DEBT
STRATEGIES
FUND III, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Semi-Annual Report
August 31, 2000
<PAGE>
DEBT STRATEGIES FUND III, INC.
The Benefits and
Risks of
Leveraging
Debt Strategies Fund III, 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 benefit from
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 III, Inc., August 31, 2000
DEAR SHAREHOLDER
For the six-month period ended August 31, 2000, Debt Strategies Fund III, Inc.'s
total investment return was -0.20%, based on a change in per share net asset
value from $9.36 to $8.80, and assuming reinvestment of $0.511 per share income
dividends. During the same six-month period, the net annualized yield of the
Fund's Common Stock was 11.21%. Since inception (July 31, 1998) through August
31, 2000, the total investment return on the Fund's Common Stock was +9.59%,
based on a change in per share net asset value from $10.00 to $8.80, and
assuming reinvestment of $1.94 per share income dividends. At the end of the
August period, the Fund was approximately 29% leveraged as a percentage of total
assets. (For a complete explanation of the benefits and risks of leverage, see
page 1 of this report to shareholders.)
Investment Approach
Debt Strategies Fund III, 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 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, 45% of the Fund's assets were allocated to bonds and 55% 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 Portfolio's floating rate investments is
between 30 days-90 days, the yield on the bank loan portion of the Portfolio 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 146 borrowers across
43 industries. (See the "Portfolio Profile" on page 22 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 managements, consistent cash
flows and appropriate risk/reward characteristics. In addition, we look for
companies with significant underlying asset and franchise value, strong capital
structures and equity sponsors that support their investments. 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 Holdings 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 Holdings,
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 III, 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 III, Inc.
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
October 4, 2000
In early December 2000, pending shareholder approval, Debt Strategies Fund, Inc.
and Debt Strategies Fund III, Inc. will be acquired by Debt Strategies Fund II,
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 III, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Advertising--1.1% B B2 $1,000,000 Adams Outdoor Advertising Inc., 10.75% due 3/15/2006 $ 1,030,000
==================================================================================================================================
Air Transport--0.5% NR* NR* 488,730 Gemini Air Cargo, Term A, due 8/12/2005 (a) 487,966
==================================================================================================================================
Aircraft & Parts--0.6% B- B3 500,000 Argo-Tech Corporation, 8.625% due 10/01/2007 400,000
CCC Caa3 1,000,000 Compass Aerospace Corp., 10.125% due 4/15/2005 147,500
------------
547,500
==================================================================================================================================
Amusement & AMC Entertainment Inc.:
Recreational CCC+ Caa3 250,000 9.50% due 3/15/2009 (c) 88,750
Services--0.8% CCC+ Caa3 200,000 9.50% due 2/01/2011 71,000
D C 200,000 +Carmike Cinemas Inc., 9.375% due 2/01/2009 44,000
B- B3 500,000 Hollywood Entertainment, 10.625% due 8/15/2004 (c) 395,000
B Caa2 500,000 Loews Cineplex Entertainment, 8.875% due 8/01/2008 165,000
------------
763,750
==================================================================================================================================
Apparel--0.7% NR* NR* 666,668 CS Brooks Canada, Inc., Term, due 6/25/2006 (a) 661,668
==================================================================================================================================
Automotive B+ B2 750,000 American Axle and Manufacturing Inc., 9.75% due 3/01/2009 740,625
Equipment--3.6% BB- Ba3 1,455,000 Collins & Aikman Corp., Term C, due 12/31/2005 (a) 1,440,905
B B2 500,000 Group 1 Automotive Inc., 10.875% due 3/01/2009 465,000
NR* Caa2 2,000,000 +Key Plastics, Inc., 10.25% due 3/15/2007 200,000
CCC+ Caa2 400,000 Special Devices Inc., 11.375% due 12/15/2008 154,000
B+ B2 375,000 Tenneco Automotive Inc., 11.625% due 10/15/2009 322,500
B- B3 250,000 Venture Holdings Trust, 12% due 6/01/2009 167,500
------------
3,490,530
==================================================================================================================================
Broadcast--Radio & B B2 3,260,000 Ackerley Group Inc., 9% due 1/15/2009 3,080,700
Television--9.9% NR* NR* 1,000,000 Bahakel Communications, Term B, due 6/30/2008 (a) 1,000,000
B B1 1,500,000 Benedek Broadcasting Corporation, Term, due 11/20/2007 (a) 1,495,312
B- B3 300,000 Citadel Broadcasting Company, 9.25% due 11/15/2008 301,500
NR* NR* 800,000 Gocom Communications, Term B, due 12/31/2007 (a) 800,000
NR* Caa1 2,800,000 Radio Unica Corp., 11.75% due 8/01/2006 (b) 1,932,000
CCC+ NR* 600,000 Sirius Satellite, 14.50% due 5/15/2009 529,500
B- B3 450,000 Spanish Broadcasting System, 9.625% due 11/01/2009 447,750
------------
9,586,762
==================================================================================================================================
Building & B- B2 325,000 Webb (Del E.) Corp., 10.25% due 2/15/2010 310,375
Construction--0.3%
==================================================================================================================================
Building B B3 1,050,000 Amatek Industries, 12% due 2/15/2008 913,500
Materials--2.2% B- B3 625,000 Formica Corporation, 10.875% due 3/01/2009 375,000
B B2 900,000 Republic Group Inc., 9.50% due 7/15/2008 900,000
------------
2,188,500
==================================================================================================================================
Business B- Caa1 1,875,000 Muzak Holdings LLC, 13% due 3/15/2010 (b) 1,050,000
Services--1.1%
==================================================================================================================================
Cable--15.3% NR* NR* 1,000,000 Century Cable, Term, due 6/30/2009 (a) 1,001,750
Charter Communications Holdings LLC:
B+ B2 500,000 8.625% due 4/01/2009 456,250
NR* NR* 1,500,000 Term, due 9/18/2008 (a) 1,494,687
Classic Cable Inc.:
B- B3 250,000 9.375% due 8/01/2009 196,250
B- B3 575,000 10.50% due 3/01/2010 480,125
B B3 3,500,000 Coaxial Communications/Phoenix, 10% due 8/15/2006 3,447,500
CCC+ Caa1 2,000,000 Coaxial LLC, 11.864% due 8/15/2008 (b) 1,350,000
Echostar DBS Corporation:
B B2 200,000 9.25% due 2/01/2006 198,000
B B2 800,000 9.375% due 2/01/2009 793,000
CCC- B3 750,000 Golden Sky Systems, 12.375% due 8/01/2006 825,000
B+ B1 500,000 Insight Midwest, 9.75% due 10/01/2009 502,500
NR* NR* 1,250,000 Mallard Cablevision LLC, Term B, due 9/30/2008 (a) 1,246,875
Pegasus Communications:
CCC+ B3 250,000 9.75% due 12/01/2006 248,750
B+ B1 500,000 Term, due 4/30/2005 (a) 501,666
B- B3 500,000 RCN Corporation, 10.125% due 1/15/2010 400,000
Telewest Communications PLC:
B+ B1 1,000,000 11.25% due 11/01/2008 995,000
B+ B1 700,000 9.875% due 2/01/2010 (c) 666,750
------------
14,804,103
==================================================================================================================================
Chemicals--8.2% BBB- Baa3 1,000,000 Equistar Chemicals LP, 8.75% due 2/15/2009 977,920
Huntsman Corp./ICI Chemical (a):
BB Ba3 742,500 Term B, due 6/30/2007 748,340
BB Ba3 742,500 Term C, due 6/30/2008 748,340
BB Ba2 1,141,325 Huntsman Corporation, Term, due 12/31/2002 (a) 1,118,499
NR* Ba3 2,962,500 Lyondell Petrochemical Co., Term E, due 5/17/2006 (a) 3,070,436
B B2 1,926,628 Pioneer America's Acquisition Corp., Term, due 12/05/2006 (a) 1,261,941
------------
7,925,476
==================================================================================================================================
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Computer-Related NR* NR* $2,191,482 Bridge Information Systems, Term B, due 5/29/2005 (a) $ 1,786,058
Services--1.8%
==================================================================================================================================
Consumer BB- Ba3 350,362 Burhmann NV, Term B, due 10/26/2007 (a) 351,488
Products--0.6% B+ B2 250,000 Evenflo Company Inc., 11.75% due 8/15/2006 248,125
------------
599,613
==================================================================================================================================
Drilling--6.8% BB- Ba3 3,000,000 Cliffs Drilling, 10.25% due 5/15/2003 3,105,000
B+ B1 1,480,768 Key Energy Group, Inc., Term B, due 9/14/2004 (a) 1,484,239
B+ B1 500,000 Parker Drilling Co., 9.75% due 11/15/2006 501,250
BB- Ba3 1,300,000 R&B Falcon Corp., 11.375% due 3/15/2009 1,482,000
------------
6,572,489
==================================================================================================================================
Drug/Proprietary SDM Corporation (a):
Stores--0.5% BB Ba3 250,000 Term C, due 2/04/2008 250,759
BB Ba3 250,000 Term E, due 2/04/2009 250,759
------------
501,518
==================================================================================================================================
Electronics/Electronic B B2 775,000 Advanced Glassfiber Yarn, 9.875% due 1/15/2009 688,781
Components--3.1% B B1 300,000 Filtronic PLC, 10% due 12/01/2005 273,000
B+ B3 995,000 High Voltage Engineering, 10.50% due 8/15/2004 686,550
B1 NR* 1,329,999 Trend Technologies, Inc., Term, due 2/28/2007 (a) 1,316,699
------------
2,965,030
==================================================================================================================================
Energy--2.8% B B1 500,000 Belco Oil & Gas Corp., 8.875% due 9/15/2007 472,500
B B2 500,000 Canadian Forest Oil Ltd., 8.75% due 9/15/2007 490,000
B B2 500,000 Chesapeake Energy Corp., 9.625% due 5/01/2005 503,125
B- Caa1 675,000 Energy Corp. of America, 9.50% due 5/15/2007 492,750
B B2 250,000 Forest Oil Corporation, 10.50% due 1/15/2006 260,937
B+ B1 500,000 Nuevo Energy Company, 9.50% due 6/01/2008 502,500
------------
2,721,812
==================================================================================================================================
Environmental URS Corporation (a):
Services--1.0% BB Ba3 495,000 Term B, due 6/09/2006 496,238
BB Ba3 495,000 Term C, due 6/09/2007 496,238
------------
992,476
==================================================================================================================================
Financial NR* Ba3 900,000 Sovereign Bankcorp, Term, due 11/17/2003 (a) 903,375
Services--0.9%
==================================================================================================================================
Food & Kindred B- B3 500,000 Luigino's Inc., 10% due 2/01/2006 395,000
Products--1.4% B B2 1,000,000 SC International Services, Inc., 9.25% due 9/01/2007 960,000
------------
1,355,000
==================================================================================================================================
Forest Products-- B+ B2 500,000 Millar Western Forest, 9.875% due 5/15/2008 495,000
0.5%
==================================================================================================================================
Gaming--5.3% B- B3 300,000 Coast Hotels & Casino, 9.50% due 4/01/2009 294,000
B B1 500,000 Eldorado Resorts LLC, 10.50% due 8/15/2006 495,000
B B2 1,000,000 Harvey Casino Resorts, 10.625% due 6/01/2006 1,030,000
Hollywood Park Inc.:
B B2 250,000 9.25% due 2/15/2007 255,625
B B2 250,000 9.50% due 8/01/2007 255,625
B+ B2 300,000 Horseshoe Gaming Holdings, 8.625% due 5/15/2009 291,750
B+ B2 300,000 Horseshoe Gaming LLC, 9.375% due 6/15/2007 300,000
Isle of Capri Casinos, Inc.:
B B2 1,040,000 8.75% due 4/15/2009 975,000
BB Ba2 532,000 Term B, due 3/01/2006 (a) 535,034
BB Ba2 465,500 Term C, due 3/01/2007 (a) 468,155
B- B3 375,000 Trump Atlantic City Associates/Funding Inc.,
11.25% due 5/01/2006 251,250
------------
5,151,439
==================================================================================================================================
Hotels & B- B2 500,000 Extended Stay America, 9.15% due 3/15/2008 460,000
Motels--5.6% BB Ba2 1,000,000 HMH Properties, Inc., 8.45% due 12/01/2008 968,750
NR* Ba1 1,000,000 Starwood Hotels & Resorts Trust, Term II, due 2/23/2003 (a) 1,002,500
Wyndham International, Inc., Term (a):
NR* NR* 1,000,000 due 6/30/2004 997,778
NR* NR* 2,000,000 due 6/30/2006 1,970,500
------------
5,399,528
==================================================================================================================================
Industrial B+ B2 350,000 Building One Services, 10.50% due 5/01/2009 (c) 306,250
Services--0.3%
==================================================================================================================================
Insurance--0.6% B+ Ba3 600,000 Willis Corroon Corporation, 9% due 2/01/2009 546,000
==================================================================================================================================
Leasing & Rental B B3 250,000 National Equipment Services, 10% due 11/30/2004 200,000
Services--1.8% BB- B1 2,000,000 Neff Corp., 10.25% due 6/01/2008 1,100,000
B- B3 500,000 Penhall International, 12% due 8/01/2006 487,500
------------
1,787,500
==================================================================================================================================
</TABLE>
8 & 9
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Manufacturing--4.2% B+ NR* $ 500,000 Citation Corporation, Term B, due 12/01/2007 (a) $ 493,125
NR* NR* 1,969,912 Environmental Systems Product, Inc., Term B, due
9/30/2005 (a) 992,343
B- B2 475,000 Fairfield Manufacturing Company Inc., 9.625% due 10/15/2008 403,750
NR* NR* 1,990,000 Metokote Corp., Term B, due 11/02/2005 (a) 1,994,975
D Ca 500,000 +Morris Materials Handling, 9.50% due 4/01/2008 28,750
B- B3 300,000 Russell-Stanley Holding Inc., 10.875% due 2/15/2009 141,375
------------
4,054,318
==================================================================================================================================
Medical B+ B1 1,671,445 Alaris Medical Systems Inc., Term D, due 5/01/2005 (a) 1,665,177
Equipment--3.7% B+ B1 1,990,000 Hanger Orthopedic Group, Inc., Term B, due 12/30/2006 (a) 1,900,450
------------
3,565,627
==================================================================================================================================
Metals & CCC+ B3 960,000 AEI Resources, Term B, due 12/31/2004 (a) 864,000
Mining--4.5% BB- B2 500,000 Golden Northwest Aluminum, 12% due 12/15/2006 510,000
BB- B1 3,000,000 Ormet Corporation, Term, due 8/15/2008 (a) 2,992,500
------------
4,366,500
==================================================================================================================================
Online Services--0.3% B- B3 300,000 PSINet Inc., 11% due 8/01/2009 259,125
==================================================================================================================================
Packaging--0.6% B- Caa1 250,000 Consumers Packaging Inc., 9.75% due 2/01/2007 62,500
B+ B2 500,000 Packaging Corporation of America, 9.625% due 4/01/2009 512,500
------------
575,000
==================================================================================================================================
Paging--0.1% CCC+ B3 100,000 Metrocall Inc., 11% due 9/15/2008 (c) 72,000
==================================================================================================================================
Paper--10.8% NR* NR* 1,975,000 Cellular Tissue Holdings, Inc., Term C, due 3/24/2005 (a) 1,896,000
BB B1 450,000 Norampac Inc., 9.50% due 2/01/2008 455,625
BB Ba2 1,980,000 Pacifica Papers Inc., Term B, due 3/12/2006 (a) 1,989,900
NR* B2 3,000,000 Repap New Brunswick, Inc., Term B, due 6/01/2004 (a) 2,947,500
Stone Container Corporation (a):
B+ Ba3 1,193,739 Term F, due 12/31/2005 1,197,003
B+ Ba3 894,444 Term G, due 12/31/2006 894,924
B+ Ba3 1,074,000 Term H, due 12/31/2007 1,074,576
------------
10,455,528
==================================================================================================================================
Petroleum NR* Ba3 2,000,000 Clark Refining & Marketing, Inc., Term, due 11/15/2004 (a) 1,653,334
Refineries--1.7%
==================================================================================================================================
Printing & BBB- Baa3 250,000 World Color Press Inc., 8.375% due 11/15/2008 243,118
Publishing--0.2%
==================================================================================================================================
Property NR* Ba3 500,000 NRT Incorporated, Term, due 7/31/2004 (a) 496,875
Management--2.4% B Caa1 1,980,000 Prison Realty, Term C, due 12/31/2002 (a) 1,752,300
B Caa1 150,000 Prison Realty Trust Inc., 12% due 6/01/2006 125,250
------------
2,374,425
==================================================================================================================================
Restaurants & Domino & Bluefence (a):
Food Service--1.0% B+ B1 485,601 Term B, due 12/21/2006 487,786
B+ B1 486,362 Term C, due 12/21/2007 488,591
------------
976,377
==================================================================================================================================
Tower Construction BB- B1 1,000,000 American Towers, Inc., Term B, due 12/30/2007 (a) 1,005,568
& Leasing--2.2% B B1 150,000 Crown Castle International Corporation, 9% due 5/15/2011 143,250
NR* NR* 1,000,000 Spectrasite Communications, Term B, due 6/30/2006 (a) 1,002,250
------------
2,151,068
==================================================================================================================================
Utilities--3.2% BB+ Ba2 3,071,542 TNP Enterprises, Inc., Term, due 6/30/2006 (a) 3,084,980
==================================================================================================================================
Waste BB- B3 1,300,000 Norcal Waste Systems, 13.50% due 11/15/2005 1,366,625
Management--1.7% D Ca 300,000 +Safety-Kleen Corporation, 9.25% due 5/15/2009 6,000
B B3 250,000 Stericycle Inc., 12.375% due 11/15/2009 260,000
------------
1,632,625
==================================================================================================================================
Wired B+ B2 400,000 Call-Net Enterprises Inc., 9.375% due 5/15/2009 236,000
Telecommunications-- B B3 775,000 Caprock Communications Corporation, 11.50% due 5/01/2009 480,500
6.0% BBB- Ba1 500,000 Global Crossing Holdings Ltd., Term B, due 6/30/2006 (a) 502,902
B- Caa1 925,000 Global Telesystems Group, 9.875% due 2/15/2005 552,687
B B3 120,000 Hermes Europe RailTel BV, 10.375% due 1/15/2009 76,800
B B2 750,000 Intermedia Communications Inc., 9.50% due 3/01/2009 608,437
B+ B2 250,000 Metromedia Fiber Network, 10% due 11/15/2008 246,250
B+ B2 300,000 Netia Holdings II BV, 13.125% due 6/15/2009 285,000
B B2 2,000,000 Nextlink Communications Inc., 12.25% due 6/01/2009 (b) 1,200,000
B- B3 500,000 Primus Telecommunications Group, 11.25% due 1/15/2009 315,000
B- B2 400,000 RSL Communications PLC, 9.875% due 11/15/2009 100,000
B- B3 200,000 Versatel Telecom BV, 11.875% due 7/15/2009 (c) 180,000
Williams Communications Group Inc.:
BB- B2 250,000 10.70% due 10/01/2007 242,187
BB- B2 250,000 10.875% due 10/01/2009 240,937
Worldwide Fiber Inc.:
B+ B3 360,000 12.50% due 12/15/2005 342,000
B+ B3 200,000 12% due 8/01/2009 180,000
------------
5,788,700
==================================================================================================================================
</TABLE>
10 & 11
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
SCHEDULE OF INVESTMENTS (concluded) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Wireless Dolphin Telecom PLC (b):
Telecommunications-- CCC Caa2 $ 250,000 11.50% due 6/01/2008 $ 55,000
11.0% CCC Caa2 330,000 14% due 5/15/2009 66,000
B- B3 400,000 Microcell Telecommunications, 12% due 6/01/2009 (b) 290,000
Nextel Communications, Inc. (a):
BB- Ba2 1,500,000 Term B, due 6/30/2008 1,508,126
BB- Ba2 1,500,000 Term C, due 12/31/2008 1,508,126
BB- Ba2 1,856,085 Term D, due 3/31/2009 1,848,492
B+ B2 200,000 PTC International Finance II SA, 11.25% due 12/01/2009 203,000
NR* NR* 2,000,000 PowerTel PCS, Inc., Term B, due 2/06/2003 (a) 1,998,750
Rural Cellular (a):
B+ B1 250,000 Term B, due 10/03/2008 249,922
B+ B1 250,000 Term C, due 4/03/2009 249,922
CCC+ Caa1 650,000 Telesystem International Wireless Inc., 13.25% due
6/30/2007 (b) 422,500
NR* B2 1,000,000 Tritel Holdings, Term B, due 12/31/2007 (a) 1,003,000
B- B2 250,000 VoiceStream Wireless Company, 10.375% due 11/15/2009 270,000
B+ B1 1,000,000 VoiceStream PCS Holdings Corp., Term B, due 1/15/2009 (a) 996,667
------------
10,669,505
==================================================================================================================================
Total Investments in Corporate Debt Obligations
(Cost--$139,096,782)--130.9% 126,851,948
==================================================================================================================================
<CAPTION>
Shares
Held Stocks & Warrants
==================================================================================================================================
<C> <C> <S> <C>
Broadcast--Radio & 1,800 Sirius Satellite (Warrants) (c)(e) 176,400
Television--0.2%
==================================================================================================================================
Energy--0.7% 28,133 Forcenergy Inc. 680,467
==================================================================================================================================
Tower Construction 2,490 Crown Castle International Corporation (Preferred) (d) 2,471,240
& Leasing--2.6%
==================================================================================================================================
Wireless 1,000 Centaur Funding Corp. (Preferred) 1,009,690
Telecommunications-- 568 Dobson Communications (Preferred) (d) 558,060
1.6% ------------
1,567,750
==================================================================================================================================
Total Investments in Stocks & Warrants
(Cost--$4,540,454)--5.1% 4,895,857
==================================================================================================================================
<CAPTION>
Face
Amount Short-Term Securities
==================================================================================================================================
<S> <C> <C> <C>
Commercial Paper**-- $ 1,048,000 Autoliv ASP Inc., 6.78% due 9/01/2000 1,048,000
1.1%
==================================================================================================================================
Total Investments in Short-Term Securities
(Cost--$1,048,000)--1.1% 1,048,000
==================================================================================================================================
Total Investments (Cost--$144,685,236)--137.1% 132,795,805
Liabilities in Excess of Other Assets--(37.1%) (35,906,261)
------------
Net Assets--100.0% $ 96,889,544
============
==================================================================================================================================
</TABLE>
(a) 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 72.4% of the Fund's net assets.
(b) Represents a zero coupon or step bond; the interest rate shown reflects
the effective yield at the time of purchase by the Fund.
(c) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(d) Represents a pay-in-kind security which may pay interest/dividends in
additional face amount/shares.
(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.
** 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.
+ Non-income producing security.
See Notes to Financial Statements.
12 & 13
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of August 31, 2000
==============================================================================================================
<C> <S> <C> <C>
Assets: Investments, at value (identified cost--$144,685,236) ......... $ 132,795,805
Cash .......................................................... 217,104
Receivables:
Interest .................................................... $ 2,397,450
Securities sold ............................................. 810,042
Principal paydowns .......................................... 179,948
Dividends ................................................... 76,337 3,463,777
-------------
Prepaid expenses and other assets ............................. 35,272
-------------
Total assets .................................................. 136,511,958
-------------
==============================================================================================================
Liabilities: Loans ......................................................... 39,000,000
Payables:
Interest on loans ........................................... 209,361
Dividends to shareholders ................................... 173,708
Securities purchased ........................................ 76,337
Investment adviser .......................................... 55,596
Commitment fees ............................................. 9,440 524,442
-------------
Accrued expenses and other liabilities ........................ 97,972
-------------
Total liabilities ............................................. 39,622,414
-------------
==============================================================================================================
Net Assets: Net assets .................................................... $ 96,889,544
=============
==============================================================================================================
Capital: Common Stock, $.10 par value, 200,000,000 shares authorized ... $ 1,101,000
Paid-in capital in excess of par .............................. 108,740,136
Undistributed investment income--net .......................... 920,829
Accumulated realized capital losses on investments--net ....... (1,982,990)
Unrealized depreciation on investments--net ................... (11,889,431)
-------------
Total--Equivalent to $8.80 per share based on 11,010,000 shares
of capital stock outstanding (market price--$8.4375) .......... $ 96,889,544
=============
==============================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended August 31, 2000
=========================================================================================================
<C> <S> <C> <C>
Investment Income: Interest and discount earned ........................ $ 7,166,363
Dividends ........................................... 258,286
Facility and other fees ............................. 44,721
-----------
Total income ........................................ 7,469,370
-----------
=========================================================================================================
Expenses: Loan interest expense ............................... $ 1,422,390
Investment advisory fees ............................ 422,405
Accounting services ................................. 52,766
Professional fees ................................... 30,387
Borrowing costs ..................................... 28,857
Transfer agent fees ................................. 12,859
Directors' fees and expenses ........................ 11,967
Printing and shareholder reports .................... 10,820
Listing fees ........................................ 8,459
Custodian fees ...................................... 6,868
Pricing services .................................... 4,779
Other ............................................... 320
-----------
Total expenses ...................................... 2,012,877
-----------
Investment income--net .............................. 5,456,493
-----------
=========================================================================================================
Realized & Unrealized Realized loss on investments--net ................... (77,727)
Loss on Change in unrealized depreciation on investments--net (5,944,934)
Investments--Net: -----------
Net Decrease in Net Assets Resulting from Operations ... $ (566,168)
===========
=========================================================================================================
</TABLE>
See Notes to Financial Statements.
14 & 15
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Six For the
Months Ended Year Ended
August 31, February 29,
Increase (Decrease) in Net Assets: 2000 2000
=========================================================================================================================
<C> <S> <C> <C>
Operations: Investment income--net ............................................. $ 5,456,493 $ 11,671,088
Realized loss on investments and foreign currency transactions--net (77,727) (1,825,285)
Change in unrealized appreciation/depreciation on investments
and foreign currency transactions--net ............................. (5,944,934) (6,098,797)
------------- -------------
Net increase (decrease) in net assets resulting from operations .... (566,168) 3,747,006
------------- -------------
=========================================================================================================================
Dividends to Dividends to shareholders from investment income--net .............. (5,623,710) (11,361,428)
Shareholders: ------------- -------------
=========================================================================================================================
Capital Share Net increase in net assets resulting from capital share transactions -- 36,136
Transactions: ------------- -------------
=========================================================================================================================
Net Assets: Total decrease in net assets ....................................... (6,189,878) (7,578,286)
Beginning of period ................................................ 103,079,422 110,657,708
------------- -------------
End of period* ..................................................... $ 96,889,544 $ 103,079,422
============= =============
=========================================================================================================================
* Undistributed investment income--net .............................. $ 920,829 $ 1,088,046
============= =============
=========================================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Six Months Ended August 31, 2000
=======================================================================================================
<C> <S> <C>
Cash Provided by Net decrease in net assets resulting from operations ........ $ (566,168)
Operating Activities: Adjustments to reconcile net increase in net assets resulting
from operations to net cash provided by operating activities:
Decrease in receivables ................................... 276,846
Increase in other liabilities ............................. (1,194,234)
Realized and unrealized gain on investments and foreign
currency transactions--net ................................ 6,022,661
Amortization of discount .................................. (601,412)
------------
Net cash provided by operating activities ................... 3,937,693
------------
=======================================================================================================
Cash Used for Proceeds from sales of long-term investments ................ 20,242,492
Investing Activities: Purchases of long-term investments .......................... (19,800,076)
Purchases of short-term investments ......................... (68,285,344)
Proceeds from sales and maturities of short-term investments 67,804,000
------------
Net cash used for investing activities ...................... (38,928)
------------
=======================================================================================================
Cash Used for Cash receipts from borrowings ............................... 20,500,000
Financing Activities: Cash payments on borrowings ................................. (18,500,000)
Dividends paid to shareholders .............................. (5,681,661)
------------
Net cash used for financing activities ...................... (3,681,661)
------------
=======================================================================================================
Cash: Net increase in cash ........................................ 217,104
Cash at beginning of period ................................. 0
------------
Cash at end of period ....................................... $ 217,104
============
=======================================================================================================
Cash Flow Cash paid for interest ...................................... $ 1,638,217
Information: ============
=======================================================================================================
</TABLE>
See Notes to Financial Statements.
16 & 17
<PAGE>
Debt Strategies Fund III, 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 July 31, 1998+
Aug. 31, Feb. 29, to Feb. 28,
Increase (Decrease) in Net Asset Value: 2000++ 2000 1999
=================================================================================================================================
<C> <S> <C> <C> <C>
Per Share Net asset value, beginning of period ........................ $ 9.36 $ 10.05 $ 10.00
Operating ------- -------- --------
Performance: Investment income--net ...................................... .50 1.06 .47
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net .......................... (.55) (.72) .01
------- -------- --------
Total from investment operations ............................ (.05) .34 .48
------- -------- --------
Less dividends from investment income--net .................. (.51) (1.03) (.40)
------- -------- --------
Capital charge resulting from the issuance of Common Stock .. -- -- (.03)
------- -------- --------
Net asset value, end of period .............................. $ 8.80 $ 9.36 $ 10.05
======= ======== ========
Market price per share, end of period ....................... $8.4375 $ 8.75 $ 8.875
======= ======== ========
=================================================================================================================================
Total Investment Based on market price per share ............................. 2.36%+++ 10.82% (7.37%)+++
Return:** ======= ======== ========
Based on net asset value per share .......................... (.20%)+++ 4.69% 4.89%+++
======= ======== ========
=================================================================================================================================
Ratios to Average Expenses, net of reimbursement and excluding interest expense 1.18%* 1.18% .31%*
Net Assets: ======= ======== ========
Expenses, net of reimbursement .............................. 4.04%* 3.36% .39%*
======= ======== ========
Expenses .................................................... 4.04%* 3.36% 1.09%*
======= ======== ========
Investment income--net ...................................... 10.94%* 10.73% 8.02%*
======= ======== ========
=================================================================================================================================
Leverage: Amount of borrowings, end of period (in thousands) .......... $39,000 $ 37,000 $ 18,000
======= ======== ========
Average amount of borrowings outstanding during the period
(in thousands) .............................................. $40,837 $ 40,776 $ 1,737
======= ======== ========
Average amount of borrowings outstanding per share during
the period .................................................. $ 3.71 $ 3.70 $ .16
======= ======== ========
=================================================================================================================================
Supplemental Net assets, end of period (in thousands) .................... $96,890 $103,079 $110,658
Data: ======= ======== ========
Portfolio turnover .......................................... 14.55% 50.07% 50.99%
======= ======== ========
=================================================================================================================================
</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 III, 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 DBU.
(a) Corporate debt obligations -- The Fund invests principally in debt
obligations of companies, including corporate loans ("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 determine 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. Positions in
options are valued at the last sale price on the market where any such option is
principally traded. Short-term securities with remaining maturities of sixty
days or less are valued at amortized cost, which approximates market value.
Securities and assets for which market price quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Fund.
(c) Derivative financial instruments -- The Fund may engage in various portfolio
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 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.
18 & 19
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
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.
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, $148 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 $19,876,413 and $21,064,358, respectively.
Net realized losses for the six months ended August 31, 2000 and net unrealized
losses as of August 31, 2000 were as follows:
--------------------------------------------------------------------------------
Realized Unrealized
Losses Losses
--------------------------------------------------------------------------------
Long-term investments .............. $ (77,727) $(11,889,431)
------------ ------------
Total .............................. $ (77,727) $(11,889,431)
============ ============
--------------------------------------------------------------------------------
As of August 31, 2000, net unrealized depreciation for Federal income tax
purposes aggregated $11,889,431, of which $1,354,322 related to appreciated
securities and $13,243,753 related to depreciated securities. The aggregate cost
of investments at August 31, 2000 for Federal income tax purposes was
$144,685,236.
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 for the year ended February 29, 2000 remained constant.
5. Short-Term Borrowings:
On December 17, 1999, the Fund extended its one-year credit agreement with State
Street Bank and Trust Company and Fleet National Bank. The agreement is a
$55,000,000 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 $48,000,000 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 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 United States
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 $40,837,000 and the daily weighted average interest rate was
6.90%. For the six months ended August 31, 2000, facility and commitment fees
aggregated approximately $29,000.
6. Capital Loss Carryforward:
At February 29, 2000, the Fund had a net capital loss carryforward of
approximately $133,000, all of which expires in 2008. This amount will be
available to offset like amounts of any future taxable gains.
7. 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 Debt Strategies Fund II, Inc. would acquire the Fund and Debt Strategies
Fund, Inc. in exchange for newly issued shares of Debt Strategies Fund II, Inc.
These Funds are registered, diversified, closed-end management investment
companies. All three entities have a similar investment objective and are
managed by FAM.
8. 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 $0.081931 per share,
payable on September 29, 2000 to shareholders of record as of September 18,
2000.
20 & 21
<PAGE>
Debt Strategies Fund III, Inc., August 31, 2000
PORTFOLIO PROFILE
As of August 31, 2000
Percent of
Quality Ratings Long-Term
S&P/Moody's Investments
--------------------------------------------------------------------------------
BBB/Baa ................................................................. 1.3%
BB/Ba ................................................................... 31.2
B/B ..................................................................... 45.3
CCC/Caa ................................................................. 3.8
NR (Not Rated) .......................................................... 18.4
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Percent of
Long-Term
Breakdown of Investments by Country Investments
--------------------------------------------------------------------------------
United States ........................................................... 92.9%
Canada .................................................................. 3.8
United Kingdom .......................................................... 2.1
Australia ............................................................... 0.7
Poland .................................................................. 0.3
Netherlands ............................................................. 0.1
Belgium ................................................................. 0.1
--------------------------------------------------------------------------------
Percent of
Ten Largest Holdings Total Assets
--------------------------------------------------------------------------------
Nextel Communications, Inc. ............................................. 3.5%
Coaxial Communications/Phoenix .......................................... 2.5
Stone Container Corporation ............................................. 2.3
Cliffs Drilling ......................................................... 2.3
TNP Enterprises, Inc. ................................................... 2.3
Ackerley Group Inc. ..................................................... 2.2
Lyondel Petrochemical Co. ............................................... 2.2
Ormet Corporation ....................................................... 2.2
Wyndham International, Inc. ............................................. 2.2
Repap New Brunswick, Inc. ............................................... 2.2
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Percent of
Five Largest Industries Total Assets
--------------------------------------------------------------------------------
Cable ................................................................... 10.8%
Wireless Telecommunications ............................................. 8.6
Paper ................................................................... 7.7
Broadcast--Radio & Television ........................................... 7.0
Chemicals ............................................................... 5.8
--------------------------------------------------------------------------------
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 & Transfer Agent
State Street Bank and Trust Company
225 Franklin Street
Boston, MA 02110
NYSE Symbol
DBU
22 & 23
<PAGE>
Debt Strategies Fund III, 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 III, 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 III, Inc.
Box 9011
Princeton, NJ
08543-9011 #DEBT03--8/00
[LOGO] Printed on post-consumer recycled paper
