N-30D 1 s6042.txt AXP FEDERAL INCOME FUND AXP(R) Federal Income Fund 2002 ANNUAL REPORT (PROSPECTUS ENCLOSED) (icon of) clock American Express(R) Fund AXP Federal Income Fund seeks to provide shareholders with a high level of current income and safety of principal consistent with investment in U.S. government and government agency securities. (This annual report includes a prospectus that describes in detail the Fund's objective, investment strategy, risks, sales charges, fees and other matters of interest. Please read the prospectus carefully before you invest or send money.) A Comfortable Compromise Balancing risk and reward is something all investors must consider. In the fixed-income area, intermediate-term securities issued by the federal government and its agencies offer a good middle ground. These securities, which form the core of AXP Federal Income Fund, normally provide greater investment stability than long-term bonds, while still offering a yield higher than that of insured investments such as bank CDs. For a conservative investor, that can be a rewarding combination. Table of Contents 2002 ANNUAL REPORT The purpose of this annual report is to tell investors how the Fund performed. From the Chairman 3 Portfolio Manager Q & A 3 Fund Facts 6 Making the Most of the Fund 7 The Fund's Long-term Performance 8 Board Members and Officers 10 Independent Auditors' Report (Fund) 13 Financial Statements (Fund) 14 Notes to Financial Statements (Fund) 17 Independent Auditors' Report (Portfolio) 23 Financial Statements (Portfolio) 24 Notes to Financial Statements (Portfolio) 26 Investments in Securities 29 Federal Income Tax Information 32 ------------------------------------------------------------------------------- 2 AXP FEDERAL INCOME FUND -- ANNUAL REPORT (picture of) Arne H. Carlson Arne H. Carlson Chairman of the board From the Chairman Although we see reason for optimism as the U.S. economy slowly improves, various factors continue to create uncertainty in the financial markets. Warnings about terrorist activities, doubts about the reliability of companies' financial information and growing unrest around the world have contributed to a volatile environment in 2002. While this short-term volatility is unsettling, we encourage you to keep a long-term perspective when it comes to your investments. At times like these, it is important for you to assess your own financial needs, set short- and long-term goals and develop a plan to obtain these goals. Your personal financial advisor can be an important asset in helping you meet your goals. American Express Financial Corporation has set its own goals to assist you in meeting yours. It has taken steps toward improving the competitive ranking and investment performance of the American Express Funds and expanding the range of investment options. The members of the Board, the majority of whom are independent from American Express Financial Corporation, oversee these efforts and believe the steps that have been taken show promise for meeting the goals. This Fund will join the other American Express Funds in holding shareholder meetings in November. We believe it is important for your voice as a Fund shareholder to be heard. When you receive your proxy statement, please take the time to consider the proposals and vote. The Board's recommendation on each proposal will be outlined in the proxy statement. On behalf of the Board, Arne H. Carlson (picture of) Scott R. Kirby Scott R. Kirby Portfolio manager Portfolio Manager Q & A Q: How did AXP Federal Income Fund perform for the 12-month period ended May 31, 2002? A: In a period when many areas of the bond market struggled, we are generally satisfied with the performance results provided by AXP Federal Income Fund, which generated a solid return of 5.77% (Class A shares, not including sales charges). By comparison, the Lehman Brothers Aggregate Bond Index returned 8.10% while the Merrill Lynch 1-3 Year U.S. Government Index generated a return of 6.12%. Another comparative index, the Lipper Short U.S. Government Funds Index, gained 5.24% during the period. ------------------------------------------------------------------------------- 3 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Q: Please describe the overall market conditions for the period under review. A: The fiscal year began in the summer of 2001, with early signs developing that the U.S. economy was close to emerging from the doldrums that plagued it in previous months. The Federal Reserve continued to cut short-term interest rates modestly during that time in an effort to push the economy in a positive direction. However, the shocking events of September 11 sent the economy reeling in the immediate aftermath. In response, the Federal Reserve cut rates much more dramatically in a short span of time. During the weeks immediately following the terrorist attacks, a classic "flight to quality" by investors occurred, with U.S. Treasury securities drawing the most attention and enjoying the best performance. Interest rates declined on a broad range of debt securities. By contrast, mortgage-backed and government agency debt securities lagged the market. By early 2002, the situation again stabilized, as the Federal Reserve indicated it was done lowering short-term interest rates and the rate environment became far less volatile. Additionally, the supply of new issues in the mortgage-backed market declined at the same time a number of new buyers were coming into the market. Many investors backed away from corporate debt securities in light of the Enron situation and related problems, and turned instead to the mortgage market. Q: What factors most significantly impacted performance? A: In the first half of the Fund's fiscal year, the portfolio benefited from its concentration in Treasury securities, which performed well due to investors' flight to quality in the weeks following September 11. By November, interest rates began to creep upward, and we added more mortgage-backed securities to the portfolio. This proved to work well for our performance; from December through May, our holdings of mortgage-backed securities -- the largest position in the portfolio -- performed exceptionally well. This was in sharp contrast to their performance in the early months of the period under review, when the market's volatility and heavy refinancing of mortgages (resulting in prepayments of higher-yielding debt) took a toll on the returns of our mortgage-backed holdings. Treasuries performed well as a whole, particularly in an environment where interest rates on shorter-term U.S. government securities declined dramatically. It should be noted that we employ a strategy of using short sales and investments in derivatives such as futures, options and forward contracts in an effort to reduce volatility in the portfolio. If underlying securities perform well, these investments will suffer losses. However, they provide an important hedge against the effects of a possible downturn in the market and help to provide overall stability to the portfolio. ------------------------------------------------------------------------------ 4 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Q: What changes did you make to the Fund's portfolio? A: Early in the period, we invested more than half of the Fund's assets in mortgage-backed securities, which we believed to be attractively priced compared to U.S. Treasury securities. Treasury debt had performed particularly well up to that point. When the mortgage-backed market started improving, we slowly began to reduce our position, putting more money to work in short-term government agency debt securities. We believed the yield advantage these issues offered vis-a-vis Treasury debt was attractive, and were confident they would perform well in the current market environment, a situation that proved to be the case. Treasury securities, as always, continued to play an important role in the Fund as well. We maintained a relatively neutral stance in terms of the Fund's interest rate sensitivity throughout the period. Q: What is your outlook for the months ahead? A: It seems likely that as the U.S. economy continues to improve, interest rates will likely trend higher. While there could be some challenges ahead, we also anticipate that any change in interest rates will be modest. We look for the Federal Reserve to raise short-term interest rates sometime in 2002, but expect their approach to be a cautious one. In this environment, we expect that the best opportunities to generate a positive total return are likely to come from the Fund's dividend. Q: How are you positioning the Fund in light of your outlook? A: In order to protect the Fund's principal value, we are putting more focus on strategies designed to offset the impact of modestly rising interest rates. We anticipate that, barring any major unforeseen events, changes in interest rates will be relatively modest during the rest of 2002, and that will result in a manageable environment for the Fund. We will maintain a cautious position in the near term in regard to the Fund's interest rate sensitivity. We will look to achieve the highest dividend that is reasonable within our risk constraints, as income will probably make up most or all of the Fund's return in the months ahead. Scott R. Kirby ------------------------------------------------------------------------------- 5 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Fund Facts Class A -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2002 $4.85 May 31, 2001 $4.78 Increase $0.07 Distributions -- June 1, 2001 - May 31, 2002 From income $0.20 From long-term capital gains $ -- Total distributions $0.20 Total return* +5.77% Class B -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2002 $4.85 May 31, 2001 $4.78 Increase $0.07 Distributions -- June 1, 2001 - May 31, 2002 From income $0.17 From long-term capital gains $ -- Total distributions $0.17 Total return* +4.98% Class C -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2002 $4.85 May 31, 2001 $4.78 Increase $0.07 Distributions -- June 1, 2001 - May 31, 2002 From income $0.17 From long-term capital gains $ -- Total distributions $0.17 Total return* +4.98% Class Y -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2002 $4.85 May 31, 2001 $4.78 Increase $0.07 Distributions -- June 1, 2001 - May 31, 2002 From income $0.21 From long-term capital gains $ -- Total distributions $0.21 Total return* +5.93% * The total return is a hypothetical investment in the Fund with all distributions reinvested. Returns do not include sales load. The prospectus discusses the effect of sales charges, if any, on the various classes. ------------------------------------------------------------------------------- 6 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Making the Most of the Fund 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. The chart below shows how dollar-cost averaging works. In these three hypothetical scenarios, you will see six months of share price fluctuations. This strategy 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 even when the price of your shares falls or the market declines, it can be an effective way to accumulate shares to meet your long-term goals. How dollar-cost averaging works Jan Feb Mar Apr May Jun $15 $16 $18 $20 $10 $10 $12 $14 $ 5 Accumulated shares* Average market Your average price per share cost per share 42.25 $15 $14.20 ------------------------------------------------------------------------------- Jan Feb Mar Apr May Jun $15 $10 $10 $10 $ 5 $8 $5 $5 $8 Accumulated shares* Average market Your average price per share cost per share 85.0 $7.66 $7.05 ------------------------------------------------------------------------------- Jan Feb Mar Apr May Jun $15 $10 $10 $ 5 $8 $6 $4 $4 $7 Accumulated shares* Average market Your average price per share cost per share 103.5 $6.50 $5.80 ------------------------------------------------------------------------------- $100 invested per month. Total invested: $600. * Shares purchased is determined by dividing the amount invested per month by the current share price. 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 dividends, interest and other income exceed its expenses. All three make up your total return. 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 ------------------------------------------------------------------------------- 7 AXP FEDERAL INCOME FUND -- ANNUAL REPORT The Fund's Long-term Performance Value of your $10,000 in AXP Federal Income Fund (line chart) $30,000 $16,919 AXP Federal Income Fund Class A Lehman Brothers Aggregate Bond Index Merrill Lynch 1-3 Year U.S. Government Index $20,000 Lipper Short U.S. Government Funds Index $9,525 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 Average Annual Total Returns (as of May 31, 2002) 1 year 5 years 10 years Since inception Class A +0.75% +4.56% +5.40% N/A Class B +0.98% +4.62% N/A +5.47%* Class C +4.98% N/A N/A +6.77%** Class Y +5.93% +5.70% N/A +6.42%* * Inception date was March 20, 1995. ** Inception date was June 26, 2000. Assumes: Holding period from 6/1/92 to 5/31/02. Returns do not reflect taxes payable on distributions. Reinvestment of all income and capital gain distributions for the Fund has a value of $8,375. Also see "Past Performance" in the Fund's current prospectus. On the graph above you can see how the Fund's total return compared to three widely cited performance indexes, the Lehman Brothers Aggregate Bond Index, the Lipper Short U.S. Government Funds Index, and the Merrill Lynch 1-3 Year U.S. Government Index. In comparing AXP Federal Income Fund (Class A) to the three indexes, you should take into account the fact that the Fund's performance reflects the maximum sales charge of 4.75%, while such charges are not reflected in the performance of the indexes. 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 impact of the maximum applicable sales charge. This was a period of widely fluctuating security prices. Past performance is no guarantee of future results. ------------------------------------------------------------------------------- 8 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Lehman Brothers Aggregate Bond Index, an unmanaged index, is made up of a representative list of government, corporate, asset-backed and mortgage-backed securities. The index is frequently used as a general measure of bond market performance. The index reflects reinvestment of all distributions and changes in market prices, but excludes brokerage commissions or other fees. However, the securities used to create the index may not be representative of the bonds held in the Fund. The Lipper Short U.S. Government Funds Index, published by Lipper Inc., includes the 30 largest funds that are generally similar to the Fund, although some funds in the index may have somewhat different investment policies and objectives. Merrill Lynch 1-3 Year U.S. Government Index, an unmanaged index, is made up of a representative list of government bonds. The index is frequently used a general measure of government bond performance. However, the securities used to create the index may not be representative of the bonds held in the Fund. ------------------------------------------------------------------------------- 9 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Board Members and Officers Shareholders elect a board that oversees the Fund's operations. The board appoints officers who are responsible for day-to-day business decisions based on policies set by the board. The following is a list of the Fund's board members. Each member oversees 15 Master Trust portfolios and 78 American Express mutual funds. Board members serve until the next regular shareholders' meeting or until he or she reaches the mandatory retirement age established by the board.
Independent Board Members Name, address, age Position held with Principal occupations during Other directorships Registrant and past five years length of service -------------------------------- -------------------- --------------------------------- ------------------------------- H. Brewster Atwater, Jr. Board member since Retired chair and chief 4900 IDS Tower 1996 executive officer, General Minneapolis, MN 55402 Mills, Inc. (consumer foods) Born in 1931 -------------------------------- -------------------- --------------------------------- ------------------------------- Arne H. Carlson Chair of the Board Chair, Board Services 901 S. Marquette Ave. since 1999 Corporation (provides Minneapolis, MN 55402 administrative services to Born in 1934 boards), former Governor of Minnesota -------------------------------- -------------------- --------------------------------- ------------------------------- Lynne V. Cheney Board member since Distinguished Fellow, AEI The Reader's Digest American Enterprise Institute 1994 Association Inc. for Public Policy Research (AEI) 1150 17th St., N.W. Washington, D.C. 20036 Born in 1941 -------------------------------- -------------------- --------------------------------- ------------------------------- Livio D. DeSimone Board member since Retired chair of the board and Cargill, Incorporated 30 Seventh Street East 2001 chief executive officer, (commodity merchants and Suite 3050 Minnesota Mining and processors), Target St. Paul, MN 55101-4901 Manufacturing (3M) Corporation (department Born in 1936 stores), General Mills, Inc. (consumer foods), Vulcan Materials Company (construction materials/chemicals) and Milliken & Company (textiles and chemicals) -------------------------------- -------------------- --------------------------------- ------------------------------- Ira D. Hall Board member since Private investor; formerly with Imagistics International, Texaco, Inc. 2001 Texaco Inc., treasurer, Inc. (office equipment), 2000 Westchester Avenue 1999-2001 and general manager, Reynolds & Reynolds Company White Plains, NY 10650 alliance management operations, (information services), TECO Born in 1944 1998-1999. Prior to that, Energy, Inc. (energy holding director, International company), The Williams Operations IBM Corp. Companies, Inc. (energy distribution company) -------------------------------- -------------------- --------------------------------- ------------------------------- Heinz F. Hutter Board member since Retired president and chief P.O. Box 2187 1994 operating officer, Cargill, Minneapolis, MN 55402 Incorporated (commodity Born in 1929 merchants and processors) -------------------------------- -------------------- --------------------------------- ------------------------------- Anne P. Jones Board member since Attorney and consultant Motorola, Inc. (electronics) 5716 Bent Branch Rd. 1985 Bethesda, MD 20816 Born in 1935 -------------------------------- -------------------- --------------------------------- -------------------------------
-------------------------------------------------------------------------------- 10 AXP FEDERAL INCOME FUND -- ANNUAL REPORT
Independent Board Members (continued) Name, address, age Position held with Principal occupations during Other directorships Registrant and past five years length of service -------------------------------- -------------------- --------------------------------- ------------------------------- Stephen R. Lewis, Jr. Board member since President and professor of Carleton College 2002 economics, Carleton College One North College Street Northfield, MN 55057 Born in 1939 -------------------------------- -------------------- --------------------------------- ------------------------------- William R. Pearce Board member since RII Weyerhaeuser World 2050 One Financial Plaza 1980 Timberfund, L.P. (develops Minneapolis, MN 55402 timber resources) - management Born in 1927 committee; former chair, American Express Funds -------------------------------- -------------------- --------------------------------- ------------------------------- Alan G. Quasha Board member since President, Quadrant Management, 720 Fifth Avenue 2002 Inc. (management of private New York, NY 10019 equities) Born in 1949 -------------------------------- -------------------- --------------------------------- ------------------------------- Alan K. Simpson Board member since Former three-term United States Biogen, Inc. 1201 Sunshine Ave. 1997 Senator for Wyoming (bio-pharmaceuticals) Cody, WY 82414 Born in 1931 -------------------------------- -------------------- --------------------------------- ------------------------------- C. Angus Wurtele Board member since Retired chair of the board and Bemis Corporation (packaging) 4900 IDS Tower 1994 chief executive officer, The Minneapolis, MN 55402 Valspar Corporation Born in 1934 -------------------------------- -------------------- --------------------------------- ------------------------------- Board Members Affiliated with American Express Financial Corporation (AEFC) Name, address, age Position held with Principal occupations during Other directorships Registrant and past five years length of service -------------------------------- -------------------- --------------------------------- ------------------------------- David R. Hubers Board member since Retired chief executive officer Chronimed Inc. (specialty 50643 AXP Financial Center 1993 and director of AEFC pharmaceutical distribution), Minneapolis, MN 55474 RTW Inc. (manages worker's Born in 1943 compensation programs), Lawson Software, Inc. (technology based business applications) -------------------------------- -------------------- --------------------------------- ------------------------------- John R. Thomas Board member since Senior vice president - 50652 AXP Financial Center 1987, president information and technology of Minneapolis, MN 55474 since 1997 AEFC Born in 1937 -------------------------------- -------------------- --------------------------------- ------------------------------- William F. Truscott Board member since Senior vice president - chief 53600 AXP Financial Center 2001, vice investment officer of AEFC; Minneapolis, MN 55474 president since former chief investment officer Born in 1960 2002 and managing director, Zurich Scudder Investments -------------------------------- -------------------- --------------------------------- -------------------------------
-------------------------------------------------------------------------------- 11 AXP FEDERAL INCOME FUND -- ANNUAL REPORT The board has appointed officers who are responsible for day-to-day business decisions based on policies it has established. The officers serve at the pleasure of the board. In addition to Mr. Thomas, who is president, and Mr. Truscott, who is vice president, the Fund's other officers are:
Other Officers Name, address, age Position held with Principal occupations during Other directorships Registrant and past five years length of service -------------------------------- -------------------- --------------------------------- ------------------------------- Leslie L. Ogg Vice president, President of Board Services 901 S. Marquette Ave. general counsel Corporation Minneapolis, MN 55402 and secretary Born in 1938 since 1978 -------------------------------- -------------------- --------------------------------- ------------------------------- Paul D. Pearson Acting treasurer Vice president - managed 222 AXP Financial Center since 2002 assets/investment accounting, Minneapolis, MN 55474 AEFC, 1998 to present; vice Born in 1956 president-mutual fund administrative services, Piper Capital Management, 1994-1998 -------------------------------- -------------------- --------------------------------- ------------------------------- Stephen W. Roszell Vice president Senior vice president - 50239 AXP Financial Center since 2002 institutional group of AEFC Minneapolis, MN 55474 Born in 1949 -------------------------------- -------------------- --------------------------------- -------------------------------
The SAI has additional information about the Fund's directors and is available, without charge, upon request by calling (800) 862-7919. ------------------------------------------------------------------------------- 12 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Independent Auditors' Report THE BOARD AND SHAREHOLDERS AXP FEDERAL INCOME FUND, INC. We have audited the accompanying statement of assets and liabilities of AXP Federal Income Fund (a series of AXP Federal Income Fund, Inc.) as of May 31, 2002, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended May 31, 2002, and the financial highlights for each of the years in the five-year period ended May 31, 2002. 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 auditing standards generally accepted in the United States of America. 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. 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 AXP Federal Income Fund as of May 31, 2002, and the results of its operations, changes in its net assets and the financial highlights for each of the periods stated in the first paragraph above, in conformity with acccounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 5, 2002 ------------------------------------------------------------------------------- 13 AXP FEDERAL INCOME FUND -- ANNUAL REPORT
Financial Statements Statement of assets and liabilities AXP Federal Income Fund May 31, 2002 Assets Investment in Portfolio (Note 1) $2,507,447,398 Capital shares receivable 560,172 ------- Total assets 2,508,007,570 ------------- Liabilities Dividends payable to shareholders 1,365,743 Capital shares payable 52,729 Accrued distribution fee 39,177 Accrued service fee 515 Accrued transfer agency fee 8,322 Accrued administrative services fee 3,162 Other accrued expenses 549,312 ------- Total liabilities 2,018,960 --------- Net assets applicable to outstanding capital stock $2,505,988,610 ============== Represented by Capital stock -- $.01 par value (Note 1) $ 5,166,468 Additional paid-in capital 2,683,021,023 Excess of distributions over net investment income (1,764,484) Accumulated net realized gain (loss) (Note 5) (213,731,863) Unrealized appreciation (depreciation) on investments 33,297,466 ---------- Total -- representing net assets applicable to outstanding capital stock $2,505,988,610 ============== Net assets applicable to outstanding shares: Class A $1,184,740,687 Class B $1,104,171,842 Class C $ 28,869,670 Class Y $ 188,206,411 Net asset value per share of outstanding capital stock: Class A shares 244,242,011 $ 4.85 Class B shares 227,652,099 $ 4.85 Class C shares 5,950,977 $ 4.85 Class Y shares 38,801,761 $ 4.85 ---------- --------------
See accompanying notes to financial statements. ------------------------------------------------------------------------------- 14 AXP FEDERAL INCOME FUND -- ANNUAL REPORT
Statement of operations AXP Federal Income Fund Year ended May 31, 2002 Investment income Income: Interest $117,775,837 ------------ Expenses (Note 2): Expenses allocated from Portfolio 12,276,481 Distribution fee Class A 2,890,834 Class B 10,269,882 Class C 157,907 Transfer agency fee 2,339,424 Incremental transfer agency fee Class A 113,504 Class B 151,420 Class C 2,907 Service fee -- Class Y 175,964 Administrative services fees and expenses 1,110,881 Compensation of board members 12,551 Printing and postage 470,300 Registration fees 247,946 Audit fees 11,750 Other 17,422 ------ Total expenses 30,249,173 Earnings credits on cash balances (Note 2) (70,081) ------- Total net expenses 30,179,092 ---------- Investment income (loss) -- net 87,596,745 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions 40,981,633 Futures contracts (16,578,269) Options contracts written 3,694,258 Short positions in securities (1,241,701) ---------- Net realized gain (loss) on investments 26,855,921 Net change in unrealized appreciation (depreciation) on investments 7,407,446 --------- Net gain (loss) on investments 34,263,367 ---------- Net increase (decrease) in net assets resulting from operations $121,860,112 ============
See accompanying notes to financial statements. ------------------------------------------------------------------------------- 15 AXP FEDERAL INCOME FUND -- ANNUAL REPORT
Statements of changes in net assets AXP Federal Income Fund Year ended May 31, 2002 2001 Operations and distributions Investment income (loss) -- net $ 87,596,745 $ 113,187,460 Net realized gain (loss) on investments 26,855,921 (17,589,286) Net change in unrealized appreciation (depreciation) on investments 7,407,446 103,404,118 --------- ----------- Net increase (decrease) in net assets resulting from operations 121,860,112 199,002,292 ----------- ----------- Distributions to shareholders from: Net investment income Class A (47,915,014) (59,338,208) Class B (34,663,888) (43,267,360) Class C (508,158) (145,067) Class Y (7,572,107) (9,058,042) ---------- ---------- Total distributions (90,659,167) (111,808,677) ----------- ------------ Capital share transactions (Note 3) Proceeds from sales Class A shares (Note 2) 657,601,521 557,031,191 Class B shares 705,152,428 616,334,169 Class C shares 31,377,389 11,695,359 Class Y shares 67,870,113 73,132,540 Reinvestment of distributions at net asset value Class A shares 41,925,856 50,921,168 Class B shares 32,558,359 40,707,729 Class C shares 466,925 135,612 Class Y shares 7,409,925 9,136,754 Payments for redemptions Class A shares (576,657,354) (743,174,447) Class B shares (Note 2) (558,439,712) (763,027,277) Class C shares (Note 2) (10,096,220) (4,929,639) Class Y shares (50,063,214) (102,610,026) ----------- ------------ Increase (decrease) in net assets from capital share transactions 349,106,016 (254,646,867) ----------- ------------ Total increase (decrease) in net assets 380,306,961 (167,453,252) Net assets at beginning of year 2,125,681,649 2,293,134,901 ------------- ------------- Net assets at end of year $2,505,988,610 $2,125,681,649 ============== ============== Undistributed (excess of distributions over) net investment income $ (1,764,484) $ 1,050,228 -------------- --------------
See accompanying notes to financial statements. ------------------------------------------------------------------------------- 16 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Notes to Financial Statements AXP Federal Income Fund 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Fund is a series of AXP Federal Income Fund, Inc. and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. AXP Federal Income Fund, Inc. has 10 billion authorized shares of capital stock that can be allocated among the separate series as designated by the board. Class C shares of the Fund were offered to the public on June 26, 2000. Prior to this date, American Express Financial Corporation (AEFC) purchased 862 shares of capital stock at $4.64 per share, which represented the initial capital in Class C. The Fund offers Class A, Class B, Class C and Class Y shares. o Class A shares are sold with a front-end sales charge. o Class B shares may be subject to a contingent deferred sales charge (CDSC) and automatically convert to Class A shares during the ninth calendar year of ownership. o Class C shares may be subject to a CDSC. o Class Y shares have no sales charge and are offered only to qualifying institutional investors. All classes of shares have identical voting, dividend and liquidation rights. The distribution fee, incremental transfer agency fee and service fee (class specific expenses) differ 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. Investment in Government Income Portfolio The Fund invests all of its assets in Government Income Portfolio (the Portfolio), a series of Income Trust (the Trust), an open-end investment company that has the same objectives as the Fund. The Portfolio invests primarily in U.S. government and government agency securities. The Fund records daily its share of the Portfolio's income, expenses and realized and unrealized gains and losses. The financial statements of the Portfolio are included elsewhere in this report and should be read in conjunction with the Fund's financial statements. The Fund records its investment in the Portfolio at the value that is equal to the Fund's proportionate ownership interest in the Portfolio's net assets. The percentage of the Portfolio owned by the Fund as of May 31, 2002 was 99.99%. Valuation of securities held by the Portfolio is discussed in Note 1 of the Portfolio's "Notes to financial statements" (included elsewhere in this report). Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities, and contingent assets and liabilities) that could differ from actual results. Federal taxes The Fund's policy is to comply with all sections of the Internal Revenue Code that apply to regulated investment companies and to distribute substantially all of its taxable income to the shareholders. No provision for income or excise taxes is thus required. ------------------------------------------------------------------------------- 17 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Net investment income (loss) and net realized gains (losses) may differ for financial statement and tax purposes primarily because of deferred losses on certain futures contracts 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 increased by $247,710 resulting in a net reclassification adjustment to decrease paid-in capital by 247,710. The tax character of distributions paid for the years indicated is as follows: Year ended May 31, 2002 2001 Class A Distributions paid from Ordinary income $47,915,014 $59,338,208 Long-term capital gain -- -- Class B Distributions paid from: Ordinary income 34,663,888 43,267,360 Long-term capital gain -- -- Class C Distributions paid from: Ordinary income 508,158 145,067 Long-term capital gain -- -- Class Y Distributions paid from: Ordinary income 7,572,107 9,058,042 Long-term capital gain -- -- As of May 31, 2002, the components of distributable earnings on a tax basis are as follows: Undistributed ordinary income $ -- Accumulated gain (loss) $(182,550,267) Unrealized appreciation (depreciation) $ 2,115,861 Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, when available, 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. 2. EXPENSES AND SALES CHARGES In addition to the expenses allocated from the Portfolio, the Fund accrues its own expenses as follows: The Fund has an agreement with AEFC to provide administrative services. Under an Administrative Services Agreement, the Fund pays AEFC a fee 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. A minor portion of additional administrative service expenses paid by the Fund are consultants' fees and fund office expenses. Under this agreement, the Fund also pays taxes, audit and certain legal fees, registration fees for shares, compensation of board members, corporate filing fees and any other expenses properly payable by the Fund and approved by the board. ------------------------------------------------------------------------------- 18 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Under a separate Transfer Agency Agreement, American Express Client Service Corporation (AECSC) maintains shareholder accounts and records. The incremental transfer agency fee is the amount charged to the specific classes for the additional expense above the fee for Class Y. The Fund pays AECSC an annual fee per shareholder account for this service as follows: o Class A $19.50 o Class B $20.50 o Class C $20.00 o Class Y $17.50 The Fund has agreements with American Express Financial Advisors Inc. (the Distributor) for distribution and shareholder services. Under a Plan and Agreement of Distribution, the Fund pays a distribution fee at an annual rate up to 0.25% of the Fund's average daily net assets attributable to Class A shares and up to 1.00% for Class B and Class C shares. Under a Shareholder Service Agreement, the Fund pays the Distributor a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.10% of the Fund's average daily net assets attributable to Class Y shares. Sales charges received by the Distributor for distributing Fund shares were $9,111,991 for Class A, $1,224,887 for Class B and $14,819 for Class C for the year ended May 31, 2002. During the year ended May 31, 2002, the Fund's transfer agency fees were reduced by $70,081 as a result of earnings credits from overnight cash balances. 3. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the years indicated are as follows:
Year ended May 31, 2002 Class A Class B Class C Class Y Sold 135,903,504 145,765,262 6,484,859 14,030,804 Issued for reinvested distributions 8,677,586 6,738,998 96,601 1,533,797 Redeemed (119,296,103) (115,594,195) (2,088,331) (10,364,442) ------------ ------------ ---------- ----------- Net increase (decrease) 25,284,987 36,910,065 4,493,129 5,200,159 ---------- ---------- --------- --------- Year ended May 31, 2001 Class A Class B Class C* Class Y Sold 117,838,668 130,460,620 2,468,176 15,440,033 Issued for reinvested distributions 10,793,813 8,634,876 28,527 1,937,886 Redeemed (157,861,929) (162,183,223) (1,038,855) (21,830,395) ------------ ------------ ---------- ----------- Net increase (decrease) (29,229,448) (23,087,727) 1,457,848 (4,452,476) ----------- ----------- --------- ----------
* Inception date was June 26, 2000. ------------------------------------------------------------------------------- 19 AXP FEDERAL INCOME FUND -- ANNUAL REPORT 4. BANK BORROWINGS The Fund has a revolving credit agreement with U.S. Bank, N.A., whereby the Fund is permitted to have bank borrowings for temporary or emergency purposes to fund shareholder redemptions. The Fund must have asset coverage for borrowings not to exceed the aggregate of 333% of advances equal to or less than five business days plus 367% of advances over five business days. The agreement, which enables the Fund to participate with other American Express mutual funds, permits borrowings up to $200 million, collectively. Interest is charged to each Fund based on its borrowings at a rate equal to the Federal Funds Rate plus 0.30% or the Eurodollar Rate (Reserve Adjusted) plus 0.20%. Borrowings are payable up to 90 days after such loan is executed. The Fund also pays a commitment fee equal to its pro rata share of the amount of the credit facility at a rate of 0.05% per annum. The Fund had no borrowings outstanding during the year ended May 31, 2002. 5. CAPITAL LOSS CARRY-OVER For federal income tax purposes, the Fund has a capital loss carry-over of $182,550,267 as of May 31, 2002, that if not offset by capital gains, will expire in 2008 through 2011. It is unlikely the board will authorize a distribution of any net realized capital gains until the available capital loss carry-over has been offset or expires. ------------------------------------------------------------------------------- 20 AXP FEDERAL INCOME FUND -- ANNUAL REPORT 6. FINANCIAL HIGHLIGHTS The tables below show certain important financial information for evaluating the Fund's results.
Class A Per share income and capital changes(a) Fiscal period ended May 31, 2002 2001 2000 1999 1998 Net asset value, beginning of period $4.78 $4.59 $4.94 $5.08 $4.98 Income from investment operations: Net investment income (loss) .19 .27 .27 .27 .30 Net gains (losses) (both realized and unrealized) .08 .19 (.27) (.07) .10 Total from investment operations .27 .46 -- .20 .40 Less distributions: Dividends from net investment income (.20) (.27) (.28) (.27) (.30) Distributions from realized gains -- -- (.07) (.07) -- Total distributions (.20) (.27) (.35) (.34) (.30) Net asset value, end of period $4.85 $4.78 $4.59 $4.94 $5.08 Ratios/supplemental data Net assets, end of period (in millions) $1,185 $1,047 $1,139 $1,723 $1,403 Ratio of expenses to average daily net assets(c) .95% .98% .92% .88% .86% Ratio of net investment income (loss) to average daily net assets 4.01% 5.72% 5.71% 5.36% 5.89% Portfolio turnover rate (excluding short-term securities) 267% 366% 674% 278% 159% Total return(e) 5.77% 10.19% (.01%) 4.07% 8.15% Class B Per share income and capital changes(a) Fiscal period ended May 31, 2002 2001 2000 1999 1998 Net asset value, beginning of period $4.78 $4.59 $4.94 $5.08 $4.98 Income from investment operations: Net investment income (loss) .16 .24 .24 .23 .26 Net gains (losses) (both realized and unrealized) .08 .18 (.28) (.07) .10 Total from investment operations .24 .42 (.04) .16 .36 Less distributions: Dividends from net investment income (.17) (.23) (.24) (.23) (.26) Distributions from realized gains -- -- (.07) (.07) -- Total distributions (.17) (.23) (.31) (.30) (.26) Net asset value, end of period $4.85 $4.78 $4.59 $4.94 $5.08 Ratios/supplemental data Net assets, end of period (in millions) $1,104 $912 $981 $1,498 $1,045 Ratio of expenses to average daily net assets(c) 1.71% 1.73% 1.68% 1.63% 1.61% Ratio of net investment income (loss) to average daily net assets 3.25% 4.96% 4.95% 4.61% 5.13% Portfolio turnover rate (excluding short-term securities) 267% 366% 674% 278% 159% Total return(e) 4.98% 9.36% (.77%) 3.31% 7.32%
See accompanying notes to financial highlights. ------------------------------------------------------------------------------- 21 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Class C Per share income and capital changes(a) Fiscal period ended May 31, 2002 2001(b) Net asset value, beginning of period $4.78 $4.63 Income from investment operations: Net investment income (loss) .16 .22 Net gains (losses) (both realized and unrealized) .08 .14 Total from investment operations .24 .36 Less distributions: Dividends from net investment income (.17) (.21) Net asset value, end of period $4.85 $4.78 Ratios/supplemental data Net assets, end of period (in millions) $29 $7 Ratio of expenses to average daily net assets(c) 1.72% 1.73%(d) Ratio of net investment income (loss) to average daily net assets 3.09% 4.93%(d) Portfolio turnover rate (excluding short-term securities) 267% 366% Total return(e) 4.98% 8.08%
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2002 2001 2000 1999 1998 Net asset value, beginning of period $4.78 $4.59 $4.94 $5.08 $4.98 Income from investment operations: Net investment income (loss) .20 .28 .28 .28 .30 Net gains (losses) (both realized and unrealized) .08 .19 (.28) (.07) .10 Total from investment operations .28 .47 -- .21 .40 Less distributions: Dividends from net investment income (.21) (.28) (.28) (.28) (.30) Distributions from realized gains -- -- (.07) (.07) -- Total distributions (.21) (.28) (.35) (.35) (.30) Net asset value, end of period $4.85 $4.78 $4.59 $4.94 $5.08 Ratios/supplemental data Net assets, end of period (in millions) $188 $161 $175 $191 $119 Ratio of expenses to average daily net assets(c) .79% .82% .78% .80% .78% Ratio of net investment income (loss) to average daily net assets 4.17% 5.89% 5.92% 5.44% 5.97% Portfolio turnover rate (excluding short-term securities) 267% 366% 674% 278% 159% Total return(e) 5.93% 10.36% .15% 4.15% 8.23%
Notes to financial highlights (a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Inception date was June 26, 2000. (c) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (d) Adjusted to an annual basis. (e) Total return does not reflect payment of a sales charge. ------------------------------------------------------------------------------- 22 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Independent Auditors' Report THE BOARD OF TRUSTEES AND UNITHOLDERS INCOME TRUST We have audited the accompanying statement of assets and liabilities, including the schedule of investments in securities, of Government Income Portfolio (a series of Income Trust) as of May 31, 2002, the related statement of operations for the year then ended and the statements of changes in net assets for each of the years in the two-year period ended May 31, 2002. These financial statements are the responsibility of portfolio management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of May 31, 2002, by correspondence with the custodian and brokers or by 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 Government Income Portfolio as of May 31, 2002, and the results of its operations and the changes in its net assets for each of the periods stated in the first paragraph above, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 5, 2002 ------------------------------------------------------------------------------- 23 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Financial Statements
Statement of assets and liabilities Government Income Portfolio May 31, 2002 Assets Investments in securities, at value (Note 1)* (identified cost $2,670,101,340) $2,704,997,993 Accrued interest receivable 17,912,552 Receivable for investment securities sold 108,671,812 ----------- Total assets 2,831,582,357 ------------- Liabilities Disbursements in excess of cash on demand deposit 4,050,372 Payable for investment securities purchased 83,080,630 Payable upon return of securities loaned (Note 5) 234,041,562 Accrued investment management services fee 34,406 Other accrued expenses 70,788 Options contracts written, at value (premiums received $1,119,785) (Note 6) 2,742,145 --------- Total liabilities 324,019,903 ----------- Net assets $2,507,562,454 ============== *Including securities on loan, at value (Note 5) $ 227,538,230 --------------
See accompanying notes to financial statements. ------------------------------------------------------------------------------- 24 AXP FEDERAL INCOME FUND -- ANNUAL REPORT
Statement of operations Government Income Portfolio Year ended May 31, 2002 Investment income Income: Interest $117,770,578 ------------ Expenses (Note 2): Investment management services fee 11,933,863 Compensation of board members 15,885 Custodian fees 234,100 Audit fees 35,500 Other 61,784 ------ Total expenses 12,281,132 Earnings credits on cash balances (Note 2) (4,073) ------ Total net expenses 12,277,059 ---------- Investment income (loss) -- net 105,493,519 ----------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) 40,983,839 Futures contracts (16,579,017) Options contracts written (Note 6) 3,694,453 Short positions in securities (1,241,758) ---------- Net realized gain (loss) on investments 26,857,517 Net change in unrealized appreciation (depreciation) on investments 7,407,629 --------- Net gain (loss) on investments and foreign currencies 34,265,146 ---------- Net increase (decrease) in net assets resulting from operations $139,758,665 ============
Statements of changes in net assets Government Income Portfolio Year ended May 31, 2002 2001 Operations Investment income (loss) -- net $ 105,493,519 $ 128,697,649 Net realized gain (loss) on investments 26,857,517 (17,587,664) Net change in unrealized appreciation (depreciation) on investments 7,407,629 103,416,833 --------- ----------- Net increase (decrease) in net assets resulting from operations 139,758,665 214,526,818 ----------- ----------- Proceeds from contributions 442,781,541 271,016,075 Fair value of withdrawals (202,909,108) (655,033,856) ------------ ------------ Net contributions (withdrawals) from partners 239,872,433 (384,017,781) ----------- ------------ Total increase (decrease) in net assets 379,631,098 (169,490,963) Net assets at beginning of year 2,127,931,356 2,297,422,319 ------------- ------------- Net assets at end of year $2,507,562,454 $2,127,931,356 ============== ==============
See accompanying notes to financial statements. ------------------------------------------------------------------------------- 25 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Notes to Financial Statements Government Income Portfolio 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Government Income Portfolio (the Portfolio) is a series of Income Trust (the Trust) and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. The Portfolio seeks to provide a high level of current income and safety of principal consistent with investment in U.S. government and government agency securities. The Declaration of Trust permits the Trustees to issue non-transferable interests in the Portfolio. The Portfolio's significant accounting policies are summarized below: Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. 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. Debt securities are generally traded in the over-the-counter market and are valued at a price that reflects fair value as quoted by dealers in these securities or by an independent pricing service. Securities for which market quotations are not readily available are valued at fair value according to methods selected in good faith by the board. 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 To produce incremental earnings, protect gains and facilitate buying and selling of securities for investments, the Portfolio may buy and sell put and call options and write put and call options. This may include purchasing mortgage-backed security (MBS) put spread options and writing 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. The risk in writing a call option is that the Portfolio gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the Portfolio 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 Portfolio pays a premium whether or not the option is exercised. The Portfolio also has the additional risk of being unable to enter into a closing transaction if a liquid secondary market does not exist. The Portfolio also may write over-the-counter options where completing the obligation depends upon the credit standing of the other party. Option contracts are valued daily at the closing prices on their primary exchanges and unrealized appreciation or depreciation is recorded. The Portfolio will realize a gain or loss when the option transaction expires or closes. When options on debt securities or futures are exercised, the Portfolio 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. ------------------------------------------------------------------------------- 26 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Futures transactions To gain exposure to or protect itself from market changes, the Portfolio may buy and sell financial futures contracts. Risks of entering into futures contracts and related options include the possibility of 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 Portfolio 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 Portfolio 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 Portfolio recognizes a realized gain or loss when the contract is closed or expires. Short sales The Portfolio may engage in short sales. In these transactions, the Portfolio sells a security that it does not own. The Portfolio is obligated to replace the security that was short by purchasing it at the market price at the time of replacement or entering into an offsetting transaction with the broker. The price at such time may be more or less than the price at which the Portfolio sold the security. Securities purchased on a forward-commitment basis Delivery and payment for securities that have been purchased by the Portfolio on a forward-commitment or when-issued basis can take place one month or more after the transaction date. During this period, such securities are subject to market fluctuations, and they may affect the Portfolio's net assets the same as owned securities. The Portfolio designates cash or liquid securities at least equal to the amount of its forward-commitments. As of May 31, 2002, the Portfolio has no outstanding forward-commitments. The Portfolio also enters into transactions to sell purchase commitments to third parties at current market values and concurrently acquires other purchase commitments for similar securities at later dates. As an inducement for the Portfolio to "roll over" its purchase commitments, the Portfolio receives negotiated amounts in the form of reductions of the purchase price of the commitment. Federal taxes For federal income tax purposes the Portfolio qualifies as a partnership and each investor in the Portfolio is treated as the owner of its proportionate share of the net assets, income, expenses and realized and unrealized gains and losses of the Portfolio. As a "pass-through" entity, the Portfolio therefore does not pay any income dividends or capital gain distributions. Other Security transactions are accounted for on the date securities are purchased or sold. Interest income, including level-yield amortization of premium and discount, is accrued daily. 2. FEES AND EXPENSES The Trust, on behalf of the Portfolio, has an Investment Management Services Agreement with AEFC to manage its portfolio. Under this agreement, AEFC determines which securities will be purchased, held or sold. The management fee is a percentage of the Portfolio's average daily net assets in reducing percentages from 0.52% to 0.395% annually. ------------------------------------------------------------------------------- 27 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Under the agreement, the Trust also pays taxes, brokerage commissions and nonadvisory expenses, which include custodian fees, audit and certain legal fees, fidelity bond premiums, registration fees for units, office expenses, consultants' fees, compensation of trustees, corporate filing fees, expenses incurred in connection with lending securities of the Portfolio and any other expenses properly payable by the Trust or Portfolio and approved by the board. During the year ended May 31, 2002, the Portfolio's custodian fees were reduced by $4,073 as a result of earnings credits from overnight cash balances. The Portfolio also pays custodian fees to American Express Trust Company, an affiliate of AEFC. According to a Placement Agency Agreement, American Express Financial Advisors Inc. acts as placement agent of the Trust's units. 3. SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $6,483,743,653 and $6,098,314,195, respectively, for the year ended May 31, 2002. For the same period, the portfolio turnover rate was 267%. Realized gains and losses are determined on an identified cost basis. 4. INTEREST RATE FUTURES CONTRACTS As of May 31, 2002, investments in securities included securities valued at $7,888,064 that were pledged as collateral to cover initial margin deposits on 1,377 open purchase contracts and 3,022 open sale contracts. The notional market value of the open purchase contracts as of May 31, 2002, was $144,972,281 with a net unrealized gain of $795,210. The notional market value of the open sale contracts as of May 31, 2002, was $319,954,250 with a net unrealized loss of $770,492. See "Summary of significant accounting policies." 5. LENDING OF PORTFOLIO SECURITIES As of May 31, 2002, securities valued at $227,538,230 were on loan to brokers. For collateral, the Portfolio received $234,041,562 in cash. Income from securities lending amounted to $513,792 for the year ended May 31, 2002. The risks to the Portfolio of securities lending are that the borrower may not provide additional collateral when required or return the securities when due. 6. OPTIONS CONTRACTS WRITTEN Contracts and premiums associated with options contracts written are as follows: Year ended May 31, 2002 Puts Calls Contracts Premiums Contracts Premiums Balance May 31, 2001 4,888 $ 784,417 638 $ 336,435 Opened 7,322 3,135,458 34,788 5,317,870 Closed (7,960) (3,528,078) (16,299) (3,061,165) Exercised -- -- (425) (263,880) Expired (4,250) (391,797) (16,070) (1,209,475) ------ -------- ------- ---------- Balance May 31, 2002 -- $ -- 2,632 $ 1,119,785 ------ -------- ------- ---------- See "Summary of significant accounting policies." ------------------------------------------------------------------------------- 28 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Investments in Securities Government Income Portfolio May 31, 2002 (Percentages represent value of investments compared to net assets) Bonds (99.8%) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (63.1%) Federal Home Loan Bank 04-15-04 3.75% $144,000,000 $145,035,359 06-15-04 3.38 83,000,000 82,912,020 02-15-05 4.38 46,000,000 46,644,046 Federal Home Loan Mtge Corp 09-01-09 6.50 2,065,383 2,151,959 10-01-10 7.00 4,809,587 5,078,174 01-01-12 5.50 29,885,882 30,425,392 01-01-13 6.00 6,605,426 6,812,908 07-01-14 6.50 12,198,927 12,668,014 04-01-17 6.50 63,896,125 66,114,173 11-01-23 8.00 4,857,409 5,251,922 05-01-24 7.50 2,138,377 2,254,549 07-01-24 8.00 674,250 723,988 07-01-24 8.00 2,226,949(d) 2,391,225 01-01-25 9.00 2,365,885 2,582,186 06-01-25 8.00 3,498,053 3,751,614 08-01-25 8.00 824,132 883,871 05-01-26 9.00 4,773,429 5,233,114 Collateralized Mtge Obligation 12-15-08 6.00 24,000,000 24,948,341 07-15-10 5.50 38,564,000 39,756,194 06-15-11 5.25 40,751,500 41,797,713 03-15-12 6.00 43,255,520 45,058,756 02-15-14 5.50 29,386,000 29,789,067 08-15-18 5.00 42,500,000 43,341,271 01-17-21 6.00 10,000,000 10,414,503 02-25-42 6.00 34,000,000 34,658,750 Interest Only 11-15-18 0.00 47,215,380(b) 2,496,825 01-01-20 0.06 54,816(b) 15,851 03-01-32 4.29 51,994,150(b) 14,288,097 Principal Only 09-15-03 1.48 1,742,822(c) 1,723,413 05-15-08 3.48 3,036,064(c) 2,941,538 05-15-08 3.28 1,143,909(c) 1,121,263 03-15-09 2.06 284,081(c) 283,418 Federal Natl Mtge Assn 09-01-07 8.50 838,814 881,850 01-01-09 5.59 39,467,204 40,062,334 05-01-13 6.00 3,425,769 3,515,972 06-01-13 6.00 29,441,660 30,216,872 09-01-13 6.00 64,324 66,017 10-01-13 6.00 11,000,636 11,290,288 11-01-13 6.00 4,193,649 4,304,070 12-01-13 5.50 19,053,615 19,281,267 12-01-13 6.00 2,468,455 2,533,451 01-01-14 5.50 34,672,619 35,086,890 01-01-14 6.00 1,965,116 2,016,859 02-01-14 5.50 3,429,832 3,470,812 03-01-14 5.50 4,695,156 4,751,254 03-01-14 6.00 3,159,018 3,242,196 04-01-14 5.50 96,487,701 97,640,538 06-01-14 6.50 39,415,721 40,955,870 07-01-14 5.50 72,673,426 73,541,731 08-01-14 6.50 2,837,867 2,941,643 09-01-14 6.00 278,058 285,068 08-01-15 5.50 16,909,297 17,111,330 11-01-21 8.00 900,009 971,422 03-01-23 9.00 592,109 654,419 09-01-23 6.50 25,241,964 25,862,005 11-01-23 6.00 6,982,023 7,014,998 12-01-23 7.00 7,359,943 7,662,242 01-01-24 6.50 6,792,269 6,959,114 06-01-24 9.00 2,042,404 2,250,062 02-01-26 6.00 396,240 397,112 02-01-26 8.00 866,327 929,223 05-01-26 7.50 6,327,601 6,673,457 12-01-28 7.00 15,916,536 16,525,862 08-01-29 7.00 6,757,211 7,001,294 04-01-31 6.50 17,826,654 18,121,273 09-01-31 7.50 6,415,526 6,754,792 11-01-31 6.50 5,315,961 5,403,817 See accompanying notes to investments in securities. ------------------------------------------------------------------------------- 29 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn (cont.) Collateralized Mtge Obligation 11-25-08 5.50% $936,761 $954,226 09-25-10 5.00 16,419,000 16,667,149 03-25-11 5.25 21,750,000 22,225,357 01-25-12 5.50 29,020,000 29,811,933 07-25-12 7.00 510,690 512,657 07-25-13 5.75 46,998,750 48,261,841 11-25-14 5.50 14,336,000 14,722,299 06-25-23 5.25 13,000,000 13,262,629 Interest Only 05-25-12 3.65 16,935,000(b) 2,188,410 08-01-18 1.97 25,828(b) 7,213 01-15-20 0.42 1,184,887(b) 349,611 02-25-22 1.54 172,272(b) 48,893 07-25-22 10.01 3,969,934(b) 911,592 Interest Only/Inverse Floater 02-25-32 33.73 49,181,433(b,f) 5,730,847 Inverse Floater 11-25-23 20.80 2,750,822(f) 3,158,638 03-25-24 20.17 179,887(f) 191,725 Principal Only 06-25-21 5.67 142,283(c) 122,244 Freddie Mac 05-15-04 5.00 150,000,000 154,689,749 Collateralized Mtge Obligation 12-15-13 5.50 47,000,000 47,771,094 Govt Natl Mtge Assn 08-20-19 11.00 87,534 100,016 Total 1,581,615,041 U.S. government obligations & agencies (36.7%) U.S. Treasury 02-15-03 10.75 15,000,000(d) 15,895,800 11-15-03 4.25 1,950,000 1,990,892 04-30-04 3.38 29,000,000 29,118,958 05-15-04 7.25 226,000,000 243,336,459 05-15-04 12.38 7,000,000 8,207,990 08-15-04 6.00 76,000,000 80,316,040 08-15-04 7.25 186,750,000 202,229,708 11-15-04 7.88 152,000,000 167,608,880 05-15-05 6.75 12,750,000 13,830,690 08-15-05 10.75 85,590,000(d) 103,343,078 11-15-09 10.38 48,000,000 55,560,000 Total 921,438,495 Total bonds (Cost: $2,468,127,486) $2,503,053,536 Option purchased (--%) Issuer Notional Exercise Expiration Value(a) amount price date Put Sept. U.S. Treasury Note $100,000,000 $103 Aug. 2002 $250,000 Total option purchased (Cost: $285,250) $250,000 Short-term securities (8.0%)(e) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies Federal Home Loan Bank Disc Nt 07-31-02 1.72% $42,900,000 $42,782,497 Federal Home Loan Mtge Corp Disc Nts 06-04-02 1.72 11,600,000 11,597,783 06-04-02 1.73 5,700,000 5,698,904 06-13-02 1.77 5,000,000 4,997,048 06-13-02 1.80 18,000,000 17,989,374 06-18-02 1.69 21,400,000 21,381,917 06-21-02 1.70 15,000,000 14,985,628 07-02-02 1.74 1,800,000 1,797,216 07-16-02 1.72 5,200,000 5,188,572 07-23-02 1.72 17,800,000 17,754,926 Federal Natl Mtge Assn Disc Nts 06-03-02 1.73 16,600,000 16,597,607 06-05-02 1.81 8,800,000 8,797,954 07-10-02 1.75 20,100,000 20,061,028 08-06-02 1.88 12,100,000 12,064,003 Total short-term securities (Cost: $201,688,604) $201,694,457 Total investments in securities (Cost: $2,670,101,340)(g) $2,704,997,993 See accompanying notes to investments in securities. ------------------------------------------------------------------------------- 30 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) Interest-only represents securities that entitle holders to receive only interest payments on the underlying mortgages. The yield to maturity of an interest-only is extremely sensitive to the rate of principal payments on the underlying mortgage assets. A rapid (slow) rate of principal repayments may have an adverse (positive) effect on yield to maturity. The principal amount shown is the notional amount of the underlying mortgages. Interest rate disclosed represents yield based upon the estimated timing of future cash flows as of May 31, 2002. (c) Principal-only represents securities that entitle holders to receive only principal payments on the underlying mortgages. The yield to maturity of a principal-only is sensitive to the rate of principal payments on the underlying mortgage assets. A slow (rapid) rate of principal repayments may have an adverse (positive) effect on yield to maturity. Interest rate disclosed represents yield based upon the estimated timing of future cash flows as of May 31, 2002. (d) Partially pledged as initial deposit on the following open interest rate futures contracts (see Note 4 to the financial statements): Type of security Notional amount Purchase contracts U.S. Treasury Notes, Sept. 2002, 10-year $137,700,000 Sale contracts U.S. Treasury Notes, Sept. 2002, 5-year 302,200,000 (e) At May 31, 2002, cash or short-term securities were designated to cover open call options written as follows (see Note 6 to the financial statements):
Issuer Notional Exercise Expiration Value(a) amount price date U.S. Treasury Notes July 2002 5-year $216,200,000 $105 June 2002 $2,330,895 U.S. Treasury Notes July 2002 10-year 47,000,000 105 June 2002 411,250 ---------- --- ---- ------- Total value $2,742,145 ----------
(f) 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, 2002. (g) At May 31, 2002, the cost of securities for federal income tax purposes was $2,670,782,456 and the aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $35,922,151 Unrealized depreciation (1,706,614) ---------- Net unrealized appreciation $34,215,537 ----------- ------------------------------------------------------------------------------- 31 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Federal Income Tax Information (Unaudited) 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. The dividends listed below are reported to you on Form 1099-DIV, Dividends and Distributions. Shareholders should consult a tax advisor on how to report distributions for state and local tax purposes. AXP Federal Income Fund Fiscal year ended May 31, 2002 Class A Income distributions taxable as dividend income, none qualifying for deduction by corporations. Payable date Per share June 26, 2001 $0.02144 July 26, 2001 0.01941 Aug. 27, 2001 0.02041 Sept. 26, 2001 0.01857 Oct. 26, 2001 0.01762 Nov. 26, 2001 0.01697 Dec. 20, 2001 0.01451 Jan. 25, 2002 0.01873 Feb. 26, 2002 0.01451 March 26, 2002 0.01235 April 26, 2002 0.01378 May 24, 2002 0.01448 Total distributions $0.20278 Class B Income distributions taxable as dividend income, none qualifying for deduction by corporations. Payable date Per share June 26, 2001 $0.01817 July 26, 2001 0.01642 Aug. 27, 2001 0.01722 Sept. 26, 2001 0.01559 Oct. 26, 2001 0.01459 Nov. 26, 2001 0.01384 Dec. 20, 2001 0.01210 Jan. 25, 2002 0.01513 Feb. 26, 2002 0.01131 March 26, 2002 0.00956 April 26, 2002 0.01069 May 24, 2002 0.01168 Total distributions $0.16630 ------------------------------------------------------------------------------- 32 AXP FEDERAL INCOME FUND -- ANNUAL REPORT Class C Income distributions taxable as dividend income, none qualifying for deduction by corporations. Payable date Per share June 26, 2001 $0.01822 July 26, 2001 0.01645 Aug. 27, 2001 0.01722 Sept. 26, 2001 0.01563 Oct. 26, 2001 0.01461 Nov. 26, 2001 0.01385 Dec. 20, 2001 0.01212 Jan. 25, 2002 0.01511 Feb. 26, 2002 0.01130 March 26, 2002 0.00956 April 26, 2002 0.01071 May 24, 2002 0.01168 Total distributions $0.16646 Class Y Income distributions taxable as dividend income, none qualifying for deduction by corporations. Payable date Per share June 26, 2001 $0.02213 July 26, 2001 0.02004 Aug. 27, 2001 0.02108 Sept. 26, 2001 0.01920 Oct. 26, 2001 0.01826 Nov. 26, 2001 0.01763 Dec. 20, 2001 0.01501 Jan. 25, 2002 0.01949 Feb. 26, 2002 0.01519 March 26, 2002 0.01294 April 26, 2002 0.01444 May 24, 2002 0.01508 Total distributions $0.21049 ------------------------------------------------------------------------------- 33 AXP FEDERAL INCOME FUND -- ANNUAL REPORT AXP Federal Income Fund 70100 AXP Financial Center Minneapolis, MN 55474 americanexpress.com Ticker Symbol Class A: IFINX Class B: ISHOX Class C: AXFCX Class Y: IDFYX This report must be accompanied or preceded by the Fund's current prospectus. Distributed by American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. (logo) AMERICAN EXPRESS S-6042 W (7/02)