PAINEWEBBER AND MITCHELL HUTCHINS/KIDDER, PEABODY MUTUAL FUNDS
PAINEWEBBER OFFERS A FAMILY OF 29 MUTUAL
FUNDS WHICH ENCOMPASS A DIVERSIFIED
RANGE OF INVESTMENT GOALS. INVESTORS
MAY EXCHANGE THEIR FUND SHARES WITH
OTHER FUNDS WITHIN THE FAMILY.
INCOME FUNDS
. MH/KP ADJUSTABLE RATE GOVERNMENT FUND
. MH/KP GLOBAL FIXED INCOME FUND
. MH/KP GOVERNMENT INCOME FUND MITCHELL HUTCHINS/
. MH/KP INTERMEDIATE FIXED INCOME FUND KIDDER, PEABODY
. PW GLOBAL INCOME FUND GOVERNMENT
. PW HIGH INCOME FUND INCOME FUND, INC.
. PW INVESTMENT GRADE INCOME FUND
. PW SHORT-TERM U.S. GOVERNMENT INCOME FUND
. PW STRATEGIC INCOME FUND
. PW U.S. GOVERNMENT INCOME FUND
TAX-FREE INCOME FUNDS
. MH/KP MUNICIPAL BOND FUND
. PW CALIFORNIA TAX-FREE INCOME FUND
. PW MUNICIPAL HIGH INCOME FUND
. PW NATIONAL TAX-FREE INCOME FUND
. PW NEW YORK TAX-FREE INCOME FUND
GROWTH FUNDS
. MH/KP EMERGING MARKETS EQUITY FUND
. MH/KP SMALL CAP GROWTH FUND
. PW CAPITAL APPRECIATION FUND
. PW GLOBAL EQUITY FUND
. PW GROWTH FUND
. PW REGIONAL FINANCIAL GROWTH FUND
. PW SMALL CAP VALUE FUND
GROWTH AND INCOME FUNDS SEMI-ANNUAL REPORT
. MH/KP ASSET ALLOCATION FUND July 31, 1995
. MH/KP EQUITY INCOME FUND
. PW BALANCED FUND
. PW GROWTH AND INCOME FUND
. PW GLOBAL ENERGY FUND
. PW UTILITY INCOME FUND
PAINEWEBBER MONEY MARKET FUND
-------------------------
(C)1995 PaineWebber Incorporated
[LOGO] Printed on
Recycled Paper
<PAGE>
- --------------------------------------------------------------------------------
September 15, 1995
Dear Shareholder,
During the six months ended July 31, 1995, the pace of U.S. economic growth
appeared to have slowed in response to the Federal Reserve Board's repeated
increases in the benchmark Federal Funds rate, the rate banks charge each other
for overnight borrowing. After seven short-term interest rate hikes between
February 1994 and February 1995, the Federal Reserve Board increased the Federal
Funds rate to 6.0%, and effectively doubled short-term interest rates in twelve
months. However, on July 6, 1995, the Federal Reserve cut the benchmark Federal
Funds rate by 0.25%. This decrease, the first in nearly three years, signals
that the Federal Reserve Board believes that inflationary pressures have eased
enough to accommodate an adjustment in monetary conditions from restrictive
toward neutral.
ECONOMIC OVERVIEW
News concerning the economy during the six months ended July 31, 1995 was
dominated by debate over whether inflation was still a threat, discussions about
the dismal performance of the dollar and details of efforts in Washington to
implement a plan to balance the budget. Interest rates trended downward, as the
perception that the Federal Reserve had won its battle with inflation and that
the next policy action would be to lower short-term interest rates became
widespread. The U.S. bond market rallied strongly in the first half of 1995, and
strength in corporate earnings pushed stock prices higher. Employment reports
indicated a slowing economy, with consumer spending declining significantly from
1994 and consumer credit reports showing high ratios of installment debt to
disposable income. Side effects of higher interest rates lingered, however.
Markets for new and existing homes were sluggish until the close of the
six-month period, despite historically attractive mortgage rates. Although the
U.S. economy appears to have been flat in the second quarter, the second half of
1995 should show signs of some economic revival, albeit with moderate growth.
PORTFOLIO REVIEW
November 1994 marked the end of a difficult bear market period for fixed income
securities, as Treasury yields rose about 200 basis points. Although the Federal
Reserve hiked short-term interest rates one more time in February 1995, the six
month period was marked by a general decline in interest rates, culminating in a
powerful bond market rally in May. As economic growth slowed, the mood of the
bond market changed from gloom to euphoria, as investors no longer feared a
continuing series of interest rate hikes by the Federal Reserve and began
looking forward to interest rate cuts.
The Fund's total return for the six months ended July 31, 1995, without
deducting sales charges, was 6.99% for Class A shares, 6.86% for Class B shares
and 7.26% for Class C shares. The Fund's total return for this period, after
deducting the maximum applicable sales charges, was 4.60% for Class A shares,
6.86% for Class B shares and 7.26% for Class C shares. During the six months
ended July 31, 1995, the Fund paid distributions from net investment income
totalling $0.42 for Class A shares, $0.41 for Class B shares and $0.46 for Class
C shares. As of July 31, 1995, the Fund's 30-day SEC yield was 5.78% for Class A
shares, 5.66% for Class B shares and 6.42% for Class C shares.
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
As growth slows and inflation pressures continue to moderate, the possibility of
long-term interest rates declining further continues. Based on this bullish
market outlook and the presently very high level of interest rate volatility,
the portfolio is underweighted in mortgage-backed securities. In declining
interest rate environments and periods of high volatility, mortgage pre-payment
risk generally increases--resulting in vulnerability in the mortgage-backed
securities sector. However, spreads over Treasuries amongst the various fixed
income products are at historically tight levels. In addition, there has not
been a large new issue supply of mortgage and corporate issues. These two
factors give mortgage-backed securities strong technical support. Our current
portfolio strategy is to concentrate on the liquid segments of the
mortgage-backed securities market, with a bias toward straight mortgage
passthroughs.
The board of directors of the Fund has approved a Plan of Reorganization and
Dissolution ("Reorganization") for submission to the Fund's shareholders, at a
special meeting expected to be held on October 19, 1995. If the proposed
Reorganization is approved and implemented, all of the Fund's assets will be
acquired and its liabilities assumed by PaineWebber U.S. Government Income Fund
("Government Income Fund") in a tax-free reorganization. As a result of the
Reorganization, the two funds' assets would be combined and each Fund
shareholder would, on the closing date of the transaction, receive a number of
full and fractional shares of the corresponding Class of shares of Government
Income Fund having an aggregate value equal to the value of the shareholder's
holdings in the Fund. Nirmal Singh and Craig Varrelman are responsible for the
day-to-day portfolio management of the Government Income Fund. There can be no
assurance that the Fund's shareholders will approve the Reorganization.
We value you as a shareholder and as a client, and thank you for your continued
support. We welcome any comments or questions you may have.
Sincerely,
/s/ FRANK P.L. MINARD /s/ DENNIS L. MCCAULEY
FRANK P.L. MINARD DENNIS L. MCCAULEY
Chairman, Managing Director and Chief Investment
Mitchell Hutchins Asset Officer--Fixed Income,
Management Inc. Mitchell Hutchins Asset Management Inc.
/s/ NIRMAL SINGH
NIRMAL SINGH
Portfolio Manager,
Mitchell Hutchins/Kidder, Peabody
Government Income Fund, Inc.
- --------------------------------------------------------------------------------
2
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
RECENT PERFORMANCE RESULTS (UNAUDITED)
<TABLE><CAPTION>
NET ASSET VALUE TOTAL RETURN1
------------------------------------ --------------------------------
12 MONTHS 6 MONTHS
07/31/95 01/31/95 07/31/94 ENDED 07/31/95 ENDED 07/31/95
<S> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------
Class A Shares $14.10 $13.58 $13.94 7.24% 6.99%
- -------------------------------------------------------------------------------------------------------------
Class B Shares 14.09 13.57 13.93 6.98 6.86
- -------------------------------------------------------------------------------------------------------------
Class C Shares 14.09 13.57 13.93 7.77 7.26
- -------------------------------------------------------------------------------------------------------------
</TABLE>
PERFORMANCE SUMMARY CLASS A SHARES
<TABLE><CAPTION>
NET ASSET VALUE
-------------------- CAPITAL GAINS TOTAL
PERIOD COVERED BEGINNING ENDING DISTRIBUTED DIVIDENDS PAID2 RETURN1
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
11/22/85 - 12/31/85 $ 15.00 $15.42 -- $ 0.1310 3.67%
- ------------------------------------------------------------------------------------------------------------------------
1986 15.42 15.11 $0.1600 1.1662 6.98
- ------------------------------------------------------------------------------------------------------------------------
1987 15.11 14.28 0.0980 1.1227 2.73
- ------------------------------------------------------------------------------------------------------------------------
1988 14.28 14.12 -- 1.1478 7.07
- ------------------------------------------------------------------------------------------------------------------------
1989 14.12 14.70 -- 1.1679 12.88
- ------------------------------------------------------------------------------------------------------------------------
1990 14.70 14.27 -- 1.2135 5.66
- ------------------------------------------------------------------------------------------------------------------------
1991 14.27 14.91 -- 1.1740 13.26
- ------------------------------------------------------------------------------------------------------------------------
1992 14.91 14.74 -- 1.0786 6.35
- ------------------------------------------------------------------------------------------------------------------------
1993 14.74 14.82 -- 0.8221 6.23
- ------------------------------------------------------------------------------------------------------------------------
1994 14.82 13.45 -- 0.7613 (4.15)
- ------------------------------------------------------------------------------------------------------------------------
01/01/95 - 07/31/95 13.45 14.10 -- 0.4248 8.38
- ------------------------------------------------------------------------------------------------------------------------
Totals: $0.2580 $ 10.2099
- ------------------------------------------------------------------------------------------------------------------------
Cumulative Total Return as of 07/31/95: 93.41%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
PERFORMANCE SUMMARY CLASS B SHARES
<TABLE><CAPTION>
NET ASSET VALUE
-------------------- CAPITAL GAINS TOTAL
PERIOD COVERED BEGINNING ENDING DISTRIBUTED DIVIDENDS PAID2 RETURN1
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
06/14/93 - 12/31/93 $ 15.00 $14.82 -- $ 0.3480 1.15%
- ------------------------------------------------------------------------------------------------------------------------
1994 14.82 13.45 -- 0.7245 (4.40)
- ------------------------------------------------------------------------------------------------------------------------
01/01/95 - 07/31/95 13.45 14.09 -- 0.4071 8.16
- ------------------------------------------------------------------------------------------------------------------------
Totals: -- $ 1.4796
- ------------------------------------------------------------------------------------------------------------------------
Cumulative Total Return as of 07/31/95: 4.56%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
PERFORMANCE SUMMARY CLASS C SHARES
<TABLE><CAPTION>
NET ASSET VALUE
-------------------- CAPITAL GAINS TOTAL
PERIOD COVERED BEGINNING ENDING DISTRIBUTED DIVIDENDS PAID2 RETURN1
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
06/14/93 - 12/31/93 $ 15.00 $14.82 -- $ 0.4079 1.53%
- ------------------------------------------------------------------------------------------------------------------------
1994 14.82 13.45 -- 0.8293 (3.68)
- ------------------------------------------------------------------------------------------------------------------------
01/01/95 - 07/31/95 13.45 14.09 -- 0.4595 8.60
- ------------------------------------------------------------------------------------------------------------------------
Totals: -- $ 1.6967
- ------------------------------------------------------------------------------------------------------------------------
Cumulative Total Return as of 07/31/95: 6.21%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Figures assume reinvestment of all dividends and capital gains distributions
at net asset value on the payable dates, and do not include sales charges;
results for Class A shares would be lower if sales charges were included.
(2) Certain distributions may contain short-term capital gains.
- --------------------------------------------------------------------------------
3
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
AVERAGE ANNUAL RETURN
<TABLE><CAPTION>
% RETURN WITHOUT DEDUCTING % RETURN AFTER DEDUCTING
MAXIMUM SALES CHARGE MAXIMUM SALES CHARGE
------------------------------- -------------------------------
CLASS CLASS
------------------------------- -------------------------------
A* B** C*** A* B** C***
<S> <C> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------
Twelve Months Ended 6/30/95 9.09% 8.83% 9.62% 6.62% 8.83% 9.62%
- --------------------------------------------------------------------------------------------------------
Five Years Ended 6/30/95 6.56 N/A N/A 6.08 N/A N/A
- --------------------------------------------------------------------------------------------------------
Commencement of Operations Through
6/30/95+ 7.14 2.39 3.14 6.89 2.39 3.14
- --------------------------------------------------------------------------------------------------------
</TABLE>
* Maximum sales charge for Class A shares is 2.25% of the public offering
price. Class A shares bear ongoing 12b-1 service fees.
** Class B shares are sold without initial or contingent deferred sales
charges, but bear ongoing 12b-1 distribution and service fees.
*** Class C shares are sold without initial or contingent deferred sales charges
and are available exclusively to PaineWebber employees.
+ Commencement of operations was November 22, 1985, June 14, 1993 and June 14,
1993 for Class A, Class B and Class C shares, respectively.
- --------------------------------------------------------------------------------
THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT IN THE FUND WILL
FLUCTUATE, SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR
LESS THAN THEIR ORIGINAL COST.
4
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Portfolio of Investments
July 31, 1995 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT MATURITY INTEREST
(000) DATES RATES VALUE
- ---------- -------------------- -------------- -----------
<C> <S> <C> <C> <C>
LONG-TERM U.S. GOVERNMENT OBLIGATIONS--24.92%
$10,610 U.S. Treasury Notes
(cost-$11,262,295)...................... 09/30/99 to 02/15/05 7.125 to 7.500% $11,134,591
-----------
FEDERAL NATIONAL MORTGAGE ASSOCIATION
CERTIFICATES--46.19%
4,600 FNMA TBA................................ 08/01/25 8.500 4,745,190
7,359 FNMA.................................... 08/01/24 to 07/01/25 7.500 7,345,434
8,757 FNMA.................................... 12/01/23 to 11/01/24 7.000 8,549,330
-----------
Total Federal National Mortgage Association
Certificates (cost-$20,389,606)................... 20,639,954
-----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
CERTIFICATES-10.83%
197 GNMA.................................... 09/15/14 to 02/15/16 10.500 217,108
76 GNMA.................................... 09/15/15 to 11/15/16 10.000 82,353
4,374 GNMA.................................... 10/15/24 8.500 4,539,844
-----------
Total Government National Mortgage Association
Certificates (cost-$4,676,829)...................... 4,839,305
-----------
SHORT-TERM U.S. GOVERNMENT OBLIGATIONS--13.55%
6,090 U.S. Treasury Bills (cost-$6,053,300)... 08/24/95 to 09/14/95 5.380 to 5.720 6,053,300
-----------
REPURCHASE AGREEMENT--4.06%
1,814 Repurchase Agreement dated 07/31/95 with
Daiwa Securities, Inc., collateralized
by $1,165,000 U.S. Treasury Bonds,
13.250% due 05/15/14; proceeds:
$1,814,292 (cost-$1,814,000)........... 08/01/95 5.800 1,814,000
-----------
TOTAL INVESTMENTS (cost-$44,196,030)--99.55%........ 44,481,150
Other assets in excess of liabilities--0.45%........ 202,826
-----------
NET ASSETS--100.00%................................. $44,683,976
-----------
-----------
</TABLE>
See accompanying notes to financial statements
5
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities
July 31, 1995 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS
Investments, at value (cost-$44,196,030)..................................... $44,481,150
Cash......................................................................... 302
Receivable for investments sold.............................................. 4,815,519
Interest receivable.......................................................... 478,092
Receivable from investment adviser........................................... 20,510
Other assets................................................................. 60,300
-----------
Total assets.............................................................. 49,855,873
-----------
LIABILITIES
Payable for investments purchased............................................ 4,752,119
Payable for fund shares repurchased.......................................... 206,561
Dividends payable............................................................ 101,440
Payable to affiliate......................................................... 42,189
Accrued expenses and other liabilities....................................... 69,588
-----------
Total liabilities......................................................... 5,171,897
-----------
NET ASSETS
Common stock--$0.01 par value; 3,170,270 stock outstanding................... 53,670,866
Accumulated net realized capital losses from investment transactions......... (9,272,010)
Net unrealized appreciation of investments................................... 285,120
-----------
Net assets................................................................ $44,683,976
-----------
-----------
CLASS A:
Net assets................................................................... $40,133,613
-----------
Shares outstanding........................................................... 2,847,258
-----------
Net asset and redemption value per share..................................... $14.10
------
------
Maximum offering price per share (net asset value plus sales charge
of 2.25% of offering price)................................................ $14.42
------
------
CLASS B:
Net assets................................................................... $ 1,318,843
-----------
Shares outstanding........................................................... 93,605
-----------
Net asset value, offering price and redemption value per share............... $14.09
------
------
CLASS C:
Net assets................................................................... $ 3,231,520
-----------
Shares outstanding........................................................... 229,407
-----------
Net asset value, offering price and redemption value per share............... $14.09
------
------
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Statement of Operations
For the Six Months Ended July 31, 1995 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest...................................................................... $1,770,497
----------
EXPENSES:
Investment advisory and administration........................................ 143,157
Service and distribution fees--Class A........................................ 104,269
Service and distribution fees--Class B........................................ 4,783
Reports and notices to shareholders........................................... 22,795
Transfer agency............................................................... 18,418
Custody and accounting........................................................ 17,093
Legal and audit............................................................... 15,207
Directors' fees and expenses.................................................. 11,034
Federal and state registration fees........................................... 9,050
Other expenses................................................................ 6,299
----------
352,105
LESS: Fee waivers from investment adviser........................................ (20,510)
----------
Net expenses.................................................................. 331,595
----------
NET INVESTMENT INCOME............................................................ 1,438,902
----------
REALIZED AND UNREALIZED GAINS FROM INVESTMENT TRANSACTIONS:
Net realized gains from investment transactions............................... 397,700
Net change in unrealized appreciation/depreciation of investments............. 1,368,624
----------
NET REALIZED AND UNREALIZED GAINS FROM INVESTMENT TRANSACTIONS................... 1,766,324
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS............................. $3,205,226
----------
----------
</TABLE>
See accompanying notes to financial statements
7
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Statement of Changes in Net Assets
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
SIX MONTHS ENDED FOR THE
JULY 31, 1995 YEAR ENDED
(UNAUDITED) JANUARY 31, 1995
---------------- ----------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income.................................... $ 1,438,902 $ 3,638,361
Net realized gains (losses) from investment
transactions........................................... 397,700 (4,973,951)
Net change in unrealized appreciation/depreciation of
investments............................................ 1,368,624 (1,972,889)
---------------- ----------------
Net increase (decrease) in net assets resulting from
operations............................................. 3,205,226 (3,308,479)
---------------- ----------------
DIVIDENDS TO SHAREHOLDERS FROM:
Net investment income--Class A........................... (1,283,038) (3,309,531)
Net investment income--Class B........................... (38,513) (79,144)
Net investment income--Class C........................... (117,351) (249,686)
---------------- ----------------
Total dividends to shareholders.......................... (1,438,902) (3,638,361)
---------------- ----------------
FROM COMMON STOCK TRANSACTIONS:
Net proceeds from the sale of shares..................... 615,708 4,765,260
Cost of shares repurchased............................... (8,972,227) (30,984,562)
Proceeds from dividends reinvested....................... 1,149,610 2,706,257
---------------- ----------------
Net decrease in net assets from common stock
transactions........................................... (7,206,909) (23,513,045)
---------------- ----------------
Net decrease in net assets............................... (5,440,585) (30,459,885)
NET ASSETS:
Beginning of period...................................... 50,124,561 80,584,446
---------------- ----------------
End of period............................................ $ 44,683,976 $ 50,124,561
---------------- ----------------
---------------- ----------------
</TABLE>
See accompanying notes to financial statements
8
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (unaudited)
- --------------------------------------------------------------------------------
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc. (formerly
Kidder, Peabody Government Income Fund, Inc.) (the "Fund") is registered under
the Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company.
Effective September 1, 1993, the Fund changed its fiscal year end from
August 31 to January 31.
Organizational Matters--On June 14, 1993 the Fund adopted the Choice Pricing
SystemSM. Prior to June 14, 1993, the Fund issued only Class A shares;
subsequent to that date the Fund issued Class A, Class B and Class C shares.
Each class represents interests in the same assets of the Fund and the classes
are identical except for differences in their sales charge structure and ongoing
service and distribution charges. All classes of shares have equal rights as to
voting privileges, except that each class has exclusive voting rights with
respect to its distribution plan.
Valuation of Investments--The value of each U.S. government security for
which quotations are available is based on the average of the quoted bid and
asked prices. An independent pricing service is used to determine valuations for
normal institutional-size trading units of securities. Options which are traded
on exchanges are valued at their last sales price as of the close of such
exchanges. Futures are valued daily using the last sales price as of the close
of trading on the Chicago Board of Trade. The amortized cost method of
valuation, which approximates market value, is used to value short-term debt
obligations with 60 days or less remaining to maturity.
Investment Transactions and Investment Income--Investment transactions are
recorded on the trade date. Realized gains and losses on sales of investments
are calculated using the identified cost method. Interest income is recorded on
an accrual basis. Discounts are accreted and premiums are amortized as
adjustments to interest income and the identified cost of investments.
Income, expenses (excluding class-specific expenses) and realized/unrealized
gains/losses are allocated proportionately to each class of shares based upon
the relative net asset value of outstanding shares (or the value of
dividend-eligible shares, as appropriate) of each class at the beginning of the
day (after adjusting for current capital share activity of the respective
classes). Class-specific expenses are charged directly to the applicable class
of shares.
Futures Contracts--Upon entering into a financial futures contract, the Fund
is required to pledge to a broker an amount of cash and/or U.S. Government
securities equal to a certain percentage of the contract amount. This amount is
known as the "initial margin." Subsequent payments, known as "variation margin,"
are made or received by the Fund each day, depending on the daily fluctuations
in the value of the underlying financial futures contracts. Such variation
margin is recorded for financial statement purposes on a daily basis as
unrealized gain or loss until the financial futures contract is closed, at which
time the net gain or loss is reclassified to realized.
Using financial futures contracts involves various market risks. The maximum
amount at risk from the purchase of a futures contract is the contract value.
The Fund is subject to a number of guidelines
9
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
which reduce this risk by seeking to ensure that financial futures contracts are
used for hedging purposes as well as to manage the average duration of the
Fund's portfolio and not for leverage. However, imperfect correlations between
futures contracts and the portfolio securities being hedged or, market
disruptions, do not normally permit full control of these risks at all times. At
July 31, 1995, there were no open futures contracts.
Option Writing--When the Fund writes a call or a put option, an amount equal
to the premium received by the Fund is included in the Fund's Statement of
Assets and Liabilities as an asset and as an equivalent liability. The amount of
the liability is subsequently marked-to-market to reflect the current market
value of the option written. If an option which the Fund has written either
expires on its stipulated expiration date or the Fund enters into a closing
purchase transaction, the Fund realizes a gain (or loss if the cost of a closing
purchase transaction exceeds the premium received when the option was written)
without regard to any unrealized gain or loss on the underlying security, and
the liability related to such option is extinguished. If a call option which the
Fund has written is exercised, the Fund realizes a capital gain or loss
(long-term or short-term, depending on the holding period of the underlying
security) from the sale of the underlying security and the proceeds from the
sale are increased by the premium originally received. If a put option which the
Fund has written is exercised, the amount of the premium originally received
reduces the cost of the security which the Fund purchases upon exercise of the
option. At July 31, 1995, there were no unexpired options.
Repurchase Agreements--The Fund's custodian takes possession of the
collateral pledged for investments in repurchase agreements. The underlying
collateral is valued daily on a mark-to-market basis to ensure that the value,
including accrued interest, is at least equal to the repurchase price. In the
event of default of the obligation to repurchase, the Fund has the right to
liquidate the collateral and apply the proceeds in satisfaction of the
obligation. Under certain circumstances, in the event of default or bankruptcy
by the other party to the agreement, realization and/or retention of the
collateral may be subject to legal proceedings. The Fund occasionally
participates in joint repurchase agreement transactions with other funds managed
by Mitchell Hutchins.
Federal Tax Status--The Fund intends to distribute all of its taxable income
and to comply with the other requirements of the Internal Revenue Code
applicable to regulated investment companies. Accordingly, no provision for
federal income taxes is required. In addition, by distributing during each
calendar year substantially all of its net investment income, capital gains and
certain other amounts, if any, the Fund intends not to be subject to a federal
excise tax.
At January 31, 1995, the Fund had a net capital loss carryforward of
$9,669,710. The loss carryforward is available as a reduction, to the extent
provided in the regulations, of future net realized capital gains, and will
expire between fiscal years 1998 and 2003.
Dividends and Distributions--Dividends and distributions to shareholders are
recorded on the ex-dividend date. The Fund declares dividends on a daily basis
from net investment income. Net capital gains, if any, will be distributed at
least annually, but the Fund may make more frequent distributions of such gains,
if necessary, to avoid income or excise taxes. Dividends from net investment
income and
10
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
distributions from realized gains from investment transactions have been
determined in accordance with federal income tax regulations, which may differ
from generally accepted accounting principles. These "book/tax" differences are
considered either temporary or permanent in nature. To the extent these
differences are permanent in nature, such amounts are reclassified within the
capital accounts based on their federal tax-basis treatment; temporary
differences do not require reclassification. Dividends and distributions that
exceed net investment income and net realized capital gains for financial
reporting
purposes but not for tax purposes are reported as dividends in excess of net
investment income or distributions in excess of net realized capital gains. To
the extent they exceed net investment income and net realized capital gains for
tax purposes, they are reported as distributions of paid-in-capital.
INVESTMENT ADVISER AND ADMINISTRATOR
The Fund's investment adviser and administrator receives compensation from
the Fund accrued daily and paid monthly at an annual rate of 0.625% of the
Fund's average daily net assets.
At a special meeting of shareholders held on April 13, 1995, Mitchell
Hutchins Asset Management Inc. ("Mitchell Hutchins") was appointed as investment
adviser and administrator of the Fund. The Fund pays the same fee for investment
advisory and administration services to Mitchell Hutchins as previously paid to
Kidder Peabody Asset Management, Inc. ("KPAM"), as described in the Fund's
prospectus. Mitchell Hutchins continues to manage the Fund in accordance with
the Fund's investment objective, policies and restrictions as stated in the
prospectus.
Investment advisory functions for the Fund were previously transferred from
KPAM to Mitchell Hutchins on an interim basis as a result of an asset purchase
transaction by and among Kidder Peabody Group Inc., its parent, General Electric
Company, and PaineWebber Group Inc. That period began on February 13, 1995 and
ended April 13, 1995.
In compliance with applicable state securities laws, the Fund's investment
adviser will reimburse the Fund if and to the extent that the aggregate
operating expenses in any fiscal year, exclusive of taxes, interest, brokerage
fees, distribution fees and extraordinary expenses, exceed limitations imposed
by various state regulations. Currently, the most restrictive limitation
applicable to the Fund is 2.5% of the first $30 million of average daily net
assets, 2.0% of the next $70 million and 1.5% of any excess over $100 million.
For the six months ended July 31, 1995, no reimbursement was required pursuant
to the above limitation. Mitchell Hutchins, however, voluntarily waived a
portion of its investment advisory and administration fee.
DISTRIBUTION PLANS
Effective February 13, 1995, Mitchell Hutchins serves as the exclusive
distributor of the Fund's shares. Under separate plans of distribution, Class A
shares are sold subject to a front-end sales load and bear a distribution fee of
0.25% per annum and a service fee of 0.25% per annum of the lesser of (i)
aggregate gross sales of the Class A shares since its inception (not including
reinvestments of
11
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)
- --------------------------------------------------------------------------------
dividends or capital gains distributions), less aggregate redemptions since
inception on which a contingent deferred sales charge has been paid or waived or
(ii) the average daily net assets attributable to Class A shares. Class B shares
are sold at net asset value without a sales load and bear a distribution fee of
0.50% per annum and a service fee of 0.25% per annum of average class net
assets.
For the period February 1, 1995 to February 13, 1995, Kidder, Peabody & Co.
Incorporated ("Kidder Peabody"), the Fund's predecessor distributor, earned
$7,680 in distribution and service fees. For the period from February 13, 1995
to July 31, 1995, Mitchell Hutchins earned $101,372 in such fees. At July 31,
1995, the Fund owed Mitchell Hutchins $18,127 in service and distribution fees.
Mitchell Hutchins also receives the proceeds of any front-end sales loads
with respect to the purchase of Class A shares. For the six months ended July
31, 1995, Kidder Peabody and Mitchell Hutchins earned approximately $260 and
$3,300, respectively, in initial sales charges on the sale of Class A shares.
INVESTMENTS IN SECURITIES
For federal income tax purposes, the cost of securities owned at July 31,
1995 was substantially the same as the cost of securities for financial
statement purposes.
At July 31, 1995, the components of the net unrealized appreciation of
investments were as follows:
<TABLE>
<S> <C>
Gross appreciation (investments having an excess of value over
cost)........................................................ $ 461,120
Gross depreciation (investments having an excess of cost over
value)....................................................... (176,000)
---------
Net unrealized appreciation of investments..................... $ 285,120
---------
---------
</TABLE>
For the six months ended July 31, 1995, aggregate purchases and sales of
portfolio securities, excluding short-term securities, were $80,119,926 and
$88,981,119, respectively.
CONCENTRATION OF RISK
The ability of the issuers of the debt securities held by the Fund to meet
their obligations may be affected by economic developments, including those
particular to specific industry or state.
12
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (concluded)
- --------------------------------------------------------------------------------
SHARES OF COMMON STOCK
There were 500,000,000 shares, consisting of several classes, of $0.01 par
value common stock authorized. Transactions in shares of common stock were as
follows:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------------------------ ------------------ ---------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
---------- ------------ ------- --------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Six months ended July 31, 1995:
Shares sold.................. 11,347 $ 158,859 11,722 $ 162,542 20,920 $ 294,307
Dividends reinvested in
additional Fund shares..... 72,111 1,006,487 2,589 36,148 7,673 106,975
Shares repurchased........... (549,396) (7,600,390) (14,997) (208,159) (83,664) (1,163,678)
---------- ------------ ------- --------- -------- -----------
Net decrease..................... (465,938) $ (6,435,044) (686) $ (9,469) (55,071) $ (762,396)
---------- ------------ ------- --------- -------- -----------
---------- ------------ ------- --------- -------- -----------
Year ended January 31, 1995:
Shares sold.................. 154,271 $ 2,160,857 27,481 $ 389,801 158,331 $ 2,214,602
Dividends reinvested in
additional Fund shares..... 173,778 2,408,464 5,144 71,137 16,434 226,656
Shares repurchased........... (2,056,749) (28,426,526) (48,732) (678,196) (136,770) (1,879,840)
---------- ------------ ------- --------- -------- -----------
Net increase (decrease).......... (1,728,700) $(23,857,205) (16,107) $(217,258) 37,995 $ 561,418
---------- ------------ ------- --------- -------- -----------
---------- ------------ ------- --------- -------- -----------
</TABLE>
PROPOSED REORGANIZATION
The Board of Directors of the Fund has approved a Plan of Reorganization and
Dissolution (the "Reorganization") for submission to its shareholders at a
special meeting to be held October 19, 1995. If the proposed Reorganization is
approved and implemented, all the Fund's assets will be acquired and its
liabilities assumed by PaineWebber U.S. Government Income Fund ("U.S. Government
Income Fund") in a tax-free reorganization. As a result of the Reorganization,
the two funds' assets would be combined and each Fund shareholder would, on the
closing date of the transaction, receive a number of full and fractional shares
of the corresponding Class of shares of U.S. Government Income Fund having an
aggregate value equal to the value of the shareholder's holdings in the Fund.
There can be no assurance that the Fund's shareholders will approve the
Reorganization.
13
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Financial Highlights
- --------------------------------------------------------------------------------
Selected data for a share of common stock outstanding is presented below:
<TABLE>
<CAPTION>
CLASS A
---------------------------------------------------------------------------------
FOR THE
FOR THE SIX MONTHS
FIVE MONTHS FOR THE ENDED
FOR THE YEARS ENDED AUGUST 31, ENDED YEAR ENDED JULY 31,
-------------------------------------- JANUARY 31, JANUARY 31, 1995
1990 1991 1992 1993 1994 1995 (UNAUDITED)
-------- ------- ------- ------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning
of period.................. $ 14.43 $ 14.21 $ 14.58 $ 14.88 $ 15.00 $ 14.93 $ 13.58
-------- ------- ------- ------- ----------- ----------- ----------
Income (loss) from
investment operations:
Net investment income...... 1.20 1.18 1.13 0.97 0.25 0.78 0.42
Net realized and unrealized
gains (losses) on
investments............... (0.22) 0.37 0.30 0.12 (0.07) (1.35) 0.52
-------- ------- ------- ------- ----------- ----------- ----------
Total income (loss) from
investment operations...... 0.98 1.55 1.43 1.09 0.18 (0.57) 0.94
-------- ------- ------- ------- ----------- ----------- ----------
Less dividends to
shareholders from net
investment income.......... (1.20) (1.18) (1.13) (0.97) (0.25) (0.78) (0.42)
-------- ------- ------- ------- ----------- ----------- ----------
Net asset value, end of
period..................... $ 14.21 $ 14.58 $ 14.88 $ 15.00 $ 14.93 $ 13.58 $ 14.10
-------- ------- ------- ------- ----------- ----------- ----------
-------- ------- ------- ------- ----------- ----------- ----------
Total investment return (1). 6.98% 11.41% 10.13% 7.70% 1.20% (3.95)% 6.99%
-------- ------- ------- ------- ----------- ----------- ----------
-------- ------- ------- ------- ----------- ----------- ----------
Ratios/Supplemental data:
Net assets, end of period
(000's)................... $100,148 $96,920 $91,955 $85,453 $75,260 $44,985 $ 40,134
Ratio of expenses to
average net assets**..... 1.40% 1.23% 1.18% 1.23% 1.56%* 1.53% 1.46%*
Ratio of net investment
income to average net
assets**................. 8.33% 8.29% 7.67% 6.38% 4.02%* 5.57% 6.15%*
Portfolio turnover rate.... 143% 3% 75% 139% 127% 256% 193%
</TABLE>
- ------------
+ For the period June 14, 1993 (commencement of offering of shares) to August
31, 1993.
* Annualized.
** During the six months ended July 31, 1995, Mitchell Hutchins waived certain
of its fees from the Fund. If such fee waivers had not been made, the
annualized ratio of expenses to average net assets and the annualized ratio
of net investment income to average net assets would have been 1.55% and
6.06%, respectively, for Class A shares, 1.80% and 5.95%, respectively, for
Class B shares and 1.05% and 6.58%, respectively, for Class C shares for the
six months ended July 31, 1995.
(1) Total investment return is calculated assuming a $1,000 investment on the
first day of each period reported, reinvestment of all dividends at net
asset value on the payable dates, and a sale at net asset value on the last
day of each period reported. The figures do not include sales charges;
results for Class A shares would be lower if sales charges were included.
Total investment returns for periods of less than one year have not been
annualized.
14
<PAGE>
- --------------------------------------------------------------------------------
Financial Highlights (concluded)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B CLASS C
- ---------------------------------------------------------- ---------------------------------------------------------
FOR THE FOR THE
FOR THE FOR THE SIX MONTHS FOR THE FOR THE SIX MONTHS
PERIOD FIVE MONTHS FOR THE ENDED PERIOD FIVE MONTHS FOR THE ENDED
ENDED ENDED YEAR ENDED JULY 31, ENDED ENDED YEAR ENDED JULY 31,
AUGUST 31, JANUARY 31, JANUARY 31, 1995 AUGUST 31, JANUARY 31, JANUARY 31, 1995
1993+ 1994 1995 (UNAUDITED) 1993+ 1994 1995 (UNAUDITED)
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 15.00 $ 14.99 $ 14.92 $13.57 $15.00 $ 14.99 $ 14.92 $13.57
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
0.17 0.23 0.74 0.41 0.20 0.28 0.84 0.46
(0.01) (0.07) (1.35) 0.52 (0.01) (0.07) (1.35) 0.52
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
0.16 0.16 (0.61) 0.93 0.19 0.21 (0.51) 0.98
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
(0.17) (0.23) (0.74) (0.41) (0.20) (0.28) (0.84) (0.46)
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
$ 14.99 $ 14.92 $ 13.57 $14.09 $14.99 $ 14.92 $ 13.57 $14.09
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
0.79% 1.06% (4.20)% 6.86% 1.22% 1.37% (3.49)% 7.26%
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
- ---------- ------------ ----------- ---------- ---------- ----------- ----------- ----------
$ 1,112 $ 1,647 $ 1,280 $1,319 $1,981 $ 3,677 $ 3,860 $3,231
1.59* 1.87%* 1.78% 1.71%* 0.93%* 1.14%* 1.03% 0.96%*
6.02%* 3.70%* 5.32% 6.04%* 6.68%* 4.44%* 6.07% 6.66%*
139% 127% 256% 193% 139% 127% 256% 193%
</TABLE>
15
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Shareholder Information
- --------------------------------------------------------------------------------
A special meeting of shareholders of Mitchell Hutchins/Kidder, Peabody
Government Income Fund ("Fund") was held on April 13, 1995. At the meeting David
J. Beaubien, William W. Hewitt, Jr., Thomas R. Jordan, Frank P.L. Minard and
Carl W. Schafer were elected as directors to serve without limit in time,
subject to resignation, retirement or removal. The selection of Deloitte &
Touche LLP as the Fund's independent accountants was ratified.
The votes were as follows:
<TABLE>
<CAPTION>
ALL SHARES VOTING AS A SINGLE CLASS
---------------------------------------------
SHARES VOTED FOR SHARES WITHHOLD AUTHORITY
---------------- -------------------------
<S> <C> <C>
David J. Beaubien...................................... 2,061,269 267,942
William W. Hewitt, Jr.................................. 2,061,269 267,942
Thomas R. Jordan....................................... 2,061,269 267,942
Frank P. L. Minard..................................... 2,061,269 267,942
Carl W. Schafer........................................ 2,061,269 267,942
</TABLE>
<TABLE>
<CAPTION>
ALL SHARES VOTING AS A SINGLE CLASS
----------------------------------------------
SHARES SHARES SHARES
VOTED FOR VOTED AGAINST WITHHOLD AUTHORITY
--------- ------------- ------------------
<S> <C> <C> <C>
Ratification of the selection of Deloitte
& Touche LLP........................................ 2,018,965 22,283 287,963
</TABLE>
In addition the following agreements were approved for the Fund:
1) An interim investment advisory agreement between the Fund and Mitchell
Hutchins Asset Management Inc. ("Mitchell Hutchins") containing substantially
the same terms, conditions and fees as the previous investment advisory
agreement with Kidder Peabody Asset Management, Inc. ("KPAM").
The votes were as follows:
<TABLE>
<CAPTION>
ALL SHARES VOTING AS A SINGLE CLASS
------------------------------------------------
SHARES SHARES SHARES
VOTED FOR VOTED AGAINST WITHOLD AUTHORITY
--------- ------------- ------------------
<S> <C> <C> <C>
2,012,888 9,868 306,455
</TABLE>
16
<PAGE>
Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
- --------------------------------------------------------------------------------
Shareholder Information (concluded)
- --------------------------------------------------------------------------------
2) A new investment advisory and administration agreement between the Fund
and Mitchell Hutchins containing the same fees and substantively similar
material terms and conditions as the previous investment advisory agreement with
KPAM to commence on the termination of the interim agreement.
The votes were as follows:
<TABLE>
<CAPTION>
ALL SHARES VOTING AS A SINGLE CLASS
------------------------------------------------
SHARES SHARES SHARES
VOTED FOR VOTED AGAINST WITHOLD AUTHORITY
--------- ------------- ------------------
<S> <C> <C> <C>
2,016,516 9,231 303,464
</TABLE>
Note: Broker non-votes and abstentions are included within the "Shares
Withhold Authority" totals.
17
<PAGE>
---------------------------------------
DIRECTORS
David J. Beaubien
William W. Hewitt, Jr.
Thomas R. Jordan
Frank P.L. Minard
Carl W. Schafer
---------------------------------------
OFFICERS
Margo N. Alexander
President
Dennis L. McCauley
Vice President
Nirmal Singh
Vice President
Victoria E. Schonfeld
Vice President
Dianne E. O'Donnell
Vice President and Secretary
Julian F. Sluyters
Vice President and Treasurer
---------------------------------------
INVESTMENT ADVISER,
ADMINISTRATOR
AND DISTRIBUTOR
Mitchell Hutchins Asset Management Inc.
1285 Avenue of the Americas
New York, New York 10019
---------------------------------------
This report is not to be used in
connection with the offering of shares
of the Fund unless accompanied or
preceded by an effective prospectus.
The financial information included
herein is taken from the records of the
Fund without examination by independent
accountants who do not express an
opinion thereon.
A prospectus containing more complete
information
for any of the funds listed on the back
cover can be
obtained from a PaineWebber investment
executive
or correspondent firm. Read the
prospectus carefully
before investing.
