Subject to Completion
Preliminary Pricing Supplement Dated October 18, 2002
PRICING SUPPLEMENT DATED NOVEMBER , 2002 Rule 424(b)(3)
- ------------------------------------------
(To Prospectus Supplement and Prospectus
dated September 25, 2002) File No. 333-97937
Pricing Supplement Number:
Merrill Lynch & Co., Inc.
Medium-Term Notes, Series B
Due Nine Months or More from Date of Issue
Enhanced Yield Notes Linked to the NASDAQ-100 Index(R)
due February , 2005
(the "Notes")
------------
The Notes will pay a cash amount at maturity which may vary depending
upon changes in the value of the NASDAQ-100 Index during the term of the
Notes. The amount payable at maturity on each $1,000 principal amount of Notes
will equal $1,000 unless the closing value of the Index on any day through the
end of the Calculation Period (as described in this pricing supplement) equals
or is less than one-half of the closing value of the Index on the day the
Notes are priced for initial sale to the public (the "Trigger Level"). If the
closing value of the Index on any day through the end of the Calculation
Period equals or is less than the Trigger Level, then the Notes will pay a
cash amount at maturity equal to the product of $1,000 multiplied by a
fraction, the numerator of which is the average closing value of the Index on
certain days immediately prior to the maturity (calculated as described in
this pricing supplement) and the denominator of which is the closing value of
the Index on the day the Notes are priced for initial sale to the public. If
the closing value of the Index on any day through the end of the Calculation
Period equals or is less than the Trigger Level, you may receive less than
$1,000 per $1,000 principal amount of Notes at maturity.
The Notes will pay interest semi-annually at a rate expected to be
between 6% and 6 1/2% per annum on the principal amount of the Notes. The
actual interest rate will be determined on the day the Notes are priced for
initial sale to the public and disclosed in the final pricing supplement
delivered in connection with sales of the Notes. The amount payable at
maturity of the Notes will include, in addition to the amounts described in
the above paragraph, accrued but unpaid interest.
The Notes are part of a series of senior debt securities entitled
"Medium-Term Notes, Series B" as more fully described in the attached
Prospectus Supplement. This pricing supplement supplements the attached
Prospectus Supplement and Prospectus and supercedes information in the
Prospectus Supplement and Prospectus to the extent it contains information
that is different from the information in the attached Prospectus Supplement
and Prospectus.
Investing in the Notes involves risks that are described in the "Risk
Factors" sections of this pricing supplement and the accompanying Prospectus
Supplement.
Aggregate principal amount.............. $
Stated Maturity Date.................... February , 2005
Issue Price............................. $1,000
Original Issue Date..................... November , 2002
Interest Rate........................... An amount expected to be between 6%
and 6 1/2% per annum on the
principal amount of each Note,
payable semi-annually. The actual
interest rate will be determined on
the date the Notes are priced for
initial sale to the public (the
"Pricing Date") and will appear in
the final pricing supplement.
Nasdaq-100(R), Nasdaq-100 Index(R), and Nasdaq(R)are trade or service
marks of The Nasdaq Stock Market, Inc. and are licensed for use by Merrill
Lynch & Co., Inc.
Interest Payment Dates.................. February and August of each year,
beginning February , 2003. If an
Interest Payment Date is not a
Business Day, any payment due on
that Interest Payment Date will be
made on the immediately succeeding
Business Day, and no additional
interest will accrue as a result of
the delayed payment.
The NASDAQ-100 Index.................... The NASDAQ-100 Index (the "Index") is
a modified capitalization-weighted
index of 100 of the largest stocks of
non-financial companies listed on the
Nasdaq National Market tier of The
Nasdaq Stock Market. The Index is
currently calculated and published
by The Nasdaq Stock Market, Inc.
(the "Nasdaq"(R)). As of October 15,
2002, the major industry groups
covered in the Index (listed
according to their respective
capitalization in the Index) were as
follows: computer and office
equipment (7.43%), computer
software/services (24.81%),
telecommunications (13.32%),
biotechnology (9.93%), retail/
wholesale trade (6.66%), services
(3.90%), health care (2.24%) and
manufacturing (0.70%). The identity
and capitalization weightings of the
five largest companies represented
in the Index as of October 15, 2002
were as follows: Microsoft
Corporation (13.93%), Intel
Corporation (5.55%), QUALCOMM
Incorporated (4.77%), Amgen Inc.
(4.33%), and Cisco Systems, Inc.
(4.13%). Current information
regarding the market value of the
Index is available from the Nasdaq
as well as numerous market
information services. The Index is
determined, comprised and calculated
by the Nasdaq without regard to the
Notes.
Please note that an investment in
the Notes does not entitle you to
any ownership interest in the stocks
of the companies included in the
Index or the value of any dividends
paid on those stocks.
Amount payable at maturity.............. In addition to accrued and unpaid
interest, at maturity you will
receive a cash payment per
$1,000 principal amount of
the Notes (the "Redemption
Amount") equal to:
(i) $1,000, or
(ii) if the closing value of
the Index on any day through
the end of the Calculation
Period (as defined below)
equals or is less than the
Trigger Level (as defined
below):
(Ending Value)
$1,000 x ----------------
(Starting Value)
You will receive the
Redemption Amount plus
accrued and unpaid interest
on the Stated Maturity Date
of February , 2005.
Trigger Level .......................... The "Trigger Level" will equal
one-half of the Starting Value, as
defined below. The actual Trigger
Level will be determined on the
Pricing Date and will appear in the
final pricing supplement.
Starting Value.......................... The "Starting Value" will equal the
closing value of the Index
through the end of the Pricing Date.
The Starting Value will appear in
the final pricing supplement.
Ending Value............................ If the closing value of the Index on
any day through the end of the
Calculation Period is equal to or
less than the Trigger Level, the
Calculation Agent will calculate an
"Ending Value" equal to the average,
arithmetic mean, of the closing
values of the Index on each of the
first five Calculation Days during
the Calculation Period. If
PS-2
there are fewer than five
Calculation Days during the
Calculation Period, then the Ending
Value will equal the average,
arithmetic mean, of the closing
values of the Index on those
Calculation Days. If there is only
one Calculation Day during the
Calculation Period, then the Ending
Value will equal the closing value
of the Index on that Calculation Day.
If no Calculation Days occur during
the Calculation Period, then the
Ending Value will equal the closing
value of the Index determined on the
last scheduled Index Business Day in
the Calculation Period, regardless
of the occurrence of a Market
Disruption Event, as defined herein,
on that day.
Business Day............................ "Business Day" means any day, other
than a Saturday or Sunday, that is
neither a legal holiday nor a day on
which commercial banks are
authorized or required by law,
regulation or executive order to
close in The City of New York.
Index Business Day...................... "Index Business Day" means a day on
which the New York Stock Exchange,
the American Stock Exchange and the
Nasdaq Stock Market are open for
trading and the Index or any
successor index is calculated and
published.
Calculation Day......................... "Calculation Day" means any Index
Business Day during the
Calculation Period on which a Market
Disruption Event has not occurred.
Calculation Period...................... "Calculation Period" means the
period from and including the
seventh scheduled Index
Business Day prior to the
Stated Maturity Date to and
including the second
scheduled Index Business Day
prior to the Stated Maturity
Date.
CUSIP number............................ 59018YNX5.
Form of Notes........................... Book-entry.
Denominations........................... We will issue and sell the Notes in
denominations of $1,000 and
integral multiples thereof.
Trustee................................. JPMorgan Chase Bank.
Calculation Agent....................... Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("MLPF&S").
All determinations made by the
Calculation Agent will be at the
sole discretion of the Calculation
Agent and, absent manifest
error, will be conclusive for all
purposes and binding on Merrill
Lynch & Co., Inc. ("ML&Co.") and
beneficial owners of the Notes.
All percentages resulting from any
calculation on the Notes will be
rounded to the nearest one hundred-
thousandth of a percentage
point, with five one-millionths of
a percentage point rounded
upwards, e.g., 9.876545% (or
.09876545) would be rounded to
9.87655% (or .0987655). All dollar
amounts used in or resulting from
this calculation will be rounded to
the nearest cent with one-half cent
being rounded upwards.
Proceeds to ML&Co....................... $
Underwriting Discount................... $
PS-3
RISK FACTORS
Your investment in the Notes will involve certain risks. You should
consider carefully the following discussion of risks before you decide that an
investment in the Notes is suitable for you.
The Notes are not principal protected and your investment may result in a loss
The Notes do not provide for a minimum repayment amount at maturity.
If the closing value of the Index on any day through the end of the
Calculation Period equals or is less than the Trigger Level, the Redemption
Amount will be determined based on the change in the value of the Index from
the Starting Value to the Ending Value. Because there is no limit to the
amount by which the Index may decline during the term of the Notes, you may
suffer a loss on your investment, and the loss may be significant. If the
closing value of the Index on any day through the end of the Calculation
Period equals or is less than the Trigger Level, the Redemption Amount for
each $1,000 principal amount of Notes is likely to be less than $1,000.
A decline in the Index to or below the Trigger Level will adversely
affect the value of the Notes
We expect that the market value of the Notes will depend in part on
the value of the Index, and that this dependence will increase if the value of
the Index approaches or falls below the Trigger Level. If the closing value of
the Index on any day through the end of the Calculation Period equals or is
less than the Trigger Level, the Redemption Amount will depend on the value of
the Index and the increased risk of loss of principal for the remaining term
of the Notes will adversely affect the value of the Notes.
Your yield may be lower than the yield on other standard debt securities
of comparable maturity
The yield that you receive on your Notes, which could be negative,
may be less than the return you could earn on other investments. Your yield
may be less than the yield you would earn if you bought a standard senior
non-callable debt security of ML&Co. with the same stated maturity date. While
the coupon is higher than the coupon on a standard senior non-callable debt
security of ML&Co. with the same maturity, if the closing value of the Index
on any day through the end of the Calculation Period equals or is less than
the Trigger Level, your actual yield could be zero or negative. Your
investment may not reflect the full opportunity cost to you when you take into
account factors that affect the time value of money. Unlike standard senior
non-callable debt securities, the Notes do not guarantee the return of a
principal amount at maturity.
Your return is limited and will not reflect the return of owning the
stocks included in the Index
You should understand that it is unlikely that you will participate
in any increases in the value of the Index through an investment in the Notes.
If the closing value of the Index on any day through the end of the
Calculation Period does not equal or is not less than the Trigger Level, the
Redemption Amount will equal $1,000, which represents the original public
offering price of the Notes, regardless of any increase or decrease in the
value of the Index relative to the Starting Value. You will participate in any
increase in the value of the Index only if the closing value of the Index on
any day through the end of the Calculation Period equals or is less than the
Trigger Level and the value of the Index increases from the Trigger Level so
that the Ending Value exceeds the Starting Value. If the closing value of the
Index on any day through the end of the Calculation Period equals or is less
than the Trigger Level and if the Ending Value is less than the Starting
Value, you will lose a part or all of the principal amount of the Notes.
In addition, your return will not reflect the return you would
realize if you actually owned the stocks underlying the Index and received the
dividends paid on those stocks because the Nasdaq calculates the Index by
reference to the prices of the common stocks included in the Index without
taking into consideration the value of dividends paid on those stocks.
A trading market for the Notes is not expected to develop
The Notes will not be listed on any securities exchange and we do not
expect a trading market for the Notes to develop. Although our affiliate,
MLPF&S, has indicated that it expects to bid for Notes offered for sale to it
by Note holders, it is not required to do so and may cease making such bids at
any time. The limited trading market for
PS-4
your Notes may affect the price that you receive for your Notes if you do
not wish to hold your investment until maturity.
Many factors affect the value of the Notes; these factors interrelate in
complex ways and the effect of any one factor may offset or magnify the effect
of another factor
The value of the Notes will be affected by factors that interrelate
in complex ways. It is important for you to understand that the effect of one
factor may offset the increase in the value of the Notes caused by another
factor and that the effect of one factor may exacerbate the decrease in the
value of the Notes caused by another factor. For example, an increase in U.S.
interest rates may offset some or all of any increase in the value of the
Notes attributable to another factor, such as an increase in the value of the
Index. The following paragraphs describe the expected impact on the market
value of the Notes given a change in a specific factor, assuming all other
conditions remain constant.
The value of the Index is expected to affect the value of the Notes.
We expect that the market value of the Notes will depend on the value of the
Index during the term of the Notes, and that the dependence will increase if
the value of the Index approaches the Trigger Level. If the closing value of
the Index on any day through the end of the Calculation Period equals or is
less than the Trigger Level, the value of the Notes will depend substantially
on the value of the Index relative to the Starting Value for the remaining
term of the Notes.
Changes in the levels of interest rates are expected to affect the
value of the Notes. In general, if U.S. interest rates increase, we expect that
the value of the Notes will decrease and, conversely, if U.S. interest rates
decrease, we expect the value of the Notes will increase. In addition, rising
U.S. interest rates may lower the value of the Index and thus may decrease the
value of the Notes. Falling U.S. interest rates may increase the value of the
Index and thus may increase the value of the Notes.
Changes in the volatility of the Index are expected to affect the
value of the Notes. Volatility is the term used to describe the size and
frequency of price and/or market fluctuations. If the volatility of the Index
increases, the value of the Notes may be adversely affected. Increased
volatility increases the probability of negative changes in the Index, and the
magnitude of such negative changes, on any particular Index Business Day
during the term of the Notes, thereby increasing the probability that the
closing value of the Index prior to the end of the Calculation Period may
equal or be less than the Trigger Level and that the Ending Value may be less
than the Starting Value, which would reduce the value of the Notes.
Changes in dividend yields of the stocks included in the Index are
expected to affect the value of the Notes. In general, if dividend yields on
the stocks included in the Index increase, we expect that the value of the
Notes will decrease and, conversely, if dividend yields on the stocks included
in the Index decrease, we expect that the value of the Notes will increase.
The effect of changes in dividend yields on those stocks may increase if the
value of the Index falls below the Trigger Level.
Changes in our credit ratings may affect the value of the Notes. Our
credit ratings are an assessment of our ability to pay our obligations.
Consequently, real or anticipated changes in our credit ratings may affect the
value of the Notes. However, because the return on your Notes is dependent
upon factors in addition to our ability to pay our obligations under the
Notes, such as the percentage increase, if any, in the value of the Index, an
improvement in our credit ratings will not reduce the other investment risks
related to the Notes.
Amounts payable on the Notes may be limited by state law
New York State law governs the 1983 Indenture under which the Notes
will be issued. New York has usury laws that limit the amount of interest that
can be charged and paid on loans, which includes debt securities like the Notes.
Under present New York law, the maximum rate of interest is 25% per annum on a
simple interest basis. This limit may not apply to debt securities in which
$2,500,000 or more has been invested.
While we believe that New York law would be given effect by a state
or Federal court sitting outside of New York, many other states also have laws
that regulate the amount of interest that may be charged to and paid by a
borrower. We will promise, for the benefit of the holders of the Notes, to the
extent permitted by law, not to voluntarily claim the benefits of any laws
concerning usurious rates of interest.
PS-5
Purchases and sales by us and our affiliates may affect your return
We and our affiliates may from time to time buy or sell the stocks
included in the Index or futures or options contracts on the Index for our own
accounts for business reasons or in connection with hedging our obligations
under the Notes. These transactions could affect the price of these stocks
and, in turn, the value of the Index in a manner that would be adverse to your
investment in the Notes.
Potential conflicts
MLPF&S, our subsidiary, is the underwriter for the offering and sale
of the Notes. After the initial offering, MLPF&S may buy and sell Notes and
may stabilize or maintain the market price of the Notes during initial
distribution. However, MLPF&S will not be obligated to engage in any of these
market activities or to continue them once it has started.
MLPF&S is also the Calculation Agent for the Notes. MLPF&S is
required to carry out its duties as Calculation Agent in good faith and using
its reasonable judgment. However, you should be aware that because we control
MLPF&S, potential conflicts of interest could arise. These conflicts could
occur under certain circumstances, for instance, in connection with the
determination as to whether the value of the Index can be calculated on a
Trading Day, or in connection with its judgments that it would be required to
make in the event of a discontinuance of the Index. See the sections entitled
"The Index--Adjustments to the Index; Market Disruption Events" and
"--Discontinuance of the Index" in this pricing supplement.
We have entered into an arrangement with one of our subsidiaries to
hedge the market risks associated with our obligations in connection with the
Notes. This subsidiary expects to make a profit in connection with this
arrangement. We did not seek competitive bids for this arrangement from
unaffiliated parties.
Uncertain tax consequences
You should consider the tax consequences of investing in the Notes,
aspects of which are uncertain. See the section entitled "United States
Federal Income Taxation" in this pricing supplement.
HYPOTHETICAL RETURNS
The amount payable at maturity on each $1,000 principal amount of
Notes will equal $1,000 and is not dependent upon changes in the Index unless
the closing value of the Index on any day through the end of the Calculation
Period equals or is less than the Trigger Level. If the closing value of the
Index on any day through the end of the Calculation Period equals or is less
than the Trigger Level, then each $1,000 principal amount of the Notes will
pay a cash amount at maturity equal to $1,000 multiplied by the fraction
derived by dividing the Ending Value by the Starting Value.
The following table illustrates, for the hypothetical Starting Value
and a range of hypothetical Ending Values (see footnote (1) of the following
table):
o the percentage change of the hypothetical Ending Value relative
to the hypothetical Starting Value;
o the Redemption Amount for each unit of the Notes; and
o the annualized yield to holders of the Notes, including the
payment of interest;
under the following two assumed situations: (1) the closing value of the
Index on a day prior to the end of the Calculation Period is equal to or less
than the hypothetical Trigger Level (i.e., the Trigger Level has been reached)
PS-6
and (2) the closing value of the Index never is equal to or less than the
Trigger Level prior to the end of the Calculation Period (i.e., the Trigger
Level has not been reached).
Percentage
change from the If the Trigger Level Assuming the Trigger Level
hypothetical were to be reached has not been reached
Ending Value --------------------------------- ----------------------------------
relative to the
Hypothetical hypothetical Redemption Annualized Yield Redemption Annualized Yield
Ending Value(1) Starting Value(1) Amount(2) on the Notes(3) Amount(2) on the Notes(3)
- ----------------- ------------------ ---------- ------------------ ----------- -----------------
91.01 -90% $100 -53.26% n/a n/a
182.03 -80% $200 -42.13% n/a n/a
273.04 -70% $300 -33.34% n/a n/a
364.05 -60% $400 -25.87% n/a n/a
455.07 -50% $500 -19.29% n/a n/a
546.08 -40% $600 -13.35% $1,000 6.35%
637.09 -30% $700 -7.90% $1,000 6.35%
728.10 -20% $800 -2.85% $1,000 6.35%
819.12 -10% $900 1.89% $1,000 6.35%
910.13(4) 0% $1,000 6.35% $1,000 6.35%
1,001.14 10% $1,100 10.59% $1,000 6.35%
1,092.16 20% $1,200 14.62% $1,000 6.35%
1,183.17 30% $1,300 18.48% $1,000 6.35%
1,274.18 40% $1,400 22.18% $1,000 6.35%
1,365.20 50% $1,500 25.74% $1,000 6.35%
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(1) If the closing value of the Index on any day through the end of the
actual Calculation Period was not equal to or less than the Trigger
Level, the Ending Value would not be calculated. The hypothetical Ending
Value and the percentage change from the hypothetical Ending Value
relative to the hypothetical Starting Value would relate only to the
situation where the closing value of the Index on any day through the end
of the actual Calculation Period equaled or was less than the Trigger
Level. However, the values are presented here as if the Ending Value was
the closing value of the Index at the end of the Calculation Period. It
is used to represent an equivalent percentage change in the value of the
Index relative to the Starting Value to illustrate that the change in the
value of the Index has no effect on the Redemption Amount, or the
annualized yield, in the situation where the Trigger Level has not been
reached.
(2) Assuming the closing value of the Index on any day prior to the end of
the hypothetical Calculation Period was equal to or less than the Trigger
Level, the fraction applied to principal is derived by dividing the
hypothetical Ending Value by the hypothetical Starting Value.
(3) The annualized yields specified in the preceding table are based on a
360-day year of twelve 30-day months, and assumes the Notes have a coupon
of 6 1/4% (the midpoint between the expected range of 6% and 6 1/2%).
(4) This is the hypothetical Starting Value for purposes of calculating this
table. This value was the actual closing value of the Index on October
16, 2002. The actual Starting Value appears in the final pricing
supplement.
The figures in the above table are for purposes of illustration only.
The table is neither an indication of the likelihood of the Trigger Level
being reached during the term of the Notes, nor is it a prediction of the
future values of the Index. The amount payable at maturity on each $1,000
principal amount of Notes will not exceed $1,000, unless (a) the closing value
of the Index first falls to or below the Trigger Level (50% of the Starting
Value) and (b) the average of the Index closing values during the Calculation
Period exceeds the Starting Value. In the event that the closing value of the
Index falls to or below the Trigger Level and the Ending Value remains less
than the Starting Value, you will lose a part or all of your initial
investment. The actual Redemption Amount, received by you, if any, and the
resulting total and pretax annualized rate of return will depend on the actual
Starting Value, whether the actual closing value of the Index on any day
through the end of the Calculation Period equals or is less than the Trigger
Level and the actual Ending Value determined by the Calculation Agent, as
described in this pricing supplement.
PS-7
ALTERNATIVE INDEX CALCULATIONS
Adjustments to the Index; Market Disruption Events
If at any time the Nasdaq changes its method of calculating the
Index, or the value of the Index changes, in any material respect, or if the
Index is in any other way modified so that the Index does not, in the opinion
of the Calculation Agent, fairly represent the value of the Index had those
changes or modifications not been made, then, from and after that time, the
Calculation Agent shall, at the close of business in New York, New York, on
each date that the closing value of the Index is to be calculated, make those
adjustments as, in the good faith judgment of the Calculation Agent, may be
necessary in order to arrive at a calculation of a value of a stock index
comparable to the Index as if those changes or modifications had not been
made, and calculate the closing value with reference to the Index, as so
adjusted. Accordingly, if the method of calculating the Index is modified so
that the value of the Index is a fraction or a multiple of what it would have
been if it had not been modified, e.g., due to a split, then the Calculation
Agent shall adjust the Index in order to arrive at a value of the Index as if
it had not been modified, e.g., as if a split had not occurred.
"Market Disruption Event" means either of the following events as
determined by the Calculation Agent:
(A) the suspension of or material limitation on trading for more
than two hours of trading, or during the one-half hour period
preceding the close of trading, on the applicable exchange, in
20% or more of the stocks which then comprise the Index or any
successor index; or
(B) the suspension of or material limitation on trading, in
each case, for more than two hours of trading, or during the
one-half hour period preceding the close of trading, on the
applicable exchange, whether by reason of movements in price
otherwise exceeding levels permitted by the relevant exchange
or otherwise, in option contracts or futures contracts
related to the Index, or any successor index, which are traded
on any major U.S. exchange.
For the purpose of the above definition:
(1) a limitation on the hours in a Trading Day and/or number of
days of trading will not constitute a Market Disruption Event
if it results from an announced change in the regular business
hours of the relevant exchange, and
(2) for the purpose of clause (A) above, any limitations on trading
during significant market fluctuations under NYSE Rule 80A, or
any applicable rule or regulation enacted or promulgated by the
NYSE or any other self regulatory organization or the SEC of
similar scope as determined by the Calculation Agent, will be
considered "material".
As a result of the terrorist attacks the financial markets were
closed from September 11, 2001 through September 14, 2001 and values of the
Index are not available for such dates. Such market closures would have
constituted Market Disruption Events.
Discontinuance of the Index
If the Nasdaq discontinues publication of the Index and the Nasdaq or
another entity publishes a successor or substitute index that the Calculation
Agent determines, in its sole discretion, to be comparable to the Index (a
"successor index"), then, upon the Calculation Agent's notification of its
determination to the trustee and ML&Co., the Calculation Agent will substitute
the successor index as calculated by the Nasdaq or any other entity for the
Index for all relevant calculations including calculating the Redemption
Amount as described above under "--Payment at maturity". Upon any selection by
the Calculation Agent of a successor index, ML&Co. shall cause notice to be
given to holders of the Notes.
PS-8
In the event that the Nasdaq discontinues publication of the Index
and:
o the Calculation Agent does not select a successor index, or
o the successor index is no longer published,
the Calculation Agent will compute a substitute value for the Index in
accordance with the procedures last used to calculate the Index before any
discontinuance. If a successor index is selected or the Calculation Agent
calculates a value as a substitute for the Index as described below, the
successor index or value will be used as a substitute for the Index for all
purposes, including for purposes of determining whether a Market Disruption
Event exists.
If the Nasdaq discontinues publication of the Index before the Stated
Maturity Date of February , 2005, and the Calculation Agent determines that no
successor index is available at that time, then on each Business Day until the
earlier to occur of:
o the determination of an Ending Value, and
o a determination by the Calculation Agent that a successor
index is available,
the Calculation Agent will determine the value that would be used in
determining if the closing value of the Index is equal to or less than the
Trigger Level or computing the Redemption Amount. The Calculation Agent will
cause notice of each value to be published not less often than once each month
in The Wall Street Journal or another newspaper of general circulation, and
arrange for information with respect to these values to be made available by
telephone.
Notwithstanding these alternative arrangements, discontinuance of the
publication of the Index may adversely affect trading in the Notes.
EVENTS OF DEFAULT AND ACCELERATION
In case an Event of Default with respect to any Notes has occurred
and is continuing, the amount payable to a beneficial owner of a Note upon any
acceleration permitted by the Notes, with respect to each unit of Notes, will
be equal to the amount payable on the Stated Maturity Date, calculated as
though the date of early repayment were the Stated Maturity Date of the Notes.
See "--Payment at maturity" in this pricing supplement. If a bankruptcy
proceeding is commenced in respect of ML&Co., the claim of the holder of a
Note may be limited, under Section 502(b)(2) of Title 11 of the United States
Code, to the original public offering price of the Note plus an additional
amount of contingent interest calculated as though the date of the
commencement of the proceeding were the Stated Maturity Date of the Notes.
In case of default in payment of the Notes, whether at the Stated
Maturity Date, an Interest Payment Date or upon acceleration, from and after
that date the Notes will bear interest, payable upon demand of their holders,
at the rate of % per annum, to the extent that payment of any interest is
legally enforceable on the unpaid amount due and payable on that date in
accordance with the terms of the Notes to the date payment of that amount has
been made or duly provided for.
THE NASDAQ-100 INDEX
The Index is a modified capitalization-weighted index of 100 of the
largest stocks of non-financial companies listed on the Nasdaq National Market
tier of The Nasdaq Stock Market. The Index was first published in January 1985
and includes companies across a variety of major industry groups. As of
October 15, 2002, the major industry groups covered in the Index (listed
according to their respective capitalization in the Index) were as follows:
computer and office equipment (7.43%), computer software/services (24.81%),
telecommunications (13.32%), biotechnology (9.93%), retail/wholesale trade
(6.66%), services (3.90%), health care (2.24%) and manufacturing (0.70%). The
identity and capitalization weightings of the five largest companies
represented in the Index as of October 15, 2002 were as follows: Microsoft
Corporation (13.93%), Intel Corporation (5.55%), QUALCOMM Incorporated
(4.77%), Amgen Inc. (4.33%), and Cisco Systems, Inc. (4.13%). Current
information regarding the market value of the Index is available from the
Nasdaq as well as numerous market information services. The Index is
determined, comprised and calculated by the Nasdaq without regard to the
Notes.
PS-9
The Index share weights of the component securities of the Index at
any time are based upon the total shares outstanding in each of the 100 Index
securities and are additionally subject, in certain cases, to rebalancing.
Accordingly, each underlying stock's influence on the value of the Index is
directly proportional to the value of its Index share weight.
Computation of the Index
Underlying Stock Eligibility Criteria and Annual Ranking Review. To
be eligible for inclusion in the Index, a security must be traded on the
Nasdaq National Market tier of The Nasdaq Stock Market and meet the following
criteria:
o the security must be of a non-financial company;
o only one class of security per issuer is allowed;
o the security may not be issued by an issuer currently in
bankruptcy proceedings;
o the security must have average daily trading volume of at least
100,000 shares;
o the security must have "seasoned" on The Nasdaq Stock
Market or another recognized market (generally, a
company is considered to be seasoned by Nasdaq if it has
been listed on a market for at least two years; in the
case of spin-offs, the operating history of the spin-off
will be considered);
o if a security would otherwise qualify to be in the top
25% of the issuers included in the Index by market
capitalization, then a one year "seasoning" criteria
would apply;
o if the security is of a foreign issuer, the company must
have a worldwide market value of at least $10 billion, a
U.S. market value of at least $4 billion, and average
trading volume on The Nasdaq Stock Market of at least
200,000 shares per day; in addition, foreign securities
must be eligible for listed options trading; and
o the issuer of the security may not have entered into a
definitive agreement or other arrangement which would
result in the security no longer being listed on The
Nasdaq Stock Market within the next six months.
These Index eligibility criteria may be revised from time to time by
The Nasdaq Stock Market, Inc. without regard to the Notes.
The Index securities are evaluated on an annual basis, except under
extraordinary circumstances which may result in an interim evaluation, as
follows (such evaluation is referred to herein as the "Ranking Review").
Securities listed on The Nasdaq Stock Market which meet the above eligibility
criteria are ranked by market value using closing prices as of the end of
October and publicly available total shares outstanding as of the end of
November. Index-eligible securities which are already in the Index and which
are in the top 150 eligible securities (based on market value) are retained in
the Index provided that such security was ranked in the top 100 eligible
securities as of the previous ranking review. Securities not meeting such
criteria are replaced. The replacement securities chosen are those
Index-eligible securities not currently in the Index which have the largest
market capitalization.
Generally, the list of annual additions and deletions is publicly
announced via a press release in the early part of December and replacements
are made effective after the close of trading on the third Friday in December.
Moreover, if at any time during the year an Index security is no longer traded
on The Nasdaq Stock Market, or is otherwise determined by the Nasdaq to become
ineligible for continued inclusion in the Index, the security will be replaced
with the largest market capitalization security not currently in the Index and
meeting the Index eligibility criteria listed above.
In addition to the Ranking Review, the securities in the Index are
monitored every day by the Nasdaq with respect to changes in total shares
outstanding arising from secondary offerings, stock repurchases, conversions,
or other corporate actions. The Nasdaq has adopted the following quarterly
scheduled weight adjustment procedures with respect to such changes. If the
change in total shares outstanding arising from such corporate action is
greater than or equal to 5.0%, such change is made to the Index on the evening
prior to the effective date of such corporate action or as soon as practical
thereafter. Otherwise, if the change in total shares outstanding is less than
5.0%, then
PS-10
all such changes are accumulated and made effective at one time on a
quarterly basis after the close of trading on the third Friday in each of
March, June, September, and December. In either case, the Index share weights
for such underlying stocks are adjusted by the same percentage amount by which
the total shares outstanding have changed in such Index securities.
Ordinarily, whenever there is a change in the Index share weights or a change
in a component security included in the Index, the Nasdaq adjusts the divisor
to assure that there is no discontinuity in the value of the Index which might
otherwise be caused by any such change.
Rebalancing of the Index. The Index is calculated under a "modified
capitalization-weighted" methodology, which is a hybrid between equal
weighting and conventional capitalization weighting. This methodology is
expected to: (1) retain in general the economic attributes of capitalization
weighting; (2) promote portfolio weight diversification (thereby limiting
domination of the Index by a few large stocks); (3) reduce Index performance
distortion by preserving the capitalization ranking of companies; and (4)
reduce market impact on the smallest Index securities from necessary weight
rebalancings.
Under the methodology employed, on a quarterly basis coinciding with
the Nasdaq's quarterly scheduled weight adjustment procedures, the Index
securities are categorized as either "Large Stocks" or "Small Stocks"
depending on whether their current percentage weights (after taking into
account such scheduled weight adjustments due to stock repurchases, secondary
offerings, or other corporate actions) are greater than, or less than or equal
to, the average percentage weight in the Index (i.e., as a 100-stock index,
the average percentage weight in the Index is 1.0%).
Such quarterly examination will result in a Index rebalancing if
either one or both of the following two weight distribution requirements are
not met: (1) the current weight of the single largest market capitalization
Index security must be less than or equal to 24.0% and (2) the "collective
weight" of those Index securities whose individual current weights are in
excess of 4.5%, when added together, must be less than or equal to 48.0%. In
addition, the Nasdaq may conduct a special rebalancing if it is determined
necessary to maintain the integrity of the Index.
If either one or both of these weight distribution requirements are
not met upon quarterly review, or the Nasdaq determines that a special
rebalancing is required, a weight rebalancing will be performed. First,
relating to weight distribution requirement (1) above, if the current weight
of the single largest Index security exceeds 24.0%, then the weights of all
Large Stocks will be scaled down proportionately towards 1.0% by enough for
the adjusted weight of the single largest Index security to be set to 20.0%.
Second, relating to weight distribution requirement (2) above, for those Index
securities whose individual current weights or adjusted weights in accordance
with the preceding step are in excess of 4.5%, if their "collective weight"
exceeds 48.0%, then the weights of all Large Stocks will be scaled down
proportionately towards 1.0% by just enough for the "collective weight," so
adjusted, to be set to 40.0%.
The aggregate weight reduction among the Large Stocks resulting from
either or both of the above rescalings will then be redistributed to the Small
Stocks in the following iterative manner. In the first iteration, the weight
of the largest Small Stock will be scaled upwards by a factor which sets it
equal to the average Index weight of 1.0%. The weights of each of the smaller
remaining Small Stocks will be scaled up by the same factor reduced in
relation to each stock's relative ranking among the Small Stocks such that the
smaller the Index security in the ranking, the less the scale-up of its
weight. This is intended to reduce the market impact of the weight rebalancing
on the smallest component securities in the Index.
In the second iteration, the weight of the second largest Small
Stock, already adjusted in the first iteration, will be scaled upwards by a
factor which sets it equal to the average index weight of 1.0%. The weights of
each of the smaller remaining Small Stocks will be scaled up by this same
factor reduced in relation to each stock's relative ranking among the Small
Stocks such that, once again, the smaller the stock in the ranking, the less
the scale-up of its weight.
Additional iterations will be performed until the accumulated
increase in weight among the Small Stocks exactly equals the aggregate weight
reduction among the Large Stocks from rebalancing in accordance with weight
distribution requirement (1) and/or weight distribution requirement (2).
Then, to complete the rebalancing procedure, once the final percent
weights of each of the Index securities are set, the Index share weights will
be determined anew based upon the last sale prices and aggregate
capitalization
PS-11
of the Index at the close of trading on the Thursday in the week
immediately preceding the week of the third Friday in March, June,
September, and December. Changes to the Index share weights will be made
effective after the close of trading on the third Friday in March, June,
September, and December and an adjustment to the Index divisor will be made to
ensure continuity of the Index.
Ordinarily, new rebalanced weights will be determined by applying the
above procedures to the current Index share weights. However, the Nasdaq may
from time to time determine rebalanced weights, if necessary, by instead
applying the above procedure to the actual current market capitalization of
the Index components. In such instances, the Nasdaq would announce the
different basis for rebalancing prior to its implementation.
Historical Data on the Index
The following table sets forth the month-end closing value of the
Index from January 1997 through October 2002. These historical data on the
Index are not necessarily indicative of the future performance of the Index or
what the value of the Notes may be. Any historical upward or downward trend in
the level of the Index during any period set forth below is not an indication
that the Index is more or less likely to increase or decrease at any time
during the term of the Notes.
1997 1998 1999 2000 2001 2002
-------- -------- -------- -------- -------- --------
January..................................... 921.55 1,071.13 2,127.19 3,570.05 2,593.00 1,550.17
February.................................... 850.46 1,194.13 1,925.28 4,266.94 1,908.32 1,359.22
March....................................... 797.06 1,220.66 2,106.39 4,397.84 1,573.25 1,452.81
April....................................... 874.74 1,248.12 2,136.39 3,773.18 1,855.15 1,277.07
May......................................... 958.85 1,192.07 2,089.70 3,324.08 1,799.89 1,208.34
June........................................ 957.30 1,337.34 2,296.77 3,763.79 1,830.19 1,051.41
July........................................ 1,107.03 1,377.26 2,270.93 3,609.35 1,683.61 962.11
August...................................... 1,074.17 1,140.34 2,396.87 4,077.59 1,469.70 942.38
September................................... 1,097.17 1,345.48 2,407.90 3,570.61 1,168.37 832.52
October..................................... 1,019.62 1,400.52 2,637.44 3,282.30 1,364.78
November.................................... 1,050.51 1,557.96 2,966.71 2,506.54 1,596.05
December.................................... 990.80 1,836.01 3,707.83 2,341.70 1,577.05
The following graph sets forth the daily closing values of the Index
from January 2, 1997 through October 16, 2002. Past movements of the Index are
not necessarily indicative of the future Index values. On October 16, 2002,
the closing value of the Index was 910.13.
[The graph here sets forth daily closing values of the Index from January 2,
1997 through October 15, 2002. The horizontal axis shows the date range in
daily increments. The vertical axis shows a range of values from 0 to 5000
in increments of 500.]
This graph is for historical information only and should not be used
or interpreted as a forecast or indication of future stock market performance,
interest rate levels or variable returns applicable to the Notes.
PS-12
License Agreement
The Nasdaq Stock Market, Inc. and Merrill Lynch & Co., Inc. have
entered into a non-exclusive license agreement providing for the license to
ML&Co., in exchange for a fee, of the right to use the Index in connection
with certain securities, including the Notes.
The license agreement between the Nasdaq and ML&Co. provides that the
following language must be stated in this prospectus supplement:
"The Notes are not sponsored, endorsed, sold or promoted by, The
Nasdaq Stock Market, Inc. (including its affiliates) (the Nasdaq,
with its affiliates, are referred to as the "Corporations"). The
Corporations have not passed on the legality or suitability of, or
the accuracy or adequacy of descriptions and disclosures relating to,
the Notes. The Corporations make no representation or warranty,
express or implied to the owners of the Notes or any member of the
public regarding the advisability of investing in securities
generally or in the Notes particularly, or the ability of the
NASDAQ-100 Index(R) to track general stock market performance. The
Corporations' only relationship to ML&Co. is in the licensing of the
NASDAQ-100(R), NASDAQ-100 Index(R), and Nasdaq(R) trademarks or
service marks, and certain trade names of the Corporations and the
use of the NASDAQ-100 Index(R) which is determined, composed and
calculated by Nasdaq without regard to ML&Co. or the Notes. Nasdaq
has no obligation to take the needs of ML&Co. or the owners of the
Notes into consideration in determining, composing or calculating the
NASDAQ-100 Index(R). The Corporations are not responsible for and
have not participated in the determination of the timing of, prices
at, or quantities of the Notes to be issued or in the determination
or calculation of the equation by which the Notes are to be converted
into cash. The Corporations have no liability in connection with the
administration, marketing or trading of the Notes.
THE CORPORATIONS DO NOT GUARANTEE THE ACCURACY AND/OR UNINTERRUPTED
CALCULATION OF THE NASDAQ-100 INDEX(R) OR ANY DATA INCLUDED THEREIN.
THE CORPORATIONS MAKE NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS
TO BE OBTAINED BY ML&CO., OWNERS OF THE NOTES, OR ANY OTHER PERSON OR
ENTITY FROM THE USE OF THE NASDAQ-100 INDEX(R) OR ANY DATA INCLUDED
THEREIN. THE CORPORATIONS MAKE NO EXPRESS OR IMPLIED WARRANTIES, AND
EXPRESSLY DISCLAIM ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE NASDAQ-100 INDEX(R) OR
ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN
NO EVENT SHALL THE CORPORATIONS HAVE ANY LIABILITY FOR ANY LOST
PROFITS OR SPECIAL, INCIDENTAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL
DAMAGES, EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES."
All disclosures contained in this prospectus supplement regarding the
Index, including its make-up, method of calculation and changes in its
components, are derived from publicly available information prepared by
Nasdaq. ML&Co. and MLPF&S do not assume any responsibility for the accuracy or
completeness of such information.
UNITED STATES FEDERAL INCOME TAXATION
The following discussion is based upon the opinion of Sidley Austin
Brown & Wood LLP, counsel to ML&Co. ("Tax Counsel"). As the law applicable to
the U.S. Federal income taxation of instruments such as the Notes is technical
and complex, the discussion below necessarily represents only a general
summary. The following summary is based upon laws, regulations, rulings and
decisions now in effect, all of which are subject to change (including changes
in effective dates) or possible differing interpretations. It deals only with
Notes held as capital assets and does not purport to deal with persons in
special tax situations, such as financial institutions, insurance companies,
regulated investment companies, dealers in securities or currencies, persons
holding Notes as a hedge against currency risks, as a position in a "straddle"
or as part of a "hedging" or "conversion" transaction for tax purposes, or
persons whose functional currency is not the United States dollar. It also
does not deal with holders other than original purchasers (except where
otherwise specifically noted). Persons considering the purchase of the Notes
should consult their own tax advisors concerning the application of U.S.
Federal income tax laws to their particular situations as well as any
consequences of the purchase, ownership and disposition of the Notes arising
under the laws of any other taxing jurisdiction.
PS-13
As used herein, the term "U.S. Holder" means a beneficial owner of a
Note that is for U.S. Federal income tax purposes (i) a citizen or resident of
the United States, (ii) a corporation or a partnership (including an entity
treated as a corporation or a partnership for U.S. Federal income tax
purposes) created or organized in or under the laws of the United States, any
state thereof or the District of Columbia (unless, in the case of a
partnership, Treasury regulations are adopted that provide otherwise), (iii)
an estate whose income is subject to U.S. Federal income tax regardless of its
source, (iv) a trust if a court within the United States is able to exercise
primary supervision over the administration of the trust and one or more
United States persons have the authority to control all substantial decisions
of the trust, or (v) any other person whose income or gain in respect of a
Note is effectively connected with the conduct of a United States trade or
business. Certain trusts not described in clause (iv) above in existence on
August 20, 1996 that elect to be treated as a United States person will also
be a U.S. Holder for purposes of the following discussion. As used herein, the
term "non-U.S. Holder" means a beneficial owner of a Note that is not a U.S.
Holder.
General
There are no statutory provisions, regulations, published rulings or
judicial decisions addressing or involving the characterization and treatment,
for U.S. Federal income tax purposes, of the Notes or securities with terms
substantially the same as the Notes. Accordingly, the proper U.S. Federal
income tax characterization and treatment of the Notes is uncertain. Pursuant
to the terms of the Notes, ML&Co. and every holder of a Note agree (in the
absence of an administrative determination or judicial ruling to the contrary)
to characterize a Note for all tax purposes as an investment unit consisting
of the following components (the "Components"): (i) a debt instrument of
ML&Co. (the "Debt Instrument") with a fixed principal amount unconditionally
payable on the maturity date equal to the principal amount of the Note and
bearing stated interest at the stated interest rate for the Notes (the
"Interest Rate") and (ii) a cash-settled forward contract linked to the value
of the Index (the "Forward Contract") pursuant to which the holder agrees to
use the principal payment due on the Debt Instrument to make a payment to
ML&Co. in exchange for the right to receive a cash payment at maturity based
upon the percentage change in the value of the Index, as described in this
pricing supplement. In the opinion of Tax Counsel, such characterization and
tax treatment of the Notes, although not the only reasonable characterization
and tax treatment, is based on reasonable interpretations of law currently in
effect and, even if successfully challenged by the Internal Revenue Service
(the "IRS"), will not result in the imposition of penalties. Furthermore,
based on ML&Co.'s determination of the relative fair market values of the
Components at the time of issuance of the Notes, ML&Co. will assign $ (i.e.,
%) of the initial issue price of the Notes to the Debt Instrument and will
assign $ (i.e., %) of the initial issue price of the Notes to the Forward
Contract. Based upon the foregoing, a U.S. Holder who acquires a Note in
connection with the original issuance thereof will be treated as having
purchased the Debt Instrument for $ and as having received an initial payment
(the "Initial Forward Contract Payment") with respect to the Forward Contract
in an amount equal to $ . The initial payment deemed to have been received by
a U.S. Holder with respect to the Forward Contract (i.e., the Initial Forward
Contract Payment) should only be taken into account by the U.S. Holder as an
additional amount realized with respect to the Forward Contract on the earlier
of the sale or other disposition of the Note by the U.S. Holder or at maturity
(which would increase the amount of gain or decrease the amount of loss, as
the case may be, recognized by the U.S. Holder at maturity or upon a sale or
exchange of the Note prior to maturity). ML&Co.'s allocation of the issue
price will be binding on a U.S. Holder of a Note, unless such U.S. Holder
timely and explicitly discloses to the IRS that its allocation is different
from ML&Co.'s allocation. The treatment of the Notes described above and
ML&Co.'s allocation are not, however, binding on the IRS or the courts. No
statutory, judicial or administrative authority directly addresses the
characterization of the Notes or instruments similar to the Notes for U.S.
Federal income tax purposes, and no ruling is being requested from the IRS
with respect to the Notes.
Due to the absence of authorities that directly address instruments
that are similar to the Notes, significant aspects of the U.S. Federal income
tax consequences of an investment in the Notes are not certain, and no
assurance can be given that the IRS or the courts will agree with the
characterization described above. Accordingly, prospective purchasers are
urged to consult their tax advisors regarding the U.S. Federal income tax
consequences of an investment in a Note (including alternative
characterizations of a Note) and with respect to any tax consequences arising
under the laws of any state, local or foreign taxing jurisdiction. Unless
otherwise stated, the following discussions are based on the assumption that
the treatment and the allocation described above are accepted for U.S. Federal
income tax purposes.
PS-14
Tax Treatment of a Note
Interest on the Debt Instrument. As described above, the Debt
Instrument is treated as bearing interest at a stated rate of % per
annum (i.e., the Interest Rate). A U.S. Holder will include "qualified stated
interest" equal to the stated interest on the Notes in income in accordance
with the U.S. Holder's regular method of accounting for U.S. Federal income
tax purposes (subject to the bond premium rules). Based on ML&Co.'s
determination and allocation set forth above, the U.S. Holder's tax basis in
the Debt Instrument will initially be % of the issue price.
Settlement of the Forward Contract. Upon the final settlement of the
Forward Contract on the maturity date, a U.S. Holder would be deemed to have
applied an amount (the "Forward Contract Payment Amount") equal to the
principal amount of the Debt Instrument less the Initial Forward Contract
Payment toward the receipt of the cash payment at maturity, and such U.S.
Holder should be required to recognize gain or loss with respect to the
Forward Contract to the extent that the amount of the cash payment received at
maturity differs from the Forward Contract Payment Amount. It is uncertain
whether any such gain or loss would be treated as ordinary income or loss or
capital gain or loss. Absent a future clarification in current law (by an
administrative determination or judicial ruling), where required, ML&Co.
intends to report any such gain or loss to the IRS in a manner consistent with
the treatment of such gain or loss as capital gain or loss. If such gain or
loss is treated as capital gain or loss, then any such gain or loss will
generally be long-term capital gain or loss, as the case may be, if the U.S.
Holder held the Note for more than one year at maturity. The deductibility of
capital losses is subject to certain limitations. Notwithstanding the
foregoing, any cash received at maturity that is attributable to accrued
interest on the Debt Instrument would be taxed as described under "Tax
Treatment of a Note--Interest on the Debt Instrument" above.
Sale or Exchange of a Note
Upon a sale or exchange of a Note prior to the maturity of the Notes,
a U.S. Holder would recognize taxable gain or loss equal to the difference
between the amount realized on such sale or exchange (as allocated among the
Components in accordance with their relative fair market values) and such U.S.
Holder's tax basis in the Components deemed so sold or exchanged. Any such
gain or loss would generally be long-term or short-term capital gain or loss
(depending on the U.S. Holder's holding period for the Note). For these
purposes, the amount realized does not include any amount attributable to
accrued interest on the Debt Instrument, which would be taxed as described
under "Tax Treatment of a Note--Interest on the Debt Instrument" above. As
discussed above, the deductibility of capital losses is subject to certain
limitations.
Premium
If a U.S. Holder purchases the Debt Instrument for an amount that is
greater than the sum of all amounts payable on the Debt Instrument after the
purchase date other than payments of qualified stated interest (i.e., the
principal amount), such U.S. Holder will be considered to have purchased the
Debt Instrument with "amortizable bond premium" equal in amount to such
excess. A U.S. Holder may elect to amortize such premium using a constant
yield method over the remaining term of the Debt Instrument and may offset
interest otherwise required to be included in respect of the Debt Instrument
during any taxable year by the amortized amount of such excess for the taxable
year. U.S. Holders are urged to consult their own tax advisors regarding the
application of these special rules. Any election to amortize bond premium
applies to all taxable debt instruments acquired by the U.S. Holder on or
after the first day of the first taxable year to which such election applies
and may be revoked only with the consent of the IRS.
Possible Alternative Tax Treatments of an Investment in a Note
Due to the absence of authorities that directly address the proper
characterization of the Notes, no assurance can be given that the IRS will
accept, or that a court will uphold, the characterization and tax treatment
described above. In particular, the IRS could seek to analyze the U.S. Federal
income tax consequences of owning a Note under Treasury regulations governing
contingent payment debt instruments (the "Contingent Payment Regulations").
ML&Co. will take the position that the Contingent Payment Regulations
do not apply to the Notes. If the IRS were successful in asserting that the
Contingent Payment Regulations applied to the Notes, the timing and character
of income thereon would be significantly affected. Among other things, a U.S.
Holder would be required
PS-15
to accrue as original issue discount, subject to the adjustments described
below, income at a "comparable yield" on the issue price, regardless of
the U.S. Holder's usual method of accounting for U.S. Federal income tax
purposes. In addition, the Contingent Payment Regulations require that a
projected payment schedule, which results in such a "comparable yield," be
determined, and that adjustments to income accruals be made to account for
differences between actual payments and projected amounts. Furthermore, any
gain realized with respect to a Note would generally be treated as ordinary
income, and any loss realized would generally be treated as ordinary loss to
the extent of the U.S. Holder's prior ordinary income inclusions (which were
not previously reversed) with respect to the Note.
Even if the Contingent Payment Regulations do not apply to the Notes,
other alternative U.S. Federal income tax characterizations or treatments of
the Notes are also possible, which may also affect the timing and the
character of the income or loss with respect to the Notes. Accordingly,
prospective purchasers are urged to consult their tax advisors regarding the
U.S. Federal income tax consequences of an investment in a Note.
Constructive Ownership Law
Section 1260 of the Internal Revenue Code of 1986, as amended (the
"Code") treats a taxpayer owning certain types of derivative positions in
property as having "constructive ownership" of that property, with the result
that all or a portion of any long-term capital gain recognized by such
taxpayer with respect to the derivative position will be recharacterized as
ordinary income. In its current form, Section 1260 of the Code does not apply
to a Note. If Section 1260 of the Code were to apply to a Note in the future,
however, the effect on a U.S. Holder of a Note would be to treat all or a
portion of any long-term capital gain recognized by such U.S. Holder on the
sale, exchange or maturity of a Note as ordinary income. In addition, Section
1260 of the Code would impose an interest charge on any such gain that was
recharacterized. U.S. Holders should consult their tax advisors regarding the
potential application of Section 1260 of the Code, if any, to the purchase,
ownership and disposition of a Note.
Non-U.S. Holders
In the case of a non-U.S. Holder, ML&Co. intends to withhold
applicable U.S. withholding taxes at a rate of 30% on payments of interest
made with respect to the Notes, subject to reduction by applicable treaty or
upon the receipt of a Form W-8ECI from a non-U.S. Holder claiming that the
payments are effectively connected with the conduct of a United States trade
or business. Any capital gain realized upon the sale or other disposition of a
Note by a non-U.S. Holder will generally not be subject to U.S. Federal income
tax if (i) such gain is not effectively connected with a United States trade
or business of such non-U.S. Holder and (ii) in the case of an individual
non-U.S. Holder, such individual is not present in the United States for 183
days or more in the taxable year of the sale or other disposition and such
individual does not have a "tax home" (as defined for U.S. Federal income tax
purposes) in the United States.
Backup Withholding and Information Reporting
A beneficial owner of a Note may be subject to information reporting
with respect to certain amounts paid to the beneficial owner. A beneficial
owner of a Note may also be subject to backup withholding at the applicable
statutory rate of U.S. Federal income tax on certain amounts paid to the
beneficial owner unless such beneficial owner provides proof of an applicable
exemption or a correct taxpayer identification number, and otherwise complies
with applicable requirements of the backup withholding rules.
Any amounts withheld under the backup withholding rules from a
payment to a beneficial owner would be allowed as a refund or a credit against
such beneficial owner's U.S. Federal income tax provided the required
information is furnished to the IRS.
ERISA CONSIDERATIONS
Each fiduciary of a pension, profit-sharing or other employee benefit
plan (a "plan") subject to the Employee Retirement Income Security Act of
1974, as amended ("ERISA"), should consider the fiduciary standards of ERISA
in the context of the plan's particular circumstances before authorizing an
investment in the Notes. Accordingly, among other factors, the fiduciary
should consider whether the investment would satisfy the prudence and
diversification requirements of ERISA and would be consistent with the
documents and instruments governing
PS-16
the plan, and whether the investment would involve a prohibited transaction
under Section 406 of ERISA or Section 4975 of the Internal Revenue Code
(the "Code").
Section 406 of ERISA and Section 4975 of the Code prohibit plans, as
well as individual retirement accounts and Keogh plans subject to Section 4975
of the Internal Revenue Code (also "plans") from engaging in certain
transactions involving "plan assets" with persons who are "parties in
interest" under ERISA or "disqualified persons" under the Code ("parties in
interest") with respect to the plan or account. A violation of these
prohibited transaction rules may result in civil penalties or other
liabilities under ERISA and/or an excise tax under Section 4975 of the Code
for those persons, unless exemptive relief is available under an applicable
statutory, regulatory or administrative exemption. Certain employee benefit
plans and arrangements including those that are governmental plans (as defined
in section 3(32) of ERISA), certain church plans (as defined in Section 3(33)
of ERISA) and foreign plans (as described in Section 4(b)(4) of ERISA)
("non-ERISA arrangements") are not subject to the requirements of ERISA or
Section 4975 of the Code but may be subject to similar provisions under
applicable federal, state, local, foreign or other regulations, rules or laws
("similar laws").
The acquisition of the Notes by a plan with respect to which we,
MLPF&S, or certain of our affiliates is or becomes a party in interest may
constitute or result in prohibited transaction under ERISA or Section 4975 of
the Code, unless those Notes are acquired pursuant to and in accordance with
an applicable exemption. The U.S. Department of Labor has issued five
prohibited transaction class exemptions, or "PTCEs", that may provide
exemptive relief if required for direct or indirect prohibited transactions
that may arise from the purchase or holding of the Notes. These exemptions
are:
(1) PTCE 84-14, an exemption for certain transactions determined or
effected by independent qualified professional asset managers;
(2) PTCE 90-1, an exemption for certain transactions involving
insurance company pooled separate accounts;
(3) PTCE 91-38, an exemption for certain transactions involving bank
collective investment funds;
(4) PTCE 95-60, an exemption for transactions involving certain
insurance company general accounts; and
(5) PTCE 96-23, an exemption for plan asset transactions managed by
in-house asset managers.
The Notes may not be purchased or held by (1) any plan, (2) any
entity whose underlying assets include "plan assets" by reason of any plan's
investment in the entity (a "plan asset entity") or (3) any person investing
"plan assets" of any plan, unless in each case the purchaser or holder is
eligible for the exemptive relief available under one or more of the PTCEs
listed above or another applicable similar exemption. Any purchaser or holder
of the Notes or any interest in the Notes will be deemed to have represented
by its purchase and holding of the Notes that it either (1) is not a plan or a
plan asset entity and is not purchasing those Notes on behalf of or with "plan
assets" of any plan or plan asset entity or (2) with respect to the purchase
or holding, is eligible for the exemptive relief available under any of the
PTCEs listed above or another applicable exemption. In addition, any purchaser
or holder of the Notes or any interest in the Notes which is a non-ERISA
arrangement will be deemed to have represented by its purchase and holding of
the Notes that its purchase and holding will not violate the provisions of any
similar law.
Due to the complexity of these rules and the penalties that may be
imposed upon persons involved in non-exempt prohibited transactions, it is
important that fiduciaries or other persons considering purchasing the Notes
on behalf of or with "plan assets" of any plan, plan asset entity or non-ERISA
arrangement consult with their counsel regarding the availability of exemptive
relief under any of the PTCEs listed above or any other applicable exemption,
or the potential consequences of any purchase or holding under similar laws,
as applicable.
PS-17
PLAN OF DISTRIBUTION
As described in the "The Plan of Distribution" in the attached
Prospectus Supplement, MLPF&S is purchasing the Notes, as principal, from
ML&Co., for resale to investors and other purchasers at the Issue Price set
forth on the cover of this Pricing Supplement. MLPF&S has advised ML&Co. that
it proposes initially to offer all or part of the Notes directly to the public
at the Issue Price set forth on the cover page of this Pricing Supplement and
to certain dealers at such prices less a concession not in excess of __% of
the principal amount of the Notes. After the initial public offering, the
public offering price and concession may be changed.