As filed with the Securities and Exchange Commission on July 21, 2005
Securities Act File No. 333-
Investment Company Act File No. 811-06660
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] PRE-EFFECTIVE AMENDMENT NO.
[ ] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940
[X] AMENDMENT NO. 6
(Check appropriate box or boxes)
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MUNIYIELD QUALITY FUND II, 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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Robert C. Doll, Jr.
MuniYield Quality Fund II, 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. Frank P. Bruno, Esq.
FUND ASSET MANAGEMENT, L.P. SIDLEY AUSTIN BROWN & WOOD LLP
P.O. Box 9011 787 Seventh Avenue
Princeton, New Jersey 08543-9011 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.
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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
Maximum Aggregate Amount of
Title of Securities Amount being Offering Price Offering Registration
Being Registered Registered Per Unit (1) Price (1) Fee(2)
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Auction Market Preferred Stock...... 400 shares $25,000 $10,000,000 $1,177
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(1) Estimated solely for the purpose of calculating the registration fee.
(2) Transmitted prior to the filing date to the designated lockbox of the
Securities and Exchange Commission at Mellon Bank in Pittsburgh, PA.
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 July 21, 2005
PROSPECTUS
$10,000,000
MuniYield Quality Fund II, Inc.
Auction Market Preferred Stock ("AMPS")
400 Shares, Series D
Liquidation Preference $25,000 per Share
----------------
MuniYield Quality Fund II, Inc. is a non-diversified, closed-end
management investment company seeking to provide shareholders with as high a
level of current income exempt from Federal income taxes as is consistent with
its investment policies and prudent investment management. The Fund seeks to
achieve its investment objective by investing, as a fundamental policy, at
least 80% of an aggregate of the Fund's net assets (including proceeds from
the issuance of preferred stock), plus the amounts 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 excludable from gross
income for Federal income tax purposes (except that the interest may be
includable in taxable income for purposes of the Federal alternative minimum
tax). The Fund invests in a portfolio of municipal obligations which are rated
high grade (A or better) or, if unrated, are considered by the Fund's
Investment Adviser to be of comparable quality. The Fund may invest in certain
tax exempt securities classified as "private activity bonds," as discussed
within, that may subject certain investors in the Fund to an alternative
minimum tax. There can be no assurance that the Fund's investment objective
will be realized.
(continued on following page)
Investing in the AMPS involves certain risks that are described in the
"Risk Factors and Special Considerations" section beginning on page [ ] of
this prospectus. The minimum purchase amount for the AMPS is $25,000.
----------------
Per Share Total
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Public offering price........................ $25,000 $10,000,000
Underwriting discount........................ $250 $100,000
Proceeds, before expenses, to the Fund(1).... $24,750 $9,900,000
(1) The estimated offering expenses payable by the Fund are $145,000.
The public offering price per share will be increased by the amount of
accumulated dividends, if any, from the date the shares are first issued.
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.
One certificate for the AMPS will be ready for delivery to the nominee
of The Depository Trust Company on or about [ ], 2005.
----------------
Merrill Lynch & Co.
----------------
The date of this prospectus is [ ], 2005.
(continued from previous page)
This prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep
it for future reference. The Fund's statement of additional information dated
[ ], 2005 contains further information about the Fund and is incorporated by
reference (legally considered to be part of this prospectus) and the table of
contents of the statement of additional information appears on page [11] of
this prospectus. A copy of the statement of additional information and copies
of the Fund's semi-annual and annual reports may be obtained without charge by
writing to the Fund at its address at 800 Scudders Mill Road, Plainsboro, New
Jersey 08536, or by calling the Fund at (800) 543-6217. In addition, you may
request other information about the Fund or make stockholder inquiries by
calling the Fund toll-free at (800) 543-6217. In addition, the Securities and
Exchange Commission maintains a Web site (http://sec.gov) that contains the
statement of additional information, material incorporated by reference and
other information regarding registrants that file electronically with the
Securities and Exchange Commission. The Fund does not maintain a website.
Certain capitalized terms used herein not otherwise defined in this
prospectus have the meaning provided in the Glossary at the back of this
prospectus.
TABLE OF CONTENTS
Prospectus Summary...........................................................5
Risk Factors and Special Considerations.....................................11
Financial Highlights........................................................15
The Fund....................................................................15
Use of Proceeds.............................................................17
Capitalization..............................................................17
Portfolio Composition.......................................................17
Investment Objective and Policies...........................................18
Other Investment Policies...................................................26
Description of AMPS.........................................................29
The Auction.................................................................34
Rating Agency Guidelines....................................................42
Investment Advisory and Management Arrangements.............................43
Taxes.......................................................................44
Description of Capital Stock................................................45
Custodian...................................................................48
Underwriting................................................................48
Transfer Agent, Dividend Disbursing Agent and Registrar.....................49
Accounting Services Provider................................................49
Legal Opinions..............................................................49
Independent Registered Public Accounting Firm and Experts...................49
Additional Information......................................................49
Table of Contents of Statement of Additional Information....................50
Glossary....................................................................51
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Information about the Fund can be reviewed and copied at the Securities
and Exchange Commission'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 Securities and Exchange Commission'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 Securities
and Exchange Commission, Washington, D.C. 20549-0102.
----------------
You should rely only on the information contained in this prospectus. We
have not, and the underwriter has 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
underwriter is 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.
4
PROSPECTUS SUMMARY
This summary is qualified in its entirety by reference to the detailed
information included in this prospectus and the statement of additional
information.
The Fund MuniYield Quality Fund II, Inc. is a non-diversified,
closed-end management investment company.
The Offering The Fund is offering a total of 400 shares of Auction
Market Preferred Stock, Series D, at a purchase price of
$25,000 per share plus accumulated dividends, if any, from
the date the shares are first issued. The shares of AMPS
are being offered by Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch"), as underwriter.
The Series D AMPS will be shares of preferred stock of the
Fund that entitle their holders to receive cash dividends
at an annual rate that may vary for the successive dividend
periods. In general, except as described below, each
dividend period following the initial dividend period will
be seven days. The applicable dividend for a particular
dividend period will be determined by an auction conducted
on the business day next preceding the start of that
dividend period.
Investors and potential investors in shares of Series D
AMPS may participate in auctions for the AMPS through
their broker-dealers.
Generally, AMPS investors will not receive certificates
representing ownership of their shares. Ownership of AMPS
will be maintained in book-entry form by the securities
depository (The Depository Trust Company) or its nominee
for the account of the investor's agent member (generally
the investor's broker-dealer). The investor's agent
member, in turn, will maintain records of such investor's
beneficial ownership of AMPS.
Investment
Objective
and Policies The investment objective of the Fund is to provide
shareholders with as high a level of current income exempt
rom Federal income taxes as is consistent with its
investment policies and prudent investment management. The
Fund seeks to achieve its investment objective by
investing, as a fundamental policy, at least 80% of its
net assets (including proceeds from the issuance of
preferred stock), and the proceeds 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 excludable from gross income for Federal income
tax purposes ("Municipal Bonds"). In general, the Fund
does not intend for its investments to earn a large amount
of interest income that is not exempt from Federal income
tax, except that the interest may be includable in taxable
income for purposes of the Federal alternative minimum
tax. There can be no assurance that the Fund's investment
objective will be realized.
Maturity. The average maturity of the Fund's portfolio
securities varies from time to time based upon an
assessment of economic and market conditions by Fund Asset
Management, L.P., the Fund's investment adviser (the
"Investment Adviser"). The Fund intends to invest
primarily in long term Municipal Bonds (that is, Municipal
Bonds with maturities of more than ten years). However,
the Fund also may invest in intermediate term Municipal
Bonds with remaining maturities of between three years and
ten years. The Fund also may invest from time to time in
short term Municipal Bonds with remaining maturities of
less than three years.
High Grade Municipal Bonds. The Fund invests in a
portfolio of Municipal Bonds that are rated high grade by
one or more nationally recognized statistical rating
organizations
5
("NRSROs") (A or higher by Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's ("S&P") or Fitch Ratings
("Fitch")), or in unrated bonds considered by the
Investment Adviser to be of comparable quality. In
assessing the quality of Municipal Bonds, the Investment
Adviser takes into account any letters of credit or
similar credit enhancement to which particular Municipal
Bonds are entitled and the creditworthiness of the
financial institution that provided such credit
enhancement.
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 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."
Risk Factors Set forth below is a summary of the main risks of
investing in the Fund's Series D AMPS. For a more detailed
description of the main risks as well as certain other
risks associated with investing in the Fund's Series D
AMPS, see "Risk Factors and Special Considerations."
o The credit ratings of the AMPS could be reduced or
terminated while an investor holds the AMPS, which
could affect liquidity.
o Neither broker-dealers nor the Fund are obligated to
purchase shares of AMPS in an
6
auction or otherwise, nor is the Fund required to
redeem shares of AMPS in the event of a failed auction.
o If sufficient bids do not exist in an auction, the
applicable dividend rate will be the maximum
applicable dividend rate, and in such event, owners
of AMPS wishing to sell will not be able to sell all,
and may not be able to sell any, AMPS in the auction.
As a result, investors may not have liquidity of
investment.
o As a result of bidding by broker-dealers in an
auction for their own account, the dividend rate that
would apply at the auction may be higher or lower
than the rate that would have prevailed had the
broker-dealer not bid.
o A broker-dealer may bid in an auction in order to
prevent what would otherwise be (i) a failed auction,
(ii) an "all-hold" auction, or (iii) an applicable
dividend rate that the broker-dealer believes, in its
sole discretion, does not reflect the market for the
AMPS at the time of the auction.
o The relative buying and selling interest of market
participants in AMPS and in the auction rate
securities market as a whole will vary over time, and
such variations may be affected by, among other
things, news relating to the issuer, the
attractiveness of alternative investments, the
perceived risk of owning the security (whether
related to credit, liquidity or any other risk), the
tax treatment accorded the instruments, the
accounting treatment accorded auction rate
securities, including recent clarifications of U.S.
generally accepted principles relating to the
treatment of auction rate securities, reactions to
regulatory actions or press reports, financial
reporting cycles and market sentiment generally.
Shifts of demand in response to any one or
simultaneous particular events cannot be predicted
and may be short-lived or exist for longer periods.
o Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") has advised the Fund that it and
various other broker-dealers and other firms that
participate in the auction rate securities market
received letters from the staff of the Securities and
Exchange Commission last spring. The letters
requested that each of these firms voluntarily
conduct an investigation regarding its respective
practices and procedures in that market. Pursuant to
this request, Merrill Lynch conducted its own
voluntary review and reported its findings to the
Securities and Exchange Commission staff. At the
Securities and Exchange Commission staff's request,
Merrill Lynch, together with certain other
broker-dealers and other firms that participate in
the auction rate securities market, is engaging in
discussions with the Securities and Exchange
Commission staff concerning its inquiry. Neither
Merrill Lynch nor the Fund can predict the ultimate
outcome of the inquiry or how that outcome will
affect the market for the AMPS or the auctions.
o Broker-dealers have no obligation to maintain a
secondary trading market in the AMPS outside of
auctions and there can be no assurance that a
secondary market for the AMPS will develop or, if it
does develop, that it will provide holders with a
liquid trading market. An increase in the level of
interest rates likely will have an adverse effect on
the secondary market price of the AMPS, and a selling
stockholder may have to sell AMPS between auctions at
a price per share of less than $25,000.
o The Fund will issue the AMPS only if the AMPS have
received a rating of Aaa from Moody's and AAA from
S&P. Under certain circumstances, the Fund may
voluntarily terminate compliance with Moody's or S&P
guidelines, or both, in which case the AMPS may no
longer be rated by Moody's or S&P, as applicable, but
will
7
be rated by at least one rating agency.
o The Fund issues shares of AMPS, which generally pay
dividends based on short term interest rates. The
Fund generally will purchase Municipal Bonds that pay
interest at fixed or adjustable rates. If market
interest rates rise, this could negatively impact the
value of the Fund's investment portfolio, reducing
the amount of assets serving as asset coverage for
the AMPS. If the asset coverage becomes too low, the
Fund may be required to redeem some or all of the
shares of AMPS.
o The Fund is registered as a "non-diversified"
investment company, 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.
o 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 the
performance of a stock fund or taxable bond fund.
o The Fund's investments in Municipal Bonds 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 the longer
term securities in which the Fund primarily invests
generally change more in response to changes in
interest rates than prices of shorter term
securities. Credit risk is the risk that the issuer
will be unable to pay the interest or principal when
due. Changes in an issuer's credit rating or the
market's perception of an issuer's creditworthiness
may affect the value of the Fund's investment in that
issuer.
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 0.50% of the Fund's average weekly net
assets (including any proceeds from the issuance of
preferred stock).
Dividends and
Dividend Periods Dividends on the Series D AMPS will be cumulative from the
date the shares are first issued and payable at the
annualized cash dividend rate for the initial dividend
period on the initial dividend payment date as follows:
Initial Initial Initial
Dividend Dividend Dividend
AMPS Series Rate Period Ending Payment Date
---------------- -------- ------------- ------------
Series D........ [ ]% [ ], 2005 [ ], 2005
After the initial dividend period, each dividend period
for the Series D AMPS will generally consist of seven
days; provided however, that before any auction, the Fund
may decide, subject to certain limitations and only if it
gives notice to holders, to declare a special dividend
period of up to five years.
After the initial dividend period, in the case of dividend
periods that are not special dividend periods, dividends
generally will be payable on each succeeding Tuesday.
Dividends for the Series D AMPS will be paid through the
securities depository (The
8
Depository Trust Company) on each dividend payment date
for the AMPS.
For each subsequent dividend period, the auction agent
(The Bank of New York) will hold an auction to determine
the cash dividend rate on the shares of the Series D AMPS.
Determination of
Maximum Dividend
Rates Generally, the applicable dividend rate for any dividend
period for the Series D AMPS will not be more than the
maximum applicable rate attributable to such shares. The
maximum applicable rate for the Series D AMPS will be the
higher of (A) the applicable percentage of the reference
rate on the auction date or (B) the applicable spread plus
the reference rate on the auction date. The reference rate
is (A) the higher of the applicable LIBOR Rate (as defined
in the Glossary) and the Taxable Equivalent of the
Short-Term Municipal Bond Rate (as defined in the
Glossary) (for a dividend period or special dividend
period of 364 or fewer days), or (B) the applicable
Treasury Index Rate (as defined in the Glossary)(for a
special dividend period of 365 days or more). The maximum
applicable rate for the AMPS will depend on the credit
rating assigned to the shares, the length of the dividend
period and whether or not the Fund has given notification
prior to the auction for the dividend period that any
taxable income will be included in the dividend on the
AMPS for that dividend period. The applicable percentage
and applicable spread are as follows:
Applicable Applicable Applicable Applicable
Credit Ratings Percentage Percentage Spread Over Spread Over
------------------------ of Reference of Reference Reference Reference
Rate-No Rate- Rate-No Rate-
Moody's S&P Notification Notification Notification Notification
----------- ----------- ------------ ------------ ------------ ------------
Aaa AAA 110% 125% 1.10% 1.25%
Aa3 to Aa1 AA- to AA+ 125% 150% 1.25% 1.50%
A3 to A1 A- to A+ 150% 200% 1.50% 2.00%
Baa3 to Baa1 BBB- to BBB+ 175% 250% 1.75% 2.50%
Below Baa3 Below BBB- 200% 300% 2.00% 3.00%
The applicable percentage and the applicable spread as so
determined may be subject to upward but not downward
adjustment in the discretion of the Board of Directors of
the Fund after consultation with the broker-dealers
participating in the auction for the AMPS.
There is no minimum applicable dividend rate for any
dividend period.
Other AMPS The Fund has outstanding 6,000 shares of three other
series of Auction Market Preferred Stock, each with a
liquidation preference of $25,000 per share, plus
accumulated but unpaid dividends, for an aggregate initial
liquidation preference of $150,000,000 (the "Other AMPS").
The Other AMPS are as follows: 2,000 shares of Auction
Market Preferred Stock, Series A; 2,000 shares of Auction
Market Preferred Stock, Series B; and 2,000 shares of
Auction Market Preferred Stock, Series C. The Series D
AMPS offered hereby rank on a parity with the Other AMPS
with respect to dividends and liquidation preference.
Asset Maintenance Under the Fund's Articles Supplementary creating the
Series D AMPS (the "Articles Supplementary"), the Fund
must maintain:
o asset coverage of the AMPS and Other AMPS as required
by the rating agencies rating the AMPS, and
o asset coverage of the AMPS and Other AMPS of at least
200% as required by the Investment Company Act of
1940 (the "1940 Act").
9
The Fund estimates that, based on the composition of its
portfolio at April 30, 2005, asset coverage of the AMPS
and Other AMPS as required by the 1940 Act would be
approximately 291% immediately after the Fund issues the
shares of AMPS offered by this prospectus representing
approximately 34% of the Fund's capital, or approximately
52% of the Fund's common stock equity, immediately after
the issuance of such AMPS.
Mandatory If the required asset coverage is not maintained or, when
Redemption necessary, restored, the Fund must redeem shares of the
Series D AMPS at the price of $25,000 per share plus
accumulated but unpaid dividends thereon (whether or not
earned or declared). The provisions of the 1940 Act may
restrict the Fund's ability to make such a mandatory
redemption.
Optional Redemption The Fund may, at its option, choose to redeem all or a
portion of the shares of AMPS on any dividend payment
date at the price of $25,000 per share, plus accumulated
but unpaid dividends thereon (whether or not earned or
declared) plus any applicable premium.
Liquidation The liquidation preference (that is, the amount the Fund
Preference must pay to holders of AMPS if the Fund is liquidated) of
each share of AMPS will be $25,000, plus an amount equal
to accumulated but unpaid dividends (whether or not earned
or declared).
Ratings The AMPS will be issued with a rating of Aaa from Moody's
and AAA from S&P.
Voting Rights The 1940 Act requires that the holders of AMPS and any
other preferred stock, including the Other AMPS, voting as
a separate class, have the right to elect at least two
directors at all times and to elect a majority of the
directors at any time when dividends on the AMPS or any
other preferred stock, including the Other AMPS, are
unpaid for two full years. The Fund's Charter, the 1940
Act and the General Corporation Laws of the State of
Maryland require holders of AMPS and any other preferred
stock, including the Other AMPS, to vote as a separate
class on certain other matters.
10
RISK FACTORS AND SPECIAL CONSIDERATIONS
An investment in the Fund's AMPS should not constitute a complete
investment program.
Set forth below are the main risks of investing in the Fund's AMPS.
Investment Considerations. Investors in AMPS should consider the
following factors:
o The credit ratings of the AMPS could be reduced or terminated
while an investor holds the AMPS, which could affect liquidity.
o Neither broker-dealers nor the Fund are obligated to purchase
shares of AMPS in an auction or otherwise, nor is the Fund
required to redeem shares of AMPS in the event of a failed
auction.
o If sufficient bids do not exist in an auction, the applicable
dividend rate will be the maximum applicable dividend rate, and in
such event, owners of AMPS wishing to sell will not be able to
sell all, and may not be able to sell any, AMPS in the auction. As
a result, investors may not have liquidity of investment.
o Broker-dealers may submit orders in auctions for the AMPS for
their own account. If a broker-dealer submits an order for its own
account in any auction, it may have knowledge of orders placed
through it in that auction and therefore have an advantage over
other bidders, but such broker-dealer would not have knowledge of
orders submitted by other broker-dealers in that auction. As a
result of bidding by a broker-dealer in an auction, the dividend
rate that would apply at the auction may be higher or lower than
the rate that would have prevailed had the broker-dealer not bid.
o A broker-dealer may bid in an auction in order to prevent what
would otherwise be (i) a failed auction, (ii) an "all-hold"
auction, or (iii) an applicable dividend rate that the
broker-dealer believes, in its sole discretion, does not reflect
the market for the AMPS at the time of the auction. A
broker-dealer may, but is not obligated to, advise owners of AMPS
that the dividend rate that would apply in an "all-hold" auction
may be lower than would apply if owners submit bids and such
advice, if given, may facilitate the submission of bids by owners
that would avoid the occurrence of an "all-hold" auction.
o The relative buying and selling interest of market participants in
AMPS and in the auction rate securities market as a whole will
vary over time, and such variations may be affected by, among
other things, news relating to the issuer, the attractiveness of
alternative investments, the perceived risk of owning the security
(whether related to credit, liquidity or any other risk), the tax
treatment accorded the instruments, the accounting treatment
accorded auction rate securities, including recent clarifications
of U.S. generally accepted principles relating to the treatment of
auction rate securities, reactions to regulatory actions or press
reports, financial reporting cycles and market sentiment
generally. Shifts of demand in response to any one or simultaneous
particular events cannot be predicted and may be short-lived or
exist for longer periods.
o Merrill Lynch has advised the Fund that it and various other
broker-dealers and other firms that participate in the auction
rate securities market received letters from the staff of the
Securities and Exchange Commission last spring. The letters
requested that each of these firms voluntarily conduct an
investigation regarding its respective practices and procedures in
that market. Pursuant to this request, Merrill Lynch conducted its
own voluntary review and reported its findings to the Securities
and Exchange Commission staff. At the Securities and Exchange
Commission staff's request, Merrill Lynch, together with certain
other broker-dealers and other firms that participate in the
auction rate securities market, is engaging in discussions with
the Securities and Exchange Commission staff concerning its
inquiry. Neither Merrill Lynch nor the Fund can predict the
ultimate outcome of the inquiry or how that outcome will affect
the market for the AMPS or the auctions.
11
Secondary Market. Broker-dealers have no obligation to maintain a
secondary trading market in the AMPS outside of auctions and there can be no
assurance that a secondary market for the AMPS will develop or, if it does
develop, that it will provide holders with a liquid trading market. The AMPS
will not be registered on any stock exchange or on any automated quotation
system. An increase in the level of interest rates likely will have an adverse
effect on the secondary market price of the AMPS, and a selling stockholder
may have to sell AMPS between auctions at a price per share of less than
$25,000.
Rating Agencies. The Fund will issue the AMPS only if the AMPS have
received a rating of Aaa from Moody's and AAA from S&P. As a result of such
ratings the Fund will be subject to guidelines of Moody's, S&P or another
substitute NRSRO 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. Also, under certain circumstances,
the Fund may voluntarily terminate compliance with Moody's or S&P's
guidelines, or both, in which case the AMPS may no longer be rated by Moody's
or S&P, as applicable, but will be rated by at least one rating agency.
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.
Interest Rate Risk and AMPS. The Fund issues shares of AMPS, which
generally pay dividends based on short-term interest rates. The Fund generally
will purchase Municipal Bonds that pay interest at fixed or adjustable rates.
If short-term interest rates rise, dividend rates on the shares of AMPS may
rise so that the amount of dividends paid to the holders of shares of AMPS
exceeds the income from the Fund's portfolio securities. Because income from
the Fund's entire investment portfolio (not just the portion of the portfolio
purchased with the proceeds of the AMPS offering) is available to pay
dividends on the shares of AMPS, dividend rates on the shares of AMPS would
need to greatly exceed the Fund's net portfolio income before the Fund's
ability to pay dividends on the shares of AMPS would be jeopardized. If market
interest rates rise, this could negatively impact the value of the Fund's
investment portfolio, reducing the amount of assets serving as asset coverage
for the AMPS. If the asset coverage becomes too low, the Fund may be required
to redeem some or all of the shares of AMPS.
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 if interest rates
increase in the future. Changes in an issuer's credit rating or the market's
perception of an issuer's creditworthiness may affect the value of the Fund's
investment in that issuer. 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.
12
Set forth below are certain other risks associated with investing in the
Fund's AMPS.
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.
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 the market price of the common
stock.
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.
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 increase 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 swap transactions and credit default swaps.
Such strategies 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 investments in inverse securities and credit default swaps may provide
investment leverage to the Fund's portfolio. The Fund is not required to use
derivatives or other portfolio strategies to seek to increase return or to
seek to hedge its portfolio and may choose not to 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 increase 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.
General Risks Related to Derivatives. 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
investment purposes, hedging purposes or to seek to increase its return, such
as options, futures contracts and swap agreements. 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 and/or to hedge against increases in the Fund's
costs associated with the dividend payments on the preferred stock, including
the AMPS. The Fund also may invest in certain derivative products that pay tax
exempt income interest via a trust or partnership through which the Fund holds
interests in one or more underlying long term municipal securities. 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 and
management risk. They also involve the risk of mispricing or improper
valuation and correlation risk (i.e., 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. Moreover, derivatives raise certain tax, legal,
regulatory and accounting issues that may not be presented by investments in
Municipal Bonds, and there is some risk that certain issues could be resolved
in a manner that could adversely impact the performance of the Fund and/or the
tax exempt nature of the dividends paid by the Fund.
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.
Swaps. Swap agreements are types of derivatives. In order to seek to
hedge the value of the Fund's portfolio, to hedge against increases in the
Fund's cost associated with the dividend payments on preferred stock,
including the AMPS, or to seek to increase the Fund's return, the Fund may
enter into interest rate or credit default
13
swap transactions. In interest rate swap transactions, there is a risk that
yields will move in the direction opposite of the direction anticipated by the
Fund, which would cause the Fund to make payments to its counterparty in the
transaction that could adversely affect Fund performance. In addition to the
risks applicable to swaps generally, credit default swap transactions involve
special risks because they are difficult to value, are highly susceptible to
liquidity and credit risk, and generally pay a return to the party that has
paid the premium only in the event of an actual default by the issuer of the
underlying obligation (as opposed to a credit downgrade or other indication of
financial difficulty). The Fund is not required to enter into interest rate or
credit default swap transactions for hedging purposes or to enhance its return
and may choose not to do so.
Taxability Risk. The Fund intends to minimize the payment of taxable
income to stockholders by investing in Municipal Bonds and other tax exempt
securities in reliance on an opinion of bond counsel to the issuer that the
interest paid on those securities will be excludable from gross income for
Federal income tax purposes. Such securities, however, may be determined for
Federal income tax purposes to pay, or to have paid, taxable income subsequent
to the Fund's acquisition of the securities. In that event, the Internal
Revenue Service may demand that the Fund pay taxes on the affected interest
income, and, if the Fund agrees to do so, the Fund's yield on its common stock
could be adversely affected. A determination that interest on a security held
by the Fund is includable in gross income for Federal income tax purposes
retroactively to its date of issue may, likewise, cause a portion of prior
distributions received by stockholders, including holders of AMPS, to be
taxable to those stockholders in the year of receipt. The Fund will not pay an
Additional Dividend (as defined herein) to a holder of AMPS under these
circumstances.
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. See "Description of Capital Stock--Certain Provisions of the Charter
and By-laws."
Market Disruption. The terrorist attacks in the United States on
September 11, 2001 had a disruptive effect on the securities markets, some of
which were closed for a four-day period. The continued threat of similar
attacks and related events, including U.S. military actions in Iraq and
continued unrest in the Middle East, 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 adversely affect
the market prices of the Fund's portfolio securities, interest rates,
auctions, secondary trading, ratings, credit risk, inflation and other factors
relating to the Fund's AMPS.
14
FINANCIAL HIGHLIGHTS
The following Financial Highlights table is intended to help you
understand the Fund's financial performance for the periods shown. Certain
information reflects financial results for a single share of common stock or
preferred stock of the Fund. The total returns in the table represent the rate
an investor would have earned or lost on an investment in shares of common
stock of the Fund (assuming reinvestment of all dividends). The information
with respect to the fiscal years October 31, 1995 to October 31, 2004 has been
audited by ______________, whose report for the fiscal year ended October 31,
2004, along with the financial statements of the Fund, is included in the
Fund's 2004 Annual Report, which is incorporated by reference herein. The
information with respect to the six months ended April 30, 2005 is unaudited
and is included in the Fund's 2005 Semi-Annual Report, which is incorporated
by reference herein. You may obtain a copy of the Fund's 2004 Annual Report
and the 2005 Semi-Annual Report at no cost by calling (800) 543-6217 between
8:30 a.m. and 5:30 p.m. Eastern time on any business day.
The following per share data and ratios have been derived from information
provided in the financial statements.
For the Six
Months Ended
April 30, For the Year Ended October 31,
---------------------------------------------------------------------------
2005
(unaudited) 2004 2003 2002 2001+ 2000+
-------------- -------------- -------------- -------------- -------------- --------------
Per Share Operating
Performance
Net asset value,
beginning of period $13.72 $13.44 $13.27 $13.21 $12.39 $12.31
-------------- -------------- -------------- -------------- -------------- --------------
Investment income -- net .46++ .94++ .97++ .94++ .94++ .99
Realized and unrealized gain
(loss) on
investments -- net .02 .27 .09 --+ .84 .17
Dividends and distributions to
Preferred Stock
Shareholders:
Investment income -- net (.06) (.07) (.07) (.10) (.22) (.27)
Realized gain -- net -- -- -- -- -- --
In excess of realized gain --
net -- -- -- -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
Total from investment
operations .42 1.14 .99 .84 1.56 .89
-------------- -------------- -------------- -------------- -------------- --------------
Less dividends and
distributions to Common
Stock Shareholders:
Investment income -- net (.43) (.86) (.82) (.78) (.74) (.81)
Realized gain on investments
-- net -- -- -- -- -- --
In excess of realized gain --
net -- -- -- -- -- --
Total dividends and
distributions to
Common Stock Shareholders (.43) (.86) (.82) (.78) (.74) (.81)
-------------- -------------- -------------- -------------- -------------- --------------
Effect of Preferred Shares
activity:
Dividends and distributions
to Preferred Stock
Shareholders:
Investment income -- net -- -- -- -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
Realized gain -- net -- -- -- -- -- --
In excess of realized gain --
net -- -- -- -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
Total effect of Preferred
Shares activity -- -- -- -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
Net asset value, end of
period $13.71 $13.72 $13.44 $13.27 $13.21 $12.39
-------------- -------------- -------------- -------------- -------------- --------------
Market price per share, end
of period $12.58 $12.69 $12.18 $11.75 $12.07 $11.50
-------------- -------------- -------------- -------------- -------------- --------------
Total Investment Return**
Based on net asset value per
share 2.57%++ 11.57% 10.83% 3.95% 11.70% 7.35%
-------------- -------------- -------------- -------------- -------------- --------------
Based on market price per
share 3.39%++ 9.32% 8.28% 7.27% 13.47% 8.04%
-------------- -------------- -------------- -------------- -------------- --------------
Ratios Based on Average Net
Assets of Common Stock
Total expenses, net of
reimbursement*** 1.02%* 1.01% 1.03% 1.06% 1.07% 1.08%
-------------- -------------- -------------- -------------- -------------- --------------
Total expenses*** 1.02%* 1.02% 1.03% 1.06% 1.07% 1.08%
-------------- -------------- -------------- -------------- -------------- --------------
Total investment income --
net*** 6.70%* 7.00% 7.17% 7.26% 7.36% 8.04%
-------------- -------------- -------------- -------------- -------------- --------------
Amount of dividends to
Preferred
Stock Shareholders .87%* .51% ,50% .78% 1.74% 2.21%
-------------- -------------- -------------- -------------- -------------- --------------
Investment income -- net, to
Common
Stock Shareholders 5.83%* 6.49% 6.67% 6.48% 5.62% 5.83%
-------------- -------------- -------------- -------------- -------------- --------------
Ratios Based on Average Net
Assets of Preferred Stock
Dividends to Preferred Stock
Shareholders 1.78%* 1.04% 1.00% 1.51% 3.31% 4.02%
-------------- -------------- -------------- -------------- -------------- --------------
Supplemental Data
Net assets applicable to
Common Stock, end of
period (in thousands) $306,582 $306,764 $300,502 $296,847 $295,457 $277,224
-------------- -------------- -------------- -------------- -------------- --------------
Preferred Stock outstanding,
end of period (in
thousands) $150,000 $150,000 $150,000 $150,000 $150,000 $150,000
-------------- -------------- -------------- -------------- -------------- --------------
Portfolio turnover 10.58% 32.30% 42.06% 42.89% 98.99% 142.46%
-------------- -------------- -------------- -------------- -------------- --------------
Leverage:
Asset coverage per $1,000 $3,044 $3,045 $3,003 $2,979 $2,970 $2,848
-------------- -------------- -------------- -------------- -------------- --------------
Liquidation preference per share $25,000 $25,000 $25,000 $25,000 $25,000 $25,000
-------------- -------------- -------------- -------------- -------------- --------------
Average market value per share# $25,000 $25,000 $25,000 $25,000 $25,000 $25,000
-------------- -------------- -------------- -------------- -------------- --------------
Dividends Per Share on Preferred
Shares Outstanding
Series A -
Investment income -- net $210 $271 $276 $390 $855 $1,017
-------------- -------------- -------------- -------------- -------------- --------------
Series B -
Investment income -- net $231 $253 $240 $388 $853 $1,024
-------------- -------------- -------------- -------------- -------------- --------------
Series C -
Investment income -- net $223 $252 $235 $351 $777 $986
-------------- -------------- -------------- -------------- -------------- --------------
For the Year Ended October 31,
----------------------------------------------------------------------------
1999+ 1998+ 1997 1996 1995
-------------- -------------- -------------- -------------- --------------
Per Share Operating
Performance
Net asset value,
beginning of period $15.52 $15.46 $14.86 $14.64 $13.20
-------------- -------------- -------------- -------------- --------------
Investment income -- net 1.04 1.10 1.15 1.16 1.16
Realized and unrealized gain
(loss) on
investments -- net (2.65) .46 .64 .23 1.53
Dividends and distributions to
Preferred Stock
Shareholders:
Investment income -- net (.19) (.17) -- -- --
Realized gain -- net -- (.12) -- -- --
In excess of realized gain --
net (.06) -- -- -- --
-------------- -------------- -------------- -------------- --------------
Total from investment
operations (1.86) 1.27 1.79 1.39 2.69
-------------- -------------- -------------- -------------- --------------
Less dividends and
distributions to Common
Stock Shareholders:
Investment income -- net (.86) (.87) (.91) (.92) (.89)
Realized gain on investments
-- net -- (.34) (.03) -- (.10)
In excess of realized gain --
net (.49) -- -- -- --+
Total dividends and
distributions to
Common Stock Shareholders (1.35) (1.21) (.94) (.92) (.99)
-------------- -------------- -------------- -------------- --------------
Effect of Preferred Shares
activity:
Dividends and distributions
to Preferred Stock
Shareholders:
Investment income -- net -- -- (.24) (.25) (.25)
-------------- -------------- -------------- -------------- --------------
Realized gain -- net -- -- (.01) -- (.01)
In excess of realized gain --
net -- -- -- -- --++
-------------- -------------- -------------- -------------- --------------
Total effect of Preferred
Shares activity -- -- (.25) (.25) (.26)
-------------- -------------- -------------- -------------- --------------
Net asset value, end of
period $12.31 $15.52 $15.46 $14.86 $14.64
-------------- -------------- -------------- -------------- --------------
Market price per share, end
of period $11.50 $15.1875 $14.375 $13.50 $12.625
-------------- -------------- -------------- -------------- --------------
Total Investment Return**
Based on net asset value per
share (16.70%) 14.51% 13.86% 14.50% 23.09%
-------------- -------------- -------------- -------------- --------------
Based on market price per
share (12.74%) 8.80% 11.24% 8.68% 20.30%
-------------- -------------- -------------- -------------- --------------
Ratios Based on Average Net
Assets of Common Stock
Total expenses, net of
reimbursement*** .99% .95% .95% .98% 1.01%
-------------- -------------- -------------- -------------- --------------
Total expenses*** .99% .95% .95% .98% 1.01%
-------------- -------------- -------------- -------------- --------------
Total investment income --
net*** 7.31% 7.21% 7.50% 7.88% 8.42%
-------------- -------------- -------------- -------------- --------------
Amount of dividends to
Preferred
Stock Shareholders 1.30% 1.12% 1.55% 1.67% 1.81%
-------------- -------------- -------------- -------------- --------------
Investment income -- net, to
Common
Stock Shareholders 6.01% 6.09% 5.95% 6.21% 6.61%
-------------- -------------- -------------- -------------- --------------
Ratios Based on Average Net
Assets of Preferred Stock
Dividends to Preferred Stock
Shareholders 2.75% 2.53% 3.48% 3.61% 3.68%
-------------- -------------- -------------- -------------- --------------
Supplemental Data
Net assets applicable to
Common Stock, end of
period (in thousands) $275,281 $342,496 $341,230 $327,881 $323,033
-------------- -------------- -------------- -------------- --------------
Preferred Stock outstanding,
end of period (in
thousands) $150,000 $150,000 $150,000 $150,000 $150,000
-------------- -------------- -------------- -------------- --------------
Portfolio turnover 164.45% 154.08% 201.87% 95.49% 79.27%
-------------- -------------- -------------- -------------- --------------
Leverage:
Asset coverage per $1,000 $2,835 $3,283 $3,275 $3,186 $3,154
-------------- -------------- -------------- -------------- --------------
Liquidation preference per share $25,000 $25,000 $25,000 $25,000 $25,000
-------------- -------------- -------------- -------------- --------------
Average market value per share# $25,000 $25,000 $25,000 $25,000 $25,000
-------------- -------------- -------------- -------------- --------------
Dividends Per Share on Preferred
Shares Outstanding
Series A -
Investment income -- net $706 $629 $869 $897 $885
-------------- -------------- -------------- -------------- --------------
Series B -
Investment income -- net $702 $634 $868 $899 $942
-------------- -------------- -------------- -------------- --------------
Series C -
Investment income -- net $650 $634 $872 $910 $934
-------------- -------------- -------------- -------------- --------------
-----------------
* Annualized.
** Total investment returns based on market value, which can be
significantly greater or less than the net asset value, may result in
substantially different returns. Total investment returns exclude the
effects of sales charges.
*** Do not reflect the effect of dividends to Preferred Stock shareholders.
++ Based on average shares outstanding.
# Based on monthly market value per share + Amount is less than $.01 per
share.
++ Aggregate total investment return.
+ Certain prior year amounts have been reclassified to conform to current
year presentation.
++ Amount is less than ($.01) per share.
16
THE FUND
MuniYield Quality Fund II, Inc. (the "Fund") is a non-diversified,
closed-end fund. The Fund was incorporated under the laws of the State of
Maryland on July 9, 1992, and has registered under the Investment Company Act
of 1940, as amended ("1940 Act"). The Fund's principal executive office is
located at 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its
telephone number is (609) 282-2800.
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 Fund Asset Management, L.P. (the
"Investment Adviser") that have 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, if the Fund is the
acquired fund, 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 $9,755,000 after
payment of offering expenses (estimated to be approximately $145,000) and the
deduction of the underwriting discount.
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 this offering, 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."
CAPITALIZATION
The following table sets forth the unaudited capitalization of the Fund
as of April 30, 2005 and as adjusted to give effect to the issuance of the
shares of AMPS offered hereby.
Actual As Adjusted
------ -----------
Preferred Stock, par value $.05 per share (6000 shares
of Other AMPS authorized, issued and outstanding at
$25,000 per share liquidation preference, plus
accumulated but unpaid dividends; 6400 shares of
AMPS and Other AMPS authorized, issued and
outstanding, as adjusted, at $25,000 per share
liquidation preference, plus
accumulated but unpaid dividends)................ $150,023,040 $160,023,040
============ ============
Common stock, par value $.10 per share (199,994,000
shares authorized, 22,366,930 shares issued and
outstanding; 199,993,600 shares authorized,
22,366,930 shares issued and outstanding, as
adjusted)........................................ $2,236,693 $2,236,693
Paid-in capital in excess of par value........... 311,763,292 311,518,292
Undistributed investment income--net.............. 4,835,663 4,835,663
Accumulated realized capital losses--net.......... (39,087,186) (39,087,186)
Unrealized /appreciation--net..................... 26,833,656 26,833,656
============ ============
Net assets applicable to outstanding common stock.. $306,582,118 $306,337,118
============ ============
PORTFOLIO COMPOSITION
As of April 30, 2005, approximately 99.21% of the market value of the
Fund's portfolio was invested in long term and intermediate term municipal
obligations and approximately 0.79% of the market value of the Fund's
portfolio was invested in short term tax exempt securities. The following
table sets forth certain information with respect to the composition of the
Fund's long term and intermediate term municipal obligations investment
portfolio as of April 30, 2005.
17
Number of Value (in
Moody's* S&P* Issues thousands) Percent
----------- ----------- ----------- ----------- -----------
Aaa AAA 105 $400,110 88.38%
Aa AA 6 14,757 3.26
A A 7 26,398 5.83
Baa BBB 2 1,669 0.37
Ba BBB 1 8,606 1.90
NR** NR** 1 1,160 0.26
Total.......................------------ ------------- ------------
122 $452,700 100.00%
============ ============= ============
------------
* Ratings: Using the higher of Moody's or S&P ratings on the Fund's
investments. Moody's rating categories may be modified further by a 1, 2 or
3 in Aa, A, Baa, Ba, B and Caa ratings. S&P rating categories may be
modified further by a plus (+) or minus (-) in AA, A, BBB, BB, B and CCC
ratings.
** Not Rated.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide shareholders with as high
a level of current income exempt from Federal income taxes as is consistent
with its investment policies and prudent investment management. The Fund seeks
to achieve its investment objective by investing, as a fundamental policy, at
least 80% of an aggregate of the Fund's net assets (including proceeds from
the issuance of preferred stock), and the proceeds 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 excludable
from gross income for Federal income tax purposes (except that the interest
may be includable in taxable income for purposes of the Federal alternative
minimum tax) ("Municipal Bonds"). The Fund invests in Municipal Bonds which
are rated high grade (A or better) or, if unrated, are considered by the
Investment Adviser to be of comparable quality. The Fund's investment
objective and its policy of investing at least 80% of an aggregate of the
Fund's net assets (including proceeds from the issuance of preferred stock),
and the proceeds of any borrowings for investment purposes, in Municipal Bonds
are fundamental policies that may not be changed without a vote of a majority
of the outstanding voting securities of the Fund (as defined in the 1940 Act).
There can be no assurance that the Fund's investment objective will be
realized.
The Fund may invest in certain tax exempt securities classified as
"private activity bonds" (or industrial development bonds, under pre-1986 law)
("PABs") (in general, bonds that benefit non-governmental entities) that may
subject certain investors in the Fund to an alternative minimum tax. See
"Taxes." The percentage of the Fund's total assets invested in PABs will vary
from time to time. The Fund will not invest more than 25% of its total assets
(taken at market value) in Municipal Bonds whose issuers are located in the
same state.
The high grade Municipal Bonds in which the Fund invests are those
Municipal Bonds rated at the date of purchase in the three highest quality
ratings as determined by either Moody's Investors Service, Inc. ("Moody's")
(currently Aaa, Aa and A), Standard & Poor's ("S&P") (currently AAA, AA and A)
or Fitch Ratings ("Fitch") (currently AAA, AA and A). In the case of short
term notes, the high grade rating categories are SP-1+ through SP-2 for S&P,
MIG-1 through MIG-3 for Moody's and F-1+ through F-2 for Fitch. In the case of
tax exempt commercial paper, the high grade rating categories are A-1+ through
A-2 for S&P, Prime-1 through Prime-2 for Moody's and F-1+ through F-2 for
Fitch. There may be sub-categories or gradations indicating relative standing
within the rating categories set forth above. In assessing the quality of
Municipal Bonds with respect to the foregoing requirements, the Investment
Adviser takes into account the nature of any letters of credit or similar
credit enhancement to which particular Municipal Bonds are entitled and the
creditworthiness of the financial institution that provided such credit
enhancement. See Appendix A -- "Description of Municipal Bond Ratings" to the
statement of additional information. If unrated, such securities will possess
creditworthiness comparable, in the opinion of the Investment Adviser, to
other obligations in which the Fund may invest.
All percentage and ratings limitations on securities in which the Fund
may invest apply at the time of making an investment and shall not be
considered violated if an investment rating is subsequently downgraded to a
18
rating that would have precluded the Fund's initial investment in such
security. In the event that the Fund disposes of a portfolio security
subsequent to its being downgraded, the Fund may experience a greater risk of
loss than if such security had been sold prior to such downgrade.
The net asset value of the shares of common stock of a closed-end
investment company, such as the Fund, which invests primarily in fixed income
securities, changes as the general levels of interest rates fluctuate. When
interest rates decline, the value of a fixed income portfolio can be expected
to rise. Conversely, when interest rates rise, the value of a fixed income
portfolio can be expected to decline. Prices of longer term securities in
which the Fund primarily invests generally fluctuate more in response to
interest rate changes than do shorter term securities. These changes in net
asset value are likely to be greater in the case of a fund having a leveraged
capital structure, such as the Fund.
The Fund intends to invest primarily in long term Municipal Bonds with
maturities of more than ten years. However, the Fund also may invest in
intermediate term Municipal Bonds with maturities of between three years and
ten years. The Fund also may invest from time to time in short term Municipal
Bonds with maturities of less than three years. The average maturity of the
Fund's portfolio securities will vary based upon the Investment Adviser's
assessment of economic and market conditions. As of May 31, 2005, the weighted
average maturity of the Fund's portfolio was approximately 19.85 years.
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. Taxable money market obligations will yield taxable
income. 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 rate obligations for hedging purposes and to seek
to enhance return.
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 receives
an opinion of counsel to the issuer that such securities pay interest that is
excludable from gross income for Federal income tax purposes ("Non-Municipal
Tax Exempt Securities"). Non-Municipal Tax Exempt Securities could include
trust certificates, partnership interests 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 the Fund's investment restrictions and 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. While the Fund receives opinions of legal
counsel to the effect that the income from the Non-Municipal Tax Exempt
Securities in which the Fund invests is excludable from gross income for
Federal income tax purposes to the same extent as the underlying municipal
securities, the Internal Revenue Service ("IRS") has not issued a ruling on
this subject. Were the IRS to issue an adverse ruling or take an adverse
position with respect to the taxation of these types of securities, there is a
risk that the interest paid on such securities would be deemed taxable at the
Federal level.
The Fund ordinarily does not intend to realize significant investment
income not exempt from Federal income tax. From time to time, the Fund may
realize taxable capital gains.
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.
19
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 derivative instruments. See "-- 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 the 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 -- "Description of Municipal Bond Ratings" to the
statement of additional information. Obligations are included within the term
Municipal Bonds if the interest paid thereon is excluded from gross income for
Federal income tax purposes in the opinion of bond counsel to the issuer.
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 PABs.
The Fund has not established any limit on the percentage of its
portfolio that may be invested in PABs. The Fund 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.
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.
20
PABs. The Fund may purchase PABs. 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. 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 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 recorded 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
21
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 counterparty 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.
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 of common stock, the net asset value of the Fund's shares
of common stock will fluctuate. No assurance can be given that the Fund's
hedging transactions will be effective. The Fund only may engage in hedging
activities from time to time and may not necessarily be engaging in hedging
activities when movements in interest rates occur. The Fund has no obligation
to enter into hedging transactions and may choose not to do so. Furthermore,
for so long as the AMPS are rated by Moody's and S&P, the Fund's use of
options and certain financial futures and options thereon will be subject to
the limitations described under "Rating Agency Guidelines."
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, and 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
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.
22
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.
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, U.S.
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
23
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.
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.
......
Under regulations of the CFTC, the futures trading activity described
herein will not result in the Fund being deemed a "commodity pool" and the
Fund need not be operated by a person registered with the CFTC as a "commodity
pool operator."
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, an amount of cash, cash equivalents (e.g.,
high grade commercial paper and daily tender adjustable notes) or liquid
securities will be segregated, 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.
24
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 or less 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.
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
25
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.
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 the Fund against interest rate
fluctuations, to hedge against increases in the Fund's costs associated with
the dividend payments on any preferred stock, including the AMPS, or to seek
to increase 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 these 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 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
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
26
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 increase 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 exchange
for an equal face amount of deliverable obligations of the reference entity
whose value may have significantly decreased. 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 whose value may
have significantly decreased. 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 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 Securities and Exchange Commission). Such segregation
will ensure that the Fund has assets available to satisfy its obligations with
respect to the transaction and
27
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 obligation0.
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.
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 a 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
28
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.
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 ?% 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. 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. In addition,
borrowed funds are subject to interest costs that may offset or exceed the
return earned on the borrowed funds.
DESCRIPTION OF AMPS
Certain of the capitalized terms used herein not otherwise defined in
this prospectus have the meaning provided in the Glossary at the back of this
prospectus.
General
The Series D AMPS will be shares of preferred stock that entitle their
holders to receive dividends when, as and if declared by the Board of
Directors, out of funds legally available therefor, at a rate per annum that
may vary for the successive Dividend Periods. After the Initial Dividend
Period, each Subsequent Dividend Period for the Series D AMPS generally will
be a 7-Day Dividend Period; provided however, that prior to any Auction, the
Fund may elect, subject to certain limitations described herein, upon giving
notice to holders thereof, a special dividend period of up to five years (a
"Special Dividend Period"). The Applicable Rate for a particular Dividend
Period will be determined by an Auction conducted on the Business Day before
the start of such Dividend Period. Beneficial Owners and Potential Beneficial
Owners of shares of AMPS may participate in Auctions therefor, although,
except in the case of a Special Dividend Period of more than 28 days,
Beneficial Owners desiring to continue to hold all of their shares of AMPS
regardless of the Applicable Rate resulting from Auctions need not
participate. For an explanation of Auctions and the method of determining the
Applicable Rate, see "The Auction" herein and in the statement of additional
information.
The Fund has outstanding 6,000 shares of three other series of Auction
Market Preferred Stock, each with a liquidation preference of $25,000 per
share, plus accumulated but unpaid dividends, for an aggregate initial
liquidation preference of $150,000,000 (the "Other AMPS"). The Other AMPS are
as follows: 2,000 shares of Auction Market Preferred Stock, Series A; 2,000
shares of Auction Market Preferred Stock, Series B; and 2,000 shares of
Auction Market Preferred Stock, Series C. The Series D AMPS offered hereby
rank on a parity with the Other AMPS with respect to dividends and liquidation
preference. The terms of the shares of Other AMPS are substantially the same
as the terms of the shares of AMPS described below.
The following is a brief description of the terms of the shares of the
Series D AMPS. This description does not purport to be complete and is subject
to and qualified in its entirety by reference to the Fund's Charter and
Articles Supplementary, including the provisions thereof establishing the
Series D AMPS. The Fund's Charter and
29
the form of Articles Supplementary establishing the terms of the Series D AMPS
have been filed as exhibits to the Registration Statement of which this
prospectus is a part.
Dividends
General. The holders of shares of AMPS will be entitled to receive,
when, as and if declared by the Board of Directors of the Fund, out of funds
legally available therefor, cumulative cash dividends on their shares, at the
Applicable Rate determined as set forth below under "Determination of Dividend
Rate," payable on the respective dates set forth below. Dividends on the
shares of AMPS so declared and payable shall be paid (i) in preference to and
in priority over any dividends so declared and payable on the Fund's common
stock, and (ii) to the extent permitted under the Code, and to the extent
available, out of net tax exempt income earned on the Fund's investments.
Generally, dividends on shares of AMPS, to the extent that they are derived
from interest paid on Municipal Bonds, will be exempt from Federal income
taxes, subject to possible application of the alternative minimum tax. See
"Taxes."
Dividends on the shares of AMPS will accumulate from the date on which
the Fund originally issues the shares of AMPS (the "Date of Original Issue")
and will be payable on the dates described below. Dividends on shares of AMPS
with respect to the Initial Dividend Period shall be payable on the Initial
Dividend Payment Date. Following the Initial Dividend Payment Date for AMPS,
dividends on AMPS will be payable, at the option of the Fund, either (i) with
respect to any 7-Day Dividend Period and any Short Term Dividend Period of 35
or fewer days, on the day next succeeding the last day thereof or (ii) with
respect to any Short Term Dividend Period of more than 35 days and with
respect to any Long Term Dividend Period, monthly on the first Business Day of
each calendar month during such Short Term Dividend Period or Long Term
Dividend Period and on the day next succeeding the last day thereof (each such
date referred to in clause (i) or (ii) being referred to herein as a "Normal
Dividend Payment Date"), except that if such Normal Dividend Payment Date is
not a Business Day, the Dividend Payment Date shall be the first Business Day
next succeeding such Normal Dividend Payment Date. Thus, following the Initial
Dividend Payment Date for AMPS, dividends generally will be payable (in the
case of Dividend Periods which are not Special Dividend Periods) on each
succeeding Tuesday in the case of the Series D AMPS. Although any particular
Dividend Payment Date may not occur on the originally scheduled date because
of the exceptions discussed above, the next succeeding Dividend Payment Date,
subject to such exceptions, will occur on the next following originally
scheduled date. If for any reason a Dividend Payment Date cannot be fixed as
described above, then the Board of Directors shall fix the Dividend Payment
Date. The Board of Directors by resolution prior to authorization of a
dividend by the Board of Directors may change a Dividend Payment Date if such
change does not adversely affect the contract rights of the holders of shares
of AMPS set forth in the Charter. The Initial Dividend Period, 7-Day Dividend
Periods and Special Dividend Periods are hereinafter sometimes referred to as
"Dividend Periods." Each dividend payment date determined as provided above is
hereinafter referred to as a "Dividend Payment Date."
Prior to each Dividend Payment Date, the Fund is required to deposit
with the Auction Agent sufficient funds for the payment of declared dividends.
The Fund does not intend to establish any reserves for the payment of
dividends.
Each dividend will be paid to the record holder of the AMPS, which
holder is expected to be the nominee of the Securities Depository. See "The
Auction -- Securities Depository." The Securities Depository will credit the
accounts of the Agent Members of the Existing Holders in accordance with the
Securities Depository's normal procedures which provide for payment in
same-day funds. The Agent Member of an Existing Holder will be responsible for
holding or disbursing such payments on the applicable Dividend Payment Date to
such Existing Holder in accordance with the instructions of such Existing
Holder. Dividends in arrears for any past Dividend Period may be declared and
paid at any time, without reference to any regular Dividend Payment Date, to
the nominee of the Securities Depository. Any dividend payment made on shares
of AMPS first shall be credited against the earliest declared but unpaid
dividends accumulated with respect to such shares.
Holders of shares of AMPS will not be entitled to any dividends, whether
payable in cash, property or stock, in excess of full cumulative dividends
except as described below under "-- Additional Dividends" in this prospectus
and under "Description of AMPS -- Dividends -- Non-Payment Period; Late
Charge" in the statement
30
of additional information. No interest will be payable in respect of any
dividend payment or payments on the shares of AMPS that may be in arrears.
The amount of cash dividends per share of the AMPS payable (if declared)
on the Initial Dividend Payment Date, and on each Dividend Payment Date of
each 7-Day Dividend Period and each Short Term Dividend Period shall be
computed by multiplying the Applicable Rate for such Dividend Period by a
fraction, the numerator of which will be the number of days in such Dividend
Period or part thereof that such share was outstanding and for which dividends
are payable on such Dividend Payment Date and the denominator of which will be
365, multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent. During any Long Term Dividend Period, the amount
of cash dividends per share of AMPS payable (if declared) on any Dividend
Payment Date shall be computed by multiplying the Applicable Rate for such
Dividend Period by a fraction, the numerator of which will be such number of
days in such part of such Dividend Period that such share was outstanding and
for which dividends are payable on such Dividend Payment Date and the
denominator of which will be 360, multiplying the amount so obtained by
$25,000, and rounding the amount so obtained to the nearest cent.
Notification of Dividend Period. With respect to each Dividend Period
that is a Special Dividend Period, the Fund, at its sole option and to the
extent permitted by law, by telephonic and written notice (a "Request for
Special Dividend Period") to the Auction Agent and to each Broker-Dealer, may
request that the next succeeding Dividend Period for the AMPS will be a number
of days (other than seven), evenly divisible by seven, and not fewer than
seven nor more than 364 in the case of a Short Term Dividend Period or one
whole year or more but not greater than five years in the case of a Long Term
Dividend Period, specified in such notice, provided that the Fund may not give
a Request for Special Dividend Period (and any such request shall be null and
void) unless, for any Auction occurring after the initial Auction, Sufficient
Clearing Bids were made in the last occurring Auction and unless full
cumulative dividends and any amounts due with respect to redemptions, and any
Additional Dividends payable prior to such date have been paid in full. Such
Request for Special Dividend Period, in the case of a Short Term Dividend
Period, shall be given on or prior to the second Business Day but not more
than seven Business Days prior to an Auction Date for the AMPS and, in the
case of a Long Term Dividend Period, shall be given on or prior to the second
Business Day but not more than 28 days prior to an Auction Date for the AMPS.
Upon receiving such Request for Special Dividend Period, the Broker-Dealers
jointly shall determine whether, given the factors set forth below, it is
advisable that the Fund issue a Notice of Special Dividend Period for the AMPS
as contemplated by such Request for Special Dividend Period and the Optional
Redemption Price of the AMPS during such Special Dividend Period and the
Specific Redemption Provisions and shall give the Fund written notice (a
"Response") of such determination by no later than the second Business Day
prior to such Auction Date. In the event the Response indicates that it is
advisable that the Fund give a notice of a Special Dividend Period for the
AMPS, the Fund, by no later than the second Business Day prior to such Auction
Date may give a notice (a "Notice of Special Dividend Period") to the Auction
Agent, the Securities Depository and each Broker-Dealer. See "Description of
AMPS -- Dividends -- Notification of Dividend Period" in the statement of
additional information for a detailed description of these procedures.
Determination of Dividend Rate. The dividend rate on shares of the AMPS
during the period from and including the Date of Original Issue for the AMPS
to but excluding the Initial Dividend Payment Date (the "Initial Dividend
Period") with respect to the AMPS will be the rate per annum set forth above
under "Prospectus Summary -- Dividends and Dividend Periods." Commencing on
the Initial Dividend Payment Date for the AMPS, the Applicable Rate on the
AMPS for each Subsequent Dividend Period, which Subsequent Dividend Period
shall be a period commencing on and including a Dividend Payment Date and
ending on and including the calendar day prior to the next Dividend Payment
Date (or calendar day prior to the last Dividend Payment Date in a Dividend
Period if there is more than one Dividend Payment Date), shall be equal to the
rate per annum that results from the Auction with respect to such Subsequent
Dividend Period. The Initial Dividend Period and Subsequent Dividend Period
for AMPS is referred to herein as a "Dividend Period." Cash dividends shall be
calculated as set forth above under "Dividends -- General."
Restrictions on Dividends and Other Payments. Under the 1940 Act, the
Fund may not declare dividends or make other distributions on shares of common
stock or purchase any such shares if, at the time of the declaration,
distribution or purchase, as applicable (and after giving effect thereto),
asset coverage (as defined in the 1940 Act) with respect to the outstanding
shares of AMPS (and Other AMPS) would be less than 200% (or such other
percentage as in the future may be required by law). The Fund estimates that,
based on the composition of its
31
portfolio at April 30, 2005, asset coverage with respect to shares of AMPS
would be approximately 291% representing approximately 34% of the Fund's
capital and 52% of the Fund's common stock equity immediately after the
issuance of the shares of AMPS offered hereby. Under the Code, the Fund, among
other things, must distribute at least 90% of its investment company taxable
income each year in order to maintain its qualification for tax treatment as a
regulated investment company. The foregoing limitations on dividends,
distributions and purchases under certain circumstances may impair the Fund's
ability to maintain such qualification. See "Taxes" in the statement of
additional information.
Upon any failure to pay dividends on shares of AMPS for two years or
more, the holders of the shares of AMPS will acquire certain additional voting
rights. See "Voting Rights" below. Such rights shall be the exclusive remedy
of the holders of shares of AMPS upon any failure to pay dividends on shares
of the Fund.
Additional Dividends. If the Fund retroactively allocates any net
capital gain or other income subject to regular Federal income taxes to shares
of AMPS without having given advance notice thereof to the Auction Agent as
described under "The Auction -- Auction Procedures -- Auction Date; Advance
Notice of Allocation of Taxable Income; Inclusion of Taxable Income in
Dividends" below, which may only happen when such allocation is made as a
result of the redemption of all or a portion of the outstanding shares of AMPS
or the liquidation of the Fund (the amount of such allocation referred to
herein as a "Retroactive Taxable Allocation"), the Fund, within 90 days (and
generally within 60 days) after the end of the Fund's fiscal year for which a
Retroactive Taxable Allocation is made, will provide notice thereof to the
Auction Agent and to each holder of shares (initially Cede as nominee of the
Securities Depository) during such fiscal year at such holder's address as the
same appears or last appeared on the stock books of the Fund. The Fund, within
30 days after such notice is given to the Auction Agent, will pay to the
Auction Agent (who then will distribute to such holders of shares of AMPS),
out of funds legally available therefor, an amount equal to the aggregate
Additional Dividend (as defined below) with respect to all Retroactive Taxable
Allocations made to such holders during the fiscal year in question.
An "Additional Dividend" means payment to a present or former holder of
shares of AMPS of an amount which, when taken together with the aggregate
amount of Retroactive Taxable Allocations made to such holder with respect to
the fiscal year in question, would cause such holder's dividends in dollars
(after Federal income tax consequences) from the aggregate of both the
Retroactive Taxable Allocations and the Additional Dividend to be equal to the
dollar amount of the dividends which would have been received by such holder
if the amount of the aggregate Retroactive Taxable Allocations had been
excludable from the gross income of such holder. Such Additional Dividend
shall be calculated (i) without consideration being given to the time value of
money; (ii) assuming that no holder of shares of AMPS is subject to the
Federal alternative minimum tax with respect to dividends received from the
Fund; and (iii) assuming that each Retroactive Taxable Allocation would be
taxable in the hands of each holder of shares of AMPS at the greater of: (a)
the maximum marginal regular Federal individual income tax rate applicable to
ordinary income or capital gains depending on the taxable character of the
distribution (including any surtax); or (b) the maximum marginal regular
Federal corporate income tax rate applicable to ordinary income or capital
gains depending on the taxable character of the distribution (disregarding in
both (a) and (b) the effect of any state or local taxes and the phase out of,
or provision limiting, personal exemptions, itemized deductions, or the
benefit of lower tax brackets). Although the Fund generally intends to
designate any Additional Dividend as an exempt-interest dividend to the extent
permitted by applicable law, it is possible that all or a portion of any
Additional Dividend will be taxable to the recipient thereof. See "Taxes" in
the statement of additional information. The Fund will not pay a further
Additional Dividend with respect to any taxable portion of an Additional
Dividend.
If the Fund does not give advance notice of the amount of taxable income
to be included in a dividend on shares of AMPS in the related Auction, the
Fund may include such taxable income in a dividend on shares of AMPS if it
increases the dividend by an additional amount calculated as if such income
were a Retroactive Taxable Allocation and the additional amount were an
Additional Dividend and notifies the Auction Agent of such inclusion at least
five Business Days prior to the applicable Dividend Payment Date. See "The
Auction -- Auction Procedures -- Auction Date; Advance Notice of Allocation of
Taxable Income; Inclusion of Taxable Income in Dividends" below.
32
Asset Maintenance
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Articles Supplementary. These requirements
are summarized below.
1940 Act AMPS Asset Coverage. The Fund will be required under the
Articles Supplementary to maintain, with respect to shares of AMPS, as of the
last Business Day of each month in which any shares of AMPS are outstanding,
asset coverage of at least 200% with respect to senior securities that are
stock, including the shares of AMPS and Other AMPS (or such other asset
coverage as in the future may be specified in or under the 1940 Act as the
minimum asset coverage for senior securities that are stock of a closed-end
investment company as a condition of paying dividends on its common stock)
("1940 Act AMPS Asset Coverage"). If the Fund fails to maintain 1940 Act AMPS
Asset Coverage and such failure is not cured as of the last Business Day of
the following month (the "1940 Act Cure Date"), the Fund will be required
under certain circumstances to redeem certain of the shares of AMPS. See
"Redemption" below.
Based upon the composition of the Fund's portfolio on April 30, 2005,
the 1940 Act AMPS Asset Coverage immediately following the issuance of AMPS
offered hereby (after giving effect to the deduction of the underwriting
discount and offering expenses for the shares of AMPS) will be computed as
follows:
Value of Fund assets
less liabilities not
constituting senior securities $466,337,118
----------------------------------- = ----------------- = 291%
Senior securities representing $160,023,040
indebtedness plus liquidation
value of the shares of AMPS
AMPS Basic Maintenance Amount. So long as shares of AMPS are
outstanding, the Fund will be required under the Articles Supplementary to
maintain as of the last Business Day of each week (a "Valuation Date") Moody's
Eligible Assets and S&P Eligible Assets each having in the aggregate a
Discounted Value at least equal to the AMPS Basic Maintenance Amount. The AMPS
Basic Maintenance Amount includes the sum of (i) the aggregate liquidation
value of AMPS and Other AMPS then outstanding and (ii) certain accrued and
projected payment obligations of the Fund. See "Description of AMPS -- Asset
Maintenance -- AMPS Basic Maintenance Amount" in the statement of additional
information. If the Fund fails to meet such requirement as of any Valuation
Date and such failure is not cured on or before the sixth Business Day after
such Valuation Date (the "AMPS Basic Maintenance Cure Date"), the Fund will be
required under certain circumstances to redeem certain of the shares of AMPS.
Upon any failure to maintain the required Discounted Value, the Fund will use
its best efforts to alter the composition of its portfolio to reattain a
Discounted Value at least equal to the AMPS Basic Maintenance Amount on or
prior to the AMPS Basic Maintenance Cure Date. See "Redemption" herein and in
the statement of additional information.
Redemption
Optional Redemption. To the extent permitted under the 1940 Act and
under Maryland law, upon giving a Notice of Redemption, as provided in the
statement of additional information, the Fund, at its option, may redeem
shares of AMPS, in whole or in part, out of funds legally available therefor,
at the Optional Redemption Price per share on any Dividend Payment Date;
provided that no share of AMPS may be redeemed at the option of the Fund
during (a) the Initial Dividend Period with respect to such share or (b) a
Non-Call Period to which such share is subject. "Optional Redemption Price"
means $25,000 per share of AMPS plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption
plus any applicable redemption premium, if any, attributable to the
designation of a Premium Call Period. In addition, holders of AMPS may be
entitled to receive Additional Dividends in the event of redemption of such
AMPS to the extent provided herein. See "Dividends -- Additional Dividends."
The Fund has the authority to redeem the AMPS for any reason and may redeem
all or part of the outstanding shares of AMPS if it anticipates that the
Fund's leveraged capital structure will result in a lower rate of return to
holders of common stock for any significant period of time than that
obtainable if the common stock were unleveraged.
33
Mandatory Redemption. The Fund will be required to redeem, out of funds
legally available therefor, at the Mandatory Redemption Price per share,
shares of AMPS to the extent permitted under the 1940 Act and Maryland law, on
a date fixed by the Board of Directors, if the Fund fails to maintain Moody's
Eligible Assets and S&P Eligible Assets each with an aggregate Discounted
Value equal to or greater than the AMPS Basic Maintenance Amount or to satisfy
the 1940 Act AMPS Asset Coverage and such failure is not cured on or before
the AMPS Basic Maintenance Cure Date or the 1940 Act Cure Date (herein
collectively referred to as a "Cure Date"), as the case may be. "Mandatory
Redemption Price" means $25,000 per share of AMPS plus an amount equal to
accumulated but unpaid dividends (whether or not earned or declared) to the
date fixed for redemption. In addition, holders of AMPS may be entitled to
receive Additional Dividends in the event of redemption of such AMPS to the
extent provided herein. See "Dividends -- Additional Dividends."
For a discussion of the allocation procedures to be used if fewer than
all of the outstanding shares of AMPS are to be redeemed and for a discussion
of other redemption procedures, see "Description of AMPS -- Redemption" in the
statement of additional information.
Liquidation Rights
Upon any liquidation, dissolution or winding up of the Fund, whether
voluntary or involuntary, the holders of shares of AMPS will be entitled to
receive, out of the assets of the Fund available for distribution to
stockholders, before any distribution or payment is made upon any shares of
common stock or any other capital stock of the Fund ranking junior in right of
payment upon liquidation of AMPS, $25,000 per share together with the amount
of any dividends accumulated but unpaid (whether or not earned or declared)
thereon to the date of distribution, and after such payment the holders of
AMPS will be entitled to no other payments except for Additional Dividends. If
such assets of the Fund shall be insufficient to make the full liquidation
payment on the outstanding shares of AMPS and liquidation payments on any
other outstanding class or series of preferred stock of the Fund ranking on a
parity with the AMPS as to payment upon liquidation, including the Other AMPS,
then such assets will be distributed among the holders of such shares of AMPS
and the holders of shares of such other class or series, including the Other
AMPS, ratably in proportion to the respective preferential amounts to which
they are entitled. After payment of the full amount of liquidation
distribution to which they are entitled, the holders of AMPS will not be
entitled to any further participation in any distribution of assets by the
Fund. A consolidation, merger or share exchange of the Fund with or into any
other entity or entities or a sale, whether for cash, shares of stock,
securities or properties, of all or substantially all or any part of the
assets of the Fund shall not be deemed or construed to be a liquidation,
dissolution or winding up of the Fund.
Voting Rights
Except as otherwise indicated in this prospectus and the statement of
additional information and except as otherwise required by applicable law,
holders of shares of AMPS will be entitled to one vote per share on each
matter submitted to a vote of stockholders of the Fund and will vote together
with holders of shares of common stock as a single class.
The 1940 Act and the Articles Supplementary require that the holders of
preferred stock, including the AMPS and Other AMPS, voting as a separate
class, have the rights to elect two of the Fund's Directors at all times and
to elect a majority of the Directors at any time that two full years'
dividends on the AMPS (and Other AMPS) are unpaid. The holders of AMPS (and
Other AMPS) will vote as a separate class or classes on certain other matters
as required under the Articles Supplementary, the 1940 Act and Maryland law.
In addition, the Series D AMPS (and Other AMPS) may vote as a separate series
under certain circumstances. See "Description of AMPS -- Voting Rights" in the
statement of additional information.
THE AUCTION
Certain of the capitalized terms used herein not otherwise defined in
this prospectus have the meaning provided in the Glossary at the back of this
prospectus.
34
General
Holders of the shares of the Series D AMPS will be entitled to receive
cumulative cash dividends on their shares when, as and if declared by the
Board of Directors of the Fund, out of funds legally available therefor, on
the Initial Dividend Payment Date with respect to the Initial Dividend Period
and, thereafter, on each Dividend Payment Date with respect to a Subsequent
Dividend Period (generally a period of seven days, subject to certain
exceptions set forth under "Description of AMPS -- Dividends -- General") at
the rate per annum equal to the Applicable Rate for each such Dividend Period.
The provisions of the Articles Supplementary establishing the terms of
the shares of the Series D AMPS offered hereby will provide that the
Applicable Rate for the shares of AMPS for each Dividend Period after the
Initial Dividend Period therefor will be equal to the rate per annum that the
Auction Agent advises has resulted on the Business Day preceding the first day
of such Dividend Period due to implementation of the auction procedures set
forth in the Articles Supplementary (the "Auction Procedures") in which
persons determine to hold or offer to purchase or sell shares of AMPS. The
Auction Procedures are attached as Appendix C to the statement of additional
information.
Each periodic operation of such procedures with respect to the shares of
AMPS is referred to hereinafter as an "Auction." If, however, the Fund should
fail to pay or duly provide for the full amount of any dividend on shares of
AMPS or the redemption price of shares of AMPS called for redemption, the
Applicable Rate for shares of AMPS will be determined as set forth under
"Description of AMPS -- Dividends -- Non-Payment Period; Late Charge" in the
statement of additional information.
Auction Agent Agreement. The Fund has entered into an agreement with The
Bank of New York (together with any successor bank or trust company or other
entity entering into a similar agreement with this Fund, the "Auction Agent")
(the "Auction Agent Agreement"), which provides, among other things, that the
Auction Agent will follow the Auction Procedures for the purpose of
determining the Applicable Rate for the AMPS. The Fund will pay the Auction
Agent compensation for its services under the Auction Agent Agreement.
Broker-Dealer Agreements. The Auction Agent has entered into agreements
with Merrill Lynch and more than 20 other broker-dealers and may enter into
similar agreements (collectively, the "Broker-Dealer Agreements") with one or
more other broker-dealers (collectively, the "Broker-Dealers") selected by the
Fund, which provide for the participation of such Broker-Dealers in Auctions.
Merrill Lynch is an affiliate of the Investment Adviser in that they share a
common parent, Merrill Lynch & Co., Inc.
Securities Depository. The Depository Trust Company initially will act
as the Securities Depository for the Agent Members with respect to the shares
of Series D AMPS. One or more registered certificates for all of the shares of
the Series D AMPS initially will be registered in the name of Cede, as nominee
of the Securities Depository. The certificate will bear a legend to the effect
that such certificate is issued subject to the provisions restricting
transfers of shares of AMPS to which it relates contained in the Articles
Supplementary. Cede initially will be the holder of record of all shares of
AMPS, and Beneficial Owners will not be entitled to receive certificates
representing their ownership interest in such shares. The Securities
Depository will maintain lists of its participants and will maintain the
positions (ownership interests) of shares of AMPS held by each Agent Member,
whether as the Beneficial Owner thereof for its own account or as nominee for
the Beneficial Owner thereof. Payments made by the Fund to holders of AMPS
will be duly made by making payments to the nominee of the Securities
Depository.
Auction Procedures
The following is a brief discussion of the procedures to be used in
conducting Auctions. This summary is qualified by reference to the Auction
Procedures set forth in Appendix C to the statement of additional information.
The Settlement Procedures to be used with respect to Auctions are set forth in
Appendix B to the statement of additional information.
Auction Date; Advance Notice of Allocation of Taxable Income; Inclusion
of Taxable Income in Dividends. An Auction to determine the Applicable Rate
for the shares of the Series D AMPS offered hereby for each Dividend
35
Period (other than the Initial Dividend Period therefor) will be held on the
first Business Day (as hereinafter defined) preceding the first day of such
Dividend Period, which first day is also a Dividend Payment Date for the
preceding Dividend Period (the date of each Auction being referred to herein
as an "Auction Date"). "Business Day" means a day on which the New York Stock
Exchange (the "NYSE") is open for trading and which is not a Saturday, Sunday
or other day on which banks in the City of New York are authorized or
obligated by law to close. Auctions for shares of the Series D AMPS for
Dividend Periods after the Initial Dividend Period normally will be held every
Monday after the preceding Dividend Payment Date, and each subsequent Dividend
Period normally will begin on the following Tuesday (also a Dividend Payment
Date). The Auction Date and the first day of the related Dividend Period for
the Series D AMPS (both of which must be Business Days) need not be
consecutive calendar days. For example, in most cases, if the Monday that
normally would be an Auction Date for Series D AMPS is not a Business Day,
then such Auction Date will be the preceding Friday and the first day of the
related Dividend Period will continue to be the following Tuesday. See
"Description of AMPS -- Dividends" for information concerning the
circumstances under which a Dividend Payment Date may fall on a date other
than the days specified above, which may affect the Auction Date.
Except as noted below, whenever the Fund intends to include any net
capital gain or other income subject to regular Federal income taxes in any
dividend on shares of AMPS, the Fund will notify the Auction Agent of the
amount to be so included at least five Business Days prior to the Auction Date
on which the Applicable Rate for such dividend is to be established. Whenever
the Auction Agent receives such notice from the Fund, in turn it will notify
each Broker-Dealer, who, on or prior to such Auction Date, in accordance with
its Broker-Dealer Agreement, will notify its customers who are Beneficial
Owners and Potential Beneficial Owners believed to be interested in submitting
an Order in the Auction to be held on such Auction Date. The Fund also may
include such income in a dividend on shares of AMPS without giving advance
notice thereof if it increases the dividend by an additional amount calculated
as if such income were a Retroactive Taxable Allocation and the additional
amount were an Additional Dividend; provided that the Fund will notify the
Auction Agent of the additional amounts to be included in such dividend at
least five Business Days prior to the applicable Dividend Payment Date. See
"Description of AMPS -- Dividends -- Additional Dividends" above.
Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders. On or prior to each Auction Date:
(a) each Beneficial Owner may submit to its Broker-Dealer by
telephone a:
(i) Hold Order -- indicating the number of outstanding
shares, if any, of AMPS that such Beneficial Owner desires to
continue to hold without regard to the Applicable Rate for the
next Dividend Period for such shares;
(ii) Bid -- indicating the number of outstanding shares, if
any, of AMPS that such Beneficial Owner desires to continue to
hold, provided that the Applicable Rate for the next Dividend
Period for such shares is not less than the rate per annum then
specified by such Beneficial Owner; and/or
(iii) Sell Order -- indicating the number of outstanding
shares, if any, of AMPS that such Beneficial Owner offers to sell
without regard to the Applicable Rate for the next Dividend Period
for such shares; and
(b) Broker-Dealers will contact customers who are Potential
Beneficial Owners of shares of AMPS to determine whether such Potential
Beneficial Owners desire to submit Bids indicating the number of shares
of AMPS which they offer to purchase provided that the Applicable Rate
for the next Dividend Period for such shares is not less than the rates
per annum specified in such Bids.
The communication by a Beneficial Owner or Potential Beneficial Owner to
a Broker-Dealer and the communication by a Broker-Dealer, whether or not
acting for its own account, to the Auction Agent of the foregoing information
is hereinafter referred to as an "Order" and collectively as "Orders." A
Beneficial Owner or a Potential Beneficial Owner placing an Order, including a
Broker-Dealer acting in such capacity for its own account, is hereinafter
referred to as a "Bidder" and collectively as "Bidders." Any Order submitted
by a Beneficial Owner or a
36
Potential Beneficial Owner to its Broker-Dealer, or by a Broker-Dealer to the
Auction Agent, prior to the Submission Deadline on any Auction Date shall be
irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders
with respect to shares of AMPS then held by such Beneficial Owner, as well as
Bids for additional shares of AMPS. For information concerning the priority
given to different types of Orders placed by Beneficial Owners, see
"Submission of Orders by Broker-Dealers to Auction Agent" below.
The Maximum Applicable Rate for shares of AMPS will be the higher of (A)
the Applicable Percentage of the Reference Rate or (B) the Applicable Spread
plus the Reference Rate. The Auction Agent will round each applicable Maximum
Applicable Rate to the nearest one-thousandth (0.001) of one percent per
annum, with any such number ending in five ten-thousandths of one percent
being rounded upwards to the nearest one-thousandth (0.001) of one percent.
The Auction Agent will not round the applicable Reference Rate as part of its
calculation of the Maximum Applicable Rate.
The Maximum Applicable Rate for shares of AMPS will depend on the credit
rating or ratings assigned to such shares. The Applicable Percentage and the
Applicable Spread will be determined based on (i) the lower of the credit
rating or ratings assigned on such date to such shares by Moody's and S&P (or
if Moody's or S&P or both shall not make such rating available, the equivalent
of either or both of such ratings by a Substitute Rating Agency or two
Substitute Rating Agencies or, in the event that only one such rating shall be
available, such rating) and (ii) whether the Fund has provided notification to
the Auction Agent prior to the Auction establishing the Applicable Rate for
any dividend that net capital gain or other taxable income will be included in
such dividend on shares of AMPS as follows:
Applicable Applicable Applicable
Credit Ratings Percentage of Percentage of Spread Over Applicable
-----------------------------------
Reference Reference Reference Rate Spread Over
Rate--No Rate-- --No Reference Rate
Moody's S&P Notification Notification Notification --Notification
------------------ ---------------- --------------- --------------- ---------------- ----------------
Aaa AAA 110% 125% 1.10% 1.25%
Aa3 to Aa1 AA- to AA+ 125% 150% 1.25% 1.50%
A3 to A1 A- to A+ 150% 200% 1.50% 2.00%
Baa3 to Baa1 BBB- to BBB+ 175% 250% 1.75% 2.50%
Below Baa3 Below BBB- 200% 300% 2.00% 3.00%
There is no minimum Applicable Rate in respect of any Dividend Period.
The Applicable Percentage and the Applicable Spread as so determined may
be further subject to upward but not downward adjustment in the discretion of
the Board of Directors of the Fund after consultation with the Broker-Dealers,
provided that immediately following any such increase, the Fund would be in
compliance with the AMPS Basic Maintenance Amount. The Fund will take all
reasonable action necessary to enable either S&P or Moody's, or both to
provide a rating for the AMPS, subject to the Fund's ability to terminate
compliance with the rating agency guidelines as discussed under "Rating Agency
Guidelines." If either S&P or Moody's, or both, shall not make such a rating
available, and subject to the Fund's ability to terminate compliance with the
rating agency guidelines discussed under "Rating Agency Guidelines," Merrill
Lynch or its affiliates and successors, after obtaining the Fund's approval,
will select another NRSRO (a "Substitute Rating Agency") or two other NRSROs
("Substitute Rating Agencies") to act as a Substitute Rating Agency or
Substitute Rating Agencies, as the case may be.
Any Bid by a Beneficial Owner specifying a rate per annum higher than
the Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of
Shares."
37
Neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to comply with the foregoing.
A Broker-Dealer also may hold AMPS in its own account as a Beneficial
Owner. A Broker-Dealer thus may submit Orders to the Auction Agent as a
Beneficial Owner or a Potential Beneficial Owner and therefore participate in
an Auction as an Existing Holder or Potential Holder on behalf of both itself
and its customers. Any Order placed with the Auction Agent by a Broker-Dealer
as or on behalf of a Beneficial Owner or a Potential Beneficial Owner will be
treated in the same manner as an Order placed with a Broker-Dealer by a
Beneficial Owner or a Potential Beneficial Owner. Similarly, any failure by a
Broker-Dealer to submit to the Auction Agent an Order in respect of any AMPS
held by it or its customers who are Beneficial Owners will be treated in the
same manner as a Beneficial Owner's failure to submit to its Broker-Dealer an
Order in respect of AMPS held by it, as described in the next paragraph.
Inasmuch as a Broker-Dealer participates in an Auction as an Existing Holder
or a Potential Holder only to represent the interests of a Beneficial Owner or
Potential Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction for Existing
Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented thereby. For information concerning the
priority given to different types of Orders placed by Existing Holders, see
"Submission of Orders by Broker-Dealers to Auction Agent." Each purchase or
sale in an Auction will be settled on the Business Day next succeeding the
Auction Date at a price per share equal to $25,000. See "Notification of
Results; Settlement" below.
If one or more Orders covering in the aggregate all of the outstanding
shares of AMPS held by a Beneficial Owner are not submitted to the Auction
Agent prior to the Submission Deadline, either because a Broker-Dealer failed
to contact such Beneficial Owner or otherwise, the Auction Agent shall deem a
Hold Order (in the case of an Auction relating to a Dividend Period which is
not a Special Dividend Period of more than 28 days) and a Sell Order (in the
case of an Auction relating to a Special Dividend Period of more than 28 days)
to have been submitted on behalf of such Beneficial Owner covering the number
of outstanding shares of AMPS held by such Beneficial Owner and not subject to
Orders submitted to the Auction Agent.
If all of the outstanding shares of AMPS are subject to Submitted Hold
Orders, the Dividend Period next succeeding the Auction automatically shall be
the same length as the immediately preceding Dividend Period, and the
Applicable Rate for the next Dividend Period for all shares of AMPS will be
60% of the Reference Rate on the date of the applicable Auction (or 90% of
such rate if the Fund has provided notification to the Auction Agent prior to
the Auction establishing the Applicable Rate for any dividend that net capital
gain or other taxable income will be included in such dividend on shares of
AMPS).
For the purposes of an Auction, shares of AMPS for which the Fund shall
have given notice of redemption and deposited moneys therefor with the Auction
Agent in trust or segregated in an account at the Fund's custodian bank for
the benefit of holders of AMPS to be redeemed and for payment to the Auction
Agent, as set forth under "Description of AMPS -- Redemption" in the statement
of additional information, will not be considered as outstanding and will not
be included in such Auction. Pursuant to the Articles Supplementary of the
Fund, the Fund will be prohibited from reissuing and its affiliates (other
than Merrill Lynch) will be prohibited from transferring (other than to the
Fund) any shares of AMPS they may acquire. Neither the Fund nor any affiliate
of the Fund may submit an Order in any Auction, except that an affiliate of
the Fund that is a Broker-Dealer (i.e., Merrill Lynch) may submit an Order.
Submission of Orders by Broker-Dealers to Auction Agent. Prior to 1:00
p.m., Eastern time, on each Auction Date, or such other time on the Auction
Date as may be specified by the Auction Agent (the "Submission Deadline"),
each Broker-Dealer will submit to the Auction Agent in writing or through a
mutually acceptable electronic means all Orders obtained by it for the Auction
to be conducted on such Auction Date, designating itself (unless otherwise
permitted by the Fund) as the Existing Holder or Potential Holder in respect
of the shares of AMPS subject to such Orders. Any Order submitted by a
Beneficial Owner or a Potential Beneficial Owner to its Broker-Dealer, or by a
Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three
figures to the right of the decimal point, the Auction Agent will round such
rate per annum up to the next highest one-thousandth (.001) of 1%.
38
If one or more Orders of an Existing Holder are submitted to the Auction
Agent and such Orders cover in the aggregate more than the number of
outstanding shares of AMPS held by such Existing Holder, such Orders will be
considered valid in the following order of priority:
(a) any Hold Order will be considered valid up to and including
the number of outstanding shares of AMPS held by such Existing Holder,
provided that if more than one Hold Order is submitted by such Existing
Holder and the number of shares of AMPS subject to such Hold Orders
exceeds the number of outstanding shares of AMPS held by such Existing
Holder, the number of shares of AMPS subject to each of such Hold Orders
will be reduced pro rata so that such Hold Orders, in the aggregate,
will cover exactly the number of outstanding shares of AMPS held by such
Existing Holder;
(b) any Bids will be considered valid, in the ascending order of
their respective rates per annum if more than one Bid is submitted by
such Existing Holder, up to and including the excess of the number of
outstanding shares of AMPS held by such Existing Holder over the number
of outstanding shares of AMPS subject to any Hold Order referred to in
clause (a) above (and if more than one Bid submitted by such Existing
Holder specifies the same rate per annum and together they cover more
than the remaining number of shares that can be the subject of valid
Bids after application of clause (a) above and of the foregoing portion
of this clause (b) to any Bid or Bids specifying a lower rate or rates
per annum, the number of shares subject to each of such Bids will be
reduced pro rata so that such Bids, in the aggregate, cover exactly such
remaining number of outstanding shares); and the number of outstanding
shares, if any, subject to Bids not valid under this clause (b) shall be
treated as the subject of a Bid by a Potential Holder; and
(c) any Sell Order will be considered valid up to and including
the excess of the number of outstanding shares of AMPS held by such
Existing Holder over the sum of the number of shares of AMPS subject to
Hold Orders referred to in clause (a) above and the number of shares of
AMPS subject to valid Bids by such Existing Holder referred to in clause
(b) above; provided that, if more than one Sell Order is submitted by
any Existing Holder and the number of shares of AMPS subject to such
Sell Orders is greater than such excess, the number of shares of AMPS
subject to each of such Sell Orders will be reduced pro rata so that
such Sell Orders, in the aggregate, will cover exactly the number of
shares of AMPS equal to such excess.
If more than one Bid of any Potential Holder is submitted in any
Auction, each Bid submitted in such Auction will be considered a separate Bid
with the rate per annum and number of shares of AMPS therein specified.
Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate. Not earlier than the Submission Deadline for each Auction,
the Auction Agent will assemble all Orders submitted or deemed submitted to it
by the Broker-Dealers (each such "Hold Order," "Bid" or "Sell Order" as
submitted or deemed submitted by a Broker-Dealer hereinafter being referred to
as a "Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as
the case may be, or as a "Submitted Order") and will determine the excess of
the number of outstanding shares of AMPS over the number of outstanding shares
of AMPS subject to Submitted Hold Orders (such excess being referred to as the
"Available AMPS") and whether Sufficient Clearing Bids have been made in such
Auction. Sufficient Clearing Bids will have been made if the number of
outstanding shares of AMPS that are the subject of Submitted Bids of Potential
Holders with rates per annum not higher than the Maximum Applicable Rate
equals or exceeds the number of outstanding shares that are the subject of
Submitted Sell Orders (including the number of shares subject to Bids of
Existing Holders specifying rates per annum higher than the Maximum Applicable
Rate).
If Sufficient Clearing Bids have been made, the Auction Agent will
determine the lowest rate per annum specified in the Submitted Bids (the
"Winning Bid Rate") which would result in the number of shares subject to
Submitted Bids specifying such rate per annum or a lower rate per annum being
at least equal to the Available AMPS. If Sufficient Clearing Bids have been
made, the Winning Bid Rate will be the Applicable Rate for the next Dividend
Period for all shares of AMPS then outstanding.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders), the
Dividend Period next following the Auction automatically will be a 7-Day
39
Dividend Period in the case of the Series D AMPS, and the Applicable Rate for
such Dividend Period will be equal to the Maximum Applicable Rate.
If Sufficient Clearing Bids have not been made, Beneficial Owners that
have Submitted Sell Orders will not be able to sell in the Auction all, and
may not be able to sell any, shares of AMPS subject to such Submitted Sell
Orders. See "Acceptance and Rejection of Submitted Bids and Submitted Sell
Orders and Allocation of Shares." Thus, under some circumstances, Beneficial
Owners may not have liquidity of investment.
Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares. Based on the determinations described under
"Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable
Rate" and subject to the discretion of the Auction Agent to round as described
below, Submitted Bids and Submitted Sell Orders will be accepted or rejected
in the order of priority set forth in the Auction Procedures with the result
that Existing Holders and Potential Holders of AMPS will sell, continue to
hold and/or purchase shares of AMPS as set forth below. Existing Holders that
submit or are deemed to have submitted Hold Orders will continue to hold the
shares of AMPS subject to such Hold Orders.
If Sufficient Clearing Bids have been made:
(a) each Existing Holder that placed a Submitted Bid specifying a
rate per annum higher than the Winning Bid Rate or a Submitted Sell
Order will sell the outstanding shares of AMPS subject to such Submitted
Bid or Submitted Sell Order;
(b) each Existing Holder that placed a Submitted Bid specifying a
rate per annum lower than the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bid;
(c) each Potential Holder that placed a Submitted Bid specifying a
rate per annum lower than the Winning Bid Rate will purchase the number
of shares of AMPS subject to such Submitted Bid;
(d) each Existing Holder that placed a Submitted Bid specifying a
rate per annum equal to the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bids, unless the
number of outstanding shares of AMPS subject to all such Submitted Bids
of Existing Holders is greater than the excess of the Available AMPS
over the number of shares of AMPS accounted for in clauses (b) and (c)
above, in which event each Existing Holder with such a Submitted Bid
will sell a number of outstanding shares of AMPS determined on a pro
rata basis based on the number of outstanding shares of AMPS subject to
all such Submitted Bids of such Existing Holders; and
(e) each Potential Holder that placed a Submitted Bid specifying a
rate per annum equal to the Winning Bid Rate will purchase any Available
AMPS not accounted for in clause (b), (c) or (d) above on a pro rata
basis based on the shares of AMPS subject to all such Submitted Bids of
Potential Holders.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders):
(a) each Existing Holder that placed a Submitted Bid specifying a
rate per annum equal to or lower than the Maximum Applicable Rate will
continue to hold the outstanding shares of AMPS subject to such
Submitted Bid;
(b) each Potential Holder that placed a Submitted Bid specifying a
rate per annum equal to or lower than the Maximum Applicable Rate will
purchase the number of shares of AMPS subject to such Submitted Bid; and
(c) each Existing Holder that placed a Submitted Bid specifying a
rate per annum higher than the Maximum Applicable Rate or a Submitted
Sell Order will sell a number of outstanding shares of AMPS determined
on a pro rata basis based on the outstanding shares of AMPS subject to
all such Submitted Bids and Submitted Sell Orders.
40
If as a result of the Auction Procedures described above any Existing
Holder would be entitled or required to sell, or any Potential Holder would be
entitled or required to purchase, a fraction of a share of AMPS, the Auction
Agent, in such manner as, in its sole discretion, it shall determine, will
round up or down the number of shares of AMPS being sold or purchased on such
Auction Date so that each share sold or purchased by each Existing Holder or
Potential Holder will be a whole share of AMPS. If any Potential Holder would
be entitled or required to purchase less than a whole share of AMPS, the
Auction Agent, in such manner as, in its sole discretion, it shall determine,
will allocate shares of AMPS for purchase among Potential Holders so that only
whole shares of AMPS are purchased by any such Potential Holder, even if such
allocation results in one or more of such Potential Holders not purchasing any
shares of AMPS.
Notification of Results; Settlement. The Auction Agent will advise each
Broker-Dealer who submitted a Bid or Sell Order in an Auction whether such Bid
or Sell Order was accepted or rejected in whole or in part and of the
Applicable Rate for the next Dividend Period for the related shares of AMPS by
telephone at approximately 3:00 p.m., Eastern time, on the Auction Date for
such Auction. Each such Broker-Dealer that submitted an Order for the account
of a customer then will advise such customer whether such Bid or Sell Order
was accepted or rejected, will confirm purchases and sales with each customer
purchasing or selling shares of AMPS as a result of the Auction and will
advise each customer purchasing or selling shares of AMPS to give instructions
to its Agent Member of the Securities Depository to pay the purchase price
against delivery of such shares or to deliver such shares against payment
therefor as appropriate. If a customer selling shares of AMPS as a result of
an Auction shall fail to instruct its Agent Member to deliver such shares, the
Broker-Dealer that submitted such customer's Bid or Sell Order will instruct
such Agent Member to deliver such shares against payment therefor. Each
Broker-Dealer that submitted a Hold Order in an Auction on behalf of a
customer also will advise such customer of the Applicable Rate for the next
Dividend Period for the AMPS. The Auction Agent will record each transfer of
shares of AMPS on the record book of Existing Holders to be maintained by the
Auction Agent. In accordance with the Securities Depository's normal
procedures, on the day after each Auction Date, the transactions described
above will be executed through the Securities Depository, and the accounts of
the respective Agent Members at the Securities Depository will be debited and
credited as necessary to effect the purchases and sales of shares of AMPS as
determined in such Auction. Purchasers will make payment through their Agent
Members in same-day funds to the Securities Depository against delivery
through their Agent Members; the Securities Depository will make payment in
accordance with its normal procedures, which now provide for payment in
same-day funds. If the procedures of the Securities Depository applicable to
AMPS shall be changed to provide for payment in next-day funds, then
purchasers may be required to make payment in next day funds. If any Existing
Holder selling shares of AMPS in an Auction fails to deliver such shares, the
Broker-Dealer of any person that was to have purchased shares of AMPS in such
Auction may deliver to such person a number of whole shares of AMPS that is
less than the number of shares that otherwise was to be purchased by such
person. In such event, the number of shares of AMPS to be so delivered will be
determined by such Broker- Dealer. Delivery of such lesser number of shares
will constitute good delivery. Each Broker-Dealer Agreement also will provide
that neither the Fund nor the Auction Agent will have responsibility or
liability with respect to the failure of a Potential Beneficial Owner,
Beneficial Owner or their respective Agent Members to deliver shares of AMPS
or to pay for shares of AMPS purchased or sold pursuant to an Auction or
otherwise.
Broker-Dealers
General. The Broker-Dealer Agreements provide that a Broker-Dealer may
submit Orders in Auctions for its own account, unless the Fund notifies all
Broker-Dealers that they no longer may do so; provided that Broker-Dealers may
continue to submit Hold Orders and Sell Orders. If a Broker-Dealer submits an
Order for its own account in any Auction of the AMPS, it may have knowledge of
Orders placed through it in that Auction and therefore have an advantage over
other Bidders, but such Broker-Dealer would not have knowledge of Orders
submitted by other Broker-Dealers in that Auction. As a result of bidding by a
Broker-Dealer in an Auction, the Applicable Rate may be higher or lower than
the rate that would have prevailed had the Broker-Dealer not Bid.
A Broker-Dealer may also Bid in an Auction in order to prevent what
would otherwise be (i) a failed Auction, (ii) an "all-hold" Auction, or (iii)
an Applicable Rate that the Broker-Dealer believes, in its sole discretion,
does not reflect the market for the AMPS at the time of the Auction. A
Broker-Dealer may, but is not obligated to, advise Beneficial Owners of AMPS
that the Applicable Rate that would apply in an "all-hold" Auction (i.e., all
of the outstanding AMPS are subject to Submitted Hold Orders) may be lower
than would apply if Beneficial Owners
41
submit Bids and such advice, if given, may facilitate the submission of Bids
by Beneficial Owners that would avoid the occurrence of an "all-hold" Auction.
Commission Inquiries. Merrill Lynch has advised the Fund that it and
various other broker-dealers and other firms that participate in the auction
rate securities market received letters from the staff of the Securities and
Exchange Commission last spring. The letters requested that each of these
firms voluntarily conduct an investigation regarding its respective practices
and procedures in that market. Pursuant to this request, Merrill Lynch
conducted its own voluntary review and reported its findings to the Commission
staff. At the Commission staff's request, Merrill Lynch, together with certain
other broker-dealers and other firms that participate in the auction rate
securities market, is engaging in discussions with the Commission staff
concerning its inquiry. Neither Merrill Lynch nor the Fund can predict the
ultimate outcome of the inquiry or how that outcome will affect the market for
the AMPS or the auctions.
Fees. The Auction Agent after each Auction will pay a service charge
from funds provided by the Fund to each Broker-Dealer on the basis of the
purchase price of shares of AMPS placed by such Broker-Dealer at such Auction.
The service charge (i) for any 7-Day Dividend Period shall be payable at the
annual rate of 0.25% of the purchase price of the shares of AMPS placed by
such Broker-Dealer in any such Auction and (ii) for any Special Dividend
Period shall be determined by mutual consent of the Fund and any such
Broker-Dealer or Broker-Dealers and shall be based upon a selling concession
that would be applicable to an underwriting of fixed or variable rate
preferred shares with a similar final maturity or variable rate dividend
period, respectively, at the commencement of the Dividend Period with respect
to such Auction. For the purposes of the preceding sentence, shares of AMPS
will be placed by a Broker-Dealer if such shares were (i) the subject of Hold
Orders deemed to have been made by Beneficial Owners that were acquired by
such Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a Submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold
such shares as a result of the Auction, (B) a Submitted Bid of a Potential
Beneficial Owner that resulted in such Potential Beneficial Owner purchasing
such shares as a result of the Auction or (C) a Submitted Hold Order. A
Broker-Dealer may share a portion of any such fees with non-participating
broker-dealers that submit Orders to the Broker-Dealer for an Auction that are
placed by that Broker-Dealer in such Auction.
Secondary Trading Market. Broker-Dealers have no obligation to maintain
a secondary trading market in the AMPS outside of Auctions and there can be no
assurance that a secondary market for the AMPS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the
trade by the Broker-Dealers). The AMPS will not be registered on any stock
exchange or on any automated quotation system. An increase in the level of
interest rates, particularly during any Long-Term Dividend Period, likely will
have an adverse effect on the secondary market price of the AMPS, and a
selling stockholder may sell AMPS between Auctions at a price per share of
less than $25,000.
RATING AGENCY GUIDELINES
Certain of the capitalized terms used herein not otherwise defined in
this prospectus have the meaning provided in the Glossary at the back of this
prospectus.
The Fund currently intends that, so long as shares of AMPS are
outstanding and the AMPS are rated by Moody's and S&P, the composition of its
portfolio will reflect guidelines established by Moody's and S&P in connection
with the Fund's receipt of a rating for such shares on or prior to their Date
of Original Issue of at least Aaa from Moody's and AAA from S&P. Moody's and
S&P, which are NRSROs, issue ratings for various securities reflecting the
perceived creditworthiness of such securities. The Board of Directors of the
Fund, however, may determine that it is not in the best interest of the Fund
to continue to comply with the guidelines of Moody's or S&P (described below).
If the Fund voluntarily terminates compliance with Moody's or S&P guidelines,
the Fund will no longer be required to maintain a Moody's Discounted Value or
a S&P Discounted Value, as applicable, at least equal to the AMPS Basic
Maintenance Amount. If the Fund voluntarily terminates compliance with Moody's
or S&P guidelines, or both, at the time of termination, it must continue to be
rated by at least one NRSRO.
42
The guidelines described below have been developed by Moody's and S&P in
connection with issuances of asset-backed and similar securities, including
debt obligations and variable rate preferred stock, generally on a
case-by-case basis through discussions with the issuers of these securities.
The guidelines are designed to ensure that assets underlying outstanding debt
or preferred stock will be varied sufficiently and will be of sufficient
quality and amount to justify investment-grade ratings. The guidelines do not
have the force of law but have been adopted by the Fund in order to satisfy
current requirements necessary for Moody's and S&P to issue the
above-described ratings for shares of AMPS, which ratings generally are relied
upon by institutional investors in purchasing such securities. The guidelines
provide a set of tests for portfolio composition and asset coverage that
supplement (and in some cases are more restrictive than) the applicable
requirements under the 1940 Act. See "Description of AMPS -- Asset
Maintenance" herein and in the statement of additional information.
The Fund intends to maintain a Discounted Value for its portfolio at
least equal to the AMPS Basic Maintenance Amount. Moody's and S&P each has
established separate guidelines for determining Discounted Value. To the
extent any particular portfolio holding does not satisfy the applicable rating
agency's guidelines, all or a portion of such holding's value will not be
included in the calculation of Discounted Value (as defined by such rating
agency). The Moody's and S&P guidelines do not impose any limitations on the
percentage of Fund assets that may be invested in holdings not eligible for
inclusion in the calculation of the Discounted Value of the Fund's portfolio.
Upon any failure to maintain the required Discounted Value, the Fund
will seek to alter the composition of its portfolio to reattain a Discounted
Value at least equal to the AMPS Basic Maintenance Amount on or prior to the
AMPS Basic Maintenance Cure Date, thereby incurring additional transaction
costs and possible losses and/or gains on dispositions of portfolio
securities. To the extent any such failure is not cured in a timely manner,
shares of AMPS will be subject to redemption. See "Description of AMPS --
Asset Maintenance" and "Description of AMPS -- Redemption" herein and in the
statement of additional information.
The Fund may, but is not required to, adopt any modifications to these
guidelines that hereafter may be established by Moody's or S&P. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for the shares of AMPS, at any time, may change or
withdraw any such rating. As set forth in the Articles Supplementary, the
Board of Directors, without stockholder approval, may modify certain
definitions or restrictions that have been adopted by the Fund pursuant to the
rating agency guidelines, provided the Board of Directors has obtained written
confirmation from Moody's and S&P that any such change would not impair the
ratings then assigned by Moody's and S&P to the AMPS.
As described by Moody's and S&P, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The ratings on the AMPS are not recommendations to purchase, hold
or sell shares of AMPS, inasmuch as the ratings do not comment as to market
price or suitability for a particular investor, nor do the rating agency
guidelines described above address the likelihood that a holder of shares of
AMPS will be able to sell such shares in an Auction. The ratings are based on
current information furnished to Moody's and S&P by the Fund and the
Investment Adviser and information obtained from other sources. The ratings
may be changed, suspended or withdrawn as a result of changes in, or the
unavailability of, such information. The common stock has not been rated by a
nationally recognized statistical rating organization.
For additional information concerning the Moody's and S&P ratings
guidelines, see "Rating Agency Guidelines" in the statement of additional
information.
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser, which is owned and controlled by Merrill Lynch &
Co. Inc. ("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
50 registered investment companies and offers investment advisory services to
individuals and institutional accounts. As of June 30, 2005, the Investment
Adviser and its affiliates, including Merrill Lynch Investment Managers, L.P.
("MLIM"), had a total of approximately $474 billion in investment company and
other portfolio assets under management, including approximately $221 billion
in fixed income assets. This amount includes assets managed by certain
43
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 portfolio manager primarily responsible for the Fund's day-to-day
management is Michael A. Kalinoski. Mr. Kalinoski has been a Vice President
and Portfolio Manager at MLIM since 1999 and has 12 years of experience
investing in Municipal Bonds. The Fund's portfolio manager will consider
analyses from various sources, make the necessary investment decisions, and
place orders for transactions accordingly. The statement of additional
information provides additional information about the Fund's portfolio
manager's compensation, other accounts managed by the portfolio manager, and
the portfolio manager's ownership of securities of the Fund.
For its services, the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.50% of the Fund's average weekly net assets ("average
weekly net assets" means the average weekly 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 weekly net assets is determined at the end of each month
on the basis of the average net assets of the Fund for each week during the
month. The assets for each weekly period are determined by averaging the net
assets at the last business day of a week with the net assets at the last
business day of the prior week. The liquidation preference of any outstanding
preferred stock (other than accumulated dividends) is not considered a
liability in determining the Fund's average weekly net assets.
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, Securities and Exchange 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
Bank 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.
TAXES
To the extent derived from Municipal Bond interest income, dividends on
the AMPS will be excludable from gross income for Federal income tax purposes
in the hands of holders of such AMPS, subject to the possible application of
the Federal alternative minimum tax and any state or local income taxes.
Interest income from other investments may produce taxable dividends. The Fund
is required to allocate net capital gain and other taxable income, if any,
proportionately among the common stock and the AMPS and Other AMPS in
accordance with the current position of the IRS described under the heading
"Taxes" in the statement of additional information. The Fund may notify the
Auction Agent of the amount of any net capital gain or other anticipated
taxable income to be included in any dividend on the AMPS prior to the Auction
establishing the Applicable Dividend Rate for such dividend. The Auction Agent
will in turn notify holders of the AMPS and prospective purchasers. The Fund
also may include such income in a dividend on shares of AMPS without giving
advance notice thereof if it increases the dividend by an additional amount
calculated as if such income were a Retroactive Taxable Allocation and the
additional amount were an Additional Dividend. See "The Auction -- Auction
Procedures --Auction Date; Advance Notice of Allocation of Taxable Income;
Inclusion of Taxable Income in Dividends." The amount of
44
taxable income allocable to the AMPS will depend upon the amount of such
income realized by the Fund and cannot be determined with certainty prior to
the end of the Fund's fiscal year, but it is not generally expected to be
significant.
If the Fund makes a Retroactive Taxable Allocation, it will pay
Additional Dividends to holders of AMPS who are subject to the Retroactive
Taxable Allocation. See "Description of AMPS -- Dividends -- Additional
Dividends." The Federal income tax consequences of Additional Dividends under
existing law are uncertain. The Fund intends to treat a holder as receiving a
dividend distribution in the amount of any Additional Dividend only as and
when such Additional Dividend is paid. An Additional Dividend generally will
be designated by the Fund as an exempt-interest dividend except as otherwise
required by applicable law. However, the IRS may assert that all or part of an
Additional Dividend is a taxable dividend either in the taxable year for which
the Retroactive Taxable Allocation is made or in the taxable year in which the
Additional Dividend is paid.
Generally within 60 days after the end of the Fund's taxable year, the
Fund will tell you the amount of exempt-interest dividends and capital gain
dividends you received during that year. Capital gain dividends are taxable as
long-term capital gains to you regardless of how long you have held your
shares.
The Fund will only purchase a Municipal Bond or Non-Municipal Tax Exempt
Security if it is accompanied by an opinion of counsel to the issuer, which is
delivered on the date of issuance of the security, that the interest paid on
such security is excludable from gross income for Federal income tax purposes
(i.e., "tax exempt"). To the extent that the dividends distributed by the Fund
are from interest income that is excludable from gross income for Federal
income tax purposes, they are exempt from Federal income tax. There is a
possibility that events occurring after the date of issuance of a security, or
after a Fund's acquisition of a security, may result in a determination that
the interest on that security is, in fact, includable in gross income for
Federal income tax purposes retroactively to its date of issue. Such a
determination may cause a portion of prior distributions received by
stockholders, including holders of AMPS, to be taxable to those stockholders
in the year of receipt. The Fund will not pay an Additional Dividend to a
holder of AMPS under these circumstances.
Because the Fund may from time to time invest a substantial portion of
its portfolio in Municipal Bonds bearing income that could increase an AMPS
holder's tax liability under the Federal alternative minimum tax, the Fund
would not ordinarily be a suitable investment for investors who are subject to
the alternative minimum tax.
If at any time when AMPS 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 "Description of AMPS -- Dividends -- Restrictions on Dividends
and Other Payments" herein and in the statement of additional information.
This may prevent the Fund from meeting certain distribution requirements for
qualification as a RIC. Upon any failure to meet the asset coverage
requirements of the 1940 Act, the Fund, in its sole discretion, may, and under
certain circumstances will be required to, redeem AMPS 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. See "Description of
AMPS -- Redemption" herein and in the statement of additional information.
There can be no assurance, however, that any such action would achieve such
objectives.
By law, your dividends and redemption proceeds will be subject to a
withholding tax if you have not provided a tax identification number or social
security number or if the number you have provided is incorrect.
This section summarizes some of the consequences of an investment in the
Fund under current Federal income tax laws. It is not a substitute for
personal tax advice. Stockholders are urged to consult their tax advisers
regarding the applicability of any state or local taxes and with specific
questions regarding Federal taxes.
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 were 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,
45
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.
In this regard, the Board of Directors previously reclassified 6,000 shares of
unissued common stock as Other AMPS and reclassified 400 shares of unissued
common stock as AMPS, which are being offered hereby. See "Description of
AMPS" herein and in the statement of additional information.
The following table shows the amount of (i) capital stock authorized,
(ii) capital stock held by the Fund for its own account and (iii) capital
stock outstanding for each class of authorized securities of the Fund as of
April 30, 2005.
Amount
Outstanding
(Exclusive
Of
Amount Held Amount Held
By Fund For By Fund For
Amount Its Own Its Own
Title of Class Authorized Account) Account)
---------------------------------------- ----------- ----------- -------------
Common Stock........................... 199,994,000 - 0 - 22,366,930
Auction Market Preferred Stock
Series A............................. 2,000 - 0 - - 2,000 -
Series B............................. 2,000 - 0 - - 2,000 -
Series C............................. 2,000 - 0 - - 2,000 -
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its stockholders.
Common Stock
Holders of common stock are entitled to share equally in dividends
declared by the Board of Directors payable to holders of common stock and in
the net assets of the Fund available for distribution to holders of common
stock after payment of the preferential amounts payable to holders of any
outstanding preferred stock. Neither holders of common stock nor holders of
preferred stock have pre-emptive or conversion rights and shares of common
stock are not redeemable. The outstanding shares of common stock are fully
paid and non-assessable.
Holders of common stock are entitled to one vote for each share held and
will vote with the holders of any outstanding shares of AMPS or other
preferred stock, including the Other AMPS on each matter submitted to a vote
of holders of common stock, except as described under "Description of AMPS --
Voting Rights" herein and in the statement of additional information.
Stockholders are entitled to one vote for each share held. The shares of
common stock, AMPS, Other AMPS and any other preferred stock do not have
cumulative voting rights, which means that the holders of more than 50% of the
shares of common stock, AMPS, Other AMPS and any other preferred stock voting
for the election of Directors can elect all of the Directors standing for
election by such holders, and, in such event, the holders of the remaining
shares of common stock, AMPS, Other AMPS and any other preferred stock will
not be able to elect any of such Directors.
So long as any shares of the Fund's preferred stock are outstanding,
including the AMPS and Other AMPS, 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
"Description of AMPS -- Dividends -- Restrictions on Dividends and Other
Payments" herein and in the statement of additional information.
46
Preferred Stock
The Fund has issued an aggregate of 6,000 shares of Other AMPS. Under
the Articles Supplementary for the AMPS, the Fund is authorized to issue an
aggregate of 400 shares of Series D AMPS. The terms of the shares of the Other
AMPS are substantially the same as the terms of the shares of the AMPS. See
"Description of AMPS." Under the 1940 Act, the Fund is permitted to have
outstanding more than one series of preferred stock as long as no single
series has priority over another series as to the distribution of assets of
the Fund or the payment of dividends. Neither holders of common stock nor
holders of preferred stock have pre-emptive rights to purchase any shares of
AMPS, Other AMPS or any other preferred stock that might be issued. It is
anticipated that the net asset value per share of the AMPS will equal its
original purchase price per share plus accumulated dividends per share.
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 common 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 ?% of the
shares entitled to vote in an election to fill that directorship. A director
elected by all of the holders of capital stock may be removed only by action
of such holders, and a director elected by the holders of AMPS and any other
preferred stock may be removed only by action of the holders of AMPS and any
other preferred stock.
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. The approval, adoption or
authorization of the foregoing also requires the favorable vote of a majority
of the Fund's outstanding shares (as defined in the 1940 Act) of preferred
stock, including the AMPS and the Other AMPS, 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 the AMPS, the Other AMPS and any other 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 at least
two-thirds of the total number of Directors fixed in accordance with the
By-laws), and the affirmative vote of a majority of outstanding shares (as
defined in the 1940 Act) of preferred stock of the Fund (including the AMPS
and the Other AMPS), 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. 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 redemption of all outstanding shares of preferred stock (including the
AMPS and the Other AMPS) and would require changes in certain of the Fund's
investment policies and restrictions, such as those relating to the issuance
of senior securities, the borrowing of money and the purchase of illiquid
securities.
47
The Charter and By-laws provide that the Board of Directors has the
power to make, amend, alter or repeal any of the By-laws (except for any
By-law specified not to be altered 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 Securities
and Exchange Commission for the full text of these provisions.
CUSTODIAN
The Fund's securities and cash are held under a custodian agreement with
The Bank of New York, 1010 Church Street, New York, New York 10286.
UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated (the "Underwriter")
has agreed, subject to the terms and conditions contained in a purchase
agreement with the Fund and the Investment Adviser, to purchase from the Fund
all of the shares of AMPS offered hereby. The Underwriter has agreed to
purchase all such shares if any are purchased.
The Fund and the Investment Adviser have agreed to indemnify the
Underwriter against certain liabilities, including liabilities under the
Securities Act of 1933, as amended, or to contribute to payments the
Underwriter may be required to make in respect of those liabilities.
The Underwriter is offering the shares, subject to prior sale, when, as
and if issued to and accepted by them, subject to approval of legal matters by
its counsel, including the validity of the shares, and other conditions
contained in the purchase agreement, such as the receipt by the Underwriter of
officer's certificates and legal opinions. The Underwriter reserves the right
to withdraw, cancel or modify offers to the public and to reject orders in
whole or in part.
Commissions and Discounts
The Underwriter has advised the Fund that it proposes initially to offer
the shares of AMPS 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 $137.50 per share. There is a sales charge or underwriting
discount of $250 per share, which is equal to 1% of the initial public
offering price per share. After the initial public offering, the public
offering price and concession may be changed. Investors must pay for any AMPS
purchased in the offering on or before [ ], 2005.
The expenses of the offering, excluding underwriting discount, are
estimated at $145,000 and are payable by the Fund.
Other Relationships
Merrill Lynch acts in Auctions as a Broker-Dealer as set forth under
"The Auction -- General -- Broker-Dealer Agreements" and will be entitled to
fees for services as a Broker-Dealer as set forth under "The Auction --
Broker-Dealers." Merrill Lynch also may provide information to be used in
ascertaining the Reference Rate.
The Fund also anticipates that Merrill Lynch may from time to time act
as a broker in connection with the execution of its portfolio transactions.
Merrill Lynch is an affiliate of the Investment Adviser. See "Investment
Restrictions" and "Portfolio Transactions" in the statement of additional
information.
The address of the Underwriter is 4 World Financial Center, New York,
New York 10080.
48
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the
Fund's shares of AMPS, Other AMPS and common stock is The Bank of New York,
101 Barclay Street, New York, New York 10286.
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 MATTERS
Certain legal matters in connection with the AMPS offered hereby are
passed on for the Fund and the Underwriter by Sidley Austin Brown & Wood LLP,
New York, New York.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM AND EXPERTS
__________ is the Fund's independent registered public accounting firm.
The audited financial statements of the Fund and certain of the information
appearing under the caption "Financial Highlights" included in this prospectus
have been audited by _______, for the periods indicated in its report with
respect thereto, and are included in reliance upon such report and upon the
authority of such firm as experts in accounting and auditing. _______ has an
office at ____________.
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, proxy statements and other information with the Securities
and Exchange 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 100 F Street, N.E., Washington, D.C. 20549.
Information on the operation of such public reference facilities may be
obtained by calling the Commission at 1-202-942-8090. Copies of such materials
can be obtained from the public reference section of the Commission by writing
to 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates, or by
electronic request at publicinfo@sec.gov. 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
New York Stock Exchange, 20 Broad Street, New York, New York 10005.
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.
49
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
Page
Investment Objective and Policies............................................3
Investment Restrictions......................................................3
Description of AMPS..........................................................5
The Auction.................................................................12
Rating Agency Guidelines....................................................13
Directors and Officers......................................................21
Investment Advisory and Management Arrangements.............................28
Portfolio Transactions......................................................36
Taxes.......................................................................38
Conflicts of Interest.......................................................43
Net Asset Value.............................................................45
Financial Statements........................................................45
APPENDIX A Ratings of Municipal Bonds.....................................A-1
APPENDIX B Settlement Procedures..........................................B-1
APPENDIX C Auction Procedures.............................................C-1
50
GLOSSARY
"Additional Dividend" has the meaning set forth on page [32] of this
prospectus.
"Agent Member" means the member of the Securities Depository that will
act on behalf of a Beneficial Owner of one or more shares of AMPS or on behalf
of a Potential Beneficial Owner.
"AMPS" means the Auction Market Preferred Stock, Series D with a par
value of $.10 per share and a liquidation preference of $25,000 per share plus
an amount equal to accumulated but unpaid dividends thereon (whether or not
earned or declared) of the Fund.
"AMPS Basic Maintenance Amount" has the meaning set forth on page [33]
of this prospectus.
"AMPS Basic Maintenance Cure Date" has the meaning set forth on page
[33] of this prospectus.
"AMPS Basic Maintenance Report" has the meaning set forth on page [9] of
the statement of additional information.
"Anticipation Notes" shall mean the following Municipal Bonds: revenue
anticipation notes, tax anticipation notes, tax and revenue anticipation
notes, grant anticipation notes and bond anticipation notes.
"Applicable Percentage" has the meaning set forth on page [37] of this
prospectus.
"Applicable Rate" means the rate per annum at which cash dividends are
payable on shares of AMPS for any Dividend Period.
"Applicable Spread" has the meaning set forth on page [37] of this
prospectus.
"Articles Supplementary" means the Articles Supplementary of the Fund
specifying the powers, preferences and rights of the shares of the AMPS.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agent" means The Bank of New York unless and until another
commercial bank, trust company or other financial institution appointed by a
resolution of the Board of Directors of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend disbursing agent and redemption agent for
the AMPS.
"Auction Agent Agreement" means the agreement entered into between the
Fund and the Auction Agent which provides, among other things, that the
Auction Agent will follow the Auction Procedures for the purpose of
determining the Applicable Rate.
"Auction Date" has the meaning set forth on page [36] of this
prospectus.
"Auction Procedures" means the procedures for conducting Auctions set
forth in Appendix C to the statement of additional information.
"Available AMPS" has the meaning set forth on page [39] of this
prospectus.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on
the records of that Broker- Dealer (or if applicable, the Auction Agent) as a
holder of shares of AMPS or a Broker-Dealer that holds AMPS for its own
account.
"Bid" has the meaning set forth on page [36] of this prospectus.
51
"Bidder" has the meaning set forth on page [36] of this prospectus.
"Board of Directors" or "Board" means the Board of Directors of the
Fund.
"Broker-Dealer" means any broker-dealer, or other entity permitted by
law to perform the functions required of a Broker-Dealer in the Auction
Procedures, that has been selected by the Fund and has entered into a
Broker-Dealer Agreement with the Auction Agent that remains effective.
"Broker-Dealer Agreement" means an agreement entered into between the
Auction Agent and a Broker- Dealer, including Merrill Lynch, Pierce, Fenner &
Smith Incorporated, pursuant to which such Broker-Dealer agrees to follow the
Auction Procedures.
"Business Day" means a day on which the New York Stock Exchange is open
for trading and which is not a Saturday, Sunday or other day on which banks in
The City of New York are authorized or obligated by law to close.
"Cede" means Cede & Co., the nominee of DTC, and in whose name the
shares of AMPS initially will be registered.
"Charter" means the Articles of Incorporation, as amended and
supplemented (including the Articles Supplementary and the Other AMPS Articles
Supplementary), of the Fund.
"Code" means the Internal Revenue Code of 1986, as amended.
"Common stock" means the common stock, par value $.10 per share, of the
Fund.
"Date of Original Issue" means, with respect to each share of AMPS, the
date on which such share first is issued by the Fund.
"Deposit Securities" means cash and Municipal Bonds rated at least A2
(having a remaining maturity of 12 months or less), P-1, VMIG-1 or MIG-1 by
Moody's or A (having a remaining maturity of 12 months or less), A-1+ or SP-1+
by S&P or A (having a remaining maturity of 12 months or less) or F-1+ by
Fitch.
"Discount Factor" means a Moody's Discount Factor or an S&P Discount
Factor, as the case may be.
"Discounted Value" means (i) with respect to an S&P Eligible Asset, the
quotient of the fair market value thereof divided by the applicable S&P
Discount Factor and (ii) with respect to a Moody's Eligible Asset, the lower
of par and the quotient of the fair market value thereof divided by the
applicable Moody's Discount Factor.
"Dividend Payment Date" has the meaning set forth on page [30] of this
prospectus.
"Dividend Period" has the meaning set forth on page [30] of this
prospectus.
"DTC" means The Depository Trust Company.
"Eligible Assets" means Moody's Eligible Assets or S&P Eligible Assets,
as the case may be.
"Existing Holder" means a Broker-Dealer or any such other person as may
be permitted by the Fund that is listed as the holder of record of shares of
AMPS in the records of the Auction Agent.
"Fitch" means Fitch Ratings or its successors.
"Forward Commitment" has the meaning set forth on page [20] of the
statement of additional information.
"Fund" means MuniYield Quality Fund II, Inc., a Maryland corporation
that is the issuer of the AMPS.
52
"High Yield Municipal Bonds" means (a) with respect to Moody's (1)
Municipal Bonds rated Ba1 to B3 by Moody's, (2) Municipal Bonds not rated by
Moody's, but rated BB+ to B- by S&P or Fitch, and (3) Municipal Bonds not
explicitly rated by Moody's, S&P or Fitch, but rated at least the equivalent
of B3 internally by the Investment Adviser, provided that Moody's reviews and
achieves sufficient comfort with the Investment Adviser's internal credit
rating processes, and (b) with respect to S&P (1) Municipal Bonds not rated by
S&P but rated equivalent to BBB+ or lower by another NRSRO and (2) Municipal
Bonds rated BB+ or lower by S&P.
"Hold Order" has the meaning set forth on page [36] of this prospectus.
"Initial Dividend Payment Date" means the first Dividend Payment Date
for the Series D AMPS.
"Initial Dividend Period" means the period from and including the Date
of Original Issue to but excluding the Initial Dividend Payment Date for the
Series D AMPS.
"Initial Margin" means the amount of cash or securities deposited with a
broker as a margin payment at the time of purchase or sale of a financial
futures contract.
"Inverse Floaters" means trust certificates or other instruments
evidencing interests in one or more Municipal Bonds that qualify as (i) S&P
Eligible Assets the interest rates on which are adjusted at short term
intervals on a basis that is inverse to the simultaneous readjustment of the
interest rates on corresponding floating rate trust certificates or other
instruments issued by the same issuer, provided that the ratio of the
aggregate dollar amount of floating rate instruments to inverse floating rate
instruments issued by the same issuer does not exceed one to one at their time
of original issuance unless the floating rate instrument has only one reset
remaining until maturity or (ii) Moody's Eligible Assets the interest rates on
which are adjusted at short term intervals on a basis that is inverse to the
simultaneous readjustment of the interest rates on corresponding floating rate
trust certificates or other instruments issued by the same issuer, provided
that (a) such Inverse Floaters are rated by Moody's with the Investment
Adviser having the capability to collapse (or relink) within seven days as a
liquidity enhancement measure, and (b) the issuer of such Inverse Floaters
employs a leverage factor (i.e., the ratio of underlying capital appreciation
bonds or other instruments to residual long-term derivative instruments) of
not more than 2:1.
"Investment Adviser" means Fund Asset Management, L.P.
"IRS" means the United States Internal Revenue Service.
"LIBOR Dealer" means Merrill Lynch, Pierce, Fenner & Smith Incorporated
and such other dealer or dealers as the Fund from time to time may appoint or,
in lieu thereof, their respective affiliates and successors.
"LIBOR Rate," on any Auction Date, means (i) the rate for deposits in
U.S. dollars for the designated Dividend Period, which appears on display page
3750 of Moneyline's Telerate Service ("Telerate Page 3750") (or such other
page as may replace that page on that service, or such other service as may be
selected by the LIBOR Dealer or its successors that are LIBOR Dealers) as of
11:00 a.m., London time, on the day that is the London Business Day preceding
the Auction Date (the "LIBOR Determination Date"), or (ii) if such rate does
not appear on Telerate Page 3750 or such other page as may replace such
Telerate Page 3750, (A) the LIBOR Dealer shall determine the arithmetic mean
of the offered quotations of the Reference Banks to leading banks in the
London interbank market for deposits in U.S. dollars for the designated
Dividend Period in an amount determined by such LIBOR Dealer by reference to
requests for quotations as of approximately 11:00 a.m. (London time) on such
date made by such LIBOR Dealer to the Reference Banks, (B) if at least two of
the Reference Banks provide such quotations, LIBOR Rate shall equal such
arithmetic mean of such quotations, (C) if only one or none of the Reference
Banks provide such quotations, LIBOR Rate shall be deemed to be the arithmetic
mean of the offered quotations that leading banks in The City of New York
selected by the LIBOR Dealer (after obtaining the Fund's approval) are quoting
on the relevant LIBOR Determination Date for deposits in U.S. dollars for the
designated Dividend Period in an amount determined by the LIBOR Dealer (after
obtaining the Fund's approval) that is representative of a single transaction
in such market at such time by reference to the principal London offices of
leading banks in the London interbank market; provided, however, that if one
of the LIBOR Dealers does not quote a rate required to determine the LIBOR
Rate, the LIBOR Rate will be determined on the basis of the quotation or
53
quotations furnished by any Substitute LIBOR Dealer or Substitute LIBOR
Dealers selected by the Fund to provide such rate or rates not being supplied
by the LIBOR Dealer; provided further, that if the LIBOR Dealer and Substitute
LIBOR Dealers are required but unable to determine a rate in accordance with
at least one of the procedures provided above, the LIBOR Rate shall be the
LIBOR Rate as determined on the previous Auction Date. If the number of
Dividend Period days shall be (i) 7 or more but fewer than 21 days, such rate
shall be the seven-day LIBOR rate; (ii) 21 or more but fewer than 49 days,
such rate shall be the one-month LIBOR rate; (iii) 49 or more but fewer than
77 days, such rate shall be the two-month LIBOR rate; (iv) 77 or more but
fewer than 112 days, such rate shall be the three-month LIBOR rate; (v) 112 or
more but fewer than 140 days, such rate shall be the four-month LIBOR rate;
(vi) 140 or more but fewer than 168 days, such rate shall be the five-month
LIBOR rate; (vii) 168 or more but fewer than 189 days, such rate shall be the
six-month LIBOR rate; (viii) 189 or more but fewer than 217 days, such rate
shall be the seven-month LIBOR rate; (ix) 217 or more but fewer than 252 days,
such rate shall be the eight-month LIBOR rate; (x) 252 or more but fewer than
287 days, such rate shall be the nine-month LIBOR rate; (xi) 287 or more but
fewer than 315 days, such rate shall be the ten-month LIBOR rate; (xii) 315 or
more but fewer than 343 days, such rate shall be the eleven-month LIBOR rate;
and (xiii) 343 or more but fewer than 365 days, such rate shall be the
twelve-month LIBOR rate.
"London Business Day" means any day on which commercial banks are
generally open for business in London.
"Long Term Dividend Period" means a Special Dividend Period consisting
of a specified period of one whole year or more but not greater than five
years.
"Mandatory Redemption Price" has the meaning set forth on page [34] of
this prospectus.
"Marginal Tax Rate" means the maximum marginal regular Federal
individual income tax rate applicable to ordinary income or the maximum
marginal regular Federal corporate income tax rate, whichever is greater.
"Maximum Applicable Rate" has the meaning set forth on page [37] of this
prospectus.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Discount Factor" has the meaning set forth on pages [16 to 17]
of the statement of additional information.
"Moody's Eligible Assets" has the meaning set forth on pages [17 to 18]
of the statement of additional information.
"Moody's Hedging Transactions" has the meaning set forth on page [18] of
the statement of additional information.
"Moody's Volatility Factor" means 272% as long as there has been no
increase enacted to the Marginal Tax Rate. If such an increase is enacted but
not yet implemented, the Moody's Volatility Factor shall be as follows:
% Change in Moody's Volatility
Marginal Tax Rate Factor
---------------------------------------------------- --------------------
<5%................................................ 292%
>5% but <= 10%..................................... 313%
>10% but <= 15%.................................... 338%
>15% but <= 20%.................................... 364%
>20% but <= 25%.................................... 396%
>25% but <= 30%.................................... 432%
>30% but <= 35%.................................... 472%
>35% but <= 40%.................................... 520%
Notwithstanding the foregoing, the Moody's Volatility Factor may mean
such other potential dividend rate increase factor as Moody's advises the Fund
in writing is applicable.
54
"Municipal Bonds" has the meaning set forth on page [18] of this
prospectus.
"Municipal Index" has the meaning set forth on page [15] of the
statement of additional information.
"1940 Act" means the Investment Company Act of 1940, as amended from
time to time.
"1940 Act AMPS Asset Coverage" has the meaning set forth on page [33] of
this prospectus.
"1940 Act Cure Date" has the meaning set forth on page [33] of this
prospectus.
"Non-Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Non-Payment Period" has the meaning set forth on page [7] of the
statement of additional information.
"Non-Payment Period Rate" has the meaning set forth on page [7] of the
statement of additional information.
"Normal Dividend Payment Date" has the meaning set forth on page [30] of
this prospectus.
"Notice of Revocation" has the meaning set forth on page [6] of the
statement of additional information.
"Notice of Special Dividend Period" has the meaning set forth on page
[31] of this prospectus.
"NRSRO" means any nationally recognized statistical rating organization,
as that term is used in Rule 15a3-1 under the Securities and Exchange Act of
1934, as amended, or any successor provisions.
"Optional Redemption Price" has the meaning set forth on page [33] of
this prospectus.
"Order" has the meaning set forth on page [36] of this prospectus.
"Other AMPS" means the Auction Market Preferred Stock, Series A; the
Auction Market Preferred Stock, Series B; and the Auction Market Preferred
Stock, Series C, each with a liquidation preference of $25,000 per share plus
an amount equal to accumulated but unpaid dividends thereon (whether or not
earned or declared) of the Fund.
"Other AMPS Articles Supplementary" means the Articles Supplementary, as
amended and supplemented, of the Fund specifying the powers, preferences and
rights of the shares of the Other AMPS.
"Potential Beneficial Owner" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of shares of AMPS but that wishes
to purchase such shares, or that is a Beneficial Owner that wishes to purchase
additional shares of AMPS.
"Potential Holder" means any Broker-Dealer or any such other person as
may be permitted by the Fund, including any Existing Holder, who may be
interested in acquiring shares of AMPS (or, in the case of an Existing Holder,
additional shares of AMPS).
"Preferred stock" means preferred stock of the Fund and includes the
AMPS.
"Premium Call Period" has the meaning set forth under "Specific
Redemption Provisions" below.
"Receivables for Municipal Bonds Sold" for Moody's has the meaning set
forth under the definition of Moody's Discount Factor, and for S&P has the
meaning set forth under the definition of S&P Discount Factor.
"Reference Banks" means four major banks in the London interbank market
selected by Merrill Lynch, Pierce, Fenner & Smith Incorporated or its
affiliates or successors or such other party as the Fund may from time to time
appoint.
55
"Reference Rate" means: (i) with respect to a Dividend Period having 364
or fewer days, the higher of the applicable LIBOR Rate and the Taxable
Equivalent of the Short-Term Municipal Bond Rate, or (ii) with respect to any
Dividend Period having 365 or more days, the applicable Treasury Index Rate.
"Request for Special Dividend Period" has the meaning set forth on page
[31] of this prospectus.
"Response" has the meaning set forth on page [31] of this prospectus.
"Retroactive Taxable Allocation" has the meaning set forth on page [32]
of this prospectus.
"Rule 2a-7 Money Market Funds" means investment companies registered
under the 1940 Act that comply with the requirements of Rule 2a-7 thereunder.
"Series D AMPS" means the Auction Market Preferred Stock, Series D, with
a par value of $.05 per share and a liquidation preference of $25,000 per
share plus an amount equal to accumulated but unpaid dividends thereon
(whether or not earned or declared), of the Fund.
"S&P" means Standard & Poor's or its successors.
"S&P Discount Factor" has the meaning set forth on pages [13 to 14] of
the statement of additional information.
"S&P Eligible Assets" has the meaning set forth on pages [14 to 15] of
the statement of additional information.
"S&P Hedging Transactions" has the meaning set forth on page [15] of the
statement of additional information.
"S&P Volatility Factor" means 277% or such other potential dividend rate
increase factor as S&P advises the Fund in writing is applicable.
"Securities Depository" means The Depository Trust Company and its
successors and assigns or any successor securities depository selected by the
Fund that agrees to follow the procedures required to be followed by such
securities depository in connection with shares of AMPS.
"Sell Order" has the meaning specified in Subsection 10(b)(i) of the
Auction Procedures.
"7-Day Dividend Period" means a Dividend Period consisting of seven
days.
"Short Term Dividend Period" means a Special Dividend Period consisting
of a specified number of days (other than seven) evenly divisible by seven,
and not fewer than seven days nor more than 364 days.
"Special Dividend Period" has the meaning set forth on page [29] of this
prospectus.
"Specific Redemption Provisions" means, with respect to a Special
Dividend Period, either, or any combination of, (i) a period (a "Non-Call
Period") determined by the Board of Directors of the Fund, after consultation
with the Auction Agent and the Broker-Dealers, during which the shares of AMPS
subject to such Dividend Period shall not be subject to redemption at the
option of the Fund and (ii) a period (a "Premium Call Period"), consisting of
a number of whole years and determined by the Board of Directors of the Fund,
after consultation with the Auction Agent and the Broker-Dealers, during each
year of which the shares of AMPS subject to such Dividend Period shall be
redeemable at the Fund's option at a price per share equal to $25,000 plus
accumulated but unpaid dividends plus a premium expressed as a percentage of
$25,000, as determined by the Board of Directors of the Fund after
consultation with the Auction Agent and the Broker-Dealers.
"Submission Deadline" has the meaning set forth on page [38] of this
prospectus.
56
"Submitted Bid" has the meaning set forth on page [39] of this
prospectus.
"Submitted Hold Order" has the meaning set forth on page [39] of this
prospectus.
"Submitted Order" has the meaning set forth on page [39] of this
prospectus.
"Submitted Sell Order" has the meaning set forth on page [39] of this
prospectus.
"Subsequent Dividend Period" means each Dividend Period after the
Initial Dividend Period.
"Substitute Rating Agency" and "Substitute Rating Agencies" shall mean a
NRSRO or two NRSROs, respectively, selected by Merrill Lynch, Pierce, Fenner &
Smith Incorporated, or its respective affiliates and successors, after
obtaining the Fund's approval, to act as a substitute rating agency or
substitute rating agencies, as the case may be, to determine the credit
ratings of the AMPS.
"Sufficient Clearing Bids" has the meaning set forth on page [39] of
this prospectus.
"Taxable Equivalent of the Short-Term Municipal Bond Rate" on any date
means 90% of the quotient of (A) the per annum rate expressed on an interest
equivalent basis equal to the Kenny S&P 30-day High Grade Index (the "Kenny
Index") or any successor index, made available for the Business Day
immediately preceding such date but in any event not later than 8:30 a.m.
Eastern time, on such date by Kenny Information Systems Inc. or any successor
thereto, based upon 30-day yield evaluations at par of bonds the interest on
which is excludable for regular Federal income tax purposes under the Code of
"high grade" component issuers selected by Kenny Information Systems Inc. or
any such successor from time to time in its discretion, which component
issuers shall include, without limitation, issuers of general obligation bonds
but shall exclude any bonds the interest on which constitutes an item of tax
preference under Section 57(a)(5) of the Code, or successor provisions, for
purposes of the "alternative minimum tax," divided by (B) 1.00 minus the
Marginal Tax Rate (expressed as a decimal); provided, however, that if the
Kenny Index is not made so available by 8:30 a.m. Eastern time, on such date
by Kenny Information Systems Inc. or any successor, the Taxable Equivalent of
the Short-Term Municipal Bond Rate shall mean the quotient of (A) the per
annum rate expressed on an interest equivalent basis equal to the most recent
Kenny Index so made available for any preceding Business Day, divided by (B)
1.00 minus the Marginal Tax Rate (expressed as a decimal). The Fund may not
utilize a successor index to the Kenny Index unless Moody's and S&P provide
the Fund with written confirmation that the use of such successor index will
not adversely affect the then-current respective Moody's and S&P ratings of
the AMPS.
"Treasury Bonds" means U.S. Treasury Bonds or Notes.
"Treasury Index Rate" means the average yield to maturity for actively
traded marketable fixed interest rate U.S. Treasury Securities having the same
number of 30-day periods to maturity as the length of the applicable Dividend
Period, determined, to the extent necessary, by linear interpolation based
upon the yield for such securities having the next shorter and next longer
number of 30-day periods to maturity treating all Dividend Periods with a
length greater than the longest maturity for such securities as having a
length equal to such longest maturity, in all cases based upon data set forth
in the most recent weekly statistical release published by the Board of
Governors of the Federal Reserve System (currently in H.15(519)); provided,
however, if the most recent such statistical release shall not have been
published during the 15 days preceding the date of computation, the foregoing
computations shall be based upon the average of comparable data as quoted to
the Fund by at least three recognized dealers in U.S. Government Securities
selected by the Fund.
"U.S. Treasury Securities" means direct obligations of the United
States Treasury that are entitled to the full faith and credit of the United
States government.
"Valuation Date" has the meaning set forth on page [33] of this
prospectus.
57
"Variation Margin" means, in connection with an outstanding futures
contract owned or sold by the Fund, the amount of cash or securities paid to
or received from a broker (subsequent to the Initial Margin payment) from time
to time as the price of such futures contract fluctuates.
"Winning Bid Rate" has the meaning set forth on page [39] of this
prospectus.
58
==============================================================================
$10,000,000
MuniYield Quality Fund II, Inc.
Auction Market Preferred Stock ("AMPS")
400 Shares, Series D
Liquidation Preference $25,000 Per Share
------------------
PROSPECTUS
------------------
Merrill Lynch & Co.
[ ], 2005
CODE #[ ]
==============================================================================
The information in this statement of additional information 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
statement of additional information 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 Statement of Additional Information dated July 21, 2005
STATEMENT OF ADDITIONAL INFORMATION
-----------------------------------
$10,000,000
MuniYield Quality Fund II, Inc.
Auction Market Preferred Stock ("AMPS")
400 Shares, Series D
Liquidation Preference $25,000 per Share
------------
MuniYield Quality Fund II, Inc. is a non-diversified, closed-end
management investment company seeking to provide shareholders with as high a
level of current income exempt from Federal income taxes as is consistent with
its investment policies and prudent investment management. The Fund seeks to
achieve its investment objective by investing, as a fundamental policy, at
least 80% of an aggregate of the Fund's net assets (including proceeds from
the issuance of preferred stock), plus the amounts 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 excludable from gross
income for Federal income tax purposes (except that the interest may be
includable in taxable income for purposes of the Federal alternative minimum
tax). The Fund invests in a portfolio of municipal obligations which are rated
high grade (A or better) or, if unrated, are considered by the Investment
Adviser to be of comparable quality. The Fund may invest in certain tax exempt
securities classified as "private activity bonds," as discussed within, that
may subject certain investors in the Fund to an alternative minimum tax. There
can be no assurance that the Fund's investment objective will be realized.
Certain capitalized terms not otherwise defined in this statement of
additional information have the meaning provided in the Glossary included as
part of the prospectus.
This statement of additional information is not a prospectus, but should
be read in conjunction with the prospectus of the Fund, which has been filed
with the Securities and Exchange Commission (the "Commission") and can be
obtained, without charge, by calling (800) 543-6217. The prospectus is
incorporated by reference into this statement of additional information, and
this statement of additional information is incorporated by reference into the
prospectus.
-----------------
Merrill Lynch & Co.
-----------------
The date of this statement of additional information is [ ],
2005.
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
Investment Objective and Policies............................................3
Investment Restrictions......................................................3
Description of AMPS..........................................................5
The Auction.................................................................12
Rating Agency Guidelines....................................................13
Directors and Officers......................................................21
Investment Advisory and Management Arrangements.............................28
Portfolio Transactions......................................................36
Taxes.......................................................................38
Conflicts of Interest.......................................................43
Net Asset Value.............................................................45
Financial Statements........................................................45
APPENDIX A Ratings Of Municipal Bonds ....................................A-1
APPENDIX B Settlement Procedures .........................................B-1
APPENDIX C Auction Procedures ............................................C-1
2
INVESTMENT OBJECTIVE AND POLICIES
MuniYield Quality Fund II, Inc. is a non-diversified, closed-end
management investment company seeking to provide shareholders with as high a
level of current income exempt from Federal income taxes as is consistent with
its investment policies and prudent investment management. The Fund seeks to
achieve its investment objective by investing, as a fundamental policy, at
least 80% of an aggregate of the Fund's net assets (including proceeds from
the issuance of preferred stock), and the proceeds 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 excludable
from gross income for Federal income tax purposes (except that the interest
may be includable in taxable income for purposes of the Federal alternative
minimum tax) ("Municipal Bonds"). The Fund invests in Municipal Bonds which
are rated high grade (A or better) or, if unrated, are considered by the
Investment Adviser to be of comparable quality. The Fund may invest in certain
tax exempt securities classified as "private activity bonds," as discussed
within, that may subject certain investors in the Fund to an alternative
minimum tax. There can be no assurance that the Fund's investment objective
will be realized.
Reference is made to "Investment Objective and Policies" and "Other
Investment Policies" in the prospectus for information regarding other types
of securities that the Fund may invest in to achieve its objective.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and
may not be changed without the approval of the holders of a majority of the
Fund's outstanding shares of common stock and outstanding shares of AMPS,
Other AMPS and any other preferred stock, voting together as a single class,
and a majority of the outstanding shares of AMPS, Other AMPS and any other
preferred stock, voting as a separate class (which for this purpose and under
the 1940 Act means the lesser of (i) 67% of the shares of each class of
capital stock represented at a meeting at which more than 50% of the
outstanding shares of each class of capital stock are represented or (ii) more
than 50% of the outstanding shares of each class of capital stock). The Fund
may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase securities of other investment companies, except (i)
in connection with a merger, consolidation, acquisition or
reorganization, (ii) by purchase of shares of tax-exempt money market
funds advised by the Investment Adviser or its affiliates (as defined in
the 1940 Act) to the extent permitted by an exemptive order issued to
the Fund by the Securities and Exchange Commission, or (iii) by purchase
in the open market of securities of closed-end investment companies and
only if immediately thereafter no more than 10% of the Fund's total
assets would be invested in such securities.
3. Purchase or sell real estate, real estate limited partnerships,
commodities or commodity contracts; provided that the Fund may invest in
securities secured by real estate or interests therein or issued by
companies that invest in real estate or interests therein, and the Fund
may purchase and sell financial futures contracts and options thereon.
4. Issue senior securities other than preferred stock or borrow
amounts in excess of 5% of its total assets taken at market value;
provided, however, that the Fund is authorized to borrow money in excess
of 5% of the value of its total assets for the purpose of repurchasing
shares of common stock or redeeming shares of preferred stock.
5. 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.
6. Make loans to other persons, except that the Fund may purchase
Municipal Bonds and other debt securities in accordance with its
investment objective, policies and limitations.
3
7. 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).
8. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund
may write, purchase and sell options and futures on Municipal Bonds,
U.S. Government obligations and related indices or otherwise in
connection with bona fide hedging activities.
9. 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, states,
municipalities and their political subdivisions are not considered to be
part of any industry.
For purposes of investment restriction (4) above, the Fund may borrow
moneys in excess of 5% of the value of its total assets to the extent
permitted by Section 18 of the 1940 Act or otherwise as permitted by
applicable law for the purpose of repurchasing shares of common stock or
redeeming shares of preferred stock. For purposes of investment restriction
(9) above, the exception for states, municipalities and their political
subdivisions applies only to tax exempt securities issued by such entities.
An additional investment restriction adopted by the Fund, which may be
changed by the Board of Directors without stockholder approval, provides that
the Fund may not 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 (4) above or except as may be necessary in connection with
transactions in financial futures contracts and options thereon.
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 or in qualified publicly
traded partnerships as defined in the Code 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, Pierce, Fenner &
Smith Incorporated ("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" in this statement of
additional information.
4
DESCRIPTION OF AMPS
Certain of the capitalized terms used herein and not otherwise defined
in this statement of additional information have the meaning provided in the
Glossary at the back of the prospectus.
The Series D AMPS will be shares of preferred stock that entitle their
holders to receive dividends when, as and if declared by the Board of
Directors, out of funds legally available therefor, at a rate per annum that
may vary for the successive Dividend Periods. After the Initial Dividend
Period, each Subsequent Dividend Period for the Series D AMPS generally will
be a 7-Day Dividend Period; provided however, that prior to any Auction, the
Fund may elect, subject to certain limitations described herein, upon giving
notice to holders thereof, a Special Dividend Period. The Applicable Rate for
a particular Dividend Period will be determined by an Auction conducted on the
Business Day before the start of such Dividend Period. Beneficial Owners and
Potential Beneficial Owners of shares of AMPS may participate in Auctions
therefor, although, except in the case of a Special Dividend Period of more
than 28 days, Beneficial Owners desiring to continue to hold all of their
shares of AMPS regardless of the Applicable Rate resulting from Auctions need
not participate. For an explanation of Auctions and the method of determining
the Applicable Rate, see Appendix C "Auction Procedures."
Except as otherwise required by law or unless there is no Securities
Depository, all outstanding shares of the AMPS will be represented by one or
more certificates registered in the name of the nominee of the Securities
Depository (initially expected to be Cede), and no person acquiring shares of
AMPS will be entitled to receive a certificate representing such shares. See
Appendix C "Auction Procedures." As a result, the nominee of the Securities
Depository is expected to be the sole holder of record of the shares of AMPS.
Accordingly, each purchaser of AMPS must rely on (i) the procedures of the
Securities Depository and, if such purchaser is not a member of the Securities
Depository, such purchaser's Agent Member, to receive dividends, distributions
and notices and to exercise voting rights (if and when applicable) and (ii)
the records of the Securities Depository and, if such purchaser is not a
member of the Securities Depository, such purchaser's Agent Member, to
evidence its beneficial ownership of shares of AMPS.
When issued and sold, the shares of AMPS will have a liquidation
preference of $25,000 per share plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) and will be fully paid and
non-assessable. See "Description of AMPS -- Liquidation Rights" in the
prospectus. The shares of AMPS will not be convertible into shares of common
stock or other capital stock of the Fund, and the holders thereof will have no
preemptive rights. The AMPS will not be subject to any sinking fund but will
be subject to redemption at the option of the Fund at the Optional Redemption
Price on any Dividend Payment Date (except during the Initial Dividend Period
and during a Non-Call Period) and, under certain circumstances, will be
subject to mandatory redemption by the Fund at the Mandatory Redemption Price
stated in the prospectus. See "Description of AMPS -- Redemption" in the
prospectus.
The Fund also has outstanding three series of shares of Other AMPS with
terms that are substantially the same as the terms of the shares of AMPS
described herein and in the prospectus. Cede, the nominee of the Securities
Depository, 55 Water Street, New York, New York 10041-0099, is the sole holder
of record of the shares of Other AMPS. The Series D AMPS offered hereby rank
on a parity with the Other AMPS with respect to dividends and liquidation
preference.
In addition to serving as the Auction Agent in connection with the
Auction Procedures described in the prospectus, The Bank of New York will be
the transfer agent, registrar, dividend disbursing agent and redemption agent
for the shares of AMPS. The Auction Agent, however, will serve merely as the
agent of the Fund, acting in accordance with the Fund's instructions, and will
not be responsible for any evaluation or verification of any matters certified
to it.
Except in an Auction, the Fund will have the right (to the extent
permitted by applicable law) to purchase or otherwise acquire any shares of
AMPS so long as the Fund is current in the payment of dividends on AMPS and on
any other capital stock of the Fund ranking on a parity with the AMPS,
including the Other AMPS, with respect to the payment of dividends or upon
liquidation. Any shares of AMPS redeemed, purchased or otherwise acquired by
the Fund may not be reissued.
5
The following supplements the description of the terms of the shares of
AMPS set forth in the prospectus. This description does not purport to be
complete and is subject to and qualified in its entirety by reference to the
Fund's Charter and Articles Supplementary, including the provisions thereof
establishing the AMPS. The Fund's Charter and the form of Articles
Supplementary establishing the terms of the AMPS have been filed as exhibits
to the Registration Statement of which this statement of additional
information is a part.
Dividends
General. The holders of shares of the Series D AMPS will be entitled to
receive, when, as and if declared by the Board of Directors of the Fund, out
of funds legally available therefor, cumulative cash dividends on their
shares, at the Applicable Rate. Dividends on the shares of AMPS so declared
and payable shall be paid (i) in preference to and in priority over any
dividends so declared and payable on the common stock, and (ii) to the extent
permitted under the Code and to the extent available, out of net tax-exempt
income earned on the Fund's investments. Generally, dividends on shares of
AMPS, to the extent that they are derived from interest paid on Municipal
Bonds, will be exempt from Federal income taxes, subject to possible
application of the alternative minimum tax. See "Taxes."
Notification of Dividend Period. In determining whether the Fund should
issue a Notice of Special Dividend for the AMPS, the Broker-Dealers will
consider (i) existing short-term and long-term market rates and indices of
such short-term and long-term rates, (ii) existing market supply and demand
for short-term and long-term securities, (iii) existing yield curves for
short-term and long-term securities comparable to the AMPS, (iv) industry and
financial conditions that may affect the AMPS, (v) the investment objective of
the Fund, and (vi) the Dividend Periods and dividend rates at which current
and potential beneficial holders of the AMPS would remain or become beneficial
holders. If the Broker-Dealers shall not give the Fund a Response by such
second Business Day or if the Response states that given the factors set forth
above it is not advisable that the Fund give a Notice of Special Dividend
Period for the AMPS, the Fund may not give a Notice of Special Dividend Period
in respect of such Request for Special Dividend Period. In the event the
Response indicates that it is advisable that the Fund give a Notice of Special
Dividend Period for the AMPS, the Fund, by no later than the second Business
Day prior to such Auction Date, may give a notice (a "Notice of Special
Dividend Period") to the Auction Agent, the Securities Depository and each
Broker-Dealer, which notice will specify (i) the duration of the Special
Dividend Period, (ii) the Optional Redemption Price as specified in the
related Response and (iii) the Specific Redemption Provisions, if any, as
specified in the related Response. The Fund also shall provide a copy of such
Notice of Special Dividend Period to Moody's and S&P. The Fund shall not give
a Notice of Special Dividend Period, and, if such Notice of Special Dividend
Period shall have been given already, shall give telephonic and written notice
of its revocation (a "Notice of Revocation") to the Auction Agent, each
Broker-Dealer, and the Securities Depository on or prior to the Business Day
prior to the relevant Auction Date if (x) either the 1940 Act AMPS Asset
Coverage is not satisfied or the Fund shall fail to maintain S&P Eligible
Assets and Moody's Eligible Assets each with an aggregate Discounted Value at
least equal to the AMPS Basic Maintenance Amount, in each case on the
Valuation Date immediately preceding the Business Day prior to the relevant
Auction Date on an actual basis and on a pro forma basis giving effect to the
proposed Special Dividend Period (using as a pro forma dividend rate with
respect to such Special Dividend Period the dividend rate which the
Broker-Dealers shall advise the Fund is an approximately equal rate for
securities similar to the AMPS with an equal dividend period), (y) sufficient
funds for the payment of dividends payable on the immediately succeeding
Dividend Payment Date have not been segregated in an account at the Fund's
custodian bank or on the books of the Fund by the close of business on the
third Business Day preceding the related Auction Date or (z) the
Broker-Dealers jointly advise the Fund that, after consideration of the
factors listed above, they have concluded that it is advisable to give a
Notice of Revocation. The Fund also shall provide a copy of such Notice of
Revocation to Moody's and S&P. If the Fund is prohibited from giving a Notice
of Special Dividend Period as a result of the factors enumerated in clause
(x), (y) or (z) above or if the Fund gives a Notice of Revocation with respect
to a Notice of Special Dividend Period, the next succeeding Dividend Period
will be a 7-Day Dividend Period. In addition, in the event Sufficient Clearing
Bids are not made in any Auction or an Auction is not held for any reason, the
next succeeding Dividend Period will be a 7-Day Dividend Period, and the Fund
may not again give a Notice of Special Dividend Period (and any such attempted
notice shall be null and void) until Sufficient Clearing Bids have been made
in an Auction with respect to a 7-Day Dividend Period.
Non-Payment Period; Late Charge. A Non-Payment Period will commence if
the Fund fails to (i) declare, prior to the close of business on the second
Business Day preceding any Dividend Payment Date, for payment on or
6
(to the extent permitted as described below) within three Business Days
after such Dividend Payment Date to the persons who held such shares as of
12:00 noon, Eastern time, on the Business Day preceding such Dividend Payment
Date, the full amount of any dividend on shares of AMPS payable on such
Dividend Payment Date or (ii) deposit, irrevocably in trust, in same-day
funds, with the Auction Agent by 12:00 noon, Eastern time, (A) on such
Dividend Payment Date the full amount of any cash dividend on such shares (if
declared) payable on such Dividend Payment Date or (B) on any redemption date
for shares of AMPS called for redemption, the Mandatory Redemption Price per
share of such AMPS or, in the case of an optional redemption, the Optional
Redemption Price per share. Such Non-Payment Period will consist of the period
commencing on and including the aforementioned Dividend Payment Date or
redemption date, as the case may be, and ending on and including the Business
Day on which, by 12:00 noon, Eastern time, all unpaid cash dividends and
unpaid redemption prices shall have been so deposited or otherwise shall have
been made available to the applicable holders in same-day funds, provided that
a Non-Payment Period for AMPS will not end unless the Fund shall have given at
least five days' but no more than 30 days' written notice of such deposit or
availability to the Auction Agent, the Securities Depository and all holders
of shares of AMPS. Notwithstanding the foregoing, the failure by the Fund to
deposit funds as provided for by clause (ii) (A) or (ii) (B) above within
three Business Days after any Dividend Payment Date or redemption date, as the
case may be, in each case to the extent contemplated below, shall not
constitute a "Non-Payment Period."
The Applicable Rate for each Dividend Period for shares of AMPS,
commencing during a Non-Payment Period, will be equal to the Non-Payment
Period Rate; and each Dividend Period commencing after the first day of, and
during, a Non-Payment Period shall be a 7-Day Dividend Period. Any dividend on
shares of AMPS due on any Dividend Payment Date for such shares (if, prior to
the close of business on the second Business Day preceding such Dividend
Payment Date, the Fund has declared such dividend payable on such Dividend
Payment Date to the persons who held such shares as of 12:00 noon, Eastern
time, on the Business Day preceding such Dividend Payment Date) or redemption
price with respect to such shares not paid to such persons when due may be
paid to such persons in the same form of funds by 12:00 noon, Eastern time, on
any of the first three Business Days after such Dividend Payment Date or due
date, as the case may be, provided that such amount is accompanied by a late
charge calculated for such period of non-payment at the Non-Payment Period
Rate applied to the amount of such non-payment based on the actual number of
days comprising such period divided by 365. In the case of a willful failure
of the Fund to pay a dividend on a Dividend Payment Date or to redeem any
shares of AMPS on the date set for such redemption, the preceding sentence
shall not apply and the Applicable Rate for the Dividend Period commencing
during the Non-Payment Period resulting from such failure shall be the
Non-Payment Period Rate. For the purposes of the foregoing, payment to a
person in same-day funds on any Business Day at any time will be considered
equivalent to payment to that person in New York Clearing House (next-day)
funds at the same time on the preceding Business Day, and any payment made
after 12:00 noon, Eastern time, on any Business Day shall be considered to
have been made instead in the same form of funds and to the same person before
12:00 noon, Eastern time, on the next Business Day.
The Non-Payment Period Rate initially will be 200% of the applicable
Reference Rate (or 300% of such rate if the Fund has provided notification to
the Auction Agent prior to the Auction establishing the Applicable Rate for
any dividend that net capital gain or other taxable income will be included in
such dividend on shares of AMPS), provided that the Board of Directors of the
Fund shall have the authority to adjust, modify, alter or change from time to
time by resolution or otherwise the initial Non-Payment Period Rate if the
Board of Directors of the Fund determines and Moody's and S&P (and any
Substitute Rating Agency or Substitute Rating Agencies, as the case may be, in
lieu of Moody's or S&P, or both, in the event either or both of such parties
shall not rate the AMPS) advise the Fund in writing that such adjustment,
modification, alteration or change will not adversely affect their then
current ratings on the AMPS.
Restrictions on Dividends and Other Payments. For so long as any shares
of AMPS are outstanding, the Fund will not declare, pay or set apart for
payment any dividend or other distribution (other than a dividend or
distribution paid in shares of, or options, warrants or rights to subscribe
for or purchase, common stock or other stock, if any, ranking junior to shares
of AMPS as to dividends or upon liquidation) in respect of common stock or any
other stock of the Fund ranking junior to or on a parity with shares of AMPS
as to dividends or upon liquidation, or call for redemption, redeem, purchase
or otherwise acquire for consideration any shares of common stock or any other
such junior stock (except by conversion into or exchange for stock of the Fund
ranking junior to AMPS as to dividends and upon liquidation) or any such
parity stock (except by conversion into or exchange for stock of the Fund
ranking junior to or on a parity with AMPS as to dividends and upon
liquidation), unless (A) immediately after
7
such transaction, the Fund would have S&P Eligible Assets and Moody's Eligible
Assets each with an aggregate Discounted Value equal to or greater than the
AMPS Basic Maintenance Amount, and the 1940 Act AMPS Asset Coverage (see
"Asset Maintenance" and "Redemption" below) would be satisfied, (B) full
cumulative dividends on shares of AMPS and shares of the Other AMPS due on or
prior to the date of the transaction have been declared and paid or shall have
been declared and sufficient funds for the payment thereof deposited with the
Auction Agent, (C) any Additional Dividend required to be paid on or before
the date of such declaration or payment has been paid, and (D) the Fund has
redeemed the full number of shares of AMPS required to be redeemed by any
provision for mandatory redemption contained in the Articles Supplementary.
Asset Maintenance
1940 Act AMPS Asset Coverage. The Fund will be required under the
Articles Supplementary to maintain, with respect to shares of AMPS, as of the
last Business Day of each month in which any shares of AMPS are outstanding,
asset coverage of at least 200% with respect to senior securities that are
stock, including the shares of AMPS and Other AMPS (or such other asset
coverage as in the future may be specified in or under the 1940 Act as the
minimum asset coverage for senior securities that are stock of a closed-end
investment company as a condition of paying dividends on its common stock)
("1940 Act AMPS Asset Coverage"). If the Fund fails to maintain 1940 Act AMPS
Asset Coverage and such failure is not cured as of the last Business Day of
the following month (the "1940 Act Cure Date"), the Fund will be required
under certain circumstances to redeem certain of the shares of AMPS. See
"Description of AMPS -- Redemption" in the prospectus and "--Redemption"
below.
AMPS Basic Maintenance Amount. So long as shares of AMPS are
outstanding, the Fund will be required under the Articles Supplementary as of
the last Business Day of each week (a "Valuation Date") to maintain S&P
Eligible Assets and Moody's Eligible Assets each having in the aggregate a
Discounted Value at least equal to the AMPS Basic Maintenance Amount. If the
Fund fails to meet such requirement as of any Valuation Date and such failure
is not cured on or before the sixth Business Day after such Valuation Date
(the "AMPS Basic Maintenance Cure Date"), the Fund will be required under
certain circumstances to redeem certain of the shares of AMPS. See
"Description of AMPS-- Redemption" in the prospectus and "--Redemption" below.
Upon any failure to maintain the required Discounted Value, the Fund will use
its best efforts to alter the composition of its portfolio to reattain a
Discounted Value at least equal to the AMPS Basic Maintenance Amount on or
prior to the AMPS Basic Maintenance Cure Date.
The AMPS Basic Maintenance Amount as of any Valuation Date, means the
dollar amount equal to (i) the sum of (A) the product of the number of shares
of AMPS and Other AMPS outstanding on such Valuation Date multiplied by the
sum of $25,000 and any applicable redemption premium attributable to the
designation of a Premium Call Period; (B) the aggregate amount of cash
dividends (whether or not earned or declared) that will have accumulated for
the AMPS and Other AMPS outstanding to (but not including) the end of the
current Dividend Period for the AMPS that follows such Valuation Date in the
event the then current Dividend Period will end within 49 calendar days of
such Valuation Date or through the 49th day after such Valuation Date in the
event the then current Dividend Period will not end within 49 calendar days of
such Valuation Date; (C) in the event the then current Dividend Period will
end within 49 calendar days of such Valuation Date, the aggregate amount of
cash dividends that would accumulate at the Maximum Applicable Rate applicable
to a Dividend Period of 28 or fewer days on any shares of AMPS and Other AMPS
outstanding from the end of such Dividend Period through the 49th day after
such Valuation Date, multiplied by the larger of the Moody's Volatility Factor
and the S&P Volatility Factor, determined from time to time by Moody's and
S&P, respectively (except that if such Valuation Date occurs during a
Non-Payment Period, the cash dividend for purposes of calculation would
accumulate at the then current Non-Payment Period Rate); (D) the amount of
anticipated expenses of the Fund for the 90 days subsequent to such Valuation
Date; (E) the amount of current outstanding balances of any indebtedness that
is senior to the AMPS plus interest actually accrued together with 30 days
additional interest on the current outstanding balances calculated at the
current rate; (F) the amount of the Fund's maximum potential Additional
Dividend liability as of such Valuation Date; and (G) any current liabilities
as of such Valuation Date to the extent not reflected in any of (i)(A) through
(i)(F) (including, without limitation, and immediately upon determination, any
amounts due and payable by the Fund for portfolio securities purchased as of
such Valuation Date and any liabilities incurred for the purpose of clearing
securities transactions) less (ii) either (A) the Discounted Value of any of
the Fund's assets, or (B) the face value of any of the Fund's assets if such
assets mature prior to or on the date of redemption of AMPS or payment of a
liability and are either securities issued or guaranteed by the United States
Government or Deposit Securities, in
8
both cases irrevocably deposited by the Fund for the payment of the amount
needed to redeem shares of AMPS subject to redemption or to satisfy any of
(i)(B) through (i)(G).
The Discount Factors and guidelines for determining the market value of
the Fund's portfolio holdings have been based on criteria established in
connection with rating the AMPS. These factors include, but are not limited
to, the sensitivity of the market value of the relevant asset to changes in
interest rates, the liquidity and depth of the market for the relevant asset,
the credit quality of the relevant asset (for example, the lower the rating of
a debt obligation, the higher the related discount factor) and the frequency
with which the relevant asset is marked to market. In no event shall the
Discounted Value of any asset of the Fund exceed its unpaid principal balance
or face amount as of the date of calculation. The Discount Factor relating to
any asset of the Fund and the AMPS Basic Maintenance Amount, the assets
eligible for inclusion in the calculation of the Discounted Value of the
Fund's portfolio and certain definitions and methods of calculation relating
thereto may be changed from time to time by the Fund, without stockholder
approval, but only in the event the Fund receives written confirmation from
S&P, Moody's and any Substitute Rating Agency that any such changes would not
impair the rating then assigned to the shares of AMPS by S&P or Moody's or any
Substitute Rating Agency.
On or before the seventh Business Day in the case of Moody's and the
next Business Day in the case of S&P after a Valuation Date on which the Fund
fails to maintain S&P Eligible Assets and Moody's Eligible Assets each with an
aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount, the Fund is required to (i) deliver to Moody's a report with respect
to the calculation of the AMPS Basic Maintenance Amount, the value of its
portfolio holdings and the net asset value and market price of the Fund's
common stock as of the date of such failure (an "AMPS Basic Maintenance
Report") and (ii) send S&P an electronic notification of such failure. The
Fund also will deliver an AMPS Basic Maintenance Report as of the 21st day of
each month (or if such day is not a Business Day, as of the next succeeding
Business Day) or as of the last Business Day of the month in which the Fund's
fiscal year ends on or before the seventh Business Day after such day. Within
ten Business Days after delivery of such report relating to the month in which
the Fund's fiscal year ends, the Fund will deliver a letter prepared by the
Fund's independent accountants regarding the accuracy of the calculations made
by the Fund in such AMPS Basic Maintenance Report. If any such letter prepared
by the Fund's independent accountants shows that an error was made in the AMPS
Basic Maintenance Report, the calculation or determination made by the Fund's
independent accountants will be conclusive and binding on the Fund. The Fund
will also (i) provide Moody's with an AMPS Basic Maintenance Report and (ii)
send S&P an electronic notification, as of each Valuation Date on or before
the seventh Business Day in the case of Moody's and the next Business Day in
the case of S&P after such date when the Discounted Value of Moody's Eligible
Assets or S&P Eligible Assets, as the case may be, fails to exceed the AMPS
Basic Maintenance Amount by 10% or more. Also, on or before 5:00 p.m., Eastern
time, on the first Business Day after shares of common stock are repurchased
by the Fund, the Fund will complete and deliver to Moody's an AMPS Basic
Maintenance Report as of the close of business on such date that common stock
is repurchased.
Redemption
Mandatory Redemption. The number of shares of AMPS to be redeemed will
be equal to the lesser of (a) the minimum number of shares of AMPS the
redemption of which, if deemed to have occurred immediately prior to the
opening of business on the Cure Date, together with all other shares of the
preferred stock subject to redemption or retirement, would result in the Fund
having S&P Eligible Assets and Moody's Eligible Assets each with an aggregate
Discounted Value equal to or greater than the AMPS Basic Maintenance Amount or
satisfaction of the 1940 Act AMPS Asset Coverage, as the case may be, on such
Cure Date (provided that, if there is no such minimum number of shares the
redemption of which would have such result, all shares of AMPS then
outstanding will be redeemed), and (b) the maximum number of shares of AMPS,
together with all other shares of preferred stock subject to redemption or
retirement, that can be redeemed out of funds expected to be legally available
therefor on such redemption date. In determining the number of shares of AMPS
required to be redeemed in accordance with the foregoing, the Fund shall
allocate the number required to be redeemed which would result in the Fund
having S&P Eligible Assets and Moody's Eligible Assets each with an aggregate
Discounted Value equal to or greater than the AMPS Basic Maintenance Amount or
satisfaction of the 1940 Act AMPS Asset Coverage, as the case may be, pro rata
among shares of AMPS, Other AMPS and other preferred stock subject to
redemption pursuant to provisions similar to those set forth below; provided
that, shares of AMPS which may not be redeemed at the option of the Fund due
to the designation of a Non-Call Period applicable to such shares (A) will be
subject to mandatory
9
redemption only to the extent that other shares are not available to satisfy
the number of shares required to be redeemed and (B) will be selected for
redemption in an ascending order of outstanding number of days in the Non-Call
Period (with shares with the lowest number of days to be redeemed first) and
by lot in the event of shares having an equal number of days in such Non-Call
Period. The Fund is required to effect such a mandatory redemption on a
Business Day which is not later than 30 days after such Cure Date, except that
if the Fund does not have funds legally available for the redemption of all of
the required number of shares of AMPS and shares of other preferred stock
which are subject to mandatory redemption or the Fund otherwise is unable to
effect such redemption on a Business Day which is on or prior to 30 days after
such Cure Date, the Fund will redeem those shares of AMPS that it was unable
to redeem on the earliest practicable date on which it is able to effect such
redemption out of funds legally available therefor.
Notice of Redemption. If shares of AMPS are to be redeemed, a notice of
redemption will be mailed to each record holder of such shares of AMPS
(initially Cede as nominee of the Securities Depository) and to the Auction
Agent not less than 17 nor more than 60 days prior to the date fixed for the
redemption thereof. Each notice of redemption will include a statement setting
forth: (i) the redemption date, (ii) the redemption price, (iii) the aggregate
number of shares of AMPS to be redeemed, (iv) the place or places where shares
of AMPS are to be surrendered for payment of the redemption price, (v) a
statement that dividends on the shares to be redeemed will cease to accumulate
on such redemption date (except that holders may be entitled to Additional
Dividends) and (vi) the provision of the Articles Supplementary pursuant to
which such shares are being redeemed. The notice also will be published in the
eastern and national editions of The Wall Street Journal. No defect in the
notice of redemption or in the mailing or publication thereof will affect the
validity of the redemption proceedings, except as required by applicable law.
In the event that less than all of the outstanding shares of AMPS are to
be redeemed, the shares to be redeemed will be selected by lot or such other
method as the Fund shall deem fair and equitable, and the results thereof will
be communicated to the Auction Agent. The Auction Agent will give notice to
the Securities Depository, whose nominee will be the record holder of all
shares of AMPS, and the Securities Depository will determine the number of
shares to be redeemed from the account of the Agent Member of each Existing
Holder. Each Agent Member will determine the number of shares to be redeemed
from the account of each Existing Holder for which it acts as agent. An Agent
Member may select for redemption shares from the accounts of some Existing
Holders without selecting for redemption any shares from the accounts of other
Existing Holders. Notwithstanding the foregoing, if neither the Securities
Depository nor its nominee is the record holder of all of the shares of AMPS,
the particular shares to be redeemed shall be selected by the Fund by lot or
by such other method as the Fund shall deem fair and equitable.
If the Fund gives notice of redemption, and concurrently or thereafter
deposits in trust with the Auction Agent, or segregates in an account at the
Fund's custodian bank for the benefit of the holders of the AMPS to be
redeemed and for payment to the Auction Agent, Deposit Securities (with a
right of substitution) having an aggregate Discounted Value equal to the
redemption payment for the shares of AMPS as to which notice of redemption has
been given, with irrevocable instructions and authority to pay the redemption
price to the record holders thereof, then upon the date of such deposit or, if
no such deposit is made, upon such date fixed for redemption (unless the Fund
shall default in making payment of the redemption price), all rights of the
holders of such shares called for redemption will cease and terminate, except
the right of such holders to receive the redemption price in respect thereof
and any Additional Dividends, but without interest, and such shares no longer
will be deemed to be outstanding. The Fund will be entitled to receive, from
time to time, the interest, if any, earned on such Deposit Securities
deposited with the Auction Agent, and the holders of any shares so redeemed
will have no claim to any such interest. Any funds so deposited which are
unclaimed at the end of one year from such redemption date will be repaid,
upon demand, to the Fund, after which the holders of the shares of AMPS so
called for redemption may look only to the Fund for payment thereof.
So long as any shares of AMPS are held of record by the nominee of the
Securities Depository (initially Cede), the redemption price for such shares
will be paid on the redemption date to the nominee of the Securities
Depository. The Securities Depository's normal procedures now provide for it
to distribute the amount of the redemption price to Agent Members who, in
turn, are expected to distribute such funds to the persons for whom they are
acting as agent. Notwithstanding the provisions for redemption described
above, no shares of AMPS shall be subject to optional redemption (i) unless
all dividends in arrears on the outstanding shares of AMPS, and all capital
10
stock of the Fund ranking on a parity with the AMPS with respect to the
payment of dividends or upon liquidation, including the Other AMPS, have been
or are being contemporaneously paid or declared and set aside for payment and
(ii) if redemption thereof would result in the Fund's failure to maintain
Moody's Eligible Assets or S&P Eligible Assets with an aggregate Discounted
Value equal to or greater than the AMPS Basic Maintenance Amount.
Voting Rights
In connection with the election of the Fund's directors, holders of
shares of AMPS, Other AMPS and any other preferred stock, voting separately as
a single class, shall be entitled at all times to elect two of the Fund's
directors, and the remaining directors will be elected by holders of shares of
common stock and shares of AMPS, Other AMPS and any other preferred stock,
voting together as a single class. In addition, if at any time dividends on
outstanding shares of AMPS shall be unpaid in an amount equal to at least two
full years' dividends thereon or if at any time holders of any shares of
preferred stock, including Other AMPS, are entitled, together with the holders
of AMPS, to elect a majority of the directors of the Fund under the 1940 Act,
then the number of directors constituting the Board of Directors automatically
shall be increased by the smallest number that, when added to the two
directors elected exclusively by the holders of shares of AMPS, Other AMPS and
any other preferred stock as described above, would constitute a majority of
the Board of Directors as so increased by such smallest number, and at a
special meeting of stockholders which will be called and held as soon as
practicable, and at all subsequent meetings at which directors are to be
elected, the holders of shares of AMPS, Other AMPS and any other preferred
stock, voting as a separate class, will be entitled to elect the smallest
number of additional directors that, together with the two directors that such
holders in any event will be entitled to elect, constitutes a majority of the
total number of directors of the Fund as so increased. The terms of office of
the persons who are directors at the time of that election will continue. If
the Fund thereafter shall pay, or declare and set apart for payment in full,
all dividends payable on all outstanding shares of AMPS and any other
preferred stock, including Other AMPS, for all past Dividend Periods, the
additional voting rights of the holders of shares of AMPS and any other
preferred stock, including Other AMPS, as described above shall cease, and the
terms of office of all of the additional directors elected by the holders of
shares of AMPS, Other AMPS and any other preferred stock (but not of the
directors with respect to whose election the holders of common stock were
entitled to vote or the two directors the holders of shares of AMPS, Other
AMPS and any other preferred stock have the right to elect in any event) will
terminate automatically.
The affirmative vote of a majority of the votes entitled to be cast by
holders of outstanding shares of AMPS and any other preferred stock, including
Other AMPS, voting as a separate class, will be required to (i) authorize,
create or issue any class or series of stock ranking prior to the AMPS or any
other series of preferred stock with respect to the payment of dividends or
the distribution of assets on dissolution, liquidation or winding up the
affairs of the Fund, 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 shares of AMPS or any other preferred stock. To the extent
permitted under the 1940 Act, in the event shares of more than one series of
preferred stock are outstanding, the Fund shall not approve any of the actions
set forth in clause (i) or (ii) which adversely affects the contract rights
expressly set forth in the Charter of a holder of shares of AMPS differently
than those of a holder of shares of any other series of preferred stock
without the affirmative vote of at least a majority of votes entitled to be
cast by holders of the shares of AMPS adversely affected and outstanding at
such time (voting separately as a class). The Board of Directors, however,
without stockholder approval, may amend, alter or repeal any or all of the
various rating agency guidelines described herein in the event the Fund
receives confirmation from the rating agencies that any such amendment,
alteration or repeal would not impair the ratings then assigned to shares of
AMPS. Furthermore, the Board of Directors, without stockholder approval, may
terminate compliance with the Moody's or S&P guidelines as discussed under
"Rating Agency Guidelines" in the prospectus. Unless a higher percentage is
provided for under "Description of Capital Stock -- Certain Provisions of the
Charter and By-laws" in the prospectus, the affirmative vote of the holders of
a majority of the outstanding shares of preferred stock (as defined under
"Investment Restrictions"), including AMPS and Other AMPS, entitled to be
cast, voting as a separate class, will be required to approve any plan of
reorganization (including bankruptcy proceedings) adversely affecting such
shares or any action requiring a vote of security holders under Section 13(a)
of the 1940 Act including, among other things, changes in the Fund's
investment objective or changes in the investment policies and restrictions
described as fundamental policies in the prospectus and under "Investment
Restrictions." So long as any shares of AMPS are outstanding, the affirmative
vote of the holders of a majority of the outstanding shares of preferred stock
(as defined under "Investment Restrictions"), including AMPS and Other AMPS,
voting together as a single class, will be required to approve any voluntary
application by the Fund for relief
11
under Federal bankruptcy law or any similar application under state law for so
long as the Fund is solvent and does not foresee becoming insolvent. The class
vote of holders of shares of AMPS, Other AMPS and any other preferred stock
described above in each case will be in addition to a separate vote of the
requisite percentage of shares of common stock and shares of AMPS, Other AMPS
and any other preferred stock, voting together as a single class, necessary to
authorize the action in question. An increase in the number of authorized
shares of preferred stock pursuant to the Charter or the issuance of
additional shares of any series of preferred stock (including AMPS and Other
AMPS) pursuant to the Charter shall not in and of itself be considered to
adversely affect the contract rights of the holders of the AMPS.
Notwithstanding the foregoing, and except as otherwise required by the
1940 Act, (i) holders of outstanding shares of the AMPS will be entitled as a
series, to the exclusion of the holders of all other securities, including
other preferred stock, common stock and other classes of capital stock of the
Fund, to vote on matters affecting the AMPS that do not materially adversely
affect any of the contract rights of holders of such other securities,
including other preferred stock, common stock and other classes of capital
stock, as expressly set forth in the Charter, and (ii) holders of outstanding
shares of AMPS will not be entitled to vote on matters affecting any other
preferred stock that do not materially adversely affect any of the contract
rights of holders of the AMPS, as expressly set forth in the Charter.
The foregoing voting provisions will not apply to any shares of AMPS if,
at or prior to the time when the act with respect to which such vote otherwise
would be required shall be effected, such shares shall have been (i) redeemed
or (ii) called for redemption and sufficient funds shall have been deposited
in trust to effect such redemption.
THE AUCTION
Auction Agent Agreement
The Auction Agent will act as agent for the Fund in connection with
Auctions. In the absence of bad faith or negligence on its part, the Auction
Agent will not be liable for any action taken, suffered or omitted, or for any
error of judgment made, by it in the performance of its duties under the
Auction Agent Agreement, and will not be liable for any error of judgment made
in good faith unless the Auction Agent shall have been negligent in
ascertaining, or failing to ascertain, the pertinent facts. Pursuant to the
Auction Agent Agreement, the Fund is required to indemnify the Auction Agent
for certain losses and liabilities incurred by the Auction Agent without
negligence or bad faith on its part in connection with the performance of its
duties under such agreement.
The Auction Agent may terminate the Auction Agent Agreement upon notice
to the Fund, which termination may be no earlier than 60 days following
delivery of such notice. If the Auction Agent resigns, the Fund will use its
best efforts to enter into an agreement with a successor Auction Agent
containing substantially the same terms and conditions as the Auction Agent
Agreement. The Fund may terminate the Auction Agent Agreement at any time,
provided that prior to such termination the Fund shall have entered into such
an agreement with respect thereto with a successor Auction Agent.
Broker-Dealer Agreements
The Auctions require the participation of one or more broker-dealers. A
Broker-Dealer Agreement may be terminated by the Auction Agent or a
Broker-Dealer on five days' notice to the other party, provided that the
Broker-Dealer Agreement with Merrill Lynch may not be terminated without the
prior written consent of the Fund, which consent may not be unreasonably
withheld.
For the six months ended April 30, 2005 and the fiscal years ended
October 31, 2004, 2003 and 2002, Merrill Lynch, an affiliate of the Investment
Adviser, earned $103,601, $171,550, $143,340 and $178,506, respectively,
pursuant to its Broker-Dealer Agreement with the Fund.
12
Auction Procedures
The Auction Procedures are set forth in Appendix C to this statement of
additional information. The Settlement Procedures to be used with respect to
Auctions are set forth in Appendix B to this statement of additional
information.
RATING AGENCY GUIDELINES
S&P AAA Rating Guidelines
The Discounted Value of the Fund's S&P Eligible Assets is calculated on
each Valuation Date. See "Description of AMPS--Asset Maintenance--AMPS Basic
Maintenance Amount." S&P Eligible Assets include cash, Receivables for
Municipal Bonds Sold (as defined below), Rule 2a-7 Money Market Funds and
Municipal Bonds eligible for consideration under S&P's current guidelines. For
purposes of calculating the Discounted Value of the Fund's portfolio under
current S&P guidelines, the fair market value of Municipal Bonds eligible for
consideration under such guidelines must be discounted by the applicable S&P
Discount Factor set forth in the table below. The Discounted Value of a
Municipal Bond eligible for consideration under S&P guidelines is the fair
market value thereof divided by the S&P Discount Factor. The S&P Discount
Factor used to discount a particular Municipal Bond will be determined by
reference to the rating by S&P, Moody's or Fitch on such Municipal Bond;
provided, however, for purposes of determining the S&P Discount Factor
applicable to Municipal Bonds not rated by S&P, the Municipal Bonds will carry
an S&P rating one full rating category lower than the S&P rating category that
is the equivalent of the rating category in which such Municipal Bond is
placed by a NRSRO, in accordance with the table set forth below:
S&P's Rating Category (1)
------------------------------------------------------------------------------
AAA*(2) AA* A* BBB* BB* B* CCC* NR**
------------ ------- ------ -------- ------- ------ -------- ---------
144.75% 147.75% 150.75% 153.75% 175.11% 195.11% 215.11% 220.00%
---------
* S&P rating.
** Not rated.
(1) For Municipal Bonds of any one issuer rated at least BBB- by S&P, or if
not rated by S&P, rated at least A- by another NRSRO, 2% is added to the
applicable S&P Discount Factor for every 1% by which the fair market
value of such Municipal Bonds exceeds 5% of the aggregate fair market
value of the S&P Eligible Assets, but in no event greater than 10%; or
for any percentage over 5% add 10 percentage points to the applicable
S&P Discount Factor.
(2) For zero coupon Municipal Bonds, the S&P Discount Factor is 441.80%.
Notwithstanding the foregoing, (i) the S&P Discount Factor for
short-term Municipal Bonds will be 115%, so long as such Municipal Bonds are
rated A-1+ or SP-1+ by S&P and mature or have a demand feature exercisable in
30 days or less, or 120% so long as such Municipal Bonds are rated A-1 or SP-1
by S&P and mature or have a demand feature exercisable in 30 days or less, or
125% if such Municipal Bonds are not rated by S&P but are rated VMIG-1, P-1 or
MIG-1 by Moody's or F-1+ by Fitch; provided, however, such short-term
Municipal Bonds rated by Moody's or Fitch but not rated by S&P having a demand
feature exercisable in 30 days or less must be backed by a letter of credit,
liquidity facility or guarantee from a bank or other financial institution
having a short-term rating of at least A-1+ from S&P; and further provided
that such short-term Municipal Bonds rated by Moody's or Fitch but not rated
by S&P may comprise no more than 50% of short-term Municipal Bonds that
qualify as S&P Eligible Assets, (ii) the S&P Discount Factor for Rule 2a-7
Money Market Funds will be 110%, (iii) the S&P Discount Factor for Receivables
for Municipal Bonds Sold that are due in more than five Business Days from
such Valuation Date will be the S&P Discount Factor applicable to the
Municipal Bonds sold and (iv) no S&P Discount Factor will be applied to cash
or to Receivables for Municipal Bonds Sold if such receivables are due within
five Business Days of such Valuation Date. "Receivables for Municipal Bonds
Sold," for purposes of calculating S&P Eligible Assets
13
as of any Valuation Date, means the book value of receivables for Municipal
Bonds sold as of or prior to such Valuation Date. For purposes of the
foregoing, Anticipation Notes rated SP-1 or, if not rated by S&P, rated VMIG-1
by Moody's or F-1+ by Fitch, which do not mature or have a demand feature
exercisable in 30 days and which do not have a long-term rating, shall be
considered to be short-term Municipal Bonds.
The S&P guidelines require certain minimum issue size and impose other
requirements for purposes of determining S&P Eligible Assets. In order to be
considered S&P Eligible Assets, Municipal Bonds must:
(i) be issued by any of the 50 states of the United States, its
territories and their subdivisions, counties, cities, towns, villages,
and school districts, agencies, such as authorities and special
districts created by the states, and certain federally sponsored
agencies such as local housing authorities (payments made on these bonds
are exempt from regular Federal income taxes and are generally exempt
from state and local taxes in the state of issuance);
(ii) except for zero coupon Municipal Bonds rated AAA by S&P that
mature in 30 years or less, be interest bearing and pay interest at
least semi-annually;
(iii) be payable with respect to principal and interest in U.S.
dollars;
(iv) not be subject to a covered call or covered put option
written by the Fund;
(v) except for Inverse Floaters, not be part of a private
placement; and
(vi) except for Inverse Floaters and legally defeased bonds that
are secured by securities issued or guaranteed by the United States
Government, be part of an issue with an original issue size of at least
$10 million or, if of an issue with an original issue size below $10
million, is rated at least AA or higher by S&P.
Notwithstanding the foregoing:
(i) Municipal Bonds issued by issuers in any one state or
territory will be considered S&P Eligible Assets only to the extent the
fair market value of such Municipal Bonds does not exceed 25% of the
aggregate fair market value of S&P Eligible Assets;
(ii) Municipal Bonds which are escrow bonds or defeased bonds may
compose up to 100% of the aggregate fair market value of S&P Eligible
Assets if such Bonds initially are assigned a rating by S&P in
accordance with S&P's legal defeasance criteria or rerated by S&P as
economic defeased escrow bonds and assigned an AAA rating. Municipal
Bonds may be rated as escrow bonds by another NRSRO or rerated as an
escrow bond and assigned the equivalent of an S&P AAA rating, provided
that such equivalent rated Bonds are limited to 50% of the aggregate
fair market value of S&P Eligible Assets and are deemed to have an AA
S&P rating for purposes of determining the S&P Discount Factor
applicable to such Municipal Bonds. The limitations on Municipal Bonds
in clause (i) above and clauses (iii) and (iv) below are not applicable
to escrow bonds;
(iii) Municipal Bonds which are not rated by any NRSRO may
comprise no more than 10% of S&P Eligible Assets;
(iv) Municipal Bonds rated at least BBB- by S&P, or if not rated
by S&P, rated at least A- by another NRSRO, of any one issuer or
guarantor (excluding bond insurers) will be considered S&P Eligible
Assets only to the extent the fair market value of such Municipal Bonds
does not exceed 10% of the aggregate fair market value of the S&P
Eligible Assets, High Yield Municipal Bonds of any issuer may comprise
no more than 5% of S&P Eligible Assets, and Municipal Bonds of any one
issuer which are not rated by any NRSRO will be considered S&P Eligible
Assets only to the extent the fair market value of such Municipal Bonds
does not exceed 5% of the aggregate fair market value of the S&P
Eligible Assets. In the aggregate, the maximum issuer exposure is
limited to 10% of the S&P Eligible Assets; and
14
(v) Municipal Bonds not rated by S&P but rated by another NRSRO
will be included in S&P Eligible Assets only to the extent the fair
market value of such Municipal Bonds does not exceed 50% of the
aggregate fair market value of the S&P Eligible Assets.
As discussed in the prospectus, the Fund may engage in options or
futures transactions. For so long as any shares of AMPS are rated by S&P, the
Fund will not purchase or sell financial futures contracts, write, purchase or
sell options on financial futures contracts or write put options (except
covered put options) or call options (except covered call options) on
portfolio securities unless it receives written confirmation from S&P that
engaging in such transactions will not impair the ratings then assigned to the
shares of AMPS by S&P, except that the Fund may purchase or sell financial
futures contracts based on the Bond Buyer Municipal Bond Index (the "Municipal
Index") or Treasury Bonds and write, purchase or sell put and call options on
such contracts (collectively, "S&P Hedging Transactions"), subject to the
following limitations:
(i) the Fund will not engage in any S&P Hedging Transaction based
on the Municipal Index (other than transactions that terminate a
financial futures contract or option held by the Fund by the Fund's
taking an opposite position thereto ("Closing Transactions")), that
would cause the Fund at the time of such transaction to own or have sold
the least of (A) more than 1,000 outstanding financial futures contracts
based on the Municipal Index, (B) outstanding financial futures
contracts based on the Municipal Index exceeding in number 25% of the
quotient of the fair market value of the Fund's total assets divided by
$1,000 or (C) outstanding financial futures contracts based on the
Municipal Index exceeding in number 10% of the average number of daily
traded financial futures contracts based on the Municipal Index in the
30 days preceding the time of effecting such transaction as reported by
The Wall Street Journal;
(ii) the Fund will not engage in any S&P Hedging Transaction based
on Treasury Bonds (other than Closing Transactions) that would cause the
Fund at the time of such transaction to own or have sold the lesser of
(A) outstanding financial futures contracts based on Treasury Bonds
exceeding in number 50% of the quotient of the fair market value of the
Fund's total assets divided by $100,000 ($200,000 in the case of the
two-year United States Treasury Note) or (B) outstanding financial
futures contracts based on Treasury Bonds exceeding in number 10% of the
average number of daily traded financial futures contracts based on
Treasury Bonds in the 30 days preceding the time of effecting such
transaction as reported by The Wall Street Journal;
(iii) the Fund will engage in Closing Transactions to close out
any outstanding financial futures contract that the Fund owns or has
sold or any outstanding option thereon owned by the Fund in the event
(A) the Fund does not have S&P Eligible Assets with an aggregate
Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount on two consecutive Valuation Dates and (B) the Fund is required
to pay Variation Margin on the second such Valuation Date;
(iv) the Fund will engage in a Closing Transaction to close out
any outstanding financial futures contract or option thereon in the
month prior to the delivery month under the terms of such financial
futures contract or option thereon unless the Fund holds the securities
deliverable under such terms; and
(v) when the Fund writes a financial futures contract or an option
thereon, it will either maintain an amount of cash, cash equivalents or
liquid assets in a segregated account with the Fund's custodian, so that
the amount so segregated plus the amount of Initial Margin and Variation
Margin held in the account of or on behalf of the Fund's broker with
respect to such financial futures contract or option equals the fair
market value of the financial futures contract or option, or, in the
event the Fund writes a financial futures contract or option thereon
that requires delivery of an underlying security, it shall hold such
underlying security in its portfolio.
For purposes of determining whether the Fund has S&P Eligible Assets
with a Discounted Value that equals or exceeds the AMPS Basic Maintenance
Amount, the Discounted Value of cash or securities held for the payment of
Initial Margin or Variation Margin shall be zero and the aggregate Discounted
Value of S&P Eligible Assets shall be reduced by an amount equal to (i) 30% of
the aggregate settlement value, as marked to market, of any outstanding
financial futures contracts based on the Municipal Index that are owned by the
Fund plus (ii) 25%
15
of the aggregate settlement value, as marked to market, of any outstanding
financial futures contracts based on Treasury Bonds which contracts are owned
by the Fund.
Moody's Aaa Rating Guidelines
The Discounted Value of the Fund's Moody's Eligible Assets is calculated
on each Valuation Date. See "Description of AMPS--Asset Maintenance--AMPS
Basic Maintenance Amount." Moody's Eligible Assets include cash, Receivables
for Municipal Bonds Sold (as defined below), Rule 2a-7 Money Market Funds and
Municipal Bonds eligible for consideration under Moody's guidelines. For
purposes of calculating the Discounted Value of the Fund's portfolio under
current Moody's guidelines, the fair market value of Municipal Bonds eligible
for consideration under such guidelines must be discounted by the applicable
Moody's Discount Factor set forth in the table below. The Discounted Value of
a Municipal Bond eligible for consideration under Moody's guidelines is the
lower of par and the quotient of the fair market value thereof divided by the
Moody's Discount Factor. The Moody's Discount Factor used to discount a
particular Municipal Bond will be determined by reference to the rating by
Moody's, S&P or Fitch on such Municipal Bond, in accordance with the tables
set forth below:
Moody's Rating Category (1)
------------------------------------------------------------------------------
Aaa Aa A Baa Other (2)
---------------- ------------ ------------- ------------- ---------------
151% 159% 160% 173% 225%
---------
(1) Ratings assigned by S&P or Fitch are generally accepted by Moody's at
face value. However, adjustments to face value may be made to particular
categories of credits for which the S&P and/or Fitch rating does not
seem to approximate a Moody's rating equivalent. Split rated securities
assigned by S&P and Fitch will be accepted at the lower of the two
ratings.
(2) Municipal Bonds rated Ba1 to B3 by Moody's or, if not rated by Moody's,
rated BB+ to B- by S&P or Fitch. In addition, Municipal Bonds not
explicitly rated by Moody's, S&P or Fitch, but rated at least the
equivalent of B3 internally by the Investment Adviser, provided that
Moody's reviews and achieves sufficient comfort with the Investment
Adviser's internal credit rating processes, will be included under
"Other" in the table. Unless conclusions regarding liquidity risk as
well as estimates of both the probability and severity of default for
the Fund's assets can be derived from other sources as well as combined
with a number of sources as presented by the Fund to Moody's, unrated
Municipal Bonds which are rated at least the equivalent of B3 by the
Investment Adviser internally are limited to 10% of Moody's Eligible
Assets.
Moody's Rating Category
------------------------------------------------------------------------------
MIG-1, VMIG-1, P-1 (1) MIG-1, VMIG-1, P-1 (2)
---------------------------------------- -------------------------------------
100% 136%
---------
(1) Moody's rated Municipal Bonds that have a maturity less than or equal to
49 days and Municipal Bonds not rated by Moody's but rated the
equivalent to MIG-1, VMIG-1, or P-1 by S&P or Fitch that have a maturity
less than or equal to 49 days.
(2) Moody's rated Municipal Bonds that have a maturity greater than 49 days
and Municipal Bonds not rated by Moody's but rated the equivalent to
MIG-1, VMIG-1, or P-1 by S&P or Fitch that have a maturity greater than
49 days.
Notwithstanding the foregoing, no Moody's Discount Factor will be
applied to cash or to Receivables for Municipal Bonds Sold that are due within
five Business Days of such Valuation Date. The Moody's Discount Factor for
Receivables for Municipal Bonds Sold that are due within six and 30 Business
Days of such Valuation Date will be the Moody's Discount Factor applicable to
the Municipal Bonds sold. "Receivables for Municipal Bonds Sold," for purposes
of calculating Moody's Eligible Assets as of any Valuation Date, means the
book value of receivables for Municipal Bonds sold as of or prior to such
Valuation Date if such receivables are due within 30 Business Days of such
Valuation Date.
16
The Moody's Discount Factor for Inverse Floaters shall be the product of
(x) the percentage determined by reference to the rating on the security
underlying such Inverse Floaters multiplied by (y) 1.25.
The Moody's Discount Factor for Rule 2a-7 Money Market Funds shall be
110%.
The Moody's guidelines impose certain requirements as to minimum issue
size, issuer diversification and geographical concentration, as well as other
requirements for purposes of determining whether Municipal Bonds constitute
Moody's Eligible Assets, as set forth in the table on the following page:
Minimum Issue Size Maximum Underlying Maximum State
Rating ($ Millions) Obligor (%) (1) Allowed (%) (1) (3)
-------------------- ------------------- ------------------ --------------------
Aaa * 100 100
Aa 10 20 60
A 10 10 40
Baa 10 6 20
Ba 10 4 12
B 10 3 12
Other (2) 10 2 12
---------
* Not applicable.
(1) The referenced percentages represent maximum cumulative totals for the
related rating category and each lower rating category.
(2) Municipal Bonds not rated by Moody's, S&P or Fitch, but rated at least
the equivalent of B3 internally by the Investment Adviser.
(3) Territorial bonds (other than those issued by Puerto Rico and counted
collectively) are each limited to 10% of Moody's Eligible Assets. For
diversification purposes, Puerto Rico will be treated as a state.
For purposes of the maximum underlying obligor requirement described
above, any Municipal Bond backed by the guaranty, letter of credit or
insurance issued by a third party will be deemed to be issued by such third
party if the issuance of such third party credit is the sole determinant of
the rating on such Bond.
Current Moody's guidelines also require that Municipal Bonds
constituting Moody's Eligible Assets pay interest in cash, are publicly rated
B3 or higher by Moody's or, if not rated by Moody's, but rated by S&P or
Fitch, are publicly rated at least B- by S&P or Fitch, or if not explicitly
rated by Moody's, S&P or Fitch, be rated at least the equivalent of B3
internally by the Investment Adviser, provided that Moody's reviews and
achieves sufficient comfort with the Investment Adviser's internal credit
rating processes, not have suspended ratings by Moody's, if an Inverse
Floater, be explicitly rated by Moody's, and be part of an issue of Municipal
Bonds of at least $10,000,000 (except for issues rated Aaa by Moody's, as
provided in the chart above).
When the Fund sells a Municipal Bond and agrees to repurchase it at a
future date, the Discounted Value of such Municipal Bond will constitute a
Moody's Eligible Asset and the amount the Fund is required to pay upon
repurchase of such Bond will count as a liability for purposes of calculating
the AMPS Basic Maintenance Amount. For so long as the AMPS are rated by
Moody's, the Fund will not enter into any such reverse repurchase agreements
unless it has received written confirmation from Moody's that such
transactions would not impair the rating then assigned the AMPS by Moody's.
When the Fund purchases a Municipal Bond and agrees to sell it at a future
date to another party, cash receivable by the Fund thereby will constitute a
Moody's Eligible Asset if the long-term debt of such other party is rated at
least A2 by Moody's and such agreement has a term of 30 days or less;
otherwise the Discounted Value of such Bond will constitute a Moody's Eligible
Asset.
High Yield Municipal Bonds may comprise no more than 20% of Moody's
Eligible Assets. Unless conclusions regarding liquidity risk as well as
estimates of both the probability and severity of default for the Fund's
assets can be derived from other sources as well as combined with a number of
sources as presented by the Fund to
17
Moody's, unrated High Yield Municipal Bonds which are rated at least the
equivalent of B3 by the Investment Adviser internally are limited to 10% of
Moody's Eligible Assets.
Inverse Floaters, including primary market and secondary market residual
interest bonds, may constitute no more than 10% of Moody's Eligible Assets.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset if it is (i) held in a margin account, (ii) subject to any
material lien, mortgage, pledge, security interest or security agreement of
any kind, (iii) held for the purchase of a security pursuant to a Forward
Commitment or (iv) irrevocably deposited by the Fund for the payment of
dividends or redemption.
For so long as shares of AMPS are rated by Moody's, in managing the
Fund's portfolio, the Investment Adviser will not alter the composition of the
Fund's portfolio if, in the reasonable belief of the Investment Adviser, the
effect of any such alteration would be to cause the Fund to have Moody's
Eligible Assets with an aggregate Discounted Value, as of the immediately
preceding Valuation Date, less than the AMPS Basic Maintenance Amount as of
such Valuation Date; provided, however, that in the event that, as of the
immediately preceding Valuation Date, the aggregate Discounted Value of
Moody's Eligible Assets exceeded the AMPS Basic Maintenance Amount by 5% or
less, the Investment Adviser will not alter the composition of the Fund's
portfolio in a manner reasonably expected to reduce the aggregate Discounted
Value of Moody's Eligible Assets unless the Fund shall have confirmed that,
after giving effect to such alteration, the aggregate Discounted Value of
Moody's Eligible Assets would exceed the AMPS Basic Maintenance Amount.
For so long as any shares of AMPS are rated by Moody's, the Fund will
not engage in Bond Market Association Municipal Swap Index swap transactions
("BMA swap transactions"), buy or sell financial futures contracts, write,
purchase or sell call options on financial futures contracts or purchase put
options on financial futures contracts or write call options (except covered
call options) on portfolio securities unless it receives written confirmation
from Moody's that engaging in such transactions would not impair the ratings
then assigned to the shares of AMPS by Moody's, except that the Fund may
engage in BMA swap transactions, purchase or sell exchange-traded financial
futures contracts based on any index approved by Moody's or Treasury Bonds,
and purchase, write or sell exchange-traded put options on such financial
futures contracts, and purchase, write or sell exchange-traded call options on
such financial futures contracts (collectively, "Moody's Hedging
Transactions"), subject to the following limitations:
(i) the Fund will not engage in any Moody's Hedging Transaction
based on the Municipal Index (other than Closing Transactions) that
would cause the Fund at the time of such transaction to own or have sold
(A) outstanding financial futures contracts based on the Municipal Index
exceeding in number 10% of the average number of daily traded financial
futures contracts based on the Municipal Index in the 30 days preceding
the time of effecting such transaction as reported by The Wall Street
Journal or (B) outstanding financial futures contracts based on the
Municipal Index having a fair market value exceeding 50% of the fair
market value of all Municipal Bonds constituting Moody's Eligible Assets
owned by the Fund (other than Moody's Eligible Assets already subject to
a Moody's Hedging Transaction);
(ii) the Fund will not engage in any Moody's Hedging Transaction
based on Treasury Bonds (other than Closing Transactions) that would
cause the Fund at the time of such transaction to own or have sold (A)
outstanding financial futures contracts based on Treasury Bonds having
an aggregate fair market value exceeding 40% of the aggregate fair
market value of Moody's Eligible Assets owned by the Fund and rated Aa
by Moody's (or, if not rated by Moody's but rated by S&P, rated AAA by
S&P) or (B) outstanding financial futures contracts based on Treasury
Bonds having an aggregate fair market value exceeding 80% of the
aggregate fair market value of all Municipal Bonds constituting Moody's
Eligible Assets owned by the Fund (other than Moody's Eligible Assets
already subject to a Moody's Hedging Transaction) and rated Baa or A by
Moody's (or, if not rated by Moody's but rated by S&P, rated A or AA by
S&P) (for purposes of the foregoing clauses (i) and (ii), the Fund shall
be deemed to own the number of financial futures contracts that underlie
any outstanding options written by the Fund);
18
(iii) the Fund will engage in Closing Transactions to close out
any outstanding financial futures contract based on the Municipal Index
if the amount of open interest in the Municipal Index as reported by The
Wall Street Journal is less than 5,000;
(iv) the Fund will engage in a Closing Transaction to close out
any outstanding financial futures contract by no later than the fifth
Business Day of the month in which such contract expires and will engage
in a Closing Transaction to close out any outstanding option on a
financial futures contract by no later than the first Business Day of
the month in which such option expires;
(v) the Fund will engage in Moody's Hedging Transactions only with
respect to financial futures contracts or options thereon having the
next settlement date or the settlement date immediately thereafter;
(vi) the Fund (A) will not engage in options and futures
transactions for leveraging or speculative purposes, except that the
Fund may engage in an option or futures transaction so long as the
combination of the Fund's non-derivative positions, together with the
relevant option or futures transaction, produces a synthetic investment
position, or the same economic result, that could be achieved by an
investment, consistent with the Fund's investment objective and
policies, in a security that is not an option or futures transaction,
subject to the Investment Adviser periodically demonstrating to Moody's
that said economic results are achieved, and (B) will not write any call
options or sell any financial futures contracts for the purpose of
hedging the anticipated purchase of an asset prior to completion of such
purchase;
(vii) the Fund will not enter into an option or futures
transaction unless, after giving effect thereto, the Fund would continue
to have Moody's Eligible Assets with an aggregate Discounted Value equal
to or greater than the AMPS Basic Maintenance Amount; and
(viii) the Fund will not engage in BMA swap transactions with
respect to more than 20% of the Fund's net assets; provided that the
Fund's use of futures will proportionately decrease as the Fund's use of
BMA swap transactions increases, and vice-versa.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the Discounted Value of Moody's Eligible Assets that the
Fund is obligated to deliver or receive pursuant to an outstanding futures
contract or option shall be as follows: (i) assets subject to call options
written by the Fund that are either exchange-traded and "readily reversible"
or that expire within 49 days after the date as of which such valuation is
made shall be valued at the lesser of (A) Discounted Value and (B) the
exercise price of the call option written by the Fund; (ii) assets subject to
call options written by the Fund not meeting the requirements of clause (i) of
this sentence shall have no value; (iii) assets subject to put options written
by the Fund shall be valued at the lesser of (A) the exercise price and (B)
the Discounted Value of the subject security; (iv) futures contracts shall be
valued at the lesser of (A) settlement price and (B) the Discounted Value of
the subject security, provided that, if a contract matures within 49 days
after the date as of which such valuation is made, where the Fund is the
seller the contract may be valued at the settlement price and where the Fund
is the buyer the contract may be valued at the Discounted Value of the subject
securities; and (v) where delivery may be made to the Fund with any security
of a class of securities, the Fund shall assume that it will take delivery of
the security with the lowest Discounted Value.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the following amounts shall be subtracted from the
aggregate Discounted Value of the Moody's Eligible Assets held by the Fund:
(i) 10% of the exercise price of a written call option; (ii) the exercise
price of any written put option; (iii) where the Fund is the seller under a
financial futures contract, 10% of the settlement price of the financial
futures contract; (iv) where the Fund is the purchaser under a financial
futures contract, the settlement price of assets purchased under such
financial futures contract; (v) the settlement price of the underlying
financial futures contract if the Fund writes put options on a financial
futures contract; and (vi) 105% of the fair market value of the underlying
financial futures contracts if the Fund writes call options on a financial
futures contract and does not own the underlying contract.
19
For so long as any shares of AMPS are rated by Moody's, the Fund will
not enter into any contract to purchase securities for a fixed price at a
future date beyond customary settlement time (other than such contracts that
constitute Moody's Hedging Transactions), except that the Fund may enter into
such contracts to purchase newly-issued securities on the date such securities
are issued ("Forward Commitments"), subject to the following limitations:
(i) the Fund will maintain in a segregated account with its
custodian cash, cash equivalents or short-term, fixed-income securities
rated P-1, MIG-1 or VMIG-1 by Moody's and maturing prior to the date of
the Forward Commitment with a fair market value that equals or exceeds
the amount of the Fund's obligations under any Forward Commitments to
which it is from time to time a party or long-term, fixed income
securities with a Discounted Value that equals or exceeds the amount of
the Fund's obligations under any Forward Commitment to which it is from
time to time a party, and
(ii) the Fund will not enter into a Forward Commitment unless,
after giving effect thereto, the Fund would continue to have Moody's
Eligible Assets with an aggregate Discounted Value equal to or greater
than the AMPS Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the AMPS Basic
Maintenance Amount, the Discounted Value of all Forward Commitments to which
the Fund is a party and of all securities deliverable to the Fund pursuant to
such Forward Commitments shall be zero.
---------------
For so long as shares of AMPS are rated by S&P or Moody's, the Fund,
unless it has received written confirmation from S&P and/or Moody's, as the
case may be, that such action would not impair the ratings then assigned to
the AMPS by S&P and/or Moody's, as the case may be, will not (i) borrow money
except for the purpose of clearing transactions in portfolio securities (which
borrowings under any circumstances shall be limited to the lesser of $10
million and an amount equal to 5% of the fair market value of the Fund's
assets at the time of such borrowings and which borrowings shall be repaid
within 60 days and not be extended or renewed and shall not cause the
aggregate Discounted Value of Moody's Eligible Assets and S&P Eligible Assets
to be less than the AMPS Basic Maintenance Amount), (ii) engage in short sales
of securities, (iii) lend any securities, (iv) issue any class or series of
stock ranking prior to or on a parity with the AMPS with respect to the
payment of dividends or the distribution of assets upon dissolution,
liquidation or winding up of the Fund, (v) reissue any AMPS previously
purchased or redeemed by the Fund, (vi) merge or consolidate into or with any
other corporation or entity, (vii) change the Fund's pricing service or (viii)
engage in reverse repurchase agreements.
For as long as the AMPS are rated by S&P, the Fund will not, unless it
has received written confirmation from S&P that such action would not impair
the rating then assigned to the shares of AMPS by S&P, engage in interest rate
swaps, caps and floors, except that the Fund may, without obtaining the
written consent described above, engage in swaps, caps and floors if: (i) the
counterparty to the swap transaction has a short-term rating of A-1 or, if the
counterparty does not have a short-term rating, the counterparty's senior
unsecured long-term debt rating is A- or higher, (ii) the original aggregate
notional amount of the interest rate swap transaction or transactions is not
to be greater than the liquidation preference of the AMPS, (iii) the interest
rate swap transaction will be marked-to-market weekly by the swap
counterparty, (iv) if the Fund fails to maintain an aggregate discounted value
at least equal to the AMPS Basic Maintenance Amount on two consecutive
Valuation Dates then the agreement shall terminate immediately, (v) for the
purpose of calculating the Discounted Value of S&P Eligible Assets, 90% of any
positive mark-to-market valuation of the Fund's rights will be S&P Eligible
Assets, 100% of any negative mark-to-market valuation of the Fund's rights
will be included in the calculation of the AMPS Basic Maintenance Amount, and
(vi) the Fund must maintain liquid assets with a value at least equal to the
net amount of the excess, if any, of the Fund's obligations over its
entitlement with respect to each swap. For caps/floors, the Fund must maintain
liquid assets with a value at least equal to the Fund's obligations with
respect to such caps or floors.
20
DIRECTORS AND OFFICERS
The Directors of the Fund consist of eight individuals, seven of whom
are not "interested persons" of the Fund as defined in the 1940 Act (the
"non-interested Directors" or "independent 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 Committee
(the "Audit Committee"). The principal responsibilities of the Audit Committee
are the appointment, compensation, retention and oversight of the Fund's
independent registered public accounting firm, including the resolution of
disagreements regarding financial reporting between Fund management and such
independent registered public accounting firm. The Audit Committee's
responsibilities include, without limitation, to (i) review with the
independent registered public accounting firm the arrangements for and scope
of annual and special audits and any other services provided by the
independent registered public accounting firm to the Fund; (ii) review with
the independent registered public accounting firm any audit problems or
difficulties encountered during or relating to the conduct of the audit; (iii)
ensure that the independent registered public accounting firm submits on a
periodic basis a formal written statement with respect to their independence,
discuss with the independent registered public accounting firm any
relationships or services that may impact the objectivity and independence of
the Fund's independent registered public accounting firm; and (iv) consider
information and comments of the independent registered public accounting firm
with respect to the Fund's accounting and financial reporting policies,
procedures and internal control over financial reporting and Fund management's
responses thereto. The Board of Directors of the Fund has adopted a written
charter for the Audit Committee. The Audit Committee has retained independent
legal counsel to assist it in connection with these duties. The Audit
Committee met four times during the Fund's fiscal year ended October 31, 2004.
Ms. Ramo and Messrs. London and Salomon are the members of the Fund's
Nominating Committee (the "Nominating Committee"). The principal
responsibilities of the Nominating Committee are to identify individuals
qualified to serve as non-interested Directors of the Fund and to recommend
its nominees for consideration by the full Board. While the Nominating
Committee is solely responsible for the selection and nomination of the Fund's
non-interested Directors, the Nominating Committee may consider nominations
for the office of the Director made by Fund stockholders in such manner as it
deems appropriate. Fund stockholders who wish to recommend a nominee should
send nominations to the Secretary of the Fund that include biographical
information and set forth the qualifications of the proposed nominee. The
Nominating Committee did not meet during the Fund's fiscal year ended October
31, 2004.
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, Merrill Lynch Investment Managers, L.P.
("MLIM") or their affiliates ("MLIM/FAM-advised funds") and other public
directorships.
Number of
Name, Term of MLIM/FAM-
Address* and Position(s) Office** and Advised Funds
Age of Held with Length of Principal Occupation(s) During and Portfolios Public
Director the Fund Time Served the Past Five Years Overseen Directorships
------------------ ------------- ---------------- ------------------------------------- -------------------- -------------------
James H. Director Director Director, The China Business 38 registered None
Bodurtha since 1995 Group, Inc. since 1996 and investment
(61) *** and Co- Executive Vice President companies
Chairman of thereof from 1996 to 2003; consisting of
the Board Chairman of the Board, 55 portfolios
since 2005 Berkshire Holding
21
Number of
Name, Term of MLIM/FAM-
Address* and Position(s) Office** and Advised Funds
Age of Held with Length of Principal Occupation(s) During and Portfolios Public
Director the Fund Time Served the Past Five Years Overseen Directorships
------------------ ------------- ---------------- ------------------------------------- -------------------- -------------------
Corporation since 1980; Partner,
Squire, Sanders & Dempsey from
1980 to 1993.
Kenneth A. Director Director Professor, Harvard University, 38 registered [None]
Froot (48) since 2005 since 1992. investment
companies
consisting of
55 portfolios
Joe Grills Director Director Member of the Committee of 38 registered Kimco Realty
(70) *** since 2002 Investment of Employee investment Corporation
and Co- Benefit Assets of the companies
Chairman of Association of Financial consisting of 55
the Board Professionals ("CIEBA") since portfolios
since 2005 1986; Member of CIEBA's
Executive Committee since
1988 and its Chairman from
1991 to 1992; Assistant
Treasurer of International
Business Machines
Corporation ("IBM") and
Chief Investment Officer of
IBM Retirement Funds from
1986 to 1993; Member of the
Investment Advisory
Committee of the State of
New York Common
Retirement Fund since 1989;
Member of the Investment
Advisory Committee of the
Howard Hughes Medical
Institute from 1997 to 2000;
Director, Duke University
Management Company from
1992 to 2004, Vice Chairman
thereof from 1998 to 2004,
and Director Emeritus thereof
since 2004; Director, LaSalle
Street Fund from 1995 to
2001; Director, Kimco Realty
Corporation since 1997;
Member of the Investment
Advisory Committee of the
Virginia Retirement System
since 1998, Vice Chairman
thereof from 2002 to 2005,
and Chairman thereof since 2005;
Director, Montpelier Foundation
since 1998 and its Vice Chairman
since 2000;
22
Number of
Name, Term of MLIM/FAM-
Address* and Position(s) Office** and Advised Funds
Age of Held with Length of Principal Occupation(s) During and Portfolios Public
Director the Fund Time Served the Past Five Years Overseen Directorships
------------------ ------------- ---------------- ------------------------------------- -------------------- -------------------
Member of the Investment Committee
of the Woodberry Forest School since
2000; Member of the Investment
Committee of the National Trust
for Historic Preservation since
2000.
Herbert I. Director Director John M. Olin professor of 38 registered None
London (66) since 1992 Humanities, New York investment
University since 1993 and companies
Professor thereof since 1980; consisting of
President, Hudson Institute 55 portfolios
since 1997 and Trustee thereof
since 1980; Dean, Gallatin
Division of New York
University from 1976 to 1993;
Distinguished Fellow, Herman
Kahn Chair, Hudson Institute
from 1984 to 1985; Director,
Damon Corp. from 1991 to
1995; Overseer, Center for
Naval Analyses from 1983 to
1993; Limited Partner,
Hypertech LP since 1996.
Roberta Director Director Shareholder, Modrall, 38 registered None
Cooper Ramo since 1999 Sperling, Roehl, Harris & investment
(62)**** Sisk, P.A. since 1993; companies
President, American Bar consisting of
Association from 1995 to 55 portfolios
1996 and Member of the Board of
Governors thereof from 1994 to 1997;
Shareholder, Poole, Kelly & Ramo,
Attorneys at Law, P.C. from 1977 to
1993; Director, Coopers, Inc. since
1999; Director of ECMC Group
(service provider to students,
schools and lenders) since 2001;
Director, United New Mexico Bank
(now Wells Fargo) from 1983 to 1988;
Director, First National Bank of
New Mexico (now Wells Fargo) from 1975
to 1976.
Robert S. Director Director Principal of STI Management 38 registered None
Salomon, Jr. (68) since 2002 (investment adviser) since investment
1994; Chairman and CEO of companies
Salomon Brothers Asset consisting of
Management from 1992 until 55 portfolios
1995; Chairman of Salomon
23
Number of
Name, Term of MLIM/FAM-
Address* and Position(s) Office** and Advised Funds
Age of Held with Length of Principal Occupation(s) During and Portfolios Public
Director the Fund Time Served the Past Five Years Overseen Directorships
------------------ ------------- ---------------- ------------------------------------- -------------------- -------------------
Brothers equity mutual funds from
1992 until 1995; regular columnist
with Forbes Magazine from 1992 to
2002; Director of Stock Research and
U.S. Equity Strategist at Salomon
Brothers from 1975 until 1991;
Trustee, Commonfund from 1980 to
2001.
Stephen B. Director Director Chairman of Fernwood 39 registered None
Swensrud (71) since 2002 Associates (investment investment
adviser) since 1996; Principal, companies
Fernwood Associates consisting of
(financial consultants) since 56 portfolios
1975; Chairman of R.P.P.
Corporation (manufacturing
company) since 1978; Director
of International Mobile
Communications,
Incorporated
(telecommunications
company), since 1998.
-------------
* 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 or Charter.
*** Co-Chair of the Board of Director s and Co-Chair of the Audit Committee.
**** Chair of the Nominating Committee.
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
MLIM/FAM-advised funds and public directorships held.
24
Number of
Term of MLIM/FAM-
Name, Position(s) Office** and Advised Funds
Address* Held with the Length of Time Principal Occupation(s) During the and Portfolios
and Age Fund Served Past Five Years Overseen
---------------------- ------------------- ------------------- ------------------------------------- --------------------------
Robert C. President President and President of MLIM/FAM advised 125 registered
Doll, Jr. and Director Director**** funds since 2005; President of investment
(50)*** since 2005 MLIM and FAM since 2001; Co- companies
Head (Americas Region) FAM consisting of
and MLIM from 2000 to 2001 and 164 portfolio
Senior Vice President thereof from
1999 to 2001; Director of
Princeton Services, Inc.
("Princeton Services") since 2001;
President of Princeton
Administrators, L.P. since 2001;
Chief Investment Officer of
OppenheimerFunds, Inc. in 1999
and Executive Vice President
thereof from 1991 to 1999.
Kenneth A. Senior Vice Senior Vice Managing Director of MLIM since 38 registered
Jacob (53) President President since 2000; First Vice President of investment
2002 MLIM from 1997 to 2000; Vice companies
President of MLIM from 1984 to consisting of
1997. 50 portfolios
John M. Senior Vice Senior Vice Managing Director of MLIM since 39 registered
Loffredo President President since 2000; First Vice President of investment
(41) 2001 MLIM from 1997 to 2000; Vice companies
President of MLIM from 1991 consisting of
to 1997; Portfolio Manager with 51 portfolios
MLIM and FAM since 1997.
Michael Vice Vice President Vice President of MLIM since 4 registered
Kalinoski President since 2000 1999 investment
(34) companies
consisting of
4 portfolios
Donald C. Vice Vice President First Vice President of FAM and 127 registered
Burke (45) President since 1994 and MLIM since 1997 and Treasurer investment
and Treasurer thereof since 1999; Senior Vice companies
Treasurer since 1999 President and Treasurer of consisting of
Princeton Services since 1999 and 166 portfolios
Director since 2004; Vice
President of FAM Distributors,
Inc. ("FAMD") since 1999; Vice
President of MLIM and FAM
from 1990 to 1997; Director of
Taxation of MLIM from 1990 to
2001.
Name,
Address* Public
and Age Directorships
---------------------- ---------------------
Robert C. None
Doll, Jr.
(50)***
Kenneth A. None
Jacob (53)
John M. None
Loffredo
(41)
Michael None
Kalinoski
(34)
Donald C. None
Burke (45)
25
Number of
Term of MLIM/FAM-
Name, Position(s) Office** and Advised Funds
Address* Held with the Length of Time Principal Occupation(s) During the and Portfolios
and Age Fund Served Past Five Years Overseen
---------------------- ------------------- ------------------- ------------------------------------- --------------------------
Jeffrey Chief Chief Chief Compliance Officer of the 128 registered
Hiller (53) Compliance Compliance MLIM/FAM-advised funds since investment
Officer Officer since 2004; First Vice President and companies
2004 Chief Compliance Officer of consisting of
MLIM since 2004; Chief 167 portfolios
Compliance Officer of the IQ
Funds since 2004; Global Director
of Compliance at Morgan Stanley
Investment Management from
2002 to 2004; Managing Director
and Global Director of
Compliance at Citigroup Asset
Management from 2000 to 2002;
Chief Compliance Officer at Soros
Fund Management in 2000; and
Chief Compliance Officer at
Prudential Financial from 1995 to
2000; Senior Counsel in the
Securities and Exchange
Commission's Division of
Enforcement in Washington, D.C.
from 1990 to 1995.
Alice A. Secretary Secretary since Director (Legal Advisory) of 125 registered
Pellegrino 2004 MLIM since 2002; Vice President investment
(45) of MLIM from 1999 to 2002; companies
Attorney associated with consisting of
MLIM since 1997; Secretary of 164 portfolios
FAM, MLIM, FAMD and Princeton
Services since 2004.
Name,
Address* Public
and Age Directorships
---------------------- ---------------------
Jeffrey None
Hiller (53)
Alice A. None
Pellegrino
(45)
---------
* The address of Mr. Doll and each officer listed 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. Doll is an "interested person," as defined in the 1940 Act, of the
Fund based on his positions with MLIM, FAM, Princeton Services, and
Princeton Administrators, L.P.
**** As a Director, Mr. Doll serves until his successor is elected and
qualified or 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 or Charter.
In connection with the election of the Fund's Directors, holders of
shares of AMPS, Other AMPS and other preferred stock, voting as a separate
class, are entitled to elect two of the Fund's Directors, and the remaining
Directors are elected by all holders of capital stock, voting as a single
class. Mr. Bodurtha and Mr. London are the Directors elected by holders of
preferred stock. See "Description of AMPS--Voting Rights."
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, 2004 is set forth in the chart below.
26
Aggregate Dollar Range of
Aggregate Dollar Range Securities in Supervised
Name of Equity in the Fund Merrill Lynch Funds
--------------------------- ------------------------ --------------------------
Interested Director:
Robert C. Doll, Jr. None Over $100,000
Non-interested Directors:
James H. Bodurtha None Over $100,000
Kenneth A. Froot** None None
Joe Grills None Over $100,000
Herbert I. London None Over $100,000
Roberta Cooper Ramo None Over $100,000
Robert S. Salomon, Jr. None Over $100,000
Stephen B. Swensrud None $50,001-$100,000
* For the number of MLIM/FAM-advised funds from which each Director
receives compensation, see the table above under "Directors and Officers
-- Biographical Information."
** Mr. Froot was not a Director of the Fund at December 31, 2004.
As of the date of this statement of additional information none of the
Directors and officers of the Fund owned any outstanding shares of common
stock or Other AMPS of the Fund. As of the date of this statement of
additional information, none of the non-interested Directors of the Fund or
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.
The Fund pays fees to each non-interested Director for service to the
Fund. Each non-interested Director receives an aggregate annual retainer of
$125,000 for his or her services to MLIM/FAM-advised funds, including the
Fund. The portion of the annual retainer allocated to each MLIM/FAM-advised
fund is determined quarterly based on the relative net assets of each fund. In
addition, each non-interested Director receives a fee per in-person Board
meeting attended and per in-person Audit Committee meeting attended. The
annual per meeting fees paid to each non-interested Director aggregate
$100,000 for all MLIM/FAM-advised funds for which that Director serves and are
allocated equally among those funds. Each Co-Chairman of the Audit Committee
receives an additional annual retainer in the amount of $50,000, which is paid
quarterly and allocated to each MLIM/FAM-advised fund for which such
Co-Chairman provides services based on the relative net assets of each such
fund.
The following table sets forth the compensation paid by the Fund to the
non-interested Directors for the Fund's fiscal year ended October 31, 2004,
and the aggregate compensation paid to them from all registered
MLIM/FAM-advised funds for the calendar year ended December 31, 2004.
Aggregate
Pension or Compensation
Retirement From Fund and
Benefits other
Accrued as MLIM/FAM-
Compensation Part of Fund Advised
Name of Director From Fund Expense Funds***
------------------------------ ---------------- --------------- --------------
James H. Bodurtha* $3,650 None $250,000
Kenneth A. Froot** -0- None -0-
Joe Grills* $3,650 None $250,000
27
Herbert I. London $3,337 None $225,000
Roberta Cooper Ramo $3,337 None $225,000
Robert S. Salomon, Jr. $3,337 None $225,000
Stephen B. Swensrud $3,337 None $231,000
---------
* Co-Chairman of the Audit Committee.
** Mr. Froot was elected as a Director of the Fund and certain other
MLIM/FAM-advised funds effective on June 3, 2005.
*** For the number of MLIM/FAM-advised funds from which each Director
received compensation see table above under "--Biographical
Information."
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 50 registered investment
companies and offers investment advisory services to individuals and
institutional accounts. As of June 30. 2005, the Investment Adviser and its
affiliates, including MLIM, had a total of approximately $474 billion in
investment company and other portfolio assets under management, including
approximately $221 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
oversight 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 oversight by the Board of
Directors.
The portfolio manager primarily responsible for the Fund's day-to-day
management is Michael A. Kalinoski. Mr. Kalinoski has been a portfolio manager
and Vice President of MLIM since 1999 and has 12 years of experience investing
in Municipal Bonds. The Fund's portfolio manager will consider analyses from
various sources, make the necessary investment decisions, and place orders for
transactions accordingly.
For its services, the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.50% of the Fund's average weekly net assets ("average
weekly net assets" means the average weekly 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 weekly net assets is determined at the end of each month
on the basis of the average net assets of the Fund for each week during the
month. The assets for each weekly period are determined by averaging the net
assets at the last business day of a week with the net assets at the last
business day of the prior week. 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
weekly net assets.
For the six months ended April 30, 2005 and the fiscal years ended
October 31, 2004, 2003, and 2002, the fees paid by the Fund to the Investment
Adviser pursuant to the Investment Advisory Agreement were $1,135,612,
$2,249,920, $2,265,983 and $2,202,564, respectively.
For the six months ended April 30, 2005 and the fiscal years ended
October 31, 2004, 2003 and 2002, the Investment Adviser reimbursed the Fund
$1,491, $12,710, $9,311 and $3,111, respectively.
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
28
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
Bank 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.
The table below shows the amounts paid by the Fund to State Street and
to the Investment Adviser for accounting services for the periods indicated:
Paid by the
Fund to the
Paid by the Fund Investment
Period: to State Street Adviser
------- ------------------- --------------
Six months ended April 30, 2005 $73,851 $4,794
Fiscal year ended October 31, 2004 $142,467 $8,773
Fiscal year ended October 31, 2003 $141,916 $9,804
Fiscal year ended October 31, 2002 $139,688 $18,351
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect from year to year 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. The Board of Directors most recently approved
the Investment Advisory Agreement at its meeting on August 12, 2004.
Activities of and Composition of the Board of Directors
All but one member of the Board of Directors is an independent Director
whose only affiliation with the Investment Adviser or other Merrill Lynch
affiliates is as a Director of the Fund and certain other funds advised by the
Investment Adviser or its affiliates. The Co-Chairmen of the Board are also
independent Directors. New Director nominees are chosen as nominees by a
Nominating Committee of independent Directors. All independent Directors also
are members of the Board's Audit Committee and the independent Directors meet
in executive session at each in-person Board meeting. The Board and the Audit
Committee meet in person for at least two days each quarter and conduct other
in person and telephone meetings throughout the year, some of which are formal
Board meetings, and some of which are informational meetings. The independent
counsel to the independent Directors attend all in-person Board and Audit
Committee meetings and other meetings at the independent Directors' request.
Investment Advisory Agreement - Matters Considered by the Board
Every year, the Board of Directors considers approval of the Fund's
Investment Advisory Agreement and throughout each year, reviews and evaluates
the performance of and services provided by the Investment Adviser. The Board
assesses the nature, scope and quality of the services provided to the Fund by
the personnel of the Investment Adviser and its affiliates, including
administrative services, shareholder services, oversight of fund accounting,
marketing services and assistance in meeting legal and regulatory
requirements. The Board also receives and assesses information regarding the
services provided to the Fund by certain unaffiliated service providers.
At various times throughout the year, the Board also considers a range
of information in connection with its oversight of the services provided by
the Investment Adviser and its affiliates. Among the matters considered are:
(a) fees (in addition to management fees) paid to the Investment Adviser and
its affiliates by the Fund, including
29
fees associated with the Fund's auction market preferred stock; (b) Fund
operating expenses paid to third parties; (c) the resources devoted to and
compliance reports relating to the Fund's investment objective, policies and
restrictions, and its compliance with its Code of Ethics and the Investment
Adviser's compliance policies and procedures; and (d) the nature, cost and
character of non-investment management services provided by the Investment
Adviser and its affiliates.
The Board believes that the Investment Adviser is one of the most
experienced global asset management firms and considers the overall quality of
services provided by the Investment Adviser to be generally of high quality.
The Board also believes that the Investment Adviser is financially sound and
well managed, and notes that the Investment Adviser is affiliated with one of
America's largest financial firms. The Board believes that, for many of the
Fund's shareholders, the investment involved the selection of the Investment
Adviser as the investment adviser to the Fund. The Board works closely with
the Investment Adviser in overseeing the Investment Adviser's efforts to
achieve good performance. As part of this effort, the Board discusses
portfolio manager effectiveness and, when performance is not satisfactory,
discusses with the Investment Adviser taking steps such as changing investment
personnel.
Annual Consideration of Approval by the Board of Directors
In the period prior to the Board meeting to consider renewal of the
Investment Advisory Agreement, the Board requests and receives materials
specifically relating to the Fund's Investment Advisory Agreement. These
materials include (a) information compiled by Lipper Inc. ("Lipper") on the
fees and expenses and the investment performance of the Fund as compared to a
comparable group of funds as classified by Lipper; (b) information comparing
the Fund's market price with its net asset value per share; (c) a discussion
by the Fund's portfolio management team of investment strategies used by the
Fund during its most recent fiscal year; and (d) information on the
profitability to the Investment Adviser and its affiliates of the Investment
Advisory Agreement and other relationships with the Fund. The Board also
considers other matters it deems important to the approval process such as
services related to the valuation and pricing of Fund portfolio holdings,
information relating to the status of the Fund's managed dividend program, the
Fund's portfolio turnover statistics, and direct and indirect benefits to the
Investment Adviser and its affiliates from their relationship with the Fund.
Certain Specific Renewal Data
In connection with the most recent renewal of the Fund's Investment
Advisory Agreement, the independent Directors' and Board's review included the
following:
The Investment Adviser's Services and Fund Performance. The Board
reviewed the nature, extent and quality of services provided by the Investment
Adviser, including the investment advisory services and the resulting
performance of the Fund. The Board focused primarily on the Investment
Adviser's investment advisory services and the Fund's investment performance,
having concluded that the other services provided to the Fund by the
Investment Adviser were satisfactory. The Board compared Fund performance -
both including and excluding the effects of the Fund's fees and expenses - to
the performance of a comparable group of funds, and the performance of a
relevant index or combination of indexes. While the Board reviews performance
data at least quarterly, consistent with the Investment Adviser's investment
goals, the Board attaches primary importance to performance over relatively
long periods of time, typically three to five years. The Board noted that the
Fund's performance within the group after fees and expenses ranked in the
first quartile for the one year, the second quartile for the three year period
and the fourth quartile for the five year period ended October 31, 2003. The
Board concluded that the Fund's performance supported the continuation of the
management fee rate at the present level and the renewal of the Investment
Advisory Agreement.
The Investment Adviser's Personnel and Investment Process. The Board
reviews at least annually the Fund's investment objectives and strategies. The
Board discusses with senior management of the Investment Adviser responsible
for investment operations and the senior management of the Investment
Adviser's tax-exempt fixed income investing group the strategies being used to
achieve the stated objectives. Among other things, the Board considers the
size, background and experience of the Investment Adviser's investment staff,
its use of technology, and the Investment Adviser's approach to training and
retaining portfolio managers and other research, advisory and management
personnel. The Board also reviews the Investment Adviser's compensation
policies and
30
practices with respect to the Fund's portfolio manager. The Board also
considered the experience of the Fund's portfolio manager and noted that Mr.
Kalinoski, the Fund's portfolio manager, has 12 years' experience investing in
Municipal Bonds. The Board concluded that the Investment Adviser and its
investment staff and the Fund's portfolio manager have extensive experience in
analyzing and managing the types of investments used by the Fund and that the
Fund benefits from that expertise.
Management Fees and Other Expenses. The Board reviews the Fund's
contractual management fee rate and actual management fee rate (including
applicable fee waivers) as a percentage of total assets at common asset levels
- the actual rate includes advisory and administrative service fees and the
effects of any fee waivers - compared to the other funds in its Lipper
category. The Board considers information regarding fee waivers provided by
such other funds. It also compares the Fund's total expenses to those of
other, comparable funds. The Board did not consider the services provided to
and the fees charged by the Investment Adviser to other types of clients with
similar investment mandates, because the Investment Adviser advised the Board
that it had no comparable investment mandates from its institutional clients.
The Board noted that the Fund's contractual management fee rate was below, and
the Fund's actual management fee rate and its overall operating expenses were
slightly above, the median of its comparable funds classified by Lipper. The
Board has concluded that the Fund's management fee and fee rate and overall
expense ratio are reasonable compared to those of other, comparable funds.
Profitability. The Board of Directors considered the cost of the
services provided to the Fund by the Investment Adviser and the Investment
Adviser's and its affiliates' profits relating to the management of the Fund
and the MLIM/FAM-advised funds. As part of its analysis, the Board reviewed
the Investment Adviser's methodology in allocating its costs to the management
of the Fund and concluded that there was a reasonable basis for the
allocation. The Board believes the Investment Adviser's profits are reasonable
in relation to the nature and quality of services provided.
Economies of Scale. The Board considered whether there have been
economies of scale in respect of the management of the MLIM/FAM-advised funds,
whether the MLIM/FAM-advised funds (including the Fund) have appropriately
benefited from any economies of scale, and whether there is potential for
realization of any further economies of scale. The Board considered economies
of scale to the extent applicable to the Fund's closed end structure and
determined that no changes were currently necessary.
Conclusion
After the independent Directors deliberated in executive session, the
entire Board including all of the independent Directors, approved the renewal
of the existing Investment Advisory Agreement, concluding that the advisory
fee rate was reasonable in relation to the services provided and that a
contract renewal was in the best interests of the shareholders.
Portfolio Manager Information
The Fund is managed by Michael A. Kalinoski.
Other Funds and Accounts Managed by Portfolio Manager as of October 31, 2004
Number of Other Accounts Managed Number of Accounts and Assets for Which
and Assets by Account Type Advisory Fee is Performance-Based
------------------------------------------------ ------------------------------------------
Registered Other Pooled Registered Other Pooled
Name of Investment Adviser and Investment Investment Other Investment Investment Other
Portfolio Manager Companies Vehicles accounts Companies Vehicles accounts
--------------------------------- ---------------- ------------- ----------------- --------------- -------------- ------------
Fund Asset Management L.P.
--------------------------
Michael A. Kalinoski
Fund Ownership
31
The following table sets forth the dollar range of equity securities of
the Fund beneficially owned by the portfolio manager(s) as of the date of this
prospectus.
Portfolio Manager Dollar Range
------------------------ ----------------------------
Michael A. Kalinoski
Portfolio Manager Compensation
Portfolio Manager Compensation
The Portfolio Manager Compensation Program of MLIM and its affiliates,
including the Investment Adviser, is critical to MLIM's ability to attract and
retain the most talented asset management professionals. This program ensures
that compensation is aligned with maximizing investment returns and it
provides a competitive pay opportunity for competitive performance.
Compensation Program
The elements of total compensation for MLIM and its affiliates portfolio
managers are base salary, annual performance-based cash and stock compensation
(cash and stock bonus) and other benefits. MLIM has balanced these components
of pay to provide portfolio managers with a powerful incentive to achieve
consistently superior investment performance. By design, portfolio manager
compensation levels fluctuate -- both up and down -- with the relative
investment performance of the portfolios that they manage.
Base Salary
Under the MLIM approach, like that of many asset management firms, base
salaries represent a relatively small portion of a portfolio manager's total
compensation. This approach serves to enhance the motivational value of the
performance-based (and therefore variable) compensation elements of the
compensation program.
Performance-Based Compensation
MLIM believes that the best interests of investors are served by
recruiting and retaining exceptional asset management talent and managing
their compensation within a consistent and disciplined framework that
emphasizes pay for performance in the context of an intensely competitive
market for talent. To that end, MLIM and its affiliates portfolio manager
incentive compensation is based on a formulaic compensation program. MLIM's
formulaic portfolio manager compensation program includes: investment
performance relative to a subset of general closed-end, leveraged, municipal
debt funds over 1-, 3- and 5-year performance periods and a measure of
operational efficiency. If a portfolio manager's tenure is less than 5 years,
performance periods will reflect time in position. Portfolio managers are
compensated based on products they manage. A discretionary element of
portfolio manager compensation may include consideration of: financial
results, expense control, profit margins, strategic planning and
implementation, quality of client service, market share, corporate reputation,
capital allocation, compliance and risk control, leadership, workforce
diversity, supervision, technology and innovation. MLIM and its affiliates
also consider the extent to which individuals exemplify and foster ML & Co.'s
principles of client focus, respect for the individual, teamwork, responsible
citizenship and integrity. All factors are considered collectively by MLIM
management.
Cash Bonus
Performance-based compensation is distributed to portfolio managers in a
combination of cash and stock. Typically, the cash bonus, when combined with
base salary, represents more than 60% of total compensation for portfolio
managers.
Stock Bonus
32
A portion of the dollar value of the total annual performance-based
bonus is paid in restricted shares of ML & Co. stock. Paying a portion of
annual bonuses in stock puts compensation earned by a portfolio manager for a
given year "at risk" based on the company's ability to sustain and improve its
performance over future periods. The ultimate value of stock bonuses is
dependent on future ML & Co. stock price performance. As such, the stock bonus
aligns each portfolio manager's financial interests with those of the ML & Co.
shareholders and encourages a balance between short-term goals and long-term
strategic objectives. Management strongly believes that providing a
significant portion of competitive performance-based compensation in stock is
in the best interests of investors and shareholders. This approach ensures
that portfolio managers participate as shareholders in both the "downside
risk" and "upside opportunity" of the company's performance. Portfolio
managers therefore have a direct incentive to protect ML & Co.'s reputation
for integrity.
Portfolio managers who meet relative investment performance and
financial management objectives during a performance year are eligible to
participate in a deferred cash program. Awards under this program are in the
form of deferred cash that may be benchmarked to a menu of MLIM mutual funds
(including their own fund) during a five-year vesting period. The deferred
cash program aligns the interests of participating portfolio managers with the
investment results of MLIM products and promotes continuity of successful
portfolio management teams.
Other Benefits
Portfolio managers are also eligible to participate in broad-based plans
offered generally to employees of ML & Co. and its affiliates, including
broad-based retirement, 401(k), health, and other employee benefit plans.
Potential Material Conflicts of Interest
Real, potential or apparent conflicts of interest may arise when a
portfolio manager has day-to-day portfolio management responsibilities with
respect to more than one fund or account, including the following:
Certain investments may be appropriate for the Fund and also for other
clients advised by the Investment. Adviser and its affiliates, including other
client accounts managed by the Fund's portfolio management team. Investment
decisions for the Fund and other clients are made with a view to achieving
their respective investment objectives and after consideration of such factors
as their current holdings, availability of cash for investment and the size of
their investments generally. Frequently, a particular security may be bought
or sold for only one client or in different amounts and at different times for
more than one but less than all clients. Likewise, because clients of the
Investment Adviser and its affiliates may have differing investment
strategies, a particular security may be bought for one or more clients when
one or more other clients are selling the security. The investment results for
the Fund may differ from the results achieved by other clients of the
Investment Adviser and its affiliates and results among clients may differ. In
addition, purchases or sales of the same security may be made for two or more
clients on the same day. In such event, such transactions will be allocated
among the clients in a manner believed by the Investment Adviser and its
affiliates to be equitable to each. The Investment Adviser will not determine
allocations based on whether it receives a performance based fee from the
client. In some cases, the allocation procedure could have an adverse effect
on the price or amount of the securities purchased or sold by the Fund.
Purchase and sale orders for the Fund may be combined with those of other
clients of the Investment Adviser and its affiliates in the interest of
achieving the most favorable net results to the Fund.
To the extent that the Fund's portfolio management team has
responsibilities for managing accounts in addition to the Fund, a portfolio
manager will need to divide his time and attention among relevant accounts.
In some cases, a real, potential or apparent conflict may also arise
where (i) the Investment Adviser may have an incentive, such as a performance
based fee, in managing one account and not with respect to other accounts it
manages or (ii) where a member of the Fund's portfolio management team owns an
interest in one fund or account he or she manages and not another.
33
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.
Proxy Voting Policies and Procedures
The Fund's Board of Directors has delegated to the Investment Adviser
authority to vote all proxies relating to the Fund's portfolio securities. The
Investment Adviser has adopted policies and procedures ("Proxy Voting
Procedures") with respect to the voting of proxies related to the portfolio
securities held in the account of one or more of its clients, including the
Fund. Pursuant to these Proxy Voting Procedures, the Investment Adviser's
primary objective when voting proxies is to make proxy voting decisions solely
in the best interests of the Fund and its stockholders, and to act in a manner
that the Investment Adviser believes is most likely to enhance the economic
value of the securities held by the Fund. The Proxy Voting Procedures are
designed to ensure that the Investment Adviser considers the interests of its
clients, including the Fund, and not the interests of the Investment Adviser,
when voting proxies and that real (or perceived) material conflicts that may
arise between the Investment Adviser's interest and those of the Investment
Adviser's clients are properly addressed and resolved.
In order to implement the Proxy Voting Procedures, the Investment
Adviser has formed a Proxy Voting Committee (the "Proxy Committee"). The Proxy
Committee is comprised of the Investment Adviser's Chief Investment Officer
(the "CIO"), one or more other senior investment professionals appointed by
the CIO, portfolio managers and investment analysts appointed by the CIO and
any other personnel the CIO deems appropriate. The Proxy Committee will also
include two non-voting representatives from the Investment Adviser's Legal
department appointed by the Investment Adviser's General Counsel. The Proxy
Committee's membership shall be limited to full-time employees of the
Investment Adviser. No person with any investment banking, trading, retail
brokerage or research responsibilities for the Investment Adviser's affiliates
may serve as a member of the Proxy Committee or participate in its decision
making (except to the extent such person is asked by the Proxy Committee to
present information to the Proxy Committee, on the same basis as other
interested knowledgeable parties not affiliated with the Investment Adviser
might be asked to do so). The Proxy Committee determines how to vote the
proxies of all clients, including the Fund, that have delegated proxy voting
authority to the Investment Adviser and seeks to ensure that all votes are
consistent with the best interests of those clients and are free from
unwarranted and inappropriate influences. The Proxy Committee establishes
general proxy voting policies for the Investment Adviser and is responsible
for determining how those policies are applied to specific proxy votes, in
light of each issuer's unique structure, management, strategic options and, in
certain circumstances, probable economic and other anticipated consequences of
alternate actions. In so doing, the Proxy Committee may determine to vote a
particular proxy in a manner contrary to its generally stated policies. In
addition, the Proxy Committee will be responsible for ensuring that all
reporting and recordkeeping requirements related to proxy voting are
fulfilled.
The Proxy Committee may determine that the subject matter of a recurring
proxy issue is not suitable for general voting policies and requires a
case-by-case determination. In such cases, the Proxy Committee may elect not
to adopt a specific voting policy applicable to that issue. The Investment
Adviser believes that certain proxy voting issues require investment analysis
- such as approval of mergers and other significant corporate transactions -
akin to investment decisions, and are, therefore, not suitable for general
guidelines. The Proxy Committee may elect to adopt a common position for the
Investment Adviser on certain proxy votes that are akin to investment
decisions, or determine to permit the portfolio manager to make individual
decisions on how best to maximize economic value for the Fund (similar to
normal buy/sell investment decisions made by such portfolio managers). While
it is expected that the Investment Adviser will generally seek to vote proxies
over which the Investment Adviser exercises voting authority in a uniform
manner for all the Investment Adviser's clients, the Proxy Committee, in
conjunction with the Fund's portfolio manager, may determine that the Fund's
specific circumstances require that its proxies be voted differently.
To assist the Investment Adviser in voting proxies, the Proxy Committee
has retained Institutional Shareholder Services ("ISS"). ISS is an independent
adviser that specializes in providing a variety of fiduciary-level
proxy-related services to institutional investment managers, plan sponsors,
custodians, consultants, and other
34
institutional investors. The services provided to the Investment Adviser by
ISS include in-depth research, voting recommendations (although the Investment
Adviser is not obligated to follow such recommendations), vote execution, and
recordkeeping. ISS will also assist the Fund in fulfilling its reporting and
recordkeeping obligations under the 1940 Act.
The Investment Adviser's Proxy Voting Procedures also address special
circumstances that can arise in connection with proxy voting. For instance,
under the Proxy Voting Procedures, the Investment Adviser generally will not
seek to vote proxies related to portfolio securities that are on loan,
although it may do so under certain circumstances. In addition, the Investment
Adviser will vote proxies related to securities of foreign issuers only on a
best efforts basis and may elect not to vote at all in certain countries where
the Proxy Committee determines that the costs associated with voting generally
outweigh the benefits. The Proxy Committee may at any time override these
general policies if it determines that such action is in the best interests of
the Fund.
From time to time, the Investment Adviser may be required to vote
proxies in respect of an issuer where an affiliate of the Investment Adviser
(each, an "Affiliate"), or a money management or other client of the
Investment Adviser, including investment companies for which the Investment
Adviser provides investment advisory, administrative and/or other services
(each, a "Client") is involved. The Proxy Voting Procedures and the Investment
Adviser's adherence to those procedures are designed to address such conflicts
of interest. The Proxy Committee intends to strictly adhere to the Proxy
Voting Procedures in all proxy matters, including matters involving Affiliates
and Clients. If, however, an issue representing a non-routine matter that is
material to an Affiliate or a widely known Client is involved such that the
Proxy Committee does not reasonably believe it is able to follow its
guidelines (or if the particular proxy matter is not addressed by the
guidelines) and vote impartially, the Proxy Committee may, in its discretion
for the purposes of ensuring that an independent determination is reached,
retain an independent fiduciary to advise the Proxy Committee on how to vote
or to cast votes on behalf of the Investment Adviser's clients.
In the event that the Proxy Committee determines not to retain an
independent fiduciary, or it does not follow the advice of such an independent
fiduciary, the Proxy Committee may pass the voting power to a subcommittee,
appointed by the CIO (with advice from the Secretary of the Proxy Committee),
consisting solely of Proxy Committee members selected by the CIO. The CIO
shall appoint to the subcommittee, where appropriate, only persons whose job
responsibilities do not include contact with the Client and whose job
evaluations would not be affected by the Investment Adviser's relationship
with the Client (or failure to retain such relationship). The subcommittee
shall determine whether and how to vote all proxies on behalf of the
Investment Adviser's clients or, if the proxy matter is, in their judgment,
akin to an investment decision, to defer to the applicable portfolio managers,
provided that, if the subcommittee determines to alter the Investment
Adviser's normal voting guidelines or, on matters where the Investment
Adviser's policy is case-by-case, does not follow the voting recommendation of
any proxy voting service or other independent fiduciary that may be retained
to provide research or advice to the Investment Adviser on that matter, no
proxies relating to the Client may be voted unless the Secretary, or in the
Secretary's absence, the Assistant Secretary of the Proxy Committee concurs
that the subcommittee's determination is consistent with the Investment
Adviser's fiduciary duties.
In addition to the general principles outlined above, the Investment
Adviser has adopted voting guidelines with respect to certain recurring proxy
issues that are not expected to involve unusual circumstances. These policies
are guidelines only, and the Investment Adviser may elect to vote differently
from the recommendation set forth in a voting guideline if the Proxy Committee
determines that it is in the Fund's best interest to do so. In addition, the
guidelines may be reviewed at any time upon the request of a Proxy Committee
member and may be amended or deleted upon the vote of a majority of Proxy
Committee members present at a Proxy Committee meeting at which there is a
quorum.
The Investment Adviser has adopted specific voting guidelines with
respect to the following proxy issues:
o Proposals related to the composition of the board of directors of
issuers other than investment companies. As a general matter, the
Proxy Committee believes that a company's board of directors
(rather than stockholders) is most likely to have access to
important, nonpublic information regarding a company's business
and prospects, and is therefore best-positioned to set corporate
policy and oversee management. The Proxy Committee, therefore,
believes that the foundation of good corporate governance is the
election of qualified, independent corporate directors who are
likely to diligently
35
represent the interests of stockholders and oversee management of
the corporation in a manner that will seek to maximize stockholder
value over time. In individual cases, the Proxy Committee may look
at a nominee's number of other directorships, history of
representing stockholder interests as a director of other
companies or other factors, to the extent the Proxy Committee
deems relevant.
o Proposals related to the selection of an issuer's independent
auditors. As a general matter, the Proxy Committee believes that
corporate auditors have a responsibility to represent the
interests of stockholders and provide an independent view on the
propriety of financial reporting decisions of corporate
management. While the Proxy Committee will generally defer to a
corporation's choice of auditor, in individual cases, the Proxy
Committee may look at an auditors' history of representing
stockholder interests as auditor of other companies, to the extent
the Proxy Committee deems relevant.
o Proposals related to management compensation and employee
benefits. As a general matter, the Proxy Committee favors
disclosure of an issuer's compensation and benefit policies and
opposes excessive compensation, but believes that compensation
matters are normally best determined by an issuer's board of
directors, rather than stockholders. Proposals to "micro-manage"
an issuer's compensation practices or to set arbitrary
restrictions on compensation or benefits will, therefore,
generally not be supported.
o Proposals related to requests, principally from management, for
approval of amendments that would alter an issuer's capital
structure. As a general matter, the Proxy Committee will support
requests that enhance the rights of common stockholders and oppose
requests that appear to be unreasonably dilutive.
o Proposals related to requests for approval of amendments to an
issuer's charter or by-laws. As a general matter, the Proxy
Committee opposes poison pill provisions.
o Routine proposals related to requests regarding the formalities of
corporate meetings.
o Proposals related to proxy issues associated solely with holdings
of investment company shares. As with other types of companies,
the Proxy Committee believes that a fund's board of directors
(rather than its stockholders) is best-positioned to set fund
policy and oversee management. However, the Proxy Committee
opposes granting boards of directors authority over certain
matters, such as changes to a fund's investment objective, that
the Investment Company Act envisions will be approved directly by
stockholders.
o Proposals related to limiting corporate conduct in some manner
that relates to the stockholder's environmental or social
concerns. The Proxy Committee generally believes that annual
stockholder meetings are inappropriate forums for discussion of
larger social issues, and opposes stockholder resolutions
"micro-managing" corporate conduct or requesting release of
information that would not help a stockholder evaluate an
investment in the corporation as an economic matter. While the
Proxy Committee is generally supportive of proposals to require
corporate disclosure of matters that seem relevant and material to
the economic interests of stockholders, the Proxy Committee is
generally not supportive of proposals to require disclosure of
corporate matters for other purposes.
Information about how the Fund voted proxies relating to securities held
by the Fund's portfolio during the most recent 12 month period ended June 30
is available without charge (i) at www.mutualfunds.ml.com, and (ii) the
Commission's website at www.sec.gov.
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
36
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, 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 Fund's
Board of Directors will reconsider this matter from time to time.
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 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
37
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 may have certain
tax consequences for stockholders.
For the six months ended April 30, 2005 and the fiscal years ended
October 31, 2004 and 2003, the Fund's portfolio turnover rates were 10.58%,
32.30% and 42.06%, respectively.
TAXES
The Fund has elected to qualify for the special tax treatment afforded
regulated investment companies ("Rocs") under the Internal Revenue Code of
1986, as amended (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. If, in any taxable year, the Fund
fails to qualify as a RIC under the Code, it would be taxed in the same manner
as an ordinary corporation and all distributions from earnings and profits (as
determined under U.S. Federal income tax principles) to its stockholders would
be taxable as ordinary dividend income eligible for the maximum 15% tax rate
for non-corporate shareholders and the dividends-received deduction for
corporate shareholders. However, the Fund's distributions derived from income
on tax exempt obligations, as defined herein, would no longer qualify for
treatment as exempt interest.
The Code requires a RIC to pay a nondeductible 4% excise tax to the
extent the RIC does not distribute, during each calendar year, 98% of its
ordinary income, determined on a calendar year basis, and 98% of its capital
gains, determined, in general, on an October 31 year-end, plus certain
undistributed amounts from previous years. 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 Internal Revenue Service (the "IRS"), in a revenue ruling, held that
certain auction rate preferred stock would be treated as stock for Federal
income tax purposes. The terms of the AMPS are substantially similar, but not
identical, to the auction rate preferred stock discussed in the revenue
ruling, and in the opinion of Sidley Austin Brown & Wood LLP, counsel to the
Fund, the shares of AMPS will constitute stock of the Fund and distributions
with respect to shares of AMPS (other than distributions in redemption of
shares of AMPS subject to Section 302(b) of the Code) will constitute
dividends to the extent of the Fund's current and accumulated earnings and
profits as calculated for Federal income tax purposes. Nevertheless, it is
possible that the IRS might take a contrary position, asserting, for example,
that the shares of AMPS constitute debt of the Fund. If this position were
upheld, the discussion of the treatment of distributions below would not
apply. Instead, distributions by the Fund to holders of shares of AMPS would
constitute taxable interest income, whether or not they exceeded the earnings
and profits of the Fund, would be included in full in the income of the
recipient and would be taxed as ordinary income. Counsel believes that such a
position, if asserted by the IRS, would be unlikely to prevail.
The Fund will only purchase a Municipal Bond or Non-Municipal Tax-Exempt
Security if it is accompanied by an opinion of counsel to the issuer, which is
delivered on the date of issuance of the security, that the interest paid on
such security is excludable from gross income for Federal income tax purposes
(i.e., "tax-
38
exempt"). 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 that pay interest 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-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 exempt from tax 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 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, 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
generally are considered ordinary income for Federal income tax purposes.
Distributions by the Fund, whether from exempt-interest income, ordinary
income or capital gains, are not eligible for the dividends received deduction
allowed to corporations under the Code or the reduced tax rates available to
non-corporate shareholders. 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 and
swaps ("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. If the Fund pays a dividend in January which 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.
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 for Federal
income tax purposes 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 AMPS could result
in capital gain or loss to holders of AMPS who hold their shares as capital
assets. Generally, a stockholder's gain or loss will be long-term capital gain
or loss if the shares have been held for more than one year. 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 AMPS, you may not be permitted to
deduct the interest on that loan. Under Federal income tax rules, the Fund's
AMPS may be treated as having been bought with borrowed money even if the
purchase cannot be traced directly to borrowed money. Stockholders should
consult their own tax advisers regarding the impact of an investment in AMPS
upon the deductibility of interest payable by the stockholder.
The IRS 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. Thus, the Fund is required to
allocate a portion of its net capital gain and other taxable income to the
shares of AMPS and Other AMPS of each series. Accordingly, the Fund intends to
designate dividends paid to the Series D AMPS and Other AMPS as tax exempt
interest, capital
39
gains or other taxable income, as applicable, in proportion to each series'
share of total dividends paid during the year. The Fund may notify the Auction
Agent of the amount of any net capital gain and other taxable income to be
included in any dividend on shares of AMPS prior to the Auction establishing
the Applicable Rate for such dividend. The Fund also may include such income
in a dividend on shares of AMPS without giving advance notice thereof if it
increases the dividend by an additional amount calculated as if such income
were a Retroactive Taxable Allocation and the additional amount were an
Additional Dividend, provided that the Fund will notify the Auction Agent of
the additional amounts to be included in such dividend prior to the applicable
Dividend Payment Date. See "The Auction--Auction Procedures--Auction Date;
Advance Notice of Allocation of Taxable Income; Inclusion of Taxable Income in
Dividends" in the prospectus. Except for the portion of any dividend that it
informs the Auction Agent will be treated as capital gains or other taxable
income, the Fund anticipates that the dividends paid on the shares of AMPS
will constitute exempt-interest dividends. The amount of net capital gain and
ordinary income allocable to shares of AMPS (the "taxable distribution") will
depend upon the amount of such gains and income realized by the Fund and the
total dividends paid by the Fund on shares of common stock and shares of the
series of AMPS during a taxable year, but the taxable distribution generally
is not expected to be significant.
If the Fund makes a Retroactive Taxable Allocation, it will pay
Additional Dividends to holders of AMPS who are subject to the Retroactive
Taxable Allocation. See "Description of AMPS--Dividends-- Additional
Dividends" in the prospectus. The Federal income tax consequences of
Additional Dividends under existing law are uncertain. The Fund intends to
treat a holder as receiving a dividend distribution in the amount of any
Additional Dividend only as and when such Additional Dividend is paid. An
Additional Dividend generally will be designated by the Fund as an
exempt-interest dividend except as otherwise required by applicable law.
However, the IRS may assert that all or part of an Additional Dividend is a
taxable dividend either in the taxable year for which the Retroactive Taxable
Allocation is made or in the taxable year in which the Additional Dividend is
paid.
In the opinion of Sidley Austin Brown & Wood LLP, counsel to the Fund,
under current law the manner in which the Fund intends to allocate items of
tax exempt income, net capital gain and other taxable income among shares of
common stock and shares of AMPS will be respected for Federal income tax
purposes. However, the tax treatment of Additional Dividends may affect the
Fund's calculation of each class's allocable share of capital gains and other
taxable income. In addition, there is currently no direct guidance from the
IRS or other sources specifically addressing whether the Fund's method for
allocating tax exempt income, net capital gain and other taxable income, if
any, among shares of common stock and shares of the AMPS will be respected for
Federal income tax purposes, and it is possible that the IRS could disagree
with counsel's opinion and attempt to reallocate the Fund's net capital gain
or other taxable income. In the event of a reallocation, some of the dividends
identified by the Fund as exempt-interest dividends to holders of shares of
AMPS may be recharacterized as additional capital gains or other taxable
income. In the event of such recharacterization, the Fund would not be
required to make payments to such stockholders to offset the tax effect of
such reallocation. In addition, a reallocation may cause the Fund to be liable
for income tax and excise tax on any reallocated taxable income. Sidley Austin
Brown & Wood LLP has advised the Fund that, in its opinion, if the IRS were to
challenge in court the Fund's allocations of income and gain, the IRS would be
unlikely to prevail. A holder should be aware, however, that the opinion of
Sidley Austin Brown & Wood LLP represents only its best legal judgment and is
not binding on the IRS or the courts.
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 PABs issued after August 7, 1986.
PABs 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 PABs and will report to stockholders at the close of the
calendar year-end the portion of its dividends declared during the year which
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.
40
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 and credit default swaps. The
Federal income tax rules governing the taxation of swaps are not entirely
clear and may require the Fund to treat payments received under such
arrangements as ordinary income and to amortize payments under certain
circumstances. 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 entered into by 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.
The Fund's ability to distribute dividends exempt from Federal income
tax depends on the exclusion from gross income of the interest income that it
receives on the securities in which it invests. The Fund will only purchase
Municipal Bonds and Non-Municipal Tax Exempt Securities if they are
accompanied by an opinion of counsel to the issuer, which is delivered on the
date of issuance of that security, that interest on such securities is
excludable from gross income for Federal income tax purposes (the "tax
exemption opinion").
Events occurring after the date of issuance of the Municipal Bonds and
Non-Municipal Tax Exempt Securities in which the Fund invests, however, may
cause the interest on such securities to be includable in gross income for
Federal income tax purposes. For example, the Code establishes certain
requirements, such as restrictions as to the investment of the proceeds of the
issue, limitations as to the use of proceeds of such issue and the property
financed by such proceeds, and the payment of certain excess earnings to the
Federal government, that must be met after the issuance of securities for
interest on such securities to remain excludable from gross income for Federal
income tax purposes. The issuers and the conduit borrowers of the Municipal
Bonds or Non-Municipal Tax Exempt Securities generally covenant to comply with
such requirements, and the tax exemption opinion generally assumes continuing
compliance with such requirements. Failure to comply with these continuing
requirements, however, may cause the interest on such securities to be
includable in gross income for Federal income tax purposes retroactive to
their date of issue.
In addition, the IRS has an ongoing enforcement program that involves
the audit of tax exempt bonds to determine whether an issue of bonds satisfies
all of the requirements that must be met for interest on such bonds to be
excludable from gross income for Federal income tax purposes. From time to
time, some of the securities held by the Fund may be the subject of such an
audit by the IRS, and the IRS may determine that the interest on such
securities is includable in gross income for Federal income tax purposes,
either because the IRS has taken a legal position adverse to the conclusion
reached by counsel to the issuer in the tax exemption opinion or as a result
of an action taken or not taken after the date of issue of such obligation. If
a Municipal Bond or Non- Municipal Tax Exempt Security in which the Fund
invests is determined to pay taxable interest subsequent to the Fund's
acquisition of such security, the IRS may demand that the Fund pay taxes on
the affected interest income. If the Fund agrees to do so, the Fund's yield on
its common stock could be adversely affected. A determination that interest on
a security held by the Fund is includable in gross income for Federal income
tax purposes retroactively to its date of issue may, likewise, cause a portion
of prior distributions received by stockholders, including holders of AMPS, to
be taxable to those stockholders in the year of receipt. The Fund will not pay
an Additional Dividend to a holder of AMPS under these circumstances.
41
If at any time when shares of AMPS 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 "Description of AMPS--Dividends--Restrictions on
Dividends and Other Payments" and in the prospectus. This may prevent the Fund
from distributing at least 90% of its net 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, and under certain circumstances will be required to, redeem
shares of AMPS 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. See "Description of AMPS--Redemption" herein and in the
prospectus. 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. Additional preferred stock that the Fund has authority to
issue 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 on a legal opinion with regard to such preferred stock,
there is no assurance that the IRS would agree that dividends on the preferred
stock are not preferential. If the IRS successfully disallowed the dividends
paid deduction for dividends on the preferred stock, the Fund could lose the
benefit of the special treatment afforded RICs under the Code. 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
alternative minimum tax.
Under certain Code provisions, some stockholders may be subject to a
withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Backup withholding may also be
required on distributions paid by the Fund, unless it reasonably estimates
that at least 95% of its distributions during the taxable year are comprised
of exempt-interest dividends. Generally, stockholders subject to backup
withholding will be those for whom no certified taxpayer identification number
is on file with the Fund or who, to the Fund's knowledge, have furnished an
incorrect number. When establishing an account, an investor must certify under
penalty of perjury that such number is correct and that such investor is not
otherwise subject to backup withholding. Backup withholding is not an
additional tax. Any amount withheld generally may be allowed as a refund or a
credit against a stockholder's Federal income tax liability, provided that the
required information is timely forwarded to the IRS.
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.
42
Stockholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
CONFLICTS OF INTEREST
The investment activities of the Investment Adviser, Merrill Lynch and
other affiliates of Merrill Lynch for their own accounts and other accounts
they manage may give rise to conflicts of interest that could disadvantage the
Fund and its stockholders. The Investment Adviser has adopted written policies
and procedures that, collectively, address investment activities of, and other
arrangements involving, the Investment Adviser that may give rise to such
conflicts of interest.
Merrill Lynch, as a diversified global financial services firm, is
involved with a broad spectrum of financial services and asset management
activities. Certain of Merrill Lynch's affiliates that are not service
providers to the Fund engage in a broad range of activities over which the
Investment Adviser has no control or ability to exercise oversight. Although
there are no formal written policies and procedures that cover all potential
or actual conflicts of interest, Merrill Lynch has established a number of
committees and related policies and procedures that are designed to identify,
analyze and/or resolve such conflicts of interest. No assurance can be given
that Merrill Lynch will be able to identify each conflict of interest or that
each identified conflict of interest will be resolved in favor of the Fund.
Merrill Lynch and its affiliates, including, without limitation, the
Investment Adviser and its advisory affiliates may have proprietary interests
in, and may manage or advise with respect to, accounts or funds (including
separate accounts and other funds and collective investment vehicles) that
have investment objectives similar to those of the Fund and/or that engage in
transactions in the same types of securities and instruments as the Fund.
Merrill Lynch and its affiliates are also major participants in, among others,
the options, swaps, and equities markets, in each case both on a proprietary
basis and for the accounts of customers. As such, Merrill Lynch and its
affiliates are actively engaged in transactions in the same securities and
instruments in which the Fund invests. Such activities could affect the prices
and availability of the securities and instruments in which the Fund invests,
which could have an adverse impact on the Fund's performance. Such
transactions, particularly in respect of most proprietary accounts or customer
accounts, will be executed independently of the Fund's transactions and thus
at prices or rates that may be more or less favorable than those obtained by
the Fund.
The results of the Fund's investment activities may differ significantly
from the results achieved by the Investment Adviser and its affiliates for its
proprietary accounts or other accounts (including investment companies or
collective investment vehicles) managed or advised by the Investment Adviser.
It is possible that the Investment Adviser and its affiliates and such other
accounts will achieve investment results that are substantially more or less
favorable than the results achieved by the Fund. Moreover, it is possible that
the Fund will sustain losses during periods in which the Investment Adviser
and its affiliates achieve significant profits on their trading for
proprietary or other accounts. The opposite result is also possible.
From time to time, the Fund's activities may also be restricted because
of regulatory restrictions applicable to Merrill Lynch and its affiliates,
and/or their internal policies designed to comply with such restrictions. As a
result, there may be periods, for example, when the Investment Adviser, and/or
its affiliates, will not initiate or recommend certain types of transactions
in certain securities or instruments with respect to which the Investment
Adviser and/or its affiliates are performing services or when position limits
have been reached.
In connection with its management of the Fund, the Investment Adviser
may have access to certain fundamental analysis and proprietary technical
models developed by Merrill Lynch. The Investment Adviser will not be under
any obligation, however, to effect transactions on behalf of the Fund in
accordance with such analysis and models. In addition, neither Merrill Lynch
nor any of its affiliates will have any obligation to make available any
information regarding their proprietary activities or strategies, or the
activities or strategies used for other accounts managed by them, for the
benefit of the management of the Fund and it is not anticipated that the
Investment Adviser will have access to such information for the purpose of
managing the Fund. The proprietary activities or portfolio strategies of
Merrill Lynch and its affiliates or the activities or strategies used for
accounts managed by them or other customer accounts could conflict with the
transactions and strategies employed by the Investment Adviser in managing the
Fund.
43
In addition, certain principals and certain employees of the Investment
Adviser are also principals or employees of Merrill Lynch or its affiliated
entities. As a result, the performance by these principals and employees of
their obligations to such other entities may be a consideration of which
investors in the Fund should be aware.
The Investment Adviser may enter into transactions and invest in
securities and instruments on behalf of the Fund in which customers of Merrill
Lynch (or, to the extent permitted by the SEC, Merrill Lynch) serve as the
counterparty, principal or issuer. In such cases, such party's interests in
the transaction will be adverse to the interests of the Fund, and such party
may have no incentive to assure that the Fund obtains the best possible prices
or terms in connection with the transactions. In addition, the purchase,
holding and sale of such investments by the Fund may enhance the profitability
of Merrill Lynch. Merrill Lynch and its affiliates may also create, write or
issue derivative instruments for customers of Merrill Lynch or its affiliates,
the underlying securities or instruments of which may be those in which the
Fund invests or which may be based on the performance of the Fund. The Fund
may, subject to applicable law, purchase investments that are the subject of
an underwriting or other distribution by Merrill Lynch or its affiliates and
may also enter into transactions with other clients of Merrill Lynch or its
affiliates where such other clients have interests adverse to those of the
Fund. At times, these activities may cause departments of Merrill Lynch or its
affiliates to give advice to clients that may cause these clients to take
actions adverse to the interests of the Fund. To the extent affiliated
transactions are permitted, the Fund will deal with Merrill Lynch and its
affiliates on an arms-length basis.
The Fund will be required to establish business relationships with its
counterparties based on the Fund's own credit standing. Neither Merrill Lynch
nor its affiliates will have any obligation to allow their credit to be used
in connection with the Fund's establishment of its business relationships, nor
is it expected that the Fund's counterparties will rely on the credit of
Merrill Lynch or any of its affiliates in evaluating the Fund's
creditworthiness.
It is also possible that, from time to time, Merrill Lynch or any of its
affiliates, may, although they are not required to, purchase, hold or sell
shares of the Fund.
It is possible that the Fund may invest in securities of companies with
which Merrill Lynch has or is trying to develop investment banking
relationships as well as securities of entities in which Merrill Lynch makes a
market. The Fund also may invest in securities of companies that Merrill Lynch
provides or may someday provide research coverage. Such investments could
cause conflicts between the interests of the Fund and the interests of other
Merrill Lynch clients. In providing services to the Fund, the Investment
Adviser is not permitted to obtain or use material non-public information
acquired by any division, department or affiliate of Merrill Lynch in the
course of these activities. In addition, from time to time, Merrill Lynch's
activities may limit the Fund's flexibility in purchases and sales of
securities. When Merrill Lynch is engaged in an underwriting or other
distribution of securities of an entity, the Investment Adviser may be
prohibited from purchasing or recommending the purchase of certain securities
of that entity for the Fund.
The Investment Adviser, its affiliates, and its directors, officers and
employees, may buy and sell securities or other investments for their own
accounts, and may have conflicts of interest with respect to investments made
on behalf of the Fund. As a result of differing trading and investment
strategies or constraints, positions may be taken by directors, officers and
employees and affiliates of the Investment Adviser that are the same,
different from or made at different times than positions taken for the Fund.
To lessen the possibility that the Fund will be adversely affected by this
personal trading, each of the Fund and the Investment Adviser has adopted a
Code of Ethics in compliance with Section 17(j) of the 1940 Act that restricts
securities trading in the personal accounts of investment professionals and
others who normally come into possession of information regarding the Fund's
portfolio transactions.
The Investment Adviser and its affiliates will not purchase securities
or other property from, or sell securities or other property to, the Fund,
except that the Fund may, in accordance with rules adopted under the 1940 Act,
engage in transactions with accounts that are affiliated with the Fund as a
result of common officers, directors, or investment advisers. These
transactions would be effected in circumstances in which the Investment
Adviser determined that it would be appropriate for the Fund to purchase and
another client to sell, or the Fund to sell and another client to purchase,
the same security or instrument on the same day.
44
Present and future activities of Merrill Lynch and its affiliates,
including of the Investment Adviser, in addition to those described in this
section, may give rise to additional conflicts of interest.
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 and other portfolio securities in which the Fund
invests are traded primarily in over-the-counter ("OTC") municipal bond and
money markets and are valued at the last available bid price for long
positions and at the last available ask price for short positions in the OTC
market or on the basis of yield equivalents as obtained from one or more
dealers or pricing services approved by the Directors. One bond is the "yield
equivalent" of another bond when, taking into account market price, maturity,
coupon rate, credit rating and ultimate return of principal, both bonds will
theoretically produce an equivalent return to the bondholder. Financial
futures contracts and options thereon, which are traded on exchanges, are
valued at their settlement prices as of the close of such exchanges.
Short-term investments with a remaining maturity of 60 days or less are valued
on an amortized cost basis, which approximates market value, unless the
Investment Adviser believes that this method no longer produces fair
valuations. Repurchase agreements will be valued at cost plus accrued
interest. The value of swaps, including interest rate swaps, caps and floors,
will be determined by obtaining dealer quotations. Repurchase agreements will
be valued at cost plus accrued interest. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Directors, including
valuations furnished by a pricing service retained by the Fund, which may use
a matrix system for valuations. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
supervision of the 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.
FINANCIAL STATEMENTS
The Fund's audited financial statements for the fiscal year ended
October 31, 2004, together with the report of _________ thereon, are
incorporated in this statement of additional information by reference to its
2004 Annual Report. The Fund's unaudited financial statements for the six
months ended April 30, 2005 are incorporated in this statement of additional
information by reference to its 2005 Semi-Annual Report. You may request a
copy of the Annual Report and the Semi-Annual Report at no charge by calling
(800) 543-6217 between 8:30 a.m. and 5:30 p.m. Eastern time on any business
day.
45
APPENDIX A
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MUNICIPAL BOND RATINGS
Description of Moody's Municipal Bond Ratings
Aaa Issuers or issues rated Aaa demonstrate the strongest
creditworthiness relative to other US municipal or tax-exempt
issuers or issues.
Aa Issuers or issues rated Aa demonstrate very strong
creditworthiness relative to other US municipal or tax-exempt
issuers or issues.
A Issuers or issues rated A present above-average creditworthiness
relative to other US municipal or tax-exempt issuers or issues.
Baa Issuers or issues rated Baa represent average creditworthiness
relative to other US municipal or tax- exempt issuers or issues.
Ba Issuers or issues rated Ba demonstrate below-average
creditworthiness relative to other US municipal or tax-exempt
issuers or issues.
B Issuers or issues rated B demonstrate weak creditworthiness
relative to other US municipal or tax- exempt issuers or issues.
Caa Issuers or issues rated Caa demonstrate very weak creditworthiness
relative to other US municipal or tax-exempt issuers or issues.
Ca Issuers or issues rated Ca demonstrate extremely weak
creditworthiness relative to other US municipal or tax-exempt
issuers or issues.
C Issuers or issues rated C demonstrate the weakest creditworthiness
relative to other US municipal or tax-exempt issuers or issues.
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a
ranking in the lower end of that generic rating category.
Description of Moody's Municipal Short-Term Debt Ratings
MIG 1 This designation denotes superior credit quality. Excellent
protection is afforded by established cash flows, highly reliable
liquidity support, or demonstrated broad-based access to the
market for refinancing.
MIG 2 This designation denotes strong credit quality. Margins of
protection are ample, although not as large as in the preceding
group.
MIG 3 This designation denotes acceptable credit quality. Liquidity
and cash-flow protection may be narrow, and market access for
refinancing is likely to be less well-established.
SG This designation denotes speculative-grade credit quality. Debt
instruments in this category may lack sufficient margins of
protection.
A-1
Description of Moody's U.S. Municipal Demand Obligation Ratings
In the case of variable rate demand obligations (VRDOs), a two-component
rating is assigned; a long or short-term debt rating and a demand obligation
rating. The first element represents Moody's evaluation of the degree of risk
associated with scheduled principal and interest payments. The second element
represents Moody's evaluation of the degree of risk associated with the
ability to receive purchase price upon demand ("demand feature"), using a
variation of the MIG rating scale, the Variable Municipal Investment Grade or
VMIG rating.
When either the long- or short-term aspect of a VRDO is not rated, that
piece is designated NR, e.g., Aaa/NR or NR/VMIG 1.
VMIG rating expirations are a function of each issue's specific
structural or credit features.
VMIG 1 This designation denotes superior credit quality. Excellent
protection is afforded by the superior short-term credit strength
of the liquidity provider and structural and legal protections
that ensure the timely payment of purchase price upon demand.
VMIG 2 This designation denotes strong credit quality. Good protection
is afforded by the strong short-term credit strength of the
liquidity provider and structural and legal protections that
ensure the timely payment of purchase price upon demand.
VMIG 3 This designation denotes acceptable credit quality. Adequate
protection is afforded by the satisfactory short-term credit
strength of the liquidity provider and structural and legal
protections that ensure the timely payment of purchase price upon
demand.
SG This designation denotes speculative-grade credit quality. Demand
features rated in this category may be supported by a liquidity
provider that does not have an investment grade short-term rating
or may lack the structural and/or legal protections necessary to
ensure the timely payment of purchase price upon demand.
Description of Moody's Short-Term Ratings
Moody's Commercial Paper ratings are opinions of the ability of issuers
to honor short-term financial obligations not having an original maturity in
excess of thirteen months. Moody's employs the following three designations,
all judged to be investment grade, to indicate the relative repayment capacity
of rated issuers:
P-1 Issuers (or supporting institutions) rated Prime-1 have a superior
ability to repay short-term debt obligations.
P-2 Issuers (or supporting institutions) rated Prime-2 have a strong
ability to repay short-term debt obligations.
P-3 Issuers (or supporting institutions) rated Prime-3 have an
acceptable ability to repay short-term obligations.
NP Issuers (or supporting institutions) 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"), Debt Ratings
A Standard & Poor's issue credit 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.
A-2
The issue credit 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 issue credit 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 other
circumstances.
The issue credit 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;
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.
Long Term Issue Credit Ratings
AAA An obligation rated "AAA" has the highest rating assigned by
Standard & Poor'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.
BB An obligation rated "BB," "B," "CCC," "CC" and "C" are regarded
B as having significant speculative characteristics. "BB" indicates
CCC the least degree of speculation and "C" the highest degree of
CC speculation. While such debt will likely have some quality and
C protective characteristics, these may be outweighed by large
uncertainties or major risk exposures to adverse conditions.
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 similar
action if payments on an obligation are jeopardized.
c The `c' subscript is used to provide additional information to
investors that the bank may terminate its obligation to purchase
tendered bonds if the long term credit rating of the issuer is
below an investment-grade level and/or the issuer's bonds are
deemed taxable.
p The letter `p' indicates that the rating is provisional. A
provisional rating assumes the successful completion of the
project financed by the debt being rated and indicates that
payment of debt service requirements is largely or entirely
dependent upon the successful, timely completion of the
A-3
project. This rating, however, while addressing credit quality
subsequent to the completion of the project, makes no comment on
the likelihood of or the risk of default upon failure of such
completion. The investor should exercise his own judgment with
respect to such likelihood and risk.
* Continuance of the ratings is contingent upon Standard & Poor's
receipt of an executed copy of the escrow agreement or closing
documentation confirming investments and cash flows.
r This symbol is attached to the ratings of instruments with
significant noncredit risks. It highlights risks to principal or
volatility of expected returns which are not addressed in the
credit rating.
N.R. This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that
Standard & Poor's does not rate a particular obligation as a
matter of policy.
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 Short-Term Issue Credit Ratings
A Standard & Poor's short-term issue credit rating is a current
assessment of the likelihood of timely payment of debt having an original
maturity of no more than three years. 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 A short-term obligation rated "A-1" is rated in the highest
category by Standard & Poor's. The obligor's capacity to meet its
financial commitment on the obligation is strong. Within this
category, certain obligations are designated with a plus sign (+).
This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
A-2 A short-term obligation rated "A-2" is somewhat more susceptible
to the adverse effects of changes in circumstances and economic
conditions than obligations in higher rating categories. However,
the obligor's capacity to meet its financial commitment on the
obligation is satisfactory.
A-3 A short-term obligation rated "A-3" 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.
B A short-term obligation rated "B" is regarded as having
significant speculative characteristics. The obligor currently has
the capacity to meet its financial commitment on the obligation;
however, it faces major ongoing uncertainties which could lead to
the obligor's inadequate capacity to meet its financial commitment
on the obligation.
C A short-term obligation rated "C" 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.
D A short-term obligation rated "D" is in payment default. The "D"
rating category is used when interest payments or principal
payments 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 will also be used upon the filing of a bankruptcy petition
or the taking of a similar action if payments on an obligation are
jeopardized.
c The "c" subscript is used to provide additional information to
investors that the bank may terminate its obligation to purchase
tendered bonds if the long term credit rating of the issuer is
below an investment-grade level and/or the issuer's bonds are
deemed taxable.
A-4
p The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the
project financed by the debt being rated and indicates that
payment of debt service requirements is largely or entirely
dependent upon the successful, timely completion of the project.
This rating, however, while addressing credit quality subsequent
to completion of the project, makes no comment on the likelihood
of or the risk of default upon failure of such completion. The
investor should exercise his own judgment with respect to such
likelihood and risk.
* Continuance of the ratings is contingent upon Standard & Poor's
receipt of an executed copy of the escrow agreement or closing.
r The "r" highlights derivative, hybrid, and certain other
obligations that Standard & Poor's believes may experience high
volatility or high variability in expected returns as a result of
noncredit risks. Examples of such obligations are securities with
principal or interest return indexed to equities, commodities, or
currencies; certain swaps and options, and interest-only and
principal-only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will
exhibit no volatility or variability in total return.
A short-term issue credit 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.
SP-3 Speculative capacity to pay principal and interest.
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.
A-5
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.
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.
A-6
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.
D Bonds are in default on interest and/or principal payments. Such
DD bonds are extremely speculative and should be valued on the basis
DDD of their ultimate recovery value in liquidation or reorganization
of the obligor. "DDD" represents the highest potential for
recovery on these bonds, and "D" represents the lowest potential
for recovery.
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 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.
NR Indicates that Fitch does not rate the specific issue.
A-7
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
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.
A-8
APPENDIX B
SETTLEMENT PROCEDURES
The following summary of Settlement Procedures sets forth the procedures
expected to be followed in connection with the settlement of each Auction and
will be incorporated by reference in the Auction Agent Agreement and each
Broker-Dealer Agreement. Nothing contained in this Appendix B constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party. Capitalized terms used herein shall have the respective meanings
specified in the Glossary in the prospectus or this Appendix B hereto, as the
case may be.
(a) On each Auction Date, the Auction Agent shall notify by telephone or
through the Auction Agent's Processing System the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order
on behalf of any Beneficial Owner or Potential Beneficial Owner of:
(i) the Applicable Rate fixed for the next succeeding Dividend
Period;
(ii) whether Sufficient Clearing Bids existed for the
determination of the Applicable Rate;
(iii) if such Broker-Dealer (a "Seller's Broker-Dealer") submitted
a Bid or a Sell Order on behalf of a Beneficial Owner, the number of
shares, if any, of AMPS to be sold by such Beneficial Owner;
(iv) if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a
Bid on behalf of a Potential Beneficial Owner, the number of shares, if
any, of AMPS to be purchased by such Potential Beneficial Owner;
(v) if the aggregate number of shares of AMPS to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or
a Sell Order exceeds the aggregate number of shares of AMPS to be
purchased by all Potential Beneficial Owners on whose behalf such
Broker-Dealer submitted a Bid, the name or names of one or more Buyer's
Broker-Dealers (and the name of the Agent Member, if any, of each such
Buyer's Broker-Dealer) acting for one or more purchasers of such excess
number of shares of AMPS and the number of such shares to be purchased
from one or more Beneficial Owners on whose behalf such Broker-Dealer
acted by one or more Potential Beneficial Owners on whose behalf each of
such Buyer's Broker-Dealers acted;
(vi) if the aggregate number of shares of AMPS to be purchased by
all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid exceeds the aggregate number of shares of AMPS to be
sold by all Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid or a Sell Order, the name or names of one or more
Seller's Broker-Dealers (and the name of the Agent Member, if any, of
each such Seller's Broker-Dealer) acting for one or more sellers of such
excess number of shares of AMPS and the number of such shares to be sold
to one or more Potential Beneficial Owners on whose behalf such
Broker-Dealer acted by one or more Beneficial Owners on whose behalf
each of such Seller's Broker-Dealers acted; and
(vii) the Auction Date of the next succeeding Auction with respect
to the AMPS.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
(i) in the case of a Broker-Dealer that is a Buyer's
Broker-Dealer, instruct each Potential Beneficial Owner on whose behalf
such Broker-Dealer submitted a Bid that was accepted, in whole or in
part, to instruct such Potential Beneficial Owner's Agent Member to pay
to such Broker-Dealer (or its Agent Member) through the Securities
Depository the amount necessary to purchase the number of shares
B-1
of AMPS to be purchased pursuant to such Bid against receipt of such
shares and advise such Potential Beneficial Owner of the Applicable Rate
for the next succeeding Dividend Period;
(ii) in the case of a Broker-Dealer that is a Seller's
Broker-Dealer, instruct each Beneficial Owner on whose behalf such
Broker-Dealer submitted a Sell Order that was accepted, in whole or in
part, or a Bid that was accepted, in whole or in part, to instruct such
Beneficial Owner's Agent Member to deliver to such Broker-Dealer (or its
Agent Member) through the Securities Depository the number of shares of
AMPS to be sold pursuant to such Order against payment therefor and
advise any such Beneficial Owner that will continue to hold shares of
AMPS of the Applicable Rate for the next succeeding Dividend Period;
(iii) advise each Beneficial Owner on whose behalf such
Broker-Dealer submitted a Hold Order of the Applicable Rate for the next
succeeding Dividend Period;
(iv) advise each Beneficial Owner on whose behalf such
Broker-Dealer submitted an Order of the Auction Date for the next
succeeding Auction; and
(v) advise each Potential Beneficial Owner on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, of
the Auction Date for the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to (a)
above, each Broker-Dealer that submitted a Bid or a Sell Order on behalf of a
Potential Beneficial Owner or a Beneficial Owner shall, in such manner and at
such time or times as in its sole discretion it may determine, allocate any
funds received by it pursuant to (b)(i) above and any shares of AMPS received
by it pursuant to (b)(ii) above among the Potential Beneficial Owners, if any,
on whose behalf such Broker-Dealer submitted Bids, the Beneficial Owners, if
any, on whose behalf such Broker-Dealer submitted Bids that were accepted or
Sell Orders, and any Broker-Dealer or Broker-Dealers identified to it by the
Auction Agent pursuant to (a)(v) or (a)(vi) above.
(d) On each Auction Date:
(i) each Potential Beneficial Owner and Beneficial Owner shall
instruct its Agent Member as provided in (b)(i) or (ii) above, as the
case may be;
(ii) each Seller's Broker-Dealer which is not an Agent Member of
the Securities Depository shall instruct its Agent Member to (A) pay
through the Securities Depository to the Agent Member of the Beneficial
Owner delivering shares to such Broker-Dealer pursuant to (b)(ii) above
the amount necessary to purchase such shares against receipt of such
shares, and (B) deliver such shares through the Securities Depository to
a Buyer's Broker-Dealer (or its Agent Member) identified to such
Seller's Broker-Dealer pursuant to (a)(v) above against payment
therefor; and
(iii) each Buyer's Broker-Dealer which is not an Agent Member of
the Securities Depository shall instruct its Agent Member to (A) pay
through the Securities Depository to a Seller's Broker-Dealer (or its
Agent Member) identified pursuant to (a)(vi) above the amount necessary
to purchase the shares to be purchased pursuant to (b)(i) above against
receipt of such shares, and (B) deliver such shares through the
Securities Depository to the Agent Member of the purchaser thereof
against payment therefor.
(e) On the day after the Auction Date:
(i) each Bidder's Agent Member referred to in (d)(i) above shall
instruct the Securities Depository to execute the transactions described
in (b)(i) or (ii) above, and the Securities Depository shall execute
such transactions;
(ii) each Seller's Broker-Dealer or its Agent Member shall
instruct the Securities Depository to execute the transactions described
in (d)(ii) above, and the Securities Depository shall execute such
transactions; and
B-2
(iii) each Buyer's Broker-Dealer or its Agent Member shall
instruct the Securities Depository to execute the transactions described
in (d)(iii) above, and the Securities Depository shall execute such
transactions.
(f) If a Beneficial Owner selling shares of AMPS in an Auction fails to
deliver such shares (by authorized book-entry), a Broker-Dealer may deliver to
the Potential Beneficial Owner on behalf of which it submitted a Bid that was
accepted a number of whole shares of AMPS that is less than the number of
shares that otherwise was to be purchased by such Potential Beneficial Owner.
In such event, the number of shares of AMPS to be so delivered shall be
determined solely by such Broker-Dealer. Delivery of such lesser number of
shares shall constitute good delivery. Notwithstanding the foregoing terms of
this paragraph (f), any delivery or non-delivery of shares which shall
represent any departure from the results of an Auction, as determined by the
Auction Agent, shall be of no effect unless and until the Auction Agent shall
have been notified of such delivery or non-delivery in accordance with the
provisions of the Auction Agent Agreement and the Broker-Dealer Agreements.
B-3
APPENDIX C
AUCTION PROCEDURES
The following procedures will be set forth in provisions of the Articles
Supplementary relating to the AMPS, and will be incorporated by reference in
the Auction Agent Agreement and each Broker-Dealer Agreement. The terms not
defined below are defined in the prospectus or in the Glossary in the
prospectus. Nothing contained in this Appendix C constitutes a representation
by the Fund that in each Auction each party referred to herein actually will
perform the procedures described herein to be performed by such party.
Paragraph 10(a) Certain Definitions.
As used in this Paragraph 10, the following terms shall have the
following meanings, unless the context otherwise requires:
(i) "AMPS" shall mean the shares of AMPS being auctioned pursuant
to this Paragraph 10.
(ii) "Auction Date" shall mean the first Business Day preceding
the first day of a Dividend Period.
(iii) "Available AMPS" shall have the meaning specified in
Paragraph 10(d)(i) below.
(iv) "Bid" shall have the meaning specified in Paragraph 10(b)(i)
below.
(v) "Bidder" shall have the meaning specified in Paragraph
10(b)(i) below.
(vi) "Hold Order" shall have the meaning specified in Paragraph
10(b)(i) below.
(vii) "Maximum Applicable Rate" for any Dividend Period will be
the higher of the Applicable Percentage of the Reference Rate or the
Applicable Spread plus the Reference Rate. The Applicable Percentage and
the Applicable Spread will be determined based on (i) the lower of the
credit rating or ratings assigned on such date to such shares by Moody's
and S&P (or if Moody's or S&P or both shall not make such rating
available, the equivalent of either or both of such ratings by a
Substitute Rating Agency or two Substitute Rating Agencies or, in the
event that only one such rating shall be available, such rating) and
(ii) whether the Fund has provided notification to the Auction Agent
prior to the Auction establishing the Applicable Rate for any dividend
that net capital gains or other taxable income will be included in such
dividend on shares of AMPS as follows:
Credit Ratings
------------------------------------
Applicable
Applicable Applicable Applicable Spread Over
Percentage of Percentage of Spread Over Reference
Reference Rate - Reference Rate - Reference Rate - Rate -
Moody's S&P Notification Notification No Notification Notification
------------------- --------------- ------------------ ----------------- ------------------ -----------------
Aaa AAA 110% 125% 1.10% 1.25%
Aa3 to Aa1 AA- to AA+ 125% 150% 1.25% 1.50%
A3 to A1 A- to A+ 150% 200% 1.50% 2.00%
Baa3 to Baa1 BBB- to BBB+ 175% 250% 1.75% 2.50%
Below Baa3 Below BBB- 200% 300% 2.00% 3.00%
The Applicable Percentage and the Applicable Spread as so determined may
be further subject to upward but not downward adjustment in the discretion of
the Board of Directors of the Fund after consultation with the Broker-Dealers,
provided that immediately following any such increase the Fund would be in
compliance with the AMPS Basic Maintenance Amount. Subject to the provisions
of paragraph 12 of the Articles Supplementary entitled
C-1
"Termination of Rating Agency Provisions," the Fund shall take all reasonable
action necessary to enable S&P and Moody's to provide a rating for the AMPS.
If either S&P or Moody's shall not make such a rating available or if neither
S&P nor Moody's shall make such a rating available, subject to the provisions
of paragraph 12 of the Articles Supplementary entitled "Termination of Rating
Agency Provisions," Merrill Lynch, Pierce, Fenner & Smith Incorporated or its
affiliates and successors, after obtaining the Fund's approval, shall select a
NRSRO or two NRSROs to act as a Substitute Rating Agency or Substitute Rating
Agencies, as the case may be.
(viii) "Order" shall have the meaning specified in Paragraph
10(b)(i) below.
(ix) "Sell Order" shall have the meaning specified in Paragraph
10(b)(i) below.
(x) "Submission Deadline" shall mean 1:00 p.m., Eastern time, on
any Auction Date or such other time on any Auction Date as may be
specified by the Auction Agent from time to time as the time by which
each Broker-Dealer must submit to the Auction Agent in writing all
Orders obtained by it for the Auction to be conducted on such Auction
Date.
(xi) "Submitted Bid" shall have the meaning specified in Paragraph
10(d)(i) below.
(xii) "Submitted Hold Order" shall have the meaning specified in
Paragraph 10(d)(i) below.
(xiii) "Submitted Order" shall have the meaning specified in
Paragraph 10(d)(i) below.
(xiv) "Submitted Sell Order" shall have the meaning specified in
Paragraph 10(d)(i) below.
(xv) "Sufficient Clearing Bids" shall have the meaning specified
in Paragraph 10(d)(i) below.
(xvi) "Winning Bid Rate" shall have the meaning specified in
Paragraph 10(d)(i) below.
Paragraph 10(b) Orders by Beneficial Owners, Potential Beneficial Owners,
Existing Holders And Potential Holders.
(i) Unless otherwise permitted by the Fund, Beneficial Owners and
Potential Beneficial Owners may only participate in Auctions through their
Broker-Dealers. Broker-Dealers will submit the Orders of their respective
customers who are Beneficial Owners and Potential Beneficial Owners to the
Auction Agent, designating themselves as Existing Holders in respect of shares
subject to Orders submitted or deemed submitted to them by Beneficial Owners
and as Potential Holders in respect of shares subject to Orders submitted to
them by Potential Beneficial Owners. A Broker-Dealer may also hold shares of
AMPS in its own account as a Beneficial Owner. A Broker-Dealer may thus submit
Orders to the Auction Agent as a Beneficial Owner or a Potential Beneficial
Owner and therefore participate in an Auction as an Existing Holder or
Potential Holder on behalf of both itself and its customers. On or prior to
the Submission Deadline on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer
information as to:
(1) the number of outstanding shares, if any, of AMPS held
by such Beneficial Owner which such Beneficial Owner desires to
continue to hold without regard to the Applicable Rate for the
next succeeding Dividend Period;
(2) the number of outstanding shares, if any, of AMPS held
by such Beneficial Owner which such Beneficial Owner desires to
continue to hold, provided that the Applicable Rate for the next
succeeding Dividend Period shall not be less than the rate per
annum specified by such Beneficial Owner; and/or
(3) the number of outstanding shares, if any, of AMPS held
by such Beneficial Owner which such Beneficial Owner offers to
sell without regard to the Applicable Rate for the next succeeding
Dividend Period; and
C-2
(B) each Broker-Dealer, using a list of Potential Beneficial
Owners that shall be maintained in good faith for the purpose of
conducting a competitive Auction, shall contact Potential Beneficial
Owners, including Persons that are not Beneficial Owners, on such list
to determine the number of outstanding shares, if any, of AMPS which
each such Potential Beneficial Owner offers to purchase, provided that
the Applicable Rate for the next succeeding Dividend Period shall not be
less than the rate per annum specified by such Potential Beneficial
Owner.
For the purposes hereof, the communication by a Beneficial Owner or
Potential Beneficial Owner to a Broker-Dealer, or the communication by a
Broker-Dealer acting for its own account to the Auction Agent, of information
referred to in clause (A) or (B) of this Paragraph 10(b)(i) is hereinafter
referred to as an "Order" and each Beneficial Owner and each Potential
Beneficial Owner placing an Order, including a Broker-Dealer acting in such
capacity for its own account, is hereinafter referred to as a "Bidder"; an
Order containing the information referred to in clause (A)(1) of this
Paragraph 10(b)(i) is hereinafter referred to as a "Hold Order"; an Order
containing the information referred to in clause (A)(2) or (B) of this
Paragraph 10(b)(i) is hereinafter referred to as a "Bid"; and an Order
containing the information referred to in clause (A)(3) of this Paragraph
10(b)(i) is hereinafter referred to as a "Sell Order." Inasmuch as a
Broker-Dealer participates in an Auction as an Existing Holder or a Potential
Holder only to represent the interests of a Beneficial Owner or Potential
Beneficial Owner, whether it be its customers or itself, all discussion herein
relating to the consequences of an Auction for Existing Holders and Potential
Holders also applies to the underlying beneficial ownership interests
represented.
(ii) (A) A Bid by an Existing Holder shall constitute an
irrevocable offer to sell:
(1) the number of outstanding shares of AMPS specified in
such Bid if the Applicable Rate determined on such Auction Date
shall be less than the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of
AMPS to be determined as set forth in Paragraph 10(e)(i)(D) if the
Applicable Rate determined on such Auction Date shall be equal to
the rate per annum specified therein; or
(3) a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(ii)(C) if such
specified rate per annum shall be higher than the Maximum
Applicable Rate and Sufficient Clearing Bids do not exist.
(B) A Sell Order by an Existing Holder shall constitute an
irrevocable offer to sell:
(1) the number of outstanding shares of AMPS specified in
such Sell Order, or
(2) such number or a lesser number of outstanding shares of
AMPS to be determined as set forth in Paragraph 10(e)(ii)(C) if
Sufficient Clearing Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable
offer to purchase:
(1) the number of outstanding shares of AMPS specified in
such Bid if the Applicable Rate determined on such Auction Date
shall be higher than the rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of
AMPS to be determined as set forth in Paragraph 10(e)(i)(E) if the
Applicable Rate determined on such Auction Date shall be equal to
the rate per annum specified therein.
Paragraph 10(c) Submission of Orders by Broker-Dealers to Auction Agent.
(i) Each Broker-Dealer shall submit in writing or through a mutually
acceptable electronic means to the Auction Agent prior to the Submission
Deadline on each Auction Date all Orders obtained by such Broker-
C-3
Dealer, designating itself (unless otherwise permitted by the Fund) as an
Existing Holder in respect of shares subject to Orders submitted or deemed
submitted to it by Beneficial Owners and as a Potential Holder in respect of
shares subject to Orders submitted to it by Potential Beneficial Owners, and
specifying with respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the
Broker-Dealer unless otherwise permitted by the Fund);
(B) the aggregate number of outstanding shares of AMPS that are
the subject of such Order;
(C) to the extent that such Bidder is an Existing Holder
(1) the number of outstanding shares, if any, of AMPS
subject to any Hold Order placed by such Existing Holder;
(2) the number of outstanding shares, if any, of AMPS
subject to any Bid placed by such Existing Holder and the rate per
annum specified in such Bid; and
(3) the number of outstanding shares, if any, of AMPS
subject to any Sell Order placed by such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate per
annum specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than three
figures to the right of the decimal point, the Auction Agent shall round such
rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the outstanding shares of
AMPS held by an Existing Holder are not submitted to the Auction Agent prior
to the Submission Deadline, the Auction Agent shall deem a Hold Order (in the
case of an Auction relating to a Dividend Period which is not a Special
Dividend Period of more than 28 days) and a Sell Order (in the case of an
Auction relating to a Special Dividend Period of more than 28 days) to have
been submitted on behalf of such Existing Holder covering the number of
outstanding shares of AMPS held by such Existing Holder and not subject to
Orders submitted to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in
the aggregate more than the number of outstanding shares of AMPS held by such
Existing Holder are submitted to the Auction Agent, such Orders shall be
considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder
shall be considered valid up to and including the number of outstanding
shares of AMPS held by such Existing Holder; provided that if more than
one Hold Order is submitted on behalf of such Existing Holder and the
number of shares of AMPS subject to such Hold Orders exceeds the number
of outstanding shares of AMPS held by such Existing Holder, the number
of shares of AMPS subject to each of such Hold Orders shall be reduced
pro rata so that such Hold Orders, in the aggregate, cover exactly the
number of outstanding shares of AMPS held by such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be
considered valid, in the ascending order of their respective rates per
annum if more than one Bid is submitted on behalf of such Existing
Holder, up to and including the excess of the number of outstanding
shares of AMPS held by such Existing Holder over the number of shares of
AMPS subject to any Hold Order referred to in Paragraph 10(c)(iv)(A)
above (and if more than one Bid submitted on behalf of such Existing
Holder specifies the same rate per annum and together they cover more
than the remaining number of shares that can be the subject of valid
Bids after application of Paragraph 10(c)(iv)(A) above and of the
foregoing portion of this Paragraph 10(c)(iv)(B) to any Bid or Bids
specifying a lower rate or rates per annum, the number of shares subject
to each of such Bids shall be reduced pro rata so that such Bids, in the
aggregate, cover exactly such
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remaining number of shares); and the number of shares, if any,
subject to Bids not valid under this Paragraph 10(c)(iv)(B) shall be
treated as the subject of a Bid by a Potential Holder; and
(C) any Sell Order shall be considered valid up to and including
the excess of the number of outstanding shares of AMPS held by such
Existing Holder over the number of shares of AMPS subject to Hold Orders
referred to in Paragraph 10(c)(iv)(A) and Bids referred to in Paragraph
10(c)(iv)(B); provided that if more than one Sell Order is submitted on
behalf of any Existing Holder and the number of shares of AMPS subject
to such Sell Orders is greater than such excess, the number of shares of
AMPS subject to each of such Sell Orders shall be reduced pro rata so
that such Sell Orders, in the aggregate, cover exactly the number of
shares of AMPS equal to such excess.
(v) If more than one Bid is submitted on behalf of any Potential Holder,
each Bid submitted shall be a separate Bid with the rate per annum and number
of shares of AMPS therein specified.
(vi) Any Order submitted by a Beneficial Owner or a Potential Beneficial
Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior
to the Submission Deadline on any Auction Date shall be irrevocable.
Paragraph 10(d) Determination of Sufficient Clearing Bids, Winning Bid
Rate and Applicable Rate.
(i) Not earlier than the Submission Deadline on each Auction Date, the
Auction Agent shall assemble all Orders submitted or deemed submitted to it by
the Broker-Dealers (each such Order as submitted or deemed submitted by a
Broker-Dealer being hereinafter referred to individually as a "Submitted Hold
Order," a "Submitted Bid" or a "Submitted Sell Order," as the case may be, or
as a "Submitted Order") and shall determine:
(A) the excess of the total number of outstanding shares of AMPS
over the number of outstanding shares of AMPS that are the subject of
Submitted Hold Orders (such excess being hereinafter referred to as the
"Available AMPS");
(B) from the Submitted Orders whether the number of outstanding
shares of AMPS that are the subject of Submitted Bids by Potential
Holders specifying one or more rates per annum equal to or lower than
the Maximum Applicable Rate exceeds or is equal to the sum of:
(1) the number of outstanding shares of AMPS that are the
subject of Submitted Bids by Existing Holders specifying one or
more rates per annum higher than the Maximum Applicable Rate, and
(2) the number of outstanding shares of AMPS that are
subject to Submitted Sell Orders (if such excess or such equality
exists (other than because the number of outstanding shares of
AMPS in clauses (1) and (2) above are each zero because all of the
outstanding shares of AMPS are the subject of Submitted Hold
Orders), such Submitted Bids by Potential Holders hereinafter
being referred to collectively as "Sufficient Clearing Bids"); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum
specified in the Submitted Bids (the "Winning Bid Rate") that if:
(1) each Submitted Bid from Existing Holders specifying the
Winning Bid Rate and all other submitted Bids from Existing
Holders specifying lower rates per annum were rejected, thus
entitling such Existing Holders to continue to hold the shares of
AMPS that are the subject of such Submitted Bids, and
(2) each Submitted Bid from Potential Holders specifying the
Winning Bid Rate and all other Submitted Bids from Potential
Holders specifying lower rates per annum were accepted, thus
entitling the Potential Holders to purchase the shares of AMPS
that are the subject of such Submitted Bids, would result in the
number of shares subject to all Submitted Bids
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specifying the Winning Bid Rate or a lower rate per annum being at
least equal to the Available AMPS.
(ii) Promptly after the Auction Agent has made the determinations
pursuant to Paragraph 10(d)(i), the Auction Agent shall advise the Fund of the
Maximum Applicable Rate and, based on such determinations, the Applicable Rate
for the next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable Rate
for the next succeeding Dividend Period shall be equal to the Winning
Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than because
all of the outstanding shares of AMPS are the subject of Submitted Hold
Orders), that the Applicable Rate for the next succeeding Dividend
Period shall be equal to the Maximum Applicable Rate; or
(C) if all of the outstanding shares of AMPS are the subject of
Submitted Hold Orders, the Dividend Period next succeeding the Auction
automatically shall be the same length as the immediately preceding
Dividend Period and the Applicable Rate for the next succeeding Dividend
Period shall be equal to 60% of the Reference Rate (or 90% of such rate
if the Fund has provided notification to the Auction Agent prior to
establishing the Applicable Rate for any dividend that net capital gain
or other taxable income will be included in such dividend on shares of
AMPS) on the date of the Auction.
Paragraph 10(e) Acceptance and Rejection of Submitted Bids and Submitted
Sell Orders and Allocation of Shares.
Based on the determinations made pursuant to Paragraph 10(d)(i), the
Submitted Bids and Submitted Sell Orders shall be accepted or rejected and the
Auction Agent shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the
provisions of Paragraph 10(e)(iii) and Paragraph 10(e)(iv), Submitted Bids and
Submitted Sell Orders shall be accepted or rejected in the following order of
priority and all other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be
accepted and the Submitted Bid of each of the Existing Holders
specifying any rate per annum that is higher than the Winning Bid Rate
shall be accepted, thus requiring each such Existing Holder to sell the
outstanding shares of AMPS that are the subject of such Submitted Sell
Order or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holders specifying
any rate per annum that is lower than the Winning Bid Rate shall be
rejected, thus entitling each such Existing Holder to continue to hold
the outstanding shares of AMPS that are the subject of such Submitted
Bid;
(C) the Submitted Bid of each of the Potential Holders specifying
any rate per annum that is lower than the Winning Bid Rate shall be
accepted;
(D) the Submitted Bid of each of the Existing Holders specifying a
rate per annum that is equal to the Winning Bid Rate shall be rejected,
thus entitling each such Existing Holder to continue to hold the
outstanding shares of AMPS that are the subject of such Submitted Bid,
unless the number of outstanding shares of AMPS subject to all such
Submitted Bids shall be greater than the number of outstanding shares of
AMPS ("Remaining Shares") equal to the excess of the Available AMPS over
the number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(i)(B) and Paragraph 10(e)(i)(C), in which
event the Submitted Bids of each such Existing Holder shall be accepted,
and each such Existing Holder shall be required to sell outstanding
shares of AMPS, but only in an amount equal to the difference between
(1) the number of outstanding shares of AMPS then held by such Existing
Holder subject to such Submitted Bid and (2) the number of shares of
AMPS obtained by multiplying (x) the number of Remaining Shares by (y) a
fraction the numerator of which shall be the number of outstanding
shares of AMPS held by such Existing Holder subject to such Submitted
Bid and the
C-6
denominator of which shall be the sum of the numbers of outstanding
shares of AMPS subject to such Submitted Bids made by all such Existing
Holders that specified a rate per annum equal to the Winning Bid Rate;
and
(E) the Submitted Bid of each of the Potential Holders specifying
a rate per annum that is equal to the Winning Bid Rate shall be accepted
but only in an amount equal to the number of outstanding shares of AMPS
obtained by multiplying (x) the difference between the Available AMPS
and the number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(i)(B), Paragraph 10(e)(i)(C) and Paragraph
10(e)(i)(D) by (y) a fraction the numerator of which shall be the number
of outstanding shares of AMPS subject to such Submitted Bid and the
denominator of which shall be the sum of the number of outstanding
shares of AMPS subject to such Submitted Bids made by all such Potential
Holders that specified rates per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than because
all of the outstanding shares of AMPS are subject to Submitted Hold Orders),
subject to the provisions of Paragraph 10(e)(iii), Submitted Orders shall be
accepted or rejected as follows in the following order of priority and all
other Submitted Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate
per annum that is equal to or lower than the Maximum Applicable Rate
shall be rejected, thus entitling such Existing Holder to continue to
hold the outstanding shares of AMPS that are the subject of such
Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying any rate
per annum that is equal to or lower than the Maximum Applicable Rate
shall be accepted, thus requiring such Potential Holder to purchase the
outstanding shares of AMPS that are the subject of such Submitted Bid;
and
(C) the Submitted Bids of each Existing Holder specifying any rate
per annum that is higher than the Maximum Applicable Rate shall be
accepted and the Submitted Sell Orders of each Existing Holder shall be
accepted, in both cases only in an amount equal to the difference
between (1) the number of outstanding shares of AMPS then held by such
Existing Holder subject to such Submitted Bid or Submitted Sell Order
and (2) the number of shares of AMPS obtained by multiplying (x) the
difference between the Available AMPS and the aggregate number of
outstanding shares of AMPS subject to Submitted Bids described in
Paragraph 10(e)(ii)(A) and Paragraph 10(e)(ii)(B) by (y) a fraction the
numerator of which shall be the number of outstanding shares of AMPS
held by such Existing Holder subject to such Submitted Bid or Submitted
Sell Order and the denominator of which shall be the number of
outstanding shares of AMPS subject to all such Submitted Bids and
Submitted Sell Orders.
(iii) If, as a result of the procedures described in Paragraph 10(e)(i)
or Paragraph 10(e)(ii), any Existing Holder would be entitled or required to
sell, or any Potential Holder would be entitled or required to purchase, a
fraction of a share of AMPS on any Auction Date, the Auction Agent shall, in
such manner as in its sole discretion it shall determine, round up or down the
number of shares of AMPS to be purchased or sold by any Existing Holder or
Potential Holder on such Auction Date so that each outstanding share of AMPS
purchased or sold by each Existing Holder or Potential Holder on such Auction
Date shall be a whole share of AMPS.
(iv) If, as a result of the procedures described in Paragraph 10(e)(i),
any Potential Holder would be entitled or required to purchase less than a
whole share of AMPS on any Auction Date, the Auction Agent, in such manner as
in its sole discretion it shall determine, shall allocate shares of AMPS for
purchase among Potential Holders so that only whole shares of AMPS are
purchased on such Auction Date by any Potential Holder, even if such
allocation results in one or more of such Potential Holders not purchasing any
shares of AMPS on such Auction Date.
(v) Based on the results of each Auction, the Auction Agent shall
determine, with respect to each Broker-Dealer that submitted Bids or Sell
Orders on behalf of Existing Holders or Potential Holders, the aggregate
number of the outstanding shares of AMPS to be purchased and the aggregate
number of outstanding shares of AMPS to be sold by such Potential Holders and
Existing Holders and, to the extent that such aggregate number of outstanding
shares to be purchased and such aggregate number of outstanding shares to be
sold differ, the Auction
C-7
Agent shall determine to which other Broker-Dealer or Broker-Dealers acting
for one or more purchasers such Broker-Dealer shall deliver, or from which
other Broker-Dealer or Broker-Dealers acting for one or more sellers such
Broker-Dealer shall receive, as the case may be, outstanding shares of AMPS.
Paragraph 10(f) Miscellaneous.
The Fund may interpret the provisions of this Paragraph 10 to resolve
any inconsistency or ambiguity, remedy any formal defect or make any other
change or modification that does not substantially adversely affect the rights
of Beneficial Owners of AMPS. A Beneficial Owner or an Existing Holder (A) may
sell, transfer or otherwise dispose of shares of AMPS only pursuant to a Bid
or Sell Order in accordance with the procedures described in this Paragraph 10
or to or through a Broker-Dealer, provided that in the case of all transfers
other than pursuant to Auctions such Beneficial Owner or Existing Holder, its
Broker-Dealer, if applicable, or its Agent Member advises the Auction Agent of
such transfer and (B) except as otherwise required by law, shall have the
ownership of the shares of AMPS held by it maintained in book entry form by
the Securities Depository in the account of its Agent Member, which in turn
will maintain records of such Beneficial Owner's beneficial ownership. Neither
the Fund nor any affiliate (other than Merrill Lynch, Pierce, Fenner & Smith
Incorporated) shall submit an Order in any Auction. Any Beneficial Owner that
is an affiliate (other than Merrill Lynch, Pierce, Fenner & Smith
Incorporated) shall not sell, transfer or otherwise dispose of shares of AMPS
to any person other than the Fund. All of the outstanding shares of AMPS of a
series shall be represented by a single certificate registered in the name of
the nominee of the Securities Depository unless otherwise required by law or
unless there is no Securities Depository. If there is no Securities
Depository, at the Fund's option and upon its receipt of such documents as it
deems appropriate, any shares of AMPS may be registered in the Stock Register
in the name of the Beneficial Owner thereof and such Beneficial Owner
thereupon will be entitled to receive certificates therefor and required to
deliver certificates thereof or upon transfer or exchange thereof.
C-8
PART C. OTHER INFORMATION
Item 25. Financial Statements And Exhibits.
(1) Financial Statements
Part Financial Highlights for each of the fiscal years in the ten-
A: year period ended October 31, 2004 and the six months ended
April 30, 2005.
Part Schedule of Investments of the Fund as of October 31, 2004.*
B:
Statement of Net Assets of the Fund as of October 31, 2004.*
Statement of Operations of the Fund for the fiscal year ended
October 31, 2004.*
Statements of Changes in Net Assets of the Fund for the fiscal
years ended October 31, 2003 and October 31, 2004.*
Financial Highlights for each of the fiscal years in the
five-year period ended October 31, 2004.*
Report of Independent Registered Public Accounting Firm.*
Statement of Investments of the Fund as of April 30, 2005**
Statement of Net Assets of the Fund as of April 30, 2005**
Statement of Operations of the Fund for the six months ended
April 30, 2005**
Statement of Changes in Net Assets of the Fund for the six
months ended April 30, 2005**
Financial Highlights of the Fund for the six months ended April
30, 2005 and each of the fiscal years in the five-year period
ended October 31, 2005**
----------
* Incorporated by reference to the Registrant's Annual Report to Shareholders
for the fiscal year ended October 31, 2004 filed with the Securities and
Exchange Commission ("Commission") on December 28, 2004 pursuant to Rule
30b2-1 under the Investment Company Act of 1940, as amended ("1940 Act").
** Incorporated by reference to the Registrant's Semi-Annual Report to
Stockholders for the six month period ended April 30, 2005 filed with the
Commission on [ ], 2005 pursuant to Rule 30b2-1 under the 1940 Act.
Exhibits Description
-------- -----------
(a)(1) Articles of Incorporation of the Registrant. (a)(2) Form of
Articles Supplementary creating Series A, Series B and
Series C Auction Market Preferred Stock ("the Other AMPS").
(a)(3) Form of Articles Supplementary creating additional shares of Other
AMPS.
(a)(4) Form of Articles of Amendment to Articles Supplementary
creating the Other AMPS.
(a)(5) Form of Articles of Amendment to Articles Supplementary
creating the Other AMPS.
(a)(6) Form of Articles Supplementary creating Series D Auction
Market Preferred Stock (the "AMPS").
(b) By-laws of the Registrant.
(c) Not applicable.
C-1
(d)(1) Portions of the Articles of Incorporation, By-laws and
Articles Supplementary of the Registrant defining the rights
of holders of shares of the Registrant. (a)
(d)(2) Form of specimen certificate for the AMPS of the Registrant.
(e) Form of Automatic Dividend Reinvestment Plan.
(f) Not applicable.
(g)(1) Investment Advisory Agreement between the Registrant and Fund
Asset Management, L.P. ("FAM" or the "Investment Adviser").
(h)(1) Form of Purchase Agreement between the Registrant and Merrill
Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch")
relating to the AMPS.
(h)(2) Form of Merrill Lynch Standard Dealer Agreement.(b)
(i) Not applicable.
(j) Form of Custodian Agreement between the Registrant and The Bank
of New York ("BONY"). (c) (k)(l) Form of Registrar, Transfer
Agency, Dividend Disbursing Agency and Shareholder Servicing
Agency Agreement between the Registrant and BONY (d)
(k)(2) Form of Agreement of Resignation, Appointment and Acceptance
among the Registrant, IBJ Whitehall Bank & Trust Company and
BONY. (d)
(k)(3) Form of Administrative Services Agreement between the
Registrant and State Street Bank & Trust Company. (e)
(k)(4) Form of Auction Agent Agreement between the Registrant and The
Bank of New York.
(k)(5) Form of Broker-Dealer Agreement.
(k)(6) Form of Letter of Representations.
(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) Not applicable.
(q) Not applicable.
(r) Code of Ethics.(f)
-----------
(a) Reference is made to Article IV (sections 2, 3, 4, 5, 6, 7 and 8),
Article V (sections 3, 6 and 7), Article VI, Article VIII, Article
IX, Article X, and Article XII of the Registrant's Articles of
Incorporation, filed as Exhibit (a) (1) to this Registration
Statement; to Article II, Article III (sections 3.01, 3.03, 3.05
and 3.17), Article VI (section 6.2), Article VII, Article XII,
Article XIII and Article XIV of the Registrant's By- laws, filed
as Exhibit (b) to this Registration Statement; and to the Forms of
Articles Supplementary and the Forms of Articles of Amendment
filed as Exhibits (a)(2), (a)(3), (a)(4), (a)(5) and (a)(6) to
this Registration Statement.
(b) Incorporated by reference to Exhibit (h)(2) to Pre-Effective
Amendment No. 3 to the Registration Statement on Form N-2 of
Preferred Income Strategies Fund, Inc. (File No. 333-102712),
filed on March 25, 2003.
(c) Incorporated by reference to Exhibit 7 to Post-Effective Amendment
No. 13 to the Registration Statement on Form N-1A of The Asset
Program, Inc. (File No. 33-53887), filed on March 21, 2002.
(d) Incorporated by reference to an exhibit to the Registration
Statement on Form N-14 of MuniYield Fund, Inc. (File No.
333-65242), filed on September 14, 2001.
(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 Pre-Effective
Amendment No. 1 to the Registration Statement on Form N-1A of
Merrill Lynch Inflation Protected Fund (File No. 333-110936),
filed on January 22, 2004.
* To be provided by amendment.
C-2
Item 26. Marketing Arrangements.
See Exhibits (h)(1) and (2).
Item 27. 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 $1,177
Printing (other than stock certificates) $17,000
Accounting Fees and Expenses $13,390
Legal fees and expenses $85,080
Rating Agency Fees $25,000
Miscellaneous $3,433
Total $145,000
===========
----------------
* To be provided by amendment.
Item 28. Persons Controlled by or Under Common Control with Registrant.
The Registrant is not controlled by, or under common control with, any
person.
Item 29. Number of Holders of Securities.
Number of
Record Holders
At
Title of Class , 2005
--------------------------------------------------------- ------------------
Common Stock, $.10 par value
Preferred Stock
Item 30. 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 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 legal counsel or the
vote of a majority of a quorum of 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.
C-3
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 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 7 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 and Statement of Additional Information.
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 31. Business And Other Connections Of The Investment Adviser.
FAM (the "Investment Adviser"), acts as the investment adviser for a
number of affiliated open-end and closed-end registered investment companies.
Merrill Lynch Investment Managers, L.P. ("MLIM"), acts as the investment
adviser for a number of affiliated open-end and closed-end registered
investment companies, and also acts as sub-adviser 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.
C-4
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; Co-Head (Americas Region) of
MLIM from 2000 to 2004; Senior Vice President of
MLIM from 1999 to 2000; Director 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 and First Vice President and Treasurer of MLIM; Senior
Treasurer Vice President, Treasurer and Director of Princeton
Services; Vice President of FAMD
Andrew J. Donohue General Counsel First Vice President and General Counsel of MLIM;
Senior Vice President and Director of Princeton
Services; President and Director of FAMD
Alice A. Pellegrino Secretary Secretary of MLIM, Princeton Services and FAMD
Item 32. 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), its custodian, The Bank of New York (100 Church
Street, New York, New York 10286), and its transfer agent, The Bank of New
York (101 Barclay Street, New York, New York 10286).
Item 33. Management Services.
Not applicable.
C-5
Item 34. Undertakings.
(1) The Registrant undertakes to suspend the offering of the shares of
preferred 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 preferred stock declines more than 10% from its
net asset value per share of preferred stock as of the effective date of this
Registration Statement, or (2) its net asset value per share of preferred
stock increases to an amount greater than its net proceeds as stated in the
prospectus contained herein.
(2) Not applicable.
(3) Not applicable.
(4) Not applicable
(5) The Registrant undertakes that:
(a) 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.
(b) 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.
(6) The Registrant undertakes to send by first-class mail or other means
designed to ensure equally prompt delivery, within two business days of
receipt of a written or oral request, any statement of additional information.
C-6
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 21st day of July, 2005.
MUNIYIELD QUALITY FUND II, INC.
(Registrant)
By: /s/ DONALD C. BURKE
--------------------
Donald C. Burke
Vice President and Treasurer
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
--------------------------------------- --------------------------------------------------- -------------------------
ROBERT C. DOLL, JR.* President (Principal Executive Officer) and
--------------------- Director
(Robert C. Doll, Jr.)
DONALD C. BURKE* Vice President and Treasurer (Principal
----------------- Financial and Accounting Officer)
(Donald C. Burke)
JAMES H. BODURTHA* Director
-------------------
(James H. Bodurtha)
_____________________ Director
(Kenneth A. Froot)
JOE GRILLS* Director
(Joe Grills)
HERBERT I. LONDON* Director
-------------------
(Herbert I. London)
ROBERTA COOPER RAMO* Director
---------------------
(Roberta Cooper Ramo)
STEPHEN B. SWENSRUD* Director
---------------------
(Stephen B. Swensrud)
ROBERT S. SALOMON, JR.* Director
------------------------
(Robert S. Salomon, Jr.)
*By /s/ DONALD C. BURKE
--------------------
July 21, 2005
(Donald C. Burke, Attorney-in-Fact)
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POWER OF ATTORNEY
The undersigned, Robert C. Doll, Jr., Donald C. Burke, James H. Bodurtha,
Joe Grills, Herbert I. London, Roberta Cooper Ramo, Robert S. Salomon, Jr. and
Stephen B. Swensrud, the Directors/Trustees and/or the Officers of each of the
registered investment companies listed below, hereby authorize Robert C. Doll,
Jr., Andrew J. Donohue, Donald C. Burke, Michael G. Clark and Alice A.
Pellegrino or any of them, as attorney-in-fact, to sign on his or her behalf
in the capacities indicated any Registration Statement or amendment thereto
(including post-effective amendments) for or on behalf of each of the
following registered investment companies and to file the same, with all
exhibits thereto, with the Securities and Exchange Commission: Apex Municipal
Fund, Inc.; Corporate High Yield Fund, Inc.; Corporate High Yield Fund III,
Inc.; Corporate High Yield Fund V, Inc.; Corporate High Yield Fund VI, Inc.;
Fund Asset Management Master Trust; Master Focus Twenty Trust; Master Large
Cap Series Trust; Mercury Funds II; Merrill Lynch California Municipal Series
Trust; Merrill Lynch Focus Value Fund, Inc.; Merrill Lynch Fundamental Growth
Fund, Inc.; Merrill Lynch Investment Managers Funds, Inc.; Merrill Lynch Large
Cap Series Funds, Inc.; Merrill Lynch Multi-State Municipal Series Trust;
Merrill Lynch Retirement Reserves Money Fund of Merrill Lynch Retirement
Series Trust; Merrill Lynch Short Term U.S. Government Fund, Inc.; Merrill
Lynch U.S. Government Mortgage Fund; Merrill Lynch Variable Series Funds,
Inc.; Merrill Lynch World Income Fund, Inc.; MuniAssets Fund, Inc.;
MuniHoldings California Insured Fund, Inc.; MuniHoldings Insured Fund II,
Inc.; MuniInsured Fund, Inc.; MuniYield Arizona Fund, Inc.; MuniYield
California Fund, Inc.; MuniYield California Insured Fund, Inc.; MuniYield
Florida Fund; MuniYield Fund, Inc.; MuniYield Insured Fund, Inc.; MuniYield
Michigan Insured Fund II, Inc.; MuniYield New Jersey Fund, Inc.; MuniYield New
York Insured Fund, Inc.; MuniYield Quality Fund, Inc.; MuniYield Quality Fund
II, Inc.; Summit Cash Reserves Fund of Financial Institutions Series Trust;
and The Asset Program, Inc.
Dated: February 23, 2005
/s/ Robert C. Doll, Jr. /s/ Donald C. Burke
--------------------------------------------- -------------------------------------------
Robert C. Doll, Jr. Donald C. Burke
(President/Principal Executive (Vice President/Treasurer/Principal
Officer/Director/Trustee) Financial and Account Officer)
/s/ James H. Bodurtha /s/ Joe Grills
--------------------------------------------- -------------------------------------------
James H. Bodurtha Joe Grills
(Director/Trustee) (Director/Trustee)
/s/ Herbert I. London /s/ Robert Cooper Ramo
--------------------------------------------- -------------------------------------------
Herbert I. London Robert Cooper Ramo
(Director/Trustee) (Director/Trustee)
/s/ Robert S. Salomon, Jr. /s/ Stephen B. Swensrud
--------------------------------------------- -------------------------------------------
Robert S. Salomon, Jr. Stephen B. Swensrud
(Director/Trustee) (Director/Trustee)
C-8
EXHIBIT INDEX
Exhibits Description
-------- -----------
(a)(1) Articles of Incorporation of the Registrant.
(a)(2) Form of Articles Supplementary creating Series A, Series B and
Series C Auction Market Preferred Stock ("the Other AMPS").
(a)(3) Form of Articles Supplementary creating additional shares of Other
AMPS.
(a)(4) Form of Articles of Amendment to Articles Supplementary creating
the Other AMPS.
(a)(5) Form of Articles of Amendment to Articles Supplementary creating
the Other AMPS.
(a)(6) Form of Articles Supplementary creating Series D Auction Market
Preferred Stock (the "AMPS").
(b) By-laws of the Registrant.
(d)(2) Form of specimen certificate for the AMPS 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. ("FAM" or the "Investment Adviser").
(h)(1) Form of Purchase Agreement between the Registrant and Merrill
Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch")
relating to the AMPS.
(k)(4) Form of Auction Agent Agreement between the Registrant and The
Bank of New York.
(k)(5) Form of Broker-Dealer Agreement.
(k)(6) Form of Letter of Representations.
C-9