March 31, 1998
Dear Shareholder:

     Remember the Milk Cow story?  I owe an apology to an unknown shareholder. 
At our annual meeting last October, someone sent me an unsigned note saying "tell the 
milk cow story again". I had the note in my pocket, fully intending to comply, but as 
my mind got diverted by questions from the floor, I forgot about the note, only to think 
of it again about a half hour too late. It is a good story, a true one, and illustrates 
the precise thing that makes a bond fund distinctive from other investments such as stock 
funds.

     A young couple came into our office a couple of years ago to investigate the 
possibility of an investment in our Kentucky Tax-Free Income Series. Our representative 
explained all the elements of tax-free bonds, all the conveniences of bond mutual funds, 
but had been careful to point out that as interest rate levels change, bond prices change 
in the opposite direction and that it was possible, therefore, for the price of her fund 
shares to go down as well as up. 

     When it was time to make a decision the young wife could not seem to relax with the 
possibility that share prices might fluctuate, particularly if prices went down. How would 
she feel then? Our representative could do little to get her past this objection. Indeed, 
he had to admit it was possible that the price might decline at some time. Of course, the 
price might rise at some other time. But if she kept the shares long enough she was almost 
certain to see prices rise and fall several times, though almost always moderate price 
swings compared with those you might experience in stocks.

     Well...she just couldn't feel good about a possible price decline.

     Her husband, who had been listening patiently and letting his wife ask her own 
questions finally tried to see if he could help. "Look Honey", he said, " think of this 
investment as a milk cow. You buy the cow for its milk (its nice tax-free income in this 
case) and you don't worry about what the cow will bring on the livestock market. You don't 
go to the market every week to see what they are paying for your cow. If you did, you 
would find that sometimes its price was down and sometimes its price was up. But so 
what? As long as you were getting a steady stream of good fresh milk you wouldn't think 
of selling that cow."

     The one characteristic that distinguishes a tax-free bond fund from other investments 
is its steady stream of tax-free income. This stream changes very little over the 
years, even if bond prices do change, and for those in the higher tax brackets it is 
an ample stream of income. You should buy a bond or bond fund primarily for this steady 
stream of income.

     I must admit, with some embarrassment, that I often forget to point out this 
salient fact to people who ask me about our fund. Only a few days ago I was asked to 
talk about our fund to an investment club. I spent a lot of time on almost every fine 
point about bond funds that you can imagine and yet failed to point out the attraction 
of a steady stream of income to an investor, indeed, the prime attraction.

     The young husband had gone straight to the heart of the matter, using a wonderful 
home grown  example that we have repeated many times. We owe him a debt of gratitude.

     Management Fees and Vanguard Funds: Once a year, usually in October, when proxys 
are returned, we receive a comment from a shareholder saying "give us lower fees, why 
can't you manage our fund for the same expense ratio as Vanguard?"


     The most comparable Vanguard fund is their Vanguard Muni-Intermediate Term Series 
which has about the same average maturity and duration as our Kentucky Tax-Free Income 
Series. Vanguard's expense ratio for this fund is only .19 of 1% and our expense ratio 
is .63 of 1%. Both are tax-free no-load funds.

     The Vanguard Muni-Intermediate Term Series has about 7 billion dollars of net 
assets, we have about $350 million. If you will send in 6.650 billion more dollars, 
I promise we will operate our fund for .19 of 1% or maybe less. Vanguard didn't operate 
their series for as little as 19 basis points when they were our size either.

     But to focus on operating expense ratios is to lose the big picture. Vanguard's 
fund has an annual 12 month yield of 4.97%. We have an annual 12 month yield of 5.15%. 
Vanguard had, on Dec. 31st  a 12 month total return (interest plus growth in share 
price) of 7.08%. We had a total return of 8.03%. Vanguard was rated four star by 
Morningstar, we were rated five star. Vanguard is not free of the Kentucky Income 
or Intangibles taxes, we are! If you had sold shares in our fund and bought the 
Vanguard fund to get that lower expense ratio, you would have ended up with about 
14% less income in a lower rated fund. Like the puppy with a bone in his mouth who 
stood on the bridge, looking at his reflection, you would have dropped the bone to 
get something that wasn't there. Obviously, we are earning our keep. But I do agree 
that we need to keep lowering our fee structure as we get larger so as to move, with 
size, in the direction of lower total expenses.

     The Economy, Asia, Inflation and Interest Rates?: Some of the best economists we follow 
see inflation as completely subdued for now and interest rates dropping over the year 
ahead (bond prices up). They also feel the economy shows more strength than normal for 
the first quarter because warmer than normal weather has provided less interruption to 
business. If that is so, then any effects of the Asian collapse on our own economy would 
have been masked in this first quarter. The stock market remains strong, Warren Buffet 
thinks it will continue, nevertheless, my opinion is that it is probably a better time 
to buy bonds than stocks with any new investment money you may accumulate. The key to 
making that an accurate opinion is for inflation to stay moderate, or non-existent. I 
think it will.

     Morningstar Ratings and Reports:  An interesting observation from the January 31st 
Morningstar report. There is now one other Tennessee Fund with a five star rating 
(Franklin TN Muni). But Franklin's 12 mo. Load adjusted return was 6.97%, ours was 
10.79%. That's what a 4.25% front end load will do to you.



                                                            Yours truly,
                                                            Dupree Mutual Funds




                                                            Thomas P. Dupree, Sr.
                                                            President