UPCOMING SHAREHOLDER
MEETING
The T. Rowe Price Funds will be
holding a shareholder meeting on October 22, 2013. Shareholders will be asked to
elect directors and consider changes to certain fundamental policies to permit
the funds greater flexibility in managing their investment
strategies.
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Manager’s Letter
Fellow Shareholders
Treasuries fell over the past year as
pessimism about the euro debt crisis receded and the U.S. economic recovery
gained momentum. Risk appetite gradually strengthened as highly accommodative
monetary policies around the world dimmed the safe-haven appeal of Treasuries
and investors gravitated to higher-yielding assets like stocks and high yield
bonds. When our reporting period began a year ago, worries about a eurozone
collapse caused investors to seek refuge in the safety of U.S. government debt.
However, steadily improving economic data and growing speculation that the
Federal Reserve was preparing to wind down its accommodative monetary policies
led to a sell-off in Treasuries as our fiscal year ended. (Please see the
sidebar, “What Rising Rates Mean for Bonds,” on page 8.)
MARKET NEWS AND INTEREST
RATES
Investor sentiment swung from one
extreme to the other over the past 12 months. Treasury yields sank to record
lows in July 2012 as fears about a eurozone collapse led investors to pile into
the relative safety of U.S. government debt. Sentiment significantly brightened
in September after the European Central Bank and the Fed separately unveiled
bond-buying programs to suppress interest rates and, in Europe’s case, defuse
the risk of a euro breakup. These measures reassured investors that global
central banks were committed to keeping interest rates low and would act
forcefully to bolster economies. As a result, investors hungry for yield bid up
credit-sensitive assets, pushing yields across non-Treasury sectors to or near
record lows by the end of 2012. This move into riskier assets intensified into
the spring, keeping yields in most sectors at historically low levels. In this
environment, returns on Treasuries and agency mortgage-backed securities (MBS)
lagged the returns of more credit-sensitive fixed income sectors. More recently, the Bank of Japan announced on April
4 that it would embark on its own massive bond-buying program in an effort to
revive Japan’s moribund economy and end 15 years of deflation.
Bonds sold off at the end of our
reporting period amid speculation that the Fed was approaching the start of
phasing out its stimulus program. Last December, the Fed said it
would buy $85 billion in Treasuries and agency MBS each
month until the job market improved and set target rates for unemployment and
inflation—6.5% and 2.5%, respectively—before it would begin raising short-term
interest rates from near 0%. Surprisingly strong economic data in May raised
expectations that the Fed would begin easing the pace of its asset purchase
program, causing long-term interest rates to rise. Those expectations picked up
after Fed Chairman Ben Bernanke said on May 22 that the central bank could start
to adjust the pace of its bond purchases “in the next few meetings” if the U.S.
economy was strong enough. As a result, bonds retreated, pushing returns in many
sectors into negative territory for the year-to-date period. The yield on the
U.S. 10-year Treasury—a benchmark for long-term borrowing costs—fell as low as
1.38% last July amid fears about a euro collapse but ended May at 2.13%, its
highest level in over a year.
The U.S. economic recovery gained
momentum as the year progressed. Unlike the past two years—when signs of
economic strength early in the year gave way to spring slowdowns—recent
indicators showed the economy stayed surprisingly resilient despite federal
spending cuts and higher tax rates that became effective this year.
First-quarter gross domestic product rose at an annualized pace of 2.4%,
compared with a 0.4% gain in last year’s final quarter. The unemployment rate
dropped from 8.2% last June at the start of our fiscal year to 7.6%
in May. Other May indicators showed housing prices and
consumer confidence rising to multiyear highs. Despite the encouraging data, T.
Rowe Price economists believe that further strength in private sector demand,
namely personal spending and business investment, is required for sustainable
gains in job creation. Also, the full effects of sequestration—or the automatic
across-the-board federal spending cuts that began in March—have yet to be felt
in the economy. Once the impact from sequestration starts to abate, we believe
the pace of the recovery should start to pick up, putting it on track to grow
from about 2% this year to 3% next year.
PORTFOLIO REVIEW
U.S. Treasury Money
Fund
Your fund returned 0.01% for the
six and 12 months ended May 31, 2013, roughly the same as its benchmark, the
Lipper U.S. Treasury Money Market Funds Index. T. Rowe Price has voluntarily
waived all or a portion of the management fee it is entitled to receive from
the fund in an effort to maintain a 0% or
positive net yield for the fund.
Continued demand for the safety and
liquidity of Treasury securities, combined with the Fed’s monthly asset purchase
program, has continued
to suppress
short-term Treasury rates. Given various sources of demand—money fund and other
liquidity investors, banks, corporate cash managers, foreign central banks, and
the Fed—for Treasury bills, which are anchored by a 0% monetary policy, it is
surprising that T-bills produce any yield at all. Indeed, during times of high
demand, such as month- and quarter-ends, some short-dated bills trade with zero
or even negative yields.
Treasury bill supply has declined
over the past six months. The decline results from several recent developments
that have reduced the need for short-term funding, including
higher-than-expected
tax receipts and
sizable reimbursements from government-backed mortgage agencies Fannie Mae and
Freddie Mac. This buoyant demand and cutbacks in supply have produced the low
yields in the short-term Treasury market.
Demand for Treasuries was also
reflected in the repo markets. The fund routinely invests in repurchase
agreements, which are collateralized exclusively by Treasury bills and Treasury
bonds. During periods of rising demand for either Treasury securities or
Treasury-backed collateral, we have seen repo rates fall increasingly lower. For
much of the past six months, overnight and seven-day Treasury-collateralized
repos
averaged yields in the mid- to
high-single digits. But as with other parts of the Treasury market, 0.00% yields
have not been unusual around month- and quarter-ends.
Our near-term outlook for the short
Treasury market calls for more of the same: Supply will remain constrained,
while demand is not expected to change dramatically. Over the longer term, a
reversal in Fed monetary policy, such as raising its fed funds target rate, will
be needed to push Treasury money market rates higher. Until then, our strategy
remains the same, with the fund positioned near the long end of its permissible
weighted average maturity of 60 days.
U.S. Treasury Intermediate
Fund
Your fund returned -1.89% and
-1.03% for the six and 12 months ended May 31, 2013, respectively, trailing its
performance benchmark, the Barclays U.S. 4–10 Year Treasury Bond Index, but
outpacing its Lipper peer group average over both periods.
Although the U.S. Treasury
Intermediate Fund invests at least 80% of its assets in Treasury securities, we
take positions in non-
benchmark securities
backed by the U.S. government, including Treasury inflation protected securities
(TIPS) and Ginnie Mae MBS, to capture additional yield. The fund’s exposure to
TIPS, detracted
from relative returns. TIPS
generated negative returns amid an increase in real (inflation-adjusted)
interest rates, reduced demand for securities providing inflation protection,
and tame inflation readings despite highly accommodative monetary policies
around the world.
On the other hand, our short-duration position helped relative performance. Because
the fund had less sensitivity to interest rate changes, it was less affected by rising rates than the benchmark as the
yield curve steepened. Our allocation to MBS also lifted returns. The agency MBS sector faced several headwinds over the
past year, such as increased prepayments from homeowners; expectations of
a less
accommodative Fed; and weaker demand from investors who increasingly favored higher-risk assets as our reporting period
progressed. Still, agency MBS experienced relatively stronger demand over Treasuries due to their high credit quality,
added yield over comparable-maturity Treasuries, and ample liquidity.
We continue to maintain modest
allocations to TIPS and agency MBS. Our MBS holdings have the benefit of
providing added yield over Treasuries, decent liquidity, and diversification for
the fund, while our TIPS allocation provides some inflation protection for our
Treasury holdings. We trimmed our MBS holdings after the Fed announced last
September it would start buying agency MBS in its third round of quantitative
easing, or QE3—an event that caused MBS
yields to plummet. However, we recently added back to our allocation as
valuations improved on growing speculation that the Fed would start to phase out
its asset purchase program. As for TIPS, we reduced our allocation toward the
end of the period as the inflation outlook in the U.S. stayed subdued despite
the Fed’s accommodative policies.
To protect shareholders from future
interest rate increases, we recently adjusted the fund’s duration—which measures
the sensitivity of a bond’s price to a change in interest rates—to short
relative to the
benchmark from neutral in
the early part of our reporting period. Rising rates generally result in
principal declines for bond securities, and the prevailing low rate environment
has exacerbated this risk because investors have less of a yield cushion to help
counter a period of rising rates. While we have some flexibility to manage
interest rate risk by keeping the fund’s average duration shorter
than that of its benchmark, our mandated focus on
intermediate-term securities puts the fund at risk of generating negative total
returns should interest rates markedly rise. Additionally, we do not typically
make large duration bets because of the challenges of predicting the timing of
interest rate moves.
U.S. Treasury Long-Term
Fund
Your fund returned -6.72%
and -7.17% for the six and 12 months ended May 31, 2013, respectively, trailing
its benchmark, the Barclays
U.S. Long
Treasury Bond Index, and its Lipper peer group average for both
periods.
Long-term Treasuries fell over the
past year as accommodative central bank policies around the world and robust
demand for yield led investors to favor higher-risk sectors. Heightened expectations that the Fed was drawing closer to the start of winding down
its stimulus measures further pressured long-term Treasuries toward the end of our reporting period. Because prices of
long-term Treasuries are more sensitive to rising rates than shorter-dated Treasuries, they fell more as rates ticked higher
over the past 12 months. The yield on the 30-year Treasury bond rose 64 basis
points over
the past 12 months to 3.28% at the end of May, exceeding the 57 basis point rise in the benchmark 10-year Treasury over the
same period.
As with the U.S. Treasury
Intermediate Fund, our out-of-benchmark exposure to TIPS detracted from relative
performance as real interest rates increased and monthly inflation
readings trailed market expectations. Similarly, the
fund’s short-duration posture and allocation to MBS lifted relative returns.
Positioning changes largely mirrored those in the U.S. Treasury Intermediate
Fund. We continue to maintain modest out-of-benchmark allocations to TIPS for
diversification and inflation protection and to agency MBS for their added yield
over Treasuries. Similar to the U.S. Treasury Intermediate Fund, we adjusted the
fund’s duration from neutral to short compared with the benchmark near the end
of the reporting period.
Treasury bonds have proven to be an
effective hedge against market turmoil, but their long-term nature and
historically low yields have subjected holders to greater interest rate risk in
recent years. As
with the U.S. Treasury
Intermediate Fund, we have some leeway to manage interest rate risk by adjusting
the fund’s duration; however, our mandate of investing in long-dated Treasuries
puts the fund at risk of generating negative returns in the event of rising
interest rates.
OUTLOOK
Treasuries have produced outstanding
returns in the past few years, but we expect challenges as the U.S. recovery
picks up and interest rates move higher. Historically, longer-term interest
rates rise before the onset of short-term interest rate increases by the Fed, as
financial markets anticipate tighter monetary policy in response to strong
economic growth or rising inflation. As evidence accumulates that the U.S.
economy is strengthening and Fed officials consider when the central bank should
curtail its asset purchases, the timing of when the Fed decides to lift
short-term rates from ultra-low levels is drawing closer. Indeed, long-term
rates have already begun rising as investors handicap a change in Fed
policy.
As of this writing, financial market
uncertainty has picked up amid speculation about the Fed tapering its asset
purchase program. The Fed has amassed more than $3 trillion in assets, and how
it plans to unwind these positions in the absence of any precedent has investors
worried that the Fed is about to enter uncharted territory. We believe that even
as the Fed starts to taper its monthly bond purchases, it will still provide
considerable monetary stimulus for some time in order to suppress interest
rates. Moreover, many central banks are cutting interest rates, which increases
the relative attractiveness of Treasuries, and quantitative easing efforts
worldwide have shrunk the supply of high-quality assets. For these reasons, we
believe demand for Treasuries will remain resilient and interest rates will stay
range-bound in the near term, albeit with a higher floor. Over the longer term,
we expect rates to rise as an improving global economy and less accommodative
Fed policy call for higher yields.
Although bond prices fall when
interest rates rise, we would like to remind shareholders that bonds should
continue to have a place in most investors’ portfolios. Bonds generate income on
a regular basis that can offset losses, increase positive returns, and help
diversify the risks of an equity portfolio. Fixed income securities tend to be
less volatile than stocks and, therefore, should become a larger allocation in
the portfolio of an investor who is approaching a long-term financial
goal, such as retirement. Finally, we would
emphasize that bonds vary in terms of issuer, maturity, and credit quality, so
not all securities respond to interest rate changes in the same way.
Thank you for investing with T. Rowe
Price.
Respectfully
submitted,
Joseph K. Lynagh
Chairman of the Investment Advisory Committee
U.S.
Treasury Money Fund
Brian J. Brennan
Chairman of the Investment Advisory
Committee
U.S. Treasury
Intermediate Fund and U.S. Treasury Long-Term Fund
June 15, 2013
The committee chairmen have
day-to-day responsibility for managing the portfolios and work with committee
members in developing and executing each fund’s investment
program.
RISKS OF INVESTING IN FIXED INCOME
SECURITIES
Funds that invest in fixed income
securities are subject to price declines due to rising interest rates, with
long-term securities generally most sensitive to rate fluctuations. Other risks
include credit rating downgrades and defaults on scheduled interest and
principal payments, but these are highly unlikely for securities backed by the
full faith and credit of the U.S. government. MBS are subject to prepayment
risk, particularly if falling rates lead to heavy refinancing activity, and
extension risk, which is an increase in interest rates that causes a fund’s
average maturity to lengthen unexpectedly due to a drop in mortgage prepayments.
This would increase the fund’s sensitivity to rising interest rates and its
potential for price declines.
RISKS OF INVESTING IN MONEY MARKET
SECURITIES
Since money market funds are managed
to maintain a constant $1.00 share price, there should be little risk of
principal loss. However, there is no assurance the fund will avoid principal
losses if fund holdings default or are downgraded—which are highly unlikely for
securities backed by the full faith and credit of the U.S. government—or if
interest rates rise sharply in an unusually short period. In addition, the
fund’s yield will vary; it is not fixed for a specific period like the yield on
a bank certificate of deposit.
An
investment in the fund is not insured or guaranteed by the Federal Deposit
Insurance Corporation (FDIC) or any other government agency. Although a money
market fund seeks to preserve the value of your investment at $1.00 per share,
it is possible to lose money by investing in it.
GLOSSARY
Barclays U.S. Long Treasury Bond
Index:
An index that includes all
Treasuries in the Barclays U.S. Aggregate Bond Index that mature in 10 years or
more.
Barclays U.S. Treasury 4–10 Year
Index:
An index that includes all
Treasuries in the Barclays U.S. Aggregate Bond Index that mature in four to 10
years.
Basis point:
One one-hundredth of a percentage point, or
0.01%.
Consumer price index:
A measure of the average price of
consumer goods and services purchased by households.
Duration:
A measure of a bond or bond fund’s sensitivity to changes
in interest rates. For example, a fund with a five-year duration would fall
about 5% in response to a one-percentage-point rise interest rates, and vice
versa.
Fed funds target rate:
An overnight lending rate set by the
Federal Reserve and used by banks to meet reserve requirements. Banks also use
the fed funds rate as a benchmark for their prime lending rates.
Gross domestic product:
Total market value of all goods and
services produced in a country in a given year.
Inflation:
A sustained increase in prices throughout the
economy.
Lipper averages:
The averages of available mutual fund performance returns
for specified time periods in categories defined by Lipper Inc.
Lipper indexes:
Fund benchmarks that consist of a small number (10 to
30) of the largest mutual funds in a particular category as tracked by Lipper
Inc.
Repurchase agreement (repo):
A form of short-term borrowing using
collateral in which a bank or broker-dealer sells government securities to
another party, such as the Federal Reserve, and commits to buy them back at a
fixed price on a future date, usually within a week.
SEC yield (7-day unsubsidized
simple):
A method of calculating a money
fund’s yield by annualizing the fund’s net investment income for the last seven
days of each period divided by the fund’s net asset value at the end of the
period. Yield will vary and is not guaranteed.
SEC yield (30-day):
A method of calculating a fund’s yield
that assumes all portfolio securities are held until maturity. Yield will vary
and is not guaranteed.
Treasury inflation protected
securities (TIPS):
Income-generating
bonds that are issued by the federal government and whose interest and principal
payments are adjusted for inflation. The inflation adjustment, which is
typically applied monthly to the principal of the bond, follows a designated
inflation index, such as the consumer price index.
Weighted average life:
A measure of a fund’s credit quality risk. In general, the longer the
average life, the greater the fund’s credit quality risk. The average life is
the dollar-weighted average maturity of a portfolio’s individual securities
without taking into account interest rate readjustment dates. Money funds must
maintain a weighted average life of less than 120 days.
Weighted average maturity:
A measure of a fund’s interest rate
sensitivity. In general, the longer the average maturity, the greater the fund’s
sensitivity to interest rate changes. The weighted average maturity may take
into account the interest rate readjustment dates for certain securities. Money
funds must maintain a weighted average maturity of less than 60 days.
Yield curve:
A graph depicting the relationship between yields and
maturity dates for a set of similar securities. These curves are in constant
flux. One of the key activities in managing any fixed income portfolio is to
study the trends reflected by yield curves.
Performance and Expenses
This chart shows the value of a
hypothetical $10,000 investment in the fund over the past 10 fiscal year periods
or since inception (for funds lacking 10-year records). The result is compared
with benchmarks, which may include a broad-based market index and a peer group
average or index. Market indexes do not include expenses, which are deducted
from fund returns as well as mutual fund averages and indexes.
This chart shows the value of a
hypothetical $10,000 investment in the fund over the past 10 fiscal year periods
or since inception (for funds lacking 10-year records). The result is compared
with benchmarks, which may include a broad-based market index and a peer group
average or index. Market indexes do not include expenses, which are deducted
from fund returns as well as mutual fund averages and indexes.
This chart shows the value of a
hypothetical $10,000 investment in the fund over the past 10 fiscal year periods
or since inception (for funds lacking 10-year records). The result is compared
with benchmarks, which may include a broad-based market index and a peer group
average or index. Market indexes do not include expenses, which are deducted
from fund returns as well as mutual fund averages and indexes.
As a mutual fund shareholder, you may
incur two types of costs: (1) transaction costs, such as redemption fees or
sales loads, and (2) ongoing costs, including management fees, distribution and
service (12b-1) fees, and other fund expenses. The following example is intended
to help you understand your ongoing costs (in dollars) of investing in the fund
and to compare these costs with the ongoing costs of investing in other mutual
funds. The example is based on an investment of $1,000 invested at the beginning
of the most recent six-month period and held for the entire period.
Actual
Expenses
The first line of the
following table (Actual) provides information about actual account values and
expenses based on the fund’s actual returns. You may use the information on this
line, together with your account balance, to estimate the expenses that you paid
over the period. Simply divide your account value by $1,000 (for example, an
$8,600 account value divided by $1,000 = 8.6), then multiply the result by the
number on the first line under the heading “Expenses Paid During Period” to
estimate the expenses you paid on your account during this period.
Hypothetical Example for
Comparison Purposes
The information
on the second line of the table (Hypothetical) is based on hypothetical account
values and expenses derived from the fund’s actual expense ratio and an assumed
5% per year rate of return before expenses (not the fund’s actual return). You
may compare the ongoing costs of investing in the fund with other funds by
contrasting this 5% hypothetical example and the 5% hypothetical examples that
appear in the shareholder reports of the other funds. The hypothetical account
values and expenses may not be used to estimate the actual ending account
balance or expenses you paid for the period.
Note:
T. Rowe Price charges an annual account service fee of
$20, generally for accounts with less than $10,000. The fee is waived for any
investor whose T. Rowe Price mutual fund accounts total $50,000 or more;
accounts electing to receive electronic delivery of account statements,
transaction confirmations, prospectuses, and shareholder reports; or accounts of
an investor who is a T. Rowe Price Preferred Services, Personal Services, or
Enhanced Personal Services client (enrollment in these programs generally
requires T. Rowe Price assets of at least $100,000). This fee is not included in
the accompanying table. If you are subject to the fee, keep it in mind when you
are estimating the ongoing expenses of investing in the fund and when comparing
the expenses of this fund with other funds.
You should also be aware that the
expenses shown in the table highlight only your ongoing costs and do not reflect
any transaction costs, such as redemption fees or sales loads. Therefore, the
second line of the table is useful in comparing ongoing costs only and will not
help you determine the relative total costs of owning different funds. To the
extent a fund charges transaction costs, however, the total cost of owning that
fund is higher.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
|
Notes to
Financial Statements
|
T. Rowe Price U.S. Treasury Funds,
Inc. (the corporation), is registered under the Investment Company Act of 1940
(the 1940 Act). The U.S. Treasury Long-Term Fund (the fund) is a diversified,
open-end management investment company established by the corporation. The fund
commenced operations on September 29, 1989. The fund seeks the highest level of
income consistent with maximum credit protection.
NOTE
1
-
SIGNIFICANT
ACCOUNTING
P
OLICIES
Basis
of
P
reparation
The
accompanying financial statements were prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP), which
require the use of estimates made by management. Management believes that
estimates and valuations are appropriate; however, actual results may differ
from those estimates, and the valuations reflected in the accompanying financial
statements may differ from the value ultimately realized upon sale or
maturity.
Investment
Transactions,
Investment
Income,
and
Distributions
Income and expenses are recorded on the accrual basis.
Premiums and discounts on debt securities are amortized for financial reporting
purposes. Paydown gains and losses are recorded as an adjustment to interest
income. Inflation adjustments to the principal amount of inflation-indexed bonds
are reflected as interest income. Dividends received from mutual fund
investments are reflected as dividend income; capital gain distributions are
reflected as realized gain/loss. Dividend income and capital gain distributions
are recorded on the ex-dividend date. Income tax-related interest and penalties,
if incurred, would be recorded as income tax expense. Investment transactions
are accounted for on the trade date. Realized gains and losses are reported on
the identified cost basis. Distributions to shareholders are recorded on the
ex-dividend date. Income distributions are declared daily and paid monthly.
Capital gain distributions, if any, are generally declared and paid by the fund
annually.
Credits
The fund earns credits on temporarily uninvested cash
balances held at the custodian, which reduce the fund’s custody charges. Custody
expense in the accompanying financial statements is presented before reduction
for credits.
Ne
w
Accounting
Guidance
In
December 2011, the Financial Accounting Standards Board issued amended guidance
requiring an entity to disclose information about offsetting and related
arrangements to enable users of its
financial statements to understand the effect of those arrangements on
its financial position. The guidance is effective for fiscal years and interim
periods beginning on or after January 1, 2013. Adoption will have no effect on
the fund’s net assets or results of operations.
NOTE
2
-
VALUATION
The fund’s financial instruments are
valued and its net asset value (NAV) per share is computed at the close of the
New York Stock Exchange (NYSE), normally 4 p.m. ET, each day the NYSE is open
for business.
Fair
Value
The fund’s financial
instruments are reported at fair value, which GAAP defines as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The T. Rowe
Price Valuation Committee (the Valuation Committee) has been established by the
fund’s Board of Directors (the Board) to ensure that financial instruments are
appropriately priced at fair value in accordance with GAAP and the 1940 Act.
Subject to oversight by the Board, the Valuation Committee develops and oversees
pricing-related policies and procedures and approves all fair value
determinations. Specifically, the Valuation Committee establishes procedures to
value securities; determines pricing techniques, sources, and persons eligible
to effect fair value pricing actions; oversees the selection, services, and
performance of pricing vendors; oversees valuation-related business continuity
practices; and provides guidance on internal controls and valuation-related
matters. The Valuation Committee reports to the fund’s Board; is chaired by the
fund’s treasurer; and has representation from legal, portfolio management and
trading, operations, and risk management.
Various valuation techniques and
inputs are used to determine the fair value of financial instruments. GAAP
establishes the following fair value hierarchy that categorizes the inputs used
to measure fair value:
Level 1 – quoted prices (unadjusted)
in active markets for identical financial instruments that the fund can access
at the reporting date
Level 2 – inputs other than Level 1
quoted prices that are observable, either directly or indirectly (including, but
not limited to, quoted prices for similar financial instruments in active
markets, quoted prices for identical or similar financial instruments in
inactive markets, interest rates and yield curves, implied volatilities, and
credit spreads)
Level 3 – unobservable
inputs
Observable inputs are developed using
market data, such as publicly available information about actual events or
transactions, and reflect the assumptions that market participants would use to
price the financial instrument. Unobservable inputs are those for which market
data are not available and are developed using the best information available
about the assumptions that market participants would use to price the financial
instrument. GAAP requires valuation techniques to maximize the use of relevant
observable inputs and minimize the use of unobservable inputs. When multiple
inputs are used to derive fair value, the financial instrument is assigned to
the level within the fair value hierarchy based on the lowest-level input that
is significant to the fair value of the financial instrument. Input levels are
not necessarily an indication of the risk or liquidity associated with financial
instruments at that level but rather the degree of judgment used in determining
those values.
Valuation
Tec
h
ni
q
ues
Debt securities generally are traded in the
over-the-counter (OTC) market. Securities with remaining maturities of one year
or more at the time of acquisition are valued at prices furnished by dealers who
make markets in such securities or by an independent pricing service, which
considers the yield or price of bonds of comparable quality, coupon, maturity,
and type, as well as prices quoted by dealers who make markets in such
securities. Securities with remaining maturities of less than one year at the
time of acquisition generally use amortized cost in local currency to
approximate fair value. However, if amortized cost is deemed not to reflect fair
value or the fund holds a significant amount of such securities with remaining
maturities of more than 60 days, the securities are valued at prices furnished
by dealers who make markets in such securities or by an independent pricing
service. Generally, debt securities are categorized in Level 2 of the fair value
hierarchy; however, to the extent the valuations include significant
unobservable inputs, the securities would be categorized in Level 3.
Investments in mutual funds are
valued at the mutual fund’s closing net asset value per share on the day of
valuation and are categorized in Level 1 of the fair value hierarchy. Financial
futures contracts are valued at closing settlement prices and are categorized in
Level 1 of the fair value hierarchy. Assets and liabilities other than financial
instruments, including short-term receivables and payables, are carried at cost,
or estimated realizable value, if less, which approximates fair
value.
Thinly traded financial instruments
and those for which the above valuation procedures are inappropriate or are
deemed not to reflect fair value are stated at fair value as determined in good
faith by the Valuation Committee. The objective of any fair value pricing
determination is to arrive at a price that could reasonably be expected from a
current sale. Financial instruments fair valued by the Valuation Committee are
primarily private placements, restricted securities, warrants, rights, and other
securities that are not publicly traded.
Subject to oversight by the Board,
the Valuation Committee regularly makes good faith judgments to establish and
adjust the fair valuations of certain securities as events occur and
circumstances warrant. For instance, in determining the fair value of troubled
or thinly traded debt instruments, the Valuation Committee considers a variety
of factors, which may include, but are not limited to, the issuer’s business
prospects, its financial standing and performance, recent investment
transactions in the issuer, strategic events affecting the company, market
liquidity for the issuer, and general economic conditions and events. In
consultation with the investment and pricing teams, the Valuation Committee will
determine an appropriate valuation technique based on available information,
which may include both observable and unobservable inputs. The Valuation
Committee typically will afford greatest weight to actual prices in arm’s length
transactions, to the extent they represent orderly transactions between market
participants; transaction information can be reliably obtained; and prices are
deemed representative of fair value. However, the Valuation Committee may also
consider other valuation methods such as a discount or premium from market value
of a similar, freely traded security of the same issuer; discounted cash flows;
yield to maturity; or some combination. Fair value determinations are reviewed
on a regular basis and updated as information becomes available, including
actual purchase and sale transactions of the issue. Because any fair value
determination involves a significant amount of judgment, there is a degree of
subjectivity inherent in such pricing decisions and fair value prices determined
by the Valuation Committee could differ from those of other market participants.
Depending on the relative significance of unobservable inputs, including the
valuation technique(s) used, fair valued securities may be categorized in Level
2 or 3 of the fair value hierarchy.
Valuation
Inputs
The following table
summarizes the fund’s financial instruments, based on the inputs used to
determine their fair values on May 31, 2013:
There were no material transfers
between Levels 1 and 2 during the period.
NOTE
3
-
DERIVATIVE
INSTRUMENTS
During the year ended May 31, 2013,
the fund invested in derivative instruments. As defined by GAAP, a derivative is
a financial instrument whose value is derived from an underlying security price,
foreign exchange rate, interest rate, index of prices or rates, or other
variable; it requires little or no initial investment and permits or requires
net settlement. The fund invests in derivatives only if the expected risks and
rewards are consistent with its investment objectives, policies, and overall
risk profile, as described in its prospectus and Statement of Additional
Information. The fund may use derivatives for a variety of purposes, such as
seeking to hedge against declines in principal value, increase yield, invest in
an asset with greater efficiency and at a lower cost than is possible through
direct investment, or to adjust portfolio duration and credit exposure. The
risks associated with the use of derivatives are different from, and potentially
much greater than, the risks associated with investing directly in the
instruments on which the derivatives are based. Investments in derivatives can
magnify returns positively or negatively; however, the fund at all times
maintains sufficient cash reserves, liquid assets, or other SEC-permitted asset
types to cover the settlement obligations under its open derivative
contracts.
The fund values its derivatives at
fair value, as described below and in Note 2, and recognizes changes in fair
value currently in its results of operations. Accordingly, the fund does not
follow hedge accounting, even for derivatives employed as economic hedges. The
fund does not offset the fair value of derivative instruments against the right
to reclaim or obligation to return collateral. As of May 31, 2013, the fund held
interest rate futures with cumulative unrealized gain of $15,000 and cumulative
unrealized loss of $123,000; the value reflected on the accompanying Statement
of Assets and Liabilities is the related unsettled variation margin.
Additionally, the amount of gains and
losses on derivative instruments recognized in fund earnings during the year
ended May 31, 2013, and the related location on the accompanying Statement of
Operations is summarized in the following table by primary underlying risk
exposure:
Futures
Contracts
The fund is subject to
interest rate risk in the normal course of pursuing its investment objectives
and uses futures contracts to help manage such risk. The fund may enter into
futures contracts to manage exposure to interest rate and yield curve movements,
security prices, foreign currencies, credit quality, and mortgage prepayments;
as an efficient means of adjusting exposure to all or part of a target market;
to enhance income; as a cash management tool; and/or to adjust portfolio
duration and credit exposure. A futures contract provides for the future sale by
one party and purchase by another of a specified amount of a particular
underlying financial instrument at an agreed-upon price, date, time, and place.
The fund currently invests only in exchange-traded futures, which generally are
standardized as to maturity date, underlying
financial instrument, and other contract terms. Upon entering into a futures
contract, the fund is required to deposit collateral with the broker in the form
of cash or securities in an amount equal to a certain percentage of the contract
value (margin requirement); the margin requirement must then be maintained at
the established level over the life of the contract. Subsequent payments are
made or received by the fund each day to settle daily fluctuations in the value
of the contract (variation margin), which reflect changes in the value of the
underlying financial instrument. Variation margin is recorded as unrealized gain
or loss until the contract is closed. The value of a futures contract included
in net assets is the amount of unsettled variation margin; net variation margin
receivable is reflected as an asset, and net variation margin payable is
reflected as a liability on the accompanying Statement of Assets and
Liabilities. Risks related to the use of futures contracts include possible
illiquidity of the futures markets, contract prices that can be highly volatile
and imperfectly correlated to movements in hedged security values and/or
interest rates, and potential losses in excess of the fund’s initial investment.
During the year ended May 31, 2013, the fund’s exposure to futures, based on
underlying notional amounts, was generally between 4% and 8% of net
assets.
Options
The fund is subject to interest rate risk in the normal
course of pursuing its investment objectives and uses options to help manage
such risk. The fund may use options on futures contracts to manage exposure to
interest rates, security prices, foreign currencies, and credit quality; as an
efficient means of adjusting exposure to all or a part of a target market; to
enhance income; as a cash management tool; and/or to adjust portfolio duration
and credit exposure. In return for a premium paid, call and put options on
futures contracts give the holder the right, but not the obligation, to purchase
or sell, respectively, a position in a particular futures contract at a
specified exercise price at any time during the period of the option. Upon
exercise, the writer of the option delivers to the holder the futures position
as well as the accumulated balance in the writer’s futures margin account, which
represents the difference between the futures contract price on the exercise
date and the exercise price of the option. Premiums on unexercised, expired
options are recorded as realized gains or losses; premiums on exercised options
are recorded as an adjustment to the proceeds from the sale or cost of the
purchase. The difference between the premium and the amount received or paid in
a closing transaction is also treated as realized gain or loss. Risks related to
the use of options include possible illiquidity of the options and/or futures
markets; trading restrictions imposed by an exchange; underlying futures prices
that can be highly volatile
and imperfectly
correlated to movements in hedged security values and/or interest rates; and,
for written options, potential losses in excess of the fund’s initial
investment. During the year ended May 31, 2013, the fund’s exposure to options,
based on underlying notional amounts, was generally less than 1% of net assets.
Transactions in written options and related premiums received during the year
ended May 31, 2013, were as follows:
NOTE
4
-
OTHER
INVESTMENT
TRANSACTIONS
Consistent with its investment
objective, the fund engages in the following practices to manage exposure to
certain risks and/or to enhance performance. The investment objective, policies,
program, and risk factors of the fund are described more fully in the fund’s
prospectus and Statement of Additional Information.
TBA
P
urc
h
ase
and
Sale
Commitments
During the year ended May 31, 2013, the fund entered into to be announced (TBA)
purchase and/or sale commitments, pursuant to which it agrees to purchase or
sell, respectively, mortgage-backed securities for a fixed unit price, with
payment and delivery at a scheduled future date beyond the customary settlement
period for such mortgage-backed securities. With TBA transactions, the
particular securities to be delivered are not identified at the trade date;
however, delivered securities must meet specified terms, including issuer, rate,
and mortgage term, and be within industry-accepted “good delivery” standards.
The fund generally enters into TBA purchase transactions with the intention of
taking possession of the underlying mortgage securities; however, for either
purchase or sale transactions, the fund also may extend the settlement by
“rolling” the transaction. Until settlement, the fund maintains cash reserves
and liquid assets sufficient to settle its TBA commitments.
Counterparty
Risk
and
Collateral
The fund has entered into collateral agreements with
certain counterparties to mitigate counterparty risk associated with certain
over-the-counter (OTC) financial instruments, including swaps, forward currency
exchange contracts, TBA purchase commitments, and OTC options (collectively,
covered OTC instruments). Subject to certain minimum exposure requirements
(which typically range from $100,000 to $500,000), collateral requirements
generally are determined and transfers made based on the net aggregate
unrealized gain or loss on all OTC instruments covered by a particular
collateral agreement with a specified counterparty. At any point in time, the
fund’s risk of loss from counterparty credit risk on covered OTC instruments is
the aggregate unrealized gain on appreciated covered OTC instruments in excess
of collateral, if any, pledged by the counterparty to the fund. Further, in
accordance with the terms of the relevant agreements, counterparties to certain
OTC instruments may be able to terminate the contracts prior to maturity upon
the occurrence of certain stated events, such as a decline in net assets above a
certain percentage or a failure by the fund to perform its obligations under the
contract. Upon termination, all transactions would typically be liquidated and a
net amount would be owed by or payable to the fund.
Counterparty risk related to
exchange-traded futures and options contracts is minimal because the exchange’s
clearinghouse provides protection against counterparty defaults. Generally, for
exchange-traded derivatives such as futures and options, each broker, in its
sole discretion, may change margin requirements applicable to the
fund.
Collateral can be in the form of cash
or debt securities issued by the U.S. government or related agencies. For OTC
instruments, collateral both pledged by the fund to a counterparty and pledged
by a counterparty to the fund, is held in a segregated account by a third-party
agent. For exchange-traded instruments, margin posted by the fund is held by the
broker. Cash posted by the fund as collateral or to meet margin requirements is
reflected as restricted cash in the accompanying financial statements and
securities posted by the fund are so noted in the accompanying Portfolio of
Investments; both remain in the fund’s assets. Collateral pledged by
counterparties is not included in the fund’s assets because the fund does not
obtain effective control over those assets. As of May 31, 2013, no collateral
was pledged by either the fund or counterparties for covered OTC instruments. As
of May 31, 2013, securities valued at $614,000 had been posted by the fund to
the broker for exchange-traded derivatives.
Ot
h
er
Purchases and sales of U.S.
government securities aggregated $225,078,000 and $265,590,000, respectively,
for the year ended May 31, 2013.
NOTE
5
-
FEDERAL
INCOME
TAXES
No provision for federal income taxes
is required since the fund intends to continue to qualify as a regulated
investment company under Subchapter M of the Internal Revenue Code and
distribute to shareholders all of its taxable income and gains. Distributions
determined in accordance with federal income tax regulations may differ in
amount or character from net investment income and realized gains for financial
reporting purposes. Financial reporting records are adjusted for permanent
book/tax differences to reflect tax character but are not adjusted for temporary
differences.
The fund files U.S. federal, state,
and local tax returns as required. The fund’s tax returns are subject to
examination by the relevant tax authorities until expiration of the applicable
statute of limitations, which is generally three years after the filing of the
tax return but which can be extended to six years in certain circumstances. Tax
returns for open years have incorporated no uncertain tax positions that require
a provision for income taxes.
Reclassifications to paid-in capital
relate primarily to a tax practice that treats a portion of the proceeds from
each redemption of capital shares as a distribution of taxable net investment
income and/or realized capital gain. Reclassifications between income and gain
relate primarily to the character of paydown gains and losses on asset-backed
securities. For the year ended May 31, 2013, the following reclassifications
were recorded to reflect tax character (there was no impact on results of
operations or net assets):
Distributions during the years ended
May 31, 2013 and May 31, 2012, were characterized for tax purposes as
follows:
At May 31, 2013, the tax-basis cost
of investments and components of net assets were as follows:
The difference between book-basis and
tax-basis net unrealized appreciation (depreciation) is attributable to the
deferral of losses from wash sales and/or certain derivative contracts for tax
purposes.
NOTE
6
-
RELATED
P
ARTY
TRANSACTIONS
The fund is managed by T. Rowe Price
Associates, Inc. (Price Associates), a wholly owned subsidiary of T. Rowe Price
Group, Inc. (Price Group). The investment management agreement between the fund
and Price Associates provides for an annual investment management fee, which is
computed daily
and paid monthly. The fee is
determined by applying a group fee rate to the fund’s average daily net assets.
The group fee rate is calculated based on the combined net assets of certain
mutual funds sponsored by Price Associates (the group) applied to a graduated
fee schedule, with rates ranging from 0.48% for the first $1 billion of assets
to 0.275% for assets in excess of $400 billion. At May 31, 2013, the effective
annual group fee rate was 0.30%.
The fund is also subject to a
contractual expense limitation through
September 30, 2014. During the limitation period, Price Associates is
required to waive its management fee and reimburse the fund for any expenses,
excluding interest, taxes, brokerage commissions, and extraordinary expenses,
that would otherwise cause the fund’s ratio of annualized total expenses to
average net assets (expense ratio) to exceed its expense limitation of 0.55%.
The fund is required to repay Price Associates for expenses previously
reimbursed and management fees waived to the extent the fund’s net assets have
grown or expenses have declined sufficiently to allow repayment without causing
the fund’s expense ratio to exceed its expense limitation. However, no repayment
will be made more than three years after the date of any reimbursement or waiver
or later than September 30, 2016. Pursuant to this agreement, management fees in
the amount of $35,000 were repaid during the year ended May 31, 2013. At May 31,
2013, there were no amounts subject to repayment by the fund.
In addition, the fund has entered
into service agreements with Price Associates and two wholly owned subsidiaries
of Price Associates (collectively, Price). Price Associates computes the daily
share price and provides certain other administrative services to the fund. T.
Rowe Price Services, Inc., provides shareholder and administrative services in
its capacity as the fund’s transfer and dividend disbursing agent. T. Rowe Price
Retirement Plan Services, Inc., provides subaccounting and recordkeeping
services for certain retirement accounts invested in the fund. For the year
ended May 31, 2013, expenses incurred pursuant to these service agreements were
$95,000 for Price Associates; $196,000 for T. Rowe Price Services, Inc.; and
$105,000 for T. Rowe Price Retirement Plan Services, Inc. The total amount
payable at period-end pursuant to these service agreements is reflected as Due
to Affiliates in the accompanying financial statements.
The fund is also one of several
mutual funds sponsored by Price Associates (underlying Price funds) in which the
T. Rowe Price Spectrum Funds (Spectrum Funds) may invest. The Spectrum Funds do
not invest in the underlying Price funds for the purpose of exercising
management or control. Pursuant to a special servicing agreement, expenses
associated with the operation of the Spectrum Funds are borne by each underlying
Price fund to the extent of estimated savings to it and in proportion to the
average daily value of its shares owned by the Spectrum Funds. Expenses
allocated under this agreement are reflected as shareholder servicing expense in
the accompanying financial statements. For the year ended May 31, 2013, the fund
was allocated $251,000 of Spectrum Funds’ expenses, of which $173,000 related to
services provided by Price. The amount payable at period-end pursuant to this
agreement is reflected as Due to Affiliates in the accompanying financial
statements. At May 31, 2013, approximately 31% of the outstanding shares of the
fund were held by the Spectrum Funds.
The fund may invest in the T. Rowe
Price Reserve Investment Fund and the T. Rowe Price Government Reserve
Investment Fund (collectively, the T. Rowe Price Reserve Investment Funds),
open-end management investment companies managed by Price Associates and
considered affiliates of the fund. The T. Rowe Price Reserve Investment Funds
are offered as cash management options to mutual funds, trusts, and other
accounts managed by Price Associates and/or its affiliates and are not available
for direct purchase by members of the public. The T. Rowe Price Reserve
Investment Funds pay no investment management fees.
|
Report of
Independent Registered Public Accounting
Firm
|
To
t
h
e
Board
of
Directors
of
T.
Ro
w
e
P
rice
U.S.
Treasury
Funds,
Inc.
and
S
h
are
h
olders
of
U.S.
Treasury
Long-Term
Fund
In our opinion, the accompanying
statement of assets and liabilities, including the portfolio of investments, and
the related statements of operations and of changes in net assets and the
financial highlights present fairly, in all material respects, the financial
position of U.S. Treasury Long-Term Fund (one of the portfolios comprising T.
Rowe Price U.S. Treasury Funds, Inc., hereafter referred to as the “Fund”) at
May 31, 2013, and the results of its operations, the changes in its net assets
and the financial highlights for each of the periods indicated therein, in
conformity with accounting principles generally accepted in the United States of
America. These financial statements and financial highlights (hereafter referred
to as “financial statements”) are the responsibility of the Fund’s management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these financial statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at May 31, 2013 by
correspondence with the custodian and brokers, and confirmation of the
underlying funds by correspondence with the transfer agent, provide a reasonable
basis for our opinion.
PricewaterhouseCoopers
LLP
Baltimore, Maryland
July 16, 2013
|
Tax
Information (Unaudited) for the Tax Year Ended
5/31/13
|
We
are providing this information as required by the Internal Revenue Code. The
amounts shown may differ from those elsewhere in this report because of
differences between tax and financial reporting requirements.
The fund’s distributions to
shareholders included:
-
$1,326,000 from short-term capital
gains,
-
$11,468,000 from long-term capital gains,
subject to the 15% rate gains category.
|
Information on Proxy Voting Policies, Procedures, and
Records
|
A description of the policies and
procedures used by T. Rowe Price funds and portfolios to determine how to vote
proxies relating to portfolio securities is available in each fund’s Statement
of Additional Information. You may request this document by calling
1-800-225-5132 or by accessing the SEC’s website, sec.gov.
The description of our proxy voting
policies and procedures is also available on our website, troweprice.com. To
access it, click on the words “Social Responsibility” at the top of our
corporate homepage. Next, click on the words “Conducting Business Responsibly”
on the left side of the page that appears. Finally, click on the words “Proxy
Voting Policies” on the left side of the page that appears.
Each fund’s most recent annual proxy
voting record is available on our website and through the SEC’s website. To
access it through our website, follow the above directions to reach the
“Conducting Business Responsibly” page. Click on the words “Proxy Voting
Records” on the left side of that page, and then click on the “View Proxy Voting
Records” link at the bottom of the page that appears.
|
How to
Obtain Quarterly Portfolio Holdings
|
The fund files a complete schedule of
portfolio holdings with the Securities and Exchange Commission for the first and
third quarters of each fiscal year on Form N-Q. The fund’s Form N-Q is available
electronically on the SEC’s website (sec.gov); hard copies may be reviewed and
copied at the SEC’s Public Reference Room, 100 F St. N.E., Washington, DC 20549.
For more information on the Public Reference Room, call 1-800-SEC-0330.
|
Approval
of Investment Management Agreement
|
On March 5, 2013, the fund’s Board of Directors (Board),
including a majority of the fund’s independent directors, approved the
continuation of the investment management agreement (Advisory Contract) between
the fund and its investment advisor, T. Rowe Price Associates, Inc. (Advisor).
In connection with their deliberations, the Board requested, and the Advisor
provided such information as the Board, with advice from independent legal
counsel, deemed reasonably necessary. The Board considered a variety of factors
in connection with its review of the Advisory Contract, also taking into account
information provided by the Advisor during the course of the year, as discussed
below:
Services
P
rovided
by
t
h
e
Advisor
The Board considered
the nature, quality, and extent of the services provided to the fund by the
Advisor. These services included, but were not limited to, directing the fund’s
investments in accordance with its investment program and the overall management
of the fund’s portfolio, as well as a variety of related activities such as
financial, investment operations, and administrative services; compliance;
maintaining the fund’s records and registrations; and shareholder
communications. The Board also reviewed the background and experience of the
Advisor’s senior management team and investment personnel involved in the
management of the fund, as well as the Advisor’s compliance record. The Board
concluded that it was satisfied with the nature, quality, and extent of the
services provided by the Advisor.
Investment
P
erformance
of
t
h
e
Fund
The Board reviewed the
fund’s three-month, one-year, and year-by-year returns, as well as the fund’s
average annualized total returns over the 3-, 5-, and 10-year periods, and
compared these returns with a wide variety of previously agreed upon comparable
performance measures and market data, including those supplied by Lipper and
Morningstar, which are independent providers of mutual fund data.
On the basis of this evaluation and
the Board’s ongoing review of investment results, and factoring in the relative
market conditions during certain of the performance periods, the Board concluded
that the fund’s performance was satisfactory.
Costs,
Benefits,
P
rofits,
and
Economies
of
Scale
The Board reviewed detailed information regarding the
revenues received by the Advisor under the Advisory Contract and other benefits
that the Advisor (and its affiliates) may have realized from its relationship
with the fund, including any research received under “soft dollar” agreements
and commission-sharing arrangements with broker-dealers. The Board considered
that the Advisor may receive some benefit from soft-dollar arrangements pursuant
to which research is received from broker-dealers that execute the applicable
fund’s portfolio transactions. The Board received information on the estimated
costs incurred and profits realized by the Advisor from managing T. Rowe Price
mutual funds. The Board also reviewed estimates of the profits realized from
managing the fund in particular and the Board concluded that the Advisor’s
profits were reasonable in light of the services provided to the
fund.
The Board also considered whether the
fund benefits under the fee levels set forth in the Advisory Contract from any
economies of scale realized by the Advisor. Under the Advisory Contract, the
fund pays a fee to the Advisor for investment management services composed of
two components—a group fee rate based on the combined average net assets of most
of the T. Rowe Price mutual funds (including the fund) that declines at certain
asset levels and an individual fund fee rate based on the fund’s average daily
net assets—and the fund pays its own expenses of operations (subject to an
expense limitation agreed to by the Advisor). However, the Board noted that the
fund’s individual fund fee is 0.00% so the management fee paid by the fund
consists only of the group fee rate. The Board concluded that the advisory fee
structure for the fund continued to provide for a reasonable sharing of benefits
from any economies of scale with the fund’s investors.
Fees
The Board was provided with information regarding
industry trends in management fees and expenses, and the Board reviewed the
fund’s management fee rate, operating expenses, and total expense ratio in
comparison with fees and expenses of other comparable funds based on information
and data supplied by Lipper. After adding amounts that were reimbursed by the
fund to the Advisor as a result of previous fee waivers or expenses paid by the
Advisor, the information provided to the Board indicated that the fund’s
management fee rate was above the median for comparable funds, and the fund’s
total expense ratio was above the median for certain groups of comparable funds
and at or below the median for other groups of comparable funds.
The Board also reviewed the fee
schedules for institutional accounts and private accounts with similar mandates
that are advised or subadvised by the Advisor and its affiliates. Management
provided the Board with information about the Advisor’s responsibilities and
services provided to institutional account clients, including information about
how the requirements and economics of the institutional business are
fundamentally different from those of the mutual fund business. The Board
considered information showing that the mutual fund business is generally more
complex from a business and compliance perspective than the institutional
business and that the Advisor generally performs significant additional services
and assumes greater risk in managing the fund and other T. Rowe Price mutual
funds than it does for institutional account clients.
On the basis of the information
provided and the factors considered, the Board concluded that the fees paid by
the fund under the Advisory Contract are reasonable.
Approval
of
t
h
e
Advisory
Contract
As
noted, the Board approved the continuation of the Advisory Contract. No single
factor was considered in isolation or to be determinative to the decision.
Rather, the Board concluded, in light of a weighting and balancing of all
factors considered, that it was in the best interests of the fund and its
shareholders for the Board to approve the continuation of the Advisory Contract
(including the fees to be charged for services thereunder). The independent
directors were advised throughout the process by independent legal
counsel.