Exhibit 17(c)
(BULL LOGO)
Merrill Lynch Investment Managers
Semi-Annual Report
February 28, 2002
Merrill Lynch
U.S. Government
Mortgage Fund
www.mlim.ml.com
This report is not authorized for use as an offer of sale or a solicitation of
an offer to buy shares of the Fund unless accompanied or preceded by the Fund's
current prospectus. Past performance results shown in this report should not be
considered a representation of future performance. Investment return and
principal value of shares will fluctuate so that shares, when redeemed, may be
worth more or less than their original cost.
Statements and other information herein are as dated and are subject to change.
Merrill Lynch U.S. Government Mortgage Fund
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
Merrill Lynch U.S. Government Mortgage Fund
DEAR SHAREHOLDER
Economic Environment
During the six-month period ended February 28, 2002, the US Treasury yield curve
steepened dramatically. The Federal Reserve Board eased monetary policy four
times during the period, bringing the Federal Funds rate 175 basis points
(1.75%) lower to 1.75%. Yields on short-term and intermediate-term Treasury
notes fell also with the two-year and five-year notes 57 basis points and 19
basis points lower, respectively, at the end of the period. Longer-term interest
rates, though volatile throughout the period, ended little changed with ten-year
and 30-year yields less than five basis points higher at the end of the
six-month period. The performance of mortgage-backed securities (MBS) for the
period were aided by a steeper Treasury yield curve, more stable long-term
interest rates and a volatile corporate sector.
During the six-month period ended February 28, 2002, MBS outperformed both the
Treasury and credit sectors on a total rate-of-return basis. This can be
illustrated in a very broad sense by the returns of these sectors in the
unmanaged Salomon Smith Barney Broad Investment Grade Index. The mortgage sector
of this Index returned +3.66% for the six-month period ended February 28, 2002,
which compares favorably to the +2.46% and +2.42% returns of the Treasury and
corporate sectors, respectively. To illustrate further, 30-year Federal National
Mortgage Association 6% returned +4.20% for the six-month period, which compares
favorably to the return of the 10-year Treasury note, which returned +1.73% for
the same period with a similar average life. Also, in 15-year MBS, Fannie Mae
Dwarf 6% returned +3.86% for the period, comparing favorably to the return of
the five-year Treasury note, which returned +3.08% for the same period and also
with a similar average life.
Portfolio Strategy
For the six months ended February 28, 2002, the Fund's Class A, Class B, Class C
and Class D Shares returned +3.39%, +3.00%, +2.98% and +3.26%, respectively.
(Fund results shown do not reflect sales charges and would be lower if sales
charges were included. Complete performance information can be found on pages 3
and 4 of this report to shareholders.) We had an ongoing strategy of avoiding
unwanted prepayments, eluding those MBS that would be adversely affected by an
increase to prepayments.
We concentrated our investments during the period in current coupon 6% and 6.5%
MBS, which also participated in dollar rolls enhancing performance. Early in the
period we sold some Fannie Mae multifamily pools that were benchmarked off of
the very short part of the US Treasury yield curve. With short-term yields at
historically low levels, we sold these pools in favor of higher-yielding MBS
collateral and longer multifamily pools benchmarked off the five-year - ten-year
portion of the Treasury yield curve. In addition to having stated final maturity
dates of five years - ten years, the multifamily pools we purchased have
protection by means of lockouts and yield maintenance. The US Treasury yield
curve remains very steep offering "roll down" value. We favored the five-year -
ten-year area of the Treasury curve as it represents the steepest, and therefore
most valuable part of the curve. Later in the period as interest rate volatility
subsided and long-term interest rates became more stable, we moved higher in
coupon. With the ten-year yield a benchmark for MBS off its low, prepayment risk
had subsided and coupon income became a larger component of total rate of
return.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
The Fund benefited from being heavily weighted in MBS for the period as it
proved to be a prudent fixed-income investment. We will continue to remain
heavily weighted in MBS as we believe they offer excellent liquidity and credit
quality with yields that remain attractive. Additionally, with short-term
interest rates so low, we anticipate continuing to remain fully invested.
In Conclusion
We thank you for your continued investment in Merrill Lynch U.S. Government
Mortgage Fund, and we look forward to discussing our outlook and strategy with
you in our next report to shareholders.
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President and Trustee
(Frank Viola)
Frank Viola
Portfolio Manager
(Teresa L. Giacino)
Teresa L. Giacino
Portfolio Manager
April 9, 2002
We are pleased to announce that Frank Viola and Teresa Giacino have been named
Portfolio Managers and are responsible for the day-to-day management of
Merrill Lynch U.S. Government Mortgage Fund. Mr. Viola joined Merrill Lynch
Investment Managers, L.P. (MLIM) in 1997 as Portfolio Manager in the US
Fixed-Income Group. Ms. Giacino joined MLIM in 1985, gaining experience in all
phases of mortgage investment.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
PERFORMANCE DATA
About Fund Performance
Investors are able to purchase shares of the Trust through the Merrill Lynch
Select Pricing SM System, which offers four pricing alternatives:
* Class A Shares incur a maximum initial sales charge (front-end load) of 4%
and bear no ongoing distribution or account maintenance fees. Class A Shares
are available only to eligible investors, as detailed in the Fund's
prospectus. If you were a Class A shareholder prior to October 21, 1994, your
Class A Shares were redesignated to Class D Shares on October 21, 1994.
However, in the case of certain eligible investors, the shares were
simultaneously exchanged for Class A Shares.
* Class B Shares are subject to a maximum contingent deferred sales charge of
4% if redeemed during the first year, decreasing 1% each year thereafter to 0%
after the fourth year. In addition, Class B Shares are subject to a
distribution fee of 0.50% and an account maintenance fee of 0.25%. These
shares automatically convert to Class D Shares after approximately 10 years.
(There is no initial sales charge for automatic share conversions.)
* Class C Shares are subject to a distribution fee of 0.55% and an account
maintenance fee of 0.25%. In addition, Class C Shares are subject to a 1%
contingent deferred sales charge if redeemed within one year of purchase.
* Class D Shares incur a maximum initial sales charge of 4% and an account
maintenance fee of 0.25% (but no distribution fee).
None of the past results shown should be considered a representation of future
performance. Performance results do not reflect the deduction of taxes that a
shareholder would pay on fund distributions or the redemption of fund shares.
Figures shown in the "Recent Performance Results" and "Average Annual Total
Return" tables assume reinvestment of all dividends and capital gains
distributions at net asset value on the payable date. Investment return and
principal value of shares will fluctuate so that shares, when redeemed, may be
worth more or less than their original cost. Dividends paid to each class of
shares will vary because of the different levels of account maintenance,
distribution and transfer agency fees applicable to each class, which are
deducted from the income available to be paid to shareholders.
Recent Performance Results*
Ten Years/
6-Month 12-Month Since Inception Standardized
As of February 28, 2002 Total Return Total Return Total Return 30-Day Yield
ML U.S. Government Mortgage Fund Class A Shares +3.39% +7.73% +73.42% 4.56%
ML U.S. Government Mortgage Fund Class B Shares +3.00 +7.02 +76.90 3.99
ML U.S. Government Mortgage Fund Class C Shares +2.98 +6.97 +63.35 3.94
ML U.S. Government Mortgage Fund Class D Shares +3.26 +7.58 +86.25 4.32
*Investment results shown do not reflect sales charges; results shown would be
lower if a sales charge was included. Total investment returns are based on
changes in net asset values for the periods shown, and assume reinvestment of
all dividends and capital gains distributions at net asset value on the payable
date. The Fund's ten-year/inception periods are from 10/21/94 for Class A &
Class C Shares and ten years for Class B & Class D Shares.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
PERFORMANCE DATA (concluded)
Average Annual Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
One Year Ended 12/31/01 +7.87% +3.55%
Five Years Ended 12/31/01 +6.96 +6.09
Inception (10/21/94) through 12/31/01 +7.67 +7.06
*Maximum sales charge is 4%. **Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
One Year Ended 12/31/01 +7.04% +3.04%
Five Years Ended 12/31/01 +6.15 +6.15
Ten Years Ended 12/31/01 +5.64 +5.64
*Maximum contingent deferred sales charge is 4% and is reduced to 0% after four
years. **Assuming payment of applicable contingent deferred sales charge.
% Return % Return
Without CDSC With CDSC**
Class C Shares*
One Year Ended 12/31/01 +6.99% +5.99%
Five Years Ended 12/31/01 +6.10 +6.10
Inception (10/21/94) through 12/31/01 +6.80 +6.80
*Maximum contingent deferred sales charge is 1% and is reduced to 0% after one
year. **Assuming payment of applicable contingent deferred sales charge.
% Return Without % Return With
Sales Charge Sales Charge**
Class D Shares*
One Year Ended 12/31/01 +7.60% +3.29%
Five Years Ended 12/31/01 +6.70 +5.83
Ten Years Ended 12/31/01 +6.19 +5.75
*Maximum sales charge is 4%. **Assuming maximum sales charge.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
SCHEDULE OF INVESTMENTS
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
US Government Agency Mortgage-Backed Obligations*--95.8%
Fannie Mae $ 24,997,510 5.50% 1/01/2032 - 3/01/2032 $24,166,969
45,000,000 6.00 TBA(9) 44,732,700
104,672,694 6.50 12/01/2008 - 1/01/2014 108,653,986
178,189,930 6.50 4/01/2026 - 11/01/2031 181,221,521
11,039,067 7.00 11/01/2013 - 11/01/2014 11,538,754
111,927 7.00 8/01/2029 115,480
257 7.50 1/01/2025 271
287,548 8.00 9/01/2024 - 9/01/2027 306,047
274,735 8.50 5/01/2010 - 8/01/2012 292,610
6,995,272 8.50(3) 7/15/2023 7,599,592
4,550,324 9.50 3/01/2020 4,868,847
7,376,524 11.00 2/01/2011 - 11/01/2020 8,357,461
9,626 11.50 6/01/2015 10,691
694,296 13.00 8/01/2010 - 4/01/2015 808,061
Fannie Mae #0384603 6,216,297 5.50(2) 12/01/2011 6,186,508
Mortgage-Backed Securities-- #0384518 7,683,098 5.56(2) 12/01/2011 7,620,366
Multi-Family++ #0384046 9,946,745 5.67(10) 9/01/2006 10,251,364
#0384758 11,488,396 5.86(10) 1/01/2009 11,815,098
#0254243 6,977,619 6.00(7) 2/01/2009 7,126,540
#0160465 32,461,929 6.16(8) 8/01/2013 33,827,729
#0380332 9,237,197 6.195(7) 6/01/2005 9,680,811
#0380021 5,994,185 6.49(2) 1/01/2008 6,334,312
#0073894 943,816 6.525(7) 12/01/2003 979,254
#0073885 850,586 6.545(2) 1/01/2007 902,865
#0073873 733,863 6.625(2) 2/01/2007 781,148
#0073221 1,395,850 6.715(7) 10/01/2005 1,484,395
#0073915 1,429,479 6.87(2) 1/01/2007 1,533,736
#0073910 11,334,086 6.875(2) 1/01/2007 12,165,086
#0375043 3,428,730 6.895(2) 4/01/2007 3,682,865
#0375007 11,596,975 6.94(2) 3/01/2007 12,477,571
#0375012 3,144,531 6.95(2) 4/01/2007 3,384,549
#0073944 13,285,157 6.96(2) 1/01/2007 14,302,483
#0073952 2,619,478 6.96(2) 1/01/2007 2,819,748
#0073946 5,124,948 6.97(2) 2/01/2007 5,519,225
#0073969 7,523,327 7.05(2) 2/01/2007 8,124,355
#0073962 4,503,329 7.085(2) 2/01/2007 4,870,599
#0073967 4,375,610 7.105(2) 2/01/2007 4,735,845
#0073992 2,487,875 7.115(2) 2/01/2007 2,693,688
#0375069 1,019,285 7.122(2) 4/01/2007 1,103,885
#0073943 1,350,628 7.18(4) 2/01/2019 1,446,198
#0073608 4,654,176 7.49(2) 8/01/2006 5,092,800
#0375052 4,555,563 7.50(2) 3/01/2027 5,058,501
#0109076 2,055,715 7.59(2) 8/01/2006 2,255,438
#0160024 2,112,779 7.625(2) 11/01/2003 2,186,024
#0160095 6,844,537 7.66(2) 3/01/2004 7,126,791
Fannie Mae 98-M1-IO2 90,043,783 0.68635(1) 2/25/2013 3,880,887
Mortgage-Backed Securities-- 94-M1-IO 45,986,957 0.87(1) 10/25/2003 712,798
REMICs**--Multi-Family++ 98-M3-B 10,355,266 6.45 8/17/2013 10,770,967
97-M8-A2 19,135,000 7.16 1/25/2022 20,582,917
96-M3-A2 40,500,000 7.41 3/25/2021 43,697,560
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
SCHEDULE OF INVESTMENTS (continued)
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
US Government Agency Mortgage-Backed Obligations* (concluded)
Fannie Mae REMICs** 94-56-TB $5,239,230 6.50(1)% 7/25/2022 $880,149
Trust 273 2,490,081 7.00(1) 7/01/2026 475,017
96-W1-AL 6,764,006 7.25 3/25/2026 7,030,643
Freddie Mac 466 10.00 7/01/2019 518
Participation Certificates 3,883,765 10.50 1/01/2010 - 9/01/2020 4,373,702
906,532 11.00 8/01/2010 - 9/01/2020 1,024,478
1,038,747 11.50 12/01/2011 - 6/01/2020 1,190,112
524,094 12.00 5/01/2010 - 6/01/2020 598,435
723,959 12.50 11/01/2014 - 7/01/2019 826,579
1,351,186 13.00 11/01/2009 - 2/01/2016 1,538,308
Freddie Mac 29,847,514 6.00 4/01/2009 - 2/01/2017 30,373,852
Participation Certificates--Gold Program 94,353,955 6.00 6/01/2029 - 2/01/2032 94,015,286
24,998,235 6.50 9/01/2013 - 1/01/2017 25,818,693
263,605,531 6.50 10/01/2028 - 10/01/2031(9) 268,077,078
37,980,270 7.00 8/01/2011 - 6/01/2016 39,709,142
140,967,540 7.00 9/01/2028 - 10/01/2031 145,379,859
6,700,757 7.50 5/01/2009 - 10/01/2011 7,115,807
205,270 7.50 8/01/2017 214,897
6,846,255 8.00 1/01/2007 - 7/01/2012 7,241,367
53,460 8.00 10/01/2027 56,820
1,927,446 8.50 1/01/2025 - 7/01/2025 2,091,765
1,147,227 10.50 10/01/2020 - 12/01/2020 1,300,158
Freddie Mac REMICs** Trust 134 428,683 9.00(1) 4/01/2022 69,418
Trust 1220 2,051,043 10.00 2/15/2022 2,034,091
Government National Mortgage Association 8,963,838 6.00 5/15/2024 - 11/15/2031 8,956,313
82,078,045 6.50 10/15/2023 - 7/15/2029(9) 83,707,682
163,100,338 7.00 4/15/2023 - 11/15/2031 168,973,443
3,214 7.50 1/15/2007 3,414
54,730,177 7.50 7/15/2022 - 2/15/2030(9) 57,729,088
23,691,586 8.00 1/15/2024 - 8/15/2026 25,298,191
11,550,402 10.00 12/15/2015 - 12/15/2021 13,009,006
48,969 10.50 1/15/2016 - 4/15/2021 55,930
78 11.00 1/15/2016 91
1,037 11.50 8/15/2013 1,199
Total US Government Agency Mortgage-Backed Obligations (Cost--$1,631,589,948) 1,669,058,427
US Government Agency Obligations***--11.5%
Fannie Mae 200,000,000 1.71 3/13/2002 199,886,333
Total US Government Agency Obligations (Cost--$199,886,333) 199,886,333
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
SCHEDULE OF INVESTMENTS (concluded)
Face
Amount Issue Value
Repurchase Agreements****--6.6%
$115,700,000 Morgan Stanley & Company, Inc., purchased on 2/28/2002 to yield 1.85% to 3/01/2002 $ 115,700,000
Total Repurchase Agreements (Cost--$115,700,000) 115,700,000
Nominal Value Strike Notification
Covered by Options Price Date
Options Purchased--0.0%
Call Options 10,902,149 Government National Mortgage Association,
Purchased 30-Year, 6.75% Adjustable Rate Mortgage(5)(6) 100 9/20/2011(5) 8,722
Total Options Purchased (Cost--$0) 8,722
Total Investments (Cost--$1,947,176,281)--113.9% 1,984,653,482
Options Written--0.0%
Put Options 10,902,149 Government National Mortgage Association,
Written 30-Year, 6.75% Adjustable Rate Mortgage(5)(6) 100 9/20/2011(5) (10,902)
Total Options Written (Premiums Received--$0) (10,902)
Total Investments, Net of Options Written (Cost--$1,947,176,281)--113.9% 1,984,642,580
Liabilities in Excess of Other Assets--(13.9%) (242,643,887)
---------------
Net Assets--100.0% $1,741,998,693
===============
(1)Represents the interest only portion of a mortgage-backed obligation.
(2)Represents balloon mortgages that amortize on a 20-year, 25-year or 30-year
schedule and have 10-year original maturities.
(3)Federal Housing Administration/Veterans' Administration Mortgages packaged
by the Federal National Mortgage Association.
(4)Represents a balloon mortgage that amortizes on a 22-year schedule and has
a 22-year original maturity.
(5)Represents European style options which can be exercised only on the
notification date. These options, when combined, represent a standby purchase
commitment whereby the Fund is obligated to purchase the outstanding principal
amount of specific Government National Mortgage Association, 30-year, 6.75%
Adjustable Rate Mortgage pools as of September 20, 2011. For this commitment,
the Fund receives a net .12% per annum based on the nominal value covered by
the options.
(6)Adjustable Rate Security. The interest rate resets annually at the 1-year
Constant Maturing Treasury rate plus 1.5%, subject to a 1% annual adjustment cap
and an 11% life cap.
(7)Represents balloon mortgages that amortize on a 30-year schedule and have
7-year original maturities.
(8)Represents a mortgage that amortizes on a 15-year schedule and has a
15-year original maturity.
(9)Represents or includes a "to-be-announced" (TBA) transaction. The Fund has
committed to purchasing or selling securities for which all specific information
is not available at this time.
(10)Represents a balloon mortgage that amortizes on a 30-year schedule and has a
5-year original maturity.
++Underlying multi-family loans have prepayment protection by means of lockout
periods and/or yield maintenance premiums.
*Mortgage-Backed Obligations are subject to principal paydowns as a result of
prepayments or refinancings of the underlying mortgage instruments. As a result,
the average life may be substantially less than the original maturity.
**Real Estate Mortgage Investment Conduits (REMIC).
***US Government Agency Obligations are traded on a discount basis; the interest
rate shown reflects the discount rate paid at the time of purchase by the Fund.
****Repurchase Agreements are fully collateralized by US Government Agency
Obligations.
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION
Statement of Assets and Liabilities as of February 28, 2002
Assets: Investments, at value (identified cost--$1,947,176,281) $1,984,644,760
Options purchased, at value (cost--$0) 8,722
Cash 2,027,033
Receivables:
Securities sold $104,163,743
Interest 10,427,750
Beneficial interest sold 7,163,582
Principal paydowns 196,038 121,951,113
------------
Prepaid registration fees and other assets 134,552
---------------
Total assets 2,108,766,180
---------------
Liabilities: Options written, at value (premiums received--$0) 10,902
Payables:
Securities purchased 351,693,364
Beneficial interest redeemed 10,660,627
Dividends to shareholders 2,135,894
Investment adviser 553,521
Distributor 552,654 365,596,060
------------
Accrued expenses and other liabilities 1,160,525
---------------
Total liabilities 366,767,487
---------------
Net Assets: Net assets $ 1,741,998,693
===============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 2,554,546
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 5,448,439
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 1,667,134
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 7,693,791
Paid-in capital in excess of par 1,886,447,232
Accumulated realized capital losses on investments--net (199,278,748)
Unrealized appreciation on investments--net 37,466,299
---------------
Net assets $ 1,741,998,693
===============
Net Asset Class A--Based on net assets of $256,344,749 and 25,545,456
Value: shares of beneficial interest outstanding $ 10.03
===============
Class B--Based on net assets of $546,595,662 and 54,484,390
shares of beneficial interest outstanding $ 10.03
===============
Class C--Based on net assets of $167,229,449 and 16,671,340
shares of beneficial interest outstanding $ 10.03
===============
Class D--Based on net assets of $771,828,833 and 76,937,905
shares of beneficial interest outstanding $ 10.03
===============
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION (continued)
Statement of Operations for the Six Months Ended February 28, 2002
Investment Interest $ 46,753,475
Income:
Expenses: Investment advisory fees$ 3,732,191 $ 3,732,191
Account maintenance and distribution fees--Class B 1,900,038
Account maintenance fees--Class D 917,991
Transfer agent fees--Class D 599,689
Transfer agent fees--Class B 458,459
Account maintenance and distribution fees--Class C 409,150
Accounting services 225,317
Transfer agent fees--Class A 196,584
Custodian fees 136,962
Transfer agent fees--Class C 90,232
Printing and shareholder reports 70,360
Professional fees 56,440
Registration fees 51,959
Pricing fees 38,332
Trustees' fees and expenses 36,657
Other 28,725
------------
Total expenses 8,949,086
---------------
Investment income--net 37,804,389
---------------
Realized & Realized gain on investments--net 2,720,944
Unrealized Change in unrealized appreciation/depreciation 10,068,206
Gain on on investments--net
Investments-- Net Increase in Net Assets Resulting from Operations $ 50,593,539
Net: ===============
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION (continued)
Statements of Changes in Net Assets
For the Six For the
Months Ended Year Ended
February 28, 2002 August 31, 2001
Increase (Decrease) in Net Assets:
Operations: Investment income--net $ 37,804,389 $ 77,114,923
Realized gain on investments--net 2,720,944 3,784,133
Change in unrealized appreciation/depreciation on investments--net 10,068,206 68,774,825
---------------- ---------------
Net increase in net assets resulting from operations 50,593,539 149,673,881
---------------- ---------------
Dividends to Investment income--net:
Shareholders: Class A (6,252,475) (12,568,680)
Class B (11,193,977) (21,183,948)
Class C (2,209,653) (1,885,812)
Class D (18,148,284) (41,476,483)
---------------- ---------------
Net decrease in net assets resulting from dividends to
shareholders (37,804,389) (77,114,923)
---------------- ---------------
Beneficial Net increase in net assets derived from beneficial interest
Interest transactions 242,005,717 65,775,375
Transactions: ---------------- ---------------
Net Assets: Total increase in net assets 254,794,867 138,334,333
Beginning of period 1,487,203,826 1,348,869,493
---------------- ---------------
End of period $ 1,741,998,693 $1,487,203,826
================ ===============
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION (continued)
Financial Highlights
Class A
The following per share data and ratios For the
have been derived from information Six Months
provided in the financial statements. Ended
February 28, For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2002 2001 2000 1999 1998
Per Share Net asset value, beginning of period $ 9.95 $ 9.44 $ 9.37 $ 9.80 $ 9.64
Operating ------------- ---------- ------------ ---------- -----------
Performance: Investment income--net .25 .57 .58 .55 .60
Realized and unrealized gain (loss)
on investments--net .08 .51 .07 (.43) .16
------------- ---------- ------------ ---------- -----------
Total from investment operations .33 1.08 .65 .12 .76
------------- ---------- ------------ ---------- -----------
Less dividends from investment
income--net (.25) (.57) (.58) (.55) (.60)
------------- ---------- ------------ ---------- -----------
Net asset value, end of period $ 10.03 $ 9.95 $ 9.44 $ 9.37 $ 9.80
============= ========== ============ ========== ===========
Total Based on net asset value per share 3.39%++ 11.77% 7.23% 1.24% 8.10%
Investment ============= ========== ============ ========== ===========
Return:**
Ratios to Expenses .72%* .75% .75% .70% .68%
Average ============= ========== ============ ========== ===========
Net Assets: Investment income--net 5.19%* 5.84% 6.23% 5.71% 6.18%
============= ========== ============ ========== ===========
Supplemental Net assets, end of period
Data: (in thousands) $ 256,345 $ 234,930 $ 192,119 $ 212,131 $ 277,568
============= ========== ============ ========== ===========
Portfolio turnover 145.78% 199.30% 37.28% 58.16% 301.88%
============= ========== ============ ========== ===========
*Annualized.
**Total investment returns exclude the effects of sales charges.
++Aggregate total investment return.
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION (continued)
Financial Highlights (continued)
Class B
The following per share data and ratios For the
have been derived from information Six Months
provided in the financial statements. Ended
February 28, For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2002 2001 2000 1999 1998
Per Share Net asset value, beginning of period $ 9.95 $ 9.44 $ 9.36 $ 9.79 $ 9.63
Operating ------------- ---------- ------------ ---------- -----------
Performance: Investment income--net .22 .50 .51 .48 .53
Realized and unrealized gain (loss)
on investments--net .08 .51 .08 (.43) .16
------------- ---------- ------------ ---------- -----------
Total from investment operations .30 1.01 .59 .05 .69
------------- ---------- ------------ ---------- -----------
Less dividends from investment
income--net (.22) (.50) (.51) (.48) (.53)
------------- ---------- ------------ ---------- -----------
Net asset value, end of period $ 10.03 $ 9.95 $ 9.44 $ 9.36 $ 9.79
============= ========== ============ ========== ===========
Total Based on net asset value per share 3.00%++ 10.91% 6.53% .46% 7.28%
Investment ============= ========== ============ ========== ===========
Return:**
Ratios to Expenses 1.48%* 1.52% 1.52% 1.46% 1.45%
Average ============= ========== ============ ========== ===========
Net Assets: Investment income--net 4.42%* 5.07% 5.47% 4.95% 5.42%
============= ========== ============ ========== ===========
Supplemental Net assets, end of period
Data: (in thousands) $ 546,596 $ 466,432 $ 405,846 $ 571,969 $ 627,818
============= ========== ============ ========== ===========
Portfolio turnover 145.78% 199.30% 37.28% 58.16% 301.88%
============= ========== ============ ========== ===========
*Annualized.
**Total investment returns exclude the effects of sales charges. ++Aggregate
total investment return.
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION (continued)
Financial Highlights (continued)
Class C
The following per share data and ratios For the
have been derived from information Six Months
provided in the financial statements. Ended
February 28, For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2002 2001 2000 1999 1998
Per Share Net asset value, beginning of period $ 9.95 $ 9.44 $ 9.36 $ 9.79 $ 9.63
Operating ------------- ---------- ------------ ---------- -----------
Performance: Investment income--net .21 .49 .51 .48 .52
Realized and unrealized gain (loss)
on investments--net .08 .51 .08 (.43) .16
------------- ---------- ------------ ---------- -----------
Total from investment operations .29 1.00 .59 .05 .68
------------- ---------- ------------ ---------- -----------
Less dividends from investment
income--net (.21) (.49) (.51) (.48) (.52)
------------- ---------- ------------ ---------- -----------
Net asset value, end of period $ 10.03 $ 9.95 $ 9.44 $ 9.36 $ 9.79
------------- ---------- ------------ ---------- -----------
Total Based on net asset value per share 2.98%++ 10.86% 6.47% .41% 7.23%
Investment ============= ========== ============ ========== ===========
Return:**
Ratios to Expenses 1.53%* 1.57% 1.57% 1.51% 1.51%
Average ============= ========== ============ ========== ===========
Net Assets: Investment income--net 4.32%* 5.00% 5.43% 4.90% 5.35%
============= ========== ============ ========== ===========
Supplemental Net assets, end of period
Data: (in thousands) $ 167,229 $ 56,706 $ 30,593 $ 46,614 $ 43,038
============= ========== ============ ========== ===========
Portfolio turnover 145.78% 199.30% 37.28% 58.16% 301.88%
============= ========== ============ ========== ===========
*Annualized.
**Total investment returns exclude the effects of sales charges.
++Aggregate total investment return.
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
FINANCIAL INFORMATION (concluded)
Class D
The following per share data and ratios For the
have been derived from information Six Months
provided in the financial statements. Ended
February 28, For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2002 2001 2000 1999 1998
Per Share Net asset value, beginning of period $ 9.95 $ 9.44 $ 9.36 $ 9.79 $ 9.63
Operating ------------- ---------- ------------ ---------- -----------
Performance: Investment income--net .24 .55 .56 .53 .58
Realized and unrealized gain (loss)
on investments--net .08 .51 .08 (.43) .16
------------- ---------- ------------ ---------- -----------
Total from investment operations .32 1.06 .64 .10 .74
------------- ---------- ------------ ---------- -----------
Less dividends from investment
income--net (.24) (.55) (.56) (.53) (.58)
------------- ---------- ------------ ---------- -----------
Net asset value, end of period $ 10.03 $ 9.95 $ 9.44 $ 9.36 $ 9.79
------------- ---------- ------------ ---------- -----------
Total Based on net asset value per share 3.26%++ 11.49% 7.08% .98% 7.84%
Investment ============= ========== ============ ========== ===========
Return:**
Ratios to Expenses .97%* 1.00% 1.00% .95% .93%
Average ============= ========== ============ ========== ===========
Net Assets: Investment income--net 4.94%* 5.59% 5.99% 5.47% 5.94%
============= ========== ============ ========== ===========
Supplemental Net assets, end of period
Data: (in thousands) $ 771,829 $ 729,136 $ 720,311 $ 795,813 $ 866,013
============= ========== ============ ========== ===========
Portfolio turnover 145.78% 199.30% 37.28% 58.16% 301.88%
============= ========== ============ ========== ===========
*Annualized.
**Total investment returns exclude the effects of sales charges.
++Aggregate total investment return.
See Notes to Financial Statements.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch U.S. Government Mortgage Fund (the "Fund") is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. The Fund's financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America, which
may require the use of management accruals and estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to a fair statement of the results for the interim period
presented. All such adjustments are of a normal, recurring nature. The Fund
offers four classes of shares under the Merrill Lynch Select Pricing SM System.
Shares of Class A and Class D are sold with a front-end sales charge. Shares of
Class B and Class C may be subject to a contingent deferred sales charge. All
classes of shares have identical voting, dividend, liquidation and other rights
and the same terms and conditions, except that Class B, Class C and Class D
Shares bear certain expenses related to the account maintenance of such shares,
and Class B and Class C Shares also bear certain expenses related to the
distribution of such shares. Each class has exclusive voting rights with respect
to matters relating to its account maintenance and distribution expenditures.
Income, expenses (other than expenses attributable to a specific class) and
realized and unrealized gains and losses on investments are allocated daily to
each class based on its relative net assets. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Securities traded in the over-the-counter market
are valued at the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers that make
markets in the securities. Options written or purchased are valued at the last
sale price in the case of exchange-traded options. In the case of options traded
in the over-the-counter market, valuation is the last asked price (options
written) or the last bid price (options purchased).
Financial futures contracts and options thereon, which are traded on exchanges,
are valued at their last sale price as of the close of such exchanges.
Securities with a remaining maturity of sixty days or less are valued on an
amortized cost basis, which approximates market value. Securities and assets for
which market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Trustees of the Fund.
(b) Repurchase agreements--The Fund invests in US Government securities pursuant
to repurchase agreements. Under such agreements, the counterparty agrees to
repurchase the security at a mutually agreed upon time and price. The Fund takes
possession of the underlying securities, marks to market such securities and, if
necessary, receives additional securities daily to ensure that the contract is
fully collateralized. If the counterparty defaults and the fair value of the
collateral declines, liquidation of the collateral by the Fund may be delayed or
limited.
(c) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies to increase or decrease the level of risk to which the
Fund is exposed more quickly and efficiently than transactions in other types of
instruments. Losses may arise due to changes in the value of the contract or if
the counterparty does not perform under the contract.
* Futures contracts--The Fund may purchase or sell financial futures contracts.
Upon entering into a contract, the Fund deposits and maintains as collateral
such initial margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from or pay to
the broker an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin and are
recorded by the Fund as unrealized gains or losses. When the contract is closed,
the Fund records a realized gain or loss equal to the difference between the
value of the contract at the time it.was opened and the value at the time is was
closed.
* Options--The Fund is authorized to write and purchase call and put options.
When the Fund writes an option, an amount equal to the premium received by the
Fund is reflected as an asset and an equivalent liability. The amount of the
liability is subsequently marked to market to reflect the current market value
of the option written. When a security is purchased or sold through an exercise
of an option, the related premium paid (or received) is added to (or deducted
from) the basis of the security acquired or deducted from (or added to) the
proceeds of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to the
extent of the premiums received or paid (or gain or loss to the extent the cost
of the closing transaction exceeds the premiums paid or received).
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
NOTES TO FINANCIAL STATEMENTS (continued)
Written and purchased options are non-income producing investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income and extended delivery fees are recognized on the accrual basis.
(f) Prepaid registration fees--Prepaid registration fees are charged to expense
as the related shares are issued.
(g) Dividends and distributions--Dividends from net investment income are
declared daily and paid monthly. Distributions of capital gains are recorded on
the ex-dividend dates.
(h) Dollar rolls--The Fund sells mortgage-backed securities for delivery in the
current month and simultaneously contracts to repurchase substantially similar
(same type, coupon and maturity) securities on a specific future date. As of
February 28, 2002, no dollar rolls were in effect.
2. Investment Advisory Agreement and Transactions with Affiliates: The Fund
has entered into an Investment Advisory Agreement with Fund Asset Management,
L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc. ("PSI"),
an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner. The Fund has also entered into a
Distribution Agreement and Distribution Plans with FAM Distributors, Inc.
("FAMD" or the "Distributor"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee
based upon the average daily value of the Fund's net assets at the following
rate:
Portion of Average Daily Value of Net Assets: Rate
Not exceeding $500 million .500%
In excess of $500 million but not exceeding $1 billion .475%
In excess of $1 billion but not exceeding $1.5 billion .450%
In excess of $1.5 billion but not exceeding $2 billion .425%
In excess of $2 billion but not exceeding $2.5 billion .400%
In excess of $2.5 billion but not exceeding $3.5 billion .375%
In excess of $3.5 billion but not exceeding $5 billion .350%
In excess of $5 billion but not exceeding $6.5 billion .325%
Exceeding $6.5 billion .300%
Pursuant to the Distribution Plans adopted by the Fund in accordance with Rule
12b-1 under the Investment Company Act of 1940, the Fund pays the Distributor
ongoing account maintenance and distribution fees. The fees are accrued daily
and paid monthly at annual rates based upon the average daily net assets of the
shares as follows:
Account Distribution
Maintenance Fee Fee
Class B .25% .50%
Class C .25% .55%
Class D .25% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch, Pierce, Fenner
& Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., also provides account
maintenance and distribution services to the Fund. The ongoing account
maintenance fee compensates the Distributor and MLPF&S for providing account
maintenance services to Class B, Class C and Class D shareholders.
The ongoing distribution fee compensates the Distributor and MLPF&S for
providing shareholder and distribution-related services to Class B and Class C
shareholders.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002 For the six
months ended February 28, 2002, FAMD earned underwriting.discounts and direct
commissions and MLPF&S earned dealer concessions on sales of the Fund's Class A
and Class D Shares as follows:
FAMD MLPF&S
Class A $ 10 $ 85
Class D $ 15,605 $ 212,268
For the six months ended February 28, 2002, MLPF&S received contingent deferred
sales charges of $286,792 and $23,525 relating to transactions in Class B and
Class C Shares, respectively.
Furthermore, MLPF&S received contingent deferred sales charges of $1,300
relating to transactions subject to front-end sales charge waivers in Class A
Shares.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Fund's transfer agent.
For the six months ended February 28, 2002, the Fund paid Merrill Lynch
Securities Pricing Service, an affiliate of MLPF&S, $17,648 for security price
quotations to compute the net asset value of the Fund.
For the six months ended February 28, 2002, the Fund reimbursed FAM $26,655 for
certain accounting services.
Certain officers and/or trustees of the Fund are officers and/or directors of
FAM, PSI, FAMD, FDS, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the six
months ended February 28, 2002 were $2,395,312,342 and $2,289,658,932,
respectively.
Net realized gains (losses) for the six months ended February 28, 2002 and net
unrealized gains (losses) as of February 28, 2002 were as follows:
Realized Unrealized
Gains Gains
(Losses) (Losses)
Long-term investments $ 824,984 $ 37,468,479
Short-term investments (1,515) --
Options purchased (425,500) 8,722
Options written 425,781 (10,902)
Financial futures contracts 1,897,194 --
----------- -------------
Total $ 2,720,944 $ 37,466,299
=========== =============
As of February 28, 2002, net unrealized appreciation for Federal income tax
purposes aggregated $37,466,299, of which $42,925,802 related to appreciated
securities and $5,459,503 related to depreciated securities. The aggregate cost
of investments, including options, at February 28, 2002 for Federal income tax
purposes was $1,947,176,281.
Transactions in options written for the six months ended February 28, 2002 were
as follows:
Nominal Value
Covered by Premiums
Put Options Written Options Received
Outstanding put options written,
beginning of period 15,602,752 $ --
Options expired (4,700,603) --
------------ -------------
Outstanding put options
written, end of period 10,902,149 $ --
============ =============
Nominal Value
Covered by Premiums
Call Options Written Options Received
Outstanding call options written,
beginning of period 50,000,000 $ 425,781
Options exercised (50,000,000) (425,781)
------------ -------------
Outstanding call options
written, end of period -- $ --
============ =============
4. Shares of Beneficial Interest:
Net increase in net assets derived from beneficial interest transactions was
$242,005,717 and $65,775,375 for the six months ended February 28, 2002 and for
the year ended August 31, 2001, respectively.
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
NOTES TO FINANCIAL STATEMENTS (concluded)
Transactions in shares of beneficial interest for each class were as follows:
Class A Shares for the Six Months Dollar
Ended February 28, 2002 Shares Amount
Shares sold 8,399,713 $ 84,271,103
Shares issued to shareholders
in reinvestment of dividends 71,168 711,029
------------ -------------
Total issued 8,470,881 84,982,132
Shares redeemed (6,532,837) (65,492,971)
------------ -------------
Net increase 1,938,044 $ 19,489,161
============ =============
Class A Shares for the Year Dollar
Ended August 31, 2001 Shares Amount
Shares sold 11,486,006 $ 112,213,653
Shares issued to shareholders
in reinvestment of dividends 162,431 1,583,430
------------ -------------
Total issued 11,648,437 113,797,083
Shares redeemed (8,390,750) (81,877,918)
Net increase 3,257,687 $ 31,919,165
============ =============
Class B Shares for the Six Months Dollar
Ended February 28, 2002 Shares Amount
Shares sold 16,448,881 $ 164,791,531
Shares issued to shareholders
in reinvestment of dividends 712,321 7,112,467
------------ -------------
Total issued 17,161,202 171,903,998
Automatic conversion of shares (2,160,779) (21,688,189)
Shares redeemed (7,400,014) (74,006,375)
------------ -------------
Net increase 7,600,409 $ 76,209,434
============ =============
Class B Shares for the Year Dollar
Ended August 31, 2001 Shares Amount
Shares sold 18,912,495 $ 185,104,145
Shares issued to shareholders
in reinvestment of dividends 1,163,858 11,346,482
------------ -------------
Total issued 20,076,353 196,450,627
Automatic conversion of shares (3,369,741) (32,877,221)
Shares redeemed (12,822,475) (124,664,599)
------------ -------------
Net increase 3,884,137 $ 38,908,807
============ =============
Class C Shares for the Six Months Dollar
Ended February 28, 2002 Shares Amount
Shares sold 12,613,154 $ 126,324,018
Shares issued to shareholders
in reinvestment of dividends 141,132 1,408,506
------------ -------------
Total issued 12,754,286 127,732,524
Shares redeemed (1,783,178) (17,800,402)
------------ -------------
Net increase 10,971,108 $ 109,932,122
============ =============
Class C Shares for the Year Dollar
Ended August 31, 2001 Shares Amount
Shares sold 3,629,627 $ 35,584,338
Shares issued to shareholders
in reinvestment of dividends 125,177 1,221,385
------------ -------------
Total issued 3,754,804 36,805,723
Shares redeemed (1,296,164) (12,624,766)
------------ -------------
Net increase 2,458,640 $ 24,180,957
============ =============
Class D Shares for the Six Months Dollar
Ended February 28, 2002 Shares Amount
Shares sold 8,923,932 $ 89,093,655
Automatic conversion of shares 2,160,779 21,688,189
Shares issued to shareholders
in reinvestment of dividends 754,435 7,534,022
------------ -------------
Total issued 11,839,146 118,315,866
Shares redeemed (8,189,399) (81,940,866)
------------ -------------
Net increase 3,649,747 $ 36,375,000
============ =============
Class D Shares for the Year Dollar
Ended August 31, 2001 Shares Amount
Shares sold 13,133,960 $ 128,224,313
Automatic conversion of shares 3,369,741 32,877,221
Shares issued to shareholders
in reinvestment of dividends 1,847,720 17,998,322
------------ -------------
Total issued 18,351,421 179,099,856
Shares redeemed (21,381,997) (208,333,410)
------------ -------------
Net decrease (3,030,576) $(29,233,554)
============ =============
Merrill Lynch U.S. Government Mortgage Fund, February 28, 2002
5. Short-Term Borrowings:
The Fund, along with certain other funds managed by FAM and its affiliates, is a
party to a $1,000,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 30, 2001, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended February 28, 2002.
6. Capital Loss Carryforward:
At August 31, 2001, the Fund had a net capital loss carryforward of
approximately $200,903,000, of which $175,708,000 expires in 2003, $16,733,000
expires in 2004, $4,697,000 expires in 2008 and $3,765,000 expires in 2009. This
amount will be available to offset like amounts of any future taxable gains.
OFFICERS AND TRUSTEES
Terry K. Glenn, President and Trustee
Joe Grills, Trustee
Robert S. Salomon Jr., Trustee
Melvin R. Seiden, Trustee
Stephen B. Swensrud, Trustee
Jeffrey B. Hewson, Vice President
Donald C. Burke, Vice President and Treasurer
Phillip S. Gillespie, Secretary
Walter Mintz, Trustee of Merrill Lynch U.S. Government Mortgage Fund, has
recently retired. The Fund's Board of Trustees wishes Mr. Mintz well in his
retirement.
Custodian
The Bank of New York
90 Washington Street, 12th Floor
New York, NY 10286
Transfer Agent
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863