NEW YORK (AP) _ Merrill Lynch & Co. moved Thursday to quell fallout from a federal investigation into junk-bond trades with a failed Florida insurer, telling employees the transactions were legal and fully disclosed.

The firm said in a memo to employees that Coopers & Lybrand, accountant for Guarantee Security Life Insurance Co., was aware of the trades and told the insurer how to represent them for tax purposes and on financial statements.

Merrill was stung by the disclosures Wednesday alleging securities ''parking'' that may have helped Guarantee Security, of Jacksonville, Fla., conceal the extent of its financial problems for years.

In a memo, Merrill Chairman William Schreyer and President Daniel Tully conceded that news of the Securities and Exchange Commission probe hurt amid recent reports of Wall Street wrongdoing.

''In the face of daily news stories alleging improprieties in our industry, our strong denials of any illegal or unethical activity did not have the immediate effect that they would have in normal regulatory times,'' the memo said.

Merrill stock, which fell $2.50 Wednesday, recovered 37 1/2 cents to close Thursday at $45.37 1/2 in heavy trading on the New York Stock Exchange. The stock price appeared to gain late in the day after the firm's memo was released.

Merrill has admitted it sold hundreds of millions of dollars in Treasury securities to Guarantee Security at the end of the year from 1984 to 1988. In exchange, the firm bought an almost equal amount of junk bonds from the insurer.

Florida regulators contend the transactions allowed the insurer to file documents with the state making its balance sheet appear stronger than it actually was. The transactions were reversed shortly into the new years.

But Merrill said in its memo the arrangement was legal because the firm assumed ''full market risk'' when holding the bonds. That means if the bonds had lost value while Merrill held them, the firm would have absorbed any losses.

Such a swap arrangement would not be illegal. Securities ''parking'' generally refers to a relationship in which ownership is hidden with the intent of avoiding regulatory requirements through an agreement to repurchase securities at a set price with a guarantee against losses.

The memo said that Merrill ''received assurances in writing from the company that these trades would be fully and fairly presented to federal and state tax authorities and insurance commissioners.''

''In fact, we understand that these as well as other transactions conducted through other securities firms were fully disclosed,'' it said.

However, W. Michael Heekin, deputy receiver for the insurance company, said regulators believe no other securities firms conducted transactions in which Treasury securities were exchanged for junk bonds.

Published reports said the Merrill probe is part of a larger civil and criminal investigation of Guarantee Security's parent, Transmark USA Inc. Regulators have accused the parent of depleting the assets of the insurance subsidiary.

The investigation reportedly stems from the lengthy government probe of Drexel Burnham Lambert Inc., which sold millions of dollars in junk bonds to Transmark. Transmark also issued junk bonds through Drexel to raise money.

Guarantee Security was seized by state regulators in August, partly because of the collapse of its huge high-yield bond portfolio.

State officials said junk bonds accounted for 62 percent of total assets when the insurer was seized. Officials said Guarantee Security is insolvent in excess of $300 million. The state has filed lawsuits seeking to recover more than $180 million from the insurer's owner and former owner.

Merrill Lynch said it had not spoken with the insurance company's receiver. Heekin said regulators expect to meet with Merrill and were interested in studying the firm's documentation of the trades. He would not comment on Merrill's assertion it assumed market risk in the trades.

Heekin also said Cooper & Lybrand's role in the transactions would be investigated. A spokesman for Coopers & Lybrand, David Nestor, declined to comment.

Court documents say Merrill gave the insurer a total of $903 million in Treasury securities - $152 million in 1984, $255 million in 1985, $292 million in 1986 and $205 million in 1988. If the securities had not been parked, Guarantee Security would have been insolvent, regulators alleged.