DEBT
STRATEGIES
FUND II, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Semi-Annual Report
August 31, 2000
<PAGE>
DEBT STRATEGIES FUND II, INC.
The Benefits and Risks of Leveraging
Debt Strategies Fund II, Inc. has the ability to utilize leverage through
borrowings or issuance of short-term debt securities or shares of Preferred
Stock. The concept of leveraging is based on the premise that the cost of assets
to be obtained from leverage will be based on short-term interest rates, which
normally will be lower than the return earned by the Fund on its longer-term
portfolio investments. To the extent that the total assets of the Fund
(including the assets obtained from leverage) are invested in higher-yielding
portfolio investments, the Fund's Common Stock shareholders will be the
beneficiaries of the incremental yield.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend rates
on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce
the Common Stock's yield and negatively impact its market price. If the income
derived from securities purchased with assets received from leverage exceeds the
cost of leverage, the Fund's net income will be greater than if leverage had not
been used. Conversely, if the income from the securities purchased is not
sufficient to cover the cost of leverage, the Fund's net income will be less
than if leverage had not been used, and therefore the amount available for
distribution to Common Stock shareholders will be reduced. In this case, the
Fund may nevertheless decide to maintain its leveraged position in order to
avoid capital losses on securities purchased with leverage. However, the Fund
will not generally utilize leverage if it anticipates that its leveraged capital
structure would result in a lower rate of return for its Common Stock than would
be obtained if the Common Stock were unleveraged for any significant amount of
time.
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
DEAR SHAREHOLDER
For the six-month period ended August 31, 2000, Debt Strategies Fund II, Inc.'s
total investment return was -1.20%, based on a change in per share net asset
value from $8.60 to $7.96, and assuming reinvestment of $0.481 per share income
dividends. During the same six-month period, the net annualized yield of the
Fund's Common Stock was 11.98%. Since inception (March 27, 1998) through August
31, 2000, the total investment return on the Fund's Common Stock was +3.84%,
based on a change in per share net asset value from $10.00 to $7.96, and
assuming reinvestment of $2.137 per share income dividends. At the end of the
August period, the Fund was approximately 27% leveraged as a percentage of total
assets. (For a complete explanation of the benefits and risks of leveraging, see
page 1 of this report to shareholders.)
Investment Approach
Debt Strategies Fund II, Inc. consists largely of high-yield bonds and
participations in leveraged bank loans. The high-yield bond and bank loan
markets are comprised of similar industry sectors and often contain overlapping
issuers. As a result, general economic events and trends tend to move the two
markets in the same direction, although bonds typically experience greater
volatility than bank loans. This can be attributed to two factors. First, bank
loans are typically senior secured obligations, thus generally offering
investors greater principal protection than unsecured bonds. Second, bank loans
are typically floating rate instruments whose principal value generally does not
move inversely with interest rate movements, as is the case with fixed rate
bonds. In the last two years, both markets have been adversely affected by the
increased premium accorded to credit risk.
Market Review
Principal (or price) returns were negative in both the high-yield and leveraged
loan markets over the six months ended August 31, 2000. The high-yield market,
as measured by the Donaldson, Lufkin, Jenrette (DLJ) High Yield Bond Index,
experienced principal depreciation of 454 basis points (4.54%). The loan market
experienced almost half that decline, reporting a principal loss of 261 basis
points, as measured by the DLJ Leveraged Loan Index. Throughout the period,
"flight-to-quality" remained the performance theme in the high-yield market.
Issues that were higher rated (securities rated BB), larger ($300 million and
greater), and in sectors with stability or positive event risk (such as cable,
wireless telecommunications, gaming and energy) outperformed their riskier
counterparts. In contrast to the high-yield market, the bank loan market had
mixed results. Both the higher-rated issues (securities rated BB) and distressed
issues (securities rated CCC/CC and C) performed well, while the B-rated issues
underperformed. The loan market favored the same sectors as the high-yield
market.
For the last six months, the total return (principal return plus interest income
earned) of the high-yield bond market was barely in positive territory as it
posted a return of +0.27%, as measured by the unmanaged DLJ High Yield Bond
Index. The loan market fared better and provided a total return of +2.27%, as
measured by the unmanaged DLJ Leveraged Loan Index. Although a reduction in
Treasury yields helped boost the performance of high-yield bonds, widening
credit spreads more than offset the reduction in underlying interest rates.
During the period, the ten-year Treasury yield fell from 6.41% to 5.73%, or 68
basis points, while high-yield credit spreads widened 143 basis points. This
maintained a continuing market theme of the last few years whereby credit risk,
as measured by the spread at which issuers' securities trade over US Treasury
securities, has been a stronger force on the price of securities than the effect
of the underlying changes in interest rates. Bank term loan spreads widened as
well, although by only 63 basis points for B-rated issuers.
During the period, the energy, chemicals, gaming, broadcasting and wireless
telecommunications sectors performed well. These industries benefited from one
or more of the following characteristics: improving commodity prices, stable
cash flows and robust growth prospects. However, certain sectors such as wired
telecommunications, retail and metals/mining continued to experience
difficulties resulting in credit deterioration and principal losses (realized
and unrealized) for some of the Fund's holdings. The wired telecommunications
industry underperformed because of investor nervousness about the completion of
business plans of some of its operators. Retailers suffered from a lack of
pricing power and an escalation of competition from e-commerce. The
metals/mining industry continued to suffer through cyclical troughs in a number
of commodities.
Investment Activities
At August 31, 2000, 50% of the Fund's assets were allocated to bonds and 49% to
bank loans. As of August 31, 2000, most of the Fund's loans were accruing
interest at a yield spread above the London Interbank Offered Rate (LIBOR), the
rate that major international banks charge each other for US dollar-denominated
deposits outside of the United States. LIBOR tracks very closely with other
short-term interest rates in the United States, particularly the Federal Funds
rate. Since the reset period on the Fund's floating rate investments is between
30 days-90 days, the yield on the bank loan portion of the Fund is likely to
move in the same direction within a short period of time after any Federal Funds
rate change.
We continue to maintain significant diversification across the Fund's
investments. At August 31, 2000, the Fund was comprised of 202 borrowers across
50 industries. (See the "Portfolio Profile" on page 25 of this report to
shareholders, which provides listings of the Fund's ten largest holdings and
five largest industries as of August 31, 2000.)
Investment Strategy
Throughout the six months ended August 31, 2000, the Fund's investment
philosophy remained unchanged: to invest in leveraged transactions in which
borrowers have strong market shares, experienced management, consistent cash
flows and appropriate risk/reward characteristics. In addition, we look for
companies with significant underlying asset and franchise value, strong capital
structures and equity sponsors that support their investments. An example of a
credit purchased in the last six months that demonstrates these criteria is
Adelphia Communications Corporation. Adelphia Communications, through its
subsidiary Century Cable LLC, issued a $1 billion institutional term loan priced
at 3% over LIBOR. Adelphia Communications is one of the top five cable companies
with over 1.5 million paid subscribers. Century Cable, the operating company
borrower, is capitalized with $4.25 billion of equity from its parent, producing
a relatively conservative debt capitalization ratio of 33%. With average
industry transactions occurring at approximately $4,000 per subscriber, the
intrinsic equity value of our borrower is significant with its debt per
subscriber estimated at $1,350. The loan also has several covenants in the
credit agreement to protect the integrity of the credit. We believe assets such
as Adelphia Communications will lessen the volatility in the Fund and are likely
to consistently generate solid income.
Market Outlook
Compared with the pace of a year ago, the current environment's leveraged loan
and high-yield bond issuance has been limited. Investors have been very
selective, and transactions that are successfully issued are well structured and
attractively priced. This activity reflects the three large themes--liquidity
risk, default risk and monetary policy risk--that are affecting the market.
As for the liquidity risk of leveraged finance, retail mutual funds are playing
a significantly reduced role in absorbing the supply of leveraged loan and
high-yield new issuance, as a result of continued outflows in mutual funds of
these asset classes. Over $7 billion in assets have exited these retail mutual
funds thus far in 2000. However, some of the weakness in retail inflows was
offset by more than $17 billion of structured product issuance, which is
targeted at institutional investors. With new ramp-up institutional activity
being the marginal buyer in the markets, these vehicles take on much of the new
issuance, as well as purchase much of the good-quality credits in secondary
trading. Because of the small per-issue appetite of a typical structured
product and the diversification requirements that it has, the leveraged finance
market has some breadth, but little depth.
2 & 3
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
At the same time, and as we mentioned in our last report to shareholders, ever
since the Russian default crisis in the late summer of 1998, the volatility of
the leveraged loan and high-yield markets has continued to increase from
historical norms. A contributing influence on the elevated risk premium being
levied on the leveraged markets is that investors have tolerance for only a
limited number of credit rating downgrades and defaults. When a borrower reports
weaker-than-expected results, investors attempt to sell immediately to avoid any
potential impairment. If a borrower's ability to repay its debts (as perceived
by the marketplace) drops precipitously, or if there is no liquidity during its
slide downward, investors are forced to sell at low recovery rates. This
heightened sensitivity creates opportunities because decisions sometimes are
based not on credit fundamentals but on a more reactionary basis. Nevertheless,
these circumstances result in increased trading activity, and hence volatility,
as everyone often tries to reach the exit first when investors sense a potential
problem.
Related to this factor is the incidence of issuers in payment default. Defaults
increased in 1999 and some sectors continue to struggle despite the resilient
strength of the domestic economy. For example, the automotive parts, healthcare,
movie theater and textile sectors have a number of transactions outstanding in
our market that have materially underperformed since origination. The
transactions were well capitalized when originally structured, but cash flow
dropped or did not grow to a sufficient level to support the existing balance
sheets. Affected by these downgrades, investors scrutinize any news with a jaded
view, creating trading activity before news has been digested and exacerbating
volatility.
As of August 31, 2000, the trailing 12-month high-yield market default rate was
4.8% (dollar-weighted), as measured by Moody's Investor Services, Inc. In recent
months, these figures have shown some encouraging signs as the default rate has
sequentially decreased from 7.0% to 6.7% for the May-June 2000 period, from 6.7%
to 5.7% for the June-July 2000 period, and then again from 5.7% to 4.8% for the
July-August 2000 period. If this trend were to continue, much of the default
risk fears that hang over the leveraged finance market could ease.
At the same time, monetary policy risk seems lower. The economic outlook is
turning increasingly favorable as the Federal Reserve Board seems to have
engineered a somewhat less torrid pace for the economy, while "new
economy"-driven productivity gains have helped keep inflation at acceptable
levels. Investors seem to accept that the economy could grow at a sustainable
rate of 4% or more without price pressures. Therefore, most market observers
conclude that the string of Federal Reserve Board tightenings has neared its
conclusion. With the economy likely having avoided a hard landing and little
inflation appearing because of the Federal Reserve Board's actions to date, the
prospects for leveraged credits should be good.
Two factors on the horizon that could alter these views include the price of oil
and the US presidential election. Oil prices currently reflect low inventories
and some holdback on the part of producers from increasing production to the
higher levels that the market may have desired. Investor fears are that any
further increase in prices could work their way into core inflation. Separately,
the election, and its resulting impact on taxes and spending issues, leaves many
investors with some uncertainty regarding future fiscal policy.
In Conclusion
The high-yield bond and loan markets continue to experience above-average
volatility as investors remain wary of higher defaults, mutual fund redemptions,
the general level of interest rates and a lack of liquidity in the dealer
community. We are confident in the Federal Reserve Board's ability to avoid an
economic "hard landing," which is a positive for the entire leveraged finance
asset class. Furthermore, we believe there will be a moderation in the market
default rate as aggressive transactions underwritten in the past few years and
sectors such as healthcare negatively affected by specific factors are
restructured and exit the system. If general fundamentals improve, and with
market yields at near all-time highs, we would expect the leveraged finance
markets to strengthen over the next 12 months. Notwithstanding the expectation
of better market conditions ahead, we continue to be conservative in our
purchasing decisions, focusing on large issuers that are well capitalized in
selective industries.
We thank you for your investment in Debt Strategies Fund II, Inc., and we look
forward to reviewing our outlook and strategy with you again in our next report
to shareholders.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President and Director
/s/ Richard C. Kilbride
Richard C. Kilbride
Vice President and
Co-Portfolio Manager
/s/ Gilles Marchand
Gilles Marchand
Vice President and
Co-Portfolio Manager
September 29, 2000
================================================================================
In early December 2000, pending shareholder approval, Debt Strategies Fund II,
Inc. will acquire Debt Strategies Fund, Inc. and Debt Strategies Fund III, Inc.
in exchange for newly issued shares of Debt Strategies Fund II, Inc. Upon
completion of the reorganization, the Fund will be known as Debt Strategies
Fund, Inc. The three Funds have a similar investment objective: to seek current
income by investing primarily in a diversified portfolio of US companies' debt
instruments, including corporate loans, which are rated in the lower rating
categories of one of the major rating services.
================================================================================
4 & 5
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Advertising--0.3% B B2 US$ 1,300,000 Adams Outdoor Advertising Inc., 10.75% due 3/15/2006 $ 1,339,000
====================================================================================================================================
Air Transport--0.4% NR* NR* 2,040,536 Gemini Air Cargo, Term A, due 8/12/2005** 2,037,348
====================================================================================================================================
Aircraft & Parts--0.6% B- B3 2,500,000 Argo-Tech Corporation, 8.625% due 10/01/2007 2,000,000
CCC Caa3 6,970,000 Compass Aerospace Corp., 10.125% due 4/15/2005 1,028,075
-----------
3,028,075
====================================================================================================================================
Amusement & AMC Entertainment Inc.:
Recreational CCC+ Caa3 1,000,000 9.50% due 3/15/2009 (d) 355,000
Services--3.2% CCC+ Caa3 850,000 9.50% due 2/01/2011 301,750
CCC B1 3,064,283 American Skiing Company, Term, due 5/31/2006** 3,002,997
D C 1,000,000 @Carmike Cinemas Inc., 9.375% due 2/01/2009 220,000
B- B3 3,000,000 Hollywood Entertainment, 10.625% due 8/15/2004 (d) 2,370,000
NR* NR* 4,887,500 Kerasotes Theatres, Inc., Term B, due 12/31/2004** 4,472,062
B Caa2 1,300,000 Loews Cineplex Entertainment, 8.875% due 8/01/2008 429,000
NR* NR* 5,000,000 Metro-Goldwyn-Mayer Co. (MGM), Term B, due 12/31/2006** 4,960,625
-----------
16,111,434
====================================================================================================================================
Apparel--0.2% NR* NR* 1,083,333 CS Brooks Canada, Inc., Term, due 6/25/2006** 1,075,208
====================================================================================================================================
Automotive B+ B2 4,250,000 American Axle and Manufacturing Inc., 9.75% due 3/01/2009 4,196,875
Equipment--4.7% NR* NR* 543,579 @Breed Technologies Inc., Revolving Credit, due 4/27/2004** 200,218
BB- Ba3 9,700,000 Collins & Aikman Corp., Term C, due 12/31/2005** 9,606,036
B B2 4,500,000 Group 1 Automotive Inc., 10.875% due 3/01/2009 4,185,000
B+ B2 3,200,000 Holley Performance Products, 12.25% due 9/15/2007 1,920,000
CCC+ Caa2 2,050,000 Special Devices Inc., 11.375% due 12/15/2008 789,250
B+ B2 2,250,000 Tenneco Automotive Inc., 11.625% due 10/15/2009 1,935,000
B- B3 800,000 Venture Holdings Trust, 12% due 6/01/2009 536,000
-----------
23,368,379
====================================================================================================================================
Broadcast--Radio & B B2 4,875,000 Ackerley Group Inc., 9% due 1/15/2009 4,606,875
Television--9.1% NR* NR* 3,500,000 Bahakel Communications, Term B, due 6/30/2008** 3,500,000
B B1 5,000,000 Benedek Broadcasting Corporation, Term B, due 11/20/2007** 4,984,375
B- B3 1,700,000 Citadel Broadcasting Company, 9.25% due 11/15/2008 1,708,500
Cumulus Media, Inc.:
B- B3 2,000,000 10.375% due 7/01/2008 1,820,000
B+ B1 1,200,000 Term B, due 9/30/2007** 1,185,000
B+ B1 800,000 Term C, due 2/28/2008** 790,000
NR* NR* 4,200,000 Gocom Communications, Term B, due 12/31/2007** 4,200,000
CCC+ B3 1,525,000 Granite Broadcasting, 9.375% due 12/01/2005 1,258,125
B B3 2,250,000 Jones International Networks Ltd., 11.75% due 7/01/2005 2,227,500
NR* Caa1 18,550,000 Radio Unica Corp., 14.636% due 8/01/2006 (c) 12,799,500
CCC+ NR* 2,950,000 Sirius Satellite, 14.50% due 5/15/2009 2,603,375
B- B3 2,200,000 Spanish Broadcasting System, 9.625% due 11/01/2009 2,189,000
B B2 1,500,000 Young Broadcasting Inc., 8.75% due 6/15/2007 1,395,000
-----------
45,267,250
====================================================================================================================================
Building & B- B2 1,600,000 Webb (Del E.) Corp., 10.25% due 2/15/2010 1,528,000
Construction--0.3%
====================================================================================================================================
Building B B3 5,950,000 Amatek Industries, 12% due 2/15/2008 5,176,500
Materials--2.6% B B2 5,100,000 Republic Group Inc., 9.50% due 7/15/2008 5,100,000
BB- B1 2,985,000 Trussway Industries Inc., Term B, due 7/08/2005** 2,880,525
-----------
13,157,025
====================================================================================================================================
Business B+ B- 6,000,000 Muzak Bridge, Term, due 3/15/2009** 5,265,000
Services--1.9% B- Caa1 7,500,000 Muzak Holdings LLC, 13% due 3/15/2010 (c) 4,200,000
-----------
9,465,000
====================================================================================================================================
Cable Television CSC Holdings Inc.:
Services--10.9% BB+ Ba1 1,025,000 7.25% due 7/15/2008 965,148
BB+ Ba1 1,275,000 7.625% due 7/15/2018 1,162,984
NR* NR* 5,000,000 Century Cable LLC, Term, due 6/30/2009** 5,008,750
Charter Communications Holdings:
B+ B2 2,800,000 8.625% due 4/01/2009 2,555,000
B+ B2 5,000,000 10% due 4/01/2009 5,000,000
BB+ Ba3 2,000,000 Term, due 9/18/2008** 1,992,916
BB+ Ba3 5,000,000 Term B, due 3/18/2008** 4,982,290
Classic Cable Inc.:
B- B3 1,000,000 9.375% due 8/01/2009 785,000
B- B3 2,925,000 10.50% due 3/01/2010 2,442,375
BB NR* 2,605,263 Term C, due 1/31/2008** 2,600,378
CCC+ Caa1 17,000,000 Coaxial LLC, 11.864% due 8/15/2008 (c) 11,475,000
B+ B1 1,000,000 Insight Midwest, 9.75% due 10/01/2009 1,005,000
NR* NR* 5,500,000 Mallard Cablevision LLC, Term B, due 9/30/2008** 5,486,250
BB+ B1 2,000,000 Multicanal SA, 10.50% due 4/15/2018 1,380,000
D Caa3 2,000,000 @Supercanal Holdings SA, 11.50% due 5/15/2005 (d) 800,000
Telewest Communications PLC:
B+ B1 1,000,000 11.25% due 11/01/2008 995,000
B+ B1 3,800,000 9.875% due 2/01/2010 (d) 3,619,500
B B2 2,500,000 United Pan-Europe Communications NV, 11.25% due 2/01/2010 2,184,375
-----------
54,439,966
====================================================================================================================================
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Chemicals--3.3% BBB- Baa3 US$ 5,000,000 Equistar Chemicals LP, 8.75% due 2/15/2009 $ 4,889,600
BB- Ba2 2,000,000 Huntsman Corp., Term C, due 12/31/2005** 1,987,500
NR* Ba2 4,011,568 Koppers Industries, Inc., Term B, due 11/30/2004** 4,001,539
D Ca 2,700,000 @LaRoche Industries Inc., 9.50% due 9/15/2007 243,000
NR* Ba3 4,937,500 Lyondell Petrochemical Co., Term E, due 5/17/2006** 5,117,393
-----------
16,239,032
====================================================================================================================================
Computer-Related NR* NR* 3,652,470 Bridge Information Systems, Term B, due 5/29/2005** 2,976,763
Products--0.6%
====================================================================================================================================
Consumer CCC+ Caa2 2,500,000 Diamond Brands Inc., 12.875% due 4/15/2009 (c) 425,000
Products--0.5% B+ B2 1,225,000 Evenflo Company Inc., 11.75% due 8/15/2006 1,215,813
B B3 1,325,000 Home Products International Inc., 9.625% due 5/15/2008 834,750
-----------
2,475,563
====================================================================================================================================
Diversified--0.4% B+ B1 1,985,000 Blount Inc., Term B, due 6/30/2006** 1,995,338
====================================================================================================================================
Drilling--4.3% BB- Ba3 5,000,000 Cliffs Drilling, 10.25% due 5/15/2003 5,175,000
B+ B1 4,935,893 Key Energy Group, Inc., Term B, due 9/14/2004** 4,947,463
Parker Drilling Co.:
B- B3 2,500,000 5.50% due 8/01/2004 (Convertible) 2,075,000
B+ B1 3,075,000 9.75% due 11/15/2006 3,082,688
BB- Ba3 4,200,000 R&B Falcon Corp., 11.375% due 3/15/2009 4,788,000
BB- Ba3 1,100,000 RBF Finance Company, 11% due 3/15/2006 1,265,000
-----------
21,333,151
====================================================================================================================================
Drug Stores--1.0% SDM Corporation**:
BB Ba3 2,500,000 Term C, due 2/04/2008 2,507,590
BB Ba3 2,500,000 Term E, due 2/04/2009 2,507,590
-----------
5,015,180
====================================================================================================================================
Educational B- B3 1,325,000 La Petite Academy/LPA Holdings, 10% due 5/15/2008 821,500
Services--0.2%
====================================================================================================================================
Electronics/ B B2 4,112,000 Advanced Glassfiber Yarn, 9.875% due 1/15/2009 3,654,540
Electrical BB- Ba3 1,500,000 Amkor Technologies Inc., 9.25% due 5/01/2006 1,496,250
Components--2.9% B+ B1 991,125 Chippac International, Term B, due 7/31/2006** 991,125
B+ B1 2,975,135 Dynamic Details Inc., Term B, due 4/22/2005** 2,937,945
B B1 1,575,000 Filtronic PLC, 10% due 12/01/2005 1,433,250
BB- Ba3 2,000,000 Semiconductor Components, Term D, due 8/04/2007** 2,004,166
NR* B1 2,161,250 Trend Technologies, Inc., Term, due 2/28/2007** 2,139,638
-----------
14,656,914
====================================================================================================================================
Energy--2.5% CCC- Caa3 550,000 Belden & Blake Corp., 9.875% due 6/15/2007 459,250
B B2 1,000,000 Chesapeake Energy Corp., 9.625% due 5/01/2005 1,006,250
CCC+ Caa1 1,275,000 Continental Resources, 10.25% due 8/01/2008 1,144,313
B- Caa1 2,575,000 Energy Corp. of America, 9.50% due 5/15/2007 1,879,750
B B2 2,750,000 Forest Oil Corporation, 10.50% due 1/15/2006 2,870,313
CCC B3 1,850,000 Gothic Production Corp., 11.125% due 5/01/2005 1,961,000
B+ B1 3,000,000 Nuevo Energy Company, 9.50% due 6/01/2008 3,015,000
-----------
12,335,876
====================================================================================================================================
Environmental URS Corporation**:
Services--0.4% BB Ba3 990,000 Term B, due 6/09/2006 992,475
BB Ba3 990,000 Term C, due 6/09/2007 992,475
-----------
1,984,950
====================================================================================================================================
Financial B B2 3,000,000 Ares Leveraged Fund II, Junior Subordinate
Services--2.8% Secured Note, due 10/31/2005 (a)(d) 2,689,200
NR* NR* 2,422,081 Blackstone Capital, Term, due 11/30/2000** 2,403,915
NR* NR* 1,000,000 Investcorp SA, Term, due 10/21/2008** 998,040
NR* NR* 1,000,000 Pennant CBO Limited, 13.43% due 3/14/2011 (d) 987,500
NR* Ba3 4,500,000 Sovereign Bankcorp, Inc., Term, due 11/17/2003** 4,516,875
NR* NR* 2,378,830 Wasserstein, Term, due 11/30/2000** 2,360,988
-----------
13,956,518
====================================================================================================================================
Food & Kindred B- B3 7,500,000 Luigino's Inc., 10% due 2/01/2006 5,925,000
Products--2.6% BB- Ba3 4,987,500 Merisant Company, Term B, due 3/30/2007** 5,012,437
B B2 2,000,000 SC International Services, Inc., 9.25% due 9/01/2007 1,920,000
-----------
12,857,437
====================================================================================================================================
Forest Products-- B B2 2,000,000 Ainsworth Lumber Company, 12.50% due 7/15/2007 (b) 1,905,000
0.5% B+ B2 650,000 Millar Western Forest, 9.875% due 5/15/2008 643,500
-----------
2,548,500
====================================================================================================================================
Furniture & B- B3 3,425,000 Formica Corporation, 10.875% due 3/01/2009 2,055,000
Fixtures--0.4%
====================================================================================================================================
Gaming--10.4% Aladdin Gaming**:
CCC+ B2 3,000,000 Term B, due 8/26/2006 2,873,751
CCC+ B2 4,500,000 Term C, due 2/26/2008 4,310,626
B- B3 4,250,000 Ameristar Casinos, Inc., 10.50% due 8/01/2004 4,308,438
B- B3 1,650,000 Coast Hotels & Casino, 9.50% due 4/01/2009 1,617,000
</TABLE>
8 & 9
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Gaming B B1 US$ 1,500,000 Eldorado Resorts LLC, 10.50% due 8/15/2006 $ 1,485,000
(concluded) B B2 4,465,000 Harvey Casino Resorts, 10.625% due 6/01/2006 4,598,950
Hollywood Park Inc.:
B B2 3,350,000 9.25% due 2/15/2007 3,425,375
B B2 2,750,000 9.50% due 8/01/2007 2,811,875
B+ B2 9,200,000 Horseshoe Gaming LLC, 9.375% due 6/15/2007 9,200,000
Isle of Capri Casinos, Inc.:
B B2 4,180,000 8.75% due 4/15/2009 3,918,750
BB- Ba2 6,384,000 Term B, due 3/01/2006** 6,420,408
NR* NR* 5,586,000 Term C, due 3/01/2007** 5,617,857
B- B3 1,950,000 Trump Atlantic City Associates/Funding Inc., 11.25% due 5/01/2006 1,306,500
-----------
51,894,530
====================================================================================================================================
Grocery--0.5% CCC Caa1 4,976,272 Grand Union Co., Term, due 8/17/2003** 2,359,584
====================================================================================================================================
Hotels & B- B2 6,000,000 Extended Stay America, 9.15% due 3/15/2008 5,520,000
Motels--5.7% NR* Ba1 3,000,000 Starwood Hotels & Resorts Trust, Term II, due 2/23/2003** 3,007,500
Wyndham International, Inc., Term**:
NR* NR* 6,500,000 due 6/30/2004 6,485,557
NR* NR* 13,500,000 due 6/30/2006 13,300,875
-----------
28,313,932
====================================================================================================================================
Industrial B+ B2 1,750,000 Building One Services, 10.50% due 5/01/2009 (d) 1,531,250
Services--0.3%
====================================================================================================================================
Insurance--0.6% B+ Ba3 3,150,000 Willis Corroon Corporation, 9% due 2/01/2009 2,866,500
====================================================================================================================================
Leasing & Rental BB- B2 3,750,000 Anthony Crane Rental LP, Term, due 7/22/2006** 3,453,124
Services--2.4% BB- NR* 3,910,000 Coinmach Laundry Corp., Term B, due 6/30/2005** 3,891,060
B B3 550,000 National Equipment Services, 10% due 11/30/2004 440,000
B B3 500,000 Neff Corp., 10.25% due 6/01/2008 275,000
B- B3 900,000 Penhall International, 12% due 8/01/2006 877,500
BB+ Ba2 3,000,000 United Rentals Inc., Term C, due 8/12/2006** 2,962,188
-----------
11,898,872
====================================================================================================================================
Manufacturing-- B+ NR* 2,000,000 Citation Corporation, Term B, due 12/01/2007** 1,972,500
3.9% NR* NR* 4,924,780 Environmental Systems Product, Inc., Term B, due 9/30/2005** 2,480,858
B- B2 2,478,000 Fairfield Manufacturing Company Inc., 9.625% due 10/15/2008 2,106,300
NR* NR* 4,975,000 Metokote Corp., Term B, due 11/02/2005** 4,987,437
D Ca 4,500,000 @Morris Materials Handling, 9.50% due 4/01/2008 258,750
B- B3 1,575,000 Russell-Stanley Holding Inc., 10.875% due 2/15/2009 742,219
BB- Ba3 4,211,377 Terex Corporation, Term B, due 3/06/2005** 4,212,363
BB Ba3 3,000,000 Westinghouse Air Brake, 9.375% due 6/15/2005 2,880,000
-----------
19,640,427
====================================================================================================================================
Medical B- B3 4,000,000 Hudson Respiratory Care, 9.125% due 4/15/2008 2,800,000
Equipment--0.6%
====================================================================================================================================
Metals & CCC+ B3 2,880,000 AEI Resources, Term B, due 12/31/2004** 2,592,000
Mining--3.6% NR* B3 2,922,857 Acme Metals Inc., Term, due 12/01/2005** 2,428,894
B B1 1,050,000 Bayou Steel Corp., 9.50% due 5/15/2008 871,500
CCC Ca 1,625,000 GS Technologies Operating Co., 12% due 9/01/2004 195,000
D C 5,000,000 @Geneva Steel, 9.50% due 1/15/2004 831,250
BB- B2 4,000,000 Golden Northwest Aluminum, 12% due 12/15/2006 4,080,000
BB+ Ba2 4,000,000 Great Central Mines Ltd., 8.875% due 4/01/2008 3,520,000
CCC Caa2 1,975,000 Metal Management Inc., 10% due 5/15/2008 197,500
B- B3 5,000,000 WHX Corp., 10.50% due 4/15/2005 3,450,000
-----------
18,166,144
====================================================================================================================================
Online B- B3 1,425,000 PSINet Inc., 11% due 8/01/2009 1,230,844
Services--0.3%
====================================================================================================================================
Packaging--1.1% B- Caa1 850,000 Consumers Packaging Inc., 9.75% due 2/01/2007 212,500
B- Caa2 1,000,000 Indesco International, 9.75% due 4/15/2008 370,000
B+ B2 2,500,000 Packaging Corporation of America, 9.625% due 4/01/2009 2,562,500
B B3 2,750,000 Spinnaker Industries Inc., 10.75% due 10/15/2006 2,200,000
-----------
5,345,000
====================================================================================================================================
Paging--0.0% CCC+ B3 325,000 Metrocall Inc., 11% due 9/15/2008 (d) 234,000
====================================================================================================================================
Paper--6.0% BB B1 2,550,000 Norampac Inc., 9.50% due 2/01/2008 2,581,875
BB Ba2 4,950,000 Pacifica Papers Inc., Term B, due 12/31/2006** 4,974,750
NR* B2 6,000,000 Repap New Brunswick, Inc., Term B, due 6/01/2004** 5,895,000
Stone Container Corp.**:
B+ Ba3 5,801,556 Term E, due 10/01/2003 5,820,800
B+ Ba3 3,979,130 Term F, due 12/31/2005 3,990,009
B+ Ba3 3,130,556 Term G, due 12/31/2006 3,132,233
B+ Ba3 3,490,500 Term H, due 12/31/2007 3,492,371
-----------
29,887,038
====================================================================================================================================
Petroleum NR* Ba3 1,377,920 Clark Refining & Marketing Inc., Term, due 11/15/2004** 1,139,081
Refineries--0.2%
====================================================================================================================================
</TABLE>
10 & 11
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Pharmaceuticals, Dade Behring Inc.**:
Life Sciences & B+ Ba3 US$ 1,237,500 Term B, due 6/30/2006 $ 1,133,196
Labs--0.5% B+ Ba3 1,237,500 Term C, due 6/30/2007 1,133,196
-----------
2,266,392
====================================================================================================================================
Printing & BBB- Baa3 1,000,000 World Color Press Inc., 8.375% due 11/15/2008 972,473
Publishing--0.2%
====================================================================================================================================
Property NR* Ba3 3,000,000 NRT Incorporated, Term, due 7/31/2004** 2,981,250
Management--1.1% B Caa1 675,000 Prison Realty Trust Inc., 12% due 6/01/2006 563,625
NR* NR* 2,500,000 Rockefeller Center Property Trust, 10.573% due
12/31/2000 (Convertible) (c) 2,137,500
-----------
5,682,375
====================================================================================================================================
Restaurants--0.8% Domino's & Bluefence**:
B+ B1 1,000,000 Term B, due 12/21/2006 1,004,500
B+ B1 2,111,910 Term C, due 12/21/2007 2,121,590
B+ B1 1,108,606 Domino Pizza Funding Corp., Term B, due 12/21/2006** 1,113,594
-----------
4,239,684
====================================================================================================================================
Retail-- NR* NR* 3,960,000 Asbury Automotive Group, Term, due 3/31/2005** 3,910,500
Specialty--0.8%
====================================================================================================================================
Satellite Echostar DBS Corporation:
Telecommunication B B2 900,000 9.25% due 2/01/2006 891,000
Distribution B B2 4,225,000 9.375% due 2/01/2009 4,188,031
Systems--2.5% CCC+ B3 4,250,000 Golden Sky Systems, 12.375% due 8/01/2006 4,675,000
Pegasus Communications:
CCC+ B3 450,000 9.75% due 12/01/2006 447,750
NR* NR* 2,000,000 Term, due 4/30/2005** 2,006,666
-----------
12,208,447
====================================================================================================================================
Textile Mill B Ca 6,500,000 Galey & Lord, Inc., 9.125% due 3/01/2008 3,380,000
Products--1.4% D Ca 1,150,000 Globe Manufacturing Corp., 10% due 8/01/2008 115,000
NR* NR* 3,477,535 Joan Fabrics Corp., Term A, due 6/30/2003** 3,381,902
-----------
6,876,902
====================================================================================================================================
Tower Construction & BB- B1 5,000,000 American Towers, Inc., Term B, due 12/30/2007** 5,027,840
Leasing--2.2% Crown Castle International Corporation:
B B1 650,000 9% due 5/15/2011 620,750
BB- Ba3 1,300,000 Term B, due 3/31/2008** 1,303,701
NR* NR* 4,000,000 Spectracite Communications, Term B, due 6/30/2006** 4,009,000
-----------
10,961,291
====================================================================================================================================
Transportation BB- NR* 1,000,000 Autopistas del Sol SA, 10.25% due 8/01/2009 (d) 760,000
Services--1.8% NR* NR* (pounds) 3,199,000 Eurotunnel, Tier 1 Tranche, due 11/04/2007** 3,802,181
B NR* US$ 5,000,000 MRS Logistica SA, 10.625% due 8/15/2005 (d) 4,412,500
-----------
8,974,681
====================================================================================================================================
Utilities--0.8% BB+ Ba1 2,750,000 Monterrey Power, SA de CV, 9.625% due 11/15/2009 (d) 2,585,000
BB+ Ba2 1,331,737 TNP Enterprises, Inc., Term, due 6/30/2006** 1,337,564
-----------
3,922,564
====================================================================================================================================
Waste B- Caa1 2,500,000 ISG Resources Inc., 10% due 4/15/2008 2,125,000
Management--1.6% BB- B3 4,590,000 Norcal Waste Systems, 13.50% due 11/15/2005 4,825,238
D Ca 1,525,000 @Safety-Kleen Corporation, 9.25% due 5/15/2009 30,500
B B3 725,000 Stericycle Inc., 12.375% due 11/15/2009 754,000
-----------
7,734,738
====================================================================================================================================
Wired B+ B2 2,000,000 Call-Net Enterprises Inc., 9.375% due 5/15/2009 1,180,000
Telecommunications-- B B3 3,925,000 Caprock Communications Corporation, 11.50%
10.8% due 5/01/2009 2,433,500
NR* NR* 4,275,000 E.Spire Communications, 10.521% due 7/01/2008 (c) 1,197,000
BBB- Ba1 3,000,000 Global Crossing Holdings Ltd., Term, due 6/30/2006** 3,017,412
B- Caa1 4,825,000 Global Telesystems Group, 9.875% due 2/15/2005 2,882,938
B B3 650,000 Hermes Europe RailTel BV, 10.375% due 1/15/2009 416,000
Intermedia Communications Inc.:
B B2 4,000,000 9.046% due 7/15/2007 (c) 2,720,000
B B2 4,250,000 9.50% due 3/01/2009 3,447,813
B B3 3,250,000 Level 3 Communications Inc., 9.125% due 5/01/2008 2,912,813
NR* NR* 1,000,000 Metromedia Fiber Network, 10% due 11/15/2008 985,000
B+ B2 1,400,000 Netia Holdings II BV, 13.125% due 6/15/2009 1,330,000
B B2 5,000,000 Nextlink Communications Inc., 9.45% due 4/15/2008 (c) 3,062,500
NR* NR* 8,750,000 Pacific Crossing Ltd., Term B, due 7/28/2006 8,585,937
Primus Telecommunications Group:
B- B3 1,000,000 11.75% due 8/01/2004 650,000
B- B3 1,875,000 11.25% due 1/15/2009 1,181,250
RSL Communications PLC:
B- B2 3,000,000 11.965% due 3/01/2008 (c) 510,000
B- B2 1,950,000 9.875% due 11/15/2009 487,500
B- B3 6,129,032 Teligent Inc., Delayed Draw, due 7/01/2002** 5,812,364
B B2 3,000,000 Time-Warner Telecom LLC, 9.75% due 7/15/2008 2,895,000
B- B3 700,000 Versatel Telecom BV, 11.875% due 7/15/2009 (d) 630,000
B- B3 4,000,000 Viatel, Inc., 11.50% due 3/15/2009 2,280,000
Williams Communications Group Inc.:
BB- B2 1,500,000 10.70% due 10/01/2007 1,453,125
BB- B2 1,500,000 10.875% due 10/01/2009 1,445,625
Worldwide Fiber Inc.:
B+ B3 1,950,000 12.50% due 12/15/2005 1,852,500
B+ B3 700,000 12% due 8/01/2009 630,000
-----------
53,998,277
====================================================================================================================================
</TABLE>
12 & 13
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (concluded) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Wireless B B1 US$ 8,750,000 CTI Holdings SA, 11.316% due 4/15/2008 (c) $ 4,637,500
Telecommunications-- NR* NR* 5,000,000 Clearnet Communications, Term C, due 7/09/2007** 4,625,000
11.6% Dolphin Telecom PLC (c):
CCC Caa2 700,000 16.331% due 6/01/2008 154,000
CCC Caa2 1,500,000 14% due 5/15/2009 300,000
B- B3 1,900,000 Microcell Telecommunications, 12% due 6/01/2009 (c) 1,377,500
Nextel Communications, Inc.**:
BB- Ba2 5,000,000 Term B, due 6/30/2008 5,027,085
BB- Ba2 5,000,000 Term C, due 12/31/2008 5,027,085
BB- Ba2 15,111,743 Term D, due 3/31/2009 15,049,921
B+ B2 1,000,000 PTC International Finance II SA, 11.25% due 12/01/2009 1,015,000
Rural Cellular**:
B+ B1 2,500,000 Term B, due 10/03/2008 2,499,220
B+ B1 2,500,000 Term C, due 4/03/2009 2,499,220
Telesystem International Wireless Inc. (c):
CCC+ Caa1 3,350,000 16.147% due 6/30/2007 2,177,500
CCC+ Caa1 4,250,000 10.052% due 11/01/2007 2,380,000
NR* B2 3,500,000 Tritel Holdings, Term B, due 12/31/2007** 3,510,500
VoiceStream PCS Holdings Corp.:
B- B2 725,000 10.375% due 11/15/2009 783,000
B+ B1 7,000,000 Term B, due 1/15/2009** 6,976,669
-------------
58,039,200
====================================================================================================================================
Total Investments in Corporate Debt Obligations
(Cost--$719,129,732)--128.3% 639,163,133
====================================================================================================================================
<CAPTION>
Shares
Held Stocks & Warrants
====================================================================================================================================
<S> <C> <C> <C>
Broadcast--Radio & 8,850 Sirius Satellite (Warrants) (d)(e) 867,300
Television--0.2%
====================================================================================================================================
Tower Construction & 6,415 Crown Castle International Corporation (Preferred) (b) 6,366,756
Leasing--1.3%
====================================================================================================================================
Wired 27,431 @McLeodUSA Incorporated (Class A) 433,753
Telecommunications-- 17,336 @Viatel, Inc. 237,287
0.1% -------------
671,040
====================================================================================================================================
Wireless 2,000 Centaur Funding Corp. (Preferred) 2,019,380
Telecommunications-- 5,124 Dobson Communications (Preferred) (b) 5,034,330
1.4% -------------
7,053,710
====================================================================================================================================
Total Investments in Stocks & Warrants
(Cost--$14,641,933)--3.0% 14,958,806
====================================================================================================================================
<CAPTION>
Face
Amount Short-Term Securities
====================================================================================================================================
<S> <C> <C> <C>
Commercial US$ 6,162,000 Autoliv ASP Inc., 6.78% due 9/01/2000 6,162,000
Paper***--1.2%
====================================================================================================================================
Total Investments in Short-Term Securities
(Cost--$6,162,000)--1.2% 6,162,000
====================================================================================================================================
Total Investments (Cost--$739,933,665)--132.5% 660,283,939
Unrealized Appreciation on Forward Foreign
Exchange Contracts--Net****--0.0% 68,403
Liabilities in Excess of Other Assets--(32.5%) (162,149,841)
-------------
Net Assets--100.0% $ 498,202,501
=============
====================================================================================================================================
</TABLE>
(a) Floating rate note.
(b) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(c) Represents a zero coupon or step bond; the interest rate shown reflects
the effective yield at the time of purchase by the Fund.
(d) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(e) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock and are non-income producing. The purchase price and number
of shares are subject to adjustment under certain conditions until the
expiration date.
* Not Rated.
** Floating or Variable Rate Corporate Debt--The interest rates on floating
or variable rate corporate debt are subject to change periodically, based
on the change in the prime rate of a US Bank, LIBOR (London Interbank
Offered Rate) or, in some cases, another base lending rate. Corporate
loans represent 63.7% of the Fund's net assets.
*** Commercial Paper is traded on a discount basis; the interest rate shown
reflects the discount rate paid at the time of purchase by the Fund.
**** Forward foreign exchange contracts as of August 31, 2000 were as follows:
--------------------------------------------------------------------------------
Foreign Expiration Unrealized
Currency Sold Date Appreciation
--------------------------------------------------------------------------------
(pounds) 2,703,139 September 2000 $68,403
--------------------------------------------------------------------------------
Total Unrealized Appreciation on Forward
Foreign Exchange Contracts--Net
(US$ Commitment--$4,003,078) $68,403
=======
--------------------------------------------------------------------------------
@ Non-income producing security.
See Notes to Financial Statements.
14 & 15
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of August 31, 2000
=============================================================================================================
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$739,933,665) ......... $ 660,283,939
Unrealized appreciation on forward foreign exchange contracts . 68,403
Receivables:
Interest .................................................... $ 12,543,304
Securities sold ............................................. 2,222,445
Dividends ................................................... 196,672 14,962,421
------------
Deferred facility fees ........................................ 1,294
Prepaid expenses and other assets ............................. 180,481
-------------
Total assets .................................................. 675,496,538
-------------
=============================================================================================================
Liabilities: Loans ......................................................... 174,000,000
Payables:
Interest on loans ........................................... 954,127
Dividends to shareholders ................................... 920,884
Custodian bank .............................................. 589,744
Investment adviser .......................................... 278,564
Securities purchased ........................................ 196,672
Commitment fees ............................................. 49,167 2,989,158
------------
Deferred income ............................................... 74,343
Accrued expenses .............................................. 230,536
-------------
Total liabilities ............................................. 177,294,037
-------------
=============================================================================================================
Net Assets: Net assets .................................................... $ 498,202,501
=============
=============================================================================================================
Capital: Common Stock, $.10 par value, 200,000,000 shares authorized ... $ 6,261,000
Paid-in capital in excess of par .............................. 619,266,581
Undistributed investment income--net .......................... 5,139,803
Accumulated realized capital losses on investments and
foreign currency transactions--net ............................ (52,937,409)
Unrealized depreciation on investments and foreign
currency transactions--net .................................... (79,527,474)
-------------
Net Assets--Equivalent to $7.96 per share based on
62,610,000 shares of capital stock outstanding
(market price--$7.4375) ....................................... $ 498,202,501
=============
=============================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended August 31, 2000
=============================================================================================================
<S> <C> <C> <C>
Investment Income: Interest and discount earned (net of $33,697
foreign withholding tax) ........................... $ 38,190,007
Dividends .......................................... 938,176
Facility and other fees ............................ 221,317
-------------
Total income ....................................... 39,349,500
-------------
=============================================================================================================
Expenses: Loan interest expense .............................. $ 6,741,411
Investment advisory fees ........................... 2,140,470
Accounting services ................................ 93,472
Borrowing costs .................................... 87,455
Professional fees .................................. 86,865
Transfer agent fees ................................ 30,084
Listing fees ....................................... 22,743
Custodian fees ..................................... 22,222
Printing and shareholder reports ................... 19,896
Directors' fees and expenses ....................... 12,187
Pricing services ................................... 5,467
Other .............................................. 8,267
------------
Total expenses ..................................... 9,270,539
-------------
Investment income--net ............................. 30,078,961
-------------
=============================================================================================================
Realized & Realized gain (loss) from:
Unrealized Gain (Loss) Investments--net ................................. (10,448,530)
On Investments & Foreign currency transactions--net ............... 266,361 (10,182,169)
Foreign Currency ------------
Transactions--Net:
Change in unrealized appreciation/depreciation on:
Investments--net ................................. (29,896,409)
Foreign currency transactions--net ............... (5,878) (29,902,287)
------------ -------------
Net Decrease in Net Assets Resulting from
Operations ......................................... $ (10,005,495)
=============
=============================================================================================================
</TABLE>
See Notes to Financial Statements.
16 & 17
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Six For the
Months Ended Year Ended
Increase (Decrease) in Net Assets: Aug. 31, 2000 Feb. 29, 2000
======================================================================================================================
<S> <C> <C> <C>
Operations: Investment income--net ............................................ $ 30,078,961 $ 61,203,057
Realized loss on investments and foreign currency
transactions--net ................................................. (10,182,169) (29,184,246)
Change in unrealized appreciation/depreciation on investments
and foreign currency transactions--net ............................ (29,902,287) (6,248,176)
------------- -------------
Net increase (decrease) in net assets resulting from operations ... (10,005,495) 25,770,635
------------- -------------
======================================================================================================================
Dividends to Dividends to shareholders from investment income--net ............. (30,134,694) (60,330,046)
Shareholders: ------------- -------------
======================================================================================================================
Net Assets: Total decrease in net assets ...................................... (40,140,189) (34,559,411)
Beginning of period ............................................... 538,342,690 572,902,101
------------- -------------
End of period* .................................................... $ 498,202,501 $ 538,342,690
============= =============
======================================================================================================================
*Undistributed investment income--net .............................. $ 5,139,803 $ 5,195,536
============= =============
======================================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Six Months Ended August 31, 2000
===============================================================================================================
<S> <C> <C>
Cash Provided by Net decrease in net assets resulting from operations .................. $ (10,005,495)
Operating Activities: Adjustments to reconcile net decrease in net assets resulting
from operations to net cash provided by operating activities:
Decrease in receivables ............................................. 746,905
Increase in other assets ............................................ (79,448)
Decrease in other liabilities ....................................... (925,485)
Realized and unrealized loss on investments and foreign currency
transactions--net ................................................... 40,084,456
Amortization of discount ............................................ (4,179,237)
-------------
Net cash provided by operating activities ............................. 25,641,696
-------------
===============================================================================================================
Cash Used for Proceeds from sales of long-term investments .......................... 112,720,725
Investing Activities: Purchases of long-term investments .................................... (115,587,595)
Purchases of short-term investments ................................... (168,337,553)
Proceeds from sales and maturities of short-term investments .......... 162,850,000
-------------
Net cash used for investing activities ................................ (8,354,423)
-------------
===============================================================================================================
Cash Used for Cash receipts from borrowings ......................................... 116,800,000
Financing Activities: Cash payments on borrowings ........................................... (103,800,000)
Dividends paid to shareholders ........................................ (30,336,482)
-------------
Net cash used for financing activities ................................ (17,336,482)
-------------
===============================================================================================================
Cash: Net decrease in cash .................................................. (49,209)
Cash at beginning of period ........................................... 49,209
-------------
Cash at end of period ................................................. $ --
=============
===============================================================================================================
Cash Flow Cash paid for interest ................................................ $ 8,194,014
Information: =============
===============================================================================================================
</TABLE>
See Notes to Financial Statements.
18 & 19
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been derived For the Six For the For the Period
from information provided in the financial statements. Months Ended Year Ended March 27, 1998+
Aug. 31, Feb. 29, to Feb. 28,
Increase (Decrease) in Net Asset Value: 2000++ 2000 1999
====================================================================================================================================
<S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period ........................... $ 8.60 $ 9.15 $ 10.00
Operating --------- --------- ---------
Performance: Investment income--net ......................................... .48 .97 .76
Realized and unrealized loss on investments and foreign
currency transactions--net ..................................... (.64) (.56) (.91)
--------- --------- ---------
Total from investment operations ............................... (.16) .41 (.15)
--------- --------- ---------
Less dividends from investment income--net ..................... (.48) (.96) (.69)
--------- --------- ---------
Capital charge resulting from the issuance of Common Stock ..... -- -- (.01)
--------- --------- ---------
Net asset value, end of period ................................. $ 7.96 $ 8.60 $ 9.15
========= ========= =========
Market price per share, end of period .......................... $ 7.4375 $ 7.1875 $ 7.875
========= ========= =========
====================================================================================================================================
Total Investment Based on market price per share ................................ 10.45%+++ 3.19% (14.87%)+++
Return:** ========= ========= =========
Based on net asset value per share ............................. (1.20%)+++ 6.26% (1.09%)+++
========= ========= =========
====================================================================================================================================
Ratio to Average Expenses, net of reimbursement and excluding interest expense .. .98%* .98% .54%*
Net Assets: ========= ========= =========
Expenses, net of reimbursement ................................. 3.57%* 2.87% .93%*
========= ========= =========
Expenses ....................................................... 3.57%* 2.87% 1.20%*
========= ========= =========
Investment income--net ......................................... 11.60%* 10.88% 8.60%*
========= ========= =========
====================================================================================================================================
Leverage: Amount of borrowings, end of period (in thousands) ............. $ 174,000 $ 161,000 $ 142,000
========= ========= =========
Average amount of borrowings outstanding during the period
(in thousands) ................................................. $ 193,142 $ 182,404 $ 42,330
========= ========= =========
Average amount of borrowings outstanding per share during
the period ..................................................... $ 3.08 $ 2.91 $ .69
========= ========= =========
====================================================================================================================================
Supplemental Net assets, end of period (in thousands) ....................... $ 498,203 $ 538,343 $ 572,902
Data: ========= ========= =========
Portfolio turnover ............................................. 16.54% 61.76% 89.76%
========= ========= =========
====================================================================================================================================
</TABLE>
* Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
charges. The Fund's Investment Adviser voluntarily waived a portion of its
management fee. Without such waiver, the Fund's performance would have
been lower.
+ Commencement of operations.
++ Based on average shares outstanding.
+++ Aggregate total investment return.
See Notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Debt Strategies Fund II, Inc. (the "Fund") is registered under the Investment
Company Act of 1940 as a diversified, closed-end management investment company.
The Fund's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America, which may require
the use of management accruals and estimates. These unaudited financial
statements reflect all adjustments, which are, in the opinion of management,
necessary to a fair statement of the results for the interim period presented.
All such adjustments are of a normal, recurring nature. The Fund determines and
makes available for publication the net asset value of its Common Stock on a
weekly basis. The Fund's Common Stock is listed on the New York Stock Exchange
under the symbol DSU.
(a) Corporate debt obligations--The Fund invests principally in debt obligations
of companies, including Corporate Loans made by banks and other financial
institutions and both privately and publicly offered corporate bonds and notes.
Because agents and intermediaries are primarily commercial banks, the Fund's
investment in Corporate Loans could be considered concentrated in financial
institutions.
(b) Valuation of investments--Corporate Loans are valued in accordance with
guidelines established by the Board of Directors. Corporate Loans are valued at
the mean between the last available bid and asked prices from one or more
brokers or dealers as obtained from Loan Pricing Corporation. For Corporate
Loans for which an active secondary market does not exist to a reliable degree
in the opinion of the Investment Adviser, such Corporate Loans will be valued by
the Investment Adviser at fair value, which is intended to approximate market
value.
Other portfolio securities may be valued on the basis of prices furnished by one
or more pricing services, which determines prices for normal, institutional-size
trading units of such securities using market information, transactions for
comparable securities and various relationships between securities that are
generally recognized by institutional traders. In certain circumstances,
portfolio securities are valued at the last sale price on the exchange that is
the primary market for such securities, or the last quoted bid price for those
securities for which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The value of
interest rate swaps, caps, and floors is determined in accordance with a formula
and then confirmed periodically by obtaining a bank quotation. Options written
or purchased are valued at the last sale price in the case of exchange-traded
options. In the case of options traded in the over-the-counter market, valuation
is the last asked price (options written) or the last bid price (options
purchased). Short-term securities with remaining maturities of sixty days or
less are valued at amortized cost, which approximates market value. Securities
and assets for which market price quotations are not readily available are
valued at fair value as determined in good faith by or under the direction of
the Board of Directors of the Fund.
(c) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies to increase or decrease the level of risk to which the
Fund is exposed more quickly and efficiently than transactions in other types of
instruments. Losses may arise due to changes in the value of the contract or if
the counterparty does not perform under the contract.
o Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon
20 & 21
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
entering into a contract, the Fund deposits and maintains as collateral such
initial margin as required by the exchange on which the transaction is effected.
Pursuant to the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the contract. Such
receipts or payments are known as variation margin and are recorded by the Fund
as unrealized gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of the contract
at the time it was opened and the value at the time it was closed.
o Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
o Options--The Fund is authorized to write covered call and put options and
purchase call and put options. When the Fund writes an option, an amount equal
to the premium received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked to market to
reflect the current market value of the option written. When a security is
purchased or sold through an exercise of an option, the related premium paid (or
received) is added to (or deducted from) the basis of the security acquired or
deducted from (or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund realizes a
gain or loss on the option to the extent of the premiums received or paid (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium paid or received).
Written and purchased options are non-income producing investments.
o Interest rate transactions--The Fund is authorized to enter into interest rate
swaps and purchase or sell interest rate caps and floors. In an interest rate
swap, the Fund exchanges with another party their respective commitments to pay
or receive interest on a specified notional principal amount. The purchase of an
interest rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest rate, to
receive payments of interest equal to the difference between the index and the
predetermined rate on a notional principal amount from the party selling such
interest rate cap (or floor).
(d) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets or liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(e) Income taxes--It is the Fund's policy to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(f) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of discount) is recognized on the accrual basis. Realized gains and
losses on security transactions are determined on the identified cost basis.
Facility fees are accreted to income over the term of the related loan.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
(h) Custodian bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft which resulted from an unprojected payment of
interest.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to perform the investment advisory function. For such services, the Fund pays a
monthly fee at an annual rate of .60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
For the six months ended August 31, 2000, the Fund paid Merrill Lynch Security
Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith
Incorporated, $406 for security price quotations to compute the net asset value
of the Fund.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the six
months ended August 31, 2000 were $115,523,446 and $114,455,607, respectively.
Net realized gains (losses) for the six months ended August 31, 2000 and net
unrealized gains (losses) as of August 31, 2000 were as follows:
--------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
--------------------------------------------------------------------------------
Long-term investments ................ $ (10,448,530) $ (79,649,726)
Unfunded corporate loans ............. -- 54,408
Forward foreign exchange contracts ... 332,887 68,403
Foreign currency transactions ........ (66,526) (559)
------------- -------------
Total ................................ $ (10,182,169) $ (79,527,474)
============= =============
--------------------------------------------------------------------------------
As of August 31, 2000, net unrealized depreciation for Federal income tax
purposes aggregated $79,649,726, of which $4,927,116 related to appreciated
securities and $84,576,842 related to depreciated securities. The aggregate cost
of investments at August 31, 2000 for Federal income tax purposes was
$739,933,665.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of Common Stock, par value
$.10 per share. Shares issued and outstanding during the six months ended August
31, 2000 and during the year ended February 29, 2000 remained constant.
5. Unfunded Loan Interests:
As of August 31, 2000, the Fund had unfunded loan commitments of $1,514,947,
which would be extended at the option of the borrower, pursuant to the following
loan agreements:
--------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in thousands)
--------------------------------------------------------------------------------
Breed Technologies Inc. ..................................... $ 15
Metro-Goldwyn-Mayer Co. ..................................... $1,500
--------------------------------------------------------------------------------
6. Short-Term Borrowings:
On July 14, 1999, the Fund extended its one-year credit agreement with The Bank
of New York. The agreement is a $225,000,000 credit facility bearing interest at
the Prime rate, the Federal Funds rate plus .55% and/or Eurodollar rate plus
.55%.
On July 6, 2000, the Fund entered into a one-year $250,000,000 revolving credit
and security agreement with Citibank, N.A. and other lenders (the "Lenders").
This agreement replaced the agreement the Fund had extended on December 17,
1999. The Fund may borrow money through (i) a line of credit from
22 & 23
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
certain Lenders at the Eurodollar rate plus .75%, or the highest of the Federal
Funds rate plus .50%, a Base rate as determined by Citibank, N.A. and the latest
three-week moving average of secondary market morning offering rates in the
United States for three-month certificates of deposit of major US money market
banks plus .50%, or (ii) through the issuance of commercial paper notes by
certain Lenders at rates of interest equivalent to the weighted average of the
per annum rates paid or payable by such Lenders in respect of those commercial
paper notes.
For the six months ended August 31, 2000, the average amount borrowed was
approximately $193,142,000 and the daily weighted average interest rate was
6.92%. For the six months ended August 31, 2000, facility and commitment fees
aggregated approximately $87,000.
7. Capital Loss Carryforward:
At February 29, 2000, the Fund had a net capital loss carryforward of
approximately $29,650,000, of which $5,992,000 expires in 2007 and $23,658,000
expires in 2008. This amount will be available to offset like amounts of any
future taxable gains.
8. Reorganization Plan:
On April 26, 2000, the Fund's Board of Directors approved a plan of
reorganization, subject to shareholder approval and certain other conditions,
whereby the Fund would acquire substantially all of the assets and liabilities
of Debt Strategies Fund, Inc. and Debt Strategies Fund III, Inc. in exchange for
newly issued shares of the Fund. These Funds are registered, diversified,
closed-end management investment companies. All three entities have a similar
investment objective and are managed by FAM.
9. Subsequent Event:
On September 7, 2000, the Fund's Board of Directors declared an ordinary income
dividend to Common Stock shareholders in the amount of $.079690 per share,
payable on September 29, 2000 to shareholders of record as of September 18,
2000.
PORTFOLIO PROFILE
As of August 31, 2000
Percent of
Quality Ratings Long-Term
S&P/Moody's Investments
--------------------------------------------------------------------------
BBB/Baa .......................................................... 1.4%
BB/Ba ............................................................ 27.4
B/B .............................................................. 46.0
CCC/Caa or lower ................................................. 6.4
NR (Not Rated) ................................................... 18.8
--------------------------------------------------------------------------
Percent of
Long-Term
Breakdown of Investments by Country Investments
--------------------------------------------------------------------------
United States .................................................... 88.9%
Canada ........................................................... 4.2
Argentina ........................................................ 1.8
United Kingdom ................................................... 1.8
Australia ........................................................ 1.3
Brazil ........................................................... 0.7
Netherlands ...................................................... 0.4
Mexico ........................................................... 0.4
Poland ........................................................... 0.3
Cayman Islands ................................................... 0.1
Belgium .......................................................... 0.1
--------------------------------------------------------------------------
Percent of
Five Largest Industries Total Assets
--------------------------------------------------------------------------
Wireless Telecommunications ...................................... 9.6%
Wired Telecommunications ......................................... 8.1
Cable Television Services ........................................ 8.1
Gaming ........................................................... 7.7
Broadcast--Radio & Television .................................... 6.8
--------------------------------------------------------------------------
Percent of
Ten Largest Holdings Total Assets
--------------------------------------------------------------------------
Nextel Communications, Inc. ...................................... 3.7%
Wyndham International, Inc. ...................................... 2.9
Stone Container Corp. ............................................ 2.4
Isle of Capri Casinos, Inc. ...................................... 2.4
Charter Communications Holdings .................................. 2.2
Radio Unica Corp. ................................................ 1.9
Coaxial LLC ...................................................... 1.7
Collins & Aikman Corp. ........................................... 1.4
Horseshoe Gaming LLC ............................................. 1.4
Pacific Crossing Ltd. ............................................ 1.3
--------------------------------------------------------------------------
24 & 25
<PAGE>
Debt Strategies Fund II, Inc., August 31, 2000
OFFICERS AND DIRECTORS
Terry K. Glenn, President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Roscoe S. Suddarth, Director
Richard R. West, Director
Arthur Zeikel, Director
Edward D. Zinbarg, Director
Joseph T. Monagle Jr., Senior Vice President
Richard C. Kilbride, Vice President
Gilles Marchand, Vice President
Donald C. Burke, Vice President and Treasurer
Bradley J. Lucido, Secretary
Custodian and Transfer Agent
The Bank of New York
110 Washington Street
New York, NY 10286
NYSE Symbol
DSU
26
<PAGE>
Debt Strategies Fund II, Inc. seeks to provide current income by investing
primarily in a diversified portfolio of US 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. or
BBB or lower by Standard & Poor's) or unrated debt instruments of comparable
quality.
This report, including the financial information herein, is transmitted to
shareholders of Debt Strategies Fund II, Inc. for their information. It is not a
prospectus. Past performance results shown in this report should not be
considered a representation of future performance. The Fund has the ability to
leverage its Common Stock to provide Common Stock shareholders with a
potentially higher rate of return. Leverage creates risk for Common Stock
shareholders, including the likelihood of greater volatility of net asset value
and market price of Common Stock shares, and the risk that fluctuations in
short-term interest rates may reduce the Common Stock's yield. Statements and
other information herein are as dated and are subject to change.
Debt Strategies
Fund II, Inc.
Box 9011
Princeton, NJ
08543-9011 #DEBTII--8/99
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