-----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, IiWZ+nrJv9WepgyBFbrxg4oGn0odguYO/H+T3tSfFZWhQO6AXG3x2TXBdwlKacjS 9DV6z1Zg6K0mEGtRjfZorw== 0000912057-96-015478.txt : 20010712 0000912057-96-015478.hdr.sgml : 20010712 ACCESSION NUMBER: 0000912057-96-015478 CONFORMED SUBMISSION TYPE: N14AE24 PUBLIC DOCUMENT COUNT: 5 FILED AS OF DATE: 19960726 DATE AS OF CHANGE: 20010711 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PIPER FUNDS INC II CENTRAL INDEX KEY: 0000943887 STANDARD INDUSTRIAL CLASSIFICATION: 0000 STATE OF INCORPORATION: MN FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: N14AE24 SEC ACT: SEC FILE NUMBER: 333-08889 FILM NUMBER: 96599173 BUSINESS ADDRESS: STREET 1: PIPER CAPITAL MANAGEMENT STREET 2: 222 S 9TH STREET 20TH FLOOR CITY: MINNEAPOLIS STATE: MN ZIP: 55402 BUSINESS PHONE: 6123426412 MAIL ADDRESS: STREET 1: C/O PIPER CAPITAL MANAGEMENT STREET 2: 222 59TH STREET 20TH FLOOR CITY: MINNEAPOLIS STATE: MN ZIP: 55402 FORMER COMPANY: FORMER CONFORMED NAME: JAFFRAY FUNDS INC DATE OF NAME CHANGE: 19950413 N14AE24 1 N-14AE24 As filed with the Securities and Exchange Commission on July 26, 1996 Securities Act File No. 33- ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 -------------------- FORM N-14 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 /X/ Pre-Effective Amendment No. ___ / / Post-Effective Amendment No. ___ / / -------------------- PIPER FUNDS INC.--II (Exact name of Registrant as specified in charter) Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402-3804 (Registrant's telephone number, including area code: (800) 866-7778 -------------------- William H. Ellis Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402-3804 (Name and address of agent for service) -------------------- Copies to: Kathleen L. Prudhomme, Esq. Stuart M. Strauss, Esq. Dorsey & Whitney LLP Gordon Altman Butowsky 220 South Sixth Street Weitzen Shalov & Wein Minneapolis, MN 55402-1498 114 West 47th Street New York, NY 10036 -------------------- It is proposed that this filing will become effective on the thirtieth day after the date of filing pursuant to Rule 488. -------------------- No filing fee is due because the Registrant has previously elected to register an indefinite number of shares under the Securities Act of 1933 pursuant to the provisions of Rule 24f-2 under the Investment Company Act of 1940 and such election under Rule 24f-2 has not been terminated. -------------------- ================================================================================ FORM N-14 PIPER FUNDS INC.--II Cross Reference Sheet Pursuant to Rule 481(a) under the Securities Act of 1933 Part A of Form N-14 Item No. Proxy Statement and Prospectus Heading - - - ------------------- -------------------------------------- 1(a) Cross Reference Sheet (b) Front Cover Sheet (c) * 2(a) * (b) Table of Contents 3(a) Fee Table (b) Synopsis (c) Principal Risk Factors 4(a) The Reorganization (b) The Reorganization--Capitalization Table (Unaudited) 5(a) Incorporation by Reference; Synopsis; Comparison of Investment Objectives, Policies and Restrictions; Additional Information About the Fund and Adjustable Rate Fund (b) * (c) * (d) * (e) Available Information (f) Available Information 6(a) Incorporation by Reference; Synopsis; Comparison of Investment Objectives, Policies and Restrictions; Additional Information About the Fund and Adjustable Rate Fund (b) Available Information (c) * (d) * 7(a) Introduction--Proxies (b) * (c) Introduction; The Reorganization--Dissenters' Rights 8(a) The Reorganization (b) * 9 * Part B of Form N-14 Item No. Statement of Additional Information Heading - - - ------------------- ------------------------------------------- 10(a) Cover Page (b) * 11 * 12(a) Cover Page (Incorporation by Reference) (b) * 13(a) Cover Page (Incorporation by Reference) (b) * (c) * 14 Cover Page (Incorporation by Reference) Part C of Form N-14 Item No. Other Information Heading - - - ------------------- ------------------------- 15 Indemnification 16 Exhibits 17 Undertakings - - - -------------------- * Not Applicable or Negative Answer PIPER CAPITAL MANAGEMENT 222 South Ninth Street Minneapolis, Minnesota 55402-3804 800 866-7778 August __, 1996 Dear Shareholder: A special meeting of shareholders of Institutional Government Adjustable Portfolio (the "Fund") will be held at the offices of the Fund on September 12, 1996 at 10:00 a.m., central time, at 222 South Ninth Street, Eleventh Floor, Minneapolis, Minnesota. This meeting has been called to seek shareholder approval of the merger of the Fund into Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), a series of Piper Funds Inc. -- II. The merger will be accomplished by selling the assets of the Fund to Adjustable Rate Fund in exchange for shares of Adjustable Rate Fund. If approved, Fund shareholders will become shareholders of Adjustable Rate Fund and will receive shares with a value equal to the value of their Fund shares. Piper Capital proposed this reorganization to the Fund's Board of Directors because the Fund has been unable to attract and retain sufficient assets to make its continued operation economically viable. We urge you to read all of the enclosed materials carefully but direct your attention to the following important points: - The Board of Directors has unanimously approved the reorganization and recommends that you vote FOR the reorganization. - The two funds have nearly identical investment objectives. The Fund's objective is high current income consistent with low principal volatility. The investment objective of Adjustable Rate Fund is to provide the maximum current income that is consistent with low volatility of principal. - Tom McGlinch currently manages both funds and would remain responsible for the Adjustable Rate Fund's day-to-day management. - Shareholders will not incur any commissions, sales loads or other charges in connection with the reorganization and Piper Capital has agreed to pay for all direct expenses including the proxy solicitation. - While reimbursements currently keep the expense ratios of both the Fund and the Adjustable Rate Fund artificially low, Piper Capital does not currently intend to continue reimbursing expenses for either fund in fiscal 1997. Absent any such expense reimbursements, the expense ratio for Adjustable Rate Fund is lower than the Fund's expense ratio. - The reorganization will not result in any federal taxable income to the Fund or its shareholder. PLEASE MARK, SIGN, DATE AND RETURN THE ENCLOSED PROXY CARD AS SOON AS POSSIBLE, AS YOUR PROMPT RESPONSE WILL ELIMINATE THE NEED FOR ADDITIONAL MAILINGS. A postage-paid envelope is enclosed with each proxy mailing for your convenience. As the meeting date approaches, if you haven't voted you may receive a telephone call reminding you to vote. Attached are the formal Notice of Special Meeting and the Proxy Statement/Prospectus. Also enclosed are a number of other documents that will provide you with more information about the Fund and Adjustable Rate Fund. If you have additional questions, please contact your investment professional or call Piper Capital at 1 800 866-7778 and press 2. Sincerely, William H. Ellis President PIPER INSTITUTIONAL FUNDS INC. Institutional Government Adjustable Portfolio Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402-3804 ----------------------------- NOTICE OF SPECIAL MEETING OF SHAREHOLDERS TO BE HELD SEPTEMBER 12, 1996 ----------------------------- TO THE SHAREHOLDERS OF INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO, A SERIES OF PIPER INSTITUTIONAL FUNDS INC. Notice is hereby given that a Special Meeting (the "Meeting") of shareholders of Institutional Government Adjustable Portfolio (the "Fund"), one of two portfolios of Piper Institutional Funds Inc. (the "Company"), will be held at the offices of the Company, 222 South Ninth Street, Eleventh Floor, Minneapolis, Minnesota 55402, on September 12, 1996 at 10:00 a.m., central time. The purposes of the Meeting are: I. To consider and vote upon an Agreement and Plan of Reorganization, dated as of _____, 1996 (the "Plan"), by and between the Company, on behalf of the Fund, and Piper Funds Inc. -- II ("Piper Funds II"), on behalf of Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), pursuant to which substantially all of the assets of the Fund will be acquired by Adjustable Rate Fund and shareholders of the Fund will become shareholders of Adjustable Rate Fund receiving shares of Adjustable Rate Fund with a value equal to the value of their holdings in the Fund. A vote in favor of the Plan will be considered a vote in favor of an amendment to the articles of incorporation of the Company required to effect the reorganization as contemplated by the Plan. II. To consider and act upon such other matters as may properly come before the Meeting or any adjournment thereof. YOUR DIRECTORS UNANIMOUSLY RECOMMEND THAT YOU VOTE IN FAVOR OF THE ABOVE PROPOSAL. The attached Proxy Statement/Prospectus describes the above proposal in detail and is being sent to shareholders of record as of the close of business on July 22, 1996, who are the shareholders entitled to notice of and to vote at the Meeting. Please read the Proxy Statement/Prospectus carefully before telling us through your proxy or in person how you wish your shares to be voted. By Order of the Board of Directors SUSAN SHARP MILEY SECRETARY August , 1996 --- - - - -------------------------------------------------------------------------------- - - - -------------------------------------------------------------------------------- IMPORTANT THE BOARD OF DIRECTORS URGES YOU TO MARK, SIGN AND RETURN THE ENCLOSED PROXY AS SOON AS POSSIBLE WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING IN PERSON. THE ENCLOSED ADDRESSED ENVELOPE REQUIRES NO POSTAGE AND IS PROVIDED FOR YOUR CONVENIENCE. - - - -------------------------------------------------------------------------------- - - - -------------------------------------------------------------------------------- ADJUSTABLE RATE MORTGAGE SECURITIES FUND A SERIES OF PIPER FUNDS INC. -- II PIPER JAFFRAY TOWER 222 SOUTH NINTH STREET MINNEAPOLIS, MINNESOTA 55402-3804 (800) 866-7778 (TOLL FREE) --------------------------- ACQUISITION OF THE ASSETS OF INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO A SERIES OF PIPER INSTITUTIONAL FUNDS INC. BY AND IN EXCHANGE FOR SHARES OF ADJUSTABLE RATE MORTGAGE SECURITIES FUND A SERIES OF PIPER FUNDS INC. -- II --------------------------- This Proxy Statement/Prospectus is being furnished to shareholders of Institutional Government Adjustable Portfolio (the "Fund"), a series of Piper Institutional Funds Inc. (the "Company"), in connection with an Agreement and Plan of Reorganization dated as of ____, 1996 (the "Plan") pursuant to which substantially all of the assets of the Fund will be combined with those of Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), a series of Piper Funds Inc. -- II ("Piper Funds II"), in exchange for shares of Adjustable Rate Fund. As a result of this transaction, shareholders of the Fund will become shareholders of Adjustable Rate Fund and will receive shares of Adjustable Rate Fund with a value equal to the value of their holdings in the Fund as of the date of the transaction. The terms and conditions of this transaction are more fully described in this Proxy Statement/ Prospectus and in the Plan, attached hereto as Exhibit A. Adjustable Rate Fund is a diversified series of Piper Funds II, an open-end management investment company the shares of which may be offered in more than one series. The investment objective of Adjustable Rate Fund is to provide the maximum current income that is consistent with low volatility of principal. Adjustable Rate Fund seeks to achieve that objective by investing primarily (at least 65% of its total assets under normal market conditions) in adjustable rate mortgage securities (as herein defined). This Proxy Statement/Prospectus sets forth concisely information about Adjustable Rate Fund that shareholders of the Fund should know before voting on the Plan. This Proxy Statement also constitutes a Prospectus of Adjustable Rate Fund filed with the Securities and Exchange Commission (the "Commission") as part of its Registration Statement on Form N-14. The following documents accompany this Proxy Statement/Prospectus: Adjustable Rate Fund's Prospectus dated December 18, 1995; the Company's Prospectus dated November 1, 1995, as supplemented June 24, 1996; a Statement of Additional Information relating to the reorganization described in this Proxy Statement/ Prospectus dated ________, 1996; Adjustable Rate Fund's Statement of Additional Information dated December 18, 1995; Adjustable Rate Fund's Annual Report for the fiscal year ended August 31, 1995; Adjustable Rate Fund's Semiannual Report for the six months ended February 29, 1996; the Company's Statement of Additional Information dated November 1, 1995; and the Company's Annual Report for the fiscal year ended June 30, 1996. Adjustable Rate Fund's Prospectus dated December 18, 1995, and the Company's Prospectus dated November 1, 1995, as supplemented June 24, 1996, are incorporated herein by reference. INVESTORS ARE ADVISED TO READ AND RETAIN THIS PROXY STATEMENT/PROSPECTUS FOR FUTURE REFERENCE. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS PROXY STATEMENT/PROSPECTUS Page ---- INTRODUCTION. . . . . . . . . . . . . . . . . . . . . . . . . . 1 General. . . . . . . . . . . . . . . . . . . . . . . . . . 1 Record Date; Share Information . . . . . . . . . . . . . . 2 Proxies. . . . . . . . . . . . . . . . . . . . . . . . . . 2 Expenses of Solicitation . . . . . . . . . . . . . . . . . 3 Vote Required. . . . . . . . . . . . . . . . . . . . . . . 3 SYNOPSIS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The Reorganization . . . . . . . . . . . . . . . . . . . . 4 Fee Table. . . . . . . . . . . . . . . . . . . . . . . . . 4 Tax Consequences of the Reorganization . . . . . . . . . . 6 Dissenting Shareholders' Rights of Appraisal . . . . . . . 6 Comparison of the Fund and Adjustable Rate Fund. . . . . . 6 PRINCIPAL RISK FACTORS. . . . . . . . . . . . . . . . . . . . . 10 Risks of Investments . . . . . . . . . . . . . . . . . . . 10 Litigation Risk. . . . . . . . . . . . . . . . . . . . . . 12 THE REORGANIZATION. . . . . . . . . . . . . . . . . . . . . . . 14 Background . . . . . . . . . . . . . . . . . . . . . . . . 14 The Board's Consideration. . . . . . . . . . . . . . . . . 14 The Plan . . . . . . . . . . . . . . . . . . . . . . . . . 16 Tax Aspects of the Reorganization. . . . . . . . . . . . . 18 Dissenters' Rights . . . . . . . . . . . . . . . . . . . . 20 Description of Shares. . . . . . . . . . . . . . . . . . . 20 Capitalization Table (unaudited) . . . . . . . . . . . . . 21 Interests of Certain Persons . . . . . . . . . . . . . . . 21 COMPARISON OF INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS. . . . . . . . . . . . . . . . . . . . . . . . . . 21 Investment Objectives. . . . . . . . . . . . . . . . . . . 21 Investment Policies. . . . . . . . . . . . . . . . . . . . 21 Investment Restrictions. . . . . . . . . . . . . . . . . . 24 ADDITIONAL INFORMATION ABOUT THE FUND AND ADJUSTABLE RATE FUND. . . . . . . . . . . . . . . . . . . . . . 25 General. . . . . . . . . . . . . . . . . . . . . . . . . . 25 Financial Information. . . . . . . . . . . . . . . . . . . 25 Management . . . . . . . . . . . . . . . . . . . . . . . . 25 Description of Securities and Shareholder Inquiries. . . . 25 Dividends, Distributions and Taxes . . . . . . . . . . . . 25 Purchases and Redemptions. . . . . . . . . . . . . . . . . 25 Pending Legal Proceedings. . . . . . . . . . . . . . . . . 25 MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE . . . . . . . . . . 26 FINANCIAL STATEMENTS AND EXPERTS. . . . . . . . . . . . . . . . 26 LEGAL MATTERS . . . . . . . . . . . . . . . . . . . . . . . . . 26 AVAILABLE INFORMATION . . . . . . . . . . . . . . . . . . . . . 26 OTHER BUSINESS. . . . . . . . . . . . . . . . . . . . . . . . . 27 EXHIBIT A--Agreement and Plan of Reorganization, dated as of_____, 1996, by and between the Company, on behalf of the Fund, and Piper Funds II, on behalf of Adjustable Rate Fund . . . . . . . . . . . . . . A-1 -------------------------- PROXY STATEMENT/PROSPECTUS INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO SPECIAL MEETING OF SHAREHOLDERS TO BE HELD SEPTEMBER 12, 1996 -------------------------- INTRODUCTION GENERAL This Proxy Statement/Prospectus is being furnished to shareholders of Institutional Government Adjustable Portfolio (the "Fund"), a diversified series of Piper Institutional Funds Inc. (the "Company"), an open-end management investment company, in connection with the solicitation by the Board of Directors of the Company (the "Board") of proxies to be used at the Special Meeting of Shareholders of the Fund to be held at the offices of the Fund, 222 South Ninth Street, Eleventh Floor, Minneapolis, Minnesota 55402-3804 on September 12, 1996 at 10:00 a.m., central time, and any adjournments thereof (the "Meeting"). It is expected that this Proxy Statement/Prospectus will be mailed on or about August __, 1996. At the Meeting, Fund shareholders will consider and vote upon an Agreement and Plan of Reorganization, dated as of _______, 1996 (the "Plan") by and between the Company, on behalf of the Fund, and Piper Funds Inc. -- II ("Piper Funds II"), on behalf of Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), pursuant to which substantially all of the assets of the Fund will be acquired by Adjustable Rate Fund in exchange for shares of Adjustable Rate Fund. As a result of this transaction, shareholders of the Fund will become shareholders of Adjustable Rate Fund and will receive shares in Adjustable Rate Fund equal to the value of their holdings in the Fund on the date of such transaction (the transactions described above are referred to as the "Reorganization"). The shares to be issued by Adjustable Rate Fund pursuant to the Reorganization ("Adjustable Rate Fund Shares") will be issued at net asset value without a sales charge. Further information relating to Adjustable Rate Fund is set forth in the current Prospectus of Adjustable Rate Fund accompanying this Proxy Statement/Prospectus and is incorporated herein by reference. A vote in favor of the Plan will be considered a vote in favor of an amendment to the articles of incorporation of the Company required to effect the reorganization as contemplated by the Plan. 1 RECORD DATE; SHARE INFORMATION The Board has fixed the close of business on July 22, 1996 as the record date (the "Record Date") for the determination of the holders of shares of the Fund entitled to notice of, and to vote at, the Meeting. As of the Record Date, there were 538,180 shares of the Fund issued and outstanding. The holders of record on the Record Date of shares of the Fund are entitled to one vote per share held and a fractional vote with respect to fractional shares held on each matter submitted to a vote at the Meeting. The holders of 10% of the shares outstanding and entitled to vote will constitute a quorum at the meeting. The following table sets forth information concerning those persons known to Fund management to own of record or beneficially 5% or more of the outstanding shares of the Fund as of the record date. The persons named below have both record and beneficial ownership. Name and Address of Record Holder Percentage Ownership --------------------------------- -------------------- Norwest Bank Minnesota, N.A. 37.8% as Trustee for St. Louis Park/Methodist Hospital 733 Marquette Avenue South, Mail Stop 0036 Minneapolis, Minnesota 55479-0031 Midsouth National Bank 18.5% Attention: Karen L. Hail, Executive Vice President 102 Versailles Lafayette, Louisiana 70501-6750 Greer State Bank 18.5% 1111 West Poinsett Street P.O. Box 1029 Greer, South Carolina 29650-1395 As of the Record Date, the directors and officers of the Company, as a group, owned less than 1% of the outstanding shares of the Fund. To the knowledge of Piper Fund II's management, as of the Record Date no person owned of record or beneficially 5% or more of the outstanding shares of Adjustable Rate Fund. As of the Record Date, the directors and officers of Piper Funds II, as a group, owned less than 1% of the outstanding shares of Adjustable Rate Fund. PROXIES The enclosed form of proxy, if properly executed and returned, will be voted in accordance with the choice specified thereon. The proxy will be voted in favor of the Plan unless a choice is indicated to vote against or to abstain from voting on the Plan. The Board knows of no business, other than that set forth in the Notice of Special Meeting, to be presented for consideration at the Meeting. However, the proxy confers discretionary authority upon the persons named therein to vote as they determine on other business, not currently contemplated, which may come before the Meeting. Abstentions will be included for purposes of determining whether a quorum is present at the Meeting and for purposes of calculating the vote but shall not be deemed to have been voted in favor of such matters. Broker non-votes are shares held in street name for which the broker indicates that instructions have not been received from the beneficial owners or other persons entitled to vote and for which the broker does not have discretionary voting authority. Broker non-votes will be included for purposes of determining whether a quorum is present at the Meeting, but will not be deemed to be represented at the Meeting for purposes of calculating whether matters to be voted upon at the Meeting have been approved. Because approval of the Plan requires an affirmative vote by a majority of the outstanding shares, abstentions and broker non-votes all have the same effect as a negative vote. 2 If a shareholder executes and returns a Proxy Card but fails to indicate how the votes should be cast, the proxy will be voted in favor of the Plan. The proxy may be revoked at any time prior to the voting thereof by: (a) delivering written notice or revocation to the Secretary of the Company at 222 South Ninth Street, Minneapolis, Minnesota 55402-3804; (b) attending the Meeting and voting in person; or (c) signing and returning a new Proxy Card (if returned and received in time to be voted). Attendance at the Meeting will not in and of itself revoke a proxy. In the event that sufficient votes to approve the Plan are not obtained by the Meeting date, or, subject to approval of the Board, for other reasons, an adjournment or adjournments of the Meeting may be sought. Any adjournment would require a vote in favor of the adjournment by the holders of a majority of the shares present at the Meeting (or any adjournment thereof) in person or by proxy. The persons named as proxies will vote all shares represented by proxies which they are required to vote in favor of the Plan, in favor of an adjournment, and will vote all shares which they are required to vote against the Plan, against an adjournment. Approval of the Plan will be deemed approval of the amendment to the articles of incorporation of the Company attached to the Plan. EXPENSES OF SOLICITATION All expenses of this solicitation, including the cost of preparing and mailing this Proxy Statement/Prospectus, will be borne by Piper Capital Management Incorporated ("Piper Capital"), investment manager to the Company and Piper Funds II. In addition to the solicitation of proxies by mail, proxies may be solicited by officers and regular employees of the Company, Piper Capital or the Fund's distributor, without compensation other than regular compensation, personally or by mail, telephone, telegraph or otherwise. Brokerage houses, banks and other fiduciaries may be requested to forward soliciting material to the beneficial owners of shares and to obtain authorization for the execution of proxies. For those services, if any, they will be reimbursed by Piper Capital for their reasonable out-of-pocket expenses. VOTE REQUIRED Approval of the Plan by the Fund's shareholders requires the affirmative vote of a majority (I.E., more than 50%) of the outstanding shares of the Fund. If the Plan is not approved by shareholders, the Fund will continue in existence and the Board will consider alternative actions. 3 SYNOPSIS THE FOLLOWING IS A SYNOPSIS OF CERTAIN INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROXY STATEMENT/PROSPECTUS. THIS SYNOPSIS IS ONLY A SUMMARY AND IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROXY STATEMENT/PROSPECTUS AND THE PLAN. SHAREHOLDERS SHOULD CAREFULLY REVIEW THIS PROXY STATEMENT/PROSPECTUS AND THE PLAN IN THEIR ENTIRETY AND, IN PARTICULAR, THE CURRENT PROSPECTUS OF ADJUSTABLE RATE FUND WHICH ACCOMPANIES THIS PROXY STATEMENT/PROSPECTUS AND WHICH IS INCORPORATED HEREIN BY REFERENCE. THE REORGANIZATION The Plan provides for the transfer of substantially all of the assets of the Fund, subject to stated liabilities, to Adjustable Rate Fund in exchange for Adjustable Rate Fund Shares. The aggregate net asset value of Adjustable Rate Fund Shares issued in the exchange will equal the aggregate value of the net assets of the Fund received by Adjustable Rate Fund. On or after the closing date scheduled for the Reorganization (the "Closing Date"), the Fund will distribute Adjustable Rate Fund Shares received by the Fund to holders of shares of the Fund issued and outstanding as of the Valuation Date (as hereinafter defined) in complete liquidation of the Fund. As a result of the Reorganization, each Fund shareholder will receive that number of full and fractional Adjustable Rate Fund Shares equal in value to such shareholder's shares of the Fund. The Board has determined that the interests of existing Fund shareholders will not be diluted as a result of the Reorganization. FOR THE REASONS SET FORTH BELOW UNDER "THE REORGANIZATION -- THE BOARD'S CONSIDERATION," THE BOARD, INCLUDING ALL OF THE DIRECTORS WHO ARE NOT "INTERESTED PERSONS" OF THE COMPANY ("INDEPENDENT DIRECTORS"), AS THAT TERM IS DEFINED IN THE INVESTMENT COMPANY ACT OF 1940, AS AMENDED (THE "1940 ACT"), HAS UNANIMOUSLY CONCLUDED THAT THE REORGANIZATION IS IN THE BEST INTERESTS OF THE FUND AND ITS SHAREHOLDERS AND RECOMMENDS APPROVAL OF THE PLAN. FEE TABLE The funds each pay a variety of expenses for management of their assets, distribution of their shares and other services, and those expenses are reflected in the net asset value per share of each of the Fund and Adjustable Rate Fund. The following table sets forth the expenses and fees that shareholders of the Fund incurred during the fiscal year ended June 30, 1996 and that shareholders of Adjustable Rate Fund are expected to incur for the fiscal year ending August 31, 1996, provided that expenses are set forth absent any expense reimbursements by Piper Capital. Piper Capital has voluntarily limited Total Fund Operating Expenses for the Fund and Adjustable Rate Fund to .60% of average daily net assets for the Fund's fiscal year ended June 30, 1996 and Adjustable Rate Fund's fiscal year ending August 31, 1996. Piper Capital does not intend to continue expense reimbursements 4 for either Fund during the 1997 fiscal year. The Pro Forma Combined fees reflect the estimated fee schedule for the fiscal year ending August 31, 1996 assuming the Reorganization had occurred 12 months prior to that date and assuming no voluntary expense reimbursements by Piper Capital. SHAREHOLDER TRANSACTION EXPENSES
Adjustable Pro Forma Fund Rate Fund Combined ------ ---------- --------- Maximum Sales Charge Imposed on Purchases (as a percentage of offering price) (1) 1.00% 1.50% 1.50% Exchange Fee (2) $ 0 $ 0 $ 0
ANNUAL FUND OPERATING EXPENSES AS A PERCENTAGE OF AVERAGE NET ASSETS Adjustable Pro Forma Fund Rate Fund Combined ------ ---------- --------- Management Fees. . . . . . . . . . . . . . . . . 0.30% 0.35% 0.35% 12b-1 Fees (3) . . . . . . . . . . . . . . . . . 0.00% 0.15% 0.15% Other Expenses . . . . . . . . . . . . . . . . . 1.45% 0.24% 0.24% Total Fund Operating Expenses (4). . . . . . . . 1.75% 0.74% 0.74%
_______________ (1) No sales charge will be imposed on Shares acquired in the Reorganization. On unrelated purchases, the front-end sales charge of 1.00% for the Fund and 1.50% for Adjustable Rate Fund applies to purchases of less than $250,000 for the Fund and $100,000 for Adjustable Rate Fund and scales down to 0% for each fund on purchases of $500,000 or more. (2) For each fund, there is a $5 fee for each exchange in excess of four exchanges per year. (3) Adjustable Rate Fund's Rule 12b-1 fee is characterized as a service fee within the meaning of the National Association of Securities Dealers, Inc. ("NASD") guidelines. (4) Total Fund Operating Expenses are set forth absent any expense reimbursements by Piper Capital. Piper Capital has voluntarily limited Total Fund Operating Expenses for the Fund and Adjustable Rate Fund to .60% of average daily net assets for the Fund's fiscal year ended June 30, 1996 and Adjustable Rate Fund's fiscal year ending August 31, 1996. EXAMPLE To attempt to show the effect of these expenses on an investment over time, the example shown below has been created. You would pay the following expenses on a $1,000 investment over various time periods assuming (a) 5% annual return and (b) redemption at the end of each time period: 1 year 3 years 5 years 10 years ------ ------- ------- -------- The Fund . . . . . . . . $28 $65 $104 $214 Adjustable Rate Fund . . $22 $38 $56 $105 Pro Forma Combined . . . $22 $38 $56 $105 THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL OPERATING EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. TAX CONSEQUENCES OF THE REORGANIZATION As a condition to the Reorganization, the Fund will receive an opinion of the law firm of Dorsey & Whitney LLP that, upon the Reorganization, no gain or loss will be recognized by the Fund or its shareholders for federal income tax purposes. The holding period and aggregate tax basis of Adjustable Rate Fund shares that are received by each Fund shareholder will be the same as the holding period and aggregate tax basis of the Fund shares previously held by such shareholders. In addition, the holding period and tax basis of the assets of the Fund in the hands of Adjustable Rate Fund as a result of the Reorganization will be the same as in the hands of the Fund immediately prior to the Reorganization. For further information about the tax consequences of the Reorganization see "The Reorganization -- Tax Aspects of the Reorganization" below. DISSENTING SHAREHOLDERS' RIGHTS OF APPRAISAL Although under Minnesota law shareholders of a company acquired in a reorganization who do not vote to approve the reorganization generally have "appraisal rights" (where they may elect to have the "fair value" of their shares (determined in accordance with Minnesota law) judicially appraised and paid to them), the Division of Investment Management of the Commission has taken the position that Rule 22c-1 under the 1940 Act preempts appraisal provisions in state statutes. This rule provides that no open-end investment company may redeem its shares other than at net asset value next computed after receipt of a tender of such security for redemption. For further information about rights of appraisal, see "The Reorganization -- Dissenters' Rights." COMPARISON OF THE FUND AND ADJUSTABLE RATE FUND INVESTMENT OBJECTIVES AND POLICIES. The Fund and Adjustable Rate Fund have nearly identical investment objectives. The Fund's investment objective is high current income consistent with low principal volatility. The investment objective of Adjustable Rate Fund is to provide the maximum current income that is consistent with low volatility of principal. The investment objectives of the Fund and Adjustable Rate Fund are fundamental and may not be changed without shareholder approval. 6 The Fund seeks to achieve its investment objective by investing, under normal circumstances, at least 65% of its total assets in a portfolio of Mortgage-Backed Securities (securities which represent interests in or are collateralized by mortgages) that have adjustable interest rates which reset at periodic intervals ("adjustable rate mortgage securities" or "ARMS") and that are issued or guaranteed as to payment of principal and interest by the U.S. Government or its agencies or instrumentalities ("U.S. Government Securities"). Adjustable Rate Fund seeks to achieve its investment objective by investing, under normal circumstances, at least 65% of its total assets in a portfolio of ARMS. Thus, the principal difference between the two funds is that the Fund invests primarily in ARMS which are U.S. Government Securities, whereas Adjustable Rate Fund's ARMS investments, for purposes of meeting its 65% test, may be both U.S. Government Securities and ARMS issued by private organizations. The balance of the Fund's assets (up to 35% of total assets) may be invested in ARMS issued by private organizations, Mortgage-Backed Securities other than ARMS, other types of U.S. Government Securities, Canadian government securities, foreign index linked instruments and corporate debt securities. Investments in each of Canadian government securities, foreign index linked instruments and corporate debt securities are limited to 10% of total assets. The balance of Adjustable Rate Fund' assets (up to 35% of total assets) may be invested in Mortgage-Backed Securities other than ARMS, U.S. Government Securities (including, with respect to 10% of net assets, U.S. Government zero-coupon securities), asset-backed securities and corporate debt securities. Adjustable Rate Fund's investments in Mortgage-Backed Securities are more restricted than are the Fund's. Adjustable Rate Fund will not invest in inverse floating, interest-only, principal-only or Z tranches of collateralized mortgage obligations ("CMOs"), in residual interests of CMOs, or in stripped Mortgage-Backed Securities. The Fund's investments in Mortgage-Backed Securities may include any tranche of a CMO, provided that the Fund may not invest in residual interests of CMOs, and the Fund may invest in stripped Mortgage-Backed Securities. Securities in which the Fund invests (other than U.S. Government Securities) must be rated, as of the date of purchase, AAA by Standard & Poor's Rating Group ("S&P") or, if unrated, be of a comparable quality as determined by Piper Capital. Adjustable Rate Fund may invest in securities rated lower than AAA. At least 85% of Adjustable Rate Fund's total assets (other than U.S. Government Securities) must be rated, as of the date of purchase, AA or better by S&P, Aa or better by Moody's Investors Service, Inc. ("Moody's"), comparably rated by any other nationally recognized statistical rating organization ("NRSRO") or, if unrated, of comparable quality as determined by Piper Capital. Adjustable Rate Fund may not invest in any security rated, as of the date of purchase, lower than A by S&P or Moody's (or below a comparable rating by any other NRSRO) or, if unrated, of a quality lower than A as determined by Piper Capital. 7 The Fund may engage in options and financial futures transactions which relate to the securities in which it invests, may engage in foreign currency exchange transactions with respect to its investments in Canadian government securities, may enter into interest rate swaps and purchase and sell interest rate caps and floors, may purchase or sell securities on a when-issued or forward commitment basis, including the use of mortgage dollar rolls, and may lend its portfolio securities. Adjustable Rate Fund may also engage in such transactions, except that Adjustable Rate Fund may not engage in foreign currency exchange transactions, enter into interest rate swaps, or enter into mortgage dollar roll transactions (although Adjustable Rate Fund may otherwise purchase or sell securities on a when-issued or forward commitment basis). In addition, Adjustable Rate Fund may make investments in Eurodollar instruments for hedging purposes. For a more detailed comparison of the investment objectives and policies of the Fund and Adjustable Rate Fund, see "Comparison of Investment Objectives, Policies and Restrictions" below. INVESTMENT MANAGEMENT AND DISTRIBUTION PLAN FEES. The Fund and Adjustable Rate Fund have the same Board of Directors. In addition, the Fund and Adjustable Rate Fund obtain management services from Piper Capital. For each fund, fees are payable monthly based on the average net asset value of such fund as of the close of business each day. The Fund pays a management fee at an annual rate of .30% of its average daily net asset value and Adjustable Rate Fund pays at the annual rate of 0.35% on the first $500 million of the Fund's average daily net assets and .30% on average daily net assets in excess of $500 million. Adjustable Rate Fund has adopted a distribution plan ("12b-1 Plan") pursuant to Rule 12b-1 under the 1940 Act pursuant to which Adjustable Rate Fund pays a monthly service fee to the Distributor at an annual rate of .15% of the Fund's average daily net assets in connection with servicing of the Fund's shareholder accounts. This fee is intended to compensate the Distributor for the ongoing servicing and/or maintenance of Adjustable Rate Fund shareholder accounts and the costs incurred in connection therewith. Payments made under Adjustable Rate Fund's 12b-1 Plan are not tied exclusively to expenses actually incurred by the Distributor and may exceed such expenses. The Fund does not have a 12b-1 Plan. OTHER SIGNIFICANT FEES. Both the Fund and Adjustable Rate Fund pay additional fees in connection with their operations, including legal, auditing, transfer agent and custodial fees. See "Fee Table" above for the percentage of average net assets represented by such Other Expenses. 8 PURCHASES, REDEMPTIONS AND EXCHANGES. PURCHASES. The Fund and Adjustable Rate Fund each continuously issue their shares to investors at a price equal to net asset value at the time of such issuance, plus a maximum sales charge of 1.00% for the Fund and 1.50% for Adjustable Rate Fund. The sales charge is reduced on a graduated scale on purchases of $250,000 or more for the Fund and $100,000 or more for Adjustable Rate Fund. For each fund, there is no initial sales charge in connection with purchases of $500,000 or more. For Adjustable Rate Fund, however, a .20% contingent deferred sales charge ("CDSC") will be imposed in the event of a redemption transaction occurring within 24 months following such a purchase. The Fund does not impose a CDSC in connection with initial purchases of $500,000 or more. Shareholders of the Fund who acquire Adjustable Rate Fund Shares in the Reorganization will not pay the front-end sales charge on such Shares; however, such sales charge will be applied to additional purchases of Adjustable Rate Fund Shares. Shares of the Fund and Adjustable Rate Fund are distributed by the Distributor and other broker-dealers who have entered into selected broker-dealer agreements with the Distributor. Purchase orders for shares of the Fund will not be accepted after the date on which the Plan is approved by Fund shareholders. The minimum initial investments for the Fund and Adjustable Rate Fund are $100,000 and $250, respectively. Neither Fund imposes a minimum on subsequent investments. REDEMPTIONS. Shareholders of the Fund and Adjustable Rate Fund may redeem their shares for cash at any time at the net asset value per share next determined. With respect to Adjustable Rate Fund, however, shareholders who invested more than $500,000 and accordingly paid no front-end sales charge are in most circumstances subject to a CDSC if shares are redeemed within 24 months. The CDSC is equal to .20% of the lesser of the net asset value of the shares at the time of purchase or at the time of redemption. No CDSC will be applied to Adjustable Rate Fund Shares acquired in the Reorganization on redemption of such shares. The Fund and Adjustable Rate Fund offer reinstatement privileges whereby a shareholder whose shares have been redeemed may, within 120 days or 30 days, respectively, after the date of redemption, invest any portion or all of the proceeds thereof in another fund managed by Piper Capital without payment of an additional sales charge, or, in the case of Adjustable Rate Fund, if such redemption was subject to a CDSC, a pro rata credit will be given for such CDSC. The Fund and Adjustable Rate Fund may redeem involuntarily, at net asset value, accounts valued at less than $50,000 and $200, respectively. EXCHANGES. Each of the Fund and Adjustable Rate Fund makes available to its shareholders exchange privileges allowing exchange of shares for shares of certain other funds. Shares of the Fund and Adjustable Rate Fund Shares may be exchanged for shares of any of the other open-end funds open to new investors that are advised by Piper Capital. Both the Fund and Adjustable Rate Fund provide telephone exchange privileges to their shareholders. 9 For a more detailed discussion of purchasing, redeeming and exchanging Adjustable Rate Fund shares, see "Shareholder Guide to Investing -- How to Purchase Shares," "-- How to Redeem Shares" and "-- Shareholder Services" in Adjustable Rate Fund's current Prospectus. DIVIDENDS. For each fund net investment income is declared as dividends daily and paid monthly. Net realized capital gains, if any, are distributed annually by the Fund and at least once annually by Adjustable Rate Fund. Dividends and capital gains distributions of both the Fund and Adjustable Rate Fund are automatically reinvested in additional shares of such fund or another fund managed by Piper Capital at net asset value unless the shareholder elects to receive cash. PRINCIPAL RISK FACTORS RISKS OF INVESTMENTS Because Adjustable Rate Fund and the Fund each seek to achieve their investment objective by investing primarily (at least 65% of total assets under normal market conditions) in ARMS, they are subject to many of the same risks. Each fund is subject to interest rate risk, which is the potential for a decline in bond prices due to rising interest rates. In addition, each fund is subject to credit risk to the extent it invests in non-U.S. Government Securities. Credit risk, also known as default risk, is the possibility that a bond issuer will fail to make timely payments of interest or principal. The Fund is required to invest primarily in ARMS that are U.S. Government Securities. Because Adjustable Rate Fund is not subject to this requirement, it may have more exposure to credit risk than the Fund. In addition, Adjustable Rate Fund's credit quality standards may expose it to more credit risk than the Fund. Adjustable Rate Fund's non-U.S. Government Securities may be rated as low as A at the time of purchase (or, if unrated, be of comparable quality as determined by Piper Capital), whereas the Fund may not invest in any non-U.S. Government Securities rated lower than AAA by S&P (or, if unrated, of comparable quality as determined by Piper Capital). Each Fund's investments in ARMS and other Mortgage-Backed Securities are also subject to prepayment risk and extension risk. Prepayment risk results because, as interest rates fall, homeowners are more likely to refinance their home mortgages. When home mortgages are refinanced, the principal on Mortgage-Backed Securities is "prepaid" earlier than expected. The unanticipated principal payments must then be reinvested at a time when interest rates on new mortgage investments are falling. Extension risk is the possibility that rising interest rates may cause prepayments to occur at a slower than expected rate. This particular risk may effectively change a security which was considered short- or intermediate-duration at the time of purchase into a long-duration security. Long-duration securities generally fluctuate more widely in response to changes in interest rates than short- or intermediate-duration securities. 10 The funds may invest the balance of their assets in many of the same types of securities and therefore are subjected to the same risks with respect to such investments. Unlike Adjustable Rate Fund, however, the Fund may invest up to 10% of its total assets in foreign index linked instruments. Foreign index linked instruments are fixed income securities which are issued by U.S. issuers (including U.S. subsidiaries of foreign issuers) and are denominated in U.S. dollars but return principal and/or pay interest to investors in amounts which are linked to the level of a particular foreign index. Foreign index linked instruments may offer higher yields than comparable securities linked to purely domestic indices but also may be more volatile. Only the Fund may enter into mortgage "dollar rolls" in which the Fund sells securities for delivery in the current month and simultaneously contracts with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities on a specified future date. The use of mortgage dollar rolls by the Fund while remaining substantially fully invested increases the amount of the Fund's assets that are subject to market risk to an amount that is greater than the Fund's net asset value, which could result in increased volatility of the price of the Fund's shares. The Fund may invest in certain Mortgage-Backed Securities which are not permissible investments for Adjustable Rate Fund. Adjustable Rate Fund may not invest in inverse floating, interest-only, principal-only or Z tranches of collateralized mortgage obligations or in stripped Mortgage-Backed Securities, whereas the Fund may invest in such securities. Such securities may be more volatile than other Mortgage-Backed Securities and involve other additional risks. The Fund may engage in foreign currency exchange transactions in connection with its investments in Canadian government securities and may enter into interest rate swaps. These transactions involve certain risks as set forth in detail in the Fund's Prospectus under "Special Investment Methods -- Interest Rate Transactions" and in Appendix A to the Fund's Prospectus. Adjustable Rate Fund does not engage in such transactions. In addition to ARMS that are U.S. Government Securities, each of the funds may invest in other types of U.S. Government Securities. Adjustable Rate Fund's investments in U.S. Government zero-coupon securities are limited to 10% of net assets, whereas the Fund's investments are not so limited. The market prices of zero-coupon securities are more volatile than the market prices of securities of comparable quality and similar maturity that pay interest periodically and may respond to a greater degree to fluctuations in interest rates than do such non-zero-coupon securities. Although holders of zero-coupon securities do not receive periodic payments of interest, income accretes on such securities and is subject to the distribution requirements of the Internal Revenue Code. Because such income may not be matched by a corresponding cash distribution to a fund holding such 11 securities, the fund may be required to borrow money or dispose of other securities to be able to make distributions to shareholders. Only Adjustable Rate Fund purchases asset-backed securities, which are securities that directly or indirectly represent a participation in or are secured by and payable from a pool of assets representing the obligations of a number of different parties. Through the use of trusts and special purpose corporations, various types of assets, primarily automobile and credit card receivables, are securitized in structures similar to those of Mortgage-Backed Securities. However, asset-backed securities do not have the benefit of the same security interest in the related collateral as do Mortgage-Backed Securities. Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of automobile receivables permit the servicers to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state law, the trustee for the holders of the automobile receivables may not have a perfected security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries of repossessed collateral may not, in some cases, be available to support payments on these securities. In addition, only Adjustable Rate Fund may invest in Eurodollar instruments. Such investments are made for hedging purposes only. Eurodollar instruments are essentially U.S. dollar denominated futures contracts or options thereon that are linked to the London Interbank Offered Rate ("LIBOR"). Eurodollar instruments are subject to the same limitations and risks as other futures contracts and options thereon, which are set forth in Adjustable Rate Fund's Prospectus. The foregoing discussion is a summary of the principal risk factors. For a more complete discussion of the risks of each fund, see "Investment Objectives and Policies -- Institutional Government Adjustable Portfolio" in the Fund's Prospectus and "Investment Objective, Policies and Risk Factors" in Adjustable Rate Fund's Prospectus. LITIGATION RISK American Adjustable Rate Term Trust Inc. -- 1996 ("BDJ"), American Adjustable Rate Term Trust Inc. -- 1997 ("CDJ"), American Adjustable Rate Term Trust Inc. -- 1998 ("DDJ") and American Adjustable Rate Term Trust Inc. -- 1999 ("EDJ") (collectively, the "Trusts") merged into Adjustable Rate Fund on September 1, 1995. Adjustable Rate Fund may be deemed to be a successor by merger to the Trusts and, as such, may succeed to their liabilities, including damages sought in any litigation. 12 A complaint was filed by Herman D. Gordon on October 20, 1994, in the United States District Court, District of Minnesota, against DDJ, EDJ, Piper Capital, the Distributor, Piper Jaffray Companies Inc. and certain associated individuals. A second complaint was filed by Frank Donio, I.R.A. and other plaintiffs on April 14, 1995, in the United States District Court, District of Minnesota, against BDJ, CDJ, DDJ, EDJ, Piper Capital, the Distributor, Piper Jaffray Companies Inc. and certain associated individuals. Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995 and by Order dated June 8, 1995, the Court consolidated the two putative class actions. The consolidated amended complaint, which purports to be a class action, alleges certain violations of federal and state securities laws, breach of fiduciary duty and negligent misrepresentation. The parties have reached an agreement-in-principle to settle all outstanding claims of the purported class action. If approved by the Court and a sufficiently large percentage of the class, a settlement agreement consistent with the terms of the agreement-in-principle would provide $14 million in principal payments consisting of $500,000 payable upon execution of the settlement agreement, $1.5 million payable upon final approval by the Court, and payments of $3 million on each anniversary of the final court approval for the next four years, with accrued interest payments of up to $1.8 million. These payments would be made by Piper Capital and Piper Jaffray Companies Inc. and would not be an obligation of Adjustable Rate Fund. Two additional complaints relating to the Trusts, which are based on claims similar to those asserted in the Gordon/Donio Consolidated Complaint, remain pending. The first of these additional complaints was filed against the Distributor on August 11, 1995 in Washington State District Court, King County, by plaintiff Ernest Volinn. The second complaint was filed against the Distributor on November 1, 1995 in the United States District Court, District of Idaho, by plaintiff Ewing Company Profit Sharing Plan. In addition to the above complaints, a number of actions have been commenced in arbitration by individual investors in the Trusts. Piper Capital and Piper Jaffray Companies Inc. have agreed, pursuant to an indemnification agreement between and among Piper Capital, Piper Jaffray Companies Inc. and Piper Funds II, to indemnify Piper Funds II against any losses incurred in connection with such litigation. This indemnification agreement will also protect Fund shareholders who become Adjustable Rate Fund shareholders pursuant to the Reorganization. 13 THE REORGANIZATION BACKGROUND The Fund began operations in February 1993 and reached its peak net assets of approximately $67 million in January 1994. Since that time, the Fund has experienced a steady decline in assets, with net assets of approximately $6 million as of the date of this Proxy Statement/Prospectus. From February 1994 to February 1995, the Federal Reserve Board increased short-term rates seven times. Resets on ARMS did not keep pace with these rate increases and, as a result, the Fund performed poorly and experienced significant redemptions. Since that time, shareholder redemptions have continued to exceed shareholder purchases. Because of the continuing inability to attract and retain assets, Piper Capital believes that the continued operation of the Fund is not economically viable. In addition, Piper Capital believes that, because Adjustable Rate Fund has a nearly identical investment objective and similar investment policies, the likelihood of increased sales of Fund shares in the future is remote. Accordingly, Piper Capital recommended to the Board of Directors of the Company that substantially all of the assets of the Fund be acquired by Adjustable Rate Fund in exchange for shares of Adjustable Rate Fund. THE BOARD'S CONSIDERATION At a meeting of the Board of Directors held on June 18, 1996, Piper Capital reviewed for the Board the basis for its recommendation and the Board, including all of the Independent Directors, unanimously approved the Reorganization. The Plan was unanimously approved by the Board, including all of the Independent Directors, on August 9, 1996, and the Board recommended that shareholders approve the Plan. In determining whether to recommend that shareholders of the Fund approve the Plan, the Board, with the advice and assistance of independent legal counsel, inquired into a number of matters. In particular, the Board considered the Fund's prospects for future growth and the effect upon shareholders should assets remain at current levels or continue to be reduced further. The Board considered in this regard that Piper Capital has voluntarily limited total expenses of the Fund and of Adjustable Rate Fund and that Piper Capital does not currently intend to continue these limitations. The Board noted that absent any expense limitations, total operating expenses are significantly lower for Adjustable Rate Fund than for the Fund. The Board carefully considered the compatibility of the investment objectives, policies, restrictions and portfolios of the Fund and Adjustable Rate Fund. The Board noted that the funds have nearly identical investment objectives and noted that the most significant difference between the two, as discussed more fully below in "Comparison of Investment Objectives, Policies and Restrictions -- 14 Investment Policies," is that the Fund invests primarily in ARMS that are U.S. Government Securities whereas Adjustable Rate Fund invests primarily in ARMS that may be either privately issued or U.S. Government Securities. Consequently, the Reorganization will result in the potential for greater exposure to privately issued ARMS for Fund shareholders. The Board also considered that, as discussed in more detail above under "Principal Risk Factors," Piper Funds II may succeed to the liabilities of certain closed-end funds that were merged into Piper Funds II and that are subject to litigation. Piper Capital and Piper Jaffray Companies Inc. have agreed, pursuant to an indemnification agreement between and among Piper Capital, Piper Jaffray Companies Inc. and Piper Funds II, to indemnify Piper Funds II against any losses incurred in connection with such litigation. The Board noted that, to the extent there are claims against Adjustable Rate Fund as a result of such litigation, this indemnification agreement would also protect Fund shareholders who become Adjustable Rate Fund shareholders pursuant to the Reorganization. In addition, the Board considered the terms and conditions of the proposed Reorganization, the comparative performance of the funds, the indirect costs (E.G., brokerage) likely to be incurred by the Fund in the Reorganization, and Piper Capital's undertaking to pay all the direct costs (E.G., proxy solicitation) of the Reorganization and any unamortized organizational expenses on the books of the Fund. In recommending the Reorganization to the shareholders of the Fund, the Board considered that the Reorganization would have the following benefits for shareholders of the Fund: (1) Absent any expense reimbursements, the total expenses borne by shareholders of the combined fund should be lower on a percentage basis than the total expenses per share of the Fund. As a result of expense reimbursements that Piper Capital has undertaken to make, the Fund's expense ratio for its fiscal year ended June 30, 1996 was, and Adjustable Rate Fund's expense ratio for its fiscal year ending August 31, 1996 will be, .60% of average daily net assets. Piper Capital does not intend to continue expense reimbursements for either Fund during the 1997 fiscal year. Absent such reimbursements, the expense ratio for the Fund would have been 1.75% for the fiscal year ended June 30, 1996. By contrast, the expense ratio for Adjustable Rate Fund for its fiscal year ending August 31, 1996 is expected to be approximately .74% of total assets absent any voluntary expense reimbursements (based on the semiannual period ended February 29, 1996). Thus, despite the fact that Adjustable Rate Fund has a 12b-1 Plan and a slightly higher advisory fee than the Fund, because Adjustable Rate Fund is significantly larger than the Fund its total operating expenses, absent any expense reimbursements, are significantly lower than those of the Fund. (2) Shareholders of the Fund will be able to acquire Adjustable Rate Fund Shares, which are otherwise subject to a maximum 1.50% front-end 15 sales charge, at net asset value and pursue a nearly identical investment objective in a larger and more economically viable fund without having to sell their shares. (3) The Fund's shareholders will retain the capabilities and resources of Piper Capital and its affiliates in the areas of management, operations, distribution, shareholder servicing and marketing. (4) It is anticipated that the Reorganization will constitute a tax-free reorganization for federal income tax purposes, and no gain or loss will be recognized by the Fund or its shareholders for federal income tax purposes as a result of the Reorganization. Based on the foregoing, the Board determined that the Reorganization is in the best interests of the shareholders of the Fund and that the interests of Fund shareholders will not be diluted as a result thereof. The Board of Directors of Adjustable Rate Fund, including all of the Independent Directors, has also determined, after considering the aforementioned factors, that the Reorganization is in the best interests of Adjustable Rate Fund and that the interests of existing shareholders of Adjustable Rate Fund will not be diluted as a result thereof. The transaction will enable Adjustable Rate Fund to acquire investment securities which are consistent with its objectives without the brokerage costs attendant to the purchase of such securities in the market. Also, the addition of the Fund's assets should result in some cost savings to the extent that fixed expenses of Adjustable Rate Fund can be spread over a larger asset base. A larger asset base could also lead to reduced management fees as a result of "breakpoints" in the management fees payable by Adjustable Rate Fund. THE PLAN The terms and conditions under which the Reorganization would be consummated are set forth in the Plan and are summarized below. This summary is qualified in its entirety by reference to the Plan, a copy of which is attached as Exhibit A to this Proxy Statement/Prospectus. The Plan provides that (a) the Fund will transfer all of its assets, including appropriate portfolio securities, cash, cash equivalents, securities, commodities, futures and interest receivables, to Adjustable Rate Fund on the Closing Date in exchange for the assumption by Adjustable Rate Fund of the Fund's stated liabilities, including all expenses, costs, charges and reserves, as reflected on an unaudited statement of assets and liabilities of the Fund prepared by the Treasurer of the Company as of the Valuation Date in accordance with generally accepted accounting principles consistently applied from the prior audited period, and the delivery of Adjustable Rate Fund Shares; and (b) such Adjustable Rate Fund Shares will be distributed to the shareholders of the Fund on the Closing Date or as soon as 16 practicable thereafter and outstanding Fund shares will be cancelled and retired. The distribution of Adjustable Rate Fund Shares and the cancellation and retirement of outstanding Fund shares is to be accomplished under the Plan by amending the articles of incorporation of the Company in the manner provided in the amendment set forth in Exhibit 1 to the Plan. For technical reasons, certain of the Fund's existing investment limitations may be deemed to preclude the Fund from consummating the Reorganization to the extent that the Reorganization would involve the Fund holding all of its assets as shares of Adjustable Rate Fund until such shares are distributed to the Fund's shareholders. By approving the Plan, the Fund's shareholders will be deemed to have agreed to waive each of these limitations. The number of Adjustable Rate Fund Shares to be delivered to the Fund will be determined by dividing the value of the Fund assets acquired by Adjustable Rate Fund (net of stated liabilities assumed by Adjustable Rate Fund) by the net asset value of an Adjustable Rate Fund Share; these values will be calculated as of the close of business of the New York Stock Exchange on a business day not later than the fifth business day following the receipt of the requisite approval of the Plan by the shareholders of the Fund or at such other time as the Fund and Adjustable Rate Fund may agree (the "Valuation Date"). The net asset value of an Adjustable Rate Fund Share shall be the net asset value per share computed on the Valuation Date, using the valuation procedures set forth in Adjustable Rate Fund's then-current Prospectus and Statement of Additional Information. As an illustration, if on the Valuation Date the Fund were to have securities with a market value of $95,000 and cash in the amount of $5,000, the value of the assets which would be transferred to Adjustable Rate Fund would be $100,000. If the net asset value per share of Adjustable Rate Fund were $10 per share at the close of business on the Valuation Date, the number of Adjustable Rate Fund Shares to be issued would be 10,000 ($100,000 DIVIDED BY $10). These 10,000 shares of Adjustable Rate Fund would be distributed to the former shareholders of the Fund. This example is given for illustration purposes only and does not bear any relationship to the dollar amounts or shares expected to be involved in the Reorganization. Adjustable Rate Fund will cause its transfer agent to credit and confirm an appropriate number of Adjustable Rate Fund Shares to each Fund shareholder. Neither the Fund nor Adjustable Rate Fund issues stock certificates. The Closing Date will be 5:00 p.m., Eastern Time, on the Valuation Date, or at such other time as the Fund and Adjustable Rate Fund may agree. The consummation of the Reorganization is contingent upon the approval of the Reorganization by the shareholders of the Fund and the receipt of the other opinions and certificates set forth in Sections 6, 7 and 8 of the Plan and the occurrence of the events described in those Sections, certain of which may be waived by the Fund or Adjustable Rate Fund. The Plan may be amended in any mutually agreeable manner, except that no amendment may be made subsequent to the Meeting which would detrimentally affect the value of the Adjustable Rate Fund 17 Shares to be distributed. Piper Capital will bear all direct costs associated with the Reorganization, including preparation, printing, filing and proxy solicitation expenses incurred in connection with obtaining requisite shareholder approval of the Reorganization. In addition, Piper Capital will pay any unamortized organizational expenses on the books of the Fund immediately prior to the Reorganization. The Plan may be terminated and the Reorganization abandoned at any time, before or after approval by the Fund's shareholders, by mutual consent of the Fund and Adjustable Rate Fund. In addition, either party may terminate the Plan upon the occurrence of a material breach of the Plan by the other party or if, by December 31, 1996, any condition set forth in the Plan has not been fulfilled or waived by the party entitled to its benefits. Prior to the Valuation Date, the Fund will declare and pay a dividend to distribute all of its investment company taxable income and net capital gain, if any, for the taxable year during which the Reorganization occurs. The proceeds of such distribution will be taxable to Fund shareholders subject to taxation. See "Tax Aspects of the Reorganization" below. All contracts entered into by or on behalf of the Fund will terminate upon consummation of the Reorganization. Shareholders of the Fund will continue to be able to redeem their shares at net asset value next determined after receipt of the redemption request until the close of business on the business day next preceding the Closing Date. Redemption requests received by the Fund thereafter will be treated as requests for redemption of shares of Adjustable Rate Fund. TAX ASPECTS OF THE REORGANIZATION At least one but not more than 20 business days prior to the Valuation Date, the Fund will declare and pay a dividend or dividends which, together with all previous such dividends, will have the effect of distributing to the Fund's shareholders all of the Fund's investment company taxable income for the current taxable year (computed without regard to any dividends-paid deduction), and all of the Fund's net capital gain, if any, realized in such year (after reduction for any capital loss carry-forward). It is intended that the Reorganization will qualify for federal income tax purposes as a tax-free reorganization under Section 368(a)(1)(C) of the Internal Revenue Code of 1986, as amended (the "Code"), and that, for federal income tax purposes, no income, gain or loss will be recognized by the Fund's shareholders (except that the dividend or dividends discussed in the preceding paragraph will be taxable to Fund shareholders subject to taxation). The Fund has not asked, nor does it plan to ask, the Internal Revenue Service to rule on the tax consequences of the Reorganization. 18 As a condition to the closing of the Reorganization, the two funds will receive an opinion from Dorsey & Whitney LLP, counsel to the funds, based in part on certain representations to be furnished by each fund, substantially to the effect that the federal income tax consequences of the Reorganization will be as follows: (i) the Reorganization will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Code, and Adjustable Rate Fund and the Fund each will qualify as a party to the Reorganization under Section 368(b) of the Code; (ii) Fund shareholders will recognize no income, gain or loss upon receipt, pursuant to the Reorganization, of Adjustable Rate Fund shares. Fund shareholders subject to taxation will recognize income upon receipt of any net investment income or net capital gains of the Fund which are distributed by the Fund prior to the Reorganization; (iii) the tax basis of Adjustable Rate Fund shares received by each Fund shareholder pursuant to the Reorganization will be equal to the tax basis of the Fund shares exchanged therefor; (iv) the holding period of Adjustable Rate Fund shares received by each Fund shareholder pursuant to the Reorganization will include the period during which the Fund shareholder held the Fund shares exchanged therefor, provided that the Fund shares were held as a capital asset on the date of the Reorganization; (v) the Fund will recognize no income, gain or loss by reason of the Reorganization; (vi) Adjustable Rate Fund will recognize no income, gain or loss by reason of the Reorganization; (vii) the tax basis of the assets received by the Fund pursuant to the Reorganization will be the same as the basis of those assets in the hands of the Fund immediately prior to the Reorganization; (viii) the holding period of the assets received by Adjustable Rate Fund pursuant to the Reorganization will include the period during which such assets were held by the Fund; and (ix) Adjustable Rate Fund will succeed to and take into account the earnings and profits, or deficit in earnings and profits, of the Fund immediately prior to the Reorganization. The foregoing advice is based in part upon certain representations furnished by the Fund, Piper Capital and certain 5% shareholders of the Fund, of which two 19 principal ones are: (a) that assets representing at least 90% of the fair market value of the Fund's net assets and at least 70% of the fair market value of the Fund's gross assets immediately prior to the Reorganization are exchanged solely for Adjustable Rate Fund shares with unrestricted voting rights, and (b) that there is no plan or intention by the shareholders of the Fund who own 5% or more of the Fund's shares and, to the best knowledge of management of the Fund, there is no plan or intention on the part of the remaining Fund shareholders to sell, exchange or otherwise dispose of a number of Adjustable Rate Fund shares to be received pursuant to the Reorganization that would reduce such shareholders' interest to a number of Adjustable Rate Fund shares having, in the aggregate, a value as of the Closing Date of less than 50% of the total value of Fund shares outstanding immediately prior to the consummation of the Reorganization. SHAREHOLDERS OF THE FUND SHOULD CONSULT THEIR TAX ADVISORS REGARDING THE EFFECT, IF ANY, OF THE PROPOSED REORGANIZATION IN LIGHT OF THEIR INDIVIDUAL CIRCUMSTANCES. SINCE THE FOREGOING DISCUSSION RELATES ONLY TO THE FEDERAL INCOME TAX CONSEQUENCES OF THE REORGANIZATION, SHAREHOLDERS OF THE FUND SHOULD CONSULT THEIR TAX ADVISORS AS TO STATE AND LOCAL TAX CONSEQUENCES, IF ANY, OF THE REORGANIZATION. DISSENTERS' RIGHTS Pursuant to Sections 302A.471 and 302A.473 of the Minnesota Business Corporation Act (the "MBCA Sections"), record holders of shares of the Company are entitled to assert dissenters' rights in connection with the Reorganization and obtain payment of the "fair value" of their shares, provided such shareholders comply with the requirements of the MBCA Sections. NOTWITHSTANDING THE PROVISIONS OF THE MBCA SECTIONS, THE DIVISION OF INVESTMENT MANAGEMENT OF THE COMMISSION HAS TAKEN THE POSITION THAT ADHERENCE TO STATE APPRAISAL PROCEDURES BY A REGISTERED INVESTMENT COMPANY ISSUING REDEEMABLE SECURITIES WOULD CONSTITUTE A VIOLATION OF RULE 22c-1 UNDER THE 1940 ACT. THIS RULE PROVIDES THAT NO OPEN-END INVESTMENT COMPANY MAY REDEEM ITS SHARES OTHER THAN AT NET ASSET VALUE NEXT COMPUTED AFTER RECEIPT OF A TENDER OF SUCH SECURITY FOR REDEMPTION. IT IS THE VIEW OF THE DIVISION OF INVESTMENT MANAGEMENT THAT RULE 22c-1 PREEMPTS APPRAISAL PROVISIONS IN STATE STATUTES. In the interests of ensuring equal valuation of all interests in the Fund, the Company will determine dissenters' rights in accordance with the Division's interpretation. It should be emphasized that Fund shareholders may sell their shares at net asset value at any time prior to the Closing Date. DESCRIPTION OF SHARES Shares of Adjustable Rate Fund to be issued pursuant to the Plan will, when issued, be fully paid and nonassessable by Adjustable Rate Fund and transferable without restrictions and will have no preemptive or conversion rights. 20 CAPITALIZATION TABLE (UNAUDITED) The following table sets forth the capitalization of Adjustable Rate Fund and the Fund as of June 30, 1996 and on a pro forma combined basis as if the Reorganization had occurred on that date: Shares Net Asset Net Assets Outstanding Value Per (000s omitted) (000s omitted) Share -------------- -------------- --------- Fund . . . . . . . . . . $ 5,774 609 $9.48 Adjustable Rate Fund . . $307,424 38,291 $8.03 Pro Forma Combined . . . $313,198 38,997 $8.03 INTERESTS OF CERTAIN PERSONS The following persons affiliated with the Fund and Adjustable Rate Fund receive payments from the Fund and Adjustable Rate Fund for services rendered pursuant to contractual arrangements with both funds: (a) Piper Capital, as the investment adviser and manager to each fund, (b) the Distributor, as the distributor of shares of each fund and for providing certain transfer agent and dividend disbursing agent services for shareholder accounts held at the Distributor, and (c) Piper Trust Company, an affiliate of Piper Capital and the Distributor, for providing certain transfer agent and dividend disbursing agent services for shareholder accounts held at Piper Trust Company. COMPARISON OF INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS INVESTMENT OBJECTIVES The Fund and Adjustable Rate Fund have nearly identical investment objectives. The Fund's objective is high current income consistent with low principal volatility. The investment objective of Adjustable Rate Fund is to provide the maximum current income that is consistent with low volatility of principal. The investment objectives of the Fund and Adjustable Rate Fund are fundamental and may not be changed without shareholder approval. INVESTMENT POLICIES GENERAL. The Fund seeks to achieve its investment objective by investing, under normal circumstances, at least 65% of its total assets in a portfolio of Mortgage-Backed Securities (securities which represent interests in or are collateralized by mortgages) that have adjustable interest rates which reset at periodic intervals ("adjustable rate mortgage securities" or "ARMS") and that are issued or guaranteed as to payment of principal and interest by the U.S. Government or its agencies or instrumentalities ("U.S. Government Securities"). 21 Adjustable Rate Fund seeks to achieve its investment objective by investing, under normal circumstances, at least 65% of its total assets in a portfolio of ARMS. Thus, the principal difference between the two funds is that the Fund invests primarily in ARMS which are U.S. Government Securities, whereas Adjustable Rate Fund's ARMS investments, for purposes of meeting its 65% test, may be both U.S. Government Securities and ARMS issued by private organizations. The balance of the Fund's assets (up to 35% of total assets) may be invested in ARMS issued by private organizations, Mortgage-Backed Securities other than ARMS, other types of U.S. Government Securities, Canadian government securities, foreign index linked instruments and corporate debt securities. Investments in each of Canadian government securities, foreign index linked instruments and corporate debt securities are limited to 10% of total assets. The balance of Adjustable Rate Fund' assets (up to 35% of total assets) may be invested in Mortgage-Backed Securities other than ARMS, U.S. Government Securities (including, with respect to 10% of net assets, U.S. Government zero-coupon securities), asset-backed securities and corporate debt securities. The investment policies of both the Fund and Adjustable Rate Fund are non-fundamental and may be changed by their respective Boards of Directors unless otherwise noted herein. MORTGAGE-BACKED SECURITIES. Adjustable Rate Fund's investments in Mortgage-Backed Securities are more restricted than are the Fund's. Adjustable Rate Fund will not invest in inverse floating, interest-only, principal-only or Z tranches of collateralized mortgage obligations ("CMOs"), in residual interests of CMOs, or in stripped Mortgage-Backed Securities. The Fund's investments in Mortgage-Backed Securities may include any tranche of a CMO, provided that the Fund may not invest in residual interests of CMOs, and the Fund may invest in stripped Mortgage-Backed Securities. Inverse floating, interest-only, principal-only and Z tranches of CMOs and stripped Mortgage-Backed Securities may be more volatile than other Mortgage-Backed Securities and involve certain additional risks. See "Investment Objectives and Policies" in the Fund's Prospectus. U.S. GOVERNMENT SECURITIES. In addition to ARMS that are U.S. Government Securities, each of the funds may invest in other types of U.S. Government Securities. Adjustable Rate Fund's investments in U.S. Government zero-coupon securities are limited to 10% of net assets, whereas the Fund's investments are not so limited. The market prices of zero-coupon securities are more volatile than the market prices of securities of comparable quality and similar maturity that pay interest periodically and may respond to a greater degree to fluctuations in interest rates than do such non-zero-coupon securities. See "Principal Risk Factors" above and "Investment Objective, Policies and Risk Factors" in Adjustable Rate Fund's Prospectus. 22 CANADIAN GOVERNMENT SECURITIES. The Fund may invest up to 10% of its total assets in Canadian government securities, which are debt securities issued or guaranteed by the Canadian federal government, Canadian provincial governments and political subdivisions, agencies or instrumentalities thereof. Adjustable Rate Fund may not invest in such securities. Investing in Canadian government securities involves considerations and possible risks not typically associated with investing in U.S. securities. See "Investment Objectives and Policies" in the Fund's Prospectus. FOREIGN INDEX LINKED INSTRUMENTS. The Fund may invest up to 10% of its total assets in foreign index linked instruments. Adjustable Rate Fund may not invest in such securities. Foreign index linked instruments are fixed income securities which are issued by U.S. issuers (including U.S. subsidiaries of foreign issuers) and are denominated in U.S. dollars but return principal and/or pay interest to investors in amounts which are linked to the level of a particular foreign index. Foreign index linked instruments may offer higher yields than comparable securities linked to purely domestic indices but also may be more volatile. See "Investment Objectives and Policies" in the Fund's Prospectus. CORPORATE DEBT SECURITIES. Each Fund may invest in corporate debt securities. The Fund may invest up to 10% of its total assets in such securities; Adjustable Rate Fund is not subject to this limitation and thus could invest up to 35% of its total assets in corporate debt securities. Corporate debt securities are debt obligations of U.S. corporations (other than ARMS or Mortgage-Backed Securities). The values of corporate debt securities typically will fluctuate in response to general economic conditions, to changes in interest rates and, to a greater extent than the values of ARMS or Mortgage-Backed Securities, to business conditions affecting the specific industries in which the issuers are engaged. Corporate debt securities will typically decrease in value as a result of increases in interest rates. ASSET-BACKED SECURITIES. Only Adjustable Rate Fund purchases asset-backed securities, which are securities that directly or indirectly represent a participation in or are secured by and payable from a pool of assets representing the obligations of a number of different parties. Through the use of trusts and special purpose corporations, various types of assets, primarily automobile and credit card receivables, are securitized in structures similar to those of Mortgage-Backed Securities. However, asset-backed securities do not have the benefit of the same security interest in the related collateral as do Mortgage-Backed Securities and are subject to different risks. See "Principal Risk Factors" above and "Investment Objective, Policies and Risk Factors" in Adjustable Rate Fund's Prospectus. SECURITIES RATINGS. Securities in which the Fund invests (other than U.S. Government Securities) must be rated, as of the date of purchase, AAA by Standard & Poor's Rating Group ("S&P") or, if unrated, be of a comparable quality as determined by Piper Capital. In the event that a security held by the Fund is downgraded to a rating below AAA or, if unrated, is no longer of a quality 23 comparable to a security rated AAA, as determined by Piper Capital, the Fund will sell such a security as promptly as possible. Adjustable Rate Fund may invest in securities rated lower than AAA. At least 85% of Adjustable Rate Fund's total assets (other than U.S. Government Securities) must be rated, as of the date of purchase, AA or better by S&P, Aa or better by Moody's Investors Service, Inc. ("Moody's"), comparably rated by any other nationally recognized statistical rating organization ("NRSRO") or, if unrated, of comparable quality as determined by Piper Capital. Adjustable Rate Fund may not invest in any security rated, as of the date of purchase, lower than A by S&P or Moody's (or below a comparable rating by any other NRSRO) or, if unrated, of a quality lower than A as determined by Piper Capital. In the event that a security is downgraded to a rating below A or, if unrated, is no longer of a quality comparable to a security rated A, as determined by Piper Capital, Adjustable Rate Fund will sell such a security as promptly as possible. OTHER INVESTMENT PRACTICES. The Fund may engage in options and financial futures transactions which relate to the securities in which it invests, may engage in foreign currency exchange transactions with respect to its investments in Canadian government securities, may enter into interest rate swaps and purchase and sell interest rate caps and floors, may purchase or sell securities on a when-issued or forward commitment basis, including the use of mortgage dollar rolls, may lend its portfolio securities and may enter into repurchase agreements and reverse repurchase agreements. Adjustable Rate Fund may also engage in such transactions, except that Adjustable Rate Fund may not engage in foreign currency exchange transactions, enter into interest rate swaps, or enter into mortgage dollar roll transactions (although Adjustable Rate Fund may otherwise purchase or sell securities on a when-issued or forward commitment basis). In addition, Adjustable Rate Fund may make investments in Eurodollar instruments for hedging purposes. The foregoing discussion is a summary of the principal differences and similarities between the investment policies of the funds. For a more complete discussion of each fund's policies, see "Investment Objectives and Policies" in each fund's respective Prospectus and "Investment Objectives, Policies and Restrictions" in each fund's respective Statement of Additional Information. INVESTMENT RESTRICTIONS Each fund has adopted certain fundamental and non-fundamental investment restrictions. A fundamental investment restriction cannot be changed without the vote of a majority of the fund's outstanding voting securities, as defined in the 1940 Act. As fundamental investment restrictions, the Fund may borrow money only from banks for temporary or emergency purposes in an amount up to one third of the value of its total assets, and the Fund may not mortgage, pledge or hypothecate its assets except to secure temporary or emergency borrowing. As fundamental investment restrictions, Adjustable Rate Fund may borrow only for temporary or emergency purposes (including borrowing through reverse repurchase agreements) in an amount up to 10% of the value of its total assets, and Adjustable 24 Rate Fund may not mortgage, pledge or hypothecate its assets, except in an amount not exceeding 10% of the value of its total assets to secure temporary or emergency borrowing. Complete descriptions of the other fundamental and non-fundamental investment restrictions adopted by the Fund and Adjustable Rate Fund appear under the caption "Special Investment Methods -- Investment Restrictions" in each fund's Prospectus and under the caption "Investment Objectives, Policies and Restrictions" in each fund's Statement of Additional Information. ADDITIONAL INFORMATION ABOUT THE FUND AND ADJUSTABLE RATE FUND GENERAL For a discussion of the organization and operation of the Fund, see "Introduction," "Management," "Investment Objectives and Policies," "Special Investment Methods" and "General Information" in its Prospectus. For a discussion of the organization and operation of Adjustable Rate Fund, see "Introduction," "Management," "Investment Objective, Policies and Risk Factors," and "General Information" in its Prospectus. FINANCIAL INFORMATION For certain financial information about Adjustable Rate Fund and the Fund, see "Financial Highlights" and "Performance Comparisons" in their respective Prospectuses. MANAGEMENT For information about Adjustable Rate Fund's and the Fund's Board of Directors, investment manager and distributor, see "Management" and "Distribution of Fund Shares" in Adjustable Rate Fund's Prospectus and "Introduction" and "Management" in the Fund's Prospectus. DESCRIPTION OF SECURITIES AND SHAREHOLDER INQUIRIES For a description of the nature and most significant attributes of shares of the Fund and Adjustable Rate Fund, and information regarding shareholder inquiries, see "General Information" and "Introduction -- Shareholder Inquiries" in their respective Prospectuses. DIVIDENDS, DISTRIBUTIONS AND TAXES For a discussion of Adjustable Rate Fund's and the Fund's policies with respect to dividends, distributions and taxes, see "Shareholder Guide to Investing -- Dividends and Distributions" and "Tax Status" in their respective Prospectuses. 25 PURCHASES AND REDEMPTIONS For a discussion of how each fund's shares may be purchased and redeemed, see "Shareholder Guide to Investing" in the funds' respective Prospectuses. PENDING LEGAL PROCEEDINGS For a discussion of pending legal proceedings see "General Information -- Pending Legal Proceedings" in the funds' respective Prospectuses. MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE For management's discussion of Adjustable Rate Fund's performance as of the fiscal year ended August 31, 1995 and six-month period ended February 29, 1996, see Adjustable Rate Fund's Annual and Semiannual Reports for such periods accompanying this Proxy Statement/Prospectus. For management's discussion of the Fund's performance, see the Company's Annual Report for the fiscal year ended June 30, 1996 accompanying this Proxy Statement/Prospectus. FINANCIAL STATEMENTS AND EXPERTS The annual financial statements of Adjustable Rate Fund and the Fund incorporated by reference in the Statement of Additional Information have been audited by KPMG Peat Marwick LLP, independent accountants, for the periods indicated in its respective reports thereon. Such financial statements have been incorporated by reference in reliance upon such reports given upon the authority of KPMG Peat Marwick LLP as experts in accounting and auditing. LEGAL MATTERS Certain legal matters concerning the issuance of shares of Adjustable Rate Fund will be passed upon by Dorsey & Whitney LLP, Minneapolis, Minnesota. AVAILABLE INFORMATION ADDITIONAL INFORMATION ABOUT THE FUND AND ADJUSTABLE RATE FUND IS AVAILABLE, AS APPLICABLE, IN THE FOLLOWING DOCUMENTS WHICH ACCOMPANY THIS PROXY STATEMENT/PROSPECTUS: (a) ADJUSTABLE RATE FUND'S PROSPECTUS DATED DECEMBER 18, 1995, WHICH PROSPECTUS FORMS A PART OF POST-EFFECTIVE AMENDMENT NO. 2 TO PIPER FUND II'S REGISTRATION STATEMENT ON FORM N-1A (FILE NOS. 33-60515; 811-07279); (b) ADJUSTABLE RATE FUND'S STATEMENT OF ADDITIONAL INFORMATION DATED DECEMBER 18, 1995; (c) ADJUSTABLE RATE FUND'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED AUGUST 31, 1995; (d) ADJUSTABLE RATE FUND'S SEMIANNUAL REPORT FOR THE SIX MONTHS ENDED FEBRUARY 29, 1996; (e) THE COMPANY'S PROSPECTUS DATED NOVEMBER 1, 1995, AS SUPPLEMENTED JUNE 24, 1996, WHICH PROSPECTUS FORMS A PART OF POST-EFFECTIVE AMENDMENT NO. 5 TO THE COMPANY'S REGISTRATION STATEMENT ON FORM N-1A (FILE 26 NOS. 33-53718; 811-7320); (f) THE COMPANY'S STATEMENT OF ADDITIONAL INFORMATION DATED NOVEMBER 1, 1995; AND (g) THE COMPANY'S ANNUAL REPORT FOR THE FISCAL YEAR ENDED JUNE 30, 1996. The Company and Piper Funds II are subject to the informational requirements of the Securities and Exchange Act of 1934, as amended, and, in accordance therewith, file reports and other information with the Commission. Proxy materials, reports and other information about the Fund and Adjustable Rate Fund which are of public record can be inspected and copied at public reference facilities maintained by the Commission at Room 1204, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and certain of its regional offices, and copies of such materials can be obtained at prescribed rates from the Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, Washington, D.C. 20549. OTHER BUSINESS Management of the Company knows of no business other than the matters specified above which will be presented at the Meeting. Since matters not known at the time of the solicitation may come before the Meeting, the proxy as solicited confers discretionary authority with respect to such matters as properly come before the Meeting, including any adjournment or adjournments thereof, and it is the intention of the persons named as attorneys-in-fact in the proxy to vote this proxy in accordance with their judgment on such matters. By Order of the Board of Directors, SUSAN SHARP MILEY SECRETARY August , 1996 -- 27 EXHIBIT A AGREEMENT AND PLAN OF REORGANIZATION INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO AND ADJUSTABLE RATE MORTGAGE SECURITIES FUND THIS AGREEMENT AND PLAN OF REORGANIZATION ("Agreement") is made as of this___ day of ___, 1996, by and between Piper Institutional Funds Inc. ("Piper Institutional"), on behalf of its series Institutional Government Adjustable Portfolio ("Institutional Fund"), and Piper Funds Inc. -- II ("Piper Funds II"), on behalf of its series Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"). Piper Institutional and Piper Funds II are Minnesota corporations. As used in this Agreement, the terms "Adjustable Rate Fund" and "Institutional Fund" shall be construed to mean, respectively, "Piper Funds II on behalf of Adjustable Rate Fund" and "Piper Institutional on behalf of Institutional Fund," where necessary to reflect the fact that a corporate series is generally considered the beneficiary of corporate level actions taken with respect to the series and is not itself recognized as a person under law. This Agreement is intended to be and is adopted as a "plan of reorganization," within the meaning of Treas. Reg. 1.368-2(g), for a reorganization under Section 368(a)(1)(C) of the Internal Revenue Code of 1986, as amended (the "Code"). The reorganization (the "Reorganization") will consist of the transfer to Adjustable Rate Fund of substantially all of the assets of Institutional Fund in exchange for the assumption by Adjustable Rate Fund of all stated liabilities of Institutional Fund and the issuance by Adjustable Rate Fund of shares of common stock, par value $0.01 per share ("Adjustable Rate Fund Shares"), to be distributed, after the Closing Date hereinafter determined, to the shareholders of Institutional Fund in liquidation of Institutional Fund as provided herein, all upon the terms and conditions hereinafter set forth in this Agreement. The distribution of Adjustable Rate Fund Shares to Institutional Fund shareholders and the retirement and cancellation of Institutional Fund shares will be effected pursuant to an amendment to the Articles of Incorporation of Piper Institutional in the form attached hereto as Exhibit 1 (the "Amendment"), to be adopted by Piper Institutional in accordance with the Minnesota Business Corporation Act. In consideration of the premises and of the covenants and agreements hereinafter set forth, the parties hereto covenant and agree as follows: 1. REORGANIZATION AND LIQUIDATION OF INSTITUTIONAL FUND 1.1. Subject to the terms and conditions set forth herein and in the Amendment and on the basis of the representations and warranties contained herein, Institutional Fund agrees to assign, deliver and otherwise transfer the Institutional Fund Assets (as defined in paragraph 1.2(a)) to Adjustable Rate Fund A-1 and Adjustable Rate Fund agrees in exchange therefor to assume all stated liabilities of Institutional Fund on the Closing Date (as defined in paragraph 3.1) as set forth in paragraph 1.3 and to deliver to Institutional Fund Shareholders (as defined in paragraph 1.5) the number of Adjustable Rate Fund Shares, including fractional Adjustable Rate Fund Shares, determined in accordance with paragraph 2.2. Such transactions shall take place at the closing provided for in paragraph 3.1 (the "Closing"). 1.2. (a) The "Institutional Fund Assets" shall consist of all property, including, without limitation, all cash, cash equivalents, securities, futures and interest receivables owned by Institutional Fund, and any deferred or prepaid expenses shown as an asset on Institutional Fund's books, on the Valuation Date (as defined in paragraph 2.1). (b) Institutional Fund reserves the right to sell any of the securities in its portfolio but will not, from the date on which the Proxy Materials (as defined in paragraph 4.3) are mailed to Institutional Fund shareholders, acquire without the prior written approval of Adjustable Rate Fund any additional securities or other instruments other than securities or instruments of the type in which Adjustable Rate Fund is permitted to invest and in amounts agreed to by Adjustable Rate Fund. In the event that Institutional Fund holds any assets that Adjustable Rate Fund is not permitted to hold, Institutional Fund will dispose of such assets on or prior to the Valuation Date. In addition, if it is determined that the portfolios of Institutional Fund and Adjustable Rate Fund, when aggregated, would contain investments exceeding certain percentage limitations imposed upon Adjustable Rate Fund with respect to investments (including, among others, percentage limitations necessary to satisfy the diversification requirements of the Code), Institutional Fund if requested by Adjustable Rate Fund will, on or prior to the Valuation Date, dispose of and/or reinvest a sufficient amount of such investments as may be necessary to avoid violating such limitations as of the Closing Date. 1.3. Institutional Fund will endeavor to discharge all of its liabilities and obligations on or prior to the Valuation Date. Adjustable Rate Fund will assume all stated liabilities, which include, without limitation, all expenses, costs, charges and reserves reflected on an unaudited Statement of Assets and Liabilities of Institutional Fund prepared by the Treasurer of Institutional Fund as of the Valuation Date in accordance with generally accepted accounting principles consistently applied from the prior audited period ("Valuation Date Statement"). 1.4. In order for Institutional Fund to comply with Section 852(a)(1) of the Code and to avoid having any investment company taxable income or any net capital gain subject to tax in the taxable year ending with its dissolution, Institutional Fund will, on or before the Valuation Date, declare and distribute dividends in an amount large enough so that it will have declared dividends of all A-2 of its investment company taxable income and net capital gain, if any, for such taxable year (determined without regard to any deduction for dividends paid). 1.5. On the Closing Date or as soon as practicable thereafter, pursuant to paragraph 1.1 hereof and the Amendment, Institutional Fund will distribute Adjustable Rate Fund Shares received by Institutional Fund pro rata to its shareholders of record determined as of the close of business on the Valuation Date ("Institutional Fund Shareholders"). Thereafter, no additional shares representing interests in Institutional Fund shall be issued. Such distribution will be accomplished by an instruction, signed by Institutional Fund's Secretary, to transfer Adjustable Rate Fund Shares then credited to Institutional Fund's account on the books of Adjustable Rate Fund to open accounts on the books of Piper Funds in the names of the Institutional Fund Shareholders and representing the respective pro rata number of Adjustable Rate Fund Shares due each such Institutional Fund Shareholder. All issued and outstanding shares of Institutional Fund simultaneously will be canceled on Institutional Fund's books. 1.6. Ownership of Adjustable Rate Fund Shares will be shown on the books of Piper Fund II's transfer agent. Adjustable Rate Fund Shares will be issued in the manner described in Piper Fund II's then-current Prospectus and Statement of Additional Information, except no front-end sales charges will be incurred by Institutional Fund Shareholders in connection with Adjustable Rate Fund Shares received in the Reorganization. 1.7. Any transfer taxes payable upon issuance of Adjustable Rate Fund Shares in a name other than the registered holder of Institutional Fund Shares on Institutional Fund's books as of the close of business on the Valuation Date shall, as a condition of such issuance and transfer, be paid by the person to whom Adjustable Rate Fund Shares are to be issued and transferred. 1.8. Any reporting responsibility of Institutional Fund is and shall remain the responsibility of Institutional Fund. 1.9. All books and records maintained on behalf of Institutional Fund will be delivered to Adjustable Rate Fund and, after the Closing, will be maintained by Adjustable Rate Fund or its designee in compliance with applicable record retention requirements under the 1940 Act. 2. VALUATION 2.1. The "Valuation Date" shall be a business day not later than the 5th business day following the receipt of the requisite approval of this Agreement by shareholders of Institutional Fund or such other date after such shareholder approval as may be mutually agreed upon. The value of the Institutional Fund Assets shall be the value of such assets computed as of 4:00 p.m., Eastern time, on A-3 the Valuation Date, using the valuation procedures set forth in Piper Fund II's then current Prospectus and Statement of Additional Information. 2.2. The net asset value of an Adjustable Rate Fund Share shall be the net asset value per share computed on the Valuation Date, using the valuation procedures set forth in Piper Fund II's then-current Prospectus and Statement of Additional Information. 2.3. The number of Adjustable Rate Fund Shares (including fractional shares, if any) to be issued hereunder shall be determined by dividing the value of the Institutional Fund Assets, net of the liabilities of Institutional Fund assumed by Adjustable Rate Fund pursuant to paragraph 1.1, determined in accordance with paragraph 2.1, by the net asset value of an Adjustable Rate Fund Share determined in accordance with paragraph 2.2. 2.4. All computations of value shall be made by Piper Capital Management Incorporated ("PCM") in accordance with its regular practice in pricing Adjustable Rate Fund. Adjustable Rate Fund shall cause PCM to deliver a copy of its valuation report at the Closing. 3. CLOSING AND CLOSING DATE 3.1. The Closing shall take place on the Valuation Date as of 5:00 p.m., Eastern time, or at such other day or time as the parties may agree (the "Closing Date"). The Closing shall be held in a location mutually agreeable to the parties hereto. All acts taking place at the Closing shall be deemed to take place simultaneously as of 5:00 p.m., Eastern time, on the Closing Date unless otherwise provided. 3.2. Portfolio securities held by Institutional Fund (together with any cash or other assets) shall be delivered by Institutional Fund to Investors Fiduciary Trust Company (the "Custodian"), as custodian for Adjustable Rate Fund, for the account of Adjustable Rate Fund on or before the Closing Date in conformity with applicable custody provisions under the 1940 Act and duly endorsed in proper form for transfer in such condition as to constitute good delivery thereof in accordance with the custom of brokers. The portfolio securities shall be accompanied by all necessary federal and state stock transfer stamps or a check for the appropriate purchase price of such stamps. Portfolio securities and instruments deposited with a securities depository (as defined in Rule 17f-4 under the 1940 Act) shall be delivered on or before the Closing Date by book-entry in accordance with customary practices of such depository and the Custodian. The cash delivered shall be in the form of a Federal Funds wire, payable to the order of "Investors Fiduciary Trust Company, Custodian for Adjustable Rate Mortgage Securities Fund, a series of Piper Funds Inc. -- II." 3.3. In the event that on the Valuation Date, (a) the New York Stock Exchange shall be closed to trading or trading thereon shall be restricted or (b) trading or the reporting of trading on such Exchange or elsewhere shall be disrupted A-4 so that, in the judgment of both Adjustable Rate Fund and Institutional Fund, accurate appraisal of the value of the net assets of Adjustable Rate Fund or the Institutional Fund Assets is impracticable, the Valuation Date shall be postponed until the first business day after the day when trading shall have been fully resumed without restriction or disruption and reporting shall have been restored. 3.4. At the Closing, each party shall deliver to the other such bills of sale, checks, assignments, share certificates, if any, receipts or other documents as such other party or its counsel may reasonably request. 4. COVENANTS OF ADJUSTABLE RATE FUND AND INSTITUTIONAL FUND 4.1. Except as otherwise expressly provided herein with respect to Institutional Fund, Adjustable Rate Fund and Institutional Fund each will operate its business in the ordinary course between the date hereof and the Closing Date, it being understood that such ordinary course will include customary dividends and other distributions. 4.2. Piper Funds II will prepare and file with the Securities and Exchange Commission (the "Commission") a registration statement on Form N-14 under the Securities Act of 1933, as amended (the "1933 Act"), relating to Adjustable Rate Fund Shares (the "Registration Statement"). Piper Institutional will provide Piper Funds II with the Proxy Materials as described in paragraph 4.3 below for inclusion in the Registration Statement. Piper Institutional will further provide Piper Funds II with such other information and documents relating to Institutional Fund as are reasonably necessary for the preparation of the Registration Statement. 4.3. Institutional Fund will call a meeting of its shareholders to consider and act upon this Agreement and the Amendment and to take all other action necessary to obtain approval of the transactions contemplated herein, including, if necessary, the waiver of any existing investment limitations that might otherwise preclude Institutional Fund from holding all of its assets as Adjustable Rate Fund Shares until such shares are distributed to Institutional Fund shareholders. Piper Institutional will prepare the notice of meeting, form of proxy and proxy statement (collectively, "Proxy Materials") to be used in connection with such meeting. Piper Funds II will furnish Piper Institutional with a currently effective Prospectus relating to Adjustable Rate Fund Shares for inclusion in the Proxy Materials and with such other information relating to Adjustable Rate Fund as is reasonably necessary for the preparation of the Proxy Materials. 4.4. Subject to the provisions of this Agreement, Adjustable Rate Fund and Institutional Fund will each take, or cause to be taken, all action, and do or cause to be done, all things reasonably necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement. A-5 4.5. As soon after the Closing Date as is reasonably practicable, Piper Institutional (a) shall prepare and file all federal and other tax returns and reports of Institutional Fund required by law to be filed with respect to all periods ending on or before the Closing Date but not theretofore filed, and (b) shall pay all federal and other taxes shown as due thereon and/or all federal and other taxes that were unpaid as of the Closing Date, including without limitation, all taxes for which the provision for payment was made as of the Closing Date (as represented in paragraph 5.2(k)). 4.6. Adjustable Rate Fund agrees to use all reasonable efforts to obtain the approvals and authorizations required by the 1933 Act, the 1940 Act and such of the state blue sky and securities laws as it may deem appropriate in order to continue its operations after the Closing Date. 5. REPRESENTATIONS AND WARRANTIES 5.1. Piper Funds II represents and warrants to Piper Institutional as follows: (a) Adjustable Rate Fund is a series of Piper Funds II. Piper Funds II is a corporation validly existing and in good standing under the laws of Minnesota with corporate power to carry on its business as presently conducted. (b) Piper Funds II is a duly registered management investment company, and its registration with the Commission as an investment company under the 1940 Act and the registration of its shares under the 1933 Act are in full force and effect; (c) All of the issued and outstanding shares of common stock of Adjustable Rate Fund have been offered and sold in compliance in all material respects with applicable registration requirements of the 1933 Act and state securities laws. Shares of Adjustable Rate Fund are registered in all jurisdictions in which they are required to be registered under state securities laws and other laws, and Piper Funds II is not subject to any stop order and is fully qualified to sell Adjustable Rate Fund shares in each state in which such shares have been registered. (d) The current Prospectus and Statement of Additional Information of Adjustable Rate Fund conform in all materials respects to the applicable requirements of the 1933 Act and the 1940 Act and the regulations thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they are made, not misleading. A-6 (e) Adjustable Rate Fund is not in, and the execution, delivery and performance of this Agreement will not result in, a materials violation of any provision of Piper Funds II's Articles of Incorporation or Bylaws or of any agreement, indenture, instrument, contract, lease or other undertaking to which Adjustable Rate Fund is a party or by which it is bound. (f) Other than as disclosed in Piper Fund II's currently effective Prospectus and Statement of Additional Information or in the Proxy Materials, no material litigation or administration proceeding or investigation of or before any court or governmental body is presently pending or, to its knowledge, threatened against Piper Funds II or Adjustable Rate Fund or any of its properties or assets which, if adversely determined, would materially and adversely affect its financial condition or the conduct of its business; and Adjustable Rate Fund is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body which materially and adversely affects, or is reasonably likely to materially and adversely affect, its business or its ability to consummate the transactions herein contemplated. (g) Piper Fund II's Statement of Assets and Liabilities, Statement of Operations, Statement of Changes in Net Assets and Financial Highlights as of August 31, 1995, and for the year then ended, certified by KPMG Peat Marwick LLP, and Piper Fund II's unaudited Statement of Assets and Liabilities, Statement of Operations, Statement of Changes in Net Assets and Financial Highlights as of February 29, 1996 and for the six-month period then ended (copies of which have been furnished to Institutional Fund), fairly present, in all material respects, Piper Fund II's financial condition as of such dates in accordance with generally accepted accounting principles, and its results of operations, changes in its net assets and financial highlights for such periods, and as of such dates there were no known liabilities of Adjustable Rate Fund (contingent or otherwise) not disclosed therein that would be required in accordance with generally accepted accounting principles to be disclosed therein. (h) Since the date of the most recent unaudited financial statements, there has not been any material adverse change in Piper Fund II's financial condition, assets, liabilities or business, other than changes occurring in the ordinary course of business, or any incurrence by Adjustable Rate Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except indebtedness incurred in the ordinary course of business. For the purpose of this subparagraph (h), neither a decline in Piper Fund II's net asset value per share nor a decrease in Piper Fund II's size due to redemptions by Adjustable Rate Fund shareholders shall constitute a material adverse change. A-7 (i) All issued and outstanding Adjustable Rate Fund shares are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and nonassessable with no personal liability attaching to the ownership thereof. Adjustable Rate Fund does not have outstanding any options, warrants or other rights to subscribe for or purchase any of its shares, not is there outstanding any security convertible into any of its shares. (j) The execution, delivery and performance of this Agreement have been duly authorized by all necessary action on the part of Piper Funds II, and this Agreement constitutes a valid and binding obligation of Adjustable Rate Fund enforceable in accordance with its terms, subject as to enforcement to bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other laws relating to or affecting creditors rights and to general equity principles. No other consents, authorizations or approvals are necessary in connection with Piper Fund II's performance of this Agreement, except such as have been obtained under the 1933 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act"), and the 1940 Act and such as may be required under state securities laws; (k) Adjustable Rate Fund Shares to be issued and delivered to Institutional Fund, for the account of the Institutional Fund Shareholders, pursuant to the terms of this Agreement will at the Closing Date have been duly authorized and, when so issued and delivered, will be duly and validly issued Adjustable Rate Fund Shares, and will be fully paid and nonassessable with no personal liability attaching to the ownership thereof; (l) All material federal and other tax returns and reports of Adjustable Rate Fund required by law to be filed on or before the Closing Date have been filed and are correct, and all federal and other taxes shown as due or required to be shown as due on said returns and reports have been paid or provision has been made for the payment thereof and, to the best of Piper Fund II's knowledge, no such return is currently under audit and no assessment has been asserted with respect to any such return and there are no facts that might form the basis for such proceedings (m) For each taxable year since its inception, Adjustable Rate Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a "regulated investment company" and neither the execution or delivery of, nor the performance of its obligations under, this Agreement will adversely affect, and no other events, to the best of Piper Fund II's knowledge, are reasonably likely to occur which will adversely affect the ability of Adjustable Rate Fund to continue to meet the requirements of Subchapter M of the Code; (n) Since Piper Fund II's most recent fiscal year-end, there has been no change by Adjustable Rate Fund in accounting methods, principles or A-8 practices, including those required by generally accepted accounting principles; (o) The information furnished or to be furnished by Adjustable Rate Fund for use in registration statements, proxy materials and other documents which may be necessary in connection with the transactions contemplated hereby shall be accurate and complete in all material respects and shall comply in all material respects with federal securities and other laws and regulations applicable thereto. (p) The Proxy Materials to be included in the Registration Statement (only insofar as they relate to Adjustable Rate Fund) will, on the effective date of the Registration Statement and on the Closing Date, not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which such statements were made, not materially misleading. 5.2 Piper Institutional represents and warrants to Piper Funds II as follows: (a) Institutional Fund is a series of Piper Institutional. Piper Institutional is a corporation validly existing and in good standing under the laws of Minnesota. (b) Piper Institutional is a duly registered management investment company, and its registration with the Commission as an investment company under the 1940 Act and the registration of its shares under the 1933 Act are in full force and effect. (c) All of the issued and outstanding shares of common stock of Institutional Fund have been offered and sold in compliance in all material respects with applicable registration requirements of the 1933 Act and state securities laws. Shares of Institutional Fund are registered in all jurisdictions in which they are required to be registered under state securities laws and other laws, and Piper Institutional is not subject to any stop order and is fully qualified to sell Institutional Fund shares in each state in which such shares have been registered. (d) The current Prospectus and Statement of Additional Information of Institutional Fund conform in all material respects to the applicable requirements of the 1933 Act and the 1940 Act and the regulations thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. A-9 (e) Institutional Fund is not in, and the execution, delivery and performance of this Agreement will not result in, a material violation of any provision of Piper Institutional's Articles of Incorporation or Bylaws or of any agreement, indenture, instrument, contract, lease or other undertaking to which Institutional Fund is a party or by which it is bound. (f) No material litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or, to its knowledge, threatened against Institutional Fund or any of its properties or assets which, if adversely determined, would materially and adversely affect its financial condition or the conduct of its business; and Institutional Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body which materially and adversely affects, or is reasonably likely to materially and adversely affect, its business or its ability to consummate the transactions herein contemplated. (g) Institutional Fund's Statement of Assets and Liabilities, Statement of Operations, Statement of Changes in Net Assets and Financial Highlights of Institutional Fund as of June 30, 1996 and for the year then ended, certified by KPMG Peat Marwick LLP, fairly present, in all material respects, Institutional Fund's financial condition as of such date, and its results of operations, changes in its net assets and financial highlights for such period in accordance with generally accepted accounting principles, and as of such date there were no known liabilities of Institutional Fund (contingent or otherwise) not disclosed therein that would be required in accordance with generally accepted accounting principles to be disclosed therein. (h) Since the date of the most recent audited financial statements, there has not been any material adverse change in Institutional Fund's financial condition, assets, liabilities or business, other than changes occurring in the ordinary course of business, or any incurrence by Institutional Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed in writing to and acknowledged by Adjustable Rate Fund prior to the date of this Agreement and prior to the Closing Date. All liabilities of Institutional Fund (contingent and otherwise) are reflected in the Valuation Date Statement. For the purpose of this subparagraph (h), neither a decline in Institutional Fund's net asset value per share nor a decrease in Institutional Fund's size due to redemptions by Institutional Fund shareholders shall constitute a material adverse change. (i) Institutional Fund has no material contracts or other commitments (other than this Agreement) that will be terminated with liability to it prior to the Closing Date. A-10 (j) All issued and outstanding shares of Institutional Fund are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and nonassessable with no personal liability attaching to the ownership thereof. Institutional Fund does not have outstanding any options, warrants or other rights to subscribe for or purchase any of its shares, nor is there outstanding any security convertible into any of its shares. All such shares will, at the time of Closing, be held by the persons and in the amounts recorded by Institutional Fund's transfer agent. (k) The execution, delivery and performance of this Agreement will have been duly authorized prior to the Closing Date by all necessary action on the part of Piper Institutional and, subject to the approval of Institutional Fund's shareholders, this Agreement constitutes a valid and binding obligation of Institutional Fund enforceable in accordance with its terms, subject as to enforcement to bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other laws relating to or affecting creditors' rights and to general equity principles. No other consents, authorizations or approvals are necessary in connection with Institutional Fund's performance of this Agreement, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act and such as may be required under state securities laws. (l) All material federal and other tax returns and reports of Institutional Fund required by law to be filed on or before the Closing Date shall have been filed and are correct and all federal and other taxes shown as due or required to be shown as due on said returns and reports have been paid or provision has been made for the payment thereof and, to the best of Institutional Fund's knowledge, no such return is currently under audit and no assessment has been asserted with respect to any such return and there are no facts that might form the basis for such proceedings. (m) For each taxable year since its inception, Institutional Fund has met all the requirements of Subchapter M of the Code for qualification and treatment as a "regulated investment company" and neither the execution or delivery of, nor the performance of its obligations under, this Agreement will adversely affect, and no other events, to the best of Institutional Fund's knowledge, are reasonably likely to occur which will adversely affect the ability of Institutional Fund to continue to meet the requirements of Subchapter M of the Code. (n) At the Closing Date, Institutional Fund will have good and valid title to the Institutional Fund Assets, subject to no liens (other than the obligation, if any, to pay the purchase price of portfolio securities purchased by Institutional Fund which have not settled prior to the Closing Date), security interests or other encumbrances, and full right, power and authority to assign, A-11 deliver and otherwise transfer such assets hereunder, and upon delivery and payment for such assets, Adjustable Rate Fund will acquire good and marketable title thereto, subject to no restrictions on the full transfer thereof, including any restrictions as might arise under the 1933 Act. (o) On the effective date of the Registration Statement, at the time of the meeting of Institutional Fund's shareholders and on the Closing Date, the Proxy Materials will (i) comply in all material respects with the provisions of the 1933 Act, the 1934 Act and the 1940 Act and the regulations thereunder and (ii) not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. Neither Institutional Fund nor Piper Institutional shall be construed to have made the foregoing representation with respect to portions of the Proxy Materials furnished by Adjustable Rate Fund. Any other information furnished by Institutional Fund for use in the Registration Statement or in any other manner that may be necessary in connection with the transactions contemplated hereby shall be accurate and complete and shall comply in all material respects with the applicable federal securities and other laws and regulations thereunder. (p) Institutional Fund has maintained or has caused to be maintained on its behalf all books and accounts as required of a registered investment company in compliance with the requirements of Section 31 of the 1940 Act and the Rules thereunder. (q) Institutional Fund is not acquiring Adjustable Rate Fund Shares to be issued hereunder for the purpose of making any distribution thereof other than in accordance with the terms of this Agreement. 6. CONDITIONS PRECEDENT TO OBLIGATIONS OF INSTITUTIONAL FUND The obligations of Institutional Fund to consummate the transactions provided for herein shall be subject, at its election, to the performance by Adjustable Rate Fund of all the obligations to be performed by it hereunder on or before the Closing Date and, in addition thereto, the following conditions: 6.1. All representations and warranties of Adjustable Rate Fund contained in this Agreement shall be true and correct in all material respects as of the date hereof and, except as they may be affected by the transactions contemplated by this Agreement, as of the Closing Date with the same force and effect as if made on and as of the Closing Date. 6.2. Adjustable Rate Fund shall have delivered to Institutional Fund a certificate of its President and Treasurer, in a form reasonably satisfactory to Institutional Fund and dated as of the Closing Date, to the effect that the representations and warranties of Piper Funds II made in this Agreement are true A-12 and correct at and as of the Closing Date, except as they may be affected by the transactions contemplated by this Agreement, and as to such other matters as Piper Institutional shall reasonably request. 6.3. As of the Closing Date, there shall have been no material change in the investment objective, policies and restrictions, nor any increase in the investment management fees or annual fees payable pursuant to Piper Fund II's 12b-1 plan of distribution, from those described in the Prospectus and Statement of Additional Information of Adjustable Rate Fund in effect on the date of this Agreement. 7. CONDITIONS PRECEDENT TO OBLIGATIONS OF ADJUSTABLE RATE FUND The obligations of Adjustable Rate Fund to complete the transactions provided for herein shall be subject, at its election, to the performance by Institutional Fund of all the obligations to be performed by it hereunder on or before the Closing Date and, in addition thereto, the following conditions: 7.1. All representations and warranties of Piper Institutional contained in this Agreement shall be true and correct in all material respects as of the date hereof and, except as they may be affected by the transactions contemplated by this Agreement, as of the Closing Date with the same force and effect as if made on and as of the Closing Date. 7.2. Institutional Fund shall have delivered to Adjustable Rate Fund at the Closing a certificate of its President and its Treasurer, in form and substance satisfactory to Adjustable Rate Fund and dated as of the Closing Date, to the effect that the representations and warranties of Institutional Fund made in this Agreement are true and correct at and as of the Closing Date, except as they may be affected by the transactions contemplated by this Agreement, and as to such other matters as Adjustable Rate Fund shall reasonably request. 7.3. Institutional Fund shall have delivered to Adjustable Rate Fund a statement, certified by the Treasurer of Piper Institutional, of the Institutional Fund Assets and its liabilities, together with a list of Institutional Fund's portfolio securities and other assets showing the respective adjusted bases and holding periods thereof for income tax purposes, such statement to be prepared as of the Closing Date and in accordance with generally accepted accounting principles consistently applied. 7.4. On the Closing Date, the Institutional Fund Assets shall include no assets that Adjustable Rate Fund, by reason of Piper Funds II's Articles of Incorporation, investment limitations or otherwise, may not properly acquire. A-13 8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF ADJUSTABLE RATE FUND AND INSTITUTIONAL FUND. The obligations of Institutional Fund and Adjustable Rate Fund hereunder are each subject to the further conditions that on or before the Closing Date: 8.1. This Agreement and the Amendment and the transactions contemplated herein and therein shall have been approved by the requisite vote of the holders of the outstanding shares of Institutional Fund in accordance with the provisions of Piper Institutional's Articles of Incorporation, and certified copies of the resolutions evidencing such approval shall have been delivered to Adjustable Rate Fund. 8.2. On the Closing Date, no action, suit or other proceeding shall be pending before any court or governmental agency in which it is sought to restrain or prohibit, or obtain damages or other relief in connection with, this Agreement or the transactions contemplated herein. 8.3. All consents of other parties and all other consents, orders and permits of federal, state and local regulatory authorities (including those of the Commission and of state blue sky and securities authorities, including "no-action" positions of and exemptive orders from such federal and state authorities) deemed necessary by Adjustable Rate Fund or Institutional Fund to permit consummation, in all material respects, of the transactions contemplated herein shall have been obtained, except where failure to obtain any such consent, order or permit would not involve risk of a material adverse effect on the assets or properties of Adjustable Rate Fund or Institutional Fund. 8.4. The Registration Statement shall have become effective under the 1933 Act, no stop orders suspending the effectiveness thereof shall have been issued and, to the best knowledge of the parties hereto, no investigation or proceeding for that purpose shall have been instituted or be pending, threatened or contemplated under the 1933 Act. 8.5. On or prior to the Valuation Date, Institutional Fund shall have declared and paid a dividend or dividends and/or other distribution or distributions that, together with all previous such dividends or distributions, shall have the effect of distributing to its shareholders all of Institutional Fund's investment company taxable income (computed without regard to any deduction for dividends paid) and all of its net capital gain (after reduction for any capital loss carry-forward and computed without regard to any deduction for dividends paid) for the taxable year during which the Reorganization occurs. 8.6 The parties shall have received an opinion of the law firm of Dorsey & Whitney LLP (based on such representations as such law firm shall reasonably request), addressed to Piper Funds II and Piper Institutional, which opinion may be A-14 relied upon by the shareholders of Institutional Fund, substantially to the effect that the federal income tax consequences of the Reorganization will be as follows: (i) the Reorganization will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Code, and Adjustable Rate Fund and Institutional Fund each will qualify as a party to the Reorganization under Section 368(b) of the Code; (ii) Institutional Fund shareholders will recognize no income, gain or loss upon receipt, pursuant to the Reorganization, of Adjustable Rate Fund shares. Institutional Fund shareholders subject to taxation will recognize income upon receipt of any net investment income or net capital gains of Institutional Fund which are distributed by Institutional Fund prior to the Reorganization; (iii) the tax basis of Adjustable Rate Fund shares received by each Institutional Fund shareholder pursuant to the Reorganization will be equal to the tax basis of Institutional Fund shares exchanged therefor; (iv) the holding period of Adjustable Rate Fund shares received by each Institutional Fund shareholder pursuant to the Reorganization will include the period during which the Institutional Fund shareholder held the Institutional Fund shares exchanged therefor, provided that the Institutional Fund shares were held as a capital asset on the date of the Reorganization; (v) Institutional Fund will recognize no income, gain or loss by reason of the Reorganization; (vi) Adjustable Rate Fund will recognize no income, gain or loss by reason of the Reorganization; (vii) the tax basis of the assets received by Adjustable Rate Fund pursuant to the Reorganization will be the same as the basis of those assets in the hands of Institutional Fund immediately prior to the Reorganization; (viii) the holding period of the assets received by Adjustable Rate Fund pursuant to the Reorganization will include the period during which such assets were held by Institutional Fund; and (ix) Adjustable Rate Fund will succeed to and take into account the earnings and profits, or deficit in earnings and profits, of Institutional Fund immediately prior to the Reorganization. A-15 Notwithstanding anything herein to the contrary, neither Adjustable Rate Fund nor Institutional Fund may waive the condition set forth in this paragraph 8.6. 8.7 The Amendment shall have been filed in accordance with applicable provisions of Minnesota law. 9. FEES AND EXPENSES 9.1. (a) PCM shall bear all direct expenses incurred in connection with entering into and carrying out the provisions of this Agreement, including expenses incurred in connection with the preparation, printing, filing and solicitation of proxies to obtain requisite shareholder approvals. (b) PCM shall pay any unamortized organizational expenses on the books of Institutional Fund immediately prior to the Reorganization. (c) In the event the transactions contemplated herein are not consummated by reason of Institutional Fund's being either unwilling or unable to go forward (other than by reason of the nonfulfillment or failure of any condition to Institutional Fund's obligations specified in this Agreement), PCM's obligations, on behalf of Institutional Fund, shall be limited to reimbursement of Adjustable Rate Fund for all reasonable out-of-pocket fees and expenses incurred by Adjustable Rate Fund in connection with those transactions. (d) In the event the transactions contemplated herein are not consummated by reason of Piper Fund II's being either unwilling or unable to go forward (other than by reason of the nonfulfillment or failure of any condition to Piper Fund II's obligations specified in the Agreement), Piper Fund II's only obligation hereunder shall be to reimburse Institutional Fund for all reasonable out-of-pocket fees and expenses incurred by Institutional Fund in connection with those transactions. 10. ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES 10.1. This Agreement constitutes the entire agreement between the parties. 10.2. The representations, warranties and covenants contained in this Agreement or in any document delivered pursuant hereto or in connection herewith shall survive the consummation of the transactions contemplated herein. A-16 11. TERMINATION 11.1. This Agreement may be terminated and the transactions contemplated hereby may be abandoned at any time prior to the Closing: (a) by the mutual written consent of Piper Institutional and Piper Funds II; (b) by either Piper Funds II or Piper Institutional by notice to the other, without liability to the terminating party on account of such termination (providing the terminating party is not otherwise in material default or breach of this Agreement) if the Closing shall not have occurred on or before December 31, 1996; or (c) by either Adjustable Rate Fund or Institutional Fund, in writing without liability to the terminating party on account of such termination (provided the terminating party is not otherwise in material default or breach of this Agreement), if (i) the other party shall fail to perform in any material respect its agreements contained herein required to be performed on or prior to the Closing Date, (ii) the other party materially breaches any of its representations, warranties or covenants contained herein, (iii) the Institutional Fund shareholders fail to approve this Agreement at any meeting called for such purpose at which a quorum was present, or (iv) any other condition herein expressed to be precedent to the obligations of the terminating party has not been met and it reasonably appears that it will not or cannot be met. 11.2. (a) Termination of this Agreement pursuant to paragraphs 11.1(a) or (b) shall terminate all obligations of the parties hereunder and there shall be no liability for damages on the part of Adjustable Rate Fund or Institutional Fund or the directors or officers of Adjustable Rate Fund or Institutional Fund, to any other party or its directors or officers. (b) Termination of this Agreement pursuant to paragraph 11.1(c) shall terminate all obligations of the parties hereunder and there shall be no liability for damages on the part of Adjustable Rate Fund or Institutional Fund or the directors or officers of Adjustable Rate Fund or Institutional Fund, except that any party in breach of this Agreement shall, upon demand, reimburse the non-breaching party for all reasonable out-of-pocket fees and expenses incurred in connection with the transactions contemplated by this Agreement, including legal, accounting and filing fee. A-17 12. AMENDMENTS This Agreement may be amended, modified or supplemented in such manner as may be mutually agreed upon in writing by the parties; PROVIDED, HOWEVER, that following the meeting of Institutional Fund's shareholders called by Institutional Fund pursuant to paragraph 4.3, no such amendment may have the effect of changing the provisions for determining the number of Adjustable Rate Fund shares to be issued to the Institutional Fund Shareholders under this Agreement to the detriment of such Institutional Fund Shareholders without their further approval. 13 MISCELLANEOUS 13.1. The article and paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 13.2. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original. 13.3. This Agreement shall be governed by and construed in accordance with the laws of the State of Minnesota. 13.4. This Agreement shall bind and inure to the benefit of the parties hereto and their respective successors and assigns, but no assignment or transfer hereof or of any rights or obligations hereunder shall be made by any party without the written consent of the other party. Nothing herein expressed or implied is intended or shall be construed to confer upon or give any person, firm or corporation, other than the parties hereto and their respective successors and assigns, any rights or remedies under or by reason of this Agreement. 13.5. The obligations and liabilities of Piper Funds II hereunder are solely those of Adjustable Rate Fund. It is expressly agreed that no shareholder, nominee, director, officer, agent or employee of Piper Funds II on behalf of Adjustable Rate Fund shall be personally liable hereunder. The execution and delivery of this Agreement have been authorized by the directors of Piper Funds II and signed by authorized officers of Piper Funds II acting as such, and neither such authorization by such directors nor such execution and delivery by such officers shall be deemed to have been made by any of them individually or to impose any liability on any of them personally. 13.6. The obligations and liabilities of Piper Institutional hereunder are solely those of Institutional Fund. It is expressly agreed that no shareholder, nominee, director, officer, agent or employee of Institutional Fund shall be personally liable hereunder. The execution and delivery of this Agreement have been authorized by the directors of Piper Institutional and signed by authorized officers of Piper A-18 Institutional acting as such, and neither such authorization by such directors nor such execution and delivery by such officers shall be deemed to have been made by any of them individually or to impose any liability on any of them personally. IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be executed by a duly authorized officer. PIPER INSTITUTIONAL FUNDS INC., on behalf of Institutional Government Adjustable Portfolio By ----------------------------- Name: William H. Ellis Title: President PIPER FUNDS INC. -- II, on behalf of Adjustable Rate Mortgage Securities Fund By ------------------------------ Name: Robert H. Nelson Title: Senior Vice President A-19 EXHIBIT 1 TO AGREEMENT AND PLAN OF REORGANIZATION ARTICLES OF AMENDMENT TO ARTICLES OF INCORPORATION OF PIPER INSTITUTIONAL FUNDS INC. The undersigned officer of Piper Institutional Funds Inc. ("Piper Institutional"), a corporation subject to the provisions of Chapter 302A of the Minnesota statutes, hereby certifies that Piper Institutional's (a) Board of Directors, at a meeting held August 9, 1996, and (b) shareholders, at a meeting held September 12, 1996, adopted the resolutions hereinafter set forth; and such officer further certifies that the amendments to Piper Institutional's Articles of Incorporation set forth in such resolutions were adopted pursuant to Chapter 302A. WHEREAS, Piper Institutional is registered as an open-end management investment company (I.E., a mutual fund) under the Investment Company Act of 1940 and offers its shares to the public in more than one series, each of which represents a separate and distinct portfolio of assets; WHEREAS, it is desirable and in the best interest of the holders of the Institutional Government Adjustable Portfolio ("Institutional Fund"), a series of Piper Institutional, that the assets belonging to such series, subject to its stated liabilities, be sold to Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), a series of Piper Funds Inc. -- II ("Piper Funds II"), a Minnesota corporation and an open-end management investment company registered under the Investment Company Act of 1940, in exchange for shares of Adjustable Rate Fund; WHEREAS, Piper Institutional wishes to provide for the PRO RATA distribution of such shares of Adjustable Rate Fund received by it to holders of shares of Institutional Fund and the simultaneous cancellation and retirement of the outstanding shares of Institutional Fund; WHEREAS, Piper Institutional and Piper Funds II have entered into an Agreement and Plan of Reorganization providing for the foregoing transactions; and WHEREAS, the Agreement and Plan of Reorganization requires that, in order to bind all shareholders of Institutional Fund to the foregoing transactions, and in particular to bind such shareholders to the cancellation and retirement of the outstanding shares of Institutional Fund, it is necessary to adopt an amendment to Piper Institutional's Articles of Incorporation. 1 NOW, THEREFORE, BE IT RESOLVED, that Piper Institutional's Articles of Incorporation be, and the same hereby are, amended to add the following Article 5A immediately following Article 5 thereof: 5A. (a) For purposes of this Article 5A, the following terms shall have the following meanings: "PIPER INSTITUTIONAL" means the Corporation. "PIPER FUNDS II" means Piper Funds Inc. -- II, a Minnesota corporation. "ACQUIRED FUND" means Institutional Government Adjustable Portfolio, the Series A Shares of the Corporation. "ACQUIRING FUND" means Piper Fund II's Adjustable Rate Mortgage Securities Fund. "VALUATION DATE" means the day established in the Agreement and Plan of Reorganization as the day upon which the value of the Acquired Fund's assets is determined for purposes of the reorganization. "CLOSING DATE" means 5:00 p.m., Eastern time, on the Valuation Date or such other date and time upon which Piper Funds II and Piper Institutional agree. (b) At the Closing Date, the assets belonging to the Acquired Fund, the Special Liabilities associated with such assets, and the General Assets and General Liabilities allocated to the Acquired Fund shall be sold to and assumed by the Acquiring Fund in return for Acquiring Fund shares, all pursuant to the Agreement and Plan of Reorganization. For purposes of the foregoing, the terms "Assets belonging to," "Special Liabilities," "General Assets" and "General Liabilities" have the meanings assigned to them in Article 7(b), (c) and (d) of Piper Institutional's Articles of Incorporation. (c) The number of Acquiring Fund shares to be received by the Acquired Fund and distributed by it to the Acquired Fund shareholders shall be determined as follows: (i) The value of the Acquired Fund's assets and the net asset value per share of the Acquiring Fund's shares shall be computed as of the Valuation Date using the valuation procedures set forth in the Acquiring Fund's then-current Prospectus and Statement of Additional Information, and as may be required by the Investment Company Act of 1940, as amended (the "1940 Act"). 2 (ii) The total number of Acquiring Fund shares to be issued (including fractional shares, if any) in exchange for assets and liabilities of the Acquired Fund shall be determined as of the Valuation Date by dividing the value of the Acquired Fund's assets, net of its stated liabilities on the Closing Date to be assumed by the Acquiring Fund, by the net asset value of the Acquiring Fund's shares, each as determined pursuant to (i) above. (iii) On the Closing Date, or as soon as practicable thereafter, the Acquired Fund shall distribute PRO RATA to its shareholders of record as of the Valuation Date the full and fractional Acquiring Fund shares received by the Acquired Fund pursuant to (ii) above. (d) The distribution of Acquiring Fund shares to Acquired Fund shareholders provided for in paragraph (c) above shall be accomplished by an instruction, signed by Piper Institutional's Secretary, to transfer Acquiring Fund shares then credited to the Acquired Fund's account on the books of the Acquiring Fund to open accounts on the books of the Acquiring Fund in the names of the Acquired Fund shareholders in amounts representing the respective PRO RATA number of Acquiring Fund shares due each such shareholder pursuant to the foregoing provisions. All issued and outstanding shares of the Acquired Fund shall simultaneously be canceled on the books of the Acquired Fund and retired. (e) From and after the Closing Date, the Acquired Fund shares canceled and retired pursuant to paragraph (d) above shall have the status of authorized and unissued Shares of Piper Institutional, without designation as to series. IN WITNESS WHEREOF, the undersigned officer of Piper Institutional has executed these Articles of Amendment on behalf of Piper Institutional on __________, 1996. PIPER INSTITUTIONAL FUNDS INC. By ------------------------------ Its --------------------------- 3 Adjustable Rate Mortgage Securities Fund a series of PIPER FUNDS INC.--II Supplement dated January 24, 1996 to Prospectus dated December 18, 1995 The section of the prospectus on page 24 entitled "Special Purchase Plans -- Purchases by Other Individuals Without a Sales Charge" is amended by adding the following paragraph: American Government Term Trust Inc. ("AGT"), a closed-end fund which was managed by the Adviser, recently dissolved and distributed its net assets to shareholders. Former AGT shareholders may invest the distributions received by them in connection with such dissolution in shares of the Fund without payment of a sales charge. (Any such sales are subject to the eligibility of Fund share purchases in the shareholder's state as well as the minimum investment requirements and other applicable terms set forth in this Prospectus.) PROSPECTUS DATED DECEMBER 18, 1995 PIPER FUNDS INC. -- II ADJUSTABLE RATE MORTGAGE SECURITIES FUND PIPER JAFFRAY TOWER 222 SOUTH NINTH STREET MINNEAPOLIS, MINNESOTA 55402-3804 (800) 866-7778 (TOLL FREE) Adjustable Rate Mortgage Securities Fund (the "Fund") is a diversified series of Piper Funds Inc. -- II (the "Company"), an open-end management investment company the shares of which can be offered in more than one series. The Fund is the only series of the Company currently outstanding. The investment objective of the Fund is to provide the maximum current income that is consistent with low volatility of principal. The Fund will seek to achieve that objective by investing primarily (at least 65% of its total assets under normal market conditions) in adjustable rate mortgage securities ("ARMS"). ARMS include both pass-through securities representing interests in adjustable rate mortgage loans and floating rate collateralized mortgage obligations. AN INVESTMENT IN THE FUND MAY INVOLVE CERTAIN RISKS, INCLUDING THE LOSS OF PRINCIPAL. THE MARKET VALUE OF THE SECURITIES IN WHICH THE FUND INVESTS WILL FLUCTUATE WITH CHANGING INTEREST RATES, AS WILL THE FUND'S NET ASSET VALUE. THE FUND MAY INVEST IN ILLIQUID SECURITIES, WHICH WILL INVOLVE GREATER RISK THAN INVESTMENTS IN OTHER SECURITIES AND MAY INCREASE FUND EXPENSES. SEE "INVESTMENT OBJECTIVE, POLICIES AND RISK FACTORS -- OTHER INVESTMENT TECHNIQUES." THE FUND INVESTS A SIGNIFICANT PORTION OF ITS ASSETS IN MORTGAGE-RELATED SECURITIES, WHICH MAY INCLUDE DERIVATIVE MORTGAGE SECURITIES. SEE "INVESTMENT OBJECTIVE, POLICIES AND RISK FACTORS -ADJUSTABLE RATE MORTGAGE SECURITIES" AND "-- OTHER ELIGIBLE INVESTMENTS." This Prospectus concisely describes the information about the Fund that you should know before investing. Please read it carefully before investing and retain it for future reference. A Statement of Additional Information about the Fund dated December 18, 1995 is available free of charge. Write to the Fund at Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804 or telephone (800) 866-7778 (toll free). The Statement of Additional Information has been filed with the Securities and Exchange Commission and is incorporated in its entirety by reference in this Prospectus. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. INTRODUCTION Adjustable Rate Mortgage Securities Fund (the "Fund") is a diversified series of Piper Funds Inc. -- II (the "Company"), an open-end management investment company the shares of which can be offered in more than one series. The Fund is the only series of the Company currently outstanding. The investment objective of the Fund is to provide the maximum current income that is consistent with low volatility of principal. On September 1, 1995, four closed-end investment companies, American Adjustable Rate Term Trust Inc. -- 1996 ("BDJ"), American Adjustable Rate Term Trust Inc. -- 1997 ("CDJ"), American Adjustable Rate Term Trust Inc. -- 1998 ("DDJ") and American Adjustable Rate Term Trust Inc. -- 1999 ("EDJ") (collectively, the "Trusts") merged into the Fund (the "Merger"). Class action lawsuits have been filed in U.S. District Court against each of the Trusts. The Company may be deemed to be a successor by merger to the Trusts and, as such, may succeed to their liabilities, including damages sought in such litigation. However, Piper Jaffray Companies Inc. and Piper Capital Management Incorporated have agreed to indemnify the Company against any losses incurred in connection with such litigation. See "General Information -- Pending Legal Proceedings." THE INVESTMENT ADVISER The Fund is managed by Piper Capital Management Incorporated (the "Adviser"), a wholly owned subsidiary of Piper Jaffray Companies Inc. The Fund pays the Adviser a fee for managing its investment portfolio. The fee for the Fund is paid at an annual rate of .35% on the first $500 million of average daily net assets and .30% on average daily net assets in excess of $500 million. See "Management -- Investment Adviser." THE DISTRIBUTOR Piper Jaffray Inc. ("Piper Jaffray" or the "Distributor"), a wholly owned subsidiary of Piper Jaffray Companies Inc. and an affiliate of the Adviser, serves as Distributor of the Fund's shares. RISK FACTORS TO CONSIDER An investment in the Fund is subject to certain risks, as set forth in detail under "Investment Objective, Policies and Risk Factors." As with other mutual funds, there can be no assurance that the Fund will achieve its objective. The Fund is subject to interest rate risk (the risk that rising interest rates will make bonds issued at lower interest rates worth less). As a result, the value of the Fund's shares will vary. The Fund is also subject to credit risk (the risk that a bond issuer will fail to make timely payments of interest or principal) to the extent it invests in non-U.S. Government securities. The Fund may engage in the following investment practices which involve certain special risks: the use of repurchase agreements, the lending of portfolio securities, borrowing from banks and through reverse repurchase agreements (but only for temporary or emergency purposes in an amount up to 10% of the value of its total assets), the use of hedging techniques, including interest rate transactions, options, futures contracts, options on futures contracts and investments in Eurodollar instruments, and the purchase or sale of securities on a "when-issued" or "forward commitment" basis. These techniques may increase the volatility of the Fund's net asset value. OFFERING PRICE Shares of the Fund are offered to the public at the next determined net asset value after receipt of an order by a shareholder's Piper Jaffray Investment Executive or other broker-dealer plus a maximum sales charge of 1.50% of the offering price (1.52% of the net asset value) on purchases of less than $100,000. The sales charge is reduced on a graduated scale on purchases of $100,000 or more. In connection with purchases of $500,000 or more, there is no initial sales charge; however, a .20% contingent deferred sales charge will be imposed in the event of a redemption transaction occurring within 24 months following such a purchase. See "How to Purchase Shares -- Purchase Price" and "-- Purchases of $500,000 or More." MINIMUM INITIAL AND SUBSEQUENT INVESTMENTS The minimum initial investment for the Fund is $250. There is no minimum for subsequent investments. The Distributor, in its discretion, may waive the minimum. See "How to Purchase Shares -- Minimum Investments." EXCHANGES You may exchange your Fund shares for shares of any other mutual fund managed by the Adviser (except Hercules Funds Inc.) which is open to new investors and eligible for sale in your state of residence, provided that, if you hold your Fund shares through a broker-dealer other than the Distributor, the exchange privilege may not be available. Exchanges will be permitted only if there is a valid sales agreement between your broker-dealer and the Distributor for the fund into which the exchange will be made. All exchanges are subject to the minimum investment requirements and other applicable terms set forth in the prospectus of the fund whose shares you acquire. Exchanges are made on the basis of the net asset values of the funds involved, except that investors exchanging into a fund which has a higher sales charge must pay the difference. However, exchanges of Fund shares which were received in the Merger will be permitted without payment of an additional sales charge. You may make four exchanges per year without payment of a service charge. Thereafter, there is a $5 service charge for each exchange. See "Shareholder Services -- Exchange Privilege." REDEMPTION PRICE Shares of the Fund may be redeemed at any time at their net asset value next determined after a redemption request is received by your Piper Jaffray Investment Executive or other broker-dealer. A contingent deferred sales charge will be imposed upon the redemption of certain shares initially purchased without a sales charge. See "How to Redeem Shares -- Contingent Deferred Shares Charge." The Fund reserves the right, upon 30 days written notice, to redeem an account if the net asset value of the shares falls below $200. See "How to Redeem Shares -- Involuntary Redemption." SHAREHOLDER INQUIRIES Any questions or communications regarding a shareholder account should be directed to your Piper Jaffray Investment Executive or, in the case of shares held through another broker-dealer, to Investors Fiduciary Trust Company ("IFTC") at (800) 874-6205. General inquiries regarding the Fund should be directed to the Fund at the telephone number set forth on the cover page of this Prospectus. FUND EXPENSES SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of the offering price) 1.50% Exchange Fee* $ 0 ANNUAL FUND OPERATING EXPENSES (as a percentage of average net assets) Management Fee .35% Rule 12b-1 Fee .15% Other Expenses (after voluntary expense reimbursement)** .10% Total Fund Operating Expenses (after voluntary expense reimbursement)** .60% * There is a $5.00 fee for each exchange in excess of four exchanges per year. See "Shareholder Services -- Exchange Privilege." ** See the discussion below for an explanation of voluntary expense reimbursements. EXAMPLE You would pay the following expenses on a $1,000 investment, assuming 5% annual return and redemption at the end of each time period: 1 year $21 3 years $34 The purpose of the above Fund Expenses table is to assist you in understanding the various costs and expenses that investors in the Fund will bear directly or indirectly. THE EXAMPLE CONTAINED IN THE TABLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. The Adviser intends, although not required under the Advisory Agreement, to reimburse the Fund for the amount, if any, by which the Total Fund Operating Expenses of the Fund (excluding interest, taxes, brokerage fees and commissions, and extraordinary expenses) for the fiscal year ending August 31, 1996, exceed .60% of average net assets. The Adviser's limitation on expenses is voluntary and may be revised or terminated at any time after fiscal year end. The Adviser may or may not assume additional expenses of the Fund from time to time, in its discretion, while retaining the ability to be reimbursed by the Fund for expenses assumed during a fiscal year prior to the end of such year. The foregoing policy will have the effect of lowering the Fund's overall expense ratio and increasing yield to investors when such amounts are assumed or the inverse when such amounts are reimbursed. It is estimated that, absent any voluntary expense reimbursements, the Fund will have Other Expenses as a percentage of average net assets (adjusted to an annual basis) of approximately .23% for the fiscal year ending August 31, 1996, resulting in Total Fund Operating Expenses of .73%. For additional information, including a more complete explanation of management and Rule 12b-1 fees, see "Management -- Investment Adviser" and "Distribution of Fund Shares." FINANCIAL HIGHLIGHTS The following financial highlights show per share data for a share of capital stock outstanding throughout each period and selected information for each period for American Adjustable Rate Term Trust Inc. -- 1998 ("DDJ"). For financial reporting purposes, DDJ is considered the surviving entity of the closed-end investment companies that merged into the Fund on September 1, 1995. These financial highlights have been audited by KPMG Peat Marwick LLP, independent auditors, and should be read in conjunction with the financial statements of the Fund contained in its Annual Report. An Annual Report is available without charge by contacting the Fund at 800-866-7778 (toll free). In addition to financial statements, the Annual Report contains further information about the performance of the Fund.
PERIOD FROM FISCAL YEAR ENDED AUGUST 31, 1/30/92* TO 1995 1994 1993 8/31/92 PER SHARE DATA Net asset value, beginning of period $ 8.82 9.67 9.74 9.58 Operations: Net investment income 0.51 0.60 0.69 0.43 Net realized and unrealized gains (losses) on investments (0.05) (0.89) (0.10) 0.08 Total from operations 0.46 (0.29) 0.59 0.51 Distributions to shareholders: From net investment income (0.58) (0.56) (0.66) (0.35) Net asset value, end of period $ 8.70 8.82 9.67 9.74 SELECTED INFORMATION Total return** 5.43% (3.18%) 6.24% 5.49% Net assets at end of period (in millions) $ 409 500 551 555 Ratio of expenses to average weekly net assets 0.63% 0.60% 0.58% 0.58%*** Ratio of net investment income to average weekly net assets 5.62% 6.39% 7.25% 7.70%*** Portfolio turnover rate (excluding short-term securities) 36% 39% 39% 41% Amount of borrowings outstanding at end of period (in millions)+ $ -- 145 145 145 Average amount of borrowings outstanding during the period (in millions) $ 57 145 149 90 Average number of shares outstanding during the period (in millions) 49 57 57 48 Average per-share amount of borrowings outstanding during the period $ 1.19 2.55 2.62 1.82
* Commencement of operations of American Adjustable Rate Term Trust Inc. -- 1998. ** Total return is based on the change in net asset value during the period, assumes reinvestment of distributions at net asset value and does not reflect a sales charge. *** Adjusted to an annual basis. + American Adjustable Rate Term Trust Inc. -- 1998 was a closed-end investment management company and was permitted to enter into borrowings for other than temporary or emergency purposes. The Fund may borrow only for temporary or emergency purposes. INVESTMENT OBJECTIVE, POLICIES AND RISK FACTORS The Fund's investment objective is to provide the maximum current income that is consistent with low volatility of principal. This investment objective cannot be changed without shareholder approval. The investment policies and techniques employed in pursuit of the Fund's objective may be changed without shareholder approval, unless otherwise noted. In view of the risks inherent in all investments in securities, there is no assurance that the Fund will achieve its objective. The Fund seeks to achieve its investment objective by investing primarily (at least 65% of total assets under normal market conditions) in a portfolio of Mortgage-Backed Securities (as defined herein) having adjustable interest rates which reset at periodic intervals ("adjustable rate mortgage securities" or "ARMS"). ARMS include both pass-through securities representing interests in adjustable rate mortgage loans and floating rate collateralized mortgage obligations. The balance of the Fund's assets (up to 35% of total assets) may be invested in (a) Mortgage-Backed Securities (other than ARMS), (b) U.S. Government Securities (including, with respect to 10% of the Fund's net assets, U.S. Government zero-coupon securities); (c) Asset-Backed Securities; and (d) Corporate Debt Securities (each as defined below). At least 85% of the Fund's total assets (other than U.S. Government Securities) must be rated, as of the date of purchase, AA or better by Standard & Poor's Ratings Group ("Standard & Poor's"), Aa or better by Moody's Investors Service, Inc. ("Moody's"), comparably rated by any other nationally recognized statistical rating organization ("NRSRO") or, if unrated, of a comparable quality as determined by the Adviser. Up to 15% of the Fund's total assets may be invested in securities rated, as of the date of purchase, A by Standard & Poor's or Moody's, comparably rated by any other NRSRO or, if unrated, of comparable quality as determined by the Adviser. The Fund may not invest in any security rated, as of the date of purchase, lower than A by Standard & Poor's or Moody's (or below a comparable rating by any other NRSRO) or, if unrated, of a quality lower than A as determined by the Adviser. In the event that a security is downgraded to a rating below A or, if unrated, is no longer of a quality comparable to a security rated A, as determined by the Adviser, the Fund will sell such a security as promptly as possible. For a discussion of Standard & Poor's and Moody's ratings, see Appendix A to the Statement of Additional Information. The Fund may engage in options and financial futures transactions which relate to the securities in which it invests, may purchase and sell interest rate caps and floors, may make investments in Eurodollar instruments for hedging purposes, may purchase or sell securities on a when-issued or forward commitment basis and may lend its portfolio securities. For temporary defensive purposes, the Fund may invest without limitation in cash or in high quality debt securities with remaining maturities of one year or less. Such securities may include (a) commercial paper rated A-1+ by Standard & Poor's, P-1 by Moody's or comparably rated by any other NRSRO; (b) certificates of deposit, time deposits and bankers' acceptances with any bank the unsecured commercial paper of which is rated A-1+ by Standard & Poor's, P-1 by Moody's or comparably rated by any other NRSRO (or, in the case of the principal bank in a bank holding company, the unsecured commercial paper of the bank holding company); and (c) U.S. Government Securities. Time deposits maturing in more than seven days are considered illiquid and subject to the Fund's limitation on investments in illiquid securities. See "Other Investment Techniques -- Illiquid Securities" below. Certain securities in which the Fund invests and certain investment techniques used by the Fund could be considered "derivative instruments." The term "derivatives" has been used to identify a variety of financial instruments; there is no discrete class of instruments that is covered by the term. A "derivative" is commonly defined as a financial instrument whose value is based upon, or derived from, an underlying index, reference rate (e.g., interest rates or currency exchange rates), security, commodity, or other asset. Securities in which the Fund invests that could be considered derivatives include mortgage-related securities and asset-backed securities, which derive their value from underlying pools of mortgages and assets, respectively. In addition, interest rate caps and floors, options on securities, futures contracts, options on futures contracts and when-issued securities transactions are derivative contracts. These derivative securities and contracts involve varying degrees and types of risk, as set forth below under "Adjustable Rate Mortgage Securities," "Other Eligible Investments -- Mortgage-Backed Securities" and "-- Asset-Backed Securities," and "Other Investment Techniques." RISK FACTORS The Fund is subject to certain risks which could result in volatility of principal. As with other mutual funds, there can be no assurance that the Fund will achieve its objective. The Fund is subject to interest rate risk, which is the potential for a decline in bond prices due to rising interest rates. In general, bond prices vary inversely with interest rates. When interest rates rise, bond prices generally fall. Conversely, when interest rates fall, bond prices generally rise. Although the ARMS in the Fund's portfolio should generally be more resistant to price swings than other debt securities because the interest rates of ARMS move with market interest rates, the adjustable rate feature of ARMS will not eliminate price fluctuations. See "Adjustable Rate Mortgage Securities -- Interest Rate Risk" below. The Fund's investments in ARMS and other Mortgage-Backed Securities are also subject to prepayment risk. See "Adjustable Rate Mortgage Securities -- Prepayment Risk." In addition, the Fund is subject to credit risk to the extent it invests in non-U.S. Government securities. Credit risk, also known as default risk, is the possibility that a bond issuer will fail to make timely payments of interest or principal. These and other risks of the Fund's investments are described in detail below. The Fund also may engage in investment practices which involve certain special risks. These practices include the use of repurchase agreements, the lending of portfolio securities, borrowing from banks and through reverse repurchase agreements (but only for temporary or emergency purposes in an amount up to 10% of the value of the Fund's total assets), the use of hedging techniques, including interest rate transactions, options, futures contracts, options on futures contracts and investments in Eurodollar instruments, and the purchase or sale of securities on a "when-issued" or "forward commitment" basis. See "Other Investment Techniques" below. The use of these techniques may increase the volatility of the Fund's net asset value. ADJUSTABLE RATE MORTGAGE SECURITIES Under normal market conditions, the Fund must invest at least 65% of its total assets in adjustable rate mortgage securities or ARMS, which include the types of securities discussed below. U.S. Government Mortgage Pass-through Securities. ARMS include "pass-through" securities issued or guaranteed by the U.S. Government or one of its agencies or instrumentalities ("U.S. Government Pass-Throughs"). Pass-through securities constituting ARMS represent ownership interests in underlying pools of adjustable rate mortgage loans originated by private lenders. Such securities differ from conventional debt securities, which provide for periodic payment of interest in fixed amounts (usually semi-annually) and principal payments at maturity or on specified call dates, in that pass-through securities provide for monthly payments that are a pass-through of the monthly interest and principal payments (including any prepayments) made by the individual borrowers on the pooled mortgage loans, net of any fees paid to the guarantor of such securities and the servicers of the underlying mortgage loans. The U.S. Government Pass-Throughs in which the Fund may invest are issued or guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). Each of GNMA, FNMA and FHLMC guarantee timely distributions of interest to securities holders. GNMA and FNMA also guarantee timely distribution of scheduled principal. FHLMC generally guarantees only ultimate collection of principal on the underlying loans, which collection may take up to one year. GNMA is a wholly owned corporate instrumentality of the U.S. Government within the Department of Housing and Urban Development and its guarantee is backed by the full faith and credit of the U.S. Government. FNMA and FHLMC are federally chartered corporations and their respective guarantees are not backed by the full faith and credit of the U.S. Government. The mortgages underlying ARMS issued by GNMA are fully guaranteed by the Federal Housing Administration ("FHA") or the Veterans Administration ("VA"). The mortgages underlying ARMS issued by FNMA or FHLMC may be backed by conventional adjustable rate mortgages not guaranteed by FHA or VA. Private Mortgage Pass-through Securities. Private Mortgage Pass-Through Securities ("Private Pass-Throughs") are structured similarly to the GNMA, FNMA and FHLMC mortgage pass-through securities described above and are issued by originators of and investors in mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment banks and special purpose subsidiaries of the foregoing. Private Pass-Throughs constituting ARMS are backed by a pool of conventional adjustable rate mortgage loans. Since Private Pass-Throughs are not guaranteed by an entity having the credit status of GNMA, FNMA or FHLMC, such securities generally are structured with one or more types of credit enhancement. See "Investment Objective, Policies and Restrictions -- Mortgage-Backed Securities -- Credit Support" in the Statement of Additional Information. CMOs and Multiclass Pass-Through Securities. ARMS in which the Fund may invest also include adjustable rate tranches of collateralized mortgage obligations and multiclass pass-through securities. Collateralized mortgage obligations are debt instruments issued by special purpose entities which are secured by pools of mortgage loans or other Mortgage-Backed Securities. Multiclass pass-through securities are equity interests in a trust composed of mortgage loans or other Mortgage-Backed Securities. Payments of principal and interest on underlying collateral provide the funds to pay debt service on the collateralized mortgage obligation or make scheduled distributions on the multiclass pass-through security. Collateralized mortgage obligations and multiclass pass-through securities (collectively, "CMOs" unless the context indicates otherwise) may be issued by agencies or instrumentalities of the U.S. Government or by private organizations. In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMO, often referred to as a "tranche," is issued at a specified coupon rate and has a stated maturity or final distribution date. Principal prepayments on collateral underlying a CMO may cause it to be retired substantially earlier than the stated maturities or final distribution dates. The principal and interest on the mortgages underlying a CMO may be allocated among the CMO's tranches in many ways. See "Other Eligible Investments -- Mortgage-Backed Securities -- CMOs," below. One or more tranches of a CMO may have coupon rates which reset periodically at a specified increment over an index such as the London Interbank Offered Rate ("LIBOR"). These adjustable rate tranches, known as "floating rate CMOs," are considered ARMS by the Fund. Floating rate CMOs may be backed by fixed rate or adjustable rate mortgages; to date, fixed rate mortgages have been more commonly utilized for this purpose. Floating rate CMOs are typically issued with lifetime caps on the coupon rate thereon. These caps, similar to the caps on adjustable rate mortgages, represent a ceiling beyond which the coupon rate on a floating rate CMO may not be increased regardless of increases in the interest rate index to which the floating rate CMO is geared, which may cause the security to be valued at a greater discount than if the security was not subject to a ceiling. How Interest Rates Are Set. The interest rates on ARMS are reset at periodic intervals (generally one year or less) to an increment over some predetermined interest rate index. There are two main categories of indices: those based on U.S. Treasury securities and those derived from a calculated measure such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices include the one-year and five-year constant maturity Treasury note rates, the three-month Treasury bill rate, the 180-day Treasury bill rate, rates on longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds Index, the National Median Cost of Funds, the one-month or three-month LIBOR, the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year constant maturity Treasury note rate, closely mirror changes in market interest rate levels. Others, such as the 11th District Home Loan Bank Cost of Funds Index (often related to ARMS issued by FNMA), tend to lag changes in market rate levels and tend to be somewhat less volatile. The Adviser seeks to diversify investments in ARMS among a variety of indices and reset periods to reduce the exposure to the risk of interest rate fluctuations. In selecting a type of ARMS for investment, the Adviser also considers the liquidity of the market for such ARMS. The underlying adjustable rate mortgages which back ARMS will frequently have caps and floors which limit the maximum amount by which the loan rate to the residential borrower may change up or down (a) per reset or adjustment interval and (b) over the life of the loan. Some residential adjustable rate mortgage loans restrict periodic adjustments by limiting changes in the borrower's monthly principal and interest payments rather than limiting interest rate changes. These payment caps may result in negative amortization, i.e., increase in the balance of the mortgage loan. Floating rate CMOs are generally backed by fixed rate mortgages and generally have lifetime caps on the coupon rate thereon. Interest Rate Risk. The values of ARMS, like other debt securities, generally vary inversely with changes in market interest rates (increasing in value during periods of declining interest rates and decreasing in value during periods of increasing interest rates); however, the values of ARMS should generally be more resistant to price swings than other debt securities because the interest rates of ARMS move with market interest rates. The adjustable rate feature of ARMS will not, however, eliminate fluctuations in the prices of ARMS, particularly during periods of extreme fluctuations in interest rates. Also, since many adjustable rate mortgages only reset on an annual basis, it can be expected that the prices of ARMS will fluctuate to the extent changes in prevailing interest rates are not immediately reflected in the interest rates payable on the underlying adjustable rate mortgages. Prepayment Risk. ARMS, like other Mortgage-Backed Securities, differ from conventional bonds in that principal is paid back over the life of the ARMS rather than at maturity. As a result, the holder of the ARMS receives monthly scheduled payments of principal and interest, and may receive unscheduled principal payments representing prepayments on the underlying mortgages. When the holder reinvests the payments and any unscheduled prepayments of principal it receives, it may receive a rate of interest which is lower than the rate on the existing ARMS. For this reason, ARMS are less effective than longer-term debt securities as a means of "locking in" long-term interest rates. ARMS, while having less risk of price decline during periods of rapidly rising rates than other investments of comparable maturities, will have less potential for capital appreciation due to the likelihood of increased prepayments of mortgages as interest rates decline. In addition, to the extent ARMS are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments will result in a loss of some or all of the premium paid. On the other hand, if ARMS are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal will increase current and total returns and will accelerate the recognition of income which, when distributed to shareholders, will be taxable as ordinary income. OTHER ELIGIBLE INVESTMENTS The balance of the Fund's assets (35% of total assets) may be invested in the following types of securities to the extent set forth below. Mortgage-Backed Securities. * General. In addition to ARMS, the Fund may invest in other types of Mortgage-Backed Securities. Mortgage-Backed Securities are securities which represent interests in or are collateralized by mortgages. Such securities are issued by GNMA, FNMA, FHLMC and by private organizations and take the same structure as ARMS, i.e., pass-through securities and CMOs. The Fund will not invest in inverse floating, interest-only, principal-only or Z tranches of CMOs, in residual interests of CMOs, or in stripped Mortgage-Backed Securities. * CMOs. As discussed above, investments in ARMS include floating rate CMOs. The Fund's investments in Mortgage-Backed Securities other than ARMS may include certain other tranches of CMOs. The principal and interest on the mortgages underlying a CMO may be allocated among the CMO's several tranches in many ways. For example, certain tranches may have variable or floating interest rates and others may provide only the principal or interest feature of the underlying security. Generally, the purpose of the allocation of the cash flow of a CMO to the various tranches is to obtain a more predictable cash flow to certain of the individual tranches than exists with the underlying collateral of the CMO. As a general rule, the more predictable the cash flow is on a CMO tranche, the lower the anticipated yield will be on that tranche at the time of issuance relative to prevailing market yields on mortgage-related securities. As part of the process of creating more predictable cash flows on most of the tranches of CMOs, one or more tranches generally must be created that absorb most of the volatility in the cash flows on the underlying mortgage loans. As a result of the uncertainty of the cash flows of these tranches, market prices and yields may be more volatile than for other CMO tranches. As noted above, the Fund will not invest in inverse floating, interest-only, principal-only or Z tranches of CMOs, which can be among the more volatile CMO tranches. * Risks of Mortgage-Backed Securities. Mortgage-Backed Securities (other than ARMS) are subject generally to the same risks as ARMS; however, such other Mortgage-Backed Securities can be expected to be affected to a greater extent than ARMS by fluctuating interest rates and prepayments and to have different yield characteristics, due to the fact that fixed rate rather than adjustable rate mortgages underlie such securities. Generally, prepayments on fixed rate mortgages will increase during a period of falling interest rates and decrease during a period of rising interest rates. Accordingly, amounts available for reinvestment are likely to be greater during a period of declining interest rates than during a period of rising interest rates, and the yield on the securities in which such amounts are reinvested is likely to be lower than the yield on the securities that were prepaid or the yield that could be achieved if such amounts were reinvested during a period of rising interest rates. If the Fund purchases Mortgage-Backed Securities at a premium, a prepayment rate that is faster than expected will reduce both the market value and the yield to maturity from that which was anticipated, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield to maturity and market value. Conversely, if the Fund purchases Mortgage-Backed Securities at a discount, faster than expected prepayments will increase, while slower than expected prepayments will reduce, yield to maturity and market value. Mortgage-Backed Securities may decrease in value as a result of increases in interest rates and may benefit less than other fixed income securities from declining interest rates because of the risk of prepayment. U.S. Government Securities. In addition to U.S. Government ARMS and other U.S. Government Mortgage-Backed Securities, the Fund may invest in other securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities, including up to 10% of its net assets in U.S. Government zero-coupon securities. U.S. Government Securities include a variety of Treasury securities, which differ in their interest rates, maturities and times of issuance. Treasury bills have maturities of one year or less, Treasury notes have maturities of one to ten years, and Treasury bonds generally have maturities of greater than ten years. Some obligations issued or guaranteed by U.S. Government agencies or instrumentalities, for example, GNMA pass-through certificates, are supported by the full faith and credit of the U.S. Treasury; others, such as those of the Federal Home Loan Banks, by the right of the issuer to borrow from the Treasury; others, such as those issued by FNMA, by the discretionary authority of the U.S. Government to purchase certain obligations of the agency or instrumentality; finally, obligations of other agencies or instrumentalities are backed only by the credit of the agency or instrumentality issuing the obligations. While the U.S. Government provides financial support to such U.S. Government-sponsored agencies and instrumentalities, no assurance can be given that it will always do so since it is not so obligated by law. * U.S. Government Zero-Coupon Securities. The Fund may invest up to 10% of its net assets in zero-coupon securities which are issued by the U.S. Treasury through its STRIPS program and constitute direct obligations of the U.S. Government. Zero-coupon securities are debt obligations which do not entitle the holder to any periodic payments of interest prior to maturity; rather, they offer the right to receive a fixed cash payment at maturity but without any payments before that date. As a result, zero-coupon securities are issued and traded at a discount from their face amounts. Through investment in zero-coupon securities, an investor is able to in effect lock in a return of principal to the extent such instruments are held to maturity. * Risks of Zero-Coupon Securities. Zero-coupon securities do not entitle the holder to any periodic payments of interest prior to maturity and therefore are issued and trade at a discount from their face or par value. The discount, in the absence of financial difficulties of the issuer, decreases as the final maturity of the security approaches. Zero-coupon securities can be sold prior to their due date in the secondary market at the then prevailing market value, which depends primarily on the time remaining to maturity, prevailing levels of interest rates and the perceived credit quality of the issuer. The market prices of zero-coupon securities are more volatile than the market prices of securities of comparable quality and similar maturity that pay interest periodically and may respond to a greater degree to fluctuations in interest rates than do such non-zero-coupon securities. Although holders of zero-coupon securities do not receive periodic payments of interest, income accretes on such securities and is subject to the distribution requirements of the Internal Revenue Code of 1986, as amended. Because such income may not be matched by a corresponding cash distribution to the Fund, the Fund may be required to borrow money or dispose of other securities to be able to make distributions to shareholders. Asset-Backed Securities. The Fund may invest in Asset-Backed Securities, which are securities that directly or indirectly represent a participation in or are secured by and payable from a pool of assets representing the obligations of a number of different parties. The Fund will only invest in Asset-Backed Securities rated, as of the date of purchase, AAA by Standard & Poor's, Aaa by Moody's, comparably rated by any other NRSRO or, if unrated, of comparable quality as determined by the Adviser. The securitization techniques used to develop Mortgage-Backed Securities are now being applied to a broad range of assets. Through the use of trusts and special purpose corporations, various types of assets, primarily automobile and credit card receivables, are being securitized in pass-through structures similar to the mortgage pass-through structures described above or in a pay-through structure similar to the CMO structure. In general, the collateral supporting Asset-Backed Securities is of shorter maturity than mortgage loans and is less likely to experience substantial prepayments. As with Mortgage-Backed Securities, Asset-Backed Securities are often backed by a pool of assets representing the obligations of a number of different parties and use similar credit enhancement techniques. Asset-Backed Securities do not have the benefit of the same security interest in the related collateral as do Mortgage-Backed Securities. Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of automobile receivables permit the servicers to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the holders of the automobile receivables may not have a perfected security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. Corporate Debt Securities. The Fund may invest in Corporate Debt Securities, which are debt obligations of U.S. corporations (other than ARMS or Mortgage-Backed Securities). The values of Corporate Debt Securities typically will fluctuate in response to general economic conditions, to changes in interest rates and, to a greater extent than the values of ARMS or Mortgage-Backed Securities, to business conditions affecting the specific industries in which the issuers are engaged. Corporate Debt Securities will typically decrease in value as a result of increases in interest rates. The Fund may invest in certain types of Corporate Debt Securities that have been issued with original issue discount or market discount. An investment in such securities poses certain economic risks and may have certain adverse cash flow consequences to the investor. New Instruments. The Fund expects that, consistent with its investment limitations, it will invest in those new types of ARMS, other Mortgage-Backed Securities, U.S. Government Securities, Asset-Backed Securities, hedging instruments and other securities in which it may invest that the Adviser believes may assist the Fund in achieving its objective. Shareholders will receive written notice in advance of a significant investment, i.e., in excess of 5% of the Fund's net assets, in such newly developed securities. OTHER INVESTMENT TECHNIQUES Hedging Transactions. The Fund may enter into certain interest rate, options and futures transactions and may make investments in Eurodollar instruments for hedging purposes as described below. * Interest Rate Transactions. The Fund may purchase or sell interest rate caps and floors to preserve a return or spread on a particular investment or portion of its portfolio or for other non-speculative purposes. The aggregate purchase price of caps and floors held by the Fund may not exceed 5% of the Fund's total assets. The Fund may sell, i.e., write, caps and floors without limitation, subject to the segregated account requirement described below. The Fund does not intend to use these transactions for speculative purposes. The purchase of an interest rate cap entitles the purchaser, to the extent a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually-based principal amount from the party selling such interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually-based principal amount from the party selling such interest rate floor. The Fund may enter into interest rate caps and floors on either an asset-based or liability-based basis, depending on whether it is hedging its assets or its liabilities. To the extent the Fund sells, i.e., writes, caps and floors, it will maintain in a segregated account cash or high quality liquid debt securities having an aggregate net asset value at least equal to the full amount, accrued on a daily basis, of the Fund's obligations with respect to any caps or floors. The Fund will not enter into any interest rate cap or floor transaction unless the unsecured senior debt or the claims-paying ability of the other party thereto is rated at least A by Standard & Poor's or Moody's or is comparably rated by any other NRSRO. The Adviser will monitor the creditworthiness of contra-parties on an ongoing basis. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreements related to the transaction. Interest rate caps and floors are somewhat recent innovations for which standardized documentation has not yet been developed and, accordingly, they are less liquid than many other investments. * Options Transactions. The Fund may write, i.e., sell, covered put and call options with respect to the securities in which it may invest. A put option is sometimes referred to as a "standby commitment" and a call option is sometimes referred to as a "reverse standby commitment." By writing a call option, the Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price if the option is exercised. By writing a put option, the Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. In connection with writing put options, the Fund will deposit and maintain in a segregated account with its custodian cash, U.S. Government securities or other liquid high-grade debt obligations having a value equal to or greater than the exercise price of the option. The Fund may not write puts if, as a result, more than 50% of its assets would be required to be segregated. The principal reason for writing call or put options is to obtain, through the receipt of premiums, a greater return than would be realized on the underlying securities alone. The Fund receives premiums from writing call or put options, which it retains whether or not the options are exercised. By writing a call option, the Fund might lose the potential for gain on the underlying security while the option is open, and by writing a put option the Fund might become obligated to purchase the underlying security for more than its current market price upon exercise. The Fund may purchase put options, solely for hedging purposes, in order to protect portfolio holdings in an underlying security against a substantial decline in the market value of such holdings ("protective puts"). Such protection is provided during the life of the put because the Fund may sell the underlying security at the put exercise price, regardless of a decline in the underlying security's market price. Any loss to the Fund is limited to the premium and transaction costs paid for the put plus the initial excess, if any, of the market price of the underlying security over the exercise price. However, if the market price of such security increases, the profit the Fund realizes on the sale of the security will be reduced by the premium paid for the put option less any amount for which the put is sold. The Fund also may purchase call options solely for the purpose of hedging against an increase in prices of securities that the Fund ultimately wants to buy. Such protection is provided during the life of the call options because the Fund may buy the underlying security at the call exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call options in this manner, the Fund will reduce any profit it might have realized had it bought the underlying security at the time it purchased the call option by the premium paid for the call option and by transaction costs. The aggregate premiums paid on all put and call options purchased by the Fund, including options on futures contracts, may not exceed 20% of the Fund's net assets. The Fund will purchase and write only exchange-traded put and call options. For further information concerning the characteristics and risks of options transactions, see "Investment Objective, Policies and Restrictions -- Options" in the Statement of Additional Information. * Futures Contracts and Options on Futures Contracts. The Fund may enter into contracts for the purchase or sale for future delivery of fixed-income securities or contracts based on financial indices including any index of securities in which the Fund may invest ("futures contracts"). A "sale" of a futures contract means the acquisition of a contractual obligation to deliver the securities called for by the contract at a specified price on a specified date. The purchaser of a futures contract on an index agrees to take or make delivery of an amount of cash equal to the difference between a specified dollar multiple of the value of the index on the expiration date of the contract ("current contract value") and the price at which the contract was originally struck. No physical delivery of the fixed-income securities underlying the index is made. The futures contracts in which the Fund may invest have been developed by and are traded on national commodity exchanges. The purpose of the acquisition or sale of a futures contract by the Fund is to hedge against fluctuations in the value of the Fund's portfolio without actually buying or selling securities. For example, if the Fund owns long-term debt securities and interest rates are expected to increase, the Fund might sell futures contracts. If interest rates did increase, the value of the debt securities in the Fund's portfolio would decline, but the value of the Fund's futures contracts would increase at approximately the same rate, thereby keeping the net asset value of the Fund from declining as much as it otherwise would have. If, on the other hand, the Fund held cash reserves and short-term investments pending anticipated investment in long-term obligations and interest rates were expected to decline, the Fund might purchase futures contracts for U.S. Government securities. Since the behavior of such contracts would generally be similar to that of long-term securities, the Fund could take advantage of the anticipated rise in the value of long-term securities without actually buying them until the market had stabilized. At that time, the Fund could accept delivery under the futures contracts or the futures contracts could be liquidated and the Fund's reserves could then be used to buy long-term securities in the cash market. The Fund will engage in such transactions only for hedging purposes, on either an asset-based or a liability-based basis, in each case in accordance with the rules and regulations of the Commodity Futures Trading Commission. See Appendix B to the Statement of Additional Information. The Fund may purchase and sell put and call options on futures contracts and enter into closing transactions with respect to such options to terminate existing positions. The Fund may use such options on futures contracts in connection with its hedging strategies in lieu of purchasing and writing options directly on the underlying securities or purchasing and selling the underlying futures contracts. The Fund's aggregate margin deposits in connection with futures contracts and options thereon may not exceed 5% of the Fund's total assets. Additional information with respect to futures contracts and options on futures contracts is set forth in Appendix B to the Statement of Additional Information. There are risks in using futures contracts and options on futures contracts as hedging devices. The primary risks associated with the use of futures contracts and options thereon are (a) the prices of futures contracts and options may not correlate perfectly with the market value of the underlying security held by the Fund, and (b) the possible lack of a liquid secondary market for a futures contract and the resulting inability to close a futures position prior to its maturity date. The risk that the Fund will be unable to close out a futures position will be minimized by entering into such transactions on a national exchange with an active and liquid secondary market. The effective use of futures contracts, options on futures contracts and the other hedging techniques discussed above is dependent upon the Adviser's judgment regarding interest rate movements and other economic factors. To the extent this judgment is incorrect, the Fund will be in a worse position than if such hedging techniques had not been used. * Eurodollar Instruments. The Fund may make investments in Eurodollar instruments for hedging purposes only. Eurodollar instruments are essentially U.S. dollar denominated futures contracts or options thereon that are linked to LIBOR. Eurodollar futures contracts enable purchasers to obtain a fixed rate for the lending of funds and sellers to obtain a fixed rate for borrowings. The Fund uses Eurodollar futures contracts and options thereon to hedge against changes in LIBOR, to which many short-term borrowings and floating rate securities are linked. Eurodollar instruments are subject to the same limitations and risks as other futures contracts and options thereon. When-Issued Securities. The Fund may purchase securities on a "when-issued" basis and may purchase or sell securities on a "forward commitment" basis. When such transactions are negotiated, the price is fixed at the time the commitment is made, but delivery and payment for the securities take place at a later date. The Fund does not accrue income with respect to when-issued or forward commitment securities prior to their stated delivery date. Pending delivery of the securities, the Fund maintains in a segregated account cash or liquid high-grade debt obligations in an amount sufficient to meet its purchase commitments. The Fund likewise segregates securities it sells on a forward commitment basis. The Fund will purchase securities on a when-issued or forward commitment basis with the intention of acquiring such securities for its portfolio. The Fund may dispose of a commitment prior to settlement, however, if the Adviser deems it appropriate to do so. The purchase of securities on a when-issued or forward commitment basis exposes the Fund to risk because the securities may decrease in value prior to their delivery. Purchasing securities on a when-issued or forward commitment basis involves the additional risk that the return available in the market when the delivery takes place will be higher than that obtained in the transaction itself. The purchase of securities on a when-issued or forward commitment basis while remaining substantially fully invested increases the amount of the Fund's assets that are subject to market risk to an amount that is greater than the Fund's net asset value, which could result in increased volatility of the price of the Fund's shares. Illiquid Securities. The Fund may invest up to 15% of its net assets in illiquid securities. Illiquid securities may offer a higher yield than securities which are more readily marketable, but they may not always be marketable on advantageous terms. The sale of illiquid securities often requires more time and results in higher brokerage charges or dealer discounts than does the sale of securities eligible for trading on national securities exchanges or in the over-the-counter markets. The Fund may be restricted in its ability to sell such securities at a time when the Adviser deems it advisable to do so. In addition, in order to meet redemption requests, the Fund may have to sell other assets, rather than such illiquid securities, at a time which is not advantageous. "Restricted securities" are securities which were originally sold in private placements and which have not been registered under the Securities Act of 1933 (the "1933 Act"). Such securities generally have been considered illiquid, since they may be resold only subject to statutory restrictions and delays or if registered under the 1933 Act. In 1990, however, the SEC adopted Rule 144A under the 1933 Act, which provides a safe harbor exemption from the registration requirements of the 1933 Act for resales of restricted securities to "qualified institutional buyers," as defined in the rule. The result of this rule has been the development of a more liquid and efficient institutional resale market for restricted securities. Thus, restricted securities are no longer necessarily illiquid. The Fund is not subject to any limitation on its ability to invest in securities simply because such securities are restricted. These securities will be treated as liquid when they have been determined to be liquid by the Board of Directors of the Fund or by the Adviser subject to the oversight of and pursuant to procedures adopted by the Board of Directors. See "Investment Objective, Policies and Restrictions -- Illiquid Securities" in the Statement of Additional Information. Similar determinations may be made with respect to commercial paper issued in reliance upon the so-called "private placement" exemption from registration under Section 4(2) of the 1933 Act. Investing in Rule 144A securities could have the effect of increasing the level of illiquidity of the Fund to the extent that qualified institutional buyers become, for a time, uninterested in purchasing these securities. Lending of Portfolio Securities. In order to generate income, the Fund may lend portfolio securities representing up to 30% of the value of its total assets to broker-dealers, banks or other financial borrowers of securities. As with other extensions of credit, there are risks of delay in recovery or even loss of rights in the collateral should the borrower of the securities fail financially. However, the Fund will only enter into loan arrangements with broker-dealers, banks or other institutions which the Adviser has determined are creditworthy under guidelines established by the Board of Directors and will receive collateral in the form of cash, U.S. Government securities or other high-grade debt obligations equal to at least 100% of the value of the securities loaned. The value of the collateral and of the securities loaned is marked to market on a daily basis. During the time portfolio securities are on loan, the borrower pays the Fund an amount equivalent to any interest paid on the securities and the Fund may invest the cash collateral and earn income or may receive an agreed upon amount of interest income from the borrower. However, the amounts received by the Fund may be reduced by finders' fees paid to broker-dealers. Collateral (including any securities purchased with cash collateral) will be maintained by the Fund's custodian in a segregated account. Repurchase Agreements. The Fund may enter into repurchase agreements pertaining to the securities in which it may invest. A repurchase agreement involves the purchase by the Fund of securities with the condition that after a stated period of time the original seller (a member bank of the Federal Reserve System or a recognized securities dealer) will buy back the same securities ("collateral") at a predetermined price or yield. Repurchase agreements involve certain risks not associated with direct investments in securities. In the event the original seller defaults on its obligation to repurchase, as a result of its bankruptcy or otherwise, the Fund will seek to sell the collateral, which action could involve costs or delays. In such case, the Fund's ability to dispose of the collateral to recover such investment may be restricted or delayed. While collateral will at all times be maintained in an amount equal to the repurchase price under the agreement (including accrued interest due thereunder), to the extent proceeds from the sale of collateral were less than the repurchase price, the Fund would suffer a loss. In the event of a seller's bankruptcy, the Fund might be delayed in, or prevented from, selling the collateral to the Fund's benefit. Repurchase agreements maturing in more than seven days are considered illiquid and subject to the Fund's restriction on investing in illiquid securities. See "Illiquid Securities" above. Borrowing. The Fund may borrow money only for temporary or emergency purposes in an amount up to 10% of the value of its total assets. The Fund may borrow from a financial institution unrelated to the Fund or by entering into reverse repurchase agreements with the same parties with whom it may enter into repurchase agreements (as discussed above). Interest paid by the Fund on borrowed funds would decrease the net earnings of the Fund. The Fund will not purchase portfolio securities while outstanding borrowings exceed 5% of the value of the Fund's total assets. The Fund may mortgage, pledge or hypothecate its assets to secure permitted borrowings. The policies set forth in this paragraph are fundamental and may not be changed without a majority vote of the Fund's shares. Under a reverse repurchase agreement, the Fund sells securities and agrees to repurchase them at a mutually agreed date and price. Reverse repurchase agreements involve the risk that the market value of the securities sold by the Fund may decline below the price at which the Fund is obligated to repurchase such securities. In the event the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, such buyer or its trustee or receiver may receive an extension of time to determine whether to enforce the Fund's obligation to repurchase the securities, and the Fund's use of the proceeds of the reverse repurchase agreement may effectively be restricted pending such decisions. Reverse repurchase agreements create leverage, a speculative factor, and are considered borrowings for purposes of the Fund's limitation on borrowing. DURATION The Adviser will attempt to maintain an average effective duration for the Fund's portfolio of one to four years. Effective duration estimates the interest rate risk (price volatility) of a security, i.e., how much the value of the security is expected to change with a given change in interest rates. The longer a security's effective duration, the more sensitive its price is to changes in interest rates. For example, if interest rates were to increase by 1%, the market price of a bond with an effective duration of five years would decrease by about 5%, with all other factors being constant. It is important to understand that, while a valuable measure, effective duration is based on certain assumptions and has several limitations. It is most useful as a measure of interest rate risk when interest rate changes are small, rapid and occur equally across all the different points of the yield curve. In addition, effective duration is difficult to calculate precisely for bonds with prepayment options, such as mortgage-backed securities, because the calculation requires assumptions about prepayment rates. For example, when interest rates go down, homeowners may prepay their mortgages at a higher rate than assumed in the initial effective duration calculation, thereby shortening the effective duration of the Fund's mortgage-backed securities. Conversely, if rates increase, prepayments may decrease to a greater extent than assumed, extending the effective duration of such securities. For these reasons, the effective durations of funds which invest a significant portion of their assets in mortgage-backed securities can be greatly affected by changes in interest rates. INVESTMENT RESTRICTIONS The Fund has adopted certain investment restrictions, which are set forth in detail in the Statement of Additional Information under "Investment Objective, Policies and Restrictions." Fundamental restrictions which may not be changed without a majority vote of shareholders include, among others, the following: (1) The Fund will not invest 25% or more of its total assets in the securities of issuers conducting their principal business activities in the same industry, except that, under normal market conditions, the Fund will invest 25% or more of the value of its total assets in ARMS issued or guaranteed by the U.S. Government or its agencies or instrumentalities or by private organizations. Except for the requirement that the Fund invest 25% or more of its total assets in ARMS, the foregoing restriction does not apply to securities of the U.S. Government or its agencies or instrumentalities or repurchase agreements relating thereto. The Fund will determine the industry classification of Asset-Backed Securities in its portfolio based on the type of collateral underlying the securities and will consider ARMS issued by the U.S. Government or its agencies or instrumentalities and ARMS issued by private organizations to be securities of issuers in the same industry. (2) With respect to 75% of its total assets, the Fund will not invest more than 5% of the value of its total assets (taken at market value at the time of purchase) in the outstanding securities of any one issuer, or own more than 10% of the outstanding voting securities of any one issuer, in each case other than securities issued or guaranteed by the U.S. Government or any agency or instrumentality thereof. PORTFOLIO TURNOVER The Fund actively uses trading to benefit from yield disparities among different issues of securities or otherwise to achieve its investment objective and policies. This strategy may result in a greater degree of portfolio turnover and, thus, a higher incidence of short-term capital gain than might be expected from investment companies that invest substantially all of their funds on a long-term basis. Such a strategy will also result in higher transaction costs. The Fund's portfolio turnover rate is set forth above under "Financial Highlights." The method of calculating portfolio turnover rate is set forth in the Statement of Additional Information under "Investment Objective, Policies and Restrictions -- Portfolio Turnover." MANAGEMENT BOARD OF DIRECTORS The Company's Board of Directors has the primary responsibility for overseeing the overall management of the Company and electing its officers. INVESTMENT ADVISER Piper Capital Management Incorporated (the "Adviser") has been retained under an Investment Advisory and Management Agreement with the Company to act as the Fund's investment adviser subject to the authority of the Board of Directors. In addition to acting as the investment adviser for the Company, the Adviser, which was incorporated in 1983, also serves as investment adviser to a number of other open-end and closed-end investment companies and to various other concerns, including pension and profit sharing funds, corporate funds and individuals. As of November 15, 1995, the Adviser rendered investment advice regarding approximately $9 billion of assets. The Adviser is a wholly owned subsidiary of Piper Jaffray Companies Inc., a publicly held corporation which is engaged through its subsidiaries in various aspects of the financial services industry. The address of the Adviser is Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804. The Adviser furnishes the Fund with investment advice and supervises the management and investment program of the Fund. The Adviser furnishes at its own expense all necessary administrative services, office space, equipment and clerical personnel for servicing the investments of the Fund, and investment advisory facilities and executive and supervisory personnel for managing the Fund's investments and effecting its portfolio transactions. In addition, the Adviser pays the salaries and fees of all officers and directors of the Company who are affiliated persons of the Adviser. Under the Investment Advisory and Management Agreement, the Fund pays the Adviser a monthly fee at an annual rate of .35% on the first $500 million of the Fund's average daily net assets and .30% on average daily net assets in excess of $500 million. PORTFOLIO MANAGEMENT Thomas S. McGlinch and Wan-Chong Kung are primarily responsible for the day-to-day management of the Fund's portfolio. Mr. McGlinch has managed the portfolio since inception and Ms. Kung has been a co-manager since December 1995. Mr. McGlinch is a Senior Vice President and fixed-income portfolio manager for the Adviser. Prior to joining the Adviser in 1992, Mr. McGlinch was an institutional mortgage-backed securities trader for the Distributor during 1992. From 1988 to January 1992, Mr. McGlinch was a specialty products trader at FBS Investment Services, Inc. He is a Chartered Financial Analyst with an M.B.A. from the University of St. Thomas. Ms. Kung is a Vice President and portfolio manager for the Adviser. Prior to joining the Adviser in 1993, she was a Senior Consultant at Cytrol Inc. in Edina, Minnesota from 1989 to December 1992. Ms. Kung received a B.S. from the University of the Philippines in Manila and an M.B.A. from the University of Minnesota. TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND CUSTODIAN Investors Fiduciary Trust Company ("IFTC"), 210 West Tenth Street, Kansas City, Missouri 64105, (800) 874-6205, serves as Custodian for the Fund's portfolio securities and cash and as Transfer Agent and Dividend Disbursing Agent for the Fund. The Company has entered into a Shareholder Account Servicing Agreement with the Distributor. Under this agreement, the Distributor provides transfer agent and dividend disbursing agent services for certain shareholder accounts. For more information, see "Investment Advisory and Other Services -- Transfer Agent and Dividend Disbursing Agent" in the Statement of Additional Information. PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSION The Adviser selects brokers and futures commission merchants to use for the Fund's portfolio transactions. In making its selection, the Adviser may consider a number of factors, which are more fully discussed in the Statement of Additional Information, including, but not limited to, research services, the reasonableness of commissions and quality of services and execution. A broker's sales of shares may also be considered a factor if the Adviser is satisfied that the Fund would receive from that broker the most favorable price and execution then available for a transaction. Portfolio transactions for the Fund may be effected through the Distributor on a securities exchange in compliance with Section 17(e) of the Investment Company Act of 1940, as amended (the "1940 Act"). For more information, see "Portfolio Transactions and Allocation of Brokerage" in the Statement of Additional Information. DISTRIBUTION OF FUND SHARES Piper Jaffray acts as the principal distributor of the Fund's shares. The Company has adopted a Distribution Plan (the "Plan") as required by Rule 12b-1 under the 1940 Act. Pursuant to the provisions of the Plan, the Fund pays a monthly service fee to the Distributor at an annual rate of .15% of the Fund's average daily net assets in connection with servicing of the Fund's shareholder accounts. This fee is intended to compensate the Distributor for the ongoing servicing and/or maintenance of Fund shareholder accounts and the costs incurred in connection therewith ("Shareholder Servicing Costs"). Shareholder Servicing Costs include all expenses of the Distributor incurred in connection with providing shareholder liaison services, including, but not limited to, an allocation of the Distributor's overhead and payments made to persons, including employees of the Distributor, who respond to inquiries of shareholders regarding their ownership of shares or their accounts with the Fund, and who provide information on shareholders' investments. The Distributor uses all or a portion of its Rule 12b-1 service fee to make payments to Investment Executives of the Distributor and broker-dealers which have entered into sales agreements with the Distributor. If shares of the Fund are sold by a representative of a broker-dealer other than the Distributor, the broker-dealer is paid .15% of the average daily net assets of the Fund attributable to shares sold by the broker-dealer's representative. If shares of the Fund are sold by an Investment Executive of the Distributor, compensation is paid to the Investment Executive in the manner set forth in a written agreement, in an amount not to exceed .15% of the average daily net assets of the Fund attributable to shares sold by the Investment Executive. Further information regarding the Plan is contained in the Statement of Additional Information. SHAREHOLDER GUIDE TO INVESTING HOW TO PURCHASE SHARES GENERAL The Fund's shares may be purchased at the public offering price from the Distributor and from other broker-dealers who have sales agreements with the Distributor. The address of the Distributor is that of the Fund. The Distributor reserves the right to reject any purchase order. You should be aware that, because the Fund does not issue stock certificates, Fund shares must be kept in an account with the Distributor or with IFTC. All investments must be arranged through your Piper Jaffray Investment Executive or other broker-dealer. PURCHASE PRICE You may purchase shares of the Fund at the net asset value per share next calculated after receipt of your order by your Piper Jaffray Investment Executive or other broker-dealer, plus a front-end sales charge as follows: SALES CHARGE SALES CHARGE AS A PERCENTAGE OF AS A PERCENTAGE OF AMOUNT OF TRANSACTION AT OFFERING PRICE OFFERING PRICE NET ASSET VALUE Less than $100,000 1.50% 1.52% $100,000 but less than $250,000 1.25% 1.27% $250,000 but less than $500,000 1.00% 1.01% $500,000 and over 0.00% 0.00% This table sets forth total sales charges or underwriting commissions. The Distributor may reallow up to the entire sales charge to broker-dealers in connection with their sales of shares. Broker-dealers who are reallowed 90% or more of the sales charge may, by virtue of such reallowance, be deemed to be "underwriters" under the 1933 Act. The Distributor will make certain payments to its Investment Executives and to other broker-dealers in connection with their sales of Fund shares. See "Distribution of Fund Shares" above. In addition, the Distributor or the Adviser, at their own expense, will provide promotional incentives to Investment Executives of the Distributor and to broker-dealers who have sales agreements with the Distributor in connection with sales of shares of the Fund and other mutual funds for which the Adviser acts as Investment Adviser. In some instances, these incentives may be made available only to certain Investment Executives or broker-dealers who have sold or may sell significant amounts of such shares. The incentives may include payment for travel expenses, including lodging at luxury resorts, incurred in connection with sales seminars. PURCHASES OF $500,000 OR MORE If you make a purchase of $500,000 or more (including purchases made under a Letter of Intent), a .20% contingent deferred sales charge will be assessed in the event you redeem shares within 24 months following the purchase. This sales charge will be paid to the Distributor. For more information, please refer to the Contingent Deferred Sales Charge section of "How to Redeem Shares." The Distributor will pay its Investment Executives and other broker-dealers in connection with these purchases as follows: FEE AS A PERCENTAGE AMOUNT OF TRANSACTION OF OFFERING PRICE First $3,000,000 .20% Next $2,000,000 .15% Next $5,000,000 .10% Above $10,000,000 .05% Piper Jaffray Investment Executives and other broker-dealers generally will not receive a fee in connection with purchases on which the contingent deferred sales charge is waived. However, the Distributor, in its discretion, may pay a fee out of its own assets to its Investment Executives and other broker-dealers in connection with purchases by employee benefit plans on which no sales charge is imposed. Please see "Special Purchase Plans" below. MINIMUM INVESTMENTS A minimum initial investment of $250 is required. There is no minimum for subsequent investments. The Distributor, in its discretion, may waive the minimum. REDUCING YOUR SALES CHARGE You may qualify for a reduced sales charge through one or more of several plans. You must notify your Piper Jaffray Investment Executive or broker-dealer at the time of purchase to take advantage of these plans. AGGREGATION Front-end or initial sales charges may be reduced or eliminated by aggregating your purchase with purchases of certain related personal accounts. In addition, purchases made by members of certain organized groups will be aggregated for purposes of determining sales charges. Sales charges are calculated by adding the dollar amount of your current purchase to the higher of the cost or current value of shares of any Piper fund sold with a sales charge that are currently held by you and your related accounts or by other members of your group. Qualified Groups. You may group purchases in the following personal accounts together: * Your individual account. * Your spouse's account. * Your children's accounts (if they are under the age of 21). * Your employee benefit plan accounts if they are exclusively for your benefit. This includes accounts such as IRAs, individual 403(b) plans or single-participant Keogh-type plans. * A single trust estate or single fiduciary account if you are the trustee or fiduciary. Additionally, purchases made by members of any organized group meeting the requirements listed below may be aggregated for purposes of determining sales charges: * The group has been in existence for more than six months. * It is not organized for the purpose of buying redeemable securities of a registered investment company. * Purchases must be made through a central administration, or through a single dealer, or by other means that result in economy of sales effort or expense. An organized group does not include a group of individuals whose sole organizational connection is participation as credit card holders of a company, policyholders of an insurance company, customers of either a bank or broker-dealer or clients of an investment adviser. RIGHT OF ACCUMULATION Sales charges for purchases of Fund shares into Piper Jaffray accounts will be automatically calculated taking into account the dollar amount of any new purchases along with the higher of current value or cost of shares previously purchased in any other mutual fund managed by the Adviser (except Hercules Funds Inc.) that was sold with a sales charge. For other broker-dealer accounts, you should notify your Investment Executive at the time of purchase of additional Piper fund shares you may own. LETTER OF INTENT Your sales charge may be reduced by signing a non-binding Letter of Intent. This Letter of Intent will state your intention to invest $100,000 or more in any of the mutual funds managed by the Adviser that are sold with a sales charge (except Hercules Funds Inc.) over a 13-month period, beginning not earlier than 90 days prior to the date you sign the Letter. You will pay the lower sales charge applicable to the total amount you plan to invest over the 13-month period. Part of your shares will be held in escrow to cover additional sales charges that may be due if you do not invest the planned amount. Please see "Purchase of Shares" in the Statement of Additional Information for more details. You can contact your Piper Jaffray Investment Executive or other broker-dealer for an application. SPECIAL PURCHASE PLANS For more information on any of the following special purchase plans, contact your Piper Jaffray Investment Executive or other broker-dealer. PURCHASES BY PIPER JAFFRAY COMPANIES INC., ITS SUBSIDIARIES AND ASSOCIATED PERSONS Piper Jaffray Companies Inc. and its subsidiaries may buy shares of the Fund without incurring a sales charge. The following persons associated with such entities also may buy Fund shares without paying a sales charge: * Officers, directors and partners. * Employees and retirees. * Sales representatives. * Spouses or children under the age of 21 of any of the above. * Any trust, pension, profit sharing or other benefit plan for any of the above. PURCHASES BY BROKER-DEALERS Employees of broker-dealers who have entered into sales agreements with the Distributor, and spouses and children under the age of 21 of such employees, may buy shares of the Fund without incurring a sales charge. PURCHASES BY OTHER INDIVIDUALS WITHOUT A SALES CHARGE The following other individuals and entities may also buy Fund shares without paying a sales charge: * Clients of the Adviser may buy shares of the Fund in their advisory accounts. * Discretionary accounts at Piper Trust Company and participants in investment companies exempt from registration under the 1940 Act that are managed by the Adviser. * Trust companies and bank trust departments using funds over which they exercise exclusive discretionary investment authority and which are held in a fiduciary, agency, advisory, custodial or similar capacity. * Investors purchasing shares through a Piper Jaffray Investment Executive if the purchase of such shares is funded by the proceeds from the sale of shares of any non-money market open-end mutual fund. This privilege is available for 30 days after the sale. PURCHASES BY EMPLOYEE BENEFIT PLANS AND TAX-SHELTERED ANNUITIES * Shares of the Fund will be sold at net asset value, without a sales charge, to employee benefit plans containing an actively maintained qualified cash or deferred arrangement under Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Code") ("401(k) Plan"). In the event a 401(k) Plan of an employer has purchased shares in the Fund during any calendar quarter, any other employee benefit plan of such employer that is a qualified plan under Section 401(a) of the Code also may purchase shares of the Fund during such quarter without incurring a sales charge. * Custodial accounts under Section 403(b) of the Code (known as tax-sheltered annuities) also may buy shares of the Fund without incurring a sales charge. PURCHASES USING FINAL TERM TRUST DISTRIBUTIONS * Prior to the merger of BDJ, CDJ, DDJ and EDJ into the Fund, the shareholders of BDJ, CDJ and DDJ received special distributions, which were payable on August 24, 1995, of all of their respective Trust's previously undistributed net income and net realized capital gains. Shareholders who received these distributions may use them to purchase shares of the Fund at net asset value through December 31, 1995, provided the shareholder holds his or her shares in a Piper Jaffray account or in the account of a broker-dealer which has a sales agreement with the Distributor. HOW TO REDEEM SHARES NORMAL REDEMPTION You may redeem all or a portion of your shares on any day that the Fund values its shares. (Please refer to "Valuation of Shares" below for more information.) Your shares will be redeemed at the net asset value next calculated after the receipt of your instructions in good form by your Piper Jaffray Investment Executive or other broker-dealer as explained below. Piper Jaffray Inc. Accounts. To redeem your shares, please contact your Piper Jaffray Investment Executive with a verbal request to redeem your shares. Other Broker-Dealer Accounts. To redeem your shares, you may either contact your broker-dealer with a verbal request or send a written request directly to the Fund's transfer agent, IFTC. This request should contain the dollar amount or number of shares to be redeemed, your Fund account number and either a social security or tax identification number (as applicable). You should sign your request in exactly the same way the account is registered. If there is more than one owner of the shares, all owners must sign. A signature guarantee is required for redemptions over $25,000. Please contact IFTC or refer to "Redemption of Shares" in the Statement of Additional Information for more details. CONTINGENT DEFERRED SALES CHARGE If you invest $500,000 or more and, as a result, pay no front-end sales charge, you may incur a contingent deferred sales charge if you redeem within 24 months. This charge will be equal to .20% of the lesser of the net asset value of the shares at the time of purchase or at the time of redemption. This charge does not apply to amounts representing an increase in the value of Fund shares due to capital appreciation or to shares acquired through reinvestment of dividend or capital gain distributions. In determining whether a contingent deferred sales charge is payable, shares that are not subject to any deferred sales charge will be redeemed first, and other shares will then be redeemed in the order purchased. Letter of Intent. In the case of a Letter of Intent, the 24-month period begins on the date the Letter of Intent is completed. Special Purchase Plans. If you purchased your shares through one of the plans described above under "Special Purchase Plans," the contingent deferred sales charge will be waived. In addition, the contingent deferred sales charge will be waived in the event of: * The death or disability (as defined in Section 72(m)(7) of the Code) of the shareholder. (This waiver will be applied to shares held at the time of death or the initial determination of disability of either an individual shareholder or one who owns the shares as a joint tenant with the right of survivorship or as a tenant in common.) * A lump sum distribution from an employee benefit plan qualified under Section 401(a) of the Code, an individual retirement account under Section 408(a) of the Code or a simplified employee pension plan under Section 408(k) of the Code. * Systematic withdrawals from any such plan or account if the shareholder is at least 59 1/2 years old. * A tax-free return of the excess contribution to an individual retirement account under Section 408(a) of the Code. * Involuntary redemptions effected pursuant to the right to liquidate shareholder accounts having an aggregate net asset value of less than $200. Exchanges. If you exchange your shares, no contingent deferred sales charge will be imposed. However, the charge will apply if you subsequently redeem the new shares within 24 months of the original purchase. Reinstatement Privilege. If you elect to use the Reinstatement Privilege (please see "Shareholder Services" below), any contingent deferred sales charge you paid will be credited to your account (proportional to the amount reinvested). Please see "Redemption of Shares" in the Statement of Additional Information for more details. PAYMENT OF REDEMPTION PROCEEDS After your shares have been redeemed, proceeds will normally be sent to you or your broker-dealer within three business days. In no event will payment be made more than seven days after receipt of your order in good form. However, payment may be postponed or the right of redemption suspended for more than seven days under unusual circumstances, such as when trading is not taking place on the New York Stock Exchange. Payment of redemption proceeds may also be delayed if the shares to be redeemed were purchased by a check drawn on a bank which is not a member of the Federal Reserve System, until such checks have cleared the banking system (normally up to 15 days from the purchase date). INVOLUNTARY REDEMPTION The Fund reserves the right to redeem your account at any time the net asset value of the account falls below $200 as the result of a redemption or exchange request. You will be notified in writing prior to any such redemption and will be allowed 30 days to make additional investments before the redemption is processed. SHAREHOLDER SERVICES AUTOMATIC MONTHLY INVESTMENT PROGRAM You may arrange to make additional automated purchases of shares of the Fund or certain other mutual funds managed by the Adviser. You can automatically transfer $100 or more per month from your bank, savings and loan or other financial institution to purchase additional shares. In addition, if you hold your shares in a Piper Jaffray account you may arrange to make such additional purchases by having $25 or more automatically transferred each month from any Piper money market fund. You should contact your Piper Jaffray Investment Executive or IFTC to obtain authorization forms or for additional information. REINSTATEMENT PRIVILEGE If you have redeemed shares of the Fund, you may be eligible to reinvest in shares of any fund managed by the Adviser without payment of an additional sales charge (except Hercules Funds Inc.). The reinvestment request must be made within 30 days of the redemption. This privilege is subject to the eligibility of share purchases in your state as well as the minimum investment requirements and any other applicable terms in the prospectus of the fund being acquired. You may reinvest through a broker-dealer other than the Distributor only if there is a valid sales agreement between your broker-dealer and the Distributor for the fund in which you wish to invest. EXCHANGE PRIVILEGE If your investment goals change, you may prefer a fund with a different objective. If you are considering an exchange into another mutual fund managed by the Adviser, you should carefully read the appropriate prospectus for additional information about that fund. A prospectus may be obtained through your Piper Jaffray Investment Executive, your broker-dealer or the Distributor. To exchange your shares, please contact your Piper Jaffray Investment Executive, your broker-dealer or IFTC. You may exchange your shares for shares of any other mutual fund managed by the Adviser (except Hercules Funds Inc.) that is open to new investors. All exchanges are subject to the eligibility of share purchases in your state as well as the minimum investment requirements and any other applicable terms in the prospectus of the fund being acquired. Exchanges are made on the basis of the net asset values of the funds involved, except that investors exchanging into a fund which has a higher sales charge generally must pay the difference. However, exchanges of Fund shares received in the Merger will be permitted without payment of an additional sales charge. If you hold your Fund shares through a broker-dealer other than the Distributor, the exchange privilege may not be available. Exchanges will be permitted only if there is a valid sales agreement between your broker-dealer and the Distributor for the fund into which you wish to exchange. You may make four exchanges per year without payment of a service charge. Thereafter you will pay a $5 service charge for each exchange. The Fund reserves the right to change or discontinue the exchange privilege, or any aspect of the privilege, upon 60 days' written notice. TELEPHONE TRANSACTION PRIVILEGES Piper Jaffray Inc. Accounts. If you hold your shares in a Piper Jaffray account, you may telephone your Investment Executive to execute any transaction or to apply for many shareholder services. In some cases, you may be required to complete a written application. Other Broker-Dealer Accounts. If you hold your shares in an account with your broker-dealer or at IFTC, you may authorize telephone privileges by completing the Account Application and Services Form. Please contact your broker-dealer or IFTC (800-874-6205) for an application or for more details. The Fund will employ reasonable procedures to confirm that a telephone request is genuine, including requiring that payment be made only to the address of record or the bank account designated on the Account Application and Services Form and requiring certain means of telephonic identification. If the Fund employs such procedures, it will not be liable for following instructions communicated by telephone that it reasonably believes to be genuine. If the Fund does not employ such procedures, it may be liable for any losses due to unauthorized or fraudulent telephone instructions. It may be difficult to reach the Fund by telephone during periods when market or economic conditions lead to an unusually large volume of telephone requests. If you cannot reach the Fund by telephone, you should contact your broker-dealer or issue written instructions to IFTC at the address set forth herein. See "Management -- Transfer Agent, Dividend Disbursing Agent and Custodian." The Fund reserves the right to suspend or terminate its telephone services at any time without notice. DIRECTED DIVIDENDS You may direct income dividends and capital gains distributions to be invested in any other mutual fund managed by the Adviser (other than a money market fund or Hercules Funds Inc.) that is offered in your state. This investment will be made at net asset value. It will not be subject to a minimum investment amount except that you must hold shares in such fund (including the shares being acquired with the dividend or distribution) with a value at least equal to such fund's minimum initial investment amount. This privilege may not be available if you hold your Fund shares through a broker-dealer other than the Distributor. Distributions may be invested in another mutual fund managed by the Adviser only if there is a valid sales agreement for that fund between your broker-dealer and the Distributor. SYSTEMATIC WITHDRAWAL PLAN If your account has a value of $5,000 or more, you may establish a Systematic Withdrawal Plan. This plan will allow you to receive regular periodic payments by redeeming as many shares from your account as necessary. As with other redemptions, a redemption to make a withdrawal is a sale for federal income tax purposes. Payments made under a Systematic Withdrawal Plan cannot be considered as actual yield or income since part of the payments may be a return of capital. A request to establish a Systematic Withdrawal Plan must be submitted in writing to your Piper Jaffray Investment Executive or other broker-dealer. There are no service charges for maintenance; the minimum amount that you may withdraw each period is $100. You will be required to have any income dividends and any capital gains distributions reinvested. You may choose to have withdrawals made monthly, quarterly or semiannually. Please contact your Piper Jaffray Investment Executive, other broker-dealer or IFTC for more information. You should be aware that additional investments in an account that has an active Systematic Withdrawal Plan may be inadvisable due to sales charges and tax liabilities. Please refer to "Redemption of Shares" in the Statement of Additional Information for additional details. ACCOUNT PROTECTION If you purchased your shares of the Fund through a Piper Jaffray Investment Executive, you may choose from several account options. Your investments in the Fund held in a Piper Jaffray account (except for non-"PAT" accounts) would be protected up to $25 million. Investments held in non-"PAT" Piper Jaffray accounts are protected up to $2.5 million. In each case, the Securities Investor Protection Corporation ("SIPC") provides $500,000 of protection; the additional coverage is provided by The Aetna Casualty & Surety Company. This additional account protection guarantees that if Piper Jaffray were to fail financially, the securities in your account would be protected. This protection does not cover any declines in the net asset value of Fund shares. CONFIRMATION OF TRANSACTIONS AND REPORTING OF OTHER INFORMATION Each time there is a transaction involving your Fund shares, such as a purchase, redemption or dividend reinvestment, you will receive a confirmation statement describing that activity. This information will be provided to you from either Piper Jaffray, your broker-dealer or IFTC. In addition, you will receive various IRS forms after the first of each year detailing important tax information and the Fund is required to supply annual and semiannual reports that list securities held by the Fund and include the current financial statements of the Fund. Householding. If you have multiple accounts with Piper Jaffray, you may receive some of the above information in combined mailings. This will not only help to reduce Fund expenses, it will help the environment by saving paper. Please contact your Piper Jaffray Investment Executive for more information. DIVIDENDS AND DISTRIBUTIONS The net investment income of the Fund will be declared as dividends daily and will be paid monthly. Net realized capital gains, if any, will be distributed at least once annually. Each daily dividend is payable to Fund shareholders of record at the time of its declaration. The term "shareholders of record" includes holders of shares purchased for which payment has been received by the Distributor or IFTC, as appropriate, and excludes holders of shares redeemed on that day. Shares redeemed will earn dividends through the day prior to settlement of the redemption. The Fund will not attempt to stabilize distributions, and intends to distribute to its shareholders substantially all of the net investment income earned during any period. Thus, dividends can be expected to vary from month to month. Distributions Options. All net investment income dividends and net realized capital gains distributions for the Fund generally will be payable in additional shares of the Fund at net asset value ("Reinvestment Option"). If you wish to receive your distributions in cash, you must notify your Piper Jaffray Investment Executive or other broker-dealer. You may elect either to receive income dividends in cash and capital gains distributions in additional shares of the Fund at net asset value ("Split Option"), or to receive both income dividends and capital gains distributions in cash ("Cash Option"). You may also direct income dividends and capital gains distributions to be invested in another mutual fund managed by the Adviser, subject to certain restrictions. See "Shareholder Services -- Directed Dividends" above. The taxable status of income dividends and/or net capital gains distributions is not affected by whether they are reinvested or paid in cash. VALUATION OF SHARES The Fund computes its net asset value on each day the New York Stock Exchange (the "Exchange") is open for business. The calculation is made as of the regular close of the Exchange (currently 4:00 p.m. New York time) after the Fund has declared any applicable dividends. The net asset value per share for the Fund is determined by dividing the value of the securities owned by the Fund plus any cash and other assets (including interest accrued and dividends declared but not collected) less all liabilities by the number of Fund shares outstanding. For the purposes of determining the aggregate net assets of the Fund, cash and receivables will be valued at their face amounts. Interest will be recorded as accrued. The value of certain fixed-income securities will be provided by an independent pricing service, which determines these valuations at a time earlier than the close of the Exchange. Pricing services consider such factors as security prices, yields, maturities, call features, ratings and developments relating to specific securities in arriving at securities valuations. Fixed income securities for which prices are not available from an independent pricing service but where an active market exists will be valued using market quotations obtained from one or more dealers that make markets in the securities. Occasionally events affecting the value of such securities may occur between the time valuations are determined and the close of the Exchange. If events materially affecting the value of such securities occur during such period, or if management determines for any other reason that valuations provided by the pricing service are inaccurate, such securities will be valued at their fair value according to procedures decided upon in good faith by the Board of Directors. In addition, any securities or other assets of the Fund for which market prices are not readily available will be valued at their fair value in accordance with such procedures. TAX STATUS The Fund intends to qualify for treatment as a regulated investment company under the Internal Revenue Code of 1986, as amended (the "Code") during its current taxable year. If so qualified, the Fund will not be liable for federal income taxes to the extent it distributes its taxable income to shareholders. Distributions by the Fund are generally taxable to the shareholders, whether received in cash or additional shares of the Fund (or shares of another mutual fund managed by the Adviser). Distributions of net capital gains (designated as "capital gain dividends") are taxable to shareholders as long-term capital gains, regardless of the length of time the shareholder has held the shares of the Fund. The Fund will send written notices to shareholders regarding the tax status of all distributions made during each year. A shareholder will recognize a capital gain or loss upon the sale or exchange of shares in the Fund if, as is normally the case, the shares are capital assets in the shareholder's hands. This capital gain or loss will be long-term if the shares have been held for more than one year. The foregoing relates to federal income taxation as in effect as of the date of this Prospectus. For a more detailed discussion of the federal income tax consequences of investing in shares of the Fund, see "Taxation" in the Statement of Additional Information. Before investing in the Fund, you should check the consequences of your local and state tax laws. PERFORMANCE COMPARISONS Advertisements and other sales literature for the Fund may refer to "average annual total return," "cumulative total return" and "yield". When the Fund advertises its yield, it will also advertise its total return as required by the rules of the Securities and Exchange Commission. All such yield and total return quotations are based upon historical earnings and are not intended to indicate future performance. The return on and principal value of an investment in the Fund will fluctuate, so that an investor's shares, when redeemed, may be worth more or less than their original cost. Total return quotations will be based upon the performance of DDJ for periods prior to the Merger. Yield calculations will be based upon a 30-day period stated in the advertisement and will be calculated by dividing the net investment income per share (as defined under Securities and Exchange Commission rules and regulations) earned during the advertised period by the offering price per share (including the maximum sales charge) on the last day of the period. The result will then be "annualized" using a formula that provides for semi-annual compounding of income. Average annual total return is the average annual compounded rate of return on a hypothetical $1,000 investment made at the beginning of the advertised period. Cumulative total return is calculated by subtracting a hypothetical $1,000 payment to the Fund from the redeemable value of such payment at the end of the advertised period, dividing such difference by $1,000 and multiplying the quotient by 100. In calculating average annual and cumulative total return, the maximum sales charge is deducted from the hypothetical investment and all dividends and distributions are assumed to be reinvested. Such total return quotations may be accompanied by quotations which do not reflect the reduction in value of the initial investment due to the sales charge, and which thus will be higher. Comparative performance information also may be used from time to time in advertising the Fund's shares. For example, advertisements may compare the Fund's performance to that of various unmanaged market indices, or may include performance data from Lipper Analytical Services, Inc., Morningstar, Inc. or other entities or organizations which track the performance of investment companies. For additional information regarding comparative performance information and the calculation of yield, average annual total return and cumulative total return, see "Performance Comparisons" in the Statement of Additional Information. GENERAL INFORMATION The Company, which was organized under the laws of the State of Minnesota on April 10, 1995, is authorized to issue a total of 100 billion shares of common stock, with a par value of $.01 per share. Ten billion of those shares have been designated as Series A Common Shares, which are the shares of common stock of the Fund. Currently, Series A is the only outstanding series of shares of the Company. The Board of Directors is empowered under the Company's Articles of Incorporation to issue additional series of the Company's common stock without shareholder approval. In addition, the Board of Directors may, without shareholder approval, create and issue one or more additional classes of shares within the Fund, as well as within any series of the Company created in the future. See "Capital Stock and Ownership of Shares" in the Statement of Additional Information. All shares, when issued, will be fully paid and nonassessable and will be redeemable. All shares have equal voting rights. They can be issued as full or fractional shares. A fractional share has pro rata the same kind of rights and privileges as a full share. The shares possess no preemptive or conversion rights. Each share of a series has one vote (with proportionate voting for fractional shares) irrespective of the relative net asset values of the series' shares. On some issues, such as the election of directors, all shares of the Company vote together as one series. On an issue affecting only a particular series, the shares of the affected series vote separately. Cumulative voting is not authorized. This means that the holders of more than 50% of the shares voting for the election of directors can elect 100% of the directors if they choose to do so, and, in such event, the holders of the remaining shares will be unable to elect any directors. The Bylaws of the Company provide that shareholder meetings be held only with such frequency as required under Minnesota law. Minnesota corporation law requires only that the Board of Directors convene shareholder meetings when it deems appropriate. In addition, Minnesota law provides that if a regular meeting of shareholders has not been held during the immediately preceding 15 months, a shareholder or shareholders holding 3% or more of the voting shares of the Company may demand a regular meeting of shareholders by written notice given to the chief executive officer or chief financial officer of the Company. Within 30 days after receipt of the demand, the Board of Directors shall cause a regular meeting of shareholders to be called, which meeting shall be held no later than 90 days after receipt of the demand, at the expense of the Company. In addition, the 1940 Act requires a shareholder vote for all amendments to fundamental investment policies and restrictions and for all amendments to investment advisory contracts and Rule 12b-1 distribution plans. The 1940 Act also provides that Directors of the Company may be removed by action of the record holders of two-thirds or more of the outstanding shares of the Company. The Directors are required to call a meeting of shareholders for the purpose of voting upon the question of removal of any Director when so requested in writing by the record holders of at least 10% of the Company's outstanding shares. PENDING LEGAL PROCEEDINGS American Adjustable Rate Term Trust Inc. -- 1996 ("BDJ"), American Adjustable Rate Term Trust Inc. -- 1997 ("CDJ"), American Adjustable Rate Term Trust Inc. -- 1998 ("DDJ") and American Adjustable Rate Term Trust Inc. -- 1999 ("EDJ") (collectively, the "Trusts") merged into the Company on September 1, 1995. The Company may be deemed to be a successor by merger to such Trusts and, as such, may succeed to their liabilities, including damages sought in any litigation. On October 20, 1994, Herman D. Gordon filed a complaint in the U.S. District Court for the District of Minnesota against DDJ and EDJ, the Adviser, the Distributor, Piper Jaffray Companies Inc. ("Piper") and certain associated individuals (the "Gordon Litigation"). A second complaint was filed by Frank Donio, I.R.A., and other plaintiffs on April 14, 1995, in the U.S. District Court for the District of Minnesota against BDJ, CDJ, DDJ and EDJ, the Adviser, the Distributor, Piper and certain associated individuals (the "Donio Litigation"). Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995. The consolidated complaint, which purports to be a class action, alleges that the defendants violated certain federal and state securities laws by making materially misleading statements in prospectuses and other disclosures concerning risks associated with investing in the Trusts, compliance with the Trusts' investment policies, and the reasons for proposing and the benefits to be obtained by shareholders from the Merger and by allegedly breaching their fiduciary duties. Damages are being sought in an unspecified amount. Piper and the Adviser have agreed, pursuant to an indemnification agreement between and among Piper, the Adviser and the Company, to indemnify the Company against any losses incurred in connection with the Gordon and Donio Litigations. In addition to the complaints against the Trusts described above, complaints have been brought against the Adviser and the Distributor relating to certain other investment companies for which the Adviser acts or has acted as investment adviser or subadviser. These lawsuits do not involve the Fund or the Trusts. A number of complaints have been brought in federal and state court against the Institutional Government Income Portfolio ("PJIGX") series of Piper Funds Inc., the Adviser, the Distributor, and certain individuals affiliated or formerly affiliated with the Adviser and the Distributor. In addition, complaints have been filed in federal court relating to a number of closed-end investment companies managed by the Adviser and two open-end investment companies for which the Adviser has acted as sub-adviser. The complaints, which ask for rescission of plaintiff shareholders' purchases or compensatory damages, plus interest, costs and expenses, generally allege, among other things, certain violations of federal and/or state securities laws, including the making of materially misleading statements in propectuses concerning investment policies and risks. See "Pending Litigation" in the Statement of Additional Information. A settlement agreement has been reached with respect to one of the complaints involving PJIGX. An Amended Consolidated Class Action Complaint, which represents a consolidation of claims previously brought by 11 persons or entities, was filed on October 5, 1994 in the United States District Court, District of Minnesota. The named plaintiffs in this putative class action (the "PJIGX action") purport to represent a class of individuals and groups who purchased shares of PJIGX during the period from July 1, 1991 through May 9, 1994. The named plaintiffs and defendants have entered into a settlement agreement which has received preliminary approval from the Court. The terms of the settlement are set forth in a Settlement Agreement dated July 20, 1995 (as modified by an Addendum filed on July 28, 1995). The Settlement Agreement contained a provision which would have permitted the defendants to cancel the Agreement if shareholders who had incurred a cumulative "loss" (as defined under the Agreement) of more than 10% of the loss sustained by the entire class had opted out. The October 2, 1995 deadline for requesting exclusion from the class has passed, and the loss sustained by persons requesting exclusions is less than 10%. If granted final approval by the Court, the settlement agreement would provide up to approximately $70 million to class members in payments scheduled over approximately three years. Such payments would be made by Piper Jaffray Companies and the Adviser and would not be an obligation of Piper Funds Inc. Six additional complaints have been brought and a number of actions have been commenced in arbitration relating to PJIGX. The Adviser and the Distributor do not believe that the PJIGX settlement or any outstanding complaint or action in arbitration will have a material adverse effect on their ability to perform under their agreements with the Company or a material adverse effect on the Fund, and they intend to defend such lawsuits and actions vigorously. NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS (AND/OR IN THE STATEMENT OF ADDITIONAL INFORMATION REFERRED TO ON THE COVER PAGE OF THIS PROSPECTUS), AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR PIPER JAFFRAY INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN THE STATE IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. PIPER FUNDS INC. -- II INVESTMENT ADVISER Piper Capital Management Incorporated DISTRIBUTOR Piper Jaffray Inc. CUSTODIAN AND TRANSFER AGENT Investors Fiduciary Trust Company INDEPENDENT AUDITORS KPMG Peat Marwick LLP LEGAL COUNSEL Dorsey & Whitney P.L.L.P. Table of Contents PAGE Introduction 2 Fund Expenses 4 Financial Highlights 5 Investment Objective, Policies and Risk Factors 6 Management 19 Distribution of Fund Shares 20 SHAREHOLDER GUIDE TO INVESTING How to Purchase Shares 21 Reducing Your Sales Charge 22 Special Purchase Plans 23 How to Redeem Shares 24 Shareholder Services 26 Dividends and Distributions 29 Valuation of Shares 30 Tax Status 30 Performance Comparisons 30 General Information 31 ADJUSTABLE RATE MORTGAGE SECURITIES FUND PROSPECTUS DECEMBER 18, 1995 PROSPECTUS DATED NOVEMBER 1, 1995, AS SUPPLEMENTED JUNE 24, 1996 PIPER INSTITUTIONAL FUNDS INC. PIPER JAFFRAY TOWER 222 SOUTH NINTH STREET, MINNEAPOLIS, MINNESOTA 55402-3804 (612) 342-6387 (LOCAL CALLS), (800) 866-7778 (TOLL FREE) --------------------- Piper Institutional Funds Inc. (the "Company") is an open-end mutual fund whose shares are currently offered in two series: Institutional Money Market Fund and Institutional Government Adjustable Portfolio (the "Funds"). Each Fund has its own investment objective and policies designed to meet different investment goals. INSTITUTIONAL MONEY MARKET FUND has an investment objective of maximum current income consistent with preservation of capital and maintenance of liquidity. Institutional Money Market Fund will invest only in securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities and repurchase agreements and reverse repurchase agreements with respect to such securities. INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO has an investment objective of high current income consistent with low principal volatility. The Fund will seek to achieve that objective by investing primarily (at least 65% of its total assets under normal market conditions) in adjustable rate mortgage securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities. The Fund's investments in mortgage-related securities include derivative mortgage securities. ON JUNE 18, 1996, THE BOARD OF DIRECTORS OF PIPER INSTITUTIONAL FUNDS INC. (THE "COMPANY") UNANIMOUSLY APPROVED THE MERGER OF INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO INTO ADJUSTABLE RATE MORTGAGE SECURITIES FUND ("ARMS FUND"), A SERIES OF PIPER FUNDS INC. -- II. SEE "INVESTMENT OBJECTIVES AND POLICIES -- INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO." INVESTMENTS IN THE FUNDS ARE NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT. THERE IS NO ASSURANCE THAT INSTITUTIONAL MONEY MARKET FUND WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE. INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO MAY INVEST IN "RESTRICTED SECURITIES." SEE "SPECIAL INVESTMENT METHODS -- ILLIQUID SECURITIES". This Prospectus concisely describes the information about the Funds that you should know before investing. Please read the Prospectus carefully before investing and retain it for future reference. A Statement of Additional Information about the Funds dated November 1, 1995 is available free of charge. Write to the Funds at Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804 or telephone (612) 342-6387 (local calls) or (800) 866-7778 (toll free). The Statement of Additional Information has been filed with the Securities and Exchange Commission and is incorporated in its entirety by reference in this Prospectus. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. INTRODUCTION Institutional Money Market Fund ("Money Market Fund") and Institutional Government Adjustable Portfolio ("Adjustable Portfolio") (sometimes individually referred to herein as a "Fund" or, collectively, as the "Funds") are series of Piper Institutional Funds Inc. (the "Company"), an open-end management investment company organized under the laws of the State of Minnesota in 1992. Each Fund has a different investment objective, as described on the cover page of this Prospectus, and is designed to meet different investment needs. The Funds are classified as diversified mutual funds. THE INVESTMENT ADVISER The Funds are managed by Piper Capital Management Incorporated (the "Adviser"), a wholly owned subsidiary of Piper Jaffray Companies Inc. Each Fund pays the Adviser a fee for managing its investment portfolio. The fees for Money Market Fund and Adjustable Portfolio are paid at annual rates of .15% and .30%, respectively, of each Fund's average daily net assets. See "Management -- Investment Adviser." THE DISTRIBUTOR Piper Jaffray Inc. ("Piper Jaffray" or the "Distributor"), a wholly owned subsidiary of Piper Jaffray Companies Inc. and an affiliate of the Adviser, serves as Distributor of the Funds' shares. OFFERING PRICES Shares of Money Market Fund are offered to the public at their net asset value of $1.00 per share with no sales charge. There can be no assurance, however, that the net asset value per share of Money Market Fund will be maintained at $1.00. Shares of Adjustable Portfolio are offered to the public at the next determined net asset value after receipt of an order by a shareholder's Piper Jaffray Investment Executive or other broker-dealer, plus a maximum sales charge of 1.00% of the offering price (1.01% of the net amount invested) on purchases of less than $250,000. The sales charge is reduced to .50% of the offering price on purchases of $250,000 or more, with no sales charge incurred on purchases of $500,000 or more. MINIMUM INITIAL AND SUBSEQUENT INVESTMENTS The minimum initial investment for each Fund is $100,000. There is no minimum for subsequent investments. The minimum initial investment for Adjustable Portfolio may be waived by the Distributor for 401(k) employee benefit plans administered by Piper Trust Company. See "How to Purchase Shares - - - -- Minimum Investments." EXCHANGES You may exchange your shares for shares of any other mutual fund managed by the Adviser which is open to new investors and eligible for sale in your state of residence. All exchanges are subject to the minimum investment requirements and other applicable terms set forth in the prospectus of the fund whose shares you acquire. Exchanges are made on the basis of the net asset values of the funds involved, except that investors exchanging into a fund which has a higher sales charge must pay the difference. You may make four exchanges per year without payment of a service charge. Thereafter, there is a $5 service charge for each exchange. See "Shareholder Services -- Exchange Privilege." REDEMPTION PRICE Shares of the Funds may be redeemed at any time at their net asset value next determined after a redemption request is received by your Piper Jaffray Investment Executive or other broker-dealer. 2 The Funds reserve the right, upon 30 days' written notice, to redeem an account if the net asset value of the shares in that account falls below $50,000. See "How to Redeem Shares -- Involuntary Redemption." CERTAIN RISK FACTORS TO CONSIDER An investment in either of the Funds is subject to certain risks, as set forth in detail under "Investment Objectives and Policies" and "Special Investment Methods." As with other mutual funds, there can be no assurance that either Fund will achieve its objective. There is no assurance Money Market Fund will be able to maintain a stable net asset value of $1.00 per share. Adjustable Portfolio is subject to interest rate risk (the risk that rising interest rates will make bonds issued at lower interest rates worth less). As a result, the value of Adjustable Portfolio's shares will vary. Adjustable Portfolio is also subject to credit risk (the risk that a bond issuer will fail to make timely payments of interest or principal) to the extent it invests in non-U.S. Government securities. Adjustable Portfolio may engage in the following investment practices: the use of repurchase agreements, the lending of portfolio securities, borrowing from banks, the use of reverse repurchase agreements (reverse repurchase agreements involve the speculative technique known as leverage), the use of hedging techniques, including interest rate transactions, options, futures contracts and options on futures contracts, and the purchase or sale of securities on a "when-issued" or "forward commitment" basis, including the use of mortgage dollar rolls. These techniques may increase the volatility of the Fund's net asset value. Adjustable Portfolio purchases mortgage-related securities which, in addition to interest rate risk, are subject to prepayment risk. Adjustable Portfolio's investments in mortgage-related securities include securities commonly referred to as derivative mortgage securities. Recent market experience has shown that certain derivative mortgage securities may be extremely sensitive to changes in interest rates and in prepayment rates on the underlying mortgage assets and, as a result, the prices of such securities may be highly volatile. Adjustable Portfolio may also invest up to 10% of its total assets in securities denominated in Canadian dollars. Money Market Fund may engage in the use of repurchase agreements and, with respect to 5% of its net assets, reverse repurchase agreements fully collateralized by securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities. All of these transactions involve certain special risks, as set forth under "Investment Objectives and Policies" and "Special Investment Methods." SHAREHOLDER INQUIRIES Any questions or communications regarding a shareholder account should be directed to your Piper Jaffray investment executive or, in the case of shares held through another broker-dealer, to IFTC at (800) 874-6205. General inquiries regarding the Funds should be directed to the Funds at the telephone number set forth on the cover of this Prospectus. 3 FUND EXPENSES
MONEY MARKET ADJUSTABLE FUND PORTFOLIO ------------ ---------- SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of offering price).................. None 1.00%(1) Exchange Fee (2)................................ $0 $0 ANNUAL FUND OPERATING EXPENSES (as a percentage of average net assets) Management Fees................................. .15% .30% Rule 12b-1 Fees................................. None None Other Expenses (after voluntary expense reimbursements)................................ .20% .30% -- --- Total Fund Operating Expenses (after voluntary expense reimbursements)........................ .35% .60% - - - ------------------------ (1) The sales charge is reduced to .50% of the offering price on purchases of $250,000 or more. In connection with purchases of $500,000 or more, there is no initial sales charge. See "How to Purchase Shares -- Public Offering Price." (2) There is a $5.00 fee for each exchange in excess of four exchanges per year. See "How to Purchase Shares -- Exchange Privilege."
EXAMPLE You would pay the following expenses on a $1,000 investment assuming a 5% annual return and redemption at the end of each time period:
MONEY MARKET ADJUSTABLE FUND PORTFOLIO ------------ ---------- 1 Year......................................... $ 4 $16 3 Years........................................ $11 $29 5 Years........................................ $20 $43 10 Years........................................ $44 $84
The purpose of the above Fund Expenses table is to assist you in understanding the various costs and expenses that investors in the Funds will bear directly or indirectly. THE EXAMPLE CONTAINED IN THE TABLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. Under an Investment Advisory and Management Agreement between the Funds and the Adviser, the Adviser is entitled to receive fees from Money Market Fund and Adjustable Portfolio equal on an annual basis to .15% and .30%, respectively, of each Fund's average daily net assets. The Adviser has voluntarily agreed, for the fiscal year ending June 30, 1996, to reimburse Money Market Fund and Adjustable Portfolio to the extent that total operating expenses exceed .35% and .60% per annum, respectively, of average daily net assets. The Total Fund Operating Expenses set forth in the above table are based on this agreement. Voluntary reimbursements by the Adviser may be discontinued at any time following the Funds' fiscal year end, at the Adviser's discretion. For the fiscal year ended June 30, 1995, the Adviser voluntarily agreed to pay all operating expenses of Money Market Fund and Adjustable Portfolio which exceeded .35% and .55%, respectively, of average daily net assets. Absent such voluntary expense reimbursements, Total Fund Operating Expenses would have been .49% and .75% of average daily net assets, respectively. For additional information, including a more complete explanation of management fees, see "Management -- Investment Adviser" and "Management -- Expenses." 4 FINANCIAL HIGHLIGHTS The following financial highlights have been audited by KPMG Peat Marwick LLP, independent auditors, and should be read in conjunction with the financial statements and the related notes thereto appearing in the Fund's annual report to shareholders. An annual report of the Funds can be obtained without charge by contacting the Funds at (612) 342-6387 (local calls) or (800) 866-7778 (toll free). In addition to financial statements, the annual report contains further information about the performance of the Funds. MONEY MARKET FUND
FISCAL YEAR ENDED JUNE 30 --------------- PERIOD FROM 1995 1994 2/2/93* TO 6/30/93 ------ ------ ------------------ Net asset value, beginning of period.... $1.00 $1.00 $1.00 Operations: Net investment income................. 0.05 0.03 0.01 ------ ------ ----- Total from operations............... 0.05 0.03 0.01 ------ ------ ----- Distributions from net investment income................................. (0.05) (0.03) (0.01) ------ ------ ----- Net asset value, end of period.......... $1.00 $1.00 $1.00 ------ ------ ----- ------ ------ ----- Total return+........................... 5.26% 3.23% 1.24% Net assets, end of period (in millions).............................. $ 52 $ 35 $ 40 Ratio of expenses to average daily net assets++............................... 0.35% 0.35% 0.35%** Ratio of net investment income to average daily net assets++............. 5.17% 3.26% 3.02%** - - - ------------------------ * Commencement of operations. ** Adjusted to an annual basis. + Total return is based on the change in net asset value during the period, assumes reinvestment of all distributions at net asset value and does not reflect a sales charge. ++ Various fees and expenses were voluntarily waived or absorbed by the Adviser during the years ended June 30, 1995 and 1994. Had the Fund paid all expenses, the ratios of expenses and net investment income to average daily net assets would have been 0.49%/5.03% in fiscal 1995 and 0.61%/3.00% in fiscal 1994.
5 ADJUSTABLE PORTFOLIO
FISCAL YEAR ENDED JUNE 30 ----------------- PERIOD FROM 1995 1994 2/2/93* TO 6/30/93 ------- ------- ------------------ Net asset value, beginning of period.... $ 9.46 $10.04 $10.00 Operations: Net investment income................. 0.52 0.49 0.18 Net realized and unrealized gains (losses) on investments.............. (0.04) (0.57) 0.04 ------- ------- ------- Total from operations............... 0.48 (0.08) 0.22 ------- ------- ------- Distributions to shareholders: From net investment income............ (0.41) (0.50) (0.18) Tax return of capital................. (0.09) -- -- ------- ------- ------- Total distributions................. (0.50) (0.50) (0.18) ------- ------- ------- Net asset value, end of period.......... $ 9.44 $ 9.46 $10.04 ------- ------- ------- ------- ------- ------- Total return+........................... 5.26% (0.91%) 2.18% Net assets, end of period (in millions).............................. $ 15 $ 35 $ 41 Ratio of expenses to average daily net assets++............................... 0.55% 0.55% 0.74%** Ratio of net investment income to average daily net assets++............. 5.54% 5.13% 4.73%** Portfolio turnover rate (excluding short-term securities)................. 43% 110% 26% - - - ------------------------ * Commencement of operations. ** Adjusted to an annual basis. + Total return is based on the change in net asset value during the period, assumes reinvestment of all distributions at net asset value and does not reflect a sales charge. ++ Various fees and expenses were voluntarily waived or absorbed by the Adviser during the years ended June 30, 1995 and 1994. Had the Fund paid all expenses, the ratios of expenses and net investment income to average daily net assets would have been 0.75%/5.34% in fiscal 1995 and 0.60%/5.08% in fiscal 1994.
6 INVESTMENT OBJECTIVES AND POLICIES The investment objectives listed below cannot be changed without shareholder approval. In view of the risks inherent in all investments in securities, there is no assurance that these objectives will be achieved. The investment policies and techniques employed in pursuit of the Funds' objectives may be changed without shareholder approval, unless otherwise noted. INSTITUTIONAL MONEY MARKET FUND RULE 2A-7. Money Market Fund will be subject to the investment restrictions of Rule 2a-7 under the Investment Company Act of 1940 in addition to its other policies and restrictions discussed below. Rule 2a-7 requires that the Fund invest exclusively in securities that mature within 397 days and that the Fund maintain an average weighted maturity of not more than 90 days. Rule 2a-7 also requires that all investments by the Fund be limited to United States dollar-denominated investments that: (1) present "minimal credit risks," and (2) are at the time of acquisition "Eligible Securities." Eligible Securities include, among others, securities that are rated by two Nationally Recognized Statistical Rating Organizations ("NRSROs") in one of the two highest categories for short-term debt obligations, such as A-1 or A-2 by Standard & Poor's Corporation ("Standard & Poor's") or P-1 or P-2 by Moody's Investors Service, Inc. ("Moody's"). It is the responsibility of the Adviser to determine that the Fund's investments present only "minimal credit risks" and are Eligible Securities. The Funds' Board of Directors has established written guidelines and procedures for the Adviser and oversees the Adviser's determination that Money Market Fund's portfolio securities present only "minimal credit risks" and are Eligible Securities. Under Rule 2a-7, 95% of the assets of non-tax-exempt money funds (such as Money Market Fund) must be invested in Eligible Securities that are deemed First Tier Securities, which include, among others, securities rated by two NRSROs in the highest category (such as A-1 and P-1). Rule 2a-7 requires that (1) a fund may not invest more than 5% of its total assets in securities of a single issuer, other than U.S. Government securities, (2) a fund may not invest more than 5% of its total assets in Second Tier Securities (I.E., Eligible Securities that are not First Tier Securities) and (3) a fund's investment in Second Tier Securities of a single issuer may not exceed the greater of 1% of the fund's total assets or $1,000,000. INVESTMENT OBJECTIVE. Money Market Fund has an investment objective of maximum current income consistent with preservation of capital and maintenance of liquidity. INVESTMENT POLICIES AND TECHNIQUES. Money Market Fund will invest only in U.S. Government Securities (as defined below) and in repurchase agreements and reverse repurchase agreements with respect to such securities. See "Special Investment Methods -- Repurchase Agreements" and "-- Reverse Repurchase Agreements." The Fund will purchase only those securities with a remaining effective maturity of 397 calendar days or less on the date of purchase and will maintain a dollar-weighted average maturity of its portfolio of 90 days or less. U.S. Government Securities are obligations issued or guaranteed as to payment of principal and interest by the U.S. Government or its agencies or instrumentalities. These securities include direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes and bonds, and obligations of U.S. Government agencies or instrumentalities, including, but not limited to, Federal Home Loan Banks, the Farmers Home Administration, Federal Farm Credit Banks, the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage 7 Corporation, the Financing Corporation and the Student Loan Marketing Association. Obligations of U.S. Government agencies or instrumentalities are backed in a variety of ways by the U.S. Government or its agencies or instrumentalities. Some of these obligations, such as Government National Mortgage Association mortgage-backed securities, are backed by the full faith and credit of the U.S. Treasury. Others, such as those of the Federal Home Loan Banks, are backed by the right of the issuer to borrow from the Treasury. Still others, such as those issued by the Federal National Mortgage Association, are backed by the discretionary authority of the U.S. Government to purchase certain obligations of the agency or instrumentality. Other obligations may be backed by an irrevocable letter of credit of an agency or instrumentality of the U.S. Government. Finally, obligations of other agencies or instrumentalities are only backed by the credit of the agency or instrumentality issuing the obligations. INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO ON JUNE 18, 1996, THE BOARD OF DIRECTORS OF THE COMPANY UNANIMOUSLY APPROVED THE MERGER OF ADJUSTABLE PORTFOLIO INTO ADJUSTABLE RATE MORTGAGE SECURITIES FUND ("ARMS FUND"), A SERIES OF PIPER FUNDS INC. -- II. PIPER CAPITAL MANAGEMENT INCORPORATED, ADJUSTABLE PORTFOLIO'S INVESTMENT ADVISER, RECOMMENDED THE MERGER TO THE BOARD BECAUSE ADJUSTABLE PORTFOLIO HAS BEEN UNABLE TO ATTRACT AND RETAIN SUFFICIENT ASSETS FOR ITS CONTINUED OPERATION TO BE ECONOMICALLY FEASIBLE. THE MERGER IS SUBJECT TO SHAREHOLDER APPROVAL. IF THE MERGER IS APPROVED BY SHAREHOLDERS, ARMS FUND WILL ACQUIRE SUBSTANTIALLY ALL OF THE ASSETS OF ADJUSTABLE PORFOLIO IN EXCHANGE FOR ARMS FUND SHARES WITH A VALUE EQUAL TO THE VALUE OF THEIR ADJUSTABLE PORTFOLIO SHARES. THE COMPANY WILL CALL A SPECIAL MEETING OF ADJUSTABLE PORTFOLIO SHAREHOLDERS AT A DATE TO BE ANNOUNCED FOR THE PURPOSE OF VOTING ON THE PROPOSED MERGER. ADDITIONAL INFORMATION CONCERNING THE PROPOSED MERGER WILL BE INCLUDED IN THE PROXY MATERIALS FOR SUCH MEETING. INVESTMENT OBJECTIVE. Adjustable Portfolio has an investment objective of high current income consistent with low principal volatility. Despite the Fund's investment objective of low principal volatility, investors should expect some fluctuation in the net asset value of their shares. See "Investment Risks" below. INVESTMENT POLICIES AND TECHNIQUES. Adjustable Portfolio, under normal conditions, will seek to achieve its investment objective by investing primarily (at least 65% of its total assets) in a portfolio of Mortgage-Backed Securities (as defined herein) having adjustable interest rates which reset at periodic intervals ("adjustable rate mortgage securities" or "ARMS") and which are U.S. Government Securities, as defined above under "Investment Objectives and Policies -- Institutional Money Market Fund." ARMS include both pass-through securities representing interests in adjustable rate mortgage loans and floating rate collateralized mortgage obligations. The balance of the Fund's assets (up to 35% of total assets) may be invested in ARMS issued by private organizations, Mortgage-Backed Securities other than ARMS, other types of U.S. Government Securities, Canadian Government Securities, Foreign Index Linked Instruments and Corporate Debt Securities. Investments in each of Canadian Government Securities, Foreign Index Linked Instruments and Corporate Debt Securities are limited to 10% of total assets. Securities in which Adjustable Portfolio invests (other than U.S. Government Securities) must be rated, as of the date of purchase, AAA or better by Standard & Poor's or, if unrated, be of a comparable quality as determined by the Adviser. In the event that a security held by Adjustable Portfolio is downgraded to a rating below AAA or, if unrated, is no longer of a quality comparable to a security rated AAA, as determined by the Adviser, the Fund will sell such a security as promptly as possible. For a discussion of Standard & Poor's ratings, see Appendix A to the Statement of Additional Information. 8 The Fund may engage in options and financial futures transactions which relate to the securities in which it invests, may engage in foreign currency exchange transactions with respect to its investments in Canadian Government Securities, may enter into interest rate swaps and purchase and sell interest rate caps and floors, may purchase or sell securities on a when-issued or forward commitment basis, including the use of mortgage dollar rolls, and may lend its portfolio securities. The Fund's investments in options and futures contracts will not be included in the 65% of total assets that must be invested in ARMS which are U.S. Government Securities, even if they relate to such securities. For temporary defensive purposes, the Fund may invest without limitation in cash or in high-quality debt securities with remaining maturities of one year or less. Such securities may include (a) commercial paper rated A-1+ by Standard & Poor's, (b) certificates of deposit, time deposits and bankers' acceptances with any bank the unsecured commercial paper of which is rated A-1+ by Standard & Poor's (or, in the case of the principal bank in a bank holding company, the unsecured commercial paper of the bank holding company), and (c) U.S. Government Securities. INVESTMENT RISKS. Adjustable Portfolio is subject to certain risks which could result in fluctuation of the net asset value of the Fund's shares. The Fund is subject to interest rate risk, which is the potential for a decline in bond prices due to rising interest rates. In general, bond prices vary inversely with interest rates. When interest rates rise, bond prices generally fall. Conversely, when interest rates fall, bond prices generally rise. Although the ARMS in the Fund's portfolio should generally be more resistant to price swings than other debt securities because the interest rates of ARMS move with market interest rates, the adjustable rate feature of ARMS will not eliminate price fluctuations. See "Adjustable Rate Mortgage Securities -- Interest Rate Risk" below. The Fund's investments in ARMS and other Mortgage-Backed Securities are also subject to prepayment risk. See "Adjustable Rate Mortgage Securities -- Prepayment Risk" below. In addition, the Fund is subject to credit risk to the extent it invests in non-U.S. Government securities. Credit risk, also known as default risk, is the possibility that a bond issuer will fail to make timely payments of interest or principal. These and other risks of Adjustable Portfolio's investments are described in detail below. Adjustable Portfolio's investments in mortgage-related securities include derivative mortgage securities such as collateralized mortgage obligations and stripped mortgage-backed securities which may involve risks in addition to those found in other mortgage-related securities. Recent market experience has shown that certain derivative mortgage securities may be highly sensitive to changes in interest and prepayment rates and, as a result, the prices of such securities may be highly volatile. In addition, recent market experience has shown that during periods of rising interest rates, the market for certain derivative mortgage securities may become more unstable and such securities may become more difficult to sell as market makers choose not to repurchase such securities or offer prices, based on current market conditions, which are unacceptable to Adjustable Portfolio. Adjustable Portfolio also may engage in investment practices which involve certain special risks. See "Special Investment Methods" below. The use of these investment practices may increase the volatility of Adjustable Portfolio's net asset value. ADJUSTABLE RATE MORTGAGE SECURITIES U.S. GOVERNMENT MORTGAGE PASS-THROUGH SECURITIES. Adjustable Portfolio may invest in ARMS which are "pass-through" securities issued or guaranteed by the U.S. Government or one of its agencies or instrumentalities ("U.S. Government Pass-Throughs"). Pass-through securities constituting ARMS represent ownership interests in underlying pools of adjustable rate mortgage loans 9 originated by private lenders. Such securities differ from conventional debt securities, which provide for periodic payment of interest in fixed amounts (usually semi-annually) and principal payments at maturity or on specified call dates, in that pass-through securities provide for monthly payments that are a pass-through of the monthly interest and principal payments (including any prepayments) made by the individual borrowers on the pooled mortgage loans, net of any fees paid to the guarantor of such securities and the servicers of the underlying mortgage loans. The U.S. Government Pass-Throughs in which Adjustable Portfolio may invest are issued or guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). Each of GNMA, FNMA and FHLMC guarantee timely distributions of interest to securities holders. GNMA and FNMA also guarantee timely distribution of scheduled principal. FHLMC generally guarantees only ultimate collection of principal on the underlying loans, which collection may take up to one year. GNMA is a wholly owned corporate instrumentality of the U.S. Government within the Department of Housing and Urban Development and its guarantee is backed by the full faith and credit of the U.S. Government. FNMA and FHLMC are federally chartered corporations and their respective guarantees are not backed by the full faith and credit of the U.S. Government. The mortgages underlying ARMS issued by GNMA are fully guaranteed by the Federal Housing Administration ("FHA") or Veterans Administration ("VA"). The mortgages underlying ARMS issued by FNMA or FHLMC may be backed by conventional adjustable rate mortgages not guaranteed by FHA or VA. PRIVATE MORTGAGE PASS-THROUGH SECURITIES. Private Mortgage Pass-Through Securities ("Private Pass-Throughs") are structured similarly to the GNMA, FNMA and FHLMC mortgage pass-through securities described above and are issued by originators of and investors in mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment banks and special purpose subsidiaries of the foregoing. Private Pass-Throughs constituting ARMS are backed by a pool of conventional adjustable rate mortgage loans. Since Private Pass-Throughs are not guaranteed by an entity having the credit status of GNMA, FNMA or FHLMC, such securities generally are structured with one or more types of credit enhancement. See "Investment Objectives, Policies and Restrictions -- Mortgage-Backed Securities -- Credit Support" in the Statement of Additional Information. CMOS AND MULTI-CLASS PASS-THROUGH SECURITIES. ARMS in which Adjustable Portfolio may invest also include adjustable rate tranches of collateralized mortgage obligations and multi-class pass-through securities, which are derivative mortgage securities. Collateralized mortgage obligations are debt instruments issued by special purpose entities which are secured by pools of mortgage loans or other Mortgage-Backed Securities. Multi-class pass-through securities are equity interests in a trust composed of mortgage loans or other Mortgage-Backed Securities. Payments of principal and interest on underlying collateral provide the funds to pay debt service on the collateralized mortgage obligation or make scheduled distributions on the multi-class pass-through security. Collateralized mortgage obligations and multi-class pass-through securities (collectively "CMOs" unless the context indicates otherwise) may be issued by agencies or instrumentalities of the U.S. Government or by private organizations. 10 In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMO, often referred to as a "tranche," is issued at a specified coupon rate and has a stated maturity or final distribution date. Principal prepayments on collateral underlying a CMO may cause it to be retired substantially earlier than the stated maturities or final distribution dates. The principal and interest on the mortgages underlying a CMO may be allocated among the CMO's tranches in many ways. See "Mortgage-Backed Securities - - - -- CMOs," below. One or more tranches of a CMO may have coupon rates which reset periodically at a specified increment over an index such as the London Interbank Offered Rate ("LIBOR"). These adjustable rate tranches, known as "floating rate CMOs," will be considered as ARMS by Adjustable Portfolio. Floating rate CMOs may be backed by fixed rate or adjustable rate mortgages; to date, fixed rate mortgages have been more commonly utilized for this purpose. Floating rate CMOs are typically issued with lifetime caps on the coupon rate thereon. These caps, similar to the caps on adjustable rate mortgages, represent a ceiling beyond which the coupon rate on a floating rate CMO may not be increased regardless of increases in the interest rate index to which the floating rate CMO is geared, which may cause the security to be valued at a greater discount than if the security was not subject to a ceiling. HOW INTEREST RATES ARE SET. The interest rates on ARMS are reset at periodic intervals (generally one year or less) to an increment over some predetermined interest rate index. There are two main categories of indices: those based on U.S. Treasury securities and those derived from a calculated measure such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices include the one-year and five-year constant maturity Treasury note rates, the three-month Treasury bill rate, the 180-day Treasury bill rate, rates on longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds Index, the National Median Cost of Funds, the one- month or three-month LIBOR, the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year constant maturity Treasury note rate, closely mirror changes in market interest rate levels. Others, such as the 11th District Home Loan Bank Cost of Funds Index (often related to ARMS issued by FNMA), tend to lag changes in market rate levels and tend to be somewhat less volatile. The Adviser will seek to diversify Adjustable Portfolio's investments in ARMS among a variety of indices and reset periods to reduce the Fund's exposure to the risk of interest rate fluctuations. In selecting a type of ARMS for investment, the Adviser will also consider the liquidity of the market for such ARMS. The underlying adjustable rate mortgages which back ARMS in which Adjustable Portfolio invests will frequently have caps and floors which limit the maximum amount by which the loan rate to the residential borrower may change up or down (1) per reset or adjustment interval and (2) over the life of the loan. Some residential adjustable rate mortgage loans restrict periodic adjustments by limiting changes in the borrower's monthly principal and interest payments rather than limiting interest rate changes. These payment caps may result in negative amortization; i.e., increase in the balance of the mortgage loan. Floating rate CMOs are generally backed by fixed rate mortgages and generally have lifetime caps on the coupon rate thereon. INTEREST RATE RISK. The values of ARMS, like other debt securities, generally vary inversely with changes in market interest rates (increasing in value during periods of declining interest rates and decreasing in value during periods of increasing interest rates); however, the values of ARMS should generally be more resistant to price swings than other debt securities because the interest rates of ARMS move with market interest rates. The adjustable rate feature of ARMS will not, however, eliminate fluctuations in the prices of ARMS, particularly during periods of extreme fluctuations in 11 interest rates. Also, since many adjustable rate mortgages only reset on an annual basis, it can be expected that the prices of ARMS will fluctuate to the extent that changes in prevailing interest rates are not immediately reflected in the interest rates payable on the underlying adjustable rate mortgages. PREPAYMENT RISK. ARMS, like other Mortgage-Backed Securities, differ from conventional bonds in that principal is paid back over the life of the ARMS rather than at maturity. As a result, the holder of the ARMS (I.E., Adjustable Portfolio) receives monthly scheduled payments of principal and interest, and may receive unscheduled principal payments representing prepayments on the underlying mortgages. When the holder reinvests the payments and any unscheduled prepayments of principal it receives, it may receive a rate of interest which is lower than the rate on the existing ARMS. For this reason, ARMS are less effective than longer-term debt securities as a means of "locking-in" long-term interest rates. ARMS, while having less risk of price decline during periods of rapidly rising rates than other investments of comparable maturities, will have less potential for capital appreciation due to the likelihood of increased prepayments of mortgages as interest rates decline. In addition, to the extent ARMS are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments will result in a loss of some or all of the premium paid. On the other hand, if ARMS are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal will increase current and total returns and will accelerate the recognition of income which, when distributed to shareholders, will be taxable as ordinary income. MORTGAGE-BACKED SECURITIES In addition to ARMS, Adjustable Portfolio may invest in other types of Mortgage-Backed Securities. Mortgage-Backed Securities are securities which represent interests in or are collateralized by mortgages. Such securities are issued by GNMA, FNMA, FHLMC and by private organizations and take the same structure as ARMS, i.e., pass-through securities and CMOs. Adjustable Portfolio may invest in any type of Mortgage-Backed Security, including traditional fixed rate Mortgage-Backed Securities and more recently developed instruments such as Stripped Mortgage-Backed Securities and CMOs. Adjustable Portfolio may also invest in Mortgage-Backed Securities backed by fixed rate mortgages and, in conjunction therewith, pursuant to an interest rate swap, exchange its right to receive payments at fixed rates of interest for floating rate payments. The intended net effect of the transaction would be the creation of a security with the economic characteristics of an adjustable rate mortgage security. Such "synthetic ARMS" will not be considered as ARMS for purposes of the requirement that the Fund invest at least 65% of its total assets in ARMS. Adjustable Portfolio's investments in Mortgage-Backed Securities other than ARMS, together with its investments in ARMS issued by private organizations, U.S. Government Securities other than ARMS and Mortgage-Backed Securities, and Canadian Government Securities, are limited to 35% of its total assets. CMOS. As discussed above, Adjustable Portfolio's investments in ARMS include floating rate CMOs. Adjustable Portfolio's investments in Mortgage-Backed Securities other than ARMS may include any other tranche of a CMO, provided that Adjustable Portfolio may not invest in the residual interests of CMOs. 12 The principal and interest on the mortgages underlying a CMO may be allocated among the CMO's several tranches in many ways. For example, certain tranches may have variable or floating interest rates and others may be stripped securities which provide only the principal or interest feature of the underlying security. See "Stripped Mortgage-Backed Securities," below. Generally, the purpose of the allocation of the cash flow of a CMO to the various tranches is to obtain a more predictable cash flow to certain of the individual tranches than exists with the underlying collateral of the CMO. As a general rule, the more predictable the cash flow is on a CMO tranche, the lower the anticipated yield will be on that tranche at the time of issuance relative to prevailing market yields on mortgage-related securities. As part of the process of creating more predictable cash flows on most of the tranches of a CMO, one or more tranches generally must be created that absorb most of the volatility in the cash flows on the underlying mortgage loans. The yields on these tranches are generally higher than prevailing market yields on mortgage-related securities with similar maturities. However, as a result of the uncertainty of the cash flows of these tranches, market prices and yields may be more volatile than for other CMO tranches. The more volatile CMO tranches include inverse floaters, IOs, POs and Z tranches, discussed below. Adjustable Portfolio's investments in CMO tranches may include "inverse floaters" and "Z tranches." An inverse floater is a CMO tranche with a coupon rate that moves inversely to a designated index, such as LIBOR or COFI (Cost of Funds Index). Like most other fixed-income securities, the value of inverse floaters will decrease as interest rates increase and increase as interest rates decrease. Inverse floaters, however, may exhibit greater price volatility with changes in interest rates than the majority of mortgage pass-through securities or CMOs. Coupon rates on inverse floaters typically change at a multiple of the changes in the relevant index rate. Thus, any rise in the index rate (as a consequence of an increase in interest rates) causes a correspondingly greater drop in the coupon rate of an inverse floater while any drop in the index rate causes a correspondingly greater increase in the coupon of an inverse floater. Some inverse floaters also exhibit extreme sensitivity to changes in prepayments. Z tranches of CMOs defer interest and principal payments until one or more other classes of the CMO have been paid in full. Interest accretes on the Z tranche, being added to principal, and is compounded through the accretion period. After the other classes have been paid in full, interest payments begin and continue through maturity. Z tranches have characteristics similar to zero coupon bonds. See "Zero Coupon Treasury Securities," below. Like a zero coupon bond, during its accretion period a Z tranche has the advantage of eliminating the risk of reinvesting interest payments at lower rates during a period of declining market interest rates. At the same time, however, and also like a zero coupon bond, the market value of a Z tranche can be expected to fluctuate more widely with changes in market interest rates than would the market value of a tranche which pays interest currently. In addition, changes in prepayment rates on the underlying mortgage loans will affect the accretion period of a Z tranche, and therefore also are likely to influence its market value. STRIPPED MORTGAGE-BACKED SECURITIES. Adjustable Portfolio's investments in Mortgage-Backed Securities other than ARMS may include Stripped Mortgage-Backed Securities ("SMBS"), which are derivative multi-class mortgage securities. SMBS may be issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment banks and special purpose subsidiaries of the foregoing. 13 There are generally two types of classes of SMBS, one of which (the interest only or "IO" class) entitles the holders thereof to receive distributions consisting solely or primarily of all or a portion of the interest on the underling pool of mortgage loans or Mortgage-Backed Securities ("Mortgage Assets") and the other of which (the principal only or "PO" class) entitles the holders thereof to receive distributions consisting solely or primarily of all or a portion of the principal of the underlying pool of Mortgage Assets. IOs and POs issued by the U.S. Government or its agencies and instrumentalities may be determined to be liquid pursuant to procedures adopted by the Board of Directors. Otherwise, Adjustable Portfolio will treat IOs and POs as illiquid and subject to Adjustable Portfolio's restriction of investing no more than 15% of its net assets in illiquid securities. See "Special Investment Methods -- Illiquid Securities." The cash flows and yields on IO and PO classes are extremely sensitive to the rate of principal payments (including prepayments) on the related underlying Mortgage Assets. For example, a rapid or slow rate of principal payments will have a material adverse effect on the yield to maturity of IOs or POs, respectively. If the underlying Mortgage Assets experience greater than anticipated prepayments of principal, an investor in an IO class may incur substantial losses, even if the IO class is rated AAA. Conversely, if the underlying Mortgage Assets experience slower than anticipated prepayments of principal, the yield on a PO class will be affected more severely than would be the case with a traditional Mortgage-Backed Security. Under the Internal Revenue Code, Adjustable Portfolio will be required to accrue a portion of the original issue discount on a PO as income each year even though Adjustable Portfolio receives no cash distribution on the security during the year. RISKS OF MORTGAGE-BACKED SECURITIES. Mortgage-Backed Securities (other than ARMS) are subject generally to the same risks as ARMS; however, such other Mortgage-Backed Securities can be expected to be affected to a greater extent than ARMS by fluctuating interest rates and prepayments and to have different yield characteristics, due to the fact that fixed rate rather than adjustable rate mortgages underlie such securities. Generally, prepayments on fixed rate mortgages will increase during a period of falling interest rates and decrease during a period of rising interest rates. Accordingly, amounts available for reinvestment are likely to be greater during a period of declining interest rates than during a period of rising interest rates and the yield on the securities in which such amounts are reinvested is likely to be lower than the yield on the securities that were prepaid or the yield that could be achieved if such amounts were reinvested during a period of rising interest rates. If Adjustable Portfolio purchases Mortgage-Backed Securities at a premium, a prepayment rate that is faster than expected will reduce both the market value and the yield to maturity from that which was anticipated, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield to maturity and market value. Conversely, if Adjustable Portfolio purchases Mortgage-Backed Securities at a discount, faster than expected prepayments will increase, while slower than expected prepayments will reduce, yield to maturity and market value. Mortgage-Backed Securities may decrease in value as a result of increases in interest rates and may benefit less than other fixed income securities from declining interest rates because of the risk of prepayment. Mortgage-Backed Securities derive their value from underlying pools of mortgages and, as such, could be considered "derivative" securities. Certain derivative mortgage securities, such as the more volatile CMO tranches and Stripped Mortgage-Backed Securities, discussed above, may involve risks in addition to those found in other Mortgage-Backed Securities. Recent market experience has shown 14 that certain derivative mortgage securities may be highly sensitive to changes in interest and prepayment rates and, as a result, the prices of such securities may be highly volatile. In addition, recent market experience has shown that during periods of rising interest rates, the market for certain derivative mortgage securities may become more unstable and such securities may become more difficult to sell as market makers either choose not to repurchase such securities or offer prices, based on current market conditions, which are unacceptable to Adjustable Portfolio. ZERO COUPON TREASURY SECURITIES Adjustable Portfolio may invest in "zero coupon" Treasury securities which are U.S. Treasury bills, notes and bonds which have been stripped of their unmatured interest coupons and receipts or certificates representing interests in such stripped debt obligations and coupons. A zero coupon security pays no interest to its holder during its life. Its value to an investor consists of the difference between its face value at the time of maturity and the price for which it was acquired, which is generally an amount significantly less than its face value (sometimes referred to as a "deep discount" price). Currently U.S. Treasury securities issued without coupons include Treasury bills and Treasury STRIPS. In addition, a number of banks and brokerage firms separate the principal portions from the coupon portions of U.S. Treasury bonds and notes and sell them separately in the form of receipts or certificates representing undivided interests in these instruments (which instruments are generally held by a bank in a custodial or trust account). Such securities are currently not deemed by the Fund to be U.S. Government Securities but rather securities issued by the bank or brokerage firm involved. Zero coupon Treasury securities do not entitle the holder to any periodic payments of interest prior to maturity. Accordingly, those securities usually trade at a deep discount from their face or par value and will be subject to greater fluctuations of market value in response to changing interest rates than debt obligations of comparable maturities which make current distributions of interest. In certain circumstances, Adjustable Portfolio could fail to recoup its initial investment in those securities. Current federal tax law requires that a holder (such as Adjustable Portfolio) of a zero coupon security accrue a portion of the discount at which the security was purchased as income each year even though Adjustable Portfolio receives no interest payment in cash on the security during the year. In addition, as a registered investment company, Adjustable Portfolio will be required to distribute this income to shareholders. See "Dividends, Distributions and Tax Status." These distributions will be made from the Fund's cash assets or, if necessary, from the proceeds of sales of portfolio securities. Adjustable Portfolio will not be able to purchase additional income producing securities with cash used to make such distributions, and the Fund's current income ultimately may be reduced as a result. CANADIAN GOVERNMENT SECURITIES Adjustable Portfolio may invest up to 10% of its total assets in Canadian Government Securities. Canadian Government Securities are debt securities issued or guaranteed by the Canadian federal government, Canadian provincial governments and political subdivisions, agencies or instrumentalities thereof. The Adviser anticipates that the Fund's portfolio of Canadian Government Securities will consist primarily of Mortgage-Backed Securities issued or guaranteed by the Canadian government or an agency or instrumentality thereof. Investing in Canadian Government Securities involves considerations and possible risks not typically associated with investing in U.S. securities, including possible application of Canadian tax laws (including possible future withholding taxes), potential difficulties in enforcing contractual obligations, changes in governmental administrations or economic or monetary 15 policy (in this country or Canada) or changed circumstances in dealing between the United States and Canada. Canadian brokerage commissions may be higher than those in the United States and Canadian securities markets may be less liquid, more volatile and less subject to governmental supervision than those in the United States. The value of Adjustable Portfolio's investments denominated in Canadian dollars could be adversely affected by a decline in the value of the Canadian dollar relative to the U.S. dollar. In connection with such investments, the Fund may from time to time enter into foreign exchange transactions, currency forward and futures contracts and foreign currency options. These investment techniques, and the risks incident thereto, are explained in Appendix A to this Prospectus. FOREIGN INDEX LINKED INSTRUMENTS Adjustable Portfolio may invest up to 10% of its total assets in Foreign Index Linked Instruments. Foreign Index Linked Instruments are fixed income securities which are issued by U.S. issuers (including U.S. subsidiaries of foreign issuers) and are denominated in U.S. dollars but return principal and/or pay interest to investors in amounts which are linked to the level of a particular foreign index. Foreign Index Linked Instruments may offer higher yields than comparable securities linked to purely domestic indices but also may be more volatile. Foreign Index Linked Instruments are relatively recent innovations for which the market has not yet been fully developed and, accordingly, they typically are less liquid than comparable securities linked to purely domestic indices. In addition, the value of Foreign Index Linked Instruments will be affected by fluctuations in foreign exchange rates or in foreign interest rates, factors which do not typically bear on the values of ARMS or most other securities in which the Fund invests. If the Adviser is incorrect in its prediction as to the movements in the direction of particular foreign currencies or foreign interest rates, the return realized by the Fund on a Foreign Index Linked Instrument may be lower than if the Fund had invested in a similarly rated domestic security. The skills needed to predict foreign currency and foreign interest rates are different from those needed to select domestic portfolio securities. Foreign currency gains and losses with respect to Foreign Index Linked Instruments may affect the amount and timing of income recognized by the Fund. CORPORATE DEBT SECURITIES Adjustable Portfolio may invest up to 10% of its total assets in Corporate Debt Securities. Corporate Debt Securities are debt obligations of U.S. corporations (other than ARMS or Mortgage-Backed Securities). The values of Corporate Debt Securities typically will fluctuate in response to general economic conditions, to changes in interest rates and, to a greater extent than the values of ARMS or Mortgage-Backed Securities, to business conditions affecting the specific industries in which the issuers are engaged. Corporate Debt Securities will typically decrease in value of a result of increases in interest rates. Adjustable Portfolio may invest in certain types of Corporate Debt Securities that have been issued with original issue discount or market discount. An investment in such securities poses certain economic risks and may have certain adverse cash flow consequences to the Fund. NEW INSTRUMENTS Investors should note that new types of ARMS, other Mortgage-Backed Securities, hedging instruments and other securities in which Adjustable Portfolio may invest are developed and marketed from time to time and that, consistent with its investment limitations, Adjustable Portfolio expects to invest in those securities and instruments that the Adviser believes may assist the Fund in 16 achieving its investment objective. Adjustable Portfolio will provide written notice to shareholders in advance of investments to a significant degree (I.E., in excess of 5% of the Fund's net assets) in any type of security other than the types disclosed in this Prospectus. SPECIAL INVESTMENT METHODS REPURCHASE AGREEMENTS Each Fund may enter into repurchase agreements with respect to U.S. Government Securities. A repurchase agreement involves the purchase by a Fund of securities with the condition that after a stated period of time the original seller (a member bank of the Federal Reserve System or a recognized securities dealer) will buy back the same securities ("collateral") at a predetermined price or yield. Repurchase agreements involve certain risks not associated with direct investments in securities. In the event the original seller defaults on its obligation to repurchase, as a result of its bankruptcy or otherwise, the Fund will seek to sell the collateral, which action could involve costs or delays. In such case, the Fund's ability to dispose of the collateral to recover such investment may be restricted or delayed. While collateral will at all times be maintained in an amount equal to the repurchase price under the agreement (including accrued interest due thereunder), to the extent proceeds from the sale of collateral were less than the repurchase price, a Fund would suffer a loss. In the event of a seller's bankruptcy, a Fund might be delayed in, or prevented from, selling the collateral to the Fund's benefit. Repurchase agreements maturing in more than seven days are considered illiquid and subject to each Fund's restriction on investing in illiquid securities. See "Illiquid Securities," below. REVERSE REPURCHASE AGREEMENTS Each Fund may engage in "reverse repurchase agreements" with banks and securities dealers. Reverse repurchase agreements are ordinary repurchase agreements in which the Fund is the seller of, rather than the investor in, securities and agrees to repurchase them at an agreed upon time and price. Use of a reverse repurchase agreement may be preferable to a regular sale and later repurchase of the securities because it avoids certain market risks and transactions costs. Because certain of the incidents of ownership of the security are retained by the Fund, reverse repurchase agreements are considered a form of borrowing by the Fund from the buyer, collateralized by the security. At the time the Fund enters into a reverse repurchase agreement, cash, U.S. Government Securities or other liquid high-grade debt obligations having a value sufficient to make payments for the securities to be repurchased will be segregated, and will be maintained throughout the period of the obligation. Reverse repurchase agreements will be used as a means of borrowing for investment purposes. This speculative technique is referred to as leveraging. Leveraging may exaggerate the effect on net asset value of any increase or decrease in the market value of the Fund's portfolio. Money borrowed for leveraging will be subject to interest costs which could possibly exceed interest income earned by the Fund on the investment of such borrowed money, and therefore could adversely affect yield. No more than 25% of the total assets of Adjustable Portfolio and 5% of the net assets of Money Market Fund will be subject to reverse repurchase agreements. BORROWING Each Fund may borrow money from banks for temporary or emergency purposes in an amount up to one-third of the value of its total assets in order to meet redemption requests without immediately selling any of its portfolio securities. Reverse repurchase agreements are not included in this limitation. If, for any reason, the current value of either Fund's total assets falls below an amount equal to three times the amount of its indebtedness from money borrowed, such Fund will, within three days, 17 reduce its indebtedness to the extent necessary. To do this, the Fund may have to sell a portion of its investments at a time when it may be disadvantageous to do so. Interest paid by a Fund on borrowed funds would decrease the net earnings of that Fund. Neither Fund will purchase portfolio securities while outstanding borrowings (other than reverse repurchase agreements) exceed 5% of the value of the Fund's total assets. Each Fund may mortgage, pledge or hypothecate its assets to secure permitted temporary or emergency borrowing. The policies set forth in this paragraph are fundamental and may not be changed with respect to a Fund without the approval of a majority of that Fund's shares. WHEN-ISSUED SECURITIES Adjustable Portfolio may purchase securities on a "when-issued" basis and may purchase or sell securities on a "forward commitment" basis. When such transactions are negotiated, the price is fixed at the time the commitment is made, but delivery and payment for the securities take place at a later date. Adjustable Portfolio will not accrue income with respect to when-issued or forward commitment securities prior to their stated delivery date. Pending delivery of the securities, the Fund maintains in a segregated account cash or liquid high-grade debt obligations in an amount sufficient to meet its purchase commitments. The Fund will likewise segregate securities it sells on a forward commitment basis. The purchase of securities on a when-issued or forward commitment basis exposes Adjustable Portfolio to risk because the securities may decrease in value prior to their delivery. Purchasing securities on a when-issued or forward commitment basis involves the additional risk that the return available in the market when the delivery takes place will be higher than that obtained in the transaction itself. The Fund's purchase of securities on a when-issued or forward commitment basis while remaining substantially fully invested increases the amount of the Fund's assets that are subject to market risk to an amount that is greater than the Fund's net asset value, which could result in increased volatility of the price of the Fund's shares. MORTGAGE DOLLAR ROLLS In connection with its ability to purchase securities on a when-issued or forward commitment basis, Adjustable Portfolio may enter into mortgage "dollar rolls" in which the Fund sells securities for delivery in the current month and simultaneously contracts with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities on a specified future date. The Fund gives up the right to receive principal and interest paid on the securities sold. However, the Fund would benefit to the extent of any difference between the price received for the securities sold and the lower forward price for the future purchase plus any fee income received. Unless such benefits exceed the income, capital appreciation and gain or loss due to mortgage prepayments that would have been realized on the securities sold as part of the mortgage dollar roll, the use of this technique will diminish the investment performance of the Fund compared with what such performance would have been without the use of mortgage dollar rolls. Adjustable Portfolio will hold and maintain in a segregated account until the settlement date cash or liquid high-grade debt securities in an amount equal to the forward purchase price. The benefits derived from the use of mortgage dollar rolls may depend upon the Adviser's ability to predict correctly mortgage prepayments and interest rates. There is no assurance that mortgage dollar rolls can be successfully employed. In addition, the use of mortgage dollar rolls by the Fund while remaining substantially fully invested increases the amount of the Fund's assets that are subject to market risk to an amount that is greater than the Fund's net asset value, which could result in increased volatility of the price of the Fund's shares. 18 For financial reporting and tax purposes, Adjustable Portfolio treats mortgage dollar rolls as two separate transactions: one involving the purchase of a security and a separate transaction involving a sale. The Fund does not currently intend to enter into mortgage dollar rolls that are accounted for as a financing. No more than one-third of Adjustable Portfolio's total assets may be committed to the purchase of securities on a when-issued or forward commitment basis, including mortgage dollar roll purchases. LENDING OF PORTFOLIO SECURITIES In order to generate income, Adjustable Portfolio may lend portfolio securities up to one-third of the value of its total assets to broker-dealers, banks or other financial borrowers of securities. As with other extensions of credit, there are risks of delay in recovery or even loss of rights in the collateral should the borrower of the securities fail financially. However, the Fund will only enter into loan arrangements with broker-dealers, banks or other institutions which the Adviser has determined are creditworthy under guidelines established by the Fund's Board of Directors and will receive collateral in the form of cash, U.S. Government Securities or other high-grade debt obligations equal to at least 100% of the value of the securities loaned. The value of the collateral and of the securities loaned will be marked to market on a daily basis. During the time portfolio securities are on loan, the borrower pays the Fund an amount equivalent to any interest paid on the securities and the Fund may invest the cash collateral and earn income or may receive an agreed upon amount of interest income from the borrower. However, the amounts received by the Fund may be reduced by finders' fees paid to broker-dealers. Collateral (including any securities purchased with cash collateral) will be maintained by the Fund's custodian in a segregated account. INTEREST RATE TRANSACTIONS To preserve a return or spread on a particular investment or portion of its portfolio, to create synthetic adjustable rate mortgage securities (see "Investment Objective and Policies -- Institutional Government Adjustable Portfolio -- Mortgage-Backed Securities") or for other non-speculative purposes, Adjustable Portfolio may enter into interest rate swaps and may purchase or sell interest rate caps and floors. The Fund does not intend to use these transactions for speculative purposes. Interest rate swaps involve the exchange by the Fund with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually-based principal amount from the party selling such interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually-based principal amount from the party selling such interest rate floor. Adjustable Portfolio may enter into interest rate swaps, caps and floors on either an asset-based or liability-based basis, depending upon whether it is hedging its assets or its liabilities, and will usually enter into interest rate swaps on a net basis, i.e., the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments. The net amount of the excess, if any, of the Fund's obligations over its entitlements with respect to each interest rate swap will be accrued on a daily basis and an amount of cash or high quality liquid securities having an aggregate net asset value at least equal to the accrued excess will be maintained in a segregated account by the Fund's custodian. If the Fund enters into an interest rate swap on other 19 than a net basis, the Fund would maintain a segregated account in the full amount accrued on a daily basis of the Fund's obligations with respect to the swap. To the extent Adjustable Portfolio sells (I.E., writes) caps and floors, it will maintain in a segregated account cash or high quality liquid debt securities having an aggregate net asset value at least equal to the full amount, accrued on a daily basis, of the Fund's obligations with respect to any caps or floors. The Fund will not enter into any interest rate swap, cap or floor transaction unless the unsecured senior debt or the claims-paying ability of the other party thereto is rated at least AA by Standard & Poor's. The Adviser will monitor the creditworthiness of contra-parties on an ongoing basis. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreements related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. The Adviser has determined that, as a result, the swap market has become relatively liquid. Caps and floors are more recent innovations for which standardized documentation has not yet been developed and, accordingly, they are less liquid than swaps. There is no limit on the amount of interest rate swap transactions that may be entered into by Adjustable Portfolio. These transactions do not involve the delivery of securities or other underlying assets or principal. Accordingly, the risk of loss with respect to interest rate swaps is limited to the net amount of interest payments that the Fund is contractually obligated to make. If the other party to an interest rate swap defaults, the Fund's risk of loss consists of the net amount of interest payments that the Fund contractually is entitled to receive. The aggregate purchase price of caps and floors held by the Fund may not exceed 5% of the Fund's total assets. The Fund may sell (I.E., write) caps and floors without limitation, subject to the segregated account requirement described above. OPTIONS TRANSACTIONS WRITING COVERED OPTIONS. Adjustable Portfolio may write (I.E., sell) covered put and call options with respect to the securities in which it may invest. By writing a call option, the Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price if the option is exercised. By writing a put option, the Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. With respect to put options written by Adjustable Portfolio, there will have been a predetermination that acquisition of the underlying security is in accordance with the investment objective of the Fund. The principal reason for writing call or put options is to obtain, through the receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Fund receives premiums from writing call or put options, which it retains whether or not the options are exercised. By writing a call option, the Fund might lose the potential for gain on the underlying security while the option is open, and by writing a put option the Fund might become obligated to purchase the underlying security for more than its current market price upon exercise. PURCHASING OPTIONS. Adjustable Portfolio may purchase put options, solely for hedging purposes, in order to protect portfolio holdings in an underlying security against a substantial decline in the market value of such holdings ("protective puts"). Such protection is provided during the life of the put because the Fund may sell the underlying security at the put exercise price, regardless of a decline in the underlying security's market price. Any loss to the Fund is limited to the premium paid for, and transaction costs paid in connection with, the put plus the initial excess, if any, of the market 20 price of the underlying security over the exercise price. However, if the market price of such security increases, the profit the Fund realizes on the sale of the security will be reduced by the premium paid for the put option less any amount for which the put is sold. Adjustable Portfolio may also purchase call options solely for the purpose of hedging against an increase in prices of securities that the Fund ultimately wants to buy. Such protection is provided during the life of the call option because the Fund may buy the underlying security at the call exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call options in this manner, Adjustable Portfolio will reduce any profit it might have realized had it bought the underlying security at the time it purchased the call option by the premium paid for the call option and by transaction costs. Adjustable Portfolio may purchase and write exchange-traded put and call options, and over-the-counter ("OTC") put and call options in negotiated transactions with the writers of the options since options on many of the portfolio securities held by the Fund are not traded on an exchange. The Fund will purchase OTC options only from investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Adviser. OTC options are two-party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third-party contracts with standardized strike prices and expiration dates, and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while OTC options may not. The staff of the SEC has taken the position that purchased OTC options and the assets used to "cover" written OTC options are illiquid securities, provided that the entire amount of assets used to cover OTC options written by Adjustable Portfolio will not be treated as illiquid in certain circumstances, as set forth in the Statement of Additional Information. Adjustable Portfolio will treat OTC options, to the extent set forth in the Statement of Additional Information, as subject to the Fund's limitation on investments in illiquid securities. See "Investment Restrictions," below. For further information concerning the characteristics and risks of options transactions, see "Investment Objectives, Policies and Restrictions -- Options" in the Statement of Additional Information. FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS Adjustable Portfolio may enter into contracts for the purchase or sale for future delivery of fixed-income securities or contracts based on financial indices including any index of securities in which the Fund may invest ("futures contracts"). A "sale" of a futures contract means the acquisition of a contractual obligation to deliver the securities called for by the contract at a specified price on a specified date. The purchaser of a futures contract on an index agrees to take or make delivery of an amount of cash equal to the difference between a specified dollar multiple of the value of the index on the expiration date of the contract ("current contract value") and the price at which the contract was originally struck. No physical delivery of the fixed-income securities underlying the index is made. The futures contracts in which the Fund may invest have been developed by and are traded on national commodity exchanges. The purpose of the acquisition or sale of a futures contract by Adjustable Portfolio is to hedge against fluctuations in the value of its portfolio without actually buying or selling securities. For 21 example, if the Fund owns long-term debt securities and interest rates are expected to increase, the Fund might sell futures contracts. If interest rates did increase, the value of the debt securities in the Fund's portfolio would decline, but the value of the Fund's futures contracts would increase at approximately the same rate, thereby keeping the net asset value of the Fund from declining as much as it otherwise would have. If, on the other hand, the Fund held cash reserves and short-term investments pending anticipated investment in long-term obligations and interest rates were expected to decline, the Fund might purchase futures contracts for U.S. Government Securities. Since the behavior of such contracts would generally be similar to that of long-term securities, the Fund could take advantage of the anticipated rise in the value of long-term securities without actually buying them until the market had stabilized. At that time, the Fund could accept delivery under the futures contracts or the futures contracts could be liquidated and the Fund's reserves could then be used to buy long-term securities in the cash market. The Fund will engage in such transactions only for hedging purposes, on either an asset-based or a liability-based basis, in each case in accordance with the rules and regulations of the Commodity Futures Trading Commission. See Appendix B to the Statement of Additional Information. Adjustable Portfolio may purchase and sell put and call options on futures contracts and enter into closing transactions with respect to such options to terminate existing positions. The Fund may use such options on futures contracts in connection with its hedging strategies in lieu of purchasing and writing options directly on the underlying securities or purchasing and selling the underlying futures contracts. There are risks in using futures contracts and options on futures contracts as hedging devices. The primary risks associated with the use of futures contracts and options thereon are (a) the prices of futures contracts and options may not correlate perfectly with the market value of the underlying security held by the Fund and (b) the possible lack of a liquid secondary market for a futures contract and the resulting inability to close a futures position prior to its maturity date. The risk that the Fund will be unable to close out a futures position will be minimized by entering into such transactions on a national exchange with an active and liquid secondary market. Additional information with respect to futures contracts and options on futures contracts is set forth in Appendix B to the Statement of Additional Information. The effective use of futures contracts, options on futures contracts and the other hedging techniques discussed above is dependent upon the Adviser's judgment regarding interest rate movements and other economic factors. To the extent that this judgment is incorrect, the Fund will be in a worse position than if such hedging techniques had not been used. ILLIQUID SECURITIES Adjustable Portfolio may invest up to 15% of its net assets in illiquid securities and Money Market Fund may invest up to 10% of its net assets in illiquid securities. Illiquid securities may offer a higher yield than securities which are more readily marketable, but they may not always be marketable on advantageous terms. The sale of illiquid securities often requires more time and results in higher brokerage charges or dealer discounts than does the sale of securities eligible for trading on national securities exchanges or in the over-the-counter markets. A Fund may be restricted in its ability to sell such securities at a time 22 when the Adviser deems it advisable to do so. In addition, in order to meet redemption requests, a Fund may have to sell other assets, rather than such illiquid securities, at a time which is not advantageous. "Restricted securities" are securities which were originally sold in private placements and which have not been registered under the Securities Act of 1933 (the "1933 Act"). Such securities generally have been considered illiquid, since they may be resold only subject to statutory restrictions and delays or if registered under the 1933 Act. In 1990, however, the SEC adopted Rule 144A under the 1933 Act, which provides a safe harbor exemption from the registration requirements of the 1933 Act for resales of restricted securities to "qualified institutional buyers," as defined in the rule. The result of this rule has been the development of a more liquid and efficient institutional resale market for restricted securities. Thus, restricted securities are no longer necessarily illiquid. Neither Fund is subject to any limitation on its ability to invest in securities simply because such securities are restricted. (Money Market Fund, however, will invest only in U.S. Government Securities, which are not considered restricted securities.) These securities will be treated as liquid when they have been determined to be liquid by the Board of Directors of the Funds or by the Adviser subject to the oversight of and pursuant to procedures adopted by the Board of Directors. See "Investment Objectives, Policies and Restrictions -- Illiquid Securities" in the Statement of Additional Information. Similar determinations may be made with respect to commercial paper issued in reliance upon the so-called "private placement" exemption from registration under Section 4(2) of the 1933 Act and with respect to IO and PO classes of Mortgage-Backed Securities issued by the U.S. Government or its agencies and instrumentalities. INVESTMENT RESTRICTIONS Each Fund has adopted certain investment restrictions, which are set forth in detail in the Statement of Additional Information under "Investment Objectives, Policies and Restrictions." Certain of these restrictions are fundamental and may not be changed without shareholder approval, including the following: (1) Neither Fund will invest 25% or more of its total assets in any one industry. (This restriction does not apply to securities of the U.S. Government or its agencies and instrumentalities and repurchase agreements relating thereto or to obligations of United States banks, domestic branches thereof and United States branches of foreign banks subject to United States regulation. The various types of utility companies, such as gas, electric, telephone, telegraph, satellite and microwave communications companies, are considered as separate industries.) (2) Neither Fund will, with respect to 75% of its total assets, invest more than 5% of the value of its total assets in the securities of any one issuer or acquire more than 10% of the outstanding voting securities of an issuer, in each case other than securities issued or guaranteed by the U.S. Government or any agency or instrumentality thereof and securities of other investment companies. Except with respect to each Fund's policy concerning borrowing, if a percentage restriction set forth in this Prospectus is adhered to at the time of an investment, a later increase or decrease in percentage resulting from changes in values or assets will not constitute a violation of such restriction. PORTFOLIO TURNOVER While it is not the policy of Adjustable Portfolio to trade actively for short-term profits, the Fund will dispose of securities without regard to the time they have been held when such action appears advisable to the Adviser. Frequent changes may result in higher transaction and other costs for the 23 Fund. The method of calculating portfolio turnover rate is set forth in the Statement of Additional Information under "Investment Objectives, Policies and Restrictions -- Portfolio Turnover." Portfolio turnover rates for Adjustable Portfolio are set forth in "Financial Highlights." MANAGEMENT BOARD OF DIRECTORS The Company's Board of Directors has the primary responsibility for overseeing the overall management of the Company and electing its officers. INVESTMENT ADVISER Piper Capital Management Incorporated (the "Adviser") has been retained under an Investment Advisory and Management Agreement with the Company to act as the Funds' investment adviser subject to the authority of the Board of Directors. In addition to acting as the investment adviser for the Funds, the Adviser also serves as investment adviser to a number of other open-end and closed-end investment companies and to various other concerns, including pension and profit sharing funds, corporate funds and individuals. As of September 30, 1995, the Adviser rendered investment advice regarding approximately $9.4 billion of assets. The Adviser is a wholly owned subsidiary of Piper Jaffray Companies Inc., a publicly held corporation which is engaged through its subsidiaries in various aspects of the financial services industry. The address of the Adviser is Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804. The Adviser furnishes each Fund with investment advice and, in general, supervises the management and investment programs of the Funds. The Adviser furnishes at its own expense all necessary administrative services, office space, equipment and clerical personnel for servicing the investments of the Funds. The Adviser also provides investment advisory facilities and executive and supervisory personnel for managing the investments and effecting the portfolio transactions of the Funds. In addition, the Adviser pays the salaries and fees of all officers and directors of the Company who are affiliated with the Adviser. Under the Investment Advisory and Management Agreement, the Adviser receives a monthly fee computed separately for each Fund. Such fees are paid at an annual rate of .15% and .30%, respectively, of the average daily net assets of Money Market Fund and Adjustable Portfolio. PORTFOLIO MANAGEMENT Nancy S. Olsen has been primarily responsible for the day-to-day management of Money Market Fund's portfolio since the Fund's inception in 1993. Ms. Olsen, who joined the Adviser in 1987, is a Senior Vice President and fixed income portfolio manager for the Adviser and directs the Adviser's cash reserve management department. Ms. Olsen has an M.B.A. from the University of Minnesota. Thomas S. McGlinch has been primarily responsible for the day-to-day management of Adjustable Portfolio's investment portfolio since October 1994. Mr. McGlinch is a vice president and fixed-income portfolio manager for the Adviser. Prior to joining the Adviser in 1992, Mr. McGlinch was an institutional mortgage-backed securities trader for Piper Jaffray Inc. during 1992. From 1988 to January 1992, Mr. McGlinch was a specialty products trader at FBS Investment Services. He is a Chartered Financial Analyst ("C.F.A.") with an M.B.A. from the University of St. Thomas. 24 TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND CUSTODIAN Investors Fiduciary Trust Company ("IFTC"), 127 West Tenth Street, Kansas City, Missouri 64105, (800) 874-6205, serves as Custodian for the Funds' portfolio securities and cash and as Transfer Agent and Dividend Disbursing Agent for the Funds. The Company has entered into a Shareholder Account Servicing Agreement with the Distributor pursuant to which the Distributor provides certain transfer agent and dividend disbursing agent services for the underlying individual shareholder accounts. For more information, see "Investment Advisory and Other Services -- Transfer Agent and Dividend Disbursing Agent" in the Statement of Additional Information. PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS The Adviser selects brokers and futures commission merchants to use for the Fund's portfolio transactions. In making its selection, the Adviser may consider a number of factors, which are more fully discussed in the Statement of Additional Information, including, but not limited to, research services, the reasonableness of commissions and quality of services and execution. A broker's sales of either of the Funds' shares may also be considered a factor if the Adviser is satisfied that a Fund would receive from that broker the most favorable price and execution then available for a transaction. Portfolio transactions for the Funds may be effected through the Distributor on a securities exchange in compliance with Section 17(e) of the 1940 Act. For more information, see "Portfolio Transactions and Allocation of Brokerage" in the Statement of Additional Information. 25 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING HOW TO PURCHASE SHARES GENERAL The Funds' shares may be purchased at the public offering price from the Distributor and from other broker-dealers who have sales agreements with the Distributor. The address of the Distributor is that of the Funds. The Distributor reserves the right to reject any purchase order. You should be aware that, because the Funds do not issue stock certificates, Fund shares must be kept in an account with the Distributor or with IFTC. All investments must be arranged through your Piper Jaffray Investment Executive or other broker-dealer. PURCHASE PRICE Shares of Money Market Fund are offered without a sales charge at the net asset value per share next calculated after receipt of your order by your Piper Jaffray Investment Executive or other broker-dealer. The net asset value per share of such Fund is normally expected to be $1.00. See "Valuation of Shares". Shares of Adjustable Portfolio are offered at the net asset value per share next calculated after receipt of your order by your Piper Jaffray Investment Executive or other broker-dealer, plus a front-end sales charge as follows:
DEALER SALES CHARGE AS SALES CHARGE AS CONCESSION AS PERCENTAGE OF PERCENTAGE OF NET PERCENTAGE OF AMOUNT OF TRANSACTION AT OFFERING PRICE OFFERING PRICE ASSET VALUE OFFERING PRICE - - - ----------------------------------------------------- ----------------- ------------------- --------------- Less than $250,000................................... 1.00% 1.01% .75% $250,000 but less than $500,000...................... .50% .50% .375% $500,000 and over.................................... 0% 0% 0%
The Adviser and/or the Distributor, out of their own assets, may pay for certain expenses incurred in connection with the distribution of shares of the Funds. In particular, in connection with sales of Adjustable Portfolio of $500,000 or more, Piper Jaffray Investment Executives and other broker-dealers are paid an amount equal to .15% of the offering price of Fund shares purchased by their clients. In addition, Piper Jaffray Investment Executives and other broker-dealers receive ongoing payments for their servicing and/or maintenance of shareholder accounts in an amount equal to .06% of the average daily net assets of Money Market Fund attributable to shares sold by them and .15% of the average daily net assets of Adjustable Portfolio attributable to shares sold by them. The Distributor or the Adviser, at their own expense, provide promotional incentives to Investment Executives of the Distributor and to broker-dealers who have sales agreements with the Distributor in connection with sales of shares of the Funds, and other mutual funds for which the Adviser acts as investment adviser. In some instances, these incentives may be made available only to certain Investment Executives or broker-dealers who have sold or may sell significant amounts of such shares. The incentives may include payment for travel expenses, including lodging at luxury resorts, incurred in connection with sales seminars. 26 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING MINIMUM INVESTMENTS A minimum initial investment of $100,000 is required for each Fund. There is no minimum for subsequent investments. The Distributor may waive the minimum initial investment for clients of Piper Trust Company. REDUCING YOUR SALES CHARGE Purchasers of Adjustable Portfolio may qualify for a reduced sales charge through one or more of several plans. You must notify your Piper Jaffray Investment Executive or broker-dealer at the time of purchase to take advantage of these plans. AGGREGATION Front-end or initial sales charges of Adjustable Portfolio may be reduced or eliminated by aggregating your purchase with purchases of certain related personal accounts. In addition, purchases made by members of certain organized groups will be aggregated for purposes of determining sales charges. Sales charges are calculated by adding the dollar amount of your current purchase to the higher of the cost or current value of shares of any Piper fund sold with a sales charge that are currently held by you and your related accounts or by other members of your group. QUALIFIED GROUPS. You may group purchases in the following personal accounts together: - Your individual account. - Your spouse's account. - Your children's accounts (if they are under the age of 21). - Your employee benefit plan accounts if they are exclusively for your benefit. This includes accounts such as IRAs, individual 403(b) plans or single-participant Keogh-type plans. - A single trust estate or single fiduciary account if you are the trustee or fiduciary. Additionally, purchases made by members of any organized group meeting the requirements listed below may be aggregated for purposes of determining sales charges: - The group has been in existence for more than six months. - It is not organized for the purpose of buying redeemable securities of a registered investment company. - Purchases must be made through a central administration, or through a single dealer, or by other means that result in economy of sales effort or expense. An organized group does not include a group of individuals whose sole organizational connection is participation as credit card holders of a company, policyholders of an insurance company, customers of either a bank or broker-dealer or clients of an investment adviser. RIGHT OF ACCUMULATION Sales charges for purchases of Adjustable Portfolio shares into Piper Jaffray accounts will be automatically calculated taking into account the dollar amount of any new purchases along with the 27 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING higher of current value or cost of shares previously purchased in the Piper funds that were sold with a sales charge. For other broker-dealer accounts, you should notify your Investment Executive at the time of purchase of additional Piper fund shares you may own. LETTER OF INTENT Your sales charge for Adjustable Portfolio may be reduced by signing a non-binding Letter of Intent. This Letter of Intent will state your intention to invest $100,000 or more in any of the Piper funds sold with a sales charge over a 13-month period, beginning not earlier than 90 days prior to the date you sign the Letter. You will pay the lower sales charge applicable to the total amount you plan to invest over the 13-month period. Part of your shares will be held in escrow to cover additional sales charges that may be due if you do not invest the planned amount. Please see "Purchase of Shares" in the Statement of Additional Information for more details. You can contact your Piper Jaffray Investment Executive or other broker-dealer for an application. SPECIAL PURCHASE PLANS For more information on any of the following special purchase plans, contact your Piper Jaffray Investment Executive or other broker-dealer. PURCHASES BY PIPER JAFFRAY COMPANIES INC., ITS SUBSIDIARIES AND ASSOCIATED PERSONS Piper Jaffray Companies Inc. and its subsidiaries may buy shares of Adjustable Portfolio without incurring a sales charge. The following persons associated with such entities also may buy such shares without paying a sales charge: - Officers, directors and partners. - Employees and retirees. - Sales representatives. - Spouses or children under the age of 21 of any of the above. - Any trust, pension, profit-sharing or other benefit plan for any of the above. PURCHASES BY BROKER-DEALERS Employees of broker-dealers who have entered into sales agreements with the Distributor, and spouses and children under the age of 21 of such employees, may buy shares of Adjustable Portfolio without incurring a sales charge. PURCHASES BY OTHER INDIVIDUALS WITHOUT A SALES CHARGE The following other individuals and entities also may buy shares of Adjustable Portfolio without paying a sales charge: - Clients of the Adviser buying shares in their advisory accounts. - Discretionary accounts at Piper Trust Company and participants in investment companies exempt from registration under the 1940 Act that are managed by the Adviser. 28 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING - Trust companies and bank trust departments using funds over which they exercise exclusive discretionary investment authority and which are held in a fiduciary, agency, advisory, custodial or similar capacity. - Investors purchasing shares through a Piper Jaffray Investment Executive if the purchase of such shares is funded by the proceeds from the sale of shares of any non-money market open-end mutual fund. This privilege is available for 30 days after the sale. - American Government Term Trust Inc. ("AGT"), a closed-end fund which was managed by the Adviser, recently dissolved and distributed its net assets to shareholders. Former AGT shareholders may invest the distributions received by them in connection with such dissolution in shares of the Fund without payment of a sales charge. PURCHASES BY EMPLOYEE BENEFIT PLANS AND TAX-SHELTERED ANNUITIES - Shares of Adjustable Portfolio will be sold at net asset value, without a sales charge, to employee benefit plans containing an actively maintained qualified cash or deferred arrangement under Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Code") (a "401(k) Plan"). In the event a 401(k) Plan of an employer has purchased shares in the Fund during any calendar quarter, any other employee benefit plan of such employer that is a qualified plan under Section 401(a) of the Code also may purchase shares of the Fund during such quarter without incurring a sales charge. - Custodial accounts under Section 403(b) of the Code (known as tax-sheltered annuities) also may buy shares of Adjustable Portfolio without incurring a sales charge. HOW TO REDEEM SHARES NORMAL REDEMPTION You may redeem all or a portion of your shares on any day that a Fund values its shares. (Please refer to "Valuation of Shares" below for more information.) Your shares will be redeemed at the net asset value next calculated after the receipt of your instructions in good form by your Piper Jaffray Investment Executive or other broker-dealer as explained below. PIPER JAFFRAY INC. ACCOUNTS. To redeem your shares, please contact your Piper Jaffray Investment Executive with an oral request to redeem your shares. OTHER BROKER-DEALER ACCOUNTS. To redeem your shares, you may either contact your broker-dealer with an oral request or send a written request directly to the Funds' transfer agent, IFTC. This request should contain: the dollar amount or number of shares to be redeemed, your Fund account number and either a social security or tax identification number (as applicable). You should sign your request in exactly the same way the account is registered. If there is more than one owner of the shares, all owners must sign. A signature guarantee is required for redemptions over $25,000. Please contact IFTC or refer to "Redemption of Shares" in the Statement of Additional Information for more details. 29 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING PAYMENT OF REDEMPTION PROCEEDS After your shares have been redeemed, the cash proceeds will normally be sent to you or your broker-dealer within three business days. In no event will payment be made more than seven days after receipt of your order in good form. However, payment may be postponed or the right of redemption suspended for more than seven days under unusual circumstances, such as when trading is not taking place on the New York Stock Exchange. Payment of redemption proceeds may also be delayed if the shares to be redeemed were purchased by a check drawn on a bank which is not a member of the Federal Reserve System, until such checks have cleared the banking system (normally up to 15 days from the purchase date). REDEMPTION IN KIND Although it is the current policy of Adjustable Portfolio to pay redemption proceeds in cash, redemption proceeds for redemption requests of $100,000 or more may be paid, at the sole option of Adjustable Portfolio, in whole or in part by a distribution in kind of securities or other assets held by Adjustable Portfolio. The determination of which of Adjustable Portfolio's assets will be distributed to meet such redemption requests will be made by the Adviser, in consultation with the redeeming shareholder. Securities or other assets so distributed will be valued in the same manner as Adjustable Portfolio's securities. In order to dispose of such securities or other assets, the redeeming shareholder would most likely be required to bear transaction costs. INVOLUNTARY REDEMPTION Each Fund reserves the right to redeem your account at any time the net asset value of the account falls below $50,000 as the result of a redemption or exchange request. You will be notified in writing prior to any such redemption and will be allowed 30 days to make additional investments before the redemption is processed. SHAREHOLDER SERVICES REINSTATEMENT PRIVILEGE If you have redeemed shares of Adjustable Portfolio, you may reinvest in shares of Adjustable Portfolio without payment of an additional sales charge. The reinvestment request must be made within 120 days of the redemption. You may also reinvest within this time period in shares of any other mutual fund managed by the Adviser except that, if that fund has a higher sales charge than Adjustable Portfolio, you must pay the difference. This privilege is subject to the eligibility of share purchases in your state as well as the minimum investment requirements and any other applicable terms in the prospectus of the fund being acquired. EXCHANGE PRIVILEGE If your investment goals change, you may prefer a fund with a different objective. If you are considering an exchange into another mutual fund managed by the Adviser, you should carefully read the appropriate prospectus for additional information about that fund. A prospectus may be obtained through your Piper Jaffray Investment Executive, your broker-dealer or the Distributor. To exchange your shares, please contact your Piper Jaffray Investment Executive, your broker-dealer or IFTC. 30 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING You may exchange your shares for shares of any other mutual fund managed by the Adviser that is open to new investors. All exchanges are subject to the eligibility of share purchases in your state as well as the minimum investment requirements and any other applicable terms in the prospectus of the fund being acquired. Exchanges are made on the basis of the net asset values of the funds involved, except that investors exchanging into a fund which has a higher sales charge must pay the difference. You may make four exchanges per year without payment of a service charge. Thereafter, you will pay a $5 service charge for each exchange. The Company reserves the right to change or discontinue the exchange privilege, or any aspect of the privilege, upon 60 days' written notice. TELEPHONE TRANSACTION PRIVILEGES PIPER JAFFRAY INC. ACCOUNTS. If you hold your shares in a Piper Jaffray account, you may telephone your Investment Executive to execute any transaction or to apply for many shareholder services. In some cases, you may be required to complete a written application. OTHER BROKER-DEALER ACCOUNTS. If you hold your shares in an account with your broker-dealer or at IFTC, you may authorize telephone privileges by completing the Account Application and Services Form. Please contact your broker-dealer or IFTC (800-874-6205) for an application or for more details. The Funds will employ reasonable procedures to confirm that a telephonic request is genuine, including requiring that payment be made only to the address of record or the bank account designated on the Account Application and Services Form and requiring certain means of telephonic identification. A Fund employing such procedures will not be liable for following instructions communicated by telephone that it reasonably believes to be genuine. If a Fund does not employ such procedures, it may be liable for any losses due to unauthorized or fraudulent telephone transactions. It may be difficult to reach the Funds by telephone during periods when market or economic conditions lead to an unusually large volume of telephone requests. If you cannot reach the Funds by telephone, you should contact your broker-dealer or issue written instructions to IFTC at the address set forth herein. See "Management -- Transfer Agent, Dividend Disbursing Agent and Custodian." The Funds reserve the right to suspend or terminate their telephone services at any time without notice. DIRECTED DIVIDENDS You may direct income dividends and capital gains distributions to be invested in any other mutual fund managed by the Adviser (other than a money market fund) that is offered in your state. This investment will be made at net asset value. It will not be subject to a minimum investment amount except that you must hold shares in such fund (including the shares being acquired with the dividend or distribution) with a value at least equal to such fund's minimum initial investment amount. SYSTEMATIC WITHDRAWAL PLAN If your account has a value of $5,000 or more, you may establish a Systematic Withdrawal Plan for either of the Funds. This plan will allow you to receive regular periodic payments by redeeming as many shares from your account as necessary. As with other redemptions, a redemption to make a 31 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING withdrawal is a sale for federal income tax purposes. Payments made under a Systematic Withdrawal Plan cannot be considered as actual yield or income since part of the payments may be a return of capital. A request to establish a Systematic Withdrawal Plan must be submitted in writing to your Piper Jaffray Investment Executive or other broker-dealer. There are no service charges for maintenance; the minimum amount that you may withdraw each period is $100. You will be required to have any income dividends and any capital gains distributions reinvested. You may choose to have withdrawals made monthly, quarterly or semiannually. Please contact your Piper Jaffray Investment Executive, other broker-dealer or IFTC for more information. With respect to Adjustable Portfolio, you should be aware that additional investments in an account that has an active Systematic Withdrawal Plan may be inadvisable due to sales charges and tax liabilities. Please refer to "Redemption of Shares" in the Statement of Additional Information for additional details. ACCOUNT PROTECTION If you purchased your shares of either Fund through a Piper Jaffray Investment Executive, you may choose from several account options. Your investments in a Fund held in a Piper Jaffray account (except for non-"PAT" accounts) would be protected up to $25 million. Investments held in non-"PAT" Piper Jaffray accounts are protected up to $2.5 million. In each case, the Securities Investor Protection Corporation ("SIPC") provides $500,000 of protection; the additional coverage is provided by The Aetna Casualty & Surety Company. This protection does not cover any declines in the net asset value of Fund shares. CONFIRMATION OF TRANSACTIONS AND REPORTING OF OTHER INFORMATION Each time there is a transaction involving your Fund shares, such as a purchase, redemption or dividend reinvestment, you will receive a confirmation statement describing that activity. This information will be provided to you from either Piper Jaffray, your broker-dealer or IFTC. In addition, you will receive various IRS forms after the first of each year detailing important tax information. Each Fund is required to supply annual and semiannual reports that list securities held by the Fund and include the current financial statements of the Fund. HOUSEHOLDING. If you have multiple accounts with Piper Jaffray, you may receive some of the above information in combined mailings. This will not only help to reduce Fund expenses, it will help the environment by saving paper. Please contact your Piper Jaffray Investment Executive for more information. DIVIDENDS AND DISTRIBUTIONS The net investment income of each Fund will be declared as dividends daily and will be paid monthly. Net realized capital gains, if any, will be distributed on an annual basis. For Adjustable Portfolio, shares begin accruing dividends on the date on which payment for such shares has been received by the Distributor or IFTC, as appropriate, and shares redeemed will earn dividends through the day prior to settlement of the redemption. For Money Market Fund, shares will begin accruing 32 - - - -------------------------------------------------------------------------------- SHAREHOLDER GUIDE TO INVESTING dividends on the date on which payment is received, provided such payment is received by 12:00 noon, New York time. If a redemption request for shares of Money Market Fund is received by 12:00 noon, New York time, shares will be redeemed that day and a dividend will not be earned. Adjustable Portfolio may at times pay out less than the entire amount of net investment income earned in any particular period in order to permit the Fund to maintain a more stable level of distributions. Any such amount retained by the Fund would be available to stabilize future distributions. As a result, the distributions paid by the Fund for any particular period may be more or less than the amount of net investment income earned by the Fund during such period. DISTRIBUTION OPTIONS. All net investment income dividends and net realized capital gains distributions for a Fund generally will be payable in additional shares of that Fund at net asset value ("Reinvestment Option"). If you wish to receive your distributions in cash, you must notify your Piper Jaffray Investment Executive or other broker-dealer. You may elect either to receive income dividends in cash and capital gains distributions in additional shares of the Fund at net asset value ("Split Option"), or to receive both income dividends and capital gains distributions in cash ("Cash Option"). You may also direct income dividends and capital gains distributions to be invested in another mutual fund managed by the Adviser. See "Shareholder Services -- Directed Dividends," above. The taxable status of income dividends and/or net capital gains distributions is not affected by whether they are reinvested or paid in cash. 33 VALUATION OF SHARES The Funds determine their net asset value on each day the New York Stock Exchange (the "Exchange") is open for business. The calculation is made as of the regular close of the Exchange (currently 4:00 p.m. New York time) after the Funds have declared any applicable dividends. The net asset value of Money Market Fund is also determined each business day at 12:00 noon (New York time). The net asset value per share for Adjustable Portfolio is determined by dividing the value of the securities owned by the Fund plus any cash and other assets (including interest accrued and dividends declared but not collected) less all liabilities by the number of Fund shares outstanding. For the purpose of determining the aggregate net assets of Adjustable Portfolio, cash and receivables will be valued at their face amounts. Interest will be recorded as accrued and dividends will be recorded on the ex-dividend date. The value of certain fixed-income securities held by Adjustable Portfolio will be provided by an independent pricing service, which determines these valuations at a time earlier than the close of the Exchange. Pricing services consider such factors as security prices, yields, maturities, call features, rating and developments relating to specific securities in arriving at securities valuations. Fixed-income securities for which prices are not available from an independent pricing service but where an active market exists will be valued using market quotations obtained from one or more dealers that make markets in the securities. Occasionally events affecting the value of such securities may occur between the time valuations are determined and the close of the Exchange. If events materially affecting the value of such securities occur during such period, or if management determines for any other reason that valuations provided by the pricing service are inaccurate, such securities will be valued at their fair value according to procedures decided upon in good faith by the Company's Board of Directors. In addition, any securities or other assets of Adjustable Portfolio for which market prices are not readily available will be valued at their fair value in accordance with such procedures. It is the policy of Money Fund to attempt to maintain a net asset value per share of $1.00. The securities held are valued on the basis of amortized cost, in accordance with the Fund's election to operate under the provisions of Rule 2a-7 under the 1940 Act. The amortized cost method of valuation involves valuing an instrument at its cost and thereafter assuming a constant amortization to maturity of a discount or premium, regardless of the impact of fluctuating interest rates on the market value of the instrument. While this method provides certainty in valuation, it may result in periods during which value as determined by amortized cost is higher or lower than the price the Fund would receive if it sold the instrument. Under the direction of the Board of Directors, procedures have been adopted to monitor and stabilize the price per share. Calculations are made to compare the value of the Fund's portfolio valued at amortized cost with market values. In the event that a deviation of one-half of 1% or more exists between the $1.00 per share net asset value for the Fund and the net asset value calculated by reference to market quotations, or if there is any other deviation which the Board of Directors believes would result in a material dilution to shareholders or purchasers, the Board of Directors will promptly consider what action, if any, should be initiated. See "Net Asset Value and Public Offering Price" in the Statement of Additional Information. 34 TAX STATUS Each Fund is treated as a separate corporation for federal tax purposes. Therefore, each Fund is treated separately in determining whether it qualifies as a regulated investment company and for purposes of determining the net ordinary income (or loss), net realized capital gains (or losses) and distributions necessary to relieve such Fund of any federal income tax liability. Each Fund qualified as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), during its last taxable year and intends to qualify as a regulated investment company during the current taxable year. If so qualified, a Fund will not be liable for federal income taxes to the extent it distributes its taxable income to shareholders. Distributions by a Fund are generally taxable to shareholders, whether received in cash or additional shares of the Fund (or shares of another mutual fund managed by the Adviser). Distributions of net capital gains (designated as "capital gain dividends") by Adjustable Portfolio, if any, are taxable to shareholders as long-term capital gains, regardless of the length of time the shareholder has held the shares of the Fund. A shareholder will recognize a capital gain or loss upon the sale or exchange of Fund shares if, as is normally the case, the shares are capital assets in the shareholder's hands. This capital gain or loss will be long-term if the shares have been held for more than one year. The foregoing relates to federal income taxation as in effect as of the date of this Prospectus. For a more detailed discussion of the federal income tax consequences of investing in shares of the Funds, see "Taxation" in the Statement of Additional Information. Before investing in either of the Funds, you should check the consequences of your local and state tax laws. PERFORMANCE COMPARISONS Advertisements and other sales literature for Adjustable Portfolio may refer to the Fund's "average annual total return" and "cumulative total return." In addition, both Funds may provide yield calculations in advertisements and other sales literature. All such yield and total return quotations are based upon historical earnings and are not intended to indicate future performance. Yield calculations for Adjustable Portfolio will be based upon a 30-day period stated in the advertisement and will be calculated by dividing the net investment income per share (as defined under SEC rules and regulations) earned during the advertised period by the offering price per share (including the maximum sales charge) on the last day of the period. The result will then be "annualized" using a formula that provides for semi-annual compounding of income. Money Market Fund may advertise its "yield" and "effective yield." The "yield" of Money Market Fund refers to the income generated by an investment in the Fund over a seven-day period stated in the advertisement. This income is then "annualized." That is, the amount of income generated by the investment during that week is assumed to be generated each week over a 52-week period and is shown as a percentage of the investment. The "effective yield" is calculated similarly but, when annualized, the income earned by an investment in the Fund is assumed to be reinvested. The "effective yield" will be slightly higher than the "yield" because of the compounding effect of this assumed reinvestment. Average annual total return is the average annual compounded rate of return on a hypothetical $1,000 investment made at the beginning of the advertised period. Cumulative total return is calculated by subtracting a hypothetical $1,000 payment to the Fund from the redeemable value of such 35 payment at the end of the advertised period, dividing such difference by $1,000 and multiplying the quotient by 100. In calculating average annual and cumulative total return, the maximum sales charge is deducted from the hypothetical investment and all dividends and distributions are assumed to be reinvested. In addition to advertising total return and yield, comparative performance information may be used from time to time in advertising the Funds' shares. For example, advertisements may compare a Fund's performance to that of various unmanaged market indices, or may include performance data from Lipper Analytical Services, Inc., Morningstar, Inc. or other entities or organizations which track the performance of investment companies. For additional information regarding comparative performance information and the calculation of yield, average annual total return and cumulative total return, see "Performance Comparisons" in the Statement of Additional Information. Advertisements and other sales literature may also refer to Adjustable Portfolio's effective duration. Effective duration estimates the interest rate risk (price volatility) of a security, I.E., how much the value of the security is expected to change with a given change in interest rates. The longer a security's effective duration, the more sensitive its price is to changes in interest rates. For example, if interest rates were to increase by 1%, the market value of a bond with an effective duration of five years would decrease by about 5%, with all other factors being constant. It is important to understand that, while a valuable measure, effective duration is based on certain assumptions and has several limitations. It is most useful as a measure of interest rate risk when interest rate changes are small, rapid and occur equally across all the different points of the yield curve. In addition, effective duration is difficult to calculate precisely for bonds with prepayment options, such as mortgage-backed securities, because the calculation requires assumptions about prepayment rates. For example, when interest rates go down, homeowners may prepay their mortgages at a higher rate than assumed in the initial effective duration calculation, thereby shortening the effective duration of Adjustable Portfolio's mortgage-backed securities. Conversely, if rates increase, prepayments may decrease to a greater extent than assumed, extending the effective duration of such securities. For these reasons, the effective durations of funds which invest a significant portion of their assets in mortgage-backed securities, particularly mortgage derivative securities, can be greatly affected by changes in interest rates. GENERAL INFORMATION The Company is authorized to issue a total of 10 trillion shares of common stock with a par value of $.01 per share. One hundred and ten billion of these shares have been authorized by the Board of Directors to be issued in two separate series: ten billion shares designated as Series A Common Shares, which are the shares of common stock of Adjustable Portfolio, and one hundred billion shares designated as Series B Common Shares, which are the shares of common stock of Money Market Fund. The Board of Directors is empowered under the Company's Articles of Incorporation to issue other series of the Company's common stock without shareholder approval. In addition, the Board of Directors may, without shareholder approval, create and issue one or more additional classes of shares within each Fund, as well as within any series of the Company created in the future. See "Capital Stock and Ownership of Shares" in the Statement of Additional Information. 36 All shares, when issued, will be fully paid and nonassessable and will be redeemable. All shares have equal voting rights. They can be issued as full or fractional shares. A fractional share has pro-rata the same kind of rights and privileges as a full share. The shares possess no preemptive or conversion rights. Each share of a series has one vote (with proportionate voting for fractional shares) irrespective of the relative net asset value of the series' shares. On some issues, such as the election of directors, all shares of the Company vote together as one series. On an issue affecting only a particular series, the shares of the affected series vote separately. Cumulative voting is not authorized. This means that the holders of more than 50% of the shares voting for the election of directors can elect 100% of the directors if they choose to do so, and, in such event, the holders of the remaining shares will be unable to elect any directors. The Bylaws of the Company provide that shareholder meetings be held only with such frequency as required under Minnesota law. Minnesota corporation law requires only that the Board of Directors convene shareholder meetings when it deems appropriate. In addition, Minnesota law provides that if a regular meeting of shareholders has not been held during the immediately preceding 15 months, a shareholder or shareholders holding 3% or more of the voting shares of the Company may demand a regular meeting of shareholders by written notice given to the chief executive officer or chief financial officer of the Company. Within 30 days after receipt of the demand, the Board of Directors shall cause a regular meeting of shareholders to be called, which meeting shall be held no later than 90 days after receipt of the demand, all at the expense of the Company. In addition, the 1940 Act requires a shareholder vote for all amendments to fundamental investment policies and restrictions and for all amendments to investment advisory contract. The 1940 Act also provides that Directors of the Company may be removed by action of the record holders of two-thirds or more of the outstanding shares of the Company. The Directors are required to call a meeting of shareholders for the purpose of voting upon the question of removal of any Director when so requested in writing by the record holders of at least 10% of the Company's outstanding shares. PENDING LEGAL PROCEEDINGS Complaints have been brought against the Adviser and the Distributor relating to certain investment companies for which the Adviser acts or has acted as investment adviser or subadviser. These lawsuits do not involve the Funds. A number of complaints have been brought in federal and state court against the Institutional Government Income Portfolio ("PJIGX") series of Piper Funds Inc., the Adviser, the Distributor, and certain individuals affiliated or formerly affiliated with the Adviser and the Distributor. In addition, complaints have been filed in federal court relating to a number of closed-end investment companies managed by the Adviser and two open-end investment companies for which the Adviser has acted as sub-adviser. The complaints, which ask for rescission of plaintiff shareholders' purchases or compensatory damages, plus interest, costs and expenses, generally allege, among other things, certain violations of federal and/or state securities laws, including the making of materially misleading statements in prospectuses concerning investment policies and risks. See "Pending Litigation" in the Statement of Additional Information. On February 13, 1996, a Settlement Agreement became effective for the consolidated class action lawsuit, titled In Re: PIPER FUNDS INC. INSTITUTIONAL GOVERNMENT INCOME PORTFOLIO LITIGATION. The Amended Consolidated Class Action Complaint was filed on October 5, 1994, in the United States District Court, District of Minnesota, against PJIGX, Piper Capital Management Incorporated 37 ("PCM"), Piper Jaffray Inc., William H. Ellis and Edward J. Kohler, and had alleged the making of materially misleading statements in the prospectus, common law negligent misrepresentation and breach of fiduciary duty. The Settlement Agreement will provide approximately $67.5 million, together with interest earned, less certain disbursements and attorney fees, to class members in payments scheduled over approximately three years. Such payments will be made by Piper Jaffray Companies Inc. and PCM and will not be an obligation of Piper Funds Inc. Three lawsuits and a number of arbitrations brought by some of the investors who requested exclusion from the settlement class remain pending. The Adviser and the Distributor do not believe that the PJIGX settlement or any outstanding complaint or action in arbitration will have a material adverse effect on their ability to perform under their agreements with the Company or a material adverse effect on the Funds, and they intend to defend such lawsuits and actions vigorously. NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS (AND/OR IN THE STATEMENT OF ADDITIONAL INFORMATION REFERRED TO ON THE COVER PAGE OF THIS PROSPECTUS), AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUNDS OR PIPER JAFFRAY INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY STATE IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. 38 APPENDIX A FOREIGN CURRENCY TRANSACTIONS As noted in the Prospectus, Adjustable Portfolio may invest up to 10% of its assets in securities denominated in Canadian dollars. Adjustable Portfolio may engage in foreign currency exchange transactions to protect against uncertainty in the level of the rate of exchange between Canadian and U.S. dollars. The Fund may engage in such transactions in connection with the purchase and sale of portfolio securities ("transaction hedging") and to protect the value of specific portfolio positions ("position hedging"). Adjustable Portfolio may engage in transaction hedging to protect against a change in the exchange rate between the date on which the Fund contracts to purchase or sell the security and the settlement date, or to "lock in" the U.S. dollar equivalent of a dividend or interest payment in Canadian dollars. For that purpose, Adjustable Portfolio may purchase or sell Canadian dollars on a spot (or cash) basis at the prevailing spot rate in connection with the settlement of transactions in portfolio securities denominated in Canadian dollars. If conditions warrant, Adjustable Portfolio may also enter into contracts to purchase or sell Canadian dollars at a future date ("forward contracts") and purchase and sell Canadian dollars or futures contracts as a hedge against changes in Canadian dollars or exchange rates between the trade and settlement dates on particular transactions and not for speculation. A foreign currency forward contract is a negotiated agreement to exchange currency at a future time at a rate or rates that may be higher or lower than the spot rate. Foreign currency futures contracts are standardized exchange-traded contracts and have margin requirements. For transaction hedging purposes, Adjustable Portfolio may also purchase exchange-listed and over-the-counter call and put options on Canadian dollars or futures contracts thereon. A put option on a futures contract gives the Fund the right to assume a short position in the futures contract until expiration of the option. A put option on currency gives the Fund the right to sell a currency at an exercise price until the expiration of the option. A call option on a futures contract gives the Fund the right to assume a long position in the futures contract until the expiration of the option. A call option on currency gives the Fund the right to purchase a currency at the exercise price until the expiration of the option. Adjustable Portfolio may engage in position hedging to protect against a decline in the value relative to the U.S. dollar in its securities, denominated in Canadian dollars (or an increase in the value of the Canadian dollar for securities which the Fund intends to buy, when it holds cash reserves and short-term investments). For position hedging purposes, Adjustable Portfolio may purchase or sell Canadian dollar futures contracts and forward contracts, and may purchase put or call options on Canadian dollars or on futures contracts thereon on exchanges or over-the-counter markets. In connection with position hedging, Adjustable Portfolio may also purchase or sell Canadian dollars on a spot basis. The precise matching of the amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the value of these securities between the dates the currency exchange transactions are entered into and the dates they mature. It is impossible to forecast with precision the market value of portfolio securities at the expiration or maturity of a forward or futures contract. Accordingly, it may be necessary for Adjustable Portfolio A-1 to purchase additional Canadian dollars on the spot market (and bear the expenses of such purchase) if the market value of the security or securities being hedged is less than the amount of Canadian dollars the Fund is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the Canadian dollars. Conversely, it may be necessary to sell on the spot market some of the Canadian dollars received upon the sale of the portfolio security or securities if the market value of such security or securities exceeds the amount of Canadian dollars the Fund is obligated to deliver. Hedging transactions involve costs and may result in losses. Adjustable Portfolio may write covered call options on Canadian dollars to offset some of such costs. The Fund may engage in over-the-counter transactions only when appropriate exchange-traded transactions are unavailable and when, in the opinion of the Adviser, the pricing mechanism and liquidity are satisfactory and the participants are responsible parties likely to meet their contractual obligations. Adjustable Portfolio's ability to engage in hedging and related option transactions may be limited by tax considerations. See "Taxation" in the Statement of Additional Information. Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities which Adjustable Portfolio owns or intends to purchase or sell. They simply establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they tend to limit any potential gain which might result from the increase in the value of such currency. A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract as agreed by the parties, at a price set at the time of the contract. In the case of a cancellable forward contract, the holder has the unilateral right to cancel the contract at maturity by paying a specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. A forward contract generally has no deposit requirement, and no commissions are charged at any stage for trades. A foreign currency futures contract is a standardized contract for the future delivery of a specified amount of a foreign currency at a future date at a price set at the time of the contract. Foreign currency futures contracts traded in the United States are designated by and traded on exchanges regulated by the Commodity Futures Trading Commission (the "CFTC"), such as the New York Mercantile Exchange. Adjustable Portfolio would enter into foreign currency futures contracts solely for hedging or other appropriate risk management purposes as defined in CFTC regulations. Forward foreign currency exchange contracts differ from foreign currency futures contracts in certain respects. For example, the maturity date of a forward contract may be any fixed number of days from the date of the contract agreed upon by the parties, rather than a predetermined date in any given month. Also, forward foreign exchange contracts are traded directly between currency traders so that no intermediary is required. A forward contract generally requires no margin or other deposit. At the maturity of a forward or futures contract, Adjustable Portfolio may either accept or make delivery of the currency specified in the contract, or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward contracts are effected with the currency trader who is a party to the original forward contract. Closing transactions with respect to futures contracts are effected on a commodities exchange; a clearing corporation associated with the exchange assumes responsibility for closing out such contracts. A-2 Positions in foreign currency futures contracts may be closed out only on an exchange or board of trade which provides a secondary market for such contracts. Although Adjustable Portfolio intends to purchase or sell foreign currency futures contracts only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a secondary market on an exchange or board of trade will exist for any particular contract or at any particular time. In such event, it may not be possible to close a futures position and, in the event of adverse price movements, Adjustable Portfolio would continue to be required to make daily cash payments of variation margin. Options on foreign currencies operate similarly to options on securities, and are traded primarily in the over-the-counter market, although options on foreign currencies have recently been listed on several exchanges. Options traded in the over-the-counter market are illiquid and it may not be possible for Adjustable Portfolio to dispose of an option it has purchased or terminate its obligations under an option it has written at a time when the Adviser believes it would be advantageous to do so. Options on futures contracts are affected by all of those factors which influence foreign exchange rates and investments generally. The value of a foreign currency option is dependent upon the value of the foreign currency and the U.S. dollar, and may have no relationship to the investment merits of a foreign debt security. Because foreign currency transactions occurring in the interbank market involve substantially larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign currencies at prices that are less favorable than for round lots. There is no systematic reporting of last sale information for foreign currencies and there is no regulatory requirement that quotations available through dealers or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of very large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global, around-the-clock market. To the extent the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in the options markets. In addition, significant price and rate movements that take place while U.S. markets are closed will not be reflected in the price of Fund shares until net asset value is next determined (as of the primary closing time of the New York Stock Exchange). Although foreign exchange dealers do not charge a fee for currency conversion, they do realize a profit based upon the difference (the "spread") between prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to Adjustable Portfolio at one rate, while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer. A-3 PIPER INSTITUTIONAL FUNDS INC. INVESTMENT ADVISER PIPER CAPITAL MANAGEMENT INCORPORATED DISTRIBUTOR PIPER JAFFRAY INC. CUSTODIAN AND TRANSFER AGENT INVESTORS FIDUCIARY TRUST COMPANY INDEPENDENT AUDITORS KPMG PEAT MARWICK LLP LEGAL COUNSEL DORSEY & WHITNEY LLP Table of Contents
PAGE ----- Introduction................................... 2 Fund Expenses.................................. 4 Financial Highlights........................... 5 Investment Objectives and Policies............. 7 Special Investment Methods..................... 17 Management..................................... 24 SHAREHOLDER GUIDE TO INVESTING How to Purchase Shares....................... 26 Reducing Your Sales Charge................... 27 Special Purchase Plans....................... 28 How to Redeem Shares......................... 29 Shareholder Services......................... 30 Dividends and Distributions.................. 32 Valuation of Shares............................ 34 Tax Status..................................... 35 Performance Comparisons........................ 35 General Information............................ 36 Appendix A -- Foreign Currency Transactions.... A-1
INSTITUTIONAL MONEY MARKET FUND INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO NOVEMBER 1, 1995, AS SUPPLEMENTED JUNE 24, 1996 PIF-05 PART B STATEMENT OF ADDITIONAL INFORMATION dated ________, 1996 ADUSTABLE RATE MORTGAGE SECURITIES FUND A Series of Piper Funds Inc. -- II Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402-3804 (800) 866-7778 __________________________________ Acquisition of the Assets of Institutional Government Adjustable Portfolio A Series of Piper Institutional Funds Inc. By and in Exchange for Shares of Adjustable Rate Mortgage Securities Fund a Series of Piper Funds Inc. -- II __________________________________ This Statement of Additional Information relates to the proposed Agreement and Plan of Reorganization providing for the acquisition of substantially all of the assets and the assumption of all stated liabilities of Institutional Government Adjustable Portfolio ("Adjustable Portfolio"), a series of Piper Institutional Funds Inc. ("Piper Institutional") by Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), a series of Piper Funds Inc. -- II ("Piper Funds II"), in exchange for shares of common stock of Adjustable Rate Fund. This Statement of Additional Information consists of this cover page and the following documents which are incorporated by reference herein: 1. The Statement of Additional Information dated December 18, 1995 of Piper Funds II. 2. The Annual Report of Piper Funds II for the fiscal year ended August 31, 1995. 3. The Semiannual Report of Piper Funds II for the six months ended February 29, 1996. 4. The Statement of Additional Information dated November 1, 1995 of Piper Institutional. 5. The Annual Report of Piper Institutional for the fiscal year ended June 30, 1996. Financial statements required pursuant to Form N-14 are included in the above documents which have been incorporated by reference herein. Pro forma financial statements are not required because the net asset value of Adjustable Portfolio does not exceed ten percent of the net asset value of Adjustable Rate Fund, measured as of the June 30, 1996. This Statement of Additional Information is not a prospectus. A Prospectus/Proxy Statement dated ________, 1996 relating to the above-referenced transaction accompanies this Statement of Additional Information and should be read in conjunction herewith. PART B ADJUSTABLE RATE MORTGAGE SECURITIES FUND A series of Piper Funds Inc.--II STATEMENT OF ADDITIONAL INFORMATION December 18, 1995 Table of Contents Investment Objective, Policies and Restrictions ................ 2 Directors and Executive Officers ............................... 10 Investment Advisory and Other Services ......................... 14 Portfolio Transactions and Allocation of Brokerage ............. 19 Capital Stock and Ownership of Shares .......................... 21 Net Asset Value and Public Offering Price ...................... 22 Performance Comparisons ........................................ 23 Purchase of Shares ............................................. 25 Redemption of Shares ........................................... 25 Taxation ....................................................... 27 General Information ............................................ 29 Financial Statements ........................................... 30 Pending Litigation ............................................. 30 Appendix A - Corporate Bond and Commercial Paper Ratings ....... A-1 Appendix B - Interest Rate Futures Contracts and Related Options B-1 This Statement of Additional Information is not a prospectus. This Statement of Additional Information relates to the Prospectus dated December 18, 1995, and should be read in conjunction therewith. A copy of the Prospectus may be obtained without charge by mailing a written request to the Fund at Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804, or by calling (800) 866-7778. INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS This Statement of Additional Information relates to Adjustable Rate Mortgage Securities Fund (the "Fund"), the only outstanding series of Piper Funds Inc.--II (the "Company"). On September 1, 1995, four closed-end investment companies, American Adjustable Rate Term Trust Inc.--1996, American Adjustable Rate Term Trust Inc.--1997, American Adjustable Rate Term Trust Inc.--1998 and American Adjustable Rate Term Trust Inc.--1999, merged into the Fund (the "Merger"). The Fund has no history of operations prior to the Merger. In this Statement of Additional Information, certain performance and financial information is provided for the Fund for periods prior to September 1, 1995. Such information relates to American Adjustable Rate Term Trust Inc.--1998 ("DDJ"), the surviving entity of the Merger for financial reporting purposes. The investment objective and policies of the Fund are set forth in the Prospectus. Certain additional investment information is set forth below. Repurchase Agreements The Fund may invest in repurchase agreements pertaining to the securities in which it may invest. The Fund's custodian will hold the securities underlying any repurchase agreement or such securities will be part of the Federal Reserve Book Entry System. The market value of the collateral underlying the repurchase agreement will be determined on each business day. If at any time the market value of the collateral falls below the repurchase price of the repurchase agreement (including any accrued interest), the Fund will promptly receive additional collateral (so the total collateral is an amount at least equal to the repurchase price plus accrued interest). The closed-end and open-end investment companies currently managed by Piper Capital Management Incorporated (the "Adviser") and all future investment companies advised by the Adviser or its affiliates have received from the Securities and Exchange Commission an exemptive order permitting them to deposit uninvested cash balances into a large single joint account to be used to enter into one or more large repurchase agreements. Mortgage-Backed Securities GENERAL. Many Mortgage-Backed Securities (principally collateralized mortgage obligations ("CMOs") secured by GNMA, FNMA and/or FHLMC Certificates) are issued by entities that operate under orders from the Securities and Exchange Commission (the "SEC") exempting such issuers from the provisions of the Investment Company Act of 1940, as amended (the "1940 Act"). Until recently, the staff of the Division of Investment Management of the SEC had taken the position that such issuers were investment companies pursuant to Section 3 of the 1940 Act and that, accordingly, an investment by an investment company (such as the Fund) in the securities of such issuers was subject to limitations imposed by Section 12 of the 1940 Act. However, in reliance on a recent SEC staff interpretation, the Fund may invest in securities issued by certain "exempted issuers" without regard to the limitations of Section 12 of the 1940 Act. In its interpretation, the SEC staff defined "exempted issuers" as unmanaged, fixed asset issuers that (a) invest primarily in Mortgage-Backed Securities, (b) do not issue redeemable securities as defined in Section 2(a)(32) of the Act, (c) operate under general exemptive orders exempting them from "all provisions of the [1940] Act" and (d) are not registered or regulated under the 1940 Act as investment companies. PASS-THROUGH SECURITIES. The investments of the Fund in Mortgage-Backed Securities include government guaranteed pass-through securities. These obligations are described below. (1) GNMA Certificates. Certificates of the Government National Mortgage Association ("GNMA Certificates") are Mortgage-Backed Securities which evidence an ownership interest in a pool of mortgage loans. GNMA Certificates differ from bonds in that principal is paid back monthly by the borrower over the term of the loan rather than returned in a lump sum at maturity. GNMA Guarantee -- The National Housing Act authorizes GNMA to guarantee the timely payment of principal and interest on securities backed by a pool of mortgages insured by the Federal Housing Administration ("FHA") or the Farmers' Home Administration ("FHA") or guaranteed by the Veterans Administration ("VA"). The GNMA guarantee is backed by the full faith and credit of the United States. GNMA is also empowered to borrow without limitation from the U.S. Treasury if necessary to make any payments required under its guarantee. Life of GNMA Certificates -- The average life of a GNMA Certificate is likely to be substantially less than the original maturity of the mortgage pools underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosures will usually result in the return of the greater part of principal investment long before the maturity of the mortgages in the pool. Foreclosures impose no risk to principal investment because of the GNMA guarantee. Because prepayment rates of individual mortgage pools vary widely, it is not possible to predict accurately the average life of a particular issue of GNMA Certificates. However, statistics published by the FHA indicate that the average life of single-family dwelling mortgages with 25- to 30-year maturities, the type of mortgages backing the vast majority of GNMA Certificates, is approximately 12 years. Therefore, it is customary to treat GNMA Certificates as 30-year mortgage-backed securities which prepay fully in the twelfth year. Yield Characteristics of GNMA Certificates -- The coupon rate of interest on GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or FHA-insured mortgages underlying the Certificates by the amount of the fees paid to GNMA and the issuer. The coupon rate by itself, however, does not indicate the yield which will be earned on GNMA Certificates. First, GNMA Certificates may be issued at a premium or discount, rather than at par and, after issuance, GNMA Certificates may trade in the secondary market at a premium or discount. Second, interest is earned monthly, rather than semi-annually as with traditional bonds; monthly compounding raises the effective yield earned. Finally, the actual yield of a GNMA Certificate is influenced by the prepayment experience of the mortgage pool underlying it. For example, if the higher-yielding mortgages from the pool are prepaid, the yield on the remaining pool will be reduced. (2) FHLMC Securities. The Federal Home Loan Mortgage Corporation ("FHLMC") was created in 1970 through enactment of Title III of the Emergency Home Finance Act of 1970. Its purpose is to promote development of a nationwide secondary market in conventional residential mortgages. FHLMC issues two types of mortgage pass-through securities, mortgage participation certificates ("PCs") and guaranteed mortgage certificates ("GMCs"). PCs resemble GNMA Certificates in that each PC represents a pro rata share of all interest and principal payments made and owed on the underlying pool. FHLMC guarantees timely payment of interest on PCs and the full return of principal. Like GNMA Certificates, PCs are assumed to be prepaid fully in their twelfth year. GMCs also represent a pro rata interest in a pool of mortgages. However, these instruments pay interest semi-annually and return principal once a year in guaranteed minimum payments. The expected average life of these securities is approximately ten years. (3) FNMA Securities. The Federal National Mortgage Association was established in 1938 to create a secondary market in mortgages insured by the FHA. FNMA issues guaranteed mortgage pass-through certificates ("FNMA Certificates"). FNMA Certificates resemble GNMA Certificates in that each FNMA Certificate represents a pro rata share of all interest and principal payments made and owed on the underlying pool. FNMA guarantees timely payment of interest on FNMA Certificates and the full return of principal. Like GNMA Certificates, FNMA Certificates are assumed to be prepaid fully in their twelfth year. CREDIT SUPPORT. To lessen the effect of failures by mortgagors to make payments on underlying mortgages, ARMS and other Mortgage-Backed Securities may contain elements of credit support. Such credit support falls into two categories: (a) liquidity protection and (b) protection against losses resulting from ultimate default by an obligor on the underlying assets. Liquidity protection refers to the provision of advances, generally by the entity administering the pool of assets, to ensure that the pass-through of payments due on the underlying pool occurs in a timely fashion. Protection against losses resulting from ultimate default enhances the likelihood of ultimate payment of the obligations on at least a portion of the assets in the pool. Such protection may be provided through guarantees, insurance policies or letters of credit obtained by the issuer or sponsor from third parties, through various means of structuring the transaction or through a combination of such approaches. The Fund will not pay any additional fees for such credit support, although the existence of credit support may increase the price of a security. The ratings of securities for which third-party credit enhancement provides liquidity protection or protection against losses from default are generally dependent upon the continued creditworthiness of the enhancement provider. The ratings of such securities could be subject to reduction in the event of deterioration in the creditworthiness of the credit enhancement provider even in cases where the delinquency and loss experience on the underlying pool of assets is better than expected. Examples of credit support arising out of the structure of the transaction include "senior-subordinated securities" (multiple class securities with one or more classes subordinate to other classes as to the payment of principal thereof and interest thereon, with the result that defaults on the underlying assets are borne first by the holders of the subordinated class), creation of "reserve funds" (where cash or investments, sometimes funded from a portion of the payments on the underlying assets, are held in reserve against future losses) and "over-collateralization" (where the scheduled payments on, or the principal amount of, the underlying assets exceed those required to make payment on the securities and pay any servicing or other fees). The degree of credit support provided for each issue is generally based on historical information with respect to the level of credit risk associated with the underlying assets. Other information which may be considered includes demographic factors, loan underwriting practices and general market and economic conditions. Delinquency or loss in excess of that which is anticipated could adversely affect the return on an investment in such a security. RESTRICTIONS ON INVESTMENTS IN MORTGAGE-BACKED SECURITIES. As set forth in the Prospectus, the Fund will not invest in any inverse floating, interest-only, principal-only or Z tranches of CMOs or in stripped Mortgage-Backed Securities. In addition, the Fund will not invest in any other Mortgage-Backed Securities that are considered "high risk" under applicable supervisory policies of the Office of the Comptroller of the Currency (the "OCC"). In OCC Banking Circular 228 (Rev.) (January 10, 1992), the OCC defined a "high-risk mortgage security" as any mortgage derivative product that at the time of purchase, or at a subsequent testing date, meets any of the following three tests: (a) Average Life Test. The mortgage derivative product has an expected weighted average life greater than 10.0 years. (b) Average Life Sensitivity Test. The expected weighted average life of the mortgage derivative product: (i) extends by more than 4.0 years, assuming an immediate and sustained parallel shift in the yield curve of plus 300 basis points; or (ii) shortens by more than 6.0 years, assuming an immediate and sustained parallel shift in the yield curve of minus 300 basis points. (c) Price Sensitivity Test. The estimated change in the price of the mortgage derivative product is more than 17%, due to an immediate and sustained parallel shift in the yield curve of plus or minus 300 basis points. Examples of certain "high-risk mortgage securities" include interest-only and principal-only classes of stripped mortgage-backed securities, inverse floating CMOs and certain zero coupon Treasury securities. Options As set forth in the Prospectus, the Fund may write covered put and call options with respect to the securities in which it may invest. The principal reason for writing call or put options is to obtain, through receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Fund receives premiums from writing call or put options, which it retains whether or not the option is exercised. The Fund will write only covered options. This means that so long as the Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option (or comparable securities satisfying the cover requirements of securities exchanges). The Fund will be considered covered with respect to a put option it writes if, so long as it is obligated as the writer of a put option, it deposits and maintains in a segregated account with its custodian cash, U.S. Government securities or other liquid high-grade debt obligations having a value equal to or greater than the exercise price of the option. The Fund may wish to protect certain portfolio securities against a decline in market value at a time when no put options on those particular securities are available for purchase. The Fund may therefore purchase a put option on securities other than those it wishes to protect even though it does not hold such other securities in its portfolio. While the Fund will only purchase put options on securities where, in the opinion of the Adviser, changes in the value of the put option should generally offset changes in the value of the securities to be hedged, the correlation will be less than in transactions in which the Fund purchases put options on underlying securities it owns. The writing by the Fund of options on securities will be subject to limitations established by each of the registered securities exchanges on which such options are traded. Such limitations govern the maximum number of options in each class which may be written by a single investor or group of investors acting in concert, regardless of whether the options are written on the same or different securities exchanges or are held or written on one or more accounts or through one or more brokers. Thus, the number of options which the Fund may write may be affected by options written by other investment companies managed by and other investment advisory clients of the Adviser. An exchange may order the liquidation of positions found to be in excess of these limits, and it may impose certain other sanctions. Illiquid Securities As set forth in the Prospectus, the Fund may invest in Rule 144A securities and commercial paper issued pursuant to Rule 4(2) under the Securities Act of 1933, and treat such securities as liquid when they have been determined to be liquid by the Board of Directors or by the Adviser subject to the oversight of and pursuant to procedures adopted by the Board of Directors. Under these procedures, factors taken into account in determining the liquidity of a security include (a) the frequency of trades and quotes for the security; (b) the number of dealers willing to purchase or sell the security and the number of other potential purchasers; (c) dealer undertakings to make a market in the security; and (d) the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers and the mechanics of transfer). Portfolio Turnover Portfolio turnover is the ratio of the lesser of annual purchases or sales of portfolio securities to the average monthly value of portfolio securities, not including securities maturing in less than 12 months. A 100% portfolio turnover rate would occur, for example, if the lesser of the value of purchases or sales of portfolio securities for a particular year were equal to the average monthly value of the portfolio securities owned during such year. Investment Restrictions In addition to the investment objective and policies set forth in the Prospectus, the Fund is subject to certain fundamental and nonfundamental investment restrictions, as set forth below. Fundamental investment restrictions may not be changed without the vote of a majority of the Fund's outstanding shares. "Majority," as used in the Prospectus and in this Statement of Additional Information, means the lesser of (a) 67% of the Fund's outstanding shares present at a meeting of the holders if more than 50% of the outstanding shares are present in person or by proxy or (b) more than 50% of the Fund's outstanding shares. As fundamental investment restrictions, the Fund will not: 1. With respect to 75% of its total assets, invest more than 5% of the value of its total assets (taken at market value at the time of purchase) in the outstanding securities of any one issuer, or own more than 10% of the outstanding voting securities of any one issuer, in each case other than securities issued or guaranteed by the U. S. Government or any agency or instrumentality thereof. 2. Invest 25% or more of the value of its total assets in the securities of issuers conducting their principal business activities in any one industry, except that, under normal market conditions, the Fund will invest 25% or more of the value of its total assets in ARMS issued or guaranteed by the U.S. Government or its agencies or instrumentalities or by private organizations. Except for the requirement that the Fund invest 25% or more of its total assets in ARMS, the foregoing restriction does not apply to securities of the U.S. Government or its agencies or instrumentalities or repurchase agreements relating thereto. 3. Issue any senior securities, as defined in the 1940 Act, other than as set forth in restriction #4 below and except to the extent that using options and futures contracts or purchasing or selling securities on a when-issued or forward commitment basis may be deemed to constitute issuing a senior security. 4. Borrow money, except for temporary or emergency purposes. The amount of such borrowing (including borrowing through reverse repurchase agreements) may not exceed 10% of the value of the Fund's total assets. The Fund will not purchase portfolio securities while outstanding borrowings exceeds 5% of the value of the Fund's total assets. The Fund will not borrow for leverage purposes. 5. Mortgage, pledge or hypothecate its assets, except in an amount not exceeding 10% of the value of its total assets to secure temporary or emergency borrowing. For purposes of this policy, collateral arrangements for margin deposits on futures contracts or with respect to the writing of options are not deemed to be a pledge of assets. 6. Purchase or sell commodities or commodity futures contracts, except that the Fund may enter into financial futures contracts and engage in related options transactions. 7. Purchase or sell real estate or interests therein (other than securities backed by mortgages and similar instruments). 8. Act as an underwriter of securities of other issuers, except insofar as the Fund may be technically deemed an underwriter under the federal securities laws in connection with the disposition of portfolio securities. 9. Make loans of money or property to any person, except through loans of portfolio securities, the purchase of debt obligations in which the Fund may invest consistent with the Fund's investment objective and policies or the acquisition of securities subject to repurchase agreements. For purposes of determining compliance with fundamental investment restriction number 2, relating to industry concentration, the various types of utilities companies, such as gas, electric, telephone, telegraph, satellite and microwave communications companies, are considered separate industries and ARMS issued by private organizations are considered to be securities of issuers in the same industry. In addition, the industry classification of Asset-Backed Securities will be determined based on the type of collateral underlying the securities. For example, Asset-Backed Securities backed by automobile receivables will be considered to be in a different industry than Asset-Backed Securities backed by credit card receivables. As nonfundamental investment restrictions that may be changed at any time without shareholder approval, the Fund will not: 1. Invest in warrants. 2. Make short sales of securities. 3. Purchase any securities on margin except to obtain such short-term credits as may be necessary for the clearance of transactions and except that the Fund may make margin deposits in connection with futures and options contracts. 4. Purchase or retain the securities of any issuer if, to the Fund's knowledge, those officers or directors of the Company or its affiliates or of its investment adviser who individually own beneficially more than 0.5% of the outstanding securities of such issuer, together own more than 5% of such outstanding securities. 5. Invest for the purpose of exercising control or management. 6. Purchase or sell oil, gas or other mineral leases, rights or royalty contracts, except that the Fund may purchase or sell securities of companies investing in the foregoing. 7. Purchase the securities of other investment companies except as part of a merger, consolidation or acquisition of assets. 8. Invest in real estate limited partnerships. 9. Invest in the securities of foreign issuers. 10. Invest more than 15% of its net assets in illiquid securities. In addition, as a nonfundamental policy, the Fund's transactions in options, futures contracts and options on futures contracts, will be subject to the following limitations: a. The Fund will not write puts if, as a result, more than 50% of its assets would be required to be segregated. b. The aggregate premiums paid on all put and call options purchased by the Fund, including options on futures contracts, may not exceed 20% of the Fund's net assets. c. The Fund's aggregate margin deposits in connection with futures contracts and options thereon will not exceed 5% of the Fund's total assets. d. The Fund will not purchase or write over-the-counter put and call options. Any investment restriction or limitation referred to above or in the Prospectus, except the borrowing policy, which involves a maximum percentage of securities or assets, shall not be considered to be violated unless an excess over the percentage occurs immediately after an acquisition of securities or utilization of assets and such excess results therefrom. DIRECTORS AND EXECUTIVE OFFICERS The names, addresses and principal occupations during the past five years of the directors and executive officers of the Fund are given below. Name, Address and Age Position with the Fund William H. Ellis* (53) Chairman of the Board Piper Jaffray Tower of Directors 222 South Ninth Street Minneapolis, Minnesota 55402 David T. Bennett (54) Director 3400 City Center 33 South Sixth Street Minneapolis, Minnesota 55402 Jaye F. Dyer (68) Director 4670 Norwest Center 90 South Seventh Street Minneapolis, Minnesota 55402 Karol D. Emmerich (46) Director 7302 Claredon Drive Edina, MN 55439 Luella G. Goldberg (58) Director 7019 Tupa Drive Edina, Minnesota 55439 George Latimer (59) Director 754 Linwood Avenue St. Paul, Minnesota 55105 Paul A. Dow (44) President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 David E. Rosedahl (48) Secretary Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Thomas S. McGlinch (38) Senior Vice President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Robert H. Nelson (31) Senior Vice President Piper Jaffray Tower and Treasurer 222 South Ninth Street Minneapolis, Minnesota 55402 Amy K. Johnson (29) Vice President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 * Directors of the Fund who are interested persons (as that term is defined by the 1940 Act) of Piper Capital Management Incorporated and the Fund. William H. Ellis has been President of Piper Jaffray Companies Inc. and Piper Jaffray Inc. (the "Distributor") since September 1982, Chief Operating Officer of the same two companies since August 1983, Director and Chairman of the Board of Piper Capital Management Incorporated ("the Adviser") since October 1985 and President of the Adviser since December 1994. David T. Bennett is of counsel to the law firm of Gray, Plant, Mooty, Mooty & Bennett, P.A., located in Minneapolis, Minnesota. Mr. Bennett is chairman of a group of privately held companies and serves on the board of directors of a number of nonprofit organizations. Jaye F. Dyer has been President of Dyer Management Company, a private management company, since January 1991. Prior to that he was President and Chief Executive Officer of Dyco Petroleum Corporation, a Minneapolis based oil and natural gas development company he founded, from 1971 to March 1, 1989, and Chairman of the Board until December 31, 1990. Mr. Dyer serves on the board of directors of Northwestern National Life Insurance Company, The ReliaStar Financial Corp. (the holding company of Northwestern National Life Insurance Company) and various privately held and nonprofit corporations. Karol D. Emmerich has been President of The Paraclete Group, a consultant to nonprofit organizations, since 1993. Prior to that she had been Vice President, Chief Accounting Officer and Treasurer of Dayton Hudson Corporation from 1980 to May 1993. Ms. Emmerich is an Executive Fellow at the University of St. Thomas Graduate School of Business and serves on the board of directors of a number of privately held and nonprofit organizations. Luella G. Goldberg has served on the board of directors of Northwestern National Life Insurance Company (since 1976), The ReliaStar Financial Corp. (since 1989), TCF Financial Corporation (since 1988), the holding company of TCF Bank Savings fsb, and Hormel Foods Corp. (since 1993). Ms. Goldberg also serves as a Trustee of Wellesley College, and as a director of a number of other organizations, including the University of Minnesota Foundation and the Minnesota Orchestral Association. Ms. Goldberg was Chairman of the Board of Trustees of Wellesley College from 1985 to 1993 and acting President from July 1, 1993 to October 1, 1993. George Latimer has been Chief Executive Officer of National Equity Fund, Chicago, Illinois since November 1995. Prior to that he was Director, Special Actions Office, Office of the Secretary, Department of Housing and Urban Development since 1993 and prior thereto, he had been Dean of Hamline Law School, Saint Paul, Minnesota from 1990 to 1993. Mr. Latimer also serves on the board of directors of Digital Biometrics, Inc. and Payless Cashways, Inc. Paul A. Dow has been a Senior Vice President of the Adviser since 1989 and Chief Investment Officer of the Adviser since 1989. David E. Rosedahl has been Secretary and a Director of the Adviser since 1985, a Managing Director of the Distributor since 1986, a Managing Director of Piper Jaffray Companies Inc. since 1987, Secretary of the Distributor since 1993 and General Counsel for the Distributor and Piper Jaffray Companies Inc. since 1979. Thomas S. McGlinch has been a Senior Vice President of the Adviser since November 1995, prior to which he had been a Vice President of the Adviser since November 1992 and, prior thereto, he had been a specialty products trader at FBS Investment Services, Inc. from 1988 to January 1992. Robert H. Nelson joined the Adviser in 1988 and has been a Senior Vice President of the Adviser since November 1993, prior to which he had been a Vice President of the Adviser from 1991 to 1993 and Assistant Vice President from 1989 to 1991. Amy K. Johnson has been a Vice President of the Adviser since November 1994, Accounting Manager of the Adviser from 1993 to 1994 and an employee of the Adviser since 1992. Prior to joining the Adviser, she was an audit senior with KPMG Peat Marwick LLP where she was employed from 1990 to 1992. Ms. Goldberg and Ms. Emmerich and Mr. Dyer are members of the Audit Committee of the Board of Directors. Ms. Goldberg acts as the chairperson of such committee. The Audit Committee oversees the Company's financial reporting process, reviews audit results and recommends annually to the Company a firm of independent certified public accountants. The Board of Directors also has a Committee of the Independent Directors, consisting of Mr. Bennett, who serves as chairperson, Messrs. Dyer, and Latimer, Ms. Emmerich and Ms. Goldberg, and a Derivatives Subcommittee consisting of Ms. Emmerich, who serves as chairperson, Ms. Goldberg and Mr. Dyer. The functions of the Committee of the Independent Directors are: (a) recommendation to the full Board of approval of any management, advisory, sub-advisory and/or administration agreements; (b) recommendation to the full Board of approval of any underwriting and/or distribution agreements; (c) review of the fidelity bond and premium allocation; (d) review of errors and omissions and any other joint insurance policies and premium allocation; (e) review of, and monitoring of compliance with, procedures adopted pursuant to certain rules promulgated under the 1940 Act; and (f) such other duties as the independent directors shall, from time to time, conclude are necessary or appropriate to carry out their duties under the 1940 Act. The functions of the Derivatives Committee are: (a) to oversee practices, policies and procedures of the Adviser in connection with the use of derivatives; (b) to receive periodic reports from management and independent accountants; and (c) to report periodically to the Committee of the Independent Directors and the Board of Directors. The directors of the Company who are officers or employees of the Adviser or any of its affiliates receive no remuneration from the Company. Each of the other directors receives from the Company a quarterly retainer of $1,000, plus a fee of $750 for each regular quarterly Board of Directors meeting attended. (The per-meeting fee will increase to $1,000 in the event total Company assets exceed $1 billion, and to $1,500 in the event total Company assets reach $5 billion or more.) In addition, members of the Audit Committee not affiliated with the Adviser receive $1,000 for each Audit Committee meeting attended ($2,000 with respect to the chairperson of the Committee), with such fee being allocated among the Company and all other publicly-held investment companies managed by the Adviser on the basis of relative net asset values. Members of the Committee of the Independent Directors and the Derivatives Subcommittee currently receive no additional compensation. Directors are also reimbursed for expenses incurred in connection with attending meetings. The following table sets forth the total compensation received by each director from all registered investment companies managed by the Adviser or affiliates of the Adviser during the calendar year ended December 31, 1994. Mr. Ellis, as an officer of the Adviser, did not receive any such compensation and is not included in the table. The directors did not receive any compensation from the Company or the Fund during the fiscal year ended August 31, 1995. The compensation received by each director from DDJ for the fiscal year ended August 31, 1995, was received pursuant to a fee schedule substantially different than that of the Company and the Fund and therefore is not included in the table. Pension or Retirement Estimated Total Benefits AnnualBenefits Compensation Accrued as Part Upon from Fund Director of Fund Expenses Retirement Complex* David T. Bennett None None $57,500 Jaye F. Dyer None None $68,250 Karol D. Emmerich None None $68,250 Luella G. Goldberg None None $71,250 George Latimer None None $65,250 * Consists of 26 registered investment companies managed by the Adviser or an affiliate of the Adviser, including the Company. Each director included in the table, other than Mr. Bennett, served on the board of each such registered investment company during 1994. Mr. Bennett served on the board of 24 such companies during 1994. INVESTMENT ADVISORY AND OTHER SERVICES The investment adviser for the Fund is Piper Capital Management Incorporated (the "Adviser"). Its affiliate, Piper Jaffray Inc. (the "Distributor"), acts as the Fund's distributor. Each acts as such pursuant to a written agreement which is periodically approved by the directors or the shareholders of the Fund. The address of both the Adviser and the Distributor is Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804. Control of the Adviser and the Distributor The Adviser and the Distributor are both wholly owned subsidiaries of Piper Jaffray Companies Inc., a publicly held corporation which is engaged through its subsidiaries in various aspects of the financial services industry. Investment Advisory and Management Agreement The Adviser acts as the investment adviser of the Fund under an Investment Advisory and Management Agreement which has been approved by the Board of Directors (including a majority of the directors who are not parties to the agreement, or interested persons of any such party, other than as directors of the Fund) and by the Fund's initial sole shareholder. The Investment Advisory and Management Agreement will terminate automatically in the event of its assignment. In addition, the agreement is terminable at any time, without penalty, by the Board of Directors of the Company or by vote of a majority of the Company's outstanding voting securities on not more than 60 days' written notice to the Adviser, and by the Adviser on 60 days' written notice to the Company. The agreement may be terminated at any time by a vote of the holders of a majority of the outstanding voting securities of the Fund upon 60 days' written notice to the Adviser. Unless sooner terminated, the agreement shall continue in effect for more than two years after its execution only so long as such continuance is specifically approved at least annually by either the Board of Directors or by a vote of a majority of the outstanding voting securities of the Company, provided that in either event such continuance is also approved by a vote of a majority of the directors who are not parties to such agreement, or interested persons of such parties, cast in person at a meeting called for the purpose of voting on such approval. Pursuant to the Investment Advisory and Management Agreement, the Fund pays the Adviser a monthly advisory fee equal on an annual basis to .35% of the first $500 million of average daily net assets and .30% of average daily net assets in excess of $500 million. The Adviser intends, although not required under the Investment Advisory and Management Agreement, to reimburse the Fund for the amount, if any, by which the total operating and management expenses of the Fund (including the Adviser's compensation and amounts paid pursuant to the Fund's Rule 12b-1 plan, but excluding interest, taxes, brokerage fees and commissions, and extraordinary expenses) for the fiscal year ending August 31, 1996, exceed .60% of average net assets. This arrangement is voluntary and may be revised or terminated at any time after August 31, 1996, at the Adviser's discretion. In the event of discontinuance of this arrangement, the Fund will still be subject to the laws of certain states, which require that if a mutual fund's expenses (including advisory fees but excluding interest, taxes, brokerage commissions and extraordinary expenses) exceed certain percentages of average net assets, the fund must be reimbursed for such excess expenses. The Investment Advisory and Management Agreement provides that the Adviser must make any expense reimbursements to the Fund required under state law. The laws of California provide that aggregate annual expenses of a mutual fund shall not normally exceed 2-1/2% of the first $30 million of the average net assets, 2% of the next $70 million of the average net assets and 1-1/2% of the remaining average net assets. Such expenses include the Adviser's compensation, but exclude interest, taxes, brokerage fees and commissions, extraordinary expenses and amounts paid under the Fund's Rule 12b-1 plan. The Adviser does not believe that the laws of any other state in which the Fund's shares may be offered for sale contain expense reimbursement requirements. Under the Investment Advisory and Management Agreement, the Adviser provides the Fund with advice and assistance in the selection and disposition of the Fund's investments. All investment decisions are subject to review by the Board of Directors of the Fund. The Adviser is obligated to pay the salaries and fees of any affiliates of the Adviser serving as officers or directors of the Fund. The same security may be suitable for the Fund and/or other funds or private accounts managed by the Adviser or its affiliates. If and when two or more funds or accounts simultaneously purchase or sell the same security, the transactions will be allocated as to price and amount in accordance with arrangements equitable to each fund or account. The simultaneous purchase or sale of the same securities by the Fund and other funds or accounts may have a detrimental effect on the Fund, as this may affect the price paid or received by the Fund or the size of the position obtainable or able to be sold by the Fund. The Adviser also acted as the investment adviser of DDJ, the surviving entity of the Merger for financial reporting purposes. Pursuant to the Investment Advisory and Management Agreement between DDJ and the Adviser, the Adviser received a monthly management fee at the per annum rate of .35% of DDJ's average weekly net assets. Under such agreement, the Adviser received compensation of $1,917,671, $1,857,513 and $1,462,719, respectively, for the fiscal years ended August 31, 1993, 1994 and 1995. The Adviser also acted as the administrator of DDJ pursuant to an Administration Agreement under which the Adviser received a monthly administration fee at the per annum rate of .15% of DDJ's average weekly net assets. Under such agreement, the Adviser received compensation of $821,859, $796,077 and $626,880, respectively, for the fiscal years ended August 31, 1993, 1994 and 1995. The Fund has not entered into an administration agreement with the Adviser. Expenses The expenses of the Fund are deducted from its income before dividends are paid. These expenses include, but are not limited to, organizational costs, fees paid to the Adviser, fees and expenses of officers and directors who are not affiliated with the Adviser, taxes, interest, legal fees, transfer agent, dividend disbursing agent and custodian fees, audit fees, brokerage fees and commissions, fees and expenses of registering and qualifying the Fund and its shares for distribution under federal and state securities laws, expenses of preparing the prospectus and statement of additional information and of printing and distributing the prospectus and statement of additional information annually to existing shareholders, the expenses of reports to shareholders, shareholders' meetings and proxy solicitations, distribution expenses pursuant to the Rule 12b-1 plan, and other expenses which are not expressly assumed by the Adviser under the Investment Advisory and Management Agreement. Distribution Plan Rule 12b-1(b) under the 1940 Act provides that any payments made by the Fund in connection with financing the distribution of its shares may only be made pursuant to a written plan describing all aspects of the proposed financing of distribution, and also requires that all agreements with any person relating to the implementation of the plan must be in writing. Rule 12b-1(b)(1) requires that such plan be approved by a majority of the Fund's outstanding shares, and Rule 12b-1(b)(2) requires that such plan, together with any related agreements, be approved by a vote of the Board of Directors and of the directors who are not interested persons of the Company and who have no direct or indirect interest in the operation of the plan or in the agreements related to the plan, cast in person at a meeting called for the purpose of voting on such plan or agreement. The Fund's Distribution Plan has been approved by the Board of Directors and by the Fund's initial sole shareholder in accordance with the Rule. Rule 12b-1(b)(3) requires that the plan or agreement provide, in substance: (a) that it shall continue in effect for a period of more than one year from the date of its execution or adoption only so long as such continuance is specifically approved at least annually in the manner described in paragraph (b)(2) of Rule 12b-1; (b) that any person authorized to direct the disposition of moneys paid or payable by the Fund pursuant to the plan or any related agreement shall provide to the Board of Directors, and the directors shall review, at least quarterly, a written report of the amounts so expended and the purposes for which such expenditures were made; and (c) in the case of a plan, that it may be terminated at any time by a vote of a majority of the members of the Board of Directors who are not interested persons of the Fund and who have no direct or indirect financial interest in the operation of the plan or in any agreements related to the plan or by a vote of a majority of the outstanding voting securities of the Fund. Rule 12b-1(b)(4) requires that such a plan may not be amended to increase materially the amount to be spent for distribution without shareholder approval and that all material amendments of the plan must be approved in the manner described in paragraph (b)(2) of Rule 12b-1. Rule 12b-1(c) provides that the Fund may rely upon Rule 12b-1(b) only if the selection and nomination of the disinterested directors are committed to the discretion of such disinterested directors. Rule 12b-1(e) provides that the Fund may implement or continue a plan pursuant to Rule 12b-1(b) only if the directors who vote to approve such implementation or continuation conclude, in the exercise of reasonable business judgment and in light of their fiduciary duties under state law, and under Sections 36(a) and (b) of the 1940 Act, that there is a reasonable likelihood that the plan will benefit the Fund and its shareholders. The Board of Directors has concluded that there is a reasonable likelihood that the Distribution Plan will benefit the Fund and its shareholders. Pursuant to the provisions of the Distribution Plan, the Fund pays the Distributor a monthly service fee equal, on an annual basis, to .15% of the Fund's average daily net assets in connection with the servicing of the Fund's shareholder accounts. This fee is intended to compensate the Distributor for ongoing servicing and/or maintenance of shareholder accounts and the costs incurred in connection therewith ("Shareholder Servicing Costs"). Shareholder Servicing Costs include all expenses of the Distributor incurred in connection with providing shareholder liaison services, including, but not limited to, an allocation of the Distributor's overhead and payments made to persons, including employees of the Distributor, who respond to inquiries of shareholders regarding their ownership of shares or their accounts with the Fund and who provide information on shareholders' investments. Underwriting and Distribution Agreement Pursuant to the Underwriting and Distribution Agreement, the Distributor has agreed to act as the principal underwriter for the Fund in the sale and distribution to the public of shares of the Fund, either through dealers or otherwise. The Distributor has agreed to offer such shares for sale at all times when such shares are available for sale and may lawfully be offered for sale and sold. As compensation for its services, in addition to receiving its service fees pursuant to the Distribution Plan discussed above, the Distributor receives the sales load on sales of the Fund shares set forth in the Prospectus. The Agreement was not in effect during the fiscal year ended August 31, 1995. Transfer Agent and Dividend Disbursing Agent Investors Fiduciary Trust Company ("IFTC"), the transfer agent for the Company, maintains certain omnibus shareholder accounts for the Fund. Each such omnibus account represents the accounts of a number of individual shareholders of the Fund. The Company has entered into a Shareholder Account Servicing Agreement with the Distributor, pursuant to which the Distributor provides certain transfer agent and dividend disbursing agent services for the underlying individual shareholder accounts. Pursuant to such Agreement, the Distributor has agreed to perform the usual and ordinary services of transfer agent and dividend disbursing agent not performed by IFTC with respect to the underlying individual shareholder accounts, including, without limitation, the following: maintaining all shareholder accounts, preparing shareholder meeting lists, mailing shareholder reports and prospectuses, tracking shareholder accounts for blue sky and Rule l2b-1 purposes, withholding taxes on nonresident alien and foreign corporation accounts, preparing and mailing checks for disbursement of income dividends and capital gains distributions, preparing and filing U.S. Treasury Department Form 1099 for all shareholders, preparing and mailing confirmation forms to shareholders and dealers with respect to all purchases, exchanges and liquidations of series shares and other transactions in shareholder accounts for which confirmations are required, recording reinvestments of dividends and distributions in series shares, recording redemptions of series shares, and preparing and mailing checks for payments upon redemption and for disbursements to withdrawal plan holders. As compensation for such services, the Distributor will be paid an annual fee of $7.50 per active shareholder account (defined as an account that has a balance of shares) and $1.60 per closed account (defined as an account that does not have a balance of shares, but has had activity within the past 12 months). Such fee is payable on a monthly basis at a rate of 1/12 of the annual per-account charge. Such fee covers all services listed above, with the exception of preparing shareholder meeting lists and mailing shareholder reports and prospectuses. These services, along with proxy processing (if applicable) and other special service requests, are billable as performed at a mutually agreed upon fee in addition to the annual fee noted above, provided that such mutually agreed upon fee shall be fair and reasonable in light of the usual and customary charges made by others for services of the same nature and quality. The Agreement was not in effect during the fiscal year ended August 31, 1995. PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE The Adviser is responsible for decisions to buy and sell securities, the selection of broker-dealers to effect the transactions and the negotiation of brokerage commissions, if any, with respect to the Fund. In placing orders for securities transactions, the primary criterion for the selection of a broker-dealer is the ability of the broker-dealer, in the opinion of the Adviser, to secure prompt execution of the transactions on favorable terms, including the reasonableness of the commission and considering the state of the market at the time. When consistent with these objectives, business may be placed with broker-dealers who furnish investment research information and statistical and other services to the Adviser. Such research or services include advice, both directly and in writing, as to the value of securities; the advisability of investing in, purchasing or selling securities; and the availability of securities, or purchasers or sellers of securities; as well as analyses and reports concerning issues, industries, securities, economic factors and trends, portfolio strategy and the performance of accounts. This allows the Adviser to supplement its own investment research activities and enables the Adviser to obtain the views and information of individuals and research staffs of many different securities firms prior to making investment decisions for the Fund. To the extent portfolio transactions are effected with broker-dealers who furnish research services to the Adviser, the Adviser receives a benefit, not capable of evaluation in dollar amounts, without providing any direct monetary benefit to the Fund from these transactions. The Adviser believes that most research services obtained by it generally benefit several or all of the investment companies and private accounts which it manages, as opposed to solely benefiting one specific managed fund or account. Normally, research services obtained through managed funds or accounts investing in common stocks would primarily benefit the managed funds or accounts which invest in common stock; similarly, services obtained from transactions in fixed-income securities would normally be of greater benefit to the managed funds or accounts which invest in debt securities. The Adviser has not entered into any formal or informal agreements with any broker-dealers, nor does it maintain any "formula" which must be followed in connection with the placement of the Fund's portfolio transactions in exchange for research services provided the Adviser. However, the Adviser does maintain an informal list of broker-dealers, which is used from time to time as a general guide in the placement of the Fund's business, in order to encourage certain broker-dealers to provide the Adviser with research services which the Adviser anticipates will be useful to it. Because the list is merely a general guide, which is to be used only after the primary criterion for the selection of broker-dealers (discussed above) has been met, substantial deviations from the list are permissible and may be expected to occur. The Adviser will authorize the Fund to pay an amount of commission for effecting a securities transaction in excess of the amount of commission another broker-dealer would have charged only if the Adviser determines in good faith that such amount of commission is reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either that particular transaction or the Adviser's overall responsibilities with respect to the accounts as to which it exercises investment discretion. Generally, the Fund pays higher than the lowest commission rates available. The Fund will not purchase at a higher price or sell at a lower price in connection with transactions effected with a director, acting as principal, who furnishes research services to the Adviser than would be the case if no weight were given by the Adviser to the dealer's furnishing of such services. Transactions in securities, options on securities, futures contracts and options on futures contracts, may be effected through the Distributor. In determining the commissions to be paid to the Distributor in connection with portfolio transactions on national securities exchanges or commodity exchanges, it is the policy of the Fund that such commissions will, in the judgment of the Adviser, subject to review by the Board of Directors, be both (a) at least as favorable as those which would be charged by other qualified brokers in connection with comparable transactions during a comparable period of time, and (b) at least as favorable as commissions contemporaneously charged by the Distributor on comparable transactions for its most favored comparable unaffiliated customers. While the Fund does not deem it practicable and in its best interest to solicit competitive bids for commission rates on each transaction, consideration will regularly be given to posted commission rates as well as to other information concerning the level of commissions charged on comparable transactions by other qualified brokers. For the fiscal years ended August 31, 1993, 1994 and 1995, DDJ paid aggregate brokerage commissions of $40,800, $69,650 and $3,740, respectively. Of such amounts, $39,525, $63,325 and $1,700, respectively, were paid to the Distributor. For the fiscal year ended August 31, 1995, 45% of DDJ's aggregate brokerage commissions were paid to the Distributor, which accounted for 45% of the aggregate dollar amount of transactions involving the payments of commissions. CAPITAL STOCK AND OWNERSHIP OF SHARES The Board of Directors is empowered under the Company's Articles of Incorporation to issue additional series of the Company's common stock without shareholder approval. On an issue affecting only a particular series, the shares of the affected series vote separately. An example of such an issue would be a fundamental investment restriction pertaining to only one series. In voting on the Investment Advisory and Management Agreement (the "Agreement"), approval of the Agreement by the shareholders of a particular series would make the Agreement effective as to that series whether or not it had been approved by the shareholders of any other series. If the Company issues shares in additional series, the assets received by the Company for the issue or sale of shares of each series, and all income, earnings, profits and proceeds thereof, subject only to the rights of creditors, will be allocated to such series, and constitute the underlying assets of such series. The underlying assets of each series are required to be segregated on the books of account, and are to be charged with the expenses relating to such series and with a share of the general expenses of the Company. Any general expenses of the Company not readily identifiable as belonging to a particular series shall be allocated among the series based on the relative net assets of the series at the time such expenses were accrued. The Board of Directors may, without shareholder approval, create and issue one or more additional classes of shares within the Fund, as well as within any series of the Company created in the future. All classes of shares in a series would be identical except that each class of shares would be available through a different distribution channel and certain classes might incur different expenses for the provision of distribution services or the provision of shareholder services or administration assistance by institutions. Shares of each class would share equally in the gross income of a series, but any variation in expenses would be charged separately against the income of the particular class incurring such expenses. This would result in variations in net investment income accrued and dividends paid by and in the net asset value of the different classes of a series. This ability to create multiple classes of shares within each series of the Company will allow the Company in the future the flexibility to better tailor its methods of marketing, administering and distributing shares of the Fund to the needs of particular investors and to allocate expenses related to such marketing, administration and distribution methods to the particular classes of shareholders of the Fund incurring such expenses. As of December 7, 1995, no shareholder was known by the Fund to own beneficially 5% or more of the outstanding shares of the Fund. The directors and officers of the Company as a group owned less than 1% of the outstanding shares of the Fund as of such date. NET ASSET VALUE AND PUBLIC OFFERING PRICE The method for determining the public offering price of Fund shares is summarized in the Prospectus in the text following the headings "How to Purchase Shares -- Public Offering Price" and "Valuation of Shares." The net asset value of the Fund's shares is determined on each day on which the New York Stock Exchange (the "Exchange") is open, provided that the net asset value need not be determined on days on which changes in the value of its portfolio securities will not materially affect the current net asset value of the Fund's shares and days when no Fund shares are tendered for redemption and no order for Fund shares is received. The Exchange is not open for business on the following holidays (or on the nearest Monday or Friday if the holiday falls on a weekend): New Year's Day, Presidents' Day, Good Friday, Memorial Day, July 4th, Labor Day, Thanksgiving and Christmas. On August 31, 1995, the net asset value per share for DDJ was calculated as follows: Net Assets ($409,306,125)/ = Net Asset Value Per Share Shares Outstanding (47,066,117) ($8.70) In the case of the Fund, a sales charge of 1.52% of the net asset value (in the case of sales of less than $100,000) will be added to the net asset value per share to determine the public offering price per share. PERFORMANCE COMPARISONS Advertisements and other sales literature for the Fund may refer to "average annual total return," "cumulative total return" and "yield." The Adviser may waive or pay certain expenses of the Fund, thereby increasing total return and yield. These expenses may or may not be waived or paid in the future in the Adviser's discretion. Average annual total return figures are computed by finding the average annual compounded rates of return over the periods indicated in the advertisement that would equate the initial amount invested to the ending redeemable value, according to the following formula: P(1+T)n = ERV Where: P = a hypothetical initial payment of $1,000; T = average annual total return; n = number of years; and ERV = ending redeemable value at the end of the period of a hypothetical $1,000 payment made at the beginning of such period. This calculation deducts the maximum sales charge from the initial hypothetical $1,000 investment, assumes all dividends and capital gains distributions are reinvested at net asset value on the appropriate reinvestment dates as described in the Prospectus, and includes all recurring fees, such as investment advisory and management fees, charged to all shareholder accounts. The Fund's average annual total returns for the one year period ended August 31, 1995 and for the period since inception on January 30, 1992 through August 31, 1995 were 3.85% and 3.42%, respectively. Cumulative total return is computed by finding the cumulative compounded rate of return over the period indicated in the advertisement that would equate the initial amount invested to the ending redeemable value, according to the following formula: CTR = [(ERV-P)/P] 100 Where: CTR = Cumulative total return; ERV = ending redeemable value at the end of the period of a hypothetical $1,000 payment made at the beginning of such period; and P = initial payment of $1,000. This calculation assumes all dividends and capital gain distributions are reinvested at net asset value on the appropriate reinvestment dates as described in the Prospectus and includes all recurring fees, such as investment advisory and management fees, charged to all shareholder accounts. The cumulative total return for the Fund from inception on January 30, 1992 through August 31, 1995 was 12.81%. Yield is computed by dividing the net investment income per share (as defined under Securities and Exchange Commission rules and regulations) earned during the computation period by the maximum offering price per share on the last day of the period, according to the following formula: YIELD = 2[(a-b/cd + 1)(6th power) -1] Where: a = dividends and interest earned during the period; b = expenses accrued for the period (net of reimbursements); c = the average daily number of shares outstanding during the period that were entitled to receive dividends; and d = the maximum offering price per share on the last day of the period. The Fund's yield was not calculated until October 1995 at which time the yield for the 30-day period ended October 31, 1995 was 5.73%. In addition to advertising total return and yield, comparative performance information may be used from time to time in advertising the Fund's shares, including data from Lipper Analytical Services, Inc. ("Lipper"), Morningstar, Inc. and other entities or organizations which track the performance of investment companies. The Fund's performance may be compared to that of the ARM Fund Average, as reported by Lipper, and to the performance of the Lehman Brothers ARM Index, an unmanaged index. Unmanaged indices generally do not reflect deductions for administrative and management costs and expenses. PURCHASE OF SHARES An investor may qualify for a reduced sales charge immediately by signing a nonbinding Letter of Intent stating the investor's intention to invest within a 13-month period, beginning not earlier than 90 days prior to the date of execution of the Letter, a specified amount which, if made at one time, would qualify for a reduced sales charge. Reinvested dividends will be treated as purchases of additional shares. Any redemptions made during the term of the Letter of Intent will be subtracted from the amount of purchases in determining whether the Letter of Intent has been completed. During the term of a Letter of Intent, IFTC will hold shares representing 5% of the amount that the investor intends to invest during the 13-month period in escrow for payment of a higher sales charge if the full amount indicated in the Letter of Intent is not purchased. Dividends on the escrowed shares will be paid to the shareholder. The escrowed shares will be released when the full amount indicated has been purchased. If the full indicated amount is not purchased within the 13-month period, the investor will be required to pay, either in cash or by liquidating escrowed shares, an amount equal to the difference in the dollar amount of sales charge actually paid and the amount of sales charge the investor would have paid on his or her aggregate purchases if the total of such purchases had been made at a single time. REDEMPTION OF SHARES General Redemption of shares, or payment, may be suspended at times (a) when the Exchange is closed for other than customary weekend or holiday closings, (b) when trading on said Exchange is restricted, (c) when an emergency exists, as a result of which disposal by the Fund of securities owned by it is not reasonably practicable, or it is not reasonably practicable for the Fund fairly to determine the value of its net assets, or (d) during any other period when the Securities and Exchange Commission, by order, so permits, provided that applicable rules and regulations of the Securities and Exchange Commission shall govern as to whether the conditions prescribed in (b) or (c) exist. Shareholders who purchased Fund shares through a broker-dealer other than the Distributor may redeem such shares either by oral request to such broker-dealer or by written request to IFTC at the address set forth in the Prospectus. To be considered in proper form, written requests for redemption should indicate the dollar amount or number of shares to be redeemed, refer to the shareholder's Fund account number, and give either a social security or tax identification number. The request should be signed in exactly the same way the account is registered. If there is more than one owner of the shares, all owners must sign. If shares to be redeemed have a value of $10,000 or more or redemption proceeds are to be paid to someone other than the shareholder at the shareholder's address of record, the signature(s) must be guaranteed by an "eligible guarantor institution," which includes a commercial bank that is a member of the Federal Deposit Insurance Corporation, a trust company, a member firm of a domestic stock exchange, a savings association or a credit union that is authorized by its charter to provide a signature guarantee. IFTC may reject redemption instructions if the guarantor is neither a member of nor a participant in a signature guarantee program. Signature guarantees by notaries public are not acceptable. The purpose of a signature guarantee is to protect shareholders against the possibility of fraud. Further documentation will be requested from corporations, administrators, executors, personal representatives, trustees and custodians. Redemption requests given by facsimile will not be accepted. Unless other instructions are given in proper form, a check for the proceeds of the redemption will be sent to the shareholder's address of record. Reinstatement Privilege A shareholder who has redeemed shares of the Fund may reinvest all or part of the redemption proceeds in shares of any Fund managed by the Adviser (except Hercules Funds Inc.) within 30 days without payment of an additional sales charge, provided that a shareholder may reinvest in a fund through a broker-dealer other than the Distributor only if there is a valid sales agreement for such fund between such broker-dealer and the Distributor. The Distributor will refund to the shareholder a pro rata amount of any contingent deferred sales charge paid by such shareholder in connection with a redemption of Fund shares if and to the extent that the redemption proceeds are reinvested within 30 days of such redemption in any mutual fund managed by the Adviser (except Hercules Funds Inc.). Such refund will be based upon the ratio of the net asset value of shares purchased in the reinvestment to the net asset value of shares redeemed. Reinvestments will be allowed at net asset value without the payment of a front-end sales charge, irrespective of the amounts of the reinvestment, but shall be subject to the same pro rata contingent deferred sales charge that was applicable to the earlier investment; however, the period during which the contingent deferred sales charge shall apply on the newly issued shares shall be the period applicable to the redeemed shares extended by the number of days between the redemption and the reinvestment dates (inclusive). Systematic Withdrawal Plan To establish a Systematic Withdrawal Plan for the Fund and receive regular periodic payments, an account must have a value of $5,000 or more. A request to establish a Systematic Withdrawal Plan must be submitted in writing to an investor's Piper Jaffray Investment Executive or other broker-dealer. There are no service charges for maintenance; the minimum amount that may be withdrawn each period is $100. (This is merely the minimum amount allowed and should not be interpreted as a recommended amount.) The holder of a Systematic Withdrawal Plan will have any income dividends and any capital gains distributions reinvested in full and fractional shares at net asset value. To provide funds for payment, the Fund will redeem as many full and fractional shares as necessary at the redemption price, which is net asset value. Redemption of shares may reduce or possibly exhaust the shares in an account, particularly in the event of a market decline. As with other redemptions, a redemption to make a withdrawal payment is a sale for federal income tax purposes. Payments made pursuant to a Systematic Withdrawal Plan cannot be considered as actual yield or income since part of such payments may be a return of capital. The maintenance of a Systematic Withdrawal Plan for the Fund concurrent with purchases of additional shares of the Fund would be disadvantageous because of the sales commission involved in the additional purchases. A confirmation of each transaction showing the sources of the payment and the share and cash balance remaining in the account will be sent. The plan may be terminated on written notice by the shareholder or the Fund, and it will terminate automatically if all shares are liquidated or withdrawn from the account or upon the death or incapacity of the shareholder. The amount and schedule of withdrawal payments may be changed or suspended by giving written notice to your Piper Jaffray Investment Executive or other broker-dealer at least seven business days prior to the end of the month preceding a scheduled payment. TAXATION The Fund intends to qualify each year as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). To qualify as a regulated investment company the Fund must, among other things, receive at least 90% of its gross income each year from dividends, interest, gains from the sale or other disposition of securities and certain other types of income, including income from options and futures contracts. If for any taxable year the Fund does not qualify as a regulated investment company, all of its taxable income will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the Fund's shareholders as ordinary dividends to the extent of the Fund's current or accumulated earnings and profits. The Code also forbids a regulated investment company from earning 30% or more of its gross income from the sale or other disposition of securities held less than three months. This restriction may limit the extent to which the Fund may purchase futures contracts and options. To the extent the Fund engages in short-term trading and enters into futures and options transactions, the likelihood of violating this 30% requirement is increased. The Code requires a regulated investment company to diversify its holdings. The Internal Revenue Service has not made its position clear regarding the treatment of futures contracts and options for purposes of the diversification test, and the extent to which the Fund can buy or sell futures contracts and options may be limited by this requirement. The Fund will be subject to a nondeductible excise tax equal to 4% of the excess, if any, of the amount required to be distributed pursuant to the Code for each calendar year over the amount actually distributed. No amount of such excess, however, will be subject to the excise tax to the extent it is subject to the corporate-level income tax. In order to avoid the imposition of this excise tax, the Fund generally must declare dividends by the end of a calendar year representing 98% of the Fund's ordinary income for the calendar year and 98% of its capital gain net income (both long-term and short-term capital gains) for the 12-month period ending October 31 of the calendar year. Gain or loss on futures contracts and options is taken into account when realized by entering into a closing transaction or by exercise. In addition, with respect to many types of futures contracts and options held at the end of the Fund's taxable year, unrealized gain or loss on such contracts is taken into account at the then current fair market value thereof under a special "marked-to-market, 60/40 system," and such gain or loss is recognized for tax purposes. The gain or loss from such futures contracts and options (including premiums on certain options that expire unexercised) is treated as 60% long-term and 40% short-term capital gain or loss, regardless of their holding period. The amount of any capital gain or loss actually realized by the Fund in a subsequent sale or other disposition of such futures contracts will be adjusted to reflect any capital gain or loss taken into account by the Fund in a prior year as a result of the constructive sale under the "marked-to-market, 60/40 system." Notwithstanding the rules described above, with respect to certain futures contracts, the Fund may make an election that will have the effect of exempting all or a part of those identified futures contracts from being treated for federal income tax purposes as sold on the last business day of the Fund's taxable year. All or part of any loss realized by the Fund on any closing of a futures contract may be deferred until all of the Fund's offsetting positions with respect to the futures contract are closed. Ordinarily, distributions and redemption proceeds earned by a shareholder are not subject to withholding of federal income tax. However, 31% of a shareholder's distributions and redemption proceeds must be withheld if a shareholder fails to supply the Fund or its agent with such shareholder's taxpayer identification number or if a shareholder, who is otherwise exempt from withholding, fails to properly document such shareholder's status as an exempt recipient. The Fund may make investments that produce income that is not matched by a corresponding distribution to the Fund, such as investments in obligations having original issue discount, such as zero coupon securities, or market discount (if the Fund elects to accrue the market discount on a current basis with respect to such instruments). Such income would be treated as income earned by the Fund and therefore would be subject to the distribution requirements of the Code. Because such income may not be matched by a corresponding cash distribution to the Fund, the Fund may be required to borrow money or dispose of other securities to be able to make distributions to shareholders. Any loss on the sale or exchange of shares of the Fund generally will be disallowed to the extent that a shareholder acquires or contracts to acquire shares of the Fund within 30 days before or after such sale or exchange. In addition, if a shareholder disposes of shares within 90 days of acquiring such shares and purchases shares of another mutual fund managed by the Adviser at a reduced sales charge, the shareholder's tax basis for determining gain or loss on the shares which are disposed of is reduced by the lesser of the amount of the sales charge that was paid when the shares disposed of were acquired or the amount by which the sales charge for the new shares is reduced. If a shareholder's tax basis is so reduced, the amount of the reduction is treated as part of the tax basis of the new shares. Additionally, distributions may be subject to state and local income taxes, and the treatment thereof may differ from the federal income tax consequences discussed above. For federal income tax purposes, the Fund had capital loss carryovers of $141,672,558 on September 1, 1995. If these loss carryovers are not offset by subsequent capital gains, they will expire at various times during 1999 through 2002. Because the Fund acquired the loss carryovers as a result of the merger of the Trusts into the Fund, certain limitations will apply to the Fund's ability to use the loss carryovers to offset any capital gains it realizes in the future. GENERAL INFORMATION Minnesota has enacted legislation which authorizes corporations to eliminate or limit the personal liability of a director to the corporation or its shareholders for monetary damages for breach of the fiduciary duty of "care" (the duty to act with the care an ordinarily prudent person in a like position would exercise under similar circumstances). Minnesota law does not, however, permit a corporation to eliminate or limit the liability of a director (a) for any breach of the director's duty of "loyalty" to the corporation or its shareholders (the duty to act in good faith and in a manner reasonably believed to be in the best interest of the corporation), (b) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (c) for authorizing a dividend, stock repurchase or redemption or other distribution in violation of Minnesota law or for violation of certain provisions of Minnesota securities laws, or (d) for any transaction from which the director derived an improper personal benefit. Minnesota law does not permit elimination or limitation of a director's liability under the Securities Act of 1933 or the Securities Exchange Act of 1934, and the 1940 Act prohibits elimination or limitation of a director's liability for acts involving willful malfeasance, bad faith, gross negligence or reckless disregard of the duties of a director. The Articles of Incorporation of the Company limit the liability of directors to the fullest extent permitted by Minnesota law and the 1940 Act. FINANCIAL STATEMENTS The audited financial statements and supplementary schedules for the Fund as of August 31, 1995, contained in the Fund's Annual Report to shareholders are incorporated by reference into this Statement of Additional Information in reliance on the independent auditors' report of KPMG Peat Marwick LLP, 4200 Norwest Center, Minneapolis, Minnesota 55402, independent auditors of the Fund, given on the authority of such firm as experts in accounting and auditing. PENDING LITIGATION Complaints have been brought in federal and state court relating to one open-end and twelve closed-end investment companies managed by the Adviser and to two open-end funds for which the Adviser has acted as sub-adviser. An Amended Consolidated Class Action Complaint was filed on October 5, 1994 in the United States District Court, District of Minnesota, against the Institutional Government Income Portfolio (a series of Piper Funds Inc.), the Adviser, the Distributor, William H. Ellis and Edward J. Kohler alleging certain violations of federal and state securities laws, including the making of materially misleading statements in the prospectus, common law negligent misrepresentation and breach of fiduciary duty. This is a consolidated putative class action in which claims brought by 11 persons or entities have been consolidated under the title In Re: Piper Funds Inc. Institutional Government Income Portfolio Litigation. The named plaintiffs in the complaint purport to represent a class of individuals and groups who purchased shares of Institutional Government Income Portfolio during the putative class period of July 1, 1991 through May 9, 1994. The named plaintiffs and defendants have entered into a settlement agreement which has received preliminary approval from the Court. The terms of the settlement are set forth in a Settlement Agreement dated July 20, 1995 (as modified by an Addendum filed on July 28, 1995). The Settlement Agreement contained a provision which would have permitted the defendants to cancel the Agreement if shareholders who had incurred a cumulative "Loss" (as defined under the Agreement) of more than 10% of the Loss sustained by the entire class had opted out. The deadline for requesting exclusion from the class has passed, and the Loss sustained by persons requesting exclusion is less than 10%. If granted final approval by the Court, the Settlement Agreement would provide up to approximately $70 million, together with interest earned, less certain disbursements and attorneys fees as approved by the Court, to class members in payments scheduled over approximately three years. Such payments would be made by Piper Jaffray Companies Inc. and the Adviser and would not be an obligation of the Institutional Government Income Portfolio or Piper Funds Inc. Six additional complaints, which are based on claims similar to those asserted in the first complaint, have been brought relating to the Institutional Government Income Portfolio. The first of such complaints was filed in the same court against the same parties on October 21, 1994, by Eltrax Systems, Inc. A second additional complaint was filed against Piper Funds Inc., the Adviser, the Distributor and Piper Jaffray Companies Inc. on September 30, 1994 in the United States District Court, District of Colorado. Plaintiffs in the complaint are Gary Pashel and Gregg S. Hayutin, Trustees of the Mae Pashel Trust; Mae Pashel, individually; Gary Pashel and Michael H. Feinstein, Trustees of the Robert Hayutin Insurance Trust; and Dennis E. Hayutin, Gregg S. Hayutin and Gary Pashel, Trustees of the Marie Ellen Hayutin Trust. The third additional complaint, a putative class action, was filed on November 1, 1994 in the United States District Court, District of Idaho by the Idaho Association of Realtors, Inc., a non-profit Idaho corporation. The complaint was filed against the Institutional Government Income Portfolio, the Adviser, the Distributor, Piper Jaffray Companies Inc., William H. Ellis and Edward J. Kohler. The fourth complaint, also a putative class action, was filed in the United States District Court for the District of Minnesota, Third Division, on January 25, 1995. The Complaint was brought by Louise S. Maher and John A. Raetz against Piper Funds Inc., the Institutional Government Income Portfolio, the Adviser, the Distributor, Piper Jaffray Companies Inc., William H. Ellis and Edward J. Kohler. The fifth complaint was brought on April 11, 1995, and in the future may be filed in the Minnesota State District Court, Hennepin County. The plaintiff, Frank R. Berman, Trustee of Frank R. Berman Professional CP Pension Plan Trust, sued individually and not on behalf of any putative class. Defendants are the Distributor, Piper Funds Inc., Morton Silverman and Worth Bruntjen. A sixth complaint relating to the Institutional Government Income Portfolio was filed on June 22, 1995 in the Montana Thirteenth Judicial District Court, Yellowstone County by Beverly Muth against the Distributor and Teresa L. Darnielle. In addition to the above complaints, a number of actions have been commenced in arbitration by individual investors in the Institutional Government Income Portfolio. The complaints discussed in this paragraph generally have been consolidated with the In Re: Piper Funds Inc. action for pretrial purposes and the arbitrations and litigation have been stayed pending entry of an order by the Court permitting those class members who have requested exclusion to proceed with their actions. A complaint was filed by Herman D. Gordon on October 20, 1994, in the United States District Court, District of Minnesota, against American Adjustable Rate Term Trust Inc.--1998, American Adjustable Rate Term Trust Inc.--1999, the Adviser, the Distributor, Piper Jaffray Companies Inc., Benjamin Rinkey, Jeffrey Griffin, Charles N. Hayssen and Edward J. Kohler. A second complaint was filed by Frank Donio, I.R.A. and other plaintiffs on April 14, 1995, in the United States District Court, District of Minnesota, against American Adjustable Rate Term Trust Inc.--1996, American Adjustable Rate Term Trust Inc.--1997, American Adjustable Rate Term Trust Inc.--1998, American Adjustable Rate Term Trust Inc.--1999, the Adviser, the Distributor, Piper Jaffray Companies Inc. and certain associated individuals. Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995 and by Order dated June 8, 1995, the Court consolidated the two putative class actions. The consolidated amended complaint, which purports to be a class action, alleges certain violations of federal and state securities laws, breach of fiduciary duty and negligent misrepresentation. A complaint was filed by Carson H. Bradley on February 3, 1995 in the Sixth Judicial District of the State of Idaho against American Government Income Fund Inc., American Government Income Portfolio Inc., the Adviser, the Distributor and Worth Bruntjen. The complaint alleges negligent misrepresentation, breach of fiduciary duty and breach of contract. The action has been removed to Federal District Court for the District of Idaho. A complaint was filed by Gary E. Nelson on June 28, 1995 in the United States District Court for the Western District of Washington at Seattle against American Strategic Income Portfolio Inc. -- II, the Adviser, the Distributor, Piper Jaffray Companies Inc., Worth Bruntjen, Charles N. Hayssen, Michael Jansen, William H. Ellis and Edward J. Kohler. A second complaint was filed by the same individual in the same court on July 12, 1995 against American Opportunity Income Fund Inc., the Adviser, the Distributor, Piper Jaffray Companies Inc., Worth Bruntjen, Charles N. Hayssen, Michael Jansen, William H. Ellis and Edward J. Kohler. On September 7, 1995, Christian Fellowship Foundation Peace United Church of Christ, Gary E. Nelson and Lloyd Schmidt filed an amended complaint purporting to be a class action in the United States District Court for the District of Washington. The complaint was filed against American Government Income Portfolio, Inc., American Government Income Fund Inc., American Government Term Trust, Inc., American Strategic Income Portfolio Inc., American Strategic Income Portfolio Inc. -- II, American Strategic Income Portfolio Inc. -- III, American Opportunity Income Fund Inc., American Select Portfolio Inc., Piper Jaffray Companies Inc., Piper Jaffray Inc., the Adviser and certain associated individuals. By Order filed October 5, 1995, the complaints were consolidated. The amended complaint alleges generally that the prospectus and financial statements of each investment company were false and misleading. Specific violations of various federal securities laws are alleged with respect to each investment company. The complaint also alleges that the defendants violated the Racketeer Influenced and Corrupt Organizations Act, the Washington State Securities Act and the Washington Consumer Protection Act. Complaints have also been filed relating to two open-end funds for which the Adviser has acted as sub-adviser, Managers Intermediate Mortgage Fund and Managers Short Government Fund. A complaint was filed on September 26, 1994 in the United States District Court, District of Connecticut, by Florence R. Hosea, Bobby W. Hosea, Getrud B. Dale and Peter M. Dale, Andrew Poffel and Diane Poffel as tenants by the Entireties, Myrone Sarone, Donna M. DiPalo, Bernard B. Geltner and Gail Geltner and Paul Delman. The complaint was filed against The Managers Funds, The Managers Funds, L.P., Robert P. Watson, the Adviser, the Distributor, an individual associated with the Adviser, Evaluation Associates, Inc. and Managers Intermediate Mortgage Fund. The complaint, which is a putative class action, alleges certain violations of federal securities laws, including the making of false and misleading statements in the prospectus, and alleges negligent misrepresentation, breach of fiduciary duty and common law fraud. A similar complaint was filed as a putative class action in the same court on November 4, 1994. The complaint was filed by Karen E. Kopelman against The Managers Fund, The Managers Funds, L.P., Robert P. Watson, the Adviser, the Distributor, Worth Bruntjen, Evaluation Associates, Inc. and Managers Intermediate Mortgage Fund. The two putative class actions were consolidated by court order on December 13, 1994. Plaintiffs filed an Amended and Restated Complaint on July 19, 1995. A complaint relating to the Managers Short Government Fund was filed on November 18, 1994 in the United States District Court, District of Minnesota. The complaint was filed by Robert Fleck as a putative class action against The Managers Funds, The Managers Funds, L.P., the Adviser, the Distributor, Worth Bruntjen, Evaluation Associates, Inc., Robert P. Watson, John E. Rosati, William M. Graulty, Madeline H. McWhinney, Steven J. Pasggioli, Thomas R. Schneeweis and Managers Short Government Fund, F/K/A/ Managers Short Government Income Fund. The complaint alleges certain violations of federal securities laws, including the making of false and misleading statements in the prospectus, and negligent misrepresentation. A third complaint relating to both the Managers Intermediate Mortgage Fund and the Managers Short Government Fund was filed on October 26, 1995 in Connecticut State Superior Court, Stamford/Norwalk District. The complaint was filed by First Commercial Trust Company, N.A. against the Managers Funds, Managers Short Government Fund, Managers Intermediate Mortgage Fund, Managers Short and Intermediate Bond Fund, The Managers Funds, L.P., EAIMC Holdings Corporation, Evaluation Associates Holding Corporation, EAI Partners, L.P., Evaluation Associates, Inc., Robert P. Watson, William W. Graulty, Madeline H. McWhinney, Steven J. Paggioli, Thomas R. Schneeweis, William J. Crerend, Piper Capital Management Inc., Piper Jaffray Companies Inc., Worth Bruntjen, Standish, Ayer & Wood, Inc., TCW Funds Managements, Inc., and TCW Management Company. The complaint alleges claims under Connecticut common law and violation of the Connecticut Securities Act and the Connecticut Unfair and Deceptive Trade Practices Act. The Adviser and Distributor do not believe that the settlement reached in connection with the first lawsuit described above, or any other of the above lawsuits, will have a material adverse effect upon their ability to perform under their agreements with the Fund, and they intend to defend the remaining lawsuits vigorously. APPENDIX A CORPORATE BOND AND COMMERCIAL PAPER RATINGS Commercial Paper Ratings Standard & Poor's Ratings Services. Commercial paper ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues assigned the A rating are regarded as having the greatest capacity for timely payment. Issues in this category are further refined with designation 1, 2 and 3 to indicate the relative degree of safety. The "A-1" designation indicates that the degree of safety regarding timely payment is very strong. Those issues determined to possess overwhelming safety characteristics will be denoted with a plus sign designation. Moody's Investors Service, Inc. Moody's commercial paper ratings are opinions of the ability of the issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Moody's makes no representation that such obligations are exempt from registration under the Securities Act of 1933, nor does it represent that any specific note is a valid obligation of a rated issuer or issued in conformity with any applicable law. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Prime-1 Superior capacity for repayment of short-term promissory obligations Prime-2 Strong capacity for repayment of short-term promissory obligations Prime-3 Acceptable capacity for repayment of short-term promissory obligations Corporate Bond Ratings Standard & Poor's Ratings Services. Standard & Poor's ratings for corporate bonds have the following definitions: Debt rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. Debt rated "AA" has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in a small degree. Debt rated "A" has a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. Debt rated "BBB" is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits 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. Moody's Investors Service, Inc. Moody's ratings for corporate bonds include the following: Bonds which 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. Bonds which 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 risk appear somewhat larger than in Aaa securities. Bonds which are rated "A" possess many favorable 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. Bonds which 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 in fact have speculative characteristics as well. APPENDIX B INTEREST RATE FUTURES CONTRACTS AND RELATED OPTIONS Interest Rate Futures Contracts The Fund may purchase and sell interest rate futures contracts and options thereon. An interest rate futures contract creates an obligation on the part of the seller (the "short") to deliver, and an offsetting obligation on the part of the purchaser (the "long") to accept delivery of, the type of financial instrument called for in the contract in a specified delivery month for a stated price. A majority of transactions in interest rate futures contracts, however, do not result in the actual delivery of the underlying instrument, but are settled through liquidation, i.e., by entering into an offsetting transaction. The interest rate futures contracts to be traded by the Fund are traded only on commodity exchanges--known as "contract markets"--approved for such trading by the Commodity Futures Trading Commission and must be executed through a futures commission merchant or brokerage firm which is a member of the relevant contract market. These contract markets, through their clearing corporations, guarantee that the contracts will be performed. Presently, futures contracts are based upon such debt securities as long-term U.S. Treasury bonds, Treasury notes, Government National Mortgage Association modified pass-through mortgage-backed securities, three-month U.S. Treasury bills and bank certificates of deposit. In addition, futures contracts are traded in the Moody's Investment Grade Corporate Bond Index and the Long Term Corporate Bond Index. Although most futures contracts by their terms call for actual delivery or acceptance of commodities or securities, in most cases the contracts are closed out before the settlement date without the making or taking of delivery. Closing out a short position is effected by purchasing a futures contract for the same aggregate amount of the specific type of financial instrument or commodity and the same delivery month. If the price of the initial sale of the futures contract exceeds the price of the offsetting purchase, the seller is paid the difference and realizes a gain. Conversely, if the price of the offsetting purchase exceeds the price of the initial sale, the trader realizes a loss. Similarly, the closing out of a long position is effected by the purchaser entering into a futures contract sale. If the offsetting sale price exceeds the purchase price, the purchaser realizes a gain and, if the purchase price exceeds the offsetting sale price, the purchaser realizes a loss. The purchase or sale of a futures contract differs from the purchase or sale of a security in that no price or premium is paid or received. Instead, an amount of cash or securities acceptable to the Adviser and the relevant contract market, which varies but is generally about 2% of the contract amount, must be deposited with the custodian in the name of the broker. This amount is known as "initial margin," and represents a "good faith" deposit assuring the performance of both the purchaser and the seller under the futures contract. Subsequent payments to and from the broker, known as "variation margin," are required to be made on a daily basis as the price of the futures contract fluctuates, making the long or short positions in the futures contract more or less valuable, a process known as "marking to the market." Prior to the settlement date of the futures contract, the position may be closed out by taking an opposite position which will operate to terminate the position in the futures contract. A final determination of variation margin is then made, additional cash is required to be paid to or released by the broker, and the purchaser realizes a loss or gain. In addition, a commission is paid on each completed purchase and sale transaction. The purpose of the acquisition or sale of a futures contract by the Fund, as the holder of long-term fixed-income securities, is to hedge against fluctuations in rates on such securities without actually buying or selling long-term fixed-income securities. For example, if the Fund owns long-term bonds and interest rates are expected to increase, the Fund might sell futures contracts. Such a sale would have much the same effect as selling some of the long-term bonds in the Fund's portfolio. If interest rates increase as anticipated by the Adviser, the value of certain long-term securities in the portfolio would decline, but the value of the Fund's futures contracts would increase at approximately the same rate, thereby keeping the net asset value of the Fund from declining as much as it otherwise would have. Of course, since the value of the securities in the Fund's portfolio will far exceed the value of the futures contracts sold by the Fund, an increase in the value of the futures contracts could only mitigate--but not totally offset--the decline in the value of the portfolio. Similarly, when it is expected that interest rates may decline, futures contracts could be purchased to hedge against the Fund's anticipated purchases of long-term fixed-income securities, such as bonds, at higher prices. Since the rate of fluctuation in the value of futures contracts should be similar to that of long-term bonds, the Fund could take advantage of the anticipated rise in the value of long-term bonds without actually buying them until the market had stabilized. At that time, the futures contracts could be liquidated and the Fund's cash could then be used to buy long-term bonds on the cash market. The Fund could accomplish similar results by selling bonds with long maturities and investing in bonds with short maturities when interest rates are expected to increase or by buying bonds with long maturities and selling bonds with short maturities when interest rates are expected to decline. However, in circumstances when the market for bonds may not be as liquid as that for futures contracts, the ability to invest in such contracts could enable the Fund to react more quickly to anticipated changes in market conditions or interest rates. Options on Interest Rate Futures Contracts The Fund may purchase and sell put and call options on interest rate futures contracts which are traded on a United States exchange or board of trade as a hedge against changes in interest rates, and will enter into closing transactions with respect to such options to terminate existing positions. An interest rate futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specific financial instrument (debt security) at a specified price, date, time and place. An option on an interest rate futures contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, in return for the premium paid, to assume a position in an interest rate futures contract at a specified exercise price at any time prior to the expiration date of the option. Options on interest rate futures contracts are similar to options on securities, which give the purchaser the right, in return for the premium paid, to purchase or sell securities. A call option gives the purchaser of such option the right to buy, and obliges its writer to sell, a specified underlying futures contract at a specified exercise price at any time prior to the expiration date of the option. A purchaser of a put option has the right to sell, and the writer has the obligation to buy, such contract at the exercise price during the option period. Upon exercise of an option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writer's future margin account, which represents the amount by which the market price of the futures contract exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. If an option is exercised on the last trading day prior to the expiration date of the option, the settlement will be made entirely in cash equal to the difference between the exercise price of the option and the closing price of the interest rate futures contract on the expiration date. A Fund will pay a premium for purchasing options on interest rate futures contracts. Because the value of the option is fixed at the point of sale, there are no daily cash payments to reflect changes in the value of the underlying contract; however, the value of the option does change daily and that change would be reflected in the net asset value of the Fund. In connection with the writing of options on interest rate futures contracts, a Fund will make initial margin deposits and make or receive maintenance margin payments that reflect changes in the market value of such options. Premiums received from the writing of an option are included in initial margin deposits. Purchase of Put Options on Futures Contracts. The Fund will purchase put options on interest rate futures contracts if the Adviser anticipates a rise in interest rates. Because the value of an interest rate futures contract moves inversely in relation to changes in interest rates, a put option on such a contract becomes more valuable as interest rates rise. By purchasing put options on interest rate futures contracts at a time when the Adviser expects interest rates to rise, the Fund will seek to realize a profit to offset the loss in value of its portfolio securities. Purchase of Call Options on Futures Contracts. The Fund will purchase call options on interest rate futures contracts if the Adviser anticipates a decline in interest rates. The purchase of a call option on an interest rate futures contract represents a means of obtaining temporary exposure to market appreciation at limited risk. Because the value of an interest rate futures contract moves inversely in relation to changes to interest rates, a call option on such a contract becomes more valuable as interest rates decline. The Fund will purchase a call option on an interest rate futures contract to hedge against a decline in interest rates in a market advance when the Fund is holding cash. The Fund can take advantage of the anticipated rise in the value of long-term securities without actually buying them until the market is stabilized. At that time, the options can be liquidated and the Fund's cash can be used to buy long-term securities. Writing Call Options on Futures Contracts. The Fund will write call options on interest rate futures contracts if the Adviser anticipates a rise in interest rates. As interest rates rise, a call option on such a contract becomes less valuable. If the futures contract price at expiration of the option is below the exercise price, the option will not be exercised and the Fund will retain the full amount of the option premium. Such amount provides a partial hedge against any decline that may have occurred in the Fund's portfolio securities. Writing Put Options on Futures Contracts. The Fund will write put options on interest rate futures contracts if the Adviser anticipates a decline in interest rates. As interest rates decline, a put option on an interest rate futures contract becomes less valuable. If the futures contract price at expiration of the option has risen due to declining interest rates and is above the exercise price, the option will not be exercised and the Fund will retain the full amount of the option premium. Such amount can then be used by the Fund to buy long-term securities when the market has stabilized. Risks of Transactions in Futures Contracts and Options on Futures Contracts Hedging Risks in Futures Contracts Transactions. There are several risks in using futures contracts as hedging devices. One risk arises because the prices of futures contracts may not correlate perfectly with movements in the underlying fixed-income security due to certain market distortions. First, all participants in the futures market are subject to initial margin and variation margin requirements. Rather than making additional variation margin payments, investors may close the contracts through offsetting transactions which could distort the normal relationship between the security and the futures market. Second, the margin requirements in the futures market are lower than margin requirements in the securities market, and as a result the futures market may attract more speculators than does the securities market. Increased participation by speculators in the futures market may also cause temporary price distortions. Because of possible price distortion in the futures market and because of imperfect correlation between movements in securities and movements in the prices of futures contracts, even a correct forecast of general market trends may not result in a successful hedging transaction over a very short period. Another risk arises because of imperfect correlation between movements in the value of the futures contracts and movements in the value of securities subject to the hedge. Successful use of futures contracts by the Fund is subject to the ability of the Adviser to predict correctly movements in the direction of interest rates. If the Fund has hedged against the possibility of an increase in interest rates adversely affecting the value of fixed-income securities held in its portfolio and interest rates decrease instead, the Fund will lose part or all of the benefit of the increased value of its security which it has hedged because it will have offsetting losses in its futures positions. In addition, in such situations, if the Fund has insufficient cash, it may have to sell securities to meet daily variation margin requirements. Such sales of securities may, but will not necessarily, be at increased prices which reflect the decline in interest rates. The Fund may have to sell securities at a time when it may be disadvantageous to do so. Liquidity of Futures Contracts. The Fund may elect to close some or all of its contracts prior to expiration. The purpose of making such a move would be to reduce or eliminate the hedge position held by the Fund. The Fund may close its positions by taking opposite positions. Final determinations of variation margin are then made, additional cash as required is paid by or to the Fund, and the Fund realizes a loss or a gain. Positions in futures contracts may be closed only on an exchange or board of trade providing a secondary market for such futures contracts. Although the Fund intend to enter into futures contracts only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a liquid secondary market will exist for any particular contract at any particular time. In addition, most domestic futures exchanges and boards of trade limit the amount of fluctuation permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and therefore does not limit potential losses because the limit may prevent the liquidation of unfavorable positions. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting some futures traders to substantial losses. In such event, it will not be possible to close a futures position and, in the event of adverse price movements, the Fund would be required to make daily cash payments of variation margin. In such circumstances, an increase in the value of the portion of the portfolio being hedged, if any, may partially or completely offset losses on the futures contract. However, as described above, there is no guarantee that the price of the securities being hedged will, in fact, correlate with the price movements in the futures contract and thus provide an offset to losses on a futures contract. Risks of Options on Futures Contracts. The use of options on futures contracts also involves additional risk. Compared to the purchase or sale of futures contracts, the purchase of call or put options on futures contracts involves less potential risk to a Fund because the maximum amount at risk is the premium paid for the options (plus transactions costs). The writing of a call option on a futures contract generates a premium which may partially offset a decline in the value of the Fund's portfolio assets. By writing a call option, the Fund becomes obligated to sell a futures contract, which may have a value higher than the exercise price. Conversely, the writing of a put option on a futures contract generates a premium, but the Fund becomes obligated to purchase a futures contract, which may have a value lower than the exercise price. Thus, the loss incurred by the Fund in writing options on futures contracts may exceed the amount of the premium received. The effective use of options strategies is dependent, among other things, on a Fund's ability to terminate options positions at a time when the Adviser deems it desirable to do so. Although the Fund will enter into option positions only if the Adviser believes that a liquid secondary market exists for such options, there is no assurance that the Fund will be able to effect closing transactions at any particular time or at an acceptable price. The Fund's transactions involving options on futures contracts will be conducted only on recognized exchanges. The Fund's purchase or sale of put or call options on futures contracts will be based upon predictions as to anticipated interest rates by the Adviser, which could prove to be inaccurate. Even if the expectations of the Adviser are correct, there may be an imperfect correlation between the change in the value of the options and of the Fund's portfolio securities. Regulatory Matters To the extent required to comply with applicable Securities and Exchange Commission releases and staff positions, when entering into futures contracts, the Fund will maintain, in a segregated account, cash or liquid high-grade debt securities equal to the value of such contracts. The Commodity Futures Trading Commission (the "CFTC"), a federal agency, regulates trading activity on the exchanges pursuant to the Commodity Exchange Act, as amended. The CFTC requires the registration of "commodity pool operators," defined as any person engaged in a business which is of the nature of an investment company, syndicate or a similar form of enterprise, and who, in connection therewith, solicits, accepts or receives from others, funds, securities or property for the purpose of trading in any commodity for future delivery on or subject to the rules of any contract market. The CFTC has adopted Rule 4.5, which provides an exclusion from the definition of commodity pool operator for any registered investment company which meets the requirements of the Rule. Rule 4.5 requires, among other things, that an investment company wishing to avoid commodity pool operator status use futures and options positions only (a) for "bona fide hedging purposes" (as defined in CFTC regulations) or (b) for other purposes so long as aggregate initial margins and premiums required in connection with non-hedging positions do not exceed 5% of the liquidation value of the investment company's portfolio. Any investment company wishing to claim the exclusion provided in Rule 4.5 must file a notice of eligibility with both the CFTC and the National Futures Association. Before engaging in transactions involving interest rate futures contracts, the Funds will file such notices and meet the requirements of Rule 4.5, or such other requirements as the CFTC or its staff may from time to time issue, in order to render registration as a commodity pool operator unnecessary. ADJUSTABLE RATE MORTGAGE SECURITIES FUND 1995 ANNUAL REPORT TABLE OF CONTENTS PRESIDENT'S LETTER.............................1 LETTER TO SHAREHOLDERS.........................2 ADJUSTABLE RATE MORTGAGE SECURITIES FUND (HISTORICAL INFORMATION OF AMERICAN ADJUSTABLE RATE TERM TRUST -- 1998) FINANCIAL STATEMENTS AND NOTES...............5 INVESTMENTS IN SECURITIES...................16 INDEPENDENT AUDITORS' REPORT................17 AMERICAN ADJUSTABLE RATE TERM TRUSTS -- 1996, 1997 AND 1999 FINANCIAL STATEMENTS AND NOTES..............18 INVESTMENTS IN SECURITIES...................34 INDEPENDENT AUDITORS' REPORT................37 FEDERAL TAX INFORMATION.......................38 SHAREHOLDER UPDATE............................39
On September 1, the American Adjustable Rate Term Trusts 1996, 1997, 1998 and 1999 merged into the Adjustable Rate Mortgage Securities Fund. In this annual report for the fiscal year ended August 31, 1995, you will find information in the financial statements and the investments in securities on all four term trusts. However, only the American Adjustable Rate Term Trust -- 1998 is featured in the shareholder letter section because it is considered the predecessor of the new Adjustable Rate Mortgage Securities Fund for performance and financial reporting purposes. ADJUSTABLE RATE MORTGAGE SECURITIES FUND The Adjustable Rate Mortgage Securities Fund is a diversified, open-end mutual fund with an investment objective of providing the maximum current income that is consistent with a low volatility of principal. The fund invests primarily in adjustable rate mortgage (ARM) securities. It may also invest in mortgage-backed securities other than ARM securities, U.S. government securities, asset-backed securities and corporate debt securities. The fund's Nasdaq symbol is PJARX. As with other mutual funds, there can be no assurance the fund will achieve its objective. THIS REPORT IS INTENDED FOR SHAREHOLDERS OF ADJUSTABLE RATE MORTGAGE SECURITIES FUND, BUT IT MAY ALSO BE USED AS SALES LITERATURE IF PRECEDED OR ACCOMPANIED BY A PROSPECTUS. THE PROSPECTUS GIVES DETAILS ABOUT THE CHARGES, INVESTMENT RESULTS AND OPERATING POLICIES OF THE FUND. PRESIDENT'S LETTER [PHOTO] William H. Ellis PRESIDENT, PIPER CAPITAL MANAGEMENT Dear Shareholders: In our last report to you, we announced that the American Adjustable Rate Term Trusts 1996, 1997, 1998 and 1999 would not be able to reach their $10 per share objective at their respective termination dates without taking unacceptable risks. At that time, we proposed the merger of the term trusts into an open-end mutual fund in order to eliminate the market discount at which the shares were trading, allowing shareholders to access their assets at net asset value. On August 10, shareholders of the term trusts approved the merger of the four closed-end funds into a single open-end fund called Adjustable Rate Mortgage Securities Fund. At the close of business on September 1, the term trusts merged into the new fund. You received shares of the fund with a total value that was equal to the total value of your term trust shares. The Adjustable Rate Mortgage Securities Fund does not have a set termination date or termination amount. It's an open-end fund with an objective of providing the maximum current income that is consistent with a low volatility of principal. As discussed in the proxy statement, the fund intends to treat the merger as a tax-free reorganization for federal tax purposes. No facts have come to our attention at this time that would change this opinion. Therefore, you will not be required to report any income, gain or loss as a result of receiving your Adjustable Rate Mortgage Securities Fund shares in the merger. Of course, if you redeem your shares, you will generally recognize a gain or loss at that time. This annual report covers the fiscal year ended August 31, 1995. You will find information in the financial statements and the investments in securities on all four term trusts. However, only the American Adjustable Rate Term Trust -- 1998 (DDJ) is featured in the shareholder letter section because it is considered the predecessor of the Adjustable Rate Mortgage Securities Fund for performance and financial reporting purposes. In the shareholder letter, portfolio managers Mike Jansen and Tom McGlinch will give an outlook for the new fund and recap DDJ's performance. We believe this merger is in the best interests of shareholders and want to thank you for approving the proposal. We look forward to serving your investment needs with the new fund. Sincerely, /s/ William H. Ellis William H. Ellis President, Piper Capital Management 1 ADJUSTABLE RATE MORTGAGE SECURITIES FUND WHAT ARE ADJUSTABLE RATE MORTGAGE (ARM) SECURITIES?* An ARM security represents ownership in a pool of adjustable rate mortgage loans. Payments on the ARM securities come from payments on the adjustable rate mortgages. When a borrower's mortgage rate resets to a higher (lower) rate due to changes in a market index, the coupon on the ARM security also resets to a higher (lower) level. This results in a larger (smaller) interest payment that is then passed through to investors. The borrower's loan document specifically states the dates on which the rate will change, the market index on which the new rate is based, and the margin by which the rate is set over the index rate. For example, many borrowers have loans indexed to the one-year Treasury rate plus a margin of 2.75%, which reset once a year. If, on the reset date, the one-year Treasury rate is 5.50%, the borrower's new rate for the following 12 months will increase to 8.25%. Likewise, the rate passed through to the investor will increase to 8.25% minus a mortgage servicer and guarantee fee. Almost all ARM loans have periodic reset caps and lifetime caps, which limit how often and how high rates can reset. Smaller periodic caps and lower lifetime caps work to the advantage of the borrower and to the disadvantage of the investor when rates are rising. Although ARM pools are made up of thousands of similarly indexed loans, in any particular month only a portion of the loans reset to a current market rate, creating lags in the adjustment process. * ARM SECURITIES ARE DEFINED MORE BROADLY IN THE FUND'S PROSPECTUS. PLEASE SEE THE PROSPECTUS FOR A COMPLETE DEFINITION. ** FIGURES SHOWN REFLECT PAST PERFORMANCE AND DO NOT GUARANTEE FUTURE RESULTS. THE RETURN AND MARKET VALUE OF INVESTMENTS IN THE FUND WILL FLUCTUATE AND SHARES, WHEN SOLD, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. October 16, 1995 Dear Shareholders: WE WOULD LIKE TO THANK YOU FOR RESPONDING TO THE RECENT PROXY CONCERNING THE MERGER OF THE AMERICAN ADJUSTABLE RATE TERM TRUSTS. Approving the proposal to merge the term trusts into the new open-end Adjustable Rate Mortgage Securities Fund benefited shareholders in a couple of ways. First, investors who want to liquidate all or part of their investment are now able to do so at net asset value instead of the discounted market price at which the term trusts were trading. Also, the new fund is not constrained by the term trust structure and therefore has greater investment flexibility to buy longer-maturity securities in an effort to obtain a higher return. The fund will attempt to maintain an average effective duration of one to four years. In addition, we feel that the new fund's expense cap of 0.60% of the fund's average daily net assets through at least August 31, 1996, makes it attractive. THE FUND INVESTS PRIMARILY IN ARM SECURITIES IN AN EFFORT TO ACHIEVE ITS OBJECTIVE OF PROVIDING THE MAXIMUM CURRENT INCOME THAT IS CONSISTENT WITH A LOW VOLATILITY OF PRINCIPAL. Over an interest rate cycle of higher and lower rates, ARM securities typically produce returns that are between the yields on money market securities and the total returns generated by one- to three-year government securities. (See the sidebar for more detailed information about ARM securities.) THE NEW FUND IS CURRENTLY POSITIONED WITH APPROXIMATELY 73% OF ITS ASSETS IN ARM SECURITIES, 18% IN FIXED RATE SECURITIES AND 7% IN SHORT-TERM CASH EQUIVALENTS (SEE PIE CHARTS ON PAGE 4). Within the ARM securities portion, 51% are issued by a U.S. government agency and 22% are privately issued. Most of the ARM securities have coupons which are indexed to the one-year Treasury yield and which reset on an annual basis. The privately issued ARM securities are rated AAA or AA by Standard and Poor's. The fund cannot own foreign securities, structured securities, inverse floaters, interest-only securities, principal-only securities or Z tranches. Also, the fund cannot employ the sale-forward (dollar-roll) program and may borrow only for temporary or emergency purposes. FOR THE YEAR ENDED AUGUST 31, 1995, AMERICAN ADJUSTABLE RATE TERM TRUST -- 1998 HAD A NET ASSET VALUE RETURN OF 5.43%.** During this same time frame, the fund's market price return was 11.38%,** which is due in part to the elimination of the discount between market price and net asset value at conversion. The fund's performance is now being compared to both the Lipper Adjustable Rate Mortgage Funds Average and the Lehman Brothers Adjustable Rate Mortgage Index. THE FUND OUTPERFORMED THE LIPPER AVERAGE RETURN OF 1.25% FOR THE ONE-YEAR PERIOD ENDED AUGUST 31, 1995. This average consists of 70 funds which invest at least 65% of their assets in ARM securities as 2 ADJUSTABLE RATE MORTGAGE SECURITIES FUND categorized by Lipper Analytical Services. The fund's emphasis on high-quality securities helped it outperform the average of other funds in its Lipper category. Some funds in the category have experienced poor returns due to losses suffered in unrated, credit-sensitive securities over the past year. THE FUND UNDERPERFORMED THE LEHMAN BROTHERS INDEX, AN UNMANAGED INDEX MADE UP SOLELY OF U.S. GOVERNMENT AGENCY ARM SECURITIES, WHICH RETURNED 8.24% FOR THE SAME ONE-YEAR PERIOD. The Lehman Brothers index included a large portion of Government National Mortgage Association (GNMA) and Cost of Funds Index (COFI) ARM securities which performed strongly because their prices are more sensitive to falling interest rates. The fund was positioned in higher-coupon, Treasury indexed securities that have returns which are more sensitive to income rather than price appreciation. SINCE THE MERGER, APPROXIMATELY 50% OF SHAREHOLDERS HAVE TAKEN THE OPPORTUNITY TO REDEEM THEIR SHARES AT NET ASSET VALUE. We anticipated this level of redemptions, in part because of the indications we received from shareholders on their proxy ballots. To prepare for these redemptions, we accumulated a 20% position in short-term securities. We also sold a number of privately issued and U.S. government agency ARM securities to meet cashflow needs. Redemption requests were fulfilled without disruption to the fund's net asset value or to the marketplace in general. THE LARGE SHORT-TERM POSITION, IN COMBINATION WITH HIGH PREPAYMENT LEVELS IN ADJUSTABLE RATE MORTGAGES, CONTRIBUTED TO A SEPTEMBER DIVIDEND OF $0.034. Borrowers are prepaying adjustable rate mortgages at a faster speed recently due to the lower rates available on fixed rate mortgages. While short-term interest rates have dropped only slightly this year, long-term rates have fallen sharply. Mortgage rates started the year near 9.50% and are now near 7.50%. At the same time, many adjustable rate mortgage borrowers are seeing their rates rise from 6.00% to 8.00% because of last year's rising rate environment and are choosing to fix their payments at lower rates. Since many of the ARM securities held in the fund were purchased at premium prices, the faster prepayments are causing the fund to amortize these premiums more quickly which reduces the fund's current income level. Our recent sales of ARM securities have been made with the objective of minimizing the impact of prepayments on the fund's income. In addition, we have swapped higher coupon, higher cost ARM securities for lower coupon, lower cost ARM securities which are less likely to be prepaid. OVER TIME, WE BELIEVE THESE ACTIONS, IN ADDITION TO A MUCH SMALLER SHORT-TERM POSITION IN THE FUND, WILL PROVIDE A HIGHER AND MORE PREDICTABLE STREAM OF DIVIDEND INCOME TO SHAREHOLDERS. The dividend policy for the fund is to distribute to shareholders substantially all of the [PHOTO] flipped FPO 75% [PHOTO] FPO 62% Thomas S. McGlinch, CFA (above) SHARES PRIMARY RESPONSIBILITY FOR THE MANAGEMENT OF THE ADJUSTABLE RATE MORTGAGE SECURITIES FUND. HE HAS 14 YEARS OF INVESTMENT EXPERIENCE. Mike Jansen, (below) SHARES PRIMARY RESPONSIBILITY FOR THE MANAGEMENT OF THE ADJUSTABLE RATE MORTGAGE SECURITIES FUND. HE HAS 14 YEARS OF INVESTMENT EXPERIENCE. 3 VALUE OF $10,000 INVESTED [GRAPHIC] If you had invested $10,000 in January 1992 and held your investment through August 31, 1995, reinvesting all distributions, your investment would have grown to $11,281 (based on historical net asset value performance of American Adjustable Rate Term Trust--1998, the fund's predecessor for performance and financial reporting purposes). Fund results reflect the Adjustable Rate Mortgage Securities Fund's maximum 1.5% sales charge, as if it was applied since the fund's inception. In comparing the fund to the Lehman Brothers index and the Lipper average, keep in mind that the fund's performance reflects the sales charge, while no such charges are reflected in the index or the average. Past performance does not guarantee future results. AVERAGE ANNUAL TOTAL RETURNS (THROUGH 8/31/95; INCLUDES 1.5% SALES CHARGE) One-Year.........................3.85% Since Inception (1/30/92)........3.42%
investment income earned during any period. Therefore, we will not attempt to stabilize monthly distributions by retaining income in a dividend reserve. CURRENTLY, THE NARROW SPREAD BETWEEN SHORT- AND LONG-TERM RATES IMPLIES THAT THE MARKET IS ANTICIPATING THE FEDERAL RESERVE WILL EASE MONETARY POLICY. Although employment is growing at a lower rate than in 1994, we see the rebound in important economic sectors such as housing as a reason the Federal Reserve will move slowly if they choose to ease further. It is likely the Federal Reserve is comfortable with the rate of economic growth and inflation anticipated for the remainder of 1995 and will remain fairly neutral with its monetary policy. If the Federal Reserve fails to ease, the market is susceptible to higher rates. Nonetheless, we would expect any changes to be moderate and have positioned the fund to perform best in a market environment of low interest rate volatility. Thank you for your investment in the Adjustable Rate Mortgage Securities Fund. We consider it a privilege to manage your money and look forward to serving your investment needs with the new fund. Sincerely, /s/ Mike Jansen /s/ Tom McGlinch Mike Jansen Tom McGlinch PORTFOLIO MANAGER PORTFOLIO MANAGER PORTFOLIO COMPOSITION BEFORE MERGER AUGUST 31, 1995 American Adjustable Rate Term Trust--1998 [PIE CHART] PORTFOLIO COMPOSITION AFTER MERGER SEPTEMBER 30, 1995 Adjustable Rate Mortgage Securities Fund [PIE CHART] INVESTMENT CATEGORIES REFLECT PERCENTAGE OF TOTAL ASSETS. 4 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES AUGUST 31, 1995
Adjustable Rate Mortgage Securities Fund** ---------------- ASSETS: Investments in securities at market value* (including a repurchase agreement of $70,714,000) (note 2) ................................................... $ 422,173,937 Cash in bank on demand deposit ........................... 101,944 Receivable for investment securities sold ................ 9,015,608 Accrued interest receivable .............................. 2,048,827 Mortgage security principal paydowns receivable .......... 1,249,401 ---------------- Total assets ......................................... 434,589,717 ---------------- LIABILITIES: Payable for investment securities purchased on a when-issued basis (note 2) ............................. 25,109,375 Accrued investment management fee ........................ 121,952 Accrued administrative fee ............................... 52,265 ---------------- Total liabilities .................................... 25,283,592 ---------------- Net assets applicable to outstanding capital stock ....... $ 409,306,125 ---------------- ---------------- REPRESENTED BY: Capital stock - authorized 1 billion shares of $0.01 par value; outstanding, 47,066,117 shares ................ $ 470,661 Additional paid-in capital ............................... 460,104,831 Accumulated net realized loss on investments ............. (47,094,867) Unrealized depreciation of investments ................... (4,174,500) ---------------- Total - representing net assets applicable to outstanding capital stock ........................ $ 409,306,125 ---------------- ---------------- Net asset value per share of outstanding capital stock ... $ 8.70 ---------------- ---------------- * Investments in securities at identified cost ........... $ 426,348,437 ---------------- ---------------- ** FORMERLY AMERICAN ADJUSTABLE RATE TERM TRUST 1998
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 5 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENT OF OPERATIONS FOR THE YEAR ENDED AUGUST 31, 1995
Adjustable Rate Mortgage Securities Fund* ---------------- INCOME: Interest (net of interest expense of $3,384,232) ....... $ 25,824,364 Fee income (note 2) ...................................... 300,962 ---------------- Total investment income .............................. 26,125,326 ---------------- EXPENSES (NOTE 3): Investment management fee ................................ 1,462,719 Administrative fee ....................................... 626,880 Custodian, accounting and transfer agent fees ............ 195,314 Reports to shareholders .................................. 181,868 Directors' fees .......................................... 24,161 Audit and legal fees ..................................... 68,994 Other expenses ........................................... 65,964 ---------------- Total expenses ....................................... 2,625,900 ---------------- Net investment income ................................ 23,499,426 ---------------- NET REALIZED AND UNREALIZED GAINS (LOSSES) ON INVESTMENTS: Net realized loss on investments (note 4) ................ (10,259,308) Net realized loss on closed put option contracts (note 4) ..................................................... (2,113,000) Net realized loss on closed interest rate swap transactions ........................................... (8,598,317) Net realized gain on closed futures contracts ............ 209,151 ---------------- Net realized loss on investments ....................... (20,761,474) Net change in unrealized appreciation or depreciation of investments ............................................ 17,558,315 ---------------- Net loss on investments ................................ (3,203,159) ---------------- Net increase in net assets resulting from operations ....................................... $ 20,296,267 ---------------- ---------------- * FORMERLY AMERICAN ADJUSTABLE RATE TERM TRUST 1998
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 6 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS FOR THE YEAR ENDED AUGUST 31, 1995
Adjustable Rate Mortgage Securities Fund* ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Interest and fee income ................................ $ 26,125,326 Expenses ................................................. (2,625,900) ---------------- Net investment income ................................ 23,499,426 ---------------- Adjustments to reconcile net investment income to cash provided by operating activities: Change in accrued interest and mortgage security principal paydowns receivable ........................ 929,586 Net amortization of bond discount and premium .......... (3,285,176) Change in accrued fees and expenses .................... (350,656) ---------------- Total adjustments .................................... (2,706,246) ---------------- Net cash provided by operating activities ............ 20,793,180 ---------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investments ....................... 391,566,255 Purchases of investments ................................. (178,008,758) Net sales of short-term securities ....................... 31,512,303 Cash paid for interest rate swap transactions ............ (10,301,092) Net variation margin receipts for futures contracts ...... 209,151 Receipts from closed put option contracts ................ 500,500 ---------------- Net cash provided by investing activities ............ 235,478,359 ---------------- CASH FLOWS FROM FINANCING ACTIVITIES: Tender of fund shares (note 7) ........................... (79,726,515) Net payments for reverse repurchase agreements ........... (145,000,000) Retirement of fund shares (note 6) ....................... (3,756,297) Distributions paid to shareholders ....................... (27,746,007) ---------------- Net cash used by financing activities ................ (256,228,819) ---------------- Net increase in cash ..................................... 42,720 Cash at beginning of year ................................ 59,224 ---------------- Cash at end of year ................................ $ 101,944 ---------------- ---------------- Supplemental disclosure of cash flow information: Cash paid for interest on reverse repurchase agreements ........................................... $ 3,695,590 ---------------- ---------------- * FORMERLY AMERICAN ADJUSTABLE RATE TERM TRUST 1998
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS ADJUSTABLE RATE MORTGAGE SECURITIES FUND*
Year Ended Year Ended 8/31/95 8/31/94 ---------------- ---------------- OPERATIONS: Net investment income .................................. $ 23,499,426 33,892,114 Net realized loss on investments ......................... (20,761,474) (25,012,875) Net change in unrealized appreciation or depreciation of investments ............................................ 17,558,315 (25,676,685) ---------------- ---------------- Net increase (decrease) in net assets resulting from operations ........................................... 20,296,267 (16,797,446) ---------------- ---------------- DISTRIBUTIONS TO SHAREHOLDERS: From net investment income ............................... (27,746,007) (31,740,989) ---------------- ---------------- CAPITAL SHARE TRANSACTIONS: Payments for tender of 9,135,819 shares (note 7) ......... (79,726,515) -- Payments for retirement of 488,000 and 335,000 shares, respectively (note 6) .................................. (3,579,372) (2,768,772) ---------------- ---------------- Decrease in net assets from capital share transactions ......................................... (83,305,887) (2,768,772) ---------------- ---------------- Total decrease in net assets ......................... (90,755,627) (51,307,207) Net assets at beginning of year ............................ 500,061,752 551,368,959 ---------------- ---------------- Net assets at end of year ................................ $ 409,306,125 500,061,752 ---------------- ---------------- ---------------- ---------------- Undistributed net investment income ...................... $ -- 7,060,244 ---------------- ---------------- ---------------- ---------------- * FORMERLY AMERICAN ADJUSTABLE RATE TERM TRUST 1998
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 8 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION These financial statements present financial information of American Adjustable Rate Term Trust 1998 (DDJ). For financial reporting purposes, DDJ is considered the surviving entity of the merger of American Adjustable Rate Term Trust 1996 (BDJ), American Adjustable Rate Term Trust 1997 (CDJ), American Adjustable Rate Term Trust 1998 (DDJ) and American Adjustable Rate Term Trust 1999 (EDJ) into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund, which was effective September 1, 1995. As such, only historical financial information of DDJ is relevant with respect to the future financial reporting of Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund. Piper Funds Inc. - II was incorporated on April 10, 1995 and is registered under the Investment Company Act of 1940 (as amended) as a single, open-end management investment company. The company currently includes only the Adjustable Rate Mortgage Securities Fund, which is classified as a diversified fund. The company's articles of incorporation permit the board of directors to create additional funds in the future. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INVESTMENTS IN SECURITIES The values of fixed income securities are determined using pricing services or prices quoted by independent brokers. Exchange-listed options are valued at the last sale price and open financial futures contracts are valued at the last settlement price. When market quotations are not readily available, securities are valued at fair value according to methods selected in good faith by the board of directors. Short-term securities with maturities of 60 days or less are valued at amortized cost which approximates market value. Securities transactions are accounted for on the date the securities are purchased or sold. Realized gains and losses are calculated on the identified-cost basis. Interest income, including amortization of bond discount and premium computed on a level-yield basis, is accrued daily. OPTION TRANSACTIONS For hedging purposes, DDJ could buy put and call options, write covered call options on portfolio securities, write cash-secured puts, and write call options that are not covered for cross-hedging purposes. DDJ also could write over-the-counter options where the completion of the obligation is dependent upon the credit standing of another party. Effective September 1, 1995, Adjustable Rate Mortgage Securities Fund may only purchase and write put and call options which are exchange-traded and cannot write call options that are not covered. The risk in writing a call option is that the fund gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the fund may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the fund pays a premium whether or not the option is exercised. The fund also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. Option contracts are valued daily, and unrealized appreciation or depreciation is recorded. The fund will realize a gain or loss upon expiration or closing of the option transaction. When an option is exercised, the proceeds on sales for a written call option, the purchase cost for a written put option, or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. 9 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS FUTURES TRANSACTIONS In order to gain exposure to or protect against changes in the market, the fund may buy and sell interest rate futures contracts and related options. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The fund recognizes the realized gain or loss when the contract is closed or expires. INTEREST RATE TRANSACTIONS To preserve a return or spread on a particular investment or portion of its portfolio or for other non-speculative purposes, DDJ could enter into interest rate swaps and could purchase or sell interest rate caps and floors. Effective, September 1, 1995, Adjustable Rate Mortgage Securities Fund may purchase and sell interest rate caps and floors but cannot enter into interest rate swaps. Interest rate swaps involve the exchange of commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate floor. If forecasts of interest rates and other market factors are incorrect, investment performance will diminish compared to what performance would have been if these investment techniques were not used. Even if the forecasts are correct, there is risk that the positions may correlate imperfectly with the asset or liability being hedged. Other risks of entering into these transactions are that a liquid secondary market may not always exist, or that another party to a transaction may not perform. For interest rate swaps, DDJ accrued weekly, as an increase or decrease to interest income, the net amount due or owed by the fund. Interest rate swap, cap and floor valuations are based on prices quoted by independent brokers. These valuations represent the net present value of all future cash settlement amounts based on implied forward interest rates. SECURITIES PURCHASED ON A WHEN-ISSUED BASIS Delivery and payment for securities that have been purchased by the fund on a forward-commitment or when-issued basis can take place one month or more after the transaction date. During this period, such securities do not earn interest, are subject to market fluctuations and may increase or decrease in value prior to their delivery. The fund maintains, in a segregated account with its custodian, cash or securities with a market value equal to the amount of its purchase commitments. The purchase of securities on a when-issued or forward-commitment basis may increase the volatility of the fund's NAV to the extent the fund makes such purchases while remaining substantially fully invested. As of August 31, 1995, the fund had outstanding when-issued or forward commitments of $25,109,375. 10 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS Consistent with its ability to purchase securities on a when-issued or forward- commitment basis, DDJ entered into mortgage "dollar rolls" in which the fund sold securities for delivery in the current month and simultaneously contracted with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities. As an inducement to "roll over" its purchase commitments, the fund received negotiated fees. For the year ended August 31, 1995, such fees amounted to $300,962. Effective September 1, 1995, Adjustable Rate Mortgage Securities Fund will not enter into mortgage "dollar rolls" but may purchase securities on a when-issued basis with the intention of acquiring such securities for its portfolio. FEDERAL TAXES The fund's policy is to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and not be subject to federal income tax. Therefore, no income tax provision is required. Net investment income and net realized gains (losses) may differ for financial statement and tax purposes primarily because of the recognition of certain foreign currency gains (losses) as ordinary income for tax purposes, and losses deferred due to "wash sale" and "straddle" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the fund. The fund will elect to utilize equalization debits, by which a portion of the fund's payments for tendered shares which occurred during the year ended August 31, 1995, will reduce undistributed net investment income for tax purposes. On the statements of assets and liabilities, as a result of permanent book-to-tax differences, a reclassification adjustment has been made to decrease undistributed net investment income by $2,813,663, decrease accumulated net realized losses by $2,690,897 and increase additional paid-in capital by $122,766. DISTRIBUTIONS DDJ paid monthly distributions from net investment income. Realized capital gains, if any, were distributed on an annual basis. These distributions were recorded as of the close of business on the ex-dividend date. Such distributions were payable in cash or, pursuant to the fund's dividend reinvestment plan, reinvested in additional shares of the fund's capital stock. Effective September 1, 1995, Adjustable Rate Mortgage Securities Fund's distributions to shareholders from net investment income will be declared daily and paid monthly in cash or reinvested in additional shares. Distributions from net realized gains, if any, will be made on at least an annual basis. REPURCHASE AGREEMENTS For repurchase agreements entered into with certain broker-dealers, the fund, along with other affiliated registered investment companies may transfer uninvested cash balances into a joint trading account, the daily aggregate of which is invested in repurchase agreements secured by U.S. government and agency obligations. Securities pledged as collateral for all individual and joint repurchase agreements are held by the fund's custodian bank until maturity of the repurchase agreements. Provisions for all agreements ensure the daily market value of the collateral is in excess of the repurchase amount in the event of default. 11 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (3) EXPENSES DDJ had entered into the following agreements with Piper Capital Management Incorporated (the adviser and administrator): The investment advisory agreement provided the adviser with a monthly investment management fee based on fund's average weekly net assets computed at the per-annum rate of 0.35%. For its fee, the adviser provided investment advice and, in general, conducted the management and investment activity of the fund. The administration agreement provided the administrator with a monthly fee in an amount equal to an annualized rate of 0.15% of the fund's average weekly net assets. For its fee, the administrator provided certain reporting, regulatory and record-keeping services for the fund. Effective September 1, 1995, Adjustable Rate Mortgage Securities Fund is subject to an investment management agreement with Piper Capital Management Incorporated (Piper Capital) under which Piper Capital manages the fund's assets and furnishes related office facilities, equipment, research and personnel. The agreement requires the fund to pay Piper Capital a monthly fee based on its average daily net assets. The fee is equal to an annual rate of 0.35% of the first $500 million in net assets and 0.30% of net assets in excess of $500 million. Effective September 1, 1995, Adjustable Rate Mortgage Securities Fund will pay Piper Jaffray Inc. (Piper Jaffray) a monthly fee for expenses incurred in the distribution and promotion of fund shares. The monthly fee is limited to a maximum of 1/12th of 0.15% of the fund's average daily net assets and is payable as a servicing fee. In addition to these fees the fund is responsible for paying most other operating expenses including outside directors' fees and expenses, custodian fees, registration fees, printing and shareholder reports, transfer agent fees and expenses, legal, auditing and accounting services, insurance, interest, taxes and other miscellaneous expenses. (4) SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than temporary investments in short-term securities) for the year ended August 31, 1995, were $162,675,184 and $400,581,863, respectively. In order to hedge the value of adjustable rate mortgage securities under certain interest rate scenarios, the fund had purchased four-year U.S. Treasury put option contracts. As a result of the fund's changing investment strategies due to the impending merger, these options were closed in fiscal 1995. The resulting realized losses are disclosed in the Statement of Operations. During the year ended August 31, 1995, the fund paid Piper Jaffray Inc., an affiliated broker, brokerage commissions of $1,700. (5) CAPITAL LOSS CARRYOVER For federal income tax purposes, the fund had capital loss carryovers of $47,094,867 at August 31, 1995. If these loss carryovers are not offset by subsequent capital gains, they will expire at various times during 1999 through 2002. It is unlikely the board of directors will authorize a distribution of any net realized capital gains until the available capital loss carryovers have been offset or expire. 12 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (6) RETIREMENT OF FUND SHARES The board of directors of DDJ approved a plan to repurchase shares of the fund in the open market and retire those shares. Repurchases were only made when the previous day's closing market price was at a discount from net asset value. Daily repurchases were limited to 25% of the previous four weeks average daily trading volume on the New York Stock Exchange. Under the plan, cumulative repurchases were limited to 3% of the total shares originally issued. The plan was last reviewed and reapproved by the board of directors on August 18, 1995. Pursuant to the plan, the fund repurchased and retired 823,000 shares (1.44% of originally issued shares) as of August 31, 1995. (7) TENDER OFFER OF FUND SHARES On August 22, 1994, shareholders of DDJ approved a fundamental policy that allowed shareholders to periodically tender their shares back to the fund at net asset value. A tender offer to repurchase up to 25% of the fund's outstanding shares was mailed to shareholders on September 6, 1994. The deadline for participating in the offer was October 3, 1994. The repurchase price was determined on October 10, 1994, at the close of the New York Stock Exchange (4 p.m. Eastern Time). Proceeds of the tender offer were paid to shareholders on October 17, 1994. The total proceeds (including tender fees) paid by the fund as well as the number and percentage of shares tendered are as follows:
Percentage Shares Proceeds Tendered Tendered Paid --------------- --------- ------------ 16% 9,135,819 $ 79,726,515
(8) PENDING LITIGATION On October 20, 1994, a complaint was filed by Herman D. Gordon in the U.S. District Court for the District of Minnesota against DDJ, EDJ, Piper Jaffray Companies Inc. (Piper Companies), Piper Capital Management Incorporated (Piper Capital), Piper Jaffray Inc. (Piper Jaffray) and certain associated individuals. A second complaint was filed on April 14, 1995, in the same court by Frank Donio, I.R.A., and other plaintiffs against BDJ, CDJ, DDJ and EDJ, Piper Companies, Piper Capital, Piper Jaffray and certain associated individuals. Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995, alleging violations of certain federal and state securities laws. Piper Companies and Piper Capital have agreed to indemnify Piper Funds II Adjustable Rate Mortgage Securities Fund (as the successor by merger to BDJ, CDJ, DDJ and EDJ) against any expenses or losses incurred in connection with such complaint. 13 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (9) SUBSEQUENT EVENT-- MERGER At the close of business on September 1, 1995, BDJ, CDJ, DDJ and EDJ merged into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund, a diversified, open end management investment company. DDJ is considered the surviving entity for financial reporting purposes. The following table presents the results of operations of DDJ for the period from August 31, 1995 to September 1, 1995 and the subsequent merger of net assets of BDJ, CDJ, DDJ and EDJ into Adjustable Rate Mortgage Securities Fund. Net assets of DDJ (surviving entity for financial reporting purposes) on 8/31/95 ................ $ 409,306,125 Results of operations on 9/1/95: Net investment income........................... 57,012 Net realized gain (loss) on investments......... (119,150) Net change in appreciation or depreciation of investments.................................... 771,219 -------------- Net increase in net assets resulting from operations..................................... 709,081 -------------- Capital share transactions: Redemption of 1,000 shares of DDJ for dissenters' rights............................. (8,710) -------------- Net assets of DDJ to be merged into Adjustable Rate Mortgage Securities Fund................................ 410,006,496 Merger of BDJ, CDJ and EDJ into Adjustable Rate Mortgage Securities Fund.................................. 801,742,686 -------------- Net assets of Adjustable Rate Mortgage Securities Fund on 9/1/95 ................................ $ 1,211,749,182 -------------- --------------
14 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (10) FINANCIAL HIGHLIGHTS Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows:
Period from Year Year Ended Year Ended 1/30/92* to Ended 8/31/95 8/31/94 8/31/93 8/31/92 ------------- ---------- ---------- ----------- PER-SHARE DATA Net asset value, beginning of period ........... $ 8.82 9.67 9.74 9.58 ------ ---------- ---------- ----------- Operations: Net investment income .......................... 0.51 0.60 0.69 0.43 Net realized and unrealized gains (losses) on investments .................................. (0.05) (0.89) (0.10) 0.08 ------ ---------- ---------- ----------- Total from operations ........................ 0.46 (0.29) 0.59 0.51 ------ ---------- ---------- ----------- Distributions to shareholders: From net investment income ..................... (0.58) (0.56) (0.66) (0.35) ------ ---------- ---------- ----------- Net asset value, end of period ................. $ 8.70 8.82 9.67 9.74 ------ ---------- ---------- ----------- ------ ---------- ---------- ----------- SELECTED INFORMATION Total investment return+ ......................... 5.43% (3.18%) 6.24% 5.49% Net assets at end of period (in millions) ...... $ 409 500 551 555 Ratio of expenses to average weekly net assets ... 0.63% 0.60% 0.58% 0.58%++ Ratio of net investment income to average weekly net assets ..................................... 5.62% 6.39% 7.25% 7.70%++ Portfolio turnover rate (excluding short-term securities) .................................... 36% 39% 39% 41% Amount of borrowings outstanding at end of period (in millions)** .............................. $ -- 145 145 145 Average amount of borrowings outstanding during the period (in millions) ..................... $ 57 145 149 90 Average number of shares outstanding during the period (in millions) ........................... 49 57 57 48 Average per-share amount of borrowings outstanding during the period ............................ $ 1.19 2.55 2.62 1.82
* COMMENCEMENT OF OPERATIONS OF AMERICAN ADJUSTABLE RATE TERM TRUST 1998. ** AMERICAN ADJUSTABLE RATE TERM TRUST 1998 WAS A CLOSED-END INVESTMENT MANAGEMENT COMPANY AND WAS PERMITTED TO ENTER INTO BORROWINGS FOR OTHER THAN TEMPORARY OR EMERGENCY PURPOSES. ADJUSTABLE RATE MORTGAGE SECURITIES FUND MAY BORROW ONLY FOR TEMPORARY OR EMERGENCY PURPOSES. + TOTAL INVESTMENT RETURN IS BASED ON THE CHANGE IN NET ASSET VALUE, ASSUMES REINVESTMENT OF DISTRIBUTIONS AT NET ASSET VALUE AND DOES NOT REFLECT A SALES CHARGE. ++ ADJUSTED TO AN ANNUAL BASIS. (11) QUARTERLY DATA (UNAUDITED)
Net Realized Net Increase Total and Unrealized (Decrease) in Net Distributions Quarter End Investment Net Investment Gains (Losses) Assets Resulting From Net Investment Net Asset Quarter Ended Income Income on Investments from Operations Income Value - - - ------------------ ---------- ----------------- ------------------- ------------------ ------------------- ----------- Per Per Per Per Amount Share Amount Share Amount Share Amount Share ---------- ----- ----------- ----- ---------- ----- ----------- ----- 11/30/94 $ 7,489,262 6,794,744 0.14 (13,697,529) (0.27) (6,902,785) (0.13) (6,183,665) (0.13) 8.56 2/28/95 5,803,517 5,246,655 0.11 5,743,189 0.13 10,989,844 0.24 (6,027,339) (0.13) 8.67 5/31/95 6,436,106 5,797,320 0.13 4,308,420 0.09 10,105,740 0.22 (6,004,113) (0.13) 8.76 8/31/95 6,396,441 5,660,707 0.13 442,761 -- 6,103,468 0.13 (9,530,890) (0.19) 8.70 ---------- ---------- ----- ----------- ----- ---------- ----- ----------- ----- $ 26,125,326 23,499,426 0.51 (3,203,159) (0.05) 20,296,267 0.46 (27,746,007) (0.58) ---------- ---------- ----- ----------- ----- ---------- ----- ----------- ----- ---------- ---------- ----- ----------- ----- ---------- ----- ----------- -----
15 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES ADJUSTABLE RATE MORTGAGE SECURITIES FUND* AUGUST 31, 1995
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) U.S. GOVERNMENT SECURITIES (10.2%): U.S. Treasury Note, 4.75%, 2/15/97 ................. $ 27,000,000 26,613,359 U.S. Treasury Note, 6.38%, 6/30/97 ................... 15,000,000 15,150,000 ----------- Total U.S. Government Securities (cost: $41,878,373) ................................ 41,763,359 ----------- MORTGAGE-BACKED SECURITIES (75.7%): U.S. AGENCY ADJUSTABLE RATE MORTGAGES (42.6%): 7.45%, FHLMC, 2/1/22 ................................. 10,785,510 10,932,733 7.81%, FHLMC, 2/1/22 ................................. 15,722,930 16,198,549 7.52%, FHLMC, 8/1/23 ................................. 6,351,483 6,530,849 7.13%, FHLMC, 11/1/16 ................................ 3,475,532 3,526,414 8.00%, FHLMC, 5/1/17 ................................. 3,581,365 3,639,956 7.74%, FHLMC, 1/1/21 ................................. 5,837,805 5,945,688 6.13%, FHLMC, 10/1/23 ................................ 2,929,008 2,974,319 7.54%, FNMA, 9/1/17 .................................. 3,837,284 3,908,043 7.29%, FNMA, 5/1/18 .................................. 5,921,419 6,029,485 7.23%, FNMA, 7/1/17 .................................. 6,204,118 6,320,011 7.80%, FNMA, 7/1/19 .................................. 2,756,865 2,832,320 7.53%, FNMA, 11/1/20 ................................. 5,057,917 5,073,698 7.23%, FNMA, 11/1/17 ................................. 9,818,814 9,931,141 7.89%, FNMA, 7/1/19 .................................. 3,970,383 4,083,658 7.41%, FNMA, 11/1/21 ................................. 7,031,651 7,165,674 7.31%, FNMA, 10/1/20 ................................. 3,445,723 3,355,272 7.01%, FNMA, 12/1/23 ................................. 1,528,113 1,567,935 6.09%, FNMA, 2/1/24 .................................. 3,863,831 3,945,512 6.00%, GNMA II, 7/20/22 .............................. 8,224,187 8,303,139 6.50%, GNMA II, 7/20/22 .............................. 7,882,746 7,985,142 7.00%, GNMA II, 5/20/22 .............................. 3,033,839 3,071,246 7.00%, GNMA II, 6/20/22 .............................. 8,463,131 8,582,969 7.38%, GNMA II, 6/20/23 .............................. 8,072,570 8,205,121 7.00%, GNMA II, 8/20/23 .............................. 8,920,228 9,050,464 6.00%, GNMA II, 9/1/25 ............................... 25,000,000(b) 25,015,750 ----------- 174,175,088 ----------- COLLATERALIZED MORTGAGE OBLIGATIONS AND OTHER MORTGAGE-BACKED SECURITIES (C) (33.1%): U.S. AGENCY FIXED RATE (0.5%): 8.13%, FNMA, Series 1991-66, Class E, 4/25/18 ........ 2,125,025 2,119,266 ----------- U.S. AGENCY FLOATING RATE (11.1%): 6.44%, FHLMC, Series 1377, Class F, LIBOR, 9/15/07 ... 5,855,599 5,835,222 6.44%, FHLMC, Series 1401, Class K, LIBOR, 9/15/20 ... 2,520,900 2,530,706 6.34%, FHLMC, Series 1508, Class J, LIBOR, 9/15/19 ... 3,025,788 3,025,577 6.44%, FHLMC, Series 1603, Class G, LIBOR, 4/15/21 ... 1,670,525 1,677,424 6.29%, FHLMC, Series 1724, Class F, LIBOR, 5/15/01 ... 12,499,787 12,498,662 6.50%, FHLMC, Series 29, Class FA, LIBOR, 3/25/23 .... 7,000,000 7,025,760 6.57%, FNMA, Series 1992-144, Class FA, LIBOR, 9/25/07 ............................................. 2,153,548 2,162,937 6.42%, FNMA, Series 1994-87, Class F, LIBOR, 3/25/09 ............................................. 10,478,681 10,477,529 ----------- 45,233,817 -----------
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- PRIVATE FLOATING RATE (21.5%): 7.79%, Donaldson, Lufkin and Jenrette, Series 1992-MF3, Class A3, 5/25/22 ....................... $ 5,000,000 5,078,125 7.94%, Merrill Lynch Mortgage Investor, Series 1988-V, 1/25/19 ............................................. 986,446 971,649 6.73%, Merrill Lynch Mortgage Investors, Series 1992-C, Class A-2, 6/15/17 .......................... 25,000,000 25,136,700 7.69%, Residential Funding Corporation, Series 1992-S25, Class A, 3/25/22 .......................... 11,294,780 11,402,708 7.81%, Residential Funding Corporation, Series 1993-S8, Class A, 2/25/23 ........................... 7,469,956 7,620,888 7.55%, Resolution Trust Corporation, Series 1992-4, Class B2, 7/25/28 ................................... 10,000,426 9,553,532 7.73%, Resolution Trust Corporation, Series 1992-6, Class B3, 1/25/26 ................................... 13,342,997 13,342,997 7.15%, Sears Mortgage Securities, Series 1991-K, Class A1, 9/25/21 ......................................... 15,175,623 15,061,808 ----------- 88,168,407 ----------- Total Mortgage-Backed Securities (cost: $313,756,064) .............................. 309,696,578 ----------- SHORT-TERM SECURITIES (17.3%): Repurchase agreement with Goldman Sachs in a joint trading account collateralized by U.S. government agency securities, acquired on 8/31/95, accrued interest at repurchase date of $11,275, 5.82%, 9/1/95 (cost: $70,714,000) ................................. 70,714,000 70,714,000 ----------- Total Investments in Securities (cost: $426,348,437) (d) ......................... $ 422,173,937 ----------- -----------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) ON AUGUST 31, 1995, THE TOTAL COST OF INVESTMENTS PURCHASED ON A WHEN-ISSUED BASIS WAS $25,109,375. (C) DESCRIPTIONS OF CERTAIN COLLATERALIZED MORTGAGE OBLIGATIONS ARE AS FOLLOWS: LIBOR - LONDON INTERBANK OFFERED RATE. FLOATING RATE - REPRESENT SECURITIES THAT PAY INTEREST AT RATES THAT INCREASE (DECREASE) WITH AN INCREASE (DECREASE) IN A SPECIFIED INDEX. (D) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES BASED ON THIS COST WERE AS FOLLOWS: GROSS UNREALIZED APPRECIATION .... $ 148,172 GROSS UNREALIZED DEPRECIATION ...... (4,322,672) ---------- NET UNREALIZED APPRECIATION: ... $ (4,174,500) ---------- ----------
* FORMERLY AMERICAN ADJUSTABLE RATE TERM TRUST 1998 16 - - - -------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT THE BOARD OF DIRECTORS AND SHAREHOLDERS PIPER FUNDS INC. - II ADJUSTABLE RATE MORTGAGE SECURITIES FUND: We have audited the accompanying statement of assets and liabilities, including the schedule of investments in securities, of Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund (formerly American Adjustable Rate Term Trust Inc. - - - - 1998) as of August 31, 1995, and the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended August 31, 1995 and the financial highlights presented in footnote 10 to the financial statements. These financial statements and the financial highlights are the responsibility of the fund's management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Investment securities held in custody are confirmed to us by the custodian. As to securities purchased and sold but not received or delivered, we request confirmations from brokers and, where replies are not received, we carry out other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund (formerly American Adjustable Rate Term Trust Inc. - 1998) as of August 31, 1995, the results of its operations and cash flows for the year then ended, the changes in its net assets for each of the years in the two-year period ended August 31, 1995 and the financial highlights presented in footnote 10 to the financial statements, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Minneapolis, Minnesota October 13, 1995 17 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF ASSETS AND LIABILITIES AUGUST 31, 1995
American American American Adjustable Adjustable Adjustable Rate Term Rate Term Rate Term Trust 1996 Trust 1997 Trust 1999 ------------ ------------ ------------ ASSETS: Investments in securities at market value* (including repurchase agreements of $14,394,000; $54,501,000 and $49,871,000, respectively) (note 2) .................. $ 186,645,080 373,531,591 256,753,174 Cash in bank on demand deposit .............. 100,302 750,846 102,236 Receivable for investment securities sold ... -- 2,760,877 1,583,544 Receivable for put options closed ........... 100 35,200 -- Accrued interest receivable ................. 1,068,066 2,230,059 1,371,910 Mortgage security principal paydowns receivable ................................ 1,046,771 736,142 1,723,902 ------------ ------------ ------------ Total assets ............................ 188,860,319 380,044,715 261,534,766 ------------ ------------ ------------ LIABILITIES: Payable for investment securities purchased on a when-issued basis (note 2) ........... -- 10,043,750 20,087,500 Accrued investment management fee ........... 57,256 111,084 71,756 Accrued administrative fee .................. 24,538 47,608 30,753 ------------ ------------ ------------ Total liabilities ....................... 81,794 10,202,442 20,190,009 ------------ ------------ ------------ Net assets applicable to outstanding capital stock ..................................... $ 188,778,525 369,842,273 241,344,757 ------------ ------------ ------------ ------------ ------------ ------------ REPRESENTED BY: Capital stock - authorized 1 billion shares of $0.01 par value; outstanding, 21,846,582; 42,433,699 and 28,114,172 shares, respectively ...................... 218,466 424,337 281,142 Additional paid-in capital .................. 211,965,074 413,266,384 274,572,715 Accumulated net realized loss on investments ............................... (21,547,695) (41,083,019) (31,946,977) Unrealized depreciation of investments ...... (1,857,320) (2,765,429) (1,562,123) ------------ ------------ ------------ Total - representing net assets applicable to outstanding capital stock ................................ $ 188,778,525 369,842,273 241,344,757 ------------ ------------ ------------ ------------ ------------ ------------ Net asset value per share of outstanding capital stock ............................. $ 8.64 8.72 8.58 ------------ ------------ ------------ ------------ ------------ ------------ * Investments in securities at identified cost ...................................... $ 188,502,400 376,297,020 258,315,297 ------------ ------------ ------------ ------------ ------------ ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 18 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF OPERATIONS FOR THE YEAR ENDED AUGUST 31, 1995
American American American Adjustable Adjustable Adjustable Rate Term Rate Term Rate Term Trust 1996 Trust 1997 Trust 1999 ------------ ------------ ------------ INCOME: Interest (net of interest expense of $1,525,774; $3,877,530 and $2,047,360, respectively) ... $ 12,520,399 23,582,776 15,318,759 Fee income (note 2) ............................ 130,648 356,398 197,723 ------------ ------------ ------------ Total investment income .................... 12,651,047 23,939,174 15,516,482 ------------ ------------ ------------ EXPENSES (NOTE 3): Investment management fee ...................... 707,664 1,335,931 856,890 Administrative fee ............................. 303,285 572,542 367,239 Custodian, accounting and transfer agent fees ......................................... 141,073 196,056 136,121 Reports to shareholders ........................ 113,392 187,950 104,909 Directors' fees ................................ 15,711 22,661 22,661 Audit and legal fees ........................... 69,473 74,040 67,639 Federal excise tax expense (note 2) ............ 87,791 -- -- Other expenses ................................. 59,534 63,377 83,071 ------------ ------------ ------------ Total expenses ............................. 1,497,923 2,452,557 1,638,530 ------------ ------------ ------------ Net investment income ...................... 11,153,124 21,486,617 13,877,952 ------------ ------------ ------------ NET REALIZED AND UNREALIZED GAINS (LOSSES) ON INVESTMENTS: Net realized loss on investments (note 4) ...... (3,157,265) (6,307,138) (7,106,564) Net realized loss on closed put option contracts (note 4) ..................................... (1,528,700) (2,494,400) (870,500) Net realized gain (loss) on closed interest rate swap transactions ............................ 527,325 1,284,681 (7,968,122) Net realized gain on closed futures contracts .................................... 75,712 148,300 116,228 ------------ ------------ ------------ Net realized loss on investments ............. (4,082,928) (7,368,557) (15,828,958) Net change in unrealized appreciation or depreciation of investments .................. 4,093,903 7,457,863 12,552,689 ------------ ------------ ------------ Net gain (loss) on investments ............... 10,975 89,306 (3,276,269) ------------ ------------ ------------ Net increase in net assets resulting from operations .............................. $ 11,164,099 21,575,923 10,601,683 ------------ ------------ ------------ ------------ ------------ ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 19 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED AUGUST 31, 1995
American American American Adjustable Adjustable Adjustable Rate Term Rate Term Rate Term Trust 1996 Trust 1997 Trust 1999 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Interest and fee income ................ $ 12,651,047 23,939,174 15,516,482 Expenses ................................. (1,497,923) (2,452,557) (1,638,530) ------------- ------------- ------------- Net investment income ................ 11,153,124 21,486,617 13,877,952 ------------- ------------- ------------- Adjustments to reconcile net investment income to cash provided by operating activities: Change in accrued interest and mortgage security principal paydowns receivable ............................ 707,294 370,513 (428,229) Net amortization of bond discount and premium ............................... (1,330,614) (3,619,847) (1,804,080) Change in accrued fees and expenses .... (284,376) (373,189) (167,712) ------------- ------------- ------------- Total adjustments .................... (907,696) (3,622,523) (2,400,021) ------------- ------------- ------------- Net cash provided by operating activities .......................... 10,245,428 17,864,094 11,477,931 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investments ....... 160,411,931 370,520,124 264,553,164 Purchases of investments ................. (56,156,777) (168,270,994) (131,072,083) Net sales of short-term securities ....... 19,391,621 3,383,866 12,489,307 Cash received (paid) for interest rate swap transactions ...................... 527,325 1,284,681 (9,245,203) Net variation margin receipts for futures contracts .............................. 75,712 148,300 116,228 Receipts from closed put option contracts .............................. -- 46,000 1,139,500 ------------- ------------- ------------- Net cash provided by investing activities .......................... 124,249,812 207,111,977 137,980,913 ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Tender of fund shares (note 7) ........... (42,903,162) (65,042,645) (47,240,592) Net payments for reverse repurchase agreements ............................. (70,000,000) (125,000,000) (85,000,000) Retirement of fund shares (note 6) ....... (1,454,560) (3,544,849) (2,045,751) Distributions paid to shareholders ....... (20,175,730) (30,683,252) (15,320,596) ------------- ------------- ------------- Net cash used by financing activities .......................... (134,533,452) (224,270,746) (149,606,939) ------------- ------------- ------------- Net increase (decrease) in cash .......... (38,212) 705,325 (148,095) Cash at beginning of year ................ 138,514 45,521 250,331 ------------- ------------- ------------- Cash at end of year ................ $ 100,302 750,846 102,236 ------------- ------------- ------------- ------------- ------------- ------------- Supplemental disclosure of cash flow information: Cash paid for interest on reverse repurchase agreements ................ $ 1,789,441 4,219,747 2,191,535 ------------- ------------- ------------- ------------- ------------- -------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 20 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS AMERICAN ADJUSTABLE RATE TERM TRUST 1996
Year Ended Year Ended 8/31/95 8/31/94 ------------ ------------ OPERATIONS: Net investment income .................................. $ 11,153,124 17,520,126 Net realized loss on investments ......................... (4,082,928) (10,318,058) Net change in unrealized appreciation or depreciation of investments ............................................ 4,093,903 (9,945,239) ------------ ------------ Net increase (decrease) in net assets resulting from operations ............................................ 11,164,099 (2,743,171) ------------ ------------ DISTRIBUTIONS TO SHAREHOLDERS: From net investment income ............................... (20,175,730) (12,495,376) ------------ ------------ CAPITAL SHARE TRANSACTIONS: Payments for tender of 4,767,018 shares (note 7) ......... (42,903,162) -- Payments for retirement of 173,700 and 142,700 shares, respectively (note 6) .................................. (1,394,350) (1,215,470) ------------ ------------ Decrease in net assets from capital share transactions .......................................... (44,297,512) (1,215,470) ------------ ------------ Total decrease in net assets ......................... (53,309,143) (16,454,017) Net assets at beginning of year ............................ 242,087,668 258,541,685 ------------ ------------ Net assets at end of year ................................ $ 188,778,525 242,087,668 ------------ ------------ ------------ ------------ Undistributed net investment income ...................... $ -- 10,238,410 ------------ ------------ ------------ ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 21 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS AMERICAN ADJUSTABLE RATE TERM TRUST 1997
Year Ended Year Ended 8/31/95 8/31/94 ------------ ------------ OPERATIONS: Net investment income .................................. $ 21,486,617 31,764,264 Net realized loss on investments ......................... (7,368,557) (23,803,088) Net change in unrealized appreciation or depreciation of investments ............................................ 7,457,863 (19,413,596) ------------ ------------ Net increase (decrease) in net assets resulting from operations ............................................ 21,575,923 (11,452,420) ------------ ------------ DISTRIBUTIONS TO SHAREHOLDERS: From net investment income ............................... (30,683,252) (26,867,223) ------------ ------------ CAPITAL SHARE TRANSACTIONS: Payments for tender of 7,396,113 shares (note 7) ......... (65,042,645) -- Payments for retirement of 420,100 and 290,700 shares, respectively (note 6) .................................. (3,396,318) (2,437,499) ------------ ------------ Decrease in net assets from capital share transactions .......................................... (68,438,963) (2,437,499) ------------ ------------ Total decrease in net assets ......................... (77,546,292) (40,757,142) Net assets at beginning of year ............................ 447,388,565 488,145,707 ------------ ------------ Net assets at end of year ................................ $ 369,842,273 447,388,565 ------------ ------------ ------------ ------------ Undistributed net investment income ...................... $ -- 11,548,663 ------------ ------------ ------------ ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 22 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS AMERICAN ADJUSTABLE RATE TERM TRUST 1999
Year Ended Year Ended 8/31/95 8/31/94 ------------ ------------ OPERATIONS: Net investment income .................................. $ 13,877,952 20,160,682 Net realized loss on investments ......................... (15,828,958) (17,443,179) Net change in unrealized appreciation or depreciation of investments ............................................ 12,552,689 (14,015,353) ------------ ------------ Net increase (decrease) in net assets resulting from operations ............................................ 10,601,683 (11,297,850) ------------ ------------ DISTRIBUTIONS TO SHAREHOLDERS: From net investment income ............................... (15,320,596) (19,270,500) In excess of net realized gains (note 2) ................. -- (183,586) ------------ ------------ Total distributions .................................... (15,320,596) (19,454,086) ------------ ------------ CAPITAL SHARE TRANSACTIONS: Payments for tender of 5,535,062 shares (note 7) ......... (47,240,592) -- Payments for retirement of 237,000 and 205,100 shares, respectively (note 6) .................................. (1,854,628) (1,674,424) ------------ ------------ Decrease in net assets from capital share transactions .......................................... (49,095,220) (1,674,424) ------------ ------------ Total decrease in net assets ......................... (53,814,133) (32,426,360) Net assets at beginning of year ............................ 295,158,890 327,585,250 ------------ ------------ Net assets at end of year ................................ $ 241,344,757 295,158,890 ------------ ------------ ------------ ------------ Undistributed net investment income ...................... $ -- 2,115,191 ------------ ------------ ------------ ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 23 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION American Adjustable Rate Term Trusts 1996 (BDJ), 1997 (CDJ) and 1999 (EDJ) are registered under the Investment Company Act of 1940 (as amended) as diversified, closed-end management investment companies. BDJ, CDJ and EDJ commenced operations on September 27, 1990; July 24, 1991; and September 24, 1992; respectively, upon completion of initial public offerings of common stock. Shares of the funds stopped trading on the New York Stock Exchange and the Chicago Stock Exchange on August 24, 1995. As discussed in footnote 9, the funds' shareholders approved a plan to merge all of the funds' net assets, along with the net assets of American Adjustable Rate Term Trust 1998 (DDJ) into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund, a diversified, open-end investment company, effective September 1, 1995. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INVESTMENTS IN SECURITIES The values of fixed income securities are determined using pricing services or prices quoted by independent brokers. Exchange-listed options are valued at the last sale price and open financial futures contracts are valued at the last settlement price. When market quotations are not readily available, securities are valued at fair value according to methods selected in good faith by the board of directors. Short-term securities with maturities of 60 days or less are valued at amortized cost which approximates market value. Securities transactions are accounted for on the date the securities are purchased or sold. Realized gains and losses are calculated on the identified-cost basis. Interest income, including amortization of bond discount and premium computed on a level-yield basis, is accrued daily. OPTION TRANSACTIONS For hedging purposes, the funds may buy and sell put and call options, write covered call options on portfolio securities, write cash-secured puts, and write call options that are not covered for cross-hedging purposes. The risk in writing a call option is that a fund gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that a fund may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that a fund pays a premium whether or not the option is exercised. A fund also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. The funds also may write over-the-counter options where the completion of the obligation is dependent upon the credit standing of another party. Option contracts are valued daily, and unrealized appreciation or depreciation is recorded. A fund will realize a gain or loss upon expiration or closing of the option transaction. When an option is exercised, the proceeds on sales for a written call option, the purchase cost for a written put option, or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. FUTURES TRANSACTIONS In order to gain exposure to or protect against changes in the market, the funds may buy and sell interest rate futures contracts and related options. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract 24 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS value. Subsequent payments (variation margin) are made or received by a fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. A fund recognizes a realized gain or loss when the contract is closed or expires. INTEREST RATE TRANSACTIONS To preserve a return or spread on a particular investment or portion of its portfolio or for other non-speculative purposes, the funds may enter into interest rate swaps and the purchase or sale of interest rate caps and floors. Interest rate swaps involve the exchange of commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate floor. If forecasts of interest rates and other market factors are incorrect, investment performance will diminish compared to what performance would have been if these investment techniques were not used. Even if the forecasts are correct, there is risk that the positions may correlate imperfectly with the asset or liability being hedged. Other risks of entering into these transactions are that a liquid secondary market may not always exist, or that another party to a transaction may not perform. For interest rate swaps, the funds accrue weekly, as an increase or decrease to interest income, the current net amount due or owed by the funds. Interest rate swap, cap and floor valuations are based on prices quoted by independent brokers. These valuations represent the net present value of all future cash settlement amounts based on implied forward interest rates. As of August 31, 1995, the funds had no open interest rate swap agreements. SECURITIES PURCHASED ON A WHEN-ISSUED BASIS Delivery and payment for securities that have been purchased by the funds on a forward-commitment or when-issued basis can take place one month or more after the transaction date. During this period, such securities do not earn interest, are subject to market fluctuations and may increase or decrease in value prior to their delivery. The funds maintain, in segregated accounts with their custodian, securities with a market value equal to the amount of their purchase commitments. The purchase of securities on a when-issued or forward-commitment basis may increase the volatility of the funds' NAVs to the extent the funds make such purchases while remaining substantially fully invested. As of August 31, 1995, CDJ and EDJ had $10,043,750 and $20,087,500 of outstanding when-issued or forward commitments, respectively. Consistent with their ability to purchase securities on a when-issued or forward- commitment basis, the funds may enter into mortgage "dollar rolls" in which the funds sell securities for delivery in the current month and simultaneously contract with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities. As an inducement to "roll over" their purchase commitments, the funds receive negotiated fees. For the year ended August 31, 1995, such fees earned by the funds amounted to $130,648; $356,398 and $197,723 for BDJ, CDJ and EDJ, respectively. 25 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS FEDERAL TAXES Each fund's policy is to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and not be subject to federal income tax. Therefore, no income tax provision is required. However, BDJ incurred federal excise taxes of $87,791 ($0.004 per share) on income retained by the fund during the 1994 excise tax year. Net investment income and net realized gains (losses) may differ for financial statement and tax purposes primarily because of the recognition of certain foreign currency gains (losses) as ordinary income for tax purposes, and losses deferred due to "wash sale" and "straddle" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. The effect on dividend distributions of certain book-to-tax differences is presented an as "excess distribution" in the statement of changes in net assets and the financial highlights. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the fund. The funds will elect to utilize equalization debits, by which a portion of the funds' payments for tendered shares which occurred during the year ended August 31, 1995, will reduce undistributed net investment income for tax purposes. On the statements of assets and liabilities, as a result of permanent book-to-tax differences, reclassification adjustments have been made as follows:
BDJ CDJ EDJ --------- --------- ---------- Decrease accumulated net realized loss on investments ..................... $ 1,242,744 2,160,720 1,694,852 Decrease undistributed net investment income ............................. $ 1,215,804 2,352,028 672,547 Increase (decrease) additional paid-in capital ............................ $ (26,940) 191,308 (1,022,305)
DISTRIBUTIONS The funds pay monthly distributions from net investment income. Realized capital gains, if any, will be distributed on an annual basis. These distributions are recorded as of the close of business on the ex-dividend date. Such distributions are payable in cash or, pursuant to the funds' dividend reinvestment plan, reinvested in additional shares of the funds' common stock. Under the plan, fund shares are purchased in the open market. REPURCHASE AGREEMENTS For repurchase agreements entered into with certain broker-dealers, the funds along with other affiliated registered investment companies may transfer uninvested cash balances into a joint trading account, the daily aggregate of which is invested in repurchase agreements secured by U.S. government and agency obligations. Securities pledged as collateral for all individual and joint repurchase agreements are held by the funds' custodian bank until maturity of the repurchase agreements. Provisions for all agreements ensure the daily market value of the collateral is in excess of the repurchase amount in the event of default. 26 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (3) EXPENSES The funds have entered into the following agreements with Piper Capital Management Incorporated (the adviser and administrator): The investment advisory agreement provides the adviser with a monthly investment management fee based on each fund's average weekly net assets computed at the per-annum rate of 0.35%. For its fee, the adviser provides investment advice and, in general, conducts the management and investment activity of the fund. The administration agreement provides the administrator with a monthly fee in an amount equal to an annualized rate of 0.15% of the each fund's average weekly net assets. For its fee, the administrator provides certain reporting, regulatory and record-keeping services for the funds. In addition to the investment management fee and the administrative fee, the funds are responsible for paying most other operating expenses including outside directors' fees and expenses, custodian fees, registration fees, printing and shareholder reports, transfer agent fees and expenses, legal, auditing and accounting services, insurance, interest, taxes and other miscellaneous expenses. (4) SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than temporary investments in short-term securities) for the year ended August 31, 1995, were as follows:
Sales Purchases Proceeds ------------ ------------ BDJ ......................................... $ 33,098,233 160,411,931 CDJ ......................................... $ 117,981,466 373,281,001 EDJ ......................................... $ 113,965,226 266,136,708
During the year ended August 31, 1995, the funds paid Piper Jaffray Inc., an affiliated broker, brokerage commissions of $850; $1,700 and $850 for BDJ, CDJ and EDJ, respectively. In order to hedge the value of adjustable rate mortgage securities under certain interest rate scenarios, each fund had purchased four-year U.S. Treasury note put option contracts. As a result of the funds' changing investment strategies due to the impending merger, these options were closed in fiscal 1995. The resulting realized losses are disclosed in the Statement of Operations. (5) CAPITAL LOSS CARRYOVER For federal income tax purposes, the funds had capital loss carryovers of $21,547,695; $41,083,019 and $31,946,977 for BDJ, CDJ and EDJ, respectively, at August 31, 1995. If these loss carryovers are not offset by subsequent capital gains, they will expire at various times during 1998 through 2002. (6) RETIREMENT OF FUND SHARES The funds' board of directors approved a plan to repurchase shares of the funds in the open market and retire those shares. Repurchases are only made when the previous day's closing market price was at a discount from net asset value. Daily repurchases are limited to 25% of the previous four weeks average daily trading volume on the New York Stock Exchange. Under the current plan, cumulative repurchases in each fund cannot exceed 3% of the total shares originally issued. The plan was last reviewed and reapproved by the board of directors on August 18, 1995. Pursuant to the plan, the funds have repurchased and retired the following cumulative number of shares as of August 31, 1995:
Shares Percent of Shares Repurchased Originally Issued ------------ ------------------- BDJ ....................................... 316,400 1.17% CDJ ....................................... 710,800 1.41% EDJ ....................................... 442,100 1.30%
27 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (7) TENDER OFFER OF FUND SHARES On August 22, 1994, shareholders of the funds approved a fundamental policy that allows shareholders of BDJ, CDJ and EDJ to periodically tender their shares back to the respective fund at net asset value. A tender offer to repurchase up to 25% of each fund's outstanding shares was mailed to shareholders on September 6, 1994. The deadline for participating in the offer was October 3, 1994. The repurchase prices were determined on October 10, 1994, at the close of the New York Stock Exchange (4 p.m. Eastern Time). Proceeds of the tender offer were paid to shareholders on October 17, 1994. The total proceeds (including tender fees) paid by the funds as well as the number and percentage of shares tendered are as follows:
Percentage Shares Proceeds Tendered Tendered Paid --------------- --------- ------------ BDJ ................................. 18% 4,767,018 $ 42,903,162 CDJ ................................. 15% 7,396,113 $ 65,042,645 EDJ ................................. 16% 5,535,062 $ 47,240,592
(8) PENDING LITIGATION On October 20, 1994, a complaint was filed by Herman D. Gordon in the U.S. District Court for the District of Minnesota against DDJ and EDJ, Piper Jaffray Companies Inc. (Piper Companies), Piper Capital Management Incorporated (Piper Capital), Piper Jaffray Inc. (Piper Jaffray) and certain associated individuals. A second complaint was filed on April 14, 1995, in the same court by Frank Donio, I.R.A., and other plaintiffs against BDJ, CDJ, DDJ and EDJ, Piper Companies, Piper Capital, Piper Jaffray and certain associated individuals. Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995, alleging violations of certain federal and state securities laws. Piper Companies and Piper Capital have agreed to indemnify Piper Funds II Adjustable Rate Mortgage Securities Fund (as the successor by merger to BDJ, CDJ, DDJ and EDJ) against any expenses or losses incurred in connection with such complaint. 28 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (9) SUBSEQUENT EVENT-- MERGER At the close of business on September 1, 1995, BDJ, CDJ, DDJ and EDJ merged into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund, a diversified, open-end management investment company. DDJ is considered the surviving entity for financial reporting purposes. The following table presents the results of operations of BDJ, CDJ and EDJ for the period from August 31, 1995 to September 1, 1995, and the subsequent merger of the net assets of those funds into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund.
BDJ CDJ EDJ ------------ ------------ ------------ Net assets on 8/31/95 ................ $ 188,778,525 369,842,273 241,344,757 Results of operations on 9/1/95: Net investment income ................ 27,390 50,782 33,372 Net realized gain (loss) on investments ......................... (265,318) (110,668) 4,106 Net change in appreciation or depreciation of investments ......... 426,963 1,018,376 600,778 ------------ ------------ ------------ Net increase in net assets resulting from operations ..................... 189,035 958,490 638,256 ------------ ------------ ------------ Capital share transactions: Redemption of 1,000 shares for dissenters' rights .................. (8,650) -- -- ------------ ------------ ------------ Net assets prior to merger on 9/1/95 ... 188,958,910 370,800,763 241,983,013 Merger into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund on 9/1/95 representing 21,845,582; 42,433,699 and 28,114,172 shares, respectively* ......................... (188,958,910) (370,800,763) (241,983,013) ------------ ------------ ------------ Net assets at close of business on 9/1/95 .............................. $ -- -- -- ------------ ------------ ------------ ------------ ------------ ------------ * SHAREHOLDERS OF BDJ, CDJ AND EDJ RECEIVED 23,619,989; 46,350,330 AND 30,248,037 SHARES, RESPECTIVELY OF PIPER FUNDS INC. - II ADJUSTABLE RATE MORTGAGE SECURITIES FUND AT AN INITIAL NET ASSET VALUE OF $8.00 PER SHARE.
29 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (10) FINANCIAL HIGHLIGHTS Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows: AMERICAN ADJUSTABLE RATE TERM TRUST 1996
Period from Year Year Ended Year Ended Year Ended 9/27/90* to Ended 8/31/95 8/31/94 8/31/93 8/31/92 8/31/91 ------------- ---------- ---------- ---------- ----------- PER-SHARE DATA Net asset value, beginning of period ........... $ 9.04 9.60 9.74 9.64 9.53 ------ ---------- ---------- ---------- ----------- Operations: Net investment income .......................... 0.51/ / 0.65 0.75 0.82 0.83 Net realized and unrealized gains (losses) on investments................................... 0.01 (0.75) (0.27) 0.07 0.05 ------ ---------- ---------- ---------- ----------- Total from operations ........................ 0.52 (0.10) 0.48 0.89 0.88 ------ ---------- ---------- ---------- ----------- Distributions to shareholders: From net investment income ..................... (0.92) (0.46) (0.62) (0.79) (0.77) ------ ---------- ---------- ---------- ----------- Net asset value, end of period ................. $ 8.64 9.04 9.60 9.74 9.64 ------ ---------- ---------- ---------- ----------- ------ ---------- ---------- ---------- ----------- Per share market value, end of period TRIANGLE ............................. $ -- 8.50 9.50 10.25 10.13 ------ ---------- ---------- ---------- ----------- ------ ---------- ---------- ---------- ----------- SELECTED INFORMATION Total investment return, net asset value+ ........ 5.86% (1.06%) 5.18% 9.58% 9.55% Total investment return, market value** .......... 12.79% (5.94%) (1.37%) 9.29% 9.15% Net assets at end of period (in millions) ...... $ 189 242 259 262 260 Ratio of expenses to average weekly net assets*** ...................................... 0.74% 0.65% 0.61% 0.62% 0.64%++ Ratio of net investment income to average weekly net assets*** .................................. 5.52% 6.97% 7.91% 8.44% 9.09%++ Portfolio turnover rate (excluding short-term securities) .................................... 17% 43% 58% 26% 60% Amount of borrowings outstanding at end of period (in millions)+++ ............................. $ -- 70 86 70 70 Per-share amount of borrowings outstanding at end of period .................................... $ -- 2.61 3.18 2.60 2.60 Per-share amount of net assets, excluding borrowings, at end of period ................. $ -- 11.65 12.78 12.34 12.24 Asset coverage ratio TRIANGLE TRIANGLE ....... $ -- 446% 402% 475% 470%
* COMMENCEMENT OF OPERATIONS. ** TOTAL INVESTMENT RETURN, MARKET VALUE, IS BASED ON THE CHANGE IN MARKET PRICE OF A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT ACTUAL PRICES PURSUANT TO THE FUND'S DIVIDEND REINVESTMENT PLAN. FOR PURPOSES OF THE FISCAL 1995 COMPUTATION, THE AUGUST 31, 1995 NET ASSET VALUE IS USED AS THE END OF PERIOD VALUE. SEE FOOTNOTE 9 TO THE FINANCIAL STATEMENTS REGARDING THE MERGER INTO AN OPEN-END MANAGEMENT INVESTMENT COMPANY ON 9/1/95. *** INCLUDES 0.04% AND 0.01% FROM FEDERAL EXCISE TAXES IN THE FISCAL YEARS 1995 AND 1994, RESPECTIVELY. + TOTAL INVESTMENT RETURN, NET ASSET VALUE, IS BASED ON THE CHANGE IN NET ASSET VALUE OF A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT NET ASSET VALUE. ++ ADJUSTED TO AN ANNUAL BASIS. +++ SECURITIES PURCHASED ON A WHEN-ISSUED BASIS FOR WHICH LIQUID, HIGH-GRADE DEBT OBLIGATIONS ARE MAINTAINED IN A SEGREGATED ACCOUNT ARE NOT CONSIDERED BORROWINGS. SEE FOOTNOTE 2 IN THE NOTES TO FINANCIAL STATEMENTS. TRIANGLE SHARES STOPPED TRADING ON THE NYSE AND CSE ON AUGUST 24, 1995. TRIANGLE TRIANGLE REPRESENTS NET ASSETS, EXCLUDING BORROWINGS, AT END OF PERIOD DIVIDED BY BORROWINGS OUTSTANDING AT END OF PERIOD. / / BASED ON AVERAGE SHARES OUTSTANDING DURING THE PERIOD. 30 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (10) FINANCIAL HIGHLIGHTS (CONTINUED) Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows: AMERICAN ADJUSTABLE RATE TERM TRUST 1997
Period from Year Year Ended Year Ended Year Ended 7/24/91* to Ended 8/31/95 8/31/94 8/31/93 8/31/92 8/31/91 ------------- ---------- ---------- ---------- ----------- PER-SHARE DATA Net asset value, beginning of period ........... $ 8.90 9.66 9.68 9.68 9.58 ------ ---------- ---------- ---------- ----------- Operations: Net investment income .......................... 0.53/ / 0.63 0.72 0.78 0.07 Net realized and unrealized gains (losses) on investments................................... 0.01 (0.86) (0.10) 0.05 0.03 ------ ---------- ---------- ---------- ----------- Total from operations ........................ 0.54 (0.23) 0.62 0.83 0.10 ------ ---------- ---------- ---------- ----------- Distributions to shareholders: From net investment income ..................... (0.72) (0.53) (0.63) (0.80) -- From net realized gains ........................ -- -- (0.01) (0.03) -- ------ ---------- ---------- ---------- ----------- Total distributions to shareholders .......... (0.72) (0.53) (0.64) (0.83) -- ------ ---------- ---------- ---------- ----------- Net asset value, end of period ................. $ 8.72 8.90 9.66 9.68 9.68 ------ ---------- ---------- ---------- ----------- ------ ---------- ---------- ---------- ----------- Per share market value, end of period TRIANGLE ............................. $ -- 8.50 9.38 10.00 10.25 ------ ---------- ---------- ---------- ----------- ------ ---------- ---------- ---------- ----------- SELECTED INFORMATION Total investment return, net asset value+ ........ 6.23% (2.46%) 6.73% 8.97% 1.04% Total investment return, market value** .......... 11.54% (3.96%) 0.04% 5.87% 2.50% Net assets at end of period (in millions) ...... $ 370 447 488 489 212 Ratio of expenses to average weekly net assets ... 0.64% 0.61% 0.58% 0.60% 0.60%++ Ratio of net investment income to average weekly net assets 5.63% 6.76% 7.55% 7.99% 7.88%++ Portfolio turnover rate (excluding short-term securities) .................................... 28% 43% 47% 38% 10% Amount of borrowings outstanding at end of period (in millions)+++ ............................. $ -- 125 162 143 50 Per-share amount of borrowings outstanding at end of period .................................... $ -- 2.49 3.20 2.83 2.29 Per-share amount of net assets, excluding borrowings, at end of period ................. $ -- 11.39 12.86 12.51 11.97 Asset coverage ratio TRIANGLE TRIANGLE ....... $ -- 458% 402% 442% 523%
* COMMENCEMENT OF OPERATIONS. ** TOTAL INVESTMENT RETURN, MARKET VALUE, IS BASED ON THE CHANGE IN MARKET PRICE OF A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT ACTUAL PRICES PURSUANT TO THE FUND'S DIVIDEND REINVESTMENT PLAN. FOR PURPOSES OF THE FISCAL 1995 COMPUTATION, THE AUGUST 31, 1995 NET ASSET VALUE IS USED AS THE END OF PERIOD VALUE. SEE FOOTNOTE 9 TO THE FINANCIAL STATEMENTS REGARDING THE MERGER INTO AN OPEN-END MANAGEMENT INVESTMENT COMPANY ON 9/1/95. + TOTAL INVESTMENT RETURN, NET ASSET VALUE, IS BASED ON THE CHANGE IN NET ASSET VALUE OF A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT NET ASSET VALUE. ++ ADJUSTED TO AN ANNUAL BASIS. +++ SECURITIES PURCHASED ON A WHEN-ISSUED BASIS FOR WHICH LIQUID, HIGH-GRADE DEBT OBLIGATIONS ARE MAINTAINED IN A SEGREGATED ACCOUNT ARE NOT CONSIDERED BORROWINGS. SEE FOOTNOTE 2 IN THE NOTES TO FINANCIAL STATEMENTS. TRIANGLE SHARES STOPPED TRADING ON THE NYSE AND CSE ON AUGUST 24, 1995. TRIANGLE TRIANGLE REPRESENTS NET ASSETS, EXCLUDING BORROWINGS, AT END OF PERIOD DIVIDED BY BORROWINGS OUTSTANDING AT END OF PERIOD. / / BASED ON AVERAGE SHARES OUTSTANDING DURING THE PERIOD. 31 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (10) FINANCIAL HIGHLIGHTS (CONTINUED) Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows: AMERICAN ADJUSTABLE RATE TERM TRUST 1999
Period from Year Year Ended 9/24/92* to Ended 8/31/95 8/31/94 8/31/93 ------------- ---------- ----------- PER-SHARE DATA Net asset value, beginning of period ........... $ 8.71 9.61 9.58 ------ ---------- ----------- Operations: Net investment income .......................... 0.49/ / 0.60 0.60 Net realized and unrealized losses on investments .................................. (0.08) (0.93) (0.04) ------ ---------- ----------- Total from operations ........................ 0.41 (0.33) 0.56 ------ ---------- ----------- Distributions to shareholders: From net investment income ..................... (0.54) (0.56) (0.53) In excess of net realized gains ................ -- (0.01) -- ------ ---------- ----------- Total distributions to shareholders .......... (0.54) (0.57) (0.53) ------ ---------- ----------- Net asset value, end of period ................. $ 8.58 8.71 9.61 ------ ---------- ----------- ------ ---------- ----------- Per share market value, end of period TRIANGLE ............................. $ -- 8.25 9.63 ------ ---------- ----------- ------ ---------- ----------- SELECTED INFORMATION Total investment return, net asset value+ ........ 4.88% (3.61%) 6.05% Total investment return, market value** .......... 11.07% (8.75%) 1.62% Net assets at end of period (in millions) ...... $ 241 295 328 Ratio of expenses to average weekly net assets ... 0.67% 0.60% 0.57%++ Ratio of net investment income to average weekly net assets ..................................... 5.67% 6.40% 6.76%++ Portfolio turnover rate (excluding short-term securities) .................................... 43% 35% 40% Amount of borrowings outstanding at end of period (in millions)+++ ............................. $ -- 85 102 Per-share amount of borrowings outstanding at end of period .................................... $ -- 2.51 3.00 Per-share amount of net assets, excluding borrowings, at end of period ................. $ -- 11.22 12.61 Asset coverage ratio TRIANGLE TRIANGLE ....... $ -- 447% 421%
* COMMENCEMENT OF OPERATIONS. ** TOTAL INVESTMENT RETURN, MARKET VALUE, IS BASED ON THE CHANGE IN MARKET PRICE OF A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT ACTUAL PRICES PURSUANT TO THE FUND'S DIVIDEND REINVESTMENT PLAN. FOR PURPOSES OF THE FISCAL 1995 COMPUTATION, THE AUGUST 31, 1995 NET ASSET VALUE IS USED AS THE END OF PERIOD VALUE. SEE FOOTNOTE 9 TO THE FINANCIAL STATEMENTS REGARDING THE MERGER INTO AN OPEN-END MANAGEMENT INVESTMENT COMPANY ON 9/1/95. + TOTAL INVESTMENT RETURN, NET ASSET VALUE, IS BASED ON THE CHANGE IN NET ASSET VALUE OF A SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF DISTRIBUTIONS AT NET ASSET VALUE. ++ ADJUSTED TO AN ANNUAL BASIS. +++ SECURITIES PURCHASED ON A WHEN-ISSUED BASIS FOR WHICH LIQUID, HIGH-GRADE DEBT OBLIGATIONS ARE MAINTAINED IN A SEGREGATED ACCOUNT ARE NOT CONSIDERED BORROWINGS. SEE FOOTNOTE 2 IN THE NOTES TO FINANCIAL STATEMENTS. TRIANGLE SHARES STOPPED TRADING ON THE NYSE AND CSE ON AUGUST 24, 1995. TRIANGLE TRIANGLE REPRESENTS NET ASSETS, EXCLUDING BORROWINGS, AT END OF PERIOD DIVIDED BY BORROWINGS OUTSTANDING AT END OF PERIOD. / / BASED ON AVERAGE SHARES OUTSTANDING DURING THE PERIOD. 32 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (11) QUARTERLY DATA (UNAUDITED)
Net Realized Net Increase Total and Unrealized (Decrease) in Net Distributions Quarter End Investment Net Investment Gains (Losses) Assets Resulting from Net Investment Net Asset Quarter Ended Income Income on Investments from Operations Income Value - - - ------------------ ---------- -------------------- --------------------- -------------------- --------------------- ----------- AMERICAN ADJUSTABLE RATE TERM TRUST 1996 Amount Per-Share Amount Per-Share Amount Per-Share Amount Per-Share ---------- --------- ----------- --------- ---------- --------- ----------- --------- 11/30/94 $ 3,467,478 2,960,212 0.13 (3,750,264) (0.16) (790,052) (0.03) (2,177,611) (0.10) 8.91 2/28/95 2,817,331 2,549,600 0.12 2,062,703 0.09 4,612,303 0.21 (2,136,600) (0.09) 9.03 5/31/95 3,162,431 2,844,355 0.13 1,939,196 0.09 4,783,551 0.22 (2,130,942) (0.10) 9.15 8/31/95 3,203,807 2,798,957 0.13 (240,660) (0.01) 2,558,297 0.12 (13,730,577) (0.63) 8.64 ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- $ 12,651,047 11,153,124 0.51 10,975 0.01 11,164,099 0.52 (20,175,730) (0.92) ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- AMERICAN ADJUSTABLE RATE TERM TRUST 1997 Amount Per-Share Amount Per-Share Amount Per-Share Amount Per-Share ---------- --------- ----------- --------- ---------- --------- ----------- --------- 11/30/94 $ 6,734,775 6,055,630 0.15 (10,412,854) (0.24) (4,357,224) (0.09) (5,200,212) (0.12) 8.69 2/28/95 5,482,168 4,909,476 0.12 5,227,426 0.12 10,136,902 0.24 (5,112,948) (0.12) 8.81 5/31/95 5,818,656 5,257,293 0.13 4,836,150 0.11 10,093,443 0.24 (5,093,960) (0.12) 8.93 8/31/95 5,903,575 5,264,218 0.13 438,584 0.02 5,702,802 0.15 (15,276,132) (0.36) 8.72 ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- $ 23,939,174 21,486,617 0.53 89,306 0.01 21,575,923 0.54 (30,683,252) (0.72) ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- AMERICAN ADJUSTABLE RATE TERM TRUST 1999 Amount Per-Share Amount Per-Share Amount Per-Share Amount Per-Share ---------- --------- ----------- --------- ---------- --------- ----------- --------- 11/30/94 $ 4,210,736 3,781,356 0.13 (9,724,958) (0.32) (5,943,602) (0.19) (3,917,275) (0.13) 8.39 2/28/95 3,675,324 3,347,658 0.12 3,676,280 0.14 7,023,938 0.26 (3,810,767) (0.13) 8.52 5/31/95 3,825,660 3,450,934 0.12 1,825,180 0.07 5,276,114 0.19 (3,797,141) (0.14) 8.57 8/31/95 3,804,762 3,298,004 0.12 947,229 0.03 4,245,233 0.15 (3,795,413) (0.14) 8.58 ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- $ 15,516,482 13,877,952 0.49 (3,276,269) (0.08) 10,601,683 0.41 (15,320,596) (0.54) ---------- ---------- --- ----------- --------- ---------- --------- ----------- --------- ---------- ---------- --- ----------- --------- ---------- --------- ----------- ---------
33 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES AMERICAN ADJUSTABLE RATE TERM TRUST 1996 AUGUST 31, 1995
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ----------- ------------ (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) MORTGAGE-BACKED SECURITIES (73.3%): U.S. AGENCY ADJUSTABLE RATE MORTGAGES (41.2%): 7.66%, FHLMC, 10/1/22 .............................. $ 2,603,005 2,667,091 7.94%, FHLMC, 8/1/23 ................................. 6,697,098 6,848,653 8.38%, FHLMC, 6/1/21 ................................. 2,377,476 2,431,564 7.25%, FHLMC, 11/1/16 ................................ 9,646,301 9,791,478 7.54%, FHLMC, 6/1/18 ................................. 2,019,504 2,062,075 7.63%, FHLMC, 5/1/19 ................................. 2,213,468 2,263,758 7.62%, FHLMC, 10/1/18 ................................ 6,769,519 6,927,791 7.75%, FHLMC, 10/1/19 ................................ 2,583,243 2,657,847 7.63%, FHLMC, 8/1/20 ................................. 10,494,136 10,706,852 5.99%, FHLMC, 1/1/24 ................................. 1,412,966 1,420,497 6.23%, FHLMC, 1/1/24 ................................. 1,815,876 1,872,168 6.98%, FNMA, 7/1/17 .................................. 1,877,083 1,899,364 7.39%, FNMA, 4/1/18 .................................. 4,818,583 4,901,511 7.54%, FNMA, 1/1/28 .................................. 2,317,781 2,360,081 7.75%, FNMA, 5/1/27 .................................. 1,678,135 1,717,370 7.72%, FNMA, 1/1/20 .................................. 2,020,948 2,075,615 7.01%, FNMA, 12/1/23 ................................. 3,438,253 3,527,854 6.18%, FNMA, 8/1/23 .................................. 2,132,298 2,207,760 7.00%, GNMA II, 8/20/23 .............................. 4,765,163 4,834,735 7.00%, GNMA II, 5/20/21 .............................. 4,542,600 4,621,005 ------------ 77,795,069 ------------ COLLATERALIZED MORTGAGE OBLIGATIONS AND OTHER MORTGAGE-BACKED SECURITIES (C) (32.1%): U.S. AGENCY FLOATING RATE (14.9%): 6.48%, FHLMC, Series 1249, Class A, LIBOR, 4/15/22 ... 14,242,781 14,310,291 6.34%, FHLMC, Series 1508, Class J, LIBOR, 9/15/19 ... 3,025,788 3,025,577 6.44%, FHLMC, Series 1603, Class G, LIBOR, 4/15/21 ... 3,132,235 3,145,171 6.29%, FHLMC, Series 1724, Class F, LIBOR, 5/15/01 ... 4,227,606 4,227,225 6.42%, FNMA, Series 1994-87, Class F, LIBOR, 3/25/09 ............................................. 3,492,894 3,492,510 ------------ 28,200,774 ------------ PRIVATE FLOATING RATE (17.2%): 7.58%, Donaldson, Lufkin and Jenrette, Series 1992-MF3, Class A3, 5/25/22 ......................... 6,000,000 6,093,750 7.71%, Paine Webber Mortgage Acceptance Corporation, Series 1993-10, Class M1, 11/25/23 .................. 13,135,441 13,201,119
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ----------- ------------ 8.00%, Paine Webber Mortgage Acceptance Corporation, Series 1993-8, Class M2, 8/25/23 .................. $ 5,091,075 5,078,348 7.81%, Residential Funding Corporation, Series 1993-S8, Class A, 2/25/23 ........................... 4,979,971 5,080,592 7.10%, Salomon Brothers Mortgage, Series 1987-2, Class A, 12/25/16 ......................................... 3,029,590 2,931,128 ------------ 32,384,937 ------------ Total Mortgage-Backed Securities (cost: $140,308,026) .............................. 138,380,780 ------------ SHORT-TERM SECURITIES (25.6%): FHLMC Discount Note, 5.91%, 3/29/96 15,000,000 14,514,300 FNMA Discount Note, 5.85%, 3/29/96 ................... 20,000,000 19,356,000 Repurchase agreement with Morgan Stanley in a joint trading account collateralized by U.S. government agency securities, acquired on 8/31/95, accrued interest at repurchase date of $2,259, 5.65%, 9/1/95 .............................................. 14,394,000 14,394,000 ------------ Total Short-Term Securities (cost: $48,194,374) ............................... 48,264,300 ------------ Total Investments in Securities (cost: $188,502,400) (c) ......................... $ 186,645,080 ------------ ------------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) DESCRIPTIONS OF CERTAIN COLLATERALIZED MORTGAGE OBLIGATIONS ARE AS FOLLOWS: LIBOR - LONDON INTERBANK OFFERED RATE. FLOATING RATE - REPRESENTS SECURITIES THAT PAY INTEREST AT RATES THAT INCREASE (DECREASE) WITH AN INCREASE (DECREASE) IN A SPECIFIED INDEX. (C) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES BASED ON THIS COST WERE AS FOLLOWS: GROSS UNREALIZED APPRECIATION .... $ 123,601 GROSS UNREALIZED DEPRECIATION ...... (1,980,921) ---------- NET UNREALIZED DEPRECIATION .... $ (1,857,320) ---------- ----------
34 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES AMERICAN ADJUSTABLE RATE TERM TRUST 1997 AUGUST 31, 1995
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ----------- ------------ (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) U.S. GOVERNMENT SECURITIES (14.0%): U.S. Treasury Note, 6.50%, 11/30/96 ................ $ 12,000,000 12,107,280 U.S. Treasury Note, 4.75%, 2/15/97 ................... 25,000,000 24,642,000 U.S. Treasury Note, 6.63%, 3/31/97 ................... 15,000,000 15,188,850 ------------ Total U.S. Government Securities (cost: $51,954,196) ............................... 51,938,130 ------------ MORTGAGE-BACKED SECURITIES (72.2%): U.S. AGENCY ADJUSTABLE RATE MORTGAGES (40.6%): 7.71%, FHLMC, 5/1/20 ................................. 2,360,845 2,425,437 8.32%, FHLMC, 6/1/21 ................................. 4,282,155 4,414,773 7.66%, FHLMC, 10/1/22 ................................ 5,206,010 5,334,182 8.26%, FHLMC, 8/1/19 ................................. 1,879,325 1,938,768 7.77%, FHLMC, 1/1/19 ................................. 170,800 173,628 7.95%, FHLMC, 4/1/22 ................................. 930,969 958,144 6.13%, FHLMC, 10/1/23 ................................ 1,464,504 1,487,160 5.99%, FHLMC, 1/1/24 ................................. 2,122,197 2,133,508 6.23%, FHLMC, 1/1/24 ................................. 3,981,375 4,104,798 7.53%, FNMA, 1/1/18 .................................. 2,110,477 2,170,520 7.92%, FNMA, 1/1/29 .................................. 3,585,600 3,661,794 7.29%, FNMA, 5/1/18 .................................. 1,519,937 1,547,675 7.41%, FNMA, 8/1/27 .................................. 8,675,614 8,846,437 7.39%, FNMA, 4/1/18 .................................. 8,074,033 8,212,987 7.54%, FNMA, 1/1/28 .................................. 1,253,302 1,276,174 7.27%, FNMA, 3/1/28 .................................. 10,019,983 10,194,531 7.49%, FNMA, 1/1/20 .................................. 3,032,650 3,055,395 8.10%, FNMA, 11/1/20 ................................. 5,305,330 5,461,201 7.50%, FNMA, 12/1/20 ................................. 7,730,529 7,866,509 8.19%, FNMA, 5/1/21 .................................. 5,946,919 6,089,110 7.96%, FNMA, 8/1/21 .................................. 3,239,340 3,301,762 6.01%, FNMA, 12/1/23 ................................. 3,557,054 3,660,031 6.15%, FNMA, 12/1/23 ................................. 3,478,790 3,600,408 6.12%, FNMA, 1/1/24 .................................. 3,355,849 3,472,095 8.12%, FNMA, 7/1/23 .................................. 4,632,679 4,822,758 5.95%, FNMA, 2/1/24 .................................. 8,389,486 8,616,422 6.01%, FNMA, 3/1/24 .................................. 4,451,509 4,581,360 6.63%, GNMA II, 11/20/21 ............................. 3,725,381 3,842,619 7.50%, GNMA II, 6/20/22 .............................. 1,078,349 1,114,225 7.38%, GNMA II, 6/20/23 .............................. 1,614,514 1,641,024 6.50%, GNMA II, 11/20/23 ............................. 4,379,109 4,425,527 5.50%, GNMA II, 4/20/24 .............................. 723,714 714,465 6.00%, GNMA II, 8/20/21 .............................. 7,440,481 7,544,350 6.13%, GNMA II, 10/20/21 ............................. 7,256,504 7,335,383 6.00%, GNMA II, 9/1/25 ............................... 10,000,000(b) 10,006,300 ------------ 150,031,460 ------------ COLLATERALIZED MORTGAGE OBLIGATIONS AND OTHER MORTGAGE-BACKED SECURITIES (C) (31.6%): U.S. AGENCY FIXED RATE (0.4%): 8.13%, FNMA, Series 1991-66, Class E, 4/25/18 ........ 1,700,020 1,695,413 ------------ U.S. AGENCY FLOATING RATE (9.2%): 6.44%, FHLMC, Series 1401, Class K, LIBOR, 9/15/20 ... 1,890,675 1,898,029 6.34%, FHLMC, Series 1508, Class J, LIBOR, 9/15/19 ... 3,025,788 3,025,577 6.44%, FHLMC, Series 1710, Class AC, LIBOR, 2/15/24 ............................................. 3,000,000 3,004,080
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ----------- ------------ 6.29%, FHLMC, Series 1724, Class F, LIBOR, 5/15/01 ........................................... $ 10,714,103 10,713,139 6.42%, FNMA, Series 1993-103, Class FA, LIBOR, 6/25/19 ............................................. 5,000,000 5,007,000 6.42%, FNMA, Series 1994-87, Class F, LIBOR, 3/25/09 ............................................. 10,478,681 10,477,528 ------------ 34,125,353 ------------ PRIVATE FLOATING RATE (22.0%): 7.58%, Donaldson, Lufkin and Jenrette, Series 1992-MF3, Class A3, 5/25/22 ......................... 17,000,000 17,265,625 7.72%, Glendale Federal Savings, Series 1989-5, Class A, 4/1/29 ........................................... 17,914,726 18,069,563 6.88%, Merrill Lynch Mortgage Investors, Series 1993-C, Class A4, 3/15/18 ........................... 7,000,000 6,794,340 7.81%, Residential Funding Corporation, Series 1993-S8, Class A, 2/25/23 ........................... 7,469,956 7,620,889 6.68%, Resolution Trust Corporation, Series 1991-2, Class B, 4/25/21 .................................... 5,000,000 4,981,250 8.12%, Resolution Trust Corporation, Series 1991-8, Class A-1, 12/25/20 ................................. 11,854,133 12,178,270 7.55%, Resolution Trust Corporation, Series 1992-4, Class B2, 7/25/28 ................................... 15,000,639 14,330,298 ------------ 81,240,235 ------------ Total Mortgage-Backed Securities (cost: $269,841,824) .............................. 267,092,461 ------------ SHORT-TERM SECURITIES (14.7%): Repurchase agreement with Goldman Sachs in a joint trading account collateralized by U.S. government agency securities, acquired on 8/31/95, accrued interest at repurchase date of $8,690, 5.82%, 9/1/95 (cost: $54,501,000) ................................. 54,501,000 54,501,000 ------------ Total Investments in Securities (cost: $376,297,020) (d) ......................... $ 373,531,591 ------------ ------------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) ON AUGUST 31, 1995, THE TOTAL COST OF INVESTMENTS PURCHASED ON A WHEN-ISSUED BASIS WAS $10,043,750. (C) DESCRIPTIONS OF CERTAIN COLLATERALIZED MORTGAGE OBLIGATIONS ARE AS FOLLOWS: LIBOR - LONDON INTERBANK OFFERED RATE FLOATING RATE - REPRESENTS SECURITIES THAT PAY INTEREST AT RATES THAT INCREASE (DECREASE) WITH AN INCREASE (DECREASE) IN A SPECIFIED INDEX (D) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES BASED ON THIS COST WERE AS FOLLOWS: GROSS UNREALIZED APPRECIATION .... $ 173,162 GROSS UNREALIZED DEPRECIATION ...... (2,938,591) ---------- NET UNREALIZED DEPRECIATION .... $ (2,765,429) ---------- ----------
35 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES AMERICAN ADJUSTABLE RATE TERM TRUST 1999 AUGUST 31, 1995
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ----------- ------------ (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) U.S. GOVERNMENT SECURITIES (10.7%): U.S. Treasury Note, 4.75%, 2/15/97 ................. $ 13,000,000 12,813,840 U.S. Treasury Note, 6.38%, 6/30/97 ................... 13,000,000 13,130,000 ------------ Total U.S. Government Securities (cost: $26,019,990) ............................... 25,943,840 ------------ MORTGAGE-BACKED SECURITIES (75.0%): U.S. AGENCY ADJUSTABLE RATE MORTGAGES (36.5%): 8.25%, FHLMC, 6/1/22 ................................. 25,917,342 26,536,507 7.74%, FHLMC, 11/1/22 ................................ 9,601,686 9,805,242 7.74%, FHLMC, 9/1/22 ................................. 5,482,171 5,644,772 7.94%, FHLMC, 8/1/23 ................................. 5,238,324 5,356,867 7.63%, FHLMC, 4/1/23 ................................. 4,202,449 4,286,414 7.38%, FNMA, 11/1/22 ................................. 3,219,526 3,283,917 6.50%, GNMA II, 7/20/22 .............................. 3,941,373 3,992,572 6.50%, GNMA II, 9/20/22 .............................. 3,599,623 3,653,078 7.38%, GNMA II, 6/20/23 .............................. 5,251,359 5,337,586 6.00%, GNMA II, 9/1/25 ............................... 20,000,000(b) 20,012,600 ------------ 87,909,555 ------------ COLLATERALIZED MORTGAGE OBLIGATIONS AND OTHER MORTGAGE-BACKED SECURITIES (C) (38.5%): U.S. AGENCY FLOATING RATE (14.9%): 6.44%, FHLMC, Series 1401, Class K, LIBOR, 9/15/20 ... 6,302,249 6,326,765 6.34%, FHLMC, Series 1508, Class J, LIBOR, 9/15/19 ... 2,269,341 2,269,182 6.29%, FHLMC, Series 1724, Class F, LIBOR, 5/15/01 ... 7,142,735 7,142,092 6.50%, FHLMC, Series 29, Class FA, LIBOR, 3/25/23 .... 8,000,000 8,029,440 6.47%, FNMA, Series 1992-141, Class FA, LIBOR, 8/25/07 ............................................. 7,005,378 7,031,298 6.42%, FNMA, Series 1994-87, Class F, LIBOR, 3/25/09 ............................................. 5,239,341 5,238,765 ------------ 36,037,542 ------------ PRIVATE FLOATING RATE (23.6%): 8.22%, California Federal, Series 1987-F, Class A2, 7/1/17 .............................................. 5,235,031 5,077,980 7.58%, Donaldson, Lufkin and Jenrette, Series 1992-MF3, Class A3, 5/25/22 ......................... 10,000,000 10,156,250 7.69%, Merrill Lynch Mortgage Investors, Series 1992-H, Class A1-2, 2/25/23 ......................... 3,781,063 3,808,252
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ----------- ------------ 6.78%, Merrill Lynch Mortgage Investors, Series 1993-B, Class A3, 11/15/17 .......................... 13,650,000 13,756,607 7.13%, Merrill Lynch Mortgage Investors, Series 1993-E, Class A4, 6/15/18 ......................... $ 6,500,000 6,243,250 7.81%, Residential Funding Corporation, Series 1993-S8, Class A, 2/25/23 ........................... 4,979,971 5,080,592 7.55%, Resolution Trust Corporation, Series 1992-4, Class B2, 7/25/28 ................................... 3,000,128 2,866,060 7.73%, Resolution Trust Corporation, Series 1992-6, Class B3, 1/25/26 ................................... 10,002,246 10,002,246 ------------ 56,991,237 ------------ Total Mortgage-Backed Securities (cost: $182,424,307) .............................. 180,938,334 ------------ SHORT-TERM SECURITIES (20.7%): Repurchase agreement with Goldman Sachs in a joint trading account collateralized by U.S. government agency securities, acquired on 8/31/95, accrued interest at repurchase date of $7,925, 5.80%, 9/1/95 (cost: $49,871,000) ................................. 49,871,000 49,871,000 ------------ Total Investments in Securities (cost: $258,315,297) (d) ......................... $ 256,753,174 ------------ ------------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) ON AUGUST 31, 1995, THE TOTAL COST OF INVESTMENTS PURCHASED ON A WHEN-ISSUED BASIS WAS $20,087,500. (C) DESCRIPTIONS OF CERTAIN COLLATERALIZED MORTGAGE OBLIGATIONS ARE AS FOLLOWS: LIBOR - LONDON INTERBANK OFFERED RATE. FLOATING RATE - REPRESENTS SECURITIES THAT PAY INTEREST AT RATES THAT INCREASE (DECREASE) WITH AN INCREASE (DECREASE) IN A SPECIFIED INDEX. (D) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES BASED ON THIS COST WERE AS FOLLOWS: GROSS UNREALIZED APPRECIATION .... $ 295,680 GROSS UNREALIZED DEPRECIATION ...... (1,857,803) ---------- NET UNREALIZED DEPRECIATION .... $ (1,562,123) ---------- ----------
36 - - - -------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT THE BOARD OF DIRECTORS AND SHAREHOLDERS AMERICAN ADJUSTABLE RATE TERM TRUST INC. - 1996, AMERICAN ADJUSTABLE RATE TERM TRUST INC. - 1997 AND AMERICAN ADJUSTABLE RATE TERM TRUST INC. - 1999: We have audited the accompanying statements of assets and liabilities, including the schedules of investments in securities, of American Adjustable Rate Term Trust Inc. - 1996, American Adjustable Rate Term Trust Inc. - 1997 and American Adjustable Rate Term Trust Inc. - 1999 as of August 31, 1995, and the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended August 31, 1995 and the financial highlights presented in footnote 10 to the financial statements. These financial statements and the financial highlights are the responsibility of the funds' management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Investment securities held in custody are confirmed to us by the custodian. As to securities purchased and sold but not received or delivered, we request confirmations from brokers and, where replies are not received, we carry out other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Adjustable Rate Term Trust Inc. - 1996, American Adjustable Rate Term Trust Inc. - 1997 and American Adjustable Rate Term Trust Inc. - 1999 as of August 31, 1995, the results of their operations and cash flows for the year then ended, the changes in their net assets for each of the years in the two-year period ended August 31, 1995 and the financial highlights presented in footnote 10 to the financial statements, in conformity with generally accepted accounting principles. As discussed in footnote 9 to the financial statements, American Adjustable Rate Term Trust Inc. - 1996, American Adjustable Rate Term Trust Inc. - 1997 and American Adjustable Rate Term Trust Inc. - 1999 merged into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund on September 1, 1995. KPMG Peat Marwick LLP Minneapolis, Minnesota October 13, 1995 37 - - - -------------------------------------------------------------------------------- FEDERAL INCOME TAX INFORMATION Fiscal Year Ended August 31, 1995 Distributions shown below are taxable as dividend income. None qualify for the corporate dividends received deduction. In February 1996, each shareholder will receive a breakdown of income earned by investment category for calendar year 1995. Information for federal income tax purposes is presented as an aid to shareholders in reporting the distributions shown below. Shareholders should consult a tax adviser on how to report these distributions for state and local income taxes.
American American American American Adjustable Adjustable Adjustable Adjustable Rate Term Rate Term Rate Term Rate Term Payable Date Trust 1996 Trust 1997 Trust 1998 Trust 1999 - - - ------------------------------------------ ----------- ----------- ----------- ----------- September 28, 1994 ..................... $ 0.0300 0.0375 0.0400 0.0425 October 26, 1994 ......................... 0.0300 0.0375 0.0400 0.0425 November 23, 1994 ........................ 0.0325 0.0400 0.0425 0.0450 December 28, 1994 ........................ 0.0325 0.0400 0.0425 0.0450 January 13, 1995 ......................... 0.0325 0.0400 0.0425 0.0450 February 22, 1995 ........................ 0.0325 0.0400 0.0425 0.0450 March 29, 1995 ........................... 0.0325 0.0400 0.0425 0.0450 April 26, 1995 ........................... 0.0325 0.0400 0.0425 0.0450 May 24, 1995 ............................. 0.0325 0.0400 0.0425 0.0450 June 28, 1995 ............................ 0.1085 0.0400 0.0425 0.0450 July 27, 1995 ............................ 0.0325 0.0400 0.0425 0.0450 August 23, 1995 .......................... 0.0325 0.0400 0.0425 0.0450 August 24, 1995 .......................... 0.4550 0.2400 0.0750 -- ----------- ----------- ----------- ----------- Total distributions .................... $ 0.9160 0.7150 0.5800 0.5350 ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
38 - - - -------------------------------------------------------------------------------- SHAREHOLDER UPDATE ANNUAL MEETING RESULTS An annual meeting of the funds' shareholders was held on August 1, 1995 and adjourned to August 10, 1995 with respect to the third matter set forth below. Each matter voted upon at the meeting, as well as the number of votes cast for, against or withheld, the number of abstentions, and the number of broker non-votes with respect to such matters, are set forth below. 1. The funds' shareholders elected the following six directors: AMERICAN ADJUSTABLE RATE TERM TRUST 1996 (BDJ)
Shares Shares Withholding Voted "For" Authority to Vote ----------- ------------------ David T. Bennett.......................................................... 18,221,539 1,292,019 Jaye F. Dyer.............................................................. 18,210,300 1,303,258 William H. Ellis.......................................................... 18,201,503 1,312,055 Karol D. Emmerich......................................................... 18,223,803 1,289,755 Luella G. Goldberg........................................................ 18,216,862 1,296,696 George Latimer............................................................ 18,207,787 1,305,771
AMERICAN ADJUSTABLE RATE TERM TRUST 1997 (CDJ)
Shares Shares Withholding Voted "For" Authority to Vote ----------- ------------------ David T. Bennett.......................................................... 36,894,551 2,473,129 Jaye F. Dyer.............................................................. 36,868,590 2,499,090 William H. Ellis.......................................................... 36,785,796 2,581,884 Karol D. Emmerich......................................................... 36,816,793 2,550,887 Luella G. Goldberg........................................................ 36,796,122 2,571,558 George Latimer............................................................ 36,798,987 2,568,693
AMERICAN ADJUSTABLE RATE TERM TRUST 1998 (DDJ)
Shares Shares Withholding Voted "For" Authority to Vote ----------- ------------------ David T. Bennett.......................................................... 40,977,588 2,602,924 Jaye F. Dyer.............................................................. 40,969,160 2,611,352 William H. Ellis.......................................................... 40,858,731 2,721,781 Karol D. Emmerich......................................................... 40,892,210 2,688,302 Luella G. Goldberg........................................................ 40,879,022 2,701,490 George Latimer............................................................ 40,850,509 2,730,003
AMERICAN ADJUSTABLE RATE TERM TRUST 1999 (EDJ)
Shares Shares Withholding Voted "For" Authority to Vote ----------- ------------------ David T. Bennett.......................................................... 23,242,175 1,955,524 Jaye F. Dyer.............................................................. 23,219,659 1,978,040 William H. Ellis.......................................................... 23,157,205 2,040,494 Karol D. Emmerich......................................................... 23,187,739 2,009,960 Luella G. Goldberg........................................................ 23,168,192 2,029,507 George Latimer............................................................ 23,179,265 2,018,434
2. The funds' shareholders ratified the selection by a majority of the independent members of the funds' Boards of Directors of KPMG Peat Marwick LLP as the independent public accountants for the funds for the fiscal year ending August 31, 1995. The following votes were cast regarding this matter:
Shares Shares Voted Broker Voted "For" "Against" Absentions Non-Votes ----------- --------------- ----------- ----------- BDJ................................................. 18,185,913 349,256 979,384 -- CDJ................................................. 36,787,530 753,257 1,836,173 -- DDJ................................................. 39,550,474 783,561 1,973,849 1,272,628 EDJ................................................. 23,263,951 592,815 1,340,931 --
39 - - - -------------------------------------------------------------------------------- SHAREHOLDER UPDATE 3. The funds' shareholders approved the Agreement and Plan of Merger whereby each approving fund merged with and into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund. The following votes were cast regarding this matter:
Shares Shares Voted Broker Voted "For" "Against" Abstentions Non-Votes ----------- --------------- ----------- ----------- BDJ................................................. 14,934,062 1,100,214 767,096 2,712,186 CDJ................................................. 29,393,183 1,634,820 1,618,708 6,720,969 DDJ................................................. 32,499,507 2,022,751 964,496 8,093,758 EDJ................................................. 18,831,029 1,383,124 1,122,038 3,861,508
40 - - - -------------------------------------------------------------------------------- DIRECTORS AND OFFICERS OF PIPER FUNDS INC. - II DIRECTORS David T. Bennett, CHAIRMAN, HIGHLAND HOMES, INC., USL PRODUCTS, INC., KIEFER BUILT, INC., OF COUNSEL, GRAY, PLANT, MOOTY, MOOTY & BENNETT, P.A. Jaye F. Dyer, PRESIDENT, DYER MANAGEMENT COMPANY William H. Ellis, CHAIRMAN OF THE BOARD, PRESIDENT, PIPER CAPITAL MANAGEMENT INCORPORATED, PIPER JAFFRAY COMPANIES INC. Karol D. Emmerich, PRESIDENT, THE PARACLETE GROUP Luella G. Goldberg, DIRECTOR, TCF FINANCIAL, RELIASTAR CORP., HORMEL FOODS CORP. George Latimer, DIRECTOR, SPECIAL ACTIONS OFFICE, OFFICE OF THE SECRETARY, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT OFFICERS Paul A. Dow, PRESIDENT Michael P. Jansen, SENIOR VICE PRESIDENT Robert H. Nelson, SENIOR VICE PRESIDENT Amy K. Johnson, VICE PRESIDENT Thomas S. McGlinch, VICE PRESIDENT David E. Rosedahl, SECRETARY Charles N. Hayssen, TREASURER INVESTMENT ADVISER Piper Capital Management Incorporated 222 SOUTH NINTH STREET, MINNEAPOLIS, MN 55402-3804 CUSTODIAN AND TRANSFER Investors Fiduciary Trust Company AGENT 127 WEST 10TH STREET, KANSAS CITY, MO 64105-1716 LEGAL COUNSEL Dorsey & Whitney P.L.L.P. 220 SOUTH SIXTH STREET, MINNEAPOLIS, MN 55402 INDEPENDENT AUDITORS KPMG Peat Marwick LLP 4200 NORWEST CENTER, MINNEAPOLIS, MN 55402
41 PIPER CAPITAL MANAGEMENT Bulk Rate U.S. Postage PAID Permit No. 3008 Mpls, MN PIPER CAPITAL MANAGEMENT INCORPORATED 222 SOUTH NINTH STREET MINNEAPOLIS, MN 55402-3804 PIPER JAFFRAY INC., FUND DISTRIBUTOR AND NASD MEMBER. [LOGO] THIS DOCUMENT IS PRINTED ON PAPER MADE FROM 100% TOTAL RECOVERED FIBER, INCLUDING 15% POST-CONSUMER WASTE. 310-95 PJARX-01 10/95 ADJUSTABLE RATE MORTGAGE SECURITIES FUND 1996 SEMIANNUAL REPORT TABLE OF CONTENTS Letter to Shareholders.................2 Investments in Securities..............5 Financial Statements and Notes.........6
ADJUSTABLE RATE MORTGAGE SECURITIES FUND Adjustable Rate Mortgage Securities Fund is a diversified, open-end mutual fund with an investment objective of providing the maximum current income that is consistent with low volatility of principal. The fund invests primarily in adjustable rate mortgage (ARM) securities. It may also invest in mortgage-backed securities other than ARM securities, U.S. government securities, asset-backed securities and corporate debt securities. The fund's Nasdaq symbol is PJARX. As with other mutual funds, there can be no assurance the fund will achieve its objective. CALL TO RECEIVE QUARTERLY UPDATES If you would like to be put on our mailing list to receive quarterly fund summaries for Adjustable Rate Mortgage Securities Fund, call our Shareholder Services Department at 1 800 866-7778. THIS REPORT IS INTENDED FOR SHAREHOLDERS OF ADJUSTABLE RATE MORTGAGE SECURITIES FUND, BUT IT MAY ALSO BE USED AS SALES LITERATURE IF PRECEDED OR ACCOMPANIED BY A PROSPECTUS. THE PROSPECTUS GIVES DETAILS ABOUT THE CHARGES, INVESTMENT RESULTS AND OPERATING POLICIES OF THE FUND. SHAREHOLDER SERVICES AS A SHAREHOLDER IN PIPER FUNDS, YOU HAVE ACCESS TO A FULL RANGE OF SERVICES AND BENEFITS. IF YOU HOLD YOUR FUND SHARES THROUGH A BROKER/DEALER OTHER THAN PIPER JAFFRAY, THESE SERVICES MAY NOT BE AVAILABLE TO YOU. CHECK YOUR PROSPECTUS FOR DETAILS ABOUT SERVICES AND ANY LIMITATIONS THAT MIGHT APPLY TO YOUR FUND. LOW MINIMUM INVESTMENTS You can open most Piper mutual fund accounts with a minimum investment of $250. QUANTITY DISCOUNTS If your initial investment exceeds a specified amount, if an investment combined with the value of your existing Piper shares exceeds a specified amount, or if your investments combined during a 13-month period exceed a specified amount, you can reduce or even eliminate the front-end sales charge. WAIVER OF SALES CHARGES Money market funds carry no sales charges.* Sales charges on other Piper funds are waived on purchases of $500,000 or more. However, a contingent deferred sales charge may be imposed. See your prospectus for details. AUTOMATIC REINVESTMENT OF DIVIDENDS For maximum growth of your assets, you can reinvest dividends and capital gains automatically in additional shares of your fund without a sales charge. CROSS-REINVESTMENT OF DISTRIBUTIONS Diversify your holdings by reinvesting dividends and capital gains from one Piper fund into another. CASH DISTRIBUTIONS If you prefer, take your dividends and/or capital gains in cash. AUTOMATIC MONTHLY INVESTMENT PROGRAM You may automatically transfer $25 or more each month from any Piper money market fund into many other Piper funds.* AUTOMATIC MONTHLY MONEY TRANSFER PROGRAM If you are starting a savings discipline or seeking a convenient way to invest, you can transfer a minimum of $100 automatically from your bank, savings and loan or other financial institution into many of the Piper funds. EXCHANGE PRIVILEGES Revise your investment plan without incurring a sales charge by moving assets from one Piper fund to another with the same fee structure. See your prospectus for restrictions involving exchanges between funds with different sales charges. REINVESTMENT PRIVILEGES If you buy a fund with a sales charge and later redeem your shares, you may reinvest all or part of the proceeds in shares of that fund or another Piper fund within 30 days and pay no additional sales charge, subject to each fund's minimum investment requirements. SYSTEMATIC WITHDRAWAL PLAN If your account has a value of $5,000 or more, you can elect to receive periodic payments of $100 or more, at no cost, excluding money market funds. ACCOUNT STATEMENTS Whenever you add to or withdraw money from your account, you'll receive a monthly statement from Piper Jaffray. Accounts with no activity receive a quarterly statement instead. Periodic dividend and capital gain distributions, if any, also appear on your statement. CONFIRMATION OF TRANSACTIONS You receive a confirmation statement following every transaction, except in the money market funds. All transactions are reflected on your account statement. $25 MILLION SHAREHOLDER PROTECTION If you have a Piper Jaffray PRIME or PAT account, you are protected up to $25 million in the unlikely event that Piper Jaffray were to fail financially. This is in addition to basic Securities Investor Protection Corporation (SIPC) coverage, which protects up to $500,000 in cash and securities ($100,000 in cash only) per customer. This protection does not cover market loss. * AN INVESTMENT IN A PIPER MONEY MARKET FUND IS NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO ASSURANCE THAT THE FUND WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1 PER SHARE. 1 ADJUSTABLE RATE MORTGAGE SECURITIES FUND [PHOTO TOM MCGLINCH] FPO 65% [PHOTO WAN-CHONG KUNG] FPO 52% TOM MCGLINCH SHARES PRIMARY RESPONSIBILITY FOR THE MANAGEMENT OF ADJUSTABLE RATE MORTGAGE SECURITIES FUND. HE HAS 15 YEARS OF INVESTMENT EXPERIENCE. WAN-CHONG KUNG SHARES PRIMARY RESPONSIBILITY FOR THE MANAGEMENT OF ADJUSTABLE RATE MORTGAGE SECURITIES FUND. SHE HAS FOUR YEARS OF INVESTMENT EXPERIENCE. PORTFOLIO COMPOSITION FEBRUARY 29, 1996 [CHART] U.S. Agency ARM Securities 69% Short-Term 1% U.S. Treasuries 11% U.S. Agency Fixed Rate Mortgage-Backed Securities 2% Privately Issued ARM Securities 16% Other Assets 1% INVESTMENT CATEGORIES REFLECT PERCENTAGE OF TOTAL ASSETS. April 17, 1996 Dear Shareholders: FOR THE SIX-MONTH PERIOD ENDED FEBRUARY 29, 1996, ADJUSTABLE RATE MORTGAGE SECURITIES FUND HAD A TOTAL RETURN OF 3.51%* which includes reinvested distributions but not the fund's sales charge. The fund's emphasis on high-quality securities helped it outperform the Lipper Adjustable Rate Mortgage Funds Average return of 1.31% for the same period. The fund performed in line with the Lehman Brothers Adjustable Rate Mortgage Index which returned 3.92% for the same six-month period. The slight outperformance by the Lehman index resulted from its larger allocation to Government National Mortgage Association (GNMA) securities and securities with coupon rates that reset to the Cost of Funds Index (COFI). Although these securities typically experience greater price appreciation during periods of falling interest rates such as we experienced for most of the six-month period, they produce less income than the higher-coupon issues held by the fund. THE FUND'S NET ASSET VALUE HAS EXPERIENCED LITTLE VOLATILITY SINCE IT WAS BROUGHT OUT AT $8.00 PER SHARE AFTER THE MERGER OF THE FOUR TERM TRUSTS. Over the last six months, interest rates generally declined as the Federal Reserve lowered the fed funds rate once in December from 5.75% to 5.50%, and another time in January from 5.50% to 5.25% to try to stimulate the economy. The rate cuts helped to move short-term interest rates lower which in turn increased the prices of ARM securities. This was reflected in a modest rise in the net asset value of Adjustable Rate Mortgage Securities Fund to a high of $8.08 on February 2. However, we positioned the fund to emphasize income more than an increase in net asset value as we expected the Federal Reserve to ease rates much less aggressively than did the market in general. This strategy paid off in February when the bond market realized it had effectively "overanticipated" the number of rate cuts the Federal Reserve would make and rates began to rise. In late February, the net asset value of the fund dropped only slightly and is currently $8.03 as of April 17. SINCE THE MERGER LAST FALL, WE HAVE FOCUSED OUR EFFORTS ON IMPROVING THE LEVEL AND PREDICTABILITY OF DIVIDEND INCOME TO SHAREHOLDERS. The lower rate environment throughout most of the period decreased the interest rates on mortgages, causing investors in ARM securities to experience a gradual reduction in coupon income as the underlying mortgage loans reset. We took steps to extend the average number of * FIGURES SHOWN REFLECT PAST PERFORMANCE AND DO NOT GUARANTEE FUTURE RESULTS. THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT FUND SHARES, WHEN SOLD, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. 2 ADJUSTABLE RATE MORTGAGE SECURITIES FUND [CHART] Adjustable Rate Mortgage Securities Fund (Results include historical net asset value performance of American Adjustable Rate Term Trust--1998, assume reinvested distribution and reflect the funds 1.5% sales charge since inception) Lehman Brothers Adjustable Rate Mortgage Index, an unmanaged index of all U.S. agency adjustable rate mortgage securities Lipper Adjustable Rate Mortgage Funds Average, the average total return, with distributions reinvested, of similar funds as characterized by Lipper Analytical Services IF YOU HAD INVESTED $10,000 IN JANUARY 1992 AND HELD YOUR INVESTMENT THROUGH FEBRUARY 29, 1996, REINVESTING ALL DISTRIBUTIONS, YOUR INVESTMENT WOULD HAVE GROWN TO $11,690. IN COMPARING THE FUND TO THE LEHMAN BROTHERS INDEX AND THE LIPPER AVERAGE, KEEP IN MIND THAT THE FUND'S PERFORMANCE REFLECTS THE SALES CHARGE, WHILE NO SUCH CHARGES ARE REFLECTED IN THE INDEX OR THE AVERAGE. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. AVERAGE ANNUAL TOTAL RETURNS THROUGH 2/29/96, INCLUDING 1.5% SALES CHARGE One Year..............................6.26% Since Inception (1/30/92).............3.90%
FUND RESULTS INCLUDE REINVESTED DISTRIBUTIONS AND REFLECT THE ADJUSTABLE RATE MORTGAGE SECURITIES FUND'S MAXIMUM 1.5% SALES CHARGE AS IF IT WAS APPLIED SINCE THE FUND'S INCEPTION. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. ON SEPTEMBER 1, 1995, FOUR AMERICAN ADJUSTABLE RATE TERM TRUSTS MERGED INTO THE ADJUSTABLE RATE MORTGAGE SECURITIES FUND. ALL PERFORMANCE RESULTS ABOVE INCLUDE THE HISTORICAL NET ASSET VALUE PERFORMANCE THROUGH SEPTEMBER 1, 1995, OF AMERICAN ADJUSTABLE RATE TERM TRUST-1998, THE FUND'S PREDECESSOR FOR PERFORMANCE AND FINANCIAL REPORTING PURPOSES. months for coupons to reset by increasing the fund's allocation to GNMA ARM securities. These securities have coupons ranging from 6.0% to 7.38% that won't reset until the fourth quarter of 1996. In addition, we overweighted ARM securities indexed to the one-year Constant Maturity Treasury, which reset less frequently than LIBOR-based or Treasury bill-based ARM securities. The lower rates also caused many adjustable rate mortgage borrowers to prepay their mortgages and lock in a lower rate with fixed rate mortgages. This level of prepayments also reduced the fund's income level. That's because the fund purchased many of these mortgages at premium prices and the prepayments forced the fund to amortize these premiums more quickly. We reduced the fund's exposure to prepayments by selling higher cost, faster prepaying ARM securities for lower cost, slower prepaying ARM securities. THESE ACTIONS, IN ADDITION TO A SMALLER CASH POSITION IN THE FUND, HAVE RESULTED IN A HIGHER LEVEL OF DIVIDEND INCOME TO SHAREHOLDERS. The dividend has increased from the September 1995 level of $0.0340 per share to the March 1996 level of $0.0403 per share. The dividend policy for the fund is to distribute to shareholders substantially all of the investment income earned during any period. Therefore, we will not attempt to stabilize monthly distributions by retaining income in a dividend reserve. THE FUND IS STILL EXPERIENCING REDEMPTIONS THAT BEGAN AFTER THE MERGER LAST FALL. We have continued to meet redemption requests without disruption to the fund's net asset value or income. This has been accomplished by maintaining a small cash position in the fund at all times and by selling privately issued and U.S. government agency ARM securities or U.S. Treasury securities when necessary. THROUGHOUT MOST OF THE SEMIANNUAL PERIOD, THE FUND MAINTAINED A HIGH PERCENTAGE IN ARM SECURITIES. We believed they represented a good value when comparing their level of income to their price stability. As of February 29, 85% of the fund's total assets were invested in ARM securities (see pie chart on page 2), with 69% issued by a U.S. government agency and 16% privately issued and rated AAA or AA by Standard and Poor's. Nearly all of these ARM securities had coupons which were indexed to the one-year Constant Maturity Treasury yield and which reset on an annual basis. 3 ADJUSTABLE RATE MORTGAGE SECURITIES FUND WHAT ARE ADJUSTABLE RATE MORTGAGE (ARM) SECURITIES?* An ARM security represents ownership in a pool of adjustable rate mortgage loans. Payments on the ARM securities come from payments on the adjustable rate mortgages. When a borrower's mortgage rate resets to a higher (lower) rate due to changes in a market index, the coupon on the ARM security also resets to a higher (lower) level. This results in a larger (smaller) interest payment that is then passed through to investors. The borrower's loan document specifically states the dates on which the rate will change, the market index on which the new rate is based, and the margin by which the rate is set over the index rate. For example, many borrowers have loans indexed to the one-year Treasury rate plus a margin of 2.75%, which reset once a year. If, on the reset date, the one-year Treasury rate is 5.50%, the borrower's new rate for the following 12 months will increase to 8.25%. Likewise, the rate passed through to the investor will increase to 8.25% minus a mortgage servicer and guarantee fee. Almost all ARM loans have periodic reset caps and lifetime caps, which limit how often and how high rates can reset. Smaller periodic caps and lower lifetime caps work to the advantage of the borrower and to the disadvantage of the investor when rates are rising. Although ARM pools are made up of thousands of similarly indexed loans, in any particular month only a portion of the loans reset to a current market rate, creating lags in the adjustment process. * ARM SECURITIES ARE DEFINED MORE BROADLY IN THE FUND'S PROSPECTUS. PLEASE SEE THE PROSPECTUS FOR A COMPLETE DEFINITION. RECENT VOLATILITY IN THE BOND MARKET HAS CAUSED US TO REDUCE THE ARM SECURITIES PORTION OF THE FUND BY ABOUT 5% AND PURCHASE TWO-YEAR U.S. TREASURY NOTES. This volatility, and higher rates, were the result of good economic data concerning job growth that came out in March and April. Positive job growth data and a stronger economy reignite inflation concerns, which in turn cause rates to rise. LOOKING AHEAD, WE EXPECT A RELATIVELY STABLE INTEREST RATE ENVIRONMENT THROUGH THE FUND'S FISCAL YEAR END IN AUGUST. The higher interest rates we're experiencing, and the additional income that now comes from extending maturities, could lead to opportunities in fixed rate securities and a reduction in the percentage of ARM securities the fund holds. SINCE WE LAST REPORTED TO YOU IN OCTOBER, WE HAVE ADDED A NEW PORTFOLIO MANAGER TO THE FUND. Wan-Chong Kung joined the fund as a co-manager in December. Wan-Chong, a vice president and fixed income portfolio manager at Piper Capital Management, also assists with the management of Highlander Income Fund and several separately managed accounts. Prior to joining Piper Capital in 1993, Wan-Chong was a senior consultant for a financial services firm. She has four years of financial experience. Mike Jansen, who previously co-managed the fund, has left Piper Capital to pursue other career opportunities. Thank you for your investment in the Adjustable Rate Mortgage Securities Fund. We remain committed to providing you with top-quality investment management and service. Sincerely, [sig] Tom McGlinch Portfolio Manager 4 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES (UNAUDITED) ADJUSTABLE RATE MORTGAGE SECURITIES FUND FEBRUARY 29, 1996
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) U.S. GOVERNMENT SECURITIES (10.7%): U.S. Treasury Note, 6.38%, 6/30/97 ................. $ 10,000,000 10,136,100 U.S. Treasury Note, 6.00%, 11/30/97 .................. 23,000,000 23,218,500 U.S. Treasury Note, 6.63%, 3/31/97 ................... 7,500,000 7,606,200 ----------- Total U.S. Government Securities (cost: $40,937,953) ............................... 40,960,800 ----------- MORTGAGE-BACKED SECURITIES (87.7%): U.S. Agency Fixed Rate Mortgages (1.8%): 10.00%, FNMA, 12/1/21 ................................ 2,205,323 2,426,517 9.00%, GNMA, 5/15/16 ................................. 1,272,415 1,359,868 10.00%, GNMA, 2/15/25 ................................ 2,876,741 3,180,554 ----------- 6,966,939 ----------- U.S. Agency Adjustable Rate Mortgages (67.4%): 7.95%, FHLMC, 2/1/22 ................................. 14,279,780 14,768,148 8.01%, FHLMC, 9/1/22 ................................. 4,485,622 4,602,651 7.50%, FHLMC, 11/1/16 ................................ 8,889,192 9,066,709 8.00%, FHLMC, 5/1/17 ................................. 3,199,579 3,252,979 7.73%, FHLMC, 6/1/18 ................................. 1,816,259 1,870,638 7.74%, FHLMC, 1/1/21 ................................. 5,230,181 5,340,643 7.72%, FHLMC, 5/1/19 ................................. 1,841,215 1,877,910 7.77%, FHLMC, 10/1/18 ................................ 6,029,254 6,197,712 7.71%, FHLMC, 8/1/20 ................................. 9,633,482 9,866,420 7.69%, FNMA, 1/1/18 .................................. 1,876,024 1,940,165 7.71%, FNMA, 1/1/29 .................................. 3,362,914 3,453,276 7.40%, FNMA, 5/1/18 .................................. 6,690,528 6,827,282 7.33%, FNMA, 3/1/28 .................................. 9,239,020 9,430,637 7.43%, FNMA, 7/1/19 .................................. 2,572,057 2,626,276 7.30%, FNMA, 11/1/17 ................................. 8,863,650 8,981,270 7.81%, FNMA, 1/1/20 .................................. 1,812,091 1,865,185 7.55%, FNMA, 12/1/20 ................................. 7,062,010 7,220,834 7.49%, FNMA, 11/1/21 ................................. 6,319,834 6,466,960 7.33%, FNMA, 10/1/25 ................................. 7,405,840 7,479,899 7.00%, GNMA, 5/20/23 ................................. 10,130,390 10,273,633 7.25%, GNMA, 9/20/23 ................................. 8,020,783 8,150,158 7.00%, GNMA, 6/20/24 ................................. 9,627,184 9,791,423 6.50%, GNMA, 9/20/25 ................................. 14,639,769 14,928,026 6.00%, GNMA, 8/20/25 ................................. 21,155,800 21,411,574 6.00%, GNMA, 9/20/25 ................................. 21,152,554 21,408,712 7.00%, GNMA II, 7/20/22 .............................. 7,667,352 7,800,074 7.25%, GNMA II, 7/20/22 .............................. 10,943,011 11,164,716 7.00%, GNMA II, 6/20/22 .............................. 7,710,315 7,818,414 7.38%, GNMA II, 6/20/23 .............................. 16,515,271 16,784,635 7.00%, GNMA II, 8/20/21 .............................. 6,916,383 7,056,370 7.00%, GNMA II, 10/20/21 ............................. 6,772,966 6,914,047 ----------- 256,637,376 ----------- Collateralized Mortgage Obligations (b) (18.5%): U.S. Agency Floating Rate (2.3%): 4.88%, FHLMC 1693, Class FA, Treasury, 3/15/09 ....... 9,139,139 8,789,568 -----------
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- Private Floating Rate (16.2%): 7.79%, Donaldson, Lufkin and Jenrette, Series 1992-MF3, Class A3, LIBOR, 6/18/07 ................ $ 13,000,000 13,130,000 8.16%, Resolution Trust Corporation, Series 1991-8, Class A1, Treasury, 12/25/20 ........................ 11,002,561 11,105,710 7.85%, Resolution Trust Corporation, Series 1992-6, Class B3, Treasury, 1/25/26 ......................... 23,345,266 23,491,174 7.15%, Sears Mortgage Securities, Series 1991-K, Class A1, LIBOR, 9/25/21 .................................. 13,776,414 13,776,414 ----------- 61,503,298 ----------- Total Mortgage-Backed Securities (cost: $335,964,435) .............................. 333,897,181 ----------- SHORT-TERM SECURITIES (1.4%): Repurchase agreement with Goldman Sachs in a joint trading account collateralized by U.S. government agency securities, acquired on 2/29/96, accrued interest at repurchase date of $803, 5.42%, 3/1/96 (cost: $5,331,000) .................................. 5,331,000 5,331,000 ----------- Total Investments in Securities (99.8%) (cost: $382,233,388) (c) .......................... 380,188,981 ----------- Other assets in excess of liabilities (0.2%) ....... 599,523 ----------- Net assets (100.0%) ............................... $ 380,788,504 ----------- -----------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) DESCRIPTIONS OF CERTAIN COLLATERALIZED MORTGAGE OBLIGATIONS ARE AS FOLLOWS: LIBOR - LONDON INTERBANK OFFERED RATE. FLOATING RATE - REPRESENT SECURITIES THAT PAY INTEREST AT RATES THAT INCREASE (DECREASE) WITH AN INCREASE (DECREASE) IN A SPECIFIED INDEX. (C) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. THE AGGREGATE GROSS UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES BASED ON THIS COST WERE AS FOLLOWS: GROSS UNREALIZED APPRECIATION .... $ 631,844 GROSS UNREALIZED DEPRECIATION ...... (2,676,251) ---------- NET UNREALIZED DEPRECIATION .... $ (2,044,407) ---------- ----------
5 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS (UNAUDITED) STATEMENT OF ASSETS AND LIABILITIES FEBRUARY 29, 1996 ASSETS: Investments in securities at market value* (including a repurchase agreement of $5,331,000) (note 2) ......... $ 380,188,981 Cash in bank on demand deposit ........................... 26,385 Mortgage security paydowns receivable .................... 958,307 Accrued interest receivable .............................. 3,052,533 ---------------- Total assets ......................................... 384,226,206 ---------------- LIABILITIES: Dividends payable to shareholders ($0.0407 per share) .... 1,924,914 Payable for fund shares redeemed ......................... 1,244,988 Accrued investment management fee ........................ 109,211 Accrued distribution fee ................................. 158,589 ---------------- Total liabilities .................................... 3,437,702 ---------------- Net assets applicable to outstanding capital stock ....... $ 380,788,504 ---------------- ---------------- REPRESENTED BY: Capital stock - authorized 1 billion shares of $0.01 par value; outstanding, 47,281,277 shares ................ $ 472,813 Additional paid-in capital ............................... 526,223,960 Undistributed net investment income ...................... 57,012 Accumulated net realized loss on investments ............. (143,920,874) Unrealized depreciation of investments ................... (2,044,407) ---------------- Total - representing net assets applicable to outstanding capital stock ........................ $ 380,788,504 ---------------- ---------------- Net asset value per share of outstanding capital stock ... $ 8.05 ---------------- ---------------- * Investments in securities at identified cost ........... $ 382,233,388 ---------------- ----------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 6 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS (UNAUDITED) STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED FEBRUARY 29, 1996 INCOME: Interest ............................................... $ 17,006,142 ---------------- EXPENSES (NOTE 3): Investment management fee ................................ 916,089 Distribution fees ........................................ 395,218 Custodian, accounting and transfer agent fees ............ 463,088 Shareholder account servicing fees ....................... 21,055 Registration fees ........................................ 69,631 Reports to shareholders .................................. 54,111 Directors' fees .......................................... 17,603 Audit and legal fees ..................................... 26,751 Other expenses ........................................... 29,844 ---------------- Total expenses ....................................... 1,993,390 Less expenses waived by the adviser ...................... (375,349) ---------------- Net expenses before expenses paid indirectly ........... 1,618,041 Less expenses paid indirectly ............................ (9,013) ---------------- Total net expenses ................................... 1,609,028 ---------------- Net investment income ................................ 15,397,114 ---------------- NET REALIZED AND UNREALIZED GAINS (LOSSES) ON INVESTMENTS: Net realized loss on investments (note 4) ................ (1,876,436) Net change in unrealized appreciation or depreciation of investments ............................................ 6,268,848 ---------------- Net gain on investments ................................ 4,392,412 ---------------- Net increase in net assets resulting from operations ....................................... $ 19,789,526 ---------------- ----------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS
Six Months Ended 2/29/96 Year Ended (Unaudited) 8/31/95* ---------------- ---------------- OPERATIONS: Net investment income .................................. $ 15,397,114 23,499,426 Net realized loss on investments ......................... (1,876,436) (20,761,474) Net change in unrealized appreciation or depreciation of investments . 6,268,848 17,558,315 ---------------- ---------------- Net increase in net assets resulting from operations ... 19,789,526 20,296,267 ---------------- ---------------- DISTRIBUTIONS TO SHAREHOLDERS: From net investment income ............................... (15,340,102) (27,746,007) ---------------- ---------------- CAPITAL SHARE TRANSACTIONS: Proceeds from sales of 344,857 shares .................... 2,765,136 -- Proceeds from issuance of 959,489 shares for reinvestment of distributions ....................................... 7,705,791 -- Payments for 105,492,397 shares redeemed ................. (845,180,658) -- Payments for retirement of 488,000 shares (note 6) ....... -- (3,579,372) Payments for tender of 9,135,819 shares respectively (note 7) ..................................................... -- (79,726,515) Net asset value of 104,403,211 shares issued in connection with merger transaction** (note 9) ..................... 801,742,686 -- ---------------- ---------------- Decrease in net assets from capital share transactions ......................................... (32,967,045) (83,305,887) ---------------- ---------------- Total decrease in net assets ......................... (28,517,621) (90,755,627) Net assets at beginning of period .......................... 409,306,125 500,061,752 ---------------- ---------------- Net assets at end of period .............................. $ 380,788,504 409,306,125 ---------------- ---------------- ---------------- ---------------- Undistributed net investment income ...................... $ 57,012 -- ---------------- ---------------- ---------------- ----------------
* REPRESENTS HISTORICAL FINANCIAL INFORMATION OF AMERICAN ADJUSTABLE RATE TERM TRUST 1998. ** INCLUDES 100,218,356 SHARES ISSUED IN CONNECTION WITH THE MERGER OF AMERICAN ADJUSTABLE RATE TERM TRUST 1996, AMERICAN ADJUSTABLE RATE TERM TRUST 1997 AND AMERICAN ADJUSTABLE RATE TERM TRUST 1999, AND AN INCREASE OF 4,184,855 SHARES DUE TO THE DIFFERENCE BETWEEN THE ENDING NET ASSET VALUE PER SHARE OF AMERICAN ADJUSTABLE RATE TERM TRUST 1998 AND THE INITIAL NET ASSET VALUE PER SHARE OF THE FUND. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 8 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (1) ORGANIZATION Piper Funds Inc. - II (the company) was incorporated on April 10, 1995 and is registered under the Investment Company Act of 1940 (as amended) as a single, open-end investment management company. The company currently includes only the Adjustable Rate Mortgage Securities Fund (the fund), which is classified as a diversified fund. The company's articles of incorporation permit the board of directors to create additional funds in the future. The fund invests primarily in adjustable rate mortgage (ARM) securities. It may also invest in mortgage-backed securities other than ARM securities, U.S. government securities, asset-backed securities and corporate debt securities. For financial reporting purposes, American Adjustable Rate Term Trust 1998 (DDJ) (a closed-end fund) is considered the surviving entity of the merger of American Adjustable Rate Term Trust 1996 (BDJ), American Adjustable Rate Term Trust 1997 (CDJ), American Adjustable Rate Term Trust 1998 (DDJ) and American Adjustable Rate Term Trust 1999 (EDJ) into Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund, which was effective September 1, 1995. As such, only historical financial information of DDJ is relevant with respect to the future financial reporting of Piper Funds Inc. - II Adjustable Rate Mortgage Securities Fund. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INVESTMENTS IN SECURITIES The values of fixed income securities are determined using pricing services or prices quoted by independent brokers. Exchange-listed options are valued at the last sale price and open financial futures contracts are valued at the last settlement price. When market quotations are not readily available, securities are valued at fair value according to methods selected in good faith by the board of directors. Short-term securities with maturities of 60 days or less are valued at amortized cost which approximates market value. Securities transactions are accounted for on the date the securities are purchased or sold. Realized gains and losses are calculated on the identified-cost basis. Interest income, including amortization of bond discount and premium computed on a level-yield basis, is accrued daily. OPTION TRANSACTIONS For hedging purposes, the fund may purchase and write put and call options which are exchange-traded and cannot write call options that are not covered. The risk in writing a call option is that the fund gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the fund may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the fund pays a premium whether or not the option is exercised. The fund also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. Option contracts are valued daily, and unrealized appreciation or depreciation is recorded. The fund will realize a gain or loss upon expiration or closing of the option transaction. When an option is exercised, the proceeds on sales for a written call option, the purchase cost for a written put option, or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. 9 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (UNAUDITED) FUTURES TRANSACTIONS In order to gain exposure to or protect against changes in the market, the fund may buy and sell interest rate futures contracts and related options. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The fund recognizes the realized gain or loss when the contract is closed or expires. INTEREST RATE TRANSACTIONS To preserve a return or spread on a particular investment or portion of its portfolio or for other non-speculative purposes, the fund may purchase and sell interest rate caps and floors. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate floor. If forecasts of interest rates and other market factors are incorrect, investment performance will diminish compared to what performance would have been if these investment techniques were not used. Even if the forecasts are correct, there is risk that the positions may correlate imperfectly with the asset or liability being hedged. Other risks of entering into these transactions are that a liquid secondary market may not always exist, or that another party to a transaction may not perform. SECURITIES PURCHASED ON A WHEN-ISSUED BASIS Delivery and payment for securities that have been purchased by the fund on a forward-commitment or when-issued basis can take place one month or more after the transaction date. During this period, such securities do not earn interest, are subject to market fluctuations and may increase or decrease in value prior to their delivery. The fund maintains, in a segregated account with its custodian, cash or securities with a market value equal to the amount of its purchase commitments. The purchase of securities on a when-issued or forward-commitment basis may increase the volatility of the fund's NAV to the extent the fund makes such purchases while remaining substantially fully invested. As of February 29, 1996, the fund had no outstanding when-issued or forward commitments. FEDERAL TAXES The fund's policy is to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and not be subject to federal income tax. Therefore, no income tax provision is required. Net investment income and net realized gains (losses) may differ for financial statement and tax purposes primarily because of the recognition of certain foreign currency gains (losses) as ordinary income for tax purposes, and losses deferred due to "wash sale" and "straddle" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. Also, due to the 10 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (UNAUDITED) timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the fund. DISTRIBUTIONS Distributions to shareholders from net investment income for the fund will be declared daily and paid monthly in cash or reinvested in additional shares. Distributions from net realized gains, if any, will be made on at least an annual basis. REPURCHASE AGREEMENTS For repurchase agreements entered into with certain broker-dealers, the fund, along with other affiliated registered investment companies may transfer uninvested cash balances into a joint trading account, the daily aggregate of which is invested in repurchase agreements secured by U.S. government and agency obligations. Securities pledged as collateral for all individual and joint repurchase agreements are held by the fund's custodian bank until maturity of the repurchase agreements. Provisions for all agreements ensure the daily market value of the collateral is in excess of the repurchase amount in the event of default. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the results of operations during the reporting period. Actual results could differ from those estimates. (3) EXPENSES The Company has entered into an investment management agreement with Piper Capital Management Incorporated (Piper Capital) under which Piper Capital manages the fund's assets and furnishes related office facilities, equipment, research and personnel. The agreement requires the fund to pay Piper Capital a monthly fee based on its average daily net assets. The fee is equal to an annual rate of 0.35% of the first $500 million in net assets and 0.30% of net assets in excess of $500 million. The fund will pay Piper Jaffray Inc. (Piper Jaffray) a monthly fee for expenses incurred in the distribution and promotion of fund shares. The fee is limited to an annual rate of 0.15% of the fund's average daily net assets and is payable as a servicing fee. The fund has also entered into shareholder account servicing agreements under which Piper Jaffray and Piper Trust Company perform various transfer and dividend disbursing agent services. The fees, which are paid monthly to Piper Jaffray and Piper Trust Company for providing such services, are equal to an annual rate of $6.00 per active shareholder account, and $1.60 per closed shareholder account. In addition to these fees the fund is responsible for paying most other operating expenses including outside directors' fees and expenses, custodian fees, registration fees, printing and shareholder reports, transfer agent fees and expenses, legal, auditing and accounting services, insurance, interest, taxes and other miscellaneous expenses. Sales charges paid to Piper Jaffray for distributing the fund's shares were $4,792 for the six months ended February 29, 1996. 11 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (UNAUDITED) Expenses paid indirectly represent a reduction of custodian fees for earnings on cash balances maintained with the custodian by the fund. (4) SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than temporary investments in short-term securities) for the six months ended February 29, 1996, were $115,831,023 and $763,165,053, respectively. During the six months ended February 29, 1996, the fund paid Piper Jaffray Inc., an affiliated broker, no brokerage commissions. (5) CAPITAL LOSS CARRYOVER For federal income tax purposes, after giving effect to capital loss carryovers acquired in the merger, the fund had capital loss carryovers of $141,672,558 at September 1, 1995. If these loss carryovers are not offset by subsequent capital gains, they will expire at various times during 1999 through 2002. It is unlikely the board of directors will authorize a distribution of any net realized capital gains until the available capital loss carryovers have been offset or expire. (6) RETIREMENT OF FUND SHARES The board of directors of DDJ (a closed-end fund) had approved a plan to repurchase shares of the fund in the open market and retire those shares. Repurchases were only made when the previous day's closing market price was at a discount from net asset value. Daily repurchases were limited to 25% of the previous four weeks average daily trading volume on the New York Stock Exchange. Under the plan, cumulative repurchases were limited to 3% of the total shares originally issued. Pursuant to the plan, DDJ cumulatively repurchased and retired 823,000 shares (1.44% of originally issued shares) as of August 31, 1995. (7) TENDER OFFER OF FUND SHARES On August 22, 1994, shareholders of DDJ approved a fundamental policy that allowed shareholders to periodically tender their shares back to the fund at net asset value. A tender offer to repurchase up to 25% of DDJ's outstanding shares was mailed to shareholders on September 6, 1994. The deadline for participating in the offer was October 3, 1994. The repurchase price was determined on October 10, 1994, at the close of the New York Stock Exchange (4 p.m. Eastern Time). Proceeds from the tender offer were paid to shareholders on October 17, 1994. The total proceeds (including tender fees) paid by DDJ as well as the number and percentage of shares tendered were as follows:
Percentage Shares Proceeds Tendered Tendered Paid --------------- --------- ------------ 16% 9,135,819 $ 79,726,515
(8) PENDING LITIGATION On October 20, 1994, a complaint was filed by Herman D. Gordon in the U.S. District Court for the District of Minnesota against DDJ, EDJ, Piper Jaffray Companies Inc. (Piper Companies), Piper Capital Management Incorporated (Piper Capital), Piper Jaffray Inc. (Piper Jaffray) and certain associated individuals. A second complaint was filed on April 14, 1995, in the same court by Frank Donio, I.R.A., and other plaintiffs against BDJ, CDJ, DDJ and EDJ, Piper Companies, Piper Capital, Piper Jaffray and certain associated individuals. Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995, alleging violations of certain federal and state securities laws. Piper Companies and Piper Capital have agreed to indemnify Piper Funds Inc. II Adjustable Rate Mortgage Securities Fund (as the successor by merger to BDJ, CDJ, DDJ and EDJ) against any expenses or losses incurred in connection with such complaint. The parties have 12 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (UNAUDITED) reached an agreement-in-principal to settle all outstanding claims of the purported class action. If approved by the Court and a sufficiently large percentage of the class, a settlement agreement consistent with the terms of the agreement-in-principle would provide $14 million in principal payments consisting of $500,000 payable upon execution of the settlement agreement, $1.5 million payable upon final approval by the court, and payments of $3 million on each anniversary of the final court approval for the next four years, with accrued interest payments of up to $1.8 million. (9) MERGER As described in note 1, BDJ, CDJ, DDJ and EDJ were combined on September 1, 1995 to create the fund. The merger was accounted for as a tax free reorganization. The following table presents the shares issued by the fund in exchange for the net assets of BDJ, CDJ, DDJ and EDJ and the composition of such net assets at September 1, 1995.
BDJ CDJ EDJ Total(a) DDJ ------------ ------------ ------------ ------------ ------------ Shares issued by Adjustable Rate Mortgage Securities fund on 9/1/95 ....................... 23,619,989 46,350,330 30,248,037 100,218,356 51,250,972 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Net assets of acquired funds on 9/1/95 ......... $ 188,958,910 370,800,763 241,983,013 801,742,686 410,006,496 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Composition of net assets: Capital stock ................................ $ 212,202,280 413,741,503 274,887,229 900,831,012 460,623,794 Accumulated net realized loss on investments ... (21,813,013) (41,193,687) (31,942,871) (94,949,571) (47,214,017) Unrealized depreciation of investments.......... (1,430,357) (1,747,053) (961,345) (4,138,755) (3,403,281) ------------ ------------ ------------ ------------ ------------ $ 188,958,910 370,800,763 241,983,013 801,742,686 410,006,496 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
(A) SINCE DDJ IS CONSIDERED THE SURVIVING ENTITY FOR FINANCIAL REPORTING PURPOSES THE COMBINED NET ASSETS OF BDJ, CDJ AND EDJ ARE PRESENTED AS BEING ACQUIRED BY THE SURVIVING ENTITY IN THE STATEMENT OF CHANGES IN NET ASSETS. 13 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (10) FINANCIAL HIGHLIGHTS Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows:
Six Months Ended Year Year Year 2/29/96 Ended Ended Ended Period Ended (Unaudited) 8/31/95 8/31/94 8/31/93 8/31/92(b) ----------- ------- ------- ------- ------------ PER-SHARE DATA (A) Net asset value, beginning of period ........... $ 7.99 8.10 8.88 8.95 8.80 ----- ------- ------- ------- ----- Operations: Net investment income .......................... 0.25 0.47 0.55 0.63 0.40 Net realized and unrealized gains (losses) on investments .................................. 0.04 (0.05) (0.82) (0.09) 0.07 ----- ------- ------- ------- ----- Total from operations ........................ 0.29 0.42 (0.27) 0.54 0.47 ----- ------- ------- ------- ----- Distributions to shareholders: From net investment income ..................... (0.23) (0.53) (0.51) (0.61) (0.32) ----- ------- ------- ------- ----- Net asset value, end of period ................. $ 8.05 7.99 8.10 8.88 8.95 ----- ------- ------- ------- ----- ----- ------- ------- ------- ----- SELECTED INFORMATION (A) Total investment return (c) ...................... 3.51% 5.43% -3.18% 6.24% 5.49% Net assets at end of period (in millions) ...... $ 381 409 500 551 555 Ratio of expenses to average net assets (d) ...... 0.60%(f) 0.63% 0.60% 0.58% 0.58%(f) Ratio of net investment income to average net assets (d) ..................................... 5.73%(f) 5.62% 6.39% 7.25% 7.70%(f) Portfolio turnover rate (excluding short-term securities) .................................... 25% 36% 39% 39% 41% Amount of borrowings outstanding at end of period (in millions) (e) ............................ $ n/a -- 145 145 145 Average amount of borrowings outstanding during the period (in millions) (e) ................. $ n/a 57 145 149 90 Average number of shares outstanding during the period (in millions) (e) ....................... n/a 53 62 62 52 Average per-share amount of borrowings outstanding during the period (e) ........................ $ n/a 1.09 2.34 2.41 1.67
(A) ON SEPTEMBER 1, 1995 FOUR CLOSED-END FUNDS, AMERICAN ADJUSTABLE RATE TERM TRUST 1996, AMERICAN ADJUSTABLE RATE TERM TRUST 1997, AMERICAN ADJUSTABLE RATE TERM TRUST 1998 (DDJ) AND AMERICAN ADJUSTABLE RATE TERM TRUST 1999 WERE COMBINED TO CREATE THE FUND. DDJ IS CONSIDERED THE SURVIVING ENTITY FOR FINANCIAL REPORTING PURPOSES. THE FINANCIAL HIGHLIGHTS PRESENTED FOR THE PERIODS PRIOR TO SEPTEMBER 1, 1995 ARE THOSE OF DDJ. THE PER SHARE INFORMATION FOR SUCH PERIODS HAS BEEN RESTATED TO REFLECT THE IMPACT OF ADDITIONAL SHARES CREATED RESULTING FROM THE DIFFERENCE IN THE NET ASSET VALUE PER SHARE OF DDJ AT THE TIME OF THE MERGER ($8.71) AND THE INITIAL NET ASSET VALUE PER SHARE OF THE FUND ($8.00). (B) COMMENCEMENT OF OPERATIONS OF DDJ WAS JANUARY 30, 1992. (C) TOTAL INVESTMENT RETURN IS BASED ON THE CHANGE IN NET ASSET VALUE, ASSUMES REINVESTMENT OF DISTRIBUTIONS AT NET ASSET VALUE AND DOES NOT REFLECT A SALES CHARGE. (D) VARIOUS FEES AND EXPENSES OF THE FUND WERE VOLUNTARILY WAIVED OR ABSORBED BY PIPER CAPITAL DURING FISCAL YEAR 1996. THE ANNUALIZED RATIOS OF EXPENSES AND NET INVESTMENT INCOME TO AVERAGE DAILY NET ASSETS WOULD HAVE BEEN 0.74%/5.59%, RESPECTIVELY, FOR THE SIX MONTHS ENDED 2/29/96. BEGINNING IN FISCAL YEAR 1996, THE EXPENSE RATIO REFLECTS THE EFFECT OF GROSS EXPENSES PAID INDIRECTLY BY THE FUND. PRIOR PERIOD EXPENSE RATIOS HAVE NOT BEEN ADJUSTED. (E) DDJ WAS A CLOSED-END INVESTMENT MANAGEMENT COMPANY AND WAS PERMITTED TO ENTER INTO BORROWINGS FOR OTHER THAN TEMPORARY OR EMERGENCY PURPOSES. ADJUSTABLE RATE MORTGAGE SECURITIES FUND MAY BORROW ONLY FOR TEMPORARY OR EMERGENCY PURPOSES. (F) ADJUSTED TO AN ANNUAL BASIS. 14 - - - -------------------------------------------------------------------------------- DIRECTORS AND OFFICERS OF PIPER FUNDS INC. - II DIRECTORS David T. Bennett, CHAIRMAN, HIGHLAND HOMES, INC., USL PRODUCTS, INC., KIEFER BUILT, INC., OF COUNSEL, GRAY, PLANT, MOOTY, MOOTY & BENNETT, P.A. Jaye F. Dyer, PRESIDENT, DYER MANAGEMENT COMPANY William H. Ellis, CHAIRMAN OF THE BOARD, PRESIDENT, PIPER CAPITAL MANAGEMENT INCORPORATED, PIPER JAFFRAY COMPANIES INC. Karol D. Emmerich, PRESIDENT, THE PARACLETE GROUP Luella G. Goldberg, DIRECTOR, TCF FINANCIAL, RELIASTAR CORP., HORMEL FOODS CORP. George Latimer, CHIEF EXECUTIVE OFFICER, NATIONAL EQUITY FUNDS OFFICERS Paul A. Dow, PRESIDENT Robert H. Nelson, SENIOR VICE PRESIDENT/TREASURER Thomas S. McGlinch, SENIOR VICE PRESIDENT Amy K. Johnson, VICE PRESIDENT Susan Miley, SECRETARY INVESTMENT ADVISER Piper Capital Management Incorporated 222 SOUTH NINTH STREET, MINNEAPOLIS, MN 55402-3804 CUSTODIAN AND Investors Fiduciary Trust Company TRANSFER AGENT 127 WEST 10TH STREET, KANSAS CITY, MO 64105-1716 LEGAL COUNSEL Dorsey & Whitney LLP 220 SOUTH SIXTH STREET, MINNEAPOLIS, MN 55402 15 PIPER CAPITAL MANAGEMENT --------------- Bulk Rate U.S. Postage PIPER CAPITAL MANAGEMENT INCORPORATED PAID 222 SOUTH NINTH STREET Permit No. 3008 MINNEAPOLIS, MN 55402-3804 Mpls., MN --------------- PIPER JAFFREY INC., FUND DISTRIBUTOR AND NASD MEMBER. [LOGO] THIS DOCUMENT IS PRINTED ON PAPER MADE FROM 100% TOTAL RECOVERED FIBER, INCLUDING 15% POST-CONSUMER WASTE. In an effort to reduce costs to our shareholders, we have implemented a process to reduce duplicate mailings of the fund's shareholder reports. This householding process should allow us to mail one report to each address where one or more registered shareholders with the same last name reside. If you would like to have additional reports mailed to your address, please call our Shareholder Services area at 1 800 866-7778, or mail your request to: Piper Capital Management Attn: Communications Department 222 South Ninth Street Minneapolis, MN 55402-3804 http://www.piperjaffray.com 115-96 PJARX-02 5/96 ADJUSTABLE RATE MORTGAGE SECURITIES FUND 1996 SEMIANNUAL REPORT PART B INSTITUTIONAL MONEY MARKET FUND INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO Series of Piper Institutional Funds Inc. STATEMENT OF ADDITIONAL INFORMATION November 1, 1995 Table of Contents Page ---- Investment Objectives, Policies and Restrictions . . . . . . . . 2 Directors and Executive Officers . . . . . . . . . . . . . . . . 9 Investment Advisory and Other Services . . . . . . . . . . . . . 14 Portfolio Transactions and Allocation of Brokerage . . . . . . . 18 Capital Stock and Ownership of Shares. . . . . . . . . . . . . . 19 Net Asset Value and Public Offering Price. . . . . . . . . . . . 20 Performance Comparisons. . . . . . . . . . . . . . . . . . . . . 21 Purchase of Shares . . . . . . . . . . . . . . . . . . . . . . . 24 Redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 General Information. . . . . . . . . . . . . . . . . . . . . . . 28 Financial Statements . . . . . . . . . . . . . . . . . . . . . . 29 Pending Litigation . . . . . . . . . . . . . . . . . . . . . . . 29 Appendix A - Commercial Paper and Corporate Bond Ratings . . . . A-1 Appendix B - Interest Rate Futures Contracts and Related Options. . . . . . . . . . . . . . . . . . . . . . B-1 This Statement of Additional Information is not a prospectus. This Statement of Additional Information relates to the Prospectus dated November 1, 1995, and should be read in conjunction therewith. A copy of the Prospectus may be obtained from the Funds at Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804. INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS The shares of Piper Institutional Funds Inc. (the "Company") are currently offered in two series: Institutional Money Market Fund ("Money Market Fund") and Institutional Government Adjustable Portfolio ("Adjustable Portfolio") (sometimes referred to herein individually as a "Fund" or, collectively, as the "Funds"). The investment objectives and policies of the Funds are set forth in the Prospectus. Certain additional investment information is set forth below. REPURCHASE AGREEMENTS Each Fund may invest in repurchase agreements. The Funds' custodian will hold the securities underlying any repurchase agreement or such securities will be part of the Federal Reserve Book Entry System. The market value of the collateral underlying the repurchase agreement will be determined on each business day. If at any time the market value of the collateral falls below the repurchase price of the repurchase agreement (including any accrued interest), the respective Fund will promptly receive additional collateral (so the total collateral is an amount at least equal to the repurchase price plus accrued interest). The Funds have received from the Securities and Exchange Commission an exemptive order permitting the Funds, along with other investment companies currently managed by Piper Capital Management Incorporated (the "Adviser"), and all future investment companies or series thereof advised by the Adviser or its affiliates, to deposit uninvested cash balances into a large single joint account to be used to enter into one or more large repurchase agreements. MORTGAGE-BACKED SECURITIES Many Mortgage-Backed Securities (principally CMOs secured by GNMA, FNMA and/or FHLMC Certificates) are issued by entities that operate under orders from the Securities and Exchange Commission (the "SEC") exempting such issuers from the provisions of the Investment Company Act of 1940, as amended (the "1940 Act"). Until recently, the staff of the Division of Investment Management of the SEC had taken the position that such issuers were investment companies pursuant to Section 3 of the 1940 Act and that, accordingly, an investment by an investment company (such as Adjustable Portfolio) in the securities of such issuers was subject to limitations imposed by Section 12 of the 1940 Act. However, in reliance on a recent SEC staff interpretation, Adjustable Portfolio may investment in securities issued by certain "exempted issuers" without regard to the limitations of Section 12 of the 1940 Act. In its interpretation, the SEC staff defined "exempted issuers" as unmanaged, fixed asset issuers that (a) invest primarily in Mortgage-Backed Securities, (b) do not issue redeemable securities as defined in Section 2(a)(32) of the Act, (c) operate under general exemptive orders exempting them from "all provisions of the [1940] Act" and (d) are not registered or regulated under the 1940 Act as investment companies. -2- TYPES OF CREDIT SUPPORT To lessen the effect of failures by mortgagors to make payments on underlying mortgages, ARMS and other Mortgage-Backed Securities may contain elements of credit support. Such credit support falls into two categories: (a) liquidity protection and (b) protection against losses resulting from ultimate default by an obligor on the underlying assets. Liquidity protection refers to the provision of advances, generally by the entity administering the pool of assets, to ensure that the pass-through of payments due on the underlying pool occurs in a timely fashion. Protection against losses resulting from ultimate default enhances the likelihood of ultimate payment of the obligations on at least a portion of the assets in the pool. Such protection may be provided through guarantees, insurance policies or letters of credit obtained by the issuer or sponsor from third parties, through various means of structuring the transaction or through a combination of such approaches. Adjustable Portfolio will not pay any additional fees for such credit support, although the existence of credit support may increase the price of a security. The ratings of securities for which third-party credit enhancement provides liquidity protection or protection against losses from default are generally dependent upon the continued creditworthiness of the enhancement provider. The ratings of such securities could be downgraded in the event of deterioration in the creditworthiness of the credit enhancement provider even in cases where the delinquency and loss experience on the underlying pool of assets is better than expected. Examples of credit support arising out of the structure of the transaction include "senior-subordinated securities" (multiple class securities with one or more classes subordinate to other classes as to the payment of principal thereof and interest thereon, with the result that defaults on the underlying assets are borne first by the holders of the subordinated class), creation of "reserve funds" (where cash or investments, sometimes funded from a portion of the payments on the underlying assets, are held in reserve against future losses) and "over-collateralization" (where the scheduled payments on, or the principal amount of, the underlying assets exceed those required to make payment on the securities and pay any servicing or other fees). The degree of credit support provided for each issue is generally based on historical information with respect to the level of credit risk associated with the underlying assets. Other information which may be considered includes demographic factors, loan underwriting practices and general market and economic conditions. Delinquency or loss in excess of that which is anticipated (and in excess of the degree of credit support provided) will adversely affect the return on an investment in such a security by decreasing the yield and value of such security. OPTIONS As set forth in the Prospectus, Adjustable Portfolio may write covered options and purchase options on securities. The principal reason for writing call or put options is to obtain, through the receipt of premiums, a greater current return than would be realized on the underlying securities alone. Adjustable Portfolio receives premiums from writing call or put options, which it retains whether or not the -3- options are exercised. Adjustable Portfolio will write only covered options. This means that so long as the Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option (or comparable securities satisfying the cover requirements of securities exchanges). The Fund will be considered covered with respect to a put option it writes if, so long as it is obligated as the writer of a put option, it deposits and maintains with its custodian cash, U.S. Government securities or other liquid high-grade debt obligations having a value equal to or greater than the exercise price of the option. Adjustable Portfolio may wish to protect certain portfolio securities against a decline in market value at a time when no put options on those particular securities are available for purchase. The Fund may therefore purchase a put option on securities other than those it wishes to protect even though it does not hold such other securities in its portfolio. While the Fund will only purchase put options on securities where, in the opinion of the Adviser, changes in the value of the put option should generally offset changes in the value of the securities to be hedged, the correlation will be less than in transactions in which the Fund purchases put options on underlying securities it owns. The writing by Adjustable Portfolio of options on securities will be subject to limitations established by each of the registered securities exchanges on which such options are traded. Such limitations govern the maximum number of options in each class which may be written by a single investor or group of investors acting in concert, regardless of whether the options are written on the same or different securities exchanges or are held or written in one or more accounts or through one or more brokers. Thus, the number of options which the Fund may write may be affected by options written by other investment companies managed by and other investment advisory clients of the Adviser. An exchange may order the liquidation of positions found to be in excess of these limits, and it may impose certain other sanctions. OVER-THE-COUNTER OPTIONS Adjustable Portfolio may purchase and write over-the-counter ("OTC") put and call options in negotiated transactions. OTC options are two-party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third-party contracts with standardized strike prices and expiration dates, and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while OTC options may not. The staff of the Securities and Exchange Commission has previously taken the position that the value of purchased OTC options and the assets used as "cover" for written OTC options are illiquid securities and, as such, are to be included in the calculation of a fund's 15% limitation on illiquid securities. However, the staff has eased its position somewhat in certain limited circumstances. Although the Adviser disagrees with the position of the staff, pending resolution of this issue Adjustable Portfolio will treat OTC options, to the extent set forth below, as subject to the Fund's limitation on illiquid securities. Adjustable Portfolio will attempt to enter into contracts with certain dealers with which it writes OTC options. Each such contract will provide that the Fund has the absolute right to repurchase the options -4- it writes at any time at a repurchase price which represents the fair market value, as determined in good faith through negotiation between the parties, but which in no event will exceed a price determined pursuant to a formula contained in the contract. Although the specific details of such formula may vary among contracts, the formula will generally be based upon a multiple of the premium received by the Fund for writing the option, plus the amount, if any, of the option's intrinsic value. The formula will also include a factor to account for the difference between the price of the security and the strike price of the option if the option is written out-of-the-money. With respect to each OTC option for which such a contract is entered into, the Fund will count as illiquid only the initial formula price minus the option's intrinsic value. Adjustable Portfolio will enter into such contracts only with primary U.S. Government securities dealers recognized by the Federal Reserve Bank of New York. Moreover, such primary dealers will be subject to the same standards as are imposed upon dealers with which the Fund enters into repurchase agreements. ILLIQUID SECURITIES As set forth in the Prospectus, the Funds may invest in Rule 144A securities, commercial paper issued pursuant to Rule 4(2) under the Securities Act of 1933, and, with respect to Adjustable Portfolio, interest-only and principal-only classes of Mortgage-Backed Securities issued by the U.S. Government or its agencies or instrumentalities and treat such securities as liquid when they have been determined to be liquid by the Board of Directors of the Fund or by the Adviser subject to the oversight of and pursuant to procedures adopted by the Board of Directors. Under these procedures, factors taken into account in determining the liquidity of a security include (a) the frequency of trades and quotes for the security; (b) the number of dealers willing to purchase or sell the security and the number of other potential purchasers; (c) dealer undertakings to make a market in the security; and (d) the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers and the mechanics of transfer). With respect to Rule 144A securities, investing in such securities could have the effect of increasing the level of Fund illiquidity to the extent that qualified institutional buyers become, for a time, uninterested in purchasing these securities. FOREIGN INDEX LINKED INSTRUMENTS As set forth in the Prospectus, Adjustable Portfolio may invest up to 10% of its total assets in Foreign Index Linked Instruments. Foreign Index Linked Instruments are fixed income securities which are issued by U.S. issuers (including U.S. subsidiaries of foreign issuers) and are denominated in U.S. dollars but return principal and/or pay interest to investors in amounts which are linked to the level of a particular foreign index. A foreign index may be based upon the exchange rate of a particular currency or currencies or the differential between two currencies, or the level of interest rates in a particular country or countries or the differential in interest rates between particular countries. In the case of Foreign Index Linked Instruments linking the principal amount to a foreign index, the amount of -5- principal payable by the issuer at maturity will increase or decrease in response to changes in the level of the foreign index during the term of the Foreign Index Linked Instrument. In the case of Foreign Index Linked Instruments linking the interest component to a foreign index, the amount of interest payable will adjust periodically in response to changes in the level of the foreign index during the term of the Foreign Index Linked Instrument. Foreign Index Linked Instruments may be issued by a U.S. governmental agency or instrumentality or by a private issuer. The Foreign Index Linked Instruments in which the Fund has invested to date have been debt instruments closely resembling corporate bonds. However, Foreign Index Linked Instruments present certain risks in addition to those presented by corporate bonds. See "Special Investment Methods--Foreign Index Linked Instruments" in the Prospectus. PORTFOLIO TURNOVER Portfolio turnover is the ratio of the lesser of annual purchases or sales of portfolio securities to the average monthly value of portfolio securities, not including securities maturing in less than 12 months. A 100% portfolio turnover rate would occur, for example, if the lesser of the value of purchases or sales of portfolio securities for a particular year were equal to the average monthly value of the portfolio securities owned during such year. Money Market Fund, consistent with its objective, may attempt to maximize yield through portfolio trading. This may involve selling portfolio instruments and purchasing different instruments to take advantage of disparities of yield in different segments of the high-grade money market or among particular instruments within the same segment of the market. Since the Fund's assets will be invested in securities with short maturities and the Fund will manage its portfolio as described above, the portfolio will turn over several times a year. However, this will not generally increase Money Market Fund's brokerage costs, since brokerage commissions as such are not usually paid in connection with the purchase or sale of the instruments in which the Fund invests. Because securities with maturities of less than one year are excluded from required portfolio turnover rate calculations, the portfolio turnover rate for Money Market Fund will be zero. While it is not the policy of Adjustable Portfolio to trade actively for short-term (less than six months) profits, the Fund will dispose of securities without regard to the time they have been held when such action appears advisable to the Adviser. In the case of Adjustable Portfolio, frequent changes may result in higher transaction and other costs for the Fund. For purposes of calculating portfolio turnover, the maturity of investment purchases and sales related to "rollover" transactions of Adjustable Portfolio is considered to be less than 12 months. See "Special Investment Methods--When-Issued Securities" in the Prospectus. The portfolio turnover rate is not expected to exceed 100% for Adjustable Portfolio, although the turnover rate will not be a limiting factor when management deems portfolio changes appropriate. -6- INVESTMENT RESTRICTIONS In addition to the investment objectives and policies set forth in the Prospectus, each Fund is subject to certain investment restrictions, as set forth below, which may not be changed without the vote of a majority of a Fund's outstanding shares. "Majority," as used in the Prospectus and in this Statement of Additional Information, means the lesser of (a) 67% of a Fund's outstanding shares present at a meeting of the holders if more than 50% of the outstanding shares are present in person or by proxy or (b) more than 50% of a Fund's outstanding shares. Unless otherwise specified below, neither Fund will: 1. With respect to 75% of its total assets, invest more than 5% of the value of its total assets in the securities of any one issuer or own more than 10% of the outstanding voting securities of any one issuer, in each case other than securities issued or guaranteed by the U.S. Government or any agency or instrumentality thereof and securities of other investment companies. 2. Invest 25% or more of the value of its total assets in the securities of issuers conducting their principal business activities in any one industry. This restriction does not apply to securities of the U.S. Government or its agencies and instrumentalities and repurchase agreements relating thereto or to obligations of U.S. banks, domestic branches thereof and U.S. branches of foreign banks subject to United States regulation. The various types of utilities companies, such as gas, electric, telephone, telegraph, satellite and microwave communications companies, are considered as separate industries. 3. Issue any senior securities (as defined in the 1940 Act), other than as set forth in restriction number 4 below and except to the extent that using options, forward foreign currency exchange contracts, futures contracts and options on futures contracts, purchasing or selling securities on a when-issued or forward commitment basis or using similar investment strategies may be deemed to constitute issuing a senior security. 4. Borrow money (provided that either of the Funds may enter into reverse repurchase agreements) except from banks for temporary or emergency purposes. Each Fund may borrow money in an amount up to one-third of the value of its total assets in order to meet redemption requests without immediately selling any of its portfolio securities. If, for any reason, the current value of the Fund's total assets falls below an amount equal to three times the amount of its indebtedness from money borrowed, the Fund will, within three business days, reduce its indebtedness to the extent necessary. Neither Fund will purchase portfolio securities while outstanding borrowings (other than reverse repurchase agreements) exceed 5% of the value of the Fund's total assets. Neither Fund will borrow money for leverage purposes (provided that each Fund may enter into reverse repurchase agreements for such purposes). 5. Mortgage, pledge or hypothecate its assets except to secure permitted indebtedness. For purposes of this policy, collateral arrangements for margin -7- deposits on forward foreign currency exchange contracts, futures contracts and options on futures contracts, with respect to the writing of options, with respect to reverse repurchase agreements or with respect to similar investment techniques are not deemed to be a pledge or hypothecation of assets. 6. Purchase any securities on margin except to obtain such short-term credits as may be necessary for the clearance of transactions and except that Adjustable Portfolio may make margin deposits in connection with permitted transactions in options, forward foreign currency exchange contracts, futures contracts, options on futures contracts and similar investment techniques. 7. Write, purchase or sell puts, calls or combinations thereof, provided that Money Market Fund may purchase securities with demand or put features and, except that Adjustable Portfolio may write put and call options with respect to the securities in which it may invest; may purchase put and call options; and may engage in financial futures contracts and related options transactions. 8. Purchase or sell commodities or commodity futures contracts except that Adjustable Portfolio may do so for hedging purposes. 9. Purchase or sell real estate or real estate mortgage loans, except that the Funds may invest in securities secured by real estate or interests therein (including ARMS, other Mortgage-Backed Securities and similar securities) or issued by companies that invest in real estate or interests therein. 10. Act as an underwriter of securities of other issuers, except insofar as a Fund may be technically deemed an underwriter under the federal securities laws in connection with the disposition of portfolio securities. 11. Make loans of money or property to any person, except for loans of portfolio securities and except through the use of repurchase agreements or the purchase of debt obligations in which such Fund may invest consistently with the Fund's investment objective and policies. In addition, as non-fundamental investment restrictions that may be changed at any time without shareholder approval, neither Fund will: (a) Invest more than 5% of the value of its total assets in the securities of any issuers which, with their predecessors, have a record of less than three years' continuous operation. (Securities of such issuers will not be deemed to fall within this limitation if they are guaranteed by an entity in continuous operation for more than three years. The value of all securities issued or guaranteed by such guarantor and owned by a Fund shall not exceed 10% of the value of the total assets of such Fund.) (b) Make short sales of securities. (c) Purchase or retain the securities of any issuer if, to the Fund's knowledge, those officers or directors of the Company or its affiliates or of its investment -8- adviser who individually own beneficially more than 0.5% of the outstanding securities of such issuer, together own more than 5% of such outstanding securities. (d) Invest for the purpose of exercising control or management. (e) Purchase or sell oil, gas or mineral leases or interests in oil, gas or other mineral exploration or development programs. (f) Invest in the securities of other investment companies except as part of a merger, consolidation or acquisition of assets, except that Adjustable Portfolio may invest in money market funds to the extent permitted by the 1940 Act. (g) Invest more than 15% of its net assets, with respect to Adjustable Portfolio, or 10% of its net assets, with respect to Money Market Fund, in illiquid securities. (h) Invest in real estate limited partnerships. (i) Invest more than 5% of its net assets in warrants, valued at the lower of cost or market. Included within this amount, but not to exceed 2% of the value of a Fund's net assets, may be warrants which are not listed on the New York or American Stock Exchange. For purposes of this investment restriction, warrants acquired by a Fund in units or attached to securities may be deemed to be without value. Any investment restriction or limitation referred to above or in the Prospectus, except the borrowing policy, which involves a maximum percentage of securities or assets, shall not be considered to be violated unless an excess over the percentage occurs immediately after an acquisition of securities or utilization of assets and such excess results therefrom. DIRECTORS AND EXECUTIVE OFFICERS The names, addresses and principal occupations during the past five years of the directors and executive officers of the Company are given below. The officers and directors of the Company also serve as officers and directors of various closed- and open-end investment companies managed by the Adviser. Name and Address Position with the Company ---------------- ------------------------- William H. Ellis* Chairman of the Board of Directors Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 David T. Bennett Director 3400 City Center 33 South Sixth Street Minneapolis, Minnesota 55402 -9- Name and Address Position with the Company ---------------- ------------------------- Jaye F. Dyer Director 4670 Norwest Center 90 South Seventh Street Minneapolis, Minnesota 55402 Karol D. Emmerich Director 7302 Claredon Drive Edina, Minnesota 55439 Luella G. Goldberg Director 7019 Tupa Drive Edina, Minnesota 55435 George Latimer Director 754 Linwood Avenue St. Paul, MN 55105 Paul A. Dow President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 David E. Rosedahl Secretary Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Charles N. Hayssen Treasurer Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Robert H. Nelson Senior Vice President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Nancy S. Olsen Senior Vice President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Thomas S. McGlinch Vice President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 -10- John Schonberg Vice President Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 - - - ------------------ * Directors of the Company who are interested persons (as that term is defined by the 1940 Act) of Piper Capital Management Incorporated and the Funds. William H. Ellis has been President of Piper Jaffray Companies Inc. and Piper Jaffray Inc. (the "Distributor") since September 1982, Chief Operating Officer of the same two companies since August 1983, Director and Chairman of the Board of Piper Capital Management Incorporated ("the Adviser") since October 1985 and President of the Adviser since December 1994. David T. Bennett is of counsel to the law firm of Gray, Plant, Mooty, Mooty & Bennett, P.A., located in Minneapolis, Minnesota. Mr. Bennett is chairman of a group of privately held companies and serves on the board of directors of a number of nonprofit organizations. Jaye F. Dyer has been President of Dyer Management Company, a private management company, since January 1991. Prior to that he was President and Chief Executive Officer of Dyco Petroleum Corporation, a Minneapolis based oil and natural gas development company he founded, from 1971 to March 1, 1989, and Chairman of the Board until December 31, 1990. Mr. Dyer serves on the board of directors of Northwestern National Life Insurance Company, The ReliaStar Financial Corp. (the holding company of Northwestern National Life Insurance Company) and various privately held and nonprofit corporations. Karol D. Emmerich has been President of The Paraclete Group, a consultant to nonprofit organizations, since 1993. Prior to that she had been Vice President, Chief Accounting Officer and Treasurer of Dayton Hudson Corporation from 1980 to May 1993. Ms. Emmerich is an Executive Fellow at the University of St. Thomas Graduate School of Business and serves on the board of directors of a number of privately held and nonprofit organizations. Luella G. Goldberg has served on the board of directors of Northwestern National Life Insurance Company (since 1976), The ReliaStar Financial Corp. (since 1989), TCF Financial Corporation (since 1988), the holding company of TCF Bank Savings fsb, and Hormel Foods Corp. (since 1993). Ms. Goldberg also serves as a Trustee of Wellesley College, and as a director of a number of other organizations, including the University of Minnesota Foundation and the Minnesota Orchestral Association. Ms. Goldberg was Chairman of the Board of Trustees of Wellesley College from 1985 to 1993 and acting President from July 1, 1993 to October 1, 1993. George Latimer is Director, Special Actions Office, Office of the Secretary, Department of Housing and Urban Development since 1993, prior to which he had been Dean of Hamline Law School, Saint Paul, Minnesota from 1990 to 1993. Mr. Latimer also serves on the board of directors of Digital Biometrics, Inc. and Payless Cashways, Inc. -11- Paul A. Dow has been a Senior Vice President of the Adviser since 1989 and Chief Investment Officer of the Adviser since 1989. David E. Rosedahl has been Secretary and a Director of the Adviser since 1985, a Managing Director of the Distributor since 1986, a Managing Director of Piper Jaffray Companies Inc. since 1987, Secretary of the Distributor since 1993 and General Counsel for the Distributor and Piper Jaffray Companies Inc. since 1979. Charles N. Hayssen has been a Managing Director of the Distributor since 1986 and of Piper Jaffray Companies Inc. since 1987, Chief Financial Officer of the Distributor since 1988, Director and Chief Financial Officer of the Adviser since 1989 and Chief Operating Officer of the Adviser since 1994. Robert H. Nelson has been a Senior Vice President of the Adviser since November 1993, prior to which he had been a Vice President of the Adviser from 1991 to 1993 and Assistant Vice President from 1989 to 1991. Nancy S. Olsen has been a Senior Vice President of the Adviser since November 1991, prior to which she had been a Vice President of the Adviser from 1987 to 1991. Mr. McGlinch has been a Vice President of the Adviser since November 1992, prior to which he had been a specialty products trader at FBS Investment Services from January 1990 to January 1992. Mr. Schonberg has been a Vice President of the Adviser since November 1992 and a portfolio manager for the Adviser since July 1989. Ms. Goldberg, Ms. Emmerich and Mr. Dyer are members of the Company's Audit Committee. Ms. Goldberg acts as the chairperson of such committee. The Audit Committee oversees the Funds' financial reporting process, reviews audit results and recommends annually to the Company a firm of independent certified public accountants. The functions to be performed by the Audit Committee are to recommend annually to the Board a firm of independent certified public accountants to audit the books and records of the Funds for the ensuing year; to monitor that firm's performance; to review with the firm the scope and results of each audit and determine the need, if any, to extend audit procedures; to confer with the firm and representatives of the Funds on matters concerning the Funds' financial statements and reports including the appropriateness of its accounting practices and of its financial controls and procedures; to evaluate the independence of the firm; to review procedures to safeguard portfolio securities; to review the purchase by the Funds from the firm of non-audit services; to review all fees paid to the firm; and to facilitate communications between the firm and the Funds' officers and Directors. The Board of Directors also has a Committee of the Independent Directors, consisting of Mr. Bennett, who serves as chairperson, Messrs. Dyer, and Latimer, Ms. -12- Emmerich and Ms. Goldberg, and a Derivatives Committee consisting of Ms. Emmerich, who serves as chairperson, Ms. Goldberg and Mr. Dyer. The functions of the Committee of the Independent Directors are: (a) recommendation to the full Board of approval of any management, advisory, sub-advisory and/or administration agreements; (b) recommendation to the full Board of approval of any underwriting and/or distribution agreements; (c) review of the fidelity bond and premium allocation; (d) review of errors and omissions and any other joint insurance policies and premium allocation; (e) review of, and monitoring of compliance with, procedures adopted pursuant to certain rules promulgated under the 1940 Act; and (f) such other duties as the independent directors shall, from time to time, conclude are necessary or appropriate to carry out their duties under the 1940 Act. The functions of the Derivatives Committee are: (a) to oversee practices, policies and procedures of the Adviser in connection with the use of derivatives; (b) to receive periodic reports from management and independent accountants; and (c) to report periodically to the Committee of the Independent Directors and the Board of Directors. The directors of the Company who are officers or employees of the Adviser or any of its affiliates receive no remuneration from the Company. Each of the other directors receives fees that are allocated among the series of the Company on the basis of the total assets of each series. Each director receives from the Company and Piper Funds Inc., collectively, an annual retainer of $1,000, plus a fee of $250 for each regular quarterly Board of Directors meeting attended. (The per-meeting fee is based on the total assets of the Company and Piper Funds Inc. and will increase to $500 per meeting in the event total assets exceed $200 million, with continuing increases to as high as $1,500 per meeting in the event total assets reach $5 billion or more. In addition, members of the Audit Committee not affiliated with the Adviser receive $1,000 for each Audit Committee meeting attended ($2,000 with respect to the chairperson of the Committee), with such fee being allocated among all open-end and closed-end investment companies managed by the Adviser. Members of the Committee of the Independent Directors and the Derivatives Committee currently receive no additional compensation. Directors are also reimbursed for expenses incurred in connection with attending meetings. The following table sets forth the aggregate compensation received by each director from the Company during the fiscal year ended June 30, 1995, as well as the total compensation received by each director from the Company and all other registered investment companies managed by the Adviser or affiliates of the Adviser during the calendar year ended December 31, 1994. Directors who are officers or employees of the Adviser or any of its affiliates did not receive any such compensation and are not included in the table. -13-
Pension or Retirement Estimated Total Aggregate Benefits Annual Benefits Compensation Compensation Accrued as Part Upon from Fund Director from the Company of Fund Expenses Retirement Complex* - - - -------- ---------------- ---------------- ---------------- ------------- David T. Bennett $1,200 None None $57,500 Jaye F. Dyer $1,358 None None $68,250 Karol D. Emmerich $1,358 None None $68,250 Luella G. Goldberg $1,516 None None $71,250 George Latimer $1,200 None None $65,250
- - - ----------------- * Consists of 21 registered investment companies managed by the Adviser or an affiliate of the Adviser, including Piper Institutional. Each director included in the table, other than Mr. Bennet, serves on the board of each such registered investment company. Mr. Bennett serves on the board of 20 such companies. INVESTMENT ADVISORY AND OTHER SERVICES GENERAL The investment adviser for the Funds is Piper Capital Management Incorporated (the "Adviser"). Its affiliate, Piper Jaffray Inc. (the "Distributor"), acts as the Funds' distributor. Each acts as such pursuant to a written agreement which is periodically approved by the directors or the shareholders of the Funds. The address of both the Adviser and the Distributor is Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402-3804. CONTROL OF THE ADVISER AND THE DISTRIBUTOR The Adviser and the Distributor are both wholly owned subsidiaries of Piper Jaffray Companies Inc., a publicly held corporation which is engaged through its subsidiaries in various aspects of the financial services industry. INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT The Adviser acts as the investment adviser of the Funds under an Investment Advisory and Management Agreement which has been approved by the Board of Directors (including a majority of the directors who are not parties to the agreement, or interested persons of any such party, other than as directors of the Company) and the initial shareholder of the Company. The Investment Advisory and Management Agreement will terminate automatically in the event of its assignment. In addition, the agreement is terminable at any time, without penalty, by the Board of Directors or by vote of a majority of the Company's outstanding voting securities on not more than 60 days' written notice to the Adviser, and by the Adviser on 60 days' written notice to the Company. The agreement may be terminated with respect to a particular Fund at any time by a vote of the holders of a majority of the outstanding voting securities of such Fund, upon 60 days' written notice to the Adviser. Unless sooner terminated, the agreement shall continue in effect for more than two years after its -14- execution only so long as such continuance is specifically approved at least annually by either the Board of Directors or by a vote of a majority of the outstanding voting securities of the Company, provided that in either event such continuance is also approved by a vote of a majority of the directors who are not parties to such agreement, or interested persons of such parties, cast in person at a meeting called for the purpose of voting on such approval. If a majority of the outstanding voting securities of any series of the Company approves the agreement, the agreement shall continue in effect with respect to such approving series whether or not the shareholders of the other series approve the agreement. Pursuant to the Investment Advisory and Management Agreement, Money Market Fund and Adjustable Portfolio pay the Adviser monthly advisory fees equal on an annual basis to .15% and .30%, respectively, of the Fund's average daily net assets. The advisory fees paid by Money Market Fund for the fiscal period from February 2, 1993 (commencement of operations) through June 30, 1993 and for the fiscal years ended June 30, 1994 and 1995 and were $18,155, $44,077 and $51,262, respectively. The fees paid by Adjustable Portfolio for the fiscal period from February 2, 1993 (commencement of operations) through June 30, 1993 and for the fiscal years ended June 30, 1994 and 1995 were $37,934, $165,558 and $70,330, respectively. Although not required under the Investment Advisory and Management Agreement, the Adviser voluntarily agreed, for the fiscal year ended June 30, 1995, to reimburse Money Market Fund and Adjustable Portfolio to the extent that total operating expenses (including the Adviser's compensation but excluding interest, taxes, brokerage fees and commissions and extraordinary expenses) exceeded .35% and .55% per annum, respectively, of average daily net assets. Voluntary fee waivers and reimbursements by the Adviser may be discontinued at any time following the Funds' fiscal year end, at the Adviser's discretion. For the fiscal year ending June 30, 1996, the Adviser intends to reimburse Money Market Fund and Adjustable Portfolio for all expenses in excess of .35% and .60%, respectively. Even in the event of discontinuance of this arrangement, the Funds will still be subject to the laws of certain states, which require that if a mutual fund's expenses (including advisory fees but excluding interest, taxes, brokerage commissions and extraordinary expenses) exceed certain percentages of average net assets, the fund must be reimbursed for such excess expenses. The Investment Advisory and Management Agreement provides that the Adviser must make any expense reimbursements to the Funds required under state law. The laws of California provide that aggregate annual expenses of a mutual fund shall not normally exceed 2-1/2% of the first $30 million of the average net assets, 2% of the next $70 million of the average net assets and 1-1/2% of the remaining average net assets. Such expenses include the Adviser's compensation, but exclude interest, taxes, brokerage fees and commissions and extraordinary expenses. The Adviser does not believe that the laws of any other state in which the Funds' shares may be offered for sale contain expense reimbursement requirements. Under the Investment Advisory and Management Agreement, the Adviser provides each Fund with advice and assistance in the selection and disposition of that Fund's investments. All investment decisions are subject to review by the -15- Company's Board of Directors. The Adviser is obligated to pay the salaries and fees of any affiliates of the Adviser serving as officers or directors of the Company. The same security may be suitable for both of the Funds and/or for other funds or private accounts managed by the Adviser or its affiliates. If and when two or more funds or accounts simultaneously purchase or sell the same security, the transactions will be allocated as to price and amount in accordance with arrangements equitable to each fund or account. The simultaneous purchase or sale of the same securities by both Funds or by either of the Funds and other funds or accounts managed by the Adviser or its affiliates may have a detrimental effect on a Fund, as this may affect the price paid or received by that Fund or the size of the position obtainable or able to be sold by that Fund. EXPENSES The expenses of each Fund are deducted from their total income before dividends are paid. These expenses include, but are not limited to, organizational costs, fees paid to the Adviser, fees and expenses of officers and directors who are not affiliated with the Adviser, taxes, interest, legal fees, transfer agent, dividend disbursing agent and custodian fees, audit fees, brokerage fees and commissions, fees and expenses of registering and qualifying the Funds and their shares for distribution under federal and state securities laws, expenses of preparing prospectuses and statements of additional information and of printing and distributing prospectuses and statements of additional information annually to existing shareholders, the expenses of reports to shareholders, shareholders' meetings and proxy solicitations and other expenses which are not expressly assumed by the Adviser under the Investment Advisory and Management Agreement. Any general expenses of the Company that are not readily identifiable as belonging to a particular Fund will be allocated between the Funds based upon the relative net assets of the Funds at the time such expenses were accrued. DISTRIBUTION PLAN Rule 12b-1(b) under the 1940 Act provides that any payments made by a fund in connection with financing the distribution of its shares may only be made pursuant to a written plan describing all aspects of the proposed financing of distribution. The Company had adopted a Distribution Plan for Adjustable Portfolio in accordance with such Rule; however, the plan was terminated by the Board of Directors on June 2, 1993 (effective June 24, 1993). The amount paid by the Fund pursuant to this plan from February 2, 1993 (commencement of operations) to June 24, 1993 was $23,771. UNDERWRITING AND DISTRIBUTION AGREEMENT Pursuant to an Underwriting and Distribution Agreement, the Distributor has agreed to act as the principal underwriter for the Funds in the sale and distribution to the public of shares of the Funds, either through dealers or otherwise. The Distributor has agreed to offer such shares for sale at all times when such shares are available for sale and may lawfully be offered for sale and sold. As -16- compensation for its services, the Distributor receives the sales load on sales of Adjustable Portfolio shares set forth in the Prospectus. For the period from February 2, 1993 (commencement of operations) through June 30, 1993 and for the fiscal years ended June 30, 1994 and 1995, Adjustable Portfolio paid $4,383, $54,430 and $0, respectively in sales charges to the Distributor. The Distributor receives no compensation from the Fund for its sales of Money Market Fund shares. TRANSFER AGENT AND DIVIDEND DISBURSING AGENT Investors Fiduciary Trust Company ("IFTC"), the transfer agent for the Company, maintains certain omnibus shareholder accounts for each Fund. Each such omnibus account represents the accounts of a number of individual shareholders of the Fund. The Company has entered into a Shareholder Account Servicing Agreement with the Distributor, pursuant to which the Distributor provides certain transfer agent and dividend disbursing agent services for the underlying individual shareholder accounts. Pursuant to such Agreement, the Distributor has agreed to perform the usual and ordinary services of transfer agent and dividend disbursing agent not performed by IFTC with respect to the underlying individual shareholder accounts, including, without limitation, the following: maintaining all shareholder accounts, preparing shareholder meeting lists, mailing shareholder reports and prospectuses, tracking shareholder accounts for blue sky and Rule l2b-1 purposes, withholding taxes on nonresident alien and foreign corporation accounts, preparing and mailing checks for disbursement of income dividends and capital gains distributions, preparing and filing U.S. Treasury Department Form 1099 for all shareholders, preparing and mailing confirmation forms to shareholders and dealers with respect to all purchases, exchanges and liquidations of series shares and other transactions in shareholder accounts for which confirmations are required, recording reinvestments of dividends and distributions in series shares, recording redemptions of series shares, and preparing and mailing checks for payments upon redemption and for disbursements to withdrawal plan holders. As compensation for such services, the Distributor is paid an annual fee of $9.00 per active shareholder account for the Money Market Fund and $7.50 per active account for the Adjustable Portfolio. The Distributor is paid an annual fee of $6.00 per inactive account (defined as an account that has a balance of shares in a Fund but that does not require a client statement for the current month) for the Money Market Fund and $7.50 per inactive account for the Adjustable Portolio. There is no charge for a closed shareholder account (defined as an account that has been inactive for at least three consecutive months). Such fee is payable on a monthly basis at a rate of 1/12 of the annual per-account charge. Such fee covers all services listed above, with the exception of preparing shareholder meeting lists and mailing shareholder reports and prospectuses. These services, along with proxy processing (if applicable) and other special service requests, are billable as performed at a mutually agreed upon fee in addition to the annual fee noted above, provided that such mutually agreed upon fee shall be fair and reasonable in light of the usual and customary charges made by others for services of the same nature and quality. The Agreement was in effect for a portion of the fiscal year ended June 30, 1995. Fees paid during the fiscal year ended June 30, 1995 were $211 for Adjustable Portfolio and $256 for Money Market Fund. -17- PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE The Adviser is responsible for decisions to buy and sell securities for the Funds, the selection of broker-dealers to effect the transactions and the negotiation of brokerage commissions, if any. In placing orders for securities transactions, the primary criterion for the selection of a broker-dealer is the ability of the broker-dealer, in the opinion of the Adviser, to secure prompt execution of the transactions on favorable terms, including the reasonableness of the commission and considering the state of the market at the time. When consistent with these objectives, business may be placed with broker-dealers who furnish investment research or services to the Adviser. Such research or services include advice, both directly and in writing, as to the value of securities; the advisability of investing in, purchasing or selling securities; and the availability of securities, or purchasers or sellers of securities; as well as analyses and reports concerning issues, industries, securities, economic factors and trends, portfolio strategy and the performance of accounts. This allows the Adviser to supplement its own investment research activities and enables the Adviser to obtain the views and information of individuals and research staffs of many different securities firms prior to making investment decisions for the Funds. To the extent portfolio transactions are effected with broker-dealers who furnish research services to the Adviser, the Adviser receives a benefit, not capable of evaluation in dollar amounts, without providing any direct monetary benefit to the Funds from these transactions. The Adviser believes that most research services obtained by it generally benefit several or all of the investment companies and private accounts which it manages, as opposed to solely benefiting one specific managed fund or account. Normally, research services obtained through managed funds or accounts investing in common stocks would primarily benefit the managed funds or accounts which invest in common stock; similarly, services obtained from transactions in fixed-income securities would normally be of greater benefit to the managed funds or accounts which invest in debt securities. The Funds will not purchase at a higher price or sell at a lower price in connection with transactions effected with a dealer, acting as principal, who furnishes research services to the Adviser than would be the case if no weight were given by the Adviser to the dealer's furnishing of such services. The Adviser has not entered into any formal or informal agreements with any broker-dealers, nor does it maintain any "formula" which must be followed in connection with the placement of the Funds' portfolio transactions in exchange for research services provided the Adviser, except as noted below. However, the Adviser does maintain an informal list of broker-dealers, which is used from time to time as a general guide in the placement of the Funds' business, in order to encourage certain broker-dealers to provide the Adviser with research services which the Adviser anticipates will be useful to it. Because the list is merely a general guide, which is to be used only after the primary criterion for the selection of broker-dealers (discussed above) has been met, substantial deviations from the list are permissible and may be expected to occur. The Adviser will authorize the Funds to pay an amount of commission for effecting a securities transaction in excess of the amount of commission another broker-dealer would have charged only if the -18- Adviser determines in good faith that such amount of commission is reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either that particular transaction or the Adviser's overall responsibilities with respect to the accounts as to which it exercises investment discretion. Generally, the Funds pay higher than the lowest commission rates available. Portfolio transactions for the Funds, including transactions in futures contracts and options thereon, may be effected through the Distributor. In determining the commissions to be paid to the Distributor in connection with transactions effected on a securities exchange, it is the policy of the Funds that such commissions will, in the judgment of the Adviser, subject to review by the Board of Directors, be both (a) at least as favorable as those which would be charged by other qualified brokers or futures commission merchants in connection with comparable transactions involving similar securities or similar futures contracts or options on futures contracts being purchased or sold on an exchange during a comparable period of time, and (b) at least as favorable as commissions contemporaneously charged by the Distributor on comparable transactions for its most favored comparable unaffiliated customers. While the Funds do not deem it practicable and in their best interest to solicit competitive bids for commission rates on each transaction, consideration will regularly be given to posted commission rates as well as to other information concerning the level of commissions charged on comparable transactions by other qualified brokers and futures commission merchants. Money Market Fund did not pay any brokerage commissions and Adjustable Portfolio paid brokerage commissions of $5,185 for the period from February 2, 1993 (commencement of operations) through June 30, 1993. For the fiscal year ending June 30, 1994, Money Market Fund did not pay any brokerage commissions and Adjustable Portfolio paid brokerage commissions of $20,188. For the fiscal year ending June 30, 1995, Money Market Fund did not pay any brokerage commissions and Adjustable Portfolio paid total brokerage commissions of $2,975 from which $2,550 was paid to Piper Jaffray Inc., an affiliate of the Fund and the Adviser. From time to time the Funds may acquire the securities of their regular brokers or dealers or affiliates of such brokers or dealers. As of June 30, 1995, Money Market Fund held securities issued by Federal National Mortgage Association in the amount of $7,369,104 and Adjustable Portfolio did not hold any such securities. During the fiscal year ended June 30, 1995, Money Market Fund purchased securities issued by Federal National Mortgage Association, Goldman Sachs and Lehman Brothers and Adjustable Portfolio did not purchase any such securities. CAPITAL STOCK AND OWNERSHIP OF SHARES Each Fund's shares of common stock have a par value of $.01 per share, and have equal rights to share in dividends and assets. The shares possess no preemptive or conversion rights. Cumulative voting is not authorized. This means that the holders of more than 50% of the shares voting for the election of directors can elect 100% of the directors if they choose to do so, and in such event the holders of the remaining shares will be unable to elect any directors. -19- As of October 16, 1995, no shareholders were beneficial owners of 5% or more of the outstanding shares of Money Market Fund. As of October 16, 1995, the following shareholders were beneficial owners of 5% or more of the outstanding shares of Adjustable Portfolio: St. Louis Park Methodist Hospital, Attn: Janis Williams, 6th & Marquette, Minneapolis, MN (13.6%); Fairview Hospital & Health Care Service General Fund, Attn: Katrina Jaworski, 2312 S. 6th Street, Minneapolis, MN (7.2%); Hitchcock Industries, 8701 Harriet Ave, Bloomington, MN (20.3%) and Helath Care Group Self Insurance Association, Berkley Administrators, Trust Account No. 7, P.O. Box 59143, Minneapolis, MN (10.2%). The Funds' officers and directors as a group owned less than 1% of the outstanding shares of each Fund as of such date. NET ASSET VALUE AND PUBLIC OFFERING PRICE The method for determining the public offering price of Fund shares is summarized in the Prospectus in "Purchase of Shares -- Public Offering Price" and "Valuation of Shares." The net asset value of each Fund's shares is determined on each day on which the New York Stock Exchange is open, provided that the net asset value need not be determined on days when no Fund shares are tendered for redemption and no order for Fund shares is received. The New York Stock Exchange is not open for business on the following holidays (or on the nearest Monday or Friday if the holiday falls on a weekend): New Year's Day, Presidents' Day, Good Friday, Memorial Day, July 4th, Labor Day, Thanksgiving and Christmas. Money Market Fund values its portfolio securities at amortized cost in accordance with Rule 2a-7 under the 1940 Act. This method involves valuing an instrument at its cost and thereafter assuming a constant amortization to maturity of any discount or premium, regardless of the impact of fluctuations in interest rates on the market value of the instrument and regardless of any unrealized capital gains or losses. While this method provides certainty in valuation, it may result in periods during which value, as determined by amortized cost, is higher or lower than the price the Fund would receive if it sold the instrument. During periods of declining interest rates, the daily yield on shares of the Fund computed by dividing the annualized daily income of the Fund by the net asset value computed as described above may tend to be higher than a like computation made by the Fund with identical investments utilizing a method of valuation based upon market prices and estimates of market prices for all of its securities. Pursuant to Rule 2a-7, the Board of Directors of the Company has determined, in good faith based upon a full consideration of all material factors, that it is in the best interests of Money Market Fund and its shareholders to maintain a stable net asset value per share by virtue of the amortized cost method of valuation. Money Market Fund will continue to use this method only so long as the Board of Directors believes that it fairly reflects the market-based net asset value per share. In accordance with Rule 2a-7, the Board of Directors has undertaken, as a particular responsibility within the overall duty of care owed to Fund shareholders, to establish procedures reasonably designed, taking into account current market conditions and Money Market Funds' investment objectives, to stabilize such Fund's net asset value per share at a single value. These procedures include the periodic determination of any deviation of current net asset value per share, calculated using available market quotations, from such Fund's amortized cost price -20- per share, the periodic review by the Board of the amount of any such deviation and the method used to calculate any such deviation, the maintenance of records of such determinations and the Board's review thereof, the prompt consideration by the Board if any such deviation exceeds 1/2 of 1%, and the taking of such remedial action by the Board as it deems appropriate where it believes the extent of any such deviation may result in material dilution or other unfair results to investors or existing shareholders. Such remedial action may include redemptions in kind, selling portfolio instruments prior to realizing capital gains or losses, shortening the average portfolio maturity, withholding dividends or utilizing a net asset value per share as determined by using available market quotations. Money Market Fund will, in further compliance with Rule 2a-7, maintain a dollar-weighted average portfolio maturity appropriate to its objective of maintaining a stable net asset value and not exceeding 90 days, will not purchase any instrument with a remaining maturity of greater than 397 calendar days, will limit its portfolio investments to those U.S. dollar-denominated instruments which the Board determines present minimal credit risks and which are at the time of acquisition Eligible Securities (as defined in Rule 2a-7), and will record, maintain and preserve a written copy of the above-described procedures and a written record of the Board's considerations and actions taken in connection with the discharge of its above-described responsibilities. On June 30, 1995, the net asset value per share of the Funds was calculated as follows: MONEY MARKET FUND Net Assets ($52,488,862) = Net Asset Value per Share ($1.00) --------------------------------- Shares Outstanding (52,488,862) ADJUSTABLE PORTFOLIO Net Assets ($14,969,773) = Net Asset Value per Share ($9.44) -------------------------------- Shares Outstanding (1,585,696) PERFORMANCE COMPARISONS Advertisements and other sales literature for Adjustable Portfolio may refer to "yield," "average annual total return" and "cumulative total return." Average annual total return figures are computed by finding the average annual compounded rates of return over the periods indicated in the advertisement that would equate the initial amount invested to the ending redeemable value, according to the following formula: n P(1+T) = ERV Where: P = a hypothetical initial payment of $1,000 T = average annual total return; n = number of years; and -21- ERV = ending redeemable value at the end of the period of a hypothetical $1,000 payment made at the beginning of such period. This calculation deducts the maximum sales charge from the initial hypothetical $1,000 investment, assumes all dividends and capital gains distributions are reinvested at net asset value on the appropriate reinvestment dates as described in the Prospectus, and includes all recurring fees, such as investment advisory and management fees, charged to all shareholder accounts. The average annual total return for Adjustable Portfolio was 4.21% for the one-year period ended June 30, 1995 and 2.26% for the period from February 2, 1993 (commencement of operations) to June 30, 1995. The Adviser has waived or paid certain expenses of the Fund, thereby increasing total return and yield. These expenses may or may not be waived or paid in the future in the Adviser's discretion. Absent any voluntary expense payments or waivers, the average annual total returns would have been 4.17% and 2.22%, respectively. Cumulative total return is computed by finding the cumulative compounded rate of return over the period indicated in the advertisement that would equate the initial amount invested to the ending redeemable value, according to the following formula: CTR = (ERV-P) 100 ----- P Where: CTR = Cumulative total return; ERV = ending redeemable value at the end of the period of a hypothetical $1,000 payment made at the beginning of such period; and P = initial payment of $1,000. This calculation assumes all dividends and capital gain distributions are reinvested at net asset value on the appropriate reinvestment dates as described in the Prospectus and includes all recurring fees, such as investment advisory and management fees, charged to all shareholder accounts. The cumulative total return for Adjustable Portfolio from inception (February 2, 1993) to June 30, 1995 was 5.52%. Absent any voluntary expense payments or waivers, the cumulative total return would have been 5.48%. Adjustable Portfolio may issue yield quotations. Yield is computed by dividing the net investment income per share (as defined under Securities and Exchange Commission rules and regulations) earned during the computation period by the maximum offering price per share on the last day of the period (based on a 30-day or one month period), according to the following formula: -22- YIELD = 2 [ (a-b + 1) 6 - 1] --- c-d Where: a = dividends and interest earned during the period; b = expenses accrued for the period ( net of reimbursements); c = the average daily number of shares outstanding during the period that were entitled to receive dividends; and d = the maximum offering price per share on the last day of the period. The yield for Adjustable Portfolio for the 30-day period ended June 30, 1995 was 6.31%. Absent any voluntary expense payments or waivers, the 30-day yield would have been 6.11%. Money Market Fund may issue current yield quotations. Simple yields are computed by determining the net change, exclusive of capital changes, in the value of a hypothetical pre-existing account having a balance of one share at the beginning of a recent seven calendar day period, subtracting a hypothetical charge reflecting deductions from shareholder accounts, and dividing the difference by the value of the account at the beginning of the base period to obtain the base period return, and then multiplying the base period return by 365/7. The resulting yield figure will be carried to at least the nearest hundredth of one percent. Effective yields are computed by determining the net change, exclusive of capital changes, in the value of a hypothetical pre-existing account having a balance of one share at the beginning of a recent seven calendar day period, subtracting a hypothetical charge reflecting deductions from shareholder accounts, and dividing the difference by the value of the account at the beginning of the base period to obtain the base period return, and then compounding the base period return by adding 1, raising the sum to a power equal to 365 divided by 7, and subtracting 1 from the result, according to the following formula: EFFECTIVE YIELD = [(BASE PERIOD RETURN +1)365/7] -1 The seven-day yield and effective yield for Money Market Fund as of June 30, 1995 were 5.67% and 5.83%, respectively. Absent any voluntary expense payments or waivers, the seven-day yield and effective yield would have been 5.53% and 5.69%, respectively. When calculating the foregoing yield or effective yield quotations, the calculation of net change in account value will include the value of additional shares purchased with dividends from the original share and dividends declared on both the original share and any such additional shares, and all fees, other than nonrecurring accounts or sales charges, that are charged to all shareholder accounts in proportion to the length of the base period. Realized gains and losses from the sale of securities and unrealized appreciation and depreciation are excluded from the calculation of yield and effective yield. -23- In addition to advertising total return and yield, comparative performance information may be used from time to time in advertising the Funds' shares. The performance of Money Market Fund may be compared to the performance of the Donoghue Institutional Money Market Fund Index and the performance of Adjustable Portfolio may be compared to the performance of the Merrill Lynch 1-3 Year Governmental Index, the Lipper ARM Fund Average, the Lipper Short-Intermediate Fund Average and the Lehman 1-3 Year Government Index. PURCHASE OF SHARES An investor in Adjustable Portfolio may qualify for a reduced sales charge immediately by signing a nonbinding Letter of Intent stating the investor's intention to invest within a 13-month period, beginning not earlier than 90 days prior to the date of execution of the Letter, a specified amount which, if made at one time, would qualify for a reduced sales charge. Reinvested dividends will be treated as purchases of additional shares. Any redemptions made during the term of the Letter of Intent will be subtracted from the amount of purchases in determining whether the Letter of Intent has been completed. During the term of a Letter of Intent, IFTC will hold shares representing 5% of the amount that the investor intends to invest during the 13-month period in escrow for payment of a higher sales charge if the full amount indicated in the Letter of Intent is not purchased. Dividends on the escrowed shares will be paid to the shareholder. The escrowed shares will be released when the full amount indicated has been purchased. If the full indicated amount is not purchased within the 13-month period, the investor will be required to pay, either in cash or by liquidating escrowed shares, an amount equal to the difference in the dollar amount of sales charge actually paid and the amount of sales charge the investor would have paid on his or her aggregate purchases if the total of such purchases had been made at a single time. REDEMPTION GENERAL Redemption of shares, or payment, may be suspended at times (a) when the New York Stock Exchange is closed for other than customary weekend or holiday closings, (b) when trading on said Exchange is restricted, (c) when an emergency exists, as a result of which disposal by the Funds of securities owned by them is not reasonably practicable, or it is not reasonably practicable for the Funds fairly to determine the value of their net assets, or (d) during any other period when the Securities and Exchange Commission, by order, so permits, provided that applicable rules and regulations of the Securities and Exchange Commission shall govern as to whether the conditions prescribed in (b) or (c) exist. Shareholders who purchased shares through a broker-dealer other than the Distributor may also redeem such shares by written request to IFTC at the address set forth in the Prospectus. To be considered in proper form, written requests for redemption should indicate the dollar amount or number of shares to be redeemed, refer to the shareholder's Fund account number, and give either a social security -24- or tax identification number. The request should be signed in exactly the same way the account is registered. If there is more than one owner of the shares, all owners must sign. If shares to be redeemed have a value of $10,000 or more or redemption proceeds are to be paid to someone other than the shareholder at the shareholder's address of record, the signature(s) must be guaranteed by an "eligible guarantor institution," which includes a commercial bank that is a member of the Federal Deposit Insurance Corporation, a trust company, a member firm of a domestic stock exchange, a savings association or a credit union that is authorized by its charter to provide a signature guarantee. IFTC may reject redemption instructions if the guarantor is neither a member of nor a participant in a signature guarantee program. Signature guarantees by notaries public are not acceptable. The purpose of a signature guarantee is to protect shareholders against the possibility of fraud. Further documentation will be requested from corporations, administrators, executors, personal representatives, trustees and custodians. Redemption requests given by facsimile will not be accepted. Unless other instructions are given in proper form, a check for the proceeds of the redemption will be sent to the shareholder's address of record. SYSTEMATIC WITHDRAWAL PLAN To establish a Systematic Withdrawal Plan for either Fund and receive regular periodic payments, an account must have a value of $5,000 or more. A request to establish a Systematic Withdrawal Plan must be submitted in writing to an investor's Piper Jaffray investment executive or other broker-dealer. There are no service charges for maintenance; the minimum amount that may be withdrawn each period is $100. (This is merely the minimum amount allowed and should not be interpreted as a recommended amount.) The holder of a Systematic Withdrawal Plan will have any income dividends and any capital gains distributions reinvested in full and fractional shares at net asset value. To provide funds for payment, the appropriate Fund will redeem as many full and fractional shares as necessary at the redemption price, which is net asset value. Redemption of shares may reduce or possibly exhaust the shares in your account, particularly in the event of a market decline. As with other redemptions, a redemption to make a withdrawal payment is a sale for federal income tax purposes. Payments made pursuant to a Systematic Withdrawal Plan cannot be considered as actual yield or income since part of such payments may be a return of capital. The maintenance of a Systematic Withdrawal Plan for Adjustable Portfolio concurrent with purchases of additional shares of the Fund would be disadvantageous because of the sales commission involved in the additional purchases. A confirmation of each transaction showing the sources of the payment and the share and cash balance remaining in the account will be sent. The plan may be terminated on written notice by the shareholder or the Fund, and it will terminate automatically if all shares are liquidated or withdrawn from the account or upon the death or incapacity of the shareholder. The amount and schedule of withdrawal payments may be changed or suspended by giving written notice to your Piper -25- Jaffray investment executive or other broker-dealer at least seven business days prior to the end of the month preceding a scheduled payment. TAXATION Each Fund qualified during its last taxable year and intends to qualify each year as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). To qualify as a regulated investment company a Fund must, among other things, receive at least 90% of its gross income each year from dividends, interest, gains from the sale or other disposition of securities and certain other types of income, including income from options and futures contracts. The Code also forbids a regulated investment company from earning 30% or more of its gross income from the sale or other disposition of securities held less than three months. This restriction may limit the extent to which Adjustable Portfolio may purchase futures contracts and options. To the extent such Fund engages in short-term trading and enter into futures and options transactions, the likelihood of violating this 30% requirement is increased. The Code also requires a regulated investment company to diversify its holdings. The Internal Revenue Service has not made its position clear regarding the treatment of futures contracts and options for purposes of the diversification test, and the extent to which Adjustable Portfolio can buy or sell futures contracts and options may be limited by this requirement. If for any taxable year one of the Funds does not qualify as a regulated investment company, all of its taxable income will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the Fund's shareholders as ordinary dividends to the extent of the Fund's current or accumulated earnings and profits. To qualify again as a regulated investment company in a subsequent year the Fund would be required to distribute to shareholders its undistributed earnings and profits and to pay an interest charge on 50% of such earnings and profits. In addition, if immediately after qualifying as a regulated investment company for any taxable year the Fund failed to qualify for a period greater than one taxable year, the Fund would be required to recognize any net built-in gains (the excess of aggregate gains over aggregate losses that would have been realized if it had been liquidated) in order to again qualify as a regulated investment company. Each Fund will be subject to a non-deductible excise tax equal to 4% of the excess, if any, of the amount required to be distributed pursuant to the Code for each calendar year over the amount actually distributed. No amount of such excess, however, will be subject to the excise tax to the extent it is subject to the corporate-level income tax. In order to avoid the imposition of this excise tax, each Fund generally must declare dividends by the end of a calendar year representing 98% of the Fund's ordinary income for the calendar year and 98% of its capital gain net income (both long-term and short-term capital gains) for the 12-month period ending October 31 of the calendar year. -26- Gain or loss on futures contracts and options is taken into account when realized by entering into a closing transaction or by exercise. In addition, with respect to many types of futures contracts and options held at the end of Adjustable Portfolio's taxable year, unrealized gain or loss on such contracts is taken into account at the then current fair market value thereof under a special "marked-to-market, 60/40 system," and such gain or loss is recognized for tax purposes. The gain or loss from such futures contracts and options (including premiums on certain options that expire unexercised) is treated as 60% long-term and 40% short-term capital gain or loss, regardless of their holding period. The amount of any capital gain or loss actually realized by the Fund in a subsequent sale or other disposition of such futures contracts will be adjusted to reflect any capital gain or loss taken into account by the Fund in a prior year as a result of the constructive sale under the "marked-to-market, 60/40 system." Notwithstanding the rules described above, with respect to certain futures contracts, the Fund may make an election that will have the effect of exempting all or a part of those identified futures contracts from being treated for federal income tax purposes as sold on the last business day of the Fund's taxable year. All or part of any loss realized by the Fund on any closing of a futures contract may be deferred until all of the Fund's offsetting positions with respect to the futures contract are closed. Ordinarily, distributions and redemption proceeds earned by a shareholder of either of the Funds are not subject to withholding of federal income tax. However, 31% of a Fund shareholder's distributions and redemption proceeds must be withheld if a Fund shareholder fails to supply the Fund or its agent with such shareholder's taxpayer identification number or if a Fund shareholder who is otherwise exempt from withholding fails to properly document such shareholder's status as an exempt recipient. Corporations are generally exempt from these requirements. Any loss on the sale or exchange of shares of either Fund generally will be disallowed to the extent that a shareholder acquires or contracts to acquire shares of the same Fund within 30 days before or after such sale or exchange. In addition, if a shareholder disposes of shares within 90 days of acquiring such shares and purchases other shares of the Company or of a series of another investment company managed by the Adviser at a reduced sales charge, the shareholder's tax basis for determining gain or loss on the shares which are disposed of is reduced by the lesser of the amount of the sales charge that was paid when the shares disposed of were acquired or the amount by which the sales charge for the new shares is reduced. If a shareholder's tax basis is so reduced, the amount of the reduction is treated as part of the tax basis of the new shares. For federal income tax purposes, Adjustable Portfolio had capital loss carryovers in the amount of $3,291,023 at June 30, 1995, which, if not offset by subsequent capital gains, will expire in 2002-2004. It is unlikely the Board of Directors will authorize a distribution of any net realized capital gains until the available capital loss carryovers have been offset or expired. -27- Interest income from direct investment by noncorporate taxpayers in U.S. Government obligations (but not repurchase agreements) generally is not subject to state taxation. However, certain states attempt to tax mutual fund dividends attributable to such income. This treatment has been challenged in a number of lawsuits. Shareholders are encouraged to consult their tax advisors concerning this matter. GENERAL INFORMATION The Board of Directors may, without shareholder approval, create and issue one or more additional classes of shares within each Fund, as well as within any series of the Company created in the future. All classes of shares in a Fund would be identical except that each class of shares would be available through a different distribution channel and certain classes might incur different expenses for the provision of distribution services or the provision of shareholder services or administration assistance by institutions. Shares of each class would share equally in the gross income of a series, but any variation in expenses would be charged separately against the income of the particular class incurring such expenses. This would result in variations in net investment income accrued and dividends paid by and in the net asset value of the different classes of a series. This ability to create multiple classes of shares within each series of the Company will allow the Company in the future the flexibility to better tailor its methods of marketing, administering and distributing shares of the Funds to the needs of particular investors and to allocate expenses related to such marketing, administration and distribution methods to the particular classes of shareholders of the Fund incurring such expenses. On an issue affecting only a particular series, the shares of the affected series vote separately. An example of such an issue would be a fundamental investment restriction pertaining to only one series. In voting on the Investment Advisory and Management Agreement (the "Agreement"), approval of the Agreement by the shareholders of a particular series would make the Agreement effective as to that series whether or not it had been approved by the shareholders of the other series. The assets received by the Company for the issue or sale of shares of each series, and all income, earnings, profits and proceeds thereof, subject only to the rights of creditors, are allocated to such series, and constitute the underlying assets of such series. The underlying assets of each series are required to be segregated on the books of account, and are to be charged with the expenses in respect to such series and with a share of the general expenses of the Company. Any general expenses of the Company not readily identifiable as belonging to a particular series shall be allocated among the series based upon the relative net assets of the series at the time such expenses were accrued. Minnesota has enacted legislation which authorizes corporations to eliminate or limit the personal liability of a director to the corporation or its shareholders for monetary damages for breach of the fiduciary duty of "care" (the duty to act with the care an ordinarily prudent person in a like position would exercise under similar circumstances). Minnesota law does not, however, permit a corporation to -28- eliminate or limit the liability of a director (a) for any breach of the director's duty of "loyalty" to the corporation or its shareholders (the duty to act in good faith and in a manner reasonably believed to be in the best interest of the corporation), (b) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (c) for authorizing a dividend, stock repurchase or redemption or other distribution in violation of Minnesota law or for violation of certain provisions of Minnesota securities laws, or (d) for any transaction from which the director derived an improper personal benefit. Minnesota law does not permit elimination or limitation of a director's liability under the 1933 Act or the Securities Exchange Act of 1934, and the 1940 Act prohibits elimination or limitation of a director's liability for acts involving willful malfeasance, bad faith, gross negligence or reckless disregard of the duties of a director. The Articles of Incorporation of Piper Global limit the liability of directors to the fullest extent permitted by Minnesota law and the 1940 Act. FINANCIAL STATEMENTS The audited financial statements and supplementary schedules for Money Market Fund and Adjustable Portfolio as of June 30, 1995, have been incorporated by reference into this Statement of Additional Information from the Funds' annual report to shareholders in reliance on the report of KPMG Peat Marwick LLP, 4200 Norwest Center, Minneapolis, Minnesota 55402, independent auditors of the Funds, given on the authority of such firm as experts in accounting and auditing. PENDING LITIGATION Complaints have been brought in federal and state court relating to one open-end and twelve closed-end investment companies managed by the Adviser and to two open-end funds for which the Adviser has acted as sub-adviser. An Amended Consolidated Class Action Complaint was filed on October 5, 1994 in the United States District Court, District of Minnesota, against the Institutional Government Income Portfolio (a series of Piper Funds Inc.), the Adviser, the Distributor, William H. Ellis and Edward J. Kohler alleging certain violations of federal and state securities laws, including the making of materially misleading statements in the prospectus, common law negligent misrepresentation and breach of fiduciary duty. This is a consolidated putative class action in which claims brought by 11 persons or entities have been consolidated under the title IN RE: PIPER FUNDS INC. INSTITUTIONAL GOVERNMENT INCOME PORTFOLIO LITIGATION. The named plaintiffs in the complaint purport to represent a class of individuals and groups who purchased shares of Institutional Government Income Portfolio during the putative class period of July 1, 1991 through May 9, 1994. The named plaintiffs and defendants have entered into a settlement agreement which has received preliminary approval from the Court. The terms of the settlement are set forth in a Settlement Agreement dated July 20, 1995 (as modified by an Addendum filed on July 28, 1995). The Settlement Agreement contained a provision which would have permitted the defendants to cancel the Agreement if shareholders who had incurred a cumulative "Loss" (as defined under the Agreement) more than 10% of the Loss sustained by the entire class had opted out. The deadline for requesting exclusion from the class has passed, and the Loss sustained by persons requesting exclusion is less than 10%. If granted -29- final approval by the Court, the Settlement Agreement would provide up to $70 million, together with interest earned, less certain disbursements and attorneys fees as approved by the Court, to class members in payments scheduled over approximately three years. Such payments would be made by Piper Jaffray Companies Inc. and the Adviser and would not be an obligation of the Institutional Government Income Portfolio or Piper Funds Inc. Six additional complaints, which are based on claims similar to those asserted in the first complaint, have been brought relating to the Institutional Government Income Portfolio. The first of such complaints was filed in the same court against the same parties on October 21, 1994, by Eltrax Systems, Inc. A second additional complaint was filed against the Company, the Adviser, the Distributor and Piper Jaffray Companies Inc. on September 30, 1994 in the United States District Court, District of Colorado. Plaintiffs in the complaint are Gary Pashel and Gregg S. Hayutin, Trustees of the Mae Pashel Trust; Mae Pashel, individually; Gary Pashel and Michael H. Feinstein, Trustees of the Robert Hayutin Insurance Trust; and Dennis E. Hayutin, Gregg S. Hayutin and Gary Pashel, Trustees of the Marie Ellen Hayutin Trust. The third additional complaint, a putative class action, was filed on November 1, 1994 in the United States District Court, District of Idaho by the Idaho Association of Realtors, Inc., a non-profit Idaho corporation. The complaint was filed against the Institutional Government Income Portfolio, the Adviser, the Distributor, Piper Jaffray Companies Inc., William H. Ellis and Edward J. Kohler. The fourth complaint, also a putative class action, was filed in the United States District Court for the District of Minnesota, Third Division, on January 25, 1995. The Complaint was brought by Louise S. Maher and John A. Raetz against Piper Funds Inc., Institutional Government Income Portfolio, the Adviser, the Distributor, Piper Jaffray Companies Inc., William H. Ellis and Edward J. Kohler. The fifth complaint was brought on April 11, 1995, and in the future may be filed in the Minnesota State District Court, Hennepin County. The plaintiff, Frank R. Berman, Trustee of Frank R. Berman Professional CP Pension Plan Trust, sued individually and not on behalf of any putative class. Defendants are the Distributor, Piper Funds Inc., Morton Silverman and Worth Bruntjen. A sixth complaint relating to Institutional Government Income Portfolio was filed on June 22, 1995 in the Montana Thirteenth Judicial District Court, Yellowstone County by Beverly Muth against the Distributor and Teresa L. Darnielle. In addition to the above complaints, a number of actions have been commenced in arbitration by individual investors in the Institutional Government Income Portfolio. The complaints discussed in this paragraph generally have been consolidated with the IN RE: PIPER FUNDS INC. action for pretrial purposes and the arbitrations and litigation have been stayed pending entry of an order by the Court permitting those class members who have requested exclusion to proceed with their actions. A complaint was filed by Herman D. Gordon on October 20, 1994, in the United States District Court, District of Minnesota, against American Adjustable Rate Term Trust Inc.--1998, American Adjustable Rate Term Trust Inc.--1999, the Adviser, the Distributor, Piper Jaffray Companies Inc., Benjamin Rinkey, Jeffrey Griffin, Charles N. Hayssen and Edward J. Kohler. A second complaint was filed by Frank Donio, I.R.A. and other plaintiffs on April 14, 1995, in the United States District Court, District of Minnesota, against American Adjustable Rate Term Trust -30- Inc.--1996, American Adjustable Rate Term Trust Inc.--1997, American Adjustable Rate Term Trust Inc.--1998, American Adjustable Rate Term Trust Inc.--1999, the Adviser, the Distributor, Piper Jaffray Companies Inc. and certain associated individuals. Plaintiffs in both actions filed a Consolidated Amended Class Action Complaint on May 23, 1995 and by Order dated June 8, 1995, the Court consolidated the two putative class actions. The consolidated amended complaint, which purports to be a class action, alleges certain violations of federal and state securities laws, breach of fiduciary duty and negligent misrepresentation. A complaint was filed by Carson H. Bradley on February 3, 1995 in the Sixth Judicial District of the State of Idaho against American Government Income Fund Inc., American Government Income Portfolio Inc., the Adviser, the Distributor and Worth Bruntjen. The complaint alleges negligent misrepresentation, breach of fiduciary duty and breach of contract. The action has been removed to Federal District Court for the District of Idaho. A complaint was filed by Gary E. Nelson on June 28, 1995 in the United States District Court for the Western District of Washington at Seattle against American Strategic Income Portfolio Inc. - II, the Adviser, the Distributor, Piper Jaffray Companies Inc., Worth Bruntjen, Charles N. Hayssen, Michael Jansen, William H. Ellis and Edward J. Kohler. A second complaint was filed by the same individual in the same court on July 12, 1995 against American Opportunity Income Fund Inc., the Adviser, the Distributor, Piper Jaffray Companies Inc., Worth Bruntjen, Charles N. Hayssen, Michael Jansen, William H. Ellis and Edward J. Kohler. On September 7, 1995, Christian Fellowship Foundation Peace United Church of Christ, Gary E. Nelson and Lloyd Schmidt filed an amended complaint purporting to be a class action in the United States District Court for the District of Washington. The complaint was filed against American Government Income Portfolio, Inc., American Government Income Fund Inc., American Government Term Trust, Inc., American Strategic Income Portfolio Inc., American Strategic Income Portfolio Inc. -- II, American Strategic Income Portfolio Inc. -- III, American Opportunity Income Fund Inc., American Select Portfolio Inc., Piper Jaffray Companies Inc., Piper Jaffray Inc., the Adviser and certain associated individuals. By Order filed October 5, 1995, the complaints were consolidated. The amended complaint alleges generally that the prospectus and financial statements of each investment company were false and misleading. Specific violations of various federal securities laws are alleged with respect to each investment company. The complaint also alleges that the defendants violated the Racketeer Influenced and Corrupt Organizations Act, the Washington State Securities Act and the Washington Consumer Protection Act. Complaints have also been filed relating to two open-end funds for which the Adviser has acted as sub-adviser, Managers Intermediate Mortgage Fund and Managers Short Government Fund. A complaint was filed on September 26, 1994 in the United States District Court, District of Connecticut, by Florence R. Hosea, Bobby W. Hosea, Getrud B. Dale and Peter M. Dale, Andrew Poffel and Diane Poffel as tenants by the Entireties, Myrone Sarone, Donna M. DiPalo, Bernard B. Geltner and Gail Geltner and Paul Delman. The complaint was filed against The Managers Funds, the Managers Funds, L.P., Robert P. Watson, the Adviser, the Distributor, an individual associated with the Adviser, Evaluation Associates, Inc. and Managers -31- Intermediate Mortgage Fund. The complaint, which is a putative class action, alleges certain violations of federal securities laws, including the making of false and misleading statements in the prospectus, and alleges negligent misrepresentation, breach of fiduciary duty and common law fraud. A similar complaint was filed as a putative class action in the same court on November 4, 1994. The complaint was filed by Karen E. Kopelman against The Managers Fund, The Managers Funds, L.P., Robert P. Watson, the Adviser, the Distributor, Worth Bruntjen, Evaluation Associates, Inc. and Managers Intermediate Mortgage Fund. The two putative class actions were consolidated by court order on December 13, 1994. Plaintiffs filed an Amended and Restated Complaint on July 19, 1995. A complaint relating to the Managers Short Government Fund was filed on November 18, 1994 in the United States District Court, District of Minnesota. The complaint was filed by Robert Fleck as a putative class action against The Managers Funds, The Managers Funds, L.P., the Adviser, the Distributor, Worth Bruntjen, Evaluation Associates, Inc., Robert P. Watson, John E. Rosati, William M. Graulty, Madeline H. McWhinney, Steven J. Pasggioli, Thomas R. Schneeweis and Managers Short Government Fund, F/K/A/ Managers Short Government Income Fund. The complaint alleges certain violations of federal securities laws, including the making of false and misleading statements in the prospectus, and negligent misrepresentation. The Adviser and Distributor do not believe that the settlement reached in connection with the first lawsuit described above, or any other of the above lawsuits, will have a material adverse effect upon their ability to perform under their agreements with the Fund, and they intend to defend the remaining lawsuits vigorously. -32- APPENDIX A COMMERCIAL PAPER AND CORPORATE BOND RATINGS COMMERCIAL PAPER RATINGS Set forth below are descriptions of the two highest commercial paper and other short-term rating categories assigned by Standard & Poor's Ratings Services ("S&P"), Moody's Investors Service, Inc. ("Moody's"), Fitch Investors Service, Inc. ("Fitch") and Duff & Phelps, Inc. ("Duff"): The designation 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 overwhelming safety characteristics are denoted with a plus sign (+) designation. Capacity for timely payment on issues with an A-2 designation is strong. However, the relative degree of safety is not as high as for issues designated A-1. The rating Prime-1 (P-1) is the highest commercial paper rating assigned by Moody's. Issuers of P-1 paper must have a superior capacity for repayment of short-term promissory obligations, and ordinarily will be evidenced by leading market positions in well established industries, high rates of return on funds employed, conservative capitalization structures with moderate reliance on debt and ample asset protection, broad margins in earnings coverage of fixed financial charges and high internal cash generation, and well established access to a range of financial markets and assured sources of alternate liquidity. Issues rated Prime-2 (P-2) have a strong capacity for repayment of short-term promissory obligations. This ordinarily will be evidenced by many of the characteristics cited above 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 alternate liquidity is maintained. The rating Fitch-1 (Highest Grade) is the highest commercial paper rating assigned by Fitch. Paper rated Fitch-1 is regarded as having the strongest degree of assurance for timely payment. The rating Fitch-2 (Very Good Grade) is the second highest commercial paper rating assigned by Fitch which reflects an assurance of timely payment only slightly less in degree than the strongest issues. The rating Duff-1 is the highest commercial paper rating assigned by Duff. Paper rated Duff-1 is regarded as having very high certainty of timely payment with excellent liquidity factors which are supported by ample asset protection. Risk factors are minor. Paper rated Duff-2 is regarded as having good certainty of timely payment, good access to capital markets and sound liquidity factors and company fundamentals. Risk factors are small. A-1 S&P CORPORATE BOND RATINGS S&P's ratings for corporate bonds have the following definitions: Debt rated "AAA" has the highest rating assigned by S&P. Capacity to pay interest and repay principal is extremely strong. Debt rated "AA" has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in a small degree. Debt rated "A" has a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. Debt rated "BBB" is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits 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. A-2 APPENDIX B INTEREST RATE FUTURES CONTRACTS AND RELATED OPTIONS INTEREST RATE FUTURES CONTRACTS Adjustable Portfolio may purchase and sell interest rate futures contracts and options thereon. An interest rate futures contract creates an obligation on the part of the seller (the "short") to deliver, and an offsetting obligation on the part of the purchaser (the "long") to accept delivery of, the type of financial instrument called for in the contract in a specified delivery month for a stated price. A majority of transactions in interest rate futures contracts, however, do not result in the actual delivery of the underlying instrument, but are settled through liquidation (I.E., by entering into an offsetting transaction). The interest rate futures contracts to be traded by the Fund are traded only on commodity exchanges--known as "contract markets"--approved for such trading by the Commodity Futures Trading Commission and must be executed through a futures commission merchant or brokerage firm which is a member of the relevant contract market. These contract markets, through their clearing corporations, guarantee that the contracts will be performed. Presently, futures contracts are based upon such debt securities as long-term U.S. Treasury bonds, Treasury notes, Government National Mortgage Association modified pass-through mortgage-backed securities, three-month U.S. Treasury bills and bank certificates of deposit. In addition, futures contracts are traded in the Moody's Investment Grade Corporate Bond Index and the Long Term Corporate Bond Index. Although most futures contracts by their terms call for actual delivery or acceptance of commodities or securities, in most cases the contracts are closed out before the settlement date without the making or taking of delivery. Closing out a short position is effected by purchasing a futures contract for the same aggregate amount of the specific type of financial instrument or commodity and the same delivery month. If the price of the initial sale of the futures contract exceeds the price of the offsetting purchase, the seller is paid the difference and realizes a gain. Conversely, if the price of the offsetting purchase exceeds the price of the initial sale, the trader realizes a loss. Similarly, the closing out of a long position is effected by the purchaser entering into a futures contract sale. If the offsetting sale price exceeds the purchase price, the purchaser realizes a gain and, if the purchase price exceeds the offsetting sale price, the purchaser realizes a loss. The purchase or sale of a futures contract differs from the purchase or sale of a security in that no price or premium is paid or received. Instead, an amount of cash or securities acceptable to the Adviser and the relevant contract market, which varies but is generally about 5% of the contract amount, must be deposited with the custodian in the name of the broker. This amount is known as "initial margin," and represents a "good faith" deposit assuring the performance of both the purchaser and the seller under the futures contract. Subsequent payments to and from the broker, known as "variation margin," are required to be made on a daily basis as the price of the futures contract fluctuates, making the long or short positions in the futures contract more or less valuable, a process known as "marking B-1 to the market." Prior to the settlement date of the futures contract, the position may be closed out by taking an opposite position which will operate to terminate the position in the futures contract. A final determination of variation margin is then made, additional cash is required to be paid to or released by the broker, and the purchaser realizes a loss or gain. In addition, a commission is paid on each completed purchase and sale transaction. The purpose of the acquisition or sale of a futures contract by the Fund, as the holder of long-term fixed-income securities, is to hedge against fluctuations in rates on such securities without actually buying or selling long-term fixed-income securities. For example, if the Fund owns long-term bonds and interest rates are expected to increase, the Fund might sell futures contracts. Such a sale would have much the same effect as selling some of the long-term bonds in the Fund's portfolio. If interest rates increase as anticipated by the Adviser, the value of certain long-term securities in the portfolio would decline, but the value of the Fund's futures contracts would increase at approximately the same rate, thereby keeping the net asset value of the Fund from declining as much as it otherwise would have. Of course, since the value of the securities in the Fund's portfolio will far exceed the value of the futures contracts sold by the Fund, an increase in the value of the futures contracts could only mitigate--but not totally offset--the decline in the value of the portfolio. Similarly, when it is expected that interest rates may decline, futures contracts could be purchased to hedge against the Fund's anticipated purchases of long-term fixed-income securities, such as bonds, at higher prices. Since the rate of fluctuation in the value of futures contracts should be similar to that of long-term bonds, the Fund could take advantage of the anticipated rise in the value of long-term bonds without actually buying them until the market had stabilized. At that time, the futures contracts could be liquidated and the Fund's cash could then be used to buy long-term bonds on the cash market. The Fund could accomplish similar results by selling bonds with long maturities and investing in bonds with short maturities when interest rates are expected to increase or by buying bonds with long maturities and selling bonds with short maturities when interest rates are expected to decline. However, in circumstances when the market for bonds may not be as liquid as that for futures contracts, the ability to invest in such contracts could enable the Fund to react more quickly to anticipated changes in market conditions or interest rates. OPTIONS ON INTEREST RATE FUTURES CONTRACTS Adjustable Portfolio may purchase and sell put and call options on interest rate futures contracts which are traded on a United States exchange or board of trade as a hedge against changes in interest rates, and will enter into closing transactions with respect to such options to terminate existing positions. An interest rate futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specific financial instrument (debt security) at a specified price, date, time and place. An option on an interest rate futures contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, in return for the premium paid, to assume a position in an interest rate futures contract at a specified exercise price at any time prior to the expiration date of the option. Options on interest rate futures contracts are similar to options on securities, which give the purchaser the right, in return for the premium paid, to purchase or sell securities. A call option gives the purchaser of such option the right to buy, and obliges its writer to sell, a specified underlying futures contract at a specified exercise price at any time prior to the expiration date of B-2 the option. A purchaser of a put option has the right to sell, and the writer has the obligation to buy, such contract at the exercise price during the option period. Upon exercise of an option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writer's future margin account, which represents the amount by which the market price of the futures contract exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. If an option is exercised on the last trading day prior to the expiration date of the option, the settlement will be made entirely in cash equal to the difference between the exercise price of the option and the closing price of the interest rate futures contract on the expiration date. The Fund will pay a premium for purchasing options on interest rate futures contracts. Because the value of the option is fixed at the point of sale, there are no daily cash payments to reflect changes in the value of the underlying contract; however, the value of the option does change daily and that change would be reflected in the net asset value of the Fund. In connection with the writing of options on interest rate futures contracts, the Fund will make initial margin deposits and make or receive maintenance margin payments that reflect changes in the market value of such options. Premiums received from the writing of an option are included in initial margin deposits. PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS. Adjustable Portfolio may purchase put options on interest rate futures contracts if the Adviser anticipates a rise in interest rates. Because the value of an interest rate futures contract moves inversely in relation to changes in interest rates, a put option on such a contract becomes more valuable as interest rates rise. By purchasing put options on interest rate futures contracts at a time when the Adviser expects interest rates to rise, the Fund will seek to realize a profit to offset the loss in value of its portfolio securities. If interest rates remain steady or fall such that the futures contract price at expiration of the option is above the option exercise price, the put option will expire worthless. PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS. Adjustable Portfolio may purchase call options on interest rate futures contracts if the Adviser anticipates a decline in interest rates. The purchase of a call option on an interest rate futures contract represents a means of obtaining temporary exposure to market appreciation at limited risk. Because the value of an interest rate futures contract moves inversely in relation to changes to interest rates, a call option on such a contract becomes more valuable as interest rates decline. The Fund may purchase a call option on an interest rate futures contract to hedge against a decline in interest rates in a market advance when the Fund is holding cash. The Fund can take advantage of the anticipated rise in the value of long-term securities without actually buying them until the market is stabilized. At that time, the options can be liquidated and the Fund's cash can be used to buy long-term securities. If interest rates remain steady or rise such that the futures contract price at expiration of the option is below the option exercise price, the call option will expire worthless. B-3 WRITING CALL OPTIONS ON FUTURES CONTRACTS. Adjustable Portfolio may write call options on interest rate futures contracts if the Adviser anticipates a rise in interest rates. As interest rates rise, a call option on such a contract becomes less valuable. If the futures contract price at expiration of the option is below the exercise price, the option will not be exercised and the Fund will retain the full amount of the option premium. Such amount provides a partial hedge against any decline that may have occurred in the Fund's portfolio securities. If interest rates decline such that the futures contract price is above the option exercise price and the option is exercised, the Fund will be liable for the amount by which the market price of the futures contract exceeds the exercise price of the option. WRITING PUT OPTIONS ON FUTURES CONTRACTS. Adjustable Portfolio may write put options on interest rate futures contracts if the Adviser anticipates a decline in interest rates. As interest rates decline, a put option on an interest rate futures contract becomes less valuable. If the futures contract price at expiration of the option has risen due to declining interest rates and is above the exercise price, the option will not be exercised and the Fund will retain the full amount of the option premium. Such amount can then be used by the Fund to buy long-term securities when the market has stabilized. If interest rates rise such that the futures contract price is below the option exercise price and the option is exercised, the Fund will be liable for the amount by which the exercise price of the option exceeds the market price of the futures contract. RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS HEDGING RISKS IN FUTURES CONTRACTS TRANSACTIONS. There are several risks in using futures contracts as hedging devices. One risk arises because the prices of futures contracts may not correlate perfectly with movements in the underlying fixed-income security due to certain market distortions. First, all participants in the futures market are subject to initial margin and variation margin requirements. Rather than making additional variation margin payments, investors may close the contracts through offsetting transactions which could distort the normal relationship between the security and the futures market. Second, the margin requirements in the futures market are lower than margin requirements in the securities market, and as a result the futures market may attract more speculators than does the securities market. Increased participation by speculators in the futures market may also cause temporary price distortions. Because of possible price distortion in the futures market and because of imperfect correlation between movements in securities and movements in the prices of futures contracts, even a correct forecast of general market trends may not result in a successful hedging transaction over a very short period. Another risk arises because of imperfect correlation between movements in the value of the futures contracts and movements in the value of securities subject to the hedge. Successful use of futures contracts by Adjustable Portfolio is subject to the ability of the Adviser to predict correctly movements in the direction of interest rates. If the Fund has hedged against the possibility of an increase in interest rates adversely affecting the value of fixed-income securities held in its portfolio and B-4 interest rates decrease instead, the Fund will lose part or all of the benefit of the increased value of its security which it has hedged because it will have offsetting losses in its futures positions. In addition, in such situations, if the Fund has insufficient cash, it may have to sell securities to meet daily variation margin requirements. Such sales of securities may, but will not necessarily, be at increased prices which reflect the decline in interest rates. The Fund may have to sell securities at a time when it may be disadvantageous to do so. LIQUIDITY OF FUTURES CONTRACTS. Adjustable Portfolio may elect to close some or all of its contracts prior to expiration. The purpose of making such a move would be to reduce or eliminate the hedge position held by the Fund. The Fund may close its positions by taking opposite positions. Final determinations of variation margin are then made, additional cash as required is paid by or to the Fund, and the Fund realizes a loss or a gain. Positions in futures contracts may be closed only on an exchange or board of trade providing a secondary market for such futures contracts. Although the Fund intends to enter into futures contracts only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a liquid secondary market will exist for any particular contract at any particular time. In addition, most domestic futures exchanges and boards of trade limit the amount of fluctuation permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and therefore does not limit potential losses because the limit may prevent the liquidation of unfavorable positions. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting some futures traders to substantial losses. In such event, it will not be possible to close a futures position and, in the event of adverse price movements, the Fund would be required to make daily cash payments of variation margin. In such circumstances, an increase in the value of the portion of the portfolio being hedged, if any, may partially or completely offset losses on the futures contract. However, as described above, there is no guarantee that the price of the securities being hedged will, in fact, correlate with the price movements in the futures contract and thus provide an offset to losses on a futures contract. RISKS OF OPTIONS ON FUTURES CONTRACTS. The use of options on futures contracts also involves additional risk. Compared to the purchase or sale of futures contracts, the purchase of call or put options on futures contracts involves less potential risk to the Fund because the maximum amount at risk is the premium paid for the options (plus transactions costs). The writing of a call option on a futures contract generates a premium which may partially offset a decline in the value of the Fund's portfolio assets. By writing a call option, the Fund becomes obligated to sell a futures contract, which may have a value higher than the exercise B-5 price. Conversely, the writing of a put option on a futures contract generates a premium, but the Fund becomes obligated to purchase a futures contract, which may have a value lower than the exercise price. Thus, the loss incurred by the Fund in writing options on futures contracts may exceed the amount of the premium received. The effective use of options strategies is dependent, among other things, on the Fund's ability to terminate options positions at a time when the Adviser deems it desirable to do so. Although the Fund will enter into an option position only if the Adviser believes that a liquid secondary market exists for such option, there is no assurance that the Fund will be able to effect closing transactions at any particular time or at an acceptable price. The Funds' transactions involving options on futures contracts will be conducted only on recognized exchanges. Adjustable Portfolio's purchase or sale of put or call options on futures contracts will be based upon predictions as to anticipated interest rates by the Adviser, which could prove to be inaccurate. Even if the expectations of the Adviser are correct, there may be an imperfect correlation between the change in the value of the options and of the Fund's portfolio securities. REGULATORY MATTERS To the extent required to comply with applicable Securities and Exchange Commission releases and staff positions, when entering into futures contracts, Adjustable Portfolio will maintain, in a segregated account, cash or liquid high-grade debt securities equal to the value of such contracts. The Commodity Futures Trading Commission (the "CFTC"), a federal agency, regulates trading activity on the exchanges pursuant to the Commodity Exchange Act, as amended. The CFTC requires the registration of "commodity pool operators," defined as any person engaged in a business which is of the nature of an investment trust, syndicate or a similar form of enterprise, and who, in connection therewith, solicits, accepts or receives from others, funds, securities or property for the purpose of trading in any commodity for future delivery on or subject to the rules of any contract market. The CFTC has adopted Rule 4.5, which provides an exclusion from the definition of commodity pool operator for any registered investment company which meets the requirements of the Rule. Rule 4.5 requires, among other things, that an investment company wishing to avoid commodity pool operator status use futures and options positions only (a) for "bona fide hedging purposes" (as defined in CFTC regulations) or (b) for other purposes so long as aggregate initial margins and premiums required in connection with non-hedging positions do not exceed 5% of the liquidation value of the investment company's portfolio. Any investment company wishing to claim the exclusion provided in Rule 4.5 must file a notice of eligibility with both the CFTC and the National Futures Association. Before engaging in transactions involving futures contracts, the Adjustable Portfolio will file such notices and meet the requirements of Rule 4.5, or such other requirements as the CFTC or its staff may from time to time issue, in order to render registration as a commodity pool operator unnecessary. B-6 ANNUAL REPORT [LOGO] JUNE 30, 1996 PIPER INSTITUTIONAL FUNDS MINNEAPOLIS 222 SOUTH NINTH STREET MINNEAPOLIS, MN 55402 612 342-6402 SEATTLE 1200 FIFTH AVENUE SEATTLE,WA 98101 206 287-8862 DENVER 1050 17TH STREET DENVER, CO 80265 303 820-5885 TABLE OF CONTENTS Letter to Shareholders . . . . . . . . 1 Financial Statements and Notes . . . . 6 Investments in Securities. . . . . . .16 Independent Auditors' Report . . . . .18 Federal Tax Information. . . . . . . .19 Letter to Shareholders . . . . . . . . 3 Financial Statements and Notes . . . . 6 Investments in Securities. . . . . . .17 Independent Auditors' Report . . . . .18 Federal Tax Information. . . . . . . .19 INSTITUTIONAL MONEY MARKET FUND Institutional Money Market Fund seeks maximum current income consistent with preservation of capital and maintenance of liquidity. To realize its objective, the fund invests in securities that are issued or guaranteed as to payment of principal and interest by the U.S. government, its agencies or instrumentalities, and repurchase agreements backed by such securities. The U.S. government securities held by the fund, not the fund shares, are guaranteed as to payment of principal and interest. An investment in the fund is neither insured nor guaranteed by the U.S. government. There can be no assurance the fund will be able to maintain a stable net asset value of $1 per share. INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO Institutional Government Adjustable Portfolio seeks high current income consistent with low principal volatility. The fund invests primarily (at least 65% of its total assets under normal market conditions) in adjustable rate mortgage (ARM) securities that are issued or guaranteed by the U.S. government, its agencies or its instrumentalities. The fund also may invest in privately issued ARM securities, mortgage-backed securities other than ARM securities, other types of U.S. government securities, Canadian government securities, structured securities including foreign linked index securities and corporate debt securities. The fund may also purchase securities through the sale-forward (dollar-roll) program. This investment technique and investments in certain types of securities, such as foreign linked index securities, may cause the fund's net asset value to fluctuate to a greater extent than would be expected from interest rate movements alone. As with other mutual funds, there can be no assurance the fund will achieve its objective. Since the fund's inception on February 2, 1993, it has had a credit rating of AAAf by Standard and Poor's Mutual Funds Ratings Group (S&P).* *THE FUND IS RATED AAAf, WHICH MEANS THE FUND'S INVESTMENTS HAVE AN OVERALL CREDIT QUALITY OF AAA. CREDIT QUALITIES ARE ASSESSED BY STANDARD AND POOR'S MUTUAL FUNDS RATINGS GROUP. S&P DOES NOT EVALUATE THE MARKET RISK OF AN INVESTMENT WHEN ASSIGNING A CREDIT RATING. SEE STANDARD AND POOR'S CORPORATE AND MUNICIPAL RATINGS DEFINITIONS FOR AN EXPLANATION OF AAA. THE FUND HAS BEEN GIVEN A MARKET RISK RATING BY S&P, WHICH WE CANNOT PUBLISH DUE TO NASD REGULATIONS. RISK RATINGS EVALUATE VARIOUS INVESTMENT RISKS THAT CAN AFFECT THE PERFORMANCE OF A BOND FUND AND INDICATE THE FUND'S OVERALL STABILITY AND SENSITIVITY TO CHANGING MARKET CONDITIONS. THESE RATINGS ARE AVAILABLE BY CALLING S&P AT 1 800 424-FUND. THIS REPORT IS INTENDED FOR SHAREHOLDERS OF INSTITUTIONAL MONEY MARKET FUND AND INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO, BUT IT MAY ALSO BE USED AS SALES LITERATURE IF PRECEDED OR ACCOMPANIED BY A PROSPECTUS. THE PROSPECTUS GIVES DETAILS ABOUT THE CHARGES, INVESTMENT RESULTS AND OPERATING POLICIES OF THE FUNDS. INSTITUTIONAL MONEY MARKET FUND PORTFOLIO COMPOSITION JUNE 30, 1996 Federal Home Loan Mortgage Corporation 24% Federal Home Loan Bank 8% Other Government- Backed Securities 3% Federal Farm Credit Bank 1% [PIE CHART] Federal National Mortgage Association 19% Student Loan Marketing Association 5% U.S. Treasury Securities 5% Repurchase Agreements 35% INVESTMENT CATEGORIES REFLECT PERCENTAGE OF TOTAL ASSETS. NANCY SHELLENBERGER OLSEN IS PRIMARILY RESPONSIBLE FOR THE MANAGEMENT OF INSTITUTIONAL MONEY MARKET FUND. SHE HAS 18 YEARS OF FINANCIAL EXPERIENCE. SHAISTA TAJAMAL ASSISTS WITH THE MANAGEMENT OF INSTITUTIONAL MONEY MARKET FUND. SHE HAS SIX YEARS OF FINANCIAL EXPERIENCE. July 19, 1996 Dear Shareholders: DURING THE PAST YEAR, INSTITUTIONAL MONEY MARKET FUND'S SEVEN-DAY CURRENT YIELD FELL FROM 5.67% ON JUNE 30, 1995, TO 5.04% ON JUNE 30, 1996.* This decline was due to a decrease in short-term interest rates brought on by the Federal Reserve Board (Fed) easing credit in July, December and January. Since January, the Fed has maintained a neutral monetary policy, meaning they have neither raised nor lowered interest rates. SEVERAL ECONOMIC DEVELOPMENTS TOOK PLACE DURING THE PERIOD THAT HAD AN IMPACT ON THE MARKET. Inflation, as measured by the Consumer Price Index, grew only 2.4% for 1995, its lowest annual increase since 1986. This kept interest rates relatively low. Inflation remained subdued during the first six months of 1996, but the economy showed signs of strength with job creation in the non-farm sector posting much higher increases than expected -- 624,000 new jobs in February and 140,000 in March. In addition, there was a substantial, though short-lived, rally in commodity prices. As a result of these signs of economic strength, both long- and short-term interest rates rose. DURING THE YEAR, WE SHORTENED THE FUND'S AVERAGE WEIGHTED MATURITY FROM 68 TO 34 DAYS. Shortening the average weighted maturity is a common strategy that we employ when we believe short-term interest rates will rise. The benefit is that we don't have to wait as long for securities to mature in order for us to put that money to work at higher interest rates. ONE OF THE WAYS WE SHORTENED THE AVERAGE MATURITY OF THE PORTFOLIO WAS TO ADD GOVERNMENT AGENCY FLOATING SECURITIES. This helped performance due to the favorable spreads on those securities and to the rising short-term rates in the first half of 1996. These securities represent approximately 12% of the fund's total assets as of June 30. *PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. THE RETURN OF AN INVESTMENT WILL FLUCTUATE. AN INVESTMENT IN THE FUND IS NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT, AND THERE CAN BE NO ASSURANCE THAT THE FUND WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1 PER SHARE. 1 INSTITUTIONAL MONEY MARKET FUND [GRAPH] CURRENT YIELD REFERS TO THE INCOME GENERATED BY THE FUND OVER A 30-DAY PERIOD. THIS INCOME IS THEN ANNUALIZED. EFFECTIVE YIELD IS CALCULATED SIMILARLY BUT THE INCOME EARNED IS ASSUMED TO BE REINVESTED. DURING SOME PERIODS, PIPER CAPITAL WAIVED OR PAID FUND EXPENSES AND/OR PIPER JAFFRAY, THE FUND'S DISTRIBUTOR, VOLUNTARILY LIMITED 12B-1 FEES FOR THE FUND. HAD THESE FEES AND EXPENSES NOT BEEN WAIVED, YIELDS WOULD HAVE BEEN: 4.98% 30-DAY CURRENT YIELD AND 5.10% 30-DAY EFFECTIVE YIELD. GOING FORWARD, THERE'S A POSSIBILITY THE FED WILL RAISE SHORT-TERM RATES AT THE FEDERAL OPEN MARKET COMMITTEE MEETING ON OR BEFORE AUGUST 20. Because we believe the market has already factored in a Fed tightening, we don't expect that a Fed rate hike will have a significant impact on prices if it does occur. As a result, a Fed increase may encourage us to increase slightly the fund's average weighted maturity. THE SAFETY OF YOUR PRINCIPAL REMAINS OUR PRIMARY CONSIDERATION IN MANAGING THE FUND AS WE STRIVE TO PROVIDE YOU WITH A CONSERVATIVE ALTERNATIVE FOR YOUR SHORT-TERM CASH. As of June 30, all of the fund's investments were in securities issued or guaranteed by the U.S. government or its agencies or instrumentalities, or in repurchase agreements backed by such securities.We continue to use a fundamental approach to identify high-quality, liquid money market securities that provide competitive yields. Our strategy is designed to add value by active positioning of the portfolio on the short end of the yield curve, investing in high-quality securities and managing the fund's average weighted maturity based on our interest rate forecast. Thank you for your investment in Institutional Money Market Fund. We remain committed to providing you with quality service and look forward to helping you achieve your financial goals. Sincerely, /s/ Nancy Shellenberger Olsen Nancy Shellenberger Olsen 30-DAY YIELDS 30-DAY CURRENT AND EFFECTIVE YIELDS ARE AS OF THE END OF EACH MONTH. 2 INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO PORTFOLIO COMPOSITION JUNE 30, 1996 U.S. Agency Adjustable Rate Mortgage-Backed Securities 72% U.S. Agency Fixed Rate Mortgage-Backed Securities 14% [PIE CHART] U.S. Treasury Securities 1% Short-Term Securities 1% Other Assets 2% INVESTMENT CATEGORIES REFLECT PERCENTAGE OF TOTAL ASSETS. TOM MCGLINCH, CFA IS PRIMARILY RESPONSIBLE FOR THE MANAGEMENT OF INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO. HE HAS 15 YEARS OF FINANCIAL EXPERIENCE. July 19, 1996 Dear Shareholders: DURING THE FISCAL YEAR ENDED JUNE 30, 1996, INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO HAD A TOTAL RETURN OF 6.34%.* This return includes reinvested distributions but not the fund's sales charge. Comparatively, the one-year return for the Lipper Adjustable Rate Mortgage Funds Average was 3.30% and the Lehman Brothers Adjustable Rate Mortgage Index's return was 6.31%. During this period, coupon income contributed a significant portion of the fund's total return. The fund slightly outperformed the Lehman index as a result of owning securities with slightly higher coupon income and less price sensitivity to higher interest rates than securities in the index. In addition, we believe the Lipper average return was lower because several of the funds in the category experienced credit losses. BOND MARKET PERFORMANCE WAS MIXED DURING THE FUND'S FISCAL YEAR. In late 1995 and early 1996, the bond market rallied as interest rates continued their decline. During this period, the Federal Reserve Board (Fed) lowered the federal funds rate in July, December and January. These moves had important implications for the adjustable-rate mortgage (ARM) securities market as many of the underlying loans reset their coupons based on the one-year Treasury yield. Also, many borrowers began to see the interest rate on their mortgage decrease, and investors experienced a gradual reduction in coupon income as the underlying mortgage loans reset to lower rates. Once economic reports showed stronger-than-expected growth, interest rates began to rise and bond prices fell sharply, abruptly ending the bond market rally. Fortunately, adjustable rate mortgages posted slightly better returns in this environment compared to most fixed income securities. Through the period, market consensus grew that the Federal Reserve would raise short-term interest rates in a pre-emptive strike against inflation. That sentiment began to wane the last few trading days in June, resulting in a slight improvement in returns. WE MAINTAINED A RELATIVELY CONSERVATIVE INVESTMENT STRATEGY, WHICH INCLUDED A NEARLY NEUTRAL EFFECTIVE DURATION IN COMPARISON TO THE FUND'S BENCHMARK INDEX. The effective duration for the fund was 1.7 years as of June 30. The fund benefited from its emphasis on ARM securities during the period. As short-term interest rates fell in late 1995, the coupon rates on these ARM securities did not fall as quickly or as far *PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT FUND SHARES, WHEN SOLD, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. 3 INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO VALUE OF $100,000 INVESTED JUNE 30, 1996 [GRAPH] $100,000 INVESTED IN FEBRUARY 1993 AND HELD THROUGH JUNE 30, 1996, WOULD HAVE GROWN TO $112,202. THE FUND'S PERFORMANCE REFLECTS THE MAXIMUM SALES CHARGE OF 1%, WHILE NO SUCH CHARGES ARE REFLECTED IN THE INDEX OR AVERAGE. ALL PERFORMANCE FIGURES INCLUDE REINVESTED DISTRIBUTIONS. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. AVERAGE ANNUALIZED TOTAL RETURNS THROUGH 6/30/96, INCLUDING 1% SALES CHARGE One Year . . . . . . . . . . . . . .5.27% Since Inception (2/2/93) . . . . . .3.44% DURING SOME PERIODS, PIPER CAPITAL WAIVED OR PAID FUND EXPENSES AND/OR PIPER JAFFRAY, THE FUND'S DISTRIBUTOR, VOLUNTARILY LIMITED 12B-1 FEES FOR THE FUND. HAD THESE FEES AND EXPENSES NOT BEEN WAIVED, THE AVERAGE ANNUALIZED TOTAL RETURNS INCLUDING REINVESTED DISTRIBUTIONS AND THE FUND'S SALES CHARGE WOULD HAVE BEEN 4.05% ONE YEAR AND 3.02% SINCE INCEPTION. as market rates due to the lagging nature of their reset frequency. As a result, they increased in value. Since the coupons did not experience significant downward adjustments as rates fell, they offered comparatively attractive income as rates began to rise, helping to hold their value. TO MEET FUND REDEMPTIONS DURING THE PAST YEAR, WE SOLD SOME OF THE FUND'S TREASURY SECURITIES AND, IN TURN, CAUSED A SLIGHT INCREASE IN ITS ALLOCATION TO U.S. AGENCY ARM SECURITIES. At the end of the period, the fund had approximately 72% of its net assets in U.S. agency ARM securities. We expect to maintain our weighting in ARM securities until we see indications of changing market conditions. Not only does the current market for these securities appear strong, but we believe they have the potential to generate high relative income in the rest of 1996. EARLY PRINCIPAL PAYMENTS IN LATE 1995 HAVE HAD A NEGATIVE IMPACT ON THE FUND'S INCOME. Borrowers were refinancing their adjustable rate mortgages at a faster speed due to the lower rates available on fixed rate mortgages. Since many of the ARM securities held in the fund were purchased at premium prices, the faster prepayments caused the fund to amortize these premiums more quickly. That reduced the fund's current income level. We were generally successful at minimizing the impact of prepayments by selling some of the fund's ARM securities that we believed were most susceptible to prepayments. As rates have risen in 1996, the refinancing opportunity has been limited, further reducing prepayments. SOME OF THE FUND'S 1995 DIVIDENDS WERE RECLASSIFIED AS A RETURN OF CAPITAL FOR TAX PURPOSES DUE TO THE SALE OF A CANADIAN MORTGAGE-BACKED SECURITY THAT RECOGNIZED FOREIGN CURRENCY LOSSES. Tax regulations require that certain foreign currency losses be treated as ordinary losses and be offset against net investment income when determining taxable ordinary income. As a result, some of the fund's distributions to investors were classified as a return of capital. A return of capital means that the distribution is not reported as taxable income but can be used to reduce the investor's cost basis in the fund. This will affect the capital gain or loss calculation upon your sale of the fund's shares. Your tax adviser can provide more information about how this will affect you in your tax reporting. 4 INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO GOING FORWARD, WE HAVE POSITIONED THE FUND TO PERFORM BEST IN A STABLE INTEREST RATE ENVIRONMENT, though we can't rule out the possibility that the Fed may raise short-term interest rates in August. The recent rise in yields has improved bond market fundamentals, and our expectation is that the economy will grow moderately in the coming months. We intend to maintain a neutral strategy and expect ARM securities to perform well in the less volatile market environment we anticipate. The securities in the fund have a relatively high average coupon, which reduces their price sensitivity to changing market rates and allows them to maintain relatively high levels of income. IN THE NEXT FEW WEEKS, YOU WILL RECEIVE A PROXY IN THE MAIL ASKING YOU TO APPROVE A PROPOSAL TO MERGE THIS FUND INTO THE ADJUSTABLE RATE MORTGAGE SECURITIES FUND, ANOTHER PIPER FUND. Piper Capital Management recommended to the board of directors of Institutional Government Adjustable Portfolio that a reorganization take place because the fund has been unable to attract and retain sufficient assets for its continued operation to be economically feasible. The board of directors approved the recommendation and recommends shareholders vote for the proposal. If the plan is approved, you will become a shareholder of the Adjustable Rate Mortgage Securities Fund and will receive shares equal to the value of your shares in Institutional Government Adjustable Portfolio. The Adjustable Rate Mortgage Securities Fund shares would be issued on a net asset value basis, and you would incur no sales charge. I manage Adjustable Rate Mortgage Securities Fund and would remain primarily responsible for its day-to-day management. Thank you for your investment in Institutional Government Adjustable Portfolio. As always, my efforts are dedicated to reaching the fund's objective and helping you achieve your financial goals. Sincerely, /s/ Tom McGlinch Tom McGlinch Portfolio Manager 5 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF ASSETS AND LIABILITIES JUNE 30, 1996
Institutional Institutional Money Government Market Adjustable Fund Portfolio ----------- ------------ ASSETS: Investments in securities at market value* (note 2) (including repurchase agreements of $61,051,000 and $46,000, respectively) ............................... $ 173,849,628 5,670,773 Cash in bank on demand deposit ........................... 48,026 48,058 Organization costs (note 2) .............................. 27,167 15,295 Mortgage security paydowns receivable .................... -- 28,925 Accrued interest receivable .............................. 575,266 38,165 ----------- ------------ Total assets ......................................... 174,500,087 5,801,216 ----------- ------------ LIABILITIES: Dividends payable to shareholders ........................ 664,593 25,308 Accrued investment management fee ........................ 19,863 1,436 ----------- ------------ Total liabilities .................................... 684,456 26,744 ----------- ------------ Net assets applicable to outstanding capital stock ....... $ 173,815,631 5,774,472 ----------- ------------ ----------- ------------ REPRESENTED BY: Capital stock - authorized 100 billion shares of $0.01 par value of Institutional Money Market Fund and 10 billion shares of $0.01 par value of Institutional Government Adjustable Portfolio; outstanding, 173,815,631 and 608,858 shares, respectively ......................... $ 1,738,156 6,089 Additional paid-in capital ............................... 172,077,475 9,124,869 Distributions in excess of net investment income ......... -- (25,308) Accumulated net realized loss on investments ............. -- (3,355,290) Unrealized appreciation of investments ................... -- 24,112 ----------- ------------ Total - representing net assets applicable to outstanding capital stock ........................ $ 173,815,631 5,774,472 ----------- ------------ ----------- ------------ Net asset value per share of outstanding capital stock ... $ 1.00 9.48 ----------- ------------ ----------- ------------ * Investments in securities at identified cost ........... $ 173,849,628 5,646,661 ----------- ------------ ----------- ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 6 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF OPERATIONS FOR THE YEAR ENDED JUNE 30, 1996
Institutional Institutional Money Government Market Adjustable Fund Portfolio ----------- ------------ INCOME: Interest (net of interest expense of $1,750 for Institutional Government Adjustable Portfolio) ....... $ 5,748,809 673,117 ----------- ------------ EXPENSES (NOTE 5): Investment management fee ................................ 155,276 30,710 Custodian, accounting and transfer agent fees ............ 123,526 52,701 Shareholder account servicing fees ....................... 1,206 365 Registration fees ........................................ 26,964 12,351 Reports to shareholders .................................. 21,026 23,265 Amortization of organization costs ....................... 14,204 7,997 Directors' fees .......................................... 5,611 5,127 Audit and legal fees ..................................... 35,540 30,874 Other expenses ........................................... 12,193 15,433 ----------- ------------ Total expenses ....................................... 395,546 178,823 Less expenses waived by the advisor ...................... (32,746) (116,698) ----------- ------------ Net expenses before expenses paid indirectly ......... 362,800 62,125 Less expenses paid indirectly ............................ (490) (424) ----------- ------------ Total net expenses ................................... 362,310 61,701 ----------- ------------ Net investment income ................................ 5,386,499 611,416 ----------- ------------ NET REALIZED AND UNREALIZED GAINS (LOSSES) ON INVESTMENTS: Net realized loss on investments (note 3) ................ -- (143,585) Net change in unrealized appreciation or depreciation of investments ............................................ -- 190,446 ----------- ------------ Net gain on investments ................................ -- 46,861 ----------- ------------ Net increase in net assets resulting from operations ....................................... $ 5,386,499 658,277 ----------- ------------ ----------- ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 7 - - - -------------------------------------------------------------------------------- FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS
Institutional Money Institutional Government Market Fund Adjustable Portfolio ------------------------------ -------------------------- Year Ended Year Ended Year Ended Year Ended 6/30/96 6/30/95 6/30/96 6/30/95 -------------- ------------- ----------- ------------ OPERATIONS: Net investment income .................................. $ 5,386,499 1,764,252 611,416 1,295,309 Net realized loss on investments ......................... -- -- (143,585) (2,209,087) Net change in unrealized appreciation or depreciation of investments ............................................ -- -- 190,446 1,791,630 -------------- ------------- ----------- ------------ Net increase in net assets resulting from operations ... 5,386,499 1,764,252 658,277 877,852 -------------- ------------- ----------- ------------ DISTRIBUTIONS TO SHAREHOLDERS: From net investment income ............................... (5,386,499) (1,764,252) (362,543) (1,105,594) Tax return of capital .................................... -- -- (221,821) (148,061) -------------- ------------- ----------- ------------ Total distributions .................................... (5,386,499) (1,764,252) (584,364) (1,253,655) -------------- ------------- ----------- ------------ CAPITAL SHARE TRANSACTIONS (NOTE 4): Proceeds from sales ...................................... 590,483,864 168,842,836 187,462 875,301 Proceeds from shares issued for reinvestment of distributions .......................................... 4,730,393 1,434,995 505,527 983,642 Payments for shares redeemed ............................. (473,887,488) (152,763,914) (9,962,203) (21,423,001) -------------- ------------- ----------- ------------ Increase (decrease) in net assets from capital share transactions ......................................... 121,326,769 17,513,917 (9,269,214) (19,564,058) -------------- ------------- ----------- ------------ Total increase (decrease) in net assets .............. 121,326,769 17,513,917 (9,195,301) (19,939,861) Net assets at beginning of year ............................ 52,488,862 34,974,945 14,969,773 34,909,634 -------------- ------------- ----------- ------------ Net assets at end of year ................................ $ 173,815,631 52,488,862 5,774,472 14,969,773 -------------- ------------- ----------- ------------ -------------- ------------- ----------- ------------ Distributions in excess of net investment income ......... $ -- -- (25,308) (198,326) -------------- ------------- ----------- ------------ -------------- ------------- ----------- ------------
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 8 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION Piper Institutional Funds Inc. (the company) is registered under the Investment Company Act of 1940 (as amended) as a single, open-end investment management company. The company currently includes two diversified series: Institutional Money Market Fund and Institutional Government Adjustable Portfolio (the funds). The company's articles of incorporation permit the board of directors to create additional series in the future. Institutional Money Market Fund invests in short-term securities that are issued or guaranteed as to payment of principal and interest by the U.S. government, its agencies or instrumentalities, and repurchase agreements backed by such securities. Institutional Government Adjustable Portfolio invests primarily in adjustable rate mortgage (ARM) securities that are issued and guaranteed as to payment of principal and interest by the U.S. government, its agencies or instrumentalities. The fund may also invest in privately issued ARM securities, mortgage-backed securities other than ARM securities, other types of U.S. government securities, Canadian government securities, structured securities including foreign linked index securities and corporate debt securities. The fund may also purchase securities through the sale-forward (dollar-roll) program. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INVESTMENTS IN SECURITIES For Institutional Money Market Fund, pursuant to Rule 2a-7 of the Investment Company Act of 1940 (as amended), securities are valued at amortized cost, which approximates market value, in order to maintain a constant net asset value of $1 per share. For Institutional Government Adjustable Portfolio, the values of fixed income securities are determined using pricing services or prices quoted by independent brokers. Exchange-listed options are valued at the last sales price, and open financial futures contracts are valued at the last settlement price. When market quotations are not readily available, securities are valued at fair value according to methods selected in good faith by the board of directors. Short-term securities with maturities of 60 days or less are valued at amortized cost which approximates market value. Securities transactions are accounted for on the date the securities are purchased or sold. Realized gains and losses are calculated on the identified-cost basis. Interest income, including amortization of bond discount and premium computed on a level-yield basis, is accrued daily. OPTIONS TRANSACTIONS For hedging purposes, Institutional Government Adjustable Portfolio may buy and sell put and call options, write covered call options on portfolio securities, and write cash-secured puts. The risk in writing a call option is that the fund gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the fund may incur a loss if the market price of the security decreases and the option is exercised. The risk of buying an option is that the fund pays a premium whether or not the option is exercised. The fund also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. Option contracts are valued daily and unrealized appreciation or depreciation is recorded. The fund will realize a gain or loss upon expiration or closing of the option transaction. When an option is exercised, the proceeds on the sale of a 9 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS written call option, the purchase cost of a written put option, or the cost of a security for purchased put and call options is adjusted by the amount of premium received or paid. FUTURES TRANSACTIONS In order to gain exposure to or protect against changes in the market, Institutional Government Adjustable Portfolio may buy and sell financial futures contracts and related options. Risks of entering into futures contracts and related options include the possibility there may be an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the fund is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the fund each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The fund recognizes a realized gain or loss when the contract is closed or expires. INTEREST RATE TRANSACTIONS To preserve a return or spread on a particular investment or portion of its portfolio or for other non-speculative purposes, Institutional Government Adjustable Portfolio may enter into various hedging transactions, such as interest rate swaps and the purchase of interest rate caps and floors. Interest rate swaps involve the exchange of commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually based notional principal amount from the party selling the interest rate floor. If forecasts of interest rates and other market factors are incorrect, investment performance will diminish compared to what performance would have been if these investment techniques were not used. Even if the forecasts are correct, there is risk that the positions may correlate imperfectly with the asset or liability being hedged. Other risks of entering into these transactions are that a liquid secondary market may not always exist or that the other party to the transaction may not perform. For interest rate swaps, caps and floors, the fund accrues weekly, as an increase or decrease to interest income, the current net amount due to or owed by the fund. Interest rate swaps, caps and floors are valued from prices quoted by independent brokers. These valuations represent the present value of all future cash settlement amounts based on implied forward interest rates. SECURITIES PURCHASED ON A WHEN-ISSUED BASIS Delivery and payment for securities that have been purchased by Institutional Government Adjustable Portfolio on a forward-commitment or when-issued basis can take place a month or more after the transaction date. During this period, such securities do not earn interest, are subject to market fluctuation and may increase or decrease in value prior to their delivery. The fund maintains, in a segregated account with its custodian, assets with a market value equal to the amount of its purchase commitments. The purchase of securities on a when-issued or forward-commitment 10 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS basis may increase the volatility of the fund's net asset value if the fund makes such purchases while remaining substantially fully invested. As of June 30, 1996, the fund had no outstanding when-issued or forward commitments. In connection with its ability to purchase securities on a when-issued or forward- commitment basis, the fund may enter into mortgage "dollar rolls" in which the fund sells securities for delivery in the current month and simultaneously contracts with the same counterparty to repurchase similar (same type, coupon and maturity) but not identical securities on a specified future date. As an inducement to "roll over" its purchase commitments, the fund receives negotiated fees. For year ended June 30, 1996, the fund earned no such fees. FEDERAL TAXES Each fund is treated separately for federal income tax purposes. Each fund intends to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and not be subject to federal income tax. Therefore, no income tax provision is required. In addition, on a calendar-year basis, the funds will distribute substantially all of their taxable net investment income and realized gains, if any, to avoid the payment of any federal excise taxes. Net investment income and net realized gains (losses) may differ for financial statement and tax purposes primarily because of the recognition of certain foreign currency gains (losses) as ordinary income (loss) for tax purposes and the non-deductibility of amortization of organization costs. The character of distributions made during the year from net investment income or net realized gains may differ from its ultimate characterization for federal income tax purposes. Distributions which exceed the net investment income or net realized gains for financial statement purposes are presented as an "excess distribution" in the statements of changes in net assets and the financial highlights. Distributions that exceed the net investment income or net realized gains recorded on a tax basis are presented as a "tax return of capital" in the statements of changes in net assets and the financial highlights. In addition, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the funds. On the statement of assets and liabilities, as a result of permanent book-to-tax differences, reclassification adjustments have been made for Institutional Government Adjustable Portfolio to decrease additional paid-in capital by $3,463, increase distributions in excess of net investment income by $75,855 and decrease accumulated net realized losses by $79,318. DISTRIBUTIONS TO SHAREHOLDERS Distributions to shareholders from net investment income are declared daily and paid monthly. Net realized gains distributions, if any, will be made at least annually. Distributions are payable in cash or reinvested in additional shares. REPURCHASE AGREEMENTS For repurchase agreements entered into with certain broker-dealers, the funds, along with other affiliated registered investment companies, may transfer uninvested cash balances into an individual, joint or tri-party trading account, the daily aggregate of which is invested in repurchase agreements secured by U.S. government or agency obligations. Securities pledged as collateral for all individual and joint repurchase agreements are held by the funds' custodian bank until maturity of the repurchase agreement. Securities pledged as collateral for all tri-party repurchase agreements are 11 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS held by a third-party custodian until maturity of the repurchase agreement. Provisions for all agreements ensure that the daily market value of the collateral is in excess of the repurchase amount, including accrued interest, to protect the funds in the event of a default. ORGANIZATION COSTS Organization costs were incurred in connection with the start up and initial registration of the funds. These costs are amortized over 60 months on a straight-line basis. If any or all of the shares representing initial capital of the fund are redeemed by any holder thereof prior to the end of the amortization period, the proceeds will be reduced by the unamortized organization cost balance in the same proportion as the number of shares redeemed bears to the number of initial shares outstanding preceding the redemption. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Management is also required to make disclosures of contingent assets and liabilities at the date of the financial statements and the reported results of operations during the reporting period. Actual results could differ from those estimates. (3) INVESTMENT SECURITY TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than temporary investments in short-term securities (for Institutional Government Adjustable Portfolio), for the year ended June 30, 1996 were as follows:
Institutional Institutional Government Money Market Adjustable Fund Portfolio -------------- ----------- Purchases .......................................... $ 3,703,354,777 4,288,478 Proceeds from sales ................................ $ 3,581,950,731 13,282,084
For the year ended June 30, 1996, no brokerage commissions were paid to Piper Jaffray Inc., an affiliated broker. (4) CAPITAL SHARE TRANSACTIONS Transactions in shares of each fund for the years ended June 30, 1996, and June 30, 1995, were as follows:
Institutional Institutional Government Money Market Adjustable Fund Portfolio ------------- ----------- 1996: Sold .............................................. 590,483,864 19,737 Issued for reinvested distributions ............... 4,730,393 53,334 Redeemed .......................................... (473,887,488) (1,049,909) ------------- ----------- Increase (decrease) ........................... 121,326,769 (976,838) ------------- ----------- ------------- ----------- 1995: Sold .............................................. 168,842,836 95,422 Issued for reinvested distributions ............... 1,434,995 104,898 Redeemed .......................................... (152,763,914) (2,304,441) ------------- ----------- Increase (decrease) ......................... 17,513,917 (2,104,121) ------------- ----------- ------------- -----------
(5) EXPENSES The company has entered into an investment management agreement with Piper Capital Management (Piper Capital) under which Piper Capital manages each fund's assets and furnishes related office facilities, equipment, research and personnel. The 12 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS agreement requires each fund to pay Piper Capital a monthly fee based on average daily net assets. The fee for Institutional Money Market Fund is equal to an annual rate of 0.15%. The fee for Institutional Government Adjustable Portfolio is equal to an annual rate of 0.30%. The company has also entered into shareholder servicing agreements under which Piper Jaffray Inc. (Piper Jaffray) and Piper Trust Company perform various transfer and dividend disbursing agent services. The fees, which are paid monthly to Piper Jaffray and Piper Trust Company for providing these services, are equal to an annual rate of $9.00 per active shareholder account and $6.00 per inactive account for Institutional Money Market Fund and $7.50 per active shareholder account and $1.60 per closed account for Institutional Government Adjustable Portfolio. In addition to the investment management and shareholder account servicing fees, each fund is responsible for paying most other operating expenses including: outside directors' fees and expenses; custodian fees; registration fees; printing and shareholder reports; transfer agent fees and expenses; legal, auditing and accounting services; organization costs; insurance; interest; taxes and other miscellaneous expenses. For the year ended June 30, 1996, Piper Capital voluntarily limited total fees and expenses, excluding interest and income tax expenses, to an annual rate of 0.35% and 0.60% of average daily net assets on an annual basis for Institutional Money Market Fund and Institutional Government Adjustable Portfolio, respectively. Expenses paid indirectly represent a reduction of custodian fees for earnings on cash balances maintained by the funds. Sales charges received by Piper Jaffray for distributing shares of Institutional Government Adjustable Portfolio were $4 for the year ended June 30, 1996. (6) CAPITAL LOSS CARRYOVER For federal income tax purposes, Institutional Government Adjustable Portfolio had capital loss carryovers of $3,355,290 at June 30, 1996, which, if not offset by subsequent capital gains, will expire in 2002 through 2005. It is unlikely the board of directors will authorize a distribution of any net realized capital gains until the available capital loss carryovers have been offset or expired. (7) PROPOSED REORGANIZATION The board of directors has approved, subject to shareholder approval, a reorganization pursuant to which Adjustable Rate Mortgage Securities Fund ('Adjustable Rate Fund'), a series of Piper Funds Inc. - II, will acquire substantially all of the assets of Institutional Government Adjustable Portfolio. Shareholders of Institutional Government Adjustable Portfolio will become shareholders of Adjustable Rate Fund, receiving shares of Adjustable Rate Fund with a value equal to the value of their holdings in Institutional Government Adjustable Portfolio. The reorganization is subject to the approval of a majority of the outstanding shares of Institutional Government Adjustable Portfolio. A special meeting to vote on the reorganization is currently scheduled for September 12, 1996. 13 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (8) FINANCIAL HIGHLIGHTS Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows: INSTITUTIONAL MONEY MARKET FUND
Year Year Year Period Ended Ended Ended Ended 6/30/96 6/30/95 6/30/94 6/30/93(c) ------- ------- ------- ------- Net asset value, beginning of period ................................ $ 1.00 1.00 1.00 1.00 ------- ------- ------- ------- Operations: Net investment income ............................................... 0.05 0.05 0.03 0.01 ------- ------- ------- ------- Total from operations ............................................ 0.05 0.05 0.03 0.01 ------- ------- ------- ------- Distributions from net investment income .............................. (0.05) (0.05) (0.03) (0.01) ------- ------- ------- ------- Net asset value, end of period .................................. $ 1.00 1.00 1.00 1.00 ------- ------- ------- ------- ------- ------- ------- ------- Total return (a) ...................................................... 5.42% 5.26% 3.23% 1.24% Net assets at end of period (in millions) ........................... $ 174 52 35 40 Ratio of expenses to average daily net assets (b) ..................... 0.35% 0.35% 0.35% 0.35%(d) Ratio of net investment income to average daily net assets (b) ........ 5.22% 5.17% 3.26% 3.02%(d)
(A) TOTAL RETURN IS BASED ON THE CHANGE IN NET ASSET VALUE DURING THE PERIOD, ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND DOES NOT REFLECT A SALES CHARGE. (B) DURING THE YEARS REFLECTED ABOVE, THE ADVISOR VOLUNTARILY WAIVED FEES AND EXPENSES. HAD THE FUND PAID ALL FEES AND EXPENSES, THE RATIOS OF EXPENSES AND NET INVESTMENT INCOME TO AVERAGE DAILY NET ASSETS WOULD HAVE BEEN AS FOLLOWS: 0.38%/5.19%, 0.49%/5.03% AND 0.61%/3.00% IN FISCAL YEARS 1996, 1995 AND 1994, RESPECTIVELY. BEGINNING IN FISCAL 1996, THE EXPENSE RATIO REFLECTS THE EFFECT OF GROSS EXPENSES PAID INDIRECTLY BY THE FUND. PRIOR PERIOD EXPENSE RATIOS HAVE NOT BEEN ADJUSTED. (C) COMMENCEMENT OF OPERATIONS WAS FEBRUARY 2, 1993. (D) ADJUSTED TO AN ANNUAL BASIS. 14 - - - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS (8) FINANCIAL HIGHLIGHTS (CONTINUED) Per-share data for a share of capital stock outstanding throughout each period and selected information for each period are as follows: INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO
Year Year Year Period Ended Ended Ended Ended 6/30/96 6/30/95 6/30/94 6/30/93(d) ------- ------- ------- ------- Net asset value, beginning of period ............................... $ 9.44 9.46 10.04 10.00 ------- ------- ------- ------- Operations: Net investment income .............................................. 0.59(f) 0.52 0.49 0.18 Net realized and unrealized gains (losses) on investments .......... (0.01) (0.04) (0.57) 0.04 ------- ------- ------- ------- Total from operations ........................................... 0.58 0.48 (0.08) 0.22 ------- ------- ------- ------- Distributions to shareholders: From net investment income ......................................... (0.25) (0.41) (0.50) (0.18) Tax return of capital .............................................. (0.29) (0.09) -- -- ------- ------- ------- ------- Total distributions to shareholders ............................. (0.54) (0.50) (0.50) (0.18) ------- ------- ------- ------- Net asset value, end of period ................................. $ 9.48 9.44 9.46 10.04 ------- ------- ------- ------- ------- ------- ------- ------- Total return (a) ..................................................... 6.34% 5.26% (0.91)% 2.18% Net assets at end of period (in millions) .......................... $ 6 15 35 41 Ratio of expenses to average daily net assets (b) .................... 0.61% 0.55% 0.55% 0.74%(e) Ratio of net investment income to average daily net assets (b) ....... 5.98% 5.54% 5.13% 4.73%(e) Portfolio turnover rate (excluding short-term securities) ............ 43% 43% 110% 26% Amount of borrowings outstanding at end of period (in millions) (c) .............................................................. $ 0 0 9 6 Average amount of borrowings outstanding during the period (in millions) ........................................................ $ -- 1.62 11.71 5.87 Average number of shares outstanding during the period (in millions) .......................................................... 1.03 2.41 5.38 3.37 Average per-share asset amount of borrowings outstanding during the period ........................................................... $ 0.03 0.67 2.18 1.74
(A) TOTAL RETURN IS BASED ON THE CHANGE IN NET ASSET VALUE DURING THE PERIOD, ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND DOES NOT REFLECT A SALES CHARGE. (B) DURING THE YEARS REFLECTED ABOVE, THE ADVISOR VOLUNTARILY WAIVED FEES AND EXPENSES. HAD THE FUND PAID ALL FEES AND EXPENSES, THE RATIOS OF EXPENSES AND NET INVESTMENT INCOME TO AVERAGE DAILY NET ASSETS WOULD HAVE BEEN AS FOLLOWS: 1.75%/4.84%, 0.75%/5.34% AND 0.60%/5.08% IN FISCAL YEARS 1996, 1995 AND 1994, RESPECTIVELY. BEGINNING IN FISCAL 1996, THE EXPENSE RATIO REFLECTS THE EFFECT OF GROSS EXPENSES PAID INDIRECTLY BY THE FUND. PRIOR PERIOD EXPENSE RATIOS HAVE NOT BEEN ADJUSTED. (C) SECURITIES PURCHASED ON A WHEN-ISSUED BASIS FOR WHICH LIQUID, HIGH-GRADE DEBT OBLIGATIONS ARE MAINTAINED IN A SEGREGATED ACCOUNT ARE NOT CONSIDERED BORROWINGS. SEE NOTE 2 IN THE NOTES TO FINANCIAL STATEMENTS. (D) COMMENCEMENT OF OPERATIONS WAS FEBRUARY 2, 1993. (E) ADJUSTED TO AN ANNUAL BASIS. (F) BASED ON AVERAGE SHARES OUTSTANDING DURING THE YEAR. 15 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES INSTITUTIONAL MONEY MARKET FUND JUNE 30, 1996
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) U.S. GOVERNMENT AND AGENCY SECURITIES (62.0%): Federal Farm Credit Bank Floating Rate Notes (b) (0.9%): 5.19%, 2/13/97 ...................................... $ 1,500,000 1,499,460 ----------- Federal Home Loan Bank Discount Notes (6.1%): 5.30%, 8/12/96 ........................................ 985,000 978,909 5.17%, 8/19/96 ........................................ 2,640,000 2,621,422 5.12%, 9/20/96 ........................................ 1,000,000 988,480 5.18%, 10/4/96 ........................................ 1,000,000 986,332 5.27%, 7/22/96 ........................................ 5,000,000 4,984,629 ----------- 10,559,772 ----------- Federal Home Loan Bank Floating Rate Notes (b) (1.7%): 5.45%, 9/2/97 ......................................... 1,000,000 997,109 5.35%, 11/21/96 ....................................... 2,000,000 1,999,813 ----------- 2,996,922 ----------- Federal Home Loan Mortgage Corporation Coupon Notes (1.7%): 7.88%, 12/20/96 ....................................... 2,000,000 2,021,274 5.56%, 11/7/96 ........................................ 1,000,000 999,848 ----------- 3,021,122 ----------- Federal Home Loan Mortgage Corporation Discount Notes (22.6%): 5.25%, 8/6/96 ......................................... 3,000,000 2,984,250 5.21%, 8/8/96 ......................................... 1,650,000 1,640,926 5.32%, 9/3/96 ......................................... 2,000,000 1,981,084 5.33%, 9/20/96 ........................................ 2,000,000 1,976,015 5.23%, 10/16/96 ....................................... 1,255,000 1,235,491 5.18%, 7/3/96 ......................................... 3,000,000 2,999,137 5.19%, 7/3/96 ......................................... 2,475,000 2,474,286 5.17%, 7/9/96 ......................................... 3,000,000 2,996,553 5.27%, 7/10/96 ........................................ 5,000,000 4,993,413 5.25%, 7/15/96 ........................................ 3,000,000 2,993,875 5.28%, 7/15/96 ........................................ 2,000,000 1,995,893 5.18%, 7/16/96 ........................................ 5,000,000 4,989,208 5.19%, 7/16/96 ........................................ 3,000,000 2,993,513 5.25%, 7/18/96 ........................................ 3,000,000 2,992,563 ----------- 39,246,207 ----------- Federal National Mortgage Association Discount Notes (14.0%): 5.15%, 8/1/96 ......................................... 1,500,000 1,493,348 5.24%, 8/6/96 ......................................... 3,000,000 2,984,280 5.29%, 8/13/96 ........................................ 2,000,000 1,987,363 4.80%, 8/16/96 ........................................ 2,000,000 1,987,733 5.23%, 8/20/96 ........................................ 3,000,000 2,978,208 5.18%, 7/24/96 ........................................ 8,000,000 7,973,525 5.27%, 7/25/96 ........................................ 5,000,000 4,982,433 ----------- 24,386,890 ----------- Federal National Mortgage Association Floating Rate Notes (b) (5.2%): 5.54%, 10/4/96 ........................................ 2,000,000 2,000,000 5.44%, 5/1/97 ......................................... 3,000,000 2,998,741 5.47%, 6/20/97 ........................................ 2,000,000 1,998,084 5.45%, 6/2/99 ......................................... 2,000,000 1,986,422 ----------- 8,983,247 -----------
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- Student Loan Marketing Association Floating Rate Notes (b) (4.6%): 5.59%, 10/30/97 ..................................... $ 2,360,000 2,360,000 6.08%, 7/1/96 ......................................... 2,700,000 2,700,000 6.13%, 6/30/97 ........................................ 1,000,000 999,585 5.45%, 12/20/96 ....................................... 2,000,000 2,000,000 ----------- 8,059,585 ----------- U.S. Treasury Notes and Bonds (5.2%): 6.50%, 11/30/96 ....................................... 1,500,000 1,506,483 6.88%, 2/28/97 ........................................ 3,000,000 3,029,435 6.63%, 3/31/97 ........................................ 3,000,000 3,023,173 8.50%, 4/15/97 ........................................ 1,500,000 1,533,001 ----------- 9,092,092 ----------- Total U.S. Government and Agency Securities (cost: $107,845,297) ...................................... 107,845,297 ----------- OTHER U.S. GOVERNMENT AGENCY-BACKED (2.9%): Downey Savings & Loan, LOC Federal Home Loan Bank San Francisco, 5.50%, 7/12/96 ............................ 1,000,000 998,319 Downey Savings & Loan, LOC Federal Home Loan Bank San Francisco, 5.25%, 8/16/96 ............................ 1,000,000 993,292 Fidelity Federal Bank, LOC Federal Home Loan Bank San Francisco, 5.22%, 9/27/96 ............................ 3,000,000 2,961,720 ----------- Total Other U.S. Government Agency-Backed (cost: $4,953,331) ........................................ 4,953,331 ----------- REPURCHASE AGREEMENTS (35.1%): Repurchase agreement with Goldman Sachs in a joint trading account, collateralized by U.S. government agency securities, acquired on 6/28/96, accrued interest of $486, 5.55%, 7/1/96 ...................... 1,051,000 1,051,000 Repurchase agreement with Goldman Sachs in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/26/96, accrued interest of $5,889, 5.30%, 7/1/96 ................................ 8,000,000(c) 8,000,000 Repurchase agreement with Goldman Sachs in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/26/96, accrued interest of $7,950, 5.30%, 7/2/96 ................................ 9,000,000(c) 9,000,000 Repurchase agreement with Goldman Sachs in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/5/96, accrued interest of $12,015, 5.34%, 7/2/96 ............................... 3,000,000(c) 3,000,000 Repurchase agreement with Goldman Sachs in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/6/96, accrued interest of $14,187, 5.32%, 7/8/96 ............................... 3,000,000(c)(d) 3,000,000
SEE ACCOMPANYING NOTES TO INVESTMENTS IN SECURITIES. 16 - - - -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES INSTITUTIONAL MONEY MARKET FUND (CONTINUED)
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- Repurchase agreement with Goldman Sachs in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/6/96, accrued interest of $15,517, 5.32%, 7/11/96 ............................ $ 3,000,000(c)(d) 3,000,000 Repurchase agreement with Morgan Stanley in a tri-party account, collateralized by U.S. government agency securities, acquired on 5/28/96, accrued interest of $39,825, 5.31%, 8/26/96 .............................. 3,000,000(c)(d) 3,000,000 Repurchase agreement with Morgan Stanley in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/24/96, accrued interest of $18,865, 5.39%, 7/1/96 ............................... 18,000,000(c) 18,000,000 Repurchase agreement with Morgan Stanley in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/26/96, accrued interest of $8,338, 5.36%, 7/3/96 ................................ 8,000,000(c) 8,000,000 Repurchase agreement with Morgan Stanley in a tri-party account, collateralized by U.S. government agency securities, acquired on 6/7/96, accrued interest of $20,689, 5.32%, 7/5/96 ............................... 5,000,000(c) 5,000,000 ----------- Total Repurchase Agreements (cost: $61,051,000) ................................ 61,051,000 ----------- Total Investments in Securities (100.0%) (cost: $173,849,628) (e) ........................... 173,849,628 ----------- Liabilities in excess of other assets (-0.0%) ....... (33,997) ----------- Net assets (100.0%) ................................ $ 173,815,631 ----------- -----------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) INTEREST RATE VARIES TO REFLECT CURRENT MARKET CONDITIONS; RATE SHOWN IS THE EFFECTIVE RATE ON JUNE 30, 1996. THE MATURITY DATE REPRESENTS FINAL MATURITY. HOWEVER, FOR PURPOSES OF RULE 2A-7, MATURITY DATE IS THE NEXT INTEREST RATE RESET DATE. (C) TRI-PARTY REPURCHASE AGREEMENTS REPRESENT AGREEMENTS WHERE UNINVESTED CASH BALANCES ARE TRANSFERRED TO AN INDEPENDENT THIRD-PARTY CUSTODIAN (BANK OF NEW YORK) AND THE COLLATERAL PLEDGED BY THE COUNTERPARTY TO THE AGREEMENT IS HELD AT THE SAME THIRD-PARTY CUSTODIAN FOR THE BENEFIT OF THE FUND. (D) REPURCHASE AGREEMENTS WITH GREATER THAN SEVEN DAYS TO MATURITY ARE CONSIDERED ILLIQUID. THE AGGREGATE VALUE OF SUCH REPURCHASE AGREEMENTS REPRESENTS 5.2% OF NET ASSETS. (E) ALSO REPRESENTS COST FOR FEDERAL INCOME TAX PURPOSES. INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO JUNE 30, 1996
Principal Market Name of Issuer Amount Value (a) - - - --------------------------------------------------------- ---------- ----------- (PERCENTAGES OF EACH INVESTMENT CATEGORY RELATE TO TOTAL NET ASSETS) U.S. GOVERNMENT AND AGENCY SECURITIES (97.4%): U.S. Government Securities (11.3%): U.S. Treasury Note, 6.00%, 11/30/97 ................ $ 650,000 650,325 ----------- U.S. Agency Mortgage-Backed Securities (86.1%): Fixed Rate (14.3%): 7.50%, FNMA, 2/1/10 .................................. 823,589 828,473 ----------- Adjustable Rate (71.8%): 7.25%, FHLMC, 1/1/17 ................................. 926,788 942,423 7.59%, FNMA, 2/1/22 .................................. 1,460,184 1,510,268 6.50%, GNMA, 11/20/25 ................................ 1,678,081 1,693,284 ----------- 4,145,975 ----------- Total U.S. Government and Agency Securities (cost: $5,600,661) ................................ 5,624,773 ----------- REPURCHASE AGREEMENTS (0.8%): Repurchase agreement with Goldman Sachs in a joint trading account, collateralized by U.S. government agency securities, acquired on 6/28/96, accrued interest of $21, 5.55%, 7/1/96 (cost: $46,000) ..................................... 46,000 46,000 ----------- Total Investments in Securities (98.2%) (cost: $5,646,661) (b) ............................ 5,670,773 ----------- Other assets in excess of liabilities (1.8%) ....... 103,699 ----------- Net assets (100.0%) ............................... $ 5,774,472 ----------- -----------
NOTES TO INVESTMENTS IN SECURITIES: (A) SECURITIES ARE VALUED IN ACCORDANCE WITH PROCEDURES DESCRIBED IN NOTE 2 TO THE FINANCIAL STATEMENTS. (B) ON JUNE 30, 1996, THE COST OF INVESTMENTS IN SECURITIES FOR FEDERAL INCOME TAX PURPOSES WAS $5,646,661. THE AGGREGATE GROSS UNREALIZED APPRECIATION AND DEPRECIATION OF INVESTMENTS IN SECURITIES WERE AS FOLLOWS: GROSS UNREALIZED APPRECIATION .... $ 46,668 GROSS UNREALIZED DEPRECIATION ...... (22,556) ----------- NET UNREALIZED APPRECIATION .... $ 24,112 ----------- -----------
17 - - - -------------------------------------------------------------------------------- INDEPENDENT AUDITOR'S REPORT THE BOARD OF DIRECTORS AND SHAREHOLDERS PIPER INSTITUTIONAL FUNDS INC.: We have audited the accompanying statements of assets and liabilities, including the schedule of investments in securities, of Institutional Money Market Fund and Institutional Government Adjustable Portfolio (funds within Piper Institutional Funds Inc.) as of June 30, 1996, the related statements of operations for the year then ended, the statements of changes in net assets for each of the years in the two- year period then ended and the financial highlights presented in note 8 to the financial statements. These financial statements and the financial highlights are the responsibility of the funds' management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Investment securities held in custody are confirmed to us by the custodian. As to securities purchased and sold but not received or delivered, we request confirmations from brokers and, where replies are not received, we carry out other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and the financial highlights referred to above present fairly, in all material respects, the financial position of Institutional Money Market Fund and Institutional Government Adjustable Portfolio as of June 30, 1996, and the results of their operations, the changes in their net assets and the financial highlights for the periods stated in the first paragraph above, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Minneapolis, Minnesota July 19, 1996 18 - - - -------------------------------------------------------------------------------- FEDERAL INCOME TAX INFORMATION The following per-share information describes the federal tax treatment of distributions made during the fiscal year. Distributions for the calendar year will be reported to you on Form 1099-DIV. Please consult a tax adviser on how to report these distributions at the state and local levels. INCOME DISTRIBUTIONS (TAXABLE AS ORDINARY DIVIDENDS, NONE QUALIFYING FOR DEDUCTION BY CORPORATIONS)
Institutional Institutional Government Money Market Adjustable Payable Date Fund Portfolio - - - ----------------------------------------------------- --------------- ------------- July 31, 1995.......................................$ 0.0047 0.0417 August 31, 1995...................................... 0.0047 0.0417 September 30, 1995................................... 0.0045 0.0448 October 31, 1995..................................... 0.0046 0.0467 November 30, 1995.................................... 0.0044 0.0492 December 31, 1995.................................... 0.0046 0.0473 January 31, 1996..................................... 0.0045 0.0467 February 29, 1996.................................... 0.0040 0.0470 March 31, 1996....................................... 0.0043 0.0464 April 30, 1996....................................... 0.0041 0.0464 May 31, 1996......................................... 0.0042 0.0452 June 30, 1996........................................ 0.0041 0.0410 ------- ------------- Total...........................................$ 0.0527 0.5441* ------- ------------- ------- -------------
* $0.2921 per share of the total distributions of $0.5441 per share represents a return of capital for tax purposes. 19 - - - -------------------------------------------------------------------------------- DIRECTORS AND OFFICERS DIRECTORS David T. Bennett, CHAIRMAN, HIGHLAND HOMES, INC., USL PRODUCTS, INC., KIEFER BUILT, INC., OF COUNSEL, GRAY, PLANT, MOOTY, MOOTY & BENNETT, P.A. Jaye F. Dyer, PRESIDENT, DYER MANAGEMENT COMPANY William H. Ellis, PRESIDENT, PIPER JAFFRAY COMPANIES INC., PIPER CAPITAL MANAGEMENT INCORPORATED Karol D. Emmerich, PRESIDENT, THE PARACLETE GROUP Luella G. Goldberg, DIRECTOR, TCF FINANCIAL, RELIASTAR FINANCIAL CORP., HORMEL FOODS CORP. George Latimer, CHIEF EXECUTIVE OFFICER, NATIONAL EQUITY FUNDS OFFICERS William H. Ellis, CHAIRMAN OF THE BOARD Paul A. Dow, PRESIDENT Thomas S. McGlinch, SENIOR VICE PRESIDENT Robert H. Nelson, SENIOR VICE PRESIDENT AND TREASURER Nancy S. Olsen, SENIOR VICE PRESIDENT Molly J. Destro, VICE PRESIDENT Amy K. Johnson, VICE PRESIDENT Paul D. Pearson, VICE PRESIDENT Susan Sharp Miley, SECRETARY INVESTMENT ADVISER Piper Capital Management Incorporated 222 SOUTH NINTH STREET, MINNEAPOLIS, MN 55402-3804 CUSTODIAN AND Investors Fiduciary Trust Company TRANSFER AGENT 127 WEST 10TH STREET, KANSAS CITY, MO 64105-1716 LEGAL COUNSEL Dorsey & Whitney LLP 220 SOUTH SIXTH STREET, MINNEAPOLIS, MN 55402 INDEPENDENT KPMG Peat Marwick LLP AUDITORS 4200 NORWEST CENTER, MINNEAPOLIS, MN 55402 20 [LOGO] PIPER CAPITAL MANAGEMENT INCORPORATED 222 SOUTH NINTH STREET MINNEAPOLIS, MN 55402-3804 PIPER JAFFRAY INC., FUND DISTRIBUTOR AND NASD MEMBER. THIS DOCUMENT IS PRINTED ON PAPER MADE FROM 100% TOTAL RECOVERED FIBER, INCLUDING 15% POST-CONSUMER WASTE. In an effort to reduce costs to our shareholders, we have implemented a process to reduce duplicate mailings of the fund's shareholder reports. This householding process should allow us to mail one report to each address where one or more registered shareholders with the same last names reside. If you would like to have additional reports mailed to your address, please call our Shareholder Services area at 1 800 866-7778, or mail your request to: Piper Capital Management Attn: Communications Department 222 South Ninth Street Minneapolis, MN 55402-3804 http://www.piperjaffray.com/ #10700 7/96 190-96 PART C PIPER FUNDS INC.--II ADJUSTABLE RATE MORTGAGE SECURITIES FUND OTHER INFORMATION ITEM 15. INDEMNIFICATION. Incorporated by reference to Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form N-1A, File No. 33-60515, filed December 18, 1995. ITEM 16. EXHIBITS. 1.1 Articles of Incorporation (1) 1.2 Amendment to Articles of Incorporation (1) 2 Bylaws (1) 3 Not Applicable 4 Agreement and Plan of Reorganization is attached as Exhibit A to the Prospectus/Proxy Statement included in Part A of this Registration Statement on Form N-14. 5 See 1.1, 1.2 and 2 above. 6 Investment Advisory and Management Agreement (2) 7.1 Underwriting and Distribution Agreement (2) 7.2 Dealer Agreement (2) 8 Not Applicable 9 Custody and Investment Accounting Agreement (2) 10 Rule 12b-1 Plan (1) 11 Opinion and Consent of Dorsey & Whitney LLP with respect to the legality of the securities being registered * 12 Opinion and Consent of Dorsey & Whitney LLP with respect to tax matters ** C-1 13 Not Applicable 14 Consent of KPMG Peat Marwick LLP * 15 Not Applicable 16 Power of Attorney * 17.1 Rule 24f-2 Election of Registrant (2) 17.2 Form of Proxy Card* - - - ---------------------- * Filed herewith. ** To be filed by post-effective amendment. (1) Incorporated by reference to the Registrant's Registration Statement on Form N-14, File No. 33-58849, filed April 26, 1995. (2) Incorporated by reference to Registrant's initial Registration Statement on Form N-1A filed June 23, 1995. (3) Incorporated by reference to Post-Effective Amendment No. 2 to the Registrant's Registration Statement on Form N-1A, File No. 33-60515, filed December 18, 1995. ITEM 17. UNDERTAKINGS. (1) The undersigned Registrant agrees that prior to any public reoffering of the securities registered through the use of a prospectus which is a part of this Registration Statement by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c) of the Securities Act, the reoffering prospectus will contain the information called for by the applicable registration form for reofferings by persons who may be deemed underwriters, in addition to the information called for by the other items of the applicable form. (2) The undersigned Registrant agrees that every prospectus that is filed under paragraph (1) above will be filed as a part of an amendment to the Registration Statement and will not be used until the amendment is effective, and that, in determining any liability under the 1933 Act, each post-effective amendment shall be deemed to be a new registration statement for the securities offered therein, and the offering of the securities at that time shall be deemed to be the initial bona fide offering of them. C-2 (3) The undersigned Registrant undertakes to file, by post-effective amendment, an opinion of counsel supporting the tax consequences of the proposed reorganization within a reasonable time after the receipt of such opinion. C-3 SIGNATURES As required by the Securities Act of 1933, this registration statement has been signed on behalf of the registrant, in the City of Minneapolis, State of Minnesota, on the 25th day of July, 1996. PIPER FUNDS INC.--II By: /S/ PAUL A. DOW ---------------------------------- Paul A. Dow, President Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. SIGNATURE TITLE DATE /S/ PAUL A. DOW President (principal July 25, 1996 - - - ---------------------------- executive officer) Paul A. Dow /S/ ROBERT H. NELSON Treasurer (principal July 25, 1996 - - - ---------------------------- financial and accounting Robert H. Nelson officer) David T. Bennett* Director Jaye F. Dyer* Director William H. Ellis* Director Karol D. Emmerich* Director Luella G. Goldberg* Director George Latimer* Director * By /S/ ROBERT H. NELSON July 25, 1996 ----------------------- Robert H. Nelson Attorney-in-Fact C-4 EX-11 2 DORSEY OPINION & CONSENT EXHIBIT 11 D O R S E Y & W H I T N E Y L L P Pillsbury Center South 220 South Sixth Street Minneapolis, Minnesota 55402-1498 Telephone: (612) 340-2600 Fax: (612) 340-2868 July 25, 1996 Piper Funds Inc. -- II Piper Jaffray Tower 222 South Ninth Street Minneapolis, Minnesota 55402 Re: Adjustable Rate Mortgage Securities Fund (Series A of Piper Funds Inc. -- II) Shares to be Issued Pursuant to Agreement and Plan of Reorganization Ladies and Gentlemen: We have acted as counsel to Piper Funds Inc. -- II, a corporation organized under the laws of the State of Minnesotal (the "Company"), in connection with its authorization and proposed issuance of its Series A common shares, $.01 par value (the "Shares"). The Shares are to be issued pursuant to an Agreement and Plan of Reorganization (the "Agreement"), by and between the Company and Piper Institutional Funds Inc., a corporation organized under the laws of the State of Minnesota, the form of which Agreement is included as Exhibit A to the Prospectus/Proxy Statement relating to the transactions contemplated by the Agreement included in the Company's Registration Statement on Form N-14 filed with the Securities and Exchange Commission (the "Registration Statement"). In rendering the opinion hereinafter expressed, we have reviewed the proceedings taken by the Company in connection with the authorization and issuance of the Shares, and we have reviewed such questions of law and examined copies of such records of the Company, certificates of public officials and of responsible officers of the Company, and other documents as we have deemed necessary as a basis for such opinion. As to the various matters of fact material to such opinion, we have, when such facts were not independently established, relied to the extent we deem proper on certificates of public officials and of responsible officers of the Company. In connection with such review and examination, we have assumed that all copies of documents provided to us conform to the originals; that all signatures are genuine; and that prior to the consummation of the transactions contemplated thereby, the Agreement will have been duly and validly executed and delivered on behalf of each of the parties thereto in substantially the form included in the Registration Statement. Based on the foregoing, it is our opinion that the Shares, when issued and delivered by the Company pursuant to, and upon satisfaction of the conditions contained in, the Agreement, will be duly authorized, validly issued, fully paid and non-assessable by the Company. In rendering the foregoing opinion (a) we express no opinion as to the laws of any jurisdiction other than the State of Minnesota; and (b) we have assumed, with your concurrence, that the conditions to closing set forth in the Agreement will have been satisfied. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement and to the reference to this firm under the caption "Legal Matters" in the Company's final Prospectus/Proxy Statement relating to the Shares included in the Registration Statement. Very truly yours, /s/ Dorsey & Whitney LLP 2 EX-14 3 CONSENT OF KPMG EXHIBIT 14 INDEPENDENT AUDITORS' CONSENT The Board of Directors Piper Institutional Funds Inc. and Piper Funds Inc.--II: We consent to the incorporation by reference in the registration statement on Form N-14 of Adjustable Rate Mortgage Securities Fund (a series of Piper Funds Inc.--II) of our report dated July 19, 1996, relating to the June 30, 1996 financial statements and financial highlights of Institutional Government Adjustable Portfolio (a series of Piper Institutional Funds Inc.) and our report dated October 13, 1995, relating to the August 31, 1995 financial statements and financial highlights of Adjustable Rate Mortgage Securities Fund. We also consent to the reference to our Firm under the heading "Financial Statements and Experts" in the registration statement. /s/ KPMG Peat Marwick LLP Minneapolis, Minnesota July 24, 1996 EX-16 4 POWER OF ATTORNEY EXHIBIT 16 PIPER FUNDS INC.--II POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Paul A. Dow, William H. Ellis, Robert H. Nelson and Susan S. Miley, and each of them, his or her true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign a Registration Statement on Form N-14 of Piper Funds Inc. -- II (the "Company"), and any and all amendments thereto, including post-effective amendments, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, each acting alone, or the substitutes for such attorneys-in-fact and agents, may lawfully do or cause to be done by virtue hereof. SIGNATURE TITLE DATE /S/ PAUL A. DOW President July 19, 1996 - - - --------------------------- Paul A. Dow /S/ ROBERT H. NELSON Treasurer July 19, 1996 - - - --------------------------- Robert H. Nelson /S/ DAVID T. BENNETT Director July 19, 1996 - - - --------------------------- David T. Bennett /S/ JAYE F. DYER Director July 19, 1996 - - - --------------------------- Jaye F. Dyer /S/ WILLIAM H. ELLIS Director July 19, 1996 - - - --------------------------- William H. Ellis /S/ KAROL D. EMMERICH Director July 19, 1996 - - - --------------------------- Karol D. Emmerich /S/ LUELLA G. GOLDBERG Director July 19, 1996 - - - --------------------------- Luella G. Goldberg /S/ GEORGE LATIMER Director July 19, 1996 - - - --------------------------- George Latimer EX-17.2 5 FORM OF PROXY CARD EXHIBIT 17.2 PROXY INSTITUTIONAL GOVERNMENT ADJUSTABLE PORTFOLIO (A SERIES OF PIPER INSTITUTIONAL FUNDS INC.) PIPER JAFFRAY TOWER 222 SOUTH NINTH STREET MINNEAPOLIS, MINNESOTA 55402-3804 THIS PROXY IS BEING SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF PIPER INSTITUTIONAL FUNDS INC. The undersigned hereby appoints William H. Ellis, Susan S. Miley and Robert H. Nelson, and each of them, with power to act without the other and with the right of substitution in each, as proxies of the undersigned and hereby authorizes each of them to represent and to vote, as designated below, all the shares of Institutional Government Adjustable Portfolio (the "Fund"), a series of Piper Institutional Funds Inc. (the "Company"), held of record by the undersigned on July 22, 1996, at the Special Meeting of shareholders of the Fund to be held on September 12, 1996, or any adjournments or postponements thereof, with all powers the undersigned would possess if present in person. All previous proxies given with respect to the Special Meeting hereby are revoked. THE PROXIES ARE INSTRUCTED TO VOTE AS FOLLOWS: PROPOSAL TO APPROVE AN AGREEMENT AND PLAN OF REORGANIZATION (the "Plan"), by and between the Company, on behalf of the Fund, and Piper Funds Inc. -- II, on behalf of Adjustable Rate Mortgage Securities Fund ("Adjustable Rate Fund"), pursuant to which substantially all of the assets of the Fund will be acquired by Adjustable Rate Fund and shareholders of the Fund will become shareholders of Adjustable Rate Fund receiving shares of Adjustable Rate Fund with a value equal to the value of their holdings in the Fund. A vote in favor of the Plan will be considered a vote in favor of an amendment to the articles of incorporation of the Company required to effect the reorganization as contemplated by the Plan. / / FOR / / AGAINST / / ABSTAIN In their discretion, the proxies are authorized to vote upon such other business as may properly come before the special meeting or any adjournments or postponements thereof. THIS PROXY WILL BE VOTED AS INSTRUCTED ON THE ABOVE PROPOSAL. IT IS UNDERSTOOD THAT, IF NO CHOICE IS SPECIFIED, THIS PROXY WILL BE VOTED "FOR" THE ABOVE PROPOSAL. UPON ALL OTHER MATTERS THE PROXIES SHALL VOTE AS THEY DEEM IN THE BEST INTERESTS OF THE FUND. RECEIPT OF NOTICE OF MEETING AND PROXY STATEMENT IS ACKNOWLEDGED BY YOUR EXECUTION OF THIS PROXY. SIGN, DATE, AND RETURN IN THE ADDRESSED ENVELOPE-NO POSTAGE REQUIRED. PLEASE MAIL PROMPTLY TO SAVE FURTHER SOLICITATION EXPENSE. Dated:_________________________, 1996 _____________________________________ _____________________________________ IMPORTANT: Please sign this proxy exactly as your name appears hereon. When shares are held by joint tenants, both should sign. When signing as attorney, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by president or other authorized officer. If a partnership, please sign in partnership name by partner or other authorized person. -----END PRIVACY-ENHANCED MESSAGE-----