-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NHMPB9wqXDuTAJ31lLp6fSPQa5XzcVyCEF4aCCb+KahAa5g3NUPhrjUdNgEUX3Eb QwrLgYFx6Fyij6CU8A7+oQ== 0000950146-96-000985.txt : 19960618 0000950146-96-000985.hdr.sgml : 19960618 ACCESSION NUMBER: 0000950146-96-000985 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19960430 FILED AS OF DATE: 19960617 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: KEYSTONE QUALITY BOND FUND B-1 CENTRAL INDEX KEY: 0000055611 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 042394419 FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-00092 FILM NUMBER: 96581798 BUSINESS ADDRESS: STREET 1: 200 BERKELEY STREET CITY: BOSTON STATE: MA ZIP: 02116 BUSINESS PHONE: 6173383200 MAIL ADDRESS: STREET 1: 200 BERKELEY STREET CITY: BOSTON STATE: MA ZIP: 02116 N-30D 1 PAGE 1 Keystone Quality Bond Fund (B-1) Seeks generous income and capital preservation from high quality bonds. Dear Shareholder: We are writing to report on the activities of Keystone Quality Bond Fund (B-1) for the six-month period which ended April 30, 1996. Performance Your Fund returned -1.04% for the six-month period and 6.17% for the twelve-month period which ended April 30, 1996. For the same periods, the Lehman Aggregate Bond Index - a widely recognized index of corporate, government and mortgage securities - returned 0.52% for the six-month period and 8.63% for the twelve-month period. Your Fund's returns, while trailing some indices, were consistent with the results we expected from a conservatively managed portfolio of high quality bond investments during a period of economic uncertainty. Higher quality bond investments are principally affected - both positively and adversely - by movements in interest rates. During the six-month fiscal period, we saw two very different investment environments as interest rates moved in different directions. At the beginning of the period, from November 1995 through January 1996, economists and professional investors were more concerned about the possibility of recession. During this period, we witnessed a positive environment for high quality bonds as interest rates continued to move down and bond prices increased. Near the end of the period, from February through April, economists and professional investors became concerned about the possibilities of strong economic growth and a revival of inflation. During this period, sparked by a February government report of unexpectedly strong economic growth, long-term interest rates rose by almost a full percentage point, from less than 6% to almost 7%, and bond prices fell. While the greatest volatility in bond yields and bond prices may have passed, this period of uncertainty has continued. It is Keystone's view, however, that the interest rates may have increased further than the economic fundamentals seem to warrant, and that we may witness a moderation in interest rates and bond price movements as the year progresses. We believe that the economy is growing moderately, and that inflation is likely to remain subdued. Keystone Quality Bond Fund (B-1) is designed for the conservative, income-oriented investor. In pursuing this approach, we continued to invest in the high quality fixed-income securities. We applied our intensive research and selective allocation process to a variety of securities, which included U.S. government obligations, mortgage-backed and asset-backed securities, and high grade corporate bonds. We believe your Fund's ability to diversify and be flexible are key elements in navigating the changing market conditions investors have recently experienced. As interest rates declined, we extended the Fund's average maturity and emphasized long-term U.S. Treasury bonds. This helped the Fund to maintain income during a period of declining interest rates, as well as maximize price appreciation. We modified the portfolio's structure as that trend reversed - shortening average maturity and building positions in mortgage-backed and asset-backed securities. This strategy was designed to enhance price stability and build income in this higher interest rate environment. (continued on next page) PAGE 2 Keystone Quality Bond Fund (B-1) While we do not like to see price erosion, we believe that higher interest rates can provide selective opportunities to the income-oriented investors. The real return from bonds - the rate of interest less the rate of inflation - - has been high by historical standards. With long-term Treasury bonds yielding almost 7% and inflation, as measured by the Consumer Price Index, at between 2.5% and 3%, real rates are approximately 4%. We think this represents an excellent value for income-oriented investors. Near-term, we expect high grade bonds to trade within a fairly narrow range as investors assess the economy's strength. Further out, we look for stable to moderate economic growth with low inflation, which should provide a favorable backdrop for bonds. Keystone Quality Bond Fund (B-1) will continue to seek attractive income and solid total returns for long-term investors. Thank you for your continued support of Keystone Quality Bond Fund (B-1). If you have any questions or comments about your investment, we encourage you to write to us. Sincerely, /s/ Albert H. Elfner, III Albert H. Elfner, III Chairman and President Keystone Investments, Inc. /s/ George S. Bissell George S. Bissell Chairman of the Board Keystone Funds June 1996 [Graphic: Telephone Receiver] [DALBAR Logo] Dalbar Key Honors DALBAR Honoring Commitment to Excellence Honors Commmitment To: Keystone was recently recognized by Dalbar, an Investors independent mutual fund rating organization, for 1995 demonstrating a commitment to serving the needs of customers. The award is intended to distinguish companies who are committed to investors and have a proven ability to provide good service. [Graphic: Telephone ringing] ============================================================================= Keystone Introduces Investment Insight Line for Shareholders Now you can keep up-to-date on your fund's current strategy and outlook by calling Keystone Investment Insight Line. You can hear Keystone portfolio managers discuss their latest strategies. You can also listen to Keystone's overall market outlook from James McCall, Chief Investment Officer. The service is available 24 hours a day, seven days a week and updated at least monthly. Keystone Investment Insight Line 1-800-346-3858, Press 2 ============================================================================= PAGE 3 A Discussion With Your Fund Manager Barbara A. McCue is vice president and senior portfolio manager of your Fund and part of Keystone's high grade bond team. A Chartered Financial Analyst, Mrs. McCue has more than 19 years of investment experience. She holds an MBA from Boston University. Other members of the high grade bond team include Christopher P. Conkey, team leader, and analysts David J. Bowers and Gary E. Pzegeo. The team evaluates interest rate and credit risk in selecting high quality bonds for Keystone fixed-income funds Q What was the environment like for high grade bonds over the past six months? A The environment changed in February. The pace of job creation surged to levels consistent with a much stronger rate of economic growth. Investors' expectations changed from fear of recession to worries about the inflationary consequences of robust growth. Interest rates reversed course and began trending higher. Yields rose and bond prices fell during that time. Q What was the tone of the bond market at the end of the period? A The bond market seemed to be in a transitional period, with prices trading in a fairly narrow range. This type of activity is not unusual. Business and economic cycles change; and with that comes a reevaluation of investors' outlooks and price adjustments. As a clearer picture of the economy begins to develop, we believe the uncertainty will fade and the market will take on a more defined direction. Q How was the portfolio structured over the past six months? A From November to January, we structured the portfolio to take advantage of the lower interest rate environment. To gain better price appreciation, we lengthened the Fund's average maturity. We did this primarily by investing in long-term U.S. Treasury bonds. We also reduced the Fund's holdings in mortgage-backed securities, which tend to underperform in a declining interest rate environment. We restructured the portfolio in February and March when interest rates began to rise. We shortened the Fund's average maturity, reduced our position in long-term U.S. Treasuries and increased our holdings in mortgage-backed and asset-backed securities. We also increased cash equivalents. These changes enhanced price stability, and built liquidity and income for this higher interest rate environment. Currently, the Fund's average maturity stands at 10.2 years and its average quality is AA, considered to be the second highest rating category. Q What is your outlook for high grade bonds over the next six months? A We have a constructive outlook over the longer term. As long as economic growth stays near the current levels of 2%-2.5%, we believe the risk of higher inflation and higher interest rates is low. In fact, we think that the higher interest rates we've seen so far will probably have a dampening effect on economic growth later this year. - -----------------------------------[Pie Chart]---------------------------------- Portfolio Quality Summary as of April 30, 1996 AAA (58.4%) AA (20.2%) A (12.3%) BBB (9.1%) (as a percentage of portfolio assets) - ------------------------------------------------------------------------------- PAGE 4 Keystone Quality Bond Fund (B-1) Your Fund's Performance - ----------------------------------[Mountain Chart]----------------------------- Growth of an Investment in Keystone Quality Bond Fund (B-1) Initial Reinvested Investment Distributions 4/86 10000 10000 4/87 9291 10195 4/88 8772 10454 4/89 8576 11131 4/90 8403 11865 4/91 8738 13432 4/92 8850 14699 4/93 8956 16100 4/94 8398 16102 4/95 8275 16910 4/96 8286 17953 A $10,000 investment in Keystone Quality Bond Fund (B-1) made on April 30, 1986 with all distributions reinvested was worth $17,953 on April 30, 1996. Past performance is no guarantee of future results. - -------------------------------------------------------------------------------- - --------------------------------[Pie Chart]------------------------------------ Asset Allocation as of April 30, 1996 Corporate bonds (21.7%) U.S. government (20.2%) Foreign (19.2%) Asset-backed securities (13.6%) Mortgage-backed (12.5%) Collateralized mortgage obligations (10.7%) Other(1) (2.1%) (as a percentage of portfolio assets) (1)Includes other assets and liabilities. - -------------------------------------------------------------------------------- Six-Month Performance as of April 30, 1996 ============================================================================= Total return* -1.04% Net asset value 10/31/95 $15.42 4/30/96 $14.84 Dividends 0.43 Capital gains None * Before deduction of contingent deferred sales charge (CDSC). Historical Record as of April 30, 1996 ============================================================================= If you If you did Cumulative total return redeemed not redeem 1-year 3.17% 6.17% 5-year 33.67% 33.67% 10-year 79.53% 79.53% Average annual total return 1-year 3.17% 6.17% 5-year 5.98% 5.98% 10-year 6.03% 6.03% The "if you redeemed" returns reflect the deduction of the 3% contingent deferred sales charge for those investors who sold Fund shares after one calendar year. Investors who retained their fund investment earned the returns reported in the second column of the table. The investment return and principal value will fluctuate so that your shares, when redeemed, may be worth more or less than the original cost. You may exchange your shares for another Keystone fund by phone or in writing for a $10 fee. The exchange fee is waived for individual investors who make an exchange using Keystone's Automated Response Line (KARL). The Fund reserves the right to change or terminate the exchange offer. PAGE 5 SCHEDULE OF INVESTMENTS--April 30, 1996 (Unaudited)
Interest Maturity Par Market Rate Date Value Value ========================================================================================================== FIXED INCOME (97.9%) CORPORATE BONDS & NOTES (21.7%) AUTOMOTIVE (1.1%) General Motors Corp. Notes 7.700% 2016 $ 3,000,000 $ 2,984,430 -------------------------------------------------------------------------------------------------------- BANK & FINANCE (14.7%) Advanta National Bank, Wilmington, DE Sr. Notes 5.810 1997 3,000,000 2,989,680 Contingent Arkwright CSN Trust Surplus Notes 9.625 2026 1,000,000 1,005,620 Barnett Banks, Inc. Notes (Subord.) 10.875 2003 4,500,000 5,339,250 Bear Stearns Cos., Inc. Sr. Notes 5.750 2001 2,000,000 1,905,640 Donaldson Lufkin & Jenrette, Inc. Med. Term Notes 5.625 2016 3,000,000 2,844,375 General Electric Capital Corp. Deb. 8.750 2007 4,000,000 4,483,200 Huntington Bancshares, Inc. Med. Term Notes 5.680 1998 3,500,000 3,426,465 International Bank for Reconstruction & Development Deb. 8.250 2016 5,000,000 5,451,550 NationsBank Corp. Notes (Subord.) 7.750 2015 3,000,000 2,998,800 Provident Bank, Cincinnati, OH Sr. Notes 6.125 2000 3,500,000 3,377,780 Lehman Holdings, Inc. Med. Term Notes 7.870 1997 2,500,000 2,537,800 Smith Barney Holdings, Inc. Notes 6.000 1997 2,000,000 1,999,840 -------------------------------------------------------------------------------------------------------- 38,360,000 -------------------------------------------------------------------------------------------------------- CONSUMER GOODS (2.3%) Procter & Gamble, ESOP Series A Deb. 9.360 2021 5,000,000 5,912,000 -------------------------------------------------------------------------------------------------------- OIL (2.3%) Atlantic Richfield Co. Deb. 9.875 2016 4,000,000 4,918,520 Occidental Petroleum Corp. Sr. Notes 9.625 1999 1,000,000 1,005,250 -------------------------------------------------------------------------------------------------------- 5,923,770 -------------------------------------------------------------------------------------------------------- UTILITIES (1.3%) First Mtg. Med. Texas Utilities Electric Co. Term Notes 6.270 2000 3,500,000 3,426,815 -------------------------------------------------------------------------------------------------------- TOTAL CORPORATE BONDS & NOTES (Cost--$57,562,529) 56,607,015 ======================================================================================================== UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (20.2%) FHLB Deb. 7.000 2001 3,900,000 3,892,688 FHLB Deb. 8.700 2005 1,000,000 1,031,410 FHLMC Deb. 7.830 2004 2,000,000 2,016,700 U.S. Treasury Notes 7.750 2000 7,250,000 7,585,313 U.S. Treasury Notes 6.375 2002 4,500,000 4,464,135 U.S. Treasury Notes 6.500 2005 10,000,000 9,868,700 U.S. Treasury Bonds 7.875 2021 16,200,000 17,660,592 U.S. Treasury Bonds 6.000 2026 7,000,000 6,220,130 -------------------------------------------------------------------------------------------------------- TOTAL UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (Cost--$55,601,469) 52,739,668 ======================================================================================================== PAGE 6 Keystone Quality Bond Fund (B-1) FOREIGN BONDS (NON U.S. DOLLARS) (15.2%) Canada (Commonwealth of) Deb. 7.500% 2003 15,000,000 $10,947,400 Canadian Dollars Canada (Commonwealth of) Deb. 8.750 2005 18,000,000 14,060,227 Canadian Dollars Germany (Federal Republic of) Deb. 6.875 2005 9,250,000 6,281,468 German Marks Spain (Kingdom of) Deb. 10.150 2006 1,000,000,000 8,345,991 Spanish Pesetas -------------------------------------------------------------------------------------------------------- TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (Cost--$40,795,232) 39,635,086 ======================================================================================================== ASSET-BACKED SECURITIES (13.6%) AT&T, Universal Master Card Series 1995-2 Trust Class A 5.950 2002 $5,000,000 4,865,600 Chemical Master Credit Card Series 1995-2 Trust Class A 6.230 2003 4,000,000 3,935,000 Contimortgage Home Equity Series 1995-4 Loans Class A4 6.330 2010 5,000,000 4,920,313 Dayton Hudson Credit Card Series 1995-1 Trust Class A 6.100 2002 3,000,000 2,984,070 First Security Auto Grantor Series 1995-A Trust Class A 6.250 2001 2,538,168 2,541,737 Fleet Financial Home Equity Series 1990-1 Trust Class AS 6.700 2006 3,384,714 3,402,686 Merrill Lynch Mortgage Series 1991-D Investors, Inc. Class A 9.000 2011 633 648 Merrill Lynch Mortgage Series 1991-G Investors, Inc. Class B 9.150 2011 3,698,153 3,818,638 Merrill Lynch Mortgage Series 1992-B Investors, Inc. Class B 8.500 2012 2,180,000 2,224,843 Old Kent Auto Receivable Series 1995-A Trust Class A 6.200 2001 2,847,090 2,849,425 Sears Credit Account Master Series 1996-1 Trust II Class A 6.200 2002 3,000,000 2,968,230 University Support Services, Inc. Series 1992-D 9.074 2007 1,040,000 1,040,000 -------------------------------------------------------------------------------------------------------- TOTAL ASSET-BACKED SECURITIES (Cost--$35,625,130) 35,551,190 ======================================================================================================== COLLATERALIZED MORTGAGE OBLIGATIONS (10.7%) American Southwest Financial Services (Est. Mat. 1998) Series 1994-C2 (a) Class A3 8.000 2010 4,400,000 4,467,375 Criimi Mae Financial Corp. Series 1 (Est. Mat. 2029) (a) Class A 7.000 2033 1,000,000 949,363 FNMA REMIC Trust (Est. Mat. Series 1993-156 2008) (a) Class B 6.500 2018 2,800,000 2,585,604 FNMA REMIC Trust (Est. Mat. Series 1992-181 2007) (a) Class PK 6.500 2021 4,000,000 3,671,560 PAGE 7 COLLATERALIZED MORTGAGE OBLIGATIONS (continued) FNMA REMIC Trust (Est. Mat. Series 1993-38 2009) (a) Class L 5.000% 2022 $ 2,500,000 $ 2,028,800 KS Mortgage Capital LP (Est. Series 1995-1 Mat. 2000) (a) Class A1 6.983 2002 3,012,493 3,016,258 Merrill Lynch Mortgage Investors, Inc. (Est. Mat. Series 1992-D 2003) (a) Class B 8.500 2017 2,580,533 2,634,414 Paine Webber Mortgage Acceptance Corp. IV (Est. Series 1993-5 Mat. 1999) (a) Class A3 6.875 2008 1,985,180 1,982,699 Residential Funding Corp. Series 1994-S15 (Est. Mat. 1998) (a) Class A1 7.750 2024 3,538,831 3,576,414 Ryland Acceptance Corp. (Est. Series 1988-E, 2 Mat. 2009) (a) PAC 7.950 2019 2,000,000 2,967,830 -------------------------------------------------------------------------------------------------------- TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$28,250,409) 27,880,317 ======================================================================================================== MORTGAGE-BACKED SECURITIES (8.9%) FHLMC Pool #607352 7.992 2022 2,966,067 3,081,930 FNMA 7.000 2025 11,000,000 10,604,660 FNMA Pool #338867 6.500 2011 5,100,000 4,938,993 GNMA 6.500 2025 5,000,000 4,689,050 -------------------------------------------------------------------------------------------------------- TOTAL MORTGAGE-BACKED SECURITIES (Cost--$23,359,840) 23,314,633 ======================================================================================================== FOREIGN BONDS (U.S. DOLLARS) (4.0%) Bayer Corp. (c) Notes 7.125 2015 3,000,000 2,865,390 Dresdner Bank A.G. Deb. (Subord.) 7.250 2015 5,000,000 4,812,550 Royal Bank Scotland Group Notes (Subord.) 6.375 2011 3,000,000 2,667,900 -------------------------------------------------------------------------------------------------------- TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost--$11,209,225) 10,345,840 ======================================================================================================== MORTGAGE PASS-THROUGH CERTIFICATES (3.6%) FHLMC Pool #303865 8.500 1997 53,535 55,106 FNMA Pool #303664 6.500 2008 6,600,361 6,429,147 Structured Asset Securities Series 1996-CFL Corp. Class B 6.303 2028 2,963,625 2,825,168 -------------------------------------------------------------------------------------------------------- TOTAL MORTGAGE PASS-THROUGH CERTIFICATES (Cost--$9,619,502) 9,309,421 ======================================================================================================== TOTAL FIXED INCOME (Cost--$262,023,336) 255,383,170 ========================================================================================================
PAGE 8 Keystone Quality Bond Fund (B-1)
Interest Maturity Maturity Market Rate Date Value Value ============================================================================================= REPURCHASE AGREEMENT (0.9%) Keystone Joint Repurchase Agreement (Investments in repurchase agreements, in a joint trading account, purchased 4/30/96) (b) (Cost--$2,403,000) 5.340% 5/1/96 $2,403,356 $ 2,403,000 =========================================================================================== TOTAL INVESTMENTS (Cost--$264,426,336) 257,786,170 OTHER ASSETS AND LIABILITIES--NET (1.2%) 3,228,412 ------------------------------------------------------------------------------------------- NET ASSETS (100%) $261,014,582 ===========================================================================================
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is based on current and projected prepayment rates. Changes in interest rates can cause the estimated maturity to differ from the listed dates. (b) The repurchase agreements are fully collateralized by U.S. government and/or agency obligations based on market prices at April 30, 1996. (c) Securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Federal Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. Legend of Portfolio Abbreviations FHLB--Federal Home Loan Bank FHLMC--Federal Home Loan Mortgage Corporation FNMA--Federal National Mortgage Association GNMA--Government National Mortgage Association REMIC--Real Estate Mortgage Investment Conduit SCHEDULE OF FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
U.S. Value at In Net Unrealized Exchange April 30, Exchange Appreciation/ Date 1996 for U.S. $ (Depreciation) ================================================================================================ Forward Foreign Currency Exchange Contracts to Sell: Contracts to Deliver ================================================================================================ 5/10/96 10,200,000 German Marks $ 6,666,514 $ 6,931,231 $264,717 5/31/96 35,298,460 Canadian Dollars 25,939,777 25,920,408 (19,369) 7/10/96 1,080,500,000 Spanish Pesetas 8,459,271 8,561,128 101,857 ------------ Net Unrealized Appreciation on Forward Foreign Currency Exchange Contracts $347,205 ============
See Notes to Financial Statements. PAGE 9 FINANCIAL HIGHLIGHTS (For a share outstanding throughout each period)
Six Months Ended April 30, Year Ended October 31, 1996 1995 1994 1993 1992 1991 ================================================================================================ (Unaudited) Net asset value beginning of period $15.42 $14.44 $16.40 $15.92 $15.92 $15.11 ------------------------------------------------------------------------------------------------ Income from investment operations: Net investment income 0.38 0.87 0.76 0.96 1.04 1.08 Net realized and unrealized gain (loss) on investments, closed futures contracts and forward foreign currency related transactions (0.53) 1.05 (1.76) 0.66 0.15 0.99 ------------------------------------------------------------------------------------------------ Total from investment operations (0.15) 1.92 (1.00) 1.62 1.19 2.07 ------------------------------------------------------------------------------------------------ Less distributions from: Net investment income (0.43) (0.87) (0.76) (0.96) (1.04) (1.08) In excess of net investment income 0 (0.05) (0.09) (0.18) (0.15) (0.18) Tax basis return of capital 0 (0.02) (0.11) 0 0 0 ------------------------------------------------------------------------------------------------ Total distributions (0.43) (0.94) (0.96) (1.14) (1.19) (1.26) ------------------------------------------------------------------------------------------------ Net asset value end of period $14.84 $15.42 $14.44 $16.40 $15.92 $15.92 ================================================================================================ Total return (a) (1.04%) 13.69% (6.27%) 10.50% 7.71% 14.09% Ratios/supplemental data Ratios to average net assets: Total expenses (b) 1.95%(c) 1.96% 1.86% 1.94% 2.01% 2.04% Net investment income 4.97%(c) 5.86% 5.05% 5.85% 6.40% 6.95% Portfolio turnover rate 108% 244% 169% 190% 102% 158% ------------------------------------------------------------------------------------------------ Net assets end of period (thousands) $261,015 $310,791 $327,276 $458,925 $456,912 $453,528 ================================================================================================
(a) Excluding applicable sales charges. (b) Beginning with the year ended October 31, 1995, the "Ratio of total expenses to average net assets" includes indirectly paid expenses. Excluding indirectly paid expenses, the expense ratios would have been 1.93% (annualized) for the six months ended April 30, 1996 and 1.94% for the year ended October 31, 1995. (c) Annualized. See Notes to Financial Statements. PAGE 10 Keystone Quality Bond Fund (B-1) STATEMENT OF ASSETS AND LIABILITIES April 30, 1996 (Unaudited) ===================================================================== Assets (Note 1) Investments at market value (identified cost-- $264,426,336) $257,786,170 Cash 171 Receivable for: Investments sold 14,890,003 Interest 3,947,800 Fund shares sold 9,888 Net unrealized appreciation on forward foreign currency exchange contracts 347,205 Prepaid expenses and other assets 64,043 ------------------------------------------------------------------- Total assets 277,045,280 ------------------------------------------------------------------- Liabilities (Notes 2 and 4) Payable for: Investments purchased 15,309,069 Fund shares redeemed 204,170 Distributions to shareholders 421,887 Accrued reimbursable expenses 2,541 Other accrued expenses 93,031 ------------------------------------------------------------------- Total liabilities 16,030,698 ------------------------------------------------------------------- Net assets $261,014,582 =================================================================== Net assets represented by (Note 1) Paid-in capital $294,206,831 Accumulated distributions in excess of net investment income (1,443,274) Accumulated net realized loss on investments and forward foreign currency related transactions (25,433,229) Net unrealized depreciation on investments, forward foreign currency exchange contracts and related transactions (6,315,746) ------------------------------------------------------------------- Total net assets $261,014,582 =================================================================== Net asset value per share (Note 2) Net assets of $261,014,582 / 17,593,490 shares outstanding $14.84 =================================================================== STATEMENT OF OPERATIONS Six Months Ended April 30, 1996 (Unaudited) ===================================================================== Investment income (Note 1) Interest $ 9,942,338 -------------------------------------------------------------------- Expenses (Notes 2 and 4) Management fee $ 849,025 Transfer agent fees 342,916 Accounting, auditing and legal fees 28,294 Custodian fees 81,650 Printing 13,731 Trustees' fees and expenses 14,861 Distribution Plan expenses 1,441,837 Registration fees 25,095 Other 4,884 -------------------------------------------------------------------- Total expenses 2,802,293 Less: Expenses paid indirectly (Note 4) (17,659) -------------------------------------------------------------------- Net expenses 2,784,634 -------------------------------------------------------------------- Net investment income 7,157,704 -------------------------------------------------------------------- Net realized and unrealized loss on investments and forward foreign currency related transactions (Notes 1 and 3) Net realized gain on: Investments 3,303,291 Forward foreign currency related transactions 312,908 -------------------------------------------------------------------- Net realized gain on investments and forward foreign currency related transactions 3,616,199 -------------------------------------------------------------------- Net change in unrealized appreciation (depreciation) on: Investments (13,404,053) Forward foreign currency related transactions 324,420 -------------------------------------------------------------------- Net change in unrealized depreciation on investments and forward foreign currency related transactions (13,079,633) -------------------------------------------------------------------- Net realized and unrealized loss on investments and forward foreign currency related transactions (9,463,434) -------------------------------------------------------------------- Net decrease in net assets resulting from operations ($ 2,305,730) ==================================================================== See Notes to Financial Statements. PAGE 11 STATEMENTS OF CHANGES IN NET ASSETS Six Months Ended Year Ended April 30, October 31, 1996 1995 ============================================================================ (Unaudited) Operations (Notes 1 and 3) Net investment income $ 7,157,704 $ 18,237,187 Net realized gain (loss) on investments, closed futures contracts and forward foreign currency related transactions 3,616,199 (6,749,977) Net change in unrealized appreciation (depreciation) on investments and forward foreign currency related transactions (13,079,633) 28,285,126 -------------------------------------------------------------------------- Net increase (decrease) in net assets resulting from operations (2,305,730) 39,772,336 -------------------------------------------------------------------------- Distributions to shareholders from (Note 1) Net investment income (8,025,766) (18,237,187) In excess of net investment income 0 (763,245) Tax basis return of capital 0 (472,154) -------------------------------------------------------------------------- Total distributions to shareholders (8,025,766) (19,472,586) -------------------------------------------------------------------------- Capital share transactions (Note 2) Proceeds from shares sold 29,727,680 78,243,761 Payments for shares redeemed (74,133,715) (126,927,895) Net asset value of shares issued in reinvestment of dividends and distributions 4,960,625 11,900,336 -------------------------------------------------------------------------- Net decrease in net assets resulting from capital share transactions (39,445,410) (36,783,798) -------------------------------------------------------------------------- Total decrease in net assets (49,776,906) (16,484,048) -------------------------------------------------------------------------- Net assets: Beginning of period 310,791,488 327,275,536 -------------------------------------------------------------------------- End of period [including accumulated distributions in excess of net investment income as follows: 1996--($1,443,274) and 1995--($575,212)] (Note 1) $261,014,582 $ 310,791,488 ========================================================================== See Notes to Financial Statements. PAGE 12 Keystone Quality Bond Fund (B-1) NOTES TO FINANCIAL STATEMENTS (Unaudited) (1.) Significant Accounting Policies Keystone Quality Bond Fund (B-1) (the "Fund") is a common law trust for which Keystone Management, Inc. ("KMI") is the investment manager and Keystone Investment Management Company ("Keystone") is the investment adviser. The Fund is registered under the Investment Company Act of 1940, as amended (the "1940 Act"), as a diversified, open-end investment company. The Fund seeks the highest possible income consistent with preservation of principal. The Fund invests primarily in high and investment grade corporate bonds, which possess a high degree of dependability of interest payments. Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("KII"), a Delaware corporation. KII is privately owned by an investor group consisting predominantly of current and former members of management of Keystone and its affiliates. Keystone Investor Resource Center, Inc. ("KIRC"), a wholly-owned subsidiary of Keystone, is the Fund's transfer agent and dividend disbursing agent. The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. The policies are in conformity with generally accepted accounting principles, which requires management to make estimates and assumptions that affect amounts reported herein. Although actual results could differ from these estimates, any such differences are expected to be immaterial to the net assets of the Fund. A. Investments are usually valued at the closing sales price, or in the absence of sales and for over-the-counter securities, the mean of bid and asked quotations. Management values the following securities at prices it deems in good faith to be fair: (1) securities (including restricted securities) for which complete quotations are not readily available, and (2) listed securities if, in the opinion of management, the last sales price does not reflect a current value, or if no sale occurred. Short-term investments maturing in sixty days or less are valued at amortized cost (original purchase cost as adjusted for amortization of premium or accretion of discount), which, when combined with accrued interest, approximates market. Short-term investments maturing in more than sixty days for which market quotations are readily available are valued at current market value. Short-term investments maturing in more than sixty days when purchased that are held on the sixtieth day prior to maturity are valued at amortized cost (market value on the sixtieth day adjusted for amortization of premium or accretion of discount), which, when combined with accrued interest, approximates market. Investments denominated in a foreign currency are adjusted daily to reflect changes in exchange rates. Market quotations are not considered to be readily available for long-term corporate bonds and notes; such investments are stated at fair value on the basis of valuations furnished by a pricing service, approved by the Trustees, which determines valuations for normal, institutional-size trading units of such securities using methods based on market transactions for comparable securities and various relationships between securities that are generally recognized by institutional traders. B. When the Fund enters into a repurchase agreement (a purchase of securities whereby the seller agrees to repurchase the securities at a mutually agreed upon date and price), the repurchase price of the securities will generally equal the amount paid by the Fund plus a negotiated interest amount. The seller under the repurchase agreement will be required to provide securities (collateral) to the Fund, the value of which will be maintained at an amount not less than the repurchase price and which generally will be maintained at 101% of the repurchase price. The Fund monitors the value of collateral on a daily basis, and, if the value of collateral falls below required levels, the Fund intends to seek additional collateral from the seller or terminate the repurchase agreement. If the seller defaults, PAGE 13 the Fund would suffer a loss to the extent that the proceeds from the sale of the underlying securities were less than the repurchase price. Any such loss would be increased by any cost incurred on disposing of such securities. If bankruptcy proceedings are commenced against the seller under the repurchase agreement, the realization on the collateral may be delayed or limited. Repurchase agreements entered into by the Fund are limited to transactions with dealers or domestic banks believed to present minimal credit risks. The Fund takes constructive receipt of all securities underlying repurchase agreements until such agreements expire. Pursuant to an exemptive order issued by the Securities and Exchange Commission, the Fund, along with certain other Keystone funds, may transfer uninvested cash balances into a joint trading account. These balances are invested in one or more repurchase agreements that are collateralized by U.S. Treasury and/or Federal Agency obligations. C. The Fund enters into currency and other financial futures contracts as a hedge against changes in interest or currency exchange rates. A futures contract is an agreement between two parties to buy and sell a specific amount of a commodity, security, financial instrument, or, in the case of a stock index, cash at a set price on a future date. Upon entering into a futures contract the Fund is required to deposit with a broker an amount ("initial margin") equal to a certain percentage of the purchase price indicated in the futures contract. Subsequent payments ("variation margin") are made or received by the Fund each day, as the value of the underlying instrument or index fluctuates, and are recorded for book purposes as unrealized gains or losses by the Fund. For federal tax purposes, any futures contracts that remain open at fiscal year-end are marked-to-market and the resultant net gain or loss is included in federal taxable income. In addition to market risk, the Fund is subject to the credit risk that the other party will not be able to complete the obligations of the contract. D. Foreign currency amounts are translated into U.S. dollars as follows: market value of investments, assets and liabilities at the daily rate of exchange, purchases and sales of investments, income and expenses at the rate of exchange prevailing on the respective dates of such transactions. Net unrealized foreign exchange gains (losses) are a component of unrealized appreciation (depreciation) on investments and forward foreign currency related transactions. E. The Fund may enter into forward foreign currency exchange contracts ("contracts") to settle purchases and sales of securities denominated in a foreign currency and to hedge certain foreign currency assets. Contracts are recorded at the forward rate and marked-to-market daily. Realized gains and losses arising from such transactions are included in net realized gain (loss) on foreign currency related transactions. The Fund is subject to the credit risk that the other party will not complete the obligations of the contract. F. Securities transactions are accounted for no later than one business day after the trade date. Realized gains and losses are computed on the identified cost basis. Interest income is recorded on the accrual basis and dividend income is recorded on the ex-dividend date. All discounts are amortized for both financial reporting and federal income tax purposes. G. The Fund distributes net investment income to shareholders monthly and net capital gains, if any, annually. Distributions are recorded at the close of business on the ex-dividend date. Distributions are determined from taxable net investment income and net capital gains and can differ from book basis net investment income and net capital gains. The significant differences between financial statement amounts available for distribution and distributions made in accordance with income tax regulations are primarily PAGE 14 Keystone Quality Bond Fund (B-1) due to the different treatment of 12b-1 expenses prior to April 1995, differences in the treatment of paydown losses and the deferral of losses for income tax purposes that have been recognized for financial statement purposes. H. The Fund has qualified, and intends to qualify in the future, as a regulated investment company under the Internal Revenue Code of 1986, as amended ("Internal Revenue Code"). Thus, the Fund is relieved of any federal income tax liability by distributing all of its net taxable investment income and net taxable capital gains, if any, to its shareholders. The Fund intends to avoid any excise tax liability by making the required distributions under the Internal Revenue Code. (2.) Capital Share Transactions The Fund's Declaration of Trust authorizes the issuance of an unlimited number of shares of beneficial interest with a par value of $1.00. Transactions in shares of the Fund were as follows: Six Months Year Ended Ended October 31, April 30, 1996 1995 - ----------------------------------------------------------------- Sales 1,926,499 5,215,666 Redemptions (4,805,295) (8,523,861) Reinvestment of dividends and distributions 323,385 799,017 - ----------------------------------------------------------------- Net decrease (2,555,411) (2,509,178) ================================================================= The Fund bears some of the costs of selling its shares under a Distribution Plan adopted pursuant to Rule 12b-1 under the 1940 Act. Under the Distribution Plan, the Fund pays Keystone Investment Distributors Company ("KIDC"), the Fund's principal underwriter and a wholly-owned subsidiary of Keystone, amounts which in total may not exceed the Distribution Plan maximum. In connection with the Distribution Plan and subject to the limitations discussed below, Fund shares are offered for sale at net asset value without any initial sales charge. From the amounts received by KIDC in connection with the Distribution Plan, and subject to the limitations discussed below, KIDC generally pays dealers or others a commission equal to 4.00% of the price paid to the Fund for each sale of a Fund share as well as a shareholder service fee at a rate of 0.25% per annum of the net asset value of shares sold by such dealers or others and maintained on the books of the Fund for specified periods. To the extent Fund shares are redeemed within four calendar years of original issuance, the Fund may be eligible to receive a deferred sales charge from the investor as partial reimbursement for sales commissions previously paid on those shares. This charge is based on declining rates, which begin at 4.00%, applied to the lesser of the net asset value of shares redeemed or the total cost of such shares. The Distribution Plan provides that the Fund may incur certain expenses, which may not exceed a maximum amount equal to 0.3125% of the Fund's average daily net assets for any calendar quarter (approximately 1.25% annually) occurring after the inception of the Distribution Plan. Rules adopted by the National Association of Securities Dealers, Inc. ("NASD") limit the annual expenditures that the Fund may incur under the Distribution Plan to 1.00%, of which 0.75% may be used to pay such distribution expenses and 0.25% may be used to pay shareholder service fees. The NASD also limits the aggregate amount that the Fund may pay for such distribution costs to 6.25% of gross share sales since the inception of the Fund's Distribution Plan, plus interest at the prime rate plus 1.00% on unpaid amounts thereof (less any contingent deferred sales charges paid by the shareholders to KIDC). KIDC intends, but is not obligated, to continue to pay or accrue distribution charges that exceed current annual payments permitted to be received by KIDC from the Fund. KIDC intends to seek full payment of such charges from the Fund (together with annual interest thereon at the prime rate plus 1.00%) at such PAGE 15 time in the future as, and to the extent that, payment thereof by the Fund would be within permitted limits. KIDC currently intends to seek payment of interest only on such charges paid or accrued by KIDC subsequent to January 1, 1992. Commencing July 8, 1992, contingent deferred sales charges applicable to shares of the Fund issued after January 1, 1992 have, to the extent permitted by the NASD rules, been paid to KIDC rather than to the Fund. During the six months ended April 30, 1996, KIDC received $142,234 in deferred sales charges. During the six months ended April 30, 1996, the Fund paid $1,441,837 under its Distribution Plan, all of which was paid to KIDC. During the six months ended April 30, 1996, KIDC paid commmissions on new sales and service fees to dealers and others of $594,465. At April 30, 1996, unpaid distribution costs amounted to $9,961,319 (3.82% of the Fund's net assets at April 30, 1996). (3.) Securities Transactions As of October 31, 1995, the Fund had a capital loss carryover for federal income tax purposes of approximately $28,549,000 which expires as follows: 1998--$2,251,000; 2002--$20,145,000; and 2003--$6,153,000. For the six months ended April 30, 1996, purchases and sales of investment securities (excluding short-term securities) were as follows: Cost of Proceeds Purchases from Sales ------------------------------------------------------------- Investments (excluding U.S. Government obligations) $130,015,724 $ 99,235,266 U.S Government obligations 171,323,454 234,300,226 ============================================================= (4.) Investment Management Agreement and Other Transactions Under the terms of the Investment Management Agreement between KMI and the Fund, KMI provides investment management and administrative services to the Fund. In return, KMI is paid a management fee computed and paid daily at a rate of 2.0% of the Fund's gross investment income plus an amount determined by applying percentage rates, which start at 0.50% and decline, as net assets increase, to 0.25% per annum, to the net asset value of the Fund. KMI has entered into an Investment Advisory Agreement with Keystone, under which Keystone provides investment advisory and management services to the Fund and receives for its services an annual fee representing 85% of the management fee received by KMI. During the six months ended April 30, 1996, the Fund paid or accrued to KMI investment management and administrative services fees of $849,025 which represented 0.59% of the Fund's average net assets on an annualized basis. Of such amount paid to KMI, $721,671 was paid to Keystone for its services to the Fund. During the six months ended April 30, 1996, the Fund paid or accrued $9,131 to KII as reimbursment for certain accounting services and $342,916 to KIRC for transfer agent fees. The Fund has entered into an expense offset arrangement with its custodian. For the six months ended April 30, 1996, the Fund paid custody fees in the amount of $63,991 and received a credit of $17,659 pursuant to the expense offset arrangement, resulting in a total expense of $81,650. The assets deposited with the custodian under the expense offset arrangement could have been invested in income-producing assets. Certain officers and/or Directors of Keystone are also officers and/or Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no compensation directly from the Fund. (5.) Distributions to Shareholders A distribution of net investment income of $0.065 per share was declared payable on June 6, 1996 to shareholders of record May 24, 1996. This distribution is not reflected in the accompanying financial statements. [COVER] KEYSTONE FAMILY OF FUNDS [diamond] Balanced Fund (K-1) Diversified Bond Fund (B-2) Growth and Income Fund (S-1) High Income Bond Fund (B-4) International Fund Inc. Liquid Trust Mid-Cap Growth Fund (S-3) Precious Metals Holdings, Inc. Quality Bond Fund (B-1) Small Company Growth Fund (S-4) Strategic Growth Fund (K-2) Tax Free Fund This report was prepared primarily for the information of the Fund's shareholders. It is authorized for distribution if preceded or accompanied by the Fund's current prospectus. The prospectus contains important information about the Fund including fees and expenses. Read it carefully before you invest or send money. For a free prospectus on other Keystone funds, contact your financial adviser or call Keystone. [Keystone logo] KEYSTONE INVESTMENTS P.O. Box 2121 Boston, Massachusets 02106-2121 B1-R-6/96 16.5M [Recycle logo] K E Y S T O N E [Photo: 2 people walking bicycles through the woods] QUALITY BOND FUND (B-1) [Keystone logo] SEMIANNUAL REPORT APRIL 30, 1996 -----END PRIVACY-ENHANCED MESSAGE-----