-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Rq4GnU6MKFW3lM8qnB2cVU8S/FoyxL18Js1aUMH/jwZ/uZBuZ+mmHBhdhR6qqEK0 VX4fWEJX/dlAoYo1ZOBCmw== 0000871839-98-000147.txt : 19981005 0000871839-98-000147.hdr.sgml : 19981005 ACCESSION NUMBER: 0000871839-98-000147 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19981002 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRICE T ROWE GNMA FUND CENTRAL INDEX KEY: 0000779785 STANDARD INDUSTRIAL CLASSIFICATION: [] FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 497 SEC ACT: SEC FILE NUMBER: 033-01041 FILM NUMBER: 98720375 BUSINESS ADDRESS: STREET 1: 100 E PRATT ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4105472000 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRICE T ROWE NEW INCOME FUND INC CENTRAL INDEX KEY: 0000080249 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 520980581 FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 497 SEC ACT: SEC FILE NUMBER: 002-48848 FILM NUMBER: 98720376 BUSINESS ADDRESS: STREET 1: 100 EAST PRATT ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4105472000 FORMER COMPANY: FORMER CONFORMED NAME: PRICE T ROWE NEW INCOME FUND INC ET AL DATE OF NAME CHANGE: 19920703 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRICE T ROWE U S TREASURY FUNDS INC CENTRAL INDEX KEY: 0000853437 STANDARD INDUSTRIAL CLASSIFICATION: [] FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 497 SEC ACT: SEC FILE NUMBER: 033-30531 FILM NUMBER: 98720377 BUSINESS ADDRESS: STREET 1: 100 E PRATT ST STREET 2: 8TH FLOOR, LEGAL DEPT. CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 3015472000 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRICE T ROWE PERSONAL STRATEGY FUNDS INC CENTRAL INDEX KEY: 0000923084 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] STATE OF INCORPORATION: MD FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 497 SEC ACT: SEC FILE NUMBER: 033-53675 FILM NUMBER: 98720378 BUSINESS ADDRESS: STREET 1: C/O T ROWE PRICE ASSOCIATES INC STREET 2: 100 EAST PRATT ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4105472000 MAIL ADDRESS: STREET 1: C/O T ROWE PRICE ASSOCIATES INC STREET 2: 100 E PRATT ST CITY: BALTIMORE STATE: MD ZIP: 21202 497 1 PROSPECTUS October 1, 1998 T. Rowe Price GNMA Fund A bond fund for investors seeking both high income and the highest credit quality. RAM LOGO These securities have not been approved or disapproved by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. T. Rowe Price GNMA Fund Prospectus October 1, 1998
1 ABOUT THE FUND Fund, Market, and Risk Characteristics 1 --------------------------------------------- Other Information About the Fund 5 --------------------------------------------- Some Basics of Fixed Income Investing 7 --------------------------------------------- 2 ABOUT YOUR ACCOUNT Pricing Shares and Receiving 9 Sale Proceeds --------------------------------------------- Distributions and Taxes 10 --------------------------------------------- Transaction Procedures and 12 Special Requirements --------------------------------------------- 3 MORE ABOUT THE FUND Organization and Management 16 --------------------------------------------- Understanding Performance Information 18 --------------------------------------------- Investment Policies and Practices 19 --------------------------------------------- Financial Highlights 25 --------------------------------------------- 4 INVESTING WITH T. ROWE PRICE Account Requirements 27 and Transaction Information --------------------------------------------- Opening a New Account 27 --------------------------------------------- Purchasing Additional Shares 29 --------------------------------------------- Exchanging and Redeeming 30 --------------------------------------------- Rights Reserved by the Fund 31 --------------------------------------------- Shareholder Services 32 --------------------------------------------- Discount Brokerage 34 --------------------------------------------- Investment Information 35 ---------------------------------------------
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates, Inc., and its affiliates managed over $141 billion for more than six million individual and institutional investor accounts as of June 30, 1998. Mutual fund shares are not deposits or obligations of, or guaranteed by, any depository institution. Shares are not insured by the FDIC, Federal Reserve Board, or any other agency, and are subject to investment risks, including possible loss of the principal amount invested. ABOUT THE FUND 1 FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT ---------------------------------------------------------- To help you decide whether this fund is appropriate for you, this section reviews its investment objective, strategy, and potential risks. What is the fund's objective? The fund seeks high current income consistent with maximum credit protection and moderate price fluctuation by investing exclusively in securities backed by the full faith and credit of the U.S. government and instruments linked to these securities. What are the fund's principal investment strategies? We will invest primarily in mortgage-backed securities issued by the Government National Mortgage Association (GNMA), an agency of the Department of Housing and Urban Development. These securities represent "pools" of mortgage loans that are either guaranteed by the Federal Housing Administration or the Veterans Administration. Mortgage lenders pool individual home mortgages to back a certificate or bond, which is then sold to investors. Interest and principal payments from the underlying mortgages are passed through to investors. GNMA guarantees the timely payment of interest and principal on its securities, a guarantee backed by the U.S. Treasury. GNMAs generally offer higher yields than Treasuries of similar maturity, for reasons explained in the next section.The GNMA guarantee does not apply in any way to the price of GNMA securities or the fund's share price, both of which will fluctuate with market conditions. We can also buy bills, notes, and bonds issued by the U.S. Treasury, and other instruments, including: related futures contracts; other agency securities backed by the full faith and credit of the U.S. government; shares of a T. Rowe Price Treasury money fund; and GNMA-related securities such as collateralized mortgage obligations (CMOs) and "strips," which receive only the interest or principal portion of the underlying mortgage payments. We may also purchase new mortgage bonds in the forward market. In selecting securities, fund managers may weigh the characteristics of various types of mortgage securities and examine yield relationships in the context of their outlook for interest rates and the economy. For example, if rates are expected to fall, mortgage securities expected to have below-average prepayment rates may be purchased and assets may also be allocated to Treasury notes or bonds, which appreciate in that environment. T. ROWE PRICE 2 o For details about the fund's investment program, please see the Investment Policies and Practices section. What are the main risks of investing in the fund? Investors should be concerned primarily with interest rate risk, or market risk. An increase in interest rates should cause the fund's share price to fall, resulting in a loss of principal (see the table entitled How Interest Rates May Affect Bond Prices). That's because the bonds and notes in the fund's portfolio become less attractive to other investors when securities with higher yields become available. Even GNMAs and other securities whose principal and interest payments are guaranteed by the U.S. Treasury can decline in price if rates rise. High-quality bonds can also gain in value when rates fall. The longer a bond's maturity, the more its value will fluctuate in response to changes in interest rates. Historically, GNMAs and other mortgage-backed securities have declined less than comparable Treasuries when rates were rising, and have gained less when rates were falling. That's because funds investing in mortgage securities carry their own special risks related to changing interest rates: prepayment risk and extension risk. . Prepayment risk A mortgage-backed bond, unlike most other bonds, can be hurt when interest rates fall, because homeowners tend to refinance. The loss of high-yielding underlying mortgages and the reinvestment of proceeds at lower interest rates can reduce the bond's potential price gain in response to falling interest rates, can reduce the bond's yield, or can even cause the bond's price to fall below what an investor paid for it, resulting in a capital loss. Any of these developments could cause a decrease in the fund's income and/or share price. . Extension risk This is the flip side of prepayment risk, where rising interest rates can cause a fund's average maturity to lengthen unexpectedly due to a drop in mortgage prepayments. This would increase the fund's sensitivity to rising rates and its potential for price declines. Shareholders are also exposed to derivatives risk, the potential that our investments in these complex and volatile instruments could affect the fund's share price. In addition to CMOs and better-known instruments such as futures and options, other derivatives used in limited fashion by the fund include interest-only (IO) and principal-only (PO) securities known as "strips." The value of these instruments is derived from underlying securities such as mortgage-backed bonds. All these instruments can be highly volatile, and their value can fall dramatically in response to rapid or unexpected changes in the mortgage or interest rate environment. ABOUT THE FUND 3 To the extent the fund invests in the forward market, it may increase its price sensitivity in relation to interest rate movements. Since GNMAs are backed by the full faith and credit of the U.S. government, credit risk, or the potential for losses in principal and income as a result of credit downgrades or defaults, is negligible. As with all mutual funds, there is no guarantee this fund will achieve its goals. o The fund's share price may decline, so when you sell your shares, you may lose money. An investment in the fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. How can I tell if the fund is appropriate for me? Consider your investment goals, your time horizon for achieving them, and your tolerance for risk. Steadily reinvesting the fund's income is a conservative strategy for building capital over time. The fund may also be appropriate if you are looking for high current income consistent with the highest credit quality and can accept fluctuations in share price. If you are investing primarily for safety and liquidity, you should consider a money market fund. o The fund should not represent your complete investment program or be used for short-term trading purposes. How has the fund performed in the past? The bar chart, which shows the fund's actual performance for each of the last 10 calendar years through December 31, 1997, indicates risk by illustrating how much returns can differ from one year to the next. The fund can also experience short-term performance swings, as shown in the following chart by the best and worst calendar quarter returns during the years depicted in the chart. Of course, the fund's past performance is no guarantee of its future returns.
Calendar Year Total Returns -------------------------------- 1988 5.91% 1989 14.02 1990 10.01 1991 15.04 1992 6.46 1993 6.15 1994 -1.63 1995 17.81 1996 3.14 1997 9.48 --------------------------------
T. ROWE PRICE 4 Quarter Ended Total Return Best Quarter 6/30/89 7.73% Worst Quarter 3/31/94 -2.40% The fund's return for the 6 months ended 6/30/98 was 3.19%. In the table, the fund's average annual total returns for the 1-year, 5-year, and 10-year periods through December 31, 1997, are compared with the Salomon Smith Barney GNMA Index, which represents the broad mortgage-backed bond market, and with the fund's Lipper peer group average. By comparing the bar chart with Table 1, you can see that average returns smooth out year-to-year variations. Table 1 Average Annual Total Returns
Periods ended December 31, 1997 ---------------------------------- 1 year 5 years 10 years GNMA Fund 9.48% 6.79% 8.50% Salomon Smith Barney GNMA Index 9.35 7.28 9.48 Lipper GNMA Funds Average 8.80 6.50 8.43 ---------------------------------------------------------------------
These figures include changes in principal value, reinvested dividends, and capital gain distributions, if any. What fees or expenses will I pay? The fund is 100% no load. There are no fees or charges to buy or sell fund shares, reinvest dividends, or exchange into other T. Rowe Price funds. There are no 12b-1 marketing fees. Table 2 Fees and Expenses of the Fund
Annual fund operating expenses (expenses that are deducted from fund assets) Management fee 0.47% Other expenses 0.23% Total annual fund operating expenses 0.70% ------------------------------------------------------------------------------
ABOUT THE FUND 5 The numbers in Table 2 provide an estimate of how much it will cost to operate the fund for a year, based on 1998 fiscal year expenses. Example. The following table gives you a rough idea of how expense ratios may translate into dollars and helps you to compare the cost of investing in this fund with the cost of investing in other funds. Although your actual costs may be higher or lower, the table shows expenses you would pay if operating expenses remain the same, you invest $10,000, you earn a 5% annual return, and you hold the investment for the following periods.
1 year 3 years 5 years 10 years $72 $224 $390 $871 ----------------------------------------------------
OTHER INFORMATION ABOUT THE FUND ---------------------------------------------------------- What are the fund's potential rewards? Our emphasis on mortgage-backed bonds is designed to offer higher income than is available from U.S. Treasury securities without any decrease in credit quality. In addition, GNMAs can offer investors better downside protection than Treasury and corporate issues, as explained in the answer to the question "What are the main risks of investing in the fund?" The fund's total return will be a combination of changes in the fund's share price and its reinvested income level over a given period. How does the portfolio manager try to reduce risk? Consistent with the fund's objective, the portfolio manager uses various tools to try to reduce risk and increase total return, including: . Diversification of mortgage assets by coupon and type to minimize prepayment risk. . Shifts in portfolio holdings, such as changing the mix of GNMAs versus Treasury securities, to reduce interest rate or prepayment risk and to take advantage of opportunities for higher income and capital growth. For example, when interest rates fall, prepayment risk may be reduced by buying new GNMAs with lower coupons, and also by buying more Treasuries. . Adjustment of fund duration to try to reduce the drop in price when interest rates rise or to benefit from the rise in price when rates fall. Duration is a measure of a fund's sensitivity to interest rate changes. T. ROWE PRICE 6 Do mortgage-backed securities differ from other high-quality bonds? Yes, in one major respect. Most bonds repay principal (face value of the bond) when their maturity date is reached, but most mortgage-backed securities repay principal continually as homeowners make mortgage payments. Homeowners have the option of paying either part or all of the loan balance before maturity, perhaps to refinance or buy a new home. As a result, the effective maturity of a mortgage-backed security is virtually always shorter than its stated maturity. For example, a new GNMA certificate backed by 30-year, fixed rate mortgages will generally have a far shorter life than 30 years - probably 12 or less. Therefore, it will usually be about as volatile as a 10-year Treasury note. It is possible to estimate the average life of an entire mortgage pool backing a particular security with some accuracy, but not with certainty. Why are yields on GNMAs higher than yields on Treasuries of similar maturity? The structure of GNMAs is much more complex, and their effective maturities are uncertain because of unscheduled prepayments. Higher yields compensate investors for these potentially negative features. See the previous discussion of prepayment risk and extension risk. Is the fund a substitute for a money market fund? No. Money market funds, which have an average maturity under one year, ordinarily generate lower income in return for stability of net asset value. The fund's total return may be higher or lower than a money market fund's and, as such, it should be viewed as a longer-term investment. What are derivatives and can the fund invest in them? A derivative is a financial instrument whose value is derived from an underlying security, such as a stock or bond, or from a market benchmark such as an interest rate index. Many types of investments representing a wide range of potential risks and rewards are derivatives, including conventional instruments such as callable bonds, futures, and options, as well as more exotic investments such as stripped mortgage securities and structured notes. Investment managers have used derivatives for many years. We invest in derivatives only if the expected risks and rewards are consistent with the fund's objective, policies, and overall risk profile described in this prospectus. We use derivatives in situations where they may enable the fund to increase yield, hedge against a decline in principal, invest in other asset classes more efficiently and at a lower cost, or adjust duration. We will not invest in any high-risk, highly leveraged derivative that we believe would cause the portfolio to be more volatile than an intermediate-term, investment-grade bond. ABOUT THE FUND 7 Is there other information I can review before making a decision? Investment Policies and Practices in Section 3 discusses the principal types of portfolio securities that the fund may purchase as well as the types of management practices that the fund may use. SOME BASICS OF FIXED INCOME INVESTING ---------------------------------------------------------- Is a fund's yield fixed or will it vary? It will vary. We calculate the yield every day by dividing a fund's net income per share, expressed at annual rates, by the share price. Since income and share price fluctuate, a fund's yield also varies. Is yield the same as total return? Not for bond funds. A fund's total return is the result of reinvested distributions from income and capital gains and the change in share price for a given period. Income is always a positive contributor to total return and can either enhance a rise in share price or help offset a price decline. What is credit quality and how does it affect yield? Credit quality refers to a bond issuer's expected ability to make all required interest and principal payments on time. Because highly rated issuers represent less risk, they can borrow at lower interest rates than less creditworthy issuers. Therefore, a fund investing in high-quality securities should have a lower yield than an otherwise comparable fund investing in lower-quality securities. Treasury securities, including GNMAs, are considered the highest quality in the fixed income market. What is meant by a bond fund's maturity? Every bond has a stated maturity date when the issuer must repay the bond's entire principal value to the investor. However, many bonds are "callable," meaning their principal can be repaid earlier, on or after specified call dates. Bonds are most likely to be called when interest rates are falling because the issuer can refinance at a lower rate, just as a homeowner refinances a mortgage. In that environment, a bond's "effective maturity" is usually its nearest call date. For example, the rate at which homeowners pay down their mortgage principal determines the effective maturity of mortgage-backed bonds. A bond mutual fund has no real maturity, but it does have a weighted average maturity and an average effective maturity. This number is an average of the stated or effective maturities of the underlying bonds, with each bond's maturity "weighted" by the percentage of fund assets it represents. Funds that target effective maturities normally use the effective, rather than stated, maturities of T. ROWE PRICE 8 the bonds in the portfolio when computing the average. This provides additional flexibility in portfolio management but, all else being equal, could result in higher volatility than a fund targeting a stated maturity or maturity range. What is meant by a bond fund's duration? Duration is a calculation that seeks to measure the price sensitivity of a bond or a bond fund to changes in interest rates. It measures this sensitivity more accurately than maturity because it takes into account the time value of cash flows generated over the bond's life. Future interest and principal payments are discounted to reflect their present value and then are multiplied by the number of years they will be received to produce a value expressed in years - the duration. Effective duration takes into account call features and sinking fund payments that may shorten a bond's life. Since duration can also be computed for bond funds, you can estimate the effect of interest rates on share price by multiplying fund duration by an expected change in interest rates. (T. Rowe Price shareholder bond fund reports show duration.) For example, the price of a bond fund with a duration of five years would be expected to fall approximately 5% if rates rose by one percentage point. How is a bond's price affected by changes in interest rates? When interest rates rise, a bond's price usually falls, and vice versa. If mortgage prepayments accelerate when interest rates fall, GNMA securities may not rise in price as much as the examples in Table 3. In general, the longer a bond's maturity, the greater the price increase or decrease in response to a given change in rates. Table 3 How Interest Rates May Affect Bond Prices
Price per $1,000 of bond face value if interest rates: Bond maturity Coupon Increase Decrease 1 point 2 points 1 point 2 points 1 year 5.36% $990 $981 $1,010 $1,020 5 years 5.50 958 918 1,044 1,091 10 years 5.50 927 861 1,080 1,168 30 years 5.72 872 768 1,160 1,360 --------------------------------------------------------------------------------------------------------------
The table reflects yields on Treasury securities as of July 31, 1998. The table may not be as representative of price changes for other types of bonds, including mortgage-backed securities because of prepayments. This is an illustration and does not represent expected yields or share price changes of any T. Rowe Price fund. ABOUT YOUR ACCOUNT 2 PRICING SHARES AND RECEIVING SALE PROCEEDS ---------------------------------------------------------- Here are some procedures you should know when investing in a T. Rowe Price fixed income fund. How and when shares are priced The share price (also called "net asset value" or NAV per share) for a fund is calculated at 4 p.m. ET each day the New York Stock Exchange is open for business. To calculate the NAV, the fund's assets are valued and totaled, liabilities are subtracted, and the balance, called net assets, is divided by the number of shares outstanding. Current market values are used to price fund shares. o The various ways you can buy, sell, and exchange shares are explained at the end of this prospectus and on the New Account Form. These procedures and the information you receive about them may differ for institutional and employer-sponsored retirement accounts. How your purchase, sale, or exchange price is determined If we receive your request in correct form by 4 p.m. ET, your transaction will be priced at that day's NAV. If we receive it after 4 p.m., it will be priced at the next business day's NAV. We cannot accept orders that request a particular day or price for your transaction or any other special conditions. Fund shares may be purchased through various third-party intermediaries including banks, brokers, and investment advisers. Where authorized by a fund, orders will be priced at the NAV next computed after receipt by the intermediary. Consult your intermediary to determine when your orders will be priced. The intermediary may charge a fee for its services. Note: The time at which transactions and shares are priced and the time until which orders are accepted may be changed in case of an emergency or if the New York Stock Exchange closes at a time other than 4 p.m. ET. How you can receive the proceeds from a sale o When filling out the New Account Form, you may wish to give yourself the widest range of options for receiving proceeds from a sale. If your request is received by 4 p.m. ET in correct form, proceeds are usually sent on the next business day. Proceeds can be sent to you by mail or to your bank account by Automated Clearing House (ACH) transfer or bank wire. Proceeds sent by ACH transfer should be credited the second day after the sale. ACH is an T. ROWE PRICE 10 automated method of initiating payments from, and receiving payments in, your financial institution account. The ACH system is supported by over 20,000 banks, savings banks, and credit unions. Proceeds sent by bank wire should be credited to your account the next business day. . Exception: Under certain circumstances and when deemed to be in the fund's best interests, your proceeds may not be sent for up to five business days after we receive your sale or exchange request. If you were exchanging into a bond or money fund, your new investment would not begin to earn dividends until the sixth business day. o If for some reason we cannot accept your request to sell shares, we will contact you. USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES ---------------------------------------------------------- o All net investment income and realized capital gains are distributed to shareholders. Dividends and Other Distributions Dividend and capital gain distributions are reinvested in additional fund shares in your account unless you select another option on your New Account Form. The advantage of reinvesting distributions arises from compounding; that is, you receive income dividends and capital gain distributions on a rising number of shares. Distributions not reinvested are paid by check or transmitted to your bank account via ACH. If the Post Office cannot deliver your check, or if your check remains uncashed for six months, the fund reserves the right to reinvest your distribution check in your account at the NAV on the business day of the reinvestment and to reinvest all subsequent distributions in shares of the fund. No interest will accrue on amounts represented by uncashed distribution or redemption checks. Income dividends . Bond funds declare income dividends daily at 4 p.m. ET to shareholders of record at that time provided payment has been received on the previous business day. . Dividends are paid on the first business day of each month. ABOUT YOUR ACCOUNT 11 . Fund shares will earn dividends through the date of redemption; also, shares redeemed on a Friday or prior to a holiday will continue to earn dividends until the next business day. Generally, if you redeem all of your shares at any time during the month, you will also receive all dividends earned through the date of redemption in the same check. When you redeem only a portion of your shares, all dividends accrued on those shares will be reinvested, or paid in cash, on the next dividend payment date. Capital gains . A capital gain or loss is the difference between the purchase and sale price of a security. . If a fund has net capital gains for the year (after subtracting any capital losses), they are usually declared and paid in December to shareholders of record on a specified date that month. Tax Information o You will be sent timely information for your tax filing needs. You need to be aware of the possible tax consequences when: . You sell fund shares, including an exchange from one fund to another. . The fund makes a distribution to your account. Taxes on fund redemptions When you sell shares in any fund, you may realize a gain or loss. An exchange from one fund to another is still a sale for tax purposes. In January, you will be sent Form 1099-B indicating the date and amount of each sale you made in the fund during the prior year. This information will also be reported to the IRS. For new accounts or those opened by exchange in 1983 or later, we will provide the gain or loss on the shares you sold during the year, based on the "average cost," single category method. This information is not reported to the IRS, and you do not have to use it. You may calculate the cost basis using other methods acceptable to the IRS, such as "specific identification." To help you maintain accurate records, we send you a confirmation immediately following each transaction you make (except for systematic purchases and redemptions) and a year-end statement detailing all your transactions in each fund account during the year. T. ROWE PRICE 12 Taxes on fund distributions o The following summary does not apply to retirement accounts, such as IRAs, which are not subject to current tax. In January, you will be sent Form 1099-DIV indicating the tax status of any dividend and capital gain distributions made to you. This information will also be reported to the IRS. Distributions made by a fund are generally taxable to you for the year in which they were paid. You will be sent any additional information you need to determine your taxes on fund distributions, such as the portion of your dividend, if any, that may be exempt from state income taxes. The tax treatment of a capital gain distribution is determined by how long the fund held the portfolio securities, not how long you held shares in the fund. Short-term (one year or less) capital gain distributions are taxable at the same rate as ordinary income. Reflecting recent changes in the tax code, gains on securities held more than 12 months are taxed at a maximum rate of 20%. If you realized a loss on the sale or exchange of fund shares which you held six months or less, your short-term loss will be reclassified to a long-term loss to the extent you received a long-term capital gain distribution during the period you held the shares. o Distributions are taxable whether reinvested in additional shares or received in cash. Tax effect of buying shares before a capital gain distribution If you buy shares shortly before or on the "record date" - the date that establishes you as the person to receive the upcoming distribution - you will receive a portion of the money you just invested in the form of a taxable distribution. Therefore, you may wish to find out a fund's record date before investing. Of course, a fund's share price may, at any time, reflect undistributed capital gains or income and unrealized appreciation, which may result in future taxable distributions. TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS ---------------------------------------------------------- o Following these procedures helps assure timely and accurate transactions. Purchase Conditions Nonpayment If your payment is not received or you pay with a check or ACH transfer that does not clear, your purchase will be canceled. You will be responsible for any losses or expenses incurred by the fund or transfer agent, and the fund can ABOUT YOUR ACCOUNT 13 redeem shares you own in this or another identically registered T. Rowe Price fund as reimbursement. The fund and its agents have the right to reject or cancel any purchase, exchange, or redemption due to nonpayment. U.S. dollars All purchases must be paid for in U.S. dollars; checks must be drawn on U.S. banks. Sale (Redemption) Conditions Holds on immediate redemptions 10-day hold If you sell shares that you just purchased and paid for by check or ACH transfer, the fund will process your redemption but will generally delay sending you the proceeds for up to 10 calendar days to allow the check or transfer to clear. If your redemption request was sent by mail or mailgram, proceeds will be mailed no later than the seventh calendar day following receipt unless the check or ACH transfer has not cleared. If, during the clearing period, we receive a check drawn against your bond or money market account, it will be returned marked "uncollected." (The 10-day hold does not apply to the following: purchases paid for by bank wire; cashier's, certified, or treasurer's checks; or automatic purchases through your paycheck.) Telephone, Tele*Access/(R)/, and personal computer transactions Exchange and redemption services through telephone and Tele*Access are established automatically when you sign the New Account Form unless you check the box that states you do not want these services. Personal computer transactions must be authorized separately. T. Rowe Price funds and their agents use reasonable procedures (including shareholder identity verification) to confirm that instructions given by telephone are genuine and they are not liable for acting on these instructions. If these procedures are not followed, it is the opinion of certain regulatory agencies that the funds and their agents may be liable for any losses that may result from acting on the instructions given. A confirmation is sent promptly after a transaction. All telephone conversations are recorded. Redemptions over $250,000 Large sales can adversely affect a portfolio manager's ability to implement a fund's investment strategy by causing the premature sale of securities that would otherwise be held. If, in any 90-day period, you redeem (sell) more than $250,000, or your sale amounts to more than 1% of fund net assets, the fund has the right to pay the difference between the redemption amount and the lesser of the two previously mentioned figures with securities from the fund. T. ROWE PRICE 14 Excessive Trading o T. Rowe Price may bar excessive traders from purchasing shares. Frequent trades, involving either substantial fund assets or a substantial portion of your account or accounts controlled by you, can disrupt management of the fund and raise its expenses. . Trades placed directly with T. Rowe Price If you trade directly with T. Rowe Price, you can make one purchase and sale involving the same fund within any 120-day period. For example, if you are in fund A, you can move substantial assets from fund A to fund B and, within the next 120 days, sell your shares in fund B to return to fund A or move to fund C. If you exceed this limit, you are in violation of our excessive trading policy. Two types of transactions are exempt from this policy: 1) trades solely in money market funds (exchanges between a money fund and a nonmoney fund are not exempt); and 2) systematic purchases or redemptions (see Shareholder Services). . Trades placed through intermediaries If you purchase fund shares through an intermediary including a broker, bank, investment adviser, or other third party and hold them for less than 60 calendar days, you are in violation of our excessive trading policy. . If you violate our excessive trading policy, you may be barred indefinitely and without further notice from further purchases of T. Rowe Price funds. Keeping Your Account Open Due to the relatively high cost to a fund of maintaining small accounts, we ask you to maintain an account balance of at least $1,000. If your balance is below $1,000 for three months or longer, we have the right to close your account after giving you 60 days in which to increase your balance. Small Account Fee Because of the disproportionately high costs of servicing accounts with low balances, a $10 fee, paid to T. Rowe Price Services, the fund's transfer agent, will automatically be deducted from nonretirement accounts with balances falling below a minimum level. The valuation of accounts and the deduction are expected to take place during the last five business days of September. The fee will be deducted from accounts with balances below $2,000, except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be waived for any investor whose aggregate T. Rowe Price mutual fund investments total $25,000 or more. Accounts employing automatic investing (e.g., payroll deduction, automatic purchase from a bank account, etc.) are also exempt from the charge. The fee will not apply to IRAs and other retirement plan accounts. (A separate custodial fee may apply to IRAs and other retirement plan accounts.) ABOUT YOUR ACCOUNT 15 Signature Guarantees o A signature guarantee is designed to protect you and the T. Rowe Price funds from fraud by verifying your signature. You may need to have your signature guaranteed in certain situations, such as: . Written requests 1) to redeem over $100,000, or 2) to wire redemption proceeds. . Remitting redemption proceeds to any person, address, or bank account not on record. . Transferring redemption proceeds to a T. Rowe Price fund account with a different registration (name or ownership) from yours. . Establishing certain services after the account is opened. You can obtain a signature guarantee from most banks, savings institutions, broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot accept guarantees from notaries public or organizations that do not provide reimbursement in the case of fraud. MORE ABOUT THE FUND 3 ORGANIZATION AND MANAGEMENT ---------------------------------------------------------- How is the fund organized? The fund was organized as a Massachusetts business trust in 1985 and is a "diversified, open-end investment company," or mutual fund. Mutual funds pool money received from shareholders and invest it to try to achieve specified objectives. o Shareholders benefit from T. Rowe Price's 61 years of investment management experience. What is meant by "shares"? As with all mutual funds, investors purchase shares when they put money in a fund. These shares are part of a fund's authorized capital stock, but share certificates are not issued. Each share and fractional share entitles the shareholder to: . Receive a proportional interest in a fund's income and capital gain distributions. . Cast one vote per share on certain fund matters, including the election of fund trustees, changes in fundamental policies, or approval of changes in the fund's management contract. Do T. Rowe Price funds have annual shareholder meetings? The fund is not required to hold annual meetings and, to avoid unnecessary costs to fund shareholders, does not intend to do so except when certain matters, such as a change in its fundamental policies, must be decided. In addition, shareholders representing at least 10% of all eligible votes may call a special meeting, if they wish, for the purpose of voting on the removal of any fund director or trustee. If a meeting is held and you cannot attend, you can vote by proxy. Before the meeting, the fund will send you proxy materials that explain the issues to be decided and include a voting card for you to mail back. Who runs the fund? General Oversight The fund is governed by a Board of Trustees that meets regularly to review the fund's investments, performance, expenses, and other business affairs. The Board elects the fund's officers. The policy of the fund is that the majority of Board members are independent of T. Rowe Price Associates, Inc. (T. Rowe Price). ABOUT YOUR ACCOUNT 17 o All decisions regarding the purchase and sale of fund investments are made by T. Rowe Price - specifically by the fund's portfolio managers. Portfolio Management The fund has an Investment Advisory Committee comprising the following members: Peter Van Dyke, Chairman, Connice A. Bavely, Deborah L. Boyer, Heather R. Landon, James M. McDonald, and Edmund M. Notzon. The committee chairman has day-to-day responsibility for managing the fund and works with the committee in developing and executing the fund's investment program. Mr. Van Dyke has been chairman of the fund's committee since 1988. He has been managing investments since joining T. Rowe Price in 1985. The Management Fee This fee has two parts - an "individual fund fee," which reflects a fund's particular investment management costs, and a "group fee." The group fee, which is designed to reflect the benefits of the shared resources of the T. Rowe Price investment management complex, is calculated daily based on the combined net assets of all T. Rowe Price funds (except the Spectrum Funds, and any institutional, index, or private label mutual funds). The group fee schedule (shown below) is graduated, declining as the asset total rises, so shareholders benefit from the overall growth in mutual fund assets. Group Fee Schedule
0.334% First $50 billion/a/ 0.305% Next $30 billion 0.300% Thereafter ----------------------------------------
/a/ Represents a blended group fee rate containing various break points. The fund's portion of the group fee is determined by the ratio of its daily net assets to the daily net assets of all the T. Rowe Price funds described previously. Based on combined T. Rowe Price funds' assets of over $86 billion at June 30, 1998, the group fee was 0.32%. The individual fund fee was 0.15%. T. ROWE PRICE 18 UNDERSTANDING PERFORMANCE INFORMATION ---------------------------------------------------------- This section should help you understand the terms used to describe fund performance. You will come across them in shareholder reports you receive from us; in our newsletter, The Price Report; in Insights articles; in T. Rowe Price advertisements; and in the media. Total Return This tells you how much an investment in a fund has changed in value over a given time period. It reflects any net increase or decrease in the share price and assumes that all dividends and capital gains (if any) paid during the period were reinvested in additional shares. Therefore, total return numbers include the effect of compounding. Advertisements for a fund may include cumulative or average annual total return figures, which may be compared with various indices, other performance measures, or other mutual funds. Cumulative Total Return This is the actual return of an investment for a specified period. A cumulative return does not indicate how much the value of the investment may have fluctuated during the period. For example, a fund could have a 10-year positive cumulative return despite experiencing three negative years during that time. Average Annual Total Return This is always hypothetical and should not be confused with actual year-by-year results. It smooths out all the variations in annual performance to tell you what constant year-by-year return would have produced the investment's actual cumulative return. This gives you an idea of an investment's annual contribution to your portfolio, provided you held it for the entire period. Yield The current or "dividend" yield on a fund or any investment tells you the relationship between the investment's current level of annual income and its price on a particular day. The dividend yield reflects the actual income paid to shareholders for a given period, annualized, and divided by the fund's net asset value. For example, a fund providing $5 of annual income per share and a price of $50 has a current yield of 10%. Yields can be calculated for any time period. The advertised or Securities and Exchange Commission (SEC) yield is found by determining the net income per share (as defined by the SEC) earned by a fund during a 30-day base period and dividing this amount by the per share price on the last day of the base period. The SEC yield may differ from the dividend yield. MORE ABOUT THE FUND 19 INVESTMENT POLICIES AND PRACTICES ---------------------------------------------------------- This section takes a detailed look at some of the types of securities the fund may hold in its portfolio and the various kinds of investment practices that may be used in day-to-day portfolio management. The fund's investment program is subject to further restrictions and risks described in the Statement of Additional Information. Shareholder approval is required to substantively change the fund's objective and certain investment restrictions noted in the following section as "fundamental policies." The managers also follow certain "operating policies," which can be changed without shareholder approval. However, significant changes are discussed with shareholders in fund reports. The fund adheres to applicable investment restrictions and policies at the time it makes an investment. A later change in circumstances will not require the sale of an investment if it was proper at the time it was made. The fund's holdings of certain kinds of investments cannot exceed maximum percentages of total assets, which are set forth in this prospectus. For instance, this fund is not permitted to invest more than 10% of total assets in certain stripped mortgage securities, known as IOs and POs. While these restrictions provide a useful level of detail about the fund's investment program, investors should not view them as an accurate gauge of the potential risk of such investments. For example, in a given period, a 5% investment in IOs and POs could have significantly more of an impact on the fund's share price than its weighting in the portfolio. The net effect of a particular investment depends on its volatility and the size of its overall return in relation to the performance of all the fund's other investments. Changes in the fund's holdings, the fund's performance, and the contribution of various investments are discussed in the shareholder reports sent to you. o Fund managers have considerable leeway in choosing investment strategies and selecting securities they believe will help the fund achieve its objective. Types of Portfolio Securities In seeking to meet its investment objective, the fund may invest in any type of security or instrument (including certain potentially high-risk derivatives described in this section) whose investment characteristics are consistent with the fund's investment program. The following pages describe the principal types of portfolio securities and investment management practices of the fund. T. ROWE PRICE 20 Bonds A bond is an interest-bearing security - an IOU - issued by companies or governmental units. The issuer has a contractual obligation to pay interest at a stated rate on specific dates and to repay principal (the bond's face value) on a specified date. An issuer may have the right to redeem or "call" a bond before maturity, and the investor may have to reinvest the proceeds at lower market rates. A bond's annual interest income, set by its coupon rate, is usually fixed for the life of the bond. Its yield (income as a percent of current price) will fluctuate to reflect changes in interest rate levels. A bond's price usually rises when interest rates fall, and vice versa, so its yield stays current. Certain bonds have interest rates that are adjusted periodically. These interest rate adjustments tend to minimize fluctuations of the bonds' principal values. In calculating the fund's weighted average maturity, the maturity of these securities may be shortened under certain specified conditions. Some specific types of bonds the fund may hold from time to time include: Mortgage-Backed Securities The fund may invest in a variety of mortgage-backed securities. Mortgage lenders pool individual home mortgages with similar characteristics to back a certificate or bond, which is sold to investors such as the fund. Interest and principal payments generated by the underlying mortgages are passed through to the investors. The "big three" issuers are the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac). GNMA certificates are backed by the full faith and credit of the U.S. government, while others, such as Fannie Mae and Freddie Mac certificates, are only supported by the ability to borrow from the U.S. Treasury or supported only by the credit of the agency. Private mortgage bankers and other institutions also issue mortgage-backed securities. Mortgage-backed securities are subject to scheduled and unscheduled principal payments as homeowners pay down or prepay their mortgages. As these payments are received, they must be reinvested when interest rates may be higher or lower than on the original mortgage security. Therefore, these securities are not an effective means of locking in long-term interest rates. In addition, when interest rates fall, the pace of mortgage prepayments picks up. These refinanced mortgages are paid off at face value (par), causing a loss for any investor who may have purchased the security at a price above par. In such an environment, this risk limits the potential price appreciation of these securities and can negatively affect the fund's net asset value. When rates rise, the prices of mortgage-backed securities can be expected to decline, although historically these securities have MORE ABOUT THE FUND 21 experienced smaller price declines than comparable quality bonds. In addition, when rates rise and prepayments slow, the effective duration of mortgage-backed securities extends, resulting in increased volatility. o The fund only purchases mortgage-backed securities that are backed by the full faith and credit of the U.S. government. Additional mortgage-backed securities in which the fund may invest include: . GNMA Certificates The fund will invest at least 65% of its total assets in GNMA certificates of the "modified pass-through" type, meaning the scheduled monthly interest and principal payments relating to mortgages in the pool will be "passed through" to investors. The fund will reinvest all payments and unscheduled prepayments of principal in additional GNMA certificates or other U.S. government-guaranteed securities. Interest will be distributed to shareholders in the form of monthly dividends. GNMA certificates evidence interests in a pool of underlying mortgages with a maximum life of 15 or 30 years. However, due to both scheduled and unscheduled principal payments, GNMA certificates have a shorter average life and, therefore, less principal volatility than a comparable 30-year bond. Since prepayment rates vary widely, it is not possible to accurately predict the average life of a particular GNMA pool. However, it is standard industry practice to treat new issues of GNMA certificates as 30-year mortgage-backed securities having an average life of no greater than 12 years. Because the expected average life is a better indicator of the maturity characteristics of GNMA certificates, principal volatility and yield may be more comparable to 10-year Treasury bonds. . GNMA Project Pass-Through Securities The fund may purchase these securities which are issued by GNMA for multifamily projects, i.e., low to moderate income housing, nursing homes, apartment rehabilitation, housing for the elderly or handicapped, and the like. Unlike GNMA "modified pass-through certificates," these bonds provide call protection for a term stated in the issue. The project loans can be made to either private enterprise or nonprofit groups. There are penalties assessed for prepayments during the call-protected period, creating a disincentive for early prepayment. These bonds incorporate the same standardized procedures as single-family pass-through certificates, and full and timely payment of principal and interest is guaranteed by GNMA. o Portfolio managers diversify fund assets to lower risk. . Collateralized Mortgage Obligations (CMOs) CMOs are debt securities that are fully collateralized by a portfolio of mortgages or mortgage-backed securities. All interest and principal payments from the underlying mortgages are passed through to the CMOs in such a way as to create, in most cases, more definite T. ROWE PRICE 22 maturities than is the case with the underlying mortgages. CMOs may pay fixed or variable rates of interest, and certain CMOs have priority over others with respect to the receipt of prepayments. . Stripped Mortgage Securities Stripped mortgage securities (a type of potentially high-risk derivative) are created by separating the interest and principal payments generated by a pool of mortgage-backed securities or a CMO to create additional classes of securities. Generally, one class receives only interest payments (IOs), and another receives principal payments (POs). Unlike with other mortgage-backed securities and POs, the value of IOs tends to move in the same direction as interest rates. The fund can use IOs as a hedge against falling prepayment rates (interest rates are rising) and/or a bear market environment. POs can be used as a hedge against rising prepayment rates (interest rates are falling) and/or a bull market environment. IOs and POs are acutely sensitive to interest rate changes and to the rate of principal prepayments. A rapid or unexpected increase in prepayments can severely depress the price of IOs, while a rapid or unexpected decrease in prepayments could have the same effect on POs. These securities are very volatile in price and may have lower liquidity than most other mortgage-backed securities. Certain non-stripped CMOs may also exhibit these qualities, especially those that pay variable rates of interest that adjust inversely with, and more rapidly than, short-term interest rates. In addition, if interest rates rise rapidly and prepayment rates slow more than expected, certain CMOs, in addition to losing value, can exhibit characteristics of longer-term securities and become more volatile. There is no guarantee the fund's investment in CMOs, IOs, or POs will be successful, and the fund's total return could be adversely affected as a result. Operating policy The fund may invest up to 10% of its total assets in stripped mortgage securities. Other Securities Backed by the Full Faith and Credit of the U.S. Government The fund may purchase securities of U.S. government agencies and instrumentalities which are backed by the full faith and credit of the U.S. government, such as securities of the Federal Housing Administration, the Department of Housing and Urban Development, the Export-Import Bank, the Farmers Home Administration, the General Services Administration, the Maritime Administration, and the Small Business Administration. The fund will not invest in the securities of any U.S. government agencies that are not backed by the full faith and credit of the U.S. government, such as Fannie Mae (FNMA) or Freddie Mac (FHLMC) securities. The fund may also purchase securities issued or guaranteed by the U.S. government, such as U.S. Treasury bills, notes, and bonds. MORE ABOUT THE FUND 23 Types of Management Practices Reserve Position The fund will hold a certain portion of its assets in money market reserves. The fund's reserve position can consist of shares of a T. Rowe Price internal money market fund that invests exclusively in securities backed by the full faith and credit of the U.S. government and repurchase agreements thereon. In addition, the fund may purchase money market securities backed by the full faith and credit of the U.S. government, including repurchase agreements collateralized by such securities. For temporary, defensive purposes, the fund may invest without limitation in money market reserves. The effect of taking such a position is that the fund may not achieve its investment objective. The reserve position provides flexibility in meeting redemptions, expenses, and the timing of new investments and can serve as a short-term defense during periods of unusual market volatility. Borrowing Money and Transferring Assets The fund can borrow money from banks (and to the extent permitted by the SEC, other Price funds) as a temporary measure for emergency purposes, to facilitate redemption requests, or for other purposes consistent with the fund's investment objective and program. Such borrowings may be collateralized with fund assets, subject to restrictions. Fundamental policy Borrowings may not exceed 33 1/3% of total fund assets. Operating policy The fund may not transfer as collateral any portfolio securities except as necessary in connection with permissible borrowings or investments, and then such transfers may not exceed 33 1/3% of the fund's total assets. The fund may not purchase additional securities when borrowings exceed 5% of total assets. Futures and Options Futures (a type of potentially high-risk derivative) are often used to manage or hedge risk because they enable the investor to buy or sell an asset in the future at an agreed-upon price. Options (another type of potentially high-risk derivative) give the investor the right (where the investor purchases the option), or the obligation (where the investor writes (sells) the option), to buy or sell an asset at a predetermined price in the future. The fund may buy and sell futures and options contracts for any number of reasons, including: to manage its exposure to changes in interest rates, bond prices, and foreign currencies; as an efficient means of adjusting its overall exposure to certain markets; in an effort to enhance income; to protect the value of portfolio securities; and to adjust portfolio duration. The fund may purchase, sell, or write call and put options on securities and financial indices. T. ROWE PRICE 24 Futures contracts and options may not always be successful hedges, and their prices can be highly volatile. Using them could lower the fund's total return, and the potential loss from the use of futures can exceed the fund's initial investment in such contracts. Operating policies Futures: Initial margin deposits and premiums on options used for non-hedging purposes will not equal more than 5% of the fund's net asset value. Options on securities: The total market value of securities against which the fund writes call or put options may not exceed 25% of its total assets. The fund will not commit more than 5% of its total assets to premiums when purchasing call or put options. Lending of Portfolio Securities Like other mutual funds, the fund may lend securities to broker-dealers, other institutions, or other persons to earn additional income. The principal risk is the potential insolvency of the broker-dealer or other borrower. In this event, the fund could experience delays in recovering its securities and possibly capital losses. Fundamental policy The value of loaned securities may not exceed 33 1/3% of total fund assets. When-Issued Securities and Forward Commitment Contracts The fund may purchase securities on a when-issued or delayed delivery basis or may purchase or sell securities on a forward commitment basis. There is no limit on the fund's investment in these securities. The price of these securities is fixed at the time of the commitment to buy, but delivery and payment can take place a month or more later. During the interim period, the market value of the securities can fluctuate, and no interest accrues to the purchaser. At the time of delivery, the value of the securities may be more or less than the purchase or sale price. To the extent the fund remains fully or almost fully invested (in securities with a remaining maturity of more than one year) at the same time it purchases these securities, there will be greater fluctuations in the fund's net asset value than if the fund did not purchase them. MORE ABOUT THE FUND 25 Portfolio Turnover Although the fund will not generally trade for short-term profits, circumstances may warrant a sale without regard to the length of time a security was held. A high turnover rate may increase transaction costs and result in additional taxable gains. The fund's portfolio turnover rates for the fiscal years ended May 31, 1998, 1997, and 1996, were 120.6%, 115.9%, and 113.6%, respectively. Year 2000 Processing Issue Many computer programs use two digits rather than four to identify the year. These programs, if not adapted, will not correctly handle the change from "99" to "00" on January 1, 2000, and will not be able to perform necessary functions. The Year 2000 issue affects virtually all companies and organizations. T. Rowe Price has implemented steps intended to assure that its major computer systems and processes are capable of Year 2000 processing. We are working with third parties to assess the adequacy of their compliance efforts and are developing contingency plans intended to assure that third-party noncompliance will not materially affect T. Rowe Price's operations. Companies, organizations, governmental entities and markets in which T. Rowe Price funds invest will be affected by the Year 2000 issue, but at this time the funds cannot predict the degree of impact. To the extent the effect is negative, the fund's returns could be adversely affected. FINANCIAL HIGHLIGHTS ---------------------------------------------------------- Table 4, which provides information about the fund's financial history, is based on a single share outstanding throughout each fiscal year. The table is part of the fund's financial statements, which are included in its annual report and are incorporated by reference into the Statement of Additional Information (available upon request). The total returns in the table represent the rate that an T. ROWE PRICE 26 investor would have earned or lost on an investment in the fund (assuming reinvestment of all dividends and distributions). The financial statements in the annual report were audited by the fund's independent accountants, PricewaterhouseCoopers LLP. Table 4 Financial Highlights
Year ended May 31 Three Months Year Ended Ended 2/28/94 5/31/94/ a/ 1995 1996 1997 1998 ----------------------------------------------------------------------------------------------------- Net asset value, beginning of period $ 9.92 $ 9.60 $ 9.14 $ 9.51 $ 9.19 $ 9.30 Income From Investment Operations Net investment income 0.68 0.17 0.68 0.67 0.65 0.63 ------------------------------------------------------------------------ Net gains or losses on securities (both realized and (0.32) (0.46) 0.37 (0.32) 0.11 0.27 unrealized) ------------------------------------------------------------------------ Total from investment operations 0.36 (0.29) 1.05 0.35 0.76 0.90 Less Distributions Dividends (from net (0.68) (0.17) (0.66) (0.67) (0.63) (0.63) investment income ------------------------------------------------------------------------ Distributions - - -ss -ss -ss -ss (from capital gains) ------------------------------------------------------------------------ Returns of capital - - (0.02) -ss (0.02) -ss ------------------------------------------------------------------------ Total distributions (0.68) (0.17) (0.68) (0.67) (0.65) (0.63) ------------------------------------------------------------------------ Net asset value, $ 9.60 $ 9.14 $ 9.51 $ 9.19 $ 9.30 $ 9.57 end of period ------------------------------------------------------------------------ Total return 3.71% (3.03)% 12.11% 3.72% 8.46% 9.97% Ratios/Supplemental Data Net assets, end of $883,391 $802,304 $810,467 $903,796 $944,046 $1,123,142 period (in thousands) ------------------------------------------------------------------------ Ratio of expenses to 0.77% 0.76% /b/ 0.76% 0.74% 0.74% 0.70% average net assets ------------------------------------------------------------------------ Ratio of net investment income to average 6.93% 7.24% /b/ 7.50% 7.04% 6.98% 6.67% net assets ------------------------------------------------------------------------ Portfolio turnover 92.5% 151.8% /b/ 121.3% 113.6% 115.9% 120.6% rate -----------------------------------------------------------------------------------------------------
/a/ The fund's fiscal year-end was changed to May 31. /b/ Annualized. INVESTING WITH T. ROWE PRICE 4 ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION ---------------------------------------------------------- Tax Identification Number We must have your correct Social Security or corporate tax identification number on a signed New Account Form or W-9 Form. Otherwise, federal law requires the funds to withhold a percentage (currently 31%) of your dividends, capital gain distributions, and redemptions, and may subject you to an IRS fine. If this information is not received within 60 days after your account is established, your account may be redeemed, priced at the NAV on the date of redemption. Always verify your transactions by carefully reviewing the confirmation we send you. Please report any discrepancies to Shareholder Services promptly. Employer-Sponsored Retirement Plans and Institutional Accounts T. Rowe Price Trust Company 1-800-492-7670 Transaction procedures in the following sections may not apply to employer-sponsored retirement plans and institutional accounts. For procedures regarding employer-sponsored retirement plans, please call T. Rowe Price Trust Company or consult your plan administrator. For institutional account procedures, please call your designated account manager or service representative. OPENING A NEW ACCOUNT ---------------------------------------------------------- $2,500 minimum initial investment; $1,000 for retirement plans or gifts or transfers to minors (UGMA/UTMA) accounts Account Registration If you own other T. Rowe Price funds, be sure to register any new account just like your existing accounts so you can exchange among them easily. (The name and account type would have to be identical.) By Mail Please make your check payable to T. Rowe Price Funds (otherwise it will be returned) and send your check, together with the New Account Form, to the appropriate address in the next paragraph. We do not accept third-party checks to open new accounts, except for IRA Rollover checks that are properly endorsed. T. ROWE PRICE 28 Regular Mail T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353 Mailgram, Express, Registered, or Certified Mail T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117 By Wire Call Investor Services for an account number and give the following wire information to your bank: PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account# 1004397951 name of owner(s) and account number Complete a New Account Form and mail it to one of the appropriate addresses listed previously. Note: No services will be established and IRS penalty withholding may occur until a signed New Account Form is received. Also, retirement plans cannot be opened by wire. By Exchange Call Shareholder Services or use Tele*Access or your personal computer (see Automated Services under Shareholder Services). The new account will have the same registration as the account from which you are exchanging. Services for the new account may be carried over by telephone request if preauthorized on the existing account. For limitations on exchanging, see explanation of Excessive Trading under Transaction Procedures and Special Requirements. In Person Drop off your New Account Form at any location listed on the cover and obtain a receipt. INVESTING WITH T. ROWE PRICE 29 PURCHASING ADDITIONAL SHARES ---------------------------------------------------------- $100 minimum purchase; $50 minimum for retirement plans, Automatic Asset Builder, and gifts or transfers to minors (UGMA/UTMA) accounts By ACH Transfer Use Tele*Access or your personal computer or call Investor Services if you have established electronic transfers using the ACH network. By Wire Call Shareholder Services or use the wire address in Opening a New Account. By Mail 1. Make your check payable to T. Rowe Price Funds (otherwise it may be returned). 2. Mail the check to us at the following address with either a fund reinvestment slip or a note indicating the fund you want to buy and your fund account number. 3. Remember to provide your account number and the fund name on the memo line of your check. Regular Mail T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500 /(For mailgrams, express, registered, or certified mail, see previous / /section.)/ By Automatic Asset Builder Fill out the Automatic Asset Builder section on the New Account or Shareholder Services Form. T. ROWE PRICE 30 EXCHANGING AND REDEEMING SHARES ---------------------------------------------------------- Exchange Service You can move money from one account to an existing identically registered account or open a new identically registered account. Remember, exchanges are purchases and sales for tax purposes. (Exchanges into a state tax-free fund are limited to investors living in states where the fund is registered.) Some of the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held for less than six months or one year, as specified in the prospectus. The fee is paid to the fund. By Phone Call Shareholder Services If you find our phones busy during unusually volatile markets, please consider placing your order by your personal computer, Tele*Access (if you have previously authorized telephone services), mailgram, or express mail. For exchange policies, please see Transaction Procedures and Special Requirements - Excessive Trading. Redemption proceeds can be mailed to your account address, sent by ACH transfer, or wired to your bank (provided your bank information is already on file). For charges, see Electronic Transfers - By Wire under Shareholder Services. By Mail For each account involved, provide the account name, number, fund name, and exchange or redemption amount. For exchanges, be sure to indicate any fund you are exchanging out of and the fund or funds you are exchanging into. Please mail to the appropriate address below. T. Rowe Price requires the signatures of all owners exactly as registered, and possibly a signature guarantee (see Transaction Procedures and Special Requirements - Signature Guarantees). Regular Mail For nonretirement and IRA accounts T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220 INVESTING WITH T. ROWE PRICE 31 For employer-sponsored retirement accounts T. Rowe Price Trust Company P.O. Box 89000 Baltimore, MD 21289-0300 /(For mailgrams, express, registered, or certified mail, see Opening a / /New Account.)/ Redemptions from employer-sponsored retirement accounts must be in writing; please call T. Rowe Price Trust Company or your plan administrator for instructions. IRA distributions may be requested in writing or by telephone; please call Shareholder Services to obtain an IRA Distribution Form or an IRA Shareholder Services Form to authorize the telephone redemption service. RIGHTS RESERVED BY THE FUND ---------------------------------------------------------- The fund and its agents reserve the following rights: (1) to waive or lower investment minimums; (2) to accept initial purchases by telephone or mailgram; (3) to refuse any purchase or exchange order; (4) to cancel or rescind any purchase or exchange order (including, but not limited to, orders deemed to result in excessive trading, market timing, fraud, or 5% ownership) upon notice to the shareholder within five business days of the trade or if the written confirmation has not been received by the shareholder, whichever is sooner; (5) to freeze any account and suspend account services when notice has been received of a dispute between the registered or beneficial account owners or there is reason to believe a fraudulent transaction may occur; (6) to otherwise modify the conditions of purchase and any services at any time; or (7) to act on instructions believed to be genuine. These actions will be taken when, in the sole discretion of management, they are deemed to be in the best interest of the fund. In an effort to protect the fund from the possible adverse effects of a substantial redemption in a large account, as a matter of general policy no shareholder or group of related shareholders controlled by the same T. ROWE PRICE 32 person or group of persons will knowingly be permitted to purchase in excess of 5% of the outstanding shares of the fund, except upon approval of the fund's management. SHAREHOLDER SERVICES ---------------------------------------------------------- Shareholder Services 1-800-225-5132 Investor Services 1-800-638-5660 Many services are available to you as a T. Rowe Price shareholder; some you receive automatically, and others you must authorize on the New Account Form. By signing up for services on the New Account Form rather than later on, you avoid having to complete a separate form and obtain a signature guarantee. This section reviews some of the principal services currently offered. Our Services Guide, which we mail to all new shareholders, contains detailed descriptions of these and other services. Note: Corporate and other institutional accounts require an original or certified resolution to establish services and to redeem by mail. For more information, call Investor Services. Retirement Plans We offer a wide range of plans for individuals, institutions, and large and small businesses: Traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money purchase pension), 401(k), and 403(b)(7). For information on IRAs, call Investor Services. For information on all other retirement plans, including our no-load variable annuity, please call our Trust Company at 1-800-492-7670. Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days Tele*Access 24-hour service via toll-free number enables you to (1) access information on fund yields, prices, distributions, account balances, and your latest transaction; (2) request checks, prospectuses, services forms, duplicate statements, and tax forms; and (3) initiate purchase, redemption, and exchange transactions in your accounts (see Electronic Transfers on the next page). INVESTING WITH T. ROWE PRICE 33 Web Address www.troweprice.com After obtaining proper authorization, account transactions may also be conducted through our web site on the Internet. If you subscribe to America Online, you can access our web site via keyword "T. Rowe Price" and conduct transactions in your account. Plan Account Line 1-800-401-3279 Plan Account Line This 24-hour service is similar to Tele*Access but is designed specifically to meet the needs of retirement plan investors. Telephone and Walk-In Services Buy, sell, or exchange shares by calling one of our service representatives or by visiting one of our investor center locations whose addresses are listed on the cover. Electronic Transfers By ACH With no charges to pay, you can initiate a purchase or redemption for as little as $100 or as much as $100,000 between your bank account and fund account using the ACH network. Enter instructions via Tele*Access or your personal computer, or call Shareholder Services. By Wire Electronic transfers can be conducted via bank wire. There is currently a $5 fee for wire redemptions under $5,000, and your bank may charge for incoming or outgoing wire transfers regardless of size. Checkwriting (Not available for equity funds, or the High Yield or Emerging Markets Bond Funds) You may write an unlimited number of free checks on any money market fund, and most bond funds, with a minimum of $500 per check. Keep in mind, however, that a check results in a redemption; a check written on a bond fund will create a taxable event which you and we must report to the IRS. Automatic Investing ($50 minimum) You can invest automatically in several different ways, including: Automatic Asset Builder You instruct us to move $50 or more from your bank account, or you can instruct your employer to send all or a portion of your paycheck to the fund or funds you designate. T. ROWE PRICE 34 Automatic Exchange You can set up systematic investments from one fund account into another, such as from a money fund into a stock fund. DISCOUNT BROKERAGE ---------------------------------------------------------- To open an account 1-800-638-5660 For existing discount brokerage investors 1-800-225-7720 This service gives you the opportunity to consolidate all of your investments with one company. Investments available through our discount brokerage include stocks, options, bonds, non-T. Rowe Price mutual funds, and others at commission savings over full-service brokers. We also provide a wide range of services, including: Automated telephone and computer services You can enter stock and option trades, access quotes, and review account information around the clock by phone with Tele-Trader or via the Internet with Internet-Trader. Any trades executed through Tele-Trader save you an additional 10% on commissions. You will save 20% on commissions for stock trades when you trade through Internet-Trader. All trades are subject to a $35 minimum commission except stock trades placed through Internet-Trader, which are subject to a $29.95 minimum commission. Investor information A variety of informative reports, such as our Brokerage Insights series, S&P Market Month newsletter, and select stock reports can help you better evaluate economic trends and investment opportunities. Dividend Reinvestment Service Virtually all stocks held in customer accounts are eligible for this free service. /Discount Brokerage is a division of //T. Rowe Price// Investment / /Services, Inc., Member NASD/SIPC./ INVESTING WITH T. ROWE PRICE 35 INVESTMENT INFORMATION ---------------------------------------------------------- To help shareholders monitor their current investments and make decisions that accurately reflect their financial goals, T. Rowe Price offers a wide variety of information in addition to account statements. Most of this information is also available on our web site at www.troweprice.com. Shareholder Reports Fund managers' reviews of their strategies and results. If several members of a household own the same fund, only one fund report is mailed to that address. To receive additional copies, please call Shareholder Services or write to us at 100 East Pratt Street, Baltimore, Maryland 21202. The T. Rowe Price Report A quarterly investment newsletter discussing markets and financial strategies. Performance Update A quarterly review of all T. Rowe Price fund results. Insights Educational reports on investment strategies and financial markets. Investment Guides Asset Mix Worksheet, College Planning Kit, Diversifying Overseas: A T. Rowe Price Guide to International Investing, Managing Your Retirement Distribution, Personal Strategy Planner, Retirees Financial Guide, Retirement Planning Kit, and Tax Considerations for Investors. To help you achieve your financial goals, T. Rowe Price offers a wide range of stock, bond, and money market investments, as well as convenient services and informative reports. For Mutual Fund or Discount Brokerage Information Investor Services 1-800-638-5660 For Existing Accounts Shareholder Services 1-800-225-5132 For Yields, Prices, Account Information, or to Conduct Transactions Tele*Access/(R)/ 24 hours, 7 days 1-800-638-2587 Internet Address www.troweprice.com Plan Account Line For retirement plan investors 1-800-401-3279 Investor Centers 101 East Lombard St. Baltimore, MD 21202 T. Rowe Price Financial Center 10090 Red Run Blvd. Owings Mills, MD 21117 Farragut Square 900 17th Street, N.W. Washington, D.C. 20006 ARCO Tower 31st Floor 515 South Flower St. Los Angeles, CA 90071 4200 West Cypress St. 10th Floor Tampa, FL 33607 Headquarters 100 East Pratt St. Baltimore, MD 21202 A Statement of Additional Information about the fund has been filed with the Securities and Exchange Commission and has been incorporated by reference into this prospectus. Further information about the fund's investments, including a review of market conditions and the manager's recent strategies and their impact on performance, is available in the annual and semiannual shareholder reports. To obtain free copies of any of these documents, or for shareholder inquiries, Fund reports and Statements of Additional Information are also available from the Securities and Exchange Commission by calling 1-800-SEC-0330 or writing the SEC's Public Reference Section, Washington, D.C. 20549-6009 (you will be charged a duplicating fee); by visiting the SEC's public reference room; or by consulting the SEC's web site at www.sec.gov. This prospectus contains information you should know before investing. Please keep it for future reference. 1940 Act File No. 811-4441 F70-040 10/1/98 PROSPECTUS October 1, 1998 T. Rowe Price New Income Fund A bond fund for investors willing to assume principal risk to achieve an attractive level of income. RAM LOGO These securities have not been approved or disapproved by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. T. Rowe Price New Income Fund, Inc. Prospectus October 1, 1998
1 ABOUT THE FUND Fund, Market, and Risk Characteristics 1 --------------------------------------------- Other Information About the Fund 5 --------------------------------------------- Some Basics of Fixed Income Investing 7 --------------------------------------------- 2 ABOUT YOUR ACCOUNT Pricing Shares and Receiving 9 Sale Proceeds --------------------------------------------- Distributions and Taxes 10 --------------------------------------------- Transaction Procedures and 13 Special Requirements --------------------------------------------- 3 MORE ABOUT THE FUND Organization and Management 16 --------------------------------------------- Understanding Performance Information 18 --------------------------------------------- Investment Policies and Practices 19 --------------------------------------------- Financial Highlights 27 --------------------------------------------- 4 INVESTING WITH T. ROWE PRICE Account Requirements 29 and Transaction Information --------------------------------------------- Opening a New Account 29 --------------------------------------------- Purchasing Additional Shares 31 --------------------------------------------- Exchanging and Redeeming 32 --------------------------------------------- Rights Reserved by the Fund 33 --------------------------------------------- Shareholder Services 34 --------------------------------------------- Discount Brokerage 36 --------------------------------------------- Investment Information 37 ---------------------------------------------
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates, Inc., and its affiliates managed over $141 billion for more than six million individual and institutional investor accounts as of June 30, 1998. Mutual fund shares are not deposits or obligations of, or guaranteed by, any depository institution. Shares are not insured by the FDIC, Federal Reserve Board, or any other agency, and are subject to investment risks, including possible loss of the principal amount invested. ABOUT THE FUND 1 FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT ---------------------------------------------------------- To help you decide whether this fund is appropriate for you, this section reviews its investment objective, strategy, and potential risks. What is the fund's objective? The fund seeks the highest level of income consistent with the preservation of capital over time by investing primarily in marketable debt securities. What are the fund's principal investment strategies? We will invest at least 80% of the fund's total assets in income-producing securities, including U.S. government and agency obligations, mortgage- and asset-backed securities, corporate bonds, foreign securities, collateralized mortgage obligations (CMOs), and others, including, on occasion, equity securities. All securities purchased by the fund must be rated investment grade (AAA, AA, A, or BBB) by at least one major credit rating agency (or, if unrated, must have a T. Rowe Price equivalent). Up to 15% of total assets may be invested in "split-rated securities," or those rated investment grade by at least one rating agency, but below investment grade by others. However, none of the fund's remaining assets can be invested in bonds rated below investment grade by Standard & Poor's, Moody's, or Fitch IBCA, Inc. Securities in the BBB category, the lowest investment-grade credit rating, may have some speculative characteristics. We have considerable flexibility in seeking high yields for the fund. There are no maturity restrictions, so we can purchase longer-term bonds with higher yields than shorter-term issues. However, the portfolio's weighted average maturity is expected to be between four and 15 years. In addition, when there is a large yield difference between the various quality levels, we may move down the credit scale and purchase lower-rated bonds with higher yields. When the difference is small, we may concentrate investments in the higher-rated issues. o For details about the fund's investment program, please see the Investment Policies and Practices section. What are the main risks of investing in the fund? Investors should be concerned primarily with interest rate risk, or market risk. An increase in interest rates could cause the fund's share price to fall, resulting in a loss of principal (see the table entitled How Interest Rates May Affect Bond Prices). That's because the bonds in the fund's portfolio can become less attractive to other investors when securities with higher yields become available. The longer a bond's maturity, the greater its potential for price declines if rates rise T. ROWE PRICE 2 and for price gains if rates fall. The fund may invest in bonds of any maturity, and thus carries more interest rate risk than short-term corporate funds, which increases the fund's potential for both losses and gains. However, the fund generally carries less interest rate risk than Treasury funds of comparable maturity. The fund is also subject to credit risk, which means shareholders could suffer declines in share price and income as a result of credit downgrades or defaults. The fund's price appreciation could be limited in a period of falling interest rates if investors fear an economic slowdown will result in credit downgrades and debt defaults. The fund's concentration in investment-grade bonds limits, but does not eliminate, its exposure to credit risk. o The fund may continue to hold a security that has been downgraded or loses its investment-grade rating after purchase. Shareholders are also exposed to foreign investing risk. There are special risks associated with investments in foreign securities whether denominated in U.S. dollars or foreign currencies. These risks include potentially adverse political and economic developments overseas, greater volatility, less liquidity and the possibility that foreign currencies will decline against the dollar, lowering the value of securities denominated in those currencies. Currency risk affects the fund to the extent that it holds nondollar foreign bonds. Because the fund can invest extensively in mortgage-backed securities, it carries special risks related to changing interest rates: prepayment risk and extension risk. . Prepayment risk A mortgage-backed bond, unlike most other bonds, can be hurt when interest rates fall, because homeowners tend to refinance. The loss of high-yielding underlying mortgages and the reinvestment of proceeds at lower interest rates can reduce the bond's potential price gain in response to falling interest rates, can reduce the bond's yield, or can even cause the bond's price to fall below what an investor paid for it, resulting in a capital loss. Any of these developments could cause a decrease in the fund's income and/or share price. . Extension risk This is the flip side of prepayment risk, where rising interest rates can cause a fund's average maturity to lengthen unexpectedly due to a drop in mortgage prepayments. This would increase the fund's sensitivity to rising rates and its potential for price declines. Shareholders are also exposed to derivatives risk, the potential that our investments in these complex and volatile instruments could affect the fund's share price. ABOUT THE FUND 3 In addition to CMOs and better-known instruments such as futures and options, other derivatives used in limited fashion by the fund include interest-only (IO) and principal-only (PO) securities known as "strips." The value of these instruments is derived from underlying securities such as mortgage-backed bonds. All these instruments can be highly volatile, and their value can fall dramatically in response to rapid or unexpected changes in the mortgage or interest rate environment. As with all mutual funds, there is no guarantee this fund will achieve its goals. o The fund's share price may decline, so when you sell your shares, you may lose money. An investment in the fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. How can I tell if the fund is appropriate for me? The fund may be appropriate for you if you seek an attractive level of income and are willing to accept the risk of a declining share price when interest rates rise. The fund may be used for both regular and tax-deferred accounts, such as IRAs and Keoghs. o The fund should not represent your complete investment program or be used for short-term trading purposes. How has the fund performed in the past? The bar chart, which shows the fund's actual performance for each of the last 10 calendar years through December 31, 1997, indicates risk by illustrating how much returns can differ from one year to the next. The fund can also experience short-term performance swings, as shown in the following chart by the best and worst calendar quarter returns during the years depicted in the chart. Of course, the fund's past performance is no guarantee of its future returns.
Calendar Year Total Returns -------------------------------- 1988 7.59% 1989 12.22 1990 8.77 1991 15.51 1992 4.96 1993 9.58 1994 -2.22 1995 18.36 1996 2.38 1997 9.32 --------------------------------
T. ROWE PRICE 4 Quarter Ended Total Return Best Quarter 6/30/89 6.63% Worst Quarter 3/31/96 -2.53% The fund's return for the 6 months ended 6/30/98 was 3.44%. In the table, the fund's average annual total returns for the 1-, 5-, and 10-year periods through December 31, 1997, are compared with the Lehman Brothers Aggregate Bond Index, a broad measure of the bond market, and with the fund's Lipper peer group average. By comparing the bar chart with Table 1, you can see that average returns smooth out year-to-year variations. Table 1 Average Annual Total Returns
Periods ended December 31, 1997 ----------------------------------- 1 year 5 years 10 years New Income Fund 9.32% 7.26% 8.50% Lehman Aggregate Bond Index 9.65 7.48 9.18 Lipper Corp. Debt Funds A-Rated 9.17 7.32 8.95 Average ----------------------------------------------------------------------
These figures include changes in principal value, reinvested dividends, and capital gain distributions, if any. What fees or expenses will I pay? The fund is 100% no load. There are no fees or charges to buy or sell fund shares, reinvest dividends, or exchange into other T. Rowe Price funds. There are no 12b-1 marketing fees. Table 2 Fees and Expenses of the Fund
Annual fund operating expenses (expenses that are deducted from fund assets) Management fee 0.47% Other expenses 0.24% Total annual fund operating expenses 0.71% ------------------------------------------------------------------------------
ABOUT THE FUND 5 The numbers in Table 2 provide an estimate of how much it will cost to operate the fund for a year, based on 1998 fiscal year expenses. Example. The following table gives you a rough idea of how expense ratios may translate into dollars and helps you to compare the cost of investing in this fund with the cost of investing in other funds. Although your actual costs may be higher or lower, the table shows expenses you would pay if operating expenses remain the same, you invest $10,000, you earn a 5% annual return, and you hold the investment for the following periods.
1 year 3 years 5 years 10 years $73 $227 $395 $883 ----------------------------------------------------
OTHER INFORMATION ABOUT THE FUND ---------------------------------------------------------- What are the fund's potential rewards? The fund can provide an attractive level of income to investors who want only a modest level of credit risk. It should offer higher yields than money market and short-term bond funds and generally less volatility than longer-term bond funds. In addition, the portfolio is widely diversified among various fixed income securities, thus reducing the effect of a bond's price fluctuations on the fund's share price or total return. How does the portfolio manager try to reduce risk? Consistent with the fund's objective, the portfolio manager uses various tools to try to reduce risk and increase total return, including: . Diversification of assets to reduce the impact of a single holding on the fund's net asset value. . Thorough credit research by our own analysts. . Adjustment of fund duration to try to reduce the drop in price when interest rates rise or to benefit from the rise in price when rates fall. Duration is a measure of a fund's sensitivity to interest rate changes. Do mortgage-backed securities differ from other high-quality bonds? Yes, in one major respect. Most bonds repay principal (face value of the bond) when their maturity date is reached, but most mortgage-backed securities repay principal continually as homeowners make mortgage payments. Homeowners have the option of paying either part or all of the loan balance before maturity, perhaps to refinance or buy a new home. As a result, the effective maturity of a mortgage-backed security is virtually always shorter than its stated maturity. T. ROWE PRICE 6 For example, a new GNMA certificate backed by 30-year, fixed rate mortgages will generally have a far shorter life than 30 years - probably 12 or less. Therefore, it will usually be about as volatile as a 10-year Treasury note. It is possible to estimate the average life of an entire mortgage pool backing a particular security with some accuracy, but not with certainty. Why are yields on mortgage-backed securities higher than yields on Treasuries of similar maturity? The structure of mortgage-backed securities is much more complex, and their effective maturities are uncertain because of unscheduled prepayments. Higher yields compensate investors for these potentially negative features. See the previous discussion of prepayment risk and extension risk. Is the fund a substitute for a money market fund? No. Money market funds, which have an average maturity under one year, ordinarily generate lower income in return for stability of net asset value. The fund's total return may be higher or lower than a money market fund's and, as such, it should be viewed as a longer-term investment. What are derivatives and can the fund invest in them? A derivative is a financial instrument whose value is derived from an underlying security, such as a stock or bond, or from a market benchmark such as an interest rate index. Many types of investments representing a wide range of potential risks and rewards are derivatives, including conventional instruments such as callable bonds, futures, and options, as well as more exotic investments such as stripped mortgage securities and structured notes. Investment managers have used derivatives for many years. We invest in derivatives only if the expected risks and rewards are consistent with the fund's objective, policies, and overall risk profile described in this prospectus. We use derivatives in situations where they may enable the fund to increase yield, hedge against a decline in principal, invest in other asset classes more efficiently and at a lower cost, or adjust duration. We will not invest in any high-risk, highly leveraged derivative that we believe would cause the portfolio to be more volatile than a long-term, investment-grade bond. Is there other information I can review before making a decision? Investment Policies and Practices in Section 3 discusses the principal types of portfolio securities that the fund may purchase as well as the types of management practices that the fund may use. ABOUT THE FUND 7 SOME BASICS OF FIXED INCOME INVESTING ---------------------------------------------------------- Is a fund's yield fixed or will it vary? It will vary. We calculate the yield every day by dividing a fund's net income per share, expressed at annual rates, by the share price. Since income and share price fluctuate, a fund's yield also varies. Is yield the same as total return? Not for bond funds. A fund's total return is the result of reinvested distributions from income and capital gains and the change in share price for a given period. Income is always a positive contributor to total return and can either enhance a rise in share price or help offset a price decline. What is credit quality and how does it affect yield? Credit quality refers to a bond issuer's expected ability to make all required interest and principal payments on time. Because highly rated issuers represent less risk, they can borrow at lower interest rates than less creditworthy issuers. Therefore, a fund investing in high-quality securities should have a lower yield than an otherwise comparable fund investing in lower-quality securities. What is meant by a bond fund's maturity? Every bond has a stated maturity date when the issuer must repay the bond's entire principal value to the investor. However, many bonds are "callable," meaning their principal can be repaid earlier, on or after specified call dates. Bonds are most likely to be called when interest rates are falling because the issuer can refinance at a lower rate, just as a homeowner refinances a mortgage. In that environment, a bond's "effective maturity" is usually its nearest call date. For example, the rate at which homeowners pay down their mortgage principal determines the effective maturity of mortgage-backed bonds. A bond mutual fund has no real maturity, but it does have a weighted average maturity and an average effective maturity. This number is an average of the stated or effective maturities of the underlying bonds, with each bond's maturity "weighted" by the percentage of fund assets it represents. Funds that target effective maturities normally use the effective, rather than stated, maturities of the bonds in the portfolio when computing the average. This provides additional flexibility in portfolio management but, all else being equal, could result in higher volatility than a fund targeting a stated maturity or maturity range. What is meant by a bond fund's duration? Duration is a calculation that seeks to measure the price sensitivity of a bond or a bond fund to changes in interest rates. It measures this sensitivity more accurately than maturity because it takes into account the time value of cash flows T. ROWE PRICE 8 generated over the bond's life. Future interest and principal payments are discounted to reflect their present value and then are multiplied by the number of years they will be received to produce a value expressed in years - the duration. Effective duration takes into account call features and sinking fund payments that may shorten a bond's life. Since duration can also be computed for bond funds, you can estimate the effect of interest rates on share price by multiplying fund duration by an expected change in interest rates. (T. Rowe Price shareholder bond fund reports show duration.) For example, the price of a bond fund with a duration of five years would be expected to fall approximately 5% if rates rose by one percentage point. How is a bond's price affected by changes in interest rates? When interest rates rise, a bond's price usually falls, and vice versa. In general, the longer a bond's maturity, the greater the price increase or decrease in response to a given change in rates, as shown in Table 3. Table 3 How Interest Rates May Affect Bond Prices
Price per $1,000 of bond face value if interest rates: Bond maturity Coupon Increase Decrease 1 point 2 points 1 point 2 points 1 year 5.36% $990 $981 $1,010 $1,020 5 years 5.50 958 918 1,044 1,091 10 years 5.50 927 861 1,080 1,168 30 years 5.72 872 768 1,160 1,360 --------------------------------------------------------------------------------------------------------------
The table reflects yields on Treasury securities as of July 31, 1998. The table may not be as representative of price changes for other types of bonds, including mortgage-backed securities because of prepayments. This is an illustration and does not represent expected yields or share price changes of any T. Rowe Price fund. ABOUT YOUR ACCOUNT 2 PRICING SHARES AND RECEIVING SALE PROCEEDS ---------------------------------------------------------- Here are some procedures you should know when investing in a T. Rowe Price fixed income fund. How and when shares are priced The share price (also called "net asset value" or NAV per share) for a fund is calculated at 4 p.m. ET each day the New York Stock Exchange is open for business. To calculate the NAV, the fund's assets are valued and totaled, liabilities are subtracted, and the balance, called net assets, is divided by the number of shares outstanding. Current market values are used to price fund shares. o The various ways you can buy, sell, and exchange shares are explained at the end of this prospectus and on the New Account Form. These procedures and the information you receive about them may differ for institutional and employer-sponsored retirement accounts. How your purchase, sale, or exchange price is determined If we receive your request in correct form by 4 p.m. ET, your transaction will be priced at that day's NAV. If we receive it after 4 p.m., it will be priced at the next business day's NAV. We cannot accept orders that request a particular day or price for your transaction or any other special conditions. Fund shares may be purchased through various third-party intermediaries including banks, brokers, and investment advisers. Where authorized by a fund, orders will be priced at the NAV next computed after receipt by the intermediary. Consult your intermediary to determine when your orders will be priced. The intermediary may charge a fee for its services. Note: The time at which transactions and shares are priced and the time until which orders are accepted may be changed in case of an emergency or if the New York Stock Exchange closes at a time other than 4 p.m. ET. How you can receive the proceeds from a sale o When filling out the New Account Form, you may wish to give yourself the widest range of options for receiving proceeds from a sale. If your request is received by 4 p.m. ET in correct form, proceeds are usually sent on the next business day. Proceeds can be sent to you by mail or to your bank account by Automated Clearing House (ACH) transfer or bank wire. Proceeds T. ROWE PRICE 10 sent by ACH transfer should be credited the second day after the sale. ACH is an automated method of initiating payments from, and receiving payments in, your financial institution account. The ACH system is supported by over 20,000 banks, savings banks, and credit unions. Proceeds sent by bank wire should be credited to your account the next business day. . Exception: Under certain circumstances and when deemed to be in the fund's best interests, your proceeds may not be sent for up to five business days after we receive your sale or exchange request. If you were exchanging into a bond or money fund, your new investment would not begin to earn dividends until the sixth business day. o If for some reason we cannot accept your request to sell shares, we will contact you. USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES ---------------------------------------------------------- o All net investment income and realized capital gains are distributed to shareholders. Dividends and Other Distributions Dividend and capital gain distributions are reinvested in additional fund shares in your account unless you select another option on your New Account Form. The advantage of reinvesting distributions arises from compounding; that is, you receive income dividends and capital gain distributions on a rising number of shares. Distributions not reinvested are paid by check or transmitted to your bank account via ACH. If the Post Office cannot deliver your check, or if your check remains uncashed for six months, the fund reserves the right to reinvest your distribution check in your account at the NAV on the business day of the reinvestment and to reinvest all subsequent distributions in shares of the fund. No interest will accrue on amounts represented by uncashed distribution or redemption checks. Income dividends . Bond funds declare income dividends daily at 4 p.m. ET to shareholders of record at that time provided payment has been received on the previous business day. . Dividends are paid on the first business day of each month. ABOUT YOUR ACCOUNT 11 . Fund shares will earn dividends through the date of redemption; also, shares redeemed on a Friday or prior to a holiday will continue to earn dividends until the next business day. Generally, if you redeem all of your shares at any time during the month, you will also receive all dividends earned through the date of redemption in the same check. When you redeem only a portion of your shares, all dividends accrued on those shares will be reinvested, or paid in cash, on the next dividend payment date. Capital gains . A capital gain or loss is the difference between the purchase and sale price of a security. . If a fund has net capital gains for the year (after subtracting any capital losses), they are usually declared and paid in December to shareholders of record on a specified date that month. Tax Information o You will be sent timely information for your tax filing needs. You need to be aware of the possible tax consequences when: . You sell fund shares, including an exchange from one fund to another. . The fund makes a distribution to your account. Taxes on fund redemptions When you sell shares in any fund, you may realize a gain or loss. An exchange from one fund to another is still a sale for tax purposes. In January, you will be sent Form 1099-B indicating the date and amount of each sale you made in the fund during the prior year. This information will also be reported to the IRS. For new accounts or those opened by exchange in 1983 or later, we will provide the gain or loss on the shares you sold during the year, based on the "average cost," single category method. This information is not reported to the IRS, and you do not have to use it. You may calculate the cost basis using other methods acceptable to the IRS, such as "specific identification." To help you maintain accurate records, we send you a confirmation immediately following each transaction you make (except for systematic purchases and redemptions) and a year-end statement detailing all your transactions in each fund account during the year. T. ROWE PRICE 12 Taxes on fund distributions o The following summary does not apply to retirement accounts, such as IRAs, which are not subject to current tax. In January, you will be sent Form 1099-DIV indicating the tax status of any dividend and capital gain distributions made to you. This information will also be reported to the IRS. Distributions made by a fund are generally taxable to you for the year in which they were paid. You will be sent any additional information you need to determine your taxes on fund distributions, such as the portion of your dividend, if any, that may be exempt from state income taxes. The tax treatment of a capital gain distribution is determined by how long the fund held the portfolio securities, not how long you held shares in the fund. Short-term (one year or less) capital gain distributions are taxable at the same rate as ordinary income. Reflecting recent changes in the tax code, gains on securities held more than 12 months are taxed at a maximum rate of 20%. If you realized a loss on the sale or exchange of fund shares which you held six months or less, your short-term loss will be reclassified to a long-term loss to the extent you received a long-term capital gain distribution during the period you held the shares. Gains and losses from the sale of foreign currencies and the foreign currency gain or loss resulting from the sale of a foreign debt security can increase or decrease a fund's ordinary income dividend. Net foreign currency losses may result in a fund's dividend being classified as a return of capital. If a fund pays nonrefundable taxes to foreign governments during the year, the taxes will reduce the fund's dividends but will still be included in your taxable income. However, you may be able to claim an offsetting deduction on your tax return for your portion of foreign taxes paid by a fund. o Distributions are taxable whether reinvested in additional shares or received in cash. Tax effect of buying shares before a capital gain distribution If you buy shares shortly before or on the "record date" - the date that establishes you as the person to receive the upcoming distribution - you will receive a portion of the money you just invested in the form of a taxable distribution. Therefore, you may wish to find out a fund's record date before investing. Of course, a fund's share price may, at any time, reflect undistributed capital gains or income and unrealized appreciation, which may result in future taxable distributions. ABOUT YOUR ACCOUNT 13 TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS ---------------------------------------------------------- o Following these procedures helps assure timely and accurate transactions. Purchase Conditions Nonpayment If your payment is not received or you pay with a check or ACH transfer that does not clear, your purchase will be canceled. You will be responsible for any losses or expenses incurred by the fund or transfer agent, and the fund can redeem shares you own in this or another identically registered T. Rowe Price fund as reimbursement. The fund and its agents have the right to reject or cancel any purchase, exchange, or redemption due to nonpayment. U.S. dollars All purchases must be paid for in U.S. dollars; checks must be drawn on U.S. banks. Sale (Redemption) Conditions Holds on immediate redemptions 10-day hold If you sell shares that you just purchased and paid for by check or ACH transfer, the fund will process your redemption but will generally delay sending you the proceeds for up to 10 calendar days to allow the check or transfer to clear. If your redemption request was sent by mail or mailgram, proceeds will be mailed no later than the seventh calendar day following receipt unless the check or ACH transfer has not cleared. If, during the clearing period, we receive a check drawn against your bond or money market account, it will be returned marked "uncollected." (The 10-day hold does not apply to the following: purchases paid for by bank wire; cashier's, certified, or treasurer's checks; or automatic purchases through your paycheck.) Telephone, Tele*Access/(R)/, and personal computer transactions Exchange and redemption services through telephone and Tele*Access are established automatically when you sign the New Account Form unless you check the box that states you do not want these services. Personal computer transactions must be authorized separately. T. Rowe Price funds and their agents use reasonable procedures (including shareholder identity verification) to confirm that instructions given by telephone are genuine and they are not liable for acting on these instructions. If these procedures are not followed, it is the opinion of certain regulatory agencies that the funds and their agents may be liable for any losses that may result from acting on the instructions given. A confirmation is sent promptly after a transaction. All telephone conversations are recorded. T. ROWE PRICE 14 Redemptions over $250,000 Large sales can adversely affect a portfolio manager's ability to implement a fund's investment strategy by causing the premature sale of securities that would otherwise be held. If, in any 90-day period, you redeem (sell) more than $250,000, or your sale amounts to more than 1% of fund net assets, the fund has the right to pay the difference between the redemption amount and the lesser of the two previously mentioned figures with securities from the fund. Excessive Trading o T. Rowe Price may bar excessive traders from purchasing shares. Frequent trades, involving either substantial fund assets or a substantial portion of your account or accounts controlled by you, can disrupt management of the fund and raise its expenses. . Trades placed directly with T. Rowe Price If you trade directly with T. Rowe Price, you can make one purchase and sale involving the same fund within any 120-day period. For example, if you are in fund A, you can move substantial assets from fund A to fund B and, within the next 120 days, sell your shares in fund B to return to fund A or move to fund C. If you exceed this limit, you are in violation of our excessive trading policy. Two types of transactions are exempt from this policy: 1) trades solely in money market funds (exchanges between a money fund and a nonmoney fund are not exempt); and 2) systematic purchases or redemptions (see Shareholder Services). . Trades placed through intermediaries If you purchase fund shares through an intermediary including a broker, bank, investment adviser, or other third party and hold them for less than 60 calendar days, you are in violation of our excessive trading policy. . If you violate our excessive trading policy, you may be barred indefinitely and without further notice from further purchases of T. Rowe Price funds. Keeping Your Account Open Due to the relatively high cost to a fund of maintaining small accounts, we ask you to maintain an account balance of at least $1,000. If your balance is below $1,000 for three months or longer, we have the right to close your account after giving you 60 days in which to increase your balance. ABOUT YOUR ACCOUNT 15 Small Account Fee Because of the disproportionately high costs of servicing accounts with low balances, a $10 fee, paid to T. Rowe Price Services, the fund's transfer agent, will automatically be deducted from nonretirement accounts with balances falling below a minimum level. The valuation of accounts and the deduction are expected to take place during the last five business days of September. The fee will be deducted from accounts with balances below $2,000, except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be waived for any investor whose aggregate T. Rowe Price mutual fund investments total $25,000 or more. Accounts employing automatic investing (e.g., payroll deduction, automatic purchase from a bank account, etc.) are also exempt from the charge. The fee will not apply to IRAs and other retirement plan accounts. (A separate custodial fee may apply to IRAs and other retirement plan accounts.) Signature Guarantees o A signature guarantee is designed to protect you and the T. Rowe Price funds from fraud by verifying your signature. You may need to have your signature guaranteed in certain situations, such as: . Written requests 1) to redeem over $100,000, or 2) to wire redemption proceeds. . Remitting redemption proceeds to any person, address, or bank account not on record. . Transferring redemption proceeds to a T. Rowe Price fund account with a different registration (name or ownership) from yours. . Establishing certain services after the account is opened. You can obtain a signature guarantee from most banks, savings institutions, broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot accept guarantees from notaries public or organizations that do not provide reimbursement in the case of fraud. MORE ABOUT THE FUND 3 ORGANIZATION AND MANAGEMENT ---------------------------------------------------------- How is the fund organized? The fund was incorporated in Maryland in 1973 and is a "diversified, open-end investment company," or mutual fund. Mutual funds pool money received from shareholders and invest it to try to achieve specified objectives. o Shareholders benefit from T. Rowe Price's 61 years of investment management experience. What is meant by "shares"? As with all mutual funds, investors purchase shares when they put money in a fund. These shares are part of a fund's authorized capital stock, but share certificates are not issued. Each share and fractional share entitles the shareholder to: . Receive a proportional interest in a fund's income and capital gain distributions. . Cast one vote per share on certain fund matters, including the election of fund directors, changes in fundamental policies, or approval of changes in the fund's management contract. Do T. Rowe Price funds have annual shareholder meetings? The fund is not required to hold annual meetings and, to avoid unnecessary costs to fund shareholders, does not intend to do so except when certain matters, such as a change in its fundamental policies, must be decided. In addition, shareholders representing at least 10% of all eligible votes may call a special meeting, if they wish, for the purpose of voting on the removal of any fund director or trustee. If a meeting is held and you cannot attend, you can vote by proxy. Before the meeting, the fund will send you proxy materials that explain the issues to be decided and include a voting card for you to mail back. Who runs the fund? General Oversight The fund is governed by a Board of Directors that meets regularly to review the fund's investments, performance, expenses, and other business affairs. The Board elects the fund's officers. The policy of the fund is that the majority of Board members are independent of T. Rowe Price Associates, Inc. (T. Rowe Price). ABOUT YOUR ACCOUNT 17 o All decisions regarding the purchase and sale of fund investments are made by T. Rowe Price - specifically by the fund's portfolio managers. Portfolio Management The fund has an Investment Advisory Committee with the following members: Peter Van Dyke, Chairman, Connice A. Bavely, Steven G. Brooks, Heather R. Landon, Edmund M. Notzon, Robert M. Rubino, and Gwendolyn G. Wagner. The committee chairman has day-to-day responsibility for managing the fund and works with the committee in developing and executing the fund's investment program. Mr. Van Dyke became chairman of the fund's committee on May 1, 1998. He has been managing investments since joining T. Rowe Price in 1985. The Management Fee This fee has two parts - an "individual fund fee," which reflects a fund's particular investment management costs, and a "group fee." The group fee, which is designed to reflect the benefits of the shared resources of the T. Rowe Price investment management complex, is calculated daily based on the combined net assets of all T. Rowe Price funds (except the Spectrum Funds, and any institutional, index, or private label mutual funds). The group fee schedule (shown below) is graduated, declining as the asset total rises, so shareholders benefit from the overall growth in mutual fund assets. Group Fee Schedule
0.334% First $50 billion/a/ 0.305% Next $30 billion 0.300% Thereafter ----------------------------------------
/a/ Represents a blended group fee rate containing various break points. The fund's portion of the group fee is determined by the ratio of its daily net assets to the daily net assets of all the T. Rowe Price funds described previously. Based on combined T. Rowe Price funds' assets of over $86 billion at June 30, 1998, the group fee was 0.32%. The individual fund fee was 0.15%. T. ROWE PRICE 18 UNDERSTANDING PERFORMANCE INFORMATION ---------------------------------------------------------- This section should help you understand the terms used to describe fund performance. You will come across them in shareholder reports you receive from us; in our newsletter, The Price Report; in Insights articles; in T. Rowe Price advertisements; and in the media. Total Return This tells you how much an investment in a fund has changed in value over a given time period. It reflects any net increase or decrease in the share price and assumes that all dividends and capital gains (if any) paid during the period were reinvested in additional shares. Therefore, total return numbers include the effect of compounding. Advertisements for a fund may include cumulative or average annual total return figures, which may be compared with various indices, other performance measures, or other mutual funds. Cumulative Total Return This is the actual return of an investment for a specified period. A cumulative return does not indicate how much the value of the investment may have fluctuated during the period. For example, a fund could have a 10-year positive cumulative return despite experiencing three negative years during that time. Average Annual Total Return This is always hypothetical and should not be confused with actual year-by-year results. It smooths out all the variations in annual performance to tell you what constant year-by-year return would have produced the investment's actual cumulative return. This gives you an idea of an investment's annual contribution to your portfolio, provided you held it for the entire period. Yield The current or "dividend" yield on a fund or any investment tells you the relationship between the investment's current level of annual income and its price on a particular day. The dividend yield reflects the actual income paid to shareholders for a given period, annualized, and divided by the fund's net asset value. For example, a fund providing $5 of annual income per share and a price of $50 has a current yield of 10%. Yields can be calculated for any time period. The advertised or Securities and Exchange Commission (SEC) yield is found by determining the net income per share (as defined by the SEC) earned by a fund during a 30-day base period and dividing this amount by the per share price on the last day of the base period. The SEC yield may differ from the dividend yield. MORE ABOUT THE FUND 19 INVESTMENT POLICIES AND PRACTICES ---------------------------------------------------------- This section takes a detailed look at some of the types of securities the fund may hold in its portfolio and the various kinds of investment practices that may be used in day-to-day portfolio management. The fund's investment program is subject to further restrictions and risks described in the Statement of Additional Information. Shareholder approval is required to substantively change the fund's objective and certain investment restrictions noted in the following section as "fundamental policies." The managers follow certain "operating policies," which can be changed without shareholder approval. However, significant changes are discussed with shareholders in fund reports. The fund adheres to applicable investment restrictions and policies at the time it makes an investment. A later change in circumstances will not require the sale of an investment if it was proper at the time it was made. The fund's holdings of certain kinds of investments cannot exceed maximum percentages of total assets, which are set forth in this prospectus. For instance, this fund is not permitted to invest more than 10% of total assets in hybrid instruments. While these restrictions provide a useful level of detail about the fund's investment program, investors should not view them as an accurate gauge of the potential risk of such investments. For example, in a given period, a 5% investment in hybrid instruments could have significantly more of an impact on the fund's share price than its weighting in the portfolio. The net effect of a particular investment depends on its volatility and the size of its overall return in relation to the performance of all the fund's other investments. Changes in the fund's holdings, the fund's performance, and the contribution of various investments are discussed in the shareholder reports sent to you. o Fund managers have considerable leeway in choosing investment strategies and selecting securities they believe will help the fund achieve its objective. Types of Portfolio Securities In seeking to meet its investment objective, the fund may invest in any type of security or instrument (including certain potentially high-risk derivatives described in this section) whose investment characteristics are consistent with the fund's investment program. The following pages describe the principal types of portfolio securities and investment management practices of the fund. Fundamental policy The fund will not purchase a security if, as a result, with respect to 75% of its total assets, more than 5% of its total assets would be invested in securities of a single issuer, or if more than 10% of the outstanding T. ROWE PRICE 20 voting securities of the issuer would be held by the fund. These limitations do not apply to the fund's purchase of securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities. Bonds A bond is an interest-bearing security - an IOU - issued by companies or governmental units. The issuer has a contractual obligation to pay interest at a stated rate on specific dates and to repay principal (the bond's face value) on a specified date. An issuer may have the right to redeem or "call" a bond before maturity, and the investor may have to reinvest the proceeds at lower market rates. A bond's annual interest income, set by its coupon rate, is usually fixed for the life of the bond. Its yield (income as a percent of current price) will fluctuate to reflect changes in interest rate levels. A bond's price usually rises when interest rates fall, and vice versa, so its yield stays current. Bonds may be unsecured (backed by the issuer's general creditworthiness only) or secured (also backed by specified collateral). Certain bonds have interest rates that are adjusted periodically. These interest rate adjustments tend to minimize fluctuations in the bonds' principal values. The maturity of those securities may be shortened under certain specified conditions. Bonds may be designated as senior or subordinated obligations. Senior obligations generally have the first claim on a corporation's earnings and assets and, in the event of liquidation, are paid before subordinated debt. Common and Preferred Stocks Stocks represent shares of ownership in a company. Generally, preferred stock has a specified dividend and ranks after bonds and before common stocks in its claim on income for dividend payments and on assets should the company be liquidated. After other claims are satisfied, common stockholders participate in company profits on a pro-rata basis; profits may be paid out in dividends or reinvested in the company to help it grow. Increases and decreases in earnings are usually reflected in a company's stock price, so common stocks generally have the greatest appreciation and depreciation potential of all corporate securities. While most preferred stocks pay a dividend, the fund may purchase preferred stock where the issuer has omitted, or is in danger of omitting, payment of its dividend. Such investments would be made primarily for their capital appreciation potential. MORE ABOUT THE FUND 21 Convertible Securities and Warrants The fund may invest in debt or preferred equity securities convertible into, or exchangeable for, equity securities. Traditionally, convertible securities have paid dividends or interest at rates higher than common stocks but lower than nonconvertible securities. They generally participate in the appreciation or depreciation of the underlying stock into which they are convertible, but to a lesser degree. In recent years, convertibles have been developed which combine higher or lower current income with options and other features. Warrants are options to buy a stated number of shares of common stock at a specified price anytime during the life of the warrants (generally, two or more years). Operating policy Without regard to quality, the fund may invest up to 25% of its total assets (not including cash) in preferred and common stocks and convertible securities, convertible into or which carry warrants for common stocks or other equity securities. Foreign Securities The fund may invest in foreign securities. These include nondollar-denominated securities traded outside of the U.S. and dollar-denominated securities of foreign issuers traded in the U.S. (such as ADRs). Such investments increase a portfolio's diversification and may enhance return, but they also involve some special risks such as exposure to potentially adverse local political and economic developments; nationalization and exchange controls; potentially lower liquidity and higher volatility; possible problems arising from accounting, disclosure, settlement, and regulatory practices that differ from U.S. standards; and the chance that fluctuations in foreign exchange rates will decrease the investment's value (favorable changes can increase its value). These risks are heightened for investments in developing countries. Operating policy The fund may invest without limitation in U.S. dollar-denominated debt securities issued by foreign issuers, foreign branches of U.S. banks, and U.S. branches of foreign banks. The fund may also invest up to 20% of its total assets (excluding reserves) in non-U.S. dollar-denominated fixed income securities principally traded in financial markets outside the United States. Asset-Backed Securities An underlying pool of assets, such as credit card or automobile trade receivables or corporate loans or bonds, backs these bonds and provides the interest and principal payments to investors. Credit quality depends primarily on the quality of the underlying assets and the level of credit support, if any, provided by the issuer. The underlying assets (i.e., loans) are subject to prepayments which can shorten the securities' weighted average life and may lower their T. ROWE PRICE 22 return. The value of these securities also may change because of actual or perceived changes in the creditworthiness of the originator, servicing agent, or of the financial institution providing the credit support. There is no limit on the fund's investment in these securities. Mortgage-Backed Securities The fund may invest in a variety of mortgage-backed securities. Mortgage lenders pool individual home mortgages with similar characteristics to back a certificate or bond, which is sold to investors such as the fund. Interest and principal payments generated by the underlying mortgages are passed through to the investors. The "big three" issuers are the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac). GNMA certificates are backed by the full faith and credit of the U.S. government, while others, such as Fannie Mae and Freddie Mac certificates, are only supported by the ability to borrow from the U.S. Treasury or supported only by the credit of the agency. Private mortgage bankers and other institutions also issue mortgage-backed securities. Mortgage-backed securities are subject to scheduled and unscheduled principal payments as homeowners pay down or prepay their mortgages. As these payments are received, they must be reinvested when interest rates may be higher or lower than on the original mortgage security. Therefore, these securities are not an effective means of locking in long-term interest rates. In addition, when interest rates fall, the pace of mortgage prepayments picks up. These refinanced mortgages are paid off at face value (par), causing a loss for any investor who may have purchased the security at a price above par. In such an environment, this risk limits the potential price appreciation of these securities and can negatively affect the fund's net asset value. When rates rise, the prices of mortgage-backed securities can be expected to decline, although historically these securities have experienced smaller price declines than comparable quality bonds. In addition, when rates rise and prepayments slow, the effective duration of mortgage-backed securities extends, resulting in increased volatility. o There is no limit on the fund's investment in mortgage-backed securities. Additional mortgage-backed securities in which the fund may invest include: . Collateralized Mortgage Obligations (CMOs) CMOs are debt securities that are fully collateralized by a portfolio of mortgages or mortgage-backed securities. All interest and principal payments from the underlying mortgages are passed through to the CMOs in such a way as to create, in most cases, more definite maturities than is the case with the underlying mortgages. CMOs may pay fixed or variable rates of interest, and certain CMOs have priority over others with respect to the receipt of prepayments. MORE ABOUT THE FUND 23 . Stripped Mortgage Securities Stripped mortgage securities (a type of potentially high-risk derivative) are created by separating the interest and principal payments generated by a pool of mortgage-backed securities or a CMO to create additional classes of securities. Generally, one class receives only interest payments (IOs), and another receives principal payments (POs). Unlike with other mortgage-backed securities and POs, the value of IOs tends to move in the same direction as interest rates. The fund can use IOs as a hedge against falling prepayment rates (interest rates are rising) and/or a bear market environment. POs can be used as a hedge against rising prepayment rates (interest rates are falling) and/or a bull market environment. IOs and POs are acutely sensitive to interest rate changes and to the rate of principal prepayments. A rapid or unexpected increase in prepayments can severely depress the price of IOs, while a rapid or unexpected decrease in prepayments could have the same effect on POs. These securities are very volatile in price and may have lower liquidity than most other mortgage-backed securities. Certain non-stripped CMOs may also exhibit these qualities, especially those that pay variable rates of interest that adjust inversely with, and more rapidly than, short-term interest rates. In addition, if interest rates rise rapidly and prepayment rates slow more than expected, certain CMOs, in addition to losing value, can exhibit characteristics of longer-term securities and become more volatile. There is no guarantee the fund's investment in CMOs, IOs, or POs will be successful, and the fund's total return could be adversely affected as a result. Operating policy The fund may invest up to 10% of its total assets in stripped mortgage securities. Hybrid Instruments These instruments (a type of potentially high-risk derivative) can combine the characteristics of securities, futures, and options. For example, the principal amount or interest rate of a hybrid could be tied (positively or negatively) to the price of some commodity, currency, or securities index or another interest rate (each a "benchmark"). Hybrids can be used as an efficient means of pursuing a variety of investment goals, including currency hedging, duration management, and increased total return. Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed principal T. ROWE PRICE 24 amount and pays a fixed rate or floating rate of interest. The purchase of hybrids also exposes the fund to the credit risk of the issuer of the hybrid. These risks may cause significant fluctuations in the net asset value of the fund. o Hybrids can have volatile prices and limited liquidity, and their use by the fund may not be successful. Operating policy The fund may invest up to 10% of its total assets in hybrid instruments. Deferrable Subordinated Securities Recently, securities have been issued which have long maturities and are deeply subordinated in the issuer's capital structure. They generally have 30-year maturities and permit the issuer to defer distributions for up to five years. These characteristics give the issuer more financial flexibility than is typically the case with traditional bonds. As a result, the securities may be viewed as possessing certain "equity-like" features by rating agencies and bank regulators. However, the securities are treated as debt securities by market participants, and the fund intends to treat them as such as well. These securities may offer a mandatory put or remarketing option that creates an effective maturity date significantly shorter than the stated one. The fund will invest in these securities to the extent their yield, credit, and maturity characteristics are consistent with the fund's investment objective and program. Private Placements These securities are sold directly to a small number of investors, usually institutions. Unlike public offerings, such securities are not registered with the SEC. 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. Operating policy The fund will not invest more than 15% of its net assets in illiquid securities. Utility Industry Concentration The fund may, under certain circumstances, invest a substantial amount of its assets in the utility industry. Investments in this industry may be affected by environmental conditions, energy conservation programs, fuel shortages, availability of capital to finance operations and construction programs, and federal and state legislative and regulatory actions. T. Rowe Price believes that any risk to the fund which might result from concentrating in any such industry will be minimized by diversification of the fund's investments. Operating policy The fund has no current intention of concentrating in the utility industry. MORE ABOUT THE FUND 25 Fundamental policy The fund will, under certain conditions, invest up to 50% of its assets in any one of the following industries: gas utility, gas transmission utility, electric utility, telephone utility, and petroleum. Types of Management Practices Reserve Position The fund will hold a certain portion of its assets in money market reserves. The fund's reserve position can consist of shares of one or more T. Rowe Price internal money market funds as well as short-term, high-quality U.S. and foreign dollar-denominated money market securities, including repurchase agreements. For temporary, defensive purposes, the fund may invest without limitation in money market reserves. The effect of taking such a position is that the fund may not achieve its investment objective. The reserve position provides flexibility in meeting redemptions, expenses, and the timing of new investments and can serve as a short-term defense during periods of unusual market volatility. Borrowing Money and Transferring Assets The fund can borrow money from banks (and to the extent permitted by the SEC, other Price funds) as a temporary measure for emergency purposes, to facilitate redemption requests, or for other purposes consistent with the fund's investment objective and program. Such borrowings may be collateralized with fund assets, subject to restrictions. Fundamental policy Borrowings may not exceed 33 1/3% of total fund assets. Operating policy The fund may not transfer as collateral any portfolio securities except as necessary in connection with permissible borrowings or investments, and then such transfers may not exceed 33 1/3% of the fund's total assets. The fund may not purchase additional securities when borrowings exceed 5% of total assets. Futures and Options Futures (a type of potentially high-risk derivative) are often used to manage or hedge risk because they enable the investor to buy or sell an asset in the future at an agreed-upon price. Options (another type of potentially high-risk derivative) give the investor the right (where the investor purchases the option), or the obligation (where the investor writes (sells) the option), to buy or sell an asset at a predetermined price in the future. The fund may buy and sell futures and options contracts for any number of reasons, including: to manage its exposure to changes in interest rates, bond prices, and foreign currencies; as an efficient means of adjusting its overall exposure to certain markets; in an effort to enhance income; to protect the value of portfolio securities; and to adjust portfolio duration. The fund may purchase, sell, or write call and put options on securities, financial indices, and foreign currencies. T. ROWE PRICE 26 Futures contracts and options may not always be successful hedges; their prices can be highly volatile. Using them could lower the fund's total return, and the potential loss from the use of futures can exceed the fund's initial investment in such contracts. Operating policies Futures: Initial margin deposits and premiums on options used for non-hedging purposes will not equal more than 5% of the fund's net asset value. Options on securities: The total market value of securities against which the fund writes call or put options may not exceed 25% of its total assets. The fund will not commit more than 5% of its total assets to premiums when purchasing call or put options. Managing Foreign Exchange Risk Investors in foreign securities may "hedge" their exposure to potentially unfavorable currency changes by purchasing a contract to exchange one currency for another on some future date at a specified exchange rate. In certain circumstances, a "proxy currency" may be substituted for the currency in which the investment is denominated, a strategy known as "proxy hedging." The fund may also use these contracts to create a synthetic bond - issued by a U.S. company, for example, but with the dollar component transformed into a foreign currency. If the fund were to engage in foreign currency transactions, they would be used primarily to protect the fund's foreign securities from adverse currency movements relative to the dollar. Such transactions involve the risk that anticipated currency movements will not occur, and the fund's total return could be reduced. Operating policy The fund will not commit more than 20% of its total assets to forward currency contracts. Lending of Portfolio Securities Like other mutual funds, the fund may lend securities to broker-dealers, other institutions, or other persons to earn additional income. The principal risk is the potential insolvency of the broker-dealer or other borrower. In this event, the fund could experience delays in recovering its securities and possibly capital losses. Fundamental policy The value of loaned securities may not exceed 33 1/3% of total fund assets. When-Issued Securities and Forward Commitment Contracts The fund may purchase securities on a when-issued or delayed delivery basis or may purchase or sell securities on a forward commitment basis. There is no limit on the fund's investment in these securities. The price of these securities is fixed at the time of the commitment to buy, but delivery and payment can take place a month or more later. During the interim period, the market value of the securities can fluctuate, and no interest accrues to the purchaser. At the time of delivery, the value of the securities may be more or less than the purchase or MORE ABOUT THE FUND 27 sale price. To the extent the fund remains fully or almost fully invested (in securities with a remaining maturity of more than one year) at the same time it purchases these securities, there will be greater fluctuations in the fund's net asset value than if the fund did not purchase them. Portfolio Turnover Although the fund will not generally trade for short-term profits, circumstances may warrant a sale without regard to the length of time a security was held. A high turnover rate may increase transaction costs and result in additional taxable gains. The fund's portfolio turnover rates for the fiscal years ended May 31, 1998, 1997, and 1996, were 147.3%, 87.1%, and 35.5%, respectively. Year 2000 Processing Issue Many computer programs use two digits rather than four to identify the year. These programs, if not adapted, will not correctly handle the change from "99" to "00" on January 1, 2000, and will not be able to perform necessary functions. The Year 2000 issue affects virtually all companies and organizations. T. Rowe Price has implemented steps intended to assure that its major computer systems and processes are capable of Year 2000 processing. We are working with third parties to assess the adequacy of their compliance efforts and are developing contingency plans intended to assure that third-party noncompliance will not materially affect T. Rowe Price's operations. Companies, organizations, governmental entities and markets in which T. Rowe Price funds invest will be affected by the Year 2000 issue, but at this time the funds cannot predict the degree of impact. To the extent the effect is negative, the fund's returns could be adversely affected. FINANCIAL HIGHLIGHTS ---------------------------------------------------------- Table 4, which provides information about the fund's financial history, is based on a single share outstanding throughout each fiscal year. The table is part of the fund's financial statements, which are included in its annual report and are incorporated by reference into the Statement of Additional Information (available upon request). The total returns in the table represent the rate that an T. ROWE PRICE 28 investor would have earned or lost on an investment in the fund (assuming reinvestment of all dividends and distributions). The financial statements in the annual report were audited by the fund's independent accountants, PricewaterhouseCoopers LLP. Table 4 Financial Highlights
Year ended May 31 Three months Year ended ended 2/28/94 5/31/94/ a/ 1995 1996 1997 1998 ------------------------------------------------------------------------------------------- Net asset value, beginning of period $ 9.24 $ 9.12 $ 8.65 $ 8.97 $ 8.70 $ 8.77 Income From Investment Operations Net investment income 0.54 0.14 0.58 0.60 0.58 0.57 -------------------------------------------------------------- Net gains or losses on securities (both realized and (0.05) (0.40) 0.34 (0.27) 0.07 0.36 unrealized) -------------------------------------------------------------- Total from investment operations 0.49 (0.26) 0.92 0.33 0.65 0.93 Less Distributions Dividends (from net (0.54) (0.14) (0.58) (0.60) (0.58) (0.57) investment income) -------------------------------------------------------------- Distributions (0.07) (0.07) (0.02) - - (0.04) (from capital gains) -------------------------------------------------------------- Returns of capital - - -------------------------------------------------------------- Total distributions (0.61) (0.21) (0.60) (0.60) (0.58) (0.61) -------------------------------------------------------------- Net asset value, $ 9.12 $ 8.65 $ 8.97 $ 8.70 $ 8.77 $ 9.09 end of period -------------------------------------------------------------- Total return 5.36% (2.84)% 11.13% 3.70% 7.70% 10.84% Ratios/Supplemental Data Net assets, end of $1,458 $1,375 $1,566 $1,634 $1,711 $2,076 period (in millions) -------------------------------------------------------------- Ratio of expenses to 0.82% 0.80% /b/ 0.78% 0.75% 0.74% 0.71% average net assets -------------------------------------------------------------- Ratio of net investment income to average 5.77% 6.43% /b/ 6.95% 6.66% 6.65% 6.31% net assets -------------------------------------------------------------- Portfolio turnover 58.3% 91.5% /b/ 54.1% 35.5% 87.1% 147.3% rate -------------------------------------------------------------------------------------------
/a/ The fund's fiscal year-end was changed to May 31. /b/ Annualized. INVESTING WITH T. ROWE PRICE 4 ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION ---------------------------------------------------------- Tax Identification Number We must have your correct Social Security or corporate tax identification number on a signed New Account Form or W-9 Form. Otherwise, federal law requires the funds to withhold a percentage (currently 31%) of your dividends, capital gain distributions, and redemptions, and may subject you to an IRS fine. If this information is not received within 60 days after your account is established, your account may be redeemed, priced at the NAV on the date of redemption. Always verify your transactions by carefully reviewing the confirmation we send you. Please report any discrepancies to Shareholder Services promptly. Employer-Sponsored Retirement Plans and Institutional Accounts T. Rowe Price Trust Company 1-800-492-7670 Transaction procedures in the following sections may not apply to employer-sponsored retirement plans and institutional accounts. For procedures regarding employer-sponsored retirement plans, please call T. Rowe Price Trust Company or consult your plan administrator. For institutional account procedures, please call your designated account manager or service representative. OPENING A NEW ACCOUNT ---------------------------------------------------------- $2,500 minimum initial investment; $1,000 for retirement plans or gifts or transfers to minors (UGMA/UTMA) accounts Account Registration If you own other T. Rowe Price funds, be sure to register any new account just like your existing accounts so you can exchange among them easily. (The name and account type would have to be identical.) By Mail Please make your check payable to T. Rowe Price Funds (otherwise it will be returned) and send your check, together with the New Account Form, to the appropriate address in the next paragraph. We do not accept third-party checks to open new accounts, except for IRA Rollover checks that are properly endorsed. T. ROWE PRICE 30 Regular Mail T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353 Mailgram, Express, Registered, or Certified Mail T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117 By Wire Call Investor Services for an account number and give the following wire information to your bank: PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account# 1004397951 name of owner(s) and account number Complete a New Account Form and mail it to one of the appropriate addresses listed previously. Note: No services will be established and IRS penalty withholding may occur until a signed New Account Form is received. Also, retirement plans cannot be opened by wire. By Exchange Call Shareholder Services or use Tele*Access or your personal computer (see Automated Services under Shareholder Services). The new account will have the same registration as the account from which you are exchanging. Services for the new account may be carried over by telephone request if preauthorized on the existing account. For limitations on exchanging, see explanation of Excessive Trading under Transaction Procedures and Special Requirements. In Person Drop off your New Account Form at any location listed on the cover and obtain a receipt. INVESTING WITH T. ROWE PRICE 31 PURCHASING ADDITIONAL SHARES ---------------------------------------------------------- $100 minimum purchase; $50 minimum for retirement plans, Automatic Asset Builder, and gifts or transfers to minors (UGMA/UTMA) accounts By ACH Transfer Use Tele*Access or your personal computer or call Investor Services if you have established electronic transfers using the ACH network. By Wire Call Shareholder Services or use the wire address in Opening a New Account. By Mail 1. Make your check payable to T. Rowe Price Funds (otherwise it may be returned). 2. Mail the check to us at the following address with either a fund reinvestment slip or a note indicating the fund you want to buy and your fund account number. 3. Remember to provide your account number and the fund name on the memo line of your check. Regular Mail T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500 /(For mailgrams, express, registered, or certified mail, see previous / /section.)/ By Automatic Asset Builder Fill out the Automatic Asset Builder section on the New Account or Shareholder Services Form. T. ROWE PRICE 32 EXCHANGING AND REDEEMING SHARES ---------------------------------------------------------- Exchange Service You can move money from one account to an existing identically registered account or open a new identically registered account. Remember, exchanges are purchases and sales for tax purposes. (Exchanges into a state tax-free fund are limited to investors living in states where the fund is registered.) Some of the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held for less than six months or one year, as specified in the prospectus. The fee is paid to the fund. By Phone Call Shareholder Services If you find our phones busy during unusually volatile markets, please consider placing your order by your personal computer, Tele*Access (if you have previously authorized telephone services), mailgram, or express mail. For exchange policies, please see Transaction Procedures and Special Requirements - Excessive Trading. Redemption proceeds can be mailed to your account address, sent by ACH transfer, or wired to your bank (provided your bank information is already on file). For charges, see Electronic Transfers - By Wire under Shareholder Services. By Mail For each account involved, provide the account name, number, fund name, and exchange or redemption amount. For exchanges, be sure to indicate any fund you are exchanging out of and the fund or funds you are exchanging into. Please mail to the appropriate address below. T. Rowe Price requires the signatures of all owners exactly as registered, and possibly a signature guarantee (see Transaction Procedures and Special Requirements - Signature Guarantees). Regular Mail For nonretirement and IRA accounts T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220 INVESTING WITH T. ROWE PRICE 33 For employer-sponsored retirement accounts T. Rowe Price Trust Company P.O. Box 89000 Baltimore, MD 21289-0300 /(For mailgrams, express, registered, or certified mail, see Opening a / /New Account.)/ Redemptions from employer-sponsored retirement accounts must be in writing; please call T. Rowe Price Trust Company or your plan administrator for instructions. IRA distributions may be requested in writing or by telephone; please call Shareholder Services to obtain an IRA Distribution Form or an IRA Shareholder Services Form to authorize the telephone redemption service. RIGHTS RESERVED BY THE FUND ---------------------------------------------------------- The fund and its agents reserve the following rights: (1) to waive or lower investment minimums; (2) to accept initial purchases by telephone or mailgram; (3) to refuse any purchase or exchange order; (4) to cancel or rescind any purchase or exchange order (including, but not limited to, orders deemed to result in excessive trading, market timing, fraud, or 5% ownership) upon notice to the shareholder within five business days of the trade or if the written confirmation has not been received by the shareholder, whichever is sooner; (5) to freeze any account and suspend account services when notice has been received of a dispute between the registered or beneficial account owners or there is reason to believe a fraudulent transaction may occur; (6) to otherwise modify the conditions of purchase and any services at any time; or (7) to act on instructions believed to be genuine. These actions will be taken when, in the sole discretion of management, they are deemed to be in the best interest of the fund. In an effort to protect the fund from the possible adverse effects of a substantial redemption in a large account, as a matter of general policy no shareholder or group of related shareholders controlled by the same T. ROWE PRICE 34 person or group of persons will knowingly be permitted to purchase in excess of 5% of the outstanding shares of the fund, except upon approval of the fund's management. SHAREHOLDER SERVICES ---------------------------------------------------------- Shareholder Services 1-800-225-5132 Investor Services 1-800-638-5660 Many services are available to you as a T. Rowe Price shareholder; some you receive automatically, and others you must authorize on the New Account Form. By signing up for services on the New Account Form rather than later on, you avoid having to complete a separate form and obtain a signature guarantee. This section reviews some of the principal services currently offered. Our Services Guide, which we mail to all new shareholders, contains detailed descriptions of these and other services. Note: Corporate and other institutional accounts require an original or certified resolution to establish services and to redeem by mail. For more information, call Investor Services. Retirement Plans We offer a wide range of plans for individuals, institutions, and large and small businesses: Traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money purchase pension), 401(k), and 403(b)(7). For information on IRAs, call Investor Services. For information on all other retirement plans, including our no-load variable annuity, please call our Trust Company at 1-800-492-7670. Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days Tele*Access 24-hour service via toll-free number enables you to (1) access information on fund yields, prices, distributions, account balances, and your latest transaction; (2) request checks, prospectuses, services forms, duplicate statements, and tax forms; and (3) initiate purchase, redemption, and exchange transactions in your accounts (see Electronic Transfers on the next page). INVESTING WITH T. ROWE PRICE 35 Web Address www.troweprice.com After obtaining proper authorization, account transactions may also be conducted through our web site on the Internet. If you subscribe to America Online, you can access our web site via keyword "T. Rowe Price" and conduct transactions in your account. Plan Account Line 1-800-401-3279 Plan Account Line This 24-hour service is similar to Tele*Access but is designed specifically to meet the needs of retirement plan investors. Telephone and Walk-In Services Buy, sell, or exchange shares by calling one of our service representatives or by visiting one of our investor center locations whose addresses are listed on the cover. Electronic Transfers By ACH With no charges to pay, you can initiate a purchase or redemption for as little as $100 or as much as $100,000 between your bank account and fund account using the ACH network. Enter instructions via Tele*Access or your personal computer, or call Shareholder Services. By Wire Electronic transfers can be conducted via bank wire. There is currently a $5 fee for wire redemptions under $5,000, and your bank may charge for incoming or outgoing wire transfers regardless of size. Checkwriting (Not available for equity funds, or the High Yield or Emerging Markets Bond Funds) You may write an unlimited number of free checks on any money market fund, and most bond funds, with a minimum of $500 per check. Keep in mind, however, that a check results in a redemption; a check written on a bond fund will create a taxable event which you and we must report to the IRS. Automatic Investing ($50 minimum) You can invest automatically in several different ways, including: Automatic Asset Builder You instruct us to move $50 or more from your bank account, or you can instruct your employer to send all or a portion of your paycheck to the fund or funds you designate. T. ROWE PRICE 36 Automatic Exchange You can set up systematic investments from one fund account into another, such as from a money fund into a stock fund. DISCOUNT BROKERAGE ---------------------------------------------------------- To open an account 1-800-638-5660 For existing discount brokerage investors 1-800-225-7720 This service gives you the opportunity to consolidate all of your investments with one company. Investments available through our discount brokerage include stocks, options, bonds, non-T. Rowe Price mutual funds, and others at commission savings over full-service brokers. We also provide a wide range of services, including: Automated telephone and computer services You can enter stock and option trades, access quotes, and review account information around the clock by phone with Tele-Trader or via the Internet with Internet-Trader. Any trades executed through Tele-Trader save you an additional 10% on commissions. You will save 20% on commissions for stock trades when you trade through Internet-Trader. All trades are subject to a $35 minimum commission except stock trades placed through Internet-Trader, which are subject to a $29.95 minimum commission. Investor information A variety of informative reports, such as our Brokerage Insights series, S&P Market Month newsletter, and select stock reports can help you better evaluate economic trends and investment opportunities. Dividend Reinvestment Service Virtually all stocks held in customer accounts are eligible for this free service. /Discount Brokerage is a division of T. Rowe Price Investment / /Services, Inc., Member NASD/SIPC./ INVESTING WITH T. ROWE PRICE 37 INVESTMENT INFORMATION ---------------------------------------------------------- To help shareholders monitor their current investments and make decisions that accurately reflect their financial goals, T. Rowe Price offers a wide variety of information in addition to account statements. Most of this information is also available on our web site at www.troweprice.com. Shareholder Reports Fund managers' reviews of their strategies and results. If several members of a household own the same fund, only one fund report is mailed to that address. To receive additional copies, please call Shareholder Services or write to us at 100 East Pratt Street, Baltimore, Maryland 21202. The T. Rowe Price Report A quarterly investment newsletter discussing markets and financial strategies. Performance Update A quarterly review of all T. Rowe Price fund results. Insights Educational reports on investment strategies and financial markets. Investment Guides Asset Mix Worksheet, College Planning Kit, Diversifying Overseas: A T. Rowe Price Guide to International Investing, Managing Your Retirement Distribution, Personal Strategy Planner, Retirees Financial Guide, Retirement Planning Kit, and Tax Considerations for Investors. To help you achieve your financial goals, T. Rowe Price offers a wide range of stock, bond, and money market investments, as well as convenient services and informative reports. For Mutual Fund or Discount Brokerage Information Investor Services 1-800-638-5660 For Existing Accounts Shareholder Services 1-800-225-5132 For Yields, Prices, Account Information, or to Conduct Transactions Tele*Access/(R)/ 24 hours, 7 days 1-800-638-2587 Internet Address www.troweprice.com Plan Account Line For retirement plan investors 1-800-401-3279 Investor Centers 101 East Lombard St. Baltimore, MD 21202 T. Rowe Price Financial Center 10090 Red Run Blvd. Owings Mills, MD 21117 Farragut Square 900 17th Street, N.W. Washington, D.C. 20006 ARCO Tower 31st Floor 515 South Flower St. Los Angeles, CA 90071 4200 West Cypress St. 10th Floor Tampa, FL 33607 Headquarters 100 East Pratt St. Baltimore, MD 21202 A Statement of Additional Information about the fund has been filed with the Securities and Exchange Commission and has been incorporated by reference into this prospectus. Further information about the fund's investments, including a review of market conditions and the manager's recent strategies and their impact on performance, is available in the annual and semiannual shareholder reports. To obtain free copies of any of these documents, or for shareholder inquiries, call 1-800-638-5660. Fund reports and Statements of Additional Information are also available from the Securities and Exchange Commission by calling 1-800-SEC-0330 or writing the SEC's Public Reference Section, Washington, D.C. 20549-6009 (you will be charged a duplicating fee); by visiting the SEC's public reference room; or by consulting the SEC's web site at www.sec.gov. This prospectus contains information you should know before investing. Please keep it for future reference. 1940 Act File No. 811-2396 F43-040 10/1/98 PROSPECTUS October 1, 1998 T. Rowe Price Personal Strategy Funds Three funds with different mixes of stocks, bonds, and money market securities to help investors match their risk tolerance with their investment goals. RAM LOGO These securities have not been approved or disapproved by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. T. Rowe Price Personal Strategy Funds, Inc. Prospectus October 1, 1998
1 ABOUT THE FUNDS Fund, Market, and Risk Characteristics 1 --------------------------------------------- Other Information About the Funds 7 --------------------------------------------- 2 ABOUT YOUR ACCOUNT Pricing Shares and Receiving 10 Sale Proceeds --------------------------------------------- Distributions and Taxes 11 --------------------------------------------- Transaction Procedures and 13 Special Requirements --------------------------------------------- 3 MORE ABOUT THE FUNDS Organization and Management 17 --------------------------------------------- Understanding Performance Information 19 --------------------------------------------- Investment Policies and Practices 19 --------------------------------------------- Financial Highlights 30 --------------------------------------------- 4 INVESTING WITH T. ROWE PRICE Account Requirements 33 and Transaction Information --------------------------------------------- Opening a New Account 33 --------------------------------------------- Purchasing Additional Shares 35 --------------------------------------------- Exchanging and Redeeming 36 --------------------------------------------- Rights Reserved by the Funds 37 --------------------------------------------- Shareholder Services 38 --------------------------------------------- Discount Brokerage 40 --------------------------------------------- Investment Information 41 ---------------------------------------------
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates, Inc., and its affiliates managed over $141 billion for more than six million individual and institutional investor accounts as of June 30, 1998. Mutual fund shares are not deposits or obligations of, or guaranteed by, any depository institution. Shares are not insured by the FDIC, Federal Reserve Board, or any other agency, and are subject to investment risks, including possible loss of the principal amount invested. ABOUT THE FUNDS 1 FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT ---------------------------------------------------------- To help you decide whether these funds are appropriate for you, this section reviews their investment objectives, strategies, and potential risks. What is each fund's objective? . Income Fund The highest total return over time, with a primary emphasis on income and a secondary emphasis on capital growth. We pursue this objective by investing in a diversified portfolio typically consisting of about 40% stocks, 40% bonds, and 20% money market securities. . Balanced Fund The highest total return over time, with an emphasis on both capital growth and income. We pursue this objective by investing in a diversified portfolio typically consisting of about 60% stocks, 30% bonds, and 10% money market securities. . Growth Fund The highest total return over time, with a primary emphasis on capital growth and a secondary emphasis on income. We pursue this objective by investing in a diversified portfolio typically consisting of about 80% stocks and 20% bonds and money market securities. o Generally, the greater the portion of stocks in the fund, the higher the fund's potential return over time and the greater the risk of price declines. What are each fund's principal investment strategies? Under normal conditions, allocations for each fund can vary by 10 percentage points above or below the benchmarks shown in the table, based on our outlook for the economy and the financial markets. Under unusual conditions, each fund may invest in money market securities without limitation for temporary defensive purposes. For example, when deciding allocations within these prescribed limits, managers may favor fixed income securities if the economy is expected to slow sufficiently to hurt corporate profit growth. The opposite may be true when strong economic growth is expected. And when selecting particular stocks to purchase, managers will examine relative values and prospects among growth and value-oriented stocks, domestic and international stocks, and small-cap and large-cap stocks. This process draws heavily upon T. Rowe Price's proprietary stock research expertise. While the funds maintain well-diversified portfolios, managers may at a particular time shade their stock selection toward markets or market sectors that appear to offer attractive value and appreciation potential. Much the same security selection process applies to bonds. For example, when deciding whether T. ROWE PRICE 2 to increase or decrease allocations to high-yield (junk) bonds, managers will weigh such factors as the outlook for the economy and corporate earnings and the yield advantage lower-rated bonds currently offer over investment-grade bonds. Table 1 Differences Among Funds
Relative risk/ reward Fund Strategy Benchmarks Ranges Income Invests at least 65% of total 40% Stocks 30 - 50% Lower assets 40% Bonds 30 - 50% in income-producing 20% Money markets 10 - 30% bonds and dividend-paying stocks. Balanced Invests at least 25% of total 60% Stocks 50 - 70% More than Income, assets in senior fixed income 30% Bonds 20 - 40% less than Growth securities. Growth Invests at least 65% of total 80% Stocks 70 - 90% Higher assets in common stocks of 20% Bonds 10 - 30% companies whose earnings and money markets and dividends we expect to increase.
o For details about each fund's investment program, please see the Investment Policies and Practices section. What are the main risks of investing in the funds? The risks vary depending on their mix of stocks, bonds, and money market securities. Stocks represent ownership in a corporation and their prices fluctuate with changes in a company's current earnings, prospects for future earnings, and with overall stock market conditions. Share prices of all companies, even the best managed and most profitable, can fall for any number of reasons, ranging from lower-than-expected earnings to changes in investor psychology. Significant trading by large institutional investors also can lead to price declines. In addition, if our assessment of company prospects proves incorrect, companies that our managers and analysts expect to do well may perform poorly. Since 1950, the stock market has experienced 10 negative years and steep drops of shorter duration. Its worst calendar quarter return in recent years was -22.5% in 1987's fourth quarter. For these reasons, stock investors should have a long-term investment horizon and be willing to wait out bear markets. o Each fund's share price may decline, so when you sell your shares, you may lose money. An investment in each fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. ABOUT THE FUNDS 3 Bonds are debt securities, meaning the issuer has a contractual obligation to pay interest at a fixed rate on specified dates and to repay the principal (face value) upon maturity. Bonds in the funds have two main sources of risk: interest rate and credit risk. Interest rate risk is the decline in bond prices that usually accompanies a rise in interest rates. (See the table entitled How Interest Rates May Affect Bond Prices.) Longer-maturity bonds typically suffer greater declines than those with shorter maturities. Credit risk is the chance that any fund holding could have its credit 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. While the funds expect to invest primarily in investment-grade bonds, they may also hold high-yield (junk) bonds, including those with the lowest rating. Investment-grade bonds are those rated from the highest (AAA) to medium (BBB) quality, and high-yield bonds are rated BB and lower. The latter are speculative since their issuers are more vulnerable to financial setbacks and recession than more creditworthy companies, but BBB-rated bonds may have speculative elements as well. High-yield bond issuers include small companies lacking the history or capital to merit investment-grade status, former blue chip companies downgraded because of financial problems, and firms with heavy debt loads. To the extent the funds invest in foreign stocks and bonds, they are also subject to foreign investing risk. There are special risks associated with investments in foreign securities whether denominated in U.S. dollars or foreign currencies. These risks include potentially adverse political and economic developments overseas, greater volatility, less liquidity and the possibility that foreign currencies will decline against the dollar, lowering the value of securities denominated in those currencies. Currency risk affects each fund to the extent that it holds nondollar foreign bonds. As with all mutual funds, there is no guarantee these funds will achieve their goals. How can I tell which fund is most appropriate for me? Review your financial objectives, time horizon, and risk tolerance, and see the table entitled Differences Among Funds, which summarizes the funds' main characteristics, to help you choose a fund for your particular needs. . Income Fund Designed for investors seeking income primarily, but also some capital growth. . Balanced Fund Intended for those seeking a middle-of-the-road approach that emphasizes stocks for potential capital appreciation but also produces significant income to temper volatility. T. ROWE PRICE 4 . Growth Fund Designed for more aggressive investors who want the greatest exposure to stocks and can withstand inevitable setbacks in an effort to achieve potential long-term growth. o The fund or funds you select should not represent your complete investment program or be used for short-term trading purposes. How has each fund performed in the past? The bar charts, which show each fund's actual performance for each year since they began through December 31, 1997, indicate risk by illustrating how much returns can differ from one year to the next. The funds can also experience short-term performance swings, as shown in the following charts by the best and worst calendar quarter returns during the years depicted in each chart. Of course, each fund's past performance is no guarantee of its future returns. Personal Strategy Income Fund
Calendar Year Total Returns -------------------------------- 1988 1989 1990 1991 1992 1993 1994 1995 24.71% 1996 11.79 1997 15.01 --------------------------------
Quarter Ended Total Return Best Quarter 6/30/97 8.01% Worst Quarter 3/31/97 -0.54% Personal Strategy Balanced Fund
Calendar Year Total Returns -------------------------------- 1988 1989 1990 1991 1992 1993 1994 1995 28.15% 1996 14.20 1997 17.79 --------------------------------
Quarter Ended Total Return ABOUT THE FUNDS 5 Best Quarter 6/30/97 10.27% Worst Quarter 3/31/97 -0.32% Personal Strategy Growth Fund
Calendar Year Total Returns -------------------------------- 1988 1989 1990 1991 1992 1993 1994 1995 31.43% 1996 17.68 1997 20.56 --------------------------------
Quarter Ended Total Return Best Quarter 6/30/97 11.73% Worst Quarter 3/31/97 -0.07% The funds' returns for the 6 months ended 6/30/98 were as follows: Personal Strategy Income Fund, 7.89%; Personal Strategy Balanced Fund, 9.73%; Personal Strategy Growth Fund, 11.38%. In the table, the funds' average annual total returns for the one-year and since inception periods through December 31, 1997, are compared with those of their appropriate benchmarks and a combined index portfolio, which represents the normal asset mix for that fund. By comparing the bar charts with Table 2, you can see that average returns smooth out year-to-year variations. Table 2 Average Annual Total Returns
Periods ended December 31, 1997 Since inception One year 7/29/94 ------------------------------------------------------------------------------ Income Fund 15.01% 15.06% Lehman Brothers Aggregate Bond Index 9.65 8.78 Combined Index Portfolio /a/ (40% Stocks, 40% Bonds, 20% Money 18.87 16.02 Markets) ---------------------------------- Balanced Fund 17.79 17.68 Merrill Lynch-Wilshire Capital Market Index 23.02 18.81 Combined Index Portfolio /a/ (60% Stocks, 30% Bonds, 10% Money 23.62 19.75 Markets) ---------------------------------- Growth Fund 20.56 20.66 Merrill Lynch-Wilshire Capital Market Index 23.02 18.81 Combined Index Portfolio /a/ (80% Stocks, 20% Bonds and Money 28.45 23.54 Markets) ------------------------------------------------------------------------------
These figures include changes in principal value, reinvested dividends, and capital gain distributions, if any. / a/The securities indexes used as comparisons for the stock, bond, and money market portions of each fund are the S&P 500, the Lehman Brothers Aggregate Bond Index, and 90-day Treasury bills, respectively. T. ROWE PRICE 6 What fees or expenses will I pay? The funds are 100% no load. There are no fees or charges to buy or sell fund shares, reinvest dividends, or exchange into other T. Rowe Price funds. There are no 12b-1 marketing fees. The numbers in Table 3 provide an estimate of how much it will cost to operate the funds for a year, based on 1998 fiscal year expenses. Table 3 Fees and Expenses of the Funds
Annual fund operating expenses /a/ (expenses that are deducted from fund assets) Management Other Total annual fund Fee waiver/expense Net fee expenses operating expenses reimbursement expenses Income /b/ 0.47% 0.63% 1.10% 0.15% 0.90% Balanced /c/ 0.60 0.45 1.05 - 1.05 Growth /d/ 0.62 0.59 1.21 0.62 1.10 ---------------------------------------------------------------------------------------
/a /T. Rowe Price is contractually obligated to waive its fees and bear any expenses to the extent such fees or expenses would cause the funds' ratios of expenses to average net assets to exceed the indicated percentage limitations. Fees waived or expenses paid or assumed are subject to reimbursement to T. Rowe Price by each fund through the indicated reimbursement date, but no reimbursement will be made if it would result in a fund's expense ratio exceeding its specified limit. A summary of the funds' expense limitations and the periods for which they are effective is set forth below:
Limitation Period Expense Ratio Limitation Reimbursement Date Income 6/1/98-5/31/00 0.90% 5/31/02 Balanced 6/1/96-5/31/98 1.05% 5/31/00 Growth 6/1/98-5/31/00 1.10% 5/31/02
/b/The Personal Strategy Income Fund operated under a 0.95% expense ratio limitation that expired on May 31, 1998. Effective June 1, 1998, T. Rowe Price agreed to extend the limitation period through May 31, 2000, and lower the expense limitation from 0.95% to 0.90% as reflected in Table 3. Any accrued fees or expenses are subject to reimbursement to T. Rowe Price by the fund whenever the fund's expense ratio is below 0.95% (for the first agreement) or below 0.90% (for the second agreement). However, no reimbursement will be made after May 31, 2000 (for the first agreement), May 31, 2002 (for the second agreement), or if it would result in the expense ratio exceeding 0.95% (for the first agreement) or 0.90% (for the second agreement). /c/The Personal Strategy Balanced Fund operated under a 1.05% expense ratio limitation that expired on May 31, 1998. Any accrued fees or expenses under the previous agreement are subject to reimbursement to T. Rowe Price through May 31, 2000. /d/The Personal Strategy Growth Fund operated under a 1.10% expense ratio limitation that expired on May 31, 1998. Effective June 1, 1998, T. Rowe Price agreed to extend this limitation through May 31, 2000. Any accrued fees or expenses are subject to reimbursement to T. Rowe Price by the fund whenever the fund's expense ratio is below 1.10%; however, no reimbursement will be made after May 31, 2000 (for the first agreement), May 31, 2002 (for the second agreement), or if it would result in the expense ratio exceeding 1.10%. Example. The following table gives you a rough idea of how expense ratios may translate into dollars and helps you to compare the cost of investing in these funds with the cost of investing in other funds. Although your actual costs may be higher or lower, the table shows expenses you would pay if operating ABOUT THE FUNDS 7 expenses remain the same, the expense limitation currently in place is not renewed, you invest $10,000, you earn a 5% annual return, and you hold the investment for the following periods.
Fund 1 year 3 years 5 years 10 years Income $ 92 $332 $598 $1,386 ---------------------------------------- Balanced 107 336 589 1,341 ---------------------------------------- Growth 112 376 668 1,533 --------------------------------------------------------
OTHER INFORMATION ABOUT THE FUNDS ---------------------------------------------------------- What are the funds' potential rewards? Stocks of many well-established corporations offer the potential for appreciation and rising dividends. While smaller companies usually reinvest earnings in their own growth and therefore pay little or no dividends, they offer the possibility of even greater appreciation if their businesses prosper. Historically, stocks have provided higher returns over time than bonds or money market securities and offer a way to invest for long-term growth of capital. Also, stocks have provided the greatest protection against the erosion of purchasing power caused by inflation. In addition, to accommodate a wider range of investor preferences and time horizons than is possible with a single fund, these funds offer three different combinations of the growth potential of stocks, the greater income of bonds, and the stability of money market securities. Generally, the potential for higher returns over time is accompanied by the higher risk of a decline in the value of your principal. Investors respond differently to this trade-off; some are comfortable with higher risk levels, while others are not. An investor's time horizon should play a major role in the choice of investments. A fundamental investment principle is that those with a longer horizon, say 15 years, can pursue a more aggressive program than those with a shorter horizon, perhaps five years. Also, investors who seek a more aggressive approach at a particular stage of life may prefer a more balanced or conservative approach as their circumstances change. How does the portfolio manager try to reduce risk? Consistent with each fund's objective, the portfolio manager uses various tools to try to reduce risk and increase total return, including: . Diversification of assets to reduce the impact of a single holding on a fund's net asset value. T. ROWE PRICE 8 . Thorough research of stocks, bonds, and other securities by our analysts to find the most favorable investment opportunities. . Gradual shifts in stock, bond, and money market allocations to take advantage of market opportunities and changing economic conditions. o We regularly review the asset allocation and may make gradual changes, within allowed ranges, based on our outlook for the economy, interest rates, and financial markets. The funds will not attempt to time short-term market swings. What are the advantages of diversifying across stocks, bonds, and money market securities? Diversification is the investment equivalent of not putting all your eggs in one basket. While there is no guarantee, spreading investments across several types of assets could reduce a fund's overall volatility. Since prices of stocks and bonds may respond differently to changes in economic conditions and interest rate levels, a rise in bond prices, for example, could help offset a fall in stock prices. Money market securities have a stabilizing influence, since their price fluctuations are very small. In addition, the steady income provided by bonds and money market securities contributes positively to total return, cushioning the impact of any price declines or enhancing price increases. Why include foreign securities? The funds may invest a portion of assets in foreign stocks and bonds, which offer advantages but also increase risk. The potential advantages are extra diversification and enhanced returns. Since foreign stock and bond markets may move independently from U.S. securities, they could reduce a fund's short-term price fluctuations while offering a way to participate in markets that may generate attractive returns. However, if U.S. and foreign markets move in the same direction, the positive or negative effect on a fund's share price could be magnified. o For a discussion of the effects of currency exchange rate fluctuations and other special risks of foreign investing, please see Investment Policies and Practices. ABOUT THE FUNDS 9 How is a bond's price affected by changes in interest rates? When interest rates rise, a bond's price usually falls, and vice versa. In general, the longer a bond's maturity, the greater the price increase or decrease in response to a given change in rates, as shown in Table 4. Table 4 How Interest Rates May Affect Bond Prices
Price per $1,000 of bond face value if interest rates: Bond maturity Coupon Increase Decrease 1 point 2 points 1 point 2 points 1 year 5.36% $990 $981 $1,010 $1,020 5 years 5.50 958 918 1,044 1,091 10 years 5.50 927 861 1,080 1,168 30 years 5.72 872 768 1,160 1,360 --------------------------------------------------------------------------------------------------------------
The table reflects yields on Treasury securities as of July 31, 1998. The table may not be as representative of price changes for other types of bonds, including mortgage-backed securities because of prepayments. This is an illustration and does not represent expected yields or share price changes of any T. Rowe Price fund. Is there other information I can review before making a decision? Investment Policies and Practices in Section 3 discusses the principal types of portfolio securities that the funds may purchase as well as the types of management practices that the funds may use. ABOUT YOUR ACCOUNT 2 PRICING SHARES AND RECEIVING SALE PROCEEDS ---------------------------------------------------------- Here are some procedures you should know when investing in a T. Rowe Price equity fund. How and when shares are priced The share price (also called "net asset value" or NAV per share) for a fund is calculated at 4 p.m. ET each day the New York Stock Exchange is open for business. To calculate the NAV, the fund's assets are valued and totaled, liabilities are subtracted, and the balance, called net assets, is divided by the number of shares outstanding. Current market values are used to price fund shares. o The various ways you can buy, sell, and exchange shares are explained at the end of this prospectus and on the New Account Form. These procedures and the information you receive about them may differ for institutional and employer-sponsored retirement accounts. How your purchase, sale, or exchange price is determined If we receive your request in correct form by 4 p.m. ET, your transaction will be priced at that day's NAV. If we receive it after 4 p.m., it will be priced at the next business day's NAV. We cannot accept orders that request a particular day or price for your transaction or any other special conditions. Fund shares may be purchased through various third-party intermediaries including banks, brokers, and investment advisers. Where authorized by a fund, orders will be priced at the NAV next computed after receipt by the intermediary. Consult your intermediary to determine when your orders will be priced. The intermediary may charge a fee for its services. Note: The time at which transactions and shares are priced and the time until which orders are accepted may be changed in case of an emergency or if the New York Stock Exchange closes at a time other than 4 p.m. ET. How you can receive the proceeds from a sale o When filling out the New Account Form, you may wish to give yourself the widest range of options for receiving proceeds from a sale. If your request is received by 4 p.m. ET in correct form, proceeds are usually sent on the next business day. Proceeds can be sent to you by mail or to your bank account by Automated Clearing House (ACH) transfer or bank wire. Proceeds sent by ACH transfer should be credited the second day after the sale. ACH is an ABOUT YOUR ACCOUNT 11 automated method of initiating payments from, and receiving payments in, your financial institution account. The ACH system is supported by over 20,000 banks, savings banks, and credit unions. Proceeds sent by bank wire should be credited to your account the next business day. . Exception: Under certain circumstances and when deemed to be in each fund's best interests, your proceeds may not be sent for up to five business days after we receive your sale or exchange request. If you were exchanging into a bond or money fund, your new investment would not begin to earn dividends until the sixth business day. o If for some reason we cannot accept your request to sell shares, we will contact you. USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES ---------------------------------------------------------- o All net investment income and realized capital gains are distributed to shareholders. Dividends and Other Distributions Dividend and capital gain distributions are reinvested in additional fund shares in your account unless you select another option on your New Account Form. The advantage of reinvesting distributions arises from compounding; that is, you receive income dividends and capital gain distributions on a rising number of shares. Distributions not reinvested are paid by check or transmitted to your bank account via ACH. If the Post Office cannot deliver your check, or if your check remains uncashed for six months, the fund reserves the right to reinvest your distribution check in your account at the NAV on the business day of the reinvestment and to reinvest all subsequent distributions in shares of the fund. No interest will accrue on amounts represented by uncashed distribution or redemption checks. Income dividends . The Balanced and Income Funds declare and pay dividends (if any) quarterly. . The Growth Fund declares and pays dividends (if any) annually. . All or part of the funds' dividends will be eligible for the 70% deduction for dividends received by corporations. T. ROWE PRICE 12 Capital gains . A capital gain or loss is the difference between the purchase and sale price of a security. . If a fund has net capital gains for the year (after subtracting any capital losses), they are usually declared and paid in December to shareholders of record on a specified date that month. Tax Information o You will be sent timely information for your tax filing needs. You need to be aware of the possible tax consequences when: . You sell fund shares, including an exchange from one fund to another. . The fund makes a distribution to your account. Taxes on fund redemptions When you sell shares in any fund, you may realize a gain or loss. An exchange from one fund to another is still a sale for tax purposes. In January, you will be sent Form 1099-B indicating the date and amount of each sale you made in the fund during the prior year. This information will also be reported to the IRS. For new accounts or those opened by exchange in 1983 or later, we will provide the gain or loss on the shares you sold during the year, based on the "average cost," single category method. This information is not reported to the IRS, and you do not have to use it. You may calculate the cost basis using other methods acceptable to the IRS, such as "specific identification." To help you maintain accurate records, we send you a confirmation immediately following each transaction you make (except for systematic purchases and redemptions) and a year-end statement detailing all your transactions in each fund account during the year. Taxes on fund distributions o The following summary does not apply to retirement accounts, such as IRAs, which are not subject to current tax. In January, you will be sent Form 1099-DIV indicating the tax status of any dividend and capital gain distributions made to you. This information will also be reported to the IRS. Distributions made by a fund are generally taxable to you for the year in which they were paid. You will be sent any additional information you need to determine your taxes on fund distributions, such as the portion of your dividend, if any, that may be exempt from state income taxes. ABOUT YOUR ACCOUNT 13 The tax treatment of a capital gain distribution is determined by how long the fund held the portfolio securities, not how long you held shares in the fund. Short-term (one year or less) capital gain distributions are taxable at the same rate as ordinary income. Reflecting recent changes in the tax code, gains on securities held more than 12 months are taxed at a maximum rate of 20%. If you realized a loss on the sale or exchange of fund shares which you held six months or less, your short-term loss will be reclassified to a long-term loss to the extent you received a long-term capital gain distribution during the period you held the shares. Gains and losses from the sale of foreign currencies and the foreign currency gain or loss resulting from the sale of a foreign debt security can increase or decrease a fund's ordinary income dividend. Net foreign currency losses may result in a fund's dividend being classified as a return of capital. If a fund pays nonrefundable taxes to foreign governments during the year, the taxes will reduce the fund's dividends but will still be included in your taxable income. However, you may be able to claim an offsetting deduction on your tax return for your portion of foreign taxes paid by a fund. o Distributions are taxable whether reinvested in additional shares or received in cash. Tax effect of buying shares before a capital gain or dividend distribution If you buy shares shortly before or on the "record date" - the date that establishes you as the person to receive the upcoming distribution - you will receive a portion of the money you just invested in the form of a taxable distribution. Therefore, you may wish to find out a fund's record date before investing. Of course, a fund's share price may, at any time, reflect undistributed capital gains or income and unrealized appreciation, which may result in future taxable distributions. TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS ---------------------------------------------------------- o Following these procedures helps assure timely and accurate transactions. Purchase Conditions Nonpayment If your payment is not received or you pay with a check or ACH transfer that does not clear, your purchase will be canceled. You will be responsible for any losses or expenses incurred by each fund or transfer agent, and the fund can T. ROWE PRICE 14 redeem shares you own in this or another identically registered T. Rowe Price fund as reimbursement. Each fund and its agents have the right to reject or cancel any purchase, exchange, or redemption due to nonpayment. U.S. dollars All purchases must be paid for in U.S. dollars; checks must be drawn on U.S. banks. Sale (Redemption) Conditions Holds on immediate redemptions 10-day hold If you sell shares that you just purchased and paid for by check or ACH transfer, the fund will process your redemption but will generally delay sending you the proceeds for up to 10 calendar days to allow the check or transfer to clear. If your redemption request was sent by mail or mailgram, proceeds will be mailed no later than the seventh calendar day following receipt unless the check or ACH transfer has not cleared. (The 10-day hold does not apply to the following: purchases paid for by bank wire; cashier's, certified, or treasurer's checks; or automatic purchases through your paycheck.) Telephone, Tele*Access/(R)/, and personal computer transactions Exchange and redemption services through telephone and Tele*Access are established automatically when you sign the New Account Form unless you check the box that states you do not want these services. Personal computer transactions must be authorized separately. T. Rowe Price funds and their agents use reasonable procedures (including shareholder identity verification) to confirm that instructions given by telephone are genuine and they are not liable for acting on these instructions. If these procedures are not followed, it is the opinion of certain regulatory agencies that the funds and their agents may be liable for any losses that may result from acting on the instructions given. A confirmation is sent promptly after a transaction. All telephone conversations are recorded. Redemptions over $250,000 Large sales can adversely affect a portfolio manager's ability to implement a fund's investment strategy by causing the premature sale of securities that would otherwise be held. If, in any 90-day period, you redeem (sell) more than $250,000, or your sale amounts to more than 1% of fund net assets, the fund has the right to pay the difference between the redemption amount and the lesser of the two previously mentioned figures with securities from the fund. ABOUT YOUR ACCOUNT 15 Excessive Trading o T. Rowe Price may bar excessive traders from purchasing shares. Frequent trades, involving either substantial fund assets or a substantial portion of your account or accounts controlled by you, can disrupt management of the fund and raise its expenses. . Trades placed directly with T. Rowe Price If you trade directly with T. Rowe Price, you can make one purchase and sale involving the same fund within any 120-day period. For example, if you are in fund A, you can move substantial assets from fund A to fund B and, within the next 120 days, sell your shares in fund B to return to fund A or move to fund C. If you exceed this limit, you are in violation of our excessive trading policy. Two types of transactions are exempt from this policy: 1) trades solely in money market funds (exchanges between a money fund and a nonmoney fund are not exempt); and 2) systematic purchases or redemptions (see Shareholder Services). . Trades placed through intermediaries If you purchase fund shares through an intermediary including a broker, bank, investment adviser, or other third party and hold them for less than 60 calendar days, you are in violation of our excessive trading policy. . If you violate our excessive trading policy, you may be barred indefinitely and without further notice from further purchases of T. Rowe Price funds. Keeping Your Account Open Due to the relatively high cost to a fund of maintaining small accounts, we ask you to maintain an account balance of at least $1,000. If your balance is below $1,000 for three months or longer, we have the right to close your account after giving you 60 days in which to increase your balance. Small Account Fee Because of the disproportionately high costs of servicing accounts with low balances, a $10 fee, paid to T. Rowe Price Services, the funds' transfer agent, will automatically be deducted from nonretirement accounts with balances falling below a minimum level. The valuation of accounts and the deduction are expected to take place during the last five business days of September. The fee will be deducted from accounts with balances below $2,000, except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be waived for any investor whose aggregate T. Rowe Price mutual fund investments total $25,000 or more. Accounts employing automatic investing (e.g., payroll deduction, automatic purchase from a bank account, etc.) are also exempt from the charge. The fee will not apply to IRAs and other retirement plan accounts. (A separate custodial fee may apply to IRAs and other retirement plan accounts.) T. ROWE PRICE 16 Signature Guarantees o A signature guarantee is designed to protect you and the T. Rowe Price funds from fraud by verifying your signature. You may need to have your signature guaranteed in certain situations, such as: . Written requests 1) to redeem over $100,000, or 2) to wire redemption proceeds. . Remitting redemption proceeds to any person, address, or bank account not on record. . Transferring redemption proceeds to a T. Rowe Price fund account with a different registration (name or ownership) from yours. . Establishing certain services after the account is opened. You can obtain a signature guarantee from most banks, savings institutions, broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot accept guarantees from notaries public or organizations that do not provide reimbursement in the case of fraud. MORE ABOUT THE FUNDS 3 ORGANIZATION AND MANAGEMENT ---------------------------------------------------------- How are the funds organized? T. Rowe Price Personal Strategy Funds, Inc. (the "Corporation") was incorporated in Maryland in 1994. The Income, Balanced, and Growth Funds were each organized in 1994 as series of the Corporation and are registered as diversified, open-end investment companies or mutual funds. Mutual funds pool money received from shareholders and invest it to try to achieve specified objectives. o Shareholders benefit from T. Rowe Price's 61 years of investment management experience. What is meant by "shares"? As with all mutual funds, investors purchase shares when they put money in a fund. These shares are part of a fund's authorized capital stock, but share certificates are not issued. Each share and fractional share entitles the shareholder to: . Receive a proportional interest in a fund's income and capital gain distributions. . Cast one vote per share on certain fund matters, including the election of fund directors, changes in fundamental policies, or approval of changes in the fund's management contract. Do T. Rowe Price funds have annual shareholder meetings? The funds are not required to hold annual meetings and, to avoid unnecessary costs to fund shareholders, do not intend to do so except when certain matters, such as a change in a fund's fundamental policies, must be decided. In addition, shareholders representing at least 10% of all eligible votes may call a special meeting, if they wish, for the purpose of voting on the removal of any fund director or trustee. If a meeting is held and you cannot attend, you can vote by proxy. Before the meeting, the fund will send you proxy materials that explain the issues to be decided and include a voting card for you to mail back. Who runs the funds? General Oversight The Corporation is governed by a Board of Directors that meets regularly to review each fund's investments, performance, expenses, and other business affairs. The Board elects the Corporation's officers. The policy of the Corporation is that a majority of Board members are independent of T. Rowe Price Associates, Inc. (T. Rowe Price). T. ROWE PRICE 18 o All decisions regarding the purchase and sale of fund investments are made by T. Rowe Price - specifically by each fund's portfolio managers. Portfolio Management The funds' investments are guided by two committees. An Asset Allocation Committee meets regularly to determine the asset allocation of the three funds among stocks, bonds, and money market securities. Committee members include Peter Van Dyke, Chairman, Stephen W. Boesel, John H. Laporte, Edmund M. Notzon, William T. Reynolds, Brian C. Rogers, and M. David Testa. The Asset Allocation Committee has been acting in this role for T. Rowe Price since 1990 and its members bring a wide range of investment experience to this task. Day-to-day responsibility for managing the funds' investments lies with an Investment Advisory Committee comprising Messrs. Van Dyke, Chairman, Boesel, Notzon, Reynolds, and Testa, Larry J. Puglia, Donald J. Peters, Judith B. Ward, and Richard T. Whitney. The committee chairman works with the committee in developing and executing the funds' investment programs. Mr. Van Dyke has been managing investments since joining T. Rowe Price in 1985. The Management Fee This fee has two parts - an "individual fund fee," which reflects a fund's particular investment management costs, and a "group fee." The group fee, which is designed to reflect the benefits of the shared resources of the T. Rowe Price investment management complex, is calculated daily based on the combined net assets of all T. Rowe Price funds (except the Spectrum Funds, and any institutional, index, or private label mutual funds). The group fee schedule (shown below) is graduated, declining as the asset total rises, so shareholders benefit from the overall growth in mutual fund assets. Group Fee Schedule
0.334% First $50 billion/a/ 0.305% Next $30 billion 0.300% Thereafter ----------------------------------------
/a/ Represents a blended group fee rate containing various break points. Each fund's portion of the group fee is determined by the ratio of its daily net assets to the daily net assets of all the T. Rowe Price funds described previously. Based on combined T. Rowe Price funds' assets of over $86 billion at June 30, 1998, the group fee was 0.32%. The individual fund fees were as follows: Income, 0.15%; Balanced, 0.25%; and Growth, 0.30%. MORE ABOUT THE FUNDS 19 UNDERSTANDING PERFORMANCE INFORMATION ---------------------------------------------------------- This section should help you understand the terms used to describe fund performance. You will come across them in shareholder reports you receive from us; in our newsletter, The Price Report; in Insights articles; in T. Rowe Price advertisements; and in the media. Total Return This tells you how much an investment in a fund has changed in value over a given time period. It reflects any net increase or decrease in the share price and assumes that all dividends and capital gains (if any) paid during the period were reinvested in additional shares. Therefore, total return numbers include the effect of compounding. Advertisements for a fund may include cumulative or average annual total return figures, which may be compared with various indices, other performance measures, or other mutual funds. Cumulative Total Return This is the actual return of an investment for a specified period. A cumulative return does not indicate how much the value of the investment may have fluctuated during the period. For example, a fund could have a 10-year positive cumulative return despite experiencing three negative years during that time. Average Annual Total Return This is always hypothetical and should not be confused with actual year-by-year results. It smooths out all the variations in annual performance to tell you what constant year-by-year return would have produced the investment's actual cumulative return. This gives you an idea of an investment's annual contribution to your portfolio, provided you held it for the entire period. INVESTMENT POLICIES AND PRACTICES ---------------------------------------------------------- This section takes a detailed look at some of the types of securities each fund may hold in its portfolio and the various kinds of investment practices that may be used in day-to-day portfolio management. Each fund's investment program is subject to further restrictions and risks described in the Statement of Additional Information. Shareholder approval is required to substantively change a fund's objective and certain investment restrictions noted in the following section as "fundamental policies." The managers also follow certain "operating policies" which can be T. ROWE PRICE 20 changed without shareholder approval. However, significant changes are discussed with shareholders in fund reports. Each fund adheres to applicable investment restrictions and policies at the time it makes an investment. A later change in circumstances will not require the sale of an investment if it was proper at the time it was made. A fund's holdings of certain kinds of investments cannot exceed maximum percentages of total assets, which are set forth in this prospectus. For instance, these funds are not permitted to invest more than 10% of total assets in hybrid instruments. While these restrictions provide a useful level of detail about a fund's investment program, investors should not view them as an accurate gauge of the potential risk of such investments. For example, in a given period, a 5% investment in hybrid instruments could have significantly more of an impact on a fund's share price than its weighting in the portfolio. The net effect of a particular investment depends on its volatility and the size of its overall return in relation to the performance of all a fund's other investments. Changes in each fund's holdings, each fund's performance, and the contribution of various investments are discussed in the shareholder reports sent to you. o Fund managers have considerable leeway in choosing investment strategies and selecting securities they believe will help each fund achieve its objective. Types of Portfolio Securities In seeking to meet its investment objective, each fund may invest in any type of security or instrument (including certain potentially high-risk derivatives described in this section) whose investment characteristics are consistent with the fund's investment program. The following pages describe the principal types of portfolio securities and investment management practices of the funds. Fundamental policy Each fund will not purchase a security if, as a result, with respect to 75% of its total assets, more than 5% of its total assets would be invested in securities of a single issuer, or if more than 10% of the voting securities of the issuer would be held by the funds. Bonds A bond is an interest-bearing security - an IOU - issued by companies or governmental units. The issuer has a contractual obligation to pay interest at a stated rate on specific dates and to repay principal (the bond's face value) on a specified date. An issuer may have the right to redeem or "call" a bond before maturity, and the investor may have to reinvest the proceeds at lower market rates. MORE ABOUT THE FUNDS 21 A bond's annual interest income, set by its coupon rate, is usually fixed for the life of the bond. Its yield (income as a percent of current price) will fluctuate to reflect changes in interest rate levels. A bond's price usually rises when interest rates fall, and vice versa, so its yield stays current. Bonds may be unsecured (backed by the issuer's general creditworthiness only) or secured (also backed by specified collateral). Certain bonds have interest rates that are adjusted periodically. These interest rate adjustments tend to minimize fluctuations in the bonds' principal values. The maturity of those securities may be shortened under certain specified conditions. Bonds may be designated as senior or subordinated obligations. Senior obligations generally have the first claim on a corporation's earnings and assets and, in the event of liquidation, are paid before subordinated debt. Common and Preferred Stocks Stocks represent shares of ownership in a company. Generally, preferred stock has a specified dividend and ranks after bonds and before common stocks in its claim on income for dividend payments and on assets should the company be liquidated. After other claims are satisfied, common stockholders participate in company profits on a pro rata basis; profits may be paid out in dividends or reinvested in the company to help it grow. Increases and decreases in earnings are usually reflected in a company's stock price, so common stocks generally have the greatest appreciation and depreciation potential of all corporate securities. While most preferred stocks pay a dividend, the funds may purchase preferred stock where the issuer has omitted, or is in danger of omitting, payment of its dividend. Such investments would be made primarily for their capital appreciation potential. Convertible Securities and Warrants The funds may invest in debt or preferred equity securities convertible into, or exchangeable for, equity securities. Traditionally, convertible securities have paid dividends or interest at rates higher than common stocks but lower than nonconvertible securities. They generally participate in the appreciation or depreciation of the underlying stock into which they are convertible, but to a lesser degree. In recent years, convertibles have been developed which combine higher or lower current income with options and other features. Warrants are options to buy a stated number of shares of common stock at a specified price anytime during the life of the warrants (generally, two or more years). Foreign Securities The funds may invest in foreign securities. These include nondollar-denominated securities traded outside of the U.S. and dollar-denominated securities of foreign issuers traded in the U.S. (such as ADRs). Such investments increase a T. ROWE PRICE 22 portfolio's diversification and may enhance return, but they also involve some special risks, such as exposure to potentially adverse local political and economic developments; nationalization and exchange controls; potentially lower liquidity and higher volatility; possible problems arising from accounting, disclosure, settlement, and regulatory practices that differ from U.S. standards; and the chance that fluctuations in foreign exchange rates will decrease the investment's value (favorable changes can increase its value). These risks are heightened for investments in developing countries, and there is no limit on the amount of the funds' foreign investments that may be made in such countries. Operating policy Each fund may invest up to 35% of its total assets (excluding reserves) in foreign securities. Asset-Backed Securities An underlying pool of assets, such as credit cards or automobile trade receivables or corporate loans or bonds, backs these bonds and provides the interest and principal payments to investors. Credit quality depends primarily on the quality of the underlying assets and the level of credit support, if any, provided by the issuer. The underlying assets (i.e., loans) are subject to prepayments which can shorten the securities' weighted average life and may lower their return. The value of these securities also may change because of actual or perceived changes in the creditworthiness of the originator, servicing agent, or the financial institution providing the credit support. There is no limit on the portion of the funds' fixed income investments in these securities. Mortgage-Backed Securities The funds may invest in a variety of mortgage-backed securities. Mortgage lenders pool individual home mortgages with similar characteristics to back a certificate or bond, which is sold to investors such as the funds. Interest and principal payments generated by the underlying mortgages are passed through to the investors. The "big three" issuers are Government National Mortgage Association (GNMA), the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac). GNMA certificates are backed by the full faith and credit of the U.S. government, while others, such as Fannie Mae and Freddie Mac certificates, are only supported by the ability to borrow from the U.S. Treasury or supported only by the credit of the agency. Private mortgage bankers and other institutions also issue mortgage-backed securities. Mortgage-backed securities are subject to scheduled and unscheduled principal payments as homeowners pay down or prepay their mortgages. As these payments are received, they must be reinvested when interest rates may be higher or lower than on the original mortgage security. Therefore, mortgage securities are not an effective means of locking in long-term interest rates. In addition, MORE ABOUT THE FUNDS 23 when interest rates fall, the pace of mortgage prepayments picks up. These refinanced mortgages are paid off at face value (par), causing a loss for any investor who may have purchased the security at a price above par. In such an environment, this risk limits the potential price appreciation of these securities and can negatively affect a fund's net asset value. When rates rise, however, mortgage-backed securities have historically experienced smaller price declines than comparable quality bonds. In addition, when rates rise, and prepayments slow, the effective duration of mortgage-backed securities extends, resulting in increased volatility. There is no limit on the portion of the funds' fixed income investments in these securities. Additional mortgage-backed securities in which the funds may invest include: . Collateralized Mortgage Obligations (CMOs) CMOs are debt securities that are fully collateralized by a portfolio of mortgages or mortgage-backed securities. All interest and principal payments from the underlying mortgages are passed through to the CMOs in such a way as to create, in most cases, more definite maturities than is the case with the underlying mortgages. CMOs may pay fixed or variable rates of interest, and certain CMOs have priority over others with respect to the receipt of prepayments. . Stripped Mortgage Securities Stripped mortgage securities (a type of potentially high-risk derivative) are created by separating the interest and principal payments generated by a pool of mortgage-backed securities or a CMO to create additional classes of securities. Generally, one class receives only interest payments (IOs), and another receives principal payments (POs). Unlike with other mortgage-backed securities and POs, the value of IOs tends to move in the same direction as interest rates. The funds can use IOs as a hedge against falling prepayment rates (interest rates are rising) and/or a bear market environment. POs can be used as a hedge against rising prepayment rates (interest rates are falling) and/or a bull market environment. IOs and POs are acutely sensitive to interest rate changes and to the rate of principal prepayments. A rapid or unexpected increase in prepayments can severely depress the price of IOs, while a rapid or unexpected decrease in prepayments could have the same effect on POs. These securities are very volatile in price and may have lower liquidity than most other mortgage-backed securities. Certain non-stripped CMOs may also exhibit these qualities, especially those that pay variable rates of interest that adjust inversely with, and more rapidly than, short-term interest rates. In addition, if interest rates rise rapidly and prepayment rates slow more than expected, certain CMOs, in addition to losing value, can exhibit characteristics of longer-term securities and become more volatile. There is no guarantee the funds' investments in CMOs, IOs, or POs will be successful, and the funds' total returns could be adversely affected as a result. T. ROWE PRICE 24 Operating policy Each fund may invest up to 10% of its total assets in stripped mortgage securities. High-Yield, High-Risk Investing The total return and yield of lower-quality (high-yield, high-risk) bonds, commonly referred to as "junk," can be expected to fluctuate more than the total return and yield of higher-quality bonds. Junk bonds (those rated below BBB or in default) are regarded as predominantly speculative with respect to the issuer's continuing ability to meet principal and interest payments. Successful investment in lower-medium- and low-quality bonds involves greater investment risk and is highly dependent on T. Rowe Price's credit analysis. A real or perceived economic downturn or higher interest rates could cause a decline in high-yield bond prices by lessening the ability of issuers to make principal and interest payments. These bonds are often thinly traded and can be more difficult to sell and value accurately than high-quality bonds. Because objective pricing data may be less available, judgment may play a greater role in the valuation process. In addition, the entire junk bond market can experience sudden and sharp price swings due to a variety of factors, including changes in economic forecasts, stock market activity, large or sustained sales by major investors, a high-profile default, or just a change in the market's psychology. This type of volatility is usually associated more with stocks than bonds, but junk bond investors should be prepared for it. Operating policy The Growth, Balanced, and Income Funds may each invest up to 15%, 20%, and 25%, respectively, of their total assets in below investment-grade or junk bonds. Hybrid Instruments These instruments (a type of potentially high-risk derivative) can combine the characteristics of securities, futures, and options. For example, the principal amount or interest rate of a hybrid could be tied (positively or negatively) to the price of some commodity, currency, or securities index or another interest rate (each a "benchmark"). Hybrids can be used as an efficient means of pursuing a variety of investment goals, including currency hedging, duration management, and increased total return. Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed principal MORE ABOUT THE FUNDS 25 amount and pays a fixed rate or floating rate of interest. The purchase of hybrids also exposes the funds to the credit risk of the issuer of the hybrid. These risks may cause significant fluctuations in the net asset value of the funds. o Hybrids can have volatile prices and limited liquidity, and their use by the funds may not be successful. Operating policy Each fund may invest up to 10% of its total assets in hybrid instruments. Zero Coupon Bonds and Pay-in-Kind Bonds A zero coupon bond does not make cash interest payments during the life of the bond. Instead, it is sold at a deep discount to face value, and the interest consists of the gradual appreciation in price as the bond approaches maturity. "Zeros" can be an attractive financing method for issuers with near-term cash-flow problems. Pay-in-kind (PIK) bonds pay interest in cash or additional securities, at the issuer's option, for a specified period. Like zeros, they may help a corporation economize on cash. PIK prices reflect the market value of the underlying debt plus any accrued interest. Zeros and PIKS can be higher- or lower-quality debt, and both are more volatile than coupon bonds. Each fund is required to distribute to shareholders income imputed to any zero or PIK investments. Such distributions could reduce a fund's reserve position. Operating policy Each fund may invest up to 10% of its total assets in zero coupon and pay-in-kind bonds. Private Placements These securities are sold directly to a small number of investors, usually institutions. Unlike public offerings, such securities are not registered with the SEC. 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. Operating policy Each fund will not invest more than 15% of its net assets in illiquid securities. Types of Management Practices Reserve Position Each fund will hold a certain portion of its assets in money market reserves. Each fund's reserve position can consist of shares of one or more T. Rowe Price internal money market funds as well as short-term, high-quality U.S. and foreign dollar-denominated money market securities, including repurchase agreements. For temporary, defensive purposes, the funds may invest without limitation in money market reserves. The effect of taking such a position is that the fund may not achieve its investment objective. The reserve position T. ROWE PRICE 26 provides flexibility in meeting redemptions, expenses, and the timing of new investments and can serve as a short-term defense during periods of unusual market volatility. Borrowing Money and Transferring Assets Each fund can borrow money from banks (and to the extent permitted by the SEC, other Price funds) as a temporary measure for emergency purposes, to facilitate redemption requests, or for other purposes consistent with each fund's investment objective and program. Such borrowings may be collateralized with fund assets, subject to restrictions. Fundamental policy Borrowings may not exceed 33 1/3% of total fund assets. Operating policy Each fund may not transfer as collateral any portfolio securities except as necessary in connection with permissible borrowings or investments, and then such transfers may not exceed 33 1/3% of the fund's total assets. Each fund may not purchase additional securities when borrowings exceed 5% of total assets. Futures and Options Futures (a type of potentially high-risk derivative) are often used to manage or hedge risk because they enable the investor to buy or sell an asset in the future at an agreed-upon price. Options (another type of potentially high-risk derivative) give the investor the right (where the investor purchases the option), or the obligation (where the investor writes (sells) the option), to buy or sell an asset at a predetermined price in the future. Each fund may buy and sell futures and options contracts for any number of reasons, including: to manage its exposure to changes in interest rates, bond prices, and foreign currencies; as an efficient means of adjusting its overall exposure to certain markets; in an effort to enhance income; to protect the value of portfolio securities; and to adjust portfolio duration. The funds may purchase, sell, or write call and put options on securities, financial indices, and foreign currencies. Futures contracts and options may not always be successful hedges; their prices can be highly volatile. Using them could lower each fund's total return, and the potential loss from the use of futures can exceed each fund's initial investment in such contracts. Operating policies Futures: Initial margin deposits and premiums on options used for non-hedging purposes will not equal more than 5% of each fund's net asset value. Options on securities: The total market value of securities against which each fund writes call or put options may not exceed 25% of its total assets. Each fund will not commit more than 5% of its total assets to premiums when purchasing call or put options. MORE ABOUT THE FUNDS 27 Interest Rate Transactions The funds may enter into various interest rate transactions (a type of potentially high-risk derivative investment), such as interest rate swaps and the purchase or sale of interest rate caps, collars, and floors, to preserve a return or spread on a particular investment or portion of its portfolio, to create synthetic securities, or to structure transactions designed for other purposes. Operating policy Each fund will not invest more than 10% of its total assets in interest rate transactions. Managing Foreign Currency Risk Investors in foreign securities may "hedge" their exposure to potentially unfavorable currency changes by purchasing a contract to exchange one currency for another on some future date at a specified exchange rate. In certain circumstances, a "proxy currency" may be substituted for the currency in which the investment is denominated, a strategy known as "proxy hedging." If a fund were to engage in foreign currency transactions, they would be used primarily to protect the fund's foreign securities from adverse currency movements relative to the dollar. Such transactions involve the risk that anticipated currency movements will not occur, and the fund's total return could be reduced. Lending of Portfolio Securities Like other mutual funds, each fund may lend securities to broker-dealers, other institutions, or other persons to earn additional income. The principal risk is the potential insolvency of the broker-dealer or other borrower. In this event, each fund could experience delays in recovering its securities and possibly capital losses. Fundamental policy The value of loaned securities may not exceed 33 1/3% of total fund assets. When-Issued Securities and Forward Commitment Contracts The funds may purchase securities on a when-issued or delayed delivery basis or may purchase or sell securities on a forward commitment basis. There is no limit on the portion of the funds' fixed income investments in these securities. The price of these securities is fixed at the time of the commitment to buy, but delivery and payment can take place a month or more later. During the interim period, the market value of the securities can fluctuate, and no interest accrues to the purchaser. At the time of delivery, the value of the securities may be more or less than the purchase or sale price. To the extent each fund remains fully or almost fully invested (in securities with a remaining maturity of more than one year) at the same time it purchases these securities, there will be greater fluctuations in the fund's net asset value than if the fund did not purchase them. T. ROWE PRICE 28 Portfolio Turnover The funds will not generally trade in securities (either common stocks or bonds) for short-term profits, but, when circumstances warrant, securities may be purchased and sold without regard to the length of time held. A high portfolio turnover rate may increase transaction costs and result in additional taxable gains. The portfolio turnover rate for each fund for the fiscal years ended May 31, 1998, 1997, and 1996, is set forth in Table 5. Table 5 Portfolio Turnover Rates
Fund 1998 1997 1996 Income 30.9% 44.8% 34.1% Balanced 41.5 54.0 47.7 Growth 33.3 39.6 39.5 ----------------------------------------------------------
Credit-Quality Considerations The credit quality of most bond issues is evaluated by rating agencies such as Moody's and Standard & Poor's. Credit quality refers to the issuer's ability to meet all required interest and principal payments. The highest ratings are assigned to issuers perceived to be the best credit risks. T. Rowe Price research analysts also evaluate all portfolio holdings of each fund, including those rated by outside agencies. Other things being equal, lower-rated bonds have higher yields due to greater risk. MORE ABOUT THE FUNDS 29 Table 6 shows the rating scale used by the major rating agencies. T. Rowe Price considers publicly available ratings, but emphasizes its own credit analysis when selecting investments. Table 6 Ratings of Corporate Debt Securities
Moody's Standard Investors & Poor's Fitch Service, Inc. Corporation IBCA, Inc. Definition Long Term Aaa AAA AAA Highest quality --------------------------------------------------------------------------------------------------- Aa AA AA High quality --------------------------------------------------------------------------------------------------- A A A Upper medium grade --------------------------------------------------------------------------------------------------- Baa BBB BBB Medium grade --------------------------------------------------------------------------------------------------- Ba BB BB Speculative --------------------------------------------------------------------------------------------------- B B B Highly speculative --------------------------------------------------------------------------------------------------- Caa CCC, CC CCC, CC Vulnerable to default --------------------------------------------------------------------------------------------------- Ca C C Default is imminent --------------------------------------------------------------------------------------------------- C D DDD, DD, D Probably in default Moody's S&P Fitch Commercial P-1 Superior quality A-1+ Extremely strong quality F-1+ Exceptionally strong quality Paper A-1 Strong quality F-1 Very strong quality --------------------------------------------------------------------------------------------------- P-2 Strong quality A-2 Satisfactory quality F-2 Good credit quality --------------------------------------------------------------------------------------------------- P-3 Acceptable quality A-3 Adequate quality F-3 Fair credit quality B Speculative quality F-5 Weak credit quality C Doubtful quality ---------------------------------------------------------------------------------------------------------------------
Year 2000 Processing Issue Many computer programs use two digits rather than four to identify the year. These programs, if not adapted, will not correctly handle the change from "99" to "00" on January 1, 2000, and will not be able to perform necessary functions. The Year 2000 issue affects virtually all companies and organizations. T. Rowe Price has implemented steps intended to assure that its major computer systems and processes are capable of Year 2000 processing. We are working with third parties to assess the adequacy of their compliance efforts and are developing contingency plans intended to assure that third-party noncompliance will not materially affect T. Rowe Price's operations. Companies, organizations, governmental entities and markets in which T. Rowe Price funds invest will be affected by the Year 2000 issue, but at this time the funds cannot predict the degree of impact. To the extent the effect is negative, the funds' returns could be adversely affected. T. ROWE PRICE 30 FINANCIAL HIGHLIGHTS ---------------------------------------------------------- Table 7, which provides information about each fund's financial history, is based on a single share outstanding throughout each fiscal year. Each fund's section of the table is part of the fund's financial statements, which are included in its annual report and are incorporated by reference into the Statement of Additional Information (available upon request). The total returns in the table represent the rate that an investor would have earned or lost on an investment in each fund (assuming reinvestment of all dividends and distributions). The financial statements in the annual report were audited by the funds' independent accountants, PricewaterhouseCoopers LLP. Table 7 Financial Highlights
7/29/94 through Year ended May 31 5/31/95 Income Fund ------------ 1996 1997 1998 ----------------------------- -------------------------------------- Net asset value, beginning of period $ 10.00 $ 10.94 $ 11.85 $ 11.98 Income From Investment Activities Net investment income 0.41/ b/ 0.50 /b/ 0.51/b/ 0.50/b/ --------------------------------------------- Net gains or losses on securities (both realized and 0.85 0.98 1.10 1.43 unrealized) --------------------------------------------- Total from investment operations 1.26 1.48 1.61 1.93 Less Distributions Dividends (from net (0.32) (0.47) (0.50) (0.50) investment income) --------------------------------------------- Distributions - (0.10) (0.98) (0.28) (from capital gains) --------------------------------------------- Returns of capital --------------------------------------------- Total distributions (0.32) (0.57) (1.48) (0.78) --------------------------------------------- Net asset value, $ 10.94 $ 11.85 $ 11.98 $ 13.13 end of period --------------------------------------------- Total return 12.90%/b/ 13.84%/b/ 14.70%/b/ 16.61%/b/ Ratios/Supplemental Data Net assets, end of period $20,705 $25,545 $44,368 $85,898 (in thousands) -------------------------------------------------- Ratio of expenses to 0.95%/ab/ 0.95%/b/ 0.95%/b/ 0.95%/b/ average net assets --------------------------------------------- Ratio of net investment income to 4.71%/ab/ 4.31%/b/ 4.38%/b/ 4.13%/b/ average net assets --------------------------------------------- Portfolio turnover 50.5%/a/ 34.1% 44.8% 30.9% rate -------------------------------------------------------------------------------
/a/ Annualized. /b/ Excludes expenses in excess of a 0.95% voluntary expense limitation in effect through May 31, 1998. MORE ABOUT THE FUNDS 31 Table 7 Financial Highlights (continued)
7/29/94 through Year ended May 31 5/31/95 Balanced Fund ------------ 1996 1997 1998 ----------------------------- ----------------------------------------- Net asset value, beginning of period $ 10.00 $ 11.15 $ 12.68 $ 14.07 Income From Investment Operations Net investment income 0.33/b/ 0.41/b/ 0.42/b/ 0.46/b/ ------------------------------------------------ Net gains or losses on securities (both realized and 1.08 1.56 1.69 2.15 unrealized) ------------------------------------------------ Total from investment operations 1.41 1.97 2.11 2.61 Less Distributions Dividends (from net (0.26) (0.37) (0.40) (0.45) investment income) ----------------------------------------------------- Distributions - (0.07) (0.32) (0.35) (from capital gains) ----------------------------------------------------- Returns of capital ----------------------------------------------------- Total distributions (0.26) (0.44) (0.72) (0.80) ----------------------------------------------------- Net asset value, $ 11.15 $ 12.68 $ 14.07 $ 15.88 end of period ----------------------------------------------------- Total return 14.35%/b/ 17.97%/b/ 17.21%/b/ 19.15%/b/ Ratios/Supplemental Data Net assets, end of period $13,336 $116,826 $205,883 $328,356 (in thousands) ----------------------------------------------------- Ratio of expenses to 1.05%/ab/ 1.05%/b/ 1.05%/b/ 1.05%/b/ average net assets ----------------------------------------------------- Ratio of net investment income to 3.74%/ab/ 3.44%/b/ 3.20%/b/ 3.09%/b/ average net assets ----------------------------------------------------- Portfolio turnover 25.8%/a/ 47.7% 54.0% 41.5% rate ----------------------------------------------------------------------------------
/a/ Annualized. /b/ Excludes expenses in excess of a 1.05% voluntary expense limitation in effect through May 31, 1998. T. ROWE PRICE 32 Table 7 Financial Highlights (continued)
7/29/94 through Year ended May 31 5/31/95 Growth Fund ------------ 1996 1997 1998 ----------------------------- --------------------------------------- Net asset value, beginning of period $ 10.00 $ 11.44 $ 13.69 $ 15.20 Income From Investment Operations Net investment income 0.25/b/ 0.30/b/ 0.27/b/ 0.29/b/ --------------------------------------------------- Net gains or losses on securities (both realized and 1.30 2.29 2.37 3.01 unrealized) --------------------------------------------------- Total from investment operations 1.55 2.59 2.64 3.30 Less Distributions Dividends (from net (0.11) (0.27) (0.24) (0.26) investment income) --------------------------------------------------- Distributions - (0.07) (0.89) (0.19) (from capital gains) --------------------------------------------------- Returns of capital --------------------------------------------------- Total distributions (0.11) (0.34) (1.13) (0.45) --------------------------------------------------- Net asset value, $ 11.44 $ 13.69 $ 15.20 $ 18.05 end of period --------------------------------------------------- Total return 15.65%/b/ 22.83%/b/ 19.89%/b/ 22.02%/b/ Ratios/Supplemental Data Net assets, end of period $10,748 $24,954 $67,552 $147,347 (in thousands) --------------------------------------------------- Ratio of expenses to 1.10%/ab/ 1.10%/b/ 1.10%/b/ 1.10%/b/ average net assets --------------------------------------------------- Ratio of net investment income to 2.76%/ab/ 2.27%/b/ 2.24%/b/ 2.15%/b/ average net assets --------------------------------------------------- Portfolio turnover 25.7%/a/ 39.5% 39.6% 33.3% rate --------------------------------------------------------------------------------
/a/ Annualized. /b/ Excludes expenses in excess of a 1.10% voluntary expense limitation in effect through May 31, 1998. INVESTING WITH T. ROWE PRICE 4 ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION ---------------------------------------------------------- Tax Identification Number We must have your correct Social Security or corporate tax identification number on a signed New Account Form or W-9 Form. Otherwise, federal law requires the funds to withhold a percentage (currently 31%) of your dividends, capital gain distributions, and redemptions, and may subject you to an IRS fine. If this information is not received within 60 days after your account is established, your account may be redeemed, priced at the NAV on the date of redemption. Always verify your transactions by carefully reviewing the confirmation we send you. Please report any discrepancies to Shareholder Services promptly. Employer-Sponsored Retirement Plans and Institutional Accounts T. Rowe Price Trust Company 1-800-492-7670 Transaction procedures in the following sections may not apply to employer-sponsored retirement plans and institutional accounts. For procedures regarding employer-sponsored retirement plans, please call T. Rowe Price Trust Company or consult your plan administrator. For institutional account procedures, please call your designated account manager or service representative. OPENING A NEW ACCOUNT ---------------------------------------------------------- $2,500 minimum initial investment; $1,000 for retirement plans or gifts or transfers to minors (UGMA/UTMA) accounts Account Registration If you own other T. Rowe Price funds, be sure to register any new account just like your existing accounts so you can exchange among them easily. (The name and account type would have to be identical.) By Mail Please make your check payable to T. Rowe Price Funds (otherwise it will be returned) and send your check, together with the New Account Form, to the appropriate address in the next paragraph. We do not accept third-party checks to open new accounts, except for IRA Rollover checks that are properly endorsed. T. ROWE PRICE 34 Regular Mail T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353 Mailgram, Express, Registered, or Certified Mail T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117 By Wire Call Investor Services for an account number and give the following wire information to your bank: PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account# 1004397951 name of owner(s) and account number Complete a New Account Form and mail it to one of the appropriate addresses listed previously. Note: No services will be established and IRS penalty withholding may occur until a signed New Account Form is received. Also, retirement plans cannot be opened by wire. By Exchange Call Shareholder Services or use Tele*Access or your personal computer (see Automated Services under Shareholder Services). The new account will have the same registration as the account from which you are exchanging. Services for the new account may be carried over by telephone request if preauthorized on the existing account. For limitations on exchanging, see explanation of Excessive Trading under Transaction Procedures and Special Requirements. In Person Drop off your New Account Form at any location listed on the cover and obtain a receipt. INVESTING WITH T. ROWE PRICE 35 PURCHASING ADDITIONAL SHARES ---------------------------------------------------------- $100 minimum purchase; $50 minimum for retirement plans, Automatic Asset Builder, and gifts or transfers to minors (UGMA/UTMA) accounts By ACH Transfer Use Tele*Access or your personal computer or call Investor Services if you have established electronic transfers using the ACH network. By Wire Call Shareholder Services or use the wire address in Opening a New Account. By Mail 1. Make your check payable to T. Rowe Price Funds (otherwise it may be returned). 2. Mail the check to us at the following address with either a fund reinvestment slip or a note indicating the fund you want to buy and your fund account number. 3. Remember to provide your account number and the fund name on the memo line of your check. Regular Mail T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500 /(For mailgrams, express, registered, or certified mail, see previous / /section.)/ By Automatic Asset Builder Fill out the Automatic Asset Builder section on the New Account or Shareholder Services Form. T. ROWE PRICE 36 EXCHANGING AND REDEEMING SHARES ---------------------------------------------------------- Exchange Service You can move money from one account to an existing identically registered account or open a new identically registered account. Remember, exchanges are purchases and sales for tax purposes. (Exchanges into a state tax-free fund are limited to investors living in states where the fund is registered.) Some of the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held for less than six months or one year, as specified in the prospectus. The fee is paid to the fund. By Phone Call Shareholder Services If you find our phones busy during unusually volatile markets, please consider placing your order by your personal computer, Tele*Access (if you have previously authorized telephone services), mailgram, or express mail. For exchange policies, please see Transaction Procedures and Special Requirements - Excessive Trading. Redemption proceeds can be mailed to your account address, sent by ACH transfer, or wired to your bank (provided your bank information is already on file). For charges, see Electronic Transfers - By Wire under Shareholder Services. By Mail For each account involved, provide the account name, number, fund name, and exchange or redemption amount. For exchanges, be sure to indicate any fund you are exchanging out of and the fund or funds you are exchanging into. Please mail to the appropriate address below. T. Rowe Price requires the signatures of all owners exactly as registered, and possibly a signature guarantee (see Transaction Procedures and Special Requirements - Signature Guarantees). Regular Mail For nonretirement and IRA accounts T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220 INVESTING WITH T. ROWE PRICE 37 For employer-sponsored retirement accounts T. Rowe Price Trust Company P.O. Box 89000 Baltimore, MD 21289-0300 /(For mailgrams, express, registered, or certified mail, see Opening a / /New Account.)/ Redemptions from employer-sponsored retirement accounts must be in writing; please call T. Rowe Price Trust Company or your plan administrator for instructions. IRA distributions may be requested in writing or by telephone; please call Shareholder Services to obtain an IRA Distribution Form or an IRA Shareholder Services Form to authorize the telephone redemption service. RIGHTS RESERVED BY THE FUNDS ---------------------------------------------------------- Each fund and its agents reserve the following rights: (1) to waive or lower investment minimums; (2) to accept initial purchases by telephone or mailgram; (3) to refuse any purchase or exchange order; (4) to cancel or rescind any purchase or exchange order (including, but not limited to, orders deemed to result in excessive trading, market timing, fraud, or 5% ownership) upon notice to the shareholder within five business days of the trade or if the written confirmation has not been received by the shareholder, whichever is sooner; (5) to freeze any account and suspend account services when notice has been received of a dispute between the registered or beneficial account owners or there is reason to believe a fraudulent transaction may occur; (6) to otherwise modify the conditions of purchase and any services at any time; or (7) to act on instructions believed to be genuine. These actions will be taken when, in the sole discretion of management, they are deemed to be in the best interest of the fund. In an effort to protect each fund from the possible adverse effects of a substantial redemption in a large account, as a matter of general policy no shareholder or group of related shareholders controlled by the same T. ROWE PRICE 38 person or group of persons will knowingly be permitted to purchase in excess of 5% of the outstanding shares of the fund, except upon approval of the fund's management. SHAREHOLDER SERVICES ---------------------------------------------------------- Shareholder Services 1-800-225-5132 Investor Services 1-800-638-5660 Many services are available to you as a T. Rowe Price shareholder; some you receive automatically, and others you must authorize on the New Account Form. By signing up for services on the New Account Form rather than later on, you avoid having to complete a separate form and obtain a signature guarantee. This section reviews some of the principal services currently offered. Our Services Guide, which we mail to all new shareholders, contains detailed descriptions of these and other services. Note: Corporate and other institutional accounts require an original or certified resolution to establish services and to redeem by mail. For more information, call Investor Services. Retirement Plans We offer a wide range of plans for individuals, institutions, and large and small businesses: Traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money purchase pension), 401(k), and 403(b)(7). For information on IRAs, call Investor Services. For information on all other retirement plans, including our no-load variable annuity, please call our Trust Company at 1-800-492-7670. Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days Tele*Access 24-hour service via toll-free number enables you to (1) access information on fund yields, prices, distributions, account balances, and your latest transaction; (2) request checks, prospectuses, services forms, duplicate statements, and tax forms; and (3) initiate purchase, redemption, and exchange transactions in your accounts (see Electronic Transfers on the next page). INVESTING WITH T. ROWE PRICE 39 Web Address www.troweprice.com After obtaining proper authorization, account transactions may also be conducted through our web site on the Internet. If you subscribe to America Online, you can access our web site via keyword "T. Rowe Price" and conduct transactions in your account. Plan Account Line 1-800-401-3279 Plan Account Line This 24-hour service is similar to Tele*Access but is designed specifically to meet the needs of retirement plan investors. Telephone and Walk-In Services Buy, sell, or exchange shares by calling one of our service representatives or by visiting one of our investor center locations whose addresses are listed on the cover. Electronic Transfers By ACH With no charges to pay, you can initiate a purchase or redemption for as little as $100 or as much as $100,000 between your bank account and fund account using the ACH network. Enter instructions via Tele*Access or your personal computer, or call Shareholder Services. By Wire Electronic transfers can be conducted via bank wire. There is currently a $5 fee for wire redemptions under $5,000, and your bank may charge for incoming or outgoing wire transfers regardless of size. Checkwriting (Not available for equity funds, or the High Yield or Emerging Markets Bond Funds) You may write an unlimited number of free checks on any money market fund, and most bond funds, with a minimum of $500 per check. Keep in mind, however, that a check results in a redemption; a check written on a bond fund will create a taxable event which you and we must report to the IRS. Automatic Investing ($50 minimum) You can invest automatically in several different ways, including: Automatic Asset Builder You instruct us to move $50 or more from your bank account, or you can instruct your employer to send all or a portion of your paycheck to the fund or funds you designate. T. ROWE PRICE 40 Automatic Exchange You can set up systematic investments from one fund account into another, such as from a money fund into a stock fund. DISCOUNT BROKERAGE ---------------------------------------------------------- To open an account 1-800-638-5660 For existing discount brokerage investors 1-800-225-7720 This service gives you the opportunity to consolidate all of your investments with one company. Investments available through our discount brokerage include stocks, options, bonds, non-T. Rowe Price mutual funds, and others at commission savings over full-service brokers. We also provide a wide range of services, including: Automated telephone and computer services You can enter stock and option trades, access quotes, and review account information around the clock by phone with Tele-Trader or via the Internet with Internet-Trader. Any trades executed through Tele-Trader save you an additional 10% on commissions. You will save 20% on commissions for stock trades when you trade through Internet-Trader. All trades are subject to a $35 minimum commission except stock trades placed through Internet-Trader, which are subject to a $29.95 minimum commission. Investor information A variety of informative reports, such as our Brokerage Insights series, S&P Market Month newsletter, and select stock reports can help you better evaluate economic trends and investment opportunities. Dividend Reinvestment Service Virtually all stocks held in customer accounts are eligible for this free service. /Discount Brokerage is a division of T. Rowe Price Investment / /Services, Inc., Member NASD/SIPC./ INVESTING WITH T. ROWE PRICE 41 INVESTMENT INFORMATION ---------------------------------------------------------- To help shareholders monitor their current investments and make decisions that accurately reflect their financial goals, T. Rowe Price offers a wide variety of information in addition to account statements. Most of this information is also available on our web site at www.troweprice.com. Shareholder Reports Fund managers' reviews of their strategies and results. If several members of a household own the same fund, only one fund report is mailed to that address. To receive additional copies, please call Shareholder Services or write to us at 100 East Pratt Street, Baltimore, Maryland 21202. The T. Rowe Price Report A quarterly investment newsletter discussing markets and financial strategies. Performance Update A quarterly review of all T. Rowe Price fund results. Insights Educational reports on investment strategies and financial markets. Investment Guides Asset Mix Worksheet, College Planning Kit, Diversifying Overseas: A T. Rowe Price Guide to International Investing, Managing Your Retirement Distribution, Personal Strategy Planner, Retirees Financial Guide, Retirement Planning Kit, and Tax Considerations for Investors. To help you achieve your financial goals, T. Rowe Price offers a wide range of stock, bond, and money market investments, as well as convenient services and informative reports. For Mutual Fund or Discount Brokerage Information Investor Services 1-800-638-5660 For Existing Accounts Shareholder Services 1-800-225-5132 For Yields, Prices, Account Information, or to Conduct Transactions Tele*Access/(R)/ 24 hours, 7 days 1-800-638-2587 Internet Address www.troweprice.com Plan Account Line For retirement plan investors 1-800-401-3279 Investor Centers 101 East Lombard St. Baltimore, MD 21202 T. Rowe Price Financial Center 10090 Red Run Blvd. Owings Mills, MD 21117 Farragut Square 900 17th Street, N.W. Washington, D.C. 20006 ARCO Tower 31st Floor 515 South Flower St. Los Angeles, CA 90071 4200 West Cypress St. 10th Floor Tampa, FL 33607 Headquarters 100 East Pratt St. Baltimore, MD 21202 A Statement of Additional Information about each fund has been filed with the Securities and Exchange Commission and has been incorporated by reference into this prospectus. Further information about each fund's investments, including a review of market conditions and the manager's recent strategies and their impact on performance, is available in the annual and semiannual shareholder reports. To obtain free copies of any of these documents, or for shareholder inquiries, call 1-800-638-5660. Fund reports and Statements of Additional Information are also available from the Securities and Exchange Commission by calling 1-800-SEC-0330 or writing the SEC's Public Reference Section, Washington, D.C. 20549-6009 (you will be charged a duplicating fee); by visiting the SEC's public reference room; or by consulting the SEC's web site at www.sec.gov. This prospectus contains information you should know before investing. Please keep it for future reference. 1940 Act File No. 811-07173 C11-040 10/1/98 PROSPECTUS October 1, 1998 T. Rowe Price U.S. Treasury Funds Money market and bond funds for investors seeking the income potential and credit safety of securities issued by the U.S. government and its agencies. RAM LOGO These securities have not been approved or disapproved by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. T. Rowe Price U.S. Treasury Funds, Inc. Prospectus October 1, 1998
1 ABOUT THE FUNDS Fund, Market, and Risk Characteristics 1 --------------------------------------------- Other Information About the Funds 6 --------------------------------------------- Some Basics of Fixed Income Investing 7 --------------------------------------------- 2 ABOUT YOUR ACCOUNT Pricing Shares and Receiving 10 Sale Proceeds --------------------------------------------- Distributions and Taxes 11 --------------------------------------------- Transaction Procedures and 14 Special Requirements --------------------------------------------- 3 MORE ABOUT THE FUNDS Organization and Management 17 --------------------------------------------- Understanding Performance Information 19 --------------------------------------------- Investment Policies and Practices 20 --------------------------------------------- Financial Highlights 26 --------------------------------------------- 4 INVESTING WITH T. ROWE PRICE Account Requirements 29 and Transaction Information --------------------------------------------- Opening a New Account 29 --------------------------------------------- Purchasing Additional Shares 31 --------------------------------------------- Exchanging and Redeeming 32 --------------------------------------------- Rights Reserved by the Funds 33 --------------------------------------------- Shareholder Services 34 --------------------------------------------- Discount Brokerage 36 --------------------------------------------- Investment Information 37 ---------------------------------------------
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates, Inc., and its affiliates managed over $141 billion for more than six million individual and institutional investor accounts as of June 30, 1998. Mutual fund shares are not deposits or obligations of, or guaranteed by, any depository institution. Shares are not insured by the FDIC, Federal Reserve Board, or any other agency, and are subject to investment risks, including possible loss of the principal amount invested. ABOUT THE FUNDS 1 FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT ---------------------------------------------------------- To help you decide whether these funds are appropriate for you, this section reviews their investment objectives, strategies, and potential risks. What is each fund's objective? U.S. Treasury Money The fund seeks to maximize preservation of capital, liquidity, and, consistent with these goals, the highest possible current income. U.S. Treasury Intermediate The fund seeks a high level of income consistent with maximum credit protection and moderate fluctuation in principal. U.S. Treasury Long-Term The fund seeks the highest level of income consistent with maximum credit protection. What are each fund's principal investment strategies? U.S. Treasury Money The fund is managed to provide a stable share price of $1.00. The fund invests at least 80% of its total assets in U.S. Treasury securities, which are backed by the full faith and credit of the federal government. The remainder is invested in other securities backed by the full faith and credit of the U.S. government. We will not purchase any security with a maturity of more than 13 months, and the fund's weighted average maturity will not exceed 90 days. U.S. Treasury Intermediate The fund invests at least 85% of its total assets in U.S. Treasury securities, which are backed by the full faith and credit of the federal government, and in other investments involving these securities. The remainder is invested in other securities backed by the full faith and credit of the U.S. government and related instruments. The portfolio's weighted average maturity is expected to range between three and seven years. No security will have a remaining effective maturity of more than 10 years from the time of purchase. U.S. Treasury Long-Term The fund invests at least 85% of its total assets in U.S. Treasury securities, which are backed by the full faith and credit of the federal government, and other investments involving these securities. The remainder is invested in other securities backed by the full faith and credit of the U.S. government and related instruments. The portfolio's weighted average maturity is expected to vary between 15 and 20 years, but may range from 10 to 30 years. In addition to Treasury securities, the funds' other investments will either be (1) backed by the full faith and credit of the U.S. government (such as GNMA mortgage securities); and, for the bond funds, (2) collateralized by such T. ROWE PRICE 2 investments; or (3) held in shares of an internal money market fund that invests exclusively in securities backed by the full faith and credit of the U.S. government. Table 1 Differences Among Funds
Credit-Quality Expected Share Expected Average Fund Categories Income Price Fluctuation Maturity Money Highest Lower Stable 90 days or less ----------------------------------------------------------------------- Intermediate Highest Moderate More than Money, 3 to 7 years Less than Long-Term ----------------------------------------------------------------------- Long-Term Highest Higher High 15 to 20 years -------------------------------------------------------------------------------------------
o For details about each fund's investment program, please see the Investment Policies and Practices section. What are each fund's principal risks? U.S. Treasury Money Fund The fund should have little or no credit risk because it invests only in securities backed by the federal government, the most creditworthy issuer of fixed income instruments. (Credit risk is the chance that a fund's holdings will have their credit ratings downgraded or that their issuers will default, that is, fail to make scheduled interest and principal payments.) There is little risk of principal loss because the fund is managed to maintain a constant $1.00 share price. However, price stability is not guaranteed, and there is no assurance that the fund will avoid principal losses if interest rates rise sharply in an unusually short period. In addition, the fund's yield will vary; it is not fixed for a specific period like the yield on a bank certificate of deposit. This should be an advantage when interest rates are rising but not when rates are falling. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. U.S. Treasury Intermediate and Long-Term Funds These bond funds should also have minimal credit risk because they invest only in securities backed by the federal government and other investments involving such securities. The primary source of risk is the possibility of rising interest rates, which generally cause bond prices and each fund's share price to fall. (See the table entitled How Interest Rates May Affect Bond Prices.) The Long-Term Fund is subject to the greatest price swings because the longer the maturity, the greater the price decline when rates rise and the greater the price increase when rates fall. As with all mutual funds, there is no guarantee these funds will achieve their goals. ABOUT THE FUNDS 3 o The bond funds' share prices will fluctuate as interest rates change, so when you sell your shares, you may lose money. How can I tell which fund is most appropriate for me? The Money Fund may be appropriate for you if the stability and accessibility of your investment are more important to you than the opportunity for higher income or total return. The Intermediate and Long-Term Funds may be appropriate if you seek an attractive level of income and are willing to accept the risk of a loss of principal when interest rates rise. The Long-Term Fund has the highest income and potential return over time, but also the greatest risk of price declines. The funds may be used for both regular and tax-deferred accounts, such as IRAs and Keoghs. o The bond funds should not represent your complete investment program or be used for short-term trading purposes. How has each fund performed in the past? The bar charts, which show each fund's actual performance for each of the last 10 calendar years (or since inception for funds lacking 10-year records) through December 31, 1997, indicate risk by illustrating how much returns can differ from one year to the next. The funds can also experience short-term performance swings, as shown in the following charts by the best and worst calendar quarter returns during the years depicted in each chart. Of course, each fund's past performance is no guarantee of its future returns. U.S. Treasury Money Fund
Calendar Year Total Returns -------------------------------- 1988 6.52% 1989 8.30 1990 7.42 1991 5.39 1992 3.24 1993 2.51 1994 3.53 1995 5.25 1996 4.76 1997 4.86 --------------------------------
Quarter Ended Total Return Best Quarter 6/30/89 2.15% Worst Quarter 3/31/93 0.60% T. ROWE PRICE 4 U.S. Treasury Intermediate Fund
Calendar Year Total Returns -------------------------------- 1988 1989 1990 8.96% 1991 14.80 1992 6.27 1993 7.99 1994 -2.25 1995 15.89 1996 2.37 1997 8.17 --------------------------------
Quarter Ended Total Return Best Quarter 12/31/91 5.40% Worst Quarter 3/31/92 -2.41% U.S. Treasury Long-Term Fund
Calendar Year Total Returns -------------------------------- 1988 1989 1990 6.67% 1991 16.28 1992 5.82 1993 12.92 1994 -5.75 1995 28.60 1996 -2.37 1997 14.73 --------------------------------
Quarter Ended Total Return Best Quarter 6/30/95 10.15% Worst Quarter 3/31/96 -7.28% The funds' returns for the 6 months ended 6/30/98 were as follows: U.S. Treasury Money Fund, 2.41%; U.S. Treasury Intermediate Fund, 3.72%; U.S. Treasury Long-Term Fund, 5.98%. In the table, the funds' average annual total returns for the 1-, 5-, and 10-year or since inception periods through December 31, 1997, are compared with those of their appropriate benchmarks. By comparing the bar charts with Table 2, you can see that average returns smooth out year-to-year variations. ABOUT THE FUNDS 5 Table 2 Average Annual Total Returns
Periods ended December 31, 1997 10 years or 1 year 5 years since inception Inception date ------------------------------------------------------------- U.S. Treasury Money Fund 4.86% 4.18% 5.16% 6/21/82 Lipper U.S. Treasury Money Market Funds 4.80 4.20 5.25 Average -------------------------------------------------------- U.S. Treasury Intermediate Fund 8.17 6.26 7.80 9/29/89 Salomon Smith Barney 1-7 Yr. Treasury Index 7.32 6.33 7.86 Lipper Intermediate U.S. Treasury Funds 8.11 .44 7.75 Average -------------------------------------------------------- U.S. Treasury Long-Term Fund 14.73 8.92 9.38 9/29/89 Salomon Smith Barney Treasury Index 9.63 7.34 8.66 Lipper General U.S. Treasury Funds 10.69 8.32 8.99 Average -------------------------------------------------------------------------------------
These figures include changes in principal value, reinvested dividends, and capital gain distributions, if any. The Money Fund's $1.00 share price is not guaranteed. What fees or expenses will I pay? The funds are 100% no load. There are no fees or charges to buy or sell fund shares, reinvest dividends, or exchange into other T. Rowe Price funds. There are no 12b-1 marketing fees. The numbers in Table 3 provide an estimate of how much it will cost to operate the funds for a year, based on 1998 fiscal year expenses. Table 3 Fees and Expenses of the Funds
Annual fund operating expenses (expenses that are deducted from fund assets) Total annual fund Management fee Other expenses operating expenses Money 0.32% 0.19% 0.51% Intermediate 0.37 0.24 0.61 Long-Term 0.37 0.30 0.67 ----------------------------------------------------------------------------
T. ROWE PRICE 6 Example. The following table gives you a rough idea of how expense ratios may translate into dollars and helps you to compare the cost of investing in these funds with the cost of investing in other funds. Although your actual costs may be higher or lower, the table shows expenses you would pay if operating expenses remain the same, you invest $10,000, you earn a 5% annual return, and you hold the investment for the following periods.
Fund 1 year 3 years 5 years 10 years Money $ 52 $ 164 $ 285 $ 640 ---------------------------------------- Intermediate 62 195 340 762 ---------------------------------------- Long-Term 68 214 373 835 ------------------------------------------------------------
OTHER INFORMATION ABOUT THE FUNDS ---------------------------------------------------------- What are the funds' potential rewards? All three offer a way to receive monthly income through investments of the highest credit quality. The Money Fund typically provides the lowest income but also offers stability of principal and liquidity. The Intermediate Fund should provide higher income, and the Long-Term Fund should provide the highest of the three. As noted previously, the level of risk increases with a fund's average maturity. How does the portfolio manager try to reduce risk? Consistent with each fund's objective, the portfolio manager uses various tools to try to reduce risk and increase total return, including: . Diversification of assets to reduce the impact of a single holding on a fund's net asset value. . Adjustment of fund duration to try to reduce the drop in price when interest rates rise or to benefit from the rise in price when rates fall. Duration is a measure of a fund's sensitivity to interest rate changes. What are derivatives and can the funds invest in them? A derivative is a financial instrument whose value is derived from an underlying security, such as a stock or bond, or from a market benchmark such as an interest rate index. Many types of investments representing a wide range of potential risks and rewards are derivatives, including conventional instruments such as callable bonds, futures, and options, as well as more exotic investments such as stripped mortgage securities and structured notes. Investment managers have used derivatives for many years. ABOUT THE FUNDS 7 o We will not invest the Money Fund's assets in high-risk, highly leveraged derivatives. We invest in derivatives only if the expected risks and rewards are consistent with each fund's objective, policies, and overall risk profile described in this prospectus. We use derivatives in situations where they may enable each fund to increase yield, hedge against a decline in principal, invest in other asset classes more efficiently and at a lower cost, or adjust duration. We will not invest in any high-risk, highly leveraged derivative that we believe would cause the portfolio to be more volatile than an intermediate- or long-term U.S. Treasury bond for the U.S. Treasury Intermediate or Long-Term Funds, respectively. Are there any tax benefits to owning shares of a U.S. Treasury fund? Yes. Monthly dividends paid by the funds from income earned on U.S. Treasury securities are exempt from state and local taxes in most states. Dividends derived from the funds' other investments may not be exempt from such taxes. Is there other information I can review before making a decision? Investment Policies and Practices in Section 3 discusses the principal types of portfolio securities that the funds may purchase as well as the types of management practices that the funds may use. SOME BASICS OF FIXED INCOME INVESTING ---------------------------------------------------------- Is a fund's yield fixed or will it vary? It will vary. The yield is calculated every day by dividing a fund's net income per share, expressed at annual rates, by the share price. Since both income and share price will fluctuate, a fund's yield will also vary. (Although money fund prices are stable, income is variable.) Is yield the same as total return? Not for bond funds. The total return reported for a fund is the result of reinvested distributions (income and capital gains) and the change in share price for a given time period. Income is always a positive contributor to total return and can enhance a rise in share price or serve as an offset to a drop in share price. Since money funds are managed to maintain a stable share price, their yield and total return should be the same. T. ROWE PRICE 8 What is credit quality and how does it affect yield? Credit quality refers to a bond issuer's expected ability to make all required interest and principal payments on time. Because highly rated issuers represent less risk, they can borrow at lower interest rates than less creditworthy issuers. Therefore, a fund investing in high-quality securities should have a lower yield than an otherwise comparable fund investing in lower-quality securities. What is meant by a bond fund's maturity? Every bond has a stated maturity date when the issuer must repay the bond's entire principal value to the investor. However, many bonds are "callable," meaning their principal can be repaid earlier, on or after specified call dates. Bonds are most likely to be called when interest rates are falling because the issuer can refinance at a lower rate, just as a homeowner refinances a mortgage. In that environment, a bond's "effective maturity" is usually its nearest call date. For example, the rate at which homeowners pay down their mortgage principal determines the effective maturity of mortgage-backed bonds. A bond mutual fund has no real maturity, but it does have a weighted average maturity and an average effective maturity. This number is an average of the stated or effective maturities of the underlying bonds, with each bond's maturity "weighted" by the percentage of fund assets it represents. Funds that target effective maturities normally use the effective, rather than stated, maturities of the bonds in the portfolio when computing the average. This provides additional flexibility in portfolio management but, all else being equal, could result in higher volatility than a fund targeting a stated maturity or maturity range. What is meant by a bond fund's duration? Duration is a calculation that seeks to measure the price sensitivity of a bond or a bond fund to changes in interest rates. It measures this sensitivity more accurately than maturity because it takes into account the time value of cash flows generated over the bond's life. Future interest and principal payments are discounted to reflect their present value and then are multiplied by the number of years they will be received to produce a value expressed in years - the duration. Effective duration takes into account call features and sinking fund payments that may shorten a bond's life. Since duration can also be computed for bond funds, you can estimate the effect of interest rates on share price by multiplying fund duration by an expected change in interest rates. (T. Rowe Price shareholder bond fund reports show duration.) For example, the price of a bond fund with a duration of five years would be expected to fall approximately 5% if rates rose by one percentage point. ABOUT THE FUNDS 9 How is a bond's price affected by changes in interest rates? When interest rates rise, a bond's price usually falls, and vice versa. In general, the longer a bond's maturity, the greater the price increase or decrease in response to a given change in rates, as shown in Table 4. Table 4 How Interest Rates May Affect Bond Prices
Price per $1,000 of bond face value if interest rates: Bond maturity Coupon Increase Decrease 1 point 2 points 1 point 2 points 1 year 5.36% $990 $981 $1,010 $1,020 5 years 5.50 958 918 1,044 1,091 10 years 5.50 927 861 1,080 1,168 30 years 5.72 872 768 1,160 1,360 --------------------------------------------------------------------------------------------------------------
The table reflects yields on Treasury securities as of July 31, 1998. The table may not be as representative of price changes for other types of bonds, including mortgage-backed securities because of prepayments. This is an illustration and does not represent expected yields or share price changes of any T. Rowe Price fund. Do money market securities react to changes in interest rates? Yes. As interest rates change, the prices of money market securities fluctuate, but changes are usually small because of their very short maturities. Investments are typically held until maturity in a money fund to help the fund maintain a $1.00 share price. ABOUT YOUR ACCOUNT 2 PRICING SHARES AND RECEIVING SALE PROCEEDS ---------------------------------------------------------- Here are some procedures you should know when investing in a T. Rowe Price fixed income fund. How and when shares are priced Bond and money funds The share price (also called "net asset value" or NAV per share) for a fund is calculated at 4 p.m. ET each day the New York Stock Exchange is open for business. To calculate the NAV, the fund's assets are valued and totaled, liabilities are subtracted, and the balance, called net assets, is divided by the number of shares outstanding. For the bond funds, current market values are used to price fund shares. Amortized cost is used to value money fund securities. o The various ways you can buy, sell, and exchange shares are explained at the end of this prospectus and on the New Account Form. These procedures and the information you receive about them may differ for institutional and employer-sponsored retirement accounts. How your purchase, sale, or exchange price is determined If we receive your request in correct form by 4 p.m. ET, your transaction will be priced at that day's NAV. If we receive it after 4 p.m., it will be priced at the next business day's NAV. We cannot accept orders that request a particular day or price for your transaction or any other special conditions. Fund shares may be purchased through various third-party intermediaries including banks, brokers, and investment advisers. Where authorized by a fund, orders will be priced at the NAV next computed after receipt by the intermediary. Consult your intermediary to determine when your orders will be priced. The intermediary may charge a fee for its services. Note: The time at which transactions and shares are priced and the time until which orders are accepted may be changed in case of an emergency or if the New York Stock Exchange closes at a time other than 4 p.m. ET. ABOUT YOUR ACCOUNT 11 How you can receive the proceeds from a sale o When filling out the New Account Form, you may wish to give yourself the widest range of options for receiving proceeds from a sale. If your request is received by 4 p.m. ET in correct form, proceeds are usually sent on the next business day. Proceeds can be sent to you by mail or to your bank account by Automated Clearing House (ACH) transfer or bank wire. Proceeds sent by ACH transfer should be credited the second day after the sale. ACH is an automated method of initiating payments from, and receiving payments in, your financial institution account. The ACH system is supported by over 20,000 banks, savings banks, and credit unions. Proceeds sent by bank wire should be credited to your account the next business day. . Exception: Under certain circumstances and when deemed to be in each fund's best interests, your proceeds may not be sent for up to five business days after we receive your sale or exchange request. If you were exchanging into a bond or money fund, your new investment would not begin to earn dividends until the sixth business day. o If for some reason we cannot accept your request to sell shares, we will contact you. USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES ---------------------------------------------------------- o All net investment income and realized capital gains are distributed to shareholders. Dividends and Other Distributions Dividend and capital gain distributions are reinvested in additional fund shares in your account unless you select another option on your New Account Form. The advantage of reinvesting distributions arises from compounding; that is, you receive income dividends and capital gain distributions on a rising number of shares. Distributions not reinvested are paid by check or transmitted to your bank account via ACH. If the Post Office cannot deliver your check, or if your check remains uncashed for six months, the fund reserves the right to reinvest your distribution check in your account at the NAV on the business day of the reinvestment and to reinvest all subsequent distributions in shares of the fund. No interest will accrue on amounts represented by uncashed distribution or redemption checks. T. ROWE PRICE 12 Income dividends . Money funds declare income dividends daily to shareholders of record as of 12 noon ET on that day. Wire purchase orders received before 12 noon ET receive the dividend for that day. Other purchase orders receive the dividend on the next business day after payment has been received. . Bond funds declare income dividends daily at 4 p.m. ET to shareholders of record at that time provided payment has been received on the previous business day. . Dividends are paid on the first business day of each month. . Fund shares will earn dividends through the date of redemption; also, shares redeemed on a Friday or prior to a holiday will continue to earn dividends until the next business day. Generally, if you redeem all of your shares at any time during the month, you will also receive all dividends earned through the date of redemption in the same check. When you redeem only a portion of your shares, all dividends accrued on those shares will be reinvested, or paid in cash, on the next dividend payment date. Capital gains o Since money funds are managed to maintain a constant share price, they are not expected to make capital gain distributions. . A capital gain or loss is the difference between the purchase and sale price of a security. . If a fund has net capital gains for the year (after subtracting any capital losses), they are usually declared and paid in December to shareholders of record on a specified date that month. Tax Information o You will be sent timely information for your tax filing needs. You need to be aware of the possible tax consequences when: . You sell fund shares, including an exchange from one fund to another. . The fund makes a distribution to your account. Taxes on fund redemptions When you sell shares in any fund, you may realize a gain or loss. An exchange from one fund to another is still a sale for tax purposes. In January, you will be sent Form 1099-B indicating the date and amount of each sale you made in the fund during the prior year. This information will also be reported to the IRS. For new accounts or those opened by exchange in 1983 or ABOUT YOUR ACCOUNT 13 later, we will provide the gain or loss on the shares you sold during the year, based on the "average cost," single category method. This information is not reported to the IRS, and you do not have to use it. You may calculate the cost basis using other methods acceptable to the IRS, such as "specific identification." To help you maintain accurate records, we send you a confirmation immediately following each transaction you make (except for systematic purchases and redemptions) and a year-end statement detailing all your transactions in each fund account during the year. Taxes on fund distributions o The following summary does not apply to retirement accounts, such as IRAs, which are not subject to current tax. In January, you will be sent Form 1099-DIV indicating the tax status of any dividend and capital gain distributions made to you. This information will also be reported to the IRS. Distributions made by a fund are generally taxable to you for the year in which they were paid. You will be sent any additional information you need to determine your taxes on fund distributions, such as the portion of your dividend, if any, that may be exempt from state income taxes. The tax treatment of a capital gain distribution is determined by how long the fund held the portfolio securities, not how long you held shares in the fund. Short-term (one year or less) capital gain distributions are taxable at the same rate as ordinary income. Reflecting recent changes in the tax code, gains on securities held more than 12 months are taxed at a maximum rate of 20%. If you realized a loss on the sale or exchange of fund shares which you held six months or less, your short-term loss will be reclassified to a long-term loss to the extent you received a long-term capital gain distribution during the period you held the shares. o Distributions are taxable whether reinvested in additional shares or received in cash. Tax effect of buying shares before a capital gain distribution If you buy shares shortly before or on the "record date" - the date that establishes you as the person to receive the upcoming distribution - you will receive a portion of the money you just invested in the form of a taxable distribution. Therefore, you may wish to find out a fund's record date before investing. Of course, a fund's share price may, at any time, reflect undistributed capital gains or income and unrealized appreciation, which may result in future taxable distributions. T. ROWE PRICE 14 TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS ---------------------------------------------------------- o Following these procedures helps assure timely and accurate transactions. Purchase Conditions Nonpayment If your payment is not received or you pay with a check or ACH transfer that does not clear, your purchase will be canceled. You will be responsible for any losses or expenses incurred by each fund or transfer agent, and the fund can redeem shares you own in this or another identically registered T. Rowe Price fund as reimbursement. Each fund and its agents have the right to reject or cancel any purchase, exchange, or redemption due to nonpayment. U.S. dollars All purchases must be paid for in U.S. dollars; checks must be drawn on U.S. banks. Sale (Redemption) Conditions Holds on immediate redemptions 10-day hold If you sell shares that you just purchased and paid for by check or ACH transfer, the funds will process your redemption but will generally delay sending you the proceeds for up to 10 calendar days to allow the check or transfer to clear. If your redemption request was sent by mail or mailgram, proceeds will be mailed no later than the seventh calendar day following receipt unless the check or ACH transfer has not cleared. If, during the clearing period, we receive a check drawn against your bond or money market account, it will be returned marked "uncollected." (The 10-day hold does not apply to the following: purchases paid for by bank wire; cashier's, certified, or treasurer's checks; or automatic purchases through your paycheck.) Telephone, Tele*Access/(R)/, and personal computer transactions Exchange and redemption services through telephone and Tele*Access are established automatically when you sign the New Account Form unless you check the box that states you do not want these services. Personal computer transactions must be authorized separately. T. Rowe Price funds and their agents use reasonable procedures (including shareholder identity verification) to confirm that instructions given by telephone are genuine and they are not liable for acting on these instructions. If these procedures are not followed, it is the opinion of certain regulatory agencies that the funds and their agents may be liable for any losses that may result from acting on the instructions given. A confirmation is sent promptly after a transaction. All telephone conversations are recorded. ABOUT YOUR ACCOUNT 15 Redemptions over $250,000 Large sales can adversely affect a portfolio manager's ability to implement a fund's investment strategy by causing the premature sale of securities that would otherwise be held. If, in any 90-day period, you redeem (sell) more than $250,000, or your sale amounts to more than 1% of fund net assets, the fund has the right to pay the difference between the redemption amount and the lesser of the two previously mentioned figures with securities from the fund. Excessive Trading o T. Rowe Price may bar excessive traders from purchasing shares. Frequent trades, involving either substantial fund assets or a substantial portion of your account or accounts controlled by you, can disrupt management of the fund and raise its expenses. . Trades placed directly with T. Rowe Price If you trade directly with T. Rowe Price, you can make one purchase and sale involving the same fund within any 120-day period. For example, if you are in fund A, you can move substantial assets from fund A to fund B and, within the next 120 days, sell your shares in fund B to return to fund A or move to fund C. If you exceed this limit, you are in violation of our excessive trading policy. Two types of transactions are exempt from this policy: 1) trades solely in money market funds (exchanges between a money fund and a nonmoney fund are not exempt); and 2) systematic purchases or redemptions (see Shareholder Services). . Trades placed through intermediaries If you purchase fund shares through an intermediary including a broker, bank, investment adviser, or other third party and hold them for less than 60 calendar days, you are in violation of our excessive trading policy. . If you violate our excessive trading policy, you may be barred indefinitely and without further notice from further purchases of T. Rowe Price funds. Keeping Your Account Open Due to the relatively high cost to a fund of maintaining small accounts, we ask you to maintain an account balance of at least $1,000. If your balance is below $1,000 for three months or longer, we have the right to close your account after giving you 60 days in which to increase your balance. T. ROWE PRICE 16 Small Account Fee Because of the disproportionately high costs of servicing accounts with low balances, a $10 fee, paid to T. Rowe Price Services, the funds' transfer agent, will automatically be deducted from nonretirement accounts with balances falling below a minimum level. The valuation of accounts and the deduction are expected to take place during the last five business days of September. The fee will be deducted from accounts with balances below $2,000, except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be waived for any investor whose aggregate T. Rowe Price mutual fund investments total $25,000 or more. Accounts employing automatic investing (e.g., payroll deduction, automatic purchase from a bank account, etc.) are also exempt from the charge. The fee will not apply to IRAs and other retirement plan accounts. (A separate custodial fee may apply to IRAs and other retirement plan accounts.) Signature Guarantees o A signature guarantee is designed to protect you and the T. Rowe Price funds from fraud by verifying your signature. You may need to have your signature guaranteed in certain situations, such as: . Written requests 1) to redeem over $100,000, or 2) to wire redemption proceeds. . Remitting redemption proceeds to any person, address, or bank account not on record. . Transferring redemption proceeds to a T. Rowe Price fund account with a different registration (name or ownership) from yours. . Establishing certain services after the account is opened. You can obtain a signature guarantee from most banks, savings institutions, broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot accept guarantees from notaries public or organizations that do not provide reimbursement in the case of fraud. MORE ABOUT THE FUNDS 3 ORGANIZATION AND MANAGEMENT ---------------------------------------------------------- How are the funds organized? The T. Rowe Price U.S. Treasury Funds, Inc. (the "Corporation") was incorporated in Maryland in 1989 and is a "diversified, open-end investment company," or mutual fund. Mutual funds pool money received from shareholders and invest it to try to achieve specified objectives. The Intermediate and Long-Term Funds are series of the Corporation that were established in 1989. The Money Fund series was added in 1990. o Shareholders benefit from T. Rowe Price's 61 years of investment management experience. What is meant by "shares"? As with all mutual funds, investors purchase shares when they put money in a fund. These shares are part of a fund's authorized capital stock, but share certificates are not issued. Each share and fractional share entitles the shareholder to: . Receive a proportional interest in a fund's income and capital gain distributions. . Cast one vote per share on certain fund matters, including the election of fund directors, changes in fundamental policies, or approval of changes in the fund's management contract. Do T. Rowe Price funds have annual shareholder meetings? The funds are not required to hold annual meetings and, to avoid unnecessary costs to fund shareholders, do not intend to do so except when certain matters, such as a change in a fund's fundamental policies, must be decided. In addition, shareholders representing at least 10% of all eligible votes may call a special meeting, if they wish, for the purpose of voting on the removal of any fund director or trustee. If a meeting is held and you cannot attend, you can vote by proxy. Before the meeting, the fund will send you proxy materials that explain the issues to be decided and include a voting card for you to mail back. T. ROWE PRICE 18 Who runs the funds? General Oversight The Corporation is governed by a Board of Directors that meets regularly to review each fund's investments, performance, expenses, and other business affairs. The Board elects the Corporation's officers. The policy of the Corporation is that a majority of Board members are independent of T. Rowe Price Associates, Inc. (T. Rowe Price). o All decisions regarding the purchase and sale of fund investments are made by T. Rowe Price - specifically by each fund's portfolio managers. Portfolio Management Each fund has an Investment Advisory Committee whose chairman has day-to-day responsibility for managing the fund and works with the committee in developing and executing the fund's investment program. The Investment Advisory Committees comprise the following members: . Money Fund Edward A. Wiese, Chairman, Patrice Berchtenbreiter Ely, Brian E. Burns, Robert P. Campbell, James M. McDonald, Joan R. Potee, and Gwendolyn G. Wagner. Mr. Wiese has been chairman of the Money Fund's committee since 1990. He joined T. Rowe Price in 1984 and has been managing investments since 1985. . Intermediate Fund Peter Van Dyke, Chairman, Connice A. Bavely, Jerome A. Clark, Heather R. Landon, and Cheryl A. Mickel. Mr. Van Dyke became chairman of the Intermediate Fund's committee effective May 1, 1998. He has been managing investments since joining T. Rowe Price in 1985. . Long-Term Fund Peter Van Dyke, Chairman, Connice A. Bavely, Jerome A. Clark, Heather R. Landon, and Cheryl A. Mickel. Mr. Van Dyke has been chairman of the Long-Term Fund's committee since 1990. He has been managing investments since joining T. Rowe Price in 1985. The Management Fee This fee has two parts - an "individual fund fee," which reflects a fund's particular investment management costs, and a "group fee." The group fee, which is designed to reflect the benefits of the shared resources of the T. Rowe Price investment management complex, is calculated daily based on the combined MORE ABOUT THE FUNDS 19 net assets of all T. Rowe Price funds (except the Spectrum Funds, and any institutional, index, or private label mutual funds). The group fee schedule (shown below) is graduated, declining as the asset total rises, so shareholders benefit from the overall growth in mutual fund assets. Group Fee Schedule
0.334% First $50 billion/a/ 0.305% Next $30 billion 0.300% Thereafter ----------------------------------------
/a/ Represents a blended group fee rate containing various break points. Each fund's portion of the group fee is determined by the ratio of its daily net assets to the daily net assets of all the T. Rowe Price funds described previously. Based on combined T. Rowe Price funds' assets of over $86 billion at June 30, 1998, the group fee was 0.32%. The individual fund fee was 0.05% for the Intermediate and Long-Term Funds. The Money Fund pays only the group fee. UNDERSTANDING PERFORMANCE INFORMATION ---------------------------------------------------------- This section should help you understand the terms used to describe fund performance. You will come across them in shareholder reports you receive from us; in our newsletter, The Price Report; in Insights articles; in T. Rowe Price advertisements; and in the media. Total Return This tells you how much an investment in a fund has changed in value over a given time period. It reflects any net increase or decrease in the share price and assumes that all dividends and capital gains (if any) paid during the period were reinvested in additional shares. Therefore, total return numbers include the effect of compounding. Advertisements for a fund may include cumulative or average annual total return figures, which may be compared with various indices, other performance measures, or other mutual funds. Cumulative Total Return This is the actual return of an investment for a specified period. A cumulative return does not indicate how much the value of the investment may have fluctuated during the period. For example, a fund could have a 10-year positive cumulative return despite experiencing three negative years during that time. T. ROWE PRICE 20 Average Annual Total Return This is always hypothetical and should not be confused with actual year-by-year results. It smooths out all the variations in annual performance to tell you what constant year-by-year return would have produced the investment's actual cumulative return. This gives you an idea of an investment's annual contribution to your portfolio, provided you held it for the entire period. Yield The current or "dividend" yield on a fund or any investment tells you the relationship between the investment's current level of annual income and its price on a particular day. The dividend yield reflects the actual income paid to shareholders for a given period, annualized, and divided by the fund's net asset value. For example, a fund providing $5 of annual income per share and a price of $50 has a current yield of 10%. Yields can be calculated for any time period. For bond funds, the advertised or Securities and Exchange Commission (SEC) yield is found by determining the net income per share (as defined by the SEC) earned by a fund during a 30-day base period and dividing this amount by the per share price on the last day of the base period. The SEC yield may differ from the dividend yield. The money fund may advertise a current yield, reflecting the latest seven-day income annualized, or an "effective" yield, which assumes the income has been reinvested in the fund. INVESTMENT POLICIES AND PRACTICES ---------------------------------------------------------- This section takes a detailed look at some of the types of securities the funds may hold in their portfolios and the various kinds of investment practices that may be used in day-to-day portfolio management. Each fund's investment program is subject to further restrictions and risks described in the Statement of Additional Information. Shareholder approval is required to substantively change a fund's objective and certain investment restrictions noted in the following section as "fundamental policies." The managers also follow certain "operating policies," which can be changed without shareholder approval. However, significant changes are discussed with shareholders in fund reports. Each fund adheres to applicable investment restrictions and policies at the time it makes an investment. A later change in circumstances will not require the sale of an investment if it was proper at the time it was made. MORE ABOUT THE FUNDS 21 The funds' holdings of certain kinds of investments cannot exceed maximum percentages of total assets, which are set forth in this prospectus. For instance, the bond funds are not permitted to invest more than 10% of total assets in certain stripped mortgage securities, known as IOs and POs. While these restrictions provide a useful level of detail about each fund's investment program, investors should not view them as an accurate gauge of the potential risk of such investments. For example, in a given period, a 5% investment in IOs and POs could have significantly more of an impact on each fund's share price than its weighting in the portfolio. The net effect of a particular investment depends on its volatility and the size of its overall return in relation to the performance of all the funds' other investments. Changes in the funds' holdings, the funds' performance, and the contribution of various investments are discussed in the shareholder reports sent to you. Types of Portfolio Securities In seeking to meet their investment objectives, the funds may invest in any type of security or instrument whose investment characteristics are consistent with the funds' investment programs. For the bond funds, but not the money fund, these investments may include potentially high-risk derivatives (described in this section). The following pages describe the principal types of portfolio securities and investment management practices of the funds. Bonds A bond is an interest-bearing security - an IOU - issued by companies or governmental units. The issuer has a contractual obligation to pay interest at a stated rate on specific dates and to repay principal (the bond's face value) on a specified date. An issuer may have the right to redeem or "call" a bond before maturity, and the investor may have to reinvest the proceeds at lower market rates. A bond's annual interest income, set by its coupon rate, is usually fixed for the life of the bond. Its yield (income as a percent of current price) will fluctuate to reflect changes in interest rate levels. A bond's price usually rises when interest rates fall, and vice versa, so its yield stays current. Certain bonds have interest rates that are adjusted periodically. These interest rate adjustments tend to minimize fluctuations in the bonds' principal values. In calculating the money fund's weighted average maturity, the maturity of these securities may be shortened under certain specified conditions and in accordance with Rule 2a-7. T. ROWE PRICE 22 In addition to Treasury securities, the funds may make the following investments: Other Securities Backed by the Full Faith and Credit of the U.S. Government The funds may purchase securities of U.S. government agencies and instrumentalities which are backed by the full faith and credit of the U.S. government, such as securities of the Government National Mortgage Association (GNMA), the Federal Housing Administration, the Department of the General Services Administration, the Maritime Administration, and the Small Business Administration. The funds will not invest in the securities of any U.S. government agencies that are not backed by the full faith and credit of the U.S. government, such as Fannie Mae (FNMA) or Freddie Mac (FHLMC) securities. No more than 20% of the Money Fund's total assets and no more than 15% of each of the Intermediate and Long-Term Funds' total assets will be maintained in these types of non-U.S. Treasury securities. The Money Fund does not expect to invest in mortgage securities. Fundamental policy The Money Fund must invest at least 80% of its total assets in U.S. Treasury securities and repurchase agreements thereon. However, as an operating policy the fund has decided not to invest in repurchase agreements. The Intermediate and Long-Term Funds' non-U.S. Treasury investments may include, but are not limited to, the following types of mortgage securities: . GNMA Mortgage Securities Mortgage-backed securities are subject to scheduled and unscheduled principal payments as homeowners pay down or prepay their mortgages. As these payments are received, they must be reinvested when interest rates may be higher or lower than on the original mortgage security. Therefore, these securities are not an effective means of locking in long-term interest rates. In addition, when interest rates fall, the pace of mortgage prepayments picks up. These refinanced mortgages are paid off at face value (par), causing a loss for any investor who may have purchased the security at a price above par. In such an environment, this risk limits the potential price appreciation of these securities and can negatively affect the funds' net asset values. When rates rise, the prices of mortgage-backed securities can be expected to decline, although historically these securities have experienced smaller price declines than comparable quality bonds. . Collateralized Mortgage Obligations (CMOs) CMOs are debt securities that are fully collateralized by a portfolio of mortgages or mortgage-backed securities. All interest and principal payments from the underlying mortgages are passed through to the CMOs in such a way as to create, in most cases, more definite maturities than is the case with the underlying mortgages. CMOs may pay fixed or variable rates of interest, and certain CMOs have priority over others with respect to the receipt of prepayments. MORE ABOUT THE FUNDS 23 . Stripped Mortgage Securities Stripped mortgage securities (a type of potentially high-risk derivative) are created by separating the interest and principal payments generated by a pool of mortgage-backed securities or a CMO to create additional classes of securities. Generally, one class receives only interest payments (IOs), and another receives principal payments (POs). Unlike with other mortgage-backed securities and POs, the value of IOs tends to move in the same direction as interest rates. The funds can use IOs as a hedge against falling prepayment rates (interest rates are rising) and/or a bear market environment. POs can be used as a hedge against rising prepayment rates (interest rates are falling) and/or a bull market environment. IOs and POs are acutely sensitive to interest rate changes and to the rate of principal prepayments. A rapid or unexpected increase in prepayments can severely depress the price of IOs, while a rapid or unexpected decrease in prepayments could have the same effect on POs. These securities are very volatile in price and may have lower liquidity than most other mortgage-backed securities. Certain non-stripped CMOs may also exhibit these qualities, especially those that pay variable rates of interest that adjust inversely with, and more rapidly than, short-term interest rates. In addition, if interest rates rise rapidly and prepayment rates slow more than expected, certain CMOs, in addition to losing value, can exhibit characteristics of longer-term securities and become more volatile. There is no guarantee the funds' investments in CMOs, IOs, or POs will be successful, and the funds' total returns could be adversely affected as a result. Operating policy Each fund may invest up to 10% of its total assets in stripped mortgage securities. Types of Management Practices Reserve Position (bond funds) Each fund will hold a certain portion of its assets in money market reserves. The funds' reserve position can consist of shares of a T. Rowe Price internal money market fund that invests exclusively in securities backed by the full faith and credit of the U.S. government and repurchase agreements thereon. In addition, the funds may purchase money market securities backed by the full faith and credit of the U.S. government, including repurchase agreements collateralized by such securities. For temporary, defensive purposes, a fund may invest without limitation in such money market reserves. The effect of taking such a position is that the fund may not achieve its investment objective. The reserve position provides flexibility in meeting redemptions, expenses, and the timing of new investments, and serves as a short-term defense during periods of unusual market volatility. T. ROWE PRICE 24 Borrowing Money and Transferring Assets Each fund can borrow money from banks (and to the extent permitted by the SEC, other Price funds) as a temporary measure for emergency purposes, to facilitate redemption requests, or for other purposes consistent with each fund's investment objective and program. Such borrowings may be collateralized with fund assets, subject to restrictions. Fundamental policy Borrowings may not exceed 33 1/3% of total fund assets. Operating policy Each fund may not transfer as collateral any portfolio securities except as necessary in connection with permissible borrowings or investments, and then such transfers may not exceed 33 1/3% of the fund's total assets. Each fund may not purchase additional securities when borrowings exceed 5% of total assets. Lending of Portfolio Securities Like other mutual funds, each fund may lend securities to broker-dealers, other institutions, or other persons to earn additional income. The principal risk is the potential insolvency of the broker-dealer or other borrower. In this event, each fund could experience delays in recovering its securities and possibly capital losses. Fundamental policy The value of loaned securities may not exceed 33 1/3% of total fund assets. When-Issued Securities (bond funds) The funds may purchase securities on a when-issued or delayed delivery basis or may purchase or sell securities on a forward commitment basis. There is no limit on each fund's investment in these securities. The price of these securities is fixed at the time of the commitment to buy, but delivery and payment can take place a month or more later. During the interim period, the market value of the securities can fluctuate, and no interest accrues to the purchaser. At the time of delivery, the value of the securities may be more or less than the purchase or sale price. To the extent each fund remains fully or almost fully invested (in securities with a remaining maturity of more than one year) at the same time it purchases these securities, there will be greater fluctuations in the fund's net asset value than if the fund did not purchase them. MORE ABOUT THE FUNDS 25 Portfolio Turnover (bond funds) Each fund generally purchases securities with the intention of holding them for investment; however, when market conditions or other circumstances warrant, securities may be purchased and sold without regard to the length of time held. Due to the nature of each fund's investment program, a fund's portfolio turnover rate may exceed 100%. A high turnover rate may increase transaction costs and result in additional taxable gains. The funds' portfolio turnover rates for the previous three fiscal years are shown in Table 5. Table 5 Portfolio Turnover Rates
Fund 1998 1997 1996 Intermediate 112.8% 57.9% 40.7% ---------------------------------- Long-Term 80.8 67.6 60.1 -----------------------------------------------------------
Year 2000 Processing Issue Many computer programs use two digits rather than four to identify the year. These programs, if not adapted, will not correctly handle the change from "99" to "00" on January 1, 2000, and will not be able to perform necessary functions. The Year 2000 issue affects virtually all companies and organizations. T. Rowe Price has implemented steps intended to assure that its major computer systems and processes are capable of Year 2000 processing. We are working with third parties to assess the adequacy of their compliance efforts and are developing contingency plans intended to assure that third-party noncompliance will not materially affect T. Rowe Price's operations. Companies, organizations, governmental entities and markets in which T. Rowe Price funds invest will be affected by the Year 2000 issue, but at this time the funds cannot predict the degree of impact. To the extent the effect is negative, the funds' returns could be adversely affected. T. ROWE PRICE 26 FINANCIAL HIGHLIGHTS ---------------------------------------------------------- Table 6, which provides information about each fund's financial history, is based on a single share outstanding throughout each fiscal year. Each fund's section of the table is part of the fund's financial statements, which are included in its annual report and are incorporated by reference into the Statement of Additional Information (available upon request). The total returns in the table represent the rate that an investor would have earned or lost on an investment in each fund (assuming reinvestment of all dividends and distributions). The financial statements in the annual report were audited by the funds' independent accountants, PricewaterhouseCoopers LLP. Table 6 Financial Highlights
Year ended May 31 Three months Year ended ended U.S. Treasury Money 2/28/94 5/31/94/ a/ 1995 1996 1997 1998 -------------------------------------------------------------------------------------------------------- Net asset value, beginning of period $ 1.000 $ 1.000 $ 1.000 $ 1.000 $ 1.000 $ 1.000 Income From Investment Operations Net investment income 0.025 0.007 0.045 0.050 0.046 0.048 Less Distributions Dividends (from net (0.025) (0.007) (0.045) (0.050) (0.046) (0.048) investment income) ---------------------------------------------------------------------- Net asset value, $ 1.000 $ 1.000 $ 1.000 $ 1.000 $ 1.000 $ 1.000 end of period ---------------------------------------------------------------------- Total return 2.51% 0.73% 4.58% 5.08% 4.74% 4.91% Ratios/Supplemental Data Net assets, end of period $613,583 $654,837 $719,215 $760,010 $821,075 $846,586 (in thousands) ---------------------------------------------------------------------- Ratio of expenses to 0.64% 0.57%/ b/ 0.56% 0.53% 0.56% 0.51% average net assets ---------------------------------------------------------------------- Ratio of net investment income to average 2.48% 2.87%/ b/ 4.51% 4.93% 4.65% 4.82% net assets --------------------------------------------------------------------------------------------------------
/a/ The fund's fiscal year-end was changed to May 31. /b/ Annualized. MORE ABOUT THE FUNDS 27 Table 6 Financial Highlights (continued)
Year ended May 31 Three months U.S. Treasury Intermediate Year ended ended 2/28/94 5/31/94/ a/ 1995 1996 1997 1998 -------------------------------------------------------------------------------------------------------- Net asset value, beginning of period $ 5.42 $ 5.32 $ 5.11 $ 5.25 $ 5.11 $ 5.12 Income From Investment Operations Net investment income 0.29 0.08 0.31 0.33 0.31 0.30 ---------------------------------------------------------------------- Net gains or losses on securities (both (0.09) (0.19) 0.14 (0.14) 0.01 0.18 realized and unrealized) ---------------------------------------------------------------------- Total from investment operations 0.20 (0.11) 0.45 0.19 0.32 0.48 Less Distributions Dividends (from net (0.29) (0.08) (0.31) (0.33) (0.31) (0.30) investment income) ---------------------------------------------------------------------- Distributions (0.01) (0.02) - - - - (from capital gains) ---------------------------------------------------------------------- Returns of capital - - - - - - ---------------------------------------------------------------------- Total distributions (0.30) (0.10) (0.31) (0.33) (0.31) (0.30) ---------------------------------------------------------------------- Net asset value, $ 5.32 $ 5.11 $ 5.25 $ 5.11 $ 5.12 $ 5.30 end of period ---------------------------------------------------------------------- Total return 3.80% (2.16)% 9.29% 3.52% 6.48% 9.58% Ratios/Supplemental Data Net assets, end of period $175,953 $181,231 $172,666 $174,176 $180,609 $203,027 (in thousands) ---------------------------------------------------------------------- Ratio of expenses to 0.79% 0.70%/ b/ 0.69% 0.65% 0.64% 0.61% average net assets ---------------------------------------------------------------------- Ratio of net investment income to average 5.41% 5.78%/ b/ 6.19% 6.14% 6.11% 5.72% net assets ---------------------------------------------------------------------- Portfolio turnover rate 20.2% 45.5%/ b/ 81.1% 40.7% 57.9% 112.8% --------------------------------------------------------------------------------------------------------
/a/ The fund's fiscal year-end was changed to May 31. /b/ Annualized. T. ROWE PRICE 28 Table 6 Financial Highlights (continued)
Year ended May 31 Three months U.S. Treasury Year ended ended Long-Term 2/28/94 5/31/94/ a/ 1995 1996 1997 1998 --------------------------------------------------------------------------------------------------------- Net asset value, beginning of period $ 10.79 $ 10.46 $ 9.81 $ 10.54 $ 10.02 $ 10.17 Income From Investment Operations Net investment income 0.68/ b/ 0.17/ b/ 0.68/ b/ 0.65/ b/ 0.63 0.63 ----------------------------------------------------------------------- Net gains or losses on securities (both realized (0.04) (0.64) 0.73 (0.52) 0.15 1.22 and unrealized) ----------------------------------------------------------------------- Total from investment operations 0.64 (0.47) 1.41 0.13 0.78 1.85 Less Distributions Dividends (from net (0.68) (0.17) (0.68) (0.65) (0.63) (0.63) investment income) ----------------------------------------------------------------------- Distributions (0.29) (0.01) - - - - (from capital gains) ----------------------------------------------------------------------- Returns of capital - - - - - - ----------------------------------------------------------------------- Total distributions (0.97) (0.18) (0.68) (0.65) (0.63) (0.63) ----------------------------------------------------------------------- Net asset value, $ 10.46 $ 9.81 $ 10.54 $ 10.02 $ 10.17 $ 11.39 end of period ----------------------------------------------------------------------- Total return 5.89%/ b/ (4.50)%/ b/ 15.24%/ b/ 1.02%/ b/ 7.97% 18.58% Ratios/Supplemental Data Net assets, end of period $56,632 $54,237 $65,284 $70,326 $71,263 $275,850 (in thousands) ----------------------------------------------------------------------- Ratio of expenses to 0.80%/ b/ 0.80%/ bc/ 0.80%/ b/ 0.80%/ b/ 0.80% 0.67% average net assets ----------------------------------------------------------------------- Ratio of net investment income to average 6.17%/ b/ 6.75%/ bc/ 7.05%/ b/ 6.05%/ b/ 6.22% 5.71% net assets ----------------------------------------------------------------------- Portfolio turnover rate 59.4% 246.9% /c/ 99.3% 60.1% 67.6% 80.8% ---------------------------------------------------------------------------------------------------------
/a/ The fund's fiscal year-end was changed to May 31. /b/ Excludes expenses in excess of a 0.80% voluntary expense limitation in effect through May 31, 1997. /c/ Annualized. INVESTING WITH T. ROWE PRICE 4 ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION ---------------------------------------------------------- Tax Identification Number We must have your correct Social Security or corporate tax identification number on a signed New Account Form or W-9 Form. Otherwise, federal law requires the funds to withhold a percentage (currently 31%) of your dividends, capital gain distributions, and redemptions, and may subject you to an IRS fine. If this information is not received within 60 days after your account is established, your account may be redeemed, priced at the NAV on the date of redemption. Always verify your transactions by carefully reviewing the confirmation we send you. Please report any discrepancies to Shareholder Services promptly. Employer-Sponsored Retirement Plans and Institutional Accounts T. Rowe Price Trust Company 1-800-492-7670 Transaction procedures in the following sections may not apply to employer-sponsored retirement plans and institutional accounts. For procedures regarding employer-sponsored retirement plans, please call T. Rowe Price Trust Company or consult your plan administrator. For institutional account procedures, please call your designated account manager or service representative. OPENING A NEW ACCOUNT ---------------------------------------------------------- $2,500 minimum initial investment; $1,000 for retirement plans or gifts or transfers to minors (UGMA/UTMA) accounts Account Registration If you own other T. Rowe Price funds, be sure to register any new account just like your existing accounts so you can exchange among them easily. (The name and account type would have to be identical.) By Mail Please make your check payable to T. Rowe Price Funds (otherwise it will be returned) and send your check, together with the New Account Form, to the appropriate address in the next paragraph. We do not accept third-party checks to open new accounts, except for IRA Rollover checks that are properly endorsed. T. ROWE PRICE 30 Regular Mail T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353 Mailgram, Express, Registered, or Certified Mail T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117 By Wire Call Investor Services for an account number and give the following wire information to your bank: PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account# 1004397951 name of owner(s) and account number Complete a New Account Form and mail it to one of the appropriate addresses listed previously. Note: No services will be established and IRS penalty withholding may occur until a signed New Account Form is received. Also, retirement plans cannot be opened by wire. By Exchange Call Shareholder Services or use Tele*Access or your personal computer (see Automated Services under Shareholder Services). The new account will have the same registration as the account from which you are exchanging. Services for the new account may be carried over by telephone request if preauthorized on the existing account. For limitations on exchanging, see explanation of Excessive Trading under Transaction Procedures and Special Requirements. In Person Drop off your New Account Form at any location listed on the cover and obtain a receipt. INVESTING WITH T. ROWE PRICE 31 PURCHASING ADDITIONAL SHARES ---------------------------------------------------------- $100 minimum purchase; $50 minimum for retirement plans, Automatic Asset Builder, and gifts or transfers to minors (UGMA/UTMA) accounts By ACH Transfer Use Tele*Access or your personal computer or call Investor Services if you have established electronic transfers using the ACH network. By Wire Call Shareholder Services or use the wire address in Opening a New Account. By Mail 1. Make your check payable to T. Rowe Price Funds (otherwise it may be returned). 2. Mail the check to us at the following address with either a fund reinvestment slip or a note indicating the fund you want to buy and your fund account number. 3. Remember to provide your account number and the fund name on the memo line of your check. Regular Mail T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500 /(For mailgrams, express, registered, or certified mail, see previous / /section.)/ By Automatic Asset Builder Fill out the Automatic Asset Builder section on the New Account or Shareholder Services Form. T. ROWE PRICE 32 EXCHANGING AND REDEEMING SHARES ---------------------------------------------------------- Exchange Service You can move money from one account to an existing identically registered account or open a new identically registered account. Remember, exchanges are purchases and sales for tax purposes. (Exchanges into a state tax-free fund are limited to investors living in states where the fund is registered.) Some of the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held for less than six months or one year, as specified in the prospectus. The fee is paid to the fund. By Phone Call Shareholder Services If you find our phones busy during unusually volatile markets, please consider placing your order by your personal computer, Tele*Access (if you have previously authorized telephone services), mailgram, or express mail. For exchange policies, please see Transaction Procedures and Special Requirements - Excessive Trading. Redemption proceeds can be mailed to your account address, sent by ACH transfer, or wired to your bank (provided your bank information is already on file). For charges, see Electronic Transfers - By Wire under Shareholder Services. By Mail For each account involved, provide the account name, number, fund name, and exchange or redemption amount. For exchanges, be sure to indicate any fund you are exchanging out of and the fund or funds you are exchanging into. Please mail to the appropriate address below. T. Rowe Price requires the signatures of all owners exactly as registered, and possibly a signature guarantee (see Transaction Procedures and Special Requirements - Signature Guarantees). Regular Mail For nonretirement and IRA accounts T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220 INVESTING WITH T. ROWE PRICE 33 For employer-sponsored retirement accounts T. Rowe Price Trust Company P.O. Box 89000 Baltimore, MD 21289-0300 /(For mailgrams, express, registered, or certified mail, see Opening a / /New Account.)/ Redemptions from employer-sponsored retirement accounts must be in writing; please call T. Rowe Price Trust Company or your plan administrator for instructions. IRA distributions may be requested in writing or by telephone; please call Shareholder Services to obtain an IRA Distribution Form or an IRA Shareholder Services Form to authorize the telephone redemption service. RIGHTS RESERVED BY THE FUNDS ---------------------------------------------------------- Each fund and its agents reserve the following rights: (1) to waive or lower investment minimums; (2) to accept initial purchases by telephone or mailgram; (3) to refuse any purchase or exchange order; (4) to cancel or rescind any purchase or exchange order (including, but not limited to, orders deemed to result in excessive trading, market timing, fraud, or 5% ownership) upon notice to the shareholder within five business days of the trade or if the written confirmation has not been received by the shareholder, whichever is sooner; (5) to freeze any account and suspend account services when notice has been received of a dispute between the registered or beneficial account owners or there is reason to believe a fraudulent transaction may occur; (6) to otherwise modify the conditions of purchase and any services at any time; or (7) to act on instructions believed to be genuine. These actions will be taken when, in the sole discretion of management, they are deemed to be in the best interest of the fund. In an effort to protect each fund from the possible adverse effects of a substantial redemption in a large account, as a matter of general policy no shareholder or group of related shareholders controlled by the same T. ROWE PRICE 34 person or group of persons will knowingly be permitted to purchase in excess of 5% of the outstanding shares of the fund, except upon approval of the fund's management. SHAREHOLDER SERVICES ---------------------------------------------------------- Shareholder Services 1-800-225-5132 Investor Services 1-800-638-5660 Many services are available to you as a T. Rowe Price shareholder; some you receive automatically, and others you must authorize on the New Account Form. By signing up for services on the New Account Form rather than later on, you avoid having to complete a separate form and obtain a signature guarantee. This section reviews some of the principal services currently offered. Our Services Guide, which we mail to all new shareholders, contains detailed descriptions of these and other services. Note: Corporate and other institutional accounts require an original or certified resolution to establish services and to redeem by mail. For more information, call Investor Services. Retirement Plans We offer a wide range of plans for individuals, institutions, and large and small businesses: Traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money purchase pension), 401(k), and 403(b)(7). For information on IRAs, call Investor Services. For information on all other retirement plans, including our no-load variable annuity, please call our Trust Company at 1-800-492-7670. Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days Tele*Access 24-hour service via toll-free number enables you to (1) access information on fund yields, prices, distributions, account balances, and your latest transaction; (2) request checks, prospectuses, services forms, duplicate statements, and tax forms; and (3) initiate purchase, redemption, and exchange transactions in your accounts (see Electronic Transfers on the next page). INVESTING WITH T. ROWE PRICE 35 Web Address www.troweprice.com After obtaining proper authorization, account transactions may also be conducted through our web site on the Internet. If you subscribe to America Online, you can access our web site via keyword "T. Rowe Price" and conduct transactions in your account. Plan Account Line 1-800-401-3279 Plan Account Line This 24-hour service is similar to Tele*Access but is designed specifically to meet the needs of retirement plan investors. Telephone and Walk-In Services Buy, sell, or exchange shares by calling one of our service representatives or by visiting one of our investor center locations whose addresses are listed on the cover. Electronic Transfers By ACH With no charges to pay, you can initiate a purchase or redemption for as little as $100 or as much as $100,000 between your bank account and fund account using the ACH network. Enter instructions via Tele*Access or your personal computer, or call Shareholder Services. By Wire Electronic transfers can be conducted via bank wire. There is currently a $5 fee for wire redemptions under $5,000, and your bank may charge for incoming or outgoing wire transfers regardless of size. Checkwriting (Not available for equity funds, or the High Yield or Emerging Markets Bond Funds) You may write an unlimited number of free checks on any money market fund, and most bond funds, with a minimum of $500 per check. Keep in mind, however, that a check results in a redemption; a check written on a bond fund will create a taxable event which you and we must report to the IRS. Automatic Investing ($50 minimum) You can invest automatically in several different ways, including: Automatic Asset Builder You instruct us to move $50 or more from your bank account, or you can instruct your employer to send all or a portion of your paycheck to the fund or funds you designate. T. ROWE PRICE 36 Automatic Exchange You can set up systematic investments from one fund account into another, such as from a money fund into a stock fund. DISCOUNT BROKERAGE ---------------------------------------------------------- To open an account 1-800-638-5660 For existing discount brokerage investors 1-800-225-7720 This service gives you the opportunity to consolidate all of your investments with one company. Investments available through our discount brokerage include stocks, options, bonds, non-T. Rowe Price mutual funds, and others at commission savings over full-service brokers. We also provide a wide range of services, including: Automated telephone and computer services You can enter stock and option trades, access quotes, and review account information around the clock by phone with Tele-Trader or via the Internet with Internet-Trader. Any trades executed through Tele-Trader save you an additional 10% on commissions. You will save 20% on commissions for stock trades when you trade through Internet-Trader. All trades are subject to a $35 minimum commission except stock trades placed through Internet-Trader, which are subject to a $29.95 minimum commission. Investor information A variety of informative reports, such as our Brokerage Insights series, S&P Market Month newsletter, and select stock reports can help you better evaluate economic trends and investment opportunities. Dividend Reinvestment Service Virtually all stocks held in customer accounts are eligible for this free service. /Discount Brokerage is a division of //T. Rowe Price// Investment / /Services, Inc., Member NASD/SIPC./ INVESTING WITH T. ROWE PRICE 37 INVESTMENT INFORMATION ---------------------------------------------------------- To help shareholders monitor their current investments and make decisions that accurately reflect their financial goals, T. Rowe Price offers a wide variety of information in addition to account statements. Most of this information is also available on our web site at www.troweprice.com. Shareholder Reports Fund managers' reviews of their strategies and results. If several members of a household own the same fund, only one fund report is mailed to that address. To receive additional copies, please call Shareholder Services or write to us at 100 East Pratt Street, Baltimore, Maryland 21202. The T. Rowe Price Report A quarterly investment newsletter discussing markets and financial strategies. Performance Update A quarterly review of all T. Rowe Price fund results. Insights Educational reports on investment strategies and financial markets. Investment Guides Asset Mix Worksheet, College Planning Kit, Diversifying Overseas: A T. Rowe Price Guide to International Investing, Managing Your Retirement Distribution, Personal Strategy Planner, Retirees Financial Guide, Retirement Planning Kit, and Tax Considerations for Investors. To help you achieve your financial goals, T. Rowe Price offers a wide range of stock, bond, and money market investments, as well as convenient services and informative reports. For Mutual Fund or Discount Brokerage Information Investor Services 1-800-638-5660 For Existing Accounts Shareholder Services 1-800-225-5132 For Yields, Prices, Account Information, or to Conduct Transactions Tele*Access/(R)/ 24 hours, 7 days 1-800-638-2587 Internet Address www.troweprice.com Plan Account Line For retirement plan investors 1-800-401-3279 Investor Centers 101 East Lombard St. Baltimore, MD 21202 T. Rowe Price Financial Center 10090 Red Run Blvd. Owings Mills, MD 21117 Farragut Square 900 17th Street, N.W. Washington, D.C. 20006 ARCO Tower 31st Floor 515 South Flower St. Los Angeles, CA 90071 4200 West Cypress St. 10th Floor Tampa, FL 33607 Headquarters 100 East Pratt St. Baltimore, MD 21202 A Statement of Additional Information about each fund has been filed with the Securities and Exchange Commission and has been incorporated by reference into this prospectus. Further information about each fund's investments, including a review of market conditions and the manager's recent strategies and their impact on performance, is available in the annual and semiannual shareholder reports. To obtain free copies of any of these documents, or for shareholder inquiries, call 1-800-638-5660. Fund reports and Statements of Additional Information are also available from the Securities and Exchange Commission by calling 1-800-SEC-0330 or writing the SEC's Public Reference Section, Washington, D.C. 20549-6009 (you will be charged a duplicating fee); by visiting the SEC's public reference room; or by consulting the SEC's web site at www.sec.gov. This prospectus contains information you should know before investing. Please keep it for future reference. 1940 Act File No. 811-5860 C07-040 10/1/98 STATEMENT OF ADDITIONAL INFORMATION The date of this Statement of Additional Information is October 1, 1998. T. ROWE PRICE CORPORATE INCOME FUND, INC. T. ROWE PRICE GNMA FUND T. ROWE PRICE HIGH YIELD FUND, INC. T. ROWE PRICE NEW INCOME FUND, INC. T. ROWE PRICE PERSONAL STRATEGY FUNDS, INC. T. Rowe Price Personal Strategy Balanced Fund T. Rowe Price Personal Strategy Growth Fund T. Rowe Price Personal Strategy Income Fund T. ROWE PRICE PRIME RESERVE FUND, INC. RESERVE INVESTMENT FUNDS, INC. Government Reserve Investment Fund Reserve Investment Fund T. ROWE PRICE SHORT-TERM BOND FUND, INC. T. ROWE PRICE SHORT-TERM U.S. GOVERNMENT FUND, INC. and T. ROWE PRICE U.S. TREASURY FUNDS, INC. U.S. Treasury Intermediate Fund U.S. Treasury Long-Term Fund U.S. Treasury Money Fund ___________________________________________________________________ Mailing Address: T. Rowe Price Investment Services, Inc. 100 East Pratt Street Baltimore, Maryland 21202 1-800-638-5660 This Statement of Additional Information is not a prospectus but should be read in conjunction with the appropriate Fund prospectus dated October 1, 1998, which may be obtained from T. Rowe Price Investment Services, Inc. If you would like a prospectus for a Fund of which you are not a shareholder, please call 1-800-638-5660. A prospectus with more complete information, including management fees and expenses, will be sent to you. Please read it carefully. Government Reserve and Reserve Investment Funds are not available for direct purchase by members of the public. C22-043 10/1/98
TABLE OF CONTENTS ----------------- Page Page ---- ---- Capital Stock 66 Management of the Funds 39 - ------------------------------ -------------------------------------------- Code of Ethics 54 Net Asset Value Per Share 61 - ------------------------------ -------------------------------------------- Custodian 53 Portfolio Management Practices 21 - ------------------------------ -------------------------------------------- Distributor for the 53 Portfolio Transactions 54 Funds - ------------------------------ -------------------------------------------- Dividends and 62 Pricing of Securities 59 Distributions - ------------------------------ -------------------------------------------- Federal Registration 67 Principal Holders of Securities 48 of Shares - ------------------------------ -------------------------------------------- Independent 68 Ratings of Commercial Paper 69 Accountants - ------------------------------ -------------------------------------------- Investment Management 49 Ratings of Corporate Debt Securities 70 Services - ------------------------------ -------------------------------------------- Investment Objectives 2 Risk Factors 2 and Policies - ------------------------------ -------------------------------------------- Investment Performance 64 Shareholder Services 54 - ------------------------------ -------------------------------------------- Investment Program 7 Tax Status 62 - ------------------------------ -------------------------------------------- Investment 36 Yield Information 63 Restrictions - ------------------------------ -------------------------------------------- Legal Counsel 68 - ------------------------------ --------------------------------------------
INVESTMENT OBJECTIVES AND POLICIES ------------------------------------------------------------------------------- The following information supplements the discussion of each Fund's investment objectives and policies discussed in the Funds' prospectus. The Funds will not make a material change in their investment objectives without obtaining shareholder approval. Unless otherwise specified, the investment programs and restrictions of the Funds are not fundamental policies. Each Fund's operating policies are subject to change by each Board of Directors/ Trustees without shareholder approval. However, shareholders will be notified of a material change in an operating policy. Each Fund's fundamental policies may not be changed without the approval of at least a majority of the outstanding shares of the Fund or, if it is less, 67% of the shares represented at a meeting of shareholders at which the holders of 50% or more of the shares are represented. Throughout this Statement of Additional Information, "the Fund" is intended to refer to each Fund listed on the cover page, unless otherwise indicated. RISK FACTORS ------------------------------------------------------------------------------- Reference is also made to the sections entitled "Types of Securities" and "Portfolio Management Practices" for discussions of the risks associated with the investments and practices described therein as they apply to the Fund. All Funds Debt Obligations Yields on short-, intermediate-, and long-term securities are dependent on a variety of factors, including the general conditions of the money and bond markets, the size of a particular offering, the maturity of the obligation, and the credit quality and rating of the issue. Debt securities with longer maturities tend to have higher yields and are generally subject to potentially greater capital appreciation and depreciation than obligations with shorter maturities and lower yields. The market prices of debt securities usually vary, depending upon available yields. An increase in interest rates will generally reduce the value of portfolio debt securities, and a decline in interest rates will generally increase the value of portfolio debt securities. The ability of the Fund to achieve its investment objective is also dependent on the continuing ability of the issuers of the debt securities in which the Fund invests to meet their obligations for the payment of interest and principal when due. Although the Fund seeks to reduce risk by portfolio diversification, credit analysis, and attention to trends in the economy, industries and financial markets, such efforts will not eliminate all risk. There can, of course, be no assurance that the Fund will achieve its investment objective. After purchase by the Fund, a debt security may cease to be rated or its rating may be reduced below the minimum required for purchase by the Fund. For the Government Reserve Investment; Prime Reserve; Reserve Investment; and U.S. Treasury Money Funds, the procedures set forth in Rule 2a-7, under the Investment Company Act of 1940 (the "1940 Act"), may require the prompt sale of any such security. For the other Funds, neither event will require a sale of such security by the Fund. However, T. Rowe Price will consider such event in its determination of whether the Fund should continue to hold the security. To the extent that the ratings given by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Corporation ("S&P") may change as a result of changes in such organizations or their rating systems, the Fund will attempt to use comparable ratings as standards for investments in accordance with the investment policies contained in the prospectus. When purchasing unrated securities, T. Rowe Price, under the supervision of the Fund's Board of Directors/Trustees, determines whether the unrated security is of a quality comparable to that which the Fund is allowed to purchase. Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds There can be no assurance that the Fund will achieve its investment objective or be able to maintain its net asset value per share at $1.00. The price of the Fund is not guaranteed or insured by the U.S. government and its yield is not fixed. An increase in interest rates could reduce the value of the Fund's portfolio investments, and a decline in interest rates could increase the value. All Funds except Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds Because of its investment policy, the Fund may or may not be suitable or appropriate for all investors. The Fund is not a money market fund and is not an appropriate investment for those whose primary objective is principal stability. The value of the portfolio securities of the Fund will fluctuate based upon market conditions. Although the Fund seeks to reduce risk by investing in a diversified portfolio, such diversification does not eliminate all risk. There can, of course, be no assurance that the Fund will achieve its investment objective. Mortgage-backed securities differ from conventional bonds in that principal is paid back over the life of the security rather than at maturity. As a result, the holder of a mortgage-backed security (i.e., the Fund) receives monthly scheduled payments of principal and interest, and may receive unscheduled principal payments representing prepayments on the underlying mortgages. The incidence of unscheduled principal prepayments is also likely to increase in mortgage pools owned by the Fund when prevailing mortgage loan rates fall below the mortgage rates of the securities underlying the individual pool. The effect of such prepayments in a falling rate environment is to (1) cause the Fund to reinvest principal payments at the then lower prevailing interest rate, and (2) reduce the potential for capital appreciation beyond the face amount of the security. Conversely, the Fund may realize a gain on prepayments of mortgage pools trading at a discount. Such prepayments will provide an early return of principal which may then be reinvested at the then higher prevailing interest rate. The market value of adjustable rate mortgage securities ("ARMs"), like other U.S. government securities, will generally vary inversely with changes in market interest rates, declining when interest rates rise and rising when interest rates decline. Because of their periodic adjustment feature, ARMs should be more sensitive to short-term interest rates than long-term rates. They should also display less volatility than long-term mortgage-backed securities. Thus, while having less risk of a decline during periods of rapidly rising rates, ARMs may also have less potential for capital appreciation than other investments of comparable maturities. Interest rate caps on mortgages underlying ARM securities may prevent income on the ARM from increasing to prevailing interest rate levels and cause the securities to decline in value. In addition, to the extent ARMs are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments may result in some loss of the holders' principal investment to the extent of the premium paid. On the other hand, if ARMs are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal will increase current and total returns and will accelerate the recognition of income which when distributed to shareholders will be taxable as ordinary income. Corporate Income, High Yield, New Income, Personal Strategy, and Short-Term Bond Funds Risk Factors of Foreign Investing There are special risks in foreign investing. Certain of these risks are inherent in any mutual fund while others relate more to the countries in which the Fund will invest. Many of the risks are more pronounced for investments in developing or emerging market countries, such as many of the countries of Asia, Latin America, Eastern Europe, Russia, Africa and the Middle East. Although there is no universally accepted definition, a developing country is generally considered to be a country which is in the initial stages of its industrialization cycle with a per capita gross national product of less than $8,000. . Political and Economic Factors Individual foreign economies of certain countries differ favorably or unfavorably from the United States' economy in such respects as growth of gross national product, rate of inflation, capital reinvestment, resource self-sufficiency and balance of payments position. The internal politics of certain foreign countries are not as stable as in the United States. For example, in 1991, the existing government in Thailand was overthrown in a military coup. In 1992, there were two military coup attempts in Venezuela and in 1992 the President of Brazil was impeached. In 1994-1995, the Mexican peso plunged in value setting off a severe crisis in the Mexican economy. Asia is still coming to terms with its own crisis and recessionary conditions sparked off by widespread currency weakness in late 1997. In addition, significant external political risks currently affect some foreign countries. Both Taiwan and China still claim sovereignty of one another and there is a demilitarized border and hostile relations between North and South Korea. Governments in certain foreign countries continue to participate to a significant degree, through ownership interest or regulation, in their respective economies. Action by these governments could have a significant effect on market prices of securities and payment of dividends. The economies of many foreign countries are heavily dependent upon international trade and are accordingly affected by protective trade barriers and economic conditions of their trading partners. The enactment by these trading partners of protectionist trade legislation could have a significant adverse effect upon the securities markets of such countries. . Currency Fluctuations The Fund invests in securities denominated in various currencies. Accordingly, a change in the value of any such currency against the U.S. dollar will result in a corresponding change in the U. S. dollar value of the Fund's assets denominated in that currency. Such changes will also affect the Fund's income. Generally, when a given currency appreciates against the dollar (the dollar weakens) the value of the Fund's securities denominated in that currency will rise. When a given currency depreciates against the dollar (the dollar strengthens) the value of the Fund's securities denominated in that currency would be expected to decline. . Investment and Repatriation of Restrictions Foreign investment in the securities markets of certain foreign countries is restricted or controlled in varying degrees. These restrictions limit at times and preclude investment in certain of such countries and increase the cost and expenses of the Fund. Investments by foreign investors are subject to a variety of restrictions in many developing countries. These restrictions may take the form of prior governmental approval, limits on the amount or type of securities held by foreigners, and limits on the types of companies in which foreigners may invest. Additional or different restrictions may be imposed at any time by these or other countries in which the Funds invest. In addition, the repatriation of both investment income and capital from several foreign countries is restricted and controlled under certain regulations, including in some cases the need for certain government consents. For example, capital invested in Chile normally cannot be repatriated for one year. . Market Characteristics It is contemplated that most foreign securities will be purchased in over-the-counter markets or on stock exchanges located in the countries in which the respective principal offices of the issuers of the various securities are located, if that is the best available market. Investments in certain markets may be made through ADRs traded in the United States. Foreign stock markets are generally not as developed or efficient as, and more volatile than, those in the United States. While growing in volume, they usually have substantially less volume than U.S. markets and the Fund's portfolio securities may be less liquid and subject to more rapid and erratic price movements than securities of comparable U.S. companies. Equity securities may trade at price/earnings multiples higher than comparable United States securities and such levels may not be sustainable. Commissions on foreign stocks are generally higher than commissions on United States exchanges, and while there is an increasing number of overseas stock markets that have adopted a system of negotiated rates, a number are still subject to an established schedule of minimum commission rates. There is generally less government supervision and regulation of foreign stock exchanges, brokers, and listed companies than in the United States. Moreover, settlement practices for transactions in foreign markets may differ from those in United States markets. Such differences include delays beyond periods customary in the United States and practices, such as delivery of securities prior to receipt of payment, which increase the likelihood of a "failed settlement." Failed settlements can result in losses to the Fund. . Investment Funds The Fund may invest in investment funds which have been authorized by the governments of certain countries specifically to permit foreign investment in securities of companies listed and traded on the stock exchanges in these respective countries. The Fund's investment in these funds is subject to the provisions of the 1940 Act. If the Fund invests in such investment funds, the Fund's shareholders will bear not only their proportionate share of the expenses of the Fund (including operating expenses and the fees of the investment manager), but also will bear indirectly similar expenses of the underlying investment funds. In addition, the securities of these investment funds may trade at a premium over their net asset value. . Information and Supervision There is generally less publicly available information about foreign companies comparable to reports and ratings that are published about companies in the United States. Foreign companies are also generally not subject to uniform accounting, auditing and financial reporting standards, practices, and requirements comparable to those applicable to United States companies. It also is often more difficult to keep currently informed of corporate actions which affect the prices of portfolio securities. . Taxes The dividends and interest payable on certain of the Fund's foreign portfolio securities may be subject to foreign withholding taxes, thus reducing the net amount of income available for distribution to the Fund's shareholders. . Other With respect to certain foreign countries, especially developing and emerging ones, there is the possibility of adverse changes in investment or exchange control regulations, expropriation or confiscatory taxation, limitations on the removal of Funds or other assets of the Funds, political or social instability, or diplomatic developments which could affect investments by U.S. persons in those countries. . Eastern Europe and Russia Changes occurring in Eastern Europe and Russia today could have long-term potential consequences. As restrictions fall, this could result in rising standards of living, lower manufacturing costs, growing consumer spending, and substantial economic growth. However, investment in the countries of Eastern Europe and Russia is highly speculative at this time. Political and economic reforms are too recent to establish a definite trend away from centrally planned economies and state-owned industries. In many of the countries of Eastern Europe and Russia, there is no stock exchange or formal market for securities. Such countries may also have government exchange controls, currencies with no recognizable market value relative to the established currencies of western market economies, little or no experience in trading in securities, no financial reporting standards, a lack of a banking and securities infrastructure to handle such trading, and a legal tradition which does not recognize rights in private property. In addition, these countries may have national policies which restrict investments in companies deemed sensitive to the country's national interest. Further, the governments in such countries may require governmental or quasi-governmental authorities to act as custodian of the Fund's assets invested in such countries, and these authorities may not qualify as a foreign custodian under the Investment Company Act of 1940 and exemptive relief from such Act may be required. All of these considerations are among the factors which could cause significant risks and uncertainties to investment in Eastern Europe and Russia. The Fund will only invest in a company located in, or a government of, Eastern Europe and Russia, if it believes the potential return justifies the risk. . Latin America Inflation Most Latin American countries have experienced, at one time or another, severe and persistent levels of inflation, including, in some cases, hyperinflation. This has, in turn, led to high interest rates, extreme measures by governments to keep inflation in check, and a generally debilitating effect on economic growth. Although inflation in many countries has lessened, there is no guarantee it will remain at lower levels. Political Instability The political history of certain Latin American countries has been characterized by political uncertainty, intervention by the military in civilian and economic spheres, and political corruption. Such developments, if they were to reoccur, could reverse favorable trends toward market and economic reform, privatization, and removal of trade barriers, and result in significant disruption in securities markets. Foreign Currency Certain Latin American countries may have managed currencies which are maintained at artificial levels to the U. S. dollar rather than at levels determined by the market. This type of system can lead to sudden and large adjustments in the currency which, in turn, can have a disruptive and negative effect on foreign investors. For example, in late 1994 the value of the Mexican peso lost more than one-third of its value relative to the dollar. Certain Latin American countries also restrict the free conversion of their currency into foreign currencies, including the U.S. dollar. There is no significant foreign exchange market for many currencies and it would, as a result, be difficult for the Fund to engage in foreign currency transactions designed to protect the value of the Fund's interests in securities denominated in such currencies. Sovereign Debt A number of Latin American countries are among the largest debtors of developing countries. There have been moratoria on, and reschedulings of, repayment with respect to these debts. Such events can restrict the flexibility of these debtor nations in the international markets and result in the imposition of onerous conditions on their economies. Corporate Income, High Yield, and Personal Strategy Funds Special Risks of Investing in Junk Bonds The following special considerations are additional risk factors associated with the Fund's investments in lower-rated debt securities. . Youth and Growth of the Lower-Rated Debt Securities Market The market for lower-rated debt securities is relatively new and its growth has paralleled a long economic expansion. Past experience may not, therefore, provide an accurate indication of future performance of this market, particularly during periods of economic recession. An economic downturn or increase in interest rates is likely to have a greater negative effect on this market, the value of lower-rated debt securities in the Fund's portfolio, the Fund's net asset value and the ability of the bonds' issuers to repay principal and interest, meet projected business goals and obtain additional financing than on higher-rated securities. These circumstances also may result in a higher incidence of defaults than with respect to higher-rated securities. An investment in this Fund is more speculative than investment in shares of a fund which invests only in higher-rated debt securities. . Sensitivity to Interest Rate and Economic Changes Prices of lower-rated debt securities may be more sensitive to adverse economic changes or corporate developments than higher-rated investments. Debt securities with longer maturities, which may have higher yields, may increase or decrease in value more than debt securities with shorter maturities. Market prices of lower-rated debt securities structured as zero coupon or pay-in-kind securities are affected to a greater extent by interest rate changes and may be more volatile than securities which pay interest periodically and in cash. Where it deems it appropriate and in the best interests of Fund shareholders, the Fund may incur additional expenses to seek recovery on a debt security on which the issuer has defaulted and to pursue litigation to protect the interests of security holders of its portfolio companies. . Liquidity and Valuation Because the market for lower-rated securities may be thinner and less active than for higher-rated securities, there may be market price volatility for these securities and limited liquidity in the resale market. Nonrated securities are usually not as attractive to as many buyers as rated securities are, a factor which may make nonrated securities less marketable. These factors may have the effect of limiting the availability of the securities for purchase by the Fund and may also limit the ability of the Fund to sell such securities at their fair value either to meet redemption requests or in response to changes in the economy or the financial markets. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of lower-rated debt securities, especially in a thinly traded market. To the extent the Fund owns or may acquire illiquid or restricted lower-rated securities, these securities may involve special registration responsibilities, liabilities and costs, and liquidity and valuation difficulties. Changes in values of debt securities which the Fund owns will affect its net asset value per share. If market quotations are not readily available for the Fund's lower-rated or nonrated securities, these securities will be valued by a method that the Fund's Board of Directors believes accurately reflects fair value. Judgment plays a greater role in valuing lower-rated debt securities than with respect to securities for which more external sources of quotations and last sale information are available. . Taxation Special tax considerations are associated with investing in lower-rated debt securities structured as zero coupon or pay-in-kind securities. The Fund accrues income on these securities prior to the receipt of cash payments. The Fund must distribute substantially all of its income to its shareholders to qualify for pass-through treatment under the tax laws and may, therefore, have to dispose of its portfolio securities to satisfy distribution requirements. INVESTMENT PROGRAM ------------------------------------------------------------------------------- Types of Securities Set forth below is additional information about certain of the investments described in the Fund's prospectus. Debt Securities Fixed income securities in which the Fund may invest include, but are not limited to, those described below. All Funds . U.S. Government Obligations Bills, notes, bonds, and other debt securities issued by the U.S. Treasury. These are direct obligations of the U.S. government and differ mainly in the length of their maturities. . U.S. Government Agency Securities Issued or guaranteed by U.S. government-sponsored enterprises and federal agencies. These include securities issued by the Federal National Mortgage Association, Government National Mortgage Association, Federal Home Loan Bank, Federal Land Banks, Farmers Home Administration, Banks for Cooperatives, Federal Intermediate Credit Banks, Federal Financing Bank, Farm Credit Banks, the Small Business Association, and the Tennessee Valley Authority. Some of these securities are supported by the full faith and credit of the U.S. Treasury; the remainder are supported only by the credit of the instrumentality, which may or may not include the right of the issuer to borrow from the Treasury. The GNMA, U.S. Treasury Money, Intermediate, and Long-Term Funds and GRIF may only invest in these securities if they are supported by the full faith and credit of the U.S. government. All Funds except GNMA, Government Reserve Investment, U.S. Treasury Money, Intermediate, and Long-Term Funds . Bank Obligations Certificates of deposit, bankers' acceptances, and other short-term debt obligations. Certificates of deposit are short-term obligations of commercial banks. A bankers' acceptance is a time draft drawn on a commercial bank by a borrower, usually in connection with international commercial transactions. Certificates of deposit may have fixed or variable rates. The Fund may invest in U.S. banks, foreign branches of U.S. banks, U.S. branches of foreign banks, and foreign branches of foreign banks. . Corporate Debt Securities Outstanding nonconvertible corporate debt securities (e.g., bonds and debentures) which have one year or less remaining to maturity. Corporate notes may have fixed, variable, or floating rates. . Commercial Paper Short-term promissory notes issued by corporations primarily to finance short-term credit needs. Certain notes may have floating or variable rates. . Foreign Government Securities Issued or guaranteed by a foreign government, province, instrumentality, political subdivision, or similar unit thereof. . Savings and Loan Obligations Negotiable certificates of deposit and other short-term debt obligations of savings and loan associations. . Supranational Agencies Securities of certain supranational entities, such as the International Development Bank. All Funds except Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds Mortgage-Related Securities Mortgage-related securities in which the Fund may invest include, but are not limited to, those described below. The GNMA, U.S. Treasury Intermediate and U.S. Treasury Long-Term Funds may only invest in these securities to the extent they are backed by the full faith and credit of the U.S. government. . Mortgage-Backed Securities Mortgage-backed securities are securities representing an interest in a pool of mortgages. The mortgages may be of a variety of types, including adjustable rate, conventional 30-year fixed rate, graduated payment, and 15-year. Principal and interest payments made on the mortgages in the underlying mortgage pool are passed through to the Fund. This is in contrast to traditional bonds where principal is normally paid back at maturity in a lump sum. Unscheduled prepayments of principal shorten the securities' weighted average life and may lower their total return. (When a mortgage in the underlying mortgage pool is prepaid, an unscheduled principal prepayment is passed through to the Fund. This principal is returned to the Fund at par. As a result, if a mortgage security were trading at a premium, its total return would be lowered by prepayments, and if a mortgage security were trading at a discount, its total return would be increased by prepayments.) The value of these securities also may change because of changes in the market's perception of the creditworthiness of the federal agency that issued them. In addition, the mortgage securities market in general may be adversely affected by changes in governmental regulation or tax policies. . U.S. Government Agency Mortgage-Backed Securities These are obligations issued or guaranteed by the United States government or one of its agencies or instrumentalities, such as the Government National Mortgage Association ("Ginnie Mae" or "GNMA"), the Federal National Mortgage Association ("Fannie Mae" or "FNMA") the Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC"), and the Federal Agricultural Mortgage Corporation ("Farmer Mac" or "FAMC"). FNMA, FHLMC, and FAMC obligations are not backed by the full faith and credit of the U.S. government as GNMA certificates are, but they are supported by the instrumentality's right to borrow from the United States Treasury. U.S. Government Agency Mortgage-Backed Certificates provide for the pass-through to investors of their pro-rata share of monthly payments (including any prepayments) made by the individual borrowers on the pooled mortgage loans, net of any fees paid to the guarantor of such securities and the servicer of the underlying mortgage loans. Each of GNMA, FNMA, FHLMC, and FAMC guarantees timely distributions of interest to certificate holders. GNMA and FNMA guarantee timely distributions of scheduled principal. FHLMC has in the past guaranteed only the ultimate collection of principal of the underlying mortgage loan; however, FHLMC now issues mortgage-backed securities (FHLMC Gold PCS) which also guarantee timely payment of monthly principal reductions. . Ginnie Mae Certificates Ginnie Mae is a wholly owned corporate instrumentality of the United States within the Department of Housing and Urban Development. The National Housing Act of 1934, as amended (the "Housing Act"), authorizes Ginnie Mae to guarantee the timely payment of the principal of and interest on certificates that are based on and backed by a pool of mortgage loans insured by the Federal Housing Administration under the Housing Act, or Title V of the Housing Act of 1949 ("FHA Loans"), or guaranteed by the Department of Veterans Affairs under the Servicemen's Readjustment Act of 1944, as amended ("VA Loans"), or by pools of other eligible mortgage loans. The Housing Act provides that the full faith and credit of the United States government is pledged to the payment of all amounts that may be required to be paid under any guaranty. In order to meet its obligations under such guaranty, Ginnie Mae is authorized to borrow from the United States Treasury with no limitations as to amount. . Fannie Mae Certificates Fannie Mae is a federally chartered and privately owned corporation organized and existing under the Federal National Mortgage Association Charter Act of 1938. FNMA Certificates represent a pro-rata interest in a group of mortgage loans purchased by Fannie Mae. FNMA guarantees the timely payment of principal and interest on the securities it issues. The obligations of FNMA are not backed by the full faith and credit of the U.S. government. . Freddie Mac Certificates Freddie Mac is a corporate instrumentality of the United States created pursuant to the Emergency Home Finance Act of 1970, as amended (the "FHLMC Act"). Freddie Mac Certificates represent a pro-rata interest in a group of mortgage loans (a "Freddie Mac Certificate group") purchased by Freddie Mac. Freddie Mac guarantees timely payment of interest and principal on certain securities it issues and timely payment of interest and eventual payment of principal on other securities it issues. The obligations of Freddie Mac are obligations solely of Freddie Mac and are not backed by the full faith and credit of the U.S. government. . Farmer Mac Certificates The Federal Agricultural Mortgage Corporation ("Farmer Mac") is a federally chartered instrumentality of the United States established by Title VIII of the Farm Credit Act of 1971, as amended ("Charter Act"). Farmer Mac was chartered primarily to attract new capital for financing of agricultural real estate by making a secondary market in certain qualified agricultural real estate loans. Farmer Mac provides guarantees of timely payment of principal and interest on securities representing interests in, or obligations backed by, pools of mortgages secured by first liens on agricultural real estate ("Farmer Mac Certificates"). Similar to Fannie Mae and Freddie Mac, Farmer Mac Certificates are not supported by the full faith and credit of the U.S. government; rather, Farmer Mac may borrow from the U.S. Treasury to meet its guaranty obligations. As discussed above, prepayments on the underlying mortgages and their effect upon the rate of return of a mortgage-backed security, is the principal investment risk for a purchaser of such securities, like the Fund. Over time, any pool of mortgages will experience prepayments due to a variety of factors, including (1) sales of the underlying homes (including foreclosures), (2) refinancings of the underlying mortgages, and (3) increased amortization by the mortgagee. These factors, in turn, depend upon general economic factors, such as level of interest rates and economic growth. Thus, investors normally expect prepayment rates to increase during periods of strong economic growth or declining interest rates, and to decrease in recessions and rising interest rate environments. Accordingly, the life of the mortgage-backed security is likely to be substantially shorter than the stated maturity of the mortgages in the underlying pool. Because of such variation in prepayment rates, it is not possible to predict the life of a particular mortgage-backed security, but FHA statistics indicate that 25- to 30-year single family dwelling mortgages have an average life of approximately 12 years. The majority of Ginnie Mae Certificates are backed by mortgages of this type, and, accordingly, the generally accepted practice treats Ginnie Mae Certificates as 30-year securities which prepay in full in the 12th year. FNMA and Freddie Mac Certificates may have differing prepayment characteristics. Fixed rate mortgage-backed securities bear a stated "coupon rate" which represents the effective mortgage rate at the time of issuance, less certain fees to GNMA, FNMA and FHLMC for providing the guarantee, and the issuer for assembling the pool and for passing through monthly payments of interest and principal. Payments to holders of mortgage-backed securities consist of the monthly distributions of interest and principal less the applicable fees. The actual yield to be earned by a holder of mortgage-backed securities is calculated by dividing interest payments by the purchase price paid for the mortgage-backed securities (which may be at a premium or a discount from the face value of the certificate). Monthly distributions of interest, as contrasted to semiannual distributions which are common for other fixed interest investments, have the effect of compounding and thereby raising the effective annual yield earned on mortgage-backed securities. Because of the variation in the life of the pools of mortgages which back various mortgage-backed securities, and because it is impossible to anticipate the rate of interest at which future principal payments may be reinvested, the actual yield earned from a portfolio of mortgage-backed securities will differ significantly from the yield estimated by using an assumption of a certain life for each mortgage-backed security included in such a portfolio as described above. . Collateralized Mortgage Obligations (CMOs) CMOs are bonds that are collateralized by whole loan mortgages or mortgage pass-through securities. The bonds issued in a CMO deal are divided into groups, and each group of bonds is referred to as a "tranche." Under the traditional CMO structure, the cash flows generated by the mortgages or mortgage pass-through securities in the collateral pool are used to first pay interest and then pay principal to the CMO bondholders. The bonds issued under a CMO structure are retired sequentially as opposed to the pro-rata return of principal found in traditional pass-through obligations. Subject to the various provisions of individual CMO issues, the cash flow generated by the underlying collateral (to the extent it exceeds the amount required to pay the stated interest) is used to retire the bonds. Under the CMO structure, the repayment of principal among the different tranches is prioritized in accordance with the terms of the particular CMO issuance. The "fastest-pay" tranche of bonds, as specified in the prospectus for the issuance, would initially receive all principal payments. When that tranche of bonds is retired, the next tranche, or tranches, in the sequence, as specified in the prospectus, receive all of the principal payments until they are retired. The sequential retirement of bond groups continues until the last tranche, or group of bonds, is retired. Accordingly, the CMO structure allows the issuer to use cash flows of long maturity, monthly-pay collateral to formulate securities with short, intermediate and long final maturities and expected average lives. In recent years, new types of CMO structures have evolved. These include floating rate CMOs, planned amortization classes, accrual bonds and CMO residuals. These newer structures affect the amount and timing of principal and interest received by each tranche from the underlying collateral. Under certain of these new structures, given classes of CMOs have priority over others with respect to the receipt of prepayments on the mortgages. Therefore, depending on the type of CMOs in which the Fund invests, the investment may be subject to a greater or lesser risk of prepayment than other types of mortgage-related securities. The primary risk of any mortgage security is the uncertainty of the timing of cash flows. For CMOs, the primary risk results from the rate of prepayments on the underlying mortgages serving as collateral. An increase or decrease in prepayment rates (resulting from a decrease or increase in mortgage interest rates) will affect the yield, average life and price of CMOs. The prices of certain CMOs, depending on their structure and the rate of prepayments, can be volatile. Some CMOs may also not be as liquid as other securities. . U.S. Government Agency Multiclass Pass-Through Securities Unlike CMOs, U.S. Government Agency Multiclass Pass-Through Securities, which include FNMA Guaranteed REMIC Pass-Through Certificates and FHLMC Multi-Class Mortgage Participation Certificates, are ownership interests in a pool of Mortgage Assets. Unless the context indicates otherwise, all references herein to CMOs include multiclass pass-through securities. . Multi-Class Residential Mortgage Securities Such securities represent interests in pools of mortgage loans to residential home buyers made by commercial banks, savings and loan associations or other financial institutions. Unlike GNMA, FNMA and FHLMC securities, the payment of principal and interest on Multi-Class Residential Mortgage Securities is not guaranteed by the U.S. government or any of its agencies. Accordingly, yields on Multi-Class Residential Mortgage Securities have been historically higher than the yields on U.S. government mortgage securities. However, the risk of loss due to default on such instruments is higher since they are not guaranteed by the U.S. government or its agencies. Additionally, pools of such securities may be divided into senior or subordinated segments. Although subordinated mortgage securities may have a higher yield than senior mortgage securities, the risk of loss of principal is greater because losses on the underlying mortgage loans must be borne by persons holding subordinated securities before those holding senior mortgage securities. . Privately Issued Mortgage-Backed Certificates These are pass-through certificates issued by non-governmental issuers. Pools of conventional residential mortgage loans created by such issuers generally offer a higher rate of interest than government and government-related pools because there are no direct or indirect government guarantees of payment. Timely payment of interest and principal of these pools is, however, generally supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance. The insurance and guarantees are issued by government entities, private insurance or the mortgage poolers. Such insurance and guarantees and the creditworthiness of the issuers thereof will be considered in determining whether a mortgage-related security meets the Fund's quality standards. The Fund may buy mortgage-related securities without insurance or guarantees if through an examination of the loan experience and practices of the poolers, the investment manager determines that the securities meet the Fund's quality standards. . Stripped Mortgage-Backed Securities These instruments are a type of potentially high-risk derivative. They represent interests in a pool of mortgages, the cash flow of which has been separated into its interest and principal components. "IOs" (interest only securities) receive the interest portion of the cash flow while "POs" (principal only securities) receive the principal portion. IOs and POs are usually structured as tranches of a CMO. Stripped Mortgage-Backed Securities may be issued by U.S. government agencies or by private issuers similar to those described above with respect to CMOs and privately issued mortgage-backed certificates. As interest rates rise and fall, the value of IOs tends to move in the same direction as interest rates. The value of the other mortgage-backed securities described herein, like other debt instruments, will tend to move in the opposite direction compared to interest rates. Under the Internal Revenue Code of 1986, as amended (the "Code"), POs may generate taxable income from the current accrual of original issue discount, without a corresponding distribution of cash to the Fund. The cash flows and yields on IO and PO classes are extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets. In the case of IOs, prepayments affect the amount, but not the timing, of cash flows provided to the investor. In contrast, prepayments on the mortgage pool affect the timing, but not the amount, of cash flows received by investors in POs. For example, a rapid or slow rate of principal payments may have a material adverse effect on the prices of IOs or POs, respectively. If the underlying mortgage assets experience greater than anticipated prepayments of principal, an investor may fail to fully recoup its initial investment in an IO class of a stripped mortgage-backed security, even if the IO class is rated AAA or Aaa or is derived from a full faith and credit obligation. Conversely, if the underlying mortgage assets experience slower than anticipated prepayments of principal, the price on a PO class will be affected more severely than would be the case with a traditional mortgage-backed security. The staff of the Securities and Exchange Commission ("SEC") has advised the Fund that it believes the Fund should treat IOs and POs, other than government-issued IOs or POs backed by fixed rate mortgages, as illiquid securities and, accordingly, limit its investments in such securities, together with all other illiquid securities, to 15% of the Fund's net assets. Under the staff's position, the determination of whether a particular government-issued IO and PO backed by fixed rate mortgages may be made on a case by case basis under guidelines and standards established by the Fund's Board of Directors/Trustees. The Fund's Board of Directors/Trustees has delegated to T. Rowe Price the authority to determine the liquidity of these investments based on the following guidelines: the type of issuer; type of collateral, including age and prepayment characteristics; rate of interest on coupon relative to current market rates and the effect of the rate on the potential for prepayments; complexity of the issue's structure, including the number of tranches; size of the issue and the number of dealers who make a market in the IO or PO. The Fund will treat nongovernment-issued IOs and POs not backed by fixed or adjustable rate mortgages as illiquid unless and until the SEC staff modifies its position. . Adjustable Rate Mortgage Securities ("ARMs") ARMs, like fixed rate mortgages, have a specified maturity date, and the principal amount of the mortgage is repaid over the life of the mortgage. Unlike fixed rate mortgages, the interest rate on ARMs is adjusted at regular intervals based on a specified, published interest rate "index" such as a Treasury rate index. The new rate is determined by adding a specific interest amount, the "margin," to the interest rate of the index. Investment in ARM securities allows the Fund to participate in changing interest rate levels through regular adjustments in the coupons of the underlying mortgages, resulting in more variable current income and lower price volatility than longer-term fixed rate mortgage securities. The ARM securities in which the Fund expects to invest will generally adjust their interest rates at regular intervals of one year or less. ARM securities are a less effective means of locking in long-term rates than fixed rate mortgages since the income from adjustable rate mortgages will increase during periods of rising interest rates and decline during periods of falling rates. . Characteristics of Adjustable Rate Mortgage Securities-Interest Rate Indices The interest rates paid on adjustable rate securities are readjusted periodically to an increment over some predetermined interest rate index. Such readjustments occur at intervals ranging from one to 60 months. There are three main categories of indexes: (1) those based on U.S. Treasury securities; (2) those derived from a calculated measure such as a cost of funds index ("COFI") or a moving average of mortgage rates; and (3) those based on actively traded or prominently posted short-term, interest rates. Commonly utilized indexes include the one-year, three-year and five-year constant maturity Treasury rates, the three-month Treasury bill rate, the 180-day Treasury bill rate, rates on longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds, the National Median Cost of Funds, the one-month, three-month, six-month or one-year London Interbank Offered Rate ("LIBOR"), the prime rate of a specific bank, or commercial paper rates. Some indexes, such as the one-year constant maturity Treasury rate, closely mirror changes in market interest rate levels. Others, such as the 11th District Home Loan Bank Cost of Funds index, tend to lag behind changes in market rate levels. The market value of the Fund's assets and of the net asset value of the Fund's shares will be affected by the length of the adjustment period, the degree of volatility in the applicable indexes and the maximum increase or decrease of the interest rate adjustment on any one adjustment date, in any one year and over the life of the securities. These maximum increases and decreases are typically referred to as "caps" and "floors," respectively. A number of factors affect the performance of the COFI and may cause the COFI to move in a manner different from indices based upon specific interest rates, such as the One Year Treasury Index. Additionally, there can be no assurance that the COFI will necessarily move in the same direction or at the same rate as prevailing interest rates. Furthermore, any movement in the COFI as compared to other indices based upon specific interest rates may be affected by changes instituted by the FHLB of San Francisco in the method used to calculate the COFI. To the extent that the COFI may reflect interest changes on a more delayed basis than other indices, in a period of rising interest rates, any increase may produce a higher yield later than would be produced by such other indices, and in a period of declining interest rates, the COFI may remain higher than other market interest rates which may result in a higher level of principal prepayments on mortgage loans which adjust in accordance with the COFI than mortgage loans which adjust in accordance with other indices. LIBOR, is the interest rate that the most creditworthy international banks dealing in U.S. dollar-denominated deposits and loans charge each other for large dollar-denominated loans. LIBOR is also usually the base rate for large dollar-denominated loans in the international market. LIBOR is generally quoted for loans having rate adjustments at one-, three-, six- or 12- month intervals. Caps and Floors ARMs will frequently have caps and floors which limit the maximum amount by which the interest rate to the residential borrower may move up or down, respectively, each adjustment period and over the life of the loan. Interest rate caps on ARM securities may cause them to decrease in value in an increasing interest rate environment. Such caps may also prevent their income from increasing to levels commensurate with prevailing interest rates. Conversely, interest rate floors on ARM securities may cause their income to remain higher than prevailing interest rate levels and result in an increase in the value of such securities. However, this increase may be tempered by the acceleration of prepayments. Mortgage securities generally have a maximum maturity of up to 30 years. However due to the adjustable rate feature of ARM securities, their prices are considered to have volatility characteristics which approximate the average period of time until the next adjustment of the interest rate. As a result, the principal volatility of ARM securities may be more comparable to short- and intermediate-term securities than to longer-term fixed rate mortgage securities. Prepayments however, will increase their principal volatility. See also the discussion of Mortgage-Backed Securities. Several characteristics of ARMs may make them more susceptible to prepayments than other Mortgage-Backed Securities. An adjustable rate mortgage has greater incentives to refinance with a fixed rate mortgage during favorable interest rate environments, in order to avoid interest rate risk. Also, homes financed with adjustable rate mortgages may be sold more frequently because of the prevalence of first-time home buyers in the adjustable rate mortgage market. Also, delinquency and foreclosure rates are higher in this market since many buyers use adjustable rate mortgages to purchase homes that they could not otherwise finance on a fixed rate basis. Significant increases in the index rates for the adjustable rate mortgages may also result in increased delinquency and default rates, which in turn, may affect prepayment rates on the ARMs. . Other Mortgage Related Securities The Fund expects that governmental, government-related or private entities may create mortgage loan pools offering pass-through investments in addition to those described above. The mortgages underlying these securities may be alternative mortgage instruments, that is, mortgage instruments whose principal or interest payments may vary or whose terms to maturity may differ from customary long-term fixed rate mortgages. As new types of mortgage-related securities are developed and offered to investors, the investment manager will, consistent with the Fund's objective, policies and quality standards, consider making investments in such new types of securities. All Funds except GNMA, Government Reserve Investment, U.S. Treasury Money, Intermediate, and Long-Term Funds Asset-Backed Securities The credit quality of most asset-backed securities depends primarily on the credit quality of the assets underlying such securities, how well the entity issuing the security is insulated from the credit risk of the originator or any other affiliated entities and the amount and quality of any credit support provided to the securities. The rate of principal payment on asset-backed securities generally depends on the rate of principal payments received on the underlying assets which in turn may be affected by a variety of economic and other factors. As a result, the yield on any asset-backed security is difficult to predict with precision and actual yield to maturity may be more or less than the anticipated yield to maturity. Asset-backed securities may be classified as pass-through certificates or collateralized obligations. Pass-through certificates are asset-backed securities which represent an undivided fractional ownership interest in an underlying pool of assets. Pass-through certificates usually provide for payments of principal and interest received to be passed through to their holders, usually after deduction for certain costs and expenses incurred in administering the pool. Because pass-through certificates represent an ownership interest in the underlying assets, the holders thereof bear directly the risk of any defaults by the obligors on the underlying assets not covered by any credit support. See "Types of Credit Support." Asset-backed securities issued in the form of debt instruments, also known as collateralized obligations, are generally issued as the debt of a special purpose entity organized solely for the purpose of owning such assets and issuing such debt. Such assets are most often trade, credit card or automobile receivables. The assets collateralizing such asset-backed securities are pledged to a trustee or custodian for the benefit of the holders thereof. Such issuers generally hold no assets other than those underlying the asset-backed securities and any credit support provided. As a result, although payments on such asset-backed securities are obligations of the issuers, in the event of defaults on the underlying assets not covered by any credit support (see "Types of Credit Support"), the issuing entities are unlikely to have sufficient assets to satisfy their obligations on the related asset-backed securities. . Methods of Allocating Cash Flows While many asset-backed securities are issued with only one class of security, many asset-backed securities are issued in more than one class, each with different payment terms. Multiple class asset-backed securities are issued for two main reasons. First, multiple classes may be used as a method of providing credit support. This is accomplished typically through creation of one or more classes whose right to payments on the asset-backed security is made subordinate to the right to such payments of the remaining class or classes. See "Types of Credit Support." Second, multiple classes may permit the issuance of securities with payment terms, interest rates or other characteristics differing both from those of each other and from those of the underlying assets. Examples include so-called "strips" (asset-backed securities entitling the holder to disproportionate interests with respect to the allocation of interest and principal of the assets backing the security), and securities with class or classes having characteristics which mimic the characteristics of non-asset-backed securities, such as floating interest rates (i.e., interest rates which adjust as a specified benchmark changes) or scheduled amortization of principal. Asset-backed securities in which the payment streams on the underlying assets are allocated in a manner different than those described above may be issued in the future. The Fund may invest in such asset-backed securities if such investment is otherwise consistent with its investment objectives and policies and with the investment restrictions of the Fund. . Types of Credit Support Asset-backed securities are often backed by a pool of assets representing the obligations of a number of different parties. To lessen the effect of failures by obligors on underlying assets to make payments, such securities may contain elements of credit support. Such credit support falls into two classes: liquidity protection and protection against ultimate default by an obligor on the underlying assets. Liquidity protection refers to the provision of advances, generally by the entity administering the pool of assets, to ensure that scheduled payments on the underlying pool are made in a timely fashion. Protection against ultimate default ensures ultimate payment of the obligations on at least a portion of the assets in the pool. Such protection may be provided through guarantees, insurance policies or letters of credit obtained from third parties "external credit enhancement", through various means of structuring the transaction "internal credit enhancement" or through a combination of such approaches. Examples of asset-backed securities with credit support arising out of the structure of the transaction include "senior-subordinated securities" (multiple class asset-backed securities with certain classes subordinate to other classes as to the payment of principal thereon, with the result that defaults on the underlying assets are borne first by the holders of the subordinated class) and asset-backed securities that have "reserve funds" (where cash or investments, sometimes funded from a portion of the initial payments on the underlying assets, are held in reserve against future losses) or that have been "over collateralized" (where the scheduled payments on, or the principal amount of, the underlying assets substantially exceeds that required to make payment of the asset-backed securities and pay any servicing or other fees). The degree of credit support provided on each issue is based generally on historical information respecting the level of credit risk associated with such payments. Depending upon the type of assets securitized, historical information on credit risk and prepayment rates may be limited or even unavailable. Delinquency or loss in excess of that anticipated could adversely affect the return on an investment in an asset-backed security. . Automobile Receivable Securities The Fund may invest in asset-backed securities which are backed by receivables from motor vehicle installment sales contracts or installment loans secured by motor vehicles ("Automobile Receivable Securities"). Since installment sales contracts for motor vehicles or installment loans related thereto ("Automobile Contracts") typically have shorter durations and lower incidences of prepayment, Automobile Receivable Securities generally will exhibit a shorter average life and are less susceptible to prepayment risk. Most entities that issue Automobile Receivable Securities create an enforceable interest in their respective Automobile Contracts only by filing a financing statement and by having the servicer of the Automobile Contracts, which is usually the originator of the Automobile Contracts, take custody thereof. In such circumstances, if the servicer of the Automobile Contracts were to sell the same Automobile Contracts to another party, in violation of its obligation not to do so, there is a risk that such party could acquire an interest in the Automobile Contracts superior to that of the holders of Automobile Receivable Securities. Also, although most Automobile Contracts grant a security interest in the motor vehicle being financed, in most states the security interest in a motor vehicle must be noted on the certificate of title to create an enforceable security interest against competing claims of other parties. Due to the large number of vehicles involved, however, the certificate of title to each vehicle financed, pursuant to the Automobile Contracts underlying the Automobile Receivable Security, usually is not amended to reflect the assignment of the seller's security interest for the benefit of the holders of the Automobile Receivable Securities. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on the securities. In addition, various state and federal securities laws give the motor vehicle owner the right to assert against the holder of the owner's Automobile Contract certain defenses such owner would have against the seller of the motor vehicle. The assertion of such defenses could reduce payments on the Automobile Receivable Securities. . Credit Card Receivable Securities The Fund may invest in asset-backed securities backed by receivables from revolving credit card agreements ("Credit Card Receivable Securities"). Credit balances on revolving credit card agreements ("Accounts") are generally paid down more rapidly than are Automobile Contracts. Most of the Credit Card Receivable Securities issued publicly to date have been Pass-Through Certificates. In order to lengthen the maturity of Credit Card Receivable Securities, most such securities provide for a fixed period during which only interest payments on the underlying Accounts are passed through to the security holder and principal payments received on such Accounts are used to fund the transfer to the pool of assets supporting the related Credit Card Receivable Securities of additional credit card charges made on an Account. The initial fixed period usually may be shortened upon the occurrence of specified events which signal a potential deterioration in the quality of the assets backing the security, such as the imposition of a cap on interest rates. The ability of the issuer to extend the life of an issue of Credit Card Receivable Securities thus depends upon the continued generation of additional principal amounts in the underlying account during the initial period and the non-occurrence of specified events. An acceleration in cardholders' payment rates or any other event which shortens the period during which additional credit card charges on an Account may be transferred to the pool of assets supporting the related Credit Card Receivable Security could shorten the weighted average life and yield of the Credit Card Receivable Security. Credit cardholders are entitled to the protection of a number of state and federal consumer credit laws, many of which give such holder the right to set off certain amounts against balances owed on the credit card, thereby reducing amounts paid on Accounts. In addition, unlike most other asset-backed securities, Accounts are unsecured obligations of the cardholder. . Other Assets Asset-backed securities backed by assets other than those described above, including, but not limited to, small-business loans and accounts receivable, equipment leases, commercial real estate loans, boat loans and manufacturing housing loans. The Fund may invest in such securities in the future if such investment is otherwise consistent with its investment objective and policies. There are, of course, other types of securities that are, or may become available, which are similar to the foregoing and the Funds may invest in these securities. High Yield Fund Collateralized Bond or Loan Obligations Collateralized Bond Obligations ("CBOs") are bonds collateralized by corporate bonds and Collateralized Loan Obligations ("CLOs") are bonds collateralized by bank loans. CBOs and CLOs are structured into tranches, and payments are allocated such that each tranche has a predictable cash flow stream and average life. CBOs are fairly recent entrants to the fixed income market. Most CBOs issue to date have been collateralized by high yield bonds or loans, with heavy credit enhancement. Loan Participations and Assignments Loan participations and assignments (collectively "participations") will typically be participating interests in loans made by a syndicate of banks, represented by an agent bank which has negotiated and structured the loan, to corporate borrowers to finance internal growth, mergers, acquisitions, stock repurchases, leveraged buy-outs and other corporate activities. Such loans may also have been made to governmental borrowers, especially governments of developing countries which is referred to as Loans to Developing Countries debt ("LDC debt"). LDC debt will involve the risk that the governmental entity responsible for the repayment of the debt may be unable or unwilling to do so when due. The loans underlying such participations may be secured or unsecured, and the Fund may invest in loans collateralized by mortgages on real property or which have no collateral. The loan participations themselves may extend for the entire term of the loan or may extend only for short "strips" that correspond to a quarterly or monthly floating rate interest period on the underlying loan. Thus, a term or revolving credit that extends for several years may be subdivided into shorter periods. The loan participations in which the Fund will invest will also vary in legal structure. Occasionally, lenders assign to another institution both the lender's rights and obligations under a credit agreement. Since this type of assignment relieves the original lender of its obligations, it is called a novation. More typically, a lender assigns only its right to receive payments of principal and interest under a promissory note, credit agreement or similar document. A true assignment shifts to the assignee the direct debtor-creditor relationship with the underlying borrower. Alternatively, a lender may assign only part of its rights to receive payments pursuant to the underlying instrument or loan agreement. Such partial assignments, which are more accurately characterized as "participating interests," do not shift the debtor-creditor relationship to the assignee, who must rely on the original lending institution to collect sums due and to otherwise enforce its rights against the agent bank which administers the loan or against the underlying borrower. There may not be a recognizable, liquid public market for loan participations. To the extent this is the case, the Fund would consider the loan participation as illiquid and subject to the Fund's restriction on investing no more than 15% of its net assets in illiquid securities. Where required by applicable SEC positions, the Fund will treat both the corporate borrower and the bank selling the participation interest as an issuer for purposes of its fundamental investment restriction on diversification. Various service fees received by the Fund from loan participations, may be treated as non-interest income depending on the nature of the fee (commitment, takedown, commission, service or loan origination). To the extent the service fees are not interest income, they will not qualify as income under Section 851(b) of the Code. Thus the sum of such fees plus any other non-qualifying income earned by the Fund cannot exceed 10% of total income. Trade Claims Trade claims are non-securitized rights of payment arising from obligations other than borrowed funds. Trade claims typically arise when, in the ordinary course of business, vendors and suppliers extend credit to a company by offering payment terms. Generally, when a company files for bankruptcy protection, payments on these trade claims cease and the claims are subject to compromise along with the other debts of the company. Trade claims typically are bought and sold at a discount reflecting the degree of uncertainty with respect to the timing and extent of recovery. In addition to the risks otherwise associated with low-quality obligations, trade claims have other risks, including the possibility that the amount of the claim may be disputed by the obligor. Over the last few years a market for the trade claims of bankrupt companies has developed. Many vendors are either unwilling or lack the resources to hold their claim through the extended bankruptcy process with an uncertain outcome and timing. Some vendors are also aggressive in establishing reserves against these receivables, so that the sale of the claim at a discount may not result in the recognition of a loss. Trade claims can represent an attractive investment opportunity because these claims typically are priced at a discount to comparable public securities. This discount is a reflection of both a less liquid market, a smaller universe of potential buyers and the risks peculiar to trade claim investing. It is not unusual for trade claims to be priced at a discount to public securities that have an equal or lower priority claim. As noted above, investing in trade claims does carry some unique risks which include: . Establishing the Amount of the Claim Frequently, the supplier's estimate of its receivable will differ from the customer's estimate of its payable. Resolution of these differences can result in a reduction in the amount of the claim. This risk can be reduced by only purchasing scheduled claims (claims already listed as liabilities by the debtor) and seeking representations from the seller. . Defenses to Claims The debtor has a variety of defenses that can be asserted under the bankruptcy code against any claim. Trade claims are subject to these defenses, the most common of which for trade claims relates to preference payments. (Preference payments are all payments made by the debtor during the 90 days prior to the filing. These payments are presumed to have benefited the receiving creditor at the expense of the other creditors. The receiving creditor may be required to return the payment unless it can show the payments were received in the ordinary course of business.) While none of these defenses can result in any additional liability of the purchaser of the trade claim, they can reduce or wipe out the entire purchased claim. This risk can be reduced by seeking representations and indemnification from the seller. . Documentation/Indemnification Each trade claim purchased requires documentation that must be negotiated between the buyer and seller. This documentation is extremely important since it can protect the purchaser from losses such as those described above. Legal expenses in negotiating a purchase agreement can be fairly high. Additionally, it is important to note that the value of an indemnification depends on the seller's credit. . Volatile Pricing Due to Illiquid Market There are only a handful of brokers for trade claims and the quoted price of these claims can be volatile. Generally, it is expected that Trade Claims would be considered illiquid investments. . No Current Yield/Ultimate Recovery Trade claims are almost never entitled to earn interest. As a result, the return on such an investment is very sensitive to the length of the bankruptcy, which is uncertain. Although not unique to trade claims, it is worth noting that the ultimate recovery on the claim is uncertain and there is no way to calculate a conventional yield to maturity on this investment. Additionally, the exit for this investment is a plan of reorganization which may include the distribution of new securities. These securities may be as illiquid as the original trade claim investment. . Tax Issue Although the issue is not free from doubt, it is likely that Trade Claims would be treated as non-securities investments. As a result, any gains would be considered "non-qualifying" under the Code. The Fund may have up to 10% of its gross income (including capital gains) derived from non-qualifying sources. High Yield and Personal Strategy Funds Zero Coupon and Pay-in-Kind Bonds A zero coupon security has no cash coupon payments. Instead, the issuer sells the security at a substantial discount from its maturity value. The interest received by the investor from holding this security to maturity is the difference between the maturity value and the purchase price. The advantage to the investor is that reinvestment risk of the income received during the life of the bond is eliminated. However, zero-coupon bonds, like other bonds, retain interest rate and credit risk and usually display more price volatility than those securities that pay a cash coupon. Pay-in-Kind ("PIK") Instruments are securities that pay interest in either cash or additional securities, at the issuer's option, for a specified period. PIKs, like zero coupon bonds, are designed to give an issuer flexibility in managing cash flow. PIK bonds can be either senior or subordinated debt and trade flat (i.e., without accrued interest). The price of PIK bonds is expected to reflect the market value of the underlying debt plus an amount representing accrued interest since the last payment. PIK's are usually less volatile than zero coupon bonds, but more volatile than cash pay securities. For federal income tax purposes, these types of bonds will require the recognition of gross income each year even though no cash may be paid to the Fund until the maturity or call date of the bond. The Fund will nonetheless be required to distribute substantially all of this gross income each year to comply with the Internal Revenue Code, and such distributions could reduce the amount of cash available for investment by the Fund. High Yield, New Income, and Personal Strategy Funds Warrants The Fund may acquire warrants. Warrants are pure speculation in that they have no voting rights, pay no dividends, and have no rights with respect to the assets of the corporation issuing them. Warrants basically are options to purchase equity securities at a specific price valid for a specific period of time. They do not represent ownership of the securities, but only the right to buy them. Warrants differ from call options in that warrants are issued by the issuer of the security which may be purchased on their exercise, whereas call options may be written or issued by anyone. The prices of warrants do not necessarily move parallel to the prices of the underlying securities. Corporate Income, High Yield, New Income, Personal Strategy, Short-Term Bond, and Short-Term U.S. Government Funds Hybrid Instruments Hybrid Instruments (a type of potentially high-risk derivative) have been developed and combine the elements of futures contracts or options with those of debt, preferred equity, or a depository instrument (hereinafter "Hybrid Instruments"). Generally, a Hybrid Instrument will be a debt security, preferred stock, depository share, trust certificate, certificate of deposit, or other evidence of indebtedness on which a portion of or all interest payments, and/or the principal or stated amount payable at maturity, redemption, or retirement, is determined by reference to prices, changes in prices, or differences between prices, of securities, currencies, intangibles, goods, articles, or commodities (collectively "Underlying Assets") or by another objective index, economic factor, or other measure, such as interest rates, currency exchange rates, commodity indices, and securities indices (collectively "Benchmarks"). Thus, Hybrid Instruments may take a variety of forms, including, but not limited to, debt instruments with interest or principal payments or redemption terms determined by reference to the value of a currency or commodity or securities index at a future point in time, preferred stock with dividend rates determined by reference to the value of a currency, or convertible securities with the conversion terms related to a particular commodity. Hybrid Instruments can be an efficient means of creating exposure to a particular market, or segment of a market, with the objective of enhancing total return. For example, a Fund may wish to take advantage of expected declines in interest rates in several European countries, but avoid the transaction costs associated with buying and currency-hedging the foreign bond positions. One solution would be to purchase a U.S. dollar-denominated Hybrid Instrument whose redemption price is linked to the average three-year interest rate in a designated group of countries. The redemption price formula would provide for payoffs of greater than par if the average interest rate was lower than a specified level, and payoffs of less than par if rates were above the specified level. Furthermore, the Fund could limit the downside risk of the security by establishing a minimum redemption price so that the principal paid at maturity could not be below a predetermined minimum level if interest rates were to rise significantly. The purpose of this arrangement, known as a structured security with an embedded put option, would be to give the Fund the desired European bond exposure while avoiding currency risk, limiting downside market risk, and lowering transactions costs. Of course, there is no guarantee that the strategy will be successful, and the Fund could lose money if, for example, interest rates do not move as anticipated or credit problems develop with the issuer of the Hybrid. The risks of investing in Hybrid Instruments reflect a combination of the risks of investing in securities, options, futures and currencies. Thus, an investment in a Hybrid Instrument may entail significant risks that are not associated with a similar investment in a traditional debt instrument that has a fixed principal amount, is denominated in U.S. dollars, or bears interest either at a fixed rate or a floating rate determined by reference to a common, nationally published benchmark. The risks of a particular Hybrid Instrument will, of course, depend upon the terms of the instrument, but may include, without limitation, the possibility of significant changes in the Benchmarks or the prices of Underlying Assets to which the instrument is linked. Such risks generally depend upon factors which are unrelated to the operations or credit quality of the issuer of the Hybrid Instrument and which may not be readily foreseen by the purchaser, such as economic and political events, the supply and demand for the Underlying Assets, and interest rate movements. In recent years, various Benchmarks and prices for Underlying Assets have been highly volatile, and such volatility may be expected in the future. Reference is also made to the discussion of futures, options, and forward contracts herein for a discussion of the risks associated with such investments. Hybrid Instruments are potentially more volatile and carry greater market risks than traditional debt instruments. Depending on the structure of the particular Hybrid Instrument, changes in a Benchmark may be magnified by the terms of the Hybrid Instrument and have an even more dramatic and substantial effect upon the value of the Hybrid Instrument. Also, the prices of the Hybrid Instrument and the Benchmark or Underlying Asset may not move in the same direction or at the same time. Hybrid Instruments may bear interest or pay preferred dividends at below market (or even relatively nominal) rates. Alternatively, Hybrid Instruments may bear interest at above market rates but bear an increased risk of principal loss (or gain). The latter scenario may result if "leverage" is used to structure the Hybrid Instrument. Leverage risk occurs when the Hybrid Instrument is structured so that a given change in a Benchmark or Underlying Asset is multiplied to produce a greater value change in the Hybrid Instrument, thereby magnifying the risk of loss as well as the potential for gain. Hybrid Instruments may also carry liquidity risk since the instruments are often "customized" to meet the portfolio needs of a particular investor, and therefore, the number of investors that are willing and able to buy such instruments in the secondary market may be smaller than that for more traditional debt securities. In addition, because the purchase and sale of Hybrid Instruments could take place in an over-the-counter market without the guarantee of a central clearing organization or in a transaction between the Fund and the issuer of the Hybrid Instrument, the creditworthiness of the counter party of issuer of the Hybrid Instrument would be an additional risk factor which the Fund would have to consider and monitor. Hybrid Instruments also may not be subject to regulation of the Commodities Futures Trading Commission ("CFTC"), which generally regulates the trading of commodity futures by U.S. persons, the SEC, which regulates the offer and sale of securities by and to U.S. persons, or any other governmental regulatory authority. The various risks discussed above, particularly the market risk of such instruments, may in turn cause significant fluctuations in the net asset value of the Fund. Accordingly, the Fund will limit its investments in Hybrid Instruments to 10% of total assets. However, because of their volatility, it is possible that the Fund's investment in Hybrid Instruments will account for more than 10% of the Fund's return (positive or negative). All Funds When-Issued Securities and Forward Commitment Contracts The price of such securities, which may be expressed in yield terms, is fixed at the time the commitment to purchase is made, but delivery and payment take place at a later date. Normally, the settlement date occurs within 90 days of the purchase for When-Issueds, but may be substantially longer for Forwards. During the period between purchase and settlement, no payment is made by the Fund to the issuer and no interest accrues to the Fund. The purchase of these securities will result in a loss if their value declines prior to the settlement date. This could occur, for example, if interest rates increase prior to settlement. The longer the period between purchase and settlement, the greater the risks are. At the time the Fund makes the commitment to purchase these securities, it will record the transaction and reflect the value of the security in determining its net asset value. The Fund will cover these securities by maintaining cash, liquid, high-grade debt securities, or other suitable cover as permitted by the SEC with its custodian bank equal in value to commitments for them during the time between the purchase and the settlement. Therefore, the longer this period, the longer the period during which alternative investment options are not available to the Fund (to the extent of the securities used for cover). Such securities either will mature or, if necessary, be sold on or before the settlement date. To the extent the Fund remains fully or almost fully invested (in securities with a remaining maturity of more than one year) at the same time it purchases these securities, there will be greater fluctuations in the Fund's net asset value than if the Fund did not purchase them. Additional Adjustable Rate Securities Certain securities may be issued with adjustable interest rates that are reset periodically by predetermined formulas or indexes in order to minimize movements in the principal value of the investment. Such securities may have long-term maturities, but may be treated as a short-term investment under certain conditions. Generally, as interest rates decrease or increase, the potential for capital appreciation or depreciation on these securities is less than for fixed-rate obligations. These securities may take the following forms: Variable Rate Securities Variable rate instruments are those whose terms provide for the adjustment of their interest rates on set dates and which, upon such adjustment, can reasonably be expected to have a market value that approximates it par value. A variable rate instrument, the principal amount of which is scheduled to be paid in 397 days or less, is deemed to have a maturity equal to the period remaining until the next readjustment of the interest rate. A variable rate instrument which is subject to a demand feature entitles the purchaser to receive the principal amount of the underlying security or securities, either (i) upon notice of no more than 30 days or (ii) at specified intervals not exceeding 397 days and upon no more than 30 days' notice, is deemed to have a maturity equal to the longer of the period remaining until the next readjustment of the interest rate or the period remaining until the principal amount can be recovered through demand. Floating Rate Securities Floating rate instruments are those whose terms provide for the adjustment of their interest rates whenever a specified interest rate changes and which, at any time, can reasonably be expected to have a market value that approximates its par value. The maturity of a floating rate instrument is deemed to be the period remaining until the date (noted on the face of the instrument) on which the principal amount must be paid, or in the case of an instrument called for redemption, the date on which the redemption payment must be made. Floating rate instruments with demand features are deemed to have a maturity equal to the period remaining until the principal amount can be recovered through demand. Put Option Bonds Long-term obligations with maturities longer than one year may provide purchasers an optional or mandatory tender of the security at par value at predetermined intervals, often ranging from one month to several years (e.g., a 30-year bond with a five-year tender period). These instruments are deemed to have a maturity equal to the period remaining to the put date. Corporate Income, High Yield, New Income, Personal Strategy, Prime Reserve, Reserve Investment, Short-Term Bond, and Short-Term U.S. Government Funds Illiquid or Restricted Securities Restricted securities may be sold only in privately negotiated transactions or in a public offering with respect to which a registration statement is in effect under the Securities Act of 1933 (the "1933 Act"). Where registration is required, the Fund may be obligated to pay all or part of the registration expenses, and a considerable period may elapse between the time of the decision to sell and the time the Fund may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, the Fund might obtain a less favorable price than prevailed when it decided to sell. Restricted securities will be priced at fair value as determined in accordance with procedures prescribed by the Fund's Board of Directors/Trustees. If, through the appreciation of illiquid securities or the depreciation of liquid securities, the Fund should be in a position where more than 15% (10% for Government Reserve Investment; Prime Reserve; Reserve Investment; and U.S. Treasury Money Funds) of the value of its net assets is invested in illiquid assets, including restricted securities, the Fund will take appropriate steps to protect liquidity. Notwithstanding the above, the Fund may purchase securities which, while privately placed, are eligible for purchase and sale under Rule 144A under the 1933 Act. This rule permits certain qualified institutional buyers, such as the Fund, to trade in privately placed securities even though such securities are not registered under the 1933 Act. T. Rowe Price, under the supervision of the Fund's Board of Directors/Trustees, will consider whether securities purchased under Rule 144A are illiquid and thus subject to the Fund's restriction of investing no more than 15% (10% for Government Reserve Investment; Prime Reserve; Reserve Investment; and U.S. Treasury Money Funds) of its net assets in illiquid securities. A determination of whether a Rule 144A security is liquid or not is a question of fact. In making this determination, T. Rowe Price will consider the trading markets for the specific security taking into account the unregistered nature of a Rule 144A security. In addition, T. Rowe Price could consider the (1) frequency of trades and quotes, (2) number of dealers and potential purchases, (3) dealer undertakings to make a market, and (4) the nature of the security and of marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer). The liquidity of Rule 144A securities would be monitored and, if as a result of changed conditions it is determined that a Rule 144A security is no longer liquid, the Fund's holdings of illiquid securities would be reviewed to determine what, if any, steps are required to assure that the Fund does not invest more than 15% (10% for Government Reserve Investment; Prime Reserve; Reserve Investment; and U.S. Treasury Money Funds) of its net assets in illiquid securities. Investing in Rule 144A securities could have the effect of increasing the amount of the Fund's assets invested in illiquid securities if qualified institutional buyers are unwilling to purchase such securities. New Income and Short-Term Bond Funds Industry Concentration When the market for corporate debt securities is dominated by issues in the gas utility, gas transmission utility, electric utility, telephone utility, or petroleum industry, the Fund will as a matter of Fundamental policy concentrate 25% or more, but not more than 50%, of its assets, in any one such industry, if the Fund has cash for such investment (i.e., the Fund will not sell portfolio securities to raise cash) and, if in T. Rowe Price's judgment, the return available and the marketability, quality, and availability of the debt securities of such industry justifies such concentration in light of the Fund's investment objectives. Domination would exist with respect to any one such industry, when, in the preceding 30-day period, more than 25% of all new-issue corporate debt offerings (within the four highest grades of Moody's or S&P's and with maturities of 10 years or less) of $25,000,000 or more consisted of issues in such industry. Although the Fund will normally purchase corporate debt securities in the secondary market as opposed to new offerings, T. Rowe Price believes that the new issue-based dominance standard, as defined above, is appropriate because it is easily determined and represents an accurate correlation to the secondary market. Investors should understand that concentration in any industry may result in increased risk. Investments in any of these industries may be affected by environmental conditions, energy conservation programs, fuel shortages, difficulty in obtaining adequate return on capital in financing operations and large construction programs, and the ability of the capital markets to absorb debt issues. In addition, it is possible that the public service commissions which have jurisdiction over these industries may not grant future increases in rates sufficient to offset increases in operating expenses. These industries also face numerous legislative and regulatory uncertainties at both federal and state government levels. Management believes that any risk to the Fund which might result from concentration in any industry will be minimized by the Fund's practice of diversifying its investments in other respects. The Fund's policy with respect to industry concentration is a Fundamental policy. (For investment restriction on industry concentration, see "Investment Restrictions"). PORTFOLIO MANAGEMENT PRACTICES ------------------------------------------------------------------------------- Lending of Portfolio Securities Securities loans are made to broker-dealers or institutional investors or other persons, pursuant to agreements requiring that the loans be continuously secured by collateral at least equal at all times to the value of the securities lent, marked to market on a daily basis. The collateral received will consist of cash, U.S. government securities, letters of credit or such other collateral as may be permitted under its investment program. While the securities are being lent, the Fund will continue to receive the equivalent of the interest or dividends paid by the issuer on the securities, as well as interest on the investment of the collateral or a fee from the borrower. The Fund has a right to call each loan and obtain the securities, within such period of time which coincides with the normal settlement period for purchases and sales of such securities in the respective markets. The Fund will not have the right to vote on securities while they are being lent, but it will call a loan in anticipation of any important vote. The risks in lending portfolio securities, as with other extensions of secured credit, consist of possible delay in receiving additional collateral or in the recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. Loans will only be made to firms deemed by T. Rowe Price to be of good standing and will not be made unless, in the judgment of T. Rowe Price, the consideration to be earned from such loans would justify the risk. Other Lending/Borrowing Subject to approval by the SEC, the Fund may make loans to, or borrow funds from, other mutual funds sponsored or advised by T. Rowe Price or Rowe Price-Fleming International, Inc. ("Price-Fleming"), (collectively, "Price Funds"). Repurchase Agreements The Fund may enter into a repurchase agreement through which an investor (such as the Fund) purchases a security (known as the "underlying security") from a well-established securities dealer or a bank that is a member of the Federal Reserve System. Any such dealer or bank will be on T. Rowe Price's approved list. At that time, the bank or securities dealer agrees to repurchase the underlying security at the same price, plus specified interest. Repurchase agreements are generally for a short period of time, often less than a week. Repurchase agreements which do not provide for payment within seven days will be treated as illiquid securities. The Fund will only enter into repurchase agreements where (i) (A) Prime Reserve, U.S. Treasury Money, Government Reserve Investment, and Reserve Investment Funds--the underlying securities are either U.S. government securities or securities that, at the time the repurchase agreement is entered into, are rated in the highest rating category by the requisite number of NRSROs (as required by Rule 2a-7 under the 1940 Act) and otherwise are of the type (excluding maturity limitations) which the Fund's investment guidelines would allow it to purchase directly, (B) GNMA, High Yield, New Income, Personal Strategy, Short-Term Bond, Short-Term U.S. Government, and U.S. Treasury Intermediate and Long-Term Funds--the underlying securities are of the type (excluding maturity limitations) which the Fund's investment guidelines would allow it to purchase directly; (ii) the market value of the underlying security, including interest accrued, will be equal to or exceed the value of the repurchase agreement; and (iii) payment for the underlying security is made only upon physical delivery or evidence of book-entry transfer to the account of the custodian or a bank acting as agent. In the event of a bankruptcy or other default of a seller of a repurchase agreement, the Fund could experience both delays in liquidating the underlying security and losses, including: (a) possible decline in the value of the underlying security during the period while the Fund seeks to enforce its rights thereto; (b) possible subnormal levels of income and lack of access to income during this period; and (c) expenses of enforcing its rights. Reverse Repurchase Agreements Although the Fund has no current intention of engaging in reverse repurchase agreements, the Fund reserves the right to do so. Reverse repurchase agreements are ordinary repurchase agreements in which a Fund is the seller of, rather than the investor in, securities, and agrees to repurchase them at an agreed upon time and price. Use of a reverse repurchase agreement may be preferable to a regular sale and later repurchase of the securities because it avoids certain market risks and transaction costs. A reverse repurchase agreement may be viewed as a type of borrowing by the Fund, subject to Investment Restriction (1). (See "Investment Restrictions"). Money Market Reserves It is expected that the Fund will invest its cash reserves primarily in one or more money market funds established for the exclusive use of the T. Rowe Price family of mutual funds and other clients of T. Rowe Price and Price-Fleming. Currently, two such money market funds are in operation-Reserve Investment Fund ("RIF") and Government Reserve Investment Fund ("GRF"), each a series of the Reserve Investment Funds, Inc. (The Prime Reserve and U.S. Treasury Money Funds will not purchase shares of either Fund, and the GNMA and U.S. Treasury Intermediate and U.S. Treasury Long-Term Funds can only purchase shares of GRF.) Additional series may be created in the future. These funds were created and operate under an Exemptive Order issued by the Securities and Exchange Commission (Investment Company Act Release No. IC-22770, July 29, 1997). Both funds must comply with the requirements of Rule 2a-7 under the 1940 Act governing money market funds. The RIF invests at least 95% of its total assets in prime money market instruments receiving the highest credit rating. The GRF invests primarily in a portfolio of U.S. government-backed securities, primarily U.S. Treasuries, and repurchase agreements thereon. The RIF and GRF provide a very efficient means of managing the cash reserves of the Fund. While neither RIF or GRF pay an advisory fee to the Investment Manager, they will incur other expenses. However, the RIF and GRF are expected by T. Rowe Price to operate at very low expense ratios. The Fund will only invest in RIF or GRF to the extent it is consistent with its objective and program. Neither fund is insured or guaranteed by the U.S. government, and there is no assurance they will maintain a stable net asset value of $1.00 per share. High Yield Fund Short Sales The Fund may make short sales for hedging purposes to protect the Fund against companies whose credit is deteriorating. Short sales are transactions in which the Fund sells a security it does not own in anticipation of a decline in the market value of that security. The Fund's short sales would be limited to situations where the Fund owns a debt security of a company and would sell short the common or preferred stock or another debt security at a different level of the capital structure of the same company. No securities will be sold short if, after the effect is given to any such short sale, the total market value of all securities sold short would exceed 2% of the value of the Fund's net assets. To complete a short sale transaction, the Fund must borrow the security to make delivery to the buyer. The Fund then is obligated to replace the security borrowed by purchasing it at the market price at the time of replacement. The price at such time may be more or less than the price at which the security was sold by the Fund. Until the security is replaced, the Fund is required to pay to the lender amounts equal to any dividends or interest which accrue during the period of the loan. To borrow the security, the Fund also may be required to pay a premium, which would increase the cost of the security sold. The proceeds of the short sale will be retained by the broker, to the extent necessary to meet margin requirements, until the short position is closed out. Until the Fund replaces a borrowed security in connection with a short sale, the Fund will: (a) maintain daily a segregated account, containing cash, U.S. government securities or other suitable cover as permitted by the SEC, at such a level that (i) the amount deposited in the account plus the amount deposited with the broker as collateral will equal the current value of the security sold short and (ii) the amount deposited in the segregated account plus the amount deposited with the broker as collateral will not be less than the market value of the security at the time its was sold short; or (b) otherwise cover its short position. The Fund will incur a loss as a result of the short sale if the price of the security sold short increases between the date of the short sale and the date on which the Fund replaces the borrowed security. The Fund will realize a gain if the security sold short declines in price between those dates. This result is the opposite of what one would expect from a cash purchase of a long position in a security. The amount of any gain will be decreased, and the amount of any loss increased, by the amount of any premium, dividends or interest the Fund may be required to pay in connection with a short sale. Any gain or loss on the security sold short would be separate from a gain or loss on the Fund security being hedged by the short sale. The Taxpayer Relief Act of 1997 requires a mutual fund to recognize gain upon entering into a constructive sale of stock, a partnership interest, or certain debt positions occurring after August 5, 1997. A constructive sale is deemed to occur if the Fund enters into a short sale, an offsetting notional principal contract, or a futures or forward contract which is substantially identical to the appreciated position. Some of the transactions in which the Fund is permitted to invest may cause certain appreciated positions in securities held by the Fund to qualify as a "constructive sale," in which case it would be treated as sold and the resulting gain subjected to tax or, in the case of a mutual fund, distributed to shareholders. If this were to occur, the Fund would be required to distribute such gains even though it would receive no cash until the later sale of the security. Such distributions could reduce the amount of cash available for investment by the Fund. Because these rules do not apply to "straight" debt transactions, it is not anticipated that they will have a significant impact on the Fund; however, the effect cannot be determined until the issuance of clarifying regulations. All Funds except Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds Options Options are a type of potentially high-risk derivative. Writing Covered Call Options The Fund may write (sell) American or European style "covered" call options and purchase options to close out options previously written by the Fund. In writing covered call options, the Fund expects to generate additional premium income which should serve to enhance the Fund's total return and reduce the effect of any price decline of the security or currency involved in the option. Covered call options will generally be written on securities or currencies which, in T. Rowe Price's opinion, are not expected to have any major price increases or moves in the near future but which, over the long term, are deemed to be attractive investments for the Fund. A call option gives the holder (buyer) the "right to purchase" a security or currency at a specified price (the exercise price) at expiration of the option (European style) or at any time until a certain date (the expiration date) (American style). So long as the obligation of the writer of a call option continues, he may be assigned an exercise notice by the broker-dealer through whom such option was sold, requiring him to deliver the underlying security or currency against payment of the exercise price. This obligation terminates upon the expiration of the call option, or such earlier time at which the writer effects a closing purchase transaction by repurchasing an option identical to that previously sold. To secure his obligation to deliver the underlying security or currency in the case of a call option, a writer is required to deposit in escrow the underlying security or currency or other assets in accordance with the rules of a clearing corporation. The Fund will write only covered call options. This means that the Fund will own the security or currency subject to the option or an option to purchase the same underlying security or currency, having an exercise price equal to or less than the exercise price of the "covered" option, or will establish and maintain with its custodian for the term of the option, an account consisting of cash, U.S. government securities, other liquid high-grade debt obligations, or other suitable cover as permitted by the SEC having a value equal to the fluctuating market value of the optioned securities or currencies. Portfolio securities or currencies on which call options may be written will be purchased solely on the basis of investment considerations consistent with the Fund's investment objective. The writing of covered call options is a conservative investment technique believed to involve relatively little risk (in contrast to the writing of naked or uncovered options, which the Fund will not do), but capable of enhancing the Fund's total return. When writing a covered call option, a Fund, in return for the premium, gives up the opportunity for profit from a price increase in the underlying security or currency above the exercise price, but conversely retains the risk of loss should the price of the security or currency decline. Unlike one who owns securities or currencies not subject to an option, the Fund has no control over when it may be required to sell the underlying securities or currencies, since it may be assigned an exercise notice at any time prior to the expiration of its obligation as a writer. If a call option which the Fund has written expires, the Fund will realize a gain in the amount of the premium; however, such gain may be offset by a decline in the market value of the underlying security or currency during the option period. If the call option is exercised, the Fund will realize a gain or loss from the sale of the underlying security or currency. The Fund does not consider a security or currency covered by a call to be "pledged" as that term is used in the Fund's policy which limits the pledging or mortgaging of its assets. The premium received is the market value of an option. The premium the Fund will receive from writing a call option will reflect, among other things, the current market price of the underlying security or currency, the relationship of the exercise price to such market price, the historical price volatility of the underlying security or currency, and the length of the option period. Once the decision to write a call option has been made, T. Rowe Price, in determining whether a particular call option should be written on a particular security or currency, will consider the reasonableness of the anticipated premium and the likelihood that a liquid secondary market will exist for those options. The premium received by the Fund for writing covered call options will be recorded as a liability of the Fund. This liability will be adjusted daily to the option's current market value, which will be the latest sale price at the time at which the net asset value per share of the Fund is computed (close of the New York Stock Exchange), or, in the absence of such sale, the latest asked price. The option will be terminated upon expiration of the option, the purchase of an identical option in a closing transaction, or delivery of the underlying security or currency upon the exercise of the option. Closing transactions will be effected in order to realize a profit on an outstanding call option, to prevent an underlying security or currency from being called, or, to permit the sale of the underlying security or currency. Furthermore, effecting a closing transaction will permit the Fund to write another call option on the underlying security or currency with either a different exercise price or expiration date or both. If the Fund desires to sell a particular security or currency from its portfolio on which it has written a call option, or purchased a put option, it will seek to effect a closing transaction prior to, or concurrently with, the sale of the security or currency. There is, of course, no assurance that the Fund will be able to effect such closing transactions at favorable prices. If the Fund cannot enter into such a transaction, it may be required to hold a security or currency that it might otherwise have sold. When the Fund writes a covered call option, it runs the risk of not being able to participate in the appreciation of the underlying securities or currencies above the exercise price, as well as the risk of being required to hold on to securities or currencies that are depreciating in value. This could result in higher transaction costs. The Fund will pay transaction costs in connection with the writing of options to close out previously written options. Such transaction costs are normally higher than those applicable to purchases and sales of portfolio securities. Call options written by the Fund will normally have expiration dates of less than nine months from the date written. The exercise price of the options may be below, equal to, or above the current market values of the underlying securities or currencies at the time the options are written. From time to time, the Fund may purchase an underlying security or currency for delivery in accordance with an exercise notice of a call option assigned to it, rather than delivering such security or currency from its portfolio. In such cases, additional costs may be incurred. The Fund will realize a profit or loss from a closing purchase transaction if the cost of the transaction is less or more than the premium received from the writing of the option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security or currency, any loss resulting from the repurchase of a call option is likely to be offset in whole or in part by appreciation of the underlying security or currency owned by the Fund. The Fund will not write a covered call option if, as a result, the aggregate market value of all portfolio securities or currencies covering written call or put options exceeds 25% of the market value of the Fund's net assets. In calculating the 25% limit, the Fund will offset, against the value of assets covering written calls and puts, the value of purchased calls and puts on identical securities or currencies with identical maturity dates. Writing Covered Put Options The Fund may write American or European style covered put options and purchase options to close out options previously written by the Fund. A put option gives the purchaser of the option the right to sell, and the writer (seller) has the obligation to buy, the underlying security or currency at the exercise price during the option period (American style) or at the expiration of the option (European style). So long as the obligation of the writer continues, he may be assigned an exercise notice by the broker-dealer through whom such option was sold, requiring him to make payment to the exercise price against delivery of the underlying security or currency. The operation of put options in other respects, including their related risks and rewards, is substantially identical to that of call options. The Fund would write put options only on a covered basis, which means that the Fund would maintain in a segregated account cash, U.S. government securities, other liquid high-grade debt obligations, or other suitable cover as determined by the SEC, in an amount not less than the exercise price or the Fund will own an option to sell the underlying security or currency subject to the option having an exercise price equal to or greater than the exercise price of the "covered" option at all times while the put option is outstanding. (The rules of a clearing corporation currently require that such assets be deposited in escrow to secure payment of the exercise price.) The Fund would generally write covered put options in circumstances where T. Rowe Price wishes to purchase the underlying security or currency for the Fund's portfolio at a price lower than the current market price of the security or currency. In such event the Fund would write a put option at an exercise price which, reduced by the premium received on the option, reflects the lower price it is willing to pay. Since the Fund would also receive interest on debt securities or currencies maintained to cover the exercise price of the option, this technique could be used to enhance current return during periods of market uncertainty. The risk in such a transaction would be that the market price of the underlying security or currency would decline below the exercise price less the premiums received. Such a decline could be substantial and result in a significant loss to the Fund. In addition, the Fund, because it does not own the specific securities or currencies which it may be required to purchase in exercise of the put, cannot benefit from appreciation, if any, with respect to such specific securities or currencies. The Fund will not write a covered put option if, as a result, the aggregate market value of all portfolio securities or currencies covering put or call options exceeds 25% of the market value of the Fund's net assets. In calculating the 25% limit, the Fund will offset, against the value of assets covering written puts and calls, the value of purchased puts and calls on identical securities or currencies with identical maturity dates. Purchasing Put Options The Fund may purchase American or European style put options. As the holder of a put option, the Fund has the right to sell the underlying security or currency at the exercise price at any time during the option period (American style) or at the expiration of the option (European style). The Fund may enter into closing sale transactions with respect to such options, exercise them or permit them to expire. The Fund may purchase put options for defensive purposes in order to protect against an anticipated decline in the value of its securities or currencies. An example of such use of put options is provided next. The Fund may purchase a put option on an underlying security or currency (a "protective put") owned by the Fund as a defensive technique in order to protect against an anticipated decline in the value of the security or currency. Such hedge protection is provided only during the life of the put option when the Fund, as the holder of the put option, is able to sell the underlying security or currency at the put exercise price regardless of any decline in the underlying security's market price or currency's exchange value. For example, a put option may be purchased in order to protect unrealized appreciation of a security or currency where T. Rowe Price deems it desirable to continue to hold the security or currency because of tax considerations. The premium paid for the put option and any transaction costs would reduce any capital gain otherwise available for distribution when the security or currency is eventually sold. The Fund may also purchase put options at a time when the Fund does not own the underlying security or currency. By purchasing put options on a security or currency it does not own, the Fund seeks to benefit from a decline in the market price of the underlying security or currency. If the put option is not sold when it has remaining value, and if the market price of the underlying security or currency remains equal to or greater than the exercise price during the life of the put option, the Fund will lose its entire investment in the put option. In order for the purchase of a put option to be profitable, the market price of the underlying security or currency must decline sufficiently below the exercise price to cover the premium and transaction costs, unless the put option is sold in a closing sale transaction. The Fund will not commit more than 5% of its assets to premiums when purchasing put and call options. The premium paid by the Fund when purchasing a put option will be recorded as an asset of the Fund. This asset will be adjusted daily to the option's current market value, which will be the latest sale price at the time at which the net asset value per share of the Fund is computed (close of New York Stock Exchange), or, in the absence of such sale, the latest bid price. This asset will be terminated upon expiration of the option, the selling (writing) of an identical option in a closing transaction, or the delivery of the underlying security or currency upon the exercise of the option. Purchasing Call Options The Fund may purchase American or European style call options. As the holder of a call option, the Fund has the right to purchase the underlying security or currency at the exercise price at any time during the option period (American style) or at the expiration of the option (European style). The Fund may enter into closing sale transactions with respect to such options, exercise them or permit them to expire. The Fund may purchase call options for the purpose of increasing its current return or avoiding tax consequences which could reduce its current return. The Fund may also purchase call options in order to acquire the underlying securities or currencies. Examples of such uses of call options are provided next. Call options may be purchased by the Fund for the purpose of acquiring the underlying securities or currencies for its portfolio. Utilized in this fashion, the purchase of call options enables the Fund to acquire the securities or currencies at the exercise price of the call option plus the premium paid. At times the net cost of acquiring securities or currencies in this manner may be less than the cost of acquiring the securities or currencies directly. This technique may also be useful to the Fund in purchasing a large block of securities or currencies that would be more difficult to acquire by direct market purchases. So long as it holds such a call option rather than the underlying security or currency itself, the Fund is partially protected from any unexpected decline in the market price of the underlying security or currency and in such event could allow the call option to expire, incurring a loss only to the extent of the premium paid for the option. The Fund will not commit more than 5% of its assets to premiums when purchasing call and put options. The Fund may also purchase call options on underlying securities or currencies it owns in order to protect unrealized gains on call options previously written by it. A call option would be purchased for this purpose where tax considerations make it inadvisable to realize such gains through a closing purchase transaction. Call options may also be purchased at times to avoid realizing losses. Dealer (Over-the-Counter) Options The Fund may engage in transactions involving dealer options. Certain risks are specific to dealer options. While the Fund would look to a clearing corporation to exercise exchange-traded options, if the Fund were to purchase a dealer option, it would rely on the dealer from whom it purchased the option to perform if the option were exercised. Failure by the dealer to do so would result in the loss of the premium paid by the Fund as well as loss of the expected benefit of the transaction. Exchange-traded options generally have a continuous liquid market while dealer options have none. Consequently, the Fund will generally be able to realize the value of a dealer option it has purchased only by exercising it or reselling it to the dealer who issued it. Similarly, when the Fund writes a dealer option, it generally will be able to close out the option prior to its expiration only by entering into a closing purchase transaction with the dealer to which the Fund originally wrote the option. While the Fund will seek to enter into dealer options only with dealers who will agree to and which are expected to be capable of entering into closing transactions with the Fund, there can be no assurance that the Fund will be able to liquidate a dealer option at a favorable price at any time prior to expiration. Until the Fund, as a covered dealer call option writer, is able to effect a closing purchase transaction, it will not be able to liquidate securities (or other assets) or currencies used as cover until the option expires or is exercised. In the event of insolvency of the contra party, the Fund may be unable to liquidate a dealer option. With respect to options written by the Fund, the inability to enter into a closing transaction may result in material losses to the Fund. For example, since the Fund must maintain a secured position with respect to any call option on a security it writes, the Fund may not sell the assets which it has segregated to secure the position while it is obligated under the option. This requirement may impair a Fund's ability to sell portfolio securities or currencies at a time when such sale might be advantageous. The Staff of the SEC has taken the position that purchased dealer options and the assets used to secure the written dealer options are illiquid securities. The Fund may treat the cover used for written OTC options as liquid if the dealer agrees that the Fund may repurchase the OTC option it has written for a maximum price to be calculated by a predetermined formula. In such cases, the OTC option would be considered illiquid only to the extent the maximum repurchase price under the formula exceeds the intrinsic value of the option. High Yield Fund Spread Option Transactions The Fund may purchase from and sell to securities dealers covered spread options. Such covered spread options are not presently exchange listed or traded. The purchase of a spread option gives the Fund the right to put, or sell, a security that it owns at a fixed dollar spread or fixed yield spread in relationship to another security that the Fund does not own, but which is used as a benchmark. The risk to the Fund in purchasing covered spread options is the cost of the premium paid for the spread options and any transaction costs. In addition, there is no assurance that closing transactions will be available. The purchase of spread options will be used to protect the Fund against adverse changes in prevailing credit quality spreads, i.e., the yield spread between high-quality and lower-quality securities. Such protection is only provided during the life of the spread option. The security covering the spread option will be maintained in a segregated account by the Fund's custodian. The Fund does not consider a security covered by a spread option to be "pledged" as that term is used in the Fund's policy limiting the pledging or mortgaging of its assets. The Fund may also buy and sell uncovered spread options. Such options would be used for the same purposes and be subject to similar risks as covered spread options. However, in an uncovered spread option, the Fund would not own either of the securities involved in the spread. All Funds except Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds Futures Contracts Futures contracts are a type of potentially high-risk derivative. Transactions in Futures The Fund may enter into futures contracts including stock index, interest rate, and currency futures ("futures" or "futures contracts"). Stock index futures contracts may be used to provide a hedge for a portion of the Fund's portfolio, as a cash management tool, or as an efficient way for T. Rowe Price to implement either an increase or decrease in portfolio market exposure in response to changing market conditions. The Fund may purchase or sell futures contracts with respect to any stock index. Nevertheless, to hedge the Fund's portfolio successfully, the Fund must sell futures contacts with respect to indices or subindices whose movements will have a significant correlation with movements in the prices of the Fund's portfolio securities. Interest rate or currency futures contracts may be used as a hedge against changes in prevailing levels of interest rates or currency exchange rates in order to establish more definitely the effective return on securities or currencies held or intended to be acquired by the Fund. In this regard, the Fund could sell interest rate or currency futures as an offset against the effect of expected increases in interest rates or currency exchange rates and purchase such futures as an offset against the effect of expected declines in interest rates or currency exchange rates. The Fund will enter into futures contracts which are traded on national or foreign futures exchanges, and are standardized as to maturity date and underlying financial instrument. Futures exchanges and trading in the United States are regulated under the Commodity Exchange Act by the CFTC. Futures are traded in London, at the London International Financial Futures Exchange, in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock Exchange. Although techniques other than the sale and purchase of futures contracts could be used for the above-referenced purposes, futures contracts offer an effective and relatively low cost means of implementing the Fund's objectives in these areas. Regulatory Limitations The Fund will engage in futures contracts and options thereon only for bona fide hedging, yield enhancement, and risk management purposes, in each case in accordance with rules and regulations of the CFTC. The Fund may not purchase or sell futures contracts or related options if, with respect to positions which do not qualify as bona fide hedging under applicable CFTC rules, the sum of the amounts of initial margin deposits and premium paid on those positions would exceed 5% of the net asset value of the Fund after taking into account unrealized profits and unrealized losses on any such contracts it has entered into; provided, however, that in the case of an option that is in-the-money at the time of purchase, the in-the-money amount may be excluded in calculating the 5% limitation. For purposes of this policy, options on futures contracts and foreign currency options traded on a commodities exchange will be considered "related options." This policy may be modified by the Board of Directors/Trustees without a shareholder vote and does not limit the percentage of the Fund's assets at risk to 5%. In instances involving the purchase of futures contracts or the writing of call or put options thereon by the Fund, an amount of cash, U.S. government securities, other liquid, high-grade debt obligations, or other suitable cover as permitted by the SEC, equal to the market value of the futures contracts and options thereon (less any related margin deposits), will be identified by the Fund to cover the position, or alternative cover (such as owning an offsetting position) will be employed. Assets used as cover or held in an identified account cannot be sold while the position in the corresponding option or future is open, unless they are replaced with similar assets. As a result, the commitment of a large portion of a Fund's assets to cover or identified accounts could impede portfolio management or the Fund's ability to meet redemption requests or other current obligations. If the CFTC or other regulatory authorities adopt different (including less stringent) or additional restrictions, the Fund would comply with such new restrictions. Trading in Futures Contracts A futures contract provides for the future sale by one party and purchase by another party of a specified amount of a specific financial instrument (e.g., units of a debt security) for a specified price, date, time and place designated at the time the contract is made. Brokerage fees are incurred when a futures contract is bought or sold and margin deposits must be maintained. Entering into a contract to buy is commonly referred to as buying or purchasing a contract or holding a long position. Entering into a contract to sell is commonly referred to as selling a contract or holding a short position. Unlike when the Fund purchases or sells a security, no price would be paid or received by the Fund upon the purchase or sale of a futures contract. Upon entering into a futures contract, and to maintain the Fund's open positions in futures contracts, the Fund would be required to deposit with its custodian in a segregated account in the name of the futures broker an amount of cash, U.S. government securities, suitable money market instruments, liquid, high-grade debt securities, or other suitable cover as determined by the SEC, known as "initial margin." The margin required for a particular futures contract is set by the exchange on which the contract is traded, and may be significantly modified from time to time by the exchange during the term of the contract. Futures contracts are customarily purchased and sold on margins that may range upward from less than 5% of the value of the contract being traded. If the price of an open futures contract changes (by increase in the case of a sale or by decrease in the case of a purchase) so that the loss on the futures contract reaches a point at which the margin on deposit does not satisfy margin requirements, the broker will require an increase in the margin. However, if the value of a position increases because of favorable price changes in the futures contract so that the margin deposit exceeds the required margin, the broker will pay the excess to the Fund. These subsequent payments, called "variation margin," to and from the futures broker, are made on a daily basis as the price of the underlying assets fluctuate, making the long and short positions in the futures contract more or less valuable, a process known as "marking to market." The Fund expects to earn interest income on its margin deposits. Although certain futures contracts, by their terms, require actual future delivery of and payment for the underlying instruments, in practice most futures contracts are usually closed out before the delivery date. Closing out an open futures contract purchase or sale is effected by entering into an offsetting futures contract sale or purchase, respectively, for the same aggregate amount of the identical securities and the same delivery date. If the offsetting purchase price is less than the original sale price, the Fund realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the offsetting sale price is more than the original purchase price, the Fund realizes a gain; if it is less, the Fund realizes a loss. The transaction costs must also be included in these calculations. There can be no assurance, however, that the Fund will be able to enter into an offsetting transaction with respect to a particular futures contract at a particular time. If the Fund is not able to enter into an offsetting transaction, the Fund will continue to be required to maintain the margin deposits on the futures contract. As an example of an offsetting transaction in which the underlying instrument is not delivered, the contractual obligations arising from the sale of one contract of September Treasury Bills on an exchange may be fulfilled at any time before delivery of the contract is required (i.e., on a specified date in September, the "delivery month") by the purchase of one contract of September Treasury Bills on the same exchange. In such instance, the difference between the price at which the futures contract was sold and the price paid for the offsetting purchase, after allowance for transaction costs, represents the profit or loss to the Fund. For example, the S&P's 500 Stock Index is made up of 500 selected common stocks, most of which are listed on the New York Stock Exchange. The S&P 500 Index assigns relative weightings to the common stocks included in the Index, and the Index fluctuates with changes in the market values of those common stocks. In the case of futures contracts on the S&P 500 Index, the contracts are to buy or sell 250 units. Thus, if the value of the S&P 500 Index were $150, one contract would be worth $37,500 (250 units x $150). The stock index futures contract specifies that no delivery of the actual stocks making up the index will take place. Instead, settlement in cash occurs. Over the life of the contract, the gain or loss realized by the Fund will equal the difference between the purchase (or sale) price of the contract and the price at which the contract is terminated. For example, if the Fund enters into a futures contract to buy 250 units of the S&P 500 Index at a specified future date at a contract price of $150 and the S&P 500 Index is at $154 on that future date, the Fund will gain $1,000 (250 units x gain of $4). If the Fund enters into a futures contract to sell 250 units of the stock index at a specified future date at a contract price of $150 and the S&P 500 Index is at $152 on that future date, the Fund will lose $500 (250 units x loss of $2). Special Risks of Transactions in Futures Contracts . Volatility and Leverage The prices of futures contracts are volatile and are influenced, among other things, by actual and anticipated changes in the market and interest rates, which in turn are affected by fiscal and monetary policies and national and international political and economic events. Most United States futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular type of futures contract, no trades may be made on that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and therefore does not limit potential losses, because the limit may prevent the liquidation of unfavorable positions. Futures contract prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting some futures traders to substantial losses. Margin deposits required on futures trading are low. As a result, a relatively small price movement in a futures contract may result in immediate and substantial loss, as well as gain, to the investor. For example, if at the time of purchase, 10% of the value of the futures contract is deposited as margin, a subsequent 10% decrease in the value of the futures contract would result in a total loss of the margin deposit, before any deduction for the transaction costs, if the account were then closed out. A 15% decrease would result in a loss equal to 150% of the original margin deposit, if the contract were closed out. Thus, a purchase or sale of a futures contract may result in losses in excess of the amount invested in the futures contract. However, the Fund would presumably have sustained comparable losses if, instead of the futures contract, it had invested in the underlying financial instrument and sold it after decline. Furthermore, in the case of a futures contract purchase, in order to be certain that the Fund has sufficient assets to satisfy its obligations under a futures contract, the Fund earmarks to the futures contract money market instruments equal in value to the current value of the underlying instrument less the margin deposit. . Liquidity The Fund may elect to close some or all of its futures positions at any time prior to their expiration. The Fund would do so to reduce exposure represented by long futures positions or short futures positions. The Fund may close its positions by taking opposite positions which would operate to terminate the Fund's position in the futures contracts. Final determinations of variation margin would then be made, additional cash would be required to be paid by or released to the Fund, and the Fund would realize a loss or a gain. Futures contracts may be closed out only on the exchange or board of trade where the contracts were initially traded. Although the Fund intends to purchase or sell futures contracts only on exchanges or boards of trade where there appears to be an active market, there is no assurance that a liquid market on an exchange or board of trade will exist for any particular contract at any particular time. In such event, it might not be possible to close a futures contract, and in the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin. However, in the event futures contracts have been used to hedge the underlying instruments, the Fund would continue to hold the underlying instruments subject to the hedge until the futures contracts could be terminated. In such circumstances, an increase in the price of underlying instruments, if any, might partially or completely offset losses on the futures contract. However, as described next, there is no guarantee that the price of the underlying instruments will, in fact, correlate with the price movements in the futures contract and thus provide an offset to losses on a futures contract. . Hedging Risk A decision of whether, when, and how to hedge involves skill and judgment, and even a well-conceived hedge may be unsuccessful to some degree because of unexpected market behavior, market or interest rate trends. There are several risks in connection with the use by the Fund of futures contracts as a hedging device. One risk arises because of the imperfect correlation between movements in the prices of the futures contracts and movements in the prices of the underlying instruments which are the subject of the hedge. T. Rowe Price will, however, attempt to reduce this risk by entering into futures contracts whose movements, in its judgment, will have a significant correlation with movements in the prices of the Fund's underlying instruments sought to be hedged. Successful use of futures contracts by the Fund for hedging purposes is also subject to T. Rowe Price's ability to correctly predict movements in the direction of the market. It is possible that, when the Fund has sold futures to hedge its portfolio against a decline in the market, the index, indices, or instruments underlying futures might advance and the value of the underlying instruments held in the Fund's portfolio might decline. If this were to occur, the Fund would lose money on the futures and also would experience a decline in value in its underlying instruments. However, while this might occur to a certain degree, T. Rowe Price believes that over time the value of the Fund's portfolio will tend to move in the same direction as the market indices used to hedge the portfolio. It is also possible that, if the Fund were to hedge against the possibility of a decline in the market (adversely affecting the underlying instruments held in its portfolio) and prices instead increased, the Fund would lose part or all of the benefit of increased value of those underlying instruments that it has hedged, because it would have offsetting losses in its futures positions. In addition, in such situations, if the Fund had insufficient cash, it might have to sell underlying instruments to meet daily variation margin requirements. Such sales of underlying instruments might be, but would not necessarily be, at increased prices (which would reflect the rising market). The Fund might have to sell underlying instruments at a time when it would be disadvantageous to do so. In addition to the possibility that there might be an imperfect correlation, or no correlation at all, between price movements in the futures contracts and the portion of the portfolio being hedged, the price movements of futures contracts might not correlate perfectly with price movements in the underlying instruments due to certain market distortions. First, all participants in the futures market are subject to margin deposit and maintenance requirements. Rather than meeting additional margin deposit requirements, investors might close futures contracts through offsetting transactions, which could distort the normal relationship between the underlying instruments and futures markets. Second, the margin requirements in the futures market are less onerous than margin requirements in the securities markets and, as a result, the futures market might attract more speculators than the securities markets do. Increased participation by speculators in the futures market might also cause temporary price distortions. Due to the possibility of price distortion in the futures market and also because of imperfect correlation between price movements in the underlying instruments and movements in the prices of futures contracts, even a correct forecast of general market trends by T. Rowe Price might not result in a successful hedging transaction over a very short time period. Options on Futures Contracts The Fund may purchase and sell options on the same types of futures in which it may invest. Options (another type of potentially high-risk derivative) on futures are similar to options on underlying instruments except that options on futures give the purchaser the right, in return for the premium paid, to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put), rather than to purchase or sell the futures contract, at a specified exercise price at any time during the period of the option. Upon exercise of the option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by the delivery of the accumulated balance in the writer's futures margin account which represents the amount by which the market price of the futures contract, at exercise, exceeds (in the case of a call) or is less than (in the case of a put) the exercise price of the option on the futures contract. Purchasers of options who fail to exercise their options prior to the exercise date suffer a loss of the premium paid. As an alternative to writing or purchasing call and put options on interest rate futures, the Fund may write or purchase call and put options on financial indices. Such options would be used in a manner similar to the use of options on futures contracts. From time to time, a single order to purchase or sell futures contracts (or options thereon) may be made on behalf of the Fund and other T. Rowe Price Funds. Such aggregated orders would be allocated among the Funds and the other T. Rowe Price Funds in a fair and nondiscriminatory manner. Special Risks of Transactions in Options on Futures Contracts The risks described under "Special Risks in Transactions on Futures Contracts" are substantially the same as the risks of using options on futures. In addition, where the Fund seeks to close out an option position by writing or buying an offsetting option covering the same index, underlying instrument or contract and having the same exercise price and expiration date, its ability to establish and close out positions on such options will be subject to the maintenance of a liquid secondary market. Reasons for the absence of a liquid secondary market on an exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options, or underlying instruments; (iv) unusual or unforeseen circumstances may interrupt normal operations on an exchange; (v) the facilities of an exchange or a clearing corporation may not at all times be adequate to handle current trading volume; or (vi) one or more exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market on that exchange (or in the class or series of options) would cease to exist, although outstanding options on the exchange that had been issued by a clearing corporation as a result of trades on that exchange would continue to be exercisable in accordance with their terms. There is no assurance that higher than anticipated trading activity or other unforeseen events might not, at times, render certain of the facilities of any of the clearing corporations inadequate, and thereby result in the institution by an exchange of special procedures which may interfere with the timely execution of customers' orders. Additional Futures and Options Contracts Although the Fund has no current intention of engaging in futures or options transactions other than those described above, it reserves the right to do so. Such futures and options trading might involve risks which differ from those involved in the futures and options described above. Foreign Futures and Options Participation in foreign futures and foreign options transactions involves the execution and clearing of trades on or subject to the rules of a foreign board of trade. Neither the National Futures Association nor any domestic exchange regulates activities of any foreign boards of trade, including the execution, delivery and clearing of transactions, or has the power to compel enforcement of the rules of a foreign board of trade or any applicable foreign law. This is true even if the exchange is formally linked to a domestic market so that a position taken on the market may be liquidated by a transaction on another market. Moreover, such laws or regulations will vary depending on the foreign country in which the foreign futures or foreign options transaction occurs. For these reasons, when the Fund trades foreign futures or foreign options contracts, it may not be afforded certain of the protective measures provided by the Commodity Exchange Act, the CFTC's regulations and the rules of the National Futures Association and any domestic exchange, including the right to use reparations proceedings before the CFTC and arbitration proceedings provided by the National Futures Association or any domestic futures exchange. In particular, funds received from the Fund for foreign futures or foreign options transactions may not be provided the same protections as funds received in respect of transactions on United States futures exchanges. In addition, the price of any foreign futures or foreign options contract and, therefore, the potential profit and loss thereon may be affected by any variance in the foreign exchange rate between the time the Fund's order is placed and the time it is liquidated, offset or exercised. U.S. Treasury Intermediate and Long-Term Funds Limitations on Futures and Options for Intermediate and Long-Term Funds The Funds will not purchase a futures contract or option theron if, with respect to positions in futures or options on futures which do not represent bona fide hedging, the aggregate initial margin and premiums on such positions would exceed 5% of the Fund's net asset value. In addition, neither of the Funds will enter into a futures transaction if it would be obligated to purchase or deliver under outstanding open futures contracts amounts which would exceed 15% of the Fund's total assets. A Fund will not write a covered call option if, as a result, the aggregate market value of all portfolio securities covering call options or subject to delivery under put options exceeds 15% of the market value of the Fund's total assets. A Fund will not write a covered put option if, as a result, the aggregate market value of all portfolio securities subject to such put options or covering call options exceeds 15% of the market value of the Fund's total assets. The Funds have no current intention of investing in futures and options. However, they reserve the right to do so in the future and could be subject to the following limitations: a Fund may invest up to 15% of its total assets in premiums on put options and 15% of its total assets in premiums on call options. The total amount of a Fund's total assets invested in futures and options will not exceed 15% of the Fund's total assets. Corporate Income, High Yield, New Income, Personal Strategy, and Short-Term Bond Funds Foreign Currency Transactions A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are principally traded in the interbank market conducted directly between currency traders (usually large, commercial banks) and their customers. A forward contract generally has no deposit requirement, and no commissions are charged at any stage for trades. The Fund may enter into forward contracts for a variety of purposes in connection with the management of the foreign securities portion of its portfolio. The Fund's use of such contracts would include, but not be limited to, the following: First, when the Fund enters into a contract for the purchase or sale of a security denominated in a foreign currency, it may desire to "lock in" the U.S. dollar price of the security. By entering into a forward contract for the purchase or sale, for a fixed amount of dollars, of the amount of foreign currency involved in the underlying security transactions, the Fund will be able to protect itself against a possible loss resulting from an adverse change in the relationship between the U.S. dollar and the subject foreign currency during the period between the date the security is purchased or sold and the date on which payment is made or received. Second, when T. Rowe Price believes that one currency may experience a substantial movement against another currency, including the U.S. dollar, it may enter into a forward contract to sell or buy the amount of the former foreign currency, approximating the value of some or all of the Fund's portfolio securities denominated in such foreign currency. Alternatively, where appropriate, the Fund may hedge all or part of its foreign currency exposure through the use of a basket of currencies or a proxy currency where such currency or currencies act as an effective proxy for other currencies. In such a case, the Fund may enter into a forward contract where the amount of the foreign currency to be sold exceeds the value of the securities denominated in such currency. The use of this basket hedging technique may be more efficient and economical than entering into separate forward contracts for each currency held in the Fund. The precise matching of the forward contract amounts and the value of the securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the value of those securities between the date the forward contract is entered into and the date it matures. The projection of short-term currency market movement is extremely difficult, and the successful execution of a short-term hedging strategy is highly uncertain. Under normal circumstances, consideration of the prospect for currency parties will be incorporated into the longer term investment decisions made with regard to overall diversification strategies. However, T. Rowe Price believes that it is important to have the flexibility to enter into such forward contracts when it determines that the best interests of the Fund will be served. Third, the Fund may use forward contracts when the Fund wishes to hedge out of the dollar into a foreign currency in order to create a synthetic bond or money market instrument-the security would be issued in U.S. dollars but the dollar component would be transformed into a foreign currency through a forward contract. The Fund may enter into forward contacts for any other purpose consistent with the Fund's investment objective and program. However, the Fund will not enter into a forward contract, or maintain exposure to any such contract(s), if the amount of foreign currency required to be delivered thereunder would exceed the Fund's holdings of liquid, high-grade debt securities, currency available for cover of the forward contract(s) or other suitable cover as permitted by the SEC. In determining the amount to be delivered under a contract, the Fund may net offsetting positions. At the maturity of a forward contract, the Fund may sell the portfolio security and make delivery of the foreign currency, or it may retain the security and either extend the maturity of the forward contract (by "rolling" that contract forward) or may initiate a new forward contract. If the Fund retains the portfolio security and engages in an offsetting transaction, the Fund will incur a gain or a loss (as described below) to the extent that there has been movement in forward contract prices. If the Fund engages in an offsetting transaction, it may subsequently enter into a new forward contract to sell the foreign currency. Should forward prices decline during the period between the Fund's entering into a forward contract for the sale of a foreign currency and the date it enters into an offsetting contract for the purchase of the foreign currency, the Fund will realize a gain to the extent the price of the currency it has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the Fund will suffer a loss to the extent of the price of the currency it has agreed to purchase exceeds the price of the currency it has agreed to sell. The Fund's dealing in forward foreign currency exchange contracts will generally be limited to the transactions described above. However, the Fund reserves the right to enter into forward foreign currency contracts for different purposes and under different circumstances. Of course, the Fund is not required to enter into forward contracts with regard to its foreign currency-denominated securities and will not do so unless deemed appropriate by T. Rowe Price. It also should be realized that this method of hedging against a decline in the value of a currency does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange at a future date. Additionally, although such contracts tend to minimize the risk of loss due to a decline in the value of the hedged currency, at the same time, they tend to limit any potential gain which might result from an increase in the value of that currency. Although the Fund values its assets daily in terms of U.S. dollars, it does not intend to convert its holdings of foreign currencies into U.S. dollars on a daily basis. It will do so from time to time, and investors should be aware of the costs of currency conversion. Although foreign exchange dealers do not charge a fee for conversion, they do realize a profit based on the difference (the "spread") between the prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to the Fund at one rate, while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer. Federal Tax Treatment of Options, Futures Contracts, and Forward Foreign Exchange Contracts The Fund may enter into certain options, futures, and forward foreign exchange contracts, including options and futures on currencies, which will be treated as Section 1256 contracts or straddles. Transactions that are considered Section 1256 contracts will be considered to have been closed at the end of the Fund's fiscal year and any gains or losses will be recognized for tax purposes at that time. Such gains or losses from the normal closing or settlement of such transactions will be characterized as 60% long-term capital gain (taxable at a maximum rate of 20%) or loss and 40% short-term capital gain or loss regardless of the holding period of the instrument (ordinary income or loss for foreign exchange contracts). The Fund will be required to distribute net gains on such transactions to shareholders even though it may not have closed the transaction and received cash to pay such distributions. Options, futures and forward foreign exchange contracts, including options and futures on currencies, which offset a foreign dollar denominated bond or currency position may be considered straddles for tax purposes, in which case a loss on any position in a straddle will be subject to deferral to the extent of unrealized gain in an offsetting position. The holding period of the securities or currencies comprising the straddle will be deemed not to begin until the straddle is terminated. The holding period of the security offsetting an "in-the-money qualified covered call" option on an equity security will not include the period of time the option is outstanding. Losses on written covered calls and purchased puts on securities, excluding certain "qualified covered call" options on equity securities, may be long-term capital losses, if the security covering the option was held for more than 12 months prior to the writing of the option. In order for the Fund to continue to qualify for federal income tax treatment as a regulated investment company, at least 90% of its gross income for a taxable year must be derived from qualifying income, i.e., dividends, interest, income derived from loans of securities, and gains from the sale of securities or currencies. Tax regulations could be issued limiting the extent that net gain realized from option, futures or foreign forward exchange contracts on currencies is qualifying income for purposes of the 90% requirement. As a result of the "Taxpayer Relief Act of 1997," entering into certain options, futures contracts, or forward contracts may result in the "constructive sale" of offsetting stocks or debt securities of the Fund. See "Portfolio Management Practices-Short Sales" for further discussion. INVESTMENT RESTRICTIONS ------------------------------------------------------------------------------- Fundamental policies may not be changed without the approval of the lesser of (1) 67% of the Fund's shares present at a meeting of shareholders if the holders of more than 50% of the outstanding shares are present in person or by proxy or (2) more than 50% of a Fund's outstanding shares. Other restrictions in the form of operating policies are subject to change by the Fund's Board of Directors/Trustees without shareholder approval. Any investment restriction which involves a maximum percentage of securities or assets shall not be considered to be violated unless an excess over the percentage occurs immediately after, and is caused by, an acquisition of securities or assets of, or borrowings by, the Fund. Calculation of the Fund's total assets for compliance with any of the following fundamental or operating policies or any other investment restrictions set forth in the Fund's prospectus or Statement of Additional Information will not include cash collateral held in connection with securities lending activities. Fundamental Policies As a matter of fundamental policy, the Fund may not: (1) Borrowing Borrow money except that the Fund may (i) borrow for non-leveraging, temporary or emergency purposes; and (ii) engage in reverse repurchase agreements and make other investments or engage in other transactions, which may involve a borrowing, in a manner consistent with the Fund's investment objective and program, provided that the combination of (i) and (ii) shall not exceed 33/1//\\/3/\\% of the value of the Fund's total assets (including the amount borrowed) less liabilities (other than borrowings) or such other percentage permitted by law. Any borrowings which come to exceed this amount will be reduced in accordance with applicable law. The Fund may borrow from banks, other Price Funds, or other persons to the extent permitted by applicable law; (2) Commodities Purchase or sell physical commodities; except that the Fund (other than the Prime Reserve, U.S. Treasury Money, Government Reserve Investment, and Reserve Investment Funds) may enter into futures contracts and options thereon; (3) (a) Industry Concentration (All Funds except High Yield, New Income, Prime Reserve, Reserve Investment, and Short-Term Bond Funds) Purchase the securities of any issuer if, as a result, more than 25% of the value of the Fund's total assets would be invested in the securities of issuers having their principal business activities in the same industry; (b) Industry Concentration (High Yield Fund) Purchase the securities of any issuer if, as a result, more than 25% of the value of the Fund's total assets would be invested in the securities of issuers having their principal business activities in the same industry; provided, however, that the Fund will normally concentrate 25% or more of its assets in securities of the banking industry when the Fund's position in issues maturing in one year or less equals 35% or more of the Fund's total assets; (c) Industry Concentration (New Income Fund) Purchase the securities of any issuer if, as a result, more than 25% of the value of the Fund's total assets would be invested in the securities of issuers having their principal business activities in the same industry; provided, however, that the Fund will invest more than 25% of its total assets, but not more than 50%, in any one of the gas utility, gas transmission utility, electric utility, telephone utility, and petroleum industries under certain circumstances, and further provided that this limitation does not apply to securities of the banking industry including, but not limited to, certificates of deposit and bankers' acceptances; (d) Industry Concentration (Prime Reserve and Reserve Investment Funds) Purchase the securities of any issuer if, as a result, more than 25% of the value of the Fund's total assets would be invested in the securities of issuers having their principal business activities in the same industry; provided, however, that this limitation does not apply to securities of the banking industry including, but not limited to, certificates of deposit and bankers' acceptances; and (e) Industry Concentration (Short-Term Bond Fund) Purchase the securities of any issuer if, as a result, more than 25% of the value of the Fund's total assets would be invested in the securities of issuers having their principal business activities in the same industry; provided, however, that the Fund will normally invest more than 25% of its total assets in the securities of the banking industry including, but not limited to, bank certificates of deposit and bankers' acceptances when the Fund's position in issues maturing in one year or less equals 35% or more of the Fund's total assets; provided, further, that the Fund will invest more than 25% of its total assets, but not more than 50%, in any one of the gas utility, gas transmission utility, electric utility, telephone utility, and petroleum industries under certain circumstances; (4) Loans Make loans, although the Fund may (i) lend portfolio securities and participate in an interfund lending program with other Price Funds provided that no such loan may be made if, as a result, the aggregate of such loans would exceed 33/1//\\/3/\\% of the value of the Fund's total assets; (ii) purchase money market securities and enter into repurchase agreements; and (iii) acquire publicly distributed or privately placed debt securities and purchase debt; (5) Percent Limit on Assets Invested in Any One Issuer Purchase a security if, as a result, with respect to 75% of the value of its total assets, more than 5% of the value of the Fund's total assets would be invested in the securities of a single issuer, except securities issued or guaranteed by the U.S. government or any of its agencies or instrumentalities; (6) Percent Limit on Share Ownership of Any One Issuer Purchase a security if, as a result, with respect to 75% of the value of the Fund's total assets, more than 10% of the outstanding voting securities of any issuer would be held by the Fund (other than obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities); (7) Real Estate Purchase or sell real estate, including limited partnership interests therein, unless acquired as a result of ownership of securities or other instruments (but this shall not prevent the Fund from investing in securities or other instruments backed by real estate or securities of companies engaged in the real estate business); (8) Senior Securities Issue senior securities except in compliance with the 1940 Act; or (9) Underwriting Underwrite securities issued by other persons, except to the extent that the Fund may be deemed to be an underwriter within the meaning of the Securities Act of 1933 in connection with the purchase and sale of its portfolio securities in the ordinary course of pursuing its investment program. NOTES The following Notes should be read in connection with the above-described fundamental policies. The Notes are not fundamental policies. With respect to investment restrictions (1) and (4), the Fund will not borrow from or lend to any other Price Fund (defined as any other mutual fund managed by or for which T. Rowe Price or Price-Fleming acts as adviser) unless each Fund applies for and receives an exemptive order from the SEC or the SEC issues rules permitting such transactions. There is no assurance the SEC would grant any order requested by the Fund or promulgate any rules allowing the transactions. With respect to investment restriction (1), the Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds have no current intention of engaging in any borrowing transactions. With respect to investment restriction (2), the Fund does not consider currency contracts or hybrid investments to be commodities. For purposes of investment restriction (3), U.S., state or local governments, or related agencies or instrumentalities, are not considered an industry. Industries are determined by reference to the classifications of industries set forth in the Fund's semiannual and annual reports. It is the position of the Staff of the SEC that foreign governments are industries for purposes of this restriction. For purposes of investment restriction (4), the Fund will consider the acquisition of a debt security to include the execution of a note or other evidence of an extension of credit with a term of more than nine months. For purposes of investment restriction (5), the Fund will consider a repurchase agreement fully collateralized with U.S. government securities to be U.S. government securities. Operating Policies As a matter of operating policy, the Fund may not: (1) Borrowing Purchase additional securities when money borrowed exceeds 5% of its total assets; (2) Control of Portfolio Companies Invest in companies for the purpose of exercising management or control; (3) (a) Equity Securities (All Funds except High Yield and New Income Funds) Purchase any equity security or security convertible into an equity security except as set forth in its prospectus and operating policy on investment companies; (b) Equity Securities (High Yield Fund) Invest more than 20% of the Fund's total assets in equity securities (including up to 5% in warrants); (c) Equity Securities (New Income Fund) Invest more than 25% of the Fund's total assets in equity securities; (4) Futures Contracts Purchase a futures contract or an option thereon, if, with respect to positions in futures or options on futures which do not represent bona fide hedging, the aggregate initial margin and premiums on such options would exceed 5% of the Fund's net asset value; (5) Illiquid Securities Purchase illiquid securities if, as a result, more than 15% (10% for the Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds) of its net assets would be invested in such securities; (6) Investment Companies Purchase securities of open-end or closed-end investment companies except (i) in compliance with the 1940 Act; (ii) securities of the Reserve Investment or Government Reserve Investment Funds; or (iii) in the case of the Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds, only securities of other money market funds; (7) Margin Purchase securities on margin, except (i) for use of short-term credit necessary for clearance of purchases of portfolio securities and (ii) it may make margin deposits in connection with futures contracts or other permissible investments; (8) Mortgaging Mortgage, pledge, hypothecate or, in any manner, transfer any security owned by the Fund as security for indebtedness except as may be necessary in connection with permissible borrowings or investments and then such mortgaging, pledging or hypothecating may not exceed 33/1//\\/3/\\% of the Fund's total assets at the time of borrowing or investment; (9) Oil and Gas Programs Purchase participations or other direct interests in, or enter into leases with respect to oil, gas, or other mineral exploration or development programs if, as a result thereof, more than 5% of the value of the total assets of the Fund would be invested in such programs; (10) Options, etc. Invest in puts, calls, straddles, spreads, or any combination thereof, except to the extent permitted by the prospectus and Statement of Additional Information; (11) (a) Short Sales (All Funds except High Yield Fund) Effect short sales of securities; (b) Short Sales (High Yield Fund) Effect short sales of securities, other than as set forth in its prospectus and Statement of Additional Information; or (12) Warrants Invest in warrants if, as a result thereof, more than 10% of the value of the net assets of the Fund would be invested in warrants. Personal Strategy Funds Notwithstanding anything in the above fundamental and operating restrictions to the contrary, the Fund may invest all of its assets in a single investment company or a series thereof in connection with a "master-feeder" arrangement. Such an investment would be made where the Fund (a "Feeder"), and one or more other Funds with the same investment objective and program as the Fund, sought to accomplish its investment objective and program by investing all of its assets in the shares of another investment company (the "Master"). The Master would, in turn, have the same investment objective and program as the Fund. The Fund would invest in this manner in an effort to achieve the economies of scale associated with having a Master fund make investments in portfolio companies on behalf of a number of Feeder funds. MANAGEMENT OF THE FUNDS ------------------------------------------------------------------------------- The officers and directors/trustees of the Fund are listed below. Unless otherwise noted, the address of each is 100 East Pratt Street, Baltimore, Maryland 21202. Except as indicated, each has been an employee of T. Rowe Price for more than five years. In the list below, the Fund's directors/trustees who are considered "interested persons" of T. Rowe Price as defined under Section 2(a)(19) of the Investment Company Act of 1940 are noted with an asterisk (*). These directors/trustees are referred to as inside directors by virtue of their officership, directorship, and/or employment with T. Rowe Price. All Funds except Personal Strategy Funds Independent Directors/Trustees CALVIN W. BURNETT, PH.D., President, Coppin State College; Director, Maryland Chamber of Commerce and Provident Bank of Maryland; Former President, Baltimore Area Council Boy Scouts of America; Vice President, Board of Directors, The Walters Art Gallery; Address: 2500 West North Avenue, Baltimore, Maryland 21216 ANTHONY W. DEERING, Director, Chairman of the Board, President and Chief Operating Officer, The Rouse Company, real estate developers, Columbia, Maryland; Advisory Director, Kleinwort, Benson (North America) Corporation, a registered broker-dealer; Address: 10275 Little Patuxent Parkway, Columbia, Maryland 21044 F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver & Associates, Inc.; Consulting Environmental & Civil Engineer(s); formerly Executive Vice President, EA Engineering, Science, and Technology, Inc., and President, EA Engineering, Inc., Baltimore, Maryland; Address: Green Spring Station, 2360 West Joppa Road, Suite 224, Lutherville, Maryland 21093 JOHN G. SCHREIBER, President, Schreiber Investments, Inc., a real estate investment company; Director, AMLI Residential Properties Trust and Urban Shopping Centers, Inc.; Partner, Blackstone Real Estate Partners, L.P.; Director and formerly Executive Vice President, JMB Realty Corporation, a national real estate investment manager and developer; Address: 1115 East Illinois Road, Lake Forest, Illinois 60045 Personal Strategy Funds DONALD W. DICK, JR., Principal, EuroCapital Advisors, LLC, an acquisition and management advisory firm; formerly (5/89-6/95) Principal, Overseas Partners, Inc., a financial investment firm; formerly (6/65-3/89) Director and Vice President; Consumer Products Division, McCormick & Company, Inc., international food processors; Director, Waverly, Inc., Baltimore, Maryland; Address: P.O. Box 491, Chilmark, MA 02535-0491 DAVID K. FAGIN, Chairman and Chief Executive Officer, Western Exploration and Development, Ltd.; Director Golden Star Resources Ltd. and Miranda Mining Development Corporation; formerly (1986-7/91) President, Chief Operating Officer and Director, Homestake Mining Company; Address: 1660 Lincoln Street, Suite 3000, Denver, Colorado 80264-3001 HANNE M. MERRIMAN, Retail business consultant; formerly President and Chief Operating Officer (1991-92), Nan Duskin, Inc., a women's specialty store, Director (1984-90) and Chairman (1989-90) Federal Reserve Bank of Richmond, and President and Chief Executive Officer (1988-89), Honeybee, Inc., a division of Spiegel, Inc.; Director, Central Illinois Public Service Company, CIPSCO Incorporated, Finlay Enterprises, Inc., The Rouse Company, State Farm Mutual Automobile Insurance Company and USAir Group, Inc.; Address: 3201 New Mexico Avenue, N.W., Suite 350, Washington, D.C. 20016 HUBERT D. VOS, President, Stonington Capital Corporation, a private investment company; Address: 1231 State Street, Suite 247, Santa Barbara, California 93190-0409 PAUL M. WYTHES, Founding General Partner, Sutter Hill Ventures, a venture capital limited partnership, providing equity capital to young high technology companies throughout the United States; Director, Teltone Corporation, Interventional Technologies Inc. and Stuart Medical, Inc.; Address: 755 Page Mill Road, Suite A200, Palo Alto, California 94304-1005 Inside Directors/Trustees/Officers All Funds * JAMES S. RIEPE, Director/Trustee and Vice President -Vice Chairman of the Board and Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director, Price-Fleming and General Re Corporation HENRY H. HOPKINS, Vice President-Vice President, Price-Fleming and T. Rowe Price Retirement Plan Services, Inc.; Director and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc. and T. Rowe Price Trust Company PATRICIA S. LIPPERT, Secretary-Assistant Vice President, T. Rowe Price and T. Rowe Price Investment Services, Inc. CARMEN F. DEYESU, Treasurer-Vice President, T. Rowe Price, T. Rowe Price Services, Inc., and T. Rowe Price Trust Company DAVID S. MIDDLETON, Controller-Vice President, T. Rowe Price, T. Rowe Price Services, Inc., and T. Rowe Price Trust Company INGRID I. VORDEMBERGE, Assistant Vice President-Employee, T. Rowe Price Corporate Income Fund * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor ROBERT M. RUBINO, Executive Vice President -Vice President, T. Rowe Price MARK J. VASELKIV, Executive Vice President -Vice President, T. Rowe Price STEVEN G. BROOKS, Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst PATRICK S. CASSIDY, Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst DEBRA R. DIES, Vice President -Credit Analyst, T. Rowe Price; formerly employed at J.P. Morgan Securities HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming VIRGINIA A. STIRLING, Vice President -Vice President, T. Rowe Price THOMAS E. TEWKSBURY, Vice President -Vice President, T. Rowe Price; formerly senior bond trader, Scudder, Stevens & Clark, New York, New York THEA N. WILLIAMS, Vice President -Vice President, T. Rowe Price GNMA Fund * WILLIAM T. REYNOLDS, Trustee -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Trustee -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio Manager, T. Rowe Price; formerly founding partner and Senior Vice President of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio Manager at Weiss Peck and Greer DEBORAH L. BOYER, Vice President -Assistant Vice President, T. Rowe Price; formerly Assistant Vice President and Government Bond Trader for First Chicago NBD Corporation HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming Government Reserve Investment and Reserve Investment Funds * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst EDWARD A. WIESE, President -Vice President, T. Rowe Price; Chartered Financial Analyst ROBERT P. CAMPBELL, Executive Vice President -Vice President, T. Rowe Price and Price-Fleming JAMES M. MCDONALD, Executive Vice President -Vice President, T. Rowe Price PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price BRIAN E. BURNS, Vice President -Assistant Vice President, T. Rowe Price JOAN R. POTEE, Vice President -Vice President, T. Rowe Price ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe Price; Chartered Financial Analyst High Yield Fund * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst MARK J. VASELKIV, President -Vice President, T. Rowe Price JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price ANDREW M. BROOKS, Vice President -Vice President, T. Rowe Price PAUL A. KARPERS, Vice President -Employee, T. Rowe Price; formerly an Investment Analyst at the Vanguard Group, Philadelphia, Pennsylvania NATHANIEL S. LEVY, Vice President -Vice President, T. Rowe Price KEVIN P. LOOME, Vice President -Employee, T. Rowe Price; formerly a Corporate Finance Analyst for Morgan Stanley in both London and New York MICHAEL J. MCGONIGLE, Vice President -Assistant Vice President, T. Rowe Price EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price HUBERT M. STILES, JR., Vice President -Vice President, T. Rowe Price THOMAS E. TEWKSBURY, Vice President -Vice President, T. Rowe Price; formerly senior bond trader, Scudder, Stevens & Clark, New York, New York PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor THEA N. WILLIAMS, Vice President -Vice President, T. Rowe Price New Income Fund * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst CHARLES P. SMITH, President -Managing Director, T. Rowe Price; Vice President, Price-Fleming ROBERT M. RUBINO, Executive Vice President -Vice President, T. Rowe Price CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio Manager, T. Rowe Price; formerly founding partner and Senior Vice President of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio Manager at Weiss Peck and Greer STEVEN G. BROOKS, Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst PATRICK S. CASSIDY, Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst DEBRA R. DIES, Vice President -Credit Analyst, T. Rowe Price; formerly employed at J.P. Morgan Securities HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst JOAN R. POTEE, Vice President -Vice President, T. Rowe Price THEODORE E. ROBSON, Vice President -Assistant Vice President, T. Rowe Price EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price VIRGINIA A. STIRLING, Vice President -Vice President, T. Rowe Price SUSAN G. TROLL, Vice President -Vice President and Analyst, T. Rowe Price; formerly Vice President at Merrill Lynch Asset Management; Certified Public Accountant PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe Price; Chartered Financial Analyst Personal Strategy Balanced, Growth, and Income Funds * JAMES A.C. KENNEDY III, Director -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Chairman of the Board -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor STEPHEN W. BOESEL, Executive Vice President -Managing Director, T. Rowe Price EDMUND M. NOTZON, Executive Vice President -Managing Director, T. Rowe Price; Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst LARRY J. PUGLIA, Executive Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company JOHN H. LAPORTE, JR., Vice President -Managing Director, T. Rowe Price; Chartered Financial Analyst DONALD J. PETERS, Vice President -Vice President, T. Rowe Price WILLIAM T. REYNOLDS, Vice President -Managing Director, T. Rowe Price; Chartered Financial Analyst BRIAN C. ROGERS, Vice President -Director and Managing Director, T. Rowe Price; Chartered Financial Analyst MARK J. VASELKIV, Vice President -Vice President, T. Rowe Price JUDITH B. WARD, Vice President -Employee, T. Rowe Price RICHARD T. WHITNEY, Vice President -Managing Director, T. Rowe Price and T. Rowe Price Trust Company; Chartered Financial Analyst J. JEFFREY LANG, Assistant Vice President-Assistant Vice President, T. Rowe Price MARY C. MUNOZ, Vice President -Assistant Vice President, T. Rowe Price Prime Reserve Fund * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst EDWARD A. WIESE, President -Vice President, T. Rowe Price; Chartered Financial Analyst ROBERT P. CAMPBELL, Executive Vice President -Vice President, T. Rowe Price and Price-Fleming JAMES M. MCDONALD, Executive Vice President -Vice President, T. Rowe Price PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price BRIAN E. BURNS, Vice President -Assistant Vice President, T. Rowe Price JOAN R. POTEE, Vice President -Vice President, T. Rowe Price ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price SUSAN G. TROLL, Vice President -Vice President and Analyst, T. Rowe Price; formerly Vice President at Merrill Lynch Asset Management; Certified Public Accountant PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe Price; Chartered Financial Analyst Short-Term Bond Fund * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst EDWARD A. WIESE, President -Vice President, T. Rowe Price; Chartered Financial Analyst CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio Manager, T. Rowe Price; formerly founding partner and Senior Vice President of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio Manager at Weiss Peck and Greer STEVEN G. BROOKS, Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst ROBERT P. CAMPBELL, Vice President -Vice President, T. Rowe Price and Price-Fleming PATRICK S. CASSIDY, Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst DEBRA R. DIES, Vice President -Credit Analyst, T. Rowe Price; formerly employed at J.P. Morgan Securities CHARLES B. HILL, Vice President -Vice President, T. Rowe Price HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price CHERYL A. MICKEL, Vice President -Assistant Vice President, T. Rowe Price THEODORE E. ROBSON, Vice President -Assistant Vice President, T. Rowe Price ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming VIRGINIA A. STIRLING, Vice President -Vice President, T. Rowe Price PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe Price; Chartered Financial Analyst Short-Term U.S. Government Fund * WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor HEATHER R. LANDON, Executive Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe Price; Chartered Financial Analyst U.S. Treasury Intermediate, Long-Term, and Money Funds * WILLIAM T. REYNOLDS, Director -Managing Director, T. Rowe Price; Chartered Financial Analyst * M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price Trust Company; Chartered Financial Analyst PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan Services, Inc., Chartered Investment Counselor CHARLES P. SMITH, Executive Vice President -Managing Director, T. Rowe Price; Vice President, Price-Fleming EDWARD A. WIESE, Executive Vice President -Vice President, T. Rowe Price; Chartered Financial Analyst CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio Manager, T. Rowe Price; formerly founding partner and Senior Vice President of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio Manager at Weiss Peck and Greer PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price BRIAN E. BURNS, Vice President -Assistant Vice President, T. Rowe Price ROBERT P. CAMPBELL, Vice President -Vice President, T. Rowe Price and Price-Fleming JEROME A. CLARK, Vice President -Vice President, T. Rowe Price HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe Price Trust Company JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price CHERYL A. MICKEL, Vice President -Assistant Vice President, T. Rowe Price EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst JOAN R. POTEE, Vice President -Vice President, T. Rowe Price ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe Price; Chartered Financial Analyst Compensation Table The Funds do not pay pension or retirement benefits to their officers or directors/trustees. Also, any director/ trustee of a Fund who is an officer or employee of T. Rowe Price or Price-Fleming does not receive any remuneration from the Fund.
Name of Person, Aggregate Compensation from Fund(a) Total Compensation from Fund and Fund Complex Paid Position ------- to Directors/ Trustees(b) - -------------------------------- ----------- - ----------------------------------------------------------------------- ----------------------------------------------------------------------------------- --------------------------------------------------- GNMA Fund Robert P. Black, Trustee(c) $2,752 $65,000 Calvin W. Burnett, Ph.D., Trustee 2,752 65,000 Anthony W. Deering, Trustee 1,694 81,000 F. Pierce Linaweaver, Trustee 2,752 66,000 John G. Schreiber, Trustee 2,752 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- High Yield Fund Robert P. Black, Director(c) $3,630 $65,000 Calvin W. Burnett, Ph.D., Director 3,630 65,000 Anthony W. Deering, Director 2,037 81,000 F. Pierce Linaweaver, Director 3,630 66,000 John G. Schreiber, Director 3,630 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- New Income Fund Robert P. Black, Director(c) $4,205 $65,000 Calvin W. Burnett, Ph.D., Director 4,205 65,000 Anthony W. Deering, Director 2,265 81,000 F. Pierce Linaweaver, Director 4,205 66,000 John G. Schreiber, Director 4,205 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- Personal Strategy Balanced Fund Donald W. Dick, Jr., Director $1,126 $81,000 David K. Fagin, Director 1,220 65,000 Hanne M. Merriman, Director 1,220 65,000 Hubert D. Vos, Director 1,220 66,000 Paul M. Wythes, Director 1,126 80,000 - ----------------------------------------------------------------------------------------------------------------------------------- Personal Strategy Growth Fund Donald W. Dick, Jr., Director $1,049 $81,000 David K. Fagin, Director 1,084 65,000 Hanne M. Merriman, Director 1,084 65,000 Hubert D. Vos, Director 1,084 66,000 Paul M. Wythes, Director 1,049 80,000 - ----------------------------------------------------------------------------------------------------------------------------------- Personal Strategy Income Fund Donald W. Dick, Jr., Director $1,037 $81,000 David K. Fagin, Director 1,059 65,000 Hanne M. Merriman, Director 1,059 65,000 Hubert D. Vos, Director 1,059 66,000 Paul M. Wythes, Director 1,037 80,000 - ----------------------------------------------------------------------------------------------------------------------------------- Prime Reserve Fund Robert P. Black, Director(c) $8,713 $65,000 Calvin W. Burnett, Ph.D., Director 8,713 65,000 Anthony W. Deering, Director 4,057 81,000 F. Pierce Linaweaver, Director 8,713 66,000 John G. Schreiber, Director 8,713 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- Short-Term Bond Fund Robert P. Black, Director(c) $1,611 $65,000 Calvin W. Burnett, Ph.D., Director 1,611 65,000 Anthony W. Deering, Director 1,240 81,000 F. Pierce Linaweaver, Director 1,611 66,000 John G. Schreiber, Director 1,611 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- Short-Term U.S. Government Fund Robert P. Black, Director(c) $1,140 $65,000 Calvin W. Burnett, Ph.D., Director 1,140 65,000 Anthony W. Deering, Director 1,340 81,000 F. Pierce Linaweaver, Director 1,140 66,000 John G. Schreiber, Director 1,140 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury Intermediate Fund Robert P. Black, Director(c) $1,124 $65,000 Calvin W. Burnett, Ph.D., Director 1,124 65,000 Anthony W. Deering, Director 1,292 81,000 F. Pierce Linaweaver, Director 1,124 66,000 John G. Schreiber, Director 1,124 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury Long-Term Fund Robert P. Black, Director(c) $1,559 $65,000 Calvin W. Burnett, Ph.D., Director 1,559 65,000 Anthony W. Deering, Director 2,412 81,000 F. Pierce Linaweaver, Director 1,559 66,000 John G. Schreiber, Director 1,559 65,000 - ----------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury Money Fund Robert P. Black, Director(c) $1,157 $65,000 Calvin W. Burnett, Ph.D., Director 1,157 65,000 Anthony W. Deering, Director 1,383 81,000 F. Pierce Linaweaver, Director 1,157 66,000 John G. Schreiber, Director 1,157 65,000 - -----------------------------------------------------------------------------------------------------------------------------------
(a) Amounts in this column are based on accrued compensation from June 1, 1997 to May 31, 1998. (b) Amounts in this column are based on compensation received from January 1, 1997, to December 31, 1997. The T. Rowe Price complex included 84 funds as of December 31, 1997. (c) Mr. Black retired from his position with the Funds in April 1998. Note: Government Reserve Investment and Reserve Investments Funds will not incur director's fees. All Funds The Fund's Executive Committee, consisting of the Fund's interested directors/trustees, has been authorized by its respective Board of Directors/Trustees to exercise all powers of the Board to manage the Funds in the intervals between meetings of the Board, except the powers prohibited by statute from being delegated. PRINCIPAL HOLDERS OF SECURITIES ------------------------------------------------------------------------------- As of the date of the prospectus, the officers and directors/trustees of the Fund, as a group, owned less than 1% of the outstanding shares of the Fund. As of June 30, 1998, the following shareholders beneficially owned more than 5% of the outstanding shares of: GNMA, High Yield, New Income, and U.S. Treasury Long-Term Funds: Yachtcrew & Co., T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202; Government Reserve Investment Fund: Barnaclesail, c/o T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202; Bridgesail & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202 Reserve Investment Fund: Drakkar & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202; Eye & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202; Taskforce & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202; Shorebird & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202; U.S. Treasury Intermediate Fund: First American Trust Co., Managed Omnibus, 421 N Main Street, Santa Ana, California 92701-4699. INVESTMENT MANAGEMENT SERVICES ------------------------------------------------------------------------------- Services Under the Management Agreement, T. Rowe Price provides the Fund with discretionary investment services. Specifically, T. Rowe Price is responsible for supervising and directing the investments of the Fund in accordance with the Fund's investment objectives, program, and restrictions as provided in its prospectus and this Statement of Additional Information. T. Rowe Price is also responsible for effecting all security transactions on behalf of the Fund, including the negotiation of commissions and the allocation of principal business and portfolio brokerage. In addition to these services, T. Rowe Price provides the Fund with certain corporate administrative services, including: maintaining the Fund's corporate existence and corporate records; registering and qualifying Fund shares under federal laws; monitoring the financial, accounting, and administrative functions of the Fund; maintaining liaison with the agents employed by the Fund such as the Fund's custodian and transfer agent; assisting the Fund in the coordination of such agents' activities; and permitting T. Rowe Price's employees to serve as officers, directors/trustees, and committee members of the Fund without cost to the Fund. The Management Agreement also provides that T. Rowe Price, its directors/trustees, officers, employees, and certain other persons performing specific functions for the Fund will only be liable to the Fund for losses resulting from willful misfeasance, bad faith, gross negligence, or reckless disregard of duty. All Funds except Government Reserve Investment and Reserve Investment Funds Management Fee The Fund pays T. Rowe Price a fee ("Fee") which consists of two components: a Group Management Fee ("Group Fee") and an Individual Fund Fee ("Fund Fee"). The Fee is paid monthly to T. Rowe Price on the first business day of the next succeeding calendar month and is calculated as described below. The monthly Group Fee ("Monthly Group Fee") is the sum of the daily Group Fee accruals ("Daily Group Fee Accruals") for each month. The Daily Group Fee Accrual for any particular day is computed by multiplying the Price Funds' group fee accrual as determined below ("Daily Price Funds' Group Fee Accrual") by the ratio of the Price Fund's net assets for that day to the sum of the aggregate net assets of the Price Funds for that day. The Daily Price Funds' Group Fee Accrual for any particular day is calculated by multiplying the fraction of one (1) over the number of calendar days in the year by the annualized Daily Price Funds' Group Fee Accrual for that day as determined in accordance with the following schedule: Price Funds' Annual Group Base Fee Rate for Each Level of Assets
0.480% First $1 billion 0.360% Next $2 billion 0.310% Next $16 billion --------------------------------------------------------------------------- 0.450% Next $1 billion 0.350% Next $2 billion 0.305% Next $30 billion --------------------------------------------------------------------------- 0.420% Next $1 billion 0.340% Next $5 billion 0.300% Thereafter --------------------------------------------------------------------------- 0.390% Next $1 billion 0.330% Next $10 billion --------------------------------------------------------------------------- 0.370% Next $1 billion 0.320% Next $10 billion
For the purpose of calculating the Group Fee, the Price Funds include all the mutual funds distributed by T. Rowe Price Investment Services, Inc., (excluding the T. Rowe Price Spectrum Funds, and any institutional, index, or private label mutual funds). For the purpose of calculating the Daily Price Funds' Group Fee Accrual for any particular day, the net assets of each Price Fund are determined in accordance with the Funds' prospectus as of the close of business on the previous business day on which the Fund was open for business. The monthly Fund Fee ("Monthly Fund Fee") is the sum of the daily Fund Fee accruals ("Daily Fund Fee Accruals") for each month. The Daily Fund Fee Accrual for any particular day is computed by multiplying the fraction of one (1) over the number of calendar days in the year by the individual Fund Fee Rate and multiplying this product by the net assets of the Fund for that day, as determined in accordance with the Fund's prospectus as of the close of business on the previous business day on which the Fund was open for business. The individual fund fees of each Fund are listed in the following chart:
Corporate Income Fund 0.15% GNMA Fund 0.15% High Yield Fund 0.30% New Income Fund 0.15% Personal Strategy Balanced Fund 0.25% Personal Strategy Growth Fund 0.30% Personal Strategy Income Fund 0.15% Prime Reserve Fund 0.05% Short-Term Bond Fund 0.10% Short-Term U.S. Government Fund 0.10% U.S. Treasury Intermediate Fund 0.05% U.S. Treasury Long-Term Fund 0.05% U.S. Treasury Money Fund 0.00%
The following chart sets forth the total management fees, if any, paid to T. Rowe Price by each Fund, during the last three years:
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income (a) (a) (a) GNMA $ 4,928,000 $ 4,398,000 $ 4,223,000 High Yield 9,797,000 8,206,000 7,752,000 New Income 9,047,000 7,984,000 7,886,000 Personal Strategy Balanced 1,685,000 897,000 150,000 Personal Strategy Growth 514,000 92,000 (a) Personal Strategy Income 206,000 22,000 (a) Prime Reserve 17,281,000 16,431,000 15,320,000 Short-Term Bond 1,478,000 1,795,000 2,099,000 Short-Term U.S. Government 317,000 250,000 281,000 U.S. Treasury Intermediate 724,000 694,000 684,000 U.S. Treasury Long-Term 687,000 276,000 240,000 U.S. Treasury Money 2,668,000 2,585,000 2,507,000 - -----------------------------------------------------------------------------------------------
(a) Due to the Fund's expense limitation in effect at that time, no management fee was paid by the Fund to T. Rowe Price. Limitation on Fund Expenses The Management Agreement between the Fund and T. Rowe Price provides that the Fund will bear all expenses of its operations not specifically assumed by T. Rowe Price. The following chart sets forth expense ratio limitations and the periods for which they are effective. For each, T. Rowe Price has agreed to bear any Fund expenses which would cause the Fund's ratio of expenses to average net assets to exceed the indicated percentage limitations. The expenses borne by T. Rowe Price are subject to reimbursement by the Fund through the indicated reimbursement date, provided no reimbursement will be made if it would result in the Fund's expense ratio exceeding its applicable limitation.
Expense Reimbursement Fund Limitation Period ------- ------------- ---- ----------------- Ratio Date - ----------------------------------------------------------------------------------------- ----- ---- Limitation ---------- --------------------------- June 1, 1997 - May 31, Corporate Income(a) 1999 0.80% May 31, 2001 June 1, 1998 - May 31, Personal Strategy Growth(b) 2000 1.10% May 31, 2000 June 1, 1998 - May 31, Personal Strategy Income(c) 2000 0.95% May 31, 2000 June 1, 1998 - May 31, Short-Term U.S. Government(d) 2000 0.70% May 31, 2000 U.S. Treasury Long-Term(e) June 1, 1997 - May 31, 0.80% May 31, 2001 1999 - --------------------------------------------------------------------------------------------------------------------
(a) The Corporate Income Fund operated under a 0.80% limitation that expired May 31, 1997. The reimbursement period for this limitation extends through May 31, 1999. (b) The Personal Strategy Growth Fund previously operated under a 1.10% limitation that expired May 31, 1998. The reimbursement period for this limitation extends through May 31, 2000. (c) The Personal Strategy Income Fund previously operated under a 0.95% limitation that expired May 31, 1998. The reimbursement period for this limitation extends through May 31, 2000. (d) The Short-Term U.S. Government Fund previously operated under a 0.70% limitation that expired May 31, 1998. The reimbursement period for this limitation extends through May 31, 2000. (e) The Long-Term Fund operated under a 0.80% limitation that expired May 31, 1997. The reimbursement period for this limitation extends through May 31, 1999. Each of the above-referenced Fund's Management Agreement also provides that one or more additional expense limitations periods (of the same or different time periods) may be implemented after the expiration of the current expense limitation, and that with respect to any such additional limitation period, the Fund may reimburse T. Rowe Price, provided the reimbursement does not result in the Fund's aggregate expenses exceeding the additional expense limitation. Pursuant to the Corporate Income Fund's current expense limitation, $148,000 of management fees were not accrued by the Fund for the year ended May 31, 1998, and $1,000 of other expenses were borne by the manager. Additionally, $261,000 of unaccrued fees and expenses related to a prior period are subject to reimbursement through May 31, 1999. Pursuant to the U.S. Treasury Long-Term Fund's previous expense limitation, $22,000 of unaccrued 1996-1997 management fees were repaid during the year ended May 31, 1998. Pursuant to the Personal Strategy Balanced Fund's previous expense limitation, $62,000 of unaccrued management fees related to a previous expense limitation are subject to reimbursement through May 31, 2000. Pursuant to the Personal Strategy Growth Fund's previous expense limitation, $110,000 of management fees were not accrued by the Fund for the year ended May 31, 1998. Additionally, $177,000 of unaccrued management fees related to a previous expense limitation are subject to reimbursement through May 31, 2000. Additionally, $137,000 of management fees and $188,000 of expenses from a previous limitation were permanently waived. Pursuant to the Personal Strategy Income Fund's previous expense limitation, $97,000 of management fees were not accrued by the Fund for the year ended May 31, 1998. Additionally, $141,000 of unaccrued management fees related to a previous expense limitation are subject to reimbursement through May 31, 2000. Additionally, $163,000 of management fees and $123,000 of expenses from a previous limitation were permanently waived. Pursuant to the Short-Term U.S. Government Fund's current expense limitation, $111,000 of management fees were not accrued by the Fund for the year ended May 31, 1998. Additionally, $155,000 of unaccrued management fees remain subject to reimbursement through May 31, 2000. GNMA, High Yield, New Income, Short-Term Bond, and U.S. Treasury Long-Term Funds T. Rowe Price Spectrum Fund, Inc. The Funds listed above are a party to a Special Servicing Agreement ("Agreement") between and among T. Rowe Price Spectrum Fund, Inc. ("Spectrum Fund"), T. Rowe Price, and various other T. Rowe Price funds which, along with the Fund, are funds in which Spectrum Fund invests (collectively all such funds "Underlying Price Funds"). The Agreement provides that, if the Board of Directors/Trustees of any Underlying Price Fund determines that such Underlying Fund's share of the aggregate expenses of Spectrum Fund is less than the estimated savings to the Underlying Price Fund from the operation of Spectrum Fund, the Underlying Price Fund will bear those expenses in proportion to the average daily value of its shares owned by Spectrum Fund, provided further that no Underlying Price Fund will bear such expenses in excess of the estimated savings to it. Such savings are expected to result primarily from the elimination of numerous separate shareholder accounts which are or would have been invested directly in the Underlying Price Funds and the resulting reduction in shareholder servicing costs. Although such cost savings are not certain, the estimated savings to the Underlying Price Funds generated by the operation of Spectrum Fund are expected to be sufficient to offset most, if not all, of the expenses incurred by Spectrum Fund. Management Fee Government Reserve Investment and Reserve Investment Funds Neither Fund pays T. Rowe Price an investment management fee. Management Related Services As noted above, the Management Agreement spells out the expenses to be paid by the Fund. In addition to the Management Fee, the Fund pays for the following: shareholder service expenses; custodial, accounting, legal, and audit fees; costs of preparing and printing prospectuses and reports sent to shareholders; registration fees and expenses; proxy and annual meeting expenses (if any); and director/trustee fees and expenses. T. Rowe Price Services, Inc., a wholly owned subsidiary of T. Rowe Price, acts as the Fund's transfer and dividend disbursing agent and provides shareholder and administrative services. Services for certain types of retirement plans are provided by T. Rowe Price Retirement Plan Services, Inc., also a wholly owned subsidiary. The address for each is 100 East Pratt St., Baltimore, MD 21202. Additionally, T. Rowe Price, under a separate agreement with the Funds, provides accounting services to the Funds. The Funds paid the expenses shown in the following table for the fiscal year ended May 31, 1998, to T. Rowe Price and its affiliates.
Transfer Agent and Retirement Accounting Fund Shareholder Services Subaccounting Services ---- -------------------- Services -------- -------- Corporate Income $ 47,000 -- $ 71,000 GNMA 1,471,000 $ 195,000 121,000 Government Reserve Investment -- -- 45,000 High Yield 1,966,000 169,000 166,000 New Income 2,112,000 1,368,000 107,000 Personal Strategy Balanced 103,000 643,000 71,000 Personal Strategy Growth 110,000 178,000 71,000 Personal Strategy Income 48,000 105,000 71,000 Prime Reserve 4,913,000 3,785,000 85,000 - ------------------------------------------------------------------------------------------------------------ Reserve Investment 1,000 -- 45,000 Short-Term Bond 351,000 251,000 121,000 Short-Term U.S. Government 111,000 11,000 101,000 U.S. Treasury Intermediate 157,000 70,000 61,000 U.S. Treasury Long-Term 300,000 17,000 61,000 U.S. Treasury Money 522,000 528,000 61,000 - ------------------------------------------------------------------------------------------------------------
All Funds except Government Reserve Investment and Reserve Investment Funds DISTRIBUTOR FOR THE FUNDS ------------------------------------------------------------------------------- T. Rowe Price Investment Services, Inc. ("Investment Services"), a Maryland corporation formed in 1980 as a wholly owned subsidiary of T. Rowe Price, serves as the Fund's distributor. Investment Services is registered as a broker-dealer under the Securities Exchange Act of 1934 and is a member of the National Association of Securities Dealers, Inc. The offering of the Fund's shares is continuous. Investment Services is located at the same address as the Fund and T. Rowe Price-100 East Pratt Street, Baltimore, Maryland 21202. Investment Services serves as distributor to the Fund pursuant to an Underwriting Agreement ("Underwriting Agreement"), which provides that the Fund will pay all fees and expenses in connection with: necessary state filings; preparing, setting in type, printing, and mailing its prospectuses and reports to shareholders; and issuing its shares, including expenses of confirming purchase orders. The Underwriting Agreement provides that Investment Services will pay all fees and expenses in connection with: printing and distributing prospectuses and reports for use in offering and selling Fund shares; preparing, setting in type, printing, and mailing all sales literature and advertising; Investment Services' federal and state registrations as a broker-dealer; and offering and selling Fund shares, except for those fees and expenses specifically assumed by the Fund. Investment Services' expenses are paid by T. Rowe Price. Investment Services acts as the agent of the Fund in connection with the sale of its shares in the various states in which Investment Services is qualified as a broker-dealer. Under the Underwriting Agreement, Investment Services accepts orders for Fund shares at net asset value. No sales charges are paid by investors or the Fund. CUSTODIAN ------------------------------------------------------------------------------- State Street Bank and Trust Company is the custodian for the Fund's U.S. securities and cash, but it does not participate in the Fund's investment decisions. Portfolio securities purchased in the U.S. are maintained in the custody of the Bank and may be entered into the Federal Reserve Book Entry System, or the security depository system of the Depository Trust Corporation. State Street Bank's main office is at 225 Franklin Street, Boston, Massachusetts 02110. The Fund (other than GNMA, Prime Reserve, U.S. Treasury Intermediate, Long-Term, Money, Government Reserve Investment, and Reserve Investment Funds) has entered into a Custodian Agreement with The Chase Manhattan Bank, N.A., London, pursuant to which portfolio securities which are purchased outside the United States are maintained in the custody of various foreign branches of The Chase Manhattan Bank and such other custodians, including foreign banks and foreign securities depositories as are approved in accordance with regulations under the Investment Company Act of 1940. The address for The Chase Manhattan Bank, N.A., London is Woolgate House, Coleman Street, London, EC2P 2HD, England. SHAREHOLDER SERVICES ------------------------------------------------------------------------------- T. Rowe Price Services, Inc., another wholly owned subsidiary, acts as the Fund's transfer and dividend disbursing agent and provides shareholder and administrative services. Services for certain types of retirement plans are provided by T. Rowe Price Retirement Plan Services, Inc., also a wholly owned subsidiary. The address for each is 100 East Pratt St., Baltimore, MD 21202. The Fund from time to time may enter into agreements with outside parties through which shareholders hold Fund shares. The shares would be held by such parties in omnibus accounts. The agreements would provide for payments by the Fund to the outside party for shareholder services provided to shareholders in the omnibus accounts. CODE OF ETHICS ------------------------------------------------------------------------------- The Fund's investment adviser (T. Rowe Price) has a written Code of Ethics which requires all employees to obtain prior clearance before engaging in personal securities transactions. In addition, all employees must report their personal securities transactions within 10 days of their execution. Employees will not be permitted to effect transactions in a security: if there are pending client orders in the security; the security has been purchased or sold by a client within seven calendar days; the security is being considered for purchase for a client; a change has occurred in T. Rowe Price's rating of the security within seven calendar days prior to the date of the proposed transaction; or the security is subject to internal trading restrictions. In addition, employees are prohibited from profiting from short-term trading (e.g., purchases and sales involving the same security within 60 days). Any material violation of the Code of Ethics is reported to the Board of the Fund. The Board also reviews the administration of the Code of Ethics on an annual basis. PORTFOLIO TRANSACTIONS ------------------------------------------------------------------------------- Investment or Brokerage Discretion Decisions with respect to the purchase and sale of portfolio securities on behalf of the Fund are made by T. Rowe Price. T. Rowe Price is also responsible for implementing these decisions, including the negotiation of commissions and the allocation of portfolio brokerage and principal business. The Fund's purchases and sales of fixed income portfolio securities are normally done on a principal basis and do not involve the payment of a commission although they may involve the designation of selling concessions. That part of the discussion below relating solely to brokerage commissions would not normally apply to the Fund (except to the extent it purchases equity securities (High Yield, New Income, and Personal Strategy Funds only)). However, it is included because T. Rowe Price does manage a significant number of common stock portfolios which do engage in agency transactions and pay commissions and because some research and services resulting from the payment of such commissions may benefit the Fund. How Brokers and Dealers Are Selected Equity Securities In purchasing and selling the Fund's portfolio securities, it is T. Rowe Price's policy to obtain quality execution at the most favorable prices through responsible brokers and dealers and, in the case of agency transactions, at competitive commission rates. However, under certain conditions, the Fund may pay higher brokerage commissions in return for brokerage and research services. As a general practice, over-the-counter orders are executed with market-makers. In selecting among market-makers, T. Rowe Price generally seeks to select those it believes to be actively and effectively trading the security being purchased or sold. In selecting broker-dealers to execute the Fund's portfolio transactions, consideration is given to such factors as the price of the security, the rate of the commission, the size and difficulty of the order, the reliability, integrity, financial condition, general execution and operational capabilities of competing brokers and dealers, and brokerage and research services provided by them. It is not the policy of T. Rowe Price to seek the lowest available commission rate where it is believed that a broker or dealer charging a higher commission rate would offer greater reliability or provide better price or execution. Fixed Income Securities Fixed income securities are generally purchased from the issuer or a primary market-maker acting as principal for the securities on a net basis, with no brokerage commission being paid by the client although the price usually includes an undisclosed compensation. Transactions placed through dealers serving as primary market-makers reflect the spread between the bid and asked prices. Securities may also be purchased from underwriters at prices which include underwriting fees. With respect to equity and fixed income securities, T. Rowe Price may effect principal transactions on behalf of the Fund with a broker or dealer who furnishes brokerage and/or research services, designate any such broker or dealer to receive selling concessions, discounts or other allowances, or otherwise deal with any such broker or dealer in connection with the acquisition of securities in underwritings. T. Rowe Price may receive research services in connection with brokerage transactions, including designations in a fixed price offerings. How Evaluations Are Made of the Overall Reasonableness of Brokerage Commissions Paid On a continuing basis, T. Rowe Price seeks to determine what levels of commission rates are reasonable in the marketplace for transactions executed on behalf of the Fund. In evaluating the reasonableness of commission rates, T. Rowe Price considers: (a) historical commission rates, both before and since rates have been fully negotiable; (b) rates which other institutional investors are paying, based on available public information; (c) rates quoted by brokers and dealers; (d) the size of a particular transaction, in terms of the number of shares, dollar amount, and number of clients involved; (e) the complexity of a particular transaction in terms of both execution and settlement; (f) the level and type of business done with a particular firm over a period of time; and (g) the extent to which the broker or dealer has capital at risk in the transaction. Descriptions of Research Services Received From Brokers and Dealers T. Rowe Price receives a wide range of research services from brokers and dealers. These services include information on the economy, industries, groups of securities, individual companies, statistical information, accounting and tax law interpretations, political developments, legal developments affecting portfolio securities, technical market action, pricing and appraisal services, credit analysis, risk measurement analysis, performance analysis and analysis of corporate responsibility issues. These services provide both domestic and international perspective. Research services are received primarily in the form of written reports, computer generated services, telephone contacts and personal meetings with security analysts. In addition, such services may be provided in the form of meetings arranged with corporate and industry spokespersons, economists, academicians and government representatives. In some cases, research services are generated by third parties but are provided to T. Rowe Price by or through broker-dealers. Research services received from brokers and dealers are supplemental to T. Rowe Price's own research effort and, when utilized, are subject to internal analysis before being incorporated by T. Rowe Price into its investment process. As a practical matter, it would not be possible for T. Rowe Price's Equity Research Division to generate all of the information presently provided by brokers and dealers. T. Rowe Price pays cash for certain research services received from external sources. T. Rowe Price also allocates brokerage for research services which are available for cash. While receipt of research services from brokerage firms has not reduced T. Rowe Price's normal research activities, the expenses of T. Rowe Price could be materially increased if it attempted to generate such additional information through its own staff. To the extent that research services of value are provided by brokers or dealers, T. Rowe Price may be relieved of expenses which it might otherwise bear. T. Rowe Price has a policy of not allocating brokerage business in return for products or services other than brokerage or research services. In accordance with the provisions of Section 28(e) of the Securities Exchange Act of 1934, T. Rowe Price may from time to time receive services and products which serve both research and non-research functions. In such event, T. Rowe Price makes a good faith determination of the anticipated research and non-research use of the product or service and allocates brokerage only with respect to the research component. Commissions to Brokers Who Furnish Research Services Certain brokers and dealers who provide quality brokerage and execution services also furnish research services to T. Rowe Price. With regard to the payment of brokerage commissions, T. Rowe Price has adopted a brokerage allocation policy embodying the concepts of Section 28(e) of the Securities Exchange Act of 1934, which permits an investment adviser to cause an account to pay commission rates in excess of those another broker or dealer would have charged for effecting the same transaction, if the adviser determines in good faith that the commission paid is reasonable in relation to the value of the brokerage and research services provided. The determination may be viewed in terms of either the particular transaction involved or the overall responsibilities of the adviser with respect to the accounts over which it exercises investment discretion. Accordingly, while T. Rowe Price cannot readily determine the extent to which commission rates or net prices charged by broker-dealers reflect the value of their research services, T. Rowe Price would expect to assess the reasonableness of commissions in light of the total brokerage and research services provided by each particular broker. T. Rowe Price may receive research, as defined in Section 28(e), in connection with selling concessions and designations in fixed price offerings in which the Funds participate. Internal Allocation Procedures T. Rowe Price has a policy of not precommitting a specific amount of business to any broker or dealer over any specific time period. Historically, the majority of brokerage placement has been determined by the needs of a specific transaction such as market-making, availability of a buyer or seller of a particular security, or specialized execution skills. However, T. Rowe Price does have an internal brokerage allocation procedure for that portion of its discretionary client brokerage business where special needs do not exist, or where the business may be allocated among several brokers or dealers which are able to meet the needs of the transaction. Each year, T. Rowe Price assesses the contribution of the brokerage and research services provided by brokers or dealers, and attempts to allocate a portion of its brokerage business in response to these assessments. Research analysts, counselors, various investment committees, and the Trading Department each seek to evaluate the brokerage and research services they receive from brokers or dealers and make judgments as to the level of business which would recognize such services. In addition, brokers or dealers sometimes suggest a level of business they would like to receive in return for the various brokerage and research services they provide. Actual brokerage received by any firm may be less than the suggested allocations but can, and often does, exceed the suggestions, because the total business is allocated on the basis of all the considerations described above. In no case is a broker or dealer excluded from receiving business from T. Rowe Price because it has not been identified as providing research services. Miscellaneous T. Rowe Price's brokerage allocation policy is consistently applied to all its fully discretionary accounts, which represent a substantial majority of all assets under management. Research services furnished by brokers or dealers through which T. Rowe Price effects securities transactions may be used in servicing all accounts (including non-Fund accounts) managed by T. Rowe Price. Conversely, research services received from brokers or dealers which execute transactions for the Fund are not necessarily used by T. Rowe Price exclusively in connection with the management of the Fund. From time to time, orders for clients may be placed through a computerized transaction network. The Fund does not allocate business to any broker-dealer on the basis of its sales of the Fund's shares. However, this does not mean that broker-dealers who purchase Fund shares for their clients will not receive business from the Fund. Some of T. Rowe Price's other clients have investment objectives and programs similar to those of the Fund. T. Rowe Price may occasionally make recommendations to other clients which result in their purchasing or selling securities simultaneously with the Fund. As a result, the demand for securities being purchased or the supply of securities being sold may increase, and this could have an adverse effect on the price of those securities. It is T. Rowe Price's policy not to favor one client over another in making recommendations or in placing orders. T. Rowe Price frequently follows the practice of grouping orders of various clients for execution which generally results in lower commission rates being attained. In certain cases, where the aggregate order is executed in a series of transactions at various prices on a given day, each participating client's proportionate share of such order reflects the average price paid or received with respect to the total order. T. Rowe Price has established a general investment policy that it will ordinarily not make additional purchases of a common stock of a company for its clients (including the T. Rowe Price Funds) if, as a result of such purchases, 10% or more of the outstanding common stock of such company would be held by its clients in the aggregate. At the present time, T. Rowe Price does not recapture commissions or underwriting discounts or selling group concessions in connection with taxable securities acquired in underwritten offerings. T. Rowe Price does, however, attempt to negotiate elimination of all or a portion of the selling-group concession or underwriting discount when purchasing tax-exempt municipal securities on behalf of its clients in underwritten offerings. Other For the fiscal years ended May 31, 1998, 1997, and 1996, the Fund's engaged in portfolio transactions involving broker-dealers in the following amounts:
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income $ 151,154,000 $ 176,025,000 $ 47,773,000 GNMA 3,404,198,000 3,521,560,000 2,878,094,000 Government Reserve Investment 46,218,342,000 -- -- High Yield 5,081,624,000 7,709,749,000 8,397,015,000 New Income 7,287,233,000 9,166,858,000 5,290,374,000 Personal Strategy Balanced 589,959,000 796,969,000 554,041,000 Personal Strategy Growth 225,909,000 354,770,000 128,451,000 Personal Strategy Income 188,714,000 350,204,000 230,017,000 Prime Reserve 64,296,588,000 84,827,266,000 52,505,379,000 Reserve Investment Fund 66,138,193,000 -- -- Short-Term Bond 1,113,884,000 3,380,454,000 4,596,925,000 Short-Term U.S. Government 332,928,000 640,894,000 646,520,000 U.S. Treasury Intermediate 507,228,000 806,082,000 215,529,000 U.S. Treasury Long-Term 604,802,000 352,705,000 149,585,000 U.S. Treasury Money 5,373,760,000 6,115,390,000 5,834,599,000 - -------------------------------------------------------------------------------------------------------------------------------
With respect to the GNMA, Government Reserve, Prime Reserve, Reserve Investment, Short-Term U.S. Government, U.S. Treasury Intermediate, Long-Term and Money Funds, the entire amount for each of these years represented principal transactions as to which the Funds have no knowledge of the profits or losses realized by the respective broker-dealers for the fiscal years ended May 31, 1998, 1997, and 1996. With respect to the Corporate Income, High Yield, New Income, Short-Term Bond, Personal Strategy Income, Personal Strategy Growth, and Personal Strategy Balanced Funds, the following amounts consisted of principal transactions as to which the Funds have no knowledge of the profits or losses realized by the respective broker-dealers for the fiscal years ended May 31, 1998, 1997, and 1996.
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income $ 147,537,000 $ 174,157,000 $ 46,566,000 High Yield 3,854,884,000 7,056,968,000 7,702,492,000 New Income 7,223,043,000 9,061,109,000 5,273,923,000 Personal Strategy Balanced 441,500,000 630,132,000 479,660,000 Personal Strategy Growth 147,604,000 303,598,000 111,536,000 Personal Strategy Income 159,536,000 327,683,000 220,100,000 Short-Term Bond 1,085,314,000 3,372,793,000 4,590,728,000 - ----------------------------------------------------------------------------
The following amounts involved trades with brokers acting as agents or underwriters for the fiscal years ended May 31, 1998, 1997, and 1996.
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income $ 3,617,000 $ 1,868,000 $ 1,207,000 High Yield 1,226,740,000 652,781,000 694,523,000 New Income 64,189,000 105,749,000 16,451,000 Personal Strategy Balanced 148,459,000 166,836,000 74,381,000 Personal Strategy Growth 78,305,000 51,173,000 16,915,000 Personal Strategy Income 29,178,000 22,521,000 9,917,000 Short-Term Bond 28,570,000 7,661,000 6,197,000 - -----------------------------------------------------------------------------------------------------------------
The amounts shown below involved trades with brokers acting as agents or underwriters, in which such brokers received total commissions, including discounts received in connection with underwritings for the fiscal years ended May 31, 1998, 1997, and 1996.
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income $ 79,000 $ 90,000 $ 34,000 High Yield 30,944,000 17,280,000 15,925,000 New Income 133,000 74,000 61,000 Personal Strategy Balanced 174,000 75,000 334,000 Personal Strategy Growth 46,000 17,000 124,000 Personal Strategy Income 47,000 18,000 136,000 Short-Term Bond 123,000 23,000 21,000 - --------------------------------------------------------------------------------
The percentage of total portfolio transactions, placed with firms which provided research, statistical, or other services to T. Rowe Price in connection with the management of the Funds, or in some cases, to the Funds for the fiscal years ended May 31, 1998, 1997, and 1996, are shown below:
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income 92% 82% 66% GNMA 98 98 99 Government Reserve Investment 97 N/A N/A High Yield 88 83 85 New Income 95 87 71 Personal Strategy Balanced 21 14 36 - ---------------------------------------------------------------------------------------------------------------------- Personal Strategy Growth 32 37 46 Personal Strategy Income 39 11 46 Prime Reserve 87 79 72 Reserve Investment 77 N/A N/A Short-Term Bond 85 81 64 Short-Term U.S. Government 95 85 68 U.S. Treasury Intermediate 96 99 94 U.S. Treasury Long-Term 100 100 96 U.S. Treasury Money 57 71 56 - ----------------------------------------------------------------------------------------------------------------------
The portfolio turnover rates for the following Funds for the fiscal years ended May 31, 1998, 1997, and 1996, are as follows:
Fund 1998 1997 1996 ---- ---- ---- ---- Corporate Income 146.0% 119.5% 70.5% GNMA 120.6 115.9 113.6 High Yield 129.6 111.3 100.1 New Income 147.3 87.1 35.5 Personal Strategy Balanced 41.5 54.0 47.7 Personal Strategy Growth 33.3 39.6 39.5 Personal Strategy Income 30.9 44.8 34.1 Short-Term Bond 73.0 103.9 118.7 Short-Term U.S. Government 107.5 82.9 152.8 U.S. Treasury Intermediate 112.8 57.9 40.7 U.S. Treasury Long-Term 80.8 67.6 60.1 - -----------------------------------------------------------------------------------------------
Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds The Fund, in pursuing its objectives, may engage in short-term trading to take advantage of market variations. The Fund will seek to protect principal, improve liquidity of its securities, or enhance yield by purchasing and selling securities based upon existing or anticipated market discrepancies. PRICING OF SECURITIES ------------------------------------------------------------------------------- Corporate Income, GNMA, High Yield, New Income, Personal Strategy, Short-Term Bond, Short-Term U.S. Government, U.S. Treasury Intermediate, and Long-Term Funds Debt securities are generally traded in the over-the-counter market. Investments in domestic securities with remaining maturities of one year or more and foreign securities are stated at fair value using a bid-side valuation as 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. Domestic securities with remaining maturities 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. The Personal Strategy Funds value short-term debt securities at their cost in local currency which, when combined with accrued interest, approximates fair value. There are a number of pricing services available, and the Board of Directors/Trustees, on the basis of an ongoing evaluation of these services, may use or may discontinue the use of any pricing service in whole or part. Corporate Income, High Yield, New Income, and Personal Strategy Funds Equity securities listed or regularly traded on a securities exchange are valued at the last quoted sales price at the time the valuations are made. 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 and securities regularly traded in the over-the-counter market are valued at the mean of the latest bid and asked prices. Other equity securities are valued at a price within the limits of the latest bid and asked prices deemed by the Board of Directors/Trustees, or by persons delegated by the Board, best to reflect fair value. Investments in mutual funds are valued at the closing net asset value per share of the mutual fund on the day of valuation. Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds Securities are valued at amortized cost. Corporate Income, High Yield, New Income, Personal Strategy, and Short-Term Bond Funds For the purposes of determining the Fund's net asset value per share, the U.S. dollar value of all assets and liabilities initially expressed in foreign currencies is determined by using the mean of the bid and offer prices of such currencies against U.S. dollars quoted by a major bank. All Funds Assets and liabilities 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 or under the supervision of the officers of the Fund, as authorized by the Board of Directors/Trustees. Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds Maintenance of Money Fund's Net Asset Value Per Share at $1.00 It is the policy of the Fund to attempt to maintain a net asset value of $1.00 per share by using the amortized cost method of valuation permitted by Rule 2a-7 under the Investment Company Act of 1940. Under this method, securities are valued by reference to the Fund's acquisition cost as adjusted for amortization of premium or accumulation of discount rather than by reference to their market value. Under Rule 2a-7: (a) The Board of Directors must establish written procedures reasonably designed, taking into account current market conditions and the Fund's investment objectives, to stabilize the Fund's net asset value per share, as computed for the purpose of distribution, redemption and repurchase, at a single value; (b) The Fund must (i) maintain a dollar-weighted average portfolio maturity appropriate to its objective of maintaining a stable price per share, (ii) not purchase any instrument with a remaining maturity greater than 397 days, and (iii) maintain a dollar-weighted average portfolio maturity of 90 days or less; (c) The Fund must limit its purchase of portfolio instruments, including repurchase agreements, to those U.S. dollar-denominated instruments which the Fund's Board of Directors determines present minimal credit risks, and which are eligible securities as defined by Rule 2a-7; and (d) The Board of Directors must determine that (i) it is in the best interest of the Fund and its shareholders to maintain a stable net asset value per share under the amortized cost method; and (ii) the Fund will continue to use the amortized cost method only so long as the Board of Directors believes that it fairly reflects the market based net asset value per share. Although the Fund believes that it will be able to maintain its net asset value at $1.00 per share under most conditions, there can be no absolute assurance that it will be able to do so on a continuous basis. If the Fund's net asset value per share declined, or was expected to decline, below $1.00 (rounded to the nearest one cent), the Board of Directors of the Fund might temporarily reduce or suspend dividend payments in an effort to maintain the net asset value at $1.00 per share. As a result of such reduction or suspension of dividends, an investor would receive less income during a given period than if such a reduction or suspension had not taken place. Such action could result in an investor receiving no dividend for the period during which he holds his shares and in his receiving, upon redemption, a price per share lower than that which he paid. On the other hand, if the Fund's net asset value per share were to increase, or were anticipated to increase above $1.00 (rounded to the nearest one cent), the Board of Directors of the Fund might supplement dividends in an effort to maintain the net asset value at $1.00 per share. Prime Reserve and Reserve Investment Funds Prime Money Market Securities Defined Prime money market securities are those which are described as First Tier Securities under Rule 2a-7 of the 1940 Act. These include any security with a remaining maturity of 397 days or less that is rated (or that has been issued by an issuer that is rated with respect to a class of short-term debt obligations, or any security within that class that is comparable in priority and security with the security) by any two nationally recognized statistical rating organizations (NRSROs) (or if only one NRSRO has issued a rating, that NRSRO) in the highest rating category for short-term debt obligations (within which there may be sub-categories). First Tier Securities also include unrated securities comparable in quality to rated securities, as determined by T. Rowe Price under the supervision of the Fund's Board of Director. All Funds NET ASSET VALUE PER SHARE ------------------------------------------------------------------------------- The purchase and redemption price of the Fund's shares is equal to the Fund's net asset value per share or share price. The Fund determines its net asset value per share by subtracting its liabilities (including accrued expenses and dividends payable) from its total assets (the market value of the securities the Fund holds plus cash and other assets, including income accrued but not yet received) and dividing the result by the total number of shares outstanding. The net asset value per share of the Fund is normally calculated as of the close of trading on the New York Stock Exchange ("NYSE") every day the NYSE is open for trading. The NYSE is closed on the following days: New Year's Day, Dr. Martin Luther King, Jr. Holiday, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. Determination of net asset value (and the offering, sale redemption and repurchase of shares) for the Fund may be suspended at times (a) during which the NYSE is closed, other than customary weekend and holiday closings, (b) during which trading on the NYSE is restricted, (c) during which an emergency exists as a result of which disposal by the Fund of securities owned by it is not reasonably practicable or it is not reasonably practicable for the Fund fairly to determine the value of its net assets, or (d) during which a governmental body having jurisdiction over the Fund may by order permit such a suspension for the protection of the Fund's shareholders; provided that applicable rules and regulations of the Securities and Exchange Commission (or any succeeding governmental authority) shall govern as to whether the conditions prescribed in (b), (c), or (d) exist. DIVIDENDS AND DISTRIBUTIONS ------------------------------------------------------------------------------- Unless you elect otherwise, the Fund's annual capital gain distribution, if any, will be reinvested on the reinvestment date using the NAV per share of that date. The reinvestment date normally precedes the payment date by about 10 days although the exact timing is subject to change. TAX STATUS ------------------------------------------------------------------------------- The Fund intends to qualify as a "regulated investment company" under Subchapter M of the Code. Dividends paid by certain Funds may be eligible for the dividends-received deduction applicable to corporate shareholders. For tax purposes, it does not make any difference whether dividends and capital gain distributions are paid in cash or in additional shares. The Fund must declare dividends by December 31 of each year equal to at least 98% of ordinary income (as of December 31) and capital gains (as of October 31) in order to avoid a federal excise tax and distribute within 12 months 100% of ordinary income and capital gains as of December 31 to avoid a federal income tax. At the time of your purchase, the Fund's net asset value may reflect undistributed capital gains or net unrealized appreciation of securities held by the Fund. A subsequent distribution to you of such amounts, although constituting a return of your investment, would be taxable as a capital gain distribution. For federal income tax purposes, the Fund is permitted to carry forward its net realized capital losses, if any, for eight years and realize net capital gains up to the amount of such losses without being required to pay taxes on, or distribute, such gains. If, in any taxable year, the Fund should not qualify as a regulated investment company under the code: (i) the Fund would be taxed at normal corporate rates on the entire amount of its taxable income, if any, without deduction for dividends or other distributions to shareholders; and (ii) the Fund's distributions to the extent made out of the Fund's current or accumulated earnings and profits would be taxable to shareholders as ordinary dividends (regardless of whether they would otherwise have been considered capital gain dividends). Taxation of Foreign Shareholders The Code provides that dividends from net income will be subject to U.S. tax. For shareholders who are not engaged in a business in the U.S., this tax would be imposed at the rate of 30% upon the gross amount of the dividends in the absence of a Tax Treaty providing for a reduced rate or exemption from U.S. taxation. Distributions of net long-term capital gains realized by the Fund are not subject to tax unless the foreign shareholder is a nonresident alien individual who was physically present in the U.S. during the tax year for more than 182 days. To the extent the Fund invests in foreign securities, the following would apply: Passive Foreign Investment Companies The Fund may purchase the securities of certain foreign investment funds or trusts called passive foreign investment companies. Such trusts have been the only or primary way to invest in certain countries. Capital gains on the sale of such holdings will be deemed to be ordinary income regardless of how long the Fund holds its investment. In addition to bearing their proportionate share of the fund's expenses (management fees and operating expenses), shareholders will also indirectly bear similar expenses of such funds. In addition, the Fund may be subject to corporate income tax and an interest charge on certain dividends and capital gains earned from these investments, regardless of whether such income and gains were distributed to shareholders. To avoid such tax and interest, the Fund intends to treat these securities as sold on the last day of the Fund's fiscal year and recognize any gains for tax purposes at that time; deductions for losses are allowable only to the extent of any gains resulting from these deemed sales for prior taxable years. Such gains and losses will be treated as ordinary income for tax purposes. The Fund will be required to distribute any resulting income even though it has not sold the security and received cash to pay such distributions. Foreign Currency Gains and Losses Foreign currency gains and losses, including the portion of gain or loss on the sale of debt securities attributable to foreign exchange rate fluctuations, are taxable as ordinary income. If the net effect of these transactions is a gain, the ordinary income dividend paid by the Fund will be increased. If the result is a loss, the income dividend paid by the Fund will be decreased, or to the extent such dividend has already been paid, it may be classified as a return of capital. Adjustments to reflect these gains and losses will be made at the end of the Fund's taxable year. YIELD INFORMATION ------------------------------------------------------------------------------- GNMA and Short-Term U.S. Government Funds In conformity with regulations of the Securities and Exchange Commission, an income factor is calculated for each security in the portfolio based upon the security's coupon rate. The income factors are then adjusted for any gains or losses which have resulted from prepayments of principal during the period. The income factors are then totalled for all securities in the portfolio. Next, expenses of the Fund for the period, net of expected reimbursements, are deducted from the income to arrive at net income, which is then converted to a per-share amount by dividing net income by the average number of shares outstanding during the period. The net income per share is divided by the net asset value on the last day of the period to produce a monthly yield which is then annualized. Quoted yield factors are for comparison purposes only, and are not intended to indicate future performance or forecast the dividend per share of the Fund. The yields of the GNMA and Short-Term U.S. Government Funds calculated under the above-described method for the month ended May 31, 1998, were 6.36% and 5.76%, respectively. Corporate Income, High Yield, New Income, Short-Term Bond, U.S. Treasury Intermediate, and Long-Term Funds An income factor is calculated for each security in the portfolio based upon the security's market value at the beginning of the period and yield as determined in conformity with regulations of the SEC. The income factors are then totaled for all securities in the portfolio. Next, expenses of the Fund for the period, net of expected reimbursements, are deducted from the income to arrive at net income, which is then converted to a per share amount by dividing net income by the average number of shares outstanding during the period. The net income per share is divided by the net asset value on the last day of the period to produce a monthly yield which is then annualized. If applicable, a taxable-equivalent yield is calculated by dividing this yield by one minus the effective federal, state, and/or city or local income tax rates. Quoted yield factors are for comparison purposes only, and are not intended to indicate future performance or forecast the dividend per share of the Fund. The yields of the Corporate Income, High Yield, New Income, Short-Term Bond, Intermediate, and Long-Term Treasury Funds calculated under the above-described method for the month ended May 31, 1998, were 7.66%, 8.19%, 6.29%, 5.52%, 5.29%, and 5.35%, respectively. Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money Funds The Fund's current and historical yield for a period is calculated by dividing the net change in value of an account (including all dividends accrued and dividends reinvested in additional shares) by the account value at the beginning of the period to obtain the base period return. This base period return is divided by the number of days in the period than multiplied by 365 to arrive at the annualized yield for that period. The Fund's annualized compound yield for such period is compounded by dividing the base period return by the number of days in the period, and compounding that figure over 365 days. The seven-day yields ending May 31, 1998, for the Prime Reserve, and U.S. Treasury Money Funds were 5.03% and 4.80%, respectively, and the Funds' compound yield for the same period were 5.16 and 4.91%, respectively. All Funds INVESTMENT PERFORMANCE ------------------------------------------------------------------------------- Total Return Performance The Fund's calculation of total return performance includes the reinvestment of all capital gain distributions and income dividends for the period or periods indicated, without regard to tax consequences to a shareholder in the Fund. Total return is calculated as the percentage change between the beginning value of a static account in the Fund and the ending value of that account measured by the then current net asset value, including all shares acquired through reinvestment of income and capital gain dividends. The results shown are historical and should not be considered indicative of the future performance of the Fund. Each average annual compound rate of return is derived from the cumulative performance of the Fund over the time period specified. The annual compound rate of return for the Fund over any other period of time will vary from the average.
Cumulative Performance Percentage Change Fund 1 Yr. Ended 5 Yrs. Ended 10 Yrs. Ended % Since Incep- Inception ---- ----------- ------------ ------------- -------------- --------- - ------------------------ 5/31/98 5/31/98 5/31/98 tion to 5/31/98 Date ------- ------- ------- --------------- ---- ---------------------------------------------------------------------- Corporate Income 13.96% -- -- 25.87% 10/31/95 GNMA 9.97 37.67% 125.57% 164.57 11/26/85 High Yield 14.51 55.03 147.80 292.39 12/31/84 New Income 10.84 39.47 125.38 721.27 08/31/73 Personal Strategy Balanced 19.15 -- -- 88.41 07/29/94 Personal Strategy Growth 22.02 -- -- 107.81 07/29/94 Personal Strategy Income 16.61 -- -- 71.89 07/29/94 Prime Reserve 5.16 25.07 69.09 407.06 01/26/76 Short-Term Bond 6.87 24.50 85.08 169.06 03/02/84 Short-Term U.S. Government 6.71 27.97 -- 36.70 09/30/91 U.S. Treasury Intermediate 9.58 32.93 -- 90.91 09/29/89 U.S. Treasury Long-Term 18.58 48.91 -- 116.76 09/29/89 U.S. Treasury Money 4.91 23.91 64.86 150.42 06/28/82 - ----------------------------------------------------------------------------------------------
Average Annual Compound Rates of Return Fund 1 Yr. Ended 5 Yrs. Ended 10 Yrs. Ended % Since Incep- Inception ---- ----------- ------------ ------------- -------------- --------- - ------------------------ 5/31/98 5/31/98 5/31/98 tion to 5/31/98 Date ------- ------- ------- --------------- ---- ---------------------------------------------------------------------- Corporate Income 13.96% -- -- 9.32% 10/31/95 GNMA 9.97 6.60% 8.47% 8.09 11/26/85 High Yield 14.51 9.21 9.50 10.73 12/31/84 New Income 10.84 6.88 8.47 8.88 08/31/73 Personal Strategy Balanced 19.15 -- -- 17.94 07/29/94 Personal Strategy Growth 22.02 -- -- 20.99 07/29/94 Personal Strategy Income 16.61 -- -- 15.15 07/29/94 Prime Reserve 5.16 4.58 5.39 7.54 01/26/76 Short-Term Bond 6.87 4.48 6.35 7.19 03/02/84 Short-Term U.S. Government 6.71 5.06 -- 4.80 09/30/91 U.S. Treasury Intermediate 9.58 5.86 -- 7.74 09/29/89 U.S. Treasury Long-Term 18.58 8.29 -- 9.33 09/29/89 U.S. Treasury Money 4.91 4.38 5.13 5.93 06/28/82 - ----------------------------------------------------------------------------------------------
Outside Sources of Information From time to time, in reports and promotional literature: (1) the Fund's total return performance, ranking, or any other measure of the Fund's performance may be compared to any one or combination of the following: (i) a broadbased index; (ii) other groups of mutual funds, including T. Rowe Price Funds, tracked by independent research firms ranking entities, or financial publications; (iii) indices of securities comparable to those in which the Fund invests; (2) the Consumer Price Index (or any other measure for inflation, government statistics, such as GNP may be used to illustrate investment attributes of the Fund or the general economic, business, investment, or financial environment in which the Fund operates; (3) various financial, economic and market statistics developed by brokers, dealers and other persons may be used to illustrate aspects of the Fund's performance; (4) the effect of tax-deferred compounding on the Fund's investment returns, or on returns in general in both qualified and nonqualified retirement plans or any other tax advantage product, may be illustrated by graphs, charts, etc.; and (5) the sectors or industries in which the Fund invests may be compared to relevant indices or surveys in order to evaluate the Fund's historical performance or current or potential value with respect to the particular industry or sector. Other Publications From time to time, in newsletters and other publications issued by Investment Services, T. Rowe Price mutual fund portfolio managers may discuss economic, financial and political developments in the U.S. and abroad and how these conditions have affected or may affect securities prices or the Fund; individual securities within the Fund's portfolio; and their philosophy regarding the selection of individual stocks, including why specific stocks have been added, removed or excluded from the Fund's portfolio. Other Features and Benefits The Fund is a member of the T. Rowe Price family of Funds and may help investors achieve various long-term investment goals, which include, but are not limited to, investing money for retirement, saving for a down payment on a home, or paying college costs. To explain how the Fund could be used to assist investors in planning for these goals and to illustrate basic principles of investing, various worksheets and guides prepared by T. Rowe Price Associates, Inc. and/or Investment Services may be made available. Redemptions in Kind In the unlikely event a shareholder were to receive an in kind redemption of portfolio securities of the Fund, brokerage fees could be incurred by the shareholder in a subsequent sale of such securities. Issuance of Fund Shares for Securities Transactions involving issuance of Fund shares for securities or assets other than cash will be limited to (1) bona fide reorganizations; (2) statutory mergers; or (3) other acquisitions of portfolio securities that: (a) meet the investment objective and policies of the Fund; (b) are acquired for investment and not for resale except in accordance with applicable law; (c) have a value that is readily ascertainable via listing on or trading in a recognized United States or international exchange or market; and (d) are not illiquid. All Funds except GNMA Fund CAPITAL STOCK ------------------------------------------------------------------------------- The Fund's Charter authorizes the Board of Directors to classify and reclassify any and all shares which are then unissued, including unissued shares of capital stock into any number of classes or series, each class or series consisting of such number of shares and having such designations, such powers, preferences, rights, qualifications, limitations, and restrictions, as shall be determined by the Board subject to the Investment Company Act and other applicable law. The shares of any such additional classes or series might therefore differ from the shares of the present class and series of capital stock and from each other as to preferences, conversions or other rights, voting powers, restrictions, limitations as to dividends, qualifications or terms or conditions of redemption, subject to applicable law, and might thus be superior or inferior to the capital stock or to other classes or series in various characteristics. The Board of Directors may increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that the Fund has authorized to issue without shareholder approval. Except to the extent that the Fund's Board of Directors might provide by resolution that holders of shares of a particular class are entitled to vote as a class on specified matters presented for a vote of the holders of all shares entitled to vote on such matters, there would be no right of class vote unless and to the extent that such a right might be construed to exist under Maryland law. The Charter contains no provision entitling the holders of the present class of capital stock to a vote as a class on any matter. Accordingly, the preferences, rights, and other characteristics attaching to any class of shares, including the present class of capital stock, might be altered or eliminated, or the class might be combined with another class or classes, by action approved by the vote of the holders of a majority of all the shares of all classes entitled to be voted on the proposal, without any additional right to vote as a class by the holders of the capital stock or of another affected class or classes. Shareholders are entitled to one vote for each full share held (and fractional votes for fractional shares held) and will vote in the election of or removal of directors (to the extent hereinafter provided) and on other matters submitted to the vote of shareholders. There will normally be no meetings of shareholders for the purpose of electing directors unless and until such time as less than a majority of the directors holding office have been elected by shareholders, at which time the directors then in office will call a shareholders' meeting for the election of directors. Except as set forth above, the directors shall continue to hold office and may appoint successor directors. Voting rights are not cumulative, so that the holders of more than 50% of the shares voting in the election of directors can, if they choose to do so, elect all the directors of the Fund, in which event the holders of the remaining shares will be unable to elect any person as a director. As set forth in the By-Laws of the Fund, a special meeting of shareholders of the Fund shall be called by the Secretary of the Fund on the written request of shareholders entitled to cast at least 10% of all the votes of the Fund entitled to be cast at such meeting. Shareholders requesting such a meeting must pay to the Fund the reasonably estimated costs of preparing and mailing the notice of the meeting. The Fund, however, will otherwise assist the shareholders seeking to hold the special meeting in communicating to the other shareholders of the Fund to the extent required by Section 16(c) of the Investment Company Act of 1940. GNMA Fund Description of the Fund For tax and business reasons, the Fund was organized in 1985 as a Massachusetts Business Trust, and is registered with the Securities and Exchange Commission under the Investment 1940 Act as diversified, open-end investment companies, commonly known as "mutual fund." The Declaration of Trust permits the Board of Trustees to issue an unlimited number of full and fractional shares of a single class. The Declaration of Trust also provides that the Board of Trustees may issue additional series or classes of shares. Each share represents an equal proportionate beneficial interest in the Fund. In the event of the liquidation of the Fund, each share is entitled to a pro-rata share of the net assets of the Fund. Shareholders are entitled to one vote for each full share held (and fractional votes for fractional shares held) and will vote in the election of or removal of trustees (to the extent hereinafter provided) and on other matters submitted to the vote of shareholders. There will normally be no meetings of shareholders for the purpose of electing trustees unless and until such time as less than a majority of the trustees holding office have been elected by shareholders, at which time the trustees then in office will call a shareholders' meeting for the election of trustees. Pursuant to Section 16(c) of the 1940 Act, holders of record of not less than two-thirds of the outstanding shares of the Fund may remove a trustee by a vote cast in person or by proxy at a meeting called for that purpose. Except as set forth above, the trustees shall continue to hold office and may appoint successor trustees. Voting rights are not cumulative, so that the holders of more than 50% of the shares voting in the election of trustees can, if they choose to do so, elect all the trustees of the Trust, in which event the holders of the remaining shares will be unable to elect any person as a trustee. No amendments may be made to the Declaration of Trust without the affirmative vote of a majority of the outstanding shares of the Trust. Shares have no preemptive or conversion rights; the right of redemption and the privilege of exchange are described in the prospectus. Shares are fully paid and nonassesable, except as set forth below. The Trust may be terminated (i) upon the sale of its assets to another diversified, open-end management investment company, if approved by the vote of the holders of two-thirds of the outstanding shares of the Trust, or (ii) upon liquidation and distribution of the assets of the Trust, if approved by the vote of the holders of a majority of the outstanding shares of the Trust. If not so terminated, the Trust will continue indefinitely. Under Massachusetts law, shareholders could, under certain circumstances, be held personally liable for the obligations of the Fund. However, the Declaration of Trust disclaims shareholder liability for acts or obligations of the Fund and requires that notice of such disclaimer be given in each agreement, obligation or instrument entered into or executed by the Fund or a Trustee. The Declaration of Trust provides for indemnification from Fund property for all losses and expenses of any shareholder held personally liable for the obligations of the Fund. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Fund itself would be unable to meet its obligations, a possibility which T. Rowe Price believes is remote. Upon payment of any liability incurred by the Fund, the shareholders of the Fund paying such liability will be entitled to reimbursement from the general assets of the Fund. The Trustees intend to conduct the operations of the Fund is such a way so as to avoid, as far as possible, ultimate liability of the shareholders for liabilities of such Fund. FEDERAL REGISTRATION OF SHARES ------------------------------------------------------------------------------- The Fund's shares (except for Government Reserve and Reserve Investment Funds) are registered for sale under the Securities Act of 1933. Registration of the Fund's shares is not required under any state law, but the Fund is required to make certain filings with and pay fees to the states in order to sell its shares in the states. LEGAL COUNSEL ------------------------------------------------------------------------------- Swidler Berlin Shereff Friedman, LLP, whose address is 919 Third Avenue, New York, New York 10022-9998, is legal counsel to the Fund. INDEPENDENT ACCOUNTANTS ------------------------------------------------------------------------------- PricewaterhouseCoopers LLP, 250 West Pratt Street, 21st Floor, Baltimore, Maryland 21201, are the independent accountants to the Funds. The financial statements of the Funds for the year ended May 31, 1998, and the report of independent accountants are included in each Fund's Annual Report for the year ended May 31, 1998. A copy of each Annual Report accompanies this Statement of Additional Information. The following financial statements and the report of independent accountants appearing in each Annual Report for the year ended May 31, 1998, are incorporated into this Statement of Additional Information by reference:
ANNUAL REPORT REFERENCES: CORPORATE GNMA NEW PRIME INCOME FUND FUND INCOME RESERVE ----------- ---- FUND FUND ---- ---- Report of Independent Accountants 20 15 23 21 Statement of Net Assets, May 31, 1998 9-13 7-9 9-16 8-16 Statement of Operations, year ended May 31, 1998 14 10 17 17 Statement of Changes in Net Assets, years ended May 31, 1998 and May 31, 1997 15 11 18 18 Notes to Financial Statements, May 31, 1998 16-19 12-14 19-22 19-20 Financial Highlights 8 6 8 7
PERSONAL PERSONAL PERSONAL STRATEGY STRATEGY STRATEGY BALANCED FUND GROWTH FUND INCOME FUND ------------- ----------- ----------- Report of Independent Accountants 31 29 28 Portfolio of Investments, May 31, 1998 3-22 3-21 3-20 Statement of Assets and Liabilities, May 31, 1998 23 22 21 Statement of Operations, year ended May 31, 1998 24 23 22 Statement of Changes in Net Assets, years ended May 31, 1998 and May 31, 1997 25 24 23 Notes to Financial Statements, May 31, 1998 26-30 25-28 24-27 Financial Highlights 2 2 2
HIGH YIELD SHORT-TERM SHORT-TERM U.S. FUND BOND FUND GOVERNMENT FUND ---- --------- --------------- Report of Independent Accountants 29 20 16 Statement of Net Assets, May 31, 1998 9-21 8-13 7-10 Statement of Operations, year ended May 31, 1998 22 14 11 Statement of Changes in Net Assets, years ended May 31, 1998 and May 31, 1997 23 15 12 Notes to Financial Statements, May 31, 1998 24-27 16-19 13-15 Financial Highlights 8 7 6
U.S. TREASURY U.S. TREASURY U.S. TREASURY INTERMEDIATE FUND LONG-TERM FUND MONEY FUND ----------------- -------------- ---------- Report of Independent Accountants 27 27 27 Statement of Net Assets, May 31, 1998 14-16 17-18 13 Statement of Operations, year ended May 31, 1998 19 19 19 Statement of Changes in Net Assets, years ended May 31, 1998 and May 31, 1997 21 22 20 Notes to Financial Statements, May 31, 1998 23-26 23-26 23-26 Financial Highlights 11 12 10
RESERVE GOVERNMENT INVESTMENT FUND RESERVE --------------- INVESTMENT FUND --------------- Report of Independent Accountants 13 13 Statement of Net Assets, May 31, 1998 3-6 7 Statement of Operations, period from August 25, 1997 (commencement of operations) to May 31, 1998 8 8 Statement of Changes in Net Assets, period from August 25, 1997 (commencement of operations) to May 31, 1998 9 9 Notes to Financial Statements, May 31, 1998 10-12 10-12 Financial Highlights 1 2
RATINGS OF COMMERCIAL PAPER ------------------------------------------------------------------------------- Moody's Investors Service, Inc. The rating of Prime-1 is the highest commercial paper rating assigned by Moody's. Among the factors considered by Moody's in assigning rating are the following: valuation of the management of the issuer; economic evaluation of the issuer's industry or industries and an appraisal of speculative-type risks which may be inherent in certain areas; evaluation of the issuer's products in relation to competition and customer acceptance; liquidity; amount and quality of long-term debt; trend of earnings over a period of 10 years; financial strength of the parent company and the relationships which exist with the issuer; and recognition by the management of obligations which may be present or may arise as a result of public interest questions and preparations to meet such obligations. These factors are all considered in determining whether the commercial paper is rated P1, P2, or P3. Standard & Poor's Corporation Commercial paper rated A (highest quality) by S&P has the following characteristics: liquidity ratios are adequate to meet cash requirements; long-term senior debt is rated "A" or better, although in some cases "BBB" credits may be allowed. The issuer has access to at least two additional channels of borrowing. Basic earnings and cash flow have an upward trend with allowance made for unusual circumstances. Typically, the issuer's industry is well established and the issuer has a strong position within the industry. The reliability and quality of management are unquestioned. The relative strength or weakness of the above factors determines whether the issuer's commercial paper is rated A1, A2, or A3. Fitch IBCA, Inc. Fitch 1-Highest grade Commercial paper assigned this rating is regarded as having the strongest degree of assurance for timely payment. Fitch 2-Very good grade Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than the strongest issues. Government Reserve Investment, Prime Reserve, and Reserve Investment Funds RATINGS OF CORPORATE DEBT SECURITIES ------------------------------------------------------------------------------- Moody's Investors Services, Inc. (Moody's) Aaa-Bonds rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Aa-Bonds rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally know as high-grade bonds. A-Bonds rated A possess many favorable investment attributes and are to be considered as upper medium-grade obligations. Baa-Bonds rated Baa are considered as medium-grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba-Bonds rated Ba are judged to have speculative elements: their futures cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterize bonds in this class. B-Bonds rated B generally lack the characteristics of a desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa-Bonds rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca-Bonds rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked short-comings. C-Bonds rated C represent the lowest-rated, and have extremely poor prospects of attaining investment standing. Standard & Poor's Corporation (S&P) AAA-This is the highest rating assigned by Standard & Poor's to a debt obligation and indicates an extremely strong capacity to pay principal and interest. AA-Bonds rated AA also qualify as high-quality debt obligations. Capacity to pay principal and interest is very strong. A-Bonds rated A have a strong capacity to pay principal and interest, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. BBB-Bonds rated BBB are regarded as having an adequate capacity to pay principal and interest. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay principal and interest for bonds in this category than for bonds in the A category. BB, B, CCC, CC, C-Bonds rated BB, B, CCC, and CC are regarded on balance, as predominantly speculative with respect to the issuer's capacity to pay interest and repay principal. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While such bonds will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. D-In default. Fitch IBCA, Inc. AAA-High grade, broadly marketable, suitable for investment by trustees and fiduciary institutions, and liable to but slight market fluctuation other than through changes in the money rate. The prime feature of a "AAA" bond is the showing of earnings several times or many times interest requirements for such stability of applicable interest that safety is beyond reasonable question whenever changes occur in conditions. Other features may enter, such as wide margin of protection through collateral, security or direct lien on specific property. Sinking funds or voluntary reduction of debt by call or purchase or often factors, while guarantee or assumption by parties other than the original debtor may influence their rating. AA-Of safety virtually beyond question and readily salable. Their merits are not greatly unlike those of "AAA" class but a bond so rated may be junior though of strong lien, or the margin of safety is less strikingly broad. The issue may be the obligation of a small company, strongly secured, but influenced as to rating by the lesser financial power of the enterprise and more local type of market. A-Bonds rated A are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB-Bonds rated BBB are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions ad circumstances, however, are more likely to have adverse impact on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. BB, B, CCC, CC, and C are regarded on balance as predominantly speculative with respect to the issuer's capacity to repay interest and repay principal in accordance with the terms of the obligation for bond issues not in default. BB indicates the lowest degree of speculation and C the highest degree of speculation. The rating takes into consideration special features of the issue, its relationship to other obligations of the issuer, and the current and prospective financial condition and operating performance of the issuer. -----END PRIVACY-ENHANCED MESSAGE-----