DEBT
STRATEGIES
FUND, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Semi-Annual Report
August 31, 1998
<PAGE>
DEBT STRATEGIES FUND, INC.
The Benefits and Risks of Leveraging
Debt Strategies Fund, Inc. has the ability to utilize leverage through
borrowings or issuance of short-term debt securities or shares of Preferred
Stock. The concept of leveraging is based on the premise that the cost of assets
to be obtained from leverage will be based on short-term interest rates, which
normally will be lower than the return earned by the Fund on its longer-term
portfolio investments. Since the total assets of the Fund (including the assets
obtained from leverage) are invested in higher-yielding portfolio investments,
the Fund's Common Stock shareholders are the beneficiaries of the incremental
yield. Should the differential between the underlying interest rates narrow, the
incremental yield "pick up" will be reduced. Furthermore, if long-term interest
rates rise, the Common Stock's net asset value will reflect the full decline in
the entire portfolio holdings resulting therefrom since the assets obtained from
leverage do not fluctuate.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend rates
on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce
the Common Stock's yield and negatively impact its market price. If the income
derived from securities purchased with assets received from leverage exceeds the
cost of leverage, the Fund's net income will be greater than if leverage had not
been used. Conversely, if the income from the securities purchased is not
sufficient to cover the cost of leverage, the Fund's net income will be less
than if leverage had not been used, and therefore the amount available for
distribution to Common Stock shareholders will be reduced. In this case, the
Fund may nevertheless decide to maintain its leveraged position in order to
avoid capital losses on securities purchased with leverage. However, the Fund
will not generally utilize leverage if it anticipates that its leveraged capital
structure would result in a lower rate of return for its Common Stock than would
be obtained if the Common Stock were unleveraged for any significant amount of
time.
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
DEAR SHAREHOLDER
For the six-month period ended August 31, 1998, the total investment return on
the Fund's Common Stock was -5.56%, based on a change in per share net asset
value from $10.15 to $9.12, and assuming reinvestment of $0.481 per share income
dividends. During the same period, the net annualized yield of the Fund's Common
Stock was 10.59%. For the three-month period ended August 31, 1998, the Fund's
total investment return was -6.11%, based on a change in per share net asset
value from $9.97 to $9.12, and assuming reinvestment of $0.242 per share income
dividends. During the same period, the net annualized yield of the Fund's Common
Stock was 10.44%. At the end of the August quarter, the Fund was 30.8% leveraged
as a percentage of total assets, having borrowed $135.0 million of its $160.0
million credit facility at an average rate of 5.88%. (For a complete explanation
of the benefits and risks of leverage, see page 1 of this report to
shareholders.)
Portfolio Strategy
In the past few months, the financial markets have experienced unprecedented
volatility. The risk premium has increased dramatically, as evidenced by a
declining equity market, widening credit spreads and a general flight to quality
that drove down Treasury yields. In August, the high-yield market's return was
the worst in the last 15 years. The volatility in the financial markets
negatively affected the Fund's performance during the six-month period ended
August 31, 1998. In this environment, we continued to maintain a majority of
investments in bank loans. On a relative value basis, high-yield bonds have
become more attractive. However, until we see more stability in the capital
markets, we expect to maintain at least a 45% weighting in floating rate secured
loans.
By August 31, 1998, more than 97% of the Fund's investments in corporate loans
were accruing interest at a yield spread above the London Interbank Offered Rate
(LIBOR), the rate that major international banks charge each other for US
dollar-denominated deposits outside of the United States. Since the average
reset on the Fund's floating rate investments is 38 days, the yield on the bank
loan portion of the Fund is likely to move up or down within a
one-month-two-month period after any LIBOR changes. By the end of August, LIBOR
stood at 5.5%. At August 31, 1998, floating rate securities made up 51.7% of the
market value of the Fund's investments, with an additional 47.3% invested in
fixed rate, high-yield bonds. Approximately $25 million remained available under
the leverage facility at the close of the period.
The leveraged loan market was strong through most of the six-month period ended
August 31, 1998, but weakened marginally in August. Through most of the period,
demand for bank loans was robust, as banks and other institutional investors
competed for allocations of new bank transactions. This demand continued the
trend in growing liquidity and the run up in prices for par loans (loans trading
at or near face value) that we have seen since the beginning of 1998. However,
as the liquidity in the capital markets dried up with the increased volatility,
bank transactions announced in August offered wider LIBOR spreads than for those
transactions closing in July. This spread expansion, approximating 1%-1.5% for a
typical liquid bank transaction, caused existing loans in the market and in our
portfolio to reprice to the market equilibrium. Par loans on average have
repriced up to two points lower, or less than 2%, demonstrating the stability of
this asset class in a difficult global environment.
Leveraged loan new-issue volume increased to $140 billion during the six-month
period ended June 30, 1998, a 133% increase over the comparable period in 1997.
(Leveraged loans are those at a spread of at least 1.5% over LIBOR.) This is the
highest total of the 1990s. At the same time, secondary trading volume of
leveraged loans reached $35.6 billion in the first half of 1998, a pace that
puts it on track to exceed the record $62.0 billion for all of 1997.
With almost uninterrupted inflows of investor assets, yield spreads in the
high-yield bond market remained at historically narrow levels through the first
half of 1998. The high-yield bond market benefited from strong demand, a good
economy, a record-breaking US stock market and low default rates. Beginning in
early summer, the high-yield market was pressured by the disruptions in the
Russian, Asian, Latin American and US equity markets. Liquidity became tight as
high-yield outflows totaled $1.5 billion in August and yield spreads widened 200
basis points-250 basis points (2.00%-2.50%). As measured by the unmanaged
Merrill Lynch High Yield Master Index, the high-yield market generated a return
of -4.32% for the month of August, dragging the year-to-date total return down
to +0.57%.
The high-yield market continued its record pace of new issuance through the
first half of 1998, nearly equaling the total record issuance during all of
1997. Total first half issuance was $106 billion, which surpassed last year's
comparable period by 83%, when $57 billion was issued. During the first half of
the year, investors' appetites for risk increased, as zero coupon and prefunded
cash-pay issues represented 21% of total issuance compared to 14% in 1997.
Telecommunications borrowers continued to dominate the market, representing
25.5% of total issuance, or $32 billion. Although telecommunications represents
a significant industry exposure for the Fund, we have gravitated to industry
borrowers who are conservatively capitalized, have an existing infrastructure
network and a growing subscriber base, and are moving toward completing their
network expansion plans.
Overall, fundamentals for both the bank loan and high-yield bond markets have
declined during the period, but still remain positive. Although downgrades by
the credit rating agencies have exceeded upgrades in the past six months, the
default rate still remains below the historic average. Downgrades have also been
concentrated in the commodity sectors such as energy and metals and mining,
which have been impacted by weaker demand in the developing global economies and
more competitive imports. Our focus will continue to be to invest in those
companies that are generating improved earnings trends or whose securities we
believe are undervalued.
Our industry focus has been on those companies that have leading market shares,
strong managements and improving cash flows. During the period, the
best-performing industry sectors included cable television, advertising,
publishing, and radio and television broadcasting. These industries not only had
more stable cash flows than many of their cyclical counterparts, but also
benefited from the substantial merger and acquisition activity in these sectors.
A number of cyclical sectors underperformed the market at large. Paper and
metals and mining were examples of such industry groups, resulting from the
concerns over the longer-term effects of the Asian currency crisis on these
industries. In certain cyclical areas we have been more willing to trade out of
the unsecured bonds and into the senior secured bank debt in order to seek to
limit the Fund's downside volatility. Underperforming sectors (exclusive of the
commodity sectors) included telecommunications and technology. The technology
group in general is suffering from oversupply and concomitant pricing pressure
in such products as printed circuit boards and memory chips. Telecommunications
issues underperformed primarily as a result of the large volume of zero-coupon
issues that usually fall out of favor in illiquid, volatile markets.
At August 31, 1998, the Fund was fully invested. The Fund's average stated
maturity was 7.4 years but had an expected average life of approximately 2
years-3 years as a result of the shorter average life of bank loans which are
freely prepayable without call protection. At August 31, 1998, the Fund's
floating rate investments were spread across 49 borrowers in 24 industries.
Fixed rate investments were spread across 93 borrowers in 30 industries. (The
"Portfolio Information" section on page 18 of this report to shareholders
provides listings of the five largest industries and ten largest holdings
represented in the Fund.)
New-issue volume in both the leveraged loan and high-yield bond markets has
slowed considerably. Investors are digesting the huge growth in supply in both
markets and the effect on domestic liquidity from the correction in the emerging
fixed-income markets. Secondary bond markets are strong for higher-quality,
large- capitalization issues, but very shallow for smaller issues and issues
with any marginal credit deterioration.
In the near term, our outlook is for continued volatility in the high-yield bond
market and a stabilizing leveraged loan market. Further Federal Reserve Board
easings of the Federal Funds rate could be the catalyst that will bring
liquidity back to the high-yield markets. Because new supply has been
nonexistent, a return of confidence to the capital markets could produce an
abrupt recovery in the high-yield market. The loan market, which has fared well
in this correction, should continue to be less volatile than the high-yield
market and benefit from a recovery in the capital markets. In the interim period
before a rebound, demand is likely to remain dormant and constrain near-term
supply, exacerbating the credit crunch. Borrowers who have to come to market
will be forced to pay a premium spread. We will continue to be opportunistic in
our high-yield bond and loan purchases, selling overvalued issues and sectors
and buying undervalued ones. We will try to divest the Fund of lower-yielding
loans to take advantage of forthcoming issues priced at wider LIBOR spreads. In
the meantime, we expect to maintain our defensive position in secured floating
rate bank debt until we see a turnaround beginning to occur in the high-yield
market or until higher-quality bonds become excessively oversold.
We had less than 12.5% of the Fund's total assets invested in companies
domiciled outside of the United States at period end, focusing primarily in
Latin America, Canada and Western Europe. Emerging markets were down
significantly during the reporting period, negatively affecting the performance
of the Fund. For the six-month period ended August 31, 1998, emerging market
exposure was 60% of our foreign holdings, or 7.5% of total assets, while less
than 1% of the Fund's total assets were invested in distressed securities. We
continue to believe that this market is less attractive near term after six
years of sustained economic growth and because of continued volatility in the
equity markets. We expect to see more attractive opportunities during the coming
months.
In Conclusion
We appreciate your ongoing investment in Debt Strategies Fund, Inc., and we look
forward to reviewing our strategy with you again in our next report to
shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ R. Douglas Henderson
R. Douglas Henderson
Senior Vice President and
Portfolio Manager
October 15, 1998
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
SCHEDULE OF INVESTMENTS
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1a)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Advertising--1.1% B B1 US$ 3,000,000 Outdoor Systems, Inc., 8.875% due
6/15/2007 (b) $ 2,977,439 $ 3,015,000
===================================================================================================================================
Aerospace--1.0% NR* NR* 2,718,215 KF Industries Inc., Term B, due
10/15/2005** 2,735,204 2,725,011
===================================================================================================================================
Agricultural B B2 3,000,000 Sun World International Inc., 11.25% due
Products--1.1% 4/15/2004 3,146,250 3,157,500
===================================================================================================================================
Aircraft & Parts--0.5% B- B3 1,500,000 Argo-Tech Corp., 8.625% due 10/01/2007 1,500,000 1,387,500
===================================================================================================================================
Amusement & B B2 2,000,000 AMC Entertainment Inc., 9.50% due 3/15/2009 2,082,500 1,840,000
Recreational NR* NR* 1,364,329 AMF Group, Inc., Term C, due 3/31/2002** 1,361,468 1,366,035
Services--4.2% B- B3 1,000,000 Hollywood Theaters Inc., 10.625% due
8/01/2007 1,000,000 970,000
Metro Goldwyn Mayer (MGM)**:
NR* NR* 2,585,000 Revolving Credit, due 9/30/2003 2,585,000 2,520,375
NR* NR* 2,000,000 Term A, due 12/31/2005 1,990,782 1,992,500
B B2 3,350,000 Riddell Sports, Inc., 10.50% due 7/15/2007 3,393,875 3,182,500
------------ ------------
12,413,625 11,871,410
===================================================================================================================================
Apparel--2.1% Arenabrands**:
NR* NR* 1,686,735 Term A, due 6/01/2002 1,688,843 1,693,060
NR* NR* 3,136,272 Term B, due 6/01/2002 3,140,192 3,148,033
B- B3 1,175,000 GFSI, Inc., 9.625% due 3/01/2007 1,198,500 1,186,750
------------ ------------
6,027,535 6,027,843
===================================================================================================================================
Automotive NR* B1 1,437,301 Advanced Accessory, Term B, due
Equipment--4.6% 10/30/2004** 1,434,755 1,445,027
B- B3 2,000,000 Cambridge Industries, Inc., 10.25% due
7/15/2007 2,000,000 1,920,000
NR* NR* 3,000,000 Federal-Mogul Corporation, Term B, due
12/31/2005** 2,985,912 2,992,500
B- B3 1,000,000 Newcor Inc., 9.875% due 3/01/2008 1,000,000 925,000
B- NR* 3,000,000 Oxford Automotive, Inc., 10.125% due
6/15/2007 (b) 2,995,860 2,880,000
B- B2 1,000,000 Trident Automotive, 10% due 12/15/2005 1,000,000 1,040,000
NR* NR* 2,000,000 Walbro Corp., 10.125% due 12/15/2007 2,000,000 1,840,000
------------ ------------
13,416,527 13,042,527
===================================================================================================================================
Broadcast--Radio B- B3 1,000,000 ACME Television LLC, 10.875% due 9/30/2004
& Television--3.3% (d) 802,178 780,000
B- B2 4,000,000 Capstar Broadcasting Partner, 9.25% due
7/01/2007 (b) 3,985,463 4,000,000
B- B3 675,000 Granite Broadcasting Corp., 8.875% due
5/15/2008 673,041 651,375
NR* NR* 675,000 Radio Unica Corporation, 11.75% due
8/01/2006 (d) 432,703 391,500
Regional Independent Media Group (b):
B- B3 575,000 10.50% due 7/01/2008 575,000 564,938
B- B3 (pound) 650,000 12.875% due 7/01/2008 (d) 590,811 544,278
B+ Ba3 US$ 3,000,000 TV Azteca S.A. de C.V., 10.50% due
2/15/2007 (b) 3,228,750 2,370,000
------------ ------------
10,287,946 9,302,091
===================================================================================================================================
Building & BB+ Ba2 2,000,000 Kaufman and Broad Home Corporation, 7.75%
Construction--1.1% due 10/15/2004 1,985,639 1,930,000
NR* NR* DM 2,000,000 Thyssen Schulte Bautechnik GmbH & Co. KG,
Term B, due 12/02/2003** 1,093,546 1,130,496
------------ ------------
3,079,185 3,060,496
===================================================================================================================================
Building NR* NR* US$ 3,218,540 Amerimax Holdings, Inc., Term C, due
Materials--5.0% 6/30/2004** 3,215,025 3,218,540
NR* NR* 4,980,000 Dal-Tile International Inc., Term B, due
12/31/2003** 4,958,713 4,889,738
NR* NR* 2,521,031 Euramax Holdings, Inc., Term B, due
6/30/2004** 2,518,278 2,521,031
NR* B1 3,728,571 Falcon Building Products, Inc., Term, due
6/30/2005** 3,715,281 3,737,893
------------ ------------
14,407,297 14,367,202
===================================================================================================================================
Cable Television CSC Holdings Inc.:
Services--4.4% BB+ Ba2 500,000 7.25% due 7/15/2008 500,000 471,875
BB+ Ba2 650,000 7.625% due 7/15/2018 649,358 598,000
B- Caa 3,000,000 EchoStar DBS Communications Corporation,
12.50% due 7/01/2002 (b) 3,000,000 3,030,000
BB- B1 1,000,000 Globo Comunicacoes e Participacoes S.A.,
10.625% due 12/05/2008 (b) 1,003,000 615,000
NR* NR* 4,301,020 Marcus Cable Operating Co., Term A, due
12/31/2002** 4,301,020 4,290,268
NR* NR* 1,928,595 NTL Group Inc., Term, due 1/31/1999** 1,928,595 1,927,390
B- B3 500,000 Park 'N View Inc., 13% due 5/15/2008 (b) 500,000 465,000
NR* B3 775,000 RCN Corporation, 11.002% due 7/01/2008
(b)(d) 461,829 410,750
B B3 1,000,000 Supercanal Holdings S.A., 11.50% due
5/15/2005 (b) 1,000,000 838,600
------------ ------------
13,343,802 12,646,883
===================================================================================================================================
Casinos--2.3% B+ B2 3,000,000 Autotote Corporation, 10.875% due 8/01/2004 3,000,000 2,940,000
BB Ba3 3,500,000 Grand Casinos, Inc., 10.125% due 12/01/2003 3,703,750 3,727,500
------------ ------------
6,703,750 6,667,500
===================================================================================================================================
Chemicals--8.9% BB Ba3 1,000,000 Dine, S.A. de C.V., 8.75% due 10/15/2007
(b) 992,908 710,000
Foamex Corporation**:
NR* NR* 1,979,371 Term B, due 6/30/2005 1,994,216 1,986,175
NR* NR* 1,799,428 Term C, due 6/30/2006 1,812,924 1,806,738
B- B2 6,000,000 Huntsman Corporation (Floater), 9.031% due
7/01/2007 (b) 6,000,000 5,835,000
Huntsman Specialty Chemicals**:
NR* NR* 2,475,000 Term B, due 3/15/2004 2,513,672 2,481,188
NR* NR* 2,475,000 Term C, due 3/15/2005 2,513,672 2,481,188
NR* NR* 3,200,000 Lyondell Chemical Co., Term B, due
6/30/2005** 3,196,832 3,214,000
NR* NR* 4,962,500 Pioneer American Holding Corporation, Term,
due 12/05/2006** 4,957,969 4,937,688
BB- NR* 3,000,000 Trikem S.A., 10.625% due 7/24/2007 (b) 2,996,276 1,995,000
------------ ------------
26,978,469 25,446,977
===================================================================================================================================
Computer NR* NR* 4,962,500 DecisionOne Corporation, Term B, due
Equipment--1.7% 8/07/2005** 4,955,748 4,863,250
===================================================================================================================================
Consumer E & S Holdings Corp.**:
Products--5.4% NR* NR* 2,833,922 Revolving Credit, due 9/30/2003 2,833,922 2,699,310
NR* NR* 3,328,431 Term A, due 9/30/2003 3,200,098 3,153,689
NR* NR* 1,944,445 Term B, due 9/30/2004 1,954,167 1,804,688
NR* NR* 1,944,445 Term C, due 9/30/2005 1,954,167 1,805,903
NR* NR* 1,111,111 Term D, due 3/31/2005 1,116,667 1,032,639
NR* NR* 2,164,063 Hedstrom Corp., Term B, due 6/30/2005** 2,156,862 2,169,473
B B3 675,000 Home Products International Inc., 9.625%
due 5/15/2008 (Convertible) 675,000 614,250
B+ Ba3 2,000,000 Shop-Vac Corp., 10.625% due 9/01/2003 (b) 2,180,000 2,110,000
------------ ------------
16,070,883 15,389,952
===================================================================================================================================
</TABLE>
4 & 5
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
SCHEDULE OF INVESTMENTS (continued)
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1a)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Diversified--3.8% AmeriServe Food Company:
B+ B1 US$ 3,000,000 8.875% due 10/15/2006 $ 3,000,000 $ 2,707,500
B- B3 3,000,000 10.125% due 7/15/2007 3,000,000 2,707,500
BB- Ba2 2,000,000 Gulf Canada Resources Limited, 9.25% due
1/15/2004 2,105,000 2,086,200
B- B3 2,000,000 Insilco Corporation, 10.25% due 8/15/2007 2,000,000 2,010,000
BBB- Ba3 2,000,000 Perez Companc, S.A., 8.125% due 7/15/2007
(b) 1,957,341 1,500,000
------------ ------------
12,062,341 11,011,200
===================================================================================================================================
Drilling--2.2% B+ B1 3,000,000 Cliffs Drilling Company, 10.25% due
5/15/2003 3,255,000 3,180,000
BBB- Ba1 3,000,000 Falcon Drilling Company, Inc., 9.75% due
1/15/2001 3,172,500 3,015,000
------------ ------------
6,427,500 6,195,000
===================================================================================================================================
Drug Stores--0.9% NR* NR* 2,493,750 Duane Reade Co., Term B, due 2/15/2005** 2,486,381 2,512,453
===================================================================================================================================
Electronics/Electrical Amphenol Corporation**:
Components--3.6% NR* Ba3 2,104,375 Term B, due 3/31/2002 2,143,832 2,116,870
NR* Ba3 2,104,375 Term C, due 3/31/2003 2,143,832 2,114,897
B+ B3 1,000,000 High Voltage Engineering Corp., 10.50% due
8/15/2004 1,000,000 950,000
NR* B1 4,968,847 International Wire Group, Inc., Term B, due
9/30/2003** 4,964,653 4,981,269
------------ ------------
10,252,317 10,163,036
===================================================================================================================================
Energy--5.8% B B1 2,000,000 Belco Oil & Gas Corp., 8.875% due 9/15/2007 2,000,000 1,660,000
B- B3 3,000,000 Belden & Blake Energy Company, 9.875% due
6/15/2007 3,000,000 2,490,000
NR* NR* 3,000,000 Clark Refining, Term, due 11/15/2004** 3,000,000 2,958,750
B- B3 625,000 Continental Resources, Inc., 10.25% due
8/01/2008 (b) 625,000 556,250
B B2 2,000,000 Cross Timbers Oil Company, 8.75% due
11/01/2009 2,000,000 1,800,000
B B2 2,000,000 Forcenergy Inc., 8.50% due 2/15/2007 1,977,165 1,600,000
B+ B2 4,000,000 Snyder Oil Corporation, 8.75% due
6/15/2007 3,979,863 3,800,000
B- B2 2,000,000 United Refining Company, 10.75% due
6/15/2007 2,000,000 1,820,000
------------ ------------
18,582,028 16,685,000
===================================================================================================================================
Financial B+ B1 3,000,000 Delta Financial Corporation, 9.50% due
Services--1.9% 8/01/2004 2,987,209 2,400,000
BBB- Baa1 4,000,000 SB Treasury Company LLC (Sumitomo), 9.40%
(b)(f) 4,090,000 3,120,000
------------ ------------
7,077,209 5,520,000
===================================================================================================================================
Food & Kindred B- B3 4,000,000 Envirodyne Industries, Inc., 10.25% due
Products--5.5% 12/01/2001 4,030,000 3,960,000
Favorite Brands International Inc.:
NR* NR* 4,000,000 10.25% due 8/20/2007 3,976,468 3,635,000
NR* NR* 3,125,000 Term B, due 5/19/2005** 3,120,452 3,078,125
NR* NR* 3,278,226 International HomeFoods, Inc., Term A, due
11/21/2001** 3,276,187 3,270,030
B B2 2,000,000 SC International Services, Inc., 9.25% due
9/01/2007 2,041,265 1,930,000
------------ ------------
16,444,372 15,873,155
===================================================================================================================================
Forest Products--1.7% B B3 3,000,000 Ainsworth Lumber Company, 12.50% due
7/15/2007 (c) 2,922,204 3,030,000
B+ B3 350,000 Millar Western Forest Products Ltd.,
9.875% due 5/15/2008 (b) 350,000 269,500
BB Ba3 1,500,000 Tembec Finance Corp., 9.875% due 9/30/2005 1,556,250 1,530,000
------------ ------------
4,828,454 4,829,500
===================================================================================================================================
Furniture & NR* NR* 5,000,000 Furniture Brands International Inc., Term,
Fixtures--1.7% due 6/27/2007** 5,000,000 5,000,000
===================================================================================================================================
General Merchandise Specialty Retailers, Inc. (b):
Stores--1.0% BB- Ba3 1,500,000 8.50% due 7/15/2005 1,500,000 1,402,500
B B2 1,500,000 9% due 7/15/2007 1,495,299 1,342,500
------------ ------------
2,995,299 2,745,000
===================================================================================================================================
Grocery Stores--5.2% NR* NR* 14,942,308 Fred Meyer, Inc., Term, due 2/28/2003** 14,833,515 14,830,240
===================================================================================================================================
Health Services--
14.0% CC B3 3,000,000 Graham-Field Health Products, Inc., 9.75%
due 8/15/2007 3,000,000 2,490,000
NR* NR* 5,000,000 Integrated Health Services, Inc., Term C,
due 9/15/2005** 5,025,000 4,996,875
NR* NR* 4,889,191 MedPartners, Inc., Term B, due 6/08/2001** 4,872,035 4,815,853
Paracelsus Healthcare Corp.**:
NR* NR* 1,381,333 Term A, due 3/31/2003 1,374,674 1,379,607
NR* NR* 2,000,000 Term B, due 3/31/2004 1,990,281 1,998,750
B B1 3,000,000 Physician Sales & Service Inc., 8.50% due
10/01/2007 2,988,998 2,925,000
NR* NR* 5,000,000 Sterling Diagnostics Imaging, Inc., Term B,
due 9/30/2005** 4,988,129 4,981,250
Sun Healthcare Group, Inc.:
B- B2 3,000,000 9.50% due 7/01/2007 3,000,000 2,805,000
NR* Ba3 2,759,424 Term B, due 9/30/2003** 2,767,899 2,757,698
NR* Ba3 2,759,318 Term C, due 9/30/2003** 2,767,761 2,757,594
BB- Ba3 1,000,000 Tenet Healthcare Corp., 8.125% due
12/01/2008 (b) 996,186 967,500
NR* NR* 5,000,000 Total Renal Care Holdings, Term, due
3/31/2008** 4,993,894 5,001,562
NR* NR* 2,500,000 Wilson Great Batch, 13% due 7/10/2007 (b) 2,196,294 2,181,620
------------ ------------
40,961,151 40,058,309
===================================================================================================================================
Hotels--0.5% BB Ba2 1,575,000 HMH Properties Inc., 7.875% due 8/01/2008 1,564,842 1,488,375
===================================================================================================================================
Manufacturing--0.7% B+ B1 2,000,000 Bucyrus International, Inc., 9.75% due
9/15/2007 2,006,250 1,560,000
B- B2 575,000 Globe Manufacturing Corp., 10% due
8/01/2008 (Convertible) 575,000 550,562
------------ ------------
2,581,250 2,110,562
===================================================================================================================================
Metals & Mining-- NR* NR* 2,952,381 Adience, Inc., Holdco, Term, due
7.9% 4/15/2005** 2,942,540 2,967,143
B B3 2,000,000 Anker Coal Group Inc., 9.75% due 10/01/2007 2,030,000 1,760,000
B B1 550,000 Bayou Steel Corp., 9.50% due 5/15/2008 (b) 544,852 503,250
B B1 3,000,000 CSN Iron Panama, 9.125% due 6/01/2007 (b) 2,987,548 1,815,000
NR* NR* 2,955,000 Centennial Inc., Revolving Credit, due
3/31/2002** 2,955,000 2,659,500
B B2 5,000,000 G.S. Technologies Operating Co., 12% due
9/01/2004 5,425,000 5,400,000
BB Ba2 2,000,000 Grupo Imsa S.A., 8.93% due 9/30/2004 1,999,441 1,550,000
BB Ba3 3,000,000 Hysla, S.A. de C.V., 9.25% due 9/15/2007
(b) 2,983,897 1,905,000
Ispat International N.V.**:
NR* NR* 1,300,000 Term B, due 7/15/2005 1,298,397 1,298,375
NR* NR* 1,300,000 Term C, due 7/15/2006 1,298,393 1,298,375
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
SCHEDULE OF INVESTMENTS (continued)
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1a)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Metals & Mining B- B3 US$ 1,000,000 Metal Management Inc., 10% due 5/15/2008
(concluded) (b) $ 1,000,000 $ 830,000
B+ B2 550,000 Pen Holdings Inc., 9.875% due 6/15/2008 (b) 545,747 533,500
------------ ------------
26,010,815 22,520,143
===================================================================================================================================
Packaging--1.9% NR* NR* 1,134,225 Packaging Resources Inc., 13% due
6/30/2003 (b)(c) 1,078,817 785,728
NR* NR* 4,811,232 Silgan Corp., Term B, due 6/30/2005** 4,835,288 4,805,218
------------ ------------
5,914,105 5,590,946
===================================================================================================================================
Paper--9.0% B- B3 5,000,000 Gaylord Container Corp., 9.75% due
6/15/2007 5,000,000 4,325,000
BB- Ba3 1,000,000 Pindo Deli Finance Mauritius, 10.75% due
10/01/2007 997,144 420,000
NR* NR* 4,500,000 Repap New Brunswick, Inc., Term B, due
6/01/2004** 4,540,000 4,545,000
B+ B1 5,678,010 Riverwood International, Inc., Term A, due
2/28/2003** 5,685,107 5,665,589
NR* Ba3 9,840,427 Stone Container Corporation, Term B, due
4/01/2000** 9,767,376 9,852,727
BB Caa1 2,000,000 Tjiwi Kimia Finance Mauritius, 10% due
8/01/2004 1,990,334 820,000
------------ ------------
27,979,961 25,628,316
===================================================================================================================================
Printing & B B2 2,000,000 Big Flower Press Holdings Inc., 8.875% due
Publishing--2.9% 7/01/2007 1,984,866 1,950,000
B- B3 1,500,000 T/SF Communications Corp., 10.375% due
11/01/2007 1,478,512 1,462,500
NR* NR* 4,987,500 Twenty First Inc., Term B, due 9/15/2005** 4,982,975 4,987,500
------------ ------------
8,446,353 8,400,000
===================================================================================================================================
Property NR* NR* 2,000,000 Rockefeller Center Properties, 11.404% due
Management--0.5% 12/31/2000 (d) 1,559,688 1,570,000
===================================================================================================================================
Retail Specialty--1.0% B B2 1,000,000 TM Group Holdings, 11% due 5/15/2008 (b) 1,000,000 987,500
B- B3 2,000,000 United Auto Group, Inc., 11% due 7/15/2007 1,972,492 1,810,000
------------ ------------
2,972,492 2,797,500
===================================================================================================================================
Shipping--2.9% B+ B3 4,000,000 Equiman Shipholdings, Ltd., 9.875% due
7/01/2007 4,000,000 3,560,000
B+ B2 2,500,000 Global Ocean Carriers Ltd., 10.25% due
7/15/2007 2,464,610 1,975,000
BB Ba2 3,000,000 Stena AB, 8.75% due 6/15/2007 3,000,000 2,880,000
------------ ------------
9,464,610 8,415,000
===================================================================================================================================
Sovereign BB- B1 2,000,000 Republic of Brazil, 10.125% due 5/15/2027 1,865,499 1,120,000
Government
Obligations--0.4%
===================================================================================================================================
Telephone NR* NR* 4,000,000 American Tower Systems Co., Term, due
Communications-- 12/16/2006** 3,990,161 4,010,000
15.2% Cellular Inc.**:
NR* NR* 586,527 Term B, due 9/30/2006 585,126 588,360
NR* NR* 1,161,440 Term C, due 3/31/2007 1,158,654 1,165,795
NR* NR* 3,252,033 Term D, due 9/30/2007 3,244,201 3,264,228
B- Caa1 850,000 Dolphin Telecom PLC, 11.50% due 6/01/2008
(b)(d) 492,626 416,500
NR* NR* 2,100,000 E. Spire Communications Inc., 10.52% due
7/01/2008 (b)(d) 1,284,404 976,500
Esprit Telecom Group PLC (b):
B- Caa1 650,000 10.875% due 6/15/2008 650,000 612,625
B- Caa1 DM 600,000 11% due 6/15/2008 336,587 316,596
B+ B2 US$ 2,500,000 Grupo Iusacell S.A., 10% due 7/15/2004 2,500,000 2,037,500
B B2 2,000,000 Intermedia Communications of Florida Inc.,
8.875% due 11/01/2007 2,000,000 1,900,000
Metronet Communications, Inc.:
B B3 3,500,000 12% due 8/15/2007 (e) 3,466,309 3,710,000
B B3 1,050,000 9.95% due 6/15/2008 (b)(d) 659,475 551,250
NEXTLINK Communications, Inc.:
B B3 1,500,000 9% due 3/15/2008 1,497,065 1,350,000
NR* B3 3,000,000 9.45% due 4/15/2008 (d) 1,957,599 1,560,000
NR* NR* 3,117,187 Omnipoint Corp., Term C, due 2/17/2006** 3,117,187 3,124,980
B+ B3 2,000,000 PTC International Finance B.V., 10.269%
due 7/01/2007 (d) 1,383,295 1,310,000
B- B3 500,000 Primus Telecommunications Group Inc.,
11.75% due 8/01/2004 517,500 490,000
NR* NR* 5,000,000 Sprint Spectrum L.P., Term, due 5/29/2004** 5,062,500 5,003,125
NR* NR* 5,000,000 Telecorp PCS, Term B, due 1/15/2008** 4,990,081 4,975,000
Telegroup Inc.:
NR* NR* 1,500,000 8% due 11/1/2000 (d) 1,282,835 1,072,500
NR* NR* 1,500,000 8% due 4/15/2005 (b) 1,500,000 1,200,000
CCC+ NR* 2,000,000 Telesystems International Wireless, Inc.,
11.929% due 6/30/2007 (d) 1,327,641 1,200,000
NR* NR* 2,500,000 Western PCS, Term B, due 6/30/2007** 2,495,066 2,509,375
------------ ------------
45,498,312 43,344,334
===================================================================================================================================
Textile Mill Joan Fabrics**:
Products--2.4% NR* NR* 3,598,158 Term B, due 6/30/2005 3,593,267 3,595,909
NR* NR* 1,870,000 Term C, due 6/30/2006 1,867,412 1,868,831
BB NR* 1,300,000 Westpoint Stevens Inc., 7.875% due
6/15/2008 1,283,033 1,272,375
------------ ------------
6,743,712 6,737,115
===================================================================================================================================
Transportation CCC- Ba3 3,000,000 Ameritruck Distribution, 12.25% due
Services--5.5% 11/15/2005 3,210,000 1,417,500
NR* NR* 4,710,811 Atlas Freight, Term, due 5/29/2004** 4,700,664 4,716,699
BB- NR* 4,250,000 Autopistas del Sol S.A., 10.25% due
8/01/2009 (b) 4,293,750 3,123,750
B+ B1 3,000,000 Coach USA, Inc., 9.375% due 7/01/2007 3,000,000 2,880,000
B NR* 3,000,000 MRS Logistica S.A., 10.625% due
8/15/2005 (b) 2,968,942 2,092,500
B- Caa1 2,000,000 Trism Inc., 10.75% due 12/15/2000 2,010,000 1,610,000
------------ ------------
20,183,356 15,840,449
===================================================================================================================================
Utilities--0.8% B+ Ba1 2,500,000 AES Corporation, 8.50% due 11/01/2007 (b) 2,495,278 2,375,000
===================================================================================================================================
Total Investments in Corporate Debt
Obligations--145.6% 443,274,500 416,331,775
===================================================================================================================================
</TABLE>
8 & 9
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
SCHEDULE OF INVESTMENTS (concluded)
<TABLE>
<CAPTION>
Shares Value
INDUSTRIES Held Preferred Stocks & Warrants Cost Note 1a)
===================================================================================================================================
<S> <C> <C> <C> <C>
Broadcast--Radio & 22 Paxson Communications, Inc. (Convertible)
Television--0.2% (b)(c) $ 220,000 $ 22,000
44 Paxson Communications, Inc.--Units (b)(c) 440,000 418,000
22 Paxson Communications, Inc. (Warrants) (a) 0 0
------------ ------------
660,000 440,000
===================================================================================================================================
Health Services--0.1% 318,830 WGL Holdings, Inc. (Warrants) (a) 318,830 318,830
===================================================================================================================================
Telephone 3,500 Metronet Communications, Inc. (Warrants)
Communications-- (a) 35,875 112,856
0.0% 2,000 Unifi Communications, Inc. (Warrants) (a) 113,180 20
------------ ------------
149,055 112,876
===================================================================================================================================
Total Investments in Preferred Stocks &
Warrants--0.3% 1,127,885 871,706
===================================================================================================================================
<CAPTION>
Face
Amount Short-Term Securities
===================================================================================================================================
<S> <C> <C> <C> <C>
Commercial US$ 905,000 General Motors Acceptance Corp., 5.81% due
Paper***--0.3% 9/01/1998 905,000 905,000
===================================================================================================================================
Total Investments in Short-Term
Securities--0.3% 905,000 905,000
===================================================================================================================================
Total Investments--146.2% $445,307,385 418,108,481
============
Unrealized Depreciation on Forward Foreign
Exchange Contracts--Net****--0.0% (39,742)
Liabilities in Excess of Other
Assets--(46.2%) (132,023,993)
------------
Net Assets--100.0% $286,044,746
============
===================================================================================================================================
</TABLE>
(a) Warrants entitle the Fund to purchase a predetermined number of
shares of common stock and are non-income producing. The purchase
price and number of shares are subject to adjustments under certain
conditions until the expiration date.
(b) The security may be offered and sold to "qualified institutional
buyers" under Rule 144A of the Securities Act of 1933.
(c) Represents a pay-in-kind security which may pay interest/dividends
in additional face/shares.
(d) Represents a zero coupon or step bond; the interest rate shown is
the effective yield at the time of purchase by the Fund.
(e) Each $1,000 face amount contains one warrant of Metronet
Communications, Inc.
(f) The security is a perpetual bond and has no definite maturity date.
* Not Rated.
** Floating or Variable Rate Corporate Debt--The interest rates on
floating or variable rate corporate debt are subject to change
periodically based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate) or, in some cases, another
base lending rate. Corporate loans represent 77.0% of the Fund's net
assets.
*** Commercial Paper is traded on a discount basis; the interest rate
shown reflects the discount rate paid at the time of purchase by the
Fund.
**** Forward foreign exchange contracts as of August 31, 1998 were as
follows:
--------------------------------------------------------------------
Foreign Expiration Unrealized
Currency Sold Date Depreciation (Note 1c)
--------------------------------------------------------------------
DM 597,733 September 1998 $ (4,544)
DM 2,170,000 November 1998 (22,414)
(pound) 347,588 November 1998 (12,784)
--------------------------------------------------------------------
Total Unrealized Depreciation on
Forward Foreign Exchange Contracts--Net
(USD Commitment--$2,116,799) $(39,742)
========
--------------------------------------------------------------------
See Notes to Financial Statements.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of August 31, 1998
============================================================================================================================
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$445,307,385) (Note 1b) .......... $418,108,481
Cash ..................................................................... 150,745
Foreign cash (Note 1d) ................................................... 15,225
Receivables:
Interest ................................................................ $ 7,027,752
Securities sold ......................................................... 2,841,596
Principal paydowns ...................................................... 255,350 10,124,698
-----------
Deferred facility fees ................................................... 30,623
Deferred organization expenses (Note 1g) ................................. 50,720
Prepaid expenses and other assets ........................................ 236,206
------------
Total assets ............................................................. 428,716,698
------------
============================================================================================================================
Liabilities: Loans (Note 6) ........................................................... 135,000,000
Unrealized depreciation on forward foreign exchange contracts (Note 1c) .. 39,742
Payables:
Interest on loans (Note 6) .............................................. 660,323
Commitment fees ......................................................... 621,967
Investment adviser (Note 2) ............................................. 211,553
Dividends to shareholders (Note 1h) ..................................... 188,812 1,682,655
-----------
Accrued expenses and other liabilities ................................... 5,949,555
------------
Total liabilities ........................................................ 142,671,952
------------
============================================================================================================================
Net Assets: Net assets ............................................................... $286,044,746
============
============================================================================================================================
Capital: Common Stock, $.10 par value, 200,000,000 shares authorized .............. $ 3,137,945
Paid-in capital in excess of par ......................................... 310,257,729
Undistributed investment income--net ..................................... 2,525,485
Accumulated realized capital losses on investments and foreign currency
transactions--net (Note 8) ............................................... (2,638,290)
Unrealized depreciation on investments and foreign currency
transactions--net ........................................................ (27,238,123)
------------
Total--Equivalent to $9.12 per share based on 31,379,454 shares of
capital stock outstanding (market price--$7.9375) ........................ $286,044,746
============
============================================================================================================================
</TABLE>
See Notes to Financial Statements.
10 & 11
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended August 31, 1998
============================================================================================================================
<S> <C> <C> <C>
Investment Income Interest and discount earned ............................................ $ 20,553,099
(Note 1f): Facility and other fees ................................................. 214,195
------------
Total income ............................................................ 20,767,294
------------
============================================================================================================================
Expenses: Loan interest expense (Note 6) .......................................... $ 3,903,781
Investment advisory fees (Note 2) ....................................... 1,336,744
Professional fees ....................................................... 59,747
Accounting services (Note 2) ............................................ 48,727
Borrowing costs (Note 6) ................................................ 27,740
Directors' fees and expenses ............................................ 20,435
Custodian fees .......................................................... 19,943
Transfer agent fees (Note 2) ............................................ 18,787
Listing fees ............................................................ 16,979
Printing and shareholder reports ........................................ 14,577
Amortization of organization expenses (Note 1g) ......................... 6,266
Pricing services ........................................................ 4,221
Other ................................................................... 5,946
-----------
Total expenses .......................................................... 5,483,893
------------
Investment income--net .................................................. 15,283,401
------------
============================================================================================================================
Realized & Realized gain (loss) from:
Unrealized Gain Investments--net ....................................................... (1,274,991)
(Loss) On Foreign currency transactions--net ..................................... 7,602 (1,267,389)
Investments & -----------
Foreign Currency Change in unrealized appreciation/depreciation on:
Transactions--Net Investments--net ....................................................... (31,386,717)
(Notes 1c, 1d, Foreign currency transactions--net ..................................... (39,219) (31,425,936)
1f & 3): ----------- ------------
Net Decrease in Net Assets Resulting from Operations .................... $(17,409,924)
============
</TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Six For the Period
Months Ended May 30, 1997+
August 31, to February 28,
Increase (Decrease) in Net Assets: 1998 1998
============================================================================================================================
<S> <C> <C> <C>
Operations: Investment income--net .................................................. $ 15,283,401 $ 22,033,100
Realized loss on investments and foreign currency transactions--net ..... (1,267,389) (1,451,593)
Change in unrealized appreciation/depreciation on investments and
foreign currency transactions--net ...................................... (31,425,936) 4,187,813
------------ ------------
Net increase (decrease) in net assets resulting from operations ......... (17,409,924) 24,769,320
------------ ------------
============================================================================================================================
Dividends to Investment income--net .................................................. (15,079,425) (19,630,899)
Shareholders ------------ ------------
(Note 1h): Net decrease in net assets resulting from dividends to shareholders ..... (15,079,425) (19,630,899)
------------ ------------
============================================================================================================================
Capital Share Proceeds from issuance of Common Stock .................................. -- 312,000,000
Transactions Value of shares issued in reinvestment of dividends ..................... 799,403 936,916
(Notes 1g & 4): Offering costs resulting from the issuance of Common Stock .............. -- (440,645)
------------ ------------
Net increase in net assets resulting from capital share transactions .... 799,403 312,496,271
------------ ------------
============================================================================================================================
Net Assets: Total increase (decrease) in net assets ................................. (31,689,946) 317,634,692
Beginning of period ..................................................... 317,734,692 100,000
------------ ------------
End of period* .......................................................... $286,044,746 $317,734,692
============ ============
============================================================================================================================
*Undistributed investment income--net .................................... $ 2,525,485 $ 2,482,893
============ ============
</TABLE>
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Six
Months Ended
August 31, 1998
============================================================================================================================
<S> <C> <C>
Cash Provided Net decrease in net assets resulting from operations .................................. $(17,409,924)
by Operating Adjustments to reconcile net decrease in net assets resulting from operations to
Activities: net cash provided by operating activities:
Decrease in receivables .............................................................. 569,988
Increase in other assets ............................................................. (166,720)
Increase in other liabilities ........................................................ 2,647,264
Realized and unrealized loss on investments and foreign currency transactions--net ... 32,693,325
Amortization of discount ............................................................. (511,975)
------------
Net cash provided by operating activities ............................................. 17,821,958
------------
============================================================================================================================
Cash Provided Proceeds from sales of long-term investments .......................................... 124,856,531
by Investing Purchases of long-term investments .................................................... (119,922,096)
Activities: Purchases of short-term investments ................................................... (26,888,213)
Proceeds from sales and maturities of short-term investments .......................... 25,989,000
------------
Net cash provided by investing activities ............................................. 4,035,222
------------
============================================================================================================================
Cash Used Cash receipts from borrowings ......................................................... 108,500,000
for Financing Cash payments on borrowings ........................................................... (116,100,000)
Activities: Dividends paid to shareholders ........................................................ (14,091,210)
------------
Net cash used for financing activities ................................................ (21,691,210)
------------
============================================================================================================================
Cash: Net increase in cash .................................................................. 165,970
Cash at beginning of period ........................................................... 0
------------
Cash at end of period ................................................................. $ 165,970
============
============================================================================================================================
Cash Flow Cash paid for interest ................................................................ $ 4,652,207
Information: ============
============================================================================================================================
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
12 & 13
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been derived For the Six For the Period
from information provided in the financial statements. Months Ended May 30, 1997+
August 31, to Feb. 28,
Increase (Decrease) in Net Asset Value: 1998 1998
============================================================================================================================
<S> <C> <C> <C>
Per Share Net asset value, beginning of period ................................... $ 10.15 $ 10.00
Operating ------------ ------------
Performance: Investment income--net ................................................. .48 .71
Realized and unrealized gain (loss) on investments and foreign currency
transactions--net ...................................................... (1.03) .09
------------ ------------
Total from investment operations ....................................... (.55) .80
------------ ------------
Less dividends from investment income--net ............................. (.48) (.63)
------------ ------------
Capital charge resulting from the issuance of Common Stock ............. -- (.02)
------------ ------------
Net asset value, end of period ......................................... $ 9.12 $ 10.15
============ ============
Market price per share, end of period .................................. $ 7.9375 $ 10.5625
============ ============
============================================================================================================================
Total Investment Based on market price per share ........................................ (21.02%)++ 12.38%++
Return:** ============ ============
Based on net asset value per share ..................................... (5.56%)++ 7.99%++
============ ============
============================================================================================================================
Ratios to Average Expenses, net of reimbursement and excluding interest expense .......... 1.01%* .61%*
Net Assets: ============ ============
Expenses, net of reimbursement ......................................... 3.50%* 2.28%*
============ ============
Expenses ............................................................... 3.50%* 2.56%*
============ ============
Investment income--net ................................................. 9.75%* 9.64%*
============ ============
============================================================================================================================
Leverage: Amount of borrowings, end of period (in thousands) ..................... $ 135,000 $ 142,600
============ ============
Average amount of borrowings outstanding during the period (in
thousands) ............................................................. $ 132,410 $ 85,903
============ ============
Average amount of borrowings outstanding per share during the period ... $ 4.22 $ 2.79
============ ============
============================================================================================================================
Supplemental Net assets, end of period (in thousands) ............................... $ 286,045$ 317,735
Data: ============ ============
Portfolio turnover ..................................................... 27.06% 43.79%
============ ============
============================================================================================================================
</TABLE>
+ Commencement of operations.
* Annualized.
** Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, may result
in substantially different returns. Total investment returns exclude
the effects of sales loads.
++ Aggregate total investment return.
See Notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Debt Strategies Fund, Inc. (the "Fund") is registered under the Investment
Company Act of 1940 as a diversified, closed-end management investment company.
These unaudited financial statements reflect all adjustments which are, in the
opinion of management, necessary to a fair statement of the results for the
interim period presented. All such adjustments are of a normal recurring nature.
The Fund determines and makes available for publication the net asset value of
its Common Stock on a weekly basis. The Fund's Common Stock is listed on the New
York Stock Exchange under the symbol DBS.
(a) Corporate debt obligations--The Fund invests principally in debt obligations
of companies, including corporate loans made by banks and other financial
institutions and both privately and publicly offered corporate bonds and notes.
Because agents and intermediaries are primarily commercial banks, the Fund's
investment in corporate loans could be considered concentrated in financial
institutions.
(b) Valuation of investments--Corporate loans will be valued in accordance with
guidelines established by the Board of Directors. Under the Fund's current
guidelines, corporate loans will be valued at the average of the mean between
the bid and asked quotes received by one or more brokers, if available.
Other portfolio securities may be valued on the basis of prices furnished by one
or more pricing services which determines prices for normal, institutional-size
trading units of such securities using market information, transactions for
comparable securities and various relationships between securities which are
generally recognized by institutional traders. In certain circumstances,
portfolio securities are valued at the last sale price on the exchange that is
the primary market for such securities, or the last quoted bid price for those
securities for which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The value of
interest rate swaps, caps, and floors is determined in accordance with a formula
and then confirmed periodically by obtaining a bank quotation. Positions in
options are valued at the last sale price on the market where any such option is
principally traded. Short-term securities with remaining maturities of sixty
days or less are valued at amortized cost, which approximates market value.
Securities and assets for which market price quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Fund.
(c) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the debt markets. Losses may arise due to changes in the
value of the contract or if the counterparty does not perform under the
contract.
o Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
o Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
o Options--The Fund is authorized to write covered call and put options and
purchase call and put options. When the Fund writes an option, an amount equal
to the premium
14 & 15
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
NOTES TO FINANCIAL STATEMENTS (concluded)
received by the Fund is reflected as an asset and an equivalent liability. The
amount of the liability is subsequently marked to market to reflect the current
market value of the option written. When a security is purchased or sold through
an exercise of an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from (or added to)
the proceeds of the security sold. When an option expires (or the Fund enters
into a closing transaction), the Fund realizes a gain or loss on the option to
the extent of the premiums received or paid (or gain or loss to the extent the
cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
o Interest rate transactions--The Fund is authorized to enter into interest rate
swaps and purchase or sell interest rate caps and floors. In an interest rate
swap, the Fund exchanges with another party their respective commitments to pay
or receive interest on a specified notional principal amount. The purchase of an
interest rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest rate, to
receive payments of interest equal to the difference between the index and the
predetermined rate on a notional principal amount from the party selling such
interest rate cap (or floor).
(d) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets or liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(e) Income taxes--It is the Fund's policy to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(f) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of discount) is recognized on the accrual basis. Realized gains and
losses on security transactions are determined on the identified cost basis.
Facility fees are accreted to income over the term of the related loan.
(g) Deferred organization expenses--Deferred organization expenses are amortized
on a straight-line basis over a period not exceeding five years. In accordance
with Statement of Position 98-5, any unamortized organization expenses will be
expensed on the first day of the next fiscal year beginning after December 15,
1998. This charge will not have any material impact on the operations of the
Fund. Direct expenses relating to the public offering of the Fund's Common Stock
were charged to capital at the time of issuance of the shares.
(h) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to perform the investment advisory function. For such services the Fund pays a
monthly fee at an annual rate of 0.60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
For the six months ended August 31, 1998, the Fund paid Merrill Lynch Security
Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith Inc.
("MLPF&S"), $163 for security price quotations to compute the net asset value of
the Fund.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the six
months ended August 31, 1998 were $118,922,096 and $127,953,477, respectively.
Net realized gains (losses) for the six months ended August 31, 1998 and net
unrealized gains (losses) as of August 31, 1998 were as follows:
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- --------------------------------------------------------------------------------
Long-term investments ..................... $(1,274,991) $(27,198,904)
Forward foreign exchange contracts ........ 7,574 (39,742)
Foreign currency transactions ............. 28 523
----------- ------------
Total ..................................... $(1,267,389) $(27,238,123)
=========== ============
- --------------------------------------------------------------------------------
As of August 31, 1998, net unrealized depreciation for Federal income tax
purposes aggregated $27,198,904, of which $1,014,417 related to appreciated
securities and $28,213,321 related to depreciated securities. The aggregate cost
of investments at August 31, 1998 for Federal income tax purposes was
$445,307,385.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of Common Stock, par value
$.10 per share. Shares issued and outstanding during the six months ended August
31, 1998 increased by 76,456 as a result of dividend reinvestment.
5. Unfunded Loan Interests:
As of August 31, 1998, the Fund had unfunded loan commitments of $7,216,928,
which would be extended at the option of the borrower, pursuant to the following
loan agreements:
- --------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in thousands)
- --------------------------------------------------------------------------------
Centennial Inc. ............................................ $ 45
E & S Holdings Corp. ....................................... 1,921
Metro Goldwyn Mayer (MGM) .................................. 515
NTL Group Inc. ............................................. 1,403
Teligent, Inc. ............................................. 3,333
- --------------------------------------------------------------------------------
6. Short-Term Borrowings:
On August 4, 1998, the Fund entered into a one-year credit agreement with The
Bank of New York, Fleet National Bank and certain other institutions party
thereto. The agreement is a $160,000,000 credit facility bearing interest at the
prime rate, Federal Funds rate plus 0.50% and/or LIBOR plus 0.50%. For the six
months ended August 31, 1998, the average amount borrowed by the Fund was
approximately $132,410,000 and the daily weighted average interest rate was
5.88%. For the six months ended August 31, 1998, facility and commitment fees
were $27,740.
7. Commitments:
At August 31, 1998, the Fund had entered into foreign exchange contracts, in
addition to the contracts listed on the Schedule of Investments, under which it
had agreed to sell various foreign currencies with an approximate value of
$14,000.
8. Capital Loss Carryforward:
At August 31, 1998, the Fund had a net capital loss carryforward of
approximately $263,000, all of which expires in 2006. This amount will be
available to offset like amounts of any future taxable gains.
9. Subsequent Event:
On September 8, 1998, the Fund's Board of Directors declared an ordinary income
dividend to Common Stock shareholders in the amount of $.080482 per share,
payable on September 30, 1998 to shareholders of record as of September 22,
1998.
16 & 17
<PAGE>
Debt Strategies Fund, Inc., August 31, 1998
PORTFOLIO INFORMATION
As of August 31, 1998
Percent of
Quality Ratings Long-Term
S&P/Moody's* Investments
- --------------------------------------------------------------------------------
BBB/Baa ............................................................. 1.8%
BB/Ba ............................................................... 13.0
B/B ................................................................. 37.1
CCC/Caa ............................................................. 0.3
NR (Not Rated) ...................................................... 47.8
- --------------------------------------------------------------------------------
* In cases where bonds are rated differently by Standard & Poor's Corp. and
Moody's Investors Service, Inc., bonds are categorized according to the
higher of the two ratings.
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries Total Assets
- --------------------------------------------------------------------------------
Telephone Communications ............................................ 10.1%
Health Services ..................................................... 9.3
Paper ............................................................... 6.0
Chemicals ........................................................... 5.9
Metals & Mining ..................................................... 5.3
- --------------------------------------------------------------------------------
Percent of
Ten Largest Holdings Total Assets
- --------------------------------------------------------------------------------
Fred Meyer .......................................................... 3.5%
E & S Holdings Corp. ................................................ 2.4
Stone Container Corporation ......................................... 2.3
Sun Healthcare Group, Inc. .......................................... 1.9
Favorite Brands International Inc. .................................. 1.6
Huntsman Corporation ................................................ 1.4
Riverwood International, Inc. ....................................... 1.3
Joan Fabrics ........................................................ 1.3
AmeriServe Food Company ............................................. 1.3
GS Technologies Operating Co. ....................................... 1.3
- --------------------------------------------------------------------------------
OFFICERS AND DIRECTORS
Arthur Zeikel, President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Terry K. Glenn, Executive Vice President
R. Douglas Henderson, Senior Vice President
Joseph T. Monagle Jr., Senior Vice President
Donald C. Burke, Vice President
Gerald M. Richard, Treasurer
Patrick D. Sweeney, Secretary
Custodian
The Bank of New York
110 Washington Street
New York, NY 10286
Transfer Agent
The Bank of New York
101 Barclay Street
New York, NY 10286
NYSE Symbol
DBS
18 & 19
<PAGE>
This report, including the financial information herein, is transmitted to the
shareholders of Debt Strategies Fund, Inc. for their information. It is not a
prospectus, circular or representation intended for use in the purchase of
shares of the Fund or any securities mentioned in the report. Past performance
results shown in this report should not be considered a representation of future
performance. The Fund has the ability to leverage its Common Stock to provide
Common Stock shareholders with a potentially higher rate of return. Leverage
creates risk for Common Stock shareholders, including the likelihood of greater
volatility of net asset value and market price of Common Stock shares, and the
risk that fluctuations in short-term interest rates may reduce the Common
Stock's yield. Statements and other information herein are as dated and are
subject to change. Printed on post-consumer recycled paper
Debt Strategies
Fund, Inc.
Box 9011
Princeton, NJ
08543-9011 #DEBT01--8/98
[RECYCLE LOGO] Printed on post-consumer recycled paper
