Capital Adequacy and Liquidity
The primary objectives of Merrill Lynch's capital structure and funding policies are to:

• Ensure sufficient equity capital to absorb losses,
• Support the business strategies, and
• Assure liquidity at all times, across market cycles, and through periods of financial stress.

Capital Adequacy
At December 29, 2000, Merrill Lynch's equity capital was comprised of $17.9 billion in common equity, $425 million in preferred stock, and $2.7 billion of TOPrS.

Merrill Lynch continually reviews overall equity capital needs to ensure that its equity capital base can support the estimated risks and needs of its businesses, as well as the regulatory and legal capital requirements of its subsidiaries. Merrill Lynch uses statistically based risk models, developed in conjunction with risk management practices, to estimate potential losses arising from market and credit risks. Equity capital needs are determined based on these models, which dynamically capture changes in risk profile. Merrill Lynch also assesses the need for equity capital to support business risks, such as process risk, that may not be adequately measured through these risk models, as well as the potential use of equity capital to support growth. Merrill Lynch determines the appropriateness of its equity capital composition, which includes common stock, preferred stock, and TOPrS, taking into account the perpetual nature of its preferred stock and TOPrS. Based on these analyses and criteria, management believes that Merrill Lynch's equity capital base of $21.0 billion is adequate.

Merrill Lynch operates in many regulated businesses that require various minimum levels of capital (see Note 13 to the Consolidated Financial Statements for further information). Merrill Lynch's broker-dealer, banking, insurance, and futures commission merchant activities are subject to regulatory requirements that may restrict the free flow of funds to affiliates. Regulatory approval is generally required for paying dividends in excess of certain established levels and making affiliated investments.

Merrill Lynch's leverage ratios were as follows:

1. Total assets to Total stockholders' equity and Preferred securities issued by subsidiaries.
   
2. Total assets less (a) Receivables under resale agreements and securities borrowed transactions,(b) Marketable investment securities to Total stockholders' equity and Preferred securities issued by subsidiaries.
   
3. Computed using month-end balances.

An asset-to-equity leverage ratio does not reflect the risk profile of assets, hedging strategies, or off-balance sheet exposures. Thus, Merrill Lynch does not rely on overall leverage ratios to assess risk-based capital adequacy.

Liquidity
Liquidity risk occurs when there are timing differences between cash inflows from the businesses and cash outflows for business needs and maturing debt obligations. Merrill Lynch's liquidity policy is to maintain alternative funding sources such that all unsecured debt obligations maturing within one year can be repaid when due without issuing new unsecured debt or liquidating business assets. Primary alternative funding sources to unsecured borrowings are repurchase agreements, securities loaned, and secured bank loans, which require pledging unhypothecated marketable securities held for trading or liquidity purposes. Other funding sources include liquidating cash equivalents; securitizing loan assets; and drawing on a committed, senior, unsecured bank credit facility that, at December 29, 2000, totaled $8 billion and was not drawn upon. Merrill Lynch maintains a contingency funding plan, which outlines actions that would be taken in the event of a severe funding disruption.

Merrill Lynch regularly reviews the level and mix of its assets and liabilities to assess its ability to conduct core business activities without issuing new unsecured debt or drawing upon its bank credit facilities. The mix of assets and liabilities provides flexibility in managing liquidity since a significant portion of assets turn over frequently and are typically match-funded with liabilities having similar maturities and cash flow characteristics. At December 29, 2000, a significant portion of Merrill Lynch's assets was considered readily marketable by management.

Merrill Lynch typically concentrates its unsecured, general-purpose funding at the ML & Co. level, except where tax regulations, time zone differences, or other business considerations make this impractical. The benefits of this strategy are enhanced control, reduced financing costs, wider name recognition by creditors, and greater flexibility to meet variable funding requirements of subsidiaries.

Merrill Lynch strives to expand and diversify its funding programs, markets, and investor and creditor base. Merrill Lynch benefits by distributing a significant portion of its liabilities and equity through its own sales force to a large, diversified global client base. Available funding sources include:

• repurchase agreements and securities loaned transactions,
  
• U.S., Canadian, Euro, Japanese, and Australian commercial paper programs,
  
• letters of credit,
  
• master notes,
  
• deposits at Merrill Lynch's banking subsidiaries,
  
• bank loans,
  
• long-term debt,
  
• TOPrS,
  
• preferred stock, and
  
• common stock.

Commercial paper represented 3% and 8% of total assets at year-end 2000 and 1999, respectively. Merrill Lynch maintains strict concentration standards for commercial paper and other short-term borrowings, including limits for any single investor.

Deposits at Merrill Lynch's banking subsidiaries have increased from $17.6 billion at year-end 1999 to $67.6 billion at year-end 2000, including $54.9 billion at Merrill Lynch's U.S. banks. The additional deposits were primarily invested in high quality marketable investment securities (see the Non-Trading Liabilities - Borrowings section for further information).

In addition to equity capital sources, Merrill Lynch views long-term debt as a stable funding source for its core balance sheet assets. Long-term, less liquid assets are fully funded with long-term sources of capital, which include the non-current portion of long-term debt, TOPrS, preferred stock, and common equity. Generally, trading and other current assets are financed with a combination of short-term funding, long-term debt, and equity capital.

As part of an overall liquidity management strategy, Merrill Lynch's insurance subsidiaries regularly review the funding requirements of their contractual obligations for in-force, fixed-rate life insurance and annuity contracts as well as expected future acquisition and maintenance expenses for all contracts. The insurance subsidiaries develop and market primarily variable life insurance and variable annuity products. These products are not subject to the interest rate, asset/liability matching, or credit risks attributable to fixed-rate products, thereby reducing the insurance subsidiaries' risk profile and liquidity demands. At December 29, 2000, approximately 80% of invested assets of insurance subsidiaries were considered liquid by management.

ASSET AND LIABILITY MANAGEMENT
The relationship between assets and liabilities is managed on a consolidated basis across businesses and subsidiaries. Merrill Lynch routinely issues debt in a variety of maturities and currencies to achieve the lowest cost financing possible. Merrill Lynch uses derivative transactions to more closely match the duration of these borrowings to the duration of the assets being funded to minimize interest rate risk. Merrill Lynch also enters into currency swaps, to ensure that foreign-currency denominated assets are funded with like-currency denominated liabilities (to the extent that the currency cannot be sourced more efficiently through a direct debt issuance). Merrill Lynch uses swaps for asset and liability management to reduce its interest expense and effective borrowing rate. For further information, see Note 6 to the Consolidated Financial Statements.

CREDIT RATINGS
The cost and availability of unsecured financing generally are dependent on credit ratings. Merrill Lynch's senior long-term debt, preferred stock, and TOPrS were rated by several recognized credit rating agencies at December 29, 2000 as follows:

1. Located in Japan.

Approximately $84.9 billion of indebtedness at December 29, 2000 is considered senior indebtedness as defined under various indentures.

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