Prospectus dated December 19, 2002
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PROSPECTUS
5,850,000 SHARES
Federated Premier Municipal Income Fund
Common Shares
$15.00 Per Share
---------------------
Investment Objective. Federated Premier Municipal Income Fund (the "Fund")
is a newly organized, diversified, closed-end management investment company. The
Fund's investment objective is to provide current income exempt from federal
income tax, including alternative minimum tax ("AMT"). The Fund cannot assure
you that it will achieve its investment objective.
Investment Portfolio. The Fund will invest primarily in securities that, in
the opinion of bond counsel to the issuer, or on the basis of another authority
believed by Federated Investment Management Company (the Fund's investment
adviser) to be reliable, pay interest exempt from federal income tax, including
AMT. The Fund normally invests substantially all (at least 90%) of its total
assets in tax exempt securities. The Fund will invest at least 80% of its total
assets in investment grade tax exempt securities. The Fund may invest up to 20%
of its total assets in tax exempt securities of below investment grade quality
(but not lower than B). Tax exempt securities of below investment grade quality
are regarded as having predominately speculative characteristics with respect to
the issuer's capacity to pay interest and repay principal, and are commonly
referred to as "junk bonds." Under normal circumstances, the Fund will maintain
a dollar-weighted average portfolio maturity of 15 to 30 years and a
dollar-weighted average duration of 7 to 13 years.
No Prior History. Because the Fund is newly organized, its common shares
("Common Shares") have no history of public trading. Shares of closed-end
investment companies frequently trade at a discount from their net asset values
("NAV") and investors may lose money by purchasing Common Shares in the initial
public offering. This risk may be greater for investors expecting to sell their
Common Shares in a relatively short period after completion of the public
offering. The Common Shares have been approved for listing, subject to notice of
issuance, on the New York Stock Exchange under the symbol "FMN".
Preferred Shares. The Fund intends to use leverage by issuing shares of
preferred stock ("Preferred Shares") representing approximately 38% of the
Fund's capital immediately after their issuance. By using leverage, the Fund
will seek to obtain higher dividends for holders of Common Shares ("Common
Shareholders") than if the Fund did not use leverage. Leveraging is a
speculative technique and there are special risks involved. There can be no
assurance that a leveraging strategy will be used or that it will be successful
during any period in which it is employed. See "Preferred Shares and Leverage,"
"Risks-Leverage Risk" and "Risks-Derivative Contracts and Inverse Floater Risk."
Investing in Common Shares involves certain risks. See "Risks" on page 25
of this prospectus.
Per Share Total
Public offering price $15.00 $87,750,000
Sales load $0.675 $3,948,750
Estimated offering
expenses(1) $0.03 $175,500
Proceeds to the Fund $14.295 $83,625,750
(1) In addition to the sales load, the Fund will pay organizational and
offering expenses of up to $.03 per Common Share, estimated to total $175,500.
"Proceeds to the Fund" (above) reflects such expenses. Federated Investment
Management Company has agreed to pay organizational expenses and offering costs
of the Fund (other than the sales load) that exceed $.03 per Common Share.
The underwriters may purchase up to 877,500 additional Common Shares at the
public offering price, less the sales load, within 45 days from the date of this
prospectus to cover over-allotments.
The Securities and Exchange Commission ("SEC") has not approved or
disapproved of these securities or determined if this prospectus is truthful or
complete. Any representation to the contrary is a criminal offense.
The underwriters expect to deliver Common Shares to purchasers on or about
December 24, 2002.
Merrill Lynch & Co.
UBS Warburg A.G. Edwards & Sons, RBC Capital Markets
Inc.
Wachovia Securities Wells Fargo Securities, Advest, Inc.
LLC
Robert W. Baird & Co. BB&T Capital Markets, a Fahnestock & Co. Inc.
subsidiary of Scott &
Stringfellow, Inc.
Ferris, Baker Watts Janney Montgomery Scott McDonald Investments,
Incorporated LLC Inc.
Parker/Hunter Quick & Reilly, Inc. Stephens Inc.
Incorporated
Stifel, Nicholaus & Company Incorporated
The date of this prospectus is December 19, 2002.
You should read this prospectus, which contains important information about
the Fund, before deciding whether to invest in Common Shares and retain it for
future reference. A Statement of Additional Information, dated December 19,
2002, containing additional information about the Fund, has been filed with the
SEC and is incorporated by reference in its entirety into this prospectus. You
may request a free copy of the Statement of Additional Information, the table of
contents of which is on page 52 of this prospectus, by calling 1-800-341-7400 or
by writing to the Fund, or obtain a copy (and other information regarding the
Fund) from the SEC's web site (http://www.sec.gov).
The Fund's Common Shares are not deposits or obligations of any bank, are
not endorsed or guaranteed by any bank and are not insured or guaranteed by the
U.S. government, the Federal Reserve Board or any other government agency.
TABLE OF CONTENTS
Prospectus Summary.....................................................2
Summary Of Fund Expenses...............................................2
The Fund...............................................................2
Use Of Proceeds........................................................2
The Fund's Investments.................................................2
Preferred Shares And Leverage..........................................2
Risks..................................................................2
How The Fund Manages Risk..............................................2
Management Of The Fund.................................................2
Net Asset Value........................................................2
Distributions..........................................................2
Dividend Reinvestment Plan.............................................2
Description Of Shares..................................................2
Certain Provisions In The Agreement And Declaration Of Trust...........2
Closed-End Fund Structure..............................................2
Repurchase Of Common Shares............................................2
Tax Matters............................................................2
Underwriting...........................................................2
Custodian And Transfer Agent...........................................2
Legal Opinions.........................................................2
Table Of Contents For The Statement Of Additional Information..........2
You should rely only on the information contained or incorporated by
reference in this prospectus. Neither the Fund nor the underwriters have
authorized anyone to provide you with different information. Neither the Fund
nor the underwriters are making an offer of these securities in any state where
the offer is not permitted. You should not assume that the information contained
in this prospectus is accurate as of any other date than the date on the front
of this prospectus.
Until January 13, 2003 (25 days after the date of this prospectus), all
dealers that buy, sell or trade the Common Shares, whether or not participating
in this offering, may be required to deliver a prospectus. This is in addition
to the dealers' obligation to deliver a prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
PROSPECTUS SUMMARY
This is only a summary. This summary does not contain all of the
information that you should consider before investing in Common Shares. You
should review the more detailed information contained in this prospectus and in
the Statement of Additional Information.
THE FUND................................... Federated Premier Municipal Income
Fund is a newly organized,
diversified, closed-end management
investment company. See "The Fund."
THE OFFERING.............................
The Fund is offering 5,850,000
Common Shares, with a par value of
$.01 per Common Share, at $15.00 per
Common Share, through a group of
underwriters led by Merrill Lynch,
Pierce, Fenner & Smith Incorporated
("Merrill Lynch"). You must
purchase at least 100 Common Shares.
The Fund has given the underwriters
an option to purchase up to 877,500
additional Common Shares to cover
orders in excess of 5,850,000 Common
Shares. Federated Investment
Management Company (the "Adviser")
has agreed to pay organizational
expenses and offering costs (other
than the sales load) that exceed
$.03 per Common Share. See
"Underwriting."
INVESTMENT OBJECTIVE............ The Fund's investment objective is
to provide current income exempt
from federal income tax, including
AMT.
INVESTMENT POLICIES............... The Fund will invest primarily in
securities that, in the opinion of
bond counsel to the issuer, or on
the basis of another authority
believed by the Adviser to be
reliable, pay interest exempt from
federal income tax, including AMT.
The Fund normally invests
substantially all (at least 90%) of
its total assets in tax exempt
securities. The Fund will invest at
least 80% of its total assets in
investment grade tax exempt
securities. Investment grade tax
exempt securities are those rated
within the four highest categories
by a nationally recognized
statistical rating organization
("NRSRO"). See "Investment
Ratings." The Fund may invest up
to 20% of its total assets in tax
exempt securities of below
investment grade quality (but not
lower than B). Tax exempt
securities of below investment grade
quality are regarded as having
predominately speculative
characteristics with respect to the
issuer's capacity to pay interest
and repay principal and are commonly
referred to as "junk bonds." See
"Investment Ratings."
Under normal circumstances, the Fund
will maintain a dollar-weighted
average portfolio maturity of 15 to
30 years and a dollar-weighted
average duration of 7 to 13 years.
See "The Fund's Investments."
The Fund may use derivative
contracts for risk management
purposes. Prior to the issuance of
Preferred Shares, the Fund may
leverage the portfolio by investing
up to 10% of its total assets in
inverse floaters and by investing in
derivative contracts. The Fund's
use of derivative contracts will be
limited by the Investment Company
Act of 1940, as amended (the "1940
Act"). See "Risks-Leverage Risk,"
"Risks-Derivative Contract and
Inverse Floater Risk," and
"Preferred Shares and Leverage-Other
Forms of Leverage and Borrowings."
SPECIAL TAX The Fund invests primarily in
CONSIDERATIONS.................... securities that pay interest exempt
from federal income tax, including
AMT. Consequently, the regular
monthly dividends that you receive
generally will be exempt from
federal income tax, including AMT.
However, dividends may be subject to
state and local taxes. In addition,
distributions of any capital gain or
other taxable income will be taxable
to shareholders. The Fund will
allocate dividends paid as exempt
interest dividends, capital gain
dividends and ordinary taxable
dividends between Common
Shareholders and Preferred
Shareholders in proportion to the
total dividends paid to each such
class of shares. See "Tax Matters."
PROPOSED OFFERING OF PREFERRED Approximately one to three months
SHARES AND OTHER FORMS OF after completion of this offering of
LEVERAGE............................... Common Shares, the Fund intends to
offer Preferred Shares that will
represent approximately 38% of the
Fund's capital immediately after
their issuance. For purposes of
this prospectus, the Fund's capital
means the total assets of the Fund
less all liabilities and
indebtedness not representing
Preferred Shares or other senior
securities. The issuance of
Preferred Shares will leverage
Common Shares. Leverage involves
special risks. There is no
assurance that the Fund will issue
Preferred Shares or that, if issued,
the Fund's leveraging strategy will
be successful. See "Risks-Leverage
Risk."
The money that the Fund obtains by
selling Preferred Shares will be
invested in accordance with the
Fund's investment objective and
policies, primarily in long-term tax
exempt securities that generally
will pay fixed rates of interest
over the life of the securities.
The Preferred Shares will pay
dividends based on short-term
interest rates, which will reset
frequently. If the yield, after the
payment of applicable Fund expenses,
on the long-term tax exempt
securities and other instruments
purchased by the Fund, is greater
than the Preferred Share dividend
rate as reset periodically, the
investment of the proceeds of the
Preferred Shares will generate more
income than will be needed to pay
dividends on the Preferred Shares.
If so, the excess income may be used
to pay higher dividends to Common
Shareholders.
Prior to the issuance of Preferred
Shares, the Fund may add leverage to
the portfolio by investing up to 10%
of its total assets in inverse
floaters and by investing in
derivative contracts. The Fund's
use of derivative contracts will be
limited by the 1940 Act. See
"Preferred Shares and Leverage-Other
Forms of Leverage and Borrowings."
The Fund cannot assure you that the
issuance of Preferred Shares or the
use of other forms of leverage will
result in a higher yield on the
Common Shares. Once Preferred
Shares are issued or other forms of
leverage are used, the NAV and
market price of Common Shares and
the yield to Common Shareholders
will be more volatile. See
"Preferred Shares and Leverage,"
"Description of Shares-Preferred
Shares" "Risks-Leverage Risk," and
"Risks-Derivative Contract and
Inverse Floater Risk."
INVESTMENT ADVISER............. Federated Investment Management
Company will be the Fund's
investment adviser. The Adviser
will receive an annual fee in a
maximum amount equal to 0.55% of the
average daily value of the Fund's
Managed Assets. "Managed Assets"
means the total assets of the Fund
(including assets attributable to
any Preferred Shares or borrowings
that may be outstanding) minus the
sum of accrued liabilities (other
than debt representing financial
leverage). The liquidation
preference of the Preferred Shares
is not a liability. The Adviser has
contractually agreed to waive
receipt of a portion of the
management fee or reimburse other
expenses of the Fund in the amount
of 0.20% of the average daily value
of the Fund's Managed Assets from
the commencement of operations
through December 31, 2007 (i.e.,
approximately the first five years
of the Fund's operations), and for a
declining amount for an additional
three years (through December 31,
2010). See "Management of the Fund."
DISTRIBUTIONS..................... The Fund intends to distribute
monthly all or a portion of its tax
exempt interest income to Common
Shareholders (after it pays accrued
dividends on any Preferred Shares of
the Fund that may be outstanding).
It is expected that the initial
monthly dividend on Common Shares
will be declared approximately 45
days after completion of this
offering and that the initial
monthly dividend will be paid
approximately 60 to 90 days after
completion of this offering. Unless
an election is made to receive
dividends in cash, Common
Shareholders will automatically have
all dividends and distributions
reinvested in Common Shares through
the receipt of additional authorized
but unissued Common Shares from the
Fund or by purchasing Common Shares
in the open market through the
Fund's Dividend Reinvestment Plan.
See "Dividend Reinvestment Plan."
If the Fund realizes a capital gain
or other taxable income, it will be
required to allocate such income
between Common Shares and Preferred
Shares in proportion to the total
dividends paid to each class for the
year in which or with respect to
which the income is paid. The Fund
will distribute capital gains, if
any, annually. See "Distributions"
and "Preferred Shares and Leverage."
LISTING..............................The Common Shares have been approved
for listing, subject to notice of
issuance, on the New York Stock
Exchange under the symbol "FMN". See
"Description of Shares-Common
Shares."
CUSTODIAN AND TRANSFER State Street Bank and Trust Company
AGENT................................ will serve as the Fund's Custodian
and EquiServe Trust Company, N.A.
will serve as the Fund's Transfer
Agent. See "Custodian and Transfer
Agent."
MARKET PRICE OF SHARES...... Common Shares of closed-end
investment companies frequently
trade at prices lower than their
NAV. Common Shares of closed-end
investment companies like the Fund
that invest primarily in investment
grade tax exempt securities have
during some periods traded at prices
higher than their NAV and during
other periods traded at prices lower
than their NAV. The Fund cannot
assure you that its Common Shares
will trade at a price higher than or
equal to NAV. The Fund's NAV will
be reduced immediately following
this offering by the sales load and
the amount of the organizational and
offering expenses paid by the Fund.
See "Use of Proceeds." In addition
to NAV, the market price of the
Fund's Common Shares may be affected
by dividend levels, which are in
turn affected by expenses, call
protection for portfolio securities,
dividend stability, portfolio credit
quality, liquidity and market supply
and demand. See "Preferred Shares
and Leverage," "Risks," "Description
of Shares" and the section of the
Statement of Additional Information
with the heading "Repurchase of
Common Shares." The Common Shares
are designed primarily for long-term
investors and you should not
purchase Common Shares if you intend
to sell them shortly after purchase.
SPECIAL RISK No Operating History. The Fund is a
CONSIDERATIONS....................... newly organized, closed-end
management investment company with
no operating history.
Market Discount Risk. Shares of
closed-end management investment
companies frequently trade at a
discount from their NAV.
Interest Rate Risk. Prices of tax
exempt securities rise and fall in
response to changes in the interest
rate paid by similar securities.
Generally, when interest rates rise,
prices of tax exempt securities
fall. However, market factors, such
as the demand for particular tax
exempt securities, may cause the
price of certain fixed income
securities to fall while the prices
of other securities rise or remain
unchanged.
Interest rate changes have a greater
effect on the price of tax exempt
securities with longer maturities.
Because the Fund will invest
primarily in long-term tax exempt
securities, the NAV of Common Shares
will fluctuate more in response to
changes in market interest rates
than if the Fund invested primarily
in shorter-term tax exempt
securities.
The Fund may use certain strategies
for the purpose of reducing the
interest rate sensitivity of the
portfolio and decreasing the Fund's
exposure to interest rate risk,
although there is no assurance that
it will do so or that such
strategies will be successful.
The Fund's use of leverage, as
described below, tends to increase
the interest rate risk of Common
Shares.
Credit Risk. Credit risk is the
possibility that an issuer of a tax
exempt security will default on a
security by failing to pay interest
or principal when due. If an issuer
defaults, the Fund will lose money.
Leverage Risk. The use of leverage
through the issuance of Preferred
Shares creates an opportunity for
increased income that may be
distributed as Common Share
dividends, but also creates special
risks for Common Shareholders. Two
major types of risks created by
leverage include:
o the likelihood of greater
volatility of NAV and market price
of Common Shares, because changes in
the value of the Fund's tax exempt
security portfolio (including
securities bought with the proceeds
of the Preferred Shares offering)
are borne entirely by Common
Shareholders; and
o the possibility either that Common
Share income will fall if the
Preferred Share dividend rate rises,
or that Common Share income will
fluctuate because the Preferred
Share dividend rate varies.
It is anticipated that dividends on
Preferred Shares will be based on
shorter-term tax exempt security
yields (which will be reset
periodically) and that the Fund will
invest the proceeds of the Preferred
Shares offering in long-term,
typically fixed rate, tax exempt
securities. So long as the Fund's
tax exempt security portfolio
provides a higher yield, net of Fund
expenses, than the Preferred Share
dividend rate, as reset
periodically, the leverage may cause
Common Shareholders to receive
higher dividends than if the Fund
were not leveraged. However, the
Fund's leveraging strategy may not
be successful. For example, if
short-term rates rise, the Preferred
Share dividend rate could exceed the
yield on long-term tax exempt
securities held by the Fund that
were acquired during periods of
generally lower interest rates,
reducing dividends to Common
Shareholders. In addition, if
interest rates rise, the value of
the Fund's holdings in long-term tax
exempt securities likely will fall,
resulting in a decline in the NAV of
Common Shares. Investment by the
Fund in inverse floaters and
derivative contracts may increase
the Fund's leverage and, during
periods of rising interest rates,
may adversely affect the Fund's
income, dividends and total returns
to Common Shareholders. See "The
Fund's Investments" for a discussion
of these instruments. Preferred
Shares are expected to pay
cumulative dividends, which may tend
to increase leverage risk.
Because the fees received by the
Adviser are based on the Managed
Assets of the Fund (including assets
represented by Preferred Shares and
any leverage created thereby), the
Adviser has a financial incentive
for the Fund to issue Preferred
Shares, which may create a conflict
of interest between the Adviser and
Common Shareholders.
Risks Associated with Non-Investment
Grade Securities. Securities rated
below investment grade, also known
as junk bonds, generally entail
greater interest rate and credit
risks than investment grade
securities. For example, their
prices are more volatile, economic
downturns and financial setbacks may
affect their prices more negatively,
and their trading market may be more
limited.
Tax Exempt Securities Market Risk.
The amount of public information
available about tax exempt
securities is generally less than
that for corporate equities or
bonds. Consequently, the Adviser
may make investment decisions based
on information that is incomplete or
inaccurate. The secondary market
for tax exempt securities also tends
to be less well-developed or liquid
than many other securities markets,
which may adversely affect the
Fund's ability to sell its tax
exempt securities at attractive
prices. Special factors, such as
legislative changes and local and
business developments, may adversely
affect the yield or value of the
Fund's investments in tax exempt
securities.
Derivative Contract and Inverse
Floater Risk. Prior to the issuance
of Preferred Shares, the Fund may
add leverage to its portfolio by
investing up to 10% of its total
assets in inverse floaters and by
investing in derivative contracts.
The Fund's use of derivative
contracts will be limited by the
1940 Act. See "Preferred Shares and
Leverage-Other Forms of Leverage and
Borrowings." The Fund also may
invest in derivative contracts for
risk management purposes.
Derivative contracts and inverse
floaters are subject to a number of
risks described elsewhere in this
prospectus, such as interest rate
and credit risks. In addition,
investment by the Fund in derivative
contracts and inverse floaters may
increase the Fund's leverage and,
during periods of rising interest
rates, may adversely affect the
Fund's income, dividends and total
returns to Common Shareholders.
Reinvestment Risk. Income from the
Fund's tax exempt security portfolio
will decline if and when the Fund
invests the proceeds from matured,
traded or called tax exempt
securities at market interest rates
that are below the portfolio's
current earnings rate. A decline in
income could affect the market price
or overall return of Common Shares.
Tax Risk. In order to be tax
exempt, municipal securities must
meet certain legal requirements.
Failure to meet such requirements
may cause the interest received and
distributed by the Fund to Common
Shareholders to be taxable.
The federal income tax treatment of
payments in respect of certain
derivative contracts is unclear.
Additionally, the Fund may not be
able to close out certain derivative
contracts when it wants to.
Consequently, the Fund may receive
payments that are treated as
ordinary income for federal income
tax purposes.
Sector Risk. The Fund may invest
25% or more of its total assets in
tax exempt securities of issuers in
the same economic sector, such as
hospitals or life care facilities
and transportation-related issuers.
In addition, a substantial part of
the Fund's portfolio may be
comprised of securities credit
enhanced by banks, insurance
companies or companies with similar
characteristics. As a result, the
Fund will be more susceptible to any
economic, business, political or
other developments which generally
affect these sectors and entities.
Anti-Takeover Provisions. The Fund's
Agreement and Declaration of Trust
includes provisions that could limit
the ability of other entities or
persons to acquire control of the
Fund or convert the Fund to open-end
status. These provisions could
deprive Common Shareholders of
opportunities to sell their Common
Shares at a premium over the then
current market price of Common
Shares or at NAV. In addition, if
the Fund issues Preferred Shares,
Preferred Shareholders will have
voting rights that could deprive
Common Shareholders of such
opportunities.
Inflation Risk. Inflation risk is
the risk that the value of assets or
income from the Fund's investments
will be worth less in the future as
inflation decreases the present
value of payments at future dates.
Market Disruption. As a result of
the terrorist attacks on the World
Trade Center and the Pentagon on
September 11, 2001, some of the U.S.
securities markets were closed for a
four-day period. These terrorist
attacks and related events have led
to increased market volatility and
may have long-term effects on U.S.
and world economies and markets. A
similar disruption of the financial
markets would impact interest rates,
auctions, secondary trading,
ratings, credit risk, inflation and
other factors relating to the
securities.
SUMMARY OF FUND EXPENSES
The following table shows Fund expenses as a percentage of net assets
attributable to Common Shares and assumes the issuance of Preferred Shares in an
amount equal to 38% of the Fund's capital (after their issuance).
Shareholder Transaction Expenses
Sales Load Paid by You (as a percentage of offering price) .........4.50%
Expenses Borne by the Fund.....................................0.20%(1)(2)
Dividend Reinvestment Plan Fees ...................................None(3)
Percentage Of Net Assets
Attributable To Common Shares
(Assumes Preferred Shares are Issued)(4)
-------------------------------------------------------
Annual Expenses
Management Fees .................................................... 0.89%
Other Expenses .................................................... 0.32%
Total Annual Expenses ............................................ 1.21%
Fee and Expense Waiver.......................................... 0.32%(5)
Total Net Annual Expenses....................................... 0.89%(5)
----------
(1) The Adviser has agreed to pay organizational and offering costs of the
Fund (other than the sales load) that exceed $0.03 per Common Share.
(2) If the Fund offers Preferred Shares, costs of that offering, estimated
to be slightly more than 1.00% of the total amount of the Preferred Share
offering, will effectively be borne by Common Shareholders and result in the
reduction of the NAV of Common Shares. Assuming the issuance of Preferred Shares
in an amount equal to 38% of the Fund's total assets (after issuance), those
offering costs are estimated to be not more than approximately $540,000 or $.09
per Common Share (0.62% of the offering price).
(3) You will pay brokerage charges if you direct the Plan Administrator to
sell your Common Shares held in a dividend reinvestment account.
(4) The table presented in this footnote also estimates Fund expenses as a
percentage of net assets attributable to Common Shares. However, unlike the
table above, this table assumes that no Preferred Shares are issued or
outstanding. In accordance with these assumptions, the Fund's estimated expenses
would be as follows:
Percentage Of
Net Assets
Attributable To Common Shares
(Assumes no Preferred Shares are Issued or Outstanding)
----------------------------------------
Annual Expenses
Management Fees................................................... 0.55%
Other Expenses...................................................... 0.20%
Total Annual Expenses............................................. 0.75%
Fee and Expense Waiver.......................................... 0.20%(5)
Total Net Annual Expenses....................................... 0.55%(5)
(5) The Adviser has agreed to waive a portion of the management fees that
it is entitled to receive from the Fund at the annual rate of 0.20% of the
Fund's Managed Assets from the commencement of operations through December 31,
2007 (i.e., approximately the first 5 years of the Fund's operations), 0.15% of
Managed Assets in year 6, 0.10% of Managed Assets in year 7 and 0.05% of Managed
Assets in year 8.
The purpose of the table above is to help you understand all fees and
expenses that you, as a Common Shareholder, would bear directly or indirectly.
The expenses shown in the table under "Other Expenses" are based on estimated
amounts for the Fund's first year of operation. See "Management of the Fund" and
"Dividend Reinvestment Plan."
The following example illustrates the expenses (including the $45 sales
load, estimated $2 offering expenses and estimated $6.10 Preferred Share
offering costs) that you would pay on a $1,000 investment in Common Shares,
assuming (a) total net annual expenses of 0.89% of net assets attributable to
Common Shares in years 1 through 5, increasing to 1.21% in year 10 and (b) a 5%
annual return(1):
1 year 3 years 5 years 10 years(2)
Total Expenses
Incurred......... $61.72 $80.04 $99.90 $171.73
(1) The example above should not be considered a representation of future
expenses. Actual expenses may be higher or lower than those shown. The example
assumes that the estimated "Other Expenses" set forth in the Annual Expenses
table are accurate, that fees and expenses increase as described in note 2
below, and that all dividends and distributions are reinvested at NAV. Actual
expenses may be greater or less than those assumed. Moreover, the Fund's actual
rate of return may be greater or less than the hypothetical 5% annual return
shown in the example.
(2) Assumes waiver of management fees at the annual rate of 0.24% of the
Fund's average daily net assets attributable to Common Shares in year 6 (0.15%
of average daily Managed Assets), 0.16% (0.10%) in year 7 and 0.08% (0.05%) in
year 8. The Adviser has not agreed to waive any portion of the management fees
it is entitled to receive from the Fund beyond December 31, 2010. See
"Management of the Fund-Investment Management Agreement."
THE FUND
The Fund is a newly organized, diversified, closed-end management
investment company registered under the 1940 Act. The Fund was organized as a
Delaware statutory trust on October 16, 2002, pursuant to an Agreement and
Declaration of Trust, which is governed by the laws of the State of Delaware. As
a newly organized entity, the Fund has no operating history. The Fund's
principal office is located at 5800 Corporate Drive, Pittsburgh, PA 15237-7000,
and its telephone number is 1-800-341-7400.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately
$83,625,750 ($96,169,613 if the underwriters exercise the over-allotment option
in full) after payment of the estimated organizational and offering costs. The
Adviser has agreed to pay the amount by which the aggregate of all the Fund's
organizational and offering costs (other than the sales load) exceeds $.03 per
Common Share. The Fund will invest the net proceeds of the offering in
accordance with the Fund's investment objective and policies as stated below.
The Fund currently anticipates that it will be able to invest primarily in tax
exempt securities that meet the Fund's investment objective and policies within
approximately three months after the completion of the offering. Pending such
investment, it is anticipated that the proceeds will be invested in short-term,
tax exempt or taxable investment grade securities.
THE FUND'S INVESTMENTS
Investment Objective
The Fund's investment objective is to provide current income exempt from
federal income tax, including AMT.
Investment Policies
The Fund will invest primarily in securities that, in the opinion of bond
counsel to the issuer, or on the basis of another authority believed by the
Adviser to be reliable, pay interest exempt from federal income tax, including
AMT. The Adviser will not conduct its own analysis of the tax status of the
interest paid by tax exempt securities held by the Fund.
The Fund normally invests substantially all (at least 90%) of its total
assets in tax exempt securities. The Fund normally will invest at least 80% of
its total assets in investment grade tax exempt securities. The Fund may invest
up to 20% of its total assets in tax exempt securities of below investment grade
quality (but not lower than B). Bonds of below investment grade quality are
commonly referred to as "junk bonds." Bonds of below investment grade quality
are regarded as having predominately speculative characteristics with respect to
the issuer's capacity to pay interest and repay principal.
The Adviser performs a fundamental credit analysis on tax exempt securities
that the Fund is contemplating purchasing before the Fund purchases such
securities. The Adviser considers various factors, including the economic
feasibility of revenue bond financings and general purpose financings; the
financial condition of the issuer or guarantor; and political developments that
may affect credit quality. The Adviser monitors the credit risks of the tax
exempt securities held by the Fund on an ongoing basis by reviewing periodic
financial data and ratings of NRSROs.
Under normal circumstances, the Fund will maintain a dollar-weighted
average portfolio maturity of 15 to 30 years and a dollar-weighted average
duration of 7 to 13 years. "Duration" measures the sensitivity of a security's
price to changes in interest rates. The greater a portfolio's duration, the
greater the change in the portfolio's value in response to a change in market
interest rates. The Adviser increases or reduces the Fund's portfolio duration
based on its interest rate outlook. When the Adviser expects interest rates to
fall, it attempts to maintain a longer portfolio duration. When the Adviser
expects interest rates to increase, it attempts to shorten the portfolio
duration. The Adviser considers a variety of factors in formulating its interest
rate outlook, including current and expected U.S. economic growth; current and
expected interest rates and inflation; the Federal Reserve's monetary policy;
and supply and demand factors related to the municipal market and the effect
they may have on the returns offered for various bond maturities.
For temporary or for defensive purposes, including the period during which
the net proceeds of this offering are being invested, the Fund may invest up to
100% of its assets in short-term investments, including high quality, short-term
securities that may be either tax exempt or taxable. The Fund intends to invest
in taxable short-term investments only in the event that suitable tax exempt
short-term investments are not available at reasonable prices and yields.
Investments in taxable short-term investments would result in a portion of your
dividends being subject to federal income taxes. For more information, see "Tax
Matters" in the Statement of Additional Information.
Because the Fund refers to municipal investments in its name, it has an
investment policy that it will normally invest so that at least 80% of the
income that it distributes will be exempt from federal regular income tax. This
policy is referred to as the "80% Policy."
The Fund cannot change its investment objective or the 80% Policy without
the approval of (1) the holders of a majority of the outstanding Common Shares
and, once the Preferred Shares are issued, the Preferred Shares voting together
as a single class, and (2) the holders of a majority of the outstanding
Preferred Shares voting as a separate class. A "majority of the outstanding"
means (1) 67% or more of the shares present at a meeting, if the holders of more
than 50% of the shares are present or represented by proxy, or (2) more than 50%
of the shares, whichever is less. See "Description of Shares-Preferred
Shares-Voting Rights" and the Statement of Additional Information under
"Description of Shares-Preferred Shares" for additional information with respect
to the voting rights of Preferred Shareholders.
Investment Ratings
The Adviser will determine whether a security is investment grade based
upon the credit ratings given by one or more NRSROs, such as Standard & Poor's
("S&P"), Moody's Investors Service ("Moody's") or Fitch, Inc. ("Fitch"). For
example, S&P assigns ratings to investment grade securities (AAA, AA, A and BBB)
based on their assessment of the likelihood of the issuer's inability to pay
interest or principal (default) when due on each security. Lower credit ratings
correspond to higher credit risk. Securities in the lowest investment grade
category may be considered to possess speculative characteristics by certain
NRSROs. An NRSRO's rating categories are determined without regard for
sub-categories and gradations. If a security is downgraded below investment
grade, the Adviser will reevaluate the security, but will not be required to
sell it.
Tax exempt securities of below investment grade quality are regarded as
having predominately speculative characteristics with respect to the issuer's
capacity to pay interest and repay principal and are commonly referred to as
"junk bonds."
If a security has not received a rating, the Fund must rely entirely upon
the Adviser's credit assessment. See Appendix A to the Statement of Additional
Information for a description of NRSRO ratings.
Investment Securities
Tax Exempt Securities
Tax exempt securities are fixed income securities that pay interest that is
not subject to federal regular income taxes. Fixed income securities pay
interest, dividends or distributions at a specified rate. The rate may be a
fixed percentage of the principal or adjusted periodically.
Typically, states, counties, cities and other political subdivisions and
authorities issue tax exempt securities. The market categorizes tax exempt
securities by their source of repayment.
General Obligation Bonds
General obligation bonds are supported by the issuer's power to exact
property or other taxes. The issuer must impose and collect taxes sufficient to
pay principal and interest on the bonds. However, the issuer's authority to
impose additional taxes may be limited by its charter or state law.
Special Revenue Bonds
Special revenue bonds are payable solely from specific revenues received by
the issuer such as specific taxes, assessments, tolls or fees. Holders of
special revenue bonds may not depend on the municipality's general taxes or
revenues for payment of the bonds. For example, a municipality may issue bonds
to build a toll road and pledge the tolls to repay the bonds. Therefore, a
shortfall in the tolls normally would result in a default on the bonds.
Private Activity Bonds
Private activity bonds are special revenue bonds used to finance private
entities. For example, a municipality may issue bonds to finance a new factory
to improve its local economy. The municipality would lend the proceeds from its
bonds to the company using the factory, and the company would agree to make loan
payments sufficient to repay the bonds. The bonds would be payable solely from
the company's loan payments, not from any other revenues of the municipality.
Therefore, any default on the loan normally would result in a default on the
bonds. The interest on many types of private activity bonds is subject to AMT.
Following are descriptions of other types of tax exempt securities in which
the Fund may invest:
Zero Coupon Securities
Zero coupon securities do not pay interest or principal until final
maturity unlike debt securities that provide periodic payments of interest
(referred to as a coupon payment). Investors buy zero coupon securities at a
price below the amount payable at maturity. The difference between the purchase
price and the amount paid at maturity represents interest on the zero coupon
security. Investors must wait until maturity to receive interest and principal,
which increases the interest rate risks and credit risks of a zero coupon
security.
Municipal Leases
Municipalities may enter into leases for equipment or facilities. In order
to comply with state public financing laws, these leases are typically subject
to annual appropriation. In other words, a municipality may end a lease, without
penalty, by not providing for the lease payments in its annual budget. After the
lease ends, the lessor can resell the equipment or facility but may lose money
on the sale.
The Fund may invest in securities supported by individual leases or pools
of municipal leases.
Inverse Floaters
Prior to the issuance of Preferred Shares, the Fund may invest up to 10% of
its total assets in inverse floaters. An inverse floater has a variable interest
rate that moves in the opposite direction of market interest rates. When market
interest rates go up, the interest rate paid on the inverse floater goes down;
when market interest rates go down, the interest rate paid on the inverse
floater goes up. Inverse floaters generally respond with more volatility to
market interest rate changes than fixed rate, tax exempt securities of the same
maturity.
Credit Enhancement
The Fund may invest in securities that have credit enhancement. Credit
enhancement consists of an arrangement in which a company agrees to pay amounts
due on a fixed income security if the issuer defaults. In some cases the company
providing credit enhancement makes all payments directly to the security holders
and receives reimbursement from the issuer. Normally, the credit enhancer has
greater financial resources and liquidity than the issuer. For this reason, the
Adviser usually evaluates the credit risk of a fixed income security with credit
enhancement based solely upon its credit enhancement.
Delayed Delivery Transactions
The Fund may engage in delayed delivery transactions. Delayed delivery
transactions, including when-issued transactions, are arrangements in which the
Fund buys securities for a set price, with payment and delivery of the
securities scheduled for a future time. During the period between purchase and
settlement, no payment is made by the Fund to the issuer and no interest accrues
to the Fund. The Fund records the transactions when it agrees to buy the
securities and reflects their value in determining the price of its shares.
Settlement dates may be a month or more after entering into these transactions
so that the market values of the securities bought may vary from the purchase
prices. Therefore, delayed delivery transactions create interest rate risks for
the Fund. Delayed delivery transactions also involve credit risks in the event
of a counterparty default.
Derivative Contracts
The Fund may buy and sell derivative contracts. Derivative contracts are
financial instruments that require payments based upon changes in the values of
designated or underlying securities, commodities, financial indices or other
assets or instruments. Some derivative contracts such as futures, forwards and
options require payments relating to a future trade involving the underlying
asset. Other derivative contracts such as swaps require payments relating to the
income or returns from the underlying asset or instrument. The other party to a
derivative contract is referred to as a counterparty.
Many derivative contracts are traded on securities or commodities
exchanges. In this case, the exchange sets all the terms of the contract except
for the price. Most exchanges require investors to maintain margin accounts
through their brokers to cover their potential obligations to the exchange. The
Fund may also trade derivative contracts over-the-counter (OTC) in transactions
negotiated directly between the Fund and the counterparty.
Depending upon how the Fund uses derivative contracts and the relationships
between the market value of a derivative contract and the underlying asset or
instrument, derivative contracts may increase or decrease the Fund's exposure to
interest rate risks, and may also expose the Fund to leverage and tax risks. OTC
contracts also expose the Fund to credit risks in the event that a counterparty
defaults on the contract.
Other Investment Companies
The Fund may invest up to 10% of its total assets in securities of other
open- or closed-end investment companies that invest primarily in tax exempt
securities of the types in which the Fund may invest directly. The Fund
generally expects to invest in other investment companies during periods when it
has large amounts of uninvested cash, such as the period shortly after the Fund
receives the proceeds of the offering of its Common Shares or Preferred Shares,
during periods when there is a shortage of attractive high-yielding tax exempt
securities available in the market, or when the Adviser believes share prices of
other investment companies offer attractive values. The Fund may invest in
investment companies advised by the Adviser to the extent permitted by
applicable law or pursuant to exemptive relief from the SEC; currently, the Fund
has not applied for such exemptive relief. As a shareholder in an investment
company, the Fund will bear its ratable share of that investment company's
expenses and will remain subject to payment of the Fund's advisory and other
fees and expenses with respect to assets so invested. Common Shareholders will
therefore be subject to duplicative expenses to the extent that the Fund invests
in other investment companies. The Adviser will take expenses into account when
evaluating the investment merits of an investment in an investment company
relative to available tax exempt securities. In addition, the securities of
other investment companies may also be leveraged and will therefore be subject
to the same leverage risks to which the Fund is subject. As described in this
prospectus in the sections entitled "Risks" and "Preferred Shares and Leverage,"
the NAV and market value of leveraged shares will be more volatile and the yield
to shareholders will tend to fluctuate more than the yield generated by
unleveraged shares. The Fund treats its investment in such open- or closed-end
investment companies as investments in tax exempt securities.
PREFERRED SHARES AND LEVERAGE
Subject to market conditions, approximately one to three months after the
completion of the offering of Common Shares, the Fund intends to offer Preferred
Shares representing approximately 38% of the Fund's capital immediately after
their issuance. Preferred Shares will have complete priority over Common Shares
upon distribution of assets in liquidation of the Fund. The issuance of
Preferred Shares will leverage Common Shares. Leverage involves special risks
and there is no assurance that the Fund's leveraging strategies will be
successful. Although the timing and other terms of the offering of Preferred
Shares will be determined by the Fund's Board of Trustees (the "Board"), the
Fund expects to invest the proceeds of a Preferred Shares offering primarily in
long-term tax exempt securities. Preferred Shares will pay dividends based on
short-term rates, which would be redetermined periodically by an auction
process. So long as the Fund's portfolio is invested in securities that provide
a higher yield than the dividend rate of Preferred Shares, after taking expenses
into consideration, the leverage will allow Common Shareholders to receive
higher dividends than if the Fund were not leveraged.
Changes in the value of the Fund's tax exempt security portfolio, including
securities bought with the proceeds of the Preferred Shares offering, will be
borne entirely by Common Shareholders. If there is a net decrease (or increase)
in the value of the Fund's investment portfolio, the leverage will decrease (or
increase) the NAV per Common Share to a greater extent than if the Fund were not
leveraged. During periods in which the Fund is using leverage, the fees paid to
the Adviser will be higher than if the Fund did not use leverage because the
fees paid will be calculated on the basis of the Fund's Managed Assets,
including the gross proceeds from the issuance of Preferred Shares.
For tax purposes, the Fund currently is required to allocate net capital
gain and other taxable income, if any, between the Common Shares and Preferred
Shares in proportion to total distributions paid to each class for the taxable
year in which the net capital gain or other taxable income is realized. If net
capital gain or other taxable income is allocated to Preferred Shares instead of
solely tax exempt income, the Fund will have to pay higher total dividends to
Preferred Shareholders or make dividend payments intended to compensate
Preferred Shareholders for the unanticipated characterization of a portion of
the dividends as taxable ("Gross-up Dividends"). This would reduce any advantage
of the Fund's leveraged structure to Common Shareholders.
Under the 1940 Act, the Fund is not permitted to issue Preferred Shares
unless immediately after such issuance the value of the Fund's capital is at
least 200% of the liquidation value of the outstanding Preferred Shares plus the
aggregate amount of any senior securities of the Fund representing indebtedness
(i.e., the liquidation value of the Preferred Shares plus the aggregate amount
of senior securities representing indebtedness may not exceed 50% of the Fund's
capital). In addition, the Fund is not permitted to declare any cash dividend or
other distribution on its Common Shares unless, at the time of such declaration,
the Fund satisfies the 200% capital requirement. If Preferred Shares are issued,
the Fund intends, to the extent possible, to purchase or redeem Preferred Shares
from time to time to the extent necessary in order to maintain coverage of at
least 200%. If the Fund has Preferred Shares outstanding, two of the Fund's
Trustees will be elected by Preferred Shareholders voting separately as a class.
The remaining Trustees will be elected by Common Shareholders and Preferred
Shareholders voting together as a single class. In the event that the Fund
failed to pay dividends on Preferred Shares for two years, Preferred
Shareholders would be entitled to elect a majority of the Trustees of the Fund.
If the Fund issues Preferred Shares, it will be subject to certain
guidelines imposed by those NRSROs that rate the Preferred Shares. These
guidelines are expected to impose capital or portfolio composition requirements
that are more stringent than those imposed on the Fund by the 1940 Act. It is
not anticipated that these guidelines will impede the Adviser from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies.
Preferred Shares may have to be redeemed to the extent that the Fund fails
to comply with the capital requirements imposed by the 1940 Act or the NRSROs.
In order to redeem Preferred Shares, the Fund may have to liquidate portfolio
securities. Such redemptions and liquidations would cause the Fund to incur
related transaction costs and could result in capital losses to the Fund.
Prohibitions on dividends and other distributions on the Common Shares could
impair the Fund's ability to qualify as a regulated investment company under the
Internal Revenue Code of 1986, as amended (the "Code").
Assuming that the Preferred Shares will represent approximately 38% of the
Fund's capital and pay dividends at an annual average rate of 2.00%, the income
generated by the Fund's portfolio (net of estimated expenses) must exceed 0.76%
in order to cover such dividend payments. Of course, these numbers are merely
estimates used for illustration. Actual Preferred Share dividend rates will vary
frequently and may be significantly higher or lower than the rate estimated
above.
The following table is designed to illustrate the effect of leverage on
Common Share total return. The assumed portfolio total returns and Common Share
total returns are hypothetical and actual returns may be greater or less than
those appearing in the table. The table assumes investment portfolio total
returns (comprised of income and changes in the value of the tax exempt
securities held in the Fund's portfolio) of -10%, -5%, 0%, 5% and 10%. The table
further assumes the issuance of Preferred Shares representing 38% of the Fund's
capital and the Fund's currently projected annual Preferred Share dividend rate
of 2.00%.
Assumed Portfolio Total
Return (10)% (5)% 0% 5% 10%
(Net of Expenses)
Common Share Total Return (17.35)% (9.29)% (1.23)% 6.84% 14.90%
Common Share total return is composed of two elements: the Common Share
dividends paid by the Fund (the amount of which is largely determined by the net
investment income of the Fund after paying dividends on Preferred Shares) and
changes in the value of the tax exempt securities that the Fund owns. The table
depicts three cases in which the Fund suffers capital losses and two in which it
enjoys capital appreciation. For example, to assume a total return of 0%, the
Fund must assume that the tax exempt interest it receives on investments in tax
exempt securities is entirely offset by losses in the value of those
investments.
Other Forms of Leverage and Borrowings Prior to the issuance of Preferred
Shares, the Fund also may add leverage to the portfolio by investing up to 10%
of its total assets in inverse floaters and by investing in derivative
contracts. By adding additional leverage, these strategies have the potential to
increase returns to Common Shareholders, but also involve additional risks.
Additional leverage will increase the volatility of the Fund's investment
portfolio and could result in larger losses than if the strategies were not
used.
Under the 1940 Act, the Fund generally is not permitted to engage in
borrowings, including through the use of derivative contracts to the extent that
these instruments constitute senior securities, unless immediately after a
borrowing the value of the Fund's capital is at least 300% of the principal
amount of such borrowing. In addition, the Fund is not permitted to declare any
cash dividend or other distribution on Common Shares unless, at the time of such
declaration, the value of the Fund's capital is at least 300% of such principal
amount. If the Fund borrows, it intends, to the extent possible, to prepay all
or a portion of the principal amount of the borrowing to the extent necessary in
order to maintain the required capital. Failure to meet the capital requirements
described herein could result in an event of default and entitle Preferred
Shareholders to elect a majority of the Trustees of the Fund. Derivative
contracts used by the Fund will not constitute senior securities (and will not
be subject to the Fund's limitations on borrowings) to the extent that the Fund
segregates liquid assets at least equal in amount to its obligations under the
instruments, or enters into offsetting transactions or owns positions covering
its obligations. For instance, the Fund may cover its position in a forward
purchase commitment by segregating liquid assets in an amount sufficient to meet
the purchase price.
RISKS
The NAV of the Common Shares will fluctuate with and be affected by, among
other things, market discount risk, interest rate risk, credit risk, leverage
risk, risks associated with non-investment grade securities, tax exempt security
market risk, derivative contract and inverse floater risk, reinvestment risk,
tax risk, sector risk and inflation risk. An investment in Common Shares will
also be subject to the risk associated with the fact that the Fund is newly
organized.
Newly Organized. The Fund is a newly organized, closed-end management
investment company and has no operating history.
Market Discount Risk. As with any stock, the price of the Common Shares
will fluctuate with market conditions and other factors. If Common Shares are
sold, the price received may be more or less than the original investment.
NAV will be reduced immediately following the initial public offering by
the amount of the sales load and organizational and selling expenses paid by the
Fund. Shares of closed-end management investment companies frequently trade at a
discount from their NAV. This risk may be greater for investors who sell Common
Shares in a relatively short period of time after completion of the initial
public offering.
Interest Rate Risk. Prices of tax exempt securities rise and fall in
response to changes in the interest rate paid by similar securities. Generally,
when interest rates rise, prices of tax exempt securities fall. However, market
factors, such as the demand for particular tax exempt securities, may cause the
price of certain fixed income securities to fall while the prices of other
securities rise or remain unchanged. Interest rate changes have a greater effect
on the price of tax exempt securities with longer maturities. Because the Fund
will invest primarily in long-term tax exempt securities, the NAV of Common
Shares will fluctuate more in response to changes in market interest rates than
if the Fund invested primarily in shorter-term tax exempt securities.
The Fund may use certain strategies for the purpose of reducing the
interest rate sensitivity of the portfolio and decreasing the Fund's exposure to
interest rate risk, although there is no assurance that it will do so or that
such strategies will be successful.
The Fund's use of leverage will increase the interest rate risk of Common
Shares.
Credit Risk. Credit risk is the possibility that an issuer will default on
a security by failing to pay interest or principal when due. If an issuer
defaults, the Fund will lose money. Many tax exempt securities receive credit
ratings from NRSROs such as S&P and Moody's. These NRSROs assign ratings to
securities by assessing the likelihood of issuer default. Lower credit ratings
correspond to higher perceived credit risk and higher credit ratings correspond
to lower perceived credit risk. Credit ratings do not provide assurance against
default or other loss of money. If a security has not received a rating, the
Fund must rely entirely upon the Adviser's credit assessment.
Credit risk includes the possibility that a party to a transaction
involving the Fund will fail to meet its obligations. This could cause the Fund
to lose the benefit of the transaction or prevent the Fund from selling or
buying other securities to implement its investment strategy.
Leverage Risk. Leverage risk includes the risk associated with the issuance
of the Preferred Shares or the use of inverse floaters and derivative contracts
in order to leverage the Fund's portfolio. There is no assurance that the Fund's
leveraging strategies involving Preferred Shares or inverse floaters and
derivative contracts will be successful. Once the Preferred Shares are issued or
other forms of leverage are used, the NAV and market value of Common Shares will
be more volatile, and the yield distribution to Common Shareholders will tend to
fluctuate more in response to changes in interest rates and with changes in the
short-term dividend rates on Preferred Shares. If the dividend rate on Preferred
Shares approaches the yield on the Fund's investment portfolio, the benefit of
leverage to Common Shareholders would be reduced. If the dividend rate on
Preferred Shares exceeds the yield on the Fund's portfolio, the leverage will
result in a lower dividend to Common Shareholders than if the Fund were not
leveraged. Because the long-term bonds included in the Fund's portfolio will
typically pay fixed rates of interest while the dividend rate on Preferred
Shares will be adjusted periodically, this could occur even when both long-term
and short-term municipal rates rise. In addition, the Fund will pay and the
Common Shareholders will bear any costs and expenses relating to the issuance
and ongoing maintenance of the Preferred Shares. Furthermore, if the Fund has
net capital gain or other taxable income that is allocated to Preferred Shares
instead of solely tax-exempt income, the Fund may have to pay higher total
dividends or Gross-up Dividends to Preferred Shareholders, which would reduce
any advantage of the Fund's leveraged structure to Common Shareholders without
reducing the associated risk. See "Preferred Shares and Leverage." The Fund
cannot assure you that it will issue Preferred Shares or use other forms of
leverage or, if used, that these strategies will result in a higher yield or
return to Common Shareholders.
Similarly, any decline in the NAV of the Fund's investments will be borne
entirely by Common Shareholders. Therefore, if the market value of the Fund's
portfolio declines, the leverage will result in a greater decrease in NAV to
Common Shareholders than if the Fund were not leveraged. This greater NAV
decrease will also tend to cause a greater decline in the market price for
Common Shares. The Fund might be in danger of failing to maintain the 200%
capital requirement or of losing its ratings on Preferred Shares or, in an
extreme case, the Fund's current investment income might not be sufficient to
meet the dividend requirements on Preferred Shares. In order to counteract such
an event, the Fund might need to liquidate investments in order to fund a
redemption of some or all of the Preferred Shares. Liquidation at times of low
tax exempt securities prices may result in capital loss and may reduce returns
to Common Shareholders.
While the Fund may from time to time consider reducing leverage in response
to actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and NAV associated with leverage, there
can be no assurance that the Fund will actually reduce leverage in the future or
that any reduction, if undertaken, will benefit the Common Shareholders. Changes
in the future direction of interest rates are very difficult to predict
accurately. If the Fund were to reduce leverage based on a prediction about
future changes to interest rates, and that prediction turned out to be
incorrect, the reduction in leverage likely would operate to reduce the income
and/or total returns to Common Shareholders relative to the circumstance where
the Fund had not reduced leverage. The Fund may decide that this risk outweighs
the likelihood of achieving the desired reduction to volatility in income and
Common Share price if the prediction were to turn out to be correct, and
determine not to reduce leverage as described above.
The Fund may invest up to 10% of its total assets in the securities of
other investment companies. Such securities may also be leveraged and will
therefore be subject to the leverage risks described above. This additional
leverage may in certain market conditions reduce the NAV of the Fund's Common
Shares and the returns to Common Shareholders.
Prior to the issuance of Preferred Shares, the Fund may leverage the
portfolio by investing up to 10% of its total assets in inverse floaters and by
investing in derivative contracts. The Fund's use of derivative contracts will
be limited by the 1940 Act. See "Preferred Shares and Leverage-Other Forms of
Leverage and Borrowings." These instruments may increase the Fund's leverage
and, during periods of rising short-term interest rates, may adversely affect
the Fund's NAV per share and distributions to Common Shareholders. See "Inverse
Floaters" and "Derivative Contracts" under "The Fund's Investments" and the
section of the Statement of Additional Information with the heading "Derivative
Contracts."
Risks Associated With Non-Investment Grade Securities. Securities rated
below investment grade, also known as junk bonds, generally entail greater
credit, interest rate and liquidity risks than investment grade securities. For
example, their prices are more volatile, economic downturns and financial
setbacks may affect their prices more negatively and their trading market may be
more limited.
Tax Exempt Security Market Risk. Investing in the tax exempt securities
market involves certain risks. The amount of public information available about
the tax exempt securities in the Fund's portfolio is generally less than that
for corporate equities or bonds. Consequently, the Adviser may make investment
decisions based on information that is incomplete or inaccurate. The secondary
market for tax exempt securities tends to be less well-developed or liquid than
many other securities markets, which may adversely affect the Fund's ability to
sell its bonds at attractive prices. Special factors, such as legislative
changes and local and business developments, may adversely affect the yield or
value of the Fund's investments in tax exempt securities.
The ability of municipal issuers to make timely payments of interest and
principal may be diminished in general economic downturns and as governmental
cost burdens are reallocated among federal, state and local governments. In
addition, laws enacted in the future by Congress or state legislatures or
referenda could extend the time for payment of principal and/or interest, or
impose other constraints on enforcement of such obligations or on the ability of
municipalities to levy taxes.
Derivative Contract and Inverse Floater Risk. Prior to the issuance of
Preferred Shares, the Fund may leverage its portfolio by investing up to 10% of
its total assets in inverse floaters and by investing in derivative contracts.
The Fund's use of derivative contracts will be limited by the 1940 Act. See
"Preferred Shares and Leverage-Other Forms of Leverage and Borrowings." The Fund
also may invest in derivative contracts for risk management purposes. Derivative
contracts and inverse floaters are subject to a number of risks described
elsewhere in this prospectus, such as interest rate risk and credit risk. In
addition, investment by the Fund in derivative contracts and inverse floaters
may increase the Fund's leverage and, during periods of rising interest rates,
may adversely affect the Fund's income, dividends and total returns to Common
Shareholders. Derivative contracts also involve the risk of mispricing or
improper valuation, the risk of ambiguous documentation and the risk that
changes in the value of a derivative contract may not correlate perfectly with
an underlying asset, interest rate or index. Suitable inverse floaters and
derivative contracts may not be available in all circumstances and there can be
no assurance that the Fund will engage in these transactions to reduce exposure
to other risks when that would be beneficial.
Reinvestment Risk. Reinvestment risk is the risk that income from the
Fund's bond portfolio will decline if and when the Fund invests the proceeds
from matured, traded, prepaid or called bonds at market interest rates that are
below the portfolio's current earnings rate. A decline in income could affect
the market price or overall returns of Common Shares.
Tax Risk. In order to be tax exempt, municipal securities must meet certain
legal requirements. Failure to meet such requirements may cause the interest
received and distributed by the Fund to Common Shareholders to be taxable.
Changes or proposed changes in federal tax laws may cause the prices of
municipal securities to fall.
The federal income tax treatment of payments in respect of certain
derivative contracts is unclear. Additionally, the Fund may not be able to close
out certain derivative contracts when it wants to. Consequently, the Fund may
receive payments that are treated as ordinary income for federal income tax
purposes.
In certain circumstances, a portion of the Fund's dividends may be subject
to AMT.
Sector Risk. The Fund may invest 25% or more of its total assets in tax
exempt securities of issuers in the same economic sector, including without
limitation the following: bonds issued by state and local health finance,
housing finance, pollution control, industrial development and other authorities
or municipal entities for the benefit of hospitals, life care facilities,
educational institutions, housing facilities, transportation systems, industrial
corporations or utilities. In addition, a substantial part of the Fund may be
comprised of securities that are credit enhanced by insurance companies, banks
or other similar financial institutions. As a result, the performance of the
Fund will be more susceptible to any economic, business, political or other
developments that generally affect these sectors or entities.
Anti-Takeover Provisions. The Fund's Agreement and Declaration of Trust
includes provisions that could limit the ability of other entities or persons to
acquire control of the Fund or convert the Fund to open-end status. These
provisions could deprive Common Shareholders of opportunities to sell their
Common Shares at a premium over the then current market price of Common Shares
or at NAV. In addition, if the Fund issues Preferred Shares, Preferred
Shareholders will have voting rights that could deprive Common Shareholders of
such opportunities.
Inflation Risk. Inflation risk is the risk that the value of assets or
income from investment will be worth less in the future as inflation decreases
the value of money. As inflation increases, the real value of, and distribution
of, Common Shares can decline. In addition, during any periods of rising
inflation, Preferred Share dividend rates would likely increase, which would
tend to further reduce returns to Common Shareholders.
Market Disruption. As a result of the terrorist attacks on the World Trade
Center and the Pentagon on September 11, 2001, some of the U.S. securities
markets were closed for a four-day period. These terrorist attacks and related
events have led to increased market volatility and may have long-term effects on
U.S. and world economies and markets. A similar disruption of the financial
markets would impact interest rates, auctions, secondary trading, ratings,
credit risk, inflation and other factors relating to the securities.
HOW THE FUND MANAGES RISK
Investment Limitations
The Fund has adopted certain investment limitations designed to limit
investment risk. These limitations are fundamental and may not be changed
without the approval of (1) the holders of a majority of the outstanding Common
Shares and, if issued, Preferred Shares voting together as a single class, and
(2) the approval of the holders of a majority of the outstanding Preferred
Shares voting as a separate class.
Concentration. The Fund will not make investments that will result in the
concentration of its investments in the securities of issuers primarily engaged
in the same industry, but may invest more than 25% of its total assets in
securities of issuers in the same economic sector.
Diversification of Investments. With respect to securities comprising 75%
of the value of its total assets, the Fund will not purchase the securities of
any one issuer (other than cash, cash items, securities issued or guaranteed by
the government of the United States or its agencies or instrumentalities and
repurchase agreements collateralized by such U.S. government securities and
securities of other investment companies) if as a result more than 5% of the
value of its total assets would be invested in the securities of that issuer, or
it would own more than 10% of the outstanding voting securities of that issuer.
Underwriting. The Fund will not underwrite any issue of securities, except
as it may be deemed to be an underwriter under the Securities Act of 1933 in
connection with the sale of securities in accordance with its investment
objective, policies and limitations.
Investing in Real Estate. The Fund may not buy or sell real estate,
although it may invest in tax exempt securities secured by real estate or
interests in real estate.
Investing in Commodities. The Fund may not purchase or sell physical
commodities, provided that the Fund may purchase securities of companies that
deal in commodities. For purposes of this restriction, investments in
transactions involving futures contracts and options, swap transactions, and
other financial contracts that settle by payment of cash are not deemed to be
investments in commodities.
Lending. The Fund will not make loans, but may acquire publicly or
non-publicly issued tax exempt securities as permitted by its investment
objective, policies and limitations.
Borrowing Money and Issuing Senior Securities. The Fund may borrow money,
directly or indirectly, and issue senior securities to the maximum extent
permitted under the 1940 Act.
The Fund may become subject to guidelines which are more limiting than its
investment restrictions in order to obtain and maintain ratings from an NRSRO on
the Preferred Shares that it intends to issue. The Fund does not anticipate that
such guidelines would have a material adverse effect on the Fund's Common
Shareholders or the Fund's ability to achieve its investment objective. See
"Investment Objective and Policies" in the Statement of Additional Information
for a complete list of the fundamental and non-fundamental investment policies
of the Fund.
Quality of Investments
The Fund will invest at least 80% of its total assets in investment grade
tax exempt securities.
Limited Issuance of Preferred Shares
Under the 1940 Act, the Fund could issue Preferred Shares having a total
liquidation value (original purchase price of the shares being liquidated plus
any accrued and unpaid dividends) of up to 50% of the value of the capital of
the Fund. To the extent that the Fund has outstanding any senior securities
representing indebtedness such as through the use of derivative contracts that
constitute senior securities, the aggregate amount of such senior securities
will be added to the total liquidation value of any outstanding Preferred Shares
for purposes of this capital requirement. If the total liquidation value of the
Preferred Shares plus the aggregate amount of such other senior securities were
ever more than 50% of the value of the capital of the Fund, the Fund would not
be able to declare dividends on the Common Shares until the liquidation value
and/or aggregate amount of other senior securities, as a percentage of the
Fund's assets, was reduced. Approximately one to three months after the
completion of the offering of the Common Shares, the Fund intends to issue
Preferred Shares representing about 38% of the Fund's capital immediately after
the time of issuance of the Preferred Shares. This higher than required margin
of NAV provides a cushion against later fluctuations in the value of the Fund's
portfolio and will subject Common Shareholders to less income and NAV volatility
than if the Fund were more highly leveraged through Preferred Shares. The Fund
intends to purchase or redeem Preferred Shares, if necessary, to keep the
liquidation value of the Preferred Shares plus the aggregate amount of other
senior securities representing indebtedness below 50% of the value of the Fund's
capital.
Management of Investment Portfolio and Capital Structure to Limit Leverage Risk
The Fund may take certain actions if short-term interest rates increase, or
market conditions otherwise change (or the Fund anticipates such an increase or
change) and the Fund's leverage begins (or is expected) to adversely affect
Common Shareholders. In order to attempt to offset such a negative impact of
leverage on Common Shareholders, the Fund may shorten the average maturity or
duration of its investment portfolio (by selling long-term securities and
investing in short-term, high quality securities or implementing certain hedging
strategies) or may extend the auction period of outstanding Preferred Shares.
The Fund may also attempt to reduce the leverage by redeeming or otherwise
purchasing Preferred Shares or redeeming holdings in derivative contracts or
other instruments that create leverage. As explained above under "Risks-Leverage
Risk," the success of any such attempt to limit leverage risk depends on the
Adviser's ability to accurately predict interest rate or other market changes.
Because of the difficulty of making such predictions, the Fund may never attempt
to manage its capital structure in the manner described in this paragraph.
If market conditions suggest that additional leverage would be beneficial,
the Fund may sell previously unissued Preferred Shares or Preferred Shares that
the Fund previously issued but later repurchased or, prior to the issuance of
Preferred Shares, use other forms of leverage, such as derivative contracts.
Hedging and Related Strategies
The Fund may use various investment strategies designed to limit the risk
of price fluctuations of its portfolio securities and to preserve capital. These
hedging strategies may include using financial futures contracts; short sales;
swap agreements or options thereon; options on financial futures; options based
on either an index of municipal securities or on taxable debt securities whose
prices, in the opinion of the Adviser, correlate with the prices of the Fund's
investments. Income earned by the Fund from many hedging activities will be
treated as capital gain and, if not offset by net realized capital loss, will be
distributed to shareholders as taxable distributions. If effectively used,
hedging strategies will offset in varying percentages losses incurred on the
Fund's investments due to adverse interest rate changes. There is no assurance
that these hedging strategies will be available at any time or that the Adviser
will determine to use them for the Fund or, if used, that the strategies will be
successful.
MANAGEMENT OF THE FUND
Trustees And Officers
The Board is responsible for the overall management of the Fund, including
supervision of the duties performed by the Adviser. There are twelve Trustees of
the Fund. Three of the Trustees are "interested persons" (as defined in the 1940
Act). The name and business addresses of the Trustees and officers of the Fund
and their principal occupations and other affiliations during the past five
years are set forth under "Management of the Fund" in the Statement of
Additional Information.
Investment Adviser
Federated Investment Management Company acts as the Fund's investment
adviser. The Adviser's address is Federated Investors Tower, 1001 Liberty
Avenue, Pittsburgh, PA 15222-3779.
The Adviser and other subsidiaries of Federated Investors, Inc.
("Federated") advise approximately 139 mutual funds and a variety of separate
accounts, which totaled approximately $180 billion in assets as of December 31,
2001. Federated was established in 1955 and is one of the largest mutual fund
investment managers in the United States, with approximately 1,800 employees.
More than 4,000 investment professionals make Federated Funds available to their
customers. In the municipal sector, as of December 31, 2001, Federated managed
12 bond funds with approximately $2.3 billion in assets and 22 money market
funds with approximately $19.5 billion in total assets.
The Fund's Portfolio Managers are:
Mary Jo Ochson Mary Jo Ochson is the Fund's Portfolio Manager. Ms. Ochson
joined Federated in 1982 and has been a Senior Portfolio Manager and a Senior
Vice President of the Fund's Adviser since 1996. From 1988 through 1995, Ms.
Ochson served as a Portfolio Manager and a Vice President of the Fund's Adviser.
Ms. Ochson is a Chartered Financial Analyst and received her M.B.A. in Finance
from the University of Pittsburgh.
Lee R. Cunningham II
Lee R. Cunningham II is the Fund's Portfolio Manager. Mr. Cunningham joined
Federated in 1995 as an Investment Analyst and has been a Portfolio Manager
since 1998. He was named an Assistant Vice President of the Fund's Adviser in
January 1998 and became a Vice President of the Fund's Adviser in July 2000.
From 1986 through 1994, Mr. Cunningham was a Project Engineer with Pennsylvania
Power and Light Company. Mr. Cunningham received his M.B.A. with concentration
in finance and operations from the University of Pittsburgh.
RJ Gallo RJ Gallo is the Fund's Portfolio Manager. Mr. Gallo joined
Federated in 2000 as an Investment Analyst. He was named an Assistant Vice
President of the Fund's Adviser in January 2002. From 1996 to 2000, Mr. Gallo
was a Financial Analyst and Trader at the Federal Reserve Bank of New York. Mr.
Gallo received a Master's in Public Affairs with a concentration in economics
and public policy from Princeton University.
Investment Management Agreement
Pursuant to an investment management agreement between the Adviser and the
Fund, the Fund has agreed to pay for the investment advisory services and
facilities provided by the Adviser a fee at an annual rate equal to 0.55% of the
average daily value of Managed Assets (the "Management Fee"). The Adviser has
contractually agreed to waive receipt of a portion of its Management Fee in the
amount of 0.20% of the average daily value of Managed Assets for the first five
years of the Fund's operations (through December 31, 2007), and for a declining
amount for an additional three years (through December 31, 2010). During periods
in which the Fund is using leverage, the fee paid to the Adviser will be higher
than if the Fund did not use leverage, because the fee is calculated as a
percentage of Managed Assets, which include those assets purchased with
leverage.
In addition to the Management Fee of the Adviser, the Fund pays all other
costs and expenses of its operations, including compensation of its trustees
(other than those affiliated with the Adviser), custodian, transfer and dividend
disbursing agent expenses, legal fees, leverage expenses, rating agency fees,
listing fees and expenses, expenses of independent auditors, expenses of
repurchasing shares, expenses of preparing, printing and distributing
shareholder reports, notices, proxy statements and reports to governmental
agencies and taxes, if any.
For the first 8 years of the Fund's operation, the Adviser has undertaken
to waive its investment advisory fees and expenses payable by the Fund in the
amounts, and for the time periods, set forth below:
Percentage Waived (as A Percentage Of
Average
Daily Managed Assets)
Twelve Month
Period Ending
Month Date, Year**
December 31, 2003 0.20%
December 31, 2004 0.20%
December 31, 2005 0.20%
December 31, 2006 0.20%
December 31, 2007 0.20%
December 31, 2008 0.15%
December 31, 2009 0.10%
December 31, 2010 0.05%
** From the commencement of operations.
The Adviser has not undertaken to waive any portion of the Fund's fees and
expenses beyond December 31, 2010 or after termination of the investment
management agreement.
Administrative Agreement
Federated Services Company, a subsidiary of Federated, provides
administrative personnel and services (including certain legal and financial
reporting services) necessary to operate the Fund. The Administrator's address
is Federated Investors Tower, 1001 Liberty Avenue, Pittsburgh, PA 15222-3779.
Federated Services Company provides these at the following annual rate of the
average aggregate daily net assets of all Federated Funds as specified below:
Average Aggregate Daily Net
Maximum Administrative Fee Assets of the Federated Funds
0.150 of 1% on the first $250 million
0.125 of 1% on the next $250 million
0.100 of 1% on the next $250 million
0.075 of 1% on assets in excess of $750 million
The administrative fee received during any fiscal year will be at least
$125,000. Federated Services Company may voluntarily waive a portion of its fee
and may reimburse the Fund for expenses.
NET ASSET VALUE
The Fund's NAV per Common Share is determined as of the close of regular
trading (normally 4:00 p.m. Eastern time) on each day the New York Stock
Exchange is open for business. To calculate NAV, the Fund's assets are valued
and totaled, liabilities and the aggregate liquidation value of the outstanding
Preferred Shares, if any, are subtracted, and the balance is divided by the
total number of Common Shares then outstanding.
The Fund values its fixed income securities by using market quotations,
prices provided by market makers or estimates of market values obtained from
yield data relating to instruments or securities with similar characteristics in
accordance with procedures established by the Board. A substantial portion of
the Fund's fixed income investments will be valued according to the mean between
bid and asked prices as furnished by an independent pricing service. Debt
securities with remaining maturities of 60 days or less will be valued at
amortized cost. Any securities or other assets for which current market
quotations are not readily available are valued at their fair value as
determined in good faith by or under the direction of the Board.
DISTRIBUTIONS
The Fund will distribute to Common Shareholders monthly dividends of all or
a portion of its tax exempt interest income after payment of dividends on any
Preferred Shares of the Fund which may be outstanding. It is expected that the
initial monthly dividend on the Fund's Common Shares will be declared
approximately 45 days and paid approximately 60 to 90 days after completion of
this offering. The Fund expects that all or a portion of any capital gain and
other taxable income will be distributed at least annually.
Various factors will affect the level of the Fund's income, including the
asset mix, the amount of leverage used by the Fund and the effects thereof and
the Fund's use of hedging. To permit the Fund to maintain a more stable monthly
distribution, the Fund may from time to time distribute less than the entire
amount of tax exempt interest income earned in a particular period. The
undistributed tax exempt interest income would be available to supplement future
distributions. As a result, the distributions paid by the Fund for any
particular monthly period may be more or less than the amount of tax exempt
interest income actually earned by the Fund during the period. Undistributed tax
exempt interest income will add to the Fund's NAV and, correspondingly,
distributions from undistributed tax exempt interest income will be deducted
from the Fund's NAV. Shareholders will automatically have all dividends and
distributions reinvested in Common Shares of the Fund issued by the Fund or
purchased in the open market in accordance with the Fund's Dividend Reinvestment
Plan unless an election is made to receive cash. See "Dividend Reinvestment
Plan."
DIVIDEND REINVESTMENT PLAN
Unless the registered owner of Common Shares elects to receive cash by
contacting the Plan Administrator, all dividends declared on Common Shares of
the Fund will be automatically reinvested by EquiServe Trust Co., N.A. (the
"Plan Administrator"), the administrator for shareholders in the Fund's Dividend
Reinvestment Plan (the "Plan"), in additional Common Shares of the Fund. Common
Shareholders who elect not to participate in the Plan will receive all dividends
and other distributions in cash paid by check mailed directly to the shareholder
of record (or, if the Common Shares are held in street or other nominee name,
then to such nominee) by the Plan Administrator, as dividend disbursing agent.
You may elect not to participate in the Plan and to receive all dividends in
cash by contacting the Plan Administrator at the address set forth below if your
Shares are registered in your name or by contacting your bank, broker or other
entity if your Shares are held in street or other nominee name. Participation in
the Plan is completely voluntary and may be terminated or resumed at any time
without penalty by notice if received and processed by the Plan Administrator
prior to the dividend record date; otherwise such termination or resumption will
be effective with respect to any subsequently declared dividend or other
distribution. Some brokers may automatically elect to receive cash on your
behalf and may re-invest that cash in additional Common Shares of the Fund for
you. If you wish for all dividends declared on your Common Shares to be
automatically reinvested pursuant to the Plan, please contact your broker. The
Plan Administrator will open an account for each Common Shareholder under the
Plan in the same name in which such Common Shareholder's Common Shares are
registered. Whenever the Fund declares a dividend or other distribution
(together, a "Dividend") payable in cash, non-participants in the Plan will
receive cash and participants in the Plan will receive the equivalent in Common
Shares. The Common Shares will be acquired by the Plan Administrator for the
participants' accounts, depending upon the circumstances described below, either
(1) through receipt of additional unissued but authorized Common Shares from the
Fund ("Newly Issued Common Shares") or (2) by purchase of outstanding Common
Shares on the open market ("Open-Market Purchases") on the New York Stock
Exchange or elsewhere. If, on the payment date for any Dividend, the closing
market price plus estimated brokerage commissions per Common Share is equal to
or greater than the NAV per Common Share, the Plan Administrator will invest the
Dividend amount in Newly Issued Common Shares on behalf of the participants. The
number of Newly Issued Common Shares to be credited to each participant's
account will be determined by dividing the dollar amount of the Dividend by the
NAV per Common Share on the payment date; provided that, if the NAV is less than
or equal to 95% of the closing market value on the payment date, the dollar
amount of the Dividend will be divided by 95% of the closing market price per
Common Share on the payment date. If, on the payment date for any Dividend, the
NAV per Common Share is greater than the closing market value plus estimated
brokerage commissions, the Plan Administrator will invest the Dividend amount in
Common Shares acquired on behalf of the participants in Open-Market Purchases.
In the event of a market discount on the payment date for any Dividend, the Plan
Administrator will have until the last business day before the next date on
which the Common Shares trade on an "ex-dividend" basis or 30 days after the
payment date for such Dividend, whichever is sooner (the "Last Purchase Date"),
to invest the Dividend amount in Common Shares acquired in Open-Market
Purchases. It is contemplated that the Fund will pay monthly income Dividends.
Therefore, the period during which Open-Market Purchases can be made will exist
only from the payment date of each Dividend through the date before the next
"ex-dividend" date, which will be approximately ten days. If, before the Plan
Administrator has completed its Open-Market Purchases, the market price per
Common Share exceeds the NAV per Common Share, the average per Common Share
purchase price paid by the Plan Administrator may exceed the NAV of the Common
Shares, resulting in the acquisition of fewer Common Shares than if the Dividend
had been paid in Newly Issued Common Shares on the Dividend payment date.
Because of the foregoing difficulty with respect to Open-Market Purchases, the
Plan provides that if the Plan Administrator is unable to invest the full
Dividend amount in Open-Market Purchases during the purchase period or if the
market discount shifts to a market premium during the purchase period, the Plan
Administrator may cease making Open-Market Purchases and may invest the
uninvested portion of the Dividend amount in Newly Issued Common Shares at the
NAV per Common Share at the close of business on the Last Purchase Date provided
that, if the NAV is less than or equal to 95% of the then current market price
per Common Share, the dollar amount of the Dividend will be divided by 95% of
the market price on the payment date.
The Plan Administrator maintains all shareholders' accounts in the Plan and
furnishes written confirmation of all transactions in the accounts, including
information needed by shareholders for tax records. Common Shares in the account
of each Plan participant will be held by the Plan Administrator on behalf of the
Plan participant, and each shareholder proxy will include those shares purchased
or received pursuant to the Plan. The Plan Administrator will forward all proxy
solicitation materials to participants and vote proxies for shares held under
the Plan in accordance with the instructions of the participants.
In the case of record shareholders such as banks, brokers or nominees which
hold Common Shares for others who are the beneficial owners, the Plan
Administrator will administer the Plan on the basis of the number of Common
Shares certified from time to time by the record shareholder and held for the
account of beneficial owners who participate in the Plan.
There will be no brokerage charges with respect to Common Shares issued
directly by the Fund. However, each participant will pay a pro rata share of
brokerage commissions incurred in connection with Open-Market Purchases. The
automatic reinvestment of Dividends will not relieve participants of any
federal, state or local income tax that may be payable (or required to be
withheld) on such Dividends. See "Tax Matters." Participants that request a sale
of shares through the Plan Administrator are subject to a $15.00 sales fee and a
$0.12 per share sold brokerage commission.
The Fund reserves the right to amend or terminate the Plan. There is no
direct service charge to participants with regard to purchases in the Plan;
however, the Fund reserves the right to amend the Plan to include a service
charge payable by the participants.
All correspondence or questions concerning the Plan should be directed to
the Plan Administrator, EquiServe Trust Company, N.A., P.O. Box 43011,
Providence, RI 02940-3011 or by telephone at (800) 730-6001.
DESCRIPTION OF SHARES
Common Shares
The Fund is an unincorporated statutory trust organized under the laws of
Delaware on October 16, 2002 pursuant to an Agreement and Declaration of Trust
amended and restated as of December 16, 2002. The Fund is authorized to issue an
unlimited number of Common Shares of beneficial interest, par value $0.01 per
Common Share. Each Common Share has one vote and, when issued and paid for in
accordance with the terms of this offering, will be fully paid and
non-assessable. Whenever Preferred Shares are outstanding, Common Shareholders
will not be entitled to receive any distributions from the Fund unless (1) all
accrued dividends on Preferred Shares have been paid, (2) the Fund satisfies the
200% capital requirement and (3) certain other requirements imposed by any
NRSROs rating the Preferred Shares have been met. See "Preferred Shares" below.
All Common Shares are equal as to dividends, assets and voting privileges and
have no conversion, preemptive or other subscription rights. The Fund will send
annual and semi-annual reports, including financial statements, to all Common
Shareholders.
The Fund has no present intention of offering any additional shares other
than the Preferred Shares and Common Shares issued under the Fund's Dividend
Reinvestment Plan. Any additional offerings of shares will require approval by
the Board. Any additional offering of shares will be subject to the requirements
of the 1940 Act, which provides that shares may not be issued at a price below
the then current NAV, exclusive of sales load, except in connection with an
offering to existing Common Shareholders or with the consent of a majority of
the Fund's outstanding voting securities.
The Common Shares have been approved for listing, subject to notice of
issuance, on the New York Stock Exchange under the symbol "FMN".
The Fund's NAV per share generally increases when interest rates decline
and decreases when interest rates rise, and these changes are likely to be
greater because the Fund intends to have a leveraged capital structure. NAV will
be reduced immediately following the offering of Common Shares by the amount of
the sales load and organizational and offering expenses paid by the Fund. See
"Use of Proceeds."
Unlike open-end funds, closed-end funds like the Fund do not continuously
offer shares and do not provide daily redemptions. Rather, if a Common
Shareholder determines to buy additional Common Shares or sell Common Shares
already held, the Common Shareholder may do so by trading through a broker on
the New York Stock Exchange or otherwise. Shares of closed-end investment
companies frequently trade on an exchange at prices lower than NAV. Shares of
closed-end investment companies like the Fund that invest primarily in
investment grade tax exempt securities have during some periods traded at prices
higher than NAV and during other periods have traded at prices lower than NAV.
Because the market value of the Common Shares may be influenced by such factors
as dividend levels (which are in turn affected by expenses), call protection on
its portfolio securities, dividend stability, portfolio credit quality, NAV,
relative demand for and supply of such shares in the market, general market and
economic conditions and other factors beyond the control of the Fund, the Fund
cannot assure you that Common Shares will trade at a price equal to or higher
than NAV in the future. The Common Shares are designed primarily for long-term
investors and you should not purchase the Common Shares if you intend to sell
them soon after purchase. See "Preferred Shares and Leverage" and the Statement
of Additional Information under "Repurchase of Common Shares."
Preferred Shares
The Fund's Agreement and Declaration of Trust provides that the Board may
authorize and issue Preferred Shares with rights as determined by the Board, by
action of the Board without the approval of the Common Shareholders. Common
Shareholders have no preemptive right to purchase any Preferred Shares that
might be issued.
The Board has indicated its intention to authorize an offering of Preferred
Shares, representing approximately 38% of the Fund's capital, immediately after
the Preferred Shares are issued, within approximately one to three months after
completion of this offering of Common Shares, subject to market conditions and
to the Board's continuing belief that leveraging the Fund's capital structure
through the issuance of Preferred Shares is likely to achieve the potential
benefits to the Common Shareholders described in this prospectus. The Fund may
conduct other offerings of Preferred Shares in the future. The Board also
reserves the right to change the foregoing percentage limitation and may issue
Preferred Shares to the extent permitted by the 1940 Act, which currently limits
the aggregate liquidation preference of all outstanding Preferred Shares to 50%
of the value of the Fund's capital. We cannot assure you, however, that any
Preferred Shares will be issued. Although the terms of any Preferred Shares,
including dividend rate, liquidation preference and redemption provisions, will
be determined by the Board, subject to applicable law and the Fund's Agreement
and Declaration of Trust, it is likely that the Preferred Shares will be
structured to carry a relatively short-term dividend rate reflecting interest
rates on short-term tax exempt debt securities, by providing for the periodic
redetermination of the dividend rate at relatively short intervals through an
auction, remarketing or other procedure. The Fund also believes that it is
likely that the liquidation preference, voting rights and redemption provisions
of the Preferred Shares will be similar to those stated below.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the Preferred Shareholders
will be entitled to receive a preferential liquidating distribution, which is
expected to equal the original purchase price per Preferred Share plus accrued
and unpaid dividends, whether or not declared, before any distribution of assets
is made to Common Shareholders. After payment of the full amount of the
liquidating distribution to which they are entitled, the Preferred Shareholders
will not be entitled to any further participation in any distribution of assets
by the Fund.
Voting Rights. The 1940 Act requires that Preferred Shareholders, voting
separately as a single class, have the right to elect at least two Trustees at
all times. The remaining Trustees will be elected by Common Shareholders and
Preferred Shareholders, voting together as a single class. In addition, subject
to the prior rights, if any, of the holders of any other class of senior
securities outstanding, the Preferred Shareholders have the right to elect a
majority of the Trustees of the Fund at any time two years' dividends on any
Preferred Shares are unpaid. The 1940 Act also requires that, in addition to any
approval by shareholders that might otherwise be required, the approval of the
holders of a majority of any outstanding Preferred Shares, voting separately as
a class, would be required to (1) adopt any plan of reorganization that would
adversely affect the Preferred Shares, and (2) take any action requiring a vote
of security holders under Section 13(a) of the 1940 Act, including, among other
things, changes in the Fund's subclassification as a closed-end investment
company or changes in its fundamental investment restrictions. See "Certain
Provisions in the Agreement and Declaration of Trust." As a result of these
voting rights, the Fund's ability to take any such actions may be impeded to the
extent that there are any Preferred Shares outstanding. The Board presently
intends that, except as otherwise indicated in this prospectus and except as
otherwise required by applicable law, Preferred Shareholders will have equal
voting rights with Common Shareholders (one vote per share, unless otherwise
required by the 1940 Act) and will vote together with Common Shareholders as a
single class.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting as a separate class, will be required to amend, alter
or repeal any of the preferences, rights or powers of Preferred Shareholders so
as to affect materially and adversely such preferences, rights or powers, or to
increase or decrease the authorized number of Preferred Shares. The class vote
of Preferred Shareholders described above will in each case be in addition to
any other vote required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the Fund. The terms of
the Preferred Shares are expected to provide that (1) they are redeemable by the
Fund in whole or in part at the original purchase price per share plus accrued
dividends per share, (2) the Fund may tender for or purchase Preferred Shares
and (3) the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of Preferred Shares by the Fund will
reduce the leverage applicable to the Common Shares, while any resale of shares
by the Fund will increase that leverage.
The discussion above describes the possible offering of Preferred Shares by
the Fund. If the Board determines to proceed with such an offering, the terms of
the Preferred Shares may be the same as, or different from, the terms described
above, subject to applicable law and the Fund's Agreement and Declaration of
Trust. The Board, without the approval of the Common Shareholders, may authorize
an offering of Preferred Shares or may determine not to authorize such an
offering, and may fix the terms of the Preferred Shares to be offered.
CERTAIN PROVISIONS IN THE AGREEMENT AND DECLARATION OF TRUST
The Fund's Agreement and Declaration of Trust includes provisions that
could have the effect of limiting the ability of other entities or persons to
acquire control of the Fund or to change the composition of its Board. This
could have the effect of depriving shareholders of an opportunity to sell their
shares at a premium over prevailing market prices by discouraging a third party
from seeking to obtain control over the Fund. Such attempts could have the
effect of increasing the expenses of the Fund and disrupting the normal
operation of the Fund. The Board is divided into three classes, with the terms
of one class expiring at each annual meeting of shareholders. At each annual
meeting, one class of Trustees is elected to a three-year term. This provision
could delay for up to two years the replacement of a majority of the Board. A
Trustee may be removed from office only for cause by the action of a majority of
the remaining Trustees followed by a vote of the holders of at least 75% of the
shares then entitled to vote for the election of the respective Trustee.
In addition, the Fund's Agreement and Declaration of Trust requires the
favorable vote of a majority of the Fund's Board followed by the favorable vote
of the holders of at least 75% of the outstanding shares of each affected class
or series of the Fund, voting separately as a class or series, to approve, adopt
or authorize certain transactions with 5% or greater holders of a class or
series of shares and their associates, unless the transaction has been approved
by at least 80% of the Trustees. For purposes of these provisions, a 5% or
greater holder of a class or series of shares (a "Principal Shareholder") refers
to any person, including its affiliates and associates, who, whether directly or
indirectly and whether alone or together with its affiliates and associates,
beneficially owns 5% or more of the outstanding shares of any class or series of
shares of beneficial interest of the Fund. The 5% holder transactions subject to
these special approval requirements are:
o the merger or consolidation of the Fund or any subsidiary of the Fund
with or into any Principal Shareholder;
o the issuance of any securities of the Fund to any Principal Shareholder
for cash (other than pursuant to any automatic dividend reinvestment plan);
o the sale, lease or exchange of all or any substantial part of the assets
of the Fund to any Principal Shareholder, except assets having an aggregate fair
market value of less than $1,000,000, aggregating for the purpose of such
computation all assets sold, leased or exchanged in any series of similar
transactions within a twelve-month period; or
o the sale, lease or exchange to the Fund or any subsidiary of the Fund, in
exchange for securities of the Fund, of any assets of any Principal Shareholder,
except assets having an aggregate fair market value of less than $1,000,000,
aggregating for purposes of such computation all assets sold, leased or
exchanged in any series of similar transactions within a twelve-month period.
To convert the Fund to an open-end investment company, the Fund's Agreement
and Declaration of Trust requires the favorable vote of a majority of the Board
followed by the favorable vote of the holders of at least 75% of the outstanding
shares of each affected class or series of shares of the Fund, voting separately
as a class or series, unless such amendment has been approved by at least 80% of
the Trustees, in which case "a majority of the outstanding voting securities" as
defined in the 1940 Act of the Fund will be required. The foregoing vote would
satisfy a separate requirement in the 1940 Act that any conversion of the Fund
to an open-end investment company be approved by the shareholders. If approved
in the foregoing manner, conversion of the Fund to an open-end investment
company could not occur until 90 days after the shareholders' meeting at which
such conversion was approved and would also require at least 30 days' prior
notice to all shareholders. Conversion of the Fund to an open-end investment
company would require the redemption of any outstanding Preferred Shares, which
could eliminate or alter the leveraged capital structure of the Fund with
respect to the Common Shares. Following any such conversion, it is also possible
that certain of the Fund's investment policies and strategies would have to be
modified to assure sufficient portfolio liquidity. In the event of conversion,
the Common Shares would cease to be listed on the New York Stock Exchange or
other national securities exchanges or market systems. Shareholders of an
open-end investment company may require the company to redeem their shares at
any time, except in certain circumstances as authorized by or under the 1940
Act, at their NAV, less such redemption charge, if any, as might be in effect at
the time of a redemption. The Fund expects to pay all such redemption requests
in cash, but reserves the right to pay redemption requests in a combination of
cash or securities. If such partial payment in securities were made, investors
may incur brokerage costs in converting such securities to cash. If the Fund
were converted to an open-end fund, it is likely that new shares would be sold
at NAV plus a sales load. The Board believes, however, that the closed-end
structure is desirable in light of the Fund's investment objective and policies.
Therefore, you should assume that it is not likely that the Board would vote to
convert the Fund to an open-end fund.
To liquidate the Fund, the Fund's Agreement and Declaration of Trust
requires the favorable vote of a majority of the Board followed by the favorable
vote of the holders of at least 75% of the outstanding shares of each affected
class or series of the Fund, voting separately as a class or series, unless such
liquidation has been approved by at least 80% of the Trustees, in which case "a
majority of the outstanding voting securities" (as defined in the 1940 Act) of
the Fund will be required.
For the purposes of calculating "a majority of the outstanding voting
securities" under the Fund's Agreement and Declaration of Trust, each class and
series of the Fund will vote together as a single class, except to the extent
required by the 1940 Act or the Fund's Agreement and Declaration of Trust with
respect to any class or series of shares. If a separate vote is required, the
applicable proportion of shares of the class or series, voting as a separate
class or series, also will be required. The Board has determined that the
provisions with respect to the Board and the shareholder voting requirements
described above, which voting requirements are greater than the minimum
requirements under Delaware law or the 1940 Act, are in the best interest of
shareholders generally. Reference should be made to the Agreement and
Declaration of Trust on file with the Securities and Exchange Commission for the
full text of these provisions.
CLOSED-END FUND STRUCTURE
The Fund is a newly organized, diversified, closed-end management
investment company, commonly referred to as a closed-end fund. Closed-end funds
differ from open-end funds, which are generally referred to as mutual funds, in
that closed-end funds generally list their shares for trading on a stock
exchange and do not redeem their shares at the request of the shareholder. This
means that if you wish to sell your shares of a closed-end fund you must trade
them on the market like any other stock at the prevailing market price at that
time. In a mutual fund, if the shareholder wishes to sell shares of the fund,
the mutual fund will redeem or buy back the shares at "NAV," less any applicable
redemption fee or "back end" sales charge. Also, mutual funds generally offer
new shares on a continuous basis to new investors, and closed-end funds
generally do not. The continuous inflows and outflows of assets in a mutual fund
can make it difficult to manage the fund's investments. By comparison,
closed-end funds are generally able to stay more fully invested in securities
that are consistent with their investment objective, and also have greater
flexibility to make certain types of investments, and to use certain investment
strategies, such as financial leverage and investments in illiquid securities.
Shares of closed-end funds frequently trade at a discount to their NAV.
Because of this possibility and the recognition that any such discount may not
be in the interest of shareholders, the Fund's Board might consider from time to
time engaging in open-market repurchases, tender offers for Common Shares or
other programs intended to reduce the discount. There is no guarantee or
assurance that the Fund's Board will decide to engage in any of these actions.
Nor is there any guarantee or assurance that such actions, if undertaken, would
result in the Common Shares trading at a price equal or close to NAV per share.
The Board might also consider converting the Fund to an open-end mutual fund,
which would also require a vote of the shareholders of the Fund.
REPURCHASE OF COMMON SHARES
Shares of closed-end investment companies often trade at a discount to
their NAVs, and the Fund's Common Shares may also trade at a discount to their
NAV, although it is possible that they may trade at a premium above NAV. The
market price of the Fund's Common Shares will be determined by such factors as
relative demand for and supply of such Common Shares in the market, the Fund's
NAV, general market and economic conditions and other factors beyond the control
of the Fund. See "Net Asset Value." Although the Fund's Common Shareholders will
not have the right to redeem their Common Shares, the Fund may take action to
repurchase Common Shares in the open market or make tender offers for its Common
Shares. This may have the effect of reducing any market discount from NAV. There
is no assurance that, if action is undertaken to repurchase or tender for Common
Shares, such action will result in the Common Shares trading at a price which
approximates their NAV. Although share repurchases and tenders could have a
favorable effect on the market price of the Fund's Common Shares, you should be
aware that the acquisition of Common Shares by the Fund will decrease the
capital of the Fund and, therefore, may have the effect of increasing the Fund's
expense ratio and decreasing the asset coverage with respect to any Preferred
Shares outstanding. Any share repurchases or tender offers will be made in
accordance with requirements of the Securities Exchange Act of 1934, as amended,
the 1940 Act and the principal stock exchange on which the Common Shares are
traded.
TAX MATTERS
Federal Tax Matters
The discussion below and in the Statement of Additional Information
provides general tax information related to an investment in the Common Shares.
The discussion reflects applicable tax laws of the United States as of the date
of this prospectus, which tax laws may be changed or subject to new
interpretations by the courts or the Internal Revenue Service retroactively or
prospectively. Because tax laws are complex and often change, you should consult
your tax advisor about the tax consequences of an investment in the Fund.
The Fund invests primarily in securities the income of which is exempt from
federal income tax, including AMT. Consequently, the regular monthly dividends
you receive will generally be exempt from Federal income tax, including AMT. A
portion of these dividends, however, may be subject to AMT.
Although the Fund does not seek to realize taxable income or capital gains,
the Fund may realize and distribute taxable income or capital gains from time to
time as a result of the Fund's normal investment activities. The Fund will
distribute at least annually any taxable income or realized capital gains.
Distributions of net short-term gains are taxable as ordinary income.
Distributions of net long-term capital gains are taxable to you as long-term
capital gains regardless of how long you have owned your Common Shares.
Dividends will not qualify for a dividends received deduction generally
available to corporate shareholders.
Each year, you will receive a year-end statement designating the amounts of
tax exempt dividends, capital gain dividends and ordinary income dividends paid
to you during the preceding year, including the source of investment income by
state. You will receive this statement from the firm where you purchased your
Common Shares if you hold your investment in street name. The Fund will send you
this statement if you hold your Common Shares in registered form.
The tax status of your dividends is not affected by whether you reinvest
your dividends or receive them in cash.
In order to avoid corporate taxation of its taxable income and be permitted
to pay tax exempt dividends, the Fund must elect to be treated as a regulated
investment company under Subchapter M of the Code and meet certain requirements
that govern the Fund's sources of income, diversification of assets and
distribution of earnings to shareholders. The Fund intends to make such an
election and meet these requirements. If the Fund failed to do so, the Fund
would be required to pay corporate taxes on its taxable income and all the
distributions would be taxable as ordinary income to the extent of the Fund's
earnings and profits. In particular, in order for the Fund to pay tax exempt
dividends, at least 50% of the value of the Fund's total assets must consist of
tax exempt obligations on a quarterly basis. The Fund intends to meet this
requirement. If the Fund failed to do so, it would not be able to pay tax exempt
dividends and your distributions attributable to interest received by the Fund
from any source would be taxable as ordinary income to the extent of the Fund's
earnings and profits.
The Fund may at times buy tax exempt securities at a discount from the
price at which they were originally issued, especially during periods of rising
interest rates. For federal income tax purposes, some or all of any market
discount that is other than de minimis will be included in the Fund's ordinary
income and will be taxable to shareholders as such when it is distributed.
The Fund may be required to withhold taxes on certain of your dividends if
you have not provided the Fund with your correct taxpayer identification number
(if you are an individual, normally your Social Security number), or if you are
otherwise subject to back-up withholding. If you receive Social Security
benefits, you should be aware that tax exempt dividend income is taken into
account in calculating the amount of these benefits that may be subject to
federal income tax. If you borrow money to buy Fund shares, you may not be
permitted to deduct the interest on that loan. Under federal income tax rules,
Fund shares may be treated as having been bought with borrowed money even if the
purchase of the Fund shares cannot be traced directly to borrowed money. Holders
are urged to consult their own tax advisors regarding the impact of an
investment in Common Shares upon the deductibility of interest payable by the
holder.
State and Local Tax Matters
The exemption from federal income tax for exempt-interest dividends does
not necessarily result in exemption for such dividends under the income or other
tax laws of any state or local taxing authority. In some states, the portion of
any exempt-interest dividend that is derived from interest received by a
regulated investment company on its holdings of that state's securities and its
political subdivisions and instrumentalities is exempt from that state's income
tax. Therefore, the Fund will report annually to its shareholders the percentage
of interest income earned by the Fund during the preceding year on tax exempt
obligations indicating, on a state-by-state basis, the source of such income.
Shareholders of the Fund are advised to consult with their own tax advisors
about state and local tax matters.
Please refer to the Statement of Additional Information for more detailed
information. You are urged to consult your tax advisor.
UNDERWRITING
Subject to the terms and conditions of a purchase agreement dated December
19, 2002, each underwriter named below has severally agreed to purchase, and the
Fund has agreed to sell to such underwriter the number of Common Shares set
forth opposite the name of such underwriter.
Underwriter Number of Common Shares
Merrill Lynch, Pierce, Fenner & Smith
Incorporated 800,000
UBS Warburg LLC 800,000
A.G. Edwards & Sons, Inc. 400,000
RBC Dain Rauscher, Inc. 400,000
Wachovia Securities, Inc. 400,000
Wells Fargo Securities, LLC 400,000
Advest, Inc. 150,000
Robert W. Baird & Co. Incorporated 150,000
BB&T Capital Markets, a subsidiary of
Scott & Stringfellow, Inc. 150,000
Fahnestock & Co. Inc. 150,000
Ferris, Baker Watts, Incorporated 150,000
Janney Montgomery Scott LLC 150,000
McDonald Investments Inc., a KeyCorp Company 150,000
Parker/Hunter Incorporated 150,000
Quick & Reilly, Inc. 150,000
Stephens Inc. 150,000
Stifel, Nicolaus & Company, Incorporated 150,000
CIBC World Markets Corp. 80,000
Deutsche Bank Securities, Inc. 80,000
Salomon Smith Barney Inc. 80,000
US Bancorp Piper Jaffray 80,000
Crowell, Weedon & Co. 40,000
Legg Mason Wood Walker, Incorporated 40,000
Morgan Keegan & Company, Inc. 40,000
TD Waterhouse Investor Services, Inc. 40,000
William Blair & Company, L.L.C. 40,000
Allen & Co. of Florida, Inc. 20,000
Arthurs, Lestrange & Company, Incorporated 20,000
Brean Murray & Co., Inc. 20,000
Chatsworth Securities LLC 20,000
D.A. Davidson & Co. 20,000
Gilford Securities Incorporated 20,000
Howe Barnes Investments, Inc. 20,000
J.J.B. Hilliard, W.L. Lyons, Inc. 20,000
Johnston, Lemon & Co. Incorporated 20,000
Mesirow Financial, Inc. 20,000
Needham & Company, Inc. 20,000
David A. Noyes & Company 20,000
Pacific Crest Securities, Inc. 20,000
Peacock, Hilsop, Staley & Givens, Inc. 20,000
Ramirez & Co., Inc. 20,000
Sands Brothers & Co., Ltd. 20,000
Smith, Moore & Co. 20,000
Sterling Financial Investment Group, Inc. 20,000
SWS Securities, Inc. 20,000
The Seidler Companies Incorporated 20,000
Torrey Pines Securities 20,000
Utendahl Capital Partners, L.P. 20,000
C.E. Unterberg, Towbin 20,000
Wedbush Morgan Securities, Inc. 20,000
Total...................................................5,850,000
The purchase agreement provides that the obligations of the underwriters to
purchase the Common Shares included in this offering are subject to the approval
of certain legal matters by counsel under the purchase agreement and to certain
other conditions. The underwriters are obligated to purchase all of the Common
Shares (other than those covered by the over-allotment described below) if any
of the Common Shares are purchased. In the purchase agreement, the Fund and the
Adviser have agreed to indemnify the underwriters against certain liabilities,
including liabilities arising under the Securities Act of 1933, as amended, or
to contribute to payments the underwriters may be required to make for any of
those liabilities.
The underwriters propose to initially offer some of the Common Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Common Shares to certain dealers at the
public offering price less a concession not in excess of $.45 per Common Share.
The sales load the Fund will pay of $.675 per Common Share is equal to 4.5% of
the initial offering price. The underwriters may allow, and the dealers may
reallow, a discount not in excess of $.10 per Common Share on sales to other
dealers. After the initial public offering, the public offering price,
concession and discount may be changed.
The following table shows the public offering price, sales load and
proceeds before and after expenses to the Fund. The information assumes either
no exercise or full exercise by the underwriters of their over-allotment option.
Without With
Per Share Option Option
Public offering price $15.00 $87,750,000 $100,912,500
Sales load $0.675 $3,948,750 $4,541,063
Proceeds, before expenses, to the Fund $14.325 $83,801,250 $96,371,438
Proceeds, after expenses, to the Fund $14.295 $83,625,750 $96,169,613
The expenses of the offering are estimated at $175,500 and are payable by
the Fund. The Fund has agreed to pay the underwriters $.005 per Common Share as
a partial reimbursement of expenses incurred in connection with the offering.
The Adviser has agreed to pay organizational expenses and offering costs of the
Fund (other than sales load, but including the reimbursement of underwriters
expenses) that exceed $.03 per Common Share.
The Fund has granted the underwriters an option to purchase up to 877,500
additional Common Shares at the public offering price, less the sales load,
within 45 days from the date of this prospectus solely to cover any
over-allotments. If the underwriters exercise this option, each will be
obligated, subject to conditions contained in the purchase agreement, to
purchase a number of additional Common Shares proportionate to that
underwriter's initial amount reflected in the above table.
Until the distribution of the Common Shares is complete, SEC rules may
limit underwriters and selling group members from bidding for and purchasing
Common Shares. However, the representatives may engage in transactions that
stabilize the price of Common Shares, such as bids or purchases to peg, fix or
maintain that price.
If the underwriters create a short position in Common Shares in connection
with the offering, i.e., if they sell more Common Shares than are listed on the
cover of this prospectus, the representatives may reduce that short position by
purchasing Common Shares in the open market. The representatives may also elect
to reduce any short position by exercising all or part of the over-allotment
option described above. The underwriters also may impose a penalty bid, whereby
selling concessions allowed to syndicate members or other broker-dealers in
respect of Common Shares sold in this offering for their account may be
reclaimed by the syndicate if such Common Shares are repurchased by the
syndicate in stabilizing or covering transactions. Purchases of Common Shares to
stabilize its price or to reduce a short position may cause the price of Common
Shares to be higher than it might be in the absence of such purchases.
Neither we nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of Common Shares. In addition, neither we
nor any of the underwriters make any representation that the representatives
will engage in these transactions or that these transactions, once commenced,
will not be discontinued without notice.
The Fund has agreed not to offer or sell any additional Common Shares for a
period of 180 days after the date of the purchase agreement without the prior
written consent of the underwriters, except for the sale of the Common Shares to
the underwriters pursuant to the purchase agreement and the sale of Common
Shares pursuant to the Fund's Dividend Reinvestment Plan.
The Fund anticipates that the underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions after they
have ceased to be underwriters. The underwriters are active underwriters of, and
dealers in, securities and act as market markers in a number of such securities,
and therefore can be expected to engage in portfolio transactions with the Fund.
The Common Shares will be sold to ensure that New York Stock Exchange
distribution standards (round lots, public shares and aggregate market value)
will be met.
The Adviser has also agreed to pay a fee to Merrill Lynch payable quarterly
at the annual rate of 0.10% of the Fund's Managed Assets during the continuance
of the investment management agreement or other advisory agreement between the
Adviser and the Fund. The sum of this fee plus the amount of the expense
reimbursement of $.005 per Common Share payable by the Fund to the underwriters
will not exceed 4.5% of the total price to the public of the Common Shares
offered hereby; provided, that in determining when the maximum amount has been
paid the value of each of the quarterly payments shall be discounted at the
annual rate of 10% to the closing date of this offering. Merrill Lynch has
agreed to provide certain after-market support services to the Adviser designed
to maintain the visibility of the Fund on an ongoing basis, to provide relevant
information, studies or reports regarding the Fund and the closed-end investment
company and asset management industries and to provide information to and
consult with the Adviser with respect to applicable strategies designed to
address market discounts, if any.
The principal business address of Merrill Lynch, Pierce, Fenner & Smith
Incorporated is 4 World Financial Center, New York, New York 10080.
CUSTODIAN AND TRANSFER AGENT
The Custodian of the assets of the Fund is State Street Bank and Trust
Company, 225 Franklin Street, Boston, Massachusetts 02110. The Custodian
performs custodial, fund accounting and portfolio accounting services. EquiServe
Trust Company, N.A., P.O. Box 43011, Providence, RI 02940-3011, will serve as
the Fund's Transfer Agent and Dividend Disbursing Agent.
LEGAL OPINIONS
Certain legal matters in connection with the Common Shares will be passed
upon for the Fund by Dickstein Shapiro Morin & Oshinsky LLP and for the
underwriters by Clifford Chance US LLP, New York, New York. Dickstein Shapiro
Morin & Oshinsky LLP and Clifford Chance US LLP may rely as to certain matters
of Delaware law on the opinion of Reed Smith LLP.
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
Page
Use of Proceeds.............................................................. 2
Investment Strategies........................................................ 2
Fundamental Investment Objective, Policy and Limitations................. 2
Non-Fundamental Investment Policies......................................... 4
Investment Securities.........................................................5
Management of the Fund.......................................................11
Brokerage Transactions.......................................................19
Description of Shares........................................................19
Repurchase of Common Shares................................................. 20
Tax Matters.............................................................. 22
Performance Related and Comparative Information.......................... 27
Federated Investors, Inc.....................................................29
Experts......................................................................30
Additional Information.......................................................30
Independent Auditors' Report.................................................30
Financial Statements..................................................... 32
APPENDIX A Ratings of Investments......................................... 34
5,850,000 Shares
Federated Premier Municipal Income Fund
Common Shares
$15.00 Per Share
PROSPECTUS
Merrill Lynch & Co.
UBS Warburg A.G. Edwards & Sons, RBC Capital Markets
Inc.
Wachovia Securities Wells Fargo Securities, Advest, Inc.
LLC
Robert W. Baird & Co. BB&T Capital Markets, a Fahnestock & Co. Inc.
subsidiary of Scott &
Stringfellow, Inc.
Ferris, Baker Watts Janney Montgomery Scott McDonald Investments,
Incorporated LLC Inc.
Parker/Hunter Quick & Reilly, Inc. Stephens Inc.
Incorporated
Stifel, Nicholaus & Company Incorporated
December 19, 2002
CUSIP 31423P108
FEDERATED PREMIER MUNICIPAL INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
Federated Premier Municipal Income Fund (the "Fund") is a newly organized,
diversified, closed-end management investment company. This Statement of
Additional Information relating to Common Shares does not constitute a
prospectus, but should be read in conjunction with the prospectus relating
thereto dated December 19, 2002. This Statement of Additional Information does
not include all information that a prospective investor should consider before
purchasing Common Shares, and investors should obtain and read the prospectus
prior to purchasing such Common Shares. A copy of the prospectus may be obtained
without charge by calling 1-800-341-7400. You may also obtain a copy of the
prospectus on the Securities and Exchange Commission's web site
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the prospectus.
TABLE OF CONTENTS
Page
Use Of Proceeds........................................................2
Investment Strategies..................................................2
Fundamental Investment Objective, Policy And Limitations...............2
Non-Fundamental Investment Policies....................................2
Investment Securities..................................................2
Management Of The Fund.................................................2
Brokerage Transactions.................................................2
Description Of Shares..................................................2
Repurchase Of Common Shares............................................2
Tax Matters............................................................2
Performance And Related Comparative Information........................2
Federated Investors, Inc...............................................2
Experts................................................................2
Additional Information.................................................2
Independent Auditors' Report...........................................2
Financial Statements...................................................2
Appendix A Ratings Of Investments......................................2
This Statement of Additional Information is dated December 19 2002.
90
USE OF PROCEEDS
Pending investment in tax exempt securities that meet the Fund's investment
objective and policies, the net proceeds of the offering will be invested in
high-quality, short-term tax exempt money market securities or in high-quality
tax exempt securities with relatively low volatility (such as pre-refunded and
intermediate-term bonds), to the extent such securities are available. If
necessary to invest fully the net proceeds of the offering immediately, the Fund
may also purchase, as temporary investments, short-term taxable investments the
income on which is subject to federal regular income tax, and securities of
other open- or closed-end investment companies that invest primarily in tax
exempt securities of the type in which the Fund may invest directly.
INVESTMENT STRATEGIES
Under normal circumstances, the Fund will maintain a dollar-weighted
average portfolio maturity of 15 to 30 years and a dollar-weighted average
duration of 7 to 13 years.
The Fund's average portfolio maturity represents an average based on the
actual stated maturity dates of the debt securities in the Fund's portfolio,
except that: (1) variable-rate securities are deemed to mature at the next
interest-rate adjustment date, unless subject to a demand feature; (2)
variable-rate securities subject to a demand feature are deemed to mature on the
longer of the next interest-rate adjustment date or the date on which principal
can be recovered through demand; (3) floating-rate securities subject to a
demand feature are deemed to mature on the date on which the principal can be
recovered through demand; and (4) securities being hedged with futures contracts
may be deemed to have a longer maturity, in the case of purchases of futures
contracts, and a shorter maturity, in the case of sales of futures contracts,
than they would otherwise be deemed to have. In addition, a security that is
subject to redemption at the option of the issuer on a particular date ("call
date"), which is prior to the security's stated maturity, may be deemed to
mature on the call date rather than on its stated maturity date. The call date
of a security will be used to calculate average portfolio maturity when the
Adviser reasonably anticipates, based upon information available to it, that the
issuer will exercise its right to redeem the security. The average portfolio
maturity of the Fund is dollar weighted based upon the market value of the
Fund's securities at the time of calculation.
The Fund cannot accurately predict its portfolio turnover rate but
anticipates that its annual portfolio turnover rate will not exceed 100%. The
Fund generally will not trade securities for the purpose of realizing short-term
profits, but it will adjust its portfolio as it deems advisable in view of
prevailing or anticipated market conditions to accomplish its investment
objective. Other than for consideration of tax consequences, frequency of
portfolio turnover will not be a limiting factor if the Fund considers it
advantageous to purchase or sell securities.
FUNDAMENTAL INVESTMENT OBJECTIVE, POLICY AND LIMITATIONS
The following fundamental investment objective, policy and limitations may
not be changed by the Fund's Board without the approval of the holders of a
majority of (1) the outstanding Common Shares and Preferred Shares (if any)
voting together as a class, and (2) the outstanding Preferred Shares (if any),
voting as a separate class. When used with respect to particular shares of the
Fund, "majority of the outstanding" means (a) 67% or more of the shares present
at a meeting, if the holders of more than 50% of the shares are present or
represented by proxy, or (b) more than 50% of the shares, whichever is less.
Investment Objectives
The Fund's investment objective is to provide current income exempt from
federal income tax, including AMT.
Investment Policy
The Fund will invest its assets so that at least 80% of the income that it
distributes will be exempt from federal regular income tax.
Investment Limitations
Concentration
The Fund will not make investments that will result in the concentration of
its investments in the securities of issuers primarily engaged in the same
industry, but may invest more than 25% of its total assets in securities of
issuers in the same economic sector.
Diversification of Investments
With respect to securities comprising 75% of the value of its total assets,
the Fund will not purchase the securities of any one issuer (other than cash,
cash items, securities issued or guaranteed by the government of the United
States or its agencies or instrumentalities and repurchase agreements
collateralized by such U.S. government securities, and securities of other
investment companies) if as a result more than 5% of the value of its total
assets would be invested in the securities of that issuer, or it would own more
than 10% of the outstanding voting securities of that issuer.
Underwriting
The Fund will not underwrite any issue of securities, except as it may be
deemed to be an underwriter under the Securities Act of 1933 in connection with
the sale of securities in accordance with its investment objective, policies and
limitations.
Investing in Real Estate
The Fund will not buy or sell real estate, although it may invest in tax
exempt securities secured by real estate or interests in real estate.
Investing in Commodities
The Fund may not purchase or sell physical commodities, provided that the
Fund may purchase securities of companies that deal in commodities. For purposes
of this restriction, investments in transactions involving futures contracts and
options, swap transactions, and other financial contracts that settle by payment
of cash are not deemed to be investments in commodities.
Lending
The Fund will not make loans, but may acquire publicly or non-publicly
issued tax exempt securities as permitted by its investment objective, policies
and limitations.
Borrowing Money and Issuing Senior Securities
The Fund may borrow money, directly or indirectly, and issue senior
securities to the maximum extent permitted under the Investment Company Act of
1940 (the "1940 Act").
For purposes of applying the concentration limitation, securities of the
U.S. government, its agencies or instrumentalities, and securities backed by the
credit of a governmental entity are not considered to represent industries.
However, obligations backed only by the assets and revenues of non-governmental
issuers may for this purpose be deemed to be issued by such non-governmental
issuers. Thus, the 25% limitation would apply to such obligations.
For the purpose of applying the concentration limitation, a
non-governmental issuer will be deemed the sole issuer of a security when its
assets and revenues are separate from other governmental entities and its
securities are backed only by its assets and revenues. Similarly, in the case of
a non-governmental issuer, such as an industrial corporation or a privately
owned or operated hospital, if the security is backed only by the assets and
revenues of the non-governmental issuer, then such non-governmental issuer would
be deemed to be the sole issuer. Where a security is also backed by the
enforceable obligation of a superior or unrelated governmental or other entity
(other than a bond insurer), it will also be included in the computation of
securities owned that are issued by such governmental or other entity. Where a
security is guaranteed by a governmental entity or some other facility, such as
a bank guarantee or letter of credit, such a guarantee or letter of credit would
be considered a separate security and would be treated as an issue of such
government, other entity or bank.
NON-FUNDAMENTAL INVESTMENT POLICIES
The Fund is also subject to the following non-fundamental investment
policies, which may be changed by the Board without shareholder approval.
Short Sales
The Fund will not make any short sale of securities except in conformity
with applicable laws, rules and regulations and unless after giving effect to
such sale, the market value of all securities sold short does not exceed 25% of
the value of the Fund's total assets and the Fund's aggregate short sales of a
particular class of securities does not exceed 25% of the then outstanding
securities of that class.
Investing in Other Investment Companies
The Fund may purchase securities of open-end or closed-end investment
companies in compliance with the 1940 Act or any exemptive relief obtained
thereunder.
Exercise of Control
The Fund will not purchase securities of companies for the purpose of
exercising control.
INVESTMENT SECURITIES
The following information supplements the discussion of the Fund's
investment securities that are described in the prospectus.
Fixed Income Securities
Fixed income securities pay interest, dividends or distributions at a
specified rate. The rate may be a fixed percentage of the principal or adjusted
periodically. In addition, the issuer of a fixed income security must repay the
principal amount of the security, normally within a specified time. Fixed income
securities provide more regular income than equity securities. However, the
returns on fixed income securities are limited and normally do not increase with
the issuer's earnings. This limits the potential appreciation of fixed income
securities as compared to equity securities.
A security's yield measures the annual income earned on a security as a
percentage of its price. A security's yield will increase or decrease depending
upon whether it costs less (a discount) or more (a premium) than the principal
amount. If the issuer may redeem the security before its scheduled maturity, the
price and yield on a discount or premium security may change based upon the
probability of an early redemption. Securities with higher risks generally have
higher yields.
The Fund may invest in tax exempt securities, which pay interest that is
not subject to regular income taxes, including AMT. Typically, states, counties,
cities and other political subdivisions and authorities issue tax exempt
securities. The market categorizes tax exempt securities by their source of
repayment.
Following is a description of non-principal tax exempt securities in which
the Fund may invest.
Variable Rate Demand Instruments. Variable rate demand instruments are tax
exempt securities that require the issuer or a third party, such as a dealer or
bank, to repurchase the security for its face value upon demand. The securities
also pay interest at a variable rate intended to cause the securities to trade
at their face value. The Fund treats demand instruments as short-term securities
because their variable interest rate adjusts in response to changes in market
rates, even though their stated maturity may extend beyond 13 months.
Municipal Notes. Municipal notes are short-term tax exempt securities. Many
municipalities issue such notes to fund their current operations before
collecting taxes or other municipal revenues. Municipalities may also issue
notes to fund capital projects prior to issuing long-term bonds. The issuers
typically repay the notes at the end of their fiscal year, either with taxes,
other revenues or proceeds from newly issued notes or bonds.
Tax Increment Financing Bonds. Tax increment financing (TIF) bonds are
payable from increases in taxes or other revenues attributable to projects
financed by the bonds. For example, a municipality may issue TIF bonds to
redevelop a commercial area. The TIF bonds would be payable solely from any
increase in sales taxes collected from merchants in the area. The bonds could
default if merchants' sales, and related tax collections, failed to increase as
anticipated.
Municipal Mortgage Back Securities. Municipal mortgage backed securities
are special revenue bonds the proceeds of which may be used to provide mortgage
loans for single family homes or to finance multifamily housing. Municipal
mortgage backed securities represent interests in pools of mortgages. The
mortgages that comprise a pool normally have similar interest rates, maturities
and other terms. Municipal mortgage backed securities generally have fixed
interest rates.
PACS. PACs (planned amortization classes) are a sophisticated form of
mortgage backed security issued with a companion class. PACs receive principal
payments and prepayments at a specified rate. In addition, PACs will receive the
companion classes' share of principal payments, if necessary, to cover a
shortfall in the prepayment rate. This helps PACs to control prepayment risks by
increasing the risks to their companion classes.
Credit Enhancement
Common types of credit enhancement include guarantees, letters of credit,
bond insurance and surety bonds. Credit enhancement also includes arrangements
where securities or other liquid assets secure payment of a fixed income
security. If a default occurs, these assets may be sold and the proceeds paid to
a security's holders. Each form of credit enhancement reduces credit risks by
providing another source of payment for a fixed income security.
Structured Notes
The Fund may invest in "structured" notes, which are privately negotiated
debt obligations where the principal and/or interest is determined by reference
to the performance of a benchmark asset, market or interest rate, such as
selected securities, an index of securities or specified interest rates or the
differential performance of two assets or markets, such as indices reflecting
taxable and tax exempt bonds. Depending on the terms of the note, the Fund may
forgo all or part of the interest and principal that would be payable on a
comparable conventional note. The rate of return on structured notes may be
determined by applying a multiplier to the performance or differential
performance of the referenced index(es) or other assets(s). Application of a
multiplier involves leverage that will serve to magnify the potential for gain
and the risk of loss.
The Fund currently intends that any use of structured notes will be for the
purpose of reducing the interest rate sensitivity of the Fund's portfolio (and
thereby decreasing the Fund's exposure to interest rate risk) and, in any event,
that the interest income on the notes will normally be exempt from federal
income tax. The Fund will only invest in structured notes if it has received an
opinion of counsel for the issuer (or the advice of another authority believed
by the Adviser to be reliable) that the interest income on the notes will be
exempt from federal income tax. Like other sophisticated strategies, the Fund's
use of structured notes may not work as intended; for example, the change in
value of the structured notes may not match very closely the change in the value
of bonds that the structured notes were purchased to hedge.
Derivative Contracts
Derivative contracts are financial instruments that require payments based
upon changes in the values of designated (or underlying) securities, currencies,
commodities, financial indices or other assets or instruments. Some derivative
contracts (such as futures, forwards and options) require payments relating to a
future trade involving the underlying asset. Other derivative contracts (such as
swaps) require payments relating to the income or returns from the underlying
asset or instrument. The other party to a derivative contract is referred to as
a counterparty.
Many derivative contracts are traded on securities or commodities
exchanges. In this case, the exchange sets all the terms of the contract except
for the price. Investors make payments due under their contracts through the
exchange. Most exchanges require investors to maintain margin accounts through
their brokers to cover their potential obligations to the exchange. Parties to
the contract make (or collect) daily payments to the margin accounts to reflect
losses (or gains) in the value of their contracts. This protects investors
against potential defaults by the counterparty. Trading contracts on an exchange
also allows investors to close out their contracts by entering into offsetting
contracts.
For example, the Fund could close out an open contract to buy an asset at a
future date by entering into an offsetting contract to sell the same asset on
the same date. If the offsetting sale price is more than the original purchase
price, the Fund realizes a gain; if it is less, the Fund realizes a loss.
Exchanges may limit the amount of open contracts permitted at any one time. Such
limits may prevent the Fund from closing out a position. If this happens, the
Fund will be required to keep the contract open (even if it is losing money on
the contract), and to make any payments required under the contract (even if it
has to sell portfolio securities at unfavorable prices to do so). Inability to
close out a contract could also harm the Fund by preventing it from disposing of
or trading any assets it has been using to secure its obligations under the
contract.
The Fund may also trade derivative contracts over-the-counter (OTC) in
transactions negotiated directly between the Fund and the counterparty. OTC
contracts do not necessarily have standard terms, so they cannot be directly
offset with other OTC contracts. In addition, OTC contracts with more
specialized terms may be more difficult to price than exchange traded contracts.
Depending upon how the Fund uses derivative contracts and the relationships
between the market value of a derivative contract and the underlying asset or
instrument, derivative contracts may increase or decrease the Fund's exposure to
interest rate risks, and may also expose the Fund to liquidity, leverage and tax
risks. OTC contracts also expose the Fund to credit risks in the event that a
counterparty defaults on the contract.
The Fund may trade in the following types of derivative contracts, as well
as combinations of these contracts, including, but not limited to, options on
futures contracts, options on forward contracts and options on swaps.
Futures Contracts. Futures contracts provide for the future sale by one
party and purchase by another party of a specified amount of an underlying asset
or instrument at a specified price, date and time. Entering into a contract to
buy an underlying asset is commonly referred to as buying a contract or holding
a long position in the asset. Entering into a contract to sell an underlying
asset is commonly referred to as selling a contract or holding a short position
in the asset. Futures contracts are considered to be commodity contracts.
Futures contracts traded OTC are frequently referred to as forward contracts.
The Fund may buy or sell the interest rate futures contracts and index
financial futures contracts. The Fund may also buy or sell futures contracts on
tax exempt securities and U.S. government and agency securities.
Options. Options are rights to buy or sell an underlying asset or
instrument for a specified price (the exercise price) during, or at the end of,
a specified period. A call option gives the holder (buyer) the right to buy the
underlying asset or instrument from the seller (writer) of the option. A put
option gives the holder the right to sell the underlying asset or instrument to
the writer of the option. The writer of the option receives a payment, or
premium, from the buyer, which the writer keeps regardless of whether the buyer
uses (or exercises) the option. If the Fund writes options on futures contracts,
it will be subject to margin requirements similar to those applied to futures
contracts.
Swaps. Swaps are contracts in which two parties agree to pay each other
(swap) the returns derived from underlying assets or instruments with differing
characteristics. Most swaps do not involve the delivery of the underlying assets
or instruments by either party, and the parties might not own the assets or
instruments underlying the swap. The payments are usually made on a net basis so
that, on any given day, the Fund would receive (or pay) only the amount by which
its payment under the contract is less than (or exceeds) the amount of the other
party's payment. Swap agreements are sophisticated instruments that can take
many different forms, and are known by a variety of names including caps, floors
and collars. Common swap agreements that the Fund may use include:
Interest Rate Swaps. Interest rate swaps are contracts in which one party
agrees to make regular payments equal to a fixed or floating interest rate times
a stated, notional principal amount of fixed income securities, in return for
payments equal to a different fixed or floating rate times the same notional
principal amount, for a specific period. For example, a $10 million LIBOR swap
would require one party to pay the equivalent of the London Interbank Offer Rate
of interest (which fluctuates) on $10 million notional principal amount in
exchange for the right to receive the equivalent of a stated fixed rate of
interest on $10 million notional principal amount.
Caps and Floors. Caps and floors are contracts in which one party agrees to
make payments only if an interest rate or index goes above (cap) or below
(floor) a certain level in return for a fee from the other party.
Total Return Swaps. Total return swaps are contracts in which one party
agrees to make payments of the total return from the underlying asset or
instrument during the specified period, in return for payments equal to a fixed
or floating rate of interest or the total return from another underlying asset
or instrument.
Municipal Market Data Rate Locks. The Fund may purchase and sell Municipal
Market Data Rate Locks ("MMD Rate Locks"). An MMD Rate Lock permits the Fund to
lock in a specified municipal interest rate for a portion of its portfolio to
preserve a return on a particular investment or a portion of its portfolio as a
duration management technique or to protect against any increase in the price of
securities to be purchased at a later date. The Fund will ordinarily use these
transactions as a hedge or for duration or risk management although it is
permitted to enter into them to enhance income or gain. An MMD Rate Lock is a
contract between the Fund and an MMD Rate Lock provider pursuant to which the
parties agree to make payments to each other on a notional amount, contingent
upon whether the Municipal Market Data AAA General Obligation Scale is above or
below a specified level on the expiration date of the contract. For example, if
the Fund buys an MMD Rate Lock and the Municipal Market Data AAA General
Obligation Scale is below the specified level on the expiration date, the
counterparty to the contract will make a payment to the Fund equal to the
specified level minus the actual level, multiplied by the notional amount of the
contract. If the Municipal Market Data AAA General Obligation Scale is above the
specified level on the expiration date, the Fund will make a payment to the
counterparty equal to the actual level minus the specified level, multiplied by
the notional amount of the contract. In entering into MMD Rate Locks, there is a
risk that municipal yields will move in the direction opposite the direction
anticipated by the Fund.
Short Sales
The Fund may make short sales of securities as part of its overall
portfolio management strategy and to offset potential declines in long positions
in securities in the Fund's portfolio. A short sale is a transaction in which
the Fund sells a security it does not own in anticipation that the market price
of that security will decline. Although short sale transactions are not
currently available with respect to Municipal Bonds, the Fund may engage in
short sales on taxable bonds and on futures contracts with respect to Municipal
Bonds and taxable bonds.
When the Fund makes a short sale on a security, it must borrow the security
sold short and deliver it to the broker-dealer through which it made the short
sale as collateral for its obligation to deliver the security upon conclusion of
the sale. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any accrued interest and dividends on such borrowed
securities.
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss; conversely, if the price declines, the Fund will realize a capital
gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. The successful use of short selling may be adversely
affected by imperfect correlation between movements in the price of the security
sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. A short sale is "against the box" to the extent
that the Fund contemporaneously owns, or has the right to obtain at no added
cost, securities identical to those sold short. The Fund may also engage in
so-called "naked" short sales (i.e., short sales that are not "against the
box"), in which case the Fund's losses could theoretically be unlimited in cases
where the Fund is unable for whatever reason to close out its short position.
The Fund has the flexibility to engage in short selling to the extent permitted
by the 1940 Act and rules and interpretations thereunder.
Investing In Securities Of Other Investment Companies
The Fund may invest its assets in securities of other open-end or
closed-end investment companies, including the securities of affiliated
investment companies, as an efficient means of carrying out its investment
policies and managing its uninvested cash.
Temporary Defensive Investments
The Fund may make temporary defensive investments in the following taxable
securities:
Treasury Securities. Treasury securities are direct obligations of the
federal government of the United States.
Agency Securities. Agency securities are issued or guaranteed by a federal
agency or other government sponsored entity ("GSE") acting under federal
authority. The United States supports some GSEs with its full faith and credit.
Other GSEs receive support through federal subsidies, loans or other benefits. A
few GSEs have no explicit financial support, but are regarded as having implied
support because the federal government sponsors their activities.
Bank Instruments. Bank instruments are unsecured interest bearing deposits
with banks. Bank instruments include bank accounts, time deposits, certificates
of deposit and banker's acceptances.
Corporate Debt Securities. Corporate debt securities are fixed income
securities issued by businesses. Notes, bonds, debentures and commercial paper
are the most prevalent types of corporate debt securities.
Commercial Paper. Commercial paper is an issuer's obligation with a
maturity of less than nine months. Companies typically issue commercial paper to
pay for current expenditures. Most issuers constantly reissue their commercial
paper and use the proceeds (or bank loans) to repay maturing paper. If the
issuer cannot continue to obtain liquidity in this fashion, its commercial paper
may default. The short maturity of commercial paper reduces both the market and
credit risks as compared to other debt securities of the same issuer.
Repurchase Agreements. Repurchase agreements are transactions in which the
Fund buys a security from a dealer or bank and agrees to sell the security back
at a mutually agreed upon time and place. The repurchase price exceeds the sale
price, reflecting the Fund's return on the transaction. This return is unrelated
to the interest rate on the underlying security. The Fund will enter into
repurchase agreements only with banks and other recognized financial
institutions, such as securities dealers, deemed creditworthy by the Adviser.
The Fund's custodian or subcustodian will take possession of the securities
subject to repurchase agreements. The Adviser or subcustodian will monitor the
value of the underlying security each day to ensure that the value of the
security always equals or exceeds the repurchase price.
Repurchase agreements are subject to credit risks.
MANAGEMENT OF THE FUND
Board of Trustees
The Board is responsible for managing the Fund's business affairs and for
exercising all the Fund's powers except those reserved for the shareholders. The
following tables give information about each Board member and the senior
officers of the Fund. Where required, the tables separately list Board members
who are "interested persons" of the Fund (i.e., "Interested" Board members) and
those who are not (i.e., "Independent" Board members). Unless otherwise noted,
the address of each person listed is Federated Investors Tower, 1001 Liberty
Avenue, Pittsburgh, PA. The Federated Fund Complex consists of 44 investment
companies (comprising 139 portfolios). Unless otherwise noted, each Board member
oversees all portfolios in the Federated Fund Complex; serves for an indefinite
term; and also serves as a Board member of the following investment company
complexes: Banknorth Funds--five portfolios; CCMI Funds--two portfolios; Regions
Funds--eight portfolios; Riggs Funds--nine portfolios; and WesMark Funds--five
portfolios.
Interested Trustees Background And Compensation
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
Total
Compensation
Aggregate From
Name Birth Date Compensation Fund and
Address Principal Occupation(s) for Past Five Years, From Federated
Positions Held Other Directorships Held and Previous Positions Fund + Fund
with Fund Complex
(past
calendar
year)
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
John F. Principal Occupations: Chairman and Director or $0 $0
Donahue* Birth Trustee of the Federated Fund Complex; Chairman
Date: July28, and Director, Federated Investors, Inc.;
1924 CHAIRMAN Chairman, Federated Investment Management
AND Company, Federated Global Investment Management
TRUSTEE(1)(2) Corp. and Passport Research, Ltd. Previous
Positions: Trustee, Federated Investment
Management Company and Chairman and Director,
Federated Investment Counseling.
J. Christopher Principal Occupations: President and Chief $0 $0
Donahue* Birth Executive Officer of the Federated Fund
Date: April11, Complex; Director or Trustee of some of the
1949 PRESIDENT Funds in the Federated Fund Complex; President,
AND Chief Executive Officer and Director, Federated
TRUSTEE(1)(2) Investors, Inc.; President, Chief Executive
Officer and Trustee, Federated Investment
Management Company; Trustee, Federated
Investment Counseling; President, Chief
Executive Officer and Director, Federated
Global Investment Management Corp.; President
and Chief Executive Officer, Passport Research,
Ltd.; Trustee, Federated Shareholder Services
Company; Director, Federated Services Company.
Previous Position: President, Federated
Investment Counseling.
Lawrence D. Principal Occupations: Director or Trustee of $0 $117,117.17
Ellis, M.D.* the Federated Fund Complex; Professor of
Birth Date: Medicine, University of Pittsburgh; Medical
October11, 1932 Director, University of Pittsburgh Medical
3471 Fifth Center Downtown; Hematologist, Oncologist and
Avenue Suite Internist, University of Pittsburgh Medical
1111 Center. Other Directorships Held: Member,
Pittsburgh, PA National Board of Trustees, Leukemia Society of
TRUSTEE(1)(2) America. Previous Positions: Trustee,
University of Pittsburgh; Director, University
of Pittsburgh Medical Center.
* Family relationships and reasons for "interested" status: John F. Donahue
is the father of J. Christopher Donahue; both are "interested" due to the
positions they hold with Federated Investors, Inc. and its subsidiaries.
Lawrence D. Ellis, M.D. is "interested" because his son-in-law is employed by,
Federated Securities Corp., a subsidiary of Federated Investors, Inc.
+ Board members will not receive compensation from the Fund during the
Fund's first fiscal year. Thereafter, the Fund will be subject to a base charge
of $250 per quarter; the remainder of the "Total Compensation" in column two
will be allocated to each fund in the Federated Fund Complex based on the net
assets of each such fund.
Independent Trustees Background And Compensation
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
Name Birth Date Principal Occupation(s) for Past Five Years, Aggregate Total
Address Other Directorships Held and Previous Compensation Compensation
Positions Held Positions From From
with Fund Fund Fund and
(past Federated
fiscal Fund
year)+ Complex
(past
calendar
year)
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
Thomas G. Principal Occupation: Director or Trustee of $0 $128,847.72
Bigley Birth the Federated Fund Complex. Other
Date: Directorships Held: Director, Member of
February3, 1934 Executive Committee, Children's Hospital of
15 Old Timber Pittsburgh; Director, Member of Executive
Trail Committee, University of Pittsburgh. Previous
Pittsburgh, PA Position: Senior Partner, Ernst & Young LLP.
TRUSTEE(1)(2)
John T. Conroy, Principal Occupations: Director or Trustee of $0 $128,847.66
Jr. Birth Date: the Federated Fund Complex; Chairman of the
June23, 1937 Board, Investment Properties Corporation;
Grubb & Partner or Trustee in private real estate
Ellis/Investment ventures in Southwest Florida. Previous
Properties Positions: President, Investment Properties
Corporation Corporation; Senior Vice President, John R.
3838 Tamiami Wood and Associates, Inc., Realtors;
Trail North President, Naples Property Management, Inc.
Naples, FL and Northgate Village Development Corporation.
TRUSTEE(1)(2)
Nicholas P. Principal Occupation: Director or Trustee of $0 $126,923.53
Constantakis the Federated Fund Complex; Previous
Birth Date: Position: Partner, Andersen Worldwide SC
September3, (prior to 9/1/97). Other Directorships Held:
1939 175 Director, Michael Baker Corporation
Woodshire Drive (engineering and energy services worldwide).
Pittsburgh, PA
TRUSTEE (1)(2)
John F. Principal Occupation: Director or Trustee of $0 $115,368.16
Cunningham the Federated Fund Complex. Other
Birth Date: Directorships Held: Chairman, President and
March5, 1943 Chief Executive Officer, Cunningham & Co.,
353 El Brillo Inc. (strategic business consulting); Trustee
Way Palm Beach, Associate, Boston College. Previous Positions:
FL TRUSTEE(1)(2) Director, Redgate Communications and EMC
Corporation (computer storage systems);
Chairman of the Board and Chief Executive
Officer, Computer Consoles, Inc.; President
and Chief Operating Officer, Wang
Laboratories; Director, First National Bank of
Boston; Director, Apollo Computer, Inc.
Peter E. Madden Principal Occupation: Director or Trustee of $0 $117,117.14
Birth Date: the Federated Fund Complex; Management
March16, 1942 Consultant. Previous Positions:
One Royal Palm Representative, Commonwealth of Massachusetts
Way 100 Royal General Court; President, State Street Bank
Palm Way Palm and Trust Company and State Street Corporation
Beach, FL (retired); Director, VISA USA and VISA
TRUSTEE(1)(2) International; Chairman and Director,
Massachusetts Bankers Association; Director,
Depository Trust Corporation; Director, The
Boston Stock Exchange.
Charles F. Principal Occupations: Director or Trustee of $0 $128,847.66
Mansfield, Jr. the Federated Fund Complex; Management
Birth Date: Consultant; Executive Vice President, DVC
April10, 1945 Group, Inc. (marketing, communications and
80 South Road technology) (prior to 9/1/00). Previous
Westhampton Positions: Chief Executive Officer, PBTC
Beach, NY International Bank; Partner, Arthur Young &
TRUSTEE(1)(2) Company (now Ernst & Young LLP); Chief
Financial Officer of Retail Banking Sector,
Chase Manhattan Bank; Senior Vice President,
HSBC Bank USA (formerly, Marine Midland Bank);
Vice President, Citibank; Assistant Professor
of Banking and Finance, Frank G. Zarb School
of Business, Hofstra University.
John E. Murray, Principal Occupations: Director or Trustee of $0 $117,117.14
Jr., J.D., the Federated Fund Complex; Chancellor and Law
S.J.D. Birth Professor, Duquesne University; Consulting
Date: Partner, Mollica & Murray. Other Directorships
December20, Held: Director, Michael Baker Corp.
1932 (engineering, construction, operations and
Chancellor, technical services). Previous Positions:
Duquesne President, Duquesne University; Dean and
University Professor of Law, University of Pittsburgh
Pittsburgh, PA School of Law; Dean and Professor of Law,
TRUSTEE(1)(2) Villanova University School of Law.
Marjorie P. Principal Occupations: Director or Trustee of $0 $117,117.17
Smuts Birth the Federated Fund Complex; Public Relations/
Date: June21, Marketing Consultant/Conference Coordinator.
1935 4905 Previous Positions: National Spokesperson,
Bayard Street Aluminum Company of America; television
Pittsburgh, PA producer; President, Marj Palmer Assoc.;
TRUSTEE(1)(2) Owner, Scandia Bord.
+ Board members will not receive compensation from the Fund during the Fund's first fiscal
year. Thereafter, the Fund will be subject to a base charge of $250 per quarter; the
remainder of the "Total Compensation" in column two will be allocated to each fund in the
Federated Fund Complex based on the net assets of each such fund.
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
Name Birth Date Principal Occupation(s) for Past Five Years, Aggregate Total
Address Other Directorships Held and Previous Compensation Compensation
Positions Held Positions From From
with Fund Fund Fund and
(past Federated
fiscal Fund
year)+ Complex
(past
calendar
year)
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
John S. Walsh Principal Occupations: Director or Trustee of $0 $117,117.17
Birth Date: the Federated Fund Complex; President and
November28, Director, Heat Wagon, Inc. (manufacturer of
1957 2604 construction temporary heaters); President and
William Drive Director, Manufacturers Products, Inc.
Valparaiso, IN (distributor of portable construction
TRUSTEE(1)(2) heaters); President, Portable Heater Parts, a
division of Manufacturers Products, Inc. Other
Directorships Held: Director, Walsh & Kelly,
Inc. (heavy highway contractor). Previous
Position: Vice President, Walsh & Kelly, Inc.
OFFICERS**
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Name Birth Principal Occupation(s) and Previous Positions
Date Address
Positions Held
with Fund
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John W. Principal Occupations: Executive Vice President and Secretary of the
McGonigle Federated Fund Complex; Executive Vice President, Secretary and
Birth Date: Director, Federated Investors, Inc. Previous Positions: Trustee,
October26, Federated Investment Management Company and Federated Investment
1938 EXECUTIVE Counseling; Director, Federated Global Investment Management Corp.,
VICE PRESIDENT Federated Services Company and Federated Securities Corp.
AND SECRETARY
Richard J. Principal Occupations: Treasurer of the Federated Fund Complex;
Thomas Birth Senior Vice President, Federated Administrative Services. Previous
Date: June17, Positions: Vice President, Federated Administrative Services; held
1954 TREASURER various management positions within Funds Financial Services
Division of Federated Investors, Inc.
Richard B. Principal Occupations: President or Vice President of some of the
Fisher Birth Funds in the Federated Fund Complex; Vice Chairman, Federated
Date: May17, Investors, Inc.; Chairman, Federated Securities Corp. Previous
1923 VICE Positions: Director or Trustee of some of the Funds in the Federated
PRESIDENT Fund Complex; Executive Vice President, Federated Investors, Inc.
and Director and Chief Executive Officer, Federated Securities Corp.
William D. Principal Occupations: Chief Investment Officer of this Fund and
Dawson III various other Funds in the Federated Fund Complex; Executive Vice
Birth Date: President, Federated Investment Counseling, Federated Global
March3, 1949 Investment Management Corp., Federated Investment Management Company
CHIEF and Passport Research, Ltd.; Director, Federated Global Investment
INVESTMENT Management Corp. and Federated Investment Management Company;
OFFICER Portfolio Manager, Federated Administrative Services; Vice
President, Federated Investors, Inc. Previous Positions: Executive
Vice President and Senior Vice President, Federated Investment
Counseling Institutional Portfolio Management Services Division;
Senior Vice President, Federated Investment Management Company and
Passport Research, Ltd.
Mary Jo Ochson Mary Jo Ochson is the Portfolio Manager of the Fund. She is Vice
Birth Date: President of the Fund. Ms. Ochson joined Federated in 1982 and has
September 12, been a Senior Portfolio Manager and a Senior Vice President of the
1953 SENIOR Fund's Adviser since 1996. From 1988 through 1995, Ms. Ochson served
VICE PRESIDENT as a Portfolio Manager and a Vice President of the Fund's Adviser.
Ms. Ochson is a Chartered Financial Analyst and received her M.B.A.
in Finance from the University of Pittsburgh.
+ Board members will not receive compensation from the Fund during the
Fund's first fiscal year. Thereafter, the Fund will be subject to a base charge
of $250 per quarter; the remainder of the "Total Compensation" in column two
will be allocated to each fund in the Federated Fund Complex based on the net
assets of each such fund.
(1) After a Trustee's initial term, each Trustee is expected to serve a
three year term concurrent with the class of trustees for which he or she
serves: -- Messrs. John F. Donahue, Thomas G. Bigley, John T. Conroy, Jr., and
John S. Walsh, as Class I trustees, are expected to stand for re-election at the
Fund's 2004 meeting of shareholders.
-- Messrs. J. Christopher Donahue, Nicholas P. Constantakis, John F.
Cunningham, and Majorie P. Smuts, as Class II trustees, are expected to stand
for re-election at the Fund's 2005 meeting of shareholders.
-- Messrs. Lawrence D. Ellis, M.D., Peter E. Madden, Charles F. Mansfield,
Jr. and John E. Murray, Jr., J.D, S.J.D., as Class III trustees, are expected to
stand for re-election at the Fund's 2006 meeting of shareholders.
** Officers do not receive any compensation from the Fund.
Thomas R. Donahue, Chief Financial Officer, Vice President, Treasurer and
Assistant Secretary of Federated Investors, Inc. and an officer of its various
advisory and underwriting subsidiaries, has served as a Term Member on the Board
of Directors of Duquesne University, Pittsburgh, Pennsylvania, since May 12,
2000. Mr. John E. Murray, Jr., an Independent Trustee of the Fund, served as
President of Duquesne from 1988 until his retirement from that position in 2001,
and became Chancellor of Duquesne on August 15, 2001. It should be noted that
Mr. Donahue abstains on any matter that comes before Duquesne's Board that
affects Mr. Murray personally.
Committees of the Board
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Meetings
Held
During
Last
Board Committee Fiscal
Committee Members Committee Functions Year
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Executive John F. In between meetings of the full Board, the NA
Donahue John Executive Committee generally may exercise all
E. Murray, the powers of the full Board in the management
Jr., J.D., and direction of the business and conduct of the
S.J.D. affairs of the Fund in such manner as the
Executive Committee shall deem to be in the best
interests of the Fund. However, the Executive
Committee cannot elect or remove Board members,
increase or decrease the number of Trustees,
elect or remove any Officer, declare dividends,
issue shares or recommend to shareholders any
action requiring shareholder approval.
Audit Thomas G. The Audit Committee reviews and recommends to NA
Bigley John T. the full Board the independent auditors to be
Conroy, Jr. selected to audit the Fund's financial
Nicholas P. statements; meets with the independent auditors
Constantakis periodically to review the results of the audits
Charles F. and report the results to the full Board;
Mansfield, Jr. evaluates the independence of the auditors,
reviews legal and regulatory matters that may
have a material effect on the financial
statements, related compliance policies and
programs, and the related reports received from
regulators; reviews the Fund's internal audit
function; review compliance with the Fund's code
of conduct/ethics; review valuation issues;
monitors inter-fund lending transactions;
reviews custody services and issues and
investigate any matters brought to the
Committee's attention that are within the scope
of its duties.
Board Ownership of Shares in the Fund and in the Federated Family of
Investment Companies
--------------------------------------------
Aggregate
Dollar Dollar
Range Range of
of Shares
Interested Board Shares Owned in
Member Name Owned Federated
in Fund Family of
Investment
Companies
--------------------------------------------
--------------------------------------------
John F. Donahue $0 Over
$100,000
J. Christopher $0 Over
Donahue $100,000
Lawrence D. Ellis, $0 Over
M.D. $100,000
Independent Board
Member Name
Thomas G. Bigley $0 Over
$100,000
John T. Conroy, Jr. $0 Over
$100,000
Nicholas P. $0 Over
Constantakis $100,000
John F. Cunningham $0 Over
$100,000
Peter E. Madden $0 Over
$100,000
Charles F. $0 $50,001 -
Mansfield, Jr. $100,000
John E. Murray, $0 Over
Jr., J.D., S.J.D. $100,000
Marjorie P. Smuts $0 Over
$100,000
John S. Walsh $0 Over
$100,000
Code of Ethics
As required by SEC rules, the Fund, its Adviser, and the Fund's principal
underwriters have adopted codes of ethics. These codes permit personnel subject
to the codes to invest in securities, including securities that may be purchased
or held by the Fund. These codes can be reviewed and copied at the Securities
and Exchange Commission's Public Reference Room in Washington, D.C. Information
on the operation of the Public Reference Room may be obtained by calling the
Securities and Exchange Commission at 1-202-942-8090. The codes of ethics are
available on the EDGAR Database on the Security and Exchange Commission's web
site (http://www.sec.gov), and copies of these codes may be obtained, after
paying a duplicating fee, by electronic request at the following e-mail address:
publicinfo@sec.gov, or by writing the Security and Exchange Commission's Public
Reference Section, Washington, D.C. 20549-0102.
Investment Adviser
The Adviser conducts investment research and makes investment decisions for
the Fund.
The Adviser is a wholly owned subsidiary of Federated.
Pursuant to an investment management agreement between the Adviser and the
Fund, the Fund has agreed to pay for the investment advisory services and
facilities provided by the Adviser a fee payable monthly in arrears at an annual
rate equal to 0.55% of the average daily value of the Fund's Managed Assets (the
"Management Fee"). The Adviser has contractually agreed to waive receipt of a
portion of its Management Fee in the amount of 0.20% of the average daily value
of the Fund's Managed Assets for the first five years of the Fund's operations
(through December 31, 2007), and for a declining amount for an additional three
years (through December 31, 2010). Managed Assets means the total assets of the
Fund including any assets attributable to any Preferred Shares or borrowings
that may be outstanding, minus the sum of accrued liabilities (other than
indebtedness attributable to financial leverage). The liquidation preference on
the Preferred Shares is not a liability. This means that during periods in which
the Fund is using leverage, the fee paid to the Adviser will be higher than if
the Fund did not use leverage because the fee is calculated as a percentage of
the Fund's Managed Assets, which include those assets purchased with leverage.
The Adviser shall not be liable to the Fund or any Fund shareholder for any
losses that may be sustained in the purchase, holding or sale of any security or
for anything done or omitted by it, except acts or omissions involving willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
imposed upon it by its contract with the Fund.
As required by the 1940 Act, the Board has reviewed the Fund's investment
advisory contract. During its review of the contract, the Board considered many
factors, among the most material of which are: the Fund's investment objectives;
the Adviser's management philosophy, personnel and processes; the preferences
and expectations of Fund shareholders and their relative sophistication; the
continuing state of competition in the mutual fund industry; comparable fees in
the mutual fund industry; the range and quality of services provided to the Fund
and its shareholders by the Federated organization in addition to investment
advisory services; and the Fund's relationship to other funds in the Federated
Fund family ("Federated Funds").
The Board also considered the compensation and benefits received by the
Adviser. This includes fees to be received for services provided to the Fund by
other entities in the Federated organization and research services to be
received by the Adviser from brokers that execute Fund trades, as well as
advisory fees. In this regard, the Board is aware that various courts have
interpreted provisions of the 1940 Act and have indicated in their decisions
that the following factors may be relevant to an adviser's compensation: the
nature and quality of the services provided by the adviser, including the
performance of the fund; the adviser's cost of providing the services; the
extent to which the adviser may realize "economies of scale" as the fund grows
larger; any indirect benefits that may accrue to the adviser and its affiliates
as a result of the adviser's relationship with the fund; performance and
expenses of comparable funds; and the extent to which the independent Board
members are fully informed about all facts bearing on the adviser's services and
fee. The Fund's Board is aware of these factors and has taken them into account
in its review of the Fund's advisory contract.
The Board considered and weighed these circumstances in light of its
accumulated experience in working with Federated on matters relating to the
Federated Funds, and was assisted in its deliberations by the advice of
independent legal counsel. In this regard, the Board requested and received a
significant amount of information about the Fund, the Federated Funds and the
Federated organization. Thus, the Board's evaluation of the Fund's advisory
contract included an analysis of reports covering such matters as: the Adviser's
investment philosophy, personnel, and processes; the short- and long-term
performance of other Federated Funds (in absolute terms as well as in
relationship to their particular investment programs and certain competitor or
"peer group" funds) and comments on the reasons for performance; the Fund's
proposed expenses (including the advisory fee itself and the overall expense
structure of the Fund, both in absolute terms and relative to similar and/or
competing funds, with due regard for contractual or voluntary expense
limitations); the possible use and allocation of brokerage commissions derived
from trading the Fund's portfolio securities; the nature and extent of the
advisory and other services to be provided to the Fund by the Adviser and its
affiliates; compliance and audit reports concerning the Federated Funds and the
Federated companies that service them; and relevant developments in the mutual
fund industry and how the Federated Funds and/or Federated are responding to
them.
The Board also received financial information about Federated, including
reports on the compensation and benefits Federated derives from its
relationships with the Federated Funds. These reports cover not only the fees
under the advisory contracts, but also fees received by Federated's subsidiaries
for providing other services to the Federated Funds under separate contracts
(e.g., for serving as administrator and transfer agent to the Federated Funds).
The reports also discuss any indirect benefit Federated may derive from its
receipt of research services from brokers who execute fund trades.
The Board based its decision to approve the Fund's advisory contract on the
totality of the circumstances and relevant factors, and with a view to past and
future long-term considerations. The Board did not consider any one of the
factors and considerations identified above to be determinative. Because the
totality of circumstances included considering the relationship of each Fund to
the Federated Funds, the Board did not approach consideration of the Fund's
advisory contract as if that were the only Federated Fund.
Custodian
State Street Bank and Trust Company, Boston, Massachusetts, is custodian
for the securities and cash of the Fund. Foreign instruments purchased by the
Fund are held by foreign banks participating in a network coordinated by State
Street Bank.
Transfer Agent and Dividend Disbursing Agent
EquiServe Trust Company, N.A. maintains all necessary shareholder records.
The Fund pays the transfer agent a fee based on the size, type and number of
accounts and transactions made by shareholders.
Independent Auditors
The independent auditor for the Fund, Ernst & Young LLP, conducts its
audits in accordance with auditing standards generally accepted in the United
States of America, which require it to plan and perform its audits to provide
reasonable assurance about whether the Fund's financial statements and financial
highlights are free of material misstatement.
BROKERAGE TRANSACTIONS
When selecting brokers and dealers to handle the purchase and sale of
portfolio instruments, the Adviser looks for prompt execution of the order at a
favorable price. The Adviser will generally use those who are recognized dealers
in specific portfolio instruments, except when a better price and execution of
the order can be obtained elsewhere. In selecting among firms believed to meet
these criteria, the Adviser may give consideration to those firms which have
sold or are selling Shares of the Fund and other funds under common control with
the Fund. The Adviser makes decisions on portfolio transactions and selects
brokers and dealers subject to review by the Fund's Board.
Investment decisions for the Fund are made independently from those of
other accounts managed by the Adviser. When the Fund and one or more of those
accounts invests in, or disposes of, the same security, available investments or
opportunities for sales will be allocated among the Fund and the accounts(s) in
a manner believed by the Adviser to be equitable. While the coordination and
ability to participate in volume transactions may benefit the Fund, it is
possible that this procedure could adversely impact the price paid or received
and/or the position obtained or disposed of by the Fund.
DESCRIPTION OF SHARES
Common Shares
The Fund intends to hold annual meetings of shareholders so long as the
Common Shares are listed on a national securities exchange and such meetings are
required as a condition to such listing.
Preferred Shares
Although the terms of any Preferred Share issued by the Fund, including
their dividend rate, voting rights, liquidation preference and redemption
provisions, will be determined by the Board (subject to applicable law and the
Fund's Agreement and Declaration of Trust) when it authorizes a Preferred Shares
offering, the Fund currently expects that the preference on distributions,
liquidation preference, voting rights and redemption provisions of any such
Preferred Shares will likely be as stated in the prospectus.
If the Board determines to proceed with an offering of Preferred Shares,
the terms of Preferred Shares may be the same as, or different from, the terms
described in the prospectus, subject to applicable law and the Fund's Agreement
and Declaration of Trust. The Board, without the approval of Common
Shareholders, may authorize an offering of Preferred Shares or may determine not
to authorize such an offering, and may fix the terms of the Preferred Shares to
be offered.
Other Shares
The Board (subject to applicable law and the Fund's Agreement and
Declaration of Trust) may authorize an offering, without the approval of the
Common Shareholders or Preferred Shareholders, of other classes of shares, or
other classes or series of shares, as they determine to be necessary, desirable
or appropriate, having such terms, rights, preferences, privileges, limitations
and restrictions as the Board sees fit. The Fund currently does not expect to
issue any other classes of shares, or series of shares, except for the Common
Shares and the Preferred Shares.
REPURCHASE OF COMMON SHARES
The Fund is a closed-end management investment company and as such its
Common Shareholders will not have the right to cause the Fund to redeem their
shares. Instead, the Fund's Common Shares will trade in the open market at a
price that will be a function of several factors, including dividend levels
(which are in turn affected by expenses), NAV, call protection, dividend
stability, relative demand for and supply of such shares in the market, general
market and economic conditions and other factors. Because shares of a closed-end
investment company may frequently trade at prices lower than NAV, the Fund's
Board may consider action that might be taken to reduce or eliminate any
material discount from NAV in respect of Common Shares, which may include the
repurchase of such Common Shares in the open market or in private transactions,
the making of a tender offer for such Common Shares or the conversion of the
Fund to an open-end investment company. The Board may decide not to take any of
these actions. In addition, there can be no assurance that share repurchases or
tender offers, if undertaken, will reduce market discount.
Notwithstanding the foregoing, at any time when the Fund's Preferred Shares
are outstanding, the Fund may not purchase, redeem or otherwise acquire any of
its Common Shares unless (1) all accrued Preferred Shares dividends have been
paid and (2) at the time of such purchase, redemption or acquisition, the NAV of
the Fund's portfolio (determined after deducting the acquisition price of the
Common Shares) is at least 200% of the liquidation value of the outstanding
Preferred Shares (expected to equal the original purchase price per share plus
any accrued and unpaid dividends thereon). Any service fees incurred in
connection with any tender offer made by the Fund will be borne by the Fund and
will not reduce the stated consideration to be paid to tendering shareholders.
Subject to its investment restrictions, the Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to
finance share repurchase transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will reduce the Fund's net income.
Any share repurchase, tender offer or borrowing that might be approved by the
Fund's Board would have to comply with the Securities Exchange Act of 1934, as
amended, the 1940 Act and the rules and regulations thereunder.
Although the decision to take action in response to a discount from NAV
will be made by the Board at the time it considers such issue, it is the Board's
present policy, which may be changed by the Board, not to authorize repurchases
of Common Shares or a tender offer for such Common Shares if: (1) such
transactions, if consummated, would (a) result in the delisting of the Common
Shares from the New York Stock Exchange, or (b) impair the Fund's status as a
regulated investment company under the Code, (which would make the Fund a
taxable entity, causing the Fund's income to be taxed at the corporate level in
addition to the taxation of shareholders who receive dividends from the Fund) or
as a registered closed-end investment company under the Investment Company Act;
(2) the Fund would not be able to liquidate portfolio securities in an orderly
manner and consistent with the Fund's investment objective and policies in order
to repurchase shares; or (3) there is, in the Board's judgment, any (a) material
legal action or proceeding instituted or threatened challenging such
transactions or otherwise materially adversely affecting the Fund, (b) general
suspension of or limitation on prices for trading securities on the New York
Stock Exchange, (c) declaration of a banking moratorium by Federal or state
authorities or any suspension of payment by United States or New York banks, (d)
material limitation affecting the Fund or the issuers of its portfolio
securities by Federal or state authorities on the extension of credit by lending
institutions or on the exchange of foreign currency, (e) commencement of war,
armed hostilities or other international or national calamity directly or
indirectly involving the United States, or (f) other event or condition which
would have a material adverse effect (including any adverse tax effect) on the
Fund or its shareholders if shares were repurchased. The Board may in the future
modify these conditions in light of experience.
The repurchase by the Fund of its shares at prices below NAV will result in
an increase in the NAV of those shares that remain outstanding. However, there
can be no assurance that share repurchases or tender offers at or below NAV will
result in the Fund's shares trading at a price equal to their net asset value.
Nevertheless, the fact that the Fund's shares may be the subject of repurchase
or tender offers from time to time, or that the Fund may be converted to an
open-end investment company, may reduce any spread between market price and NAV
that might otherwise exist.
In addition, a purchase by the Fund of its Common Shares will decrease the
Fund's Managed Assets which would likely have the effect of increasing the
Fund's expense ratio. Any purchase by the Fund of its Common Shares at a time
when Preferred Shares are outstanding will increase the leverage applicable to
the outstanding Common Shares then remaining.
Before deciding whether to take any action if the Common Shares trade below
NAV, the Fund's Board would likely consider all relevant factors, including the
extent and duration of the discount, the liquidity of the Fund's portfolio, the
impact of any action that might be taken on the Fund or its shareholders and
market considerations. Based on these considerations, even if the Fund's shares
should trade at a discount, the Board may determine that, in the interest of the
Fund and its shareholders, no action should be taken.
TAX MATTERS
The following is a description of certain federal income tax consequences
to a shareholder of acquiring, holding and disposing of Common Shares. The
discussion reflects applicable tax laws of the United States as of the date of
this prospectus, which tax laws may be changed or subject to new interpretations
by the courts or the Internal Revenue Service retroactively or prospectively.
The Fund intends to elect to be treated and to qualify to be taxed as a
regulated investment company under Subchapter M of the Code. In order to qualify
as a regulated investment company, the Fund must satisfy certain requirements
relating to the source of its income, diversification of its assets and
distributions of its income to its shareholders. First, the Fund must derive at
least 90% of its annual gross income (including tax exempt interest) from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock or securities or foreign currencies, or other
income (including but not limited to gains from options, futures and forward
contracts) derived with respect to its business of investing in such stock,
securities or currencies (the "90% gross income test"). Second, the Fund must
diversify its holdings so that, at the close of each quarter of its taxable
year, (1) at least 50% of the value of its total assets is comprised of cash,
cash items, United States government securities, securities of other regulated
investment companies and other securities, limited in respect of any one issuer
to an amount not greater in value than 5% of the value of the Fund's total
assets and to not more than 10% of the outstanding voting securities of such
issuer, and (2) not more than 25% of the value of the total assets is invested
in the securities of any one issuer (other than United States government
securities and securities of other regulated investment companies) or two or
more issuers controlled by the Fund and engaged in the same, similar or related
trades or businesses.
As a regulated investment company, the Fund will not be subject to federal
income tax on income and gains that it distributes each taxable year to its
shareholders, provided that in such taxable year it distributes at least 90% of
the sum of (1) its "investment company taxable income" (which includes, among
other items, dividends, taxable interest, taxable original issue discount and
market discount income, income from securities lending, net short-term capital
gain in excess of net long-term capital loss and any other taxable income other
than "net capital gain" (as defined below) and is reduced by deductible
expenses) determined without regard to the deduction for dividends paid and (2)
its net tax exempt interest (the excess of its gross tax exempt interest income
over certain disallowed deductions). The Fund may retain for investment its net
capital gain (which consists of the excess of its net long-term capital gain
over its net short-term capital loss). However, if the Fund retains any net
capital gain or any investment company taxable income, it will be subject to tax
at regular corporate rates on the amount retained. If the Fund retains any net
capital gain, it may designate the retained amount as undistributed capital
gains in a notice to its shareholders who, if subject to federal income tax on
long-term capital gains, (1) will be required to include in income for federal
income tax purposes, as long-term capital gain, their share of such
undistributed amount and (2) will be entitled to credit their proportionate
shares of the tax paid by the Fund against their federal income tax liabilities,
if any, and to claim refunds to the extent the credit exceeds such liabilities.
For federal income tax purposes, the tax basis of shares owned by a shareholder
of the Fund will be increased by the amount of undistributed capital gains
included in the gross income of the shareholder less the tax deemed paid by the
shareholder under clause (ii) of the preceding sentence. The Fund intends to
distribute at least annually to its shareholders all or substantially all of its
net tax exempt interest and any investment company taxable income and net
capital gain.
Treasury regulations permit a regulated investment company, in determining
its investment company taxable income and net capital gain, to elect (unless it
has made a special taxable year election for excise tax purposes) to treat all
or part of any net capital loss, any net long-term capital loss or any net
foreign currency loss incurred after October 31 as if it had been incurred in
the succeeding year.
Distributions by the Fund of investment company taxable income, if any,
whether received in cash or additional shares, will be taxable to shareholders
as ordinary income (to the extent of the current or accumulated earning and
profits of the Fund) and generally will not qualify for the dividends received
deduction in the case of corporate shareholders. Net long-term capital gains
realized by the Fund and distributed to shareholders in cash or additional
shares will be taxable to shareholders as long-term capital gains regardless of
the length of time investors have owned shares of the Fund. Distributions by the
Fund that do not constitute ordinary income dividends, capital gain
distributions or exempt-interest dividends (as defined below) will be treated as
a return of capital to the extent of (and in reduction of) the shareholder's tax
basis in his or her shares. Any excess will be treated as gain from the sale of
his or her shares, as discussed below.
The Fund intends to invest in sufficient tax exempt securities to permit
payment of "exempt-interest dividends" (as defined in the Code). Except as
provided below, exempt-interest dividends paid to Common Shareholders are not
includable in the holder's gross income for federal income tax purposes.
If the Fund engages in hedging transactions involving financial futures and
options, these transactions will be subject to special tax rules, the effect of
which may be to accelerate income to the Fund, defer the Fund's losses, cause
adjustments in the holding periods of the Fund's securities, convert long-term
capital gains into short-term capital gains and convert short-term capital
losses into long-term capital losses. These rules could therefore affect the
amount, timing and character of distributions to Common Shareholders.
Prior to purchasing shares in the Fund, an investor should carefully
consider the impact of dividends which are expected to be or have been declared,
but not paid. Any dividend declared shortly after a purchase of such shares
prior to the record date will have the effect of reducing the per share net
asset value by the per share amount of the dividend.
Although dividends generally will be treated as distributed when paid,
dividends declared in October, November or December, payable to holders of
common shares of record on a specified date in one of those months and paid
during the following January, will be treated as having been distributed by the
Fund (and received by the holder of common shares) on December 31.
The Internal Revenue Service's position in a published revenue ruling
indicates that the Fund is required to designate distributions paid with respect
to its Common Shares and its Preferred Shares as consisting of a portion of each
type of income distributed by the Fund. The portion of each type of income
deemed received by the holders of each class of shares will be equal to the
portion of total Fund dividends received by such class. Thus, the Fund will
designate dividends paid as exempt-interest dividends in a manner that allocates
such dividends between Common Shareholders and Preferred Shareholders in
proportion to the total dividends paid to each such class during or with respect
to the taxable year, or otherwise as required by applicable law. Capital gain
dividends and ordinary income dividends will similarly be allocated between the
two classes.
Exempt-interest dividends are included in determining what portion, if any,
of a person's Social Security and railroad retirement benefits will be
includable in gross income subject to federal income tax.
Although exempt-interest dividends generally may be treated by Common
Shareholders as items of interest excluded from their gross income, each Common
Shareholder is advised to consult his tax advisor with respect to whether
exempt-interest dividends retain their exclusion if the shareholder would be
treated as a "substantial user," or a "related person" of a substantial user, of
the facilities financed with respect to any of the tax exempt obligations held
by the Fund.
Federal income tax law imposes an alternative minimum tax with respect to
both corporations and individuals based on certain items of tax preference.
Interest on certain "private activity bonds" is an item of tax preference
subject to the alternative minimum tax on individuals and corporations. In
addition, for corporations alternative minimum taxable income is increased by
75% of the difference between an alternative measure of income ("adjusted
current earnings") and the amount otherwise determined to be the alternative
minimum taxable income. Interest on municipal bonds, and therefore all
exempt-interest dividends received from the Fund, are included in calculating
adjusted current earnings. Accordingly, investment in the Fund could cause
Common Shareholders to be subject to or result in an increased liability under
the AMT. The Fund will annually supply Common Shareholders a report indicating
the amount and nature of amounts distributed to them.
The redemption, sale or exchange of Common Shares normally will result in
capital gain or loss to Common Shareholders who hold their Common Shares as
capital assets. Generally, a Common Shareholder's gain or loss will be long-term
capital gain or loss if the shares have been held for more than one year even
though the increase in value in such common shares is attributable to tax exempt
interest income. In addition, gain realized by the Fund from the disposition of
a tax exempt security that is attributable to accrued market discount will be
treated as ordinary income rather than capital gain, and thus may increase the
amount of ordinary income dividends received by Common Shareholders. Present law
taxes both long- and short-term capital gains of corporations at the rates
applicable to ordinary income. For non-corporate taxpayers, however, long-term
capital gains will be taxed at a maximum rate of 20% (or 18% for capital assets
that have been held for more than five years and whose holding periods began
after December 31, 2000), while short-term capital gains and other ordinary
income will currently be taxed at a maximum rate of 38.6%1. Because of the
limitations on itemized deductions and the deduction for personal exemptions
applicable to higher income taxpayers, the effective tax rate may be higher in
certain circumstances.
All or a portion of a sales charge paid in purchasing Common Shares cannot
be taken into account for purposes of determining gain or loss on the
redemption, sale or exchange of such Shares within 90 days after their purchase
to the extent Common Shares or shares of another fund are subsequently acquired
without payment of a sales charge pursuant to the reinvestment or exchange
privilege. Any disregarded portion of such charge will result in an increase in
the shareholder's tax basis in the shares subsequently acquired. In addition, no
loss will be allowed on the redemption, sale or exchange of Common Shares if the
Common Shareholder purchases other Common Shares of the Fund (whether through
reinvestment of distributions or otherwise) or the shareholder acquires or
enters into a contract or option to acquire shares that are substantially
identical to Common Shares of the Fund within a period of 61 days beginning 30
days before and ending 30 days after such redemption, sale or exchange. If
disallowed, the loss will be reflected in an adjustment to the basis of the
shares acquired. Further, any losses realized on the redemption, sale or
exchange of Common Shares held for six months or less will be disallowed to the
extent of any exempt-interest dividends received with respect to such Common
Shares and, if not disallowed, such losses will be treated as long-term capital
losses to the extent of any capital gain dividends received (or amounts credited
as undistributed capital gains) with respect to such Common Shares.
In order to avoid a 4% federal excise tax, the Fund must distribute or be
deemed to have distributed by December 31 of each calendar year the sum of at
least 98% of its taxable ordinary income for such year, at least 98% of its
capital gain net income (the excess of its realized capital gains over its
realized capital losses, generally computed on the basis of the one-year period
ending on October 31 of such year) and 100% of any taxable ordinary income and
capital gain net income for the prior year that was not distributed during such
year and on which the Fund paid no federal income tax. For purposes of the
excise tax, a regulated investment company may reduce its capital gain net
income (but not below its net capital gain) by the amount of any net ordinary
loss for the calendar year. The Fund intends to make timely distributions in
compliance with these requirements and consequently it is anticipated that it
generally will not be required to pay the excise tax.
If in any tax year the Fund should fail to qualify under Subchapter M for
tax treatment as a regulated investment company, the Fund would incur a regular
corporate federal income tax upon its taxable income for that year, and
distributions to its shareholders would be taxable to shareholders as ordinary
dividend income for federal income tax purposes to the extent of the Fund's
earnings and profits.
----------
1 The Economic Growth and Tax Relief Reconciliation Act of 2001, effective
for taxable years beginning after December 31, 2000, creates a new 10 percent
income tax bracket and reduces the tax rates applicable to ordinary income over
a six year phase-in period. Beginning in the taxable year 2006, ordinary income
will be subject to a 35% maximum rate, with approximately proportionate
reductions in the other ordinary rates.
---------
The Fund is required to withhold tax at a rate equal to the fourth lowest
rate applicable to unmarried individuals (currently, 30%) on taxable dividends
and certain other payments paid to non-corporate shareholders who have not
furnished to the Fund their correct taxpayer identification number (in the case
of individuals, their Social Security number) and certain certifications, or who
are otherwise subject to backup withholding. Backup withholding is not an
additional tax and any amount withheld may be refunded or credited against the
shareholder's federal income tax liability, provided the required information is
furnished to the Internal Revenue Service.
The foregoing is a general and abbreviated summary of the provisions of the
Code and the Treasury Regulations presently in effect as they directly govern
the taxation of the Fund and its shareholders. For complete provisions,
reference should be made to the pertinent Code sections and Treasury
Regulations. The Code and the Treasury Regulations are subject to change by
legislative or administrative action, and any such change may be retroactive
with respect to Fund transactions. Common Shareholders are advised to consult
their own tax advisers for more detailed information concerning the federal
income taxation of the Fund and the income tax consequences to its holders of
Common Shares.
PERFORMANCE AND RELATED COMPARATIVE INFORMATION
Tax Equivalency Table
Set forth below is a sample of a tax-equivalency table that may be used in
advertising and sales literature. This table is for illustrative purposes only
and is not representative of past or future performance of the Fund. The
interest earned by the municipal securities owned by the Fund generally remains
free from federal income tax. However, some of the Fund's income may be subject
to state or local taxes.
Taxable Yield Equivalent for 2002
Multistate Municipal Fund
Federal Income Tax Bracket
10.00% 15.00% 27.00% 30.00% 35.00% 38.60%
Joint $0- $12,001 $46,701 $112,851 $17,951- Over
Return 12,000 - 46,700 112,850 307,050
Single $0- $6,001 $27,951 $67,701- $141-251- Over
Return 6,000 27,950 67,700 141,250 307,050 307,050
Tax Exempt
Yield Taxable Yield Equivalent
0.50% 0.56% 0.59% 0.68% 0.71% 0.77% 0.81%
1.00% 1.11% 1.18% 1.37% 1.43% 1.54% 1.63%
1.50% 1.67% 1.76% 2.05% 2.14% 2.31% 2.44%
2.00% 2.22% 2.35% 2.74% 2.86% 3.08% 3.26%
2.50% 2.78% 2.94% 3.42% 3.57% 3.85% 4.07%
3.00% 3.33% 3.53% 4.11% 4.29% 4.62% 4.89%
3.50% 3.89% 4.12% 4.79% 5.00% 5.38% 5.70%
4.00% 4.44% 4.71% 5.48% 5.71% 6.15% 6.51%
4.50% 5.00% 5.29% 6.16% 6.43% 6.92% 7.33%
5.00% 5.56% 5.88% 6.85% 7.14% 7.69% 8.14%
5.50% 6.11% 6.47% 7.53% 7.86% 8.46% 8.96%
6.00% 6.67% 7.06% 8.22% 8.57% 9.23% 9.77%
6.50% 7.22% 7.65% 8.90% 9.29% 10.00% 10.59%
7.00% 7.78% 8.24% 9.59% 10.00% 10.77% 11.40%
7.50% 8.33% 8.82% 10.27% 10.71% 11.54% 12.21%
8.00% 8.89% 9.41% 10.96% 11.43% 12.31% 13.03%
8.50% 9.44% 10.00% 11.64% 12.14% 13.08% 13.84%
9.00% 10.00% 10.59% 12.33% 12.86% 13.85% 14.66%
9.50% 10.56% 11.18% 13.01% 13.57% 14.62% 15.47%
10.00% 11.11% 11.76% 13.70% 14.29% 15.38% 16.29%
10.50% 11.67% 12.35% 14.38% 15.00% 16.15% 17.10%
11.00% 12.22% 12.94% 15.07% 15.71% 16.92% 17.92%
Note: The maximum marginal tax rate for each bracket was used in
calculating the taxable yield equivalent.
Performance Comparisons
Advertising and sales literature may include:
- references to ratings, rankings and financial publications and/or
performance comparisons of Common Shares to certain indices;
- charts, graphs and illustrations using the Fund's returns, or returns in
general, that demonstrate investment concepts such as tax-deferred
compounding, dollar-cost averaging and systematic investment;
- discussions of economic, financial and political developments and their
impact on the securities market, including the portfolio manager's views on
how such developments could impact the Fund; and
- information about the mutual fund industry from sources such as the
Investment Company Institute.
The Fund may compare its performance, or performance for the types of
securities in which it invests, to a variety of other investments, including
federally insured bank products such as bank savings accounts, certificates of
deposit, and Treasury bills. Advertisements may contain a chart showing average
tax-adjusted returns and volatility of returns for the last 10 years ending
October 31, 2002 for indices of municipal bonds, corporate bonds, U.S. Treasury
securities, high-yield securities, mortgage-backed securities, the S&P 500, the
Russell 2000 and NASDAQ.
The Fund may quote information from reliable sources regarding individual
countries and regions, world stock exchanges, and economic and demographic
statistics.
You may use financial publications and/or indices to obtain a more complete
view of Share performance. When comparing performance, you should consider all
relevant factors such as the composition of the index used, prevailing market
conditions, portfolio compositions of other funds, and methods used to value
portfolio securities and compute offering price. The financial publications
and/or indices which the Fund uses in advertising may include:
Lipper Analytical Services, Inc.
Lipper Analytical Services, Inc. ranks funds in various fund categories
based on total return.
Morningstar, Inc.
Morningstar, Inc., an independent rating service, is the publisher of the
bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000
NASDAQ-listed mutual funds of all types, according to their risk-adjusted
returns.
Money
Money, a monthly magazine, regularly ranks money market funds in various
categories based on the latest available seven-day effective yield.
Lehman Brothers Municipal Bond Index
Lehman Brothers Municipal Bond Index is an unmanaged broad based total
return performance benchmark for the long-term, investment grade bond market.
FEDERATED INVESTORS, INC.
Federated is dedicated to meeting investor needs by making structured,
straightforward and consistent investment decisions. Federated investment
products have a history of competitive performance and have gained the
confidence of thousands of financial institutions and individual investors.
Federated's disciplined investment selection process is rooted in sound
methodologies backed by fundamental and technical research. At Federated,
success in investment management does not depend solely on the skill of a single
portfolio manager. It is a fusion of individual talents and state-of-the-art
industry tools and resources. Federated's investment process involves teams of
portfolio managers and analysts, and investment decisions are executed by
traders who are dedicated to specific market sectors and who handle trillions of
dollars in annual trading volume.
Municipal Funds. In the municipal sector, as of December 31, 2001,
Federated managed 12 bond funds with approximately $2.3 billion in assets and 22
money market funds with approximately $19.5 billion in total assets. In 1976,
Federated introduced one of the first municipal bond mutual funds in the
industry and is now one of the largest institutional buyers of municipal
securities. The Funds may quote statistics from organizations including The Tax
Foundation and the National Taxpayers Union regarding the tax obligations of
Americans.
The Chief Investment Officers responsible for oversight of the various
investment sectors within Federated are William D. Dawson III--Global and Fixed
Income and Stephen F. Auth--Federated Global and Equity. The Chief Investment
Officers are Executive Vice Presidents of the Federated advisory companies.
EXPERTS
The financial statements of the Fund at December 16, 2002 appearing in this
Statement of Additional Information have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein, and are included in reliance upon such report given on the authority of
such firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares offered hereby, has been filed by the Fund with the
Securities and Exchange Commission, Washington, D.C. The prospectus and this
Statement of Additional Information do not contain all of the information set
forth in the Registration Statement, including any exhibits and schedules
thereto. For further information with respect to the Fund and the shares offered
hereby, reference is made to the Registration Statement. Statements contained in
the prospectus and this Statement of Additional Information as to the contents
of any contract or other document referred to are not necessarily complete and
in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference. A copy of the Registration
Statement may be inspected without charge on the EDGAR Database at the
Commission's website at http://www.sec.gov or at the Commission's principal
office in Washington, D.C., and copies of all or any part thereof may be
obtained from the Commission upon the payment of certain fees prescribed by the
Commission. The Fund changed its name from Federated Municipal Income Fund to
Federated Premier Municipal Income Fund on December 16, 2002.
INDEPENDENT AUDITORS' REPORT
Report of Ernst & Young LLP, Independent Auditors
To the Shareholders and
Board of Trustees of
Federated Premier Municipal Income Fund
We have audited the accompanying statement of assets and liabilities of
Federated Premier Municipal Income Fund (the Fund) as of December 16, 2002. This
financial statement is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this financial statement based on our
audit.
We conducted our audit in accordance with the auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statement is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statement. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statement referred to above present fairly,
in all material respects, the financial position of Federated Premier Municipal
Income Fund at December 16, 2002, in conformity with accounting principles
generally accepted in the United States of America.
[GRAPHIC OMITTED]
Boston, Massachusetts
December 16, 2002
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES December 16, 2002
Assets:
Cash $100,003
Deferred Offering Costs 200,000
Total Assets 300,003
Liabilities:
Offering Costs Payable (200,000)
Total Liabilities (200,000)
Net Assets (6,981 shares of $0.01 par value shares of beneficial interest
issued and outstanding; unlimited authorized shares) $100,003
Net Asset Value Per Share $14.33
Maximum Offering Price Per Share (100/95.50 of $14.33) $15.00
NOTES TO FINANCIAL STATEMENTS
1. Organization
Federated Premier Municipal Income Fund ("the Fund") was organized as a
Delaware Statutory Trust on October 16, 2002. The Fund has had no operations to
date other than matters relating to its organization and registration as a
diversified, closed-end management investment company under the Investment
Company Act of 1940, as amended, and the sale and issuance to Federated
Investment Management Company ("the Investment Adviser"), a wholly owned
subsidiary of Federated Investors, Inc., of 6,981 shares of beneficial interest
at an aggregate purchase price of $100,003.
2. Accounting Policies
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts of assets, liabilities, expenses and
revenues reported in the financial statements. Actual results could differ from
those estimates.
3. Investment Adviser and Related Parties
The Fund has entered into an Investment Management Agreement (the
"Agreement") with the Investment Adviser to serve as investment manager to the
Fund. Pursuant to the Agreement, the Fund pays the Investment Adviser an annual
management fee, payable daily, at the annual rate of 0.55 % of the Fund's
average daily net assets.
In order to reduce fund expenses, the Investment Adviser has contractually
agreed to waive a portion of its management fee at the annual rate of 0.20% of
the Fund's average daily net assets, not inclusive of any net assets
attributable to any preferred shares that may be issued, from the commencement
of operations through December 31, 2007, and for a declining amount thereafter
through December 31, 2010.
Federated Services Company ("FServ"), under the Administrative Services
Agreement, provides the Fund with administrative personnel and services. The fee
paid to FServ is based on a scale that ranges from 0.150% to 0.075% of the
average aggregate daily net assets of all funds advised by subsidiaries of
Federated Investors, Inc., subject to a $125,000 minimum per portfolio and
$30,000 per each additional class.
4. Organization Expenses and Offering Costs
Based on an estimated Fund offering of 5,850,000 shares, organization
expenses and offering costs are estimated to be $461,114. The Investment Advisor
has agreed to pay i) all organizational costs; and ii) the amount by which the
aggregate of all of the Fund's offering costs (other than sales load) exceed
$0.03 per share. Such amount to be paid by the Investment Adviser is $285,614.
The Fund will pay offering costs estimated at $175,500 from the proceeds of the
offering. Offering costs paid by the Fund will be charged as a reduction of
paid-in capital at the completion of the Fund offering.
5. Federal Income Taxes
The Fund intends to comply with the provisions of the Internal Revenue
Code, as amended, applicable to regulated investment companies and to distribute
to shareholders each year substantially all of its income. Accordingly, no
provision for federal tax is necessary. In addition, by distributing
substantially all of its ordinary income and long-term capital gains, if any,
during each calendar year, the Fund intends not to be subject to federal excise
tax.
6. Contingent Receivable from Investment Adviser
In the event that the public offering of the Fund does not occur, the
Investment Adviser has agreed to reimburse the Fund for all offering costs.
APPENDIX A
RATINGS OF INVESTMENTS
Standard and Poor's Long-Term Debt Rating Definitions
AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay
interest and repay principal is extremely strong.
AA--Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher-rated issues only in small degree.
A--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.
BBB--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.
BB--Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB rating.
B--Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB or BB- rating.
CCC--Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC--The rating CC typically is applied to debt subordinated to senior debt
that is assigned an actual or implied CCC debt rating.
C--The rating C typically is applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating. The C rating may be used
to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued. Moody's Investors Service Long-Term Bond Rating
Definitions
AAA--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 edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
AA--Bonds 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 risks appear somewhat larger than in AAA securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
BAA--Bonds 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.
BA--Bonds which are BA are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA--Bonds which are rated CAA are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
CA--Bonds which are rated CA represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C--Bonds which are rated C are the lowest-rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing. Fitch Ratings Long-Term Debt Rating Definitions
AAA--Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA--Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated AAA. Because bonds rated in
the AAA and AA categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated F-1+.
A--Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB--Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds, and therefore
impair timely payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher ratings.
BB--Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B--Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC--Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
CC--Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C--Bonds are imminent default in payment of interest or principal.
Moody's Investors Service Commercial Paper Ratings
Prime-1--Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations. Prime-1
repayment capacity will normally be evidenced by the following characteristics:
Leading market positions in well-established industries; High rates of return on
funds employed; Conservative capitalization structure with moderate reliance on
debt and ample asset protection; Broad margins in earning 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.
Prime-2--Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations. This will
normally 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.
Standard and Poor's Commercial Paper Ratings
A-1--This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
A-2--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
Fitch Ratings Commercial Paper Rating Definitions
FITCH-1--(Highest Grade) Commercial paper assigned this rating is regarded
as having the strongest degree of assurance for timely payment.
FITCH-2--(Very Good Grade) Issues assigned this rating reflect an assurance
of timely payment only slightly less in degree than the strongest issues.
Addresses
federated PREMIER municipal INCOME FUND
Federated Investors Funds
5800 Corporate Drive
Pittsburgh, PA 15237-7000
Underwriter
Merrill Lynch, Pierce, Fenner & Smith Incorporated
4 World Financial Center
New York, NY 10080
Investment Adviser
Federated Investment Management Company
Federated Investors Tower
1001 Liberty Avenue
Pittsburgh, PA 15222-3779
Custodian
State Street Bank and Trust Company
P. O. Box 8600
Boston, MA 02266-8600
Transfer Agency and Dividend Disbursing Agent
EquiServe Trust Company, N.A.
P.O. Box 43011
Providence, RI 02940-3011
Independent Auditors
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116-5072
CUSIP 31423P108