As filed with the Securities and Exchange Commission on June 25, 2003
Securities Act File No. 333-105343
Investment Company Act File No. 811-21348
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X] PRE-EFFECTIVE AMENDMENT NO. 1
[ ] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] AMENDMENT NO. 1
(Check appropriate box or boxes)
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MUNI INTERMEDIATE DURATION Fund, Inc.
(Exact Name of Registrant as Specified in Charter)
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800 Scudders Mill Road
Plainsboro, New Jersey 08536
(Address of Principal Executive Offices)
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(609) 282-2800
(Registrant's Telephone Number, Including Area Code)
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Terry K. Glenn
Muni Intermediate Duration Fund, Inc.
800 Scudders Mill Road, Plainsboro, New Jersey 08536
Mailing Address: P.O. Box 9011, Princeton, New Jersey 08543-9011
(Name and Address of Agent for Service)
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Copies to:
Andrew J. Donohue, Esq. Laurin Blumenthal Leonard B. Mackey,
FUND ASSET Kleiman, Esq. Jr., Esq.
MANAGEMENT, L.P. SIDLEY AUSTIN BROWN CLIFFORD CHANCE US LLP
P.O. Box 9011 & WOOD LLP 200 Park Avenue
New Jersey 08543-9011 787 Seventh Avenue New York, New York 10166
New York, New York 10019
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Approximate date of proposed public offering: As soon as practicable after
the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, as amended (the "Securities Act"), other than securities offered only
in connection with dividend or interest reinvestment plans, check the following
box. [_]
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed
Proposed Maximum
Title of Amount Maximum Aggregate Amount of
Securities Being Being Offering Price Offering Registration
Registered Registered(1)(2) Per Unit(1) Price(1) Fee(3)
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Common Stock
($.10 par value)... 7,705,000 shares $15.00 $115,575,000 $9,351
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(1) Estimated solely for the purpose of calculating the registration fee.
(2) Includes 1,005,000 shares subject to the underwriters' overallotment option.
(3) Transmitted prior to the filing date to the designated lockbox of the
Securities and Exchange Commission at Mellon Bank in Pittsburgh, PA. $81 was
previously paid, $9,270 was transmitted in connection with this filing.
The Registrant hereby amends this Registration Statement on such date or dates
as may become necessary to delay its effective date until the Registrant shall
file a further amendment, which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
Subject to Completion
Preliminary Prospectus dated June 25, 2003
PROSPECTUS
Shares
Muni Intermediate Duration Fund, Inc.
Common Stock
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Muni Intermediate Duration Fund, Inc. is a newly organized,
non-diversified, closed-end fund. The investment objective of the Fund is to
provide stockholders with high current income exempt from Federal income taxes.
The Fund seeks to achieve its objective by investing, as a fundamental policy,
at least 80% of its net assets (including assets acquired from the sale of
preferred stock), plus the amount of any borrowings, for investment purposes in
a portfolio of municipal obligations the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal income taxes. Under normal
market conditions, the Fund expects to invest at least 75% of its total assets
in municipal obligations that are rated investment grade or, if unrated, are
considered by the Fund's investment adviser to be of comparable quality. The
Fund may invest up to 25% of its total assets in municipal obligations that are
rated below investment grade (commonly known as "junk bonds") or, if unrated,
are considered by the Fund's investment adviser to possess similar credit
characteristics. Under normal market conditions and after the initial investment
period following this offering (expected to be approximately three months), the
Fund will invest, as a non-fundamental policy, at least 80% of its net assets
(including assets acquired from the sale of preferred stock), plus the amount of
any borrowings for investment purposes, in municipal obligations with an
option-adjusted duration, as calculated by the Fund's investment adviser, of
three to ten years, including after giving effect to leverage. The Fund expects
to maintain, under normal market conditions, a dollar-weighted average portfolio
option-adjusted duration, as calculated by the Fund's investment adviser, of
three to ten years, including after giving effect to leverage. There can be no
assurance that the Fund's investment objective will be realized.
(continued on following page)
Investing in the Fund's common stock involves certain risks that are
described in the "Risk Factors and Special Considerations" section beginning on
page 11 of this prospectus.
Per Share Total
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Public offering price ......................... $15.00 $
Underwriting discount(1) ...................... $.675 $
Proceeds, before expenses, to the Fund(2) ..... $14.325 $
(1) To the extent that the Fund's offering costs do not exceed $.03 per share
of common stock, the Fund has agreed to pay the underwriters up to $.005
per share of common stock as a partial reimbursement of expenses incurred
in connection with the offering. However, in no event will the Fund pay
offering costs (other than the underwriting discount, but including the
partial reimbursement to the underwriters) in excess of $.03 per share of
common stock. See "Underwriting."
(2) The Fund's investment adviser has agreed to pay all organizational
expenses of the Fund. The investment adviser or an affiliate will pay the
amount by which the offering costs of the Fund (other than the
underwriting discount and the up to $.005 per share partial reimbursement
of expenses to the underwriters) exceeds $.03 per share of common stock.
The estimated offering expenses to be incurred by the Fund are $ .
The underwriters may also purchase up to an additional shares at the public
offering price, less the underwriting discount, within 45 days from the date of
this prospectus to cover overallotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares will be ready for delivery on or about August , 2003.
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Merrill Lynch & Co.
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The date of this prospectus is August , 2003.
(continued from previous page)
Because the Fund is newly organized, its shares have no history of public
trading. Shares of closed-end investment companies frequently trade at a price
lower than their net asset value. This is commonly referred to as "trading at a
discount." The risk may be greater for investors expecting to sell their shares
in a relatively short period after completion of the public offering. The Fund
plans to apply to list its shares on the New York Stock Exchange or another
national securities exchange under the symbol "MUI."
The Fund may leverage through borrowings or the issuance of preferred
stock or debt securities. Within approximately three months after completion of
this offering of common stock, the Fund intends to offer shares of preferred
stock representing approximately 35% of the Fund's capital, or approximately 54%
of the Fund's common stock equity, immediately after the issuance of such
preferred stock. There can be no assurance, however, that preferred stock
representing such percentage of the Fund's capital will actually be issued. The
use of preferred stock to leverage the common stock can create special risks.
There can be no assurance that a leveraging strategy will be successful during
any period in which it is employed.
This prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep it
for future reference.
2
TABLE OF CONTENTS
Page
----
Prospectus Summary ......................................................... 5
Risk Factors and Special Considerations .................................... 11
Fee Table .................................................................. 14
The Fund ................................................................... 15
Use of Proceeds ............................................................ 15
Investment Objective and Policies .......................................... 15
Other Investment Policies .................................................. 26
Risks and Special Considerations of Leverage ............................... 31
Investment Restrictions .................................................... 33
Directors and Officers ..................................................... 35
Investment Advisory and Management Arrangements ............................ 39
Portfolio Transactions ..................................................... 41
Dividends and Distributions ................................................ 43
Taxes ...................................................................... 44
Automatic Dividend Reinvestment Plan ....................................... 48
Mutual Fund Investment Option .............................................. 50
Net Asset Value ............................................................ 50
Description of Capital Stock ............................................... 51
Custodian .................................................................. 54
Underwriting ............................................................... 55
Transfer Agent, Dividend Disbursing Agent and Registrar .................... 57
Accounting Services Provider ............................................... 57
Legal Opinions ............................................................. 57
Independent Auditors and Experts ........................................... 58
Additional Information ..................................................... 58
Report of Independent Auditors ............................................. 59
Statement of Assets and Liabilities ........................................ 60
Appendix A Ratings of Municipal Bonds ...................................... A-1
Appendix B Taxable Equivalent Yields For 2003 .............................. B-1
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Information about the Fund can be reviewed and copied at the SEC's Public
Reference Room in Washington, D.C. Call 1-202-942-8090 for information on the
operation of the public reference room. This information is also available on
the SEC's Internet site at http://www.sec.gov and copies may be obtained upon
payment of a duplicating fee by writing to the Public Reference Section of the
SEC, Washington, D.C. 20549-0102.
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You should rely only on the information contained in this prospectus. We
have not, and the underwriters have not, authorized any other person to provide
you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriters are not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted. You should assume that
the information appearing in this prospectus is accurate only as of the date on
the front cover of this prospectus. Our business, financial condition, results
of operations and prospects may have changed since that date.
3
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PROSPECTUS SUMMARY
This summary is qualified in its entirety by reference to the detailed
information included in this prospectus.
The Fund Muni Intermediate Duration Fund, Inc. is a newly
organized, non-diversified, closed-end fund.
The Offering The Fund is offering shares of common stock at
an initial offering price of $15.00 per share through a
group of underwriters led by Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"). You must
purchase at least 100 shares of common stock to
participate in this offering. The underwriters may
purchase up to an additional shares of common
stock within 45 days of the date of this prospectus to
cover overallotments, if any.
Investment Objective The investment objective of the Fund is to provide
and Policies stockholders with high current income exempt from
Federal income taxes. The Fund seeks to achieve its
objective by investing, as a fundamental policy, at
least 80% of its net assets (including assets acquired
from the sale of preferred stock), plus the amount of
any borrowings for investment purposes, in a portfolio
of municipal obligations issued by or on behalf of
states, territories and possessions of the United States
and their political subdivisions, agencies or
instrumentalities, each of which pays interest that, in
the opinion of bond counsel to the issuer, is exempt
from Federal income tax ("Municipal Bonds"). There can
be no assurance that the Fund's investment objective
will be realized.
Under normal market conditions, and after the initial
investment period following this offering (expected to
be approximately three months), the Fund will invest, as
a non-fundamental policy, at least 80% of net assets
(including assets acquired from the sale of preferred
stock), plus the amount of any borrowings for investment
purposes, in Municipal Bonds with an option-adjusted
duration, as calculated by Fund Asset Management, L.P.,
(the "Investment Adviser"), of three to ten years. The
Fund expects to maintain, under normal market
conditions, a dollar-weighted average portfolio
option-adjusted duration, as calculated by the
Investment Adviser, of three to ten years, including
after giving effect to leverage. There is no limit on
the remaining maturity of each individual Municipal Bond
investment by the Fund. In general, the Fund does not
intend its investments to earn a large amount of
interest income that is not exempt from Federal income
taxes.
Investment Grade Municipal Bonds. Under normal market
conditions, the Fund expects to invest at least 75% of
its total assets in Municipal Bonds that are rated
investment grade by one or more nationally recognized
statistical rating agencies or in unrated bonds
considered by the Investment Adviser to be of comparable
quality.
Junk Bonds. The Fund may invest up to 25% of its total
assets in junk bonds. Junk bonds are debt securities
that are rated below investment grade by the major
rating agencies or are unrated securities that are
considered by the Investment Adviser to possess similar
credit characteristics. Although junk bonds generally
pay higher rates of interest than investment grade
bonds, they are high risk investments that may cause
income and principal losses for the Fund. Junk bonds
generally are less liquid and experience more price
volatility than higher rated debt securities. The
issuers of junk bonds may have a larger amount of
outstanding debt relative to their assets than
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5
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issuers of investment grade bonds. In the event of an
issuer's bankruptcy, claims of other creditors may have
priority over the claims of junk bond holders, leaving
few or no assets available to repay junk bond holders.
Junk bonds may be subject to greater call and redemption
risk than higher rated debt securities.
Indexed and Inverse Floating Rate Securities. The Fund
may invest in securities whose potential returns are
directly related to changes in an underlying index or
interest rate, known as indexed securities. The return
on indexed securities will rise when the underlying
index or interest rate rises and fall when the index or
interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes
in an interest rate (inverse floaters). In general,
income on inverse floaters will decrease when short term
interest rates increase and increase when short term
interest rates decrease. Investments in inverse floaters
may subject the Fund to the risks of reduced or
eliminated interest payments and loss of principal. In
addition, certain indexed securities and inverse
floaters may increase or decrease in value at a greater
rate than the underlying interest rate, which
effectively leverages the Fund's investment. As a
result, the market value of such securities will
generally be more volatile than that of fixed rate, tax
exempt securities. Both indexed securities and inverse
floaters are derivative securities and can be considered
speculative.
Hedging Transactions. The Fund may seek to hedge its
portfolio against changes in interest rates using
options and financial futures contracts or swap
transactions. The Fund's hedging transactions are
designed to reduce volatility, but come at some cost.
For example, the Fund may try to limit its risk of loss
from a decline in price of a portfolio security by
purchasing a put option. However, the Fund must pay for
the option, and the price of the security may not in
fact drop. In large part, the success of the Fund's
hedging activities depends on its ability to forecast
movements in securities prices and interest rates. The
Fund is not required to hedge its portfolio and may
choose not to do so. The Fund cannot guarantee that any
hedging strategies it uses will work.
Swap Agreements. The Fund is authorized to enter into
swap agreements, which are over-the-counter contracts in
which one party agrees to make periodic payments based
on the change in the market value of a specific bond,
basket of bonds or index in return for periodic payments
based on a fixed or variable interest rate or the change
in market value of a different bond, basket of bonds or
index. Swap agreements may be used to obtain exposure to
a bond or market without owning or taking physical
custody of securities.
Tax Considerations. While exempt-interest dividends are
excluded from gross income for Federal income tax
purposes, they may be subject to the Federal alternative
minimum income tax in certain circumstances.
Distributions of any capital gain or other taxable
income will be taxable to stockholders. The Fund may not
be a suitable investment for investors subject to the
Federal alternative minimum tax or who would become
subject to such tax by investing in the Fund. See
"Taxes."
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6
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Use of Leverage by Issuance of Preferred Stock. The Fund
intends to offer the Fund shares of preferred stock
within approximately three months after completion of
this offering. Under normal market conditions it is
anticipated that the preferred stock will represent
approximately 35% of the Fund's capital, including the
capital raised by issuing the preferred stock, or
approximately 54% of the Fund's common stock equity.
There can be no assurance, however, that preferred stock
will actually be issued or, if issued, what percentage
of the Fund's capital it will represent. Issuing
preferred stock will result in the leveraging of the
Fund's common stock. Although the Board of Directors has
not yet determined the terms of the preferred stock
offering, the Fund expects that the preferred stock will
pay dividends that will be adjusted over either
relatively short term periods (generally 7 to 28 days)
or medium term periods (up to five years) and that the
preferred stock dividend rate will be based upon
prevailing interest rates for debt obligations of
comparable maturity. The proceeds of the preferred stock
offering will be invested in accordance with the Fund's
investment objective. The expenses of the preferred
stock, which will be borne by the Fund, will reduce the
net asset value of the Fund's common stock. During
periods when the Fund has preferred stock outstanding,
the Fund will pay fees to the Investment Adviser for its
services that are higher than if the Fund did not issue
preferred stock because the fees will be calculated on
the basis of the Fund's average daily net assets
(including any proceeds from the issuance preferred
stock), plus the proceeds of any outstanding borrowings
used for leverage.
Potential Benefits of Leverage. Under normal market
conditions, the income earned on the Fund's portfolio
should exceed the dividend rate the Fund must pay to the
preferred stockholders. Thus, the Fund's use of
preferred stock should provide common stockholders with
a higher yield than they would receive if the Fund were
not leveraged, although no assurance can be given that
the issuance of preferred stock will result in a higher
yield or return to common stockholders.
Risks of Leverage. The use of leverage creates certain
risks for common stockholders, including the greater
likelihood of higher volatility of the Fund's yield, its
net asset value and the market price of its common
stock. Changes in short term, medium term and long term
rates, and their relationship to each other, could
negatively impact the Fund's yield, net asset value and
market price of the common stock. Furthermore, since any
decline in the value of the Fund's investments will
affect only the common stockholders, in a declining
market the use of leverage will cause the Fund's net
asset value to decrease more than it would if the Fund
were not leveraged. This decrease in net asset value
will likely also cause a decline in the market price for
shares of common stock. There can be no assurance that
the Fund will earn a higher yield or return on its
investment portfolio than the then current dividend rate
(and any additional distribution) it pays on the
preferred stock. Under certain circumstances, when the
Fund is required to allocate taxable income to holders
of preferred stock, the Fund anticipated that the terms
of the preferred stock will require the Fund to make an
additional distribution to such holders in an amount
approximately equal to the tax liability resulting from
such allocation. Under certain conditions, the benefits
of leverage to common stockholders will be reduced or
eliminated, and the Fund's leveraged capital structure
could result in a lower yield or return to common
stockholders than if the Fund were not leveraged.
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7
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In particular, during times of rising interest rates,
the market value of the Fund's portfolio investments
and, consequently, the net asset value of its shares may
decline. The Fund's leveraging of its portfolio by
issuing preferred stock may accentuate the potential
decline, since both the cost of issuing the preferred
stock and any decline in the value of the portfolio
investments (including investments purchased with the
proceeds of the preferred stock) will be borne entirely
by the holders of the common stock. The Fund also may
invest in inverse floating obligations and similar
securities that create investment leverage, which may
further accentuate any decline. Any investor who
purchases shares with borrowed funds may experience an
even greater decline.
Distributions. When the Fund issues preferred stock,
common stockholders will receive all of the Fund's net
income that remains after it pays dividends (and any
additional distribution) on the preferred stock and
generally will be entitled to a pro rata share of net
realized capital gains. If the Fund is liquidated,
preferred stockholders will be entitled to receive
liquidating distributions before any distribution is
made to common stockholders. These liquidating
distributions are expected to equal the original
purchase price per share of the preferred stock plus any
accumulated and unpaid dividends and additional
distributions.
Redemption of Preferred Stock. The Fund may redeem the
preferred stock for any reason. For example, the Fund
may redeem all or part of the preferred stock if the
asset coverage for the preferred stock declines below
200% or in order to maintain the asset coverage
guidelines established by a nationally recognized
statistical ratings organization that rates the
preferred stock.
Voting Rights. Preferred stockholders, voting as a
separate class, will be entitled to elect two of the
Fund's Directors. Common and preferred stockholders,
voting together as a single class, will be entitled to
elect the remaining Directors. If the Fund fails to pay
dividends to the preferred stockholders for two full
years, the holders of all outstanding shares of
preferred stock, voting as a separate class, would then
be entitled to elect a majority of the Fund's Directors.
The preferred stockholders also will vote separately on
certain other matters as required under the Fund's
Articles of Incorporation, as amended and supplemented
(the "Charter"), the Investment Company Act of 1940, as
amended (the "1940 Act"), and the General Corporation
Law of the State of Maryland. Otherwise, common and
preferred stockholders will have equal voting rights
(one vote per share) and will vote together as a single
class.
Ratings. Before it offers the preferred stock, the Fund
intends to apply to one or more nationally recognized
statistical ratings organizations for ratings on the
preferred stock. The Fund believes that a rating for the
preferred stock will make it easier to market the stock,
which should reduce the dividend rate.
Listing Currently, there is no public market for the Fund's
common stock. However, the Fund plans to apply to list
the Fund's shares of common stock on the New York Stock
Exchange or another national securities exchange under
the symbol "MUI."
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Investment Adviser The Investment Adviser provides investment advisory and
administrative services to the Fund. For its services,
the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.55% of the Fund's average daily net
assets (including any proceeds from the issuance of
preferred stock), plus the proceeds of any outstanding
borrowings used for leverage. The Investment Adviser has
contractually agreed to waive a portion of its fee
during the first seven years of the Fund's operations
ending July , 2010, as follows:
Fee Waiver (as a
percentage of average
daily net assets)
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Years 1 through 5 ........... 0.15%
Year 6 ...................... 0.10%
Year 7 ...................... 0.05%
Year 8 and thereafter ....... 0.00%
Dividends The Fund intends to distribute dividends from its net
and Distributions investment income monthly, and net realized capital
gains, if any, at least annually. The Fund expects that
it will commence paying dividends within 90 days of the
date of this prospectus. Once the Fund issues preferred
stock, the monthly dividends to common stockholders will
consist of net investment income that remains after the
Fund pays dividends on the preferred stock. Currently,
in order to maintain a more stable level of monthly
dividend distributions to common stockholders, the Fund
intends to pay out less than all of its net investment
income or pay out accumulated undistributed income in
addition to current net investment income. The Fund will
distribute net capital gains, if any, at least annually
to common stockholders and, after it issues the
preferred stock, on a pro rata basis to common and
preferred stockholders. The Fund may not declare any
cash dividend or other distribution on its common stock
unless the preferred stock has asset coverage of at
least 200%. If the Fund issues preferred stock
representing 35% of its total capital, the preferred
stock's asset coverage will be approximately 286%. If
the Fund's ability to make distributions on its common
stock is limited, the Fund may not be able to qualify
for taxation as a regulated investment company. This
would have adverse tax consequences for stockholders.
Yield Considerations The yield on the Fund's common stock will vary from
period to period depending on factors including, but not
limited to, the length of the initial investment period,
market conditions, the timing of the Fund's investment
in portfolio securities, the securities comprising the
Fund's portfolio, the ability of the issuers of the
portfolio securities to pay interest on such securities,
changes in tax exempt interest rates (which may not
change to the same extent or in the same direction as
taxable rates) including changes in the relationship
between short term rates and long term rates, the amount
and timing of the issuance of the Fund's preferred
stock, the effects of preferred stock leverage on the
common stock discussed above under "Use of Leverage by
the Fund," the timing of the investment of preferred
stock proceeds in portfolio securities, the Fund's net
assets and its operating expenses. Consequently, the
Fund cannot guarantee any particular yield on its shares
and the yield for any given period is not an indication
or representation of future yields on Fund shares. The
Fund's ability to
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achieve any particular yield level after it commences
operations depends on future interest rates and other
factors mentioned above, and the initial yield and later
yields may be lower. Any statements as to an estimated
yield are based on certain assumptions and conditions
and are as of the date made, and no guarantee can be
given that the Fund will achieve or maintain any
particular yield level.
Automatic Dividend Dividend and capital gains distributions generally are
Reinvestment Plan used to purchase additional shares of the Fund's common
stock. However, an investor can choose to receive
distributions in cash. Since not all investors can
participate in the automatic dividend reinvestment plan,
you should call your broker or nominee to confirm that
you are eligible to participate in the plan.
Mutual Fund Investors who purchase shares in this offering and later
Investment Option sell their shares have the option, subject to certain
conditions, to purchase Class A shares of certain funds
advised by the Investment Adviser or its affiliates with
the proceeds from such sale.
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RISK FACTORS AND SPECIAL CONSIDERATIONS
An investment in the Fund's common stock should not constitute a complete
investment program.
Liquidity and Market Price of Shares. The Fund is newly organized and has
no operating history or history of public trading.
Shares of closed-end funds that trade in a secondary market frequently
trade at a market price that is below their net asset value. This is commonly
referred to as "trading at a discount." The risk may be greater for investors
expecting to sell their shares in a relatively short period after completion of
the public offering. Accordingly, the Fund is designed primarily for long term
investors and should not be considered a vehicle for trading purposes. Net asset
value will be reduced following the offering by the underwriting discount and
the amount of offering expenses paid by the Fund.
Non-diversification. The Fund is registered as a "non-diversified"
investment company. This means that the Fund may invest a greater percentage of
its assets in a single issuer than a diversified investment company. Since the
Fund may invest a relatively high percentage of its assets in a limited number
of issuers, the Fund may be more exposed to any single economic, political or
regulatory occurrence than a more widely-diversified fund. Even as a
non-diversified fund, the Fund must still meet the diversification requirements
applicable to regulated investment companies under the Federal income tax laws.
Market Risk and Selection Risk. Market risk is the risk that the bond
market will go down in value, including the possibility that the market will go
down sharply and unpredictably. Selection risk is the risk that the securities
that Fund management selects will underperform the bond market, the market
relevant indices, or other funds with similar investment objectives and
investment strategies.
Tax Exempt Securities Market Risk. The amount of public information
available about Municipal Bonds in the Fund's portfolio is generally less than
that for corporate equities or bonds, and the investment performance of the Fund
may therefore be more dependent on the analytical abilities of the Investment
Adviser than that of a stock fund or taxable bond fund.
Interest Rate and Credit Risk. The Fund invests in Municipal Bonds, which
are subject to interest rate and credit risk. Interest rate risk is the risk
that prices of Municipal Bonds generally increase when interest rates decline
and decrease when interest rates increase. Prices of longer term securities
generally change more in response to interest rate changes than prices of
shorter term securities. The Fund's use of leverage by the issuance of preferred
stock and its investment in inverse floating obligations, as discussed below,
may increase interest rate risk. Because market interest rates are currently
near their lowest levels in many years, there is a greater risk that the Fund's
portfolio will decline in value. Credit risk is the risk that the issuer will be
unable to pay the interest or principal when due. The degree of credit risk
depends on both the financial condition of the issuer and the terms of the
obligation.
Call and Redemption Risk. A Municipal Bond's issuer may call the bond for
redemption before it matures. If this happens to a Municipal Bond that the Fund
holds, the Fund may lose income and may have to invest the proceeds in Municipal
Bonds with lower yields.
Risks Associated with Non-Investment Grade Securities. Under normal market
conditions, the Fund expects to invest at least 75% of its total assets in
Municipal Bonds that are rated investment grade by Standard & Poor's, Moody's
Investors Service, Inc. or Fitch Ratings, or in unrated Municipal Bonds that are
considered by the Investment Adviser to possess similar credit characteristics.
Obligations rated in the lowest investment grade category may have certain
speculative characteristics. The Fund may invest up to 25% of its total assets
in Municipal Bonds that are rated below investment grade or are unrated
securities that are considered by the Investment Adviser to possess similar
credit characteristics. Securities rated below investment grade, also known
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as junk bonds, generally entail greater interest rate and credit risks than
investment grade securities. For example, their prices are more volatile,
economic downturns and financial setbacks may affect their prices more
negatively, and their trading market may be more limited.
Private Activity Bonds. The Fund may invest in certain tax exempt
securities classified as "private activity bonds." These bonds may subject
certain investors in the Fund to the Federal alternative minimum tax.
Reinvestment Risk. Reinvestment risk is the risk that income from the
Fund's Municipal Bond portfolio will decline if and when the Fund invests the
proceeds from matured, traded or called bonds at market interest rates that are
below the portfolio's current earnings rate. A decline in income could
negatively affect the Fund's yield, return or market price of the common stock.
Leverage. The Fund currently plans to issue preferred stock within
approximately three months after the completion of this offering. Under normal
market conditions it is anticipated that the preferred stock will represent
approximately 35% of the Fund's capital, including capital raised by issuing the
preferred stock. There can be no assurance, however, that preferred stock will
actually be issued, or if issued what percentage of the Fund's capital it will
represent. Leverage creates certain risks for common stockholders, including the
greater likelihood of higher volatility of the Fund's yield, the net asset value
and the market price of the common stock. Leverage also creates the risk that
the yield or return on shares of the Fund's common stock will be reduced or
eliminated to the extent the dividends paid on preferred stock and other
expenses of the preferred stock exceed the yield or return earned by the Fund on
its investments. Since both the cost of issuing the preferred stock and any
decline in the value of the Fund's portfolio investments (including investments
purchased with the proceeds of the preferred stock) will be borne entirely by
the holders of common stock. The effect of leverage in a declining market would
result in a greater decrease in the Fund's net asset value, and possibly the
market price of the common stock, than if the Fund was not leveraged. If the
Fund is liquidated, preferred stockholders will be entitled to receive
liquidating distributions before any distribution is made to common
stockholders.
Sector Risk. The Fund may invest 25% or more of its total assets in tax
exempt securities of issuers in the industries comprising the same economic
sector, such as hospitals or life care facilities and transportation-related
issuers. However, the Fund will not invest 25% or more of its total assets in
any one of the industries comprising an economic sector. In addition, a
substantial part of the Fund's portfolio may be comprised of securities credit
enhanced by banks, insurance companies or companies with similar
characteristics. Emphasis on these sectors may subject the Fund to certain
risks.
Rating Agencies. The Fund may be subject to guidelines of one or more
nationally recognized statistical ratings organizations that may issue ratings
for its preferred stock. These guidelines may impose asset coverage or portfolio
composition requirements that are more stringent than those imposed by the 1940
Act and may prohibit or limit the use by the Fund of certain portfolio
management techniques or investments. The Fund does not expect these guidelines
to prevent the Investment Adviser from managing the Fund's portfolio in
accordance with the Fund's investment objective and policies.
Liquidity of Investments. Certain Municipal Bonds in which the Fund
invests may lack an established secondary trading market or are otherwise
considered illiquid. Liquidity of a security relates to the ability to easily
dispose of the security and the price to be obtained and does not generally
relate to the credit risk or likelihood of receipt of cash at maturity. Illiquid
securities may trade at a discount from comparable, more liquid investments.
Portfolio Strategies. The Fund may engage in various portfolio strategies
both to seek to enhance the return of the Fund and to seek to hedge its
portfolio against adverse effects from movements in interest rates and in the
securities markets. These portfolio strategies include the use of derivatives,
such as indexed securities, inverse securities, options, futures, options on
futures, interest rate transactions, credit default swaps, and the use of short
sales. Such strategies
--------------------------------------------------------------------------------
12
--------------------------------------------------------------------------------
subject the Fund to the risk that, if the Investment Adviser incorrectly
forecasts market values, interest rates or other applicable factors, the Fund's
performance could suffer. Certain of these strategies such as inverse
securities, credit default swaps and short sales may provide investment leverage
to the Fund's portfolio and result in many of the same risks of leverage to the
holders of the Fund's common stock as discussed above under "Leverage." The Fund
is not required to use derivatives or other portfolio strategies to seek to
enhance return or to seek to hedge its portfolio and may not do so. There can be
no assurance that the Fund's portfolio strategies will be effective. Some of the
derivative strategies that the Fund may use to seek to enhance its return are
riskier than its hedging transactions and have speculative characteristics. Such
strategies do not attempt to limit the Fund's risk of loss.
Derivatives Risk. Derivatives are financial contracts or instruments whose
value depends on, or is derived from, the value of an underlying asset,
reference rate or index (or relationship between two indices). The Fund may
invest in a variety of derivative instruments for hedging purposes or to enhance
its return, such as options, futures contracts and swap agreements, and may
engage in short sales. The Fund may use derivatives as a substitute for taking a
position in an underlying security or other asset and/or as part of a strategy
designed to reduce exposure to other risks, such as interest rate risk. The Fund
also may use derivatives to add leverage to the portfolio. The Fund's use of
derivative instruments involves risks different from, and possibly greater than,
the risks associated with investing directly in securities and other traditional
investments. Derivatives are subject to a number of risks such as liquidity
risk, interest rate risk, credit risk, leverage risk, the risk of ambiguous
documentation and management risk. They also involve the risk of mispricing or
improper valuation and the risk that changes in the value of the derivative may
not correlate perfectly with the underlying asset, rate or index. If the Fund
invests in a derivative instrument it could lose more than the principal amount
invested. The use of derivatives also may increase the amount of taxes payable
by stockholders. Also, suitable derivative transactions may not be available in
all circumstances and there can be no assurance that the Fund will engage in
these transactions to reduce exposure to other risks when that would be
beneficial.
Antitakeover Provisions. The Fund's Charter, By-laws and the General
Corporation Law of the State of Maryland include provisions that could limit the
ability of other entities or persons to acquire control of the Fund or to change
the composition of its Board of Directors. Such provisions could limit the
ability of stockholders to sell their shares at a premium over prevailing market
prices by discouraging a third party from seeking to obtain control of the Fund.
Suitability. The economic benefit of an investment in the Fund depends
upon many factors beyond the control of the Fund, the Investment Adviser and its
affiliates. Because of its emphasis on intermediate duration Municipal Bonds,
the Fund should be considered a vehicle for diversification and not as a
balanced investment program. The suitability for any particular investor of a
purchase of shares of the Fund will depend upon, among other things, such
investor's investment objectives and such investor's ability to accept the risks
of investing in such securities, including the loss of principal.
Market Disruption. The terrorist attacks in the United States on September
11, 2001 have had a disruptive effect on the securities markets, some of which
were closed for a four-day period. These terrorist attacks and related events,
including recent U.S. military actions overseas, have led to increased short
term market volatility and may have long term effects on U.S. and world
economies and markets. Similar disruptions of the financial markets could impact
interest rates, auctions, secondary trading, ratings, credit risk, inflation and
other factors relating to the Fund's common stock. Non-investment grade
securities tend to be more volatile than investment grade fixed income
securities so that these events and other market disruptions may have a greater
impact on the prices and volatility of non-investment grade securities than on
investment grade fixed income securities. There can be no assurance that these
events and other market disruptions will not have other material and adverse
implications for the non-investment grade securities markets.
--------------------------------------------------------------------------------
13
FEE TABLE
Stockholder Transaction Expenses:
Maximum Sales Load (as a percentage of offering price) ................................ 4.50%
Offering Expenses Borne by the Fund (as a percentage of offering price)(a) ............ 0.19%
Dividend Reinvestment Plan Fees ....................................................... None
Annual Expenses (as a percentage of net assets attributable to common stock):
Investment Advisory Fees(b)(c) ........................................................ 0.85%
Interest Payments on Borrowed Funds ................................................... None
Other Expenses(b)(c) .................................................................. 0.31%
----
Total Annual Operating Expenses(b)(c) ............................................... 1.16%
----
Fee and Expense Reimbursement(b)(c)(d) ................................................ (0.23)%
Total Net Annual Expenses(b)(c)(d) .................................................. 0.93%
----------
(a) The Investment Adviser has agreed to pay all of the Fund's organizational
expenses. Offering costs will be paid by the Fund up to $.03 per share.
The Investment Adviser or an affiliate has agreed to pay the amount by
which the offering costs (other than the sales load and the $.005 per
share partial reimbursement of expenses to the underwriters) exceeds $.03
per share of common stock (0.20% of the offering price). To the extent
that offering costs do not exceed $.03 per share of common stock, the Fund
will pay the underwriters up to $.005 per share of common stock as a
partial reimbursement of expenses incurred in connection with the
offering. However, in no event will the Fund pay offering costs (other
than the sales load, but including the partial reimbursement to the
underwriters) in excess of $.03 per share of common stock. The offering
costs to be paid by the Fund are not included in the annual expenses shown
in the table. Offering costs borne by common stockholders will result in a
reduction of capital of the Fund attributable to common stock. If the Fund
offers preferred stock in an amount equal to approximately 35% of the
Fund's capital, the costs of that offering, estimated to be approximately
1.22% of the total dollar amount of the preferred stock offering, will be
effectively borne by the common stockholders and result in a reduction of
the net asset value of the shares of common stock. These preferred stock
offering costs are estimated to be approximately $.10 per share of common
stock (0.67% of the offering price).
(b) See "Investment Advisory and Management Arrangements" -- page 39.
(c) Assumes leverage by issuing preferred stock in an amount equal to
approximately 35% of the Fund's capital at a dividend rate of 0.80%. If
the Fund does not use leverage, it is estimated that, as a percentage of
net assets attributable to common stock, the Investment Advisory Fee would
be 0.55%, Interest Payments on Borrowed Funds would be None, Other
Expenses would be 0.16%, Total Annual Expenses would be 0.71%, Fee and
Expense Reimbursement would be 0.15% and Total Net Annual Expenses would
be 0.56%.
(d) The Investment Adviser has contractually agreed to waive its fee in the
amount of 0.15% of average daily net assets for the first five full years
of the Fund's operations, 0.10% of average daily net assets for year six
and 0.05% of average daily net assets for year seven. The Total Net Annual
Expenses reflect expenses estimated for the first fiscal year restated to
reflect this agreement.
Example
1 Year 3 Years 5 Years 10 Years
------ ------- ------- -------
An investor would pay the following expenses (including the
sales load of $45, estimated offering expenses of this offering
of $1.90 and the estimated preferred stock offering costs
assuming the Fund offers preferred stock in an amount equal to
approximately 35% of the Fund's capital (after issuance) of
$6.70) on a $1,000 investment, assuming total annual expenses
of 0.93% for the years 1-5, 1.01% for year 6, 1.08% for year 7 and
1.16% for years 8-10, and a 5% annual return throughout the periods ... $63 $82 $102 $173
The Fee Table is intended to assist investors in understanding the costs and
expenses that a stockholder in the Fund will bear directly or indirectly. The
expenses set forth under "Other Expenses" are based on estimated amounts through
the end of the Fund's first fiscal year and assume that the Fund issues
approximately 13,400,000 shares of common stock. If the Fund issues fewer shares
of common stock, all other things being equal, these expenses would increase.
The Example set forth above assumes reinvestment of all dividends and
distributions and uses a 5% annual rate of return as mandated by the Securities
and Exchange Commission (the "Commission") regulations. The Example should not
be considered a representation of future expenses or annual rates of return, and
actual expenses or annual rates of return may be more or less than those assumed
for purposes of the Example.
14
THE FUND
Muni Intermediate Duration Fund, Inc. (the "Fund") is a newly organized,
non-diversified, closed-end fund. The Fund was incorporated under the laws of
the State of Maryland on May 15, 2003, and has registered under the Investment
Company Act of 1940, as amended (the "1940 Act"). The Fund's principal office is
located at 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its
telephone number is (609) 282-2800.
The Fund is organized as a closed-end investment company. Closed-end
investment companies differ from open-end investment companies (commonly
referred to as mutual funds) in that closed-end investment companies do not
redeem their securities at the option of the stockholder, whereas open-end
companies issue securities redeemable at net asset value at any time at the
option of the stockholder and typically engage in a continuous offering of their
shares. Accordingly, open-end investment companies are subject to continuous
asset in-flows and out-flows that can complicate portfolio management. However,
shares of closed-end investment companies frequently trade at a discount to net
asset value. They may also, at times, trade at a premium to net asset value. The
risk that shares will trade at a discount may be greater for investors expecting
to sell their shares in a relatively short period after completion of the public
offering.
The Board of Directors of the Fund may at any time consider a merger,
consolidation or other form of reorganization of the Fund with one or more other
investment companies advised by the Fund's Investment Adviser with similar
investment objectives and policies as the Fund. Any such merger, consolidation
or other form of reorganization would require the prior approval of the Board of
Directors and the stockholders of the Fund. See "Description of Capital
Stock--Certain Provisions of the Charter and By-laws."
USE OF PROCEEDS
The net proceeds of this offering will be approximately $ million (or
approximately $ million assuming the underwriters exercise the overallotment
option in full) after payment of offering expenses estimated to be approximately
$ million and the deduction of the underwriting discount. However, in no event
will the Fund pay offering costs (other than the underwriting discount, but
including the partial reimbursement to the underwriters) in excess of $.03 per
share of common stock. The Investment Adviser or an affiliate will pay the
amount by which the offering costs (other than the underwriting discount, and
the up to $.005 per share partial reimbursement of expenses to the underwriters)
exceeds $.03 per share of common stock. The Investment Adviser has agreed to pay
all the Fund's organizational expenses.
The net proceeds of the offering will be invested in accordance with the
Fund's investment objective and policies within approximately three months after
completion of the offering of common stock, depending on market conditions and
the availability of appropriate securities. Pending such investment, it is
anticipated that the proceeds will be invested in short term, tax exempt
securities. See "Investment Objective and Policies."
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide stockholders with high
current income exempt from Federal income taxes. The Fund seeks to achieve its
investment objective by investing at least 80% of its net assets (including
assets acquired from the sale of preferred stock), plus the amount of any
borrowings for investment purposes, in a portfolio of municipal obligations
issued by or on behalf of states, territories and possessions of the United
States and their political subdivisions, agencies or instrumentalities, each of
which pays interest that, in the opinion of bond counsel to the issuer, is
exempt from Federal income tax ("Municipal Bonds"). The Fund's investment
objective and its policy of investing at least 80% of its net assets (including
assets acquired from the sale of preferred stock), plus the amount of any
outstanding borrowings for investment purposes in Municipal Bonds are
fundamental policies that may not be changed without the approval of a majority
of the outstanding
15
voting securities of the Fund (as defined in the 1940 Act). Under normal market
conditions and after the initial investment period following this offering
(expected to be approximately three months), the Fund will invest at least 80%
of its net assets (including assets acquired from the sale of preferred stock),
plus the amount of any borrowings for investment purposes, in Municipal Bonds
with an option-adjusted duration, as calculated by Fund Asset Management, L.P.
(the "Investment Adviser"), of three to ten years. This is a non-fundamental
policy and may be changed by the Fund's Board of Directors provided that
stockholders are provided with at least 60 days' prior notice of any change as
required by the 1940 Act. The Fund expects to maintain, under normal market
conditions, a dollar-weighted average portfolio duration of three to ten years.
There is no limit on the remaining maturity of each individual Municipal Bond
investment by the Fund. There can be no assurance that the Fund's investment
objective will be realized.
Under normal market conditions, the Fund expects to invest at least 75% of
its total assets in Municipal Bonds that are commonly referred to as "investment
grade" securities, which are obligations rated at the time of purchase within
the four highest quality ratings as determined by either Moody's Investors
Service, Inc. ("Moody's") (currently Aaa, Aa, A and Baa), Standard & Poor's
("S&P") (currently AAA, AA, A and BBB) or Fitch Ratings ("Fitch") (currently
AAA, AA, A and BBB). If unrated, such securities will possess creditworthiness
comparable, in the opinion of the Investment Adviser, to other obligations in
which the Fund may invest. Securities rated in the lowest investment grade
category may be considered to have speculative characteristics.
The Fund may invest up to 25% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by S&P or Fitch or, if unrated, are
considered by the Investment Adviser to possess similar credit characteristics.
Such securities, sometimes referred to as "high yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security and generally involve a
greater volatility of price than securities in higher rating categories. See
"Description of Municipal Bonds --'High Yield' or 'Junk' Bonds." The Fund does
not intend to purchase debt securities that are in default or which the
Investment Adviser believes will soon be in default.
The Fund may invest 25% or more of its total assets in tax exempt
securities of issuers in the industries comprising the same economic sector,
such as hospitals or life care facilities and transportation-related issuers.
However, the Fund will not invest 25% or more of its total assets in any one of
the industries comprising an economic sector. In addition, a substantial part of
the Fund's portfolio may be comprised of securities credit enhanced by banks,
insurance companies or companies with similar characteristics. Emphasis on these
sectors may subject the Fund to certain risks.
The value of bonds and other fixed income obligations may fall when
interest rates rise and rise when interest rates fall. In general, bonds and
other fixed income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal market conditions, the Fund
expects to maintain a dollar-weighted average portfolio duration of three to ten
years, including after giving effect to leverage. "Duration" measures the
sensitivity of a security's price to changes in interest rates. The greater a
portfolio's duration, the greater the change in the portfolio's value in
response to changes in interest rates. The Investment Adviser increases or
reduces the Fund's portfolio duration based on its interest rate outlook. When
the Investment Adviser expects interest rates to fall, it attempts to maintain a
longer portfolio duration. When the Investment Adviser expects interest rates to
increase, it attempts to shorten the portfolio's duration. Generally, as is the
case with any investment grade fixed income obligations, Municipal Bonds with
longer maturities tend to produce higher yields. Under normal market conditions,
however, such yield-to-maturity increases tend to decline in the longer
maturities (i.e., the slope of the yield curve flattens). At the same time, due
to their longer exposure to interest rate risk, prices of longer term
obligations are subject to greater market fluctuations as a result of changes in
interest rates. Based on the
16
foregoing premises, the Investment Adviser believes that the yield and price
volatility characteristics of an intermediate duration portfolio generally offer
an attractive trade-off between return and risk. There may be market conditions,
however, where an intermediate duration portfolio may be less attractive due to
the fact that the Municipal Bond yield curve changes from time to time depending
on supply and demand forces, monetary and tax policies and investor
expectations. As a result, there may be situations where investments in
individual Municipal Bonds with longer durations may be more attractive than
individual intermediate duration Municipal Bonds.
For temporary periods or to provide liquidity, the Fund has the authority
to invest as much as 20% of its total assets in tax-exempt and taxable money
market obligations with a maturity of one year or less (such short term
obligations being referred to herein as "Temporary Investments"). In addition,
the Fund reserves the right as a defensive measure to invest temporarily a
greater portion of its assets in Temporary Investments, when, in the opinion of
the Investment Adviser, prevailing market or financial conditions warrant. These
investments will yield taxable income. From time to time, the Fund may also
realize taxable capital gains.
The Fund also may invest in variable rate demand obligations ("VRDOs") and
VRDOs in the form of participation interests ("Participating VRDOs") in variable
rate tax exempt obligations held by a financial institution. See "Other
Investment Policies -- Temporary Investments." The Fund's hedging strategies,
which are described in more detail under "Hedging Transactions -- Financial
Futures Transactions and Options," are not fundamental policies and may be
modified by the Board of Directors of the Fund without the approval of the
Fund's stockholders. The Fund is also authorized to invest in indexed and
inverse floating obligations for hedging purposes and to seek to enhance return.
Certain Municipal Bonds may be entitled to the benefits of letters of
credit or similar credit enhancements issued by financial institutions. In such
instances, the Board of Directors of the Fund and the Investment Adviser will
take into account, in assessing the quality of such bonds, both the
creditworthiness of the issuer of such bonds and the creditworthiness of the
financial institution that provides the credit enhancement.
The Fund ordinarily does not intend to realize investment income not
exempt from Federal income tax. The Fund may invest in securities not issued by
or on behalf of a state or territory or by an agency or instrumentality thereof,
if the Fund believes such securities to be exempt from Federal income taxation
("Non-Municipal Tax Exempt Securities"). Non-Municipal Tax Exempt Securities
could include trust certificates or other instruments evidencing interest in one
or more long term municipal securities. Non-Municipal Tax Exempt Securities also
may include securities issued by other investment companies that invest in
Municipal Bonds, to the extent such investments are permitted by applicable law.
Non-Municipal Tax Exempt Securities are subject to the same risks associated
with an investment in Municipal Bonds as well as many of the risks associated
with investments in derivatives. Interest received on certain otherwise tax
exempt securities that are classified as "private activity bonds" (in general,
bonds that benefit non-governmental entities) may be subject to a Federal
alternative minimum tax. See "Taxes." The percentage of the Fund's total assets
invested in "private activity bonds" will vary from time to time. Federal tax
legislation has limited the types and volume of bonds the interest on which
qualifies for a Federal income tax exemption. As a result, this legislation and
legislation that may be enacted in the future may affect the availability of
Municipal Bonds for investment by the Fund.
Risk Factors and Special Considerations Relating to Municipal Bonds
The risks and special considerations involved in investment in Municipal
Bonds vary with the types of instruments being acquired. Investments in
Non-Municipal Tax Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as
17
derivative instruments. See "Investment Objective and Policies -- Description
of Municipal Bonds" and "-- Hedging Transactions -- Financial Futures
Transactions and Options."
The value of Municipal Bonds generally may be affected by uncertainties in
the municipal markets as a result of legislation or litigation including
legislation or litigation, that changes the taxation of Municipal Bonds or the
rights of Municipal Bond holders in the event of a bankruptcy. Municipal
bankruptcies are rare, and certain provisions of the U.S. Bankruptcy Code
governing such bankruptcies are unclear. Further, the application of state law
to Municipal Bond issuers could produce varying results among the states or
among Municipal Bond issuers within a state. These uncertainties could have a
significant impact on the prices of the Municipal Bonds in which the Fund
invests.
Description of Municipal Bonds
Set forth below is a detailed description of Municipal Bonds and Temporary
Investments in which the Fund may invest. Information with respect to ratings
assigned to tax exempt obligations that the Fund may purchase is set forth in
Appendix A to this prospectus. Obligations are included within the term
Municipal Bonds if the interest paid thereon is excluded from gross income for
Federal income tax purposes.
Municipal Bonds include debt obligations issued to obtain funds for
various public purposes, including the construction of a wide range of public
facilities, refunding of outstanding obligations and obtaining funds for general
operating expenses and loans to other public institutions and facilities. In
addition, certain types of bonds are issued by or on behalf of public
authorities to finance various privately owned or operated facilities, including
certain facilities for the local furnishing of electric energy or gas, sewage
facilities, solid waste disposal facilities and other specialized facilities.
Other types of industrial development bonds or private activity bonds, the
proceeds of which are used for the construction, equipment or improvement of
privately operated industrial or commercial facilities, may constitute Municipal
Bonds, although the current Federal tax laws place substantial limitations on
the size of such issues. The interest on Municipal Bonds may bear a fixed rate
or be payable at a variable or floating rate. The two principal classifications
of Municipal Bonds are "general obligation" and "revenue" bonds, which latter
category includes industrial development bonds ("IDBs") and, for bonds issued
after August 15, 1986, private activity bonds ("PABs").
The Fund has not established any limit on the percentage of its portfolio
that may be invested in IDBs or PABs. The Fund's common stock may not be a
suitable investment for investors who are already subject to the Federal
alternative minimum tax or who would become subject to the Federal alternative
minimum tax as a result of an investment in the Fund's common stock. See
"Taxes."
General Obligation Bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit and taxing power for the payment of
principal and interest. The taxing power of any governmental entity may be
limited, however, by provisions of its state constitution or laws, and an
entity's creditworthiness will depend on many factors, including potential
erosion of its tax base due to population declines, natural disasters, declines
in the state's industrial base or inability to attract new industries, economic
limits on the ability to tax without eroding the tax base, state legislative
proposals or voter initiatives to limit ad valorem real property taxes and, the
extent to which the entity relies on Federal or state aid, access to capital
markets or other factors beyond the state's or entity's control. Accordingly,
the capacity of the issuer of a general obligation bond as to the timely payment
of interest and the repayment of principal when due is affected by the issuer's
maintenance of its tax base.
18
Revenue Bonds. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other specific revenue sources such as
payments from the user of the facility being financed. Accordingly, the timely
payment of interest and the repayment of principal in accordance with the terms
of the revenue or special obligation bond is a function of the economic
viability of such facility or such revenue source.
IDBs and PABs. The Fund may purchase IDBs and PABs. IDBs and PABs are, in
most cases, tax exempt securities issued by states, municipalities or public
authorities to provide funds, usually through a loan or lease arrangement, to a
private entity for the purpose of financing construction or improvement of a
facility to be used by the entity. Such bonds are secured primarily by revenues
derived from loan repayments or lease payments due from the entity which may or
may not be guaranteed by a parent company or otherwise secured. IDBs and PABs
generally are not secured by a pledge of the taxing power of the issuer of such
bonds. Therefore, an investor should be aware that repayment of such bonds
generally depends on the revenues of a private entity and be aware of the risks
that such an investment may entail. Continued ability of an entity to generate
sufficient revenues for the payment of principal and interest on such bonds will
be affected by many factors including the size of the entity, capital structure,
demand for its products or services, competition, general economic conditions,
government regulation and the entity's dependence on revenues for the operation
of the particular facility being financed.
Moral Obligation Bonds. The Fund also may invest in "moral obligation"
bonds, which are normally issued by special purpose public authorities. If an
issuer of moral obligation bonds is unable to meet its obligations, the
repayment of such bonds becomes a moral commitment but not a legal obligation of
the state or municipality in question.
Municipal Lease Obligations. Also included within the general category of
Municipal Bonds are certificates of participation ("COPs") issued by government
authorities or entities to finance the acquisition or construction of equipment,
land and/or facilities. COPs represent participations in a lease, an installment
purchase contract or a conditional sales contract (hereinafter collectively
called "lease obligations") relating to such equipment, land or facilities.
Although lease obligations do not constitute general obligations of the issuer
for which the issuer's unlimited taxing power is pledged, a lease obligation is
frequently backed by the issuer's covenant to budget for, appropriate and make
the payments due under the lease obligation. However, certain lease obligations
contain "non-appropriation" clauses which provide that the issuer has no
obligation to make lease or installment purchase payments in future years unless
money is appropriated for such purpose on a yearly basis. Although
"non-appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult
and the value of the property may be insufficient to issue lease obligations.
Certain investments in lease obligations may be illiquid.
Indexed and Inverse Floating Rate Securities. The Fund may invest in
Municipal Bonds (and Non-Municipal Tax Exempt Securities) that yield a return
based on a particular index of value or interest rates. For example, the Fund
may invest in Municipal Bonds that pay interest based on an index of Municipal
Bond interest rates. The principal amount payable upon maturity of certain
Municipal Bonds also may be based on the value of the index. To the extent the
Fund invests in these types of Municipal Bonds, the Fund's return on such
Municipal Bonds will be subject to risk with respect to the value of the
particular index. Interest and principal payable on the Municipal Bonds may also
be based on relative changes among particular indices. Also, the Fund may invest
in so called "inverse floating obligations" or "residual interest bonds" on
which the interest rates vary inversely with a short term floating rate (which
may be reset periodically by a dutch auction, a remarketing agent, or by
reference to a short term tax exempt interest rate index). The Fund may purchase
synthetically
19
created inverse floating rate bonds evidenced by custodial or trust receipts.
Generally, income on inverse floating rate bonds will decrease when short term
interest rates increase, and will increase when short term interest rates
decrease. Such securities have the effect of providing a degree of investment
leverage, since they may increase or decrease in value in response to changes,
as an illustration, in market interest rates at a rate which is a multiple
(typically two) of the rate at which fixed rate long term tax exempt securities
increase or decrease in response to such changes. As a result, the market values
of such securities will generally be more volatile than the market values of
fixed rate tax exempt securities. To seek to limit the volatility of these
securities, the Fund may purchase inverse floating obligations with shorter-term
maturities or which contain limitations on the extent to which the interest rate
may vary. Certain investments in such obligations may be illiquid.
When Issued Securities, Delayed Delivery Securities and Forward
Commitments. The Fund may purchase or sell securities that it is entitled to
receive on a when issued basis. The Fund may also purchase or sell securities on
a delayed delivery basis. The Fund may also purchase or sell securities through
a forward commitment. These transactions involve the purchase or sale of
securities by the Fund at an established price with payment and delivery taking
place in the future. The purchase will be received on the date the Fund enters
into the commitment and the value of the securities will thereafter be reflected
in the Fund's net asset value. The Fund enters into these transactions to obtain
what is considered an advantageous price to the Fund at the time of entering
into the transaction. The Fund has not established any limit on the percentage
of its assets that may be committed in connection with these transactions. When
the Fund purchases securities in these transactions, the Fund segregates liquid
securities in an amount equal to the amount of its purchase commitments.
There can be no assurance that a security purchased on a when issued basis
will be issued or that a security purchased or sold through a forward commitment
will be delivered. A default by a counter party may result in the Fund missing
the opportunity of obtaining a price considered to be advantageous. The value of
securities in these transactions on the delivery date may be more or less than
the Fund's purchase price. The Fund may bear the risk of a decline in the value
of the security in these transactions and may not benefit from an appreciation
in the value of the security during the commitment period.
Call Rights. The Fund may purchase a Municipal Bond issuer's right to call
all or a portion of such Municipal Bond for mandatory tender for purchase (a
"Call Right"). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to maturity of the related
Municipal Bond will expire without value. The economic effect of holding both
the Call Right and the related Municipal Bond is identical to holding a
Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid.
"High Yield" or "Junk" Bonds. The Fund may invest up to 25% of its total
assets in Municipal Bonds that are rated below Baa by Moody's or below BBB by
S&P or Fitch or are unrated securities that are considered by the Investment
Adviser to possess similar credit characteristics. See Appendix A - "Ratings of
Municipal Bonds" for additional information regarding ratings of debt
securities. Junk bonds are debt securities that are rated below investment grade
by the major rating agencies or are unrated securities that are considered by
the Investment Adviser to possess similar credit characteristics. Although junk
bonds generally pay higher rates of interest than investment grade bonds, they
are high risk investments that may cause income and principal losses for the
Fund. The major risks in junk bond investments include the following:
o Junk bonds may be issued by less creditworthy issuers. These
securities are vulnerable to adverse changes in the issuer's
industry and to general economic conditions. Issuers of junk bonds
may be unable to meet their interest or principal payment
obligations because of an economic downturn, specific issuer
developments or the unavailability of additional financing.
20
o The issuers of junk bonds may have a larger amount of outstanding
debt relative to their assets than issuers of investment grade
bonds. If the issuer experiences financial stress, it may be unable
to meet its debt obligations. The issuer's ability to pay its debt
obligations also may be lessened by specific issuer developments, or
the unavailability of additional financing.
o Junk bonds are frequently ranked junior to claims by other
creditors. If the issuer cannot meet its obligations, the senior
obligations are generally paid off before the junior obligations.
o Junk bonds frequently have call or redemption features that permit
an issuer to repurchase the security from the Fund before it
matures. If an issuer redeems the junk bonds, the Fund may have to
invest the proceeds in bonds with lower yields and may lose income.
o Prices of junk bonds are subject to extreme price fluctuations.
Negative economic developments may have a greater impact on the
prices of junk bonds than on other higher rated fixed income
securities.
o Junk bonds may be less liquid than higher rated fixed income
securities even under normal economic conditions. There are fewer
dealers in the junk bond market, and there may be significant
differences in the prices quoted for junk bonds by the dealers.
Because they are less liquid, judgment may play a greater role in
valuing certain of the Fund's portfolio securities than in the case
of securities trading in a more liquid market.
The Fund may incur expenses to the extent necessary to seek recovery
upon default or to negotiate new terms with a defaulting issuer.
Yields. Yields on Municipal Bonds are dependent on a variety of factors,
including the general condition of the money market and of the municipal bond
market, the size of a particular offering, the financial condition of the
issuer, the maturity of the obligation and the rating of the issue. The ability
of the Fund to achieve its investment objective is also dependent on the
continuing ability of the issuers of the securities in which the Fund invests to
meet their obligations for the payment of interest and principal when due. There
are variations in the risks involved in holding Municipal Bonds, both within a
particular classification and between classifications, depending on numerous
factors. Furthermore, the rights of owners of Municipal Bonds and the
obligations of the issuer of such Municipal Bonds may be subject to applicable
bankruptcy, insolvency and similar laws and court decisions affecting the rights
of creditors generally and to general equitable principles, which may limit the
enforcement of certain remedies.
Hedging Transactions
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of the
Fund's shares, the net asset value of the Fund's shares will fluctuate. There
can be no assurance that the Fund's hedging transactions will be effective. The
Fund has no obligation to enter into hedging transactions and may choose not to
do so.
Financial Futures Transactions and Options. The Fund is authorized to
purchase and sell certain exchange traded financial futures contracts
("financial futures contracts") in order to hedge its investments in Municipal
Bonds against declines in value, to hedge against increases in the cost of
securities it intends to purchase or to seek to enhance the Fund's return.
However, any transactions involving financial futures or options (including puts
and calls associated therewith) will be in accordance with the Fund's investment
policies and limitations. A financial futures contract obligates the seller of a
contract to deliver and the purchaser of a contract to take
21
delivery of the type of financial instrument covered by the contract, or in the
case of index-based futures contracts to make and accept a cash settlement, at a
specific future time for a specified price. To hedge its portfolio, the Fund may
take an investment position in a futures contract which will move in the
opposite direction from the portfolio position being hedged. A sale of financial
futures contracts may provide a hedge against a decline in the value of
portfolio securities because such depreciation may be offset, in whole or in
part, by an increase in the value of the position in the financial futures
contracts. A purchase of financial futures contracts may provide a hedge against
an increase in the cost of securities intended to be purchased because such
appreciation may be offset, in whole or in part, by an increase in the value of
the position in the futures contracts.
Distributions, if any, of net long term capital gains from certain
transactions in futures or options are taxable at long term capital gains rates
for Federal income tax purposes. See "Taxes."
Futures Contracts. A futures contract is an agreement between two parties
to buy and sell a security or, in the case of an index-based futures contract,
to make and accept a cash settlement for a set price on a future date. A
majority of transactions in futures contracts, however, do not result in the
actual delivery of the underlying instrument or cash settlement, but are settled
through liquidation, i.e., by entering into an offsetting transaction. Futures
contracts have been designed by boards of trade which have been designated
"contracts markets" by the Commodity Futures Trading Commission ("CFTC").
The purchase or sale of a futures contract differs from the purchase or
sale of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the purchaser
and seller under the futures contract. Subsequent payments to and from the
broker, called "variation margin," are required to be made on a daily basis as
the price of the futures contract fluctuates making the long and short positions
in the futures contract more or less valuable, a process known as "marking to
the market." At any time prior to the settlement date of the futures contract,
the position may be closed out by taking an opposite position that will operate
to terminate the position in the futures contract. A final determination of
variation margin is then made, additional cash is required to be paid to or
released by the broker and the purchaser realizes a loss or gain. In addition, a
nominal commission is paid on each completed sale transaction.
The Fund deals in financial futures contracts based on a long term
municipal bond index developed by the Chicago Board of Trade ("CBT") and The
Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is comprised
of 40 tax exempt municipal revenue and general obligation bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or S&P
and must have a remaining maturity of 19 years or more. Twice a month new issues
satisfying the eligibility requirements are added to, and an equal number of old
issues are deleted from, the Municipal Bond Index. The value of the Municipal
Bond Index is computed daily according to a formula based on the price of each
bond in the Municipal Bond Index, as evaluated by six dealer-to-dealer brokers.
The Municipal Bond Index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the exchange
membership which is also responsible for handling daily accounting of deposits
or withdrawals of margin.
22
The Fund may also purchase and sell financial futures contracts on U.S.
Government securities as a hedge against adverse changes in interest rates as
described below. With respect to U.S. Government securities, currently there are
financial futures contracts based on long term U.S. Treasury bonds, Treasury
notes, Government National Mortgage Association ("GNMA") Certificates and
three-month U.S. Treasury bills. The Fund may purchase and write call and put
options on futures contracts on U.S. Government securities and purchase and sell
Municipal Bond Index futures contracts in connection with its hedging
strategies.
The Fund also may engage in other futures contracts transactions such as
futures contracts on other municipal bond indices that may become available if
the Investment Adviser should determine that there is normally a sufficient
correlation between the prices of such futures contracts and the Municipal Bonds
in which the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as a
result of the shortening of maturities. The sale of futures contracts provides
an alternative means of hedging against declines in the value of its investments
in Municipal Bonds. As such values decline, the value of the Fund's positions in
the futures contracts will tend to increase, thus offsetting all or a portion of
the depreciation in the market value of the Fund's Municipal Bond investments
that are being hedged. While the Fund will incur commission expenses in selling
and closing out futures positions, commissions on futures transactions are lower
than transaction costs incurred in the purchase and sale of Municipal Bonds. In
addition, the ability of the Fund to trade in the standardized contracts
available in the futures markets may offer a more effective defensive position
than a program to reduce the average maturity of the portfolio securities due to
the unique and varied credit and technical characteristics of the municipal debt
instruments available to the Fund. Employing futures as a hedge also may permit
the Fund to assume a defensive posture without reducing the yield on its
investments beyond any amounts required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such Municipal
Bonds resulting from a decrease in interest rates or otherwise, that may occur
before such purchases can be effected. Subject to the degree of correlation
between the Municipal Bonds and the futures contracts, subsequent increases in
the cost of Municipal Bonds should be reflected in the value of the futures held
by the Fund. As such purchases are made, an equivalent amount of futures
contracts will be closed out. Due to changing market conditions and interest
rate forecasts, however, a futures position may be terminated without a
corresponding purchase of portfolio securities.
Call Options on Futures Contracts. The Fund may also purchase and sell
exchange traded call and put options on financial futures contracts. The
purchase of a call option on a futures contract is analogous to the purchase of
a call option on an individual security. Depending on the pricing of the option
compared to either the futures contract upon which it is based or the price of
the underlying debt securities, it may or may not be less risky than ownership
of the futures contract or underlying debt securities. Like the purchase of a
futures contract, the Fund will purchase a call option on a futures contract to
hedge against a market advance when the Fund is not fully invested.
23
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in the
Fund's portfolio holdings.
Put Options on Futures Contracts. The purchase of a put option on a
futures contract is analogous to the purchase of a protective put option on
portfolio securities. The Fund will purchase a put option on a futures contract
to hedge the Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial
hedge against increasing prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is higher
than the exercise price, the Fund will retain the full amount of the option
premium which provides a partial hedge against any increase in the price of
Municipal Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an option
will be included in initial margin. The writing of an option on a futures
contract involves risks similar to those relating to futures contracts.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed 5%
of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. However, the Fund may engage in options and futures transactions for
hedging purposes or to seek to enhance the Fund's return. Margin deposits may
consist of cash or securities acceptable to the broker and the relevant contract
market.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender adjustable
notes) or liquid securities in a segregated account with the Fund's custodian,
so that the amount so segregated plus the amount of initial and variation margin
held in the account of its broker equals the market value of the futures
contracts, thereby ensuring that the use of such futures contract is
unleveraged. It is not anticipated that transactions in futures contracts will
have the effect of increasing portfolio turnover.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
24
The particular municipal bonds comprising the index underlying the
Municipal Bond Index financial futures contract may vary from the bonds held by
the Fund. As a result, the Fund's ability to hedge effectively all or a portion
of the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of the Municipal Bonds held by the Fund. The correlation may be
affected by disparities in the average maturity, ratings, geographical mix or
structure of the Fund's investments as compared to those comprising the
Municipal Bond Index and general economic or political factors. In addition, the
correlation between movements in the value of the Municipal Bond Index may be
subject to change over time as additions to and deletions from the Municipal
Bond Index alter its structure. The correlation between futures contracts on
U.S. Government securities and the Municipal Bonds held by the Fund may be
adversely affected by similar factors and the risk of imperfect correlation
between movements in the prices of such futures contracts and the prices of
Municipal Bonds held by the Fund may be greater. Municipal Bond Index futures
contracts were approved for trading in 1986. Trading in such futures contracts
may tend to be less liquid than trading in other futures contracts. The trading
of futures contracts also is subject to certain market risks, such as inadequate
trading activity, which could at times make it difficult or impossible to
liquidate existing positions.
The Fund expects to liquidate a majority of the futures contracts it
enters into through offsetting transactions on the applicable contract market.
There can be no assurance, however, that a liquid secondary market will exist
for any particular futures contract at any specific time. Thus, it may not be
possible to close out a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments of
variation margin. In such situations, if the Fund has insufficient cash, it may
be required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The liquidity
of a secondary market in a futures contract may be adversely affected by "daily
price fluctuation limits" established by commodity exchanges which limit the
amount of fluctuation in a futures contract price during a single trading day.
Once the daily limit has been reached in the contract, no trades may be entered
into at a price beyond the limit, thus preventing the liquidation of open
futures positions. Prices have in the past moved beyond the daily limit on a
number of consecutive trading days. The Fund will enter into a futures position
only if, in the judgment of the Investment Adviser, there appears to be an
actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Investment Adviser to forecast correctly the
direction and extent of interest rate movements within a given time frame. To
the extent interest rates remain stable during the period in which a futures
contract or option is held by the Fund or such rates move in a direction
opposite to that anticipated, the Fund may realize a loss on the hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Fund's total return for such period
may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by the
Fund of margin deposits in the event of bankruptcy of a broker with whom the
Fund has an open position in a financial futures contract. Because the Fund will
engage in the purchase and sale of futures contracts for hedging purposes or to
seek to enhance the Fund's return, any losses incurred in connection therewith
should, if the hedging strategy is successful, be offset in whole or in part by
increases in the value of securities held by the Fund or decreases in the price
of securities the Fund intends to acquire.
25
The amount of risk the Fund assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract also entails the risk that changes in the value of
the underlying futures contract will not be fully reflected in the value of the
option purchased.
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
Temporary Investments
The Fund may invest in short term tax exempt and taxable securities
subject to the limitations set forth above. The tax exempt money market
securities may include municipal notes, municipal commercial paper, municipal
bonds with a remaining maturity of less than one year, variable rate demand
notes and participations therein. Municipal notes include tax anticipation
notes, bond anticipation notes, revenue anticipation notes and grant
anticipation notes. Anticipation notes are sold as interim financing in
anticipation of tax collection, bond sales, government grants or revenue
receipts. Municipal commercial paper refers to short term unsecured promissory
notes generally issued to finance short term credit needs. The taxable money
market securities in which the Fund may invest as Temporary Investments consist
of U.S. Government securities, U.S. Government agency securities, domestic bank
or savings institution certificates of deposit and bankers' acceptances, short
term corporate debt securities such as commercial paper and repurchase
agreements. These Temporary Investments must have a stated maturity not in
excess of one year from the date of purchase. The Fund may not invest in any
security issued by a commercial bank or a savings institution unless the bank or
institution is organized and operating in the United States, has total assets of
at least one billion dollars and is a member of the Federal Deposit Insurance
Corporation ("FDIC"), except that up to 10% of total assets may be invested in
certificates of deposit of smaller institutions if such certificates are fully
insured by the FDIC.
Interest Rate Swap Transactions
In order to seek to hedge the value of a Fund against interest rate
fluctuations or to seek to enhance the Fund's return, the Fund may enter into
interest rate swap transactions such as Municipal Market Data AAA Cash Curve
swaps ("MMD Swaps") or Bond Market Association Municipal Swap Index swaps ("BMA
Swaps"). To the extent that the Fund enters into transactions, the Fund expects
to do so primarily to preserve a return or spread on a particular investment or
portion of its portfolio as a duration management technique or to protect
against any increase in the price of securities the Fund anticipates purchasing
at a later date. The Fund may enter into to use these transactions primarily as
a hedge or for duration or risk management rather than as a speculative
investment. However, the Fund also may invest in MMD Swaps and BMA Swaps to seek
to enhance return or gain or to increase the Fund's yield, for example, during
periods of steep interest rate yield curves (i.e., wide differences between
short term and long term interest rates).
The Fund may purchase and sell BMA Swaps in the BMA swap market. In a BMA
Swap, the Fund exchanges with another party their respective commitments to pay
or receive interest (e.g., an exchange of fixed rate payments for floating rate
payments linked to the Bond Market Association Municipal Swap Index). Because
the underlying index is a tax exempt index, BMA Swaps may reduce cross-market
risks incurred by the Fund and increase the Fund's ability to hedge effectively.
BMA Swaps are typically quoted for the entire yield
26
curve, beginning with a seven day floating rate index out to 30 years. The
duration of a BMA Swap is approximately equal to the duration of a fixed rate
Municipal Bond with the same attributes as the swap (e.g., coupon, maturity,
call feature).
The Fund also may purchase and sell MMD Swaps, also known as MMD rate
locks. An MMD Swap permits the Fund to lock in a specified municipal interest
rate for a portion of its portfolio to preserve a return on a particular
investment or a portion of its portfolio as a duration management technique or
to protect against any increase in the price of securities to be purchased at a
later date. By using an MMD Swap, the Fund can create a synthetic long or short
position, allowing the Fund to select the most attractive part of the yield
curve. An MMD Swap is a contract between the Fund and an MMD Swap provider
pursuant to which the parties agree to make payments to each other on a notional
amount, contingent upon whether the Municipal Market Data AAA General Obligation
Scale is above or below a specified level on the expiration date of the
contract. For example, if the Fund buys an MMD Swap and the Municipal Market
Data AAA General Obligation Scale is below the specified level on the expiration
date, the counterparty to the contract will make a payment to the Fund equal to
the specified level minus the actual level, multiplied by the notional amount of
the contract. If the Municipal Market Data AAA General Obligation Scale is above
the specified level on the expiration date, the Fund will make a payment to the
counterparty equal to the actual level minus the specified level, multiplied by
the notional amount of the contract.
In connection with investments in BMA and MMD Swaps, there is a risk that
municipal yields will move in the opposite direction than anticipated by the
Fund, which would cause the Fund to make payments to its counterparty in the
transaction that could adversely affect the Fund's performance.
The Fund has no obligation to enter into BMA or MMD Swaps and may not do
so. The net amount of the excess, if any, of the Fund's obligations over its
entitlements with respect to each interest rate swap will be accrued on a daily
basis, and the Fund will segregate liquid securities having an aggregate net
asset value at least equal to the accrued excess.
Credit Default Swap Agreements
The Fund may enter into credit default swap agreements for hedging
purposes or to seek to enhance its return. The credit default swap agreement may
have as reference obligations one or more securities that are not currently held
by the Fund. The protection "buyer" in a credit default contract may be
obligated to pay the protection "seller" an upfront or a periodic stream of
payments over the term of the contract provided that no credit event on a
reference obligation has occurred. If a credit event occurs, the seller
generally must pay the buyer the "par value" (full notional value) of the swap
in exchange for an equal face amount of deliverable obligations of the reference
entity described in the swap, or the seller may be required to deliver the
related net cash amount, if the swap is cash settled. The Fund may be either the
buyer or seller in the transaction. If the Fund is a buyer and no credit event
occurs, the Fund may recover nothing if the swap is held through its termination
date. However, if a credit event occurs, the buyer generally may elect to
receive the full notional value of the swap in
27
exchange for an equal face amount of deliverable obligations of the reference
entity that may have little or no value. As a seller, the Fund generally
receives an upfront payment or a fixed rate of income throughout the term of the
swap, which typically is between six months and three years, provided that there
is no credit event. If a credit event occurs, generally the seller must pay the
buyer the full notional value of the swap in exchange for an equal face amount
of deliverable obligations of the reference entity that may have little or no
value. As the seller, the Fund would effectively add leverage to its portfolio
because, in addition to its total net assets, the Fund would be subject to
investment exposure on the notional amount of the swap.
Credit default swap agreements involve greater risks than if the Fund had
invested in the reference obligation directly since, in addition to general
market risks, credit default swaps are subject to illiquidity risk, counterparty
risk and credit risks. The Fund will enter into credit default swap agreements
only with counterparties who are rated investment grade quality by at least one
nationally recognized statistical rating organization at the time of entering
into such transaction or whose creditworthiness is believed by the Investment
Adviser to be equivalent to such rating. A buyer generally also will lose its
investment and recover nothing should no credit event occur and the swap is held
to its termination date. If a credit event were to occur, the value of any
deliverable obligation received by the seller, coupled with the upfront or
periodic payments previously received, may be less than the full notional value
it pays to the buyer, resulting in a loss of value to the seller. The Fund's
obligations under a credit default swap agreement will be accrued daily (offset
against any amounts owing to the Fund). The Fund will at all times segregate
with its custodian in connection with each such transaction unencumbered liquid
securities or cash with a value at least equal to the Fund's exposure (any
accrued but unpaid net amounts owed by the Fund to any counterparty), on a
marked-to-market basis (as calculated pursuant to requirements of the
Commission). Such segregation will ensure that the Fund has assets available to
satisfy its obligations with respect to the transaction and will avoid any
potential leveraging of the Fund's portfolio. Such segregation will not limit
the Fund's exposure to loss.
VRDOs and Participating VRDOs
VRDOs are tax exempt obligations that contain a floating or variable
interest rate adjustment formula and right of demand on the part of the holder
thereof to receive payment of the unpaid principal balance plus accrued interest
upon a short notice period not to exceed seven days. There is, however, the
possibility that because of default or insolvency the demand feature of VRDOs
and Participating VRDOs may not be honored. The interest rates are adjustable at
intervals (ranging from daily to up to one year) to some prevailing market rate
for similar investments, such adjustment formula being calculated to maintain
the market value of the VRDOs, at approximately the par value of the VRDOs on
the adjustment date. The adjustments typically are based upon the Public
Securities Association Index or some other appropriate interest rate adjustment
index. The Fund may invest in all types of tax exempt instruments currently
outstanding or to be issued in the future which satisfy its short term maturity
and quality standards.
Participating VRDOs provide the Fund with a specified undivided interest
(up to 100%) of the underlying obligation and the right to demand payment of the
unpaid principal balance plus accrued interest on the Participating VRDOs from
the financial institution upon a specified number of days' notice, not to exceed
seven days. In addition, the Participating VRDO is backed by an irrevocable
letter of credit or guaranty of the financial institution. The Fund would have
an undivided interest in the underlying obligation and thus participate on the
same basis as the financial institution in such obligation except that the
financial institution typically retains fees out of the interest paid on the
obligation for servicing the obligation, providing the letter of credit and
issuing the repurchase commitment. The Fund has been advised by its counsel that
the Fund should be entitled to treat the income received on Participating VRDOs
as interest from tax exempt obligations as long as the Fund does not invest more
than 20% of its total assets in such investments and certain other conditions
are met. It is contemplated that the Fund will not invest more than 20% of its
assets in Participating VRDOs.
28
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. The Directors may adopt
guidelines and delegate to the Investment Adviser the daily function of
determining and monitoring liquidity of such VRDOs. The Directors, however, will
retain sufficient oversight and will be ultimately responsible for such
determinations.
The Temporary Investments, VRDOs and Participating VRDOs in which the Fund
may invest will be in the following rating categories at the time of purchase:
MIG-1/VMIG-1 through MIG-3/VMIG-3 for notes and VRDOs and Prime-1 through
Prime-3 for commercial paper (as determined by Moody's), SP-1 through SP-2 for
notes and A-1 through A-3 for VRDOs and commercial paper (as determined by S&P),
or F-1 through F-3 for notes, VRDOs and commercial paper (as determined by
Fitch). Temporary Investments, if not rated, must be of comparable quality in
the opinion of the Investment Adviser. In addition, the Fund reserves the right
to invest temporarily a greater portion of its assets in Temporary Investments
for defensive purposes, when, in the judgment of the Investment Adviser, market
conditions warrant.
Repurchase Agreements
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the Federal
Reserve System or primary dealer or an affiliate thereof, in U.S. Government
securities. Under such agreements, the bank or primary dealer or an affiliate
thereof agrees, upon entering into the contract, to repurchase the security at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. In repurchase agreements, the prices at
which the trades are conducted do not reflect accrued interest on the underlying
obligations. Such agreements usually cover short periods, such as under one
week. Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
In a repurchase agreement, the Fund will require the seller to provide
additional collateral if the market value of the securities falls below the
repurchase price at any time during the term of the repurchase agreement. In the
event of default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities are not owned by the Fund but
only constitute collateral for the seller's obligation to pay the repurchase
price. Therefore, the Fund may suffer time delays and incur costs or possible
losses in connection with the disposition of the collateral. In the event of a
default under such a repurchase agreement, instead of the contractual fixed rate
of return, the rate of return to the Fund shall be dependent upon intervening
fluctuations of the market value of such security and the accrued interest on
the security. In such event, the Fund would have rights against the seller for
breach of contract with respect to any losses arising from market fluctuations
following the failure of the seller to perform.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold." Therefore,
amounts earned under such agreements will not be considered tax exempt interest.
The treatment of purchase and sales contracts is less certain.
Short Sales
The Fund may make short sales of securities. A short sale is a transaction
in which the Fund sells a security it does not own in anticipation that the
market price of that security will decline. The Fund may make short sales both
as a form of hedging to offset potential declines in long positions in similar
securities and in order to seek to enhance return.
29
When the Fund makes a short sale, it must borrow the security sold short
and deliver collateral to the broker dealer through which it made the short sale
to cover its obligation to deliver the security upon conclusion of the sale. The
Fund may have to pay a fee to borrow particular securities and is often
obligated to pay over any payments received on such borrowed securities.
The Fund's obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer, usually cash or liquid securities
similar to those borrowed. The Fund also will be required to segregate similar
collateral with its custodian to the extent, if any, necessary so that the value
of both collateral amounts in the aggregate is at all times equal to at least
100% of the current market value of the security sold short. Depending on
arrangements made with the broker-dealer from which it borrowed the security
regarding payment over any payments received by the Fund on such security, the
Fund may not receive any payments (including interest) on its collateral
deposited with such broker-dealer.
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss. Conversely, if the price declines, the Fund will realize a gain.
Any gain will be decreased, and any loss increased, by the transaction costs
described above. Although the Fund's gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited.
The Fund also may make short sales "against the box." These transactions
will involve either short sales of securities retained in the Fund's portfolio
or securities which it has the right to acquire without the payment of further
consideration.
Investment in Other Investment Companies
The Fund may invest in other investment companies whose investment
objectives and policies are consistent with those of the Fund. In accordance
with the 1940 Act, the Fund may invest up to 10% of its total assets in
securities of other investment companies. In addition, under the 1940 Act the
Fund may not own more than 3% of the total outstanding voting stock of any
investment company and not more than 5% of the value of the Fund's total assets
may be invested in securities of any investment company. The Fund has received
an exemptive order from the Commission permitting it to invest in affiliated
registered money market funds and in an affiliated private investment company
without regard to such limitations, provided however, that in all cases the
Fund's aggregate investment of cash in shares of such investment companies shall
not exceed 25% of the Fund's total assets at any time. If the Fund acquires
shares in investment companies, stockholders would bear both their proportionate
share of expenses in the Fund (including management and advisory fees) and,
indirectly, the expenses of such investment companies (including management and
advisory fees).
Borrowings
The Fund is authorized to borrow money in amounts of up to 5% of the value
of its total assets at the time of such borrowings, provided, however, that the
Fund is authorized to borrow moneys in amounts of up to 33 1/3% of the value of
its total assets at the time of such borrowings to finance the repurchase of its
own common stock pursuant to tender offers or otherwise, to redeem or repurchase
shares of preferred stock, or for temporary, extraordinary or emergency
purposes, including the payment of dividends and the settlement of securities
transactions which otherwise might require untimely dispositions of portfolio
securities. Borrowings by the Fund (commonly known, as with the issuance of
preferred stock, as "leveraging") create an opportunity for greater total return
since, for example, the Fund will not be required to sell portfolio securities
to repurchase or redeem shares but, at the same time, increase exposure to
capital risk. See "Risks and Special Considerations of Leverage." In addition,
borrowed funds are subject to interest costs that may offset or exceed the
return earned on the borrowed funds.
30
RISKS AND SPECIAL CONSIDERATIONS OF LEVERAGE
Effects of Leverage
The Fund currently intends to issue preferred stock within approximately
three months after the completion of this offering. Under normal market
conditions it is anticipated that the preferred stock will represent
approximately 35% of the Fund's capital, including the capital raised by issuing
the preferred stock, or approximately 54% of the Fund's common stock equity.
There can be no assurance, however, that preferred stock will actually be issued
or if issued what percentage of the Fund's capital it will represent. Issuing
the preferred stock will result in the leveraging of the common stock. Although
the Fund's Board of Directors has not yet determined the terms of the preferred
stock offering, the Fund anticipates that the preferred stock will pay dividends
that will be adjusted over either relatively short term periods (generally 7 to
28 days) or medium term periods (up to five years). The dividend rate will be
based upon prevailing interest rates for debt obligations of comparable
maturity. The proceeds of the preferred stock offering will be invested in
accordance with the Fund's investment objective. The expenses of the preferred
stock, which will be borne by the Fund, will reduce the net asset value of the
common stock. Additionally, under certain circumstances, when the Fund is
required to allocate taxable income to holders of preferred stock, the Fund
anticipates that the terms of the preferred stock will require the Fund to make
an additional distribution to such holders in an amount approximately equal to
the tax liability resulting from such allocation (an "Additional Distribution").
Because under normal market conditions, obligations with longer maturities
produce higher yields than short term and medium term obligations, the yield
spread inherent in the difference between the short term and medium term rates
(and any Additional Distribution) paid by the Fund as dividends on the preferred
stock and the generally longer term rates received by the Fund on its portfolio
securities may provide holders of common stock with a potentially higher yield.
The Fund also may borrow money as discussed under "Other Investment
Policies -- Borrowings".
The use of leverage, however, involves certain risks to the holders of
common stock. For example, issuance of the preferred stock may result in higher
volatility of the Fund's yield, net asset value and in the market price of the
common stock. In addition, changes in short term, medium term and long term
rates and their relationship to each other, could negatively impact the Fund's
yield, net asset value and market price of the common stock. Leverage will allow
holders of common stock to realize a higher current yield or return than if the
Fund were not leveraged as long as the Fund, while accounting for its costs and
operating expenses, is able to earn higher income or return on its investment
portfolio than the then current dividend rate paid on (and any Additional
Distribution) the preferred stock. Similarly, since a pro rata portion of the
Fund's net realized capital gains are generally payable to holders of common
stock, the effect of leverage may be to increase the amount of such gains
distributed to holders of common stock. However, short term, medium term and
long term interest rates change from time to time, as do their relationships to
each other (i.e., the slope of the yield curve), depending upon such factors as
supply and demand forces, monetary and tax policies and investor expectations.
Changes in any or all of such factors could cause the relationship between short
term, medium term and long term rates to change (i.e., to flatten or to invert
the slope of the yield curve) so that short term and medium term rates may
substantially increase relative to the long term obligations in which the Fund
may be invested. If short term rates were to rise relative to long term rates,
the incremental yield pickup on the common stock as a result of leverage will be
reduced or eliminated completely. To the extent that the current dividend rate
(and any Additional Distribution) paid on the preferred stock approaches the
yield or return on the Fund's investment portfolio, the benefit of leverage to
holders of common stock will be decreased. If the current dividend rate (and any
Additional Distribution) paid on the preferred stock were to exceed the yield or
return on the Fund's portfolio, holders of common stock would receive a lower
yield or return than if the Fund were not leveraged. If long term rates rise,
the value of the Fund's investments (including assets obtained from leverage)
may decline. Since both the cost of issuing the preferred
31
stock and any decline in the value of the Fund's investments (including
investments purchased with the proceeds from any preferred stock offering) will
be borne entirely by holders of common stock, the effect of leverage in a
declining market would result in a greater decrease in the Fund's net asset
value and possibly the market price of the common stock than if the Fund were
not leveraged. If the Fund is liquidated, holders of preferred stock will be
entitled to receive liquidating distributions before any distribution is made to
holders of common stock.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the common stock. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under the Federal tax laws. See "Taxes." However, the Fund
intends to take all measures necessary to make common stock dividend payments.
If the Fund's current investment income is ever insufficient to meet dividend
payments on either the common stock or the preferred stock, the Fund may have to
liquidate certain of its investments. In addition, the Fund will have the
authority to redeem the preferred stock for any reason and may redeem all or
part of the preferred stock under the following circumstances:
o if the asset coverage for the preferred stock declines below 200%,
or
o in order to maintain the asset coverage guidelines established by
the nationally recognized statistical rating organization(s)
("NRSRO(s)") that have rated the preferred stock.
Redemption of the preferred stock or insufficient investment income to
make dividend payments may reduce the net asset value of the common stock and
require the Fund to liquidate a portion of its investments at a time when it may
be disadvantageous to do so.
As discussed under "Investment Advisory and Management Arrangements,"
during periods when the Fund has preferred stock outstanding, the fees paid the
Investment Adviser for investment advisory and management services will be
higher than if the Fund did not issue preferred stock because the fees paid will
be calculated on the basis of the Fund's average daily net assets (including any
proceeds from the issuance of preferred stock), plus the proceeds of any
outstanding borrowings used for leverage.
Assuming the use of leverage by issuing preferred stock (paying dividends
at a rate that generally will be adjusted every 7 days) in an amount
representing approximately 35% of the Fund's capital at an annual dividend rate
of 0.80% payable on such preferred stock based on market rates as of the date of
this prospectus, the annual return that the Fund's portfolio must experience
(net of expenses) in order to cover such dividend payments would be 0.28%.
The following table is designed to illustrate the effect on the return to
a holder of common stock of the leverage obtained by the issuance of preferred
stock representing approximately 35% of the Fund's capital, assuming
hypothetical annual returns on the Fund's portfolio of minus 10% to plus 10%. As
the table shows, leverage generally increases the return to stockholders when
portfolio return is positive and decreases the return when portfolio return is
negative. The figures appearing in the table are hypothetical and actual returns
may be greater or less than those appearing in the table.
Assumed Portfolio Return
(net of expenses) ............................. (10)% (5)% 0% 5% 10%
Corresponding Common Stock Return ............... (16)% (8)% 0% 7% 15%
Leveraging the common stock cannot be fully achieved until preferred stock
is issued and the proceeds of such offering have been invested in accordance
with the Fund's investment objective and policies.
Portfolio Management and Other Considerations
If short term or medium term rates increase or other changes in market
conditions occur to the point where the Fund's leverage could adversely affect
holders of common stock as noted above (or in anticipation of such changes),
32
the Fund may attempt to shorten the average maturity or duration of its
investment portfolio in order to offset the negative impact of leverage. The
Fund also may attempt to reduce the degree to which it is leveraged by redeeming
preferred stock pursuant to the Fund's Articles Supplementary, which establish
the rights and preferences of the preferred stock, or otherwise by purchasing
shares of preferred stock. Purchases and redemptions of preferred stock, whether
on the open market or in negotiated transactions, are subject to limitations
under the 1940 Act. In determining whether or not it is in the best interest of
the Fund and its stockholders to redeem or repurchase outstanding preferred
stock, the Board of Directors will take into account a variety of factors,
including the following:
o market conditions;
o the ratio of preferred stock to common stock; and
o the expenses associated with such redemption or repurchase.
If market conditions subsequently change, the Fund may sell previously
unissued shares of preferred stock or shares of preferred stock that the Fund
had issued but later repurchased or redeemed. The Fund will incur additional
expenses in connection with the subsequent registration and sale of preferred
stock.
The Fund intends to apply for ratings of the preferred stock from one or
more NRSRO(s). In order to obtain these ratings, the Fund may be required to
maintain portfolio holdings that meet the specified guidelines of such
organizations. These guidelines may impose asset coverage requirements that are
more stringent than those imposed by the 1940 Act. The Fund does not anticipate
that these guidelines will impede the Investment Adviser from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies. Ratings on preferred stock issued by the Fund should not be confused
with ratings on the obligations held by the Fund.
Under the 1940 Act, the Fund is not permitted to issue shares of preferred
stock unless immediately after such issuance the net asset value of the Fund's
portfolio is at least 200% of the liquidation value of the outstanding preferred
stock (expected to equal the original purchase price of the outstanding shares
of preferred stock plus any accumulated and unpaid dividends thereon and any
accumulated and unpaid Additional Distribution). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on its common stock
unless, at the time of such declaration, the net asset value of the Fund's
portfolio (determined after deducting the amount of such dividend or
distribution) is at least 200% of the liquidation value of the outstanding
preferred stock. Under the Fund's proposed capital structure, assuming the sale
of shares of preferred stock representing approximately 35% of the Fund's
capital, the net asset value of the Fund's portfolio is expected to be
approximately 286% of the liquidation value of the Fund's preferred stock. To
the extent possible, the Fund intends to purchase or redeem shares of preferred
stock from time to time to maintain coverage of preferred stock of at least
200%.
The Fund may in the future employ new or additional investment strategies
and hedging instruments if those strategies and instruments are consistent with
the Fund's investment objective and are permissible under applicable regulations
governing the Fund.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and,
prior to issuance of any preferred stock, may not be changed without the
approval of the holders of a majority of the Fund's outstanding shares of common
stock (which for this purpose and under the 1940 Act means the lesser of (i) 67%
of the shares of common stock represented at a meeting at which more than 50% of
the outstanding shares of common stock are represented or (ii) more than 50% of
the outstanding shares). Subsequent to the issuance of a class of preferred
stock, the following investment restrictions may not be changed without the
approval of a majority of the outstanding shares of common stock and of
preferred
33
stock, voting together as a class, and the approval of a majority of the
outstanding shares of preferred stock, voting separately as a class. The Fund
may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, commodities or commodity contracts;
except that to the extent permitted by applicable law, the Fund may invest
in securities directly or indirectly secured by real estate or interests
therein or issued by entities that invest in real estate or interests
therein, and the Fund may purchase and sell financial futures contracts
and options thereon.
3. Issue senior securities or borrow money except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended,
in selling portfolio securities.
5. Make loans to other persons, except (i) the Fund shall not be
deemed to be making a loan to the extent that the Fund purchases Municipal
Bonds or other debt instruments or enters into repurchase agreements or
any similar instruments and (ii) the Fund may lend its portfolio
securities in an amount not in excess of 33 1/3% of its total assets,
taken at market value, provided that such loans shall be made in
accordance with the guidelines set forth in this prospectus.
6. Invest more than 25% of its total assets (taken at market value
at the time of each investment) in the securities of issuers in a single
industry; provided that, for purposes of this restriction, tax exempt
securities of issuers that are states, municipalities or their political
subdivisions are not considered to be the securities of issuers in any
single industry.
Additional investment restrictions adopted by the Fund, which may be changed by
the Board of Directors without stockholder approval, provide that the Fund may
not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the
Fund, (ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities and provided
that the Fund, together with other investment companies having the same
investment adviser and companies controlled by such companies, owns not
more than 10% of the total outstanding stock of any one closed-end
investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Fund except
as may be necessary in connection with borrowings mentioned in investment
restriction (3) above or except as may be necessary in connection with
transactions described under "Other Investment Policies."
c. Purchase any securities on margin, except that the Fund may
obtain such short term credit as may be necessary for the clearance of
purchases and sales of portfolio securities (the deposit or payment by the
Fund of initial or variation margin in connection with financial futures
contracts and options thereon is not considered the purchase of a security
on margin).
d. Change its policy of investing, under normal market conditions,
at least 80% of the Fund's net assets (including assets acquired from the
sale of preferred stock, plus the amount of any borrowings for investment
purposes), in Municipal Bonds with an option-adjusted duration, as
calculated by the Fund's Investment Adviser, of three to ten years, unless
the Fund provides stockholders with at least 60 days prior written notice
of such change.
34
If a percentage restriction on investment policies or the investment or
use of assets set forth above is adhered to at the time a transaction is
effected, later changes in percentage resulting from changing values will not be
considered a violation.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by the 1940 Act in the proportion
of its assets that it may invest in securities of a single issuer. As a
non-diversified fund, the Fund's investments are limited, however, in order to
allow the Fund to continue to qualify as a regulated investment company under
the Internal Revenue Code of 1986, as amended (the "Code"). See "Taxes." To
qualify, the Fund complies with certain requirements, including limiting its
investments so that at the close of each quarter of the taxable year (i) not
more than 25% of the market value of the Fund's total
assets will be invested in the securities of a single issuer and (ii) with
respect to 50% of the market value of its total assets, not more than 5% of the
market value of its total assets will be invested in the securities of a single
issuer and the Fund will not own more than 10% of the outstanding voting
securities of a single issuer. For purposes of this restriction, the Fund will
regard each state and each political subdivision, agency or instrumentality of
such state and each multi-state agency of which such state is a member and each
public authority which issues securities on behalf of a private entity as a
separate issuer, except that if the security is backed only by the assets and
revenues of a non-government entity then the entity with the ultimate
responsibility for the payment of interest and principal may be regarded as the
sole issuer. These tax-related limitations may be changed by the Board of
Directors of the Fund to the extent necessary to comply with changes in the
Federal tax requirements. A fund that elects to be classified as "diversified"
under the 1940 Act must satisfy the foregoing 5% and 10% requirements with
respect to 75% of its total assets.
The Investment Adviser of the Fund and Merrill Lynch are owned and
controlled by Merrill Lynch & Co., Inc. ("ML & Co."). Because of the affiliation
of Merrill Lynch with the Investment Adviser, the Fund is prohibited from
engaging in certain transactions involving Merrill Lynch except pursuant to an
exemptive order or otherwise in compliance with the provisions of the 1940 Act
and the rules and regulations thereunder. Included among such restricted
transactions will be purchases from or sales to Merrill Lynch of securities in
transactions in which it acts as principal. See "Portfolio Transactions."
DIRECTORS AND OFFICERS
The Directors of the Fund consist of five individuals, four of whom are
not "interested persons" of the Fund as defined in the 1940 Act (the
"non-interested Directors"). The Directors are responsible for the overall
supervision of the operations of the Fund and perform the various duties imposed
on the directors of investment companies by the 1940 Act.
Each non-interested Director is a member of the Fund's Audit and
Nominating Committee (the "Committee"). The principal responsibilities of the
Committee are the appointment, compensation and oversight of the Fund's
independent auditors, including resolution of disagreements regarding financial
reporting between Fund management and such auditors. The Board of the Fund has
adopted a written charter for the Committee. The Committee also reviews and
nominates candidates to serve as non-interested Directors. The Committee has
retained independent legal counsel to assist them in connection with these
duties. Since the Fund was incorporated, the Committee has held one meeting.
Biographical Information
Certain biographical and other information relating to the non-interested
Directors of the Fund is set forth below, including their ages, their principal
occupations for at least the last five years, the length of time served, the
total number of portfolios overseen in the complex of funds advised by the
Investment Adviser and its affiliate, Merrill Lynch Investment Managers, L.P.
("MLIM") ("FAM/MLIM-advised funds") and other public directorships.
35
Number of
Term of FAM/MLIM-
Position(s) Office** and Advised Funds
Held with Length of Principal Occupation(s) and Portfolios Public
Name, Address* and Age the Fund Time Served During Past Five Years Overseen Directorships
---------------------- --------- ------------ ---------------------- -------------- -------------
Donald W. Burton (59) Director Director since General Partner of The Burton 21 registered ITC DeltaCom,
2003 Partnership, Limited investment Inc.
Partnership (an Investment companies (telecommunications);
Partnership) since 1979; consisting of ITC Holding Company,
Managing General Partner of 35 Inc.
The South Atlantic Venture portfolios (telecommunications);
Funds since 1983; Member of Knology, Inc.
the Investment Advisory (telecommunications);
Committee of the Florida State MainBancorp, N.A.
Board of Administration since (bank holding company);
2001. PriCare, Inc.
(health care); Symbion,
Inc. (healthcare)
M. Colyer Crum (71) Director Director James R. Williston Professor 22 registered Cambridge Bancorp
since 2003 of Investment Management investment (banking company)
Emeritus, Harvard Business companies
School since 1996; James R. consisting of
Williston Professor of 36 portfolios
Investment Management, Harvard
Business School, from 1971 to
1996.
Laurie Simon Hodrick Director Director Professor of Finance and 21 registered None
(40) since 1999 Economics, Graduate School of investment
Business, Columbia University companies
since 1998; Associate consisting of
Professor of Finance and 35 portfolios
Economics, Graduate School of
Business, Columbia University
from 1996 to 1998.
Fred G. Weiss (61) Director Director Managing Director of FGW 21 registered Watson
since 1998 Associates since 1977; Vice investment Pharmaceutical Inc.
President, Planning Investment companies (pharmaceutical company)
and Development of Warner consisting of
Lambert Co. from 1979 to 1997; 35 portfolios
Director of BTG International
PLC (a global technology
commercialisation company)
since 2001; Director of the
Michael J. Fox Foundation for
Parkinson's Research.
----------
* The address of each non-interested Director is P.O. Box 9095, Princeton,
New Jersey 08543-9095.
** Each Director serves until his or her successor is elected and qualified,
until December 31 of the year in which he or she turns 72, or until his or
her death, resignation, or removal as provided in the Fund's By-laws,
Charter or by statute.
36
Certain biographical and other information relating to the Director who is
an "interested person" of the Fund as defined in the 1940 Act (the "interested
Director") and the other officers of the Fund is set forth below, including
their ages, their principal occupations for at least the last five years, the
length of time served, the total number of portfolios overseen in
FAM/MLIM-advised funds and public directorships held.
Number of
Term of FAM/MLIM-
Position(s) Office+ and Advised Funds
Held with Length of Principal Occupation(s) and Portfolios Public
Name, Address* and Age the Fund Time Served During Past Five Years Overseen Directorships
---------------------- --------- ------------ ---------------------- -------------- -------------
Terry K. Glenn++ (62) President and President and President and Chairman of the 114 registered None
Director Director+++ MLIM/FAM-advised funds since investment
since 2003 1999; Chairman (Americas companies
Region) of MLIM from 2000 to consisting of
2002; Executive Vice President 159 portfolios
of MLIM and the Investment
Adviser (which terms
as used herein, include their
corporate predecessors) from
1983 to 2002; President of FAM
Distributors, Inc. ("FAMD" or
the "Distributor") from 1986
to 2002 and Director thereof
from 1991 to 2002; Executive
Vice President and Director of
Princeton Services, Inc.
("Princeton Services") from
1993 to 2002; President of
Princeton Administrators, L.P.
from 1988 to 2002; Director of
Financial Data Services, Inc.
from 1985 to 2002.
Donald C. Burke (43) Vice President Vice President First Vice President of MLIM 113 registered None
and Treasurer since and since 1997 and the Treasurer investment
Treasurer since thereof since 1999; Senior companies
2003 Vice President and Treasurer consisting of
of Princeton Services since 158 portfolios
1999; Vice President of FAMD
since 1999; Vice President of
MLIM and the Investment Adviser
from 1990 to 1997; Director of
Taxation of MLIM since 1990.
Robert A. DiMella, CFA Vice President Vice President Vice President of MLIM since 5 registered None
(36) and Portfolio since 2003 1997; Assistant Vice President investment
Manager of MLIM from 1995 to 1997; companies
Assistant Portfolio Investment consisting of
Adviser of MLIM from 1993 to 5 portfolios
1995.
Brian D. Stewart Secretary Secretary Vice President of MLIM since 37 registered None
(34) since 2003 2002; Attorney associated with investment
Reed Smith LLP from 2001 to companies
2002; Attorney associated with consisting of
Saul Ewing LLP from 1999 to 51 portfolios
2001.
(footnotes on next page)
37
(footnotes from previous page)
----------
* The address of each officer is P.O. Box 9011, Princeton, New Jersey
08543-9011.
+ Elected by and serves at the pleasure of the Board of Directors of the
Fund.
++ Mr. Glenn is a director, trustee or member of an advisory board of certain
other investment companies for which MLIM or FAM acts as investment
adviser. Mr. Glenn is an "interested person," as defined in the 1940 Act,
of the Fund based on his former positions with the Investment Adviser,
MLIM, FAMD, Princeton Services and Princeton Administrators, L.P.
+++ As Director, Mr. Glenn serves until his successor is elected and
qualified, until December 31 of the year in which he turns 72, or until
his death, resignation, or removal as provided in the Fund's By-laws,
Charter or by statute.
In the event that the Fund issues preferred stock, holders of shares of
preferred stock, voting as a separate class, will be entitled to elect two of
the Fund's Directors, and the remaining Directors will be elected by all holders
of capital stock, voting as a single class. See "Description of Capital Stock."
Share Ownership
Information relating to each Director's share ownership in the Fund and in
all registered funds in the Merrill Lynch family of funds that are overseen by
the respective Director ("Supervised Merrill Lynch Funds") as of December 31,
2002 is set forth in the chart below.
Aggregate Dollar Range
Aggregate Dollar Range of Securities in Supervised
Name of Equity in the Fund Merrill Lynch Funds*
---- ---------------------- ---------------------------
Interested Directors:
Terry K. Glenn ............................ None Over $100,000
Non-interested Directors:
Donald W. Burton .......................... None Over $100,000
M. Colyer Crum ............................ None Over $100,000
Laurie Simon Hodrick ...................... None Over $100,000
Fred G. Weiss ............................. None Over $100,000
----------
* For the number of FAM/MLIM-advised funds from which each Director receives
compensation, see the table above under "Directors and Officers --
Biographical Information."
As of the date of this prospectus, the Investment Adviser owned all of the
outstanding shares of common stock of the Fund; none of the Directors and
officers of the Fund owned outstanding shares of the Fund. As of the date of
this prospectus, none of the non-interested Directors of the Fund nor any of
their immediate family members owned beneficially or of record any securities in
ML & Co..
Compensation of Directors
Pursuant to its investment advisory agreement with the Fund (the
"Investment Advisory Agreement"), the Investment Adviser pays all compensation
of officers and employees of the Fund as well as the fees of all Directors of
the Fund who are affiliated persons of ML & Co. or its subsidiaries as well as
such Directors' actual out-of-pocket expenses relating to attendance at
meetings.
38
The Fund pays each non-interested Director a combined fee for services on
the Board and the Committee of $3,000 per year, $500 per in person Board meeting
attended and $500 per in person committee meeting attended. The Fund pays the
Chairman of the Committee an additional fee of $1,000 per year. The Fund
reimburses each non-interested Director for his or her out-of-pocket expenses
relating to attendance at Board and Committee meetings.
The following table sets forth the estimated compensation to be paid by
the Fund to the non-interested Directors projected through the end of the Fund's
first full fiscal year and the aggregate compensation paid to them from all
registered FAM/MLIM-advised funds for the calendar year ended December 31, 2002.
Pension or Aggregate
Retirement Compensation
Benefits Estimated From Fund
Accrued Annual and other
Position Compensation as Part of Benefits Upon FAM/MLIM-
Name of Director with Fund from Fund Fund Expense Retirement Advised Funds
---------------- --------- ------------ ------------ ------------- -------------
Donald W. Burton* Director $7,000 None None $189,042
M. Colyer Crum Director $8,000 None None $226,583
Laurie Simon Hodrick Director $7,000 None None $208,917
Fred G. Weiss Director $7,000 None None $208,917
----------
* Chairman of the Committee.
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser, which is owned and controlled by ML & Co., a
financial services holding company and the parent of Merrill Lynch, provides the
Fund with investment advisory and administrative services. The Investment
Adviser acts as the investment adviser to more than 100 registered investment
companies and offers investment advisory services to individuals and
institutional accounts. As of April 2003, the Investment Adviser and its
affiliates, including MLIM, had a total of approximately $449 billion in
investment company and other portfolio assets under management, including
approximately $257 billion in fixed income assets. This amount includes assets
managed by certain affiliates of the Investment Adviser. The Investment Adviser
is a limited partnership, the partners of which are ML & Co. and Princeton
Services. The principal business address of the Investment Adviser is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement provides that, subject to the direction
of the Fund's Board of Directors, the Investment Adviser is responsible for the
actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.
The Fund's portfolio manager will consider analyses from various sources,
make the necessary investment decisions, and place orders for transactions
accordingly. The Investment Adviser will also be responsible for the performance
of certain management services for the Fund. The Fund will be managed by a team
of investment professionals from the Investment Adviser. The portfolio manager
primarily responsible for the Fund's day-to-day management is Robert A. DiMella,
CFA.
Robert DiMella is a Vice President of MLIM since 1997 and has 13 years of
experience investing in Municipal Bonds.
39
For its services, the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.55% of the Fund's average daily net assets plus the
proceeds of any outstanding borrowings used for leverage ("average daily net
assets" means the average daily value of the total assets of the Fund, including
the amount obtained from leverage and any proceeds from the issuance of
preferred stock, minus the sum of (i) accrued liabilities of the Fund, (ii) any
accrued and unpaid interest on outstanding borrowings and (iii) accumulated
dividends on shares of preferred stock). For purposes of this calculation,
average daily net assets is determined at the end of each month on the basis of
the average net assets of the Fund for each day during the month. It is
understood that the liquidation preference of any outstanding preferred stock
(other than accumulated dividends) is not considered a liability in determining
the Fund's average daily net assets.
The Investment Adviser has contractually agreed to waive a portion of its
fee during the first seven years of the Fund's operations ending July , 2010,
as follows:
Fee Waiver (as a percentage
of average daily net assets)
----------------------------
Years 1 through 5 ..................... 0.15%
Year 6 ................................ 0.10%
Year 7 ................................ 0.05%
The Investment Adviser has not agreed to waive any of its fee beyond
July , 2010.
The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and furnish
office space for officers and employees of the Fund connected with investment
and economic research, trading and investment management of the Fund, as well as
the compensation of all Directors of the Fund who are affiliated persons of the
Investment Adviser or any of its affiliates. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of preparing, printing and mailing
proxies, listing fees, stock certificates and stockholder reports, charges of
the custodian and the transfer agent, dividend disbursing agent and registrar,
Commission fees, fees and expenses of non-interested Directors, accounting and
pricing costs, insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, mailing and other expenses properly
payable by the Fund. Certain accounting services are provided to the Fund by
State Street and Trust Company ("State Street") pursuant to an agreement between
State Street and the Fund. The Fund will pay the costs of these services. In
addition, the Fund will reimburse the Investment Adviser for certain additional
accounting services.
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940 Act)
of any such party. Such contract is not assignable and may be terminated without
penalty on 60 days' written notice at the option of either party thereto or by
the vote of the stockholders of the Fund.
In connection with the Board of Director's consideration of the Investment
Advisory Agreement, the Board reviewed information derived from a number of
sources and covering a range of issues relating to, among other things,
alternatives to the Investment Advisory Agreement. The Board of Directors
considered the services to be provided to the Fund by the Investment Adviser
under the Investment Advisory Agreement, as well as other services to be
provided by the Investment Adviser and its affiliates under other agreements,
and the personnel who will provide these services. In addition to the investment
advisory services to be provided to the Fund, the Investment Adviser and its
affiliates will provide administrative services, stockholder services, oversight
of fund accounting,
40
assistance in meeting legal and regulatory requirements, and other services
necessary for the operation of the Fund. The Fund's Board of Directors also
considered the direct and indirect benefits to the Investment Adviser from its
relationship with the Fund. The benefits considered by the Board of Directors
included not only the Investment Adviser's compensation for investment advisory
services, but also compensation paid to the Investment Adviser or its affiliates
for other non-advisory services provided to the Fund. The Board of Directors
concluded that the advisory fee was reasonable in relation to the services to be
provided by the Investment Adviser to the Fund as well as the anticipated costs
and benefits to be gained by the Investment Adviser in providing such services.
In reaching its conclusion, the Board of Directors focused on the
experience, resources and strengths of the Investment Adviser and its affiliates
in managing leveraged, closed-end investment companies that invest in Municipal
Bonds. The Board of Directors, based on their experience as directors of other
investment companies managed by the Investment Adviser and its affiliates, also
focused on the quality of the compliance and administrative staff at the
Investment Adviser. In connection with its consideration of the Investment
Advisory Agreement, the Board of Directors placed significant emphasis on the
Fund's advisory fee rate and anticipated expense ratios as compared to those of
comparable leveraged, closed-end funds managed by other investment advisers
("comparable funds") investing in Municipal Bonds and similar instruments as
provided by Lipper Inc. In particular, the Board of Directors reviewed the
advisory fee rate of eleven comparable leveraged, closed-end funds with
substantially similar investment objectives and policies. The Board of Directors
noted that the Fund has the lowest contractual advisory fee rate at the
estimated asset level for the Fund's among the comparable funds. Based in part
on this fee comparison, and taking into account the quality of the various
services to be provided to the Fund by the Investment Adviser and its affiliates
discussed above, the Investment Adviser's experience in managing Municipal
Bonds, and the Board of Directors' experience with the nature and quality of
portfolio management, administrative and compliance services provided by the
Investment Adviser to other investment companies, the Fund's Board of Directors
concluded that the advisory fee rate was reasonable. The Board of Directors
considered whether there should be changes in the advisory fee rate or structure
in order to enable the Fund to participate in any economies of scale that the
Investment Adviser may experience as a result of growth in the Fund's assets.
The Fund's Board of Directors also reviewed materials supplied by counsel that
were prepared for use by the Board of Directors in fulfilling its duties under
the 1940 Act.
Based on the information reviewed and the discussions, the Board of
Directors, including a majority of the non-interested Directors, concluded that
it was satisfied with the nature and quality of the services to be provided by
the Investment Adviser to the Fund and that the advisory fee rate was reasonable
in relation to such services. The non-interested Directors were represented by
independent counsel who assisted them in their deliberations.
Code of Ethics
The Fund's Board of Directors approved a Code of Ethics under Rule 17j-1
of the 1940 Act that covers the Fund and the Investment Adviser. The Code of
Ethics establishes procedures for personal investing and restricts certain
transactions. Employees subject to the Code of Ethics may invest in securities
for their personal investment accounts, including securities that may be
purchased or held by the Fund.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any dealer or group of dealers in the execution of transactions in
portfolio securities of the Fund. Where possible, the Fund deals directly with
the dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Fund to obtain the best results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread or commission), the size, type and difficulty of
the transaction involved,
41
the firm's general execution and operations facilities and the firm's risk in
positioning the securities involved. The cost of portfolio securities
transactions of the Fund primarily consists of dealer or underwriter spreads and
brokerage commissions. While reasonable competitive spreads or commissions are
sought, the Fund will not necessarily be paying the lowest spread or commission
available on any particular transaction.
Subject to obtaining the best net results, dealers who provide
supplemental investment research (such as quantitative and modeling information
assessments and statistical data and provide other similar services) to the
Investment Adviser may receive orders for transactions by the Fund. Information
so received will be in addition to and not in lieu of the services required to
be performed by the Investment Adviser under the Investment Advisory Agreement
and the expense of the Investment Adviser will not necessarily be reduced as a
result of the receipt of such supplemental information. Supplemental investment
research obtained from such dealers might be used by the Investment Adviser in
servicing all of its accounts and such research might not be used by the
Investment Adviser in connection with the Fund.
The Fund invests in securities traded in the over-the-counter markets, and
the Fund intends to deal directly with dealers who make markets in the
securities involved, except in those circumstances where better execution is
available elsewhere. Under the 1940 Act, except as permitted by exemptive order,
persons affiliated with the Fund, including Merrill Lynch, are prohibited from
dealing with the Fund as principal in the purchase and sale of securities. Since
transactions in the over-the-counter market usually involve transactions with
dealers acting as principals for their own accounts, the Fund does not deal with
Merrill Lynch and its affiliates in connection with such principal transactions
except that, pursuant to exemptive orders obtained by the Investment Adviser,
the Fund may engage in principal transactions with Merrill Lynch in high
quality, short term, tax exempt securities. See "Investment Restrictions."
However, affiliated persons of the Fund, including Merrill Lynch, may serve as
its brokers in certain over-the-counter transactions conducted on an agency
basis. In addition, the Fund has received an exemptive order, under which it may
purchase investment grade Municipal Bonds through group orders from an
underwriting syndicate of which Merrill Lynch is a member subject to conditions
set forth in such order (the "Group Order Exemptive Order"). A group order is an
order for securities held in an underwriting syndicate for the account of all
members of the syndicate, and in proportion to their respective participation in
the syndicate.
The Fund also may purchase tax exempt debt instruments in individually
negotiated transactions with the issuers. Because an active trading market may
not exist for such securities, the prices that the Fund may pay for these
securities or receive on their resale may be lower than that for similar
securities with a more liquid market.
Certain court decisions have raised questions as to the extent to which
investment companies should seek exemptions under the 1940 Act in order to seek
to recapture underwriting and dealer spreads from affiliated entities. The
Fund's Board of Directors has considered all factors deemed relevant and has
made a determination not to seek such recapture at this time. The Board of
Directors will reconsider this matter from time to time.
The Fund has received an exemptive order from the Commission permitting it
to lend portfolio securities to Merrill Lynch or its affiliates. Pursuant to
that order, the Fund also has retained an affiliated entity of the Investment
Adviser as the securities lending agent for a fee, including a fee based on a
share of the returns on investment of cash collateral. That entity may, on
behalf of the Fund, invest cash collateral received by the Fund for such loans,
among other things, in a private investment company managed by that entity or in
registered money market funds advised by the Investment Adviser or its
affiliates.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
investment objectives or other factors, a particular security may be bought for
an advisory client when
42
other clients are selling the same security. If purchases or sales of securities
by the Investment Adviser for the Fund or other funds for which it acts as
investment adviser or for other advisory clients arise for consideration at or
about the same time, transactions in such securities will be made, insofar as
feasible, for the respective funds and clients in a manner deemed equitable to
all. Transactions effected by the Investment Adviser (or its affiliates) on
behalf of more than one of its clients during the same period may increase the
demand for securities being purchased or the supply of securities being sold,
causing an adverse effect on price.
Section 11(a) of the Securities Exchange Act of 1934 generally prohibits
members of the U.S. national securities exchanges from executing exchange
transactions for their affiliates and institutional accounts that they manage
unless the member (i) has obtained prior express authorization from the account
to effect such transactions, (ii) at least annually furnishes the account with a
statement setting forth the aggregate compensation received by the member in
effecting such transactions, and (iii) complies with any rules the Commission
has prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch acting as a broker for the
Fund in any of its portfolio transactions executed on any such securities
exchange of which it is a member, appropriate consents have been obtained from
the Fund and annual statements as to aggregate compensation will be provided to
the Fund.
Portfolio Turnover
Generally, the Fund does not purchase securities for short term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such actions, for defensive or other reasons, appear
advisable to the Investment Adviser. While it is not possible to predict
turnover rates with any certainty, at present it is anticipated that the Fund's
annual portfolio turnover rate, under normal circumstances, should be less than
100%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded.) A high portfolio turnover rate results in greater transaction costs,
which are borne directly by the Fund and also has certain tax consequences for
stockholders.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute dividends from its net investment income
monthly to holders of common stock. It is expected that the Fund will commence
paying dividends to holders of common stock within approximately 90 days of the
date of this prospectus. From and after issuance of the preferred stock, monthly
dividends to holders of common stock normally will consist of net investment
income remaining after the payment of dividends (and any Additional
Distributions) on the preferred stock. The Fund currently intends either to pay
out less than the entire amount of net investment income earned in any
particular period or pay out such accumulated undistributed income in addition
to net investment income earned in other periods in order to permit the Fund to
maintain a more stable level of dividend distributions. As a result, the
dividend paid by the Fund to holders of common stock for any particular period
may be more or less than the amount of net investment income earned by the Fund
during such period. The Fund is not required to attempt to maintain a more
stable level of distributions to stockholders and may choose not to do so. For
Federal tax purposes, the Fund is required to distribute substantially all of
its net investment income for each calendar year. All net realized capital
gains, if any, will be distributed pro rata at least annually to holders of
common stock and any preferred stock. While any shares of preferred stock are
outstanding, the Fund may not declare any cash dividend or other distribution on
its
43
common stock, unless at the time of such declaration, (i) all accumulated
preferred stock dividends, including any Additional Distribution, have been
paid, and (ii) the net asset value of the Fund's portfolio (determined after
deducting the amount of such dividend or other distribution) is at least 200% of
the liquidation value of the outstanding preferred stock (expected to equal the
original purchase price of the outstanding shares of preferred stock plus any
accumulated and unpaid dividends thereon and any accumulated but unpaid
Additional Distribution). If the Fund's ability to make distributions on its
common stock is limited, such limitation could under certain circumstances
impair the ability of the Fund to maintain its qualification for taxation as a
regulated investment company, which would have adverse tax consequences for
stockholders. See "Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of common stock may be
automatically reinvested in shares of common stock of the Fund. Dividends and
distributions may be taxable to stockholders under certain circumstances as
discussed below, whether they are reinvested in shares of the Fund or received
in cash.
The yield on the Fund's common stock will vary from period to period
depending on factors including, but not limited to, the length of the initial
investment period, market conditions, the ability of the issuer of the portfolio
securities to pay interest on such securities, the timing of the Fund's
investment in portfolio securities, the securities comprising the Fund's
portfolio, changes in tax exempt interest rates (which may not change to the
same extent or in the same direction as taxable rates) including changes in the
relationship between short term rates and long term rates, the amount and timing
of the issuance of the Fund's preferred stock, the effects of preferred stock
leverage on the common stock discussed above under "Risks and Special
Considerations of Leverage," the timing of the investment of preferred stock
proceeds in portfolio securities, the Fund's net assets and its operating
expenses. Consequently, the Fund cannot guarantee any particular yield on its
shares and the yield for any given period is not an indication or representation
of future yields on Fund shares.
TAXES
General
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. As long as it
so qualifies, in any taxable year in which it distributes at least 90% of its
taxable net income and 90% of its tax exempt net income (see below), the Fund
(but not its stockholders) will not be subject to Federal income tax to the
extent that it distributes its net investment income and net realized capital
gains. The Fund intends to distribute substantially all of such income.
The Code requires a regulated investment company ("RIC") to pay a
nondeductible 4% excise tax to the extent the RIC does not distribute, during
each calendar year, 98% of its ordinary income, determined on a calendar year
basis, and 98% of its capital gains, determined, in general, on an October 31
year-end, plus certain undistributed amounts from previous years. The required
distributions, however, are based only on the taxable income of a RIC. The
excise tax, therefore, generally will not apply to the tax exempt income of a
RIC, such as the Fund, that pays exempt-interest dividends.
The Fund intends to qualify to pay "exempt-interest dividends" as defined
in Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations the interest on which is excludable from gross income
for Federal income tax purposes ("tax exempt obligations") under Section 103(a)
of the Code (relating generally to obligations of a state or local governmental
unit), the Fund shall be qualified to pay exempt-interest dividends to its
stockholders. Exempt-
44
interest dividends are dividends or any part thereof paid by the Fund that are
attributable to interest on tax exempt obligations and designated by the Fund as
exempt-interest dividends in a written notice mailed to the Fund's stockholders
within 60 days after the close of its taxable year. To the extent that the
dividends distributed to the Fund's stockholders are derived from interest
income excludable from gross income for Federal income tax purposes under Code
Section 103(a) and are properly designated as exempt-interest dividends, they
will be excludable from a stockholder's gross income for Federal income tax
purposes. Exempt-interest dividends are included, however, in determining the
portion, if any, of a person's social security and railroad retirement benefits
subject to Federal income taxes. Each stockholder is advised to consult a tax
adviser with respect to whether exempt-interest dividends retain the exclusion
under Code Section 103(a) if such stockholder would be treated as a "substantial
user" or "related person" under Code Section 147(a) with respect to property
financed with the proceeds of an issue of PABs or IDBs, if any, held by the
Fund.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short term capital gains over
net long term capital losses ("ordinary income dividends"), such distributions
are considered taxable ordinary income for Federal income tax purposes.
Distributions, if any, from an excess of net long term capital gains over net
short term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long term capital gains for Federal income tax purposes, regardless of the
length of time the stockholder has owned Fund shares. Generally not later than
60 days after the close of its taxable year, the Fund will provide its
stockholders with a written notice designating the amounts of any
exempt-interest dividends and capital gain dividends. Distributions by the Fund,
whether from exempt-income, ordinary income or capital gains, are not eligible
for the dividends received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax
exempt obligations purchased at a market discount will be treated as ordinary
income rather than capital gain. This rule may increase the amount of ordinary
income dividends received by stockholders. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
The sale or exchange of common stock normally will result in capital gain or
loss to the holders of common stock who hold their shares as capital assets.
Generally, a shareholders' gain or loss will be long-term capital gain or loss
if the shares have been held for more than one year.
No loss will be allowed on the sale of common stock if the stockholder
purchases other common stock of the Fund (whether through reinvestment or
distributions or otherwise) or the stockholder acquires or enters into a
contract or an option to acquire shares that are substantially identical to
common stock of the Fund within a period of 61 days beginning 30 days before and
ending 30 days after such sale or exchange. If disallowed, the loss will be
reflected in an adjustment to the basis of the shares acquired. Any loss upon
the sale or exchange of Fund shares held for six months or less will be
disallowed to the extent of any exempt-interest dividends received by the
stockholder. In addition, any such loss that is not disallowed under the rule
stated above will be treated as long term capital loss to the extent of any
capital gain dividends received by the stockholder.
If you borrow money to buy the Fund's common stock, you may not be
permitted to deduct the interest on that loan. Under Federal income tax rules,
the Fund's common stock may be treated as having been bought with borrowed money
even if the purchase of the Fund's common stock cannot be traced directly to
borrowed money. Stockholders should consult their own tax advisers regarding the
impact of an investment in common stock upon the deductibility of interest
payable by the stockholder.
45
Prior to purchasing the Fund's common stock, an investor should carefully
consider the impact of dividends which are expected to be or have been declared,
but not paid. Any dividend declared shortly after a purchase of the Fund's
common stock prior to the record date will have the effect of reducing the per
share net asset value by the per share amount of the dividend. If the Fund pays
a dividend in January that was declared in the previous October, November or
December to stockholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its stockholders on December 31 of the year in which such
dividend was declared.
The Internal Revenue Service ("Service") has taken the position in a
revenue ruling that if a RIC has two or more classes of shares, it may designate
distributions made to each class in any year as consisting of no more than such
class's proportionate share of particular types of income, including
exempt-interest income and net long term capital gains. A class's proportionate
share of a particular type of income is determined according to the percentage
of total dividends paid by the RIC during such year that was paid to such class.
Consequently, when common stock and one or more series of preferred stock are
outstanding, the Fund intends to designate distributions made to the classes as
consisting of particular types of income in accordance with each class's
proportionate share of such income. Thus, the Fund will designate dividends paid
as exempt-interest dividends in a manner that allocates such dividends among the
holders of common stock and each series of preferred stock in proportion to the
total dividends paid to each class during the taxable year, or otherwise as
required by applicable law. Capital gain dividends will similarly be allocated
among the classes in proportion to the total dividends paid to each class during
the taxable year, or otherwise as required by applicable law. When capital gain
or other taxable income is allocated to holders of preferred stock pursuant to
the allocation rules described above, the terms of the preferred stock may
require the Fund to make an additional distribution to or otherwise compensate
such holders for the tax liability resulting from such allocation.
The Code subjects interest received on certain otherwise tax exempt
securities to a Federal alternative minimum tax. The Federal alternative minimum
tax applies to interest received on certain "private activity bonds" issued
after August 7, 1986. Private activity bonds are bonds that, although tax
exempt, are used for purposes other than those performed by governmental units
and that benefit non-governmental entities (e.g., bonds used for industrial
development or housing purposes). Income received on such bonds is classified as
an item of "tax preference" which could subject certain investors in such bonds,
including stockholders of the Fund, to an increased Federal alternative minimum
tax. The Fund intends to purchase such "private activity bonds" and will report
to stockholders within 60 days after calendar year-end the portion of its
dividends declared during the year that constitutes an item of tax preference
for Federal alternative minimum tax purposes. The Code further provides that
corporations are subject to a Federal alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax preferences
and the corporation's "adjusted current earnings," which more closely reflect a
corporation's economic income. Because an exempt-interest dividend paid by the
Fund will be included in adjusted current earnings, a corporate stockholder may
be required to pay a Federal alternative minimum tax on exempt-interest
dividends paid by the Fund.
The Fund may invest in instruments the return on which includes
nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such nontraditional
instruments could be recharacterized as taxable ordinary income.
The Fund may engage in interest rate swaps. The Federal income tax rules
governing the taxation of interest rate swaps are not entirely clear and may
require the Fund to treat payments received under such arrangements as ordinary
income and to amortize payments made under certain circumstances. Additionally,
46
because the treatment of swaps under the RIC qualification rules is not clear,
the Fund will monitor its activity in this regard in order to maintain its
qualification as a RIC. Because payments received by the Fund in connection with
swap transactions will be taxable rather than tax exempt, they may result in
increased taxable distributions to stockholders.
Certain transactions of the Fund are subject to complex Federal income tax
provisions that may, among other things, (a) affect the character of gains and
losses realized, (b) disallow, suspend or otherwise limit the allowance of
certain losses or deductions, and (c) accelerate the recognition of income.
Operation of these tax rules could, therefore, affect the character, amount and
timing of distributions and result in increased taxable distributions to
stockholders. Special tax rules also will require the Fund to mark to market
certain types of positions in its portfolio (i.e., treat them as sold on the
last day of the taxable year), and may result in the recognition of income
without a corresponding receipt of cash. The Fund intends to monitor its
transactions, make appropriate tax elections and make appropriate entries in its
books and records to lessen the effect of these tax rules and avoid any possible
disqualification for the special treatment afforded RICs under the Code.
If at any time when shares of preferred stock are outstanding the Fund
does not meet the asset coverage requirements of the 1940 Act, the Fund will be
required to suspend distributions to holders of common stock until the asset
coverage is restored. See "Dividends and Distributions." This may prevent the
Fund from distributing at least 90% of its net investment income and may,
therefore, jeopardize the Fund's qualification for taxation as a RIC. If the
Fund were to fail to qualify as a RIC, some or all of the distributions paid by
the Fund would be fully taxable for Federal income tax purposes. Upon any
failure to meet the asset coverage requirements of the 1940 Act, the Fund, in
its sole discretion, may redeem shares of preferred stock in order to maintain
or restore the requisite asset coverage and avoid the adverse consequences to
the Fund and its stockholders of failing to qualify as a RIC. There can be no
assurance, however, that any such action would achieve such objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund contemplates issuing may raise an
issue as to whether distributions on such preferred stock are "preferential"
under the Code and, therefore, not eligible for the dividends paid deduction.
The Fund intends to issue preferred stock that counsel advises will not result
in the payment of a preferential dividend. If the Fund ultimately relies solely
on a legal opinion when it issues such preferred stock, there is no assurance
that the Service would agree that dividends on the preferred stock are not
preferential. If the Service successfully disallowed the dividends paid
deduction for dividends on the preferred stock, the Fund could be disqualified
as a RIC. In this case, dividends paid by the Fund would not be exempt from
Federal income taxes. Additionally, the Fund would be subject to Federal income
tax including the Federal alternative minimum tax.
The value of shares acquired pursuant to the Fund's dividend reinvestment
plan will generally be excluded from gross income to the extent that the cash
amount reinvested would be excluded from gross income. If, when the Fund's
shares are trading at a premium over net asset value, the Fund issues shares
pursuant to the dividend reinvestment plan that have a greater fair market value
than the amount of cash reinvested, it is possible that all or a portion of such
discount (which may not exceed 5% of the fair market value of the Fund's shares)
could be viewed as a taxable distribution. If the discount is viewed as a
taxable distribution, it is also possible that the taxable character of this
discount would be allocable to all of the stockholders, including stockholders
who do not participate in the dividend reinvestment plan. Thus, stockholders who
do not participate in the dividend reinvestment plan, as well as dividend
reinvestment plan participants, might be required to report as ordinary income a
portion of their distributions equal to their allocable share of the discount.
47
Under certain Code provisions, some taxpayers may be subject to a
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
stockholders subject to backup withholding are those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Fund is generally not an appropriate investment for retirement plans,
other entities that are not subject to tax and foreign stockholders.
----------
State and Local Taxes
The exemption from Federal income tax for exempt-interest dividends does
not necessarily result in an exemption for such dividends under the income or
other tax laws of any state or local taxing authority. Stockholders are advised
to consult their own tax advisers concerning state and local matters.
In some states, the portion of any exempt-interest dividend that is
derived from interest received by a RIC on its holdings of that state's
securities and its political subdivisions and instrumentalities is exempt from
that state's income tax. Therefore, the Fund will report annually to its
stockholders the percentage of interest income earned by the Fund during the
preceding year on tax-exempt obligations indicating, on a state-by-state basis,
the source of such income.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Stockholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the "Plan"),
unless a stockholder is ineligible or elects otherwise, all dividend and capital
gains distributions are automatically reinvested by EquiServe, L.P.
("EquiServe"), as agent for stockholders in administering the Plan (the "Plan
Agent"), in additional shares of common stock of the Fund. Stockholders whose
shares are held in the name of a broker or nominee should contact such broker or
nominee to confirm that they are eligible to participate in the Plan.
Stockholders who are ineligible or who elect not to participate in the Plan will
receive all dividends and distributions in cash paid by check mailed directly to
the stockholder of record (or, if the shares are held in street or other nominee
name, then to such nominee) by EquiServe, as dividend paying agent. Such
stockholders may elect not to participate in the Plan and to receive all
distributions of dividends and capital gains in cash by sending written
instructions to EquiServe, as dividend paying agent, at the address set forth
below. Participation in the Plan is completely voluntary and may be terminated
or resumed at any time without penalty by written notice if received by the Plan
Agent not less than ten days prior to any dividend record date; otherwise, such
termination will be effective with respect to any subsequently declared dividend
or capital gains distribution.
48
Whenever the Fund declares an ordinary income dividend or a capital gain
dividend (collectively referred to as "dividends") payable either in shares or
in cash, non-participants in the Plan will receive cash, and participants in the
Plan will receive the equivalent in shares of common stock. The shares are
acquired by the Plan Agent for the participant's account, depending upon the
circumstances described below, either (i) through receipt of additional unissued
but authorized shares of common stock from the Fund ("newly issued shares") or
(ii) by purchase of outstanding shares of common stock on the open market
("open-market purchases") on the NYSE or elsewhere. If, on the dividend payment
date, the net asset value per share of the common stock is equal to or less than
the market price per share of the common stock plus estimated brokerage
commissions (such condition being referred to herein as "market premium"), the
Plan Agent will invest the dividend amount in newly issued shares on behalf of
the participant. The number of newly issued shares of common stock to be
credited to the participant's account will be determined by dividing the dollar
amount of the dividend by the net asset value per share on the date the shares
are issued, provided that the maximum discount from the then current market
price per share on the date of issuance may not exceed 5%. If on the dividend
payment date the net asset value per share is greater than the market value
(such condition being referred to herein as "market discount"), the Plan Agent
will invest the dividend amount in shares acquired on behalf of the participant
in open-market purchases.
In the event of a market discount on the dividend payment date, the Plan
Agent has until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase date") to invest the dividend amount
in shares acquired in open-market purchases. It is contemplated that the Fund
will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date on the
dividend through the date before the next "ex-dividend" date, which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of common stock exceeds the
net asset value per share, the average per share purchase price paid by the Plan
Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisition of fewer shares than if the dividend had been paid in newly issued
shares on the dividend payment date. Because of the foregoing difficulty with
respect to open-market purchases, the Plan provides that if the Plan Agent is
unable to invest the full dividend amount in open-market purchases during the
purchase period or if the market discount shifts to a market premium during the
purchase period, the Plan Agent will cease making open-market purchases and will
invest the uninvested portion of the dividend amount in newly issued shares at
the close of business on the last purchase date.
The Plan Agent maintains all stockholders' accounts in the Plan and
furnishes written confirmation of all transactions in the account, including
information needed by stockholders for tax records. Shares in the account of
each Plan participant will be held by the Plan Agent in non-certificated form in
the name of the participant, and each stockholder's proxy will include those
shares purchased or received pursuant to the Plan. The Plan Agent will forward
all proxy solicitation materials to participants and vote proxies for shares
held pursuant to the Plan in accordance with the instructions of the
participants.
In the case of stockholders such as banks, brokers or nominees which hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by the
record stockholders as representing the total amount registered in the record
stockholder's name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued directly
by the Fund as a result of dividends or capital gains distributions payable
either in shares or in cash. However, each participant will pay a pro rata share
of brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.
49
The automatic reinvestment of dividends and distributions will not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. See "Taxes."
Stockholders participating in the Plan may receive benefits not available
to stockholders not participating in the Plan. If the market price plus
commissions of the Fund's shares is higher than the net asset value,
participants in the Plan will receive shares of the Fund at less than they could
otherwise purchase them and will have shares with a cash value greater than the
value of any cash distribution they would have received on their shares. If the
market price plus commissions is below the net asset value, participants receive
distributions of shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem its
shares, the price on resale may be more or less than the net asset value.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan. There
is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by the
participants.
All correspondence concerning the Plan should be directed to the Plan
Agent at 150 Royall Street, Canton, Massachusetts 02021.
MUTUAL FUND INVESTMENT OPTION
Purchasers of shares of common stock of the Fund in this offering will
have an investment option consisting of the right to reinvest the net proceeds
from a sale of such shares (the "Original Shares") in Class A initial sales
charge shares of certain FAM/MLIM advised open-end mutual funds ("Eligible Class
A Shares") at their net asset value, without the imposition of the initial sales
charge, if the conditions set forth below are satisfied. First, the sale of Fund
shares must be made through Merrill Lynch or another broker-dealer or other
financial intermediary ("Selected Dealer") that maintains an arrangement with
the open-end fund's distributor for the purchase of the eligible Class A Shares,
and the net proceeds therefrom must be immediately reinvested in Eligible Class
A Shares. Second, the Fund shares must either have been acquired in the Fund's
initial public offering or represent dividends paid on shares of common stock
acquired in such offering. Third, the Fund shares must have been continuously
maintained in a securities account held at Merrill Lynch or another Selected
Dealer. Fourth, there must be a minimum purchase of $250 to be eligible for the
investment option. The Eligible Class A Shares may be redeemed at any time at
the next determined net asset value, subject in certain cases to a redemption
fee.
NET ASSET VALUE
Net asset value per share of common stock is determined Monday through
Friday as of the close of business on the NYSE (generally, the NYSE closes at
4:00 p.m., Eastern time), on each business day during which the NYSE is open for
trading. For purposes of determining the net asset value of a share of common
stock, the value of the securities held by the Fund plus any cash or other
assets (including interest accrued but not yet received) minus all liabilities
(including accrued expenses) and the aggregate liquidation value of any
outstanding shares of preferred stock is divided by the total number of shares
of common stock outstanding at such time. Expenses, including the fees payable
to the Investment Adviser, are accrued daily.
The Municipal Bonds in which the Fund invests are traded primarily in the
over-the-counter markets. In determining net asset value, the Fund uses the
valuations of portfolio securities furnished by a pricing service approved by
the Board of Directors. The pricing service typically values portfolio
securities at the bid price or
50
the yield equivalent when quotations are readily available. Municipal Bonds for
which quotations are not readily available are valued at fair market value on a
consistent basis as determined by the pricing service using a matrix system to
determine valuations. The procedures of the pricing service and its valuations
are reviewed by the officers of the Fund under the general supervision of the
Board of Directors. The Board of Directors has determined in good faith that the
use of a pricing service is a fair method of determining the valuation of
portfolio securities. Positions in futures contracts and interest rate swaps are
valued at closing prices for such contracts established by the exchange or
dealer market on which they are traded, or if market quotations are not readily
available, are valued at fair value on a consistent basis using methods approved
in good faith by the Board of Directors.
The Fund makes available for publication the net asset value of its shares
of common stock determined as of the last business day each week. Currently, the
net asset values of shares of publicly traded closed-end investment companies
investing in debt securities are published in Barron's, the Monday edition of
The Wall Street Journal and the Monday and Saturday editions of The New York
Times.
The value of interest rate swaps, caps and floors is determined in
accordance with a formula and then confirmed periodically by obtaining a bank
quotation. Positions in options are valued at the last sale price on the market
where any such option is principally traded. Positions in futures contracts are
valued at closing prices for such contracts established by the exchange on which
they are traded. Obligations with remaining maturities of 60 days or less are
valued at amortized cost unless this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest.
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares initially are classified as common
stock. The Board of Directors is authorized, however, to classify and reclassify
any unissued shares of capital stock into one or more additional or other
classes or series as may be established from time to time by setting or changing
in any one or more respects the designations, preferences, conversion or other
rights, voting powers, restrictions, limitations as to dividends, qualifications
or terms or conditions of redemption of such shares of stock and pursuant to
such classification or reclassification to increase or decrease the number of
authorized shares of any existing class or series. The Fund may reclassify an
amount of unissued common stock as preferred stock and at that time offer shares
of preferred stock. See "Risks and Special Considerations of Leverage."
Common Stock
Shares of common stock, when issued and outstanding, will be fully paid
and non-assessable. Stockholders are entitled to share pro rata in the net
assets of the Fund available for distribution to stockholders upon liquidation
of the Fund. Stockholders are entitled to one vote for each share held.
In the event that the Fund issues preferred stock and so long as any
shares of the Fund's preferred stock are outstanding, holders of common stock
will not be entitled to receive any net income of or other distributions from
the Fund unless all accumulated dividends on preferred stock have been paid, and
unless asset coverage (as defined in the 1940 Act) with respect to preferred
stock would be at least 200% after giving effect to such distributions. See
"Risks and Special Considerations of Leverage."
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its stockholders.
51
The Investment Adviser provided the initial capital for the Fund by
purchasing shares of common stock of the Fund for $ . As of the date of this
prospectus, the Investment Adviser owned 100% of the outstanding shares of
common stock of the Fund. The Investment Adviser may be deemed to control the
Fund until such time as it owns less than 25% of the outstanding shares of the
Fund.
Preferred Stock
It is anticipated that the Fund's shares of preferred stock will be issued
in one or more series, with rights as determined by the Board of Directors, by
action of the Board of Directors without the approval of the holders of common
stock. Under the 1940 Act, the Fund is permitted to have outstanding more than
one series of preferred stock so long as no single series has a priority over
another series as to the distribution of assets of the Fund or the payment of
dividends. Holders of common stock have no preemptive right to purchase any
shares of preferred stock that might be issued. It is anticipated that the net
asset value per share of the preferred stock will equal its original purchase
price per share plus accumulated dividends per share.
The Fund's Board of Directors has declared its intention to authorize an
offering of shares of preferred stock (representing approximately 35% of the
Fund's capital immediately after the issuance of such preferred stock) within
approximately three months after completion of the offering of common stock,
subject to market conditions and to the Board's continuing to believe that
leveraging the Fund's capital structure through the issuance of preferred stock
is likely to achieve the benefits to the holders of common stock described in
the prospectus. Although the terms of the preferred stock, including its
dividend rate, voting rights, liquidation preference and redemption provisions
will be determined by the Board of Directors (subject to applicable law and the
Fund's Charter), the initial series of preferred stock will be structured to
carry either a relatively short term dividend rate, in which case periodic
redetermination of the dividend rate will be made at relatively short intervals
(generally 7 or 28 days), or a medium term dividend rate, in which case periodic
redetermination of the dividend rate will be made at intervals of up to five
years. In either case, such redetermination of the dividend rate will be made
through an auction or remarketing procedure. The Board also has indicated that
it is likely that the liquidation preference, voting rights and redemption
provisions of the preferred stock will be as stated below.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of shares of
preferred stock will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus an
amount equal to accumulated and unpaid dividends whether or not earned or
declared) before any distribution of assets is made to holders of common stock.
After payment of the full amount of the liquidating distribution to which they
are entitled, the preferred stockholders will not be entitled to any further
participation in any distribution of assets by the Fund. A consolidation or
merger of the Fund with or into any other corporation or corporations or a sale
of all or substantially all of the assets of the Fund will not be deemed to be a
liquidation, dissolution or winding up of the Fund.
Voting Rights. Except as otherwise indicated in this prospectus and except
as otherwise required by applicable law, holders of shares of preferred stock
will have equal voting rights with holders of shares of common stock (one vote
per share) and will vote together with holders of common stock as a single
class.
In connection with the election of the Fund's Directors, holders of shares
of preferred stock, voting as a separate class, will be entitled to elect two of
the Fund's Directors, and the remaining Directors will be elected by all holders
of capital stock, voting as a single class. So long as any preferred stock is
outstanding, the Fund will have not less than five Directors. If at any time
dividends on shares of the Fund's preferred stock shall be
52
unpaid in an amount equal to two full years' dividends thereon, the holders of
all outstanding shares of preferred stock, voting as a separate class, will be
entitled to elect a majority of the Fund's directors until all dividends in
default have been paid or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding
shares of the preferred stock, voting as a separate class, will be required to
(i) authorize, create or issue any class or series of stock ranking prior to any
series of preferred stock with respect to payment of dividends or the
distribution of assets on liquidation or (ii) amend, alter or repeal the
provisions of the Charter, whether by merger, consolidation or otherwise, so as
to adversely affect any of the contract rights expressly set forth in the
Charter of holders of preferred stock.
Redemption Provisions. It is anticipated that shares of preferred stock
will generally be redeemable at the option of the Fund at a price equal to their
liquidation preference plus accumulated but unpaid dividends to the date of
redemption plus, under certain circumstances, a redemption premium. Shares of
preferred stock will also be subject to mandatory redemption at a price equal to
their liquidation preference plus accumulated but unpaid dividends to the date
of redemption upon the occurrence of certain specified events, such as the
failure of the Fund to maintain asset coverage requirements for the preferred
stock specified by the rating agencies that issue ratings on the preferred
stock.
Certain Provisions of the Charter and By-laws
The Fund's Charter includes provisions that could have the effect of
limiting the ability of other entities or persons to acquire control of the Fund
or to change the composition of its Board of Directors and could have the effect
of depriving stockholders of an opportunity to sell their shares at a premium
over prevailing market prices by discouraging a third party from seeking to
obtain control of the Fund. A Director may be removed from office with or
without cause but only by vote of the holders of at least 66 2/3% of the shares
entitled to vote in an election to fill that directorship.
In addition, the Charter requires the favorable vote of the holders of at
least 66 2/3% of the Fund's shares to approve, adopt or authorize the following:
o a merger or consolidation or statutory share exchange of the Fund
with any other corporation;
o a sale of all or substantially all of the Fund's assets (other than
in the regular course of the Fund's investment activities); or
o a liquidation or dissolution of the Fund;
unless such action has been approved, adopted or authorized by the affirmative
vote of at least two-thirds of the total number of Directors fixed in accordance
with the By-laws, in which case the affirmative vote of a majority of the Fund's
shares of capital stock is required. Following any issuance of preferred stock
by the Fund, it is anticipated that the approval, adoption or authorization of
the foregoing also would require the favorable vote of a majority of the Fund's
shares of preferred stock then entitled to be voted, voting as a separate class.
In addition, conversion of the Fund to an open-end investment company
would require an amendment to the Fund's Charter. The amendment would have to be
declared advisable by the Board of Directors prior to its submission to
stockholders. Such an amendment would require the favorable vote of the holders
of at least 66 2/3% of the Fund's outstanding shares of capital stock (including
any preferred stock) entitled to be voted on the matter, voting as a single
class (or a majority of such shares if the amendment was previously approved,
adopted or authorized by two-thirds of the total number of Directors fixed in
accordance with the By-laws), and,
53
assuming preferred stock is issued, the affirmative vote of a majority of
outstanding shares of preferred stock of the Fund, voting as a separate class.
Such a vote also would satisfy a separate requirement in the 1940 Act that the
change be approved by the stockholders. Stockholders of an open-end investment
company may require the company to redeem their shares of common stock at any
time (except in certain circumstances as authorized by or under the 1940 Act) at
their net asset value, less such redemption charge, if any, as might be in
effect at the time of a redemption. All redemptions will be made in cash. If the
Fund is converted to an open-end investment company, it could be required to
liquidate portfolio securities to meet requests for redemption, and the common
stock would no longer be listed on a stock exchange.
Conversion to an open-end investment company would also require changes in
certain of the Fund's investment policies and restrictions, such as those
relating to the borrowing of money and the purchase of illiquid securities.
The Charter and By-laws provide that the Board of Directors has the power,
to the exclusion of stockholders, to make, alter or repeal any of the By-laws
(except for any By-law specified not to be amended or repealed by the Board),
subject to the requirements of the 1940 Act. Neither this provision of the
Charter, nor any of the foregoing provisions of the Charter requiring the
affirmative vote of 66 2/3% of shares of capital stock of the Fund, can be
amended or repealed except by the vote of such required number of shares.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of stockholders generally.
Reference should be made to the Charter on file with the Commission for the full
text of these provisions.
The Fund's By-laws generally require that advance notice be given to the
Fund in the event a stockholder desires to nominate a person for election to the
Board of Directors or to transact any other business at an annual meeting of
stockholders. With respect to an annual meeting following the first annual
meeting of stockholders, notice of any such nomination or business must be
delivered to or received at the principal executive offices of the Fund not less
than 60 calendar days nor more than 90 calendar days prior to the anniversary
date of the prior year's annual meeting (subject to certain exceptions). In the
case of the first annual meeting of stockholders, the notice must be given no
later than the tenth calendar day following the day upon which public disclosure
of the date of the meeting is first made. Any notice by a stockholder must be
accompanied by certain information as provided in the By-laws.
CUSTODIAN
The Fund's securities and cash are held under a custodian agreement with
State Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts
02110.
54
UNDERWRITING
The Fund intends to offer the shares through the underwriters. Merrill
Lynch, Pierce, Fenner & Smith Incorporated is acting as representative of the
underwriters named below. Subject to the terms and conditions contained in a
purchase agreement between the Fund and the Investment Adviser and the
underwriters, the Fund has agreed to sell to the underwriters, and each
underwriter listed below has severally has agreed to purchase from the Fund, the
number of shares listed opposite their names below.
Number of
Underwriter Shares
----------- ---------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated ..................................
---------
Total ................................................
=========
The underwriters have agreed to purchase all of the shares sold pursuant
to the purchase agreement if any of these shares are purchased. If an
underwriter defaults, the purchase agreement provides that the purchase
commitments of the nondefaulting underwriters may be increased or the purchase
agreement may be terminated.
The Fund and the Investment Adviser have agreed to indemnify the
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended, or to contribute to payments the
underwriters may be required to make in respect of those liabilities.
The underwriters are offering the shares, subject to prior sale, when, as
and if issued to and accepted by them, subject to approval of legal matters by
their counsel, including the validity of the shares, and other conditions
contained in the purchase agreement, such as the receipt by the underwriters of
officer's certificates and legal opinions. The underwriters reserve the right to
withdraw, cancel or modify offers to the public and to reject orders in whole or
in part.
Commissions and Discounts
The underwriters have advised the Fund that they propose initially to
offer the shares to the public at the initial public offering price on the cover
page of this prospectus and to dealers at that price less a concession not in
excess of $ per share. The underwriters may allow, and the dealers may reallow,
a discount not in excess of $ per share to other dealers. There is a sales
charge or underwriting discount of $.675 per share, which is equal to 4.5% of
the initial public offering price per share. After the initial public offering,
the public offering price, concession and discount may be changed. Investors
must pay for the shares of common stock purchased in the offering on or before
August , 2003.
55
The following table shows the public offering price, underwriting discount
and proceeds before expenses to the Fund. The information assumes either no
exercise or full exercise by the underwriters of their overallotment option.
Per Share Without Option With Option
--------- -------------- -----------
Public offering price ................... $ 15.00 $ $
Underwriting discount ................... $ .675 $ $
Proceeds, before expenses, to the Fund .. $14.325 $ $
The expenses of the offering, excluding underwriting discount, are
estimated at $ and are payable by the Fund. To the extent that the Fund's
offering costs do not exceed $.03 per share of common stock, the Fund has agreed
to pay the underwriters up to $.005 per share of common stock as a partial
reimbursement of expenses incurred in connection with the offering. However, in
no event will the Fund pay offering costs (other than the underwriting discount,
but including the partial reimbursement to the underwriters) in excess of $.03
per share of common stock. The Investment Adviser or an affiliate will pay the
amount by which the offering costs (other than the underwriting discount and the
up to $.005 per share partial reimbursement of expenses to the underwriters)
exceeds $.03 per share of common stock. The Investment Adviser has agreed to pay
all of the Fund's organizational expenses.
Overallotment Option
The Fund has granted the underwriters an option to purchase up to
additional shares at the public offering price less the underwriting
discount. The underwriters may exercise the option from time to time for 45 days
from the date of this prospectus solely to cover any overallotments. If the
underwriters exercise this option, each will be obligated, subject to conditions
contained in the purchase agreement, to purchase a number of additional shares
proportionate to that underwriter's initial amount reflected in the above table.
Price Stabilization, Short Positions and Penalty Bids
Until the distribution of the shares is completed, Commission rules may
limit the underwriters and selling group members from bidding for and purchasing
the Fund's shares. However, the representatives may engage in transactions that
stabilize the price of the shares, such as bids or purchases to peg, fix or
maintain that price.
If the underwriters create a short position in the shares in connection
with the offering, i.e., if they sell more shares than are listed on the cover
of this prospectus, the representative may reduce that short position by
purchasing shares in the open market. The representative also may elect to
reduce any short position by exercising all or part of the overallotment option
described above. Purchases of the shares to stabilize its price or to reduce a
short position may cause the price of the shares to be higher than it might be
in the absence of such purchases.
The representative also may impose a penalty bid on underwriters and
selling group members. This means that if the representative purchases shares in
the open market to reduce the underwriters' short position or to stabilize the
price of such shares, it may reclaim the amount of the selling concession from
the underwriters and selling group members who sold those shares. The imposition
of a penalty bid also may affect the price of the shares in that it discourages
resales of those shares.
Neither the Fund nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the shares. In addition, neither the
Fund nor any of the underwriters makes any representation that the
representative will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
56
Stock Exchange Listing
Prior to this offering, there has been no public market for the shares.
The Fund plans to apply to list its shares on the NYSE or another national
securities exchange under the symbol "MUI". However, during an initial period
that is not expected to exceed two weeks from the date of this prospectus, the
Fund's shares will not be listed on any securities exchange. Additionally,
before it begins trading, the underwriters do not intend to make a market in the
Fund's shares, although a limited market may develop. Thus, it is anticipated
that investors may not be able to buy and sell shares of the Fund during such
period. In order to meet the requirements for listing, the underwriters have
undertaken to sell lots of 100 or more shares to a minimum of 2,000 beneficial
owners.
Other Relationships
The Investment Adviser (and not the Fund) also has agreed to pay a fee to
Merrill Lynch quarterly at the annual rate of 0.10% of the Fund's average daily
net assets through July , 2008 and at the annual rate of 0.15% of the Fund's
average daily net assets thereafter during the continuance of the Investment
Advisory Agreement. The maximum amount of this fee, plus the partial
reimbursement of underwriting expenses discussed above, will not exceed 4.5% of
the aggregate initial offering price of the common stock offered hereby;
provided, that in determining when the maximum amount has been paid the value of
each of the quarterly payments shall be discounted at the annual rate of 10%
back to the closing date of this offering. Merrill Lynch has agreed to provide
certain after-market services to the Investment Adviser designed to maintain the
visibility of the Fund on an ongoing basis and to provide relevant information,
studies or reports regarding the Fund and the closed-end investment company
industry.
The Fund anticipates that Merrill Lynch and other underwriters may from
time to time act as brokers in connection with the execution of its portfolio
transactions, and after they have ceased to be underwriters, the Fund
anticipates that underwriters other than Merrill Lynch may from time to time act
as dealers in connection with the execution of portfolio transactions. See
"Portfolio Transactions." Merrill Lynch is an affiliate of the Investment
Adviser.
The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated is 4
World Financial Center, New York, New York 10080.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the shares
of common stock of the Fund is EquiServe, L.P., 150 Royall Street, Canton,
Massachusetts 02021.
ACCOUNTING SERVICES PROVIDER
State Street Bank and Trust Company, 500 College Road East, Princeton, New
Jersey 08540, provides certain accounting services for the Fund.
LEGAL OPINIONS
Certain legal matters in connection with the shares of common stock
offered hereby are passed on for the Fund by Sidley Austin Brown & Wood LLP, New
York, New York. Certain legal matters will be passed on for the underwriters by
Clifford Chance US LLP, New York, New York. Clifford Chance US LLP may rely on
the opinion of Sidley Austin Brown & Wood LLP as to certain matters of Maryland
law.
57
INDEPENDENT AUDITORS AND EXPERTS
, independent auditors, have audited the statement of assets
and liabilities of the Fund as of July , 2003 which is included in this
prospectus and Registration Statement. The statement of assets and liabilities
is included in reliance upon their report, which is also included in this
prospectus and in the Registration Statement, given on their authority as
experts in accounting and auditing.
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the 1940 Act and in accordance therewith is required to
file reports and other information with the Commission. Any such reports and
other information, including the Fund's Code of Ethics, can be inspected and
copied at the public reference facilities of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
following regional offices of the Commission: Pacific Regional Office, at 5670
Wilshire Boulevard, 11th Floor, Los Angeles, California 90036; and Midwest
Regional Office, at Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such materials can be obtained
from the public reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission maintains a Web site
at http://www.sec.gov containing reports and information statements and other
information regarding registrants, including the Fund, that file electronically
with the Commission. Reports, proxy statements and other information concerning
the Fund can also be inspected at the offices of the Exchange.
Additional information regarding the Fund is contained in the Registration
Statement on Form N-2, including amendments, exhibits and schedules thereto,
relating to such shares filed by the Fund with the Commission in Washington,
D.C. This prospectus does not contain all of the information set forth in the
Registration Statement, including any amendments, exhibits and schedules
thereto. For further information with respect to the Fund and the shares offered
hereby, reference is made to the Registration Statement. Statements contained in
this prospectus as to the contents of any contract or other document referred to
are not necessarily complete and in each instance reference is made to the copy
of such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. A copy of the Registration Statement may be inspected without charge
at the Commission's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the Commission upon the payment of certain
fees prescribed by the Commission.
58
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholder of
Muni Intermediate Duration Fund, Inc.:
We have audited the accompanying statement of assets and liabilities of
Muni Intermediate Duration Fund, Inc. as of July , 2003. This statement of
assets and liabilities is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this statement of assets and
liabilities based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statement of assets and liabilities is
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the statement of assets and
liabilities. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
statement of assets and liabilities presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of Muni
Intermediate Duration Fund, Inc. at July , 2003 in conformity with generally
accepted accounting principles.
July , 2003
59
MUNI INTERMEDIATE DURATION FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
July , 2003
ASSETS
Cash ........................................................................................ $
Offering costs (Note 1) .....................................................................
---------------
Total assets ..............................................................................
===============
LIABILITIES
Liabilities and accrued expenses (Note 1) ...................................................
---------------
NET ASSETS ..................................................................................... $
===============
NET ASSETS CONSIST OF:
Common Stock, par value $.10 per share; 200,000,000 shares
authorized; shares issued and outstanding (Note 1) .............................. $
Paid-in Capital in excess of par ............................................................
---------------
Total Capital-Equivalent to $ net asset value per share of
Common Stock (Note 1) ................................................................... $
===============
NOTES TO STATEMENT OF ASSETS AND LIABILITIES
Note 1. Organization
The Fund was incorporated under the laws of the State of Maryland on May
15, 2003 and is registered under the Investment Company Act of 1940 as a
closed-end, non-diversified management investment company and has had no
operations other than the sale to Fund Asset Management, L.P. (the "Investment
Adviser") of an aggregate of shares for $ on July , 2003. The General Partner
of the Investment Adviser is an indirect wholly-owned subsidiary of Merrill
Lynch & Co., Inc. Certain officers and/or directors of the Fund are officers of
the Investment Adviser.
The Investment Adviser, on behalf of the Fund, will incur organization
costs estimated at $ . In no event will the Fund pay offering costs (other than
the underwriting discount, but including the partial reimbursement to the
underwriters) in excess of $.03 per share of common stock. The Investment
Adviser or an affiliate will pay the amount by which the offering costs of the
Fund (other than the underwriting discount, and up to $.005 per share partial
reimbursement of expenses to the underwriters) exceeds $.03 per share of common
stock. Direct costs relating to the public offering of the Fund's shares will be
charged to capital at the time of issuance of shares.
Note 2. Investment Advisory Arrangements
The Fund has engaged the Investment Adviser to provide investment advisory
and management services to the Fund. The Investment Adviser will receive a
monthly fee for advisory and management services at an annual rate of 0.55% of
the Fund's average daily net assets (including any proceeds from the issuance of
preferred stock), plus the proceeds of any outstanding borrowings used for
leverage.
60
The Investment Adviser has contractually agreed to waive a portion of its
fee during the first five full year of operations at the annual rate of 0.15% of
the average daily net assets of the Fund and at a declining rate for an
additional two years. The Investment Adviser has not agreed to waive any portion
of its fee beyond the seven year period.
Note 3. Federal Income Taxes
The Fund intends to qualify as a "regulated investment company" and as
such (and by complying with the applicable provisions of the Internal Revenue
Code of 1986, as amended) will not be subject to Federal income tax on taxable
income (including realized capital gains) that is distributed to stockholders.
61
APPENDIX A
RATINGS OF MUNICIPAL BONDS
Description of Moody's Investors Service, Inc.'s ("Moody's") Municipal Bond
Ratings
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edged." Interest payments are protected by a
large or by an exceptionally stable margin and principal is secure.
While the various protective elements are likely to change, such
changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high-grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in
Aaa securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make
the long term risk in Aa-rated bonds appear somewhat larger than
those securities rated Aaa.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium-grade-obligations. Factors
giving security to principal and interest are considered adequate,
but elements may be present which suggest a susceptibility to
impairment some time in the future.
Baa Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the
present, but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the
protection of interest and principal payments may be very moderate,
and thereby not well safeguarded during both good and bad times over
the future. Uncertainty of position characterizes bonds in this
class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments
or of maintenance of other terms of the contract over any long
period of time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect
to principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects
of ever attaining any real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa1, A1, Baa1, Ba1 and B1.
A-1
Short term Notes: The three ratings of Moody's for short term notes are
MIG 1/VMIG 1, MIG 2/VMIG 2, and MIG 3/VMIG 3; MIG 1/VMIG 1 denotes "best
quality, enjoying strong protection from established cash flows"; MIG 2/VMIG 2
denotes "high quality" with "ample margins of protection"; MIG 3/VMIG 3
instruments are of "favorable quality . . . but . . . lacking the undeniable
strength of the preceding grades."
Description of Moody's Commercial Paper Ratings
Moody's Commercial Paper ratings are opinions of the ability of issuers to
honor senior financial obligations and contracts. Such obligations generally
have an original maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: leading market
positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
to repay senior short term debt obligations. This will normally be evidenced by
many of the characteristics cited above, but to a lesser degree. Earnings trends
and coverage ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short term promissory obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Description of Standard & Poor's, a Division of The McGraw-Hill Companies, Inc.
("Standard & Poor's"), Municipal Debt Ratings
A Standard & Poor's municipal debt rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations or a specific program. It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or based on circumstances.
The ratings are based, in varying degrees, on the following
considerations:
I. Likelihood of payment--capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
A-2
II. Nature of and provisions of the obligation;
III. Protection afforded to, and relative position of, the
obligation in the event of bankruptcy, reorganization or other arrangement under
the laws of bankruptcy and other laws affecting creditors' rights.
AAA An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial
commitment on the obligation is extremely strong.
AA An obligation rated "AA" differs from the highest rated issues only
in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
A An obligation rated "A" is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
debt in higher-rated categories. However, the obligor's capacity to
meet its financial commitment on the obligation is still strong.
BBB An obligation rated "BBB" exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet
its financial commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as
having significant speculative characteristics. "BB" indicates the
least degree of speculation and "C" the highest. While such debt
will likely have some quality and protective characteristics, these
may be outweighed by large uncertainties or major risk exposures to
adverse conditions.
BB An obligation rated "BB" is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions
which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
B An obligation rated "B" is more vulnerable to nonpayment than
obligations rated `BB', but the obligor currently has the capacity
to meet its financial commitment on the obligation. Adverse
business, financial, or economic conditions will likely impair the
obligor's capacity or willingness to meet its financial commitment
on the obligation.
CCC An obligation rated "CCC" is currently vulnerable to nonpayment, and
is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the
obligation. In the event of adverse business, financial, or economic
conditions, the obligor is not likely to have the capacity to meet
its financial commitment on the obligation.
CC An obligation rated "CC" is currently highly vulnerable to
nonpayment.
C A subordinated debt or preferred stock obligation rated "C" is
CURRENTLY HIGHLY VULNERABLE to nonpayment. The "C" rating may be
used to cover a situation where a bankruptcy petition has been filed
or similar action taken, but payments on this obligation are being
continued. A `C' also will be assigned to a preferred stock issue in
arrears on dividends or sinking fund payments, but that is currently
paying.
D An obligation rated "D" is in payment default. The "D" rating
category is used when payments on an obligation are not made on the
date due even if the applicable grace period has not expired,
unless Standard & Poor's believes that such payments will be made
during such grace period. The "D" rating also will be used upon the
filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
A-3
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
Description of Standard & Poor's Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from "A-1" for the
highest-quality obligations to "D" for the lowest. These categories are as
follows:
A-1 This designation indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign
(+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high
as for issues designated "A-1".
A-3 Issues carrying this designation have an adequate capacity for
timely payment. They are, however, more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the
higher designations.
B Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C This rating is assigned to short term debt obligations with a
doubtful capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is
used when interest payments of principal payments are not made on
the date due, even if the applicable grace period has not expired,
unless Standard & Poor's believes such payments will be made during
such grace period.
A commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's note rating reflects the liquidity factors and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three years will most likely
receive a long term debt rating. The following criteria will be used in making
that assessment.
--Amortization schedule--the larger the final maturity relative to
other maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market
for its refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined
to possess a very strong capacity to pay debt service is given a
plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the
term of the notes.
A-4
Description of Fitch Ratings' ("Fitch") Investment Grade Bond Ratings
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guarantees unless otherwise indicated.
Bonds carrying the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated "AAA."
Because bonds rated in the "AAA" and "AA" categories are not
significantly vulnerable to foreseeable future developments, short
term debt of these issuers is generally rated "F-1+."
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse
changes in economic conditions and circumstances than bonds with
higher ratings.
BBB Bonds considered to be investment grade and of satisfactory-credit
quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have adverse impact
on these bonds, and therefore impair timely payment. The likelihood
that the ratings of these bonds will fall below investment grade is
higher than for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
A-5
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as "Positive,"
indicating a potential upgrade, "Negative," for potential downgrade,
or "Evolving," where ratings may be raised or lowered. FitchAlert is
relatively short term, and should be resolved within 12 months.
Ratings Outlook: An outlook is used to describe the most likely direction
of any rating change over the intermediate term. It is described as "Positive"
or "Negative." The absence of a designation indicates a stable outlook.
Description of Fitch's Speculative Grade Bond Ratings
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives can
be identified which could assist the obligor in satisfying its debt
service requirements.
B Bonds are considered highly speculative. While bonds in this class
are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the
obligor's limited margin of safety and the need for reasonable
business and economic activity throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, Bonds are in default on interest and/or principal payments. Such
DD, bonds are extremely speculative and should be valued on the basis of
and D their ultimate recovery value in liquidation or reorganization of
Default the obligor. "DDD" represents the highest potential for recovery on
these bonds, and "D" represents the lowest potential for recovery.
A-6
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
Description of Fitch's Short Term Ratings
Fitch's short term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium term notes, and municipal and investment
notes.
The short term rating places greater emphasis than a long term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely
payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated "F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is
not as great as for issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial
and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of
credit issued by a commercial bank.
A-7
APPENDIX B
TAXABLE EQUIVALENT YIELDS FOR 2003
Taxable Income* A Tax Exempt Yield of
------------------------------------- -----------------------------------------------------
2003
Federal
Tax
Single Return Joint Return Bracket 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
------------- ------------ ------- ----- ----- ----- ----- ----- -----
is equal to a taxable yield of
$28,401-$68,800 $47,451-$114,650 25.00% 6.67% 7.33% 8.00% 8.67% 9.33% 10.00%
$68,801-$143,500 $114,651-$174,700 28.00% 6.94% 7.64% 8.33% 9.03% 9.72% 10.42%
$143,501-$311,950 $174,701-$311,950 33.00% 7.46% 8.21% 8.96% 9.70% 10.45% 11.19%
Over $311,500 Over $311,500 35.00% 7.69% 8.46% 9.23% 10.00% 10.77% 11.54%
----------
* An investor's marginal tax rates may exceed the rates shown in the above
table due to the reduction, or possible elimination, of the personal
exemption deduction for high-income taxpayers and an overall limit on
itemized deductions. Income also may be subject to certain state and local
taxes. For investors who pay Federal alternative minimum tax, tax exempt
yields may be equivalent to lower taxable yields than those shown above.
The tax rates shown above do not apply to corporate taxpayers. The tax
characteristics of the Fund are described more fully elsewhere in this
prospectus. Consult your tax adviser for further details. This chart is
for illustrative purposes only and cannot be taken as an indication of
anticipated Fund performance.
B-1
================================================================================
Through and including August , 2003 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealers' obligation to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
Shares
Muni Intermediate Duration Fund, Inc.
Common Stock
----------
PROSPECTUS
----------
Merrill Lynch & Co.
[names of underwriting syndicate members]
August , 2003 CODE #19140-0603
================================================================================
PART C. OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
(1) Financial Statements:
Independent Auditors' Report
Statement of Assets and Liabilities as of July 24, 2003
(2) Exhibits:
Exhibit
Number Description
------- -----------
(a) -- Articles of Incorporation of the Registrant. (a)
(b) -- By-Laws of the Registrant.
(c) -- Not applicable
(d)(1) -- Portions of the Articles of Incorporation and By-Laws of the
Registrant defining the rights of holders of shares of common
stock of the Registrant. (b)
(d)(2) -- Form of specimen certificate for shares of common stock of the
Registrant.
(e) -- Form of Automatic Dividend Reinvestment Plan.
(f) -- Not applicable
(g)(1) -- Form of Investment Advisory Agreement between the Registrant
and Fund Asset Management, L.P. ("FAM" or the "Investment
Adviser").
(g)(2) -- Form of Fee Waiver Agreement between the Registrant and FAM.
(h)(1) -- Form of Purchase Agreement between the Registrant and Merrill
Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch")
and other underwriters.
(h)(2) -- Form of Merrill Lynch Standard Dealer Agreement.
(h)(3) -- Form of Master Agreement Among Underwriters.
(i) -- Not applicable
(j) -- Form of Custodian Agreement between the Registrant and State
Street Bank and Trust Company ("State Street"). (c)
(k)(1) -- Form of Registrar, Transfer Agency, Dividend Disbursing Agency
and Stockholder Service Agreement between the Registrant and
EquiServe, L.P. (d)
(k)(2) -- Form of Administrative Services Agreement between Registrant
and State Street. (e)
(k)(3) -- Form of Additional Compensation Agreement between FAM and
Merrill Lynch.
(l) -- Opinion and Consent of Sidley Austin Brown & Wood LLP.*
(m) -- Not applicable
(n) -- Consent of , independent auditors for the Registrant.*
(o) -- Not applicable
(p) -- Certificate of FAM.*
(q) -- Not applicable
(r) -- Code of Ethics. (f)
----------
(a) Filed on May 16, 2003 as an exhibit to the Registrant's Registration
Statement (the "Registration Statement") on Form N-2 (File No.
333-105343).
(b) Reference is made to Article IV, Article V (sections 2, 3, 5, 6 and 7),
Article VI, Article VII, Article VIII, Article IX, Article X and Article
XII of the Registrant's Articles of Incorporation, filed as Exhibit (a)
C-1
hereto; and to Article II, Article III (sections 1, 2, 3, 5 and 17),
Article VI, Article VII, Article XII, Article XIII and Article XIV of the
Registrant's By-Laws, filed as Exhibit (b) to the Registration Statement.
(c) Incorporated by reference to Exhibit 7 to Post-Effective No. 10 to the
Registration Statement on Form N-1A of Merrill Lynch Municipal Bond Fund
of Merrill Lynch Multi-State Municipal Series Trust (File No. 33-49873),
filed on October 30, 2001.
(d) Incorporated by reference to Exhibit 13 to Pre-Effective Amendment No. 2
to the Registration Statement on Form N-14 of Corporate High Yield Fund,
Inc. (File No. 333-10193), filed on December 31, 2002.
(e) Incorporated by reference to exhibit 8(d) to Post-Effective Amendment No.
1 to the Registration Statement on Form N-1A of Merrill Lynch Focus Twenty
Fund, Inc. (File No. 333-89775) filed on March 20, 2001.
(f) Incorporated by reference to Exhibit 15 to Post-Effective Amendment No. 9
to the Registration Statement on Form N-1A of Merrill Lynch Multi-State
Limited Maturities Municipal Series Trust (File No. 33-50417), filed on
November 22, 2000.
* To be provided by amendment.
Item 25. Marketing Arrangements.
See Exhibits (h)(1) and (2).
Item 26. Other Expenses of Issuance and Distribution.
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this Registration Statement:
Registration fees........................................... $ *
---
Stock Exchange listing fee.................................. *
---
Printing (other than stock certificates).................... *
---
Engraving and printing stock certificates................... *
---
Legal fees and expenses..................................... *
---
Accounting fees and expenses................................ *
---
NASD fees................................................... *
---
Underwriters' expense reimbursement......................... *
---
Miscellaneous............................................... *
---
Total....................................................... $ *
===
----------
*To be provided by amendment.
Item 27. Persons Controlled by or Under Common Control with Registrant.
The information in the prospectus under the captions "Investment Advisory
and Management Arrangements" and "Description of Capital Stock--Common Stock"
and in Note 1 to the Statement of Assets and Liabilities is incorporated herein
by reference.
Item 28. Number of Holders of Securities.
There will be one record holder of the Common Stock, par value $0.10 per
share, as of the effective date of this Registration Statement.
Item 29. Indemnification.
Reference is made to Section 2-418 of the General Corporation Law of the
State of Maryland, Article V of the Registrant's Articles of Incorporation,
Article VI of the Registrant's By-laws and Section 6 of the Purchase Agreement,
which provide for indemnification.
Article VI of the By-laws provides that each officer and director of the
Registrant shall be indemnified by the Registrant to the full extent permitted
under the Maryland General Corporation Law, except that such indemnity shall not
protect any such person against any liability to the Registrant or any
stockholder thereof to
C-2
which such person would otherwise be subject by reason of willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in the
conduct of his or her office. Absent a court determination that an officer or
director seeking indemnification was not liable on the merits or guilty of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of his or her office, the decision by the
Registrant to indemnify such person must be based upon the reasonable
determination of independent counsel or non-party independent directors, after
review of the facts, that such officer or director is not guilty of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office.
Each officer and director of the Registrant claiming indemnification
within the scope of Article VI of the By-laws shall be entitled to advances from
the Registrant for payment of the reasonable expenses incurred by him or her in
connection with proceedings to which he or she is a party in the manner and to
the full extent permitted under the Maryland General Corporation Law; provided,
however, that the person seeking indemnification shall provide to the Registrant
a written affirmation of his or her good faith belief that the standard of
conduct necessary for the indemnification by the Registrant has been met and a
written undertaking to repay any such advance, if it ultimately should be
determined that the standard of conduct has not been met, and provided further
that at least one of the following additional conditions is met: (i) the person
seeking indemnification shall provide a security in form and amount acceptable
to the Registrant for his or her undertaking; (ii) the Registrant is insured
against losses arising by reason of the advance; or (iii) a majority of a quorum
of non-party independent directors, or independent legal counsel in a written
opinion shall determine, based on a review of facts readily available to the
Registrant at the time the advance is proposed to be made, that there is reason
to believe that the person seeking indemnification will ultimately be found to
be entitled to indemnification.
The Registrant may purchase insurance on behalf of an officer or director
protecting such person to the full extent permitted under the Maryland General
Corporation Law from liability arising from his or her activities as officer or
director of the Registrant. The Registrant, however, may not purchase insurance
on behalf of any officer or director of the Registrant that protects or purports
to protect such person from liability to the Registrant or to its stockholders
to which such officer or director would otherwise be subject by reason of
willful misfeasance, bad faith, gross negligence, or reckless disregard of the
duties involved in the conduct of his or her office.
In Section 6 of the Purchase Agreement relating to the securities being
offered hereby, the Registrant agrees to indemnify Merrill Lynch and each
person, if any, who controls Merrill Lynch within the meaning of the Securities
Act of 1933 (the "1933 Act") against certain types of civil liabilities arising
in connection with the Registration Statement or Prospectus.
Insofar as indemnification for liabilities arising under the 1933 Act may
be provided to directors, officers and controlling persons of the Registrant and
Merrill Lynch, pursuant to the foregoing provisions or otherwise, the Registrant
has been advised that, in the opinion of the Securities and Exchange Commission,
such indemnification is against public policy as expressed in the 1933 Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in connection with any successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the 1933 Act and will be governed by the
final adjudication of such issue.
Item 30. Business and Other Connections of the Investment Adviser.
FAM acts as the investment adviser for a number of affiliated open-end and
closed-end registered investment companies.
C-3
Merrill Lynch Investment Managers, L.P. ("MLIM"), an affiliate of the
Investment Adviser, acts as the investment adviser for a number of affiliated
open-end and closed-end registered investment companies and also acts as
subadviser to certain other portfolios.
The address of each of these registered investment companies is P.O. Box
9011, Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch
Funds for Institutions Series is One Financial Center, 23rd
Floor, Boston, Massachusetts 02111-2665. The address of the Investment Adviser,
MLIM, Princeton Services, Inc. ("Princeton Services") and Princeton
Administrators, L.P. ("Princeton Administrators") is also P.O. Box 9011,
Princeton, New Jersey 08543-9011. The address of FAM Distributors, Inc.,
("FAMD") is P.O. Box 9081, Princeton, New Jersey 08543-9081. The address of
Merrill Lynch and Merrill Lynch & Co., Inc. ("ML & Co.") is World Financial
Center, North Tower, 250 Vesey Street, New York, New York 10080. The address of
the Fund's transfer agent, Financial Data Services, Inc. ("FDS"), is 4800 Deer
Lake Drive East, Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner of the
Investment Adviser indicating each business, profession, vocation or employment
of a substantial nature in which each such person or entity has been engaged for
the past two years for his, her or its own account or in the capacity of
director, officer, employee, partner or Director. Mr. Burke is Vice President
and Treasurer of all or substantially all of the investment companies advised by
FAM or its affiliates, and Mr. Doll is an officer of one or more of such
companies.
Position(s) with Other Substantial Business,
Name Investment Adviser Profession, Vocation Or Employment
-------------------- ---------------------------- ---------------------------------------------------
ML & Co. Limited Partner Financial Services Holding Company; Limited Partner
of MLIM
Princeton Services General Partner General Partner of MLIM
Robert C. Doll, Jr. President President of MLIM; President of Princeton Services;
Chief Investment Officer of OppenheimerFunds, Inc.
in 1999 and Executive Vice President thereof from
1991 to 1999
Donald C. Burke First Vice President, First Vice President, Treasurer and Director of
Treasurer and Director of Taxation of MLIM; Treasurer of Princeton Services;
Taxation Senior Vice President and Treasurer of Princeton
Services from 1997 to 2002; Vice President of FAMD;
Senior Vice President of MLIM from 1999 to 2000;
First Vice President of MLIM from 1997 to 1999
Lawrence D. Haber First Vice President First Vice President of MLIM; Senior Vice President
and Treasurer of Princeton Services
Brian A. Murdock Senior Vice President and Senior Vice President of MLIM and Chief Operating
Chief Operating Officer Officer of MLIM Americas; Chief Investment Officer
of EMEA Pacific Region and Global CIO for Fixed
Income and Alternative Investments; Head of MLIM's
Pacific Region and President of MLIM Japan,
Australia and Asia
Andrew J. Donohue General Counsel General Counsel of MLIM and Princeton Services
C-4
ITEM 31. Location of Account and Records.
All accounts, books and other documents required to be maintained by
Section 31(a) of the 1940 Act, and the Rules promulgated thereunder are
maintained at the offices of the Registrant (800 Scudders Mill Road, Plainsboro,
New Jersey 08536), its investment adviser (800 Scudders Mill Road, Plainsboro,
New Jersey 08536), and its custodian and transfer agent.
ITEM 32. Management Services.
Not applicable.
ITEM 33. Undertakings.
(a) The Registrant undertakes to suspend the offering of the shares of
common stock covered hereby until it amends its prospectus contained herein if
(1) subsequent to the effective date of this Registration Statement, its net
asset value per share of common stock declines more than 10% from its net asset
value per share of common stock as of the effective date of this Registration
Statement, or (2) its net asset value per share of common stock increases to an
amount greater than its net proceeds as stated in the prospectus contained
herein.
(b) The Registrant undertakes that:
(1) For purposes of determining any liability under the 1933 Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the registrant pursuant to Rule 497(h) under
the 1933 Act shall be deemed to be part of this Registration Statement as
of the time it was declared effective.
(2) For the purpose of determining any liability under the 1933 Act,
each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
C-5
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the Township of Plainsboro, State of New Jersey, on the 25th day
of June, 2003.
MUNI INTERMEDIATE DURATION FUND, INC.
(Registrant)
By: /s/ TERRY K. GLENN
--------------------
(Terry K. Glenn, President)
Each person whose signature appears below hereby authorizes Terry K.
Glenn, Donald C. Burke or Brian D. Stewart, or any of them, as attorney-in-fact,
to sign on his behalf, individually and in each capacity stated below, any
amendments to this Registration Statement (including any Post-Effective
Amendments) and to file the same, with all exhibits thereto, with the Securities
and Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following person in the
capacities and on the dates indicated.
Signatures Title Date
------------------------ ------------------------------ ------------
/s/ TERRY K. GLENN
(Terry K. Glenn) President (Principal Executive
Officer) and Director June 25, 2003
/s/ DONALD C. BURKE
(Donald C. Burke) Vice President and Treasurer June 25, 2003
(Principal Financial and
Accounting Officer)
/s/ DONALD W. BURTON
(Donald W. Burton) Director June 25, 2003
/s/ M. COLYER CRUM
(M. Colyer Crum) Director June 25, 2003
/s/ LAURIE SIMON HODRICK
(Laurie Simon Hodrick) Director June 25, 2003
/s/ FRED G. WEISS
(Fred G. Weiss) Director June 25, 2003
C-6
Exhibit Index
Exhibit Description
------- -----------
(b) -- By-Laws of the Registrant.
(d)(2) -- Form of specimen certificate for shares of common stock
of the Registrant.
(e) -- Form of Automatic Dividend Reinvestment Plan.
(g)(1) -- Form of Investment Advisory Agreement between the
Registrant and Fund Asset Management, L.P.
(g)(2) -- Form of Fee Waiver Agreement between the Registrant and Fund
Asset Management, L.P.
(h)(1) -- Form of Purchase Agreement between the Registrant and
Merrill Lynch, Pierce, Fenner & Smith Incorporated and
other underwriters.
(h)(2) -- Form of Merrill Lynch Standard Dealer Agreement.
(h)(3) -- Form of Master Agreement Among Underwriters.
(k)(3) -- Form of Additional Compensation Agreement between Fund Asset
Mangement, L.P. and Merrill Lynch, Pierce, Fenner & Smith
Incorporated.
C-7