<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 24, 1998
SECURITIES ACT FILE NO. 333-44051
INVESTMENT COMPANY ACT FILE NO. 811-08603
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X]
PRE-EFFECTIVE AMENDMENT NO. 2
[_] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X]
AMENDMENT NO. 2
--------------
DEBT STRATEGIES FUND II, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
--------------
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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(609) 282-2800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
--------------
ARTHUR ZEIKEL
DEBT STRATEGIES FUND II, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
--------------
COPIES TO:
PATRICK D. SWEENEY, ESQ. FRANK P. BRUNO, ESQ.
FUND ASSET MANAGEMENT, L.P. BROWN & WOOD LLP NTER
P.O. BOX 9011 ONE WORLD TRADE CENTER
PRINCETON, NEW JERSEY 08543-9011 NEW YORK, NEW YORK 10048-0557
--------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after
the effective date of this Registration Statement.
--------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), other than securities offered only in
connection with dividend or interest reinvestment plans, check the following
box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering.
[_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering.
[_]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [_]
--------------
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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<TABLE>
<CAPTION>
PROPOSED PROPOSED
TITLE OF AMOUNT MAXIMUM MAXIMUM AMOUNT OF
SECURITIES BEING BEING OFFERING PRICE AGGREGATE REGISTRATION
REGISTERED REGISTERED(1) PER UNIT OFFERING PRICE FEE(2)
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<S> <C> <C> <C> <C>
Common Stock ($.10 par
value)................ 66,125,000 shares $10.00 $661,250,000 $195,068.75
</TABLE>
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(1) Includes 8,625,000 shares subject to the Underwriter's over-allotment
option.
(2) Transmitted to the designated lockbox at Mellon Bank in Pittsburgh, PA.
$34,264.25 was previously paid. $160,804.50 has been transmitted in
connection with this filing.
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<PAGE>
DEBT STRATEGIES FUND II, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
--------------------- ---------------------
<S> <C>
PART A--INFORMATION REQUIRED IN A PROSPECTUS
1. Outside Front Cover Page..... Outside Front Cover Page
2. Inside Front and Outside Back Inside Front and Outside Back Cover Pages;
Cover Pages................. Underwriting
3. Fee Table and Synopsis....... Prospectus Summary; Fee Table
4. Financial Highlights......... Not Applicable
5. Plan of Distribution......... Prospectus Summary; Net Asset Value;
Underwriting
6. Selling Shareholders......... Not Applicable
7. Use of Proceeds.............. Use of Proceeds; Investment Objectives and
Policies
8. General Description of the Prospectus Summary; The Fund; Investment
Registrant.................. Objectives and Policies; Other Investment
Policies; Investment Restrictions;
Dividends and Distributions; Automatic
Dividend Reinvestment Plan; Mutual Fund
Investment Option
9. Management................... Directors and Officers; Investment Advisory
and Management Arrangements; Custodian;
Transfer Agent, Dividend Disbursing Agent
and Registrar
10. Capital Stock, Long-Term
Debt, and Other Securities.. Description of Capital Stock
11. Defaults and Arrears on
Senior Securities........... Not Applicable
12. Legal Proceedings............ Not Applicable
13. Table of Contents of the
Statement of Additional
Information................. Not Applicable
PART B--INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION
14. Cover Page................... Not Applicable
15. Table of Contents............ Not Applicable
16. General Information and
History..................... Not Applicable
17. Investment Objective and Prospectus Summary; Investment Objectives
Policies.................... and Policies; Investment Restrictions
18. Management................... Directors and Officers; Investment Advisory
and Management Arrangements
19. Control Persons and Principal Investment Advisory and Management
Holders of Securities....... Arrangements
20. Investment Advisory and Other Investment Advisory and Management
Services.................... Arrangements; Custodian; Underwriting;
Transfer Agent, Dividend Disbursing Agent
and Registrar; Legal Opinions; Experts
21. Brokerage Allocation and
Other Practices............. Portfolio Transactions
22. Tax Status................... Taxes; Automatic Dividend Reinvestment Plan
23. Financial Statements......... Independent Auditors' Report; Statement of
Assets, Liabilities and Capital
</TABLE>
PART C--OTHER INFORMATION
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
PROSPECTUS
57,500,000 SHARES
DEBT STRATEGIES FUND II, INC.
COMMON STOCK
----------------
Debt Strategies Fund II, Inc. (the "Fund") is a newly organized,
diversified, closed-end management investment company that seeks to provide
current income by investing primarily in a diversified portfolio of U.S.
companies' debt instruments, including corporate loans, that are rated in the
lower rating categories of the established rating services (Baa or lower by
Moody's Investor Service, Inc. ("Moody's") or BBB or lower by Standard &
Poor's ("S&P")) or unrated debt instruments of comparable quality. Such
securities generally involve greater volatility of price and risks to
principal and income than securities in the higher rating categories. As a
secondary objective, the Fund will seek capital appreciation. Up to 20% of the
Fund's total assets may be invested in debt instruments which, at the time of
investment, are the subject of bankruptcy proceedings or otherwise in default
as to the repayment of principal or payment of interest or are rated in the
lowest rating categories (Ca or lower by Moody's and CC or lower by S&P) or
unrated debt instruments of comparable quality. The Fund may invest up to 20%
of its total assets in financial instruments of issuers domiciled outside the
United States or that are denominated in various foreign currencies and
multinational foreign currency units. The Fund does not currently intend to
hedge its non-U.S. dollar denominated portfolio investments. For these
reasons, an investment in the Fund may be speculative in that it involves a
high degree of risk and should not constitute a complete investment program.
See "Risk Factors and Special Considerations." The Fund may engage in various
portfolio strategies to enhance income or capital appreciation and to hedge
its portfolio against investment, interest rate and foreign currency risks,
including the utilization of leverage, the use of options and futures
transactions and the use of foreign currency swaps. There can be no assurance
that the investment objectives of the Fund will be realized.
Because the Fund is newly organized, its shares have no history of public
trading, and shares of closed-end investment companies frequently trade at a
discount from their net asset value. The risk of loss may be greater for
initial investors expecting to sell their shares in a relatively short period
after completion of the public offering. See "Risk Factors and Special
Considerations."
(continued on next page)
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
PRICE TO SALES LOAD PROCEEDS TO
PUBLIC(1) (1)(2) FUND(3)
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<S> <C> <C> <C>
Per Share................................. $10.00 None $10.00
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Total(4).................................. $575,000,000 None $575,000,000
</TABLE>
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(footnotes on next page)
----------------
The shares are offered by the Underwriter, subject to prior sale, when, as
and if issued by the Fund and accepted by the Underwriter, subject to approval
of certain legal matters by counsel for the Underwriter and certain other
conditions. The Underwriter reserves the right to withdraw, cancel or modify
such offer and to reject orders in whole or in part. It is expected that
delivery of the shares will be made in New York, New York on or about March
27, 1998.
----------------
MERRILL LYNCH & CO.
----------------
The date of this Prospectus is March 24, 1998.
<PAGE>
(continued from previous page)
At times, the Fund expects to utilize leverage through borrowings, including
the issuance of short-term debt securities, or the issuance of shares of
preferred stock. Under current market conditions, the Fund intends to utilize
leverage in an amount equal to approximately 33 1/3% of its total assets
(including the amount obtained from leverage). The Fund will generally not
utilize leverage if it anticipates that the Fund's leveraged capital structure
would result in a lower return to holders of the Common Stock than that
obtainable if the Common Stock were unleveraged for any significant amount of
time. Use of leverage creates an opportunity for increased income and capital
appreciation, but, at the same time, creates special risks. See "Risk Factors
and Special Considerations" and "Other Investment Policies--Leverage."
Prior to this offering, there has been no public market for the Fund's
shares. The Fund's shares of Common Stock have been approved for listing on
the New York Stock Exchange, subject to official notice of issuance. However,
during an initial period which is not expected to exceed two weeks from the
date of this Prospectus, the Fund's shares will not be listed on any
securities exchange. During such period, the Underwriter does not intend to
make a market in the Fund's shares. Consequently, it is anticipated that an
investment in the Fund will be illiquid during such period.
This Prospectus sets forth in concise form the information about the Fund
that a prospective investor should know before investing in the Fund.
Investors should read and retain this Prospectus for future reference. Fund
Asset Management, L.P. is the Fund's investment adviser (the "Investment
Adviser"). The address of the Fund is 800 Scudders Mill Road, Plainsboro, New
Jersey 08536, and its telephone number is (609) 282-2800.
The Underwriter may engage in transactions that stabilize, maintain, or
otherwise affect the price of the Fund's Common Stock. Such transactions may
include stabilizing, the purchase of the Fund's Common Stock to cover short
positions and the imposition of penalty bids. For a description of these
activities, see "Underwriting."
------------
(footnotes from previous page)
(1) The Investment Adviser or an affiliate will pay the Underwriter a
commission in the amount of 2.00% of the Price to Public per share in
connection with the sale of shares of Common Stock offered hereby. See
"Underwriting."
(2) The Fund and the Investment Adviser have agreed to indemnify the
Underwriter against certain liabilities under the Securities Act of 1933.
See "Underwriting."
(3) Before deducting organizational and offering expenses payable by the Fund
estimated at $687,000.
(4) The Fund has granted the Underwriter an option, exercisable for 45 days
after the date hereof, to purchase up to an additional 8,625,000 shares to
cover over-allotments. If all such shares are purchased, the total Price
to Public and Proceeds to Fund will be $661,250,000. See "Underwriting."
2
<PAGE>
PROSPECTUS SUMMARY
The following summary should be read in conjunction with the detailed
information appearing elsewhere in this Prospectus.
THE FUND Debt Strategies Fund II, Inc. (the "Fund") is a newly
organized, diversified, closed-end management investment
company. See "The Fund."
THE
OFFERING The Fund is offering 57,500,000 shares of Common Stock at an
initial offering price of $10.00 per share. The Common Stock is
being offered by Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch" or the "Underwriter"). The
Underwriter has been granted an option, exercisable for 45 days
from the date of this Prospectus, to purchase up to 8,625,000
additional shares of Common Stock to cover over-allotments. See
"Underwriting."
INVESTMENT The primary investment objective of the Fund is to seek to
OBJECTIVES provide current income by investing primarily in a diversified
AND portfolio of U.S. companies' debt instruments, including
POLICIES corporate loans, which are rated in the lower rating categories
of the established rating services (Baa or lower by Moody's or
BBB or lower by S&P) or unrated debt instruments which are in
the judgment of the Investment Adviser of equivalent quality.
Such investments generally involve greater volatility of price
and risks to principal and income than securities in the higher
rating categories. As a secondary objective, the Fund will seek
capital appreciation. Up to 20% of the Fund's total assets may
be invested in publicly offered or privately placed debt
securities and corporate loans which, at the time of
investment, are the subject of bankruptcy proceedings or
otherwise in default as to the repayment of principal or
payment of interest or are rated in the lowest rating
categories (Ca or lower by Moody's and CC or lower by S&P) or
which, if unrated, are in the judgment of the Investment
Adviser of equivalent quality ("Distressed Securities"). Up to
20% of the Fund's total assets may be invested in financial
instruments of issuers domiciled outside the United States or
that are denominated in various foreign currencies and
multinational foreign currency units, provided that the foreign
issuers of any non-U.S. dollar denominated instruments
purchased by the Fund are domiciled in a country that is a
member of the Organisation for Economic Co-operation and
Development ("OECD"). The Fund does not currently intend to
hedge its non-U.S. dollar denominated portfolio investments.
For these reasons, an investment in the Fund may be speculative
in that it involves a high degree of risk and should not
constitute a complete investment program. See "Risk Factors and
Special Considerations." Up to 20% of the Fund's total assets
can be invested in convertible debt instruments and preferred
stock, each of which may be converted into common stock or
other securities of the same or a different issuer, and non-
convertible preferred stock. No assurance can be given that the
Fund's investment objectives will be achieved. See "Investment
Objectives and Policies".
The Fund's investment policies permit investment in the
following asset classes: (i) senior and subordinated corporate
loans, both secured and unsecured ("Corporate Loans"), issued
either directly by the borrower or in the form of participation
interests in Corporate Loans made by banks and other financial
institutions; (ii) publicly offered and privately placed high-
yield debt securities, senior and subordinated, both secured
and unsecured (commonly known as "high-
3
<PAGE>
yield securities" or "junk bonds"); and (iii) convertible debt
instruments and preferred stock, each of which may be
convertible into common stock or other securities of the same
or a different issuer, and non-convertible preferred stock. The
debt securities and Corporate Loans in which the Fund invests
may pay interest at fixed rates or at rates that float at a
margin above a generally recognized base lending rate such as
the prime rate ("Prime Rate") of a designated U.S. bank, or
that adjusts periodically at a margin above the Certificate of
Deposit ("CD") rate or the London Interbank Offered Rate
("LIBOR").
At times, the Fund expects to utilize leverage through
borrowings, including the issuance of short-term debt
securities, or the issuance of shares of preferred stock. Under
current market conditions, the Fund intends to utilize leverage
in an amount up to approximately 33 1/3% of its total assets
(including the amount obtained from leverage). The Fund intends
to utilize leverage to provide the holders of Common Stock with
a potentially higher return. The Fund will generally not
utilize leverage if it anticipates that the Fund's leveraged
capital structure would result in a lower return to holders of
the Common Stock than that obtainable if the Common Stock were
unleveraged for any significant amount of time. Use of leverage
creates an opportunity for increased income and capital
appreciation, but, at the same time, creates special risks. See
"Risk Factors and Special Considerations" and "Other Investment
Policies--Leverage."
The Fund may engage in various portfolio strategies to seek to
increase its return and to hedge its portfolio against
movements in interest rates or foreign currencies through the
use of interest rate or foreign currency swap transactions, the
purchase of call and put options on securities, the sale of
covered call and put options on its portfolio securities and
transactions in financial futures and related options on such
futures. See "Other Investment Policies."
Investment in shares of Common Stock of the Fund offers several
benefits. The Fund offers investors the opportunity to receive
current income and capital appreciation by investing in a
professionally managed portfolio that, to the extent the
portfolio is comprised of Corporate Loans, is a type of
investment typically not available to individual investors. In
managing such portfolio, the Investment Adviser provides the
Fund and its shareholders with professional credit analysis.
The Fund also relieves the investor of the burdensome
administrative details involved in managing a portfolio of such
investments. Additionally, the Investment Adviser will seek to
enhance the return on the Common Stock by leveraging the Fund's
capital structure through the borrowing of money or the
issuance of short-term debt securities or shares of preferred
stock. The benefits are at least partially offset by the
expenses involved in operating an investment company. Such
expenses primarily consist of the advisory fee and operational
costs. Additionally, the use of leverage involves certain
expenses and risk considerations. See "Risk Factors and Special
Considerations" and "Other Investment Policies--Leverage."
LISTING
Prior to this offering, there has been no public market for the
shares of Common Stock of the Fund. The Fund's shares of Common
Stock have been approved for listing on the New York Stock
Exchange, subject to official notice of issuance. However,
during an initial period which is not expected to exceed two
weeks from the date of this Prospectus, the Fund's shares will
4
<PAGE>
not be listed on any securities exchange. During such period,
the Underwriter does not intend to make a market in the Fund's
shares. Consequently, it is anticipated that an investment in
the Fund will be illiquid during such period. See
"Underwriting."
INVESTMENT
ADVISER Fund Asset Management, L.P. is the Fund's investment adviser
(the "Investment Adviser") and is responsible for the
management of the Fund's investment portfolio and for providing
administrative services to the Fund. For its services, the Fund
pays the Investment Adviser a monthly fee at the annual rate of
0.60 of 1% of the Fund's average weekly net assets plus the
proceeds of any outstanding borrowings used for leverage. The
Investment Adviser is an affiliate of Merrill Lynch Asset
Management, L.P. ("MLAM"), which is owned and controlled by
Merrill Lynch & Co., Inc. ("ML & Co."). The Investment Adviser,
or MLAM, acts as the investment adviser for over 100 other
registered management investment companies. The Investment
Adviser also offers portfolio management and portfolio analysis
services to individual and institutional accounts. As of
February 1998, the Investment Adviser and MLAM had a total of
approximately $479 billion in investment company and other
portfolio assets under management, including selected accounts
of certain affiliates of the Investment Adviser. See
"Investment Advisory and Management Arrangements."
DIVIDENDS
AND
DISTRIBUTIONS
The Fund intends to distribute dividends of substantially all
of its net investment income monthly to holders of Common
Stock. All net realized capital gains, if any, will be
distributed to the Fund's shareholders at least annually. See
"Dividends and Distributions."
The Fund expects that it will commence paying dividends within
90 days of the date of this Prospectus.
AUTOMATIC All dividend and capital gains distributions will be
DIVIDEND automatically reinvested in additional shares of Common Stock
REINVESTMENTof the Fund unless a shareholder elects to receive cash.
PLAN Shareholders whose shares are held in the name of a broker or
nominee should contact such broker or nominee to confirm that
they may participate in the Fund's dividend reinvestment plan.
See "Automatic Dividend Reinvestment Plan."
MUTUAL Purchasers of shares of Common Stock of the Fund through
FUND Merrill Lynch in this offering will have an investment option
INVESTMENT consisting of the right to reinvest the net proceeds from a
OPTION sale of such shares (the "Original Shares") in Class D initial
sales charge shares of certain Merrill Lynch-sponsored open-end
mutual funds ("Eligible Class D Shares") at their net asset
value, without the imposition of the initial sales charge, if
the conditions set forth below are satisfied. First, the sale
of the Original Shares must be made through Merrill Lynch, and
the net proceeds therefrom must be immediately reinvested in
Eligible Class D Shares. Second, the Original Shares must have
been either acquired in this offering or be shares representing
reinvested dividends from shares of Common Stock acquired in
this offering. Third, the Original Shares must have been
continuously maintained in a Merrill Lynch securities account.
Fourth, there must be a minimum purchase of $250 to be eligible
for the investment option. Class D shares of the mutual funds
are subject to an account maintenance fee at an annual rate of
up to 0.25% of the average daily net asset value of such mutual
fund. See "Mutual Fund Investment Option."
5
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
The Fund is a newly organized, diversified, closed-end management investment
company and has no operating history. As described under "Prospectus Summary--
Listing," it is anticipated that an investment in the Fund will be illiquid
prior to listing of the Fund's shares of Common Stock on the New York Stock
Exchange. See "Underwriting." Shares of closed-end investment companies
frequently trade at a discount from their net asset value. This risk may be
greater for investors expecting to sell their shares in a relatively short
period after completion of the public offering. Accordingly, the Common Stock
of the Fund is designed primarily for long-term investors and should not be
considered a vehicle for trading purposes. The net asset value of the Fund's
shares of Common Stock will fluctuate with interest rate changes as well as
with price changes of the Fund's portfolio securities and these fluctuations
are likely to be greater in the case of a fund having a leveraged capital
structure, as contemplated for the Fund. See "Investment Objectives and
Policies."
Corporate Loans. The Fund may invest in senior and subordinated Corporate
Loans, both secured and unsecured. A Corporate Loan which is unsecured is not
supported by any specific pledge of collateral and therefore constitutes only a
general obligation of the borrower. In addition to being unsecured, a Corporate
Loan in which the Fund may invest may be subordinate in right of payment to the
senior debt obligations of the borrower. Upon a liquidation or bankruptcy of
the borrower the senior debt obligations of the borrower are often required to
be paid in full before the subordinated debtholders are permitted to receive
any distribution on behalf of their claim. Distributions, if any, to
subordinated debtholders in such situations may consist in whole or in part in
non-income producing securities, including common stock. Accordingly, following
an event of default or liquidation or bankruptcy of a borrower, there can be no
assurance that the assets of the borrower will be sufficient to satisfy the
claims of unsecured and subordinated debtholders or that such debtholders will
receive income producing debt securities in satisfaction of their claims. As a
result, the Fund might not receive payments to which it is entitled and thereby
may experience a decline in the value of its investment and possibly, its net
asset value.
The Fund may invest in Corporate Loans made in connection with highly
leveraged transactions. Corporate Loans made in connection with highly
leveraged transactions are subject to greater credit risks than other Corporate
Loans in which the Fund may invest. These credit risks include a greater
possibility of default or bankruptcy of the borrower and the assertion that the
pledging of collateral, if any, to secure the loan constituted a fraudulent
conveyance or preferential transfer which can be nullified or subordinated to
the rights of other creditors of the borrower under applicable law. Highly
leveraged Corporate Loans also may be less liquid than other Corporate Loans.
The success of the Fund depends to a great degree, on the skill with which
the agent banks administer the terms of the Corporate Loan agreements, monitor
borrower compliance with covenants, collect principal, interest and fee
payments from borrowers and, where necessary, enforce creditor remedies against
borrowers. Typically, the agent bank will have broad discretion in enforcing a
Corporate Loan agreement. The financial status of the agent bank and co-lenders
and participants interposed between the Fund and a borrower may affect the
ability of the Fund to receive payments of interest and principal.
Lower-Rated Securities. Junk bonds and high-yield Corporate Loans are
regarded as being predominantly speculative as to the issuer's ability to make
payments of principal and interest. Investment in such securities involves
substantial risk. Issuers of junk bonds and high-yield Corporate Loans may be
highly leveraged and may not have available to them more traditional methods of
financing. Therefore, the risks associated with acquiring the securities of
such issuers generally are greater than is the case with higher-rated
securities. For
6
<PAGE>
example, during an economic downturn or a sustained period of rising interest
rates, issuers of junk bonds and high-yield Corporate Loans may be more likely
to experience financial stress, especially if such issuers are highly
leveraged. During periods of economic downturn, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments, or the issuer's inability to meet specific
projected business forecasts or the unavailability of additional financing.
Therefore, there can be no assurance that in the future there will not exist a
higher junk bond and high-yield Corporate Loan default rate relative to the
rates currently existing in the junk bond and high-yield Corporate Loan
markets. The risk of loss due to default by the issuer is significantly greater
for the holders of junk bond and high-yield Corporate Loans because such
securities may be unsecured and may be subordinate to other creditors of the
issuer. Other than with respect to Distressed Securities, the junk bonds and
high-yield Corporate Loans in which the Fund may invest do not include
instruments which, at the time of investment, are in default or the issuers of
which are in bankruptcy. However, there can be no assurance that such events
will not occur after the Fund purchases a particular security, in which case
the Fund may experience losses and incur costs.
Junk bonds frequently have call or redemption features that would permit an
issuer to repurchase the security from the Fund. If a call were exercised by
the issuer during a period of declining interest rates, the Fund is likely to
have to replace such called security with a lower yielding security, thus
decreasing the net investment income to the Fund and dividends to shareholders.
Junk bonds and high-yield Corporate Loans tend to be more volatile than
higher-rated debt instruments, so that adverse economic events may have a
greater impact on the prices of junk bonds and high-yield Corporate Loans than
on high-rated debt instruments. Factors adversely affecting the market value of
such securities are likely to affect adversely the Fund's net asset value.
Recently, demand for junk bonds and high-yield Corporate Loans has increased
significantly and the difference between the yields paid by such securities and
investment grade bonds (i.e., the "spread") has narrowed. To the extent this
differential increases, the value of junk bonds and high-yield Corporate Loans
in the Fund's portfolio could be adversely affected.
Like higher-rated debt instruments, junk bonds and high-yield Corporate Loans
generally are purchased and sold through dealers who make a market in such
securities for their own accounts. However, there are fewer dealers in the junk
bond and high-yield Corporate Loan markets, which markets may be less liquid
than the market for higher-rated debt instruments, even under normal economic
conditions. Also, there may be significant disparities in the prices quoted for
junk bonds and high-yield Corporate Loans by various dealers. As a result,
during periods of high demand in the junk bond and high-yield Corporate Loan
markets, it may be difficult to acquire junk bonds and high-yield Corporate
Loans appropriate for investment by the Fund. Adverse economic conditions and
investor perceptions thereof (whether or not based on economic fundamentals)
may impair liquidity in the junk bond and high-yield Corporate Loan markets and
may cause the prices the Fund receives for its junk bonds and high-yield
Corporate Loans to be reduced. In addition, the Fund may experience difficulty
in liquidating a portion of its portfolio when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as
deterioration in the creditworthiness of the issuers. Under such conditions,
judgment may play a greater role in valuing certain of the Fund's portfolio
instruments than in the case of instruments trading in a more liquid market. In
addition, the Fund may incur additional expense to the extent that it is
required to seek recovery upon a default on a portfolio holding or to
participate in the restructuring of the obligation.
Distressed Securities. The Fund may invest up to 20% of its total assets in
Distressed Securities. Distressed Securities are high yield/high risk
securities, including Corporate Loans purchased in the secondary market, which
are the subject of bankruptcy proceedings or otherwise in default as to the
repayment of principal
7
<PAGE>
and/or payment of interest at the time of acquisition by the Fund or are rated
in the lower rating categories (Ca or lower by Moody's and CC or lower by S&P)
or which, if unrated, are in the judgment of the Investment Adviser of
equivalent quality. Investment in Distressed Securities is speculative and
involves significant risk. Distressed Securities frequently do not produce
income while they are outstanding and may require the Fund to bear certain
extraordinary expenses in order to protect and recover its investment.
Therefore, to the extent the Fund pursues its secondary objective of capital
appreciation through investment in Distressed Securities, the Fund's ability to
achieve current income for its shareholders may be diminished. The Fund also
will be subject to significant uncertainty as to when and in what manner and
for what value the obligations evidenced by the Distressed Securities will
eventually be satisfied; e.g., through a liquidation of the obligor's assets,
an exchange offer or plan of reorganization involving the Distressed Securities
or a payment of some amount in satisfaction of the obligation. In addition,
even if an exchange offer is made or plan of reorganization is adopted with
respect to Distressed Securities held by the Fund, there can be no assurance
that the securities or other assets received by the Fund in connection with
such exchange offer or plan of reorganization will not have a lower value or
income potential than may have been anticipated when the investment was made.
Moreover, any securities received by the Fund upon completion of an exchange
offer or plan of reorganization may be restricted as to resale. As a result of
the Fund's participation in negotiations with respect to any exchange offer or
plan of reorganization with respect to an issuer of Distressed Securities, the
Fund may be restricted from disposing of such securities.
Leverage. The use of leverage by the Fund creates an opportunity for
increased net income and capital appreciation for the Common Stock, but, at the
same time, creates special risks. The Fund intends to utilize leverage to
provide the holders of Common Stock with a potentially higher return. Leverage
creates risks for holders of Common Stock, including the likelihood of greater
volatility of net asset value and market price of shares of the Common Stock,
and the risk that fluctuations in interest rates on borrowings and short-term
debt or in the dividend rates on any preferred stock may affect the return to
holders of Common Stock. To the extent the income or capital appreciation
derived from securities purchased with funds received from leverage exceeds the
cost of leverage, the Fund's return will be greater than if leverage had not
been used. Conversely, if the income or capital appreciation from the
securities purchased with such funds is not sufficient to cover the cost of
leverage, the return to the Fund will be less than if leverage had not been
used, and therefore the amount available for distribution to shareholders as
dividends and other distributions will be reduced. In the latter case, the
Investment Adviser in its best judgment may nevertheless determine to maintain
the Fund's leveraged position if it expects that the benefits to the Fund's
shareholders of maintaining the leveraged position will outweigh the current
reduced return. Certain types of borrowings by the Fund may result in the Fund
being subject to covenants in credit agreements relating to asset coverage and
portfolio composition requirements. The Fund may be subject to certain
restrictions on investments imposed by guidelines of one or more nationally
recognized statistical ratings organization which may issue ratings for the
short-term corporate debt securities or preferred stock issued by the Fund.
These guidelines may impose asset coverage or portfolio composition
requirements that are more stringent than those imposed by the Investment
Company Act of 1940, as amended (the "Investment Company Act"). It is not
anticipated that these covenants or guidelines will impede the Investment
Adviser from managing the Fund's portfolio in accordance with the Fund's
investment objectives and policies. See "Other Investment Policies--Leverage."
The Fund at times may borrow from affiliates of the Investment Adviser,
provided that the terms of such borrowings are no less favorable than those
available from comparable sources of funds in the marketplace. As discussed
under "Investment Advisory and Management Arrangements," the fee paid to the
Investment Adviser will be calculated on the basis of the Fund's assets
including proceeds from borrowings for leverage and the issuance of preferred
stock.
8
<PAGE>
Other Investment Management Techniques. The Fund may use various other
investment management techniques that also involve special considerations,
including engaging in interest rate transactions, utilization of options and
futures transactions, utilization of foreign currency swaps, making forward
commitments and lending its portfolio securities. For further discussion of
these practices and the associated risks and special considerations, see "Other
Investment Policies."
Non-U.S. Securities. The Fund may invest up to 20% of its total assets in
financial instruments of issuers domiciled outside the United States or that
are denominated in various foreign currencies and multinational foreign
currency units, provided that the foreign issuers of any non-U.S. dollar
denominated instruments purchased by the Fund are domiciled in a country that
is a member of the OECD. Investing in securities issued by non-U.S. issuers
involves certain special risks not typically involved in U.S. investments,
including fluctuations in foreign exchange rates, future political and economic
developments, the possible imposition of exchange controls or other foreign or
U.S. governmental laws or restrictions applicable to such loans. With respect
to certain countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, currency devaluations, or diplomatic
developments which could affect the Fund's investments in those financial
instruments. Moreover, an individual country's economy may differ favorably or
unfavorably from the U.S. economy in such respects as, but not limited to,
growth of gross national product, rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payments position. In addition,
information with respect to non-U.S. issuers may differ from that available
with respect to U.S. issuers, since non-U.S. issuers are not generally subject
to uniform accounting, auditing and financial reporting standards, practices
and requirements comparable to those applicable to U.S. issuers. The Fund does
not currently intend to hedge its non-U.S. dollar denominated portfolio
investments. Additionally, the Fund may invest in Corporate Loans made to U.S.
Borrowers with significant non-dollar denominated revenues.
Concentration in Financial Institutions. As a result of the Fund's investment
in Corporate Loans, the Fund may be deemed to be concentrated in securities of
issuers in the industry group consisting of financial institutions and their
holding companies, including commercial banks, thrift institutions, insurance
companies and finance companies. Consequently, the Fund is subject to certain
risks associated with such institutions, including, among other things, changes
in governmental regulation, interest rate levels and general economic
conditions. See "Investment Objectives and Policies--Description of Corporate
Loans" and "--Description of Participation Interests."
Illiquid Securities. The Fund may invest in securities that lack an
established secondary trading market or are otherwise considered illiquid. Some
or all of the Corporate Loans in which the Fund invests will be considered to
be illiquid. Liquidity of a security relates to the ability to easily dispose
of the security and the price to be obtained and does not generally relate to
the credit risk or likelihood of receipt of cash at maturity. Illiquid
corporate bonds and notes may trade at a discount from comparable, more liquid
investments.
Antitakeover Provisions. The Fund's Articles of Incorporation include
provisions that could have the effect of limiting the ability of other entities
or persons to acquire control of the Fund or to change the composition of its
Board of Directors and could have the effect of depriving shareholders of an
opportunity to sell their shares at a premium over prevailing market prices by
discouraging a third party from seeking to obtain control of the Fund. See
"Description of Capital Stock--Certain Provisions of the Articles of
Incorporation."
For these reasons, an investment in Common Stock of the Fund may be
speculative in that it involves a high degree of risk and should not constitute
a complete investment program.
9
<PAGE>
FEE TABLE
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load (as a percentage of offering price)................ None
Dividend Reinvestment and Plan Fees................................... None
ANNUAL EXPENSES (as a percentage of net assets attributable to shares of
Common Stock)
Management Fees(a)(b)................................................. 0.60%
Interest Payments on Borrowed Funds(b)................................ None
Other Expenses(b)..................................................... 0.13%
----
Total Annual Expenses(b)............................................ 0.73%
====
</TABLE>
<TABLE>
<CAPTION>
1 3 5 10
EXAMPLE YEAR YEARS YEARS YEARS
------- ---- ----- ----- -----
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a
$1,000 investment, assuming (1) total annual expenses
of 0.73% (assuming no leverage) and 3.93% (assuming
leverage of 33 1/2% of the Fund's total assets) and
(2) a 5% annual return throughout the periods:
Assuming No Leverage................................ $ 7 $ 23 $ 41 $ 91
Assuming Leverage................................... $40 $120 $202 $415
</TABLE>
- --------
(a) See "Investment Advisory and Management Arrangements"--page 32.
(b) In the event the Fund utilizes leverage by borrowing in an amount of
approximately 33 1/3% of the Fund's total assets, it is estimated that the
Management Fees would be 0.90%, Interest Payments on Borrowed Funds would
be 2.90% and Total Annual Expenses would be 3.93%. See "Risk Factors and
Special Considerations--Leverage" and "Other Investment Policies--
Leverage."
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under "Other Expenses" are based on
estimated amounts through the end of the Fund's first fiscal year on an
annualized basis. The Example set forth above assumes reinvestment of all
dividends and distributions and utilizes a 5% annual rate of return as mandated
by Securities and Exchange Commission regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF FUTURE EXPENSES OR ANNUAL RATE OF RETURN, AND
ACTUAL EXPENSES OR ANNUAL RATE OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED
FOR PURPOSES OF THE EXAMPLE.
10
<PAGE>
THE FUND
Debt Strategies Fund II, Inc. (the "Fund") is a newly organized,
diversified, closed-end management investment company. The Fund was
incorporated under the laws of the State of Maryland on December 10, 1997, and
has registered under the Investment Company Act. See "Description of Capital
Stock." The Fund's principal office is located at 800 Scudders Mill Road,
Plainsboro, New Jersey 08536, and its telephone number is (609) 282-2800.
The Fund has been organized as a closed-end investment company. Closed-end
investment companies differ from open-end investment companies (commonly
referred to as mutual funds) in that closed-end investment companies do not
redeem their securities at the option of the shareholder, whereas open-end
companies issue securities redeemable at net asset value at any time at the
option of the shareholder and typically engage in a continuous offering of
their shares. Accordingly, open-end companies are subject to continuous asset
in-flows and out-flows that can complicate portfolio management. However,
shares of closed-end investment companies frequently trade at a discount from
net asset value. This risk may be greater for initial investors expecting to
sell their shares in a relatively short period after completion of the public
offering.
USE OF PROCEEDS
The net proceeds of this offering will be approximately $574,313,000 (or
approximately $660,563,000 assuming the Underwriter exercises the over-
allotment option in full) after payment of organizational and offering costs.
Due to significant current demand for Corporate Loans and high yield debt
securities, investments that, in the judgment of the Investment Adviser, are
appropriate investments for the Fund may not be immediately available.
Therefore, the Fund expects that there will be an initial investment period of
up to six months following the completion of its Common Stock offering before
it is invested in accordance with its investment objectives and policies.
Pending such investment, it is anticipated that all or a portion of the
proceeds will be invested in U.S. government securities or high grade, short-
term money market instruments. See "Investment Objectives and Policies."
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to seek to provide current income
by investing primarily in a diversified portfolio of U.S. companies' debt
instruments, including Corporate Loans, which are rated in the lower rating
categories of the established rating services (Baa or lower by Moody's or BBB
or lower by S&P) or unrated debt instruments which are in the judgment of the
Investment Adviser of equivalent quality. Such investments generally involve
greater volatility of price and risks to principal and income than securities
in the higher rating categories. As a secondary objective, the Fund will seek
capital appreciation. Up to 20% of the Fund's total assets may be invested in
Distressed Securities, which includes publicly offered or privately placed
debt securities and Corporate Loans which, at the time of investment, are the
subject of bankruptcy proceedings or otherwise in default as to the repayment
of principal or payment of interest or are rated in the lowest rating
categories (Ca or lower by Moody's and CC or lower by S&P) or which, if
unrated, are in the judgment of the Investment Adviser of equivalent quality.
Up to 20% of the Fund's total assets may be invested in financial instruments
of issuers domiciled outside the United States or that are denominated in
various foreign currencies and multinational foreign currency units, provided
that the foreign issuers of any non-U.S. dollar denominated instruments
purchased by the Fund are domiciled in a country that is a member of the OECD.
The Fund does
11
<PAGE>
not currently intend to hedge its non-U.S. dollar denominated portfolio
investments. For these reasons, an investment in the Fund may be speculative
in that it involves a high degree of risk and should not constitute a complete
investment program. See "Risk Factors and Special Considerations." Up to 20%
of the Fund's total assets can be invested in convertible debt instruments and
preferred stock, each of which may be converted into common stock or other
securities of the same or a different issuer, and non-convertible preferred
stock. As a result of conversions of convertible securities or upon an
exchange offer or bankruptcy plan of reorganization, a significant portion of
the Fund's total assets may be invested in common stock at certain points in
time. Under normal market conditions, at least 65% of the Fund's total assets
will be invested in debt instruments. The Fund's investment objectives are
fundamental policies and may not be changed without the approval of a majority
of the outstanding voting securities of the Fund (as defined in the Investment
Company Act). There can be no assurance that the investment objectives of the
Fund will be realized.
The Fund's investment policies permit investment in the following asset
classes which are described in greater detail below: (i) senior and
subordinated Corporate Loans, both secured and unsecured, issued either
directly by the borrower or in the form of participation interests in
Corporate Loans made by banks and other financial institutions; (ii) publicly
offered and privately placed high-yield debt securities, senior and
subordinated, both secured and unsecured; and (iii) convertible debt
instruments and preferred stock, each of which may be converted into common
stock or other securities of the same or a different issuer, and non-
convertible preferred stock. The debt securities and Corporate Loans in which
the Fund invests may pay interest at fixed rates or at rates that float at a
margin above a generally recognized base lending rate such as the prime rate
of a designated U.S. bank, or that adjust periodically at a margin above the
CD rate or LIBOR.
Subject to other investment restrictions applicable to the Fund, up to 10%
of the Fund's assets may be invested in debt instruments, including Corporate
Loans, of investment companies (which may or may not be registered under the
Investment Company Act) whose portfolio securities consist entirely of (i)
corporate debt or equity securities acceptable to the Fund's Investment
Adviser or (ii) money market instruments.
Under unusual market or economic conditions or for temporary or defensive or
liquidity purposes, the Fund may invest up to 100% of its assets in securities
issued or guaranteed by the U.S. Government or its instrumentalities or
agencies, certificates of deposits, banker's acceptances, and other bank
obligations, commercial paper rated in the highest category by a nationally
recognized statistical rating organization or other fixed-income securities
deemed by the Investment Adviser to be consistent with a defensive posture.
The yield on such securities may be lower than the yield on lower-rated fixed-
income securities.
Although the Fund will invest primarily in lower-rated securities, other
than with respect to Distressed Securities (which are discussed below) it will
not invest in securities in the lowest rating categories (Ca or below by
Moody's and CC or below by S&P) unless the Investment Adviser believes that
the financial condition of the issuer or the protection afforded to the
particular securities is stronger than would otherwise be indicated by such
low ratings.
The Fund's investment philosophy is based on the belief that, under varying
economic and market conditions, certain debt instruments will perform better
than other debt instruments. The Fund's fully managed approach puts maximum
emphasis on the flexibility of the Investment Adviser to analyze various
opportunities among debt instruments and to make judgments regarding which
debt instruments provide, in the opinion of the Investment Adviser, the
highest potential opportunity for current income and, secondarily, capital
appreciation. This approach distinguishes the Fund from other funds which
often seek either capital growth or current income or are restricted to fixed-
rate securities or floating rate instruments. Consistent with this approach,
when changing
12
<PAGE>
economic conditions and other factors cause the yield difference between
lower-rated and higher-rated securities to narrow, the Fund may purchase
higher-rated securities if the Investment Adviser believes that the risk of
loss of income and principal may be substantially reduced with only a
relatively small reduction in yield.
Investment in the Common Stock of the Fund offers the individual investor
several potential benefits. First, the Fund offers the opportunity to
participate in a portfolio which may contain investments, such as Corporate
Loans, that historically have been available mainly to institutional
investors. In managing such a portfolio, the Investment Adviser provides
professional management which includes the extensive credit analysis needed to
invest in Corporate Loans, junk bonds and Distressed Securities. The Fund also
relieves the investor of the burdensome administrative details involved in
managing a portfolio of such investments. Additionally, the Investment Adviser
may seek to enhance the yield or capital appreciation of the Fund's Common
Stock by leveraging the Fund's capital structure through the borrowing of
money or the issuance of short-term debt securities or shares of preferred
stock. The benefits are at least partially offset by the expenses involved in
running an investment company. Such expenses primarily consist of advisory
fees and operational costs. The use of leverage also involves certain expenses
and risk considerations. See "Risk Factors and Special Considerations" and
"Other Investment Policies--Leverage."
The Fund may engage in various portfolio strategies to seek to increase its
return and to hedge its portfolio against movements in interest rates or
foreign currencies through the use of interest rate or foreign currency swap
transactions, the purchase of call and put options on securities, the sale of
covered call and put options on its portfolio securities and transactions in
financial futures and related options on such futures. Each of these portfolio
strategies is described below. There can be no assurance that the Fund will
employ these strategies or that, if employed, they will be effective.
The Fund may invest in, among other things, the types of instruments
described below:
DESCRIPTION OF CORPORATE LOANS
The Corporate Loans in which the Fund may invest generally consist of direct
obligations of a borrower ("Borrower") undertaken to finance the growth of the
Borrower's business internally or externally, or to finance a capital
restructuring. Corporate Loans may also include obligations of a Borrower
issued in connection with a restructuring or a bankruptcy. A significant
portion of the Corporate Loans in which the Fund invests are highly leveraged
loans, such as leveraged buy-out loans, leveraged recapitalization loans and
other types of acquisition loans. Such Corporate Loans may be structured to
include both term loans, which are generally fully funded at the time of the
Fund's investment and revolving credit facilities, which would require the
Fund to make additional investments in Corporate Loans as required under the
terms of the credit facility. Such Corporate Loans may also include
receivables purchase facilities, which are similar to revolving credit
facilities secured by a Borrower's receivables.
The Fund may invest in senior and subordinated Corporate Loans, both secured
and unsecured. The Corporate Loans in which the Fund invests may be senior
debt obligations of the Borrower and may, in some instances, hold the most
senior position in the capitalization structure of the Borrower (i.e. not
subordinated to other debt obligations in right of payment). Corporate Loans
which are senior debt obligations of the Borrower may be wholly or partially
secured by collateral, or may be unsecured. However, even in the case of a
secured Corporate Loan, upon an event of default the ability of a lender to
have access to the collateral, if any, or otherwise recover its investment may
be limited by bankruptcy and other insolvency laws. The value of the
13
<PAGE>
collateral may decline subsequent to the Fund's investment in the Corporate
Loan. Under certain circumstances, the collateral may be released with the
consent of the syndicate of lenders and the lender which is administering the
Corporate Loan on behalf of the syndicate ("Agent Bank") or pursuant to the
terms of the underlying credit agreement with the Borrower. There is no
assurance that the liquidation of the collateral would satisfy the Borrower's
obligations in the event of the nonpayment of scheduled interest or principal,
or that the collateral could be readily liquidated. As a result, the Fund
might not receive payments to which it is entitled and thereby may experience
a decline in the value of the investment and possibly, its net asset value.
In addition to senior and secured Corporate Loans, the Fund may invest in
Corporate Loans which are unsecured and subordinated. A Corporate Loan which
is unsecured is not supported by any specific pledge of collateral and
therefore constitutes only a general obligation of the Borrower. In addition
to being unsecured a Corporate Loan in which the Fund may invest may be
subordinate in right of payment to the senior debt obligations of the
Borrower. Upon a liquidation or bankruptcy of the Borrower the senior debt
obligations of the Borrower are often required to be paid in full before the
subordinated debtholders are permitted to receive any distribution on behalf
of their claim. Distributions, if any, to subordinated debtholders in such
situations may consist in whole or in part in non-income producing securities,
including common stock. Accordingly, following an event of default or
liquidation or bankruptcy of a Borrower, there can be no assurance that the
assets of the Borrower will be sufficient to satisfy the claims of unsecured
and subordinated debtholders or that such debtholders will receive income
producing debt securities in satisfaction of their claims. As a result, the
Fund might not receive payments to which it is entitled and thereby may
experience a decline in the value of its investment and possibly, its net
asset value.
Corporate Loans made in connection with highly leveraged transactions are
subject to greater risks than other Corporate Loans in which the Fund may
invest. These credit risks include a greater possibility of default or
bankruptcy of the Borrower, and the potential assertion that the pledging of
collateral, if any, to secure the loan constituted a fraudulent conveyance or
preferential transfer which can be nullified or subordinated to the rights of
other creditors of the Borrower under applicable law. Highly leveraged
Corporate Loans may also be less liquid than other Corporate Loans.
The rate of interest payable on floating or variable rate Corporate Loans is
established as the sum of a base lending rate used by commercial lenders plus
a specified margin. These base lending rates generally are the Prime Rate of a
designated U.S. bank, LIBOR, the CD rate or another base lending rate used by
commercial lenders. The interest rate on Prime Rate-based Corporate Loans
floats daily as the Prime Rate changes, while the interest rate on LIBOR-based
and CD-based Corporate Loans is reset periodically, typically every 30 days to
one year. Certain of the floating or variable rate Corporate Loans in which
the Fund will invest may permit the Borrower to select an interest rate reset
period of up to one year. A portion of the Fund's portfolio may be invested in
Corporate Loans with longer interest rate reset periods or fixed interest
rates which are generally more susceptible to interest rate risks in the event
of fluctuations in prevailing interest rates.
The Fund may receive and/or pay certain fees in connection with its
investments in Corporate Loans. These fees are in addition to interest
payments received and may include facility fees, commissions and prepayment
penalty fees. When the Fund buys a Corporate Loan it may receive a facility
fee and when it sells a Corporate Loan it may pay a facility fee. In certain
circumstances, the Fund may receive a prepayment penalty fee on the prepayment
of a Corporate Loan by a Borrower. These fees are intended to adjust the yield
on such Corporate Loans. In connection with the acquisition of Corporate
Loans, the Fund may also acquire warrants and other
14
<PAGE>
debt or equity securities of the Borrower or its affiliates. The acquisition
of such securities will only be incidental to the Fund's purchase of an
interest in a Corporate Loan.
In making an investment in a Corporate Loan, the Investment Adviser will
consider factors deemed by it to be appropriate to the analysis of the
Borrower and the Corporate Loan. Such factors include financial ratios of the
Borrower such as pre-tax interest coverage, leverage ratios, and the ratios of
cash flows to total debts and the ratio of tangible assets to debt. In its
analysis of these factors, the Investment Adviser also will be influenced by
the nature of the industry in which the Borrower is engaged, the nature of the
Borrower's assets and the Investment Adviser's assessments of the general
quality of the Borrower.
A Borrower also may be required to comply with various restrictive covenants
contained in any loan agreement between the Borrower and the lending syndicate
("Corporate Loan Agreement"). Such covenants, in addition to requiring the
scheduled payment of interest and principal, may include restrictions on
dividend payments and other distributions to stockholders, provisions
requiring the Borrower to maintain specific financial ratios or relationships
and limits on total debt. In addition, a Corporate Loan Agreement may contain
a covenant requiring the Borrower to prepay the Corporate Loan with any excess
cash flow. Excess cash flow generally includes net cash flow after scheduled
debt service payments and permitted capital expenditures, among other things,
as well as the proceeds from asset dispositions or sales of securities. A
breach of covenant (after giving effect to any cure period) which is not
waived by the Agent Bank and the lending syndicate normally is an event of
acceleration, i.e., the Agent Bank has the right to call the outstanding
Corporate Loan, generally at the request of the lending syndicate.
The Fund has no restrictions on portfolio maturity, but it is anticipated
that a majority of the Corporate Loans will have stated maturities ranging
from five to ten years. However, such Corporate Loans usually will require, in
addition to scheduled payments of interest and principal, the prepayment of
the Corporate Loans from excess cash flow, as discussed above, and may permit
the Borrower to prepay at its election. The degree to which Borrowers prepay
Corporate Loans, whether as a contractual requirement or at their election,
may be affected by general business conditions, the financial condition of the
Borrower and competitive conditions among lenders, among other factors.
Accordingly, prepayments cannot be predicted with accuracy.
Loans to non-U.S. Borrowers or to U.S. Borrowers with significant non-
dollar-denominated revenues may provide for conversion of all or part of the
loan from a dollar-denominated obligation into a foreign currency obligation
at the option of the Borrower.
DESCRIPTION OF PARTICIPATION INTERESTS
Corporate Loans in which the Fund may invest are typically originated,
negotiated and structured by a syndicate of lenders ("Co-Lenders") consisting
of commercial banks, thrift institutions, insurance companies, finance
companies or other financial institutions, one or more of which acts as Agent
Bank. Co-Lenders may sell Corporate Loans to third parties called
"Participants." The Fund may invest in a Corporate Loan either by
participating as a Co-Lender at the time the loan is originated or by buying
an interest in the Corporate Loan from a Co-Lender or a Participant. Co-
Lenders and Participants interposed between the Fund and a Borrower, together
with Agent Banks, are referred to herein as "Intermediate Participants."
The Fund may invest in a Corporate Loan at origination as a Co-Lender or by
purchasing a Corporate Loan from an Intermediate Participant by means of a
novation, an assignment or a participation. In a novation, the
15
<PAGE>
Fund would assume all of the rights of the Intermediate Participant in a
Corporate Loan, including the right to receive payments of principal and
interest and other amounts directly from the Borrower and to enforce its
rights as lender directly against the Borrower and would assume all of the
obligations of the Intermediate Participant, including any obligation to make
future advances to the Borrower. As a result, therefore, the Fund would have
the status of a Co-Lender. As an alternative, the Fund may purchase an
assignment of all or a portion of an Intermediate Participant's interest in a
Corporate Loan, in which case the Fund may be required generally to rely on
the assigning lender to demand payment and enforce its rights against the
Borrower, but would otherwise be entitled to all of such lender's rights in
the Corporate Loan. The Fund also may purchase a participation in a portion of
the rights of an Intermediate Participant in a Corporate Loan by means of a
participation agreement with such Intermediate Participant. A participation in
the rights of an Intermediate Participant is similar to an assignment in that
the Intermediate Participant transfers to the Fund all or a portion of an
interest in a Corporate Loan. Unlike an assignment, however, a participation
does not establish any direct relationship between the Fund and the Borrower.
In such a case, the Fund would be required to rely on the Intermediate
Participant that sold the participation not only for the enforcement of the
Fund's rights against the Borrower but also for the receipt and processing of
payments due to the Fund under the Corporate Loan. The Fund will not act as an
Agent Bank, guarantor, sole negotiator or sole structurer with respect to a
Corporate Loan.
Because it may be necessary to assert through an Intermediate Participant
such rights as may exist against the Borrower, in the event that the Borrower
fails to pay principal and interest when due, the Fund may be subject to
delay, expense and risks that are greater than those that would be involved if
the Fund could enforce its rights directly against the Borrower. Moreover,
under the terms of the participation, the Fund may be regarded as a creditor
of the Intermediate Participant (rather than of the Borrower), so that the
Fund may also be subject to the risk that the Intermediate Participant may
become insolvent. Similar risks may arise with respect to the Agent Bank, as
described below. Further, in the event of the bankruptcy or insolvency of the
Borrower, the obligation of the Borrower to repay the Corporate Loan may be
subject to certain defenses that can be asserted by such Borrower as result of
improper conduct by the Agent Bank or Intermediate Participant.
Because the Fund will regard the issuer of a Corporate Loan as including the
Borrower under a Corporate Loan Agreement, the Agent Bank and any Intermediate
Participant, the Fund may be deemed to be concentrated in securities of
issuers in the industry group consisting of financial institutions and their
holding companies, including commercial banks, thrift institutions, insurance
companies and finance companies. As a result, the Fund is subject to certain
risks associated with such institutions. Banking and thrift institutions are
subject to extensive governmental regulations which may limit both the amounts
and types of loans and other financial commitments which such institutions may
make and the profitability of these institutions is largely dependent on the
availability and cost of capital funds. In addition, general economic
conditions are important to the operation of these institutions, with exposure
to credit losses resulting from possible financial difficulties of borrowers
potentially having an adverse effect. Insurance companies are also affected by
economic and financial conditions and are subject to extensive government
regulation, including rate regulations. Individual companies may be exposed to
material risks, including reserve inadequacy.
In a typical Corporate Loan, the Agent Bank administers the terms of the
Corporate Loan Agreement and is responsible for the collection of principal
and interest and fee payments from the Borrower and the apportionment of these
payments to the credit of all investors which are parties to the Corporate
Loan Agreement. The Fund generally will rely on the Agent Bank or an
Intermediate Participant to collect its portion of the payments on the
Corporate Loan. Furthermore, the Fund will rely on the Agent Bank to enforce
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<PAGE>
appropriate creditor remedies against the Borrower. Typically, under Corporate
Loan Agreements, the Agent Bank is given broad discretion in enforcing the
Corporate Loan Agreement, and it is obliged to use only the same care it would
use in the management of its own property. For these services the Borrower
compensates the Agent Bank. Such compensation may include special fees paid on
structuring and funding the Corporate Loan and other fees paid on a continuing
basis.
In the event that an Agent Bank becomes insolvent, or has a receiver,
conservator, or similar official appointed for it by the appropriate bank
regulatory authority or becomes a debtor in a bankruptcy proceeding, assets
held by the Agent Bank under the Corporate Loan Agreement should remain
available to holders of Corporate Loans. If, however, assets held by the Agent
Bank for the benefit of the Fund are determined by an appropriate regulatory
authority or court to be subject to the claims of the Agent Bank's general or
secured creditors, the Fund might incur certain costs and delays in realizing
payment on a Corporate Loan, or suffer a loss of principal and/or interest. In
situations involving Intermediate Participants similar risks may arise, as
described above.
Intermediate Participants may have certain obligations pursuant to a
Corporate Loan Agreement, which may include the obligation to make future
advances to the Borrower in connection with revolving credit facilities in
certain circumstances. The Fund currently intends to reserve against such
contingent obligations by segregating sufficient investments in liquid
instruments. The Fund will not invest in Corporate Loans that would require
the Fund to make any additional investments in connection with such future
advances if such commitments would exceed 20% of the Fund's total assets or
would cause the Fund to fail to meet the diversification requirements
described under "Investment Objectives and Policies."
DESCRIPTION OF HIGH-YIELD SECURITIES
The Fund may invest in high-yield corporate debt securities, including
Corporate Loans, which are rated in the lower rating categories of the
established rating services (Baa or lower by Moody's and BBB or lower by S&P),
or in unrated securities considered by the Investment Adviser to be of
comparable quality. Securities rated below Baa by Moody's or below BBB by S&P,
and unrated securities of comparable quality, are commonly known as "junk
bonds." See Appendix--"Description of Corporate Bond Ratings" for additional
information concerning rating categories.
Although high-yield securities can be expected to provide higher yields,
such securities may be subject to greater market fluctuations and risk of loss
of income and principal than lower-yielding, higher-rated fixed-income
securities. As described under "Risk Factors and Special Considerations,"
economic conditions and interest rate levels may impact significantly the
values of high-yield securities. In addition, high-yield securities are often
unsecured and subordinated obligations of the issuer. Accordingly, following
an event of default or liquidation or bankruptcy of the issuer, the Fund might
not receive payments to which it is entitled, or may receive distributions of
non-income producing securities, including common stock, and thereby may
experience a decline in the value of its investment and possibly its net asset
value.
Selection and supervision of high-yield securities by the Investment Adviser
involves continuous analysis of individual issuers, general business
conditions and other factors which may be too time-consuming or too costly for
the average investor. The furnishing of these services does not, of course,
guarantee successful results. The Investment Adviser's analysis of issuers
includes, among other things, historic and current financial conditions,
current and anticipated cash flow and borrowing requirements, value of assets
in relation to historical
17
<PAGE>
costs, strength of management, responsiveness to business conditions, credit
standing and current and anticipated results of operations. Analysis of
general conditions and other factors may include anticipated change in
economic activity and interest rates, the availability of new investment
opportunities and the economic outlook for specific industries. While the
Investment Adviser considers as one factor in its credit analysis the ratings
assigned by the rating services, the Investment Adviser performs its own
independent credit analysis of issuers and, consequently, the Fund may invest,
without limit, in unrated securities. As a result, the Fund's ability to
achieve its investment objectives may depend to a greater extent on the
Investment Adviser's own credit analysis than investment companies which
invest in higher-rated securities. Although the Fund will invest primarily in
lower-rated securities, other than with respect to Distressed Securities
(which are discussed below) it will not invest in securities in the lowest
rating categories (Ca or below by Moody's and CC or below by S&P) unless the
Investment Adviser believes that the financial condition of the issuers or the
protection afforded to the particular securities is stronger than would
otherwise be indicated by such ratings. Securities which subsequently are
downgraded may continue to be held by the Fund and will be sold only if, in
the judgment of the Investment Adviser, it is advantageous to do so.
In connection with its investments in corporate debt securities, or
restructuring of investments owned by the Fund, the Fund may receive warrants
or other non-income producing debt or equity securities. The Fund may retain
such securities until the Investment Adviser determines it is appropriate in
light of current market conditions to effect a disposition of such securities.
When changing economic and other factors cause the yield difference between
lower-rated and higher-rated securities to narrow, the Fund may purchase
higher-rated securities if the Investment Adviser believes that the risk of
loss of income and principal may be reduced substantially with only a
relatively small reduction in yield.
DESCRIPTION OF DISTRESSED SECURITIES
The Fund may invest up to 20% of its total assets in Distressed Securities.
Distressed Securities are high yield/high risk securities, including Corporate
Loans purchased in the secondary market, which are the subject of bankruptcy
proceedings or otherwise in default as to the repayment of principal and/or
payment of interest at the time of acquisition by the Fund or are rated in the
lower rating categories (Ca or lower by Moody's and CC or lower by S&P) or
which, if unrated, are in the judgment of the Investment Adviser of equivalent
quality. Investment in Distressed Securities is speculative and involves
significant risk. Distressed Securities frequently do not produce income while
they are outstanding and may require the Fund to bear certain extraordinary
expenses in order to protect and recover its investment. Therefore, to the
extent the Fund pursues its secondary objective of capital appreciation
through investment in Distressed Securities, the Fund's ability to achieve
current income for its shareholders may be diminished. The Fund also will be
subject to significant uncertainty as to when and in what manner and for what
value the obligations evidenced by the Distressed Securities will eventually
be satisfied; e.g., through a liquidation of the obligor's assets, an exchange
offer or plan of reorganization involving the Distressed Securities or a
payment of some amount in satisfaction of the obligation. In addition, even if
an exchange offer is made or plan of reorganization is adopted with respect to
Distressed Securities held by the Fund, there can be no assurance that the
securities or other assets received by the Fund in connection with such
exchange offer or plan of reorganization will not have a lower value or income
potential than may have been anticipated when the investment was made.
Moreover, any securities received by the Fund upon completion of an exchange
offer or plan of reorganization may be restricted as to resale. As a result of
the Fund's participation in negotiations with respect to any exchange offer or
plan of reorganization with respect to an issuer of Distressed Securities, the
Fund may be restricted from disposing of such securities. See "Risk Factors
and Special Considerations."
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<PAGE>
DESCRIPTION OF CONVERTIBLE SECURITIES AND PREFERRED STOCK
A convertible security is a bond, debenture, note or preferred stock that
may be converted into or exchanged for a prescribed amount of common stock or
other securities of the same or a different issuer within a particular period
of time at a specified price or formula. A convertible security entitles the
holder to receive interest generally paid or accrued on debt or the dividend
paid on preferred stock until the convertible security matures or is redeemed,
converted or exchanged. Convertible securities have several unique investment
characteristics such as (i) higher yields than common stocks, but lower yields
than comparable nonconvertible securities, (ii) a lesser degree of fluctuation
in value than the underlying stock since they have fixed income
characteristics, and (iii) the potential for capital appreciation if the
market price of the underlying common stock increases. Holders of convertible
securities have a claim on the assets of the issuer prior to the common
stockholders but may be subordinated to similar non-convertible securities of
the same issuer. A convertible security might be subject to redemption at the
option of the issuer at a price established in the convertible security's
governing instrument. If a convertible security held by the Fund is called for
redemption, the Fund may be required to permit the issuer to redeem the
security, convert it into the underlying common stock or other securities or
sell it to a third party.
The Fund may invest in non-convertible preferred stock which generally
entitles the holders to receive a dividend payment. Holders of preferred stock
have a claim on the assets of the issuer prior to the common stockholders but
subordinate to the creditors and holders of debt instruments of the same
issuer. Preferred stock may be subject to redemption at the option of the
issuer at a price established in the preferred stock governing instrument.
ILLIQUID SECURITIES
Corporate Loans, junk bonds, and other securities held by the Fund may not
be readily marketable and may be subject to restrictions on resale. Although
Corporate Loans are transferred among certain financial institutions, as
described above, the Corporate Loans in which the Fund invests may not have
the liquidity of conventional debt securities traded in the secondary market
and may be considered illiquid. As the market for Corporate Loans becomes more
seasoned, the Investment Adviser expects that liquidity will improve. The Fund
has no limitation on the amount of its investments which are not readily
marketable or are subject to restrictions on resale.
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
LEVERAGE
At times, the Fund expects to utilize leverage through borrowings, including
the issuance of short-term debt securities, or the issuance of shares of
preferred stock. Under current market conditions, the Fund intends to utilize
leverage in an amount equal to approximately 33 1/3% of its total assets
(including the amount obtained from leverage). The Fund will generally not
utilize leverage if it anticipates that the Fund's leveraged capital structure
would result in a lower return to holders of the Common Stock than that
obtainable if the Common Stock were unleveraged for any significant amount of
time. The Fund may also borrow money as a temporary measure for extraordinary
or emergency purposes, including the payment of dividends and the settlement
of securities transactions which may otherwise require untimely dispositions
of Fund securities. The Fund at times may borrow from affiliates of the
Investment Adviser, provided that the terms of such borrowings are no less
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<PAGE>
favorable than those available from comparable sources of funds in the
marketplace. As discussed under "Investment Advisory and Management
Arrangements," the fee paid to the Investment Adviser will be calculated on
the basis of the Fund's assets including proceeds from borrowings for leverage
and the issuance of preferred stock.
The concept of leveraging is based on the premise that the cost of the
assets to be obtained from leverage will be based on short-term 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) will be invested in higher yielding portfolio
investments or portfolio investments with the potential for capital
appreciation, the holders of Common Stock will be the beneficiaries of the
incremental return. Should the differential between the return on the
underlying assets and the cost of leverage narrow, the incremental return
"pick up" will be reduced. Furthermore, if long-term rates rise, the Common
Stock net asset value will reflect the decline in the value of portfolio
holdings resulting therefrom.
Leverage creates risks for the holders of Common Stock, including the
likelihood of greater volatility of net asset value and market price of shares
of the Common Stock, and the risk that fluctuations in interest rates on
borrowings or in the dividend rates on any preferred stock may affect the
return to the holders of Common Stock. To the extent the income or capital
appreciation derived from securities purchased with funds received from
leverage exceeds the cost of leverage, the Fund's return will be greater than
if leverage had not been used. Conversely, if the income or capital
appreciation from the securities purchased with such funds is not sufficient
to cover the cost of leverage, the return of the Fund will be less than if
leverage had not been used, and therefore the amount available to shareholders
as dividends and other distributions will be reduced. In the latter case, the
Investment Adviser in its best judgment may nevertheless determine to maintain
the Fund's leveraged position if it expects that the benefits to the Fund's
shareholders of maintaining the leveraged position will outweigh the current
reduced return.
Capital raised through leverage will be subject to interest costs or
dividend payments which may or may not exceed the income and appreciation on
the assets purchased. The Fund also may be required to maintain minimum
average balances in connection with borrowings or to pay a commitment or other
fee to maintain a line of credit. Either of these requirements will increase
the cost of borrowing over the stated interest rate. The issuance of preferred
stock involves offering expenses and other costs and may limit the Fund's
freedom to pay dividends on shares of Common Stock or to engage in other
activities. Borrowings and the issuance of preferred stock having priority
over the Fund's Common Stock create an opportunity for greater return per
share of Common Stock, but at the same time such borrowing or issuance of
preferred stock is a speculative technique in that it will increase the Fund's
exposure to capital risk. Such risks may be reduced through the use of
borrowings and preferred stock that have floating rates of interest. Unless
the income and appreciation, if any, on assets acquired with borrowed funds or
offering proceeds exceeds the cost of borrowing or issuing additional classes
of securities, the use of leverage will diminish the investment performance of
the Fund compared with what it would have been without leverage.
Certain types of borrowings may result in the Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more nationally recognized
statistical rating organizations which may issue ratings for the short-term
corporate debt securities or preferred stock. These guidelines may impose
asset coverage or portfolio composition requirements that are more stringent
than those imposed by the Investment Company Act. It is not anticipated that
these covenants or guidelines will impede the Investment Adviser from managing
the Fund's portfolio in accordance with the Fund's investment objectives and
policies.
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Under the Investment Company Act, the Fund is not permitted to incur
indebtedness unless immediately after such incurrence the Fund has an asset
coverage of 300% of the aggregate outstanding principal balance of
indebtedness (i.e., such indebtedness may not exceed 33 1/3% of the Fund's
total assets). Additionally, under the Investment Company Act the Fund may not
declare any dividend or other distribution upon any class of its capital
stock, or purchase any such capital stock, unless the aggregate indebtedness
of the Fund has, at the time of the declaration of any such dividend or
distribution or at the time of any such purchase, an asset coverage of at
least 300% after deducting the amount of such dividend, distribution, or
purchase price, as the case may be. Under the Investment Company Act, the Fund
is not permitted to issue shares of preferred stock unless immediately after
such issuance the net asset value of the Fund's portfolio is at least 200% of
the liquidation value of the outstanding preferred stock (i.e., such
liquidation value may not exceed 50% of the Fund's total assets). In addition,
the Fund is not permitted to declare any cash dividend or other distribution
on its Common Stock unless, at the time of such declaration, the net asset
value of the Fund's portfolio (determined after deducting the amount of such
dividend or distribution) is a least 200% of such liquidation value. In the
event shares of preferred stock are issued, the Fund intends, to the extent
possible, to purchase or redeem shares of preferred stock from time to time to
maintain coverage of any preferred stock of at least 300%.
The Fund's willingness to borrow money and issue new securities for
investment purposes, and the amount it will borrow or issue, will depend on
many factors, the most important of which are investment outlook, market
conditions and interest rates. Successful use of a leveraging strategy depends
on the Investment Adviser's ability to predict correctly interest rates and
market movements, and there is no assurance that a leveraging strategy will be
successful during any period in which it is employed.
Assuming the utilization of leverage by borrowings in the amount of
approximately 33 1/3% of the Fund's total assets, and an annual interest rate
of 5.875% payable on such leverage based on market rates as of the date of
this Prospectus, the annual return that the Fund's portfolio must experience
(net of expenses) in order to cover such interest payments would be 1.96%.
The following table is designed to illustrate the effect on the return to a
holder of the Fund's Common Stock of the leverage obtained by borrowings in
the amount of approximately 33 1/3% of the Fund's total assets, assuming
hypothetical annual returns of the Fund's portfolio of minus 10% to plus 10%.
As the table shows, leverage generally increases the return to stockholders
when portfolio return is positive and greater than the cost of leverage and
decreases the return when the portfolio return is negative or less than the
cost of leverage. The figures appearing in the table are hypothetical and
actual returns may be greater or less than those appearing in the table.
<TABLE>
<S> <C> <C> <C> <C> <C>
Assumed Portfolio Return (net of expenses)........ (10)% (5)% 0 % 5% 10%
Corresponding Common Stock Return................. (18)% (10)% (3)% 5% 12%
</TABLE>
Until the Fund borrows or issues shares of preferred stock, the Fund's
Common Stock will not be leveraged, and the risks and special considerations
related to leverage described in this Prospectus will not apply. Such
leveraging of the Common Stock cannot be fully achieved until the proceeds
resulting from the use of leverage have been invested in longer-term debt
instruments in accordance with the Fund's investment objectives and policies.
INTEREST RATE TRANSACTIONS
In order to hedge the value of the Fund's portfolio against interest rate
fluctuations or to enhance the Fund's income the Fund may enter into various
interest rate transactions, such as interest rate swaps and the purchase or
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<PAGE>
sale of interest rate caps and floors. The Fund expects to enter into these
transactions primarily to preserve a return or spread on a particular
investment or portion of its portfolio or to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date. The
Fund intends to use these transactions primarily as a hedge and not as a
speculative investment. However, the Fund may also invest in interest rate
swaps to enhance income or increase the Fund's yield, for example, during
periods of steep interest rate yield curves (i.e., wide differences between
short term and long term interest rates).
In an interest rate swap, the Fund exchanges with another party their
respective commitments to pay or receive interest, e.g., an exchange of fixed
rate payments for floating rate payments. For example, if the Fund holds a
debt instrument with an interest rate that is reset only once each year, it
may swap the right to receive interest at this fixed rate for the right to
receive interest at a rate that is reset every week. This would enable the
Fund to offset a decline in the value of the debt instrument due to rising
interest rates but would also limit its ability to benefit from falling
interest rates. Conversely, if the Fund holds a debt instrument with an
interest rate that is reset every week and it would like to lock in what it
believes to be a high interest rate for one year, it may swap the right to
receive interest at this variable weekly rate for the right to receive
interest at a rate that is fixed for one year. Such a swap would protect the
Fund from a reduction in yield due to falling interest rates and may permit
the Fund to enhance its income through the positive differential between one
week and one year interest rates, but would preclude it from taking full
advantage of rising interest rates.
The Fund usually will enter into interest rate swaps on a net basis, i.e.,
the two payment streams are netted out, with the Fund receiving or paying, as
the case may be, only the net amount of the two payments. The net amount of
the excess, if any, of the Fund's obligations over its entitlements with
respect to each interest rate swap will be accrued on a daily basis, and an
amount of cash or liquid instruments having an aggregate net asset value at
least equal to the accrued excess will be maintained in a segregated account
by the Fund's custodian. If the interest rate swap transaction is entered into
on other than a net basis, the full amount of the Fund's obligations will be
accrued on a daily basis, and the full amount of the Fund's obligations will
be maintained in a segregated account by the Fund's custodian.
The Fund may also engage in interest rate transactions in the form of
purchasing or selling interest rate caps or floors. The Fund will not sell
interest rate caps or floors that it does not own. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds
a predetermined interest rate, to receive payments of interest equal to the
difference of the index and the predetermined rate on a notional principal
amount (the reference amount with respect to which interest obligations are
determined although no actual exchange of principal occurs) from the party
selling such interest rate cap. The purchase of an interest rate floor
entitles the purchaser, to the extent that a specified index falls below a
predetermined interest rate, to receive payments of interest at the difference
of the index and the predetermined rate on a notional principal amount from
the party selling such interest rate floor. The Fund will not enter into caps
or floors if, on a net basis, the aggregate notional principal amount with
respect to such agreements exceeds the net assets of the Fund.
Typically, the parties with which the Fund will enter into interest rate
transactions will be broker-dealers and other financial institutions. The Fund
will not enter into any interest rate swap, cap or floor transaction unless
the unsecured senior debt or the claims-paying ability of the other party
thereto is rated investment grade quality by at least one nationally
recognized statistical rating organization at the time of entering into such
transaction or whose creditworthiness is believed by the Investment Adviser to
be equivalent to such rating. If there is a default by the other party to such
a transaction, the Fund will have contractual remedies pursuant to the
agreements related to the transaction. The swap market has grown substantially
in recent years with a large
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<PAGE>
number of banks and investment banking firms acting both as principals and as
agents utilizing standardized swap documentation. As a result, the swap market
has become relatively liquid in comparison with other similar instruments
traded in the interbank market. Caps and floors, however, are more recent
innovations and are less liquid than swaps. Certain Federal income tax
requirements may limit the Fund's ability to engage in certain interest rate
transactions. Gains from transactions in interest rate swaps distributed to
shareholders will be taxable as ordinary income or, in certain circumstances,
as long-term capital gains to shareholders. See "Taxes."
FOREIGN CURRENCY SWAPS
Although the Fund has no current intention to do so, the Fund may enter into
foreign currency swaps in order to hedge non-U.S. dollar denominated portfolio
investments.
Foreign currency swaps involve the exchange by the lenders, including the
Fund, with another party (the "counterparty") of the right to receive the
currency in which the loan is denominated for the right to receive dollars.
The Fund will generally enter into a transaction subject to a foreign currency
swap only if, at the time of entering into such swap, the outstanding debt
obligations of the counterparty are investment grade; i.e., rated BBB or A-3
or higher by S&P, Baa or B3 or higher by Moody's, BBB or F4 or higher by Fitch
IBCA, Inc., or are determined to be of comparable quality in the judgment of
the Investment Adviser. The amounts of dollar payments to be received by the
lenders and the foreign currency payments to be received by the counterparty
are fixed at the time the swap arrangement is entered into. Accordingly, the
swap protects the Fund from fluctuations in exchange rates and locks in the
right to receive payments under the loan in a predetermined amount of dollars.
If there is a default by the counterparty the Fund will have contractual
remedies pursuant to the swap arrangement. However, the dollar value of the
Fund's right to foreign currency payments under the loan will be subject to
fluctuations in the applicable exchange rate to the extent that a replacement
swap arrangement is unavailable or the Fund is unable to recover damages from
the defaulting counterparty. If the Borrower defaults on or prepays the
underlying Corporate Loan, the Fund may be required pursuant to the swap
arrangements to compensate the counterparty to the extent of fluctuations in
exchange rates adverse to the counterparty. In the event of such a default or
prepayment, an amount of cash or liquid instruments having an aggregate net
asset value at least equal to the amount of compensation that must be paid to
the counterparty pursuant to the swap arrangements will be maintained in a
segregated account by the Fund's custodian.
OPTIONS ON PORTFOLIO SECURITIES
Call Options on Portfolio Securities. The Fund may purchase call options on
any of the types of securities in which it may invest. A purchased call option
gives the Fund the right to buy, and obligates the seller to sell, the
underlying security at the exercise price at any time during the option
period. The Fund also is authorized to write (i.e., sell) covered call options
on the securities in which it may invest and to enter into closing purchase
transactions with respect to certain of such options. A covered call option is
an option where the Fund, in return for a premium, gives another party a right
to buy specified securities owned by the Fund at a specified future date and
price set at the time of the contract. The principal reason for writing call
options is attempt to realize, through the receipt of premiums, a greater
return than would be realized on the securities alone. By writing covered call
options, the Fund gives up the opportunity, while the option is in effect, to
profit from any price increase in the underlying security above the option
exercise price. In addition, the Fund's ability to sell the underlying
security will be limited while the option is in effect unless the Fund effects
a closing purchase transaction. A closing purchase transaction cancels out the
Fund's position as the writer of an option by means of an offsetting purchase
of an identical option prior to the expiration of the option it has written.
Covered call
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<PAGE>
options also serve as a partial hedge against the price of the underlying
security declining. The Fund may also purchase and sell call options on
indices. Index options are similar to options on securities except that,
rather than taking or making delivery of securities underlying the option at a
specified price upon exercise, an index option gives the holder the right to
receive cash upon exercise of the option if the level of the index upon which
the option is based is greater than the exercise price of the option.
Put Options on Portfolio Securities. The Fund is authorized to purchase put
options to hedge against a decline in the value of its securities. By buying a
put option, the Fund has a right to sell the underlying security at the
exercise price, thus limiting the Fund's risk of loss through a decline in the
market value of the security until the put option expires. The amount of any
appreciation in the value of the underlying security will be partially offset
by the amount of the premium paid for the put option and any related
transaction costs. Prior to its expiration, a put option may be sold in a
closing sale transaction and profit or loss from the sale will depend on
whether the amount received is more or less than the premium paid for the put
option plus the related transaction costs. A closing sale transaction cancels
out the Fund's position as the purchaser of an option by means of an
offsetting sale of an identical option prior to the expiration of the option
it has purchased. The Fund also has authority to write (i.e., sell) put
options on the types of securities which may be held by the Fund, provided
that such put options are covered, meaning that such options are secured by
segregated, liquid instruments. The Fund will receive a premium for writing a
put option, which increases the Fund's return. The Fund will not sell puts if,
as a result, more than 50% of the Fund's assets would be required to cover its
potential obligations under its hedging and other investment transactions. The
Fund may purchase and sell put options on indices. Index options are similar
to options on securities except that, rather than taking or making delivery of
securities underlying the option at a specified price upon exercise, an index
option gives the holder the right to receive cash upon exercise of the option
if the level of the index upon which the option is based is less than the
exercise price of the option.
FINANCIAL FUTURES AND OPTIONS THEREON
The Fund is authorized to engage in transactions in financial futures
contracts ("futures contracts") and related options on such futures contracts
either as a hedge against adverse changes in the market value of its portfolio
securities and interest rates or to enhance the Fund's income. A futures
contract is an agreement between two parties which obligates the purchaser of
the futures contract to buy and the seller of a futures contract to sell a
security for a set price on a future date or, in the case of an index futures
contract to make and accept a cash settlement based upon the difference in
value of the index between the time the contract was entered into and the time
of its settlement. A majority of transactions in futures contracts, however,
do not result in the actual delivery of the underlying instrument or cash
settlement, but are settled through liquidation, i.e., by entering into an
offsetting transaction. Futures contracts have been designed by boards of
trade which have been designated "contract markets" by the Commodities Futures
Trading Commission ("CFTC"). Transactions by the Fund in futures contracts and
financial futures are subject to limitations as described below under
"Restrictions on the Use of Futures Transactions."
The Fund may sell financial futures contracts in anticipation of an increase
in the general level of interest rates. Generally, as interest rates rise, the
market values of securities which may be held by the Fund will fall, thus
reducing the net asset value of the Fund. However, as interest rates rise, the
value of the Fund's short position in the futures contract will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of the Fund's investments which are being hedged. While the Fund will
incur commission expenses
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<PAGE>
in selling and closing out futures positions, these commissions are generally
less than the transaction expenses which the Fund would have incurred had the
Fund sold portfolio securities in order to reduce its exposure to increases in
interest rates. The Fund also may purchase financial futures contracts in
anticipation of a decline in interest rates when it is not fully invested in a
particular market in which it intends to make investments to gain market
exposure that may in part or entirely offset an increase in the cost of
securities it intends to purchase. It is anticipated that, in a substantial
majority of these transactions, the Fund will purchase securities upon
termination of the futures contract.
The Fund also has authority to purchase and write call and put options on
futures contracts. Generally, these strategies are utilized under the same
market and market sector conditions (i.e., conditions relating to specific
types of investments) in which the Fund enters into futures transactions. The
Fund may purchase put options or write call options on futures contracts
rather than selling the underlying futures contract in anticipation of a
decrease in the market value of securities or an increase in interest rates.
Similarly, the Fund may purchase call options, or write put options on futures
contracts, as a substitute for the purchase of such futures to hedge against
the increased cost resulting from an increase in the market value or a decline
in interest rates of securities which the Fund intends to purchase.
The Fund may engage in options and futures transactions on exchanges and
options in the over-the-counter markets ("OTC options"). In general, exchange-
traded contracts are third-party contracts (i.e., performance of the parties'
obligation is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. OTC options transactions are
two-party contracts with price and terms negotiated by the buyer and seller.
See "Restrictions on OTC Options" below for information as to restrictions on
the use of OTC options.
Restrictions on the Use of Futures Transactions. Under regulations of the
CFTC, the futures trading activity described herein will not result in the
Fund being deemed a "commodity pool," as defined under such regulations,
provided that the Fund adheres to certain restrictions. In particular, the
Fund may purchase and sell futures contracts and options thereon (i) for bona
fide hedging purposes, and (ii) for non-hedging purposes, if the aggregate
initial margin and premiums required to establish positions in such contracts
and options does not exceed 5% of the liquidation value of the Fund's
portfolio, after taking into account unrealized profits and unrealized losses
on any such contracts and options. Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases a futures contract or writes a put option or
purchases a call option thereon, an amount of cash or liquid instruments will
be deposited in a segregated account with the Fund's custodian so that the
amount so segregated, plus the amount of variation margin held in the account
of its broker, equals the market value of the futures contract, thereby
ensuring that the use of such futures is unleveraged.
An order has been obtained from the Securities and Exchange Commission (the
"Commission") which exempts the Fund from certain provisions of the Investment
Company Act in connection with transactions involving futures contracts and
options thereon.
Restrictions on OTC Options. The Fund will engage in transactions in OTC
options only with banks or dealers which have capital of at least $50 million
or whose obligations are guaranteed by an entity having capital of at least
$50 million. OTC options and assets used to cover OTC options written by the
Fund are considered by the staff of the Commission to be illiquid. The
illiquidity of such options or assets may prevent a successful
25
<PAGE>
sale of such options or assets, result in a delay of sale, or reduce the
amount of proceeds that might otherwise be realized.
RISK FACTORS IN INTEREST RATE TRANSACTIONS AND OPTIONS AND FUTURES
TRANSACTIONS
The use of interest rate transactions is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. Interest rate transactions involve
the risk of an imperfect correlation between the index used in the hedging
transaction and that pertaining to the securities which are the subject of
such transaction. If the Investment Adviser is incorrect in its forecasts of
market values, interest rates and other applicable factors, the investment
performance of the Fund would diminish compared with what it would have been
if these investment techniques were not used. In addition, interest rate
transactions that may be entered into by the Fund do not involve the delivery
of securities or other underlying assets or principal. Accordingly, the risk
of loss with respect to interest rate swaps is limited to the net amount of
interest payments that the Fund is contractually obligated to make. If the
security underlying an interest rate swap is prepaid and the Fund continues to
be obligated to make payments to the other party to the swap, the Fund would
have to make such payments from another source. If the other party to an
interest rate swap defaults, the Fund's risk of loss consists of the net
amount of interest payments that the Fund contractually is entitled to
receive. In the case of a purchase by the Fund of an interest rate cap or
floor, the amount of loss is limited to the fee paid. Since interest rate
transactions are individually negotiated, the Investment Adviser expects to
achieve an acceptable degree of correlation between the Fund's rights to
receive interest on securities and its rights and obligations to receive and
pay interest pursuant to interest rate swaps.
Utilization of options and futures transactions to hedge the portfolio
involves the risk of imperfect correlation in movements in the price of
options and futures and movements in the prices of the securities which are
the subject of the hedge. If the price of the options or futures moves more or
less than the price of the subject of the hedge, the Fund will experience a
gain or loss which will not be completely offset by movements in the price of
the subject of the hedge. This risk particularly applies to the Fund's use of
futures and options thereon since it will generally use such instruments as a
so called "cross-hedge," which means that the security that is the subject of
the futures contract is different from the security being hedged by the
contract.
Prior to exercise or expiration, an exchange-traded option position can only
be terminated by entering into a closing purchase or sale transaction. This
requires a secondary market on an exchange for call or put options of the same
series. The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a
liquid secondary market for such options or futures. However, there can be no
assurance that a liquid secondary market will exist at any specific time.
Thus, it may not be possible to close an options or futures position. The
inability to close options and futures positions also could have an adverse
impact on the Fund's ability to effectively hedge its portfolio. There is also
the risk of loss by the Fund of margin deposits or collateral in the event of
bankruptcy of a broker with whom the Fund has an open position in an option, a
futures contract or an option related to a futures contract.
OTHER INVESTMENT STRATEGIES
Repurchase Agreements. The Fund may enter into repurchase agreements with
respect to its permitted investments with financial institutions that (i)
have, in the opinion of the Investment Adviser, substantial capital relative
to the Fund's exposure, or (ii) have provided the Fund with a third-party
guaranty or other credit enhancement. Under a repurchase agreement the Fund
buys a security at one price and simultaneously promises
26
<PAGE>
to sell that same security back to the seller at a higher price. The Fund's
repurchase agreements will provide that the value of the collateral underlying
the repurchase agreement will always be at least equal to the repurchase
price, including any accrued interest earned on the repurchase agreement, and
will be marked to market daily. The repurchase date usually is within seven
days of the original purchase date. Repurchase agreements are deemed to be
loans under the Investment Company Act. In all cases, the Investment Adviser
must be satisfied with the creditworthiness of the other party to the
agreement before entering into a repurchase agreement. In the event of the
bankruptcy (or other insolvency proceeding) of the other party to a repurchase
agreement, the Fund might experience delays in recovering its cash. To the
extent that, in the meantime, the value of the securities the Fund purchases
may have declined, the Fund could experience a loss.
Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreements with respect to its portfolio investments subject to the investment
restrictions set forth herein. Reverse repurchase agreements involve the sale
of securities held by the Fund with an agreement by the Fund to repurchase the
securities at an agreed upon price, date and interest payment. The use by the
Fund of reverse repurchase agreements involves many of the same risks of
leverage described under "Risk Factors and Special Considerations" and "Other
Investment Policies--Leverage" since the proceeds derived from such reverse
repurchase agreements may be invested in additional securities. At the time
the Fund enters into a reverse repurchase agreement, it may establish and
maintain a segregated account with the custodian containing cash or liquid
instruments having a value not less than the repurchase price (including
accrued interest). If the Fund establishes and maintains such a segregated
account, a reverse repurchase agreement will not be considered a borrowing by
the Fund; however, under circumstances in which the Fund does not establish
and maintain such a segregated account, such reverse repurchase agreement will
be considered a borrowing for the purpose of the Fund's limitation on
borrowings. Reverse repurchase agreements involve the risk that the market
value of the securities acquired in connection with the reverse repurchase
agreement may decline below the price of the securities the Fund has sold but
is obligated to repurchase. Also, reverse repurchase agreements involve the
risk that the market value of the securities retained in lieu of sale by the
Fund in connection with the reverse repurchase agreement may decline in price.
In the event the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, such buyer or its trustee or
receiver may receive an extension of time to determine whether to enforce the
Fund's obligation to repurchase the securities, and the Fund's use of the
proceeds of the reverse repurchase agreement may effectively be restricted
pending such decision. Also, the Fund would bear the risk of loss to the
extent that the proceeds of the reverse repurchase agreement are less than the
value of the securities subject to such agreement.
Lending of Portfolio Securities. The Fund may from time to time lend
securities from its portfolio, with a value not exceeding 33 1/3% of its total
assets, to banks, brokers and other financial institutions and receive
collateral in cash or securities issued or guaranteed by the U.S. government,
its agencies or instrumentalities which will be maintained at all times in an
amount equal to at least 100% of the current market value of the loaned
securities. The purpose of such loans is to permit the borrower to use such
securities for delivery to purchasers when such borrower has sold short. If
cash collateral is received by the Fund, it is invested in short-term money
market securities, and a portion of the yield received in respect of such
investment is retained by the Fund. Alternatively, if securities are delivered
to the Fund as collateral, the Fund and the borrower negotiate a rate for the
loan premium to be received by the Fund for lending its portfolio securities.
In either event, the total yield on the Fund's portfolio is increased by loans
of its portfolio securities. The Fund will have the right to regain record
ownership of loaned securities to exercise beneficial rights such as voting
rights, subscription rights and rights to dividends, interest or other
distributions. Such loans are terminable at any time. The Fund may pay
reasonable finder's, administrative and custodial fees in connection with such
loans.
27
<PAGE>
When-Issued and Forward Commitment Securities. The Fund may purchase
securities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" basis in order to hedge against anticipated changes in
interest rates and prices. When such transactions are negotiated, the price,
which is generally expressed in yield terms, is fixed at the time the
commitment is made, but delivery and payment for the securities take place at
a later date. When-issued securities and forward commitments may be sold prior
to the settlement date, but the Fund will enter into when-issued and forward
commitments only with the intention of actually receiving or delivering the
securities, as the case may be. If the Fund disposes of the right to acquire a
when-issued security prior to its acquisition or disposes of its right to
deliver or receive against a forward commitment, it can incur a gain or loss.
At the time the Fund enters into a transaction on a when-issued or forward
commitment basis, it will segregate with the custodian cash or liquid
instruments with a value not less than the value of the when-issued or forward
commitment securities. The value of these assets will be monitored daily to
ensure that their marked to market value will at all times exceed the
corresponding obligations of the Fund. There is always a risk that the
securities may not be delivered, and the Fund may incur a loss. Settlements in
the ordinary course, which may take substantially more than five business days
for mortgage-related securities, are not treated by the Fund as when-issued or
forward commitment transactions and accordingly are not subject to the
foregoing restrictions.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and, prior
to issuance of any preferred stock, may not be changed without the approval of
the holders of a majority of the Fund's outstanding shares of Common Stock
(which for this purpose and under the Investment Company Act means the lesser
of (i) 67% of the shares of Common Stock represented at a meeting at which
more than 50% of the outstanding shares of Common Stock are represented or
(ii) more than 50% of the outstanding shares). Subsequent to the issuance of a
class of preferred stock, the following investment restrictions may not be
changed without the approval of a majority of the outstanding shares of Common
Stock and of the preferred stock, voting together as a class, and the approval
of a majority of the outstanding shares of preferred stock, voting separately
by class. The Fund may not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act.
2. Make investments for the purpose of exercising control or management.
3. Purchase or sell real estate, commodities or commodity contracts;
provided that the Fund may invest in securities secured by real estate or
interests therein or issued by companies that invest in real estate or
interests therein, and the Fund may purchase and sell financial futures
contracts and options thereon.
4. Issue senior securities or borrow money except as permitted by Section
18 of the Investment Company Act.
5. Underwrite securities of other issuers except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933, as amended, in
selling portfolio securities.
6. Make loans to other persons, except (i) to the extent that the Fund
may be deemed to be making loans by purchasing Corporate Loans, as a Co-
Lender or otherwise, and other debt securities and entering into repurchase
agreements in accordance with its investment objectives, policies and
limitations, and
28
<PAGE>
(ii) the Fund may lend its portfolio securities in an amount not in excess
of 33 1/3% of its total assets, taken at market value, provided that such
loans shall be made in accordance with the guidelines set forth in this
Prospectus.
7. Invest more than 25% of its total assets in the securities of issuers
in any one industry; provided that this limitation shall not apply with
respect to obligations issued or guaranteed by the U.S. Government or by
its agencies or instrumentalities; and provided further that to the extent
that the Fund invests in Corporate Loans the Fund may invest more than 25%
and may invest up to 100% of its assets in securities of issuers in the
industry group consisting of financial institutions and their holding
companies, including commercial banks, thrift institutions, insurance
companies and finance companies. For purposes of this restriction, the term
"issuer" includes the Borrower, the Agent Bank and any Intermediate
Participant (as defined under "Investment Objectives and Policies").
Additional investment restrictions adopted by the Fund, which may be changed
by the Board of Directors, provide that the Fund may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as security
for indebtedness, any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned in investment restriction
(4) above or except as may be necessary in connection with transactions in
financial futures contracts and options thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on
margin).
d. Make short sales of securities or maintain a short position or invest
in put, call, straddle or spread options, except that the Fund may write,
purchase and sell options and futures on portfolio securities and related
indices or otherwise in connection with bona fide hedging activities.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentage resulting from changing values will not be
considered a violation.
Because of the affiliation of Merrill Lynch with the Investment Adviser, the
Fund is prohibited from engaging in certain transactions involving Merrill
Lynch except pursuant to an exemptive order or otherwise in compliance with
the provisions of the Investment Company Act and the rules and regulations
thereunder. Included among such restricted transactions will be purchases from
or sales to Merrill Lynch of securities in transactions in which it acts as
principal. See "Portfolio Transactions."
29
<PAGE>
The Fund has established procedures for blocking the use of inside
information in securities transactions (commonly referred to as "Chinese Wall
procedures"). As a result, the Fund's purchase of a security in a private
placement may deprive the Fund of investment in certain publicly traded
securities of the same issuer and the Fund's purchase of a publicly traded
security may deprive the Fund of the opportunity to purchase certain privately
placed securities of the same issuer. Also, in relation to other funds managed
by the same portfolio manager as the Fund, if one fund buys a security that is
publicly traded or privately placed, respectively, the other fund may be
deprived of the opportunity to buy a security of the same issuer that is
privately placed or publicly traded, respectively.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
manager of the Fund, including their ages and their principal occupations
during the last five years is set forth below. Unless otherwise noted, the
address of each Director, executive officer and the portfolio manager is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
Arthur Zeikel (65)--President and Director (1)(2)--Chairman of the
Investment Adviser and MLAM (which terms, as used herein, include their
corporate predecessors) since 1997; President of the Investment Adviser and
MLAM from 1977 to 1997; Chairman of Princeton Services, Inc. ("Princeton
Services") since 1997, Director since 1993 and President from 1993 to 1997;
Executive Vice President of ML & Co. since 1990.
Ronald Forbes (57)--Director (2)--1400 Washington Avenue, Albany, New York
12222. Professor of Finance, School of Business, State University of New York
at Albany since 1989.
Cynthia A. Montgomery (45)--Director (2)--Harvard Business School, Soldiers
Field Road, Boston, Massachusetts 02163. Professor, Harvard Business School
since 1989; Associate Professor, J.L. Kellogg Graduate School of Management,
Northwestern University from 1985 to 1989; Assistant Professor, Graduate
School of Business Administration, The University of Michigan from 1979 to
1985; Director, UNUM Corporation since 1990 and Director of Newell Co. since
1995.
Charles C. Reilly (66)--Director (2)-- 9 Hampton Harbor Road, Hampton Bays,
New York 11946. Self-employed financial consultant since 1990; President and
Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior Vice
President of Arnhold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business from 1990 to 1991;
Adjunct Professor, Wharton School, The University of Pennsylvania from 1989 to
1990; Partner, Small Cities Cable Television since 1986.
Kevin A. Ryan (65)--Director (2)--127 Commonwealth Avenue, Chestnut Hill,
Massachusetts 02167. Founder and current Director and Professor of The Boston
University Center for the Advancement of Ethics and Character; Professor of
Education at Boston University since 1982; formerly taught on the faculties of
The University of Chicago, Stanford University and Ohio State University.
30
<PAGE>
Richard R. West (60)--Director (2)--Box 604, Genoa, Nevada 89411, Professor
of Finance since 1984, and Dean from 1984 to 1993, and currently Dean Emeritus
of New York University, Leonard N. Stern School of Business Administration;
Director of Bowne & Co., Inc. (financial printers), Vornado, Inc. (real estate
holding company) and Alexander's Inc. (real estate company).
Terry K. Glenn (57)--Executive Vice President (1)(2)--Executive Vice
President of the Investment Adviser and MLAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of Merrill
Lynch Funds Distributor, Inc. ("MLFD") since 1986 and Director thereof since
1991; President of Princeton Administrators, L.P. since 1988.
Joseph T. Monagle, Jr. (49)--Senior Vice President (1)(2)--Senior Vice
President of the Investment Adviser and MLAM since 1990; Department Head of
the Global Fixed Income Division of the Investment Adviser and MLAM since
1997; Senior Vice President of Princeton Services since 1993.
R. Douglas Henderson (40)--Senior Vice President and Portfolio Manager
(1)(2)--First Vice President of MLAM since 1997; Vice President of MLAM from
1989 to 1997.
Donald C. Burke (37)--Vice President (1)(2)-- First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation of
MLAM since 1990.
Gerald M. Richard (48)--Treasurer (1)(2)--Senior Vice President and
Treasurer of the Investment Adviser and MLAM since 1984; Senior Vice President
and Treasurer of Princeton Services since 1993; Vice President of MLFD since
1981 and Treasurer since 1984.
Patrick D. Sweeney (43)--Secretary (1)(2)-- First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997.
- --------
(1) Interested person, as defined in the Investment Company Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of one or more
other investment companies for which the Investment Adviser, MLAM or their
affiliates act as investment adviser.
In the event that the Fund issues preferred stock, in connection with the
election of the Fund's Directors, holders of shares of preferred stock, voting
as a separate class, will be entitled to elect two of the Fund's Directors,
and the remaining Directors will be elected by all holders of capital stock,
voting as a single class. See "Description of Capital Stock."
The Fund pays each Director not affiliated with the Investment Adviser an
annual fee of $4,500 plus $400 per meeting attended, together with such
Director's actual out-of-pocket expenses relating to attendance at meetings.
The Fund also pays members of its audit committee, which consists of all of
the Directors not affiliated with the Investment Adviser, an annual fee of
$1,400. The Chairman of the Audit Committee receives an additional annual fee
of $1,000.
The following table sets forth compensation to be paid by the Fund to the
non-affiliated Directors projected through the end of the Fund's first full
fiscal year and for the calendar year ended December 31, 1997 the
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<PAGE>
aggregate compensation paid by all investment companies advised by the
Investment Adviser, MLAM and their affiliates ("FAM/MLAM Advised Funds") to
the non-affiliated Directors.
<TABLE>
<CAPTION>
TOTAL COMPENSATION
PENSION OR FROM FUND AND
AGGREGATE RETIREMENT BENEFITS FAM/MLAM
COMPENSATION ACCRUED AS PART OF ADVISED FUNDS PAID
NAME OF DIRECTOR FROM FUND FUND EXPENSE TO DIRECTORS
- ----------------- ------------ ------------------- ------------------
<S> <C> <C> <C>
Ronald W. Forbes (1)........ $7,500 None $153,500
Cynthia A. Montgomery (1)... $7,500 None $153,500
Charles C. Reilly (1)....... $8,500 None $313,000
Kevin A. Ryan (1)........... $7,500 None $153,500
Richard R. West (1)......... $7,500 None $299,000
</TABLE>
- --------
(1) The Directors serve on the boards of other FAM/MLAM Advised Funds as
follows: Mr. Forbes (26 registered investment companies consisting of 39
portfolios); Ms. Montgomery (26 registered investment companies consisting
of 39 portfolios); Mr. Reilly (44 registered investment companies
consisting of 57 portfolios); Mr. Ryan (26 registered investment companies
consisting of 39 portfolios); and Mr. West (45 registered investment
companies consisting of 67 portfolios).
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser is an affiliate of MLAM, which is owned and
controlled by ML & Co. The Investment Adviser will provide the Fund with
investment advisory and management services. The Investment Adviser, or MLAM,
acts as the investment adviser for over 100 other registered investment
companies. The Investment Adviser also offers portfolio management and
portfolio analysis services to individual and institutional accounts. As of
February 1998, the Investment Adviser and MLAM had a total of approximately
$479 billion in investment company and other portfolio assets under
management, including selected accounts of certain affiliates of the
Investment Adviser. The principal business address of the Investment Adviser
is 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
The Investment Advisory Agreement with the Investment Adviser (the
"Investment Advisory Agreement") provides that, subject to the supervision of
the Board of Directors of the Fund, the Investment Adviser is responsible for
the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.
The Investment Adviser provides the portfolio management for the Fund. Such
portfolio management will consider analyses from various sources (including
brokerage firms with which the Fund does business), make the necessary
investment decisions, and place orders for transactions accordingly. The
Investment Adviser will also be responsible for the performance of certain
administrative and management services for the Fund. R. Douglas Henderson is
the portfolio manager for the Fund and is primarily responsible for the Fund's
day-to-day management.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay a monthly fee at the annual rate of 0.60
of 1% of the Fund's average weekly net assets plus the proceeds of any
outstanding borrowings used for leverage ("average weekly net assets" means
the average weekly value of the total assets of the Fund, including proceeds
from the issuance of preferred stock, minus the sum of
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<PAGE>
(i) accrued liabilities of the Fund, (ii) any accrued and unpaid interest on
outstanding borrowings and (iii) accumulated dividends on shares of preferred
stock). For purposes of this calculation, average weekly net assets is
determined at the end of each month on the basis of the average net assets of
the Fund for each week during the month. The assets for each weekly period are
determined by averaging the net assets at the last business day of a week with
the net assets at the last business day of the prior week.
The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and
furnish office space for officers and employees of the Fund connected with
investment and economic research, trading and investment management of the
Fund, as well as the compensation of all Directors of the Fund who are
affiliated persons of the Investment Adviser or any of its affiliates. The
Fund pays all other expenses incurred in the operation of the Fund, including,
among other things, expenses for legal and auditing services, taxes, listing
fees, costs of printing proxies, stock certificates and shareholder reports,
charges of the custodian and the transfer, dividend disbursing agent and
registrar, Securities and Exchange Commission fees, fees and expenses of
unaffiliated Directors, accounting and pricing costs, insurance, interest,
brokerage costs, litigation and other extraordinary or non-recurring expenses,
mailing and other expenses properly payable by the Fund. Accounting services
are provided to the Fund by the Investment Adviser, and the Fund reimburses
the Investment Adviser, for its costs in connection with such services.
Securities held by the Fund also may be held by or be appropriate
investments for other funds for which the Investment Adviser or MLAM acts as
an adviser or by investment advisory clients of MLAM. Because of different
investment objectives or other factors, a particular security may be bought
for one or more clients when one or more clients are selling the same
security. If purchases or sales or securities for the Fund or other funds for
which the Investment Adviser or MLAM acts as investment adviser or for their
advisory clients arise for consideration at or about the same time,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the
extent that transactions on behalf of more than one client of the Investment
Adviser or MLAM during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an
adverse effect on price.
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the
Investment Company Act) of any such party. Such contract is not assignable and
may be terminated without penalty on 60 days' written notice at the option of
either party thereto or by the vote of the shareholders of the Fund.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the Investment Company Act that incorporates the Code of
Ethics of the Investment Adviser (together, the "Codes"). The Codes
significantly restrict the personal investing activities of all employees of
the Investment Adviser and, as described below, impose additional, more
onerous, restrictions on Fund investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as U.S.
Government securities). The preclearance requirement and associated procedures
are designed to identify any substantive prohibition or limitation applicable
to the proposed
33
<PAGE>
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot"
initial public offering and a prohibition from profiting on short-term trading
securities. In addition, no employee may purchase or sell any security that at
the time is being purchased or sold (as the case may be), or to the knowledge
of the employee is being considered for purchase or sale, by any fund advised
by the Investment Adviser. Furthermore, the Codes provide for trading
"blackout periods" that prohibit trading by investment personnel of the Fund
within periods of trading by the Fund in the same (or equivalent) security (15
or 30 days depending upon the transaction).
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such
factors as price (including the applicable fee, commission or spread), size of
order, difficulty of execution and operational facilities of the firm
involved, the firm's risk in positioning a block of securities and the
provision of supplemental investment research by the firm. While the
Investment Adviser generally seeks reasonably competitive fees, commissions or
spreads, the Fund does not necessarily pay the lowest fee, commission or
spread available.
The Fund has no obligation to deal with any broker or dealer in execution of
transactions in portfolio securities. Subject to obtaining the best price and
execution, securities firms which provided supplemental investment research to
the Investment Adviser, including Merrill Lynch, may receive orders for
transactions by the Fund. Information so received will be in addition to and
not in lieu of the services required to be performed by the Investment Adviser
under the Investment Advisory Agreement and the expenses of the Investment
Adviser will not necessarily be reduced as a result of the receipt of such
supplemental information.
The Fund will purchase Corporate Loans in individually negotiated
transactions with commercial banks, thrifts, insurance companies, finance
companies and other financial institutions. In selecting such financial
institutions, the Investment Adviser may consider, among other factors, the
financial strength, professional ability, level of service and research
capability of the institution. See "Investment Objectives and Policies--
Description of Corporate Loans." While such financial institutions generally
are not required to repurchase Corporate Loans which they have sold, they may
act as principal or on an agency basis in connection with the Fund's
disposition of Corporate Loans.
Other securities in which the Fund may invest, such as publicly traded
corporate bonds and notes, are traded primarily in the over-the-counter
markets, and the Fund intends to deal directly with the dealers who make
markets in the securities involved, except in those circumstances where better
prices and execution are available elsewhere. Under the Investment Company
Act, except as permitted by exemptive order, persons affiliated with the Fund
are prohibited from dealing with the Fund as principal in the purchase and
sale of securities. Since transactions in the over-the-counter market usually
involve transactions with dealers acting as principal for their own account,
the Fund will not deal with affiliated persons, including Merrill Lynch and
its affiliates, in connection with such transactions. In addition, the Fund
may not purchase securities for the Fund during the existence of any
underwriting syndicate of which Merrill Lynch is a member or in a private
placement in which Merrill Lynch serves as a placement agent except pursuant
to procedures approved by the Board of Directors of the Fund which comply with
rules adopted by the Commission or with interpretations of the Commission
staff. An affiliated person of the Fund may serve as its broker in over-the-
counter transactions conducted on an agency basis.
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PORTFOLIO TURNOVER
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the
time they have been held when such actions for defensive or other reasons,
appear advisable to the Investment Adviser. While it is not possible to
predict turnover rates with any certainty, at present it is anticipated that
the Fund's annual portfolio turnover rate, under normal circumstances, will be
less than 100%. (The portfolio turnover rate is calculated by dividing the
lesser of purchases or sales of portfolio securities for the particular fiscal
year by the monthly average of the value of the portfolio securities owned by
the Fund during the particular fiscal year. For purposes of determining this
rate, all securities whose maturities at the time of acquisition are one year
or less are excluded.)
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute dividends of substantially all of its net
investment income monthly. All net realized capital gains, if any, will be
distributed to the Fund's shareholders at least annually.
Under the Investment Company Act, the Fund is not permitted to incur
indebtedness unless immediately after such incurrence the Fund has an asset
coverage of 300% of the aggregate outstanding principal balance of
indebtedness. Additionally, under the Investment Company Act, the Fund may not
declare any dividend or other distribution upon any class of its capital
stock, or purchase any such capital stock, unless the aggregate indebtedness
of the Fund has, at the time of the declaration of any such dividend or
distribution or at the time of any such purchase, an asset coverage of at
least 300% after deducting the amount of such dividend, distribution, or
purchase price, as the case may be. While any shares of preferred stock are
outstanding, the Fund may not declare any cash dividend or other distribution
on its Common Stock, unless at the time of such declaration, (i) all
accumulated preferred stock dividends have been paid and (ii) the net asset
value of the Fund's portfolio (determined after deducting the amount of such
dividend or other distribution) is at least 200% of the liquidation value of
the outstanding preferred stock (expected to be equal to original purchase
price per share plus any accumulated and unpaid dividends thereon). In
addition to the limitations imposed by the Investment Company Act described in
this paragraph, certain lenders may impose additional restrictions on the
payment of dividends or distributions on the Fund's Common Stock in the event
of a default on the Fund's borrowings. Any limitation on the Fund's ability to
make distributions on its Common Stock could under certain circumstances
impair the ability of the Fund to maintain its qualification for taxation as a
regulated investment company. See "Other Investment Policies--Leverage" and
"Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
matter in which dividends and distributions to holders of Common Stock may be
automatically reinvested in shares of Common Stock of the Fund. Dividends and
distributions will be taxable to shareholders whether they are reinvested in
shares of the Fund or received in cash.
The Fund expects that it will commence paying dividends within 90 days of
the date of this Prospectus.
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TAXES
GENERAL
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. As long as it
so qualifies, in any taxable year in which it distributes at least 90% of its
net income (see below), the Fund (but not its shareholders) will not be
subject to Federal income tax to the extent that it distributes its net
investment income and net realized capital gains. The Fund intends to
distribute substantially all of such income.
Dividends paid by the Fund from its ordinary income or from an excess of net
short-term capital gains over net long-term capital losses (together referred
to hereafter as "ordinary income dividends") are taxable to shareholders as
ordinary income. Distributions made from an excess of net long-term capital
gains over net short-term capital losses (including gains or losses from
certain transactions in swaps, futures and options) ("capital gain dividends")
are taxable to shareholders as long-term capital gains, regardless of the
length of time the shareholder has owned Fund shares. Any loss upon the sale
or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. Distributions in excess of the Fund's earnings and profits
will first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Recent legislation
creates additional categories of capital gains taxable at different rates.
Generally not later than 60 days after the close of its taxable year, the Fund
will provide its shareholders with a written notice designating the amounts of
any ordinary income dividends or capital gain dividends (including the amount
of capital gain dividends in the different categories of capital gain referred
to above), as well as any dividends eligible for the dividends received
deduction.
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Distributions attributable to any dividend
income earned by the Fund will be eligible for the dividends received
deduction allowed to corporations under the Code, if certain requirements are
met. If the Fund pays a dividend in January which was declared in the previous
October, November or December to shareholders of record on a specified date in
one of such months, then such dividend will be treated for tax purposes as
being paid by the Fund and received by its shareholders on December 31 of the
year in which the dividend was declared.
The Internal Revenue Service (the "Service") has taken the position in a
revenue ruling that if a RIC has more than one class of shares, it may
designate distributions made to each class in any year as consisting of no
more than such class's proportionate share of particular types of income,
including the different categories of capital gain referred to above. A
class's proportionate share of a particular type of income is determined
according to the percentage of total dividends paid by the RIC during such
year that was paid to such class. Consequently, if both Common Stock and
preferred stock are outstanding, the Fund intends to designate distributions
made to the classes as consisting of particular types of income in accordance
with the classes' proportionate shares of such income. Thus, capital gain
dividends including the different categories of capital gain referred to above
will be allocated between the holders of Common Stock and preferred stock in
proportion to the total dividends paid to each class during the taxable year,
or otherwise as required by applicable law.
If at any time when shares of preferred stock are outstanding the Fund does
not meet the asset coverage requirements of the Investment Company Act, the
Fund will be required to suspend distributions to holders of Common Stock
until the asset coverage is restored. See "Dividends and Distributions." This
may prevent the
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Fund from distributing at least 90% of its net income, and may therefore
jeopardize the Fund's qualification for taxation as a RIC or may subject the
Fund to the 4% excise tax described below. Upon any failure to meet the asset
coverage requirement of the Investment Company Act, the Fund may, in its sole
discretion, redeem shares of preferred stock in order to maintain or restore
the requisite asset coverage and avoid the adverse consequences to the Fund
and its shareholders of failing to qualify as a RIC. There can be no
assurance, however, that any such action would achieve these objectives.
As noted above, the Fund must distribute annually at least 90% of its net
investment income. A distribution will only be counted for this purpose if it
qualifies for the dividends paid deduction under the Code. Some types of
preferred stock that the Fund has the authority to issue may raise an issue as
to whether distributions on such preferred stock are "preferential" under the
Code and therefore not eligible for the dividends paid deduction. In the event
the Fund determines to issue preferred stock, the Fund intends to issue
preferred stock that counsel advises will not result in the payment of a
preferential dividend and may seek a private letter ruling from the Service to
that effect. If the Fund ultimately relies solely on a legal opinion in the
event it issues such preferred stock, there is no assurance that the Service
would agree that dividends on the preferred stock are not preferential. If the
Service successfully disallowed the dividends paid deduction for dividends on
the preferred stock, the Fund could be disqualified as a RIC.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the United States
withholding tax.
Interest income from non-U.S. securities may be subject to withholding taxes
imposed by the country in which the issuer is located. The Fund will not be
able to pass through to its shareholders foreign tax credits or deductions
with respect to these taxes.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have
furnished an incorrect number. When establishing an account, an investor must
certify under penalty of perjury that such number is correct and that such
investor is not otherwise subject to backup withholding.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income
and capital gains in the manner necessary to minimize imposition of the 4%
excise tax, there can be no assurance that sufficient amounts of the Fund's
taxable income and capital gains will be distributed to avoid entirely the
imposition of the tax. In such event, the Fund will be liable for the tax only
on the amount by which it does not meet the foregoing distribution
requirements.
The Fund will invest in securities rated in the lower rating categories of
nationally recognized rating organizations, in unrated securities (together
with lower rated securities, "junk bonds") and in high yield Corporate Loans,
as previously described. Some of these junk bonds and high yield Corporate
Loans may be purchased at a discount and may therefore cause the Fund to
accrue and distribute income before amounts due under the obligations are
paid. In addition, a portion of the interest payments on such junk bonds and
high yield
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Corporate Loans may be treated as dividends for Federal income tax purposes;
in such case, if the issuer of the junk bonds or high yield Corporate Loans is
a domestic corporation, dividend payments by the Fund will be eligible for the
dividends received deduction to the extent of the deemed dividend portion of
such interest payments.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may engage in interest rate transactions, write (i.e., sell)
covered call and covered put options on its portfolio securities, purchase
call and put options on securities, and engage in transactions in financial
futures and related options on such futures. In general, unless an election is
available to the Fund or an exception applies, such options and futures
contracts that are "Section 1256 contracts" will be "marked to market" for
Federal income tax purposes at the end of each taxable year, i.e., each such
options or futures contract will be treated as sold for its fair market value
on the last day of the taxable year, and any gain or loss attributable to such
contracts will be 60% long-term and 40% short-term capital gain or loss.
Application of these rules to Section 1256 contracts held by the Fund may
alter the timing and character of distributions to shareholders. The mark-to-
market rules outlined above, however, will not apply to certain transactions
entered into by the Fund solely to reduce the risk of changes in price or
interest or currency exchange rates with respect to its investments.
The Federal income tax rules governing the taxation of swaps are not
entirely clear and may require the Fund to treat payments received under such
arrangements as ordinary income and to amortize such payments under certain
circumstances. The Fund does not anticipate that its activity in this regard
will affect its qualification as a RIC.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and options, futures and swap
transactions. Under Section 1092, the Fund may be required to postpone
recognition for tax purposes of losses incurred in certain sales of securities
and certain closing transactions in options, futures and swap transactions.
SPECIAL RULES FOR CERTAIN FOREIGN CURRENCY TRANSACTIONS
Under Code Section 988, special rules are provided for certain transactions
in a currency other than the taxpayer's functional currency (i.e, unless
certain special rules apply, currencies other than the U.S. dollar). In
general, foreign currency gains and losses in connection with certain of the
Fund's debt instruments and the Fund's foreign currency swaps, if any, will be
treated as ordinary income or loss under Code Section 988 and will increase or
decrease the amount of the Fund's investment company taxable income available
to be distributed to shareholders as ordinary income. Additionally, if Code
Section 988 losses exceed other investment company taxable income during a
taxable year, the Fund would not be able to make any ordinary income dividend
distributions, and any distributions made before the losses were realized but
in the same taxable year would be recharacterized as a return of capital to
shareholders, thereby reducing the basis of each shareholder's Fund shares,
and resulting in a capital gain for any shareholder who received a
distribution greater than the shareholder's tax basis in Fund shares (assuming
the shares were held as a capital asset). These rules, however, will not apply
to certain transactions entered into by the Fund solely to reduce the risk of
currency fluctuations with respect to its investments.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
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Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the "Plan"),
unless a shareholder otherwise elects, all dividend and capital gains
distributions will be automatically reinvested by The Bank of New York, as
agent for shareholders in administering the Plan (the "Plan Agent"), in
additional shares of Common Stock of the Fund. Shareholders who elect not to
participate in the Plan will receive all dividends and distributions in cash
paid by check mailed directly to the shareholder of record (or, if the shares
are held in street or other nominee name, then to such nominee) by The Bank of
New York, as dividend paying agent. The Fund is not responsible for any
failure of delivery to the shareholder's address of record and no interest
will accrue on amounts represented by uncashed dividend or distribution
checks. Such participants may elect not to participate in the Plan and to
receive all distributions of dividends and capital gains in cash by sending
written instructions to The Bank of New York, as dividend paying agent, at the
address set forth below. Participation in the Plan is completely voluntary and
may be terminated or resumed at any time without penalty by written notice if
received by the Plan Agent not less than ten days prior to any dividend record
date; otherwise such termination will be effective with respect to any
subsequently declared dividend or distribution.
Whenever the Fund declares an income dividend or a capital gains
distribution (collectively referred to as "dividends") payable either in
shares or in cash, non-participants in the Plan will receive cash, and
participants in the Plan will receive the equivalent in shares of Common
Stock. The shares will be acquired by the Plan Agent for the participant's
account, depending upon the circumstances described below, either (i) through
receipt of additional unissued but authorized shares of Common Stock from the
Fund ("newly issued shares") or (ii) by purchase of outstanding shares of
Common Stock on the open market ("open-market purchases") on the New York
Stock Exchange or elsewhere. If on the payment date for the dividend, the net
asset value per share of the Common Stock is equal to or less than the market
price per share of the Common Stock plus estimated brokerage commissions (such
condition being referred to herein as "market premium"), the Plan Agent will
invest the dividend amount in newly issued shares on behalf of the
participant. The number of newly issued shares of Common Stock to be credited
to the participant's account will be determined by dividing the dollar amount
of the dividend by the net asset value per share on the date the shares are
issued, provided that the maximum discount from the then current market price
per share on the date of issuance may not exceed 5%. If on the dividend
payment date the net asset value per share is greater than the market value
(such condition being referred to herein as "market discount"), the Plan Agent
will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases. Prior to the time the shares of Common
Stock commence trading on the New York Stock Exchange, participants in the
Plan will receive any dividends in newly issued shares.
In the event of a market discount on the dividend payment date, the Plan
Agent will have until the last business day before the next date on which the
shares trade on an "ex-dividend" basis or in no event more than 30 days after
the dividend payment date (the "last purchase date") to invest the dividend
amount in shares acquired in open-market purchases. It is contemplated that
the Fund will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date
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on the dividend through the date before the next "ex-dividend" date which
typically will be approximately ten days. If, before the Plan Agent has
completed its open-market purchases, the market price of a share of Common
Stock exceeds the net asset value per share, the average per share purchase
price paid by the Plan Agent may exceed the net asset value of the Fund's
shares, resulting in the acquisition of fewer shares than if the dividend had
been paid in newly issued shares on the dividend payment date. Because of the
foregoing difficulty with respect to open-market purchases, the Plan provides
that if the Plan Agent is unable to invest the full dividend amount in open-
market purchases during the purchase period or if the market discount shifts
to a market premium during the purchase period, the Plan Agent will cease
making open-market purchases and will invest the uninvested portion of the
dividend amount in newly issued shares at the close of business on the last
purchase date.
The Plan Agent maintains all shareholders' accounts in the Plan and
furnishes written confirmation of all transactions in the account, including
information needed by shareholders for tax records. Shares in the account of
each Plan participant will be held by the Plan Agent on behalf of the Plan
participant, and each shareholder's proxy will include those shares purchased
or received pursuant to the Plan. The Plan Agent will forward all proxy
solicitation materials to participants and vote proxies for shares held
pursuant to the Plan in accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees which hold
shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of shares certified from time
to time by the record shareholders as representing the total amount registered
in the record shareholder's name and held for the account of beneficial owners
who are to participate in the Plan.
There will be no brokerage charges with respect to shares issued directly by
the Fund as a result of dividends or capital gains distributions payable
either in shares or in cash. However, each participant will pay a pro rata
share of brokerage commissions incurred with respect to the Plan Agent's open-
market purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. See "Taxes."
Shareholders participating in the Plan may receive benefits not available to
shareholders not participating in the Plan. If the market price plus
commissions of the Fund's shares is above the net asset value, participants in
the Plan will receive shares of the Fund at less than they could otherwise
purchase them and will have shares with a cash value greater than the value of
any cash distribution they would have received on their shares. If the market
price plus commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem its
shares, the price on resale may be more or less than the net asset value. See
"Taxes" for a discussion of tax consequences of the Plan.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan. There
is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by
the participants.
All correspondence concerning the Plan should be directed to the Plan Agent
at 101 Barclay Street, New York, New York 10286.
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MUTUAL FUND INVESTMENT OPTION
Purchasers of shares of Common Stock of the Fund through Merrill Lynch in
this offering will have an investment option consisting of the right to
reinvest the net proceeds from a sale of such shares (the "Original Shares")
in Class D initial sales charge shares of certain Merrill Lynch-sponsored
open-end mutual funds ("Eligible Class D Shares") at their net asset value,
without the imposition of the initial sales charge, if the conditions set
forth below are satisfied. First, the sale of the Original Shares must be made
through Merrill Lynch, and the net proceeds therefrom must be immediately
reinvested in Eligible Class D Shares. Second, the Original Shares must have
been either acquired in this offering or be shares representing reinvested
dividends from shares of Common Stock acquired in this offering. Third, the
Original Shares must have been continuously maintained in a Merrill Lynch
securities account. Fourth, there must be a minimum purchase of $250 to be
eligible for the investment option. Class D shares of the mutual funds are
subject to an account maintenance fee at an annual rate of up to 0.25% of the
average daily net asset value of such mutual fund. The Eligible Class D Shares
may be redeemed at any time at the next determined net asset value, subject in
certain cases to a redemption fee. Prior to the time the shares of Common
Stock commence trading on the New York Stock Exchange, the distributor for the
mutual funds will advise Merrill Lynch Financial Consultants as to those
mutual funds that offer the investment option described above.
NET ASSET VALUE
Net asset value per share of Common Stock is determined as of 15 minutes
after the close of business on the New York Stock Exchange (generally, 4:00
p.m., New York time), on the last business day in each week. For purposes of
determining the net asset value of a share of Common Stock, the value of the
securities held by the Fund plus any cash or other assets (including interest
accrued but not yet received) minus all liabilities (including accrued
expenses) and the aggregate liquidation value of any outstanding shares of
preferred stock is divided by the total number of shares of Common Stock
outstanding at such time. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
The Fund determines and makes available for publication the net asset value
of its shares of Common Stock weekly. Currently, the net asset values of
shares of publicly traded closed-end investment companies investing in debt
securities are published in Barrons, the Monday edition of The Wall Street
Journal and the Monday and Saturday editions of The New York Times.
Corporate Loans will be valued in accordance with guidelines established by
the Board of Directors. Under the Fund's current guidelines, Corporate Loans
for which an active secondary market exists to a reliable degree in the
opinion of the Investment Adviser and for which the Investment Adviser can
obtain at least two quotations from banks or dealers in Corporate Loans will
be valued by the Investment Adviser by calculating the mean of the last
available bid and asked prices in the market for such Corporate Loans, and
then using the mean of those two means. If only one quote for a particular
Corporate Loan is available, such Corporate Loan will be valued on the basis
of the mean of the last available bid and asked prices in the market. 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. In valuing a Corporate Loan at fair value, the
Investment Adviser will consider, among other factors, (i) the
creditworthiness of the Borrower and any Intermediate Participants, (ii) the
current interest rate, period until next interest rate reset and maturity of
the Corporate Loan, (iii) recent prices in the market for similar Corporate
Loans, if any, and (iv) recent prices in the market for instruments of similar
quality, rate, period until next interest rate reset and maturity.
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Other portfolio securities (other than short-term obligations but including
listed issues) may be valued on the basis of prices furnished by one or more
pricing services which determine 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. Obligations with remaining maturities of 60
days or less are valued at amortized cost unless this method no longer
produces fair valuations. Repurchase agreements are valued at cost plus
accrued interest. Rights or warrants to acquire stock, or stock acquired
pursuant to the exercise of a right or warrant, may be valued taking into
account various factors such as original cost to the Fund, earnings and net
worth of the issuer, market prices for securities of similar issuers,
assessment of the issuer's future prosperity, liquidation value or third party
transactions involving the issuer's securities. Securities for which there
exist no price quotations or valuations and all other assets are valued at
fair value as determined in good faith by or on behalf of the Board of
Directors of the Fund.
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify and
reclassify any unissued shares of capital stock into one or more additional or
other classes or series as may be established from time to time by setting or
changing in any one or more respects the designations, preferences, conversion
or other rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption of such shares of stock
and pursuant to such classification or reclassification to increase or
decrease the number of authorized shares of any existing class or series. The
Fund may reclassify an amount of unissued Common Stock as preferred stock and
at that time offer shares of preferred stock representing up to approximately
33 1/3% of the Fund's total assets immediately after the issuance of such
preferred stock.
COMMON STOCK
Shares of Common Stock, when issued and outstanding, will be fully paid and
non-assessable. Shareholders are entitled to share pro rata in the net assets
of the Fund available for distribution to shareholders upon liquidation of the
Fund. Shareholders are entitled to one vote for each share held.
In the event that the Fund issues preferred stock and so long as any shares
of the Fund's preferred stock are outstanding, holders of Common Stock will
not be entitled to receive any net income of or other distributions from the
Fund unless all accumulated dividends on preferred stock have been paid, and
unless asset coverage (as defined in Investment Company Act) with respect to
preferred stock would be at least 200% after giving effect to such
distributions. See "Other Investment Policies--Leverage."
The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its shareholders of record.
The Investment Adviser provided the initial capital for the Fund by
purchasing 10,000 shares of Common Stock of the Fund for $100,000. As of the
date of this Prospectus, the Investment Adviser owned 100% of the outstanding
shares of Common Stock of the Fund. The Investment Adviser may be deemed to
control the Fund until such time as it owns less than 25% of the outstanding
shares of the Fund.
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CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of any opportunity to sell their
shares at a premium over prevailing market prices by discouraging a third
party from seeking to obtain control of the Fund. A Director may be removed
from office with or without cause but only by vote of the holders of at least
66 2/3% of the shares entitled to be voted on the matter.
In addition, the Articles of Incorporation require the favorable vote of the
holders of at least 66 2/3% of the Fund's shares to approve, adopt or
authorize the following:
(i) a merger or consolidation or statutory share exchange of the Fund
with other corporations;
(ii) a sale of all or substantially all of the Fund's assets (other
than in the regular course of the Fund's investment activities); or
(iii) a liquidation or dissolution of the Fund,
unless such action has been approved, adopted or authorized by the affirmative
vote of two-thirds of the total number of Directors fixed in accordance with
the by-laws, in which case the affirmative vote of a majority of the Fund's
shares of capital stock is required. Following any issuance of preferred stock
by the Fund, it is anticipated that the approval, adoption or authorization of
the foregoing would also require the favorable vote of a majority of the
Fund's shares of preferred stock then entitled to be voted, voting as a
separate class.
In addition, conversion of the fund to an open-end investment company would
require an amendment to the Fund's Articles of Incorporation. The amendment
would have to be declared advisable by the Board of Directors prior to its
submission to shareholders. Such an amendment would require the favorable vote
of the holders of at least 66 2/3% of the Fund's outstanding shares (including
any preferred stock) entitled to be voted on the matter, voting as a single
class (or a majority of such shares if the amendment was previously approved,
adopted or authorized by two-thirds of the total number of Directors fixed in
accordance with the by-laws), and, assuming preferred stock is issued, the
affirmative vote of a majority of outstanding shares of preferred stock of the
Fund, voting as a separate class. Such a vote also would satisfy a separate
requirement in the Investment Company Act that the change be approved by the
shareholders. Shareholders of an open-end investment company may require the
company to redeem their shares of common stock at any time (except in certain
circumstances as authorized by or under the Investment Company Act) at their
net asset value, less such redemption charge, if any, as might be in effect at
the time of a redemption. All redemptions would usually be made in cash. If
the Fund is converted to an open-end investment company, it could be required
to liquidate portfolio securities to meet requests for redemption, and the
shares would no longer be listed on a stock exchange. Conversion to an open-
end investment company would also require changes in certain of the Fund's
investment policies and restrictions, such as those relating to the borrowing
of money and the purchase of illiquid securities.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under
Maryland law or the Investment Company Act, are in the best interests of
shareholders generally. Reference should be made to the Articles of
Incorporation on file with the Securities and Exchange Commission for the full
text of these provisions.
CUSTODIAN
The Fund's securities and cash are held under a custodian agreement with The
Bank of New York, 110 Washington Street, New York, New York 10286.
43
<PAGE>
UNDERWRITING
The Underwriter has agreed, subject to the terms and conditions of a
Purchase Agreement with the Fund and the Investment Adviser, to purchase
57,500,000 shares of Common Stock from the Fund. The Underwriter is committed
to purchase all of such shares if any are purchased.
The Underwriter has advised the Fund that it proposes initially to offer the
shares of Common Stock to the public at the public offering price set forth on
the cover page of this Prospectus. There is no sales charge or underwriting
discount charged to investors on purchases of shares of Common Stock in the
offering. The Investment Adviser or an affiliate has agreed to pay the
Underwriter from its own assets a commission in connection with the sale of
shares of Common Stock in the offering in the amount of $.20 per share. Such
payment is equal to 2.00% of the initial public offering price per share. The
Underwriter also has advised the Fund that from this amount the Underwriter
may pay a concession to certain dealers not in excess of $.20 per share on
sales by such dealers. After the initial public offering, the public offering
price and other selling terms may be changed. Investors must pay for shares of
Common Stock purchased in the offering on or before March 27, 1998.
The Fund has granted the Underwriter an option, exercisable for 45 days
after the date hereof, to purchase up to 8,625,000 additional shares of Common
Stock to cover over-allotments, if any, at the initial offering price.
The Underwriter may engage in certain transactions that stabilize the price
of the shares of Common Stock. Such transactions consist of bids or purchases
for the purpose of pegging, fixing or maintaining the price of the shares of
Common Stock.
If the Underwriter creates a short position in the shares of Common Stock in
connection with the offering, i.e., if it sells more shares of Common Stock
than are set forth on the cover page of this Prospectus, the Underwriter may
reduce that short position by purchasing shares of Common Stock in the open
market. The Underwriter also may elect to reduce any short position by
exercising all or part of the over-allotment option described above.
The Underwriter may also impose a penalty bid on certain syndicate and
selling group members. This means that if the Underwriter purchases shares of
Common Stock in the open market to reduce the Underwriter's short position or
to stabilize the price of the shares of Common Stock, it may reclaim the
amount of the selling concession from the selling group members who sold those
shares of Common Stock as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher
than it might be in the absence of such purchases. The imposition of a penalty
bid might also have an effect on the price of a security to the extent that it
were to discourage resales of the security.
Neither the Fund nor the Underwriter makes any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the shares of Common Stock. In addition,
neither the Fund nor the Underwriter makes any representation that the
Underwriter will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
44
<PAGE>
Prior to this offering, there has been no public market for the shares of
the Common Stock. The Fund's shares of Common Stock have been approved for
listing on the New York Stock Exchange, subject to official notice of
issuance. However, during an initial period, which is not expected to exceed
two weeks from the date of this Prospectus, the Fund's shares will not be
listed on any securities exchange. Additionally, during such period, the
Underwriter does not intend to make a market in the Fund's shares, although a
limited market may develop. Consequently, it is anticipated that an investment
in the Fund will be illiquid during such period. In order to meet the
requirements for listing, the Underwriter has undertaken to sell lots of 100
or more shares to a minimum of 2,000 beneficial owners.
The Fund anticipates that the Underwriter may from time to time act as
broker in connection with the execution of its portfolio transactions.
The Underwriter is an affiliate of the Investment Adviser of the Fund.
The Fund and the Investment Adviser have agreed to indemnify the Underwriter
against certain liabilities, including liabilities under the Securities Act.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the shares
of the Fund is The Bank of New York, 110 Washington Street, New York, New York
10286.
LEGAL OPINIONS
Certain legal matters in connection with the shares offered hereby will be
passed upon for the Fund and the Underwriter by Brown & Wood LLP, New York,
New York.
EXPERTS
The statement of assets, liabilities and capital of the Fund included in
this Prospectus has been so included in reliance on the report of Deloitte &
Touche LLP, independent auditors, and on their authority as experts in
auditing and accounting. The selection of independent auditors is subject to
ratification by shareholders of the Fund.
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the Investment Company Act and in accordance
therewith is required to file reports, proxy statements and other information
with the Securities and Exchange Commission (the "Commission"). Any such
reports, proxy statements and other information can be inspected and copied at
the public reference facilities of the Commission at Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the following
regional offices of the Commission: Regional Office, at Seven World Trade
Center, Suite 1300, New York, New York 10048; Pacific Regional Office, at 5670
Wilshire Boulevard, 11th Floor, Los Angeles, California 90036; and Midwest
Regional Office, at Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such materials can be obtained
from the public reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission maintains
45
<PAGE>
a Web site at http://www.sec.gov containing reports, proxy and information
statements and other information regarding registrants, including the Fund,
that file electronically with the Commission. Reports, proxy statements and
other information concerning the Fund can also be inspected at the offices of
the New York Stock Exchange, 20 Broad Street, New York, New York 10005.
Additional information regarding the Fund is contained in the Registration
Statement on Form N-2, including amendments, exhibits and schedules thereto,
relating to such shares filed by the Fund with the Commission in Washington,
D.C. This Prospectus does not contain all of the information set forth in the
Registration Statement, including any amendments, exhibits and schedules
thereto. For further information with respect to the Fund and the shares
offered hereby, reference is made to the Registration Statement. Statements
contained in this Prospectus as to the contents of any contract or other
document referred to are not necessarily complete and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference. A copy of the Registration Statement may be
inspected without charge at the Commission's principal office in Washington,
D.C., and copies of all or any part thereof may be obtained from the
Commission upon the payment of certain fees prescribed by the Commission.
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the
Year 1900 (commonly known as the "Year 2000 Problem"). Like other investment
companies and financial and business organizations, the Fund could be
adversely affected if the computer systems used by the Investment Adviser or
other Fund service providers do not properly address this problem prior to
January 1, 2000. The Investment Adviser has established a dedicated group to
analyze these issues and to implement any systems modifications necessary to
prepare for the Year 2000. Currently, the Investment Adviser does not
anticipate that the transition to the 21st Century will have any material
impact on its ability to continue to service the Fund at current levels. In
addition, the Investment Adviser has sought assurances from the Fund's other
service providers that they are taking all necessary steps to ensure that
their computer systems will accurately reflect the Year 2000, and the
Investment Adviser will continue to monitor the situation. At this time,
however, no assurance can be given that the Fund's other service providers
have anticipated every step necessary to avoid any adverse effect on the Fund
attributable to the Year 2000 Problem.
46
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholder,Debt Strategies Fund II, Inc.:
We have audited the accompanying statement of assets, liabilities and capital
of Debt Strategies Fund II, Inc. as of March 20, 1998. This financial
statement is the responsibility of the Fund's management. Our responsibility
is to express an opinion on this financial statement based on our audit.
We conducted our audit 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 statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. 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 audit provides a reasonable basis
for our opinion.
In our opinion, such statement of assets, liabilities and capital presents
fairly, in all material respects, the financial position of Debt Strategies
Fund II, Inc. as of March 20, 1998 in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
March 23, 1998
47
<PAGE>
DEBT STRATEGIES FUND II, INC.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
MARCH 20, 1998
<TABLE>
<S> <C>
ASSETS
Cash................................................................ $100,000
Deferred organization and offering costs (Note 1)................... 755,000
--------
Total Assets...................................................... 855,000
--------
LIABILITIES
Deferred organization and offering costs payable (Note 1)........... 755,000
--------
NET ASSETS............................................................ $100,000
========
CAPITAL
Common Stock, par value $.10 per share; 200,000,000 shares autho-
rized; 10,000 shares issued and outstanding (Note 1)............... $ 1,000
Paid-in Capital in excess of par.................................... 99,000
--------
Total Capital--Equivalent to $10.00 net asset value per share of
Common Stock
(Note 1)......................................................... $100,000
========
</TABLE>
NOTES TO STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
NOTE 1. ORGANIZATION
The Fund was incorporated under the laws of the State of Maryland on
December 10, 1997, as a closed-end, diversified management investment company
and has had no operations other than the sale to Fund Asset Management, L.P.
(the "Investment Adviser") of an aggregate of 10,000 shares for $100,000 on
March 20, 1998. The General Partner of the Investment Adviser is an indirectly
wholly-owned subsidiary of Merrill Lynch & Co., Inc.
Deferred organization costs will be amortized on a straight-line basis over
a five-year period beginning with the commencement of operations of the Fund.
Direct costs relating to the public offering of the Fund's shares will be
charged to capital at the time of issuance of shares.
NOTE 2. MANAGEMENT ARRANGEMENTS
The Fund has engaged the Investment Adviser to provide investment advisory
and management services to the Fund. The Investment Adviser will receive a
monthly fee at the annual rate of 0.60 of 1% of the Fund's average weekly net
assets plus the proceeds of any outstanding borrowings used for leverage.
NOTE 3. FEDERAL INCOME TAXES
The Fund intends to qualify as a "regulated investment company" and as such
(and by complying with the applicable provisions of the Internal Revenue Code
of 1986, as amended) will not be subject to Federal income tax on a taxable
income (including realized capital gains) that is distributed to shareholders.
48
<PAGE>
APPENDIX
DESCRIPTION OF CORPORATE BOND RATINGS
DESCRIPTION OF CORPORATE BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.:
Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and generally are referred to as
"gilt-edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what generally are known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa--Bonds which are rated Baa are considered medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa--Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca--Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C--Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
The modifier 1 indicates that the bond ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its rating
category.
A-1
<PAGE>
DESCRIPTION OF CORPORATE BOND RATINGS OF STANDARD & POOR'S, A DIVISION OF THE
MCGRAW-HILL COMPANIES, INC.:
AAA--Bonds rated AAA have the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA--Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the higher rated issues only in small degree.
A--Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than bonds in higher rated
categories.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay interest and repay
principal for bonds in this category than in higher rated categories.
BB--B--CCC--CC--Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation.
BB indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds likely will have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C--The C rating is reserved for income bonds on which no interest is being
paid.
D--Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
NR--Indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of bond as a matter of policy.
Plus (+) or Minus (-): The ratings from AA to B may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
A-2
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS NOT CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFOR-
MATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OF ANY SECURITIES OTHER THAN
THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY
STATE OR JURISDICTION OF THE U.S. OR ANY COUNTRY WHERE SUCH OFFER WOULD BE UN-
LAWFUL.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................................................... 3
Risk Factors and Special Considerations.................................... 6
Fee Table.................................................................. 10
The Fund................................................................... 11
Use of Proceeds............................................................ 11
Investment Objectives and Policies......................................... 11
Other Investment Policies.................................................. 19
Investment Restrictions.................................................... 28
Directors and Officers..................................................... 30
Investment Advisory and Management Arrangements............................ 32
Portfolio Transactions..................................................... 34
Dividends and Distributions................................................ 35
Taxes...................................................................... 36
Automatic Dividend Reinvestment Plan....................................... 39
Mutual Fund Investment Option.............................................. 41
Net Asset Value............................................................ 41
Description of Capital Stock............................................... 42
Custodian.................................................................. 43
Underwriting............................................................... 44
Transfer Agent, Dividend Disbursing Agent and Registrar.................... 45
Legal Opinions............................................................. 45
Experts.................................................................... 45
Additional Information..................................................... 45
Independent Auditors' Report............................................... 47
Statement of Assets, Liabilities and Capital............................... 48
Appendix................................................................... A-1
</TABLE>
---------------
UNTIL JUNE 22, 1998 (90 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
57,500,000 SHARES
DEBT STRATEGIES FUND II, INC.
COMMON STOCK
---------------
PROSPECTUS
---------------
MERRILL LYNCH & CO.
MARCH 24, 1998
CODE 19023-0398
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(1) Financial Statements
Independent Auditors' Report
Statement of Assets, Liabilities and Capital as of March 20, 1998
(2) Exhibits:
<TABLE>
<C> <S>
(a) --Articles of Incorporation (a)
(b) --By-Laws (a)
(c) --Not applicable
(d)(1) --Portions of the Articles of Incorporation and By-Laws of the
Registrant defining the rights of holders of shares of the
Registrant (b)
(d)(2) --Form of specimen certificate for shares of Common Stock of the
Registrant (a)
(e) --Form of Dividend Reinvestment Plan (a)
(f) --Not applicable
(g) --Form of Investment Advisory Agreement between the Registrant and
the Investment Adviser (c)
(h)(1) --Form of Purchase Agreement (c)
(h)(2) --Merrill Lynch Standard Dealer Agreement (c)
(i) --Not applicable
(j) --Custodian Contract between the Registrant and The Bank of New
York (c)
(k) --Registrar, Transfer Agency and Service Agreement between the
Registrant and The Bank of New York (c)
(l) --Opinion and consent of Brown & Wood LLP, counsel to the
Registrant
(m) --Not applicable
(n) --Consent of Deloitte & Touche LLP, independent auditors for the
Registrant
(o) --Not applicable
(p) --Certificate of Fund Asset Management, L.P.
(q) --Not applicable
</TABLE>
- --------
(a) Filed on January 12, 1998 as an Exhibit to the Registrant's Registration
Statement on Form N-2 (File No. 333-44051).
(b) Reference is made to Article V, Article VI (sections 2,3,4,5 and 6),
Article VII, Article VIII, Article X, Article XI, Article XII and Article
XIII of the Registrant's Articles of Incorporation, filed as Exhibit (a)
to this Registration Statement; and to Article II, Article III (sections
1,2,3,5 and 17), Article VI, Article VII, Article XII, Article XIII and
Article XIV of the Registrant's By-Laws, filed as Exhibit (b) to this
Registration Statement.
(c) Filed on February 18, 1998 as an Exhibit to the Registrant's Registration
Statement on Form N-2 (File No. 333-44051).
ITEM 25. MARKETING ARRANGEMENTS.
See Exhibit (h).
C-1
<PAGE>
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this Registration Statement:
<TABLE>
<S> <C>
Registration fees.................................................. $195,069
Stock Exchange listing fee......................................... 301,600
Printing (other than stock certificates)........................... 54,600
Engraving and printing stock certificates.......................... 20,000
Legal fees and expenses............................................ 65,000
Accounting fees and expenses....................................... 5,500
NASD fees.......................................................... 30,500
Miscellaneous...................................................... 2,731
--------
Total............................................................ 675,000
========
</TABLE>
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The information in the Prospectus under the caption "Investment Advisory and
Management Arrangements" and in Note 1 to the Statement of Assets, Liabilities
and Capital is incorporated herein by reference.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES.
There will be one record holder of the Common Stock, par value $.10 per
share, as of the effective date of this Registration Statement.
ITEM 29. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, filed as Exhibit
(a)(1) to this Registration Statement, Article VI of the Registrant's By-Laws,
filed as Exhibit (b) to this Registration Statement, and the Investment
Advisory Agreement, a form of which will be filed as Exhibit (g)(1) to this
Registration Statement, provide for indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "1933 Act") may be provided to directors, officers
and controlling persons of the Fund, pursuant to the foregoing provisions or
otherwise, the Fund has been advised that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Fund of expenses incurred or paid by a director, officer or controlling
person of the Fund in connection with any successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Fund will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
Reference is made to Section Six of the Purchase Agreement, a form of which
will be filed as Exhibit (h)(1) hereto, for provisions relating to the
indemnification of the underwriter.
C-2
<PAGE>
ITEM 30. Business and Other Connections of the Investment Adviser.
Fund Asset Management, L.P. (the "Investment Adviser") acts as investment
adviser for the following open-end registered investment companies: CBA Money
Fund, CMA Government Securities Fund, CMA Money Fund, CMA Multi-State
Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate
Fund Accumulation Program, Inc., Financial Institutions Series Trust, Merrill
Lynch Basic Value Fund, Inc., Merrill Lynch California Municipal Series Trust,
Merrill Lynch Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers Fund,
Inc., Merrill Lynch Federal Securities Trust, Merrill Lynch Funds for
Institutions Series, Merrill Lynch Multi-State Limited Maturity Municipal
Series Trust, Merrill Lynch Multi-State Municipal Series Trust, Merrill Lynch
Municipal Bond Fund, Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch
Special Value Fund, Inc., Merrill Lynch World Income Fund, Inc., and The
Municipal Fund Accumulation Program, Inc., and for the following closed-end
registered investment companies: Apex Municipal Fund, Inc., Corporate High
Yield Fund, Inc., Corporate High Yield Fund II, Inc., Corporate High Yield
Fund III, Inc., Debt Strategies Fund, Inc., Debt Strategies Fund II, Inc.,
Income Opportunities Fund 1999, Inc., Income Opportunities Fund 2000, Inc.,
Merrill Lynch Municipal Strategy Fund, Inc, MuniAssets Fund, Inc.,
MuniEnhanced Fund, Inc., MuniHoldings Fund, Inc., MuniHoldings Fund II, Inc.,
MuniHoldings California Insured Fund, Inc., MuniHoldings California Insured
Fund II, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured
Fund II, MuniHoldings New Jersey Insured Fund, MuniHoldings New York Fund,
MuniHoldings New York Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest
Florida Fund, MuniVest Fund, Inc., MuniVest Fund II, Inc., MuniVest Michigan
Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest Pennsylvania
Insured Fund, MuniYield Arizona Fund, Inc., MuniYield California Fund, Inc.,
MuniYield California Insured Fund, Inc., MuniYield California Insured Fund II,
Inc., MuniYield Florida Fund, MuniYield Florida Insured Fund, MuniYield Fund,
Inc., MuniYield Insured Fund, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield
New York Insured Fund II, Inc., MuniYield Pennsylvania Fund, MuniYield Quality
Fund, Inc., MuniYield Quality Fund II, Inc., Senior High Income Portfolio,
Inc. and Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the
Investment Adviser, acts as the investment adviser for the following open-end
registered investment companies: Merrill Lynch Adjustable Rate Securities
Fund, Inc., Merrill Lynch Americas Income Fund, Inc., Merrill Lynch Asset
Builder Program, Inc., Merrill Lynch Asset Growth Fund, Inc., Merrill Lynch
Asset Income Fund, Inc., Merrill Lynch Capital Fund, Inc., Merrill Lynch
Convertible Fund, Inc., Merrill Lynch Developing Capital Markets Fund, Inc.,
Merrill Lynch Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch
Fundamental Growth Fund, Inc., Merrill Lynch Fund for Tomorrow, Inc., Merrill
Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch Global
Allocation Fund, Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill
Lynch Global Growth Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill
Lynch Global Resources Trust, Merrill Lynch Global SmallCap Fund, Inc.,
Merrill Lynch Global Utility Fund, Inc., Merrill Lynch Global Value Fund,
Inc., Merrill Lynch Growth Fund, Inc., Merrill Lynch Healthcare Fund, Inc.,
Merrill Lynch Intermediate Government Bond Fund, Merrill Lynch International
Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill Lynch Middle
East/Africa Fund, Inc., Merrill Lynch Municipal Series Trust, Merrill Lynch
Pacific Fund, Inc., Merrill Lynch Ready Assets Trust, Merrill Lynch Real
Estate Fund, Inc., Merrill Lynch Retirement Series Trust, Merrill Lynch Series
Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch
Strategic Dividend Fund, Merrill Lynch Technology Fund, Inc., Merrill Lynch
U.S. Treasury Money Fund, Merrill Lynch U.S.A. Government Reserves, Merrill
Lynch Utility Income Fund, Inc., Merrill Lynch Variable Series Funds, Inc. and
Hotchkis and Wiley Funds (advised by Hotchkis and Wiley, a division of MLAM);
and for the following closed-end registered investment companies: Convertible
Holdings, Inc., Merrill Lynch High Income Municipal Bond Fund, Inc. and
Merrill Lynch Senior Floating Rate Fund, Inc. MLAM also acts as subadviser to
Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic Value Equity
Portfolio, two investment portfolios of EQ Advisory Trust.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch
Funds for Institutions Series and Merrill Lynch Intermediate Government Bond
Fund is One Financial Center, 23rd Floor, Boston, Massachusetts 02111-2646.
The address of the Investment Adviser, MLAM, Merrill Lynch Funds Distributor,
Inc. ("MLFD"), Princeton Services, Inc. ("Princeton Services") and Princeton
Administrators, L.P. also is P.O. Box 9011, Princeton, New Jersey 08543-
C-3
<PAGE>
9011. The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") and Merrill Lynch & Co., Inc. ("ML & Co.") is World
Financial Center, North Tower, 250 Vesey Street, New York, New York: 10281-
1201.
Set forth below is a list of each executive officer and partner of the
Investment Adviser indicating each business, profession, vocation or
employment of a substantial nature in which each such person or entity has
been engaged for the past two years for his or her or its own account or in
the capacity of director, officer, employee, partner or trustee. In addition,
Mr. Zeikel is President, Mr. Richard is Treasurer and Mr. Glenn is Executive
Vice President of all or substantially all of the investment companies
described in the preceding paragraphs and also hold the same positions with
all or substantially all of the investment companies advised by MLAM as they
do with those advised by the Investment Adviser. Messrs. Giordano, Harvey,
Kirstein and Monagle are directors or officers of one or more of such
companies.
<TABLE>
<CAPTION>
POSITION WITH
INVESTMENT OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME ADVISER VOCATION OR EMPLOYMENT
---- -------------- ---------------------------------------
<C> <C> <S>
ML & Co............ Limited Partner Financial Services Holding Company;
Limited Partner of MLAM
Princeton Services. General Partner General Partner of MLAM
Arthur Zeikel...... Chairman Chairman of MLAM; President of MLAM and
FAM (from 1977 to 1997); Chairman and
Director of Princeton Services;
President of Princeton Services (from
1993 to 1997); Executive Vice President
of ML & Co.
Jeffrey M. Peek.... President President of MLAM since 1997; President
and Director of Princeton Services;
Executive Vice President of ML & Co.
Terry K. Glenn..... Executive Vice Executive Vice President of MLAM;
President Executive Vice President and Director of
Princeton Services; President and
Director of MLFD; President of Princeton
Administrators, L.P.
Linda L. Federici.. Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services
Vincent R. Senior Vice Senior Vice President of MLAM; Senior
Giordano........... President Vice President of Princeton Services
Elizabeth A. Senior Vice Senior Vice President of MLAM; Senior
Griffin............ President Vice President of Princeton Services
Norman R. Harvey... Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services
Michael J. Senior Vice Senior Vice President of MLAM; Senior
Hennewinkel........ President Vice President of the MLAM International
Group
Philip L. Kirstein. Senior Vice Senior Vice President, General Counsel
President, and Secretary of MLAM; Senior Vice
General Counsel President, General Counsel Director and
and Secretary Secretary of Princeton Services
Ronald M. Kloss.... Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services
Debra W. Landsman- Senior Vice Senior Vice President of MLAM; Senior
Yaros.............. President Vice President of Princeton Services;
Vice President of MLFD
Stephen M. M. Senior Vice Executive Vice President of Princeton
Miller............. President Administrators L.P.; Senior Vice
President of Princeton Services
Joseph T. Monagle, Senior Vice Senior Vice President of MLAM; Senior
Jr. ............... President Vice President of Princeton Services
Michael L. Quinn... Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services;
Managing Director and First Vice
President of Merrill Lynch from 1989 to
1995
Richard L. Reller.. Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services and
Director of MLFD
Gerald M. Richard.. Senior Vice Senior Vice President and Treasurer of
President and MLAM; Senior Vice President and
Treasurer Treasurer of Princeton Services; Vice
President and Treasurer of MLFD
Gregory D. Upah.... Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services
Ronald L. Welburn.. Senior Vice Senior Vice President of MLAM; Senior
President Vice President of Princeton Services
</TABLE>
C-4
<PAGE>
ITEM 31. LOCATION OF ACCOUNT AND RECORDS.
All accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act of 1940, as amended, and the rules
promulgated thereunder are maintained at the offices of the registrant (800
Scudders Mill Road, Plainsboro, New Jersey 08536), its investment adviser (800
Scudders Mill Road, Plainsboro, New Jersey 08536), and its custodian and
transfer agent.
ITEM 32. MANAGEMENT SERVICES.
Not applicable.
ITEM 33. UNDERTAKINGS.
(a) Registrant undertakes to suspend the offering of the shares of Common
Stock covered hereby until it amends its Prospectus contained herein if (1)
subsequent to the effective date of this registration statement, its net
asset value per share of Common Stock declines more than 10 percent from
its net asset value per share of Common Stock as of the effective date of
this Registration Statement, or (2) its net asset value per share of Common
Stock increases to an amount greater than its net proceeds as stated in the
Prospectus contained herein.
(b) Registrant undertakes that:
(1) For purposes of determining any liability under the 1933 Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the registrant pursuant to Rule 497(h)
under the 1933 Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the 1933 Act,
each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.
C-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant has duly caused this Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in
the Township of Plainsboro, and State of New Jersey, on the 23rd day of March,
1998.
Debt Strategies Fund II, Inc.
(Registrant)
/s/ Arthur Zeikel
By
------------------------------------
(ARTHUR ZEIKEL, PRESIDENT)
Each person whose signature appears below hereby authorizes Arthur Zeikel,
Terry K. Glenn or Gerald M. Richard, or any of them, as attorney-in-fact, to
sign on his or her behalf, individually and in each capacity stated below, any
amendment to this Registration Statement (including post-effective amendments)
and to file the same, with all exhibits thereto, with the Securities and
Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed below by the following person in the capacities and
on the date indicated.
SIGNATURES TITLE DATE
/s/ Arthur Zeikel President (Principal
- ------------------------------------ Executive Officer) March 23, 1998
(ARTHUR ZEIKEL) and Director
/s/ Gerald M. Richard Treasurer (Principal
- ------------------------------------ Financial and March 23, 1998
(GERALD M. RICHARD) Accounting Officer)
/s/ Ronald W. Forbes Director
- ------------------------------------ March 23, 1998
(RONALD W. FORBES)
Director
- ------------------------------------
(CYNTHIA A. MONTGOMERY)
/s/ Charles C. Reilly Director
- ------------------------------------ March 23, 1998
(CHARLES C. REILLY)
/s/ Kevin A. Ryan Director
- ------------------------------------ March 23, 1998
(KEVIN A. RYAN)
/s/ Richard R. West Director
- ------------------------------------ March 23, 1998
(RICHARD R. WEST)
C-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
(l) --Opinion and consent of Brown & Wood LLP
(n) --Consent of Deloitte & Touche LLP
(p) --Certificate of Fund Asset Management, L.P.
</TABLE>
<PAGE>
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
Telephone: (212)839-5300
Facsimile: (212)839-5599
Exhibit L
March 24, 1998
Debt Strategies Fund II, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Ladies and Gentlemen:
This opinion is being furnished in connection with the registration by Debt
Strategies Fund II, Inc. a Maryland corporation (the "Fund"), of shares of
common stock, par value $0.10 per share (the "Shares"), under the Securities Act
of 1933, as amended, pursuant to a registration statement on Form N-2 (File No.
333-44051), as amended (the "Registration Statement"), in the amounts set forth
under "Amount Being Registered" on the facing page of the Registration
Statement.
As counsel for the Fund, we are familiar with the proceedings taken by it
in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Articles of Incorporation
and By-Laws of the Fund, and such other documents as we have deemed
relevant to the matters referred to in this opinion.
Based upon the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement, will
be legally issued, fully paid and non-assessable shares of common stock of the
Fund.
<PAGE>
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus constituting
a part thereof.
Very truly yours,
/s/ Brown & Wood LLP
2
<PAGE>
EXHIBIT N
INDEPENDENT AUDITORS' CONSENT
Debt Strategies Fund II, Inc.:
We consent to the use in Pre-Effective Amendment No. 2 to Registration Statement
No. 333-44051 of our report dated March 23, 1998 and to the reference to us
under the caption "Experts" both of which appear in the Prospectus, which is a
part of such Registration Statement.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
March 24, 1998
<PAGE>
EXHIBIT P
CERTIFICATE OF THE SOLE STOCKHOLDER OF
DEBT STRATEGIES FUND II, INC.
Fund Asset Management, L.P. ("FAM"), the holder of 10,000 shares of common
stock, par value $0.10 per share, of Debt Strategies Fund II, Inc. (the "Fund"),
a Maryland corporation, does hereby confirm to the Fund its representation that
it purchased such shares for investment purposes, with no present intention of
redeeming or reselling any portion thereof, and further agrees that if it
redeems (by tender offer or otherwise) any portion of such shares prior to the
amortization of the Fund's organizational expenses, the proceeds thereof will be
reduced by the proportionate amount of unamortized organizational expenses which
the number of shares being redeemed bears to the number of shares initially
purchased and outstanding at the time of redemption. FAM further agrees that,
in the event such shares are sold or otherwise transferred to any other party,
prior to such sale or transfer FAM will obtain on behalf of the Fund an
agreement from such other party to comply with the foregoing as to the reduction
of redemption proceeds and to obtain a similar agreement from any transferee of
such party.
FUND ASSET MANAGEMENT, L.P.
By: /s/ Robert Harris
---------------------------------
Name: Robert Harris
Title:Assistant Secretary
Dated: March 24, 1998
