-----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, EIJW+5QFxU9qhwjg8459kQBIQlIBLY3ZFKNnVWX/EEZvpifNdBvjInHjQFp3PNIE ql5klkQpt88syL+SVnwYeA== 0000820027-96-000443.txt : 19960805 0000820027-96-000443.hdr.sgml : 19960805 ACCESSION NUMBER: 0000820027-96-000443 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19960802 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: IDS EXTRA INCOME FUND INC CENTRAL INDEX KEY: 0000728374 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 411458705 STATE OF INCORPORATION: MN FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 002-86637 FILM NUMBER: 96603343 BUSINESS ADDRESS: STREET 1: 80 SOUTH 8TH STREET STREET 2: T33/52 CITY: MINNEAPOLIS STATE: MN ZIP: 55440 BUSINESS PHONE: 6123722772 497 1 IDS EXTRA INCOME FUND, INC. PAGE 1 1996 Annual Report IDS Extra Income Fund (prospectus enclosed) (Icon of) Coins The primary goal of IDS Extra Income Fund, Inc. is to provide high current income. Capital growth is a secondary goal. (This annual report includes a prospectus that describes in detail the Fund's objective, investment policies, risks, sales charges, fees and other matters of interest. Please read the prospectus carefully before you invest or send money.) AMERICAN EXPRESS Financial Advisors Distributed by American Express Financial Advisors Inc. PAGE 2 (Icon of) Coins Bonds with something extra Bonds aren't necessarily conservative securities strictly for people willing to settle for modest returns. High-yield corporate bonds, for example, are actually quite aggressive investments, offering high potential returns to investors willing to take more risk. These are the bonds that Extra Income Fund invests in. High-yield bonds are issued by a wide range of companies - from well- established ones that might be experiencing financial difficulty to new, rapidly growing ones that have yet to build a credit history. Importantly, the Fund spreads its investments among many bonds representing many types of businesses. This helps to reduce the investment risk for shareholders. PAGE 3 Contents (Icon of) One open book inside of another. The purpose of this annual report is to tell investors how the Fund performed. The prospectus, which is bound into the middle of this annual report, describes the Fund in detail. 1996 annual report From the president 4 From the portfolio manager 4 Ten largest holdings 6 Making the most of the Fund 7 Long-term performance 8 Independent auditors' report 9 Financial statements 10 Notes to financial statements 13 Investments in securities 22 IDS mutual funds 35 Federal income tax information 38 1996 prospectus The Fund in brief 3p Goals 3p Investment policies and risks 3p Structure of the Fund 4p Manager and distributor 4p Portfolio manager 4p Alternative purchase arrangements 4p Sales charge and Fund expenses 5p Performance 7p Financial highlights 7p Total returns 9p Yield 10p Investment policies and risks 11p Facts about investments and their risks 11p Valuing Fund shares 16p How to purchase, exchange or redeem shares 17p Alternative purchase arrangements 17p How to purchase shares 19p How to exchange shares 22p How to redeem shares 22p Reductions and waivers of the sales charge 27p Special shareholder services 31p Services 31p Quick telephone reference 31p Distributions and taxes 32p Dividend and capital gain distributions 32p Reinvestments 33p PAGE 4 Taxes 33p How to determine the correct TIN 35p How the Fund is organized 36p Shares 36p Voting rights 36p Shareholder meetings 36p Special considerations regarding master/feeder structure 37p Board members and officers 39p Investment manager 41p Administrator and Transfer Agent 41p Distributor 42p About American Express Financial Corporation 43p General information 43p Appendices 44p Description of corporate bond ratings 44p Descriptions of derivative instruments 46p PAGE 5 To our shareholders (Photo of William Pearce) Williarm R. Pearce President of the Fund (Photo of Jack Utter) Jack Utter Portfolio manager From the president If you're an experienced investor, you know that 1995 was an unusually strong year for the U.S. financial markets. Perhaps just as important, you also know that history shows that bull markets don't last forever. Though they're often unpredictable, declines - whether they're brief or long-lasting, moderate or substantial - are always a possibility. That fact reinforces the need for investors to review periodically their long-term goals and assets whether their investment program remains on track to achieving them. Your quarterly investment statements are one part of that monitoring process. The other is a meeting with your American Express financial advisor. That becomes even more important if there's a major change in your financial situatiion or in the financial markets. (signature) William R. Pearce From the portfolio manager A largely positive environment for high-yield bonds prevailed during the past fiscal period, thanks to the favorable forces of moderage economic growth, a low rate of inflation and, for part of the nine months, declining long-term interest rates. Taking good advantage of the conditions, IDS Extra Income Fund provided investors with a total return of 11.7% on Class A shares for the September 1995 through May 1996 period. Shaking off early concerns about recession, the economy continued to move more slowly forward during the period, while inflation remained low. Those factors bolstered the spirits of fixed-income investors, who became increasingly attracted the relatively generous real (minus inflation) returns offered by high-yield bonds. The trend was reflected by strong cash flows into high- yield mutual funds throughout the nine months. As is always the case, the increased buying drove up bond prices and, consequently, the net asset value of mutual funds such as this one. PAGE 6 The Fed lends a hand The market found further support in the form of two reductions in short-term interest rates by the Federal Reserve, which were taken by investors as an indication that inflation was remaining well under control. Long-term rates followed suit, declining through the end of 1995 and providing a boost to bond prices. Also working in the bond market's favor, at least last fall, was the possibility of an agreement between Congress and the Clinton administration to balance the federal budget. In that environment, I made only one noteworthy change to the portfolio. After enjoying strong performance from bonds of paper/packaging companies, I reduced our holdings in that sector because of weakening business conditions in that industry. More important to Fund performance, I maintained a substantial exposure to bonds of gaming, telecommunications and media companies, which continued to perform very well. On the other hand, I continued to hold relatively few bonds in the retailing and industrial cyclical (steel and chemicals, for example) sectors. This proved to be an appropriate strategy, as those issues were relatively poor performers during the nine months. Outlook OK, but repeat performance unlikely Looking to the new fiscal year, I remain basically optimistic about prospects for the bond market and high-yield securities, but I don't expect a repeat of the market's spectacular 1995 performance. While the outlook for important fundamentals such as economic growth and inflation continues to be favorable, long-term interest rates nevertheless rose early in 1996 and, while I expect them to move lower before year-end, a substantial decline seems unlikely. Moreover, because of potential uncertainty surrounding the presidential election, the market may have another reason to become unsettled at times. Still, barring any major negative events, I think the positive market fundamentals will ultimately prevail. (signature) Jack Utter Class A 9-month performance (all figures per share) Net asset value (NAV) May 31, 1996 $ 4.34 Aug. 31, 1995 $ 4.15 Increase $ 0.19 Distributions Sept. 1, 1995 - May 31, 1996 From Income $ 0.29 From capital gains $ -- Total distributions $ 0.29 Total return* + 11.7%** PAGE 7 Class B 9-month performance (All figures per share) Net asset value (NAV) May 31, 1996 $ 4.34 Aug. 31, 1995 $ 4.15 Increase $ 0.19 Distributions Sept. 1, 1995 - May 31, 1996 From Income $ 0.26 From capital gains $ -- Total distributions $ 0.26 Total return* + 11.1%** Class Y 9-month performance (all figures per share) Net asset value (NAV) May 31, 1996 $ 4.34 Aug. 31, 1995 $ 4.15 Increase $ 0.19 Distributions Sept. 1, 1995 - May 31, 1996 From income $ 0.29 From capital gains $ -- Total distributions $ 0.29 Total return* +11.8%** * The prospectus discusses the effect of sales charges, if any, on the various classes. ** The total return is a hypothetical investment in the Fund with all distributions reinvested. PAGE 8
The Fund's ten largest holdings (Pie chart) The ten holdings here make up 11.87% of the Fund's total net assets. _____________________________________________________________________________________ Percent Value (of Fund's net assets) (as of May 31, 1996) _____________________________________________________________________________________ Trump Atlantic City Funding 1.57% $37,829,906 11.25% 1st Mtge 2006 Echostar Satellite Broadcasting 1.37 32,988,375 Zero Coupon 2000 Gaylord Container 1.22 29,540,000 12.75% Sr Sub Disc Deb 2005 Adelphia Communications 1.21 29,246,306 9.50% Pay-in-kind 2004 Plitt Theatres 1.17 28,337,375 10.875% 2004 Cablevision Systems 1.16 28,037,947 11.125% Pay-in-kind Alliance Entertainment 1.08 26,193,750 11.25% Sr Sub Nts 2005 Intermedia Communications of Florida 1.06 25,536,875 13.50% Sr Nts 2005 Revlon Worldwide 1.02 24,712,500 Zero Coupon Sr Disc Nts 1998 Specialty Equipment 1.01 24,348,500 11.375% Sr Sub Nts 2003
PAGE 9 Making the most of the Fund Average annual total return (as of May 31, 1996) 1 year 5 year 10 years or since inception Class A +9.80% +13.81% +8.94% Class B* +10.12% --% +12.44% Class Y* +15.72% --% +19.04% * Inception date was March 20, 1995. The performance of Class B and Class Y will vary from the performance of Class A based on differences in sales charges and fees. Your investment and return values fluctuate so that your shares, when redeemed, may be worth more or less than the original cost. Figures for Class A and Class B reflect the effect of the maximum 5% sales charge. This was a period of widely fluctuation security prices. Past performance is no guarantee of future results. Build your assets systematically One of the best ways to invest in the Fund is by dollar-cost averaging - a time-tested strategy that can make market fluctuations work for you. To dollar-cost average, simply invest a fixed amount of money regularly. You'll automatically buy more shares when the Fund's share price is low, fewer shares when it is high. This does not ensure a profit or avoid a loss if the market declines. But, if you can continue to invest regularly through changing market conditions, it can be an effective way to accumulate shares to meet your long-term goals. How dollar-cost averaging works Month Amount Per-share Number of shares purchased invested market price Jan $100 $20 5.00 XXXXX Feb 100 18 5.56 XXXXXx March 100 17 5.88 XXXXXx April 100 15 6.67 XXXXXXx May 100 16 6.25 XXXXXXx June 100 18 5.56 XXXXXx July 100 17 5.88 XXXXXx Aug 100 19 5.26 XXXXXx Sept 100 21 4.76 XXXXx Oct 100 20 5.00 XXXXX (footnotes to table) By investing an equal number of dollars each month... (arrow in table pointing to April) you automatically buy more shares when the per share market price is low. PAGE 10 (arrow in table pointing to September) and fewer shares when the per share market price is high. You have paid an average price of only $17.91 per share over the 10 months, while the average market price actually was $18.10. PAGE 11 The Fund's long term performance Three ways to benefit from a mutual fund: o your shares increase in value when the Fund's investments do well o you receive capital gains when the gains on investments sold by the Fund exceed losses o you receive income when the Fund's stock dividends, interest and short-term gains exceed its expenses. All three make up your total return. And you potentially can increase your investment if, like most investors, you reinvest your dividends and capital gain distributions to buy additional shares of the Fund or another fund.
How your $10,000 has grown in IDS Extra Income Fund $23,562 $20,000 Extra Income Fund Lehman Aggregate Class A Bond Index $9,500 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96
(the following two paragraphs appear in the margin next to the graph:) Assumes: *Holding period from 6/1/86 to 5/31/96. *Returns do not reflect taxes payable on distributions. *Reinvestment of all income and capital gain distributions for the Fund, with a value of $15,868. Also see "Performance" in the Fund's current prospectus. The Lehman Aggregate Bond Index is made up of a representative list of government and corporate bonds as well as asset-backed securities and mortgage-backed securities. The index is frequently used as a general measure of bond market performance. However, the securities used to create the index may not be representative of the bonds held in Extra Income Fund. Average annual total return (as of May 31, 1996) 1 year 5 years 10 years or since inception Class A + 9.80% + 13.81% + 8.94% Class B* + 10.12% --% + 12.44% Class Y* + 15.72% --% + 19.04% *Inception date was March 20, 1995. PAGE 12 On the graph above you can see how the Fund's total return compared to a widely cited performance measure, the Lehman Aggregate Bond Index. In comparing Extra Income Fund with this index, you should take into account the fact that the Fund's performance reflects the maximum sales charge of 5%, while such charges are not reflected in the performance of the index. If you were actually to buy either individual bonds or bond mutual funds, any sales charges that you pay would reduce your total return as well. Your investment and return values fluctuate so that your shares, when redeemed, may be worth more or less than the original cost. Average annual total return figures reflect the deduction of the maximum 5% sales charge, if any. This was a period of widely fluctuating security prices. Past performance is no guarantee of future results. PAGE 13 Independent auditors' report The board and shareholders IDS Extra Income Fund, Inc.: We have audited the accompanying statement of assets and liabilities, including the schedule of investments in securities, of IDS Extra Income Fund, Inc. as of May 31, 1996, and the related statements of operations and changes in net assets, and the financial highlights for the nine months then ended and the statement of changes in net assets for the year ended August 31, 1995 and the financial highlights for each of the years in the nine-year period ended August 31, 1995. These financial statements and the financial highlights are the responsibility of fund management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Investment securities held in custody are confirmed to us by the custodian. As to securities purchased and sold but not received or delivered and securities on loan, we request confirmations from brokers, and where replies are not received, we carry out other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of IDS Extra Income Fund, Inc. at May 31, 1996, and the results of its operations and changes in its net assets for the nine months then ended and the changes in its net assets for the year ended August 31, 1995, and the financial highlights for the periods stated in the first paragraph above, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Minneapolis, Minnesota July 5, 1996 PAGE 14
Financial statements Statement of assets and liabilities IDS Extra Income Fund, Inc. May 31, 1996 _____________________________________________________________________________________________________________ Assets _____________________________________________________________________________________________________________ Investments in securities, at value (Note 1): Investments in securities of unaffiliated issuers (identified cost $2,305,677,559) $2,387,373,389 Investments in securities of affiliated issuers (identified cost $30,962,600) 26,687,448 Cash in bank on demand deposit 4,370,148 Dividends and accrued interest receivable 48,040,917 Receivable for investment securities sold 31,022,257 U.S. government securities held as collateral (Note 5) 1,006,887 _____________________________________________________________________________________________________________ Total assets 2,498,501,046 _____________________________________________________________________________________________________________ Liabilities _____________________________________________________________________________________________________________ Dividends payable to shareholders 1,982,497 Payable for investment securities purchased 78,797,268 Payable upon return of securities loaned (Note 5) 2,006,887 Accrued investment management services fee 37,601 Accrued distribution fee 5,475 Accrued service fee 11,522 Accrued transfer agency fee 6,171 Accrued administrative services fee 3,043 Other accrued expenses 432,119 _____________________________________________________________________________________________________________ Total liabilities 83,282,583 _____________________________________________________________________________________________________________ Net assets applicable to outstanding capital stock $2,415,218,463 _____________________________________________________________________________________________________________ Represented by _____________________________________________________________________________________________________________ Capital stock -- authorized 10,000,000,000 shares of $.01 par value $ 5,564,019 Additional paid-in capital 2,578,603,209 Undistributed net investment income 6,778,069 Accumulated net realized loss (Notes 1 and 8) (253,147,512) Unrealized appreciation of investments 77,420,678 _____________________________________________________________________________________________________________ Total -- representing net assets applicable to outstanding capital stock $2,415,218,463 _____________________________________________________________________________________________________________ Net assets applicable to outstanding shares: Class A $2,145,455,185 Class B $ 269,754,238 Class Y $ 9,040 Net asset value per share of outstanding capital stock: Class A shares 494,251,079 $4.34 Class B shares 62,148,719 $4.34 Class Y shares 2,082 $4.34 See accompanying notes to financial statements. PAGE 15 Financial statements Statement of operations IDS Extra Income Fund, Inc. Nine months ended May 31, 1996 _____________________________________________________________________________________________________________ Investment income _____________________________________________________________________________________________________________ Income: Interest $150,747,464 Dividends 7,042,024 _____________________________________________________________________________________________________________ Total income 157,789,488 _____________________________________________________________________________________________________________ Expenses (Note 2): Investment management services fee 9,170,111 Distribution fee -- Class B 907,154 Transfer agency fee 1,538,421 Incremental transfer agency fee -- Class B 8,608 Service fee Class A 2,552,021 Class B 211,334 Administrative services fee 749,696 Compensation of board members 37,776 Compensation of officers 15,052 Custodian fees 129,746 Postage 254,139 Registration fees 267,428 Reports to shareholders 26,235 Audit fees 36,500 Administrative 10,141 Other 42,853 _____________________________________________________________________________________________________________ Total expenses 15,957,215 Earnings credits on cash balances (Note 2) (77,789) _____________________________________________________________________________________________________________ Total net expenses 15,879,426 _____________________________________________________________________________________________________________ Investment income -- net 141,910,062 _____________________________________________________________________________________________________________ Realized and unrealized gain -- net _____________________________________________________________________________________________________________ Net realized gain on security transactions (Note 3) 30,517,451 Net realized gain on sale of affiliated security 69,732 Net change in unrealized appreciation or depreciation of investments 63,851,546 _____________________________________________________________________________________________________________ Net gain on investments 94,438,729 _____________________________________________________________________________________________________________ Net increase in net assets resulting from operations $236,348,791 _____________________________________________________________________________________________________________ See accompanying notes to financial statements. PAGE 16 Financial statements Statements of changes in net assets IDS Extra Income Fund, Inc. _____________________________________________________________________________________________________________ Operations and distributions May 31, 1996 Aug. 31, 1995 _____________________________________________________________________________________________________________ Nine months ended Year ended Investment income -- net $141,910,062 $164,956,308 Net realized gain (loss) on investments and foreign currency 30,587,183 (94,618,530) Net change in unrealized appreciation or depreciation of investments 63,851,546 154,638,498 _____________________________________________________________________________________________________________ Net increase in net assets resulting from operations 236,348,791 224,976,276 _____________________________________________________________________________________________________________ Distributions to shareholders from: Net investment income Class A (131,968,668) (163,086,676) Class B (10,053,530) (1,285,639) Class Y (35,126) (64,716) _____________________________________________________________________________________________________________ Total distributions (142,057,324) (164,437,031) _____________________________________________________________________________________________________________ Capital share transactions (Note 6) _____________________________________________________________________________________________________________ Proceeds from sales Class A shares (Note 2) 409,958,480 386,116,539 Class B shares 211,284,632 76,560,620 Class Y shares 281,250 2,243,811 Reinvestment of distributions at net asset value Class A shares 88,685,134 105,087,318 Class B shares 8,360,841 977,944 Class Y shares 26,891 60,615 Payments for redemptions Class A shares (262,062,635) (354,557,559) Class B shares (Note 2) (33,183,891) (2,378,996) Class Y shares (1,890,774) (807,210) _____________________________________________________________________________________________________________ Increase in net assets from capital share transactions 421,459,928 213,303,082 _____________________________________________________________________________________________________________ Total increase in net assets 515,751,395 273,842,327 Net assets at beginning of period 1,899,467,068 1,625,624,741 _____________________________________________________________________________________________________________ Net assets at end of period (including undistributed net investment income of $6,778,069 and $7,554,854) $2,415,218,463 $1,899,467,068 _____________________________________________________________________________________________________________ See accompanying notes to financial statements.
PAGE 17 Notes to financial statements IDS Extra Income Fund, Inc. ___________________________________________________________________ 1. Summary of significant accounting policies The Fund is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. The Fund invests primarily, and may invest all of its assets, in long-term corporate bonds in the lower-rating categories, commonly known as junk bonds. The Fund offers Class A, Class B and Class Y shares. Class A shares are sold with a front-end sales charge. Class B shares may be subject to a contingent deferred sales charge and such shares automatically convert to Class A after eight years. Class Y shares have no sales charge and are offered only to qualifying institutional investors. All classes of shares have identical voting, dividend, liquidation and other rights, and the same terms and conditions, except that the level of distribution fee, transfer agency fee and service fee (class specific expenses) differs among classes. Income, expenses (other than class specific expenses) and realized and unrealized gains or losses on investments are allocated to each class of shares based upon its relative net assets. Significant accounting policies followed by the Fund are summarized below: Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increase and decrease in net assets from operations during the period. Actual results could differ from those estimates. PAGE 18 Valuation of securities All securities are valued at the close of each business day. Securities traded on national securities exchanges or included in national market systems are valued at the last quoted sales price; securities for which market quotations are not readily available, including illiquid securities, are valued at fair value according to methods selected in good faith by the board. Determination of fair value involves, among other things, reference to market indexes, matrixes and data from independent brokers. Short-term securities maturing in more than 60 days from the valuation date are valued at the market price or approximate market value based on current interest rates; those maturing in 60 days or less are valued at amortized cost. Option transactions In order to produce incremental earnings, protect gains, and facilitate buying and selling of securities for investment purposes, the Fund may buy or write options traded on any U.S. or foreign exchange or in the over-the-counter market where the completion of the obligation is dependent upon the credit standing of the other party. The Fund also may buy and sell put and call options and write covered call options on portfolio securities and may write cash-secured put options. The risk in writing a call option is that the Fund gives up the opportunity of profit if the market price of the security increases. The risk in writing a put option is that the Fund may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Fund pays a premium whether or not the option is exercised. The Fund also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. PAGE 19 Option contracts are valued daily at the closing prices on their primary exchanges and unrealized appreciation or depreciation is recorded. The Fund will realize a gain or loss upon expiration or closing of the option transaction. When options on debt securities or futures are exercised, the Fund will realize a gain or loss. When other options are exercised, the proceeds on sales for a written call option, the purchase cost for a written put option or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. Futures transactions In order to gain exposure to or protect itself from changes in the market, the Fund may buy and sell interest rate futures contracts traded on any U.S. or foreign exchange. The Fund also may buy or write put and call options on these futures contracts. Risks of entering into futures contracts and related options include the possibility that there may be an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the Fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Fund recognizes a realized gain or loss when the contract is closed or expires. PAGE 20 Foreign currency translations and foreign currency contracts Securities and other assets and liabilities denominated in foreign currencies are translated daily into U.S. dollars at the closing rate of exchange. Foreign currency amounts related to the purchase or sale of securities and income and expenses are translated at the exchange rate on the transaction date. The effect of changes in foreign exchange rates on realized and unrealized security gains or losses is reflected as a component of such gains or losses. In the statement of operations, net realized gains or losses from foreign currency transactions may arise from sales of foreign currency, closed forward contracts, exchange gains or losses realized between the trade date and settlement dates on securities transactions, and other translation gains or losses on dividends, interest income and foreign withholding taxes. The Fund may enter into forward foreign currency exchange contracts for operational purposes and to protect against adverse exchange rate fluctuation. The net U.S. dollar value of foreign currency underlying all contractual commitments held by the Fund and the resulting unrealized appreciation or depreciation are determined using foreign currency exchange rates from an independent pricing service. The Fund is subject to the credit risk that the other party will not complete the obligations of the contract. PAGE 21 Federal taxes Since the Fund's policy is to comply with all sections of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to shareholders, no provision for income or excise taxes is required. Net investment income (loss) and net realized gains (losses) may differ for financial statement and tax purposes primarily because of the deferral of losses on certain futures contracts, the recognition of certain foreign currency gains (losses) as ordinary income (loss) for tax purposes and losses deferred due to "wash sale" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the Fund. On the statement of assets and liabilities, as a result of permanent book-to-tax differences, undistributed net investment income has been decrease by $629,523 resulting in a net reclassification adjustment to decrease accumulated net realized loss by $629,523. Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, are reinvested in additional shares of the Fund at net asset value or payable in cash. Capital gains, when available, are distributed along with the last income dividend of the calendar year. PAGE 22 Other Security transactions are accounted for on the date securities are purchased or sold. Dividend income is recognized on the ex-dividend date. For U.S. dollar denominated bonds, interest income includes level-yield amortization of premium and discount. For foreign bonds, except for original issue discount, the Fund does not amortize premium and discount. Interest income, including level-yield amortization of premium and discount, is accrued daily. __________________________________________________________________ 2. Expenses and sales charges Effective March 20, 1995, the Fund entered into agreements with American Express Financial Corporation (AEFC) for managing its portfolio, providing administrative services and serving as transfer agent as follows: Under its Investment Management Services Agreement, AEFC determines which securities will be purchased, held or sold. The management fee is a percentage of the Fund's average daily net assets in reducing percentages from 0.59% to 0.465% annually. Under an Administrative Services Agreement, the Fund pays AEFC for administration and accounting services at a percentage of the Fund's average daily net assets in reducing percentages from 0.05% to 0.025% annually. Under a separate Transfer Agency Agreement, AEFC maintains shareholder accounts and records. The Fund pays AEFC an annual fee per shareholder account for this service as follows: o Class A $15.50 o Class B $16.50 o Class Y $15.50 Also effective March 20, 1995, the Fund entered into agreements with American Express Financial Advisors Inc. for distribution and shareholder servicing-related services as follows: Under a Plan and Agreement of Distribution, the Fund pays a distribution fee at an annual rate of 0.75% of the Fund's average daily net assets attributable to Class B shares for distribution-related services. PAGE 23 Under a Shareholder Service Agreement, the Fund pays a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.175% of the Fund's average daily net assets attributable to Class A and Class B shares. AEFC will assume and pay any expenses (except taxes and brokerage commissions) that exceed the most restrictive applicable state expense limitation. Sales charges by American Express Financial Advisors Inc. for distributing Fund shares were $8,627,557 for Class A and $87,595 for Class B for the period ended May 31, 1996. During the period ended May 31, 1996, the Fund's custodian and transfer agency fees were reduced by $77,789 as a result of earnings credits from overnight-cash balances. Prior to April 30, 1996, the Fund had a retirement plan for its independent board members. The plan was terminated April 30, 1996. The retirement plan expense amounted to $14,979 for the period. The total liability for the plan is $86,231, which will be paid out at some future date. ___________________________________________________________________ 3. Securities transactions Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $1,670,881,472 and $1,255,528,927, respectively, for the fiscal period ended May 31, 1996. Realized gains and losses are determined on an identified cost basis. PAGE 24 ___________________________________________________________________ 4. Change of Fund's fiscal year The By-Laws of the Fund were amended on Jan. 10 - 11, 1996, changing its fiscal year-end from Aug. 31 to May 31, effective 1996. ___________________________________________________________________ 5. Lending of portfolio securities At May 31, 1996, securities valued at $1,853,700 were on loan to brokers. For collateral, the Fund received $1,000,000 in cash and U.S. government securities valued at $1,006,887. Income from securities lending amounted to $126,108 for the fiscal period ended May 31, 1996. The risks to the Fund of securities lending are that the borrower may not provide additional collateral when required or return the securities when due. 6. Capital share transactions Transactions in shares of capital stock for the periods indicated are as follows:
Nine months ended May 31, 1996 Class A Class B Class Y _____________________________________________________________________ Sold 96,295,627 49,606,436 67,241 Issued for reinvested 20,843,375 1,956,298 6,442 distributions Redeemed (61,588,802) (7,759,632) (453,087) _____________________________________________________________________ Net increase (decrease) 55,550,200 43,803,102 (379,404) ______________________________________________________________________ Year ended Aug. 31, 1995 Class A Class B* Class Y* _____________________________________________________________________ Sold 97,298,897 18,688,995 565,786 Issued for reinvested 26,443,241 236,714 14,823 distributions Redeemed (89,533,246) (580,092) (199,123) _____________________________________________________________________ Net increase 34,208,892 18,345,617 381,486 _____________________________________________________________________ *Inception date was March 20, 1995.
PAGE 25 7. Illiquid securities At May 31, 1996, investments in securities included issues that are illiquid. The Fund currently limits investments in illiquid securities to 10% of the net assets, at market value, at the time of purchase. The aggregate value of such securities at May 31, 1996 was $51,322,481 representing 2.1% of net assets. Pursuant to guidelines adopted by the Fund's board, certain unregistered securities are determined to be liquid and are not included within the 10% limitation specified above. ___________________________________________________________________ 8. Capital loss carryover For federal income tax purposes, the Fund had a capital loss carryover of $257,355,361 at May 31, 1996, that will expire in 1999 through 2004 if not offset by subsequent capital gains. It is unlikely the board will authorize a distribution of any net realized capital gains until the available capital loss carryover has been offset or expires. ___________________________________________________________________ 9. Subsequent event The Fund invested its assets in a master portfolio, called the High Yield Portfolio, on June 10, 1996. The portfolio is a separate investment company, but has the same goals and investment policies as the Fund. Additional information on investment policies may be found in the prospectus and Statement of Additional Information (SAI). ___________________________________________________________________ 10. Financial highlights "Financial highlights" showing per share data and selected information is presented on pages 7 and 8 of the prospectus. PAGE 26
Investments in securities (Percentages represent value of IDS Extra Income Fund, Inc. investments compared to net assets) May 31, 1996 Investments in securities of unaffiliated issuers _____________________________________________________________________________________________________________________________ Bonds (88.0%) _____________________________________________________________________________________________________________________________ Issuer Coupon Maturity Principal Value(a) rate year amount _____________________________________________________________________________________________________________________________ Mortgage-backed securities (1.0%) Federal Home Loan Mtge Corp 6.875% 2017 $ 6,696 (b) $ 6,822 Inverse Floater 7.26 2024 9,865,946 (l) 7,374,696 8.72 2023 4,407,829 (l) 3,374,855 Merrill Lynch Mtge Investors 8.29 2021 9,717,850 (c) 8,598,779 Resolution Trust 8.00 2026 6,438,924 5,070,653 ______________ Total 24,425,805 _____________________________________________________________________________________________________________________________ Financial (3.1%) Banks and savings & loans (0.4%) First Nationwide Bank Sr Nts 12.50 2003 10,250,000 (c) 10,660,000 _____________________________________________________________________________________________________________________________ Financial services (1.0%) Homeside Sr Nts 11.25 2003 6,375,000 (c) 6,534,375 Malan Realty Investors REIT Cv Sub Deb 9.50 2004 2,750,000 2,530,000 Olympic Financial Sr Nts 13.00 2000 14,500,000 15,895,625 ______________ Total 24,960,000 _____________________________________________________________________________________________________________________________ Insurance (1.7%) Americo Life Sr Sub Nts 9.25 2005 15,000,000 14,587,500 Life Partners Sr Sub Nts 12.75 2002 10,000,000 10,925,000 Reliance Group Holdings Sr Sub Deb 9.75 2003 15,000,000 15,300,000 _____________ Total 40,812,500 _____________________________________________________________________________________________________________________________ Industrial (71.2%) Aerospace & defense (1.9%) Alliant Techsystems Sr Sub Nts 11.75 2003 9,250,000 (c) 10,059,375 Sequa 9.625 1999 3,000,000 3,067,500 Sr Sub Nts 9.375 2003 20,750,000 20,698,125 TransDigm Sr Secured Nts 13.00 2000 14,030,000 (e) 12,837,450 ______________ Total 46,662,450 _____________________________________________________________________________________________________________________________ Automotive & related (0.7%) Harvard Inds Sr Nts 12.00 2004 7,000,000 6,982,500 Penda Sr Nts 10.75 2004 12,000,000 10,890,000 ______________ Total 17,872,500 _____________________________________________________________________________________________________________________________ Building materials & construction (1.7%) American Standard Zero Coupon Sr Sub Disc Deb 10.46 1998 15,000,000 (g) 12,900,000 Peters (JM) Sr Nts 12.75 2002 10,500,000 9,948,750 PAGE 27 Schuller Intl Group Sr Nts 10.875 2004 12,000,000 13,020,000 Southdown Sr Sub Nts 10.00 2006 4,700,000 (c) 4,741,125 ______________ Total 40,609,875 _____________________________________________________________________________________________________________________________ Communications equipment & services (8.1%) American Communication Services Zero Coupon 14.64 2000 10,000,000 (c,g) 5,625,000 Celcaribe Zero Coupon 10.42 1998 3,800,000 (c,g) 3,914,000 Zero Coupon 13.44 1998 7,350,000 (g) 5,806,500 Cencall Communications Zero Coupon Sr Nts 10.09 1999 8,000,000 (g) 4,980,000 Comcast Cellular Zero Coupon Series A 11.73 2000 33,000,000 (f) 23,182,500 Zero Coupon Series B 7.08 2000 10,000,000 (f) 7,025,000 Geotek Communications Cv 12.00 2001 5,000,000 (e) 7,575,000 Zero Coupon 17.41 2000 26,250,000 (g) 16,143,750 GST Telecommunications Zero Coupon 12.01 2000 20,880,000 (c,g) 13,154,400 Horizon Cellular Zero Coupon 10.28 1997 16,000,000 (g) 14,320,000 Intermedia Communications of Florida Sr Nts 13.50 2005 22,750,000 (c) 25,536,875 Nextlink Communications Sr Nts 12.50 2006 15,000,000 (c) 15,225,000 Pagemart Nationwide Zero Coupon Sr Nts 15.80 2000 23,000,000 (c,g) 15,180,000 Peoples Telephone Sr Nts 12.25 2002 7,000,000 6,720,000 Pronet Sr Sub Nts 10.875 2006 6,100,000 6,100,000 Western Wireless Sr Sub Nts 10.50 2006 5,000,000 5,037,500 Winstar Communications Zero Coupon 14.50 2000 30,000,000 (c,g) 18,800,000 ______________ Total 194,325,525 _____________________________________________________________________________________________________________________________ Computers & office equipment (1.9%) Anacomp -- 1997 727 (e) 727 Dictaphone Sr Sub Nts 11.75 2005 14,500,000 14,028,750 Softkey Cv Sr Nts 5.50 2000 2,500,000 (c) 2,168,750 Unisys Sr Nts 10.625 1999 3,500,000 3,561,250 Sr Nts 12.00 2003 8,000,000 (c) 8,260,000 Credit Sensitive Nts 15.00 1997 15,600,000 (j) 16,653,000 ______________ Total 44,672,477 _____________________________________________________________________________________________________________________________ Energy (1.6%) Chesapeake Energy 12.00 2001 7,000,000 7,560,000 Harcor Energy Sr Nts 14.875 2002 5,000,000 (c) 5,300,000 Petroleum Heat & Power Sub Deb 9.375 2006 10,000,000 9,550,000 PAGE 28 TransTexas Gas Sr Secured Nts 11.50 2002 10,000,000 9,750,000 United Meridian Sr Sub Nts 10.375 2005 5,800,000 6,003,000 ______________ Total 38,163,000 _____________________________________________________________________________________________________________________________ Food (1.1%) Chiquita Brands Intl Sr Nts 9.625 2004 8,500,000 8,415,000 Specialty Foods 11.25 2003 19,000,000 (c) 15,200,000 Twin Laboratories Sr Sub Nts 10.25 2006 4,000,000 (c) 4,060,000 ______________ Total 27,675,000 _____________________________________________________________________________________________________________________________ Health care (2.4%) Dade Intl Sr Sub Nts 11.125 2006 5,850,000 (c) 6,054,750 Magellan Health Services Sr Sub Nts Cl A 11.25 2004 12,500,000 (c) 13,750,000 Merit Behavioral 11.50 2005 5,500,000 (c) 5,788,750 Tenet Healthcare Sr Sub Nts 10.125 2005 20,000,000 21,350,000 Total Renal Care Zero Coupon 15.46 1997 10,388,000 (g) 10,232,180 ______________ Total 57,175,680 _____________________________________________________________________________________________________________________________ Industrial equipment & services (2.3%) ACF Inds 11.60 2000 3,020,000 3,027,550 Borg-Warner Security Sr Sub Nts 9.125 2003 10,000,000 9,337,500 Envirodyne Inds Sr Nts 12.00 2000 7,000,000 7,210,000 Interlake Sr Sub Deb 12.125 2002 11,000,000 10,945,000 Specialty Equipment Sr Sub Nts 11.375 2003 23,300,000 24,348,500 ______________ Total 54,868,550 _____________________________________________________________________________________________________________________________ Leisure time & entertainment (12.8%) Alliance Entertainment Sr Sub Nts 11.25 2005 27,500,000 (c) 26,193,750 Bally's Health & Tennis Sr Sub Nts 13.00 2003 5,000,000 4,350,000 Bally's Park Place Funding 1st Mtge Nts 9.25 2004 11,000,000 11,110,000 Cinemark (USA) Sr Sub Nts 12.00 2002 7,500,000 8,156,250 Coast Hotels & Casino 1st Mtge 13.00 2002 19,800,000 (c) 21,111,750 Cobblestone Golf Group Sr Nts 11.50 2003 4,550,000 (c) 4,618,250 Cobblestone Holdings Zero Coupon Units 13.50 2004 10,250,000 (c,f) 3,766,875 Grand Casinos 1st Mtge 10.125 2003 15,000,000 15,450,000 Hollywood Casino Sr Nts 12.75 2003 12,800,000 12,608,000 PAGE 29 IHF Holdings Zero Coupon Sr Disc Nts 13.44 1999 15,000,000 (g) 10,425,000 Lady Luck Gaming 1st Mtge 11.875 2001 5,000,000 4,968,750 Marvel Holdings Zero Coupon 13.57 1998 15,150,000 (f) 12,006,375 Marvel Parent Holdings Zero Coupon Sr Nts 14.82 1998 7,100,000 (f) 5,626,750 MGM Grand Hotel Finance 11.75 1999 10,000,000 10,612,500 12.00 2002 14,000,000 15,400,000 Mohegan Tribal Gaming Sr Nts 13.50 2002 13,400,000 (c) 16,750,000 Plitt Theatres 10.875 2004 27,850,000 28,337,375 Resorts Intl Mtge Nts 11.00 2003 8,000,000 8,320,000 Showboat Marina 1st Mtge 13.50 2003 5,000,000 (c) 5,400,000 Trump Atlantic City Funding 1st Mtge 11.25 2006 37,225,000 37,829,906 Trump Castle Funding Mtge Nts 11.75 2003 19,711,250 19,809,806 Trump Holdings Sr Nts 15.50 2005 10,000,000 11,650,000 United Artists 11.50 2002 6,000,000 (c) 6,345,000 United Artists Theatres Pass Thru Certs 9.30 2015 10,000,000 (c) 9,500,000 ______________ Total 310,346,337 _____________________________________________________________________________________________________________________________ Media (11.2%) Ackerley Communications Sr Secured Nts 10.75 2003 13,500,000 (c) 14,107,500 Adelphia Communications Pay-in-kind 9.50 2004 33,093,415 (n) 29,246,306 Sr Deb 11.875 2004 5,000,000 5,050,000 American Telecasting Zero Coupon 16.69 1999 9,606,320 (g) 6,916,550 Zero Coupon Sr Disc Nts 12.14 2000 10,000,000 (e,g) 6,325,000 Bell & Howell Zero Coupon 11.08 2000 21,750,000 (g) 14,898,750 Big Flower Press Sr Sub Nts 10.75 2003 4,673,000 (c) 4,708,048 CAI Wireless Systems Sr Nts 12.25 2002 11,250,000 11,896,875 Continental Cablevision Sr Sub Deb 11.00 2007 6,800,000 7,616,000 CS Wireless Systems Zero Coupon 11.375 2001 3,250,000 (c,g) 6,857,500 Echostar Satellite Broadcasting Zero Coupon 13.13 2000 49,700,000 (c,g) 32,988,375 Grupo Televisa Sr Nts 11.875 2006 4,500,000 (c) 4,601,250 Zero Coupon 13.25 2001 18,000,000 (c,g) 9,720,000 Heritage Media Services Sr Sub Nts 8.75 2006 5,000,000 4,762,500 Outdoor Systems Sr Nts 10.75 2003 11,000,000 11,330,000 Paramount Communications Sub Deb 7.00 2003 15,000,000 13,790,850 PAGE 30 Paxson Communications Sr Sub Nts 11.625 2002 12,000,000 (c) 12,720,000 Pegasus Media & Communications Cl B 12.50 2005 7,500,000 (c) 8,025,000 People's Choice TV Zero Coupon 13.12 2000 23,500,000 (g) 14,276,250 Scandinavian Broadcasting Cv Sub Deb 7.25 2005 4,000,000 4,340,000 United Intl Holdings Zero Coupon Disc Nts 11.99 1999 12,500,000 (f) 8,156,250 Universal Outdoor Sr Nts 11.00 2003 13,000,000 13,325,000 Zero Coupon 12.34 1999 12,934,000 (g) 9,538,825 Viacom Sub Deb 8.00 2006 8,000,000 7,440,000 Wireless One Units 13.00 2003 7,750,000 8,253,750 ______________ Total 270,890,579 _____________________________________________________________________________________________________________________________ Metals (2.5%) Bar Technologies Units 13.50 2001 10,000,000 (c) 10,050,000 Carbide/Graphite Group Sr Nts 11.50 2003 9,091,000 9,886,463 EnviroSource Sr Nts 9.75 2003 18,750,000 17,109,375 NS Group Units 13.50 2003 14,000,000 (m) 13,440,000 Republic Engineered Steel 1st Mtge 9.875 2001 10,000,000 9,150,000 _____________ Total 59,635,838 _____________________________________________________________________________________________________________________________ Multi-industry conglomerates (3.9%) Communications & Power Inds Sr Sub Nts 12.00 2005 10,000,000 (c) 10,575,000 G-I Holdings Sr Nts 10.00 2006 22,214,220 22,408,594 Zero Coupon Sr Nts 9.55 1998 29,484,000 (f) 23,808,330 Saul (BF) REIT Sr Nts 11.625 2002 9,300,000 (c) 9,579,000 Talley Inds Zero Coupon Sr Disc Deb 11.80 1998 24,000,000 (g) 18,690,000 Talley Mfg & Technology Sr Nts 10.75 2003 8,500,000 8,606,250 _____________ Total 93,667,174 _____________________________________________________________________________________________________________________________ Paper & packaging (4.9%) Florida Coast Paper 12.75 2003 10,000,000 (c) 10,275,000 Gaylord Container Sr Sub Disc Deb 12.75 2005 28,000,000 29,540,000 Plastic Container Sr Secured Nts 10.75 2001 14,200,000 14,448,500 Silgan Sr Sub Nts 11.75 2002 7,500,000 7,950,000 Zero Coupon 13.25 1996 20,000,000 (g) 19,850,000 PAGE 31 Stone Container Sr Nts 12.625 1998 4,500,000 4,786,875 Sweetheart Cup Sr Sub Nts 10.50 2003 13,500,000 13,500,000 Warren (SD) Sr Nts 12.00 2004 16,500,000 (c) 17,325,000 ______________ Total 117,675,375 _____________________________________________________________________________________________________________________________ Restaurants & lodging (1.1%) Flagstar Sr Nts 10.875 2002 10,000,000 8,925,000 Sr Sub Deb 11.25 2004 10,000,000 7,200,000 Hammons (John Q) Hotels 1st Mtge 8.875 2004 12,000,000 11,460,000 ______________ Total 27,585,000 _____________________________________________________________________________________________________________________________ Retail (7.9%) Apparel Retail Zero Coupon 12.21 1998 14,500,000 (c,g) 11,455,000 Dairy Mart Convenience Stores Sr Sub Nts 10.25 2004 20,700,000 19,302,750 Di Giorgio Sr Nts 12.00 2003 16,000,000 15,080,000 Dr Structured Finance Pass Thru Certs 8.55 2019 10,000,000 8,400,000 Hill Stores Sr Nts 12.50 2003 5,250,000 (c) 5,368,125 Jitney-Jungle Stores Sr Nts 12.00 2006 15,000,000 15,525,000 Kash n' Karry Food Stores Pay-in-kind 11.50 2003 17,501,290 (n) 17,588,796 Musicland Group Sr Sub Nts 9.00 2003 20,375,000 13,855,000 Parisian Sr Sub Nts 9.875 2003 2,150,000 2,053,250 Pathmark Stores Zero Coupon Jr Sub Nts 12.83 1999 13,500,000 (g) 8,572,500 Penn Traffic Sr Sub Nts 9.625 2005 26,000,000 21,970,000 Pueblo Xtra Intl Sr Nts 9.50 2003 19,140,000 17,273,850 Ralphs Grocery Sr Nts 10.45 2004 10,000,000 9,675,000 Specialty Retailers 10.00 2000 2,000,000 1,972,500 Sr Sub Nts 11.00 2003 6,750,000 6,716,250 Stater Brothers Holdings Sr Nt 11.00 2001 14,500,000 15,152,500 ______________ Total 189,960,521 _____________________________________________________________________________________________________________________________ Soaps & cosmetics (1.3%) Coty Sr Sub Nts 10.25 2005 7,000,000 7,332,500 Revlon Worldwide Zero Coupon Sr Disc Nts 11.50 1998 30,000,000 (c,f) 24,712,500 ______________ Total 32,045,000 PAGE 32 _____________________________________________________________________________________________________________________________ Textiles & apparel (1.3%) CMI Inds Sr Sub Nts 9.50 2003 5,000,000 4,262,500 Dominion Textiles Sr Nts 8.875 2003 5,000,000 4,912,500 Hat Brand Holdings Zero Coupon -- 2002 5,000,000 (d,e,f) 3,500,000 Hosiery Corp of America 13.75 2002 9,993,175 10,692,697 US Leather Sr Nts 10.25 2003 10,000,000 8,400,000 ___________ Total 31,767,697 _____________________________________________________________________________________________________________________________ Miscellaneous (2.6%) Adams Outdoor Advertising 10.75 2006 10,700,000 (c) 10,887,250 Benedek Communications Zero Coupon 13.25 2001 9,500,000 (c,g) 4,987,500 Darling-Delaware Sr Sub Nts 11.00 2000 9,932,000 9,857,510 ECM Funding LP 11.92 2002 2,735,472 (e,j) 3,009,019 KinderCare Learning Centers Sr Nts 10.375 2001 6,000,000 6,232,500 Norcal Waste Systems Sr Nts 12.50 2005 20,300,000 (c,j) 21,441,875 SC Intl Sr Sub Nts 13.00 2005 6,000,000 6,465,000 ______________ Total 62,880,654 _____________________________________________________________________________________________________________________________ Transportation (0.8%) Braniff Sr Reset Nts -- 1999 5,000,000 (d,e,h,j) -- GPA Delaware 8.75 1998 10,000,000 (d) 10,047,600 Trans Ocean Container 12.25 2004 8,750,000 9,034,375 ______________ Total 19,081,975 _____________________________________________________________________________________________________________________________ Utilities (3.1%) Electric (2.0%) California Energy Ltd Resource Sr Secured Nts 9.875 2003 7,000,000 7,140,000 First Palo Verde Funding 10.15 2016 6,150,000 6,426,750 Midland Funding II 11.75 2005 5,000,000 5,281,250 13.25 2006 12,500,000 13,812,500 Niagara Mohawk Power 1st Mtge 9.75 2005 9,000,000 8,868,510 Texas-New Mexico Power Secured Deb 10.75 2003 7,000,000 7,385,000 ______________ Total 48,914,010 _____________________________________________________________________________________________________________________________ Telephone (1.1%) Millicom Intl Cellular Zero Coupon 13.50 2000 28,125,000 (c,g) 15,117,187 Mobil Telecommunications Technology Sr Nts 13.50 2002 10,000,000 10,475,000 ______________ Total 25,592,187 PAGE 33 _____________________________________________________________________________________________________________________________ Foreign (8.8%) Asian Pulp & Paper (U.S. Dollar) 11.75 2005 6,600,000 6,864,000 Banco Nacional de Comercio Exterior (U.S. Dollar) 7.25 2004 14,300,000 11,583,000 Cable Systems (U.S. Dollar) 10.75 1999 2,716,120 (e) 2,688,959 Caguas Humacas (U.S. Dollar) 10.50 1998 10,528,492 (e) 10,265,280 Clearnet Communications (U.S. Dollar) Zero Coupon 11.56 2000 10,800,000 (g) 6,750,000 Dom's Telecable (U.S. Dollar) 10.50 1996 1,617,555 (e) 1,601,379 Doman Inds (U.S. Dollar) 8.75 2004 10,500,000 9,660,000 Fresh Delmonte (U.S. Dollar) 10.00 2003 22,000,000 20,790,000 Gulf Canada Resources (U.S. Dollar) 9.25 2004 13,500,000 13,500,000 Imexsa Export Trust (U.S. Dollar) 10.125 2003 10,000,000 9,987,500 Intl Cabletel (U.S. Dollar) Zero Coupon 15.25 2001 31,000,000 (c,g) 18,367,500 Repap New Brunswick (U.S. Dollar) Sr Nts 10.625 2005 15,000,000 13,987,500 Republic of Brazil (U.S. Dollar) 6.875 2012 6,500,000 (j) 4,257,500 Rogers Cablesystems (U.S. Dollar) Sr Secured Nts 9.625 2002 5,000,000 4,987,500 Rogers Cantel (U.S. Dollar) Sr Sub Nts 11.125 2002 10,000,000 10,650,000 Tarkett Intl (U.S. Dollar) 9.00 2002 10,000,000 (c) 10,387,500 Telewest (U.S. Dollar) Zero Coupon 11.00 2000 20,000,000 (g) 12,000,000 Tjiwi Kimia (U.S. Dollar) 13.25 2001 10,000,000 11,125,000 United Mexican States (U.S. Dollar) 11.50 2026 6,669,000 6,167,758 Venezuela (U.S. Dollar) Front Loaded Interest Reduction 6.81 2007 16,000,000 11,330,000 Viridian (U.S. Dollar) 9.75 2003 3,500,000 3,657,500 (U.S. Dollar) 10.50 2014 10,000,000 10,937,500 ______________ Total 211,545,376 _____________________________________________________________________________________________________________________________ Total bonds (Cost: $2,047,998,654) $2,124,471,085 _____________________________________________________________________________________________________________________________ Stocks and other (8.5%) _____________________________________________________________________________________________________________________________ Issuer Shares Value(a) _____________________________________________________________________________________________________________________________ American Communication Services Warrants 15,200 (c) 1,672,000 American Telecasting Warrants 85,225 383,513 PAGE 34 Benedek Broadcasting Units Preferred 7,000 7,000,000 Berg Electronics Common 90,121 (c,d) 2,331,881 Cablevision Systems 11.125% Pay-in-kind 289,051 (c,n) 28,037,947 11.75% Preferred Cv 106,134 (c) 10,666,467 Calenergy Capital Trust 6.25% Cv Preferred 60,000 (c) 3,330,000 Celcaribe Common 1,195,110 (c,d) 1,876,323 Cherokee Warrants 44,107 3,867 Chevy Chase Savings 13% Preferred 180,000 5,445,000 Communications & Power Inds 14% Preferred 51,595 (c,d) 5,231,733 Warrants 3,500 (c) 366,625 Crown Packaging Warrants 10,000 70,000 Dairy Mart Convenience Stores Warrants 311,333 414,073 Dr. Pepper Bottling Holdings Common 100,000 (d) 550,000 Earthwatch 12% Preferred 700,000 (c) 7,000,000 Echostar Satellite Broadcasting Common 100,000 (d) 3,450,000 El Paso Electric 11.40% Pay-in-kind 30,000 (c,n) 3,030,000 First Nationwide Bank 11.50% Preferred 166,500 18,315,000 Foodmaker Warrants 7,000 154,000 Gaylord Container Common 437,500 (d) 3,910,156 Warrants 562,500 4,992,187 Geotek Communications Warrants 872,500 5,671,250 Harcor Energy Warrants 110,000 (c) 297,000 Harvard Inds Pay-in-Kind 14.25% Preferred 438,224 (n) 11,448,602 Hat Brand Holdings Warrants 90,345 (e) -- Hemmeter Enterprises Warrants 36,000 (c,e) 58,500 Hosiery Corp of America Warrants 10,000 (c) 50,000 Houlihan's Restaurant Warrants 5,886 30,166 IFINT Diversified Holdings Common 42,418 (e) 1,018,032 PAGE 35 Intermedia Communications Warrants 22,750 (d) 1,023,750 K-III Communications 10% Preferred 75,000 (c) 6,975,000 Pay-in-Kind Sr Exchangeable 115,695 (n) 11,685,216 Kelley Oil & Gas $2.625 Cv Preferred 100,000 2,050,000 Lady Luck Gaming Common 200,000 (d) 653,125 MFS Communications Common 2,264 (d) 78,674 Natl Health Investors 8.50% Cv Preferred 60,000 1,833,750 Nextel Communications Warrants 18,902 189 Pagemart Common 50,750 (c,d) 475,781 Panamsat Common 150,000 (d) 4,237,500 Pay-in-kind 12.75% Cv Preferred 11,312 (n) 12,618,536 Pantry Pride 14.875% Preferred 100,000 10,000,000 Pegasus Media Communications Common 750 (d) 450,000 Pullman Common 273,141 (d) 2,321,699 Reliance Group Holdings Warrants 277,791 581,625 Riggs Natl Series B Preferred 72,825 2,039,100 Southdown Warrants 50,000 (e) 418,750 Specialty Foods Acquisition Common 300,000 (d) 150,000 Station Casinos 7% Cv Preferred 50,000 2,968,750 Supermarket General Pay-in-kind Cv 275,000 (n) 6,875,000 Time Warner Pay-in-kind Preferred 8,750 (c,n) 8,706,250 TransDigm Warrants 11,195 (e) 1,533,671 Triangle Wire & Cable Common 548,889 (d,e) 548,889 Webcraft Technology Common 32,502 (d,e) 325 Wireless One Common 25,000 (d) 462,500 Warrants 23,250 162,750 _____________________________________________________________________________________________________________________________ Total stocks and other (Cost: $200,431,753) $ 205,655,152 PAGE 36 _____________________________________________________________________________________________________________________________ Short-term securities (2.4%) _____________________________________________________________________________________________________________________________ Issuer Annualized Amount Value(a) yield on payable at date of maturity purchase _____________________________________________________________________________________________________________________________ U.S. government agency (0.3%) Federal Home Loan Mtge Corp Disc Nts 06-20-96 5.22% $4,000,000 $ 3,989,022 06-20-96 5.24 2,000,000 1,994,490 ______________ Total 5,983,512 _____________________________________________________________________________________________________________________________ Commercial paper (2.1%) Albertson's 06-27-96 5.29 6,000,000 5,977,163 BellSouth Telephone 06-05-96 5.31 4,500,000 4,497,360 Commerzbank US Finance 06-17-96 5.30 2,900,000 2,893,195 Dean Witter, Discover & Co 06-24-96 5.30 2,500,000 2,491,567 06-25-96 5.30 5,600,000 5,580,288 Fleet Funding 07-01-96 5.31 3,800,000 (i) 3,783,280 General Electric Capital 07-08-96 5.30 3,100,000 3,083,209 Met Life 06-03-96 5.30 7,300,000 7,297,859 Mobil Australia Finance 06-12-96 5.32 3,600,000 (i) 3,594,170 Reed Elsevier 06-21-96 5.30 4,800,000 (i) 4,785,920 Sandoz 07-11-96 5.30 2,800,000 2,783,604 USL Capital 06-07-96 5.33 4,500,000 4,496,025 ______________ Total 51,263,640 _____________________________________________________________________________________________________________________________ Total short-term securities (Cost: $57,247,152) $ 57,247,152 _____________________________________________________________________________________________________________________________ Total investments in securities of unaffiliated issuers (Cost: $2,305,677,559) $2,387,373,389 _____________________________________________________________________________________________________________________________ Investments in securities of affiliated issuers (k) _____________________________________________________________________________________________________________________________ Common stocks (1.1%) _____________________________________________________________________________________________________________________________ Issuer Shares Value(a) _____________________________________________________________________________________________________________________________ Envirodyne Inds 727,116 (d) $ 3,453,801 Kash n' Karry Food Stores 822,430 (d) 23,233,647 _____________________________________________________________________________________________________________________________ Total investments in securities of affiliated issuers (Cost: $30,962,600) $ 26,687,448 _____________________________________________________________________________________________________________________________ Total investments in securities (Cost: $2,336,640,159)(o) $2,414,060,837 PAGE 37 _____________________________________________________________________________________________________________________________ Notes to investments in securities _____________________________________________________________________________________________________________________________ (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) Adjustable rate mortgage; interest rate varies to reflect current market conditions; rate shown is the effective rate on May 31, 1996. (c) Represents a security sold under Rule 144A, which is exempt from registration under the Securities Act of 1933, as amended. This security has been determined to be liquid under guidelines established by the board. (d) Presently non-income producing. For long-term debt securities, item identified is in default as to payment of interest and/or principal. (e) Identifies issues considered to be illiquid (see Note 7 to the financial statements). Information concerning such security holdings at May 31, 1996 is as follows: Security Acquisition Cost dates _____________________________________________________________________________________________ American Telecasting Zero Coupon Sr Disc Nts 01-25-96 thru 03-08-96 $ 6,488,125 Anacomp 1997 03-21-96 727 Braniff Sr Reset Nts 04-03-89 4,550,000 Cable Systems (U.S. Dollar) 02-09-96 2,716,120 Caguas Humacas (U.S. Dollar) 02-05-96 10,141,781 Dom's Telecable (U.S. Dollar) 02-05-96 1,558,142 ECM Funding LP 04-03-89 3,030,092 Geotek Communications Cv 03-04-96 5,000,000 Hat Brand Holdings Warrants 09-03-92 -- Zero Coupon 2002 09-03-92 5,000,000 Hemmeter Enterprises Warrants 06-21-95 120,000 IFINT Diversified Holdings Common 08-18-94 35,493 Southdown Warrants 10-30-91 150,000 TransDigm Sr Secured Nts 09-29-93 thru 04-24-96 12,722,817 Warrants 09-29-93 thru 04-24-96 1,027,809 Triangle Wire & Cable Common 01-13-92 13,000,117 Webcraft Technology Common 12-22-86 16,874 PAGE 38 IDS Extra Income Fund, Inc. May 31, 1996 Notes to investments in securities (f) For zero coupon bonds, the interest rate disclosed represents the annualized effective yield on the date of acquisition. (g) For those zero coupon bonds that become coupon paying at a future date, the interest rate disclosed represents the annualized effective yield from the date of acquisition to interest reset date disclosed. (h) Presently negligible market value. (i) Commercial paper sold within terms of a private placement memorandum, exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, and may be sold only to dealers in that program or other "accredited investors." This security has been determined to be liquid under guidelines established by the board. (j) Interest rate varies either based on a predetermined schedule or to reflect current market conditions; rate shown is the effective rate on May 31, 1996. (k) Investments representing 5% or more of the outstanding voting securities of the issuer. (l) Inverse floaters represent securities that pay interest at a rate that increases (decreases) in the same magnitude as, or in a multiple of, a decline (increase) in the LIBOR (London InterBank Offering Rate) Index. Interest rate disclosed is the rate in effect on May 31, 1996. Inverse floaters in the aggregate represent 0.4% of the Fund's net assets as of May 31, 1996. (m) Security is partially or fully on loan. See note 5 to the financial statements. (n) Pay-in-kind securities are securities in which the issuer has the option to make interest payments in cash or in additional securities. These securities issued as interest usually have the same terms, including maturity date, as the pay-in-kind securities. (o) At May 31, 1996, the cost of securities for federal income tax purposes was $2,332,432,310 and the aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $130,421,535 Unrealized depreciation (48,793,608) ___________________________________________________________________________________________ Net unrealized appreciation $81,628,527 ___________________________________________________________________________________________
PAGE 39 IDS mutual funds Cash equivalent investments These money market funds have three main goals: conservation of capital, constant liquidity and the highest possible current income consistent with these objectives. Very limited risk. IDS Cash Management Fund Invests in such money market securities as high quality commercial paper, bankers' acceptances, certificates of deposits (CDs) and other bank securities. (icon of) piggy bank IDS Tax-Free Money Fund Invests primarily in short-term bonds and notes issued by state and local governments to seek high current income exempt from federal income taxes. (icon of) shield with piggy bank enclosed Income investments The funds in this group invest their assets primarily in corporate bonds or government securities to seek interest income. Secondary objective is capital growth. Risk varies by bond quality. IDS Global Bond Fund Invests primarily in debt securities of U.S. and foreign issuers to seek high total return through income and growth of capital. (icon of) globe IDS Extra Income Fund Invests mainly in long-term, high-yielding corporate fixed-income securities in the lower rated, higher risk bond categories to seek high current income. Secondary objective is capital growth. (icon of) coins IDS Bond Fund Invests mainly in corporate bonds, at least 50% in the higher rated, lower risk bond categories, or the equivalent, and in government bonds. (icon of) greek column IDS Selective Fund Invests in high-quality corporate bonds and other highly rated debt instruments including government securities and short-term PAGE 40 investments. Seeks current income and preservation of capital. (icon of) skyline IDS Federal Income Fund Invests primarily in securities issued or guaranteed as to the timely payment of principal and interest by the U.S. government, its agencies and instrumentalities. Seeks a high level of current income and safety of principal consistent with its type of investments. (icon of) shield with eagle head enclosed PAGE 41 Tax-exempt income investments These funds provide tax-free income by investing in municipal bonds. The income is generally free from federal income tax. Risk varies by bond quality. IDS High Yield Tax-Exempt Fund Invests primarily in medium- and lower-quality municipal bonds and notes. Lower-quality securities generally involve greater risk of principal and income. (icon of) shield with basket of apples enclosed IDS State Tax-Exempt Funds (CA, MA, MI, MN, NY, OH) Invests primarily in high- and medium-grade municipal securities to provide income to residents of each respective state that is exempt from federal, state and local income taxes. (New York is the only state that is exempt at the local level.) (icon of) shield with U.S. enclosed IDS Tax-Exempt Bond Fund Invests mainly in bonds and notes of state or local government units, with at least 75% in the four highest rated, lowest risk bond categories. (icon of) shield with Greek column enclosed IDS Insured Tax-Exempt Fund Invests primarily in municipal securities that are insured as to the timely payment of principal and interest. The insurance feature minimizes credit risk of the fund but does not guarantee the market value of the fund's shares. (icon of) shield with star enclosed Growth and income investments These funds focus on securities of medium to large, well- established companies that offer long-term growth of capital and reasonable income from dividends and interest. Moderate risk. IDS International Fund Invests primarily in common stocks of foreign companies that offer potential for superior growth. The fund may invest up to 20% of its assets in the U.S. market. (icon of) three flags IDS Managed Retirement Fund PAGE 42 Invests in U.S. equity securities, U.S. and foreign debt securities, foreign equity securities and money market instruments. The fund provides diversification among these major investment categories and has a target mix that represents the way the fund's investments will be allocated over the long term. (icon of) bird in a nest IDS Equity Select Fund Invests primarily in a combination of moderate growth stocks, higher-yielding equities and bonds. Seeks growth of capital and income. (icon of) three pine trees IDS Blue Chip Advantage Fund Invests in selected stocks from a major market index. Securities purchased are those recommended by our research analysts as the best from each industry represented on the index. Offers potential for long-term growth as well as dividend income. (icon of) ribbon IDS Stock Fund Invests in common stock of companies representing many sectors of the economy. Seeks current income and growth of capital. (icon of) building with columns IDS Equity Value Fund Invests primarily in undervalued common stocks that offer potential for growth of capital and income. (icon of) three growing flowers PAGE 43 IDS Utilities Income Fund Invests primarily in the stocks of public utility companies to seek high current income and growth of income and capital with reduced volatility. (icon of) light bulb IDS Diversified Equity Income Fund Invests primarily in high-yielding common stocks to seek high current income and, secondarily, to benefit from the growth potential offered by stock investments. (icon of) two puzzle pieces IDS Mutual Invests in a balance between common stocks and senior securities (preferred stocks and bonds). Seeks a balance of growth of capital and current income. (icon of) scale of justice Growth investments Funds in this group seek capital growth, primarily from common stocks. They are high risk mutual funds with a potential for high reward. IDS Discovery Fund Invests in small- and medium-size, growth-oriented companies emphasizing technological innovation and productivity enhancement. Buys and holds larger growth-oriented stocks. (icon of) ship IDS Strategy Aggressive Fund Invests primarily in common stocks of companies that are selected for their potential for above-average growth. Above-average means that their growth potential is better, in the opinion of the portfolio's investment manager, than the Standard & Poor's Corporation (S&P) 500 Stock Index. (icon of) chess piece IDS Growth Fund Invests primarily in companies that have above-average potential for long-term growth as a result of new management, marketing opportunities or technological superiority. (icon of) trees IDS Global Growth Fund PAGE 44 Invests in stocks of companies throughout the world that are positioned to meet market needs in a changing world economy. These companies offer above-average potential for long-term growth. (icon of) world IDS New Dimensions Fund Invests primarily in companies with significant growth potential due to superiority in technology, marketing or management. The fund frequently changes its industry mix. (icon of) dimension IDS Progressive Fund Invests primarily in undervalued common stocks. The fund holds stocks for the long term with the goal of capital growth. (icon of) shooting star Specialty growth investment This fund aggressively seeks capital growth as a hedge against inflation. IDS Precious Metals Fund Invests primarily in the securities of foreign or domestic companies that explore for, mine and process or distribute gold and other precious metals. This is the most aggressive and most speculative IDS mutual fund. (icon of) cart of precious gems For more complete information about any of these funds, including charges and expenses, you can obtain a prospectus by contacting your financial advisor or writing to American Express Shareholder Service, P.O. Box 534, Minneapolis, MN 55440-0534. Read it carefully before you invest or send money. PAGE 45 Federal income tax information IDS Extra Income Fund, Inc. _____________________________________________________ The Fund is required by the Internal Revenue Code of 1986 to tell its shareholders about the tax treatment of the dividends it pays during its fiscal year. Some of the dividends listed below were reported to you on a Form 1099-DIV, Dividends and Distributions, last January. Dividends paid to you since the end of last year will be reported to you on a tax statement sent next January. Shareholders should consult a tax advisor on how to report distributions for state and local purposes. IDS Extra Income Fund, Inc. Fiscal period ended May 31, 1996 Class A Income distributions taxable as dividend income, 4.98% qualifying for deduction by corporations. Payable date Per share Sept. 27, 1995 $0.03272 Oct. 27, 1995 0.03253 Nov. 28, 1995 0.03090 Dec. 28, 1995 0.03067 Jan. 26, 1996 0.02966 Feb. 28, 1996 0.03129 March 28, 1996 0.03110 April 29, 1996 0.03110 May 29, 1996 0.03735 Total distributions $0.28732 PAGE 46 Class B Income distributions taxable as dividend income, 4.98% qualifying for deduction by corporations. Payable date Per share Sept. 27, 1995 $0.02998 Oct. 27, 1995 0.02995 Nov. 28, 1995 0.02815 Dec. 28, 1995 0.02808 Jan. 26, 1996 0.02713 Feb. 28, 1996 0.02837 March 28, 1996 0.02851 April 29, 1996 0.02843 May 29, 1996 0.03450 Total distributions $0.26310 Class Y Income distributions taxable as dividend income, 4.98% qualifying for deduction by corporations. Payable date Per share Sept. 27, 1995 $0.03335 Oct. 27, 1995 0.03312 Nov. 28, 1995 0.03153 Dec. 28, 1995 0.02963 Jan. 26, 1996 0.03024 Feb. 28, 1996 0.03197 March 28, 1996 0.03166 April 29, 1996 0.03171 May 29, 1996 0.03799 Total distributions $0.29120 PAGE 47 Quick telephone reference American Express Telephone Transaction Service Redemptions and exchanges, dividend payments or reinvestments and automatic payment arrangements National/Minnesota: 800-437-3133 Mpls./St. Paul area: 671-3800 American Express Shareholder Service Fund performance, objectives and account inquiries 612-671-3733 TTY Service For the hearing impaired 800-846-4852 American Express Infoline Automated account information (TouchToneR phones only), including current fund prices and performance, account values and recent account transactions National/Minnesota: 800-272-4445 Mpls./St. Paul area: 671-1630 AMERICAN EXPRESS Financial Advisors IDS Extra Income Fund IDS Tower 10 Minneapolis, MN 55440-0010 PAGE 48 IDS Extra Income Fund Prospectus July 30, 1996 The primary goal of IDS Extra Income Fund, Inc. is to provide high current income. Capital growth is a secondary goal. The Fund seeks to achieve its goals by investing all of its assets in High Yield Portfolio of Income Trust. The Portfolio is a separate investment company managed by American Express Financial Corporation that has the same goals as the Fund. This arrangement is commonly known as a master/feeder structure. The Portfolio invests primarily, and may invest all of its assets, in long-term corporate bonds in the lower-rating categories, commonly known as junk bonds. These securities generally have greater price fluctuations than higher-rated securities and are more likely to experience a default. Investors should carefully consider these risks before investing. See the prospectus section entitled "Investment policies and risks." This prospectus contains facts that can help you decide if the Fund is the right investment for you. Read it before you invest and keep it for future reference. Additional facts about the Fund are in a Statement of Additional Information (SAI), filed with the Securities and Exchange Commission (SEC) and available for reference, along with other related materials, on the SEC Internet Website (http://www.sec.gov). The SAI, dated July 30, 1996, is incorporated here by reference. For a free copy, contact American Express Shareholder Service. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. SHARES IN THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY. INVESTMENTS IN THE FUND INVOLVE INVESTMENT RISK INCLUDING POSSIBLE LOSS OF PRINCIPAL. American Express Shareholder Service P.O. Box 534 Minneapolis, MN 55440-0534 612-671-3733 TTY: 800-846-4852 PAGE 49 The Fund in brief Goals Investment policies and risks Structure of the Fund Manager and distributor Portfolio manager Alternative purchase arrangements Sales charge and Fund expenses Performance Financial highlights Total returns Yield Investment policies and risks Facts about investments and their risks Valuing Fund shares How to purchase, exchange or redeem shares Alternative purchase arrangements How to purchase shares How to exchange shares How to redeem shares Reductions and waivers of the sales charge Special shareholder services Services Quick telephone reference Distributions and taxes Dividend and capital gain distributions Reinvestments Taxes How to determine the correct TIN How the Fund is organized Shares Voting rights Shareholder meetings Special considerations regarding master/feeder structure Board members and officers Investment manager Administrator and transfer agent Distributor About American Express Financial Corporation General information Appendices Description of corporate bond ratings Descriptions of derivative instruments PAGE 50 The Fund in brief Goals IDS Extra Income Fund (the Fund) seeks to provide shareholders with current income as its primary goal and capital growth as its secondary goal. It does so by investing all of its assets in High Yield Portfolio (the Portfolio) of Income Trust (the Trust). Both the Fund and the Portfolio are diversified investment companies that have the same goals. Because any investment involves risk, achieving these goals cannot be guaranteed. Goals can be changed only by holders of a majority of outstanding securities. The Fund may withdraw its assets from the Portfolio at any time if the board determines that it is in the best interests of the Fund to do so. In such event, the Fund would consider what action should be taken, including whether to retain an investment advisor to manage the Fund's assets directly or to reinvest all of the Fund's assets in another pooled investment entity. Investment policies and risks Both the Fund and the Portfolio have the same investment policies. Accordingly, the Portfolio invests primarily in long-term, high- yielding, high risk debt securities below investment grade issued by U.S. and foreign corporations. These securities are commonly known as junk bonds. They generally involve greater volatility of price and risk of principal and income than higher rated securities. The Portfolio also invests in government securities, investment- grade bonds, convertible securities, common and preferred stocks, derivative instruments and money market instruments. Investment policies may be changed by the boards. PAGE 51 Structure of the Fund This Fund uses what is commonly known as a master/feeder structure. This means that it is a feeder fund that invests all of its assets in the Portfolio which is its master fund. The Portfolio actually invests in and manages the securities and has the same goal and investment policies as the Fund. This structure is described in more detail in the section captioned "Special considerations regarding master/feeder structure". Here is an illustration of the structure: Investors buy shares in the Fund The Fund invests in the Portfolio The Portfolio invests in securities, such as stocks or bonds Manager and distributor The Portfolio is managed by American Express Financial Corporation (AEFC), a provider of financial services since 1894. AEFC currently manages more than $52 billion in assets. Shares of the Fund are sold through American Express Financial Advisors Inc., a wholly owned subsidiary of AEFC. Portfolio manager Jack Utter joined AEFC in 1962 and serves as vice president and senior portfolio manager. He has managed the assets of this Fund since 1985 and serves as portfolio manager of the Portfolio. He also became portfolio manager of IDS Life Income Advantage Fund in 1996. Alternative purchase arrangements The Fund offers its shares in three classes. Class A shares are subject to a sales charge at the time of purchase. Class B shares are subject to a contingent deferred sales charge (CDSC) on redemptions made within six years of purchase and an annual distribution (12b-1) fee. Class Y shares are sold without a sales charge to qualifying institutional investors. PAGE 52 Sales charge and Fund expenses Shareholder transaction expenses are incurred directly by an investor on the purchase or redemption of Fund shares. Fund operating expenses are paid out of Fund assets for each class of shares and include expenses charged by both the Fund and the Portfolio. Operating expenses are reflected in the Fund's daily share price and dividends, and are not charged directly to shareholder accounts. Shareholder transaction expenses Class A Class B Class Y Maximum sales charge on purchases* (as a percentage of offering price).......5% 0% 0% Maximum deferred sales charge imposed on redemptions (as a percentage of original purchase price)....0% 5% 0% Annual Fund and allocated Portfolio operating expenses+ (% of average daily net assets): Class A Class B Class Y Management fee** 0.57% 0.57% 0.57% 12b-1 fee 0.00% 0.75% 0.00% Other expenses*** 0.37% 0.38% 0.19% Total**** 0.94% 1.70% 0.76% *This charge may be reduced depending on your total investments in IDS funds. See "Reductions of the sales charge." **The management fee is paid by the Trust on behalf of the Portfolio. ***Other expenses include an administrative services fee, a shareholder services fee for Class A and Class B, a transfer agency fee and other non-advisory expenses. ****The Fund changed to a master/feeder structure on June 10, 1996. The Board considered whether the aggregate expenses of the Fund and the Portfolio would be more or less than if the Fund invested directly in the type of securities being held by the Portfolio. American Express Financial Corporation has agreed to pay the small additional costs required to use a master/feeder structure to manage the investment portfolio during the first year of its operation and half of such costs in the second year. These additional costs may be more than offset in subsequent years if the assets being managed increase. +Expenses are based on actual annualized expenses for the period from Sept. 1, 1995 to May 31, 1996. PAGE 53 Example: Suppose for each year for the next 10 years, Fund expenses are as above and annual return is 5%. If you sold your shares at the end of the following years, for each $1,000 invested, you would pay total expenses of: 1 year 3 years 5 years 10 years Class A $ 59 $ 78 $ 99 $ 160 Class B $ 67 $ 94 $112 $ 181 ** Class B* $ 17 $ 54 $ 92 $ 181 ** Class Y $ 8 $ 24 $ 42 $ 95 *Assuming Class B shares are not redeemed at the end of the period. **Based on conversion of Class B shares to Class A shares after eight years. This example does not represent actual expenses, past or future. Actual expenses may be higher or lower than those shown. Because Class B pays annual distribution (12b-1) fees, long-term shareholders of Class B may indirectly pay an equivalent of more than a 6.25% sales charge, the maximum permitted by the National Association of Securities Dealers. PAGE 54 Performance Financial highlights
IDS Extra Income Fund, Inc. Performance Financial highlights Fiscal period ended May 31, Per share income and capital changes* Class A 1996** 1995 1994 1993 1992 1991 1990 1989 1988 1987 Net asset value, $4.15 $4.02 $4.44 $4.24 $3.72 $3.47 $4.46 $4.67 $4.94 $5.16 beginning of period Income from investment operations: Net investment income .28 .39 .43 .47 .44 .42 .46 .53 .53 .53 Net gains (losses) .20 .13 (.42) .16 .52 .24 (1.01) (.20) (.27) (.12) (both realized and unrealized) Total from investment .48 .52 .01 .63 .96 .66 (.55) .33 .26 .41 operations Less distributions: Dividends from net (.29) (.39) (.43) (.43) (.44) (.41) (.44) (.54) (.53) (.53) investment income Distributions from -- -- -- -- -- -- -- -- -- (.10) realized gains Total distributions (.29) (.39) (.43) (.43) (.44) (.41) (.44) (.54) (.53) (.63) Net asset value, $4.34 $4.15 $4.02 $4.44 $4.24 $3.72 $3.47 $4.46 $4.67 $4.94 end of period Ratios/supplemental data Class A 1996** 1995 1994 1993 1992 1991 1990 1989 1988 1987 Net assets, end of $2,145 $1,822 $1,626 $1,547 $1,304 $990 $931 $1,302 $1,186 $1,110 period (in millions) Ratio of expenses to .94%+ .87% .79% .81% .83% .88% .84% .82% .81% .82% average daily net assets Ratio of net income 8.90%+ 9.93% 9.85% 10.03% 11.13% 12.45% 12.28% 11.67% 11.38% 10.34% to average daily net assets Portfolio turnover rate 61% 70% 74% 70% 89% 88% 88% 102% 105% 87% (excluding short-term securities) Total return++ 11.7% 14.2% (0.2%) 15.8% 26.9% 21.2% (12.5%) 7.4% 5.8% 8.3% *For a share outstanding throughout the period. Rounded to the nearest cent. **The Fund's fiscal year-end changed from Aug. 31 to May 31, effective 1996. +Adjusted to an annual basis. ++Total return does not reflect payment of a sales charge. /TABLE PAGE 55 IDS Extra Income Fund, Inc.
Fiscal period ended May 31, Per share income and capital changes* Class B Class Y 1996++ 1995** 1996++ 1995** Net asset value, $4.15 $3.93 $4.15 $3.93 beginning of period Income from investment operations: Net investment income .25 .18 .28 .20 Net gains .20 .21 .20 .21 (both realized and unrealized) Total from investment .45 .39 .48 .41 operations Less distributions: Dividends from net (.26) (.17) (.29) (.19) investment income Net asset value, $4.34 $4.15 $4.34 $4.15 end of period Ratios/supplemental data Class B Class Y 1996++ 1995** 1996++ 1995** Net assets, end of $270 $76 -- $2 period (in millions) Ratio of expenses to 1.70%+ 1.72%+ .76%+ .78%+ average daily net assets Ratio of net income 8.34%+ 9.51%+ 8.24%+ 10.19%+ to average daily net assets Portfolio turnover rate 61% 70% 61% 70% (excluding short-term securities) Total return*** 11.1% 9.9% 11.8% 10.4% *For a share outstanding throughout the period. Rounded to the nearest cent. **Inception date was March 20, 1995 for Class B and Class Y. ***Total return does not reflect payment of a sales charge. +Adjusted to an annual basis. ++The Fund's fiscal year-end was changed from Aug. 31 to May 31, effective 1996. The information in these tables has been audited by KPMG Peat Marwick LLP, independent auditors. The independent auditors' report and additional information about the performance of the Fund are contained in the Fund's annual report which, if not included with this prospectus, may be obtained without charge.
PAGE 56 Total returns Total return is the sum of all of your returns for a given period, assuming you reinvest all distributions. It is calculated by taking the total value of shares you own at the end of the period (including shares acquired by reinvestment), less the price of shares you purchased at the beginning of the period. Average annual total return is the annually compounded rate of return over a given time period (usually two or more years). It is the total return for the period converted to an equivalent annual figure. Average annual total returns as of May 31, 1996 Purchase 1 year 5 years 10 years or made ago ago since inception Extra Income: Class A + 9.80% +13.81% + 8.94% Class B* +10.12% --% +12.44% Class Y* +15.72% --% +19.04% Lehman Aggregate Bond Index + 3.76% + 7.89% + 8.65% *Inception date was March 20, 1995. Cumulative total returns as of May 31, 1996 Purchase 1 year 5 years 10 years or made ago ago since inception Extra Income: Class A + 9.80% +90.94% +135.44% Class B* +10.12% --% 15.24% Class Y* +15.72% --% 22.55% Lehman Aggregate Bond Index + 3.76% +46.25% +129.42% *Inception date was March 20, 1995. These examples show total returns from hypothetical investments in Class A, Class B and Class Y shares of the Fund. These returns are compared to those of a popular index for the same periods. The performance of Class B and Class Y will vary from the performance of Class A based on differences in sales charges and fees. March 20, 1995 was the inception date for Class B and Class Y. Past performance for Class Y for the periods prior to March 20, 1995 may be calculated based on the performance of Class A, adjusted to reflect differences in sales charges although not for other differences in expenses. PAGE 57 For purposes of calculation, information about the Fund assumes: o a sales charge of 5% for Class A shares o redemption at the end of the period and deduction of the applicable contingent deferred sales charge for Class B shares o no sales charge for Class Y shares o no adjustments for taxes an investor may have paid on the reinvested income and capital gains o a period of widely fluctuating securities prices. Returns shown should not be considered a representation of the Fund's future performance. Lehman Aggregate Bond Index is made up of an unmanaged, representative list of government and corporate bonds as well as asset-backed and mortgage-backed securities. The index is frequently used as a general measure of bond market performance. However, the securities used to create the index may not be representative of the bonds held in the Fund. The index reflects reinvestment of all distributions and changes in market prices, but excludes brokerage commissions or other fees. Yield Yield is the net investment income earned per share for a specified time period, divided by the offering price at the end of the period. The Fund's annualized yield for the 30-day period ended May 31, 1996, was 7.91% for Class A, 7.57% for Class B and 8.54% for Class Y. The Fund calculates this 30-day annualized yield by dividing: o net investment income per share deemed earned during a 30-day period by o the public offering price per share on the last day of the period, and o converting the result to a yearly equivalent figure. This yield calculation does not include any contingent deferred sales charge, ranging from 5% to 0% on Class B shares, which would reduce the yield quoted. The Fund's yield varies from day to day, mainly because share values and offering prices (which are calculated daily) vary in response to changes in interest rates. Net investment income normally changes much less in the short run. Thus, when interest rates rise and share values fall, yield tends to rise. When interest rates fall, yield tends to follow. Past yields should not be considered an indicator of future yields. PAGE 58 Investment policies and risks The Fund and the Portfolio have the same investment policies. These policies may be changed by the boards. The Portfolio primarily invests in debt securities below investment grade issued by U.S. and foreign corporations. Most of these will be rated BBB, BB, or B by Standard & Poor's Corporation (S&P) or the Moody's Investors Service, Inc. (Moody's) equivalent. However,the Portfolio may invest in debt securities with lower ratings, including those in default. Other investments include investment- grade bonds, convertible securities, stocks, derivative instruments and money market instruments. The various types of investments the portfolio manager uses to achieve investment performance are described in more detail in the next section and in the SAI. Facts about investments and their risks Debt securities: The price of bonds generally falls as interest rates increase, and rises as interest rates decrease. The price of bonds also fluctuates if the credit rating is upgraded or downgraded. The price of bonds below investment grade may react more to the ability of a company to pay interest and principal when due than to changes in interest rates. They have greater price fluctuations, are more likely to experience a default, and sometimes are referred to as junk bonds. Reduced market liquidity for these bonds may occasionally make it more difficult to value them. In valuing bonds, the Portfolio relies both on independent rating agencies and the investment manager's credit analysis. Securities that are subsequently downgraded in quality may continue to be held by the Portfolio and will be sold only when the Portfolio's investment manager believes it is advantageous to do so. PAGE 59 Bond ratings and holdings for the fiscal period ending May 31, 1996
Percent of S&P Rating Protection of net assets in Percent of (or Moody's principal and unrated securities net assets equivalent) interest assessed by AEFC 1.28% AAA Highest quality -- % 0.27 AA High quality -- 0.02 A Upper medium grade -- 0.38 BBB Medium grade 0.19 23.24 BB Moderately speculative 0.30 52.97 B Speculative 2.49 6.40 CCC Highly speculative 3.39 0.52 CC Poor quality -- 0.19 C Lowest quality -- __ D In default -- 8.36 Unrated Unrated securities 1.99 (See Appendix to this prospectus describing corporate bond ratings for further information.)
Debt securities sold at a deep discount: Some bonds are sold at deep discounts because they do not pay interest until maturity. They include zero coupon bonds and PIK (pay-in-kind) bonds. To comply with tax laws, the Portfolio has to recognize a computed amount of interest income and pay dividends to shareholders even though no cash has been received. In some instances, the Portfolio may have to sell securities to have sufficient cash to pay the dividends. Convertible securities: These securities generally are preferred stocks or bonds that can be exchanged for other securities, usually common stock, at prestated prices. When the trading price of the common stock makes the exchange likely, the convertible securities trade more like common stock. Preferred stocks: If a company earns a profit, it generally must pay its preferred stockholders a dividend at a pre-established rate. PAGE 60 Common stocks: Stock prices are subject to market fluctuations. Stocks of smaller companies may be subject to more abrupt or erratic price movements than stocks of larger, established companies or the stock market as a whole. The Portfolio may invest up to 10% of its total assets in common stocks, preferred stocks that do not pay dividends and warrants to purchase common stocks. Foreign investments: Securities of foreign companies and governments may be traded in the United States, but often they are traded only on foreign markets. Frequently, there is less information about foreign companies and less government supervision of foreign markets. Foreign investments are subject to political and economic risks of the countries in which the investments are made, including the possibility of seizure or nationalization of companies, imposition of withholding taxes on income, establishment of exchange controls or adoption of other restrictions that might affect an investment adversely. If an investment is made in a foreign market, the local currency may be purchased using a forward contract in which the price of the foreign currency in U.S. dollars is established on the date the trade is made, but delivery of the currency is not made until the securities are received. As long as the Portfolio holds foreign currencies or securities valued in foreign currencies, the value of those assets will be affected by changes in the value of the currencies relative to the U.S. dollar. Because of the limited trading volume in some foreign markets, efforts to buy or sell a security may change the price of the security, and it may be difficult to complete the transaction. The Portfolio may invest up to 25% of its total assets in foreign investments. Derivative instruments: The portfolio manager may use derivative instruments in addition to securities to achieve investment performance. Derivative instruments include futures, options and forward contracts. Such instruments may be used to maintain cash reserves while remaining fully invested, to offset anticipated declines in values of investments, to facilitate trading, to reduce transaction costs or to pursue higher investment returns. Derivative instruments are characterized by PAGE 61 requiring little or no initial payment and a daily change in price based on or derived from a security, a currency, a group of securities or currencies, or an index. A number of strategies or combination of instruments can be used to achieve the desired investment performance characteristics. A small change in the value of the underlying security, currency or index will cause a sizable gain or loss in the price of the derivative instrument. Derivative instruments allow the portfolio manager to change the investment performance characteristics very quickly and at lower costs. Risks include losses of premiums, rapid changes in prices, defaults by other parties and inability to close such instruments. The Portfolio will use derivative instruments only to achieve the same investment performance characteristics it could achieve by directly holding those securities and currencies permitted under the investment policies. The Portfolio will designate cash or appropriate liquid assets to cover its portfolio obligations. No more than 5% of the Portfolio's net assets can be used at any one time for good faith deposits on futures and premiums for options on futures that do not offset existing investment positions. This does not, however, limit the portion of the Portfolio's assets at risk to 5%. The Portfolio is not limited as to the percentage of its assets that may be invested in permissible investments, including derivatives, except as otherwise explicitly provided in this prospectus or the SAI. For descriptions of these and other types of derivative instruments, see the Appendix to this prospectus and the SAI. PAGE 62 Securities and other instruments that are illiquid: A security or other instrument is illiquid if it cannot be sold quickly in the normal course of business. Some investments cannot be resold to the U.S. public because of their terms or government regulations. All securities and other instruments, however, can be sold in private sales, and many may be sold to other institutions and qualified buyers or on foreign markets. The portfolio manager will follow guidelines established by the board and consider relevant factors such as the nature of the security and the number of likely buyers when determining whether a security is illiquid. No more than 10% of the Portfolio's net assets will be held in securities and other instruments that are illiquid. Money market instruments: Short-term debt securities rated in the top two grades or the equivalent are used to meet daily cash needs and at various times to hold assets until better investment opportunities arise. Generally less than 25% of the Portfolio's total assets are in these money market instruments. However, for temporary defensive purposes these investments could exceed that amount for a limited period of time. Lending portfolio securities: The Portfolio may lend its securities to earn income so long as borrowers provide collateral equal to the market value of the loans. The risks are that borrowers will not provide collateral when required or return securities when due. Unless a majority of the outstanding voting securities approve otherwise, loans may not exceed 30% of net assets. PAGE 63 Valuing Fund shares The public offering price is the net asset value (NAV) adjusted for the sales charge for Class A. It is the NAV for Class B and Class Y. The NAV is the value of a single Fund share. The NAV usually changes daily, and is calculated at the close of business, normally 3 p.m. Central time, each business day (any day the New York Stock Exchange is open). NAV generally declines as interest rates increase and rises as interest rates decline. To establish the net assets, all securities held by the Portfolio are valued as of the close of each business day. In valuing assets: o Securities (except bonds) and assets with available market values are valued on that basis. o Securities maturing in 60 days or less are valued at amortized cost. o Bonds and assets without readily available market values are valued according to methods selected in good faith by the board. PAGE 64 How to purchase, exchange or redeem shares Alternative purchase arrangements The Fund offers three different classes of shares - Class A, Class B and Class Y. The primary differences among the classes are in the sales charge structures and in their ongoing expenses. These differences are summarized in the table below. You may choose the class that best suits your circumstances and objectives.
Sales charge and distribution (12b-1) fee Service fee Other information Class A Maximum initial 0.175% of average Initial sales charge sales charge of daily net assets waived or reduced 5%; no 12b-1 fee for certain purchases Class B No initial sales 0.175% of average Shares convert to charge; maximum CDSC daily net assets Class A after eight of 5% declines to 0% years; CDSC waived in after six years; 12b-1 certain circumstances fee of 0.75% of average daily net assets Class Y None None Available only to certain qualifying institutional investors
Conversion of Class B shares to Class A shares - Eight calendar years after Class B shares are originally purchased, Class B shares will convert to Class A shares and will no longer be subject to a distribution fee. The conversion will be on the basis of relative net asset values of the two classes, without the imposition of any sales charge. Class B shares purchased through reinvested dividends and distributions will convert to Class A shares in a pro rata portion as the Class B shares purchased other than through reinvestment. PAGE 65 Considerations in determining whether to purchase Class A or Class B shares - You should consider the information below in determining whether to purchase Class A or Class B shares. The sales charges and distribution fee (included in "Ongoing expenses") are structured so that you will have approximately the same total return at the end of eight years regardless of which class you chose. Sales charges on purchase or redemption If you purchase Class A If you purchase Class B shares shares o You will not have all o All of your money is of your purchase price invested in shares of invested. Part of your stock. However, you will purchase price will go pay a sales charge if you to pay the sales charge. redeem your shares within You will not pay a sales six years of purchase. charge when you redeem your shares. o You will be able to o No reductions of the take advantage of sales charge are reductions in the sales available for large charge. purchases. If your investments in IDS funds that are subject to a sales charge total $250,000 or more, you are better off paying the reduced sales charge in Class A than paying the higher fees in Class B. If you qualify for a waiver of the sales charge, you should purchase Class A shares. Ongoing expenses If you purchase Class A If you purchase Class B shares shares o Your shares will have o The distribution and a lower expense ratio transfer agency fees for than Class B shares Class B will cause your because Class A does not shares to have a higher pay a distribution fee expense ratio and to pay and the transfer agency lower dividends than fee for Class A is lower Class A shares. After than the fee for Class B. eight years, Class B As a result, Class A shares shares will convert to will pay higher dividends Class A shares and will than Class B shares. no longer be subject to higher fees. PAGE 66 You should consider how long you plan to hold your shares and whether the accumulated higher fees and CDSC on Class B shares prior to conversion would be less than the initial sales charge on Class A shares. Also consider to what extent the difference would be offset by the lower expenses on Class A shares. To help you in this analysis, the example in the "Sales charge and Fund expenses" section of the prospectus illustrates the charges applicable to each class of shares. PAGE 67 Class Y shares - Class Y shares are offered to certain institutional investors. Class Y shares are sold without a front- end sales charge or a CDSC and are not subject to either a service fee or a distribution fee. The following investors are eligible to purchase Class Y shares: o Qualified employee benefit plans* if the plan: - uses a daily transfer recordkeeping service offering participants daily access to IDS funds and has - at least $10 million in plan assets or - 500 or more participants; or - does not use daily transfer recordkeeping and has - at least $3 million invested in funds of the IDS MUTUAL FUND GROUP or - 500 or more participants. o Trust companies or similar institutions, and charitable organizations that meet the definition in Section 501(c)(3) of the Internal Revenue Code.* These must have at least $10 million invested in funds of the IDS MUTUAL FUND GROUP. o Nonqualified deferred compensation plans* whose participants are included in a qualified employee benefit plan described above. * Eligibility must be determined in advance by American Express Financial Advisors. To do so, contact your financial advisor. How to purchase shares If you're investing in this Fund for the first time, you'll need to set up an account. Your financial advisor will help you fill out and submit an application. Once your account is set up, you can choose among several convenient ways to invest. Important: When opening an account, you must provide AEFC with your correct Taxpayer Identification Number (Social Security or Employer Identification number). See "Distributions and taxes." When you purchase shares for a new or existing account, the price you pay per share is determined at the close of business on the day your investment is received and accepted at the Minneapolis headquarters. PAGE 68 Purchase policies: o Investments must be received and accepted in the Minneapolis headquarters on a business day before 3 p.m. Central time to be included in your account that day and to receive that day's share price. Otherwise, your purchase will be processed the next business day and you will pay the next day's share price. o The minimums allowed for investment may change from time to time. o Wire orders can be accepted only on days when your bank, AEFC, the Fund and Norwest Bank Minneapolis are open for business. o Wire purchases are completed when wired payment is received and the Fund accepts the purchase. o AEFC and the Fund are not responsible for any delays that occur in wiring funds, including delays in processing by the bank. o You must pay any fee the bank charges for wiring. o The Fund reserves the right to reject any application for any reason. o If your application does not specify which class of shares you are purchasing, it will be assumed that you are investing in Class A shares. PAGE 69
Three ways to invest 1 By regular account Send your check and application Minimum amounts (or your name and account number Initial investment: $2,000 if you have an established account) Additional to: investments: $ 100 American Express Financial Advisors Inc. Account balances: $ 300* P.O. Box 74 Qualified retirement Minneapolis, MN 55440-0074 accounts: none Your financial advisor will help you with this process. 2 By scheduled Contact your financial advisor Minimum amounts investment plan to set up one of the following Initial investment: $100 scheduled plans: Additional investments: $100/mo. o automatic payroll deduction Account balances: none (on active plans of o bank authorization monthly payments) o direct deposit of Social Security check o other plan approved by the Fund 3 By wire If you have an established account, If this information is not you may wire money to: included, the order may be rejected and all money Norwest Bank Minneapolis received by the Fund, less Routing No. 091000019 any costs the Fund or AEFC Minneapolis, MN incurs, will be returned Attn: Domestic Wire Dept. promptly. Give these instructions: Minimum amounts Credit IDS Account #00-30-015 Each wire investment: $1,000 for personal account # (your account number) for (your name). *If your account balance falls below $300, you will be asked in writing to bring it up to $300 or establish a scheduled investment plan. If you don't do so within 30 days, your shares can be redeemed and the proceeds mailed to you. /TABLE PAGE 70 How to exchange shares You can exchange your shares of the Fund at no charge for shares of the same class of any other publicly offered fund in the IDS MUTUAL FUND GROUP available in your state. Exchanges into IDS Tax-Free Money Fund must be made from Class A shares. For complete information, including fees and expenses, read the prospectus carefully before exchanging into a new fund. If your exchange request arrives at the Minneapolis headquarters before the close of business, your shares will be redeemed at the net asset value set for that day. The proceeds will be used to purchase new fund shares the same day. Otherwise, your exchange will take place the next business day at that day's net asset value. For tax purposes, an exchange represents a redemption and purchase and may result in a gain or loss. However, you cannot create a tax loss (or reduce a taxable gain) by exchanging from the Fund within 91 days of your purchase. For further explanation, see the SAI. How to redeem shares You can redeem your shares at any time. American Express Shareholder Service will mail payment within seven days after receiving your request. When you redeem shares, the amount you receive may be more or less than the amount you invested. Your shares will be redeemed at net asset value, minus any applicable sales charge, at the close of business on the day your request is accepted at the Minneapolis headquarters. If your request arrives after the close of business, the price per share will be the net asset value, minus any applicable sales charge, at the close of business on the next business day. A redemption is a taxable transaction. If your proceeds from your redemption are more or less than the cost of your shares, you will have a gain or loss, which can affect your tax liability. Redeeming shares held in an IRA or qualified retirement account may subject you to certain federal taxes, penalties and reporting requirements. Consult your tax advisor. PAGE 71
Two ways to request an exchange or redemption of shares' 1 By letter Include in your letter: o the name of the fund(s) o the class of shares to be exchanged or redeemed o your account number(s) (for exchanges, both funds must be registered in the same ownership) o your Taxpayer Identification Number (TIN) o the dollar amount or number of shares you want to exchange or redeem o signature of all registered account owners o for redemptions, indicate how you want your money delivered to you o any paper certificates of shares you hold Regular mail: American Express Shareholder Service Attn: Redemptions P.O. Box 534 Minneapolis, MN 55440-0534 Express mail: American Express Shareholder Service Attn: Redemptions 733 Marquette Ave. Minneapolis, MN 55402 2 By phone American Express Telephone o The Fund and AEFC will honor any telephone exchange or redemption request believed to be Transaction Service: authentic and will use reasonable procedures to confirm that they are. This includes 800-437-3133 or asking identifying questions and tape recording calls. If reasonable procedures are not 612-671-3800 followed, the Fund or AEFC will be liable for any loss resulting from fraudulent requests. o Phone exchange and redemption privileges automatically apply to all accounts except custodial, corporate or qualified retirement accounts unless you request these privileges NOT apply by writing American Express Shareholder Service. Each registered owner must sign the request. o AEFC answers phone requests promptly, but you may experience delays when call volume is high. If you are unable to get through, use mail procedure as an alternative. o Acting on your instructions, your financial advisor may conduct telephone transactions on your behalf. o Phone privileges may be modified or discontinued at any time. Minimum amount Redemption: $100 Maximum amount Redemption: $50,000 /TABLE PAGE 72 Exchange policies: o You may make up to three exchanges within any 30- day period, with each limited to $300,000. These limits do not apply to scheduled exchange programs and certain employee benefit plans or other arrangements through which one shareholder represents the interests of several. Exceptions may be allowed with pre-approval of the Fund. o Exchanges must be made into the same class of shares of the new fund. o If your exchange creates a new account, it must satisfy the minimum investment amount for new purchases. o Once we receive your exchange request, you cannot cancel it. o Shares of the new fund may not be used on the same day for another exchange. o If your shares are pledged as collateral, the exchange will be delayed until written approval is obtained from the secured party. o AEFC and the Fund reserve the right to reject any exchange, limit the amount, or modify or discontinue the exchange privilege, to prevent abuse or adverse effects on the Fund and its shareholders. For example, if exchanges are too numerous or too large, they may disrupt the Fund's investment strategies or increase its costs. PAGE 73 Redemption policies: o A "change of mind" option allows you to change your mind after requesting a redemption and to use all or part of the proceeds to purchase new shares in the same class from which you redeemed. If you reinvest in Class A, you will purchase the new shares at net asset value rather than the offering price on the date of a new purchase. If you reinvest in Class B, any CDSC you paid on the amount you are reinvesting also will be reinvested. To take advantage of this option, send a written request within 30 days of the date your redemption request was received. Include your account number and mention this option. This privilege may be limited or withdrawn at any time, and it may have tax consequences. o A telephone redemption request will not be allowed within 30 days of a phoned-in address change. Important: If you request a redemption of shares you recently purchased by a check or money order that is not guaranteed, the Fund will wait for your check to clear. It may take up to 10 days from the date of purchase before a check is mailed to you. (A check may be mailed earlier if your bank provides evidence satisfactory to the Fund and AEFC that your check has cleared.) PAGE 74
Three ways to receive payment when you redeem shares 1 By regular or express mail o Mailed to the address on record. o Payable to names listed on the account. NOTE: The express mail delivery charges you pay will vary depending on the courier you select. 2 By wire o Minimum wire redemption: $1,000. o Request that money be wired to your bank. o Bank account must be in the same ownership as the IDS fund account. NOTE: Pre-authorization required. For instructions, contact your financial advisor or American Express Shareholder Service. 3 By scheduled payout plan o Minimum payment: $50. o Contact your financial advisor or American Express Shareholder Service to set up regular payments to you on a monthly, bimonthly, quarterly, semiannual or annual basis. o Purchasing new shares while under a payout plan may be disadvantageous because of the sales charges. /TABLE PAGE 75 Reductions and waivers of the sales charge Class A - initial sales charge alternative On purchases of Class A shares, you pay a 5% sales charge on the first $50,000 of your total investment and less on investments after the first $50,000: Total investment Sales charge as a percent of:* Public Net offering amount price invested Up to $50,000 5.0% 5.26% Next $50,000 4.5 4.71 Next $400,000 3.8 3.95 Next $500,000 2.0 2.04 $1,000,000 or more 0.0 0.00 * To calculate the actual sales charge on an investment greater than $50,000 and less than $1,000,000, amounts for each applicable increment must be totaled. See the SAI. Reductions of the sales charge on Class A shares Your sales charge may be reduced, depending on the totals of: o the amount you are investing in this Fund now, o the amount of your existing investment in this Fund, if any, and o the amount you and your primary household group are investing or have in other funds in the IDS MUTUAL FUND GROUP that carry a sales charge (The primary household group consists of accounts in any ownership for spouses or domestic partners and their unmarried children under 21. Domestic partners are individuals who maintain a shared primary residence and have joint property or other insurable interests.) Other policies that affect your sales charge: o IDS Tax-Free Money Fund and Class A shares of IDS Cash Management Fund do not carry sales charges. However, you may count investments in these funds if you acquired shares in them by exchanging shares from IDS funds that carry sales charges. PAGE 76 o IRA purchases or other employee benefit plan purchases made through a payroll deduction plan or through a plan sponsored by an employer, association of employers, employee organization or other similar entity, may be added together to reduce sales charges for all shares purchased through that plan. PAGE 77 o If you intend to invest $1 million over a period of 13 months, you can reduce the sales charges in Class A by filing a letter of intent. For more details, see the SAI. Waivers of the sales charge for Class A shares Sales charges do not apply to: o Current or retired board members, officers or employees of the Fund or AEFC or its subsidiaries, their spouses and unmarried children under 21. o Current or retired American Express financial advisors, their spouses and unmarried children under 21. o Qualified employee benefit plans* using a daily transfer recordkeeping system offering participants daily access to IDS funds. (Participants in certain qualified plans for which the initial sales charge is waived may be subject to a deferred sales charge of up to 4% on certain redemptions. For more information, see the SAI.) o Shareholders who have at least $1 million invested in funds of the IDS MUTUAL FUND GROUP. If the investment is redeemed in the first year after purchase, a CDSC of 1% will be charged on the redemption. o Purchases made within 30 days after a redemption of shares (up to the amount redeemed): - of a product distributed by American Express Financial Advisors in a qualified plan subject to a deferred sales charge or - in a qualified plan where American Express Trust Company has a recordkeeping, trustee, investment management or investment servicing relationship. Send the Fund a written request along with your payment, indicating the amount of the redemption and the date on which it occurred. o Purchases made with dividend or capital gain distributions from another fund in the IDS MUTUAL FUND GROUP that has a sales charge. o Purchases made through American Express Strategic Portfolio Service (total amount of all investments made in the Strategic Portfolio Service must be at least $50,000). o Purchases made under the University of Texas System ORP. *Eligibility must be determined in advance by American Express Financial Advisors. To do so, contact your financial advisor. PAGE 78 Class B - contingent deferred sales charge alternative Where a CDSC is imposed on a redemption, it is based on the amount of the redemption and the number of calendar years, including the year of purchase, between purchase and redemption. The following table shows the declining scale of percentages that apply to redemptions during each year after a purchase: If a redemption is The percentage rate made during the for the CDSC is: First year 5% Second year 4% Third year 4% Fourth year 3% Fifth year 2% Sixth year 1% Seventh year 0% If the amount you are redeeming reduces the current net asset value of your investment in Class B shares below the total dollar amount of all your purchase payments during the last six years (including the year in which your redemption is made), the CDSC is based on the lower of the redeemed purchase payments or market value. The following example illustrates how the CDSC is applied. Assume you had invested $10,000 in Class B shares and that your investment had appreciated in value to $12,000 after 15 months, including reinvested dividend and capital gain distributions. You could redeem any amount up to $2,000 without paying a CDSC ($12,000 current value less $10,000 purchase amount). If you redeemed $2,500, the CDSC would apply only to the $500 that represented part of your original purchase price. The CDSC rate would be 4% because a redemption after 15 months would take place during the second year after purchase. PAGE 79 Because the CDSC is imposed only on redemptions that reduce the total of your purchase payments, you never have to pay a CDSC on any amount you redeem that represents appreciation in the value of your shares, income earned by your shares or capital gains. In addition, when determining the rate of any CDSC, your redemption will be made from the oldest purchase payment you made. Of course, once a purchase payment is considered to have been redeemed, the next amount redeemed is the next oldest purchase payment. By redeeming the oldest purchase payments first, lower CDSCs are imposed than would otherwise be the case. Waivers of the contingent deferred sales charge The CDSC on Class B shares will be waived on redemptions of shares: o In the event of the shareholder's death, o Purchased by any board member, officer or employee of a fund or AEFC or its subsidiaries, o Held in a trusteed employee benefit plan, o Held in IRAs or certain qualified plans for which American Express Trust Company acts as custodian, such as Keogh plans, tax- sheltered custodial accounts or corporate pension plans, provided that the shareholder is: - at least 59-1/2 years old, and - taking a retirement distribution (if the redemption is part of a transfer to an IRA or qualified plan in a product distributed by American Express Financial Advisors, or a custodian-to- custodian transfer to a product not distributed by American Express Financial Advisors, the CDSC will not be waived), or - redeeming under an approved substantially equal periodic payment arrangement. For investors in Class A shares who have over $1 million invested in one year, the 1% CDSC on redemption of those shares will be waived in the same circumstances described for Class B. PAGE 80 Special shareholder services Services To help you track and evaluate the performance of your investments, AEFC provides these services: Quarterly statements listing all of your holdings and transactions during the previous three months. Yearly tax statements featuring average-cost-basis reporting of capital gains or losses if you redeem your shares along with distribution information - which simplifies tax calculations. A personalized mutual fund progress report detailing returns on your initial investment and cash-flow activity in your account. It calculates a total return to reflect your individual history in owning Fund shares. This report is available from your financial advisor. Quick telephone reference American Express Telephone Transaction Service Redemptions and exchanges, dividend payments or reinvestments and automatic payment arrangements National/Minnesota: 800-437-3133 Mpls./St. Paul area: 671-3800 American Express Shareholder Service Fund performance, objectives and account inquiries 612-671-3733 TTY Service For the hearing impaired 800-846-4852 American Express Infoline Automated account information (TouchToneR phones only), including current Fund prices and performance, account values and recent account transactions National/Minnesota: 800-272-4445 Mpls./St. Paul area: 671-1630 PAGE 81 Distributions and taxes As a shareholder you are entitled to your share of the Fund's net income and any net gains realized on its investments. The Fund distributes dividends and capital gain distributions to qualify as a regulated investment company and to avoid paying corporate income and excise taxes. Dividend and capital gain distributions will have tax consequences you should know about. Dividend and capital gain distributions Investment income is allocated to the Fund by the Portfolio, less direct and allocated expenses. The Fund's net realized capital gains or losses, if any, consist of the net realized capital gains or losses allocated to the Fund from the Portfolio. The Fund's net investment income from dividends and interest is distributed to you monthly as dividends. Short-term capital gains are distributed at the end of the calendar year and are included in net investment income. Long-term capital gains are realized whenever a security held for more than one year is sold for a higher price than was paid for it. Net realized long-term capital gains, if any, are distributed at the end of the calendar year as capital gain distributions. Before they're distributed, net long-term capital gains are included in the value of each share. After they're distributed, the value of each share drops by the per-share amount of the distribution. (If your distributions are reinvested, the total value of your holdings will not change.) Dividends for each class will be calculated at the same time, in the same manner and will be the same amount prior to deduction of expenses. Expenses attributable solely to a class of shares will be paid exclusively by that class. Class B shareholders will receive lower per share dividends than Class A and Class Y shareholders because expenses for Class B are higher than for Class A or Class Y. Class A shareholders will receive lower per share dividends than Class Y shareholders because expenses for Class A are higher than for Class Y. PAGE 82 Reinvestments Dividends and capital gain distributions are automatically reinvested in additional shares in the same class of the Fund, unless: o you request the Fund in writing or by phone to pay distributions to you in cash, or o you direct the Fund to invest your distributions in any publicly available IDS fund for which you've previously opened an account. You pay no sales charge on shares purchased through reinvestment from this Fund into any IDS fund. The reinvestment price is the net asset value at close of business on the day the distribution is paid. (Your quarterly statement will confirm the amount invested and the number of shares purchased.) If you choose cash distributions, you will receive only those declared after your request has been processed. If the U.S. Postal Service cannot deliver the checks for the cash distributions, we will reinvest the checks into your account at the then-current net asset value and make future distributions in the form of additional shares. Taxes The Fund has received a Private Letter Ruling from the Internal Revenue Service stating that, for purposes of the Internal Revenue Code, the Fund will be regarded as directly holding its allocable share of the income and gain realized by the Portfolio. Distributions are subject to federal income tax and also may be subject to state and local taxes. Distributions are taxable in the year the Fund declares them regardless of whether you take them in cash or reinvest them. Each January, you will receive a tax statement showing the kinds and total amount of all distributions you received during the previous year. You must report distributions on your tax returns, even if they are reinvested in additional shares. PAGE 83 Buying a dividend creates a tax liability. This means buying shares shortly before a capital gain distribution. You pay the full pre-distribution price for the shares, then receive a portion of your investment back as a distribution, which is taxable. Redemptions and exchanges subject you to a tax on any capital gain. If you sell shares for more than their cost, the difference is a capital gain. Your gain may be either short term (for shares held for one year or less) or long term (for shares held for more than one year). Your Taxpayer Identification Number (TIN) is important. As with any financial account you open, you must list your current and correct Taxpayer Identification Number (TIN) -- either your Social Security or Employer Identification number. The TIN must be certified under penalties of perjury on your application when you open an account at AEFC. If you don't provide the TIN, or the TIN you report is incorrect, you could be subject to backup withholding of 31% of taxable distributions and proceeds from certain sales and exchanges. You also could be subject to further penalties, such as: o a $50 penalty for each failure to supply your correct TIN o a civil penalty of $500 if you make a false statement that results in no backup withholding o criminal penalties for falsifying information You also could be subject to backup withholding because you failed to report interest or dividends on your tax return as required. PAGE 84 How to determine the correct TIN Use the Social Security or For this type of account: Employer Identification number of: Individual or joint account The individual or individuals listed on the account Custodian account of a minor The minor (Uniform Gifts/Transfers to Minors Act) A living trust The grantor-trustee (the person who puts the money into the trust) An irrevocable trust, pension The legal entity (not the trust or estate personal representative or trustee, unless no legal entity is designated in the account title) Sole proprietorship The owner Partnership The partnership Corporate The corporation Association, club or The organization tax-exempt organization For details on TIN requirements, ask your financial advisor or local American Express Financial Advisors office for federal Form W-9, "Request for Taxpayer Identification Number and Certification." Important: This information is a brief and selective summary of certain federal tax rules that apply to this Fund. Tax matters are highly individual and complex, and you should consult a qualified tax advisor about your personal situation. PAGE 85 How the Fund is organized The Fund is a diversified, open-end management investment company, as defined in the Investment Company Act of 1940. It was incorporated on Aug. 17, 1983 in Minnesota. The Fund headquarters are at 901 S. Marquette Ave., Suite 2810, Minneapolis, MN 55402- 3268. Shares The Fund is owned by its shareholders. The Fund issues shares in three classes - Class A, Class B and Class Y. Each class has different sales arrangements and bears different expenses. Each class represents interests in the assets of the Fund. Par value is one cent per share. Both full and fractional shares can be issued. The Fund no longer issues stock certificates. Voting rights As a shareholder, you have voting rights over the Fund's management and fundamental policies. You are entitled to one vote for each share you own. Shares of the Fund have cumulative voting rights. Each class has exclusive voting rights with respect to the provisions of the Fund's distribution plan that pertain to a particular class and other matters for which separate class voting is appropriate under applicable law. Shareholder meetings The Fund does not hold annual shareholder meetings. However, the board members may call meetings at their discretion, or on demand by holders of 10% or more of the outstanding shares, to elect or remove board members. PAGE 86 Special considerations regarding master/feeder structure The Fund pursues its goals by investing its assets in a master fund called the Portfolio. This means that the Fund does not invest directly in securities; rather the Portfolio invests in and manages its portfolio of securities. The Portfolio is a separate investment company, but it has the same goals and investment policies as the Fund. The goals and investment policies of the Portfolio are described under the captions "Investment policies and risks" and "Facts about investments and their risks." Additional information on investment policies may be found in the SAI. Board considerations: The board considered the advantages and disadvantages of investing the Fund's assets in the Portfolio. The board believes that the master/feeder structure can be in the best interest of the Fund and its shareholders since it offers the opportunity for economies of scale. The Fund may redeem all of its assets from the Portfolio at any time. Should the board determine that it is in the best interest of the Fund and its shareholders to terminate its investment in the Portfolio, it would consider hiring an investment advisor to manage the Fund's assets, or other appropriate options. The Fund would terminate its investment if the Portfolio changed its goals, investment policies or restrictions without the same change being approved by the Fund. PAGE 87 Other feeders: The Portfolio sells securities to other affiliated mutual funds and may sell securities to non-affiliated investment companies and institutional accounts (known as feeders). These feeders buy the Portfolio's securities on the same terms and conditions as the Fund and pay their proportionate share of the Portfolio's expenses. However, their operating costs and sales charges are different from those of the Fund. Therefore, the investment returns for other feeders are different from the returns of the Fund. Information about other feeders may be obtained by calling American Express Financial Advisors at 1-800-AXP-SERV. Each feeder that invests in the Portfolio is different and activities of its investors may adversely affect all other feeders, including the Fund. For example, if one feeder decides to terminate its investment in the Portfolio, the Portfolio may elect to redeem in cash or in kind. If cash is used, the Portfolio will incur brokerage, taxes and other costs in selling securities to raise the cash. This may result in less investment diversification if entire investment positions are sold, and it also may result in less liquidity among the remaining assets. If in-kind distribution is made, a smaller pool of assets remains that may affect brokerage rates and investment options. In both cases, expenses may rise since there are fewer assets to cover the costs of managing those assets. PAGE 88 Shareholder meetings: Whenever the Portfolio proposes to change a fundamental investment policy or to take any other actions requiring approval of its security holders, the Fund must hold a shareholder meeting. The Fund will vote for or against the Portfolio's proposals in proportion to the vote it receives for or against the same proposals from its shareholders. Board members and officers Shareholders elect a board that oversees the operations of the Fund and chooses its officers. Its officers are responsible for day-to- day business decisions based on policies set by the board. The board has named an executive committee that has authority to act on its behalf between meetings. The board members serve on the boards of all 41 of the funds in the IDS MUTUAL FUND GROUP, except for Mr. Dudley, who is a board member of all 32 publicly offered funds. The members of the Board also serve as members of the Board of the Income Trust which manages the investments of the Fund and other accounts. Should any conflict of interest arise between the interests of the shareholders of the Fund and those of the other accounts, the Board will follow written procedures to address the conflict. PAGE 89 Board members and officers of the Fund President and interested board member William R. Pearce President of all funds in the IDS MUTUAL FUND GROUP. Independent board members Lynne V. Cheney Distinguished fellow, American Enterprise Institute for Public Policy Research. Robert F. Froehlke Former president of all funds in the IDS MUTUAL FUND GROUP. Heinz F. Hutter Former president and chief operating officer, Cargill, Inc. Anne P. Jones Attorney and telecommunications consultant. Melvin R. Laird Senior counsellor for national and international affairs, The Reader's Digest Association, Inc. Edson W. Spencer Former chairman and chief executive officer, Honeywell, Inc. Wheelock Whitney Chairman, Whitney Management Company. C. Angus Wurtele Chairman of the board, The Valspar Corporation. Interested board members who are officers and/or employees of AEFC William H. Dudley Executive vice president, AEFC. David R. Hubers President and chief executive officer, AEFC. John R. Thomas Senior vice president, AEFC. Officers who also are officers and/or employees of AEFC Peter J. Anderson Vice president of all funds in the IDS MUTUAL FUND GROUP. Melinda S. Urion Treasurer of all funds in the IDS MUTUAL FUND GROUP. PAGE 90 Other officer Leslie L. Ogg Vice president, general counsel and secretary of all funds in the IDS MUTUAL FUND GROUP. Refer to the SAI for the board members' and officers' biographies. PAGE 91 Investment manager The Portfolio pays AEFC for managing its assets. The Fund pays its proportionate share of the fees. Under the Investment Management Services Agreement that became effective March 20, 1995 and was assumed by the Portfolio on June 10, 1996, AEFC is paid a fee for these services based on the average daily net assets of the Portfolio, as follows: Assets Annual rate (billions) at each asset level First $1.0 0.590% Next 1.0 0.565 Next 1.0 0.540 Next 3.0 0.515 Next 3.0 0.490 Over 9.0 0.465 For the fiscal period ended May 31, 1996, the Fund paid AEFC a total investment management fee of 0.57% of its average daily net assets. Under the Agreement, the Fund also pays taxes, brokerage commissions and nonadvisory expenses. Administrator and Transfer Agent The Fund pays AEFC for shareholder accounting and transfer agent services under two agreements. The first, the Administrative Service Agreement, has a declining annual rate beginning at 0.05% and decreasing to 0.025% as assets increase. The second, the Transfer Agency Agreement, has an annual fee per shareholder account as follows: o Class A $15.50 o Class B $16.50 o Class Y $15.50 PAGE 92 Distributor The Fund has an exclusive distribution agreement with American Express Financial Advisors, a wholly owned subsidiary of AEFC. Financial advisors representing American Express Financial Advisors provide information to investors about individual investment programs, the Fund and its operations, new account applications, and exchange and redemption requests. The cost of these services is paid partially by the Fund's sales charges. Persons who buy Class A shares pay a sales charge at the time of purchase. Persons who buy Class B shares are subject to a contingent deferred sales charge on a redemption in the first six years and pay an asset-based sales charge (also known as a 12b-1 plan) of 0.75% of the Fund's average daily net assets. Class Y shares are sold without a sales charge and without an asset-based sales charge. Financial advisors may receive different compensation for selling Class A, Class B and Class Y shares. Portions of the sales charge also may be paid to securities dealers who have sold the Fund's shares or to banks and other financial institutions. The amounts of those payments range from 0.8% to 4% of the Fund's offering price depending on the monthly sales volume. Under a Shareholder Service Agreement, the Fund also pays a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.175% of the Fund's average daily net assets attributable to Class A and Class B shares. Total expenses paid by the Fund's Class A shares for the fiscal period ended May 31, 1996, were 0.94% of its average daily net assets. Expenses for Class B and Class Y were 1.70% and 0.76%, respectively. Total fees and expenses (excluding taxes and brokerage commissions) cannot exceed the most restrictive applicable state expense limitation. PAGE 93 About American Express Financial Corporation General information The AEFC family of companies offers not only mutual funds but also insurance, annuities, investment certificates and a broad range of financial management services. Besides managing investments for all publicly offered funds in the IDS MUTUAL FUND GROUP, AEFC also manages investments for itself and its subsidiaries, IDS Certificate Company and IDS Life Insurance Company. Total assets under management on May 31, 1996 were more than $137 billion. American Express Financial Advisors serves individuals and businesses through its nationwide network of more than 175 offices and more than 7,800 advisors. Other AEFC subsidiaries provide investment management and related services for pension, profit sharing, employee savings and endowment funds of businesses and institutions. AEFC is located at IDS Tower 10, Minneapolis, MN 55440-0010. It is a wholly owned subsidiary of American Express Company (American Express), a financial services company with headquarters at American Express Tower, World Financial Center, New York, NY 10285. The Fund may pay brokerage commissions to broker-dealer affiliates of American Express and AEFC. PAGE 94 Appendix A Description of corporate bond ratings Bond ratings concern the quality of the issuing corporation. They are not an opinion of the market value of the security. Such ratings are opinions on whether the principal and interest will be repaid when due. A security's rating may change, which could affect its price. Ratings by Moody's Investors Service, Inc. are Aaa, Aa, A, Baa, Ba, B, Caa, Ca and C. Ratings by Standard & Poor's Corporation are AAA, AA, A, BBB, BB, B, CCC, CC, C and D. The following is a compilation of the two agencies' rating descriptions. For further information, see the SAI. Aaa/AAA - Judged to be of the best quality and carry the smallest degree of investment risk. Interest and principal are secure. Aa/AA - Judged to be high-grade although margins of protection for interest and principal may not be quite as good as Aaa or AAA rated securities. A - Considered upper-medium grade. Protection for interest and principal is deemed adequate but may be susceptible to future impairment. Baa/BBB - Considered medium-grade obligations. Protection for interest and principal is adequate over the short-term; however, these obligations may have certain speculative characteristics. Ba/BB - Considered to have speculative elements. The protection of interest and principal payments may be very moderate. B - Lack characteristics of more desirable investments. There may be small assurance over any long period of time of the payment of interest and principal. Caa/CCC - Are of poor standing. Such issues may be in default or there may be risk with respect to principal or interest. Ca/CC - Represent obligations that are highly speculative. Such issues are often in default or have other marked shortcomings. C - Are obligations with a higher degree of speculation. These securities have major risk exposures to default. D - Are in payment default. The D rating is used when interest payments or principal payments are not made on the due date. PAGE 95 Non-rated securities will be considered for investment when they possess a risk comparable to that of rated securities consistent with the Portfolio's objectives and policies. When assessing the risk involved in each non-rated security, the Portfolio will consider the financial condition of the issuer or the protection afforded by the terms of the security. Definitions of zero-coupon and pay-in-kind securities A zero-coupon security is a security that is sold at a deep discount from its face value and makes no periodic interest payments. The buyer of such a security receives a rate of return by gradual appreciation of the security, which is redeemed at face value on the maturity date. A pay-in-kind security is a security in which the issuer has the option to make interest payments in cash or in additional securities. The securities issued as interest usually have the same terms, including maturity date, as the pay-in-kind securities. PAGE 96 Appendix B Descriptions of derivative instruments What follows are brief descriptions of derivative instruments the Portfolio may use. At various times the Portfolio may use some or all of these instruments and is not limited to these instruments. It may use other similar types of instruments if they are consistent with the Portfolio's investment goal and policies. For more information on these instruments, see the SAI. Options and futures contracts. An option is an agreement to buy or sell an instrument at a set price during a certain period of time. A futures contract is an agreement to buy and sell an instrument for a set price on a future date. The Portfolio may buy and sell options and futures contracts to manage its exposure to changing interest rates, security prices and currency exchange rates. Options and futures may be used to hedge the Portfolio's investments against price fluctuations or to increase market exposure. Asset-backed and mortgage-backed securities. Asset-backed securities include interests in pools of assets such as motor vehicle installment sale contracts, installment loan contracts, leases on various types of real and personal property, receivables from revolving credit (credit card) agreements or other categories of receivables. Mortgage-backed securities include collateralized mortgage obligations and stripped mortgage-backed securities. Interest and principal payments depend on payment of the underlying loans or mortgages. The value of these securities may also be affected by changes in interest rates, the market's perception of the issuers and the creditworthiness of the parties involved. The non-mortgage related asset-backed securities do not have the benefit of a security interest in the related collateral. Stripped mortgage-backed securities include interest only (IO) and principal only (PO) securities. Cash flows and yields on IOs and POs are extremely sensitive to the rate of principal payments on the underlying mortgage loans or mortgage-backed securities. PAGE 97 Indexed securities. The value of indexed securities is linked to currencies, interest rates, commodities, indexes or other financial indicators. Most indexed securities are short- to intermediate- term fixed income securities whose values at maturity or interest rates rise or fall according to the change in one or more specified underlying instruments. Indexed securities may be more volatile than the underlying instrument itself. Inverse floaters. Inverse floaters are created by underwriters using the interest payment on securities. A portion of the interest received is paid to holders of instruments based on current interest rates for short-term securities. The remainder, minus a servicing fee, is paid to holders of inverse floaters. As interest rates go down, the holders of the inverse floaters receive more income and an increase in the price for the inverse floaters. As interest rates go up, the holders of the inverse floaters receive less income and a decrease in the price for the inverse floaters. Structured products. Structured products are over-the-counter financial instruments created specifically to meet the needs of one or a small number of investors. The instrument may consist of a warrant, an option or a forward contract embedded in a note or any of a wide variety of debt, equity and/or currency combinations. Risks of structured products include the inability to close such instruments, rapid changes in the market and defaults by other parties. PAGE 98 IDS Extra Income Fund IDS Tower 10 Minneapolis, MN 55440-0010 Distributed by American Express Financial Advisors Inc. PAGE 99 STATEMENT OF ADDITIONAL INFORMATION FOR IDS EXTRA INCOME FUND July 30, 1996 This Statement of Additional Information (SAI) is not a prospectus. It should be read together with the prospectus and the financial statements contained in the Annual Report which may be obtained from your American Express financial advisor or by writing to American Express Shareholder Service, P.O. Box 534, Minneapolis, MN 55440-0534. This SAI is dated July 30, 1996, and it is to be used with the prospectus dated July 30, 1996, and the Annual Report for the fiscal period ended May 31, 1996. PAGE 100 TABLE OF CONTENTS Goals and Investment Policies......................See Prospectus Additional Investment Policies................................p. 3 Security Transactions.........................................p. 6 Brokerage Commissions Paid to Brokers Affiliated with American Express Financial Corporation........................p. 9 Performance Information.......................................p. 9 Valuing Fund Shares...........................................p. 11 Investing in the Fund.........................................p. 13 Redeeming Shares..............................................p. 17 Pay-out Plans.................................................p. 17 Capital Loss Carryover........................................p. 19 Taxes.........................................................p. 19 Agreements....................................................p. 20 Board Members and Officers....................................p. 23 Custodian.....................................................p. 27 Independent Auditors..........................................p. 27 Financial Statements..............................See Annual Report Prospectus....................................................p. 28 Appendix A: Foreign Currency Transactions....................p. 29 Appendix B: Options and Interest Rate Futures Contracts......p. 34 Appendix C: Mortgage-Backed Securities.......................p. 40 Appendix D: Dollar-Cost Averaging............................p. 41 PAGE 101 ADDITIONAL INVESTMENT POLICIES The Fund pursues its goals by investing all of its assets in High Yield Portfolio (the "Portfolio") of the Income Trust (the "Trust"), a separate investment company, rather than by directly investing in and managing its own portfolio of securities. The Portfolio has the same investment objectives, policies and restrictions as the Fund. Fundamental investment restrictions adopted by the Fund or Portfolio cannot be changed without the approval of a majority of the outstanding voting securities of the Fund or Portfolio, as defined in the Investment Company Act of 1940 (the 1940 Act). Whenever the Fund is requested to vote on a change in the investment restrictions of the corresponding Portfolio, the Fund will hold a meeting of Fund shareholders and will cast the Fund's vote as instructed by the shareholders. These are investment policies in addition to those presented in the prospectus. The policies below are fundamental policies of the Fund and the Portfolio and may be changed only with shareholder approval. Unless holders of a majority of the outstanding voting securities agree to make the change, the Fund and Portfolio will not: 'Act as an underwriter (sell securities for others). However, under the securities laws, the Portfolio may be deemed to be an underwriter when it purchases securities directly from the issuer and later resells them. 'Borrow money or property, except as a temporary measure for extraordinary or emergency purposes, in an amount not exceeding one-third of the market value of its total assets (including borrowings) less liabilities (other than borrowings) immediately after the borrowing. The Portfolio has not borrowed in the past and has no present intention to borrow. 'Make cash loans if the total commitment amount exceeds 5% of the Portfolio's total assets. 'Purchase more than 10% of the outstanding voting securities of an issuer. 'Invest more than 5% of its total assets in securities of any one company, government or political subdivision thereof, except the limitation will not apply to investments in securities issued by the U.S. government, its agencies or instrumentalities, and except that up to 25% of the Portfolio's total assets may be invested without regard to this 5% limitation. PAGE 102 'Buy or sell real estate, unless acquired as a result of ownership of securities or other instruments, except this shall not prevent the Portfolio from investing in securities or other instruments backed by real estate or securities of companies engaged in the real estate business or real estate investment trusts. For purposes of this policy, real estate includes real estate limited partnerships. 'Buy or sell physical commodities unless acquired as a result of ownership of securities or other instruments, except this shall not prevent the Portfolio from buying or selling options and futures contracts or from investing in securities or other instruments backed by, or whose value is derived from, physical commodities. 'Lend Portfolio securities in excess of 30% of its net assets. The current policy of the board is to make these loans, either long- or short-term, to broker-dealers. In making loans, the Portfolio gets the market price in cash, U.S. government securities, letters of credit or such other collateral as may be permitted by regulatory agencies and approved by the board. If the market price of the loaned securities goes up, the Portfolio will get additional collateral on a daily basis. The risks are that the borrower may not provide additional collateral when required or return the securities when due. During the existence of the loan, the Portfolio receives cash payments equivalent to all interest or other distributions paid on the loaned securities. A loan will not be made unless the investment manager believes the opportunity for additional income outweighs the risks. 'Issue senior securities, except this restriction shall not be deemed to prohibit the Portfolio from borrowing from banks, using options or futures contracts, lending its securities or entering into repurchase agreements. 'Concentrate in any one industry. According to the present interpretation by the Securities and Exchange Commission (SEC), this means no more than 25% of the Portfolio's total assets, based on current market value at the time of purchase, can be invested in any one industry. Unless changed by the board, the Fund and Portfolio will not: 'Pledge or mortgage its assets beyond 15% of total assets. If the Portfolio were ever to do so, valuation of the pledged or mortgaged assets would be based on market values. For purposes of this restriction, collateral arrangements for margin deposits on futures contracts are not deemed to be a pledge of assets. PAGE 103 'Invest more than 10% of its total assets in securities of investment companies. Under one states's law, the Portfolio is limited to investments in the open market where no commission or profit to a sponsor or dealer results from the purchase other than the customary broker's commission, or when the purchase is part of a plan or merger, consolidation, reorganization or acquisition. The Portfolio has no current intention to invest in securities of other investment companies. 'Invest in exploration or development programs, such as oil, gas or mineral leases. 'Invest more than 5% of its total assets in securities of companies, including any predecessors, that have a record of less than three years continuous operations. 'Invest in a company to control or manage it. 'Buy on margin or sell short, except they may enter into interest rate future contracts. 'Purchase securities of an issuer if the board members and officers of the Fund, the Portfolio and American Express Financial Corporation (AEFC) hold more than a certain percentage of the issuer's outstanding securities. The holdings of all board members and officers of the Fund, the Portfolio and of AEFC who own more than 0.5% of an issuer's securities are added together, and if in total they own more than 5%, the Portfolio will not purchase securities of that issuer. 'Invest more than 5% of its net assets in warrants. Under one state's law no more than 2% of the Portfolio's net assets may be invested in warrants not listed on the New York or American Stock Exchange. 'Invest more than 10% of its net assets in securities and derivative instruments that are illiquid. For purposes of this policy, illiquid securities include some privately placed securities, public securities and Rule 144A securities that for one reason or another may no longer have a readily available market, loans and loan participations, repurchase agreements with maturities greater than seven days, non-negotiable fixed-time deposits and over-the-counter options. 'In determining the liquidity of Rule 144A securities, which are unregistered securities offered to qualified institutional buyers, and interest-only and principal-only fixed mortgage-backed securities (IOs and POs) issued by the U.S. government or its agencies and instrumentalities. The investment manager, under guidelines established by the board, will consider any relevant factors including the frequency of trades, the number of dealers willing to purchase or sell the security and the nature of marketplace trades. PAGE 104 'In determining the liquidity of commercial paper issued in transactions not involving a public offering under Section 4(2) of the Securities Act of 1933, the investment manager, under guidelines established by the board, will evaluate relevant factors such as the issuer and the size and nature of its commercial paper programs, the willingness and ability of the issuer or dealer to repurchase the paper, and the nature of the clearance and settlement procedures for the paper. Loans, loan participations and interests in securitized loan pools are interests in amounts owed by a corporate, governmental or other borrower to a lender or consortium of lenders (typically banks, insurance companies, investment banks, government agencies or international agencies). Loans involve a risk of loss in case of default or insolvency of the borrower and may offer less legal protection to the Portfolio in the event of fraud or misrepresentation. In addition, loan participations involve a risk of insolvency of the lender or other financial intermediary. The Portfolio may make contracts to purchase securities for a fixed price at a future date beyond normal settlement time (when-issued securities or forward commitments). Under normal market conditions, the Portfolio does not intend to commit more than 5% of its total assets to these practices. The Portfolio does not pay for the securities or receive dividends or interest on them until the contractual settlement date. The Portfolio will designate cash or liquid high-grade debt securities at least equal in value to its commitments to purchase the securities. When-issued securities or forward commitments are subject to market fluctuations and they may affect the Portfolio's total assets the same as owned securities. The Portfolio may maintain a portion of its assets in cash and cash-equivalent investments. The cash-equivalent investments the Portfolio may use are short-term U.S. and Canadian government securities and negotiable certificates of deposit, non-negotiable fixed-time deposits, bankers' acceptances and letters of credit of banks or savings and loan associations having capital, surplus and undivided profits (as of the date of its most recently published annual financial statements) in excess of $100 million (or the equivalent in the instance of a foreign branch of a U.S. bank) at the date of investment. Any cash-equivalent investments in foreign securities will be subject to the limitations on foreign investments described in the prospectus. The Portfolio also may purchase short-term corporate notes and obligations rated in the top two classifications by Moody's Investors Service, Inc. (Moody's) or Standard & Poor's Corporation (S&P) or the equivalent and may use repurchase agreements with broker-dealers registered under the Securities Exchange Act of 1934 and with commercial banks. A risk of a repurchase agreement is that if the seller seeks the protection of the bankruptcy laws, the Portfolio's ability to liquidate the security involved could be impaired. PAGE 105 Notwithstanding any of the Fund's other investment policies, the Fund may invest its assets in an open-end management investment company having substantially the same investment objectives, policies and restrictions as the Fund for the purpose of having those assets managed as part of a combined pool. For a discussion about foreign currency transactions, see Appendix A. For a discussion on options and interest rate futures contracts see Appendix B. For a discussion on mortgage-backed securities, see Appendix C. SECURITY TRANSACTIONS Subject to policies set by the board, AEFC is authorized to determine, consistent with the Portfolio's investment goal and policies, which securities will be purchased, held or sold. In determining where the buy and sell orders are to be placed, AEFC has been directed to use its best efforts to obtain the best available price and most favorable execution except where otherwise authorized by the board. AEFC has a strict Code of Ethics that prohibits its affiliated personnel from engaging in personal investment activities that compete with or attempt to take advantage of planned portfolio transactions for any fund or trust for which it acts as investment manager. AEFC carefully monitors compliance with its Code of Ethics. Normally, the Portfolio's securities are traded on a principal rather than an agency basis. In other words, AEFC will trade directly with the issuer or with a dealer who buys or sells for its own account, rather than acting on behalf of another client. AEFC does not pay the dealer commissions. Instead, the dealer's profit, if any, is the difference, or spread, between the dealer's purchase and sale price for the security. On occasion, it may be desirable to compensate a broker for research services or for brokerage services by paying a commission that might not otherwise be charged or a commission in excess of the amount another broker might charge. The board has adopted a policy authorizing AEFC to do so to the extent authorized by law, if AEFC determines, in good faith, that such commission is reasonable in relation to the value of the brokerage or research services provided by a broker or dealer, viewed either in the light of that transaction or AEFC's overall responsibilities to the funds in the IDS MUTUAL FUND GROUP and other funds for which it acts as investment advisor. PAGE 106 Research provided by brokers supplements AEFC's own research activities. Such services include economic data on, and analysis of, U.S. and foreign economies; information on specific industries; information about specific companies, including earnings estimates; purchase recommendations for stocks and bonds; portfolio strategy services; political, economic, business and industry trend assessments; historical statistical information; market data services providing information on specific issues and prices; and technical analysis of various aspects of the securities markets, including technical charts. Research services may take the form of written reports, computer software or personal contact by telephone or at seminars or other meetings. AEFC has obtained, and in the future may obtain, computer hardware from brokers, including but not limited to personal computers that will be used exclusively for investment decision-making purposes, which include the research, portfolio management and trading functions and other services to the extent permitted under an interpretation by the SEC. When paying a commission that might not otherwise be charged or a commission in excess of the amount another broker might charge, AEFC must follow procedures authorized by the board. To date, three procedures have been authorized. One procedure permits AEFC to direct an order to buy or sell a security traded on a national securities exchange to a specific broker for research services it has provided. The second procedure permits AEFC, in order to obtain research, to direct an order on an agency basis to buy or sell a security traded in the over-the-counter market to a firm that does not make a market in that security. The commission paid generally includes compensation for research services. The third procedure permits AEFC, in order to obtain research and brokerage services, to cause the Portfolio to pay a commission in excess of the amount another broker might have charged. AEFC has advised the Portfolio it is necessary to do business with a number of brokerage firms on a continuing basis to obtain such services as the handling of large orders, the willingness of a broker to risk its own money by taking a position in a security, and the specialized handling of a particular group of securities that only certain brokers may be able to offer. As a result of this arrangement, some portfolio transactions may not be effected at the lowest commission, but AEFC believes it may obtain better overall execution. AEFC has assured the Portfolio that under all three procedures the amount of commission paid will be reasonable and competitive in relation to the value of the brokerage services performed or research provided. All other transactions shall be placed on the basis of obtaining the best available price and the most favorable execution. In so doing, if in the professional opinion of the person responsible for selecting the broker or dealer, several firms can execute the transaction on the same basis, consideration will be given by such person to those firms offering research services. Such services may be used by AEFC in providing advice to all the funds in the IDS MUTUAL FUND GROUP even though it is not possible to relate the benefits to any particular fund or account. PAGE 107 Each investment decision made for the Portfolio is made independently from any decision made for another portfolio, fund or other account advised by AEFC or any of its subsidiaries. When the Portfolio buys or sells the same security as another portfolio, fund or account, AEFC carries out the purchase or sale in a way the Portfolio agrees in advance is fair. Although sharing in large transactions may adversely affect the price or volume purchased or sold by the Portfolio, the Portfolio hopes to gain an overall advantage in execution. AEFC has assured the Portfolio it will continue to seek ways to reduce brokerage costs. On a periodic basis, AEFC makes a comprehensive review of the broker-dealers and the overall reasonableness of their commissions. The review evaluates execution, operational efficiency and research services. The Fund paid total brokerage commissions of $12,092 for the fiscal period ended May 31, 1996, $40,448 for the fiscal year ended Aug. 31, 1995, and $145,758 for the fiscal year ended Aug. 31, 1994. Substantially all firms through whom transactions were executed provide research services. No transactions were directed to brokers because of research services they provided to the Fund.As of the fiscal period ended May 31, 1996, the Fund held securities of its regular brokers or dealers or of the parent of those brokers or dealers that derived more than 15% of gross revenue from securities-related activities as presented below: Value of Securities Owned at End of Name of Issuer Fiscal Year Dean Witter $8,071,855 Merrill Lynch 8,598,779 The portfolio turnover rate was 61% in the fiscal period ended May 31, 1996, and 74% in the fiscal year ended Aug. 31, 1995. BROKERAGE COMMISSIONS PAID TO BROKERS AFFILIATED WITH AMERICAN EXPRESS FINANCIAL CORPORATION Affiliates of American Express Company (American Express) (of which AEFC is a wholly owned subsidiary) may engage in brokerage and other securities transactions on behalf of the Portfolio according to procedures adopted by the board and to the extent consistent with applicable provisions of the federal securities laws. AEFC will use an American Express affiliate only if (i) AEFC determines that the Portfolio will receive prices and executions at least as favorable as those offered by qualified independent brokers performing similar brokerage and other services for the Portfolio and (ii) the affiliate charges the Portfolio commission rates consistent with those the affiliate charges comparable unaffiliated customers in similar transactions and if such use is consistent with terms of the Investment Management Services Agreement. PAGE 108 AEFC may direct brokerage to compensate an affiliate. AEFC will receive research on South Africa from New Africa Advisors, a wholly-owned subsidiary of Sloan Financial Group. AEFC owns 100% of IDS Capital Holdings Inc. which in turn owns 40% of Sloan Financial Group. New Africa Advisors will send research to AEFC and in turn AEFC will direct trades to a particular broker. The broker will have an agreement to pay New Africa Advisors. All transactions will be on a best execution basis. Compensation received will be reasonable for the services rendered. No brokerage commissions were paid to brokers affiliated with AEFC for the three most recent fiscal years. PERFORMANCE INFORMATION The Fund may quote various performance figures to illustrate past performance. Average annual total return and current yield quotations used by the Fund are based on standardized methods of computing performance as required by the SEC. An explanation of the methods used by the Fund to compute performance follows below. Average annual total return The Fund may calculate average annual total return for a class for certain periods by finding the average annual compounded rates of return over the period that would equate the initial amount invested to the ending redeemable value, according to the following formula: P(1+T)n = ERV where: P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years ERV = ending redeemable value of a hypothetical $1,000 payment, made at the beginning of a period, at the end of the period (or fractional portion thereof) Aggregate total return The Fund may calculate aggregate total return for a class for certain periods representing the cumulative change in the value of an investment in the Fund over a specified period of time according to the following formula: ERV - P P where: P = a hypothetical initial payment of $1,000 ERV = ending redeemable value of a hypothetical $1,000 payment, made at the beginning of a period, at the end of the period (or fractional portion thereof) PAGE 109 Annualized yield The Fund may calculate an annualized yield for a class by dividing the net investment income per share deemed earned during a period by the net asset value per share on the last day of the period and annualizing the results. Yield is calculated according to the following formula: Yield = 2[(a-b + 1)6 - 1] cd where: a = dividends and interest earned during the period b = expenses accrued for the period (net of reimbursements c = the average daily number of shares outstanding during the period that were entitled to receive dividends d = the maximum offering price per share on the last day of the period The Fund's annualized yield was 7.91% for Class A, 7.57% for Class B and 8.54% for Class Y for the 30-day period ended May 31, 1996.The Fund's yield, calculated as described above according to the formula prescribed by the SEC, is a hypothetical return based on market value yield to maturity for the Portfolio's securities. It is not necessarily indicative of the amount which was or may be paid to the Fund's shareholders. Actual amounts paid to Fund shareholders are reflected in the distribution yield. Distribution yield Distribution yield is calculated according to the following formula: D divided by POP F equals DY 30 30 where: D = sum of dividends for 30-day period POP = sum of public offering price for 30-day period F = annualizing factor DY = distribution yield The Fund's distribution yield was 9.64% for Class A, 9.38% for Class B and 10.32% for Class Y for the 30-day period ended May 31, 1996. PAGE 110 In its sales material and other communications, the Fund may quote, compare or refer to rankings, yields or returns as published by independent statistical services or publishers and publications such as The Bank Rate Monitor National Index, Barron's, Business Week, Donoghue's Money Market Fund Report, Financial Services Week, Financial Times, Financial World, Forbes, Fortune, Global Investor, Institutional Investor, Investor's Daily, Kiplinger's Personal Finance, Lipper Analytical Services, Money, Mutual Fund Forecaster, Newsweek, The New York Times, Personal Investor, Stanger Report, Sylvia Porter's Personal Finance, USA Today, U.S. News and World Report, The Wall Street Journal and Wiesenberger Investment Companies Service. VALUING FUND SHARES The value of an individual share for each class is determined by using the net asset value before shareholder transactions for the day. On June 3, 1996, the first business day following the end of the fiscal period, the computation looked like this:
Net assets before Shares outstanding Net asset value shareholder transactions at end of previous day of one share Class A $2,140,107,172 divided by 494,251,079 equals $4.33 Class B 269,103,953 62,148,719 4.33 Class Y 9,015 2,082 4.33
In determining net assets before shareholder transactions, the Portfolio's securities are valued as follows as of the close of business of the New York Stock Exchange (the Exchange): 'Securities, except bonds other than convertibles, traded on a securities exchange for which a last-quoted sales price is readily available are valued at the last-quoted sales price on the exchange where such security is primarily traded. 'Securities traded on a securities exchange for which a last-quoted sales price is not readily available are valued at the mean of the closing bid and asked prices, looking first to the bid and asked prices on the exchange where the security is primarily traded and, if none exist, to the over-the-counter market. 'Securities included in the NASDAQ National Market System are valued at the last-quoted sales price in this market. 'Securities included in the NASDAQ National Market System for which a last-quoted sales price is not readily available, and other securities traded over-the-counter but not included in the NASDAQ National Market System are valued at the mean of the closing bid and asked prices. 'Futures and options traded on major exchanges are valued at the last-quoted sales price on their primary exchange. PAGE 111 'Foreign securities traded outside the United States are generally valued as of the time their trading is complete, which is usually different from the close of the Exchange. Foreign securities quoted in foreign currencies are translated into U.S. dollars at the current rate of exchange. Occasionally, events affecting the value of such securities may occur between such times and the close of the Exchange that will not be reflected in the computation of the Fund's net asset value. If events materially affecting the value of such securities occur during such period, these securities will be valued at their fair value according to procedures decided upon in good faith by the board. 'Short-term securities maturing more than 60 days from the valuation date are valued at the readily available market price or approximate market value based on current interest rates. Short- term securities maturing in 60 days or less that originally had maturities of more than 60 days at acquisition date are valued at amortized cost using the market value on the 61st day before maturity. Short-term securities maturing in 60 days or less at acquisition date are valued at amortized cost. Amortized cost is an approximation of market value determined by systematically increasing the carrying value of a security if acquired at a discount, or reducing the carrying value if acquired at a premium, so that the carrying value is equal to maturity value on the maturity date. 'Securities without a readily available market price, bonds other than convertibles and other assets are valued at fair value as determined in good faith by the board. The board is responsible for selecting methods it believes provide fair value. When possible, bonds are valued by a pricing service independent from the Portfolio. If a valuation of a bond is not available from a pricing service, the bond will be valued by a dealer knowledgeable about the bond if such a dealer is available. The New York Stock Exchange, AEFC and the Fund will be closed on the following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. INVESTING IN THE FUND Sales Charge Shares of the Fund are sold at the public offering price determined at the close of business on the day an application is accepted. The public offering price is the net asset value of one share adjusted for a sales charge, if applicable. For Class B and Class Y, there is no initial sales charge so the public offering price is the same as the net asset value. For Class A, the public offering price for an investment of less than $50,000, made June 3, 1996, was determined by dividing the net asset value of one share, $4.33, by 0.95 (1.00-0.05 for a maximum 5% sales charge) for a public offering price of $4.56. The sales charge is paid to American Express Financial Advisors by the person buying the shares. PAGE 112 Class A - Calculation of the Sales Charge Sales charges are determined as follows:
Within each increment, sales charge as a percentage of: Public Net Amount of Investment Offering Price Amount Invested First $ 50,000 5.0% 5.26% Next 50,000 4.5 4.71 Next 400,000 3.8 3.95 Next 500,000 2.0 2.04 $1,000,000 or more 0.0 0.00
Sales charges on an investment greater than $50,000 and less than $1,000,000 are calculated for each increment separately and then totaled. The resulting total sales charge, expressed as a percentage of the public offering price and of the net amount invested, will vary depending on the proportion of the investment at different sales charge levels. For example, compare an investment of $60,000 with an investment of $85,000. The $60,000 investment is composed of $50,000 that incurs a sales charge of $2,500 (5.0% x $50,000) and $10,000 that incurs a sales charge of $450 (4.5% x $10,000). The total sales charge of $2,950 is 4.92% of the public offering price and 5.17% of the net amount invested. In the case of the $85,000 investment, the first $50,000 also incurs a sales charge of $2,500 (5.0% x $50,000) and $35,000 incurs a sales charge of $1,575 (4.5% x $35,000). The total sales charge of $4,075 is 4.79% of the public offering price and 5.04% of thenet amount invested. The following table shows the range of sales charges as a percentage of the public offering price and of the net amount invested on total investments at each applicable level.
On total investment, sales charge as a percentage of Public Net Offering Price Amount Invested Amount of Investment ranges from: First $ 50,000 5.00% 5.26% More than 50,000 to 100,000 5.00-4.50 5.26-4.71 More than 100,000 to 500,000 4.50-3.80 4.71-3.95 More than 500,000 to 999,999 3.80-2.00 3.95-2.04 $1,000,000 or more 0.00 0.00 /TABLE PAGE 113 The initial sales charge is waived for certain qualified plans that meet the requirements described in the prospectus. Participants in these qualified plans may be subject to a deferred sales charge on certain redemptions. The deferred sales charge on certain redemptions will be waived if the redemption is a result of a participant's death, disability, retirement, attaining age 59 1/2, loans or hardship withdrawals. The deferred sales charge varies depending on the number of participants in the qualified plan and total plan assets as follows: Deferred Sales Charge Number of Participants Total Plan Assets 1-99 100 or more Less than $1 million 4% 0% $1 million or more 0% 0% _________________________________________________________ Class A - Reducing the Sales Charge Sales charges are based on the total amount of your investments in the Fund. The amount of all prior investments plus any new purchase is referred to as your "total amount invested." For example, suppose you have made an investment of $20,000 and later decide to invest $40,000 more. Your total amount invested would be $60,000. As a result, $10,000 of your $40,000 investment qualifies for the lower 4.5% sales charge that applies to investments of more than $50,000 and up to $100,000. The total amount invested includes any shares held in the Fund in the name of a member of your primary household group. The primary household group consists of accounts in any ownership for spouses or domestic partners and their unmarried children under 21. Domestic partners are individuals who maintain a shared primary residence and have joint property or other insurable interests. For instance, if your spouse already has invested $20,000 and you want to invest $40,000, your total amount invested will be $60,000 and therefore you will pay the lower charge of 4.5% on $10,000 of the $40,000. Until a spouse remarries, the sales charge is waived for spouses and unmarried children under 21 of deceased board members, officers or employees of the Fund or AEFC or its subsidiaries and deceased advisors. PAGE 114 The total amount invested also includes any investment you or your immediate family already have in the other publicly offered funds in the IDS MUTUAL FUND GROUP where the investment is subject to a sales charge. For example, suppose you already have an investment of $30,000 in another IDS Fund. If you invest $40,000 more in this Fund, your total amount invested in the funds will be $70,000 and therefore $20,000 of your $40,000 investment will incur a 4.5% sales charge. Finally, Individual Retirement Account (IRA) purchases, or other employee benefit plan purchases made through a payroll deduction plan or through a plan sponsored by an employer, association of employers, employee organization or other similar entity, may be added together to reduce sales charges for shares purchased through that plan. Class A - Letter of Intent (LOI) If you intend to invest $1 million over a period of 13 months, you can reduce the sales charges in Class A by filing a LOI. The agreement can start at any time and will remain in effect for 13 months. Your investment will be charged normal sales charges until you have invested $1 million. At that time, your account will be credited with the sales charges previously paid. Class A investments made prior to signing an LOI may be used to reach the $1 million total, excluding Cash Management Fund and Tax-Free Money Fund. However, we will not adjust for sales charges on investments made prior to the signing of the LOI. If you do not invest $1 million by the end of 13 months, there is no penalty, you'll just miss out on the sales charge adjustment. A LOI is not an option (absolute right) to buy shares. Here's an example. You file a LOI to invest $1 million and make an investment of $100,000 at that time. You pay the normal 5% sales charge on the first $50,000 and 4.5% sales charge on the next $50,000 of this investment. Let's say you make a second investment of $900,000 (bringing the total up to $1 million) one month before the 13-month period is up. On the date that you bring your total to $1 million, AEFC makes an adjustment to your account. The adjustment is made by crediting your account with additional shares, in an amount equivalent to the sales charge previously paid. Systematic Investment Programs After you make your initial investment of $2,000 or more, you can arrange to make additional payments of $100 or more on a regular basis. These minimums do not apply to all systematic investment programs. You decide how often to make payments - monthly, quarterly, or semiannually. You are not obligated to make any payments. You can omit payments or discontinue the investment program altogether. The Fund also can change the program or end it at any time. If there is no obligation, why do it? Putting money aside is an important part of financial planning. With a systematic investment program, you have a goal to work for. PAGE 115 How does this work? Your regular investment amount will purchase more shares when the net asset value per share decreases, and fewer shares when the net asset value per share increases. Each purchase is a separate transaction. After each purchase your new shares will be added to your account. Shares bought through these programs are exactly the same as any other fund shares. They can be bought and sold at any time. A systematic investment program is not an option or an absolute right to buy shares. The systematic investment program itself cannot ensure a profit, nor can it protect against a loss in a declining market. If you decide to discontinue the program and redeem your shares when their net asset value is less than what you paid for them, you will incur a loss. For a discussion on dollar-cost averaging, see Appendix D. Automatic Directed Dividends Dividends, including capital gain distributions, paid by another fund in the IDS MUTUAL FUND GROUP subject to a sales charge, may be used to automatically purchase shares in the same class of this Fund without paying a sales charge. Dividends may be directed to existing accounts only. Dividends declared by a fund are exchanged to this Fund the following day. Dividends can be exchanged into one fund but cannot be split to make purchases in two or more funds. Automatic directed dividends are available between accounts of any ownership except: Between a non-custodial account and an IRA, or 401(k) plan account or other qualified retirement account of which American Express Trust Company acts as custodian; Between two American Express Trust Company custodial accounts with different owners (for example, you may not exchange dividends from your IRA to the IRA of your spouse); Between different kinds of custodial accounts with the same ownership (for example, you may not exchange dividends from your IRA to your 401(k) plan account, although you may exchange dividends from one IRA to another IRA). Dividends may be directed from accounts established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) only into other UGMA or UTMA accounts with identical ownership. The Fund's investment goals are described in its prospectus along with other information, including fees and expense ratios. Before exchanging dividends into another fund, you should read its prospectus. You will receive a confirmation that the automatic directed dividend service has been set up for your account. PAGE 116 REDEEMING SHARES You have a right to redeem your shares at any time. For an explanation of redemption procedures, please see the prospectus. During an emergency, the board can suspend the computation of net asset value, stop accepting payments for purchase of shares or suspend the duty of the Fund to redeem shares for more than seven days. Such emergency situations would occur if: 'The Exchange closes for reasons other than the usual weekend and holiday closings or trading on the Exchange is restricted, or 'Disposal of the Portfolio's securities is not reasonably practicable or it is not reasonably practicable for the Fund to determine the fair value of its net assets, or 'The SEC, under the provisions of the 1940 Act, as amended, declares a period of emergency to exist. Should the Fund stop selling shares, the board may make a deduction from the value of the assets held by the Fund to cover the cost of future liquidations of the assets so as to distribute fairly these costs among all shareholders. The Fund has elected to be governed by Rule 18f-1 under the 1940 Act, which obligates the Fund to redeem shares in cash, with respect to any one shareholder during any 90-day period, up to lesser of $250,000 or 1% of the net assets of the Fund at the beginning of the period. Although redemptions in excess of this limitation would normally be paid in cash, the Fund reserves the right to make these payments in whole or in part in securities or other assets in case of an emergency, or if the payment of a redemption in cash would be detrimental to the existing shareholders of the Fund as determined by the board. In these circumstances, the securities distributed would be valued as set forth in the prospectus. Should the Fund distribute securities, a shareholder may incur brokerage fees or other transaction costs in converting the securities to cash. PAY-OUT PLANS You can use any of several pay-out plans to redeem your investment in regular installments. If you redeem Class B shares you may be subject to a contingent deferred sales charge as discussed in the prospectus. While the plans differ on how the pay-out is figured, they all are based on the redemption of your investment. Net investment income dividends and any capital gain distributions will automatically be reinvested, unless you elect to receive them in cash. If you are redeeming a tax-qualified plan account for which American Express Trust Company acts as custodian, you can elect to PAGE 117 receive your dividends and other distributions in cash when permitted by law. If you redeem an IRA or a qualified retirement account, certain restrictions, federal tax penalties and special federal income tax reporting requirements may apply. You should consult your tax advisor about this complex area of the tax law. Applications for a systematic investment in a class of the Fund subject to a sales charge normally will not be accepted while a pay-out plan for any of those funds is in effect. Occasional investments, however, may be accepted. To start any of these plans, please write or call American Express Shareholder Service, P.O. Box 534, Minneapolis, MN 55440-0534, 612-671-3733. Your authorization must be received in the Minneapolis headquarters at least five days before the date you want your payments to begin. The initial payment must be at least $50. Payments will be made on a monthly, bimonthly, quarterly, semiannual or annual basis. Your choice is effective until you change or cancel it. The following pay-out plans are designed to take care of the needs of most shareholders in a way AEFC can handle efficiently and at a reasonable cost. If you need a more irregular schedule of payments, it may be necessary for you to make a series of individual redemptions, in which case you'll have to send in a separate redemption request for each pay-out. The Fund reserves the right to change or stop any pay-out plan and to stop making such plans available. Plan #1: Pay-out for a fixed period of time If you choose this plan, a varying number of shares will be redeemed at regular intervals during the time period you choose. This plan is designed to end in complete redemption of all shares in your account by the end of the fixed period. Plan #2: Redemption of a fixed number of shares If you choose this plan, a fixed number of shares will be redeemed for each payment and that amount will be sent to you. The length of time these payments continue is based on the number of shares in your account. Plan #3: Redemption of a fixed dollar amount If you decide on a fixed dollar amount, whatever number of shares is necessary to make the payment will be redeemed in regular installments until the account is closed.Plan #4: Redemption of a percentage of net asset value PAGE 118 Payments are made based on a fixed percentage of the net asset value of the shares in the account computed on the day of each payment. Percentages range from 0.25% to 0.75%. For example, if you are on this plan and arrange to take 0.5% each month, you will get $50 if the value of your account is $10,000 on the payment date. CAPITAL LOSS CARRYOVER For federal income tax purposes, the Fund had capital loss carryover of $257,355,361 at May 31, 1996, that will expire as follows: 1999 2000 2003 2004 $163,877,886 $28,359,344 $20,159,025 $44,959,106 It is unlikely that the board will authorize a distribution of any net realized capital gains until the available capital loss carryover has been offset or has expired. TAXES If you buy shares in the Fund and then exchange into another fund, it is considered a sale and subsequent purchase of shares. Under the tax laws, if this exchange is done within 91 days, any sales charge waived on Class A shares on a subsequent purchase of shares applies to the new shares acquired in the exchange. Therefore, you cannot create a tax loss or reduce a tax gain attributable to the sales charge when exchanging shares within 91 days. Retirement Accounts If you have a nonqualified investment in the Fund and you wish to move part or all of those shares to an IRA or qualified retirement account in the Fund, you can do so without paying a sales charge. However, this type of exchange is considered a sale of shares and may result in a gain or loss for tax purposes. In addition, this type of exchange may result in an excess contribution under IRA or qualified plan regulations if the amount exchanged plus the amount of the initial sales charge applied to the amount exchanged exceeds annual contribution limitations. For example: If you were to exchange $2,000 in Class A shares from a nonqualified account to an IRA without considering the 5% ($100) initial sales charge applicable to that $2,000, you may be deemed to have exceeded current IRA annual contribution limitations. You should consult your tax advisor for further details about this complex subject. Net investment income dividends received should be treated as dividend income for federal income tax purposes. Corporate shareholders are generally entitled to a deduction equal to 70% of that portion of the Fund's dividend that is attributable to dividends the Fund received from domestic (U.S.) securities. For the fiscal period ended May 31, 1996, 4.98% of the Fund's net investment income dividends qualified for the corporate deduction. PAGE 119 Capital gain distributions received by individual and corporate shareholders, if any, should be treated as long-term capital gains regardless of how long they owned their shares. Short-term capital gains earned by the Fund are paid to shareholders as part of their ordinary income dividend and are taxable. Under federal tax law, by the end of a calendar year the Fund must declare and pay dividends representing 98% of ordinary income for that calendar year and 98% of net capital gains (both long-term and short-term) for the 12-month period ending Oct. 31 of that calendar year. The Fund is subject to an excise tax equal to 4% of the excess, if any, of the amount required to be distributed over the amount actually distributed. The Fund intends to comply with federal tax law and avoid any excise tax. The Fund may be subject to U.S. taxes resulting from holdings in a passive foreign investment company (PFIC). A foreign corporation is a PFIC when 75% or more of its gross income for the taxable year is passive income or if 50% or more of the average value of its assets consists of assets that produce or could produce passive income. This is a brief summary that relates to federal income taxation only. Shareholders should consult their tax advisor as to the application of federal, state and local income tax laws to Fund distributions. AGREEMENTS Investment Management Services Agreement The Trust, on behalf of the Portfolio, has an Investment Management Services Agreement with AEFC. For its services, AEFC is paid a fee based on the following schedule: Assets Annual rate at (billions) each asset level First $1.0 0.590% Next 1.0 0.565 Next 1.0 0.540 Next 3.0 0.515 Next 3.0 0.490 Over 9.0 0.465 On May 31, 1996, the daily rate applied to the Fund's net assets was equal to 0.571% on an annual basis. The fee is calculated for each calendar day on the basis of net assets as of the close of business two business days prior to the day for which the calculation is made. PAGE 120 The management fee is paid monthly. The total amount paid was $9,170,111 for the fiscal period ended May 31, 1996, $9,856,787 for the fiscal year ended Aug. 31, 1995, and $10,075,839 for the fiscal year ended Aug. 31, 1994. The Portfolio also pays taxes, brokerage commissions and nonadvisory expenses, which include custodian fees; audit and certain legal fees; fidelity bond premiums; registration fees for shares; office expenses; consultants' fees; compensation of board members, officers and employees; corporate filing fees; organizational expenses; expenses incurred in connection with lending securities of the Portfolio; and expenses properly payable by the Portfolio, approved by the board. The Fund paid nonadvisory expenses of $742,081 for the fiscal period ended May 31, 1996, $761,716 for the fiscal year ended Aug. 31, 1995, and $765,283 for the fiscal year ended Aug. 31, 1994. Administrative Services Agreement The Fund has an Administrative Services Agreement with AEFC. Under this agreement, the Fund pays AEFC for providing administration and accounting services. The fee is calculated as follows: Assets Annual rate (billions) each asset level First $1.0 0.050% Next 1.0 0.045 Next 1.0 0.040 Next 3.0 0.035 Next 3.0 0.030 Over 9.0 0.025 On May 31, 1996, the daily rate applied to the Fund's net assets was equal to 0.046% on an annual basis. The fee is calculated for each calendar day on the basis of net assets as of the close of business two business days prior to the day for which the calculation is made. Under the agreement, the Fund paid fees of $749,696 for the fiscal period ended May 31, 1996. Transfer Agency Agreement The Fund has a Transfer Agency Agreement with AEFC. This agreement governs AEFC's responsibility for administering and/or performing transfer agent functions, for acting as service agent in connection with dividend and distribution functions and for performing shareholder account administration agent functions in connection with the issuance, exchange and redemption or repurchase of the Fund's shares. Under the agreement, AEFC will earn a fee from the Fund determined by multiplying the number of shareholder accounts at the end of the day by a rate determined for each class per year and dividing by the number of days in the year. The rate for Class PAGE 121 A and Class Y is $15.50 per year and for Class B is $16.50 per year. The fees paid to AEFC may be changed from time to time upon agreement of the parties without shareholder approval. Under the agreement, the Fund paid fees of $1,547,029 for the fiscal period ended May 31, 1996.Distribution Agreement Under a Distribution Agreement, sales charges deducted for distributing Fund shares are paid to American Express Financial Advisors daily. These charges amounted to $8,715,152 for the fiscal period ended May 31, 1996. Commissions paid to personal financial advisors totaled $9,367,444. The amounts were $7,922,313 and $6,523,595 for the fiscal year ended Aug. 31, 1995, and $14,976,206 and $9,772,761 for the fiscal year ended Aug. 31, 1994. Additional information about commissions and compensation for the fiscal period ended May 31, 1996, is contained in the following table:
(1) (2) (3) (4) (5) Net Compensation Name of Underwriting on Redemption Principal Discounts and and Brokerage Other Underwriter Commissions Repurchases Commissions Compensation AEFC None None None $907,154* American Express Financial Advisors $8,715,152 None None None
*Distribution fees paid pursuant to the Plan and Agreement of Distribution. Shareholder Service Agreement The Fund pays a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.175% of the Fund's average daily net assets attributable to Class A and Class B shares. Plan and Agreement of Distribution For Class B shares, to help American Express Financial Advisors defray the cost of distribution and servicing, not covered by the sales charges received under the Distribution Agreement, the Fund and American Express Financial Advisors entered into a Plan and Agreement of Distribution (Plan). These costs cover almost all aspects of distributing the Fund's shares except compensation to the sales force. A substantial portion of the costs are not specifically identified to any one fund in the IDS MUTUAL FUND GROUP. Under the Plan, American Express Financial Advisors is paid a fee at an annual rate of 0.75% of the Fund's average daily net assets attributable to Class B shares. PAGE 122 The Plan must be approved annually by the board, including a majority of the disinterested board members, if it is to continue for more than a year. At least quarterly, the board must review written reports concerning the amounts expended under the Plan and the purposes for which such expenditures were made. The Plan and any agreement related to it may be terminated at any time by vote of a majority of board members who are not interested persons of the Fund and have no direct or indirect financial interest in the operation of the Plan or in any agreement related to the Plan, or by vote of a majority of the outstanding voting securities of the Fund's Class B shares or by American Express Financial Advisors. The Plan (or any agreement related to it) will terminate in the event of its assignment, as that term is defined in the 1940 Act, as amended. The Plan may not be amended to increase the amount to be spent for distribution without shareholder approval, and all material amendments to the Plan must be approved by a majority of the board members, including a majority of the board members who are not interested persons of the Fund and who do not have a financial interest in the operation of the Plan or any agreement related to it. The selection and nomination of disinterested board members is the responsibility of the other disinterested board members. No board member who is not an interested person, has any direct or indirect financial interest in the operation of the Plan or any related agreement. For the fiscal period ended May 31, 1996, the Fund paid fees of $907,154. Total fees and expenses Total combined fees and nonadvisory expenses of both the Fund and the Portfolio cannot exceed the most restrictive applicable state limitation. Currently, the most restrictive applicable state expense limitation, subject to exclusion of certain expenses, is 2.5% of the first $30 million of the Fund's average daily net assets, 2% of the next $70 million and 1.5% of average daily net assets over $100 million, on an annual basis. At the end of each month, if the fees and expenses of the Fund exceed this limitation for the Fund's fiscal year in progress, AEFC will assume all expenses in excess of the limitation. AEFC then may bill the Fund for such expenses in subsequent months up to the end of that fiscal year, but not after that date. No interest charges are assessed by AEFC for expenses it assumes. The Fund paid total fees and nonadvisory expenses of $15,879,426 for the fiscal period ended May 31, 1996. BOARD MEMBERS AND OFFICERS The following is a list of the Fund's board members and officers who, except for Mr. Dudley, are also board members and officers of all other funds in the IDS MUTUAL FUND GROUP. Mr. Dudley is a board member of the 32 publicly offered funds. The board members and officers are also board members and officers of all five trusts in the Preferred Master Trust Group. All shares have cumulative voting rights with respect to the election of board members. PAGE 123 Lynne V. Cheney' Born in 1941. American Enterprise Institute for Public Policy Research (AEI) 1150 17th St., N.W. Washington, D.C. Distinguished Fellow AEI. Former Chair of National Endowment of the Humanities. Director, The Reader's Digest Association Inc., Lockheed-Martin, the Interpublic Group of Companies, Inc. (advertising), and FPL Group, Inc. (holding company for Florida Power and Light). William H. Dudley** Born in 1932. 2900 IDS Tower Minneapolis, MN Executive vice president and director of AEFC. Robert F. Froehlke+ Born in 1922. 1201 Yale Place Minneapolis, MN Former president of all funds in the IDS MUTUAL FUND GROUP. Director, the ICI Mutual Insurance Co., Institute for Defense Analyses, Marshall Erdman and Associates, Inc. (architectural engineering) and Public Oversight Board of the American Institute of Certified Public Accountants. David R. Hubers+** Born in 1943. 2900 IDS Tower Minneapolis, MN President, chief executive officer and director of AEFC. Previously, senior vice president, finance and chief financial officer of AEFC. Heinz F. Hutter+' Born in 1929. P.O. Box 5724 Minneapolis, MN President and chief operating officer, Cargill, Incorporated (commodity merchants and processors) from February 1991 to September 1994. Executive vice president from 1981 to February 1991. PAGE 124 Anne P. Jones Born in 1935. 5716 Bent Branch Rd. Bethesda, MD Attorney and telecommunications consultant. Former partner, law firm of Sutherland, Asbill & Brennan. Director, Motorola, Inc. and C-Cor Electronics, Inc. Melvin R. Laird Born in 1922. Reader's Digest Association, Inc. 1730 Rhode Island Ave., N.W. Washington, D.C. Senior counsellor for national and international affairs, The Reader's Digest Association, Inc. Chairman of the board, COMSAT Corporation, former nine-term congressman, secretary of defense and presidential counsellor. Director, Martin Marietta Corp., Metropolitan Life Insurance Co., The Reader's Digest Association, Inc., Science Applications International Corp., Wallace Reader's Digest Funds and Public Oversight Board (SEC Practice Section, American Institute of Certified Public Accountants). William R. Pearce+* Born in 1927. 901 S. Marquette Ave. Minneapolis, MN President of all funds in the IDS MUTUAL FUND GROUP since June 1993. Former vice chairman of the board, Cargill, Incorporated (commodity merchants and processors). Edson W. Spencer+ Born in 1926. 4900 IDS Center 80 S. 8th St. Minneapolis, MN President, Spencer Associates Inc. (consulting). Chairman of the board, Mayo Foundation (healthcare). Former chairman of the board and chief executive officer, Honeywell Inc. Director, Boise Cascade Corporation (forest products) and CBS Inc. Member of International Advisory Councils, Robert Bosch (Germany) and NEC (Japan). John R. Thomas** Born in 1937. 2900 IDS Tower Minneapolis, MN Senior vice president and director of AEFC. PAGE 125 Wheelock Whitney+ Born in 1926. 1900 Foshay Tower 821 Marquette Ave. Minneapolis, MN Chairman, Whitney Management Company (manages family assets).C. Angus Wurtele' Born in 1934. Valspar Corporation Suite 1700 Foshay Tower Minneapolis, MN Chairman of the board, The Valspar Corporation (paints). Director, Bemis Corporation (packaging), Donaldson Company (air cleaners & mufflers) and General Mills, Inc. (consumer foods). + Member of executive committee. ' Member of joint audit committee. * Interested person by reason of being an officer and employee of the Fund. **Interested person by reason of being an officer, board member, employee and/or shareholder of AEFC or American Express. The board also has appointed officers who are responsible for day- to-day business decisions based on policies it has established. In addition to Mr. Pearce, who is president, the Fund's other officers are: Leslie L. Ogg Born in 1938. 901 S. Marquette Ave. Minneapolis, MN Vice president, general counsel and secretary of all funds in the IDS MUTUAL FUND GROUP. Officers who also are officers and/or employees of AEFC Peter J. Anderson Born in 1942. IDS Tower 10 Minneapolis, MN Vice president-investments of all funds in the IDS MUTUAL FUND GROUP. Director and senior vice president-investments of AEFC. Melinda S. Urion Born in 1953. IDS Tower 10 Minneapolis, MN PAGE 126 Treasurer of all funds in the IDS MUTUAL FUND GROUP. Director, senior vice president and chief financial officer of AEFC. Director and executive vice president and controller of IDS Life Insurance Company. Members of the board who are not officers of the Fund or of AEFC receive an annual fee of $2,000. They also receive attendance and other fees, the cost of which the Fund shares with the other funds in the IDS MUTUAL FUND GROUP. These fees include attendance of meetings of the Board, $1,000; meetings of the Contracts Committee, $750; meetings of the Audit, Executive or Investment Review Committees, $500; meetings of the Personnel Committee, $300; out- of-state, $500; and Chair of the Contracts Committee, $5,000. Expenses for attending those meetings are also reimbursed. During the fiscal period ended May 31, 1996, the members of the board, for attending up to 24 meetings, received the following compensation:
Compensation Table Pension or Estimated Aggregate Retirement annual Total cash compensation benefits benefit compensation from the accrued as upon from the IDS Board member Fund Fund expenses* retirement MUTUAL FUND GROUP Lynne V. Cheney $2,257 $ 924 $1,000 $69,800 Robert F. Froehlke 2,243 3,417 1,000 69,300 Heinz F. Hutter 2,270 1,495 483 70,300 Anne P. Jones 2,283 849 1,000 70,800 Donald M. Kendall 2,031 2,078 1,000 62,500 (Part of Year) Melvin R. Laird 2,330 1,930 1,000 72,600 Lewis W. Lehr 2,090 799 975 64,800 (Part of Year) Edson W. Spencer 2,375 438 533 74,300 Wheelock Whitney 2,263 1,468 1,000 70,000 C. Angus Wurtele 2,191 1,581 992 67,300
On May 31, 1996, the Fund's board members and officers as a group owned less than 1% of the outstanding shares. During the fiscal period ended May 31, 1996, no board member or officer earned more than $60,000 from this Fund. All board members and officers as a group earned $52,828, including $14,979 of retirement plan benefits, from this Fund. *The Fund had a retirement plan for its independent board members. The plan terminated April 30, 1996. CUSTODIAN The Trust's securities and cash are held by First Bank National Association, 180 E. Fifth St., St. Paul, MN 55101-1631, through a custodian agreement. The Fund also retains the custodian pursuant to a custodian agreement. The custodian is permitted to deposit some or all of its securities in central depository systems as allowed by federal law. For its services, the Portfolio pays the custodian a maintenance charge and a charge per transaction in addition to reimbursing the custodian's out-of-pocket expenses. PAGE 127 INDEPENDENT AUDITORS The financial statements contained in the Annual Report to shareholders for the fiscal period ended May 31, 1996, were audited by independent auditors, KPMG Peat Marwick LLP, 4200 Norwest Center, 90 S. Seventh St., Minneapolis, MN 55402-3900. The independent auditors also provide other accounting and tax-related services as requested by the Fund.FINANCIAL STATEMENTS The Independent Auditors' Report and the Financial Statements, including Notes to the Financial Statements and the Schedule of Investments in Securities, contained in the 1996 Annual Report to shareholders, pursuant to Section 30(d) of the Investment Company Act of 1940, as amended, are hereby incorporated in this SAI by reference. No other portion of the Annual Report, however, is incorporated by reference. PROSPECTUS The prospectus for IDS Extra Income Fund dated July 30, 1996, is hereby incorporated in this SAI by reference. PAGE 128 APPENDIX A FOREIGN CURRENCY TRANSACTIONS Since investments in foreign countries usually involve currencies of foreign countries, and since the Portfolio may hold cash and cash-equivalent investments in foreign currencies, the value of the Portfolio's assets as measured in U.S. dollars may be affected favorably or unfavorably by changes in currency exchange rates and exchange control regulations. Also, the Portfolio may incur costs in connection with conversions between various currencies. Spot Rates and Forward Contracts. The Portfolio conducts its foreign currency exchange transactions either at the spot (cash) rate prevailing in the foreign currency exchange market or by entering into forward currency exchange contracts (forward contracts) as a hedge against fluctuations in future foreign exchange rates. A forward contract involves an obligation to buy or sell a specific currency at a future date, which may be any fixed number of days from the contract date, at a price set at the time of the contract. These contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. A forward contract generally has no deposit requirements. No commissions are charged at any stage for trades. The Portfolio may enter into forward contracts to settle a security transaction or handle dividend and interest collection. When the Portfolio enters into a contract for the purchase or sale of a security denominated in a foreign currency or has been notified of a dividend or interest payment, it may desire to lock in the price of the security or the amount of the payment in dollars. By entering into a forward contract, the Portfolio will be able to protect itself against a possible loss resulting from an adverse change in the relationship between different currencies from the date the security is purchased or sold to the date on which payment is made or received or when the dividend or interest is actually received. The Portfolio also may enter into forward contracts when management of the Portfolio believes the currency of a particular foreign country may suffer a substantial decline against another currency. It may enter into a forward contract to sell, for a fixed amount of dollars, the amount of foreign currency approximating the value of some or all of the Portfolio's securities denominated in such foreign currency. The precise matching of forward contract amounts and the value of securities involved generally will not be possible since the future value of such securities in foreign currencies more than likely will change between the date the forward contract is entered into and the date it matures. The projection of short- term currency market movements is extremely difficult and successful execution of a short-term hedging strategy is highly uncertain. The Portfolio will not enter into such forward PAGE 129 contracts or maintain a net exposure to such contracts when consummating the contracts would obligate the Portfolio to deliver an amount of foreign currency in excess of the value of the Portfolio's securities or other assets denominated in that currency. The Portfolio will designate cash or securities in an amount equal to the value of the Portfolio's total assets committed to consummating forward contracts entered into under the second circumstance set forth above. If the value of the securities declines, additional cash or securities will be designated on a daily basis so that the value of the cash or securities will equal the amount of the Portfolio's commitments on such contracts. At maturity of a forward contract, the Portfolio may either sell the security and make delivery of the foreign currency or retain the security and terminate its contractual obligation to deliver the foreign currency by purchasing an offsetting contract with the same currency trader obligating it to buy, on the same maturity date, the same amount of foreign currency. If the Portfolio retains the security and engages in an offsetting transaction, the Portfolio will incur a gain or a loss (as described below) to the extent there has been movement in forward contract prices. If the Portfolio engages in an offsetting transaction, it may subsequently enter into a new forward contract to sell the foreign currency. Should forward prices decline between the date the Portfolio enters into a forward contract for selling foreign currency and the date it enters into an offsetting contract for purchasing the foreign currency, the Portfolio will realize a gain to the extent that the price of the currency it has agreed to sell exceeds the price of the currency it has agreed to buy. Should forward prices increase, the Portfolio will suffer a loss to the extent the price of the currency it has agreed to buy exceeds the price of the currency it has agreed to sell. It is impossible to forecast what the market value of securities will be at the expiration of a contract. Accordingly, it may be necessary for the Portfolio to buy additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security is less than the amount of foreign currency the Portfolio is obligated to deliver and a decision is made to sell the security and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received on the sale of the portfolio security if its market value exceeds the amount of foreign currency the Portfolio is obligated to deliver. PAGE 130 The Portfolio's dealing in forward contracts will be limited to the transactions described above. This method of protecting the value of the Portfolio's securities against a decline in the value of a currency does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange that can be achieved at some point in time. Although such forward contracts tend to minimize the risk of loss due to a decline in value of hedged currency, they tend to limit any potential gain that might result should the value of such currency increase. Although the Portfolio values its assets each business day in terms of U.S. dollars, it does not intend to convert its foreign currencies into U.S. dollars on a daily basis. It will do so from time to time, and shareholders should be aware of currency conversion costs. Although foreign exchange dealers do not charge a fee for conversion, they do realize a profit based on the difference (spread) between the prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to the Portfolio at one rate, while offering a lesser rate of exchange should the Portfolio desire to resell that currency to the dealer. Options on Foreign Currencies. The Portfolio may buy put and write covered call options on foreign currencies for hedging purposes. For example, a decline in the dollar value of a foreign currency in which securities are denominated will reduce the dollar value of such securities, even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of securities, the Portfolio may buy put options on the foreign currency. If the value of the currency does decline, the Portfolio will have the right to sell such currency for a fixed amount in dollars and will thereby offset, in whole or in part, the adverse effect on its portfolio which otherwise would have resulted. As in the case of other types of options, however, the benefit to the Portfolio derived from purchases of foreign currency options will be reduced by the amount of the premium and related transaction costs. In addition, where currency exchange rates do not move in the direction or to the extent anticipated, the Portfolio could sustain losses on transactions in foreign currency options which would require it to forego a portion or all of the benefits of advantageous changes in such rates. The Portfolio may write options on foreign currencies for the same types of hedging purposes. For example, when the Portfolio anticipates a decline in the dollar value of foreign-denominated securities due to adverse fluctuations in exchange rates it could, instead of purchasing a put option, write a call option on the relevant currency. If the expected decline occurs, the option will most likely not be exercised and the diminution in value of securities will be fully or partially offset by the amount of the premium received. PAGE 131 As in the case of other types of options, however, the writing of a foreign currency option will constitute only a partial hedge up to the amount of the premium, and only if rates move in the expected direction. If this does not occur, the option may be exercised and the Portfolio would be required to buy or sell the underlying currency at a loss which may not be offset by the amount of the premium. Through the writing of options on foreign currencies, the Portfolio also may be required to forego all or a portion of the benefits which might otherwise have been obtained from favorable movements on exchange rates. All options written on foreign currencies will be covered. An option written on foreign currencies is covered if the Portfolio holds currency sufficient to cover the option or has an absolute and immediate right to acquire that currency without additional cash consideration upon conversion of assets denominated in that currency or exchange of other currency held in its portfolio. An option writer could lose amounts substantially in excess of its initial investments, due to the margin and collateral requirements associated with such positions. Options on foreign currencies are traded through financial institutions acting as market-makers, although foreign currency options also are traded on certain national securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Board Options Exchange, subject to SEC regulation. In an over-the- counter trading environment, many of the protections afforded to exchange participants will not be available. For example, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Although the purchaser of an option cannot lose more than the amount of the premium plus related transaction costs, this entire amount could be lost. Foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the Options Clearing Corporation (OCC), thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may be more readily available than in the over-the-counter market, potentially permitting the Portfolio to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, is subject to the risks of availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exchange-traded options on foreign PAGE 132 currencies involve certain risks not presented by the over-the- counter market. For example, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in certain foreign countries for the purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. Foreign Currency Futures and Related Options. The Portfolio may enter into currency futures contracts to sell currencies. It also may buy put options and write covered call options on currency futures. Currency futures contracts are similar to currency forward contracts, except that they are traded on exchanges (and have margin requirements) and are standardized as to contract size and delivery date. Most currency futures call for payment of delivery in U.S. dollars. The Portfolio may use currency futures for the same purposes as currency forward contracts, subject to Commodity Futures Trading Commission (CFTC) limitations. All futures contracts are aggregated for purposes of the percentage limitations. Currency futures and options on futures values can be expected to correlate with exchange rates, but will not reflect other factors that may affect the values of the Portfolio's investments. A currency hedge, for example, should protect a Yen-denominated bond against a decline in the Yen, but will not protect the Portfolio against price decline if the issuer's creditworthiness deteriorates. Because the value of the Portfolio's investments denominated in foreign currency will change in response to many factors other than exchange rates, it may not be possible to match the amount of a forward contract to the value of the Portfolio's investments denominated in that currency over time. The Portfolio will hold securities or other options or futures positions whose values are expected to offset its obligations. The Portfolio will not enter into an option or futures position that exposes the Portfolio to an obligation to another party unless it owns either (i) an offsetting position in securities or (ii) cash, receivables and short-term debt securities with a value sufficient to cover its potential obligations. PAGE 133 APPENDIX B OPTIONS AND INTEREST RATE FUTURES CONTRACTS The Portfolio may buy or write options traded on any U.S. or foreign exchange or in the over-the-counter market. The Portfolio may enter into interest rate futures contracts traded on any U.S. or foreign exchange. The Portfolio also may buy or write put and call options on these futures. Options in the over-the-counter market will be purchased only when the investment manager believes a liquid secondary market exists for the options and only from dealers and institutions the investment manager believes present a minimal credit risk. Some options are exercisable only on a specific date. In that case, or if a liquid secondary market does not exist, the Portfolio could be required to buy or sell securities at disadvantageous prices, thereby incurring losses. OPTIONS. An option is a contract. A person who buys a call option for a security has the right to buy the security at a set price for the length of the contract. A person who sells a call option is called a writer. The writer of a call option agrees to sell the security at the set price when the buyer wants to exercise the option, no matter what the market price of the security is at that time. A person who buys a put option has the right to sell a security at a set price for the length of the contract. A person who writes a put option agrees to buy the security at the set price if the purchaser wants to exercise the option, no matter what the market price of the security is at that time. An option is covered if the writer owns the security (in the case of a call) or sets aside the cash (in the case of a put) that would be required upon exercise. The price paid by the buyer for an option is called a premium. In addition the buyer generally pays a broker a commission. The writer receives a premium, less a commission, at the time the option is written. The cash received is retained by the writer whether or not the option is exercised. A writer of a call option may have to sell the security for a below-market price if the market price rises above the exercise price. A writer of a put option may have to pay an above-market price for the security if its market price decreases below the exercise price. Options can be used to produce incremental earnings, protect gains and facilitate buying and selling securities for investment purposes. The use of options and futures contracts may benefit the Portfolio and its shareholders by improving the Portfolio's liquidity and by helping to stabilize the value of its net assets. PAGE 134 Buying options. Put and call options may be used as a trading technique to facilitate buying and selling securities for investment reasons. Options are used as a trading technique to take advantage of any disparity between the price of the underlying security in the securities market and its price on the options market. It is anticipated the trading technique will be utilized only to effect a transaction when the price of the security plus the option price will be as good or better than the price at which the security could be bought or sold directly. When the option is purchased, the Portfolio pays a premium and a commission. It then pays a second commission on the purchase or sale of the underlying security when the option is exercised. For record-keeping and tax purposes, the price obtained on the purchase of the underlying security will be the combination of the exercise price, the premium and both commissions. When using options as a trading technique, commissions on the option will be set as if only the underlying securities were traded. Put and call options also may be held by the Portfolio for investment purposes. Options permit the Portfolio to experience the change in the value of a security with a relatively small initial cash investment. The risk the Portfolio assumes when it buys an option is the loss of the premium. To be beneficial to the Portfolio, the price of the underlying security must change within the time set by the option contract. Furthermore, the change must be sufficient to cover the premium paid, the commissions paid both in the acquisition of the option and in a closing transaction or in the exercise of the option and subsequent sale (in the case of a call) or purchase (in the case of a put) of the underlying security. Even then the price change in the underlying security does not ensure a profit since prices in the option market may not reflect such a change. Writing covered options. The Portfolio will write covered options when it feels it is appropriate and will follow these guidelines: 'Underlying securities will continue to be bought or sold solely on the basis of investment considerations consistent with the Portfolio's goal. 'All options written by the Portfolio will be covered. For covered call options if a decision is made to sell the security, the Portfolio will attempt to terminate the option contract through a closing purchase transaction. 'The Portfolio will write options only as permitted under federal or state laws or regulations, such as those that limit the amount of total assets subject to the options. While no limit has been set by the Portfolio, it will conform to the requirements of those states. For example, California limits the writing of options to 50% of the assets of a fund. PAGE 135 Net premiums on call options closed or premiums on expired call options are treated as short-term capital gains. Since the Portfolio is taxed as a regulated investment company under the Internal Revenue Code, any gains on options and other securities held less than three months must be limited to less than 30% of its annual gross income. If a covered call option is exercised, the security is sold by the Portfolio. The Portfolio will recognize a capital gain or loss based upon the difference between the proceeds and the security's basis. Options on many securities are listed on options exchanges. If the Portfolio writes listed options, it will follow the rules of the options exchange. Options are valued at the close of the New York Stock Exchange. An option listed on a national exchange, Chicago Board Options Exchange (CBOE) or NASDAQ will be valued at the last- quoted sales price or, if such a price is not readily available, at the mean of the last bid and asked prices. FUTURES CONTRACTS. A futures contract is an agreement between two parties to buy and sell a security for a set price on a future date. They have been established by boards of trade which have been designated contracts markets by the Commodity Futures Trading Commission (CFTC). Futures contracts trade on these markets in a manner similar to the way a stock trades on a stock exchange, and the boards of trade, through their clearing corporations, guarantee performance of the contracts. Currently, there are futures contracts based on such debt securities as long-term U.S. Treasury bonds, Treasury notes, GNMA modified pass-through mortgage-backed securities, three-month U.S. Treasury bills and bank certificates of deposit. While futures contracts based on debt securities do provide for the delivery and acceptance of securities, such deliveries and acceptances are very seldom made. Generally, the futures contract is terminated by entering into an offsetting transaction. An offsetting transaction for a futures contract sale is effected by the Portfolio entering into a futures contract purchase for the same aggregate amount of the specific type of financial instrument and same delivery date. If the price in the sale exceeds the price in the offsetting purchase, the Portfolio immediately is paid the difference and realizes a gain. If the offsetting purchase price exceeds the sale price, the Portfolio pays the difference and realizes a loss. Similarly, closing out a futures contract purchase is effected by the Portfolio entering into a futures contract sale. If the offsetting sale price exceeds the purchase price, the Portfolio realizes a gain, and if the offsetting sale price is less than the purchase price, the Portfolio realizes a loss. At the time a futures contract is made, a good-faith deposit called initial margin is set up within a segregated account at the Portfolio's custodian bank. The initial margin deposit is approximately 1.5% of a contract's face value. PAGE 136 Daily thereafter, the futures contract is valued and the payment of variation margin is required so that each day the Portfolio would pay out cash in an amount equal to any decline in the contract's value or receive cash equal to any increase. At the time a futures contract is closed out, a nominal commission is paid, which is generally lower than the commission on a comparable transaction in the cash markets. The purpose of a futures contract, in the case of a portfolio holding long-term debt securities, is to gain the benefit of changes in interest rates without actually buying or selling long- term debt securities. For example, if the Portfolio owned long- term bonds and interest rates were expected to increase, it might enter into futures contracts to sell securities which would have much the same effect as selling some of the long-term bonds it owned. Futures contracts are based on types of debt securities referred to above, which have historically reacted to an increase or decline in interest rates in a fashion similar to the debt securities the Portfolio owns. If interest rates did increase, the value of the debt securities in the portfolio would decline, but the value of the Portfolio's futures contracts would increase at approximately the same rate, thereby keeping the net asset value of the Portfolio from declining as much as it otherwise would have. If, on the other hand, the Portfolio held cash reserves and interest rates were expected to decline, the Portfolio might enter into interest rate futures contracts for the purchase of securities. If short- term rates were higher than long-term rates, the ability to continue holding these cash reserves would have a very beneficial impact on the Portfolio's earnings. Even if short-term rates were not higher, the Portfolio would still benefit from the income earned by holding these short-term investments. At the same time, by entering into futures contracts for the purchase of securities, the Portfolio could take advantage of the anticipated rise in the value of long-term bonds without actually buying them until the market had stabilized. At that time, the futures contracts could be liquidated and the Portfolio's cash reserves could then be used to buy long-term bonds on the cash market. The Portfolio could accomplish similar results by selling bonds with long maturities and investing in bonds with short maturities when interest rates are expected to increase or by buying bonds with long maturities and selling bonds with short maturities when interest rates are expected to decline. But by using futures contracts as an investment tool, given the greater liquidity in the futures market than in the cash market, it might be possible to accomplish the same result more easily and more quickly. Successful use of futures contracts depends on the investment manager's ability to predict the future direction of interest rates. If the investment manager's prediction is incorrect, the Portfolio would have been better off had it not entered into futures contracts. PAGE 137 OPTIONS ON FUTURES CONTRACTS. Options on futures contracts give the holder a right to buy or sell futures contracts in the future. Unlike a futures contract, which requires the parties to the contract to buy and sell a security on a set date, an option on a futures contract merely entitles its holder to decide on or before a future date (within nine months of the date of issue) whether to enter into such a contract. If the holder decides not to enter into the contract, all that is lost is the amount (premium) paid for the option. Furthermore, because the value of the option is fixed at the point of sale, there are no daily payments of cash to reflect the change in the value of the underlying contract. However, since an option gives the buyer the right to enter into a contract at a set price for a fixed period of time, its value does change daily and that change is reflected in the net asset value of the Portfolio. RISKS. There are risks in engaging in each of the management tools described above. The risk the Portfolio assumes when it buys an option is the loss of the premium paid for the option. Purchasing options also limits the use of monies that might otherwise be available for long-term investments. The risk involved in writing options on futures contracts the Portfolio owns, or on securities held in its portfolio, is that there could be an increase in the market value of such contracts or securities. If that occurred, the option would be exercised and the asset sold at a lower price than the cash market price. To some extent, the risk of not realizing a gain could be reduced by entering into a closing transaction. The Portfolio could enter into a closing transaction by purchasing an option with the same terms as the one it had previously sold. The cost to close the option and terminate the Portfolio's obligation, however, might be more or less than the premium received when it originally wrote the option. Furthermore, the Portfolio might not be able to close the option because of insufficient activity in the options market. A risk in employing futures contracts to protect against the price volatility of portfolio securities is that the prices of securities subject to futures contracts may not correlate perfectly with the behavior of the cash prices of the Portfolio's securities. The correlation may be distorted because the futures market is dominated by short-term traders seeking to profit from the difference between a contract or security price and their cost of borrowed funds. Such distortions are generally minor and would diminish as the contract approached maturity. PAGE 138 Another risk is that the Portfolio's investment manager could be incorrect in anticipating as to the direction or extent of various interest rate movements or the time span within which the movements take place. For example, if the Portfolio sold futures contracts for the sale of securities in anticipation of an increase in interest rates, and interest rates declined instead, the Portfolio would lose money on the sale. TAX TREATMENT. As permitted under federal income tax laws, the Portfolio intends to identify futures contracts as mixed straddles and not mark them to market, that is, not treat them as having been sold at the end of the year at market value. Such an election may result in the Portfolio being required to defer recognizing losses incurred by entering into futures contracts and losses on underlying securities identified as being hedged against. Federal income tax treatment of gains or losses from transactions in options on futures contracts and indexes will depend on whether such option is a section 1256 contract . If the option is a non- equity option, the Portfolio will either make a 1256(d) election and treat the option as a mixed straddle or mark to market the option at fiscal year end and treat the gain/loss as 40% short-term and 60% long-term. Certain provisions of the Internal Revenue Code may also limit the Portfolio's ability to engage in futures contracts and related options transactions. For example, at the close of each quarter of the Portfolio's taxable year, at least 50% of the value of its assets must consist of cash, government securities and other securities, subject to certain diversification requirements. Less than 30% of its gross income must be derived from sales of securities held less than three months. The IRS has ruled publicly that an exchange-traded call option is a security for purposes of the 50%-of-assets test and that its issuer is the issuer of the underlying security, not the writer of the option, for purposes of the diversification requirements. In order to avoid realizing a gain within the three-month period, the Portfolio may be required to defer closing out a contract beyond the time when it might otherwise be advantageous to do so. The Portfolio also may be restricted in purchasing put options for the purpose of hedging underlying securities because of applying the short sale holding period rules with respect to such underlying securities. Accounting for futures contracts will be according to generally accepted accounting principles. Initial margin deposits will be recognized as assets due from a broker (the Portfolio's agent in acquiring the futures position). During the period the futures contract is open, changes in value of the contract will be recognized as unrealized gains or losses by marking to market on a daily basis to reflect the market value of the contract at the end of each day's trading. Variation margin payments will be made or received depending upon whether gains or losses are incurred. All contracts and options will be valued at the last-quoted sales price on their primary exchange. PAGE 139 APPENDIX C MORTGAGE-BACKED SECURITIES A mortgage pass-through certificate is one that represents an interest in a pool, or group, of mortgage loans assembled by the Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) or non-governmental entities. In pass-through certificates, both principal and interest payments, including prepayments, are passed through to the holder of the certificate. Prepayments on underlying mortgages result in a loss of anticipated interest, and the actual yield (or total return) to the Portfolio, which is influenced by both stated interest rates and market conditions, may be different than the quoted yield on certificates. Some U.S. government securities may be purchased on a when-issued basis, which means that it may take as long as 45 days after the purchase before the securities are delivered to the Portfolio. Stripped Mortgage-Backed Securities. The Portfolio may invest in stripped mortgage-backed securities. Generally, there are two classes of stripped mortgage-backed securities: Interest Only (IO) and Principal Only (PO). IOs entitle the holder to receive distributions consisting of all or a portion of the interest on the underlying pool of mortgage loans or mortgage-backed securities. POs entitle the holder to receive distributions consisting of all or a portion of the principal of the underlying pool of mortgage loans or mortgage-backed securities. The cash flows and yields on IOs and POs are extremely sensitive to the rate of principal payments (including prepayments) on the underlying mortgage loans or mortgage-backed securities. A rapid rate of principal payments may adversely affect the yield to maturity of IOs. A slow rate of principal payments may adversely affect the yield to maturity of POs. On an IO, if prepayments of principal are greater than anticipated, an investor may incur substantial losses. If prepayments of principal are slower than anticipated, the yield on a PO will be affected more severely than would be the case with a traditional mortgage-backed security. Mortgage-Backed Security Spread Options. The Portfolio may purchase mortgage-backed security (MBS) put spread options and write covered MBS call spread options. MBS spread options are based upon the changes in the price spread between a specified mortgage-backed security and a like-duration Treasury security. MBS spread options are traded in the OTC market and are of short duration, typically one to two months. The Portfolio would buy or sell covered MBS call spread options in situations where mortgage- backed securities are expected to underperform like-duration Treasury securities. PAGE 140 APPENDIX D DOLLAR-COST AVERAGING A technique that works well for many investors is one that eliminates random buy and sell decisions. One such system is dollar-cost averaging. Dollar-cost averaging involves building a portfolio through the investment of fixed amounts of money on a regular basis regardless of the price or market condition. This may enable an investor to smooth out the effects of the volatility of the financial markets. By using this strategy, more shares will be purchased when the price is low and less when the price is high. As the accompanying chart illustrates, dollar-cost averaging tends to keep the average price paid for the shares lower than the average market price of shares purchased, although there is no guarantee. While this does not ensure a profit and does not protect against a loss if the market declines, it is an effective way for many shareholders who can continue investing through changing market conditions to accumulate shares in a fund to meet long-term goals. Dollar-cost averaging ___________________________________________________________________ Regular Market Price Shares Investment of a Share Acquired $100 $6.00 16.7 100 4.00 25.0 100 4.00 25.0 100 6.00 16.7 100 5.00 20.0 $500 $25.00 103.4 Average market price of a share over 5 periods: $5.00 ($25.00 divided by 5). The average price you paid for each share: $4.84 ($500 divided by 103.4). PAGE 141 STATEMENT OF DIFFERENCES Difference Description 1) The layout is different 1) Some of the layout in the throughout the annual report. annual report to shareholders is in two columns. 2) Headings. 2) The headings in the annual report and prospectus are placed in a blue strip at the top of the page. 3) There are pictures, icons 3) Each picture, icon and and graphs throughout the graph is described in annual report and prospectus. parentheses. 4) Footnotes for charts and 4) The footnotes for each graphs are described at chart or graph are typed the left margin. below the description of the chart or graph. -----END PRIVACY-ENHANCED MESSAGE-----