Management's Discussion and Analysis Table of Contents
•  Business Environment •  Results of Operations •  Consolidated Results of Operations •  Business Segments •  Global Operations •  Consolidated Balance Sheets	•  Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments •  Capital Adequacy and Funding •  Capital Projects and Expenditures •  Risk Management	•  Non-Investment Grade Holdings and Highly Leveraged Transactions •  Litigation •  Critical Accounting Policies and Estimates •  Recent Developments

Merrill Lynch & Co., Inc. ("ML & Co." and, together with its subsidiaries, "Merrill Lynch") is a holding company that, through its subsidiaries, provides broker-dealer, investment banking, financing, advisory, wealth management, asset management, insurance, lending, and related products and services on a global basis. In addition, Merrill Lynch makes principal investments for market making on behalf of its clients and for its own account. The financial services industry, in which Merrill Lynch is a leading participant, is highly competitive and highly regulated. This industry and the global financial markets are influenced by numerous unpredictable factors. These factors include economic conditions, monetary and fiscal policies, the liquidity of global markets, international and regional political events, acts of war or terrorism, changes in applicable laws and regulations, the competitive environment, and investor sentiment. In addition to these factors, Merrill Lynch and other financial services companies may be affected by the regulatory and legislative initiatives which may affect the conduct of its business, including increased regulation, and by the outcome of legal and regulatory proceedings. These conditions or events can significantly affect the volatility of the financial markets as well as the volumes and revenues in businesses such as brokerage, trading, investment banking, wealth management and asset management. Revenues and net earnings may vary significantly from period to period due to these unpredictable factors and the resulting market volatility and trading volumes.

The financial services industry continues to be affected by an intensifying competitive environment, as demonstrated by consolidation through mergers, competition from new and established competitors using the internet or other technology to provide financial services and diminishing margins in many mature products and services. Commercial and investment bank consolidations, which were made possible by the enactment of the Gramm-Leach-Bliley Act, have also increased the competition for investment banking business in part through the extension of credit in conjunction with investment banking and capital raising activities. In 2002, the U.S. Congress passed the Sarbanes-Oxley Act of 2002 which is a broad overhaul of existing corporate and securities laws. In addition, various Federal and state securities regulators, self-regulatory organizations (including the New York Stock Exchange) and industry participants reviewed and in many cases adopted sweeping changes to their established rules including rules in the areas of corporate governance, research analyst conflicts of interest and auditor independence. Changes pertaining to the role of research analysts in connection with providing financial services may also affect how financial services companies interact with their clients and the cost structure for such services. Outside the United States, there is continued focus by regulators and legislators on regulatory supervision of both banks and investment firms on a consolidated and individual basis, especially in the area of risk management. Credit rating agencies also took negative rating actions in 2002 with respect to several financial institutions, including Merrill Lynch.

Certain statements contained in this Report may be considered forward-looking, including statements about management expectations, strategic objectives, business prospects, anticipated expense savings and financial results, anticipated results of litigation and regulatory proceedings, and other similar matters. These forward-looking statements are not statements of historical fact and represent only Management's beliefs regarding future events, which are inherently uncertain. There are a variety of factors, many of which are beyond Merrill Lynch's control, which affect its operations, performance, business strategy and results and could cause its actual results and experience to differ materially from the expectations and objectives expressed in any forward-looking statements. These factors include, but are not limited to, the factors listed in the previous two paragraphs, as well as actions and initiatives taken by both current and potential competitors, the effect of current, pending and future legislation and regulation, and the other risks and uncertainties detailed in Merrill Lynch's Form 10-K and in the following sections. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the dates on which they are made. Merrill Lynch does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the dates the forward-looking statements are made. The reader should, however, consult any further disclosures Merrill Lynch may make in its Quarterly Reports on Form 10-Q and its Current Reports on Form 8-K.

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Business Environment
The global financial markets had a difficult year in 2002. Equity markets experienced the sharpest declines since the 1970s. The equity markets fell sharply as the combination of a global slowdown in economic activity, political unrest in the Middle East, widespread corporate downsizing, regulatory probes, accounting and corporate governance scandals and seven of the twelve largest ever U.S. bankruptcies caused investors to reduce equity market activity and shift to less volatile, fixed-income investments and money market instruments.

The yield on the 10-year U.S. Treasury bond, used as a benchmark for long-term interest rates, started the year at 5.06% and moved as high as 5.40% in late March, amid rising expectation for a recovery in the economy. Throughout the balance of 2002, the 10-year yield declined dramatically, reaching a 44-year low in October and finishing the year at 3.82%. This was the third consecutive year in which bond prices rose sharply while stocks declined in value. The U.S. Federal Reserve Bank cut interest rates during the fourth quarter of 2002, bringing the federal funds rate and the discount rate to 40-year lows of 1.25% and 0.75%, respectively.

Despite a fourth quarter rally that moved broad equity indices up sharply from five-year lows, U.S. equity indices declined for the third consecutive year. Technology and telecommunication stocks remained the hardest hit and most volatile. The Nasdaq Composite Index, dominated by large-cap technology stocks, fell 31.5% for the year after declining 21.1% in 2001. That performance left the index 73.6% off its record high set in early 2000. The Dow Jones Industrial Average dropped 16.8% in 2002 and the S&P 500 fell 23.4%, marking the sharpest declines since 1977 and 1974, respectively.

Global stocks were also affected by financial crisis in Latin America, economic uncertainty in Japan and a further decline in the technology sector across most of Europe. The Dow Jones World Index, excluding the United States, declined 15.6% during the year, leaving it down 45% over the past three years. European stock markets contributed significantly to that global decline as reflected by a 32% reduction in the Dow Jones Stock Index of 600 European blue chips in 2002. Each of the 18 industry sectors of the index ended the year with double-digit declines, one of the worst annual performances ever. Depressed by weak regional economies and dragged lower by the U.S. benchmarks, in U.S. dollar terms, major markets in Asia also fell heavily: in Japan, the Nikkei 225 index slipped 17.3% during the year and Hong Kong's Hang Seng declined by 17.4%. Latin American markets also performed poorly, led by Argentina and Brazil, where local political and economic turmoil exacerbated stock losses. For the second straight year, emerging markets, led by Thailand, South Korea and Eastern European economies, outperformed the developed world.

The volume of global stock and bond underwriting fell 5.1% in 2002, according to Thomson Financial Securities Data. The decline in underwriting fees was more significant at 21% from 2001 as lower-margin debt issuance predominated capital market origination activity. The largest contributor to the decline in underwriting fees was the 28% drop in global issues of stock. According to Thomson Financial Securities Data, the value of global Initial Public Offerings ("IPOs") fell 34% while U.S. IPOs fell 32% and activity levels hit a two-decade low of just 97 offerings.

Declining equity values, accounting scandals, the weak economy, poor earnings and global uncertainty all continued to affect the merger and acquisition market in 2002. Globally, the value of announced deals fell 28% during 2002 as the 41% drop in U.S. deals was partially mitigated by stronger activity levels in Europe. The number of U.S. deals declined to its lowest level since 1993, and the value of U.S. deals was 74% lower than its peak in 2000.

Merrill Lynch continually evaluates its businesses for profitability and performance under varying market conditions and, in light of changes in its competitive environment, for alignment with its long-term strategic objectives. Maintaining long-term client relationships, closely managing costs and carefully monitoring business and trading risks, diversifying revenue sources, and growing fee-based and recurring revenue sources all continue as objectives to mitigate the effects of a volatile market environment on Merrill Lynch's business as a whole.

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Results of Operations



Consolidated Results of Operations
Merrill Lynch's net earnings were $2.5 billion in 2002, up from $573 million in 2001. Earnings per diluted share were $2.63, compared with $0.57 in 2001. Net earnings in 2001 included after-tax restructuring and other charges of $1.7 billion ($2.2 billion pre-tax) and $83 million of after-tax September 11-related expenses ($131 million pre-tax). Full year 2002 results included $126 million of September 11-related net insurance recoveries ($212 million pre-tax), research and other settlement-related expenses of $207 million ($291 million pre-tax) and $42 million of after-tax net restructuring and other charges benefits ($8 million expense pre-tax). Net earnings in 2000 were $3.8 billion, or $4.11 per diluted share.

In 2002, the return on average common stockholders' equity was 11.7% and the pre-tax profit margin was 20.2%. The 2001 return on average common stockholders' equity was 2.7% (11.7% excluding the restructuring and other charges and expenses related to September 11) and the pre-tax profit margin was 6.3% (16.9% excluding the restructuring and other charges and expenses related to September 11). Return on average common stockholders' equity for 2000 was 24.2% and the pre-tax profit margin was 21.4%.

The following chart illustrates the composition of net revenues by category in 2002.



Net revenues in 2002 were $18.6 billion, 15% lower than in 2001. Commission revenues in 2002 were $4.7 billion, down 12% due primarily to a global decline in client transaction volumes, particularly in listed equities and mutual funds. Principal transactions revenues in 2002 decreased 40%, to $2.3 billion, due to lower revenues from equities and equity derivatives trading, reduced client transaction flows, and the conversion of the Nasdaq business to a commission-based structure over the past year, partially offset by higher debt trading revenues. Net interest profit in 2002 was $3.5 billion, up 8% due primarily to a steeper yield curve environment and the widening of credit spreads. Underwriting revenues in 2002 decreased 30% to $1.7 billion and Strategic advisory revenues in 2002 declined 36% to $703 million, reflecting reduced investment banking activity. Asset management and portfolio service fees in 2002 were $4.9 billion, down 8% due primarily to the market-driven decline in equity assets under management. Other revenues in 2002 increased 42%, to $751 million, due in part to increased realized gains related to sales of mortgages originated by Merrill Lynch Credit Corporation, as well as investment losses incurred in 2001.

Net revenues in 2001 were $21.9 billion, 18% lower than in 2000. Commission revenues in 2001 were $5.3 billion, down 25% due primarily to a global decline in client transaction volumes, particularly in listed equities and mutual funds. Principal transactions revenues in 2001 decreased 34%, to $3.9 billion, due principally to lower revenues from equities and equity derivatives, resulting from reduced global transaction volumes, and lower volatility throughout much of the year, partially offset by improved debt trading results. Net interest profit in 2001 was $3.3 billion, up 6% from 2000. Underwriting revenues in 2001 decreased 10% to $2.4 billion due to a decline in global origination activity. Strategic advisory revenues in 2001 declined 20% to $1.1 billion, due to a reduced volume of completed merger and acquisition transactions. Asset management and portfolio service fees in 2001 were $5.4 billion, down 6% due primarily to the market-driven decline in assets under management and assets in asset-priced accounts. Other revenues in 2001 decreased 45%, to $528 million, principally reflecting investment losses incurred in 2001.

Compensation and benefits expenses were $9.4 billion in 2002, a decrease of $1.8 billion, or 16%, from 2001. The decrease was due primarily to lower incentive compensation expenses and lower Financial Advisor compensation, as well as reduced staffing levels. Compensation and benefits expenses were 50.7% of net revenues in 2002, compared to 51.5% in 2001. Non-compensation expenses were $5.4 billion in 2002, compared to $9.2 billion in 2001. Excluding the impact of recoveries/expenses related to September 11, research and other settlement-related expenses, and restructuring and other charges, non-compensation expenses were $5.3 billion in 2002, a reduction of $1.6 billion, or 23% from the 2001 level. This decrease included the absence of amortization expense on goodwill related to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. Goodwill amortization totaled $207 million in 2001.

Communications and technology costs were $1.7 billion, down 22% from 2001 due to lower technology equipment depreciation, communications costs, and systems consulting costs. Occupancy and related depreciation was $909 million, a decline of 16% from 2001 due primarily to lower rent expense resulting from the fourth quarter 2001 restructuring initiatives. Brokerage, clearing, and exchange fees were $727 million, down 19% from 2001. Advertising and market development expenses were $540 million, down 23% from 2001 due primarily to reduced spending on travel and advertising. Professional fees remained essentially unchanged at $552 million. Office supplies and postage decreased 26% from 2001, to $258 million, due to lower levels of business activity and to efficiency initiatives. Other expenses were $611 million in 2002, down 32% due to lower provisions for losses, including litigation. Research and other settlement-related expenses reflect the $100 million settlement with the New York Attorney General and related costs of $11 million, which were recorded in the second quarter of 2002, Merrill Lynch's $100 million portion of the global settlement accrued in the fourth quarter of 2002 for the funding of independent research and investor education, as well as $80 million related to a February 2003 settlement with the Securities and Exchange Commission regarding Merrill Lynch's transactions with Enron Corporation. For additional information regarding this subsequent event see Note 2 to the Consolidated Financial Statements.

Net recoveries related to September 11 were $212 million in 2002 compared with net expenses of $131 million in 2001. Restructuring and other charges were $8 million in 2002 and $2.2 billion in 2001. See Note 3 to the Consolidated Financial Statements for additional information.

In the fourth quarter of 2001, Merrill Lynch recorded a pre-tax charge of $2.2 billion ($1.7 billion after-tax) related to the resizing of selected businesses and other structural changes. This charge was recorded as Restructuring and other charges on the Consolidated Statements of Earnings. The charge was the result of a detailed review of all businesses, with a focus on improving profit margins and aligning capacity with the current business environment and opportunities for future growth. These actions were expected to result in pre-tax annual expense savings of approximately $1.4 billion. Merrill Lynch achieved these savings in the first nine months of 2002. Opportunities exist to reduce non-compensation expenses further, although many of the savings realized going forward will be reinvested into priority growth initiatives and necessary incremental expenses such as compliance with the Patriot Act and contingency planning. During 2002, Merrill Lynch recorded pre-tax restructuring and other charges of $8 million. This amount represents a charge of $17 million related to current year reductions in excess office space, which were not part of the 2001 restructuring charge, offset by a net credit of $9 million, which represents a change in estimate, related to facilities, severance, and other charges. The primary components of this change in estimate were a net increase in facilities costs, principally in the United States and a net decrease in severance and other costs principally in Japan. On an after-tax basis, restructuring and other charges resulted in a $42 million increase in earnings in 2002, which primarily reflects a tax benefit related to a reduction in the original estimate for the Global Private Client ("GPC") restructuring in Japan. For further information regarding the details of restructuring and other charges, see Note 3 to the Consolidated Financial Statements.

Non-interest expenses were $20.5 billion in 2001, compared with $21.0 billion in 2000. Excluding September 11-related expenses and restructuring and other charges, non-interest expenses were $18.2 billion in 2001. Compensation and benefits were down 18% from 2000 due to a decrease in incentive and production-related compensation resulting from lower revenues and fewer employees. Compensation and benefits were 51.5% of net revenues for 2001, relatively unchanged from 2000.

Communications and technology expense declined 4% in 2001 to $2.2 billion due to reduced systems consulting costs. Occupancy and related depreciation increased 7% in 2001, due primarily to a new London headquarters building. Brokerage, clearing, and exchange fees were $895 million in 2001, essentially unchanged from 2000. Advertising and market development expense was $703 million in 2001, down 25% from 2000 due to reduced spending on travel, advertising, and recognition programs. Professional fees decreased 14% in 2001, to $545 million, as a result of a reduction in spending on employment fees and non-technology consulting services. Office supplies and postage expense decreased 14% to $349 million due primarily to lower levels of business activity and efficiency initiatives. Other expenses were $902 million, essentially unchanged from 2000. Also included in 2001 non-compensation expenses were $2.2 billion of restructuring and other charges and $131 million of net September 11-related expenses.

Operating Earnings
Net operating earnings, which are net earnings excluding the impact of restructuring charges, research and other settlement-related expenses, and September 11-related recoveries/expenses, were $2.6 billion in 2002, up 7% from 2001, despite a 15% decline in net revenues, to $18.6 billion. Net operating earnings per diluted share were $2.67 in 2002 compared with $2.50 in 2001. Net operating earnings should not be considered an alternative to net earnings (as determined in accordance with generally accepted accounting principles ("GAAP") in the United States), but rather as a non-GAAP measure considered relevant by management in comparing current year results with prior year results. Management believes this measure is a valuable tool for investors to judge the quality of Merrill Lynch's financial performance as it allows investors to more readily gauge earnings and identify trends.

Income Taxes
Merrill Lynch's 2002 income tax provision was $1.1 billion, representing a 28.0% effective tax rate compared with 44.2% in 2001 and 30.4% in 2000. The 2002 effective tax rate declined from the prior year as the 2001 tax provision included nondeductible losses associated with the refocusing of the Japan Private Client business, which were included in the fourth-quarter 2001 charge, including a write-off of previously recognized deferred tax assets of approximately $135 million. In addition, 2002 net earnings reflected the tax benefits associated with the wind-down of the Merrill Lynch HSBC joint venture, as well as the lower tax rate associated with certain European, Asian and other international activities and a net benefit of $77 million related to prior years and settlements with various tax authorities. Deferred tax assets and liabilities are recorded for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the Consolidated Financial Statements. Merrill Lynch assesses its ability to realize deferred tax assets within each jurisdiction, primarily based on a strong earnings history and the absence of negative evidence as discussed in SFAS No. 109, "Accounting for Income Taxes." During the last 10 years, average pre-tax earnings were $2.9 billion. Accordingly, management believes that it is more likely than not that remaining deferred tax assets, net of the related valuation allowance, will be realized. See Note 17 to the Consolidated Financial Statements for further information.

Business Segments
The following discussion provides details of the operating performance for each Merrill Lynch business segment, as well as details of products and services offered. The discussion also includes details of net revenues by segment. Certain prior year amounts have been restated to conform with the current year presentation.

Merrill Lynch reports its results in three business segments: The Global Markets and Investment Banking group ("GMI"), Global Private Client ("GPC"), and Merrill Lynch Investment Managers ("MLIM"). GMI provides capital markets and investment banking services to corporate, institutional, and governmental clients around the world. GPC provides global wealth management products and services to individuals, small- to mid-size businesses, and employee benefit plans. MLIM provides asset management services to individual, institutional and corporate clients.



Certain MLIM and GMI products are distributed through GPC distribution channels, and, to a lesser extent, certain MLIM products are distributed through GMI. Revenues and expenses associated with these inter-segment activities are recognized in each segment and eliminated at the corporate level. In addition, revenue and expense sharing agreements for shared activities between segments are in place, and the results of each segment reflect the agreed-upon portion of these activities. The following segment results represent the information that is relied upon by management in its decision-making processes. These results exclude items reported at the corporate level. Business segment results are restated to reflect reallocations of revenues and expenses that result from changes in Merrill Lynch's business strategy and structure. Management views non-interest expenses before recoveries related to September 11 and restructuring and other charges in evaluating operating performance. Included in GMI's and GPC's 2002 results are September 11-related partial business interruption insurance recoveries for forgone pre-tax profits of $90 million and $25 million, respectively. September 11-related expenses and research and other settlement-related expenses were recorded in the Corporate segment. Restructuring and other charges have been recorded in each of the business segments. See Note 4 to the Consolidated Financial Statements for further information.

Global Markets and Investment Banking
GMI provides equity and debt trading, capital markets services, investment banking and strategic merger and acquisition advisory services to its clients around the world. GMI raises capital for its clients through securities underwritings, private placements, and loan syndications. GMI makes a market in securities, derivatives, currencies, and other financial instruments to satisfy client demand for these instruments, and for proprietary trading. Merrill Lynch has one of the largest equity trading and underwriting operations of any firm in the world and is a leader in the origination and distribution of equity products. GMI is also a leader in the global origination and distribution of debt market products. GMI's client-focused strategy provides investors with opportunities to diversify their portfolios, manage risk, and enhance returns. GMI also provides clients with financing, securities clearing, settlement, and custody services.

GMI faced a 2002 environment marked by economic and geopolitical uncertainty, weaker corporate earnings and decreased investor confidence, which led to a significant deterioration in market conditions. Global equity indices posted their third consecutive year of declines, and capital markets origination and merger and acquisition activity were severely depressed. For GMI, these factors were partially offset by strength in fixed income markets due to a favorable yield curve environment and proprietary trading.

During 2002, GMI improved its pre-tax profit margin despite the deteriorating market environment through its continued focus on reducing expenses, efficiency, and strategic reallocation of resources to businesses such as debt trading, which posted record revenues and profits for the year. While maintaining expense discipline, GMI invested in profitable growth opportunities that leverage its scale and complement its business mix and client reach. These growth opportunities included derivatives, mortgages, foreign exchange, and prime brokerage. The combination of discipline in managing expenses together with investing selectively has been integral to further enhancing GMI's competitive positioning and profitability across market cycles.

In 2001, equity origination and trading activity declined and global completed merger and acquisition volumes decreased throughout the year due to the challenging market environment. Offsetting these factors were strong debt markets, as 11 interest rate cuts by the U.S. Federal Reserve were a catalyst for significant trading and origination activity for most of the year.

In 2002, Merrill Lynch formed the Merrill Lynch Global Bank Group, through which the lending and deposit-taking businesses were brought under one common management team, improving consistency and efficiency. The Global Bank Group allows Merrill Lynch to leverage the expertise developed through the creation and growth of its U.S. banks, create uniformity in its approach to lending, and apply stable bank deposit funding in pursuit of key lending business initiatives across both GPC and GMI. GMI is responsible for managing the investment portfolio of Merrill Lynch's U.S. banks, and earns a spread on these activities which is recorded in principal transactions and net interest profit.

During 2002, GMI's Securities Services Division was merged into the equity division. In early 2001, Merrill Lynch sold essentially all of its energy trading assets, effectively exiting the business.

In 2001, as part of Merrill Lynch's overall business review process, GMI completed in-depth reviews of its businesses with the goal of improving overall efficiency and operating flexibility. As a result of these reviews, GMI streamlined its management and reorganized the investment banking division by reducing the number of global industry teams, realigning sector coverage, and broadening responsibilities. In addition, GMI consolidated trading operations outside the United States to enhance client service and realize efficiencies. The completion of these reviews led to a fourth quarter 2001 pre-tax charge of $833 million, primarily related to severance. During 2002, GMI's costs related to the 2001 restructuring were adjusted to reflect a change in estimate, primarily related to facilities, resulting in an additional net pre-tax charge of $51 million.

GMI's Results of Operations



In 2002, GMI's pre-tax earnings were $2.4 billion, 22% higher than in 2001, with a pre-tax profit margin of 28.6%. Excluding the September 11 recoveries and restructuring and other charges, GMI's pre-tax earnings declined 15% from 2001 to $2.4 billion. GMI's net revenues declined 18% in 2002, to $8.4 billion, driven primarily by reduced equity and investment banking revenues, partially offset by a strong increase in debt markets revenues. Included in GMI's results are net revenues related to investments, including dividend income and realized and unrealized gains and losses. Investment-related net revenues were $162 million in 2002, $291 million in 2001 and $611 million in 2000. Excluding the restructuring and other charges, GMI's 2001 net revenues and pre-tax earnings decreased 20% and 31%, respectively, from 2000 due principally to reduced equity and equity-linked trading and origination. Additionally, lower strategic advisory revenues as well as write-downs of certain credit and private equity positions contributed to the decline. These declines were partially offset by increased debt trading and origination revenues in 2001.

The September 11 terrorist attacks on the World Trade Center had a negative impact on GMI's 2001 results, as the temporary closure of markets, loss of communication with key clients, and business disruption caused by the relocation of GMI employees led to lower than normal market shares and reduced business activity in the period immediately following the attacks. During 2002, GMI recognized $90 million in business interruption insurance recoveries for forgone pre-tax profits related to September 11. For further information regarding September 11, see Note 3 to the Consolidated Financial Statements.

A detailed discussion of GMI's revenues follows:

Client Facilitation and Trading
Commissions Commissions revenues primarily arise from agency transactions in listed and over-the-counter ("OTC") equity securities, money market instruments, options and commodities. In late 2001, Merrill Lynch instituted a program for providing enhanced brokerage services to its customers with large-size Nasdaq orders in exchange for an agreed-upon per share commission in lieu of the traditional spread. Nearly all Nasdaq institutional client trades are now executed on an agency, rather than a principal, basis.

In 2002, commissions revenues were essentially unchanged from 2001 at $2.1 billion. In 2001, commissions revenues declined 12% from 2000. This decrease resulted from a global decline in client transaction volumes. The impact of lower transaction volumes in 2002 was mitigated by over $225 million of commissions generated by large-size Nasdaq orders.

Principal transactions and net interest profit



Principal transactions revenues include realized gains and losses from the purchase and sale of securities in which Merrill Lynch acts as principal, and unrealized gains and losses on trading assets and liabilities. In addition, principal transactions revenues include unrealized gains related to equity investments held by Merrill Lynch's broker-dealers, which amounted to $117 million, $213 million and $212 million in 2002, 2001, and 2000, respectively.

Net interest profit is a function of the level and mix of total assets and liabilities, including trading assets owned, financing and lending transactions, trading strategies associated with GMI's institutional securities business, and the prevailing level, term structure, and volatility of interest rates. Net interest profit is an integral component of trading activity. Beginning in 2002, GMI's net interest profit includes income generated by the investment portfolio of Merrill Lynch's U.S. banks, all of which was previously recorded in GPC. This change follows a transfer in responsibility for this activity, which was made to better align functional and management responsibilities. The prior year segment results have been restated to reflect this change.

In assessing the profitability of its client facilitation and trading activities, Merrill Lynch views principal transactions and net interest profit in the aggregate as net trading revenues. Changes in the composition of trading inventories and hedge positions can cause the mix of principal transactions and net interest profit to fluctuate. Net trading revenues were $3.7 billion in 2002, down 19% from 2001. Debt and debt derivatives net trading revenues were $3.0 billion, up 9% from 2001, reflecting increased trading of interest rate and other products due to a favorable yield curve environment and proprietary trading. Equities and equity derivatives net trading revenues decreased 61% from 2001 to $714 million, primarily due to reduced customer flows, lower volatility during much of the year, and the conversion of the Nasdaq business to a commission-based structure over the past year.

In 2001, net trading revenues declined 26% from 2000. Equities and equity derivatives net trading revenues decreased 52% from 2000, to $1.8 billion, due to reduced global transaction volumes and lower volatility throughout much of 2001. Debt and debt derivatives net trading revenues were $2.7 billion in 2001, up 18% from 2000, as improvements in interest rate trading results were partially offset by provisions and write-downs of certain credit positions of approximately $470 million. Included in debt and debt derivatives trading revenues in 2001 are net revenues from the energy-trading business of $53 million. The 2001 energy-trading net revenues include a first quarter gain on the sale of essentially all of the assets of this business.

Investment banking



Underwriting Underwriting revenues represent fees earned from the underwriting of debt and equity and equity-linked securities as well as loan syndication and commitment fees.

Total underwriting revenues were $1.4 billion in 2002, down 29% from 2001, as equity and equity-linked underwriting revenues declined 39% and debt underwriting revenues declined 10%. These decreases resulted from a reduced volume of transactions as well as lower market share. Merrill Lynch's debt underwriting focus has shifted toward higher margin businesses and away from the achievement of aggregate market share goals; however, debt transactions remain highly competitive and not all transactions are profitable. In 2001, total underwriting revenues were essentially unchanged from 2000, as a 58% increase in debt underwriting revenues was more than offset by an 18% decline in equity and equity-linked underwriting.

Merrill Lynch's underwriting market share information based on transaction value is as follows:



Strategic Advisory Services Strategic advisory services revenues, which include merger and acquisition and other advisory fees, decreased 36% in 2002, to $702 million, as deteriorating market conditions continued to have a negative impact on global merger and acquisition activity and on client demand for strategic advisory services.

Merrill Lynch's merger and acquisition share information based on transaction values is as follows:



Other Revenues Other revenues, which include realized investment gains and losses and distributions on equity investments, increased 5% to $488 million in 2002. Other revenues in 2002 reflected increased realized gains on the investment portfolios of Merrill Lynch's U.S. banks and a $45 million pre-tax gain on the sale of the Securities Pricing Services business. In 2001, Other revenues decreased 42% compared to 2000 and included a pre-tax gain of $50 million related to the sale of the Canadian securities clearing business, which was more than offset by write-downs of equity investments of $126 million.

Global Private Client
At the end of 2002, Merrill Lynch created GPC, formerly known as the Private Client Group ("PCG"). While encompassing the same businesses as PCG, GPC will more fully integrate the U.S. and non-U.S. businesses into a global organization to bring the full resources of GPC together as Merrill Lynch continues to enhance its services to clients. The formation of the GPC group will also provide more efficient leverage of technology platforms and reduced costs as the management structure is streamlined.

GPC provides wealth management products and services to assist clients in building financial assets, and maximizing returns relative to risk tolerance and investment objectives. GPC offers a wide range of products and services, including retail brokerage, asset and liability management, banking, trust and generational planning, consumer and small business loans and insurance products. GPC serves individual investors, and middle market corporations and institutions through approximately 14,000 Financial Advisors ("FAs") in approximately 670 offices around the world as of year-end 2002.

To align asset account structure with each client's specific investment requirements and goals, GPC offers a choice of traditional commission-based investment accounts, a variety of asset-priced investment services, and self-directed online accounts. Assets in GPC accounts totaled $1.1 trillion at December 27, 2002, down from $1.3 trillion at December 28, 2001, due primarily to market depreciation. In a difficult operating environment, GPC attracted net new assets from clients of $18 billion during 2002.

There was also continued progress in diversifying revenues as sales of annuity products and the volume of mortgage originations reached record levels in 2002. Mortgage origination volume more than doubled in 2002, to $21 billion.

In May 2002, Merrill Lynch and HSBC Holdings plc ("HSBC") agreed to exit their joint venture, Merrill Lynch HSBC ("MLHSBC"), and integrate it into the HSBC Group. MLHSBC was a 50/50 joint venture formed by Merrill Lynch and HSBC in April 2000 to create a global online investment and banking services company, serving individual self-directed customers outside the United States. As the decline in worldwide equity markets reduced the demand for online trading, MLHSBC did not achieve the growth that was forecast when the venture was formed and never achieved profitability. Although Merrill Lynch exited the joint venture in 2002, MLHSBC will continue to operate using Merrill Lynch as part of its name through 2004 and clients will have access to Merrill Lynch research during that time.

GPC has faced a difficult market environment as equity securities prices continued to drop and investor confidence declined. As the markets have declined, Merrill Lynch has become involved in an increased number of client claims, which is likely to result in higher professional fees and litigation expenses than those incurred in the past.

In 2001, Merrill Lynch adopted a multi-channel service model in the United States, more closely aligning FAs with clients based on levels of investable assets. This segmentation repositioned the business to provide a more comprehensive suite of financial products and services. In the United States, ultra-high-net-worth clients are aligned with Private Wealth Advisors ("PWAs"). PWAs are FAs who have completed a rigorous accreditation program and focus on clients with more than $10 million of investable assets. For clients in the United States with less than $100,000 of investable assets, Merrill Lynch developed the telephone-based Financial Advisory Center ("FAC") to more effectively serve these clients in a cost efficient manner.

During 2001, GPC conducted a detailed business review to reallocate and focus the use of resources in its businesses. In the United States, this process began in 2000 and resulted in the completion of several actions in 2001, including: a long-term outsourcing arrangement for certain mortgage origination and servicing operations of Merrill Lynch Credit Corporation; outsourcing the administrative services for smaller U.S. 401(k) plans; and the sale of the health and welfare division of Merrill Lynch's Howard Johnson and Company. In addition, in 2001, GPC consolidated certain offices and announced the closing of one of three operations centers in the United States. These initiatives were completed in 2002. Outside the United States, GPC narrowed its focus to serving high-net-worth and ultra-high-net-worth clients, GPC's traditional strength. This resulted in several strategic actions, including: the sale of the Canadian Private Client business in 2001; the consolidation of branch offices in Europe, the Middle East, and Asia Pacific; and the refocusing of GPC's Japan business in 2002. These strategic changes were made with the goal of retaining and growing the elements of the business where GPC can make the best returns on its investments. GPC continuously looks for opportunities to reallocate resources and achieve greater efficiencies while making strategic investments and continues to scale its infrastructure to the business environment.

GPC's Results of Operations



GPC's 2002 pre-tax earnings were $1.3 billion as compared to a pre-tax loss of $159 million in 2001. Excluding the September 11 recoveries and restructuring and other charges, GPC's pre-tax earnings increased 31% from 2001 to $1.2 billion as a 16% decline in non-interest expenses more than offset an 11% reduction in net revenues. On the same basis, the pre-tax operating margin was 13.7%, up more than four percentage points from 9.3% in 2001, reflecting substantially improved performance both inside and outside the United States. The growing percentage of fee-based and recurring revenues helped stabilize overall revenues in 2002 as transaction volumes fell.

Excluding restructuring and other charges in 2001, GPC's pre-tax earnings decreased 39% and net revenues decreased 18% from 2000. The pre-tax profit margin declined to 9.3% in 2001 from 12.4% in 2000. These declines resulted from lower transaction volumes and reduced demand for mutual fund and equity products. In addition, as a result of the completion of a detailed business review, GPC recorded $1.1 billion of pre-tax restructuring and other charges in the fourth quarter of 2001, primarily related to severance and the write-down of real estate and technology assets. These charges included costs associated with a decision to focus the non-U.S. business, principally in Japan, more exclusively on high-net-worth individuals and institutional middle markets clients. During 2002, GPC's costs related to the 2001 restructuring were adjusted to reflect a change in estimate, related to facilities, severance and other costs resulting in a net pre-tax credit of $83 million, primarily related to Japan. This credit was partially offset by a $17 million real estate-related 2002 other charge. See Note 3 to the Consolidated Financial Statements for further information.

Commissions Commissions revenues primarily arise from agency transactions in listed and OTC equity securities, as well as sales of mutual funds, insurance products, and options.

Commissions revenues decreased 19% to $2.5 billion in 2002 as a result of a global decline in client transaction volumes, particularly in equity securities and mutual funds. Commissions have also been negatively affected by the ongoing transition of GPC assets to asset-priced accounts. Commissions revenues also declined in 2001 to $3.0 billion from $4.5 billion in 2000, or 32%, due to a decline in client transaction volume.

Principal transactions and new issue revenues GPC's Principal transactions and new issue revenues primarily represent bid-offer revenues in OTC equity securities, government bonds and municipal securities as well as selling concessions on underwriting of debt and equity products. GPC does not take any significant principal trading risk positions.

Principal transactions and new issue revenues declined 26% to $1.2 billion in 2002 as trading and new issue volume declined in a less favorable market environment. In 2001, Principal transactions and new issue revenues similarly declined 22% from 2000, to $1.6 billion.

Asset management and portfolio service fees Asset management and portfolio service fees include asset management fees from taxable and tax-exempt money market funds as well as portfolio fees from fee-based accounts such as Unlimited Advantage^SM and Merrill Lynch Consults^®. Also included are servicing fees related to these accounts, as well as certain other account-related fees.

In 2002, Asset management and portfolio service fees totaled $3.5 billion, 4% lower than in 2001. In 2001, Asset management and portfolio service fees totaled $3.7 billion, down from $3.9 billion in 2000. These decreases resulted primarily from market-driven declines in asset levels.

The value of assets in GPC accounts at year-end 2002, 2001, and 2000 is summarized as follows:



The changes in assets in GPC accounts from year-end 2001 to year-end 2002 are detailed below:



The decline in asset levels in 2002 was due primarily to market depreciation.

Net interest profit Net interest profit for GPC includes an allocation of the interest spread earned in Merrill Lynch's banks for deposits as well as interest earned on margin and other loans. Prior to 2002, GPC's net interest profit included all revenues and expenses associated with managing the investment portfolio of Merrill Lynch's U.S. banks. The revenues and expenses associated with managing this portfolio are now included in GMI's results. Prior year segment results have been restated for this change.

Net interest profit was $1.3 billion, down 12% from $1.5 billion in 2001. This decrease is primarily due to lower margin balances and a reduction in the related interest rates. In 2001, net interest profit was essentially unchanged from 2000 levels.

Other revenues Other revenues increased $177 million, from $102 million in 2001 to $279 million in 2002. Other revenues in 2002 reflect increased realized gains related to the sales of mortgages originated by Merrill Lynch Credit Corporation. Investment-related net revenues were a gain (loss) of $(11) million, $(52) million, and $18 million in 2002, 2001, and 2000, respectively. Investment-related net revenues in 2002 included a pre-tax gain of $39 million related to the release of provisions subsequent to the conclusion of the sale of the Canadian GPC business, which was partially offset by losses related to MLHSBC of $34 million. Investment-related net revenues in 2001 included a pre-tax gain on the sale of the Canadian GPC business of $108 million, which was more than offset by losses on various e-commerce investments, including losses related to MLHSBC of $150 million.

Merrill Lynch Investment Managers
MLIM is among the world's largest asset managers with $462 billion of assets under management at the end of 2002. MLIM offers a wide array of taxable and tax-exempt fixed-income, equity and balanced mutual funds and segregated accounts to a diverse global clientele. MLIM also offers a wide assortment of index-based equity and alternative investment products. MLIM's clients include institutions, high-net-worth individuals, mutual funds, and other investment vehicles. MLIM-branded mutual fund products are available through third-party distribution networks and the GPC distribution channel. MLIM also distributes its products through GMI. MLIM maintains a significant sales and marketing presence in both the United States and overseas that is focused on acquiring and maintaining institutional investment management relationships. MLIM markets its services both directly to these investors and through pension consultants.

During 2002, MLIM continued to review all of its businesses. As a consequence of these reviews, certain overlap of investment management activities between the U.S. and London offices of MLIM were eliminated. Also during 2002, MLIM merged its three separate international mutual fund families into a single mutual fund family, Merrill Lynch International Investment Funds ("MLIIF"). This merger resulted in the elimination of nine funds separately marketed under the Mercury and MLAM brands. The MLIIF merger also permitted MLIM to rationalize its various fee structures and introduce a wider range of share classes aligned to investor requirements. In addition, in January 2002, MLIM sold its Canadian retail asset management operations.

These measures along with the impact of similar actions undertaken in 2001 contributed to MLIM's improved pre-tax profit margin in 2002. This improvement took place in a very challenging business environment for investment management in general and MLIM in particular. The equity market downturn from 2000 through 2002 has had a significant effect in the marketplace for investment management products. There has been a broad shift away from higher fee-yielding equity products towards lower fee-yielding short-duration fixed-income products. This has been observable behavior for both retail and institutional clients. Furthermore, the operating environment both inside and outside of the United States has been further constrained by the impact of media attention related to a number of corporate accounting, disclosure, governance, and litigation issues. In Europe, MLIM's sales efforts were also constrained by media attention related to several events that occurred during the latter part of 2001 and continuing into 2002. These matters included the retirement or termination of several senior executives or portfolio managers, the public trial in the United Kingdom related to claims made by a large institutional MLIM client and the possibility of similar litigation in the future.

During 2001, MLIM reviewed all of its business activities to further enhance future profit potential and target selected growth opportunities. As a result of these in-depth reviews, MLIM consolidated the management of its Japan, Asia Pacific and European activities into a single management structure. MLIM significantly reduced its global real estate footprint by selling, closing or downsizing offices in Los Angeles, Korea, and Singapore and consolidating its New York metropolitan area-based operations. MLIM also undertook strategic outsourcing opportunities, consolidated real estate in Tokyo and London, reduced technology spending, and exited its Defined Asset Funds business. See Note 3 to the Consolidated Financial Statements for additional information.

MLIM's Results of Operations



Pre-tax earnings for MLIM were $321 million in 2002, up from $19 million in 2001. Excluding restructuring and other charges, pre-tax earnings were $344 million in 2002, up 14% from $302 million in 2001. On this basis, MLIM's pre-tax operating margin was 22.2%, up from 15.6% in 2001. The integration of MLIM's global investment platform and re-alignment of resources resulted in reduced expenses and improved productivity which more than offset a 20% decline in net revenues, to $1.6 billion in 2002. MLIM continued to generate strong investment performance with approximately 70% of global assets under management above benchmark or median for the 1-, 3-, and 5-year periods ending December 2002. In 2001, net revenues decreased 13%, to $1.9 billion from $2.2 billion in 2000 and pre-tax earnings, excluding restructuring and other charges, declined 34% to $302 million from $455 million in 2000. The reduction in net revenues and pre-tax earnings was primarily the result of a market-driven decline in assets under management. Pre-tax earnings in 2001 also reflected higher costs related to litigation. In 2001, as a result of the completion of the previously mentioned detailed business review, MLIM recorded $283 million of pre-tax restructuring and other charges, primarily related to severance and costs associated with the closing of certain mutual funds, including investment write-downs of $32 million principally related to mutual fund seed capital. During 2002, MLIM's costs related to the 2001 restructuring were adjusted to reflect a change in estimate, primarily related to severance and facilities, resulting in an additional net pre-tax charge of $23 million.

Commissions Commissions for MLIM principally consist of distribution fees and redemption fees related to mutual funds. The distribution fees represent revenues earned for promoting and distributing mutual funds ("12b-1 fees"). As a result of lower transaction volumes and the impact of lower market values, commissions decreased 29% to $177 million in 2002. Commissions in 2001 declined 26% from 2000 to $249 million as a result of lower transaction volumes.

Asset management fees Asset management fees primarily consist of fees earned from the management and administration of funds as well as performance fees earned by MLIM on separately managed accounts. Asset management fees declined 17% to $1.4 billion from $1.6 billion in 2001. These fees were $1.8 billion in 2000. These reductions are due to market-driven declines in the value of equity assets under management as well as the shift of assets by clients from higher yielding equity funds to lower yielding fixed income and money market funds.

MLIM's assets under management for each of the last three years were comprised of the following:



At year-end 2002, assets under management totaled $462 billion, a 13% decline from 2001. This decrease is primarily due to market-driven declines, $19 billion of global net outflows primarily from equity funds during the year, and $8 billion of outflows from retail money market funds. The outflows from retail money market funds continue to be negatively impacted by the change in the cash sweep options for certain CMA^® and other types of Merrill Lynch accounts. Beginning in mid-2000, these accounts were modified to sweep most cash into interest-bearing bank deposits at Merrill Lynch's U.S. banks rather than into MLIM-managed retail money market funds.

An analysis of changes in assets under management from year-end 2001 to year-end 2002 is as follows:



Other Revenues Other revenues, which primarily include net interest profit and investment gains and losses, decreased from $44 million in 2001 to $8 million in 2002. The 2002 Other revenues reflect investment losses and also include a $17 million pre-tax gain on the sale of the Canadian retail asset management business. Other revenues in 2001 declined $69 million from 2000 due to losses on investments.

Global Operations
Merrill Lynch's operations outside the United States are organized into five geographic regions:

• Europe, Middle East, and Africa
• Japan
• Asia Pacific
• Canada, and
• Latin America

Merrill Lynch operates in Europe, the Middle East, and Africa as a broker-dealer in a wide array of equity and debt products, and also provides investment banking, asset management and private banking services. Additionally, Merrill Lynch offers its clients a broad range of equity, fixed income and economic research. Since opening its first European office in Geneva in 1952, Merrill Lynch has extended its presence across the region, with 33 offices in 16 countries.

In 2002, Merrill Lynch adjusted its resource capacity in the region to be more in line with market conditions and to achieve greater efficiencies. In May 2002, Merrill Lynch and HSBC agreed to exit their joint venture Merrill Lynch HSBC, and integrate MLHSBC into the HSBC Group. MLHSBC was a 50/50 joint venture between Merrill Lynch and HSBC that provided online financial services. The decision to exit this joint venture resulted from a review of Merrill Lynch's international retail operations in light of changed market conditions and a view that the online brokerage would not achieve a profit in the foreseeable future.

As a result of a detailed business review in the fourth quarter of 2001, GPC consolidated offices in Europe and the Middle East, MLIM consolidated its Japan, Asia Pacific and European activities into a single management structure and GMI streamlined its management and reorganized its investment banking division. These actions resulted in a fourth quarter 2001 pre-tax charge of $293 million in the region, primarily related to severance. In 2002, costs related to the 2001 restructuring were adjusted to reflect a change in estimate, primarily related to severance, resulting in a pre-tax charge of $7 million. In addition, the region recorded an other charge of $17 million in 2002 related to certain real estate leases associated with its GPC businesses.

In 2002, net revenues for the region decreased 24% from 2001. Pre-tax earnings before restructuring and other charges decreased 64% from 2001 to $93 million due primarily to decreased equity trading and origination revenues. In 2001, net revenues for the region decreased 30% from 2000. Pre-tax earnings before restructuring and other charges decreased 79% from 2000 to $261 million also due primarily to decreased equity trading and origination revenues.

Japan



In 2002, Japan's GMI business focused on high-value added, high-margin activities and adding new businesses, especially in the areas of balance sheet restructuring and capital reinforcement.

In 2002, GPC completed its restructuring program in Japan, closing 25 branch offices; outsourcing data center and technology services; and launching a direct-client Financial Service Center to serve clients with limited investable assets. These actions resulted in a significant reduction in the number of full-time employees in the region and an annual expense savings of over $200 million. GPC is now focused on small- to medium-sized business clients and high-net-worth individual investors. The restructuring program resulted in a fourth quarter 2001 pre-tax charge of $380 million and additional wind-down expenses in 2002. In 2002, costs related to the 2001 restructuring were adjusted to reflect a change in estimate, primarily related to severance, facilities and other expenses, resulting in a net pre-tax credit of $120 million. The facilities-related change in estimate is primarily related to the decision to maintain an existing data center as a back-up facility in the region.

Net revenues in the Japan region in 2002 decreased 24% from 2001 to $761 million, primarily reflecting continued weak market conditions which negatively impacted the region's GMI businesses. In addition, the downsizing of the GPC business resulted in lower revenues in the region. Pre-tax earnings before restructuring and other charges (credits) were $97 million in 2002 compared to a loss of $14 million in 2001 reflecting continued disciplined cost management and the impact of restructuring actions taken. Net revenues in the Japan region in 2001 were down 35% from 2000 to $997 million, reflecting weak market conditions, except in the GMI debt business. The corresponding decrease in pre-tax earnings before restructuring and other charges (credits) was partially alleviated by a reduction in expenses as a result of cost reduction initiatives in 2001.

Asia Pacific



Merrill Lynch serves a broad retail and institutional client base throughout the Asia Pacific region, offering a full range of GMI, GPC, and MLIM products. Merrill Lynch has an established trading presence and exchange memberships in all major financial markets in the region. The GPC business operates 11 offices serving the region, including four on the west coast of the United States, offering asset management services and wealth management products to its clients. MLIM operates offices offering a diverse mix of investment management products and services to institutional and private clients in the region.

As part of an ongoing review, in 2002, Merrill Lynch sold the Malaysian brokerage business of Smith Zain Securities, a joint venture. In addition, GMI migrated its debt trading business from Australia to Japan, completing the final stage of centralizing all Asian debt trading desks in Tokyo. GPC is in the process of closing its office in Kaohsiung, Taiwan while continuing to maintain a presence in Taipei. As part of Merrill Lynch's detailed business review in 2001, GPC restructured its operations in Australia by narrowing its focus to high-net-worth investors and consolidating offices. MLIM restructured its operations by consolidating the asset management activities for the region into its London location, and GMI sold its equity brokerage operation in the Philippines to a local management team. As a result of the completion of these detailed business reviews, a pre-tax charge of $89 million was recorded in the fourth quarter of 2001. In 2002, costs related to the 2001 restructuring were adjusted to reflect a change in estimate, primarily related to severance, resulting in a net pre-tax credit of $7 million.

Opportunities for growth in 2003 are concentrated in the North Asian markets due to ongoing financial market deregulation. Merrill Lynch is reviewing opportunities in China and planning an expansion of its debt business in Korea.

Net revenues in the Asia Pacific region in 2002 decreased 24% from 2001 to $612 million. Pre-tax earnings before restructuring and other charges were $50 million in 2002, a decline of only 15% from 2001, due primarily to strong expense management. Net revenues in the region declined 33% in 2001 to $802 million. Pre-tax earnings before restructuring and other charges declined 75% in 2001 to $59 million. These declines were due to the deterioration in business volumes resulting from the slowdown in the regional economy.


Canada



During 2002, Merrill Lynch operated as a broker-dealer providing an integrated range of GMI products and services. As a result of the completion of a detailed business review, in the fourth quarter of 2001 Merrill Lynch sold its Canadian GPC and securities clearing businesses and in early 2002 sold its MLIM retail asset management business.

All GMI businesses maintained competitive margins in 2002, despite a difficult operating environment. The fixed income markets continued to perform strongly, resulting in increased debt underwriting and strong trading revenues. In 2002, Merrill Lynch continued to make significant progress in expanding its advisory business and has built a premier organization in this market. In the Brendan Woods International Survey, Merrill Lynch continued to show market share gains in the institutional equity commission business in Canada, and within the key market segment of the large institutions Merrill Lynch was ranked second.

Net revenues in the Canada region in 2002 decreased 69% from 2001 to $262 million reflecting the sales of the GPC, securities clearing, and MLIM businesses and lower revenues from GMI. Pre-tax earnings before restructuring and other charges were $125 million in 2002, down 49% from 2001, largely due to the 2001 pre-tax gain of $158 million on the sale of the GPC and securities clearing businesses. Pre-tax earnings in 2002 included a pre-tax gain of $39 million related to the release of provisions subsequent to the conclusion of the sale of the GPC business and a pre-tax gain of $17 million related to the sale of the MLIM retail asset management business. In 2001, net revenues in the region were essentially unchanged from 2000 as the gains on the sale of businesses essentially offset decreases in the net revenues of GMI and GPC. Pre-tax earnings before restructuring and other charges increased to $246 million in 2001 due to record earnings in investment banking and the pre-tax gain on the sale of businesses. The sales of businesses in 2001 and early 2002 resulted in a significant reduction in the number of full-time employees in the region.


Latin America



Merrill Lynch provides various brokerage and investment services, including financial planning, investment banking, research, and asset management to Latin American clients.

The economies of Latin America continued to decline in 2002; in January 2002, Argentina abandoned peso convertibility to the U.S. dollar, causing a 70% devaluation of the peso. Subsequently, Argentina defaulted on $141 billion of debt, the largest sovereign default in history. Political uncertainty during 2002 caused Brazil's currency to depreciate 38% and capital inflows to slow. These and other factors have had a negative impact on the overall Latin American economy.

In 2002, Merrill Lynch's Latin American businesses completed their restructuring program initiated in 2001. GPC narrowed its focus to high-net-worth investors and, as a result, a Financial Advisory Center was established in Uruguay for clients with accounts with limited investable assets.

Net revenues for the region in 2002 of $527 million were essentially unchanged from 2001. Pre-tax earnings before restructuring and other charges were $87 million, up $63 million from 2001. These results reflect an improved performance in GMI's businesses in Latin America. Net revenues for the region in 2001 decreased 30% from 2000. Pre-tax earnings before restructuring and other charges in 2001 of $24 million decreased $128 million from 2000 primarily due to the volatility of the Latin American economy. Despite this economic environment, GPC's business in Latin America was strong in 2001. Pre-tax earnings in 2000 included a gain on the sale of the Puerto Rico retail brokerage business.




Consolidated Balance Sheets
Overview
Management continually monitors and evaluates the size and composition of the Consolidated Balance Sheet. The following chart illustrates the composition of the balance sheet at December 27, 2002.



In 2002, average total assets were $452 billion, up 4% from $436 billion in 2001. Average total liabilities in 2002 increased 4% to $428 billion from $413 billion in 2001, and average equity capital increased 5% to $24 billion during 2002. The major components of the increase in average total assets and liabilities are summarized as follows:



The increase in average deposits, as well as interest and other payables, was primarily used by Merrill Lynch Bank USA and its subsidiaries to make loans, which increased significantly due to GPC mortgage and small business loan originations. Additionally, securities financing transactions rose due to increased matched-book activity. Merrill Lynch enters into matched-book transactions to accommodate clients, obtain securities for settlement and to earn residual interest rate spreads.

The discussion that follows analyzes the changes in year-end financial statement balances of the major asset and liability categories.

Trading-Related Assets and Liabilities
Trading-related balances primarily consist of trading assets (including securities pledged as collateral) and liabilities, receivables under resale agreements and securities borrowed transactions, payables under repurchase agreements and securities loaned transactions, and certain receivable/payable balances that result from trading activities. At December 27, 2002, total trading-related assets and liabilities were $245.1 billion and $191.9 billion, respectively.

Although trading-related balances comprise a significant portion of the Consolidated Balance Sheet, the magnitude of these balances does not necessarily convey a sense of the risk profile assumed by Merrill Lynch. The market and credit risks associated with trading-related balances are mitigated through various hedging strategies, as discussed in the following section. See Note 7 to the Consolidated Financial Statements for descriptions of market and credit risks.

Merrill Lynch reduces a significant portion of the credit risk associated with trading-related assets by requiring counterparties to post cash or securities as collateral in accordance with collateral maintenance policies. Conversely, Merrill Lynch may be required to post cash or securities to counterparties in accordance with similar policies.

Trading Assets and Liabilities
Trading inventory principally represents securities purchased ("long" positions), securities sold but not yet purchased ("short" positions), and the fair value of derivative contracts. See Note 1 to the Consolidated Financial Statements for related accounting policies. These positions are primarily the result of market-making, hedging, and proprietary activities.

Merrill Lynch acts as a market-maker in a wide range of securities, resulting in a significant amount of trading inventory that is required to facilitate client transaction flow. To a lesser degree, Merrill Lynch also maintains proprietary trading inventory in seeking to profit from existing or projected market opportunities.

Merrill Lynch uses both cash instruments and derivatives to manage trading inventory market risks. As a result of these hedging techniques, a significant portion of trading assets and liabilities represent hedges of other trading positions. Long U.S. Government securities, for example, may be hedged with short interest rate futures contracts. These hedging techniques, which are generally initiated at the trading unit level, are supplemented by corporate risk management policies and procedures (see the Risk Management section for a description of risk management policies and procedures).

Trading assets, including securities pledged and received as collateral, at year-end 2002 were $113.6 billion, up 5% from year-end 2001, and trading liabilities increased 3% to $81.2 billion.

Securities Financing Transactions
Repurchase agreements and, to a lesser extent, securities loaned transactions are used to fund a significant portion of trading assets. Likewise, Merrill Lynch uses resale agreements and securities borrowed transactions to obtain the securities needed for delivery on short positions. These transactions are typically short-term in nature with a significant portion entered into on an overnight or open basis. Resale and repurchase agreements entered into on a term basis typically mature within 90 days.

Merrill Lynch also enters into these transactions to meet clients' needs. These "matched-book" repurchase and resale agreements or securities borrowed and loaned transactions are entered into with different clients using the same underlying securities, generating a spread between the interest revenue on the resale agreements or securities borrowed transactions and the interest expense on the repurchase agreements or securities loaned transactions. Exposures on these transactions are limited by the typically short-term nature of the transactions and collateral maintenance policies.

Receivables under resale agreements and securities borrowed transactions at year-end 2002 decreased 3% from 2001 to $120.8 billion, and payables under repurchase agreements and securities loaned transactions increased 7% from year-end 2001 to $93.0 billion.

Other Trading-Related Receivables and Payables
Securities trading may lead to various customer or broker-dealer receivable and payable balances. Broker-dealer receivable and payable balances may also result from recording trading inventory on a trade date basis. Certain receivable and payable balances also arise when customers or broker-dealers fail to pay for securities purchased or fail to deliver securities sold, respectively. These receivables are generally fully collateralized by the securities that the customer or broker-dealer purchased but did not receive. Customer receivables also include margin loans collateralized by customer-owned securities held by Merrill Lynch. Collateral policies significantly limit Merrill Lynch's credit exposure to customers and broker-dealers. Merrill Lynch, in accordance with regulatory requirements, will sell securities that have not been paid for, or purchase securities sold but not delivered, after a relatively short period of time, or will require additional margin collateral, as necessary. These measures reduce market risk exposure related to these balances.

Interest receivable and payable balances related to trading inventory are principally short-term in nature. Interest balances for resale and repurchase agreements, securities borrowed and loaned transactions, and customer margin loans are generally considered when determining the collateral requirements related to these transactions.

Trading-related receivables at year-end 2002 were $10.7 billion, up 15% from 2001, and trading-related payables were $17.7 billion, up 32% from December 28, 2001.

Non-Trading Assets
Investment Securities
Investment securities consist of highly liquid debt securities, including those held for liquidity management purposes, and equity securities. Investment securities decreased to $81.8 billion at December 27, 2002 from $87.7 billion at December 28, 2001. Investments of insurance subsidiaries, primarily debt securities, are used to fund policyholder liabilities. Other investments consist of equity and debt securities, including those acquired in connection with merchant banking activities, and venture capital investments, including investments in technology companies, and investments that economically hedge employee deferred compensation liabilities. See Note 6 to the Consolidated Financial Statements for further information.

Loans, Notes, and Mortgages
Merrill Lynch's portfolio of loans, notes, and mortgages consists of residential mortgages, home equity loans, syndicated loans, small business loans and other loans to individuals, corporations, or other businesses. Merrill Lynch maintains collateral on some of these extensions of credit in the form of securities, liens on real estate, perfected security interests in other assets of the borrower or other loan parties, and guarantees. Loans, notes, and mortgages increased 80% in 2002 to $34.7 billion due to increased consumer and commercial lending activities as a result of record levels of mortgage originations. Merrill Lynch maintains collateral to mitigate risk of loss in the event of default. Merrill Lynch periodically sells mortgage loans originated by GPC into the secondary market. See Note 9 to the Consolidated Financial Statements for additional information.

Other
Other non-trading assets, which include cash and cash equivalents, goodwill, equipment and facilities, separate accounts assets, and other assets, decreased $0.3 billion from year-end 2001 levels. Separate account assets are related to Merrill Lynch's insurance businesses and represent segregated funds which are invested for certain policy holders and other customers. The assets of each account are legally segregated and are generally not subject to claims that arise out of any other business of Merrill Lynch.

Non-Trading Liabilities
Borrowings
Portions of trading and non-trading assets are funded through deposits, long-term borrowings, and commercial paper (see the Capital Adequacy and Funding section for further information on funding sources).

Commercial paper remained low at $4.0 billion at year-end 2002 compared to $2.9 billion at year-end 2001. Deposits decreased $4.0 billion to $81.8 billion in 2002 as a result of lower customer deposits in U.S. banking subsidiaries. Outstanding long-term borrowings were $78.5 billion at year-end 2002, up 2% from December 28, 2001.

Major components of the changes in long-term borrowings for 2002 and 2001 are as follows:



Other
Other non-trading liabilities, which include liabilities of insurance subsidiaries, separate accounts liabilities, and other payables, remained essentially unchanged from year-end 2001 levels. Separate accounts liabilities represent Merrill Lynch's obligation to its customers related to separate accounts assets. See preceding Non-Trading Assets — Other section for additional information.

Preferred Securities Issued by Subsidiaries
Preferred securities issued by subsidiaries consist primarily of Trust Originated Preferred SECURITIES^SM ("TOPrS"^SM) (see Note 12 to the Consolidated Financial Statements for further information). TOPrS^SM proceeds are utilized as part of general balance sheet funding (see Capital Adequacy and Funding section for more information).

Stockholders' Equity
Stockholders' equity at December 27, 2002 increased 14% to $22.9 billion from $20.0 billion at year-end 2001. This increase primarily resulted from net earnings and the net effect of employee stock transactions, partially offset by dividends.

At December 27, 2002, total common shares outstanding, excluding shares exchangeable into common stock, were 867.3 million, 3% higher than the 843.5 million shares outstanding at December 28, 2001. The increase was attributable principally to employee stock grants and option exercises. There were no common stock repurchases during 2002 or 2001.

Total shares exchangeable into common stock at year-end 2002, issued in connection with the 1998 merger with Midland Walwyn Inc., were 3.9 million, compared with 4.2 million at year-end 2001. For additional information, see Note 13 to the Consolidated Financial Statements.

Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments
As a part of its normal operating strategy, Merrill Lynch enters into various contractual obligations, contingent liabilities and commitments which may require future payments. The table below outlines the significant contractual obligations, contingent liabilities, and commitments, as well as the future expiration as of December 27, 2002:



In February 2003, Merrill Lynch entered into an investors' agreement with UFJ Holdings (one of the four largest Japanese banks) which provides that, in exchange for Merrill Lynch's investment of 120 billion Japanese yen (approximately $960 million) into UFJ Strategic Partner Co., Ltd., a UFJ Holding's subsidiary created to hold, manage, and resolve various non-performing and sub-performing UFJ loans, Merrill Lynch will receive 100% of UFJ Strategic Partner Co.'s preferred shares. The timing of the funding of this commitment is anticipated to be in the first quarter of 2003.

Refer to Note 9 and Note 14 to the Consolidated Financial Statements for a complete discussion of commitments, contingencies and guarantees and to Note 10 to the Consolidated Financial Statements for short-term and long-term borrowings.

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Capital Adequacy and Funding
The primary objectives of Merrill Lynch's capital structure and funding policies are to support the successful execution of the firm's business strategies while ensuring:

• sufficient equity capital to absorb losses and
• liquidity at all times, across market cycles, and through periods of financial stress.

Merrill Lynch also assesses the need for equity capital to support business risks that may not be adequately measured through these risk models, such as process, legal and other operating risks. When deemed prudent or when required by regulations, Merrill Lynch also purchases insurance to protect against some risks. When assessing capital adequacy, Merrill Lynch does not view insurance as a complete substitute for capital because of uncertainty and timing of insurance recovery proceeds and the need to periodically renew coverage.

Merrill Lynch also considers equity capital that may be required to support normal business growth and strategic initiatives. Merrill Lynch increasingly has opportunities to serve individual and institutional clients through the use of its own equity capital. Merrill Lynch continued to grow its equity capital base in 2002 primarily through net earnings and the net effect of employee stock transactions. Equity capital of $25.5 billion at December 27, 2002 (including common equity, preferred equity and TOPrS^SM) was 12% higher than at the beginning of the year.

Merrill Lynch's capital adequacy planning also takes into account the regulatory environment in which the company operates. Many regulated businesses require various minimum levels of capital (see Note 18 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.

Based on the risks and equity needs of its businesses, Merrill Lynch believes that its equity capital base of $25.5 billion is adequate.

Merrill Lynch's leverage ratios were as follows:



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.

Funding
Liquidity Risk Management
Merrill Lynch manages funding globally to assure liquidity at all times, across market cycles and through periods of financial stress. Merrill Lynch's primary liquidity objective is to ensure that all unsecured debt obligations maturing within one year can be repaid without issuing new unsecured debt or requiring liquidation of business assets. In order to accomplish this objective, Merrill Lynch has established a set of liquidity practices which are outlined below:

Maintain appropriate mix of short- and long-term capital: Merrill Lynch regularly reviews its mix of assets, liabilities and commitments to ensure the maintenance of adequate long-term capital, which includes portions of deposits, the non-current portion of long-term debt and equity capital. The following items are generally financed with long-term capital:

• The portion of trading and other current assets that cannot be self-funded in the secured financing market, considering stressed market conditions
  
• Long-term, less liquid assets such as goodwill, fixed assets and loans
  
• Regulatory capital requirements
  
• Collateral on derivative contracts that may be required in the event of changes in ratings or movements in underlying commodity prices
  
• Portions of commitments to extend credit based on the probability of drawdown

Included in its debt obligations are structured notes issued by Merrill Lynch with returns linked to other debt or equity securities, indices, or currencies. Merrill Lynch could be required to immediately settle a structured note obligation for cash or other securities under some circumstances. Merrill Lynch typically hedges these notes with positions in the underlying instrument.

Maintain sufficient alternative funding sources: Merrill Lynch seeks to ensure availability of sufficient alternative funding sources to enable the repayment of all unsecured debt obligations maturing within one year without issuing new unsecured debt or requiring liquidation of business assets. The main alternative funding sources to unsecured borrowings are repurchase agreements, securities loaned, and other secured borrowings, which require pledging unencumbered securities held for trading or investment purposes.

Merrill Lynch also maintains a separate liquidity portfolio of U.S. Government and agency obligations and asset-backed securities of high credit quality that is funded with debt with an average maturity greater than one year. The carrying value of this portfolio, net of related hedges, was $12.6 billion and $8.4 billion at December 27, 2002 and December 28, 2001, respectively. These assets may be sold or pledged to provide immediate liquidity to ML & Co. to repay maturing debt obligations. In addition to this portfolio, the firm monitors the extent to which other unencumbered assets are available as a source of funds during a liquidity event.

Merrill Lynch also maintains a committed, multi-currency, unsecured bank credit facility. The facility totaled $3.5 billion at December 27, 2002 and $5.0 billion at December 28, 2001. Merrill Lynch elected to reduce the amount of its credit facility in 2002 and offset this reduction by an increase in the liquidity portfolio of unencumbered securities. The facility, which expires in May 2003, is expected to be renewed although Merrill Lynch may elect to further reduce the amount of the facility. At December 27, 2002 and December 28, 2001, there were no borrowings outstanding under this credit facility. Merrill Lynch's credit facility contains covenants, including a minimum net worth requirement, with which Merrill Lynch has maintained compliance at all times. The credit facility does not, however, require Merrill Lynch to maintain specified credit ratings.

Concentrate unsecured financing at ML & Co.: ML & Co. is the primary issuer of all unsecured, non-deposit financing instruments that are used primarily to fund assets in subsidiaries, some of which are regulated. 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. Where regulations, time zone differences, or other business considerations make this impractical, some subsidiaries enter into their own financing arrangements.

Merrill Lynch recognizes that regulatory restrictions may limit the free flow of funds from subsidiaries, where assets are held, to ML & Co. and also between subsidiaries. For example, a portion of deposits held by Merrill Lynch bank subsidiaries fund securities that can be sold or pledged to provide immediate liquidity for the banks. However, there are regulatory restrictions on the use of this liquidity for non-bank affiliates of Merrill Lynch. Merrill Lynch takes these and other restrictions into consideration when evaluating the liquidity of individual legal entities and ML & Co.

Diversify unsecured funding sources: Merrill Lynch strives to continually expand and globally diversify its funding programs, markets, and investor and creditor base to minimize reliance on any one investor base or region. Merrill Lynch diversifies its borrowings by maintaining various limits, including a limit on the amount of commercial paper held by a single investor. Merrill Lynch benefits by distributing a significant portion of its debt issuances through its own sales force to a large, diversified global client base. Merrill Lynch also makes markets buying and selling its debt instruments.

Adhere to prudent governance processes: In order to ensure that both daily and strategic funding activities are appropriate and subject to senior management review and control, Merrill Lynch reviews its liquidity management in Asset/Liability Committee meetings with senior Treasury management and presents a financing plan to the Finance Committee of the Board of Directors. Merrill Lynch also closely manages the growth and composition of its assets and sets limits on the availability of unsecured funding at any time. Merrill Lynch also maintains a contingency funding plan that outlines actions that would be taken in the event of a funding disruption.

Asset and Liability Management
Merrill Lynch routinely issues debt in a variety of maturities and currencies to achieve low cost financing and an appropriate liability maturity profile. The cost and availability of unsecured funding may also be impacted by general market conditions or by matters specific to the financial services industry or Merrill Lynch. In 2002, corporate credit spreads widened considerably with the potential to significantly impact the cost and availability of funding for financial institutions, including Merrill Lynch. Throughout the year, Merrill Lynch adhered to its established liquidity practices and had sufficient financial flexibility to avoid significant changes in the cost and availability of funding.

Merrill Lynch uses derivative transactions to more closely match the duration of borrowings to the duration of the assets being funded to enable interest rate risk to be managed within limits set by the Corporate Risk Management Group. Interest rate swaps also serve to adjust Merrill Lynch's interest expense and effective borrowing rate principally to floating rate. Merrill Lynch also enters into currency swaps to hedge non-local-currency denominated assets that are not financed through debt issuance in the same currency. Investments in subsidiaries in non-U.S. dollar currencies are also hedged to a level that minimizes translation adjustments in the Cumulative Translation Account (see Notes 1 and 7 to the Consolidated Financial Statements for further information).

Credit Ratings
The cost and availability of unsecured funding are also impacted by credit ratings. In addition, credit ratings are important when competing in certain markets and when seeking to engage in long-term transactions including over-the-counter derivatives. Factors that influence Merrill Lynch's credit ratings include the credit rating agencies' assessment of the general operating environment, relative positions in the markets in which Merrill Lynch competes, reputation, level and volatility of earnings, risk management policies, liquidity and capital management.

Merrill Lynch's senior long-term debt, preferred stock, and TOPrS^SM were rated by several recognized credit rating agencies at February 24, 2003 as indicated below. These ratings do not reflect outlooks that may be expressed by the rating agencies from time to time, which are currently stable or negative.



On May 17, 2002, Fitch Ratings lowered its long-term debt ratings for ML & Co. (senior to "AA–" from "AA" and preferred stock and TOPrS^SM to "A+" from "AA–"). On October 17, 2002, Standard and Poor's Ratings Services lowered its long-term debt ratings for ML & Co. (senior to "A+" from "AA–" and preferred stock and TOPrS^SM to "A–" from "A") and the short-term debt rating for ML & Co. (senior to "A-1" from "A-1+"). Several other securities firms were downgraded on the same days as ML & Co.

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Capital Projects and Expenditures
Merrill Lynch continually looks for opportunities to enhance client service and improve efficiency by investing in new technology to improve service to clients. During the fourth quarter of 2002, Merrill Lynch and Thomson Financial announced their intention to develop and implement the Wealth Management Workstation ("WMW"), which will be designed to enhance the capabilities currently available through GPC's Trusted Global Advisor system. The WMW will be designed to provide a new standard of desktop technology to more than 25,000 users including Financial Advisors, Client Associates, the Financial Advisory Center and call centers. Total expenditures related to this project, which are expected to approximate $300 million, will commence in 2003 and continue through 2009.

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Risk Management
Risk Management Philosophy
Risk-taking is an integral part of Merrill Lynch's core business activities. In the course of conducting its business operations, Merrill Lynch is exposed to a variety of risks including market, credit, liquidity, operational, and other risks that are material and require comprehensive controls and ongoing management. The responsibility and accountability for these risks remain primarily with the businesses. The Corporate Risk Management ("CRM") group, along with other control units, works to ensure that these risks are properly identified, monitored, and managed throughout Merrill Lynch. To accomplish this, CRM has established a risk management process, which includes:

• a formal risk governance organization that defines the oversight process and its components;
  
• a regular review of the entire risk management process by the Audit Committee of the Board of Directors;
  
• clearly defined risk management policies and procedures supported by a rigorous analytical framework;
  
• communication and coordination between the business, executive, and risk functions while maintaining strict segregation of responsibilities, controls, and oversight; and
  
• clearly articulated risk tolerance levels as defined by a group composed of executive management ("the Management Group") which are regularly reviewed to ensure that Merrill Lynch's risk-taking is consistent with its business strategy, capital structure, and current and anticipated market conditions.

Risk Governance Structure
Merrill Lynch's risk governance structure is comprised of the Audit Committee, the Management Group, the Risk Oversight Committee ("ROC"), the business units, CRM, and various corporate governance committees. The roles of these respective groups are as follows:

The Audit Committee is comprised entirely of external directors and has authorized the ROC to establish Merrill Lynch's risk management policies.

The Management Group establishes risk tolerance levels for the firm and authorizes material changes in Merrill Lynch's risk profile. This Group also ensures that the risks assumed by Merrill Lynch are managed within these tolerance levels and verifies that Merrill Lynch has implemented appropriate policies for the effective management of risks. The Management Group must approve all substantive changes to risk policies, including those proposed by the ROC. The Management Group pays particular attention to risk concentrations and liquidity concerns.

The ROC, comprised of senior business and control managers and currently chaired by the Chief Financial Officer, oversees Merrill Lynch's risks and ensures that the business units create and implement processes to identify, measure, and monitor their risks. The ROC also assists the Management Group in determining risk tolerance levels for the firm's business units and monitors the activities of Merrill Lynch's corporate governance committees, reporting significant issues and transactions to the Management Group and the Audit Committee.

Various other governance committees exist to create policy, review activity, and ensure that new and existing business initiatives remain within established risk tolerance levels. These committees include the New Product Review Committee, the Debt and Equity Capital Commitment Committees, the Real Estate Capital Commitment Committee, the Credit Policy Committee, the Special Transaction Review Committee, the Special and Structured Product Committee, the Corporate Transaction Review Committee, and the Reserve Committee. Representatives of the principal independent control functions participate as voting members of these committees.

Corporate Risk Management
CRM is an independent control function responsible for Merrill Lynch's market and credit risk management processes both within and across the firm's business units. The co-heads of CRM report directly to the Chief Financial Officer who chairs the ROC and is a member of the Management Group. Market risk is defined to be the potential change in value of financial instruments caused by fluctuations in interest rates, exchange rates, equity and commodity prices, credit spreads, and/or other risks. Credit risks are defined to be the potential for loss that can occur as a result of impairment in the creditworthiness of an issuer or counterparty or a default by an issuer or counterparty on its contractual obligations. CRM also provides Merrill Lynch with an overview of its risk for various aggregate portfolios and develops and maintains the analytics, systems, and policies to conduct all risk management functions.

CRM's chief monitoring and risk measurement tool is Merrill Lynch's Risk Framework. The Risk Framework defines and communicates Merrill Lynch's risk tolerance and establishes aggregate and broad risk limits for the firm. Market risk limits are intended to constrain exposure to specific asset classes, market risk factors, and Value-at-Risk ("VaR"). VaR is a statistical measure of the potential loss in the fair value of a portfolio due to adverse movements in underlying risk factors. Credit risk limits are intended to constrain the magnitude and tenor of exposure to individual counterparties and issuers, types of counterparties and issuers, countries, and types of financing collateral. Risk Framework exceptions and violations are reported and investigated at pre-defined and appropriate levels of management. The Risk Framework and its limits have been approved by the Management Group and the risk parameters that define the Risk Framework have been reviewed by the Audit Committee. The Management Group reviews the Risk Framework annually and approves any material changes. The ROC reports all substantive Risk Framework changes to the Audit Committee.

The overall effectiveness of Merrill Lynch's risk processes and policies can be seen on a broader level when analyzing weekly net trading revenues over time. CRM policies and procedures of monitoring and controlling risk combined with the businesses' focus on customer order-flow driven revenues and selective proprietary positioning have helped Merrill Lynch to reduce earnings volatility within its trading portfolios. While no guarantee can be given regarding future earnings volatility, Merrill Lynch will continue to pursue policies and procedures that assist the firm in measuring and monitoring its risks. A graph of Merrill Lynch's weekly revenues from trading-related activities for 2002 follows:



Market Risk
CRM's Market Risk Group is responsible for approving the products and markets in which Merrill Lynch's major business units and functions will transact and take risk. Moreover, it is responsible for identifying the risks to which these businesses and units will be exposed in these approved products and markets. The Market Risk Group uses a variety of quantitative methods to assess the risk of Merrill Lynch's positions and portfolios. In particular, the Market Risk Group quantifies the sensitivities of Merrill Lynch's current portfolios to changes in market variables. These sensitivities are then utilized in the context of historical data to estimate earnings and loss distributions that Merrill Lynch's current portfolios would have incurred throughout the historical period. From these distributions, CRM derives a number of useful risk statistics including VaR. The disclosed VaR is an estimate of the amount that Merrill Lynch's current portfolios could lose with a specified degree of confidence, over a given time interval. The VaR for Merrill Lynch's overall portfolios is less than the sum of the VaRs for individual risk categories because movements in different risk categories occur at different times and, historically, extreme movements have not occurred in all risk categories simultaneously. The difference between the sum of the VaRs for individual risk categories and the VaR calculated for all risk categories is shown in the following tables and may be viewed as a measure of the diversification within Merrill Lynch's portfolios. CRM believes that the tabulated risk measures provide broad guidance as to the amount Merrill Lynch could lose in future periods, and CRM works continuously to improve its measurement and the methodology of the firm's VaR. However, the calculation of VaR requires numerous assumptions and thus VaR should not be viewed as a precise measure of risk.

In the Merrill Lynch VaR system, CRM uses a historical simulation approach to estimate VaR using a 95% confidence level and a one-week holding period for trading and non-trading instruments. Sensitivities to market risk factors are aggregated and combined with a database of historical market factor movements to simulate a series of profits and losses. The level of loss that is exceeded in that series 5% of the time is used as the estimate for the 95% confidence level VaR. The overall total VaR amounts are presented across major risk categories, including exposure to volatility risk found in certain products, e.g., options.

VaR associated with Merrill Lynch's U.S. banks, which previously had been reported separately, has been integrated into the firm's trading and non-trading VaR tables below. Virtually all of the U.S. bank VaR is related to non-trading assets from their investment portfolio and has been reallocated to the non-trading VaR table with only a small portion reallocated to the trading-related VaR table.

The non-trading VAR table includes the interest rate risk associated with Merrill Lynch's $4.7 billion of outstanding LYONs^®. At year-end 2002, the decline in price of ML & Co. stock gives LYONs^® the characteristics of a fixed-income security. The December 28, 2001 VaR amounts have been restated to conform with the current presentation.

The table that follows presents Merrill Lynch's VaR for trading instruments at year-end 2002 and 2001 and the 2002 average VaR. Additionally, high and low VaR is presented independently for each risk category and overall. Because high and low VaR numbers for these risk categories may have occurred on different days, high and low numbers for diversification benefit would not be meaningful.



Due to the mix of the trading portfolio, overall VaR decreased in 2002 due to decreases in interest rate and credit spread VaR, volatility related VaR, and increased diversification benefits.

The following table presents Merrill Lynch's VaR for non-trading instruments (including Merrill Lynch's U.S. banks and Merrill Lynch's LYONs^®):



As mentioned above, the year-end 2001 non-trading VaR amounts have been restated to reflect the integration of the U.S. banks and LYONs^®. On a comparable basis, as reflected in the table above, non-trading VaR increased modestly in 2002 due primarily to an increase in the interest rate and credit spread VaR.

Credit Risk
CRM's Credit Risk Group assesses the creditworthiness of existing and potential individual clients, institutional counterparties and issuers, and determines firm-wide credit risk levels within the Risk Framework limits. The Group reviews and monitors specific transactions as well as portfolio and other credit risk concentrations both within and across businesses. The Group is also responsible for ongoing monitoring of credit quality and limit compliance and the Group actively works with all the business units of Merrill Lynch to manage and mitigate credit risk.

The Credit Risk Group uses a variety of methodologies to set limits on exposure resulting from a counterparty or issuer failing to perform on its contractual obligations. The Group performs analysis in the context of industrial, regional, and global economic trends and incorporates portfolio and concentration effects when determining tolerance levels. Credit risk limits take into account measures of both current and potential exposure and are set and monitored by broad risk type, product type, and tenor to maturity. Credit risk mitigation techniques include, where appropriate, the right to require initial collateral or margin, the right to terminate transactions or obtain collateral should unfavorable events occur, the right to call for collateral when certain exposure thresholds are exceeded, and the purchase of credit default protection. With senior management involvement, Merrill Lynch conducts regular portfolio reviews, monitors counterparty creditworthiness, and evaluates transaction risk with a view toward early problem identification and protection against unacceptable credit-related losses. In 2002, the Credit Risk Group invested additional resources to enhance its methods and policies to assist in the management of Merrill Lynch's credit risk.

Credit risk and exposure that originates from Merrill Lynch's Global Private Client business is monitored constantly by CRM. Exposures include credit risks for mortgages, home equity lines of credit, margin accounts, loans to individuals and working capital lines and other loans that Merrill Lynch maintains with certain small business clients. When required, these exposures are collateralized in accordance with regulatory requirements governing such activities. Credit risk in Merrill Lynch's U.S. banks' investment portfolios is monitored within CRM and by credit risk management analysts. In addition, Merrill Lynch's U.S. banks have independent credit approval and monitoring processes in place.

Merrill Lynch enters into International Swaps and Derivatives Association, Inc. master agreements or their equivalent ("master netting agreements") with substantially all of its derivative counterparties as soon as possible. The agreements are negotiated with each counterparty and are complex in nature. While every effort is taken to execute such agreements, it is possible that a counterparty may be unwilling to sign such an agreement, and as a result, would subject Merrill Lynch to additional credit risk. Master netting agreements provide protection in bankruptcy in certain circumstances and, in some cases, enable receivables and payables with the same counterparty to be offset on the Consolidated Balance Sheets, providing for a more meaningful balance sheet presentation of credit exposure. However, the enforceability of master netting agreements under bankruptcy laws in certain countries or in certain industries is not free from doubt and receivables and payables with counterparties in these countries or industries are accordingly recorded on a gross basis.

In addition, to reduce default risk, Merrill Lynch requires collateral, principally cash and U.S. Government and agency securities, on certain derivative transactions. From an economic standpoint, Merrill Lynch evaluates default risk exposures net of related collateral. The following is a summary of counterparty credit ratings for the replacement cost (net of $11.6 billion of collateral) of trading derivatives in a gain position by maturity at December 27, 2002. (Please note that the following table is inclusive of credit exposure from derivative transactions only and does not include other material credit exposures).



In addition to obtaining collateral, Merrill Lynch attempts to mitigate its default risk on derivatives whenever possible by entering into transactions with provisions that enable Merrill Lynch to terminate or reset the terms of its derivative contracts.

Operational Risk
Operational Risk Management is an evolving discipline. Merrill Lynch defines operational risk as the risk of loss resulting from inadequate controls or business disruption relating to employees, internal processes, systems, or external events. Examples of operational risks faced by the firm include systems failure, human error, fraud, acts of terrorism, and major fire or other disasters. Merrill Lynch manages operational risks in a variety of ways including maintaining a comprehensive system of internal controls, using technology to automate processes and reduce manual errors, monitoring risk events, employing experienced personnel, monitoring business activities by compliance professionals, maintaining fully operational, off-site backup facilities, conducting internal audits, requiring education and training of employees, and emphasizing the importance of management oversight. In light of the terrorist attacks of September 11, 2001, Merrill Lynch has further strengthened its contingency and recovery resources throughout 2002 and will continue to do so where necessary.

Other Risks
Liquidity risks arise in the course of Merrill Lynch's general funding activities and in the management of its balance sheet. These risks include both being unable to raise funding with appropriate maturity and interest rate characteristics or being unable to liquidate an asset in a timely manner at a reasonable price. For more information on how Merrill Lynch manages liquidity risk, see the Capital Adequacy and Funding section.

Merrill Lynch encounters a variety of other risks, which have the ability to impact the viability, profitability, and cost effectiveness of present or future transactions. Such risks include political, tax, and regulatory risks that may arise due to changes in local laws, regulations, accounting standards, or tax statutes. To assist in the mitigation of such risks, Merrill Lynch rigorously reviews new and pending legislation and regulations. Additionally, Merrill Lynch employs professionals in jurisdictions in which the company operates to actively follow issues of potential concern or impact to the firm and to participate in related interest groups.

During 2002, the research function at integrated broker-dealers was the subject of substantial regulatory and media attention. As a result of regulatory mandates and firm initiatives, Merrill Lynch enacted a number of new policies to enhance the quality of its research product including: modifying the compensation system for research analysts; forming a new Research Recommendations Committee; appointing a Research Compliance Monitor; adopting a new simplified securities ratings system; and adding disclosure on research reports regarding potential conflicts of interest. The modification to the compensation system for research analysts provides that an analyst's pay will be based on an evaluation of how the analyst's insights and recommendations benefit investors. Merrill Lynch's Investment Banking group does not have input into research analyst compensation. In mid-2001, in an effort to ensure the independence and objectivity of its research, Merrill Lynch announced a policy which prohibited equity analysts and their staff members from buying equity shares of the companies they cover.

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Non-Investment Grade Holdings and Highly Leveraged Transactions
Non-investment grade holdings and highly leveraged transactions involve risks related to the creditworthiness of the issuers or counterparties and the liquidity of the market for such investments. Merrill Lynch recognizes these risks and, whenever possible, employs strategies to mitigate exposures. The specific components and overall level of non-investment grade and highly leveraged positions may vary significantly from period to period as a result of inventory turnover, investment sales, and asset redeployment.

In the normal course of business, Merrill Lynch underwrites, trades, and holds non-investment grade cash instruments in connection with its investment banking, market-making, and derivative structuring activities. Non-investment grade holdings have been defined as debt and preferred equity securities rated as BB+ or lower or equivalent ratings by recognized credit rating agencies, sovereign debt in emerging markets, amounts due under derivative contracts from non-investment grade counterparties, and other instruments that, in the opinion of management, are non-investment grade.

In addition to the amounts included in the following table, derivatives may also expose Merrill Lynch to credit risk related to the underlying security where a derivative contract can either replicate ownership of the underlying security (e.g., long total return swaps) or potentially force ownership of the underlying security (e.g., short put options). Derivatives may also subject Merrill Lynch to credit spread or issuer default risk, in that changes in credit spreads or in the credit quality of the underlying securities may adversely affect the derivatives' fair values. Merrill Lynch seeks to manage these risks by engaging in various hedging strategies to reduce its exposure associated with non-investment grade positions, such as purchasing an option to sell the related security or entering into other offsetting derivative contracts.

Merrill Lynch provides financing and advisory services to, and invests in, companies entering into leveraged transactions, which may include leveraged buyouts, recapitalizations, and mergers and acquisitions. On a selected basis, Merrill Lynch provides extensions of credit to leveraged companies, in the form of senior and subordinated debt, as well as bridge financing on a select basis. In addition, Merrill Lynch syndicates loans for non-investment grade companies or in connection with highly leveraged transactions and may retain a portion of these loans.

Merrill Lynch holds direct equity investments in leveraged companies and interests in partnerships that invest in leveraged transactions. Merrill Lynch has also committed to participate in limited partnerships that invest in leveraged transactions. Future commitments to participate in limited partnerships and other direct equity investments will continue to be made on a select basis.

Trading Exposures
The following table summarizes trading exposures to non-investment grade or highly leveraged issuers or counterparties at year-end 2002 and 2001:



Included in the preceding table are debt and equity securities and bank loans of companies in various stages of bankruptcy proceedings or in default. At December 27, 2002, the carrying value of such debt and equity securities totaled $140 million, of which 29% resulted from Merrill Lynch's market-making activities in such securities. This compared with $58 million at December 28, 2001, of which 18% related to market-making activities. Also included are distressed bank loans totaling $203 million and $245 million at year-end 2002 and 2001, respectively.

Non-Trading Exposures
The following table summarizes non-trading exposures to non-investment grade or highly leveraged issuers or counterparties at year-end 2002 and 2001:



On March 3, 2003, Merrill Lynch and the other senior lenders to Mobilcom S.A., closed on the assignment of their loans to France Telecom S.A. Per this agreement Merrill Lynch received a subordinated perpetual convertible security of France Telecom approximating Euro 500 million. This amount represents 100% of Merrill Lynch's loan to Mobilcom, accrued and unpaid interest, and certain accrued expenses.

The following table summarizes Merrill Lynch's commitments with exposure to non-investment grade or highly leveraged counterparties at year-end 2002 and 2001:



At December 27, 2002, the largest industry exposure was to the financial services sector, which accounted for 29% of total non-investment grade positions and highly leveraged transactions.

Merrill Lynch sponsors deferred compensation plans in which employees who meet certain minimum compensation requirements may participate. Contributions to the plans are made on a tax-deferred basis by the participants. Participants' returns on these contributions may be indexed to various Merrill Lynch mutual funds and other funds, including certain company-sponsored investment vehicles that qualify as employee securities companies. Prior to 2002, eligible participants whose deferred amounts were indexed to those company-sponsored investment vehicles could make one-time elections to augment their returns through "leverage" provided by Merrill Lynch, generally on a two-for-one basis. This leverage bears interest and is repaid as distributions are made by the investment vehicles.

Merrill Lynch also sponsors several cash-based employee award programs, under which certain employees are eligible to receive future cash compensation, generally upon fulfillment of the vesting criteria for the particular program.

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Litigation
Certain actions have been filed against Merrill Lynch in connection with Merrill Lynch's business activities. Although the ultimate outcome of legal actions, arbitration proceedings, and claims pending against ML & Co. or its subsidiaries cannot be ascertained at this time and the results of legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these actions will not have a material adverse effect on the financial condition of Merrill Lynch as set forth in the Consolidated Financial Statements, but may be material to Merrill Lynch's operating results or cash flows for any particular period and may impact ML & Co.'s credit ratings. Refer to Note 14 to the Consolidated Financial Statements for additional information.

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Critical Accounting Policies and Estimates
The following is a summary of Merrill Lynch's critical accounting policies. For a full description of these and other accounting policies see Note 1 to the Consolidated Financial Statements.

Use of Estimates
In presenting the Consolidated Financial Statements, Management makes estimates regarding certain trading inventory valuations, the outcome of litigation, the carrying amount of goodwill, the allowance for loan losses, the realization of deferred tax assets, tax reserves, insurance reserves, recovery of insurance deferred acquisition costs, and other matters that affect the reported amounts and disclosure of contingencies in the financial statements. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on the Consolidated Financial Statements, and it is possible that such changes could occur in the near term. For more information regarding the specific methodologies used in determining estimates, refer to Use of Estimates in Note 1 to the Consolidated Financial Statements.

Valuation of Financial Instruments
Fair values for exchange traded securities and certain exchange-traded derivatives, principally futures and certain options, are based on quoted market prices. Fair values for OTC derivative financial instruments, principally forwards, options, and swaps, represent amounts estimated to be received from or paid to a third party in settlement of these instruments. These derivatives are valued using pricing models based on the net present value of estimated future cash flows, and directly observed prices from exchange-traded derivatives, other OTC trades, or external pricing services. Obtaining the fair value for OTC derivative contracts requires the use of management judgment and estimates.

New and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation often incorporate significant estimates and assumptions, which may impact the level of precision in the financial statements. For long-dated and illiquid contracts, extrapolation methods are applied to observed market data in order to estimate inputs and assumptions that are not directly observable. This enables Merrill Lynch to mark all positions consistently when only a subset of prices are directly observable. Values for non-exchange-traded derivatives are verified using observed information about the costs of hedging out the risk and other trades in the market. As the markets for these products develop, Merrill Lynch continually refines its pricing models based on experience to correlate more closely to the market risk of these instruments. Unrealized gains for these instruments are not recognized unless the valuation model incorporates significant observable market inputs.

Merrill Lynch holds investments that may have quoted market prices but that are subject to restrictions (e.g., consent of other investor to sell) that may limit Merrill Lynch's ability to realize the quoted market price. Accordingly, Merrill Lynch estimates the fair value of these securities based on management's best estimate which incorporates pricing models based on projected cash flows, earnings multiples, comparisons based on similar market transactions and/or review of underlying financial conditions and other market factors.

Valuation adjustments are an integral component of the mark-to-market process and are taken for individual positions where either the sheer size of the trade or other specific features of the trade or particular market (such as counterparty credit quality, concentration or market liquidity) requires more than the simple application of the pricing models.

Assets recorded on the balance sheet can therefore be broadly categorized as follows:

1. highly liquid cash and derivative instruments for which quoted market prices are readily available (for example, exchange-traded equity securities and derivatives such as listed options)
2. liquid instruments, including
   a) cash instruments for which quoted prices are available but which may trade less frequently such that there is not complete pricing transparency for these instruments across all market cycles (for example, corporate and municipal bonds)
   b) derivative instruments that are valued using a model, where inputs to the model are directly observable in the market (for example, U.S. dollar interest rate swaps); and
   c) instruments that are priced with reference to comparable financial instruments whose parameters can be directly observed
3. less liquid instruments that are priced using management's best estimate of fair value, and instruments which are valued using a model, where either the inputs to the model and/or the models themselves require significant judgement by management (for example, private equity investments, long dated or complex derivatives such as certain foreign exchange options and credit default swaps, distressed debt, and aged inventory positions).

Many of the SPEs with which Merrill Lynch enters into transactions with, meet the requirements of qualifying special purpose entities ("QSPEs") as defined by SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. SPEs that are considered QSPEs by Merrill Lynch include: SPEs that convert pools of commercial and residential loans into securities; SPEs that convert pools of municipal bonds into floating rate securities; and SPEs that transform the cash flows of transferred assets in some specified manner for clients. As an example of this last type of SPE, an SPE may transform the interest rate on securities from a fixed to a floating rate for investors by entering into a derivative such as an interest rate swap. Another example is an SPE that provides an investor with exposure to a particular credit risk that does not arise from assets held by the SPE, by entering into a derivative transaction such as a credit default swap to hedge the return provided to the investor. Based on the requirements of SFAS No. 140, QSPEs are not consolidated by Merrill Lynch.

Many SPEs do not qualify as QSPEs either because the SPEs' permitted activities are not sufficiently limited, or because the SPE owns assets that are not financial instruments, or otherwise does not meet all of the conditions of a QSPE. In situations where Merrill Lynch is either the sponsor of the SPE or where it transfers assets to the SPE, Merrill Lynch relies on the guidance provided by Emerging Issues Task Force ("EITF") Topic D-14, Transactions Involving Special-Purpose Entities, to determine whether consolidation of these SPEs is required. Under this guidance, an SPE is not required to be consolidated by a transferor or sponsor if the SPE issues equity in legal form to unaffiliated third parties that is at least 3% of the value of the assets held by the SPE, the transferor or sponsor has not retained the substantive risks and rewards of ownership of the SPE and does not have control over the activities of the SPE. Merrill Lynch considers a number of both qualitative and quantitative factors in determining whether it is the sponsor of an SPE for purposes of applying the guidance in EITF Topic D-14, and judgment is required in making this determination.

Merrill Lynch also acts as a liquidity provider to investors in securities issued by certain SPEs and enters into other guarantees related to SPEs. Additional information regarding liquidity facilities and guarantees to SPEs is provided in Note 14 to the Consolidated Financial Statements. Merrill Lynch also retains interests in assets securitized by an SPE, and enters into derivative transactions with SPEs. These transactions are recorded at estimated fair value in the Consolidated Financial Statements. Therefore, material economic exposures to SPEs created in these transactions are recorded or disclosed in the Consolidated Financial Statements. Refer to Note 8 to the Consolidated Financial Statements for more information on interests retained in securitization transactions.

In addition to the SPEs described above, Merrill Lynch has entered into transactions with SPEs to facilitate the financing of physical property (facilities and aircraft) for its own use. The physical property is purchased or constructed by the SPE and leased to Merrill Lynch. For these structures, Merrill Lynch follows the guidance in EITF Issue No. 90-15, Impact of Nonsubstantive Lessors, Residual Value Guarantees, and other Provisions in Leasing Transactions and EITF Issue No. 97-10, The Effect of Lessee Involvement in Asset Construction, to determine whether or not consolidation of the SPE is required. Under this guidance, a company that leases property from an SPE is not required to consolidate that SPE if, among other conditions, a third-party investor has made a substantive residual equity capital investment in the SPE that is at risk during the entire term of the lease. Substantive residual equity capital is currently defined as amounting to at least 3% of the value of the assets held by the SPE. Merrill Lynch has met the requirements of EITF Issues No. 90-15 and 97-10 for these SPEs and accordingly, these SPEs are not consolidated in the Consolidated Financial Statements. See Note 8 and Note 14 to the Consolidated Financial Statements for additional detail regarding these transactions.

Merrill Lynch's U.S. banking subsidiaries have also entered into transactions with SPEs in order to improve the liquidity of their mortgage portfolios and reduce the credit risk of their investment portfolios, which resulted in reduced regulatory capital requirements. See Note 18 to the Consolidated Financial Statements for additional information about these transactions.

In January 2003, the Financial Accounting Standards Board ("FASB") issued new guidance regarding consolidation of SPEs which will supercede EITF Topic D-14 and Issue 90-15. FASB Interpretation No. ("FIN") 46, Consolidations of Variable Interest Entities — an Interpretation of ARB No. 51, is effective for newly created SPEs beginning February 1, 2003 and for existing SPEs as of the third quarter of 2003. See New Accounting Pronouncements below for additional information and Note 8 to the Consolidated Financial Statements for disclosures.

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Recent Developments
Risk Management Philosophy
On July 31, 2002, the American Institute of Certified Public Accountants ("AICPA") issued a Proposed Statement of Position ("SOP") "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." The proposed SOP provides guidance on accounting and reporting by insurance companies for certain nontraditional long-duration contracts and for separate accounts. A final SOP would be effective for financial statements for Merrill Lynch beginning in 2004. The SOP would require the establishment of a liability for contracts that contain death or other insurance benefits using a specified reserve methodology that is different from the methodology that Merrill Lynch employs. Depending on market conditions at the time of adoption, the impact of implementing this reserve methodology may have a material impact on the Consolidated Statement of Earnings.

On January 17, 2003, the FASB issued FIN 46, which clarifies when an entity should consolidate another entity known as a Variable Interest Entity ("VIE"), more commonly referred to as an SPE. A VIE is an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties, and may include many types of SPEs. FIN 46 requires that an entity consolidate a VIE if that enterprise has a variable interest that will absorb a majority of the VIE's expected losses, receive a majority of the VIE's expected residual returns, or both. FIN 46 does not apply to QSPEs, the accounting for which is governed by SFAS No. 140. FIN 46 is effective for VIEs created on or after February 1, 2003 and for existing VIEs as of the third quarter of 2003. See Note 8 to the Consolidated Financial Statements for disclosures regarding the expected impact of adoption of FIN 46 on Merrill Lynch's Consolidated Balance Sheet.

On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 permits three alternative methods of transition for a voluntary change to the fair value based method of accounting for employee stock-based compensation. SFAS No. 148 continues to permit prospective application for companies that adopt prior to the beginning of fiscal year 2004. SFAS No. 148 also allows for a modified prospective application, which requires the fair value of all unvested awards to be amortized over the remaining service period, as well as restatement of prior years' expense. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002, with earlier application permitted in certain circumstances.

On November 25, 2002, the FASB issued FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others — an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 requires guarantors to disclose their obligations under certain guarantees. It also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosures are effective for financial statements of interim or annual periods ending after December 15, 2002. See Note 14 to the Consolidated Financial Statements for these disclosures.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces the guidance provided by EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

In August 2001, the FASB released SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets which superceded both SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. SFAS No. 144 also amends Accounting Research Bulletin No. 51, Consolidated Financial Statements to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. SFAS No. 144 provides guidance on the financial accounting and reporting for the impairment or disposal of long-lived assets. The adoption of SFAS No. 144 did not have a material impact on Merrill Lynch's Consolidated Financial Statements.

In July 2001, the FASB issued SFAS No. 142. Under SFAS No. 142, intangible assets with indefinite lives and goodwill are no longer amortized. Instead, these assets are tested annually for impairment. Merrill Lynch adopted the provisions of SFAS No. 142 at the beginning of fiscal year 2002. See Note 1 to the Consolidated Financial Statements for further discussion.

In July 2001, the FASB released SFAS No. 141, Business Combinations. SFAS No. 141 requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. Merrill Lynch adopted the provisions of SFAS No. 141 on July 1, 2001.

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