-----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, LqGUny6vMWdJj0+Bdo8lWbIqNaIUv666eRLji9fxyqPXTV/Z0f/VeOCjNqDvyRVp +OThntBNGj8m7s6QsO/ghQ== 0000875267-98-000004.txt : 19980430 0000875267-98-000004.hdr.sgml : 19980430 ACCESSION NUMBER: 0000875267-98-000004 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19980429 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FEDERATED ADJUSTABLE RATE U S GOVERNMENT FUND INC CENTRAL INDEX KEY: 0000875267 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 251659310 STATE OF INCORPORATION: MD FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 497 SEC ACT: SEC FILE NUMBER: 033-41004 FILM NUMBER: 98604014 BUSINESS ADDRESS: STREET 1: FEDERATED INVESTORS TOWER CITY: PITTSBURGH STATE: PA ZIP: 15222 BUSINESS PHONE: 4122881581 MAIL ADDRESS: STREET 1: FEDERATED INVESTORS TOWER CITY: PITTSBURGH STATE: PA ZIP: 15222-3779 FORMER COMPANY: FORMER CONFORMED NAME: FORTRESS ADJUSTABLE RATE U S GOVERNMENT FUND INC DATE OF NAME CHANGE: 19920703 497 1 Federated Adjustable Rate U.S. Government Fund, Inc. PROSPECTUS Federated Adjustable Rate U.S. Government Fund, Inc. (the "Fund") is an open-end, diversified management investment company (a mutual fund) that seeks to provide current income consistent with lower volatility of principal by investing primarily in a professionally managed, diversified portfolio of adjustable and floating rate mortgage securities which are issued or guaranteed by the U.S. government, its agencies or instrumentalities. THE SHARES OFFERED BY THIS PROSPECTUS ARE NOT DEPOSITS OR OBLIGATIONS OF ANY BANK, ARE NOT ENDORSED OR GUARANTEED BY ANY BANK, AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION ("FDIC"), THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY. INVESTMENT IN THESE SHARES INVOLVES INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. This prospectus contains the information you should read and know before you invest in the Fund. Keep this prospectus for future reference. The Fund has also filed a Statement of Additional Information dated April 30, 1998, with the Securities and Exchange Commission ("SEC"). The information contained in the Statement of Additional Information is incorporated by reference into this prospectus. You may request a copy of the Statement of Additional Information or a paper copy of this prospectus, if you have received your prospectus electronically, free of charge by calling 1-800-341-7400. To obtain other information, or make inquiries about the Fund, contact your financial institution or the Fund at the address listed in the back of this prospectus. This Statement of Additional Information, material incorporated by reference into this document, and other information regarding the Fund is maintained electronically with the SEC at Internet Web site (http://www.sec.gov). THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Prospectus dated April 30, 1998 TABLE OF CONTENTS Summary of Fund Expenses 1 Financial Highlights 2 General Information 3 Calling the Fund 3 Investment Information 3 Investment Objective 3 Investment Policies 3 Acceptable Investments 3 Portfolio Turnover 6 Investment Limitations 7 Net Asset Value 7 Investing in the Fund 7 Purchasing Shares 7 Purchasing Shares Through a Financial Intermediary 7 Purchasing Shares by Wire 7 Purchasing Shares by Check 8 Systematic Investment Program 8 Retirement Plans 8 Eliminating the Sales Charge 8 Redeeming and Exchanging Shares 8 Redeeming or Exchanging Shares Through a Financial Intermediary 8 Redeeming or Exchanging Shares by Telephone 8 Redeeming or Exchanging Shares by Mail 9 Requirements for Redemption 9 Requirements for Exchange 9 Systematic Withdrawal Program 9 Contingent Deferred Sales Charge 9 Account and Share Information 10 Confirmations and Account Statements 10 Dividends and Distributions 10 Accounts with Low Balances 10 Fund Information 10 Management of the Fund 10 Distribution of Shares 11 Administration of the Fund 12 Administrative Services 12 Shareholder Information 12 Tax Information Inside Back Cover Federal Income Tax Inside Back Cover State and Local Taxes Inside Back Cover Performance Information Inside Back Cover SUMMARY OF FUND EXPENSES
SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Charge Imposed on Purchases (as a percentage of offering price) None Maximum Sales Charge Imposed on Reinvested Dividends (as a percentage of offering price) None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable) 1.00% Redemption Fee (as a percentage of amount redeemed, if applicable) None Exchange Fee None ANNUAL OPERATING EXPENSES (As a percentage of average net assets) Management Fee (after waiver)(1) 0.57% 12b-1 Fee 0.01% Total Other Expenses (after expense reimbursement) 0.44% Shareholder Services Fee (after waiver)(2) 0.24% Total Operating Expenses(3) 1.02%
(1) The contingent deferred sales charge assessed is 1.00% of the lesser of the original purchase price or the net asset value of shares redeemed within four years of their purchase date. For a more complete description, see "Contingent Deferred Sales Charge." (2) The management fee has been reduced to reflect the voluntary waiver of a portion of the management fee. The adviser can terminate this voluntary waiver at any time at its sole discretion. The maximum management fee is 0.60%. (3) The 12b-1 fee has been reduced to reflect the voluntary waiver of a portion of the 12b-1 fee. The distributor can terminate the voluntary waiver at any time at its sole discretion. The maximum 12b-1 fee is 0.25%. (4) The shareholder services fee has been reduced to reflect the voluntary waiver of a portion of the shareholder services fee. The shareholder service provider can terminate this voluntary waiver at any time at its sole discretion. The maximum shareholder services fee is 0.25%. (5) The total operating expenses were 1.10% and would have been 1.38% absent the voluntary waivers of portions of the management fee, the 12b-1 fee, and the shareholder services fee for the fiscal year ended February 28, 1998. The total operating expenses are expected to be 1.30% absent the voluntary waivers of portions of the management fee, 12b-1 fee, and the shareholder services fee. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Fund will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Investing in the Fund", "Redeeming Shares" and "Fund Information." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. LONG-TERM SHAREHOLDERS MAY PAY MORE THAN THE ECONOMIC EQUIVALENT OF THE MAXIMUM FRONT-END SALES CHARGES PERMITTED UNDER THE RULES OF THE NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
EXAMPLE You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return and (2) redemption at the end of each time period. (3) payment of the maximum sales charge. 1 Year $ 21 3 Years $ 44 5 Years $ 56 10 Years $125 You would pay the following expenses on the same investment, assuming no redemption. 1 Year $ 21 3 Years $ 44 5 Years $ 56 10 Years $125
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. FINANCIAL HIGHLIGHTS (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by Deloitte & Touche LLP, the Fund's independent auditors. Their report, dated April 10, 1998, on the Fund's financial statements for the year ended February 28, 1998, and on the following table for the periods presented, is included in the Fund's Annual Report, which is herein incorporated by reference. This table should be read in conjunction with the Fund's financial statements and notes thereto, contained in the Fund's Annual Report, which may be obtained free of charge.
YEAR ENDED FEBRUARY 28 OR 29, 1998 1997 1996 1995 1994 1993 1992(A) NET ASSET VALUE, BEGINNING OF $ 9.56 $ 9.55 $ 9.46 $ 9.79 $ 9.90 $ 9.98 $10.00 PERIOD INCOME FROM INVESTMENT OPERATIONS Net investment income 0.53 0.52 0.54 0.47 0.43 0.53 0.47 Net realized and unrealized gain (0.04) 0.03 0.08 (0.32) (0.11) (0.08) (0.06) (loss) on investments and foreign currency Total from investment operations 0.49 0.55 0.62 0.15 0.32 0.45 0.41 LESS DISTRIBUTIONS Distributions from net investment (0.53) (0.52) (0.53) (0.47) (0.43) (0.53) (0.42) income Distributions in excess of net (0.00) (0.02) -- (0.01) -- -- (0.01) investment income(b) Total distributions (0.53) (0.54) (0.53) (0.48) (0.43) (0.53) (0.43) NET ASSET VALUE, END OF PERIOD $ 9.52 $ 9.56 $ 9.55 $ 9.46 $ 9.79 $ 9.90 $ 9.98 TOTAL RETURN(C) 5.25% 5.90% 6.77% 1.58% 3.27% 4.58% 4.14% RATIOS TO AVERAGE NET ASSETS Expenses 1.10% 1.02% 1.02% 1.02% 1.02% 1.01% 0.63%* Net investment income 5.53% 5.42% 5.67% 4.76% 4.38% 5.29% 6.79%* Expense waiver/reimbursement(d) 0.28% 0.42% 0.34% 0.30% 0.24% 0.01% 0.37%* SUPPLEMENTAL DATA Net assets, end of period (000 $183,604$224,447 $304,191 $419,095 $798,213$1,136,198 $965,289 omitted) Portfolio turnover 67% 108% 144% 170% 40% 56% 22%
* Computed on an annualized basis. (a) Reflects operations for the period from July 25, 1991 (date of initial public investment) to February 29, 1992. (b) Distributions in excess of net investment income were the result of certain book and tax timing differences. These distributions do not represent a return of capital for federal income tax purposes. (c) Based on net asset value, which does not reflect the sales charge or contingent deferred sales charge, if applicable. (d) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE FUND'S ANNUAL REPORT DATED FEBRUARY 28, 1998, WHICH CAN BE OBTAINED FREE OF CHARGE. GENERAL INFORMATION The Fund was incorporated under the laws of the State of Maryland on March 20, 1991. Shares of the Fund ("Shares") are designed primarily for individuals as a convenient means of seeking current income consistent with lower volatility of principal through a professionally managed, diversified portfolio of adjustable and floating rate mortgage securities which are issued or guaranteed by the U.S. government, its agencies or instrumentalities. Volatility of principal is a measure of the degree to which the Fund's net asset value fluctuates. A fund that invests primarily in adjustable rate securities would tend to have a lower degree of volatility in its net asset value than a fund that invests primarily in fixed-rate securities. This is because the value of adjustable rate securities does not fluctuate as much as the value of fixed-rate securities when interest rates rise or fall. By investing primarily in mortgage securities whose interest rates adjust periodically, the Fund will attempt to maintain a net asset value that would be less volatile than that of a fund which invested primarily in fixed-rate mortgage securities. The Fund's current net asset value and offering price may be found in the mutual funds section of local newspapers under "Federated" and the appropriate class designation listing. CALLING THE FUND Call the Fund at 1-800-341-7400. INVESTMENT INFORMATION INVESTMENT OBJECTIVE The investment objective of the Fund is to provide current income with volatility of principal which is lower than investment companies investing primarily in fixed-rate mortgage securities. The investment objective cannot be changed without approval of shareholders. While there is no assurance that the Fund will achieve its investment objective, it endeavors to do so by following the investment policies described in this prospectus. INVESTMENT POLICIES The Fund's assets will be managed so that the Fund is a permissible investment for federal credit unions under the Federal Credit Union Act and rules and regulations established by the National Credit Union Administration ("NCUA"). To the extent that any investment or investment practice under the Fund's investment policies listed below are not permissible for federal credit unions, the Fund shall refrain from purchasing such investment or engaging in such practices. The Fund will notify shareholders 60 days before making any change to this policy. The investment policies and limitations described below cannot be changed without shareholder approval. ACCEPTABLE INVESTMENTS The Fund pursues its investment objective by investing primarily in adjustable and floating rate mortgage securities. Under normal circumstances, the Fund will invest at least 65% of the value of its total assets in adjustable and floating rate mortgage securities which are issued or guaranteed by the U.S. government, its agencies or instrumentalities. The types of mortgage securities in which the Fund may invest include the following: * adjustable rate mortgage securities ("ARMS"); * collateralized mortgage obligations ("CMOs"); * real estate mortgage investment conduits ("REMICs"); and * other securities collateralized by or representing an interest in real estate mortgages whose interest rates reset at periodic intervals and are issued or guaranteed by the U.S. government, its agencies or instrumentalities. In addition to the securities described above, the Fund may also invest in the following: * direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes, and bonds; * notes, bonds, and discount notes issued or guaranteed by U.S. government agencies and instrumentalities supported by the full faith and credit of the United States; * notes, bonds, and discount notes of U.S. government agencies or instrumentalities which receive or have access to federal funding; and * notes, bonds, and discount notes of other U.S. government instrumentalities supported only by the credit of the instrumentalities. The government securities in which the Fund may invest are backed in a variety of ways by the U.S. government or its agencies or instrumentalities. Some of these securities are backed by the full faith and credit of the U.S. government. Other securities, such as obligations of the Federal National Mortgage Association ("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC"), are backed by the credit of the agency or instrumentality issuing the obligations but not the full faith and credit of the U.S. government. The Fund will not invest in stripped mortgage securities. ADJUSTABLE RATE MORTGAGE SECURITIES ARMS are pass-through mortgage securities with adjustable rather than fixed interest rates. The ARMS in which the Fund invests are issued by Government National Mortgage Association ("GNMA"), FNMA, and FHLMC and are actively traded. The underlying mortgages which collateralize ARMS issued by GNMA are fully guaranteed by the Federal Housing Administration or Veterans Administration while those collateralizing ARMS issued by FHLMC or FNMA are typically conventional residential mortgages conforming to strict underwriting size and maturity constraints. Unlike conventional bonds, ARMS pay back principal over the life of the ARMS rather than at maturity. Thus, a holder of the ARMS, such as the Fund, would receive monthly scheduled payments of principal and interest, and may receive unscheduled principal payments representing pre-payments on the underlying mortgages. At the time that a holder of the ARMS reinvests the payments and any unscheduled prepayments of principal that it receives, the holder may receive a rate of interest which is actually lower than the rate of interest paid on the existing ARMS. As a consequence, ARMS may be a less effective means of "locking in" long-term interest rates than other types of U.S. government securities. Not unlike other U.S. government securities, the market value of ARMS will generally vary inversely with changes in market interest rates. Thus, the market value of ARMS generally declines when interest rates rise and generally rises when interest rates decline. While ARMS generally entail less risk of a decline during periods of rapidly rising rates, ARMS may also have less potential for capital appreciation than other similar investments (e.g. investments with comparable maturities) because as interest rates decline, the likelihood increases that mortgages will be prepaid. Furthermore, if ARMS are purchased at a premium, mortgage foreclosures and unscheduled principal payments may result in some loss of a holder's principal investment to the extent of the premium paid. Conversely, if ARMS are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal would increase current and total returns and would accelerate the recognition of income, which would be taxed as ordinary income when distributed to shareholders. COLLATERALIZED MORTGAGE OBLIGATIONS CMOs are debt obligations collateralized by mortgage loans or mortgage pass-through securities. Typically, CMOs are collateralized by GNMA, FNMA, or FHLMC Certificates, but also may be collateralized by whole loans or Private Pass-Throughs (such collateral collectively hereinafter referred to as "Mortgage Assets"). Multiclass pass-through securities are equity interests in a trust composed of Mortgage Assets. Unless the context indicates otherwise, all references herein to CMOs include multiclass pass-through securities. Payments of principal of and interest on the Mortgage Assets, and any reinvestment income thereon, provide the funds to pay debt service on the CMOs or make scheduled distributions on the multiclass pass-through securities. CMOs in which the Fund invests are issued by agencies or instrumentalities of the U.S. government. The issuer of a series of CMOs may elect to be treated as a REMIC, which has certain special tax attributes. In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMOs, often referred to as a "tranche," is issued at a specific fixed or floating coupon rate and has a stated maturity or final distribution date. Principal prepayments on the Mortgage Assets may cause the CMOs to be retired substantially earlier than their stated maturities or final distribution dates. Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly or semi-annual basis. The principal of and interest on the Mortgage Assets may be allocated among the several classes of a series of a CMO in innumerable ways. In one structure, payments of principal, including any principal prepayments, on the Mortgage Assets are applied to the classes of a CMO in the order of their respective stated maturities or final distribution dates, so that no payment of principal will be made on any class of CMOs until all other classes having an earlier stated maturity or final distribution date have been paid in full. Because the mortgages underlying mortgage-backed securities often may be prepaid without penalty or premium, mortgage-backed securities are generally subject to higher prepayment risks than most other types of debt instruments. Prepayment risks on mortgage securities tend to increase during periods of declining mortgage interest rates because many borrowers refinance their mortgages to take advantage of the more favorable rates. Depending upon market conditions, the yield that the Fund receives from the reinvestment of such prepayments, or any scheduled principal payments, may be lower than the yield on the original mortgage security. As a consequence, mortgage securities may be a less effective means of "locking in" interest rates than other types of debt securities having the same stated maturity and may also have less potential for capital appreciation. For certain types of asset pools, such as CMOs, prepayments may be allocated to one tranche of securities ahead of other tranches, in order to reduce the risk of prepayment for the other tranches. Prepayments may result in a capital loss to the Fund to the extent that the prepaid mortgage securities were purchased at a market premium over their stated principal amount. Conversely, the prepayment of mortgage securities purchased at a market discount from their stated principal amount will accelerate the recognition of interest income by the Fund, which would be taxed as ordinary income when distributed to the shareholders. REAL ESTATE MORTGAGE INVESTMENT CONDUITS REMICs are offerings of multiple class real estate mortgage-backed securities which qualify and elect treatment as such under provisions of the Internal Revenue Code. Issuers of REMICs may take several forms, such as trusts, partnerships, corporations, associations, or a segregated pool of mortgages. Once REMIC status is elected and obtained, the entity is not subject to federal income taxation. Instead, income is passed through the entity and is taxed to the person or persons who hold interests in the REMIC. A REMIC interest must consist of one or more classes of "regular interests," some of which may offer adjustable rates (the type in which the Fund primarily invests), and a single class of "residual interests." To qualify as a REMIC, substantially all the assets of the entity must be in assets directly or indirectly secured principally by real property. REGULATORY COMPLIANCE In accordance with the Rules and Regulations of the NCUA, unless the purchase is made solely to reduce interest-rate risk, the Fund will not invest in any CMO or REMIC security that meets any of the following three tests: (1) the CMO or REMIC has an expected average life greater than 10 years; (2) the average life of the CMO or REMIC extends by more than four years assuming an immediate and sustained parallel shift in the yield curve of plus 300 basis points, or shortens by more than six years assuming an immediate and sustained parallel shift in the yield curve of minus 300 basis points; or (3) the estimated change in the price of the CMO or REMIC is more than 17%, due to an immediate and sustained parallel shift in the yield curve of plus or minus 300 basis points. Neither test (1) nor (2) above apply to floating or adjustable rate CMOs or REMICs with all of the following characteristics: (a) the interest rate of the instrument is reset at least annually; (b) the interest rate is below the contractual cap of the instrument; (c) the instrument is tied to a widely-used market rate; and (d) the instrument varies directly (not inversely) and is reset in proportion with the index's changes. The Fund may not purchase a residual interest in a CMO or REMIC. In addition, the Fund will not purchase zero coupon securities with maturities greater than 10 years. RESETS OF INTEREST The interest rates paid on the ARMS, CMOs, and REMICs in which the Fund invests generally are readjusted or reset at intervals of one year or less to an increment over some predetermined interest rate index. There are two main categories of indices: those based on U.S. Treasury securities and those derived from a calculated measure, such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices include the one-year and five-year constant maturity Treasury Note rates, the three-month Treasury Bill rate, the 180-day Treasury Bill rate, rates on longer-term Treasury securities, the National Median Cost of Funds, the one-month or three-month London Interbank Offered Rate (LIBOR), the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year constant maturity Treasury Note rate, closely mirror changes in market interest rate levels. Others tend to lag changes in market rate levels and tend to be somewhat less volatile. CAPS AND FLOORS The underlying mortgages which collateralize the ARMS, CMOs, and REMICs in which the Fund invests will frequently have caps and floors which limit the maximum amount by which the loan rate to the residential borrower may change up or down: (1) per reset or adjustment interval; and (2) over the life of the loan. Some residential mortgage loans restrict periodic adjustments by limiting changes in the borrower's monthly principal and interest payments rather than limiting interest rate changes. These payment caps may result in negative amortization. The value of mortgage securities in which the Fund invests may be affected if market interest rates rise or fall faster and farther than the allowable caps or floors on the underlying residential mortgage loans. An example of the effect of caps and floors on a residential mortgage loan may be found in the Statement of Additional Information. Additionally, even though the interest rates on the underlying residential mortgages are adjustable, amortization and prepayments may occur, thereby causing the effective maturities of the mortgage securities in which the Fund invests to be shorter than the maturities stated in the underlying mortgages. RESTRICTED AND ILLIQUID SECURITIES The Fund may invest no more than 10% of its net assets in restricted securities. Restricted securities are any securities in which the fund may invest pursuant to its investment objective and policies but which are subject to restrictions on resale under federal securities law. The Fund will invest no more than 10% of its net assets in illiquid securities including repurchase agreements providing for settlement in more than seven days after notice. TEMPORARY INVESTMENTS The Fund may invest temporarily in cash and cash items during times of unusual market conditions for defensive purposes and to maintain liquidity. Cash items may include short-term obligations such as: * obligations of the U.S. government or its agencies or instrumentalities; and * repurchase agreements. To the extent that investments in temporary investments are not for defensive purposes, the Fund intends to limit its investment in these securities to 20% of its total assets. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Fund may lend portfolio securities on a short-term or long-term basis up to one-third of the value of its total assets to broker/dealers, banks, or other institutional borrowers of securities. The Fund will only enter into loan arrangements with broker/dealers, banks, or other institutions which the investment adviser has determined are creditworthy under guidelines established by the Fund's Board of Directors (the "Directors"). The Fund will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. There is the risk that when lending portfolio securities, the securities may not be available to the Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Fund may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which the Fund purchases securities with payment and delivery scheduled for a future time. Delivery of the security is to be made within 30 days from the trade date and the period from the trade date to the settlement date will not exceed 120 days. The seller's failure to complete these transactions may cause the Fund to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. The Fund may dispose of a commitment prior to settlement if the adviser deems it appropriate to do so. In addition, the Fund may enter into transactions to sell its purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Fund may realize short-term profits or losses upon the sale of such commitments. PORTFOLIO TURNOVER The Fund does not attempt to set or meet any specific portfolio turnover rate, since turnover is incidental to transactions undertaken in an attempt to achieve the Fund's investment objective. The turnover rates for the fiscal years ended February 28, 1998 and February 28, 1997 were 67% and 108%, respectively. Such high turnover rates may result in higher brokerage commissions and capital gains. See "Tax Information" in this prospectus. INVESTMENT LIMITATIONS The Fund will not: * borrow money directly or through reverse repurchase agreements (arrangements in which the Fund sells a portfolio instrument for a percentage of its cash value with an agreement to buy it back on a set date) or pledge securities except, under certain circumstances, the Fund may borrow up to one-third of the value of its total assets and pledge up to 10% of the value of those assets to secure such borrowings. NET ASSET VALUE The Fund's net asset value ("NAV") per Share fluctuates and is based on the market value of all securities and other assets of the Fund. All purchases, redemptions and exchanges are processed at the NAV next determined after the request in proper form is received by the Fund. The NAV is determined as of the close of trading on the New York Stock Exchange (normally 4:00 p.m., Eastern time) every day the New York Stock Exchange is open. INVESTING IN THE FUND This prospectus offers its Shares with the characteristics described below. Minimum and Subsequent Investment Amount $1500/$100 Minimum and Subsequent Investment Amount for $250/$100 Retirement Plans Maximum Sales Charge None Maximum Contingent Deferred Sales Charge** 1.00%* *Computed on the lesser of the NAV of the redeemed Shares at the time of purchase or the NAV of the redeemed Shares at the time of redemption. ** The following contingent deferred sales charge schedule applies to Shares: CONTINGENT DEFERRED AMOUNT OF PURCHASE SHARES HELD SALES CHARGE Up to $1,999,999 Four Years or less 1.00% $2,000,000 to $4,999,999 Two Years or less 0.50% $5,000,000 to $24,999,999 One Year or less 0.25% $25,000,000 or more NA None PURCHASING SHARES Shares of the Fund are sold on days on which the New York Stock Exchange is open. Shares of the Fund may be purchased as described below, either through a financial intermediary (such as a bank or broker/dealer) or by sending a wire or check directly to the Fund. Financial intermediaries may impose different minimum investment requirements on their customers. An account must be established with a financial intermediary or by completing, signing, and returning the new account form available from the Fund before Shares can be purchased. Shareholders in Class F Shares of other funds advised and distributed by affiliates of Federated Investors ("Federated Funds") may exchange their Shares for Shares of the Fund. The Fund reserves the right to reject any purchase or exchange request. In connection with any sale, Federated Securities Corp. may, from time to time, offer certain items of nominal value to any shareholder or investor. PURCHASING SHARES THROUGH A FINANCIAL INTERMEDIARY Orders placed through a financial intermediary are considered received when the Fund is notified of the purchase order or when payment is converted into federal funds. Purchase orders through a broker/dealer must be received by the broker before 4:00 p.m. (Eastern time) and must be transmitted by the broker to the Fund before 5:00 p.m. (Eastern time) in order for Shares to be purchased at that day's price. Purchase orders through other financial intermediaries must be received by the financial intermediary and transmitted to the Fund before 4:00 p.m. (Eastern time) in order for Shares to be purchased at that day's price. It is the financial intermediary's responsibility to transmit orders promptly. Financial intermediaries may charge fees for their services. The financial intermediary which maintains investor accounts in Shares with the Fund must do so on a fully disclosed basis unless it accounts for share ownership periods used in calculating the contingent deferred sales charge (see "Contingent Deferred Sales Charge"). In addition, advance payments made to financial intermediaries may be subject to reclaim by the distributor for accounts transferred to financial intermediaries which do not maintain investor accounts on a fully disclosed basis and do not account for share ownership periods. PURCHASING SHARES BY WIRE Shares may be purchased by Federal Reserve wire by calling the Fund. All information needed will be taken over the telephone, and the order is considered received when State Street Bank receives payment by wire. Federal funds should be wired as follows: Federated Shareholder Services Company, c/o State Street Bank and Trust Company, Boston, MA 02266-8600; Attention; EDGEWIRE; For Credit to: (Fund Name); (Fund Number--this number can be found on the account statement or by contacting the Fund); Account Number; Trade Date and Order Number; Group Number or Dealer Number; Nominee or Institution Name; and ABA Number 011000028. Shares cannot be purchased by wire on holidays when wire transfers are restricted. PURCHASING SHARES BY CHECK Shares may be purchased by mailing a check made payable to the name of the Fund (designate account number) to: Federated Shareholder Services Company, P.O. Box 8600, Boston, MA 02266-8600. Orders by mail are considered received when payment by check is converted into federal funds (normally the business day after the check is received). SYSTEMATIC INVESTMENT PROGRAM Under this program, funds in a minimum amount of $50 may be automatically withdrawn periodically from the shareholder's checking account at an Automated Clearing House ("ACH") member and invested in the Fund. Shareholders should contact their financial intermediary or the Fund to participate in this program. RETIREMENT PLANS Fund Shares can be purchased as an investment for retirement plans or Individual Retirement Accounts ("IRA) accounts. For further details, contact the Fund and consult a tax adviser. ELIMINATING THE SALES CHARGE Shares are sold at NAV. However: SHAREHOLDERS MAY PARTICIPATE IN THE FOLLOWING PROGRAMS TO ELIMINATE THE SALES CHARGE APPLICABLE TO THE PURCHASE OF CLASS F SHARES OF OTHER FEDERATED FUNDS: * purchasing in quantity and accumulating purchases; * combining concurrent purchases of two or more funds; * signing a letter of intent to purchase a specific quantity of shares within 13 months; or * using the reinvestment privilege. Consult a financial intermediary or Federated Securities Corp. for details on these programs. In order to eliminate the sales charge, Federated Securities Corp. must be notified by the shareholder in writing or by a financial intermediary at the time of purchase. REDEEMING AND EXCHANGING SHARES Shares of the Fund may be redeemed for cash or exchanged for corresponding Shares of other Federated Funds on days on which the Fund computes its NAV. Shares are redeemed at NAV less any applicable contingent deferred sales charge. Exchanges are made at NAV. Shareholders who desire to automatically exchange Shares, of a like Share class, in a pre-determined amount on a monthly, quarterly, or annual basis may take advantage of a systematic exchange privilege. Information on this privilege is available from the Fund or your financial intermediary. Depending upon the circumstances, a capital gain or loss may be realized when Shares are redeemed or exchanged. REDEEMING OR EXCHANGING SHARES THROUGH A FINANCIAL INTERMEDIARY Shares of the Fund may be redeemed or exchanged by contacting your financial intermediary before 4:00 p.m. (Eastern time). In order for these transactions to be processed at that day's NAV, financial intermediaries (other than broker/dealers) must transmit the request to the Fund before 4:00 p.m. (Eastern time), while broker/dealers must transmit the request to the Fund before 5:00 p.m. (Eastern time). The financial intermediary is responsible for promptly submitting transaction requests and providing proper written instructions. Customary fees and commissions may be charged by the financial intermediary for this service. Appropriate authorization forms for these transactions must be on file with the Fund. REDEEMING OR EXCHANGING SHARES BY TELEPHONE Shares acquired directly from the Fund may be redeemed in any amount, or exchanged, by calling 1-800-341-7400. Appropriate authorization forms for these transactions must be on file with the Fund. Shares held in certificate form must first be returned to the Fund as described in the instructions under "Redeeming or Exchanging Shares by Mail." Redemption proceeds will either be mailed in the form of a check to the shareholder's address of record or wire-transferred to the shareholder's account at a domestic commercial bank that is a member of the Federal Reserve System. The minimum amount for a wire transfer is $1,000. Proceeds from redeemed Shares purchased by check or through ACH will not be wired until that method of payment has cleared. Telephone instructions will be recorded. If reasonable procedures are not followed by the Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. In the event of drastic economic or market changes, a shareholder may experience difficulty in redeeming by telephone. If this occurs, "Redeeming or Exchanging Shares by Mail" should be considered. The telephone transaction privilege may be modified or terminated at any time. Shareholders would be promptly notified. REDEEMING OR EXCHANGING SHARES BY MAIL Shares may be redeemed in any amount, or exchanged, by mailing a written request to: Federated Shareholder Services Company, Fund Name, Fund Class, P.O. Box 8600, Boston, MA 02266-8600. If share certificates have been issued, they must accompany the written request. It is recommended that certificates be sent unendorsed by registered or certified mail. All written requests should state: Fund Name; the account name as registered with the Fund; the account number; and the number of Shares to be redeemed or the dollar amount of the transaction. An exchange request should also state the name of the Fund, and if applicable, the Share class name into which the exchange is to be made. All owners of the account must sign the request exactly as the Shares are registered. A check for redemption proceeds is normally mailed within one business day, but in no event more than seven days, after receipt of a proper written redemption request. Dividends are paid up to and including the day that a redemption or exchange request is processed. REQUIREMENTS FOR REDEMPTION Shareholders requesting a redemption of any amount to be sent to an address other than that on record with the Fund, or a redemption payable other than to the shareholder of record, must have their signatures guaranteed by a commercial or savings bank, trust company or savings association whose deposits are insured by an organization which is administered by the FDIC; a member firm of a domestic stock exchange; or any other "eligible guarantor institution," as defined in the Securities Exchange Act of 1934. The Fund does not accept signatures guaranteed by a notary public. REQUIREMENTS FOR EXCHANGE Shareholders must exchange Shares having a NAV equal to the minimum investment requirements of the fund into which the exchange is being made. Contact your financial intermediary directly or the Fund for free information on and prospectuses for the Federated Funds into which your Shares may be exchanged. Before the exchange, the shareholder must receive a prospectus of the fund for which the exchange is being made. Upon receipt of proper instructions and required supporting documents, Shares submitted for exchange are redeemed and proceeds invested in the same class of shares of the other fund. Signature guarantees will be required to exchange between fund accounts not having identical shareholder registrations. The exchange privilege may be modified or terminated at any time. Shareholders will be notified of the modification or termination of the exchange privilege. SYSTEMATIC WITHDRAWAL PROGRAM Under this program, Shares are redeemed to provide for periodic withdrawal payments in an amount directed by the shareholder of not less than $100. To be eligible to participate in this program, a shareholder must have an account value of at least $10,000, other than retirement accounts subject to required minimum distributions. A shareholder may apply for participation in this program through his financial intermediary or by calling the Fund. Because participation in this program may reduce, and eventually deplete, the shareholder's investment in the Fund, payments under this program should not be considered as yield or income. A contingent deferred sales charge will be imposed on Shares redeemed through this program within four years of their purchase dates. CONTINGENT DEFERRED SALES CHARGE The contingent deferred sales charge will be deducted from the redemption proceeds otherwise payable to the shareholder and will be retained by the distributor. Redemptions will be processed in a manner intended to maximize the amount of redemption which will not be subject to a contingent deferred sales charge. The contingent deferred sales charge will not be imposed with respect to Shares acquired through the reinvestment of dividends or distributions of long-term capital gains. In determining the applicability of the contingent deferred sales charge, the required holding period for your new Shares received through an exchange will include the period for which your original Shares were held. ELIMINATING THE CONTINGENT DEFERRED SALES CHARGE Upon written notification to Federated Securities Corp. or the transfer agent, no contingent deferred sales charge will be imposed on redemptions: * following the death or disability, as defined in Section 72(m)(7) of the Internal Revenue Code of 1986, of the last surviving shareholder; * representing a total or partial distribution from an IRA, Keogh Plan, or a custodial account to a shareholder who has attained the age of 70 1/2; * representing a total or partial distribution from a qualified plan, other than an IRA, Keogh Plan, or a custodial account following retirement; * which are involuntary redemptions of shareholder accounts that do not comply with the minimum balance requirements; * which are reinvested in the Fund under the reinvestment privilege; * of Shares acquired through the exchange of shares of Federated Government Income Securities, Inc. where those shares were purchased during that fund's Charter Offering Period; * of Shares held by Directors, employees and sales representatives of the Fund, the distributor, or affiliates of the Fund or distributor, employees of any financial intermediary that sells Shares of the Fund pursuant to a sales agreement with the distributor, and their immediate family members to the extent that no payments were advanced for purchases made by these persons; and * of Shares originally purchased through a bank trust department, an investment adviser registered under the Investment Advisers Act of 1940 or retirement plans where the third party administrator has entered into certain arrangements with Federated Securities Corp. or its affiliates, or any other financial intermediary, to the extent that no payments were advanced for purchases made through such entities. For more information regarding the contingent deferred sales charge or any of the above provisions, contact your financial intermediary or the Fund. The Fund reserves the right to discontinue or modify these provisions. Shareholders will be notified of such action. ACCOUNT AND SHARE INFORMATION CONFIRMATIONS AND ACCOUNT STATEMENTS Shareholders will receive detailed confirmations of transactions (except for systematic program transactions). In addition, shareholders will receive periodic statements reporting all account activity, including dividends paid. The Fund will not issue share certificates. DIVIDENDS AND DISTRIBUTIONS Dividends are declared and paid monthly to all shareholders invested in the Fund on the record date. Net long-term capital gains realized by the Fund, if any, will be distributed at least once every twelve months. Dividends and distributions are automatically reinvested in additional Shares of the Fund on payment dates at the ex-dividend date NAV unless shareholders request cash payments on the new account form or by contacting the transfer agent. ACCOUNTS WITH LOW BALANCES Due to the high cost of maintaining accounts with low balances, the Fund may close an account by redeeming all Shares and paying the proceeds to the shareholder if the account balance falls below the applicable minimum investment amount. Retirement plan accounts and accounts where the balance falls below the minimum due to NAV changes will not be closed in this manner. Before an account is closed, the shareholder will be notified and allowed 30 days to purchase additional Shares to meet the minimum. FUND INFORMATION MANAGEMENT OF THE FUND BOARD OF DIRECTORS The Fund is managed by a Board of Directors. The Directors are responsible for managing the Fund's business affairs and for exercising all the Fund's powers except those reserved for the shareholders. An Executive Committee of the Board of Directors handles the Board's responsibilities between meetings of the Board. INVESTMENT ADVISER Investment decisions for the Fund are made by Federated Advisers, the Fund's investment adviser, subject to direction by the Directors. The adviser continually conducts investment research and supervision for the Fund and is responsible for the purchase or sale of portfolio instruments, for which it receives an annual fee from the Fund. ADVISORY FEES The Fund's adviser receives an annual investment advisory fee equal to 0.60% of the Fund's average daily net assets. The adviser may voluntarily choose to waive a portion of its fee or reimburse the Fund for certain operating expenses. The adviser can terminate this voluntary waiver of some or all of its advisory fee at any time at its sole discretion. ADVISER'S BACKGROUND Federated Advisers, a Delaware business trust organized on April 11, 1989, is a registered investment adviser under the Investment Advisers Act of 1940. It is a subsidiary of Federated Investors. All of the Class A (voting) shares of Federated Investors are owned by a trust, the Trustees of which are John F. Donahue, Chairman and Trustee of Federated Investors, Mr. Donahue's wife, and Mr. Donahue's son, J. Christopher Donahue, who is President and Trustee of Federated Investors. Federated Advisers and other subsidiaries of Federated Investors serve as investment advisers to a number of investment companies and private accounts. Certain other subsidiaries also provide administrative services to a number of investment companies. With over $120 billion invested across more than 300 funds under management and/or administration by its subsidiaries, as of December 31, 1997, Federated Investors is one of the largest mutual fund investment managers in the United States. With more than 2,000 employees, Federated continues to be led by the management who founded the company in 1955. Federated funds are presently at work in and through approximately 4,000 financial institutions nationwide. Kathleen M. Foody-Malus has been the Fund's portfolio manager since July 1991. Ms. Foody-Malus joined Federated Investors in 1983 and has been a Vice President of the Fund's investment adviser since 1993. Ms. Foody-Malus served as an Assistant Vice President of the investment adviser from 1990 until 1992. Ms. Foody-Malus received her M.B.A. in Accounting/Finance from the University of Pittsburgh. Todd A. Abraham has been the Fund's portfolio manager since October 1995. Mr. Abraham has been a Vice President of the Fund's investment adviser since July 1997. Mr. Abraham joined Federated Investors in 1993 as an Investment Analyst and served as Assistant Vice President from 1995 to 1997. Mr. Abraham served as a Portfolio Analyst at Ryland Mortgage Co. from 1992 to 1993. Mr. Abraham is a Chartered Financial Analyst and received his M.B.A. in finance from Loyola College. Robert E. Cauley has been the Fund's portfolio manager since October 1997. Mr. Cauley joined Federated Investors in 1996 as an Assistant Vice President of the Fund's adviser. Mr. Cauley served as an Associate in the Asset-Backed Securities Group at Lehman Brothers Holding, Inc. from 1994 to 1996. From 1992 to 1994, Mr. Cauley served as a Senior Associate/Corporate Finance at Barclays Bank, PLC. Mr. Cauley earned his M.S.I.A., concentrating in Finance and Economics, from Carnegie Mellon University. Both the Fund and the adviser have adopted strict codes of ethics governing the conduct of all employees who manage the Fund and its portfolio securities. These codes recognize that such persons owe a fiduciary duty to the Fund's shareholders and must place the interests of shareholders ahead of the employees' own interest. Among other things, the codes: require preclearance and periodic reporting of personal securities transactions; prohibit personal transactions in securities being purchased or sold, or being considered for purchase or sale, by the Fund; prohibit purchasing securities in initial public offerings; and prohibit taking profits on securities held for less than sixty days. Violations of the codes are subject to review by the Directors, and could result in severe penalties. DISTRIBUTION OF SHARES Federated Securities Corp. is the principal distributor for shares of the Fund. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Securities Corp. is a subsidiary of Federated Investors. DISTRIBUTION PLAN AND SHAREHOLDER SERVICES Under a distribution plan adopted in accordance with Investment Company Act Rule 12b-1 (the "Plan"), the distributor may be paid a fee by the Fund in an amount, computed at an annual rate of 0.25% of the average daily net asset value of the Fund. The distributor may select financial institutions such as banks, fiduciaries, custodians for public funds, investment advisers, and broker/dealers to provide sales services and distribution-related support services as agents for their clients or customers. The Plan is a compensation-type plan. As such, the Fund makes no payments to the distributor except as described above. Therefore, the Fund does not pay for unreimbursed expenses of the distributor, including amounts expended by the distributor in excess of amounts received by it from the Fund, interest, carrying or other financing charges in connection with excess amounts expended, or the distributor's overhead expenses. However, the distributor may be able to recover such amount or may earn a profit from future payments made by the Fund under the Plan. In addition, the Fund has entered into a Shareholder Services Agreement with Federated Shareholder Services, a subsidiary of Federated Investors, under which the Fund may make payments up to 0.25% of the average daily net asset value of its shares to obtain certain personal services for shareholders and to maintain shareholder accounts. Under the Shareholder Services Agreement, Federated Shareholder Services will either perform shareholder services directly or will select financial institutions to perform shareholder services. Financial institutions will receive fees based upon shares owned by their clients or customers. The schedules of such fees and the basis upon which such fees will be paid will be determined from time to time by the Fund and Federated Shareholder Services. SUPPLEMENTAL PAYMENTS TO FINANCIAL INSTITUTIONS In addition to payments made pursuant to the Distribution Plan and Shareholder Services Agreement, Federated Securities Corp. and Federated Shareholder Services, from their own assets, may pay financial institutions supplemental fees for the performance of substantial sales services, distribution-related support services, or shareholder services. The support may include sponsoring sales, educational and training seminars for their employees, providing sales literature, and engineering computer software programs that emphasize the attributes of the Fund. Such assistance will be predicated upon the amount of shares the financial institution sells or may sell, and/or upon the type and nature of sales or marketing support furnished by the financial institution. Any payments made by the distributor may be reimbursed by the Fund's investment adviser or its affiliates. ADMINISTRATION OF THE FUND ADMINISTRATIVE SERVICES Federated Services Company, a subsidiary of Federated Investors, provides administrative personnel and services (including certain legal and financial reporting services) necessary to operate the Fund. Federated Services Company provides these at an annual rate which relates to the average aggregate daily net assets of all funds advised by affiliates of Federated Investors as specified below: MAXIMUM AVERAGE AGGREGATE FEE DAILY NET ASSETS 0.150% on the first $250 million 0.125% on the next $250 million 0.100% on the next $250 million 0.075% on assets in excess of $750 million The administrative fee received during any fiscal year shall be at least $125,000 per portfolio and $30,000 per each additional class of shares. Federated Services Company may choose voluntarily to waive a portion of its fee. SHAREHOLDER INFORMATION Each Share of the Fund gives the shareholder one vote in Director elections and other matters submitted to shareholders for vote. Directors may be removed by the Directors or by shareholders at a special meeting. A special meeting of shareholders shall be called by the Directors upon the written request of shareholders owning at least 10% of the Fund's outstanding shares. As of April 8, 1998, the following shareholder of record owned 25% or more of the outstanding Shares of the Fund: Merrill Lynch Pierce Fenner & Smith (as record owner holding Shares for its clients), owned 5,811,837.44 Shares (30.79%) and, therefore may, for certain purposes, be deemed to control the Fund and be able to affect the outcome of certain matters presented for a vote of shareholders. TAX INFORMATION FEDERAL INCOME TAX The Fund will pay no federal income tax because it expects to meet requirements of the Internal Revenue Code applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. Unless otherwise exempt, shareholders are required to pay federal income tax on any dividends and other distributions, including capital gains distributions, received. This applies whether dividends and distributions are received in cash or as additional shares. Distributions representing long-term capital gains, if any, will be taxable to shareholders as long-term capital gains no matter how long the shareholders have held the shares. No federal income tax is due on any distributions earned in an IRA or qualified retirement plan until distributed, so long as such IRA or qualified retirement plan meets the applicable requirements of the Internal Revenue Code. STATE AND LOCAL TAXES Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. PERFORMANCE INFORMATION From time to time the Fund advertises its total return and yield. Total return represents the change, over a specified period of time, in the value of an investment in the Fund after reinvesting all income and capital gain distributions. It is calculated by dividing that change by the initial investment and is expressed as a percentage. The yield of the Fund is calculated by dividing the net investment income per Share (as defined by the SEC) earned by the Fund over a thirty-day period by the maximum offering price per Share of the Fund on the last day of the period. This number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by the Fund and, therefore, may not correlate to the dividends or other distributions paid to shareholders. The performance information reflects the effect of the contingent deferred sales charge, a non-recurring charge, which, if excluded, would increase the total return and yield. From time to time, advertisements for the Fund may refer to ratings, rankings, and other information in certain financial publications and/or compare the Fund's performance to certain indices. [Graphic] Federated Adjustable Rate U.S. Government Fund, Inc. PROSPECTUS APRIL 30, 1998 An Open-End, Diversified, Management Investment Company Federated Adjustable Rate U.S. Government Fund, Inc. Federated Investors Funds 5800 Corporate Drive Pittsburgh, PA 15237-7000 DISTRIBUTOR Federated Securities Corp. Federated Investors Tower 1001 Liberty Avenue Pittsburgh, PA 15222-3779 INVESTMENT ADVISER Federated Advisers Federated Investors Tower 1001 Liberty Avenue Pittsburgh, PA 15222-3779 CUSTODIAN State Street Bank and Trust Company P.O. Box 8600 Boston, MA 02266-8600 TRANSFER AGENT AND DIVIDEND DISBURSING AGENT Federated Shareholder Services Company P.O Box 8600 Boston, MA 02266-8600 INDEPENDENT AUDITORS Deloitte & Touche LLP 2500 One PPG Place Pittsburgh, PA 15222-5401 Federated Securities Corp., Distributor 1-800-341-7400 www.federatedinvestors.com Cusip 314072109 1071005A (4/98) [Graphic] FEDERATED ADJUSTABLE RATE U.S. GOVERNMENT FUND, INC. STATEMENT OF ADDITIONAL INFORMATION This Statement of Additional Information should be read with the prospectus of Federated Adjustable Rate U.S. Government Fund, Inc. (the "Fund"), dated April 30, 1998. This Statement is not a prospectus. You may request a copy of a prospectus or a paper copy of this Statement, if you have received it electronically, free of charge by calling 1-800-341-7400. FEDERATED ADJUSTABLE RATE U.S. GOVERNMENT FUND, INC. FEDERATED INVESTORS FUNDS 5800 CORPORATE DRIVE PITTSBURGH, PA 15237-7000 Statement dated April 30, 1998 [Graphic] Cusip 314072109 1071005B(4/98) [Graphic] TABLE OF CONTENTS GENERAL INFORMATION ABOUT THE FUND 1 INVESTMENT OBJECTIVE AND POLICIES 1 Types of Investments 1 Caps and Floors 1 When-Issued and Delayed Delivery Transactions 1 Lending of Portfolio Securities 1 Repurchase Agreements 2 Reverse Repurchase Agreements 2 Restricted Securities 2 Portfolio Turnover 2 INVESTMENT LIMITATIONS 2 Buying on Margin 2 Issuing Senior Securities and Borrowing Money 2 Pledging Assets 3 Diversification of Investments 3 Investing in Real Estate 3 Investing in Commodities 3 Investing in Restricted Securities 3 Underwriting 3 Lending Cash or Securities 3 Selling Short 3 Investing in New Issuers 3 Investing in Minerals 4 Investing in Issuers Whose Securities are Owned by Officers and Directors of the Fund 4 Investing in Securities of Other Investment Companies 4 Investing in Stripped Mortgage Securities 4 FEDERATED ADJUSTABLE RATE U.S. GOVERNMENT FUND, INC. MANAGEMENT 4 Fund Ownership 8 Directors' Compensation 9 Director Liability 9 INVESTMENT ADVISORY SERVICES 9 Adviser to the Fund 9 Advisory Fees 10 BROKERAGE TRANSACTIONS 10 OTHER SERVICES 10 Fund Administration 10 Custodian and Portfolio Recordkeeper 10 Transfer Agent 10 Independent Auditors 10 PURCHASING SHARES 11 Quantity Discounts and Accumulated Purchases 11 Concurrent Purchases 11 Letter of Intent 11 Reinvestment Privilege 11 Purchases by Sales Representatives, Fund Directors, and Employees 12 Distribution Plan and Shareholder Services 12 Conversion to Federal Funds 12 DETERMINING NET ASSET VALUE 12 Determining Market Value of Securities 13 REDEEMING SHARES 13 Redemption in Kind 13 Contingent Deferred Sales Charge 13 TAX STATUS 14 The Fund's Tax Status 14 Shareholders' Tax Status 14 TOTAL RETURN 14 YIELD 14 PERFORMANCE COMPARISONS 15 Economic and Market Information 15 ABOUT FEDERATED INVESTORS 16 Mutual Fund Market 16 Institutional Clients 16 Bank Marketing 16 Broker/Dealers and Bank Broker/Dealer Subsidiaries 16 FINANCIAL STATEMENTS 16 GENERAL INFORMATION ABOUT THE FUND The Fund was incorporated under the laws of the State of Maryland on March 20, 1991. It is qualified to do business as a foreign corporation in Pennsylvania. Effective March 31, 1996, the Fund changed its name from Fortress Adjustable Rate U.S. Government Fund, Inc. to Federated Adjustable Rate U.S. Government Fund, Inc. INVESTMENT OBJECTIVE AND POLICIES The investment objective of the Fund is to provide current income with volatility of principal which is lower than investment companies investing primarily in fixed-rate mortgage securities. The investment objective and policies of the Fund cannot be changed without approval of shareholders. TYPES OF INVESTMENTS The Fund invests primarily in adjustable and floating rate mortgage securities which are issued or guaranteed by the U.S. government, its agencies, and instrumentalities. These securities are backed by: * the full faith and credit of the U.S. Treasury; * the issuer's right to borrow from the U.S. Treasury; * the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or * the credit of the agency or instrumentality issuing the obligations. Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: * Federal Home Loan Banks; * Farmers Home Administration; and * Federal National Mortgage Association. CAPS AND FLOORS The value of mortgage-related securities in which the Fund invests may be affected if interest rates rise or fall faster and farther than the allowable caps on the underlying residential mortgage loans. For example, consider a residential mortgage loan with a rate which adjusts annually, an initial interest rate of 10%, a 2% per annum interest rate cap, and a 5% life of loan interest rate cap. If the index against which the underlying interest rate on the residential mortgage loan is compared--such as the one-year Treasury--moves up by 3%, the residential mortgage loan rate may not increase by more than 2% to 12% the first year. As one of the underlying residential mortgages for the securities in which the Fund invests, the residential mortgage would depress the value of the securities and, therefore, the net asset value of the Fund. If the index against which the interest rate on the underlying residential mortgage loan is compared moves up no faster or farther than the cap on the underlying mortgage loan allows, or if the index moves down as fast or faster than the floor on the underlying mortgage loan allows, the mortgage would maintain or improve the value of the securities in which the Fund invests and, therefore, the net asset value of the Fund. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payments for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction is settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. REPURCHASE AGREEMENTS The Fund requires its custodian to take possession of the securities subject to repurchase agreements, and these securities are marked to market daily. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller files for bankruptcy or becomes insolvent, disposition of securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by the Fund's adviser to be creditworthy pursuant to guidelines established by the Board of Directors (the "Directors"). REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. A reverse repurchase transaction is similar to borrowing cash. In a reverse repurchase agreement the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future, the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and are maintained until the transaction is settled. RESTRICTED SECURITIES The ability of the Directors to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933. The Directors consider the following criteria in determining the liquidity of certain restricted securities: * the frequency of trades and quotes for the security; * the number of dealers willing to purchase or sell the security and the number of other potential buyers; * dealer undertakings to make a market in the security; and * the nature of the security and the nature of the marketplace trades. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objective. For the fiscal years ended February 28, 1998 and February 28, 1997, the portfolio turnover rates were 67% and 108%, respectively. INVESTMENT LIMITATIONS The Fund will not change any of the investment limitations described below without approval of shareholders. BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as are necessary for clearance of transactions. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities except that the Fund may borrow money and engage in reverse repurchase agreements in amounts up to one-third of the value of its total assets, including the amounts borrowed. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the portfolio by enabling the Fund to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding, but only to the extent necessary to assure completion of the reverse repurchase agreements, the Fund will restrict the purchase of portfolio instruments to money market instruments maturing on or before the expiration date of the reverse repurchase agreements. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 10% of the value of total assets at the time of the borrowing. DIVERSIFICATION OF INVESTMENTS With respect to securities comprising 75% of the value of its total assets, the Fund will not purchase securities of any one issuer (other than cash, cash items, or securities issued or guaranteed by the government of the United States, or its agencies, or instrumentalities and repurchase agreements collateralized by U.S. government securities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests in real estate, although it may invest in securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities. INVESTING IN RESTRICTED SECURITIES The Fund will not invest more than 10% of the value of its net assets in securities subject to restrictions on resale under the Securities Act of 1933, including repurchase agreements providing for settlement in more than seven days after notice. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of restricted securities which the Fund may purchase pursuant to its investment objective, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets, except portfolio securities up to one-third of the value of its total assets. This shall not prevent the Fund from purchasing or holding U.S. government obligations, money market instruments, variable amount demand master notes, bonds, debentures, notes, certificates of indebtedness, or other securities, entering into repurchase agreements, or engaging in other transactions where permitted by a Fund's investment objective, policies, and limitations. SELLING SHORT The Fund will not sell securities short unless: * during the time the short position is open, it owns an equal amount of the securities sold or securities readily and freely convertible into or exchangeable, without payment of additional consideration, for securities of the same issue as, and equal in amount to, the securities sold short; and * not more than 10% of the Fund's net assets (taken at current value) is held as collateral for such sales at any one time. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in securities of issuers which have records of less than three years of operating history, including the operation of any predecessor. (This limitation does not apply to issuers of collateralized mortgage obligations or real estate mortgage investment conduits which are collateralized by securities or mortgages issued or guaranteed as to prompt payment of principal and interest by an agency of the U.S. government.) INVESTING IN MINERALS The Fund will not purchase or sell oil, gas, or other mineral exploration or development programs or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND DIRECTORS OF THE FUND The Fund will not purchase or retain the securities of any issuer if the Officers and Directors of the Fund or its investment adviser owning individually more than 1/2 of 1% of the issuer's securities together own more than 5% of the issuer's securities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund may not own securities of open-end investment companies. The Fund can acquire up to 3% of the total outstanding stock of closed-end investment companies. The Fund will not be subject to any other limitations with regard to the acquisition of securities of closed-end investment companies so long as the public offering price of the Fund's shares does not include a sales charge exceeding 1.5%. The Fund will purchase securities of closed-end investment companies only in open-market transactions involving only customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. INVESTING IN STRIPPED MORTGAGE SECURITIES The Fund will not invest its assets in stripped mortgage securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund does not expect to pledge securities or invest in stock of closed-end investment companies during the coming year. The Fund has not borrowed money or sold any securities short in an amount exceeding 5% of the value of its net assets during the last fiscal year and has no present intent to do so in the coming fiscal year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings association having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." FEDERATED ADJUSTABLE RATE U.S. GOVERNMENT FUND INC. MANAGEMENT Officers and Directors are listed with their addresses, birthdates, present positions with Federated Adjustable Rate U.S. Government Fund Inc., and principal occupations. John F. Donahue@* Federated Investors Tower Pittsburgh, PA Birthdate: July 28, 1924 Chairman and Director Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp. and Federated Global Research Corp.; Chairman, Passport Research, Ltd.; Chief Executive Officer and Director or Trustee of the Funds. Mr. Donahue is the father of J. Christopher Donahue, Executive Vice President of the Company. Thomas G. Bigley 15 Old Timber Trail Pittsburgh, PA Birthdate: February 3, 1934 Director Director, Member of Executive Committee, Children's Hospital of Pittsburgh; formerly, Senior Partner, Ernst & Young LLP; Director, MED 3000 Group, Inc.; Director, Member of Executive Committee, University of Pittsburgh; Director or Trustee of the Funds. John T. Conroy, Jr. Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Birthdate: June 23, 1937 Director President, Investment Properties Corporation; Senior Vice President, John R. Wood and Associates, Inc., Realtors; Partner or Trustee in private real estate ventures in Southwest Florida; formerly, President, Naples Property Management, Inc. and Northgate Village Development Corporation; Director or Trustee of the Funds. Nicholas P. Constantakis 175 Woodshire Drive Pittsburgh, PA Birthdate: September 3, 1939 Director Formerly, Partner, Andersen Worldwide SC; Director or Trustee of the Funds. William J. Copeland One PNC Plaza--23rd Floor Pittsburgh, PA Birthdate: July 4, 1918 Director Director and Member of the Executive Committee, Michael Baker, Inc.; formerly, Vice Chairman and Director, PNC Bank, N.A. and PNC Bank Corp.; Director, Ryan Homes, Inc.; Director or Trustee of the Funds. James E. Dowd 571 Hayward Mill Road Concord, MA Birthdate: May 18, 1922 Director Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director or Trustee of the Funds. Lawrence D. Ellis, M.D.* 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Birthdate: October 11, 1932 Director Professor of Medicine, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center--Downtown; Member, Board of Directors, University of Pittsburgh Medical Center; formerly, Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Director or Trustee of the Funds. Richard B. Fisher* Federated Investors Tower Pittsburgh, PA Birthdate: May 17, 1923 President and Director Executive Vice President and Trustee, Federated Investors; Chairman and Director, Federated Securities Corp.; President or Vice President of some of the Funds; Director or Trustee of some of the Funds. Edward L. Flaherty, Jr.@ Miller, Ament, Henny & Kochuba 205 Ross Street Pittsburgh, PA Birthdate: June 18, 1924 Director Attorney of Counsel, Miller, Ament, Henny & Kochuba; Director, Eat'N Park Restaurants, Inc.; formerly, Counsel, Horizon Financial, F.A., Western Region; Director or Trustee of the Funds. Peter E. Madden One Royal Palm Way 100 Royal Palm Way Palm Beach, FL Birthdate: March 16, 1942 Director Consultant; Former State Representative, Commonwealth of Massachusetts; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation; Director or Trustee of the Funds. John E. Murray, Jr., J.D., S.J.D. President, Duquesne University Pittsburgh, PA Birthdate: December 20, 1932 Director President, Law Professor, Duquesne University; Consulting Partner, Mollica & Murray; Director or Trustee of the Funds. Wesley W. Posvar 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Birthdate: September 14, 1925 Director Professor, International Politics; Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., National Defense University, and U.S. Space Foundation; President Emeritus, University of Pittsburgh; Founding Chairman, National Advisory Council for Environmental Policy and Technology, Federal Emergency Management Advisory Board, and Czech Management Center, Prague; Director or Trustee of the Funds. Marjorie P. Smuts 4905 Bayard Street Pittsburgh, PA Birthdate: June 21, 1935 Director Public Relations/Marketing/Conference Planning; Director or Trustee of the Funds. J. Christopher Donahue Federated Investors Tower Pittsburgh, PA Birthdate: April 11, 1949 Executive Vice President President and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; President and Director, Federated Research Corp. and Federated Global Research Corp.; President, Passport Research, Ltd.; Trustee, Federated Shareholder Services Company and Federated Shareholder Services; Director, Federated Services Company; President or Executive Vice President of the Funds; Director or Trustee of some of the Funds. Mr. Donahue is the son of John F. Donahue, Chairman and Director of the Company. Edward C. Gonzales Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 Executive Vice President Vice Chairman, Treasurer, and Trustee, Federated Investors; Vice President, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., Federated Global Research Corp., and Passport Research, Ltd.; Executive Vice President and Director, Federated Securities Corp.; Trustee, Federated Shareholder Services Company; Trustee or Director of some of the Funds; President, Executive Vice President, and Treasurer of some of the Funds. John W. McGonigle Federated Investors Tower Pittsburgh, PA Birthdate: October 26, 1938 Executive Vice President, Secretary, and Treasurer Executive Vice President, Secretary, and Trustee, Federated Investors; Trustee, Federated Advisers, Federated Management, and Federated Research; Director, Federated Research Corp. and Federated Global Research Corp.; Trustee, Federated Shareholder Services Company; Director, Federated Services Company; President and Trustee, Federated Shareholder Services; Director, Federated Securities Corp.; Executive Vice President and Secretary of the Funds; Treasurer of some of the Funds. * This Director is deemed to be an "interested person" as defined in the Investment Company Act of 1940. @ Member of the Executive Committee. The Executive Committee of the Board of Directors handles the responsibilities of the Board between meetings of the Board. As used in the table above, "The Funds" and "Funds" mean the following investment companies: 111 Corcoran Funds; Automated Government Money Trust; Blanchard Funds; Blanchard Precious Metals Fund, Inc.; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated Adjustable Rate U.S. Government Fund, Inc.; Federated American Leaders Fund, Inc.; Federated ARMs Fund; Federated Core Trust; Federated Equity Funds; Federated Equity Income Fund, Inc.; Federated Fund for U.S. Government Securities, Inc.; Federated GNMA Trust; Federated Government Income Securities, Inc.; Federated Government Trust; Federated High Income Bond Fund, Inc.; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Insurance Series; Federated Investment Portfolios; Federated Investment Trust; Federated Master Trust; Federated Municipal Opportunities Fund, Inc.; Federated Municipal Securities Fund, Inc.; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock and Bond Fund, Inc.; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.S. Government Securities Fund: 1-3 Years; Federated U.S. Government Securities Fund: 2-5 Years; Federated U.S. Government Securities Fund: 5-10 Years; Federated Utility Fund, Inc.; First Priority Funds; Fixed Income Securities, Inc.; High Yield Cash Trust; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Term Trust, Inc.--1999; Liberty U.S. Government Money Market Trust; Liquid Cash Trust; Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Obligations Trust II; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; RIMCO Monument Funds; Targeted Duration Trust; Tax-Free Instruments Trust; The Planters Funds; The Virtus Funds; Trust for Financial Institutions; Trust for Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Treasury Obligations; WesMark Funds; WCT Funds; and World Investment Series, Inc. Federated Securities Corp. also acts as principal underwriter for the following closed-end investment company: Liberty Term Trust, Inc.--1999. FUND OWNERSHIP Officers and Directors as a group own less than 1% of the Fund's outstanding shares. As of April 8, 1998, Merrill Lynch Pierce Fenner & Smith, (as record owner holding shares for its clients) owned 5,811,837.4430 shares (30.79%) of the outstanding shares of the Fund. DIRECTORS' COMPENSATION AGGREGATE NAME, COMPENSATION POSITION WITH FROM TOTAL COMPENSATION PAID TRUST TRUST* FROM FUND COMPLEX+ John F. Donahue $0 $0 for the Fund and Chairman and Director 56 other investment companies in the Fund Complex Richard B. Fisher $0 $0 for the Fund and President and Director 56 other investment companies in the Fund Complex Thomas G. Bigley $1,178.34 $111,222 for the Fund and Director 56 other investment companies in the Fund Complex John T. Conroy, Jr. $1,296.36 $122,362 for the Fund and Director 56 other investment companies in the Fund Complex Nicholas P. Constantakis** $304.20 $0 for the Fund and Director 34 other investment companies in the Fund Complex William J. Copeland $1,296.36 $122,362 for the Fund and Director 56 other investment companies in the Fund Complex James E. Dowd $1,296.36 $122,362 for the Fund and Director 56 other investment companies in the Fund Complex Lawrence D. Ellis, M.D. $1,178.34 $111,222 for the Fund and Director 56 other investment companies in the Fund Complex Edward L. Flaherty, Jr. $1,296.36 $122,362 for the Fund and Director 56 other investment companies in the Fund Complex Peter E. Madden $1,178.34 $111,222 for the Fund and Director 56 other investment companies in the Fund Complex John E. Murray, Jr. $1,178.34 $111,222 for the Fund and Director 56 other investment companies in the Fund Complex Wesley W. Posvar $1,178.34 $111,222 for the Fund and Director 56 other investment companies in the Fund Complex Marjorie P. Smuts $1,178.34 $111,222 for the Fund and Director 56 other investment companies in the Fund Complex * Information is furnished for the fiscal year ended February 28, 1998. + The information is provided for the last calendar year. ** Mr. Constantakis became a member of the Board of Directors on February 23, 1998. He did not receive any fees from the Fund Complex as of the end of the last calendar year. DIRECTOR LIABILITY The Fund's Articles of Incorporation provide that the Directors will not be liable for errors of judgment or mistakes of fact or law. However, they are not protected against any liability to which they would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of their office. INVESTMENT ADVISORY SERVICES ADVISER TO THE FUND The Fund's investment adviser is Federated Advisers. It is a subsidiary of Federated Investors. All the voting securities of Federated Investors are owned by a trust, the trustees of which are John F. Donahue, his wife, and his son, J. Christopher Donahue. The adviser shall not be liable to the Fund or any shareholder for any losses that may be sustained in the purchase, holding, or sale of any security or for anything done or omitted by it, except acts or omissions involving willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Fund. ADVISORY FEES For its advisory services, Federated Advisers receives an annual investment advisory fee as described in the prospectus. For the fiscal years ended February 28, 1998 and 1997, and the fiscal year ended February 29, 1996, the adviser earned $1,201,782, $1,540,544, and $2,154,062, respectively, of which $65,849, $432,964, and $332,589, respectively, were waived. BROKERAGE TRANSACTIONS When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the adviser looks for prompt execution of the order at a favorable price. In working with dealers, the adviser will generally use those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The adviser makes decisions on portfolio transactions and selects brokers and dealers subject to guidelines established by the Directors. The adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the adviser and may include: advice as to the advisability of investing in securities; security analysis and reports; economic studies; industry studies; receipt of quotations for portfolio evaluations; and similar services. Research services provided by brokers and dealers may be used by the adviser or its affiliates in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. The adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. During the fiscal years ended February 28, 1998 and 1997, and the fiscal year ended February 29, 1996, the Fund paid no brokerage commissions. Although investment decisions for the Fund are made independently from those of the other accounts managed by the adviser, investments of the type the Fund may make may also be made by those other accounts. When the Fund and one or more other accounts managed by the adviser are prepared to invest in, or desire to dispose of, the same security, available investments or opportunities for sales will be allocated in a manner believed by the adviser to be equitable to each. In some cases, this procedure may adversely affect the price paid or received by the Fund or the size of the position obtained or disposed of by the Fund. In other cases, however, it is believed that coordination and the ability to participate in volume transactions will be to the benefit of the Fund. OTHER SERVICES FUND ADMINISTRATION Federated Services Company, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the prospectus. From March 1, 1994 to March 1, 1996, Federated Administrative Services served as the Fund's Administrator. Prior to March 1, 1994, Federated Administrative Services, Inc. served as the Fund's Administrator. Both former Administrators are subsidiaries of Federated Investors. For purposes of this Statement of Additional Information, Federated Services Company, Federated Administrative Services, and Federated Administrative Services, Inc. may hereinafter collectively be referred to as the "Administrators." For the fiscal years ended February 28, 1998 and 1997, and the fiscal year ended February 29, 1996, the Administrators earned $151,178, $194,044, and $271,695, respectively. CUSTODIAN AND PORTFOLIO RECORDKEEPER State Street Bank and Trust Company, Boston, MA, is custodian for the securities and cash of the Fund. Federated Services Company, Pittsburgh, PA, provides certain accounting and recordkeeping services with respect to the Fund's portfolio investments. The fee paid for this service is based upon the level of the Fund's average net assets for the period plus out-of-pocket expenses. TRANSFER AGENT Federated Services Company, through its registered transfer agent, Federated Shareholder Services Company, maintains all necessary shareholder records and receives a fee based on the size, type, and number of accounts and transactions made by shareholders. INDEPENDENT AUDITORS The independent auditors for the Fund are Deloitte & Touche LLP, Pittsburgh, Pennsylvania. PURCHASING SHARES Except under certain circumstances described in the prospectus, shares of the Fund ("Shares") are sold at their net asset value on days the New York Stock Exchange is open for business. The procedure for purchasing Shares is explained in the prospectus under "Investing in the Fund" and "Purchasing Shares." Shareholders may participate in the following programs with respect to the purchase of Class F Shares in other Federated Funds. For further information on any of the programs listed below, please contact your financial intermediary or Federated Securities Corp. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases of the same Share class eliminate the applicable sales charge paid. For example, the Fund will combine all Class F Share purchases made on the same day by the investor, the investor's spouse, and the investor's children under age 21 when it calculates an applicable sales charge. In addition, the sales charge, if applicable, is reduced for purchases made at one time by a trustee or fiduciary for a single trust estate or a single fiduciary account. In addition, the Fund will also combine purchases for the purpose of reducing the contingent deferred sales charge imposed on Share redemptions. For example, if a shareholder already owns Shares having current value at the public offering price of $1 million and purchases an additional $1 million at the current public offering price, the applicable contingent deferred sales charge would be reduced to 0.50% of those additional Shares. To receive the sales charge reduction or elimination, Federated Securities Corp. must be notified by the shareholder in writing or by his financial intermediary at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce or eliminate the sales charge after it confirms the purchases. CONCURRENT PURCHASES Shareholders have the privilege of combining concurrent purchases of Class F Shares of two or more funds in the Federated Complex in calculating the applicable sales charge. To receive a sales charge reduction or elimination, Federated Securities Corp. must be notified by the shareholder in writing or by his financial intermediary at the time the concurrent purchases are made. The Fund will reduce or eliminate the sales charge after it confirms the purchases. LETTER OF INTENT A shareholder can sign a letter of intent committing to purchase a certain amount of the same Share class within a 13-month period in order to combine such purchases in calculating the applicable sales charge. The Fund's custodian will hold Shares in escrow equal to the maximum applicable sales charge. If the shareholder completes the commitment, the escrowed Shares will be released to their account. If the commitment is not completed within 13 months, the custodian will redeem an appropriate number of escrowed Shares to pay for the applicable sales charge. The letter of intent for Shares also includes a provision for reductions in the contingent deferred sales charge and holding period depending on the amount actually purchased within the 13-month period. While this letter of intent will not obligate the shareholder to purchase Shares, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. At the time a letter of intent is established, current balances in accounts in Class F Shares of other Federated Funds, excluding money market accounts, will be aggregated to provide a purchase credit towards fulfillment of the letter of intent. The letter may be dated as of a prior date to include any purchase made within the past 90 days. Prior trade prices will not be adjusted. REINVESTMENT PRIVILEGE The reinvestment privilege is available for all Shares of the Fund within the same Share class. Shareholders who redeem from the Fund may reinvest the redemption proceeds back into the same Share class at the next determined net asset value without any sales charge. The original Shares must have been subject to a sales charge and the reinvestment must be within 120 days. Similarly, shareholders who redeem may reinvest their redemption proceeds in the same Share class within 120 days. Shareholders would not be entitled to a reimbursement of the contingent deferred sales charge if paid at the time of redemption. However, reinvested Shares would not be subject to a contingent deferred sales charge, if otherwise applicable, upon later redemption. In addition, if Shares were reinvested through a financial intermediary, the financial intermediary would not be entitled to an advanced payment from Federated Securities Corp. on the reinvested Shares, if otherwise applicable. Federated Securities Corp. must be notified by the shareholder in writing or by his financial intermediary of the reinvestment in order to eliminate a sales charge or a contingent deferred sales charge. If the shareholder redeems Shares in the Fund, there may be tax consequences. PURCHASES BY SALES REPRESENTATIVES, FUND DIRECTORS, AND EMPLOYEES The following individuals and their immediate family members may buy Shares at net asset value without a sales charge: * Directors, employees, and sales representatives of the Fund, Federated Advisers, and Federated Securities Corp. and its affiliates; * any associated person of an investment dealer who has a sales agreement with Federated Securities Corp.; and * trusts, pensions, or profit-sharing plans for these individuals. These sales are made with the purchaser's written assurance that the purchase is for investment purposes and that the securities will not be resold except through redemption by the Fund. DISTRIBUTION PLAN AND SHAREHOLDER SERVICES These arrangements permit the payment of fees to financial institutions, the distributor, and Federated Shareholder Services to stimulate distribution activities and to cause services to be provided to shareholders by a representative who has knowledge of the shareholder's particular circumstances and goals. These activities and services may include, but are not limited to, marketing efforts; providing office space, equipment, telephone facilities, and various clerical, supervisory, computer, and other personnel as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries, and assisting clients in changing dividend options, account designations, and addresses. By adopting the Plan, the Directors expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in pursuing its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, it may be possible to curb sharp fluctuations in rates of redemptions and sales. Other benefits, which may be realized under either arrangement, may include: (1) providing personal services to shareholders; (2) investing shareholder assets with a minimum of delay and administrative detail; (3) enhancing shareholder recordkeeping systems; and (4) responding promptly to shareholders' requests and inquiries concerning their accounts. For the fiscal year ended February 28, 1998, the Fund paid $500,743 pursuant to the Plan, $480,712 of which was waived. For the same period, the Fund paid $500,743 in shareholder services fees, $20,029 of which was waived. CONVERSION TO FEDERAL FUNDS It is the Fund's policy to be as fully invested as possible so that maximum interest may be earned. To this end, all payments from shareholders must be in federal funds or be converted into federal funds before shareholders begin to earn dividends. State Street Bank acts as the shareholder's agent in depositing checks and converting them to federal funds. DETERMINING NET ASSET VALUE The Fund's net asset value per Share fluctuates and is based on the market value of all securities and other assets of the Fund. Net asset value is not determined on (i) days on which there are not sufficient changes in the value of the Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; or (iii) the following holidays: New Year's Day, Martin Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. DETERMINING MARKET VALUE OF SECURITIES Market values of the Fund's securities are determined as follows: * as provided by an independent pricing service; * for short-term obligations, according to the mean between the bid and asked prices, as furnished by an independent pricing service, or for short-term obligations with remaining maturities of 60 days or less at the time of purchase, at amortized cost unless the Directors determine this is not fair value; or * at fair value as determined in good faith by the Fund's Directors. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: * yield; * quality; * coupon rate; * maturity; * type of issue; * trading characteristics; and * other market data. REDEEMING SHARES The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request. Shareholder redemptions may be subject to a contingent deferred sales charge. Redemption procedures are explained in the respective prospectuses under "Redeeming and Exchanging Shares." Although the transfer agent does not charge for telephone redemptions, it reserves the right to charge a fee for the cost of wire-transferred redemptions of less than $5,000. REDEMPTION IN KIND Although the Fund intends to redeem Shares in cash, it reserves the right under certain circumstances to pay the redemption price in whole or in part by a distribution of securities from the Fund's portfolio. Redemption in kind will be made in conformity with applicable SEC rules, taking such securities at the same value employed in determining net asset value and selecting the securities in a manner the Directors determine to be fair and equitable. The Fund has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940 under which the Fund is obligated to redeem Shares for any shareholder in cash up to the lesser of $250,000 or 1% of the Fund's net asset value during any 90-day period. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. CONTINGENT DEFERRED SALES CHARGE In computing the amount of the applicable Contingent Deferred Sales Charge, redemptions are deemed to have occurred in the following order: (1) Shares acquired through the reinvestment of dividends and long-term capital gains; and (2) Shares held for more than four full years from the date of purchase on a first-in, first-out basis. Certain shares redeemed within one to four years of purchase may be subject to a contingent deferred sales charge. The amount of the contingent deferred sales charge is based upon the amount of the administrative fee paid at the time of purchase by the distributor to the financial institutions for services rendered, and the length of time the investor remains a shareholder in the Fund. Should financial institutions elect to receive an amount less than the administrative fee that is stated in the prospectus for servicing a particular shareholder, the contingent deferred sales charge and/or holding period for that particular shareholder will be reduced accordingly. TAX STATUS THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: * derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; * invest in securities within certain statutory limits; and * distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. No portion of any income dividend paid by the Fund is eligible for the dividends received deduction available to corporations. CAPITAL GAINS Shareholders will pay federal tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held the Fund Shares. TOTAL RETURN The Fund's average annual total returns for the one-year and five-year periods ended February 28, 1998, and for the period from July 25, 1991 (date of initial public investment) to February 28, 1998, were 4.14%, 4.54%, and 4.76%, respectively. The average annual total return for the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of Shares owned at the end of the period by the offering price per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, adjusted over the period by any additional Shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable redemption fee is deducted from the ending value of the investment based on the lesser of the original purchase price or the offering price of Shares redeemed. YIELD The Fund's yield for the thirty-day period ended February 28, 1998, was 5.55%. The yield for the Fund is determined by dividing the net investment income per Share (as defined by the SEC) earned by the Fund over a thirty-day period by the maximum offering price per Share of the Fund on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by the Fund because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in the Fund, performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS The Fund's performance depends upon such variables as: * portfolio quality; * average portfolio maturity; * type of instruments in which the portfolio is invested; * changes in interest rates and market value of portfolio securities; * changes in the Fund's expenses; and * various other factors. The Fund's performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: * LEHMAN BROTHERS ADJUSTABLE RATE MORTGAGE FUNDS AVERAGE is comprised of all agency guaranteed securities with coupons that periodically adjust over a spread of a published index. * LEHMAN BROTHERS MUTUAL FUND SHORT (1-3) U.S. GOVERNMENT INDEX is an index comprised of mutual funds which invest in short-term (1-3 year) government securities. * LIPPER ANALYTICAL SERVICES, INC., ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in offering price over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "U.S. Mortgage Funds" category in advertising and sales literature. * MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. Advertisements and other sales literature for the Fund may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in the Fund based on monthly reinvestment of dividends over a specified period of time. From time to time, the Fund may advertise its performance, using charts, graphs, and descriptions, compared to federally insured bank products including certificates of deposit and time deposits and to money market funds using the Lipper Analytical Services, Inc. money market instruments average. Advertising and sales literature may show the Fund's offering price history in relation to certain political and economic events. Advertising and other promotional literature may include charts, graphs, and other illustrations using the Fund's returns, or returns in general, that demonstrate basic investment concepts such as tax-deferred compounding, dollar-cost averaging, and systematic investment. In addition, the Fund can compare its performance, or performance for the types of securities in which it invests, to a variety of other investments, such as bank savings accounts, certificates of deposit, and Treasury bills. ECONOMIC AND MARKET INFORMATION Advertising and sales literature for the Fund may include discussions of economic, financial, and political developments and their effect on the securities market. Such discussions may take the form of commentary on these developments by Fund portfolio managers and their views and analysis on how such developments could affect the Funds. In addition, advertising and sales literature may quote statistics and give general information about the mutual fund industry, including the growth of the industry, from sources such as the Investment Company Institute. ABOUT FEDERATED INVESTORS Federated Investors is dedicated to meeting investor needs which is reflected in its investment decision making--structured, straightforward, and consistent. This has resulted in a history of competitive performance with a range of competitive investment products that have gained the confidence of thousands of clients and their customers. The company's disciplined security selection process is firmly rooted in sound methodologies backed by fundamental and technical research. Investment decisions are made and executed by teams of portfolio managers, analysts, and traders dedicated to specific market sectors. These traders handle trillions of dollars in annual trading volume. In the government sector, as of December 31, 1997, Federated Investors manages 9 mortgage-backed, 6 government/ agency, and 17 government money market mutual funds, with assets approximating $5.9 billion, $1.5 billion, and $29.7 billion, respectively. Federated trades approximately $400 million in U.S. government and mortgage-backed securities daily and places approximately $23 billion in repurchase agreements each day. Federated introduced the first U.S. government fund to invest in U.S. government bond securities in 1969. Federated has been a major force in the short- and intermediate-term government markets since 1982 and currently manages approximately $36 billion in government funds within these maturity ranges. J. Thomas Madden, Executive Vice President, oversees Federated Investors' equity and high yield corporate bond management while William D. Dawson, Executive Vice President, oversees Federated Investors' domestic fixed income management. Henry A. Frantzen, Executive Vice President, oversees the management of Federated Investors' international and global portfolios. MUTUAL FUND MARKET Thirty-seven percent of American households are pursuing their financial goals through mutual funds. These investors, as well as businesses and institutions, have entrusted over $4.4 trillion to the more than 6,700 funds available.* Federated Investors, through its subsidiaries, distributes mutual funds for a variety of investment applications. Specific markets include: INSTITUTIONAL CLIENTS Federated Investors meets the needs of approximately 900 institutional clients nationwide by managing and servicing separate accounts and mutual funds for a variety of applications, including defined benefit and defined contribution programs, cash management, and asset/liability management. Institutional clients include corporations, pension funds, tax-exempt entities, foundations/endowments, insurance companies, and investment and financial advisors. The marketing effort to these institutional clients is headed by John B. Fisher, President, Institutional Sales Division. BANK MARKETING Other institutional clients include close relationships with more than 1,600 banks and trust organizations. Virtually all of the trust divisions of the top 100 bank holding companies use Federated funds in their clients' portfolios. The marketing effort to trust clients is headed by Timothy C. Pillion, Senior Vice President, Bank Marketing & Sales. BROKER/DEALERS AND BANK BROKER/DEALER SUBSIDIARIES Federated funds are available to consumers through major brokerage firms nationwide -- we have over 2,200 broker/dealer and bank broker/dealer relationships across the country -- supported by more wholesalers than any other mutual fund distributor. Federated's service to financial professionals and institutions has earned it high ratings in several surveys performed by DALBAR, Inc. DALBAR is recognized as the industry benchmark for service quality measurement. The marketing effort to these firms is headed by James F. Getz, President, Federated Securities Corp. FINANCIAL STATEMENTS The Financial Statements for the fiscal year ended February 28, 1998, are incorporated herein by reference to the Annual Report of the Fund dated February 28, 1998 (File Nos. 33-41004 and 811-6307). A copy of the Report may be obtained without charge by contacting the Fund. * Source: Investment Company Institute -----END PRIVACY-ENHANCED MESSAGE-----