930 $ 1,576
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
7
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ABOUT THE PORTFOLIO MANAGEMENT TEAM
Frank Viola is a Director of Merrill Lynch Investment Managers, L.P. and has
been a Portfolio Manager thereof since 1997. Mr. Viola was the Treasurer of
Merrill Lynch Bank & Trust from 1996 to 1997 and a Vice President of Merrill
Lynch Capital Markets from 1993 to 1996.
Teresa L. Giacino has been a Vice President and Portfolio Manager of Merrill
Lynch Investment Managers, L.P. since 1992.
ABOUT THE MANAGER
The Fund is managed by Fund Asset Management.
HOW THE FUND INVESTS
The Fund's objective is to seek high current return. The Fund tries to achieve
this objective by investing in U.S. Government securities and U.S. Government
Agency securities of any maturity, including Government National Mortgage
Association ("Ginnie Mae") mortgage backed certificates and other mortgage
backed government securities.
At least 80% of the Fund's total assets will be invested in Ginnie Mae mortgage
backed certificates, other U.S. Government securities representing ownership
interest in mortgage pools, or U.S. Government and Agency securities of issuers
whose primary purpose is to facilitate the making of residential or commercial
mortgages. These securities are issued or guaranteed by (i) the U.S.
Government, (ii) various agencies of the U.S. Government and (iii) various
instrumentalities that have been established or sponsored by the U.S.
Government. Some of these securities, including securities of Ginnie Mae and
the Federal Housing Administration ("FHA"), are issued or guaranteed by the
U.S. Government and are supported by the full faith and credit of the U.S.
Other securities are issued or guaranteed by Federal agencies or
Government-sponsored enterprises and are not direct obligations of the United
States, but involve sponsorship or guarantees by government agencies or
enterprises. These obligations include securities that are supported by the
right of the issuer to borrow from the Treasury, such as obligations of Federal
Home Loan Banks, and securities that are supported only by the credit of the
instrumentality, such as Federal National Mortgage Association ("Fannie Mae")
bonds. Because the U.S. Government is not obligated to provide support to its
instrumentalities, the Fund will invest in obligations issued by these
instrumentalities where the Fund is satisfied that the credit risk with respect
to the issuers is minimal. In addition, the Fund may invest up to 5% of its
assets in obligations issued or guaranteed by the International Bank for
Reconstruction and Development, an international organization of which the
United States is a member country.
The Fund has the authority to invest in all U.S. Government and Agency
securities, but it is anticipated that the Fund will invest primarily in Ginnie
Mae mortgage backed certificates and other U.S. Government securities
representing ownership interest in mortgage pools. Ginnie Mae certificates are
mortgage backed securities of the modified pass-through type, which means that
both interest and principal payments (including prepayments) are passed through
monthly to the holder of the certificate. The average life of Ginnie Mae
certificates varies with the maturities of the underlying mortgage instruments,
which have maximum maturities of 30 years. The Fund may
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
8
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also invest in mortgage backed securities issued by Fannie Mae and the Federal
Home Loan Mortgage Corporation ("Freddie Mac"). In selecting portfolio
securities, the Fund's manager will consider the relative yield of different
types of U.S. Government and Agency securities and its assessment of future
interest rate patterns.
The Fund is not limited as to the maturities of its portfolio investments and
may take full advantage of the entire range of maturities offered by U.S.
Government and Agency securities. The Manager may adjust the average maturity
of the Fund's portfolio from time to time, depending on its assessment of the
relative yields available on securities of different maturities and its
assessment of future interest rate patterns. Thus, at various times the average
maturity of the portfolio may be relatively short (from under one year to five
years, for example) and at other times may be relatively long (over 10 years,
for example).
The Fund may seek to enhance its return through the use of derivatives, such as
indexed and inverse securities, options, futures, options on futures, interest
rate swaps and credit default swaps, and to hedge its portfolio through the use
of derivative transactions. Derivatives are financial instruments whose value
is derived from another security, a commodity (such as oil or gold) or an index
such as the Standard & Poor's 500 Index or the prime lending rate. The hedging
strategies are intended to reduce volatility in the net asset value of Fund
shares. There can be no assurance that the Fund's hedging strategy will reduce
risk or that hedging transactions will be either available or cost effective.
INVESTMENT RISKS
This section contains a summary discussion of the general risks of investing in
the Fund. As with any fund, there can be no guarantee that the Fund will meet
its goals or that the Fund's performance will be positive for any period of
time.
Market and Selection Risk -- Market risk is the risk that bond market will go
down in value, including the possibility that the market will go down sharply
and unpredictably. Selection risk is the risk that the securities that Fund
management selects will underperform the bond market, relevant
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
9
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indices or other funds with similar investment objectives and investment
strategies.
Credit Risk -- Credit risk is the risk that the issuer will be unable to pay
the interest or principal when due. The degree of credit risk depends on both
the financial condition of the issuer and the terms of the obligation.
Interest Rate Risk -- Interest rate risk is the risk that prices of bonds
generally increase when interest rates decline and decrease when interest rates
increase. Prices of longer term securities generally change more in response to
interest rate changes than prices of shorter term securities.
Call and Redemption Risk -- A bond's issuer may call a bond for redemption
before it matures. If this happens to a bond the Fund holds, the Fund may lose
income and may have to invest the proceeds in bonds with lower yields.
Borrowing Risk -- The Fund may borrow for temporary or emergency purposes
including to meet redemptions. Borrowing may exaggerate changes in the net
asset value of Fund shares and in the yield on the Fund's portfolio. Borrowing
will cost the Fund interest expense and other fees. The cost of borrowing may
reduce the Fund's return.
Securities Lending -- The Fund may lend securities with a value not exceeding
33 1/3% of its total assets to financial institutions that provide cash or
securities issued or guaranteed by the U.S. as collateral. Securities lending
involves the risk that the borrower may fail to return the securities in a
timely manner or at all. As a result, the Fund may lose money and there may be
a delay in recovering the loaned securities. The Fund could also lose money if
it does not recover the securities and/or the value of the collateral falls,
including the value of investments made with cash collateral. These events
could trigger adverse tax consequences to the Fund.
Risks associated with certain types of securities in which the Fund may invest
include:
Mortgage Backed Securities -- Mortgage backed securities represent the right to
receive a portion of principal and/or interest payments made on a pool of
residential or commercial mortgage loans. When interest rates fall, borrowers
may refinance or otherwise repay principal on their mortgages earlier than
scheduled. When this happens, certain types of mortgage backed securities will
be paid off more quickly than originally anticipated and the Fund has to invest
the proceeds in securities with lower yields. This risk is known as "prepayment
risk." When interest rates rise, certain types of
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
10
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mortgage backed securities will be paid off more slowly than originally
anticipated and the value of these securities will fall. This risk is known as
"extension risk."
Because of prepayment risk and extension risk mortgage backed securities react
differently to changes in interest rates than other fixed income securities.
Small movements in interest rates (both increase and decrease) may quickly and
significantly reduce the value of certain mortgage backed securities.
Most mortgage backed securities are issued by Federal government agencies, such
as Ginnie Mae, Freddie Mac or Fannie Mae. Principal and interest payments on
mortgage backed securities issued by Federal government agencies are guaranteed
by either the Federal government or the government agency. Such securities have
very little credit risk, but may be subject to substantial interest rate risks.
Mortgage backed securities may be either pass-through securities or
collateralized mortgage obligations (CMOs). Pass-through securities represent a
right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams (tranches) with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only (IOs), principal only
(POs) or an amount that remains after other floating-rate tranches are paid (an
inverse floater). These securities are frequently referred to as "mortgage
derivatives" and may be extremely sensitive to changes in interest rates. If
the Fund invests in CMO tranches issued by government agencies and interest
rates move in a manner not anticipated by Fund management, it is possible that
the Fund could lose all or substantially all of its investment.
Derivatives -- The Fund may use derivative instruments including indexed and
inverse securities, futures, options, options on futures, interest rate swaps
and credit default swaps. Derivatives allow the Fund to increase or decrease
its risk exposure more quickly and efficiently than other types of instruments.
Derivatives are volatile and involve significant risks, including:
o Credit risk -- the risk that the counterparty (the party on the other side
of the transaction) on a derivative transaction will be unable to honor
its financial obligation to the Fund.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
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o Leverage risk -- the risk associated with certain types of investments or
trading strategies that relatively small market movements may result.in
large changes in the value of an investment. Certain investments or
trading strategies that involve leverage can result in losses that greatly
exceed the amount originally invested.
o Liquidity risk -- the risk that certain securities may be difficult or
impossible to sell at the time that the seller would like or at the price
that the seller believes the security is currently worth.
The Fund may use derivatives for hedging purposes, including anticipatory
hedges, as well as to seek to enhance total returns. Hedging is a strategy in
which the Fund uses a derivative to offset the risks associated with other Fund
holdings. While hedging can reduce losses, it can also reduce or eliminate
gains or cause losses if the market moves in a different manner than
anticipated by the Fund or if the cost of the derivative outweighs the benefit
of the hedge. Hedging also involves the risk that changes in the value of the
derivative will not match those of the holdings being hedged as expected by the
Fund, in which case any losses on the holdings being hedged may not be reduced.
There can be no assurance that the Fund's hedging strategy will reduce risk or
that hedging transactions will be either available or cost effective. The Fund
is not required to use hedging and may choose not to do so.
Swap Agreements -- Swap agreements involve the risk that the party with whom
the Fund has entered into the swap will default on its obligation to pay the
Fund and the risk that the Fund will not be able to meet its obligations to pay
the other party to the agreement.
Indexed and Inverse Floating Rate Securities -- The Fund may invest in
securities whose potential returns are directly related to changes in an
underlying index or interest rate, known as indexed securities. The return on
indexed securities will rise when the underlying index or interest rate rises
and fall when the index or interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes in an interest rate
(inverse floaters). In general, income on inverse floaters will decrease when
interest rates increase and increase when interest rates decrease. Investments
in inverse floaters may subject the Fund to the risks of reduced or eliminated
interest payments and losses of principal. In addition, certain indexed
securities and inverse floaters may increase or decrease in value at a greater
rate than the underlying interest rate, which effectively leverages the Fund's
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
12
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investment. Indexed securities and inverse floaters are derivative securities
and can be considered speculative. Indexed and inverse securities involve
credit risk and certain indexed and inverse securities may involve currency
risk, leverage risk and liquidity risk.
Debt Securities -- Debt securities, such as bonds, involve credit risk. This is
the risk that the borrower will not make timely payments of principal and
interest. The degree of credit risk depends on the issuer's financial condition
and on the terms of the bonds. These securities are also subject to interest
rate risk. This is the risk that the value of the security may fall when
interest rates rise. In general, the market price of debt securities with
longer maturities will go up or down more in response to changes in interest
rates than the market price of shorter term securities.
Repurchase Agreements -- The Fund may enter into certain types of repurchase
agreements. Under a repurchase agreement, the seller agrees to repurchase a
security at a mutually agreed upon time and price. If the other party to a
repurchase agreement defaults on its obligation, the Fund may suffer delays and
incur costs or even lose money in exercising its rights under the agreement.
When Issued Securities, Delayed Delivery Securities and Forward Commitments --
When issued and delayed delivery securities and forward commitments involve the
risk that the security the Fund buys will lose value prior to its delivery.
There also is the risk that the security will not be issued or that the other
party will not meet its obligation. If this occurs, the Fund both loses the
investment opportunity for the assets it has set aside to pay for the security
and any gain in the security's price.
Illiquid Securities -- The Fund may invest up to 15% of its net assets in
illiquid securities that it cannot easily sell within seven days at current
value or that have contractual or legal restrictions on resale. If the Fund
buys illiquid securities it may be unable to quickly sell them or may be able
to sell them only at a price below current value.
Restricted Securities -- Restricted securities have contractual or legal
restrictions on their resale. They may include private placement securities
that the Fund buys directly from the issuer. Private placement and other
restricted securities may not be listed on an exchange and may have no active
trading market.
Restricted securities may be illiquid. The Fund may be unable to sell them on
short notice or may be able to sell them only at a price below current value.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
13
- ------------------------------------------------------------------------------
The Fund may get only limited information about the issuer, so it may be less
able to predict a loss. In addition, if Fund management receives material
adverse nonpublic information about the issuer, the Fund will not be able to
sell the securities.
Rule 144A Securities -- Rule 144A securities are restricted securities that can
be resold to qualified institutional buyers but not to the general public. Rule
144A securities may have an active trading market, but carry the risk that the
active trading market may not continue.
STATEMENT OF ADDITIONAL INFORMATION
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
14
- ------------------------------------------------------------------------------
MERRILL LYNCH SELECT PRICING SM SYSTEM
The Fund offers four share classes, each with its own sales charge and expense
structure, allowing you to invest in the way that best suits your needs. Each
share class represents an ownership interest in the same investment portfolio.
When you choose your class of shares you should consider the size of your
investment and how long you plan to hold your shares. Your Merrill Lynch
Financial Advisor or other financial intermediary can help you determine which
share class is best suited to your personal financial goals.
For example, if you select Class A or Class D shares, you generally pay a sales
charge at the time of purchase. If you buy Class D shares, you also pay an
ongoing account maintenance fee of 0.25%. You may be eligible for a sales
charge reduction or waiver.
Certain financial intermediaries may charge additional fees in connection with
transactions in Fund shares. The Manager, the Distributor or their affiliates
may make payments out of their own resources to selected securities dealers and
other financial intermediaries for providing services intended to result in the
sale of Fund shares or for shareholder servicing activities.
The Fund has adopted a plan under Rule 12b-1 to pay distribution fees for the
sale and distribution of its shares. If you select Class B or C shares, you
will invest the full amount of your purchase price, but you will be subject to
a distribution fee of 0.50% for Class B shares and 0.55% for Class C shares and
an account maintenance fee of 0.25% for both classes of shares. Because these
fees are paid out of the Fund's assets on an ongoing basis, over time these
fees increase the cost of your investment and may cost you more than paying
other types of sales charges. In addition, you may be subject to a deferred
sales charge when you sell Class B or C shares.
The Fund's shares are distributed by FAM Distributors, an affiliate of Merrill
Lynch.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
15
- ------------------------------------------------------------------------------
The Table below summarizes key features of the Merrill Lynch Select Pricing SM
System.
Class A Class B Class C Class D
- ---------------------------------------------------------------------------------------------------------------------------
Availability Limited to certain Generally available Generally available through Generally available through
investors including: through Merrill Lynch. Merrill Lynch. Limited Merrill Lynch. Limited
o Current Class A Limited availability availability through availability through
shareholders through selected selected securities dealers selected securities dealers
o Certain securities dealers and other financial and other financial
Retirement Plans and other financial intermediaries. intermediaries.
o Participants in intermediaries.
certain Merrill
Lynch-sponsored
programs
o Certain
affiliates of
Merrill Lynch,
selected securities
dealers and other
financial
intermediaries
- ---------------------------------------------------------------------------------------------------------------------------
Initial Sales Charge? Yes. Payable at time of No. Entire purchase No. Entire purchase Yes. Payable at time of
purchase. Lower sales price is invested in price is invested in purchase. Lower sales
charges available for shares of the Fund. shares of the Fund. charges available for
larger investments. larger investments.
- ---------------------------------------------------------------------------------------------------------------------------
Deferred Sales Charge? No. (May be charged for Yes. Payable if you Yes. Payable if you No. (May be charged for
purchases over $1 redeem within four redeem within one year purchases over $1 million
million that are years of purchase. of purchase. that are redeemed within
redeemed within one one year.)
year.)
- ---------------------------------------------------------------------------------------------------------------------------
Account Maintenance and No. 0.25% Account 0.25% Account 0.25% Account Maintenance
Distribution Fees? Maintenance Fee. Maintenance Fee. Fee.
0.50% Distribution Fee. 0.55% Distribution Fee. No Distribution Fee.
- ---------------------------------------------------------------------------------------------------------------------------
Conversion to Class D No. Yes, automatically No. N/A
shares? after approximately
ten years.
- ---------------------------------------------------------------------------------------------------------------------------
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
16
- ------------------------------------------------------------------------------
Right of Accumulation -- permits you to pay the sales charge that would apply
to the cost or value (whichever is higher) of all shares you own in the Merrill
Lynch mutual funds that offer Select PricingSM options.
Letter of Intent -- permits you to pay the sales charge that would be
applicable if you add up all shares of Merrill Lynch Select PricingSM System
funds that you agree to buy within a 13 month period. Certain restrictions
apply.
Class A and Class D Shares -- Initial Sales Charge Options
If you select Class A or Class D shares, you will pay a sales charge at the
time of purchase as shown in the following table:
As a % of As a % of Your Dealer Compensation as a %
Your Investment Offering Price Investment* of Offering Price
- ----------------------------------------------------------------------------------------------
Less than $25,000 4.00% 4.17% 3.75%
- ----------------------------------------------------------------------------------------------
$25,000 but less than $50,000 3.75% 3.90% 3.50%
- ----------------------------------------------------------------------------------------------
$50,000 but less than $100,000 3.25% 3.36% 3.00%
- ----------------------------------------------------------------------------------------------
$100,000 but less than $250,000 2.50% 2.56% 2.25%
- ----------------------------------------------------------------------------------------------
$250,000 but less than $1,000,000 1.50% 1.52% 1.25%
- ----------------------------------------------------------------------------------------------
$1,000,000 and over** 0.00% 0.00% 0.00%
- ----------------------------------------------------------------------------------------------
*Rounded to the nearest one-hundredth percent.
**If you invest $1,000,000 or more in Class A or Class D shares, you may not
pay an initial sales charge. In that case, the Manager compensates the
selling dealer or other financial intermediary from its own funds.
However, if you redeem your shares within one year after purchase, you may
be charged a deferred sales charge. This charge is 1.00% of the lesser of
the original cost of the shares being redeemed or your redemption
proceeds. A sales charge of 0.75% will be charged on purchases of
$1,000,000 or more of Class A or Class D shares by certain employer-
sponsored retirement or savings plans.
No initial sales charge applies to Class A or Class D shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class A or Class D shares may
apply for:
o Purchases under a Right of Accumulation or Letter of Intent
o TMA SM Managed Trusts
o Certain Merrill Lynch investment or central asset accounts
o Certain employer-sponsored retirement or savings plans
o Purchases using proceeds from the sale of certain Merrill Lynch closed-end
funds under certain circumstances
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
17
- ------------------------------------------------------------------------------
o Merrill Lynch Blueprint SM Program participants
o Certain investors, including directors or trustees of Merrill Lynch mutual
funds and Merrill Lynch employees
o Certain fee-based programs of Merrill Lynch and other financial
intermediaries that have agreements with the Distributor or its affiliates
Only certain investors are eligible to buy Class A shares. Your Merrill Lynch
Financial Advisor can help you determine whether you are eligible to buy Class
A shares or to participate in any of these programs.
As a result of the implementation of the Merrill Lynch Select PricingSM System,
Class A shares of the Fund outstanding prior to October 21, 1994, were
redesignated Class D shares. The Class A shares offered here differ from the
Class A shares offered prior to October 21, 1994 in many respects, including
eligible investors, sales charges and exchange privilege.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class A and Class D shares, you should buy Class A
since Class D shares are subject to a 0.25% account maintenance fee, while
Class A shares are not.
If you redeem Class A or Class D shares and within 30 days buy new shares of
the same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your Merrill Lynch
Financial Advisor, selected securities dealer, other financial intermediary or
contact the Fund's Transfer Agent at 1-800-MER-FUND.
Class B and Class C Shares -- Deferred Sales Charge Options
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within four
years after purchase or your Class C shares within one year after purchase, you
may be required to pay a deferred sales charge. You will also pay distribution
fees of 0.50% for Class B shares and 0.55% for Class C shares and account
maintenance fees of 0.25% each year under distribution plans that the Fund has
adopted under Rule 12b-1. Because these fees are paid out of the Fund's assets
on an ongoing basis, over time these fees increase the cost of your investment
and may cost you more than paying
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
18
- ------------------------------------------------------------------------------
other types of sales charges. The Distributor uses the money that it receives
from the deferred sales charges and the distribution fees to cover the costs of
marketing, advertising and compensating the Merrill Lynch Financial Advisor,
selected securities dealer or other financial intermediary who assists you in
purchasing Fund shares.
Class B Shares
If you redeem Class B shares within four years after purchase, you may be
charged a deferred sales charge. The amount of the charge gradually decreases
as you hold your shares over time, according to the following schedule:
Years Since Purchase Sales Charge*
------------------------------- -------------------------
0 - 1 4.00%
------------------------------- -------------------------
1 - 2 3.00%
------------------------------- -------------------------
2 - 3 2.00%
------------------------------- -------------------------
3 - 4 1.00%
------------------------------- -------------------------
4 and thereafter 0.00%
------------------------------- -------------------------
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends are not subject to a deferred sales
charge. Not all Merrill Lynch funds have identical deferred sales charge
schedules. If you exchange your shares for shares of another fund, the
higher charge will apply.
The deferred sales charge relating to Class B shares may be reduced or waived
in certain circumstances, such as:
o Certain post-retirement withdrawals from an IRA or other retirement plan
if you are over 591/2 years old
o Redemption by certain eligible 401(a) and 401(k) plans, certain related
accounts, group plans participating in the Merrill Lynch Blueprint SM
Program and certain retirement plan rollovers
o Redemption in connection with participation in certain fee-based programs
of Merrill Lynch or other financial intermediaries that have agreements
with the Distributor or its affiliates or in connection with involuntary
termination of an account in which Fund shares are held
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
19
- ------------------------------------------------------------------------------
o Withdrawals resulting from shareholder death or disability as long as the
waiver request is made within one year of death or disability or, if
later, reasonably promptly following completion of probate
o Withdrawal through the Merrill Lynch Systematic Withdrawal Plan of up to
10% per year of your Class B account value at the time the plan is
established
Your Class B shares convert automatically into Class D shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
dividends paid on converting shares will also convert at that time. Class D
shares are subject to lower annual expenses than Class B shares. The conversion
of Class B to Class D shares is not a taxable event for Federal income tax
purposes.
Different conversion schedules apply to Class B shares of different Merrill
Lynch mutual funds. For example, Class B shares of a fixed income fund
typically convert approximately ten years after purchase compared to
approximately eight years for equity funds. If you acquire your Class B shares
in an exchange from another fund with a shorter conversion schedule, the Fund's
ten year conversion schedule will apply. If you exchange your Class B shares in
the Fund for Class B shares of a fund with a longer conversion schedule, the
other fund's conversion schedule will apply. The length of time that you hold
both the original and exchanged Class B shares in both funds will count toward
the conversion schedule. The conversion schedule may be modified in certain
other cases as well.
Class C Shares
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of 1.00%. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends. The deferred sales charge
relating to Class C shares may be reduced or waived in connection with
involuntary termination of an account in which Fund shares are held and
withdrawals through the Merrill Lynch Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
20
- ------------------------------------------------------------------------------
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
- ------------------------------------------------------------------------------
The chart on the following pages summarizes how to buy, sell, transfer and
exchange shares through Merrill Lynch, a selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-MER-FUND. Because the selection of a
mutual fund involves many considerations, your Merrill Lynch Financial Advisor
may help you with this decision.
Because of the high costs of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will
then have 60 days to make an additional investment to bring the value of your
account to at least $500 before the Fund takes any action. This involuntary
redemption does not apply to retirement plans or Uniform Gifts or Transfers to
Minors Act accounts.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
21
- ------------------------------------------------------------------------------
If You Want to Your Choices Information Important for You to Know
- --------------------------------------------------------------------------------------------------------------------------------
Buy Shares First, select the share Refer to the Merrill Lynch Select
class appropriate for you Pricing SM table on page 16. Be
sure to read this Prospectus carefully.
---------------------------------------------------------------------------------------------------
Next, determine the amount The minimum initial investment
of your investment for the Fund is $1,000 for all
accounts except:
o $250 for certain Merrill Lynch fee-based
programs
o $100 for retirement plans
(The minimums for initial investments
may be waived under certain
circumstances.)
-----------------------------------------------------------------------------------------------------
Have your Merrill Lynch Financial The price of your shares is based on
Advisor, selected securities dealer, the next calculation of net asset value
or other financial intermediary after your order is placed. Any
submit your purchase order purchase orders placed prior to the
close of business on the New York Stock
Exchange (generally 4:00 p.m. Eastern
time) will be priced at the net asset
value determined that day. Certain
financial intermediaries, however, may
equire submission of orders prior to
that time.
Purchase orders placed after that time
will be priced at the net asset value
determined on the next business day.
Each Fund may reject any order to buy
shares and may suspend the sale of
shares at any time. Selected securities
dealers or other financial
intermediaries, including Merrill
Lynch, may charge a processing fee to
confirm a purchase. Merrill Lynch
currently charges a fee of $5.35.
-----------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer
Agent at 1-800-MER-FUND and request a purchase
application. Mail the completed purchase
application to the Transfer Agent at the address on
the inside back cover of this Prospectus.
- ----------------------------------------------------------------------------------------------------------------------------------
Add to Your Purchase additional shares The minimum investment for additional purchases is
Investment generally $50 except that retirement plans have a
minimum additional purchase of $1 and certain
programs, such as automatic investment plans, may
have higher minimums. (The minimum for additional
purchases may be waived under certain
circumstances.)
-----------------------------------------------------------------------------------------------------
Acquire additional shares through the All dividends are automatically
automatic dividend reinvestment plan reinvested without a sales charge.
-----------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a
investment plan periodic basis through certain Merrill
Lynch investment or central asset
accounts.
- ----------------------------------------------------------------------------------------------------------------------------------
Transfer Shares to Transfer to a participating securities You may transfer your Fund shares only
Another Securities dealer or other financial intermediary to another securities dealer that has
Dealer or Other entered into an agreement with the
Financial Distributor. Certain shareholder
Intermediary services may not be available for the
transferred shares. You may only
purchase additional shares of funds
previously owned before the transfer.
All future trading of these assets must
be coordinated by the receiving firm.
- ----------------------------------------------------------------------------------------------------------------------------------
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
22
- ----------------------------------------------------------------------------------------------------------------------------------
If You Want to Your Choices Information Important for You to Know
- ----------------------------------------------------------------------------------------------------------------------------------
Transfer Shares to Another Transfer to a non-participating securities You must either:
Securities Dealer or Other dealer or other financial intermediary o Transfer your shares to an account with
Financial Intermediary the Transfer Agent; or
(continued) o Sell your shares, paying any applicable
deferred sales charge.
- ----------------------------------------------------------------------------------------------------------------------------------
Sell Your Shares Have your Merrill Lynch Financial Advisor, The price of your shares is based on
selected securities dealer or other the next calculation of net asset value
financial intermediary submit your after your order is placed. For your
sales order redemption request to be priced at the
net asset value on the day of your
request, you must submit your request
to your dealer or other financial
intermediary prior to that day's close
of business on the New York Stock
Exchange (generally 4:00 p.m. Eastern
time). Certain financial
intermediaries, however, may require
submission of orders prior to that
time. Any redemption request placed
after that time will be priced at the
net asset value at the close of
business on the next business day.
Securities dealers or other financial
intermediaries, including Merrill
Lynch, may charge a fee to process a
redemption of shares. Merrill Lynch
currently charges a fee of $5.35. No
processing fee is charged if you redeem
shares directly through the Transfer
Agent.
A Fund may reject an order to sell
shares under certain circumstances.
-----------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by
writing to the Transfer Agent at the address on the
inside back cover of this prospectus. All
shareholders on the account must sign the letter.
A signature guarantee will generally be required
but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank,
securities dealer, securities broker, credit union,
savings association, national securities exchange
and registered securities association. A notary
public seal will not be acceptable. If you hold
stock certificates, you must return the
certificates with the letter so that they may be
converted. The Transfer Agent will normally mail
redemption proceeds within seven days following
receipt of a properly completed request. If you
make a redemption request before a Fund has
collected payment for the purchase of shares, the
Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten
days.
You may also sell shares held at the
Transfer Agent by telephone request if
the amount being sold is less than
$50,000 and if certain other conditions
are met. Contact the Transfer Agent at
1-800-MER-FUND for details.
- ----------------------------------------------------------------------------------------------------------------------------------
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
23
- ----------------------------------------------------------------------------------------------------------------------------------
If You Want to Your Choices Information Important for You to Know
- ----------------------------------------------------------------------------------------------------------------------------------
Sell Shares Participate in the Fund's You can choose to receive systematic
Systematically Systematic Withdrawal Plan payments from your Fund account either
by check or through direct deposit to
your bank account on a monthly or
quarterly basis. If you hold your Fund
shares in a Merrill Lynch CMA(R),
CBA(R) or Retirement Account you can
arrange for systematic redemptions of a
fixed dollar amount on a monthly,
bi-monthly, quarterly, semi-annual or
annual basis, subject to certain
conditions. Under either method you
must have dividends automatically
reinvested. For Class B and Class C
shares your total annual withdrawals
cannot be more than 10% per year of the
value of your shares at the time your
plan is established. The deferred sales
charge is waived for systematic
redemptions. Ask your Merrill Lynch
Financial Advisor or other financial
intermediary for details.
Exchange Your Shares Select the fund into which you want to You can exchange your shares of a Fund
exchange. Be sure to read that fund's for shares of many other Merrill Lynch
prospectus mutual funds. You must have held the
shares used in the exchange for at
least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally
exchangeable for shares of the same
class of another fund. If you own A
shares and wish to exchange into a fund
in which you have no Class A shares
(and are not eligible to buy A shares),
you will exchange into Class D shares.
Some of the Merrill Lynch mutual funds
impose a initial or deferred sales
charge schedule. If you Class A or
Class D shares for shares of a fund
with a higher initial sales charge than
you originally paid, will be charged
the difference at the time of exchange
you exchange Class B shares for shares
of a fund with different deferred sales
charge schedule, the higher schedule
will generally apply. The time you hold
Class or Class C shares in both funds
will count when determining your
holding period for calculating a sales
charge at redemption. If you exchange
Class A or Class D shares for money
market fund shares, you will receive
Class A shares of Summit Cash Reserves
Fund. B or Class C shares of the Fund
will be exchanged for Class B shares of
Summit.
To exercise the exchange privilege
contact your Merrill Lynch Financial
Advisor or other financial intermediary
call the Transfer Agent at
1-800-MER-FUND.
Although there is currently no limit on
the number of exchanges that you can
make, the exchange privilege modified
or terminated at any time in the
future.
- ---------------------------------------------------------------------------------------------------------------------------------
Short term or excessive trading into and out of the Fund may harm performance
by disrupting portfolio management strategies and by increasing expenses.
Accordingly, the Fund may reject any purchase orders, including exchanges,
particularly from market timers or investors who, in Fund management opinion,
have a pattern of short term or excessive trading or whose trading has been or
may be disruptive to the Fund. For these purposes, Fund management may consider
an investor trading history in the Fund or other Merrill Lynch funds, and
accounts under common ownership or control.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
24
- ------------------------------------------------------------------------------
Net Asset Value -- the market value of the Fund's total assets after deducting
liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
- ------------------------------------------------------------------------------
When you buy shares, you pay the net asset value, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open, as of the close of business on the Exchange based on prices
at the time of closing. The Exchange generally closes at 4:00 p.m. Eastern
time. If events that materially affect the value of securities traded in other
markets occur between the close of those markets and the close of business on
the New York Stock Exchange, the Fund's Board of Directors will value those
securities at their fair value. The net asset value used in determining your
share price is the next one calculated after your purchase or redemption order
is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the financial intermediary or designee and the order will receive the net asset
value next computed by the Fund after such acceptance. If the payment for a
purchase order is not made by a designated later time, the order will be
canceled and the financial intermediary could be held liable for any losses.
Generally, Class A shares will have the highest net asset value because that
class has the lowest expenses, and Class D shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class A and Class
D shares will generally be higher than dividends paid on Class B and Class C
shares because Class A and Class D shares have lower expenses.
PARTICIPATION IN FEE-BASED PROGRAMS
- ------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by Merrill Lynch or
other financial intermediaries, you may be able to buy Class A shares at net
asset value, including by exchanges from other share classes. Sales charges on
the shares being exchanged may be reduced or waived under certain
circumstances.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
25
- ------------------------------------------------------------------------------
Dividends -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or
automatically exchanged into another class of Fund shares or into a money
market fund. The class you receive may be the class you originally owned when
you entered the program, or in certain cases, a different class. If the
exchange is into Class B shares, the period before conversion to Class D shares
may be modified. Any redemption or exchange will be at net asset value.
However, if you participate in the program for less than a specified period,
you may be charged a fee in accordance with the terms of the program.
Details about these features and the relevant charges are included in the
client agreement for each fee-based program and are available from your Merrill
Lynch Financial Advisor, selected securities dealer or other financial
intermediary.
DIVIDENDS AND TAXES
- ------------------------------------------------------------------------------
Dividends from net investment income will be paid at least monthly. All net
realized capital gains, if any, will be distributed to the Fund's shareholders
at least annually. The Fund may also pay a special distribution at the end of
the calendar year to comply with Federal tax requirements. If you would like to
receive dividends in cash, contact your Merrill Lynch Financial
Advisor,.selected securities dealer, other financial intermediary or the
Transfer Agent. Although this cannot be predicted with any certainty, the Fund
anticipates that the majority of its dividends, if any, will consist of
ordinary income, although it may distribute capital gains as well. Capital
gains may be taxable to you at different rates depending, in part, on how long
the Fund held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
26
- ------------------------------------------------------------------------------
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed income or capital
gains, you will pay the full price for the shares and then receive a portion of
the price back in the form of a taxable dividend. Before investing you may want
to consult your tax adviser.
shares and any gain on the transaction may be subject to tax. Capital gain
dividends are generally taxed at different rates than ordinary income
dividends.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.
By law, your dividends and redemption proceeds will be subject to a withholding
tax if you have not provided a taxpayer identification number or social
security number or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
27
- ------------------------------------------------------------------------------
FUND ASSET MANAGEMENT
- ------------------------------------------------------------------------------
Fund Asset Management, the Fund's Manager, manages the Fund's investments and
its business operations under the overall supervision of the Fund's Board of
Trustees. The Manager has the responsibility for making all investment
decisions for the Fund. The Fund pays the Manager a fee at the annual rate of
0.50% of the average daily net assets of the Fund not exceeding $500 million;
0.475% of the average daily net assets of the Fund in excess of $500 million
but not exceeding $1 billion; 0.45% of the average daily net assets of the Fund
in excess of $1 billion but not exceeding $1.5 billion; 0.425% of the average
daily net assets of the Fund in excess of $1.5 billion but not exceeding $2
billion; 0.40% of the.average daily net assets of the Fund in excess of $2
billion but not exceeding $2.5 billion; 0.375% of the average daily net assets
of the Fund in excess of $2.5 billion but not exceeding $3.5 billion; 0.35% of
the average daily net assets of the Fund in excess of $3.5 billion but not
exceeding $5 billion; 0.325% of the average daily net assets of the Fund in
excess of $5 billion but not exceeding $6.5 billion; and 0.30% of the average
daily net assets of the Fund in excess of $6.5 billion. For the fiscal year
ended August 31, 2001, the Manager received a fee equal to 0.48% of the Fund's
average daily net assets.
Fund Asset Management was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
Fund Asset Management and its affiliates had approximately $518 billion in
investment company and other portfolio assets under management as of October
2001.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
28
- ------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- ------------------------------------------------------------------------------
The Financial Highlights table is intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate an investor would have earned on an investment in the Fund
(assuming reinvestment of all dividends). This information has been audited by
Deloitte & Touche LLP, whose report, along with the Fund's financial
statements, is included in the Fund's Annual Report, which is available upon
request.
Class A Class B
For the Year Ended August 31, For the Year Ended August 31,
Increase (Decrease) in
Net Asset Value: 2001 2000 1999 1998 1997 2001 2000 1999 1998 1997
Per Share Operating
Performance:
Net asset value,
beginning of year.......... $ 9.44 $ 9.37 $ 9.80 $ 9.64 $ 9.40 $ 9.44 $ 9.36 $ 9.79 $ 9.63 $ 9.40
Investment income - net...... .57 .58 .55 .60 .64 .50 .51 .48 .53 .57
Realized and unrealized
gain (loss) on
investments - net.......... .51 .07 (.43) .16 .24 .51 .08 (.43) .16 .23
Total from investment
operations................. 1.08 .65 .12 .76 .88 1.01 .59 .05 .69 .80
Less dividends from
investment income - net.... (.57) (.58) (.55) (.60) (.64) (.50) (.51) (.48) (.53) (.57)
Net asset value, end of
year....................... $ 9.95 $ 9.44 $ 9.37$ 9.80 $ 9.64 $ 9.95$ 9.44 $ 9.36 $ 9.79$ 9.63
Total Investment Return:*
Based on net asset value
per share.................. 11.77% 7.23% 1.24% 8.10% 9.66% 10.91% 6.53% .46% 7.28% 8.71%
Ratios to Average Net
Assets:
Expenses..................... .75% .75% .70% .68% .65% 1.52% 1.52% 1.46% 1.45% 1.42%
Investment income - net...... 5.84% 6.23% 5.71% 6.18% 6.73% 5.07% 5.47% 4.95% 5.42% 5.98%
Supplemental Data:
Net assets, end of year
(in thousands)............. $234,930 $192,119 $212,131 $277,568 $278,103 $466,432 $405,846 $571,969 $627,818 $672,541
Portfolio turnover........... 199.30% 37.28% 58.16% 301.88% 349.05% 199.30% 37.28% 58.16% 301.88% 349.05%
*Total investment returns exclude the effects of sales charges.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
29
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FINANCIAL HIGHLIGHTS (concluded)
Class C Class D
Increase (Decrease)in For the Year Ended August 31, For the Year Ended August 31,
Net Asset Value: 2001 2000 1999 1998 1997 2001 2000 1999 1998 1997
Per Share Operating
Performance:
Net asset value,
beginning of year... $9.44 $9.36 $9.79 $9.63 $9.40 $9.44 $9.36 $9.79 $9.63 $9.40
Investment income -
net................. .49 .51 .48 .52 .56 .55 .56 .53 .58 .62
Realized and
unrealized gain
(loss) on
investments - net... .51 .08 (.43) .16 .23 .51 .08 (.43) .16 .23
Total from
investment
operations.......... 1.00 .59 .05 .68 .79 1.06 .64 .10 .74 .85
Less dividends from
investment income
- net............... (.49) (.51) (.48) (.52) (.56) (.55) (.56) (.53) (.58) (.62)
Net asset value, end
of year............. $9.95 $9.44 $9.36 $9.79 $9.63 $9.95 $9.44 $9.36 $9.79 $9.63
Total Investment
Return:*
Based on net asset
value per share..... 10.86% 6.47% .41% 7.23% 8.66% 11.49% 7.08% .98% 7.84% 9.27%
Ratios to Average
Net Assets:
Expenses.............. 1.57% 1.57% 1.51% 1.51% 1.47% 1.00% 1.00% .95% .93% .90%
Investment income -
net................. 5.00% 5.43% 4.90% 5.35% 5.91% 5.59% 5.99% 5.47% 5.94% 6.49%
Supplemental Data:
Net assets, end of
year (in thousands). $56,706 $30,593 $46,614 $43,038 $28,723 $729,136 $720,311 $795,813 $866,013 $927,756
Portfolio turnover.... 199.30% 37.28% 58.16% 301.88% 349.05% 199.30% 37.28% 58.16% 301.88% 349.05%
*Total investment returns exclude the effects of sales charges.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
30
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MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
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MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
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Shareholder Reports
Additional information about the Fund's investments is available in the Fund's
annual and semi-annual reports to shareholders. In the Fund's annual report you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. You
may obtain these reports at no cost by calling 1-800-MER-FUND.
The Fund will send you one copy of each shareholder report and certain other
mailings, regardless of the number of Fund accounts you have. To receive
separate shareholder reports for each account, call your Merrill Lynch
Financial Advisor or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and Merrill Lynch
brokerage or mutual fund account number. If you have any questions, please call
your Merrill Lynch Financial Advisor, or other financial intermediary or call
the Transfer Agent at 1-800-MER-FUND.
Statement of Additional Information
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing the Fund at
Financial Data Services, Inc. P.O. Box 45289 Jacksonville, Florida 32232-5289
or by calling 1-800-MER-FUND.
Contact your Merrill Lynch Financial Advisor or other financial intermediary,
or contact the Fund, at the telephone number or address indicated above, if you
have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet site
at http://www.sec.gov and copies may be obtained upon payment of a duplicating
fee, by electronic request at the following e-mail address: publicinfo@sec.gov,
or by writing the Public Reference Section of the SEC, Washington, D.C.
20549-0102.
You should rely only on the information contained in this Prospectus. No one is
authorized to provide you with information that is different from information
contained in this Prospectus.
Investment Company Act file #811-4077
Code #10259-12-01
(c) Fund Asset
Management, L.P.
Merrill Lynch U.S. Government Mortgage Fund
December 19, 2001
_______________________________________________________________________________
STATEMENT OF ADDITIONAL INFORMATION
Merrill Lynch U.S. Government Mortgage Fund
P.O. Box 9011, Princeton, New Jersey 08543-9011 o Phone No. (609) 282-2800
--------------------
The investment objective of Merrill Lynch U.S. Government Mortgage
Fund (the "Fund") is to seek high current return through investments in U.S.
Government and Government agency securities, including Government National
Mortgage Association ("GNMA") mortgage backed certificates and other mortgage
backed government securities. The Fund may seek to enhance its return through
the use of certain portfolio strategies involving options and to hedge its
portfolio through the use of options and futures transactions. The Fund will
declare dividends daily and pay them monthly from its net investment income.
The Fund's current return consists of interest, premiums from its expired call
and put options, any short term gains from sales of portfolio securities on
exercise of options or otherwise, and any gains from closing purchase or sale
transactions. There can be no assurance that the investment objective of the
Fund will be realized. For more information on the Fund's investment objective
and policies, see "Investment Objectives and Policies."
Pursuant to the Merrill Lynch Select PricingSM System, the Fund
offers four classes of shares, each with a different combination of sales
charges, ongoing fees and other features. The Merrill Lynch Select PricingSM
System permits an investor to choose the method of purchasing shares that the
investor believes is most beneficial given the amount of the purchase, the
length of time the investor expects to hold the shares and other relevant
circumstances. See "Purchase of Shares."
--------------------
This Statement of Additional Information of the Fund is not a
prospectus and should be read in conjunction with the Prospectus of the Fund,
dated December 19, 2001 (the "Prospectus"), which has been filed with the
Securities and Exchange Commission (the "Commission") and can be obtained,
without charge, by calling 1-800-MER-FUND or by writing to the Fund at the
above address. The Prospectus is incorporated by reference into this Statement
of Additional Information, and this Statement of Additional Information is
incorporated by reference into the Prospectus. The Fund's audited financial
statements are incorporated in this Statement of Additional Information by
reference to its 2001 Annual Report. You may request a copy of the Annual
Report or the Prospectus at no charge by calling 1-800-637-3863 between 8:00
a.m. and 8:00 p.m. Eastern time on any business day.
Fund Asset Management - Manager
--------------------
FAM Distributors - Distributor
--------------------
The date of this Statement of Additional
Information is December 19, 2001.
TABLE OF CONTENTS
Page
Investment Objective and Policies..........................................4
GNMA Certificates and Other Mortgage Backed Government Securities..........5
Derivatives................................................................5
Indexed and Inverse Floating Rate Securities..............................11
Other Investment Practices................................................11
Suitability...............................................................12
Investment Restrictions...................................................13
Portfolio Turnover........................................................14
Management of the Fund....................................................15
Trustees and Officers.....................................................15
Compensation of Trustees..................................................16
Management and Advisory Arrangements......................................17
Code of Ethics............................................................19
Purchase of Shares........................................................19
Initial Sales Charge Alternatives -- Class A and Class D Shares...........20
Reduced Initial Sales Charges.............................................21
Deferred Sales Charge Alternatives -- Class B and Class C Shares..........24
Closed-End Fund Reinvestment Options......................................27
Distribution Plans........................................................28
Limitations on the Payment of Deferred Sales Charges......................29
Redemption of Shares......................................................30
Redemption................................................................31
Repurchase................................................................32
Reinstatement Privilege -- Class A and Class D Shares.....................32
Pricing of Shares.........................................................32
Determination of Net Asset Value..........................................32
Computation of Offering Price Per Share...................................33
Portfolio Transactions....................................................34
Shareholder Services......................................................36
Investment Account........................................................36
Exchange Privilege........................................................37
Fee-Based Programs........................................................39
Retirement and Education Savings Plans....................................39
Automatic Investment Plans................................................40
Automatic Dividend Reinvestment Plan......................................40
Systematic Withdrawal Plan................................................40
Dividends and Taxes.......................................................41
Dividends.................................................................41
Taxes.....................................................................42
Tax Treatment of Options and Futures......................................43
Performance Data..........................................................44
General Information.......................................................45
Description of Shares.....................................................45
Independent Auditors......................................................46
Accounting Services Provider..............................................46
Custodian.................................................................46
Transfer Agent............................................................46
Legal Counsel.............................................................46
Reports to Shareholders...................................................46
Shareholder Inquiries.....................................................47
Additional Information....................................................47
Security Ownership of Certain Beneficial Owners...........................47
Financial Statements......................................................48
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek a high current return
through investments in U.S. Government and Government agency securities,
including GNMA mortgage backed certificates and other mortgage backed
government securities. This investment objective is a fundamental policy of
the Fund which may not be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities (which for this purpose
and under the Investment Company Act means the lesser of (a) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares are
represented or (b) more than 50% of the outstanding shares). The Fund may seek
to enhance its return through the use of certain portfolio strategies
involving options and to hedge its portfolio through the use of options and
futures transactions. The hedging strategies are intended to reduce volatility
in the net asset value of Fund shares. The Fund's portfolio strategies are not
fundamental policies and may be modified by the Trustees of the Fund without
the approval of the Fund's shareholders. Reference is made to "How the Fund
Invests" and "Investment Risks" in the Prospectus. The Fund is classified as a
diversified fund under the Investment Company Act of 1940, as amended (the
"Investment Company Act").
The portfolio securities in which the Fund may invest are marketable
securities issued or guaranteed by the United States Government, by various
agencies of the United States Government and by various instrumentalities
which have been established or sponsored by the United States Government
("U.S. Government securities"). Certain of these obligations, including U.S.
Treasury bills, notes and bonds and securities of GNMA and the Federal Housing
Administration ("FHA"), are issued or guaranteed by the U.S. Government and
supported by the full faith and credit of the United States. Other U.S.
Government securities are issued or guaranteed by Federal agencies or
government-sponsored enterprises and are not direct obligations of the United
States but involve sponsorship or guarantees by Government agencies or
enterprises. These obligations include securities that are supported by the
right of the issuer to borrow from the Treasury, such as obligations of
Federal Home Loan Banks, and securities that are supported only by the credit
of the instrumentality, such as Federal National Mortgage Association ("FNMA")
bonds. Because the U.S. Government is not obligated to provide support to its
instrumentalities, the Fund will invest in obligations issued by these
instrumentalities where the Fund is satisfied that the credit risk with
respect to the issuers is minimal. In addition, the Fund may invest up to 5%
of its assets in obligations issued or guaranteed by the International Bank
for Reconstruction and Development, an international organization of which the
United States is a member country.
The Fund has authority to invest in all U.S. Government securities.
Under normal circumstances, at least 80% of the Fund's total assets will
consist of GNMA mortgage backed certificates ("GNMA Certificates"), other U.S.
Government securities representing ownership interests in mortgage pools, or
U.S. Government securities of issuers whose primary purpose is to facilitate
the making of residential or commercial mortgages (together, "U.S. Government
mortgage securities"). For a description of GNMA Certificates and other
eligible securities representing interests in mortgage pools, see "GNMA
Certificates and Other Mortgage Backed Government Securities" below.
Determinations as to the types of U.S. Government securities held by the Fund
will be made by the Manager. The Manager's decisions will be based on, among
other factors, the relative yields of the various types of U.S. Government
securities, its assessment of future interest rate patterns and the
desirability of holding U.S. Government securities on which it may write
covered options, as described below.
The Fund is not limited as to the maturities of its portfolio
investments and may take full advantage of the entire range of maturities
offered by U.S. Government securities. The Manager may adjust the average
maturity of the Fund's portfolio from time to time, depending on its
assessment of the relative yields available on securities of different
maturities and its assessment of future interest rate patterns. Thus, at
various times the average maturity of the portfolio may be relatively short
(from under one year to five years, for example) and at other times may be
relatively long (over 10 years, for example).
Inasmuch as the Fund invests in fixed-income securities, it is
important to note that the Fund's net asset value may fall when interest rates
rise and may rise when interest rates fall. In general, fixed-income
securities with longer maturities will be subject to greater volatility
resulting from interest rate fluctuations than will fixed-income securities
with shorter maturities. Inasmuch as the Fund invests in mortgage backed
securities, however, it is also important to note that the Fund's net asset
value may also fall when interest rates fall to the extent the Fund's
holdings expose the Fund to losses from prepayment risk. See "GNMA
Certificates and Other Mortgage Backed Government Securities" below.
GNMA Certificates and Other Mortgage Backed Government Securities
GNMA Certificates are mortgage backed securities of the modified pass
through type, which means that both interest and principal payments (including
prepayments) are passed through monthly to the holder of the Certificate. The
National Housing Act provides that the full faith and credit of the United
States is pledged to the timely payment of principal and interest by GNMA of
amounts due on these GNMA Certificates. Each Certificate evidences an interest
in a specific pool of mortgage loans insured by the FHA or the Farmers Home
Administration or guaranteed by the Veterans Administration ("VA"). GNMA is a
wholly owned corporate instrumentality of the United States within the
Department of Housing and Urban Development.
The average life of GNMA Certificates varies with the maturities of
the underlying mortgage instruments, which have maximum maturities of 30
years. The average life may be substantially less than the original maturity
of the mortgage pools underlying the securities as a result of prepayments or
refinancing of such mortgages. Such prepayments are passed through to the
registered holder with the regular monthly payments of principal and interest.
In addition, GNMA offers a pass through security backed by adjustable rate
mortgages. As prepayment rates vary widely, it is not possible to predict
accurately the average life of a particular pool. The actual yield of each
GNMA Certificate is influenced by the prepayment experience of the mortgage
pool underlying the certificate.
In addition to GNMA Certificates, the Fund may invest in mortgage
backed securities issued by FNMA and by the Federal Home Loan Mortgage
Corporation ("FHLMC"). FNMA, a federally chartered and privately owned
corporation, issues pass through securities and certificates representing an
interest in a pool of FNMA pass through securities which are guaranteed as to
payment of principal and interest by FNMA. FHLMC, a corporate instrumentality
of the United States, issues participation certificates which represent an
interest in mortgages from FHLMC's portfolio and securities representing an
interest in a pool of FHLMC participation certificates. FHLMC guarantees the
timely payment of interest and the ultimate collection of principal. As is the
case with GNMA Certificates, the actual maturity of and realized yield on
particular FNMA and FHLMC mortgage backed securities will vary based on the
prepayment experience of the underlying pool of mortgages. Securities
guaranteed by FNMA and FHLMC are not backed by the full faith and credit of
the United States.
Mortgage backed U.S. Government securities typically provide a higher
potential for current income than other types of U.S. Government securities;
however, U.S. Treasury bills, notes and bonds typically provide a higher
potential for capital appreciation than mortgage backed securities.
Payments of principal and interest on mortgage backed securities are
made more frequently than are payments on conventional debt securities. In
addition, holders of mortgage backed securities may receive unscheduled
payments of principal at any time representing prepayments on the underlying
mortgage loans or financial assets. Such prepayments may usually be made by
the related obligor without penalty. Prepayment rates are affected by changes
in prevailing interest rates and numerous other economic, geographic, social
and other factors. Changes in the rate of prepayments will generally affect
the yield to maturity of the security. Moreover, when the holder of the
security attempts to reinvest prepayments or even the scheduled payments of
principal and interest, it may receive a rate of interest which is higher or
lower than the rate on the mortgage backed securities originally held. To the
extent that mortgage backed securities are purchased at a premium, mortgage
foreclosures and principal prepayments may result in a loss to the extent of
the premium paid. If such securities are bought at a discount, both scheduled
payments of principal and unscheduled prepayments will increase current and
total returns and will accelerate the recognition of income which, when
distributed to shareholders, will be taxable as ordinary income.
Derivatives
The Fund may use instruments referred to as Derivatives. Derivatives
are financial instruments the value of which is derived from another security,
a commodity (such as gold or oil) or an index (a measure of value or rates,
such as the Standard & Poor's 500 Index or the prime lending rate).
Derivatives allow the Fund to increase or
5
decrease the level of risk to which the Fund is exposed more quickly and
efficiently than transactions in other types of instruments. The Fund may use
Derivatives for hedging purposes or to seek to increase total returns.
Hedging. Hedging is a strategy in which a Derivative is used to
offset the risks associated with other Fund holdings. Losses on the other
investment may be substantially reduced by gains on a Derivative that reacts
in an opposite manner to market movements. While hedging can reduce losses, it
can also reduce or eliminate gains or cause losses if the market moves in a
different manner than anticipated by the Fund or if the cost of the Derivative
outweighs the benefit of the hedge. Hedging also involves the risk that
changes in the value of the Derivative will not match those of the holdings
being hedged as expected by the Fund, in which case any losses on the holdings
being hedged may not be reduced.
The types of derivative instruments and trading strategies the Fund
may use include the following:
Options and Futures Portfolio Strategies
The Fund may seek to increase its return through the use of options
on the underlying securities and may hedge all or a portion of its portfolio
investments against fluctuations in interest rates through the use of options,
interest rate futures and options on interest rate futures. While the Fund's
use of hedging strategies is intended to reduce the volatility of the net
asset value of Fund shares, the Fund's net asset value will fluctuate. The
Fund may only engage in hedging activities from time to time and may not
necessarily be engaging in hedging activities when movements in interest rates
occur. There can be no assurance that the Fund's hedging transactions will be
effective.
The Fund is authorized to use certain strategies involving options
and futures. Such instruments, which may be regarded as derivatives, are
referred to collectively herein as "Strategic Instruments."
Options on Securities and Securities Indices. The Fund may invest in
options on individual securities, baskets of securities or particular
measurements of value or rate (an "index"), such as an index of the price of
treasury securities or an index representative of short term interest rates.
Purchasing Options. The Fund is authorized to purchase put options on
securities held in its portfolio or securities indices the performance of
which is substantially correlated to securities held in its portfolio. When
the Fund purchases a put option, in consideration for an upfront payment (the
"option premium") the Fund acquires a right to sell to another party specified
securities owned by the Fund at a specified price (the "exercise price") on or
before a specified date (the "expiration date"), in the case of an option on
securities, or to receive from another party a payment based on the amount a
specified securities index declines below a specified level on or before the
expiration date, in the case of an option on a securities index. The purchase
of a put option limits the Fund's risk of loss in the event of a decline in
the market value of the portfolio holdings underlying the put option prior to
the option's expiration date. If the market value of the portfolio holdings
associated with the put option increases rather than decreases, however, the
Fund will lose the option premium and will consequently realize a lower return
on the portfolio holdings than would have been realized without the purchase
of the put.
The Fund is also authorized to purchase call options on securities it
intends to purchase or securities indices the performance of which
substantially correlates with the performance of the types of securities it
intends to purchase. When the Fund purchases a call option, in consideration
for the option premium the Fund acquires a right to purchase from another
party specified securities at the exercise price on or before the expiration
date, in the case of an option on securities, or to receive from another party
a payment based on the amount a specified securities index increases beyond a
specified level on or before the expiration date, in the case of an option on
a securities index. The purchase of a call option may protect the Fund from
having to pay more for a security as a consequence of increases in the market
value for the security during a period when the Fund is contemplating its
purchase, in the case of an option on a security, or. attempting to identify
specific securities in which to invest in a market the Fund believes to be
attractive, in the case of an option on an index (an "anticipatory hedge"). In
the event the Fund determines not to purchase a security underlying a call
option, however, the Fund may lose the entire option premium.
6
The Fund is also authorized to purchase put or call options in
connection with closing out put or call options it has previously sold.
Writing Options. The Fund is authorized to write (i.e., sell) call
options on securities held in its portfolio or securities indices the
performance of which is substantially correlated with securities held in its
portfolio. When the Fund writes a call option, in return for an option premium
the Fund gives another party the right to buy specified securities owned by
the Fund at the exercise price on or before the expiration date, in the case
of an option on securities, or agrees to pay to another party an amount based
on any gain in a specified securities index beyond a specified level on or
before the expiration date, in the case of an option on a securities index.
The Fund may write call options to earn income, through the receipt of option
premiums. In the event the party to which the Fund has written an option fails
to exercise its rights under the option because the value of the underlying
securities is less than the exercise price, the Fund will partially offset any
decline in the value of the underlying securities through the receipt of the
option premium. By writing a call option, however, the Fund limits its ability
to sell the underlying securities, and gives up the opportunity to profit from
any increase in the value of the underlying securities beyond the exercise
price, while the option remains outstanding.
The Fund may also write put options on securities or securities
indices. When the Fund writes a put option, in return for an option premium
the Fund gives another party the right to sell to the Fund a specified
security at the exercise price on or before the expiration date, in the case
of an option on a security, or agrees to pay to another party an amount based
on any decline in a specified securities index below a specified level on or
before the expiration date, in the case of an option on a securities index.
The Fund may write put options to earn income, through the receipt of option
premiums. In the event the party to which the Fund has written an option fails
to exercise its rights under the option because the value of the underlying
securities is greater than the exercise price, the Fund will profit by the
amount of the option premium. By writing a put option, however, the Fund will
be obligated to purchase the underlying security at a price that may be higher
than the market value of the security at the time of exercise as long as the
put option is outstanding, in the case of an option on a security, or make a
cash payment reflecting any decline in the index, in the case of an option on
an index. Accordingly, when the Fund writes a put option it is exposed to a
risk of loss in the event the value of the underlying securities falls below
the exercise price, which loss potentially may substantially exceed the amount
of option premium received by the Fund for writing the put option. The Fund
will write a put option on a security or a securities index only if the Fund
would be willing to purchase the security at the exercise price for investment
purposes (in the case of an option on a security) or is writing the put in
connection with trading strategies involving combinations of options -- for
example, the sale and purchase of options with identical expiration dates on
the same security or index but different exercise prices (a technique called a
"spread").
The Fund is also authorized to sell call or put options in connection
with closing out call or put options it has previously purchased.
Other than with respect to closing transactions, the Fund will only
write call or put options that are "covered." A put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options and Futures" below. A call option
will be considered covered if the Fund owns the securities it would be
required to deliver upon exercise of the option (or, in the case of option on
a securities index, securities which substantially replicate the performance
of such index) or owns a call option, warrant or convertible instrument which
is immediately exercisable for, or convertible into, such security.
Options on GNMA Certificates. The following information relates to
unique characteristics of options on GNMA Certificates. Since the remaining
principal balance of GNMA Certificates declines each month as a result of
mortgage payments, the Fund, as a writer of a GNMA call holding GNMA
Certificates as "cover" to satisfy its delivery obligation in the event of
exercise, may find that the GNMA Certificates it holds no longer have a
sufficient remaining principal balance for this purpose. Should this occur,
the Fund will purchase additional GNMA Certificates from the same pool (if
obtainable) or other GNMA Certificates in the cash market in order to maintain
its "cover."
A GNMA Certificate held by the Fund to cover an option position in
any but the nearest expiration month may cease to represent cover for the
option in the event of a decline in the GNMA coupon rate at which new pools
are originated under the FHA/ VA loan ceiling in effect at any given time. If
this should occur, the Fund will no
7
longer be covered, and the Fund will either enter into a closing purchase
transaction or replace such Certificate with a certificate which represents
cover. When the Fund closes its position or replaces such Certificate, it may
realize an unanticipated loss and incur transaction costs.
Types of Options. The Fund may engage in transactions in options on
securities or securities indices on exchanges and in the over the counter
("OTC") markets. In general, exchange traded options have standardized
exercise prices and expiration dates and require the parties to post margin
against their obligations, and the performance of the parties' obligations in
connection with such options is guaranteed by the exchange or a related
clearing corporation. OTC options have more flexible terms negotiated between
the buyer and the seller, but generally do not require the parties to post
margin and are subject to greater risk of counterparty default. See
"Additional Risk Factors of OTC Transactions" below.
Futures. The Fund may engage in transactions in futures and options
thereon. Futures are standardized, exchange traded contracts which obligate a
purchaser to take delivery, and a seller to make delivery, of a specific
amount of a commodity at a specified future date at a specified price. No
price is paid upon entering into a futures contract. Rather, upon purchasing
or selling a futures contract the Fund is required to deposit collateral
("margin") equal to a percentage (generally less than 10%) of the contract
value. Each day thereafter until the futures position is closed, the Fund will
pay additional margin representing any loss experienced as a result of the
futures position the prior day or be entitled to a payment representing any
profit experienced as a result of the futures position the prior day.
The sale of a futures contract limits the Fund's risk of loss through
a decline in the market value of portfolio holdings correlated with the
futures contract prior to the futures contract's expiration date. In the event
the market value of the portfolio holdings correlated with the futures
contract increases rather than decreases, however, the Fund will realize a
loss on the futures position and a lower return on the portfolio holdings than
would have been realized without the purchase of the futures contract.
The purchase of a futures contract may protect the Fund from having
to pay more for securities as a consequence of increases in the market value
for such securities during a period when the Fund was attempting to identify
specific securities in which to invest in a market the Fund believes to be
attractive. In the event that such securities decline in value or the Fund
determines not to complete an anticipatory hedge transaction relating to a
futures contract, however, the Fund may realize a loss relating to the futures
position.
In order to comply with current applicable regulations of the
Commodity Futures Trading Commission ("CFTC") pursuant to which the Fund
avoids being deemed a "commodity pool operator", the Fund is limited in its
futures trading activities to positions which constitute "bona fide hedging"
positions within the meaning and intent of applicable CFTC rules, or to
non-hedging positions for which the aggregate initial margin and premiums will
not exceed 5% of the liquidation value of the Fund's assets.
Risk Factors in Options and Futures. Use of Strategic Instruments for
hedging purposes involves the risk of imperfect correlation in movements in
the value of the Strategic Instruments and the value of the instruments being
hedged. If the value of the Strategic Instruments moves more or less than the
value of the hedged instruments the Fund will experience a gain or loss which
will not be completely offset by movements in the value of the hedged
instruments.
The Fund intends to enter into transactions involving Strategic
Instruments only if there appears to be a liquid secondary market for such
instruments or, in the case of illiquid instruments traded in OTC
transactions, such instruments satisfy the criteria set forth below under
"Additional Risk Factors of OTC Transactions." However, there can be no
assurance that, at any specific time, either a liquid secondary market will
exist for a Strategic Instrument or the Fund will otherwise be able to sell
such instrument at an acceptable price. It may therefore not be possible to
close a position in a Strategic Instrument without incurring substantial
losses, if at all.
Certain transactions in Strategic Instruments (e.g., futures
transactions, sales of put options) and other types of transactions in which
the Fund may engage (e.g., delayed delivery transactions, discussed below) may
expose the Fund to potential losses which exceed the amount originally
invested by the Fund in such instruments. When the Fund engages in such a
transaction, the Fund will deposit in a segregated account at its custodian
liquid securities
8
with a value at least equal to the Fund's exposure, on a mark-to-market basis,
to the transaction (as calculated pursuant to requirements of the Commission).
Such segregation will ensure that the Fund has assets available to satisfy its
obligations with respect to the transaction, but will not limit the Fund's
exposure to loss.
Additional Risk Factors of OTC Transactions; Limitations on the Use
of OTC Strategic Instruments. Certain Strategic Instruments traded in OTC
markets, including OTC options, may be substantially less liquid than other
instruments in which the Fund may invest. The absence of liquidity may make it
difficult or impossible for the Fund to sell such instruments promptly at an
acceptable price. The absence of liquidity may also make it more difficult for
the Fund to ascertain a market value for such instruments. The Fund will
therefore acquire illiquid OTC instruments (i) if the agreement pursuant to
which the instrument is purchased contains a formula price at which the
instrument may be terminated or sold, or (ii) for which the Manager
anticipates the Fund can receive on each business day at least two independent
bids or offers, unless a quotation from only one dealer is available, in which
case that dealer's quotation may be used.
The staff of the Securities and Exchange Commission has taken the
position that purchased OTC options and the assets underlying written OTC
options are illiquid securities. The Fund has therefore adopted an investment
policy pursuant to which it will not purchase or sell OTC options (including
OTC options on futures contracts) if, as a result of such transactions, the
sum of the market value of OTC options currently outstanding which are held by
the Fund, the market value of the securities underlying OTC call options
currently outstanding which have been sold by the Fund and margin deposits on
the Fund's outstanding OTC options exceeds 15% of the net assets of the Fund,
taken at market value, together with all other assets of the Fund which are
deemed to be illiquid or are otherwise not readily marketable. However, if an
OTC option is sold by the Fund to a dealer in U.S. government securities
recognized as a "primary dealer" by the Federal Reserve Bank of New York and
the Fund has the unconditional contractual right to repurchase such OTC option
at a predetermined price, then the Fund will treat as illiquid such amount of
the underlying securities as is equal to the repurchase price less the amount
by which the option is "in-the-money" (i.e., current market value of the
underlying security minus the option's exercise price).
Because Strategic Instruments traded in OTC markets are not
guaranteed by an exchange or clearing corporation and generally do not require
payment of margin, to the extent that the Fund has unrealized gains in such
instruments or has deposited collateral with its counterparty the Fund is at
risk that its counterparty will become bankrupt or otherwise fail to honor its
obligations. The Fund will attempt to minimize the risk that a counterparty
will become bankrupt or otherwise fail to honor its obligations by engaging in
transactions in Strategic Instruments traded in OTC markets only with
financial institutions which have substantial capital or which have provided
the Fund with a third party guaranty or other credit enhancement.
Additional Limitations on the Use of Strategic Instruments. The Fund
may not use any Strategic Instrument to gain exposure to an asset or type or
class of assets that it would be prohibited by its investment restrictions
from purchasing directly.
Interest Rate Swaps, Caps and Floors
The Fund may enter into interest rate swaps, which are OTC contracts
in which each party agrees to make a periodic payment based on an index or the
value of an asset in return for a periodic payment from the other party based
on a different index or asset.
In order to hedge the value of the Fund's portfolio against interest
rate fluctuations or to enhance the Fund's income, the Fund may enter into
various transactions, such as interest rate swaps and the purchase or sale of
interest rate caps and floors. The Fund expects to enter into these
transactions primarily to preserve a return or spread on a particular
investment or portion of its portfolio or to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date. The
Fund intends to use these transactions primarily as a hedge and not as a
speculative investment. However, the Fund may also invest in interest rate
swaps to enhance income or to increase. the Fund's yield during periods of
steep interest rate yield curves (i.e., wide differences between short term
and long term interest rates).
The Fund usually will enter into interest rate swap transactions on a
net basis, i.e., the two payment streams are netted out, with the Fund
receiving or paying, as the case may be, only the net amount of the two
payments.
9
Inasmuch as these transactions are entered into for good faith
hedging purposes, the Investment Adviser believes that such obligations do not
constitute senior securities and, accordingly, will not treat them as being
subject to its borrowing restrictions. The net amount of the excess, if any,
of the Fund's obligations over its entitlements with respect to each interest
rate swap will be accrued on a daily basis, and an amount of cash or liquid
securities having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian. If
the interest rate swap transaction is entered into on other than a net basis,
the full amount of the Fund's obligations will be accrued on a daily basis,
and the full amount of the Fund's obligations will be maintained in a
segregated account by the Fund's custodian.
In an interest rate swap, the Fund exchanges with another party their
respective commitments to pay or receive interest, e.g., an exchange of fixed
rate payments for floating rate payments. For example, if the Fund holds a
mortgage backed security with an interest rate that is reset only once each
year, it may swap the right to receive interest at this fixed rate for the
right to receive interest at a rate that is reset every week. This would
enable the Fund to offset a decline in the value of the mortgage backed
security due to rising interest rates but would also limit its ability to
benefit from falling interest rates. Conversely, if the Fund holds a mortgage
backed security with an interest rate that is reset every week and it would
like to lock in what it believes to be a high interest rate for one year, it
may swap the right to receive interest at this variable weekly rate for the
right to receive interest at a rate that is fixed for one year. Such a swap
would protect the Fund from a reduction in yield due to falling interest rates
and may permit the Fund to enhance its income through the positive
differential between one week and one year interest rates, but would preclude
it from taking full advantage of rising interest rates.
The Fund also may engage in interest rate transactions in the form of
purchasing or selling interest rate caps or floors. The purchase of an
interest rate cap entitles the purchaser, to the extent that a specified index
exceeds a predetermined interest rate, to receive payments of interest on a
notional principal amount from the party selling such interest rate cap. The
purchase of an interest rate floor entitles the purchaser, to the extent that
a specified index falls below a predetermined interest rate, to receive
payments of interest on a notional principal amount from the party selling
such interest rate floor.
Typically the parties with which the Fund will enter into interest
rate transactions will be broker-dealers and other financial institutions. The
Fund will enter into interest rate swap, cap or floor transactions only with
counterparties that are rated investment grade quality by at least one
nationally recognized statistical rating organization at the time of entering
into such transaction or whose creditworthiness is believed by the Investment
Adviser to be equivalent to such rating. If there is a default by the other
party to such a transaction, the Fund will have contractual remedies pursuant
to the agreements related to the transaction. The swap market has grown
substantially in recent years with a large number of banks and investment
banking firms acting both as principals and as agents utilizing standardized
swap documentation. As a result, the swap market has become relatively liquid
in comparison with other similar instruments traded in the interbank market.
Caps and floors, however, are less liquid than swaps. Certain Federal income
tax requirements may limit the Fund's ability to engage in certain interest
rate transactions. Gains from transactions in interest rate swaps distributed
to shareholders will be taxable as ordinary income or, in certain
circumstances, as long term capital gains to shareholders.
Credit Default Swap Agreements
The Fund may enter into credit default swap agreements. The "buyer"
in a credit default contract is obligated to pay the "seller" a periodic
stream of payments over the term of the contract provided that no credit event
with respect to an underlying reference obligation has occurred. Generally a
credit event means bankruptcy, failure to pay, obligation acceleration or
modified restructuring. If a credit event occurs, the seller typically must
pay the buyer the "par value" (full notional value) of the reference
obligation in exchange for the reference obligation. The Fund may be either
the buyer or seller in the transaction. If the Fund is a buyer and no credit
event occurs, the Fund loses its investment and recovers nothing. However, if
a credit event occurs, the buyer receives full notional value for a reference
obligation that may have little or no value. As a seller, the Fund receives a
fixed rate of income throughout the term of the contract, which typically is
between one month and five years, provided that no credit event occurs. If a
credit event occurs, the seller must pay the buyer the full notional value of
the reference obligation.
10
Credit default swaps involve greater risks than if the Fund had
invested in the reference obligation directly. In addition to general market
risks, credit default swaps are subject to illiquidity risk, counterparty risk
and credit risks. The Fund will enter into swap agreements only with
counterparties who are rated investment grade quality by at least one
nationally recognized statistical rating organization at the time of entering
into such transaction or whose creditworthiness is believed by the Manager to
be equivalent to such rating. A buyer also will lose its investment and
recover nothing should no credit event occur. If a credit event were to occur,
the value of the reference obligation received by the seller, coupled with the
periodic payments previously received, may be less than the full notional
value it pays to the buyer, resulting in a loss of value to the Fund.
The Fund will only be a buyer of a credit default swap if it owns the
reference obligation. If the Fund is a seller of a credit default swap, it
will maintain an amount of cash or liquid instruments having an aggregate net
asset value at least equal to the full notional value of the reference
obligation in a segregated account with the Fund's custodian. The value of
these assets will be monitored daily to ensure that their marked to market
value at all times will exceed the corresponding obligation of the Fund.
Indexed and Inverse Floating Rate Securities
The Fund may invest in securities whose potential returns are
directly related to changes in an underlying index or interest rate, known as
indexed securities. The return on indexed securities will rise when the
underlying index or interest rate rises and fall when the index or interest
rate falls. The Fund may also invest in securities whose return is inversely
related to changes in an interest rate ("inverse floaters"). In general,
inverse floaters change in value in a manner that is opposite to most bonds --
that is, interest rates on inverse floaters will decrease when short-term
rates increase and increase when short-term rates decrease. Investments in
indexed securities and inverse floaters may subject the Fund to the risk of
reduced or eliminated interest payments. Investments in indexed securities
also may subject the Fund to loss of principal. In addition, certain indexed
securities and inverse floaters may increase or decrease in value at a greater
rate than the underlying interest rate, which effectively leverages the Fund's
investment. As a result, the market value of such securities will generally be
more volatile than that of fixed rate securities. Both indexed securities and
inverse floaters can be derivative securities and can be considered
speculative.
Other Investment Practices
When Issued Securities and Delayed Delivery Transactions. The Fund
may purchase U.S. Government securities on a when issued basis, and it may
purchase or sell U.S. Government securities for delayed delivery. These
transactions occur when securities are purchased or sold by the Fund with
payment and delivery taking place in the future to secure what is considered
an advantageous yield and price to the Fund at the time of entering into the
transaction.
Stripped Mortgage Backed Securities. The Fund may invest in stripped
mortgage backed securities ("SMBSs") issued by agencies or instrumentalities
of the United States. SMBSs are derivative multiclass mortgage backed
securities. SMBS arrangements commonly involve two classes of securities that
receive different proportions of the interest and principal distributions on a
pool of mortgage assets. A common variety of SMBS is where one class (the
principal only or PO class) receives some of the interest and most of the
principal from the underlying assets, while the other class (the interest only
or IO class) receives most of the interest and the remainder of the principal.
In the most extreme case, the IO class receives all of the interest, while the
PO class receives all of the principal. While the Fund may purchase securities
of a PO class, it is more likely to purchase the securities of an IO class.
The yield to maturity of an IO class is extremely sensitive to the rate of
principal payments (including prepayments) on the related underlying assets,
and a rapid rate of principal payments in excess of that considered in pricing
the securities will have a material adverse effect on an IO security's yield
to maturity. If the underlying mortgage assets experience greater than
anticipated payments of principal, the Fund may fail to recoup fully its
initial investment in IOs. In addition, there are certain types of IOs which
represent the interest portion of a particular class as opposed to the
interest portion of the entire pool. The sensitivity of this type of IO to
interest rate fluctuations may be increased because of the characteristics of
the principal portion to which they relate. As a result of the above factors,
the Fund generally will purchase IOs only as a component of so called
"synthetic" securities. This means that purchases of IOs will be matched with
certain purchases of other securities, such as POs, inverse floating rate CMOs
or fixed rate securities; as interest rates fall, presenting a greater risk of
unanticipated
11
prepayments of principal, the negative effect on the Fund because of its
holdings of IOs should be diminished somewhat because of the increased yield
on the inverse floating rate CMOs or the increased appreciation on the POs or
fixed rate securities. IOs and POs are considered by the staff of the
Securities and Exchange Commission to be illiquid securities and,
consequently, the Fund will not invest in IOs or POs in an amount which, taken
together with the Fund's other investments in illiquid securities, exceeds 15%
of the Fund's net assets.
Short Sales. The Fund may from time to time make short sales. These
transactions will involve either short sales of securities retained in the
Fund's portfolio or securities which it has the right to acquire without the
payment of further consideration (a short sale "against the box").
Repurchase Agreements. The Fund may invest in U.S. Government
securities pursuant to repurchase agreements. Repurchase agreements may be
entered into only with a member bank of the Federal Reserve System or primary
dealer in U.S. Government securities or an affiliate thereof. Under such
agreements, the seller agrees, upon entering into the contract, to repurchase
the security at a mutually agreed upon time and price, thereby determining the
yield during the term of the agreement. This results in a fixed rate of return
insulated from market fluctuations during such period. The Fund may not invest
in repurchase agreements maturing in more than seven days if, as a result,
more than 15% of the Fund's net assets would be invested in illiquid
securities, including such repurchase agreements. In the event of default by
the seller under a repurchase agreement, the Fund may suffer time delays and
incur costs or possible losses in connection with the disposal of the
collateral.
Securities Lending. The Fund may lend portfolio securities, with a
value not in excess of 33 1/3% of its total assets, to brokers, dealers and
financial institutions and receive collateral in cash or U.S. Government
securities which will be maintained at all times in an amount equal to at
least 100% of the current market value of the loaned securities. Where the
Fund receives securities as collateral for the loaned securities, the Fund
typically receives the income on both the loaned securities and the collateral
and, as a result, the Fund's yield may increase. 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. The Fund may receive a
flat fee for its loans. 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 otherwise, 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. The Fund has received an exemptive
order from the Commission permitting it to lend portfolio securities to
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") or its
affiliates and to retain an affiliate of the Fund as lending agent. See
"Portfolio Transactions and Brokerage."
Borrowing of Money. Except to the extent permitted by the Fund's
investment policies as set forth in its Prospectus and Statement of Additional
Information, the Fund may not borrow money to purchase portfolio securities.
However, the Fund may borrow from banks as a temporary measure for
extraordinary or emergency purposes or to meet redemptions in amounts not
exceeding 10% (taken at market value) of its total assets and pledge its
assets to secure such borrowings. The Fund will not purchase portfolio
securities while any borrowings are outstanding.
Suitability
The economic benefit of an investment in the Fund depends upon many
factors beyond the control of the Fund, the Manager and its affiliates.
Because of its emphasis on U.S. Government mortgage securities, the Fund
should be considered a vehicle for diversification and not as a balanced
investment program. The suitability for any particular investor of a purchase
of shares in the Fund will depend upon, among other things, such investor's
investment objectives and such investor's ability to accept the risks
associated with investing in U.S. Government mortgage securities, including
the risk of loss of principal.
12
Investment Restrictions
The Fund has adopted the following restrictions and policies relating
to the investment of its assets and its activities, which are fundamental
policies and may not be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities (which for this purpose
and under the Investment Company Act means the lesser of (i) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares are
represented or (ii) more than 50% of the outstanding shares). The Fund may
not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act of 1940, as
amended (the "Investment Company Act").
2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).
3. Make investments for the purpose of exercising control or management.
4. Purchase or sell real estate, except that, to the extent permitted by
applicable law, the Fund may invest in securities directly or
indirectly secured by real estate or interests therein or issued by
companies which invest in real estate or interests therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in
government obligations, commercial paper, pass through instruments,
certificates of deposit, bankers acceptances, repurchase agreements or
any similar instruments shall not be deemed to be the making of a loan,
and except further that the Fund may lend its portfolio securities,
provided that the lending of portfolio securities may be made only in
accordance with applicable law and the guidelines set forth in the
Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of
its total assets (including the amount borrowed), (ii) the Fund may,
to the extent permitted by applicable law, borrow up to an
additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv)
the Fund may purchase securities on margin to the extent permitted
by applicable law. The Fund may not pledge its assets other than to
secure such borrowings or, to the extent permitted by the Fund's
investment policies as set forth in its Prospectus and Statement of
Additional Information, as they may be amended from time to time, in
connection with hedging transactions, short sales, when issued and
forward commitment transactions and similar investment strategies.
8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of
1933, as amended (the "Securities Act") in selling portfolio
securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law
and the Fund's Prospectus and Statement of Additional Information, as
they may be amended from time to time, and without registering as a
commodity pool operator under the Commodity Exchange Act.
Under the Fund's non-fundamental investment restrictions, which may
be changed by the Board of Trustees without shareholder approval, the Fund may
not:
a. Purchase securities of other investment companies, except to the extent
such purchases are permitted by applicable law. As a matter of policy,
however, the Fund will not purchase shares of any registered open end
investment company or registered unit investment trust, in reliance on Section
12(d)(1)(F) or (G) (the "fund of
13
funds" provisions) of the Investment Company Act at any time the Fund's shares
are owned by another investment company that is part of the same group of
investment companies as the Fund.
b. Make short sales of securities or maintain a short position, except to
the extent permitted by applicable law. The Fund currently does not intend to
engage in short sales, except short sales "against the box."
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed or
put to the issuer or a third party, if at the time of acquisition more than
15% of its total assets taken at market value would be invested in such
securities. This restriction shall not apply to securities which mature within
seven days or securities which the Board of Trustees of the Fund has otherwise
determined to be liquid pursuant to applicable law. Securities purchased in
accordance with Rule 144A under the Securities Act (each, a "Rule 144A
security") and determined to be liquid by the Fund's Board of Trustees are not
subject to the limitations set forth in this investment restriction.
d. Notwithstanding fundamental investment restriction (7) above, borrow
money or pledge its assets except that the Fund may borrow from a bank as a
temporary measure for extraordinary or emergency purposes or to meet
redemptions in amounts not exceeding 10% (taken at the market value) of its
total assets and pledge its assets to secure such borrowings. (For the purpose
of this restriction, collateral arrangements with respect to the writing of
options, interest rate futures contracts, options on interest rate futures
contracts, and collateral arrangements with respect to initial and variation
margin are not deemed to be a pledge of assets and neither such arrangements
nor the purchase or sale of futures or related options are deemed to be the
issuance of a senior security.)
e. Change its investment policy that, under normal circumstances, the
Fund will invest at least 80% of its total assets in U.S. Government mortgage
securities. unless the Fund provides its shareholders with at least 60 days'
prior written notice of such change.
The staff of the Commission has taken the position that purchased
over-the-counter ("OTC") options and the assets used as cover for written OTC
options are illiquid securities to the extent set forth under "Investment
Objective and Policies -- Options and Futures Portfolio Strategies" in this
Statement of Additional Information.
Because of the affiliation of the Manager with the Fund, the Fund is
prohibited from engaging in certain transactions involving the Manager's
affiliate, Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill
Lynch") or its affiliates except for brokerage transactions permitted under
the Investment Company Act involving only usual and customary commissions or
transactions pursuant to an exemptive order under the Investment Company Act.
See "Portfolio Transactions". Without such an exemptive order, the Fund is
prohibited from engaging in portfolio transactions with Merrill Lynch or its
affiliates acting as principal and from purchasing securities in public
offerings which are not registered under the Securities Act of 1933 in which
such firm or any of its affiliates participate as an underwriter or dealer.
The Trustees have established the policy that the Fund will not
purchase or retain the securities of any issuer, if those individual officers,
directors and Trustees of the Fund, Merrill Lynch Investment Managers, L.P.
("MLIM") or any affiliate thereof each owning beneficially more than one-half
of 1% of the securities of such issuer own in the aggregate more than 5% of
the securities of such issuer. Portfolio securities of the Fund may not be
purchased from, sold or loaned to the Manager or its affiliates or any of
their directors, general partners, officers or employees, acting as principal.
The Fund has adopted a policy pursuant to which it will not write any
covered put options on U.S. Government securities if as a result the Fund
would then have more than 50% of its total assets (taken at market value)
subject to being invested upon the exercise of put options. This policy may be
amended without the approval of the Fund's shareholders.
Portfolio Turnover
The Manager will effect portfolio transactions without regard to the
time the securities have been held, if, in its judgment, such transactions are
advisable in light of a change in circumstances of a particular company or
14
within a particular industry or in general market, financial or economic
conditions. As a result of its investment policies, under certain market
conditions the Fund's portfolio turnover rate may be higher than that of other
investment companies; however, it is extremely difficult to predict portfolio
rates with any degree of accuracy. A high portfolio turnover may result in
negative tax consequences, such as an increase in capital gain dividends or in
ordinary income dividends of accrued market discount. See "Dividends and Taxes
- -- Taxes." High portfolio turnover may also involve correspondingly greater
transaction costs in the form of dealer spreads and brokerage commissions,
which are borne directly by the Fund. The Fund's portfolio turnover increased
to 199.30% for the fiscal year ended August 31, 2001 from 37.28% for the
fiscal year ended August 31, 2000, largely due to a significant increase in
mortgage refinancings that resulted from declining interest rates.
MANAGEMENT OF THE FUND.
Trustees and Officers
The Trustees of the Fund consist of five individuals, four of whom
are not "interested persons" of the Fund as defined in the Investment Company
Act (the "non-interested Trustees"). The Trustees are responsible for the
overall supervision of the operations of the Fund and perform the various
duties imposed on the trustees of investment companies by the Investment
Company Act. Information about the Trustees, executive officers and the
portfolio managers of the Fund, including their ages and their principal
occupations for at least the last five years, is set forth below. Unless
otherwise noted, the address of each Trustee, executive officer and the
portfolio manager is P.O. Box 9011, Princeton, New Jersey 08543-9011.
TERRY K. GLENN (61) -- President and Trustee(1)(2) -- Chairman
(Americas Region) of Merrill Lynch Investment Managers, L.P. ("MLIM") since
2001. Executive Vice President of the Manager and MLIM (which terms as used
herein include their corporate predecessors) since 1983; President of Merrill
Lynch Mutual Funds since 1999; President of FAM Distributors, Inc. ("FAMD")
since 1986 and Director thereof since 1991; Executive Vice President and
Director of Princeton Services, Inc. ("Princeton Services") since 1993;
President of Princeton Administrators, L.P. since 1988; Director of Financial
Data Services, Inc. ("FDS") since 1985.
JOE GRILLS (66) -- Trustee(2)(3) -- P.O. Box 98, Rapidan, Virginia
22733. Member of the Committee of Investment of Employee Benefit Assets of the
Association of Financial Professionals ("CIEBA") since 1986; Member of CIEBA's
Executive Committee since 1988 and its Chairman from 1991 to 1993; Assistant
Treasurer of International Business Machines Incorporated ("IBM") and Chief
Investment Officer of IBM Retirement Funds from 1986 until 1993; Member of the
Investment Advisory Committee of the State of New York Common Retirement Fund
since 1989; Member of the Investment Advisory Committee of the Howard Hughes
Medical Institute from 1997 to 2000; Director, Duke Management Company since
1992 and Vice Chairman since 1998; Director, LaSalle Street Fund from 1995 to
2001; Director, Kimco Realty Corporation since January 1997; Member of the
Investment Advisory Committee of the Virginia Retirement System since 1998;
Director, Montpelier Foundation since 1998 and its Vice Chairman since 2000;
Member of the Investment Committee of the Woodberry Forest School since 2000;
Member of the Investment Committee of the National Trust for Historic
Preservation since 2000.
ROBERT S. SALOMON, JR. (65) -- Trustee(2)(3) -- 106 Dolphin Cove
Quay, Stamford, Connecticut 06902. Principal of STI Management (investment
adviser) since 1994; Trustee, Commonfund from 1980 to 2001; Chairman and CEO
of Salomon Brothers Asset Management from 1992 until 1995; Chairman of Salomon
Brothers equity mutual funds from 1992 until 1995; regular columnist with
Forbes magazine since 1992; Director of Stock Research and U.S. Equity
Strategist at Salomon Brothers from 1975 until 1991.
MELVIN R. SEIDEN (71) -- Trustee(2)(3) -- 780 Third Avenue, Suite 2502,
New York, New York 10017. Director of Silbanc Properties, Ltd. (real estate,
investment and consulting) since 1987; Chairman and President of Seiden & de
Cuevas, Inc. (private investment firm) from 1964 to 1987.
STEPHEN B. SWENSRUD (68) -- Trustee(2)(3) -- 88 Broad Street, 2nd
floor, Boston, Massachusetts 02110. Chairman of Fernwood Advisors (investment
adviser) since 1996; Principal, Fernwood Associates (financial
15
consultant) since 1975; Chairman of RPP Corporation since 1978; Director of
International Mobile Communications, Inc. since 1998..
JEFFREY B. HEWSON (50) -- Senior Vice President(1)(2) -- Director
(Global Fixed Income) of MLIM since 1998; Vice President of MLIM from 1989 to
1998; Portfolio Manager of MLIM since 1984.
FRANK VIOLA (37) -- Portfolio Manager(1)(2) -- Portfolio Manager of
MLIM since 1997; Treasurer of Merrill Lynch Bank & Trust from 1996 to 1997;
Vice President of Merrill Lynch Capital Markets from 1993 to 1996.
TERESA L. GIACINO (39) -- Portfolio Manager(1)(2) -- Vice President
and Portfolio Manager of MLIM since 1992.
DONALD C. BURKE (41) -- Vice President and Treasurer(1)(2) -- First
Vice President of the Manager and MLIM since 1997 and Treasurer thereof since
1999; Senior Vice President and Treasurer of Princeton Services since 1999;
Vice President of FAMD since 1999; Vice President of MLIM from 1990 to 1997;
Director of Taxation of MLIM since 1990.
PHILLIP S. GILLESPIE (37) -- Secretary(1)(2) -- First Vice President
of MLIM 2001; Director of MLIM from 2000 to 2001; Vice President of MLIM from
1999 to 2000; Attorney associated with MLIM since 1998; Assistant General
Counsel of Chancellor LGT Asset Management Inc. from 1997 to 1998; Senior
Counsel and Attorney in the Division of Investment Management and the Office
of General Counsel at the U.S. Securities and Exchange Commission from 1993 to
1997.
---------------
(1) Interested person, as defined in the Investment Company Act, of the Fund.
(2) Such Trustee or officer is a director, officer or member of certain
other investment companies for which the Manager or MLAM acts as the
investment adviser or manager.
(3) Member of the Fund's Audit and Nominating Committee, which is
responsible for the selection of the independent auditors and the
selection and nomination of non-interested Directors.
As of December 14, 2001, the Trustees and officers of the Fund as a
group (10 persons) owned an aggregate of less than 1% of the outstanding
shares of the Fund. At such date, Mr. Glenn, a Trustee and officer of the
Fund, and the other officers of the Fund owned an aggregate of less than 1% of
the outstanding shares of common stock of Merrill Lynch & Co. ("ML & Co.").
Compensation of Trustees
The Fund pays each non-interested Trustee a fee of $4,000 per year
plus $1,000 per Board meeting attended. The Fund also compensates each member
of the Audit and Nominating Committee (the "Committee"), which consists of the
non-interested Trustees at a rate of $4,000 per year, plus $1,000 per
Committee meeting attended. The Fund reimburses each non-interested Trustee
for his out-of-pocket expenses relating to attendance at Board and Committee
meetings.
The following table shows the compensation earned by the
non-interested Trustees for the fiscal year ended August 31, 2001 and the
aggregate compensation paid to them from all registered investment companies
advised by the Manager and its affiliate, MLIM ("MLIM/ FAM-advised funds"),
for the calendar year ended December 31, 2000.
16
Pension or
Retirement Aggregate
Benefits Estimated Compensation from
Accrued as Part Annual Fund and Other
Position Compensation of Benefits upon MLIM/FAM-
Name with Fund from Fund Fund Expense Retirement Advised Funds (1)
Joe Grills Trustee $15,750 None None $224,500
Robert S. Salomon, Jr. Trustee $15,750 None None $184,000
Melvin R. Seiden Trustee $15,750 None None $184,000
Stephen B. Swensrud Trustee $15,750 None None $280,233
<FN>
(1) The trustees serve on the boards of MLIM/ FAM-advised funds as follows: Joe Grills (20 registered investment companies
consisting of 49 portfolios), Robert S. Salomon, Jr. (16 registered investment companies consisting of 36 portfolios),
Melvin R. Seiden (16 registered investment companies consisting of 36 portfolios), Stephen B. Swensrud (42 registered
investment companies consisting of 87 portfolios).
</FN>
Trustees of the Fund may purchase Class A shares of the Fund at net
asset value. See "Purchase of Shares -- Initial Sales Charge Alternatives --
Class A and Class D Shares -- Reduced Initial Sales Charges -- Purchase
Privilege of Certain Persons."
Management and Advisory Arrangements
Management Services. The Manager provides the Fund with investment
advisory and management services. Subject to the supervision of the Trustees,
the Manager is responsible for the actual management of the Fund's portfolio
and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Manager.
The Manager performs certain of the other administrative services and provides
all the office space, facilities, equipment and necessary personnel for
management of the Fund.
Management Fee. The Fund has entered into a management agreement with
the Manager (the "Management Agreement"), pursuant to which the Manager
receives for its services to the Fund monthly compensation at the following
annual rates.
Portion of average daily value of net assets: Management Fee
Not exceeding $500 million 0.500%
$500 million to $1 billion 0.475%
$1 billion to $1.5 billion 0.450%
$1.5 billion to $2 billion 0.425%
$2 billion to $2.5 billion 0.400%
$2.5 billion to $3.5 billion 0.375%
$3.5 billion to $5 billion 0.350%
$5 billion to $6.5 billion 0.325%
Exceeding $6.5 billion 0.300%
The table below sets forth information about the total management
fees paid by the Fund to the Manager for the periods indicated.
Investment
Fiscal Year Ended August 31, Advisory Fee
2001 $ 6,734,054
2000 $ 6,976,712
1999 $ 8,460,586
Payment of Fund Expenses. The Management Agreement obligates the
Manager to provide investment advisory services and to pay all compensation of
and furnish office space for officers and employees of the Fund connected with
investment and economic research, trading and investment management of the
Fund, as well as the
17
fees of all Trustees of the Fund who are affiliated persons of the Manager.
The Fund pays all other expenses incurred in the operation of the Fund,
including among other things: taxes; expenses for legal and auditing services,
costs of preparing and printing proxies, stock certificates, shareholder
reports, prospectuses and statements of additional information, except to the
extent paid by the Distributor; charges of the custodian and sub-custodian,
and the transfer agent; expenses of redemption of shares; Commission fees;
expenses of registering the shares under Federal, state or foreign laws; fees
and expenses of non-interested Trustees; accounting and pricing costs
(including the daily calculations of net asset value); insurance; interest;
brokerage costs; litigation and other extraordinary or non-recurring expenses;
and other expenses properly payable by the Fund. Certain accounting services
are provided for the Fund by State Street Bank and Trust Company ("State
Street") pursuant to an agreement between State Street and the Fund. The Fund
pays a fee for these services. In addition, the Fund reimburses the Manager
for the cost of other accounting services. The Distributor will pay certain
promotional expenses of the Fund incurred in connection with the offering of
shares of the Fund. Certain expenses will be financed by the Fund pursuant to
distribution plans in compliance with Rule 12b-1 under the Investment Company
Act. See "Purchase of Shares -- Distribution Plans."
Organization of the Manager. The Manager is a limited partnership,
the partners of which are ML & Co., a financial services holding company and
the parent of Merrill Lynch, and Princeton Services. ML & Co. and Princeton
Services are "controlling persons" of the Manager as defined under the
Investment Company Act because of their ownership of its voting securities or
their power to exercise a controlling influence over its management or
policies.
Duration and Termination. Unless earlier terminated as described
herein, the Management Agreement will continue in effect from year to year if
approved annually (a) by the Trustees of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Trustees who are
not parties to such contract or interested persons (as defined in the
Investment Company Act) of any such party. Such contracts are not assignable
and may be terminated without penalty on 60 days' written notice at the option
of either party or by vote of the shareholders of the Fund.
Transfer Agency Services. Financial Data Services, Inc. (the
"Transfer Agent"), a subsidiary of ML & Co., acts as the Fund's Transfer Agent
pursuant to a Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of
shareholder accounts. For the fiscal year ended August 31, 2001, the Transfer
Agency Agreement received a fee of $11.00 per Class A or Class D account and
$14.00 per Class B or Class C account, a fee equal to 0.10% of account assets
for certain accounts that participate in the Merrill Lynch Mutual Fund Advisor
(Merrill Lynch MFASM) Program (the "MFA Program") and was entitled to
reimbursement for certain transaction charges and out-of-pocket expenses
incurred by the Transfer Agent under the Transfer Agency Agreement.
Additionally, a $.20 monthly closed account charge was assessed on all
accounts that closed during the calendar year. The Transfer Agency fee
schedule has been changed and the Fund currently pays between $16.00 and
$20.00 for each Class A or Class D shareholder account and between $19.00 and
$23.00 for each Class B or Class C shareholder account, depending on the level
of service required. The Fund continues to reimburse the Transfer Agent's
reasonable out-of-pocket expenses and to pay a fee of 0.10% of account assets
for certain accounts that participate in the MFA Program but it no longer pays
transaction charges or closed account charges. Application of this fee will
commence the month following the month the account is closed. At the end of
the calendar year, no further fees will be due. For purposes of the Transfer
Agency Agreement, the term "account" includes a shareholder account maintained
directly by the Transfer Agent and any other account representing the
beneficial interest of a person in the relevant share class on a recordkeeping
system, provided the recordkeeping system is maintained by a subsidiary of ML
& Co.
Accounting Services. The Fund entered into an agreement with State
Street effective January 1, 2001, pursuant to which State Street provides
certain accounting services to the Fund. The Fund pays a fee for these
services. Prior to January 1, 2001, the Manager provided accounting services
to the Fund and was reimbursed by the Fund at its cost in connection with such
services. The Manager continues to provide certain accounting services to the
Fund and the Fund reimburses the Manager for the cost of these services.
The table below shows the amounts paid by the Fund to State Street
and to the Manager for the periods indicated:
18
State Street the Manager
Paid to Paid to
Fiscal year ended August 31, State Street The Manager
2001 $ 263,702+ $ 106,729
2000 N/A $ 398,927
1999 N/A $ 328,944
----------------
+Represents payments pursuant to the agreement with State Street commencing
January 1, 2001.
Distribution Expenses. The Fund has entered into a distribution
agreement with the Distributor in connection with the continuous offering of
shares of the Fund (the "Distribution Agreement"). The Distribution Agreement
obligates the Distributor to pay certain expenses in connection with the
offering of each class of shares of the Fund. After the prospectuses,
statements of additional information and periodic reports have been prepared,
set in type and mailed to shareholders, the Distributor pays for the printing
and distribution of copies thereof used in connection with the offering to
dealers and investors. The Distributor also pays for other supplementary sales
literature and advertising costs. The Distribution Agreement is subject to the
same renewal requirements and termination provisions as the Management
Agreement described above.
Code of Ethics
The Board of Trustees of the Fund has approved a Code of Ethics under
Rule 17j-1 of the Investment Company Act that covers the Fund, the Manager and
the Distributor. The Code of Ethics establishes procedures for personal
investing and restricts certain transactions. Employees subject to the Code of
Ethics may invest in securities for their personal investment accounts,
including securities that may be purchased or held by the Fund.
PURCHASE OF SHARES
Reference is made to "Your Account -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund offers four classes of shares under the Merrill Lynch Select
PricingSM System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class
A, Class B, Class C or Class D share of the Fund represents an identical
interest in the investment portfolio of the Fund and has the same rights,
except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees (also known as service fees) and Class B and
Class C shares bear the expenses of the ongoing distribution fees and the
additional incremental transfer agency costs resulting from the deferred sales
charge arrangements. The contingent deferred sales charges ("CDSCs"),
distribution fees and account maintenance fees that are imposed on Class B and
Class C shares, as well as the account maintenance fees that are imposed on
Class D shares, are imposed directly against those classes and not against all
assets of the Fund and, accordingly, such charges do not affect the net asset
value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares are
calculated in the same manner at the same time and differ only to the extent
that account maintenance and distribution fees and any incremental transfer
agency costs relating to a particular class are borne exclusively by that
class. Each class has different exchange privileges. See "Shareholder Services
- -- Exchange Privilege."
Investors should understand that the purpose and function of the
initial sales charges with respect to the Class A and Class D shares are the
same as those of the CDSCs and distribution fees with respect to the Class B
and Class C shares in that the sales charges and distribution fees applicable
to each class provide for the financing of the distribution of the shares of
the Fund. The distribution-related revenues paid with respect to a class will
not be used to finance the distribution expenditures of another class. Sales
personnel may receive different compensation for selling different classes of
shares.
19
The Merrill Lynch Select PricingSM System is used by more than 50
registered investment companies advised by the Manager or MLIM. Funds advised
by the Manager or MLIM that use the Merrill Lynch Select PricingSM System are
referred to herein as "Select Pricing Funds."
The Fund offers its shares at a public offering price equal to the
next determined net asset value per share plus any sales charge applicable to
the class of shares selected by the investor. The applicable offering price
for purchase orders is based upon the net asset value of the Fund next
determined after receipt of the purchase order by the Distributor. As to
purchase orders received by securities dealers or other financial
intermediaries prior to the close of business on the New York Stock Exchange
(the "NYSE") (generally 4:00 p.m., Eastern time) which includes orders
received after the determination of the net asset value on the previous day,
the applicable offering price will be based on the net asset value on the day
the order is placed with the Distributor, provided that the orders are
received by the Distributor prior to 30 minutes after the close of business on
the NYSE on that day. If the purchase orders are not received prior to 30
minutes after the close of business on the NYSE on that day, such orders shall
be deemed received on the next business day. Dealers or other financial
intermediaries have the responsibility of submitting purchase orders to the
Fund not later than 30 minutes after the close of business on the NYSE.
The Fund or the Distributor may suspend the continuous offering of
the Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor.
Neither the Distributor, the securities dealers nor other financial
intermediaries are permitted to withhold placing orders to benefit themselves
by a price change. Certain selected securities dealers or other financial
intermediaries may charge a processing fee to confirm a sale of shares. For
example, the fee currently charged by Merrill Lynch is $5.35. Purchases made
directly through the Transfer Agent are not subject to the processing fee.
Initial Sales Charge Alternatives -- Class A and Class D Shares
Investors who prefer an initial sales charge alternative may elect to
purchase Class D shares or, if an eligible investor, Class A shares. Investors
choosing the initial sales charge alternative who are eligible to purchase
Class A shares should purchase Class A shares rather than Class D shares
because there is an account maintenance fee imposed on Class D shares.
Investors qualifying for significantly reduced initial sales charges may find
the initial sales charge alternative particularly attractive because similar
sales charge reductions are not available with respect to the deferred sales
charges imposed in connection with purchases of Class B or Class C shares.
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also may elect to
purchase Class A or Class D shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charges and, in the case of Class D shares, the
account maintenance fee. Although some investors who previously purchased
Class A shares may no longer be eligible to purchase Class A shares of other
Select Pricing Funds, those previously purchased Class A shares, together with
Class B, Class C and Class D share holdings, will count toward a right of
accumulation which may qualify the investor for a reduced initial sales charge
on new initial sales charge purchases. In addition, the ongoing Class B and
Class C account maintenance and distribution fees will cause Class B and Class
C shares to have higher expense ratios, pay lower dividends and have lower
total returns than the initial sales charge shares. The ongoing Class D
account maintenance fees will cause Class D shares to have a higher expense
ratio, pay lower dividends and have a lower total return than Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children
under the age of 21 years purchasing shares for his, her or their own account
and to single purchases by a trustee or other fiduciary purchasing shares for
a single trust estate or single fiduciary account although more than one
beneficiary is involved. The term "purchase" also includes purchases by any
"company," as that term is defined in the Investment Company Act, but does not
include purchases by any such company that has not been in existence for at
least six months or which has no purpose other than the purchase of shares of
the Fund or shares of other registered investment companies at a discount;
provided, however, that it shall not include purchases by any group of
individuals whose sole organizational nexus is that the participants therein
are credit cardholders of a company, policyholders of an insurance company,
customers of either a bank or broker-dealer or clients of an investment
adviser.
20
Eligible Class A Investors
Class A shares are offered to a limited group of investors and also
will be issued upon reinvestment of dividends on outstanding Class A shares.
Investors who currently own Class A shares in a shareholder account, including
participants in the Merrill Lynch BlueprintSM Program, are entitled to
purchase additional Class A shares of the Fund in that account. Certain
employer-sponsored retirement or savings plans, including eligible 401(k)
plans, may purchase Class A shares at net asset value provided such plans meet
the required minimum number of eligible employees or required amount of assets
advised by the Manager or any of its affiliates. Class A shares are available
at net asset value to corporate warranty insurance reserve fund programs and
U.S. branches of foreign banking institutions provided that the program or
bank has $3 million or more initially invested in Select Pricing Funds. Also
eligible to purchase Class A shares at net asset value are participants in
certain investment programs including TMASM Managed Trusts to which Merrill
Lynch Trust Company provides discretionary trustee services, collective
investment trusts for which Merrill Lynch Trust Company serves as trustee and
certain purchases made in connection with certain fee-based programs. In
addition, Class A shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees and to members of the Boards of
MLIM/ FAM-advised investment companies. Certain persons who acquired shares of
certain MLIM/ FAM-advised closed-end funds in their initial offerings who wish
to reinvest the net proceeds from a sale of their closed-end fund shares of
common stock in shares of the Fund also may purchase Class A shares of the
Fund if certain conditions are met. In addition, Class A shares of the Fund
and certain other Select Pricing Funds are offered at net asset value to
shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. and, if certain
conditions are met, to shareholders of certain MLIM/FAM-advised continuously
offered closed-end funds who wish to reinvest the net proceeds from a sale of
certain of their shares of common stock pursuant to a tender offer conducted
by such funds. See "Purchase of Shares -- Closed-End Reinvestment Options." in
shares of the Fund and certain other Select Pricing Funds.
Class A and Class D Sales Charge Information
Class A Shares
- ---------------------------------------------------------------------------------------------------------------------
Sales Charges Sales Charges CDSCs Received on
For the Fiscal Year Gross Sales Retained by Paid to Received of
Ended August 31, Charges Collected Distributor Merrill Lynch Load-Waived Shares
- ---------------------------------------------------------------------------------------------------------------------
2001 $ 1,877 $ 136 $ 1,741 $ 0
2000 $ 1,055 $ 80 $ 975 $ 0
1999 $ 8,265 $ 1,003 $ 7,262 $ 0
Class D Shares
- ---------------------------------------------------------------------------------------------------------------------
Sales Charges Sales Charges CDSCs Received on
For the Fiscal Year Gross Sales Retained by Paid to Received of
Ended August 31, Charges Collected Distributor Merrill Lynch Load-Waived Shares
- ---------------------------------------------------------------------------------------------------------------------
2001 $239,299 $18,183 $221,116 $31,473
2000 $56,796 $6,634 $50,162 $213
1999 $88,828 $9,300 $79,528 $32,048
The Distributor may reallow discounts to selected securities dealers
and other financial intermediaries and retain the balance over such discounts.
At times the Distributor may reallow the entire sales charge to such dealers.
Since securities dealers and other financial intermediaries selling Class A
and Class D shares of the Fund will receive a concession equal to most of the
sales charge, they may be deemed to be underwriters under the Securities Act.
Reduced Initial Sales Charges
Reductions in or exemptions from the imposition of a sales load are
due to the nature of the investors and/or the reduced sales efforts that will
be needed to obtain such investments.
21
Reinvested Dividends. No initial sales charges are imposed upon Class
A and Class D shares issued as a result of the automatic reinvestment of
dividends.
Right of Accumulation. Reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value
or cost, whichever is higher, of the purchaser's combined holdings of all
classes of shares of the Fund and of any other Select Pricing Funds. For any
such right of accumulation to be made available, the Distributor must be
provided at the time of purchase, by the purchaser or the purchaser's
securities dealer or other financial intermediary, with sufficient information
to permit confirmation of qualification. Acceptance of the purchase order is
subject to such confirmation. The right of accumulation may be amended or
terminated at any time. Shares held in the name of a nominee or custodian
under pension, profit-sharing or other employee benefit plans may not be
combined with other shares to qualify for the right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or
any Select Pricing Funds made within a 13-month period starting with the first
purchase pursuant to a Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit
plans for which Merrill Lynch provides plan participant recordkeeping
services. The Letter of Intent is not a binding obligation to purchase any
amount of Class A or Class D shares; however, its execution will result in the
purchaser paying a lower sales charge at the appropriate quantity purchase
level. A purchase not originally made pursuant to a Letter of Intent may be
included under a subsequent Letter of Intent executed within 90 days of such
purchase if the Distributor is informed in writing of this intent within such
90-day period. The value of Class A and Class D shares of the Fund and of
other Select Pricing Funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, may be included as a credit toward the completion of such Letter, but
the reduced sales charge applicable to the amount covered by such Letter will
be applied only to new purchases. If the total amount of shares does not equal
the amount stated in the Letter of Intent (minimum of $25,000), the investor
will be notified and must pay, within 20 days of the expiration of such
Letter, the difference between the sales charge on the Class A or Class D
shares purchased at the reduced rate and the sales charge applicable to the
shares actually purchased through the Letter. Class A or Class D shares equal
to at least 5.0% of the intended amount will be held in escrow during the
13-month period (while remaining registered in the name of the purchaser) for
this purpose. The first purchase under the Letter of Intent must be at least
5.0% of the dollar amount of such Letter. If a purchase during the term of
such Letter would otherwise be subject to a further reduced sales charge based
on the right of accumulation, the purchaser will be entitled on that purchase
and subsequent purchases to the further reduced percentage sales charge that
would be applicable to a single purchase equal to the total dollar value of
the Class A or Class D shares then being purchased under such Letter, but
there will be no retroactive reduction of the sales charge on any previous
purchase.
The value of any shares redeemed or otherwise disposed of by the
purchaser prior to termination or completion of the Letter of Intent will be
deducted from the total purchases made under such Letter. An exchange from the
Summit Cash Reserves Fund ("Summit"), a series of Financial Institutions
Series Trust, into the Fund that creates a sales charge will count toward
completing a new or existing Letter of Intent from the Fund.
Merrill Lynch BlueprintSM Program. Class D shares of the Fund are
offered to participants in the Merrill Lynch BlueprintSM Program
("Blueprint"). In addition, participants in Blueprint who own Class A shares
of the Fund may purchase additional Class A shares of the Fund through
Blueprint. Blueprint is directed to small investors, group IRAs and
participants in certain affinity groups such as credit unions, trade
associations and benefit plans. Investors placing orders to purchase Class A
or Class D shares of the Fund through Blueprint will acquire the Class A or
Class D shares at net asset value plus a sales charge calculated in accordance
with the Blueprint sales charge schedule (i.e., up to $300 at 4.25%, $300.01
up to $5,000 at 3.25% plus $3, and $5,000.01 or more at the standard sales
charge rates disclosed in the Prospectus). In addition, Class A or Class D
shares of the Fund are offered at net asset value plus a sales charge of .50%
of 1% for corporate or group IRA programs placing orders to purchase their
Class A or Class D shares through Blueprint. Services, including the exchange
privilege, available to Class A and Class D investors through Blueprint,
however, may differ from those available to other Class A or Class D share
investors.
22
Class A and Class D shares are offered at net asset value to
participants in Blueprint through the Merrill Lynch Directed IRA Rollover
Program ("IRA Rollover Program") available from Merrill Lynch Business
Financial Services, a business unit of Merrill Lynch. The IRA Rollover Program
is available to custodian rollover assets from employer-sponsored retirement
and savings plans whose trustee and/or plan sponsor has entered into a Merrill
Lynch Directed IRA Rollover Program Service Agreement.
Orders for purchases and redemptions of Class A or Class D shares of
the Fund may be grouped for execution purposes which, in some circumstances,
may involve the execution of such orders two business days following the day
such orders are placed. The minimum initial purchase price is $100, with a $50
minimum for subsequent purchases through Blueprint. There are no minimum
initial or subsequent purchase requirements for participants who are part of
an automatic investment plan. Additional information concerning purchases
through Blueprint, including any annual fees and transaction charges, is
available from Merrill Lynch, Pierce, Fenner & Smith Incorporated, The
BlueprintSM Program, P.O. Box 30441, New Brunswick, New Jersey 08989-0441.
TMASM Managed Trusts. Class A shares are offered at net asset value
to TMASM Managed Trusts to which Merrill Lynch Trust Company provides
discretionary trustee services.
Employee AccessSM Accounts. Provided applicable threshold
requirements are met, either Class A or Class D shares are offered at net
asset value to Employee AccessSM Accounts available through authorized
employers. The initial minimum investment for such accounts is $500, except
that the initial minimum investment for shares purchased for such accounts
pursuant to the Automatic Investment Program is $50.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and
certain other arrangements may purchase Class A or Class D shares at net asset
value, based on the number of employees or number of employees eligible to
participate in the plan, the aggregate amount invested by the plan in
specified investments and/or the services provided by Merrill Lynch to the
plan. Additional information regarding purchases by employer-sponsored
retirement or savings plans and certain other arrangements is available
toll-free from Merrill Lynch Business Financial Services at 1-800-237-7777.
Purchase Privilege of Certain Persons. Trustees of the Fund, members
of the Boards of other MLIM/ FAM-advised investment companies, ML & Co. and
its subsidiaries (the term "subsidiaries," when used herein with respect to ML
& Co., includes MLIM, FAM and certain other entities directly or indirectly
wholly owned and controlled by ML & Co.) and their directors and employees,
and any trust, pension, profit-sharing or other benefit plan for such persons,
may purchase Class A shares of the Fund at net asset value. The Fund realizes
economies of scale and reduction of sales-related expenses by virtue of the
familiarity of these persons with the Fund. Employees and directors or
trustees wishing to purchase shares of the Fund must satisfy the Fund's
suitability standards.
Class D shares of the Fund are offered at net asset value, without a
sales charge, to an investor that has a business relationship with a Financial
Advisor who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that
it will purchase Class D shares of the Fund with proceeds from a redemption of
shares of a mutual fund that was sponsored by the Financial Advisor's previous
firm and was subject to a sales charge either at the time of purchase or on a
deferred basis; and, second, the investor must establish that such redemption
had been made within 60 days prior to the investment in the Fund and the
proceeds from the redemption had been maintained in the interim in cash or a
money market fund.
Class D shares of the Fund are also offered at net asset value,
without a sales charge, to an investor that has a business relationship with a
Merrill Lynch Financial Advisor and that has invested in a mutual fund
sponsored by a non-Merrill Lynch company for which Merrill Lynch has served as
a selected dealer and where Merrill Lynch has either received or given notice
that such arrangement will be terminated ("notice") if the following
conditions are satisfied: first, the investor must purchase Class D shares of
the Fund with proceeds from a redemption of shares of such other mutual fund
and the shares of such other fund were subject to a sales charge either at the
time of purchase or on a deferred basis; and, second, such purchase of Class D
shares must be made within 90 days after such notice.
Class D shares of the Fund are offered at net asset value, without a
sales charge, to an investor that has a business relationship with a Merrill
Lynch Financial Advisor and that has invested in a mutual fund for which
23
Merrill Lynch has not served as a selected dealer if the following conditions
are satisfied: first, the investor must advise Merrill Lynch that it will
purchase Class D shares of the Fund with proceeds from the redemption of
shares of such other mutual fund and that such shares have been outstanding
for a period of no less than six months; and, second, such purchase of Class D
shares must be made within 60 days after the redemption and the proceeds from
the redemption must be maintained in the interim in cash or a money market
fund.
Acquisition of Certain Investment Companies. Class D shares may be
offered at net asset value in connection with the acquisition of the assets of
or merger or consolidation with a personal holding company or a public or
private investment company.
Purchases Through Certain Financial Intermediaries. Reduced sales
charges may be applicable for purchases of Class A or Class D shares of the
Fund through certain financial advisers, selected securities dealers and other
financial intermediaries that meet and adhere to standards established by the
Manager from time to time.
Deferred Sales Charge Alternatives -- Class B and Class C Shares
Investors choosing the deferred sales charge alternatives should
consider Class B shares if they intend to hold their shares for an extended
period of time and Class C shares if they are uncertain as to the length of
time they intend to hold their assets in Select Pricing Funds.
Because no initial sales charges are deducted at the time of the
purchase, Class B and Class C shares provide the benefit of putting all of the
investor's dollars to work from the time the investment is made. The deferred
sales charge alternatives may be particularly appealing to investors that do
not qualify for the reduction in initial sales charges. Both Class B and Class
C shares are subject to ongoing account maintenance fees and distribution
fees; however, the ongoing account maintenance and distribution fees
potentially may be offset to the extent any return is realized on the
additional funds initially invested in Class B or Class C shares. In addition,
Class B shares will be converted into Class D shares of the Fund after a
conversion period of approximately ten years, and thereafter investors will be
subject to lower ongoing fees.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. See "Pricing of Shares -- Determination of Net Asset Value" below.
Contingent Deferred Sales Charges -- Class B Shares
Class B shares that are redeemed within four years of purchase may be
subject to a CDSC at the rates set forth below charged as a percentage of the
dollar amount subject thereto. In determining whether a CDSC is applicable to
a redemption, the calculation will be determined in the manner that results in
the lowest applicable rate being charged. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed. Accordingly, no CDSC will be imposed on increases in
net asset value above the initial purchase price. In addition, no CDSC will be
assessed on shares derived from reinvestment of dividends. It will be assumed
that the redemption is first of shares held for over four years or shares
acquired pursuant to reinvestment of dividends and then of shares held longest
during the four-year period. A transfer of shares from a shareholder's account
to another account will be assumed to be made in the same order as a
redemption.
24
The following table sets forth the Class B CDSC:
CDSC as a Percentage
of Dollar Amount
Year Since Purchase Payment Made Subject to Charge
0-1 4.0%
1-2 3.0%
2-3 2.0%
3-4 1.0%
4 and thereafter None
To provide an example, assume an investor purchased 100 shares at $10
per share (at a cost of $1,000) and in the third year after purchase, the net
asset value per share is $12 and, during such time, the investor has acquired
10 additional shares upon dividend reinvestment. If at such time the investor
makes his or her first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to a CDSC because of dividend reinvestment. With respect
to the remaining 40 shares, the charge is applied only to the original cost of
$10 per share and not to the increase in net asset value of $2 per share.
Therefore, $400 of the $600 redemption proceeds will be charged at a rate of
2.0% (the applicable rate in the third year after purchase).
The Class B CDSC may be waived on redemptions of shares in connection
with certain post-retirement withdrawals from an Individual Retirement Account
("IRA") or other retirement plan or following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended) of a
shareholder.(including one who owns the Class B shares as joint tenant with
his or her spouse), provided the redemption is requested within one year of
the death or initial determination of disability or, if later, reasonably
promptly following completion of probate. The Class B CDSC also may be waived
on redemptions of shares by certain eligible 401(a) and 401(k) plans. The CDSC
may also be waived for any Class B shares that are purchased by eligible
401(k) or eligible 401(a) plans that are rolled over into a Merrill Lynch or
Merrill Lynch Trust Company custodied IRA and held in such account at the time
of redemption. The Class B CDSC may also be waived for any Class B shares that
are purchased by a Merrill Lynch rollover IRA that was funded by a rollover
from a terminated 401(k) plan managed by the MLIM Private Portfolio Group and
held in such account at the time of redemption. The Class B CDSC may also be
waived or its terms may be modified in connection with certain fee-based
programs. The Class B CDSC may also be waived in connection with involuntary
termination of an account in which Fund shares are held or for withdrawals
through the Merrill Lynch Systematic Withdrawal Plan. See "Shareholder
Services -- Fee Based Programs" and "-- Systematic Withdrawal Plan."
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and
certain other arrangements may purchase Class B shares with a waiver of the
CDSC upon redemption, based on the number of employees or number of employees
eligible to participate in the plan, the aggregate amount invested by the plan
in specified investments and/or the services provided by Merrill Lynch to the
plan. Such Class B shares will convert into Class D shares approximately ten
years after the plan purchases the first share of any Select Pricing Fund.
Minimum purchase requirements may be waived or varied for such plans.
Additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements is available toll-free from
Merrill Lynch Business Financial Services at 1-800-237-7777.
Merrill Lynch BlueprintSM Program. Class B shares are offered to
certain participants in Blueprint. Blueprint is directed to small investors,
group IRAs and participants in certain affinity groups such as trade
associations and credit unions. Class B shares of the Fund are offered through
Blueprint only to members of certain affinity groups. The CDSC is waived in
connection with purchase orders placed through Blueprint. Services, including
the exchange privilege, available to Class B investors through Blueprint,
however, may differ from those available to other investors in Class B shares.
Orders for purchases and redemptions of Class B shares of the Fund will be
grouped for execution purposes which, in some circumstances, may involve the
execution of such orders two business days following the day such orders are
placed. The minimum initial purchase price is $100, with a $50 minimum for
subsequent purchases through Blueprint. There is no minimum initial or
subsequent purchase requirement for investors who are part of the Blueprint
automatic investment plan. Additional information concerning these Blueprint
programs, including any annual fees or transaction charges, is available from
Merrill
25
Lynch, Pierce, Fenner & Smith Incorporated, The BlueprintSM Program, P.O. Box
30441, New Brunswick, New Jersey 08989-0441.
Conversion of Class B Shares to Class D Shares. After approximately
ten years (the "Conversion Period"), Class B shares will be converted
automatically into Class D shares of the Fund. Class D shares are subject to
an ongoing account maintenance fee of 0.25% of the average daily net assets
but are not subject to the distribution fee that is borne by Class B shares.
Automatic conversion of Class B shares into Class D shares will occur at least
once each month (on the "Conversion Date") on the basis of the relative net
asset value of the shares of the two classes on the Conversion Date, without
the imposition of any sales load, fee or other charge. Conversion of Class B
shares to Class D shares will not be deemed a purchase or sale of the shares
for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on
Class B shares also will convert automatically to Class D shares. The
Conversion Date for dividend reinvestment shares will be calculated taking
into account the length of time the shares underlying such dividend
reinvestment shares were outstanding. If at the Conversion Date the conversion
of Class B shares to Class D shares of the Fund in a single account will
result in less than $50 worth of Class B shares being left in the account, all
of the Class B shares of the Fund held in the account on the Conversion Date
will be converted to Class D shares of the Fund.
In general, Class B shares of equity Select Pricing Funds will
convert approximately eight years after initial purchase and Class B shares of
taxable and tax-exempt fixed income Select Pricing Funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa,
the Conversion Period applicable to the Class B shares acquired in the
exchange will apply and the holding period for the shares exchanged will be
tacked on to the holding period for the shares acquired. The Conversion Period
also may be modified for investors that participate in certain fee-based
programs. See "Shareholder Services -- Fee-Based Programs."
Class B shareholders of the Fund exercising the exchange privilege
described under "Shareholder Services -- Exchange Privilege" will continue to
be subject to the Fund's CDSC schedule if such schedule is higher than the
CDSC schedule relating to the Class B shares acquired as a result of the
exchange.
Share certificates for Class B shares of the Fund to be converted
must be delivered to the Transfer Agent at least one week prior to the
Conversion Date applicable to those shares. In the event such certificates are
not received by the Transfer Agent at least one week prior to the Conversion
Date, the related Class B shares will convert to Class D shares on the next
scheduled Conversion Date after such certificates are delivered.
Contingent Deferred Sales Charges -- Class C Shares
Class C shares that are redeemed within one year of purchase may be
subject to a 1.0% CDSC charged as a percentage of the dollar amount subject
thereto. In determining whether a Class C CDSC is applicable to a redemption,
the calculation will be determined in the manner that results in the lowest
possible rate being charged. The charge will be assessed on an amount equal to
the lesser of the proceeds of redemption or the cost of the shares being
redeemed. Accordingly, no Class C CDSC will be imposed on increases in net
asset value above the initial purchase price. In addition, no Class C CDSC
will be assessed on shares derived from reinvestment of dividends. It will be
assumed that the redemption is first of shares held for over one year or
shares acquired pursuant to reinvestment of dividends and then of shares held
longest during the one-year period. A transfer of shares from a shareholder's
account to another account will be assumed to be made in the same order as a
redemption. The Class C CDSC may be waived in connection with involuntary
termination of an account in which Fund shares are held and withdrawals
through the Merrill Lynch Systematic Withdrawal Plan. See "Shareholder
Services -- Systematic Withdrawal Plan."
Class B and Class C Sales Charge Information
26
Class B Shares*
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended August 31, by Distributor Merrill Lynch
2001 $ 429,175 $ 429,175
2000 $ 980,687 $ 980,687
1999 $ 1,122,692 $ 1,122,692
* Additional Class B CDSCs payable to the Distributor may have been waived or
converted to a contingent obligation in connection with a shareholder's
participation in certain fee-based programs.
Class C Shares
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended August 31, by Distributor Merrill Lynch
2001 $ 12,236 $ 12,236
2000 $ 21,747 $ 21,747
1999 $ 40,079 $ 40,079
Merrill Lynch compensates its Financial Advisors for selling Class B
and Class C shares at the time of purchase from its own funds. Proceeds from
the CDSC and the distribution fee are paid to the Distributor and are used in
whole or in part by the Distributor to defray the expenses of dealers or other
financial intermediaries (including Merrill Lynch) related to providing
distribution-related services to the Fund in connection with the sale of the
Class B and Class C shares, such as the payment of compensation to financial
advisors for selling Class B and Class C shares from a dealer's own funds. The
combination of the CDSC and the ongoing distribution fee facilitates the
ability of the Fund to sell the Class B and Class C shares without a sales
charge being deducted at the time of purchase. See "Distribution Plans" below.
Imposition of the CDSC and the distribution fee on Class B and Class C shares
is limited by the National Association of Securities Dealers, Inc. (the
"NASD") asset-based sales charge rule. See "Limitations on the Payment of
Deferred Sales Charges" below.
Closed-End Fund Reinvestment Options
Class A shares of the Fund ("Eligible Class A Shares") are offered at
net asset value to holders of the common stock of certain closed-end funds
advised by the Manager or MLIM who purchased such closed-end fund shares prior
to October 21, 1994 (the date the Merrill Lynch Select PricingSM System
commenced operations) and wish to reinvest the net proceeds from a sale of
such shares in Eligible Class A Shares, if the conditions set forth below are
satisfied.
Alternatively, holders of the common stock of closed-end funds who
purchased such shares on or after October 21, 1994 and wish to reinvest the
net proceeds from a sale of those shares may purchase Class A shares (if
eligible to buy Class A shares) or Class D shares of the Fund ("Eligible Class
D Shares") at net asset value if the following conditions are met. First, the
sale of closed-end fund shares must be made through Merrill Lynch, and the net
proceeds therefrom must be immediately reinvested in Eligible Class A or
Eligible Class D Shares.
Second, the closed-end fund shares must either have been acquired in
that fund's initial public offering or represent dividends from shares of
common stock acquired in such offering. Third, the closed-end fund shares must
have been continuously maintained in a Merrill Lynch securities account.
Fourth, there must be a minimum purchase of $250 to be eligible for the
reinvestment option.
Subject to the conditions set forth below, shares of the Fund are
offered at net asset value to holders of the common stock of certain MLIM/
FAM-advised continuously offered closed-end funds who wish to reinvest the net
proceeds from a sale of such shares. Upon exercise of this reinvestment
option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. will
receive Class A shares of the Fund, shareholders of Merrill Lynch Senior
Floating Rate
27
Fund II, Inc. will receive Class C shares of the Fund and shareholders of
Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch High Income
Municipal Bond Fund, Inc. will receive Class D shares of the Fund, except that
shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch
High Income Municipal Bond Fund, Inc. who already own Class A shares of the
Fund may be eligible to purchase additional Class A shares pursuant to this
option, if such additional Class A shares will be held in the same account as
the existing Class A shares and the other requirements pertaining to the
reinvestment privilege are met. In order to exercise this reinvestment option,
a shareholder of one of the above-referenced continuously offered closed-end
funds (an "eligible fund") must sell his or her shares of common stock of the
eligible fund (the "eligible shares") back to the eligible fund in connection
with a tender offer conducted by the eligible fund and reinvest the proceeds
immediately in the designated class of shares of the Fund. This option is
available only with respect to eligible shares as to which no Early Withdrawal
Charge or CDSC (each as defined in the eligible fund's prospectus) is
applicable. Purchase orders from eligible fund shareholders who wish to
exercise this reinvestment option will be accepted only on the day that the
related tender offer terminates and will be effected at the net asset value of
the designated class of shares of the Fund on such day. The Class C CDSC may
be waived upon redemption of Class C shares purchased by an investor pursuant
to this closed-end fund reinvestment option. Such waiver is subject to the
requirement that the investor have held the tendered shares for a minimum of
one year and to such other conditions as are set forth in the prospectus for
the related closed-end fund.
Distribution Plans
Reference is made to "Key Facts -- Fees and Expenses" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
Investment Company Act (each a "Distribution Plan") with respect to the
account maintenance and/or distribution fees paid by the Fund to the
Distributor with respect to such classes.
The Distribution Plans for Class B, Class C and Class D shares each
provides that the Fund pay the Distributor an account maintenance fee relating
to the shares of the relevant class, accrued daily and paid monthly, at the
annual rate of 0.25% of the average daily net assets of the Fund attributable
to shares of the relevant class in order to compensate the Distributor,
Merrill Lynch, a selected securities dealer or other financial intermediary
(pursuant to a sub-agreement) in connection with account maintenance
activities with respect to Class B, Class C and Class D shares. Each of those
classes has exclusive voting rights with respect to the Distribution Plan
adopted with respect to such class pursuant to which account maintenance
and/or distribution fees are paid (except that Class B shareholders may vote
upon any material changes to expenses charged under the Class D Distribution
Plan).
The Distribution Plans for Class B and Class C shares each provides
that the Fund also pay the Distributor a distribution fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.50% for Class B shares and 0.55% for Class C shares of the average
daily net assets of the Fund attributable to the shares of the relevant class
in order to compensate the Distributor, Merrill Lynch, a selected securities
dealer or other financial intermediary (pursuant to a sub-agreement) for
providing shareholder and distribution services and bearing certain
distribution-related expenses of the Fund, including payments to financial
advisors or other financial intermediaries for selling Class B and Class C
shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B or Class C
shares through selected securities dealers or other financial intermediaries
without the assessment of an initial sales charge and at the same time permit
the dealer to compensate its financial advisors, selected dealers or other
financial intermediaries in connection with the sale of the Class B and Class
C shares.
The Fund's Distribution Plans are subject to the provisions of Rule
12b-1 under the Investment Company Act. In their consideration of each
Distribution Plan, the Trustees must consider all factors they deem relevant,
including information as to the benefits of the Distribution Plan to the Fund
and each related class of shareholders. Each Distribution Plan further
provides that, so long as the Distribution Plan remains in effect, the
selection and nomination of non-interested Trustees shall be committed to the
discretion of the non-interested Trustees then in office. In approving each
Distribution Plan in accordance with Rule 12b-1, the non-interested Trustees
concluded that there is reasonable likelihood that each Distribution Plan will
benefit the Fund and its related class of shareholders. Each Distribution Plan
can be terminated at any time, without penalty, by the vote of a majority of
the non-interested Trustees or by the vote of the holders of a majority of the
outstanding related class of voting securities of the Fund. A Distribution
Plan cannot be amended to increase materially the amount to be spent by the
28
Fund without the approval of the related class of shareholders and all
material amendments are required to be approved by the vote of Trustees,
including a majority of the non-interested Trustees who have no direct or
indirect financial interest in the Distribution Plan, cast in person at a
meeting called for that purpose. Rule 12b-1 further requires that the Fund
preserve copies of the Distribution Plan and any report made pursuant to such
plan for a period of not less than six years from the date of the Distribution
Plan or such report, the first two years in an easily accessible place.
Among other things, each Distribution Plan provides that the
Distributor shall provide and the Trustees shall review quarterly reports of
the disbursement of the account maintenance and/or distribution fees paid to
the Distributor. Payments under the Distribution Plans are based on a
percentage of average daily net assets attributable to the shares regardless
of the amount of expenses incurred and, accordingly, distribution-related
revenues from the Distribution Plans may be more or less than
distribution-related expenses. Information with respect to the
distribution-related revenues and expenses is presented to the Trustees for
their consideration quarterly and, in connection with their deliberations as
to the continuance of the Class B and Class C Distribution Plans, annually.
Distribution-related revenues consist of the account maintenance fees,
distribution fees and CDSCs. Distribution-related expenses consist of
financial advisor compensation.
As of August 31, 2001, revenues for the period since the commencement
of operations of Class B shares exceeded expenses by $121,731,499 (26.13% of
Class B net assets at that date). As of August 31, 2001, revenues for the
period since the commencement of operations of Class C shares exceeded
expenses by $1,121,930 (1.98% of Class C net assets at that date).
For the fiscal year ended August 31, 2001, the Fund paid the
Distributor $3,134,219 pursuant to the Class B Distribution Plan (based on
average daily net assets subject to such Class B Distribution Plan of
approximately $414.5 million), all of which was paid to Merrill Lynch for
providing account maintenance and distribution-related activities and services
in connection with Class B shares. For the fiscal year ended August 31, 2001,
the Fund paid the Distributor $301,617 pursuant to the Class C Distribution
Plan (based on average daily net assets subject to such Class C Distribution
Plan of approximately $37.4 million), all of which was paid to Merrill Lynch
for providing account maintenance and distribution-related activities and
services in connection with Class C shares. For the fiscal year ended August
31, 2001, the Fund paid the Distributor $1,853,739 pursuant to the Class D
Distribution Plan (based on average daily net assets subject to such Class D
Distribution Plan of approximately $735.5 million), all of which was paid to
Merrill Lynch for providing account maintenance activities in connection with
Class D shares.
Limitations on the Payment of Deferred Sales Charges
The maximum sales charge rule in the Conduct Rules of the NASD
imposes a limitation on certain asset-based sales charges such as the
distribution fee and the CDSC borne by the Class B and Class C shares but not
the account maintenance fee. The maximum sales charge rule is applied
separately to each class. As applicable to the Fund, the maximum sales charge
rule limits the aggregate of distribution fee payments and CDSCs payable by
the Fund to (1) 6.25% of eligible gross sales of Class B shares and Class C
shares, computed separately (defined to exclude shares issued pursuant to
dividend reinvestments and exchanges), plus (2) interest on the unpaid balance
for the respective class, computed separately, at the prime rate plus 1% (the
unpaid balance being the maximum amount payable minus amounts received from
the payment of the distribution fee and the CDSC). In connection with the
Class B shares, the Distributor has voluntarily agreed to waive interest
charges on the unpaid balance in excess of 0.50% of eligible gross sales.
Consequently, the maximum amount payable to the Distributor (referred to as
the "voluntary maximum") in connection with the Class B shares is 6.75% of
eligible gross sales. The Distributor retains the right to stop waiving the
interest charges at any time. To the extent payments would exceed the
voluntary maximum, the Fund will not make further payments of the distribution
fee with respect to Class B shares and any CDSCs will be paid to the Fund
rather than to the Distributor; however, the Fund will continue to make
payments of the account maintenance fee. In certain circumstances the amount
payable pursuant to the voluntary maximum may exceed the amount payable under
the NASD formula. In such circumstances payment in excess of the amount
payable under the NASD formula will not be made.
The following table sets forth comparative information as of August
31, 2001 with respect to the Class B and Class C shares of the Fund indicating
the maximum allowable payments that can be made under the NASD maximum sales
charge rule and, with respect to the Class B shares, the Distributor's
voluntary maximum.
29
Data Calculated as of August 31, 2001
----------------------------------------------------------------------------------------------------------
(in thousands)
Annual
Amounts Distribution
Allowable Previously Fee at
Allowable Interest on Maximum Paid to Aggregate Current Net
Eligible Gross Aggregate Sales Unpaid Amount Distributor Unpaid Asset Level
Sales (1) Charges (2) Balance (3) Payable (4) Balance (5)
----------------- ---------------- -------------- ------------- -------------- ------------- -------------
Class B Shares for the $ 5,161,374,817 $ 311,984,371 $ 416,126,938 $ 728,111,309 $ 160,380,034 $567,731,279 $ 2,329,188
period December 23, 1991
(commencement of
operation) to August 31,
2001 Under NASD Rule as
Adopted
Under Distributor's
Voluntary Waiver $ 5,161,347,817 $ 322,585,926 $ 25,806,874 $ 348,392,800 $ 160,380,034 $188,012,767 $ 2,329,188
Class C Shares for the
period October 21, 1994
(commencement of
operations) to August 31,
2001 Under NASD Rule as
Adopted $ 105,343,897 $ 6,530,009 $ 2,169,250 $ 8,699,259 $ 1,289,493 $ 7,409,764 $ 311,347
- -----------------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated other than shares acquired through dividend
reinvestment and the exchange privilege.
(2) Includes amounts attributable to exchanges from Summit which are not
reflected in Eligible Gross Sales. Shares of Summit can only be purchased
by exchange from another fund (the "redeemed fund"). Upon such an
exchange, the maximum allowable sales charge payment to the redeemed fund
is reduced in accordance with the amount of the redemption. This amount
is then added to the maximum allowable sales charge payment with respect
to Summit. Upon an exchange out of Summit, the remaining balance of this
amount is deducted from the maximum allowable sales charge payment to
Summit and added to the maximum allowable sales charge payment to the
fund into which the exchange is made.
(3) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0%, as permitted under the
NASD Rule.
(4) Consists of CDSC payments, distribution fee payments and accruals. See
"Key Facts -- Fees and Expenses" in the Prospectus. This figure may
include CDSCs that were deferred when a shareholder redeemed shares prior
to the expiration of the applicable CDSC period and invested the
proceeds, without the imposition of a sales charge, in Class A shares in
conjunction with the shareholder's participation in the MFA Program. The
CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA Program.
(5) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum (with respect to
Class B shares) or the NASD maximum (with respect to Class B and Class C
shares).
REDEMPTION OF SHARES
Reference is made to "Your Account -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon
receipt of a written request in proper form. The redemption price is the net
asset value per share next determined after the initial receipt of proper
notice of redemption. Except for any CDSC that may be applicable, there will
be no charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption.
30
The right to redeem shares or to receive payment with respect to any
such redemption may be suspended for more than seven days only for any period
during which trading on the New York Stock Exchange (the "NYSE") is restricted
as determined by the Commission or the NYSE is closed (other than customary
weekend and holiday closings), for any period during which an emergency exists
as defined by the Commission as a result of which disposal of portfolio
securities or determination of the net asset value of the Fund is not
reasonably practicable, and for such other periods as the Commission may by
order permit for the protection of shareholders of the Fund.
The value of shares at the time of redemption may be more or less
than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Fund has entered into a joint committed line of credit with other
investment companies advised by the Manager and its affiliates and a syndicate
of banks that is intended to provide the Fund with a temporary source of cash
to be used to meet redemption requests from Fund shareholders in extraordinary
or emergency circumstances.
Redemption
A shareholder wishing to redeem shares held with the Transfer Agent
may do so without charge by tendering the shares directly to the Transfer
Agent at Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida
32232-5289. Redemption requests delivered other than by mail should be
delivered to Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484. Proper notice of redemption in the case of
shares deposited with the Transfer Agent may be accomplished by a written
letter requesting redemption. Proper notice of redemption in the case of
shares for which certificates have been issued may be accomplished by a
written letter as noted above accompanied by certificates for the shares to be
redeemed. Redemption requests should not be sent to the Fund. The redemption
request in either event requires the signature(s) of all persons in whose
name(s) the shares are registered, signed exactly as such name(s) appear(s) on
the Transfer Agent's register. The signatures on the redemption request may
require a guarantee by an "eligible guarantor institution" as defined in Rule
17Ad-15 under the Securities Exchange Act of 1934 (the "Exchange Act"), the
existence and validity of which may be verified by the Transfer Agent through
the use of industry publications. In the event a signature guarantee is
required, notarized signatures are not sufficient. In general, signature
guarantees are waived on redemptions of less than $50,000 as long as the
following requirements are met: (i) all requests require the signature(s) of
all persons in whose name(s) shares are recorded on the Transfer Agent's
register; (ii) all checks must be mailed to the stencil address of record on
the Transfer Agent's register and (iii) the stencil address must not have
changed within 30 days. Certain rules may apply regarding certain account
types such as but not limited to UGMA/UTMA accounts, Joint Tenancies With
Rights of Survivorship, contra broker transactions, and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the
Transfer Agent at 1-800-MER-FUND. The request must be made by the shareholder
of record and be for an amount less than $50,000. Before telephone requests
will be honored, signature approval from all shareholders of record on the
account must be obtained. The shares being redeemed must have been held for at
least 15 days. Telephone redemption requests will not be honored in the
following situations: the accountholder is deceased, the proceeds are to be
sent to someone other than the shareholder of record, funds are to be wired to
the client's bank account, a systematic withdrawal plan is in effect, the
request is by an individual other than the accountholder of record, the
account is held by joint tenants who are divorced, the address on the account
has changed within the last 30 days or share certificates have been issued on
the account.
Since this account feature involves a risk of loss from unauthorized
or fraudulent transactions, the Transfer Agent will take certain precautions
to protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address
registered on the account and the social security number registered on the
account. The Fund or the Transfer Agent may temporarily suspend telephone
transactions at any time.
For shareholders redeeming directly with the Transfer Agent, payments
will generally be mailed within seven days of receipt of a proper notice of
redemption. At various times the Fund may be requested to redeem shares for
which it has not yet received good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank).
31
The Fund may delay or cause to be delayed the mailing of a redemption check
until such time as it has assured itself that good payment (e.g., cash,
Federal funds or certified check drawn on a U.S. bank) has been collected for
the purchase of such Fund shares, which will not usually exceed 10 days. In
the event that a shareholder account held directly with the Transfer Agent
contains a fractional share balance, such fractional share balance will be
automatically redeemed by the Fund.
Repurchase
The Fund also will repurchase Fund shares through a shareholder's
listed selected securities dealer or other financial intermediary. The Fund
normally will accept orders to repurchase Fund shares by wire or telephone
from dealers for their customers at the net asset value next computed after
the order is placed. Shares will be priced at the net asset value calculated
on the day the request is received, provided that the request for repurchase
is submitted to the selected securities dealer or other financial intermediary
prior to the regular close of business on the NYSE (generally, the NYSE closes
at 4:00 p.m., Eastern time) and such request is received by the Fund from such
selected securities dealer or other financial intermediary not later than 30
minutes after the close of business on the NYSE on the same day. Dealers have
the responsibility of submitting such repurchase requests to the Fund not
later than 30 minutes after the close of business on the NYSE, in order to
obtain that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any
applicable CDSC). Securities firms that do not have selected dealer agreements
with the Distributor, however, may impose a transaction charge on the
shareholder for transmitting the notice of repurchase to the Fund. Merrill
Lynch, selected securities dealers or other financial intermediaries may
charge customers a processing fee (Merrill Lynch currently charges $5.35) to
confirm a repurchase of shares to such customers. Repurchases made directly
through the Transfer Agent on accounts held at the Transfer Agent are not
subject to the processing fee. The Fund reserves the right to reject any order
for repurchase, which right of rejection might adversely affect shareholders
seeking redemption through the repurchase procedure. However, a shareholder
whose order for repurchase is rejected by the Fund may redeem Fund shares as
set forth above.
Reinstatement Privilege -- Class A and Class D Shares
Shareholders who have redeemed their Class A or Class D shares of the
Fund have a privilege to reinstate their accounts by purchasing Class A or
Class D shares, as the case may be, of the Fund at net asset value without a
sales charge up to the dollar amount redeemed. The reinstatement privilege may
be exercised by sending a notice of exercise along with a check for the amount
to be reinstated to the Transfer Agent within 30 days after the date the
request for redemption was accepted by the Transfer Agent or the Distributor.
Alternatively, the reinstatement privilege may be exercised through the
investor's Merrill Lynch Financial Advisor within 30 days after the date the
request for redemption was accepted by the Transfer Agent or the Distributor.
The reinstatement will be made at the net asset value per share next
determined after the notice of reinstatement is received and cannot exceed the
amount of the redemption proceeds.
PRICING OF SHARES
Determination of Net Asset Value
Reference is made to "Your Account -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of all classes of the Fund is
determined once daily Monday through Friday as of the close of business on the
NYSE on each day the NYSE is open for trading based on prices at the time of
closing. The NYSE generally closes at 4:00 p.m., Eastern time. Any assets or
liabilities initially expressed in terms of non-U.S. dollar currencies are
translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation. The NYSE is not open for
trading on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
32
Net asset value is computed by dividing the value of the securities
held by the Fund plus any cash or other assets (including interest and
dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Manager and Distributor are accrued daily.
The per share net asset value of Class B, Class C and Class D shares
generally will be lower than the per share net asset value of Class A shares,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares, and the daily expense accruals of the account maintenance fees
applicable with respect to the Class D shares; moreover, the per share net
asset value of the Class B and Class C shares generally will be lower than the
per share net asset value of Class D shares reflecting the daily expense
accruals of the distribution fees and higher transfer agency fees applicable
with respect to Class B and Class C shares of the Fund. It is expected,
however, that the per share net asset value of the four classes will tend to
converge (although not necessarily meet) immediately after the payment of
dividends, which will differ by approximately the amount of the expense
accrual differentials between the classes.
Portfolio securities of the Fund that are traded on stock exchanges
are valued at the last sale price on the exchange on which such securities are
traded as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price for long positions, and
at the last available ask price for short positions. In cases where securities
are traded on more than one exchange, the securities are valued on the
exchange designated by or under the authority of the Trustees as the primary
market. Long positions in securities traded in the OTC market are valued at
the last available bid price or yield equivalent obtained from one or more
dealers or pricing services approved by the Board of Trustees of the Fund.
Short positions in securities traded in the OTC market are valued at the last
available ask price. Portfolio securities that are traded both in the OTC
market and on a stock exchange are valued according to the broadest and most
representative market. When the Fund writes an option, the amount of the
premium received is recorded on the books of the Fund as an asset and an
equivalent liability. The amount of the liability is subsequently valued to
reflect the current market value of the option written, based upon the last
sale price in the case of exchange-traded options or, in the case of options
traded in the OTC market, the last asked price. Options purchased by the Fund
are valued at their last sale price in the case of exchange-traded options or,
in the case of options traded in the OTC market, the last bid price. Other
investments, including financial futures contracts and related options, are
generally valued at market value. Obligations with remaining maturities of 60
days or less are valued at amortized cost unless the Manager believes that
this method no longer produces fair valuations. Repurchase agreements will be
valued at cost plus accrued interest. Securities and assets for which market
quotations are not readily available are stated at fair value as determined in
good faith by or under the direction of the Trustees of the Fund. Where there
is no market quotation on securities or options, fair market value will be
determined in good faith by or under the direction of the Trustees of the
Fund. Such valuations and procedures will be reviewed periodically by the
Board of Trustees of the Fund.
Generally, trading in U.S. Government securities is substantially
completed each day at various times prior to the close of business on the NYSE
(generally 4:00 p.m. Eastern time). The values of such securities used in
computing the net asset value of the Fund's shares are determined as of such
times. 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 materially affecting the value of
such securities occur during such period, then these securities will be valued
at their fair value as determined in good faith by the Board of Trustees of
the Fund.
Computation of Offering Price Per Share
An illustration of the computation of the offering price for Class A,
Class B, Class C and Class D shares of the Fund based on the value of the
Fund's net assets and number of shares outstanding on August 31, 2001 is set
forth below.
Class A Class B Class C Class D
--------------- ---------------- -------------- ----------------
Net Assets $234,929,682 $466,432,519 $56,706,036 $729,135,589
------------ ------------ ----------- ------------
Number of Shares Outstanding 23,607,412 46,883,981 5,700,232 73,288,158
------------ ------------ ----------- ------------
33
Net Asset Value Per Share
(net assets divided by number of shares $ 9.95 $ 9.95 $ 9.95 $ 9.95
outstanding)
Sales Charge (for Class A and Class D
shares: 4.00% of offering
price; 4.17% of net asset value
per share)* .41 ** ** .41
------------ ----------- ----------- ----------
Offering Price $ 10.36 $ 9.95 $ 9.95 $ 10.36
------------ ----------- ----------- ----------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC on redemption of shares. See "Purchase of Shares
-- Deferred Sales Charges Alternatives -- Class B and Class C Shares"
herein.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Trustees of the
Fund, the Manager is primarily responsible for the execution of the Fund's
portfolio transactions and the allocation of brokerage. The Manager does not
execute transactions through any particular broker or dealer, but seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution, operational facilities of the firm and the
firm's risk and skill in positioning blocks of securities. While the Manager
generally seeks reasonably competitive trade execution costs, the Fund does
not necessarily pay the lowest spread or commission available. Subject to
applicable legal requirements, the Manager may select a broker based partly
upon brokerage or research services provided to the Manager and its clients,
including the Fund. In return for such services the Manager may pay a higher
commission than other brokers would charge if the Manager determines in good
faith that the commission is reasonable in relation to the services provided.
Section 28(e) of the Securities Exchange Act of 1934 ("Section
28(e)") permits an investment adviser, such as the Manager, under certain
circumstances, to cause an account to pay a broker a commission for effecting
a transaction that exceeds the amount of commission another broker would have
charged for effecting the same transaction in recognition of the value of
brokerage and research services provided by that broker. Brokerage and
research services include (1) furnishing advice as to the value of securities,
the advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (2)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (3) effecting securities transactions and performing functions
incidental to securities transactions (such as clearance, settlement, and
custody). The Manager believes that access to independent investment research
is beneficial to its investment decision-making processes and, therefore, to
the Fund.
To the extent research services may be a factor in selecting brokers,
such services may be in written form or through direct contact with
individuals and may include information as to particular companies and
securities as well as market, economic, or institutional areas and information
which assists in the valuation of investments. Examples of research-oriented
services for which the Manager might use Fund commissions include research
reports and other information on the economy, industries, groups of
securities, individual companies, statistical information, political
developments, technical market action, pricing and appraisal services, credit
analysis, risk measurement analysis, performance and other analysis. Except as
noted immediately below, research services furnished by brokers may be used in
servicing some or all client accounts and not all services may be used in
connection with the account that paid commissions to the broker providing such
services. In some cases, research information received from brokers by mutual
fund management personnel or personnel principally responsible for the
Manager's individually managed portfolios is not necessarily shared by and
between such personnel. Any investment advisory or other fees paid by the Fund
to the Manager are not reduced as a result of the Manager's receipt of
research services.
In some cases the Manager may receive a service from a broker that
has both a "research" and a "non-research" use. When this occurs, the Manager
makes a good faith allocation, under all the circumstances, between the
research and non-research uses of the service. The percentage of the
34
service that is used for research purposes may be paid for with client
commissions, while the Manager will use its own funds to pay for the
percentage of the service that is used for non-research purposes. In making
this good faith allocation, the Manager faces a potential conflict of
interest, but the Manager believes that its allocation procedures are
reasonably designed to ensure that it appropriately allocates the anticipated
use of such services to their research and non-research uses.
From time to time, the Fund may purchase new issues of securities in
a fixed price offering. In these situations, the broker may be a member of the
selling group that will, in addition to selling securities, provide the
Manager with research services. The NASD has adopted rules expressly
permitting these types of arrangements under certain circumstances. Generally,
the broker will provide research "credits" in these situations at a rate that
is higher than that which is available for typical secondary market
transactions. These arrangements may not fall within the safe harbor of
Section 28(e).
In addition, consistent with the Conduct Rules of the NASD and
policies established by the Board of Directors of the Fund and subject to best
execution, the Manager may consider sales of shares of the Fund as a factor in
the selection of brokers or dealers to execute portfolio transactions for the
Fund; however, whether or not a particular broker or dealer sells shares of
the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide
supplemental investment research services to the Manager may receive orders
for transactions by the Fund. Such supplemental research services ordinarily
consist of assessments and analysis of the business or prospects of a company,
industry or economic sector. Information so received will be in addition to
and not in lieu of the services required to be performed by the Manager under
the Management Agreement, and the expenses of the Manager will not necessarily
be reduced as a result of the receipt of such supplemental information. If in
the judgment of the Manager the Fund will benefit from supplemental research
services, the Manager is authorized to pay brokerage commissions to a broker
furnishing such services that are in excess of commissions that another broker
may have charged for effecting the same transaction. Certain supplemental
research services may primarily benefit one or more other investment companies
or other accounts for which the Manager exercises investment discretion.
Conversely, the Fund may be the primary beneficiary of the supplemental
research services received as a result of portfolio transactions effected for
such other accounts or investment companies.
For the fiscal years ended August 31, 1999, 2000 and 2001, the Fund
paid no brokerage commissions.
The Fund invests primarily in U.S. Government securities traded in
the OTC market and intends to deal directly with the dealers who make a market
in securities involved, except in those circumstances in which better prices
and execution are available elsewhere. Under the Investment Company Act,
persons affiliated with the Fund and persons who are affiliated with such
affiliated persons are prohibited from dealing with the Fund as principal in
the purchase and sale of securities unless a permissive order allowing such
transactions is obtained from the Commission. Since transactions in the OTC
market usually involve transactions with the dealers acting as principal for
their own accounts, the Fund will not deal with affiliated persons, including
Merrill Lynch and its affiliates, in connection with such transactions.
However, an affiliated person of the Fund may serve as its broker in OTC
transactions conducted on an agency basis provided that, among other things,
the fee or commission received by such affiliated broker is reasonable and
fair compared to the fee or commission received by non-affiliated brokers in
connection with comparable transactions. In addition, the Fund may not
purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch is a member or in a private placement
in which Merrill Lynch serves as placement agent except pursuant to procedures
approved by the Board of Trustees of the Fund that either comply with rules
adopted by the Commission or with interpretations of the Commission staff.
Because of the affiliation of Merrill Lynch with the Manager, the
Fund is prohibited from engaging in certain transactions involving such firm
or its affiliates except for brokerage transactions permitted under the
Investment Company Act involving only usual and customary commissions or
transactions pursuant to an exemptive order under the Investment Company Act.
See "Portfolio Transactions." Without such an exemptive order, the Fund would
be prohibited from engaging in portfolio transactions with Merrill Lynch or
any of its affiliates acting as principal.
The Fund has received an exemptive order from the Commission
permitting it to lend portfolio securities to Merrill Lynch or its affiliates.
Pursuant to that order, the Fund also has retained an affiliated entity of the
Manager as
35
the securities lending agent for a fee, including a fee based on a share of
the returns on investment of cash collateral. That entity 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 that entity or in
registered money market funds advised by the Manager or its affiliates.
Section 11(a) of the Exchange Act generally prohibits members of the
United States national securities exchanges from executing exchange
transactions for their affiliates and institutional accounts that they manage
unless the member (i) has obtained prior express authorization from the
account to effect such transactions, (ii) at least annually furnishes the
account with the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch acting as a broker for the
Fund in any of its portfolio transactions executed on any such securities
exchange of which it is a member, appropriate consents have been obtained from
the Fund and annual statements as to aggregate compensation will be provided
to the Fund.
The Board of Trustees of the Fund has considered the possibility of
seeking to recapture for the benefit of the Fund brokerage commissions and
other expenses of possible portfolio transactions by conducting portfolio
transactions through affiliated entities. For example, brokerage commissions
received by affiliated brokers could be offset against the advisory fee paid
by the Fund to the Manager. After considering all factors deemed relevant, the
Board of Trustees made a determination not to seek such recapture. The Board
will reconsider this matter from time to time.
Because of different objectives or other factors, a particular
security may be bought for one or more clients of the Manager or an affiliate
when one or more clients of the Manager or an affiliate are selling the same
security. If purchases or sales of securities arise for consideration at or
about the same time that would involve the Fund or other clients or funds for
which the Manager or an affiliate acts as manager transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions
on behalf of more than one client of the Manager or an affiliate during the
same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below that are designed to facilitate investment in shares of the
Fund. Full details as to each of such services, copies of the various plans
and instructions as to how to participate in the various services or plans, or
how to change options with respect thereto, can be obtained from the Fund, by
calling the telephone number on the cover page hereof, or from the Distributor
or Merrill Lynch, a selected securities dealer or other financial
intermediary. Certain of these services are available only to U.S. investors
and certain of these services are not available to investors who place orders
through the Merrill Lynch BlueprintSM Program.
Investment Account
Each shareholder whose account is maintained at the Transfer Agent
has an Investment Account and will receive statements, at least quarterly,
from the Transfer Agent. These statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
dividends. The statements will also show any other activity in the account
since the preceding statement. Shareholders will also receive separate
confirmations for each purchase or sale transaction other than automatic
investment purchases and the reinvestment of dividends. A shareholder with an
account held at the Transfer Agent may make additions to his or her Investment
Account at any time by mailing a check directly to the Transfer Agent. A
shareholder may also maintain an account through Merrill Lynch, a selected
securities dealer or other financial intermediary. Upon the transfer of shares
out of a Merrill Lynch brokerage account or an account maintained with a
selected securities dealer or other financial intermediary, an Investment
Account in the transferring shareholder's name may be opened automatically at
the Transfer Agent.
36
Share certificates are issued only for full shares and only upon the
specific request of a shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders may transfer their Fund shares from Merrill Lynch, a
securities dealer or other financial intermediary to another securities dealer
or other financial intermediary that has entered into an agreement with the
Distributor. Certain shareholder services may not be available for the
transferred shares. After the transfer, the shareholder may purchase
additional shares of funds owned before the transfer and all future trading of
these assets must be coordinated by the new firm. If a shareholder wishes to
transfer his or her shares to a securities dealer or other financial
intermediary that has not entered into an agreement with the Distributor, the
shareholder must either (i) redeem his or her shares, paying any applicable
CDSC or (ii) continue to maintain an Investment Account at the Transfer Agent
for those shares. The shareholder may also request the new securities dealer
or other financial intermediary to maintain the shares in an account at the
Transfer Agent registered in the name of the securities dealer or other
financial intermediary for the benefit of the shareholder whether the
securities dealer or other financial intermediary has entered into a selected
dealer agreement or not.
Shareholders considering transferring a tax-deferred retirement
account, such as an individual retirement account, from Merrill Lynch to
another securities dealer or other financial intermediary should be aware
that, if the firm to which the retirement account is to be transferred will
not take delivery of shares of the Fund, a shareholder must either redeem the
shares, paying any applicable CDSC, so that the cash proceeds can be
transferred to the account at the new firm, or such shareholder must continue
to maintain a retirement account at Merrill Lynch for those shares.
Exchange Privilege
U.S. shareholders of each class of shares of the Fund have an
exchange privilege with certain other Select Pricing Funds and Summit, which
is a Merrill Lynch-sponsored money market fund specifically designated for
exchange by holders of Class A, Class B, Class C and Class D shares of Select
Pricing Funds. Shares with a net asset value of at least $100 are required to
qualify for the exchange privilege and any shares utilized in an exchange must
have been held by the shareholder for at least 15 days. Before effecting an
exchange, shareholders should obtain a currently effective prospectus of the
fund into which the exchange is to be made. Exercise of the exchange privilege
is treated as a sale of the exchanged shares and a purchase of the acquired
shares for Federal income tax purposes.
Exchanges of Class A and Class D Shares. Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second Select
Pricing Fund if the shareholder holds any Class A shares of the second fund in
the account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class
A shareholder wants to exchange Class A shares for shares of a second Select
Pricing Fund, but does not hold Class A shares of the second fund in his or
her account at the time of the exchange and is not otherwise eligible to
acquire Class A shares of the second fund, the shareholder will receive Class
D shares of the second fund as a result of the exchange. Class D shares also
may be exchanged for Class A shares of a second Select Pricing Fund at any
time as long as, at the time of the exchange, the shareholder holds Class A
shares of the second fund in the account in which the exchange is made or is
otherwise eligible to purchase Class A shares of the second fund. Class D
shares are exchangeable with shares of the same class of other Select Pricing
Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding
Class A or Class D shares") for Class A or Class D shares of other Select
Pricing Funds or for Class A shares of Summit, ("new Class A or Class D
shares") are transacted on the basis of relative net asset value per Class A
or Class D share, respectively, plus an amount equal to the difference, if
any, between the sales charge previously paid on the outstanding Class A or
Class D shares and the sales charge payable at the time of the exchange on the
new Class A or Class D shares. With respect to outstanding Class A or Class D
shares as to which previous exchanges have taken place, the "sales charge
previously paid" shall include the aggregate of the sales charges paid with
respect to such Class A or Class D shares in the initial purchase and any
subsequent exchange. Class A or Class D shares issued pursuant to dividend
reinvestment are sold on a no-load basis in each of the funds offering Class A
or Class D shares. For purposes of the exchange privilege, Class A or Class D
shares acquired through dividend reinvestment shall be deemed to have been
sold with a sales charge equal to the sales charge previously paid on the
Class A or Class D shares on which the
37
dividend was paid. Based on this formula, Class A and Class D shares generally
may be exchanged into the Class A or Class D shares, respectively, of the
other funds with a reduced sales charge or without a sales charge.
Exchanges of Class B and Class C Shares. Certain Select Pricing Funds
with Class B or Class C shares outstanding ("outstanding Class B or Class C
shares") offer to exchange their Class B or Class C shares for Class B or
Class C shares, respectively, of certain other Select Pricing Funds or for
Class B shares of Summit ("new Class B or Class C shares") on the basis of
relative net asset value per Class B or Class C share, without the payment of
any CDSC that might otherwise be due on redemption of the outstanding shares.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares acquired through use
of the exchange privilege. In addition, Class B shares of the Fund acquired
through use of the exchange privilege will be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the
Class B shares of the fund from which the exchange has been made. For purposes
of computing the CDSC that may be payable on a disposition of the new Class B
or Class C shares, the holding period for the outstanding Class B or Class C
shares is "tacked" to the holding period of the new Class B or Class C shares.
For example, an investor may exchange Class B shares of the Fund for those of
Merrill Lynch Small Cap Value Fund, Inc. ("Small Cap Value Fund") after having
held the Fund's Class B shares for two and a half years. The 2% CDSC that
generally would apply to a redemption would not apply to the exchange. Three
years later the investor may decide to redeem the Class B shares of Small Cap
Value Fund and receive cash. There will be no CDSC due on this redemption,
since by "tacking" the two and a half year holding period of Fund Class B
shares to the three-year holding period for the Small Cap Value Fund Class B
shares, the investor will be deemed to have held the Small Cap Value Fund
Class B shares for more than five years.
Exchanges for Shares of a Money Market Fund. Class A and Class D
shares are exchangeable for Class A shares of Summit and Class B and Class C
shares are exchangeable for Class B shares of Summit. Class A shares of Summit
have an exchange privilege back into Class A or Class D shares of Select
Pricing Funds; Class B shares of Summit have an exchange privilege back into
Class B or Class C shares of Select Pricing Funds and, in the event of such an
exchange, the period of time that Class B shares of Summit are held will count
toward satisfaction of the holding period requirement for purposes of reducing
any CDSC and toward satisfaction of any Conversion Period with respect to
Class B shares. Class B shares of Summit will be subject to a distribution fee
at an annual rate of 0.75% of average daily net assets of such Class B shares.
This exchange privilege does not apply with respect to certain Merrill Lynch
fee-based programs for which alternative exchange arrangements may exist.
Please see your Merrill Lynch Financial Advisor for further information.
Prior to October 12, 1998, exchanges from the Fund and other Select
Pricing Funds into a money market fund were directed to certain Merrill
Lynch-sponsored money market funds other than Summit. Shareholders who
exchanged Select Pricing Fund shares for shares of such other money market
funds and subsequently wish to exchange those money market fund shares for
shares of the Fund will be subject to the CDSC schedule applicable to such
Fund shares, if any. The holding period for the money market fund shares will
not count toward satisfaction of the holding period requirement for reduction
of the CDSC imposed on such shares, if any, and, with respect to Class B
shares, toward satisfaction of the Conversion Period. However, the holding
period for Class B or Class C shares of the Fund received in exchange for such
money market fund shares will be aggregated with the holding period for the
fund shares originally exchanged for such money market fund shares for
purposes of reducing the CDSC or satisfying the Conversion Period.
Exchanges by Participants in the MFA Program. The exchange privilege
is modified with respect to certain retirement plans which participate in the
MFA Program. Such retirement plans may exchange Class B, Class C or Class D
shares that have been held for at least one year for Class A shares of the
same fund on the basis of relative net asset values in connection with the
commencement of participation in the MFA Program, i.e., no CDSC will apply.
The one-year holding period does not apply to shares acquired through
reinvestment of dividends. Upon termination of participation in the MFA
Program, Class A shares will be re-exchanged for the class of shares
originally held. For purposes of computing any CDSC that may be payable upon
redemption of Class B or Class C shares so reacquired, or the Conversion
Period for Class B shares so reacquired, the holding period for the Class A
shares will be "tacked" to the holding period for the Class B or Class C
shares originally held. The Fund's exchange privilege is also modified with
respect to purchases of Class A and Class D shares by non-retirement plan
investors under the MFA Program. First, the initial allocation of assets is
made under the MFA Program. Then, any subsequent exchange under the MFA
Program of Class A or Class D shares of a Select Pricing Fund for Class A or
38
Class D shares of the Fund will be made solely on the basis of the relative
net asset values of the shares being exchanged. Therefore, there will not be a
charge for any difference between the sales charge previously paid on the
shares of the other Select Pricing Fund and the sales charge payable on the
shares of the Fund being acquired in the exchange under the MFA Program.
Exercise of the Exchange Privilege. To exercise the exchange
privilege, a shareholder should contact his or her Merrill Lynch Financial
Advisor, who will advise the Fund of the exchange. Shareholders of the Fund,
and shareholders of the other Select Pricing Funds with shares for which
certificates have not been issued, may exercise the exchange privilege by wire
through their securities dealers or other financial intermediary. The Fund
reserves the right to require a properly completed Exchange Application.
Telephone exchange requests are also available in accounts held with
the Transfer Agent for amounts up to $50,000. To request an exchange from your
account, call the Transfer Agent at 1-800-MER-FUND. The request must be from
the shareholder of record. Before telephone requests will be honored,
signature approval from all shareholders of record must be obtained. The
shares being exchanged must have been held for at least 15 days. Telephone
requests for an exchange will not be honored in the following situations: the
accountholder is deceased, the request is by an individual other than the
accountholder of record, the account is held by joint tenants who are divorced
or the address on the account has changed within the last 30 days. Telephone
exchanges may be refused if the caller is unable to provide: the account
number, the name and address registered on the account and the social security
number registered on the account. The Fund or the Transfer Agent may
temporarily suspend telephone transactions at any time.
This exchange privilege may be modified or terminated in accordance
with the rules of the Commission. The Fund reserves the right to limit the
number of times an investor may exercise the exchange privilege. Certain funds
may suspend the continuous offering of their shares to the general public at
any time and may thereafter resume such offering from time to time. The
exchange privilege is available only to U.S. shareholders in states where the
exchange legally may be made. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
Fee-Based Programs
Certain fee-based programs, offered by Merrill Lynch and other
financial intermediaries, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit
the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of
shares held therein or the automatic exchange thereof to another class at net
asset value, which may be shares of a money market fund. In addition, upon
termination of participation in a Program, shares that have been held for less
than specified periods within such Program may be subject to a fee based upon
the current value of such shares. These Programs also generally prohibit such
shares from being transferred to another account at Merrill Lynch, to another
financial intermediary, to another broker-dealer or to the Transfer Agent.
Except in limited circumstances (which may also involve an exchange as
described above), such shares must be redeemed and another class of shares
purchased (which may involve the imposition of initial or deferred sales
charges and distribution and account maintenance fees) in order for the
investment not to be subject to Program fees. Additional information regarding
a specific Program (including charges and limitations on transferability
applicable to shares that may be held in such Program) is available in such
Program's client agreement and from the Transfer Agent at 1-800-MER-FUND or
1-800-637-3863.
Retirement and Education Savings Plans
Individual retirement accounts and other retirement and education
savings plans are available from Merrill Lynch. Under these plans, investments
may be made in the Fund and certain of the other mutual funds sponsored by
Merrill Lynch as well as in other securities. There may be fees associated
with investing through these plans. Merrill Lynch may charge an initial
establishment fee and an annual fee for each account. Information with respect
to these plans is available on request from Merrill Lynch.
39
Dividends received in each of the plans referred to above are exempt
from Federal taxation until distributed from the plans and, in the case of
Roth IRAs and education savings plans, may be exempt from taxation when
distributed, as well. Investors considering participation in any retirement or
education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the
establishment and maintenance of any such plan.
Automatic Investment Plans
A shareholder may make additions to an Investment Account at any time
by purchasing Class A shares (if he or she is an eligible Class A investor) or
Class B, Class C or Class D shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities
dealer, or by mail directly to the Transfer Agent, acting as agent for such
securities dealer. Voluntary accumulation also can be made through a service
known as the Fund's Automatic Investment Plan. Under the Automatic Investment
Plan, the Fund would be authorized, on a regular basis, to provide systematic
additions to the Investment Account of such shareholder through charges of $50
or more to the regular bank account of the shareholder by either
pre-authorized checks or automated clearing house debits. For investors who
buy shares of the Fund through Blueprint, no minimum charge to the investor's
bank account is required. Alternatively, an investor that maintains a CMA(R)
or CBA(R) Account may arrange to have periodic investments made in the Fund in
amounts of $100 ($1 or more for retirement accounts) or more through the
CMA(R) or CBA(R) Automated Investment Program.
Automatic Dividend Reinvestment Plan
Unless specific instructions are given as to the method of payment,
dividends will be automatically reinvested, without sales charge, in
additional full and fractional shares of the Fund. Such reinvestment will be
at the net asset value of shares of the Fund determined as of the close of
business on the NYSE on the monthly payment date for such dividends. No CDSC
will be imposed upon redemption of shares issued as a result of the automatic
reinvestment of dividends.
Shareholders may, at any time, elect to have subsequent dividends
paid in cash, rather than reinvested in shares of the Fund or vice versa
(provided that, in the event that a payment on an account maintained at the
Transfer Agent would amount to $10.00 or less, a shareholder will not receive
such payment in cash and such payment will automatically be reinvested in
additional shares). If the shareholder's account is maintained with the
Transfer Agent, he or she may contact the Transfer Agent in writing or by
telephone at 1-800-MER-FUND. For other accounts, the shareholder should
contact his or her Merrill Lynch Financial Advisor, selected securities dealer
or other financial intermediary. Commencing ten days after the receipt by the
Transfer Agent of such notice, those instructions will be effected. The Fund
is not responsible for any failure of delivery to the shareholder's address of
record and no interest will accrue on amounts represented by uncashed dividend
checks. Cash payments can also be directly deposited to the shareholder's bank
account.
Systematic Withdrawal Plan
A shareholder may elect to receive systematic withdrawals from his or
her Investment Account by check or through automatic payment by direct deposit
to his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders that have acquired
shares of the Fund having a value, based on cost or the current offering
price, of $5,000 or more, and monthly withdrawals are available for
shareholders with shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are
redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The shareholder may specify
the dollar amount and the class of shares to be redeemed. Redemptions will be
made at net asset value determined as of the close of business on the NYSE
(generally, the NYSE closes at 4:00 p.m., Eastern time) on the 24th day of
each month or the 24th day of the last month of each quarter, whichever is
applicable. If the NYSE is not open for business on such date, the shares will
be redeemed at the net asset value determined as of the close of business on
the NYSE on the following business day. The check for the withdrawal payment
will be mailed, or the direct deposit will be made, on the following business
day. When a shareholder is making systematic withdrawals, dividends on all
shares in the Investment Account are reinvested automatically in Fund shares.
A shareholder's systematic
40
withdrawal plan may be terminated at any time, without charge or penalty, by
the shareholder, the Fund, the Transfer Agent or the Distributor.
With respect to redemptions of Class B or Class C shares pursuant to
a systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed 10% of the
value of shares of such class in that account at the time the election to join
the systematic withdrawal plan was made. Any CDSC that otherwise might be due
on such redemption of Class B or Class C shares will be waived. Shares
redeemed pursuant to a systematic withdrawal plan will be redeemed in the same
order as Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares -- Deferred Sales Charge Alternatives -- Class B and Class C Shares."
Where the systematic withdrawal plan is applied to Class B shares, upon
conversion of the last Class B shares in an account to Class D shares, the
systematic withdrawal plan will be applied thereafter to Class D shares if the
shareholder so elects. If an investor wishes to change the amount being
withdrawn in a systematic withdrawal plan the investor should contact his or
her Merrill Lynch Financial Advisor.
Withdrawal payments should not be considered as dividends. Each
withdrawal is a taxable event. If periodic withdrawals continuously exceed
reinvested dividends, the shareholder's original investment may be reduced
correspondingly. Purchases of additional shares concurrent with withdrawals
are ordinarily disadvantageous to the shareholder because of sales charges and
tax liabilities. The Fund will not knowingly accept purchase orders for shares
of the Fund from investors that maintain a systematic withdrawal plan unless
such purchase is equal to at least one year's scheduled withdrawals or $1,200,
whichever is greater. Automatic investments may not be made into an Investment
Account in which the shareholder has elected to make systematic withdrawals.
Alternatively, a shareholder whose shares are held within a CMA(R) or
CBA(R) or Retirement Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA(R) or CBA(R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$50. The proceeds of systematic redemptions will be posted to the
shareholder's account three business days after the date the shares are
redeemed. All redemptions are made at net asset value. A shareholder may elect
to have his or her shares redeemed on the first, second, third or fourth
Monday of each month, in the case of monthly redemptions, or of every other
month, in the case of bimonthly redemptions. For quarterly, semiannual or
annual redemptions, the shareholder may select the month in which the shares
are to be redeemed and may designate whether the redemption is to be made on
the first, second, third or fourth Monday of the month. If the Monday selected
is not a business day, the redemption will be processed at net asset value on
the next business day. The CMA(R) or CBA(R) Systematic Redemption Program is
not available if Fund shares are being purchased within the account pursuant
to the Automated Investment Program. For more information on the CMA(R) or
CBA(R) Systematic Redemption Program, eligible shareholders should contact
their Merrill Lynch Financial Advisor.
DIVIDENDS AND TAXES
Dividends
The Fund intends to distribute substantially all of its net
investment income, if any. Dividends from such net investment income are paid
at least monthly. All net realized capital gains, if any, will be distributed
to the Fund's shareholders at least annually. From time to time, the Fund may
declare a special distribution at or about the end of the calendar year in
order to comply with Federal tax requirements that certain percentages of its
ordinary income and capital gains be distributed during the year. If in any
fiscal year, the Fund has net income from certain foreign currency
transactions, such income will be distributed at least annually.
For information concerning the manner in which dividends may be
reinvested automatically in shares of the Fund, see "Shareholder Services --
Automatic Dividend Reinvestment Plan". A shareholder may also elect in writing
to receive any such dividends in cash. Dividends are taxable to shareholders,
as discussed below, whether they are reinvested in shares of the Fund or
received in cash. The per share dividends on Class B and Class C shares will
be lower than the per share dividends on Class A and Class D shares as a
result of the account maintenance, distribution and higher transfer agency
fees applicable with respect to the Class B and Class C shares; similarly, the
per share dividends on Class D shares will be lower than the per share
dividends on Class A shares as a result of the account
41
maintenance fees applicable with respect to the Class D shares. See "Pricing
of Shares -- Determination of Net Asset Value."
Taxes
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (the "Code"). As long as it so qualifies, the Fund
(but not its shareholders) will not be subject to Federal income tax on the
part of its net ordinary income and net realized capital gains which it
distributes to Class A, Class B, Class C and Class D shareholders (together,
the "shareholders"). The Fund intends to distribute substantially all of such
income.
The Code requires a RIC to pay a nondeductible 4% excise tax to the
extent the RIC does not distribute, during each calendar year, 98% of its
ordinary income, determined on a calendar year basis, and 98% of its capital
gains, determined, in general, on an October 31 year end, plus certain
undistributed amounts from previous years. While the Fund intends to
distribute its income and capital gains in the manner necessary to minimize
imposition of the 4% excise tax, there can be no assurance that sufficient
amounts of the Fund's taxable income and capital gains will be distributed to
avoid entirely the imposition of the tax. In such event, the Fund will be
liable for the tax only on the amount by which it does not meet the foregoing
distribution requirements.
Dividends paid by the Fund from its ordinary income or from an excess
of net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in futures and options) ("capital gain
dividends") are taxable to shareholders as long-term capital gains, regardless
of the length of time the shareholder has owned Fund shares. Any loss upon the
sale or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. Distributions in excess of the Fund's earnings and profits
will first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Certain categories
of capital gains are taxable at different rates. Generally not later than 60
days after the close of its taxable year, the Fund will provide its
shareholders with a written notice designating the amounts of any capital gain
dividends, as well as the amount of capital gain dividends in different
categories of capital gain referred to above.
Dividends are taxable to shareholders even though they are reinvested
in additional shares of the Fund. Distributions by the Fund, whether from
ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code. If the Fund pays a
dividend in January which was declared in the previous October, November or
December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis
in the Class D shares acquired will be the same as such shareholder's basis in
the Class B shares converted, and the holding period of the acquired Class D
shares will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales
charge paid to the Fund on the exchanged shares reduces any sales charge the
shareholder would have owed upon the purchase of the new shares in the absence
of the exchange privilege. Instead, such sales charge will be treated as an
amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
42
Ordinary income dividends paid to shareholders who are nonresident
aliens or foreign entities will be subject to a 30% United States withholding
tax under existing provisions of the Code applicable to foreign individuals
and entities unless a reduced rate of withholding or a withholding exemption
is provided under applicable treaty law. Nonresident shareholders are urged to
consult their own tax advisers concerning the applicability of the United
States withholding tax.
Dividends and interest received by the Fund may give rise to
withholding and other taxes imposed by foreign countries. Tax conventions
between certain countries and the United States may reduce or eliminate such
taxes.
Under certain provisions of the Code, some shareholders may be
subject to a withholding tax on ordinary income dividends, capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account,
an investor must certify under penalty of perjury that such number is correct
and that the investor is not otherwise subject to backup withholding.
The Fund may make investments that produce taxable income that is not
matched by a corresponding receipt of cash or an offsetting loss deduction.
Such investments would include obligations that have original issue discount,
accrue discount or are subordinated in the mortgage-backed securities
structure. Such taxable income would be treated as income earned by the Fund
and would be subject to the distribution requirements of the Code. Because
such income may not be matched by a corresponding receipt of cash by the Fund
or an offsetting loss deduction, the Fund may be required to dispose of other
securities to be able to make distributions to shareholders. The Fund intends
to make sufficient and timely distributions to shareholders so as to qualify
for treatment as a RIC at all times.
Tax Treatment of Options and Futures
The Fund may write, purchase or sell options and futures. In general,
unless an election is available to the Fund or an exception applies, such
options and futures contracts that are "Section 1256 contracts" will be
"marked to market" for Federal income tax purposes at the end of each taxable
year (i.e., each such option or futures contract will be treated as sold for
its fair market value on the last day of the taxable year), and any gain or
loss attributable to Section 1256 contracts will be 60% long term and 40%
short term capital gain or loss. Application of these rules to Section 1256
contracts held by the Fund may alter the timing and character of distributions
to shareholders. The mark-to-market rules outlined above, however, will not
apply to certain transactions entered into by the Fund solely to reduce the
risk of changes in price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect
the taxation of the Fund's sales of securities and transactions in options and
futures contracts. Under Section 1092, the Fund may be required to postpone
recognition for tax purposes of losses incurred in certain sales of securities
and closing transactions in options and futures contracts.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to
state and local taxes.
Certain states exempt from state income taxation dividends paid by
RICs which are derived from interest on U.S. Government obligations. State law
varies as to whether dividend income attributable to U.S. Government
obligations is exempt from state income tax. In general, state law does not
consider income derived from MBSs to be income attributable to U.S. Government
obligations.
43
Shareholders are urged to consult their own tax advisers regarding
specific questions as to Federal, foreign, state or local taxes. Foreign
investors should consider applicable foreign taxes in their evaluation of an
investment in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total
return and other total return data in advertisements or information furnished
to present or prospective shareholders. Total return figures are based on the
Fund's historical performance and are not intended to indicate future
performance. Average annual total return is determined separately for Class A,
Class B, Class C and Class D shares in accordance with formulas specified by
the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on
net investment income and any realized and unrealized capital gains or losses
on portfolio investments over such periods) that would equate the initial
amount invested to the redeemable value of such investment at the end of each
period. Average annual total return is computed assuming all dividends are
reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class A and Class
D shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period as in the case of Class B and
Class C shares and the maximum sales charge in the case of Class A and D
shares.
The Fund also may quote annual, average annual and annualized total
return and aggregate total return performance data, both as a percentage and
as a dollar amount based on a hypothetical investment of $1,000 or some other
amount, for various periods other than those noted below. Such data will be
computed as described above, except that (1) as required by the periods of the
quotations, actual annual, annualized or aggregate data, rather than average
annual data, may be quoted and (2) the maximum applicable sales charges will
not be included with respect to annual or annualized rates of return
calculations. Aside from the impact on the performance data calculations of
including or excluding the maximum applicable sales charges, actual annual or
annualized total return data generally will be lower than average annual total
return data since the average rates of return reflect compounding of return;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time.
Set forth below is total return information for the Class A, Class B,
Class C and Class D shares of the Fund for the periods indicated.
Class D Shares
(formerly
Class A Shares Class B Shares Class C Shares Class A Shares)
-------------- -------------- -------------- --------------
Expressed as Expressed as Expressed as Expressed as
a percentage a percentage a percentage a percentage
based on a based on a based on a based on a
hypothetical hypothetical hypothetical hypothetical
$1,000 $1,000 $1,000 $1,000
Period investment investment investment investment
- ----------------------------------------------- -------------- -------------- -------------- --------------
Average Annual Total Return
(including maximum applicable sales charges)
One Year Ended August 31, 2001 7.29% 6.91% 9.86% 7.03%
Five Years Ended August 31, 2001 6.67% 6.72% 6.67% 6.40%
Ten Years Ended August 31, 2001 -- -- -- 6.17%
Inception (October 21, 1994) to August 31, 2001 7.19% -- 6.96% --
Inception (December 23, 1991) to August 31, 2001 -- 5.74% --
Total return figures are based on the Fund's historical performance
and are not intended to indicate future performance. The Fund's total return
will vary depending on market conditions, the securities comprising the Fund's
portfolio, the Fund's operating expenses and the amount of realized and
unrealized net capital gains or losses during the period. The value of an
investment in the Fund will fluctuate and an investor's shares, when redeemed,
may be worth more or less than their original cost.
44
In order to reflect the reduced sales charges in the case of Class A
or Class D shares, or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of
Shares," the total return data quoted by the Fund in advertisements directed
to such investors may take into account the reduced, and not the maximum,
sales charge or may not take into account the CDSC, and therefore may reflect
greater total return since, due to the reduced sales charges or the waiver of
CDSCs, a lower amount of expenses may be deducted.
On occasion, the Fund may compare its performance to various indices
including the Standard & Poor's 500 Index, the Dow Jones Industrial Average,
or to performance data published by Lipper Analytical Services, Inc.,
Morningstar Publications, Inc. ("Morningstar"), CDA Investment Technology,
Inc., Money Magazine, U.S. News & World Report, Business Week, Forbes
Magazine, Fortune Magazine or other industry publications. When comparing its
performance to a market index, the Fund may refer to various statistical
measures derived from the historic performance of the Fund and the index, such
as standard deviation and beta. In addition, from time to time, the Fund may
include its Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature.
The Fund may provide information designed to help investors
understand how the Fund is seeking to achieve its investment objectives. This
may include information about past, current or possible economic, market,
political or other conditions, descriptive information on general principles
of investing such as asset allocation, diversification and risk tolerance,
discussion of the Fund's portfolio composition, investment philosophy,
strategy or investment techniques, comparisons of the Fund's performance or
portfolio composition to that of other funds or types of investments, indices
relevant to the comparison being made, or to a hypothetical or model
portfolio. The Fund may also quote various measures of volatility and
benchmark correlation in advertising and other materials, and may compare
these measures to those of other funds or types of investments. As with other
performance data, performance comparisons should not be considered indicative
of the Fund's relative performance for any future period.
GENERAL INFORMATION
Description of Shares
The Fund was organized on July 20, 1984 under the laws of the
Commonwealth of Massachusetts and is a business entity commonly known as a
"Massachusetts business trust." It is a diversified, open-end investment
company. The Declaration of Trust of the Fund permits the Trustees to issue an
unlimited number of full and fractional shares of beneficial interest, par
value $0.10 per share, of different classes and to divide or combine the
shares into a greater or lesser number of shares without thereby changing the
proportionate beneficial interests in the Fund. At the date of this Statement
of Additional Information, the shares of the Fund are divided into four
classes, designated Class A, Class B, Class C and Class D shares. Class A,
Class B, Class C and Class D shares represent interests in the same assets of
the Fund and have identical voting, dividend, liquidation and other rights and
the same terms and conditions except that the Class B, Class C and Class D
shares bear certain expenses related to the account maintenance and/or
distribution of such shares and have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
The Fund has received an order from the Commission permitting the issuance and
sale of multiple classes of shares of beneficial interests. The Board of
Trustees of the Fund may classify and reclassify the shares of the Fund into
additional classes at a future date.
All shares of the Fund have equal voting rights, except that as noted
above, each class will have exclusive voting rights with respect to matters
relating to the expenses being born solely by such class. Each issued and
outstanding share is entitled to one vote and to participate equally in a
dividends and distributions declared by the Fund, and upon liquidation or
dissolution each share is entitled to receive its allocable share of the net
assets of the Fund remaining after satisfaction of outstanding liabilities,
except that, as noted above, expenses related to the distribution of each
class will be borne solely by such class. There normally will be no meetings
of shareholders for the purposes of electing Trustees unless and until such
time as less than a majority of the Trustees holding office have been elected
by shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees. The Fund also would be
required to hold a special shareholders' meeting to elect new Trustees at such
time as less than a majority of the Trustees holding office have been elected
by shareholders. The
45
Declaration of Trust provides that a shareholders' meeting may be called for
any reason at the request of 10% of the outstanding shares of the Fund or by a
majority of the Trustees. Shareholders may, in accordance with the terms of
the Declaration of Trust, cause a meeting of shareholders to be held for the
purpose of voting on the removal of Trustees. Also, the Fund will be required
to call a special meeting of shareholders in accordance with the requirements
of the Investment Company Act to seek approval of new management and advisory
arrangements, of a material increase in distribution fees or of a change in
the fundamental policies, objectives or restrictions of the Fund.
Shares of the Fund, when issued, will be fully paid and
nonassessable, have no preference, preemptive, exchange or similar rights, and
will be freely transferable. Redemption and conversion rights are discussed
elsewhere herein and in the Prospectus. Holders of shares of the Fund are
entitled to redeem their shares as set forth elsewhere herein and in the
Prospectus. Shares do not have cumulative voting rights and the holders of
more than 50% of the shares of the Fund voting for the election of Trustees
can elect all of the Trustees if they choose to do so and in such event the
holders of the remaining shares would not be able to elect any Trustees. No
amendment may be made to the Declaration of Trust without the affirmative vote
of a majority of the outstanding shares of the Fund.
Independent Auditors
Deloitte & Touche LLP, Two World Financial Center, New York, New York
10281 has been selected as the independent auditors of the Fund. The selection
of independent auditors is subject to approval by the non-interested Trustees
of the Fund. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
Accounting Services Provider
State Street Bank and Trust Company, 500 College Road East,
Princeton, New Jersey 08540, provides certain accounting services for the
Fund.
Custodian
The Bank of New York, (the "Custodian"), 15 Broad Street, New York,
New York 10286, acts as the custodian of the Fund's assets. Under its contract
with the Fund, the Custodian is authorized, among other things, to establish
separate accounts in foreign currencies and to cause foreign securities owned
by the Fund to be held in its offices outside of the United States and with
certain foreign banks and securities depositories. The Custodian is
responsible for safeguarding and controlling the Fund's cash and securities,
handling the receipt and delivery of securities and collecting interest and
dividends on the Fund's investments.
Transfer Agent
Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Fund's Transfer Agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Your Account -- How to Buy, Sell, Transfer and Exchange Shares -- Through the
Transfer Agent" in the Prospectus.
Legal Counsel
Sidley Austin Brown & Wood LLP, 875 Third Avenue, New York, New York
10022-6225, is counsel for the Fund.
Reports to Shareholders
The fiscal year of the Fund ends on August 31 of each year. The Fund
sends to its shareholders, at least semi-annually, reports showing the Fund's
portfolio and other information. An Annual Report, containing financial
statements audited by independent auditors, is sent to shareholders each year.
After the end of each year, shareholders will receive Federal income tax
information regarding dividends.
46
Shareholder Inquiries
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
Additional Information
The Prospectus and this Statement of Additional Information do not
contain all the information set forth in the Registration Statement and the
exhibits relating thereto, which the Fund has filed with the Securities and
Exchange Commission, Washington, D.C., under the Securities Act and the
Investment Company Act, to which reference is hereby made.
Under a separate agreement, ML & Co. has granted the Fund the right
to use the "Merrill Lynch" name and has reserved the right to withdraw its
consent to the use of such name by the Fund at any time or to grant the use of
such name to any other company, and the Fund has granted ML & Co. under
certain conditions, the use of any other name it might assume in the future,
with respect to any corporation organized by ML & Co.
Security Ownership of Certain Beneficial Owners
To the knowledge of the Fund, the following entities owned
beneficially or of record 5% or more of a class of the Fund's shares as of
December 14, 2001:
Name Address Percentage and Class
- ---------------------------- --------------------------- --------------------
MERRILL LYNCH TRUST COMPANY* 800 Scudders Mill Road 15% of Class A
TRUSTEE FBO HONDA OF AMERICA Plainsboro, NJ 08536
MFG., INC. SAVINGS PLAN
MERRILL LYNCH TRUST COMPANY* 800 Scudders Mill Road 9.7% of Class A
TTEE FBO Plainsboro, NJ 08536
WORLDCOM 401(K) SALARY SAVINGS
MERRILL LYNCH TRUST COMPANY* 800 Scudders Mill Road 6.6% of Class A
TRUSTEE FBO CHRYSLER HOURLY Plainsboro, NJ 08536
EMPLOYEES DEFERRED PAY PLAN
MERRILL LYNCH TRUST COMPANY* 800 Scudders Mill Road 10% of Class A
TRUSTEE FBO CHRYSLER SALARIED Plainsboro, NJ 08536
EMPLOYEES' SAVINGS PLAN
MERRILL LYNCH TRUST COMPANY* 800 Scudders Mill Road 9.2% of Class A
Plainsboro, NJ 08536
MERRILL LYNCH TRUST COMPANY* 800 Scudders Mill Road 46.4% of Class D
Plainsboro, NJ 08536
- ----------
* Merrill Lynch Trust Company is the record holder on behalf of certain
employee retirement, personal trust or savings plan accounts for which it acts
as trustee.
The Declaration of Trust establishing the Fund, dated July 20, 1984,
a copy of which, together with all amendments thereto (the "Declaration"), is
on file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name "Merrill Lynch U.S. Government Mortgage Fund" refers to
the Trustees under the Declaration collectively as Trustees, but not as
individuals or personally; and no Trustee, shareholder, officer, employee or
agent of the Fund shall be held to any personal liability, nor shall resort be
had to their private property for the satisfaction of any obligation or claim
of the Fund, but the "Trust Property" only shall be liable.
47
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Statement of
Additional Information by reference to its 2001 Annual Report. You may request
a copy of the Annual Report at no charge by calling 1-800-637-3863 between
8:00 a.m. and 8:00 p.m. Eastern time on any business day.
Code #10260-12-01
48
PART C
Item 23. Exhibits
Exhibit
Number Description
- -------- --------------------------------------------------------------------
1(a) -- Declaration of Trust of the Registrant, dated July 20, 1984.(a)
(b) -- Certification of Amendment, dated December 20, 1991, to
Declaration of Trust.(d)
(c) -- Instrument establishing Class A and Class B shares of the
Registrant.(d)
(d) -- Certification of Amendment, dated October 13, 1994, to Declaration
of Trust and Instrument establishing Class C and Class D shares of
the Registrant.(f)
(e) -- Certification of Amendment, dated April 18, 2000, to Declaration of
Trust.(m)
2(a) -- By-Laws of the Registrant.(a)
(b) -- Amended By-Laws of the Registrant.
3 -- Portions of the Declaration of Trust, and By-Laws of the Registrant
defining the rights of shareholders of the Registrant.(b)
4(a) -- Management Agreement between the Registrant and Fund Asset
Management, L.P.(e) (b) -- Supplement to Management Agreement between
the Registrant and Fund Asset Management, L.P.(f)
5(a) -- Form of Distribution Agreement between the Registrant and FAM
Distributors, Inc. (the "Distributor").(j)
6 -- None.
7 -- Custody Agreement between the Registrant and The Bank of New York.(c)
8(a)(1) -- Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between the Registrant and Financial Data
Services, Inc.(c)
(a)(2) -- Form of Amendment to the Transfer Agency, Dividend Disbursing Agency
and Shareholder Servicing Agency Agreement.(n)
(b) -- Amended and Restated Transfer Agency, Dividend Disbursing Agency and
Shareholder Servicing Agency Agreement between the Registrant and
Financial Data Services, Inc.(m)
(c) -- Second Amended and Restated Credit Agreement between the
Registrant and a syndicate of banks.(i)
9(a) -- Opinion of Brown &
Wood LLP, counsel to the Registrant.(c)
(b) -- Consent of Brown & Wood LLP, counsel to the Registrant.(h)
10 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
11 -- None.
12 -- Certificate of Fund Asset Management, Inc.(c)
13(a) -- Form of Amended and Restated Class B Distribution Plan of the
Registrant.(k)
(b) -- Form of Amended and Restated Class C
Distribution Plan of the Registrant.(k)
(c) -- Form of Amended and
Restated Class D Distribution Plan of the Registrant.(k)
14 -- Merrill Lynch Select PricingSM System Plan pursuant to Rule 18f-3.(g)
15 -- Code of Ethics.(1)
- ----------
(a) Filed on July 24, 1984, as an exhibit to the Pre-Effective Amendment to
the Registrant's Registration Statement on Form N-1A under the Securities
Act of 1933, as amended ("Registration Statement") and refiled with
Post-Effective Amendment No. 12 on December 21, 1995 pursuant to the
Electronic Data Gathering, Analysis and Retrieval ("EDGAR") requirements.
(b) Reference is made to Article II, Section 2.3 and Articles III, V, VI,
VIII, IX, X and XI of the Registrant's Declaration of Trust, filed as
Exhibit 1(a) to Post-Effective Amendment No. 12 to the Registrant's
Registration Statement under the Securities Act of 1933, as amended (the
"Registration C-1 Statement"); and to Articles I, V and VI of the
Registrant's By-Laws, filed as Exhibit 2 to Post-Effective Amendment No.
12 to the Registration Statement.
(c) Filed on August 21, 1984, as an Exhibit to Pre-Effective Amendment No. 1
to the Registrant's Registration Statement and refiled with Post-Effective
Amendment No. 12 on December 21, 1995 pursuant to EDGAR requirements.
C-1
(d) Filed on August 6, 1991 as an Exhibit to Post-Effective Amendment No. 8
to the Registrant's Registration Statement and refiled with
Post-Effective Amendment No. 12 on December 21, 1995 pursuant to EDGAR
requirements.
(e) Filed on December 23, 1993 as an Exhibit to Post-Effective Amendment No.
10 of the Registrant's Registration Statement.
(f) Filed on October 21, 1994 as an Exhibit to Post-Effective Amendment No.
11 of the Registrant's Registration Statement.
(g) Incorporated by reference to Post-Effective Amendment No. 13 to the
Registration Statement on Form N-1A of Merrill Lynch New York Municipal
Bond Fund of Merrill Lynch Multi-State Municipal Series Trust filed on
January 25, 1996.
(h) Filed on October 27, 1999 as an exhibit to Post-Effective Amendment No.
16 to the Registrant's Registration Statement.
(i) Incorporated by reference to Exhibit (b)(2) to the Issuer Tender Offer
Statement on Schedule TO of Merrill Lynch Senior Floating Rate Fund, Inc.
(File No. 333-39837), filed December 14, 2001.
(j) Incorporated by reference to Exhibit 5 of Post-Effective Amendment No. 12
to the Registration Statement on Form N-1A of Merrill Lynch Adjustable
Rate Securities Fund, Inc. (File No. 33-40332), filed on July 5, 2000.
(k) Incorporated by reference to Exhibit 13 of Post-Effective Amendment No.
14 to the Registration Statement on Form N-1A of Merrill Lynch Adjustable
Rate Securities Fund, Inc. (File No. 33-40332), filed on September 28,
2000.
(l) Incorporated by reference to Exhibit 15 to Post-Effective Amendment No. 9
to the Registration Statement on Form N-1A of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust (File No. 33-50417), filed on
November 22, 2000.
(m) Filed on November 29, 2000, as an Exhibit to Post-Effective Amendment No.
19 to the Registrant's Registration Statement.
(n) Incorporated by reference to Exhibit 8(a)(2) to Post-Effective Amendment
No. 11 to the Registration Statement on Form N-1A of Merrill Lynch
International Equity Fund (File No. 33-44917) filed on September 28,
2001.
Item 24. Persons Controlled by or Under Common Control with Registrant
The Registrant does not control and is not under common control with
any other person.
Item 25. Indemnification
Section 5.3 of the Registrant's Declaration of Trust provides as
follows:
"The Trust shall indemnify each of its Trustees, officers, employees,
and agents (including persons who serve as its request as directors, officers
or trustees of another organization in which it has any interest as a
shareholder, creditor or otherwise) against all liabilities and expenses
(including amounts paid in satisfaction of judgments, in compromise, as fines
and penalties, and as counsel fees) reasonably incurred by him in connection
with the defense or disposition of any action, suit or other proceeding,
whether civil or criminal, in which he may be involved or with which he may be
threatened, while in office or thereafter, by reason of his being or having
been such a trustee, officer, employee or agent, except with respect to any
matter as to which he shall have been adjudicated to have acted in bad faith,
willfull misfeasance, gross negligence or reckless disregard of his duties;
provided, however, that as to any matter disposed of by a compromise payment
by such person, pursuant to a consent decree or otherwise, no indemnification
either for said payment or for any other expenses shall be provided unless the
Trust shall have received a written opinion from independent legal counsel
approved by the Trustees to the effect that if either the matter of willful
misfeasance, gross negligence or reckless disregard of duty, or the matter of
good faith and reasonable belief as to the best interests of the Trust, had
been adjudicated, it would have been adjudicated in favor of such person. The
rights accruing to any Person under these provisions shall not exclude any
other right to which he may be lawfully entitled; provided that no Person may
satisfy any right of indemnity or reimbursement granted herein or in Section
5.1 or to which he may be otherwise entitled except out of the property of the
Trust, and no shareholder shall be personally liable to any Person with
respect to any claim for indemnity or reimbursement or otherwise. The Trustees
may make advance payments in connection with indemnification under this
Section 5.3, provided that the indemnified person shall have given a written
undertaking to reimburse the Trust in the event it is subsequently determined
that he is not entitled to such indemnification."
C-2
Insofar as the conditional advancing of indemnification moneys for
actions based upon the Investment Company Act of 1940 may be concerned, such
payments will be made only on the following conditions: (i) the advances must
be limited to amounts used, or to be used, for the preparation or presentation
of a defense to the action, including costs connected with the preparation of
a settlement; (ii) advances may be made only upon receipt of a written promise
by, or on behalf of, the recipient to repay less that amount of the advance
which exceeds the amount to which it is ultimately determined that he is
entitled to receive from the Registrant by reason of indemnification; and
(iii) (a) such promise must be secured by a surety bond, other suitable
insurance or an equivalent form of security which assures that any repayments
may be obtained by the Registrant without delay or litigation, which bond,
insurance or other form of security must be provided by the recipient of the
advance, or (b) a majority of a quorum of the Registrant's disinterested,
non-party Trustees, or an independent legal counsel in a written opinion,
shall determine, based upon a review of readily available facts, that the
recipient of the advance ultimately will be found entitled to indemnification.
In Section 9 of the Distribution Agreement relating to the securities
being offered hereby, the Registrant agrees to indemnify the Distributor and
each person, if any, who controls the Distributor within the meaning of the
Securities Act of 1933, as amended (the "Act") against certain types of civil
liabilities arising in connection with the Registration Statement or
Prospectus and Statement of Additional Information.
Insofar as indemnification for liabilities arising under the Act may
be permitted to Trustees, officers and controlling persons of the Registrant
and the principal underwriter pursuant to the foregoing provisions or
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a Trustee, officer
or controlling person of the Registrant and the principal underwriter in
connection with the successful defense of any action, suit or proceeding) is
asserted by such Trustee, officer or controlling person or the principal
underwriter in connection with the shares being registered, the Registrant
will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
Item 26. Business and Other Connections of the Manager
Fund Asset Management, L.P. ("FAM" or the "Manager"), acts as the
investment adviser for the following open-end registered investment companies:
CBA Money Fund, CMA Government Securities Fund, CMA Money Fund, CMA
Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund,
Financial Institutions Series Trust, Master Basic Value Trust, Master Focus
Twenty Trust, Master Large Cap Series Trust, Master Mid Cap Growth Trust,
Master Premier Growth Trust, Master Small Cap Value Trust, Master U.S. High
Yield Trust, Mercury Global Holdings, Inc., Mercury HW Funds, Mercury Senior
Floating Rate Fund, Inc., Merrill Lynch Bond Fund, Inc., Merrill Lynch
California Municipal Series Trust, Merrill Lynch U.S. High Yield Fund, Inc.,
Merrill Lynch Focus Value Fund, Inc., Merrill Lynch Funds for Institutions
Series, Merrill Lynch Multi-State Limited Maturity Municipal Series Trust,
Merrill Lynch Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond
Fund, Inc., Merrill Lynch U.S. Government Mortgage Fund, Merrill Lynch World
Income Fund, Inc., The Asset Program, Inc., The Corporate Fund Accumulation
Program, Inc., and The Municipal Fund Accumulation Program, Inc.; and for the
following closed-end registered investment companies: Apex Municipal Fund,
Inc., Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc.,
Corporate High Yield Fund III, Inc., Corporate High Yield Fund IV, Inc., Debt
Strategies Fund, Inc., Master Senior Floating Rate Trust, Merrill Lynch
Municipal Strategy Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund, Inc.,
MuniHoldings Fund, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings Florida Insured Fund, MuniHoldings Insured Fund, Inc.,
MuniHoldings Insured Fund II, Inc., MuniHoldings Michigan Insured Fund II,
Inc., MuniHoldings New Jersey Insured Fund, Inc., MuniHoldings New York
Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund
II, Inc., MuniYield Arizona Fund, Inc., MuniYield California Fund, Inc.,
MuniYield California Insured Fund, Inc., MuniYield California Insured Fund II,
Inc., MuniYield Florida Fund, MuniYield Florida Insured Fund, MuniYield Fund,
Inc., MuniYield Insured Fund, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield
Pennsylvania Insured Fund, MuniYield Quality Fund, Inc., MuniYield Quality
Fund II, Inc., and Senior High Income Portfolio, Inc.
C-3
Merrill Lynch Investment Managers, L.P. ("MLIM"), an affiliate of the
Manager, acts as the investment adviser for the following open-end registered
investment companies: Global Financial Services Master Trust, Merrill Lynch
Balanced Capital Fund, Inc., Merrill Lynch Developing Capital Markets Fund,
Inc., Merrill Lynch Disciplined Equity Fund, Inc., Merrill Lynch Dragon Fund,
Inc., Merrill Lynch Emerging Capital Market Debt Fund, Inc., Merrill Lynch
Equity Income Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fundamental
Growth Fund, Inc., Merrill Lynch Global Allocation Fund, Inc., Merrill Lynch
Global Bond Fund for Investment and Retirement, Merrill Lynch Global Growth
Fund, Inc., Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch Global
Technology Fund, Inc., Merrill Lynch Global Value Fund, Inc., Merrill Lynch
Growth Fund, Merrill Lynch Healthcare Fund, Inc., Merrill Lynch Index Funds,
Inc., Merrill Lynch International Equity Fund, Merrill Lynch Latin America
Fund, Inc., Merrill Lynch Municipal Series Trust, Merrill Lynch Natural
Resources Trust, Merrill Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets
Trust, Merrill Lynch Retirement Series Trust, Merrill Lynch Series Fund, Inc.,
Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch Short Term
U.S. Government Fund, Inc., Merrill Lynch U.S. Treasury Money Fund, Merrill
Lynch U.S.A. Government Reserves, Merrill Lynch Utilities and
Telecommunications Fund, Inc., Merrill Lynch Variable Series Funds, Inc., and
The Asset Program, Inc. and Hotchkis and Wiley Funds (advised by Hotchkis and
Wiley, a division of MLIM); and for the following closed-end registered
investment companies: Merrill Lynch Senior Floating Rate Fund, Inc. and S&P
500(R) Protected Equity Fund, Inc. MLIM also acts as sub-adviser to Merrill
Lynch World Strategy Portfolio and Merrill Lynch Basic Value Equity Portfolio,
two investment portfolios of EQ Advisors Trust.
The address of each of these registered investment companies is P.O. Box
9011, Princeton, New Jersey 08543-9011, except that the address of Merrill
Lynch Funds for Institutions Series is One Financial Center, 23rd Floor,
Boston, Massachusetts 02111-2665. The address of the Manager, MLIM, Princeton
Services, Inc. ("Princeton Services") and Princeton Administrators, L.P.
("Princeton Administrators") is also P.O. Box 9011, Princeton, New Jersey
08543-9011. The address of FAM Distributors, Inc. ("FAMD") is P.O. Box 9081,
Princeton, New Jersey 08543-9081. The address of Merrill Lynch, Pierce, Fenner
& Smith Incorporated ("Merrill Lynch") and ML & Co. is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536. The address of the Fund's transfer agent,
Financial Data Services, Inc. ("FDS"), is 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner of
the Manager indicating each business, profession, vocation or employment of a
substantial nature in which each such person or entity has been engaged since
September 1, 1999 for his, her or its own account or in the capacity of
director, officer, partner or trustee. In addition, Mr. Glenn is President and
Mr. Burke is Vice President and Treasurer of all or substantially all of the
investment companies described in the first two paragraphs of this Item 26,
and Messrs. Doll and Giordano are officers of one or more of such companies.
Position(s) with the Other Substantial Business,
Name Manager Profession, Vocation or Employment
ML & Co. Limited Partner Financial Services Holding Company; Limited Partner of
MLIM
Princeton Services General Partner General Partner of MLIM
Robert C. Doll, Jr. President President of MLIM; Co-Head (Americas Region) of the
Manager and MLIM from 2000 to 2001 and Sr. Vice
President thereof from 1999 to 2000; Director of
Princeton Services; Chief Investment Officer of
Oppenheimer Funds, Inc. in 1999 and Executive Vice
President thereof from 1991 to 1999
Terry K. Glenn Chairman (Americas Region) Executive Vice President of MLIM; Executive Vice
and Executive Vice President President and Director of Princeton Services; President
and Director of FAMD; President of Merrill Lynch Mutual
Funds; Director of FDS; President of Princeton
Administrators
Donald C. Burke First Vice President, First Vice President and Treasurer of MLIM; Senior Vice
Treasurer and Director of President and Treasurer of Princeton Services; Vice
Taxation President of FAMD
C-4
Position(s) with the Other Substantial Business,
Name Manager Profession, Vocation or Employment
Vincent R. Giordano First Vice President First Vice President of MLIM; Senior Vice President of
Princeton Services
Philip L. Kirstein General Counsel (Americas General Counsel (Americas Region) of MLIM; Senior Vice
Region) President, Secretary, General Counsel and Director of
Princeton Services
Debra W. Landsman-Yaros Senior Vice President Senior Vice President of MLIM; Senior Vice President of
Princeton Services; Vice President of FAMD
Stephen M. M. Miller Senior Vice President Executive Vice President of Princeton Administrators;
Senior Vice President of Princeton Services
Mary E. Taylor Head (Americas Region) Head (Americas Region) of MLIM; Senior Vice President of
ML & Co.; President and Chief Operating Officer of MLIM
Canada
Item 27. Principal Underwriters
(a) FAMD acts as the principal underwriter for the Registrant and for
each of the open-end registered investment companies referred to in the first
two paragraphs of Item 26 except CBA Money Fund, CMA Government Securities
Fund, CMA Money Fund, CMA Multi-State Municipal Series Trust, CMA Tax-Exempt
Fund, CMA Treasury Fund, Global Financial Services Trust, Master Basic Value
Trust, Master Focus Twenty Trust, Master Large Cap Series Trust, Master
Premier Growth Trust, Master Small Cap Value Trust, Master U.S. High Yield
Trust, The Corporate Fund Accumulation Program, Inc. and The Municipal Fund
Accumulation Program. Inc. FAMD acts as the principal underwriter for each of
the following additional open-end registered investment companies: Mercury
Basic Value Fund, Inc., Mercury Focus Twenty Fund, Inc., Mercury Global
Balanced Fund of Mercury Funds, Inc., Mercury Global Financial Services Fund,
Inc., Mercury Gold and Mining Fund of Mercury Funds, Inc., Mercury
International Fund of Mercury Funds, Inc., Mercury Large Cap Series Funds,
Inc., Mercury Pan-European Growth Fund of Mercury Funds, Inc., Mercury Premier
Growth Fund, Inc., Mercury Small Cap Value Fund, Inc., Mercury U.S. High Yield
Fund, Inc., Summit Cash Reserves Fund of Financial Institutions Series Trust,
Merrill Lynch Basic Value Fund, Inc., Merrill Lynch Focus Twenty Fund, Inc.,
Merrill Lynch Global Financial Services Fund, Inc., Merrill Lynch Large Cap
Growth Focus Fund of Mercury V.I. Funds, Inc., Merrill Lynch Large Cap Series
Funds, Inc., Merrill Lynch Mid Cap Growth Fund, Inc., Merrill Lynch Premier
Growth Fund, Inc., Merrill Lynch Small Cap Value Fund, Inc. and Merrill Lynch
U.S. High Yield Fund, Inc. FAMD also acts as the principal underwriter for the
following closed-end registered investment companies: Mercury Senior Floating
Rate Fund, Inc., Merrill Lynch High Income Municipal Bond Fund Inc., Merrill
Lynch Municipal Strategy Fund, Inc., Merrill Lynch Senior Floating Rate Fund,
Inc. and Merrill Lynch Senior Floating Rate Fund II, Inc.
(b) Set forth below is information concerning each director and
officer of FAMD. The principal business address of each such person is P.O.
Box 9081, Princeton, New Jersey 08543-9081, except that the address of Messrs.
Breen, Fatseas and Wasel is One Financial Center, 23rd Floor, Boston,
Massachusetts 02111-2665.
Name Position(s) and Office(s) Position(s) and Office(s)
with FAMD with Registrant
Terry K. Glenn President and Director President and Trustee
Michael G. Clark Treasurer and Director None
Thomas J. Verage Director None
Michael J. Brady Vice President None
William M. Breen Vice President None
Donald C. Burke Vice President Vice President and
Treasurer
James T. Fatseas Vice President None
Debra W. Landsman-Yaros Vice President None
William Wasel Vice President None
Robert Harris Secretary None
C-5
(c) Not applicable.
Item 28. Location of Accounts and Records
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended (the "1940
Act") and the rules thereunder are maintained at the offices of the Registrant
(800 Scudders Mill Road, Plainsboro, New Jersey 08536), and its transfer
agent, Financial Data Services, Inc. (4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484).
Item 29. Management Services
Other than as set forth under the caption "Management of the Fund -- Fund
Asset Management" in the Prospectus constituting Part A of the Registration
Statement and under "Management of the Fund -- Management and Advisory
Arrangements" in the Statement of Additional Information constituting Part B
of the Registration Statement, the Registrant is not a party to any
management-related service contract.
Item 30. Undertakings.
Not applicable.
C-6
SIGNATURES
Pursuant to the requirements of the Securities Act and the Investment
Company Act, the Registrant certifies that it meets all the requirements for
effectiveness of this Registration Statement under Rule 485(b) under the
Securities Act and has duly caused this Registration Statement to be signed on
its behalf by the undersigned, duly authorized, in the Township of Plainsboro,
and State of New Jersey, on the 19th day of December, 2001.
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
(Registrant)
By/s/ DONALD C. BURKE
- -----------------------------------------------------
(Donald C. Burke, Vice President and Treasurer)
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to the Registration Statement has been signed below
by the following persons in the capacities and on the dates indicated.
Signature Title Date
TERRY K. GLENN* President and Trustee (Principal
Executive Officer)
- ---------------------------------
(Terry K. Glenn)
DONALD C. BURKE* Vice President and Treasurer
(Principal Financial and Accounting
- --------------------------------- Officer)
(Donald C. Burke)
JOE GRILLS* Trustee
- ---------------------------------
(Joe Grills)
ROBERT S. SALOMON, JR.* Trustee
- ---------------------------------
(Robert S. Salomon, Jr.)
MELVIN R. SEIDEN* Trustee
- ---------------------------------
(Melvin R. Seiden)
STEPHEN B. SWENSRUD* Trustee
- ---------------------------------
(Stephen B. Swensrud)
*By: /s/ DONALD C. BURKE December 19, 2001
- ---------------------------------
(Donald C. Burke, Attorney-in-Fact)
C-7
EXHIBIT INDEX
Exhibit
Number Description
- --------- -----------------------------------------------------------------
2(b) -- Amended and Restated By-Laws of the Registrant.
10 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
Exhibit 2(b)
[Revised and Effective April 11, 200l]
BY-LAWS
OF
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND
BY-LAWS
These By-Laws are made and adopted pursuant to Section 2.6 of the
Declaration of Trust establishing MERRILL LYNCH U.S. GOVERNMENT MORTGAGE FUND,
dated July 20, 1984, as from time to time amended (hereinafter called the
"Declaration"). All words and terms capitalized in these By-Laws shall have
the meaning or meanings set forth for such words or terms in the Declaration.
ARTICLE I
Shareholder Meetings
Section 1.1. Chairman. The Chairman, if any, shall act as chairman at
all meetings of the Shareholders; in his absence, the President shall act as
chairman; and in the absence of the Chairman and President, the Trustee or
Trustees present at each meeting may elect a temporary chairman for the
meeting, who may be one of themselves.
Section 1.2. Proxy Representation; Voting. Shareholders may vote
either in person or by duly executed proxy and each full share represented at
the meeting shall have one vote, all as provided in Article X of the
Declaration. A Shareholder may cast or authorize the casting of a vote by
filing a written appointment of a proxy with an officer of the Trust at or
before the meeting at which the appointment is to be effective. A Shareholder
may also authorize the casting of a vote by proxy pursuant to telephonic or
electronically transmitted instructions (including, without limitation,
instructions transmitted over the Internet) obtained pursuant to procedures
which are reasonably designed to verify that such instructions have been
authorized by such Shareholder. The appointment of a proxy is valid for eleven
months, unless a longer period is expressly provided in the appointment. No
appointment is irrevocable unless the appointment is coupled with an interest
in the Shares or in the Trust. Any copy, facsimile telecommunication or other
reliable reproduction of a proxy may be substituted for or used in lieu of the
original proxy for any and all purposes for which the original proxy could be
used, provided that such copy, facsimile telecommunication or other
reproduction shall be a complete reproduction of the entire original proxy or
the portion thereof to be returned by the Shareholder.
Section 1.3. Closing of Transfer Books and Fixing Record Dates. For
the purpose of determining the Shareholders who are entitled to notice of or
to vote or act at any meeting, including any adjournment thereof, or who are
entitled to participate in any dividends, or for any other proper purpose, the
Trustees may from time to time close the transfer books or fix a record date
in the manner provided in Section 10.4 of the Declaration. If the Trustees do
not prior to any meeting of Shareholders so fix a record date or close the
transfer books, then the date of mailing notice of the meeting or the date
upon which the dividend resolution is adopted, as the case may be, shall be
the record date.
Section 1.4. Inspectors of Election. In advance of any meeting of
Shareholders, the Trustees may appoint Inspectors of Election to act at the
meeting or any adjournment thereof. If Inspectors of Election are not so
appointed, the Chairman, if any, of any meeting of Shareholders may, and on
the request of any Shareholder or his proxy shall, appoint Inspectors of
Election of the meeting. The number of Inspectors shall be either one or
three. If appointed at the meeting on the request of one or more Shareholders
or proxies, a majority of Shares present shall determine whether one or three
Inspectors are to be appointed, but failure to allow such determination by the
Shareholders shall not affect the validity of the appointment of Inspectors of
Election. In case any person appointed as Inspector fails to appear or fails
or refuses to act, the vacancy may be filled by appointment made by the
Trustees in advance of the convening of the meeting or at the meeting by the
person acting as chairman. The Inspectors of Election shall determine the
number of Shares outstanding, the Shares represented at the meeting, the
existence of a quorum, the authenticity, validity and effect of proxies, shall
receive votes, ballots or consents, shall hear and determine all challenges
and questions in any way arising in connection with the right to vote, shall
count and tabulate all votes or consents, determine the results, and do such
other acts as may be proper to conduct the election or vote with fairness to
all Shareholders. If there are three Inspectors of Election, the decision, act
or certificate of a majority is effective in all respects as the decision, act
or certificate of all. On request of the Chairman, if any, of the meeting, or
of any Shareholder or his proxy, the Inspectors of Election shall make a
report in writing of any challenge or question or matter determined by them
and shall execute a certificate of any facts found by them.
Section 1.5. Records at Shareholder Meetings. At each meeting of the
Shareholders there shall be open for inspection the minutes of the last
previous Shareholder Meeting of the Trust and a list of the Shareholders of
the Trust, certified to be true and correct by the Secretary or other proper
agent of the Trust, as of the record date of the meeting or the date of
closing of transfer books, as the case may be. Such list of Shareholders shall
contain the name of each Shareholder in alphabetical order and the address and
number of Shares owned by such Shareholder. Shareholders shall have such other
rights and procedures of inspection of the books and records of the Trust as
are granted to shareholders of a Massachusetts business corporation.
ARTICLE II
Trustees
Section 2.1. Annual and Regular Meetings. The Trustees shall hold an
annual meeting for the election of officers and the transaction of other
business which may come before such meeting, on such date as shall be fixed by
the Trustees from time to time. Regular meetings of the Trustees may be held
without call or notice at such place or places and times as the Trustees may
by resolution provide from time to time.
Section 2.2. Special Meetings. Special Meetings of the Trustees shall
be held upon the call of the Chairman, if any, the President, the Secretary or
any two Trustees, at such time, on such day, and at such place, as shall be
designated in the notice of the meeting.
Section 2.3. Notice. Notice of a meeting shall be given by mail or by
telegram (which term shall include a cablegram) or delivered personally. If
notice is given by mail, it shall be mailed not later than 48 hours preceding
the meeting and if given by telegram or personally, such telegram shall be
sent or delivery made not later than 48 hours preceding the meeting. Notice by
telephone shall constitute personal delivery for these purposes. Notice of a
meeting of Trustees may be waived before or after any meeting by signed
written waiver. Neither the business to be transacted at, nor the purpose of,
any meeting of the Board of Trustees need be stated in the notice or waiver of
notice of such meeting, and no notice need be given of action proposed to be
taken by unanimous written consent. The attendance of a Trustee at a meeting
shall constitute a waiver of notice of such meeting except where a Trustee
attends a meeting for the express purpose of objecting to the transaction of
any business on the ground that the meeting has not been lawfully called or
convened.
Section 2.4. Chairman; Records. The Chairman, if any, shall act as
chairman at all meetings of the Trustees; in his absence the President shall
act as chairman; and, in the absence of the Chairman and the President, the
Trustees present shall elect one of their number to act as temporary chairman.
The results of all actions taken at a meeting of the Trustees, or by unanimous
written consent of the Trustees, shall be recorded by the Secretary.
ARTICLE III
Officers
Section 3.1. Officers of the Trust. The officers of the Trust shall
consist of a Chairman, if any, a President, a Secretary, a Treasurer and such
other officers or assistant officers, including Vice-Presidents, as may be
elected by the Trustees. Any two or more of the offices may be held by the
same person, except that the same person may not be both President and
Secretary. The Trustees may designate a Vice-President as an Executive
Vice-President and may designate the order in which the other Vice-Presidents
may act. The Chairman and the President shall be Trustees, but no other
officer of the Trust need be a Trustee.
Section 3.2. Election and Tenure. At the initial organization meeting
and thereafter at each annual meeting of the Trustees, the Trustees shall
elect the Chairman, if any, President, Secretary, Treasurer and such other
officers as the Trustees shall deem necessary or appropriate in order to carry
out the business of the Trust. Such officers shall hold office until the next
annual meeting of the Trustees and until their successors have been duly
elected and qualified. The Trustees may till any vacancy in office or add any
additional officers at any time.
Section 3.3. Removal of Officers. Any officer may be removed at any
time, with or without cause, by action of a majority of the Trustees. This
provision shall not prevent the making of a contract of employment for a
definite term with any officer and shall have no effect upon any cause of
action which any officer may have as a result of removal in breach of a
contract of employment. Any officer may resign at any time by notice in
writing signed by such officer and delivered or mailed to the Chairman, if
any, President, or Secretary, and such resignation shall take effect
immediately upon receipt by the Chairman, if any, President, or Secretary, or
at a later date according to the terms of such notice in writing.
Section 3.4. Bonds and Surety. Any officer may be required by the
Trustees to be bonded for the faithful performance of his duties in such
amount and with such sureties as the Trustees may determine.
Section 3.5. Chairman, President, and Vice-Presidents. The Chairman,
if any, shall, if present, preside at all meetings of the Shareholders and of
the Trustees and shall exercise and perform such other powers and duties as
may be from time to time assigned to him by the Trustees. Subject to such
supervisory powers, if any, as may be given by the Trustees to the Chairman,
if any, the President shall be the chief executive officer of the Trust and,
subject to the control of the Trustees, shall have general supervision,
direction and control of the business of the Trust and of its employees and
shall exercise such general powers of management as are usually vested in the
office of President of a corporation. In the absence of the Chairman, if any,
the President shall preside at all meetings of the Shareholders and of the
Trustees. The President shall be, ex-officio, a member of all standing
committees, except as otherwise provided in the resolutions or instruments
creating any such committees. Subject to direction of the Trustees, the
Chairman, if any, and the President shall each have power in the name and on
behalf of the Trust to execute any and all loan documents, contracts,
agreements, deeds, mortgages, and other instruments in writing, and to employ
and discharge employees and agents of the Trust. Unless otherwise directed by
the Trustees, the Chairman, if any, and the President shall each have full
authority and power, on behalf of all of the Trustees, to attend and to act
and to vote, on behalf of the Trust at any meetings of business organizations
in which the Trust holds an interest, or to confer such powers upon any other
persons, by executing any proxies duly authorizing such persons. The Chairman,
if any, and the President shall have such further authorities and duties as
the Trustees shall from time to time determine. In the absence or disability
of the President, the Vice-Presidents in order of their rank as fixed by the
Trustees or, if more than one and not ranked, the Vice-President designated by
the Trustees, shall perform all of the duties of the President, and when so
acting shall have all the powers of and be subject to all of the restrictions
upon the President. Subject to the direction of the Trustees, and of the
President, each Vice-President shall have the power in the name and on behalf
of the Trust to execute any and all loan documents, contracts, agreements,
deeds, mortgages and other instruments in writing, and, in addition, shall
have such other duties and powers as shall be designated from time to time by
the Trustees or by the President.
Section 3.6. Secretary. The Secretary shall keep the minutes of all
meetings of, and record all votes of, Shareholders, Trustees and the Executive
Committee, if any. He shall be custodian of the seal of the Trust, if any, and
he (and any other person so authorized by the Trustees) shall affix the seal
or, if permitted, a facsimile thereof, to any instrument executed by the Trust
which would be sealed by a Massachusetts corporation executing the same or a
similar instrument and shall attest the seal and the signature or signatures
of the officer or officers executing such instrument on behalf of the Trust.
The Secretary shall also perform any other duties commonly incident to such
office in a Massachusetts business corporation, and shall have such other
authorities and duties as the Trustees shall from time to time determine.
Section 3.7. Treasurer. Except as otherwise directed by the Trustees,
the Treasurer shall have the general supervision of the monies, funds,
securities, notes receivable and other valuable papers and documents of the
Trust, and shall have and exercise under the supervision of the Trustees and
of the President all powers and duties normally incident to his office. He may
endorse for deposit or collection all notes, checks and other instruments
payable to the Trust or to its order. He shall deposit all funds of the Trust
in such depositories as the Trustees shall designate. He shall be responsible
for such disbursement of the funds of the Trust as may be ordered by the
Trustees or the President. He shall keep accurate account of the books of the
Trust's transactions which shall be the property of the Trust, and which
together with all other property of the Trust in his possession, shall be
subject at all times to the inspection and control of the Trustees. Unless the
Trustees shall otherwise determine, the Treasurer shall be the principal
accounting officer of the Trust and shall also be the principal financial
officer of the Trust. He shall have such other duties and authorities as the
Trustees shall from time to time determine. Notwithstanding anything to the
contrary herein contained, the Trustees may authorize any adviser,
administrator, manager or transfer agent to maintain bank accounts and deposit
and disburse funds of the Trust.
Section 3.8. Other Officers and Duties. The Trustees may elect such
other officers and assistant officers as they shall from time to time
determine to be necessary or desirable in order to conduct the business of the
Trust. Assistant officers shall act generally in the absence of the officer
whom they assist and shall assist that officer in the duties of his office.
Each officer, employee and agent of the Trust shall have such other duties and
authority as may be conferred upon him by the Trustees or delegated to him by
the President.
ARTICLE IV
Miscellaneous
Section 4.1. Custodians. In accordance with Section 7.1 of the
Declaration, the funds of the Trust shall be deposited with such custodian or
custodians as the Trustees shall designate and shall be drawn out on checks,
drafts or other orders signed by such officer, officers, agent or agents
(including any adviser, administrator or manager), as the Trustees may from
time to time authorize.
Section 4.2. Signatures. All contracts and other instruments shall be
executed on behalf of the Trust by such officer, officers, agent or agents, as
provided in these By-Laws or as the Trustees may from time to time by
resolution provide.
Section 4.3. Seal. The seal of the Trust, if any, may be affixed to
any document, and the seal and its attestation may be lithographed, engraved
or otherwise printed on any document with the same force and effect as if it
had been imprinted and attested manually in the same manner and with the same
effect as if done by a Massachusetts business corporation.
ARTICLE V
Share Certificates and Share Transfers
Section 5.1. Share Certificates. Each holder of Shares of the Trust
shall be entitled upon request to have a certificate or certificates, in such
form as shall be approved by the Trustees, representing the number of Shares
owned by him, provided, however, that certificates for fractional Shares shall
not be delivered in any case. The certificates representing Shares shall be
signed by or in the name of the Trust by the President or a Vice-President and
by the Secretary or an Assistant Secretary or the Treasurer or an Assistant
Treasurer and sealed with the seal of the Trust. Any or all of the signatures
or the seal on the certificate may be a facsimile. In case any officer,
transfer agent or registrar who has signed or whose facsimile signature has
been placed upon a certificate shall have ceased to be such officer, transfer
agent or registrar before such certificate shall be issued, it may be issued
by the Trust with the same effect as if such officer, transfer agent or
registrar were still in office at the date of issue.
Section 5.2. Transfer Agents, Registrars and the Like. As provided in
Section 6.6 of the Declaration, the Trustees shall have authority to employ
and compensate such transfer agents and registrars with respect to the Shares
of the Trust as the Trustees shall deem necessary or desirable and may require
all certificates for Shares to bear the signature or signatures of any of
them. In addition, the Trustees shall have power to employ and compensate such
dividend disbursing agents, warrant agents and agents for the reinvestment of
dividends as they shall deem necessary or desirable. Any of such agents shall
have such power and authority as is delegated to any of them by the Trustees.
Section 5.3. Transfer of Shares. The Shares of the Trust shall be
transferable on the books of the Trust only upon delivery to the Trustees or a
transfer agent of the Trust of proper documentation as provided in Section 6.7
of the Declaration, and on surrender of the certificate or certificates, if
issued, for such Shares properly endorsed or accompanied by a duly executed
stock transfer power and the payment of all taxes thereon. The Trust, or its
transfer agents, shall be authorized to refuse any transfer unless and until
presentation of such evidence as may be reasonably required to show that the
requested transfer is proper.
Section 5.4. Registered Shareholders. The Trust may deem and treat
the holder of record of any Share as the absolute owner thereof for all
purposes and shall not be required to take any notice of any right or claim of
right of any other person.
Section 5.5. Regulations. The Trustees may make such additional rules
and regulations, not inconsistent with these By-Laws, as it may deem expedient
concerning the issue, transfer and registration of certificates for Shares of
the Trust.
Section 5.6. Lost, Destroyed or Mutilated Certificates. The holder of
any certificate representing Shares of the Trust shall immediately notify the
Trust of any loss, destruction or mutilation of such certificate, and the
Trust may issue a new certificate in the place of any certificate theretofore
issued by it which the owner thereof shall allege to have been lost or
destroyed or which shall have been mutilated, and the Trustees may, in their
discretion, require such owner or his legal representatives to give the Trust
a bond in such sum, limited or unlimited, and in such form and with such
surety or sureties, as the Trustees in their absolute discretion shall
determine, to indemnify the Trust against any claim that may be made against
it on account of the alleged loss or destruction of any such certificate, or
issuance of a new certificate. Anything herein to the contrary
notwithstanding, the Trustees in their absolute discretion, may refuse to
issue any such new certificates, except pursuant to legal proceedings under
the laws of the Commonwealth of Massachusetts.
ARTICLE VI
Amendment of By-Laws
Section 6.1. Amendment and Repeal of By-Laws. In accordance with
Section 2.6 of the Declaration, the Trustees shall have the power to alter,
amend or repeal the By-Laws or adopt new By-Laws at any time. Action by the
Trustees with respect to the By-Laws shall be taken by an affirmative vote of
a majority of the Trustees. The Trustees shall in no event adopt By-Laws which
are in conflict with the Declaration, and any apparent inconsistency shall be
construed in favor of the related provisions in the Declaration.
The Declaration establishing Merrill Lynch U.S. Government Mortgage
Fund, a copy of which, together with all amendments thereto (the
"Declaration"), is on file in the office of the Secretary of the Commonwealth
of Massachusetts, provides that the name Merrill Lynch U.S. Government
Mortgage Fund refers to the Trustees under the Declaration collectively as
Trustees, but not as individuals or personally; and no Trustee, shareholder,
officer, employee or agent of Merrill Lynch U.S. Government Mortgage Fund
shall be held to any personal liability, nor shall resort be had to their
private property for the satisfaction of any obligation or claim or otherwise
in connection with the affairs of said Merrill Lynch U.S. Government Mortgage
Fund but the Trust Property only shall be liable.
CONSENT OF DELOITTE & TOUCHE LLP
Exhibit 10
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Post-Effective Amendment No.
19 to Registration Statement No. 2-92366 on Form N-1A of our report dated
October 12, 2001 appearing in the August 31, 2001 Annual Report of Merrill
Lynch U.S. Government Mortgage Fund, and to the reference to us under the
caption 'Financial Highlights' in the Prospectus, which is part of such
Registration Statement.
/s/ Deloitte & Touche LLP
_______________________
New York, New York
December 14, 2001