-----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, PQqw/HdZllF3cRXk2AIU0yu8ls5td6IHiLwoGP/WDMACMu/F337fybBqpFMkRiAX JV2c/oR6MHK9owJCe3wjOw== 0000950130-02-000347.txt : 20020414 0000950130-02-000347.hdr.sgml : 20020414 ACCESSION NUMBER: 0000950130-02-000347 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20020125 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMITH BARNEY INTERMEDIATE MUNICIPAL FUND INC CENTRAL INDEX KEY: 0000882300 IRS NUMBER: 133643581 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 333-73414 FILM NUMBER: 02516798 BUSINESS ADDRESS: STREET 1: 1345 AVE OF THE AMERICAS CITY: NEW YORK STATE: NY ZIP: 10105 BUSINESS PHONE: 2126985344 MAIL ADDRESS: STREET 2: 388 GREENWICH ST CITY: NEW YORK STATE: NY ZIP: 10013 FORMER COMPANY: FORMER CONFORMED NAME: SMITH BARNEY INTERMEDIATE QUALITY MUNICIPAL FUND INC DATE OF NAME CHANGE: 19600201 497 1 d497.txt INTERMEDIATE MUNI FUND, INC. Filed pursuant to Rule 497(h) under Regulation C Investment Company Act File No. 811-6506 Securities Act No. 333-73414 PROSPECTUS $50,000,000 Intermediate Muni Fund, Inc. Municipal Auction Rate Cumulative Preferred Stock ("Preferred Shares") 2,000 Shares, Series M Liquidation Preference $25,000 Per Share --------------- Intermediate Muni Fund, Inc. (the Fund) is offering 2,000 shares of Municipal Auction Rate Cumulative Preferred Stock, Series M. The Fund is a diversified, closed-end management investment company. The Fund's investment objective is to provide common shareholders a high level of current income exempt from regular federal income taxes consistent with prudent investing. The Fund invests primarily in investment grade municipal debt securities issued by state and local governments, including U.S. territories and possessions, political subdivisions, agencies and public authorities (municipal obligations) with remaining effective maturities of less than 15 years. The Fund's policy is to invest, under normal market conditions, at least 80% of its total assets in municipal obligations with remaining maturities of less than 15 years. The Fund seeks to maintain a dollar-weighted average effective maturity between 3 and 10 years. Under normal market conditions, the Fund will invest at least two-thirds of its total assets in municipal obligations rated in the three highest categories by a nationally recognized statistical rating organization at the time of investment. Investment grade debt securities are those rated in one of the four highest rating categories by a nationally recognized statistical rating organization. There is no assurance that the Fund will achieve its investment objective. Investors in Preferred Shares will be entitled to receive cash dividends at an annual rate that may vary for the successive dividend periods for such Preferred Shares. The dividend rate on Preferred Shares for the period from and including the date of issue to but excluding February 5, 2002 will be 1.25% per year. For each subsequent period, the Auction Agent will determine the dividend rate for a particular period by an auction conducted on the Business Day prior to that period. The auction is usually held weekly. Investors in Preferred Shares may participate in auctions through their broker-dealers in accordance with the procedures specified in this Prospectus and in the Statement of Additional Information. The Fund may redeem Preferred Shares as described under "Description of Preferred Shares -- Redemption." --------------- Investing in Preferred Shares involves certain risks. See "Risk Factors" beginning on page 12. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. ---------------
Per Share Total ----- ----- Public Offering Price $25,000 $50,000,000 Sales Load $ 250 $ 500,000 Proceeds to Fund/(1)/ (before expenses) $24,750 $49,500,000
- -------- (1) Not including offering expenses payable by the Fund, estimated to be $200,000. The Fund and, under certain circumstances, Smith Barney Fund Management LLC have agreed to indemnify the underwriter against certain liabilities, including liabilities under the Securities Act of 1933, as amended, and the Investment Company Act of 1940, as amended. The public offering price per share will be increased by the amount of dividends, if any, that have accumulated from the date the Preferred Shares are first issued. The underwriter is offering Preferred Shares subject to certain conditions. The underwriter expects to deliver Preferred Shares to broker-dealers, in book-entry form through the Depository Trust and Clearing Corporation, on or about January 28, 2002. --------------- Salomon Smith Barney January 24, 2002 Preferred Shares are not listed on an exchange. You may only buy or sell Preferred Shares through an order placed at an auction with or through a broker-dealer that has entered into an agreement with the Auction Agent and the Fund, or in a secondary market maintained by certain broker-dealers. These broker-dealers are not required to maintain this market, and it may not provide you with liquidity. Preferred Shares will be senior to shares of the Fund's outstanding Common Stock, par value $.001 per share. The Fund's Common Stock is traded on the American Stock Exchange under the symbol "SBI." It is a condition of the closing of this offering that Preferred Shares be offered with a rating of "Aaa" from Moody's Investors Service, Inc. and "AAA" from Fitch, Inc. This Prospectus sets forth concisely the information you should know before investing, including information about risks. You should read this Prospectus before you invest and keep it for future reference. The Fund's Statement of Additional Information, dated January 24, 2002, contains additional information about the Fund and is incorporated by reference into (which means it is considered to be a part of) this Prospectus. You may obtain a free copy of the Statement of Additional Information by calling the Fund at 1-800-331-1710, or by writing to the Fund at 125 Broad Street, New York, New York 10004. A table of contents to the Statement of Additional Information is located at page 32 of this Prospectus. The Statement of Additional Information is also available, along with other Fund-related materials, on the Securities and Exchange Commission's Web site (http://www.sec.gov). --------------- You should rely only on the information contained in or incorporated by reference into this Prospectus. Neither the Fund nor the underwriter has authorized anyone to provide you with different information. If anyone provides you with different information, you should not rely on it. Neither the Fund nor the underwriter is making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this Prospectus is accurate as of any date other than the date on the front of this Prospectus. The Fund's business, financial conditions, results of operations and prospects may have changed since that date. TABLE OF CONTENTS
Page ---- Prospectus Summary............................................ 1 Financial Highlights.......................................... 5 The Fund...................................................... 6 Use of Proceeds............................................... 7 Capitalization................................................ 7 Portfolio Composition......................................... 8 The Fund's Investments........................................ 8 Risk Factors.................................................. 12 How the Fund Manages Risk..................................... 15 Management of the Fund........................................ 15 Description of Preferred Shares............................... 16 The Auction................................................... 24 Description of Common Stock................................... 27 Certain Provisions in the Charter and Bylaws.................. 27 Repurchase of Common Stock; Conversion to Open-End Fund....... 28 Tax Matters................................................... 29 Custodian, Transfer Agent, Dividend Paying Agent and Registrar 30 Underwriting.................................................. 30 Legal Opinions................................................ 31 Additional Information........................................ 31 Special Note Regarding Forward-Looking Statements............. 31 Table of Contents for the Statement of Additional Information. 32 Further Information........................................... 33 Appendix A.................................................... A-1
Until February 18, 2002 (25 days after the effective date of this Prospectus), all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a Prospectus. This is in addition to the obligation of dealers to deliver a Prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. PROSPECTUS SUMMARY The following summary is qualified in its entirety by reference to the more detailed information included elsewhere in this Prospectus, the Statement of Additional Information and the Fund's Articles Supplementary Creating and Fixing the Rights of Municipal Auction Rate Cumulative Preferred Stock (the "Articles Supplementary"). Cross references in this summary are to headings in the body of this Prospectus or the Statement of Additional Information. Capitalized terms used but not defined in this Prospectus shall have the meanings given to such terms in the Glossary appended as Appendix C to the Statement of Additional Information. The Fund................ Intermediate Muni Fund, Inc. (the "Fund") is a diversified, closed-end management investment company. The Fund's principal office is located at 125 Broad Street, New York, New York 10004 and its telephone number is 1-800-331-1710. See "The Fund." The Fund's outstanding shares of common stock, par value $.001 per share (the "Common Stock"), are listed on the American Stock Exchange under the symbol "SBI." See "Description of Common Stock." As of December 31, 2001, the Fund had 14,004,750 shares of Common Stock outstanding and net assets of $142,865,649. Investment Objective and Investment Strategies............ The Fund's investment objective is to provide common shareholders a high level of current income exempt from regular federal income taxes consistent with prudent investing. This income, if any, will be distributed to common shareholders after the satisfaction of the obligation to pay dividends on Preferred Shares. The Fund seeks to achieve its objective by investing primarily in investment grade municipal debt securities issued by state and local governments, including U.S. territories and possessions, political subdivisions, agencies and public authorities (municipal obligations) with remaining effective maturities of less than 15 years. The Fund's policy is to invest, under normal market conditions, at least 80% of its total assets in municipal obligations with remaining maturities of less than 15 years. This is a fundamental policy of the Fund and cannot be changed without shareholder approval. The Fund seeks to maintain a dollar-weighted average effective maturity between 3 and 10 years. Under normal market conditions, the Fund will invest at least two-thirds of its total assets in municipal obligations rated in the three highest rating categories by a nationally recognized statistical rating organization ("NRSRO") at the time of investment. Investment grade debt securities are those rated in one of the four highest rating categories by a NRSRO. There is no assurance that the Fund will achieve its investment objective. See "The Fund's Investments." The Fund's investments are subject to diversification, liquidity and related guidelines established in connection with the Fund's receipt from Moody's Investors Service, Inc. ("Moody's") and Fitch, Inc. ("Fitch") of ratings of "Aaa" and "AAA", respectively, for Preferred Shares. Ratings issued by NRSROs, including Moody's and Fitch, do not eliminate or mitigate the risk of investing in the Fund's securities. 1 Investment Manager...... Smith Barney Fund Management LLC (formerly known as SSB Citi Fund Management LLC) ("Smith Barney" or the "Manager") serves as the Fund's investment manager. Smith Barney also serves as the Fund's administrator. Smith Barney selects and manages the Fund's investments in accordance with the Fund's investment objective and policies. The Fund pays Smith Barney for the services it provides to the Fund a monthly fee equal on an annual basis to 0.60 of 1% of the Fund's average daily total net assets. For purposes of calculating the management fee, the liquidation value of any outstanding preferred stock of the Fund is not deducted in determining the Fund's average daily total net assets. Smith Barney is a wholly-owned subsidiary of Citigroup Inc. See "Management of the Fund" and "Underwriting." The Offering............ The Fund is offering 2,000 shares of Municipal Auction Rate Cumulative Preferred Stock, Series M, at a purchase price of $25,000 per share plus dividends, if any, that have accumulated from the date the Fund first issues the shares. Preferred Shares are being offered by Salomon Smith Barney Inc. as the underwriter (the "Underwriter"). Salomon Smith Barney Inc. is an affiliate of the Manager and a wholly-owned subsidiary of Citigroup Inc. See "Underwriting." Risk Factors Summary.... Risk is inherent in all investing. Therefore, before investing in Preferred Shares, you should consider carefully certain risks. The primary risks of investing in Preferred Shares are: . if an auction fails you may not be able to sell some or all of your shares; . because of the nature of the market for Preferred Shares, you may receive less than the price you paid for your shares if you sell them outside of the auction, especially when market interest rates are rising; . a rating agency could downgrade the rating assigned to Preferred Shares, which could affect liquidity; . the Fund may be forced to redeem your shares to meet regulatory or rating agency requirements or may voluntarily redeem your shares in certain circumstances; . in extraordinary circumstances, the Fund may not earn sufficient income from its investments to pay dividends on Preferred Shares; . if the Fund redeems your Preferred Shares, you may not be able to find as good a yield on an investment with similar terms and quality; . if long-term interest rates rise or if the value of the Fund's investment portfolio declines for other reasons, the asset coverage for Preferred Shares will be reduced; and . if an issuer of a municipal bond in which the Fund invests is downgraded or defaults, there may be a negative impact on the income and/or net asset value of the Fund's portfolio. For additional general risks of investing in the Fund and Preferred Shares, see "Risk Factors" below. Trading Market.......... Preferred Shares are not listed on an exchange. Instead, you may buy or sell Preferred Shares at an auction that normally is held weekly by submitting orders to a broker-dealer that has entered into an agreement with the Auction Agent and the Fund (a "Broker-Dealer"), or to a broker-dealer that has entered into a separate agreement with a Broker-Dealer. 2 In addition to the auctions, Broker-Dealers and other broker-dealers may maintain a secondary trading market in Preferred Shares outside of auctions, but are not obligated to do so, and may discontinue such activity at any time. There is no assurance that a secondary market will provide shareholders with liquidity. You may transfer shares outside of auctions only to or through a Broker-Dealer, or a broker-dealer that has entered into a separate agreement with a Broker-Dealer. The first auction date for Preferred Shares will be Monday, February 4, 2002, the Business Day before the Dividend Payment Date for the Initial Rate Period for Preferred Shares. The auction date for Preferred Shares will be a Business Day, normally a Monday, and the start date for Subsequent Rate Periods normally will be the following Business Day, typically a Tuesday, unless the then-current Rate Period is a Special Rate Period, or the day that normally would be the auction date or the first day of the Subsequent Rate Period is not a Business Day. Dividends and Rate Periods............... The dividend rate for the Initial Rate Period of Preferred Shares offered in this Prospectus is 1.25% per year. For Subsequent Rate Periods, Preferred Shares will pay dividends based on a rate set at Auction, normally held weekly. In most instances dividends are also paid weekly, on the first Business Day following the end of the Rate Period. The rate set at Auction will not exceed the Maximum Rate. See "Description of Preferred Shares -- Dividends and Dividend Periods -- General." The date from which dividends on Preferred Shares will accumulate at the initial rate is Monday, January 28, 2002. The Dividend Payment Date for the Initial Rate Period will be Tuesday, February 5, 2002 and the day on which dividends will normally be paid is a Tuesday; provided, however, that if the Tuesday on which dividends would otherwise be payable is not a Business Day, then dividends will be paid on the first Business Day that falls after such Tuesday. The number of days of the Initial Rate Period for Preferred Shares is days. Subsequent Rate Periods generally will be seven days. The dividend payment date for Special Rate Periods of more than 28 days will be set out in a notice to holders of Preferred Shares designating a Special Rate Period. See "Description of Preferred Shares -- Dividends and Dividend Periods -- Designation of Special Rate Periods." Taxation................ Because under normal circumstances the Fund will invest substantially all of its assets in municipal obligations that pay interest which is exempt from regular federal income taxes, the dividends paid on Preferred Shares will ordinarily be similarly exempt. However, dividends paid on Preferred Shares may be subject to state and local taxes. All or a portion of the interest paid on the municipal obligations held by the Fund will be subject to the federal alternative minimum tax ("AMT"), with the result that all or a portion of the dividends paid on Preferred Shares will also be subject to 3 such tax. Preferred Shares thus may not be a suitable investment if you are subject to this tax or would become subject to such tax by investing in Preferred Shares. Taxable income or gain earned by the Fund will be allocated proportionately to holders of Preferred Shares and shares of Common Stock, based on the percentage of total dividends paid to each class for that year. Accordingly, certain specified Preferred Shares dividends may be subject to regular federal income tax. The Fund intends to notify holders of Preferred Shares, before any applicable Auction for a Rate Period of 28 days or less, of the amount of any taxable income and gain for regular federal income tax purposes to be paid as dividends on Preferred Shares for the period relating to that Auction. For longer periods, the Fund may notify holders of Preferred Shares of such amount. In certain circumstances, the Fund will make holders of Preferred Shares whole for taxes owing on dividends paid to holders of Preferred Shares that include taxable income and gain. See "Tax Matters." Ratings................. It is a condition of the closing of the offering described in this Prospectus that Preferred Shares be issued with a rating of "Aaa" from Moody's and "AAA" from Fitch. Because the Fund is required to maintain at least one of these ratings, it must own portfolio securities of a sufficient value and with adequate credit quality to meet the rating agencies' guidelines. See "Description of Preferred Shares -- Rating Agency Guidelines and Asset Coverage." Redemption.............. The Fund will not ordinarily redeem Preferred Shares. However, it may be required to redeem shares if, for example, the Fund does not meet an asset coverage ratio required by law or correct a failure to meet a rating agency guideline in a timely manner. The Fund voluntarily may redeem Preferred Shares under certain conditions. See "Description of Preferred Shares --Redemption" and "Description of Preferred Shares -- Rating Agency Guidelines and Asset Coverage." Liquidation Preference.. The liquidation preference of each Preferred Share will be $25,000 plus any accumulated but unpaid dividends to the date of distribution, if any, whether or not earned or declared. See "Description of Preferred Shares -- Liquidation." Voting Rights........... The holders of Preferred Shares, voting as a separate class, have the right to elect at least two directors at all times and to elect a majority of the directors in the event two years' dividends on Preferred Shares are unpaid. In each case, the remaining directors will be elected by holders of shares of Common Stock and holders of Preferred Shares, voting together as a single class. The holders of Preferred Shares will vote as a separate class or classes on certain other matters as required under the Articles of Incorporation (which, as hereafter amended, restated or supplemented from time to time, is together with the Articles Supplementary referred to as the "Charter"), the Investment Company Act of 1940, as amended (the "1940 Act") and Maryland law. See "Description of Preferred Shares --Voting Rights" and "Certain Provisions in the Charter and Bylaws." 4 FINANCIAL HIGHLIGHTS The tables below set forth selected financial information for an outstanding share of Common Stock throughout each period presented. The financial highlights for each year presented have been audited by KPMG LLP, the Fund's independent auditors, whose report covering each of the five years during the period ended December 31, 2000 is included in the Fund's December 31, 2000 Annual Report and incorporated by reference into the Fund's Statement of Additional Information. The Fund's unaudited financial statements in its June 30, 2001 Semi-Annual Report are also incorporated by reference in the Statement of Additional Information. The financial highlights should be read in conjunction with the financial statements and notes thereto included in the Fund's December 31, 2000 Annual Report and the June 30, 2001 Semi-Annual Report, which are available without charge by calling the Fund at 1-800-331-1710. Per Common Share Operating Performance Throughout Each Period/(1) /
Six Months Ended Year Ended December 31, (unless otherwise noted) June 30, --------------------------------------------------------------------- 2001 2000 1999 1998 1997 1996 1995 1994/(3)/ 1993/(3)/ ----------- ------ ------- ------ ------ ------ ------ -------- -------- (unaudited) Net Asset Value, Beginning of Period......................... $10.20 $ 9.89 $ 10.61 $10.64 $10.47 $10.66 $ 9.95 $10.81 $10.36 ------ ------ ------- ------ ------ ------ ------ ------ ------ Income (Loss) from Operations: Net Investment Income......... 0.28 0.55 0.53 0.55 0.57 0.58 0.58 0.58 0.59 Net Realized and Unrealized Gain (Loss) on Securities.... 0.06 0.28 (0.71) 0.01 0.28 (0.17) 0.73 (0.84) 0.46 ------ ------ ------- ------ ------ ------ ------ ------ ------ Total Income (Loss) from Investment Operations....... 0.34 0.83 (0.18) 0.56 0.85 0.41 1.31 (0.26) 1.05 ------ ------ ------- ------ ------ ------ ------ ------ ------ Gains from Repurchase of Treasury Stock................. -- 0.02 -- -- -- -- -- -- -- ------ ------ ------- ------ ------ ------ ------ ------ ------ Less Distributions from: Net Investment Income......... (0.28) (0.54) (0.53) (0.55) (0.57) (0.60) (0.60) (0.60) (0.57) In excess of Net Investment Income....................... -- -- -- -- (0.01) -- -- -- -- Net Realized Gains............ -- -- (0.01) (0.04) (0.10) -- -- -- (0.03) ------ ------ ------- ------ ------ ------ ------ ------ ------ Total Distributions.......... (0.28) (0.54) (0.54) (0.59) (0.68) (0.60) (0.60) (0.60) (0.60) ------ ------ ------- ------ ------ ------ ------ ------ ------ Net Asset Value, End of Period...................... $10.26 $10.20 $ 9.89 $10.61 $10.64 $10.47 $10.66 $ 9.95 $10.81 ====== ====== ======= ====== ====== ====== ====== ====== ====== Market Value, End of Period..... $ 9.58 $ 8.81 $ 8.38 $10.69 $10.56 $ 9.94 $10.38 $ 9.50 $11.13 Total Return, Based on Market Value/(2)/..................... 11.90%/(5)/ 11.90% (17.10)% 7.05% 13.42% 1.56% 15.93% (9.34)% 16.71% Total Return, Based on Net Asset Value/(2)/..................... 3.54%/(5)/ 9.68% (1.39)% 5.50% 8.49% 4.13% 13.72% (2.33)% 10.30%
1992/(3)(4)/ ----------- Net Asset Value, Beginning of Period......................... $10.00 ------ Income (Loss) from Operations: Net Investment Income......... 0.48/(6)/ Net Realized and Unrealized Gain (Loss) on Securities.... 0.34 ------ Total Income (Loss) from Investment Operations....... 0.82 ------ Gains from Repurchase of Treasury Stock................. -- ------ Less Distributions from: Net Investment Income......... (0.46) In excess of Net Investment Income....................... -- Net Realized Gains............ -- ------ Total Distributions.......... (0.46) ------ Net Asset Value, End of Period...................... $10.36 ====== Market Value, End of Period..... $10.13 Total Return, Based on Market Value/(2)/..................... 1.66%/(5)/ Total Return, Based on Net Asset Value/(2)/..................... 8.44%/(5)/
- -------- (1) Shearson Lehman Advisors, the Fund's previous investment adviser, was acquired by Mutual Management Corp., or MMC, a wholly-owned subsidiary of The Travelers Inc., in 1993. On February 23, 1999 the Board of Directors of MMC voted to change its name to SSBC Fund Management Inc. ("SSBC"). On September 21, 1999 SSBC converted to a limited liability company and changed its name to SSB Citi Fund Management LLC ("SSB Citi"). On April 3, 2001, SSB Citi changed its name to Smith Barney Fund Management LLC. (2) The total return calculation assumes that dividends are reinvested in accordance with the Fund's dividend reinvestment plan. (3) Based on the monthly average shares outstanding for period. (4) For the period from March 2, 1992 (commencement of operations) to December 31, 1992. (5) Total return is not annualized, as it may not be representative of the total return for the year. (6) The Manager waived a portion of its fees for the period from March 2, 1992 to December 31, 1992. If such fees were not waived, the per share decrease in net investment income would have been $0.01, and the ratio of expenses to average net assets would have been 0.70% (annualized). 5 Ratios/Supplemental Data
Six Months Ended Year Ended December 31, (unless otherwise noted) June 30, ---------------------------------------------------------------- 2001 2000/(1)/ 1999 1998 1997 1996 1995 1994 1993 1992/(4)/ ----------- -------- ----- ----- ----- ----- ----- ----- ----- -------- (unaudited) Net assets, end of period (in millions)........................ $ 144 $ 143 $ 83 $ 89 $ 89 $ 87 $ 88 $ 82 $ 89 $ 83 Ratio of Expenses to Average Net Assets........................... 0.74%/(3)/ 0.78% 0.77% 0.76% 0.74% 0.77% 0.72% 0.72% 0.73% 0.59%/(2)(3)/ Ratio of Net Income to Average Net Assets........................... 5.49%/(3)/ 5.47% 5.17% 5.10% 5.42% 5.56% 5.63% 5.64% 5.56% 5.74%/(3)/ Supplemental Data: Portfolio Turnover Rate.................... 17% 45% 54% 42% 58% 21% 13% 26% 10% 23%
- -------- (1) During the fiscal year ended December 31, 2000, the Fund acquired the assets of Smith Barney Municipal Fund, Inc. (2) The Manager waived a portion of its fees for the period from March 2, 1992 to December 31, 1992. If such fees were not waived, the per share decrease in net investment income would have been $0.01, and the ratio of expenses to average net assets would have been 0.70% (annualized). (3) Annualized. (4) For the period from March 2, 1992 (commencement of operations) to December 31, 1992. THE FUND Intermediate Muni Fund, Inc. is a diversified, closed-end management investment company registered under the 1940 Act. The Fund was incorporated under the laws of the State of Maryland on December 19, 1991 pursuant to Articles of Incorporation (the "Articles") under the name "Smith Barney Intermediate Quality Municipal Fund, Inc." On December 27, 1991, the Fund changed its name to "Smith Barney Intermediate Municipal Fund, Inc." and on December 26, 2000 the Fund changed its name to "Intermediate Muni Fund, Inc." On March 2, 1992, the Fund commenced its operations. The Fund's Common Stock is traded on the American Stock Exchange (the "Exchange") under the symbol "SBI." The Fund's principal office is located at 125 Broad Street, New York, New York 10004, and its telephone number is 1-800-331-1710. The following provides information about the Fund's outstanding shares as of December 31, 2001:
Amount Held by the Fund or Amount Title of Class Amount Authorized for its Account Outstanding - -------------- ----------------- --------------- ----------- Common....................... 100,000,000* 0 14,004,750 Preferred Shares............. 0 0 0
- -------- * A total of 100,000,000 shares of capital stock of the Fund are authorized under the Articles, all originally designated Common Stock pursuant to the Articles. The Board of Directors of the Fund (the "Board") may classify or reclassify any unissued shares of capital stock from time to time without a shareholder vote into one or more classes of preferred or other stock by setting or changing the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications or terms or conditions of redemption of such shares of stock. The Board has reclassified 2,000 shares of Common Stock as Municipal Auction Rate Cumulative Preferred Stock, Series M, or Preferred Shares, and has authorized the issuance of Preferred Shares. 6 USE OF PROCEEDS The net proceeds of this offering will be approximately $49,300,000 after payment of the sales load and estimated offering costs. The Fund will invest the net proceeds of the offering in accordance with the Fund's investment objective and policies as stated below. It is presently anticipated that the Fund will be able to invest substantially all of the net proceeds in municipal obligations that meet those investment objective and policies at or shortly (within three months) after the completion of the offering. Pending such investment, it is anticipated that the proceeds will be invested in short-term, tax-exempt securities. CAPITALIZATION The following table sets forth the unaudited capitalization of the Fund as of December 31, 2001, and as adjusted to give effect to the issuance of Preferred Shares offered by this Prospectus.
Actual As Adjusted ------------ ------------ (Unaudited) Shareholders' Equity: Municipal Auction Rate Cumulative Preferred Stock, Series M, $25,000 per share liquidation preference; 2,000 shares authorized (no shares issued and 2,000 shares issued, as adjusted, respectively)........................ $ 0 $ 50,000,000 Common Stock, $.001 par value per share; 100,000,000 shares authorized* (14,004,750 shares outstanding, and 14,004,750 shares outstanding as adjusted)**......................... 14,005 14,005 Capital in excess of par value***........................... 142,012,528 141,312,528 Balance of undistributed net investment income.............. (16,296) (16,296) Accumulated net realized gain (loss) from investment transactions.............................................. (2,520,393) (2,520,393) Net unrealized appreciation (depreciation) of investments... 3,375,805 3,375,805 ------------ ------------ Total Net Assets............................................ 142,865,649 192,165,649 Less liquidation value of Preferred Shares.................. -- (50,000,000) ------------ ------------ Net assets attributable to Common Stock outstanding......... $142,865,649 $142,165,649 ============ ============
- -------- * A total of 100,000,000 shares of capital stock of the Fund are authorized under the Articles, all originally designated Common Stock pursuant to the Articles. The Board may classify or reclassify any unissued shares of capital stock from time to time without a shareholder vote into one or more classes of preferred or other stock by setting or changing the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications or terms or conditions of redemption of such shares of stock. The Board has reclassified 2,000 shares of Common Stock as Municipal Auction Rate Cumulative Preferred Stock, Series M, or Preferred Shares, and has authorized the issuance of Preferred Shares. ** None of these outstanding shares are held by or for the account of the Fund as of December 31, 2001. *** As adjusted capital in excess of par value reflects a reduction for the sales load and estimated offering costs of the Preferred Shares issuance ($700,000). 7 PORTFOLIO COMPOSITION As of December 31, 2001, 49.8% of the market value of the Fund's portfolio was invested in long-term municipal obligations, 48.5% in intermediate-term municipal obligations and 1.7% in short-term municipal obligations. The following table sets forth certain information with respect to the composition of the Fund's investment portfolio as of December 31, 2001. This information reflects the average composition of the Fund's assets as of December 31, 2001, and is not necessarily representative of the Fund as of the current fiscal year or at any time in the future.
Credit Rating Value Percent - ------------- ------------ ------- Aaa/AAA*.... $ 42,801,460 29.7% Aa/AA....... 21,881,970 15.2% A/A......... 29,924,558 20.7% Baa/BBB..... 25,511,659 17.7% Other....... 21,573,779 15.0% Short-term.. 2,500,000 1.7% ------------ ----- Total...... $144,193,426 100.0% ============ =====
- -------- * Includes securities that are backed by an escrow or trust containing sufficient U.S. Government securities or U.S. Government agency securities to ensure the timely payment of principal and interest. THE FUND'S INVESTMENTS Investment Objective and Policies The Fund's investment objective is to provide common shareholders a high level of current income exempt from regular federal income taxes consistent with prudent investing. This income, if any, will be distributed to common shareholders after the satisfaction of the obligation to pay dividends on Preferred Shares. The Fund may not achieve its investment objective. The Fund's investment objective may be changed only with the approval of a majority of the Fund's outstanding voting securities. As defined in the 1940 Act, "majority" means the lesser of (i) more than 50% of the Fund's outstanding common stock and of any outstanding shares of preferred stock, voting by class, and (ii) 67% of the Fund's outstanding common stock and of any outstanding shares of preferred stock, voting by class, present at a meeting at which holders of more than 50% of the outstanding shares of each such class are present in person or by proxy. All other investment policies or practices, unless otherwise stated, are considered by the Fund not to be fundamental and, accordingly, may be changed without shareholder approval. The Fund invests primarily in investment grade municipal debt securities issued by state and local governments including U.S. territories and possessions, political subdivisions, agencies and public authorities (municipal obligations) with remaining effective maturities of less than 15 years. The Fund's policy is to invest, under normal market conditions, at least 80% of its total assets in municipal obligations with remaining maturities of less than 15 years. This is a fundamental policy of the Fund and may not be changed without shareholder approval. The Fund seeks to maintain a dollar-weighted average effective maturity between 3 and 10 years. Under normal market conditions, the Fund will invest at least two-thirds of its total assets in municipal obligations rated, at the time of investment, (i) "A" or better by Standard & Poor's Rating Agency ("S&P") or by Moody's or (ii) within the three highest categories by an NRSRO (or, if unrated, deemed by the Manager to be of comparable quality). Investment grade debt securities are those rated "BBB" or higher by S&P, "Baa" or higher by Moody's or within one of the four highest rating categories by an NRSRO. The Fund will not invest in any municipal obligations that are rated lower than "BBB" by S&P or "Baa" by Moody's if they are not otherwise rated investment grade by another NRSRO. 8 Municipal obligations may have all types of interest rate payment and reset terms, including fixed rate, floating and variable rate, zero coupon, payment in kind and auction rate features. Securities rated "BBB" by S&P are regarded by S&P as having an adequate capacity to pay interest and repay principal; whereas such securities normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. Securities rated "Baa" by Moody's are regarded by Moody's as being medium grade obligations; they are neither highly protected nor poorly secured. Although interest payments and principal payments for these securities appear adequate for the present, they may lack certain protective elements or may be characteristically unreliable over any great length of time. They also may lack outstanding investment characteristics and may have speculative characteristics. The Fund may be more dependent upon the Manager's investment analysis of unrated municipal obligations than is the case with rated municipal obligations. Municipal Obligations Municipal obligations are obligations issued by or on behalf of states, territories and possessions of the United States and the District of Columbia and their political subdivisions, agencies and instrumentalities, the interest on which, in the opinion of bond counsel or other counsel to the issuer of such securities is, at the time of issuance, not includable in gross income for federal income tax purposes. Under normal market conditions, at least 80% of the Fund's total assets will be invested in municipal obligations with remaining maturities of less than fifteen years. This policy is fundamental and cannot be changed without shareholder approval. The Fund has not established any limit on the percentage of its portfolio that may be invested in municipal obligations subject to the alternative minimum tax provisions of federal tax law, and a substantial portion of the dividends paid on Preferred Shares may thus be subject to the AMT. Preferred Shares may not be a suitable investment for investors who are already subject to the AMT or who would become subject to the AMT as a result of an investment in Preferred Shares. See "Tax Matters." The two principal classifications of municipal bonds are "general obligation" bonds and "revenue" or "special obligation" bonds, which include "industrial revenue bonds." General obligation bonds are secured by the issuer's pledge of its faith, credit and taxing power for the payment of principal and interest, and, accordingly, the capacity of the issuer of a general obligation bond as to the timely payment of interest and the repayment of principal when due is affected by the issuer's maintenance of its tax base. Revenue or special obligation bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special tax or other specific revenue source such as from the user of the facility being financed; accordingly, the timely payment of interest and the repayment of principal in accordance with the terms of the revenue or special obligation bond is a function of the economic viability of such facility or such revenue source. Although the ratings of NRSROs of the municipal obligations in the Fund's portfolio are relative and subjective, and are not absolute standards of quality, such ratings reflect the assessment of the NRSROs of the issuer's ability, or the economic viability of the special revenue source, with respect to the timely payment of interest and the repayment of principal in accordance with the terms of the obligation. See Appendix A to the Statement of Additional Information. Municipal obligations may have fixed or variable interest rates. The Fund may purchase floating and variable rate demand notes, which are municipal obligations normally having a stated maturity in excess of one year, but which permit the holder to tender the notes for purchase at the principal amount thereof. The interest rate on a floating rate demand note is based on a known lending rate, such as a bank's prime rate, and is adjusted each time such rate is adjusted. The interest rate on a variable rate demand note is adjusted at specified intervals. There generally is no secondary market for these notes, although they may be tendered for redemption or remarketing at face value and thus may be determined to be liquid. See "Investment Policies and Techniques" in 9 the Statement of Additional Information. Each such note purchased by the Fund will meet the criteria established for the purchase of municipal obligations. The Fund may invest in unrated "non-appropriation" lease obligations or installment purchase contract obligations of municipal authorities or entities believed by the Manager to be of comparable quality to securities that are rated investment grade. There is no limitation on the percentage of the Fund's assets that may be invested in these lease obligations. A lease obligation is backed by the municipality's promise to make the payments due under the lease obligation. Lease obligations containing "non-appropriation" clauses provide that the municipality has no obligation to make lease installment purchase payments in future years unless money is appropriated for such purpose on a yearly basis. The Fund may invest in zero coupon bonds. A zero coupon bond pays no interest in cash to its holder during its life, although interest is accrued during that period. Its value to an investor consists of the difference between its face value at the time of maturity and the price at which it was issued, which is generally an amount significantly less than its face value (sometimes referred to as a "deep discount" price). The Fund may also engage in interest rate and other hedging and risk management transactions; purchase and sell options (including swaps, caps, floors and collars) on municipal obligations and on indices based on municipal obligations; and purchase and sell municipal obligations on a "when-issued" or "delayed delivery" basis. In general, the Fund may purchase and sell (or write) options on up to 20% of its assets. The Securities and Exchange Commission (the "Commission") requires that obligations of investment companies such as the Fund, in connection with options sold, must comply with certain segregation or cover requirements which are more fully described in the Statement of Additional Information. The Fund may engage in these transactions both for speculative purposes and as a means to hedge risk. The Fund may also engage, to a limited extent, in financial futures contracts and related options contracts for hedging purposes. The Fund may also hold securities or use investment techniques that provide for payments based on or "derived" from the performance of an underlying asset, index or other economic benchmark. Although the Manager believes that these investment practices may further the Fund's investment objective, no assurance can be given that these investment practices will achieve this result. See the Statement of Additional Information for a further description of these investment practices. Selection of Investments The Manager selects securities for the Fund's portfolio which the Manager believes entail reasonable credit risk considered in relation to the particular investment policies of the Fund. As a result, the Fund does not necessarily invest in the highest yielding municipal obligations permitted by its investment policies if the Manager determines that market risks or credit risks associated with such investments would subject the Fund's portfolio to excessive risk. The potential for realization of capital gains resulting from possible changes in interest rates is not a major consideration. The Fund's policy is to invest at least 80% of its total assets in municipal obligations with remaining maturities of less than fifteen years. For this purpose, any scheduled principal prepayments on municipal obligations are reflected in the calculation of dollar-weighted average effective maturity. The Manager may adjust the average effective maturity of the Fund's portfolio from time to time, depending on its assessment of the relative yields available on securities of different maturities and its expectations of future changes in interest rates. The Fund generally does not invest more than 25% of its total assets in any industry, nor does the Fund invest more than 5% of its total assets in the securities of any single issuer. Governmental issuers of municipal obligations are not considered part of any "industry". However, municipal obligations backed only by the assets and revenues of nongovernmental users may for this purpose be deemed to be issued by such nongovernmental users, and the 25% limitation would apply to the industries of such nongovernmental users. It is nonetheless possible that the Fund may invest more than 25% of its total assets in a broader segment of the municipal obligations market, such as hospital and other health care facilities obligations, housing agency revenue obligations, and airport revenue obligations. The Fund will invest more than 25% of its assets in such types of 10 municipal obligations if the Manager determines that the yields available from such obligations in a particular segment justify the additional risks associated with a large investment in that segment. Although these obligations could be supported by the credit of governmental users, or by the credit of nongovernmental users engaged in a number of industries, economic, business, political and other developments generally affecting the revenues of such users (for example, proposed legislation or pending court decisions affecting the financing of such projects and market factors affecting the demand for their services or products) may have a general adverse effect on all such municipal obligations in such a market segment. The Fund may invest more than 25% of its assets in industrial development bonds or in issuers located in the same state. If the Fund were to invest more than 25% of its total assets in issuers located in the same state, it would be more susceptible to adverse economic, business, or regulatory conditions in that state. From time to time, the Fund may invest in securities of a municipal issuer, most or all of which is held by the Fund, by itself or together with other funds or accounts managed by the Manager. Because there may be relatively few potential purchasers for such investments and, in some cases, there may be contractual restrictions on resales, the Fund may find it more difficult to sell such securities at a time when the Manager believes it is advisable to do so. Temporary Defensive Strategies When the Manager believes a temporary defensive posture in the market is warranted (e.g., times when, in the Manager's opinion, temporary imbalances of supply and demand or other temporary dislocations in the municipal obligations market adversely affect the price at which municipal obligations are available), and in order to keep cash on hand fully invested, the Fund may temporarily invest to a substantial degree in high-quality, short-term municipal obligations. If these high-quality, short-term municipal obligations are not available or, in the Manager's judgment, do not afford sufficient protection against adverse market conditions, the Fund may invest in the following taxable securities: obligations of the U.S. Government, its agencies or instrumentalities; other debt securities rated within the four highest categories by an NRSRO; commercial paper rated in the highest category by an NRSRO; certificates of deposit, time deposits and bankers' acceptances; or repurchase agreements with respect to any of the foregoing investments or any other fixed-income securities that the Manager considers consistent with such strategy. To the extent the Fund invests in taxable securities, the Fund will not at such times be able to achieve its investment objective of income exempt from regular federal income taxes. "When-Issued" and "Delayed Delivery" Securities The Fund may purchase municipal obligations on a "when-issued" and "delayed delivery" basis. No income accrues to the Fund on municipal obligations in connection with such transactions prior to the date the Fund actually takes delivery of such securities. These transactions are subject to market fluctuations; the value of the municipal obligations at delivery may be more or less than their purchase price, and yields generally available on municipal obligations when delivery occurs may be higher than yields on the municipal obligations obtained pursuant to such transactions. Because the Fund relies on the buyer or seller, as the case may be, to consummate the transaction, failure by the other party to complete the transaction may result in the Fund missing the opportunity of obtaining a price or yield considered to be advantageous. When the Fund is the buyer in such a transaction, however, it will maintain, in a segregated account, cash or liquid securities having a value equal to or greater than the Fund's purchase commitments, provided such securities have been determined by the Manager to be liquid and unencumbered, and are marked to market daily, pursuant to guidelines established by the Board. The Fund will make commitments to purchase municipal obligations on such basis only with the intention of actually acquiring these securities, but the Fund may sell such securities prior to the settlement date if such sale is considered to be advisable. To the extent that the Fund engages in "when-issued" and "delayed delivery" transactions, it will do so for the purpose of acquiring securities for the Fund's portfolio consistent with the Fund's investment objective and policies. However, although the Fund does not intend to engage in such transactions for speculative purposes, 11 purchases of securities on such basis may involve more risk than other types of purchases. For example, if the Fund determines it is necessary to sell the "when-issued" or "delayed delivery" securities before delivery, it may realize a gain or incur a loss because of market fluctuations since the time the commitment to purchase such securities was made. Subject to the requirement of maintaining a segregated account, no specified limitation exists as to the percentage of the Fund's assets which may be used to acquire securities on a "when-issued" or "delayed delivery" basis. A significant percentage of the Fund's assets committed to the purchase of securities on a "when-issued" and/or "delayed delivery" basis may increase the volatility of the Fund's net asset value and may limit the flexibility to manage the Fund's investments. See the Statement of Additional Information for a more detailed discussion of the Fund's investment practices. RISK FACTORS Risk is inherent in all investing. Investing in any investment company security involves risk, including the risk that you may receive little or no return on your investment or even that you may lose part or all of your investment. Therefore, before investing you should consider carefully the following risks that you assume when you invest in Preferred Shares. Interest Rate Risk Pursuant to this Prospectus, the Fund will issue Preferred Shares, which pay dividends based on short-term interest rates, and intends to use the proceeds to buy municipal obligations which pay interest based on long-term yields. Long-term municipal obligation yields are typically, although not always, higher than short-term interest rates. Both long-term and short-term interest rates may fluctuate. If short-term interest rates rise, Preferred Shares dividend rates may rise so that the amount of dividends paid to holders of Preferred Shares exceeds the income from the portfolio securities purchased with the proceeds from the sale of Preferred Shares. Because income from the Fund's entire investment portfolio (not just the portion of the portfolio purchased with the proceeds of the Preferred Shares offering) is available to pay Preferred Shares dividends, however, Preferred Shares dividend rates would need to greatly exceed the Fund's net portfolio income before the Fund's ability to pay Preferred Shares dividends would be jeopardized. If long-term interest rates rise, the value of the Fund's investment portfolio will decline, reducing the amount of assets serving as asset coverage for Preferred Shares. Auction Risk You may not be able to sell your Preferred Shares at an Auction if the Auction fails; that is, if there are more Preferred Shares offered for sale than there are buyers for those shares. Also, if you place hold orders (orders to retain Preferred Shares) at an Auction only at a specified rate, and that bid rate exceeds the rate set at the Auction, you will not retain your Preferred Shares. Additionally, if you buy shares or elect to retain shares without specifying a rate below which you would not wish to continue to hold those shares, and the Auction sets a below-market rate, you may receive a lower rate of return on your shares than the market rate. Finally, the Dividend Period may be changed, subject to certain conditions and with notice to the holders of Preferred Shares, which could affect the liquidity of your investment. See "Description of Preferred Shares" and "The Auction -- Auction Procedures." Secondary Market Risk If you try to sell your Preferred Shares between Auctions, you may not be able to sell any or all of your shares, or you may not be able to sell them for $25,000 per share or $25,000 per share plus accumulated dividends. If the Fund has designated a Special Rate Period (a Rate Period of more than seven days), changes in 12 interest rates could affect the price you would receive if you sold your shares in the secondary market. Broker-dealers that maintain a secondary trading market for Preferred Shares are not required to maintain this market, and the Fund is not required to redeem shares either if an Auction or an attempted secondary market sale fails because of a lack of buyers. Preferred Shares are not registered on a stock exchange or the Nasdaq stock market. If you sell your Preferred Shares to a broker-dealer between Auctions, you may receive less than the price you paid for them, especially when market interest rates have risen since the last Auction. Investors who purchase Preferred Shares in an Auction for a Special Rate Period should note that because the dividend will be fixed for a longer period, the value of Preferred Shares may fluctuate in response to changes in interest rates, and may be more or less than their original cost if sold on the open market in advance of the next Auction. Accrued Preferred Share dividends, however, should at least partially compensate for the increased market interest rates. Ratings and Asset Coverage Risk While Moody's and Fitch assign ratings of "Aaa" or "AAA", respectively, to Preferred Shares, the ratings do not eliminate or necessarily mitigate the risks of investing in Preferred Shares. A rating agency could downgrade the Preferred Shares rating which may make your shares less liquid at an Auction or in the secondary market, though probably with higher resulting dividend rates. If a rating agency downgrades the rating of Preferred Shares, the Fund will alter its portfolio or redeem Preferred Shares. The Fund may voluntarily redeem Preferred Shares under certain circumstances. See "Description of Preferred Shares -- Rating Agency Guidelines and Asset Coverage" for a description of the asset maintenance tests the Fund must meet. Inflation Risk Inflation is the reduction in the purchasing power of money resulting from the increase in the price of goods and services. Inflation risk is the risk that the inflation-adjusted (or "real") value of your Preferred Shares investment or the income from that investment will be worth less in the future. As inflation occurs, the real value of Preferred Shares and distributions declines. In an inflationary period, however, it is expected that, through the auction process, Preferred Shares dividend rates would increase, tending to offset this risk. Credit Risk Credit risk is the risk that an issuer of a municipal bond will become unable to meet its obligation to make interest and principal payments. In general, lower rated municipal obligations carry a greater degree of credit risk. If rating agencies lower their ratings of municipal obligations in the Fund's portfolio, the value of those obligations could decline, which could jeopardize the rating agencies' ratings of Preferred Shares. In addition, the underlying revenue source for a municipal obligation other than a general obligation bond may be insufficient to pay principal or interest in a timely manner. Because the primary source of income for the Fund is the interest and principal payments on the municipal obligations in which it invests, any default by an issuer of a municipal obligation could have a negative impact on the Fund's ability to pay dividends on Preferred Shares and could result in the redemption of some or all Preferred Shares. This risk of default may be greater for private activity bonds or other municipal obligations whose payments are dependent upon a specific source of revenue. Even if the issuer does not actually default, adverse changes in the issuer's financial condition may negatively affect its credit rating or presumed creditworthiness. These developments would adversely affect the market value of the issuer's obligations. Reinvestment Risk Reinvestment risk is the risk that income from the Fund's portfolio will decline if and when the Fund invests the proceeds from matured, traded, prepaid or called fixed-income securities at lower interest rates. A decline in income could affect the Fund's ability to pay dividends on Preferred Shares. Reinvestment risk also exists for holders of Preferred Shares because the shares are subject to involuntary redemption under circumstances where the investor may not be able to achieve a comparable yield or an investment with similar terms and quality. 13 Income Risk The Fund's income is based primarily on the interest it earns from its investments, which can vary widely over the short and long term. If interest rates drop, the Fund's income available over time to make dividend payments with respect to Preferred Shares could drop as well if the Fund purchases securities with lower interest coupons. This risk is magnified when prevailing short-term interest rates increase and the Fund holds residual interest municipal bonds. Call Risk If interest rates fall, it is possible that issuers of callable bonds with higher interest coupons will "call" (or prepay) their bonds before their maturity date. If a call were exercised by the issuer during a period of declining interest rates, the Fund is likely to replace such called security with a lower yielding security. Liquidity Risk The market for municipal obligations may be less liquid than for corporate bonds. The market for special obligation bonds, lease obligations, participation certificates and variable rate instruments, which the Fund may purchase, may be less liquid than for general obligation bonds. Liquid secondary trading in unrated municipal obligations may not exist. The Fund may not be able to sell these securities when the Manager determines it is appropriate. Less liquid markets tend to be more volatile and react more negatively to adverse publicity and investor perception than more liquid markets. If markets are less liquid, the Fund may not be able to dispose of municipal obligations in a timely manner and at a fair price. There may be no established trading markets for certain municipal obligations, and trading in these securities may be relatively inactive. Some of the Fund's investments may be restricted as to resale. Although restricted securities may be sold in private transactions, a security's value may be less than the price originally paid by the Fund. The ability of the Manager to value illiquid or restricted securities will be more difficult and the Manager's judgment may play a greater role in their valuation. Risks of Certain Investments of the Fund In addition to the risks described above, the Fund's investments are subject to certain other kinds of risk, such as: . the Manager's judgment about the attractiveness, value or income potential of a particular municipal obligation may prove to be incorrect; . municipal obligations may fall out of favor with investors; . a rise in interest rates could cause the value of the Fund's portfolio generally to decline; and . unfavorable legislation may affect the tax-exempt status of municipal obligations. The Fund may invest more than 25% of its assets in municipal obligations that finance the same or similar types of facilities or issuers located in the same state. If the Fund invests more than 25% of its assets in such segments, it will be more susceptible to economic, business, political, regulatory and other developments generally affecting issuers of those segments of the municipal market. The Fund may invest in unrated "non-appropriation" lease obligations or installment purchase contract obligations of municipal authorities or entities believed by the Manager to be of comparable quality to securities that are rated investment grade. It is possible that a municipality will fail to appropriate money in the future because of political changes, changes in the economic viability of a project or general economic changes. While these lease obligations generally are secured by a lien on the leased property, disposing of foreclosed property could be costly and time-consuming, and the Fund may not recoup its original investment. 14 The Fund invests in investment grade debt securities, and unrated securities that the Manager believes are of comparable quality. Investment grade securities that are not in the highest rating category may be subject to greater risk of downgrade and issuer default than higher rated securities and may have speculative characteristics. The Fund may experience more difficulty selling unrated securities because markets for these securities may be less liquid. The Fund may invest in zero coupon bonds. Because these securities usually trade at a deep discount, they will be subject to greater fluctuations of market value in response to changing interest rates than debt obligations of comparable maturities which make periodic distributions of interest. On the other hand, because there are no periodic interest payments to be reinvested prior to maturity, zero coupon securities eliminate the reinvestment risk and lock in a rate of return to maturity. It is possible that some of the Fund's income may be subject to federal taxation. The Fund may realize taxable gain on some of its securities, and some of the Fund's income may be subject to the AMT. The Fund may invest in derivatives. A derivative contract will obligate or entitle the Fund to deliver or receive an asset or cash payment that is based on the change in value of one or more securities or indices. Even a small investment in derivative contracts can have a big impact on the Fund's interest-rate exposure. Therefore, using derivatives can disproportionately increase losses and reduce opportunities for gains when interest rates are changing. The Fund may not fully benefit from or may lose money on derivatives if changes in their value do not correspond accurately to changes in the value of the Fund's holdings. The other parties to certain derivative contracts present the same types of default risk as issuers of fixed-income securities. Derivatives can also make the Fund less liquid and harder to value, especially in declining markets. HOW THE FUND MANAGES RISK Investment Limitations The Fund has adopted certain investment limitations designed to limit investment risk and maintain portfolio diversification. These limitations are fundamental and may not be changed without the approval of the holders of a majority (as such term is defined in the 1940 Act) of the outstanding shares of Common Stock and Preferred Shares voting together as a single class, and the approval of the holders of a majority (as such term is defined in the 1940 Act) of the outstanding Preferred Shares voting as a separate class. The Fund may not invest more than 25% of total Fund assets in securities of issuers in any one industry, except that the Fund may from time to time invest more than 25% of its total assets in a particular segment of the municipal obligations market or in obligations of issuers located in the same state; and may not invest more than 5% of total Fund assets in securities of any one issuer, except that this limitation does not apply to bonds issued by the U.S. Government, its agencies and instrumentalities or to the investment of 25% of its total assets. The Fund may become subject to guidelines which are more limiting than the investment restrictions set forth above in order to obtain and maintain ratings from Moody's or Fitch on Preferred Shares. See the Statement of Additional Information for a complete list of the fundamental and non-fundamental investment policies of the Fund. The Fund may use various investment strategies designed to limit the risk of bond price fluctuations and to preserve capital. These hedging strategies include purchasing put and call options and using financial futures contracts and related options contracts. See "Investment Policies and Techniques" in the Statement of Additional Information. MANAGEMENT OF THE FUND Directors and Officers The Board is responsible for the management of the Fund, including supervision of the duties performed by Smith Barney. There are nine directors of the Fund, one of whom is an "interested person" (as defined in the 15 1940 Act) and eight of whom are not "interested persons." The names and business addresses of the directors and officers of the Fund and their principal occupations and other affiliations during the past five years are set forth under "Management of the Fund" in the Statement of Additional Information. Investment Manager Smith Barney Fund Management LLC (formerly known as SSB Citi Fund Management LLC), located at 125 Broad Street, New York, New York 10004, serves as the Fund's investment manager. The Manager, through its predecessors, has been in the investment counseling business since 1934 and is a registered investment adviser. The Manager manages investment companies that had total assets of approximately $119.2 billion as of December 31, 2001, of which approximately $10 billion consisted of municipal bond portfolios (not including municipal money market portfolios). Pursuant to an investment management agreement with the Fund and subject to the supervision and direction of the Board, Smith Barney is responsible for the management of the investment of the Fund's assets, managing the Fund's corporate affairs and providing certain clerical and bookkeeping services. See the Statement of Additional Information under "Management of the Fund --Investment Manager." The Fund pays the Manager for the services it provides to the Fund a monthly fee equal on an annual basis to 0.60 of 1% of the Fund's average daily total net assets. For purposes of calculating the management fee, the liquidation value of any outstanding preferred stock of the Fund is not deducted in determining the Fund's average daily total net assets. The Manager is a wholly-owned subsidiary of Citigroup Inc. ("Citigroup"). Citigroup businesses produce a broad range of financial services -- asset management, banking and consumer finance, credit and charge cards, insurance, investments, investment banking and trading -- and use diverse channels to make them available to consumer and corporate customers around the world. The Manager is responsible for execution of specific investment strategies and day-to-day investment operations. Peter Coffey, Vice President and Investment Officer of the Fund, is primarily responsible for management of the Fund's assets. Mr. Coffey is a Managing Director of Smith Barney and is the senior asset manager for ten other funds investing in tax-exempt securities with aggregate assets of approximately $2.1 billion as of December 31, 2001. In addition to the management fee, the Fund pays all other costs and expenses of its operations, including fees of its directors not affiliated with Smith Barney and Board meeting expenses; interest charges; taxes; charges and expenses of the Fund's legal counsel and independent accountants, and of the transfer agent, registrar and dividend disbursing agent of the Fund; expenses of repurchasing shares; expenses of printing and mailing share certificates, shareholder reports, notices, proxy statements and reports to governmental offices; brokerage and other expenses connected with the execution, recording and settlement of portfolio security transactions; expenses connected with negotiating of, effecting purchase or sale of, or registering privately issued portfolio securities; fees and expenses of the Fund's custodian for all services to the Fund, including safekeeping of funds and securities and maintaining required books and accounts; expenses of calculating and publishing the net asset value of the Fund's Common Stock; expenses of membership in investment company associations; expenses of fidelity bonding and other insurance premiums; expenses of shareholders' meetings; registration fees and state notice filing fees; Exchange listing fees; and its other business and operating expenses. DESCRIPTION OF PREFERRED SHARES The following is a brief description of the terms of Preferred Shares. This description does not purport to be complete and is subject to and qualified in its entirety by reference to the more detailed description of Preferred Shares in the Fund's Articles Supplementary, and other charter documents, which have been filed with the Commission. 16 General Under the Articles, the Fund is authorized to issue up to 100,000,000 shares of capital stock, designated Common Stock. Pursuant to the Articles, the Board may classify or reclassify any unissued shares of capital stock without a shareholder vote into one or more classes of preferred or other stock with no restrictions on the rights or preferences of any such class except as may be imposed by the 1940 Act, Maryland law or the Articles Supplementary. The Board has authorized the issuance of up to 2,000 shares of Municipal Auction Rate Preferred Stock Series M, or Preferred Shares. All Preferred Shares will have a liquidation preference of $25,000 per share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared). Preferred Shares will rank on parity with shares of any other class or series of preferred shares of the Fund as to the payment of dividends and the distribution of assets upon liquidation. All Preferred Shares carry one vote per share on all matters on which such shares are entitled to be voted. Preferred Shares are, when issued, fully paid and non-assessable and have no preemptive, exchange conversion or cumulative voting rights. Dividends and Dividend Periods General. The Initial Rate Period of Preferred Shares will be a period consisting of eight days. Any Subsequent Rate Period of Preferred Shares will be a Minimum Rate Period (seven Rate Period Days), unless the Fund, subject to certain conditions, designates such Subsequent Rate Period as a Special Rate Period. See "-- Designation of Special Rate Periods" below. Dividends on Preferred Shares shall be payable, when, as and if declared by the Board out of funds legally available therefor in accordance with the Charter, and applicable law, on Tuesday, February 5, 2002, and thereafter on each Tuesday; provided, however, that (i) if the Tuesday on which dividends would otherwise be payable as set forth above is not a Business Day, then such dividends shall be payable on such shares on the first Business Day that falls after such Tuesday; and (ii) the Fund may specify different Dividend Payment Dates in respect of any Special Rate Period of more than 28 Rate Period Days. The amount of dividends per share payable on Preferred Shares on any date on which dividends shall be payable shall be computed by multiplying the Applicable Rate in effect for such Dividend Period or part thereof for which dividends have not been paid by a fraction, the numerator of which shall be the number of days in such Dividend Period or part thereof and the denominator of which shall be 365 if such Dividend Period consists of seven Rate Period Days and 360 for all other Dividend Periods, and applying the rate obtained against $25,000. Dividends will be paid through the Securities Depository on each Dividend Payment Date in accordance with its normal procedures, which currently provide for it to distribute dividends in next-day funds to Agent Members, who in turn are expected to distribute such dividend payments to the persons for whom they are acting as agents. Each of the current Broker-Dealers, however, has indicated to the Fund that such Broker-Dealer or the Agent Member designated by such Broker-Dealer will make such dividend payments available in same-day funds on each Dividend Payment Date to customers that use such Broker-Dealer or its designee as Agent Member. Dividends on Preferred Shares will accumulate from the Date of Original Issue. The dividend rate for the Initial Rate Period shall be 1.25% per year. For each Subsequent Rate Period, the dividend rate will be the Applicable Rate that the Auction Agent advises the Fund results from an Auction, except as provided below. The Applicable Rate that results from an Auction will not be greater than the Maximum Rate, which is: (a) in the case of any Auction Date which is not the Auction Date immediately prior to the first day of any proposed Special Rate Period, the product of (i) the Reference Rate on such Auction Date for the next Rate Period and (ii) the Rate Multiple on such Auction Date, unless Preferred Shares have or had a Special Rate Period (other than a Special Rate Period of 28 Rate Period Days or fewer) and an Auction at which 17 Sufficient Clearing Bids existed has not yet occurred for a Minimum Rate Period after such Special Rate Period, in which case the higher of: (A) the dividend rate for the then-ending Rate Period; and (B) the product of (x) the higher of (I) the Reference Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was 364 Rate Period Days or fewer, or the Treasury Note Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was more than 364 Rate Period Days, and (II) the Reference Rate on such Auction Date for a Rate Period equal in length to such Special Rate Period, if such Special Rate Period was 364 Rate Period Days or fewer, or the Treasury Note Rate on such Auction Date for a Rate Period equal in length to such Special Rate Period, if such Special Rate Period was more than 364 Rate Period Days and (y) the Rate Multiple on such Auction Date; or (b) in the case of any Auction Date which is the Auction Date immediately prior to the first day of any proposed Special Rate Period, the product of (i) the highest of (x) the Reference Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was 364 Rate Period Days or fewer, or the Treasury Note Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was more than 364 Rate Period Days, (y) the Reference Rate on such Auction Date for the Special Rate Period for which the Auction is being held if such Special Rate Period is 364 Rate Period Days or fewer or the Treasury Note Rate on such Auction Date for the Special Rate Period for which the Auction is being held if such Special Rate Period is more than 364 Rate Period Days, and (z) the Reference Rate on such Auction Date for Minimum Rate Periods and (ii) the Rate Multiple on such Auction Date. If an Auction for any Subsequent Rate Period is not held for any reason other than as described below, the dividend rate for such Subsequent Rate Period will be the Maximum Rate on the Auction Date for such Subsequent Rate Period. If the Fund fails to pay in a timely manner to the Auction Agent the full amount of any dividend on, or the redemption price of, any Preferred Shares during any Rate Period (other than any Special Rate Period of more than 364 Rate Period Days or any Rate Period succeeding any Special Rate Period of more than 364 Rate Period Days during which such a failure occurred that has not been cured), but, prior to 12:00 Noon on the third Business Day next succeeding the date such failure occurred, such failure shall have been cured and the Fund shall have paid a late charge, as described more fully in the Articles Supplementary, no Auction will be held for the first Subsequent Rate Period thereafter and the dividend rate for such Subsequent Rate Period will be the Maximum Rate on the Auction Date for such Subsequent Rate Period. If the Fund fails to pay in a timely manner to the Auction Agent the full amount of any dividend on, or the redemption price of, any Preferred Shares during any Rate Period (other than any Special Rate Period of more than 364 Rate Period Days or any Rate Period succeeding any Special Rate Period of more than 364 Rate Period Days during which such a failure occurred that has not been cured), and, prior to 12:00 Noon on the third Business Day next succeeding the date such failure occurred, such failure shall not have been cured or the Fund shall not have paid a late charge, as described more fully in the Articles Supplementary, no Auction will be held for the first Subsequent Rate Period thereafter (or for any Rate Period thereafter to and including the Rate Period during which such failure is so cured and such late charge so paid) (such late charge to be paid only in the event Moody's is rating such shares at the time the Fund cures such failure), and the dividend rate for each such Subsequent Rate Period shall be a rate per annum equal to the Maximum Rate on the Auction Date for such Subsequent Rate Period (but with the prevailing rating for Preferred Shares, for purposes of determining such Maximum Rate, being deemed to be "Below 'ba3'/BB2"). If the Fund fails to pay in a timely manner to the Auction Agent the full amount of any dividend on, or the redemption price of, any Preferred Shares during a Special Rate Period of more than 364 Rate Period Days, or 18 during any Rate Period succeeding any Special Rate Period of more than 364 Rate Period Days during which such a failure occurred that has not been cured, and such failure shall not have been cured or the Fund shall not have paid a late charge, as described more fully in the Articles Supplementary, no Auction will be held for such Subsequent Rate Period (or for any Rate Period thereafter to and including the Rate Period during which such failure is so cured and such late charge so paid) (such late charge to be paid only in the event Moody's is rating such shares at the time the Fund cures such failure), and the dividend rate for each such Subsequent Rate Period shall be a rate per year equal to the Maximum Rate on the Auction Date for each such Subsequent Rate Period (but with the prevailing rating for Preferred Shares, for purposes of determining such Maximum Rate, being deemed to be "Below 'ba3'/BB2"). A failure to pay dividends on, or the redemption price of, Preferred Shares shall have been cured with respect to any Rate Period if, within the respective time periods described in the Articles Supplementary, the Fund shall have paid to the Auction Agent (a) all accumulated and unpaid dividends on Preferred Shares and (b) without duplication, the redemption price for shares, if any, for which notice of redemption has been mailed by the Fund; provided, however, that the foregoing clause (b) shall not apply to the Fund's failure to pay the redemption price in respect of Preferred Shares when the related notice of redemption provides that redemption of such shares is subject to one or more conditions precedent and any such condition precedent shall not have been satisfied at the time or times and in the manner specified in such notice of redemption. Gross-up Payments. Holders of Preferred Shares are entitled to receive, when, as and if declared by the Board, out of funds legally available therefore in accordance with the Articles, including the Articles Supplementary, and applicable law, dividends in an amount equal to the aggregate Gross-up Payments in accordance with the following: If, in the case of any Minimum Rate Period or any Special Rate Period of 28 Rate Period Days or fewer, the Fund allocates any net capital gain or other income taxable for regular federal income tax purposes to a dividend paid on Preferred Shares without having given advance notice thereof to the Auction Agent as described below under "The Auction -- Auction Procedures" (a "Taxable Allocation") solely by reason of the fact that such allocation is made retroactively as a result of the redemption of all or a portion of the outstanding Preferred Shares or the liquidation of the Fund, the Fund will, prior to the end of the calendar year in which such dividend was paid, provide notice thereof to the Auction Agent and direct the Fund's dividend disbursing agent to send such notice with a Gross-up Payment to each holder of shares (initially Cede & Co., as nominee of the Securities Depository) that was entitled to such dividend payment during such calendar year at such holder's address as the same appears or last appeared on the stock books of the Fund. If, in the case of any Special Rate Period of more than 28 Rate Period Days, the Fund makes a Taxable Allocation to a dividend paid on Preferred Shares without having given advance notice thereof to the Auction Agent, the Fund shall, prior to the end of the calendar year in which such dividend was paid, provide notice thereof to the Auction Agent and direct the Fund's dividend disbursing agent to send such notice with a Gross-up Payment to each holder of shares that was entitled to such dividend payment during such calendar year at such holder's address as the same appears or last appeared on the stock books of the Fund. A "Gross-up Payment" means payment to a holder of Preferred Shares of an amount which, when taken together with the aggregate amount of Taxable Allocations made to such holder to which such Gross-up Payment relates, would cause such holder's dividends in dollars (after federal income tax consequences) from the aggregate of such Taxable Allocations and the related Gross-up Payment to be equal to the dollar amount of the dividends which would have been received by such holder if the amount of the aggregate Taxable Allocations would have been excludable from the gross income of such holder for federal income tax purposes. Such Gross-up Payment shall be calculated: (a) without consideration being given to the time value of money; (b) assuming that no holder of Preferred Shares is subject to the AMT with respect to dividends received from the Fund; and (c) assuming that each Taxable Allocation and each Gross-up Payment (except to the extent such Gross-up Payment is designated as an exempt-interest dividend under Section 852(b)(5) of the Internal Revenue Code of 19 1986, as amended (the "Code") or successor provisions) would be taxable in the hands of each holder of Preferred Shares at the maximum marginal regular federal income tax rate applicable to ordinary income, or net capital gain, as applicable, or the maximum marginal regular federal corporate income tax rate applicable to ordinary income or net capital gain, as applicable, whichever is greater, in effect at the time such Gross-up Payment is made. Restrictions on Dividends and Other Distributions. Except as otherwise described herein, for so long as any Preferred Shares are outstanding, the Fund may not declare, pay or set apart for payment any dividend or other distribution (other than a dividend or distribution paid in, or in options, warrants or rights to subscribe for or purchase, its shares of Common Stock) in respect of its Common Stock or other shares of the Fund ranking junior to, or on parity with, Preferred Shares as to the payments of dividends or the distribution of assets upon dissolution, liquidation or winding up, or call for redemption, redeem, purchase or otherwise acquire for consideration any shares of Common Stock or other such junior shares or other such parity shares (except by conversion into or exchange for shares of the Fund ranking junior to Preferred Shares as to the payment of dividends and the distribution of assets upon liquidation), unless (a) full cumulative dividends on Preferred Shares through the most recently ended Dividend Period shall have been paid or shall have been declared and sufficient funds for the payment thereof deposited with the Auction Agent and (b) the Fund shall have redeemed the full number of Preferred Shares required to be redeemed by any provision for mandatory redemption pertaining thereto. Except as otherwise described herein, for so long as any Preferred Shares are outstanding, the Fund may not declare, pay or set apart for payment any dividend or other distribution (other than a dividend or distribution paid in shares of, or in options, warrants or rights to subscribe for or purchase, shares of Common Stock or other shares, if any, ranking junior to Preferred Shares as to the payment of dividends and the distribution of assets upon dissolution, liquidation or winding up) in respect of shares of Common Stock or any other shares of the Fund ranking junior to Preferred Shares as to the payment of dividends or the distribution of assets upon dissolution, liquidation or winding up, or call for redemption, redeem, purchase or otherwise acquire for consideration any shares of Common Stock or any other such junior shares (except by conversion into or exchange for shares of the Fund ranking junior to Preferred Shares as to the payment of dividends and the distribution of assets upon dissolution, liquidation or winding up), unless immediately after such transaction the Discounted Value of the Fund's portfolio would at least equal the Preferred Shares Basic Maintenance Amount in accordance with guidelines of the rating agency or agencies then rating Preferred Shares. Except as set forth in the next sentence, no dividends shall be declared or paid or set apart for payment on the shares of any class or series of Fund shares ranking, as to the payment of dividends, on a parity with Preferred Shares for any period unless full cumulative dividends have been or contemporaneously are declared and paid on Preferred Shares through the most recent Dividend Payment Date. When dividends are not paid in full upon Preferred Shares through the most recent Dividend Payment Date or upon the shares of any other class or series of shares ranking on a parity as to the payment of dividends with Preferred Shares through their most recent respective dividend payment dates, all dividends declared upon Preferred Shares and any such other class or series of shares ranking on a parity as to the payment of dividends with Preferred Shares shall be declared pro rata so that the amount of dividends declared per share on Preferred Shares and such other class or series of shares shall in all cases bear to each other the same ratio that accumulated dividends per share on Preferred Shares and such other class or series of shares bear to each other. Designation of Special Rate Periods. The Fund, at its option, may designate any succeeding Subsequent Rate Period as a Special Rate Period consisting of a specified number of Rate Period Days evenly divisible by seven and not more than 1,820 (approximately 5 years), subject to certain adjustments. A designation of a Special Rate Period shall be effective only if, among other things, (a) the Fund shall have given certain notices to the Auction Agent, (b) an Auction shall have been held on the Auction Date immediately preceding the first day of such proposed Special Rate Period and Sufficient Clearing Bids shall have existed in such Auction and (c) if the Fund shall have mailed a notice of redemption with respect to any Preferred Shares, the redemption price with respect to such shares shall have been deposited with the Auction Agent. The Fund will give holders of Preferred Shares notice of a Special Rate Period as provided in the Articles Supplementary. 20 Redemption Mandatory Redemption. In the event the Fund does not timely cure a failure to maintain (a) a Discounted Value of its portfolio equal to the Preferred Shares Basic Maintenance Amount or (b) the 1940 Act Preferred Shares Asset Coverage, in each case in accordance with the requirements of the rating agency or agencies then rating Preferred Shares, Preferred Shares will be subject to mandatory redemption on a date specified by the Board out of funds legally available therefor in accordance with the Charter, including the Articles Supplementary, and applicable law, at the redemption price of $25,000 per share plus an amount equal to accumulated but unpaid dividends thereon (whether or not earned or declared) to (but not including) the date fixed for redemption. Any such redemption will be limited to the number of Preferred Shares necessary to restore the required Discounted Value or the 1940 Act Preferred Shares Asset Coverage, as the case may be. Optional Redemption. Preferred Shares are redeemable, at the option of the Fund: (a) as a whole or from time to time in part, on the second Business Day preceding any Dividend Payment Date, out of funds legally available therefor in accordance with the Charter, including the Articles Supplementary, and applicable law, at the redemption price of $25,000 per share plus an amount equal to accumulated but unpaid dividends thereon (whether or not earned or declared) to (but not including) the date fixed for redemption; provided, however, that (i) shares may not be redeemed in part if after such partial redemption fewer than 250 shares would remain outstanding; (ii) shares are redeemable by the Fund during the Initial Rate Period only on the second Business Day next preceding the last Dividend Payment Date for the Initial Rate Period; and (iii) the notice establishing a Special Rate Period, as delivered to the Auction Agent and filed with the Secretary of the Fund, may provide that shares shall not be redeemable during the whole or any part of such Special Rate Period (except as provided in clause (b) below) or shall be redeemable during the whole or any part of such Special Rate Period only upon payment of such redemption premium or premiums as shall be specified therein; and (b) as a whole but not in part, out of funds legally available therefor in accordance with the Charter, including the Articles Supplementary, and applicable law, on the first Business Day following any Dividend Period included in a Rate Period of more than 364 Rate Period Days if, on the date of determination of the Applicable Rate for such Rate Period, such Applicable Rate equaled or exceeded on such date of determination the Treasury Note Rate for such Rate Period, at a redemption price of $25,000 per share plus an amount equal to accumulated but unpaid dividends thereon (whether or not earned or declared) to (but not including) the date fixed for redemption. Notwithstanding the foregoing, if any dividends on Preferred Shares (whether or not earned or declared) are in arrears, no Preferred Shares shall be redeemed unless all outstanding Preferred Shares are simultaneously redeemed, and the Fund shall not purchase or otherwise acquire any Preferred Shares; provided, however, that the foregoing shall not prevent the purchase or acquisition of all outstanding Preferred Shares pursuant to the successful completion of an otherwise lawful purchase or exchange offer made on the same terms to, and accepted by, holders of all outstanding Preferred Shares. Liquidation Subject to the rights of holders of any series or class or classes of shares ranking on a parity with Preferred Shares with respect to the distribution of assets upon liquidation of the Fund, upon a liquidation of the Fund, whether voluntary or involuntary, the holders of Preferred Shares then outstanding will be entitled to receive and to be paid out of the assets of the Fund available for distribution to its shareholders, before any payment or distribution shall be made on the shares of Common Stock, an amount equal to the liquidation preference with respect to such shares ($25,000 per share), plus an amount equal to all dividends thereon (whether or not earned or declared) accumulated but unpaid to (but not including) the date of final distribution in same-day funds, together with any applicable Gross-up Payments in connection with the liquidation of the Fund. After the payment to the holders of Preferred Shares of the full preferential amounts provided for as described herein, the holders of Preferred Shares as such shall have no right or claim to any of the remaining assets of the Fund. 21 Neither the sale of all or substantially all the property or business of the Fund, nor the merger or consolidation of the Fund into or with any other corporation nor the merger or consolidation of any other corporation into or with the Fund, shall be a liquidation, whether voluntary or involuntary, for the purposes of the foregoing paragraph. Rating Agency Guidelines and Asset Coverage The Fund is required under the 1940 Act and Moody's and Fitch guidelines to maintain assets having in the aggregate a Discounted Value at least equal to the Preferred Shares Basic Maintenance Amount. Moody's and Fitch have each established separate guidelines for determining Discounted Value. To the extent any particular portfolio holding does not satisfy the applicable rating agency's guidelines, all or a portion of such holding's value will not be included in the calculation of Discounted Value (as defined by such rating agency). The Moody's and Fitch guidelines do not impose any limitations on the percentage of the Fund's assets that may be invested in holdings not eligible for inclusion in the calculation of the Discounted Value of the Fund's portfolio. The amount of such assets included in the portfolio at any time may vary depending upon the rating, diversification and other characteristics of the eligible assets included in the portfolio, although it is not anticipated that in the normal course of business the value of such assets would exceed 40% of the Fund's total assets. The Preferred Shares Basic Maintenance Amount includes the sum of (a) the aggregate liquidation preference of Preferred Shares then outstanding and (b) certain accrued and projected payment obligations of the Fund. The Fund is also required under the 1940 Act and rating agency guidelines to maintain, with respect to Preferred Shares, as of the last Business Day of each month in which any such shares are outstanding, asset coverage of at least 200% with respect to senior securities which are shares, including Preferred Shares (or such other asset coverage as may in the future be specified in or under the 1940 Act as the minimum asset coverage for senior securities which are shares of a closed-end investment company as a condition of declaring dividends on its common shares) ("1940 Act Preferred Shares Asset Coverage"). Based on the composition of the portfolio of the Fund and market conditions as of December 31, 2001, 1940 Act Preferred Shares Asset Coverage with respect to Preferred Shares, assuming the issuance of all Preferred Shares offered hereby and giving effect to the deduction of sales load and offering costs related thereto estimated at $700,000, would have been computed as follows: Value of Fund assets less liabilities not constituting senior securities $192,165,649 - ----------------------------------------------------------------------- = ------------ = 384% Senior securities representing indebtedness plus liquidation value of $ 50,000,000 Preferred Shares
In the event the Fund does not timely cure a failure to maintain (a) a Discounted Value of its portfolio equal to the Preferred Shares Basic Maintenance Amount or (b) the 1940 Act Preferred Shares Asset Coverage, in each case in accordance with the requirements of the rating agency or agencies then rating Preferred Shares, the Fund will be required to redeem Preferred Shares as described under "Redemption -- Mandatory Redemption" above. The Fund may, but is not required to, adopt any modifications to the guidelines that may hereafter be established by Moody's or Fitch. Failure to adopt any such modifications, however, may result in a change in the ratings described above or a withdrawal of ratings altogether. In addition, any rating agency providing a rating for Preferred Shares may, at any time, change or withdraw any such rating. The Board may, without shareholder approval, amend, alter or repeal any or all of the definitions and related provisions which have been adopted by the Fund pursuant to the rating agency guidelines in the event the Fund receives written confirmation from Moody's or Fitch, or both, as appropriate, that any such amendment, alteration or repeal would not impair the ratings then assigned by Moody's and Fitch to Preferred Shares. As described by Moody's and Fitch, a preferred stock rating is an assessment of the capacity and willingness of an issuer to pay preferred stock obligations. The ratings on Preferred Shares are not 22 recommendations to purchase, hold or sell those shares, inasmuch as the ratings do not comment as to market price or suitability for a particular investor. The rating agency guidelines described above also do not address the likelihood that an owner of Preferred Shares will be able to sell such shares in an Auction or otherwise. The ratings are based on current information furnished to Moody's and Fitch by the Fund and the Manager and information obtained from other sources. The ratings may be changed, suspended or withdrawn as a result of changes in, or the unavailability of, such information. The Common Stock has not been rated by an NRSRO. A rating agency's guidelines will apply to Preferred Shares only so long as such rating agency is rating such shares. The Fund will pay certain fees to Moody's or Fitch, or both, for rating Preferred Shares. Voting Rights Except as otherwise provided in this Prospectus and in the Statement of Additional Information, in the Charter, including the Articles Supplementary, or as otherwise required by law, holders of Preferred Shares will have equal voting rights with holders of shares of Common Stock and holders of any other shares of preferred stock of the Fund (one vote per share) and will vote together with holders of shares of Common Stock and holders of any other shares of preferred stock of the Fund as a single class. There is presently no other preferred stock of the Fund authorized or issued. In connection with the election of the Fund's directors, holders of outstanding Preferred Shares, voting as a separate class, are entitled to elect two of the Fund's directors, and the remaining directors are elected by holders of shares of Common Stock and Preferred Shares, voting together as a single class. In addition, if at any time dividends (whether or not earned or declared) on outstanding Preferred Shares shall be due and unpaid in an amount equal to two full years' dividends thereon, and sufficient cash or specified securities shall not have been deposited with the Auction Agent for the payment of such dividends, then, as the sole remedy of holders of outstanding Preferred Shares, the number of directors constituting the Board shall be increased by the smallest number that, when added to the two directors elected exclusively by the holders of Preferred Shares, as described above, would constitute a majority of the Board as so increased by such smallest number, and at a special meeting of shareholders which will be called and held as soon as practicable, and at all subsequent meetings at which directors are to be elected, the holders of Preferred Shares, voting as a separate class, will be entitled to elect the smallest number of additional directors that, together with the two directors which such holders will be in any event entitled to elect, constitutes a majority of the total number of directors of the Fund as so increased. The terms of office of the persons who are directors at the time of that election will continue. If the Fund thereafter shall pay, or declare and set apart for payment, in full, all dividends payable on all outstanding Preferred Shares, the voting rights stated in the second preceding sentence shall cease, and the terms of office of all of the additional directors elected by the holders of Preferred Shares (but not of the directors with respect to whose election the holders of shares of Common Stock were entitled to vote or the two directors the holders of Preferred Shares have the right to elect in any event), will terminate automatically. So long as any Preferred Shares are outstanding, the Fund will not, without the affirmative vote or consent of the holders of at least a majority of Preferred Shares outstanding at the time (voting as a separate class): (a) authorize, create or issue any class or series of stock ranking prior to or on a parity with Preferred Shares with respect to the payment of dividends or the distribution of assets upon liquidation, or authorize, create or issue additional shares of any series of Preferred Shares (except that, notwithstanding the foregoing, but subject to certain rating agency approvals, the Board, without the vote or consent of the holders of Preferred Shares, may from time to time authorize and create, and the Fund may from time to time issue additional shares of, any series of Preferred Shares, or classes or series of other preferred shares ranking on a parity with Preferred Shares with respect to the payment of dividends and the distribution of assets upon liquidation; provided, however, that if Moody's or Fitch is not then rating Preferred Shares, the aggregate liquidation preference of all preferred stock of the Fund outstanding after any such issuance, exclusive of accumulated and unpaid dividends, may not exceed $50,000,000); or 23 (b) amend, alter or repeal the provisions of the Charter, including the Articles Supplementary, whether by merger, consolidation or otherwise, so as to affect any preference, right or power of such Preferred Shares or the holders thereof; provided, however, that (i) none of the actions permitted by the exception to (a) above will be deemed to affect such preferences, rights or powers and (ii) a division or split of a share of Preferred Shares will be deemed to affect such preferences, rights or powers only if the terms of such division adversely affect the holders of Preferred Shares and (iii) the authorization, creation and issuance of classes or series of stock ranking junior to Preferred Shares with respect to the payment of dividends and the distribution of assets upon liquidation will be deemed to affect such preferences, rights or powers only if Moody's or Fitch is then rating Preferred Shares and such issuance would, at the time thereof, cause the Fund not to satisfy the 1940 Act Preferred Shares Asset Coverage or the Preferred Shares Basic Maintenance Amount. So long as any Preferred Shares are outstanding, the Fund shall not, without the affirmative vote or consent of the holders of at least a majority of Preferred Shares outstanding at the time, voting as a separate class, file a voluntary application for relief under federal bankruptcy law or any similar application under state law for so long as the Fund is solvent and does not foresee becoming insolvent. The Board may, without shareholder approval, amend, alter or repeal any or all of the definitions and related provisions which have been adopted by the Fund pursuant to the rating agency guidelines in the event the Fund receives written confirmation from Moody's or Fitch, or both, as appropriate, that any such amendment, alteration or repeal would not impair the ratings then assigned by Moody's and Fitch to Preferred Shares. Unless a higher percentage is provided for in the Articles (see "Certain Provisions in the Charter and Bylaws"), (A) the affirmative vote of the holders of at least a majority of the outstanding Preferred Shares (as such term is used in the 1940 Act), voting as a separate class, shall be required to approve any conversion of the Fund from a closed-end to an open-end investment company and (B) the affirmative vote of the holders of a majority of the outstanding Preferred Shares (as such term is used in the 1940 Act), voting as a separate class, shall be required to approve any plan of reorganization (as such term is used in the 1940 Act) adversely affecting such shares. Unless a higher percentage is provided for in the Articles, the affirmative vote of the holders of a majority of the outstanding Preferred Shares, voting as a separate class, shall be required to approve any action not described in the preceding sentence requiring a vote of security holders of the Fund under Section 13(a) of the 1940 Act. The foregoing voting provisions will not apply with respect to Preferred Shares if, at or prior to the time when a vote is required, such shares shall have been (i) redeemed or (ii) called for redemption and sufficient funds shall have been deposited in trust to effect such redemption. THE AUCTION General The Articles Supplementary provide that, except as otherwise described herein, the Applicable Rate for Preferred Shares for each Rate Period after the Initial Rate Period shall be equal to the rate per annum that the Auction Agent advises has resulted on the Business Day preceding the first day of such Subsequent Rate Period (an "Auction Date") from implementation of the auction procedures (the "Auction Procedures") set forth in the Articles Supplementary and summarized below, in which persons determine to hold or offer to sell or, based on dividend rates bid by them, offer to purchase or sell Preferred Shares. Each periodic implementation of the Auction Procedures is referred to herein as an "Auction." See the Articles Supplementary for a more complete description of the Auction process. Auction Agency Agreement. The Fund has entered into an Auction Agency Agreement (the "Auction Agency Agreement") with the Auction Agent (currently, Bankers Trust Company) which provides, among other things, that the Auction Agent will follow the Auction Procedures for purposes of determining the Applicable Rate for Preferred Shares so long as the Applicable Rate is to be based on the results of an Auction. 24 The Auction Agent may terminate the Auction Agency Agreement upon notice to the Fund on a date no earlier than 45 days after such notice. If the Auction Agent should resign, the Fund will use its best efforts to enter into an agreement with a successor Auction Agent containing substantially the same terms and conditions as the Auction Agency Agreement. The Fund may remove the Auction Agent provided that prior to such removal the Fund shall have entered into such an agreement with a successor Auction Agent. Broker-Dealer Agreements. Each Auction requires the participation of one or more Broker-Dealers. The Auction Agent has entered into agreements (collectively, the "Broker-Dealer Agreements") with several Broker-Dealers selected by the Fund, which provide for the participation of those Broker-Dealers in Auctions for Preferred Shares. The Auction Agent after each Auction for Preferred Shares will pay to each Broker-Dealer, from funds provided by the Fund, a service charge at the annual rate of 1/4 of 1% in the case of any Auction immediately preceding a Rate Period of less than one year, or a percentage agreed to by the Fund and the Broker-Dealers in the case of any Auction immediately preceding a Rate Period of one year or longer, of the purchase price of Preferred Shares placed by such Broker-Dealer at such Auction. For the purposes of the preceding sentence, Preferred Shares will be placed by a Broker-Dealer if such shares were (a) the subject of Hold Orders deemed to have been submitted to the Auction Agent by the Broker-Dealer and were acquired by such Broker-Dealer for its own account or were acquired by such Broker-Dealer for its customers who are Beneficial Owners or (b) the subject of an Order submitted by such Broker-Dealer that is (i) a Submitted Bid of an Existing Holder that resulted in such Existing Holder continuing to hold such shares as a result of the Auction or (ii) a Submitted Bid of a Potential Holder that resulted in such Potential Holder purchasing such shares as a result of the Auction or (iii) a valid Hold Order. The Fund may request the Auction Agent to terminate one or more Broker-Dealer Agreements at any time, provided that at least one Broker-Dealer Agreement is in effect after such termination. Auction Procedures Prior to the Submission Deadline on each Auction Date for Preferred Shares, each customer of a Broker-Dealer who is listed on the records of that Broker-Dealer (or, if applicable, the Auction Agent) as a holder of Preferred Shares (a "Beneficial Owner") may submit orders ("Orders") with respect to such Preferred Shares to that Broker-Dealer as follows: . Hold Order -- indicating its desire to hold such shares without regard to the Applicable Rate for the next Rate Period thereof. . Bid -- indicating its desire to sell such shares at $25,000 per share if the Applicable Rate for the next Rate Period thereof is less than the rate specified in such Bid (also known as a hold-at-a-rate order). . Sell Order -- indicating its desire to sell such shares at $25,000 per share without regard to the Applicable Rate for the next Rate Period thereof. A Beneficial Owner may submit different types of Orders to its Broker-Dealer with respect to Preferred Shares then held by such Beneficial Owner. A Beneficial Owner that submits a Bid with respect to such shares to its Broker-Dealer having a rate higher than the Maximum Rate on the Auction Date will be treated as having submitted a Sell Order with respect to such shares to its Broker-Dealer. A Beneficial Owner that fails to submit an Order with respect to such shares to its Broker-Dealer will be deemed to have submitted a Hold Order with respect to such shares to its Broker-Dealer; provided, however, that if a Beneficial Owner fails to submit an Order with respect to such shares to its Broker-Dealer for an Auction relating to a Rate Period of more than 28 Rate Period Days, such Beneficial Owner will be deemed to have submitted a Sell Order with respect to such shares to its Broker-Dealer. A Sell Order shall constitute an irrevocable offer to sell Preferred Shares subject 25 thereto. A Beneficial Owner that offers to become the Beneficial Owner of additional Preferred Shares is, for purposes of such offer, a Potential Beneficial Owner as discussed below. A customer of a Broker-Dealer that is not a Beneficial Owner of Preferred Shares but that wishes to purchase Preferred Shares, or that is a Beneficial Owner of Preferred Shares that wishes to purchase additional Preferred Shares (in each case, a "Potential Beneficial Owner"), may submit Bids to its Broker-Dealer in which it offers to purchase Preferred Shares at $25,000 per share if the Applicable Rate for the next Rate Period is not less than the rate specified in such Bid. A Bid placed by a Potential Beneficial Owner specifying a rate higher than the Maximum Rate on the Auction Date will not be accepted. The Broker-Dealers in turn will submit the Orders of their respective customers who are Beneficial Owners and Potential Beneficial Owners to the Auction Agent, designating themselves (unless otherwise permitted by the Fund) as Existing Holders in respect of shares subject to Orders submitted or deemed submitted to them by Beneficial Owners and as Potential Holders in respect of shares subject to Orders submitted to them by Potential Beneficial Owners. However, neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's failure to comply with the foregoing. Any Order placed with the Auction Agent by a Broker-Dealer as or on behalf of an Existing Holder or a Potential Holder will be treated in the same manner as an Order placed with a Broker-Dealer by a Beneficial Owner or Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to submit to the Auction Agent an Order in respect of any Preferred Shares held by it or customers who are Beneficial Owners will be treated in the same manner as a Beneficial Owner's failure to submit to its Broker-Dealer an Order in respect of Preferred Shares held by it. A Broker-Dealer may also submit Orders to the Auction Agent for its own account as an Existing Holder or Potential Holder, provided it is not an affiliate of the Fund. If Sufficient Clearing Bids for Preferred Shares exist (that is, the number of Preferred Shares subject to Bids submitted or deemed submitted to the Auction Agent by Broker-Dealers as or on behalf of Potential Holders with rates equal to or lower than the Maximum Rate is at least equal to the number of Preferred Shares subject to Sell Orders submitted or deemed submitted to the Auction Agent by Broker-Dealers as or on behalf of Existing Holders), the Applicable Rate for the next succeeding Rate Period will be the lowest rate specified in the Submitted Bids which, taking into account such rate and all lower rates bid by Broker-Dealers as or on behalf of Existing Holders and Potential Holders, would result in Existing Holders and Potential Holders owning the Preferred Shares available for purchase in the Auction. If Sufficient Clearing Bids do not exist, the Applicable Rate for the next succeeding Rate Period will be the Maximum Rate on the Auction Date. In such event, Beneficial Owners that have submitted or are deemed to have submitted Sell Orders may not be able to sell in such Auction all shares subject to such Sell Orders. If Broker-Dealers submit or are deemed to have submitted to the Auction Agent Hold Orders with respect to all Existing Holders of Preferred Shares, the Applicable Rate for the next succeeding Rate Period will be the All Hold Order Rate. The Auction Procedures include a pro rata allocation of shares for purchase and sale, which may result in an Existing Holder continuing to hold or selling, or a Potential Holder purchasing, a number of Preferred Shares that is fewer than the number of Preferred Shares specified in its Order. To the extent the allocation procedures have that result, Broker-Dealers that have designated themselves as Existing Holders or Potential Holders in respect of customer Orders will be required to make appropriate pro rata allocations among their respective customers. Settlement of purchases and sales will be made on the next Business Day (also a Dividend Payment Date) after the Auction Date through the Securities Depository. Purchasers will make payment through their Agent Members in same-day funds to the Securities Depository against delivery to their respective Agent Members. The Securities Depository will make payment to the sellers' Agent Members in accordance with the Securities Depository's normal procedures, which now provide for payment against delivery by their Agent Members in same-day funds. The Auctions for Preferred Shares will normally be held every Monday and each Subsequent Rate Period will normally begin on the following Tuesday. 26 Whenever the Fund intends to include any net capital gain or other income taxable for regular federal income tax purposes in any dividend on Preferred Shares, the Fund shall, in the case of Minimum Rate Periods or Special Rate Periods of 28 Rate Period Days or fewer, and may, in the case of any other Special Rate Period, notify the Auction Agent of the amount to be so included not later than the Dividend Payment Date next preceding the Auction Date on which the Applicable Rate for such dividend is to be established. Whenever the Auction Agent receives such notice from the Fund, it will be required in turn to notify each Broker-Dealer, who, on or prior to such Auction Date, in accordance with its Broker-Dealer Agreement, will be required to notify its customers who are Beneficial Owners and Potential Beneficial Owners believed by it to be interested in submitting an Order in the Auction to be held on such Auction Date. Secondary Market Trading and Transfer of Preferred Shares The Broker-Dealers are expected to maintain a secondary trading market in Preferred Shares outside of Auctions, but are not obligated to do so, and may discontinue such activity at any time. There can be no assurance that such secondary trading market in Preferred Shares will provide owners with liquidity of investment. Preferred Shares are not registered on any stock exchange or on the Nasdaq Stock Market. Investors who purchase shares in an Auction for a Special Rate Period should note that because the dividend rate on such shares will be fixed for the length of such Rate Period, the value of the shares may fluctuate in response to changes in interest rates, and may be more or less than their original cost if sold on the open market in advance of the next Auction, depending upon market conditions. A Beneficial Owner or an Existing Holder may sell, transfer or otherwise dispose of Preferred Shares only in whole shares and only (1) pursuant to a Bid or Sell Order placed with the Auction Agent in accordance with the Auction Procedures, (2) to a Broker-Dealer or (3) to such other persons as may be permitted by the Fund; provided, however, that (a) a sale, transfer or other disposition of Preferred Shares from a customer of a Broker-Dealer who is listed on the records of that Broker-Dealer as the holder of such shares to that Broker-Dealer or another customer of that Broker-Dealer shall not be deemed to be a sale, transfer or other disposition for purposes of the foregoing if such Broker-Dealer remains the Existing Holder of the shares so sold, transferred or disposed of immediately after such sale, transfer or disposition and (b) in the case of all transfers other than pursuant to Auctions, the Broker-Dealer (or other person, if permitted by the Fund) to whom such transfer is made shall advise the Auction Agent of such transfer. DESCRIPTION OF COMMON STOCK The Articles authorize the issuance of 100,000,000 shares of capital stock of the Fund, designated pursuant to the Articles as Common Stock, par value $.001 per share. Pursuant to the Articles, the Board may classify or reclassify any unissued shares of capital stock from time to time by setting or changing the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications or terms or conditions of redemption of such shares of stock. All shares of Common Stock have equal rights to the payment of dividends and the distribution of assets upon liquidation. Shares of Common Stock are fully paid and non-assessable when issued and have no preemptive, conversion or cumulative voting rights. Whenever Preferred Shares are outstanding, shareholders of Common Stock will not be entitled to receive any distributions from the Fund unless all accrued dividends on Preferred Shares have been paid, and unless asset coverage (as defined in the 1940 Act) with respect to Preferred Shares would be at least 200% after giving effect to the distributions. CERTAIN PROVISIONS IN THE CHARTER AND BYLAWS The Articles and the Fund's bylaws include provisions that could limit the ability of other entities or persons to acquire control of the Fund, to cause it to engage in certain transactions or to modify its structure. 27 The Articles require a vote by holders of at least 75% of the shares of each class of capital stock of the Fund outstanding and entitled to vote, except as described below, to authorize (1) the Fund's conversion from a closed-end to an open-end investment company or generally to authorize any of the following transactions; (2) any merger or consolidation or share exchange of the Fund with or into any other company; (3) the dissolution or liquidation of the Fund; (4) any sale, lease, exchange, mortgage, pledge, transfer or other disposition of all or substantially all of the Fund's assets; (5) a change in the nature of the business of the Fund so that it would cease to be an investment company registered under the 1940 Act; or (6) with certain exceptions, the issuance or transfer by the Fund of any securities of the Fund to any other person in exchange for cash, securities or other property having an aggregate fair market value of $1,000,000 or more; provided, with respect to (1) through (5), if such action has been authorized by the affirmative vote of at least 70% of the entire Board, the affirmative vote of the holders of only a majority of the Fund's shares of capital stock outstanding and entitled to vote at the time is required; and provided, further, with respect to (6), if such transaction has been authorized by the affirmative vote of at least 70% of the entire Board, no shareholder vote is required to authorize such action. None of the foregoing provisions may be amended except by the vote of at least 75% of the outstanding shares of each class of capital stock of the Fund outstanding and entitled to vote thereon. The percentage vote required under these provisions is higher than that required under Maryland law or by the 1940 Act. The Board believes that the provisions of the Articles relating to such a higher vote are in the best interest of the Fund and its shareholders. See the Statement of Additional Information under "Certain Provisions in the Charter and Bylaws." The Board is classified into three classes, each with a term of three years with only one class of Directors standing for election in any year. Such classification may prevent replacement of a majority of the Directors for up to a two-year period. Directors may be removed from office only for cause and only by vote of at least 75% of the shares entitled to be voted for such director in an election of directors. Reference should be made to the Articles on file with the Commission for the full text of these provisions. See the Statement of Additional Information under "Certain Provisions in the Articles of Incorporation" for a discussion of the voting requirements applicable to certain other transactions. REPURCHASE OF COMMON STOCK; CONVERSION TO OPEN-END FUND The Fund is a closed-end investment company and as such its shareholders do not have the right to cause the Fund to redeem their shares. Instead, the Fund's shares of Common Stock trade in the open market at a price that is a function of several factors, including dividend levels (which are in turn affected by expenses), net asset value, call protection, dividend stability, portfolio credit quality, relative demand for and supply of such shares in the market, general market and economic conditions and other factors. Shares of closed-end investment companies frequently trade at a discount from net asset value, or in some cases trade at a premium. Some closed-end companies have taken certain actions, including the repurchase of common stock in the market at market prices and the making of one or more tender offers for common stock at net asset value, in an effort to reduce or mitigate any such discount. Others have converted to an open-end investment company, the shares of which are redeemable at net asset value. The Board has seen no reason to adopt any of these steps with respect to the Fund. Accordingly, the Fund cannot assure you that the Board will decide to take any of these actions, or, if taken, that share repurchases or tender offers will cause the Fund's shares to trade at a price equal to their net asset value. If the Fund converted to an open-end company, it would be required to redeem all Preferred Shares then outstanding (requiring in turn that it liquidate a portion of its investment portfolio), and the Fund's Common Stock would no longer be listed on the American Stock Exchange. In contrast to a closed-end investment company, shareholders of an open-end investment company may require the company to redeem their shares at any time (except in certain circumstances as authorized by or under the 1940 Act) at their net asset value, less any redemption charge that is in effect at the time of redemption. See this Prospectus under "Certain Provisions in the Charter and Bylaws" for a discussion of the voting requirements applicable to the conversion of the Fund to an open-end company. 28 Before deciding whether to take any action if the shares of Common Stock trade below net asset value, the Board would consider all relevant factors, including the extent and duration of the discount, the liquidity of the Fund's portfolio, the impact of any action that might be taken on the Fund or its shareholders, and market considerations. Based on these considerations, even if the Fund's shares should trade at a discount, the Board may determine that, in the interest of the Fund and its shareholders, no action should be taken. See the Statement of Additional Information under "Repurchase of Fund Shares; Conversion to Open-End Fund" for a further discussion of possible action to reduce or eliminate such discount to net asset value. TAX MATTERS Federal Income Tax Matters The discussion below and in the Statement of Additional Information provides general tax information. Because tax laws are complex and often change, you should consult your tax advisor about the tax consequences of an investment in Preferred Shares. The Fund has qualified and intends to continue to qualify each year as a regulated investment company under Subchapter M of the Code, and intends to distribute substantially all of its net income and gains to its shareholders. Therefore, it is not expected that the Fund will be subject to any federal income tax to the extent its earnings are so distributed. In addition, the Fund intends to satisfy each year conditions contained in the Code that will enable interest from municipal obligations, excluded from gross income for federal income tax purposes with respect to the Fund, to retain that status when distributed to the holders of Common Stock and holders of Preferred Shares (that is, to be classified as "exempt-interest" dividends of the Fund). A shareholder treats an exempt-interest dividend as interest on state and local bonds exempt from regular federal income tax. Some or all of an exempt-interest dividend, however, may be subject to AMT imposed on the shareholder. Different AMT rules apply to individuals and to corporations. In addition to exempt-interest dividends, the Fund also may distribute to its shareholders amounts that are treated as long-term capital gain or ordinary income. The Fund will allocate distributions to shareholders that are treated as interest that is exempt from regular federal income taxes and as long-term capital gain and ordinary income, if any, among the shares of Common Stock and Preferred Shares in proportion to total dividends paid to each class for the year. The Fund intends to notify holders of Preferred Shares in advance if it will allocate to them income that is not exempt from regular federal income tax. In certain circumstances, the Fund will make payments to holders of Preferred Shares to offset the tax effects of the taxable distribution. See "Description of Preferred Shares -- Dividends and Dividend Periods -- Gross-Up Payments." The sale or other disposition of shares of Common Stock or Preferred Shares of the Fund will normally result in capital gain or loss to shareholders. Present law taxes both long-term and short-term capital gains of corporations at the rates applicable to ordinary income. For non-corporate taxpayers, under current law short-term capital gains and ordinary income will be taxed at a maximum rate of 38.6% while long-term capital gains will generally be taxed at a maximum rate of 20%. Because of certain limitations on itemized deductions and the deduction for personal exemptions applicable to higher income taxpayers, the effective rate of tax may be higher in certain circumstances. Losses realized by a shareholder on the sale or exchange of shares of the Fund held for six months or less are disallowed to the extent of any distribution of exempt-interest dividends received with respect to such shares, and, if not disallowed, such losses are treated as long-term capital losses to the extent of any distribution of long-term capital gain received (or amounts credited as an undistributed capital gain) with respect to such shares. Under certain circumstances, a shareholder's holding period may have to restart after, or may be suspended for, any periods during which the shareholder's risk of loss is diminished as a result of holding one or more other positions in substantially similar or related property, or through certain options or short sales. Any loss realized on a sale or exchange of shares of the Fund will be disallowed to the extent those shares of the Fund are replaced by other shares within a period of 61 days beginning 30 days before and ending 30 days after the date of disposition of the original shares. In that event, the basis of the replacement shares of the Fund will be adjusted to reflect the disallowed loss. Although dividends generally will be treated as distributed when paid, dividends declared in October, November or December, payable to shareholders of record on a specified date in 29 one of those months and paid during the following January, will be treated as having been distributed by the Fund (and received by the shareholders) on December 31 of the year declared. The Fund is required in certain circumstances to withhold 31% of taxable dividends and certain other payments paid to non-corporate holders of the Fund's shares who do not furnish to the Fund their correct taxpayer identification number (in the case of individuals, their social security number) and certain certifications, or who are otherwise subject to backup withholding. The Statement of Additional Information contains a more detailed summary of the federal tax rules that apply to the Fund and its shareholders. Legislative, judicial or administrative action may change the tax rules that apply to the Fund or its shareholders and any such change may be retroactive. You should consult with your tax advisor about federal income tax matters. CUSTODIAN, TRANSFER AGENT, DIVIDEND PAYING AGENT AND REGISTRAR State Street Bank and Trust Company, located at 225 Franklin Street, Boston, Massachusetts 02110, acts as the Fund's custodian and has custody of all securities and cash of the Fund. The custodian, among other things, attends to the collection of principal and income, and payment for securities bought and sold by the Fund. PFPC Inc., located at P.O. Box 8030, Boston, Massachusetts 02266, serves as the Fund's transfer agent, dividend-paying agent and registrar. UNDERWRITING Salomon Smith Barney Inc. is acting as Underwriter in this offering. Subject to the terms and conditions of the Underwriting Agreement between the Underwriter and the Fund (the "Underwriting Agreement") dated the date hereof, the Underwriter has agreed to purchase, and the Fund has agreed to sell, 2,000 shares of Preferred Shares offered hereby. The Underwriting Agreement provides that the obligations of the Underwriter to purchase the shares included in this offering are subject to the approval of certain legal matters by counsel and to certain other conditions. The Underwriter is obligated to purchase all Preferred Shares offered hereby if it purchases any Preferred Shares. In the Underwriting Agreement, the Fund has agreed to indemnify the Underwriter against certain liabilities, including liabilities arising under the Securities Act of 1933, as amended, or to contribute payments the Underwriter may be required to make for any of those liabilities, and the Manager has agreed to indemnify the Underwriter to the extent the Fund does not. The Fund has been advised by the Underwriter that it proposes initially to offer some Preferred Shares directly to the public at the public offering price set forth on the cover page of this Prospectus and some of the shares to selected dealers at the public offering price less a concession not in excess of $137.50 per share. The underwriting commission the Fund will pay of $250 per share is equal to 1% of the initial offering price. After the initial public offering, the Underwriter may change the public offering price and the concession. The Fund anticipates that the Underwriter may from time to time act as a broker or dealer in connection with the execution of its portfolio transactions after it has ceased to be an underwriter. The Fund anticipates that the Underwriter or one of its affiliates may from time to time act in auctions as a Broker-Dealer and will receive fees as described under "The Auction" in this Prospectus and in the Statement of Additional Information. The Underwriter is an active underwriter of, and dealer in, securities and acts as a market maker in a number of such securities, and therefore can be expected to engage in portfolio transactions with the Fund. The principal business address of Salomon Smith Barney Inc. is 388 Greenwich Street, New York, New York 10013. The settlement date for the purchase of Preferred Shares will be January 28, 2002, as agreed upon by the Underwriter, the Fund and the Manager pursuant to Rule 15c6-1 under the Securities Exchange Act of 1934. 30 LEGAL OPINIONS Certain legal matters in connection with Preferred Shares offered hereby will be passed upon for the Fund by Willkie Farr & Gallagher, New York, New York, and for the Underwriter by Simpson Thacher & Bartlett, New York, New York. Willkie Farr & Gallagher and Simpson Thacher & Bartlett may rely as to certain matters of Maryland law on the opinion of Venable, Baetjer and Howard, LLP, Baltimore, Maryland. ADDITIONAL INFORMATION The Fund is subject to the information requirements of the Securities Exchange Act of 1934 and the 1940 Act, and in accordance therewith files reports and other information with the Commission. Such reports, proxy and public statements and other information can be inspected and copied at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Washington, DC 20549. Call 202-942-8090 for information about the public reference facilities. Copies of such material can be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, DC 20549 at prescribed rates. Such reports, proxy and information statements and other information concerning the Fund may also be inspected at the offices of the American Stock Exchange. The Commission maintains a Web site (http:\\www.sec.gov) that contains the Statement of Additional Information, material incorporated by reference into this Prospectus and the Statement of Additional Information, and reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The registration statement may be inspected without a charge at the Commission's office in Washington, D.C. and copies of all or any part thereof may be obtained from such office after payment of the fees prescribed by the Commission. This Prospectus does not contain all of the information in the Fund's Registration Statement, including amendments, exhibits, and schedules. Statements in this Prospectus about the contents of any contract or other document are not necessarily complete and in each instance reference is made to the copy of the contract or other document filed as an exhibit to the registration statement, each such statement being qualified in all respects by this reference. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements in this Prospectus constitute forward-looking statements, which involve known and unknown risks, uncertainties and other factors that may cause the actual results, levels of activity, performance or achievements of the Fund to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, those listed under "Risk Factors" and elsewhere in this Prospectus. As a result of the foregoing and other factors, no assurance can be given as to the future results, levels of activity or achievements, and neither the Fund nor any other person assumes responsibility for the accuracy and completeness of such statements. 31 TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
Page ---- Investment Objective............................................... S-2 Investment Restrictions............................................ S-2 Investment Policies and Techniques................................. S-3 Management of the Fund............................................. S-13 Portfolio Transactions............................................. S-18 Net Asset Value.................................................... S-19 Additional Information Concerning the Auctions for Preferred Shares S-20 Certain Provisions in the Articles of Incorporation................ S-22 Repurchase of Common Stock; Conversion to Open-End Fund............ S-22 Tax Matters........................................................ S-24 Experts............................................................ S-30 Appendix A -- Ratings of Investments............................... A-1 Appendix B -- Options and Futures.................................. B-1 Appendix C -- Glossary............................................. C-1
32 FURTHER INFORMATION No dealer, salesman or other person has been authorized to give any information or to make any representation not contained in this Prospectus in connection with the offer contained in this Prospectus, and, if given or made, any information or representation must not be relied upon as having been authorized by the Fund, the Fund's investment manager or by the underwriter of the offering described in this Prospectus. This Prospectus does not constitute an offer to sell, or a solicitation of an offer to buy, any securities in any jurisdiction to any person to whom it is unlawful to make an offer or solicitation in such jurisdiction. Neither the delivery of this prospectus nor any sale made pursuant to this Prospectus, under any circumstances, is intended to create an implication that there has been no change in the affairs of the Fund since the date of this Prospectus or that the information in this Prospectus is correct as of any time subsequent to its date. However, if any material change occurs while this Prospectus is required by law to be delivered, this Prospectus will be supplemented or amended accordingly. 33 APPENDIX A TAXABLE EQUIVALENT YIELD TABLE The taxable equivalent yield is the current yield you would need to earn on a taxable investment in order to equal a stated tax-free yield for federal regular income tax purposes on a municipal investment. To assist you to more easily compare municipal investments like the Fund with taxable alternative investments, the table below presents the taxable equivalent yield for a range of hypothetical tax-free yields assuming the stated marginal Federal tax rates for 2002 listed below: Taxable Equivalent of Tax-Free Yields Tax-Free Yield
Tax Rate 1.00% 1.50% 2.00% 2.50% 3.00% - -------- ----- ----- ----- ----- ----- 10.00%................................. 1.11% 1.67% 2.22% 2.78% 3.33% 15.00%................................. 1.18% 1.76% 2.35% 2.94% 3.53% 27.00%................................. 1.37% 2.05% 2.74% 3.42% 4.11% 30.00%................................. 1.43% 2.14% 2.86% 3.57% 4.29% 35.00%................................. 1.54% 2.31% 3.08% 3.85% 4.62% 38.60%................................. 1.63% 2.44% 3.26% 4.07% 4.89%
- -------- * In the table above, the taxable equivalent yields are calculated assuming that the Fund's exempt interest dividends are 100% federally tax-free. To the extent the Fund were to invest in federally taxable investments (which it does not expect to do), its taxable equivalent yield would be lower. The following tables show the approximate taxable yields for individuals that are equivalent to tax-free yields under Federal taxes, using published 2002 marginal Federal tax rates currently available and scheduled to be in effect.
Single Return Joint Return Tax Bracket Bracket Rate 1.00% 1.50% 2.00% 2.50% 3.00% ------------- --------------- ------ ----- ----- ----- ----- ----- $0-6,000 $0-12,000 10.00% 1.11% 1.67% 2.22% 2.78% 3.33% 6,000-27,950 12,000-46,700 15.00% 1.18% 1.76% 2.35% 2.94% 3.53% 27,950-67,700 46,700-112,850 27.00% 1.37% 2.05% 2.74% 3.42% 4.11% 67,700-141,250 112,850-171,950 30.00% 1.43% 2.14% 2.86% 3.57% 4.29% 141,250-307,050 171,950-307,050 35.00% 1.54% 2.31% 3.08% 3.85% 4.62% Over 307,050 Over 307,050 38.60% 1.63% 2.44% 3.26% 4.07% 4.89%
- -------- * Please note that the table does not reflect (i) any federal limitations on the amounts of allowable itemized deductions, phase-outs of personal or dependent exemption credits or other allowable credits, (ii) any state or local taxes imposed, or (iii) any alternative minimum taxes or any taxes other than personal income taxes. A-1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- $50,000,000 Intermediate Muni Fund, Inc. Municipal Auction Rate Cumulative Preferred Stock 2,000 Shares, Series M ------------- PROSPECTUS January 24, 2002 ------------- Salomon Smith Barney - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- INTERMEDIATE MUNI FUND, INC. STATEMENT OF ADDITIONAL INFORMATION This Statement of Additional Information relating to this offering does not constitute a prospectus, but should be read in conjunction with the Prospectus relating thereto dated January 24, 2002. This Statement of Additional Information does not include all information that a prospective investor should consider before purchasing shares of Preferred Shares in this offering, and investors should obtain and read the Prospectus prior to purchasing such shares. A copy of the Prospectus may be obtained without charge by calling 1-800-331-1710. Capitalized terms used but not defined in this Statement of Additional Information have the meanings ascribed to them in the Prospectus. TABLE OF CONTENTS
PAGE ---- Investment Objective ........................................................... S-2 Investment Restrictions ........................................................ S-2 Investment Policies and Techniques ............................................. S-3 Management of the Fund ......................................................... S-13 Portfolio Transactions ......................................................... S-18 Net Asset Value ................................................................ S-19 Additional Information Concerning the Auctions for Preferred Shares ............ S-20 Certain Provisions in the Articles of Incorporation ............................ S-22 Repurchase of Common Stock; Conversion to Open-End Fund ........................ S-22 Tax Matters .................................................................... S-24 Experts ........................................................................ S-30
Appendix A - Ratings of Investments A-1 Appendix B - Options and Futures B-1 Appendix C - Glossary C-1
The date of this Statement of Additional Information is January 24, 2002. INVESTMENT OBJECTIVE The Fund's investment objective is to provide common shareholders a high level of current income exempt from regular federal income taxes consistent with prudent investing. The Fund's investment objective is a fundamental policy of the Fund. The Fund has not established any limit on the percentage of its portfolio that may be invested in municipal obligations subject to the alternative minimum tax provisions ("AMT") of federal tax law, and the Fund expects that a substantial portion of the income it produces will be includable in AMT income. Preferred Shares therefore would not ordinarily be a suitable investment for investors who are subject to the AMT or who would become subject to such tax by purchasing Preferred Shares. The suitability of an investment in Preferred Shares will depend upon a comparison of the after-tax yield likely to be provided from the Fund with that from comparable tax-exempt investments not subject to the AMT, and from comparable fully taxable investments, in light of each such investor's tax position. Special considerations apply to corporate investors. See "Tax Matters." Under normal market conditions, the Fund will invest at least two-thirds of its total assets in municipal obligations rated, at the time of investment, (i) "A" or better by S&P or by Moody's or (ii) within the three highest categories by an NRSRO (or, if unrated, deemed by the Manager to be of comparable quality). The Fund's policies on the credit quality of its investments apply only at the time of the purchase of a security, and the Fund is not required to dispose of securities in the event that S&P or Moody's or any other NRSRO downgrades its assessment of the credit characteristics of a particular issuer or in the event the Manager reassesses its view with respect to the credit quality of the issuer thereof. INVESTMENT RESTRICTIONS The following investment restrictions of the Fund are fundamental and cannot be changed without the approval of the holders of a majority of the Fund's outstanding voting securities as defined in the 1940 Act. If a percentage restriction on investment or use of assets set forth below is adhered to at the time a transaction is effected, later changes in percentage resulting from changing market values will not be considered a deviation from policy. The Fund may not: 1. Purchase securities (other than obligations issued or guaranteed by the United States Government or its agencies or instrumentalities) of any issuer if as a result of the purchase, more than 5% of the value of the Fund's total assets would be invested in the securities of the issuer, except that up to 25% of the value of the Fund's total assets may be invested without regard to this 5% limitation. 2. Invest more than 25% of its total assets in a single industry; however, as described under "Investment Objective and Management Policies" in the Prospectus, the Fund may from time to time invest more than 25% of its total assets in a particular segment of the municipal securities market or in obligations of issuers located in the same state. 3. Issue senior securities if such issuance is specifically prohibited by the 1940 Act or the rules or regulations thereunder. S-2 4. Borrow money in excess of 33 1/3% of its total assets (including the amount of money borrowed but excluding any liabilities and indebtedness not constituting senior securities) except that the Fund may borrow up to an additional 5% of its total assets for temporary purposes; pledge its assets other than to secure such borrowings or in connection with when-issued and forward commitment transactions and similar investment strategies. 5. Make loans of money or property to any person, except to the extent that the securities in which the Fund may invest are considered to be loans and except that the Fund may lend money or property in connection with the maintenance of the value of or the Fund's interest with respect to the municipal securities owned by the Fund. 6. Buy any securities on "margin." Neither the deposit of initial or variation margin in connection with hedging and risk management transactions nor short-term credits as may be necessary for the clearance of transactions is considered the purchase of a security on margin. 7. Sell any securities "short," write, purchase or sell puts, calls or combinations thereof, or purchase or sell financial futures or options, except as described under the heading "Investment Policies and Techniques -- Investment Techniques" and in Appendix B to this Statement of Additional Information. 8. Act as an underwriter of securities, except to the extent that the Fund may be deemed an underwriter in connection with the sale of securities in its portfolio. 9. Make investments for the purpose of exercising control or participation in management, except to the extent that exercise by the Fund of its rights under agreements related to municipal securities would be deemed to constitute such control or participation. 10. Invest in securities of other investment companies in an amount exceeding the limitation set forth in the 1940 Act and the rules thereunder, except as part of a merger, consolidation or other acquisition. 11. Invest in equity interests in oil, gas or other mineral exploration or development programs except pursuant to the exercise by the Fund of its rights under agreements relating to municipal securities. 12. Purchase or sell real estate, commodities or commodity contracts, except to the extent that the municipal securities the Fund may invest in are considered to be interests in real estate, commodities or commodity contracts, or to the extent that the Fund exercises its rights under agreements relating to such municipal securities (in which case the Fund may liquidate real estate acquired as a result of default on a mortgage). INVESTMENT POLICIES AND TECHNIQUES The following information supplements the discussion of the Fund's investment objective, policies, and techniques that are described in the Prospectus. S-3 The Fund's policy is to invest at least 80% of its total assets in municipal obligations with remaining maturities of less than fifteen years and to maintain a dollar-weighted average effective maturity of the entire portfolio between three and ten years. For this purpose, any scheduled principal prepayments will be reflected in the calculation of dollar-weighted average effective maturity. Investment In Municipal Obligations. Municipal obligations are ----------------------------------- obligations issued by or on behalf of states, territories and possessions of the United States and the District of Columbia and their political subdivisions, agencies and instrumentalities, the interest on which, in the opinion of bond counsel or other counsel to the issuer of such securities is, at the time of issuance, not includable in gross income for federal income tax purposes. Under normal market conditions, at least 80% of the Fund's total assets will be invested in municipal obligations with remaining maturities of less than fifteen years. This policy is fundamental and cannot be changed without shareholder approval. The "issuer" of municipal obligations is generally deemed to be the governmental agency, authority, instrumentality or other political subdivision, or the non-governmental user of a revenue bond-financed facility, the assets and revenues of which will be used to meet the payment obligations, or the guarantee of such payment obligations, of the municipal obligations. Municipal obligations may have fixed or variable interest rates. The Fund may purchase floating and variable rate demand notes, which are municipal obligations normally having a stated maturity in excess of one year, but which permit the holder to tender the notes for purchase at the principal amount thereof. The interest rate on a floating rate demand note is based on a known lending rate, such as a bank's prime rate, and is adjusted each time such rate is adjusted. The interest rate on a variable rate demand note is adjusted at specified intervals. There generally is no secondary market for these notes, although they may be tendered for redemption or remarketing at face value. Each such note purchased by the Fund will meet the criteria established for the purchase of municipal obligations. The Fund's investments in municipal obligations may be subject to certain risks. In addition to those discussed in the Prospectus, they include the following. Municipal obligations that have fixed rates of interest are sensitive to changes in interest rates. Generally, when interest rates are rising, the value of the Fund's fixed-income securities can be expected to decrease. When interest rates are declining, the value of the Fund's fixed-income securities can be expected to increase. The Fund's net asset value may fluctuate in response to the increasing or decreasing value of the Fund's fixed-income securities. The issuer of a municipal obligation might declare bankruptcy and the Fund could experience delays collecting interest and principal. To enforce its rights, the Fund might be required to take possession of and manage the assets securing the issuer's obligation. This may increase the Fund's expenses, reduce its net asset value and increase the amount of the Fund's distributions that is in taxable form. If the Fund took possession of a bankrupt issuer's assets, income derived from the Fund's ownership and management of the assets may not be tax exempt. Shareholders may receive more of the total distributions from the Fund in taxable form. The Fund might not be able to take possession of the assets of a bankrupt issuer because of laws S-4 protecting state and local institutions, limits on the investments the Fund is permitted to make, and the nature of the income the Fund is entitled to receive from its investments imposed on it by the Code. If the Fund cannot take possession of the assets and enforce its rights, the value of the security may be greatly diminished. This could reduce the Fund's net asset value. The U.S. Government has enacted laws that have restricted or diminished the income tax exemption on some municipal obligations and it may do so again in the future. If this were to happen, shareholders could receive more of the distributions from the Fund in taxable form. The issuer of a municipal obligation may be obligated to redeem the security at face value, but if the Fund paid more than face value for the security, the Fund may lose money on the security when it is sold. Market rates of interest may be lower for municipal obligations than for taxable securities but this may be offset by the federal income tax on income derived from taxable securities. There may be less extensive information available about the financial condition of issuers of municipal obligations than for corporate issuers with publicly traded securities. Lease Obligations. Also included within the general category of ----------------- municipal obligations are participations in lease obligations or installment purchase contract obligations (hereinafter collectively called "lease obligations") of municipal authorities or entities. Although lease obligations do not constitute general obligations of the municipality for which the municipality's taxing power is pledged, a lease obligation is ordinarily backed by the municipality's covenant to budget for, appropriate and make the payments due under the lease obligation. However, certain lease obligations contain "non-appropriation" clauses which provide that the municipality has no obligation to make lease or installment purchase payments in future years unless money is appropriated for such purpose on a yearly basis. In addition to the "non-appropriation" risk, these securities represent a relatively new type of financing that has not yet developed the depth of marketability associated with more conventional bonds. Although "non-appropriation" lease obligations are often secured by the underlying property, disposition of the property in the event of foreclosure might prove difficult. The Fund may invest up to 100% of its assets in "non-appropriation" lease obligations and in unrated "non-appropriation" lease obligations believed, at the time of investment, by the Manager to have credit characteristics equivalent to, and to be of comparable quality as, securities that are rated investment grade. In evaluating such unrated lease obligations, the Manager will consider such factors as it deems appropriate, including: . whether the lease can be cancelled; . the ability of the lease obligee to direct the sale of the underlying assets; . the general creditworthiness of the lease obligor; . the likelihood that the municipality will discontinue appropriating funding for the leased property in the event such property is no longer considered essential by the municipality; S-5 . the legal recourse of the lease obligee in the event of such a failure to appropriate funding; and . any limitations which are imposed on the lease obligor's ability to utilize substitute property or services other than those covered by the lease obligations. Participation Certificates. Participation certificates are -------------------------- obligations issued by state and local governments or authorities to finance the acquisition of equipment and facilities. They may represent participations in a lease, an installment purchase contract, or a conditional sales contract. Some municipal leases and participation certificates may not be readily marketable. Zero Coupon Bonds. The Fund may invest in zero coupon bonds. A ----------------- zero coupon bond pays no interest in cash to its holder during its life, although interest is accrued during that period. Its value to an investor consists of the difference between its face value at the time of maturity and the price at which it was issued, which is generally an amount significantly less than its face value (sometimes referred to as a "deep discount" price). Because these securities usually trade at a deep discount, they will be subject to greater fluctuations of market value in response to changing interest rates than debt obligations of comparable maturities which make periodic distributions of interest. On the other hand, because there are no periodic interest payments to be reinvested prior to maturity, zero coupon securities eliminate the reinvestment risk and lock in a rate of return to maturity. INVESTMENT TECHNIQUES The Fund may employ, among others, the investment techniques described below, which may give rise to taxable income. In connection with the investment objective and policies described in this Statement of Additional Information and in the Prospectus, the Fund may: purchase and sell options (including swaps, caps, floors and collars) on municipal securities and on indices based on municipal securities; borrow funds and issue senior securities to the extent permitted under the 1940 Act; engage in interest rate and other hedging and risk management transactions; and purchase and sell municipal securities on a "when-issued" or "delayed delivery" basis. These investment practices entail risks. The Manager may use some or all of the following hedging and risk management practices when their use appears appropriate. Although the Manager believes that these investment practices may further the Fund's investment objective, no assurance can be given that these investment practices will achieve this result. The Manager may also decide not to engage in any of these investment practices. Securities Options Transactions. The Fund may invest in options ------------------------------- on municipal securities, traded over-the-counter and, if applicable, traded on a national securities exchange. In general, the Fund may purchase and sell (or write) options on up to 20% of its assets. The Commission requires that obligations of investment companies such as the Fund, in connection with options sold, must comply with certain segregation or cover requirements which are more fully described in Appendix B to this Statement of Additional Information. There is no limitation on the amount of the Fund's assets which can be used to comply with such segregation or cover requirements. S-6 A call option gives the purchaser the right to buy, and the writer the obligation to sell, the underlying security at the agreed-upon exercise (or "strike") price during the option period. A put option gives the purchaser the right to sell, and the writer the obligation to buy, the underlying security at the strike price during the option period. Purchasers of options pay an amount, known as a premium, to the option writer in exchange for the right under the option contract. Option contracts may be written with terms which would permit the holder of the option to purchase or sell the underlying security only upon the expiration date of the option. The Fund may purchase put and call options in hedging transactions to protect against a decline in the market value of municipal securities in the Fund's portfolio (e.g., by the purchase of a put option) and to protect against an increase in the cost of fixed-income securities that the Fund may seek to purchase in the future (e.g., by the purchase of a call option). In the event the Fund purchases put and call options, paying premiums therefor, and price movements in the underlying securities are such that exercise of the options would not be profitable for the Fund, to the extent such underlying securities correlate in value to the Fund's portfolio securities, losses of the premiums paid may be offset by an increase in the value of the Fund's portfolio securities (in the case of a purchase of put options) or by a decrease in the cost of acquisition of securities by the Fund (in the case of a purchase of call options). The Fund may also sell put and call options as a means of increasing the yield on the Fund's portfolio and also as a means of providing limited protection against decreases in market value of the Fund's portfolio. When the Fund sells an option, if the underlying securities do not increase (in the case of a call option) or decrease (in the case of a put option) to a price level that would make the exercise of the option profitable to the holder of the option, the option generally will expire without being exercised and the Fund will realize as profit the premium received for such option. When a call option written by the Fund is exercised, the option holder purchases the underlying security at the strike price and the Fund does not participate in any increase in the price of such securities above the strike price. When a put option written by the Fund is exercised, the Fund will be required to purchase the underlying securities at the strike price, which may be in excess of the market value of such securities. OTC Options. Over-the-counter options (OTC options) differ ----------- from exchange-traded options in several respects. They are transacted directly with dealers and not with a clearing corporation, and there is a risk of non-performance by the dealer. OTC options are available for a greater variety of securities and for a wider range of expiration dates and exercise prices than are exchange-traded options. Because OTC options are not traded on an exchange, pricing is normally done by reference to information from a market maker, which information is carefully monitored by the Manager and verified in appropriate cases. The Fund may be required to treat certain of its OTC options transactions as illiquid securities. See Appendix B to this Statement of Additional Information. It will generally be the Fund's policy, in order to avoid the exercise of an option sold by it, to cancel its obligation under the option by entering into a closing purchase transaction, if available, unless it is determined to be in the Fund's interest to sell (in the case of a call option) or to purchase (in the case of a put option) the underlying securities. A closing purchase transaction consists of the Fund purchasing an option having the same terms as the option sold by the Fund and has the effect of cancelling the Fund's position as a seller. The S-7 premium which the Fund will pay executing a closing purchase transaction may be higher than the premium received when the option was sold, depending in large part upon the relative price of the underlying security at the time of each transaction. To the extent options sold by the Fund are exercised and the Fund either delivers portfolio securities to the holder of a call option or liquidates securities in its portfolio as a source of funds to purchase securities put to the Fund, the Fund's portfolio turnover rate will increase, which would cause the Fund to incur additional brokerage expenses. During the option period, the Fund, as a covered call writer, gives up the potential appreciation above the exercise price should the underlying security rise in value, and the Fund, as a secured put writer, retains the risk of loss should the underlying security decline in value. For the covered call writer, substantial appreciation in the value of the underlying security would result in the security being "called away" at the strike price of the option which may be substantially below the fair market value of such security. For the secured put writer, substantial depreciation in the value of the underlying security would result in the security being "put to" the writer at the strike price of the option which may be substantially in excess of the fair market value of such security. If a covered call option or a secured put option expires unexercised, the writer realizes a gain, and the buyer a loss, in the amount of the premium. To the extent that an active market exists or develops, whether on a national securities exchange or over-the-counter, in options on indices based upon municipal securities, the Fund may purchase and sell options on such indices, subject to the limitation that the Fund may purchase and sell options on up to 20% of its assets. Through the writing or purchase of index options, the Fund can achieve many of the same objectives as through the use of options on individual securities. Options on securities indices are similar to options on securities except that, rather than the right to take or make delivery of a security at a specified price, an option on a securities index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of the securities index upon which the option is based is greater than, in the case of a call, or less than, in the case of a put, the strike price of the option. Price movements in securities which the Fund owns or intends to purchase will not correlate perfectly with movements in the level of an index and, therefore, the Fund bears the risk of a loss on an index option which is not completely offset by movements in the price of such securities. Because index options are settled in cash, a call writer cannot determine the amount of its settlement obligations in advance and, unlike call writing on specific securities, cannot provide in advance for, or cover, its potential settlement obligations by acquiring and holding the underlying securities. Gains, if any, recognized or deemed to be recognized by the Fund from transactions in securities options will be taxable income of the Fund. Under a revenue ruling issued by the Internal Revenue Service (the "IRS"), the Fund is required to allocate its tax-exempt income, net capital gain and other taxable income, if any, between the Common Stock and preferred stock, including the Preferred Shares, issued by the Fund on a pro rata basis in proportion to the total dividends paid to each such class of stock for the tax year. See "Tax Matters." For a further discussion of certain characteristics of options and risks associated with options transactions, see Appendix B to this Statement of Additional Information. S-8 Borrowing and Leverage. The Fund is authorized to borrow ---------------------- amounts up to 33-1/3% of its total assets (including the amount borrowed). The use of borrowed Funds involves the speculative factor known as "leverage." The Fund is also permitted under its Articles of Incorporation to issue preferred stock, including the Preferred Shares issued pursuant to the Registration Statement of which the Prospectus and this Statement of Additional Information form a part, which would permit it to assume leverage in an amount up to 50% of its total assets. Preferred stock, including, when issued, the Preferred Shares, would have a priority on the income and assets of the Fund over the Common Stock and would have certain other rights with respect to voting and the election of directors. In certain circumstances, the net asset value of and dividends payable on shares of Common Stock could be adversely affected by such preferences. The use of leverage creates an opportunity for increased returns to holders of the Common Stock, but, at the same time, creates special risks. The Fund will only utilize leverage when there is an expectation that it will benefit the Fund or the holders of Common Stock. To the extent the income or other gain derived from securities purchased with the proceeds of borrowings or preferred stock issuances exceed the interest or dividends the Fund would have to pay thereon, the Fund's net income or other gain would be greater than if leverage had not been used. Conversely, if the income or other gain from the securities purchased through leverage is not sufficient to cover the cost of such leverage the total return of the Fund would be less than if leverage had not been used. If leverage is used, in certain circumstances, the Fund could be required to liquidate securities it would not otherwise sell in order to satisfy dividend or interest obligations. The Fund may also borrow up to an additional 5% of its total assets for temporary purposes without regard to the foregoing limitations. See "Investment Restrictions." In addition to the foregoing, the Fund may borrow on a short-term basis in order to facilitate the settlement of portfolio securities transactions. Interest Rate and Other Hedging Transactions. In order to seek -------------------------------------------- to protect the value of its portfolio securities against declines resulting from changes in interest rates or other market changes, the Fund may enter into the following hedging transactions: financial futures contracts and related options contracts. The Fund may enter into various interest rate hedging transactions using financial instruments with a high degree of correlation to the municipal securities which the Fund may purchase for its portfolio, including interest rate futures contracts (e.g., futures contracts on U.S. Treasury securities) and futures contracts on interest rate related indices (e.g., municipal bond indices). The Fund may also purchase and write put and call options on such futures contracts and on the underlying instruments. The Fund may enter into these transactions in an attempt to "lock in" a return or spread on a particular investment or portion of its portfolio, to protect against any increase in the price of securities the Fund anticipates purchasing at a later date, or for other risk management strategies such as managing the effective dollar-weighted average duration of the Fund's portfolio. Financial futures and options contracts and the risk attendant to the Fund's use thereof, are more completely described in Appendix B to this Statement of Additional Information. The successful utilization of hedging and risk management transactions requires skills different from those needed in the selection of the Fund's portfolio securities. S-9 The Fund will not engage in the foregoing transactions for speculative purposes, but only in limited circumstances as a means to hedge risks associated with management of the Fund's portfolio. Typically, investments in futures contracts and sales of futures options contracts require the Fund to deposit in a custodial account a good faith deposit, known as "initial margin," in connection with its obligations in an amount of cash or specified debt securities which generally is equal to 1%-15% of the face amount of the contract, which initial margin requirement may be revised periodically by the applicable exchange as the volatility of the contract fluctuates. Thereafter, the Fund must make additional deposits with the applicable financial intermediary equal to any net losses due to unfavorable price movements of the contract, and will be credited with an amount equal to any net gains due to favorable price movements. These additional deposits or credits are calculated and required daily and are known as "variation margin." The Commission generally requires that when investment companies, such as the Fund, effect transactions of the foregoing nature, such Funds must either segregate cash or liquid securities in the amount of their obligations under the foregoing transactions, or cover such obligations by maintaining positions in portfolio securities, futures contracts or options that would serve to satisfy or offset the risk of such obligations. When effecting transactions of the foregoing nature, the Fund will comply with such segregation or cover requirements. There is no limitation on the percentage of the Fund's assets which may be segregated with respect to such transactions. The Fund will not enter into a futures contract or related option, if immediately after such investment, the sum of the amount of its initial margin deposit and premiums on open contracts and options would exceed 5% of the fair market value of the Fund's total assets after taking into account unrealized profits and unrealized losses on any such contracts. The Fund may, however, invest more than such amount in the future if it obtains authority to do so from the appropriate regulatory agencies without requiring the Fund to register as a commodity pool operator or adversely affecting its status as an investment company for federal securities law or a regulated investment company for income tax purposes. All of the foregoing transactions present certain risks. In particular, the variable degree of correlation between price movements of futures contracts and price movements in the securities being hedged creates the possibility that losses on the hedge may be greater than gains in the value of the Fund's securities. In addition, these instruments may not be liquid in all circumstances and generally are closed out by entering into offsetting transactions rather than by delivery or cash settlement at maturity. As a result, in volatile markets, the Fund may not be able to close out a transaction on favorable terms or at all. Although the contemplated use of those contracts should tend to reduce the risk of loss due to a decline in the value of the hedged security, at the same time the use of these contracts could tend to limit any potential gain which might result from an increase in the value of such security. Finally, the daily deposit requirements for futures contracts and sales of futures options contracts create an ongoing greater potential financial risk than do option purchase transactions, where the exposure is limited to the cost of the premium for the option. Successful use of futures contracts and options thereon by the Fund is subject to the ability of the Manager to predict correctly movements in the direction of interest rates and S-10 other factors affecting securities markets. If the Manager's expectations are not met, the Fund would be in a worse position than if a hedging strategy had not been pursued. For example, if the Fund has hedged against the possibility of an increase in interest rates which would adversely affect the price of securities in its portfolio and the price of such securities increases instead, the Fund will lose part or all of the benefit of the increased value of its securities because it will have offsetting losses in its futures positions. In addition, in such situations, if the Fund has insufficient cash to meet daily variation margin requirements, it may have to sell securities to meet such requirements. Such sales of securities may be, but will not necessarily be, at increased prices which reflect the rising market. The Fund may have to sell securities at a time when it is disadvantageous to do so. In addition to engaging in transactions utilizing options on futures contracts, the Fund may purchase put and call options on securities and, as developed from time to time, on interest indices and other instruments. Purchasing options may increase investment flexibility and improve total return, but also risks loss of the option premium if an asset the Fund has the option to buy declines in value or if an asset the Fund has the option to sell increases in value. New options and futures contracts and other financial products and various combinations thereof continue to be developed and the Fund may invest in any such options, contracts and products as may be developed to the extent consistent with its investment objective and the regulatory requirements applicable to investment companies. Gains, if any, recognized or deemed to be recognized by the Fund from its hedging activities will be taxable income of the Fund. See "Tax Matters." When-Issued And Delayed Delivery Transactions. The Fund may --------------------------------------------- purchase municipal securities on a "when-issued" and "delayed delivery" basis. No income accrues to the Fund on municipal securities in connection with such transactions prior to the date the Fund actually takes delivery of such securities. These transactions are subject to market fluctuation; the value of the municipal securities at delivery may be more or less than their purchase price, and yields generally available on municipal securities when delivery occurs may be higher than yields on the municipal securities obtained pursuant to such transactions. Because the Fund relies on the buyer or seller, as the case may be, to consummate the transaction, failure by the other party to complete the transaction may result in the Fund missing the opportunity of obtaining a price or yield considered to be advantageous. When the Fund is the buyer in such a transaction, however, it will maintain, in a segregated account, cash, or liquid securities, having a value equal to or greater than the Fund's purchase commitments, provided such securities have been determined by the Manager to be liquid and unencumbered, and are marked to market daily, pursuant to guidelines established by the Board. The Fund will make commitments to purchase municipal securities on such basis only with the intention of actually acquiring these securities, but the Fund may sell such securities prior to the settlement date if such sale is considered to be advisable. To the extent that the Fund engages in "when-issued" and "delayed delivery" transactions, it will do so for the purpose of acquiring securities for the Fund's portfolio consistent with the Fund's investment objective and policies. However, although the Fund does not intend to engage in such transactions for speculative purposes, purchases of securities on S-11 such basis may involve more risk than other types of purchases. For example, if the Fund determines it is necessary to sell the "when-issued" or "delayed delivery" securities before delivery, it may realize a gain or incur a loss because of market fluctuations since the time the commitment to purchase such securities was made. Subject to the requirement of maintaining a segregated account, no specified limitation exists as to the percentage of the Fund's assets which may be used to acquire securities on a "when-issued" or "delayed delivery" basis. A significant percentage of the Fund's assets committed to the purchase of securities on a "when-issued" or "delayed delivery" basis may increase the volatility of the Fund's net asset value and may limit the flexibility to manage the Fund's investments. Repurchase Agreements. The Fund may use repurchase agreements --------------------- to manage its cash position. A repurchase agreement is a contractual agreement whereby the seller of securities (U.S. Government securities or municipal bonds) agrees to repurchase the same security at a specified price on a future date agreed upon by the parties. The agreed-upon repurchase price determines the yield during the Fund's holding period. Repurchase agreements are considered to be loans collateralized by the underlying security that is the subject of the repurchase contract. Income, if any, generated from transactions in repurchase agreements will be taxable. See "Tax Matters" for information relating to the allocation of taxable income, if any, between the Common Stock and Preferred Shares. If the other party to the repurchase agreement defaults, the Fund may not be able to sell the underlying securities. If the Fund must assert its rights against the other party to recover the securities, the Fund will incur unexpected expenses, risk losing the income on the security and bear the risk of loss in the value of the security. Investment in Other Investment Companies. The Fund does not ---------------------------------------- presently invest in investment companies and does not currently intend to invest in investment companies, but the Fund may, consistent with the provisions of the 1940 Act and the Fund's investment restrictions, determine to do so in the future in appropriate circumstances. Presently, under the 1940 Act, the Fund may hold securities of another investment company in amounts which (i) do not exceed 3% of the total outstanding voting stock of such company, (ii) do not exceed 5% of the value of the Fund's total assets and (iii) when added to all other investment company securities held by the Fund, do not exceed 10% of the value of the Fund's total assets. In the event of such an investment, as a shareholder in an investment company the Fund would bear its ratable share of the investment company's expenses, including management fees, and would remain subject to payment of the Fund's administration fees and other expenses with respect to assets so invested. PORTFOLIO TRADING AND TURNOVER RATE The Fund cannot accurately predict its turnover rate, but anticipates that its annual turnover rate will not exceed 100%. The Fund's turnover rate is calculated by dividing the lesser of the Fund's sales or purchases of securities during a year (excluding any security the maturity of which at the time of acquisition is one year or less) by the average monthly value of the Fund's securities for the year. The Fund generally will not engage in the trading of securities for the purpose of realizing short-term profits, but it will adjust its portfolio as it deems advisable in view of prevailing or anticipated market conditions to accomplish the Fund's investment S-12 objective. For example, the Fund may sell portfolio securities in anticipation of a movement in interest rates. Higher turnover rates can result in corresponding increases in the Fund's transaction costs, which must be borne by the Fund and its shareholders. High portfolio turnover may also result in the realization of substantial net short-term capital gains, and any distributions resulting from such gains will be taxable at ordinary income rates for federal income tax purposes. Other than for tax purposes, frequency of portfolio turnover will not be a limiting factor if the Fund considers it advantageous to purchase or sell securities. MANAGEMENT OF THE FUND OFFICERS AND DIRECTORS The business and affairs of the Fund, including the general supervision of the duties performed by the Manager under the Investment Management Agreement, are the responsibility of the Board. The Board currently has nine Directors, one of whom is an "interested person" (as such term is defined in the 1940 Act) and eight of whom are not interested persons. The names and business addresses of the Directors and officers of the Fund and their principal occupations and other affiliations during the past five years are set forth below.
POSITIONS AND PRINCIPAL OCCUPATIONS OFFICES WITH THE DURING PAST FIVE YEARS NAME AND ADDRESS FUND AND AGE - --------------------- --------------------- ----------------------------------- Heath B. McLendon*+ Chairman of the Board Managing Director of Salomon 125 Broad Street of Directors, Chief Smith Barney; Chairman, Co- New York, NY 10004 Executive Officer and Chairman or Director/Trustee of President the Board of 77 investment companies associated with Citigroup; President, Smith Barney Fund Management LLC and Travelers Investment Adviser, Inc. ("TIA"); 68. Lee Abraham+ Director Retired; Director of R.G. Barry 106 Barnes Road Corp., a footwear manufacturer, Stamford, CT 06902 Signet Group plc, a specialty retailer and eNote.com, Inc., a computer hardware company; formerly, Chairman and Chief Executive Officer of Associated Merchandising Corporation, a major retail merchandising and sourcing organization; Director/Trustee of 11 investment companies associated with Citigroup; 74. Allan J. Bloostein+ Director President of Allan J. Bloostein 27 West 67th Street Associates, a consulting firm; New York, NY 10023 Director of CVS Corporation, a drugstore chain, and Taubman
S-13
POSITIONS AND PRINCIPAL OCCUPATIONS OFFICES WITH THE DURING PAST FIVE YEARS NAME AND ADDRESS FUND AND AGE ------------------------------ ---------------- ------------------------------- Centers Inc., a real estate development company; retired Vice Chairman and Director of The May's Department Stores Company; Director/Trustee of 18 investment companies associated with Citigroup; 72. Jane F. Dasher+ Director Investment Officer, Korsant 283 Greenwich Avenue Partners, a family investment Greenwich, CT 06830 company; prior to 1997, independent financial consultant; Director/Trustee of 11 investment companies associated with Citigroup; 52. Donald R. Foley+ Director Retired; formerly, Vice President 3668 Freshwater Drive of Edwin Bird Wilson, Jupiter, FL 33477 Incorporated, an advertising firm; Director/Trustee of 11 investment companies associated with Citigroup; 79. Richard E. Hanson, Jr. + Director Retired; formerly, Head of School, 2751 Vermont Rte. 140 The New Atlanta Jewish Community Poultney, VT 05764 High School, Atlanta, Georgia; Headmaster, The Peck School, Morristown, New Jersey; Director/Trustee of 11 investment companies associated with Citigroup; 60. Paul Hardin+ Director Chancellor Emeritus and Professor 12083 Morehead of Law at the University of North Chapel Hill, NC 27514 Carolina at Chapel Hill; formerly, Director of The Summit Bancorporation; formerly, Chancellor of the University of North Carolina at Chapel Hill; Director/Trustee of 13 investment companies associated with Citigroup; 70. Roderick C. Rasmussen+ Director Investment counselor; formerly, 9 Cadence Court Vice President of Dresdner and Morristown, NJ 07960 Company Inc., investment counselors; Director/Trustee of 11 investment companies associated with Citigroup; 75. John P. Toolan+ Director Retired; Trustee of John Hancock 13 Chadwell Place Funds; formerly, Director and Morristown, NJ 07960 Chairman of Smith Barney Trust
S-14
POSITIONS AND PRINCIPAL OCCUPATIONS OFFICES WITH THE DURING PAST FIVE YEARS NAME AND ADDRESS FUND AND AGE ------------------------------ ---------------- ---------------------------------- Company, Director of Smith Barney Holdings Inc. and various subsidiaries, Senior Executive Vice President, Director and Member of the Executive Committee of Smith Barney; Director/Trustee of 11 investment companies associated with Citigroup; 71. Lewis E. Daidone Senior Vice President, Managing Director of Salomon 125 Broad Street Chief Financial and Smith Barney, Senior Vice New York, NY 10004 Accounting Officer and President or Executive Vice Treasurer President and Treasurer of 83 investment companies associated with Citigroup; Director and Senior Vice President of Smith Barney Fund Management and TIA; 44. Peter Coffey Vice President and Managing Director of Salomon 333 West 34th Street Investment Officer Smith Barney, Vice President of New York, NY 10001 Smith Barney Fund Management and 5 investment companies associated with Citigroup; 57. Anthony Pace Controller Director of Salomon Smith Barney 125 Broad Street and Controller or Assistant New York, NY 10004 Treasurer of 61 investment companies associated with Citigroup since 1998; 36. Christina T. Sydor Secretary Managing Director of Salomon 666 Fifth Avenue Smith Barney and Secretary of New York, NY 10103 certain investment companies associated with Citigroup; Secretary and General Counsel of Smith Barney Fund Management; 50.
* Denotes a director who is an "interested person" of the Fund as defined in the 1940 Act. + Director, trustee and/or general partner of other investment companies registered under the 1940 Act with which Salomon Smith Barney is affiliated. Fees for directors who are not "interested persons" of the Fund and who are directors of a group of funds sponsored by Salomon Smith Barney (the "Fund Complex") are set at $60,000 per year and are allocated based on relative net assets of each fund in the Fund Complex, plus a per-meeting fee of $2,500 with respect to in-person meetings. In addition, these directors receive $100 per fund for each telephone meeting plus travel and out-of-pocket S-15 expenses incurred in connection with board meetings. The board meeting fees and out-of-pocket expenses are borne proportionately by each individual fund or portfolio in the Fund Complex. The following table sets forth compensation paid by the Fund to each person who was a Director during the Fund's most recent fiscal year (from January 1, 2001 through December 31, 2001). The Fund does not have a retirement or pension plan.
AGGREGATE PENSION OR RETIREMENT COMPENSATION FROM BENEFITS ACCRUED AS PART OF TOTAL COMPENSATION FROM NAME OF DIRECTOR FUND FUND EXPENSES FUND COMPLEX ---------------- ---- ------------- ------------ Lee Abraham ................ $166 $0 $ 71,625 Allan J. Bloostein ......... $191 $0 $116,400 Jane F. Dasher ............. $229 $0 $ 74,500 Donald R. Foley+ ........... $ 97 $0 $ 49,900 Richard E. Hanson, Jr. ..... $129 $0 $ 73,800 Paul Hardin ................ $129 $0 $ 97,150 Heath B. McLendon* ......... $ 0 $0 $ 0 Roderick C. Rasmussen+ ..... $189 $0 $ 44,000 John P. Toolan+ ............ $ 0 $0 $ 0
_________ * Designates a Director who is an "interested person" of the Fund. + Pursuant to a deferred compensation plan, the indicated persons elected to defer the following amounts of their compensation from the Fund: Donald R. Foley: $22, Roderick C. Rasmussen: $19, and John P. Toolan: $229, and the following amounts of their total compensation from the Fund Complex: Donald R. Foley: $21,600, Roderick C. Rasmussen: $30,000, and John P. Toolan: $71,500. Upon attainment of age 72, the Fund's current Directors may elect to change to emeritus status. Any directors elected or appointed to the Board in the future will be required to change to emeritus status upon attainment of age 80. Directors emeritus are entitled to serve in emeritus status for a maximum of 10 years during which time they are paid 50% of the annual retainer fee and meeting fees otherwise applicable to the Fund Directors, together with reasonable out-of-pocket expenses for each meeting attended. During the Fund's fiscal year ended December 31, 2001, aggregate compensation from the Fund to emeritus directors totaled $47. The Board has no compensation committee or any committee performing similar functions. The Board has an administrative and governance committee composed of Lee Abraham, Jane F. Dasher, Donald R. Foley and Paul Hardin, which acts as a nominating committee of the Board. The Fund has an audit and investment performance committee (the "Audit Committee"). The Audit Committee is charged with recommending a firm of independent auditors to the Board and reviewing the Fund's accounting matters. The Audit Committee consists of Allan J. Bloostein, Richard E. Hanson, Jr., Roderick C. Rasmussen and John P. Toolan. The Fund has a pricing committee which is charged with determining fair value prices for securities when required. The directors of these respective committees are not "interested persons" of the Fund as defined under the 1940 Act. Eight meetings of the Board were held between January 1, 2001 and December 31, 2001, four of which were regular meetings. Four administrative and governance committee meetings, and three Audit Committee meetings were held. No pricing committee meetings were held. No incumbent director attended less than 75% of meetings of the Board or of any committee on which he or she serves. INVESTMENT MANAGER Smith Barney Fund Management LLC, or SBFM (formerly known as SSB Citi Fund Management LLC), serves as the Fund's investment manager. Pursuant to an investment management agreement (the "Investment Management Agreement"), the Fund has retained the Manager to manage the investment of the Fund's assets and to provide such investment research, advice and supervision, in conformity with the Fund's investment objective and policies, as may be necessary for the investment activities of the Fund. The Manager is also the Fund's administrator and oversees the Fund's non-investment operations and its relations with its service providers. The Manager administers the Fund's corporate affairs subject to the supervision of the Fund's Board and, in connection therewith, furnishes the Fund with office facilities together with such ordinary clerical and bookkeeping services (e.g., preparation of annual and other reports to shareholders and the S-16 Commission and the filing of federal, state and local income tax returns) as are not being furnished by the Fund's custodian. The Investment Management Agreement provides, among other things, that the Manager will bear all expenses of its employees and overhead incurred in connection with its duties under the Investment Management Agreement, other than those assumed by the Fund, as described in the Prospectus, and will pay all Director's fees and salaries of the Fund's Directors and officers who are affiliated persons (as such term is defined in the 1940 Act) of the Manager. The Investment Management Agreement provides that the Fund shall pay to the Manager a monthly fee in arrears equal to 0.60% per year of the Fund's average daily total net assets at the end of each month. For purposes of calculating the management fee, the liquidation value of any outstanding preferred stock of the Fund is not deducted in determining the Fund's average daily total net assets. Although the Manager intends to devote such time and effort to the business of the Fund as reasonably necessary to perform its duties to the Fund, the services of the Manager are not exclusive and the Manager provides similar services to other investment companies and may engage in other activities. The Investment Management Agreement also provides that in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations thereunder, the Manager is not liable to the Fund or any of the Fund's shareholders for any act or omission by the Manager in the supervision or management of its investment activities or for any loss sustained by the Fund or the Fund's shareholders. The Investment Management Agreement will continue in effect for successive periods of 12 months, provided that each continuance is specifically approved at least annually by both (1) the vote of a majority of the Fund's Board or the vote of a "majority of the outstanding voting securities" of the Fund (as such term is defined in the 1940 Act) and (2) by the vote of a majority of the Directors who are not parties to such agreement or interested persons (as such term is defined in the 1940 Act) of any such party, cast in person at a meeting called for the purpose of voting on such approval. The Investment Management Agreement may be terminated at any time by the Fund, without the payment of any penalty, upon the vote of the majority of the Fund's Board or a majority of the outstanding voting securities of the Fund, or by the Manager, on 60 days' written notice by either party to the Investment Management Agreement to the other. The Investment Management Agreement will terminate automatically in the event of its assignment (as such term is defined in the 1940 Act and the rules thereunder). Peter Coffey, vice-president and investment officer of the Fund, has been primarily responsible for the day-to-day management of the Fund since 1992, when the Fund commenced operations. Mr. Coffey is a managing director of Salomon Smith Barney. For the years ended December 31, 1999, 2000 and 2001 the Fund paid $516,522, $494,918 and $872,221, respectively, in management fees to the Manager. CODE OF ETHICS Pursuant to Rule 17j-1 of the 1940 Act, the Fund and the Manager have adopted codes of ethics that permit personnel to invest in securities for their own accounts, including S-17 securities that may be purchased or held by the Fund. All personnel must place the interests of clients first and avoid activities, interests and relationships that might interfere with the duty to make decisions in the best interests of the clients. All personal securities transactions by employees must adhere to the requirements of the codes and must be conducted in such a manner as to avoid any actual or potential conflict of interest, the appearance of such a conflict, or the abuse of an employee's position of trust and responsibility. The Fund's Code of Ethics can be reviewed and copied at the Commission's Public Reference Room in Washington, D.C. In addition, information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-202-942-8090. The Code of Ethics is available on the EDGAR Database on the Commission's website at http://www.sec.gov. A copy of the Code of Ethics may be ------------- obtained for a duplicating fee by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Commission's Public Reference ------------------ Section, Washington, D.C. 20549-0102. PORTFOLIO TRANSACTIONS Subject to the general supervision of the Board, the Manager is responsible for decisions to buy and sell securities and the selection of broker-dealers to effect the transactions. The Fund invests primarily in the over-the-counter market. Securities are generally traded in the over-the-counter market on a "net" basis with dealers acting as principal for their own accounts without charging a stated commission, although the price of the security usually includes a profit to the dealer. The Fund also purchases securities at times in underwritten offerings, where the price includes a fixed amount of compensation, generally referred to as the underwriter's concession or discount. On occasion, the Fund may also purchase certain money market instruments directly from an issuer, in which case no commissions or discounts are paid. The Fund will not engage in any principal transactions with Salomon Smith Barney, except pursuant to an exemptive order under the 1940 Act. The Manager currently serves as investment adviser to other investment companies, some of which invest principally in municipal securities. In the future it may act as investment adviser to other investment companies or accounts that invest in municipal securities. Although each investment company is individually managed, from time to time the Manager may, to the extent permitted by law, allocate purchase or sale transactions among various investment companies and other accounts. In making such allocations the Manager will consider, among other things, the respective investment objectives, the relative size of portfolio holdings of the same or comparable securities and the liquidity of the portfolio. The Fund's policy regarding purchases and sales of securities for its portfolio is that primary consideration will be given to obtaining the most favorable prices consistent with efficient execution of transactions in seeking to implement the Fund's policies. The Manager will effect transactions with those dealers whom the Manager believes provide the most favorable prices and who are capable of providing efficient executions. Those factors that the Manager believes contribute to efficient execution include size of the order, difficulty of execution, operational capabilities and facilities of the dealer involved, whether that dealer has risked its own capital in positioning a block of securities and the dealer's prior experience in effecting transactions of this type. If the Manager believes such price and execution are S-18 obtainable from more than one dealer, it may give consideration to placing portfolio transactions with those dealers who also furnish research and other services to the Manager. Such services may include, but are not limited to, any one or more of the following: information as to the availability of securities for purchase or sale; statistical or factual information or opinions pertaining to investment; economic analysis; and appraisals or evaluations of portfolio securities. The information and services so received by the Manager may be of benefit to the Manager in the management of other accounts and may not in all cases benefit the Fund directly. While the receipt of such information and services is useful in varying degrees and would generally reduce the amount of research or services otherwise performed by the Manager and thus may reduce its expenses, it is of indeterminable value and the advisory fee paid to the Manager is not reduced by any amount that may be attributable to the value of such services. NET ASSET VALUE For the purpose of determining the net asset value per share of the Common Stock, the value of the Fund's net assets shall be deemed to equal the value of the Fund's assets less (1) the Fund's liabilities, (2) the aggregate liquidation value (i.e., $25,000 per outstanding share) of the Preferred Shares and (3) accumulated and unpaid dividends on the outstanding Preferred Shares. The net asset value is computed as of the close of regular trading on the New York Stock Exchange (normally 4 p.m.) on each day the New York Stock Exchange is open for business. The Fund reserves the right to calculate the net asset value more frequently if deemed desirable. The Fund's securities are valued on the basis of bid prices provided by a pricing service when the Fund believes such prices reflect fair market value. Pricing services generally determine value by reference to transactions in municipal securities, quotations from municipal bond dealers, market transactions in comparable securities and various relationships between securities. If a pricing service is not used, municipal securities will be valued at the quoted bid prices provided by municipal bond dealers. Short-term instruments maturing within 60 days will be valued at cost plus amortized discount, if any, when the Board has determined that amortized cost equals fair value. Securities and other assets that are not priced by a pricing service and for which market quotations are not available will be valued in good faith at fair value by or under the direction of the Board. If any securities held by the Fund are restricted as to resale, the Manager will determine their fair value following procedures approved by the Board. The Board will periodically review such valuations and procedures. The fair value of such securities generally will be determined as the amount which the Fund could reasonably expect to realize from an orderly disposition of such securities over a reasonable period of time. The valuation procedures applied in any specific instance are likely to vary from case to case. However, consideration will be generally given to the financial position of the issuer and other fundamental analytical data relating to the investment and to the nature of the restrictions on disposition of securities (including any registration expenses that might be borne by the Fund in connection with such disposition). In addition, specific factors also generally will be considered, such as the cost of the investment, the market value of any unrestricted securities of the same class (both at the time of purchase and at the time of valuation), the size of the holding, the prices of any recent transactions or offers with respect to such securities, and any available analysts' reports regarding the issuer. Shares of closed-end investment companies frequently trade at a discount from net asset value, but in some cases trade at a premium. Since the market price of the Fund's shares is S-19 determined by such factors as trading volume of the shares, general market and economic conditions and other factors beyond the control of the Fund, the Fund cannot predict whether its shares will trade at, below or above its computed net asset value. ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR PREFERRED SHARES GENERAL Auction Agency Agreement. The Fund has entered into an Auction Agency ------------------------ Agreement (the "Auction Agency Agreement") with the Auction Agent (currently, Bankers Trust Company) which provides, among other things, that the Auction Agent will follow the Auction Procedures for purposes of determining the Applicable Rate for Preferred Shares so long as the Applicable Rate for Preferred Shares is to be based on the results of an Auction. Broker-Dealer Agreements. Each Auction requires the participation of ------------------------ one or more Broker-Dealers. The Auction Agent has entered into agreements (collectively, the "Broker-Dealer Agreements") with several Broker-Dealers selected by the Fund, which provide for the participation of those Broker-Dealers in Auctions for Preferred Shares. See "Broker-Dealers" below. Securities Depository. The Depository Trust Company ("DTC") will act as --------------------- the Securities Depository for the participants in Preferred Shares (the "Agent Members") with respect to Preferred Shares. One certificate for all of the Preferred Shares will be registered in the name of Cede & Co., as nominee of the Securities Depository. Such certificate will bear a legend to the effect that such certificate is issued subject to the provisions restricting transfers of Preferred Shares contained in the Statement. The Fund will also issue stop-transfer instructions to the transfer agent for Preferred Shares. Prior to the commencement of the right of holders of Preferred Shares to elect a majority of the Fund's Directors, as described under "Description of Preferred Shares -- Voting Rights" in the Prospectus, Cede & Co. will be the holder of record of all Preferred Shares and owners of such shares will not be entitled to receive certificates representing their ownership interest in such shares. DTC, a New York-chartered limited purpose trust company, performs services for its participants (including the Agent Members), some of whom (and/or their representatives) own DTC. DTC maintains lists of its participants and will maintain the positions (ownership interests) held by each such Agent Member in Preferred Shares, whether for its own account or as a nominee for another person. CONCERNING THE AUCTION AGENT The Auction Agent is acting as agent for the Fund in connection with Auctions. In the absence of bad faith or negligence on its part, the Auction Agent will not be liable for any action taken, suffered, or omitted or for any error of judgment made by it in the performance of its duties under the Auction Agency Agreement and will not be liable for any error of judgment made in good faith unless the Auction Agent will have been negligent in ascertaining the pertinent facts. S-20 The Auction Agent may rely upon, as evidence of the identities of the Existing Holders of Preferred Shares, the Auction Agent's registry of Existing Holders, the results of Auctions and notices from any Broker-Dealer (or other Person, if permitted by the Fund) with respect to transfers described under "The Auction -- Secondary Market Trading and Transfer of Preferred Shares" in the Prospectus and notices from the Fund. The Auction Agent is not required to accept any such notice for an Auction unless it is received by the Auction Agent by 3:00 p.m., New York City time, on the Business Day preceding such Auction. The Auction Agent may terminate the Auction Agency Agreement upon notice to the Fund on a date no earlier than 45 days after such notice. If the Auction Agent should resign, the Fund will use its best efforts to enter into an agreement with a successor Auction Agent containing substantially the same terms and conditions as the Auction Agency Agreement. The Fund may remove the Auction Agent provided that prior to such removal the Fund shall have entered into such an agreement with a successor auction agent. BROKER-DEALERS The Auction Agent after each Auction for shares of Preferred Shares will pay to each Broker-Dealer, from funds provided by the Fund, a service charge at the annual rate of 1/4 of 1% in the case of any Auction immediately preceding a Rate Period of less than one year, or a percentage agreed to by the Fund and the Broker-Dealers in the case of any Auction immediately preceding a Rate Period of one year or longer, of the purchase price of shares of Preferred Shares placed by such Broker-Dealer at such Auction. For the purposes of the preceding sentence, shares of Preferred Shares will be placed by a Broker-Dealer if such shares were (a) the subject of Hold Orders deemed to have been submitted to the Auction Agent by the Broker-Dealer and were acquired by such Broker-Dealer for its own account or were acquired by such Broker-Dealer for its customers who are Beneficial Owners or (b) the subject of an Order submitted by such Broker-Dealer that is (i) a Submitted Bid of an Existing Holder that resulted in such Existing Holder continuing to hold such shares as a result of the Auction or (ii) a Submitted Bid of a Potential Holder that resulted in such Potential Holder purchasing such shares as a result of the Auction or (iii) a valid Hold Order. The Fund may request the Auction Agent to terminate one or more Broker-Dealer Agreements at any time, provided that at least one Broker-Dealer Agreement is in effect after such termination. The Broker-Dealer Agreement provides that a Broker-Dealer (other than an affiliate of the Fund) may submit Orders in Auctions for its own account, unless the Fund notifies all Broker-Dealers that they may no longer do so, in which case Broker-Dealers may continue to submit Hold Orders and Sell Orders for their own accounts. Any Broker-Dealer that is an affiliate of the Fund may submit Orders in Auctions, but only if such Orders are not for its own account. If a Broker-Dealer submits an Order for its own account in any Auction, it might have an advantage over other Bidders because it would have knowledge of all Orders submitted by it in that Auction; such Broker-Dealer, however, would not have knowledge of Orders submitted by other Broker-Dealers in that Auction. S-21 CERTAIN PROVISIONS IN THE ARTICLES OF INCORPORATION The Articles of Incorporation include provisions that could limit the ability of other entities or persons to acquire control of the Fund, to cause it to engage in certain transactions or to modify its structure. The Articles require a vote by holders of at least 75% of the shares of each class of capital stock of the Fund outstanding and entitled to vote, except as described below, to authorize (1) the conversion of the Fund from a closed-end to an "open-end company" or any amendment to the Articles to make any class of the Fund's stock a "redeemable security" (as such terms are defined in the 1940 Act); (2) any merger or consolidation or share exchange of the Fund with or into any other company (including, without limitation, a partnership, corporation, joint venture, business trust, common loan trust or any other business organization); (3) the dissolution or liquidation of the Fund, notwithstanding any other provision in the Articles; (4) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of transactions) of all or substantially all of the Fund's assets other than in the ordinary course of the Fund's business; (5) a change in the nature of the business of the Fund so that it would cease to be an investment company registered under the 1940 Act; or (6) the issuance or transfer by the Fund (in one transaction or a series of transactions) of any securities of the Fund to any other person in exchange for cash, securities or other property having an aggregate fair market value of $1,000,000 or more excluding (i) sales of any securities of the Fund in connection with a public offering thereof, (ii) issuance of any securities of the Fund pursuant to a dividend reinvestment plan adopted by the Fund or pursuant to a stock dividend and (iii) issuances of any securities of the Fund upon the exercise of any stock subscription rights distributed by the Fund; provided, with respect to (1) through (5), if such action has been authorized by the affirmative vote of at least 70% of the entire Board, the affirmative vote of the holders of only a majority of the Fund's shares of capital stock outstanding and entitled to vote at the time is required; and provided, further, with respect to (6), if such transaction has been authorized by the affirmative vote of at least 70% of the entire Board, no shareholder vote is required to authorize such action. None of the foregoing provisions may be amended except by the vote of at least 75% of the shares of each class of capital stock of the Fund outstanding and entitled to vote thereon. The percentage votes required under these provisions, which are greater than the minimum requirements under Maryland law or the 1940 Act, will make more difficult a change in the Fund's business or management and may have the effect of depriving common shareholders of an opportunity to sell shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of the Fund in a tender offer or similar transaction. The Board believes that the provisions of the Articles relating to such higher votes are in the best interest of the Fund and its shareholders. Reference should be made to the Articles on file with the Commission for the full text of these provisions. REPURCHASE OF COMMON STOCK; CONVERSION TO OPEN-END FUND The Fund is a closed-end investment company and, as such, its common shareholders do not have the right to cause the Fund to redeem their shares. Instead, the Fund's Common Stock trades in the open market at a price that is a function of several factors. Shares S-22 of closed-end investment companies investing primarily in fixed-income securities tend to trade on the basis of income yield on the market price of the shares and the market price may also be affected by trading volume, general market conditions, economic conditions and other factors beyond the control of the Fund. As a result, the market price of the Common Stock may be greater or less than net asset value. Some closed-end companies have taken certain actions, including the repurchase of common stock in the market at market prices and the making of one or more tender offers for common stock at net asset value, in an effort to reduce or mitigate the discount, and others have converted to an open-end investment company, the shares of which are redeemable at net asset value. The Board has seen no reason to adopt any of these actions. Accordingly, there can be no assurance that any of these actions will be taken or, if taken, will cause the Fund's shares to trade at a price equal to their net asset value. In addition, at any time when the Fund's Preferred Shares are outstanding, the Fund may not purchase, redeem or otherwise acquire any of its Common Stock unless (1) all accrued Preferred Shares dividends have been paid and (2) at the time of such purchase, redemption or acquisition, the net asset value of the Fund's portfolio (determined after deducting the acquisition price of the Common Stock) is at least 200% of the liquidation value of the outstanding Preferred Shares (expected to equal the original purchase price per share plus any accrued and unpaid dividends thereon). The repurchase by the Fund of its shares of Common Stock at prices below net asset value will result in an increase in the net asset value of those shares of Common Stock that remain outstanding. However, there can be no assurance that share repurchases or tenders at or below net asset value will result in the Fund's shares of Common Stock trading at a price equal to their net asset value. Nevertheless, the fact that the Fund's shares of Common Stock may be the subject of repurchase or tender offers at net asset value from time to time, or that the Fund may be converted to an open-end company, may reduce any spread between market price and net asset value that might otherwise exist. Any service fees incurred in connection with any tender offer made by the Fund will be borne by the Fund and will not reduce the stated consideration to be paid to tendering shareholders. In addition, a purchase by the Fund of its shares of Common Stock will decrease the Fund's total assets which would likely have the effect of increasing the Fund's expense ratio. Any purchase by the Fund of its shares of Common Stock at a time when Preferred Shares are outstanding will increase the leverage applicable to the outstanding shares of Common Stock then remaining. Subject to its investment limitations, the Fund may borrow to finance the repurchase of shares or to make a tender offer. Interest on any borrowings to finance share repurchase transactions or the accumulation of cash by the Fund in anticipation of share repurchases or tenders will reduce the Fund's net income. Any share repurchase, tender offer or borrowing that might be approved by the Board would have to comply with the Securities Exchange Act of 1934, as amended, and the 1940 Act and the rules and regulations thereunder. S-23 See "Certain Provisions in the Charter and Bylaws" in the Prospectus and "Certain Provisions in the Articles of Incorporation" in this Statement of Additional Information for a discussion of voting requirements applicable to conversion of the Fund to an open-end company. If the Fund converted to an open-end company, it would be required to redeem all Preferred Shares then outstanding, and the Fund's shares of Common Stock would no longer be listed on the American Stock Exchange. Holders of common stock of an open-end investment company may require the company to redeem their shares on any business day (except in certain circumstances as authorized by or under the 1940 Act) at their net asset value, less such redemption charge, if any, as might be in effect at the time of redemption. In order to avoid maintaining large cash positions or liquidating favorable investments to meet redemptions, open-end companies typically engage in a continuous offering of their common stock. Open-end companies are thus subject to periodic asset in-flows and out-flows that can complicate portfolio management. TAX MATTERS The discussion set out below of tax considerations generally affecting the Fund and its shareholders is intended to be only a summary and is not intended as a substitute for careful tax planning by prospective shareholders who should consult their own tax advisors. The Fund has qualified and intends to continue to qualify each year under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), as a regulated investment company and to satisfy conditions contained in the Code which will enable interest from municipal obligations owned by the Fund to be exempt from regular federal income tax in the hands of owners of the Fund's shares, subject to the possible application of the federal alternative minimum tax (the "AMT".) To qualify under Subchapter M for tax treatment as a regulated investment company, the Fund must, among other things: (a) derive at least 90% of its annual gross income (including tax-exempt interest) from dividends, interest, payments with respect to certain securities loans, gains from the sale or other disposition of stock or securities or foreign currencies, or other income (including but not limited to gains from options, futures and forward contracts) derived with respect to its business of investing in such stock, securities or currencies and (b) diversify its holdings so that, at the end of each quarter of the Fund's taxable year (i) at least 50% of the market value of the Fund's assets is represented by cash, cash items, U.S. Government securities, securities of other regulated investment companies, and other securities, with such other securities limited, with respect to any one issuer, to an amount not greater in value than 5% of the Fund's total assets, and to not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the market value of the Fund's assets is invested in the securities (other than U.S. Government securities or securities of other regulated investment companies) of any one issuer or two or more issuers controlled by the Fund and engaged in the same, similar or related trades or businesses. As a regulated investment company, the Fund will not be subject to federal income tax in any taxable year with respect to its "net investment income" i.e., its "investment company taxable income," as that term is defined in the Code, determined without regard to the deduction for dividends paid) and "net capital gain" (i.e., the excess of the Fund's net long-term capital gain over net short-term capital loss), if any, that it distributes in each taxable year to its shareholders, provided that it distributes at least 90% of its net investment income and its net tax-exempt interest (the excess of its gross tax-exempt interest over certain disallowed deductions) for such taxable year. In meeting these requirements of Subchapter M of the Code, the Fund may be restricted in the utilization of certain of the investment techniques described under "The Fund's Investments" in the Prospectus and "Investment Policies and Techniques" in this Statement of Additional Information. If in any year the Fund should fail to qualify under Subchapter M for tax treatment as a regulated investment company, the Fund would incur a regular federal corporate income tax upon its taxable income for that year (computed without any deduction for the dividends paid by the Fund to its shareholders), and distributions by the Fund to its shareholders would be taxable to such holders as ordinary income to the extent of the current or accumulated earnings and profits of the Fund. A regulated investment company that fails to distribute, by the close of each calendar year, an amount at least equal to the sum of 98% of its ordinary S-24 taxable income for such year and 98% of its capital gain net income for the one- year period ending October 31 in such year, plus any shortfalls from the prior year's required distribution, is liable for a 4% excise tax on the excess of the required distribution for such calendar year over the distributed amount for such calendar year. To avoid the imposition of this excise tax, the Fund generally intends to make the required distributions of its ordinary taxable income, if any, and its capital gain net income, if any, to the extent possible, by the close of each calendar year. As described above, the Fund may invest in financial futures contracts and options on financial futures contracts that are traded on a U.S. exchange or board of trade. As a general rule, these investment activities will increase or decrease the amount of long-term and short-term capital gains or losses realized by the Fund and, thus, will affect the amount of capital gains distributed to the Fund's shareholders. For federal income tax purposes, gain or loss on the futures and options described above (collectively referred to as "Section 1256 Contracts") would, as a general rule, be taxed pursuant to a special "mark-to-market" system. Under the mark-to-market system, the Fund may be required to take into account at the end of its taxable years, a greater or lesser amount of gains or losses than actually realized. As a general rule, gain or loss on Section 1256 Contracts is treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss, and as a result, the mark-to-market system will generally affect the character, amount and timing of distributions taxable to a shareholder. Moreover, if the Fund invests in both Section 1256 Contracts and offsetting positions in those contracts, then the Fund might not be able to receive the benefit of certain realized losses for an indeterminate amount of time. The Fund expects that its activities with respect to Section 1256 Contracts and offsetting positions in those Contracts (1) will not cause it or its shareholders to be treated as receiving a materially greater amount of capital gains or distributions than actually realized or received and (2) will permit it to use substantially all of its losses for the taxable years in which the losses actually occur (to the extent it realizes corresponding gains in such years). The Fund intends to qualify to pay "exempt-interest dividends", as defined in the Code, on its shares of Common Stock and Preferred Shares by satisfying the requirement that at the close of each quarter of its taxable year, at least 50% of the value of its total assets consists of tax-exempt municipal obligations. Exempt-interest dividends are dividends or any part thereof (other than a capital gain dividend) paid by the Fund which are attributable to interest on tax-exempt municipal obligations and are so designated by the Fund. Exempt-interest dividends will be exempt from regular federal income tax, but may be subject to the AMT. Insurance proceeds received by the Fund under any insurance policies in respect of scheduled interest payments on defaulted municipal obligations will generally be excludable from federal gross income under Section 103(a) of the Code. In the case of municipal lease obligations, however, there can be no assurance that bond insurance payments received in lieu of interest on such obligations in the event of a "non-appropriation" will be excludable from gross income for federal income tax purposes. See "Investment Policies and Techniques" above. Gains of the Fund that are attributable to market discount on certain municipal obligations are treated as ordinary taxable income. Distributions to shareholders by the Fund of net income received, if any, from taxable temporary investments and net short-term capital gains, if any, realized by the Fund will be taxable to its shareholders as ordinary income. Distributions by the Fund of its net capital gains (i.e., the excess of net long-term capital gain over net short-term S-25 capital loss), if any, are taxable as long-term capital gains regardless of the length of time the shareholder has owned shares of Common Stock or Preferred Shares. The amount of taxable income allocable to the Fund's Preferred Shares will depend upon the amount of such income realized by the Fund, but is not generally expected to be significant. Except for dividends paid on Preferred Shares, which include an allocable portion of any net capital gain or other taxable income, the Fund anticipates that all other dividends paid on Preferred Shares will constitute exempt-interest dividends for federal income tax purposes. Distributions, if any, in excess of the Fund's earnings and profits will first reduce the adjusted tax basis of a shareholder's shares and, after that basis has been reduced to zero, will constitute capital gain to the shareholder (assuming the shares are held as a capital asset). As long as the Fund qualifies as a regulated investment company under the Code, no part of its distributions to shareholders will qualify for the dividend received deduction available to corporate shareholders. The IRS requires that a regulated investment company which has two or more classes of shares must designate to each such class proportionate amounts of each type of its income for each taxable year based upon the percentage of total dividends distributed to each class for such year. The Fund intends each year to allocate, to the fullest extent practicable, net interest which is exempt from regular federal income taxes and exempt from the AMT, net interest which is exempt from regular income taxes but nevertheless subject to the AMT, net capital gain and other taxable income, if any, between its shares of Common Stock and Preferred Shares in proportion to the total dividends paid to each class with respect to such year. To the extent permitted under applicable law, the Fund reserves the right to make special allocations of income within a class, consistent with the objectives of the Fund. The Fund will, in the case of a Minimum Rate Period or a Special Rate Period of 28 Rate Period Days or fewer, and may, in the case of any other Special Rate Period, notify the Auction Agent of the amount of any net capital gain or other income taxable for regular federal income tax purposes to be included in any dividend on Preferred Shares prior to the Auction establishing the Applicable Rate for such dividend period. If (a) in the case of any Minimum Rate Period or any Special Rate Period of 28 Rate Period Days or fewer, the Fund allocates any net capital gain or other income taxable for regular federal income tax purposes to a dividend paid on Preferred Shares without having given advance notice thereof to the Auction Agent as required by the Articles Supplementary solely by reason of the fact that such allocation is made retroactively as a result of the redemption of all or a portion of the outstanding Preferred Shares or the liquidation of the Fund or (b) in the case of any Special Rate Period of more than 28 Rate Period Days, the Fund allocates any net capital gain or other taxable income for regular federal income tax purposes to Preferred Shares without having given advance notice thereof as described above, the Fund will make certain payments to owners of Preferred Shares to which such allocation was made to offset the federal income tax effect thereof as described under "Description of Preferred Shares -- Dividends and Dividend Periods -- Gross-up Payments" in the Prospectus. In order for any distributions to owners of Preferred Shares to be eligible to be treated as exempt-interest dividends, such shares must be treated as stock for federal income tax purposes. The Manager believes the Preferred Shares should be treated as stock for federal income tax purposes. If at any time when the Preferred Shares are outstanding, the Fund fails to meet the Preferred Shares Basic Maintenance Amount or the 1940 Act Preferred Shares Asset Coverage, the Fund will be required to suspend distributions to holders of its shares of Common Stock until such maintenance amount or asset coverage, as the case may be, is restored. See S-26 "Description of Preferred Shares-- Dividends and Dividend Periods -- Restrictions on Dividends and Other Distributions" in the Prospectus. This may prevent the Fund from distributing at least 90% of the sum of its investment company taxable income (as that term is defined in the Code determined without regard to the deduction for dividends paid) and its net tax-exempt income, and may therefore jeopardize the Fund's qualification for taxation as a regulated investment company or cause the Fund to incur a tax liability or a non-deductible 4% excise tax on the undistributed taxable income (including gain), or both. Upon failure to meet the Preferred Shares Basic Maintenance Amount or the 1940 Act Preferred Shares Asset Coverage, the Fund will be required to redeem Preferred Shares in order to maintain or restore such maintenance amount or asset coverage and avoid the adverse consequences to the Fund and its shareholders of failing to qualify as a regulated investment company. There can be no assurance, however, that any such redemption would achieve such objectives. The Code provides that interest on indebtedness incurred or continued to purchase or carry the Fund's shares is not deductible for federal income tax purposes. Under rules used by the IRS for determining when borrowed funds are considered used for the purpose of purchasing or carrying particular assets, the purchase or ownership of the Fund's shares may be considered to have been made with borrowed funds even though such funds are not directly used for the purchase or ownership of such shares. The interest on private activity bonds is not federally tax-exempt to a holder who is a "substantial user" of a facility financed by such bonds or a "related person" of such "substantial user." As a result, the Fund may not be an appropriate investment for shareholders who are considered either a "substantial user" or a "related person" within the meaning of the Code. In general, a "substantial user" of a facility includes a "non-exempt person who regularly uses a part of such facility in his trade or business." "Related persons" are in general defined to include persons among whom there exists a relationship, either by family or business, which would result in a disallowance of losses in transactions among them under various provisions of the Code (or if they are members of the same controlled group of corporations under the Code), including a partnership and each of its partners (and certain members of their families), an S corporation and each of its shareholders (and certain members of their families) and various combinations of these and other relationships. The foregoing is not a complete description of all of the provisions of the Code covering the definitions of "substantial user" and "related person." The Fund may, at its option, redeem Preferred Shares in whole or in part, and is required to redeem Preferred Shares to the extent required to maintain the Preferred Shares Basic Maintenance Amount and the 1940 Act Preferred Shares Asset Coverage. Gain or loss, if any, resulting from a redemption of Preferred Shares will be taxed as gain or loss from the sale or exchange of Preferred Shares under Section 302 of the Code rather than as a dividend, but only if the redemption distribution (a) is deemed not to be essentially equivalent to a dividend, (b) is in complete redemption of an owner's interest in the Fund, (c) is substantially disproportionate with respect to the owner's interest in the Fund, or (d) with respect to non-corporate owners, is in partial liquidation of the Fund. For purposes of (a), (b) and (c) above, an owner's ownership of shares of Common Stock will be taken into account. S-27 Nonresident alien individuals and certain foreign corporations and other entities ("foreign investors") generally are subject to U.S. withholding tax at the rate of 30% (or possibly a lower rate provided by an applicable tax treaty) on distributions of taxable net investment income and net short-term capital gain. To the extent received by foreign investors, exempt-interest dividends, distributions of net capital gain and gain from the sale or other disposition of Preferred Shares generally are exempt from U.S. federal income taxation. Different tax consequences may result if, in the case of a foreign corporation, the foreign owner is engaged in a trade or business in the United States or, in the case of an individual, the owner is present in the United States for more than 182 days during a taxable year and certain other conditions are met. Although dividends generally will be treated as distributed when paid, dividends declared in October, November or December, payable to shareholders of record on a specified date in one of those months and paid during the following January will be treated as having been distributed by the Fund (and received by the shareholders) on December 31 of the year declared. Certain of the Fund's investment practices are subject to special provisions of the Code that, among other things, may defer the use of certain deductions or losses of the Fund and affect the holding period of securities held by the Fund and the character of the gains or losses realized by the Fund. These provisions may also require the Fund to recognize income or gain without receiving cash with which to make distributions in the amounts necessary to satisfy the requirements for maintaining regulated investment company status and for avoiding income and excise taxes. The Fund will monitor its transactions and may make certain tax elections in order to mitigate the effect of these rules and prevent disqualification of the Fund as a regulated investment company. The sale or other disposition of shares of Common Stock or Preferred Shares of the Fund (other than redemptions, the rules for which are described above) will normally result in capital gain or loss to shareholders if such shares are held as capital assets. Present law taxes both long-term and short-term capital gains of corporations at the rates applicable to ordinary income. For non-corporate taxpayers, however, under current law, short-term capital gains and ordinary income will be taxed at a maximum rate of 38.6% while long-term capital gains generally will be taxed at a maximum rate of 20%. However, because of the limitations on itemized deductions and the deduction for personal exemptions applicable to higher income taxpayers, the effective rate of tax may be higher in certain circumstances. Losses realized by a shareholder on the sale or exchange of shares of the Fund held for six months or less are disallowed to the extent of any distribution of exempt-interest dividends received with respect to such shares, and, if not disallowed, such losses are treated as long-term capital losses to the extent of any distribution of long-term capital gain received (or amounts credited as undistributed capital gain) with respect to such shares. Under certain circumstances, a shareholder's holding period may have to restart after, or may be suspended for, any periods during which the shareholder's risk of loss with respect to its shares is diminished as a result of holding one or more other positions in substantially similar or related property, or through certain options or short sales. Any loss realized on a sale or exchange of shares of the Fund will be disallowed to the extent those shares of the Fund are replaced by other shares within a period of 61 days beginning 30 days before and ending 30 days after the date of disposition of the original shares. In that event, the basis of the replacement shares of the Fund will be adjusted to reflect the disallowed loss. S-28 Federal tax law imposes the AMT with respect to corporations, individuals, trusts and estates. Interest on certain municipal obligations, such as bonds issued to make loans for housing purposes or to private entities (but not to certain tax-exempt organizations such as universities and non-profit hospitals) is included as an item of tax preference in determining the amount of a taxpayer's alternative minimum taxable income. To the extent that the Fund receives income from municipal obligations which is subject to the AMT, a portion of the dividends paid by it, although otherwise exempt from federal income tax, will be taxable to its shareholders to the extent that their tax liability is determined under the AMT. The Fund will annually supply a report indicating the percentage of the Fund's income attributable to interest on municipal obligations subject to the AMT. In addition, for certain corporations, alternative minimum taxable income is increased by 75% of the difference between an alternative measure of income ("adjusted current earnings") and the amount otherwise determined to be the alternative minimum taxable income. Interest on all municipal obligations, and therefore all distributions by the Fund that would otherwise be tax-exempt, is included in calculating a corporation's adjusted current earnings. Certain small corporations are not subject to the federal AMT. Tax-exempt income, including exempt-interest dividends paid by the Fund, is taken into account in calculating the amount of social security and railroad retirement benefits that may be subject to federal income tax. If a shareholder fails to furnish a correct taxpayer identification number, fails to report fully dividend or interest income, or fails to certify that he has provided a correct taxpayer identification number and that he is not subject to "backup withholding," the shareholder may be subject to a "backup withholding" tax with respect to (1) taxable dividends and distributions and (2) the proceeds of any sales or repurchases of shares of Common Stock and Preferred Shares. An individual's taxpayer identification number is his social security number. The backup withholding tax is not an additional tax and may be refunded or credited against a taxpayer's federal income tax liability, provided the required information is furnished to the IRS. The Code provides that every shareholder required to file a tax return must include for information purposes on such return the amount of tax-exempt interest received during the taxable year, including any exempt-interest dividends received from the Fund. The value of shares of Common Stock acquired pursuant to the Fund's Dividend Reinvestment Plan for the holders of Common Stock will generally be excluded from gross income for federal income tax purposes to the extent that the cash amount reinvested would be excluded from gross income. The foregoing is a general summary of the provisions of the Code and regulations thereunder presently in effect as they directly govern the taxation of the Fund and its shareholders. These provisions are subject to change by legislative or administrative action, and any such change may be retroactive. Moreover, the foregoing does not address many of the factors that may be determinative of whether an investor will be liable for the AMT. Shareholders are advised to consult their own tax advisors for more detailed information concerning the federal income tax consequences of purchasing, holding and disposing of Fund shares. S-29 EXPERTS The financial statements of the Fund as of December 31, 2000 incorporated by reference in this Statement of Additional Information in reliance upon the report of KPMG LLP, independent auditors, are incorporated by reference herein, and upon the authority of said firm as experts in accounting and auditing. S-30 Appendix A RATINGS OF INVESTMENTS MOODY'S INVESTORS SERVICE, INC. A brief description of the applicable Moody's Investors Service, Inc. ("Moody's") rating symbols and their meanings (as published by Moody's) follows: DESCRIPTION OF MOODY'S MUNICIPAL BOND RATINGS: Aaa Bonds that are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa Bonds that are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. A Bonds that are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa Bonds that are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and may have speculative characteristics as well. Ba Bonds that are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. Moody's applies the numerical note modifiers 1, 2 and 3 in each generic rating classification from Aa through Baa. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. Advanced refunded issues that are secured by escrowed funds held in cash, held in trust, reinvested in direct non-callable United States Government obligations or non-callable obligations unconditionally A-1 guaranteed by the United States Government are identified with a number (hatchmark) symbol, e.g., Aaa. DESCRIPTION OF MOODY'S MUNICIPAL NOTE RATINGS: Moody's ratings for state and municipal notes and other short-term loans are designated Moody's Investment Grade (MIG) and for variable demand obligations are designated Variable Moody's Investment Grade (MVIG). This distinction recognizes the difference between short-term credit risk and long-term risk. Loans bearing the designation MIG 1/VMIG 1 are of the best quality, enjoying strong protection from established cash flows of funds for their servicing, superior liquidity support or from established and broad-based access to the market for refinancing. Loans bearing the designation MIG 2/VMIG 2 are of high quality with margins of protection ample although not so large as in the preceding group. Loans bearing the designation MIG 3/VMIG 3 are of favorable quality, with all security elements accounted for but lacking the undeniable strength of the preceding grades. Liquidity and cash flow protection may be narrow and market access for refinancing, in particular, is likely to be less well established. DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS: The rating Prime-1 is the highest commercial paper rating assigned by Moody's. Issuers rated Prime-1 (or related supporting institutions) are considered to have a superior capacity for repayment of short-term promissory obligations. Issuers rated Prime-2 (or related supporting institutions) are considered to have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics of issuers rated Prime-1 but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternative liquidity is maintained. STANDARD & POOR'S RATINGS GROUP A brief description of the applicable Standard & Poor's Ratings Group ("S&P") rating symbols and their meanings (as published by S&P) follows: DESCRIPTION OF S&P MUNICIPAL BOND RATINGS: AAA - Debt rated AAA has the highest rating assigned by S&P. Superior financial security on an absolute and relative basis. Capacity to meet policyholder obligations is extremely strong under a variety of economic and underwriting conditions. AA - Debt rated AA is an excellent financial instrument. Capacity to meet policyholder obligations is strong under a variety of economic and underwriting conditions. A - Debt rated A is a good financial instrument. Capacity to meet policyholder obligations is somewhat susceptible to adverse economic and underwriting conditions. A-2 BBB - Debt rated BBB is an adequate financial security. Capacity to meet policyholder obligations is susceptible to adverse economic and underwriting conditions. BB, B, CCC, CC, C - Debt rated BB, B, CCC, CC or C is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. BB indicates the lowest degree of speculation and C the highest degree of speculation and are classified as "vulnerable" claims-paying ability rating. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. Plus (+) or Minus (-): The ratings from AA to B may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. Provisional Ratings: The letter "p" indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. The investor should exercise judgment with respect to such likelihood and risk. L - The letter "L" indicates that the rating pertains to the principal amount of those bonds where the underlying deposit collateral is fully insured by the Federal Savings & Loan Insurance Corp. or the Federal Deposit Insurance Corp. + - Continuance of the rating is contingent upon S&P's receipt of closing documentation confirming investments and cash flow. * - Continuance of the rating is contingent upon S&P's receipt of an executed copy of the escrow agreement. NR - Indicates no rating has been requested, that there is insufficient information on which to base a rating, or that S&P does not rate a particular type of obligation as a matter of policy. DESCRIPTION OF S&P MUNICIPAL NOTE RATINGS: Municipal notes with maturities of three years or less are usually given note ratings (designated SP1, -2, or -3) to distinguish more clearly the credit quality of notes as compared to bonds. Notes rated SP-1 have a very strong or strong capacity to pay principal and interest. Those issues determined to possess overwhelming safety characteristics are given the designation of SP-1+. Notes rated SP-2 have a satisfactory capacity to pay principal and interest. DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS: Commercial paper rated A-1 by S&P indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess A-3 overwhelming safety characteristics are denoted A-1+. Capacity for timely payment on commercial paper rated A-2 is strong, but the relative degree of safety is not as high as for issues designated A-1. FITCH, INC. DESCRIPTION OF FITCH'S MUNICIPAL BOND RATINGS: AAA - Bonds rated AAA by Fitch have the lowest expectation of credit risk. The obligor has an exceptionally strong capacity for timely payment of financial commitments, which is highly unlikely to be adversely affected by foreseeable events. AA - Bonds rated AA by Fitch have a very low expectation of credit risk. They indicate very strong capacity for timely payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events. A - Bonds rated A by Fitch are considered to have a low expectation of credit risk. The capacity for timely payment of financial commitments is considered to be strong, but may be more vulnerable to changes in economic conditions and circumstances than bonds with higher ratings. BBB - Bonds rated BBB by Fitch currently have a low expectation of credit risk. The capacity for timely payment of financial commitments is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to impair this capacity. This is the lowest investment grade category assigned by Fitch. Plus and minus signs are used by Fitch to indicate the relative position of a credit within a rating category. Plus and minus signs, however, are not used in the AAA category. DESCRIPTION OF FITCH SHORT-TERM RATINGS: Fitch's short-term ratings apply to debt obligations that are payable on demand or have original maturities of generally up to three years, including commercial paper, certificates of deposit, medium-term notes, and municipal and investment notes. The short-term rating places greater emphasis than a long-term rating on the existence of liquidity necessary to meet financial commitments in a timely manner. Fitch's short-term ratings are as follows: F1 + - Issues assigned this rating are regarded as having the strongest capacity for timely payment of financial commitments. The "+" denotes an exceptionally strong credit feature. F1 - Issues assigned this rating are regarded as having the strongest capacity for timely payment of financial commitments. A-4 F2 - Issues assigned this rating have a satisfactory capacity for timely payment of financial commitments, but the margin of safety is not as great as in the case of the higher ratings. F3 - The capacity for timely payment of financial commitments is adequate; however, near-term adverse changes could result in a reduction to non-investment grade. A-5 Appendix B OPTIONS AND FUTURES General. The Fund may engage in futures and options transactions in ------- accordance with its investment objective and policies. The Fund may engage in such transactions if it appears advantageous to the Manager to do so in order to pursue its investment objective, to hedge (i.e. protect) against the effects of market conditions and to stabilize the value of its assets. The Manager may also decide not to engage in any of these investment practices. The use of futures and options, and the possible benefits and attendant risks are discussed below, along with information concerning certain other investment policies and techniques. There are risks associated with futures and options transactions. Because it is not possible to perfectly correlate the price of the securities being hedged with the price movement in a futures contract, it is not possible to provide a perfect offset on losses on the futures contract or the option on the contract. Because there is imperfect correlation between the Fund's securities that are hedged and the futures contract, the hedge may not be fully effective. Losses on the Fund's security may be greater than gains on the futures contract, or losses on the futures contract may be greater than gains on the securities subject to the hedge. To compensate for imperfect correlation, the Fund may over-hedge or under-hedge by entering into futures contracts or options on futures contracts in dollar amounts greater or less than the dollar amounts of the securities being hedged. If market movements are not as anticipated, the Fund could lose money from these positions. If the Fund hedges against an increase in interest rates, and rates decline instead, the Fund will lose all or part of the benefit of the increase in value of the securities it hedged because it will have offsetting losses in its futures or options positions. Also, in order to meet margin requirements, the Fund may have to sell securities at a time it would not normally choose. Financial Futures Contracts. The Fund may enter into financial --------------------------- futures contracts for the future delivery of a financial instrument, such as a security, or the cash value of a securities index. This investment technique is designed primarily to hedge against anticipated future changes in market conditions which otherwise might adversely affect the value of securities which the Fund holds or intends to purchase. A "sale" of a futures contract means the undertaking of a contractual obligation to deliver the securities, or the cash value of an index, called for by the contract at a specified price during a specified delivery period. At the time of delivery, in the case of fixed-income securities pursuant to the contract, adjustments are made to recognize differences in value arising from the delivery of securities with a different interest rate than that specified in the contract. In some cases, securities called for by a futures contract may not have been issued at the time the contract was written. Although some financial futures contracts by their terms call for the actual delivery or acquisition of securities, in most cases the contractual commitment is closed out before delivery without having to make or take delivery of the securities. The offsetting of a B-1 contractual obligation is accomplished by purchasing (or selling, as the case may be) on a commodities exchange an identical futures contract calling for delivery in the same period. Such a transaction cancels the obligation to make or take delivery of the securities. All transactions in the futures market are made, offset or fulfilled through a clearing house associated with the exchange on which the contracts are traded. The Fund will incur brokerage fees when it purchases or sells contracts, and will be required to maintain margin deposits. Futures contracts entail risk. If the Manager's judgment about the general direction of securities markets or interest rates is wrong, the Fund's overall performance may be poorer than if the Fund had not entered into such contracts. There may be an imperfect correlation between movements in prices of futures contracts and portfolio securities being hedged. In addition, the market prices of futures contracts may be affected by certain factors. If participants in the futures market elect to close out their contracts through offsetting transactions rather than meet margin requirements, distortions in the normal relationship between the securities and futures markets could result. Price distortions could also result if investors in futures contracts decide to make or take delivery of underlying securities rather than engage in closing transactions due to the resultant reduction in the liquidity of the futures market. In addition, because from the point of view of speculators, the margin requirements in the futures market may be less onerous than margin requirements in the cash market, increased participation by speculators in the futures market could cause temporary price distortions. Due to the possibility of price distortions in the futures market and because of the imperfect correlation between movements in the prices of securities and movements in the prices of futures contracts, a correct forecast of market trends by the Manager may still not result in a successful hedging transaction. If this should occur, the Fund could lose money on the financial futures contracts and also on the value of its portfolio securities. Options on Financial Futures Contracts. The Fund may purchase and -------------------------------------- write call and put options on financial futures contracts. An option on a futures contract gives the purchaser the right, in return for the premium paid, to assume a position in a futures contract at a specified exercise price at any time during the period specified in the terms of the option. Upon exercise, the writer of the option delivers the futures contract to the holder at the exercise price. The Fund would be required to deposit with its custodian initial margin and maintenance margin with respect to put and call options on futures contracts written by it. Options on futures contracts involve risks similar to those risks relating to transactions in financial futures contracts described above. Also, an option purchased by the Fund may expire worthless, in which case the Fund would lose the premium paid therefor. Options on Securities. The Fund may write covered call options so --------------------- long as it owns securities which are acceptable for escrow purposes and may write secured put options, which means that so long as the Fund is obligated as a writer of a put option, it will invest an amount, not less than the exercise price of the put option, in securities consistent with the Fund's investment objective and policies and restrictions on investment. See "Investment Objective" and "Investment Restrictions." A call option gives the purchaser the right to buy, and the writer the obligation to sell, the underlying security at the exercise price during the period specified in the terms of the option. A put option gives the purchaser the right to sell, and the writer the obligation to buy, the underlying security at the exercise price during the period specified in the B-2 terms of the option. The premium received for writing an option will reflect, among other things, the current market price of the underlying security, the relationship of the exercise price to the market price, the price volatility of the underlying security, the option period, supply and demand and interest rates. The Fund may write or purchase spread options, which are options for which the exercise price may be a fixed dollar spread or yield spread between the security underlying the option and another security that is used as a benchmark. The exercise price of an option may be below, equal to or above the current market value of the underlying security at the time the option is written. The buyer of a put who also owns the related security is protected by ownership of a put option against any decline in that security's price below the exercise price, less the amount paid for the option. At times the Fund may wish to establish a position in a security upon which call options are available. By purchasing a call option on such security the Fund would be able to fix the cost of acquiring the security, which is the cost of the call plus the exercise price of the option. This procedure also provides some protection from an unexpected downturn in the market, because the Fund is only at risk for the amount of the premium paid for the call option which it can, if it chooses, permit to expire. Options on Securities Indices. The Fund also may purchase and write ----------------------------- call and put options on securities indices. Through the writing or purchase of index options, the Fund can achieve many of the same objectives as through the use of options on individual securities. Options on securities indices are similar to options on a security except that, rather than the right to take or make delivery of a security at a specified price, an option on a securities index gives the holder the right to receive upon exercise of the option, an amount of cash, if the closing level of the securities index upon which the option is based is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to the difference between the closing price of the index and the exercise price of the option. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike options on securities (which require, upon exercise, delivery of the underlying security), settlements of options on securities indices, upon exercise thereof, are in cash, and the gain or loss of an option on an index depends on price movements in the market generally (or in a particular industry or segment of the market on which the underlying index is based) rather than price movements in individual securities, as is the case with respect to options on securities. When the Fund writes an option on a securities index, it will be required to deposit with its custodian eligible securities equal in value to 100% of the exercise price in the case of a put, or the contract's value in the case of a call. In addition, where the Fund writes a call option on a securities index at a time when the contract value exceeds the exercise price, the Fund will segregate, until the option expires or is closed out, cash or cash equivalents equal in value to such excess. Options on securities and index options involve risks similar to those risks relating to transactions in financial futures described above. Also, an option purchased by the Fund may expire worthless, in which case the Fund would lose the premium paid therefor. Over-the-Counter Options. As previously indicated in the Prospectus ------------------------ and Statement of Additional Information, the Fund may deal in OTC options. B-3 The Fund and the Manager have found the dealers with which they engage in OTC options transactions generally agreeable to and capable of entering into closing transactions. The Fund has adopted procedures for engaging in OTC options for the purpose of reducing any potential adverse impact of such transactions upon the liquidity of the Fund's portfolio. As part of these procedures the Fund will only engage in OTC options transactions with respect to U.S. Government securities with primary dealers that have been specifically approved by the Board. The Fund will engage in OTC options transactions with respect to municipal securities only with dealers that have been specifically approved by the Board. The Fund and its Manager believe that the approved dealers should be agreeable and able to enter into closing transactions as necessary and, therefore, present minimal credit risk to the Fund. The Fund anticipates entering into written agreements with those dealers to whom the Fund may sell OTC options, pursuant to which the Fund would have the absolute right to repurchase the OTC options from such dealers at any time at a price with respect to U.S. Government securities set forth in such agreement. The amount invested by the Fund in OTC options on securities other than U.S. Government securities, including options on municipal securities, will be treated as illiquid and subject to the Fund's 25% limitation on the Fund's assets which may be invested in illiquid securities. Regulatory Restrictions. To the extent required to comply with ----------------------- applicable Commission releases and staff positions, when purchasing a futures contract or writing a put option, the Fund will maintain, in a segregated account, cash or liquid securities equal to the value of such contracts. The Fund will not enter into a futures contract or purchase an option thereon if immediately thereafter the initial margin deposits for futures contracts held by the Fund plus premiums paid by it for open options on futures would exceed 5% of the fair market value of the Fund's total assets after taking into account unrealized profits and unrealized losses on any such contracts. The Fund will not engage in transactions in financial futures contracts or options thereon for speculation, but only to attempt to hedge against changes in market conditions affecting the values of securities which the Fund holds or intends to purchase. Accounting and Tax Considerations. When the Fund writes an option, an --------------------------------- amount equal to the premium received by it is included in the Fund's Statement of Assets and Liabilities as a liability. The amount of the liability is subsequently marked to market to reflect the current market value of the option written. When the Fund purchases an option, the premium paid by B-4 the Fund is recorded as an asset and is subsequently adjusted to the current market value of the option. In the case of a regulated futures contract purchased or sold by the Fund, an amount equal to the initial margin deposit is recorded as an asset. The amount of the asset is subsequently adjusted to reflect changes in the amount of the deposit as well as changes in the value of the contract. Certain listed options and futures contracts are considered "Section 1256 contracts" for federal income tax purposes. See "Tax Matters." In general, gain or loss realized by the Fund on Section 1256 contracts will be considered 60% long-term and 40% short-term capital gain or loss. Also, Section 1256 contracts held by the Fund at the end of each taxable year (and at October 31 for purposes of calculating the excise tax) will be "marked to market", that is, treated for federal income tax purposes as though sold for fair market value on the last business day of such taxable year. The Fund can elect to exempt its Section 1256 contracts which are part of a "mixed straddle" (as described below) from the application of Section 1256. Gain or loss realized by the Fund upon the expiration or sale of certain over-the-counter put and call options held by the Fund will be either long-term or short-term capital gain or loss depending upon the Fund's holding period with respect to such option. However, gain or loss realized upon the expiration or closing out of such options that are written by the Fund will be treated as short-term capital gain or loss. In general, if the Fund exercises an option, or an option that the Fund has written is exercised, gain or loss on the option will not be separately recognized, but the premium received or paid will be included in the calculation of gain or loss upon disposition of the property underlying the option. Any security, option or futures contract, delayed delivery transaction, or other position entered into or held by the Fund in conjunction with any other position held by the Fund may constitute a "straddle" for federal income tax purposes. A properly defined straddle of which at least one, but not all, the positions are Section 1256 contracts will constitute a "mixed straddle". In general, straddles are subject to certain rules that may affect the character and timing of the Fund's gains and losses with respect to straddle positions by requiring, among other things, that loss realized on disposition of one position of a straddle be deferred to the extent of any unrealized gain in an offsetting position until such position is disposed of; that the Fund's holding period in certain straddle positions be suspended until the straddle is terminated (possibly resulting in gain being treated as short-term capital gain rather than long-term capital gain); and that losses recognized with respect to certain straddle positions, that otherwise constitute short-term capital losses, be treated as long-term capital losses. Different elections are available to the Fund which may mitigate the effects of the straddle rules, particularly with respect to mixed straddles. B-5 Appendix C GLOSSARY ""AA" COMPOSITE COMMERCIAL PAPER RATE" on any date for any Rate Period of shares of Preferred Shares, shall mean (i) (A) in the case of any Minimum Rate Period or any Special Rate Period of fewer than 49 Rate Period Days, the interest equivalent of the 30-day rate; provided, however, that if such Rate Period is a Minimum Rate Period and the "AA" Composite Commercial Paper Rate is being used to determine the Applicable Rate for shares of Preferred Shares when all of the Outstanding Preferred Shares are subject to Submitted Hold Orders, then the interest equivalent of the seven-day rate, and (B) in the case of any Special Rate Period of (1) 49 or more but fewer than 70 Rate Period Days, the interest equivalent of the 60-day rate; (2) 70 or more but fewer than 85 Rate Period Days, the arithmetic average of the interest equivalent of the 60-day and 90-day rates; (3) 85 or more but fewer than 99 Rate Period Days, the interest equivalent of the 90-day rate; (4) 99 or more but fewer than 120 Rate Period Days, the arithmetic average of the interest equivalent of the 90-day and 120-day rates; (5) 120 or more but fewer than 141 Rate Period Days, the interest equivalent of the 120-day rate; (6) 141 or more but fewer than 162 Rate Period Days, the arithmetic average of the interest equivalent of the 120-day and 180-day rates; (7) 162 or more but fewer than 183 Rate Period Days, the interest equivalent of the 180-day rate, in each case on commercial paper placed on behalf of issuers whose corporate bonds are rated "AA" by S&P or the equivalent of such rating by S&P or another rating agency, as made available on a discount basis or otherwise by the Federal Reserve Bank of New York for the Business Day next preceding such date; and (8) in the case of a Special Rate Period of 183 or more Rate Period Days, the Treasury Rate which most closely matches the Special Rate Period; or (ii) in the event that the Federal Reserve Bank of New York does not make available any such rate, then the arithmetic average of such rates, as quoted on a discount basis or otherwise, by the Commercial Paper Dealers to the Auction Agent for the close of business on the Business Day next preceding such date. If any Commercial Paper Dealer does not quote a rate required to determine the "AA" Composite Commercial Paper Rate, the "AA" Composite Commercial Paper Rate shall be determined on the basis of the quotation or quotations furnished by the remaining Commercial Paper Dealer or Commercial Paper Dealers and any Substitute Commercial Paper Dealer or Substitute Commercial Paper Dealers selected by the Fund to provide such rate or rates not being supplied by any Commercial Paper Dealer or Commercial Paper Dealers, as the case may be, or, if the Fund does not select any such Substitute Commercial Paper Dealer or Substitute Commercial Paper Dealers, by the remaining Commercial Paper Dealer or Commercial Paper Dealers. For purposes of this definition, the "interest equivalent" of a rate stated on a discount basis (a "discount rate") for commercial paper of a given days' maturity shall be equal to the quotient (rounded upwards to the next higher one-thousandth (.001) of 1%) of (A) the discount rate divided by (B) the difference between (x) 1.00 and (y) a fraction, the numerator of which shall be the product of the discount rate times the number of days in which such commercial paper matures and the denominator of which shall be 360. "ACCOUNTANT'S CONFIRMATION" shall have the meaning specified in paragraph (c) of Section 7 of Part I of the Articles Supplementary. "AFFILIATE" shall mean, for purposes of the definition of "Outstanding," any Person known to the Auction Agent to be controlled by, in control of or under common control with the Fund; provided, however, that no Broker-Dealer controlled by, in control of or under common control C-1 with the Fund shall be deemed to be an Affiliate nor shall any corporation or any Person controlled by, in control of or under common control with such corporation, one of the trustees, directors, or executive officers of which is a Director of the Fund be deemed to be an Affiliate solely because such trustee, director or executive officer is also a Director of the Fund. "AGENT MEMBER" shall mean a member of or participant in the Securities Depository that will act on behalf of a Bidder. "ALL HOLD ORDER RATE" shall have the meaning specified in subparagraph (b)(iii) of Section 3 of Part 1 of the Articles Supplementary. "ANNUAL VALUATION DATE" shall mean the last Business Day of each December of each year. "APPLICABLE RATE" shall have the meaning specified in subparagraph (e)(i) of Section 2 of Part I of the Articles Supplementary. "AUCTION" shall mean each periodic implementation of the Auction Procedures. "AUCTION AGENCY AGREEMENT" shall mean the agreement between the Fund and the Auction Agent which provides, among other things, that the Auction Agent will follow the Auction Procedures for purposes of determining the Applicable Rate for shares of Preferred Shares so long as the Applicable Rate for shares of Preferred Shares is to be based on the results of an Auction. "AUCTION AGENT" shall mean the entity appointed as such by a resolution of the Board of Directors in accordance with Section 6 of Part II of the Articles Supplementary. "AUCTION DATE" with respect to any Rate Period, shall mean the Business Day next preceding the first day of such Rate Period. "AUCTION PROCEDURES" shall mean the procedures for conducting Auctions set forth in Part II of the Articles Supplementary. "AVAILABLE PREFERRED SHARES" shall have the meaning specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. "BENCHMARK RATE" shall have the meaning specified in paragraph (b)(iii) of Section 3 of Part II of the Articles Supplementary. "BENEFICIAL OWNER" with respect to shares of Preferred Shares, means a customer of a Broker-Dealer who is listed on the records of that Broker-Dealer (or, if applicable, the Auction Agent) as a holder of such shares. "BID" and "BIDS" shall have the respective meanings specified in paragraph (a) of Section 1 of Part II of the Articles Supplementary. "BIDDER" and "BIDDERS" shall have the respective meanings specified in paragraph (a) of Section 1 of Part II of the Articles Supplementary; provided, however, that neither the Fund nor any affiliate thereof shall be permitted to be a Bidder in an Auction, except that any Broker- C-2 Dealer that is an affiliate of the Fund may be a Bidder in an Auction, but only if the Orders placed by such Broker-Dealer are not for its own account. "BOARD OF DIRECTORS" shall mean the Board of Directors of the Fund or any duly authorized committee thereof. "BROKER-DEALER" shall mean any broker-dealer, commercial bank or other entity permitted by law to perform the functions required of a Broker-Dealer in Part II of the Articles Supplementary, that is a member of, or a participant in, the Securities Depository or is an affiliate of such member or participant, has been selected by the Fund and has entered into a Broker-Dealer Agreement that remains effective. "BROKER-DEALER AGREEMENT" shall mean an agreement among the Fund, the Auction Agent and a Broker-Dealer pursuant to which such Broker-Dealer agrees to follow the procedures specified in Part II of the Articles Supplementary. "BUSINESS DAY" shall mean a day on which the New York Stock Exchange is open for trading and which is neither a Saturday, Sunday nor any other day on which banks in The City of New York, New York, are authorized by law to close. "CHARTER" shall have the meaning specified on the first page of the Articles Supplementary. "CLOSING TRANSACTION" shall have the meaning specified in paragraph (a)(i)(A) of Section 13 of Part I of the Articles Supplementary. "CODE" means the Internal Revenue Code of 1986, as amended. "COMMERCIAL PAPER DEALERS" shall mean Lehman Commercial Paper Incorporated, Goldman, Sachs & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated and any other commercial paper dealer selected by the Fund as to which Moody's, Fitch or any substitute rating agency then rating the Preferred Shares shall not have objected or, in lieu of any thereof, their respective affiliates or successors, if such entity is a commercial paper dealer. "COMMON SHARES" shall mean the shares of common stock, par value $.001 per share, of the Fund. "CURE DATE" shall mean the Preferred Shares Basic Maintenance Cure Date or the 1940 Act Cure Date, as the case may be. "DATE OF ORIGINAL ISSUE" with respect to the Preferred Shares, shall mean the date on which the Fund initially issued such shares. "DEPOSIT SECURITIES" shall mean cash and Municipal Obligations rated at least P-1, MIG-1 or VMIG-1 by Moody's or F1 by Fitch. "DISCOUNTED VALUE" as of any Valuation Date, shall mean, (i) with respect to a Fitch Eligible Asset or Moody's Eligible Asset that is not currently callable as of such Valuation Date at the option of the issuer thereof, the lesser of the Market Value or par value thereof divided by C-3 the Fitch Discount Factor for a Fitch Eligible Asset or Moody's Discount Factor for a Moody's Eligible Asset, or (ii) with respect to a Fitch Eligible Asset or Moody's Eligible Asset that is currently callable as of such Valuation Date at the option of the issuer thereof, the quotient of (1) the lesser of the Market Value or next call price thereof, including any call premium, divided by (2) the Fitch Discount Factor for Fitch Eligible Assets or the Moody's Discount Factor for Moody's Eligible Assets. "DIVIDEND PAYMENT DATE" with respect to shares of Preferred Shares, shall mean any date on which dividends are payable on such shares pursuant to the provisions of paragraph (d) of Section 2 of Part I of the Articles Supplementary. "DIVIDEND PERIOD," with respect to shares of Preferred Shares, shall mean the period from and including the Date of Original Issue of Preferred Shares to but excluding the initial Dividend Payment Date for Preferred Shares and any period thereafter from and including one Dividend Payment Date for Preferred Shares to but excluding the next succeeding Dividend Payment Date for Preferred Shares. "EXISTING HOLDER," with respect to shares of Preferred Shares, shall mean a Broker-Dealer (or any such other Person as may be permitted by the Fund) that is listed on the records of the Auction Agent as a holder of such shares of Preferred Shares. "EXPOSURE PERIOD" shall mean the period commencing on a given Valuation Date and ending 56 days thereafter. "FAILURE TO DEPOSIT," with respect to shares of Preferred Shares, shall mean a failure by the Fund to pay to the Auction Agent, not later than 12:00 noon, New York City time, (A) on the Business Day next preceding any Dividend Payment Date for Preferred Shares, in funds available on such Dividend Payment Date in The City of New York, New York, the full amount of any dividend (whether or not earned or declared) to be paid on such Dividend Payment Date on any share of Preferred Shares or (B) on the Business Day next preceding any redemption date in funds available on such redemption date for Preferred Shares in The City of New York, New York, the Redemption Price to be paid on such redemption date for any share of Preferred Shares after notice of redemption is mailed pursuant to paragraph (c) of Section 11 of Part I of the Articles Supplementary; provided, however, that the foregoing clause (B) shall not apply to the Fund's failure to pay the Redemption Price in respect of shares of Preferred Shares when the related Notice of Redemption provides that redemption of such shares is subject to one or more conditions precedent and any such condition precedent shall not have been satisfied at the time or times and in the manner specified in such Notice of Redemption. "FEDERAL TAX RATE INCREASE" shall have the meaning specified in the definition of "Fitch Volatility Factor" and "Moody's Volatility Factor." "FITCH" shall mean Fitch, Inc. and its successors. "FITCH DISCOUNT FACTOR" shall mean, for purposes of determining the Discounted Value of any Fitch Eligible Asset, the percentage determined by reference to the rating on such asset and the shortest Exposure Period set forth opposite such rating that is the same length as or is longer than the Exposure Period, in accordance with the table set forth below. C-4
- --------------------------------------------------------------------------------------------------- RATING CATEGORY - --------------------------------------------------------------------------------------------------- EXPOSURE PERIOD AAA* AA* A* BBB* F1** UNRATED*** - --------------------------------------------------------------------------------------------------- 7 weeks 151% 159% 166% 173% 136% 225% - --------------------------------------------------------------------------------------------------- 8 weeks or less but greater 154% 161% 168% 176% 137% 231% than 7 weeks - --------------------------------------------------------------------------------------------------- 9 weeks or less but greater 158% 163% 170% 177% 138% 240% than 8 weeks - ---------------------------------------------------------------------------------------------------
* Fitch rating (or, if not rated by Fitch but rated by Moody's or S&P, see "Fitch Eligible Asset" below) ** Municipal Obligations rated F1 by Fitch (or, if not rated by Fitch, see "Fitch Eligible Asset" below), which do not mature or have a demand feature at par exercisable in 30 days and which do not have a long-term rating. *** Municipal Obligations rated less than BBB by Fitch (or, if not rated by Fitch, see "Fitch Eligible Asset" below) or unrated, not to exceed 10% of Fitch Eligible Assets. Notwithstanding the foregoing, (i) the Fitch Discount Factor for short-term Municipal Obligations will be 115%, so long as such Municipal Obligations are rated at least F1 by Fitch (or, if not rated by Fitch, rated MIG-1, VMIG-1 or P-1 by Moody's or at least A-1+ or SP-1+ by S&P) and mature or have a demand feature at par exercisable in 30 days or less, and (ii) no Fitch Discount Factor will be applied to cash or to Receivables for Municipal Obligations Sold. Notwithstanding the foregoing, inverse floating rate structured securities, including primary market and secondary market residual interest bonds, may constitute no more than 10% of the Discounted Value of Fitch Eligible Assets. The Fitch Discount Factor for such securities shall be the product of (x) the percentage determined by reference to the rating on the security underlying such inverse floating rate structured securities multiplied by (y) 1.25. "FITCH ELIGIBLE ASSET" shall mean cash, Receivables for Municipal Obligations Sold or a Municipal Obligation that (i) pays interest in cash, (ii) does not have its Fitch rating, as applicable, suspended by Fitch, and (iii) is part of an issue of Municipal Obligations of at least $10,000,000. Municipal Obligations issued by any one issuer and rated BB or B (for the C-5 purposes of this definition only, "Other Securities") may comprise no more than 4% of total Fitch Eligible Assets; such Other Securities, if any, together with any Municipal Obligations issued by the same issuer and rated BBB by Fitch may comprise no more than 6% of total Fitch Eligible Assets; such Other Securities and BBB-rated Municipal Obligations, if any, together with any Municipal Obligations issued by the same issuer and rated A by Fitch, may comprise no more than 10% of total Fitch Eligible Assets; and such Other Securities, and BBB and A-rated Municipal Obligations, if any, together with any Municipal Obligations issued by the same issuer and rated AA by Fitch, may comprise no more than 20% of total Fitch Eligible Assets. For purposes of the foregoing sentence any Municipal Obligation backed by the guaranty, letter of credit or insurance issued by a third party shall be deemed to be issued by such third party if the issuance of such third party credit is the sole determinant of the rating on such Municipal Obligation. Other Securities issued by issuers located within a single state or territory may comprise no more than 12% of total Fitch Eligible Assets; such Other Securities, if any, together with any Municipal Obligations issued by issuers located within the same state or territory and rated BBB by Fitch, may comprise no more than 20% of total Fitch Eligible Assets; such Other Securities, BBB-rated Municipal Obligations, if any, together with any Municipal Obligations issued by issuers located within the same state or territory and rated A by Fitch, may comprise no more than 40% of total Fitch Eligible Assets; and such Other Securities and BBB and A-rated Municipal Obligations, if any, together with any Municipal Obligations issued by issuers located within the same state or territory and rated AA by Fitch, may comprise no more than 60% of total Fitch Eligible Assets. For purposes of applying the foregoing requirements and applying the applicable Fitch Discount Factor, if a Municipal Obligation is not rated by Fitch but is rated by Moody's and S&P, such Municipal Obligation (excluding short-term Municipal Obligations) will be deemed to have the Fitch rating which is the lower of the Moody's and S&P rating. If a Municipal Obligation is not rated by Fitch but is rated by Moody's or S&P, such Municipal Obligation (excluding short-term Municipal Obligations) will be deemed to have such rating. Eligible Assets shall be calculated without including cash; and Municipal Obligations rated F1 by Fitch or, if not rated by Fitch, rated MIG-1, VMIG-1 or P-1 by Moody's; or, if not rated by Moody's, rated A-1+/AA or SP-1+/AA by S&P; shall be considered to have a long-term rating of A. When the Fund sells a Municipal Obligation and agrees to repurchase such Municipal Obligation at a future date, such Municipal Obligation shall be valued at its Discounted Value for purposes of determining Fitch Eligible Assets, and the amount of the repurchase price of such Municipal Obligation shall be included as a liability for purposes of calculating the Preferred Shares Basic Maintenance Amount. When the Fund purchases a Fitch Eligible Asset and agrees to sell it at a future date, such Fitch Eligible Asset shall be valued at the amount of cash to be received by the Fund upon such future date, provided that the counterparty to the transaction has a long-term debt rating of at least A by Fitch and the transaction has a term of no more than 30 days, otherwise, such Fitch Eligible Asset shall be valued at the Discounted Value of such Fitch Eligible Asset. Notwithstanding the foregoing, an asset will not be considered a Fitch Eligible Asset for purposes of determining the Preferred Shares Basic Maintenance Amount to the extent it is (i) subject to any material lien, mortgage, pledge, security interest or security agreement of any kind (collectively, "Liens"), except for (a) Liens which are being contested in good faith by C-6 appropriate proceedings and which Fitch (if Fitch is then rating the Preferred Shares) has indicated to the Fund will not affect the status of such asset as a Fitch Eligible Asset, (b) Liens for taxes that are not then due and payable or that can be paid thereafter without penalty, (c) Liens to secure payment for services rendered or cash advanced to the Fund by the Fund's investment adviser, custodian or the Auction Agent, (d) Liens by virtue of any repurchase agreement, and (e) Liens in connection with any futures margin account; or (ii) deposited irrevocably for the payment of any liabilities. "FITCH HEDGING TRANSACTION" shall have the meaning specified in paragraph 13(b)(1) of Part I of the Articles Supplementary. "FITCH VOLATILITY FACTOR" shall mean, as of any Valuation Date, (i) in the case of any Minimum Rate Period, any Special Rate Period of 28 Rate Period Days or fewer, or any Special Rate Period of 57 Rate Period Days or more, a multiplicative factor equal to 275%, except as otherwise provided in the last sentence of this definition; (ii) in the case of any Special Rate Period of more than 28 but fewer than 36 Rate Period Days, a multiplicative factor equal to 203%; (iii) in the case of any Special Rate Period of more than 35 but fewer than 43 Rate Period Days, a multiplicative factor equal to 217%; and (iv) in the case of any Special Rate Period of more than 42 but fewer than 50 Rate Period Days, a multiplicative factor equal to 226%; and (v) in the case of any special Rate Period of more than 49 but fewer than 57 Rate Period Days, a multiplicative factor equal to 235%. If, as a result of the enactment of changes to the Code, the greater of the maximum marginal Federal individual income tax rate applicable to ordinary income and the maximum marginal Federal corporate income tax rate applicable to ordinary income will increase, such increase being rounded up to the next five percentage points (the "Federal Tax Rate Increase"), until the effective date described in (i) above in this definition instead shall be determined by reference to the following table: FEDERAL TAX RATE INCREASE FITCH VOLATILITY FACTOR 5% 295% 10% 317% 15% 341% 20% 369% 25% 400% 30% 436% 35% 477% 40% 525% "FORWARD COMMITMENTS" shall have the meaning specified in paragraph (a)(iv) of Section 13 of Part I of the Articles Supplementary. "FUND" shall mean the entity named on the first page of these Articles Supplementary, which is the issuer of the shares of Preferred Shares. C-7 "GROSS-UP PAYMENT" means payment to a Holder of shares of Preferred Shares of an amount which, when taken together with the aggregate amount of Taxable Allocations made to such Holder to which such Gross-up Payment relates, would cause such Holder's dividends in dollars (after Federal income tax consequences) from the aggregate of such Taxable Allocations and the related Gross-up Payment to be equal to the dollar amount of the dividends which would have been received by such Holder if the amount of such aggregate Taxable Allocations would have been excludable from the gross income of such Holder. Such Gross-up Payment shall be calculated (i) without consideration being given to the time value of money; (ii) assuming that no Holder of shares of Preferred Shares is subject to the AMT with respect to dividends received from the Fund; and (iii) assuming that each Taxable Allocation and each Gross-up Payment (except to the extent such Gross-up Payment is designated as an exempt-interest dividend under Section 852(b)(5) of the Code or successor provisions) would be taxable in the hands of each Holder of shares of Preferred Shares at the maximum marginal combined regular Federal personal income tax rate applicable to ordinary income (taking into account the Federal income tax deductibility of state and local taxes paid or incurred) or net capital gains, as applicable, or the maximum marginal regular Federal corporate income tax rate applicable to ordinary income or net capital gains, as applicable, whichever is greater, in effect at the time such Gross-up Payment is made. "HOLDER" with respect to shares of Preferred Shares, shall mean the registered holder of such shares as the same appears on the record books of the Fund. "HOLD ORDER" and "HOLD ORDERS" shall have the respective meanings specified in paragraph (a) of Section 1 of Part II of the Articles Supplementary. "INDEPENDENT ACCOUNTANT" shall mean a nationally recognized accountant, or firm of accountants, that is with respect to the Fund an independent public accountant or firm of independent public accountants under the Securities Act of 1933, as amended from time to time. "INITIAL RATE PERIOD" shall be the period from and including the Date of Original Issue to but excluding February 5, 2002. "INTEREST EQUIVALENT" means a yield on a 360-day basis of a discount basis security which is equal to the yield on an equivalent interest-bearing security. "KENNY INDEX" shall have the meaning specified in the definition of "Taxable Equivalent of the Short-Term Municipal Bond Rate." "LATE CHARGE" shall have the meaning specified in subparagraph (e)(1)(B) of Section 2 of Part I of the Articles Supplementary. "LIQUIDATION PREFERENCE" with respect to a given number of shares of Preferred Shares, means $25,000 times that number. "MARKET VALUE" of any asset of the Fund shall mean the market value thereof determined by FT Interactive Data, J.J. Kenny or any other pricing service or services designated from time to time by management or the Board of Directors, provided that management or the Board of Directors obtains written assurance from Moody's and Fitch, if Moody's and Fitch are then C-8 rating the Preferred Shares, and from any substitute rating agency then rating the Preferred Shares that such designation will not impair the rating then assigned by Moody's, Fitch or such substitute rating agency to the Preferred Shares (the "Pricing Service"). Market Value of any asset shall include any interest accrued thereon. The Pricing Service values portfolio securities at the mean between the quoted bid and asked price or the yield equivalent when quotations are readily available. Securities for which quotations are not readily available are valued at fair value as determined by the Pricing Service using methods which include consideration of: yields or prices of municipal bonds of comparable quality, type of issue, coupon, maturity and rating; indications as to value from dealers; and general market conditions. The Pricing Service may employ electronic data processing techniques or a matrix system, or both, to determine valuations. If the Pricing Service fails to provide the Market Value of any Municipal Obligation, such Municipal Obligation shall be valued at the lower of two bid quotations (one of which shall be in writing) obtained by the Fund from two dealers who are members of the National Association of Securities Dealers, Inc. and are making a market in such Municipal Obligations. Futures contracts and options are valued at closing prices for such instruments established by the exchange or board of trade on which they are traded, or if market quotations are not readily available, are valued at fair value as determined by the Pricing Service or if the Pricing Service is not able to value such instruments they shall be valued at fair value on a consistent basis using methods determined in good faith by the Board of Directors. "MAXIMUM POTENTIAL GROSS-UP PAYMENT LIABILITY" as of any Valuation Date, shall mean the aggregate amount of Gross-up Payments that would be due if the Fund were to make Taxable Allocations, with respect to any taxable year, estimated based upon dividends paid and the amount of undistributed realized net capital gains and other taxable income earned by the Fund, as of the end of the calendar month immediately preceding such Valuation Date, and assuming such Gross-up Payments are fully taxable. "MAXIMUM RATE" for shares of Preferred Shares on any Auction Date, shall mean: in the case of any Auction Date which is not the Auction Date immediately prior to the first day of any proposed Special Rate Period designated by the Fund pursuant to Section 4 of Part I of these Articles Supplementary, the product of (A) the Reference Rate on such Auction Date for the next Rate Period and (B) the Rate Multiple on such Auction Date, unless Preferred Shares have or had a Special Rate Period (other than a Special Rate Period of 28 Rate Period Days or fewer) and an Auction at which Sufficient Clearing Bids existed has not yet occurred for a Minimum Rate Period after such Special Rate Period, in which case the higher of: the dividend rate on shares for the then-ending Rate Period; and the product of (1) the higher of (x) the Reference Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was 364 Rate Period Days or fewer, or the Treasury Note Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was more than 364 Rate Period Days, and (y) the Reference Rate on such Auction Date for a Rate Period equal in length to such Special Rate Period, if such Special Rate Period was 364 Rate Period Days or fewer, or the Treasury Note Rate on such Auction Date for a Rate Period equal in length to such Special C-9 Rate Period, if such Special Rate Period was more than 364 Rate Period Days and (2) the Rate Multiple on such Auction Date; or in the case of any Auction Date which is the Auction Date immediately prior to the first day of any proposed Special Rate Period designated by the Fund pursuant to Section 4 of Part I of these Articles Supplementary, the product of (A) the highest of (1) the Reference Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was 364 Rate Period Days or fewer, or the Treasury Note Rate on such Auction Date for a Rate Period equal in length to the then-ending Rate Period, if such then-ending Rate Period was more than 364 Rate Period Days, (2) the Reference Rate on such Auction Date for the Special Rate Period for which the Auction is being held if such Special Rate Period is 364 Rate Period Days or fewer or the Treasury Note Rate on such Auction Date for the Special Rate Period for which the Auction is being held if such Special Rate Period is more than 364 Rate Period Days, and (3) the Reference Rate on such Auction Date for Minimum Rate Periods and (B) the Rate Multiple on such Auction Date. "MINIMUM RATE PERIOD" shall mean any Rate Period consisting of 7 Rate Period Days. "MOODY'S" shall mean Moody's Investors Service, Inc., a Delaware corporation, and its successors. "MOODY'S DISCOUNT FACTOR" shall mean, for purposes of determining the Discounted Value of any Moody's Eligible Asset, the percentage determined by reference to the rating on such asset and the shortest Exposure Period set forth opposite such rating that is the same length as or is longer than the Moody's Exposure Period, in accordance with the table set forth below:
RATING CATEGORY EXPOSURE PERIOD Aaa* Aa* A* Baa* OTHER** (V)MIG-1*** SP-1+**** UNRATED***** 7 weeks 151% 159% 166% 173% 187% 136% 148% 225% 8 weeks or less but greater than 7 weeks 154 161 168 176 190 137 149 231 9 weeks or less but greater than 8 weeks 158 163 170 177 192 138 150 240
- ------------------- * Moody's rating. ** Municipal Obligations not rated by Moody's but rated at least BBB by S&P. *** Municipal Obligations rated MIG-1 or VMIG-1, which do not mature or have a demand feature at par exercisable in 30 days and which do not have a long-term rating. **** Municipal Obligations not rated by Moody's but rated A-1+ or SP-1+ by S&P, which do not mature or have a demand feature at par exercisable in 30 days and which do not have a long-term rating. C-10 ***** Municipal Obligations rated less than Baa3 by Moody's or less than BBB by S&P or not rated by Moody's or S&P not to exceed 10% of Moody's Eligible Assets. Notwithstanding the foregoing, (i) the Moody's Discount Factor for short-term Municipal Obligations will be 115%, so long as such Municipal Obligations are rated at least MIG-1, VMIG-1 or P-1 by Moody's and mature or have a demand feature at par exercisable in 30 days or less or 125% as long as such Municipal Obligations are rated at least A-1+/AA or SP-1+/AA by S&P and mature or have a demand feature at par exercisable in 30 days or less and (ii) no Moody's Discount Factor will be applied to cash or to Receivables for Municipal Obligations Sold. Notwithstanding the foregoing, inverse floating rate structured securities, including primary market and secondary market residual interest bonds, may constitute no more than 10% of the Discounted Value of Moody's Eligible Assets. The Moody's Discount Factor for such securities shall be the product of (x) the percentage determined by reference to the rating on the security underlying such inverse floating rate structured securities multiplied by (y) 1.25. "MOODY'S ELIGIBLE ASSET" shall mean cash, Receivables for Municipal Obligations Sold or a Municipal Obligation that (i) pays interest in cash, (ii) does not have its Moody's rating, as applicable, suspended by Moody's, and (iii) is part of an issue of Municipal Obligations of at least $10,000,000. Municipal Obligations issued by any one issuer and rated BBB or lower by S&P, Ba or B by Moody's or not rated by S&P and Moody's (for the purposes of this definition only, "Other Securities") may comprise no more than 4% of total Moody's Eligible Assets; such Other Securities, if any, together with any Municipal Obligations issued by the same issuer and rated Baa by Moody's or A by S&P, may comprise no more than 6% of total Moody's Eligible Assets; such Other Securities, Baa and A-rated Municipal Obligations, if any, together with any Municipal Obligations issued by the same issuer and rated A by Moody's or AA by S&P, may comprise no more than 10% of total Moody's Eligible Assets; and such Other Securities, Baa, A and AA-rated Municipal Obligations, if any, together with any Municipal Obligations issued by the same issuer and rated Aa by Moody's or AAA by S&P, may comprise no more than 20% of total Moody's Eligible Assets. For purposes of the foregoing sentence, any Municipal Obligation backed by the guaranty, letter of credit or insurance issued by a third party shall be deemed to be issued by such third party if the issuance of such third party credit is the sole determinant of the rating on such Municipal Obligation. Other Securities issued by issuers located within a single state or territory may comprise no more than 12% of total Moody's Eligible Assets; such Other Securities, if any, together with any Municipal Obligations issued by issuers located within a single state or territory and rated Baa by Moody's or A by S&P, may comprise no more than 20% of total Moody's Eligible Assets; such Other Securities, Baa and A-rated Municipal Obligations, if any, together with any Municipal Obligations issued by issuers located within a single state or territory and rated A by Moody's or AA by S&P, may comprise no more than 40% of total Moody's Eligible Assets; and such Other Securities, Baa, A and AA-rated Municipal Obligations, if any, together with any Municipal Obligations issued by issuers located within a single state or territory and rated Aa by Moody's or AAA by S&P, may comprise no more than 60% of total Moody's Eligible Assets. For purposes of applying the foregoing requirements and applying the applicable Moody's Discount Factor, if a Municipal Obligation is not rated by Moody's but is rated by S&P, such Municipal Obligation (excluding short-term Municipal Obligations) will be deemed to have the Moody's rating which is one full C-11 rating category lower than its S&P rating; a Municipal Obligation shall be deemed to be rated BBB by S&P if rated BBB-, BBB or BBB+ by S&P; Moody's Eligible Assets should be calculated without including cash; and Municipal Obligations rated MIG-1, VMIG-1 or P-1 or, if not rated by Moody's, rated A1+/AA or SP1+/AA by S&P, shall be considered to have a long-term rating of A. When the Fund sells a Municipal Obligation and agrees to repurchase such Municipal Obligation at a future date, such Municipal Obligation shall be valued at its Discounted Value for purposes of determining Moody's Eligible Assets and the amount of the repurchase price of such Municipal Obligation shall be included as a liability for purposes of calculating the Preferred Shares Basic Maintenance Amount. When the Fund purchases a Moody's Eligible Asset and agrees to sell it at a future date, such Moody's Eligible Asset shall be valued at the amount of cash to be received by the Fund upon such future date, provided that the counterparty to the transaction has a long-term debt rating of at least A2 from Moody's and the transaction has a term of no more than 30 days; otherwise, such Moody's Eligible Asset shall be valued at the Discounted Value of such Moody's Eligible Asset. Notwithstanding the foregoing, an asset will not be considered a Moody's Eligible Asset for purposes of determining the Preferred Shares Basic Maintenance Amount to the extent it is (i) subject to any Liens, except for (a) Liens which are being contested in good faith by appropriate proceedings and which Moody's (if Moody's is then rating the Preferred Shares) has indicated to the Fund will not affect the status of such asset as a Moody's Eligible Asset, (b) Liens for taxes that are not then due and payable or that can be paid thereafter without penalty, (c) Liens to secure payment for services rendered or cash advanced to the Fund by the Fund's investment adviser, custodian or the Auction Agent, (d) Liens by virtue of any repurchase agreement, and (e) Liens in connection with any futures margin account; or (ii) deposited irrevocably for the payment of any liabilities. "MOODY'S HEDGING TRANSACTION" shall have the meaning specified in paragraph (a)(i) of Section 13 of Part I of the Articles Supplementary. "MOODY'S VOLATILITY FACTOR" shall mean, as of any Valuation Date, (i) in the case of any Minimum Rate Period, any Special Rate Period of 28 Rate Period Days or fewer, or any Special Rate Period of 57 Rate Period Days or more, a multiplicative factor equal to 275%, except as otherwise provided in the last sentence of this definition; (ii) in the case of any Special Rate Period of more than 28 but fewer than 36 Rate Period Days, a multiplicative factor equal to 203%; (iii) in the case of any Special Rate Period of more than 35 but fewer than 43 Rate Period Days, a multiplicative factor equal to 217%; (iv) in the case of any Special Rate Period of more than 42 but fewer than 50 Rate Period Days, a multiplicative factor equal to 226%; and (v) in the case of any Special Rate Period of more than 49 but fewer than 57 Rate Period Days, a multiplicative factor equal to 235%. If, as a result of the enactment of changes to the Code, the greater of the maximum marginal Federal individual income tax rate applicable to ordinary income and the maximum marginal Federal corporate income tax rate applicable to ordinary income will increase, such increase being rounded up to the next five percentage points (the "Federal Tax Rate Increase"), until the effective date of such increase, the Moody's Volatility Factor in the case of any Rate Period described in (i) above in this definition instead shall be determined by reference to the following table: C-12 FEDERAL TAX RATE VOLATILITY INCREASE FACTOR - ---------------- ---------- 5% 295% 10% 317% 15% 341% 20% 369% 25% 400% 30% 436% 35% 477% 40% 525% "MUNICIPAL INDEX" shall have the meaning specified in paragraph (a)(i) of Section 13 of Part I of the Articles Supplementary. "MUNICIPAL OBLIGATIONS" shall mean any and all instruments that pay interest or make other distributions that are exempt from regular Federal income tax and in which the Fund may invest consistent with the investment policies and restrictions contained in its registration statement on Form N-2 (333-73414) ("Registration Statement"), as the same may be amended from time to time. "1940 ACT" shall mean the Investment Company Act of 1940, as amended from time to time. "1940 ACT CURE DATE," with respect to the failure by the Fund to maintain the 1940 Act Preferred Shares Asset Coverage (as required by Section 6 of Part I of these Articles Supplementary) as of the last Business Day of each month, shall mean the last Business Day of the following month. "1940 ACT PREFERRED SHARES ASSET COVERAGE" shall mean asset coverage, as defined in Section 18(h) of the 1940 Act, of at least 200% with respect to all outstanding senior securities of the Fund which are shares of stock, including all outstanding shares of Preferred Shares (or such other asset coverage as may in the future be specified in or under the 1940 Act as the minimum asset coverage for senior securities which are shares or stock of a closed-end investment company as a condition of declaring dividends on its common shares or stock). C-13 "NOTICE OF REDEMPTION" shall mean any notice with respect to the redemption of shares of Preferred Shares pursuant to paragraph (c) of Section 11 of Part I of the Articles Supplementary. "NOTICE OF SPECIAL RATE PERIOD" shall mean any notice with respect to a Special Rate Period of shares of Preferred Shares pursuant to subparagraph (d)(i) of Section 4 of Part I of the Articles Supplementary. "ORDER" and "ORDERS" shall have the respective meanings specified in paragraph (a) of Section 1 of Part II of the Articles Supplementary. "OTHER SECURITIES" shall have the meaning specified, as applicable, in the definitions of "Fitch Eligible Assets" and "Moody's Eligible Assets" above. "OUTSTANDING" shall mean, as of any Auction Date with respect to shares of Preferred Shares, the number of shares theretofore issued by the Fund except, without duplication, (i) any shares theretofore cancelled or delivered to the Auction Agent for cancellation or redeemed by the Fund, (ii) any shares as to which the Fund or any Affiliate thereof shall be an Existing Holder and (iii) any shares represented by any certificate in lieu of which a new certificate has been executed and delivered by the Fund. "PERSON" shall mean and include an individual, a partnership, a corporation, a trust, an unincorporated association, a joint venture or other entity or a government or any agency or political subdivision thereof. "POTENTIAL BENEFICIAL OWNER," with respect to shares of Preferred Shares, shall mean a customer of a Broker-Dealer that is not a Beneficial Owner of shares of Preferred Shares but that wishes to purchase Preferred Shares, or that is a Beneficial Owner of shares of Preferred Shares that wishes to purchase additional shares of Preferred Shares. "POTENTIAL HOLDER," with respect to shares of Preferred Shares, shall mean a Broker-Dealer (or any such other person as may be permitted by the Fund) that is not an Existing Holder of shares of Preferred Shares or that is an Existing Holder of shares of Preferred Shares that wishes to become the Existing Holder of additional shares of Preferred Shares. "PREFERRED SHARES" shall have the meaning set forth on the first page of the Articles Supplementary. "PREFERRED SHARES BASIC MAINTENANCE AMOUNT" as of any Valuation Date, shall mean the dollar amount equal to the sum of (i)(A) the product of the number of shares of Preferred Shares outstanding on such date multiplied by $25,000 plus any redemption premium applicable to shares of Preferred Shares then subject to redemption; (B) the aggregate amount of dividends that will have accumulated at the Applicable Rate (whether or not earned or declared) to (but not including) the first Dividend Payment Date for shares of Preferred Shares outstanding that follows such Valuation Date; (C) the aggregate amount of dividends that would accumulate on shares of Preferred Shares outstanding from such first respective Dividend Payment Date therefor through the 56th day after such Valuation Date, at the Maximum Rate (calculated as if such Valuation Date were the Auction Date for the Rate Period commencing on such Dividend C-14 Payment Date) for a Minimum Rate Period to commence on such Dividend Payment Date, assuming, solely for purposes of the foregoing, that if on such Valuation Date the Fund shall have delivered a Notice of Special Rate Period to the Auction Agent pursuant to Section 4(d)(i) of this Part I with respect to such shares, such Maximum Rate shall be the higher of (a) the Maximum Rate for the Special Rate Period to commence on such Dividend Payment Date and (b) the Maximum Rate for a Minimum Rate Period to commence on such Dividend Payment Date, multiplied by the greater of the Moody's Volatility Factor (if Moody's is then rating the Preferred Shares) and the Fitch Volatility Factor (if Fitch is then rating the Preferred Shares) applicable to a Minimum Rate Period, or, in the event the Fund shall have delivered a Notice of Special Rate Period to the Auction Agent pursuant to Section 4(d)(i) of this Part I with respect to such shares designating a Special Rate Period consisting of 56 Rate Period Days or more, the Moody's Volatility Factor and Fitch Volatility Factor applicable to a Special Rate Period of that length (except that (1) if such Valuation Date occurs at a time when a Failure to Deposit has occurred that has not been cured, the dividend for purposes of calculation would accumulate at the current dividend rate then applicable to the shares in respect of which such failure has occurred and (2) for those days during the period described in this subparagraph (C) in respect of which the Applicable Rate in effect immediately prior to such Dividend Payment Date will remain in effect, the dividend for purposes of calculation would accumulate at such Applicable Rate (or other rate or rates, as the case may be) in respect of those days); (D) the amount of anticipated expenses of the Fund for the 90 days subsequent to such Valuation Date; (E) the amount of the Fund's Maximum Potential Gross-up Payment Liability in respect of shares of Preferred Shares as of such Valuation Date; (F) the amount of any indebtedness or obligations of the Fund senior in right of payment to the Preferred Shares; and (G) any current liabilities as of such Valuation Date to the extent not reflected in any of (i)(A) through (i)(F) (including, without limitation, any payables for Municipal Obligations purchased as of such Valuation Date and any liabilities incurred for the purpose of clearing securities transactions) less (ii) the value (i.e., for purposes of current Moody's guidelines, the face value of cash, short-term Municipal Obligations rated MIG-1, VMIG-1 or P-1, and short-term securities that are the direct obligation of the U.S. government, provided in each case that such securities mature on or prior to the date upon which any of (i)(A) through (i)(G) become payable, otherwise the Moody's Discounted Value) of any of the Fund's assets irrevocably deposited by the Fund for the payment of any of (i)(A) through (i)(G). "PREFERRED SHARES BASIC MAINTENANCE CURE DATE," with respect to the failure by the Fund to satisfy the Preferred Shares Basic Maintenance Amount (as required by paragraph (a) of Section 7 of Part I of the Articles Supplementary) as of a given Valuation Date, shall mean the seventh Business Day following such Valuation Date. "PREFERRED SHARES BASIC MAINTENANCE REPORT" shall mean a report signed by the President, Treasurer, Controller, Assistant Controller or any Senior Vice President or Vice President of the Fund which sets forth, as of the related Valuation Date, the assets of the Fund, the Market Value and the Discounted Value thereof (seriatim and in aggregate), and the Preferred Shares Basic Maintenance Amount. "PRICING SERVICE" shall have the meaning specified in the definition of "Market Value" above. C-15 "QUARTERLY VALUATION DATE" shall mean the last Business Day of each March, June, September and December of each year, commencing on March 28, 2002. "RATE MULTIPLE," for shares of Preferred Shares on any Auction Date, shall mean the percentage, determined as set forth in the columns below (depending on whether the Fund has notified the Auction Agent of its intent to allocate income taxable for Federal income tax purposes to such shares prior to the Auction establishing the Applicable Rate for such shares as provided in these Articles Supplementary) and based on the lower of the credit rating or ratings assigned, at the close of business on the Business Day next preceding such Auction Date, to shares of such Preferred Shares by Moody's or Fitch (or if Moody's and Fitch shall not make such rating available, the equivalent of either or both of such ratings by S&P or a nationally recognized statistical rating organization (as that term is used in the rules and regulations of the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended from time to time) that acts as a substitute rating agency in respect of shares of Preferred Shares) (the Fund taking all reasonable action to enable such rating agency to provide a rating for such shares):
- ------------------------------------------------------------------------------------------------------------- CREDIT RATING APPLICABLE PERCENTAGE- APPLICABLE PERCENTAGE-NOTIFICATION NO NOTIFICATION - ----------------------------------------- MOODY'S FITCH Aa3 or higher AA- or higher 110% 150% A3 to A1 A- to A+ 125% 160% Baa3 to Baa1 BBB- to BBB+ 150% 250% Ba3 to Ba1 BB- to BB+ 200% 275% Below Ba3 Below BB- 250% 300%
"RATE PERIOD," with respect to shares of Preferred Shares, shall mean the Initial Rate Period of such shares that have a Moody's rating of Aaa (if Moody's is then rating the Preferred Shares) and a Fitch long-term debt rating of AAA (if Fitch is then rating the Preferred Shares) and any Subsequent Rate Period, including any Special Rate Period, of Preferred Shares. "RATE PERIOD DAYS," for any Rate Period or Dividend Period, means the number of days that would constitute such Rate Period or Dividend Period but for the application of paragraph (d) of Section 2 of Part I of these Articles Supplementary or paragraph (b) of Section 4 of Part I of these Articles Supplementary. "RECEIVABLES FOR MUNICIPAL OBLIGATIONS SOLD" shall mean for purposes of calculation of Moody's Eligible Assets and Fitch Eligible Assets as of any Valuation Date, no more than the aggregate of the following: (i) the book value of receivables for Municipal Obligations sold as of or prior to such Valuation Date if such receivables are due within five business days of such Valuation Date, and if the trades which generated such receivables are (x) settled through clearing house firms with respect to which the Fund has received prior written C-16 authorization from Moody's (if Moody's is then rating the Preferred Shares) and Fitch (if Fitch is then rating the Preferred Shares) or (y) with counterparties having a Moody's long-term debt rating of at least Baa3 (if Moody's is then rating the Preferred Shares) and a Fitch long-term debt rating of BBB (if Fitch is then rating the Preferred Shares); and (ii) the Discounted Value of Municipal Obligations sold as of or prior to such Valuation Date which generated receivables, if such receivables are due within five business days of such Valuation Date but do not comply with either of the conditions specified in (i) above. "REDEMPTION PRICE" shall mean the applicable redemption price specified in Section 11 of Part I of the Articles Supplementary. "REFERENCE RATE" shall mean (i) the higher of the Taxable Equivalent of the Short-Term Municipal Bond Rate and the "AA" Composite Commercial Paper Rate in the case of Minimum Rate Periods and Special Rate Periods of 28 Rate Period Days or fewer, (ii) the "AA" Composite Commercial Paper Rate in the case of Special Rate Periods of more than 28 Rate Period Days but fewer than 183 Rate Period Days; and (iii) the Treasury Bill Rate in the case of Special Rate Periods of more than 182 Rate Period Days but fewer than 365 Rate Period Days. "REGISTRATION STATEMENT" has the meaning specified in the definition of "Municipal Obligations." "S&P" shall mean Standard & Poor's Rating Group and its successors. "SECURITIES DEPOSITORY" shall mean The Depository Trust Company and its successors and assigns or any other securities depository selected by the Fund which agrees to follow the procedures required to be followed by such securities depository in connection with the Preferred Shares. "SELL ORDER" and "SELL ORDERS" shall have the respective meanings specified in paragraph (a) of Section 1 of Part II of the Articles Supplementary. "SPECIAL RATE PERIOD," with respect to shares of Preferred Shares, shall have the meaning specified in paragraph (a) of Section 4 of Part I of the Articles Supplementary. "SPECIAL REDEMPTION PROVISIONS" shall have the meaning specified in subparagraph (a)(i) of Section 11 of Part I of the Articles Supplementary. "SUBMISSION DEADLINE" shall mean 1:30 P.M., New York City time, on any Auction Date or such other time on any Auction Date by which Broker-Dealers are required to submit Orders to the Auction Agent as specified by the Auction Agent from time to time. "SUBMITTED BID" and "SUBMITTED BIDS" shall have the respective meanings specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. "SUBMITTED HOLD ORDER" and "SUBMITTED HOLD ORDERS" shall have the respective meanings specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. C-17 "SUBMITTED ORDER" and "SUBMITTED ORDERS" shall have the respective meanings specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. "SUBMITTED SELL ORDER" and "SUBMITTED SELL ORDERS" shall have the respective meanings specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. "SUBSEQUENT RATE PERIOD," with respect to shares of Preferred Shares, shall mean the period from and including the first day following the Initial Rate Period of Preferred Shares to but excluding the next Dividend Payment Date for Preferred Shares and any period thereafter from and including one Dividend Payment Date for Preferred Shares to but excluding the next succeeding Dividend Payment Date for Preferred Shares; provided, however, that if any Subsequent Rate Period is also a Special Rate Period, such term shall mean the period commencing on the first day of such Special Rate Period and ending on the last day of the last Dividend Period thereof. "SUBSTITUTE COMMERCIAL PAPER DEALER" shall mean Credit Suisse First Boston or Morgan Stanley & Co., Incorporated or their respective affiliates or successors, if such entity is a commercial paper dealer; provided, however, that none of such entities shall be a Commercial Paper Dealer. "SUBSTITUTE U.S. GOVERNMENT SECURITIES DEALER" shall mean Credit Suisse First Boston and Merrill Lynch, Pierce, Fenner & Smith Incorporated or their respective affiliates or successors, if such entity is a U.S. Government securities dealer; provided, however, that none of such entities shall be a U.S. Government Securities Dealer. "SUFFICIENT CLEARING BIDS" shall have the meaning specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. "TAXABLE ALLOCATION" shall have the meaning specified in Section 3 of Part I of the Articles Supplementary. "TAXABLE INCOME" shall have the meaning specified in paragraph (b)(iii) of Section 3 of Part II of the Articles Supplementary. "TAXABLE EQUIVALENT OF THE SHORT-TERM MUNICIPAL BOND RATE," on any date for any Rate Period of 28 Rate Period Days or fewer, shall mean 90% of the quotient of (A) the per annum rate expressed on an interest equivalent basis equal to the Kenny S&P 30 day High Grade Index or any successor index (the "Kenny Index") (provided, however, that any such successor index must be approved by Moody's (if Moody's is then rating the Preferred Shares) and Fitch (if Fitch is then rating the Preferred Shares)), made available for the Business Day immediately preceding such date but in any event not later than 8:30 A.M., New York City time, on such date by Kenny S&P Evaluation Services or any successor thereto, based upon 30-day yield evaluations at par of short-term bonds the interest on which is excludable for regular Federal income tax purposes under the Code of "high grade" component issuers selected by Kenny S&P Evaluation Services or any such successor from time to time in its discretion, which component issuers shall include, without limitation, issuers of general obligation bonds, but shall exclude any bonds the interest on which constitutes an item of tax preference under Section 57 (a)(5) of the Code, or successor provisions, for purposes of the "alternative minimum tax," C-18 divided by (B) 1.00 minus the maximum marginal regular Federal individual income tax rate applicable to ordinary income or the maximum marginal regular Federal corporate income tax rate applicable to ordinary income (in each case expressed as a decimal), whichever is greater; provided, however, that if the Kenny Index is not made so available by 8:30 A.M., New York City time, on such date by Kenny S&P Evaluation Services or any successor, the Taxable Equivalent of the Short-Term Municipal Bond Rate shall mean the quotient of (A) the per annum rate expressed on an interest equivalent basis equal to the most recent Kenny Index so made available for any preceding Business Day, divided by (B) 1.00 minus the maximum marginal regular Federal individual income tax rate applicable to ordinary income or the maximum marginal regular Federal corporate income tax rate applicable to ordinary income (in each case expressed as a decimal), whichever is greater. "TREASURY BILL" shall mean a direct obligation of the U.S. Government having a maturity at the time of issuance of 364 days or less. "TREASURY BILL RATE," on any date for any Rate Period, shall mean (i) the bond equivalent yield, calculated in accordance with prevailing industry convention, of the rate on the most recently auctioned Treasury Bill with a remaining maturity closest to the length of such Rate Period, as quoted in The Wall Street Journal on such date for the Business Day next preceding such date; or (ii) in the event that any such rate is not published in The Wall Street Journal, then the bond equivalent yield, calculated in accordance with prevailing industry convention, as calculated by reference to the arithmetic average of the bid price quotations of the most recently auctioned Treasury Bill with a remaining maturity closest to the length of such Rate Period, as determined by bid price quotations as of the close of business on the Business Day immediately preceding such date obtained from the U.S. Government Securities Dealers to the Auction Agent. If any U.S. Government Securities Dealer does not quote a rate required to determine the Treasury Bill Rate or the Treasury Note Rate, the Treasury Bill Rate or the Treasury Note Rate shall be determined on the basis of the quotation or quotations furnished by the remaining U.S. Government Securities Dealer or U.S. Government Securities Dealers and any substitute U.S. Government Securities Dealers selected by the Fund to provide such rate or rates not being supplied by any U.S. Government Securities Dealer of U.S. Government Securities Dealers, as the case may be, or, if the Fund does not select any such Substitute U.S. Government Securities Dealer or Substitute U.S. Government Securities Dealers, by the remaining U.S. Government Securities Dealer or U.S. Government Securities Dealers. "TREASURY FUTURES" shall have the meaning specified in paragraph (a)(i) of Section 13 of Part I of the Articles Supplementary. "TREASURY NOTE" shall mean a direct obligation of the U.S. Government having a maturity at the time of issuance of five years or less but more than 364 days. "TREASURY NOTE RATE," on any date for any Rate Period, shall mean (i) the yield on the most recently auctioned Treasury Note with a remaining maturity closest to the length of such Rate Period, as quoted in The Wall Street Journal on such date for the Business Day next preceding such date; or (ii) in the event that any such rate is not published in The Wall Street Journal, then the yield as calculated by reference to the arithmetic average of the bid price quotations of the most recently auctioned Treasury Note with a remaining maturity closest to the C-19 length of such Rate Period, as determined by bid price quotations as of the close of business on the Business Day immediately preceding such date obtained from the U.S. Government Securities Dealers to the Auction Agent. If any U.S. Government Securities Dealer does not quote a rate required to determine the Treasury Bill Rate or the Treasury Note Rate, the Treasury Bill Rate or the Treasury Note Rate shall be determined on the basis of the quotation or quotations furnished by the remaining U.S. Government Securities Dealer or U.S. Government Securities Dealers and any Substitute U.S. Government Securities Dealers selected by the Fund to provide such rate or rates not being supplied by any U.S. Government Securities Dealer or U.S. Government Securities Dealers, as the case may be, or, if the Fund does not select any such Substitute U.S. Government Securities Dealer or Substitute U.S. Government Securities Dealers, by the remaining U.S. Government Securities Dealer or U.S. Government Securities Dealers. "U.S. GOVERNMENT SECURITIES DEALER" shall mean Lehman Government Securities Incorporated, Goldman, Sachs & Co., Salomon Brothers Inc., Morgan Guaranty Trust Company of New York and any other U.S. Government Securities dealer selected by the Fund as to which Moody's (if Moody's is then rating the Preferred Shares) or Fitch (if Fitch is then rating the Preferred Shares) shall not have objected or their respective affiliates or successors, if such entity is a U.S. Government securities dealer. "VALUATION DATE" shall mean, for purposes of determining whether the Fund is maintaining the Preferred Shares Basic Maintenance Amount, the last Business Day of each month. "VOTING PERIOD" shall have the meaning specified in paragraph (b) of Section 5 of Part I of the Articles Supplementary. "WINNING BID RATE" shall have the meaning specified in paragraph (a) of Section 3 of Part II of the Articles Supplementary. C-20 -----END PRIVACY-ENHANCED MESSAGE-----