EXHIBIT 13.01
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
Consolidated Financial Statements for the Years Ended
December 31, 1998, 1997 and 1996 and
Independent Auditors' Report
[LOGO] MERRILL LYNCH
To: The Limited Partners of ML Principal Protection L.P.
ML Principal Protection L.P. (the "Fund" or the "Partnership") ended its fifth
fiscal year of trading on December 31, 1998 with an increase in Net Asset Value
("NAV"). During 1998, trading profits were generated in the interest rate,
currency and stock index markets while losses were incurred in agricultural,
metals and energy trading. Please see the accompanying summary financial
information for the NAV of your series of Units.
Global interest rate markets provided the Fund with its most profitable
positions for the first quarter, particularly in European bonds where an
extended bond market rally continued despite an environment of robust growth in
the United States, Canada and the United Kingdom, as well as a strong pick-up in
growth in continental Europe. In the second quarter, swings in the U.S. dollar
and developments in Japan affected bond markets, causing the Fund's interest
rate trading to result in losses. This was turned around in the third quarter,
as markets worldwide were turned upside down and the Fund's non-correlation with
general equity and debt markets was strongly exhibited, and trading was
particularly profitable in positions in Eurodollars, German and Japanese bonds,
and U.S. Treasury notes and bonds. Global investors staged a major flight to
quality, resulting in a significant widening of credit spreads on a global
basis. In October, investors pushed the yields on U.S. Treasury bonds to a 31-
year low. The long bond yield fell about 75 basis points in 1998 as the world
economy slowed more than expected, inflation continued to fall, the anticipated
small U.S. budget deficit turned into substantial surplus, and the Federal
Reserve lowered interest rates.
In currency markets, results early in the year were mixed, although marginally
profitable. During the second quarter, strong gains were realized in positions
in the Japanese yen, which weakened during June to an eight-year low versus the
U.S. dollar. Significant gains from Japanese yen trading continued into the
third quarter, and Japan's problems spread to other sectors of the global
economy, causing commodities prices to decline as demand from the Asian
economies weakened. Japan's deepening recession and credit crunch continued
through the fourth quarter, and the Fund achieved gains from long yen positions.
Trading results in stock index markets were also mixed in early 1998, despite a
strong first-quarter performance by the U.S. equity market as several
consecutive weekly gains were recorded with most market averages setting new
highs. Second quarter results were profitable as the Asia-Pacific region's
equity markets weakened across the board. In particular, Hong Kong's Hang Seng
index trended downward during most of the second quarter and traded at a three-
year low. As U.S. equity markets declined in July and August, the Fund profited
from short positions in the S&P 500, most notably during August, when the index
dropped 14.5%. Volatility in September made for a difficult trading environment
in the stock index sector, and the Fund incurred modest losses, although results
remained profitable for the quarter and the year overall in these markets
In agricultural commodity markets, 1998 began with strong gains as live cattle
and hog prices trended downward throughout the first quarter. In the second
quarter, although the U.S. soybean crop got off to a good start which
contributed to higher yield expectations and a more burdensome supply outlook,
soybean prices traded in a volatile pattern. Sugar futures maintained mostly a
downtrend, as no major buyers emerged to support the market. Similarly, coffee
prices trended
downward, as good weather conditions in Central America and Mexico increased the
prospects of more output from these countries. The third quarter resulted in
losses as the U.S. soybean crop increased relative to the USDA's production
estimate as a result of timely rains, which contributed to lower prices. These
losses continued into the fourth quarter as the Fund was caught on the short
side of the soybean complex, as the soybean supply surplus became more
manageable following the November 10th USDA reports, causing prices to gain
upward momentum.
Gold prices began the year drifting sideways, and continued to weaken following
news in the second quarter of a European Central Bank consensus that ten to
fifteen percent of reserves should be made up of gold bullion, which was at the
low end of expectations. Gold was unable to extend third quarter rallies or to
build any significant upside momentum, resulting in a trendless environment.
This was also the case in the fourth quarter, as gold's cost of production
declined. Also, silver markets remained range-bound, while also experiencing a
significant selloff in November, and aluminum traded at its lowest levels since
1994, with many aluminum smelters operating at a loss.
In energy markets, demand for crude oil in the Middle East was affected by low
oil prices early in the year, and trading resulted in losses. Initially buoyed
on concerns about a U.S.-led military strike against Iraq, crude oil fell to a
nine-year low, as the globally warm winter, the return of Iraq as a producer and
the Asian economic crisis added to OPEC's supply glut problems. Despite
production cuts initiated by OPEC at the end of March, world oil supplies
remained excessive and oil prices stood at relatively low levels throughout the
first half of 1998. Short heating oil positions in the third quarter proved
profitable for the Fund as the market for heating oil prices dropped to its
lowest level in more than a decade. In early December, oil and natural gas
prices dropped sharply, causing continued problems for many emerging market
countries that depend on commodity exports for economic growth and government
financing. These price pressures were mainly due to excessive supply
availability and near-term weather indications that inventories would remain at
more than adequate levels even in the event of a cold Northern Hemisphere
winter. Also, the December U.S. air attack on Iraq failed to cause any damage
to oil pumping and shipping operations, and oil prices fell over 10%.
Despite a year of unprecedented volatility in key global markets, we were
pleased with the Fund's ability to generate a profit by trading both the long
and short side of a variety of markets, demonstrating its value as an element of
diversification in an investor's portfolio. We look forward to 1999 and the
opportunities it may present.
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, AS SUPPLEMENTED, WHICH
CONTAINS IMPORTANT INFORMATION CONCERNING RISK FACTORS, PERFORMANCE AND OTHER
MATERIAL ASPECTS OF THE FUND, TOGETHER WITH SUMMARY FINANCIAL INFORMATION
CURRENT WITHIN 60 DAYS. 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.
(A Delaware Limited Partnership)
------------------------------
TABLE OF CONTENTS
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Page
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INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996:
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Changes in Partners' Capital 4
Notes to Consolidated Financial Statements 5-14
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. (the "Partnership") as of December 31, 1998 and
1997, and the related consolidated statements of income and of changes in
partners' capital for each of the three years in the period ended December 31,
1998. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of ML Principal Protection L.P. as of
December 31, 1998 and 1997, and the results of their operations for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
New York, New York
February 4, 1999
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
1998 1997
----------------- ------------------
ASSETS
Equity in commodity futures trading accounts:
Cash and option premiums $ 20,564,400 $ 6,127,857
Net unrealized profit on open contracts 601,178 2,958,175
Government Securities (Note 1) (Cost : $60,044,483 and $93,663,044) 60,536,271 93,851,028
Cash 43,497 1,423
Accrued interest receivable (Note 2) 685,821 839,464
----------------- ------------------
TOTAL $ 82,431,167 $ 103,777,947
================= ==================
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES:
Brokerage commissions payable (Note 2) $ 402,923 $ 494,349
Profit Shares payable (Note 4) 594,328 591,195
Redemptions payable 1,467,829 636,155
Administrative fees payable (Note 2) 16,960 14,330
----------------- ------------------
Total liabilities 2,482,040 1,736,029
----------------- ------------------
Minority Interest 842,289 815,233
----------------- ------------------
PARTNERS' CAPITAL:
General Partner (6,654.61 Units and 23,141.61 Units) 735,280 2,564,153
Limited Partners (717,784.1628 Units and 989,140.56 Units) 78,371,558 105,628,837
Subscriptions Receivable (0 Units and 69,663.05 Units) - (6,966,305)
----------------- ------------------
Total partners' capital 79,106,838 101,226,685
----------------- ------------------
TOTAL $ 82,431,167 $ 103,777,947
================= ==================
NET ASSET VALUE PER UNIT (Note 5)
See notes to consolidated financial statements.
-2-
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
REVENUES:
Trading profit (loss):
Realized $ 8,746,563 $ 5,412,457 $ 9,038,064
Change in unrealized (2,053,193) 1,083,826 (396,221)
--------------- --------------- ---------------
Total trading results 6,693,370 6,496,283 8,641,843
Interest income (Note 2) 5,434,851 4,873,872 4,545,186
--------------- --------------- ---------------
Total revenues 12,128,221 11,370,155 13,187,029
--------------- --------------- ---------------
EXPENSES:
Brokerage commissions (Note 2) 6,159,359 4,833,598 4,775,116
Profit Shares (Note 4) 1,658,306 931,522 978,264
Administrative fees (Note 2) 193,861 138,103 129,057
--------------- --------------- ---------------
Total expenses 8,011,526 5,903,223 5,882,437
--------------- --------------- ---------------
INCOME BEFORE MINORITY INTEREST 4,116,695 5,466,932 7,304,592
--------------- --------------- ---------------
Minority interest in income (27,056) (46,687) (81,228)
--------------- --------------- ---------------
NET INCOME $ 4,089,639 $ 5,420,245 $ 7,223,364
=============== =============== ===============
NET INCOME PER UNIT:
Weighted average number of General Partner
and Limited Partner Units outstanding (Note 6) 929,254 818,689 754,428
=============== =============== ===============
Net income per weighted average General Partner
and Limited Partner Unit $ 4.40 $ 6.62 $ 9.57
=============== =============== ===============
See notes to consolidated financial statements.
-3-
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
Limited General Subscriptions
Units Partners Partner Receivable Total
------------------- ------------------ --------------- ----------------- ------------------
PARTNERS' CAPITAL,
DECEMBER 31, 1995 714,318.9800 $ 73,080,141 $ 1,766,403 $ - $ 74,846,544
Redemptions (245,127.3600) (25,748,519) - - (25,748,519)
Subscriptions 254,468.3500 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 723,659.9700 76,542,105 2,301,180 - 78,843,285
Redemptions (183,442.9100) (19,816,833) - - (19,816,833)
Subscriptions 472,065.1100 46,994,656 211,855 - 47,206,511
Subscriptions Receivable (69,663.0500) - - (6,966,305) (6,966,305)
Distributions - (3,362,913) (97,305) - (3,460,218)
Net income - 5,271,822 148,423 - 5,420,245
------------------- ------------------ --------------- ----------------- ------------------
PARTNERS' CAPITAL,
DECEMBER 31, 1997 942,619.1200 105,628,837 2,564,153 (6,966,305) 101,226,685
Redemptions (426,071.8902) (43,562,357) (1,807,512) - (45,369,869)
Subscriptions 138,228.4930 13,822,849 - - 13,822,849
Subscriptions Receivable 69,663.0500 - - 6,966,305 6,966,305
Distributions - (1,595,262) (33,509) - (1,628,771)
Net income - 4,077,491 12,148 - 4,089,639
------------------- ------------------ --------------- ----------------- ------------------
PARTNERS' CAPITAL,
DECEMBER 31, 1998 724,438.7728 $ 78,371,558 $ 735,280 $ - $ 79,106,838
=================== ================== =============== ================= ==================
See notes to consolidated financial statements.
-4-
ML PRINCIPAL PROTECTION L.P.
(A Delaware Limited Partnership)
------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
------------
ML Principal Protection L.P (the "Partnership") was organized as an open-end
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, forwards and options on forward contracts on a wide range of
commodities through ML Principal Protection Trading L.P (the "Trading
Partnership"), of which the Partnership is the sole limited partner, and
investing in Government Securities, as defined. Merrill Lynch Investment
Partners Inc. (the "General Partner", "Trading 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.
Merrill Lynch Futures Inc. ("MLF"), an affiliate of Merrill Lynch, is the
Trading Partnership's commodity broker. Merrill Lynch Asset Management, Inc.
("MLAM"), another affiliate of Merrill Lynch, provides cash management
services to the Partnership investing in Government Securities.
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 intends to maintain a general
partner's interest of at least 1% of the total capital in each series of
units. The General Partner and the Limited Partners share in the profits and
losses of the Partnership and the Trading Partnership in proportion to the
respective interests in the Partnership and the Trading Partnership.
References to the Partnership include references to the Trading Partnership
unless the context otherwise requires.
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 partners' capital on the Consolidated Statements
of Financial Condition and the Consolidated Statements of Changes in
Partners' Capital.
The Partnership issues different series of 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. For series issued prior to
May 1, 1997, each series may allocate different percentages of their total
capital to trading. For series issued after May 1, 1997, all such series
must allocate the same percentage of their total capital to trading. All
series, regardless of when issued, 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.
MLIP selects the Advisors to manage the Partnership's trading assets, and
allocates and reallocates the Partnership's trading assets among existing,
replacement and additional Advisors.
-5-
MLIP determines what percentage of the Partnership's total capital to
allocate to trading by investing in the Trading Partnership 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),
and subject to the requirement that all series issued after May 1, 1997 must
allocate the same percentage of their capital to trading.
Certain of the prior year balances have been reclassified to conform with
the current year's presentation.
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, forwards and options on forward
contracts are recorded on the trade date, and open contracts are reflected
in net unrealized profit on open contracts in the Consolidated Statements of
Financial Condition at the difference between the original contract value
and the market value (for those commodity interests for which market
quotations are readily available) or at fair value. The change in unrealized
(loss) profit on open contracts and Government Securities, as defined below,
from one period to the next is reflected in change in unrealized in the
Consolidated Statements of Income.
Foreign Currency Transactions
-----------------------------
The Partnership's functional currency is the U.S. dollar; however, it
transacts business in currencies other than the U.S. dollar. Assets and
liabilities denominated in currencies other than the U.S. dollar are
translated into U.S. dollars at the rates in effect at the dates of the
Statements of Financial Condition. Income and expense items denominated in
currencies other than the U.S. dollar are translated into U.S. dollars at
the rates in effect during the period. Gains and losses resulting from the
translation to U.S. dollars are reported in total trading results currently.
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.
Operating Expenses and Selling Commissions
------------------------------------------
The General Partner pays all routine operating costs (including legal,
accounting, printing, postage 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 administrative fees as
well as a portion of the brokerage commissions paid to MLF by the
Partnership.
No selling commissions have been or are paid directly by Limited Partners.
All selling commissions are paid by MLIP.
-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 such Units were issued
are assessed an early redemption charge of 3% of their Net Asset Value as of
the date of redemption. Units redeemed after the twelfth month but on or
before the end of the eighteenth month after such Units were issued are
subject to a redemption charge of 1.5%. Units redeemed after the eighteenth
month but on or before the end of the twenty-fourth month after such Units
were issued are subject to a 1% redemption charge.
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.
Recently Issued Accounting Pronouncements
-----------------------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (the "Statement"). Such Statement is
effective for fiscal years commencing after June 15, 1999. The General
Partner does not believe that the Statement will have a significant effect
on the financial statements of the Partnership.
2. RELATED PARTY TRANSACTIONS
MLAM manages a substantial portion all of the Partnership's available U.S.
dollar assets, pursuant to guidelines established by MLIP for which MLAM
assumes no responsibility, in the Government Securities markets. MLF pays
MLAM annual management fees of .20 of 1% on the first $25 million of certain
assets ("Capital"), including the Partnership's assets managed by MLAM, .15
of 1% on the next $25 million of Capital, .125 of 1% on the next $50
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.
A portion of the Partnership's U.S. dollar assets is maintained at MLF. On
assets held in U.S. dollars, Merrill Lynch credits the Partnership with
interest at the prevailing 91-day U.S. Treasury bill rate. The Partnership
is credited with interest on any of its net gains actually held by Merrill
Lynch in non-U.S. dollar currencies at a prevailing local rate received by
Merrill Lynch. Merrill Lynch may derive certain economic benefits, in excess
of the interest which Merrill Lynch pays to the Partnership, from possession
of such assets.
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.
The General Partner determined that there may have been a miscalculation in
the interest credited to the Partnership for a period prior to November 1996
(such period may extend prior to that covered by these financial
statements). Accordingly, the General Partner credited current and former
investors who maintained a Merrill Lynch customer account in December 1997
with interest which was compounded.
-7-
Former investors who do not maintain a Merrill Lynch customer account have
been credited as their response forms are processed. The total amount of the
adjustment was approximately $54,000. Since this amount was paid directly to
investors by the General Partner, it is not reflected in these financial
statements. The General Partner determined that interest was calculated
appropriately since November 1996.
Prior to January 1, 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 invested in the
Trading Partnership. Effective January 1, 1996, this rate was reduced to
.771 of 1% (a 9.25% annual rate), 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 invested in the Trading Partnership (this
recharacterization had no economic effect on the Partnership). Effective
January 1, 1997, each series' brokerage commission percentage was reduced to
.729 of 1% (an 8.75% annual rate). Effective October 1, 1998, the
administrative fee calculation base was changed so as to equal .021 of 1% (a
.25% annual rate) of the Partnership's month-end total assets, and each
series' brokerage commission percentage was reduced to .625 of 1% (a 7.50%
annual rate). Assets committed to trading and total assets 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 Trading Partnership during the years ended December 31, 1998,
1997 and 1996, was approximately $80, $116 and $116, respectively, (not
including, in calculating round-turn equivalents, forward contracts on a
futures-equivalent basis.)
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.
Many of the Partnership's currency trades are executed in the spot and
forward foreign exchange markets (the "FX Markets") where there are no
direct execution costs. Instead, the participants, banks and dealers,
including Merrill Lynch International Bank ("MLIB"), in the FX Markets take
a "spread" between the prices at which they are prepared to buy and sell a
particular currency and such spreads are built into the pricing of the spot
or forward contracts with the Partnership. The General Partner anticipates
that some of the Partnership's foreign currency trades will be executed
through MLIB, an affiliate of the General Partner. MLIB has discontinued the
operation of the foreign exchange service desk, which included seeking
multiple quotes from counterparties unrelated to MLIB for a service fee and
trade execution.
In its exchange of futures for physical ("EFP") trading, the Partnership
acquires cash currency positions through banks and dealers, including
Merrill Lynch. The Partnership pays a spread when it exchanges these
positions for futures. This spread 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
the banks and dealers, which may include a Merrill Lynch entity.
-8-
3. ANNUAL DISTRIBUTIONS
The Partnership makes annual fixed-rate distributions, payable
irrespective of profitability, of $3.50 per Unit on Units issued prior to
May 1, 1997. The Partnership may also pay discretionary distributions on
such series of Units of up to 50% of any Distributable New Appreciation,
as defined on such Units. No distributions are payable on Units issued
after May 1, 1997. As of December 31, 1998, the Partnership had made the
following distributions:
Distribution Fixed-Rate Discretionary
Series Date Distribution Distribution
--------- ----------------------------------------------
1998
-----
Series A 10/1/98 $ 3.50 $ -
Series B 1/1/98 3.50 1.50
Series C 4/1/98 3.50 -
Series D 7/1/98 3.50 -
Series E 10/1/98 3.50 -
Series F 1/1/98 3.50 1.25
Series G 4/1/98 3.50 -
Series H 7/1/98 3.50 -
1997
-----
Series A 10/1/97 $ 3.50 $ -
Series B 1/1/97 3.50 3.00
Series C 4/1/97 3.50 4.00
Series D 7/1/97 3.50 1.00
Series E 10/1/97 3.50 2.00
Series F 1/1/97 3.50 2.50
Series G 4/1/97 3.50 3.50
Series H 7/1/97 3.50 2.50
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 -
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, options on
futures, forwards and option on forward contract trades to be made on
behalf of their respective Trading Partnership accounts, subject 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 any series, either as of the end of each
calendar quarter or year and upon the net reallocation of assets away from
an Advisor, including unit redemptions, are paid to the appropriate
Advisors to the extent of the applicable percentage of any New Trading
Profit attributable to such Units.
-9-
5. NET ASSET VALUE PER UNIT
At December 31, 1998 the Net Asset Values of the different series of Units
were as follows:
Number Net Asset Value
Net Asset Value of Units per Unit
--------------------------------------------------
--------------------------------------------------
Series A Units $ 12,718,104 109,886.0000 $ 115.74
Series B Units 1,498,896 13,150.0000 113.98
Series C Units 2,145,087 19,694.0000 108.92
Series D Units 6,658,019 59,742.0000 111.45
Series E Units 6,063,352 54,556.5800 111.14
Series F Units 3,285,111 30,152.6400 108.95
Series G Units 2,854,082 26,507.1000 107.67
Series H Units 2,185,925 20,275.7250 107.81
Series K Units 7,063,107 64,436.0000 109.61
Series L Units 9,686,313 90,690.0000 106.81
Series M Units 10,476,381 96,696.0600 108.34
Series N Units 5,800,784 55,546.4250 104.43
Series O Units 7,205,406 68,774.2420 104.77
Series P Units 655,841 6,134.0000 106.92
Series Q Units 810,430 8,198.0008 98.86
-------------- ----------------
$ 79,106,838 724,438.7728
============== ================
As of December 31, 1997, the Net Asset Value of the different series of
Units were as follows:
Number Net Asset Value
Net Asset Value of Units per Unit
------------------------------------------------------
------------------------------------------------------
Series A Units $ 17,716,313 155,778.0000 $ 113.73
Series B Units 2,865,130 25,100.0000 114.15
Series C Units 4,061,256 37,551.0000 108.15
Series D Units 10,499,613 95,504.0000 109.94
Series E Units 7,685,677 70,255.8600 109.40
Series F Units 6,136,370 56,275.4800 109.04
Series G Units 5,470,415 51,354.5000 106.52
Series H Units 5,610,794 52,626.2200 106.62
Series K Units 12,127,411 115,752.0000 104.77
Series L Units 14,732,144 144,314.0000 102.08
Series M Units 14,321,562 138,108.0600 103.70
------------------ ----------------
$ 101,226,685 942,619.1200
================== ================
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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 number of Units outstanding at December 31, 1998, 1997 and 1996
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 the year.
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 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 in respect of such Units, not
less than $100.
8. FAIR VALUE AND OFF-BALANCE SHEET RISK
The Trading Partnership trades futures, options on futures, forwards and
options on forward contracts on interest rates, stock indices,
commodities, currencies, energy and metals. The Trading Partnership's
total trading results by reporting category for the years ended December
31, 1998, 1997 and 1996 were as follows:
Total Trading Results
--------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
Interest Rates $ 7,116,336 $ 1,706,686 $ 3,183,955
Stock Indices 824,905 232,314 (746,255)
Commodities (967,695) 679,157 20,119
Currencies 2,085,218 3,911,109 3,301,360
Energy (882,409) (1,278,003) 3,280,677
Metals (1,482,985) 1,245,020 (398,013)
--------------- --------------- ---------------
$ 6,693,370 $ 6,496,283 $ 8,641,843
=============== =============== ===============
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 the market values of the
financial instruments or commodities underlying such derivative
instruments frequently result in changes in the Partnership's net
unrealized profit on such derivative instruments as reflected in the
Consolidated Statements of Financial Condition. The Trading 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 such derivative instruments are traded.
The General Partner has procedures in place intended to control market
risk exposure, although there can be no assurance that they will, in fact,
succeed in doing so. These 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 invested in the
Trading Partnership 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 does not itself intervene in
the markets to hedge or
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diversify the Partnership's market exposure, the General Partner may urge
Advisors to reallocate 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 the Units trade. If MLIP makes a
leverage adjustment to any series issued after May 1, 1997, a
corresponding adjustment is made to the leverage used by all such series.
For series issued prior to May 1, 1997, adjustments to leverage may be
made individually by series. By controlling the percentage of the assets
invested in the Trading Partnership, 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 net unrealized profit recorded in the
Consolidated Statements of Financial Condition and the related profit
reflected in trading results in the Consolidated Statements of Income.
The contract/notional values of the Trading Partnership's open derivative
instrument positions as of December 31, 1998 and 1997 were as follows:
1998 1997
----------------------------------------- ----------------------------------------
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 $ 83,065,616 $ 91,012,676 $ 121,435,283 $ 85,620,621
Stock Indices 3,698,279 1,622,808 1,665,588 8,854,122
Commodities 1,797,931 7,856,776 11,663,786 21,791,599
Currencies 52,385,528 53,181,016 70,272,888 147,312,282
Energy - 2,079,384 1,085,885 9,041,759
Metals 4,190,146 9,506,207 4,412,002 19,039,071
------------------ ------------------ ------------------ -----------------
$ 145,137,500 $ 165,258,867 $ 210,535,432 $ 291,659,454
================== ================== ================== =================
Substantially all of the Trading Partnership's open derivative instruments
outstanding as of December 31, 1998 expire within one year.
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The contract/notional values of the Trading Partnership's open exchange-
traded and non-exchange-traded derivative instrument positions as of
December 31, 1998 and 1997 were as follows:
1998 1997
-------------------------------------------- -------------------------------------------
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 $ 102,156,889 $ 116,203,862 $ 142,565,779 $ 183,223,917
Non- Exchange-Traded 42,980,611 49,055,005 67,969,653 108,435,537
------------------ ----------------- ----------------- -----------------
$ 145,137,500 $ 165,258,867 $ 210,535,432 $ 291,659,454
================== ================= ================= =================
The average fair values, based on contract/notional values, of the
Trading Partnership's derivative instrument positions which were open as
of the end of each calendar month during the years ended December 31,
1998 and 1997 were as follows:
1998 1997
--------------------------------------------- --------------------------------------------
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 $ 221,031,675 $ 98,633,884 $ 177,189,103 $ 68,697,138
Stock Indices 7,202,373 4,205,480 7,544,449 4,040,832
Commodities 9,417,012 14,567,919 13,113,725 11,481,639
Currencies 119,142,464 136,575,495 70,061,899 113,287,725
Energy 1,961,831 4,354,689 3,621,533 3,415,726
Metals 7,976,980 11,836,785 7,369,251 14,913,348
------------------- ------------------- ------------------- -------------------
$ 366,732,335 $ 270,174,252 $ 278,899,960 $ 215,836,408
=================== =================== =================== ===================
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 nonperformance, is the net unrealized
profit included on the Consolidated Statements of Financial Condition.
-13-
The gross unrealized profit and the net unrealized profit on the Trading
Partnership's open derivative instrument positions as of December 31, 1998
and 1997 were as follows:
1998 1997
----------------------------------------- --------------------------------------
Gross Unrealized Net Unrealized Gross Unrealized Net Unrealized
Profit Profit Profit Profit
----------------- --------------- -------------- ---------------
Exchange-Traded $ 1,271,311 $ 733,034 $ 3,263,519 $ 2,416,539
Non-Exchange-Traded 911,388 (131,856) 2,119,281 541,636
----------------- --------------- -------------- ---------------
$ 2,182,699 $ 601,178 $ 5,382,800 $ 2,958,175
================= =============== ============== ===============
The Partnership has credit risk in respect of its counterparties and
brokers, but attempts to control this risk by dealing almost exclusively
with Merrill Lynch entities as counterparties and brokers.
The Partnership, in its normal course of business, enters into various
contracts, with MLF acting as its commodity broker. Pursuant to the
brokerage arrangement with MLF (which includes a netting arrangement), 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
On January 4, 1999, distributions were announced for Series B and Series
F. During 1999, both the Series B Unitholders and the Series F Unitholders
received a fixed-rate distribution of $3.50 per unit.
* * * * * * * * * *
To the best of the knowledge and belief of the
undersigned, the information contained in this
report is accurate and complete.
/s/Jo Ann Di Dario
Jo Ann Di Dario
Chief Financial Officer
Merrill Lynch Investment Partners Inc.
General Partner of
ML Principal Protection L.P.
-14-