PROSPECTUS
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$285,000,000
Muni Intermediate Duration Fund, Inc.
Auction Market Preferred Stock ("AMPS")
2,000 Shares, Series M7
2,700 Shares, Series T7
2,000 Shares, Series W7
2,700 Shares, Series TH7
2,000 Shares,Series F7
Liquidation Preference $25,000 Per Share
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Muni Intermediate Duration Fund, Inc. is a recently organized,
non-diversified, closed-end fund. The investment objective of the Fund is to
provide common stockholders with high current income exempt from Federal income
taxes. The Fund seeks to achieve its objective by investing, as a fundamental
policy, at least 80% of its net assets (including assets acquired from the sale
of preferred stock), plus the amount of any borrowings for investment purposes,
in a portfolio of municipal obligations the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal income taxes. Under normal
market conditions, the Fund expects to invest at least 75% of its total assets
in municipal obligations that are rated investment grade or, if unrated, are
considered by the Fund's investment adviser to be of comparable quality. The
Fund may invest up to 25% of its total assets in municipal obligations that are
rated below investment grade (commonly known as "junk bonds") or, if unrated,
are considered by the Fund's investment adviser to possess similar credit
characteristics. Under normal market conditions and after the initial investment
period following this offering (expected to be approximately three months), the
Fund will invest, as a non-fundamental policy, at least 80% of its net assets
(including assets acquired from the sale of preferred stock), plus the amount of
any borrowings for investment purposes, in municipal obligations with a
duration, as calculated by the Fund's investment adviser, of three to ten years.
The Fund expects to maintain, under normal market conditions, a dollar-weighted
average portfolio duration, as calculated by the Fund's investment adviser, of
three to ten years. There can be no assurance that the Fund's investment
objective will be realized.
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 contains
further information about the Fund and is incorporated by reference (legally
considered to be part of this prospectus). You may request a free copy by
writing or calling the Fund at (800) 543-6217.
Investing in the AMPS involves certain risks that are described in the
"Risk Factors and Special Considerations" section beginning on page 7 of this
prospectus. The minimum purchase amount for the AMPS is $25,000.
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Per Share Total
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Public offering price....................... $25,000 $285,000,000
Underwriting discount....................... $250 $2,850,000
Proceeds, before expenses, to the Fund(1)... $24,750 $282,150,000
(1) The estimated offering expenses payable by the Fund are $340,000.
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 each series of AMPS will be ready for delivery to the
nominee of The Depository Trust Company on or about August 20, 2003.
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Merrill Lynch & Co.
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The date of this prospectus is August 15, 2003.
TABLE OF CONTENTS
Page
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Prospectus Summary......................................................... 3
Risk Factors and Special Considerations.................................... 7
Financial Highlights....................................................... 10
The Fund................................................................... 10
Use of Proceeds............................................................ 11
Capitalization............................................................. 11
Portfolio Composition...................................................... 11
Investment Objective and Policies.......................................... 12
Other Investment Policies.................................................. 20
Description of AMPS........................................................ 24
The Auction................................................................ 29
Rating Agency Guidelines................................................... 36
Investment Advisory and Management Arrangements............................ 37
Taxes...................................................................... 38
Description of Capital Stock............................................... 39
Custodian.................................................................. 41
Underwriting............................................................... 42
Transfer Agent, Dividend Disbursing Agent and Registrar.................... 42
Accounting Services Provider............................................... 43
Legal Opinions............................................................. 43
Independent Auditors and Experts........................................... 43
Table of Contents of Statement of Additional Information................... 44
Glossary................................................................... 45
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Information about the Fund can be reviewed and copied at the SEC's Public
Reference Room in Washington, D.C. Call 1-202-942-8090 for information on the
operation of the public reference room. This information is also available on
the SEC's Internet site at http://www.sec.gov and copies may be obtained upon
payment of a duplicating fee by writing to the Public Reference Section of the
SEC, Washington, D.C. 20549-0102.
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You should rely only on the information contained in this prospectus. We
have not, and the underwriters have not, authorized any other person to provide
you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriters are not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted. You should assume that
the information appearing in this prospectus is accurate only as of the date on
the front cover of this prospectus. Our business, financial condition, results
of operations and prospects may have changed since that date.
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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 Muni Intermediate Duration Fund, Inc. is a recently
organized, non-diversified, closed-end management
investment company.
The Offering The Fund is offering a total of 2,000 shares of Auction
Market Preferred Stock, Series M7, 2,700 shares of
Auction Market Preferred Stock, Series T7, 2,000 shares
of Auction Market Preferred Stock, Series W7, 2,700
shares of Auction Market Preferred Stock, Series TH7,
and 2,000 shares of Auction Market Preferred Stock,
Series F7, each 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 AMPS of each series 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 for each series. In general,
except as described below, each dividend period for each
series of AMPS 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 AMPS of
each series 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 The investment objective of the Fund is to provide
and Policies common stockholders with high current income exempt from
Federal income taxes. The Fund seeks to achieve its
objective by investing, as a fundamental policy, at
least 80% of its net assets (including assets acquired
from the sale of preferred stock), plus the amount of
any borrowings for investment purposes, in a portfolio
of municipal obligations issued by or on behalf of
states, territories and possessions of the United States
and their political subdivisions, agencies or
instrumentalities, each of which pays interest that, in
the opinion of bond counsel to the issuer, is exempt
from Federal income tax ("Municipal Bonds"). There can
be no assurance that the Fund's investment objective
will be realized.
Under normal market conditions, and after the initial
investment period following this offering (expected to
be approximately three months), the Fund will invest, as
a non-fundamental policy, at least 80% of its net assets
(including assets acquired from the sale of preferred
stock), plus the amount of any borrowings for investment
purposes, in Municipal Bonds with a duration, as
calculated by Fund Asset Management, L.P. (the
"Investment Adviser"), of three to ten years. The Fund
expects to maintain, under normal market conditions, a
dollar-weighted average portfolio duration, as
calculated by the Investment Adviser, of three to ten
years. There is no limit on the remaining maturity of
each individual Municipal Bond investment by the Fund.
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.
Investment Grade Municipal Bonds. Under normal market
conditions, the Fund expects to invest at least 75% of
its total assets in Municipal Bonds that are rated
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investment grade by one or more nationally recognized
statistical rating agencies or in unrated bonds
considered by the Investment Adviser to be of comparable
quality.
Junk Bonds. The Fund may invest up to 25% of its total
assets in junk bonds. Junk bonds are debt securities
that are rated below investment grade by the major
rating agencies or are unrated securities that are
considered by the Investment Adviser to possess similar
credit characteristics. Although junk bonds generally
pay higher rates of interest than investment grade
bonds, they are high risk investments that may cause
income and principal losses for the Fund. Junk bonds
generally are less liquid and experience more price
volatility than higher rated debt securities. The
issuers of junk bonds may have a larger amount of
outstanding debt relative to their assets than issuers
of investment grade bonds. In the event of an issuer's
bankruptcy, claims of other creditors may have priority
over the claims of junk bond holders, leaving few or no
assets available to repay junk bond holders. Junk bonds
may be subject to greater call and redemption risk than
higher rated debt securities.
Indexed and Inverse Floating Rate Securities. The Fund
may invest in securities whose potential returns are
directly related to changes in an underlying index or
interest rate, known as indexed securities. The return
on indexed securities will rise when the underlying
index or interest rate rises and fall when the index or
interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes
in an interest rate (inverse floaters). In general,
income on inverse floaters will decrease when short term
interest rates increase and increase when short term
interest rates decrease. Investments in inverse floaters
may subject the Fund to the risks of reduced or
eliminated interest payments and loss of principal. In
addition, certain indexed securities and inverse
floaters may increase or decrease in value at a greater
rate than the underlying interest rate, which
effectively leverages the Fund's investment. As a
result, the market value of such securities will
generally be more volatile than that of fixed rate, tax
exempt securities. Both indexed securities and inverse
floaters are derivative securities and can be considered
speculative.
Hedging Transactions. The Fund may seek to hedge its
portfolio against changes in interest rates using
options and financial futures contracts or swap
transactions. The Fund's hedging transactions are
designed to reduce volatility, but come at some cost.
For example, the Fund may try to limit its risk of loss
from a decline in price of a portfolio security by
purchasing a put option. However, the Fund must pay for
the option, and the price of the security may not in
fact drop. In large part, the success of the Fund's
hedging activities depends on its ability to forecast
movements in securities prices and interest rates. The
Fund is not required to hedge its portfolio and may
choose not to do so. The Fund cannot guarantee that any
hedging strategies it uses will work.
Swap Agreements. The Fund is authorized to enter into
swap agreements, which are over-the-counter contracts in
which one party agrees to make periodic payments based
on the change in the market value of a specific bond,
basket of bonds or index in return for periodic payments
based on a fixed or variable interest rate or the change
in market value of a different bond, basket of bonds or
index. Swap agreements may be used to obtain exposure to
a bond or market without owning or taking physical
custody of securities.
Tax Considerations. While exempt-interest dividends are
excluded from gross income for Federal income tax
purposes, they may be subject to the Federal alternative
minimum tax in certain circumstances. Distributions of
any capital gain or other taxable income will be taxable
to stockholders. The Fund may not be a suitable
investment for investors subject to the Federal
alternative minimum tax or who would become subject to
such tax by investing in the Fund. See "Taxes."
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Investment Adviser The Investment Adviser provides investment advisory and
administrative services to the Fund. For its services,
the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.55% of the Fund's average daily net
assets (including any proceeds from the issuance of
preferred stock), plus the proceeds of any outstanding
borrowings used for leverage. The Investment Adviser has
contractually agreed to waive a portion of its fee
during the first seven years of the Fund's operations
ending July 31, 2010, as follows:
Fee Waiver (as a
percentage of average
daily net assets)
-------------------
Years 1 through 5................. 0.15%
Year 6 ........................... 0.10%
Year 7 ........................... 0.05%
Year 8 and thereafter ............ 0.00%
Dividends and Dividends on each series of AMPS will be cumulative from
Dividend Periods 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 Period Payment
AMPS Series Rate Ending Date
------------------ ----------- ----------------- -----------------
Series M7......... 0.85% September 8, 2003 September 9, 2003
Series T7......... 0.85% September 2, 2003 September 3, 2003
Series W7......... 0.85% September 3, 2003 September 4, 2003
Series TH7........ 0.85% September 4, 2003 September 5, 2003
Series F7......... 0.85% September 7, 2003 September 8, 2003
After the initial dividend period, each dividend period
for each series of 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 in the case of the Series M7 AMPS, Wednesday in
the case of the Series T7 AMPS, Thursday in the case of
the Series W7 AMPS, Friday in the case of the Series TH7
AMPS and Monday in the case of the Series F7 AMPS.
Dividends for each series of AMPS will be paid through
the securities depository (The Depository Trust Company)
on each dividend payment date for each series of 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 each series of
AMPS.
Determination of Generally, the applicable dividend rate for any dividend
Maximum Dividend period for each series of AMPS will not be more than the
Rates maximum applicable rate attributable to such shares. The
maximum applicable rate for each series of 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 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
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auction for the AMPS. The maximum applicable rate for
each series of 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
Percentage Percentage Spread Over Spread Over
Credit Ratings 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%
There is no minimum applicable dividend rate for any
dividend period.
Asset Maintenance Under the Fund's Articles Supplementary creating the
series of AMPS (the "Articles Supplementary"), the Fund
must maintain:
o asset coverage of the AMPS as required by the rating
agencies rating the AMPS, and
o asset coverage of the AMPS of at least 200% as
required by the Investment Company Act of 1940
(the "1940 Act").
The Fund estimates that, based on the composition of its
portfolio at August 6, 2003, asset coverage of the AMPS
as required by the 1940 Act would be approximately 266%
immediately after the Fund issues the shares of AMPS
offered by this prospectus representing approximately
38% of the Fund's capital, or approximately 60% of the
Fund's common stock equity, immediately after the
issuance of such AMPS.
Mandatory If the required asset coverage is not maintained or,
Redemption when necessary, restored, the Fund must redeem shares of
AMPS at the price of $25,000 per share plus accumulated
but unpaid dividends thereon (whether or not earned or
declared). The provisions of the1940 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 of each series 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 Preference The liquidation preference (that is, the amount the Fund
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 Investors Service, Inc. ("Moody's") and AAA from
Standard & Poor's ("S&P").
Voting Rights The 1940 Act requires that the holders of AMPS and any
other preferred stock, 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
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 to vote as a separate class on certain
other matters.
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RISK FACTORS AND SPECIAL CONSIDERATIONS
An investment in the Fund's AMPS should not constitute a complete
investment program.
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.
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.
Secondary Market. The broker-dealers intend to maintain a secondary
trading market in the AMPS outside of auctions; however, they have no obligation
to do so 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 nationally recognized statistical ratings organizations that may
issue ratings for its preferred stock. These guidelines may impose asset
coverage or portfolio composition requirements that are more stringent than
those imposed by the 1940 Act and may prohibit or limit the use by the Fund of
certain portfolio management techniques or investments. The Fund does not expect
these guidelines to prevent the Investment Adviser from managing the Fund's
portfolio in accordance with the Fund's investment objective and policies. 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.
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.
Non-diversification. The Fund is registered as a "non-diversified"
investment company. This means that the Fund may invest a greater percentage of
its assets in a single issuer than a diversified investment company. Since the
Fund may invest a relatively high percentage of its assets in a limited number
of issuers, the Fund may be more exposed to any single economic, political or
regulatory occurrence than a more widely-diversified fund. Even as a
non-diversified fund, the Fund must still meet the diversification requirements
applicable to regulated investment companies under the Federal income tax laws.
Market Risk and Selection Risk. Market risk is the risk that the bond
market will go down in value, including the possibility that the market will go
down sharply and unpredictably. Selection risk is the risk that the securities
that Fund management selects will underperform the bond market, the market
relevant indices, or other funds with similar investment objectives and
investment strategies.
Tax Exempt Securities Market Risk. The amount of public information
available about Municipal Bonds in the Fund's portfolio is generally less than
that for corporate equities or bonds, and the investment performance of the Fund
may therefore be more dependent on the analytical abilities of the Investment
Adviser than that of a stock fund or taxable bond fund.
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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. Credit
risk is the risk that the issuer will be unable to pay the interest or principal
when due. The degree of credit risk depends on both the financial condition of
the issuer and the terms of the obligation.
Call and Redemption Risk. A Municipal Bond's issuer may call the bond for
redemption before it matures. If this happens to a Municipal Bond that the Fund
holds, the Fund may lose income and may have to invest the proceeds in Municipal
Bonds with lower yields.
Risks Associated with Non-Investment Grade Securities. Under normal market
conditions, the Fund expects to invest at least 75% of its total assets in
Municipal Bonds that are rated investment grade by Standard & Poor's, Moody's
Investors Service, Inc. or Fitch Ratings, or in unrated Municipal Bonds that are
considered by the Investment Adviser to possess similar credit characteristics.
Obligations rated in the lowest investment grade category may have certain
speculative characteristics. The Fund may invest up to 25% of its total assets
in Municipal Bonds that are rated below investment grade or are unrated
securities that are considered by the Investment Adviser to possess similar
credit characteristics. Securities rated below investment grade, also known as
junk bonds, generally entail greater credit risks than investment grade
securities. For example, their prices are more volatile, economic downturns and
financial setbacks may affect their prices more negatively, and their trading
market may be more limited.
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.
Sector Risk. The Fund may invest 25% or more of its total assets in tax
exempt securities of issuers in the industries comprising the same economic
sector, such as hospitals or life care facilities and transportation-related
issuers. However, the Fund will not invest 25% or more of its total assets in
any one of the industries comprising an economic sector. In addition, a
substantial part of the Fund's portfolio may be comprised of securities credit
enhanced by banks, insurance companies or companies with similar
characteristics. Emphasis on these sectors may subject the Fund to certain
risks.
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 enhance the return of the Fund and to seek to hedge its
portfolio against adverse effects from movements in interest rates and in the
securities markets. These portfolio strategies include the use of derivatives,
such as indexed securities, inverse securities, options, futures, options on
futures, interest rate transactions, credit default swaps, and the use of short
sales. Such strategies subject the Fund to the risk that, if the Investment
Adviser incorrectly forecasts market values, interest rates or other applicable
factors, the Fund's performance could suffer. Certain of these strategies such
as inverse securities, credit default swaps and short sales may provide
investment leverage to the Fund's portfolio. The Fund is not required to use
derivatives or other portfolio strategies to seek to enhance return or to seek
to hedge its portfolio and may not do so. There can be no assurance that the
Fund's portfolio strategies will be effective. Some of the derivative strategies
that the Fund may use to seek to enhance its return are riskier than its hedging
transactions and have speculative characteristics. Such strategies do not
attempt to limit the Fund's risk of loss.
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Derivatives Risk. Derivatives are financial contracts or instruments whose
value depends on, or is derived from, the value of an underlying asset,
reference rate or index (or relationship between two indices). The Fund may
invest in a variety of derivative instruments for hedging purposes or to seek to
enhance its return, such as options, futures contracts and swap agreements, and
may engage in short sales. The Fund may use derivatives as a substitute for
taking a position in an underlying security or other asset and/or as part of a
strategy designed to reduce exposure to other risks, such as interest rate risk.
The Fund also may use derivatives to add leverage to the portfolio 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's use of
derivative instruments involves risks different from, and possibly greater than,
the risks associated with investing directly in securities and other traditional
investments. Derivatives are subject to a number of risks such as liquidity
risk, interest rate risk, credit risk, leverage risk, the risk of ambiguous
documentation and management risk. They also involve the risk of mispricing or
improper valuation and the risk that changes in the value of the derivative may
not correlate perfectly with the underlying asset, rate or index. If the Fund
invests in a derivative instrument it could lose more than the principal amount
invested. The use of derivatives also may increase the amount of taxes payable
by stockholders. Also, suitable derivative transactions may not be available in
all circumstances and there can be no assurance that the Fund will engage in
these transactions to reduce exposure to other risks when that would be
beneficial.
Antitakeover Provisions. The Fund's Charter, By-laws and the General
Corporation Law of the State of Maryland include provisions that could limit the
ability of other entities or persons to acquire control of the Fund or to change
the composition of its Board of Directors. Such provisions could limit the
ability of stockholders to sell their shares at a premium over prevailing market
prices by discouraging a third party from seeking to obtain control of the Fund.
Market Disruption. The terrorist attacks in the United States on September
11, 2001 have had a disruptive effect on the securities markets, some of which
were closed for a four-day period. These terrorist attacks and related events,
including recent U.S. military actions overseas, have led to increased short
term market volatility and may have long term effects on U.S. and world
economies and markets. Similar disruptions of the financial markets could impact
interest rates, auctions, secondary trading, ratings, credit risk, inflation and
other factors relating to the Fund's AMPS. Non-investment grade securities tend
to be more volatile than investment grade fixed income securities so that these
events and other market disruptions may have a greater impact on the prices and
volatility of non-investment grade securities than on investment grade fixed
income securities. There can be no assurance that these events and other market
disruptions will not have other material and adverse implications for the
non-investment grade securities markets.
--------------------------------------------------------------------------------
9
FINANCIAL HIGHLIGHTS
Information contained in the table below shows the unaudited operating
performance of the Fund from the commencement of the Fund's investment
operations on August 1, 2003 to August 6, 2003. Since the Fund was recently
organized and commenced operations on August 1, 2003, the table covers a portion
of time during which a substantial portion of the Fund's portfolio was held in
temporary investments pending investment in longer term securities that meet the
Fund's investment objective and policies. Accordingly, the information presented
may not provide a meaningful picture of the Fund's operating performance.
For the Period
August 1, 2003+
to August 6, 2003
-----------------
(unaudited)
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Common stock net asset value, beginning of period............. $ 14.33
---------
Investment income-- net....................................... .01
Unrealized loss on investments-- net.......................... (.02)
---------
Total from investment operations.............................. (.01)
---------
Capital charge resulting from the issuance of common stock.... (.02)
---------
Common stock net asset value, end of period................... $ 14.30
=========
Market price per share, end of period......................... $ 15.00
=========
Total Investment Return:**
Based on market price per share............................... 0.00%++
=========
Based on common stock net asset value per share............... (0.21%)++
=========
Ratios Based on Average Net Assets of Common Stock:
Total expenses, net of waiver................................. .01%*
=========
Total expenses................................................ .61%*
=========
Total investment income-- net................................. 2.36%*
=========
Supplemental Data:
Net assets, applicable to common stock, end of period
(in thousands).............................................. $476,994
=========
Portfolio turnover............................................ --
=========
----------
* 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. The Investment Adviser voluntarily waived all of its management
fee from August 1, 2003 (commencement of operations) to August 6, 2003.
Without such waiver, the Fund's performance would have been lower.
+ Commencement of operations.
++ Aggregate total investment return.
THE FUND
Muni Intermediate Duration Fund, Inc. (the "Fund") is a recently
organized, non-diversified, closed-end fund. The Fund was incorporated under the
laws of the State of Maryland on May 15, 2003, and has registered under the
Investment Company Act of 1940, as amended. The Fund's principal office is
located at 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its
telephone number is (609) 282-2800.
The Fund commenced operations on August 1, 2003 upon the closing of an
initial public offering of 33,350,000 shares of its common stock. The net
proceeds of such offering were approximately $476,993,750 after the payment of
offering expenses and the deduction of the underwriting discount. In connection
with the initial public offering of the Fund's common stock, the underwriters
were granted an option to purchase up to an additional 5,002,500 shares of
common stock to cover overallotments. On August 15, 2003, the Fund issued an
additional 2,000,000 shares of common stock pursuant to the underwriters'
partial exercise of the overallotment option for additional net proceeds to the
Fund of $28,650,000.
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") with similar investment objectives and policies as the Fund. Any such
merger, consolidation or other form of reorganization would require the prior
approval of the Board of Directors and the stockholders of the Fund. See
"Description of Capital Stock -- Certain Provisions of the Charter and By-laws."
10
USE OF PROCEEDS
The net proceeds of this offering will be approximately $281,810,000 after
payment of offering expenses (estimated to be approximately $340,000) 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 August 6, 2003 and as adjusted to give effect to the issuance of the shares
of AMPS offered hereby.
Actual As Adjusted
------ -----------
Stockholders' equity:
Capital Stock (200,000,000 shares authorized) Preferred stock, par value $.10
per share (no shares issued;
11,400 shares of AMPS issued and outstanding, as adjusted, at
$25,000 per share liquidation preference) ............................... -- $ 285,000,000
============= =============
Common stock, par value $.10 per share (33,356,981* shares issued
and outstanding) .......................................................... $ 3,335,698 $ 3,335,698
Paid-in capital in excess of par value .................................... 473,887,130 470,697,130
Undistributed investment income-- net ..................................... 184,843 184,843
Unrealized depreciation on investments-- net .............................. (413,874) (413,874)
------------- -------------
Net assets .................................................................. $ 476,993,797 $ 758,803,797
============= =============
* On August 15, 2003, the Fund issued an additional 2,000,000 shares of
common stock pursuant to the underwriters' partial exercise of the
overallotment option for additional net proceeds to the Fund of
$28,650,000.
PORTFOLIO COMPOSITION
As of August 6, 2003, approximately 62.6% of the market value of the
Fund's portfolio was invested in intermediate duration municipal obligations and
approximately 37.4% of the market value of the Fund's portfolio was invested in
short term investments. The following table sets forth certain information with
respect to the composition of the Fund's intermediate duration municipal
obligation investment portfolio as of August 6, 2003.
Number of Value
Moody's* Fitch* S&P* Issues (in thousands) Percent
--------- ------ ----- --------- ------------ -------
Aaa AAA AAA 35 $263,071 74.29%
Aa AA AA 6 23,572 6.66
A A A 11 50,581 14.28
Baa BBB BBB 2 9,431 2.66
NR** NR** NR** 1 7,481 2.11
---- -------- -----
Total ................................. 55 $354,136 100%
==== ======== =====
----------
* Ratings: Using the higher of Moody's, S&P or Fitch Ratings ("Fitch")
ratings on the Fund's investments. See "Schedule of 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. Fitch rating
categories may be modified further by a plus (+) or minus (-) in AA, A,
BBB, BB, B and CCC.
** Not Rated.
11
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide common stockholders with
high current income exempt from Federal income taxes. The Fund seeks to achieve
its objective by investing at least 80% of its net assets (including assets
acquired from the sale of preferred stock), plus the amount of any borrowings
for investment purposes, in a portfolio of municipal obligations issued by or on
behalf of states, territories and possessions of the United States and their
political subdivisions, agencies or instrumentalities, each of which pays
interest that, in the opinion of bond counsel to the issuer, is exempt from
Federal income tax ("Municipal Bonds"). The Fund's investment objective and its
policy of investing at least 80% of its net assets (including assets acquired
from the sale of preferred stock), plus the amount of any borrowings for
investment purposes, in Municipal Bonds are fundamental policies that may not be
changed without the approval of a majority of the outstanding voting securities
of the Fund (as defined in the 1940 Act). Under normal market conditions, and
after the initial investment period following this offering (expected to be
approximately three months), the Fund will invest at least 80% of its net assets
(including assets acquired from the sale of preferred stock), plus the amount of
any borrowings for investment purposes, in Municipal Bonds with a duration, as
calculated by the Investment Adviser, of three to ten years. This is a
non-fundamental policy and may be changed by the Fund's Board of Directors
provided that stockholders are provided with at least 60 days' prior notice of
any change as required by the 1940 Act. The Fund expects to maintain, under
normal market conditions, a dollar-weighted average portfolio duration of three
to ten years. There is no limit on the remaining maturity of each individual
Municipal Bond investment by the Fund. There can be no assurance that the Fund's
investment objective will be realized.
Under normal market conditions, the Fund expects to invest at least 75% of
its total assets in Municipal Bonds that are commonly referred to as "investment
grade" securities, which are obligations rated at the time of purchase within
the four highest quality ratings as determined by either Moody's Investors
Service, Inc. ("Moody's") (currently Aaa, Aa, A and Baa), Standard & Poor's
("S&P") (currently AAA, AA, A and BBB) or Fitch Ratings ("Fitch") (currently
AAA, AA, A and BBB). If unrated, such securities will possess creditworthiness
comparable, in the opinion of the Investment Adviser, to other obligations in
which the Fund may invest. Securities rated in the lowest investment grade
category may be considered to have speculative characteristics.
The Fund may invest up to 25% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by S&P or Fitch or, if unrated, are
considered by the Investment Adviser to possess similar credit characteristics.
Such securities, sometimes referred to as "high yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security and generally involve a
greater volatility of price than securities in higher rating categories.
See "-- Description of Municipal Bonds -- 'High Yield' or 'Junk' Bonds." The
Fund does not intend to purchase debt securities that are in default or which
the Investment Adviser believes will soon be in default.
The Fund may invest 25% or more of its total assets in tax exempt
securities of issuers in the industries comprising the same economic sector,
such as hospitals or life care facilities and transportation-related issuers.
However, the Fund will not invest 25% or more of its total assets in any one of
the industries comprising an economic sector. In addition, a substantial part of
the Fund's portfolio may be comprised of securities credit enhanced by banks,
insurance companies or companies with similar characteristics. Emphasis on these
sectors may subject the Fund to certain risks.
The value of bonds and other fixed income obligations may fall when
interest rates rise and rise when interest rates fall. In general, bonds and
other fixed income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal market conditions, the Fund
expects to maintain a dollar-weighted average portfolio duration of three to ten
years. "Duration" measures the sensitivity of a security's price to changes in
interest rates. Unlike final maturity, duration takes account of all payments
made over the life of the security. Typically, with a 1% change in interest
rates, an investment's value may be expected to move in the opposite direction
approximately 1% for each year of its duration. The greater a portfolio's
duration, the greater the change in the portfolio's value in response to changes
in interest rates. The Investment Adviser increases or reduces the Fund's
portfolio duration based on its interest rate outlook. When the Investment
Adviser expects interest rates to fall, it attempts to maintain a longer
portfolio duration. When the Investment Adviser expects interest rates to
increase, it attempts to shorten the portfolio's duration. Generally, as is the
case with any investment grade fixed income obligations, Municipal Bonds with
longer maturities tend to produce higher yields. Under normal market conditions,
however, such yield-to-maturity increases tend to decline in the longer
maturities (i.e., the slope of the yield curve flattens).
12
At the same time, due to their longer exposure to interest rate risk, prices of
longer term obligations are subject to greater market fluctuations as a result
of changes in interest rates. Based on the foregoing premises, the Investment
Adviser believes that the yield and price volatility characteristics of an
intermediate duration portfolio generally offer an attractive trade-off between
return and risk. There may be market conditions, however, where an intermediate
duration portfolio may be less attractive due to the fact that the Municipal
Bond yield curve changes from time to time depending on supply and demand
forces, monetary and tax policies and investor expectations. As a result, there
may be situations where investments in individual Municipal Bonds with longer
durations may be more attractive than individual intermediate duration Municipal
Bonds.
For temporary periods or to provide liquidity, the Fund has the authority
to invest as much as 20% of its total assets in tax exempt and taxable money
market obligations with a maturity of one year or less (such short term
obligations being referred to herein as "Temporary Investments"). In addition,
the Fund reserves the right as a defensive measure to invest temporarily a
greater portion of its assets in Temporary Investments, when, in the opinion of
the Investment Adviser, prevailing market or financial conditions warrant. These
investments will yield taxable income. From time to time, the Fund may also
realize taxable capital gains.
The Fund also may invest in variable rate demand obligations ("VRDOs") and
VRDOs in the form of participation interests ("Participating VRDOs") in variable
rate tax exempt obligations held by a financial institution. See "Other
Investment Policies -- Temporary Investments." The Fund's hedging strategies,
which are described in more detail under "Hedging Transactions -- Financial
Futures Transactions and Options," are not fundamental policies and may be
modified by the Board of Directors of the Fund without the approval of the
Fund's stockholders. The Fund is also authorized to invest in indexed and
inverse floating obligations for hedging purposes and to seek to enhance return.
Certain Municipal Bonds may be entitled to the benefits of letters of
credit or similar credit enhancements issued by financial institutions. In such
instances, the Board of Directors of the Fund and the Investment Adviser will
take into account, in assessing the quality of such bonds, both the
creditworthiness of the issuer of such bonds and the creditworthiness of the
financial institution that provides the credit enhancement.
The Fund ordinarily does not intend to realize investment income not
exempt from Federal income tax. The Fund may invest in securities not issued by
or on behalf of a state or territory or by an agency or instrumentality thereof,
if the Fund believes such securities to be exempt from Federal income taxation
("Non-Municipal Tax Exempt Securities"). Non-Municipal Tax Exempt Securities
could include trust certificates or other instruments evidencing interest in one
or more long term municipal securities. Non-Municipal Tax Exempt Securities also
may include securities issued by other investment companies that invest in
Municipal Bonds, to the extent such investments are permitted by applicable law.
Non-Municipal Tax Exempt Securities are subject to the same risks associated
with an investment in Municipal Bonds as well as many of the risks associated
with investments in derivatives. Interest received on certain otherwise tax
exempt securities that are classified as "private activity bonds" (in general,
bonds that benefit non-governmental entities) may be subject to a Federal
alternative minimum tax. See "Taxes." The percentage of the Fund's total assets
invested in "private activity bonds" will vary from time to time. Federal tax
legislation has limited the types and volume of bonds the interest on which
qualifies for a Federal income tax exemption. As a result, this legislation and
legislation that may be enacted in the future may affect the availability of
Municipal Bonds for investment by the Fund.
Risk Factors and Special Considerations Relating to Municipal Bonds
The risks and special considerations involved in investment in Municipal
Bonds vary with the types of instruments being acquired. Investments in
Non-Municipal Tax Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as 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.
13
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 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.
Municipal Bonds include debt obligations issued to obtain funds for
various public purposes, including the construction of a wide range of public
facilities, refunding of outstanding obligations and obtaining funds for general
operating expenses and loans to other public institutions and facilities. In
addition, certain types of bonds are issued by or on behalf of public
authorities to finance various privately owned or operated facilities, including
certain facilities for the local furnishing of electric energy or gas, sewage
facilities, solid waste disposal facilities and other specialized facilities.
Other types of industrial development bonds or private activity bonds, the
proceeds of which are used for the construction, equipment or improvement of
privately operated industrial or commercial facilities, may constitute Municipal
Bonds, although the current Federal tax laws place substantial limitations on
the size of such issues. The interest on Municipal Bonds may bear a fixed rate
or be payable at a variable or floating rate. The two principal classifications
of Municipal Bonds are "general obligation" and "revenue" bonds, which latter
category includes industrial development bonds ("IDBs") and, for bonds issued
after August 15, 1986, private activity bonds ("PABs").
The Fund has not established any limit on the percentage of its portfolio
that may be invested in IDBs or PABs. The Fund 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.
IDBs and PABs. The Fund may purchase IDBs and PABs. IDBs and PABs are, in
most cases, tax exempt securities issued by states, municipalities or public
authorities to provide funds, usually through a loan or lease arrangement, to a
private entity for the purpose of financing construction or improvement of a
facility to be used by the entity. Such bonds are secured primarily by revenues
derived from loan repayments or lease payments due from the entity which may or
may not be guaranteed by a parent company or otherwise secured. IDBs and PABs
generally are not secured by a pledge of the taxing power of the issuer of such
bonds. Therefore, an investor should be aware that repayment of such bonds
generally depends on the revenues of a private entity and be aware of the risks
that such an investment may entail. Continued ability of an entity to generate
sufficient revenues for the payment of principal and interest on such bonds will
be affected by many factors including the size of the entity, capital structure,
demand for its products or services, competition, general economic conditions,
government regulation and the entity's dependence on revenues for the operation
of the particular facility being financed.
Moral Obligation Bonds. The Fund also may invest in "moral obligation"
bonds, which are normally issued by special purpose public authorities. If an
issuer of moral obligation bonds is unable to meet its obligations, the
repayment of such bonds becomes a moral commitment but not a legal obligation of
the state or municipality in question.
14
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 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.
15
"High Yield" or "Junk" Bonds. The Fund may invest up to 25% of its total
assets in Municipal Bonds that are rated below Baa by Moody's or below BBB by
S&P or Fitch or are unrated securities that are considered by the Investment
Adviser to possess similar credit characteristics. See Appendix A "Ratings of
Municipal Bonds" in the statement of additional information regarding ratings of
debt securities. Junk bonds are debt securities that are rated below investment
grade by the major rating agencies or are unrated securities that are considered
by the Investment Adviser to possess similar credit characteristics. Although
junk bonds generally pay higher rates of interest than investment grade bonds,
they are high risk investments that may cause income and principal losses for
the Fund. The major risks in junk bond investments include the following:
o Junk bonds may be issued by less creditworthy issuers. These
securities are vulnerable to adverse changes in the issuer's industry
and to general economic conditions. Issuers of junk bonds may be
unable to meet their interest or principal payment obligations
because of an economic downturn, specific issuer developments or the
unavailability of additional financing.
o The issuers of junk bonds may have a larger amount of outstanding
debt relative to their assets than issuers of investment grade bonds.
If the issuer experiences financial stress, it may be unable to meet
its debt obligations. The issuer's ability to pay its debt
obligations also may be lessened by specific issuer developments, or
the unavailability of additional financing.
o Junk bonds are frequently ranked junior to claims by other creditors.
If the issuer cannot meet its obligations, the senior obligations are
generally paid off before the junior obligations.
o Junk bonds frequently have call or redemption features that permit an
issuer to repurchase the security from the Fund before it matures. If
an issuer redeems the junk bonds, the Fund may have to invest the
proceeds in bonds with lower yields and may lose income.
o Prices of junk bonds are subject to extreme price fluctuations.
Negative economic developments may have a greater impact on the
prices of junk bonds than on other higher rated fixed income
securities.
o Junk bonds may be less liquid than higher rated fixed income
securities even under normal economic conditions. There are fewer
dealers in the junk bond market, and there may be significant
differences in the prices quoted for junk bonds by the dealers.
Because they are less liquid, judgment may play a greater role in
valuing certain of the Fund's portfolio securities than in the case
of securities trading in a more liquid market.
The Fund may incur expenses to the extent necessary to seek recovery upon
default or to negotiate new terms with a defaulting issuer.
Yields. Yields on Municipal Bonds are dependent on a variety of factors,
including the general condition of the money market and of the municipal bond
market, the size of a particular offering, the financial condition of the
issuer, the maturity of the obligation and the rating of the issue. The ability
of the Fund to achieve its investment objective is also dependent on the
continuing ability of the issuers of the securities in which the Fund invests to
meet their obligations for the payment of interest and principal when due. There
are variations in the risks involved in holding Municipal Bonds, both within a
particular classification and between classifications, depending on numerous
factors. Furthermore, the rights of owners of Municipal Bonds and the
obligations of the issuer of such Municipal Bonds may be subject to applicable
bankruptcy, insolvency and similar laws and court decisions affecting the rights
of creditors generally and to general equitable principles, which may limit the
enforcement of certain remedies.
Hedging Transactions
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of the
Fund's shares of common stock, the net asset value of the Fund's shares of
common stock will fluctuate. There can be no assurance that the Fund's hedging
transactions will be effective. The Fund has no obligation to enter into hedging
transactions and may choose not to do so. 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."
16
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.
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.
17
The Fund also may engage in other futures contracts transactions such as
futures contracts on other municipal bond indices that may become available if
the Investment Adviser should determine that there is normally a sufficient
correlation between the prices of such futures contracts and the Municipal Bonds
in which the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as a
result of the shortening of maturities. The sale of futures contracts provides
an alternative means of hedging against declines in the value of its investments
in Municipal Bonds. As such values decline, the value of the Fund's positions in
the futures contracts will tend to increase, thus offsetting all or a portion of
the depreciation in the market value of the Fund's Municipal Bond investments
that are being hedged. While the Fund will incur commission expenses in selling
and closing out futures positions, commissions on futures transactions are lower
than transaction costs incurred in the purchase and sale of Municipal Bonds. In
addition, the ability of the Fund to trade in the standardized contracts
available in the futures markets may offer a more effective defensive position
than a program to reduce the average maturity of the portfolio securities due to
the unique and varied credit and technical characteristics of the municipal debt
instruments available to the Fund. Employing futures as a hedge also may permit
the Fund to assume a defensive posture without reducing the yield on its
investments beyond any amounts required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such Municipal
Bonds resulting from a decrease in interest rates or otherwise, that may occur
before such purchases can be effected. Subject to the degree of correlation
between the Municipal Bonds and the futures contracts, subsequent increases in
the cost of Municipal Bonds should be reflected in the value of the futures held
by the Fund. As such purchases are made, an equivalent amount of futures
contracts will be closed out. Due to changing market conditions and interest
rate forecasts, however, a futures position may be terminated without a
corresponding purchase of portfolio securities.
Call Options on Futures Contracts. The Fund may also purchase and sell
exchange traded call and put options on financial futures contracts. The
purchase of a call option on a futures contract is analogous to the purchase of
a call option on an individual security. Depending on the pricing of the option
compared to either the futures contract upon which it is based or the price of
the underlying debt securities, it may or may not be less risky than ownership
of the futures contract or underlying debt securities. Like the purchase of a
futures contract, the Fund will purchase a call option on a futures contract to
hedge against a market advance when the Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in the
Fund's portfolio holdings.
Put Options on Futures Contracts. The purchase of a put option on a
futures contract is analogous to the purchase of a protective put option on
portfolio securities. The Fund will purchase a put option on a futures contract
to hedge the Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial
hedge against increasing prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is higher
than the exercise price, the Fund will retain the full amount of the option
premium which provides a partial hedge against any increase in the price of
Municipal Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an option
will be included in initial margin. The writing of an option on a futures
contract involves risks similar to those relating to futures contracts.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes,
18
if the aggregate initial margin and premiums required to establish positions in
such contracts and options does not exceed 5% of the liquidation value of the
Fund's portfolio assets after taking into account unrealized profits and
unrealized losses on any such contracts and options. However, the Fund may
engage in options and futures transactions for hedging purposes or to seek to
enhance the Fund's return. Margin deposits may consist of cash or securities
acceptable to the broker and the relevant contract market.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender adjustable
notes) or liquid securities in a segregated account with the Fund's custodian,
so that the amount so segregated plus the amount of initial and variation margin
held in the account of its broker equals the market value of the futures
contracts, thereby ensuring that the use of such futures contract is
unleveraged. It is not anticipated that transactions in futures contracts will
have the effect of increasing portfolio turnover.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
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
19
the Fund or such rates move in a direction opposite to that anticipated, the
Fund may realize a loss on the hedging transaction which is not fully or
partially offset by an increase in the value of portfolio securities. As a
result, the Fund's total return for such period may be less than if it had not
engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by the
Fund of margin deposits in the event of bankruptcy of a broker with whom the
Fund has an open position in a financial futures contract. Because the Fund will
engage in the purchase and sale of futures contracts for hedging purposes or to
seek to enhance the Fund's return, any losses incurred in connection therewith
should, if the hedging strategy is successful, be offset in whole or in part by
increases in the value of securities held by the Fund or decreases in the price
of securities the Fund intends to acquire.
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 the preferred stock, including the AMPS, or to seek to
enhance the Fund's return, the Fund may enter into interest rate swap
transactions such as Municipal Market Data AAA Cash Curve swaps ("MMD Swaps") or
Bond Market Association Municipal Swap Index swaps ("BMA Swaps"). To the extent
that the Fund enters into 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
20
curve, beginning with a seven day floating rate index out to 30 years. The
duration of a BMA Swap is approximately equal to the duration of a fixed rate
Municipal Bond with the same attributes as the swap (e.g., coupon, maturity,
call feature).
The Fund also may purchase and sell MMD Swaps, also known as MMD rate
locks. An MMD Swap permits the Fund to lock in a specified municipal interest
rate for a portion of its portfolio to preserve a return on a particular
investment or a portion of its portfolio as a duration management technique or
to protect against any increase in the price of securities to be purchased at a
later date. By using an MMD Swap, the Fund can create a synthetic long or short
position, allowing the Fund to select the most attractive part of the yield
curve. An MMD Swap is a contract between the Fund and an MMD Swap provider
pursuant to which the parties agree to make payments to each other on a notional
amount, contingent upon whether the Municipal Market Data AAA General Obligation
Scale is above or below a specified level on the expiration date of the
contract. For example, if the Fund buys an MMD Swap and the Municipal Market
Data AAA General Obligation Scale is below the specified level on the expiration
date, the counterparty to the contract will make a payment to the Fund equal to
the specified level minus the actual level, multiplied by the notional amount of
the contract. If the Municipal Market Data AAA General Obligation Scale is above
the specified level on the expiration date, the Fund will make a payment to the
counterparty equal to the actual level minus the specified level, multiplied by
the notional amount of the contract.
In connection with investments in BMA and MMD Swaps, there is a risk that
municipal yields will move in the opposite direction than anticipated by the
Fund, which would cause the Fund to make payments to its counterparty in the
transaction that could adversely affect the Fund's performance.
The Fund has no obligation to enter into BMA or MMD Swaps and may not do
so. The net amount of the excess, if any, of the Fund's obligations over its
entitlements with respect to each interest rate swap will be accrued on a daily
basis, and the Fund will segregate liquid securities having an aggregate net
asset value at least equal to the accrued excess.
Credit Default Swap Agreements
The Fund may enter into credit default swap agreements for hedging
purposes or to seek to enhance its return. The credit default swap agreement may
have as reference obligations one or more securities that are not currently held
by the Fund. The protection "buyer" in a credit default contract may be
obligated to pay the protection "seller" an upfront or a periodic stream of
payments over the term of the contract provided that no credit event on a
reference obligation has occurred. If a credit event occurs, the seller
generally must pay the buyer the "par value" (full notional value) of the swap
in exchange for an equal face amount of deliverable obligations of the reference
entity described in the swap, or the seller may be required to deliver the
related net cash amount, if the swap is cash settled. The Fund may be either the
buyer or seller in the transaction. If the Fund is a buyer and no credit event
occurs, the Fund may recover nothing if the swap is held through its termination
date. However, if a credit event occurs, the buyer generally may elect to
receive the full notional value of the swap in exchange for an equal face amount
of deliverable obligations of the reference entity that may have little or no
value. As a seller, the Fund generally receives an upfront payment or a fixed
rate of income throughout the term of the swap, which typically is between six
months and three years, provided that there is no credit event. If a credit
event occurs, generally the seller must pay the buyer the full notional value of
the swap in exchange for an equal face amount of deliverable obligations of the
reference entity that may have little or no value. As the seller, the Fund would
effectively add leverage to its portfolio because, in addition to its total net
assets, the Fund would be subject to investment exposure on the notional amount
of the swap.
Credit default swap agreements involve greater risks than if the Fund had
invested in the reference obligation directly since, in addition to general
market risks, credit default swaps are subject to illiquidity risk, counterparty
risk and credit risks. The Fund will enter into credit default swap agreements
only with counterparties who are rated investment grade quality by at least one
nationally recognized statistical rating organization at the time of entering
into such transaction or whose creditworthiness is believed by the Investment
Adviser to be equivalent to such rating. A buyer generally also will lose its
investment and recover nothing should no credit event occur and the swap is held
to its termination date. If a credit event were to occur, the value of any
deliverable obligation received by the seller, coupled with the upfront or
periodic payments previously received, may be less than the full notional value
it pays to the buyer, resulting in a loss of value to the seller. The Fund's
obligations under a credit default swap agreement will be accrued daily (offset
against any amounts owing to the Fund). The Fund will at all times segregate
with its custodian in connection with each
21
such transaction unencumbered liquid securities or cash with a value at least
equal to the Fund's exposure (any accrued but unpaid net amounts owed by the
Fund to any counterparty), on a marked-to-market basis (as calculated pursuant
to requirements of the Commission). Such segregation will ensure that the Fund
has assets available to satisfy its obligations with respect to the transaction
and will avoid any potential leveraging of the Fund's portfolio. Such
segregation will not limit the Fund's exposure to loss.
VRDOs and Participating VRDOs
VRDOs are tax exempt obligations that contain a floating or variable
interest rate adjustment formula and right of demand on the part of the holder
thereof to receive payment of the unpaid principal balance plus accrued interest
upon a short notice period not to exceed seven days. There is, however, the
possibility that because of default or insolvency the demand feature of VRDOs
and Participating VRDOs may not be honored. The interest rates are adjustable at
intervals (ranging from daily to up to one year) to some prevailing market rate
for similar investments, such adjustment formula being calculated to maintain
the market value of the VRDOs, at approximately the par value of the VRDOs on
the adjustment date. The adjustments typically are based upon the Public
Securities Association Index or some other appropriate interest rate adjustment
index. The Fund may invest in all types of tax exempt instruments currently
outstanding or to be issued in the future which satisfy its short term maturity
and quality standards.
Participating VRDOs provide the Fund with a specified undivided interest
(up to 100%) of the underlying obligation and the right to demand payment of the
unpaid principal balance plus accrued interest on the Participating VRDOs from
the financial institution upon a specified number of days' notice, not to exceed
seven days. In addition, the Participating VRDO is backed by an irrevocable
letter of credit or guaranty of the financial institution. The Fund would have
an undivided interest in the underlying obligation and thus participate on the
same basis as the financial institution in such obligation except that the
financial institution typically retains fees out of the interest paid on the
obligation for servicing the obligation, providing the letter of credit and
issuing the repurchase commitment. The Fund has been advised by its counsel that
the Fund should be entitled to treat the income received on Participating VRDOs
as interest from tax exempt obligations as long as the Fund does not invest more
than 20% of its total assets in such investments and certain other conditions
are met. It is contemplated that the Fund will not invest more than 20% of its
assets in Participating VRDOs.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. The Directors may adopt
guidelines and delegate to the Investment Adviser the daily function of
determining and monitoring liquidity of such VRDOs. The Directors, however, will
retain sufficient oversight and will be ultimately responsible for such
determinations.
The Temporary Investments, VRDOs and Participating VRDOs in which the Fund
may invest will be in the following rating categories at the time of purchase:
MIG-1/VMIG-1 through MIG-3/VMIG-3 for notes and VRDOs and Prime-1 through
Prime-3 for commercial paper (as determined by Moody's), SP-1 through SP-2 for
notes and A-1 through A-3 for VRDOs and commercial paper (as determined by S&P),
or F-1 through F-3 for notes, VRDOs and commercial paper (as determined by
Fitch). Temporary Investments, if not rated, must be of comparable quality in
the opinion of the Investment Adviser. In addition, the Fund reserves the right
to invest temporarily a greater portion of its assets in Temporary Investments
for defensive purposes, when, in the judgment of the Investment Adviser, market
conditions warrant.
Repurchase Agreements
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the Federal
Reserve System or primary dealer or an affiliate thereof, in U.S. Government
securities. Under such agreements, the bank or primary dealer or an affiliate
thereof agrees, upon entering into the contract, to repurchase the security at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. In repurchase agreements, the prices at
which the trades are conducted do not reflect accrued interest on the underlying
obligations. Such agreements usually cover short periods, such as under one
week. Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
In a repurchase agreement, the Fund will require the seller to provide
additional collateral if the market value of the securities falls below the
repurchase price at any time during the term of the repurchase agreement. In the
event of default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities are not owned by the Fund but
only constitute collateral for the seller's obligation to pay the repurchase
price. Therefore, the Fund may suffer time delays and incur costs or possible
losses in connection with the disposition of the collateral. In the event of a
default under such a repurchase
22
agreement, instead of the contractual fixed rate of return, the rate of return
to the Fund shall be dependent upon intervening fluctuations of the market value
of such security and the accrued interest on the security. In such event, the
Fund would have rights against the seller for breach of contract with respect to
any losses arising from market fluctuations following the failure of the seller
to perform.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold." Therefore,
amounts earned under such agreements will not be considered tax exempt interest.
The treatment of purchase and sales contracts is less certain.
Short Sales
The Fund may make short sales of securities. A short sale is a transaction
in which the Fund sells a security it does not own in anticipation that the
market price of that security will decline. The Fund may make short sales both
as a form of hedging to offset potential declines in long positions in similar
securities and in order to seek to enhance return.
When the Fund makes a short sale, it must borrow the security sold short
and deliver collateral to the broker-dealer through which it made the short sale
to cover its obligation to deliver the security upon conclusion of the sale. The
Fund may have to pay a fee to borrow particular securities and is often
obligated to pay over any payments received on such borrowed securities.
The Fund's obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer, usually cash or liquid securities
similar to those borrowed. The Fund also will be required to segregate similar
collateral with its custodian to the extent, if any, necessary so that the value
of both collateral amounts in the aggregate is at all times equal to at least
100% of the current market value of the security sold short. Depending on
arrangements made with the broker-dealer from which it borrowed the security
regarding payment over any payments received by the Fund on such security, the
Fund may not receive any payments (including interest) on its collateral
deposited with such broker-dealer.
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss. Conversely, if the price declines, the Fund will realize a gain.
Any gain will be decreased, and any loss increased, by the transaction costs
described above. Although the Fund's gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited.
The Fund also may make short sales "against the box." These transactions
will involve either short sales of securities retained in the Fund's portfolio
or securities which it has the right to acquire without the payment of further
consideration.
Investment in Other Investment Companies
The Fund may invest in other investment companies whose investment
objectives and policies are consistent with those of the Fund. In accordance
with the 1940 Act, the Fund may invest up to 10% of its total assets in
securities of other investment companies. In addition, under the 1940 Act the
Fund may not own more than 3% of the total outstanding voting stock of any
investment company and not more than 5% of the value of the Fund's total assets
may be invested in securities of any investment company. The Fund has received
an exemptive order from the Commission permitting it to invest in affiliated
registered money market funds and in an affiliated private investment company
without regard to such limitations, provided however, that in all cases the
Fund's aggregate investment of cash in shares of such investment companies shall
not exceed 25% of the Fund's total assets at any time. If the Fund acquires
shares in investment companies, stockholders would bear both their proportionate
share of expenses in the Fund (including management and advisory fees) and,
indirectly, the expenses of such investment companies (including management and
advisory fees).
Borrowings
The Fund is authorized to borrow money in amounts of up to 5% of the value
of its total assets at the time of such borrowings; provided, however, that the
Fund is authorized to borrow moneys in amounts of up to 33 1/3% of the value of
its total assets at the time of such borrowings to finance the repurchase of its
own common stock
23
pursuant to tender offers or otherwise to redeem or repurchase shares of
preferred stock, or for temporary, extraordinary or emergency purposes,
including the payment of dividends and the settlement of securities transactions
which otherwise, might require untimely dispositions of portfolio securities.
Borrowings by the Fund (commonly known, as with the issuance of preferred stock,
as "leveraging") create an opportunity for greater total return since, for
example, the Fund will not be required to sell portfolio securities to
repurchase or redeem shares but, at the same time, increase exposure to capital
risk. In addition, borrowed funds are subject to interest costs that may offset
or exceed the return earned on the borrowed funds.
DESCRIPTION OF AMPS
General
Certain of the capitalized terms used herein are defined in the Glossary
that appears at the back of this prospectus.
The AMPS of each series 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 for each such series. After the Initial
Dividend Period, each Subsequent Dividend Period for each series of 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 "The Auction" herein and in the statement of additional
information.
The following is a brief description of the terms of the shares of 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 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 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 M7 AMPS, Wednesday in the case of the Series T7 AMPS, Thursday in the
case of the
24
Series W7 AMPS, Friday in the case of the Series TH7 AMPS and Monday in the case
of the Series F7 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 of additional information. No interest will be payable in respect
of any dividend payment or payments on the shares of AMPS which may be in
arrears.
The amount of cash dividends per share of any series of AMPS payable (if
declared) on the Initial Dividend Payment Date, each Dividend Payment Date of
each 7-Day Dividend Period and each Dividend Payment Date of 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 a series of 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 a series of 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
25
Notice of Special Dividend Period for the series of 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 series of 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 each series
of AMPS to but excluding the Initial Dividend Payment Date (the "Initial
Dividend Period") with respect to each series of 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 each series of AMPS, the
Applicable Rate on each series of 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 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 portfolio at
August 6, 2003, asset coverage with respect to shares of AMPS would be
approximately 266% representing approximately 38% of the Fund's capital and 60%
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
26
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.
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 which are stock,
including the shares of 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 which 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.
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 = $758,803,797 = 266%
------------------------------ ---------------------
Senior securities $285,000,000
representing 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 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
27
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 series of shares 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.
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 AMPS of any series 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 each
outstanding series 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, 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 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.
28
The 1940 Act and the Articles Supplementary require that the holders of
preferred stock, including the 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 are unpaid. The
holders of 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, each series of AMPS may vote as a separate series under
certain circumstances. See "Description of AMPS -- Voting Rights" in the
statement of additional information.
THE AUCTION
General
Holders of the shares of AMPS of each series 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 for each series of AMPS, 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 AMPS offered hereby will provide that the Applicable Rate for each
series 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 of such series. 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 of any series or the redemption price of shares of AMPS of such series
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 will enter into an agreement (the
"Auction Agent 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"), 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 will enter into agreements
with Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"),
Jefferies & Company and Lehman Brothers Incorporated, 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
AMPS of each series. One or more registered certificates for all of the shares
of each series of 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 of the series 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. Separate auctions will be conducted for each series of
AMPS. 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.
29
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 each series of AMPS offered hereby for each Dividend 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 Series M7 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). Auctions for shares of Series T7 AMPS
for Dividend Periods after the Initial Dividend Period normally will be held
every Tuesday after the preceding Dividend Payment Date, and each subsequent
Dividend Period normally will begin on the following Wednesday (also a Dividend
Payment Date). Auctions for shares of Series W7 AMPS for Dividend Periods after
the Initial Dividend Period normally will be held every Wednesday after the
preceding Dividend Payment Date, and each subsequent Dividend Period normally
will begin on the following Thursday (also a Dividend Payment Date). Auctions
for shares of Series TH7 AMPS for Dividend Periods after the Initial Dividend
Period normally will be held every Thursday after the preceding Dividend Payment
Date, and each subsequent Dividend Period normally will begin on the following
Friday (also a Dividend Payment Date). Auctions for shares of Series F7 AMPS for
Dividend Periods after the Initial Dividend Period normally will be held every
Friday after the preceding Dividend Payment Date, and each subsequent Dividend
Period normally will begin on the following Monday (also a Dividend Payment
Date). The Auction Date and the first day of the related Dividend Period for any
series of 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 M7 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
30
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 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 Applicable
Percentage Percentage Spread Over Spread Over
Credit Ratings 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%
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."
31
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 of such series 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 such series 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., New York City 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%.
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:
32
(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
Dividend Period in the case of each series of 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.
33
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.
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
34
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 any series of 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.
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.
Secondary Trading Market. The Broker-Dealers intend to maintain a
secondary trading market in the AMPS outside of Auctions; however, they have no
obligation to do so 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.
35
RATING AGENCY GUIDELINES
Certain of the capitalized terms used herein are defined in the Glossary
that appears at the end 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.
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.
36
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 100
registered investment companies and offers investment advisory services to
individuals and institutional accounts. As of June 2003, the Investment Adviser
and its affiliates, including Merrill Lynch Investment Managers, L.P. ("MLIM"),
had a total of approximately $498 billion in investment company and other
portfolio assets under management, including approximately $262 billion in fixed
income assets. This amount includes assets managed by certain affiliates of the
Investment Adviser. The Investment Adviser is a limited partnership, the
partners of which are ML & Co. and Princeton Services. The principal business
address of the Investment Adviser is 800 Scudders Mill Road, Plainsboro, New
Jersey 08536.
The Investment Advisory Agreement provides that, subject to the direction
of the Fund's Board of Directors, the Investment Adviser is responsible for the
actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.
The portfolio manager primarily responsible for the Fund's day-to-day
management is Robert A. DiMella. Robert DiMella has been a Vice President of
MLIM since 1997 and has 13 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 Fund is also assisted by 13 research analysts with an average of 12 years of
experience. The Investment Adviser will also be responsible for the performance
of certain management services for the Fund.
For its services, the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.55% of the Fund's average daily net assets, plus the
proceeds of any outstanding borrowings used for leverage ("average daily net
assets" means the average daily value of the total assets of the Fund, including
the amount obtained from leverage and any proceeds from the issuance of
preferred stock, minus the sum of (i) accrued liabilities of the Fund, (ii) any
accrued and unpaid interest on outstanding borrowings and (iii) accumulated
dividends on shares of preferred stock). For purposes of this calculation,
average daily net assets is determined at the end of each month on the basis of
the average net assets of the Fund for each day during the month. The
liquidation preference of any outstanding preferred stock (other than
accumulated dividends) is not considered a liability in determining the Fund's
average daily net assets.
The Investment Adviser has contractually agreed to waive a portion of its
fee during the first seven years of the Fund's operations ending July 31, 2010,
as follows:
Fee Waiver (as
a percentage of
average daily
net assets)
---------------
Years 1 through 5................................ 0.15%
Year 6 .......................................... 0.10%
Year 7 .......................................... 0.05%
Year 8 and thereafter............................ 0.00%
The Investment Adviser has not agreed to waive any portion of its fee beyond
July 31, 2010.
The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and furnish
office space for officers and employees of the Fund connected with investment
and economic research, trading and investment management of the Fund, as well as
the compensation of all Directors of the Fund who are affiliated persons of the
Investment Adviser or any of its affiliates. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of preparing, printing and mailing
proxies, listing fees, stock certificates and stockholder reports, charges of
the custodian and the transfer agent, dividend disbursing agent and registrar,
Commission fees, fees and expenses of non-interested Directors, accounting and
pricing costs, insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, mailing
37
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
In general, dividends on the AMPS will be exempt from Federal income tax
in the hands of holders of such AMPS, subject to the possible application of the
Federal alternative minimum tax. However, the Fund is required to allocate net
capital gain and other taxable income, if any, proportionately among the common
stock and each series of AMPS in accordance with the current position of the
Internal Revenue Service ("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 taxable income allocable to each series of 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.
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 IRS currently requires that a RIC that has two or more classes of stock
allocate to each class proportionate amounts of each type of its income (e.g.,
tax-exempt interest, capital gains and other taxable income). Accordingly, the
Fund intends to designate dividends paid to each series of AMPS as tax-exempt
interest, capital gains or other taxable income, as applicable, in proportion to
each series' share of total dividends paid during the year.
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.
Because the Fund may from time to time invest a substantial portion of its
portfolio in Municipal Bonds bearing income that is taxable 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.
Stockholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes and with specific
questions as to Federal, foreign, state or local taxes.
38
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, 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 has reclassified 11,400 shares of unissued common stock as AMPS. 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 August 6,
2003.
Amount Outstanding
Amount Held (Exclusive Of Amount
Amount By Fund For Held By Fund For
Title of Class Authorized Its Own Account Its Own Account)
----------- ---------- --------------- -------------------
Common Stock................................ 199,988,600 - 0 - 33,356,981
Auction Market Preferred Stock
Series M7 AMPS............................ 2,000 - 0 - - 0 -
Series T7 AMPS............................ 2,700 - 0 - - 0 -
Series W7 AMPS............................ 2,000 - 0 - - 0 -
Series TH7 AMPS........................... 2,700 - 0 - - 0 -
Series F7 AMPS............................ 2,000 - 0 - - 0 -
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 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 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 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 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,
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."
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its stockholders.
The shares of common stock commenced trading on the NYSE on July 30, 2003.
At August 6, 2003, the net asset value per share of common stock was $14.30 and
the closing price per share on the NYSE was $15.00.
39
Preferred Stock
Under the Articles Supplementary, the Fund is authorized to issue an
aggregate of 11,400 shares of 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 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 2/3% 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 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. Following any issuance of preferred stock
by the Fund, it is anticipated that the approval, adoption or authorization of
the foregoing also would require the favorable vote of a majority of the Fund's
shares of preferred stock, including the 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 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 two-thirds of the total number of
Directors fixed in accordance with the By-laws), and, assuming preferred stock
is issued, the affirmative vote of a majority of outstanding shares (as defined
in the 1940 Act) of preferred stock of the Fund (including the 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 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.
The Charter and By-laws provide that the Board of Directors has the power,
to the exclusion of stockholders, to make, alter or repeal any of the By-laws
(except for any By-law specified not to be amended or repealed by the Board),
subject to the requirements of the 1940 Act. Neither this provision of the
Charter, nor any of the foregoing provisions of the Charter requiring the
affirmative vote of 66 2/3% of shares of capital stock of the Fund, can be
amended or repealed except by the vote of such required number of shares.
40
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of stockholders generally.
Reference should be made to the Charter on file with the Commission for the full
text of these provisions.
The Fund's By-laws generally require that advance notice be given to the
Fund in the event a stockholder desires to nominate a person for election to the
Board of Directors or to transact any other business at an annual meeting of
stockholders. With respect to an annual meeting following the first annual
meeting of stockholders, notice of any such nomination or business must be
delivered to or received at the principal executive offices of the Fund not less
than 60 calendar days nor more than 90 calendar days prior to the anniversary
date of the prior year's annual meeting (subject to certain exceptions). In the
case of the first annual meeting of stockholders, the notice must be given no
later than the tenth calendar day following the day upon which public disclosure
of the date of the meeting is first made. Any notice by a stockholder must be
accompanied by certain information as provided in the By-laws.
CUSTODIAN
The Fund's securities and cash are held under a custodian agreement with
State Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts
02110.
41
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 August 20, 2003.
The expenses of the offering, excluding underwriting discount, are
estimated at $340,000 and are payable by the Fund.
Other Relationships
The Investment Adviser (and not the Fund) also has agreed to pay a fee to
Merrill Lynch quarterly at the annual rate of .10% of the Fund's average daily
net assets through July 31, 2008 and at the annual rate of .15% of the Fund's
average daily net assets thereafter during the continuance of the Investment
Advisory Agreement. The maximum amount of this fee, plus the partial
reimbursement of underwriting expenses made by the Fund in connection with the
initial public offering of the common stock, will not exceed 4.5% of the
aggregate initial offering price of the Fund's initial public offering of its
common stock. Merrill Lynch has agreed to provide certain after-market services
to the Investment Adviser designed to maintain the visibility of the Fund on an
ongoing basis and to provide relevant information, studies or reports regarding
the Fund and the closed-end investment company industry.
Merrill Lynch will act 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. See
"Portfolio Transactions" in the statement of additional information. 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.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the Fund's
shares of AMPS is The Bank of New York, 100 Church Street, New York, New York
10286. The transfer agent, dividend disbursing agent and registrar for the
Fund's shares of common stock is EquiServe, L.P., 150 Royall Street, Canton,
Massachusetts 02021.
42
ACCOUNTING SERVICES PROVIDER
State Street Bank and Trust Company, 500 College Road East, Princeton, New
Jersey 08540, provides certain accounting services for the Fund.
LEGAL OPINIONS
Certain legal matters in connection with the AMPS offered hereby are
passed on for the Fund and the Underwriter by Sidley Austin Brown & Wood LLP,
New York, New York.
INDEPENDENT AUDITORS AND EXPERTS
Ernst & Young LLP, independent auditors, have audited the statement of
assets and liabilities of the Fund as of July 17, 2003 which is included in this
prospectus and Registration Statement. The statement of assets and liabilities
is included in reliance upon their report, which is also included in this
prospectus and in the Registration Statement, given on their authority as
experts in accounting and auditing.
43
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
Page
----
Investment Objective and Policies......................................... 3
Investment Restrictions................................................... 4
Description of AMPS....................................................... 6
The Auction............................................................... 13
Rating Agency Guidelines.................................................. 14
Directors and Officers.................................................... 20
Investment Advisory and Management Arrangements........................... 24
Portfolio Transactions.................................................... 29
Taxes..................................................................... 30
Net Asset Value........................................................... 34
Additional Information.................................................... 35
Report of Independent Auditors............................................ F-1
Statement of Assets and Liabilities (audited)............................. F-2
Financial Statements (unaudited).......................................... F-3
APPENDIX A Ratings of Municipal Bonds.................................... A-1
APPENDIX B Settlement Procedures......................................... B-1
APPENDIX C Auction Procedures............................................ C-1
44
GLOSSARY
"Additional Dividend" has the meaning set forth on page 26 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, as the case may be, the Auction Market Preferred Stock,
Series M7; or the Auction Market Preferred Stock, Series T7; or the Auction
Market Preferred Stock, Series W7; or the Auction Market Preferred Stock, Series
TH7; or the Auction Market Preferred Stock, Series F7; each 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 27 of
this prospectus.
"AMPS Basic Maintenance Cure Date" has the meaning set forth on page 27 of
this prospectus.
"AMPS Basic Maintenance Report" has the meaning set forth on page 10 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 31 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 31 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 30 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 33 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 33 of this prospectus.
"Bidder" has the meaning set forth on page 31 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.
45
"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), 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.
"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 25 of this
prospectus.
"Dividend Period" has the meaning set forth on page 25 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 Muni Intermediate Duration Fund, Inc., a Maryland corporation
that is the issuer of the AMPS.
"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 30 of this prospectus.
"Initial Dividend Payment Date" means the first Dividend Payment Date for
each series of AMPS.
"Initial Dividend Period" means the period from and including the Date of
Original Issue to but excluding the Initial Dividend Payment Date for each
series of the 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.
46
"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 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)
more than 21 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.
47
"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 28 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 31 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.
"Municipal Bonds" has the meaning set forth on page 12 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 27 of
this prospectus.
"1940 Act Cure Date" has the meaning set forth on page 27 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 8 of the statement
of additional information.
"Non-Payment Period Rate" has the meaning set forth on page 8 of the
statement of additional information.
"Normal Dividend Payment Date" has the meaning set forth on page 24 of
this prospectus.
"Notice of Revocation" has the meaning set forth on page 7 of the
statement of additional information.
"Notice of Special Dividend Period" has the meaning set forth on page 26
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 28 of this
prospectus.
"Order" has the meaning set forth on page 31 of this prospectus.
48
"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, par value $.10 per share, 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.
"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 25
of this prospectus.
"Response" has the meaning set forth on page 26 of this prospectus.
"Retroactive Taxable Allocation" has the meaning set forth on page 26 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 M7 AMPS" means the Auction Market Preferred Stock, Series M7, 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.
"Series T7 AMPS" means the Auction Market Preferred Stock, Series T7, 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.
"Series W7 AMPS" means the Auction Market Preferred Stock, Series W7, 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.
"Series TH7 AMPS" means the Auction Market Preferred Stock, Series TH7,
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.
"Series F7 AMPS" means the Auction Market Preferred Stock, Series F7, 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.
"S&P" means Standard & Poor's or its successors.
"S&P Discount Factor" has the meaning set forth on pages 14 to 15 of the
statement of additional information.
"S&P Eligible Assets" has the meaning set forth on pages 15 to 16 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.
49
"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 24 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 32 of this
prospectus.
"Submitted Bid" has the meaning set forth on page 33 of this prospectus.
"Submitted Hold Order" has the meaning set forth on page 33 of this
prospectus.
"Submitted Order" has the meaning set forth on page 33 of this prospectus.
"Submitted Sell Order" has the meaning set forth on page 33 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 33 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., New York City
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., New York City 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.
50
"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 27 of this prospectus.
"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 33 of this
prospectus.
51
================================================================================
$285,000,000
Muni Intermediate Duration Fund, Inc.
Auction Market Preferred Stock ("AMPS")
2,000 Shares, Series M7
2,700 Shares, Series T7
2,000 Shares, Series W7
2,700 Shares, Series TH7
2,000 Shares, Series F7
Liquidation Preference $25,000 Per Share
----------
PROSPECTUS
----------
Merrill Lynch & Co.
August 15, 2003 CODE #19141-0803
================================================================================
STATEMENT OF ADDITIONAL INFORMATION
$285,000,000
Muni Intermediate Duration Fund, Inc.
Auction Market Preferred Stock ("AMPS")
2,000 Shares, Series M7
2,700 Shares, Series T7
2,000 Shares, Series W7
2,700 Shares, Series TH7
2,000 Shares, Series F7
Liquidation Preference $25,000 Per Share
----------
Muni Intermediate Duration Fund, Inc. (the "Fund") is a recently
organized, non-diversified, closed-end fund. The investment objective of the
Fund is to provide common stockholders with high current income exempt from
Federal income taxes. The Fund seeks to achieve its objective by investing, as a
fundamental policy, at least 80% of its net assets (including assets acquired
from the sale of preferred stock), plus the amount of any borrowings for
investment purposes, in a portfolio of municipal obligations the interest on
which, in the opinion of bond counsel to the issuer, is exempt from Federal
income taxes. Under normal market conditions, the Fund expects to invest at
least 75% of its total assets in municipal obligations that are rated investment
grade or, if unrated, are considered by the Fund's investment adviser to be of
comparable quality. The Fund may invest up to 25% of its total assets in
municipal obligations that are rated below investment grade (commonly known as
"junk bonds") or, if unrated, are considered by the Fund's investment adviser to
possess similar credit characteristics. Under normal market conditions and after
the initial investment period following this offering (expected to be
approximately three months), the Fund will invest, as a non-fundamental policy,
at least 80% of its net assets (including assets acquired from the sale of
preferred stock), plus the amount of any borrowings for investment purposes, in
municipal obligations with a duration, as calculated by the Fund's investment
adviser, of three to ten years. The Fund expects to maintain, under normal
market conditions, a dollar-weighted average portfolio duration, as calculated
by the Fund's investment adviser, of three to ten years. 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 August 15, 2003.
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
Page
----
Investment Objective and Policies ....................................... 3
Investment Restrictions ................................................. 4
Description of AMPS ..................................................... 6
The Auction ............................................................. 13
Rating Agency Guidelines ................................................ 14
Directors and Officers .................................................. 20
Investment Advisory and Management Arrangements ......................... 24
Portfolio Transactions .................................................. 29
Taxes ................................................................... 30
Net Asset Value ......................................................... 34
Additional Information .................................................. 35
Report of Independent Auditors .......................................... F-1
Statement of Assets and Liabilities (audited) ........................... F-2
Financial Statements (unaudited) ........................................ F-3
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
The Fund's investment objective is to provide common stockholders with
high current income exempt from Federal income taxes. The Fund seeks to achieve
its objective by investing at least 80% of its net assets (including assets
acquired from the sale of preferred stock), plus the amount of any borrowings
for investment purposes, in a portfolio of municipal obligations issued by or on
behalf of states, territories and possessions of the United States and their
political subdivisions, agencies or instrumentalities, each of which pays
interest that, in the opinion of bond counsel to the issuer, is exempt from
Federal income tax ("Municipal Bonds"). The Fund's investment objective and its
policy of investing at least 80% of its net assets (including assets acquired
from the sale of preferred stock), plus the amount of any borrowings for
investment purposes, in Municipal Bonds are fundamental policies that may not be
changed without the approval of a majority of the outstanding voting securities
of the Fund (as defined in the 1940 Act). Under normal market conditions, and
after the initial investment period following this offering (expected to be
approximately three months), the Fund will invest at least 80% of its net assets
(including assets acquired from the sale of preferred stock), plus the amount of
any borrowings for investment purposes, in Municipal Bonds with a duration, as
calculated by Fund Asset Management, L.P. (the "Investment Adviser"), of three
to ten years. This is a non-fundamental policy and may be changed by the Fund's
Board of Directors provided that stockholders are provided with at least 60
days' prior notice of any change as required by the 1940 Act. The Fund expects
to maintain, under normal market conditions, a dollar-weighted average portfolio
duration of three to ten years. There is no limit on the remaining maturity of
each individual Municipal Bond investment by the Fund. There can be no assurance
that the Fund's investment objective will be realized.
Under normal market conditions, the Fund expects to invest at least 75% of
its total assets in Municipal Bonds that are commonly referred to as "investment
grade" securities, which are obligations rated at the time of purchase within
the four highest quality ratings as determined by either Moody's Investors
Service, Inc. ("Moody's") (currently Aaa, Aa, A and Baa), Standard & Poor's
("S&P") (currently AAA, AA, A and BBB) or Fitch Ratings ("Fitch") (currently
AAA, AA, A and BBB). If unrated, such securities will possess creditworthiness
comparable, in the opinion of the Investment Adviser, to other obligations in
which the Fund may invest. Securities rated in the lowest investment grade
category may be considered to have speculative characteristics.
The Fund may invest up to 25% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by S&P or Fitch or, if unrated, are
considered by the Investment Adviser to possess similar credit characteristics.
Such securities, sometimes referred to as "high yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security and generally involve a
greater volatility of price than securities in higher rating categories. The
Fund does not intend to purchase debt securities that are in default or which
the Investment Adviser believes will soon be in default.
The Fund may invest 25% or more of its total assets in tax exempt
securities of issuers in the industries comprising the same economic sector,
such as hospitals or life care facilities and transportation-related issuers.
However, the Fund will not invest 25% or more of its total assets in any one of
the industries comprising an economic sector. In addition, a substantial part of
the Fund's portfolio may be comprised of securities credit enhanced by banks,
insurance companies or companies with similar characteristics. Emphasis on these
sectors may subject the Fund to certain risks.
The value of bonds and other fixed income obligations may fall when
interest rates rise and rise when interest rates fall. In general, bonds and
other fixed income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal market conditions, the Fund
expects to maintain a dollar-weighted average portfolio duration of three to ten
years. "Duration" measures the sensitivity of a security's price to changes in
interest rates. Unlike final maturity, duration takes account of all payments
made over the life of the security. Typically, with a 1% change in interest
rates, an investment's value may be expected to move in the opposite direction
approximately 1% for each year of its duration. The greater a portfolio's
duration, the greater the change in the portfolio's value in response to changes
in interest rates. The Investment Adviser increases or reduces the Fund's
portfolio duration based on its interest rate outlook. When the Investment
Adviser expects interest rates to increase, it attempts to shorten the
portfolio's duration. Generally, as is the case with any investment grade fixed
income obligations, Municipal Bonds with longer maturities tend to produce
higher yields. Under normal market conditions, however, such yield-to-maturity
increases tend to decline in the longer maturities (i.e., the slope of the yield
curve flattens). At the
3
same time, due to their longer exposure to interest rate risk, prices of longer
term obligations are subject to greater market fluctuations as a result of
changes in interest rates. Based on the foregoing premises, the Investment
Adviser believes that the yield and price volatility characteristics of an
intermediate duration portfolio generally offer an attractive trade-off between
return and risk. There may be market conditions, however, where an intermediate
duration portfolio may be less attractive due to the fact that the Municipal
Bond yield curve changes from time to time depending on supply and demand
forces, monetary and tax policies and investor expectations. As a result, there
may be situations where investments in individual Municipal Bonds with longer
durations may be more attractive than individual intermediate duration Municipal
Bonds.
For temporary periods or to provide liquidity, the Fund has the authority
to invest as much as 20% of its total assets in tax exempt and taxable money
market obligations with a maturity of one year or less (such short term
obligations being referred to herein as "Temporary Investments"). In addition,
the Fund reserves the right as a defensive measure to invest temporarily a
greater portion of its assets in Temporary Investments, when, in the opinion of
the Investment Adviser, prevailing market or financial conditions warrant. These
investments will yield taxable income. From time to time, the Fund may also
realize taxable capital gains.
The Fund also may invest in variable rate demand obligations ("VRDOs") and
VRDOs in the form of participation interests ("Participating VRDOs") in variable
rate tax exempt obligations held by a financial institution. See "Other
Investment Policies -- Temporary Investments." The Fund's hedging strategies,
which are described in more detail under "Hedging Transactions -- Financial
Futures Transactions and Options," are not fundamental policies and may be
modified by the Board of Directors of the Fund without the approval of the
Fund's stockholders. The Fund is also authorized to invest in indexed and
inverse floating obligations for hedging purposes and to seek to enhance return.
Certain Municipal Bonds may be entitled to the benefits of letters of
credit or similar credit enhancements issued by financial institutions. In such
instances, the Board of Directors of the Fund and the Investment Adviser will
take into account, in assessing the quality of such bonds, both the
creditworthiness of the issuer of such bonds and the creditworthiness of the
financial institution that provides the credit enhancement.
The Fund ordinarily does not intend to realize investment income not
exempt from Federal income tax. The Fund may invest in securities not issued by
or on behalf of a state or territory or by an agency or instrumentality thereof,
if the Fund believes such securities to be exempt from Federal income taxation
("Non-Municipal Tax Exempt Securities"). Non-Municipal Tax Exempt Securities
could include trust certificates or other instruments evidencing interest in one
or more long term municipal securities. Non-Municipal Tax Exempt Securities also
may include securities issued by other investment companies that invest in
Municipal Bonds, to the extent such investments are permitted by applicable law.
Non-Municipal Tax Exempt Securities are subject to the same risks associated
with an investment in Municipal Bonds as well as many of the risks associated
with investments in derivatives. Interest received on certain otherwise tax
exempt securities that are classified as "private activity bonds" (in general,
bonds that benefit non-governmental entities) may be subject to a Federal
alternative minimum tax. See "Taxes." The percentage of the Fund's total assets
invested in "private activity bonds" will vary from time to time. Federal tax
legislation has limited the types and volume of bonds the interest on which
qualifies for a Federal income tax exemption. As a result, this legislation and
legislation that may be enacted in the future may affect the availability of
Municipal Bonds for investment by the Fund.
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 and any other
preferred stock, voting together as a single class, and the majority of the
outstanding shares of 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.
4
2. Purchase or sell real estate, commodities or commodity contracts
except that, to the extent permitted by applicable law, the Fund may
invest in securities directly or indirectly secured by real estate or
interests therein or issued by entities that invest in real estate or
interests therein, and the Fund may purchase and sell financial futures
contracts and options thereon.
3. Issue senior securities or borrow money except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended,
in selling portfolio securities.
5. Make loans to other persons, except (i) the Fund shall not be
deemed to be making a loan to the extent that the Fund purchases Municipal
Bonds or other debt instruments or enters into repurchase agreements or
any similar instruments and (ii) the Fund may lend its portfolio
securities in an amount not in excess of 33 1/3% of its total assets,
taken at market value, provided that such loans shall be made in
accordance with the guidelines set forth in this prospectus.
6. Invest more than 25% of its total assets (taken at market value
at the time of each investment) in the securities of issuers in a single
industry; provided that, for purposes of this restriction, tax exempt
securities of issuers that are states, municipalities or their political
subdivisions are not considered to be the securities of issuers in any
single industry.
Additional investment restrictions adopted by the Fund, which may be
changed by the Board of Directors without stockholder approval, provide that the
Fund may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the
Fund, (ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities and provided
that the Fund, together with other investment companies having the same
investment adviser and companies controlled by such companies, owns not
more than 10% of the total outstanding stock of any one closed-end
investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Fund except
as may be necessary in connection with borrowings mentioned in investment
restriction (3) above or except as may be necessary in connection with
transactions described under "Other Investment Policies."
c. Purchase any securities on margin, except that the Fund may
obtain such short term credit as may be necessary for the clearance of
purchases and sales of portfolio securities (the deposit or payment by the
Fund of initial or variation margin in connection with financial futures
contracts and options thereon is not considered the purchase of a security
on margin).
d. Change its policy of investing, under normal market conditions,
at least 80% of the Fund's net assets (including assets acquired from the
sale of preferred stock), plus the amount of any borrowings for investment
purposes, in Municipal Bonds with a duration, as calculated by the Fund's
Investment Adviser, of three to ten years, unless the Fund provides
stockholders with at least 60 days' prior written notice of such change.
If a percentage restriction on investment policies or the investment or
use of assets set forth above is adhered to at the time a transaction is
effected, later changes in percentage resulting from changing values will not be
considered a violation.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by the 1940 Act in the proportion
of its assets that it may invest in securities of a single issuer. As a
non-diversified fund, the Fund's investments are limited, however, in order to
allow the Fund to continue to qualify as a regulated investment company under
the Internal Revenue Code of 1986, as amended (the "Code"). See "Taxes." To
qualify, the Fund complies with certain requirements, including limiting its
investments so that at the close of each quarter of the taxable year (i) not
more than 25% of the market value of the Fund's total assets will be invested in
the securities of a single issuer and (ii) with respect to 50% of the market
value of its total assets, not more than 5% of the market value of its total
assets will be invested in the securities of a single issuer and the
5
Fund will not own more than 10% of the outstanding voting securities of a single
issuer. For purposes of this restriction, the Fund will regard each state and
each political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a
non-government entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Board of Directors of the Fund to
the extent necessary to comply with changes in the Federal tax requirements. A
fund that elects to be classified as "diversified" under the 1940 Act must
satisfy the foregoing 5% and 10% requirements with respect to 75% of its total
assets.
The Investment Adviser of the Fund and Merrill Lynch are owned and
controlled by Merrill Lynch & Co., Inc. ("ML & Co."). Because of the affiliation
of Merrill Lynch with the Investment Adviser, the Fund is prohibited from
engaging in certain transactions involving Merrill Lynch except pursuant to an
exemptive order or otherwise in compliance with the provisions of the 1940 Act
and the rules and regulations thereunder. Included among such restricted
transactions will be purchases from or sales to Merrill Lynch of securities in
transactions in which it acts as principal. See "Portfolio Transactions" in this
statement of additional information.
DESCRIPTION OF AMPS
Certain of the capitalized terms used herein are defined in the Glossary
that appears at the back of the prospectus.
The AMPS of each series 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 for each such series. After the Initial
Dividend Period, each Subsequent Dividend Period for each series of 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 each series of 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. Each series of 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 for such series (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.
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
6
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 with respect
to the payment of dividends or upon liquidation.
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 each series 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. 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 a series of 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 which 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 series
of 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 series of 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
7
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 for any
series of AMPS, the next succeeding Dividend Period for that series 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 (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, New York City
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 any series of 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 of such series.
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 of any
series, 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 in the case of
each series of AMPS. 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.
8
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 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 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 which are stock,
including the shares of 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 which 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 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 each share of AMPS outstanding to (but
not including) the end of the current Dividend Period for each series of AMPS
that follows such Valuation Date in the event the then current Dividend Period
for each series of AMPS 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 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
9
Date; (E) the amount of current outstanding balances of any indebtedness which
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's 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 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 ratings 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 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 deliver to Moody's and S&P, as the
case may be, 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"). 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 Fund's fiscal year end, 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 provide Moody's and S&P with an AMPS Basic Maintenance
Report as of each Valuation Date on or before the seventh Business Day 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
25% 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 S&P and 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
10
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 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
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 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 which are
subject to mandatory redemption or the Fund otherwise is unable to effect such
redemption on or prior to 30 days after such Cure Date, the Fund will redeem
those shares of AMPS which it was unable to redeem on the earliest practicable
date on which it is able to effect such redemption.
Notice of Redemption. If shares of AMPS of any series are to be redeemed,
a notice of redemption will be mailed to each record holder of such series 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 aggregate number of shares of AMPS of
such series to be redeemed, (iii) the redemption price, (iv) the place or places
where shares of AMPS of such series 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 and (vi) the provision of the
Articles Supplementary pursuant to which such shares are being redeemed. The
notice also will be published in 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 such series, 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 such series of 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 notice thereof, 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 of such series so called for redemption may look only to the Fund for
payment thereof.
11
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 stock of the Fund ranking on a
parity with the AMPS with respect to the payment of dividends or upon
liquidation, 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 and any other preferred stock, voting as a separate 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 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 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 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 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 which 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 for all past Dividend Periods, the
additional voting rights of the holders of shares of AMPS and any other
preferred stock as described above shall cease, and the terms of office of all
of the additional directors elected by the holders of shares of 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 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, 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 AMPS 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 a series of AMPS
differently than those of a holder of shares of any other series of AMPS without
the affirmative vote of at least a majority of votes entitled to be cast by
holders of the shares of AMPS of each series adversely affected and outstanding
at such time (each such adversely affected series 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, 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)
12
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, voting together as a single class,
will be required to approve any voluntary application by the Fund for relief
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 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 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) 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 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.
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.
13
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 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.
S&P Discount Factors applicable to Municipal Bonds are set forth below:
S&P's Rating Category(1)
--------------------------------------------------------------------------------
AAA* 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.
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 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) be interest bearing and pay interest at least semi-annually;
(iii) be payable with respect to principal and interest in U.S.
dollars;
14
(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
(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;
15
(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%
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" herein. 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 Bond in accordance with the tables set forth below:
Moody's Rating Category(1)
----------------------------------------------------------------
Aaa Aa A Baa Other(2)
---- ---- ---- ---- --------
151% 159% 168% 202% 220%
----------
(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.
16
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.
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 below:
Minimum Maximum Maximum
Issue Size Underlying State Allowed
Rating ($ Millions) Obligor (%)(1) (%)(1)(3)
------ ------------ -------------- -------------
Aaa....................... N/A 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
----------
(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.
N/A Not applicable.
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 ratings then assigned the AMPS by Moody's. When the Fund purchases a
Municipal Bond and
17
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 probbaility 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 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 the Municipal Index 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 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 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.
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-
19
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.
DIRECTORS AND OFFICERS
The Directors of the Fund consist of five individuals, four of whom are
not "interested persons" of the Fund as defined in the 1940 Act (the
"non-interested Directors"). The Directors are responsible for the overall
20
supervision of the operations of the Fund and perform the various duties imposed
on the directors of investment companies by the 1940 Act.
Each non-interested Director is a member of the Fund's Audit and
Nominating Committee (the "Committee"). The principal responsibilities of the
Committee are the appointment, compensation and oversight of the Fund's
independent auditors, including resolution of disagreements regarding financial
reporting between Fund management and such auditors. The Board of the Fund has
adopted a written charter for the Committee. The Committee also reviews and
nominates candidates to serve as non-interested Directors. The Committee has
retained independent legal counsel to assist them in connection with these
duties. Since the Fund was incorporated, the Committee has held one meeting.
Biographical Information
Certain biographical and other information relating to the non-interested
Directors of the Fund is set forth below, including their ages, their principal
occupations for at least the last five years, the length of time served, the
total number of portfolios overseen in the complex of funds advised by the
Investment Adviser and its affiliate, Merrill Lynch Investment Managers, L.P.
("MLIM") ("FAM/MLIM-advised funds") and other public directorships.
Term of Number of
Position(s) Office** and FAM/MLIM-Advised
Name, Address* Held with the Length of Time Principal Occupation(s) Funds and Portfolios Public
and Age Fund Served During Past Five Years Overseen Directorships
------------------ -------------- --------------- --------------------------- -------------------- -------------------
Donald W. Burton Director Director since General Partner of The 21 registered ITC DeltaCom,
(59) 2003 Burton Partnership, Limited investment Inc. (telecom-
Partnership (an Investment companies consisting munications); ITC
Partnership) since 1979; of 35 portfolios Holding Company,
Managing General Partner of Inc. (telecommuni-
The South Atlantic Venture cations);
Funds since 1983; Member of Knology, Inc.
the Investment Advisory (telecommuni-
Committee of the Florida cations);
State Board of MainBancorp, N.A.
Administration since 2001. (bank holding
company);
PriCare, Inc.
(health care);
Symbion, Inc.
(health care)
M. Colyer Crum Director Director since James R. Williston Professor 22 registered Cambridge Bancorp
(71) 2003 of Investment Management investment companies (banking company)
Emeritus, Harvard Business consisting of 36
School since 1996; James R. portfolios
Williston Professor of
Investment Management,
Harvard Business School,
from 1971 to 1996.
Laurie Simon Director Director since Professor of Finance and 21 registered None
Hodrick (40) 2003 Economics, Graduate School investment companies
of Business, Columbia consisting of 35
University since 1998; portfolios
Associate Professor of
Finance and Economics,
Graduate School of Business,
Columbia University from
1996 to 1998.
(footnotes on the next page)
21
Term of Number of
Position(s) Office** and FAM/MLIM-Advised
Name, Address* Held with the Length of Time Principal Occupation(s) Funds and Portfolios Public
and Age Fund Served During Past Five Years Overseen Directorships
------------------ -------------- --------------- --------------------------- -------------------- -------------------
Fred G. Weiss (61) Director Director since Managing Director of FGW 21 registered Watson
2003 Associates since 1977; Vice investment companies Pharmaceutical
President, Planning consisting of 35 Inc. (pharmaceuti-
Investment and Development portfolios cal company)
of Warner Lambert Co. from
1979 to 1997; Director of
BTG International PLC (a
global technology
commercialisation company)
since 2001; Director of the
Michael J. Fox Foundation
for Parkinson's Research.
----------
* The address of each non-interested Director is P.O. Box 9095, Princeton,
New Jersey 08543-9095.
** Each Director serves until his or her successor is elected and qualified,
until December 31 of the year in which he or she turns 72, or until his or
her death, resignation, or removal as provided in the Fund's By-laws,
Charter or by statute.
Certain biographical and other information relating to the Director who is
an "interested person" of the Fund as defined in the 1940 Act (the "interested
Director") and the other officers of the Fund is set forth below, including
their ages, their principal occupations for at least the last five years, the
length of time served, the total number of portfolios overseen in
FAM/MLIM-advised funds and public directorships held.
Number of
Position(s) Term of Office+ FAM/MLIM-Advised
Name, Address* Held with the and Length of Principal Occupation(s) Funds and Portfolios Public
and Age Fund Time Served During Past Five Years Overseen Directorships
------------------ -------------- --------------- --------------------------- -------------------- -------------------
Terry K. President and President and President and Chairman of 114 registered None
Glenn++(62) Director Director+++ the FAM/MLIM-advised funds investment companies
since 2003 since 1999; Chairman consisting of 159
(Americas Region) of MLIM portfolios
from 2000 to 2002; Executive
Vice President of MLIM and
the Investment Adviser
(which terms as used herein,
include their corporate
predecessors) from 1983 to
2002; President of FAM
Distributors, Inc. ("FAMD"
or the "Distributor") from
1986 to 2002 and Director
thereof from 1991 to 2002;
Executive Vice President and
Director of Princeton
Services, Inc. ("Princeton
Services") from 1993 to
2002; President of Princeton
Administrators, L.P. from
1988 to 2002; Director of
Financial Data Services,
Inc. from 1985 to 2002.
Donald C. Burke Vice President Vice President First Vice President of MLIM 113 registered None
(43) and Treasurer and Treasurer since 1997 and the Treasurer investment companies
since 2003 thereof since 1999; Senior consisting of 158
Vice President and Treasurer portfolios
of Princeton Services since
1999; Vice President of FAMD
since 1999; Vice President
of MLIM and the Investment
Adviser from 1990 to 1997;
Director of Taxation of MLIM
since 1990.
(footnotes on the next page)
22
Number of
Position(s) Term of Office+ FAM/MLIM-Advised
Name, Address* Held with the and Length of Principal Occupation(s) Funds and Portfolios Public
and Age Fund Time Served During Past Five Years Overseen Directorships
------------------ -------------- --------------- --------------------------- -------------------- -------------------
Kenneth A. Jacob Senior Vice Senior Vice Managing Director of MLIM 37 registered None
(52) President President since since 2000; First Vice investment companies
2003 President of MLIM from 1997 consisting of 49
to 2000; Vice President of portfolios
MLIM from 1984 to 1997; Vice
President of the Investment
Adviser since 1984.
John M. Loffredo Senior Vice Senior Vice Managing Director of MLIM 37 registered None
(39) President President since since 2000; First Vice investment companies
2003 President of MLIM from 1997 consisting of 49
to 2000; Vice President of portfolios
MLIM from 1991 to 1997;
Portfolio Manager of the
Investment Adviser and MLIM
since 1997.
Robert A. DiMella Vice President Vice President Vice President of MLIM since 5 registered None
(36) and Portfolio since 2003 1997; Assistant Vice investment companies
Manager President of MLIM from 1995 consisting of 5
to 1997; Assistant Portfolio portfolios
Investment Adviser of MLIM
from 1993 to 1995.
Brian D. Stewart Secretary Secretary since Vice President of MLIM since 37 registered None
(34) 2003 2002; Attorney associated investment companies
with Reed Smith LLP from consisting of 51
2001 to 2002; Attorney portfolios
associated with Saul Ewing
LLP from 1999 to 2001.
----------
* The address of each officer is P.O. Box 9011, Princeton, New Jersey
08543-9011.
+ Elected by and serves at the pleasure of the Board of Directors of the
Fund.
++ Mr. Glenn is a director, trustee or member of an advisory board of certain
other investment companies for which MLIM or the Investment Adviser acts
as investment adviser. Mr. Glenn is an "interested person," as defined in
the 1940 Act, of the Fund based on his former positions with the
Investment Adviser, MLIM, FAMD, Princeton Services and Princeton
Administrators, L.P.
+++ As Director, Mr. Glenn serves until his successor is elected and
qualified, until December 31 of the year in which he turns 72, or until
his death, resignation, or removal as provided in the Fund's By-laws,
Charter or by statute.
In connection with the election of the Fund's Directors, holders of shares
of AMPS and other preferred stock, voting as a separate class, will be entitled
to elect two of the Fund's Directors, and the remaining Directors will be
elected by all holders of capital stock, voting as a single class. Mr. Crum and
Ms. Hodrick have been designated as the Directors to be 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,
2002 is set forth in the chart below.
Aggregate Dollar Range
Aggregate Dollar Range of Securities in Supervised
Name of Equity in the Fund Merrill Lynch Funds*
---- ---------------------- ---------------------------
Interested Director:
Terry K. Glenn............................. None Over $100,000
Non-interested Directors:
Donald W. Burton........................... None Over $100,000
M. Colyer Crum............................. None Over $100,000
Laurie Simon Hodrick....................... None Over $100,000
Fred G. Weiss.............................. None Over $100,000
----------
* For the number of FAM/MLIM-advised funds from which each Director receives
compensation, see the table above under "Directors and Officers --
Biographical Information."
23
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 AMPS of the Fund. As of the date of this statement of additional information,
none of the non-interested Directors of the Fund nor any of their immediate
family members owned beneficially or of record any securities in ML & Co.
Compensation of Directors
Pursuant to its investment advisory agreement with the Fund (the
"Investment Advisory Agreement"), the Investment Adviser pays all compensation
of officers and employees of the Fund as well as the fees of all Directors of
the Fund who are affiliated persons of ML & Co. or its subsidiaries as well as
such Directors' actual out-of-pocket expenses relating to attendance at
meetings.
The Fund pays each non-interested Director a combined fee for services on
the Board and the Committee of $3,000 per year, $250 per in person Board meeting
attended and $250 per in person committee meeting attended. The Fund pays the
Chairman of the Committee an additional fee of $500 per year. The Fund
reimburses each non-interested Director for his or her out-of-pocket expenses
relating to attendance at Board and Committee meetings.
The following table sets forth the estimated compensation to be paid by
the Fund to the non-interested Directors projected through the end of the Fund's
first full fiscal year and the aggregate compensation paid to them from all
registered FAM/MLIM-advised funds for the calendar year ended December 31, 2002.
Pension or Aggregate
Retirement Compensation
Benefits Estimated From Fund and
Accrued as Annual other
Position Compensation Part of Fund Benefits Upon FAM/MLIM-
Name of Director with Fund From Fund Expense Retirement Advised Funds
---------------- --------- ------------ ------------ ------------- -------------
Donald W. Burton..................... Director $5,000 None None $189,042
M. Colyer Crum*...................... Director $5,500 None None $226,583
Laurie Simon Hodrick................. Director $5,000 None None $208,917
Fred G. Weiss........................ Director $5,000 None None $208,917
----------
* Chairman of the Committee.
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser, which is owned and controlled by ML & Co., a
financial services holding company and the parent of Merrill Lynch, provides the
Fund with investment advisory and administrative services. The Investment
Adviser acts as the investment adviser to more than 100 registered investment
companies and offers investment advisory services to individuals and
institutional accounts. As of June 2003, the Investment Adviser and its
affiliates, including MLIM, had a total of approximately $498 billion in
investment company and other portfolio assets under management, including
approximately $262 billion in fixed income assets. This amount includes assets
managed by certain affiliates of the Investment Adviser. The Investment Adviser
is a limited partnership, the partners of which are ML & Co. and Princeton
Services. The principal business address of the Investment Adviser is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement provides that, subject to the direction
of the Fund's Board of Directors, the Investment Adviser is responsible for the
actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.
The portfolio manager primarily responsible for the Fund's day-to-day
management is Robert A. DiMella. Robert DiMella has been a Vice President of
MLIM since 1997 and has 13 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 Fund is also assisted by 13 research analysts with an average of 12 years of
experience. The Investment Adviser will also be responsible for the performance
of certain management services for the Fund.
For its services, the Fund pays the Investment Adviser a monthly fee at
the annual rate of 0.55% of the Fund's average daily net assets plus the
proceeds of any outstanding borrowings used for leverage ("average daily net
assets" means the average daily value of the total assets of the Fund, including
the amount obtained from leverage
24
and any proceeds from the issuance of preferred stock, minus the sum of (i)
accrued liabilities of the Fund, (ii) any accrued and unpaid interest on
outstanding borrowings and (iii) accumulated dividends on shares of preferred
stock). For purposes of this calculation, average daily net assets is determined
at the end of each month on the basis of the average net assets of the Fund for
each day during the month. It is understood that the liquidation preference of
any outstanding preferred stock (other than accumulated dividends) is not
considered a liability in determining the Fund's average daily net assets.
The Investment Adviser has contractually agreed to waive a portion of its
fee during the first seven years of the Fund's operations ending July 31, 2010,
as follows:
Fee Waiver (as
a percentage of
average daily
net assets)
---------------
Years 1 through 5............................... 0.15%
Year 6.......................................... 0.10%
Year 7.......................................... 0.05%
Year 8 and thereafter........................... 0.00%
The Investment Adviser has not agreed to waive any portion of its fee beyond
July 31, 2010.
The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and furnish
office space for officers and employees of the Fund connected with investment
and economic research, trading and investment management of the Fund, as well as
the compensation of all Directors of the Fund who are affiliated persons of the
Investment Adviser or any of its affiliates. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of preparing, printing and mailing
proxies, listing fees, stock certificates and stockholder reports, charges of
the custodian and the transfer agent, dividend disbursing agent and registrar,
Commission fees, fees and expenses of non-interested Directors, accounting and
pricing costs, insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, mailing and other expenses properly
payable by the Fund. Certain accounting services are provided to the Fund by
State Street 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.
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940 Act)
of any such party. Such contract is not assignable and may be terminated without
penalty on 60 days' written notice at the option of either party thereto or by
the vote of the stockholders of the Fund.
In connection with the Board of Directors' consideration of the Investment
Advisory Agreement, the Board reviewed information derived from a number of
sources and covering a range of issues relating to, among other things,
alternatives to the Investment Advisory Agreement. The Board of Directors
considered the services to be provided to the Fund by the Investment Adviser
under the Investment Advisory Agreement, as well as other services to be
provided by the Investment Adviser and its affiliates under other agreements,
and the personnel who will provide these services. In addition to the investment
advisory services to be provided to the Fund, the Investment Adviser and its
affiliates will provide administrative services, stockholder services, oversight
of fund accounting, assistance in meeting legal and regulatory requirements, and
other services necessary for the operation of the Fund. The Fund's Board of
Directors also considered the direct and indirect benefits to the Investment
Adviser from its relationship with the Fund. The benefits considered by the
Board of Directors included not only the Investment Adviser's compensation for
investment advisory services, but also compensation paid to the Investment
Adviser or its affiliates for other non-advisory services provided to the Fund.
The Board of Directors concluded that the advisory fee was reasonable in
relation to the services to be provided by the Investment Adviser to the Fund as
well as the anticipated costs and benefits to be gained by the Investment
Adviser in providing such services.
25
In reaching its conclusion, the Board of Directors focused on the
experience, resources and strengths of the Investment Adviser and its affiliates
in managing leveraged, closed-end investment companies that invest in Municipal
Bonds. The Board of Directors, based on their experience as directors of other
investment companies managed by the Investment Adviser and its affiliates, also
focused on the quality of the compliance and administrative staff at the
Investment Adviser. In connection with its consideration of the Investment
Advisory Agreement, the Board of Directors placed significant emphasis on the
Fund's advisory fee rate and anticipated expense ratios as compared to those of
comparable leveraged, closed-end funds managed by other investment advisers
("comparable funds") investing in Municipal Bonds and similar instruments as
provided by Lipper Inc. In particular, the Board of Directors reviewed the
advisory fee rate of eleven comparable leveraged, closed-end funds with
substantially similar investment objectives and policies. The Board of Directors
noted that the Fund has the lowest contractual advisory fee rate at the
estimated asset level for the Fund among the comparable funds. Based in part on
this fee comparison, and taking into account the quality of the various services
to be provided to the Fund by the Investment Adviser and its affiliates
discussed above, the Investment Adviser's experience in managing Municipal
Bonds, and the Board of Directors' experience with the nature and quality of
portfolio management, administrative and compliance services provided by the
Investment Adviser to other investment companies, the Fund's Board of Directors
concluded that the advisory fee rate was reasonable. The Board of Directors
considered whether there should be changes in the advisory fee rate or structure
in order to enable the Fund to participate in any economies of scale that the
Investment Adviser may experience as a result of growth in the Fund's assets.
The Fund's Board of Directors also reviewed materials supplied by counsel that
were prepared for use by the Board of Directors in fulfilling its duties under
the 1940 Act.
Based on the information reviewed and the discussions, the Board of
Directors, including a majority of the non-interested Directors, concluded that
it was satisfied with the nature and quality of the services to be provided by
the Investment Adviser to the Fund and that the advisory fee rate was reasonable
in relation to such services. The non-interested Directors were represented by
independent counsel who assisted them in their deliberations.
Code of Ethics
The Fund's Board of Directors approved a Code of Ethics under Rule 17j-1
of the 1940 Act that covers the Fund and the Investment Adviser. The Code of
Ethics establishes procedures for personal investing and restricts certain
transactions. Employees subject to the Code of Ethics may invest in securities
for their personal investment accounts, including securities that may be
purchased or held by the Fund.
Proxy Voting 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 "Committee"). The 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 Committee will also include two non-voting
representatives from the Investment Adviser's Legal department appointed by the
Investment Adviser's General Counsel. The 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 Committee or
participate in its decision making (except to the extent such person is asked by
the Committee to present information to the Committee, on the same basis as
other interested knowledgeable parties not affiliated with the Investment
Adviser
26
might be asked to do so). The 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 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 Committee may determine to vote a particular proxy in a manner contrary to
its generally stated policies. In addition, the Committee will be responsible
for ensuring that all reporting and recordkeeping requirements related to proxy
voting are fulfilled.
The 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 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
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 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 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 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
Committee determines that the costs associated with voting generally outweigh
the benefits. The 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
(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 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
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 Committee may, in its discretion for the purposes of ensuring
that an independent determination is reached, retain an independent fiduciary to
advise the Committee on how to vote or to cast votes on behalf of the Investment
Adviser's clients.
In the event that the Committee determines not to retain an independent
fiduciary, or it does not follow the advice of such an independent fiduciary,
the powers of the Committee shall pass to a subcommittee, appointed by the CIO
(with advice from the Secretary of the Committee), consisting solely of
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,
27
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 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 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 Committee member
and may be amended or deleted upon the vote of a majority of Committee members
present at a 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
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 Committee, therefore, believes that the foundation
of good corporate governance is the election of qualified,
independent corporate directors who are likely to diligently
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 Committee may look at a
nominee's history of representing stockholder interests as a
director of other companies or other factors, to the extent the
Committee deems relevant.
o Proposals related to the selection of an issuer's independent
auditors. As a general matter, the 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
Committee will generally defer to a corporation's choice of auditor,
in individual cases, the Committee may look at an auditors' history
of representing stockholder interests as auditor of other companies,
to the extent the Committee deems relevant.
o Proposals related to management compensation and employee benefits.
As a general matter, the 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 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 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
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 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.
28
o Proposals related to limiting corporate conduct in some manner that
relates to the stockholder's environmental or social concerns. The
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 Committee is generally supportive of proposals to
require corporate disclosure of matters that seem relevant and
material to the economic interests of stockholders, the Committee is
generally not supportive of proposals to require disclosure of
corporate matters for other purposes.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any dealer or group of dealers in the execution of transactions in
portfolio securities of the Fund. Where possible, the Fund deals directly with
the dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Fund to obtain the best results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread or commission), the size, type and difficulty of
the transaction involved, 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.
29
The Fund has received an exemptive order from the Commission permitting it
to lend portfolio securities to Merrill Lynch or its affiliates. Pursuant to
that order, the Fund also has retained an affiliated entity of the Investment
Adviser as the securities lending agent for a fee, including a fee based on a
share of the returns on investment of cash collateral. That entity may, on
behalf of the Fund, invest cash collateral received by the Fund for such loans,
among other things, in a private investment company managed by that entity or in
registered money market funds advised by the Investment Adviser or its
affiliates.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
investment objectives or other factors, a particular security may be bought for
an advisory client when other clients are selling the same security. If
purchases or sales of securities by the Investment Adviser for the Fund or other
funds for which it acts as investment adviser or for other advisory clients
arise for consideration at or about the same time, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. Transactions effected by the
Investment Adviser (or its affiliates) on behalf of more than one of its clients
during the same period may increase the demand for securities being purchased or
the supply of securities being sold, causing an adverse effect on price.
Section 11(a) of the Securities Exchange Act of 1934 generally prohibits
members of the U.S. national securities exchanges from executing exchange
transactions for their affiliates and institutional accounts that they manage
unless the member (i) has obtained prior express authorization from the account
to effect such transactions, (ii) at least annually furnishes the account with a
statement setting forth the aggregate compensation received by the member in
effecting such transactions, and (iii) complies with any rules the Commission
has prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch acting as a broker for the
Fund in any of its portfolio transactions executed on any such securities
exchange of which it is a member, appropriate consents have been obtained from
the Fund and annual statements as to aggregate compensation will be provided to
the Fund.
Portfolio Turnover
Generally, the Fund does not purchase securities for short term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such actions, for defensive or other reasons, appear
advisable to the Investment Adviser. While it is not possible to predict
turnover rates with any certainty, at present it is anticipated that the Fund's
annual portfolio turnover rate, under normal circumstances, should be less than
100%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded.) A high portfolio turnover rate results in greater transaction costs,
which are borne directly by the Fund and also has certain tax consequences for
stockholders.
TAXES
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") 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 to its
stockholders would be taxable as ordinary income.
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.
30
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 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 exempt from Federal income tax ("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 which 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
"industrial development bonds" or "private activity bonds," if any, held by the
Fund.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short-term capital gains over
net long-term capital losses ("ordinary income dividends"), such distributions
are considered ordinary income for Federal income tax purposes. Distributions,
if any, from an excess of net long-term capital gains over net short-term
capital losses derived from the sale of securities or from certain transactions
in futures or options ("capital gain dividends") are taxable as long-term
capital gains for Federal income tax purposes, regardless of the length of time
the stockholder has owned Fund shares. Generally not later than 60 days after
the close of its taxable year, the Fund will provide its stockholders with a
written notice designating the amounts of any exempt-interest dividends and
capital gain dividends. 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. 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.
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.
31
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
of each series. 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 the series 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 series of 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 "private activity bonds" issued after August
7, 1986. Private activity bonds are bonds which, although tax-exempt, are used
for purposes other than
32
those performed by governmental units and which benefit non-governmental
entities (e.g., bonds used for industrial development or housing purposes).
Income received on such bonds is classified as an item of "tax preference,"
which could subject certain investors in such bonds, including stockholders of
the Fund, to an increased Federal alternative minimum tax. The Fund intends to
purchase such "private activity bonds" and will report to stockholders within 60
days after calendar year-end the portion of its dividends declared during the
year 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.
The Fund may invest in instruments the return on which includes
nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such nontraditional
instruments could be recharacterized as taxable ordinary income.
The Fund may engage in interest rate swaps. The Federal income tax rules
governing the taxation of interest rate swaps are not entirely clear and may
require the Fund to treat payments received under such arrangements as ordinary
income and to amortize payments under certain circumstances. Additionally,
because the treatment of swaps under the RIC qualification rules is not clear,
the Fund will monitor its activity in this regard in order to maintain its
qualification as a RIC. Because payments received by the Fund in connection with
swap transactions will be taxable rather than tax exempt, they may result in
increased taxable distributions to stockholders.
Certain transactions of the Fund are subject to complex Federal income tax
provisions that may, among other things, (a) affect the character of gains and
losses realized, (b) disallow, suspend or otherwise limit the allowance of
certain losses or deductions, and (c) accelerate the recognition of income.
Operation of these tax rules could, therefore, affect the character, amount and
timing of distributions and result in increased taxable distributions to
stockholders. Special tax rules also will require the Fund to mark-to-market
certain types of positions in its portfolio (i.e., treat them as sold on the
last day of the taxable year), and may result in the recognition of income
without a corresponding receipt of cash. The Fund intends to monitor its
transactions, make appropriate tax elections and make appropriate entries in its
books and records to lessen the effect of these tax rules and avoid any possible
disqualification for the special treatment afforded RICs under the Code.
If at any time when shares of 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 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
33
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"). 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.
The Fund is generally not an appropriate investment for retirement plans,
other entities that are not subject to tax and foreign stockholders.
State and Local Taxes
The exemption from Federal income tax for exempt-interest dividends does
not necessarily result in an exemption for such dividends under the income or
other tax laws of any state or local taxing authority. Stockholders are advised
to consult their own tax advisers concerning state and local matters.
In some states, the portion of any exempt-interest dividend that is
derived from interest received by a RIC on its holdings of that state's
securities and its political subdivisions and instrumentalities is exempt from
that state's income tax. Therefore, the Fund will report annually to its
stockholders the percentage of interest income earned by the Fund during the
preceding year on tax-exempt obligations indicating, on a state-by-state basis
the source of such income.
----------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Stockholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
NET ASSET VALUE
Net asset value per share of common stock is determined Monday through
Friday as of the close of business on the NYSE (generally, the NYSE closes at
4:00 p.m., Eastern time), on each business day during which the NYSE is open for
trading. For purposes of determining the net asset value of a share of common
stock, the value of the securities held by the Fund plus any cash or other
assets (including interest accrued but not yet received) minus all liabilities
(including accrued expenses) and the aggregate liquidation value of any
outstanding shares of preferred stock is divided by the total number of shares
of common stock outstanding at such time. Expenses, including the fees payable
to the Investment Adviser, are accrued daily.
The Municipal Bonds in which the Fund invests are traded primarily in the
over-the-counter markets. In determining net asset value, the Fund uses the
valuations of portfolio securities furnished by a pricing service approved by
the Board of Directors. The pricing service typically values portfolio
securities at the bid price or the yield equivalent when quotations are readily
available. Municipal Bonds for which quotations are not readily available are
valued at fair market value on a consistent basis as determined by the pricing
service using a matrix system to determine valuations. The procedures of the
pricing service and its valuations are reviewed by the officers of the Fund
under the general supervision of the Board of Directors. The Board of Directors
has determined in good faith that the use of a pricing service is a fair method
of determining the valuation of portfolio securities. Positions in futures
contracts and interest rate swaps are valued at closing prices for such
contracts established by the exchange or dealer market on which they are traded,
or if market quotations are not readily available, are valued at fair value on a
consistent basis using methods approved in good faith by the Board of Directors.
34
The Fund makes available for publication the net asset value of its shares
of common stock determined as of the last business day each week. Currently, the
net asset values of shares of publicly traded closed-end investment companies
investing in debt securities are published in Barron's, the Monday edition of
The Wall Street Journal and the Monday and Saturday editions of The New York
Times.
The value of interest rate swaps, caps and floors is determined in
accordance with a formula and then confirmed periodically by obtaining a bank
quotation. Positions in options are valued at the last sale price on the market
where any such option is principally traded. Positions in futures contracts are
valued at closing prices for such contracts established by the exchange on which
they are traded. Obligations with remaining maturities of 60 days or less are
valued at amortized cost unless this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest.
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 Commission. Any
such reports and other information, including the Fund's Code of Ethics, can be
inspected and copied at the public reference facilities of the Commission at
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the following regional offices of the Commission: Pacific Regional Office, at
5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036; and Midwest
Regional Office, at Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such materials can be obtained
from the public reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission maintains a Web site
at http://www.sec.gov containing reports and information statements and other
information regarding registrants, including the Fund, that file electronically
with the Commission. Reports, proxy statements and other information concerning
the Fund can also be inspected at the offices of the New York Stock Exchange.
Additional information regarding the Fund is contained in the Registration
Statement on Form N-2, including amendments, exhibits and schedules thereto,
relating to such shares filed by the Fund with the Commission in Washington,
D.C. This prospectus does not contain all of the information set forth in the
Registration Statement, including any amendments, exhibits and schedules
thereto. For further information with respect to the Fund and the shares offered
hereby, reference is made to the Registration Statement. Statements contained in
this prospectus as to the contents of any contract or other document referred to
are not necessarily complete and in each instance reference is made to the copy
of such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. A copy of the Registration Statement may be inspected without charge
at the Commission's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the Commission upon the payment of certain
fees prescribed by the Commission.
35
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholder,
Muni Intermediate Duration Fund, Inc.:
We have audited the accompanying statement of assets and liabilities of Muni
Intermediate Duration Fund, Inc. as of July 17, 2003. This statement of assets
and liabilities is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this statement of assets and
liabilities based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the statement of assets and
liabilities is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement of
assets and liabilities. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement of assets and liabilities presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of Muni
Intermediate Duration Fund, Inc. at July 17, 2003 in conformity with accounting
principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
July 21, 2003
F-1
MUNI INTERMEDIATE DURATION FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
July 17, 2003
ASSETS
Cash .................................................................................... $100,003
Deferred offering costs (Note 1).......................................................... 575,205
--------
Total assets........................................................................ 675,208
========
LIABILITIES
Liabilities and accrued expenses (Note 1)................................................. 575,205
--------
NET ASSETS................................................................................... $100,003
========
NET ASSETS CONSIST OF:
Common Stock, par value $.10 per share; 200,000,000 shares authorized; 6,981 shares
issued and outstanding (Note 1)......................................................... 698
Paid-in Capital in excess of par.......................................................... 99,305
--------
Total Capital--Equivalent to $14.325 net asset value per share of Common Stock (Note 1)... $100,003
========
NOTES TO STATEMENT OF ASSETS AND LIABILITIES
Note 1. Organization
The Fund was incorporated under the laws of the State of Maryland on May
15, 2003, and is registered under the Investment Company Act of 1940, as a
closed-end, non-diversified management investment company and has had no
operations other than the sale to Fund Asset Management, L.P. (the "Investment
Adviser") of an aggregate of 6,981 shares for $100,003 on July 17, 2003. The
General Partner of the Investment Adviser is an indirect wholly-owned subsidiary
of Merrill Lynch & Co., Inc. Certain officers and/or directors of the Fund are
officers of the Investment Adviser.
The Investment Adviser, on behalf of the Fund, will incur organization
costs estimated at $51,500. To the extent that the Fund's offering costs
otherwise do not exceed $.03 per share of common stock, the Fund has agreed to
pay the underwriters up to $.005 per share of common stock as a partial
reimbursement of expenses incurred in connection with the offering. However, in
no event will the Fund pay offering costs (other than the underwriting discount,
but including the partial reimbursement to the underwriters) in excess of $.03
per share of common stock. The Investment Adviser or an affiliate will pay the
amount by which the offering costs of the Fund (other than the underwriting
discount, and the $.005 per share partial reimbursement of expenses to the
underwriters) exceeds $.03 per share of common stock. Direct costs relating to
the public offering of the Fund's shares will be charged to capital at the time
of issuance of shares.
Note 2. Investment Advisory Arrangements
The Fund has engaged the Investment Adviser to provide investment advisory
and management services to the Fund. The Investment Adviser will receive a
monthly fee for advisory and management services at an annual rate of 0.55% of
the Fund's average daily net assets (including any proceeds from the issuance of
preferred stock), plus the proceeds of any outstanding borrowings used for
leverage.
The Investment Adviser has contractually agreed to waive a portion of its
fee during the first five full years of operations at the annual rate of 0.15%
of the average daily net assets of the Fund and at a declining rate for an
additional two years. The Investment Adviser has not agreed to waive any portion
of its fee beyond the seven year period.
Note 3. Federal Income Taxes
The Fund intends to qualify as a "regulated investment company" and as
such (and by complying with the applicable provisions of the Internal Revenue
Code of 1986, as amended) will not be subject to Federal income tax on taxable
income (including realized capital gains) that is distributed to stockholders.
Note 4. Use of Estimates
The Fund's statement of assets and liabilities is prepared in conformity
with accounting principles generally accepted in the United States, which may
require the use of management accruals and estimates. Actual results may differ
from these estimates.
F-2
MUNI INTERMEDIATE DURATION FUND, INC.
SCHEDULE OF INVESTMENTS (Unaudited)
AUGUST 6, 2003
(In Thousands)
S&P Moody's Face
STATE Ratings Ratings Amount Municipal Bonds Value
---------------------------------------------------------------------------------------------------------------------------------
California -- 23.9% AAA Aaa $ 20,000 California State Department Water Resource Power Supply,
Revenue Bond, Series A, 5.50% due 5/01/2013 (a) ............. $ 21,930
-----------------------------------------------------------------------------------------------------------
AAA Aaa 20,000 California State, GO, TRACER, 5% due 2/01/2016 (b) ............ 20,683
-----------------------------------------------------------------------------------------------------------
SP1 VMIG1+ 50,000 California State, RAW, Series A, 2% due 6/16/2004 ............. 50,132
-----------------------------------------------------------------------------------------------------------
Los Angeles, California, University School District, GO:
AAA Aaa 10,000 (Election of 1997-Series F), 5% due 7/01/2017 (c) ........... 10,347
AAA Aaa 5,000 Series A, 5.375% due 7/01/2017 (d)........................... 5,355
-----------------------------------------------------------------------------------------------------------
San Jose, California, Airport Revenue Bonds, Series A:
AAA Aaa 2,040 5.25% due 3/01/2016.......................................... 2,161
AAA Aaa 3,000 5.25% due 3/01/2017.......................................... 3,164
---------------------------------------------------------------------------------------------------------------------------------
Colorado -- 1.6% NR* NR* 7,500 Plaza Metropolitan District, Colorado, Tax Incremental
No. 1 Revenue Bonds (Public Improvement Fees),
7.50% due 12/01/2015......................................... 7,481
---------------------------------------------------------------------------------------------------------------------------------
Florida -- 1.0% AAA Aaa 4,345 Orlando & Orange County, Florida, Expressway
Authority Revenue Refunding Bonds, Series A,
5.25% due 7/01/2016 (a)...................................... 4,639
---------------------------------------------------------------------------------------------------------------------------------
Illinois -- 1.6% AAA Aaa 7,350 Chicago, Illinois, Public Building, Community Building
Revenue Bonds (Chicago Transit Authority),
5.25% due 3/01/2018 (a)...................................... 7,670
---------------------------------------------------------------------------------------------------------------------------------
Massachusetts -- 2.6% A1 VMIG1+ 12,350 Massachusetts State, GO, Refunding, VRDN, Series B,
0.85% due 9/01/2016 (e)...................................... 12,350
---------------------------------------------------------------------------------------------------------------------------------
Missouri -- 11.0% Missouri State Regional Convention & Sports Complex
Authority, Revenue Bonds (Convention & Sports Facility
Project A-1) (a):
AAA Aaa 6,640 5.375% due 8/15/2015......................................... 7,205
AAA Aaa 7,405 5.25% due 8/15/2016.......................................... 7,898
AAA Aaa 7,770 5.25% due 8/15/2017.......................................... 8,223
-----------------------------------------------------------------------------------------------------------
St. Louis County, Missouri, Revenue Refunding Bonds
(Regional Convention & Sports Complex
Authority/Facilities Project), Series B-1 (a):
AAA Aaa 2,485 5.375% due 8/15/2015......................................... 2,696
AAA Aaa 3,700 5.25% due 8/15/2016.......................................... 3,946
AAA Aaa 3,895 5.25% due 8/15/2017.......................................... 4,122
-----------------------------------------------------------------------------------------------------------
St. Louis, Missouri, Airport Revenue Bonds (Airport
Developmental Program), Series A (d):
AAA Aaa 5,220 5.625% due 7/01/2016......................................... 5,603
AAA Aaa 3,500 5.625% due 7/01/2017......................................... 3,809
AAA Aaa 8,500 5.625% due 7/01/2018......................................... 9,202
---------------------------------------------------------------------------------------------------------------------------------
Montana -- 0.4% AA+ Aa1 2,035 Montana State Board of Housing, AMT, S/F Program
Revenue Bonds, Series B-2, 6.35% due 12/01/2021................ 2,137
---------------------------------------------------------------------------------------------------------------------------------
Nevada -- 3.3% AAA Aaa 14,780 Clark County, Nevada, Passenger Facility Charge, Revenue
Refunding Bonds (Las Vegas McCarran International),
5.375% due 7/01/2014 (d)..................................... 15,740
---------------------------------------------------------------------------------------------------------------------------------
New Jersey -- 5.4% AAA Aaa 7,975 Garden State Preservation Trust, New Jersey, Revenue Bonds,
Series A, 5.25% due 11/01/2018 (c)........................... 8,387
-----------------------------------------------------------------------------------------------------------
AAA Aaa 7,980 New Jersey Economic Development Authority Revenue
School Facilities, Revenue Bonds, Series F,
5.25% due 6/15/2019 (b)...................................... 8,297
-----------------------------------------------------------------------------------------------------------
AA- Aa3 8,000 New Jersey State Transportation Transit Funding Authority,
Revenue Bonds, Series A, 5.625% due 6/15/2013................ 8,898
---------------------------------------------------------------------------------------------------------------------------------
New York -- 22.2% AAA A2 5,050 New York City, New York, GO, Refunding, Series F,
5.25% due 8/01/2015 (d)...................................... 5,359
-----------------------------------------------------------------------------------------------------------
A A2 14,000 New York City, New York, GO, Series C,
5.50% due 8/01/2013.......................................... 14,827
-----------------------------------------------------------------------------------------------------------
A A2 5,000 New York City, New York, Refunding, Series B, 5.75%
due 8/01/2015................................................ 5,291
F-3
MUNI INTERMEDIATE DURATION FUND, INC.
SCHEDULE OF INVESTMENTS (Unaudited) (Continued)
AUGUST 6, 2003
(In Thousands)
S&P Moody's Face
STATE Ratings Ratings Amount Municipal Bonds Value
---------------------------------------------------------------------------------------------------------------------------------
New York (concluded) AA+ Aa2 $ 2,800 New York City, New York, Transitional Finance Authority
Revenue Bonds, Future Tax Secured, Series C,
5.50% due 5/01/2025.......................................... $ 2,906
-----------------------------------------------------------------------------------------------------------
New York State Dormitory Authority Revenue Bonds (North
Shore L I Jewish Group):
NR* A3 840 5% due 5/01/2011............................................... 874
NR* A3 1,000 5% due 5/01/2012............................................... 1,032
-----------------------------------------------------------------------------------------------------------
New York State Dormitory Authority Revenue Refunding
Bonds, Series A:
AAA Aaa 11,450 (City University System), Consolidated Second Generation,
6.125% due 7/01/2012 (a)..................................... 13,000
-----------------------------------------------------------------------------------------------------------
AAA Aaa 7,775 (City University System), Consolidated Second Generation,
6.125% due 7/01/2013 (a)..................................... 8,842
-----------------------------------------------------------------------------------------------------------
AAA NR* 12,660 (Third General Resources), 5.25% due 11/15/2012 (d) ......... 13,917
-----------------------------------------------------------------------------------------------------------
NR* VMIG1+ 20,000 New York State HFA, M/F Revenue Bonds (Kew Gardens Hills),
VRDN, AMT, Series A, 0.85% due 5/15/2036 (e)................. 20,000
-----------------------------------------------------------------------------------------------------------
AA- A3 4,755 New York State Thruway Authority, Service Contract Revenue
Refunding Bonds (Local Highway & Bridge),
5.50% due 4/01/2017.......................................... 5,114
-----------------------------------------------------------------------------------------------------------
Tobacco Settlement Financing Corporation, New York,
Revenue Bonds, Series A-1:
AA- NR* 2,500 5.50% due 6/01/2014.......................................... 2,611
AA- NR* 1,840 5.50% due 6/01/2016.......................................... 1,906
AAA NR* 10,000 5.25% due 6/01/2022 (a)...................................... 10,215
---------------------------------------------------------------------------------------------------------------------------------
Pennsylvania -- 5.9% Erie County, Pennsylvania, GO, Series A (d):
NR* Aaa 2,245 5.375% due 9/01/2014......................................... 2,464
NR* Aaa 2,140 5.375% due 9/01/2015......................................... 2,328
NR* Aaa 2,445 5.375% due 9/01/2016......................................... 2,639
-----------------------------------------------------------------------------------------------------------
Pennsylvania State Turnpike Commission, Highway
Improvement Senior Revenue Bonds (Oil Franchise Tax) (d):
AAA Aaa 2,895 Series A, 5% due 12/01/2011.................................. 3,141
AAA Aaa 2,840 Series A, 5.25% due 12/01/2012............................... 3,121
AAA Aaa 3,370 Series B, 5.25% due 12/01/2016............................... 3,603
AAA Aaa 3,860 Series B, 5.25% due 12/01/2017............................... 4,093
-----------------------------------------------------------------------------------------------------------
Sayre, Pennsylvania, Health Care Facilities Authority Revenue
Refunding Bonds (Guthrie Health), Series A:
A- NR* 1,750 6.25% due 12/01/2015......................................... 1,870
A- NR* 3,000 6.25% due 12/01/2016......................................... 3,176
A- NR* 1,490 6.25% due 12/01/2018......................................... 1,559
---------------------------------------------------------------------------------------------------------------------------------
South Carolina -- 2.0% AAA Aaa 8,745 South Carolina State Public Service Authority, Revenue
Refunding Bonds, Series A, 5.50% due 1/01/2010 (c) .......... 9,708
---------------------------------------------------------------------------------------------------------------------------------
Tennessee -- 2.8% NR* VMIG1+ 10,000 Sevier County, Tennessee, Public Building Authority
Revenue Bonds, Local Government Public Improvement IV,
VRDN, Series B-2, 0.71% due 6/01/2019 (c)(e)................. 10,000
-----------------------------------------------------------------------------------------------------------
Shelby County, Tennessee, Health, Educational and Housing
Facility Board, Hospital Revenue Bonds (Methodist Healthcare):
A- Baa1 2,000 6% due 9/01/2017............................................. 2,096
A- Baa1 1,000 6.25% due 9/01/2018.......................................... 1,061
---------------------------------------------------------------------------------------------------------------------------------
Texas -- 2.0% BBB Baa2 4,250 Brazos River Authority, Texas, PCR, Refunding (TXU
Electric Company Project), AMT, Series C,
5.75% due 5/01/2036.......................................... 4,333
-----------------------------------------------------------------------------------------------------------
BBB Baa2 5,000 Sabine River Authority, Texas, PCR, Refunding (TXU
Electric Company Project/TXU Energy Company LLC),
AMT, Series B, 5.75% due 5/01/2030........................... 5,098
---------------------------------------------------------------------------------------------------------------------------------
Washington -- 4.1% Port Seattle, Washington, Revenue Refunding Bonds, Series A (d):
AAA Aaa 9,435 5.25% due 7/01/2015.......................................... 10,088
AAA Aaa 8,930 5.25% due 7/01/2016.......................................... 9,475
---------------------------------------------------------------------------------------------------------------------------------
Wisconsin -- 1.7% A- Baa2 8,500 Badger Asset Securitization Corporation, Asset-Backed
Revenue Bonds, 5.75% due 6/01/2012........................... 8,093
F-4
MUNI INTERMEDIATE DURATION FUND, INC.
SCHEDULE OF INVESTMENTS (Unaudited) (Concluded)
AUGUST 6, 2003
(In Thousands)
S&P Moody's Face
STATE Ratings Ratings Amount Municipal Bonds Value
---------------------------------------------------------------------------------------------------------------------------------
Puerto Rico -- 2.2% A- Baa1 $10,000 Puerto Rico Commonwealth, Public Improvement Refunding
Bonds, GO, Series C, 5% due 7/01/2018........................ $ 10,703
---------------------------------------------------------------------------------------------------------------------------------
Total Municipal Bonds (Cost -- $447,031) -- 93.7% ............. 446,618
---------------------------------------------------------------------------------------------------------------------------------
Shares
Held Short-Term Securities
---------------------------------------------------------------------------------------------------------------------------------
119,000 Merrill Lynch Institutional Tax-Exempt Fund **................. 119,000
---------------------------------------------------------------------------------------------------------------------------------
Total Short-Term Securities (Cost -- $119,000) -- 24.9% ....... 119,000
---------------------------------------------------------------------------------------------------------------------------------
Total Investments (Cost -- $566,031) -- 118.6%................. 565,618
---------------------------------------------------------------------------------------------------------------------------------
Liabilities in Excess of Other Assets -- (18.6%)............... (88,624)
--------
---------------------------------------------------------------------------------------------------------------------------------
Net Assets Applicable to Common Stock -- 100.0%................ $476,994
========
---------------------------------------------------------------------------------------------------------------------------------
+ Highest short-term rating by Moody's Investors Service, Inc.
* Not Rated.
** Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
--------------------------------------------------------------------------
Net Dividend
Affiliate Activity Income
--------------------------------------------------------------------------
Merrill Lynch Institutional Tax-Exempt Fund........ 119,000 $14,410
--------------------------------------------------------------------------
See Notes to Financial Statements (Unaudited).
(a) AMBAC Insured.
(b) FGIC Insured.
(c) FSA Insured.
(d) MBIA Insured.
(e) The interest rate is subject to change periodically based upon prevailing
market rates. The interest rate shown is the rate in effect at August 6,
2003.
Portfolio Abbreviations
To simplify the listings of Municipal Intermediate Duration Fund, Inc.'s
portfolio holdings in the Schedule of Investments, we have abbreviated the names
of many of the securities according to the list below.
AMT Alternative Minimum Tax (subject to)
GO General Obligation Bonds
HFA Housing Finance Agency
M/F Multi-Family
PCR Pollution Control Revenue Bonds
RAW Revenue Anticipation Warrants
S/F Single-Family
TRACER Tradeable Custodial Receipts
VRDN Variable Rate Demand Notes
F-5
MUNI INTERMEDIATE DURATION FUND, INC.
STATEMENT OF NET ASSETS
(Unaudited)
As of August 6, 2003
-------------------------------------------------------------------------------------------------------------------
Assets: Investments, at value (identified cost-$566,031,420) ..... $565,617,546
Receivables:
Securities sold......................................... $ 42,506,401
Interest................................................ 2,506,593
Dividends............................................... 14,410
Investment adviser...................................... 3,912 45,031,316
------------ ------------
Total assets ............................................. 610,648,862
------------
-------------------------------------------------------------------------------------------------------------------
Liabilities: Payables:
Securities purchased.................................... 121,124,163
Custodian bank.......................................... 12,076,921
Offering cost........................................... 449,175
Other affiliates........................................ 171 133,650,430
------------
Accrued expenses and other liabilities.................... 4,635
------------
Total liabilities......................................... 133,655,065
------------
-------------------------------------------------------------------------------------------------------------------
Net Assets Net assets applicable to Common Stock..................... $476,993,797
Applicable to ============
Common Stock:
-------------------------------------------------------------------------------------------------------------------
Analysis of Net Common Stock, par value $.10 per share
Assets Applicable (33,356,981 shares issued and outstanding).............. $ 3,335,698
To Common Stock: Paid-in capital in excess of par.......................... 473,887,130
Undistributed investment income-net....................... $ 184,843
Unrealized depreciation on investments-net................ (413,874)
------------
Total accumulated losses-net.............................. (229,031)
------------
Total-Equivalent to $14.30 net asset value per share of
Common Stock (market price-$15.00) ..................... $476,993,797
============
-------------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements (Unaudited).
F-6
MUNI INTERMEDIATE DURATION FUND, INC.
STATEMENT OF OPERATIONS
(Unaudited)
For the Period August 1, 2003+ to August 6, 2003
-------------------------------------------------------------------------------------------------------------------------
Investment Interest ................................................. $ 171,326
Income: Dividends................................................. 14,410
---------
Total income.............................................. 185,736
---------
-------------------------------------------------------------------------------------------------------------------------
Expenses: Investment advisory fees.................................. $ 42,944
Accounting services....................................... 2,444
Custodian fees............................................ 468
Transfer agent fees....................................... 431
Directors' fees and expenses.............................. 366
Professional fees......................................... 348
Printing and shareholder reports.......................... 318
Pricing fees.............................................. 259
Other..................................................... 172
--------
Total expenses before waiver and reimbursement............ 47,750
Waiver and reimbursement of expenses...................... (46,857)
--------
Total expenses after waiver and reimbursement............. 893
---------
Investment income-net..................................... 184,843
---------
-------------------------------------------------------------------------------------------------------------------------
Unrealized Loss on Unrealized depreciation on investments--net .............. (413,874)
---------
Investments--Net: Net Decrease in Net Assets Resulting from Operations .... $(229,031)
=========
-------------------------------------------------------------------------------------------------------------------------
+ Commencement of operations.
See Notes to Financial Statements (Unaudited).
F-7
MUNI INTERMEDIATE DURATION FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
(Unaudited)
For the Period
August 1, 2003+
Increase (Decrease) in Net Assets: to August 6, 2003
-----------------------------------------------------------------------------------------------------------------
Operations: Investment income-net....................................................... $ 184,843
Unrealized depreciation on investments-net.................................. (413,874)
------------
Net decrease in net assets resulting from operations........................ (229,031)
------------
-----------------------------------------------------------------------------------------------------------------
Common Stock Net proceeds from issuance of Common Stock.................................. 477,738,750
Transactions: Offering costs resulting from the issuance of Common Stock.................. (615,925)
------------
Net increase in net assets derived from Common Stock transactions........... 477,122,825
------------
-----------------------------------------------------------------------------------------------------------------
Net Assets Total increase in net assets applicable to Common Stock..................... 476,893,794
Applicable to Beginning of period......................................................... 100,003
------------
Common Stock: End of period*.............................................................. $476,993,797
============
-----------------------------------------------------------------------------------------------------------------
* Undistributed investment income-net....................................... $ 184,843
============
-----------------------------------------------------------------------------------------------------------------
+ Commencement of operations.
See Notes to Financial Statements (Unaudited).
F-8
MUNI INTERMEDIATE DURATION FUND, INC.
Financial Highlights
(Unaudited)
The following per share data and ratios have been derived
from information provided in the financial statements
For the Period
August 1, 2003+
Increase (Decrease) in Net Asset Value: to August 6, 2003
--------------------------------------------------------------------------------------------------------------------
Per Share Net asset value, beginning of period..................................... $ 14.33
Operating --------
Performance: Investment income-net.................................................... .01
Unrealized loss on investments-net....................................... (.02)
--------
Total from investment operations......................................... (.01)
--------
Capital charge resulting from issuance of Common Stock................... (.02)
--------
Net asset value, end of period........................................... $ 14.30
========
Market price per share, end of period.................................... $ 15.00
========
--------------------------------------------------------------------------------------------------------------------
Total Based on market price per share.......................................... 0.00%++
Investment ========
Return:** Based on net asset value per share....................................... (0.21%)++
========
--------------------------------------------------------------------------------------------------------------------
Ratios Based on Expenses, net of waiver and reimbursement................................ .01%*
Average Net Assets ========
of Common Stock: Expenses ................................................................ .61%*
========
Investment income-net.................................................... 2.36%*
========
--------------------------------------------------------------------------------------------------------------------
Supplemental Net assets applicable to Common Stock, end of period (in thousands)...... $476,994
Data: ========
Portfolio turnover....................................................... --
========
--------------------------------------------------------------------------------------------------------------------
* 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. The Investment Adviser voluntarily waived all of its management
fee from August 1, 2003 (commencement of operations) to August 6, 2003.
Without such waiver, the Fund's performance would have been lower.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements (Unaudited).
F-9
MUNI INTERMEDIATE DURATION FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Significant Accounting Policies:
Muni Intermediate Duration Fund, Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a non-diversified, closed-end
management investment company. Prior to commencement of operations on August 1,
2003, the Fund had no operations other than those relating to organizational
matters and the sale of 6,981 shares of Common Stock on July 17, 2003 to Fund
Asset Management, L.P. ("FAM") for $100,003. The Fund's financial statements are
prepared in conformity with accounting principles generally accepted in the
United States of America, which may require the use of management accruals and
estimates. These unaudited financial statements reflect all adjustments, which
are, in the opinion of management, necessary to a fair statement of the results
for the interim period presented. The Fund's Common Stock is listed on the New
York Stock Exchange under the symbol MUI. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments -- Municipal bonds are traded primarily in the
over-the-counter markets and are valued at the most recent bid price or yield
equivalent as obtained by the Fund's pricing service from dealers that make
markets in such securities. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their closing prices as of the
close of such exchanges. Options written or purchased are valued at the last
sale price in the case of exchange-traded options. In the case of options traded
in the over-counter-market, valuation is the last asked price (options written)
or the last bid price (options purchased). Forward interest rate swaps are
valued by quoted fair values received daily by the Fund from the counterparty.
Securities with remaining maturities of sixty days or less are valued at
amortized cost, which approximates market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Fund, including valuations furnished by a pricing service retained by the
Fund, which may utilize 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 Board of Directors.
(b) Derivative financial instruments -- The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movement and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
o Financial futures contracts-- The Fund may purchase or sell financial
futures contracts and options on such futures contracts. Futures contracts
are contracts for delayed delivery of securities at a specific future date
and at a specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required by
the exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an amount
of cash equal to the daily fluctuation in value of the contract. Such
receipts or payments are known as variation margin and are recorded by the
Fund as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss equal to the difference between the value
of the contract at the time it was opened and the value at the time it was
closed.
o Options-- The Fund is authorized to write covered call options and
purchase call and put options. When the Fund writes an option, an amount
equal to the premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently marked
to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the
related premium paid (or received) is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to
the extent of the premiums received or paid (or gain or loss to the extent
the cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
o Forward interest rate swaps -- The Fund is authorized to enter into forward
interest rate swaps. In a forward interest rate swap, the Fund and the
counterparty agree to pay or receive interest on a specified notional
contract amount, commencing on a specified future effective date, unless
terminated earlier. When the agreement is closed, the Fund records a
realized gain or loss in an amount equal to the value of the agreement.
F-10
(c) Income taxes -- It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(e) Dividends and distributions -- Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
(f) Custodian bank -- The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft, which resulted from a failed trade that
settled the next day.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
an annual rate of 0.55% of the Fund's average daily net assets, including
proceeds from the issuance of Preferred Stock. For the period August 1, 2003 to
August 6, 2003, FAM earned fees of $42,944, all of which was waived. FAM also
reimbursed the Fund in the amount of $3,913 for additional expenses.
During the period August 1, 2003 to August 6, 2003, Merrill Lynch, Pierce,
Fenner & Smith Incorporated, an affiliate of FAM, received underwriting fees of
$22,511,250 in connection with the issuance of the Fund's Common Stock.
For the period August 1, 2003 to August 6, 2003, the Fund reimbursed FAM $2,273
for certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, and/or ML & Co.
3. Investments:
Purchases of investments, excluding short-term securities, for the period August
1, 2003 to August 6, 2003 were $354,589,186.
Net unrealized gains (losses) as of August 6, 2003 were as follows:
--------------------------------------------------------------------------------
Unrealized
Gains (Losses)
--------------------------------------------------------------------------------
Long-term investments....................................... $(415,849)
Short-term investments...................................... 1,975
---------
Total....................................................... $(413,874)
=========
--------------------------------------------------------------------------------
As of August 6, 2003, net unrealized depreciation for Federal income tax
purposes aggregated $413,874, of which $1,027,944 related to appreciated
securities and $1,441,818 related to depreciated securities. The aggregate cost
of investments at August 6, 2003 for Federal income tax purposes was
$566,031,420.
4. Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of stock, including Preferred
Stock, par value $.10 per share, all of which were initially classified as
Common Stock. The Board of Directors is authorized, however, to reclassify any
unissued shares of stock without approval of holders of Common Stock.
Common Stock
Shares issued and outstanding during the period August 1, 2003 to August 6, 2003
increased by 33,350,000 from shares sold.
F-11
APPENDIX A
RATINGS OF MUNICIPAL BONDS
Description of Moody's Investors Service, Inc.'s ("Moody's") Municipal Bond
Ratings
Aaa Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are
generally referred to as "gilt edged." Interest payments are
protected by a large or by an exceptionally stable margin and
principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most
unlikely to impair the fundamentally strong position of such
issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high-grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in
Aaa securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which
make the long term risk in Aa-rated bonds appear somewhat larger
than those securities rated Aaa.
A Bonds which are rated A possess many favorable investment
attributes and are to be considered as
upper-medium-grade-obligations. Factors giving security to
principal and interest are considered adequate, but elements may
be present which suggest a susceptibility to impairment some time
in the future.
Baa Bonds which are rated Baa are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly
secured). Interest payments and principal security appear adequate
for the present, but certain protective elements may be lacking or
may be characteristically unreliable over any great length of
time. Such bonds lack outstanding investment characteristics and
in fact have speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the
protection of interest and principal payments may be very
moderate, and thereby not well safeguarded during both good and
bad times over the future. Uncertainty of position characterizes
bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments
or of maintenance of other terms of the contract over any long
period of time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect
to principal or interest.
Ca Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or
have other marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects
of ever attaining any real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa1, A1, Baa1, Ba1 and B1.
Short term Notes: The three ratings of Moody's for short term notes are
MIG 1/VMIG 1, MIG 2/VMIG 2, and MIG 3/VMIG 3; MIG 1/VMIG 1 denotes "best
quality, enjoying strong protection from established cash flows"; MIG 2/VMIG 2
denotes "high quality" with "ample margins of protection"; MIG 3/VMIG 3
instruments are of "favorable quality... but... lacking the undeniable strength
of the preceding grades."
Description of Moody's Commercial Paper Ratings
Moody's Commercial Paper ratings are opinions of the ability of issuers to
honor senior financial obligations and contracts. Such obligations generally
have an original maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
A-1
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: leading market
positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
to repay senior short term debt obligations. This will normally be evidenced by
many of the characteristics cited above, but to a lesser degree. Earnings trends
and coverage ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short term promissory obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Description of Standard & Poor's ("Standard & Poor's") Municipal Debt Ratings
A Standard & Poor's municipal debt rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations or a specific program. It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or based on circumstances.
The ratings are based, in varying degrees, on the following
considerations:
I. Likelihood of payment--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, and relative position of, the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
AAA An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial
commitment on the obligation is extremely strong.
AA An obligation rated "AA" differs from the highest rated issues
only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
A An obligation rated "A" is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than debt in higher-rated categories. However, the
obligor's capacity to meet its financial commitment on the
obligation is still strong.
BBB An obligation rated "BBB" exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet
its financial commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as having
significant speculative characteristics. "BB" indicates the least degree of
speculation and "C" the highest. While such debt will likely have some quality
and protective characteristics, these may be outweighed by large uncertainties
or major risk exposures to adverse conditions.
A-2
BB An obligation rated "BB" is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing
uncertainties or exposure to adverse business, financial, or
economic conditions which could lead to the obligor's inadequate
capacity to meet its financial commitment on the obligation.
B An obligation rated "B" is more vulnerable to nonpayment than
obligations rated 'BB', but the obligor currently has the capacity
to meet its financial commitment on the obligation. Adverse
business, financial, or economic conditions will likely impair the
obligor's capacity or willingness to meet its financial commitment
on the obligation.
CCC An obligation rated "CCC" is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the
obligation. In the event of adverse business, financial, or
economic conditions, the obligor is not likely to have the
capacity to meet its financial commitment on the obligation.
CC An obligation rated "CC" is currently highly vulnerable to
nonpayment.
C A subordinated debt or preferred stock obligation rated "C" is
CURRENTLY HIGHLY VULNERABLE to nonpayment. The "C" rating may be
used to cover a situation where a bankruptcy petition has been
filed or similar action taken, but payments on this obligation are
being continued. A `C' also will be assigned to a preferred stock
issue in arrears on dividends or sinking fund payments, but that
is currently paying.
D An obligation rated "D" is in payment default. The "D" rating
category is used when payments on an obligation are not made on
the date due even if the applicable grace period has not expired,
unless Standard & Poor's believes that such payments will be made
during such grace period. The "D" rating also will be used upon
the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
Description of Standard & Poor's Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from "A-1" for the
highest-quality obligations to "D" for the lowest. These categories are as
follows:
A-1 This designation indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus
sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as
high as for issues designated "A-1."
A-3 Issues carrying this designation have an adequate capacity for
timely payment. They are, however, more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the
higher designations.
B Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C This rating is assigned to short term debt obligations with a
doubtful capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is
used when interest payments of principal payments are not made on
the date due, even if the applicable grace period has not expired,
unless Standard & Poor's believes such payments will be made
during such grace period.
A commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A-3
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.
Description of Fitch Ratings ("Fitch") Investment Grade Bond Ratings
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided
by insurance policies or financial guarantees unless otherwise indicated.
Bonds carrying the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated "AAA."
Because bonds rated in the "AAA" and "AA" categories are not
significantly vulnerable to foreseeable future developments, short
term debt of these issuers is generally rated "F-1+."
A Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal
is considered to be strong, but may be more vulnerable to adverse
changes in economic conditions and circumstances than bonds with
higher ratings.
BBB Bonds considered to be investment grade and of satisfactory-credit
quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic
conditions and circumstances, however, are more likely to have
adverse impact on these bonds, and therefore impair timely
payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher
ratings.
A-4
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised or
lowered. FitchAlert is relatively short term, and should be
resolved within 12 months.
Ratings Outlook: An outlook is used to describe the most likely direction
of any rating change over the intermediate term. It is described as "Positive"
or "Negative." The absence of a designation indicates a stable outlook.
Description of Fitch's Speculative Grade Bond Ratings
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives can
be identified which could assist the obligor in satisfying its
debt service requirements.
B Bonds are considered highly speculative. While bonds in this class
are currently meeting debt service requirements, the probability
of continued timely payment of principal and interest reflects the
obligor's limited margin of safety and the need for reasonable
business and economic activity throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, Bonds are in default on interest and/or principal payments. Such
DD, bonds are extremely speculative and should be valued on the basis
and D of their ultimate recovery value in liquidation or reorganization
Default 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.
A-5
Description of Fitch's Short Term Ratings
Fitch's short term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium term notes, and municipal and investment
notes.
The short term rating places greater emphasis than a long term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than
issues rated "F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as for issues assigned "F-1+" and
"F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could
cause these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of
credit issued by a commercial bank.
A-6
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 of this 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 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;
B-1
(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
(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-2
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. 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 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) as follows:
Applicable Applicable Applicable Applicable
Percentage Percentage Spread Over Spread Over
Credit Ratings 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 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 "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., New York City 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.
C-1
(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
(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
C-2
(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-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
C-3
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
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
C-4
(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 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
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
C-5
(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 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
C-6
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-7