PROSPECTUS SUPPLEMENT P/R/O/C/E/E/D/S (SM)
- ---------------------
(To prospectus dated February 25, 2005)
[Logo Omitted]
21,878 Units
Merrill Lynch & Co., Inc.
PROtected Covered Call EnhancED Income NoteS(SM)
Linked to the Income Select 10 PROCEEDS Index
due May 12, 2010
(the "PROCEEDS(SM)")
$1,000 principal amount per unit
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The PROCEEDS: o The Reference Index is a composite
index that measures the
o The PROCEEDS are designed for performance of a strategy that
investors who are seeking allocates hypothetical funds
exposure to the level of the among three index components:
Income Select 10 PROCEEDS Index (i) "Basket Units"
(the "Reference Index"). representing the value of
hypothetical purchases of
o Variable quarterly interest certain stocks and sales of
payments may be paid, depending call options on those stocks
upon the performance of the in the "Income Select 10
Basket Units described below. Basket" using a "covered-call"
strategy, (ii) "Zero Coupon
o 100% principal protection on Bond Units" representing the
the maturity date. value of hypothetical zero
coupon bonds and (iii)
o Senior unsecured debt "Leverage Units" representing
securities of Merrill Lynch & the cost of hypothetical
Co., Inc. borrowed funds which may
increase allocations to the
o The PROCEEDS will not be listed Basket Units. The Reference
on any securities exchange. Index will be rebalanced
periodically pursuant to a
o The settlement date for the formula described in this
PROCEEDS is expected to be May prospectus supplement. This
5, 2005. rebalancing will reflect
changes in the performance of
Payment on the maturity date: the Basket Units, prevailing
interest rates and market
o On the maturity date, for each conditions, all as more fully
unit of the PROCEEDS you own, described in this prospectus
we will pay you an amount equal supplement. Your return on the
to the sum of the principal PROCEEDS will be reduced by
amount and a supplemental certain fees, deductions and
redemption amount (which may be charges described in this
zero) based on the percentage prospectus supplement.
increase, if any, in the level
of the Reference Index. o The stocks in the Income Select
10 Basket will be the ten
stocks in the Dow Jones
Industrial Average(SM) having the
highest dividend yield, as
determined by Merrill Lynch
International, as the
Calculation Agent, and
reconstituted on an annual
basis.
Investing in the PROCEEDS involves risks that are described in the
"Risk Factors" section beginning on page S-9 of this prospectus supplement.
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Per Unit Total
Public offering price....................................... $1,000.00 $21,878,000
Underwriting discount....................................... $30.00 $656,340
Proceeds, before expenses, to Merrill Lynch & Co., Inc...... $970.00 $21,221,660
Neither the Securities and Exchange Commission nor any state
securities commission has approved or disapproved of these securities or
determined if this prospectus supplement or the accompanying prospectus is
truthful or complete. Any representation to the contrary is a criminal
offense.
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Merrill Lynch & Co.
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The date of this prospectus supplement is May 2, 2005.
"PROtected Covered Call EnhancED Income NoteS" and "PROCEEDS" are service
marks of Merrill Lynch & Co., Inc. "Dow Jones", "Dow Jones Industrial
Average(SM)" and "DJIA(SM)" are service marks of Dow Jones & Company, Inc. and
have been licensed for use for certain purposes by Merrill Lynch, Pierce,
Fenner & Smith Incorporated. The PROCEEDS are not sponsored, endorsed, sold or
promoted by Dow Jones.
TABLE OF CONTENTS
Prospectus Supplement
Page
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SUMMARY INFORMATION-Q&A...................................................S-3
RISK FACTORS..............................................................S-9
RISK FACTORS RELATING TO THE PROCEEDS AND THE REFERENCE INDEX.............S-9
RISK FACTORS RELATING TO THE BASKET UNITS................................S-12
DESCRIPTION OF THE PROCEEDS..............................................S-15
FEES, DEDUCTIONS AND CHARGES.............................................S-19
THE INCOME SELECT 10 PROCEEDS INDEX......................................S-20
DESCRIPTION OF THE INCOME SELECT 10 BASKET...............................S-35
UNITED STATES FEDERAL INCOME TAXATION....................................S-43
ERISA CONSIDERATIONS.....................................................S-47
USE OF PROCEEDS AND HEDGING..............................................S-48
WHERE YOU CAN FIND MORE INFORMATION......................................S-49
UNDERWRITING.............................................................S-50
VALIDITY OF THE PROCEEDS.................................................S-50
EXPERTS ................................................................S-50
INDEX OF CERTAIN DEFINED TERMS...........................................S-51
Prospectus
Page
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MERRILL LYNCH & CO., INC...................................................2
USE OF PROCEEDS............................................................2
RATIO OF EARNINGS TO FIXED CHARGES AND RATIO
OF EARNINGS TO COMBINED FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS..........................................4
THE SECURITIES.............................................................4
DESCRIPTION OF DEBT SECURITIES.............................................5
DESCRIPTION OF DEBT WARRANTS..............................................14
DESCRIPTION OF CURRENCY WARRANTS..........................................16
DESCRIPTION OF INDEX WARRANTS.............................................17
DESCRIPTION OF PREFERRED STOCK............................................24
DESCRIPTION OF DEPOSITARY SHARES..........................................29
DESCRIPTION OF PREFERRED STOCK WARRANTS...................................32
DESCRIPTION OF COMMON STOCK...............................................35
DESCRIPTION OF COMMON STOCK WARRANTS......................................38
PLAN OF DISTRIBUTION......................................................41
WHERE YOU CAN FIND MORE INFORMATION.......................................41
INCORPORATION OF INFORMATION WE FILE WITH THE SEC.........................42
EXPERTS .................................................................44
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SUMMARY INFORMATION-Q&A
This summary includes questions and answers that highlight selected
information from this prospectus supplement and the accompanying prospectus to
help you understand the PROtected Covered Call EnhancED Income NoteS(SM) Linked
to the Income Select 10 PROCEEDS Index (the "Reference Index") due May 12,
2010. You should carefully read this prospectus supplement and the
accompanying prospectus to fully understand the terms of the PROCEEDS, the
Reference Index and the tax and other considerations that are important to you
in making a decision about whether to invest in the PROCEEDS. You should
carefully review the "Risk Factors" section, which highlights certain risks
associated with an investment in the PROCEEDS, to determine whether an
investment in the PROCEEDS is appropriate for you.
References in this prospectus supplement to "ML&Co.", "we", "us" and
"our" are to Merrill Lynch & Co., Inc. References to "MLPF&S" are to Merrill
Lynch, Pierce, Fenner & Smith Incorporated. References to "MLI" are to Merrill
Lynch International.
What are the PROCEEDS?
The PROCEEDS will be a series of senior debt securities issued by
ML&Co. and will not be secured by collateral. The PROCEEDS will rank equally
with all of our other unsecured and unsubordinated debt. The PROCEEDS will
mature on May 12, 2010. We cannot redeem the PROCEEDS at an earlier date. We
will make variable quarterly interest payments only under the circumstances
described in this prospectus supplement.
Each unit of the PROCEEDS represents $1,000 principal amount of
PROCEEDS. You may transfer the PROCEEDS only in whole units. You will not have
the right to receive physical certificates evidencing your ownership except
under limited circumstances. Instead, we will issue the PROCEEDS in the form
of a global certificate, which will be held by The Depository Trust Company
("DTC") or its nominee. Direct and indirect participants in DTC will record
your ownership of the PROCEEDS. You should refer to the section entitled
"Description of the Debt Securities--Depository" in the accompanying
prospectus.
Are there any risks associated with my investment?
Yes. An investment in the PROCEEDS is subject to risks, including the
risk that the PROCEEDS will only return their principal amount on the maturity
date, resulting in a substantial economic opportunity loss to you. Please
refer to the section entitled "Risk Factors" in this prospectus supplement.
Who publishes the Reference Index and what does the Reference Index measure?
The daily closing values of the Reference Index, the Basket Units and
the Zero Coupon Bond Units determined as of approximately 4:00 p.m. (New York
City time) will be published on each Business Day on Reuters Page MEREDUS15
(or any successor page for the purpose of displaying those closing values as
identified by MLI, as the Reference Index calculation agent (the "Calculation
Agent")).
The Reference Index is a composite index that will track the
performance of hypothetical investments in two assets, the Basket Units and
the Zero Coupon Bond Units, and one liability, the Leverage Units (each an
"Index Component," and together the "Index Components"). Generally, the level
of the Reference Index at any time will equal the sum of the values of the
Basket Units and the Zero Coupon Bond Units, less the value of Leverage Units
and reduced by a pro rata portion of the Index Adjustment Factor, as described
below. The level of the Reference Index was set to 97 on May 2, 2005, the date
the PROCEEDS were priced for initial sale to the public (the "Pricing Date").
The initial allocations of hypothetical funds to the Index Components
as set on the Pricing Date will be 84.74% in Basket Units, 15.26% in Zero
Coupon Bond Units and 0% in Leverage Units. We expect the allocations among
the Index Components to change upon an Allocation Determination Event, as
described in the section entitled "The Income Select 10 PROCEEDS Index" in
this prospectus supplement.
The formula will not allocate more than 150% of the hypothetical
funds to the Basket Units. The relative allocations among each Index Component
will be determined by the formula described herein and calculated by the
Calculation Agent.
The PROCEEDS are senior unsecured debt securities of ML&Co. An
investment in the PROCEEDS does not entitle you to any dividends, voting
rights, option premiums or any other ownership interest in the securities
included in the Reference Index.
What hypothetical investment does each Index Component track?
The Index Components are defined as follows:
A "Basket Unit" will track the value of an initial $100 hypothetical
investment in the Income Select 10 Basket. The "Income Select 10 Basket" is a
hypothetical investment in a "covered call" strategy in which (i) the Income
Select 10 Stocks are purchased and (ii) call options are sold, on a quarterly
basis for a three month term, on the Income Select 10 Stocks. The "Income
Select 10 Stocks"
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are the top ten dividend yielding stocks in the Dow Jones Industrial Average
(the "DJIA"), reconstituted annually, as determined by the Calculation Agent.
A "Zero Coupon Bond Unit" will track the value of a $100 face value
hypothetical investment in a hypothetical zero coupon bond maturing on the
scheduled Valuation Date, as described below, with a yield equal to the
applicable zero coupon yield based upon USD swap rates as published on
Bloomberg Page EDS. The applicable zero coupon yield will be estimated from
the USD swap rate yields corresponding to the published maturities closest in
time to the scheduled Valuation Date. The Calculation Agent may, when
necessary, estimate the applicable zero coupon yield by interpolating the
appropriate USD swap rate yields based on those published maturities. The Zero
Coupon Bond Units will not yield any return after the scheduled Valuation
Date.
A "Leverage Unit" will track the value of $1 of hypothetical
borrowings used to increase the exposure to the Basket Units. To the extent
that exposure to the Basket Units is leveraged (i.e., increased with borrowed
funds) through the use of Leverage Units, the number of Leverage Units will be
increased daily by an amount equal to the Daily Leverage Charge (see the
section entitled "Fees, Deductions and Charges--Direct Fees, Deductions and
Charges--Daily Leverage Charge" in this prospectus supplement). The Daily
Leverage Charge will reduce the level of the Reference Index.
What will I receive on the maturity date of the PROCEEDS?
We have designed the PROCEEDS for investors who want to protect their
investment by receiving at least the principal amount of their investment on
the maturity date and who also want to participate in possible periodic
interest payments and, to the extent provided herein, in possible increases in
the level of the Reference Index (after the deduction of certain fees,
deductions and charges). On the maturity date, you will receive a cash
payment, in addition to any interest payment due, on the PROCEEDS equal to the
sum of two amounts: the "principal amount" and the "Supplemental Redemption
Amount", if any.
Principal Amount
The "principal amount" per unit is $1,000.
Supplemental Redemption Amount
The "Supplemental Redemption Amount" per unit will equal:
( Ending Value - Threshold Value )
$1,000 x (---------------------------------)
( Threshold Value )
provided, however, that in no event will the Supplemental Redemption Amount be
less than zero.
The "Ending Value" will be determined by the Calculation Agent and
will equal the closing level of the Reference Index on the Valuation Date.
The "Threshold Value" equals 100.
The "Starting Value" was set to 97, the level of the Reference Index
on the Pricing Date.
The "Valuation Date" will be the seventh scheduled Index Business Day
before the maturity date, or an alternate date shortly thereafter as described
under the section entitled "Description of the PROCEEDS--Payment on the
maturity date" in this prospectus supplement.
Because the Starting Value was set to 97, which is less than the
Threshold Value, we will pay you a Supplemental Redemption Amount only if the
Ending Value is 3.1% greater than the Starting Value on the Valuation Date
(see the section entitled "Fees, Deductions and Charges--Implicit Sales
Charge" in this prospectus supplement). If the Ending Value is less than or
equal to the Threshold Value, the Supplemental Redemption Amount will be zero.
We will pay you the principal amount of your PROCEEDS regardless of whether
any Supplemental Redemption Amount is payable.
S-4
Examples
Here are three examples of Supplemental Redemption Amount
calculations:
Example 1--At the stated maturity, the Reference Index is below the Starting
Value:
Starting Value: 97
Threshold Value: 100
Hypothetical Ending Value: 90
( 90 - 100 ) (Supplemental
Supplemental Redemption Amount (per unit) = $1,000 x (----------) = $0 Redemption Amount
( 100 ) cannot be less
than zero)
Total payment on the maturity date (per unit) = $1,000 + $0 = $1,000
Example 2--At the stated maturity, the Reference Index is above the Starting
Value but below the Threshold Value:
Starting Value: 97
Threshold Value: 100
Hypothetical Ending Value: 99
( 99 - 100 ) (Supplemental
Supplemental Redemption Amount (per unit) = $1,000 x (----------) = $0 Redemption Amount
( 100 ) cannot be less
than zero)
Total payment on the maturity date (per unit) = $1,000 + $0 = $1,000
Example 3--At the stated maturity, the Reference Index is above the Threshold
Value:
Threshold Value: 100
Hypothetical Ending Value: 105
( 105 - 100 )
Supplemental Redemption Amount (per unit) = $1,000 x (-----------) = $5
( 100 )
Total payment on the maturity date (per unit) = $1,000 + $50.00 = $1,050.00
For more specific information about the Supplemental Redemption
Amount, please see the section entitled "Description of the PROCEEDS" in this
prospectus supplement.
Will I receive interest payments on the PROCEEDS?
The interest payable on the PROCEEDS will vary and may be zero. We
expect to pay interest, if any, in cash quarterly on the dates described under
the section entitled "Description of the PROCEEDS--Interest" in this
prospectus supplement.
The interest payments, if any, on the PROCEEDS will depend on the
hypothetical income of the Basket Units (the "Basket Unit Income") held in the
Reference Index over each quarterly calculation period and the level of the
Reference Index at the end of that period. The Basket Unit Income will be
based on the cash dividends in respect of the stocks in the Income Select 10
Basket and the value of premiums in respect of call options on those stocks.
See the section entitled "Description of the Income Select 10
Basket--Calculation of the Value of the Income Select 10 Basket" in this
prospectus supplement. If the level of the Reference Index (less any Basket
Unit Income) falls below certain thresholds relative to the Floor Level
described in this prospectus supplement during any quarterly calculation
period, you will not receive any interest payment for that quarterly
calculation period and, in certain circumstances, you will not receive any
interest payments for the remaining term of the PROCEEDS. See the section
entitled "Description of the PROCEEDS--Interest" in this prospectus
supplement.
S-5
What are the costs associated with an investment in the PROCEEDS?
Your return on the PROCEEDS will reflect the deduction of the
following costs over the term of the PROCEEDS:
Index Adjustment Factor: The level of the Reference Index will reflect a 1.5%
per annum reduction (the "Index Adjustment Factor") that will be applied and
accrue daily on the basis of a 365-day year from the date the PROCEEDS are
issued to the public through the Valuation Date. The Index Adjustment Factor
will accrue to the benefit of the Calculation Agent and the Distributor (as
defined herein) as described herein. The Index Adjustment Factor will remain
at 1.5% per annum for so long as any hypothetical funds are allocated to
Basket Units. If at any time that allocation is zero, the Index Adjustment
Factor will not apply.
Daily Leverage Charge: To the extent that the hypothetical investment in the
Basket Units is leveraged (i.e., increased with hypothetical borrowed funds)
through the use of Leverage Units, the number of Leverage Units will be
increased daily by an amount equal to the interest expense deemed to have been
incurred on those funds (the "Daily Leverage Charge"). The Daily Leverage
Charge will equal the number of Leverage Units outstanding on the applicable
day multiplied by the Federal Funds rate on the applicable day plus .5%,
divided by 360. This deemed interest expense will reduce the level of the
Reference Index on each day that the Reference Index includes Leverage Units.
Implicit sales charge: An implicit sales charge is paid to MLPF&S upon the
purchase of the PROCEEDS because the Starting Value was set to 97, while the
Threshold Value will equal 100. In order for you to receive a Supplemental
Redemption Amount on the maturity date, the Ending Value must exceed 100 on
the Valuation Date. Therefore, the level of the Reference Index must increase
by more than 3.1% for you to receive an amount in excess of $1,000 principal
amount per unit of the PROCEEDS. This is analogous to paying an up front sales
charge of 3% per unit of the PROCEEDS.
Basket Adjustment Factor: The value of the Income Select 10 Basket will
reflect a 0.75% per annum annual reduction (the "Basket Adjustment Factor")
that will be applied and accrue daily based on the value of the Income Select
10 Basket at the end of the previous day on the basis of a 365-day year and
will be subtracted from the Basket Unit Income on the Income Select 10 Basket
at the end of each day prior to effecting any reallocation that day. The value
of the Basket Adjustment Factor for any quarterly calculation period will not
exceed the value of the Basket Unit Income on the Income Select 10 Basket for
that quarterly calculation period. The Basket Adjustment Factor will accrue to
the benefit of the Calculation Agent and the Distributor as described herein.
Because the value of the Income Select 10 Basket reflects the reduction of the
Basket Adjustment Factor, the return on an investment in the "covered call"
strategy (as described in the section entitled "Description of the Income
Select 10 Basket" in this prospectus supplement) represented by the Income
Select 10 Basket, and therefore the Reference Index and the PROCEEDS, will be
less than a return on a "covered call" strategy on the Income Select 10 Basket
that did not include the Basket Adjustment Factor.
What does the Reference Index rebalancing "formula" do and when will the
Reference Index undergo reallocations among the Index Components?
The Reference Index rebalancing formula (the "formula") determines
the allocation of the hypothetical funds tracked by the Reference Index to the
Basket Units (the "Targeted Exposure"), and the consequent allocations to the
Zero Coupon Bond Units and the Leverage Units. The formula will cause these
allocations to vary over the term of the PROCEEDS in order to participate in
any appreciation of the Basket Units, but only to the extent consistent with
the objective that the Reference Index level on the scheduled Valuation Date
is at least 100.
An "Allocation Determination Event" will occur and a reallocation
will be effected if the absolute value of the difference in (i) the closing
value of the Basket Units in the Reference Index divided by the closing level
of the Reference Index on any Index Business Day and (ii) the Targeted
Exposure, is greater than 5% of the Targeted Exposure. In addition, if at any
time during any Index Business Day the closing level of the DJIA has declined
from its closing level on the previous Index Business Day by 10% or more, an
Allocation Determination Event will have been deemed to have occurred.
In general, the Targeted Exposure may increase following increases in
the value of the Basket Units or decreases in the Floor Level (due to interest
rate increases). Using Leverage Units, the Targeted Exposure may equal up to
150%. In general, the Targeted Exposure may decrease following decreases in
the value of the Basket Units or increases in the Floor Level (due to interest
rate decreases).
In some circumstances, the amount of the hypothetical funds tracked
by the Reference Index allocated to the Basket Units may be reduced to zero,
which will result in the hypothetical funds allocated to the Basket Units
remaining at zero for the remaining term of the PROCEEDS. You should refer to
the section entitled "Risk Factors--Risk Factors Relating to the PROCEEDS and
the Reference Index--Less than 100%, and possibly none, of the hypothetical
funds tracked by the Reference Index may be allocated to the Basket Units" in
this prospectus supplement.
For a detailed description of the formula and the Targeted Exposure,
see the section entitled "The Income Select 10 PROCEEDS Index--Reallocation of
the hypothetical funds tracked by the Reference Index" in this prospectus
supplement.
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When would the formula allocate none of the hypothetical funds to the Basket
Units, and what happens in that event?
If the "Cushion", a ratio which reflects the level of the Reference
Index relative to the value of the Floor Level, is less than 1% on any
Business Day (a "Defeasance Event"), the formula will not allocate any
hypothetical funds to the Basket Units. The "Floor Level" for any date will
equal the value of a $100 face value hypothetical zero coupon bond maturing on
the scheduled Valuation Date with a yield equal to the applicable zero coupon
yield based upon USD swap rates, plus the Fee Protection Factor (as described
under the section entitled "The Income Select 10 PROCEEDS Index--Reallocation
of hypothetical funds tracked by the Reference Index--Allocation Determination
Events" in this prospectus supplement), if any.
Because the amount of the interest payments on the PROCEEDS will
depend on the performance of the Basket Units in the Reference Index, no
interest will be paid for the remaining term of the PROCEEDS after the
occurrence of a Defeasance Event. In addition, the Reference Index will not
participate in any subsequent increase in the value of the Basket Units and
your payment on the maturity date will be limited to the $1,000 principal
amount per unit (except as described under the section entitled "The Income
Select 10 PROCEEDS Index--Defeasance Events" in this prospectus supplement).
This means that, while a holder of hypothetical Basket Units would benefit
from a subsequent increase in the value of the Basket Units, a holder of
PROCEEDS would not.
What is "leveraging" and how are the Leverage Units used?
The Leverage Units represent a hypothetical borrowing that permits
the Targeted Exposure to exceed 100%, subject to a maximum of 150%. When
required by the formula, the Calculation Agent will use Leverage Units to
increase the allocation of hypothetical funds to the Basket Units above 100%.
The use of hypothetical borrowed funds will increase the Reference Index's
exposure to movements in the value of the Basket Units and will therefore make
the Reference Index more volatile than the Income Select 10 Basket.
Accordingly, if the value of the Basket Units increases when Leverage Units
are outstanding, the level of the Reference Index may increase by a greater
amount than will the value of the Income Select 10 Basket. Conversely, if the
value of the Basket Units decreases when Leverage Units are outstanding, the
level of the Reference Index may decrease by a greater amount than will the
value of the Income Select 10 Basket. For risks associated with the use of
hypothetical borrowed funds, see the section entitled "Risk Factors--Risk
Factors Relating to the PROCEEDS and the Reference Index--The use of leverage
may adversely affect the Supplemental Redemption Amount" in this prospectus
supplement.
How has the Reference Index performed historically?
The Reference Index did not exist until the Pricing Date. However, we
have included tables and graphs showing the hypothetical month-end closing
level of the Index during six different five year periods beginning April 30,
1994, 1995, 1996, 1997, 1998 and 1999. These hypothetical closing levels have
been calculated on the same basis that the Reference Index will be calculated,
assuming the Reference Index was created on the first day of each five year
period with a level of 97. However, the calculations used to determine these
levels contain assumptions and necessary estimates and approximations that
will not be reflected in the calculation of the level of the Reference Index
and interest payments over the term of the PROCEEDS. For further details on
the calculation of these hypothetical values, please refer to the section
entitled "The Income Select 10 PROCEEDS Index--Hypothetical Historical Data on
the Reference Index" in this prospectus supplement. Any historical upward or
downward trend in the levels of the Reference Index during the periods
presented is not an indication that the Reference Index is more or less likely
to increase or decrease at any time during the term of the PROCEEDS.
What are the Income Select 10 Stocks and how are the Income Select 10 Stocks
determined?
The Income Select 10 Stocks are the top ten dividend yielding stocks
in the DJIA with the highest annualized dividend yields, as determined by the
Calculation Agent. The Income Select 10 Stocks were originally determined on
April 28, 2005. The Income Select 10 Basket will be reconstituted on April
30th of each year or, under certain circumstances, on a day shortly after the
anniversary date, as described in this prospectus supplement. For more
specific information about the Income Select 10 Basket and its reconstitution,
see the section entitled "Description of the Income Select 10
Basket--Determination of the Income Select 10 Stocks" in this prospectus
supplement.
The PROCEEDS are senior unsecured debt obligations of ML&Co. and an
investment in the PROCEEDS does not entitle you to any ownership interest in
the Income Select 10 Stocks.
What is the "Income Select 10 Basket" and what does it measure?
The Income Select 10 Basket is designed to track the performance of a
hypothetical "covered call" strategy for the Income Select 10 Stocks. A
"covered call" strategy on a portfolio is an investment strategy in which an
investor:
o buys stocks; and
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o sells call options on the stocks with exercise prices higher
than the prices of the stocks when the options are priced.
A "covered call" strategy provides income from option premiums, or
the value of the option when it is priced, helping to offset losses if there
is a decline in the prices of the stocks to which the options relate. However,
the strategy limits participation in the appreciation of a stock beyond the
option's exercise price. Thus, in a period of significant stock market
increases, a "covered call" strategy will tend to produce lower returns than
ownership of the related stock. See the section entitled "Risk Factors--Risk
Factors Relating to the Basket Units--The appreciation of the Income Select 10
Basket will be capped due to the `covered call' strategy" in this prospectus
supplement.
The value of the Income Select 10 Basket is based on hypothetical
purchases of the Income Select 10 Stocks, including dividends on those stocks,
and hypothetical premiums on call options sold on each of those stocks, as
reduced by a pro rata portion of the Basket Adjustment Factor.
An investment in the PROCEEDS does not entitle you to any dividends,
voting rights, option premiums or any other ownership interest in respect of
the securities included in the Income Select 10 Basket.
How will the Calculation Agent determine the value of hypothetical call
options included in the Income Select 10 Basket?
The mark-to-market value of each hypothetical call option will be
determined by the Calculation Agent in accordance with an option pricing
formula and using prevailing market parameters as described in the section
entitled "Description of the Income Select 10 Basket--Hypothetical Call
Options--Valuation of Hypothetical Call Options" in this prospectus
supplement.
What about taxes?
Each year, you will be required to pay taxes on ordinary income from
the PROCEEDS over their term based upon an estimated yield for the PROCEEDS,
even though you may not receive any variable quarterly interest payments or
any other cash payments from us prior to the maturity date. We have determined
this estimated yield, in accordance with regulations issued by the U.S.
Treasury Department, solely in order for you to calculate the amount of taxes
that you will owe each year as a result of owning a PROCEEDS. This estimated
yield is neither a prediction nor a guarantee of what either the actual
variable quarterly interest payments or the actual Supplemental Redemption
Amount will be, or that either the actual variable quarterly interest payments
or the actual Supplemental Redemption Amount will even exceed zero. We have
determined that this estimated yield will equal 4.22% per annum, compounded
quarterly.
For further information, see the section entitled "United States
Federal Income Taxation" in this prospectus supplement.
Will the PROCEEDS be listed on a stock exchange?
The PROCEEDS will not be listed on any securities exchange and we do
not expect a trading market for the PROCEEDS to develop, which may affect the
price you receive for your PROCEEDS upon any sale prior to the maturity date.
You should review the section entitled "Risk Factors--A trading market for the
PROCEEDS is not expected to develop" in this prospectus supplement.
What is the role of MLPF&S?
Our subsidiary MLPF&S is the underwriter for the offering and sale of
the PROCEEDS. MLPF&S intends to offer the PROCEEDS to Wells Fargo Investments,
LLC or one of its affiliates, as the dealer in the initial distribution of the
PROCEEDS (the "Distributor").
After the initial offering, MLPF&S currently intends to buy and sell
the PROCEEDS to create a secondary market for holders of the PROCEEDS, and may
stabilize or maintain the market price of the PROCEEDS during the initial
distribution of the PROCEEDS. However, MLPF&S will not be obligated to engage
in any of these market activities or continue them once it has started.
What is the role of Merrill Lynch International?
MLI, as Calculation Agent, will be our agent for purposes of
determining, among other things, the level of the Reference Index, the value
of the Basket Units and the call options, the occurrence of an Allocation
Determination Event, any reallocations of the hypothetical funds tracked by
the Reference Index, the Ending Value and the Supplemental Redemption Amount.
Under certain circumstances, MLI as Calculation Agent and its other business
activities or its affiliation with ML&Co. could give rise to conflicts of
interest. MLI is required to carry out its duties as Calculation Agent in good
faith and using its reasonable judgment.
Who is ML&Co.?
Merrill Lynch & Co., Inc. is a holding company with various
subsidiary and affiliated companies that provide investment, financing,
insurance and related services on a global basis. For information about ML&Co.
see the section entitled "Merrill Lynch & Co., Inc." in the accompanying
prospectus. You should also read the other documents we have filed with the
Securities and Exchange Commission (the "SEC"), which you can find by
referring to the section entitled "Where You Can Find More Information" in
this prospectus supplement.
S-8
RISK FACTORS
Investment in the PROCEEDS involves risks, which include, but are not
limited to, the risks referred to below. The level of the Reference Index may
decrease as well as increase. If you receive only the principal amount of the
PROCEEDS on the maturity date, you will have incurred a significant loss of
opportunity to otherwise profit from the amount invested. In addition, the
PROCEEDS are illiquid and if you sell your PROCEEDS prior to the maturity
date, your sale price may be substantially less than the principal amount of
the PROCEEDS.
You should consult your financial and legal advisors concerning risks
associated with an investment in the PROCEEDS and the suitability of investing
in the PROCEEDS in light of your particular circumstances. In addition, you
should consult your tax advisors concerning the characterization of the
PROCEEDS as contingent payment debt instruments for United States federal
income tax purposes.
RISK FACTORS RELATING TO THE PROCEEDS AND THE REFERENCE INDEX
Less than 100%, and possibly none, of the hypothetical funds tracked by the
Reference Index may be allocated to the Basket Units
The formula that determines the Index Component allocations is
designed so that the level of the Reference Index should equal at least 100 on
the scheduled Valuation Date, even upon the occurrence of a Defeasance Event.
The formula will allocate the hypothetical funds to the Basket Units, but only
to the extent consistent with the objective that the Reference Index level on
the scheduled Valuation Date equal at least 100. Certain economic or market
factors, such as low interest rates or insufficient gains by the Basket Units
to offset the costs embedded in the Reference Index, will cause the allocation
in the Zero Coupon Bond Units to be increased.
Any allocation of the hypothetical funds to Zero Coupon Bond Units
will reduce the probability that the Reference Index will reflect any
increases in the value of the Basket Units, which is the primary Index
Component likely to result in appreciation in the Reference Index level. If
the Reference Index level does not exceed 100 on the Valuation Date, the
PROCEEDS will only return their principal amount on the maturity date, and you
will have incurred substantial economic opportunity losses. Initially, 15.26%
of the hypothetical funds will be allocated to the Zero Coupon Bond Units.
The performance of the Basket Units may exceed the performance of the
Reference Index
The Calculation Agent will adjust the allocations of hypothetical
funds among the Index Components systematically using the formula.
Accordingly, the performance of the Reference Index will likely differ
significantly from the performance of each of the Index Components.
Initially, 15.26% of the hypothetical funds tracked by the Reference
Index will be allocated to the Zero Coupon Bond Units. However, the percentage
of hypothetical funds represented by Zero Coupon Bond Units may increase or
decrease during the term of the PROCEEDS, depending upon the performance of
the Basket Units, the effect of any Leverage Units and the then-current
interest rate environment. Changes in economic conditions may cause a change
in the allocations of hypothetical funds among the Index Components as
determined by the formula. The timing of any rebalancing, and the magnitude of
the reallocations, may result in less than full participation in the
increases, if any, in the value of the Basket Units, which would in turn
affect the level of the Reference Index, and as a result the Supplemental
Redemption Amount.
Because the formula is designed so that the level of the Reference
Index should equal at least 100 on the scheduled Valuation Date, the
allocation of hypothetical funds to the Zero Coupon Bond Units may increase
during the term of the PROCEEDS depending upon the performance of the Basket
Units and interest rates. Should the allocation to the Basket Units be reduced
to zero, that allocation will remain at zero for the remaining term of the
PROCEEDS and your payment on the maturity date will be limited to the $1,000
principal amount per unit. This means that, while a holder of Basket Units
would benefit from a subsequent increase in the value of the Basket Units, a
holder of PROCEEDS would not.
The level of the Reference Index will not increase or decrease
directly in proportion with increases or decreases in the value of the Basket
Units due to the allocation of the Reference Index's hypothetical funds to
other Index Components. The Basket Units may increase in value substantially
over the duration of the PROCEEDS, but the Supplemental Redemption Amount of
the PROCEEDS may reflect little, if any, of that increase. The Supplemental
Redemption Amount of the PROCEEDS may represent a yield less than the yield
you would earn if you invested directly in the Basket Units or their
equivalent or in the Zero Coupon Bond Units or their equivalent.
S-9
Certain other similar investments offered by our affiliates have lost all
potential for appreciation
Our affiliates have offered indexed investments based upon
rebalancing formulas similar to the PROCEEDS, certain of which have, in fact,
terminated all exposure to the instruments equivalent to the Basket Units,
which has resulted in a loss of the opportunity to profit from the amount
invested.
The use of leverage may adversely affect the Supplemental Redemption Amount
The Targeted Exposure may be as much as 150% pursuant to the formula.
Exposure above 100% would reflect the use of leverage, as represented by the
allocation to Leverage Units. This leverage offers the potential for increases
in the level of the Reference Index greater than any corresponding increase in
the value of the Basket Units, but also entails a high degree of risk,
including the risk of decreases in the level of the Reference Index greater
than any corresponding decrease in the value of the Basket Units. In addition,
the deemed interest expense associated with the allocation to Leverage Units
will reduce the level of the Reference Index daily, which will result in a
reduction in the Ending Value.
Reference Index rebalancing procedures may adversely impact the Supplemental
Redemption Amount
The Reference Index tracks the performance of a hypothetical
investment in the Index Components whose allocations of hypothetical funds
will be rebalanced from time to time according to the rebalancing procedures
described in this prospectus supplement. The timing and magnitude of any
change in the allocations among the Index Components will be based on certain
threshold values used in the formula as described herein. For example, under
the rebalancing procedures, we expect the allocation to the Basket Units to
increase as the level of the Reference Index increases or the Floor Level
decreases and to decrease as the level of the Reference Index decreases or the
Floor Level increases. This may expose the Reference Index to a higher risk of
decreases (and a higher possibility of increases) if, for example, the
Leverage Units are used to obtain more exposure to the Basket Units. In
addition, certain market conditions, such as high volatility of the Basket
Units or low interest rates, may result in larger reallocations among the
Index Components. The timing and frequency of the reallocations among the
Index Components may affect the level of the Reference Index on the Valuation
Date, which in turn could affect the Supplemental Redemption Amount.
Fees, deductions and charges will reduce the Supplemental Redemption Amount
Your return on the PROCEEDS will reflect the deduction of certain
fees, deductions and charges. These fees, deductions and charges include
explicit charges that will be reflected in the level of the Reference Index
over the term of the PROCEEDS, namely the Index Adjustment Factor and the
Daily Leverage Charge. See the section entitled "Fees, Deductions and Charges"
in this prospectus supplement. Also, there is an implicit sales charge paid
upon the purchase of the PROCEEDS because the Starting Value was set below the
Threshold Value on the Pricing Date. See the section entitled "Fees,
Deductions and Charges--Implicit Sales Charge" in this prospectus supplement.
In addition, the value of the Income Select 10 Basket will reflect the
reduction of the Basket Adjustment Factor which, if the Reference Index
includes Basket Units, will reduce the level of the Reference Index over the
term of the PROCEEDS by reducing the value of the Basket Units. See the
section entitled "Fees, Deductions and Charges" in this prospectus supplement.
The net effect of these fees, deductions and charges will be to decrease the
level of the Reference Index on the Valuation Date, thereby reducing the
Ending Value. Accordingly, the Supplemental Redemption Amount payable to you
on the maturity date will be less than it would have been absent these fees,
deductions and charges.
Potential conflicts of interest may arise
We may face possible conflicts of interest in connection with our
obligations under the PROCEEDS. We may presently, or from time to time, engage
in investment banking and other activities for or provide services to the
Income Select 10 Companies (as defined herein) or trade in the Income Select
10 Stocks for its own account or for the account of others. In particular,
potential investors should note that our affiliates may execute transactions
on behalf of Income Select 10 Companies regularly in various capacities, and
may extend loans or act in an advisory capacity. All of these activities may
result in conflicts of interest with respect to the financial interests of our
affiliates and your financial interests.
The Calculation Agent is responsible for the calculation of the
Reference Index pursuant to the formula. While the application of the formula
is largely objective, there are certain situations where the Calculation Agent
will exercise judgment in its capacity as the Calculation Agent. The
Calculation Agent will also be responsible for calculating the value of the
Basket Units.
The Calculation Agent for the PROCEEDS is MLI, our affiliate. Under
certain circumstances, MLI as our subsidiary and its responsibilities as
Calculation Agent for the PROCEEDS could give rise to conflicts of interest.
MLI is required to carry
S-10
out its duties as calculation agent in good faith and using its reasonable
judgment. However, you should be aware that because we control MLI, potential
conflicts of interest could arise.
We have entered into an arrangement with MLI to hedge the market
risks associated with our obligations in connection with the PROCEEDS. This
subsidiary expects to make a profit in connection with this arrangement. We
did not seek competitive bids for this arrangement from unaffiliated parties.
The level of the Reference Index on the Valuation Date must be more than 3.1%
higher than the Starting Value for you to receive a Supplemental Redemption
Amount on the maturity date
The Starting Value was set to 97 on the Pricing Date. As a result,
the level of the Reference Index must increase by more than 3.1% as of the
Valuation Date in order for you to receive a Supplemental Redemption Amount.
If the level of the Reference Index declines, or does not increase
sufficiently, you will receive only the principal amount of your investment,
in addition to any interest payment due, on the maturity date, which could
represent a significant loss of opportunity to otherwise profit from the
amount invested in the PROCEEDS.
The interest payable on the PROCEEDS, if any, will vary
The interest payments, if any, on the PROCEEDS will depend on the
Basket Unit Income held in the Reference Index over each quarterly calculation
period and the level of the Reference Index at the end of that period. If the
level of the Reference Index (less any Basket Unit Income) falls below certain
thresholds relative to the Floor Level described in this prospectus supplement
during any quarterly calculation period (except the last quarterly calculation
period before the maturity date), you will not receive any interest payment
for that quarterly calculation period and, in certain circumstances, you will
not receive any interest payments for the remaining term of the PROCEEDS. See
the section entitled "Description of the PROCEEDS--Interest" in this
prospectus supplement.
The yield on the PROCEEDS may be lower than the yield on other debt securities
of comparable maturity
Even if payment on the PROCEEDS on the maturity date exceeds the
principal amount of the PROCEEDS, such payment may represent a yield less than
the yield an investor would have earned if the investor had bought a
traditional interest bearing debt security of ML&Co. with the same stated
maturity date.
A trading market for the PROCEEDS is not expected to develop
The PROCEEDS will not be listed on any securities exchange and we do
not expect a trading market for the PROCEEDS to develop. Although our
affiliate MLPF&S has indicated that it expects to bid for PROCEEDS offered for
sale to it by holders of the PROCEEDS, it is not required to do so and may
cease making such bids at any time. The limited trading market for your
PROCEEDS may affect the price that you receive for your PROCEEDS if you do not
wish to hold your investment until maturity.
Ownership of the PROCEEDS does not entitle you to any rights with respect to
any securities tracked by the Index Components
You will not own or have any beneficial or other legal interest in,
and will not be entitled to any rights with respect to, any of the Index
Components or Income Select 10 Stocks.
Changes in our credit ratings may affect the value of the PROCEEDS
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 trading value of the PROCEEDS. However, because your return on
the PROCEEDS is dependent upon factors in addition to our ability to pay our
obligations under the PROCEEDS, such as the percentage increase, if any, in
the level of the Reference Index on the maturity date, an improvement in our
credit ratings will not reduce the other investment risks related to the
PROCEEDS.
An investment in the PROCEEDS will have tax consequences
You should consider the tax consequences of investing in the
PROCEEDS. See the section entitled "United States Federal Income Taxation" in
this prospectus supplement.
S-11
RISK FACTORS RELATING TO THE BASKET UNITS
Volatility of the markets may adversely affect the value of the Basket Units
Movements in the value of the Income Select 10 Stocks and the
relevant options in the Income Select 10 Basket tracked by the Basket Units
may be volatile from month to month. High volatility of the Basket Units will
increase the likelihood of larger allocation changes among the Index
Components upon an Allocation Determination Event (as described in the section
entitled "The Income Select 10 PROCEEDS Index--Reallocation of the
Hypothetical Funds tracked by the Reference Index--Allocation Determination
Events" in this prospectus supplement). A rebalancing may result in
reallocation from the Basket Units to the Zero Coupon Bond Units, thus
reducing or eliminating the possibility of future increases in the level of
the Reference Index. A rebalancing may also result in selling Basket Units at
a time when prices for those sales are unfavorable due to prevailing market
conditions.
There may be delays between the determination of an Allocation Determination
Event and reallocation of hypothetical funds which could affect the level of
the Reference Index
The Calculation Agent will determine whether an Allocation
Determination Event has occurred and, if so, the Targeted Exposure at the
beginning of an Index Business Day based on the values of the Reference Index,
the Basket Units and the Cushion at the close of business on the previous
Index Business Day, but any necessary reallocation will be effected at the
close of business on the Index Business Day on which the occurrence of the
Allocation Determination Event is determined. As a result:
o the Calculation Agent may determine that an Allocation
Determination Event has occurred even if the values of the
Reference Index, the Income Select 10 Basket and the Floor Level
at the time the reallocation is effected would not result in an
Allocation Determination Event;
o the Reference Index will not participate in as fully any
appreciation of the Basket Units that occurs between the
determination of the occurrence of an Allocation Determination
Event and the resulting reallocation as it would if a
reallocation were effected immediately following determination
of the Targeted Exposure; and
o the Calculation Agent may effect a greater or lesser allocation
of the Basket Units than otherwise would be required if the
occurrence of an Allocation Determination Event were determined
by the Calculation Agent at the end of that Index Business Day.
The valuation of hypothetical call options for purposes of determining the
occurrence of an Allocation Determination Event will be different than the
valuation of hypothetical call options for purposes of effecting a
reallocation
For purposes of determining the occurrence of an Allocation
Determination Event, the value of hypothetical call options in the Income
Select 10 Basket will be determined using mid-market implied volatility (or
the arithmetic mean of bid-side and offered-side implied volatility). However,
reallocations will be effected through:
o deemed purchases of Basket Units at prices that reflect the
value of call options determined using bid-side implied
volatility, which will result in Basket Units being purchased at
a higher price than will be subsequently reflected in the level
of the Reference Index; and
o deemed sales of Basket Units at prices that reflect the value of
call options determined using offered-side implied volatility,
which will result in Basket Units being sold at a price lower
than was previously reflected in the level of the Reference
Index.
As a result, the level of the Reference Index will be reduced following each
reallocation. See the section entitled "Description of the Income Select 10
Basket--Hypothetical Call Options--Valuation of Call Options" in this
prospectus supplement.
The appreciation of the Income Select 10 Basket will be capped due to the
"covered call" strategy
Because the exercise price of each hypothetical call option limits
the portion of any appreciation in the value of each Income Select 10 Stock to
the amount by which the exercise price exceeds the price of the related stock
at the time the call option is priced, the Income Select 10 Basket will not
participate as fully in the appreciation of the Income Select 10 Stocks as
would a direct investment in those stocks. If the value of a Income Select 10
Stock increases by an amount greater than the amount by which the exercise
price exceeds the price of that stock at the time the call option is priced,
the value of the Income Select 10 Basket will be less than it would be if it
reflected a direct investment in that stock.
S-12
The use of Basket Unit Income to make interest payments will reduce the value
of the Basket Units at the end of each quarterly calculation period and may
cause an Allocation Determination Event
The value of Basket Unit Income will be removed from the value of the
Income Select 10 Basket on the last day of each quarterly calculation period.
The deduction of the value of the Basket Unit Income will reduce the value of
the Basket Units and may cause an Allocation Determination Event in which the
allocation of the hypothetical funds to the Basket Units is reduced, even if
the prices of any of the Income Select 10 Stocks have not fallen. This
Allocation Determination Event may reduce the allocation of the Reference
Index to the Basket Units, possibly to zero, in which case it would remain at
zero for the remaining term of the PROCEEDS. See the section entitled "--Risk
Factors Relating to the PROCEEDS and the Reference Index--Less than 100%, and
possibly none, of the hypothetical funds may be allocated to the Basket Units"
above.
The ability of the Calculation Agent to effect a reallocation upon a 10%
decline in the value of the DJIA may not prevent significant losses in the
value of the Basket Units
If at any point during an Index Business Day the value of the DJIA
declines from its closing value on the previous Index Business Day by 10% or
more, the Calculation Agent, as soon as reasonably practicable, will determine
the Targeted Exposure and reallocate among the Index Components so that the
percentage of the Reference Index hypothetically invested in the Basket Units
is as close as is reasonably practicable to the Targeted Exposure. However,
the ability of the Calculation Agent to effect this reallocation may not
prevent losses in the value of the Basket Units because of potential delays in
effecting the reallocation pursuant to the formula under the market conditions
at that time.
In addition, the Income Select 10 Basket does not include all of the
stocks in the DJIA. As a result, the Income Select 10 Basket (and therefore
the Basket Units) may decline at a faster rate than the DJIA, resulting in a
decline in the value of the Basket Units in excess of 10% before the
implementation of a reallocation during that Index Business Day. In addition,
the value of the Basket Units may decline by more than 10% during an Index
Business Day even though the DJIA does not decline by 10% or more during that
day. In these circumstances, the Calculation Agent will not determine whether
an Allocation Determination Event has occurred until the following Index
Business Day and will not effect any reallocation until the close of business
on that following Index Business Day.
The use of leverage may increase the risk of loss in the value of the Basket
Units
If the Index Components include Leverage Units, your PROCEEDS will be
exposed to a greater degree of risk than that represented by Basket Units
alone. Accordingly, a small downward movement in the value of the Basket Units
may result in a significantly larger reduction in the Reference Index.
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 Income
Select 10 Stocks or futures or option contracts on the Income Select 10 Stocks
for our own accounts for business reasons and may enter into these
transactions in connection with hedging our obligations under the PROCEEDS.
These transactions could affect the price of the Income Select 10 Stocks, the
value of the Income Select 10 Basket and, in turn, the level of the Reference
Index in a manner that would be adverse to your investment in the PROCEEDS.
You must rely on your own evaluation of the merits of an investment linked to
the Income Select 10 Stock
In the ordinary course of their businesses, affiliates of ML&Co. from
time to time express views on the Income Select 10 Companies and expected
movements in the value of the Income Select 10 Stock and these views are
sometimes communicated to clients. However, these views may vary over
differing time-horizons and are subject to change. Moreover, other
professionals who deal in equity markets may at any time have significantly
different views from those of our affiliates. For reasons such as these, we
believe that most investors in the PROCEEDS derive information concerning the
Income Select 10 Stocks from multiple sources.
In connection with your purchase of the PROCEEDS, you should
investigate the Income Select 10 Companies and not rely on views which may be
expressed by our affiliates in the ordinary course of their businesses with
respect to future interest rate movements and other factors. You should make
such investigation as you deem appropriate as to the merits of an investment
which is based in part on the value of the Income Select 10 Stocks. Neither
the offering of the PROCEEDS nor any views which may from time to time be
expressed by our affiliates in the ordinary course of their businesses with
respect to future price movements constitutes a recommendation as to the
merits of an investment in the PROCEEDS.
S-13
There is no affiliation between ML&Co. and the Income Select 10 Companies
We are not affiliated with the Income Select 10 Companies, and the
Income Select 10 Companies have not authorized or approved the PROCEEDS and
have no financial or legal obligations relating to the PROCEEDS or amounts to
be paid to you, including any obligation to take the needs of ML&Co. or of
holders of the PROCEEDS into consideration for any reason. The Income Select
10 Companies will not receive any of the proceeds of the offering of the
PROCEEDS and are not responsible for, and has not participated in, the
offering of the PROCEEDS and are not responsible for, and will not participate
in, the determination or calculation of the amount receivable by holders of
the PROCEEDS.
Neither ML&Co., MLI nor MLPF&S have conducted any due diligence
inquiry with respect to the Income Select 10 Companies in connection with the
offering of the PROCEEDS; and they make no representation as to the
completeness or accuracy of publicly available information regarding the
Income Select 10 Companies or as to the future performance of the Income
Select 10 Stocks. Any prospective purchaser of the PROCEEDS should undertake
such independent investigation of the Income Select 10 Companies as in its
judgment is appropriate to make an informed decision with respect to an
investment in the PROCEEDS.
S-14
DESCRIPTION OF THE PROCEEDS
ML&Co. will issue the PROCEEDS as a series of senior debt securities
under the 1983 Indenture, which is more fully described in the accompanying
prospectus. The PROCEEDS will mature on May 12, 2010.
The PROCEEDS will not be subject to redemption by ML&Co. or at the
option of any beneficial owner before the maturity date. If an Event of
Default occurs with respect to the PROCEEDS, holders of the PROCEEDS may
accelerate the maturity of the PROCEEDS, as described under the section
entitled "--Events of Default and Acceleration" in this prospectus supplement
and the section entitled "Description of Debt Securities--Events of Default"
in the accompanying prospectus.
ML&Co. will issue the PROCEEDS in denominations of whole units, each
with a principal amount of $1,000 per unit. You may transfer the PROCEEDS only
in whole units. You will not have the right to receive physical certificates
evidencing your ownership except under limited circumstances. Instead, we will
issue the PROCEEDS in the form of a global certificate, which will be held by
The Depository Trust Company, also known as DTC, or its nominee. Direct and
indirect participants in DTC will record your ownership of the PROCEEDS. You
should refer to the section entitled "Description of the Debt
Securities--Depository" in the accompanying prospectus.
The PROCEEDS will not have the benefit of any sinking fund.
Payment on the maturity date
The maturity date for the PROCEEDS is May 12, 2010. On the maturity
date, a beneficial owner of a PROCEEDS will be entitled to receive the
principal amount, in addition to any interest payment due, of that PROCEEDS
plus a Supplemental Redemption Amount, if any, all as provided below. If the
Ending Value does not exceed the Threshold Value, a beneficial owner will be
entitled to receive only the principal amount, in addition to any interest
payment due, of the PROCEEDS.
The "Supplemental Redemption Amount" for a PROCEEDS will be
determined by the Calculation Agent and will equal:
( Ending Value - Threshold Value )
principal amount of each PROCEEDS ($1,000 per unit) x (---------------------------------)
( Threshold Value )
provided, however, that in no event will the Supplemental Redemption Amount be
less than zero.
The "Ending Value" will be determined by the Calculation Agent and
will equal the closing level of the Reference Index determined on the
Valuation Date.
The "Threshold Value" equals 100.
The "Starting Value" equals 97, the level at which the Reference
Index was set on May 2, 2005, the date the PROCEEDS were priced for initial
sale to the public (the "Pricing Date").
The "Valuation Date" will be the seventh scheduled Index Business Day
before the maturity date, or if that day is not an Index Business Day, the
next Index Business Day; provided, however, that if no Index Business Days
occur between the seventh scheduled Index Business Day before the maturity
date and the second scheduled Index Business Day before the maturity date due
to the occurrence of a Market Disruption Event, the Valuation Date will be the
second scheduled Index Business Day before the maturity date, regardless of
the occurrence or continuance of a Market Disruption Event.
An "Index Business Day" means a day, as determined by the Calculation
Agent, on which securities comprising more than 80% of the value of the Income
Select 10 Basket on that day are capable of being traded on their respective
relevant exchanges during the one-half hour before the determination of the
closing level of the Reference Index for that day.
Because the Starting Value is 97, which is less than the Threshold
Value, we will pay you a Supplemental Redemption Amount only if the Ending
Value is 3.1% greater than the Starting Value on the Valuation Date. If the
Ending Value is less than or equal to the Threshold Value, the Supplemental
Redemption Amount will be zero. We will pay you the principal amount of your
PROCEEDS, in addition to any interest payment due, regardless of whether any
Supplemental Redemption Amount is payable.
S-15
Interest
The interest payable on the PROCEEDS will vary and may be zero. We
expect to pay interest, if any, in cash quarterly on the third Business Day
following each Commencement Date and on the maturity date. A "Commencement
Date" is each February 1, May 1, August 1 and November 1, beginning August 1,
2005. If a Commencement Date falls on a day that is not a Business Day, the
Commencement Date will be the next succeeding Business Day. If an interest
payment date falls on a day that is not a Business Day, the interest payment,
if any, to be made on that interest payment date will be made on the next
succeeding Business Day with the same force and effect as if made on that
interest payment date, and no additional interest will be paid as a result of
the delayed payment. A "Business Day" means any day other than a Saturday or
Sunday that is not a day on which banking institutions in The City of New York
are authorized or required by law, regulation or executive order to close.
The interest payments, if any, on the PROCEEDS will depend on the
income, if any, deemed to be derived from the Basket Units held in the
Reference Index over each quarterly calculation period, and the level of the
Reference Index at the end of that period as described in the next paragraph.
This hypothetical income from the Basket Units (the "Basket Unit Income") will
be based on the cash dividends in respect of the Income Select 10 Stocks and
the value of premiums in respect of call options on those stocks. See the
section entitled "Description of the Income Select 10 Basket--Calculation of
the Value of the Income Select 10 Basket" in this prospectus supplement. The
Zero Coupon Bond Units and the Leverage Units will not produce hypothetical
income for purposes of the interest payments on the PROCEEDS.
The interest payment on the PROCEEDS, if any, for any quarterly
calculation period will be based on figures determined on the last Business
Day of a quarterly calculation period and will equal:
Number of Basket Units x Adjusted Quarterly Income
provided the Calculation Agent determines that the level of the Reference
Index (less any Basket Unit Income) is greater than 105% of the Floor Level at
the close of business on the last day of any quarterly calculation period,
except the last quarterly calculation period before the maturity date, for
which any interest payment will be paid in addition to the Supplemental
Redemption Amount. For a description of how the Adjusted Quarterly Income is
calculated, see the section entitled "Description of the Income Select 10
Basket--Calculation of the Value of the Income Select 10 Basket" in this
prospectus supplement.
Interest will be calculated from, and including, each Commencement
Date to, but excluding, the next Commencement Date, provided, that the initial
quarterly calculation period will commence on, and include, May 5, 2005 and
the final quarterly calculation period will extend to, and include, the
Valuation Date. No interest will accrue on the PROCEEDS after the Valuation
Date. The interest payment date related to any quarterly calculation period
with respect to which interest is paid will be the interest payment date
following the last day of the applicable quarterly calculation period or, with
respect to the final quarterly calculation period, the stated maturity date.
The Calculation Agent will notify the indenture trustee of the amount of
interest payable on or before the second Business Day immediately following
the last day of the applicable quarterly calculation period. Interest will be
payable to the persons in whose names the PROCEEDS are registered at the close
of business on the Business Day succeeding the last day of the applicable
quarterly calculation period.
As described above, the interest, if any, on the PROCEEDS will depend
on the allocation of the hypothetical funds to the Basket Units and on the
Basket Unit Income. However, if at the close of business on the last day of
any quarterly calculation period (except the last quarterly calculation period
before the maturity date), the Calculation Agent determines that the level of
the Reference Index (less any Basket Unit Income) is less than 105% of the
Floor Level, the Calculation Agent will be deemed to reinvest the value of any
Basket Unit Income relating to that quarterly calculation period in the Basket
Units at the close of business on the first Index Business Day of the next
quarterly calculation period (by increasing the number of Basket Units
included in the Reference Index) and no interest will be payable on the
PROCEEDS on the interest payment date relating to that quarterly calculation
period. See the section entitled "The Income Select 10 PROCEEDS
Index--Calculation of The Reference Index--Reinvestment of the Basket Unit
Income" in this prospectus supplement.
If the amount allocated to the Basket Units is zero at any time
during the term of the PROCEEDS (either following a Allocation Determination
Event or a Defeasance Event), it will remain zero for the remaining term of
the PROCEEDS and no interest will be paid for the remaining term of the
PROCEEDS. See the section entitled "Risk Factors--Risk Factors Relating to the
PROCEEDS and the Reference Index--Less than 100%, and possibly none, of the
hypothetical funds may be allocated to the Basket Units" in this prospectus
supplement.
Adjustments to the Reference Index; Market Disruption Events
If the value (including a closing value) of any component of the
Reference Index is unavailable on any Index Business Day because of a Market
Disruption Event or otherwise, unless deferred by the Calculation Agent as
described below, the Calculation Agent will determine the value of each Index
Component for which no value is available as follows:
S-16
o the value of any Income Select 10 Stock for which no value is
available will be the arithmetic mean, as determined by the
Calculation Agent, of the value of that stock obtained from as
many dealers in equity securities (which may include MLPF&S or
any of our other subsidiaries or affiliates), but not exceeding
three of those dealers, as will make that value available to the
Calculation Agent;
o the value of any hypothetical call option related to a stock
underlying the Income Select 10 Basket for which no value is
available will be the arithmetic mean, as determined by the
Calculation Agent, of the value of that option obtained from as
many dealers in options (which may include MLPF&S or any of our
other subsidiaries or affiliates), but not exceeding three of
those dealers, as will make that value available to the
Calculation Agent;
o the value of the Zero Coupon Bond Units will be the arithmetic
mean, as determined by the Calculation Agent, of the value of
the hypothetical bond tracked by the Zero Coupon Bond Units
obtained from as many dealers in fixed-income securities (which
may include MLPF&S or any of our other subsidiaries or
affiliates), but not exceeding three of those dealers, as will
make that value available to the Calculation Agent; or
o the value, if any, of the Leverage Units will be calculated as
described in the section entitled "The Income Select 10 PROCEEDS
Index" in this prospectus supplement.
The Calculation Agent will use the value of the Income Select 10
Stocks and the related hypothetical call options to determine the value of the
Basket Units. The Calculation Agent will then calculate the level of the
Reference Index and, if earlier than the Valuation Date, will determine
whether an Allocation Determination Event has occurred. If the Calculation
Agent determines that an Allocation Determination Event has occurred, it will
reallocate the hypothetical funds tracked by the Reference Index as described
in the section entitled "The Income Select 10 PROCEEDS Index--Reallocation of
the Hypothetical Funds tracked by the Reference Index" in this prospectus
supplement.
The determination of any of the above values or of an Allocation
Determination Event by the Calculation Agent in the event any of those values
is unavailable may be deferred by the Calculation Agent for up to ten
consecutive Index Business Days on which a Market Disruption Event is
occurring. Following this period, the Calculation Agent will determine the
relevant values in consultation with ML&Co. No reallocation of the level of
the Reference Index will occur on any day the determination of any of the
above values is so deferred.
"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
(without taking into account any extended or after-hours
trading session), in 20% or more of the stocks which then
comprise the Reference Index; or
(B) 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
(without taking into account any extended or after-hours
trading session), whether by reason of movements in price
otherwise exceeding levels permitted by the applicable
exchange or otherwise, in option contracts or futures
contracts related to 20% or more of the stocks which then
comprise the Reference Index.
For the purpose of determining whether a Market Disruption Event has
occurred:
(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 applicable exchange;
(2) a suspension in trading in a futures or option contract on a
stock which then comprises a part of the Income Select 10
Basket by the primary securities market trading in the options
contracts related to such stock by reason of (a) a price
change exceeding limits set by the securities exchange or
market, (b) an imbalance of orders relating to those contracts
on the stock, or (c) a disparity in bid and ask quotes
relating to those contracts on the stock, will constitute a
suspension or material limitation of trading in futures or
option contracts related to that stock; and
S-17
(3) a suspension of, absence of or material limitation on trading
on the primary securities market on which futures or option
contracts on a stock which then comprises a part of the Income
Select 10 Basket are traded will not include any time when
that securities market is closed for trading under ordinary
circumstances.
(4) for the purpose of clause (A) above, any limitations on
trading during significant market fluctuations under New York
Stock Exchange (the "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 terrorist attacks the financial markets were closed
from September 11, 2001 through September 14, 2001 and values of the Reference
Index would not have been available for those dates. Those market closures
would have constituted Market Disruption Events.
All determinations made by the Calculation Agent are to be made in
good faith and in a commercially reasonable manner and, absent a determination
of a manifest error, will be conclusive for all purposes and binding on ML&Co.
and the holders and beneficial owners of the PROCEEDS.
Events of Default and Acceleration
In case an Event of Default (as described under "Description of Debt
Securities--Events of Default" in the accompanying prospectus) with respect to
any PROCEEDS has occurred and is continuing, the amount payable to a
beneficial owner of a PROCEEDS upon any acceleration permitted by the
PROCEEDS, with respect to each PROCEEDS, will be equal to the principal amount
and the Supplemental Redemption Amount, if any, calculated as though the date
of acceleration were the stated maturity date of the PROCEEDS, provided,
however, the Index Adjustment Factor will be applied to the values used to
calculate the Supplemental Redemption Amount as if the PROCEEDS had not been
accelerated and had remained outstanding to the stated maturity date. See the
section entitled "--Payment on the maturity date" in this prospectus
supplement. If a bankruptcy proceeding is commenced in respect of ML&Co., the
claim of the holder of a PROCEEDS may be limited, under Section 502(b)(2) of
Title 11 of the United States Code, to the principal amount of the PROCEEDS
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
PROCEEDS.
In case of default in payment of the PROCEEDS, whether at the stated
maturity date or upon acceleration, from and after that date the PROCEEDS will
bear interest, payable upon demand of their holders, at the rate of 2.25% 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 PROCEEDS to the date payment of that amount has been made or duly provided
for.
S-18
FEES, DEDUCTIONS AND CHARGES
Your return on the PROCEEDS will reflect the deductions of the
following costs over the term of the PROCEEDS.
Direct Fees, Deductions and Charges
The following will be deducted from the level of the Reference Index
over the term of the PROCEEDS:
Index Adjustment Factor. The level of the Reference Index
will reflect a 1.5% per annum annual reduction (the "Index Adjustment
Factor") that will be applied and accrue daily on the basis of a
365-day year from the date the PROCEEDS are issued to the public
through the Valuation Date. A portion of the Index Adjustment Factor
equal to 0.70% per annum will accrue to the benefit of the
Distributor and the remainder will accrue to the benefit of the
Calculation Agent. The Index Adjustment Factor will remain at 1.5%
per annum for so long as any hypothetical funds are allocated to
Basket Units. If at any time the allocation of hypothetical funds to
the Basket Units is zero, the Index Adjustment Factor will not apply.
Daily Leverage Charge. To the extent that the hypothetical
investment in the Basket Units is leveraged (i.e., increased with
hypothetical borrowed funds) through the use of Leverage Units, the
number of Leverage Units will be increased daily by an amount equal
to the interest expense deemed to have been incurred on those
borrowed funds (the "Daily Leverage Charge"). The Daily Leverage
Charge will equal the number of Leverage Units outstanding on the
applicable day multiplied by Federal Funds rate on the applicable day
plus .5%, divided by 360. This deemed interest expense will reduce
the level of the Reference Index on each day that the Reference Index
includes Leverage Units.
"Federal Funds rate" means:
(1) the rate on any day for United States dollar federal
funds as published in H.15(519) under the caption
"Federal Funds (Effective)" and displayed on Bloomberg
or any successor service on page FEDL or any other page
as may replace page FEDL on that service ("Bloomberg
Page FEDL"); or
(2) if the rate referred to in clause (1) does not appear on
Bloomberg Page FEDL or is not published by 3:00 P.M.,
New York City time, on the relevant date, the rate on
that date for United States dollar federal funds as
published in H.15 Daily Update, or other recognized
electronic source used for the purpose of displaying the
applicable rate, under the caption "Federal Funds
(Effective)"; or
(3) if the rate referred to in clause (2) is not published
by 3:00 P.M., New York City time, on the relevant date,
the rate on that date calculated by the Calculation
Agent as the arithmetic mean of the rates for the last
transaction in overnight United States dollar federal
funds arranged by three leading brokers of United States
dollar federal funds transactions in The City of New
York, which may include MLPF&S or its affiliates,
selected by the Calculation Agent as of 9:00 A.M., New
York City time, on that date; or
(4) if the brokers selected by the Calculation Agent are not
quoting as mentioned in clause (3), the Federal Funds
rate in effect on that date.
Implicit Sales Charge. An implicit sales charge is paid to
MLPF&S upon the purchase of the PROCEEDS because the Starting Value
was set to 97, while the Threshold Value will equal 100. In order for
you to receive a Supplemental Redemption Amount on the maturity date,
the Ending Value must exceed the Threshold Value on the Valuation
Date. Therefore, the level of the Reference Index must increase by
more than 3.1% for you to receive an amount in excess of $1,000 per
unit of the PROCEEDS. This is analogous to paying an up front sales
charge of 3% per unit of the PROCEEDS.
Indirect Fees, Deductions and Charges
Basket Adjustment Factor. The value of the Income Select 10
Basket will reflect a 0.75% per annum reduction that will be applied
and accrue daily based on the value of the Income Select 10 Basket at
the end of the previous day on the basis of a 365-day year and will
be subtracted from the Basket Unit Income on the Income Select 10
Basket at the end of each day prior to effecting any reallocation
that day; provided, however, the value of the Basket Adjustment
Factor for any quarterly calculation period will not exceed the value
of the Basket Unit Income for that quarterly calculation period. A
portion of the hypothetical value of the Basket Adjustment Factor
equal to 0.375% per annum will accrue to the benefit of the
Distributor and the reminder will accrue to the benefit of the
Calculation Agent. Because the Basket Adjustment Factor reduces the
value of the Income Select 10 Basket, the return on an investment in
the "covered call" strategy represented by the Income Select 10
Basket, and therefore the Reference Index and the PROCEEDS, will be
less than a return on a "covered call" strategy on the Income Select
10 Basket that did not include the Basket Adjustment Factor.
S-19
THE INCOME SELECT 10 PROCEEDS INDEX
The Income Select 10 PROCEEDS Index is a composite index that will
track the performance of hypothetical investments in two assets, the Basket
Units and the Zero Coupon Bond Units, and one liability, the Leverage Units.
Provided that a Defeasance Event has not occurred, the amount of hypothetical
funds allocated to each of the Index Components is expected to vary over the
term of the PROCEEDS. The Calculation Agent will adjust the allocations
systematically using the Reference Index formula, which is described below
under "--Reallocation of the Hypothetical Funds tracked by the Reference
Index", that systematically shifts hypothetical funds among the Index
Components based on the performance of the Basket Units, prevailing interest
rates and market conditions. The formula will cause the allocations of
hypothetical funds to vary over the term of the PROCEEDS in order to
participate in any appreciation of the Basket Units, but only to the extent
consistent with the objective that the Reference Index level is at least 100
on the scheduled Valuation Date. As a result, the performance of the Reference
Index may differ significantly from the performance of each of the Index
Components.
The Index Components are defined as follows:
Each "Basket Unit" will track the value of an initial $100
hypothetical investment in the Income Select 10 Basket. The "Income
Select 10 Basket" is a hypothetical investment in a "covered call"
strategy in which (i) the Income Select 10 Stocks are purchased and
(ii) call options on the Income Select 10 Stocks are sold on a
quarterly basis for a three month term. The Income Select 10 Stocks
consist of the top ten dividend yielding stocks in the DJIA,
reconstituted annually, as determined by the Calculation Agent. The
hypothetical income on each Basket Unit will equal a pro rata share
of the Basket Unit Income on the Income Select 10 Basket.
Each "Zero Coupon Bond Unit" will track the value of a $100
face value hypothetical investment in a hypothetical zero coupon bond
maturing on the scheduled Valuation Date with a yield equal to the
applicable zero coupon yield based upon USD swap rates as published
on Bloomberg Page EDS. The applicable zero coupon yield will be
estimated from the USD swap rate yields corresponding to the
published maturities closest in time to the scheduled Valuation Date.
The Calculation Agent may, when necessary, estimate the applicable
zero coupon yield by interpolating the appropriate USD swap rate
yields based on those published maturities. The Zero Coupon Bond
Units will bear no interest after the scheduled Valuation Date.
Each "Leverage Unit" will track the value of $1 of
hypothetical borrowings used to increase the exposure to the Basket
Units. To the extent that exposure to the Basket Units is leveraged
(i.e., increased with borrowed funds) through the use of Leverage
Units, the number of Leverage Units will be increased daily by an
amount equal to the Daily Leverage Charge. The Daily Leverage Charge
will reduce the level of the Reference Index.
The PROCEEDS are senior unsecured debt securities of ML&Co. An
investment in the PROCEEDS does not entitle you to any dividends, voting
rights, option premiums or any other ownership interest in the securities
included in the Reference Index.
The initial allocations of hypothetical funds to the Index Components
as set on the Pricing Date will be 84.74% in Basket Units, 15.26% in Zero
Coupon Bond Units and 0% in Leverage Units. We expect the allocations among
the Index Components to change upon an Allocation Determination Event, as
described below. The formula will not allocate more than 150% of the
hypothetical funds to the Basket Units. The relative allocations among each
Index Component will be determined by the formula described herein and
calculated by the Calculation Agent.
Defeasance Events
A "Defeasance Event" will have been deemed to have occurred if the
Cushion is less than 1% on any Business Day. Upon the occurrence of a
Defeasance Event, no hypothetical funds will be allocated to the Basket Units
for the remaining term of the PROCEEDS. This means that, while a holder of
Basket Units would benefit from a subsequent increase in the value of the
Basket Units, a holder of PROCEEDS would not.
If, at the time of a Defeasance Event, the amount resulting from the
hypothetical sale of the Basket Units added to the value of the Zero Coupon
Bond Units in the Reference Index is greater than the Floor Level, then that
excess amount will be allocated in Zero Coupon Bond Units and the Reference
Index will track the value of one Zero Coupon Bond Unit plus this additional
excess amount for the remaining term of the PROCEEDS. If the amount resulting
from the hypothetical sale of the Basket Units added to the value of the Zero
Coupon Bond Units in the Reference Index is equal to or less than the Floor
Level, then the Reference Index will track the value of one Zero Coupon Bond
Unit for the remaining term of the PROCEEDS.
S-20
Because the amount of the interest payments on the PROCEEDS will
depend on the performance of the Basket Units in the Reference Index, no
interest will be paid for the remaining term of the PROCEEDS after the
occurrence of a Defeasance Event. In addition, the Reference Index will not
participate in any subsequent increase in the value of the Basket Units and
your payment on the maturity date will be limited to the $1,000 principal
amount per unit (except as described in the first sentence of the immediately
preceding paragraph).
Calculation of the Reference Index
The daily closing values of the Reference Index, the Basket Units and
the Zero Coupon Bond Units will be published daily on Reuters Page MEREDUS15
(or any successor page for the purpose of displaying those closing values as
identified by the Calculation Agent) and will be the respective values
determined as of approximately 4:00 p.m. (New York City time) on any Business
Day.
The level of the Reference Index and the daily closing values of each
of the Index Components will be calculated by the Calculation Agent. The level
of the Reference Index was set to 97 on the Pricing Date, with 84.74% of the
hypothetical funds allocated to the Basket Units, 15.26% of the hypothetical
funds allocated to the Zero Coupon Bond Units and 0% of the hypothetical funds
allocated to the Leverage Units. Thereafter, the level of the Reference Index
on any Index Business Day will equal the sum of closing value of the Basket
Units in the Reference Index and the value of the Zero Coupon Bond Units in
the Reference Index, less the value of Leverage Units representing
hypothetical borrowed funds outstanding and reduced by a pro rata portion of
the Index Adjustment Factor.
In addition, the level of the Reference Index will include the value
of the Basket Unit Income, if any, if that income is to be hypothetically
reinvested in the Basket Units at the close of business on the first Index
Business Day of the next quarterly calculation period, as described below
under "--Reinvestment of the Basket Unit Income".
The level of the Reference Index on any day that is not an Index
Business Day will equal the level of the Reference Index on the previous day
minus the Index Adjustment Factor and the Daily Leverage Charge for that day
regardless of any changes in the level of the Income Select 10 Basket on that
day.
Reinvestment of the Basket Unit Income
At the close of business on the last day of each quarterly
calculation period (except for the last quarterly calculation period before
the maturity date) and after effecting any reallocation for that day, the
Calculation Agent will determine the Basket Unit Income. If, at that time, the
level of the Reference Index (less any Basket Unit Income) is less than 105%
of the Floor Level, then the interest payment on the PROCEEDS for that
quarterly calculation period will be zero. Under these circumstances, the
Calculation Agent will be deemed to reinvest the Basket Unit Income at the
close of business on the first Index Business Day of the next quarterly
calculation period in additional Basket Units at a price per unit that does
not include that Basket Unit Income (calculated as described under
"Description of the Income Select 10 Basket--Calculation of the Value of the
Income Select 10 Basket').
Reallocation of the hypothetical funds tracked by the Reference Index
After the Pricing Date, the allocation of the hypothetical funds
tracked by the Reference Index to the Basket Units and the Zero Coupon Bond
Units will be modified if an Allocation Determination Event occurs.
Reallocations of the hypothetical funds are designed to allow participation in
any appreciation in the value of the Basket Units, but only to the extent
consistent with the objective that the level of the Reference Index is at
least 100 on the scheduled Valuation Date and will be effected through the
hypothetical purchase and sale of Basket Units and Zero Coupon Bond Units.
Reallocations of the hypothetical funds may involve the hypothetical purchase
and sale of fractional Basket Units and fractional Zero Coupon Bond Units.
Allocation Determination Events
An "Allocation Determination Event" will occur and a reallocation
will be effected if the absolute value of the difference in (i) the closing
value of the Basket Units in the Reference Index divided by the closing level
of the Reference Index on any Index Business Day and (ii) the Targeted
Exposure, is greater than 5% of the Targeted Exposure. In general, the
Targeted Exposure may increase following increases in the value of the Basket
Units or decreases in the Floor Level (due to interest rate increases). Using
Leverage Units, the Targeted Exposure may equal up to 150% (the "Maximum
Leverage"). In general, the Targeted Exposure may decrease following decreases
in the value of the Income Select 10 Basket or increases in the Floor Level
(due to interest rate decreases).
S-21
The target allocation of hypothetical funds tracked by the Reference
Index to the Basket Units (the "Targeted Exposure") upon the occurrence of an
Allocation Determination Event will depend on the last available closing level
of the Reference Index (the "Last Value"), the Floor Level and the Trading
Multiple, and is subject to the Maximum Leverage.
The Targeted Exposure will equal:
Cushion x Trading Multiple,
provided, the Targeted Exposure will not exceed 150%.
The "Cushion" equals the (Last Value minus the Floor Level)/Last
Value; provided, however, that in no instance will the Cushion be less than
zero.
The "Floor Level" for any date will equal the value of a $100 face
value hypothetical zero coupon bond maturing on the scheduled Valuation Date
with a yield equal to the applicable zero coupon yield based upon USD swap
rates, plus the Fee Protection Factor, if any.
The "Trading Multiple" is set at 5.0.
The "Fee Protection Factor" will increase the Floor Level when the
then current value of the Zero Coupon Bond Units ("ZCBU Value") equals 90% or
more of the Last Value. In that case, the Floor Level will be increased upon
the occurrence of an Allocation Determination Event by an amount equal to:
.50 x the number of years to the maturity date
x Zero Coupon Bond Unit Contribution
where the number of years to the maturity date allows for fractional years and
the "Zero Coupon Bond Unit Contribution" equals:
( ( Last Value - ZCBU Value ))
(10% - (-------------------------)) divided by 9%
( ( Last Value ))
provided, however, that in no instance will the Zero Coupon Bond Unit
Contribution be less than zero or greater than one. Upon the occurrence of the
Defeasance Event where the amount resulting from the hypothetical sale of the
Basket Units added to the value of the Zero Coupon Bond Units in the Reference
Index is greater than the Floor Level, the Zero Coupon Bond Unit Contribution
will equal one. Because the Fee Protection Factor is included in the Floor
Level, upon the occurrence of the Defeasance Event, the amount resulting from
the hypothetical sale of the Basket Units added to the value of the Zero
Coupon Bond Units in the Reference Index will reflect an implicit reduction
equal to the value of the Fee Protection Factor. In the circumstance described
in the two preceding sentences a portion equal to 0.25 of the Fee Protection
Factor will accrue to the benefit of the Distributor and the remainder of the
Fee Protection Factor will accrue to the benefit of the Calculation Agent.
The effect of the Fee Protection Factor is to decrease the Targeted
Exposure when the level of the Reference Index is equal to or less than 10%
greater than the value of the Zero Coupon Bond Units upon the occurrence of an
Allocation Determination Event. This, in turn, will increase the allocation of
hypothetical funds to the Zero Coupon Bond Units so that the level of the
Reference Index should equal at least 100 on the scheduled Valuation Date,
inclusive of all fees, deductions and charges described under the section
entitled "Fees, Deductions and Charges" in this prospectus supplement.
The Calculation Agent will determine whether an Allocation
Determination Event has occurred at the beginning of each Index Business Day
up to and including the Valuation Date. For purposes of determining an
Allocation Determination Event, the value of hypothetical call options in the
Income Select 10 Basket will be determined using mid-market implied volatility
(or the arithmetic mean of bid-side and offered-side implied volatility). See
the section entitled "Description of the Income Select 10 Basket--Hypothetical
Call Options--Valuation of Call Options" in this prospectus supplement.
The Calculation Agent may defer the determination of the values of
the Basket Units and the Zero Coupon Bond Units for up to ten consecutive
Index Business Days on which any Market Disruption Event is occurring.
Following this deferral period, the Calculation Agent will determine the
values of the Basket Units and the Zero Coupon Bond Units. No reallocation of
the hypothetical funds tracked by the Reference Index will occur on any day
the determination of the value of the Basket Units and the Zero Coupon Bond
Units is deferred by the Calculation Agent.
S-22
If the Calculation Agent determines that an Allocation Determination
Event has occurred, the Calculation Agent will determine the Targeted
Exposure, or the percentage of the hypothetical funds that must be allocated
to the Basket Units pursuant to the formula. The Targeted Exposure will be
determined on the basis of values at the close of business on the previous
Index Business Day. At the close of business on the Index Business Day on
which an Allocation Determination Event has occurred, the Calculation Agent
will reallocate the hypothetical funds.
The Targeted Exposure cannot be greater than 150% or less than 0%. If
the Targeted Exposure is greater than 100%, the hypothetical borrowed funds
necessary to make the hypothetical investment in the Basket Units in excess of
100% of the level of the Reference Index will be obtained through the
allocation to the Leverage Units.
Reallocation procedures
Reallocations may involve hypothetical sales and purchases of Basket
Units and Zero Coupon Bond Units. The number of Basket Units to be
hypothetically sold or purchased will be determined by the Calculation Agent
at the beginning of each Index Business Day. However, those hypothetical sales
or purchases will be effected at the values (as determined by the Calculation
Agent) of Basket Units and Zero Coupon Bond Units at the close of business on
the date of reallocation. Any reallocation on the last day of any quarterly
calculation period will be effected through the hypothetical purchase or sale
of Basket Units at a price that includes the Basket Unit Income for that
quarterly calculation period. Hypothetical purchases of Basket Units will be
made at prices that reflect the value of call options determined using
bid-side implied volatility and hypothetical sales of Basket Units will be
made at prices that reflect the value of call options determined using
offered-side implied volatility. See the section entitled "Risk Factors--Risk
Factors Relating to the Basket Units--The valuation of hypothetical call
options for purposes of determining the occurrence of an Allocation
Determination Event for purposes of effecting a reallocation" and the section
entitled "Description of the Income Select 10 Basket--Hypothetical Call
Options--Valuation of Hypothetical Call Options" in this prospectus
supplement.
If the reallocation results in an increased percentage of
hypothetical funds tracked by the Reference Index allocated to the Basket
Units, the reallocation will involve the hypothetical sale of Zero Coupon Bond
Units and the hypothetical purchase of Basket Units with the hypothetical
proceeds of the sale. Any purchase of Basket Units that cannot be effected
through the sale of Zero Coupon Bond Units will be effected using the Leverage
Units. The Leverage Units will be increased by the amount necessary to
purchase the Basket Units, subject to the Maximum Leverage.
The hypothetical sale of Zero Coupon Bond Units will be made at
prices that reflect the value of zero coupon bonds determined using relevant
offered-side swap rates. The hypothetical purchase of Zero Coupon Bond Units
will be made at prices that reflect the value of zero coupon bonds determined
using relevant bid-side swap rates.
If the reallocation results in a decreased percentage of hypothetical
funds tracked by the Reference Index allocated to the Basket Units, the
reallocation will involve the hypothetical sale of Basket Units. The
hypothetical proceeds of this sale will be used first to reduce any allocation
to the Leverage Units to zero and then to make hypothetical purchases of Zero
Coupon Bond Units.
The number of Basket Units and Zero Coupon Bond Units in the
Reference Index will then be adjusted to reflect the units hypothetically sold
or purchased as a result of the reallocation.
The Calculation Agent will determine whether an Allocation
Determination Event has occurred and, if so, the Targeted Exposure based on
the values of the Reference Index, the Basket Units and the Floor Level at the
close of business on the previous Index Business Day and any necessary
reallocation will be effected at the close of business on the Index Business
Day on which the occurrence of the Allocation Determination Event is
determined. As a result:
o the Calculation Agent may determine that an Allocation
Determination Event has occurred even if the values of the
Reference Index, the Income Select 10 Basket and the Floor
Level at the time the reallocation is effected would not result
in an Allocation Determination Event;
o the Reference Index may not participate as fully in any
appreciation of the Basket Units that occurs between the
determination of the occurrence of an Allocation Determination
Event and the resulting reallocation as it would if the
reallocation were effected immediately following determination
of the Targeted Exposure; and
o the Calculation Agent may effect a greater or lesser allocation
to the Basket Units than otherwise would be required if the
occurrence of an Allocation Determination Event were determined
by the Calculation Agent at the end of that Index Business Day.
S-23
See the section entitled "Risk Factors--Risk Factors Relating to the
PROCEEDS and the Reference Index--There may be delays between the
determination of an Allocation Determination Event and reallocation of
hypothetical funds which could affect the level of the Reference Index" in
this prospectus supplement.
Reallocation upon the occurrence of Defeasance Events
Upon the occurrence of a Defeasance Event, no hypothetical funds will
be allocated to the Basket Units for the remaining term of the PROCEEDS, even
if at the close of business on that Business Day the value of the Cushion is
greater than 1%.
If the amount allocated to the Basket Units falls to zero at any
time, it will remain zero for the remaining term of the PROCEEDS and the
reallocation procedures described in this section will no longer apply. If the
value of the Basket Units subsequently increases, the Reference Index will not
participate in that increase. See the section entitled "Risk Factors--Risk
Factors Relating to the PROCEEDS and the Reference Index--The performance of
the Basket Units may exceed the performance of the Reference Index" in this
prospectus supplement.
Reallocation following a 10% decrease in the level of the Dow Jones
Industrial Average
If at any time during any Index Business Day the level of the DJIA
has declined from its closing level on the previous Index Business Day by 10%
or more, the Calculation Agent, as soon as reasonably practicable, will
determine the Targeted Exposure and reallocate the hypothetical funds tracked
by the Reference Index at the close of business on the Index Business Day that
such decline was first determined to have occurred, so that the percentage of
hypothetical funds invested in the Basket Units is as close as is reasonably
practicable to the Targeted Exposure, as described under the section entitled
"--Reallocation of the Hypothetical Funds tracked by the Reference Index"
above. This reallocation will be effected even if an Allocation Determination
Event has not occurred and, if an Allocation Determination Event was
determined to have occurred at the beginning of that Index Business Day, the
reallocation of hypothetical funds determined in connection with that
Allocation Determination Event will be disregarded.
S-24
- -------------------------------------------------------------------------------
Allocation Determination Events--Hypothetical Examples
The following are seven hypothetical examples of the effects of
Allocation Determination Events. These hypothetical examples assume that: (i)
purchases and sales of Basket Units to effect reallocations are at prices that
reflect the value of hypothetical call options determined using mid-market
implied volatility; (ii) the level of the Reference Index does not change
between the determination of an Allocation Determination Event and the
subsequent reallocation; (iii) the Basket Units have a value of 100; and (iv)
the Zero Coupon Bond Units have a value of 86.
EXAMPLE 1: AN ALLOCATION DETERMINATION EVENT REQUIRES THE ENTIRE VALUE OF THE
HYPOTHETICAL FUNDS TRACKED BY THE REFERENCE INDEX TO BE ALLOCATED TO THE
BASKET UNITS
An Allocation Determination Event requires the entire value of the
hypothetical funds tracked by the Reference Index to be allocated to the Basket
Units, but without using the Leverage Units.
Before Reallocation: After Reallocation:
Level of the Reference Index: 107.50 Level of the Reference Index: 107.50
Floor Level: 86.00 Floor Level: 86.00
Cushion: approximately 20% Targeted Exposure: 100%
Amount Allocated to Basket Units: 75.00 Amount Allocated to Basket Units: 107.50
Amount Allocated to Zero Coupon Bond Units: Amount Allocated to Zero Coupon Bond Units: 0.00
32.50 Amount Allocated to Leverage Units: 0.00
Amount Allocated to Leverage Units: 0.00
EXAMPLE 2: AN ALLOCATION DETERMINATION EVENT REQUIRES THE USE OF THE LEVERAGE
UNITS TO INCREASE THE ALLOCATION TO THE BASKET UNITS TO GREATER THAN 100% OF
THE VALUE OF THE HYPOTHETICAL FUNDS
An Allocation Determination Event requires reallocation of more than
the entire value of the hypothetical funds tracked by the Reference Index to
the Basket Units. Because the Targeted Exposure is greater than 100%, the
Leverage Units must be used.
Before Reallocation: After Reallocation:
Level of the Reference Index: 110.00 Level of the Reference Index: 110.00
Floor Level: 86.00 Floor Level: 86.00
Cushion: approximately 21.82% Targeted Exposure: approximately 109.09%
Amount Allocated to Basket Units: 86.00 Amount Allocated to Basket Units: 120.00
Amount Allocated to Zero Coupon Bond Units: Amount Allocated to Zero Coupon Bond Units: 0.00
24.00 Amount Allocated to Leverage Units: 10.00
Amount Allocated to Leverage Units: 0.00
- -------------------------------------------------------------------------------
S-25
- ------------------------------------------------------------------------------
EXAMPLE 3: AN ALLOCATION DETERMINATION EVENT REQUIRES THE USE OF THE LEVERAGE
UNITS TO INCREASE THE ALLOCATION TO THE BASKET UNITS TO 150% OF THE VALUE OF
THE HYPOTHETICAL FUNDS
An Allocation Determination Event requires allocation of more than the
entire value of the hypothetical funds tracked by the Reference Index to the
Basket Units. Because the Targeted Exposure is at the maximum of 150%, the
maximum amount of the Leverage Units must be used.
Before Reallocation: After Reallocation:
Level of the Reference Index: 123.35 Level of the Reference Index: 123.35
Floor Level: 86.00 Floor Level: 86.00
Cushion: approximately 30.28% Targeted Exposure: 150.00%
Amount Allocated to Basket Units: 165.00 Amount Allocated to Basket Units: 185.03
Amount Allocated to Zero Coupon Bond Units: 0.00 Amount Allocated to Zero Coupon Bond Units: 0.00
Amount Allocated to Leverage Units: 41.65 Amount Allocated to Leverage Units: 61.68
EXAMPLE 4: AN ALLOCATION DETERMINATION EVENT REQUIRES THE ALLOCATION TO THE
BASKET UNITS TO BE REDUCED AND THE REDUCTION OF THE LEVERAGE UNITS TO ZERO
BEFORE INCREASING THE ALLOCATION TO THE ZERO COUPON BOND UNITS
An Allocation Determination Event requires the allocation of the value
of the hypothetical funds tracked by the Reference Index to the Basket Units to
be reduced. The Leverage Units Amount must be reduced to zero before any
reallocation to the Zero Coupon Bond Units can be effected.
Before Reallocation: After Reallocation:
Level of the Reference Index: 101.25 Level of the Reference Index: 101.25
Floor Level: 86.00 Floor Level: 86.00
Cushion: approximately 15.06% Targeted Exposure: approximately 75.31%
Amount Allocated to Basket Units: 109.50 Amount Allocated to Basket Units: 76.25
Amount Allocated to Zero Coupon Bond Units: 0.00 Amount Allocated to Zero Coupon Bond Units:
Amount Allocated to Leverage Units: 8.25 25.00
Amount Allocated to Leverage Units: 0.00
EXAMPLE 5: AN ALLOCATION DETERMINATION EVENT REQUIRES THE ALLOCATION TO THE
BASKET UNITS TO BE REDUCED An Allocation Determination Event requires
the allocation of the value of the hypothetical funds tracked by the Reference
Index to the Basket Units to be reduced.
Before Reallocation: After Reallocation:
Level of the Reference Index: 101.25 Level of the Reference Index: 101.25
Floor Level: 86.00 Floor Level: 86.00
Cushion: approximately 15.06% Targeted Exposure: approximately 75.31%
Amount Allocated to Basket Units: 90.00 Amount Allocated to Basket Units: 76.25
Amount Allocated to Zero Coupon Bond Units: Amount Allocated to Zero Coupon Bond Units:
11.25 25.00
Amount Allocated to Leverage Units: 0.00 Amount Allocated to Leverage Units: 0.00
- -------------------------------------------------------------------------------
S-26
- -------------------------------------------------------------------------------
EXAMPLE 6: A DEFEASANCE EVENT OCCURS, REQUIRING THE ALLOCATION TO THE BASKET
UNITS TO BE ZERO AND THE AMOUNT RESULTING FROM THE HYPOTHETICAL SALE OF THE
BASKET UNITS ADDED TO THE VALUE OF THE ZERO COUPON BOND UNITS IN THE REFERENCE
INDEX IS GREATER THAN THE FLOOR LEVEL
Upon the occurrence of a Defeasance Event, no hypothetical funds will
be allocated to the Basket Units and no hypothetical funds will be allocated to
the Basket Units for the remaining term of the PROCEEDS.
Before Reallocation: After Reallocation:
Level of the Reference Index: 86.35 Level of the Reference Index: 86.00
Floor Level: 86.10* Floor Level: 86.35
Cushion: 0.41% Targeted Exposure: 0.00%
Amount Allocated to Basket Units: 4.00 Amount Allocated to Basket Units: 0.00
Amount Allocated to Zero Coupon Bond Units: Amount Allocated to Zero Coupon Bond Units:
82.35 86.00
Amount Allocated to Leverage Units: 0.00 Amount Allocated to Leverage Units: 0.00
* Reflects an increase due to the Fee Protection Factor.
EXAMPLE 7: A DEFEASANCE EVENT OCCURS, REQUIRING THE ALLOCATION TO THE BASKET
UNITS TO BE ZERO AND THE AMOUNT RESULTING FROM THE HYPOTHETICAL SALE OF THE
BASKET UNITS ADDED TO THE VALUE OF THE ZERO COUPON BOND UNITS IN THE REFERENCE
INDEX IS LESS THAN THE FLOOR LEVEL
Upon the occurrence of a Defeasance Event, no hypothetical funds will
be allocated to the Basket Units and no hypothetical funds will be allocated
to the Basket Units for the remaining term of the PROCEEDS.
Before Reallocation: After Reallocation:
Level of the Reference Index: 85.50 Level of the Reference Index: 86.00
Floor Level: 86.10* Floor Level: 86.10
Cushion: -0.58% Targeted Exposure: 0.00%
Amount Allocated to Basket Units: 5.00 Amount Allocated to Basket Units: 0.00
Amount Allocated to Zero Coupon Bond Units: Amount Allocated to Zero Coupon Bond Units:
80.50 86.00
Amount Allocated to Leverage Units: 0.00 Amount Allocated to Leverage Units: 0.00
* Reflects an increase due to the Fee Protection Factor.
- ------------------------------------------------------------------------------
Hypothetical Historical Data on the Reference Index
The following tables and graphs set forth hypothetical historical
levels of the Reference Index, quarterly income and the Income Select 10 Basket
price return (excluding dividends) at the end of each month during six different
five year periods beginning April 30, 1994, 1995, 1996, 1997, 1998 and 1999.
This hypothetical historical information has been calculated as if the Reference
Index and each Index Component had existed during that period. For purposes of
these calculations, the stocks underlying the Income Select 10 Basket have
been selected from the stocks comprising the DJIA as of April 30th of each year
from 1994 to 2004.
The following hypothetical historical information should not be taken
as an indication of the future performance of the Reference Index during the
term of the PROCEEDS or future interest payments or the actual total payment on
the maturity date on the PROCEEDS.
The following hypothetical historical information has been calculated
by the Calculation Agent on the same basis as the Reference Index and the
interest payments will be calculated. However, the calculations used to
determine the hypothetical historical closing value of the Reference Index
contain assumptions and necessary estimates and approximations that will not be
reflected in the calculation of the level of the Reference Index and interest
payments during the term of the PROCEEDS. As a result, the following
hypothetical historical values of the Reference Index and quarterly income may
be different than they would be if those assumptions were not made and those
estimates and approximations were not necessary to calculate the hypothetical
historical values of the Reference Index and quarterly income.
S-27
The calculations assume that:
o the Reference Index was created on the first Business Day of each
five year period with a level of 97;
o the Income Select 10 Basket was reconstituted annually on April
30th of each year, or on an alternate date shortly after each
April 30th, as described below;
o upon the occurrence of a spin-off, a stock dividend or a special
cash dividend related to any Income Select 10 Stock, the adjusted
price reported on Bloomberg which adjusts for that spin-off,
stock dividend or special cash dividend was used to reflect the
impact of the spin-off, stock dividend or special cash dividend
for that Income Select 10 Stock as well as the call option
related to that Income Select 10 Stock;
o the value of any rights offering or issuances, including any
rights triggered by the making of an offer to purchase a certain
percentage of the issued and outstanding shares of a Income
Select 10 Stock (e.g., poison pill rights), was zero;
o the maximum exercise price of any hypothetical call option was
175% of the last price of the related stock as reported on
Bloomberg for the day the hypothetical call option was priced;
o where the implied volatility of any hypothetical call option was
unavailable for any day and no implied volatility for that
hypothetical call option was available for any previous day, the
implied volatility of that hypothetical call option was equal to
the median value of all hypothetical call implied volatilities in
the Income Select 10 Basket for which a value was available on
that day;
o reallocations between Basket Units and Zero Coupon Bond Units
were at mid-volatility or mid-swap rates (rather than at the
bid-volatility or bid-swap rates which will be used for
hypothetical purchases of Basket Units or Zero Coupon Bond Units,
or the offered-volatility or offered-swap rates which will be
used for hypothetical sales of Basket Units or Zero Coupon Bond
Units, in order to effect a reallocation).
The following hypothetical historical values have not been verified by
an independent third party. The options values were calculated using
approximately 93% of the historical implied mid-volatility available on
Bloomberg for the 3 months comparable listed options, the historical short-term
mid-interest rates available on Bloomberg and the historical dividend yield
available on Bloomberg. Swap rates used to calculate the hypothetical historical
Zero Coupon Bond Units were taken from Bloomberg. Quarterly income represents
the hypothetical historical interest paid per $1,000 principal amount per unit.
S-28
1994 1995 1996
---------------------------- ------------------------------ ------------------------------
Income Income Income
Select Select Select
Five Year Period Reference 10 Reference 10 Reference 10
Beginning Index Quarterly Price Index Quarterly Price Index Quarterly Price
April 30, 1994 Level Income Return Level Income Return Level Income Return
--------- ---------- --------- --------- ---------- ---------- --------- ---------- -------
January......... 96.43 26.80 102.32 111.02 33.50 118.53
February........ 100.44 -- 105.79 113.57 -- 120.94
March........... 102.69 -- 107.80 114.59 -- 121.93
April........... 97.00 -- 100.00 101.42 23.70 107.03 112.96 39.50 121.04
May............. 98.20 -- 101.02 104.45 -- 109.98 116.33 -- 124.15
June............ 96.58 -- 100.06 103.74 -- 109.58 118.18 -- 125.76
July............ 96.23 32.50 100.13 102.61 29.00 109.00 110.62 35.20 120.40
August.......... 100.00 -- 103.25 101.71 -- 108.45 112.24 -- 122.12
September....... 98.99 -- 102.81 108.88 -- 115.28 115.82 -- 125.42
October......... 99.47 37.70 103.47 106.25 27.60 113.42 114.45 39.50 125.00
November........ 94.57 -- 100.25 112.36 -- 118.85 121.04 -- 130.87
December........ 95.20 -- 101.04 113.01 -- 119.73 122.96 -- 132.77
1997 1998 1999
----------------------------- ------------------------------ ------------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Index Quarterly Price Index Quarterly Price Index Quarterly Price
Level Income Return Level Income Return Level Income Return
--------- ---------- --------- --------- ------------ --------- -------- ---------- --------
January......... 122.83 39.40 133.00 122.51 45.60 138.48 116.36 26.20 138.44
February........ 124.23 -- 134.35 132.13 -- 146.66 114.00 -- 135.11
March........... 121.30 -- 132.48 138.04 -- 151.54 114.57 -- 136.71
April........... 119.18 44.20 131.54 131.91 50.40 147.39 117.03 24.90 141.66
May............. 127.02 -- 138.09 127.69 -- 144.36
June............ 130.41 -- 140.91 126.45 -- 144.06
July............ 130.42 46.40 141.29 125.47 44.80 143.65
August.......... 126.79 -- 139.00 110.22 -- 126.20
September....... 135.97 -- 146.05 115.18 -- 134.07
October......... 124.65 50.30 138.23 118.27 27.90 139.25
November........ 130.55 -- 143.31 121.85 -- 144.53
December........ 131.25 -- 144.41 123.45 -- 146.92
[Graph setting forth hypothetical historic levels of the Income Select 10
PROCEEDS Index, the Income Select 10 price return and quarterly income from
April 1994 to April 1999.]
S-29
1995 1996 1997
------------------------------ ------------------------------- -----------------------------
Income Income Income
Select Select Select
Five Year Period Reference 10 Reference 10 Reference 10
Beginning Index Quarterly Price Index Quarterly Price Index Quarterly Price
April 30, 1995 Level Income Return Level Income Return Level Income Return
-------- ---------- ---------- --------- ----------- --------- --------- ---------- ------
January......... 106.07 33.50 110.36 118.88 39.50 123.83
February........ 108.50 -- 112.60 120.27 -- 125.09
March........... 109.28 -- 113.52 117.32 -- 123.35
April........... 97.00 -- 100.00 107.74 37.50 112.70 115.17 42.60 122.48
May............. 99.58 -- 102.40 111.17 -- 115.59 123.04 -- 128.58
June............ 98.83 -- 102.02 112.92 -- 117.10 126.32 -- 131.20
July............ 97.66 29.50 101.48 105.58 36.10 112.10 126.33 45.00 131.55
August.......... 96.78 -- 100.97 107.37 -- 113.71 122.82 -- 129.42
September....... 103.98 -- 107.34 111.10 -- 116.78 131.71 -- 135.99
October......... 101.40 26.50 105.60 110.14 40.10 116.39 120.79 48.60 128.71
November........ 107.47 -- 110.66 116.95 -- 121.85 126.82 -- 133.44
December........ 108.11 -- 111.47 119.03 -- 123.62 127.73 -- 134.46
1998 1999 2000
------------------------------- ----------------------------- -----------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Index Quarterly Price Index Quarterly Price Index Quarterly Price
Level Income Return Level Income Return Level Income Return
----------- ---------- -------- --------- ----------- -------- --------- ---------- ------
January......... 119.13 46.00 128.93 111.55 26.40 128.89 102.00 -- 105.35
February........ 128.97 -- 136.55 108.91 -- 125.80 101.25 -- 98.86
March........... 134.60 -- 141.10 109.49 -- 127.29 102.30 -- 105.21
April........... 128.52 49.90 137.23 111.98 25.20 131.89 102.21 3.80 103.78
May............. 124.15 -- 134.41 109.23 -- 127.80
June............ 122.63 -- 134.13 109.57 -- 128.71
July............ 121.56 47.20 133.75 105.60 17.40 121.27
August.......... 105.62 -- 117.51 105.71 -- 121.15
September....... 110.62 -- 124.83 103.94 -- 116.31
October......... 113.64 27.10 129.65 102.37 8.20 110.38
November........ 117.18 -- 134.57 102.78 -- 111.08
December........ 118.78 -- 136.80 102.75 -- 110.29
[Graph setting forth hypothetical historic levels of the Income Select 10
PROCEEDS Index, the Income Select 10 price return and quarterly income from
April 1995 to April 2000.]
S-30
1996 1997 1998
------------------------------ ------------------------------ ----------------------------
Income Income Income
Select Select Select
Five Year Period Reference 10 Reference 10 Reference 10
Beginning Index Quarterly Price Index Quarterly Price Index Quarterly Price
April 30, 1996 Level Income Return Level Income Return Level Income Return
-------- ---------- --------- --------- ---------- ---------- --------- ---------- --------
January......... 104.90 33.90 109.60 104.15 32.70 114.11
February........ 105.98 -- 110.71 111.18 -- 120.85
March........... 103.18 -- 109.16 115.59 -- 124.87
April........... 97.00 -- 100.00 101.61 35.80 108.40 110.78 40.00 121.45
May............. 99.39 -- 102.30 107.90 -- 113.79 107.81 -- 118.96
June............ 100.90 -- 103.63 110.60 -- 116.12 106.81 -- 118.71
July............ 94.70 29.00 99.21 110.62 38.70 116.43 106.21 30.50 118.37
August.......... 96.14 -- 100.63 107.37 -- 114.54 95.81 -- 104.00
September....... 98.91 -- 103.35 114.75 -- 120.35 99.68 -- 110.48
October......... 98.04 31.90 103.01 105.70 39.10 113.91 101.59 17.30 114.74
November........ 103.31 -- 107.84 110.24 -- 118.10 103.65 -- 119.10
December........ 105.01 -- 109.41 110.56 -- 119.00 104.62 -- 121.07
1999 2000 2001
------------------------------ ----------------------------- -----------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Index Quarterly Price Index Quarterly Price Index Quarterly Price
Level Income Return Level Income Return Level Income Return
--------- ---------- --------- --------- ---------- ----------- --------- ---------- -------
January......... 100.13 16.60 114.08 93.64 -- 93.24 99.62 -- 95.82
February........ 98.07 -- 111.34 93.43 -- 87.50 100.08 -- 96.01
March........... 98.65 -- 112.65 94.17 -- 93.12 100.52 -- 93.28
April........... 100.23 15.90 116.73 94.19 -- 91.84 100.94 -- 98.24
May............. 98.52 -- 113.11 94.48 -- 92.02
June............ 98.78 -- 113.91 95.08 -- 87.85
July............ 96.05 11.30 107.33 95.74 -- 86.89
August.......... 96.14 -- 107.22 96.43 -- 91.59
September....... 95.30 -- 102.94 97.03 -- 86.18
October......... 94.25 -- 97.69 97.63 -- 90.56
November........ 94.49 -- 98.31 98.21 -- 88.78
December........ 94.32 -- 97.61 98.87 -- 94.75
[Graph setting forth hypothetical historic levels of the Income Select 10
PROCEEDS Index, the Income Select 10 price return and quarterly income from
April 1996 to April 2001.]
* A Defeasance Event occurred on June 16, 2000.
S-31
1997 1998 1999
----------------------------- --------------------------- -----------------------------
Income Income Income
Select Select Select
Five Year Period Reference 10 Reference 10 Reference 10
Beginning Index Quarterly Price Index Quarterly Price Index Quarterly Price
April 30, 1997 Level Income Return Level Income Return Level Income Return
-------- ----------- ---------- -------- --------- ----------- --------- --------- ---------
January......... 99.36 32.90 105.03 94.92 16.60 105.00
February........ 106.39 -- 111.24 92.69 -- 102.48
March........... 110.90 -- 114.94 93.24 -- 103.69
April........... 97.00 -- 100.00 105.99 38.90 111.79 94.76 15.40 107.44
May............. 103.07 -- 104.74 102.97 -- 109.49 92.82 -- 104.11
June............ 105.82 -- 106.88 101.96 -- 109.26 93.01 -- 104.85
July............ 105.82 37.70 107.16 101.34 30.70 108.95 90.10 10.80 98.79
August.......... 102.84 -- 105.43 90.91 -- 95.72 90.07 -- 98.69
September....... 110.16 -- 110.78 94.75 -- 101.69 89.40 -- 94.75
October......... 101.17 37.90 104.85 96.46 16.50 105.61 88.44 -- 89.92
November........ 105.44 -- 108.70 98.30 -- 109.62 88.45 -- 90.48
December........ 105.81 -- 109.53 99.24 -- 111.44 88.07 -- 89.85
2000 2001 2002
------------------------------- ---------------------------- -----------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Index Quarterly Price Index Quarterly Price Index Quarterly Price
Level Income Return Level Income Return Level Income Return
--------- --------- -------- --------- ----------- --------- -------- ----------- -------
January......... 87.04 -- 85.82 94.74 -- 88.19 100.59 -- 84.70
February........ 86.90 -- 80.54 95.30 -- 88.37 100.74 -- 86.17
March........... 87.66 -- 85.71 95.90 -- 85.86 100.88 -- 89.44
April........... 87.58 -- 84.54 96.25 -- 90.43 101.06 -- 84.85
May............. 87.70 -- 84.70 97.21 -- 92.33
June............ 88.55 -- 80.86 97.58 -- 91.45
July............ 89.25 -- 79.98 98.21 -- 92.38
August.......... 90.09 -- 84.31 98.75 -- 89.56
September....... 90.86 -- 79.32 99.57 -- 83.45
October......... 91.50 -- 83.36 99.97 -- 76.82
November........ 92.30 -- 81.71 100.21 -- 83.61
December........ 93.47 -- 87.21 100.40 -- 85.30
[Graph setting forth hypothetical historic levels of the Income Select 10
PROCEEDS Index, the Income Select 10 price return and quarterly income from
April 1997 to April 2002.]
* A Defeasance Event occurred on June 23, 2000.
S-32
1998 1999 2000
------------------------------ ------------------------------ -----------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Five Year Period Index Quarterly Price Index Quarterly Price Index Quarterly Price
Beginning 1998 Level Income Return Level Income Return Level Income Return
--------- ---------- --------- ------------------------------ ------------------------------
January......... 87.94 12.10 93.69 80.47 -- 76.58
February........ 85.78 -- 91.44 80.52 -- 71.86
March........... 86.32 -- 92.53 81.15 -- 76.48
April........... 97.00 -- 100.00 87.61 11.90 95.87 81.13 -- 75.43
May............. 94.19 -- 97.70 85.67 -- 92.90 81.03 -- 75.58
June............ 93.26 -- 97.50 85.78 -- 93.56 82.33 -- 72.15
July............ 92.72 25.00 97.22 83.31 8.60 88.15 83.01 -- 71.37
August.......... 84.40 -- 85.41 83.20 -- 88.06 84.00 -- 75.23
September....... 87.94 -- 90.74 82.92 -- 84.55 84.92 -- 70.78
October......... 89.20 12.80 94.24 82.04 -- 80.23 85.49 -- 74.38
November........ 90.51 -- 97.82 81.99 -- 80.74 86.48 -- 72.92
December........ 91.23 -- 99.44 81.63 -- 80.17 88.01 -- 77.82
2001 2002 2003
------------------------------ ------------------------------ -----------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Index Quarterly Price Index Quarterly Price Index Quarterly Price
Level Income Return Level Income Return Level Income Return
--------- ---------- --------- ------------------------------ ------------------------------
January......... 89.57 -- 78.70 96.63 -- 75.58 100.65 -- 58.88
February........ 90.18 -- 78.86 96.99 -- 76.89 100.75 -- 57.84
March........... 90.84 -- 76.61 96.55 -- 79.81 100.87 -- 57.04
April........... 90.97 -- 80.69 97.38 -- 75.71 100.98 -- 60.17
May............. 92.19 -- 82.38 98.61 -- 76.09
June............ 92.40 -- 81.60 99.06 -- 69.88
July............ 93.68 -- 82.44 99.41 -- 63.50
August.......... 94.27 -- 79.92 99.76 -- 64.53
September....... 95.71 -- 74.46 99.99 -- 56.36
October......... 96.80 -- 68.55 100.19 -- 61.03
November........ 96.34 -- 74.60 100.36 -- 67.41
December........ 96.36 -- 76.11 100.52 -- 65.25
[Graph setting forth hypothetical historic levels of the Income Select 10
PROCEEDS Index, the Income Select 10 price return and quarterly income from
April 1998 to April 2003.]
* A Defeasance Event occurred on June 6, 2000.
S-33
1999 2000 2001
------------------------------ ------------------------------ -----------------------------
Income Income Income
Select Select Select
Five Year Period Reference 10 Reference 10 Reference 10
Beginning Index Quarterly Price Index Quarterly Price Index Quarterly Price
April 30, 1999 Level Income Return Level Income Return Level Income Return
--------- ----------- --------- --------- ---------- ---------- --------- ----------- --------
January......... 78.83 8.20 79.77 85.22 -- 81.98
February........ 77.43 -- 74.86 85.78 -- 82.14
March........... 79.07 -- 79.67 85.89 -- 79.81
April........... 97.00 -- 100.00 78.33 -- 78.58 85.79 -- 84.05
May............. 93.15 -- 96.77 77.96 -- 78.73 86.83 -- 85.82
June............ 93.53 -- 97.46 78.39 -- 75.16 86.89 -- 85.00
July............ 87.58 25.70 91.82 78.72 -- 74.34 88.66 -- 85.87
August.......... 87.40 -- 91.73 80.25 -- 78.36 89.37 -- 83.25
September....... 84.57 -- 88.07 80.24 -- 73.73 91.29 -- 77.57
October......... 81.66 12.00 83.58 80.95 -- 77.48 92.76 -- 71.40
November........ 82.02 -- 84.11 81.67 -- 75.96 91.68 -- 77.71
December........ 81.23 -- 83.51 83.73 -- 81.06 91.34 -- 79.29
2002 2003 2004
------------------------------ ------------------------------ -----------------------------
Income Income Income
Select Select Select
Reference 10 Reference 10 Reference 10
Index Quarterly Price Index Quarterly Price Index Quarterly Price
Level Income Return Level Income Return Level Income Return
--------- ---------- ---------- --------- ---------- ----------- -------- ----------- --------
January......... 91.83 -- 78.73 98.56 -- 61.34 100.73 -- 75.49
February........ 92.45 -- 80.10 98.96 -- 60.25 100.84 -- 76.44
March........... 91.52 -- 83.14 99.13 -- 59.42 100.94 -- 75.63
April........... 92.85 -- 78.87 99.33 -- 62.68 101.03 -- 72.40
May............. 94.31 -- 79.26 99.91 -- 67.18
June............ 95.22 -- 72.79 100.03 -- 68.10
July............ 96.41 -- 66.15 100.08 -- 68.71
August.......... 96.95 -- 67.22 100.17 -- 70.73
September....... 97.74 -- 58.71 100.32 -- 68.62
October......... 97.95 -- 63.57 100.36 -- 70.21
November........ 97.57 -- 70.23 100.50 -- 71.43
December........ 98.52 -- 67.97 100.63 -- 76.14
[Graph setting forth hypothetical historic levels of the Income Select 10
PROCEEDS Index, the Income Select 10 price return and quarterly income from
April 1999 to April 2004.]
* A Defeasance Event occurred on September 22, 2001.
S-34
DESCRIPTION OF THE INCOME SELECT 10 BASKET
The Income Select 10 Basket is designed to track the performance of a
hypothetical investment in a portfolio using a "covered call" strategy on the
Income Select 10 Stocks. The "covered call" strategy is an investment strategy
in which an investor:
o buys the stocks; and
o sells call options on the stocks with exercise prices higher than
the prices of the stocks when the options are priced.
The "covered call" strategy provides income from option premiums, or
the value of the option when it is priced, helping to offset losses if there is
a decline in the prices of the stocks to which the options relate. However, the
strategy limits participation in appreciation of a stock beyond the option's
exercise price. Thus, in a period of significant stock market increases, the
"covered call" strategy will tend to produce lower returns than ownership of the
applicable Income Select 10 Stock. See the section entitled "Risk Factors--Risk
Factors Relating to the Basket Units--The appreciation of the Income Select 10
Basket will be capped due to the "covered call" strategy" in this prospectus
supplement.
The hypothetical call options included in the Income Select 10 Basket
will be sold on a quarterly basis for a three month term. The hypothetical call
options are not intended to represent or indicate that any of those options
exist or are capable of being traded. For more information about the
hypothetical call options, see the section entitled "--Hypothetical Call
Options" in this prospectus supplement.
The value of the Income Select 10 Basket will also include the value of
dividends on the Income Select 10 Stocks. The Income Select 10 Stocks and their
respective dividend yields are shown below, and have been determined by the
Calculation Agent to be the ten common stocks in the DJIA having the highest
dividend yield on April 28, 2005. The "dividend yield" for each common stock is
determined by annualizing the last quarterly or semi-annual ordinary cash
dividend for which the ex-dividend date has occurred, excluding any
extraordinary dividend, summing the result and then dividing that result by the
last available sale price for each stock on its primary exchange on the date
that dividend yield is to be determined. The average dividend yield of the
stocks contained in the Income Select 10 Index as of May 2, 2005 was 4.23%.
Dividend Share
Company Yield(1) Multiplier(2)
------- ----------- ---------------
Altria Group, Inc....................................... 4.46% 0.15288
Citigroup Inc........................................... 3.78% 0.21492
Coca-Cola Co. .......................................... 2.57% 0.22952
E.I. du Pont de Nemours and Company..................... 2.97% 0.21191
General Motors Corporation.............................. 7.36% 0.36819
J.P. Morgan Chase & Co.................................. 3.82% 0.28114
Merck & Co., Inc........................................ 4.47% 0.29412
Pfizer Inc. ............................................ 2.77% 0.36483
SBC Communication Inc................................... 5.42% 0.42052
Verizon Communications Inc.............................. 4.63% 0.28596
- ------------------
(1) As of May 2, 2005, as obtained from Bloomberg Financial Markets.
(2) As of May 2, 2005, as obtained from the Calculation Agent.
The Share Multipliers will be recalculated by the Calculation Agent
on April 30th of each year, or in certain circumstances on a day shortly
thereafter as described below. The "Share Multiplier" is set to equal the
number of shares of that stock, or portion thereof, based upon the closing
market price of that stock on the Annual Reconstitution Date, so that each
stock represents approximately an equal percentage of the Income Select 10
Basket as of the Annual Reconstitution Date. Each Share Multiplier remains
constant until adjusted for certain corporate events, option exercises and
annual reconstitutions as described below.
Please note that an investment in the PROCEEDS does not entitle you to
any dividends, voting rights, option premiums or any other ownership interest in
respect of the securities included in the Income Select 10 Basket.
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Determination of the Income Select 10 Stocks
The Income Select 10 Stocks are the stocks that have been determined by
the Calculation Agent to be the ten stocks in the DJIA having the highest
dividend yield on April 28, 2005.
Annual Income Select 10 Basket Reconstitution
As of the close of business on each Anniversary Date, the Income
Select 10 Basket will be reconstituted to include the ten stocks in the DJIA
having the highest Dividend Yield (the "New Stocks") on the second scheduled
Index Business Day prior to the applicable Anniversary Date (the "Annual
Reconstitution Date"). "Anniversary Date" will mean April 30th of each year;
provided, however, that if the date is not an Index Business Day or a Market
Disruption Event occurs on that date, then the Anniversary Date for that year
will mean the immediately succeeding Index Business Day on which a Market
Disruption Event does not occur. The Calculation Agent will only add a stock
having characteristics as of the applicable Annual Reconstitution Date that
will permit the Income Select 10 Basket to remain within the criteria
specified in the rules of the American Stock Exchange (the "AMEX") and within
the applicable rules of the SEC. The criteria and rules will apply only on an
Annual Reconstitution Date to exclude a proposed New Stock. If a proposed New
Stock does not meet these criteria or rules, the Calculation Agent will
replace it with the stock in the DJIA with the next highest Dividend Yield
which meets the criteria and rules. These criteria currently provide, among
other things, (i) that each component stock must have a minimum market value
of at least $75 million, except that up to 10% of the component securities in
the Income Select 10 Basket may have a market value of $50 million; (ii) that
each component stock must have an average monthly trading volume in the
preceding six months of not less than 1,000,000 shares, except that up to 10%
of the component stocks in the Income Select 10 Basket may have an average
monthly trading volume of 500,000 shares or more in the last six months; (iii)
90% of the Income Select 10 Basket's numerical index value and at least 80% of
the total number of component stocks will meet the then current criteria for
standardized option trading set forth in the rules of the AMEX; and (iv) all
component stocks will either be listed on the AMEX, the NYSE or traded through
the facilities of the National Association of Securities Dealers Automated
Quotation System and reported as National Market System Securities.
The Share Multiplier for each New Stock will be determined by the
Calculation Agent and will equal the number of shares of each New Stock, based
upon the closing market price of that New Stock on the Anniversary Date, so that
each New Stock represents approximately an equal percentage of a value equal to
the Income Select 10 Basket in effect at the close of business on the applicable
Anniversary Date; provided, however, that if the Calculation Agent holds more
than 8% of the outstanding shares of any New Stock, the Share Multiplier for
that New Stock will be adjusted to reflect a holding in the Income Select 10
Basket of no more than 7.5% of the outstanding shares of the applicable New
Stock. As of the Pricing Date, the Calculation Agent will not hold more than 1%
of the outstanding shares of any Income Select 10 Stock. As an example, if the
Income Select 10 Basket in effect at the close of business on an Anniversary
Date equaled 200, then each of the ten New Stocks would be allocated a portion
of the value of the Income Select 10 Basket equal to 20 and if, for example, the
closing market price of a New Stock on the Anniversary Date was 40, the
applicable Share Multiplier would be 0.5. If the Income Select 10 Basket equaled
80, then each of the ten New Stocks would be allocated a portion of the value of
the Income Select 10 Basket equal to 8 and if the closing market price of a New
Stock on the Anniversary Date was 40, the applicable Share Multiplier would be
0.2.
Dow Jones Industrial Average
The DJIA is comprised of 30 stocks chosen by the editors of the Wall
Street Journal (the "WSJ") as representative of the broad market of American
industry generally. The companies are major factors in their industries and
their stocks are typically widely held by individuals and institutional
investors. Changes in the composition of the DJIA are made entirely by the
editors of the WSJ without consultation with the companies, the stock exchange
or any official agency or ML&Co. For the sake of continuity, changes are made
infrequently. Most substitutions have been the result of mergers, but from time
to time, changes may be made to achieve a better representation. The components
of the DJIA may be changed at any time for any reason. Dow Jones & Company,
Inc., publisher of the WSJ, is not affiliated with ML&Co., has not participated
in any way in the creation of the PROCEEDS or in the selection of stocks to be
included in the Income Select 10 Basket and has not reviewed or approved any
information included in this prospectus supplement.
The first DJIA, consisting of 12 stocks, was published in the WSJ in
1896. The list grew to 20 stocks in 1916 and to 30 stocks on October 1, 1928.
For two periods of 17 consecutive years each, there were no changes to the list:
March 15, 1939 through July 2, 1956 and June 2, 1959 through August 8, 1976.
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Adjustments to the Share Multipliers and the Income Select 10 Basket
In addition to the adjustments to the Share Multiplier related to
hypothetical call option exercise, the Share Multiplier for any Income Select 10
Stock and the Income Select 10 Basket will be adjusted as follows:
1. If a Income Select 10 Stock is subject to a stock split or
reverse stock split, then once the split has become effective, the
Share Multiplier for that Income Select 10 Stock will be adjusted to
equal the product of the number of shares of that Income Select 10
Stock issued with respect to one such share of that Income Select 10
Stock in the split and the prior multiplier.
2. If a Income Select 10 Stock is subject to a stock dividend,
issuance of additional shares of the Income Select 10 Stock, that is
given equally to all holders of shares of the issuer of that Income
Select 10 Stock, then once the dividend has become effective and that
Income Select 10 Stock is trading ex-dividend, the Share Multiplier
will be adjusted so that the new Share Multiplier shall equal the
former Share Multiplier plus the product of the number of shares of
that Income Select 10 Stock issued with respect to one such share of
that Income Select 10 Stock and the prior multiplier.
3. If a company whose common stock is included in the Income
Select 10 Basket (each, a "Income Select 10 Company") is being
liquidated or is subject to a proceeding under any applicable
bankruptcy, insolvency or other similar law, that Income Select 10
Stock will continue to be included in the Income Select 10 Basket so
long as a market price for that Income Select 10 Stock is available. If
a market price is no longer available for a Income Select 10 Stock for
whatever reason, including the liquidation of the issuer of the Income
Select 10 Stock or the subjection of the issuer of the Income Select 10
Stock to a proceeding under any applicable bankruptcy, insolvency or
other similar law, then the value of that Income Select 10 Stock will
equal zero in connection with calculating the value of the Income
Select 10 Basket for so long as no market price is available, and no
attempt will be made to immediately find a replacement stock or
increase the value of the Income Select 10 Basket to compensate for the
deletion of that Income Select 10 Stock. If a market price is no longer
available for a Income Select 10 Stock as described above, the value of
the Income Select 10 Basket will be computed based on the remaining
Income Select 10 Stocks for which market prices are available and no
new stock will be added to the Income Select 10 Basket until the annual
reconstitution of the Income Select 10 Basket. As a result, there may
be periods during which the Income Select 10 Basket contains fewer than
ten Income Select 10 Stocks.
4. If a Income Select 10 Company has been subject to a merger
or consolidation and is not the surviving entity or is nationalized,
then a value for that Income Select 10 Stock will be determined at the
time the issuer is merged or consolidated or nationalized and will
equal the last available market price for that Income Select 10 Stock
and that value will be constant until the Income Select 10 Basket is
reconstituted. At that time, no adjustment will be made to the Share
Multiplier of the relevant Income Select 10 Stock.
5. If a Income Select 10 Company issues to all of its
shareholders equity securities that are publicly traded of an issuer
other than the Income Select 10 Company, or a tracking stock is issued
by a Income Select 10 Company to all of its shareholders, then the new
equity securities will be added to the Income Select 10 Basket as a new
Income Select 10 Stock. The Share Multiplier for the new Income Select
10 Stock will equal the product of the original Share Multiplier with
respect to the Income Select 10 Stock for which the new Income Select
10 Stock is being issued (the "Original Income Select 10 Stock") and
the number of shares of the new Income Select 10 Stock issued with
respect to one share of the Original Income Select 10 Stock.
6. If a Income Select 10 Stock represents a market
capitalization of less than $50,000,000, that stock will be immediately
removed from the Income Select 10 Basket. A pro rata portion of the
value of that stock at the time of its removal from the Income Select
10 Basket will be reflected in Share Multiplier adjustments among the
remaining Income Select 10 Stocks until the next Annual Reconstitution
Date.
7. If the average monthly volume of any Income Select 10 Stock
during the previous 6 months to any Index Business Day is less than
500,000 shares, that stock will be immediately removed from the Income
Select 10 Basket. A pro rata portion of the value of that stock at the
time of its removal from the Income Select 10 Basket will be reflected
in Share Multiplier adjustments among the remaining Income Select 10
Stocks until the next Annual Reconstitution Date.
8. If a Market Disruption Event occurs due to a suspension of
or material limitation on trading of a particular Income Select 10
Stock and is continuing for more than 10 consecutive Business Days, the
relevant stock will be immediately removed from the Income Select 10
Basket. A pro rata portion of the value of that stock at the
S-37
time of its removal from the Income Select 10 Basket will be
reflected in Share Multiplier adjustments among the remaining Income
Select 10 Stocks until the next Annual Reconstitution Date.
9. If the Calculation Agent holds more than 8% of the
outstanding shares of any Income Select 10 Stock, the Share Multiplier
for that Income Select 10 Stock will be adjusted to reflect a holding
in the Income Select 10 Basket of no more than 7.5% of the outstanding
shares of the applicable Income Select 10 Stock. A pro rata portion of
the value of the number of shares of that Income Select 10 Stock at the
time of its removal from the Income Select 10 Basket will be reflected
in Share Multiplier adjustments among the remaining Income Select 10
Stocks until the next Annual Reconstitution Date.
10. In order to preserve the continuity of the value of the
Income Select 10 Basket, if any hypothetical call option has a value
greater than zero at expiration, the Share Multiplier of the related
stock in the Income Select 10 Basket will be reduced by an amount that,
when multiplied by the closing price of the related stock on the last
Index Business Day of the quarterly calculation period, equals the
value of the hypothetical option at expiration.
Except for 10 above, no adjustments of any Share Multiplier of a Income
Select 10 Stock will be required unless the adjustment would require a change of
at least 1% in the Share Multiplier then in effect. The Share Multiplier
resulting from any of the adjustments specified above will be rounded to the
nearest ten-thousandth with five hundred-thousandths being rounded upward.
The Calculation Agent expects that no adjustments to the Share
Multiplier of any Income Select 10 Stock or to the Income Select 10 Basket will
be made other than those specified above and those specified below under
"--Calculation of the Value of the Income Select 10 Basket"; however, the
Calculation Agent may at its discretion make adjustments to maintain the value
of the Income Select 10 Basket if certain events would otherwise alter the value
of the Income Select 10 Basket despite no change in the market prices of the
Income Select 10 Stocks.
Calculation of the Value of the Income Select 10 Basket
The value of the Income Select 10 Basket will be calculated at the
close of business on each day by the Calculation Agent and published on Reuters
Page MEREDUS15. The value of the Income Select 10 Basket will be equal to 100 on
the Pricing Date. The value of the Income Select 10 Basket on each Index
Business Day will equal the sum of the values of the Income Select 10 Stocks and
the Adjusted Quarterly Income, less the Current Option Value (determined as
described under "--Hypothetical Call Options--Valuation of hypothetical call
options" in this Prospectus Supplement). The value of the Income Select 10
Basket on any day that is not an Index Business Day will equal the value of the
Income Select 10 Basket on the previous day as reduced by the pro rata portion
of the Basket Adjustment Factor for that day.
The "Adjusted Quarterly Income" will equal the sum of the hypothetical
income related to each of the Income Select 10 Stocks (the "Quarterly Income"),
reduced by the pro rata portion of the Basket Adjustment Factor. The Quarterly
Income for each Income Select 10 Stock will be the cash dividends per share in
respect of that Income Select 10 Stock during that quarterly calculation period
and Targeted Quarterly Premium, less the Premium Adjustment, if any, multiplied
by the applicable Share Multiplier. The value of the Adjusted Quarterly Income
on any day that is not an Index Business Day will equal the value of the
Adjusted Quarterly Income on the previous day as reduced by the pro rata portion
of the Basket Adjustment Factor for that day.
The "Targeted Quarterly Premium" equals the adjusted annual target
yield less the historical dividend yield on that Income Select 10 Stock on the
first day of that quarterly calculation period, multiplied by the closing price
of that Income Select 10 Stock on the day the hypothetical call option is
priced, divided by 4. The adjusted annual target yield is obtained by increasing
the annual target yield of 10% on the Income Select 10 Basket on the first day
of each quarterly calculation period by an amount intended to, but which may or
may not, offset the value of the Basket Adjustment Factor. The annual target
yield has the rate described above, and does not represent a guarantee,
representation or estimate of the actual annual yield of the PROCEEDS.
If the highest exercise price bid for any option is less than 105% of
the closing price of the related stock on the day the hypothetical call option
is priced, a premium adjustment will be subtracted from the cash dividends and
the Targeted Quarterly Premium. A "premium adjustment" is the difference between
the Targeted Quarterly Premium in respect of that Income Select 10 Stock and the
actual highest quarterly premium in respect of that hypothetical call option
with an exercise price equal to 105% of the closing price of that Income Select
10 Stock.
If any hypothetical call option has a value greater than zero at
expiration, the value of that option will be removed from the value of the
Income Select 10 Basket at the close of business on the day the option expires.
In order to preserve the continuity of the value of the Income Select 10 Basket
following any removal, the contributing value of the related Income Select 10
Stock to the Income Select 10 Basket will be reduced by an amount equal to the
value of the option at expiration. This
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reduction will be effected by decreasing the Share Multiplier of the related
stock in the Income Select 10 Basket by an amount that, when multiplied by the
closing price of the related stock on the last Index Business Day of the
quarterly calculation period, equals the value of the hypothetical option at
expiration. The reduction of the Share Multiplier of an underlying stock under
these circumstances will reduce the contributing value of the Income Select 10
Stock to the Income Select 10 Basket. Because these reductions will have the
effect of ensuring the continuity of the value of the Income Select 10 Basket,
they will not result in Allocation Determination Events. The reduced Share
Multiplier will be used to calculate the value of the Income Select 10 Basket,
and thus the value of the Basket Units, on the following Index Business Day.
For more information on the reduction of Share Multipliers under these
circumstances, see the section entitled "--Determination of the Income Select
10 Stocks--Adjustments to the Share Multipliers and the Income Select 10
Basket" in this prospectus supplement.
The value of a cash dividend or distribution will be included in the
Basket Unit Income at the close of business on the ex-dividend date for that
dividend or distribution. The value of premiums in respect of hypothetical call
options will be included in the Basket Unit Income at the close of business on
the day on which the hypothetical call option is priced.
The Basket Unit Income will be removed from the value of the Income
Select 10 Basket at the close of business on the last day of the related
quarterly calculation period. The Basket Unit Income will be zero until
hypothetical call options are priced during the following quarterly calculation
period or until the next ex-dividend date for an underlying stock. The removal
of Basket Unit Income will reduce the value of the Income Select 10 Basket and
may therefore cause an Allocation Determination Event in which the allocation to
the Basket Units is reduced, even if the prices of the Income Select 10 Stocks
have not fallen. For risks associated with the occurrence of an Allocation
Determination Event under these circumstances, see the section entitled "Risk
Factors--Risk Factors Relating to the Basket Units--The removal of the value of
the Basket Unit Income will reduce the value of the Basket Units at the end of
each quarterly calculation period and may cause an Allocation Determination
Event in this prospectus supplement.
If no value (including a closing value) of the Income Select 10 Basket
is available on any date because of a Market Disruption Event or otherwise,
unless deferred by the Calculation Agent as described below under
"--Hypothetical Call Options--Valuation of hypothetical call options" in this
prospectus supplement, the Calculation Agent will determine the values of the
components of the Income Select 10 Basket as follows:
o the value of any Income Select 10 Stock for which no value is
available will be the arithmetic mean, as determined by the
Calculation Agent, of the value of that stock obtained from as
many dealers in equity securities (which may include MLPF&S or
any of our other subsidiaries or affiliates), but not exceeding
three of those dealers, as will make that value available to
the Calculation Agent; and
o the value of any hypothetical call option related to a Income
Select 10 Stock for which no value is available will be the
arithmetic mean, as determined by the Calculation Agent, of the
value of that option obtained from as many dealers in options
(which may include MLPF&S or any of our other subsidiaries or
affiliates), but not exceeding three of those dealers, as will
make that value available to the Calculation Agent.
Hypothetical Call Options
Terms of hypothetical call options
The Calculation Agent will price hypothetical cash-settled call options
relating to shares of each of the Income Select 10 Stocks on a quarterly basis
for a three month term, beginning on the Pricing Date. Hypothetical call options
will be priced on the first Index Business Day of each quarterly calculation
period. The hypothetical call options relating to each underlying stock will
correlate to the number of shares of that underlying stock used to calculate the
value of the Income Select 10 Basket on the day the options are priced. For more
information about the number of shares of an underlying stock used to calculate
the value of the Income Select 10 Basket, see the section entitled "Description
of the Income Select 10 Basket--Calculation of the Value of the Income Select 10
Basket" in this prospectus supplement.
Each hypothetical call option will:
o expire on the last day of the quarterly calculation period;
o be automatically settled on the last Business Day of the
quarterly calculation period if the closing price of the
underlying stock on that day exceeds the exercise price; and
o have an exercise price greater than or equal to 105% of the
closing price of the underlying stock on the day the
hypothetical call option is priced.
S-39
The exercise price of each hypothetical call option will be determined
through the bidding process described below. Before seeking bids on the exercise
price of a hypothetical call option, the Calculation Agent will determine the
option's Targeted Quarterly Premium. Once the Calculation Agent has determined
the Targeted Quarterly Premium for a hypothetical call option, it will seek
exercise prices for that hypothetical call option from as many dealers in
options (which may include MLPF&S or any of our other subsidiaries or
affiliates), but not exceeding five of those dealers, as will make bid prices
available to the Calculation Agent. The exercise price for the hypothetical call
option will equal the highest exercise price quoted by these dealers or, in the
Calculation Agent's absolute discretion, such higher exercise price as the
Calculation Agent determines to be quoted by another principal market
participant, and the value of this hypothetical call option and the related
Targeted Quarterly Premium will be included in the value of the Income Select 10
Basket at close of business on the day the hypothetical call option is priced.
If the highest exercise price bid is less than 105% of the closing
price of the related stock on the day the hypothetical call option is priced,
the Calculation Agent will set the exercise price of the hypothetical call
option at 105% of the closing price of the related stock on the day the
hypothetical call option is priced and will seek quotations for premiums for the
hypothetical call option from as many dealers in options (which may include
MLPF&S or any of our other subsidiaries or affiliates), but not exceeding five
of those dealers, as will make bid prices available to the Calculation Agent.
The premium for the hypothetical call option will equal the highest premium
quoted by these dealers or, in the Calculation Agent's absolute discretion, any
higher exercise price as the Calculation Agent determines to be quoted by
another principal market participant, and the value of this hypothetical call
option and the related premium will be included in the value of the Income
Select 10 Basket at the close of business on the day the hypothetical call
option is priced. Under these circumstances, the Basket Unit Income will be less
than it would have been if the highest exercise price bid had been greater than
or equal to 105% of the closing price of the related stock on the day the
hypothetical call option was priced, except to the extent that dividends on the
Income Select 10 Stocks are higher than historical dividends by an amount
sufficient to offset the difference between the actual Basket Unit Income and
the Basket Unit Income that would have resulted if the premium in respect of
each hypothetical call option had been equal to its Targeted Quarterly Premium.
In seeking exercise prices or premiums from dealers in options in
respect of hypothetical call options relating to any of the underlying stocks,
the Calculation Agent may reject any exercise price or premium that does not
meet the requirements for hypothetical call options stated above or that relates
to a number of shares of the related underlying stock that is different than the
number of shares of that stock used to calculate the value of the Income Select
10 Basket with respect to the outstanding number of PROCEEDS at the close of
business on the Index Business Day prior to the date on which the options are
priced.
The closing price of any Income Select 10 Stock on any date will be (i)
if the common stock is listed on a national securities exchange on that date of
determination, the last reported sale price, regular way, of the principal
trading session on that date on the principal U.S. exchange on which the common
stock is listed or admitted to trading, (ii) if the common stock is not listed
on a national securities exchange on that date of determination, or if the last
reported sale price on that exchange is not obtainable (even if the common stock
is listed or admitted to trading on that exchange), and the common stock is
quoted on The Nasdaq National Market, the last reported sale price of the
principal trading session on that date as reported on The Nasdaq National Market
and (iii) if the common stock is not quoted on The Nasdaq National Market on
that date of determination, or if the last reported sale price on the Nasdaq
Stock Market is not obtainable (even if the common stock is quoted on The Nasdaq
National Market), the last reported sale price of the principal trading session
on the over-the-counter market on that date as reported on the OTC Bulletin
Board, the National Quotation Bureau or a similar organization. If no reported
sale price of the principal trading session is available pursuant to clauses
(i), (ii) or (iii) above or if there is a Market Disruption Event, the trading
price on any date of determination, unless deferred by the Calculation Agent as
described in the preceding sentence, will be the arithmetic mean, as determined
by the Calculation Agent, of the bid prices of the common stock obtained from as
many dealers in that stock (which may include MLPF&S or any of our other
subsidiaries or affiliates), but not exceeding three of those dealers, as will
make bid prices available to the Calculation Agent. A security "quoted on The
Nasdaq National Market" will include a security included for listing or
quotation in any successor to that system and the term "OTC Bulletin Board" will
include any successor to that service.
If during any quarterly calculation period the Calculation Agent
removes one of the stocks underlying the Income Select 10 Basket, all
outstanding hypothetical call options in respect of that stock will be treated
as terminated at the close of business on the day on which the underlying stock
is removed. At that time, the value of the shares of the removed stock in the
Income Select 10 Basket, less the value, if any, of the hypothetical call
options in respect of that stock, will be reallocated to hypothetical
investments in shares (or fractional shares) of the remaining underlying stocks.
The amount allocated to hypothetical investments in respect of each remaining
underlying stock will be in proportion to the percentage of the value of each
remaining underlying stock relative to the value of the Income Select 10 Basket
(less the value of the removed stock) at the close of business on the Index
Business Day on which the underlying stock is removed. See the section entitled
"Description of the Income Select 10 Basket-Adjustments to the Share Multipliers
and the Income Select 10 Basket" in this prospectus supplement. The Calculation
Agent will determine the terms of a new hypothetical call option in respect of
each additional share (or fractional share) as described above in
"--Hypothetical Call Options--Terms of Hypothetical Call Options" in this
S-40
prospectus supplement. The premium in respect of each additional hypothetical
call option will be included in the value of the Income Select 10 Basket at the
close of business on the day the option is priced and will be included in the
Basket Unit Income for that quarterly calculation period.
The terms of the hypothetical call options will provide for adjustments
to reflect the occurrence of a corporate or other similar event affecting an
underlying stock (such as, for example, a merger or other corporate combination
or a stock split or reverse stock split).
Valuation of hypothetical call options
The "Current Option Value" is the sum of the mark-to-market value of
each hypothetical call option and will be determined by the Calculation Agent at
the close of business on each Index Business Day using accepted option valuation
methods. The valuation methods take into account variables such as:
o the closing price of the related stock as of the time the
hypothetical call option is valued;
o the cumulative normal distribution function (a fixed
statistical function), which determines the probability of a
variable falling within a given range under specified
conditions;
o the exercise price of the hypothetical call option;
o the computed continuously compounded annualized current
dividend yield on the related stock based on expected
dividends;
o the U.S. dollar interest rate as of the time the hypothetical
call option is valued, converted into a continuously compounded
rate; and
o the implied volatility of the related stock (determined by the
Calculation Agent as described below).
At the time the hypothetical call option is priced, the U.S. dollar
interest rate will equal the U.S. dollar LIBOR rate as calculated and published
at that time by Bloomberg Financial Markets, or another recognized source
selected by the Calculation Agent at that time, based on the time to maturity of
that hypothetical call option. During the remaining term of the hypothetical
call option, the interest rate will equal the published interest rate for a term
identical to the remaining term of the hypothetical call option. If an interest
rate for a term identical to the remaining term of the hypothetical call option
is not published, the Calculation Agent will determine the interest rate used to
compute the value of an option by interpolating between the published rate for a
shorter term nearest to the term of the hypothetical call option and the
published rate for a longer term nearest to the term of the hypothetical call
option. All interest rates will be converted by the Calculation Agent into a
rate compounded on a continuous basis.
The annualized current dividend yield for a stock on which an option is
priced will be calculated on any Index Business Day by annualizing (based on a
365-day year) to the end of that quarterly calculation period the result
obtained by summing the ordinary dividend or dividends (as described above in
"Description of the Income Select 10 Basket" in this prospectus supplement)
historically paid by each issuer of that stock during the most recent period
corresponding to the current quarterly calculation period (or if the issuer of
that stock has publicly disclosed that any dividend payable during the quarterly
calculation period in which the hypothetical call option is being priced will be
a different amount than the most recent corresponding historical dividend, the
amount publicly disclosed by that issuer) and then dividing that result by the
closing price of that stock on the principal U.S. exchange or market on that
day. The annualized current dividend yield for any stock on which an option is
priced will be zero:
o for the remainder of each quarterly calculation period
following the ex-dividend date for that stock corresponding to
the final ex-dividend date in the most recent period
corresponding to the current quarterly calculation period; and
o in each quarterly calculation period in which an ordinary
dividend has not been payable historically (because the
dividend is payable annually, semiannually or otherwise),
in either case, unless and until the issuer of that stock publicly discloses a
dividend payable during the remainder of that quarterly calculation period, in
which case the annualized current dividend yield will be calculated using the
amount publicly disclosed by that issuer.
S-41
The implied volatility of a hypothetical call option on any Index
Business Day is:
o when hypothetically purchasing Basket Units, the bid-side
implied volatility;
o when hypothetically selling Basket Units, the offered-side
implied volatility; and
o under all other circumstances, the mid-market implied
volatility (i.e., the arithmetic mean of the bid-side and
offered-side implied volatility)
of the relevant stock as determined by the Calculation Agent by interpolating
from the implied volatility surface for the most comparable call options listed
on the AMEX, the Chicago Board Options Exchange or the International Securities
Exchange on the relevant stock as determined by the Calculation Agent in
accordance with option pricing methodologies selected by the Calculation Agent,
taking into account the nearest exercise price and maturity and using the U.S.
dollar interest rate and dividend yield determined as described above.
If no value of a hypothetical call option is available on any date
because of a Market Disruption Event, because the Calculation Agent determines
that the market for the listed options described above is not sufficiently
liquid (based upon factors including, but not limited to, the time elapsed since
the last trade in options relating to that stock, the size of the open interest
in call options with related exercise prices and maturities relating to that
stock and the size of the bid-offer relative to the number of hypothetical
options related to that stock to be priced on that day in respect of the notes
then outstanding) for the purpose of calculating the implied volatility of any
hypothetical call option or otherwise, or if the reported prices for the listed
options described above contain or are the result of manifest error, unless
deferred by the Calculation Agent as described below, the value of that
hypothetical call option will be the arithmetic mean, as determined by the
Calculation Agent, of the value of that option obtained from as many dealers in
options (which may include MLPF&S or any of our other subsidiaries or
affiliates), but not exceeding three of these dealers, as will make that value
available to the Calculation Agent.
The Calculation Agent may defer the determination of the values of the
hypothetical call options for up to ten consecutive Index Business Days on which
a Market Disruption Event is occurring. Following this period, the Calculation
Agent will determine the values of the hypothetical call options in consultation
with ML&Co. No determination of the value of the Income Select 10 Basket or
reallocation of hypothetical funds in the Reference Index will occur on any day
the determination of the values of the hypothetical call options is deferred by
the Calculation Agent.
S-42
UNITED STATES FEDERAL INCOME TAXATION
General
Set forth in full below is the opinion of Sidley Austin Brown & Wood
LLP, our counsel, as to certain United States federal income tax consequences of
the purchase, ownership and disposition of the PROCEEDS. This opinion is based
upon laws, regulations, rulings and decisions now in effect, all of which are
subject to change (including retroactive changes in effective dates) or possible
differing interpretations. The discussion below deals only with PROCEEDS held as
capital assets and does not purport to deal with persons in special tax
situations, such as financial institutions, insurance companies, real estate
investment trusts, regulated investment companies, dealers in securities or
currencies, tax-exempt entities (except to the extent specifically discussed
below), persons holding PROCEEDS in a tax-deferred or tax-advantaged account, or
persons holding PROCEEDS as a hedge against currency risks, as a position in a
"straddle" or as part of a "hedging", "conversion" or "integrated" transaction
for tax purposes. It also does not deal with holders other than original
purchasers (except where otherwise specifically noted in this prospectus
supplement). Persons considering the purchase of the PROCEEDS should consult
their own tax advisors concerning the application of the United States federal
income tax laws to their particular situations as well as any consequences of
the purchase, ownership and disposition of the PROCEEDS arising under the laws
of any other taxing jurisdiction.
We do not address all of the tax consequences that may be relevant to
an investor. In particular, we do not address:
o the United States federal income tax consequences to
shareholders in, or partners or beneficiaries of, an entity
that is a holder of PROCEEDS;
o the United States federal estate, gift or alternative minimum
tax consequences of the purchase, ownership or disposition of
PROCEEDS;
o persons who hold the PROCEEDS whose functional currency is not
the United States dollar; or
o any state, local or foreign tax consequences of the purchase,
ownership or disposition of PROCEEDS.
Accordingly, you should consult your own tax advisor regarding the tax
consequences of purchasing, owning and disposing of the PROCEEDS in light of
your own circumstances.
A U.S. Holder is a beneficial owner of the PROCEEDS who or which is:
o a citizen or individual resident of the United States, as
defined in Section 7701 (b) of the Internal Revenue Code of
1986, as amended (the "Code");
o a corporation or partnership, including any entity treated as a
corporation or partnership for United States 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
enacted that provide otherwise;
o an estate if its income is subject to United States federal
income taxation regardless of its source; or
o a trust if (1) a United States court can exercise primary
supervision over its administration and (2) one or more United
States persons have the authority to control all of its
substantial decisions.
Notwithstanding the preceding sentence, certain trusts in existence on
August 20, 1996, and treated as a U.S. Holder prior to such date, may also be
treated as U.S. Holders. A Non-U.S. Holder is a beneficial owner of PROCEEDS
other than a U.S. Holder.
We urge you to consult your own tax advisor with respect to the tax
consequences to you of the purchase, ownership and disposition of the PROCEEDS
in light of your own particular circumstances, including the tax consequences
under state, local, foreign and other tax laws and the possible effects of
changes in United States federal or other tax laws.
S-43
Classification of the PROCEEDS
We have received an opinion from our counsel, Sidley Austin Brown &
Wood LLP, that the PROCEEDS will be treated as indebtedness for United States
federal income tax purposes and that the PROCEEDS will be subject to the special
regulations issued by the U.S. Treasury Department governing contingent payment
debt instruments (the "CPDI regulations").
Accrual of Interest on the PROCEEDS
Pursuant to the terms of the PROCEEDS, we and you will agree, for
United States federal income tax purposes, to treat the PROCEEDS as debt
instruments that are subject to the CPDI regulations. Pursuant to these
regulations, U.S. Holders of the PROCEEDS will be required to accrue interest
income on the PROCEEDS, in the amounts described below, regardless of whether
the U.S. Holder uses the cash or accrual method of tax accounting.
The CPDI regulations provide that a U.S. Holder must accrue an amount
of ordinary interest income, as original issue discount for United States
federal income tax purposes, for each accrual period prior to and including the
maturity date of the PROCEEDS that equals:
(1) the product of (i) the adjusted issue price (as defined below)
of the PROCEEDS as of the beginning of the accrual period; and
(ii) the comparable yield to maturity (as defined below) of
the PROCEEDS, adjusted for the length of the accrual period;
(2) divided by the number of days in the accrual period; and
(3) multiplied by the number of days during the accrual period
that the U.S. Holder held the PROCEEDS.
A PROCEEDS's issue price is the first price to the public at which a
substantial amount of the PROCEEDS is sold, excluding sales to bond houses,
brokers or similar persons or organizations acting in the capacity of
underwriters, placement agents or wholesalers. The adjusted issue price of a
PROCEEDS is its issue price increased by any interest income previously accrued,
determined without regard to any adjustments to interest accruals described
below, and decreased by the amount of any projected payments, as defined below,
scheduled to have previously been made with respect to the PROCEEDS.
The CPDI regulations require that we provide to U.S. Holders, solely
for United States federal income tax purposes, a schedule of the projected
amounts of payments, which we refer to as projected payments, on the PROCEEDS.
This schedule must produce the comparable yield. Solely for purposes of
applying the CPDI regulations to the PROCEEDS, ML&Co. has determined that the
projected payments for the PROCEEDS consist of (i) estimates of the variable
quarterly interest payments on the PROCEEDS and (ii) a payment on the maturity
date of the principal amount thereof. In particular, ML&Co. has determined
that, per $1,000 principal amount of PROCEEDS, the comparable yield is 4.22%,
compounded quarterly, and the projected payments consist of (i) projected
variable quarterly interest payments equal to $10.32 on August 5, 2005, May 4,
2006, May 4, 2007 and May 6, 2009, $10.43 on May 6, 2008, $10.55 on May 12,
2010 and $10.67 for each of the other variable quarterly interest payments,
and (ii) a projected payment per $1,000 principal amount of PROCEEDS on May 12,
2010 equal to $1,000. U.S. Holders may also obtain the projected payment
schedule by submitting a written request for such information to Merrill Lynch
& Co., Inc., Corporate Secretary's Office, 222 Broadway, 17th Floor, New York,
New York 10038 or to corporatesecretary@exchange.ml.com.
For United States federal income tax purposes, a U.S. Holder must use
the comparable yield and the schedule of projected payments in determining its
interest accruals, and the adjustments thereto described below, in respect of
the PROCEEDS, unless a U.S. Holder timely discloses and justifies the use of
other estimates to the Internal Revenue Service (the "IRS"). A U.S. Holder that
determines its own comparable yield or schedule of projected payments must also
establish that our comparable yield or schedule of projected payments is
unreasonable.
The comparable yield and the schedule of projected payments are not
determined for any purpose other than for the determination of a U.S. Holder's
interest accruals and adjustments thereof in respect of the PROCEEDS for United
States federal income tax purposes and do not constitute a projection or
representation regarding the actual amounts payable on the PROCEEDS.
Amounts treated as interest under the CPDI regulations are treated as
original issue discount for all purposes of the Code.
S-44
Adjustments to Interest Accruals on the PROCEEDS
If, during any taxable year, a U.S. Holder receives actual payments
with respect to the PROCEEDS for that taxable year that in the aggregate exceed
the total amount of projected payments for that taxable year, the U.S. Holder
will incur a "net positive adjustment" under the CPDI regulations equal to the
amount of that excess. The U.S. Holder will treat a "net positive adjustment" as
additional interest income for the taxable year. For this purpose, the payments
in a taxable year include the fair market value of property received in that
year.
If a U.S. Holder receives in a taxable year actual payments with
respect to the PROCEEDS for that taxable year that in the aggregate were less
than the amount of projected payments for that taxable year, the U.S. Holder
will incur a "net negative adjustment" under the CPDI regulations equal to the
amount of such deficit. This adjustment will (a) reduce the U.S. Holder's
interest income on the PROCEEDS for that taxable year, and (b) to the extent of
any excess after the application of (a), give rise to an ordinary loss to the
extent of the U.S. Holder's interest income on the PROCEEDS during prior taxable
years, reduced to the extent that interest was offset by prior net negative
adjustments.
Sale or Exchange of the PROCEEDS
Generally, the sale or exchange of a PROCEEDS will result in taxable
gain or loss to a U.S. Holder. The amount of gain or loss on a taxable sale or
exchange will be equal to the difference between (a) the amount realized by the
U.S. Holder on that sale or exchange and (b) the U.S. Holder's adjusted tax
basis in the PROCEEDS. A U.S. Holder's adjusted tax basis in a PROCEEDS on any
date will generally be equal to the U.S. Holder's original purchase price for
the PROCEEDS, increased by any interest income previously accrued by the U.S.
Holder (determined without regard to any adjustments to interest accruals
described above), and decreased by the amount of any projected payments, as
defined above, previously made to the U.S. Holder through that date. Gain
recognized upon a sale or exchange of a PROCEEDS will generally be treated as
ordinary interest income; any loss will be ordinary loss to the extent of
interest previously included in income, and thereafter, capital loss (which will
be long-term if the PROCEEDS is held for more than one year). The deductibility
of net capital losses by individuals and corporations is subject to limitations.
Unrelated Business Taxable Income
Section 511 of the Code generally imposes a tax, at regular corporate
or trust income tax rates, on the "unrelated business taxable income" of certain
tax-exempt organizations, including qualified pension and profit sharing plan
trusts and individual retirement accounts. In general, if the PROCEEDS are held
for investment purposes, the amount of income or gain realized with respect to
the PROCEEDS will not constitute unrelated business taxable income. However, if
a PROCEEDS constitutes debt-financed property (as defined in Section 514(b) of
the Code) by reason of indebtedness incurred by a holder of a PROCEEDS to
purchase the PROCEEDS, all or a portion of any income or gain realized with
respect to such PROCEEDS may be classified as unrelated business taxable income
pursuant to Section 514 of the Code. Moreover, prospective investors in the
PROCEEDS should be aware that whether or not any income or gain realized with
respect to a PROCEEDS which is owned by an organization that is generally exempt
from U.S. federal income taxation pursuant to Section 501(a) of the Code
constitutes unrelated business taxable income will depend upon the specific
facts and circumstances applicable to such organization. Accordingly, any
potential investors in the PROCEEDS that are generally exempt from U.S. federal
income taxation pursuant to Section 501(a) of the Code are urged to consult with
their own tax advisors concerning the U.S. federal income tax consequences to
them of investing in the PROCEEDS.
Treatment of Non-U.S. Holders
All payments on the PROCEEDS made to a Non-U.S. Holder, including any
payment of quarterly interest, and any gain realized on a sale or exchange of
the PROCEEDS (other than income or gain attributable to accrued interest
payments), will be exempt from United States income or withholding tax,
provided, that: (i) the Non-U.S. Holder does not own, actually or
constructively, 10 percent or more of the total combined voting power of all
classes of our stock entitled to vote, is not a controlled foreign corporation
related, directly or indirectly, to us through stock ownership and is not a bank
receiving interest described in Section 881(c)(3)(A) of the Code; (ii) the
statement requirement set forth in Section 871 (h) or Section 881 (c) of the
Code has been fulfilled with respect to the beneficial owner, as discussed
below; and (iii) the payments and gain are not effectively connected with the
conduct by the Non-U.S. Holder of a trade or business in the United States.
The statement requirement referred to in the preceding paragraph will
be fulfilled if the beneficial owner of a PROCEEDS certifies on IRS Form W-8BEN,
under penalties of perjury, that it is not a United States person and provides
its name, address and other information as the form may require.
If a Non-U.S. Holder of the PROCEEDS is engaged in a trade or business
in the United States, and if interest on the PROCEEDS is effectively connected
with the conduct of that trade or business, the Non-U.S. Holder, although exempt
from the
S-45
withholding tax discussed in the preceding paragraphs, will generally
be subject to regular United States federal income tax on interest and on any
gain realized on the sale or exchange of the PROCEEDS in the same manner as if
it were a U.S. Holder. In lieu of the certificate described in the preceding
paragraph, a Non-U.S. Holder will be required to provide to the withholding
agent a properly executed IRS Form W-8ECI (or successor form) in order to claim
an exemption from withholding tax. In addition, if a Non- U.S. Holder is a
foreign corporation, the Non-U.S. Holder may be subject to a branch profits tax
equal to 30% (or lower rate provided by an applicable treaty) of its effectively
connected earnings and profits for the taxable year, subject to certain
adjustments.
Backup Withholding Tax and Information Reporting
Payments of principal, premium, if any, and interest (including
original issue discount) on, and the proceeds from a disposition of, the
PROCEEDS may be subject to information reporting and United States federal
backup withholding tax at the applicable statutory rate if the U.S. Holder
thereof fails to supply an accurate taxpayer identification number or otherwise
fails to comply with applicable United States information reporting or
certification requirements. A Non-U.S. Holder may be subject to United States
backup withholding tax on payments on the PROCEEDS and the proceeds from a sale
or other disposition of the PROCEEDS unless the Non-U.S. Holder complies with
certification procedures to establish that it is not a United States person. Any
amounts so withheld will be allowed as a credit against the holder's United
States federal income tax liability and may entitle a holder to a refund,
provided, the required information is timely furnished to the IRS.
S-46
ERISA CONSIDERATIONS
Each fiduciary of a pension, profit-sharing or other employee benefit
plan or an individual retirement account or a Keogh Plan (a "plan") should
consider whether an investment in the PROCEEDS would be consistent with the
documents and instruments governing the plan, and whether the investment would
involve a prohibited transaction under Section 406 of the Employee Retirement
Income Security act of 1974, as amended ("ERISA"), or Section 4975 of the Code.
Section 406 of ERISA and Section 4975 of the Code prohibit 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) ("similar
law 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 PROCEEDS by a plan with respect to which the
Company, MLPF&S or certain of their 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 PROCEEDS 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 PROCEEDS. 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 PROCEEDS 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 prohibited
transaction class exemptions, or "PTCEs", listed above or another applicable
similar exemption. Any purchaser or holder of the PROCEEDS or any interest in
the PROCEEDS will be deemed to have represented by its purchase and holding of
the PROCEEDS that either (1) it is not a plan or a plan asset entity and is not
purchasing those PROCEEDS on behalf of or with "plan assets" of any plan or plan
asset entity or (2) with respect to the purchase or holding, it 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 PROCEEDS or
any interest in the PROCEEDS which is subject to any similar laws will be deemed
to have represented by its purchase and holding of the PROCEEDS that its
purchase and holding will not violate the provisions of those laws.
The sale of any PROCEEDS to a plan is in no respect a representation by
the Company, MLPF&S or any of their respective affiliates that such an
investment meets all relevant legal requirements with respect to investments by
plans generally or any particular plan, or that such an investment is otherwise
appropriate for plans generally or any particular plan.
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 PROCEEDS
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.
S-47
USE OF PROCEEDS AND HEDGING
The net proceeds from the sale of the PROCEEDS will be used as
described under "Use of Proceeds" in the accompanying prospectus and to hedge
market risks of ML&Co. associated with its obligation to pay the principal
amount and the Supplemental Redemption Amount, if any, in connection with the
PROCEEDS.
S-48
WHERE YOU CAN FIND MORE INFORMATION
We file reports, proxy statements and other information with the SEC.
Our SEC filings are also available over the Internet at the SEC's web site at
http://www.sec.gov. The address of the SEC's Internet site is provided solely
for the information of prospective investors and is not intended to be an active
link. You may also read and copy any document we file at the SEC's public
reference rooms in Washington, D.C. Please call the SEC at 1-800-SEC-0330 for
more information on the public reference rooms and their copy charges. You may
also inspect our SEC reports and other information at the New York Stock
Exchange, Inc., 20 Broad Street, New York, New York 10005.
We have filed a registration statement on Form S-3 with the SEC
covering the PROCEEDS and other securities. For further information on ML&Co.
and the PROCEEDS, you should refer to our registration statement and its
exhibits. The prospectus accompanying this prospectus supplement summarizes
material provisions of contracts and other documents that we refer you to.
Because the prospectus may not contain all the information that you may find
important, you should review the full text of these documents. We have included
copies of these documents as exhibits to our registration statement.
You should rely only on the information contained or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We have
not, and the underwriter has not, authorized any other person to provide you
with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriter is not, making an offer to sell these securities in any jurisdiction
where the offer or sale is not permitted.
You should assume that the information appearing in this prospectus
supplement and the accompanying prospectus is accurate as of the date on the
front cover of this prospectus supplement only. Our business, financial
condition and results of operations may have changed since that date.
S-49
UNDERWRITING
MLPF&S has agreed, subject to the terms and conditions of the
underwriting agreement and a terms agreement, to purchase from ML&Co.
$21,878,000 aggregate principal amount of PROCEEDS. The underwriting agreement
provides that the obligations of the underwriter are subject to certain
conditions and that the underwriter will be obligated to purchase all of the
PROCEEDS if any are purchased.
MLPF&S has advised ML&Co. that it proposes initially to offer all or
part of the PROCEEDS to a dealer that will resell the PROCEEDS to the public at
the offering price set forth on the cover page of this prospectus supplement.
MLPF&S may reallow any portion of the discount received in connection with such
purchase of PROCEEDS to the dealer. After the initial public offering, the
public offering price and the discount allowed to the dealer may be changed.
MLPF&S is offering the PROCEEDS subject to receipt and acceptance and subject to
MLPF&S's right to reject any order in whole or in part. Proceeds to be received
by ML&Co. will be net of the underwriting discount and expenses payable by
ML&Co.
MLPF&S, a broker-dealer subsidiary of ML&Co. is a member of the
National Association of Securities Dealers, Inc. (the "NASD") and will
participate in distributions of the PROCEEDS. Accordingly, offerings of the
PROCEEDS will conform to the requirements of Rule 2720 of the Conduct Rules of
the NASD.
MLPF&S is permitted to engage in certain transactions that stabilize
the price of the PROCEEDS. These transactions consist of bids or purchases for
the purpose of pegging, fixing or maintaining the price of the PROCEEDS.
If MLPF&S creates a short position in the PROCEEDS in connection with
the offering, i.e., if it sells more units of the PROCEEDS than are set forth on
the cover page of this prospectus supplement, MLPF&S may reduce that short
position by purchasing units of the PROCEEDS in the open market. In general,
purchases of a security for the purpose of stabilization or to reduce a short
position could cause the price of the security to be higher than it might be in
the absence of these purchases. "Naked" short sales are sales in excess of the
underwriter's overallotment option or, where no overallotment option exists,
sales in excess of the number of units an underwriter has agreed to purchase
from the issuer. Because MLPF&S, as underwriter for the PROCEEDS, has no
overallotment option, it would be required to closeout a short position in the
PROCEEDS by purchasing PROCEEDS in the open market. Neither ML&Co. nor MLPF&S
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 the
PROCEEDS. In addition, neither ML&Co. nor MLPF&S makes any representation that
the underwriter will engage in these transactions or that these transactions,
once commenced, will not be discontinued without notice.
MLPF&S may use this prospectus supplement and the accompanying
prospectus for offers and sales related to market-making transactions in the
PROCEEDS. MLPF&S may act as principal or agent in these transactions, and the
sales will be made at prices related to prevailing market prices at the time of
sale.
VALIDITY OF THE PROCEEDS
The validity of the PROCEEDS will be passed upon for ML&Co. and for
the underwriter by Sidley Austin Brown & Wood LLP, New York, New York.
EXPERTS
The consolidated financial statements, the related financial statement
schedule, and management's report on the effectiveness of internal control over
financial reporting incorporated in this prospectus supplement by reference from
the Annual Report on Form 10-K of Merrill Lynch & Co., Inc. for the year ended
December 31, 2004, have been audited by Deloitte & Touche LLP, an independent
registered public accounting firm, as stated in their reports dated March 2,
2004, which are incorporated herein by reference, and have been so incorporated
in reliance upon the reports of such firm given upon their authority as experts
in accounting and auditing.
S-50
INDEX OF CERTAIN DEFINED TERMS
Adjusted Quarterly Income..................................................S-38
Allocation Determination Event..............................................S-6
Anniversary Date...........................................................S-36
Annual Reconstitution Date.................................................S-36
Basket Adjustment Factor....................................................S-6
Basket Unit Income..........................................................S-5
Basket Units................................................................S-1
Business Day...............................................................S-16
Calculation Agent...........................................................S-3
Commencement Date..........................................................S-16
Cushion.....................................................................S-7
Daily Leverage Charge.......................................................S-6
Defeasance Event............................................................S-7
dividend yield.............................................................S-35
Distributor.................................................................S-8
Ending Value................................................................S-4
Floor Level.................................................................S-7
formula.....................................................................S-6
Income Select 10 Basket.....................................................S-1
Income Select 10 Company...................................................S-37
Income Select 10 Stock......................................................S-4
Index Adjustment Factor.....................................................S-6
Index Business Day.........................................................S-15
Index Components............................................................S-3
Leverage Units..............................................................S-1
Market Disruption Event....................................................S-17
New Stocks.................................................................S-36
Pricing Date................................................................S-3
PROCEEDS....................................................................S-1
Reference Index.............................................................S-1
Share Multiplier...........................................................S-35
Starting Value..............................................................S-4
Supplemental Redemption Amount..............................................S-4
Targeted Quarterly Premium.................................................S-38
Targeted Exposure...........................................................S-6
Threshold Value.............................................................S-4
Valuation Date..............................................................S-4
Zero Coupon Bond Units......................................................S-1
S-51
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[GRAPHIC OMITTED]
21,878 Units
Merrill Lynch & Co., Inc.
PROtected Covered Call EnhancED Income Notes(SM)
Linked to the Income Select 10 PROCEEDS Index
due May 12, 2010
(the "PROCEEDS(SM)")
$1,000 principal amount per unit
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PROSPECTUS SUPPLEMENT
----------------------------
Merrill Lynch & Co.
May 2, 2005
"PROtected Covered Call EnhancED Income NoteS" and "PROCEEDS" are service
marks of Merrill Lynch & Co., Inc.
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