N-CSRS 1 nif.txt T. ROWE PRICE NEW INCOME FUND Item 1. Report to Shareholders November 30, 2004 New Income Fund Semiannual Report T. Rowe Price -------------------------------------------------------------------------------- The views and opinions in this report were current as of November 30, 2004. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund's future investment intent. The report is certified under the Sarbanes-Oxley Act of 2002, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects. -------------------------------------------------------------------------------- REPORTS ON THE WEB Sign up for our E-mail Program, and you can begin to receive updated fund reports and prospectuses online rather than through the mail. Log in to your account at troweprice.com for more information. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Fellow Shareholders The past six months were favorable for investment-grade bonds and your fund as long-term bond prices rallied in response to falling yields. Although the Federal Reserve raised its target for the key federal funds rate four times in the period, your portfolio's defensive posture and focus on intermediate- and longer-term securities benefited results. The New Income Fund posted solid returns for six and 12 months that compared favorably with its Lipper peer group average. MARKET ENVIRONMENT Short- and long-term Treasury yields moved in opposite directions in the six-month period ended November 30, 2004. As anticipated, the Federal Reserve repeatedly nudged short-term interest rates higher--in four quarter-point increments since June 30--in response to a sustained economic expansion. The federal funds target rate has doubled from a multi-decade low to 2.0%, and short-maturity fixed-income yields have responded in kind. For example, the yield on the three-month Treasury bill rose 116 basis points (100 basis points equal 1.0%) to 2.22% over the past six months. (The Federal Reserve raised rates another quarter point to 2.25% on December 14, following the end of our reporting period.) [GRAPHIC OMITTED] INTEREST RATE LEVELS -------------------------------------------------------------------------------- 10-Year Treasury Note Lehman Brothers Baa U.S. Credit Index 2-Year Treasury Note 10-Year Lehman Brothers Baa 2-Year Treasury Note U.S. Credit Index Treasury Note 11/30/03 4.33% 5.15% 2.04% 4.25 4.95 1.82 4.13 4.84 1.82 2/04 3.97 4.68 1.64 3.84 4.61 1.57 4.51 5.27 2.32 5/04 4.65 5.50 2.53 4.58 5.51 2.68 4.48 5.35 2.68 8/04 4.12 5.01 2.39 4.12 5.00 2.61 4.02 4.92 2.55 11/30/04 4.35 5.20 3.00 Nevertheless, long-term bond yields fell in the first half of your fund's fiscal year (although rates spiked in November) due to job market weakness, a squeeze on consumers from sharply rising oil prices, and continued geopolitical uncertainty. From this year's high near 5.35% (at the end of May), the yield on the 30-year Treasury note dipped to 5.00% at the end of the reporting period. The yield on the 10-year Treasury note, which is closer to the portfolio's weighted average maturity, declined a similar amount, to 4.35% from 4.65%, over the last six months. The combination of rising short-term yields and falling longer-term yields resulted in a flattening (or pivoting) of the yield curve. (The yield curve is a graphic depiction of interest rates for bonds of the same quality with various maturities.) Since May, long-term securities--the "back end" of the curve--dramatically outperformed short-term issues--the "front end." We think it is likely that longer-term yields will increase in coming quarters but that the yield curve will continue flattening as short rates rise more than those further out the curve. MAJOR INDEX RETURNS -------------------------------------------------------------------------------- Period Ended 11/30/04 6 Months 12 Months -------------------------------------------------------------------------------- Lehman Brothers U.S. Aggregate Index 3.82% 4.44% Lehman Brothers U.S. Treasury Index 3.14 2.52 Lehman Brothers Mortgage-Backed Securities Index 4.09 5.09 Lehman Brothers U.S. Credit Index 4.60 5.04 CS First Boston High Yield Index 9.31 12.85 Sources: Lehman Brothers and CS First Boston. Intermediate- and long-term bonds posted strong gains for the past six months as price gains augmented interest income. Overseas credits, particularly in emerging markets, generated the best results as the dollar fell and world economic growth resumed. Corporate bonds, especially lower-quality credits, generated good results as well, helped by economic strength, improving profit trends, and continuing balance sheet repair. Mortgage-backed securities outperformed other comparable government securities as prepayment volatility subsided. Treasury inflation-protected securities (TIPS) also produced strong returns. The dollar's weakness, fears relating to energy-induced inflation, and the rising CPI helped boost demand for TIPS, especially by institutional investors, who have added the class to their asset allocation to enhance diversification and hedge inflation risks. Asset-backed and government agency securities, which have minimal default risk, lagged the Lehman Brothers U.S. Aggregate Index, a broad measure of the domestic investment-grade bond market, but outperformed similar-maturity Treasuries. PERFORMANCE REVIEW The New Income Fund generated a solid 4.10% six-month gain for the period ended November 30, 2004. The portfolio outperformed the Lipper average for similar funds and the Lehman Brothers U.S. Aggregate Index. In the past six months, we emphasized longer maturity debt--the long end of the curve--while maintaining a defensive posture through purchases of floating-rate notes on the short end and increasing diversification in nondollar-denominated securities. We concentrated purchases especially in Canada and in newly developed markets such as Mexico and Poland where yields are significantly higher than in the U.S. Returns for the 12-month period were also better than both of our benchmarks. Performance for the Advisor Class and R Class will vary due to their differing fee structures. PERFORMANCE COMPARISON -------------------------------------------------------------------------------- Periods Ended 11/30/04 6 Months 12 Months -------------------------------------------------------------------------------- New Income Fund 4.10% 4.66% New Income Fund-Advisor Class 3.86 4.31 New Income Fund-R Class 3.74 4.08 Lehman Brothers U.S. Aggregate Index 3.82 4.44 Lipper Average of Corporate Debt Funds A Rated 3.71 4.10 As we wrote six months ago, fundamental credit research and broader market themes play a major role in determining our individual security selections and sector allocations. Improving credit trends and stronger economic growth supported our commitment to corporate bonds in the utility, industrials, and energy sectors. The fund continues to overweight lower-quality, investment-grade (BBB rated) credits, and, in anticipation of higher short-term rates, we increased our positions in floating-rate notes. This positioning allowed the portfolio to generate slightly more income in the first half of the current fiscal year than in the prior six-month period, and that income generation is reflected in the higher 30-day standardized yield. Over the past six months the portfolio's weighted average maturity notched higher to 7.1 years from 6.7 years, but because of our concern about rising interest rates, we maintained the portfolio's defensive 4.4-year duration. (Duration is a measure of a bond fund's sensitivity to interest rates; for example, a fund with a four-year duration should rise or fall approximately 4% for each one-percentage-point fall or rise in interest rates.) Our defensive posture also led us to underweight the highest-quality corporate bonds, which are acutely sensitive to changes in underlying U.S. Treasury yields. STRATEGY The beginning of the long-awaited Fed campaign to raise short-term interest rates set the tone for our portfolio positioning. We buttressed the fund for higher interest rates by maintaining a shorter duration than the benchmark Lehman Brothers U.S. Aggregate Index. We also attempted to stay defensive in our short-term holdings. This latter positioning proved more beneficial to performance than our overall rate outlook because longer-term interest rates declined. PORTFOLIO CHARACTERISTICS -------------------------------------------------------------------------------- Periods Ended 5/31/04 11/30/04 -------------------------------------------------------------------------------- New Income Fund Share Price $8.87 $9.06 Dividends Per Share For 6 Months 0.16 0.17 For 12 Months 0.32 0.33 30-Day Standardized Yield to Maturity 3.74% 3.84% -------------------------------------------------------------------------------- New Income Fund-Advisor Class Share Price $8.87 $9.05 Dividends Per Share For 6 Months 0.15 0.16 For 12 Months 0.30 0.31 30-Day Standardized Yield to Maturity 3.53% 3.58% -------------------------------------------------------------------------------- New Income Fund-R Class Share Price $8.88 $9.06 Dividends Per Share For 6 Months 0.14 0.15 For 12 Months 0.28 0.29 30-Day Standardized Yield to Maturity 3.28% 3.37% -------------------------------------------------------------------------------- Weighted Average Maturity (years) 6.7 7.1 Weighted Average Effective Duration (years) 4.4 4.4 Yields will vary and are not guaranteed. For the past six months, the portfolio held a sizable allocation of its corporate holdings in floating-rate notes. This gave us credit exposure and higher yields but minimized our overall interest rate exposure. In addition, we owned a modest position in dividend-paying stocks in several high-quality sectors such as integrated oils and financials that allowed the fund to generate additional income. This also helped broaden diversification and generate capital appreciation while mitigating a measure of interest rate risk. Investors became more interested in higher-yielding corporate bonds as they grew less concerned about corporate governance and balance sheet leverage. Many of our lower-quality issues, particularly those that experienced severe distress last year, performed well. Owning fixed-rate securities that pay higher yields than Treasuries cushioned the impact of Fed tightening. Many residential and commercial mortgage-backed, asset-backed, and corporate bonds also generated good gains over the six-month period. Nondollar bonds also contributed to results, thanks to a weaker dollar, and in most cases, they paid substantially higher yields than U.S. Treasuries. Unlike the U.S., many overseas governments have fiscal and monetary policies that are supportive of steady or declining interest rates. [GRAPHIC OMITTED] SECURITY DIVERSIFICATION -------------------------------------------------------------------------------- Mortgage-Backed Securities 40% Corporate Bonds and Convertibles 27 U.S. Treasuries 15 Foreign Government Obligations and Municipal Bonds 6 U.S. Agency Obligations 6 Equity and Preferred 1 Other and Reserves 5 Based on net assests as of 11/30/04. Strengthening economic fundamentals supported our commitment to higher-yielding sectors. Throughout the period, we added to mortgage-backed issues (40% of net assets). Our commitment to the commercial mortgage-backed market and asset-backed securities provided a steady source of income and cash flow stability. However, we trimmed our already underweight position in agency holdings because valuations are high and regulatory uncertainty increases risk in the sector. [GRAPHIC OMITTED] QUALITY DIVERSIFICATION -------------------------------------------------------------------------------- U.S. Government Agency Securities * 41% AAA Rated 30 AA Rated 2 A Rated 9 BBB Rated 16 BB and Below 1 Not Rated 1 Based on net assets as of 11/30/04. * U.S. government agencies include GNMA and conventional pass-throughs, CMOs, and project loans. Source: Standard & Poor's; if Standard & Poor's does not rate a security, then Moody's Investors Service is used as a secondary source. Strong investor demand for additional yield and higher headline inflation boosted the performance of Treasury inflation-protected securities. Maintaining a modest allocation to TIPS proved beneficial during the period. Steadily improving credit trends and stronger economic growth led us to attractively priced corporate bonds in the natural gas, cable and media, and energy sectors. The fund maintained its significant overweight in BBB rated corporate bonds because supply remains low while foreign demand is strong. OUTLOOK The steady, resource-absorbing pace of job gains should provide further support to a fundamentally healthy economy. In such an environment, we expect the Federal Reserve to continue its slow march toward higher short-term rates through 2005. Increases in long-term rates should be muted as long as core inflation remains contained. Several issues, however, could potentially disrupt this benign outlook. Bulging imbalances created by the U.S. budget and trade deficits are worrisome, especially with the prospect of a weaker dollar. Foreign investors, especially Asian central banks, have been active participants in the investment-grade markets over the past several years. Their support of the U.S. bond market has clearly contributed to a relatively stable interest rate environment. Though it is not our base case, a dramatic shift in asset preferences away from the U.S. dollar would clearly be a negative across the yield curve. Current valuations also concern us. Both corporate and mortgage yield spreads (the difference between Treasury yields and other similar-maturity bonds) leave little room for a negative market event, such as more aggressive Fed tightening. Although credit fundamentals remain strong and mortgage prepayment volatility is low, we believe the possibility of significant spread compression from current levels is remote. We will be more selective in these sectors going forward. Our research team continues to seek opportunities wherever they present themselves. For example, many foreign investment-grade government bonds offer higher yields than comparable-maturity U.S. Treasuries. We believe that tax-exempt bonds also offer tactical opportunities for us, as do longer-term TIPS. As always, we strive to enhance returns while managing risk by investing in securities that hold what we believe are favorable total return characteristics. We appreciate your continued confidence in this endeavor. Respectfully submitted, Daniel O. Shackelford Chairman of the fund's Investment Advisory Committee December 15, 2004 The committee chairman has day-to-day responsibility for managing the portfolio and works with committee members in developing and executing the fund's investment program. -------------------------------------------------------------------------------- RISKS OF BOND INVESTING Bonds are subject to interest rate risk, the decline in bond prices that usually accompanies a rise in interest rates, and credit risk, the chance that any fund holding could have its credit rating downgraded or that a bond issuer will default (fail to make timely payments of interest or principal), potentially reducing the fund's income level and share price. Mortgage-backed securities are subject to prepayment risk, particularly if falling rates lead to heavy refinancing activity, and extension risk, which is an increase in interest rates that causes a fund's average maturity to lengthen unexpectedly due to a drop in mortgage prepayments. This could increase the fund's sensitivity to rising interest rates and its potential for price declines. GLOSSARY CS First Boston High Yield Index: An index that tracks the performance of domestic noninvestment-grade corporate bonds. Duration: A measure of a bond or bond fund's sensitivity to changes in interest rates. For example, a fund with a four-year duration would fall about 4% in response to a one-percentage-point rise in interest rates, and vice versa. Federal funds rate: The interest rate charged on overnight loans of reserves by one financial institution to another in the United States. The Federal Reserve sets a target federal funds rate to affect the direction of interest rates. Lehman Brothers Mortgage-Backed Securities Index: An unmanaged index of 15- and 30-year fixed-rate securities backed by GNMA. Lehman Brothers U.S. Aggregate Index: An unmanaged index that tracks the performance of investment-grade government and corporate bonds. This index is widely accepted as the benchmark for the broad U.S. investment-grade bond market. Lehman Brothers U.S. Credit Index: (Formerly the U.S. Corporate Investment Grade Index) An unmanaged index that tracks the performance of investment-grade corporate bonds. Lehman Brothers U.S. Treasury Index: An unmanaged index of publicly traded obligations of the U.S. Treasury. Lipper averages: The averages of all mutual funds in a particular category as tracked by Lipper Inc. Weighted average maturity: The weighted average of the stated maturity dates of a portfolio's securities. In general, the longer the average maturity, the greater the fund's sensitivity to interest rate changes. A shorter average maturity usually means less interest rate sensitivity and therefore a less volatile portfolio. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- GROWTH OF $10,000 -------------------------------------------------------------------------------- This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes. [GRAPHIC OMITTED] NEW INCOME FUND -------------------------------------------------------------------------------- As of 11/30/04 New Income Fund $19,515 Lehman Brothers U.S. Aggregate Index $20,991 Lipper Average of Corporate Debt Funds A-Rated $19,935 Lehman Brothers Lipper Average of New Income U.S. Aggregate Corporate Debt Fund Index Funds A-Rated 11/94 $ 10,000 $ 10,000 $ 10,000 11/95 11,757 11,764 11,887 11/96 12,362 12,478 12,523 11/97 13,219 13,421 13,447 11/98 13,927 14,689 14,592 11/99 13,872 14,683 14,299 11/00 15,019 16,014 15,343 11/01 16,743 17,801 17,003 11/02 17,501 19,108 17,977 11/03 18,647 20,098 19,119 11/04 19,515 20,991 19,935 Note: Performance in the Advisor Class and R Class will vary due to their differing fee structures. See returns table below. AVERAGE ANNUAL COMPOUND TOTAL RETURN -------------------------------------------------------------------------------- This table shows how the fund and its benchmarks would have performed if their actual (or cumulative) returns for the periods shown had been earned at a constant rate. Since Inception Periods Ended 11/30/04 1 Year 5 Years 10 Years 9/30/02 -------------------------------------------------------------------------------- New Income Fund 4.66% 7.06% 6.91% - New Income Fund-Advisor Class 4.31 - - 4.78% New Income Fund-R Class 4.08 - - 4.59 Lehman Brothers U.S. Aggregate Index 4.44 7.41 7.70 4.20 Lipper Average of Corporate Debt Funds A Rated 4.10 6.66 7.12 4.62 Returns do not reflect taxes that the shareholder may pay on fund distributions or the redemption of fund shares. Past performance cannot guarantee future results. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- FUND EXPENSE EXAMPLE -------------------------------------------------------------------------------- As a mutual fund shareholder, you may incur two types of costs: (1) transaction costs such as redemption fees or sales loads and (2) ongoing costs, including management fees, distribution and service (12b-1) fees, and other fund expenses. The following example is intended to help you understand your ongoing costs (in dollars) of investing in the fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the most recent six-month period and held for the entire period. Please note that the fund has three share classes: The original share class ("investor class") charges no distribution and service (12b-1) fee; Advisor Class shares are offered only through unaffiliated brokers and other financial intermediaries and charge a 0.25% 12b-1 fee; R Class shares are available to retirement plans serviced by intermediaries and charge a 0.50% 12b-1 fee. Each share class is presented separately in the table. Actual Expenses The first line of the following table ("Actual") provides information about actual account values and expenses based on the fund's actual returns. You may use the information in this line, together with your account balance, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading "Expenses Paid During Period" to estimate the expenses you paid on your account during this period. Hypothetical Example for Comparison Purposes The information on the second line of the table ("Hypothetical") is based on hypothetical account values and expenses derived from the fund's actual expense ratio and an assumed 5% per year rate of return before expenses (not the fund's actual return). You may compare the ongoing costs of investing in the fund with other funds by contrasting this 5% hypothetical example and the 5% hypothetical examples that appear in the shareholder reports of the other funds. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. Note: T. Rowe Price charges an annual small-account maintenance fee of $10, generally for accounts with less than $2,000 ($500 for UGMA/UTMA). The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $25,000 or more, accounts employing automatic investing, and IRAs and other retirement plan accounts that utilize a prototype plan sponsored by T. Rowe Price (although a separate custodial or administrative fee may apply to such accounts). This fee is not included in the accompanying table. If you are subject to the fee, keep it in mind when you are estimating the ongoing expenses of investing in the fund and when comparing the expenses of this fund with other funds. You should also be aware that the expenses shown in the table highlight only your ongoing costs and do not reflect any transaction costs, such as redemption fees or sales loads. Therefore, the second line of the table is useful in comparing ongoing costs only and will not help you determine the relative total costs of owning different funds. To the extent a fund charges transaction costs, however, the total cost of owning that fund is higher. T. ROWE PRICE NEW INCOME FUND -------------------------------------------------------------------------------- Beginning Ending Expenses Paid Account Value Account Value During Period* 6/1/04 11/30/04 6/1/04 to 11/30/04 -------------------------------------------------------------------------------- Investor Class Actual $1,000 $1,041.00 $3.53 Hypothetical (assumes 5% return before expenses) 1,000 1,021.61 3.50 Advisor Class Actual 1,000 1,038.60 4.60 Hypothetical (assumes 5% return before expenses) 1,000 1,020.56 4.56 R Class Actual 1,000 1,037.40 5.87 Hypothetical (assumes 5% return before expenses) 1,000 1,019.30 5.82 * Expenses are equal to the fund's annualized expense ratio for the six-month period, multiplied by the average account value over the period, multiplied by the number of days in the most recent fiscal half year (183) divided by the days in the year (365) to reflect the half-year period. The annualized expense ratio of the Investor Class was 0.69%, the Advisor Class was 0.90%, and the R Class was 1.15%. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- QUARTER-END RETURNS -------------------------------------------------------------------------------- Periods Ended 12/31/04 1 Year 5 Years 10 Years -------------------------------------------------------------------------------- New Income Fund 4.60% 7.37% 6.93% New Income Fund-Advisor Class 4.48 7.28 6.89 New Income Fund-R Class 4.12 7.16 6.83 Lehman Brothers U.S. Aggregate Index 4.34 7.71 7.72 Lipper Average of Corporate Debt Funds A Rated 4.09 6.99 7.14 Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results. Share price, principal value, and return will vary, and you may have a gain or loss when you sell your shares. For the most recent month-end performance information, please visit our Web site (troweprice.com) or contact a T. Rowe Price representative at 1-800-225-5132. This table provides returns through the most recent calendar quarter-end rather than through the end of the fund's fiscal period. It shows how each class would have performed each year if its actual (or cumulative) returns for the periods shown had been earned at a constant rate. The T. Rowe Price New Income Fund-Advisor Class and the T. Rowe Price New Income Fund-R Class began operations on September 30, 2002. Each shares the portfolio of the existing retail fund (the original share class of the fund is referred to as the "investor class"). The average annual total return figures for the Advisor and R Class have been calculated using the performance data of the investor class up to the inception date of the class and the actual performance results of the class since that date. The performance results of the investor class have not been adjusted to reflect the 12b-1 fee associated with either the Advisor Class (0.25%) or the R Class (0.50%). Had these fees been included, the performance of the Advisor and R Classes would have been lower. Average annual total return figures include changes in principal value, reinvested dividends, and capital gain distributions. Returns do not reflect taxes that the shareholder may pay on portfolio distributions or the redemption of portfolio shares. When assessing performance, investors should consider both short- and long-term returns. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited FINANCIAL HIGHLIGHTS For a share outstanding throughout each period -------------------------------------------------------------------------------- Investor Class 6 Months Year Ended Ended 11/30/04 5/31/04 5/31/03 5/31/02 5/31/01 5/31/00 NET ASSET VALUE Beginning of period $ 8.87 $ 9.21 $ 8.70 $ 8.53 $ 8.07 $ 8.50 Investment activities Net investment income (loss) 0.16 0.32 0.37 0.47 0.53 0.52 Net realized and unrealized gain (loss) 0.20 (0.34) 0.52 0.17 0.46 (0.43) Total from investment activities 0.36 (0.02) 0.89 0.64 0.99 0.09 Distributions Net investment income (0.17) (0.32) (0.38) (0.47) (0.53) (0.52) NET ASSET VALUE End of period $ 9.06 $ 8.87 $ 9.21 $ 8.70 $ 8.53 $ 8.07 ------------------------------------------------------ Ratios/Supplemental Data Total return^ 4.10% (0.26)% 10.52% 7.68% 12.54% 1.13% Ratio of total expenses to average net assets 0.69%+ 0.71% 0.74% 0.72% 0.73% 0.73% Ratio of net investment income (loss) to average net assets 3.67%+ 3.56% 4.23% 5.38% 6.30% 6.32% Portfolio turnover rate 151.7%+ 219.0% 221.2% 222.0% 112.1% 83.6% Net assets, end of period (in millions) $ 2,781 $ 2,512 $ 2,266 $ 1,863 $ 1,684 $ 1,633 ^ Total return reflects the rate that an investor would have earned on an investment in the fund during each period, assuming reinvestment of all distributions. + Annualized The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited FINANCIAL HIGHLIGHTS For a share outstanding throughout each period -------------------------------------------------------------------------------- Advisor Class 6 Months Year 9/30/02 Ended Ended Through 11/30/04 5/31/04 5/31/03 NET ASSET VALUE Beginning of period $ 8.87 $ 9.21 $ 8.84 Investment activities Net investment income (loss) 0.21* 0.30* 0.23* Net realized and unrealized gain (loss) 0.13 (0.34) 0.38 Total from investment activities 0.34 (0.04) 0.61 Distributions Net investment income (0.16) (0.30) (0.24) NET ASSET VALUE End of period $ 9.05 $ 8.87 $ 9.21 ------------------------------------- Ratios/Supplemental Data Total return^ 3.86%* (0.45)%* 7.02%* Ratio of total expenses to average net assets 0.90%*+ 0.90%* 0.90%+* Ratio of net investment income (loss) to average net assets 3.27%*+ 3.36%* 2.61%+* Portfolio turnover rate 151.7%+ 219.0% 221.2% Net assets, end of period (in thousands) $ 512 $ 139 $ 107 ^ Total return reflects the rate that an investor would have earned on an investment in the fund during each period, assuming reinvestment of all distributions. * Excludes expenses in excess of a 0.90% contractual expense limitation in effect through 9/30/06. + Annualized The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited FINANCIAL HIGHLIGHTS For a share outstanding throughout each period -------------------------------------------------------------------------------- R Class 6 Months Year 9/30/02 Ended Ended Through 11/30/04 5/31/04 5/31/03 NET ASSET VALUE Beginning of period $ 8.88 $ 9.21 $ 8.84 Investment activities Net investment income (loss) 0.15* 0.28* 0.22* Net realized and unrealized gain (loss) 0.18 (0.33) 0.38 Total from investment activities 0.33 (0.05) 0.60 Distributions Net investment income (0.15) (0.28) (0.23) NET ASSET VALUE End of period $ 9.06 $ 8.88 $ 9.21 Ratios/Supplemental Data Total return^ 3.74%* (0.57)%* 6.84%* Ratio of total expenses to average net assets 1.15%*+ 1.15%* 1.15%+* Ratio of net investment income (loss) to average net assets 3.22%*+ 3.12%* 2.32%+* Portfolio turnover rate 151.7%+ 219.0% 221.2% Net assets, end of period (in thousands) $ 3,450 $ 2,885 $ 321 --------------------------------------- ^ Total return reflects the rate that an investor would have earned on an investment in the fund during each period, assuming reinvestment of all distributions. * Excludes expenses in excess of a 1.15% contractual expense limitation in effect through 9/30/06. + Annualized The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited November 30, 2004 PORTFOLIO OF INVESTMENTS (1) $ Par/Shares Value -------------------------------------------------------------------------------- (Amounts in 000s) CORPORATE BONDS AND NOTES 24.4% Aerospace & Defense 0.1% Boeing, 8.75%, 8/15/21 2,425 3,206 3,206 Automobiles and Related 1.6% DaimlerChrysler 6.50%, 11/15/13 5,945 6,341 VR, 2.343%, 9/10/07 4,300 4,308 Ford Motor Credit 5.625%, 10/1/08 12,700 12,898 VR, 3.24%, 11/16/06 2,900 2,899 GM, 8.375%, 7/15/33 8,905 9,048 GMAC, 7.25%, 3/2/11 5,900 6,122 Lear, 144A, 5.75%, 8/1/14 2,000 2,006 43,622 Banking 1.5% Bank One, 5.25%, 1/30/13 5,300 5,386 Capital One Bank, 6.50%, 6/13/13 3,520 3,811 Citigroup, 5.00%, 9/15/14 7,800 7,814 First Union, 6.40%, 4/1/08 2,215 2,387 HBOS, 144A, 6.00%, 11/1/33 4,300 4,379 MBNA America Bank 4.625%, 8/3/09 5,100 5,159 7.125%, 11/15/12 2,200 2,475 U.S. Bank, 2.87%, 2/1/07 4,000 3,943 Wells Fargo, VR, 1.99%, 3/23/07 5,900 5,905 41,259 Beverages 0.2% Miller Brewing, 144A, 5.50%, 8/15/13 6,200 6,360 6,360 Broadcasting 0.4% AOL Time Warner, 7.625%, 4/15/31 4,415 5,177 Chancellor Media, 8.00%, 11/1/08 2,615 2,929 Hearst-Argyle, 7.00%, 1/15/18 3,685 4,067 12,173 Building and Real Estate 0.5% Lennar, 144A, 5.50%, 9/1/14 3,850 3,848 NVR, 5.00%, 6/15/10 4,085 4,044 Pulte Homes, 7.875%, 8/1/11 5,000 5,768 13,660 Building Products 0.3% Centex, 4.55%, 11/1/10 4,000 3,950 Masco, 5.875%, 7/15/12 5,190 5,519 9,469 Cable Operators 0.3% Cox Communications, 7.875%, 8/15/09 4,900 5,499 Rogers Cable, 5.50%, 3/15/14 4,120 3,852 9,351 Computer Service & Software 0.3% IBM, 4.25%, 9/15/09 5,155 5,204 SunGard Data Systems, 3.75%, 1/15/09 2,750 2,658 7,862 Conglomerates 0.8% General Electric Capital 6.00%, 6/15/12 5,290 5,713 6.125%, 2/22/11 5,700 6,164 Hutchison Whampoa, 144A, 5.45%, 11/24/10 3,235 3,316 Tyco International, 6.375%, 10/15/11 6,310 6,922 22,115 Container 0.2% Sealed Air, 144A, 5.375%, 4/15/08 5,200 5,355 5,355 Department Stores 0.2% Federated Department Stores, 6.625%, 4/1/11 3,630 4,028 May Department Stores, 144A, 3.95%, 7/15/07 1,470 1,475 5,503 Diversified Chemicals 0.1% Dow Chemical, 6.125%, 2/1/11 3,225 3,487 3,487 Drugs 0.4% Amgen, 144A, 4.00%, 11/18/09 3,285 3,254 GlaxoSmithKline, 5.375%, 4/15/34 3,355 3,211 Wyeth, 6.50%, 2/1/34 3,125 3,235 9,700 Electric Utilities 3.3% Alabama Power, Series B, VR, 2.571%, 8/25/09 3,980 3,980 Appalachian Power, 4.80%, 6/15/05 5,115 5,166 Black Hills, 6.50%, 5/15/13 5,160 5,289 CE Electric UK Funding, 144A, 6.995%, 12/30/07 3,835 4,070 Centerpoint Energy, 5.875%, 6/1/08 4,000 4,181 Cleveland Electric Illuminating, 5.65%, 12/15/13 4,500 4,591 Dominion Resources, 5.00%, 3/15/13 4,350 4,302 Entergy Gulf States, 5.20%, 12/3/07 4,675 4,675 Exelon Generation, 5.35%, 1/15/14 3,900 3,952 FirstEnergy, 7.375%, 11/15/31 3,000 3,333 PG&E 6.05%, 3/1/34 4,035 4,064 VR, 2.72%, 4/3/06 1,568 1,570 Pinnacle West Capital, 6.40%, 4/1/06 4,285 4,437 PPL Capital Funding, 4.33%, 3/1/09 5,075 5,056 Progress Energy, 6.75%, 3/1/06 3,348 3,482 PSEG Power, 8.625%, 4/15/31 4,450 5,657 Public Service of New Mexico, 4.40%, 9/15/08 4,735 4,758 Puget Sound Energy, VR, 2.681%, 7/14/06 5,135 5,133 Sempra Energy, 6.00%, 2/1/13 4,780 5,026 Tri-State Generation, 144A, 6.04%, 1/31/18 2,850 2,936 TXU Energy, VR, 2.838%, 1/17/06 2,325 2,324 Western Power Distribution Holdings, 144A, 6.875%, 12/15/07 2,690 2,779 90,761 Electronic Components 0.1% Motorola, 7.625%, 11/15/10 2,540 2,936 2,936 Energy 0.6% Pioneer Natural Resource, 5.875%, 7/15/16 2,445 2,526 Plains All American Pipeline, 7.75%, 10/15/12 2,255 2,615 Transocean, 7.50%, 4/15/31 2,960 3,506 XTO Energy, 6.25%, 4/15/13 3,240 3,503 YPF Sociedad Anonima, 10.00%, 11/2/28 4,660 5,545 17,695 Entertainment and Leisure 0.1% International Speedway, 4.20%, 4/15/09 2,300 2,281 2,281 Exploration and Production 0.8% Canadian Natural Resources, 7.20%, 1/15/32 5,200 6,002 Diamond Offshore Drilling, 144A, 5.15%, 9/1/14 3,500 3,512 Encana Holdings Finance, 5.80%, 5/1/14 5,150 5,411 Kaneb Pipe Line Operations, 7.75%, 2/15/12 5,430 6,229 21,154 Finance and Credit 1.5% CIT Group Holdings, 7.75%, 4/2/12 6,805 7,994 Colonial Bank, 9.375%, 6/1/11 3,980 4,721 Countrywide Home Loans, 4.125%, 9/15/09 5,450 5,386 Household Finance, 6.375%, 11/27/12 4,475 4,899 International Lease Finance, 6.375%, 3/15/09 5,020 5,421 Northern Trust, 4.60%, 2/1/13 3,075 3,025 SLM Corporation VR, 2.30%, 1/26/09 5,600 5,607 VR, 3.66%, 4/1/09 3,840 3,857 40,910 Food Processing 0.6% Bunge Limited Finance, 4.375%, 12/15/08 5,290 5,305 Kraft Foods, 5.625%, 11/1/11 4,700 4,924 McCormick, 6.40%, 2/1/06 7,300 7,579 17,808 Food/Tobacco 0.2% UST, 6.625%, 7/15/12 5,400 5,947 5,947 Gaming 0.2% GTECH, 144A, 4.50%, 12/1/09 3,500 3,468 Harrah's Operating, 5.50%, 7/1/10 2,700 2,778 6,246 Gas & Gas Transmission 0.8% Buckeye Partners 5.30%, 10/15/14 1,430 1,427 6.75%, 8/15/33 3,140 3,385 Duke Capital 4.302%, 5/18/06 3,450 3,486 6.25%, 2/15/13 4,350 4,662 Kinder Morgan, 6.50%, 9/1/12 5,000 5,424 Panhandle Eastern Pipeline, 4.80%, 8/15/08 3,600 3,638 22,022 Healthcare Services 0.3% Highmark, 144A, 6.80%, 8/15/13 4,005 4,305 Hospira, 4.95%, 6/15/09 4,800 4,874 9,179 Insurance 2.5% ACE INA Holdings, 5.875%, 6/15/14 3,945 3,982 AIG Sunamerica Global Financing XII, 144A, 5.30%, 5/30/07 6,070 6,310 Allstate Financial Global Funding, 144A, 5.25%, 2/1/07 5,200 5,395 Cigna, 7.40%, 5/15/07 2,000 2,148 Fund American Companies, 5.875%, 5/15/13 4,735 4,747 Genworth Financial, 5.75%, 6/15/14 4,700 4,880 Jefferson Pilot, 144A, 8.14%, 1/15/46 3,000 3,354 Mangrove Bay Trust, 144A, VR, 6.102%, 7/15/33 2,500 2,482 Nationwide Financial Services, 5.90%, 7/1/12 5,170 5,442 Nationwide Mutual Insurance, 144A, 6.60%, 4/15/34 2,735 2,647 NLV Financial, 144A, 7.50%, 8/15/33 3,375 3,562 Principal Life Global Funding I, 144A, 5.25%, 1/15/13 4,900 4,959 Prudential Financial, 3.75%, 5/1/08 4,520 4,473 Security Benefit Life Insurance, 144A, 7.45%, 10/1/33 2,150 2,259 Sun Life of Canada (U.S.) Capital Trust, 144A, 8.526%, 5/29/49 7,000 7,903 XL Capital, 6.50%, 1/15/12 4,070 4,402 68,945 Investment Dealers 0.7% Franklin Resources, 3.70%, 4/15/08 1,650 1,633 Goldman Sachs Capital I, 6.345%, 2/15/34 10,000 10,157 Morgan Stanley, 3.625%, 4/1/08 7,880 7,828 19,618 Long Distance 0.5% AT&T Broadband, 8.375%, 3/15/13 5,395 6,541 Sprint Capital, 6.90%, 5/1/19 6,115 6,687 13,228 Manufacturing 0.2% John Deere Capital, 7.00%, 3/15/12 5,250 5,999 5,999 Media and Communications 0.3% News America 6.75%, 1/9/38 1,705 1,883 7.625%, 11/30/28 2,160 2,510 144A, 6.20%, 12/15/34 3,185 3,160 7,553 Metals 0.2% Alcan, 6.125%, 12/15/33 4,250 4,360 4,360 Oil Field Services 0.2% Halliburton, 144A, VR, 2.86%, 1/26/07 5,000 4,998 4,998 Paper and Paper Products 0.6% Celulosa Arauco Y Constitucion, 8.625%, 8/15/10 7,500 8,834 SCA Coordination Center, 144A, 4.50%, 7/15/15 3,425 3,209 Weyerhaeuser 6.75%, 3/15/12 2,425 2,713 7.375%, 3/15/32 1,085 1,252 16,008 Petroleum 0.9% Amerada Hess, 7.875%, 10/1/29 4,800 5,505 ConocoPhillips, 5.90%, 10/15/32 4,560 4,624 Devon Financing, 7.875%, 9/30/31 4,035 4,970 Pemex Project Funding Master Trust 7.375%, 12/15/14 3,280 3,589 144A, VR, 3.18%, 6/15/10 4,700 4,812 PF Export Receivables Master Trust Series 2003, Class A, 144A, 6.436%, 6/1/15 2,566 2,525 26,025 Railroads 0.6% Canadian National Railway, 6.25%, 8/1/34 5,110 5,396 Norfolk Southern, 6.00%, 4/30/08 6,175 6,522 Union Pacific, 6.50%, 4/15/12 5,020 5,542 17,460 Real Estate Investment Trust Securities 0.5% Developers Diversified Realty, 3.875%, 1/30/09 3,565 3,468 EOP Operating, 4.65%, 10/1/10 4,100 4,086 Reckson Operating Partnership, 5.15%, 1/15/11 2,500 2,470 Simon Property Group, 3.75%, 1/30/09 4,650 4,540 14,564 Retail 0.1% CVS, 144A, 4.00%, 9/15/09 2,985 2,952 2,952 Savings and Loan 0.2% Webster Financial, 5.125%, 4/15/14 5,310 5,302 5,302 Specialty Chemicals 0.1% Lubrizol, 5.50%, 10/1/14 3,800 3,747 3,747 Supermarkets 0.2% Kroger, 8.05%, 2/1/10 4,855 5,603 5,603 Telecommunications 0.3% Telus 7.50%, 6/1/07 2,530 2,752 8.00%, 6/1/11 4,250 4,946 7,698 Telephones 0.7% Deutsche Telekom International Finance, STEP, 8.75%, 6/15/30 4,550 5,833 France Telecom, STEP, 8.50%, 3/1/11 4,360 5,173 Telefonos de Mexico, 4.50%, 11/19/08 2,480 2,490 Verizon Global Funding, 7.75%, 12/1/30 4,155 4,977 18,473 Wireless Communications 0.2% America Movil, 5.50%, 3/1/14 3,255 3,171 U.S. Cellular, 6.70%, 12/15/33 2,695 2,707 5,878 Total Corporate Bonds and Notes (Cost $660,656) 678,472 ASSET-BACKED SECURITIES 3.2% Auto-Backed 0.9% Capital Auto Receivables Asset Trust Series 2002-2, Class CERT, 4.18%, 10/15/07 2,994 3,010 Chase Manhattan Auto Owner Trust Series 2001-B, Class CTFS, 3.75%, 5/15/08 1,731 1,736 Series 2003-A, Class A4, 2.06%, 12/15/09 9,125 8,892 GS Auto Loan Trust, Series 2004-1, Class C, 2.68%, 5/15/11 1,750 1,737 Hyundai Auto Receivables Trust Series 2003-A, Class A4, 3.02%, 10/15/10 4,950 4,894 Series 2003-A, Class D, 4.06%, 10/15/10 2,050 2,065 Morgan Stanley Auto Loan Trust Series 2004-HB1, Class C, VR, 2.88%, 10/15/11 3,636 3,621 SSB Auto Loan Trust, Series 2002-1, Class C, 4.13%, 2/15/09 938 940 26,895 Credit Card-Backed 1.5% Citibank Credit Card Issuance Trust Series 2001-C1, Class C1, VR, 2.68%, 1/15/10 6,035 6,136 Series 2004-C1, Class C1, VR, 2.75%, 7/15/13 13,000 13,022 MBNA Master Credit Card Trust II Series 2000-D, Class C, 144A, 8.40%, 9/15/09 10,075 11,105 World Financial Network Series 2003-A, Class A2, VR, 2.47%, 5/15/12 10,925 10,973 41,236 Recreational Vehicles 0.0% CIT RV Trust, Series 1997-A, Class A6, 6.35%, 4/15/11 639 641 641 Stranded Asset 0.8% Peco Energy Transition Trust Series 2001-A, Class A1, 6.52%, 12/31/10 11,475 12,757 Reliant Energy Transition Bond Series 2001-1, Class A4, 5.63%, 9/15/15 8,572 9,058 21,815 Total Asset-Backed Securities (Cost $89,979) 90,587 NON-U.S. GOVERNMENT MORTGAGE-BACKED SECURITIES 6.1% Commercial Mortgage-Backed 3.8% Banc of America Commercial Mortgage Series 2003-1, Class A2, CMO, 4.648%, 9/11/36 11,450 11,407 Bear Stearns Commercial Mortgage Series 2002-TOP8, Class A2, CMO, 4.83%, 8/15/38 8,210 8,234 DLJ Commercial Mortgage Series 1999-CG2, Class A1B, CMO, 7.30%, 6/10/32 13,000 14,509 GE Capital Commercial Mortgage Series 2001-1, Class A2, CMO, 6.531%, 3/15/11 11,300 12,418 Greenwich Capital Commercial Funding Series 2004-GG1A, Class A2, CMO, 3.835%, 10/8/08 9,181 9,174 GS Mortgage Securities Corp. II Series 2004-GG2, Class A2, CMO, 4.293%, 8/1/38 6,050 6,106 J.P. Morgan Chase Commercial Mortgage Series 2001-CIB2, Class A2, CMO, 6.244%, 4/15/35 6,750 7,195 Series 2001-CIBC, Class A3, CMO, 6.26%, 3/15/33 7,275 7,946 LB-UBS Commercial Mortgage Trust Series 2004-C2, Class A2, CMO, 3.246%, 3/15/29 5,975 5,772 Series 2004-C4, Class A2, CMO, 4.567%, 5/15/29 11,750 11,934 Morgan Stanley Dean Witter Capital Series 2002-TOP7, Class A2, CMO, 5.98%, 1/15/39 9,400 10,157 Prudential Securities Secured Financing Series 1999-NRF1, Class A1, CMO, 6.074%, 1/15/08 2,204 2,250 107,102 Home Equity Loans-Backed 0.5% BankBoston Home Equity Loan Trust Series 1998-1, Class A6, 6.35%, 2/25/13 3,287 3,463 Chase Funding Mortgage Loan Series 1998-1, Class 1M1, 6.59%, 5/25/28 1,422 1,440 Series 2002-2, Class 1M1, 5.599%, 9/25/31 1,750 1,775 Countrywide Asset-Backed Certificates Series 2003-5, Class AF3, 3.613%, 4/25/30 7,925 7,910 14,588 Whole Loans-Backed 1.8% Bank of America Mortgage Securities Series 2003-L, Class 2A2, CMO, 4.32%, 1/25/34 16,566 16,421 Series 2004-1, Class 3A2, CMO, 5.008%, 10/25/34 6,301 6,350 Series 2004-A, Class 2A2, CMO, 4.152%, 2/25/34 8,945 8,827 Series 2004-D, Class 2A2, CMO, 4.225%, 5/25/34 4,575 4,525 Series 2004-H, Class 2A2, CMO, 4.821%, 9/25/34 5,899 5,967 Countrywide Home Loans Series 2003-60, Class 2A1, CMO, 5.017%, 2/25/34 2,441 2,446 Residential Accredit Loans Series 1997-QS12, Class A7, CMO, 7.25%, 11/25/27 319 320 Washington Mutual Series 2004-AR1, Class A, CMO, 4.229%, 3/25/34 5,080 5,004 49,860 Total Non-U.S. Government Mortgage-Backed Securities (Cost $173,010) 171,550 U.S. GOVERNMENT & AGENCY MORTGAGE-BACKED SECURITIES 33.9% U.S. Government Agency Obligations+/- 25.6% Federal Home Loan Mortgage 4.50%, 11/1/18 - 6/1/19 34,487 34,309 5.00%, 1/1/09 - 4/1/34 64,714 65,499 5.50%, 4/1/29 709 722 6.00%, 5/1/17 - 12/1/33 26,524 27,541 6.50%, 5/1/17 - 5/1/24 6,209 6,580 7.00%, 2/1/24 - 6/1/32 4,146 4,402 7.50%, 5/1 - 6/1/24 297 321 10.50%, 3/1/13 - 8/1/20 28 31 11.00%, 11/1/17 - 7/1/20 17 19 ARM, 4.577%, 9/1/32 3,756 3,779 CMO 4.50%, 3/15/16 31,450 31,324 5.50%, 4/15/28 21,750 22,428 6.50%, 3/15/23 10,810 11,025 CMO, IO 4.50%, 6/15/11 - 4/15/18 29,866 2,961 CMO, Principal Only, 8/1/28 569 493 TBA 5.50%, 1/1/32 1,075 1,087 6.00%, 1/1/18 12,469 13,054 Federal National Mortgage Assn. 4.50%, 5/1/18 - 1/1/19 42,527 42,334 5.00%, 1/1/09 - 6/1/34 132,026 131,182 5.50%, 4/1/16 - 10/1/34 177,479 181,184 6.00%, 4/1/14 - 11/1/34 66,318 68,547 6.50%, 6/1/13 - 7/1/32 28,534 29,999 7.00%, 10/1/29 - 11/1/30 163 174 CMO, 3.50%, 4/25/13 7,250 7,255 CMO, IO 5.50%, 11/25/28 7,420 490 6.50%, 2/1/32 2,275 456 TBA, 6.50%, 1/1/33 25,875 27,136 714,332 U.S. Government Obligations 8.3% Government National Mortgage Assn. 5.00%, 7/15 - 9/20/33 61,591 61,303 5.50%, 1/20 - 4/15/34 53,219 54,065 6.00%, 2/15/14 - 9/20/34 42,428 44,103 6.50%, 8/15/25 - 9/20/34 4,473 4,714 7.00%, 3/15/13 - 11/20/28 9,396 10,037 7.50%, 8/15/16 - 8/15/28 1,833 1,973 8.00%, 7/15/16 - 10/15/27 5,974 6,529 8.50%, 9/15/16 - 9/20/26 1,108 1,221 9.00%, 1/15/09 - 11/15/19 253 282 9.50%, 6/15/09 - 2/15/25 59 65 10.25%, 9/15/19 - 11/15/20 200 226 11.00%, 12/15/09 - 6/15/19 1,889 2,133 11.50%, 3/15/10 - 10/15/15 258 295 CMO, 2.946%, 3/16/19 7,050 6,813 CMO, Principal Only, 3/16/28 1,104 1,004 TBA 5.00%, 1/1/33 7,175 7,120 5.50%, 1/1/32 14,120 14,314 6.00%, 1/1/33 14,750 15,220 231,417 Total U.S. Government & Agency Mortgage-Backed Securities (Cost $940,539) 945,749 U.S. GOVERNMENT & AGENCY OBLIGATIONS (EXCLUDING MORTGAGE-BACKED) 21.0% U.S. Government Agency Obligations+/- 6.5% Federal Home Loan Bank, 1.833%, 2/25/05 20,000 19,894 Federal Home Loan Mortgage 2.75%, 3/15/08(ss.) 32,182 31,343 4.75%, 10/11/12(ss.) 10,000 9,871 5.125%, 7/15/12 31,258 32,526 6.875%, 1/15/05 4,750 4,777 Federal National Mortgage Assn. 4.25%, 7/15/07(ss.) 20,000 20,400 4.375%, 9/15/12(ss.) 10,650 10,543 5.75%, 2/15/08 15,045 16,023 7.125%, 1/15/30 11,300 13,807 CMO 2.91%, 11/25/33 6,325 6,303 5.00%, 3/25/15 15,800 16,021 181,508 U.S. Treasury Obligations 14.5% U.S. Treasury Bonds 5.375%, 2/15/31(ss.) 24,475 25,744 5.50%, 8/15/28(ss.) 7,500 7,920 6.00%, 2/15/26(ss.) 9,805 10,994 6.25%, 8/15/23 - 5/15/30(ss.)++ 50,310 58,448 6.50%, 11/15/26(ss.) 29,650 35,251 7.50%, 11/15/16(ss.)++ 21,100 26,639 8.50%, 2/15/20(ss.) 3,600 5,005 U.S. Treasury Inflation-Indexed Bonds, 2.375%, 1/15/25(ss.) 26,091 27,004 U.S. Treasury Notes 1.50%, 2/28/05(ss.) 114,100 113,904 1.625%, 4/30/05(ss.) 30,000 29,906 4.00%, 6/15/09(ss.) 17,800 18,056 4.25%, 8/15 - 11/15/13(ss.) 9,800 9,767 4.75%, 5/15/14(ss.) 9,000 9,277 5.00%, 8/15/11(ss.) 11,500 12,161 U.S. Treasury Stripped Interest Payment Zero Coupon, 5/15/20(ss.) 32,250 14,578 404,654 Total U.S. Government & Agency Obligations (excluding Mortgage-Backed) (Cost $576,530) 586,162 FOREIGN GOVERNMENT OBLIGATIONS & AGENCY OBLIGATIONS 3.8% Federal Republic of Germany, 5.00%, 5/20/05 (EUR) 9,100 12,217 Government of Canada, 6.00%, 9/1/05 (CAD) 34,650 29,823 Government of Poland, 5.75%, 6/24/08 (PLN) 85,300 26,235 Republic of Chile, 5.50%, 1/15/13 4,710 4,868 Republic of South Africa, 6.50%, 6/2/14(ss.) 2,575 2,797 United Mexican States 8.00%, 12/19/13 (MXN) 337,500 25,940 VR, 2.29%, 1/13/09(ss.) 3,500 3,549 Total Foreign Government Obligations & Agency Obligations (Cost $89,653) 105,429 MUNICIPAL BONDS 2.3% California Economic Recovery 5.00%, 7/1/23 (Tender 7/1/07) 2,280 2,421 5.00%, 7/1/23 (Tender 7/1/08) 2,450 2,646 GO 5.25%, 4/1/34 2,570 2,635 5.50%, 11/1/33 2,500 2,631 Kansas Dev. Fin. Auth., Public Employee Retirement 5.501%, 5/1/34 (FSA Insured) 3,175 3,164 Massachusetts, GO, 5.25%, 8/1/15 (MBIA Insured) 11,250 12,471 New York State Urban Dev. Corp., Corrections & Youth Fac. 5.25%, 1/1/21 (Tender 1/1/09) 5,675 6,136 North Carolina, GO, 5.25%, 3/1/13 15,740 17,671 Oregon, Taxable Pension Fund, GO, 5.892%, 6/1/27 1,640 1,732 Puerto Rico Public Fin. Corp. 5.25%, 8/1/29 (MBIA Insured) (Tender 2/1/12) 11,050 12,160 Total Municipal Bonds (Cost $63,325) 63,667 COMMON STOCKS 1.0% Bank and Trust 0.4% AmSouth Bancorp(ss.) 60 1,556 Citizens Banking(ss.) 50 1,755 Hudson United Bancorp(ss.) 48 1,931 KeyCorp(ss.) 76 2,517 National City(ss.) 45 1,668 U.S. Bancorp(ss.) 55 1,630 Washington Mutual(ss.) 39 1,567 12,624 Building and Real Estate 0.2% CarrAmerica Realty, REIT(ss.) 60 1,943 Weingarten Realty Investors, REIT(ss.) 59 2,384 4,327 Financial Services 0.1% Citigroup 47 2,092 2,092 Integrated Petroleum - International 0.3% BP ADR(ss.) 49 2,994 ChevronTexaco(ss.) 56 3,058 Royal Dutch Petroleum ADS(ss.) 47 2,668 8,720 Total Common Stocks (Cost $23,238) 27,763 PREFERRED STOCKS 0.1% Real Estate 0.1% Roslyn Real Estate Asset * 0 1,995 Total Preferred Stocks (Cost $2,045) 1,995 INTEREST RATE SWAP AGREEMENTS 0.0% Citigroup Capital Services, Pay 4.435% Fixed Receive 3 month LIBOR (Currently 2.29%), 5/11/09 0 101 Morgan Stanley Capital Services, Pay 3.955% Fixed Receive 3 month LIBOR (Currently 2.29%), 11/12/08 0 (54) Morgan Stanley Capital Services, Pay 4.213% Fixed Receive 3 month LIBOR (Currently 2.29%), 11/12/08 0 (50) Total Interest Rate Swap Agreements (Premium Paid $0) (3) SHORT-TERM INVESTMENTS 6.2% Money Market Funds 6.2% T. Rowe Price Reserve Investment Fund, 2.00% #+ 172,102 172,102 Total Short-Term Investments (Cost $172,102) 172,102 SECURITIES LENDING COLLATERAL 16.3% Money Market Trust 16.3% State Street Bank and Trust Company of New Hampshire N.A. Securities Lending Quality Trust units, 1.998% # 453,183 453,183 Total Securities Lending Collateral (Cost $453,183) 453,183 FORWARD CURRENCY EXCHANGE CONTRACTS 0.0% Unrealized Gain (Loss) on Forward Currency Exchange Contracts(2) (949) Total Forward Currency Exchange Contracts (949) FUTURES CONTRACTS 0.0% Variation margin receivable (payable) on open future contracts(3) 22 Total Futures Contracts 22 Total Investments in Securities 118.3% of Net Assets (Cost $3,244,260) $3,295,729 ---------- (1) Denominated in U.S. dollars unless otherwise noted # Seven-day yield * Non-income producing (ss.) All or a portion of this security is on loan at November 30, 2004 - See Note 2 +/- The issuer is a publicly-traded company that operates under a congressional charter; its securities are neither issued nor guaranteed by the U.S. government. ++ All or a portion of this security is pledged to cover margin requirements on futures contracts at November 30, 2004. + Affiliated company - See Note 4 144A Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be resold in transactions exempt from registration only to qualified institutional buyers - total value of such securities at period- end amounts to $122,695 and represents 4.4% of net assets ADR American Depository Receipts ADS American Depository Shares ARM Adjustable Rate Mortgage CAD Canadian dollar CMO Collateralized Mortgage Obligation EUR Euro FSA Financial Security Assurance Inc. GO General Obligation IO Interest Only security for which the fund receives interest on notional principal (par) MBIA MBIA Insurance Corp. MXN Mexican peso PLN Polish zloty REIT Real Estate Investment Trust STEP Stepped coupon bond for which the coupon rate of interest will adjust on specified future date(s) TBA To Be Announced security was purchased on a forward commitment basis USD U.S. dollar VR Variable Rate (2) Open Forward Currency Exchange Contracts at November 30, 2004 were as follows: Amounts in (000s) Unrealized Counterparty Settlement Receive Deliver Gain (Loss) ------------------ ---------- --------------- --------------- ----------- RPC Capital Markets 1/31/05 USD 16,231 CAD 19,165 $ 139 CS First Boston 2/7/05 USD 29,417 EUR 23,000 (1,088) Net unrealized gain (loss) on open forward currency exchange contracts $ (949) ------ (3) Open Futures Contracts at November 30, 2004 were as follows: ($ 000s) Contract Unrealized Expiration Value Gain (Loss) ---------- -------- ----------- Short, 679 U.S. Treasury five year contracts, $350 par of 6.25% U.S. Treasury Bonds pledged as initial margin 3/05 $ (73,894) $ 180 Short, 175 U.S. Treasury ten year contracts, $1,575 par of 7.50% U.S. Treasury Bonds pledged as initial margin 3/05 (19,381) 46 Long, 195 Federal Republic of Germany five year contracts 12/04 29,140 528 Long, 105 Federal Republic of Germany ten year contracts 12/04 16,424 32 Net payments (receipts) of variation margin to date (764) Variation margin receivable (payable) on open futures contracts $ 22 ----- The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited November 30, 2004 STATEMENT OF ASSETS AND LIABILITIES -------------------------------------------------------------------------------- (In thousands except shares and per share amounts) Assets Investments in securities, at value Affiliated companies (cost $172,102) $ 172,102 Non-affiliated companies (cost $3,072,158) 3,123,627 Total investments in securities 3,295,729 Other assets 66,369 Total assets 3,362,098 Liabilities Obligation to return securities lending collateral 453,183 Other liabilities 123,845 Total liabilities 577,028 NET ASSETS $ 2,785,070 ------------ Net Assets Consist of: Undistributed net investment income (loss) $ (442) Undistributed net realized gain (loss) (19,668) Net unrealized gain (loss) 52,387 Paid-in-capital applicable to 307,537,455 shares of $1.00 par value capital stock outstanding; 300,000,000 shares authorized 2,752,793 NET ASSETS $ 2,785,070 ------------ NET ASSET VALUE PER SHARE Investor Class ($2,781,107,861/307,099,999 shares outstanding) $ 9.06 ------------ Advisor Class ($512,000/56,550 shares outstanding) $ 9.05 ------------ R Class ($3,450,314/380,906 shares outstanding) $ 9.06 ------------ The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited STATEMENT OF OPERATIONS -------------------------------------------------------------------------------- ($ 000s) 6 Months Ended 11/30/04 Investment Income (Loss) Income Interest $ 55,301 Dividend 2,291 Securities lending 192 Total income 57,784 Expenses Investment management 6,148 Shareholder servicing Investor Class 2,664 R Class 7 Custody and accounting 188 Prospectus and shareholder reports Investor Class 44 Advisor Class 1 R Class 1 Registration 60 Legal and audit 14 Rule 12b-1 fees R Class 6 Directors 5 Miscellaneous 10 Reductions/repayments of fees and expenses Expenses (reimbursed by) repaid to manager (3) Total expenses 9,145 Net investment income (loss) 48,639 Realized and Unrealized Gain (Loss) Net realized gain (loss) Securities 11,627 Futures (1,686) Foreign currency transactions (8,190) Net realized gain (loss) 1,751 T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited STATEMENT OF OPERATIONS -------------------------------------------------------------------------------- ($ 000s) 6 Months Ended 11/30/04 Change in net unrealized gain (loss) Securities 52,064 Futures 718 Written options 215 Other assets and liabilities denominated in foreign currencies (999) Change in net unrealized gain (loss) 51,998 Net realized and unrealized gain (loss) 53,749 INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS $ 102,388 ---------- The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited STATEMENT OF CHANGES IN NET ASSETS -------------------------------------------------------------------------------- ($ 000s) 6 Months Year Ended Ended 11/30/04 5/31/04 Increase (Decrease) in Net Assets Operations Net investment income (loss) $ 48,639 $ 79,320 Net realized gain (loss) 1,751 41,550 Change in net unrealized gain (loss) 51,998 (128,783) Increase (decrease) in net assets from operations 102,388 (7,913) Distributions to shareholders Net investment income Investor Class (50,226) (82,278) Advisor Class (5) (4) R Class (55) (55) Decrease in net assets from distributions (50,286) (82,337) Capital share transactions * Shares sold Investor Class 339,609 693,833 Advisor Class 385 38 R Class 1,106 3,387 Distributions reinvested Investor Class 48,188 77,952 Advisor Class 3 4 R Class 55 55 Shares redeemed Investor Class (170,386) (436,124) Advisor Class (18) (6) R Class (662) (834) Increase (decrease) in net assets from capital share transactions 218,280 338,305 Net Assets Increase (decrease) during period 270,382 248,055 Beginning of period 2,514,688 2,266,633 End of period $2,785,070 $2,514,688 ---------- ---------- (Including undistributed net investment income (loss) of $(442) at 11/30/04 and $1,205 at 5/31/04) T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited STATEMENT OF CHANGES IN NET ASSETS -------------------------------------------------------------------------------- ($ 000s) 6 Months Year Ended Ended 11/30/04 5/31/04 *Share information Shares sold Investor Class 37,677 76,658 Advisor Class 42 5 R Class 124 377 Distributions reinvested Investor Class 5,333 8,648 R Class 6 6 Shares redeemed Investor Class (18,955) (48,398) Advisor Class (2) (1) R Class (74) (93) Increase (decrease) in shares outstanding 24,151 37,202 The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- Unaudited November 30, 2004 NOTES TO FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES T. Rowe Price New Income Fund, Inc. (the fund) is registered under the Investment Company Act of 1940 (the 1940 Act) as a diversified, open-end management investment company. The fund seeks the highest level of income consistent with the preservation of capital over time by investing primarily in marketable debt securities. The fund has three classes of shares: the New Income Fund original share class, referred to in this report as the Investor Class, offered since August 31, 1973, New Income Fund--Advisor Class (Advisor Class), offered since September 30, 2002, and New Income Fund--R Class (R Class), offered since September 30, 2002. Advisor Class shares are sold only through unaffiliated brokers and other unaffiliated financial intermediaries, and R Class shares are available to retirement plans serviced by intermediaries. The Advisor Class and R Class each operate under separate Board-approved Rule 12b-1 plans, pursuant to which each class compensates financial intermediaries for distribution, shareholder servicing, and/or certain administrative services. Each class has exclusive voting rights on matters related solely to that class, separate voting rights on matters that relate to all classes, and, in all other respects, the same rights and obligations as the other classes. The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates made by fund management. Valuation The fund values its investments and computes its net asset value per share at the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day that the NYSE is open for business. Debt securities are generally traded in the over-the-counter market. Securities with original maturities of one year or more are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service, which considers yield or price of bonds of comparable quality, coupon, maturity, and type, as well as prices quoted by dealers who make markets in such securities. Securities with original maturities of less than one year are stated at fair value, which is determined by using a matrix system that establishes a value for each security based on bid-side money market yields. Equity securities listed or regularly traded on a securities exchange or in the over-the-counter market are valued at the last quoted sale price or, for certain markets, the official closing price at the time the valuations are made, except for OTC Bulletin Board securities, which are valued at the mean of the latest bid and asked prices. A security that is listed or traded on more than one exchange is valued at the quotation on the exchange determined to be the primary market for such security. Listed securities not traded on a particular day are valued at the mean of the latest bid and asked prices for domestic securities and the last quoted sale price for international securities. Investments in mutual funds are valued at the mutual fund's closing net asset value per share on the day of valuation. Options on futures contracts are valued at the last sale price. Financial futures contracts are valued at closing settlement prices. Swap agreements are valued at prices furnished by dealers who make markets in such securities. Other investments and those for which the above valuation procedures are inappropriate or are deemed not to reflect fair value are stated at fair value as determined in good faith by the T. Rowe Price Valuation Committee, established by the fund's Board of Directors. In the course of making a good faith determination of a security's fair value, the fund reviews a variety of factors, including market and trading trends and the value of comparable securities, such as unrestricted securities of the same issuer. Most foreign markets close before the close of trading on the NYSE. If the fund determines that developments between the close of a foreign market and the close of the NYSE will, in its judgment, materially affect the value of some or all of its portfolio securities, which in turn will affect the fund's share price, the fund will adjust the previous closing prices to reflect the fair value of the securities as of the close of the NYSE, as determined in good faith by the T. Rowe Price Valuation Committee, established by the fund's Board of Directors. A fund may also fair value securities in other situations, such as when a particular foreign market is closed but the fund is open. In deciding whether to make fair value adjustments, the fund reviews a variety of factors, including developments in foreign markets, the performance of U.S. securities markets, and the performance of instruments trading in U. S. markets that represent foreign securities and baskets of foreign securities. The fund uses outside pricing services to provide it with closing market prices and information used for adjusting those prices. The fund cannot predict how often it will use closing prices and how often it will adjust those prices. As a means of evaluating its fair value process, the fund routinely compares closing market prices, the next day's opening prices in the same markets, and adjusted prices. Currency Translation Assets, including investments, and liabilities denominated in foreign currencies are translated into U.S. dollar values each day at the prevailing exchange rate, using the mean of the bid and asked prices of such currencies against U.S. dollars as quoted by a major bank. Purchases and sales of securities, income, and expenses are translated into U.S. dollars at the prevailing exchange rate on the date of the transaction. The effect of changes in foreign currency exchange rates on realized and unrealized security gains and losses is reflected as a component of security gains and losses. Class Accounting The Advisor Class and R Class each pay distribution, shareholder servicing, and/or certain administrative expenses in the form of Rule 12b-1 fees, in an amount not exceeding 0.25% and 0.50%, respectively, of the class's average daily net assets. Shareholder servicing, prospectus, and shareholder report expenses incurred by each class are charged directly to the class to which they relate. Expenses common to all classes and investment income are allocated to the classes based upon the relative daily net assets of each class's settled shares; realized and unrealized gains and losses are allocated based upon the relative daily net assets of each class's outstanding shares. Investment Transactions, Investment Income, and Distributions Income and expenses are recorded on the accrual basis. Premiums and discounts on debt securities are amortized for financial reporting purposes. Inflation adjustments to the principal amount of inflation-indexed bonds are included in interest income. Dividends received from mutual fund investments are reflected as dividend income; capital gain distributions are reflected as realized gain/loss. Dividend income and capital gain distributions are recorded on the ex-dividend date. Investment transactions are accounted for on the trade date. Realized gains and losses are reported on the identified cost basis. Payments ("variation margin") made or received to settle the daily fluctuations in the value of futures contracts are recorded as unrealized gains or losses until the contracts are closed. Unsettled variation margin on futures contracts is included in investments in securities, and unrealized gains and losses on futures contracts are included in the change in net unrealized gain or loss in the accompanying financial statements. Unrealized gains and losses on forward currency exchange contracts are included in investments in securities, and in the change in net unrealized gain or loss in the accompanying financial statements. Net periodic receipts or payments required by swap agreements are accrued daily and recorded as realized gain or loss on securities in the accompanying financial statements. Fluctuations in the fair value of swap agreements are recorded in the change in net unrealized gain or loss on securities in the accompanying financial statements and are reclassified to realized gain or loss on securities upon termination prior to maturity. Distributions to shareholders are recorded on the ex-dividend date. Income distributions are declared by each class on a daily basis and paid monthly. Capital gain distributions, if any, are declared and paid by the fund, typically on an annual basis. Other In the normal course of business, the fund enters into contracts that provide general indemnifications. The fund's maximum exposure under these arrangements is dependent on claims that may be made against the fund in the future and, therefore, cannot be estimated; however, based on experience, the risk of material loss from such claims is considered remote. NOTE 2 - INVESTMENT TRANSACTIONS Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks or enhance performance. The investment objective, policies, program, and risk factors of the fund are described more fully in the fund's prospectus and Statement of Additional Information. Restricted Securities The fund may invest in securities that are subject to legal or contractual restrictions on resale. Although certain of these securities may be readily sold, for example, under Rule 144A, others may be illiquid, and their sale may involve substantial delays and additional costs, and prompt sale at an acceptable price may be difficult. Forward Currency Exchange Contracts During the six months ended November 30, 2004, the fund was a party to forward currency exchange contracts under which it is obligated to exchange currencies at specified future dates and exchange rates. Risks arise from the possible inability of counterparties to meet the terms of their agreements and from movements in currency values. Futures Contracts During the six months ended November 30, 2004, the fund was a party to futures contracts, which provide for the future sale by one party and purchase by another of a specified amount of a specific financial instrument at an agreed upon price, date, time, and place. Risks arise from possible illiquidity of the futures market and from movements in security values and/or interest rates. Options Call and put options on futures contracts give the holder the right to purchase or sell, respectively, a particular futures contract at a specified price on a certain date. Risks arise from possible illiquidity of the options market and from movements in underlying futures prices. Transactions in options written and related premiums received during the six months ended November 30, 2004, were as follows: Number of Contracts Premiums Outstanding at beginning of period 240 $ 258,000 Expired (240) (258,000) Outstanding at end of period - $ - ------------------------------ Swap Agreements During the six months ended November 30, 2004, the fund was a party to interest rate swap agreements under which it is obligated to exchange cash flows based on the difference between specified interest rates applied to a notional principal amount for a specified period of time. Risks arise from the possible inability of counterparties to meet the terms of their agreements and from movements in interest rates. Securities Lending The fund lends its securities to approved brokers to earn additional income. It receives as collateral cash and U.S. government securities valued at 102% to 105% of the value of the securities on loan. Cash collateral is invested in a money market pooled trust managed by the fund's lending agent in accordance with investment guidelines approved by fund management. Collateral is maintained over the life of the loan in an amount not less than the value of loaned securities, as determined at the close of fund business each day; any additional collateral required due to changes in security values is delivered to the fund the next business day. Although risk is mitigated by the collateral, the fund could experience a delay in recovering its securities and a possible loss of income or value if the borrower fails to return the securities. Securities lending revenue recognized by the fund consists of earnings on invested collateral and borrowing fees, net of any rebates to the borrower and compensation to the lending agent. At November 30, 2004, the value of loaned securities was $468,570,000; aggregate collateral consisted of $453,183,000 in the money market pooled trust and U.S. government securities valued at $29,584,000. Other Purchases and sales of portfolio securities, other than short-term and U.S. government securities, aggregated $368,480,000 and $406,948,000, respectively, for the six months ended November 30, 2004. Purchases and sales of U.S. government securities aggregated $1,792,806,000 and $1,500,120,000, respectively, for the six months ended November 30, 2004. NOTE 3 - FEDERAL INCOME TAXES No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute to shareholders all of its taxable income and gains. Federal income tax regulations differ from generally accepted accounting principles; therefore, distributions determined in accordance with tax regulations may differ in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character. Financial records are not adjusted for temporary differences. The amount and character of tax-basis distributions and composition of net assets are finalized at fiscal year-end; accordingly, tax-basis balances have not been determined as of November 30, 2004. The fund intends to retain realized gains to the extent of available capital loss carryforwards. As of May 31, 2004, the fund had $22,720,000 of unused capital loss carryforwards that expire in fiscal 2009 At November 30, 2004, the cost of investments for federal income tax purposes was $3,244,260,000. Net unrealized gain aggregated $52,387,000 at period-end, of which $97,860,000 related to appreciated investments and $45,473,000 related to depreciated investments. NOTE 4 - RELATED PARTY TRANSACTIONS The fund is managed by T. Rowe Price Associates, Inc. (the manager or Price Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. The investment management agreement between the fund and the manager provides for an annual investment management fee, which is computed daily and paid monthly. The fee consists of an individual fund fee, equal to 0.15% of the fund's average daily net assets, and the fund's pro-rata share of a group fee. The group fee is calculated based on the combined net assets of certain mutual funds sponsored by Price Associates (the group) applied to a graduated fee schedule, with rates ranging from 0.48% for the first $1 billion of assets to 0.295% for assets in excess of $120 billion. The fund's portion of the group fee is determined by the ratio of its average daily net assets to those of the group. At November 30, 2004, the effective annual group fee rate was 0.31%, and investment management fee payable totaled $1,053,000. The Advisor Class and R Class are also subject to a contractual expense limitation through the limitation dates indicated in the table below. During the limitation period, the manager is required to waive its management fee and reimburse a class for any expenses, excluding interest, taxes, brokerage commissions, and extraordinary expenses, that would otherwise cause the class's ratio of total expenses to average net assets (expense ratio) to exceed its expense limitation. Through the repayment date, each class is required to repay the manager for expenses previously reimbursed and management fees waived to the extent the class's net assets have grown or expenses have declined sufficiently to allow repayment without causing the class's expense ratio to exceed its expense limitation. -------------------------------------------------------------------------------- Advisor Class R Class Expense Limitation 0.90% 1.15% Limitation Date 9/30/06 9/30/06 Repayment Date 9/30/08 9/30/08 Pursuant to this agreement, at November 30, 2004, management fees waived remain subject to repayment in the following amounts: $10,000 through September 30, 2006 and $1,000 through September 30, 2008. In addition, the fund has entered into service agreements with Price Associates and two wholly owned subsidiaries of Price Associates (collectively, Price). Price Associates computes the daily share prices and maintains the financial records of the fund. T. Rowe Price Services, Inc., provides shareholder and administrative services in its capacity as the fund's transfer and dividend disbursing agent. T. Rowe Price Retirement Plan Services, Inc., provides subaccounting and recordkeeping services for certain retirement accounts invested in the Investor Class and R Class. For the six months ended November 30, 2004, expenses incurred pursuant to these service agreements were $72,000 for Price Associates, $348,000 for T. Rowe Price Services, Inc., and $611,000 for T. Rowe Price Retirement Plan Services, Inc. At period-end, a total of $205,000 of these expenses was payable. Additionally, the fund is one of several mutual funds in which certain college savings plans managed by Price Associates may invest. As approved by the fund's Board of Directors, shareholder servicing costs associated with each college savings plan are borne by the fund in proportion to the average daily value of its shares owned by the college savings plan. For the six months ended November 30, 2004, the fund was charged $2,000 for shareholder servicing costs related to the college savings plans, of which $1,000 was for services provided by Price and $0 was payable at period-end. At November 30, 2004, no shares of the Investor Class were held by college savings plans. The fund is also one of several mutual funds sponsored by Price Associates (underlying Price funds) in which the T. Rowe Price Spectrum Funds (Spectrum Funds) and T. Rowe Price Retirement Funds (Retirement Funds) may invest. Neither the Spectrum Funds nor the Retirement Funds invest in the underlying Price funds for the purpose of exercising management or control. Pursuant to separate, special servicing agreements, expenses associated with the operation of the Spectrum and Retirement Funds are borne by each underlying Price fund to the extent of estimated savings to it and in proportion to the average daily value of its shares owned by the Spectrum and Retirement Funds, respectively. Expenses allocated under these agreements are reflected as shareholder servicing expenses in the accompanying financial statements. For the six months ended November 30, 2004, the fund was allocated $911,000 of Spectrum Funds' expenses and $484,000 of Retirement Funds' expenses. Of these amounts, $900,000 related to services provided by Price and $223,000 was payable at period-end. At November 30, 2004, approximately 35.3% of the outstanding shares of the Investor Class were held by the Spectrum Funds and 12.5% were held by the Retirement Funds. The fund may invest in the T. Rowe Price Reserve Investment Fund and the T. Rowe Price Government Reserve Investment Fund (collectively, the Reserve Funds), open-end management investment companies managed by Price Associates and affiliates of the fund. The Reserve Funds are offered as cash management options to mutual funds, trusts, and other accounts managed by Price Associates and/or its affiliates, and are not available for direct purchase by members of the public. The Reserve Funds pay no investment management fees. During the six months ended November 30, 2004, dividend income from the Reserve Funds totaled $1,660,000, and the value of shares of the Reserve Funds held at November 30, 2004 and May 31, 2004 was $172,102,000 and $238,642,000, respectively. As of November 30, 2004, T. Rowe Price Group, Inc. and/or its wholly owned subsidiaries owned 12,226 shares of the Advisor Class, aggregating less than 1% of the fund's net assets. T. Rowe Price New Income Fund -------------------------------------------------------------------------------- INFORMATION ON PROXY VOTING POLICIES, PROCEDURES, AND RECORDS -------------------------------------------------------------------------------- A description of the policies and procedures used by T. Rowe Price funds and portfolios to determine how to vote proxies relating to portfolio securities is available in each fund's Statement of Additional Information, which you may request by calling 1-800-225-5132 or by accessing the SEC's Web site, www.sec.gov. The description of our proxy voting policies and procedures is also available on our Web site, www.troweprice.com. To access it, click on the words "Company Info" at the top of our homepage for individual investors. Then, in the window that appears, click on the "Proxy Voting Policy" navigation button in the top left corner. Each fund's most recent annual proxy voting record is available on our Web site and through the SEC's Web site. To access it through our Web site, follow the directions above, then click on the words "Proxy Voting Record" at the bottom of the Proxy Voting Policy page. HOW TO OBTAIN QUARTERLY PORTFOLIO HOLDINGS -------------------------------------------------------------------------------- The fund files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The fund's Form N-Q is available electronically on the SEC's Web site (www.sec.gov); hard copies may be reviewed and copied at the SEC's Public Reference Room, 450 Fifth St. N.W., Washington, DC 20549. For more information on the Public Reference Room, call 1-800-SEC-0330. Item 2. Code of Ethics. A code of ethics, as defined in Item 2 of Form N-CSR, applicable to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions is filed as an exhibit to the registrant's annual Form N-CSR. No substantive amendments were approved or waivers were granted to this code of ethics during the registrant's most recent fiscal half-year. Item 3. Audit Committee Financial Expert. Disclosure required in registrant's annual Form N-CSR. Item 4. Principal Accountant Fees and Services. Disclosure required in registrant's annual Form N-CSR. Item 5. Audit Committee of Listed Registrants. Not applicable. Item 6. Schedule of Investments. Not applicable. The complete schedule of investments is included in Item 1 of this Form N-CSR. Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. Not applicable. Item 8. Portfolio Managers of Closed-End Management Investment Companies. Not applicable. Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers. Not applicable. Item 10. Submission of Matters to a Vote of Security Holders. Not applicable. Item 11. Controls and Procedures. (a) The registrant's principal executive officer and principal financial officer have evaluated the registrant's disclosure controls and procedures within 90 days of this filing and have concluded that the registrant's disclosure controls and procedures were effective, as of that date, in ensuring that information required to be disclosed by the registrant in this Form N-CSR was recorded, processed, summarized, and reported timely. (b) The registrant's principal executive officer and principal financial officer are aware of no change in the registrant's internal control over financial reporting that occurred during the registrant's second fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 12. Exhibits. (a)(1) The registrant's code of ethics pursuant to Item 2 of Form N-CSR is filed with the registrant's annual Form N-CSR. (2) Separate certifications by the registrant's principal executive officer and principal financial officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(a) under the Investment Company Act of 1940, are attached. (3) Written solicitation to repurchase securities issued by closed-end companies: not applicable. (b) A certification by the registrant's principal executive officer and principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(b) under the Investment Company Act of 1940, is attached. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. T. Rowe Price New Income Fund, Inc. By /s/ James S. Riepe ----------------------------------- James S. Riepe Principal Executive Officer Date January 14, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By /s/ James S. Riepe ----------------------------------- James S. Riepe Principal Executive Officer Date January 14, 2005 By /s/ Joseph A. Carrier ----------------------------------- Joseph A. Carrier Principal Financial Officer Date January 14, 2005