As filed with the Securities and Exchange Commission on May 16, 2003
Securities Act File No. 333-
Investment Company Act File No. 811-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] PRE-EFFECTIVE AMENDMENT NO.
[ ] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[ ] AMENDMENT NO.
(Check appropriate box or boxes)
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MUNI INTERMEDIATE DURATION FUND, INC.
(Exact Name of Registrant as Specified in Charter)
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800 Scudders Mill Road
Plainsboro, New Jersey 08536
(Address of Principal Executive Offices)
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(609) 282-2800
(Registrant's Telephone Number, Including Area Code)
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Terry K. Glenn
Muni Intermediate Duration Fund, Inc.
800 Scudders Mill Road, Plainsboro, New Jersey 08536
Mailing Address: P.O. Box 9011, Princeton, New Jersey 08543-9011
(Name and Address of Agent for Service)
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Copies to:
Andrew J. Donohue, Esq. Laurin Blumenthal Kleiman, Esq.
FUND ASSET MANAGEMENT, L.P. SIDLEY AUSTIN BROWN & WOOD LLP
P.O. Box 9011 787 Seventh Avenue
Princeton, New Jersey 08543-9011 New York, New York 10019
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Approximate date of proposed public offering: As soon as practicable after the
effective date of this Registration Statement.
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If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, as amended (the "Securities Act"), other than securities offered only
in connection with dividend or interest reinvestment plans, check the
following box. [_]
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
================================ ===================== ==================== ===================== ====================
Proposed
Proposed Maximum
Title of Amount Maximum Aggregate Amount of
Securities Being Being Offering Price Offering Registration
Registered Registered(1)(2) Per Unit(1) Price(1) Fee(3)
-------------------------------- --------------------- -------------------- --------------------- --------------------
Common Stock ($.10 par
value)............... 66,667 shares $15.00 $1,000,005 $81
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(1) Estimated solely for the purpose of calculating the registration fee.
(2) Includes shares subject to the underwriters' overallotment option.
(3) Previously paid. Transmitted prior to the original filing date to the
designated lockbox at Mellon Bank in Pittsburgh, PA.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BECOME NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT, WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(A), MAY DETERMINE.
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an
offer to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
Subject To Completion
Preliminary Prospectus dated May 16, 2003
PROSPECTUS
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_____________ Shares
Muni Intermediate Duration Fund, Inc.
Common Stock
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Muni Intermediate Duration Fund, Inc. is a newly organized,
non-diversified, closed-end fund. The primary investment objective of the Fund
is to provide stockholders with high current income exempt from Federal income
taxes. The Fund seeks to achieve its objective by investing primarily 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. The Fund
intends to invest in municipal obligations that are rated investment grade or,
if unrated, are considered by the Fund's investment adviser to be of
comparable quality. Under normal market conditions and after the initial
investment period following this offering, at least 80% of the Fund's net
assets will be invested in municipal obligations with a duration of three to
ten years. The Fund expects to maintain, under normal market conditions, a
dollar-weighted average portfolio duration of three to ten years. 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 current market conditions, the Fund expects to invest
primarily in municipal obligations that are rated investment grade. There can
be no assurance that the Fund's investment objective will be realized.
(continued on following page)
Investing in the Fund's common stock involves certain risks that are
described in the "Risk Factors and Special Considerations" section beginning
on page ____ of this prospectus.
Per Share Total
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Public offering price................................ $15.00 $
Underwriting discount................................ $ $
Proceeds, before expenses, to the Fund............... $ $
The underwriters may also purchase up to an additional _______ shares at
the public offering price, less the underwriting discount, within 45 days from
the date of this prospectus to cover overallotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
The shares will be ready for delivery on or about ___________, 2003.
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Merrill Lynch & Co.
[names of underwriting syndicate members]
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The date of this prospectus is ___________, 2003.
Because the Fund is newly organized, its shares have no history of public
trading. Shares of closed-end investment companies frequently trade at a price
lower than their net asset value. This is commonly referred to as "trading at
a discount." The risk may be greater for investors expecting to sell their
shares in a relatively short period after completion of the public offering.
The Fund plans to apply to list its shares on the New York Stock Exchange or
another national securities exchange under the symbol "_____."
The Fund may leverage through borrowings or the issuance of preferred
stock or debt securities. Within approximately three months after completion
of this offering of common stock, the Fund intends to offer shares of
preferred stock representing approximately ___% of the Fund's capital, or
approximately ___% of the Fund's common stock equity, immediately after the
issuance of such preferred stock. There can be no assurance, however, that
preferred stock representing such percentage of the Fund's capital will
actually be issued. The use of preferred stock to leverage the common stock
can create special risks. There can be no assurance that a leveraging strategy
will be successful during any period in which it is employed.
This prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep
it for future reference.
2
TABLE OF CONTENTS
Page
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Prospectus Summary...........................................................................................4
Risk Factors and Special Considerations......................................................................8
Fee Table...................................................................................................11
The Fund....................................................................................................13
Use of Proceeds.............................................................................................13
Investment Objective and Policies...........................................................................13
Other Investment Policies...................................................................................23
Risks and Special Considerations of Leverage................................................................25
Investment Restrictions.....................................................................................28
Directors and Officers......................................................................................30
Investment Advisory and Management Arrangements.............................................................32
Portfolio Transactions......................................................................................33
Dividends and Distributions.................................................................................35
Taxes.......................................................................................................36
Automatic Dividend Reinvestment Plan........................................................................39
Mutual Fund Investment Option...............................................................................41
Net Asset Value.............................................................................................41
Description of Capital Stock................................................................................41
Custodian...................................................................................................44
Underwriting................................................................................................45
Transfer Agent, Dividend Disbursing Agent and Registrar.....................................................47
Accounting Services Provider................................................................................47
Legal Opinions..............................................................................................47
Independent Auditors and Experts............................................................................47
Additional Information......................................................................................47
Report of Independent Auditors..............................................................................49
Statement of Assets and Liabilities.........................................................................50
Appendix A Ratings of Municipal Bonds.....................................................................A-1
Appendix B Taxable Equivalent Yields For 2002.............................................................B-1
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INFORMATION ABOUT THE FUND CAN BE REVIEWED AND COPIED AT THE SEC'S PUBLIC
REFERENCE ROOM IN WASHINGTON, D.C. CALL 1-202-942-8090 FOR INFORMATION ON THE
OPERATION OF THE PUBLIC REFERENCE ROOM. THIS INFORMATION IS ALSO AVAILABLE ON
THE SEC'S INTERNET SITE AT HTTP://WWW.SEC.GOV AND COPIES MAY BE OBTAINED UPON
PAYMENT OF A DUPLICATING FEE BY WRITING THE PUBLIC REFERENCE SECTION OF THE
SEC, WASHINGTON, D.C. 20549-0102.
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You should rely only on the information contained in this prospectus. We
have not, and the underwriters have not, authorized any other person to
provide you with different information. If anyone provides you with different
or inconsistent information, you should not rely on it. We are not, and the
underwriters are not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted. You should assume that
the information appearing in this prospectus is accurate only as of the date
on the front cover of this prospectus. Our business, financial condition,
results of operations and prospects may have changed since that date.
3
PROSPECTUS SUMMARY
This summary is qualified in its entirety by reference to the detailed information included in this prospectus.
The Fund Muni Intermediate Duration Fund, Inc. is a newly organized, non-diversified, closed-end fund.
The Offering The Fund is offering _________ shares of common stock at an initial offering price of $15.00 per
share through a group of underwriters led by Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch"). You must purchase at least 100 shares of common stock to participate in this
offering. The underwriters may purchase up to an additional _______ shares of common stock
within 45 days of the date of this prospectus to cover overallotments, if any.
Investment The investment objective of the Fund is to provide stockholders with high current income exempt
Objective and from Federal income taxes. The Fund seeks to achieve its objective by investing primarily in a
Policies portfolio of investment grade municipal obligations the interest on which, in the opinion of
bond counsel to the issuer, is exempt from Federal income taxes ("Municipal Bonds"). The Fund
will normally invest at least 80% of its net assets in Municipal Bonds with a duration of three
to ten years. 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,
at least 80% of the Fund's net assets will be invested in municipal obligations with a duration
of three to ten years. The Fund also 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. In general, the Fund does not
intend its investments to earn a large amount of interest income that is not exempt from Federal
income taxes.
Investment Grade Municipal Bonds. The Fund intends to invest in Municipal Bonds that are rated
investment grade by one or more nationally recognized statistical rating agencies or in unrated
bonds considered by the Investment Adviser to be of comparable quality.
Junk Bonds. The Fund may invest up to 25% of its total assets in junk bonds. Junk bonds are debt
securities that are rated below investment grade by the major rating agencies or are unrated
securities that Fund management believes are of comparable quality. 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
4
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.
Use of Issuance of Preferred Stock. The Fund intends to offer shares of preferred stock within
Leverage by approximately three months after completion of this offering. Under current market conditions
the Fund it is anticipated that the preferred stock will represent approximately ___% of the Fund's
capital, including the capital raised by issuing the preferred stock, or approximately ___% of
the Fund's common stock equity. There can be no assurance, however, that preferred stock will
actually be issued or if issued what percentage of the Fund's capital it will represent. Issuing
preferred stock will result in the leveraging of the Fund's common stock. Although the Board of
Directors has not yet determined the terms of the preferred stock offering, the Fund expects
that the preferred stock will pay dividends that will be adjusted over either relatively short
term periods (generally seven to 28 days) or medium term periods (up to five years) and that the
preferred stock dividend rate will be based upon prevailing interest rates for debt obligations
of comparable maturity. The proceeds of the preferred stock offering will be invested in
accordance with the Fund's investment objective. The expenses of the preferred stock, which will
be borne by the Fund, will reduce the net asset value of the Fund's common stock. During periods
when the Fund has preferred stock outstanding, the Fund will pay fees to the Investment Adviser
for its services that are higher than if the Fund did not issue preferred stock because the fees
will be calculated on the basis of the Fund's average daily net assets including proceeds from
the sale of preferred stock.
Potential Benefits of Leverage. Under normal market conditions, the Investment Adviser believes
that the dividend and interest income on the Fund's portfolio should exceed the dividend rate
the Fund must pay to the preferred stockholders. Thus, the Fund's use of preferred stock should
provide common stockholders with a higher yield than they would receive if the Fund were not
leveraged, although no assurance can be given that the issuance of preferred stock will result
in a higher yield to common stockholders.
5
Risks of Leverage. The use of leverage creates certain risks for common stockholders, including
higher volatility of both the net asset value and the market value of the common stock. Since
any decline in the value of the Fund's investments will affect only the common stockholders, in
a declining market the use of leverage will cause the Fund's net asset value to decrease more
than it would if the Fund were not leveraged. This decrease in net asset value will likely also
cause a decline in the market price for shares of common stock. In addition, fluctuations in the
dividend rates paid on, and the amount of taxable income allocable to, the preferred stock will
affect the yield to common stockholders. There can be no assurance that the Fund will earn a
higher net return on its investments than the then current dividend rate (and any Additional
Distribution) it pays on the preferred stock. Under certain conditions, the benefits of leverage
to common stockholders will be reduced, and the Fund's leveraged capital structure could result
in a lower rate of return to common stockholders than if the Fund were not leveraged.
During times of rising interest rates, the market value of the Fund's portfolio investments and,
consequently, the net asset value of its shares may decline. The Fund's leveraging of its
portfolio by issuing preferred stock may accentuate the potential decline. The Fund also may
invest in inverse floating obligations and similar securities that create investment leverage,
which may further accentuate any decline. Any investor who purchases shares with borrowed funds
may experience an even greater decline.
Distributions. When the Fund issues preferred stock, common stockholders will receive all of the
Fund's net income that remains after it pays dividends (and any Additional Distribution) on the
preferred stock and generally will be entitled to a pro rata share of net realized capital
gains. If the Fund is liquidated, preferred stockholders will be entitled to receive liquidating
distributions before any distribution is made to common stockholders. These liquidating
distributions are expected to equal the original purchase price per share of the preferred stock
plus any accumulated and unpaid dividends and Additional Distributions.
Redemption of Preferred Stock. The Fund may redeem the preferred stock for any reason. For
example, the Fund may redeem all or part of the preferred stock if it believes that the Fund's
leveraged capital structure will cause common stockholders to obtain a lower return than they
would if the common stock were unleveraged for any significant amount of time.
Voting Rights. Preferred stockholders, voting as a separate class, will be entitled to elect two
of the Fund's Directors. Common and preferred stockholders, voting together as a single class,
will be entitled to elect the remaining Directors. If the Fund fails to pay dividends to the
preferred stockholders for two full years, the holders of all outstanding shares of preferred
stock, voting as a separate class, would then be entitled to elect a majority of the Fund's
Directors. The preferred stockholders also will vote separately on certain other matters as
required under the Fund's Articles of Incorporation, as amended and supplemented (the
"Charter"), the Investment Company Act of 1940, as amended (the "1940 Act"), and the General
Corporation Law of the State of Maryland. Otherwise, common and preferred stockholders will have
equal voting rights (one vote per share) and will vote together as a single class.
Ratings. Before it offers the preferred stock, the Fund intends to apply to one or more
nationally recognized statistical ratings organizations for ratings on the preferred stock. The
Fund believes that a rating for the preferred stock will make it easier to market the stock,
which should reduce the dividend rate.
Listing Currently, there is no public market for the Fund's common stock. However, the Fund plans to
apply to list the Fund's shares of common stock on the New York Stock Exchange or another
national securities exchange under the symbol "___."
6
Investment Fund Asset Management, L.P., the Investment Adviser, provides investment advisory and
Adviser administrative services to the Fund. For its services, the Fund pays the Investment Adviser a
monthly fee at the annual rate of ____% of the Fund's average daily net assets (including assets
acquired from the sale of any preferred stock), plus the proceeds of any outstanding borrowings
used for leverage.
Dividends and The Fund intends to distribute dividends from its net investment income monthly, and net
Distributions realized capital gains, if any, at least annually. The Fund expects that it will commence paying
dividends within 90 days of the date of this prospectus. Once the Fund issues preferred stock,
the monthly dividends to common stockholders will consist of all or a portion of net investment
income that remains after the Fund pays dividends on the preferred stock. Currently, in order to
maintain a more stable level of monthly dividend distributions to common stockholders, the Fund
intends to pay out less than all of its net investment income or pay out accumulated
undistributed income in addition to current net investment income. The Fund will distribute net
capital gains, if any, at least annually to common stockholders and, after it issues the
preferred stock, on a pro rata basis to common and preferred stockholders. The Fund may not
declare any cash dividend or other distribution on its common stock unless the preferred stock
has asset coverage of at least 200%. If the Fund issues preferred stock representing ____% of
its total capital, the preferred stock's asset coverage will be approximately ___%. If the
Fund's ability to make distributions on its common stock is limited, the Fund may not be able to
qualify for taxation as a regulated investment company. This would have adverse tax consequences
for stockholders.
Yield The yield on the Fund's common stock will vary from period to period depending on factors
Considerations including, but not limited to, the length of the initial investment period, market conditions,
the timing of the Fund's investment in portfolio securities, the securities comprising the
Fund's portfolio, the ability of the issuers of the portfolio securities to pay interest on such
securities, changes in tax exempt interest rates (which may not change to the same extent or in
the same direction as taxable rates) including changes in the relationship between short term
rates and long term rates, the amount and timing of the issuance of the Fund's preferred stock,
the effects of preferred stock leverage on the common stock discussed above under "Leverage,"
the timing of the investment of preferred stock proceeds in portfolio securities, the Fund's net
assets and its operating expenses. Consequently, the Fund cannot guarantee any particular yield
on its shares and the yield for any given period is not an indication or representation of
future yields on Fund shares. The Fund's ability to achieve any particular yield level after it
commences operations depends on future interest rates and other factors mentioned above, and the
initial yield and later yields may be lower. Any statements as to the estimated yield are as of
the date made, and no guarantee can be given that the Fund will achieve or maintain any
particular yield level.
Automatic Dividend and capital gains distributions generally are used to purchase additional shares of
Dividend the Fund's common stock. However, an investor can choose to receive distributions in cash.
Reinvestment Since not all investors can participate in the automatic dividend reinvestment plan, you should
Plan call your broker or nominee to confirm that you are eligible to participate in the plan.
Mutual Fund Investors who purchase shares in this offering and later sell their shares have the option,
Investment Option subject to certain conditions, to purchase Class A shares of certain funds advised by the
Investment Adviser or its affiliates with the proceeds from such sale.
7
RISK FACTORS AND SPECIAL CONSIDERATIONS
An investment in the Fund's common stock should not constitute a complete
investment program.
Liquidity and Market Price of Shares. The Fund is newly organized and has
no operating history or history of public trading.
Shares of closed-end funds that trade in a secondary market frequently
trade at a market price that is below their net asset value. This is commonly
referred to as "trading at a discount." The risk may be greater for investors
expecting to sell their shares in a relatively short period after completion
of the public offering. Accordingly, the Fund is designed primarily for long
term investors and should not be considered a vehicle for trading purposes.
Net asset value will be reduced following the offering by the underwriting
discount and the amount of offering expenses paid by the Fund.
Non-diversification. The Fund is registered as a "non-diversified"
investment company. This means that the Fund may invest a greater percentage
of its assets in a single issuer than a diversified investment company. Since
the Fund may invest a relatively high percentage of its assets in a limited
number of issuers, the Fund may be more exposed to any single economic,
political or regulatory occurrence than a more widely-diversified fund. Even
as a non-diversified fund, the Fund must still meet the diversification
requirements of applicable Federal income tax law.
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 the Municipal Bonds in the Fund's portfolio is generally less
than that for corporate equities or bonds, and the investment performance of
the Fund may therefore be more dependent on the analytical abilities of the
Investment Adviser than that of a stock fund or taxable bond fund.
Interest Rate and Credit Risk. The Fund invests in Municipal Bonds, which
are subject to interest rate and credit risk. Interest rate risk is the risk
that prices of Municipal Bonds generally increase when interest rates decline
and decrease when interest rates increase. Prices of longer term securities
generally change more in response to interest rate changes than prices of
shorter term securities. The Fund's use of leverage by the issuance of
preferred stock and its investment in inverse floating obligations, as
discussed below, may increase interest rate risk. 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 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. The Fund intends
to invest in Municipal Bonds that are rated investment grade by Standard &
Poor's, Moody's Investors Service, Inc. or Fitch Ratings. It may also invest
in unrated Municipal Bonds that the Investment Adviser believes are of
comparable quality. 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 by
the major rating agencies or are unrated securities that Fund management
believes are of comparable quality. Securities rated below investment grade,
also known as junk bonds, generally entail greater interest rate and credit
risks than investment grade securities. For example, their prices are more
volatile, economic downturns and financial setbacks may affect their prices
more negatively, and their trading market may be more limited.
8
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.
Leverage. The Fund currently plans to issue preferred stock within
approximately three months after the completion of this offering. Under
current market conditions it is anticipated that the preferred stock will
represent approximately ____% of the Fund's capital, including capital raised
by issuing the preferred stock. There can be no assurance, however, that
preferred stock will actually be issued, or if issued what percentage of the
Fund's capital it will represent. Leverage creates certain risks for common
stockholders, including higher volatility of both the net asset value and the
market value of the common stock, because common stockholders bear the effects
of changes in the value of the Fund's investments. Leverage also creates the
risk that the investment return on shares of the Fund's common stock will be
reduced to the extent the dividends paid on preferred stock and other expenses
of the preferred stock exceed the dividend and interest income earned by the
Fund on its investments. If the Fund is liquidated, preferred stockholders
will be entitled to receive liquidating distributions before any distribution
is made to common stockholders.
Portfolio Strategies. The Fund may engage in various portfolio strategies
both to seek to increase the return of the Fund and to seek to hedge its
portfolio against adverse effects from movements in interest rates and in the
securities markets. These strategies include the use of derivatives, such as
indexed securities, inverse securities, options, futures, options on futures,
interest rate transactions, credit default swaps and 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 and result in many of the same
risks of leverage to the holders of the Fund's common stock as discussed above
under "Leverage." The Fund is not required to use derivatives or other
portfolio strategies to enhance income or 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 enhance
its return are riskier than its hedging transactions and have speculative
characteristics. Such strategies do not attempt to limit the Fund's risk of
loss.
Derivatives Risk. Derivatives are financial contracts 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
returns, such as options, futures contracts and swap agreements and may engage
in short sales. The Fund may use derivatives as a substitute for taking a
position in an underlying security or other asset and/or as part of a strategy
designed to reduce exposure to other risks, such as interest rate risk. The
Fund also may use derivatives to add leverage to the portfolio. The Fund's use
of derivative instruments involves risks different from, and possibly greater
than, the risks associated with investing directly in securities and other
traditional investments. Derivatives are subject to a number of risks
described elsewhere in this prospectus, such as liquidity risk, interest rate
risk, credit risk, leveraging 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 potential U.S. military actions, have led to
increased short term market volatility and may have long term effects on U.S.
and world economies and markets. Similar disruptions of the financial markets
could impact interest rates, auctions, secondary trading, ratings, credit
risk, inflation and other factors relating to the Fund's common stock. High
yield securities tend to be more volatile than investment grade fixed income
securities
9
so that these events and other market disruptions may have a greater impact on
the prices and volatility of high yield 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 high yield securities markets.
10
FEE TABLE
Stockholder Transaction Expenses:
Maximum Sales Load (as a percentage of offering price).......................................... ____%
Offering Expenses Borne by the Fund (as a percentage of offering price)(a)...................... ____%
Dividend Reinvestment Plan Fees................................................................. None
Annual Expenses (as a percentage of net assets attributable to common stock):
Investment Advisory Fees(b)(c).................................................................. ____%
Interest Payments on Borrowed Funds............................................................. None
Other Expenses(b)(c)............................................................................ ____%
Total Annual Operating Expenses(b)(c)......................................................... ____%
------------
(a) The Investment Adviser has agreed to pay all of the Fund's organizational
expenses. Offering costs will be paid by the Fund. The offering costs to
be paid by the Fund are not included in the annual expenses shown in the
table. Offering costs borne by common stockholders will result in a
reduction of capital of the Fund attributable to common stock. If the
Fund offers preferred stock in an amount equal to approximately ____% of
the Fund's capital, the costs of that offering, estimated to be
approximately ___% of the total dollar amount of the preferred stock
offering, will be effectively borne by the common stockholders and result
in a reduction of the net asset value of the shares of common stock.
These preferred stock offering costs are estimated to be approximately
$___ per share of common stock (___% of the offering price).
(b) See "Investment Advisory and Management Arrangements" -- page __.
(c) Assumes leverage by issuing preferred stock in an amount equal to
approximately ____% of the Fund's capital at a dividend rate of ___%. The
Fund intends to use leverage only if the Investment Adviser believes that
it would result in a higher yield to common stockholders over time. See
"Risk Factors and Special Considerations--Leverage" and "Risks and
Special Considerations of Leverage." If the Fund does not use leverage,
it is estimated that, as a percentage of net assets attributable to
common stock, the Investment Advisory Fee would be ___%, Interest
Payments on Borrowed Funds would be None, Other Expenses would be ___%
and Total Annual Expenses would be ___%.
EXAMPLE 1 Year 3 Years 5 Years 10 Years
------- ------ ------- ------- --------
An investor would pay the following expenses
(including the sales load of $___, estimated offering
expenses of this offering of $___ and the estimated
preferred stock offering costs assuming the Fund
offers preferred stock in an amount equal to
approximately _____% of the Fund's capital (after
issuance) of $___) on a $1,000 investment, assuming
total annual expenses of ___% and a 5% annual return
throughout the periods........................................ $____ $____ $____ $____
The Fee Table is intended to assist investors in understanding the costs
and expenses that a stockholder in the Fund will bear directly or indirectly.
The expenses set forth under "Other Expenses" are based on estimated amounts
through the end of the Fund's first fiscal year and assume that the Fund
issues approximately ______ shares of common stock. If the Fund issues fewer
shares of common stock, all other things being equal, these expenses would
increase. The Example set forth above assumes reinvestment of all dividends
and distributions and uses a 5% annual rate of return as mandated by the
Securities and Exchange Commission (the "Commission") regulations. THE EXAMPLE
SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES OR ANNUAL RATES
OF
11
RETURN, AND ACTUAL EXPENSES OR ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN
THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE.
12
THE FUND
Muni Intermediate Duration Fund, Inc. (the "Fund") is a newly organized,
non-diversified, closed-end fund. The Fund was incorporated under the laws of
the State of Maryland on May 15, 2003, and has registered under the Investment
Company Act of 1940, as amended (the "1940 Act"). The Fund's principal office
is located at 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its
telephone number is (609) 282-2800.
The Fund is organized as a closed-end investment company. Closed-end
investment companies differ from open-end investment companies (commonly
referred to as mutual funds) in that closed-end investment companies do not
redeem their securities at the option of the stockholder, whereas open-end
companies issue securities redeemable at net asset value at any time at the
option of the stockholder and typically engage in a continuous offering of
their shares. Accordingly, open-end investment companies are subject to
continuous asset in-flows and out-flows that can complicate portfolio
management. However, shares of closed-end investment companies frequently
trade at a discount to net asset value. They may also, at times, trade at a
premium to net asset value. The risk that shares will trade at a discount may
be greater for investors expecting to sell their shares in a relatively short
period after completion of the public offering.
The Board of Directors of the Fund may at any time consider a merger,
consolidation or other form of reorganization of the Fund with one or more
other investment companies advised by the Fund's investment adviser with
similar investment objectives and policies as the Fund. Any such merger,
consolidation or other form of reorganization would require the prior approval
of the Board of Directors and the stockholders of the Fund. See "Description
of Capital Stock--Certain Provisions of the Charter and By-Laws."
USE OF PROCEEDS
The net proceeds of this offering will be approximately $__________
million (or approximately $__________ million assuming the underwriters
exercise the overallotment option in full) after payment of offering expenses
estimated to be approximately $__________ million and the deduction of the
underwriting discount.
The net proceeds of the offering will be invested in accordance with the
Fund's investment objective and policies within approximately three months
after completion of the offering of common stock, depending on market
conditions and the availability of appropriate securities. Pending such
investment, it is anticipated that the proceeds will be invested in short
term, tax exempt securities. See "Investment Objective and Policies."
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide stockholders with a high
level of income exempt from Federal income taxes. The Fund's investment
objective is a fundamental policy and may not be changed without the approval
of a majority of the outstanding voting securities of the Fund (as defined in
the 1940 Act).
The Fund seeks to achieve its objective by investing primarily in a
portfolio of obligations issued by or on behalf of states, territories and
possessions of the United States and the District of Columbia and their
political subdivisions, agencies and instrumentalities, the payments from
which, in the opinion of bond counsel to the issuer, are exempt from Federal
income taxes ("Municipal Bonds"). The Fund's investment objective and its
policy of investing at least 80% of its net assets 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, the Fund will invest at least 80% of its net
assets in Municipal Bonds with a duration of three to ten years, except during
temporary defensive periods. For this purpose, net assets includes any
borrowings for investment purposes. The Fund also expects to maintain, under
normal market conditions, a dollar-weighted average portfolio duration of
three to ten years. These are non-fundamental policies 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 rules under the
1940 Act. There can be
13
no assurance that the Fund's investment objective will be realized. At times
the Fund may seek to hedge its portfolio through the use of options and
futures transactions or swap transactions to reduce the volatility in the net
asset value of its shares of common stock.
The Fund intends to invest 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 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 which, in the
Investment Adviser's judgment, 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 be in default.
The Fund may invest 25% or more of its total assets in tax exempt
securities of issuers in 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. The greater a portfolio's duration, the greater the
change in the portfolio's value in response to changes in interest rates. The
Investment Adviser increases or reduces the Fund's portfolio duration based on
its interest rate outlook. When the Investment Adviser expects interest rates
to fall, it attempts to maintain a longer portfolio duration. When the
Investment Adviser expects interest rates to increase, it attempts to shorten
the portfolio's duration. Generally, as is the case with any investment grade
fixed income obligations, Municipal Bonds with longer maturities tend to
produce higher yields. Under normal market conditions, however, such
yield-to-maturity increases tend to decline in the longer maturities (i.e.,
the slope of the yield curve flattens). At the same time, due to their longer
exposure to interest rate risk, prices of longer term obligations are subject
to greater market fluctuations as a result of changes in interest rates. Based
on the foregoing premises, the Investment Adviser believes that the yield and
price volatility characteristics of an intermediate term portfolio generally
offer an attractive trade-off between return and risk. There may be market
conditions, however, where an intermediate term 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 remaining maturities may
be more attractive than individual intermediate term 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 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.
14
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 "Financial Futures
Transactions and Options," are not fundamental policies and may be modified by
the 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 enhance income.
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 Directors and the Investment Adviser will take into
account in assessing the quality of such bonds not only the creditworthiness
of the issuer of such bonds but also 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 that pay
interest exempt from Federal income tax will be considered "Municipal Bonds"
for purposes of the Fund's investment objective and policies. 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. The percentage
of the Fund's total assets invested in "private activity bonds" will vary
during the year. 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 "Investment Objective and
Policies -- Description of Municipal Bonds" and "-- Hedging Transactions --
Financial Futures Transactions and Options."
The value of Municipal Bonds generally may be affected by uncertainties
in the municipal markets as a result of legislation or litigation including
legislation or litigation that changes the taxation of Municipal Bonds or the
rights of Municipal Bond holders in the event of a bankruptcy. Municipal
bankruptcies are rare and certain provisions of the U.S. Bankruptcy Code
governing such bankruptcies are unclear. Further, the application of state law
to Municipal Bond issuers could produce varying results among the states or
among Municipal Bond issuers within a state. These uncertainties could have a
significant impact on the prices of the Municipal Bonds in which the Fund
invests.
Description of Municipal Bonds
Set forth below is a detailed description of 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 this Prospectus.
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. Such obligations are included within the term Municipal Bonds if
the interest paid thereon is excluded from gross income for Federal income tax
purposes. Other types of industrial development bonds or private activity
bonds, the proceeds of which are used for the construction, equipment or
improvement of privately
15
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").
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 source 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. The Fund may invest more than 25% of its total assets in IDBs
or PABs.
Moral Obligation Bonds. The Fund also may invest in "moral obligation"
bonds, which are normally issued by special purpose public authorities. If an
issuer of moral obligation bonds is unable to meet its obligations, the
repayment of such bonds becomes a moral commitment but not a legal obligation
of the state or municipality in question.
Municipal Lease Obligations. Also included within the general category of
Municipal Bonds are certificates of participation ("COPs") issued by
government authorities or entities to finance the acquisition or construction
of equipment, land and/or facilities. COPs represent participations in a
lease, an installment purchase contract or a conditional sales contract
(hereinafter collectively called "lease obligations") relating to such
equipment, land or facilities. Although lease obligations do not constitute
general obligations of the issuer for which the issuer's unlimited taxing
power is pledged, a lease obligation is frequently backed by the issuer's
covenant to budget for, appropriate and make the payments due under the lease
obligation. However, certain lease obligations contain "non-appropriation"
clauses which provide that the issuer has no obligation to make lease or
installment purchase payments in future years unless money is appropriated for
such purpose on a yearly basis. Although "non-appropriation" lease obligations
are secured by the leased property, disposition of the property in the event
of foreclosure might prove difficult. Certain investments in lease obligations
may be illiquid. The Fund may not invest in illiquid lease obligations if such
investments, together with all other illiquid investments, would exceed 15% of
the Fund's net assets. The Fund may, however, invest without regard to such
limitation in lease obligations which the Investment Adviser, pursuant to
guidelines which have been adopted by the Board of Directors and subject to
the supervision of the Board, determines to be liquid. The Investment Adviser
will deem lease obligations to be liquid if they are publicly offered and have
received an investment grade rating of Baa or better by Moody's, or BBB or
16
better by S&P or Fitch. Unrated lease obligations, or those rated below
investment grade, will be considered liquid if the obligations come to the
market through an underwritten public offering and at least two dealers are
willing to give competitive bids. In reference to the latter, the Investment
Adviser must, among other things, also review the creditworthiness of the
entity obligated to make payment under the lease obligation and make certain
specified determinations based on such factors as the existence of a rating or
credit enhancement such as insurance, the frequency of trades or quotes for
the obligation and the willingness of dealers to make a market in the
obligation.
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. The Fund may not invest in
such illiquid obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's net assets.
When Issued Securities, Delayed Delivery Securities and Forward
Commitments. The Fund may purchase or sell securities that it is entitled to
receive on a when issued basis. The Fund may also purchase or sell securities
on a delayed delivery basis. The Fund may also purchase or sell securities
through a forward commitment. These transactions involve the purchase or sale
of securities by the Fund at an established price with payment and delivery
taking place in the future. The purchase will be received on the date the Fund
enters into the commitment and the value of the securities will thereafter be
reflected in the Fund's net asset value. The Fund enters into these
transactions to obtain what is considered an advantageous price to the Fund at
the time of entering into the transaction. The Fund has not established any
limit on the percentage of its assets that may be committed in connection with
these transactions. When the Fund purchases securities in these transactions,
the Fund segregates liquid securities in an amount equal to the amount of its
purchase commitments.
There can be no assurance that a security purchased on a when issued
basis will be issued or that a security purchased or sold through a forward
commitment will be delivered. A default by a counter party may result in the
Fund missing the opportunity of obtaining a price considered to be
advantageous. The value of securities in these transactions on the delivery
date may be more or less than the Fund's purchase price. The Fund may bear the
risk of a decline in the value of the security in these transactions and may
not benefit from an appreciation in the value of the security during the
commitment period.
Call Rights. The Fund may purchase a Municipal Bond issuer's right to
call all or a portion of such Municipal Bond for mandatory tender for purchase
(a "Call Right"). A holder of a Call Right may exercise such right to require
a mandatory tender for the purchase of related Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to maturity of
the related Municipal Bond will expire without value. The economic effect of
holding both the Call Right and the related Municipal Bond is identical to
holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% of the Fund's net assets.
17
"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 which, in the Investment Adviser's judgment, possess similar
credit characteristics. See Appendix A -- "Ratings of Municipal Bonds" for
additional information regarding ratings of debt securities. Junk bonds are
debt securities that are rated below investment grade by the major rating
agencies or are unrated securities that Fund management believes are of
comparable quality. 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:
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.
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.
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.
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.
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.
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.
Interest Rate Swap Transactions. In order to hedge the value of a Fund
against interest rate fluctuations or to enhance the Fund's income, 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 intends
to use these transactions primarily as a hedge or for duration or risk
management rather than as a speculative
18
investment. However, the Fund also may invest in MMD Swaps and BMA Swaps to
enhance income or gain or to increase the Fund's yield, for example, during
periods of steep interest rate yield curves (i.e., wide differences between
short term and long term interest rates).
The Fund may purchase and sell BMA Swaps in the BMA swap market. In a BMA
Swap, the Fund exchanges with another party their respective commitments to
pay or receive interest (e.g., an exchange of fixed rate payments for floating
rate payments linked to the Bond Market Association Municipal Swap Index).
Because the underlying index is a tax exempt index, BMA Swaps may reduce
cross-market risks incurred by the Fund and increase the Fund's ability to
hedge effectively. BMA Swaps are typically quoted for the entire yield curve,
beginning with a seven day floating rate index out to 30 years. The duration
of a BMA Swap is approximately equal to the duration of a fixed rate Municipal
Bond with the same attributes as the swap (e.g., coupon, maturity, call
feature).
The Fund also may purchase and sell MMD Swaps, also known as MMD rate
locks. An MMD Swap permits the Fund to lock in a specified municipal interest
rate for a portion of its portfolio to preserve a return on a 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 an amount of cash or liquid securities having an aggregate net
asset value at least equal to the accrued excess will be maintained in a
segregated account by the Fund's custodian.
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, and swap transactions. While
the Fund's use of hedging strategies is intended to reduce the volatility of
the net asset value of the Fund's shares, the net asset value of the Fund's
shares will fluctuate. There can be no assurance that the Fund's hedging
transactions will be effective. Furthermore, the Fund may only engage in
hedging activities from time to time and may not necessarily be engaging in
hedging activities when movements in interest rates occur. The Fund has no
obligation to enter into hedging transactions and may choose not to do so.
Financial Futures Transactions and Options. The Fund is authorized to
purchase and sell certain exchange traded financial futures contracts
("financial futures contracts") solely for the purpose of hedging its
investments in Municipal Bonds against declines in value and to hedge against
increases in the cost of securities it intends to purchase. 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
19
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 as long term capital gains
rates for Federal income tax purposes. See "Taxes -- Tax Treatment of Options
and Futures Transactions."
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 is authorized to purchase and sell certain exchange traded
financial futures contracts ("financial futures contracts") solely for the
purpose of hedging its investments in Municipal Bonds against declines in
value and to hedge against increases in the cost of securities it intends to
purchase. 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.
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.
20
The Fund may also purchase and sell financial futures contracts on U.S.
Government securities as a hedge against adverse changes in interest rates as
described below. With respect to U.S. Government securities, currently there
are financial futures contracts based on long term U.S. Treasury bonds,
Treasury notes, Government National Mortgage Association ("GNMA") Certificates
and three-month U.S. Treasury bills. The Fund may purchase and write call and
put options on futures contracts on U.S. Government securities and purchase
and sell Municipal Bond Index futures contracts in connection with its hedging
strategies.
Subject to policies adopted by the Directors, 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 and
the Directors of the Fund 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.
21
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.
The Fund has received an order from the Commission exempting it from the
provisions of Section 17(f) and Section 18(f) of the 1940 Act, in connection
with its strategy of investing in futures contracts. Section 17(f) relates to
the custody of securities and other assets of an investment company and may be
deemed to prohibit certain arrangements between the Fund and commodities
brokers with respect to initial and variation margin. Section 18(f) of the
1940 Act prohibits an open-end investment company such as the Fund from
issuing a "senior security" other than a borrowing from a bank. The staff of
the Commission has in the past indicated that a futures contract may be a
"senior security" under the 1940 Act.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes.) 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
22
Fund may be greater. Municipal Bond Index futures contracts were approved for
trading in 1986. Trading in such futures contracts may tend to be less liquid
than trading in other futures contracts. The trading of futures contracts also
is subject to certain market risks, such as inadequate trading activity, which
could at times make it difficult or impossible to liquidate existing
positions.
The Fund expects to liquidate a majority of the futures contracts it
enters into through offsetting transactions on the applicable contract market.
There can be no assurance, however, that a liquid secondary market will exist
for any particular futures contract at any specific time. Thus, it may not be
possible to close out a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments
of variation margin. In such situations, if the Fund has insufficient cash, it
may be required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability
to close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The liquidity
of a secondary market in a futures contract may be adversely affected by
"daily price fluctuation limits" established by commodity exchanges which
limit the amount of fluctuation in a futures contract price during a single
trading day. Once the daily limit has been reached in the contract, no trades
may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past moved beyond
the daily limit on a number of consecutive trading days. The Fund will enter
into a futures position only if, in the judgment of the Investment Adviser,
there appears to be an actively traded secondary market for such futures
contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Investment Adviser to forecast correctly the
direction and extent of interest rate movements within a given time frame. To
the extent interest rates remain stable during the period in which a futures
contract or option is held by the Fund or such rates move in a direction
opposite to that anticipated, the Fund may realize a loss on the hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Fund's total return for such period
may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by the
Fund of margin deposits in the event of bankruptcy of a broker with whom the
Fund has an open position in a financial futures contract. Because the Fund
will engage in the purchase and sale of futures contracts solely for hedging
purposes, however, 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
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
23
("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.
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 a limited amount (not 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 a limited
amount 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. A VRDO with a
demand notice period exceeding seven days will therefore be subject to the
Fund's restriction on illiquid investments unless, in the judgment of the
Directors, such VRDO is liquid. 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
24
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. The Fund may not invest in repurchase
agreements maturing in more than seven days if such investments, together with
all other illiquid investments, would exceed 15% of the Fund's net assets.
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.
Illiquid Securities. The Fund may invest up to 15% of its net assets in
illiquid securities that it cannot easily sell within seven days at current
value or that have contractual or legal restrictions on resale. If the Fund
buys illiquid securities it may be unable to quickly sell them or may be able
to sell them only at a price below current value.
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). Investments by the Fund in wholly owned investment
entities created under the laws of certain countries will not be deemed an
investment in other investment companies.
Suitability
The economic benefit of an investment in the Fund depends upon many
factors beyond the control of the Fund, the Investment Adviser and its
affiliates. Because of its emphasis on intermediate term Municipal Bonds, the
Fund should be considered a vehicle for diversification and not as a balanced
investment program. The suitability for any particular investor of a purchase
of shares of the Fund will depend upon, among other things, such investor's
investment objectives and such investor's ability to accept the risks of
investing in such markets, including the loss of principal.
RISKS AND SPECIAL CONSIDERATIONS OF LEVERAGE
Effects of Leverage
The Fund currently intends to issue preferred stock within approximately
three months after the completion of this offering. Under current market
conditions it is anticipated that the preferred stock will represent
approximately ___% of the Fund's capital, including the capital raised by
issuing the preferred stock, or approximately ___% of the Fund's common stock
equity. There can be no assurance, however, that preferred stock will actually
be issued or if issued what percentage of the Fund's capital it will
represent. Issuing the preferred stock will result in the leveraging of the
common stock. Although the Fund's Board of Directors has not yet determined
the terms of the preferred stock offering, the Fund anticipates that the
preferred stock will pay dividends that will be adjusted over either
relatively short term periods (generally seven to 28 days) or medium term
periods (up to five years). The dividend rate will be based upon prevailing
interest rates for debt obligations of comparable maturity. The proceeds of
the preferred stock offering will be invested in accordance with the Fund's
investment objective. The expenses of the preferred stock, which will be borne
by the Fund, will reduce the net asset value of the common stock.
Additionally, under certain circumstances, when the Fund is required to
allocate taxable income to holders of preferred stock, the Fund anticipates
that the terms of the preferred stock will require the Fund to make an
additional
25
distribution to such holders in an amount approximately equal to the tax
liability resulting from such allocation (an "Additional Distribution").
Because under normal market conditions, obligations with longer maturities
produce higher yields than short term and medium term obligations, the
Investment Adviser believes that the spread inherent in the difference between
the short term and medium term rates (and any Additional Distribution) paid by
the Fund as dividends on the preferred stock and the generally longer term
rates received by the Fund on its portfolio securities may provide holders of
common stock with a potentially higher yield.
The Fund also may borrow money as a temporary measure for extraordinary
or emergency purposes, including the payment of dividends and the settlement
of securities transactions which otherwise might require untimely dispositions
of Fund securities. The Fund at times may borrow from affiliates of the
Investment Adviser, provided that the terms of such borrowings are no less
favorable than those available from comparable sources of funds in the
marketplace.
The use of leverage, however, involves certain risks to the holders of
common stock. For example, issuance of the preferred stock may result in
higher volatility of the net asset value of the common stock and potentially
more volatility in the market value of the common stock. In addition, changes
in the short term and medium term dividend rates on, and the amount of taxable
income allocable to, the preferred stock will affect the yield to holders of
common stock. Leverage will allow holders of common stock to realize a higher
current rate of return than if the Fund were not leveraged as long as the
Fund, while accounting for its costs and operating expenses, is able to
realize a higher net return on its investment portfolio than the then current
dividend rate (and any Additional Distribution) of the preferred stock.
Similarly, since a pro rata portion of the Fund's net realized capital gains
are generally payable to holders of common stock, the effect of leverage will
be to increase the amount of such gains distributed to holders of common
stock. However, short term, medium term and long term interest rates change
from time to time as do their relationships to each other (i.e., the slope of
the yield curve) depending upon such factors as supply and demand forces,
monetary and tax policies and investor expectations. Changes in any or all of
such factors could cause the relationship between short term, medium term and
long term rates to change (i.e., to flatten or to invert the slope of the
yield curve) so that short term and medium term rates may substantially
increase relative to the long term obligations in which the Fund may be
invested. To the extent that the current dividend rate (and any Additional
Distribution) on the preferred stock approaches the net return on the Fund's
investment portfolio, the benefit of leverage to holders of common stock will
be decreased. If the current dividend rate (and any Additional Distribution)
on the preferred stock were to exceed the net return on the Fund's portfolio,
holders of common stock would receive a lower rate of return than if the Fund
were not leveraged. Similarly, since both the cost of issuing the preferred
stock and any decline in the value of the Fund's investments (including
investments purchased with the proceeds from any preferred stock offering)
will be borne entirely by holders of common stock, the effect of leverage in a
declining market would result in a greater decrease in net asset value to
holders of common stock than if the Fund were not leveraged. If the Fund is
liquidated, holders of preferred stock will be entitled to receive liquidating
distributions before any distribution is made to holders of common stock.
In an extreme case, a decline in net asset value could affect the Fund's
ability to pay dividends on the common stock. Failure to make such dividend
payments could adversely affect the Fund's qualification as a regulated
investment company under the Federal tax laws. See "Taxes." However, the Fund
intends to take all measures necessary to make common stock dividend payments.
If the Fund's current investment income is ever insufficient to meet dividend
payments on either the common stock or the preferred stock, the Fund may have
to liquidate certain of its investments. In addition, the Fund will have the
authority to redeem the preferred stock for any reason and may redeem all or
part of the preferred stock under the following circumstances:
o if the Fund anticipates that the leveraged capital structure will
result in a lower rate of return for any significant amount of time to
holders of common stock than that obtainable if the common stock were
not leveraged,
o if the asset coverage for the preferred stock declines below 200%
either as a result of a decline in the value of the Fund's portfolio
investments or as a result of the repurchase of common stock in tender
offers, or
26
o in order to maintain the asset coverage guidelines established by the
NRSROs that have rated the preferred stock.
Redemption of the preferred stock or insufficient investment income to make
dividend payments may reduce the net asset value of the common stock and
require the Fund to liquidate a portion of its investments at a time when it
may be disadvantageous to do so.
As discussed under "Investment Advisory and Management Arrangements,"
during periods when the Fund has preferred stock outstanding, the fees paid
the Investment Adviser for investment advisory and management services will be
higher than if the Fund did not issue preferred stock because the fees paid
will be calculated on the basis of the Fund's average daily net assets,
including proceeds from the sale of preferred stock.
Assuming the use of leverage by issuing preferred stock (paying dividends
at a rate that generally will be adjusted every __ days) in an amount
representing approximately ___% of the Fund's capital at an annual dividend
rate of ___% payable on such preferred stock based on market rates as of the
date of this prospectus, the annual return that the Fund's portfolio must
experience (net of expenses) in order to cover such dividend payments would be
___%.
The following table is designed to illustrate the effect on the return to
a holder of common stock of the leverage obtained by the issuance of preferred
stock representing approximately ___% of the Fund's capital, assuming
hypothetical annual returns on the Fund's portfolio of minus 10% to plus 10%.
As the table shows, leverage generally increases the return to stockholders
when portfolio return is positive and decreases the return when portfolio
return is negative. The figures appearing in the table are hypothetical and
actual returns may be greater or less than those appearing in the table.
Assumed Portfolio Return
(net of expenses)....................................... (10)% (5)% 0% 5% 10%
Corresponding Common Stock Return.......................... (___)% (___)% (___)% (___)% (___)%
Leveraging the common stock cannot be fully achieved until preferred
stock is issued and the proceeds of such offering have been invested in long
term Municipal Bonds.
Portfolio Management and Other Considerations
If short term or medium term rates increase or other changes in market
conditions occur to the point where the Fund's leverage could adversely affect
holders of common stock as noted above (or in anticipation of such changes),
the Fund may attempt to shorten the average maturity or duration of its
investment portfolio in order to offset the negative impact of leverage. The
Fund also may attempt to reduce the degree to which it is leveraged by
redeeming preferred stock pursuant to the Fund's Articles Supplementary, which
establish the rights and preferences of the preferred stock, or otherwise by
purchasing shares of preferred stock. Purchases and redemptions of preferred
stock, whether on the open market or in negotiated transactions, are subject
to limitations under the 1940 Act. In determining whether or not it is in the
best interest of the Fund and its stockholders to redeem or repurchase
outstanding preferred stock, the Board of Directors will take into account a
variety of factors, including the following:
o market conditions,
o the ratio of preferred stock to common stock, and
o the expenses associated with such redemption or repurchase.
If market conditions subsequently change, the Fund may sell previously
unissued shares of preferred stock or shares of preferred stock that the Fund
had issued but later repurchased or redeemed.
The Fund intends to apply for ratings of the preferred stock from one or
more NRSROs. In order to obtain these ratings, the Fund may be required to
maintain portfolio holdings that meet the specified guidelines of such
27
organizations. These guidelines may impose asset coverage requirements that
are more stringent than those imposed by the 1940 Act. The Fund does not
anticipate that these guidelines will impede the Investment Adviser from
managing the Fund's portfolio in accordance with the Fund's investment
objective and policies. Ratings on preferred stock issued by the Fund should
not be confused with ratings on the obligations held by the Fund.
Under the 1940 Act, the Fund is not permitted to issue shares of
preferred stock unless immediately after such issuance the net asset value of
the Fund's portfolio is at least 200% of the liquidation value of the
outstanding preferred stock (expected to equal the original purchase price of
the outstanding shares of preferred stock plus any accumulated and unpaid
dividends thereon and any accumulated and unpaid Additional Distribution). In
addition, the Fund is not permitted to declare any cash dividend or other
distribution on its common stock unless, at the time of such declaration, the
net asset value of the Fund's portfolio (determined after deducting the amount
of such dividend or distribution) is at least 200% of the liquidation value of
the outstanding preferred stock. Under the Fund's proposed capital structure,
assuming the sale of shares of preferred stock representing approximately ___%
of the Fund's capital, the net asset value of the Fund's portfolio is expected
to be approximately 250% of the liquidation value of the Fund's preferred
stock. To the extent possible, the Fund intends to purchase or redeem shares
of preferred stock from time to time to maintain coverage of preferred stock
of at least 200%.
----------------------
The Fund may in the future employ new or additional investment strategies
and hedging instruments if those strategies and instruments are consistent
with the Fund's investment objective and are permissible under applicable
regulations governing the Fund.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and,
prior to issuance of any preferred stock, may not be changed without the
approval of the holders of a majority of the Fund's outstanding shares of
common stock (which for this purpose and under the 1940 Act means the lesser
of (i) 67% of the shares of common stock represented at a meeting at which
more than 50% of the outstanding shares of common stock are represented or
(ii) more than 50% of the outstanding shares). Subsequent to the issuance of a
class of preferred stock, the following investment restrictions may not be
changed without the approval of a majority of the outstanding shares of common
stock and of preferred stock, voting together as a class, and the approval of
a majority of the outstanding shares of preferred stock, voting separately as
a class. The Fund may not:
1. Make investments for the purpose of exercising control or
management.
2. Purchase or sell real estate, commodities or commodity contracts;
except that to the extent permitted by applicable law, the Fund may
invest in securities directly or indirectly secured by real estate or
interests therein or issued by entities that invest in real estate or
interests therein, and the Fund may purchase and sell financial futures
contracts and options thereon.
3. Issue senior securities or borrow money except as permitted by
Section 18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as
amended, in selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
Municipal Bonds and other debt securities and enter into repurchase
agreements in accordance with its investment objective, policies and
limitations.
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, states,
municipalities and their political subdivisions are not considered to be
part of any 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:
28
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 (iv) 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 in financial futures contracts and options
thereon.
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. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund may
write, purchase and sell options and futures on Municipal Bonds, U.S.
Government obligations and related indices or otherwise in connection
with bona fide hedging activities and may purchase and sell Call Rights
to require mandatory tender for the purchase of related Municipal Bonds.
e. Change its policy of investing, under normal market conditions,
at least 80% of its net assets in Municipal Bonds with a duration of
three to ten years, unless the Fund provides stockholders with at least
60 days prior written notice of such change.
For purposes of restriction (6), the exception for states, municipalities
and their political subdivisions applies only to tax exempt securities issued
by such entities.
If a percentage restriction on investment policies or the investment or
use of assets set forth above is adhered to at the time a transaction is
effected, later changes in percentage resulting from changing values will not
be considered a violation.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by the 1940 Act in the
proportion of its assets that it may invest in securities of a single issuer.
As a non-diversified fund, the Fund's investments are limited, however, in
order to allow the Fund to continue to qualify as a regulated investment
company under the Internal Revenue Code of 1986, as amended (the "Code"). See
"Taxes." To qualify, the Fund complies with certain requirements, including
limiting its investments so that at the close of each quarter of the taxable
year (i) not more than 25% of the market value of the Fund's total assets will
be invested in the securities of a single issuer and (ii) with respect to 50%
of the market value of its total assets, not more than 5% of the market value
of its total assets will be invested in the securities of a single issuer and
the Fund will not own more than 10% of the outstanding voting securities of a
single issuer. For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if the security is backed only by the assets and revenues
of a non-government entity then the entity with the ultimate responsibility
for the payment of interests 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
29
compliance with the provisions of the 1940 Act and the rules and regulations
thereunder. Included among such restricted transactions will be purchases from
or sales to Merrill Lynch of securities in transactions in which it acts as
principal. See "Portfolio Transactions."
DIRECTORS AND OFFICERS
The Directors of the Fund consist of ___ individuals, ___ of whom are
not "interested persons" of the Fund as defined in the 1940 Act (the
"non-interested Directors"). The Directors are responsible for the overall
supervision of the operations of the Fund and perform the various duties
imposed on the directors of investment companies by the 1940 Act.
Each non-interested Director is a member of the Fund's Audit and
Nominating Committee (the "Committee"). The principal responsibilities of the
Committee are the appointment, compensation and oversight of the Fund's
independent auditors, including resolution of disagreements regarding
financial reporting between Fund management and such auditors. The Board of
the Fund has adopted a written charter for the Committee. The Committee also
reviews and nominates candidates to serve as non-interested Directors. The
Committee has retained independent legal counsel to assist them in connection
with these duties. The Committee has not held any meetings since the Fund was
incorporated on May 15, 2003.
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.
Number of
Term of FAM/MLIM-Advised
Position(s) Office** and Funds and
Held with the Length of Time Principal Occupation(s) Portfolios Public
Name, Address* and Age Fund Served During Past Five Years Overseen Directorships
----------------------------- --------------- --------------- -------------------------- ----------------- ---------------
[TO BE PROVIDED BY AMENDMENT]
--------------------------
* The address of each non-interested Director is P.O. Box 9011, Princeton,
New Jersey 08543-9011.
** 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 to the other officers of the Fund is set forth
below, including their ages, their principal occupations for at least the last
five years, the length of time served, the total number of portfolios overseen
in FAM/MLIM-advised funds and public directorships held.
Number of
Term of FAM/MLIM-Advised
Position(s) Office+ and Funds and
Held with the Length of Time Principal Occupation(s) Portfolios Public
Name, Address* and Age Fund Served During Past Five Years Overseen Directorships
----------------------------- --------------- --------------- -------------------------- ----------------- ---------------
30
Number of
Term of FAM/MLIM-Advised
Position(s) Office+ and Funds and
Held with the Length of Time Principal Occupation(s) Portfolios Public
Name, Address* and Age Fund Served During Past Five Years Overseen Directorships
----------------------------- --------------- --------------- -------------------------- ----------------- ---------------
[TO BE PROVIDED BY AMENDMENT]
-----------------------
* The address of each officer is P.O. Box 9095, Princeton, New Jersey
08543-9095.
+ Elected by and serves at the pleasure of the Board of Directors of the
Fund.
++ ________ is a director, Director or member of an advisory board of
certain other investment companies for which MLIM or FAM acts as
investment adviser. _____ is an "interested person," as defined in the
1940 Act, of the Fund based on his positions as _____.
+++ As 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.
In the event that the Fund issues preferred stock, holders of shares of
preferred stock, voting as a separate class, will be entitled to elect two of
the Fund's Directors, and the remaining Directors will be elected by all
holders of capital stock, voting as a single class. See "Description of
Capital Stock."
Share Ownership
Information relating to each Director's share ownership in the Fund and
in all registered funds in the Merrill Lynch family of funds that are overseen
by the respective Director ("Supervised Merrill Lynch Funds") as of December
31, 2002 is set forth in the chart below.
Aggregate Dollar Range of
Aggregate Dollar Range of Securities in Supervised
Name Equity in the Fund Merrill Lynch Funds*
Interested Directors:
[TO BE PROVIDED BY AMENDMENT]
Non-interested Directors:
[TO BE PROVIDED BY AMENDMENT]
-----------------------
* For the number of FAM-MLIM-advised funds from which each Director
receives compensation, see the table above under "Directors and Officers
- Biographical Information."
As of the date of this prospectus, the Investment Adviser owned all of
the outstanding shares of common stock of the Fund; none of the Directors and
officers of the Fund owned outstanding shares of the Fund. As of the date of
this prospectus, none of the non-interested Directors of the Fund nor any of
their immediate family members owned beneficially or of record any securities
in ML & Co.
Compensation of Directors
Pursuant to its investment advisory agreement with the Fund (the
"Investment Advisory Agreement"), the Investment Adviser pays all compensation
of officers and employees of the Fund as well as the fees of all Directors of
the Fund who are affiliated persons of ML & Co. or its subsidiaries as well as
such Directors' actual out-of-pocket expenses relating to attendance at
meetings.
31
The Fund pays each non-interested Director a combined fee for services on
the Board and the Committee of $ per year, $ per in person Board
meeting attended and $ per in person committee meeting attended. The Fund
pays the Chairman of the Committee an additional fee of $ 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-Advised
Name of Director with Fund From Fund Expense Retirement Funds
---------------- --------- ------------ ------------ ------------- ----------------
[TO BE PROVIDED BY AMENDMENT]
*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 February 2003, the Investment Adviser and its
affiliates, including MLIM, had a total of approximately $439 billion in
investment company and other portfolio assets under management, including
approximately $260 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, Inc. The principal business address of the Investment
Adviser is 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement provides that, subject to the direction
of the Fund's Board of Directors, the Investment Adviser is responsible for
the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.
The Fund's portfolio managers will consider analyses from various
sources, make the necessary investment decisions, and place orders for
transactions accordingly. The Investment Adviser will also be responsible for
the performance of certain management services for the Fund. The Fund will be
managed by a team of investment professionals from the Investment Adviser. The
portfolio manager primarily responsible for the Fund's day-to-day management
is _______________.
For its services, the Fund pays the Investment Adviser a monthly fee at
the annual rate of ___% of the Fund's average daily net assets, plus the
proceeds of any outstanding borrowings used for leverage ("average daily net
assets" means the average daily value of the total assets of the Fund,
including the amount obtained from leverage and any proceeds from the issuance
of preferred stock, minus the sum of (i) accrued liabilities of the Fund, (ii)
any accrued and unpaid interest on outstanding borrowings and (iii)
accumulated dividends on shares of preferred stock). For purposes of this
calculation, average daily net assets is determined at the end of each month
on the basis of the average net assets of the Fund for each day during the
month. It is understood that the liquidation
32
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 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 ____ ("_____") pursuant to an agreement
between _____ and the Fund. The Fund will pay the costs of these services. In
addition, the Fund will reimburse the Investment Adviser for certain
additional accounting services.
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940
Act) of any such party. Such contract is not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party
thereto or by the vote of the stockholders of the Fund.
In connection with the Board of Director's consideration of the
Investment Advisory Agreement, the Board reviewed information derived from a
number of sources and covering a range of issues relating to, among other
things, alternatives to the Investment Advisory Agreement. [To Be Completed By
Amendment]
Code of Ethics
The Fund's Board of Directors approved a Code of Ethics under Rule 17j-1
of the 1940 Act that covers the Fund and the Investment Adviser. The Code of
Ethics establishes procedures for personal investing and restricts certain
transactions. Employees subject to the Code of Ethics may invest in securities
for their personal investment accounts, including securities that may be
purchased or held by the Fund.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to
deal with any dealer or group of dealers in the execution of transactions in
portfolio securities of the Fund. Where possible, the Fund deals directly with
the dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Fund to obtain the best results in conducting portfolio
transactions for the Fund, taking into account such factors as price
(including the applicable dealer spread or commission), the size, type and
difficulty of the transaction involved, 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.
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
33
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. Under another
exemptive order, the Fund may effect principal transactions with Merrill Lynch
in high quality, short term, tax exempt securities subject to conditions set
forth in such order.
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 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.
The Investment Adviser of the Fund and Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch") are owned and controlled by Merrill Lynch
& Co., Inc. ("ML & Co."). Because of the affiliation of Merrill Lynch with the
Investment Adviser, the Fund is prohibited from engaging in certain
transactions involving Merrill Lynch except pursuant to an exemptive order or
otherwise in compliance with the provisions of the 1940 Act and the rules and
regulations thereunder. Included among such restricted transactions will be
purchases from or sales to Merrill Lynch of securities in transactions in
which it acts as principal. An exemptive order has been obtained that permits
the Fund to effect principal transactions with Merrill Lynch in high quality,
short term, tax exempt securities subject to conditions set forth in such
order. Another exemptive order has been obtained that permits the Fund to
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. A group order is an order for securities
held in an underwriting syndicate for the account of all members of the
syndicate, and in the proportion to their respective participation in the
syndicate. The Fund may consider in the future requesting an order permitting
other principal transactions with Merrill Lynch, but there can be no assurance
that such application will be made and, if made, that such order would be
granted. See "Portfolio Transactions."
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
34
one of its clients during the same period may increase the demand for
securities being purchased or the supply of securities being sold, causing an
adverse effect on price.
Section 11(a) of the Securities Exchange Act of 1934 generally prohibits
members of the U.S. national securities exchanges from executing exchange
transactions for their affiliates and institutional accounts that they manage
unless the member (i) has obtained prior express authorization from the
account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules
the Commission has prescribed with respect to the requirements of clauses (i)
and (ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund.
Portfolio Turnover
Generally, the Fund does not purchase securities for short term trading
profits. However, the Fund may dispose of securities without regard to the
time they have been held when such actions, for defensive or other reasons,
appear advisable to the Investment Adviser. While it is not possible to
predict turnover rates with any certainty, at present it is anticipated that
the Fund's annual portfolio turnover rate, under normal circumstances, should
be less than 100%. (The portfolio turnover rate is calculated by dividing the
lesser of purchases or sales of portfolio securities for the particular fiscal
year by the monthly average of the value of the portfolio securities owned by
the Fund during the particular fiscal year. For purposes of determining this
rate, all securities whose maturities at the time of acquisition are one year
or less are excluded.) A high portfolio turnover rate results in greater
transaction costs, which are borne directly by the Fund and also has certain
tax consequences for stockholders.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute dividends of all or a portion of its net
investment income monthly to holders of common stock. It is expected that the
Fund will commence paying dividends to holders of common stock within
approximately 90 days of the date of this prospectus. From and after issuance
of the preferred stock, monthly dividends to holders of common stock normally
will consist of all or a portion of its net investment income remaining after
the payment of dividends (and any Additional Distributions) on the preferred
stock. The Fund may at times in its discretion pay out less than the entire
amount of net investment income earned in any particular period and may at
times pay out such accumulated undistributed income in addition to net
investment income earned in other periods in order to permit the Fund to
maintain a more stable level of distributions. As a result, the dividend paid
by the Fund to holders of common stock for any particular period may be more
or less than the amount of net investment income earned by the Fund during
such period. The Fund is not required to maintain a stable level of
distributions to stockholders. For Federal tax purposes, the Fund is required
to distribute substantially all of its net investment income for each calendar
year. All net realized capital gains, if any, will be distributed pro rata at
least annually to holders of common stock and any preferred stock.
While any shares of preferred stock are outstanding, the Fund may not
declare any cash dividend or other distribution on its common stock, unless at
the time of such declaration, (i) all accumulated preferred stock dividends,
including any Additional Distribution, have been paid, and (ii) the net asset
value of the Fund's portfolio (determined after deducting the amount of such
dividend or other distribution) is at least 200% of the liquidation value of
the outstanding preferred stock (expected to equal the original purchase price
of the outstanding shares of preferred stock plus any accumulated and unpaid
dividends thereon and any accumulated but unpaid Additional Distribution). If
the Fund's ability to make distributions on its common stock is limited, such
limitation could under certain circumstances impair the ability of the Fund to
maintain its qualification for taxation as a regulated investment company,
which would have adverse tax consequences for stockholders. See "Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of common stock may be
automatically reinvested in shares of common stock of the Fund. Dividends and
distributions may be taxable to stockholders under certain circumstances as
discussed below, whether they are reinvested in shares of the Fund or received
in cash.
35
The yield on the Fund's common stock will vary from period to period
depending on factors including, but not limited to, market conditions, the
timing of the Fund's investment in portfolio securities, the securities
comprising the Fund's portfolio, changes in tax exempt interest rates (which
may not change to the same extent or in the same direction as taxable rates)
including changes in the relationship between short term rates and long term
rates, the amount and timing of the issuance of the Fund's preferred stock,
the effects of preferred stock leverage on the common stock discussed above
under "Risks and Special Considerations of Leverage," the timing of the
investment of preferred stock proceeds in portfolio securities, the Fund's net
assets and its operating expenses. Consequently, the Fund cannot guarantee any
particular yield on its shares and the yield for any given period is not an
indication or representation of future yields on Fund shares.
TAXES
General
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. As long as it
so qualifies, in any taxable year in which it distributes at least 90% of its
taxable net income and 90% of its tax exempt net income (see below), the Fund
(but not its stockholders) will not be subject to Federal income tax to the
extent that it distributes its net investment income and net realized capital
gains. The Fund intends to distribute substantially all of such income.
The Code requires a RIC to pay a nondeductible 4% excise tax to the
extent the RIC does not distribute, during each calendar year, 98% of its
ordinary income, determined on a calendar year basis, and 98% of its capital
gains, determined, in general, on an October 31 year-end, plus certain
undistributed amounts from previous years. The required distributions,
however, are based only on the taxable income of a RIC. The excise tax,
therefore, generally will not apply to the tax exempt income of a RIC, such as
the Fund, that pays exempt-interest dividends.
The Fund intends to qualify to pay "exempt-interest dividends" as defined
in Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations the interest on which is excludable from gross income
for Federal income tax purposes ("tax exempt obligations") under Section
103(a) of the Code (relating generally to obligations of a state or local
governmental unit), the Fund shall be qualified to pay exempt-interest
dividends to its stockholders. Exempt-interest dividends are dividends or any
part thereof paid by the Fund that are attributable to interest on tax exempt
obligations and designated by the Fund as exempt-interest dividends in a
written notice mailed to the Fund's stockholders within 60 days after the
close of its taxable year. To the extent that the dividends distributed to the
Fund's stockholders are derived from interest income excludable from gross
income for Federal income tax purposes under Code Section 103(a) and are
properly designated as exempt-interest dividends, they will be excludable from
a stockholder's gross income for Federal income tax purposes. Exempt-interest
dividends are included, however, in determining the portion, if any, of a
person's social security and railroad retirement benefits subject to Federal
income taxes. Each stockholder is advised to consult a tax adviser with
respect to whether exempt-interest dividends retain the exclusion under Code
Section 103(a) if such stockholder would be treated as a "substantial user" or
"related person" under Code Section 147(a) with respect to property financed
with the proceeds of an issue of PABs or IDBs, if any, held by the Fund.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short term capital gains over
net long term capital losses ("ordinary income dividends"), such distributions
are considered taxable ordinary income for Federal income tax purposes.
Distributions, if any, from an excess of net long term capital gains over net
short term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long term capital gains for Federal income tax purposes, regardless of the
length of time the stockholder has owned Fund shares. Generally not later than
60 days after the close of its taxable year, the Fund will provide its
stockholders with a written notice designating the amounts of any
exempt-interest dividends and capital gain dividends. Distributions by the
Fund, whether from exempt-income, ordinary income or capital gains, are not
eligible for the dividends received deduction allowed to corporations under
the Code.
36
All or a portion of the Fund's gain from the sale or redemption of tax
exempt obligations purchased at a market discount will be treated as ordinary
income rather than capital gain. This rule may increase the amount of ordinary
income dividends received by stockholders. Distributions in excess of the
Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of Fund shares held for six
months or less will be disallowed to the extent of any exempt-interest
dividends received by the stockholder. In addition, any such loss that is not
disallowed under the rule stated above will be treated as long term capital
loss to the extent of any capital gain dividends received by the stockholder.
If the Fund pays a dividend in January that was declared in the previous
October, November or December to stockholders of record on a specified date in
one of such months, then such dividend will be treated for tax purposes as
being paid by the Fund and received by its stockholders on December 31 of the
year in which such dividend was declared.
The Internal Revenue Service ("Service") has taken the position in a
revenue ruling that if a RIC has two or more classes of shares, it may
designate distributions made to each class in any year as consisting of no
more than such class's proportionate share of particular types of income,
including exempt-interest income and net long term capital gains. A class's
proportionate share of a particular type of income is determined according to
the percentage of total dividends paid by the RIC during such year that was
paid to such class. Consequently, when common stock and one or more series of
preferred stock are outstanding, the Fund intends to designate distributions
made to the classes as consisting of particular types of income in accordance
with each class's proportionate share of such income. Thus, the Fund will
designate dividends paid as exempt-interest dividends in a manner that
allocates such dividends among the holders of common stock and each series of
preferred stock in proportion to the total dividends paid to each class during
the taxable year, or otherwise as required by applicable law. Capital gain
dividends will similarly be allocated among the classes in proportion to the
total dividends paid to each class during the taxable year, or otherwise as
required by applicable law. When capital gain or other taxable income is
allocated to holders of preferred stock pursuant to the allocation rules
described above, the terms of the preferred stock may require the Fund to make
an additional distribution to or otherwise compensate such holders for the tax
liability resulting from such allocation.
The Code subjects interest received on certain otherwise tax exempt
securities to a Federal alternative minimum tax. The Federal alternative
minimum tax applies to interest received on certain "private activity bonds"
issued after August 7, 1986. Private activity bonds are bonds that, although
tax exempt, are used for purposes other than those performed by governmental
units and that benefit non-governmental entities (e.g., bonds used for
industrial development or housing purposes). Income received on such bonds is
classified as an item of "tax preference" which could subject certain
investors in such bonds, including stockholders of the Fund, to an increased
Federal alternative minimum tax. The Fund intends to purchase such "private
activity bonds" and will report to stockholders within 60 days after calendar
year-end the portion of its dividends declared during the year that
constitutes an item of tax preference for Federal alternative minimum tax
purposes. The Code further provides that corporations are subject to a Federal
alternative minimum tax based, in part, on certain differences between taxable
income as adjusted for other tax preferences and the corporation's "adjusted
current earnings," which more closely reflect a corporation's economic income.
Because an exempt-interest dividend paid by the Fund will be included in
adjusted current earnings, a corporate stockholder may be required to pay a
Federal alternative minimum tax on exempt-interest dividends paid by the Fund.
The Fund may invest in instruments the return on which includes
nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special
tax rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such nontraditional
instruments could be recharacterized as taxable ordinary income.
The Fund may engage in interest rate swaps. The Federal income tax rules
governing the taxation of interest rate swaps are not entirely clear and may
require the Fund to treat payments received under such arrangements as
ordinary income and to amortize payments made under certain circumstances.
Additionally, 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.
37
If at any time when shares of preferred stock are outstanding the Fund
does not meet the asset coverage requirements of the 1940 Act, the Fund will
be required to suspend distributions to holders of common stock until the
asset coverage is restored. See "Dividends and Distributions." This may
prevent the Fund from distributing at least 90% of its net investment income
and may, therefore, jeopardize the Fund's qualification for taxation as a RIC.
If the Fund were to fail to qualify as a RIC, some or all of the distributions
paid by the Fund would be fully taxable for Federal income tax purposes. Upon
any failure to meet the asset coverage requirements of the 1940 Act, the Fund,
in its sole discretion, may redeem shares of preferred stock in order to
maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its stockholders of failing to qualify as a RIC.
There can be no assurance, however, that any such action would achieve such
objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax exempt interest income. A distribution will only be counted
for this purpose if it qualifies for the dividends paid deduction under the
Code. Some types of preferred stock that the Fund contemplates issuing may
raise an issue as to whether distributions on such preferred stock are
"preferential" under the Code and, therefore, not eligible for the dividends
paid deduction. The Fund intends to issue preferred stock that counsel advises
will not result in the payment of a preferential dividend. If the Fund
ultimately relies solely on a legal opinion when it issues such preferred
stock, there is no assurance that the Service would agree that dividends on
the preferred stock are not preferential. If the Service successfully
disallowed the dividends paid deduction for dividends on the preferred stock,
the Fund could be disqualified as a RIC. In this case, dividends paid by the
Fund would not be exempt from Federal income taxes. Additionally, the Fund
would be subject to the Federal alternative minimum tax.
The value of shares acquired pursuant to the Fund's dividend reinvestment
plan will generally be excluded from gross income to the extent that the cash
amount reinvested would be excluded from gross income. If, when the Fund's
shares are trading at a premium over net asset value, the Fund issues shares
pursuant to the dividend reinvestment plan that have a greater fair market
value than the amount of cash reinvested, it is possible that all or a portion
of such discount (which may not exceed 5% of the fair market value of the
Fund's shares) could be viewed as a taxable distribution. If the discount is
viewed as a taxable distribution, it is also possible that the taxable
character of this discount would be allocable to all of the stockholders,
including stockholders who do not participate in the dividend reinvestment
plan. Thus, stockholders who do not participate in the dividend reinvestment
plan, as well as dividend reinvestment plan participants, might be required to
report as ordinary income a portion of their distributions equal to their
allocable share of the discount.
Ordinary income dividends paid to stockholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax
under existing provisions of the Code applicable to foreign individuals and
entities unless a reduced rate of withholding or a withholding exemption is
provided under applicable treaty law. Nonresident stockholders are urged to
consult their own tax advisers concerning the applicability of the United
States withholding tax.
Under certain Code provisions, some taxpayers may be subject to a
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
stockholders subject to backup withholding are those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account,
an investor must certify under penalty of perjury that such number is correct
and that such investor is not otherwise subject to backup withholding.
The Code provides that every stockholder required to file a tax return
must include for information purposes on such return the amount of
exempt-interest dividends received from all sources (including the Fund)
during the taxable year.
Tax Treatment of Options and Futures Transactions
The Fund may purchase or sell municipal bond index financial futures
contracts and interest rate financial futures contracts on U.S. Government
securities. The Fund may also purchase and write call and put options on such
financial futures contracts. In general, unless an election is available to
the Fund or an exception applies, such options and financial futures contracts
that are "Section 1256 contracts" will be "marked to market" for Federal
income tax purposes at the end of each taxable year, i.e., each such option or
financial futures contract will be
38
treated as sold for its fair market value on the last day of the taxable year,
and any gain or loss attributable to Section 1256 contracts will be 60% long
term and 40% short term capital gain or loss. Application of these rules to
Section 1256 contracts held by the Fund may alter the timing and character of
distributions to stockholders. The mark-to-market rules outlined above,
however, will not apply to certain transactions entered into by the Fund
solely to reduce the risk of changes in price or interest rates with respect
to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in financial
futures contracts and related options. Under Section 1092, the Fund may be
required to postpone recognition for tax purposes of losses incurred in
certain sales of securities and certain closing transactions in financial
futures contracts or the related options.
---------------
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.
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,
the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Stockholders are urged to consult their tax advisers regarding specific
questions as to Federal, state, local or foreign taxes.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the "Plan"),
unless a stockholder is ineligible or elects otherwise, all dividend and
capital gains distributions are automatically reinvested by _____ ("______"),
as agent for stockholders in administering the Plan (the "Plan Agent"), in
additional shares of common stock of the Fund. Stockholders whose shares are
held in the name of a broker or nominee should contact such broker or nominee
to confirm that they are eligible to participate in the Plan. Stockholders who
are ineligible or who elect not to participate in the Plan will receive all
dividends and distributions in cash paid by check mailed directly to the
stockholder of record (or, if the shares are held in street or other nominee
name, then to such nominee) by _____, as dividend paying agent. Such
stockholders may elect not to participate in the Plan and to receive all
distributions of dividends and capital gains in cash by sending written
instructions to _____, as dividend paying agent, at the address set forth
below. Participation in the Plan is completely voluntary and may be terminated
or resumed at any time without penalty by written notice if received by the
Plan Agent not less than ten days prior to any dividend record date;
otherwise, such termination will be effective with respect to any subsequently
declared dividend or capital gains distribution.
Whenever the Fund declares an ordinary income dividend or a capital gain
dividend (collectively referred to as "dividends") payable either in shares or
in cash, non-participants in the Plan will receive cash, and participants in
the Plan will receive the equivalent in shares of common stock. The shares are
acquired by the Plan Agent for the participant's account, depending upon the
circumstances described below, either (i) through receipt of additional
unissued but authorized shares of common stock from the Fund ("newly issued
shares") or (ii) by purchase of outstanding shares of common stock on the open
market ("open-market purchases") on the NYSE or elsewhere. If, on the dividend
payment date, the net asset value per share of the common stock is equal to or
less than the market price per share of the common stock plus estimated
brokerage commissions (such condition being referred to herein as "market
premium"), the Plan Agent will invest the dividend amount in newly issued
shares on behalf of the participant. The number of newly issued shares of
common stock to be credited to the participant's account will be determined by
dividing the dollar amount of the dividend by the net asset value per share on
the date the shares are issued, provided that the maximum discount from the
then current market price per share on the date of issuance
39
may not exceed 5%. If on the dividend payment date the net asset value per
share is greater than the market value (such condition being referred to
herein as "market discount"), the Plan Agent will invest the dividend amount
in shares acquired on behalf of the participant in open-market purchases.
In the event of a market discount on the dividend payment date, the Plan
Agent has until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase date") to invest the dividend amount
in shares acquired in open-market purchases. It is contemplated that the Fund
will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date on the
dividend through the date before the next "ex-dividend" date, which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of common stock exceeds the
net asset value per share, the average per share purchase price paid by the
Plan Agent may exceed the net asset value of the Fund's shares, resulting in
the acquisition of fewer shares than if the dividend had been paid in newly
issued shares on the dividend payment date. Because of the foregoing
difficulty with respect to open-market purchases, the Plan provides that if
the Plan Agent is unable to invest the full dividend amount in open-market
purchases during the purchase period or if the market discount shifts to a
market premium during the purchase period, the Plan Agent will cease making
open-market purchases and will invest the uninvested portion of the dividend
amount in newly issued shares at the close of business on the last purchase
date.
The Plan Agent maintains all stockholders' accounts in the Plan and
furnishes written confirmation of all transactions in the account, including
information needed by stockholders for tax records. Shares in the account of
each Plan participant will be held by the Plan Agent in non-certificated form
in the name of the participant, and each stockholder's proxy will include
those shares purchased or received pursuant to the Plan. The Plan Agent will
forward all proxy solicitation materials to participants and vote proxies for
shares held pursuant to the Plan in accordance with the instructions of the
participants.
In the case of stockholders such as banks, brokers or nominees which hold
shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of shares certified from time
to time by the record stockholders as representing the total amount registered
in the record stockholder's name and held for the account of beneficial owners
who are to participate in the Plan.
There will be no brokerage charges with respect to shares issued directly
by the Fund as a result of dividends or capital gains distributions payable
either in shares or in cash. However, each participant will pay a pro rata
share of brokerage commissions incurred with respect to the Plan Agent's
open-market purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not
relieve participants of any Federal, state or local income tax that may be
payable (or required to be withheld) on such dividends. See "Taxes."
Stockholders participating in the Plan may receive benefits not available
to stockholders not participating in the Plan. If the market price plus
commissions of the Fund's shares is higher than the net asset value,
participants in the Plan will receive shares of the Fund at less than they
could otherwise purchase them and will have shares with a cash value greater
than the value of any cash distribution they would have received on their
shares. If the market price plus commissions is below the net asset value,
participants receive distributions of shares with a net asset value greater
than the value of any cash distribution they would have received on their
shares. However, there may be insufficient shares available in the market to
make distributions in shares at prices below the net asset value. Also, since
the Fund does not redeem its shares, the price on resale may be more or less
than the net asset value.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan. There
is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by
the participants.
All correspondence concerning the Plan should be directed to the Plan
Agent at _____________________.
40
MUTUAL FUND INVESTMENT OPTION
Purchasers of shares of common stock of the Fund in this offering will
have an investment option consisting of the right to reinvest the net proceeds
from a sale of such shares (the "Original Shares") in Class A initial sales
charge shares of certain FAM/MLIM advised open-end mutual funds ("Eligible
Class A Shares") at their net asset value, without the imposition of the
initial sales charge, if the conditions set forth below are satisfied. First,
the net proceeds from the sale of Original Shares must be immediately
reinvested in Eligible Class A Shares. Second, the Original Shares must either
have been acquired in this offering or be shares representing reinvested
dividends from shares of common stock acquired in this offering. Third, there
must be a minimum purchase of $250 to be eligible for the investment option.
Class A shares of certain of the mutual funds are subject to an account
maintenance fee at an annual rate of up to 0.25% of the average daily net
asset value of such mutual fund. The Eligible Class A Shares may be redeemed
at any time at the next determined net asset value, subject in certain cases
to a redemption fee.
NET ASSET VALUE
Net asset value per share of common stock is determined Monday through
Friday as of the close of business on the NYSE (generally, the NYSE closes at
4:00 p.m., Eastern time), on each business day during which the NYSE is open
for trading. For purposes of determining the net asset value of a share of
common stock, the value of the securities held by the Fund plus any cash or
other assets (including interest accrued but not yet received) minus all
liabilities (including accrued expenses) and the aggregate liquidation value
of any outstanding shares of preferred stock is divided by the total number of
shares of common stock outstanding at such time. Expenses, including the fees
payable to the Investment Adviser, are accrued daily.
The Municipal Bonds in which the Fund invests are traded primarily in the
over-the-counter markets. In determining net asset value, the Fund uses the
valuations of portfolio securities furnished by a pricing service approved by
the Board of Directors. The pricing service typically values portfolio
securities at the bid price or the yield equivalent when quotations are
readily available. Municipal Bonds for which quotations are not readily
available are valued at fair market value on a consistent basis as determined
by the pricing service using a matrix system to determine valuations. The
procedures of the pricing service and its valuations are reviewed by the
officers of the Fund under the general supervision of the Board of Directors.
The Board of Directors has determined in good faith that the use of a pricing
service is a fair method of determining the valuation of portfolio securities.
Positions in futures contracts and interest rate swaps are valued at closing
prices for such contracts established by the exchange or dealer market on
which they are traded, or if market quotations are not readily available, are
valued at fair value on a consistent basis using methods approved in good
faith by the Board of Directors.
The Fund makes available for publication the net asset value of its
shares of common stock determined as of the last business day each week.
Currently, the net asset values of shares of publicly traded closed-end
investment companies investing in debt securities are published in Barron's,
the Monday edition of The Wall Street Journal and the Monday and Saturday
editions of The New York Times.
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares initially are classified as common
stock. The Board of Directors is authorized, however, to classify and
reclassify any unissued shares of capital stock into one or more additional or
other classes or series as may be established from time to time by setting or
changing in any one or more respects the designations, preferences, conversion
or other rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption of such shares of stock
and pursuant to such classification or reclassification to increase or
decrease the number of authorized shares of any existing class or series. The
Fund may reclassify an amount of unissued common stock as preferred stock and
at that time offer shares of preferred stock. See "Risks and Special
Considerations of Leverage."
41
Common Stock
Shares of common stock, when issued and outstanding, will be fully paid
and non-assessable. Stockholders are entitled to share pro rata in the net
assets of the Fund available for distribution to stockholders upon liquidation
of the Fund. Stockholders are entitled to one vote for each share held.
In the event that the Fund issues preferred stock and so long as any
shares of the Fund's preferred stock are outstanding, holders of common stock
will not be entitled to receive any net income of or other distributions from
the Fund unless all accumulated dividends on preferred stock have been paid,
and unless asset coverage (as defined in the 1940 Act) with respect to
preferred stock would be at least 200% after giving effect to such
distributions. See "Risks and Special Considerations of Leverage."
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its stockholders.
The Investment Adviser provided the initial capital for the Fund by
purchasing ______ shares of common stock of the Fund for $________. As of the
date of this prospectus, the Investment Adviser owned 100% of the outstanding
shares of common stock of the Fund. The Investment Adviser may be deemed to
control the Fund until such time as it owns less than 25% of the outstanding
shares of the Fund.
Preferred Stock
It is anticipated that the Fund's shares of preferred stock will be
issued in one or more series, with rights as determined by the Board of
Directors, by action of the Board of Directors without the approval of the
holders of common stock. Under the 1940 Act, the Fund is permitted to have
outstanding more than one series of preferred stock so long as no single
series has a priority over another series as to the distribution of assets of
the Fund or the payment of dividends. Holders of common stock have no
preemptive right to purchase any shares of preferred stock that might be
issued. It is anticipated that the net asset value per share of the preferred
stock will equal its original purchase price per share plus accumulated
dividends per share.
The Fund's Board of Directors has declared its intention to authorize an
offering of shares of preferred stock (representing approximately ____% of the
Fund's capital immediately after the issuance of such preferred stock) within
approximately three months after completion of the offering of common stock,
subject to market conditions and to the Board's continuing to believe that
leveraging the Fund's capital structure through the issuance of preferred
stock is likely to achieve the benefits to the holders of common stock
described in the prospectus. Although the terms of the preferred stock,
including its dividend rate, voting rights, liquidation preference and
redemption provisions will be determined by the Board of Directors (subject to
applicable law and the Fund's Charter), the initial series of preferred stock
will be structured to carry either a relatively short term dividend rate, in
which case periodic redetermination of the dividend rate will be made at
relatively short intervals (generally seven or 28 days), or a medium term
dividend rate, in which case periodic redetermination of the dividend rate
will be made at intervals of up to five years. In either case, such
redetermination of the dividend rate will be made through an auction or
remarketing procedure. The Board also has indicated that it is likely that the
liquidation preference, voting rights and redemption provisions of the
preferred stock will be as stated below.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of shares of
preferred stock will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus an
amount equal to accumulated and unpaid dividends whether or not earned or
declared) before any distribution of assets is made to holders of common
stock. After payment of the full amount of the liquidating distribution to
which they are entitled, the preferred stockholders will not be entitled to
any further participation in any distribution of assets by the Fund. A
consolidation or merger of the Fund with or into any other corporation or
corporations or a sale of all or substantially all of the assets of the Fund
will not be deemed to be a liquidation, dissolution or winding up of the Fund.
Voting Rights. Except as otherwise indicated in this prospectus and
except as otherwise required by applicable law, holders of shares of preferred
stock will have equal voting rights with holders of shares of common stock
(one vote per share) and will vote together with holders of common stock as a
single class.
42
In connection with the election of the Fund's Directors, holders of
shares of preferred stock, voting as a separate class, will be entitled to
elect two of the Fund's Directors, and the remaining Directors will be elected
by all holders of capital stock, voting as a single class. So long as any
preferred stock is outstanding, the Fund will have not less than five
Directors. If at any time dividends on shares of the Fund's preferred stock
shall be unpaid in an amount equal to two full years' dividends thereon, the
holders of all outstanding shares of preferred stock, voting as a separate
class, will be entitled to elect a majority of the Fund's directors until all
dividends in default have been paid or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding
shares of the preferred stock, voting as a separate class, will be required to
(i) authorize, create or issue any class or series of stock ranking prior to
any series of preferred stock with respect to payment of dividends or the
distribution of assets on liquidation or (ii) amend, alter or repeal the
provisions of the Charter, whether by merger, consolidation or otherwise, so
as to adversely affect any of the contract rights expressly set forth in the
Charter of holders of preferred stock.
Redemption Provisions. It is anticipated that shares of preferred stock
will generally be redeemable at the option of the Fund at a price equal to
their liquidation preference plus accumulated but unpaid dividends to the date
of redemption plus, under certain circumstances, a redemption premium. Shares
of preferred stock will also be subject to mandatory redemption at a price
equal to their liquidation preference plus accumulated but unpaid dividends to
the date of redemption upon the occurrence of certain specified events, such
as the failure of the Fund to maintain asset coverage requirements for the
preferred stock specified by the rating agencies that issue ratings on the
preferred stock.
Certain Provisions of the Charter and By-Laws
The Fund's Charter includes provisions that could have the effect of
limiting the ability of other entities or persons to acquire control of the
Fund or to change the composition of its Board of Directors and could have the
effect of depriving stockholders of an opportunity to sell their shares at a
premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A Director may be removed from office
with or without cause but only by vote of the holders of at least 662/3% of
the shares entitled to vote in an election to fill that directorship.
In addition, the Charter requires the favorable vote of the holders of at
least 662/3% of the Fund's shares to approve, adopt or authorize the
following:
o a merger or consolidation or statutory share exchange of the Fund with
any other corporation;
o a sale of all or substantially all of the Fund's assets (other than in
the regular course of the Fund's investment activities); or
o a liquidation or dissolution of the Fund;
unless such action has been approved, adopted or authorized by the affirmative
vote of at least two-thirds of the total number of Directors fixed in
accordance with the By-laws, in which case the affirmative vote of a majority
of the Fund's shares of capital stock is required. Following any issuance of
preferred stock by the Fund, it is anticipated that the approval, adoption or
authorization of the foregoing also would require the favorable vote of a
majority of the Fund's shares of preferred stock then entitled to be voted,
voting as a separate class.
In addition, conversion of the Fund to an open-end investment company
would require an amendment to the Fund's Charter. The amendment would have to
be declared advisable by the Board of Directors prior to its submission to
stockholders. Such an amendment would require the favorable vote of the
holders of at least 662/3% of the Fund's outstanding shares of capital stock
(including any preferred stock) entitled to be voted on the matter, voting as
a single class (or a majority of such shares if the amendment was previously
approved, adopted or authorized by two-thirds of the total number of Directors
fixed in accordance with the By-laws), and, assuming preferred stock is
issued, the affirmative vote of a majority of outstanding shares of preferred
stock of the Fund, voting as a separate class. Such a vote also would satisfy
a separate requirement in the 1940 Act that the change be approved by the
stockholders. Stockholders of an open-end investment company may require the
company to
43
redeem their shares of common stock at any time (except in certain
circumstances as authorized by or under the 1940 Act) at their net asset
value, less such redemption charge, if any, as might be in effect at the time
of a redemption. All redemptions will be made in cash. If the Fund is
converted to an open-end investment company, it could be required to liquidate
portfolio securities to meet requests for redemption, and the common stock
would no longer be listed on a stock exchange.
Conversion to an open-end investment company would also require changes
in certain of the Fund's investment policies and restrictions, such as those
relating to the borrowing of money and the purchase of illiquid securities.
The Charter and By-laws provide that the Board of Directors has the
power, to the exclusion of stockholders, to make, alter or repeal any of the
By-laws (except for any By-law specified not to be amended or repealed by the
Board), subject to the requirements of the 1940 Act. Neither this provision of
the Charter, nor any of the foregoing provisions of the Charter requiring the
affirmative vote of 662/3% of shares of capital stock of the Fund, can be
amended or repealed except by the vote of such required number of shares.
The Board of Directors has determined that the 662/3% 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
____________________, ____________________, ________________________.
44
UNDERWRITING
The Fund intends to offer the shares through the underwriters. Merrill
Lynch, Pierce, Fenner & Smith Incorporated is acting as representative of the
underwriters named below. Subject to the terms and conditions contained in a
purchase agreement between the Fund and the Investment Adviser and the
underwriters, the Fund has agreed to sell to the underwriters, and the
underwriters severally have agreed to purchase from the Fund, the number of
shares listed opposite their names below.
Underwriters Number of Shares
------------ ----------------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated..............
................................................
................................................
---------------------------
Total
The underwriters have agreed to purchase all of the shares sold pursuant
to the purchase agreement if any of these shares are purchased. If an
underwriter defaults, the purchase agreement provides that the purchase
commitments of the nondefaulting underwriters may be increased or the purchase
agreement may be terminated.
The Fund and the Investment Adviser have agreed to indemnify the
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended, or to contribute to payments the
underwriters may be required to make in respect of those liabilities.
The underwriters are offering the shares, subject to prior sale, when, as
and if issued to and accepted by them, subject to approval of legal matters by
their counsel, including the validity of the shares, and other conditions
contained in the purchase agreement, such as the receipt by the underwriters
of officer's certificates and legal opinions. The underwriters reserve the
right to withdraw, cancel or modify offers to the public and to reject orders
in whole or in part.
Commissions and Discounts
The underwriters have advised the Fund that they propose initially to
offer the shares to the public at the initial public offering price on the
cover page of this prospectus and to dealers at that price less a concession
not in excess of $___ per share. The underwriters may allow, and the dealers
may reallow, a discount not in excess of $___ per share to other dealers.
There is a sales charge or underwriting discount of $___ per share, which is
equal to ___% of the initial public offering price per share. After the
initial public offering, the public offering price, concession and discount
may be changed. Investors must pay for the shares of common stock purchased in
the offering on or before ________ __, 2003.
The following table shows the public offering price, underwriting
discount and proceeds before expenses to the Fund. The information assumes
either no exercise or full exercise by the underwriters of their overallotment
option.
45
Per Share Without Option With Option
--------- -------------- -----------
Public offering price $15.00 $ $
Underwriting discount $ $ $
Proceeds, before expenses, to the Fund $ $ $
The expenses of the offering, excluding underwriting discount, are
estimated at $___ and are payable by the Fund.
Overallotment Option
The Fund has granted the underwriters an option to purchase up to
_________additional shares at the public offering price less the underwriting
discount. The underwriters may exercise the option from time to time for 45
days from the date of this prospectus solely to cover any overallotments. If
the underwriters exercise this option, each will be obligated, subject to
conditions contained in the purchase agreement, to purchase a number of
additional shares proportionate to that underwriter's initial amount reflected
in the above table.
Price Stabilization, Short Positions and Penalty Bids
Until the distribution of the shares is completed, Commission rules may
limit the underwriters and selling group members from bidding for and
purchasing the Fund's shares. However, the representatives may engage in
transactions that stabilize the price of the shares, such as bids or purchases
to peg, fix or maintain that price.
If the underwriters create a short position in the shares in connection
with the offering, i.e., if they sell more shares than are listed on the cover
of this prospectus, the representative may reduce that short position by
purchasing shares in the open market. The representative also may elect to
reduce any short position by exercising all or part of the overallotment
option described above. Purchases of the shares to stabilize its price or to
reduce a short position may cause the price of the shares to be higher than it
might be in the absence of such purchases.
The representative also may impose a penalty bid on underwriters and
selling group members. This means that if the representative purchases shares
in the open market to reduce the underwriters' short position or to stabilize
the price of such shares, it may reclaim the amount of the selling concession
from the underwriters and selling group members who sold those shares. The
imposition of a penalty bid also may affect the price of the shares in that it
discourages resales of those shares.
Neither the Fund nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the shares. In addition,
neither the Fund nor any of the underwriters makes any representation that the
representative will engage in such transactions or that such transactions,
once commenced, will not be discontinued without notice.
Stock Exchange Listing
Prior to this offering, there has been no public market for the shares.
The Fund plans to apply to list its shares on the NYSE or another national
securities exchange under the symbol "____". However, during an initial period
that is not expected to exceed two weeks from the date of this prospectus, the
Fund's shares will not be listed on any securities exchange. Additionally,
before it begins trading, the underwriters do not intend to make a market in
the Fund's shares, although a limited market may develop. Thus, it is
anticipated that investors may not be able to buy and sell shares of the Fund
during such period. In order to meet the requirements for listing, the
underwriters have undertaken to sell lots of 100 or more shares to a minimum
of 2,000 beneficial owners.
Other Relationships
The Investment Adviser (and not the Fund) also has agreed to pay a fee to
Merrill Lynch quarterly at the annual rate of 0. % of the Fund's average daily
net assets, plus the proceeds of any outstanding borrowings used for leverage,
during the continuance of the Investment Advisory Agreement. The maximum
amount of this fee will not exceed 4.5% of the aggregate initial offering
price of the common stock offered hereby; provided, that in
46
determining when the maximum amount has been paid the value of each of the
quarterly payments shall be discounted at the annual rate of 10% back to the
closing date of this offering. Merrill Lynch has agreed to provide certain
after-market services to the Investment Adviser designed to maintain the
visibility of the Fund on an ongoing basis and to provide relevant
information, studies or reports regarding the Fund and the closed-end
investment company industry.
The Fund anticipates that Merrill Lynch may from time to time act as a
broker in connection with the execution of its portfolio transactions. See
"Portfolio Transactions." Merrill Lynch is an affiliate of the Investment
Adviser.
The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated is 4
World Financial Center, New York, New York 10080.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the
shares of common stock of the Fund is _____________________,
__________________, ________________________.
ACCOUNTING SERVICES PROVIDER
State Street Bank and Trust Company, 500 College Road East, Princeton,
New Jersey 08540, provides certain accounting services for the Fund.
LEGAL OPINIONS
Certain legal matters in connection with the shares of common stock
offered hereby are passed on for the Fund by Sidley Austin Brown & Wood LLP,
New York, New York. Certain legal matters will be passed on for the
underwriters by __________________.
INDEPENDENT AUDITORS AND EXPERTS
______________, independent auditors, have audited the statement of
assets and liabilities of the Fund as of _______, 2003 which is included in
this prospectus and Registration Statement. The statement of assets and
liabilities is included in reliance upon their report, which is also included
in this prospectus and in the Registration Statement, given on their authority
as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the 1940 Act and in accordance therewith is required
to file reports and other information with the Commission. Any such reports
and other information, including the Fund's Code of Ethics, can be inspected
and copied at the public reference facilities of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
following regional offices of the Commission: Pacific Regional Office, at 5670
Wilshire Boulevard, 11th Floor, Los Angeles, California 90036; and Midwest
Regional Office, at Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such materials can be obtained
from the public reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission maintains a Web
site at http://www.sec.gov containing reports and information statements and
other information regarding registrants, including the Fund, that file
electronically with the Commission. Reports, proxy statements and other
information concerning the Fund can also be inspected at the offices of the
Exchange.
47
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.
48
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Muni Intermediate Duration Fund, Inc.:
We have audited the accompanying statement of assets and liabilities of
Muni Intermediate Duration Fund, Inc. as of __________________,2003. This
statement of assets and liabilities is the responsibility of the Fund's
management. Our responsibility is to express an opinion on this statement of
assets and liabilities based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of assets and
liabilities is free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the statement
of assets and liabilities. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement of assets and liabilities presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of Muni
Intermediate Duration Fund, Inc. at __________________, 2003 in conformity
with generally accepted accounting principles.
__________________
New York, New York
_________, 2003
49
Muni Intermediate Duration Fund, Inc.
Statement of Assets and Liabilities
__________, 2003
ASSETS
Cash................................................................................ $______
Offering costs (Note 1)............................................................. ______
Total assets...................................................................... ______
LIABILITIES
Liabilities and accrued expenses (Note 1)........................................... ______
NET ASSETS............................................................................... $
======
NET ASSETS CONSIST OF:
Common Stock, par value $.10 per share; 200,000,000 shares authorized; _____ shares
issued and outstanding (Note 1)................................................... $______
Paid-in Capital in excess of par.................................................... ______
Total Capital-Equivalent to $________ net asset value per share of
Common Stock (Note 1)............................................................. $
======
NOTES TO STATEMENT OF ASSETS AND LIABILITIES
Note 1. Organization
The Fund was incorporated under the laws of the State of Maryland on May
15, 2003, as a closed-end, non-diversified management investment company and
has had no operations other than the sale to Fund Asset Management, L.P. (the
"Investment Adviser") of an aggregate of ___________ shares for $________ on
____________, 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 has agreed to reimburse all organizational
expenses (approximately $_____) and pay all offering costs (other than the
underwriting discount) that exceed $ ___ per share of common stock (___% of
the offering price).
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 ___% of the Fund's average daily net assets (including net assets
attributable to preferred stock).
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.
50
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."
A-1
Description of Moody's Commercial Paper Ratings
Moody's Commercial Paper ratings are opinions of the ability of issuers
to honor senior financial obligations and contracts. Such obligations
generally have an original maturity not exceeding one year, unless explicitly
noted. Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well established industries; high rates of return
on funds employed; conservative capitalization structures with moderate
reliance on debt and ample asset protection; broad margins in earning coverage
of fixed financial charges and high internal cash generation; and well
established access to a range of financial markets and assured sources of
alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
to repay senior short term debt obligations. This will normally be evidenced
by many of the characteristics cited above, but to a lesser degree. Earnings
trends and coverage ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected
by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short term promissory obligations. The effect
of industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level
of debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Description of Standard & Poor's, a Division of The McGraw-Hill Companies,
Inc. ("Standard & Poor's"), Municipal Debt Ratings
A Standard & Poor's municipal debt rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations or a specific program.
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or based on circumstances.
The ratings are based, in varying degrees, on the following
considerations:
I. Likelihood of payment--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
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.
A-2
AA An obligation rated "AA" differs from the highest rated issues
only in small degree. The obligor's capacity to meet its
financial commitment on the obligation is very strong.
A An obligation rated "A" is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than debt in higher-rated categories. However, the
obligor's capacity to meet its financial commitment on the
obligation is still strong.
BBB An obligation rated "BBB" exhibits adequate protection
parameters. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of
the obligor to meet its financial commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as
having significant speculative characteristics. "BB" indicates
the least degree of speculation and "C" the highest. While such
debt will likely have some quality and protective
characteristics, these may be outweighed by large uncertainties
or major risk exposures to adverse conditions.
BB An obligation rated "BB" is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing
uncertainties or exposure to adverse business, financial, or
economic conditions which could lead to the obligor's inadequate
capacity to meet its financial commitment on the obligation.
B An obligation rated "B" is more vulnerable to nonpayment than
obligations rated 'BB', but the obligor currently has the
capacity to meet its financial commitment on the obligation.
Adverse business, financial, or economic conditions will likely
impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC An obligation rated "CCC" is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on
the obligation. In the event of adverse business, financial, or
economic conditions, the obligor is not likely to have the
capacity to meet its financial commitment on the obligation.
CC An obligation rated "CC" is currently highly vulnerable to
nonpayment.
C A subordinated debt or preferred stock obligation rated "C" is
CURRENTLY HIGHLY VULNERABLE to nonpayment. The "C" rating may be
used to cover a situation where a bankruptcy petition has been
filed or similar action taken, but payments on this obligation
are being continued. A 'C' also will be assigned to a preferred
stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
D An obligation rated "D" is in payment default. The "D" rating
category is used when payments on an obligation are not made on
the date due even if the applicable grace period has not expired,
unless Standard & Poor's believes that such payments will be made
during such grace period. The "D" rating also will be used upon
the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
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-3
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as
high as for issues designated "A-1".
A-3 Issues carrying this designation have an adequate capacity for
timely payment. They are, however, more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the
higher designations.
B Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C This rating is assigned to short term debt obligations with a
doubtful capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is
used when interest payments of principal payments are not made on
the date due, even if the applicable grace period has not expired,
unless Standard & Poor's believes such payments will be made
during such grace period.
A commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's note rating reflects the liquidity factors and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three years will most likely
receive a long term debt rating. The following criteria will be used in making
that assessment.
--Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market for
its refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined
to possess a very strong capacity to pay debt service is given a
plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the
term of the notes.
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.
A-4
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability
to pay interest and repay principal, which is unlikely to be
affected by reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay
principal is very strong, although not quite as strong as bonds
rated "AAA." Because bonds rated in the "AAA" and "AA"
categories are not significantly vulnerable to foreseeable
future developments, short term debt of these issuers is
generally rated "F-1+."
A Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay
principal is considered to be strong, but may be more vulnerable
to adverse changes in economic conditions and circumstances than
bonds with higher ratings.
BBB Bonds considered to be investment grade and of
satisfactory-credit quality. The obligor's ability to pay
interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is
higher than for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful
completion of a project or the occurrence of a specific
event.
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
A-5
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
DD, payments. Such bonds are extremely speculative and
and D Default should be valued on the basis of their ultimate recovery
value in liquidation or reorganization of the obligor.
"DDD" represents the highest potential for recovery on
these bonds, and "D" represents the lowest potential for
recovery.
Plus (+) or Minus (-): Plus and minus signs are used with
a rating symbol to indicate the relative position of a
credit within the rating category. Plus and minus signs,
however, are not used in the "DDD," "DD," or "D"
categories.
Description of Fitch's Short term Ratings
Fitch's short term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium term notes, and 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.
A-6
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for
timely payment is adequate; however, near-term adverse
changes could cause these securities to be rated below
investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse
changes in financial and economic conditions.
D Default. Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol "LOC" indicates that the rating is based on a
letter of credit issued by a commercial bank.
A-7
APPENDIX B
TAXABLE EQUIVALENT YIELDS FOR 2003
Taxable Income* A Tax Exempt Yield of
------------------------------------------ ---------------------------------------------------------
Single 2003 Federal
Return Joint Return Tax Bracket 5.00% 5.50% 6.00% 6.50% 7.00% 7.50%
-------------------- ------------------- -------------- --------- ------- ------- ------- ------- ---------
is equal to a taxable yield of
$28,401-$68,800 $47,451-$114,650 27.00% 6.85% 7.53% 8.22% 8.90% 9.59% 10.27%
$68,801-$143,500 $114,651-$174,700 30.00% 7.14% 7.86% 8.57% 9.29% 10.00% 10.71%
$143,501-$311,950 $174,701-$311,950 35.00% 7.69% 8.46% 9.23% 10.00% 10.77% 11.54%
Over $311,500 Over $311,500 38.60% 8.14% 8.96% 9.77% 10.59% 11.40% 12.21%
---------------
* An investor's marginal tax rates may exceed the rates shown in the above
table due to the reduction, or possible elimination, of the personal
exemption deduction for high-income taxpayers and an overall limit on
itemized deductions. Income also may be subject to certain state and
local taxes. For investors who pay Federal alternative minimum tax, tax
exempt yields may be equivalent to lower taxable yields than those shown
above. The tax rates shown above do not apply to corporate taxpayers.
Certain legislative proposals are under consideration which would change
the Federal tax rates listed above and thereby affect the tax equivalent
yield calculations. The tax characteristics of the Fund are described
more fully elsewhere in this prospectus. Consult your tax adviser for
further details. This chart is for illustrative purposes only and cannot
be taken as an indication of anticipated Fund performance.
B-1
==============================================================================
Through and including __________ ___, 2003 (the 25th day after the date
of this prospectus), all dealers effecting transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
__________ Shares
Muni Intermediate Duration Fund, Inc.
Common Stock
---------------------------
PROSPECTUS
---------------------------
Merrill Lynch & Co.
[names of underwriting syndicate members]
____________, 2003
CODE #_____-____ 03
==============================================================================
PART C. OTHER INFORMATION
Item 24. Financial Statements and Exhibits.
(1) Financial Statements:
Independent Auditors' Report
Statement of Assets and Liabilities as of ____________, 2003
(2) Exhibits:
Exhibit
Number Description
------ -----------
(a) --Articles of Incorporation of the Fund.
(b) --By-Laws of the Fund.
(c) --Not applicable
(d)(1) --Portions of the Articles of Incorporation and By-Laws of the Fund defining the rights of
holders of shares of common stock of the Fund. (a)
(d)(2) --Form of specimen certificate for shares of common stock of the Fund.*
(e) --Form of Automatic Dividend Reinvestment Plan.*
(f) --Not applicable
(g) --Form of Investment Advisory Agreement between the Fund and Fund Asset
Management, L.P. ("FAM" or the "Investment Adviser").*
(h)(1) --Form of Purchase Agreement between the Fund and Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch") and other underwriters.*
(h)(2) --Form of Merrill Lynch Standard Dealer Agreement.*
(h)(3) --Form of Master Agreement Among Underwriters.*
(i) --Not applicable
(j) --Form of Custodian Agreement between the Registrant and ____________________. *
(k)(1) --Form of Registrar, Transfer Agency, Dividend Disbursing Agency and Stockholder
Service Agreement between the Fund and ____________________.*
(k)(2) --Form of Administrative Services Agreement between Registrant and State Street Bank
and Trust Company. (c)
(k)(3) --Form of Additional Compensation Agreement between FAM and Merrill Lynch.*
(l) --Opinion and Consent of Sidley Austin Brown & Wood LLP.*
(m) --Not applicable
(n) --Consent of _________________, independent auditors for the Fund.*
(o) --Not applicable
(p) --Certificate of FAM.*
(q) --Not applicable
(r) --Code of Ethics.*
---------------------
(a) Reference is made to Article IV, Article V (sections 2, 3, 5, 6 and 7),
Article VI, Article VII, Article VIII, Article IX, Article X and Article
XII of the Registrant's Articles of Incorporation, filed as Exhibit (a)
hereto; and to Article II, Article III (sections 1, 2, 3, 5 and 17),
Article VI, Article VII, Article XII, Article XIII and Article XIV of the
Registrant's By-Laws, filed as Exhibit (b) hereto.
(b) Incorporated by reference to Exhibit 8(d) to Post-Effective Amendment No.
1 to the Registration Statement on Form N-1A of Merrill Lynch Focus
Twenty Fund, Inc. (File No. 333-89775) filed on March 20, 2001.
* To be provided by amendment.
Item 25. Marketing Arrangements.
See Exhibits (h)(1) and (2).
Item 26. Other Expenses of Issuance and Distribution.
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this Registration Statement:
Registration fees........................................................ $ *
--
[____________] Stock Exchange listing fee................................ *
--
Printing (other than stock certificates)................................. *
--
Engraving and printing stock certificates................................ *
--
Legal fees and expenses.................................................. *
--
Accounting fees and expenses............................................. *
--
NASD fees................................................................ *
--
Miscellaneous............................................................ *
--
Total.................................................................... *
==
---------------------
*To be provided by amendment.
Item 27. Persons Controlled by or Under Common Control with Registrant.
The information in the prospectus under the captions "Investment Advisory
and Management Arrangements" and "Description of Capital Stock--Common Stock"
and in Note 1 to the Statement of Assets and Liabilities is incorporated
herein by reference.
Item 28. Number of Holders of Securities.
There will be one record holder of the Common Stock, par value $0.10
per share, as of the effective date of this Registration Statement.
Item 29. Indemnification.
Reference is made to Section 2-418 of the General Corporation Law of the
State of Maryland, Article V of the Registrant's Articles of Incorporation,
Article VI of the Registrant's By-Laws, Article IV of the Investment Advisory
Agreement and Section 6 of the Purchase Agreement, which provide for
indemnification.
Article V of the Articles of Incorporation provides that each officer and
director of the Registrant shall be indemnified and advanced expenses by the
Registrant to the full extent permitted by the General Laws of the State of
Maryland, now or hereafter in force, including the advance of expenses under
the procedures and to the full extent permitted by law subject to the
requirements of the Investment Company Act of 1940, as amended (the "1940
Act"). These rights of indemnification shall not be exclusive of any other
rights to which those seeking indemnification may be entitled. Article V of
the Articles of Incorporation states that no amendment may be made to the
Articles of Incorporation or any repeal of any provision of the Articles of
Incorporation that would limit or eliminate the benefits provided to directors
and officers in connection with any act or omission that occurred prior to
such amendment or repeal.
Article V of the Articles of Incorporation further provides that to the
fullest extent permitted by the General Laws of the State of Maryland or
decisional law, as amended or interpreted, subject to the requirements of the
1940 Act, no director or officer of the Registrant shall be personally liable
to the Registrant or its security holders for money damages. No amendment of
the Articles of Incorporation or repeal of any provision hereof shall limit or
eliminate the benefits provided to directors and officers under this provision
in connection with any act or omission that occurred prior to such amendment
or repeal.
Article VI of the By-Laws provides that each officer and director of the
Registrant shall be indemnified by the Registrant to the full extent permitted
under the General Laws of the State of Maryland, except that such indemnity
shall not protect any such person against any liability to the Registrant or
any stockholder thereof to which such person would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office. Absent a court
determination that an officer or director seeking indemnification was not
liable on the merits or guilty of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his
office, the decision by the Registrant to indemnify such person must be based
upon the reasonable determination of independent counsel or non-party
independent directors, after review of the facts, that such officer or
director is not guilty of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his office.
The Registrant may purchase insurance on behalf of an officer or director
protecting such person to the full extent permitted under the General Laws of
the State of Maryland from liability arising from his activities as officer or
director of the Registrant. The Registrant, however, may not purchase
insurance on behalf of any officer or director of the Registrant that protects
or purports to protect such person from liability to the Registrant or to its
stockholders to which such officer or director would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of his office.
C-2
Insofar as the conditional advancing of indemnification moneys for
actions based upon the 1940 Act, may be concerned, such payments will be made
only on the following conditions: (i) the advances must be limited to amounts
used, or to be used, for the preparation or presentation of a defense to the
action, including costs connected with the preparation of a settlement; (ii)
advances may be made only upon receipt of a written promise by, or on behalf
of, the recipient to repay that amount of the advance which exceeds the amount
to which it is ultimately determined that he is entitled to receive from the
Registrant by reason of indemnification; and (iii) (a) such promise must be
secured by a surety bond, other suitable insurance or an equivalent form of
security which assures that any repayments may be obtained by the Registrant
without delay or litigation, which bond, insurance or other form of security
must be provided by the recipient of the advance, of (b) a majority of a
quorum of the Registrant's disinterested, non-party Directors, or an
independent legal counsel in a written opinion, shall determine, based upon a
review of readily available facts, that the recipient of the advance
ultimately will be found entitled to indemnification.
In Section 6 of the Purchase Agreement relating to the securities being
offered hereby, the Registrant agrees to indemnify Merrill Lynch and each
person, if any, who controls Merrill Lynch within the meaning of the
Securities Act of 1933 (the "1933 Act") against certain types of civil
liabilities arising in connection with the Registration Statement or
Prospectus.
In Section IV of the Investment Advisory Agreement, the Registrant agrees
to indemnify the Investment Adviser for any error of judgment or mistake of
law or for any loss arising out of any investment or for any act or omission
in the management of the Registrant, except for willful misfeasance, bad faith
or gross negligence in the performance of its duties, or by reason of reckless
disregard of its obligations and duties thereunder.
Insofar as indemnification for liabilities arising under the 1933 Act may
be provided to directors, officers and controlling persons of the Registrant
and Merrill Lynch, pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that, in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as
expressed in the 1933 Act and is, therefore, unenforceable. In the event that
a claim for indemnification against such liabilities (other than the payment
by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in connection with any successful defense
of any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the 1933 Act and will be governed by the final
adjudication of such issue.
Item 30. Business and Other Connections of the Investment Adviser.
FAM acts as the investment adviser for a number of affiliated open-end
and closed-end registered investment companies.
Merrill Lynch Investment Managers, L.P. ("MLIM"), an affiliate of the
Investment Adviser, acts as the investment adviser for a number of affiliated
open-end and closed-end registered investment companies and also acts as
subadviser to certain other portfolios.
The address of each of these registered investment companies is P.O. Box
9011, Princeton, New Jersey 08543-9011, except that the address of Merrill
Lynch Funds for Institutions Series is One Financial Center, 23rd Floor,
Boston, Massachusetts 02111-2665. The address of the Investment Adviser, MLIM,
Princeton Services, Inc. ("Princeton Services") and Princeton Administrators,
L.P. ("Princeton Administrators") is also P.O. Box 9011, Princeton, New Jersey
08543-9011. The address of FAM Distributors, Inc., ("FAMD") is P.O. Box 9081,
Princeton, New Jersey 08543-9081. The address of Merrill Lynch and Merrill
Lynch & Co., Inc. ("ML & Co.") is World Financial Center, North Tower, 250
Vesey Street, New York, New York 10080. The address of the Fund's transfer
agent, Financial Data Services, Inc. ("FDS"), is 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner of the
Investment Adviser indicating each business, profession, vocation or
employment of a substantial nature in which each such person or entity has
been engaged for the past two years for his, her or its own account or in the
capacity of director, officer, employee,
C-3
partner or Director. Mr. Burke is Vice President and Treasurer of all or
substantially all of the investment companies advised by FAM or its
affiliates, and Mr. Doll is an officer of one or more of such companies.
Position(s) with Other Substantial Business,
Name Investment Adviser Profession, Vocation Or Employment
----------------------------- --------------------------- ---------------------------------------------------
ML & Co. Limited Partner Financial Services Holding Company; Limited Partner
of MLIM
Princeton Services General Partner General Partner of MLIM
Robert C. Doll, Jr. President President of MLIM; President of Princeton Services;
Chief Investment Officer of OppenheimerFunds, Inc.
in 1999 and Executive Vice President thereof from
1991 to 1999
Donald C. Burke First Vice President, First Vice President, Treasurer and Director of
Treasurer and Director of Taxation of MLIM; Treasurer of Princeton Services;
Taxation Senior Vice President and Treasurer of Princeton
Services from 1997 to 2002; Vice President of
FAMD; Senior Vice President of MLIM from 1999 to
2000; First Vice President of MLIM from 1997 to 1999
Lawrence D. Haber First Vice President First Vice President of MLIM; Senior Vice President
and Treasurer of Princeton Services
Brian A. Murdock Senior Vice President and Senior Vice President of MLIM and Chief Operating
Chief Operating Officer Officer of MLIM Americas; Chief Investment Officer
of EMEA Pacific Region and Global CIO for Fixed
Income and Alternative Investments; Head of MLIM's
Pacific Region and President of MLIM Japan,
Australia and Asia
Andrew J. Donohue General Counsel General Counsel of MLIM and Princeton Services
ITEM 31. Location of Account and Records.
All accounts, books and other documents required to be maintained by
Section 31(a) of the 1940 Act, and the Rules promulgated thereunder are
maintained at the offices of the Registrant (800 Scudders Mill Road,
Plainsboro, New Jersey 08536), its investment adviser (800 Scudders Mill Road,
Plainsboro, New Jersey 08536), and its custodian and transfer agent.
ITEM 32. Management Services.
Not applicable.
ITEM 33. Undertakings.
(a) The Registrant undertakes to suspend the offering of the shares of
common stock covered hereby until it amends its prospectus contained herein if
(1) subsequent to the effective date of this Registration Statement, its net
asset value per share of common stock declines more than 10% from its net
asset value per share of common stock
C-4
as of the effective date of this Registration Statement, or (2) its net asset
value per share of common stock increases to an amount greater than its net
proceeds as stated in the prospectus contained herein.
(b) The Registrant undertakes that:
(1) For purposes of determining any liability under the 1933 Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the registrant pursuant to Rule 497(h) under
the 1933 Act shall be deemed to be part of this Registration Statement as
of the time it was declared effective.
(2) For the purpose of determining any liability under the 1933 Act,
each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.
C-5
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this
Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the Township of Plainsboro, State of New Jersey,
on the 16th day of May, 2003.
MUNI INTERMEDIATE DURATION FUND, INC.
(Registrant)
By: /s/ BRIAN D. STEWART
---------------------------------
(Brian D. Stewart, President)
Each person whose signature appears below hereby authorizes Brian D.
Stewart, Bradley J. Lucido or David Clayton, or any of them, as
attorney-in-fact, to sign on his behalf, individually and in each capacity
stated below, any amendments to this Registration Statement (including any
Post-Effective Amendments) and to file the same, with all exhibits thereto,
with the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following person in the
capacities and on the dates indicated.
Signatures Title Date
-------------------------------------- ------------------------------------------------- --------------------
/s/ BRIAN D. STEWART
--------------------
(Brian D. Stewart) President (Principal Executive Officer) and May 16, 2003
Director
/s/ BRADLEY J. LUCIDO
---------------------
(Bradley J. Lucido) Treasurer (Principal Financial and Accounting May 16, 2003
Officer) and Director
/s/ DAVID CLAYTON
-----------------
(David Clayton) Secretary and Director May 16, 2003
C-6
Exhibit Index
Exhibit Description
(a) -- Articles of Incorporation of the Registrant.
(b) -- By-Laws of the Registrant.
C-7