ML PRINCIPAL PROTECTION L.P.
(Formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
Consolidated Financial Statements for
The Years Ended December 31, 1996, 1995
and the Period from October 12, 1994
(Commencement of Operations) to
December 31, 1994 and
Independent Auditors' Report
To: The Limited Partners of ML Principal Protection L.P.
ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.; the
"Fund" or the "Partnership") ended its third fiscal year of trading on
December 31, 1996 with an increase in Net Asset Value ("NAV"). During 1996,
trading profits were generated in the interest rate, currency, energy and
agriculture sectors while losses were incurred in the stock index and metals
sectors. Please see the accompanying summary financial information for the NAV
of your series of Units.
In 1996, strong price trends prevailed in several key markets enabling the
Fund's Trading Advisors to trade profitably for the Fund. Although trading in
stock index and agricultural commodity markets may have been lackluster, the
global bond and currency markets offered substantial trading opportunities.
Interest rate and currency price trends resulted in profitable trading
opportunities in these markets throughout the year.
As the new year began, the U.S. dollar rallied throughout most of January, after
being locked in a tight trading range for the two prior months. However, the
dollar weakened against major currencies in February, and returned to a
relatively narrow trading range. In March, crude oil prices rose throughout most
of the month, as unusually cold weather in the U.S. and Europe resulted in an
extended period of strong demand and oil talks between the United Nations and
Iraq were suspended.
During April, grain and soybean prices rallied to new highs, sometimes daily, as
adverse weather conditions and strong demand affected prices. Difficult trading
conditions in many markets prevailed and a lack of clear price trends in key
markets negatively impacted the Fund's performance in May and June. For example,
U.S. bond markets remained trendless as continued volatility, reflected investor
confusion over conflicting reports on the direction of the economy.
As the third quarter of 1996 began, it was the U.S. stock market that
experienced increased volatility coupled with sharp declines in July. In the
currency markets, the U.S. dollar posted its biggest one-day gain against the
Deutsche mark in almost four months on August 14, after comments from the
Bundesbank's chief economist encouraged expectations for lower German interest
rates. In September, crude oil prices continued, as they had during the summer,
to trend upward throughout most of the month.
Despite continued price volatility during the final quarter of 1996, the Fund's
Trading Advisors were able to single out trends in key markets, such as the
world's major bond markets which rallied into October and November.
Additionally, price trends prevailed in several major foreign currency markets,
for instance, the British pound extended its rally into November, as it soared
to a 4-year high against the U.S. dollar and a 29-month high against the
Deutsche mark on November 20. In December, however, the world's major bond
market rallies came to an abrupt halt early in the month. Specifically, U.S.
Treasury prices dropped on reports of strength in the economy, as well as a
weaker dollar which further encouraged investor selling of treasury securities.
1996 proved to be a profitable year for the Fund. We continue to work diligently
with the Trading Advisors to meet the Fund's objective of achieving, through
speculative trading, substantial capital appreciation over time. We look forward
to 1997 and the trading opportunities it may bring.
Sincerely,
John R. Frawley, Jr.
President
Merrill Lynch Investment Partners Inc.
(General Partner)
FOR THE EXCLUSIVE USE OF INVESTORS IN ML PRINCIPAL PROTECTION L.P. THIS ANNUAL
REPORT IS NOT AN OFFER TO SELL NOR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES. AN OFFER CAN ONLY BE MADE BY THE PROSPECTUS, WHICH CONTAINS
IMPORTANT INFORMATION CONCERNING RISK FACTORS, PERFORMANCE AND OTHER MATERIAL
ASPECTS OF THE FUND, TOGETHER WITH THE CURRENT PROSPECTUS SUPPLEMENT AND RECENT
MONTHLY AND ANNUAL REPORTS FOR THE FUND. THE PROSPECTUS MUST BE READ CAREFULLY
BEFORE ANY DECISION WHETHER TO INVEST IS MADE. THIS ANNUAL REPORT MUST NOT BE
REPRODUCED OR DISTRIBUTED IN ANY MANNER. FUTURES TRADING IS SPECULATIVE AND
INVOLVES A HIGH DEGREE OF RISK. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE
OF FUTURE RESULTS.
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
TABLE OF CONTENTS
- ----------------------------------------------------------------------
Page
----
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD
FROM OCTOBER 12, 1994 (COMMENCEMENT OF
OPERATIONS) TO DECEMBER 31, 1994:
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Changes in Partners' Capital 4
Notes to Consolidated Financial Statements 5-13
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Partners of
ML Principal Protection L.P.:
We have audited the accompanying consolidated statements of financial condition
of ML Principal Protection L.P. (formerly, ML Principal Protection Plus L.P.) (a
Delaware limited partnership; the "Partnership") as of December 31, 1996 and
1995, and the related consolidated statements of income and changes in partners'
capital for the years ended December 31, 1996 and 1995 and the period from
October 12, 1994 (commencement of operations) to December 31, 1994. These
consolidated financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of ML Principal Protection L.P. (a
Delaware limited partnership) as of December 31, 1996 and 1995, and the results
of their operations for the years ended December 31, 1996 and 1995 and the
period from October 12, 1994 (commencement of operations) to December 31, 1994
in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
February 3, 1997
New York, New York
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------
1996 1995
---- ----
ASSETS
- ------
Cash $ 328 $ 19,332
Accrued interest receivable (Note 2) 23,501 17,852
U. S. Government obligations (Note 1) 72,815,648 74,280,477
Equity in commodity futures trading accounts:
Cash and option premiums 7,177,888 1,586,839
Net unrealized profit on open contracts 1,677,317 2,073,538
------------------- ----------------
TOTAL $81,694,682 $77,978,038
=================== ================
LIABILITIES AND PARTNERS' CAPITAL
- ---------------------------------
LIABILITIES:
Redemptions payable $ 966,906 $ 539,877
Brokerage commissions payable (Note 2) 378,291 356,607
Administrative fee payable (Note 2) 10,224 -
Profit shares payable (Note 4) 658,800 78,840
Organization and initial offering costs payable (Note 1) 68,630 148,331
Settlement payment due to broker - 1,496,925
------------------- ----------------
Total liabilities 2,082,851 2,620,580
------------------- ----------------
Minority Interest 768,546 510,914
------------------- ----------------
PARTNERS' CAPITAL:
General Partner (20,873.06 and 16,603.42 units) 2,301,180 1,766,403
Limited Partners (702,786.91 and 697,715.56 units) 76,542,105 73,080,141
------------------- ----------------
Total partners' capital 78,843,285 74,846,544
------------------- ----------------
TOTAL $81,694,682 $77,978,038
=================== ================
NET ASSET VALUE PER UNIT (Note 5)
See notes to consolidated financial statements.
-2-
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD
FROM OCTOBER 12, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1994
- --------------------------------------------------------------------------------------------------------------------
1996 1995 1994
---- ---- ----
REVENUES:
Trading profit (loss):
Realized $ 9,038,064 $4,407,833 $ (363,054)
Change in unrealized (396,221) 1,355,377 1,115,935
------------------ --------------- ------------------
Total trading results 8,641,843 5,763,210 752,881
Interest income (Note 2) 4,545,186 3,415,670 377,303
------------------ --------------- ------------------
Total revenues 13,187,029 9,178,880 1,130,184
------------------ --------------- ------------------
EXPENSES:
Profit shares (Note 4) 978,264 652,366 129,169
Brokerage commissions (Note 2) 4,775,116 3,303,292 416,617
Administrative fee (Note 2) 129,057 - -
------------------ --------------- ------------------
Total expenses 5,882,437 3,955,658 545,786
------------------ --------------- ------------------
INCOME BEFORE MINORITY INTEREST 7,304,592 5,223,222 584,398
------------------ --------------- ------------------
Minority interest in income (81,228) (36,730) (4,504)
------------------ --------------- ------------------
NET INCOME $ 7,223,364 $5,186,492 $ 579,894
================== =============== ==================
NET INCOME PER UNIT OF PARTNERSHIP INTEREST:
Weighted average number of Units outstanding (Note 6) 754,428 551,944 319,887
================== =============== ==================
Net income per weighted average General Partner
and Limited Partner Unit $9.57 $9.40 $1.81
================== =============== ==================
See notes to consolidated financial statements.
-3-
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED
DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM OCTOBER 12, 1994 (COMMENCEMENT OF
OPERATIONS) TO DECEMBER 31, 1994
- ------------------------------------------------------------------------------------------------------------
Limited General
Units Partners Partner Total
----- -------- ------- -----
Initial offering 320,000.00 $30,942,800 $1,057,200 $32,000,000
Organization and initial
offering costs - (237,615) (1,485) (239,100)
Redemptions (2,438.00) (247,955) - (247,955)
Net income - 560,624 19,270 579,894
-------------- ----------------- --------------- ---------------
PARTNERS' CAPITAL,
DECEMBER 31, 1994 317,562.00 31,017,854 1,074,985 32,092,839
Redemptions (47,810.02) (5,054,249) - (5,054,249)
Subscriptions 444,567.00 43,851,304 605,396 44,456,700
Distributions - (1,771,806) (63,432) (1,835,238)
Net income - 5,037,038 149,454 5,186,492
-------------- ----------------- --------------- ---------------
PARTNERS' CAPITAL,
DECEMBER 31, 1995 714,318.98 73,080,141 1,766,403 74,846,544
Redemptions (245,127.36) (25,748,519) - (25,748,519)
Subscriptions 254,468.35 25,102,217 344,618 25,446,835
Distributions - (2,833,925) (91,014) (2,924,939)
Net income - 6,942,191 281,173 7,223,364
-------------- ----------------- --------------- ---------------
PARTNERS' CAPITAL,
DECEMBER 31, 1996 723,659.97 $76,542,105 $2,301,180 $78,843,285
============== ================= =============== ===============
See notes to consolidated financial statements.
-4-
ML PRINCIPAL PROTECTION L.P.
(formerly, ML Principal Protection Plus L.P.)
(A Delaware Limited Partnership)
------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
OCTOBER 12, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1994
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML Principal Protection L.P. (formerly, ML Principal Protection Plus
L.P.) (the "Partnership") was organized as an open-ended fund under the
Delaware Revised Uniform Limited Partnership Act on January 3, 1994 and
commenced trading activities on October 12, 1994. The Partnership engages
in both the speculative trading of futures, options on futures and
forward contracts on a wide range of commodities through ML Principal
Protection Trading L.P. (formerly, ML Principal Protection Plus Trading
L.P.) (the "Trading Partnership"), of which the Partnership is the sole
limited partner and investing in U.S. Government Securities, as defined.
Merrill Lynch Investment Partners Inc. (formerly, ML Futures Investment
Partners Inc.) (the "General Partner" or "MLIP"), a wholly-owned
subsidiary of Merrill Lynch Group Inc., which in turn is a wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("Merrill Lynch"), is the general
partner of both the Partnership and the Trading Partnership and Merrill
Lynch Futures Inc. ("MLF"), also an affiliate of Merrill Lynch, is the
Trading Partnership's commodity broker. Merrill Lynch Asset Management,
L.P. ("MLAM"), another affiliate of Merrill Lynch, provides cash
management services to the Partnership investing in Government
Securities, as defined. Substantially all of the Partnership's assets are
held in accounts maintained at MLF or Merrill Lynch, Pierce, Fenner &
Smith Incorporated, a Merrill Lynch affiliate. The General Partner has
agreed to maintain a general partner's interest of at least 1% of the
total capital in each of the Partnership and the Trading Partnership. The
General Partner and the Limited Partners share in the profits and losses
of the Partnership, and the General Partner and the Partnership share in
the profits and losses of the Trading Partnership, in proportion to the
respective interests in the Partnership and the Trading Partnership owned
by each.
The consolidated financial statements include the accounts of the Trading
Partnership in which the Partnership is the sole limited partner. All
related transactions and intercompany balances between the Partnership
and the Trading Partnership are eliminated in consolidation.
The ownership by the General Partner in the Trading Partnership
represents a minority interest when the financial results of the Trading
Partnership are consolidated into those of the Partnership. The General
Partner's share of the Trading Partnership's profits and losses is
deducted from the Consolidated Statements of Income, and the General
Partner's interest in the Trading Partnership reduces the partners'
capital on the Consolidated Statements of Financial Condition and the
Consolidated Statements of Changes in Partners' Capital.
The Partnership issues units of limited partnership interest ("Units")
generally as of the beginning of each calendar quarter. Each series has
its own Net Asset Value per Unit. Different series may allocate different
percentages of their total capital to trading, but all series trade under
the direction of the same combination of independent advisors (the
"Trading Advisors" or the "Advisors"), chosen from time to time by MLIP
to manage the Trading Partnership's trading.
-5-
MLIP selects the Advisors to manage the Partnership's assets, and
allocates and reallocates the Partnership's trading assets among
existing, replacement and additional Advisors.
MLIP also determines what percentage of the Partnership's total capital
to allocate to trading from time to time, attempting to balance the
desirability of reducing the opportunity costs of the Partnership's
"principal protection" structure against the necessity of preventing
Merrill Lynch from ever being required to make any payments to the
Partnership under the Merrill Lynch guarantee (see Note 7). Through
December 31, 1996, no series of Units had allocated to trading a greater
percentage of its assets than was so allocated at the time the series was
issued.
Estimates
---------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Revenue Recognition
-------------------
Commodity futures, options on futures and forward contract transactions
are recorded on the trade date, and open contracts are reflected in net
unrealized profit (loss) on open contracts in the Consolidated Statements
of Financial Condition at the difference between the original contract
amount and the fair value. The change in net unrealized profit (loss) on
open contracts from one period to the next is reflected in change in
unrealized in the Consolidated Statements of Income. Fair value is based
on quoted market prices on the exchange or market on which the contract
is traded.
U.S. Government Securities
--------------------------
The Partnership invests a portion of its assets in obligations of the
U.S. Treasury and certain other U.S. government agencies ("Government
Securities") under the direction of MLAM within the parameters
established by MLIP for which MLAM accepts no responsibility. These
investments are carried at fair value.
Organization and Initial Offering Costs, Operating Expenses and Selling
-----------------------------------------------------------------------
Commissions
-----------
The General Partner advanced all organization and initial offering costs
relating to the Partnership and the Trading Partnership. The Partnership
and Trading Partnership are reimbursing the General Partner for such
costs in 36 equal monthly installments. For financial reporting purposes,
the Partnership deducted the organization and initial offering
reimbursement costs of $239,100 from partners' capital at inception. For
all other purposes (including determining Net Asset Values of the Units),
the Partnership deducts the organization and initial offering cost
reimbursements only as actually paid.
The General Partner pays all routine operating costs (including legal,
accounting, printing and similar administrative expenses) of the
Partnership and the Trading Partnership, including the cost of the
ongoing offering of the Units. The General Partner receives an
administrative fee as well as a portion of the brokerage commissions paid
to MLF by the Partnership as reimbursement for the foregoing expenses.
No selling commissions have been or are paid by Limited Partners.
-6-
Income Taxes
------------
No provision for income taxes has been made in the accompanying consolidated
financial statements as each Partner is individually responsible for
reporting income or loss based on such Partner's respective share of the
Partnership's consolidated income and expenses as reported for income tax
purposes.
Redemptions
-----------
A Limited Partner may require the Partnership to redeem some or all of such
Partner's Units at Net Asset Value as of the close of business on the last
business day of any month upon ten calendar days' notice. Units redeemed on
or prior to the end of the twelfth full month after purchase are assessed an
early redemption charge of 3% of their Net Asset Value as of the date of
redemption.
Dissolution of the Partnership
------------------------------
The Partnership will terminate on December 31, 2024, or at an earlier date
if certain conditions occur, as well as under certain other circumstances as
set forth in the Limited Partnership Agreement.
2. RELATED PARTY TRANSACTIONS
A portion of the Partnership's U.S. dollar-denominated assets are held at
MLF in cash or short-term Treasury bills. The Partnership receives all
interest paid on such Treasury bills. On the cash held at MLF, the
Partnership receives interest from Merrill Lynch at rates ranging from .50
of 1% per annum below the prevailing 91-day Treasury bill rate up to the
full prevailing 91-day Treasury bill rate. Merrill Lynch may derive certain
economic benefits, in excess of the interest which Merrill Lynch pays to the
Partnership, from possession of such cash.
Merrill Lynch credits the Partnership with interest on the Partnership's
non-U.S. dollar-denominated available assets based on local short-term
rates. Merrill Lynch charges the Partnership Merrill Lynch's cost of
financing realized and unrealized losses on the Partnership's non-U.S.
dollar-denominated positions.
Prior to 1996, the Partnership paid brokerage commissions to MLF in respect
of each series of Units at a flat monthly rate equal to .792 of 1% (a 9.5%
annual rate) of such series' month-end assets allocated to the trading.
Effective January 1, 1996, this rate was reduced to .771 of 1% (a 9.25%
annual rate) of each series' month-end assets allocated to trading and the
Partnership began to pay MLIP a monthly administrative fee of .021 of 1% (a
.25% annual rate) of each series' month-end assets allocated to trading
(this recharacterization had no economic effect on the Partnership). Assets
committed to trading are not reduced for purposes of calculating brokerage
commissions and administrative fees by any accrued brokerage commissions,
administrative fees, profit shares or other fees or charges.
The General Partner estimates that the round-turn equivalent commission rate
charged to the Partnership during the years ended December 31, 1996 and
1995, and the period from October 12, 1994 to December 31, 1994, was
approximately $116, $134 and $53, respectively, not including, in
calculating round-turn equivalents, forward contracts on a futures-
equivalent basis.
MLF pays MLAM annual management fees of .20 of 1% on the first $25 million
of Partnership capital managed by MLAM, .15 of 1% on the next $25 million of
capital, .125 of 1% on the next $50
- 7 -
million, and .10 of 1% on capital in excess of $100 million. Such fees are
paid quarterly in arrears and are calculated on the basis of the average
daily assets managed by MLAM.
MLF pays the Trading Advisors annual Consulting Fees, ranging up to 4% of
the Partnership's average month-end assets allocated to them for management,
after reduction for a portion of the brokerage commissions accrued with
respect to such assets.
The Partnership trades forward contracts through a Foreign Exchange Service
Desk (the "F/X Desk") established by MLIP that contacts at least two
counterparties along with Merrill Lynch International Bank ("MLIB") for all
of the Partnership's currency transactions. All counterparties other than
MLIB are unaffiliated with any Merrill Lynch entity. The F/X Desk charges a
service fee (at current exchange rates) equal to approximately $5.00 to
$12.50 on each purchase or sale of a futures-contract equivalent face amount
of a foreign currency. No service fee is charged on trades awarded to MLIB
(on which MLIB receives a "bid-ask" spread). MLIB is awarded trades only if
its price (without the service fee) is equal to or better than the best
price (including the service charge) offered by any of the other
counterparties contacted.
The F/X Desk trades using credit lines provided by a Merrill Lynch entity.
The Partnership is not required to margin or otherwise guarantee its F/X
Desk trading.
Certain of the Partnership's currency trades are executed in the form of
"exchange of futures for physical" ("EFP") transactions involving MLIB and
MLF. In these transactions, a spot or forward (collectively referred to as
"cash") currency position is acquired and exchanged for an equivalent
futures position on the Chicago Mercantile Exchange's International Monetary
Market. In its EFP trading, the Partnership acquires cash currency positions
through the F/X Desk in the same manner and on the same terms as in the case
of the Partnership's other F/X Desk trading. When the Partnership exchanges
these positions for futures, there is a "differential" between the prices of
these two positions. This "differential" reflects, in part, the different
settlement dates of the cash and the futures contracts as well as prevailing
interest rates, but also includes a pricing spread in favor of MLIB or
another Merrill Lynch entity.
The Partnership's F/X Desk service fee and EFP differential costs combined
have, to date, totaled no more than .25 of 1% per annum of the Partnership's
average month-end assets allocated to trading.
3. ANNUAL DISTRIBUTIONS
The Trading Partnership makes annual fixed-rated distributions, payable
irrespective of profitability, of between $2 and $6 per Unit on the Series
A-H Units. The Partnership may also pay discretionary distributions on such
Series of Units of up to 50% of any Distributable New Appreciation, as
defined. As of December 31, 1996, the Partnership has made the following
distributions:
Distribution Fixed-Rate Discretionary
Series Date Distribution Distribution
---------- ---------------- ------------------ -------------------
1996
------
Series A 10/1/96 $3.50 $2.50
Series B 1/1/96 3.50 2.50
Series C 4/1/96 3.50 -
Series D 7/1/96 3.50 -
Series E 10/1/96 3.50 -
1995
------
Series A 10/1/95 3.50 2.50
- 8 -
4. AGREEMENTS
The Trading Partnership and the Advisors have each entered into Advisory
Agreements. These Advisory Agreements generally terminate one year after
they are entered into, subject to certain renewal rights exercisable by the
Partnership. The Advisors determine the commodity futures and forward
contract trades to be made on behalf of their respective Partnership
accounts, subject to certain trading policies and to certain rights reserved
for the General Partner.
Profit Shares, generally ranging from 15% to 25% of any New Trading Profit,
as defined, recognized by each Advisor individually, irrespective of the
overall performance of the Partnership, as of the end of each calendar
quarter are paid to the appropriate Advisors. Profit shares are also paid
out as in respect of Units redeemed as of the end of interim months during a
quarter to the extent of the applicable percentage of any New Trading Profit
attributable to such Units.
5. NET ASSET VALUE PER UNIT
For financial reporting purposes, the Partnership deducted the total
organizational and initial offering costs payable to the General Partner at
inception for purposes of determining Net Asset Value. Such deduction was
allocated pro-rata among the outstanding Units of each series based upon the
aggregate Net Asset Value of each series, and then equally among all Units
of the same series. For all other purposes (including computing Net Asset
Value for redemptions) the Partnership deducts the organizational and
initial offering cost reimbursements only as actually paid. Consequently, at
December 31, 1996 and 1995, the Net Asset Values of the different series of
Units for financial reporting purposes and for all other purposes were:
Net Asset Value Net Asset Value per Unit
-------------------------------- ---------------------------
All Other Financial Number of All Other Financial
Purposes Reporting Units Purposes Reporting
---------------- -------------- ----------- ------------ -------------
1996
---------------------------------------------------------------------------
Series A Units $21,048,780 $21,031,369 190,136.00 $110.70 $110.61
Series B Units 3,447,686 3,444,936 30,179.00 114.24 114.15
Series C Units 4,996,014 4,992,389 45,696.00 109.33 109.25
Series D Units 12,582,502 12,567,310 116,303.00 108.19 108.06
Series E Units 10,484,159 10,476,812 96,561.50 108.58 108.50
Series F Units 10,179,910 10,173,793 93,465.62 108.92 108.85
Series G Units 6,967,116 6,962,973 64,920.50 107.32 107.25
Series H Units 9,199,107 9,193,703 86,398.35 106.47 106.41
------------ ------------ ----------
Total $78,905,274 $78,843,285 723,659.97
=========== =========== ==========
1995
---------------------------------------------------------------------------
Series A Units $29,380,564 $29,321,472 274,693.00 $106.96 $106.74
Series B Units 7,011,988 6,999,016 63,540.00 110.36 110.15
Series C Units 6,800,466 6,788,236 65,800.00 103.35 103.16
Series D Units 20,522,519 20,485,530 200,540.00 102.34 102.15
Series E Units 11,272,696 11,252,290 109,745.98 102.72 102.53
------------ ----------- ----------
Total $74,988,233 $74,846,544 714,318.98
=========== =========== ==========
- 9 -
6. WEIGHTED AVERAGE UNITS
Weighted average number of Units outstanding was computed for purposes of
disclosing consolidated net income per weighted average Unit. The weighted
average Units at December 31, 1996, 1995 and 1994 equals the Units
outstanding as of such date, adjusted proportionately for Units redeemed or
issued based on the respective length of time each was outstanding during
such period.
7. MERRILL LYNCH & CO., INC. GUARANTEE
Merrill Lynch has guaranteed to the Partnership that it will have sufficient
net assets, as of the Principal Assurance Date, as defined, for each series
of Units, that the Net Asset Value per Unit of such series as of such
Principal Assurance Date will equal, after reduction for all liabilities to
third parties and all distributions paid to such Units, not less than $100.
8. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Partnership trades futures, options on futures and forward contracts on
interest rates, stock indices, commodities, currencies, energy and metals.
The Partnership's trading results by reporting category were as follows:
Total Trading Results
------------------------------------------
1996 1995
-------------- --------------
Interest Rates $3,183,955 $3,933,366
Stock Indices (746,255) 587,931
Commodities 20,119 (447,486)
Currencies 3,301,360 2,914,300
Energy 3,280,677 238,988
Metals (398,013) (1,463,889)
-------------- --------------
$8,641,843 $5,763,210
============== ===============
Market Risk
-----------
Derivative financial instruments involve varying degrees of off-balance
sheet market risk, and changes in the level or volatility of interest rates,
foreign currency exchange rates or market values of the financial
instruments or commodities underlying such derivative instruments frequently
result in changes in the Partnership's unrealized profit (loss) on such
derivative instruments as reflected in the Consolidated Statements of
Financial Condition. The Partnership's exposure to market risk is influenced
by a number of factors, including the relationships among the derivative
instruments held by the Trading Partnership as well as the volatility and
liquidity in the markets in which the derivative instruments are traded.
The General Partner has procedures in place intended to control market risk,
although there can be no assurance that they will, in fact, succeed in doing
so. The procedures focus primarily on monitoring the trading of the Advisors
selected from time to time for the Partnership, adjusting the percentage of
the Partnership's total assets allocated to trading with respect to each
Series of Units, calculating the Net Asset Value of the Advisors' respective
Partnership accounts as of the close of business on each day and reviewing
outstanding positions for over-concentrations -- both on an Advisor-by-
Advisor and on an overall Partnership basis. While the General Partner will
not itself intervene in the markets to hedge or diversify the Partnership's
market exposure, the General Partner may urge Advisors to reallocate
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positions, or itself reallocate Partnership assets among Advisors (although
typically only as of the end of a month), in an attempt to avoid over-
concentrations. However, such interventions are unusual. Except in cases in
which it appears that an Advisor has begun to deviate from past practice and
trading policies or to be trading erratically, the General Partner's basic
risk control procedures consist simply of the ongoing process of Advisor
monitoring and selection, with the market risk controls being applied by the
Advisors themselves.
One important aspect of the General Partner's risk controls is its
adjustments to the leverage at which each series of Units trades. By
controlling the percentage of each series' assets allocated to trading, the
General Partner can directly affect the market exposure of the Partnership.
Leverage control is the principal means by which the General Partner hopes
to be able to ensure that Merrill Lynch is never required to make any
payments under its guarantee that the Net Asset Value per Unit of each
series will equal no less than $100 as of the Principal Assurance Date for
such series.
Fair Value
----------
The derivative instruments traded by the Trading Partnership are marked to
market daily with the resulting unrealized profit (loss) recorded in the
Consolidated Statements of Financial Condition and the related profit (loss)
reflected in trading revenues in the Consolidated Statements of Income.
The contract/notional values of the Trading Partnership's open derivative
instrument positions as of December 31, 1996 and 1995 were as follows:
1996 1995
----------------------------------------- -----------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------- ------------------- ------------------- -------------------
Interest Rates $103,258,306 $ 38,270,540 $230,060,441 $ 37,950,386
Stock Indices 4,259,475 2,340,013 8,866,682 152,858
Commodities 8,541,433 12,761,047 17,582,456 3,850,643
Currencies 53,592,111 86,479,803 34,118,884 71,457,359
Energy 5,566,768 - 9,047,015 3,440,800
Metals 4,593,702 14,839,516 7,796,167 11,765,623
---------------- ---------------- ---------------- ----------------
$179,811,795 $154,690,919 $307,471,645 $128,617,669
================ ================ ================ ================
Substantially all of the Trading Partnership's open derivative instruments
outstanding as of December 31, 1996, expire within one year.
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The contract/notional value of the Trading Partnership's exchange-traded and
non-exchange-traded derivative instrument positions as of December 31, 1996
and 1995 was as follows:
1996 1995
------------------------------------------- ------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------- ------------------- ------------------- -------------------
Exchange-Traded $133,757,339 $ 85,639,298 $238,654,840 $ 76,980,099
Non-Exchange
Traded 46,054,456 69,051,621 68,816,805 51,637,570
---------------- ----------------- --------------- -----------------
$179,811,795 $154,690,919 $307,471,645 $128,617,669
================ ================= =============== =================
The average fair value of the Trading Partnership's derivative instrument
positions which were open as of the end of each calendar month during the
year ended December 31, 1996 and 1995 was as follows:
1996 1995
------------------------------------------ ------------------------------------------
Commitment to Commitment to Commitment to Commitment to
Purchase (Futures, Sell (Futures, Purchase (Futures, Sell (Futures,
Options & Forwards) Options & Forwards) Options & Forwards) Options & Forwards)
------------------- ------------------- ------------------- -------------------
Interest Rates $224,985,973 $91,029,835 $170,252,009 $14,100,439
Stock Indices 10,235,486 2,492,230 5,390,839 1,288,747
Commodities 13,316,970 7,175,841 9,360,681 2,915,357
Currencies 94,601,907 115,671,672 36,054,488 38,557,545
Energy 6,862,906 1,348,945 2,823,925 2,417,008
Metals 13,579,528 19,196,951 6,113,263 10,207,341
----------------- ---------------- ---------------- ---------------
$363,582,770 $236,915,474 $229,995,205 $69,486,437
================= ================ ================ ===============
A portion of the amounts indicated as off-balance sheet risk reflects
offsetting commitments to purchase and to sell the same derivative
instrument on the same date in the future. These commitments are
economically offsetting but are not, as a technical matter, offset in the
forward markets until the settlement date.
Credit Risk
-----------
The risks associated with exchange-traded contracts are typically perceived
to be less than those associated with over-the-counter (non-exchange-traded)
transactions, because exchanges typically (but not universally) provide
clearinghouse arrangements in which the collective credit (in some cases
limited in amount, in some cases not) of the members of the exchange is
pledged to support the financial integrity of the exchange. In over-the-
counter transactions, on the other hand, traders must rely solely on the
credit of their respective individual counterparties. Margins, which may be
subject to loss in the event of a default, are generally required in
exchange trading, and counterparties may require margin in the over-the-
counter markets.
The fair value amounts in the above tables represent the extent of the
Trading Partnership's market exposure in the particular class of derivative
instrument, but not the credit risk associated with counterparty
nonperformance. The credit risk associated with these instruments, from
counterparty
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nonperformance, is the net unrealized profit, if any, included on the
Consolidated Statements of Financial Condition. The Trading Partnership also
has credit risk because the sole counterparty or broker with respect to most
of the Trading Partnership's assets is MLF.
The gross unrealized profit and the net unrealized profit (loss) on the
Trading Partnership's open derivative instrument positions as of December
31, 1996 and 1995 were as follows:
1996 1995
----------------------------------- --------------------------------------
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit (Loss) Profit Profit (Loss)
---------------- ---------------- ---------------- ----------------
Exchange
Traded $2,090,698 $1,611,482 $2,942,622 $2,223,484
Non-Exchange 1,172,965 65,835 352,246 (149,946)
Traded
------------- ------------- -------------- --------------
$3,263,663 $1,677,317 $3,294,868 $2,073,538
============= ============= ============== ==============
The Partnership controls credit risk by dealing almost exclusively with
Merrill Lynch entities as brokers and counterparties.
The Partnership, through its normal course of business, enters into various
contracts with MLF acting as its commodity broker. Pursuant to the brokerage
arrangement with MLF, to the extent that such trading results in receivables
from and payables to MLF, these receivables and payables are offset and
reported as a net receivable or payable.
9. SUBSEQUENT EVENT
Effective January 1, 1997, each series of Units' brokerage commission
percentage was reduced to .729 of 1% (an 8.75% annual rate) of the
Partnership's month-end assets allocated to trading.
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
James M. Bernard
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
General Partner of
ML Principal Protection L.P.
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