DEBT
STRATEGIES
FUND, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Annual Report
February 29, 2000
<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., February 29, 2000
DEAR SHAREHOLDER
For the 12-month period ended February 29, 2000, Debt Strategies Fund, Inc.'s
total investment return was -0.64%, based on a change in per share net asset
value from $8.20 to $7.21, and assuming reinvestment of $0.856 per share income
dividends. During the same 12-month period, the net annualized yield of the
Fund's Common Stock was 11.89%. Since inception (May 30, 1997) through February
29, 2000, the total investment return on the Fund's Common Stock was -3.82%,
based on a change in per share net asset value from $10.00 to $7.21, and
assuming reinvestment of $2.418 per share income dividends. At the end of the
February period, the Fund was 23.3% leveraged as a percentage of total assets.
(For a complete explanation of the benefits and risks of leverage, see page 1 of
this report to shareholders.)
Investment Approach
The Fund largely consists of high-yield bonds and participations in leveraged
bank loans. The high-yield bond and bank loan markets are comprised of similar
industry sectors and often contain overlapping issuers. As a result, general
economic events and trends tend to move the two markets in the same direction,
although the bonds typically move to a greater degree than the bank loans. This
is driven usually by two factors. First, bank loans are often senior secured
obligations, thus offering investors greater principal protection than unsecured
bonds. Second, bank loans are floating rate instruments whose principal value
generally does not move conversely with interest rate fluctuations, as is the
case with fixed-income bonds.
Market Review
Market conditions were difficult for high-yield securities during 1999. While
benefiting from a strong economy, the high-yield market suffered from a rise in
Treasury rates because of inflationary fears and an increase in default rates.
The yield on the ten-year Treasury note rose from 4.65% at the beginning of 1999
to 6.44% at year-end, producing a return of -8.25% for the year. To keep the
economy from overheating and igniting inflation, the Federal Reserve Board
increased the Federal Funds rate (the rate US banks charge each other for
overnight loans) 100 basis points (1.00%) to 5.75% during the Fund's fiscal
year. This sharp increase in interest rates resulted in the high-yield market
posting its second consecutive year of declining prices. The average price of a
bond in the high-yield market fell to 86% of par from 91% at the beginning of
the year. The risk premium, measured by the spread between the yield on the
average high-yield bond and the comparable Treasury bond, narrowed to 5.73% at
year-end as compared to 6.57% at the beginning of the year. The reduction in the
credit risk premium reflects the high-yield market's recovery from its
overreaction to the global financial crisis in the third quarter of 1998.
In 1999, there was approximately $91 billion in new high-yield debt issued
compared to $123 billion in 1998 and $137 billion in 1997. The new-issue market
was not as active as prior years because of investors' concerns about higher
interest rates and the crowding out effect of the equity market, whose sky-high
returns attracted capital from the high-yield market. In addition, capital
deployed by investment banks and dealers to support secondary market trading in
high-yield bonds dissipated throughout the year because of uncertainty about how
liquid the market would be at year-end because of Year 2000 concerns.
Another major factor that affected the high-yield market in 1999 was the higher
default rate. High-yield bond defaults rose to a 5.5% annual rate in 1999, the
highest level in almost a decade, as 86 domestic issuers defaulted in 1999,
representing $22 billion in par amount, compared to 46 issuers and $7.9 billion
in 1998. Ironically, the high level of defaults occurred during a period of
strong economic growth. This was the result of several factors. First, lower
commodity prices, especially in energy and chemicals, from global overcapacity
derived from the 1998 Asian crisis, drove smaller companies to lose access to
capital at a time when business prospects were pressured. Second, in response to
huge demand, heavy issuance of high-yield debt from 1996 to 1998 strained
underwriting standards and lower-quality transactions entered the marketplace.
Moreover, pricing power vanished in the global competitive arena, unfavorably
positioning producers of low value-added products. Finally, the healthcare
industry was specifically damaged by governmental change in reimbursement rates.
Going forward into 2000 and 2001, these trends have already shifted direction.
In general, the global markets have turned around and demand for commodities
should improve, raising prices. In addition, new issuance has been subdued and
healthcare issuance has been almost non-existent. Therefore, we believe there
will be a reduction in the default rate over the near term.
The loan market also experienced more volatility in 1999 than its historical
norm because of the higher default rate. Loan investors, seeking to prevent the
anticipated problems associated with financial restructurings, sold loans that
reported weaker-than-expected financial results faster to avoid potential
problems. This increased trading activity heightened volatility, as dealers
became less optimistic about providing liquidity for borrowers that were not
meeting projected budgets. In addition, loan investors dynamically shifted their
portfolios, increasing exposure to less volatile sectors or adding exposure to
sectors with greater potential for credit improvement. In essence, the loan
market appears to be assuming the portfolio management practices similar to
other markets, substantiating our view that loans do have prices, actively
trade, and should be valued on the basis of available market quotations, rather
than being marked at face value for the life of the loan.
The technical and fundamental problems of the high-yield market have resulted in
high-yield market outflows rather consistently for the past ten months. Because
of fund redemptions and higher interest rates, the high-yield bond sector (as
measured by the Donaldson, Lufkin and Jenrette (DLJ) High Yield Index) had a
poor total return of +1.60% for the six-month period ended February 29, 2000.
Bank loans (as measured by the DLJ Leveraged Loan Index) fared better, given the
floating rate nature of the asset class, and generated a return of +2.27% for
the same period. The Fund underperformed the Indexes because of defaults in the
portfolio, limited exposure to emerging markets that performed strongly in 1999
and its leverage, which amplifies losses in a declining market.
Investment Activities
At February 29, 2000, 63% of the Fund's long-term assets were allocated to bonds
and 37% to bank loans. More than 97% of the Fund's bank loan holdings were
accruing interest at a yield spread above the London Interbank Offered Rate
(LIBOR), the rate that major banks charge each other for US denominated deposits
outside of the United States. LIBOR tracks very closely with other short-term
interest rates, such as the Federal Funds rate. Since the average interest rate
reset across the bank loan portion of the portfolio is about 45 days, the yield
on that portion of the Fund will move within a two-month period of any change in
the Federal Funds rate. The portfolio's stated average maturity was
approximately 6.7 years at February 29, 2000, but based on our experience, the
portfolio can be expected to have an actual average life of about three
years-four years because of the freely prepayable nature of the bank loans.
The Fund was approximately 23% leveraged as a percentage of total assets and was
extremely well diversified across 180 issuers in 44 industries. See the
"Portfolio Profile" on page 23 of this report to shareholders, which provides
listings of the Fund's ten largest holdings and five largest industries as of
February 29, 2000.
Investment Strategy
Throughout the six months ended February 29, 2000, our investment strategy has
been unchanged: to invest in leveraged transactions in which borrowers have
strong market shares, experienced managements, consistent cash flows and
appropriate risk/reward characteristics. In addition, we look for companies with
significant underlying asset and franchise value, strong capital structures and
equity sponsors that support their investments. Throughout the last three
months, we have focused on the better-priced new-issue market. The new
transactions were also much more conservatively structured, with lower leverage
and higher interest coverage as investors have become more demanding.
Looking ahead, we expect to emphasize growth sectors, such as wireless
2 & 3
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
telecommunications, that are exhibiting improving credit trends and have access
to equity capital. Substantial merger and acquisition activity and
better-than-expected subscriber growth have attracted equity capital to the
wireless telecommunications sector. The Fund's largest holding in this sector is
Nextel Communications, Inc. In 1999, Nextel Communications entered the Standard
& Poor's 500 Index, a tribute to its success in meeting investors' high
expectations for growth and profitability. While a potential acquisition with
MCI WorldCom Inc. fell through in 1999, it highlighted the strategic value of
the company and since that time the stock has tripled. Nextel Communications
remains a core holding of the Fund and we expect its credit profile to continue
to improve.
While we anticipate that the Federal Reserve Board may increase short-term
interest rates by another 0.50% before year-end and acknowledge that this may
put pressure on high-yield bond prices over the next few months, we are
optimistic about the prospects for the Fund in 2000. This is based on our
expectations for a continuation of the strong economy in the United States with
a relatively stable interest rate environment, a gradual improvement in the
Asian economies, and a gradual decline in credit spreads to a more normal range.
In Conclusion
As difficult as the last six months were for the high-yield bond and leveraged
loan markets and the Fund, their performances illustrate the bank loan market's
ability to weather market fluctuations with less volatility than the high-yield
bond market. This is what differentiates the Fund from a pure high-yield bond
fund. This attribute continues to draw many new institutional buyers to the bank
loan market. We believe that both the technical and fundamental aspects are
improving in both the high-yield bond and bank loan sectors. We also believe we
have positively positioned the Fund to follow further expected improvements in
the marketplace in an effort to enhance total return potential in the coming
months.
We thank you for your investment in Debt Strategies Fund, Inc., and we look
forward to reviewing our outlook and strategy with you again in our next report
to shareholders.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President and Director
/s/ Richard C. Kilbride
Richard C. Kilbride
Vice President and
Co-Portfolio Manager
/s/ Gilles Marchand
Gilles Marchand
Vice President and
Co-Portfolio Manager
/s/ Paul Travers
Paul Travers
Vice President and
Co-Portfolio Manager
April 11, 2000
================================================================================
Please be advised that the 2000 Annual Meeting of Stockholders will take place
in August 2000. Any stockholder who intends to present a proposal at the meeting
and desires to have the proposal included in the Fund's proxy statement and form
of proxy for that meeting must have delivered the proposal to the offices of the
Fund, attention: Bradley J. Lucido, Secretary, by May 15, 2000.
================================================================================
RISK/REWARD OF VARIOUS ASSETS
The graph below plots the annualized return and volatility experienced by
several asset classes averaged over the last eight years. The annualized returns
represent the annualization of the monthly series of returns for each asset
class over the time period indicated. The annualized volatility represents the
annualization of the monthly series of standard deviation for each asset class
over the time period indicated. Asset classes resting on the capital markets
line, linking the risk/return data points for money market securities and the
broad equity market, experienced a proportionate amount of return for the
corresponding amount of risk. Asset classes falling below the line endured a
disproportionate amount of risk relative to the return they achieved. Finally,
asset classes lying above the line achieved higher returns than justified by the
risk they experienced. Leveraged bank loans fall above the line, which
illustrates that, compared to other asset classes, the bank loan market provided
superior risk/reward characteristics over the period.
A line graph depicting the annualized return and volatility for various assets
from 1992 to 1999.
Volatility Return
Broad Equity Market 14.53% 18.25%
Emerging Market Bonds 20.36% 13.79%
High Yield Bonds 5.74% 9.96%
US Long-Term Treasury Bonds 9.03% 8.45%
Leveraged Loans 1.97% 8.15%
Investment-Grade Bonds 5.07% 7.51%
Mortgage Secs 3.29% 6.76%
US Intermediate Treasury Bonds 4.74% 6.19%
Money Market Secs .30% 4.47%
US Inflation .56% 2.54%
Source: Calculated by Merrill Lynch using information and data presented in
Ibbotson Investment Analysis Software, (C) 2000 Ibbotson Associates, Inc. All
rights reserved. Used with permission.
The assets used in the above analysis are represented by the following indexes:
US 30-day Treasury Bill Index (Money Market Securities); Merrill Lynch Mortgage
Index (Mortgage Securities); Ibbotson's US IT (Intermediate Treasuries);
Ibbotson's US LT Index (Long-Term Treasuries); Merrill Lynch Corporate Index
(Investment-Grade Bonds); Donaldson, Lufkin & Jenrette HY Index (High Yield
Bonds); Donaldson, Lufkin & Jenrette Leveraged Loan Index (Leveraged Loans);
EMBI Fixed Rate Index (Emerging Market Bonds); and Standard & Poor's 500 Index
(Broad Equity Market).
Money market securities are managed to maintain stable net asset values and are
highly liquid. US long-term Treasury bonds and US intermediate Treasury bonds
are guaranteed by the US government, and, if held at maturity, offer both a
fixed investment return and a fixed principal value. Investment-grade bonds,
although not guaranteed by the US government, also offer both fixed principal
value and investment return if held at maturity. High-yield bonds, emerging
market bonds and leveraged loans entail greater risk than investment-grade bonds
or loans. Certain leveraged bank loans may be considered illiquid.
Past performance is not a guarantee of future results. The Fund's performance is
not represented in the above chart.
4 & 5
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Advertising--1.8% B B2 US$1,000,000 Adams Outdoor Advertising Inc., 10.75% due 3/15/2006 $ 1,037,500
B B1 3,000,000 Outdoor Systems Inc., 8.875% due 6/15/2007 3,060,000
------------
4,097,500
====================================================================================================================================
Agricultural B B2 3,000,000 Sun World International, Inc., 11.25% due 4/15/2004 3,037,500
Products--1.3%
====================================================================================================================================
Amusement & AMC Entertainment Inc.:
Recreational B- B3 2,450,000 9.50% due 3/15/2009 (b) 1,874,250
Services--4.5% B- B3 400,000 9.50% due 2/01/2011 302,000
B B2 475,000 Carmike Cinemas Inc., 9.375% due 2/01/2009 356,250
BBB- Baa3 5,000,000 Metro Goldwyn Mayer Co. (MGM), Term A, due 3/15/2005** 4,908,335
B B2 3,350,000 Riddell Sports, Inc., 10.50% due 7/15/2007 2,814,000
------------
10,254,835
====================================================================================================================================
Apparel--2.1% Arena Brands, Inc.**:
NR* NR* 1,274,060 Term A, due 6/01/2002 1,180,098
NR* NR* 3,037,440 Term B, due 6/01/2002 2,817,226
B- B3 1,175,000 GFSI Inc., 9.625% due 3/01/2007 705,000
------------
4,702,324
====================================================================================================================================
Automotive D Caa1 580,259 +Breed Technologies Inc., Revolving Credit, due 4/27/2004** 340,612
Equipment--4.1% CC Ca 3,500,000 Cambridge Industries Inc., 10.25% due 7/15/2007 630,000
NR* NR* 1,000,000 Citation Corporation, Term B, due 12/01/2007** 990,313
B B2 500,000 Hayes Lemmerz International Inc., 8.25% due 12/15/2008 436,250
CCC+ Caa2 1,850,000 Key Plastics, Inc., 10.25% due 3/15/2007 592,000
CCC+ Caa1 1,000,000 Newcor Inc., 9.875% due 3/01/2008 590,000
Safelite Glass Corp.**:
B+ B1 2,051,122 Term B, due 12/23/2004 1,119,912
B+ B1 2,051,122 Term C, due 12/23/2005 1,119,912
B- B3 950,000 Special Devices Inc., 11.375% due 12/15/2008 646,000
BB B2 750,000 Tenneco Inc., 11.625% due 10/15/2009 (b) 762,187
Venture Holdings Trust:
B B2 1,800,000 9.50% due 7/01/2005 1,638,000
B- B3 400,000 12% due 6/01/2009 340,000
------------
9,205,186
====================================================================================================================================
Broadcast--Radio & B B2 1,865,000 Ackerley Group Inc., 9% due 1/15/2009 1,760,094
Television--8.6% B- B3 1,000,000 Acme Television/Finance, 10.875% due 9/30/2004 (d) 881,250
B- B3 500,000 Albritton Communications, 9.75% due 11/30/2007 485,000
B B2 4,000,000 Capstar Broadcasting, 9.25% due 7/01/2007 4,080,000
NR* NR* 5,000,000 Corus Entertainment, Term B, due 8/31/2007** 5,015,625
NR* NR* 1,800,000 Gocom Communications, Term B, due 12/31/2007** 1,795,500
NR* Caa1 3,175,000 Radio Unica Corp., 14.384% due 8/01/2006 (d) 2,032,000
CCC+ NR* 1,450,000 Sirius Satellite, 14.50% due 5/15/2009 1,399,250
B- B3 2,000,000 Spanish Broadcasting System, 9.625% due 11/01/2009 1,965,000
------------
19,413,719
====================================================================================================================================
Building & B- B2 850,000 Webb (Del E.) Corp., 10.25% due 2/15/2010 741,625
Construction--0.3%
====================================================================================================================================
Building NR* NR* 4,920,000 Dal-Tile International Inc., Term B, due 12/31/2003** 4,843,125
Materials--2.4% NR* NR* (euro)511,292 Schulte GmbH & Co. KG, Term B, due 12/02/2003** 489,810
------------
5,332,935
====================================================================================================================================
Cable Television CSC Holdings Inc.:
Services--10.7% BB+ Ba2 US$ 500,000 7.25% due 7/15/2008 466,775
BB+ Ba2 650,000 7.625% due 7/15/2018 598,556
Charter Communications Holdings LLC:
B+ B2 1,400,000 8.625% due 4/01/2009 1,274,000
B+ B2 5,000,000 10% due 4/01/2009 (b) 4,968,750
Classic Cable Inc.:
B- B3 475,000 9.375% due 8/01/2009 445,312
B- B3 1,250,000 10.50% due 3/01/2010 (b) 1,251,562
BB B1 1,736,842 Term C, due 1/31/2008** 1,739,013
CCC+ B3 1,000,000 Coaxial Communications/Phoenix, 10% due 8/15/2006 956,250
CCC+ Caa1 1,000,000 Coaxial LLC, 11.864% due 8/15/2008 (d) 625,000
Echostar DBS Corporation:
B B2 400,000 9.25% due 2/01/2006 390,000
B B2 1,925,000 9.375% due 2/01/2009 1,881,687
B+ B2 1,000,000 Globo Comunicacoes e Participacoes, Ltd., 10.625%
due 12/05/2008 (b) 863,750
B+ Ba3 1,000,000 Insight Midwest/Insight Capital, 9.75% due 10/01/2009 (b) 1,010,000
CCC+ B3 500,000 Park 'N View Inc., 13% due 5/15/2008 350,000
Pegasus Communications:
B- B3 250,000 9.75% due 12/01/2006 241,250
B+ B1 1,500,000 Term, due 4/30/2005** 1,504,376
B- B3 500,000 RCN Corporation, 10.125% due 1/15/2010 465,000
D Caa3 1,000,000 +Supercanal Holdings SA, 11.50% due 5/15/2005 (b) 590,000
B+ B1 1,600,000 Telewest Communications PLC, 9.875% due 2/01/2010 (b) 1,602,000
B B2 3,000,000 United Pan-European Communications NV, 11.25%
due 2/01/2010 (b) 3,022,500
------------
24,245,781
====================================================================================================================================
Chemicals--7.4% BBB- Baa3 2,000,000 Equistar Chemicals LP, 8.75% due 2/15/2009 1,949,520
B+ B2 6,000,000 Huntsman Corp., 9.38% due 7/01/2007 (b)(g) 5,460,000
NR* NR* 4,962,500 Lyondell Petrochemical Co., Term E, due 5/17/2006** 5,094,954
B+ B2 4,875,000 Pioneer American Holding Corporation, Term, due 12/05/2006** 4,350,938
------------
16,855,412
====================================================================================================================================
Consumer BB- Ba3 750,000 Burhmann NV, Term B, due 10/26/2007** 755,906
Products--0.6% B B3 675,000 Home Products International Inc., 9.625% due 5/15/2008 607,500
------------
1,363,406
====================================================================================================================================
Drilling--3.6% BB- B1 3,000,000 Cliffs Drilling, 10.25% due 5/15/2003 2,985,000
BBB- NR* 3,000,000 Falcon Drilling Co. Inc., 9.75% due 1/15/2001 3,000,000
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Drilling B+ B1 US$1,450,000 Parker Drilling Co., 9.75% due 11/15/2006 $ 1,381,125
(concluded) RBF Finance Company:
BB- Ba3 575,000 11% due 3/15/2006 600,875
BB- Ba3 250,000 11.375% due 3/15/2009 265,000
------------
8,232,000
====================================================================================================================================
Drug Stores--1.1% B+ B1 2,450,000 Duane Reade Co., Term B, due 2/15/2005** 2,450,767
====================================================================================================================================
Electronics/Electrical B B2 1,881,000 Advanced Glassfiber Yarn, 9.875% due 1/15/2009 1,730,520
Components--2.4% BB- Ba3 2,000,000 Amkor Technologies Inc., 9.25% due 5/01/2006 1,940,000
B B2 939,000 BGF Industries Inc., 10.25% due 1/15/2009 859,185
B+ B3 1,000,000 High Voltage Engineering, 10.50% due 8/15/2004 817,500
------------
5,347,205
====================================================================================================================================
Energy--4.8% B Ba2 2,000,000 Belco Oil & Gas Corp., 8.875% due 9/15/2007 1,860,000
CCC- Caa3 3,000,000 Belden & Blake Corp., 9.875% due 6/15/2007 1,500,000
CCC Caa1 625,000 Continental Resources, 10.25% due 8/01/2008 593,750
BBB+ Ba3 2,000,000 Cross Timbers Oil Company, 8.75% due 11/01/2009 1,835,000
B B2 2,000,000 Forest Oil Corporation, 10.50% due 1/15/2006 2,020,000
BB- Ba2 2,000,000 Gulf Canada Resources Ltd., 9.25% due 1/15/2004 2,008,360
B+ B1 1,000,000 Nuevo Energy Company, 9.50% due 6/01/2008 975,000
------------
10,792,110
====================================================================================================================================
Environmental--0.8% B+ B3 1,800,000 IT Group Inc., 11.25% due 4/01/2009 1,712,250
====================================================================================================================================
Financial NR* NR* 2,522,523 Blackstone, Term, due 11/30/2000** 2,503,604
Services--6.5% NR* NR* 500,000 Investcorp SA, Term, due 10/21/2008** 496,915
B B3 3,000,000 Lodgian Financing Corporation, 12.25% due 7/15/2009 2,820,000
NR* Ba3 1,000,000 Pennant CBO Limited, 13.43% due 3/14/2011 (b) 990,000
SKM-Libertyview CBO Limited (b)(f):
NR* Baa2 1,500,000 1A-C1, 8.71% due 4/10/2011 1,314,585
NR* Ba3 1,000,000 1A-D, 11.91% due 4/10/2011 877,031
BB+ Ba3 2,000,000 Sovereign Bank, Term, due 11/17/2003** 2,008,750
NR* NR* 2,477,477 Wasserstein, Term, due 11/30/2000** 2,458,896
B+ Ba3 1,425,000 Willis Corroon Corporation, 9% due 2/01/2009 1,140,000
------------
14,609,781
====================================================================================================================================
Food & Kindred CCC+ Caa1 4,000,000 Envirodyne Industries, 10.25% due 12/01/2001 2,000,000
Products--5.0% NR* NR* 2,500,000 GoldenState Foods, Term, due 5/01/2008** 2,468,750
B B2 2,000,000 SC International Services, Inc., 9.25% due 9/01/2007 1,840,000
Specialty Foods, Inc.**:
NR* NR* 1,832,299 Revolving Credit, due 1/31/2001 1,823,137
NR* NR* 3,127,011 Term A, due 1/31/2001 3,134,829
------------
11,266,716
====================================================================================================================================
Forest Products--2.9% B B2 3,000,000 Ainsworth Lumber Company, 12.50% due 7/15/2007 (c) 3,232,500
B+ B3 350,000 Millar Western Forest, 9.875% due 5/15/2008 345,625
BB+ Ba2 1,500,000 Tembec Finance Corporation, 9.875% due 9/30/2005 1,515,000
CC Ca 3,000,000 Uniforet Inc., 11.125% due 10/15/2006 1,350,000
------------
6,443,125
====================================================================================================================================
Furniture & B+ Ba3 1,800,000 Formica Corporation, 10.875% due 3/01/2009 1,593,000
Fixtures--0.7%
====================================================================================================================================
Gaming--4.1% B B2 550,000 Argosy Gaming Company, 10.75% due 6/01/2009 565,125
B- Ba3 750,000 Coast Hotels & Casino, 9.50% due 4/01/2009 703,125
B B2 700,000 Hollywood Park Inc., 9.25% due 2/15/2007 677,250
BB- Ba2 625,000 Horseshoe Gaming Holdings, 8.625% due 5/15/2009 576,562
BB Ba2 1,340,000 Isle of Capri Casinos, 8.75% due 4/15/2009 1,187,575
B B2 3,500,000 Majestic Star LLC, 10.875% due 7/01/2006 3,360,000
B B2 2,150,000 Peninsula Gaming LLC, 12.25% due 7/01/2006 2,236,000
------------
9,305,637
====================================================================================================================================
Health Care NR* B1 968,641 Caremark Rx, Inc., Term B, due 6/08/2001** 908,100
Providers--0.4%
====================================================================================================================================
Hotels--0.5% B- Ba3 500,000 Extended Stay America, 9.15% due 3/15/2008 446,250
BB Ba2 800,000 HMH Properties, Inc., 8.45% due 12/01/2008 718,000
------------
1,164,250
====================================================================================================================================
Industrial BB- Ba3 500,000 American Plumbing & Mechanic, 11.625% due 10/15/2008 455,000
Services--0.5% B+ B2 850,000 Building One Services, 10.50% due 5/01/2009 (b) 782,000
------------
1,237,000
====================================================================================================================================
Leasing & Rental B B3 500,000 National Equipment Services, 10% due 11/30/2004 482,500
Services--3.1% B B3 250,000 Neff Corp., 10.25% due 6/01/2008 225,000
B+ B1 4,975,000 Panavision Inc., Term B, due 3/31/2005** 4,622,606
BB+ Ba2 1,000,000 United Rental, Term C, due 8/12/2006** 998,906
B B3 1,000,000 Universal Hospital Services, 10.25% due 3/01/2008 680,000
------------
7,009,012
====================================================================================================================================
Manufacturing--1.9% B+ B1 2,000,000 Bucyrus International, 9.75% due 9/15/2007 1,105,000
B- B2 1,115,000 Fairfield Manufacturing Company Inc., 9.625% due 10/15/2008 1,014,650
B- B3 725,000 Russell-Stanley Holding Inc, 10.875% due 2/15/2009 630,750
NR* NR* 1,500,000 TransTechnology, Term, due 8/31/2009** 1,477,500
------------
4,227,900
====================================================================================================================================
Medical NR* NR* 2,500,000 Wilson Great Batch, 13% due 7/10/2007 (b) 2,162,500
Equipment--1.0%
====================================================================================================================================
Metals & Mining-- B- B3 5,000,000 Acme Metals, Term, due 12/01/2005** 4,365,000
6.3% CC Ca 2,000,000 Anker Coal Group, Inc., 9.75% due 10/01/2007 1,400,000
BB NR* 397,797 Asarco Incorporated, Term B, due 5/15/2001** 397,051
B Ba3 550,000 Bayou Steel Corp., 9.50% due 5/15/2008 507,375
</TABLE>
8 & 9
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Metals & Mining B Caa1 US$5,000,000 GS Technologies Operating Co., 12% due 9/01/2004 $ 2,800,000
(concluded) Ispat Inland LP**:
BB Ba3 1,280,500 Term B, due 7/15/2005 1,273,386
BB Ba3 1,280,500 Term C, due 7/15/2006 1,273,386
CCC+ Caa2 1,000,000 Metal Management Inc., 10% due 5/15/2008 750,000
B+ B2 550,000 Pen Holdings Inc., 9.875% due 6/15/2008 500,500
B+ B1 1,000,000 Russel Metals Inc., 10% due 6/01/2009 1,020,000
------------
14,286,698
====================================================================================================================================
Online Services--0.5% B- B3 675,000 PSINet Inc., 11% due 8/01/2009 676,687
B- B3 500,000 Verio Inc., 11.25% due 12/01/2008 512,500
------------
1,189,187
====================================================================================================================================
Packaging--0.1% B- Caa1 400,000 Consumers Packaging Inc., 9.75% due 2/01/2007 228,000
====================================================================================================================================
Paging--0.2% CCC+ B3 525,000 Metrocall Inc., 11% due 9/15/2008 (b) 435,750
====================================================================================================================================
Paper--2.2% B B3 650,000 American Tissue Inc., 12.50% due 7/15/2006 (b) 666,250
B+ B2 4,500,000 Repap New Brunswick, Inc., Term B, due 6/01/2004** 4,407,188
------------
5,073,438
====================================================================================================================================
Petroleum BB- Ba3 5,000,000 Clark Refining & Marketing Inc., Term, due 11/15/2004** 3,125,000
Refineries--1.9% B- B3 2,000,000 United Refining Co., 10.75% due 6/15/2007 1,200,000
------------
4,325,000
====================================================================================================================================
Printing & BB- Caa3 475,000 Premier Graphics Inc., 11.50% due 12/01/2005 213,750
Publishing--1.2% B- B3 575,000 Regional Independent Media, 10.50% due 7/01/2008 575,000
B- B3 1,500,000 T/SF Communications Corp., 10.375% due 11/01/2007 1,428,750
BB- Baa3 500,000 World Color Press Inc., 8.375% due 11/15/2008 488,883
------------
2,706,383
====================================================================================================================================
Property NR* Ba3 1,000,000 NRT Incorporated, Term, due 7/31/2004** 995,938
Management--1.3% B+ Ba2 350,000 Prison Realty Trust Inc., 12% due 6/01/2006 336,000
NR* NR* 2,000,000 Rockefeller Center Property Trust, 11.404%
due 12/31/2000 (Convertible) (d) 1,670,000
------------
3,001,938
====================================================================================================================================
Retail--Specialty-- B B3 1,000,000 TM Group Holdings, 11% due 5/15/2008 990,000
2.7% B B2 4,409,504 US Office, Term B, due 6/09/2006** 3,293,899
B- Caa1 2,000,000 United Auto Group, Inc., 11% due 7/15/2007 1,900,000
------------
6,183,899
====================================================================================================================================
Shipping--1.0% B+ B3 4,000,000 Equimar Shipholdings Ltd., 9.875% due 7/01/2007 (b) 2,200,000
====================================================================================================================================
Textile Mill B Caa3 1,400,000 Galey & Lord, Inc., 9.125% due 3/01/2008 434,000
Products--2.1% B- Caa1 575,000 Globe Manufacturing Corp., 10% due 8/01/2008 241,500
Joan Fabrics Corp.**:
NR* NR* 2,617,820 Term B, due 6/30/2005 2,611,275
NR* NR* 1,357,283 Term C, due 6/30/2006 1,353,890
------------
4,640,665
====================================================================================================================================
Tower Construction BB- B1 2,000,000 American Tower Systems Co., Term B, due 12/30/2007** 2,015,416
& Leasing--1.0% B B3 300,000 Crown Castle International Corporation, 9% due 5/15/2001 283,500
------------
2,298,916
====================================================================================================================================
Transportation D Ca 3,000,000 +AmeriTruck Distribution Corp., 12.25% due 11/15/2005 63,750
Services--3.8% BB- NR* 2,250,000 Autopistas del Sol SA, 10.25% due 8/01/2009 (b) 1,856,250
NR* NR*(pound)3,200,000 Eurotunnel, Term 2, due 7/15/2025** 3,687,843
B NR* US$3,000,000 MRS Logistica SA, 10.625% due 8/15/2005 (b) 2,572,500
NR* NR* 695,814 Trism, 12% due 2/09/2005 417,488
------------
8,597,831
====================================================================================================================================
Utilities--1.0% B+ Ba3 2,500,000 AES Corporation, 8.50% due 11/01/2007 2,281,250
====================================================================================================================================
Waste BB- B3 1,000,000 Norcal Waste Systems, 13.50% due 11/15/2005 1,052,500
Management--0.9% B+ Ca 750,000 Safety-Kleen Corporation, 9.25% due 5/15/2009 645,000
B B3 350,000 Stericycle Inc., 12.375% due 11/15/2009 357,875
------------
2,055,375
====================================================================================================================================
Wired B B3 1,925,000 Caprock Communications Corporation, 11.50% due 5/01/2009 1,953,875
Telecommunications-- NR* NR* 2,100,000 E.Spire Communications, 10.52% due 7/01/2008 (d) 1,029,000
8.5% B- B3 650,000 Esprit Telecom Group PLC, 10.875% due 6/15/2008 611,000
B B3 300,000 Hermes Europe RailTel BV, 10.375% due 1/15/2009 281,250
B B2 2,000,000 Intermedia Communications Inc., 8.875% due 11/01/2007 1,870,000
B+ B2 500,000 Metromedia Fiber Network, 10% due 11/15/2008 491,250
BBB Baa3 1,050,000 Metronet Communications, 9.95% due 6/15/2008 (d) 825,823
B B3 500,000 Netia Holdings II BV, 13.125% due 6/15/2009 532,500
Nextlink Communications Inc.:
B B2 1,500,000 9% due 3/15/2008 1,395,000
NR* B2 3,000,000 9.45% due 4/15/2008 (d) 1,875,000
Primus Telecommunications Group:
B- B3 500,000 11.75% due 8/01/2004 495,000
B- B3 850,000 11.25% due 1/15/2009 807,500
Telegroup Inc.:+
NR* NR* 1,500,000 8% due 11/01/2004 (d) 720,000
NR* NR* 1,500,000 8% due 4/15/2005 (b) 15
NR* B3 3,333,333 Teligent Inc., Term, due 7/01/2002** 3,272,917
NR* NR* 350,000 Versatel Telecom BV, 11.875% due 7/15/2009 (b) 357,000
Williams Communications Group Inc.:
BB- B2 750,000 10.70% due 10/01/2007 770,625
BB- B2 750,000 10.875% due 10/01/2009 765,000
Worldwide Fiber Inc.:
B+ B3 900,000 12.50% due 12/15/2005 942,750
B+ B3 350,000 12% due 8/01/2009 364,000
------------
19,359,505
====================================================================================================================================
</TABLE>
10 & 11
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (concluded) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Wireless Dolphin Telecom PLC (d):
Telecommunications-- CCC+ Caa1 US$ 850,000 11.50% due 6/01/2008 $ 384,625
7.9% CCC+ Caa1 670,000 14% due 5/15/2009 281,400
B- B3 950,000 Microcell Telecommunications, 12% due 6/01/2009 (d) 619,875
Nextel Communications, Inc.**:
BB- Ba2 2,500,000 Term B, due 6/30/2008 2,527,233
NR* NR* 2,500,000 Term C, due 12/31/2008 2,527,233
CCC+ B3 2,075,000 Nextel Partners Inc., 14% due 2/01/2009 (d) 1,385,063
B+ NR* 2,000,000 PTC International Finance BV, 10.269% due 7/01/2007 (d) 1,360,000
B+ B2 425,000 PTC International Finance II SA, 11.25% due 12/01/2009 (b) 429,250
NR* NR* 3,835,714 PowerTel PCS, Term B, due 12/31/2006** 3,823,728
CCC+ Caa1 2,000,000 Telesystem International Wireless Inc., 11.929%
due 6/30/2007 (d) 1,280,000
VoiceStream Wireless Corporation/VoiceStream
Wireless Holding Company:
B- B1 350,000 10.375% due 11/15/2009 (b) 361,813
NR* NR* 3,000,000 Term B, due 2/25/2009** 3,017,577
------------
17,997,797
====================================================================================================================================
Total Investments in Corporate Debt
Obligations (Cost--$324,548,873)--125.7% 284,573,208
====================================================================================================================================
<CAPTION>
Shares
Held Stocks & Warrants
====================================================================================================================================
<S> <C> <C> <C>
Broadcast--Radio & 4,350 Sirius Satellite (Warrants) (a)(b) 565,500
Television--0.6% 25 Paxson Communications (Convertible Preferred) (b)(c) 251,609
53 Paxson Communications (Preferred) (c) 541,774
704 Paxson Communications (Warrants) (a)(b) 2,112
------------
1,360,995
====================================================================================================================================
Cable Television 500 Park 'N View Inc. (Warrants) (a) 500
Services--0.0%
====================================================================================================================================
Energy--0.7% 111,533 Forcenergy Inc. 1,561,462
====================================================================================================================================
High Technology--0.1% 318,830 WGL Holdings (Warrants) (a)(e) 159,415
====================================================================================================================================
Transportation 44,068 +Trism 22,034
Services--0.0%
====================================================================================================================================
Wired 3,500 Metronet Communications (Warrants) (a)(b) 719,250
Telecommunications-- 2,000 Unifi Communications (Warrants) (a)(b) 20
0.3% ------------
719,270
====================================================================================================================================
Wireless 2,135 Dobson Communications (Preferred) (c) 2,316,573
Telecommunications--
1.0%
====================================================================================================================================
Total Investments in Stocks & Warrants
(Cost--$5,598,022)--2.7% 6,140,249
====================================================================================================================================
<CAPTION>
Face
Amount Short-Term Securities
====================================================================================================================================
<S> <C> <C> <C>
Commercial US$ 409,000 General Motors Acceptance Corp., 5.94% due 3/01/2000 409,000
Paper***--0.2%
====================================================================================================================================
Total Investments in Short-Term Securities
(Cost--$409,000)--0.2% 409,000
====================================================================================================================================
Total Investments (Cost--$330,555,895)--128.6% 291,122,457
Unrealized Appreciation on Forward Foreign Exchange
Contracts--Net****--0.0% 77,822
Liabilities in Excess of Other Assets--(28.6%) (64,725,737)
Net Assets--100.0% ------------
$226,474,542
============
====================================================================================================================================
</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 adjustment 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/share.
(d) Represents a zero coupon or step bond; the interest rate shown reflects
the effective yield at the time of purchase by the Fund.
(e) Restricted securities as to resale. The value of the Fund's investment in
restricted securities was approximately $159,000, representing 0.1% of net
assets.
--------------------------------------------------------------------------
Acquisition
Issue Date Cost Value
--------------------------------------------------------------------------
WGL Holdings (Warrants) 9/03/1997 $318,000 $159,415
--------------------------------------------------------------------------
Total $318,000 $159,415
======== ========
--------------------------------------------------------------------------
(f) Mortgage-Backed Obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments. As
a result, the average life may be substantially less than the original
maturity.
(g) Floating rate note.
* 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 47.2% 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 February 29, 2000 were as
follows:
--------------------------------------------------------------------------
Foreign Expiration Unrealized
Currency Sold Date Appreciation
--------------------------------------------------------------------------
(euro) 512,108 March 2000 $12,659
(pound) 2,489,984 March 2000 65,163
--------------------------------------------------------------------------
Total Unrealized Appreciation on Forward
Foreign Exchange Contracts--Net
(US$ Commitment--$4,501,968) $77,822
=======
--------------------------------------------------------------------------
+ Non-income producing security.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
12 & 13
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of February 29, 2000
=================================================================================================
<C> <S> <C> <C>
Assets: Investments, at value (identified
cost--$330,555,895) ................................ $291,122,457
Cash ............................................... 661
Unrealized appreciation on forward foreign
exchange contracts ................................. 77,822
Receivables:
Interest ......................................... $ 6,350,131
Securities sold .................................. 269,000 6,619,131
-----------
Prepaid expenses and other assets .................. 204,129
------------
Total assets ....................................... 298,024,200
------------
=================================================================================================
Liabilities: Loans .............................................. 70,000,000
Payables:
Interest on loans ................................ 876,385
Dividends to shareholders ........................ 159,048
Investment adviser ............................... 116,532
Commitment fees .................................. 12,053 1,164,018
-----------
Deferred income .................................... 6,047
Accrued expenses ................................... 379,593
------------
Total liabilities .................................. 71,549,658
------------
=================================================================================================
Net Assets: Net assets ......................................... $226,474,542
============
=================================================================================================
Capital: Common Stock, $.10 par value, 200,000,000
shares authorized .................................. $ 3,142,523
Paid-in capital in excess of par ................... 310,639,558
Undistributed investment income--net ............... 2,144,532
Accumulated realized capital losses on investments
and foreign currency transactions--net ............. (50,217,316)
Unrealized depreciation on investments and foreign
currency transactions--net ......................... (39,234,755)
------------
Total--Equivalent to $7.21 per share based on
31,425,226 shares of capital stock outstanding
(market price--$6.1875) ............................ $226,474,542
============
=================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended February 29, 2000
=======================================================================================================
<C> <S> <C> <C>
Investment Income: Interest and discount earned (net of $35,794
foreign withholding tax) ............................ $ 34,958,766
Facility and other fees ............................. 290,359
Dividends ........................................... 223,305
------------
Total income ........................................ 35,472,430
------------
=======================================================================================================
Expenses: Loan interest expense ............................... $ 5,620,670
Investment advisory fees ............................ 2,063,756
Borrowing costs ..................................... 263,187
Professional fees ................................... 200,497
Accounting services ................................. 104,589
Printing and shareholder reports .................... 51,949
Listing fees ........................................ 49,018
Transfer agent fees ................................. 48,489
Organization expenses ............................... 38,786
Custodian fees ...................................... 33,104
Directors' fees and expenses ........................ 27,003
Pricing services .................................... 14,188
Other ............................................... 58,829
-----------
Total expenses ...................................... 8,574,065
------------
Investment income--net .............................. 26,898,365
------------
=======================================================================================================
Realized & Realized gain (loss) from:
Unrealized Gain Investments--net .................................. (34,118,643)
(Loss) On Foreign currency transactions--net ................ 202,781 (33,915,862)
Investments & ----------
Foreign Currency Change in unrealized appreciation/depreciation on:
Transactions--Net: Investments--net .................................. 2,608,571
Foreign currency transactions--net ................ (8,392) 2,600,179
----------- ------------
Net Decrease in Net Assets Resulting
from Operations ..................................... $ (4,417,318)
============
=======================================================================================================
</TABLE>
See Notes to Financial Statements.
14 & 15
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended
--------------------------------
February 29, February 28,
Increase (Decrease) in Net Assets: 2000 1999
====================================================================================================================================
<C> <S> <C> <C>
Operations: Investment income--net .......................................................... $ 26,898,365 $ 28,979,361
Realized loss on investments and foreign currency transactions--net ............. (33,915,862) (14,808,405)
Change in unrealized appreciation/depreciation on investments and
foreign currency transactions--net .............................................. 2,600,179 (46,022,747)
------------ ------------
Net decrease in net assets resulting from operations ............................ (4,417,318) (31,851,791)
------------ ------------
====================================================================================================================================
Dividends to Dividends to shareholders from investment income--net ........................... (26,887,455) (29,289,396)
Shareholders: ------------ ------------
====================================================================================================================================
Capital Share Value of shares issued in reinvestment of dividends ............................. -- 1,185,810
Transactions: ------------ ------------
====================================================================================================================================
Net Assets: Total decrease in net assets .................................................... (31,304,773) (59,955,377)
Beginning of year ............................................................... 257,779,315 317,734,692
------------ ------------
End of year* .................................................................... $226,474,542 $257,779,315
============ ============
====================================================================================================================================
* Undistributed investment income--net ............................................ $ 2,144,532 $ 1,930,842
============ ============
====================================================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended February 29, 2000
====================================================================================================================================
<C> <S> <C>
Cash Provided by Net decrease in net assets resulting from operations ...................................... $ (4,417,318)
Operating Activities: Adjustments to reconcile net decrease in net assets resulting from operations to
net cash provided by operating activities:
Increase in receivables ................................................................. (462,623)
Decrease in other assets ................................................................ 3,401
Increase in other liabilities ........................................................... 251,020
Realized and unrealized loss on investments and foreign currency transactions--net ...... 31,315,683
Amortization of discount ................................................................ (2,504,569)
-------------
Net cash provided by operating activities ................................................. 24,185,594
-------------
====================================================================================================================================
Cash Provided by Proceeds from sales of long-term investments .............................................. 210,264,959
Investing Activities: Purchases of long-term investments ........................................................ (166,108,607)
Purchases of short-term investments ....................................................... (144,297,825)
Proceeds from sales and maturities of short-term investments .............................. 144,733,000
-------------
Net cash provided by investing activities ................................................. 44,591,527
-------------
====================================================================================================================================
Cash Used for Cash receipts from borrowings ............................................................. 136,000,000
Financing Activities: Cash payments from borrowings ............................................................. (178,000,000)
Dividends paid to shareholders ............................................................ (26,923,236)
-------------
Net cash used for financing activities .................................................... (68,923,236)
-------------
====================================================================================================================================
Cash: Net decrease in cash ...................................................................... (146,115)
Cash at beginning of year ................................................................. 146,776
-------------
Cash at end of year ....................................................................... $ 661
=============
====================================================================================================================================
Cash Flow Cash paid for interest .................................................................... $ 5,569,304
Information: =============
====================================================================================================================================
</TABLE>
See Notes to Financial Statements.
16 & 17
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been derived For the Year Ended For the Period
from information provided in the financial statements. ---------------------------- May 30, 1997+
February 29, February 28, to February 28,
Increase (Decrease) in Net Asset Value: 2000++ 1999 1998
====================================================================================================================================
<C> <S> <C> <C> <C>
Per Share Net asset value, beginning of period ........................... $ 8.20 $ 10.15 $ 10.00
Operating -------- -------- --------
Performance: Investment income--net ......................................... .86 .91 .71
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net ............................. (.99) (1.93) .09
-------- -------- --------
Total from investment operations ............................... (.13) (1.02) .80
-------- -------- --------
Less dividends from investment income--net ..................... (.86) (.93) (.63)
-------- -------- --------
Capital charge resulting from the issuance of Common Stock ..... -- -- (.02)
-------- -------- --------
Net asset value, end of period ................................. $ 7.21 $ 8.20 $ 10.15
-------- -------- --------
Market price per share, end of period .......................... $ 6.1875 $ 7.625 $10.5625
======== ======== ========
====================================================================================================================================
Total Investment Based on market price per share ................................ (8.30%) (19.90%) 12.38%@
Return:** ======== ======== ========
Based on net asset value per share ............................. (.64%) (10.36%) 7.99%@
======== ======== ========
====================================================================================================================================
Ratios to Average Expenses, net of reimbursement and excluding interest expense .. 1.19% 1.09% .61%*
Net Assets: ======== ======== ========
Expenses, net of reimbursement ................................. 3.46% 3.48% 2.28%*
======== ======== ========
Expenses ....................................................... 3.46% 3.48% 2.56%*
======== ======== ========
Investment income--net ......................................... 10.85% 10.03% 9.64%*
======== ======== ========
====================================================================================================================================
Leverage: Amount of borrowings, end of period (in thousands) ............. $ 70,000 $112,000 $142,600
======== ======== ========
Average amount of borrowings outstanding during the period
(in thousands) ................................................. $ 97,120 $120,528 $ 85,903
======== ======== ========
Average amount of borrowings outstanding per share
during the period .............................................. $ 3.09 $ 3.84 $ 2.79
======== ======== ========
====================================================================================================================================
Supplemental Net assets, end of period (in thousands) ....................... $226,475 $257,779 $317,735
Data: ======== ======== ========
Portfolio turnover ............................................. 48.73% 61.30% 43.79%
======== ======== ========
====================================================================================================================================
</TABLE>
* Annualized.
** Total investment returns exclude the effects of sales charges. 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.
+ Commencement of operations.
++ Based on average shares outstanding.
@ 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.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles, which may require the use of management accruals
and estimates. 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 are valued in accordance with
guidelines established by the Board of Directors. Until July 9, 1999, Corporate
Loans for which an active secondary market exists and for which the Investment
Adviser can obtain at least two quotations from banks or dealers in Corporate
Loans were valued by calculating the mean of the last available bid and asked
prices in the markets for such Corporate Loans, and then using the mean of those
two means. If only one quote for a particular Corporate Loan was available, such
Corporate Loan was valued on the basis of the mean of the last available bid and
asked prices in the market. As of July 12, 1999, pursuant to the approval of the
Board of Directors, the Corporate Loans are valued at the mean between the last
available bid and asked prices from one or more brokers or dealers as obtained
from Loan Pricing Corporation. For Corporate Loans for which an active secondary
market does not exist to a reliable degree in the opinion of the Investment
Adviser, such Corporate Loans will be valued by the Investment Adviser at fair
value, which is intended to approximate market value.
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 that 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. Options written
or purchased are valued at the last sale price in the case of exchange-traded
options. In the case of options traded in the over-the-counter market, valuation
is the last asked price (options written) or the last bid price (options
purchased). 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 and currency 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
18 & 19
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
NOTES TO FINANCIAL STATEMENTS (continued)
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.
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 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) Organization expenses--In accordance with Statement of Position 98-5,
unamortized organization expenses of $38,786 were expensed during the year ended
February 29, 2000. This was considered to be a change in accounting principle
and had no material impact on the operations of the Fund.
(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.
(i) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $202,780 have been reclassified between undistributed
net investment income and accumulated net realized capital losses. Those
reclassifications have no effect on net assets or net asset value per share.
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 .60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
For the year ended February 29, 2000, the Fund paid Merrill Lynch Security
Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), $520 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
year ended February 29, 2000 were $164,083,607 and $209,536,131, respectively.
Net realized gains (losses) for the year ended February 29, 2000 and net
unrealized gains (losses) as of February 29, 2000 were as follows:
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- --------------------------------------------------------------------------------
Long-term investments ......................... $(34,118,643) $(39,433,438)
Unfunded corporate loans ...................... -- 122,042
Forward foreign exchange contracts ............ 176,466 77,822
Foreign currency transactions ................. 26,315 (1,181)
------------ ------------
Total ......................................... $(33,915,862) $(39,234,755)
============ ============
- --------------------------------------------------------------------------------
As of February 29, 2000, net unrealized depreciation for Federal income tax
purposes aggregated $39,502,060, of which $3,982,938 related to appreciated
securities and $43,484,998 related to depreciated securities. The aggregate cost
of investments at February 29, 2000 for Federal income tax purposes was
$330,624,517.
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 year ended February 29,
2000 remained constant and during the year ended February 28, 1999 increased by
122,228 as a result of dividend reinvestment.
5. Unfunded Loan Interests:
As of February 29, 2000, the Fund had unfunded loan commitments of $15,955,
which would be extended at the option of the borrower, pursuant to the following
loan agreement:
- --------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in thousands)
- --------------------------------------------------------------------------------
Breed Technologies Inc. ........................................ $16
- --------------------------------------------------------------------------------
20 & 21
<PAGE>
Debt Strategies Fund, Inc., February 29, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
6. Short-Term Borrowings:
On August 3, 1999, the Fund extended its 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 .55% and /or Eurodollar rate plus .55%. For the
year ended February 29, 2000, the average amount borrowed by the Fund was
approximately $97,120,000 and the daily weighted average interest rate was
5.77%. For the year ended February 29, 2000, facility and commitment fees were
approximately $263,000.
7. Capital Loss Carryforward:
At February 29, 2000, the Fund had a net capital loss carryforward of
approximately $33,583,000, of which $264,000 expires in 2006, $12,067,000
expires in 2007 and $21,252,000 expires in 2008. This amount will be available
to offset like amounts of any future taxable gains.
8. Subsequent Event:
On March 7, 2000, the Fund's Board of Directors declared an ordinary income
dividend to Common Stock shareholders in the amount of $.065926 per share,
payable on March 31, 2000 to shareholders of record as of March 17, 2000.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Debt Strategies Fund, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Debt Strategies Fund, Inc. as of
February 29, 2000, the related statements of operations and cash flows for the
year then ended and the statement of changes in net assets and the financial
highlights for each of the years in the two-year period then ended and for the
period May 30, 1997 (commencement of operations) to February 28, 1998. These
financial statements and the financial highlights are the responsibility of the
Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at February
29, 2000 by correspondence with the custodian and financial intermediaries;
where replies were not received from financial intermediaries, we performed
other auditing procedures. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights present
fairly, in all material respects, the financial position of Debt Strategies
Fund, Inc. as of February 29, 2000, the results of its operations, the changes
in its net assets, its cash flows, and the financial highlights for the
respective stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
April 17, 2000
PORTFOLIO PROFILE (unaudited)
As of February 29, 2000
Percent of
Ten Largest Holdings Total Assets
- --------------------------------------------------------------------------------
Charter Communications Holdings LLC ................................. 2.1%
Huntsman Corp. ...................................................... 1.8
Lyondell Petrochemical Co. .......................................... 1.7
Nextel Communications, Inc. ......................................... 1.7
Corus Entertainment ................................................. 1.7
Specialty Foods, Inc. ............................................... 1.7
Metro Goldwyn Mayer Co. (MGM) ....................................... 1.6
Dal-Tile International Inc. ......................................... 1.6
Panavision Inc. ..................................................... 1.5
Repap New Brunswick, Inc. ........................................... 1.5
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries Total Assets
- --------------------------------------------------------------------------------
Cable Television Services ........................................... 8.1%
Broadcast--Radio & Television ....................................... 6.9
Wireless Telecommunications ......................................... 6.8
Wired Telecommunications ............................................ 6.7
Chemicals ........................................................... 5.6
- --------------------------------------------------------------------------------
Percent of
Quality Ratings Long-Term
S&P/Moody's Investments
- --------------------------------------------------------------------------------
BBB/Baa ............................................................. 5.0%
BB/Ba ............................................................... 16.7
B/B ................................................................. 51.4
CCC/Caa or lower .................................................... 5.8
NR (Not Rated) ...................................................... 21.1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Percent of
Long-Term
Breakdown of Investments by Country Investments
- --------------------------------------------------------------------------------
United States ....................................................... 85.8%
Canada .............................................................. 4.5
United Kingdom ...................................................... 3.2
Netherlands ......................................................... 2.3
Brazil .............................................................. 1.2
Cayman Islands ...................................................... 1.1
Argentina ........................................................... 0.8
Luxembourg .......................................................... 0.6
Poland .............................................................. 0.2
Germany ............................................................. 0.2
Belgium ............................................................. 0.1
- --------------------------------------------------------------------------------
22 & 23
<PAGE>
Officers and Directors
Terry K. Glenn, President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Arthur Zeikel, Director
Joseph T. Monagle Jr., Senior Vice President
Richard C. Kilbride, Vice President
Gilles Marchand, Vice President
Paul Travers, Vice President
Donald C. Burke, Vice President and Treasurer
Bradley J. Lucido, 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
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.
Debt Strategies
Fund, Inc.
Box 9011
Princeton, NJ
08543-9011 #DEBT01--2/00
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